National Bankshares
Your Local
Community
Bank
2018 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
National Bankshares
National 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 127 years of service in the area. National
Bank currently operates 25 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.
Financial Highlights
($ in thousands, except ratios, share and per share data)
FOR THE YEAR
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 (1)
Average equity to average assets
$
2018
16,151
2.32
2.32
1.21
1.29%
8.65%
3.36%
53.20%
14.91%
2017
14,092
2.03
2.03
1.17
1.14%
7.64%
3.45%
50.41%
14.93%
2016
14,942
2.15
2.15
1.16
1.24%
8.30%
3.51%
49.32%
14.92%
2015
15,833
2.28
2.28
1.14
1.37%
9.22%
3.86%
49.41%
14.86%
2014
16,914
2.43
2.43
1.13
1.51%
10.72%
4.00%
47.08%
14.08%
AT YEAR-END
2018
2017
2016
2015
2014
Loans, net
Allowance for loan losses to total loans
Total securities
Total assets
Total deposits
Stockholders’ equity
Book value per share
$ 702,409
660,144
639,452
610,711
597,203
1.04%
1.19%
1.28%
1.34%
1.36%
$ 426,230
1,256,032
1,051,942
190,238
27.34
459,751
1,256,757
1,059,734
184,896
26.57
440,409
1,233,942
1,043,442
178,263
25.62
389,288
1,203,519
1,018,859
172,114
24.74
385,385
1,158,798
982,428
166,303
23.93
Net income ($ millions)
18
Cash dividends per share ($)
1.5
Return on average assets (%)
2.0
15
12
9
6
3
0
16.9
15.8
16.2
14.9
14.1
2014
2015
2016
2017
2018
1.2
0.9
0.6
0.3
0.0
1.13
1.14
1.16
1.17
1.21
2014
2015
2016
2017
2018
1.5
1.0
0.5
0.0
1.51
1.37
1.24
1.14
1.29
2014
2015
2016
2017
2018
Return on average equity (%)
12
Loans, net ($ millions)
800
Allowance for loan losses to total
1.5
loans (%)
10
10.72
8
6
4
2
0
9.22
8.65
8.30
7.64
2014
2015
2016
2017
2018
700
600
500
400
300
200
100
0
702.4
660.1
639.5
597.2
610.7
2014
2015
2016
2017
2018
1.2
0.9
0.6
0.3
0.0
1.36
1.34
1.28
1.19
1.04
2014
2015
2016
2017
2018
(1) The efficiency ratio is a non-GAAP financial measure that the Company believes provides investors with important information regarding
operational efficiency. Such information is not prepared in accordance with U.S. generally accepted accounting principles (GAAP) and should
not be viewed as a substitute for GAAP. See “Non-GAAP Financial Measures” included in Item 7 of the enclosed Form 10-K.
To Our Shareholders
At National Bankshares, we believe in local
community banking. In a world where many
financial institutions serve customers across the
nation and globe, we think that there is still a place for
a bank deeply rooted in the many communites that we
serve. A bank where personal service is the foundation
of the business and our customers are also our friends
and neighbors. For over 127 years, we have proven that
community banking can be profitable and purpose-
driven. 2018 was no exception, and we are pleased to
share the following good news with you:
Net income increased by 14.61% to $16.15 million
(vs. $14.09 million in 2017)
Net loans increased by 6.40% to $702.41 million
(vs. $660.14 million in 2017)
Return on average assets increased to 1.29%
(vs. 1.14% in 2017)
Return on average equity increased to 8.65%
(vs. 7.64% in 2017)
Allowance for loan losses to total loans decreased
to 1.04% (vs. 1.19% in 2017)
Per share dividend increased to $1.21
(vs. $1.17 in 2017)
As we anticipated in last year’s report, The Tax Cuts
and Jobs Act of 2017 has been very beneficial for
our bottom line. However, it is worth noting that
underlying factors – in particular loan growth and
asset quality improvement - contributed significantly
to our increased earnings in 2018. Making good loans
can be a challenging task, especially in some of the
markets we serve where economic growth is measured
and competition from other banks is significant.
Despite these challenges, our lenders have been
successful in securing new loans that are a dependable
source of income and are of good credit quality.
This year’s tax savings have been put to work in
several key areas of our organization. As a community
bank dedicated to personalized service, providing an
inviting branch environment for our customers is
very important. In 2018 we completed renovations at
most of our branch offices as part of our larger plan
for physical improvements across our network of 25
offices.
Our Company invested heavily in technology in 2018.
An overhaul of our items processing systems has
greatly increased operational efficiency. The Company
hired an experienced Information Security Officer and
launched a bank-wide security initiative. Under this
program, improvements to hardware, software and
staff training have led to measurably higher security
throughout our organization.
We have also put powerful new banking tools into the
hands of our customers. In the first quarter of 2019
we launched a new and improved mobile banking app
that allows users to deposit checks from anywhere
with their phone. Select business customers are
now originating Automated Clearing House (ACH)
transactions, with plans to expand this convenient
service.
As we look toward the future, we are actively seeking
ways to better serve our communities while ensuring
ongoing profitability. As part of this effort, National
Bank will relocate its Abingdon Office to a centralized
downtown location later this year. We are optimistic
that this new location will improve convenience for
our customers and give our brand more visibility in
this dynamic market.
At National Bankshares, we value our customers,
our communities, our shareholders and our fellow
employees. We believe that community banking is
a people business, and that by serving you well, our
business will thrive. Your support and trust is the key
to our success. Thank you for helping to make 2018
another successful year at National Bankshares.
F. Brad Denardo
President &
Chief Executive Officer
A complete discussion of the Company’s financial results
is available in the SEC Form 10-K for 2018 that follows this
summary annual report.
National Bankshares Inc. Board of Directors
Standing from left: Michael E. Dye, Glenn P. Reynolds, Lawrence J. Ball, Dr. J. Lewis Webb, Jr., William A.
Peery, Norman V. Fitzwater, III, James C. Thompson, Dr. Mary G. Miller, Dr. John E. Dooley. Seated, from
left: Mildred R. Johnson, Charles E. Green, III, Dr. Jack M. Lewis, F. Brad Denardo, James G. Rakes.
Lawrence J. Ball
President, Retired
Moog Components Group
Michael E. Dye
Pharmacist/Owner
New Graham Pharmacy
F. Brad Denardo
President & CEO
National Bankshares, Inc.
Chairman, President & CEO
National Bank
Chairman, President & CEO
National Bankshares
Financial Services, Inc.
Dr. John E. Dooley
CEO
Virginia Tech Foundation, Inc.
Norman V. Fitzwater, III
President
A Cleaner World, Blacksburg
Charles E. Green, III
Financial Planner
AXA Advisors, L.L.C.
Mildred R. Johnson
Dean of Admissions
Radford University
National Bank Board of Directors
Dr. Jack M. Lewis
Past President
New River Community
College
Dr. Mary G. Miller
Director
Regional Acceleration and
Mentoring Program
William A. Peery
President
Cargo Oil Co., Inc.
James G. Rakes
Chairman
National Bankshares, Inc.
Glenn P. Reynolds
President
Reynolds Architects, Inc.
James C. Thompson
Chairman
Thompson & Litton, Inc.
Dr. J. Lewis Webb, Jr.
Retired Dentist
Standing from left: Glenn P. Reynolds, Lawrence J. Ball, J. Lewis Webb, Jr., William A. Peery, Michael
E. Dye, Norman V. Fitzwater, III, Mary G. Miller. Seated, from left: James C. Thompson, Charles E.
Green, III, Mildred R. Johnson, John E. Dooley, F. 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 14, 2019 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
1. Abingdon
2. Blacksburg
6 offices
10. Pulaski
2 offices
11. Radford
3. Bluefield, VA
12. Rich Creek
2 offices
4. Christiansburg
2 offices
5. Claypool Hill
6. Dublin
7. Galax
8. Pearisburg
9. Pembroke
13. Richlands
14. Roanoke Loan
Production Office
15. Tazewell
3 offices
16. 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)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2018
[ ] 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 of incorporation)
54-1375874
(I.R.S. Employer Identification No.)
101 Hubbard Street
P.O. Box 90002
Blacksburg, VA 24062-9002
(540) 951-6300
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.25 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [x]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation
S-T(§232.405 of this chapter) during the preceding 12 months (or for such period that the registrant was required to submit files). Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging
growth company. See definition of “accelerated filer, large accelerated filer, smaller reporting company and emerging growth company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [x] Non-accelerated filer [ ] Smaller reporting company [ ] Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [x]
The aggregate market value of the voting common stock of the registrant held by stockholders (not including voting common stock held by Directors, Executive
Officers and Corporate Governance) on June 30, 2018 (the last business day of the most recently completed second fiscal quarter) was approximately $322,849,994.
As of March 11, 2019, the registrant had 6,505,574 shares of voting common stock outstanding.
Portions of the following documents are incorporated herein by reference into the Part of the Form 10-K indicated.
DOCUMENTS INCORPORATED BY REFERENCE
National Bankshares, Inc. 2018 Annual Report to Stockholders
National Bankshares, Inc. Proxy Statement for the 2019 Annual Meeting of Stockholders
Part II
Part III
Document
Part of Form 10-K into which incorporated
NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-K
Index
Part I
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Item 9A.
Item 9B.
Part III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Part IV
Item 15.
Item 16.
Signatures
Index of Exhibits
Financial Statements and Supplementary Data
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
Summary Information
2
Page
3
10
14
14
14
14
15
16
17
45
46
95
95
96
96
97
97
97
97
98
99
100
105
Part I
$ in thousands, except per share data
Item 1. Business
History and Business
National Bankshares, Inc. (the “Company” or “NBI”) is a financial holding company that was organized in 1986 under the laws of
Virginia and is registered under the Bank Holding Company Act of 1956. It conducts most of its operations through its wholly-owned
community bank subsidiary, the National Bank of Blacksburg (“NBB”). It also owns National Bankshares Financial Services, Inc.
(“NBFS”), which does business as National Bankshares Insurance Services and National Bankshares Investment Services.
The National Bank of Blacksburg
The National Bank of Blacksburg, which does business as National Bank, was originally chartered in 1891 as the Bank of
Blacksburg. Its state charter was converted to a national charter in 1922 and it became the National Bank of Blacksburg. In 2004, NBB
purchased Community National Bank of Pulaski, Virginia. In May, 2006, Bank of Tazewell County, a Virginia bank which since 1996
was a wholly-owned subsidiary of NBI, was merged with and into NBB.
NBB is community-oriented and offers a full range of retail and commercial banking services to individuals, businesses, non-profits
and local governments from its headquarters in Blacksburg, Virginia and its twenty-four branch offices throughout southwest Virginia
and one loan production office in Roanoke Virginia. NBB has telephone, mobile and internet banking and it operates twenty-four
automated teller machines in its service area.
The Bank’s primary source of revenue stems from lending activities. The Bank focuses lending on small and mid-sized businesses
and individuals. Loan types include commercial and agricultural, commercial real estate, construction for commercial and residential
properties, residential real estate, home equity and various consumer loan products. The Bank believes its prudent lending policies align
its underwriting and portfolio management with its risk tolerance and income strategies. Underwriting and documentation requirements
are tailored to the unique characteristics and inherent risks of each loan category.
The Bank’s loan policy is updated and approved by the Board of Directors annually and disseminated to lending and loan portfolio
management personnel to ensure consistent lending practices. The policy communicates the Company’s risk tolerance by prescribing
underwriting guidelines and procedures, including approval limits and hierarchy, documentation standards, requirements for collateral
and loan-to-value limits, debt coverage, overall credit-worthiness and guarantor support.
Of primary consideration is the repayment ability of the borrowers and (if secured) the collateral value in relation to the principal
balance. Collateral lowers risk and may be used as a secondary source of repayment. The credit decision must be supported by
documentation appropriate to the type of loan, including current financial information, income verification or cash flow analysis, tax
returns, credit reports, collateral information, guarantor verification, title reports, appraisals (where appropriate) and other documents.
A discussion of underwriting policies and procedures specific to the major loan products follows.
Commercial Loans. Commercial and agricultural loans primarily finance equipment acquisition, expansion, working capital, and
other general business purposes. Because these loans have a higher degree of risk, the Bank generally obtains collateral such as
inventory, accounts receivables or equipment and personal guarantees from the borrowing entity’s principal owners. The Bank’s policy
limits lending up to 60% of the appraised value for inventory, up to 90% of the lower of cost of market value of equipment and up to
70% for accounts receivables less than 90 days old. Credit decisions are based upon an assessment of the financial capacity of the
applicant, including the primary borrower’s ability to repay within proposed terms, a risk assessment, financial strength of guarantors
and adequacy of collateral. Credit agency reports of individual owners’ credit history supplement the analysis.
Commercial Real Estate Loans. Commercial mortgages and construction loans are offered to investors, developers and builders
primarily within the Bank’s market area in southwest Virginia. These loans generally are secured by first mortgages on real estate. The
loan amount is generally limited to 80% of the collateral value and is individually determined based on the property type, quality,
location and financial strength of any guarantors. Commercial properties financed include retail centers, office space, hotels and motels,
apartments, and industrial properties.
Underwriting decisions are based upon an analysis of the economic viability of the collateral and creditworthiness of the borrower.
The Bank obtains appraisals from qualified certified independent appraisers to establish the value of collateral properties. The property’s
projected net cash flows compared to the debt service requirement (the “debt service coverage ratio” or “DSCR”) is required to be 115%
or greater and is computed after deduction for a vacancy factor and property expenses, as appropriate. Borrower cash flow may be
supplemented by a personal guarantee from the principal(s) of the borrower and guarantees from other parties. The Bank requires title
insurance, fire, extended coverage casualty insurance and flood insurance, if appropriate, in order to protect the security interest in the
underlying property. In addition, the Bank may employ stress testing techniques on higher balance loans to determine repayment ability
in a changing rate environment before granting loan approval.
Public Sector and Industrial Development Loans. The Company provides both long and short term loans to municipalities and other
governmental entities within its geographical footprint. Borrowers include general taxing authorities such as a city or county,
industrial/economic development authorities or utility authorities. Repayment sources are derived from taxation, such as property taxes
3
and sales taxes, or revenue from the project financed with the loan. The Company’s underwriting considers local economic and
population trends, reserves and liabilities, including pension liabilities.
Construction Loans. Construction loans are underwritten against projected cash flows from rental income, business and/or personal
income from an owner-occupant or the sale of the property to an end-user. Associated risks may be mitigated by requiring fixed-price
construction contracts, performance and payment bonding, controlled disbursements, and pre-sale contracts or pre-lease agreements.
Consumer Real Estate Loans. The Bank offers a variety of first mortgage and junior lien loans secured by primary residences to
individuals within our markets. Credit decisions are primarily based on loan-to-value (“LTV”) ratios, debt-to-income (“DTI”) ratios,
liquidity and net worth. Income and financial information is obtained from personal tax returns, personal financial statements and
employment documentation. A maximum LTV ratio of 80% is generally required, although higher levels are permitted. The DTI ratio
is limited to 43% of gross income.
Consumer real estate mortgages may have fixed interest rates for the entire term of the loan or variable interest rates subject to
change after the first, third, or fifth year. Variable rates are based on the weekly average yield of United States Treasury Securities and
are underwritten at fully-indexed rates. We do not offer certain high risk loan products such as interest-only consumer mortgage loans,
hybrid loans, payment option ARMs, reverse mortgage loans, loans with initial teaser rates or any product with negative amortization.
Hybrid loans are loans that start out as a fixed rate mortgage, but after a set number of years they automatically adjust to an adjustable
rate mortgage. Payment option ARMs usually have adjustable rates, for which borrowers choose their monthly payment of either a full
payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan in
accordance with the originally underwritten amortization.
Home equity loans are secured primarily by second mortgages on residential property. The underwriting policy for home equity
loans generally permits aggregate (the total of all liens secured by the collateral property) borrowing availability up to 80% of the
appraised value of the collateral. We offer both fixed rate and variable rate home equity loans, with variable rate loans underwritten at
fully-indexed rates. Decisions are primarily based on LTV ratios, DTI ratios, liquidity and credit history. We do not offer home equity
loan products with reduced documentation.
Consumer Loans. Consumer loans include loans secured by automobiles, loans to consumers secured by other non-real estate
collateral and loans to consumers that are unsecured. Automobile loans include loans secured by new or used automobiles. We originate
automobile loans on a direct basis. During 2018 and years prior, automobile loans were also originated on an indirect basis through
selected dealerships. This program has been discontinued in 2019. We require borrowers to maintain collision insurance on automobiles
securing consumer loans. Our procedures for underwriting consumer loans include an assessment of an applicant’s overall financial
capacity, including credit history and the ability to meet existing obligations and payments on the proposed loan. An applicant’s
creditworthiness is the primary consideration, and if the loan is secured by an automobile or other collateral, the underwriting process
also includes a comparison of the value of the collateral security to the proposed loan amount.
Other Products and Services. Deposit products offered by the Bank include interest-bearing and non-interest bearing demand
deposit accounts, money market deposit accounts, savings accounts, certificates of deposit, health savings accounts and individual
retirement accounts. Deposit accounts are offered to both individuals and commercial businesses. Business and consumer debit and
credit cards are available. NBB offers other miscellaneous services normally provided by commercial banks, such as letters of credit,
night depository, safe deposit boxes, utility payment services and automatic funds transfer. NBB conducts a general trust business that
has wealth management, trust and estate services for individual and business customers.
At December 31, 2018, NBB had total assets of $1,253,172 and total deposits of $1,052,082. NBB’s net income for 2018 was
$16,877, which produced a return on average assets of 1.35% and a return on average equity of 9.14%. Refer to Note 11 of the Notes to
Consolidated Financial Statements for NBB’s risk-based capital ratios.
National Bankshares Financial Services, Inc.
In 2001, National Bankshares Financial Services, Inc. was formed in Virginia as a wholly-owned subsidiary of NBI. NBFS offers
non-deposit investment products and insurance products for sale to the public. NBFS works cooperatively with Infinex Investments,
Inc. to provide investments and with Bankers Insurance, LLC for insurance products. NBFS does not significantly contribute to NBI’s
net income.
4
Operating Revenue
The following table displays components that contributed 15% or more of the Company’s total operating revenue for the years
ended December 31, 2018, 2017 and 2016.
Period
December 31, 2018
December 31, 2017
December 31, 2016
Market Area
Class of Service
Interest and Fees on Loans
Interest on Investments
Noninterest Income
Interest and Fees on Loans
Interest on Investments
Noninterest Income
Interest and Fees on Loans
Interest on Investments
Noninterest Income
Percentage of
Total Revenues
61.49 %
22.02 %
15.17 %
61.22 %
21.55 %
15.62 %
61.12 %
22.96 %
14.81 %
The Company’s market area in southwest Virginia is made up of the counties of Montgomery, Roanoke, Giles, Pulaski, Tazewell,
Wythe, Smyth and Washington. It includes the independent cities of Roanoke, Radford and Galax, and the portions of Carroll and
Grayson Counties that are adjacent to Galax. The Company also serves those portions of Mercer County, Monroe County and McDowell
County, West Virginia that are contiguous with Tazewell County, Virginia. Although largely rural, the market area is home to two major
universities, Virginia Tech and Radford University, and to three community colleges. Virginia Tech, located in Blacksburg, Virginia, is
the area’s largest employer and is the Commonwealth’s second largest university. A second state supported university, Radford
University, is located nearby. In recent years, Virginia Tech’s Corporate Research Center has brought a number of technology-related
companies to Montgomery County.
In addition to education, the market area has a diverse economic base with manufacturing, agriculture, tourism, healthcare, retail
and service industries. Large manufacturing facilities in the region include Celanese Acetate, the largest employer in Giles County, and
Volvo Heavy Trucks, the largest company in Pulaski County. Both of these firms have experienced cycles of hiring and layoffs within
the past several years. Tazewell County is largely dependent on the coal mining industry and on agriculture for its economic base. Coal
production is a cyclical industry that has declined significantly in recent years and suffered from increased regulations. Montgomery
County, Bluefield in Tazewell County and Abingdon in Washington County are regional retail centers and have facilities to provide
basic health care for the region.
NBI’s market area offers the advantages of a good quality of life, scenic beauty, moderate climate and historical and cultural
attractions. The region has had some recent success attracting retirees, particularly from the Northeast and urban northern Virginia.
Because NBI’s market area is economically diverse and includes large public employers, it has historically avoided the most extreme
effects of past economic downturns. If the economy wavers or experiences recession, it is likely that unemployment will rise and that
other economic indicators will negatively impact the Company's trade area.
Competition
The banking and financial services industry in NBI’s market area is highly competitive. The competitive business environment is a
result of changes in regulation, changes in technology and product delivery systems and competition from other financial institutions as
well as non-traditional financial services. NBB competes for loans and deposits with other commercial banks, credit unions, securities
and brokerage companies, mortgage companies, insurance companies, retailers, automobile companies and other nonbank financial
service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets
and offer a broader array of financial services than NBB. In order to compete, NBB relies upon a deep knowledge of its markets, a
service-based business philosophy, personal relationships with customers, specialized services tailored to meet customers’ needs and
the convenience of office locations. In addition, the bank is generally competitive with other financial institutions in its market area with
respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts.
Cybersecurity
As a financial institution holding company, NBI is subject to cybersecurity risks and has suffered two cybersecurity incidents. To
manage and mitigate cybersecurity risk, the Company limits certain transactions and interactions with customers. The Company does
not offer online account openings or loan originations, limits the dollar amount of online banking transfers to other banks, does not
permit customers to submit address changes or wire requests through online banking, requires a special vetting process for commercial
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customers who wish to originate ACH transfers, and limits certain functionalities of mobile banking. The Company also requires
assurances from key vendors regarding their cybersecurity. While these measures reduce the likelihood and scope of the risk of further
cybersecurity breaches, in light of the evolving sophistication of system intruders, the risk of such breaches continues to exist. We
maintain insurance for these risks but insurance policies are subject to exceptions, exclusions and terms whose applications have not
been widely interpreted in litigation. Accordingly, insurance can provide less than complete protection against the losses that result
from cybersecurity breaches and pursuing recovery from insurers can result in significant expense. In addition, some risks such as
reputational damage and loss of customer goodwill, which can result from cybersecurity breaches cannot be insured against.
Organization and Employment
NBI, NBB and NBFS are organized in a holding company/subsidiary structure. At December 31, 2018, NBB had 231 full time
equivalent employees and NBFS had 4 full time employees. NBB performs services and charges commensurate fees to NBI and NBFS.
Regulation, Supervision and Government Policy
NBI and NBB are subject to state and federal banking laws and regulations that provide for general regulatory oversight of all
aspects of their operations. As a result of substantial regulatory burdens on banking, financial institutions like NBI and NBB are at a
disadvantage to other competitors who are not as highly regulated, and NBI and NBB’s costs of doing business are accordingly higher.
Legislative efforts to prevent a repeat of the 2008 financial crisis culminated in the Dodd-Frank Wall Street Reform Act of 2010. This
legislation, together with existing and planned regulations, dramatically increased the regulatory burden on commercial banks. The
burden falls disproportionately on community banks like NBB, which must devote a higher proportion of their human and other
resources to compliance than do their larger competitors. The financial crisis also heightened the examination focus by banking
regulators, particularly on Bank Secrecy Act, real estate-related assets and commercial loans. However, with the passage of the
Economic Growth, Regulatory Reform and Consumer Protection Act (“EGRRCPA”) in 2018, a number of regulatory requirements for
smaller financial institutions like the Company were reduced or eliminated (see below). The following is a brief summary of certain
laws, rules and regulations that affect NBI and NBB.
National Bankshares, Inc.
NBI is a bank holding company qualified as a financial holding company under the Federal Bank Holding Company Act (“BHCA”),
which is administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). NBI is required to file an
annual report with the Federal Reserve and may be required to furnish additional information pursuant to the BHCA. The Federal
Reserve is authorized to examine NBI and its subsidiaries. With some limited exceptions, the BHCA requires a bank holding company
to obtain prior approval from the Federal Reserve before acquiring or merging with a bank or before acquiring more than 5% of the
voting shares of a bank unless it already controls a majority of shares.
The Bank Holding Company Act. Under the BHCA, a bank holding company is generally prohibited from engaging in nonbanking
activities unless the Federal Reserve has found those activities to be incidental to banking. Bank holding companies also may not acquire
more than 5% of the voting shares of any company engaged in nonbanking activities. Amendments to the BHCA that were included in
the Gramm-Leach-Bliley Act of 1999 (see below) permitted any bank holding company with bank subsidiaries that are well-capitalized,
well-managed and which have a satisfactory or better rating under the Community Reinvestment Act (see below) to file an election with
the Federal Reserve to become a financial holding company. A financial holding company may engage in any activity that is (i) financial
in nature (ii) incidental to a financial activity or (iii) complementary to a financial activity. Financial activities include insurance
underwriting, insurance agency activities, securities dealing and underwriting and providing financial, investment or economic advising
services. NBI is a financial holding company that currently engages in insurance agency activities and providing financial, investment
or economic advising services.
The Virginia Banking Act. The Virginia Banking Act requires all Virginia bank holding companies to register with the Virginia
State Corporation Commission (the “Commission”). NBI is required to report to the Commission with respect to its financial condition,
operations and management. The Commission may also make examinations of any bank holding company and its subsidiaries and must
approve the acquisition of ownership or control of more than 5% of the voting shares of any Virginia bank or bank holding company.
The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (“GLBA”) permits significant combinations among different sectors
of the financial services industry, allows for expansion of financial service activities by bank holding companies and offers financial
privacy protections to consumers. GLBA preempts most state laws that prohibit financial holding companies from engaging in insurance
activities. GLBA permits affiliations between banks and securities firms in the same holding company structure, and it permits financial
holding companies to directly engage in a broad range of securities and merchant banking activities.
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The Sarbanes-Oxley Act. The Sarbanes-Oxley Act (“SOX”) protects investors by improving the accuracy and reliability of corporate
disclosures. It impacts all companies with securities registered under the Securities Exchange Act of 1934, including NBI. SOX creates
increased responsibility for chief executive officers and chief financial officers with respect to the content of filings with the Securities
and Exchange Commission. Section 404 of SOX and related Securities and Exchange Commission rules focused increased scrutiny by
internal and external auditors on NBI’s systems of internal controls over financial reporting, which is designed to ensure that those
internal controls are effective in both design and operation. SOX sets out enhanced requirements for audit committees, including
independence and expertise, and it includes stronger requirements for auditor independence and limits the types of non-audit services
that auditors can provide. Finally, SOX contains additional and increased civil and criminal penalties for violations of securities laws.
Capital and Related Requirements. In August, 2018, the Federal Reserve updated the Small Bank Holding Company Policy
Statement (“the Statement”), in compliance with the EGRRCPA. The Statement, among other things, exempts bank holding companies
that fall below a certain asset threshold from reporting consolidated regulatory capital ratios and from minimum regulatory capital
requirements. The interim final rule expands the exemption to bank holding companies with consolidated total assets of less than $3
billion. Prior to August 2018, the statement exempted bank holding companies with consolidated total assets of less than $1 billion. As
a result of the interim final rule, the Company qualifies as of August, 2018 as a small bank holding company and is no longer subject to
regulatory capital requirements on a consolidated basis.
The Bank continues to be subject to various capital requirements administered by banking agencies. Failure to meet minimum
capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the
Company’s financial statements. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators
about components, risk weightings and other factors.
The regulations require a minimum ratio of certain capital measures. In addition, the Bank is required to maintain a “capital
conservation buffer” in excess of the minimum ratio requirements. The implementation period for the capital conservation buffer began
in 2016 and will be fully phased in on January 1, 2019. The following table presents the required minimum ratios and minimum ratios
with the capital conservation buffer for 2018, as well as the final minimum ratios with the capital conservation buffer when fully phased
in:
Regulatory Capital Ratios
Common Equity Tier 1 Capital to Risk Weighted
Assets
Tier 1 Capital to Risk Weighted Assets
Total Capital to Risk Weighted Assets
Leverage Ratio
Minimum Ratio
Minimum Ratio With
Capital Conservation
Buffer as of
December 31, 2018
Minimum Ratio With
Capital Conservation
Buffer beginning
January 1, 2019
4.50 %
6.00 %
8.00 %
4.00 %
6.375 %
7.875 %
9.875 %
4.00 %
7.00 %
8.50 %
10.50 %
4.00 %
Risk-weighted assets are assets on the balance sheet as well as certain off-balance sheet items, such as standby letters of credit, to
which weights between 0% and 1250% are applied, according to the risk of the asset type. Common Equity Tier 1 Capital (“CET1”) is
capital according to the balance sheet, adjusted for goodwill and intangible assets and other prescribed adjustments. At the Company’s
election, CET1 is also adjusted to exclude accumulated other comprehensive income. Tier 1 Capital is CET1 adjusted for additional
capital deductions. Total Capital is Tier 1 Capital increased for the allowance for loan losses and adjusted for other items. The leverage
ratio is the ratio of Tier 1 capital to total average assets, less goodwill and intangibles and certain deferred tax assets. Pursuant to the
EGRRCPA the regulators have proposed a single “Community Bank Leverage Ratio” which would eliminate the four required capital
ratios disclosed above for qualifying and electing banks and require the disclosure of a single leverage ratio based on the new Community
Capital Leverage Ratio.
NBI is expected to be a source of capital strength for its subsidiary bank, and regulators can undertake a number of enforcement
actions against NBI if its subsidiary bank becomes undercapitalized. NBI’s bank subsidiary is well capitalized and fully in compliance
with capital guidelines. Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for
financial institutions could subject NBB or the Company to a variety of enforcement remedies, including issuance of a capital directive,
the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of
interest that the institution may pay on its deposits and other restrictions on its business. Failure to maintain excess reserves for the
capital conservation buffer would limit the ability to make capital distributions and pay discretionary bonuses to executives. As
described above, significant additional restrictions can be imposed on NBB if it would fail to meet applicable capital requirements.
Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act was signed into law on July 21, 2010. Its wide
ranging provisions affect all federal financial regulatory agencies and nearly every aspect of the American financial services industry.
The Dodd-Frank Act created an independent Consumer Financial Protection Bureau (“CFPB”) which has the ability to write rules for
consumer protections governing all financial institutions. All consumer protection responsibility formerly handled by other banking
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regulators was consolidated in the CFPB. It oversees the enforcement of all federal laws intended to ensure fair access to credit. For
smaller financial institutions such as NBI and NBB, the CFPB coordinates its examination activities through their primary regulators.
The Dodd-Frank Act contains provisions designed to reform mortgage lending, which includes the requirement of additional
disclosures for consumer mortgages, and the CFPB implemented many mortgage lending regulations to carry out its mandate.
Additionally, in response to the Dodd-Frank Act, the Federal Reserve issued rules in 2011 which had the effect of limiting the fees
charged to merchants by credit card companies for debit card transactions. The Dodd-Frank Act also contains provisions that affect
corporate governance and executive compensation.
The Dodd-Frank Act provisions are extensive and have required the Company and the Bank to deploy resources to comply with
them. Several federal agencies, including the Federal Reserve, the CFPB and the Securities and Exchange Commission, have been in
the process of issuing final regulations implementing major portions of the legislation, and this process will be affected by the
EGRRCPA, which rolls back many provisions of the Dodd-Fran Act (see below).
Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and
managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this
requirement, the Company is expected to commit resources to support NBB, including at times when the Company may not be in a
financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate
in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s
bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary
bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
The Economic Growth, Regulatory Reform and Consumer Protection Act of 2018. In May 2018 the EGRRCPA amended provisions
of the Dodd-Frank Act and other statutes administered by banking regulators. Among these amendments are provisions to tailor
applicability of certain of the enhanced prudential standards for Systemically Important Financial Institutions (“SIFI’s”) and to increase
the $50 billion asset threshold in two stages to $250 billion to which these enhanced standards apply. The Act exempts insured depositary
institutions (and their parent companies) with less than $10 billion in consolidated assets and that meet certain tests from the Volker
Rule (which prohibits banks from conducting certain investment activities with their own accounts). As discussed above, the EGRRCPA
requires the regulators to promulgate rules establishing a new Community Bank Leverage Ratio (currently proposed to be 9%) for
financial institutions with less than $10 billion in consolidated assets. If the financial institution maintains its tangible equity above the
Community Bank Leverage Ratio it will be deemed in compliance with the various regulatory capital requirements currently in effect.
The Act increases the asset threshold from $1 billion to $3 billion for financial institutions to qualify for an 18 month on site examination
schedule. The EGRRCPA changes numerous other regulatory requirements based on the size and complexity of financial institutions,
particularly benefiting smaller institutions like the Company.
The National Bank of Blacksburg
NBB is a national banking association incorporated under the laws of the United States, and the bank is subject to regulation and
examination by the Office of the Comptroller of the Currency (“the OCC”). NBB’s deposits are insured by the Federal Deposit Insurance
Corporation (“the FDIC”) up to the limits of applicable law. The OCC, as the primary regulator, and the FDIC regulate and monitor all
areas of NBB’s operation. These areas include adequacy of capitalization and loss reserves, loans, deposits, business practices related
to the charging and payment of interest, investments, borrowings, payment of dividends, security devices and procedures, establishment
of branches, corporate reorganizations and maintenance of books and records. NBB is required to maintain certain capital ratios. It must
also prepare quarterly reports on its financial condition for the OCC and conduct an annual audit of its financial affairs. The OCC
requires NBB to adopt internal control structures and procedures designed to safeguard assets and monitor and reduce risk exposure.
While appropriate for the safety and soundness of banks, these requirements add to overhead expense for NBB and other banks.
The Community Reinvestment Act. NBB is subject to the provisions of the Community Reinvestment Act (“CRA”), which imposes
an affirmative obligation on financial institutions to meet the credit needs of the communities they serve, including low and moderate
income neighborhoods. The OCC monitors NBB’s compliance with the CRA and assigns public ratings based upon the bank’s
performance in meeting stated assessment goals. Unsatisfactory CRA ratings can result in restrictions on bank operations or expansion.
NBB received a “satisfactory” rating in its last CRA examination by the OCC.
The Gramm-Leach-Bliley Act. In addition to other consumer privacy provisions, the Gramm-Leach-Bliley Act (“GLBA”) restricts
the use by financial institutions of customers’ nonpublic personal information. At the inception of the customer relationship and annually
thereafter, NBB is required to provide its customers with information regarding its policies and procedures with respect to handling of
customers’ nonpublic personal information. GLBA generally prohibits a financial institution from providing a customer’s nonpublic
personal information to unaffiliated third parties without prior notice and approval by the customer.
The USA Patriot Act. The USA Patriot Act (“Patriot Act”) facilitates the sharing of information among government entities and
financial institutions to combat terrorism and money laundering. The Patriot Act imposes an obligation on NBB to establish and maintain
8
anti-money laundering policies and procedures, including a customer identification program. The Bank must screen all customers against
government lists of known or suspected terrorists. The Patriot Act, particularly as it relates to money laundering, is a significant focus
of regulators and there is substantial regulatory oversight to insure compliance.
Consumer Laws and Regulations. There are a number of laws and regulations that regulate banks’ consumer loan and deposit
transactions. Among these are the Truth in Lending Act, the Truth in Savings Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Electronic Funds Transfer Act, the Fair Debt Collections
Practices Act, the Home Mortgage Disclosure Act, the Service Members Civil Relief Act, laws governing flood insurance, federal and
state laws prohibiting unfair and deceptive business practices, foreclosure laws and various regulations that implement some or all of
the foregoing. NBB is required to comply with these laws and regulations in its dealings with customers. In addition, the CFPB has
adopted and may continue to refine rules regulating consumer mortgage lending pursuant to the Dodd-Frank Act. There are numerous
disclosure and other compliance requirements associated with the consumer laws and regulations. The EGRRCPA modified a number
of these requirements, including, for qualifying institutions with less than $10 billion in assets, a safe harbor for compliance with the
“ability to pay” requirements for consumer mortgage loans.
Deposit Insurance. NBB has deposits that are insured by the FDIC. The FDIC maintains a Deposit Insurance Fund (“DIF”) that is
funded by risk-based insurance premium assessments on insured depository institutions. Assessments are determined based upon several
factors, including the level of regulatory capital and the results of regulatory examinations. The FDIC may adjust assessments if the
insured institution’s risk profile changes or if the size of the DIF declines in relation to the total amount of insured deposits. Beginning
April 1, 2011, an institution’s assessment base became consolidated total assets less its average tangible equity as defined by the FDIC.
The FDIC has authority to impose (and has imposed during the recent financial crisis) special measures to boost the deposit insurance
fund such as prepayments of assessments and additional special assessments.
After giving primary regulators an opportunity to first take action, FDIC may initiate an enforcement action against any depository
institution it determines is engaging in unsafe or unsound actions or which is in an unsound condition, and the FDIC may terminate that
institution’s deposit insurance. NBB has no knowledge of any matter that would threaten its FDIC insurance coverage.
Capital Requirements. The capital requirements discussed above with relation to NBI are applied to NBB by the OCC. The OCC
guidelines provide that banks experiencing internal growth or making acquisitions are expected to maintain strong capital positions well
above minimum levels, without reliance on intangible assets. In addition, implementation of the BASEL III requirements increase
required capital minimums as well as compliance costs due to their complexity unless the Bank qualifies and elects to comply with the
new Community Bank Leverage Ratio discussed above.
Limits on Dividend Payments. A significant portion of NBI’s income is derived from dividends paid by NBB. As a national bank,
NBB may not pay dividends from its capital, and it may not pay dividends if the bank would become undercapitalized, as defined by
regulation, after paying the dividend. Without prior OCC approval, NBB’s dividend payments in any calendar year are restricted to the
bank’s retained net income for that year, as that term is defined by the laws and regulations, combined with retained net income from
the preceding two years, less any required transfer to surplus.
The OCC and FDIC have authority to limit dividends paid by NBB if the payments are determined to be an unsafe and unsound
banking practice. Any payment of dividends that depletes the bank’s capital base could be deemed to be an unsafe and unsound banking
practice.
Branching. As a national bank, NBB is required to comply with the state branch banking laws of Virginia, the state in which the
bank is located. NBB must also have the prior approval of the OCC to establish a branch or acquire an existing banking operation. Under
Virginia law, NBB may open branch offices or acquire existing banks or bank branches anywhere in the state. Virginia law also permits
banks domiciled in the state to establish a branch or to acquire an existing bank or branch in another state. The Dodd-Frank Act permits
the OCC to approve applications by national banks like NBB to establish de novo branches in any state in which a bank located in that
state is permitted to establish a branch.
Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB amended Regulation Z as implemented
by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and
documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms.
Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage
lender to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income
or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any
simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support;
(vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the mortgage lender can originate
“qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements.
In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments or terms
exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan
9
amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) create a rebuttable presumption of compliance with the
ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance.
The Company is predominantly an originator of compliant qualified mortgages.
Monetary Policy
The monetary and interest rate policies of the Federal Reserve, as well as general economic conditions, affect the business and
earnings of NBI. NBB and other banks are particularly sensitive to interest rate fluctuations. The spread between the interest paid on
deposits and that which is charged on loans is the most important component of the bank’s earnings. In addition, interest earned on
investments held by NBI and NBB has a significant effect on earnings. U.S. fiscal policy, including deficits requiring increased
governmental borrowing also can affect interest rates. As conditions change in the national and international economy and in the money
markets, the Federal Reserve’s actions, particularly with regard to interest rates, and the effects of fiscal policies can impact loan demand,
deposit levels and earnings at NBB. It is not possible to accurately predict the effects on NBI of economic and interest rate changes.
Other Legislative and Regulatory Concerns
Particularly because of uncertain economic conditions and the current political environment, federal and state laws and regulations
are regularly proposed that could affect the regulation of financial institutions. New, revised or rescinded regulations could add to the
regulatory burden on banks and other financial service providers and increase the costs of compliance, or they could change the products
that can be offered and the manner in which financial institutions do business. We cannot foresee how regulation of financial institutions
may change in the future and how those changes might affect NBI.
Company Website
NBI maintains a website at www.nationalbankshares.com. The Company’s annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and all amendments to those reports are made available on its website as soon as is practical after
the material is electronically filed with the Securities and Exchange Commission. The Company’s proxy materials for the 2019 annual
meeting of stockholders are also posted on a separate website at www.nationalbanksharesproxy.com. Access through the Company’s
websites to the Company’s filings is free of charge. The Securities and Exchange Commission maintains an internet site
(http://www.sec.gov) that contains reports, proxy, and information statements, and other information the Company files electronically
with the SEC.
Item 1A. Risk Factors
If economic trends reverse or recession returns, our credit risk will increase and there could be greater loan losses.
A reversal in economic trends or return to a recession is likely to result in a higher rate of business closures and increased job losses
in the region in which we do business. In addition, reduced State funding for the public colleges and universities that are large employers
in our market area could have an adverse effect on employment levels and on the area’s economy. These factors would increase the
likelihood that more of our customers would become delinquent or default on their loans. A higher level of loan defaults could result in
higher loan losses, which could adversely affect our performance.
A reversal in economic trends, return to recession, or change in interest rates could increase the risk of losses in our investment
portfolio.
The Company holds both corporate and municipal bonds in its investment portfolio. A reversal in economic recovery or return to
recession could increase the actual or perceived risk of default by both corporate and government issuers and, in either case, could
adversely affect the value of these investments. In addition, the value of these investments could be affected by a change in interest rates
and related factors, including the pricing of securities.
The condition of the local real estate market could negatively affect our business.
Substantially all of the Company’s real property collateral is located in its market area. If there is a decline in real estate values,
especially in the Company’s market area, the collateral for loans would deteriorate and provide significantly less security.
Focus on lending to small to mid-sized community-based businesses may increase its credit risk.
Most of the Company’s commercial business and commercial real estate loans are made to small business or middle market
customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and
have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which the Company
operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely
affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have
experienced a complete business or economic cycle since becoming borrowers of the Bank. The deterioration of the borrowers’
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businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on the Company’s
financial condition and results of operations.
Market interest rates are rising. When market interest rates rise further, our net interest income can be negatively affected in
the short term.
The direction and speed of interest rate changes affect our net interest margin and net interest income. In the short term, rising
interest rates may negatively affect our net interest income if our interest-bearing liabilities (generally deposits) reprice sooner than our
interest-earning assets (generally loans).
The allowance for loan losses may not be adequate to cover actual losses.
In accordance with accounting principles generally accepted in the United States, an allowance for loan losses is maintained to
provide for loan losses. The allowance for loan losses may not be adequate to cover actual credit losses, and future provisions for credit
losses could materially and adversely affect operating results. The allowance for loan losses is based on prior experience, as well as an
evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating, and other
outside forces and conditions, including changes in interest rates, all of which are beyond the Company’s control; and these losses may
exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and
allowance for loan losses. The Company also outsources an independent loan review. While management believes that the allowance
for loan losses is adequate to cover current losses, it cannot make assurances that it will not further increase the allowance for loan losses
or that regulators will not require it to increase this allowance. Either of these occurrences could adversely affect earnings.
The allowance for loan losses requires management to make significant estimates that affect the financial statements. Due to the
inherent nature of this estimate, management cannot provide assurance that it will not significantly increase the allowance for loan
losses, which could materially and adversely affect earnings.
Nonperforming assets take significant time to resolve and adversely affect the Company’s results of operations and financial
condition.
The Company’s nonperforming assets adversely affect its net income in various ways. The Company expects to continue to incur
additional losses relating to volatility in nonperforming loans. The Company does not record interest income on nonaccrual loans, which
adversely affects its income and increases credit administration costs. When the Company receives collateral through foreclosures and
similar proceedings, it is required to mark the related asset to the then fair market value of the collateral less estimated selling costs,
which may, and often does, result in a loss. An increase in the level of nonperforming assets also increases the Company’s risk profile
and may impact the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques such
as workouts and restructurings to manage problem assets. Increases in or negative adjustments in the value of these problem assets, the
underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s business, results
of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from
management and staff, which can be detrimental to the performance of their other responsibilities, including generation of new
loans. There can be no assurance that the Company will avoid further increases in nonperforming loans in the future.
The Company relies upon independent appraisals to determine the value of the real estate which secures a significant portion of
its loans, and the values indicated by such appraisals may not be realizable if the Company is forced to foreclose upon such
loans.
A significant portion of the Company’s loan portfolio consists of loans secured by real estate. The Company relies upon independent
appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make
mistakes of fact or judgment which adversely affect the reliability of their appraisals. In addition, events occurring after the initial
appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some
of the Company’s loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan
secured by real estate that is less valuable than originally estimated, the Company may not be able to recover the outstanding balance of
the loan and will suffer a loss.
If more competitors come into our market area, our business could suffer.
The financial services industry in our market area is highly competitive, with a number of commercial banks, credit unions,
insurance companies and stockbrokers seeking to do business with our customers. If there is additional competition from new business
or if our existing competitors focus more attention on our market, we could lose customers and our business could suffer.
Additional laws and regulations or revisions and rescission of existing laws and regulations could lead to a significant increase
in our regulatory burden.
While the risk appears to have diminished somewhat, both federal and state governments could enact new laws affecting financial
institutions that would further increase our regulatory burden and could negatively affect our profits. Likewise, revisions or rescission
of existing laws and regulations already implemented may result in additional compliance costs, at least in the short-term or, if done
imprudently, could ultimately create economic risks negatively affecting our revenues.
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New laws and regulations could limit our sources of noninterest income.
While the risk appears to have diminished somewhat, new laws and regulations could limit our ability to offer certain profitable
products and services. This could have a negative effect on the level of noninterest income.
Intense oversight by regulators could result in stricter requirements and higher overhead costs.
Regulators for the Company and the subsidiary bank are tasked with ensuring compliance with applicable laws and regulations.
Laws and regulations are subject to a degree of interpretation. The regulatory environment has caused financial industry regulators to
take more extreme interpretations, which could impact the Company’s earnings.
Political risks in the U.S. and the rest of the world could negatively affect the financial markets.
Political risks in the U.S. and the rest of the world could affect financial markets and affect fiscal policy which could negatively
affect our investment portfolio and earnings.
Our information systems may experience an interruption or security breach.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security
of these systems could result in failures or disruptions of our internet banking, deposit, loan and other systems. While we have policies
and procedures designed to prevent or limit the effect of the possible failure, interruption or security breach of our information systems,
there can be no assurance that any such failure, interruption or security breach will not occur or, if they do occur, that they will be
adequately addressed.
In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and
personally identifiable information of its customers and employees, in systems and on networks. The secure processing, maintenance
and use of this information is critical to the Company’s operations and business strategy. The Company has invested in accepted
technologies, and annually reviews its processes and practices that are designed to protect its networks, computers and data from damage
or unauthorized access. Despite these security measures, the Company’s computer systems experienced two cyber-intrusions, one in
May 2016 and one in January 2017 in which certain customer information was compromised, but which did not cause interruption to
the Company’s normal operations. The Company has implemented additional security measures since the breaches. The Company’s
computer systems and infrastructure may in the future be vulnerable to attacks by hackers or breached due to employee error,
malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed,
damaged or disclosed. The occurrence of any failure, interruption or security breach of our communications and information systems
could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil
litigation and possible financial liability.
Cyber-attacks may disarm and/or bypass system safeguards and allow unauthorized access and misappropriation of financial
data and assets.
As a financial institution holding company, we are vulnerable to and the target of cyber-attacks that attempt to access our digital
technology systems, disarm and/or bypass system safeguards, access customer data and ultimately increase the risk of economic and
reputational loss.
The Company experienced two cyber-intrusions, one in May 2016 and one in January 2017 in which certain customer information
was compromised. The Company has strengthened its multi-faceted approach to reduce the exposure of our systems to cyber- intrusions,
strengthen our defenses against hackers and protect customer accounts and information relevant to customer accounts from unauthorized
access. These tools include digital technology safeguards, internal policies and procedures, and employee training.
The Company believes its cybersecurity risk management program reasonably addresses the risk from cybersecurity attacks.
However, it is not possible to fully eliminate exposure. We may experience human error or have unknown susceptibilities that allow our
systems to become victim to a highly-sophisticated cyber-attack. If hackers gain entry to our systems, they may disable other safeguards
that limit loss, including limits on the number, amount, and frequency of ATM withdrawals, as well as other loss-prevention or detection
measures.
Cybersecurity attacks are probable and may result in additional costs.
The Company has experienced many attempted cybersecurity attacks, of which two resulted in a breach. The Company estimates
that the probability of future attempted cyber-attacks is high. To reduce the risk of loss from cyber-attacks and to remediate
vulnerabilities discovered through the breach investigations, the Company has incurred costs related to forensic investigations, legal and
advisory expenses, insurance premiums, system monitoring and testing, and installing new technological infrastructure and defenses.
The Company has implemented every recommendation from the forensic investigations. If the Company experiences another cyber-
breach, these costs will increase as well as potential costs for litigation, reputational harm and regulatory costs.
12
Insurance may not cover losses from cybersecurity attacks.
The Company has invested in insurance related to cybersecurity. Insurance policies are necessary to protect the Company from
major losses but may be written in such a way as to limit the protection from certain risks, including cyber risks for which the availability
of insurance coverage is currently limited. If the insurance carrier denies coverage of losses the Company may litigate, resulting in
additional legal expense. Because of policy technicalities, litigation may not result in a favorable outcome for the Company.
The Company relies on other companies to provide key components of the Company’s business infrastructure.
Third parties provide key components of the Company’s business operations such as data processing, recording and monitoring
transactions, online banking interfaces and services, internet connections and network access. While the Company has selected these
third party vendors carefully, it does not control their actions. Any problem caused by these third parties, including those resulting from
disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, failures of a vendor
to provide services for any reason or poor performance of services, could adversely affect the Company’s ability to deliver products and
services to its customers and otherwise conduct its business. Financial or operational difficulties of a third party vendor could also hurt
the Company’s operations if those difficulties interface with the vendor’s ability to serve the Company. Replacing these third party
vendors could also create significant delay and expense and damage the Company’s ability to service its customers resulting in a loss of
goodwill. Accordingly, use of such third parties creates an unavoidable inherent risk to the Company’s business operations.
Consumers may increasingly decide not to use the Bank to complete their financial transactions, which would have a material
adverse impact on the Company’s financial condition and operations.
Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically
have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in
brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying
bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result
in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of
these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on the Company’s financial
condition and results of operations.
Changes in funding for higher education could materially affect our business.
Two major employers in the Company’s market area are Virginia Tech and Radford University, both state-supported institutions.
If federal or state support for public colleges and universities wanes, our business may be adversely affected from declines in university
programs, capital projects, employment, enrollment and other related factors.
The Company is dependent on key personnel and the loss of one or more of those key personnel may materially and adversely
affect the Company’s operations and prospects.
The Company currently depends on the services of a number of key management personnel. The loss of key personnel could
materially and adversely affect the results of operations and financial condition. The Company’s success also depends in part on the
ability to attract and retain additional qualified management personnel. Competition for such personnel is strong and the Company may
not be successful in attracting or retaining the personnel it requires.
Changes in accounting standards could impact reported earnings.
The authorities who promulgate accounting standards, including the Financial Accounting Standards Board, SEC, and other
regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s
consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports
its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard
retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also require the Company to
incur additional personnel or technology costs. Most notably, new guidance on the calculation of credit reserves using current expected
credit losses (“CECL”) was finalized in June, 2016. The standard will be effective for the Company beginning January 1, 2020. The
Company has formed a management committee to prepare for the new standards. The committee has implemented new data collection
and has begun the process to run preliminary CECL models along with the incurred loss model currently in use. To implement the new
standard, the Company will incur costs related to data collection and documentation, technology, training and increased audit expenses
to validate the model. The Company expects that implementation could significantly impact our required credit reserves. Other impacts
to capital levels, profit and loss and various financial metrics will also result.
The Company is subject to claims and litigation pertaining to fiduciary responsibility.
From time to time, customers make claims and take legal action pertaining to the performance of the Company’s fiduciary
responsibilities. Whether customer claims and legal action related to the performance of the Company’s fiduciary responsibilities are
founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in
significant financial liability and/or adversely affect the market perception of the Company and its products and services, as well as
13
impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse
effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results
of operations.
The Company’s ability to pay dividends depends upon the results of operations of its subsidiaries.
The Company is a financial holding company and a bank holding company that conducts substantially all of its operations through
NBB. As a result, the Company’s ability to make dividend payments on its common stock depends primarily on certain federal regulatory
considerations and the receipt of dividends and other distributions from NBB. There are various regulatory restrictions on the ability of
NBB to pay dividends or make other payments to the Company. Although the Company has historically paid a cash dividend to the
holders of its common stock, holders of the common stock are not entitled to receive dividends, and regulatory or economic factors may
cause the Company’s Board of Directors to consider, among other things, the reduction of dividends paid on the Company’s common
stock.
While the Company’s common stock is currently traded on the NASDAQ Capital Market, it has less liquidity than stocks for
larger companies quoted on a national securities exchange.
The trading volume in the Company’s common stock on the NASDAQ Capital Market has been relatively low when compared
with larger companies listed on the NASDAQ Capital Market or other stock exchanges. There is no assurance that a more active and
liquid trading market for the common stock will exist in the future. Consequently, stockholders may not be able to sell a substantial
number of shares for the same price at which stockholders could sell a smaller number of shares. In addition, the Company cannot
predict the effect, if any, that future sales of its common stock in the market, or the availability of shares of common stock for sale in
the market, will have on the market price of the common stock. Sales of substantial amounts of common stock in the market, or the
potential for large amounts of sales in the market, could cause the price of the Company’s common stock to decline, or reduce the
Company’s ability to raise capital through future sales of common stock.
A change in tax rates applicable to the Company may cause impairment of deferred tax assets.
The Company determines deferred income taxes using the balance sheet method. Under this method, each asset and liability is
examined to determine the difference between its book basis and its tax basis. The difference between the book basis and the tax basis
of each asset and liability is multiplied by the Company’s marginal tax rate to determine the net deferred tax asset or liability. If the
applicable tax rate changes, the effect of the change on deferred tax assets is recognized as an increase or decrease to income tax expense.
When changes in tax rates and laws are enacted, the company must recognize the changes in the period in which they are enacted.
On December 22, 2017, The Tax Cuts and Jobs Act (“the ACT”) was signed into law and became effective January 1, 2018. The Act
changed the Company’s applicable tax rate from a 35% marginal rate in 2017 and years prior to a flat 21% for 2018. Deferred tax assets
were re-valued from 35% to 21% in 2017, with a resulting charge to income tax expense.
Item 1B. Unresolved Staff Comments
There are no unresolved staff comments.
Item 2. Properties
NBB owns and has a branch bank in NBI’s headquarters building located at 101 Hubbard Street, Blacksburg, Virginia. NBB’s main
office is at 100 South Main Street, Blacksburg, Virginia. NBB owns an additional seventeen branch offices and it leases six branch locations
and a loan production office. We believe that existing facilities are adequate for current needs and to meet anticipated growth.
Item 3. Legal Proceedings
NBI, NBB, and NBFS are not currently involved in any material pending legal proceedings. There are no legal proceedings against the
company related to cybersecurity. As of December 31, 2018, the Company is party to a lawsuit to recover from the insurance carrier damages
related to the two cybersecurity incidents. The lawsuit was settled during the first quarter of 2019 subject to a non-disclosure agreement.
Item 4. Mine Safety Disclosures
Not applicable.
14
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Information and Dividends
National Bankshares, Inc.’s common stock is traded on the NASDAQ Capital Market under the symbol “NKSH.” As of December
31, 2018, there were 628 record stockholders of NBI common stock.
NBI’s primary source of funds for dividend payments is dividends from its bank subsidiary, NBB. Bank dividend payments are
restricted by regulators, as more fully disclosed in Note 10 of Notes to Consolidated Financial Statements.
On May 9, 2018, NBI’s Board of Directors approved the repurchase of up to 100,000 shares of equity securities and on November
14, 2018 NBI’s Board of Directors approved the repurchase of an additional 150,000 shares of equity securities that are registered by
the Company pursuant to Section 12 of the Securities Exchange Act of 1934. During 2018, there were no shares repurchased, and
250,000 shares may yet be purchased under the program.
Stock Performance Graph
The following graph compares the yearly percentage change in the cumulative total of stockholder return on NBI common stock
with the cumulative return on the NASDAQ Composite Index, and the NASDAQ Bank Index for the five-year period commencing on
December 31, 2013. These comparisons assume the investment of $100 in National Bankshares, Inc. common stock in each of the
indices on December 31, 2013, and the reinvestment of dividends.
NATIONAL BANKSHARES, INC.
NASDAQ COMPOSITE INDEX
NASDAQ BANK INDEX
2013
2014
2015
2016
2017
2018
100
100
100
85
115
104
104
123
112
131
134
155
141
174
163
116
169
138
15
Item 6. Selected Financial Data
National Bankshares, Inc. and Subsidiaries
Selected Consolidated Financial Data
$ in thousands, except per share data
Selected Income Statement Data:
Interest income
Interest expense
Net interest income
Provision for (recovery of) loan losses
Noninterest income
Noninterest expense
Income taxes
Net income
Per Share Data:
Basic net income
Diluted net income
Cash dividends declared
Book value
Selected Balance Sheet Data at End of Year:
Loans, net of unearned income and deferred fees and
costs, and the allowance for loan losses
Total securities
Total assets
Total deposits
Stockholders’ equity
Selected Balance Sheet Daily Averages:
Loans, net of unearned income and deferred fees and
costs, and the allowance for loan losses
Total securities
Total assets
Total deposits
Stockholders’ equity
Selected Ratios:
Return on average assets
Return on average equity
Dividend payout ratio
Average equity to average assets
Efficiency ratio(1)
2018
Year ended December 31,
2016
2015
2017
$
43,224 $
5,047
38,177
(81 )
7,729
27,276
2,560
16,151
41,260 $
4,125
37,135
157
7,636
24,229
6,293
14,092
40,930 $
4,166
36,764
1,650
7,115
23,335
3,952
14,942
42,914 $
4,183
38,731
2,009
6,764
22,913
4,740
15,833
2.32
2.32
1.21
27.34
2.03
2.03
1.17
26.57
2.15
2.15
1.16
25.62
2.28
2.28
1.14
24.74
2014
43,944
4,899
39,045
1,641
6,503
21,815
5,178
16,914
2.43
2.43
1.13
23.93
702,409
426,230
1,256,032
1,051,942
190,238
660,144
459,751
1,256,757
1,059,734
184,896
639,452
440,409
1,233,942
1,043,442
178,263
610,711
389,288
1,203,519
1,018,859
172,114
597,203
385,385
1,158,798
982,428
166,303
675,647
455,810
1,251,843
1,045,798
186,637
644,998
442,101
1,235,754
1,038,586
184,539
613,366
420,915
1,206,745
1,013,787
180,047
611,554
379,805
1,155,594
976,597
171,732
584,857
361,028
1,120,848
957,684
157,832
1.29 %
8.65 %
52.13 %
14.91 %
53.20 %
1.14 %
7.64 %
57.77 %
14.93 %
50.41 %
1.24 %
8.30 %
54.02 %
14.92 %
49.32 %
1.37 %
9.22 %
50.09 %
14.86 %
49.41 %
1.51 %
10.72 %
46.43 %
14.08 %
47.08 %
(1) The efficiency ratio is a non-GAAP financial measure that the Company believes provides investors with important information
regarding operational efficiency. Such information is not prepared in accordance with U.S. generally accepted accounting
principles (GAAP) and should not be viewed as a substitute for GAAP. See “Non-GAAP Financial Measures” included in Item
7 of this Form 10-K.
16
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
$ in thousands, except per share data
The purpose of this discussion and analysis is to provide information about the results of operations, financial condition, liquidity and
capital resources of National Bankshares, Inc. and its subsidiaries (the “Company”). The discussion should be read in conjunction with the
material presented in Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K.
Subsequent events have been considered through the date on which the Form 10-K was issued.
Cautionary Statement Regarding Forward-Looking Statements
We make forward-looking statements in this Form 10-K that are subject to significant risks and uncertainties. These forward-
looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market
risk, growth strategy, and financial and other goals, and are based upon our management’s views and assumptions as of the date of this
report. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or
other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are based upon or are affected by factors that could cause our actual results to differ materially
from historical results or from any results expressed or implied by such forward-looking statements. These factors include, but are not
limited to, changes in:
interest rates,
general economic conditions,
the legislative/regulatory climate,
•
•
•
• monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury, the Office of the Comptroller of
the Currency, the Federal Reserve Board, the Consumer Financial Protection Bureau and the Federal Deposit Insurance
Corporation, and the impact of any policies or programs implemented pursuant to the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and other financial reform legislation,
unanticipated increases in the level of unemployment in the Company’s trade area,
the quality or composition of the loan and/or investment portfolios,
demand for loan products,
deposit flows,
competition,
demand for financial services in the Company’s trade area,
the real estate market in the Company’s trade area,
the Company’s technology initiatives, and
applicable accounting principles, policies and guidelines.
•
•
•
•
•
•
•
•
•
These risks and uncertainties should be considered in evaluating the forward-looking statements contained in this report. We caution
readers not to place undue reliance on those statements, which speak only as of the date of this report. This discussion and analysis
should be read in conjunction with the description of our “Risk Factors” in Item 1A. of this Form 10-K.
If the national economy or the Company’s market area experience a downturn, it is likely that unemployment will rise and that other
economic indicators will negatively impact the Company’s trade area. Because of the importance to the Company’s markets of state-
funded universities, cutbacks in the funding provided by the Commonwealth could also negatively impact employment. This could lead
to a higher rate of delinquent loans and a greater number of real estate foreclosures. Higher unemployment and the fear of layoffs causes
reduced consumer demand for goods and services, which negatively impacts the Company’s business and professional customers. An
economic downturn could have an adverse effect on all financial institutions, including the Company.
17
Non-GAAP Financial Measures
This report refers to certain financial measures that are computed under a basis other than GAAP (“non-GAAP”), including the
efficiency ratio, the net interest margin and the noninterest margin.
The efficiency ratio is computed by dividing noninterest expense, excluding the write-down of insurance receivable, by the sum of
net interest income on a tax-equivalent basis and noninterest income. The tax rate used to calculate fully taxable equivalent basis is 21%
in 2018 and 35% in 2017 and years prior. This is a non-GAAP financial measure that the Company believes provides investors with
important information regarding operational efficiency. Such information is not prepared in accordance with U.S. generally accepted
accounting principles (GAAP) and should not be construed as such. Management believes such financial information is meaningful to
the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The
components of the efficiency ratio calculation are summarized in the following table.
$ in thousands
Noninterest expense
Less: write-down of insurance receivable
Noninterest expense for ratio calculation
Taxable-equivalent net interest income
Noninterest income
Total income for ratio calculation
Year ended December 31,
2017
2018
27,276
(2,010 )
25,266
39,764
7,729
47,493
$
$
$
$
24,229
---
24,229
40,432
7,636
48,068
$
$
$
$
2016
23,335
---
23,335
40,201
7,115
47,316
$
$
$
$
Efficiency ratio
53.20 %
50.41 %
49.32 %
The net interest margin is calculated by dividing taxable equivalent net interest income by total average earning assets. Because a
portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation
of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable
to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2018 is 21% and
35% for 2017 and years prior. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net
interest income, is reflected in the table below.
$ in thousands
GAAP measures:
Interest and fees on loans
Interest on interest-bearing deposits
Interest and dividends on securities - taxable
Interest on securities - nontaxable
Total interest income
Interest on deposits
Interest on borrowings
Total interest expense
Year ended December 31,
2017
2018
2016
$
$
$
$
31,333
672
6,856
4,363
43,224
4,883
164
5,047
$
$
$
$
29,932
791
5,711
4,826
41,260
4,125
---
4,125
$
$
$
$
29,365
532
5,910
5,123
40,930
4,166
---
4,166
Net interest income
$
38,177
$
37,135
$
36,764
Non-GAAP measures:
Tax benefit on nontaxable loan income
Tax benefit on nontaxable securities income
Total tax benefit on nontaxable interest income
Total tax-equivalent net interest income
406
1,181
1,587
39,764
$
$
$
661
2,636
3,297
40,432
$
$
$
628
2,809
3,437
40,201
$
$
$
18
The noninterest margin is calculated by dividing noninterest expense (excluding the write-down of insurance receivable) less
noninterest income (excluding realized securities gain/loss, net) by average year-to-date assets. The reconciliation of adjusted noninterest
income and adjusted noninterest expense, which are not measurements under GAAP, is reflected in the table below.
$ in thousands
Noninterest expense under GAAP
Less: write-down of insurance receivable
Noninterest expense for ratio calculation, non-GAAP
Noninterest income under GAAP
Less: realized securities gains, net
Noninterest income for ratio calculation, non-GAAP
Year ended December 31,
2017
2018
27,276
(2,010 )
25,266
7,729
(17 )
7,712
$
$
$
$
24,229
---
24,229
7,636
(14 )
7,622
$
$
$
$
2016
23,335
---
23,335
7,115
(232 )
6,883
$
$
$
$
Net noninterest expense, non-GAAP
$
17,554
$
16,607
$
16,452
Average assets
Noninterest margin
Critical Accounting Policies
General
$
1,251,843
$
1,235,755
$ 1,206,745
1.40 %
1.34 %
1.36 %
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States
(GAAP). The financial information contained within our statements is, to a significant extent, financial information based on measures
of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value obtained
when earning income, recognizing an expense, recovering an asset or relieving a liability. Although the economics of the Company’s
transactions may not change, the timing of events that would impact the transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of probable losses inherent in our loan portfolio. The allowance is funded by the
provision for loan losses, reduced by charge-offs of loans and increased by recoveries of previously charged-off loans. The determination
of the allowance is based on two accounting principles, Accounting Standards Codification (“ASC”) Topic 450-20 (Contingencies)
which requires that losses be accrued when occurrence is probable and the amount of the loss is reasonably estimable, and ASC Topic
310-10 (Receivables) which requires accrual of losses on impaired loans if the recorded investment exceeds fair value.
Probable losses are accrued through two calculations, individual evaluation of impaired loans and collective evaluation of the
remainder of the portfolio. Impaired loans are larger non-homogeneous loans for which there is a probability that collection will not
occur according to the loan terms, as well as loans whose terms have been modified in a troubled debt restructuring. Impaired loans that
are not TDR’s with an estimated impairment loss are placed on nonaccrual status. TDR’s with an impairment loss may accrue interest
if they have demonstrated six months of timely payment performance.
Impaired loans
Impaired loans are identified through the Company’s credit risk rating process. Estimated loss for an impaired loan is the amount
of recorded investment that exceeds the loan’s fair value. Fair value of an impaired loan is measured by one of three methods: the fair
value of collateral (“collateral method”), the present value of future cash flows (“cash flow method”), or observable market price. The
Company applies the collateral method to collateral-dependent loans, loans for which foreclosure is imminent and to loans for which
the fair value of collateral is a more reliable estimate of fair value. The cash flow method is applied to loans that are not collateral
dependent and for which cash flows may be estimated.
The Company bases collateral method fair valuation upon the “as-is” value of independent appraisals or evaluations. Valuations for
impaired loans secured by residential 1-4 family properties with outstanding principal balances greater than $250 are based on an
appraisal. Appraisals are also used to value impaired loans secured by commercial real estate with outstanding principal balances greater
than $500. Collateral-method impaired loans secured by residential 1-4 family property with outstanding principal balances of $250 or
less, or secured by commercial real estate with outstanding principal balances of $500 or less, are valued using an internal evaluation.
19
Appraisals and internal valuations provide an estimate of market value. Appraisals must conform to the Uniform Standards of
Professional Appraisal Practice (“USPAP”) and are prepared by an independent third-party appraiser who is certified and licensed and
who is approved by the Company. Appraisals may incorporate market analysis, comparable sales analysis, cash flow analysis and market
data pertinent to the property to determine market value.
Internal evaluations are prepared by third party providers and reviewed by employees of the Company who are independent of the
loan origination, operation, management and collection functions. Evaluations provide a property’s market value based on the property’s
current physical condition and characteristics and the economic market conditions that affect the collateral’s market value. Evaluations
incorporate multiple sources of data to arrive at a property’s market value, including physical inspection, independent third-party
automated tools, comparable sales analysis and local market information.
Updated appraisals or evaluations are ordered when the loan becomes impaired if the appraisal or evaluation on file is more than
twenty-four months old. Appraisals and evaluations are reviewed for propriety and reasonableness and may be discounted if the
Company determines that the value exceeds reasonable levels. If an updated appraisal or evaluation has been ordered but has not been
received by a reporting date, the fair value may be based on the most recent available appraisal or evaluation, discounted for age.
The appraisal or evaluation value for a collateral-dependent loan for which recovery is expected solely from the sale of collateral is
reduced by estimated selling costs. Estimated losses on collateral-dependent loans, as well as any other impairment loss considered
uncollectible, are charged against the allowance for loan losses. Impairment losses that are not considered uncollectible or for loans that
are not collateral dependent are accrued in the allowance. Impaired loans with partial charge-offs are maintained as impaired until the
remaining balance is satisfied. Smaller homogeneous impaired loans that are not troubled debt restructurings and are not part of a larger
impaired relationship are collectively evaluated.
Troubled debt restructurings are impaired loans and are measured for impairment under the same valuation methods as other
impaired loans. Troubled debt restructurings are maintained in nonaccrual status until the loan has demonstrated reasonable assurance
of repayment with at least six months of consecutive timely payment performance. Troubled debt restructurings may be removed from
TDR status, and therefore from individual evaluation, if the restructuring agreement specifies a contractual interest rate that is a market
interest rate at the time of restructuring and the loan is in compliance with its modified terms one year after the restructure was completed.
Collectively-evaluated loans
Non-impaired loans and smaller homogeneous impaired loans that are not troubled debt restructurings and not part of a larger
impaired relationship are grouped by portfolio segments. Portfolio segments are further divided into smaller loan classes. Loans within
a segment or class have similar risk characteristics.
Probable loss is determined by applying historical net charge-off rates as well as additional percentages for trends and current levels
of quantitative and qualitative factors. Loss rates are calculated for and applied to individual classes by averaging loss rates over the
most recent 8 quarters. The look-back period of 8 quarters is applied consistently among all classes.
Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class
loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Classified
loans are those with risk ratings that indicate credit quality is “substandard”, “doubtful” or “loss”. Net charge-offs in both calculations
include charge-offs and recoveries of classified and non-classified loans as well as those associated with impaired loans. Class historical
loss rates are applied to collectively-evaluated non-classified loan balances, and classified historical loss rates are applied to collectively-
evaluated classified loan balances.
Qualitative factors are evaluated and allocations are applied to each class. Qualitative factors include delinquency rates, loan quality
and concentrations, loan officers’ experience, changes in lending policies and changes in the loan review process. Economic factors
such as unemployment rates, bankruptcy rates and others are evaluated, with standard allocations applied consistently to relevant classes.
The Company accrues additional allocations for criticized loans within each class and for loans designated high risk. Criticized
loans include classified loans as well as loans rated “special mention”. Loans rated special mention indicate weakened credit quality
but to a lesser degree than classified loans. High risk loans are defined as junior lien mortgages, loans with high loan-to-value ratios
and loans with terms that require interest only payments. Both criticized loans and high risk loans are included in the base risk analysis
for each class and are allocated additional reserves.
Estimation of the allowance for loan losses
The estimation of the allowance involves analysis of internal and external variables, methodologies, assumptions and our judgment
and experience. Key judgments used in determining the allowance for loan losses include internal risk rating determinations, market
and collateral values, discount rates, loss rates, and our view of current economic conditions. These judgments are inherently subjective
and our actual losses could be greater or less than the estimate. Future estimates of the allowance could increase or decrease based on
changes in the financial condition of individual borrowers, concentrations of various types of loans, economic conditions or the markets
in which collateral may be sold. The estimate of the allowance accrual determines the amount of provision expense and directly affects
our financial results.
The estimate of the allowance for December 31, 2018 considered market and portfolio conditions during 2018 as well as the levels
of delinquencies and net charge-offs in the eight quarters prior to the quarter ended December 31, 2018. If the economy experiences a
downturn, the ultimate amount of loss could vary from that estimate. For additional discussion of the allowance, see Note 5 to the
consolidated financial statements and “Asset Quality,” and “Provision and Allowance for Loan Losses.”
20
Goodwill
Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company performs
impairment testing in the fourth quarter of each year. The Company’s most recent impairment test was performed using data from
September 30, 2018. Accounting guidance provides the option of performing preliminary assessment of qualitative factors before
performing more substantial testing for impairment. The Company opted not to perform the preliminary assessment. The Company’s
goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first technique uses the
Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing
multiples for companies comparable to the Company; while the third technique uses current market pricing multiples for change-of-
control transactions involving companies comparable to the Company. Each measure indicated that the Company’s fair value exceeded
its book value, validating that goodwill is not impaired.
Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank
subsidiary is 100% owned by the Company, and no market capitalization is available. Because most of the Company’s assets are
comprised of the subsidiary bank’s equity, the Company’s market capitalization was used to estimate the Bank’s market
capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third
technique were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of
fair value, and compliant with accounting guidance.
Other Real Estate Owned (“OREO”)
Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at fair value of the property, less estimated
disposal costs, if any. Any excess of cost over the fair value less costs to sell at the time of acquisition is charged to the allowance for
loan losses. The fair value is reviewed periodically by management and any write-downs are charged against current earnings.
Accounting policy and treatment is consistent with accounting for impaired loans described above.
Pension Plan
The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key
assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases.
Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets,
liabilities or expense.
Other Than Temporary Impairment of Securities (“OTTI”)
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is
considered other-than-temporary and recognized in its entirety in net income if either (i) the Company intends to sell the security or
(ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If,
however, the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell
the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs
when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If
there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists,
and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive
income (loss). The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that
include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects
for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from debt securities, the
Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the
security before recovery.
Overview
National Bankshares, Inc. is a financial holding company incorporated under the laws of Virginia. Located in southwest Virginia,
NBI has two wholly-owned subsidiaries, the National Bank of Blacksburg and National Bankshares Financial Services, Inc. The
National Bank of Blacksburg (“NBB”), which does business as National Bank from twenty-five office locations and one loan production
office, is a community bank. NBB is the source of nearly all of the Company’s revenue. National Bankshares Financial Services, Inc.
(“NBFS”) does business as National Bankshares Investment Services and National Bankshares Insurance Services. Income from NBFS
is not significant at this time, nor is it expected to be so in the near future.
National Bankshares, Inc. common stock is listed on the NASDAQ Capital Market and is traded under the symbol “NKSH.”
National Bankshares, Inc. has been included in the Russell Investments Russell 3000 and Russell 2000 Indexes since June 29, 2009.
21
Performance Summary
The following table presents NBI’s key performance ratios for the years ending December 31, 2018 and December 31, 2017:
Return on average assets
Return on average equity
Basic net earnings per common share
$
Fully diluted net earnings per common share $
Net interest margin (1)
Noninterest margin (2)
Year Ended December 31,
2018
2017
1.29 %
8.65 %
2.32
2.32
3.36 %
1.40 %
$
$
1.14 %
7.64 %
2.03
2.03
3.45 %
1.34 %
(1) Net Interest Margin – Non-GAAP measure of year-to-date tax equivalent net interest income divided by year-to-date average
earning assets. Please see Item 7 for a reconciliation of non-GAAP measures to GAAP.
(2) Noninterest Margin – Non-GAAP measure of noninterest expense (excluding the insurance receivable write-down, provision
for bad debts and income taxes) less noninterest income (excluding securities gains and losses) divided by average year-to-
date assets. Please see Item 7 for a reconciliation of non-GAAP measures to GAAP.
The return on average assets for the year ended December 31, 2018 was 1.29%, an increase from 1.14% for the year ended December
31, 2017. The return on average equity increased from 7.64% for the year ended December 31, 2017 to 8.65% for the year ended
December 31, 2018.
The net interest margin decreased from 3.45% for the year ended December 31, 2017 to 3.36% for the year ended December 31,
2018. The net interest margin benefitted from Federal Reserve interest rate increases but reflected a decline in the taxable-equivalent
yield of tax-advantaged loans and securities. The taxable-equivalent yield is based on the Company’s statutory tax rate, which fell from
35% in 2017 to 21% in 2018 when the Tax Cuts and Jobs Act became effective.
The noninterest margin increased from 1.34% to 1.40% over the same period, while basic net earnings per common share
increased from $2.03 for the year ended December 31, 2017 to $2.32 for the year ended December 31, 2018.
Growth
NBI’s key growth indicators are shown in the following table:
$ in thousands
Securities
Loans, net of unearned income and deferred fees and
costs, and the allowance for loan losses
Deposits
Total assets
12/31/2018
12/31/2017
$
426,230 $
702,409
1,051,942
1,256,032
459,751
660,144
1,059,734
1,256,757
Total assets decreased in 2018, as a result of a decrease in customer deposits. Customer deposits decreased $7,792 or 0.74% from
December 31, 2017, with decreases mainly from maturing certificates of deposit. The liquidity provided by the maturation of securities
supported growth in loans of $42,265 or 6.40%. Securities decreased by $33,521 or 7.29%.
22
Asset Quality
Key indicators of NBI’s asset quality are presented in the following table:
$ in thousands
Nonperforming loans(1)
Loans past due 90 days or more and accruing
Other real estate owned
Allowance for loan losses to loans(2)
Net charge-off ratio
$
12/31/2018
3,420
35
2,052
1.04 %
0.07 %
12/31/2017
2,769
$
51
2,817
1.19 %
0.08 %
(1) Nonperforming loans include nonaccrual loans plus restructured loans in nonaccrual status. Accruing restructured loans are not
included.
(2) Loans are net of unearned income and deferred fees and costs.
The Company monitors asset quality indicators in managing credit risk and in determining the allowance and provision for loan
losses. At December 31, 2018, nonperforming loans were $3,420 or 0.48% of loans net of unearned income and deferred fees and costs.
This compares to $2,769 or 0.41% at December 31, 2017. Loans past due 90 days or more and still accruing at year-end 2018 totaled
$35, a decrease from $51 at December 31, 2017. The net charge-off ratio decreased from 0.08% for the year ended December 31, 2017
to 0.07% for the year ended December 31, 2018, while other real estate owned decreased $765 for the same period.
The Company’s risk analysis determined an allowance for loan losses of $7,390 at December 31, 2018, resulting in a recovery for
the year of $81. This compares with an allowance for loan losses of $7,925 as of December 31, 2017, and a provision of $157 for the
year ended December 31, 2017. The ratio of the allowance for loan losses to loans decreased to 1.04%, from 1.19% at December 31,
2018. The methodology for determining the allowance for loan losses relies on historical charge-off trends, modified by trends in
nonperforming loans and economic indicators. More information about the level and calculation methodology of the allowance for loan
losses is provided in “Provision and Allowance for Loan Losses”, “Balance Sheet – Loans – Risk Elements,” “Balance Sheet – Loans
– Troubled Debt Restructurings,” as well as Notes 1 and 5 to the financial statements.
Sufficient resources have been dedicated to working out problem assets, and exposure to loss is somewhat mitigated because most
of the nonperforming loans are collateralized. More information about nonaccrual and past due loans is provided in “Balance Sheet –
Loans – Risk Elements” and Note 5 to the financial statements. The Company continues to monitor risk levels within the loan portfolio
and expects that any further increase in the allowance for loan losses would be the result of the refinement of loss estimates and would
not dramatically affect net income.
Net Interest Income
Net interest income for the year ended December 31, 2018 was $38,177, an increase of $1,042, or 2.81%, when compared to the
prior year. The net interest margin for 2018 was 3.36%, compared to 3.45% for 2017. Total interest income for the period ended
December 31, 2018 was $43,224, an increase of $1,964 from the period ended December 31, 2017. Interest expense increased by $922
during the same time frame, from $4,125 for the year ended December 31, 2017 to $5,047 for the year ended December 31, 2018. The
increase in interest expense came about in part because of deposit pricing increases required to remain competitive in a rising interest
rate environment. The Company also engaged in short-term borrowings during 2018 to meet loan demand while anticipating maturity
of securities and an increase in deposits that is typical during the fourth quarter. Please refer to the section titled “Analysis of Changes
In Interest Income and Interest Expense” for further information related to rate and volume changes.
The amount of net interest income earned is affected by various factors, including changes in market interest rates due to the Federal
Reserve Board’s monetary policy, U.S. fiscal policy, the level and composition of the earning assets and the composition of interest-
bearing liabilities. The Company has the ability to respond over time to interest rate movements and reduce volatility in the net interest
margin. However, the frequency and/or magnitude of changes in market interest rates are difficult to predict and may have a greater
impact on net interest income than adjustments by management.
The Federal Reserve increased its target federal funds rate by 25 basis points in December 2017 and raised rates by 25 basis points
again in March, June, September and December, 2018, ending the year at a target of 2.50%. The rate increases positively affected the
yield on the Company’s interest-bearing deposits in other banks and taxable securities for 2018. The yield on interest-bearing deposits
increased from 1.10% for 2017 to 1.84% for 2018 and the yield on taxable securities increased from 1.82% for 2017 to 2.07% for 2018.
The rate increases also positively affected the yield on loans, but was offset by the decline in the Company’s tax rate. The Tax Cuts and
Jobs Act became effective January 1, 2018 and decreased the Company’s tax rate from a marginal 35% to a flat 21%. The resulting
decrease in the fully taxable equivalent value of income on tax-exempt loans exceeded the benefit of the rate increases.
The primary source of funds used to support the Company’s interest-earning assets is deposits. Deposits are obtained in the
Company’s trade area through traditional marketing techniques. Other funding sources, such as the Federal Home Loan Bank, while
23
available, are only used occasionally. The cost of funds is dependent on interest rate levels and competitive factors. This limits the ability
of the Company to react to interest rate movements.
Federal Reserve policies and market forces influence the Company’s net interest margin. Rates may increase or decrease in the
future. The Company anticipates any rate increases will have a positive impact on the Company’s future net interest income.
Management cannot predict the timing and level of interest rate movements.
Analysis of Net Interest Earnings
The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the
average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest-earning assets for the
years indicated.
December 31, 2018
December 31, 2017
December 31, 2016
Average
Balance
Interest
Average
Yield/
Rate
Average
Balance
Interest
Average
Yield/
Rate
Average
Balance
Interest
Average
Yield/
Rate
$ 683,624 $ 31,739
340,594 6,856
123,668 5,544
672
36,562
4.64 % $
2.01 %
4.48 %
1.84 %
653,756 $ 30,593
5,711
7,462
791
313,255
131,762
71,603
4.68 % $ 622,239 $ 29,993
5,910
280,842
1.82 %
7,932
139,429
5.66 %
532
102,819
1.10 %
4.82 %
2.10 %
5.69 %
0.52 %
$ in thousands
Interest-earning assets:
Loans, net of unearned
income and deferred
fees and costs
(1)(2)(3)(4)
Taxable securities(5)
Nontaxable securities (1)(5)
Interest-bearing deposits
Total interest-earning
assets
$
1,184,448 $ 44,811
3.78 % $
1,170,376 $ 44,557
3.81 % $ 1,145,329 $ 44,367
3.87 %
Interest-bearing liabilities:
Interest-bearing demand
deposits
Savings deposits
Time deposits
Borrowings
$ 606,766 $ 4,121
236
526
164
140,918
105,674
7,192
0.68 % $
0.17 %
0.50 %
2.28 %
598,661 $ 3,344
244
537
---
140,997
120,220
---
0.56 % $ 567,971 $ 3,144
315
134,982
0.17 %
707
140,490
0.45 %
---
---
---
0.55 %
0.23 %
0.50 %
---
Total interest-bearing
liabilities
Net interest income(1) and
interest rate spread
Net yield on average
interest-earning
assets
$ 860,550 $ 5,047
0.59 % $
859,878 $ 4,125
0.48 % $ 843,443 $ 4,166
0.49 %
$ 39,764
3.19 %
$ 40,432
3.33 %
$ 40,201
3.38 %
3.36 %
3.45 %
3.51 %
(1) Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 21%
in 2018 and 35% in 2017 and 2016.
(2) Loan fees of $115 in 2018, $303 in 2017 and $360 in 2016 are included in total interest income.
(3) Nonaccrual loans are included in average balances for yield computations.
(4) Includes loans held for sale.
(5) Daily averages are shown at amortized cost.
24
The following table reconciles net interest income on a fully-taxable equivalent basis to net interest income on a GAAP basis.
$ in thousands
Net interest income, GAAP
Taxable equivalent adjustment
Net interest income, fully taxable equivalent
$
$
2018
December 31,
2017
38,177 $
1,587
39,764 $
37,135 $
3,297
40,432 $
2016
36,764
3,437
40,201
Analysis of Changes in Interest Income and Interest Expense
The Company’s primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans
and investments and the interest paid on deposits and other funds. The Company’s net interest income is affected by changes in the amount
and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on
interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest
expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
$ in thousands
Interest income: (1)
Loans
Taxable securities
Nontaxable securities
Interest-bearing deposits
Increase (decrease) in income on interest-earning
assets
Interest expense:
Interest-bearing demand deposits
Savings deposits
Time deposits
Short-term borrowings
Increase (decrease) in expense of interest-bearing
liabilities
Increase (decrease) in net interest income
2018 Over 2017
2017 Over 2016
Changes Due To
Changes Due To
Rates(2)
Volume(2)
Net Dollar
Change
Rates(2)
Volume(2)
Net Dollar
Change
$
(243 ) $ 1,389
522
623
(436 )
(1,482 )
(496 )
377
$ 1,146 $
1,145
(1,918 )
(119 )
(891 ) $ 1,491
640
(839 )
(434 )
(36 )
(201 )
460
$
600
(199 )
(470 )
259
$
$
$
(725 ) $
979
$
731 $
(8 )
58
---
46
---
(69 )
164
254 $
(1,306 ) $ 1,496
$
190
777 $
(8 )
(11 )
164
29 $
(84 )
(74 )
---
171
13
(96 )
---
$
200
(71 )
(170 )
---
$
781 $
$ (1,506 ) $
141
838
$
$
922 $
(668 ) $
(129 ) $
88
(1,177 ) $ 1,408
$
$
(41 )
231
(1) Taxable equivalent basis using a Federal income tax rate of 21% in 2018 and 35% in 2017 and 2016.
(2) Variances caused by the change in rate times the change in volume have been allocated to rate and volume changes
proportional to the relationship of the absolute dollar amounts of the change in each.
Net interest income on a taxable-equivalent basis decreased $668 when 2018 is compared with 2017. Total interest income on a taxable
equivalent basis increased $254 while total interest expense increased by $922. A decline in the yield of interest-earning assets and an increase
in the yield on interest-bearing liabilities decreased net interest income by $1,506, offset by increases due to volume of $838.
The Federal Reserve increased rates by 25 basis points in December 2017 and four times in 2018. The rate increases had a direct
and immediate effect on the Company’s interest-bearing deposits. Interest income on interest-bearing deposits increased $377 due to
rates, but declined by $496 due to reduced volume, for a net decrease of $119 when 2018 is compared with 2017. Taxable securities
also benefitted from the increased interest rate environment, as matured and called securities were invested at higher rates. Interest
income on taxable securities increased $1,145 when 2018 is compared with 2017, the result of an increase of $522 due to volume along
with an increase of $623 due to rates.
Taxable equivalent interest income on loans increased $1,146 when 2018 and 2017 are compared, due to robust growth in the loan
portfolio. The average balance of loans increased from $653,756 in 2017 to $683,624 in 2018, increasing interest income by $1,389. Increase
due to volume was offset slightly by a decrease of $243 due to yield. Taxable equivalent yields on tax-advantaged loans were negatively
impacted by a decrease in the Company’s statutory tax rate from 35% in 2017 to 21% in 2018. If the 35% rate were applicable during 2018,
yields would have shown an increase.
25
Taxable-equivalent interest on non-taxable securities declined $1,482 due to rates and $436 due to volume. The lower yields
available upon reinvestment of called and matured securities negatively impacted income from securities during 2018.
Interest on time deposits declined $11 from 2017 to 2018, with a increase of $58 due to rates offset by a decline of $69 due to decreased
volume. See “Net Interest Income” for additional information related to the decline in interest expense.
When 2017 is compared with 2016, taxable-equivalent net interest income increased by $231. Total interest income on a taxable
equivalent basis increased $190 while total interest expense declined by $41. Declining yields impacted net interest income by $1,177,
offset by increases due to volume of $1,408.
The Federal Reserve increased rates by 25 basis points in December 2016 and three times in 2017. The rate increases had a direct
and immediate effect on the Company’s interest-bearing deposits. Interest income on interest-bearing deposits increased $460 due to
rates, but declined by $201 due to reduced volume, for a net increase of $259 when 2017 is compared with 2016. The Company’s
securities and loan portfolios did not experience a similar increase in yields due to the longer-term nature of the portfolios, reinvestment
opportunities in the bond market and the competitive lending environment of the Company’s market area.
Taxable equivalent interest income on loans increased $600 when 2017 and 2016 are compared. The average balance of loans
increased from $622,239 in 2016 to $653,756 in 2017, increasing interest income by $1,491. Lower yields reduced interest income by
$891.
Interest income on taxable securities decreased $199 when 2017 is compared with 2016, the result of an increase of $640 due to
volume offset by a decline of $839 due to rates. Taxable-equivalent interest on non-taxable securities declined $36 due to rates and $434
due to volume. The low interest rate environment in 2016 resulted in a large number of called securities at a time when re-investment
opportunities were less attractive than the yields on the original called securities. The lower yields available upon reinvestment of the
call securities negatively impacted income from securities during 2017. Because of low yields in the securities markets and a highly
competitive loan environment, the Company priced deposits accordingly.
Interest on time deposits declined $170 from 2016 to 2017, with a decline of $74 due to rates and $96 due to decreased volume.
Interest Rate Sensitivity
The Company considers interest rate risk to be a significant risk and has systems in place to measure the exposure of net interest income
and fair market values to movement in interest rates. Among the tools available to management is interest rate sensitivity analysis, which
provides information related to repricing opportunities. Interest rate shock simulations indicate potential economic loss due to future interest
rate changes. Shock analysis is a test that measures the effect of a hypothetical, immediate and parallel shift in interest rates. The following
table shows the results of a rate shock and the effects on the return on average assets and the return on average equity projected at December
31, 2018 and 2017. For purposes of this analysis, noninterest income and expenses are assumed to be flat.
Rate Shift (bp)
Return on Average Assets
Return on Average Equity
300
200
100
(-)100
(-)200
(-)300
2018
1.38 %
1.39 %
1.40 %
1.32 %
1.16 %
1.12 %
2017
1.37 %
1.40 %
1.42 %
1.37 %
1.23 %
1.25 %
2018
8.84 %
8.92 %
8.95 %
8.46 %
7.47 %
7.32 %
2017
9.13 %
9.28 %
9.42 %
9.06 %
8.17 %
8.33 %
Simulation analysis is another tool available to the Company to test asset and liability management strategies under rising and falling
rate conditions. As a part of the simulation process, certain estimates and assumptions must be made. These include, but are not limited to,
asset growth, the mix of assets and liabilities, rate environment and local and national economic conditions. Asset growth and the mix of
assets can, to a degree, be influenced by management. Other areas, such as the rate environment and economic factors, cannot be controlled.
In addition, competitive pressures can make it difficult to price deposits and loans in a manner that optimally minimizes interest rate
risk. Therefore, actual results may vary materially from any particular forecast or shock analysis. This shortcoming is offset somewhat by the
periodic reforecasting of the balance sheet to reflect current trends and economic conditions. Shock analysis must also be updated periodically
as a part of the asset and liability management process.
26
Noninterest Income
$ in thousands
Service charges on deposits
Other service charges and fees
Credit card fees
Trust fees
Bank-owned life insurance income
Other income
Realized securities gains
Total noninterest income
$
$
December 31, 2018
Year Ended
December 31, 2017
December 31, 2016
2,678 $
132
1,431
1,565
901
1,005
17
7,729 $
2,776 $
205
1,205
1,530
758
1,148
14
7,636 $
2,458
212
981
1,346
597
1,289
232
7,115
Service charges on deposit accounts totaled $2,678 for the year ended December 31, 2018. This is a decrease of $98, or 3.53%,
from $2,776 for the year ended December 31, 2017. Service charges on deposit accounts increased $318, or 12.94%, from 2016 to 2017.
This income category is affected by the number of deposit accounts, the level of service charges and the number of checking account
overdrafts. The 2018 decrease was driven by a decrease in fees from a lower volume of customer non-sufficient funds and overdraft
activity. The 2017 increase resulted primarily from an increase of $325 in non-sufficient funds and overdraft fees due to implementation
of a new overdraft privilege program during the second half of 2016.
Other service charges and fees include charges for official checks, income from the sale of checks to customers, safe deposit box
rent, fees from letters of credit and income from commissions on the sale of credit life, accident and health insurance. These fees were
$132 for the year ended December 31, 2018, a decrease of $73, or 35.61%, from the $205 for 2017. The decline resulted from service
charges on letters of credit and check charges. The total for the year ended December 31, 2017 was $7 below the $212 posted for the
year ended December 31, 2016.
Credit card fees for the year ended December 31, 2018, were $226 above the $1,205 reported for the year ended December 31,
2017. From 2016 to 2017, credit card fees increased $224, or 22.83%. Credit card fees are presented net of certain processing expenses
and are dependent on the volume of transactions.
Trust fees at $1,565 increased by $35 or 2.29% when the years ended December 31, 2018 and 2017 are compared. For the year
ended December 31, 2017 trust fees were $1,530, an increase of $184, or 13.67%, from 2016. Trust fees are generated from a number
of different types of accounts, including estates, personal trusts, employee benefit trusts, investment management accounts, attorney-in-
fact accounts and guardianships. Trust income varies depending on the number and type of accounts under management and financial
market conditions. The mix of account types affected the level of trust fees in 2017 and 2018.
Noninterest income from bank-owned life insurance (BOLI) increased, from $758 for the year ended December 31, 2017 to $901
for 2018. The Company purchased an additional $10 million in BOLI in June 2017. BOLI income for the year ended December 31,
2016 was $597. Income from bank-owned life insurance was affected by the performance of the variable rate policies, which has not
varied significantly.
Other income is income from smaller balance accounts that cannot be classified in another category. Some examples include gains
on mortgage loans sold, net gains from the sale of fixed assets and revenue from investment and insurance sales. Other income for 2018
was $1,005, a decrease of $143, or 12.46%, when compared with $1,148 for the year ended December 31, 2017. In December 2017, the
Company realized a gain on the sale of its Marion branch office of $134. When 2017 is compared with 2016, the gain on the sale of
fixed assets was offset by a decline of $69 from the sale of mortgage loans due to lower volume, and a decline of $230 due to a one-
time vendor signing incentive received in 2016, resulting in a net decrease of $141 from 2016.
During 2018, the $17 realized securities gain stemmed from the call of one security with a gain of $1 and the sale of another security
for a gain of $16. During 2017, the Company sold a small investment in community bank stock that resulted in a gain of $4 while all
other net realized gains resulted from calls of securities. During 2016, all realized securities gains resulted from calls of securities.
27
Noninterest Expense
$ in thousands
Salaries and employee benefits
Occupancy, furniture and fixtures
Data processing and ATM
FDIC assessment
Intangibles amortization
Net costs of other real estate owned
Franchise taxes
Write-down of insurance receivable
Other operating expenses
Total noninterest expense
December 31, 2018
Year Ended
December 31, 2017
December 31, 2016
$
$
14,506 $
1,845
2,784
359
50
553
1,278
2,010
3,891
27,276 $
13,670 $
1,820
2,280
364
68
205
1,315
---
4,507
24,229 $
12,684
1,849
2,151
476
257
472
1,296
347
3,803
23,335
Salary and benefits expense increased $836, or 6.12%, from $13,670 for the year ended December 31, 2017 to $14,506 for 2018.
Employee salaries decreased $135 or 1.35%, from $9,968 for 2017 to $9,833 for 2018 due to normal staffing and compensation
decisions. Fringe benefits increased $467, or 24.89%, from $1,874 for the year ended December 31, 2017 to $2,341 for 2018. In 2017,
fringe benefits expense was reduced by a one-time $175,000 refund, while in 2018 the expense increased $240 for reserve requirements
based on claims history. Other salary expenses include expenses for contributions to the employee stock ownership program, pension,
salary continuation and incentives. Other salary expense increased $231, or 15.66%, from $1,476 for the year ended December 31, 2017
to $1,707 for 2018 as the result of increased contributions and expenses related to the employee stock ownership plan and the pension
plan. Also impacting salary expense was an increase of $170 for deferred costs associated with loan production.
When 2017 is compared with 2016, salary and benefits expense increased $986, or 7.77%, from $12,684 for the year ended December
31, 2016 to $13,670 for 2017. Employee salaries increased $256 or 2.63% which was the result of normal staffing and compensation
decisions. Expense associated with the health insurance reserve increased $419. The Company participates in a “self-funded” insurance
plan and reserves amounts based on employee health insurance usage and calculated projections. In 2016, the Company benefitted from
refunds due to a change in the calculation of the required minimum reserve and from positive claims history. The Company began in 2017,
a new incentive compensation program for senior employees, which contributed $280 to the increase. The increases were offset by a $101
decrease in salary expense related to deferred costs associated with loan production.
Occupancy, furniture and fixtures expense was $1,845 for the year ended December 31, 2018, an increase of $25, or 1.37%, from
the prior year. When 2017 is compared with 2016, the expense decreased $29 or 1.57% due to higher expenditures on security equipment
and building maintenance in 2016.
Data processing and ATM expense was $2,784 in 2018, $2,280 in 2017 and $2,151 in 2016. The increase of $504 or 22.11% from
2017 to 2018 and $129 or 6.00% from 2016 to 2017 was due to increased maintenance expense associated with infrastructure upgrades.
The Company is committed to maintaining up-to-date technology in a cost-effective manner.
When the years ended December 31, 2018 and December 31, 2017 are compared, the Federal Deposit Insurance Corporation
assessment expense decreased $5 or 1.37%. The total expense for 2018 was $359, which compares with $364 for 2017. The FDIC
assessment is accrued based on a method provided by the FDIC. The FDIC’s Deposit Insurance Fund reserve ratio reached a target
threshold during the second quarter of 2016, resulting in lower FDIC insurance expense for many federally insured institutions. The
FDIC assessment expense for the year ended December 31, 2017 decreased $112 from $476 for 2016.
The expense for intangibles amortization is related to acquisitions. There were no acquisitions in the last year, and the expense for
2018 decreased from 2017 by $18 or 26.47%. The expense for intangibles amortization decreased $189 from 2016 to 2017. The decrease
in core deposit intangibles amortization from 2016 to 2017 and from 2017 to 2018 is due to certain core deposit intangibles becoming
fully amortized. As of December 31, 2018, all core deposits are fully amortized.
Net costs of other real estate owned increased from $205 for the period ended December 31, 2017 to $553 for the year ended
December 31, 2018. From 2016 to 2017, net costs of other real estate owned decreased $267 from $472. This expense category varies
with the number of foreclosed properties owned by NBB and with the expense associated with each. It includes write-downs on other
real estate owned plus other costs associated with carrying these properties, as well as net gains or losses on the sale of other real estate.
In 2018, write-downs on other real estate were $476. This compares with $113 in 2017 and $268 in 2016. Other real estate is initially
accounted for at fair value less estimated costs to sell using current valuations, which include appraisals, real estate evaluations and
realtor market opinions. If new valuation information indicates a decline from the initial basis, the Company records a write-down. Other
costs for these properties in 2018 were $64, compared with $80 in 2017 and $118 in 2016. The Company recorded a loss of $13 on the
sale of OREO in 2018, a loss of $12 for 2017 and a loss of $86 for 2016. The Company’s market area is showing positive economic
signs, and the national economy appears to show mixed economic signals. We anticipate that there may be additional foreclosures in
the future. The Company currently has loans of $140 in process of foreclosure.
28
Franchise taxes are based upon NBB’s total equity at the prior year-end, adjusted for real estate taxes and certain other items.
Franchise taxes were $1,278 for the period ended December 31, 2018 and $1,315 for 2017, a decrease of $37 or 2.81% due to a
refinement in the accrual. Franchise tax expense increased $19 in 2017 from $1,296 in 2016.
The write-down of insurance receivables totaled $2,010 for the year ended December 31, 2018. The Company recognized a previous
write-down in 2016 for $347. The write-downs are associated with the two cybersecurity breaches. Please see additional information
under the heading Cybersecurity Risks and Incidents.
The category of other operating expenses includes noninterest expense items such as professional services, stationery and supplies,
telephone costs and charitable donations. For the year ended December 31, 2018, other operating expenses were $3,891. This compares
with $4,507 for 2017 and $3,803 for 2016. The $616 decrease from 2017 to 2018 was due to a loss of $189 resulting from a wire fraud
in 2017 and a decrease in expenses associated with consulting services related to the cybersecurity breaches and the non-servicing
component of pension expense. The $704 increase from 2016 to 2017 was due to the loss of $189 resulting from a wire fraud and an
increase in expenses associated with the overdraft program, legal fees, and audit and consulting services.
Cybersecurity Risks and Incidents
The Company treats cybersecurity risk seriously. The Company has a program to identify, mitigate and manage its cybersecurity
risks. The program includes penetration testing and vulnerability assessment, technological defenses such as antivirus software, patch
management, firewall management, email and web protections, an intrusion prevention system, a cybersecurity insurance policy which
covers some but not all losses arising from cybersecurity breaches, as well as ongoing employee training. The costs of these measures
were $224 for the twelve months ended December 31, 2018 and $153 for the twelve months ended December 31, 2017. These costs are
included in various categories of noninterest expense.
The Company experienced two intrusions to its digital systems, one in May 2016 and one in January 2017. Hackers and related
organized criminal groups obtained unauthorized access to certain customer accounts. The attacks disabled certain systems protections,
including limits on the number, amount, and frequency of ATM withdrawals. The attacks resulted in the theft of funds disbursed through
ATMs. In the May 2016 attack, hackers accessed customer funds and in the January 2017 intrusion, the hackers artificially inflated
account balances and did not access customer funds. The Company notified all affected customers, and restored all funds so that no
customer experienced a loss.
The Company retained a nationally recognized firm to investigate and remediate the May 2016 intrusion and a separate nationally
recognized firm to investigate and remediate the January 2017 intrusion. The Company adopted and implemented all of the
recommendations provided through the investigations.
The financial impact of the attacks include the amount of the theft, as well as costs of investigation and remediation. The theft of
funds totaled $570 in the May 2016 attack and $1,838 in the January 2017 attack. The Company recognized an estimated loss of $347
in 2016, and $2,010 in 2018 currently recognizes an insurance receivable in other assets of $50. The insurance carrier offered a
settlement of $50 in 2018 and the Company filed suit to recover additional amounts. Litigation procedures were in process as of
December 31, 2108. Costs for investigation, remediation, and legal consultation totaled $224 in 2018, $407 in 2017 and $46 in 2016.
The Company’s litigation against the insurance carrier was settled during the first quarter of 2019, subject to a non-disclosure agreement.
As of December 31, 2018, the Company has appropriately accounted for the breaches. There has been no litigation against the Company
to date associated with the breaches.
We have deployed a multi-faceted approach to limit the risk and impact of unauthorized access to customer accounts and to
information relevant to customer accounts. We use digital technology safeguards, internal policies and procedures, and employee
training to reduce the exposure of our systems to cyber-intrusions. However, it is not possible to fully eliminate exposure. The potential
for financial and reputational losses due to cyber-breaches is increased by the possibility of human error, unknown system
susceptibilities, and the rising sophistication of cyber-criminals to attack systems, disable safeguards and gain access to accounts and
related information. The Company maintains insurance which provides a degree of coverage depending on the nature and circumstances
of any cyber penetration but cannot be relied upon to reimburse fully the Company for all losses that may arise. The Company has
adopted new protections and invested additional resources to increase its security.
Income Taxes
Income tax expense for 2018 was $2,560 compared to $6,293 in 2017 and $3,952 in 2016. During 2018, the Company’s statutory
tax rate was 21%; during 2017 and 2016, the Company’s marginal tax rate was 35%. The decrease in the tax rate was due to the
enactment on December 22, 2017 of the Tax Cuts and Jobs Act, which became effective January 1, 2018.
The Company’s effective tax rates for 2018, 2017 and 2016 were 13.68%, 30.87% and 20.92%, respectively. The expected income
tax expense based on the Company’s statutory tax rate differs from the actual income tax expense due to tax exempt income on municipal
securities and loans, and in 2017, the re-valuation of deferred tax assets from 35% to 21%. Generally accepted accounting principles in
the United States (“GAAP”) require deferred tax assets to be valued at the tax rate at which the Company expects to realize them. As a
result of the change in the Company’s tax rate, the Company recognized a revaluation adjustment of $1.56 million in 2017, with a
corresponding charge to income tax expense. See Note 9 of the Notes to Consolidated Financial Statements for information relating to
income taxes.
29
Effects of Inflation
The Company’s consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and
deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect
the effects of inflation is depreciation expense. Historical dollar values used to determine depreciation expense do not reflect the effects
of inflation on the market value of depreciable assets after their acquisition.
Provision and Allowance for Loan Losses
The Company’s risk analysis at December 31, 2018 determined an allowance for loan losses of $7,390 or 1.04% of loans net of
unearned income and deferred fees and costs, a decrease from $7,925 or 1.19% at December 31, 2017. The determination of the
appropriate level for the allowance for loan losses resulted in a recovery of $81 for the twelve months ended December 30, 2018,
compared with a provision for the twelve month period ended December 31, 2017 of $157. The recovery for the three-month periods
ended December 31, 2018 and December 31, 2017 totaled $174 and $567, respectively. To determine the appropriate level of the
allowance for loan losses, the Company considers credit risk for certain loans designated as impaired and for non-impaired (“collectively
evaluated”) loans.
Individually evaluated impaired loans totaled $6,820 on a gross basis and as well as net of unearned income and deferred fees and
costs, with specific allocations to the allowance for loan losses totaling $139 at December 31, 2018. Individually evaluated impaired
loans at December 31, 2017 were $11,924 on a gross basis and $11,919 net of unearned income and deferred fees and costs, with specific
allocations to the allowance for loan losses of $177. The specific allocation is determined based on criteria particular to each impaired
loan.
Collectively evaluated loans totaled $703,577 on a gross basis and $702,979 net of unearned income and deferred fees and costs,
with an allowance of $7,251 or 1.03% at December 31, 2018. At December 31, 2017, collectively evaluated loans totaled $656,758 on
a gross basis and $656,150 net of unearned income and deferred fees and costs, with an allowance of $7,748 or 1.18%.
For collectively evaluated loans, the Company applies to each loan class a historical net charge-off rate, adjusted for qualitative
factors that influence credit risk. Qualitative factors evaluated for impact to credit risk include economic measures, asset quality
indicators, loan characteristics, and internal Bank policies and management.
Net charge-off rates for each class are averaged over 8 quarters (2 years) to determine the historical net charge off rate applied to
each class of collectively evaluated loans. Net charge-offs for the twelve months ended December 31, 2018 were $454 or 0.07% of
average loans, an improvement from $532 or 0.08% for the twelve months ended December 30, 2017. The 8-quarter average historical
loss rate applied to the calculation was 0.07% for December 30, 2018 and 0.17% for December 31, 2017. Increases in the net charge-
off rate increase the required allowance for collectively-evaluated loans, while decreases in the net charge-off rate decrease the required
allowance for collectively-evaluated loans.
Economic factors influence credit risk and impact the allowance for loan loss. The Company considers economic indicators within
its market area, including: unemployment, personal bankruptcy filings, business bankruptcy filings, the interest rate environment,
residential vacancy rates, housing inventory for sale, and the competitive environment. Lower unemployment lowers credit risk and the
allowance for loan losses, while higher unemployment increases credit risk. Higher bankruptcy filings indicate heightened credit risk
and increase the allowance for loan losses, while lower bankruptcy filings have a beneficial impact on credit risk. The interest rate
environment impacts variable rate loans. As interest rates increase, the payment on variable rate loans increases, which may increase
credit risk. However the effect of gradual, measured interest rate changes does not affect credit risk as much as a volatile interest rate
environment. Residential vacancy rates and housing inventory for sale impact the Company’s residential construction customers and
the consumer real estate market. Higher levels increase credit risk. Higher competition for loans increases credit risk, while lower
competition decreases credit risk.
Within the Company’s market area, the unemployment, business bankruptcies, the inventory of homes, and the residential vacancy
rate improved from December 31, 2017. Personal bankruptcies and the competitive, legal and regulatory environments remained at
similar levels to December 31, 2017. Interest rates increased from December 31, 2017. The Federal Reserve’s rate increases have
been gradual and measured and have not resulted in volatility. The Bank’s adjustable rate loans appear to have absorbed the increases
without negative impact, as evidenced by improving trends in charge-offs and asset quality since 2016. Because the gradual increases
have not resulted in negative impact, no additional allocation was made for the rate increases during the second half of 2018.
The Company considers other factors that impact credit risk, including the risk from changes in the legal and regulatory
environments, changes to lending policies and loan review, and changes in management’s experience. Each of the factors remained at
similar levels to December 31, 2017. Management examined the allocation to the allowance for the risk from changes in the loan review
system. The allocation was a legacy from changes made in years prior to 2015. Management deemed that the risk from changes prior
to 2015 would now be reflected in the historical loss rates and removed the allocation.
Asset quality indicators affect the level of the allowance for loan losses. Accruing loans past due 30-89 days were 0.23% of total
loans, net of unearned income and deferred fees and costs at December 30, 2018, a decrease from 0.34% at December 31, 2017. Accruing
loans past due 90 days or more were 0.00% of total loans, net of unearned income and deferred fees and costs at December 30, 2018, a
decrease from 0.01% at December 31, 2017. Nonaccrual loans at December 31, 2018 were 0.48% of total loans, net of unearned income
30
and deferred fees and costs, an increase from 0.41% at December 31, 2017. Decreases in past due and nonaccrual loans reduce the
required level of the allowance for loan losses, while increases in past due and nonaccrual loans increase the required level of the
allowance for loan losses.
Levels of high risk loans are considered in the determination of the level of the allowance for loan loss. High risk loans are defined
by the Company as loans secured by junior liens, interest-only loans and loans with a high loan-to-value ratio. A decrease in the level
of high risk loans within a class decreases the required allocation for the loan class, and an increase in the level of high risk loans within
a class increases the required allocation for the loan class. Total high risk loans rose $1,337 or 0.86% from the level at December 31,
2017, resulting in an increased allocation.
Loans rated “special mention” and “classified” (together, “criticized assets”) indicate heightened credit risk. Higher levels of
criticized assets increase the required level of the allowance for collectively-evaluated loans, while lower levels of criticized assets
reduce the required level of the allowance for collectively-evaluated loans. Loans rated special mention receive a 50% greater allocation
for qualitative risk factors, and loans rated classified receive a 100% greater allocation for qualitative risk factors. A classified loss rate
is also applied to classified loans, calculated as net charge offs divided by classified loans.
Collectively evaluated loans rated “special mention” were $1,455 at December 31, 2018 and $3,361 at December 31, 2017.
Collectively evaluated loans rated classified were $735 at December 31, 2018 and $1,691 at December 31, 2017. The improvements in
levels of criticized assets resulted in lower allocations.
The calculation of the appropriate level for the allowance for loan losses incorporates analysis of multiple factors and requires
management’s prudent and informed judgment. The ratio of the allowance for loan losses to total loans, net of unearned income and
deferred fees and costs at December 31, 2018 is 1.04%, a decrease from 1.19% at December 31, 2017. The ratio of the allowance for
collectively-evaluated loan losses to collectively-evaluated loans, net of unearned income and deferred fees and costs was 1.03%,
compared with 1.18% at December 31, 2017. Improvements from December 31, 2017 in the charge-off rate, unemployment, business
bankruptcy rate, the inventory of homes, residential vacancy, and criticized loans decreased the required level of the allowance for loan
losses, slightly offset by worsening in the level of nonaccrual loans and the impact of the interest rate environment. Based on analysis
of historical indicators, asset quality and economic factors, management believes the level of allowance for loan losses is reasonable for
the credit risk in the loan portfolio.
31
Quarterly Results of Operations
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2018, 2017 and 2016:
$ in thousands
2018
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Income Statement Data:
Interest income
Interest expense
Net interest income
Provision for (recovery of) loan losses
Noninterest income
Noninterest expense
Income taxes
Net income
Per Share Data:
Basic net income per common share
Fully diluted net income per common share
Cash dividends per common share
Book value per common share
$ in thousands
Income Statement Data:
Interest income
Interest expense
Net interest income
Provision for (recovery of) loan losses
Noninterest income
Noninterest expense
Income taxes
Net income
Per Share Data:
Basic net income per common share
Fully diluted net income per common share
Cash dividends per common share
Book value per common share
$
$
$
$
$
$
10,484 $
1,081
9,403
(472 )
2,023
8,164
438
3,296 $
0.47 $
0.47
---
26.67
10,726 $
1,145
9,581
342
1,868
6,424
642
4,041 $
0.58 $
0.58
0.58
26.71
2017
10,945 $
1,245
9,700
223
1,914
6,463
677
4,251 $
0.61 $
0.61
---
27.04
11,069
1,576
9,493
(174 )
1,924
6,225
803
4,563
0.66
0.66
0.63
27.34
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
10,238 $
1,028
9,210
59
1,850
6,283
1,069
3,649 $
0.52 $
0.52
---
26.30
10,295 $
1,048
9,247
464
1,731
5,974
970
3,570 $
0.51 $
0.51
0.56
26.49
10,301 $
1,021
9,280
201
1,884
6,031
1,147
3,785 $
0.54 $
0.54
---
26.97
10,426
1,028
9,398
(567 )
2,171
5,941
3,107
3,088
0.46
0.46
0.61
26.57
32
$ in thousands
2016
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Income Statement Data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Income taxes
Net income
Per Share Data:
Basic net income per common share
Fully diluted net income per common share
Cash dividends per common share
Book value per common share
Balance Sheet
$
$
$
10,484 $
1,068
9,416
203
1,678
6,021
1,091
3,779 $
0.54 $
0.54
---
25.76
10,292 $
1,063
9,229
654
1,908
5,528
1,090
3,865 $
0.56 $
0.56
0.55
25.86
10,157 $
1,019
9,138
291
1,769
5,908
880
3,828 $
0.55 $
0.55
---
26.47
9,997
1,016
8,981
502
1,760
5,878
891
3,470
0.51
0.51
0.61
25.62
On December 31, 2018, the Company had total assets of $1,256,032, a decrease of $725 or 0.06%, over total assets of $1,256,757
on December 31, 2017. Total assets at December 31, 2017 were up by $22,815, or 1.85%, over the total at December 31, 2016.
Loans
The Company’s loan categorization reflects its approach to loan portfolio management and includes six groups. Real estate
construction loans include construction loans for residential and commercial properties, as well as land. Consumer real estate loans
include conventional and junior lien mortgages, equity lines and investor-owned residential real estate. Commercial real estate loans are
comprised of owner-occupied and leased nonfarm, nonresidential properties, multi-family residence loans and farmland. Commercial
non real estate loans include agricultural loans, operating capital lines and loans secured by capital assets. Public sector and IDA loans
are extended to municipalities. Consumer non real estate loans include automobile loans, personal loans, credit cards and consumer
overdrafts.
A. Types of Loans
$ in thousands
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total loans
Less unearned income and deferred fees
Total loans, net of unearned income and
deferred fees and costs
Less allowance for loans losses
Total loans, net
2018
2017
2016
2015
2014
December 31,
$
$
$
$
37,845 $
175,456
353,546
46,535
60,777
36,238
710,397 $
(598 )
34,694 $
36,345 $
48,251 $
166,965
340,414
40,518
51,443
34,648
157,718
336,457
39,204
45,474
33,528
143,504
309,378
37,571
51,335
29,845
668,682 $
(613 )
648,546 $
(794 )
619,884 $
(876 )
709,799 $
(7,390 )
702,409 $
668,069 $
(7,925 )
660,144 $
647,752 $
(8,300 )
639,452 $
619,008 $
(8,297 )
610,711 $
45,562
147,039
310,762
33,413
41,361
28,182
606,319
(853 )
605,466
(8,263 )
597,203
33
B. Maturities and Interest Rate Sensitivities
The following table presents maturities and interest rate sensitivities for commercial non real estate, commercial real estate and real estate
construction loans.
$ in thousands
Commercial non real estate
Commercial real estate
Real estate construction
Total
Less loans with predetermined interest rates
Loans with adjustable rates
Risk Elements
< 1 Year
1 – 5 Years
After 5 Years
Total
December 31, 2018
33,948 $
74,858
19,111
127,917
(24,993 )
102,924 $
11,964 $
225,268
17,612
254,844
(25,881 )
228,963 $
623 $ 46,535
353,546
53,420
37,845
1,122
437,926
55,165
(11,528 )
(62,402 )
43,637 $ 375,524
$
$
The following table presents aggregate amounts for nonaccrual loans, restructured loans in nonaccrual, other real estate owned net, and
accruing loans which are contractually past due ninety days or more as to interest or principal payments, and accruing restructured loans.
$ in thousands
Nonaccrual loans
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total nonaccrual loans
Restructured loans (TDR Loans) in nonaccrual
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total restructured loans in nonaccrual
Total nonperforming loans
Other real estate owned, net
Total nonperforming assets
Accruing loans past due 90 days or more
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
$
$
$
$
$
$
$
Total accruing loans past due 90 days or more
$
2018
2017
2016
2015
2014
December 31,
--- $
6
---
---
---
---
6 $
--- $
145
2,602
15
---
1
2,763 $
2,769 $
2,817
5,586 $
--- $
11
---
---
---
40
51 $
--- $
256
698
217
---
---
1,168 $
270 $
---
4,390
24
---
3
4,687 $
5,855 $
3,156
9,011 $
--- $
42
---
---
---
21
63 $
--- $
14
1,146
883
---
---
2,043 $
718 $
---
3,921
---
---
---
4,639 $
6,682 $
4,165
10,847 $
--- $
145
---
---
---
11
156 $
---
164
3,087
748
---
---
3,999
---
---
5,288
---
---
---
5,288
9,287
4,744
14,031
---
82
102
---
---
23
207
(continued)
--- $
119
192
---
---
---
311 $
--- $
610
2,494
5
---
---
3,109 $
3,420 $
2,052
5,472 $
--- $
---
---
2
---
33
35 $
34
Accruing restructured loans
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total accruing restructured loans
$
$
--- $
417
1,112
1,010
---
13
2,552 $
--- $
947
2,948
1,214
---
25
5,134 $
--- $
877
2,892
---
---
---
3,769 $
--- $
962
7,645
207
---
---
8,814 $
---
819
5,192
29
---
---
6,040
Loan loss and other indicators related to asset quality are presented in the Loan Loss Data table.
Loan Loss Data Table
$ in thousands
Provision for (recovery of) loan losses
Net charge-offs to average net loans
Allowance for loan losses to loans, net of unearned
income and deferred fees
Allowance for loan losses to nonperforming loans
Allowance for loan losses to nonperforming assets
Nonperforming assets to loans, net of unearned income
and deferred fees and costs, plus other real estate owned
Nonaccrual loans
Restructured loans in nonaccrual status
Other real estate owned, net
Total nonperforming assets
Accruing loans past due 90 days or more
2018
$
2017
(81 )
0.07 %
$
1.04 %
216.08 %
135.05 %
0.77 %
311
3,109
2,052
5,472
35
$
$
$
$
$
$
157
0.08 %
1.19 %
286.20 %
141.87 %
0.83 %
6
2,763
2,817
5,586
51
2016
$
$
$
$
1,650
0.26 %
1.28 %
141.76 %
92.11 %
1.38 %
1,168
4,687
3,156
9,011
63
Nonperforming loans include nonaccrual loans and restructured loans (“troubled debt restructurings” or “TDR loans”) in nonaccrual
status, but do not include accruing loans 90 days or more past due or accruing restructured loans. Troubled debt restructurings are
discussed in detail under the section titled “D. Modifications and Troubled Debt Restructurings (TDR Loans)” below. Impaired loans,
or loans for which management does not expect to collect at the original loan terms, but which may or may not be nonperforming, are
presented in Note 5 of Notes to Consolidated Financial Statements.
Total impaired loans at December 31, 2018 were $6,820, of which $3,420 were in nonaccrual status. Impaired loans at December
31, 2017 and 2016 were $11,924 and $9,173, of which $2,763 and $5,404 were in nonaccrual status, respectively.
The ratio of the allowance for loan losses to total nonperforming loans decreased from 286.20% in 2017 to 216.08% in 2018. The
Company believes the allowance for loan losses is adequate for the credit risk inherent in the loan portfolio.
D. Modifications and Troubled Debt Restructurings (“TDRs”)
In the ordinary course of business the Company modifies loan terms on a case-by-case basis, including both consumer and
commercial loans, for a variety of reasons. Modifications to consumer loans generally involve short-term deferrals to accommodate
specific, temporary circumstances. The Company may grant extensions to borrowers who have demonstrated a willingness and ability
to repay their loan but who are experiencing consequences of a specific unforeseen temporary hardship.
An extension defers monthly payments and requires a balloon payment at the original contractual maturity. If the temporary event
is not expected to impact a borrower’s ability to repay the debt, and if the Company expects to collect all amounts due including interest
accrued at the contractual interest rate for the period of delay at contractual maturity, the modification is not designated a TDR.
Modifications to commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial
covenants. In the original underwriting, loan terms are established that represent the then-current and projected financial condition of
the borrower. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could
otherwise obtain in the open market, the modified loan is not categorized as a TDR.
The Company codes modifications to assist in identifying troubled debt restructurings. The majority of modifications were granted
for competitive reasons and did not constitute troubled debt restructurings. A description of modifications that did not result in troubled
debt restructurings follows:
35
8,384
646
22,663
11,777
2,304
2,076
1,542
783
300
2,862
53,337
11,783
2,693
29,253
14,675
3,474
4,603
4,884
448
5,044
76,857
Modifications Made During the 12 Months Ended December 31, 2018
to Borrowers Not Experiencing Financial Difficulty
Total Amount Modified
Modification
Rate reductions for competitive purposes
Payment extensions for less than 3 months
Maturity date extensions of more than 3 months
and up to 6 months
Maturity date extensions of more than 6 months
and up to 12 months
Maturity date extensions of more than 12 months
Advances on non-revolving loans or
recapitalization
Change in amortization term or method
Change or release of collateral
Renewal of expired Home Equity Line of Credit
loans to additional 10 years
Renewal of single-payment notes
Total modifications that do not constitute TDRs
Number of Loans
Modified
18
61
$
134
308
17
8
11
43
20
138
758
$
Modifications Made During the 12 Months Ended December 31, 2017
to Borrowers Not Experiencing Financial Difficulty
Modification
Rate reductions for competitive purposes
Payment extensions for less than 3 months
Maturity date extensions of more than 3 months
and up to 6 months
Maturity date extensions of more than 6 months
and up to 12 months
Maturity date extensions of more than 12 months
Advances on non-revolving loans or
recapitalization
Change in amortization term or method
Renewal of expired Home Equity Line of Credit
loans to additional 10 years
Renewal of single-payment notes
Total modifications that do not constitute TDRs
Number of Loans
Modified
29
126
$
Total Amount
Modified
182
316
7
12
42
19
240
973
$
36
Modifications Made During the 12 Months Ended December 31, 2016
to Borrowers Not Experiencing Financial Difficulty
Modification
Rate reductions for competitive purposes
Payment extensions for less than 3 months
Maturity date extensions of more than 3 months
and up to 6 months
Maturity date extensions of more than 6 months
and up to 12 months
Maturity date extensions of more than 12 months
Advances on non-revolving loans or
recapitalization
Change in amortization term or method
Renewal of expired Home Equity Line of Credit
loans to additional 10 years
Renewal of single-payment notes
Total modifications that do not constitute TDRs
Number of Loans
Modified
73
142
$
219
274
17
2
26
19
244
1,016
$
Total Amount Modified
34,080
2,475
20,781
13,277
3,073
177
2,292
678
4,722
81,555
Modifications in which the borrower is experiencing financial difficulty and for which the Company makes a concession to the
original contractual loan terms are designated troubled debt restructurings. Modifications of loan terms to borrowers experiencing
financial difficulty are made in an attempt to protect as much of the Company’s investment in the loan as possible. The determination
of whether a modification should be accounted for as a TDR requires significant judgment after consideration of all facts and
circumstances surrounding the transaction.
Assuming all other TDR criteria are met, the Company considers one or a combination of the following concessions to the loan
terms to indicate TDR status: a reduction of the stated interest rate, an extension of the maturity date at an interest rate lower than the
current market rate for a new loan with a similar term and similar risk, or forgiveness of principal or accrued interest.
The Company has restructured loan terms for certain qualified financially distressed borrowers who have agreed to work in good
faith and have demonstrated the ability to make the restructured payments in order to avoid a foreclosure. TDR loans are individually
evaluated for impairment for purposes of determining the allowance for loan losses. TDR loans with at least six months of timely
repayment history may accrue interest. TDR loans that do not have six months of timely repayment performance are maintained on
nonaccrual until the borrower demonstrates sustained repayment history under the restructured terms and continued repayment is not in
doubt. TDR loans may be removed from TDR status, and placed in the appropriate collectively-evaluated pool, if the restructuring
agreement specified a market interest rate at the time of restructuring and the loan is in compliance with modified terms for a period of
at least one year after the restructuring was executed.
The Company’s TDRs amounted to $5,661 as of December 31, 2018 and $7,897 as of December 31, 2017. Accruing TDR loans
amounted to $2,552 at December 31, 2018 compared to $5,134 at December 31, 2017.
Restructuring generally results in loans with lower payments or an extended maturity beyond that originally required, and are
expected to have a lower risk of loss due to nonperformance than loans classified as nonperforming. In 2018, the Company modified
loans in troubled debt restructurings that, directly prior to restructuring, totaled $4,212 and that have total principal balances of $3,800
as of December 31, 2018. None of the Company’s restructured loans defaulted during the twelve months ended December 31, 2018.
The Company defines default as a delay in one payment of more than 90 days or foreclosure after the date of restructuring. All of the
restructured loans that defaulted had been modified more than twelve months prior to default.
In 2017, the Company modified loans in troubled debt restructurings that, directly prior to restructuring, totaled $1,387 and that had
total principal balances of $1,369 as of December 31, 2017. All of the restructured loans that defaulted in 2017 had been modified more
than twelve months prior to default. Please refer to Note 5 for information on the effect of default on the allowance for loan losses.
37
Nonaccrual
---
610
2,494
5
---
---
3,109
--- $
---
---
---
---
---
--- $
Nonaccrual
---
145
2,602
15
---
1
2,763
--- $
---
---
---
---
---
--- $
Nonaccrual
270
---
4,390
24
---
3
4,687
--- $
---
---
---
---
---
--- $
The following tables present the delinquency status of TDR loans.
$ in thousands
TDR Delinquency Status as of December 31, 2018
Total TDR
Loans
Current
Accruing
30-89 Days
Past Due
90+ Days
Past Due
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total TDR Loans
$
--- $
--- $
1,027
3,606
1,015
---
13
5,661
417
1,112
1,010
---
9
$ 2,548 $
$
--- $
---
---
---
---
4
4 $
$ in thousands
TDR Delinquency Status as of December 31, 2017
Total TDR
Loans
Current
Accruing
30-89 Days
Past Due
90+ Days
Past Due
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total TDR Loans
$
$
---
1,092
5,550
1,229
---
26
7,897
$
--- $
773
2,948
1,214
---
25
$ 4,960 $
--- $
174
---
---
---
---
174 $
$ in thousands
TDR Delinquency Status as of December 31, 2016
Total TDR
Loans
Current
Accruing
30-89 Days
Past Due
90+ Days
Past Due
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public sector and IDA
Consumer non real estate
Total TDR Loans
$
$
270
877
7,282
24
---
3
8,456
$
--- $
717
2,892
---
---
---
$ 3,609 $
--- $
160
---
---
---
---
160 $
38
Summary of Loan Loss Experience
A. Analysis of the Allowance for Loan Losses
The following tabulation shows average loan balances at the end of each period; changes in the allowance for loan losses arising from
loans charged off and recoveries on loans previously charged off by loan category; and additions to the allowance which have been charged
to operating expense:
$ in thousands
2018
2017
2016
2015
2014
December 31,
Average loans, net of unearned income and deferred
fees and costs
$
Allowance for loan losses at beginning of year
Charge-offs:
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public Sector and IDA
Consumer non real estate
Total loans charged off
Recoveries:
Real estate construction
Consumer real estate
Commercial real estate
Commercial non real estate
Public Sector and IDA
Consumer non real estate
Total recoveries
Net loans charged off
Provision for (recovery of) loan losses
Allowance for loan losses at end of year
Net charge-offs to average loans net of unearned
income and deferred fees and costs
$
683,310 $ 653,364 $ 621,654 $ 619,745 $ 592,944
8,227
8,297
8,263
8,300
7,925
---
38
---
107
---
544
689
---
146
139
82
---
452
819
29
133
488
883
---
273
1,806
---
205
1,114
490
---
311
2,120
---
3
49
22
---
161
235
454
(81 )
7,390 $
---
1
131
23
---
132
287
532
157
7,925 $
---
2
83
10
---
64
159
1,647
1,650
8,300 $
---
2
49
1
---
93
145
1,975
2,009
8,297 $
2
222
1,201
89
---
346
1,860
---
---
50
132
---
73
255
1,605
1,641
8,263
0.07 %
0.08 %
0.26 %
0.32 %
0.27 %
The Company charges off commercial real estate loans at the time that a loss is confirmed. When delinquency status or other information
indicates that the borrower will not repay the loan, the Company considers collateral value based upon a current appraisal or internal
evaluation. Any loan amount in excess of collateral value is charged off and the collateral is taken into other real estate owned.
Management analyzes many factors to determine the appropriate level for the allowance for loan losses and resultant provision
expense, including the historical loss rate, the quality of the loan portfolio as determined by management, diversification as to type of
loans in the portfolio, internal policies and economic factors. Management considers net charge-offs over the most recent eight quarters
to determine the historical loss rate to be applied to the calculation. The historical loss rate contributes significantly to the required level
for the allowance for loan losses.
39
B. Allocation of the Allowance for Loan Losses
The allowance for loan losses has been allocated according to the amount deemed necessary to provide for anticipated losses within the
categories of loans for the years indicated as follows:
$ in thousands
2018
2017
December 31,
2016
2015
2014
Percent of
Loans in
Each
Category to
Total
Loans(1)
Percent of
Loans in
Each
Category to
Total
Loans(1)
Percent of
Loans in
Each
Category to
Total
Loans(1)
Percent of
Loans in
Each
Category to
Total
Loans(1)
Allowance
Amount
Allowance
Amount
Percent of
Loans in
Each
Category to
Total
Loans(1)
Allowance
Amount
Allowance
Amount
Allowance
Amount
Real estate
construction $
Consumer
real estate
Commercial
real estate
Commercial
non real
estate
Public sector
and IDA
Consumer
non real
estate
Unallocated
$
398
5.33 % $ 337
5.19 % $
438
5.60 % $ 576
7.78 % $ 612
7.52 %
2,049
24.70 %
2,027
24.97 %
1,830
24.32 %
1,866
23.15 %
1,662
24.25 %
2,798
49.77 %
3,044
50.91 %
3,738
51.88 %
4,109
49.92 %
3,537
51.25 %
602
6.55 %
1,072
6.06 %
1,063
6.02 %
655
6.06 %
1,475
5.51 %
583
8.55 %
419
7.69 %
330
7.01 %
436
8.28 %
327
6.82 %
750
210
7,390
5.10 %
707
319
100.00 % $ 7,925
5.18 %
644
257
100.00 % $ 8,300
5.17 %
627
28
100.00 % $ 8,297
4.81 %
602
48
100.00 % $ 8,263
4.65 %
100.00 %
(1) Loans are presented on a gross basis.
An analysis of the allowance for loan losses by impairment basis follows:
$ in thousands
December 31,
2018
2017
2016
$
$
6,820
139
2.04 %
11,924 $
177
1.48 %
703,577
7,251
1.03 %
710,397
(598 )
709,799
7,390
656,758
7,748
1.18 %
668,682
(613 )
668,069
7,925
9,173
26
0.27 %
639,373
8,274
1.30 %
648,546
(794 )
647,752
8,300
1.04 %
1.19 %
1.28 %
Impaired loans(1)
Allowance related to impaired loans(1)
Allowance to impaired loans(1)
Non-impaired loans(1)
Allowance related to non-impaired loans(1)
Allowance to non-impaired loans(1)
Total gross loans
Less: unearned income and deferred fees and costs
Loans, net of unearned income and deferred fees and costs
Allowance for loan losses, total
Allowance as a percentage of loans, net of unearned
income and deferred fees and costs
(1) Loans are presented on a gross basis.
40
Individually-evaluated impaired loans are valued using the appraised value of the underlying collateral or the present value of cash
flows for each loan. Valuation procedures for impaired loans resulted in a required reserve for impaired loans of $139 at December 31,
2018, $177 at December 31, 2017 and $26 at December 31, 2016. The amount of the individual impaired loan balance that exceeds the
fair value is accrued in the allowance for loan losses.
Management’s analysis of the loan portfolio and pertinent economic conditions resulted in a determination of the allowance for
loan losses for collectively-evaluated loans of $7,251 or 1.03% of such loans at December 31, 2018, $7,748 or 1.18% at December 31,
2017, and $8,274 or 1.30% at December 31, 2016. The allowance for collectively-evaluated loans is determined by applying historical
charge-off percentages, as well as additional accruals for internal and external credit risk factors to groups of collectively-evaluated
loans. The ratio decreased from 2017 to 2018 due to a decreased charge-off ratio, down from 0.08% for the twelve months ended
December 31, 2017 to 0.07% for the year ended December 31, 2018. The ratio was 0.26% for 2016. The Company applies the average
of the most recent eight quarters of net charge-offs to calculate historical net charge-offs for the allowance. Also contributing to the
reduced allowance requirement were improved asset quality indicators, and favorable economic indicators. The ratio decreased from
2016 to 2017 due to the decrease in the charge-off ratio, from 0.26% for the twelve months ended December 31, 2016 to 0.08% for the
year ended December 31, 2017. Also contributing to the reduced allowance requirement were improved asset quality indicators, lower
levels of high risk loans and favorable economic indicators.
The unallocated portion of the reserve was $210 at December 31, 2018, $319 at December 31, 2017 and $257 at December 31,
2016. The unallocated portion of the reserve is the amount that exceeds the calculated requirement for the allowance for loan losses.
The Company’s policy permits an unallocated reserve of up to 5% in excess of the required level for the allowance for loan losses.
The total calculated allowance for loan losses of $7,390 at December 31, 2018, $7,925 as of December 31, 2017 and $8,300 as of
December 31, 2016 indicated a recovery of loan losses of $81 for the twelve months ended December 31, 2018 and indicated provision
charges of $157 for the twelve months ended December 31, 2017 and $1,650 for the twelve months ended December 31, 2016. Please
refer to the discussion under “Provision and Allowance for Loan Losses” for additional information on the determination of the
allowance for loan loss.
Securities
The fair value of securities available for sale was $425,010, an increase of $93,623 or 28.25% from December 31, 2017. The
amortized cost of securities held to maturity was $0 at December 31, 2018 and $127,164 at December 31, 2017. During the second
quarter of 2018, the Company reclassified all held to maturity securities as available for sale. At the time of transfer, the securities were
recorded at fair value of $119,790 and an unrealized gain of $891, net of tax, was recorded in accumulated other comprehensive income.
Additional information about securities available for sale and securities held to maturity can be found in Note 3 of the Notes to
Consolidated Financial Statements.
The securities portfolio is subject to the volatility and risk in the financial markets. The risk in financial markets affects the Company
in the same way that it affects other institutional and individual investors. The Company’s investment portfolio includes corporate bonds.
If, because of economic hardship, the corporate issuers were to default, there could be a delay in the payment of interest, or there could
be a loss of principal and accrued interest. To date, there have been no defaults in any of the corporate bonds held in the portfolio. The
Company’s investment portfolio also contains a large percentage of municipal bonds. If economic forces reduce the ability of states and
municipalities to make scheduled principal and interest payments on their outstanding indebtedness, or if their income from taxes and
other sources declines significantly, states and municipalities could default on their bond obligations. There have been no defaults among
the municipal bonds in the Company’s investment portfolio. The fair value of our bond portfolio is affected by interest rates. The fair
value of available for sale securities is reflected on the Company's balance sheet, while held to maturity securities are reported at
amortized cost.
In making investment decisions, management follows internal policy guidelines that help to limit risk by specifying parameters for
both security quality and industry and geographic concentrations. Management regularly monitors the quality of the investment portfolio
and tracks changes in financial markets. The value of individual securities will be written down if a decline in fair value is considered
to be other than temporary, given the totality of the circumstances.
41
Maturities and Associated Yields
The following table presents the maturities for securities available for sale and held to maturity at their carrying values as of
December 31, 2018 and weighted average yield for each range of maturities.
$ in thousands, except percent data
Maturities and Yields
December 31, 2018
< 1 Year
1-5 Years
5-10 Years
> 10 Years
None
Total
Available for Sale:
U.S. Government agencies
Mortgage-backed securities
$ 54,567
$ 164,119
$ 55,929
$ 25,432
$
$
1.24 %
11
5.00 %
$
1.74 %
47
5.70 %
$
3.03 %
315
5.55 %
$
3.38 %
255
5.68 %
$
States and political subdivision – nontaxable (1)
$ 16,435
$ 11,006
$ 28,340
$ 62,835
$
$
5.41 %
---
---
$ 71,013
4.94 %
$ 1,969
2.44 %
$ 177,141
$
4.25 %
---
---
$ 84,584
4.00 %
$ 3,750
4.08 %
$ 92,272
$
$
2.21 %
1.95 %
3.45 %
3.84 %
---
---
---
---
---
---
---
---
---
---
$ 300,047
$
2.03 %
628
5.60 %
$ 118,616
4.34 %
$
5,719
3.54 %
$ 425,010
2.70 %
Corporate
Total
Restricted stock:
Restricted stock
$
$
---
---
$
---
---
$
---
---
---
---
$ 1,220
$
1,220
6.64 %
6.64 %
(1) Rates shown represent weighted average yield on a fully taxable basis.
The majority of mortgage-backed securities and collateralized mortgage obligations held at December 31, 2018 were backed by
U.S. agencies. Certain holdings are required to be periodically subjected to the Federal Financial Institution Examination Council’s
(FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and variances caused by the change
in rate times the change in volume that have been allocated to rate and volume changes proportional to the relationship of the absolute
dollar amounts of the change in each. Except for U.S. Government securities, the Company has no securities with any issuer that exceeds
10% of stockholders’ equity.
Deposits
Total deposits decreased by $7,792 or 0.74%, from $1,059,734 at December 31, 2017 to $1,051,942 at December 31, 2018. The
decrease is primarily due to a decline in time deposits. Total deposits grew $16,292, or 1.56%, from $1,043,442 at December 31, 2016
to December 31, 2017. A portion of the increase in 2017 is attributable to a higher level of municipal deposits.
A. Average Amounts of Deposits and Average Rates Paid
Average amounts and average rates paid on deposit categories are presented below:
$ in thousands
Noninterest-bearing demand deposits
Interest-bearing demand deposits
Savings deposits
Time deposits
Average total deposits
2018
Year Ended December 31,
2017
2016
Average
Amounts
$
192,440
606,766
140,918
105,674
$ 1,045,798
Average
Rates
Paid
Average
Amounts
---
$ 178,708
0.68 %
598,661
0.17 %
140,997
120,220
0.50 %
0.47 % $ 1,038,586
Average
Rates
Paid
Average
Amounts
Average
Rates
Paid
$
---
170,344
0.56 %
567,971
0.17 %
134,982
140,490
0.45 %
0.40 % $ 1,013,787
---
0.55 %
0.23 %
0.50 %
0.41 %
42
B. Time Deposits of $250 or More
The following table sets forth time certificates of deposit and other time deposits of $250 or more:
$ in thousands
3 Months or Less
Over 3 Months
Through 6 Months
December 31, 2018
Over 6 Months
Through 12 Months
Over 12 Months
Total
Total time deposits of $250
or more
$
1,328 $
4,711
$
5,042
$
3,196 $
14,277
Derivatives and Market Risk Exposures
The Company is not a party to derivative financial instruments with off-balance sheet risks such as futures, forwards, swaps, and
options. The Company is a party to financial instruments with off-balance sheet risks such as commitments to extend credit, standby
letters of credit, and recourse obligations in the normal course of business to meet the financing needs of its customers. See Note 13, of
Notes to Consolidated Financial Statements for additional information relating to financial instruments with off-balance sheet risk.
Management does not plan any future involvement in high risk derivative products. The Company has investments in mortgage-backed
securities, principally GNMA’s and FNMA’s, with a fair value of approximately $628. See Note 3 of Notes to Consolidated Financial
Statements for additional information relating to securities.
The Company’s securities and loans are subject to credit and interest rate risk, and its deposits are subject to interest rate risk.
Management considers credit risk when a loan is granted and monitors credit risk after the loan is granted. The Company maintains an
allowance for loan losses to absorb losses in the collection of its loans. See Note 5 of Notes to Consolidated Financial Statements for
information relating to the allowance for loan losses. See Note 14 of Notes to Consolidated Financial Statements for information relating
to concentrations of credit risk. The Company has an asset/liability program to manage its interest rate risk. This program provides
management with information related to the rate sensitivity of certain assets and liabilities and the effect of changing rates on profitability
and capital accounts.
The effects of changing interest rates are primarily managed through adjustments to the loan portfolio and deposit base, to the extent
competitive factors allow. The investment portfolio is generally longer term. Adjustments for asset and liability management are made
when securities are called or mature and funds are subsequently reinvested. Securities may be sold for reasons related to credit quality
or regulatory limitations, and in limited circumstances, securities available for sale have been disposed of for interest rate risk
management. No trading activity for this purpose is planned in the foreseeable future, though it does remain an option.
While the asset/liability planning program is designed to protect the Company over the long term, it does not provide near-term
protection from interest rate shocks, as interest rate sensitive assets and liabilities do not by their nature move up or down in tandem in
response to changes in the overall rate environment. The Company’s profitability in the near term may be temporarily negatively affected
in a period of rapidly rising or rapidly falling rates, because it takes some time for the Company to change its rates to adjust to a new
interest rate environment. See Note 15 of Notes to Consolidated Financial Statements for information relating to fair value of financial
instruments and comments concerning interest rate sensitivity.
Liquidity
Liquidity measures the Company’s ability to meet its financial commitments at a reasonable cost. Demands on the Company’s
liquidity include funding additional loan demand and accepting withdrawals of existing deposits. The Company has diverse liquidity
sources, including customer and purchased deposits, customer repayments of loan principal and interest, sales, calls and maturities of
securities, Federal Reserve discount window borrowing, short-term borrowing, and Federal Home Loan Bank advances. At December
31, 2018, the bank did not have discount window borrowings, short-term borrowings, or FHLB advances. To assure that short-term
borrowing is readily available, the Company tests accessibility annually.
The Company considers its security portfolio for typical liquidity needs, within accounting, legal and strategic parameters. Prior to
the second quarter of 2018, the securities portfolio was segregated into available-for-sale and held-to-maturity. During the second quarter
of 2018, the Company re-classified all its held-to-maturity securities to available-for-sale. Portions of the securities portfolio are pledged
to meet state requirements for public funds deposits. Discount window borrowings also require pledged securities. Increased/decreased
liquidity from public funds deposits or discount window borrowings results in increased/decreased liquidity from pledging requirements.
The Company monitors public funds pledging requirements and unpledged available-for-sale securities accessible for liquidity needs.
Regulatory capital levels determine the Company’s ability to use purchased deposits and the Federal Reserve discount window. At
December 31, 2018, the Company is considered well capitalized and does not have any restrictions on purchased deposits or borrowing
ability at the Federal Reserve discount window.
The Company monitors factors that may increase its liquidity needs. Some of these factors include deposit trends, large depositor
activity, maturing deposit promotions, interest rate sensitivity, maturity and repricing timing gaps between assets and liabilities, the level
of unfunded loan commitments and loan growth. At December 31, 2018, the Company’s liquidity is sufficient to meet projected trends
43
in these areas.
To monitor and estimate liquidity levels, the Company performs stress testing under varying assumptions on credit sensitive
liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows. The Company’s Contingency
Funding Plan sets forth avenues for rectifying liquidity shortfalls. At December 31, 2018, the analysis indicated adequate liquidity under
the tested scenarios.
The Company utilizes several other strategies to maintain sufficient liquidity. Loan and deposit growth are managed to keep the
loan to deposit ratio within the Company’s own policy range of 65% to 75%. At December 31, 2018, the loan to deposit ratio was
67.48%. The investment strategy takes into consideration the term of the investment, and securities in the available for sale portfolio are
laddered based upon projected funding needs.
In the normal course of business, we enter into certain contractual obligations, including obligations to make future payments on
lease arrangements, contractual commitments with depositors, and service contracts. The table below presents our significant contractual
obligations as of December 31, 2018, except for pension and other postretirement benefit plans, which are included in Note 8, "Employee
Benefit Plans," to the Consolidated Financial Statements in this Form 10-K.
$ in thousands
Payments Due by Period
Time deposits
Purchase obligations (1)
Operating leases
Total
Total
$
$
101,799
6,328
1,935
110,062
$
$
Less Than
1 Year
1-3 Years
4-5 Years
More Than
5 Years
53,337
3,956
346
57,639
$
$
43,274 $
1,832
365
45,471 $
5,125
540
352
6,017
$
$
63
---
872
935
(1) Includes contracts with a minimum annual payment of $100
As of December 31, 2018, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably
likely to have a material impact on our liquidity. As of December 31, 2018, the Company has no material commitments for long-term
debt or for capital expenditures.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements.
Capital Resources
Total stockholders’ equity at December 31, 2018 was $190,238, an increase of $5,342, or 2.89%, from the $184,896 at December
31, 2017. The largest component of 2018 stockholders’ equity was retained earnings of $193,625, which included net income of $16,151,
offset by dividends of $8,419. Total stockholders’ equity increased by $6,633 or 3.72%, from $178,263 on December 31, 2016 to
$184,896 on December 31, 2017.
In August, 2018, the Federal Reserve updated the Small Bank Holding Company Policy Statement (“the Statement”), in compliance
with The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (“EGRRCPA”). The Statement, among other
things, exempts bank holding companies that fall below a certain asset threshold from reporting consolidated regulatory capital ratios
and from minimum regulatory capital requirements. The interim final rule expands the exemption to bank holding companies with
consolidated total assets of less than $3 billion. Prior to August 2018, the statement exempted bank holding companies with consolidated
total assets of less than $1 billion. As a result of the interim final rule, the Company qualifies as of August, 2018 as a small bank holding
company and is no longer subject to regulatory capital requirements on a consolidated basis.
The Bank continues to be subject to various capital requirements administered by banking agencies. Risk based capital ratios for
the Bank are shown in the following tables.
Ratios at
December 31, 2018
Regulatory Capital
Minimum Ratios
Regulatory Capital Minimum
Ratios with Capital Conservation
Buffer
Common Equity Tier I Capital Ratio
Tier I Capital Ratio
Total Capital Ratio
Leverage Ratio
23.856 %
23.856 %
24.764 %
15.788 %
44
4.500 %
6.000 %
8.000 %
4.000 %
6.375 %
7.875 %
9.875 %
4.000 %
Ratios at
December 31, 2017
Regulatory Capital
Minimum Ratios
Regulatory Capital Minimum
Ratios with Capital Conservation
Buffer
Common Equity Tier I Capital Ratio
Tier I Capital Ratio
Total Capital Ratio
Leverage Ratio
23.332 %
23.332 %
24.316 %
15.254 %
4.500 %
6.000 %
8.000 %
4.000 %
5.750 %
7.250 %
9.250 %
4.000 %
Risk-based capital ratios are calculated in compliance with FDIC rules based on Basel III capital requirements. The Bank’s ratios
are well above the required minimums at December 31, 2018 and December 31, 2017.
Banks are subject to an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments.
The implementation period for the capital conservation buffer began in 2016 and was fully phased in January 1, 2019, with .625% added
each year and a final buffer of 2.5% in excess of regulatory capital minimum ratios.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements at December 31, 2018 are detailed in the table below.
$ in thousands
Payments Due by Period
Commitments to extend credit
Standby letters of credit
Mortgage loans with potential recourse
Operating leases
Total
Total
Less Than 1 Year
1-3 Years
$
$
145,635
16,092
13,013
1,935
176,675
$
$
145,635
16,092
13,013
346
175,086
$
$
---
---
---
365
365
---
---
---
352
352
$
$
4-5 Years More Than 5 Years
$
$
---
---
---
872
872
In the normal course of business the Company’s banking affiliate extends lines of credit to its customers. Amounts drawn upon
these lines vary at any given time depending on the business needs of the customers.
Standby letters of credit are also issued to the bank’s customers. There are two types of standby letters of credit. The first is a
guarantee of payment to facilitate customer purchases. The second type is a performance letter of credit that guarantees a payment if the
customer fails to perform a specific obligation. Revenue from these letters was approximately $40 in 2018.
While it would be possible for customers to fully draw on approved lines of credit and for beneficiaries to call all letters of credit,
historically this has not occurred. In the event of a sudden and substantial draw on these lines, the Company has its own lines of credit
from which it can draw funds. A sale of loans or investments would also be an option to meet liquidity demands.
The Company sells mortgages on the secondary market subject to recourse agreements. The mortgages originated must meet strict
underwriting and documentation requirements for the sale to be completed. The Company estimates a potential loss reserve for recourse
provisions. The amount is not material as of December 31, 2018. To date, no recourse provisions have been invoked.
Operating leases are for buildings used in the Company’s day-to-day operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information about market risk is set forth above in the “Interest Rate Sensitivity” and “Derivatives and Market Risk Exposure” sections
of the Management’s Discussion and Analysis.
45
Item 8. Financial Statements and Supplementary Data
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 of $130,113 at December 31, 2017)
Restricted stock
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 and costs
Loans, net of unearned income and deferred fees and costs
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,
2018
2017
$
$
12,882
43,491
425,010
---
1,220
72
12,926
51,233
331,387
127,164
1,200
260
37,845
175,456
353,546
46,535
60,777
36,238
710,397
(598 )
709,799
(7,390 )
702,409
8,646
5,160
2,052
5,848
34,657
14,585
$ 1,256,032
34,694
166,965
340,414
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
$
195,441
616,527
138,175
101,799
1,051,942
89
13,763
1,065,794
$
182,511
622,189
140,150
114,884
1,059,734
62
12,065
1,071,861
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 2018 and 2017
Retained earnings
Accumulated other comprehensive loss, net
Total stockholders’ equity
Total liabilities and stockholders’ equity
8,698
193,625
(12,085 )
190,238
$ 1,256,032
8,698
185,893
(9,695 )
184,896
$ 1,256,757
The accompanying notes are an integral part of these consolidated financial statements.
46
Consolidated Statements of Income
$ in thousands, except per share data
Interest Income
Interest and fees on loans
Interest on interest-bearing deposits
Interest and dividends on securities – taxable
Interest on securities – nontaxable
Total interest income
Interest Expense
Interest on deposits
Interest on borrowings
Total interest expense
Net interest income
Provision for (recovery of) loan losses
Net interest income after provision for (recovery of) loan
losses
Noninterest Income
Service charges on deposit accounts
Other service charges and fees
Credit and debit card fees
Trust income
BOLI income
Other income
Realized securities gains, net
Total noninterest income
Noninterest Expense
Salaries and employee benefits
Occupancy, furniture and fixtures
Data processing and ATM
FDIC assessment
Intangible assets amortization
Net costs of other real estate owned
Franchise taxes
Write-down of insurance receivable
Other operating expenses
Total noninterest expense
Income before income taxes
Income tax expense
Net income
Basic net income per common share
Fully diluted net income per common share
$
$
$
Years ended December 31,
2018
2017
2016
$
$
31,333
672
6,856
4,363
43,224
29,932 $
791
5,711
4,826
41,260
29,365
532
5,910
5,123
40,930
4,166
---
4,166
36,764
1,650
35,114
2,458
212
981
1,346
597
1,289
232
7,115
12,684
1,849
2,151
476
257
472
1,296
347
3,803
23,335
18,894
3,952
14,942
2.15
2.15
4,883
164
5,047
38,177
(81 )
38,258
2,678
132
1,431
1,565
901
1,005
17
7,729
14,506
1,845
2,784
359
50
553
1,278
2,010
3,891
27,276
18,711
2,560
16,151
2.32
2.32
$
$
$
4,125
---
4,125
37,135
157
36,978
2,776
205
1,205
1,530
758
1,148
14
7,636
13,670
1,820
2,280
364
68
205
1,315
---
4,507
24,229
20,385
6,293
14,092 $
2.03 $
2.03 $
The accompanying notes are an integral part of these consolidated financial statements.
47
Consolidated Statements of Comprehensive Income
$ in thousands, except per share data
Net Income
Other Comprehensive Income (Loss), Net of Tax
Unrealized holding gain (loss) on available for sale securities
net of tax of ($595) in 2018, $296 in 2017 and ($431) in
2016
Reclassification adjustment for gain included in net income, net
of tax of ($4) in 2018, ($4) in 2017 and ($65) in 2016
Transfer from held to maturity to available for sale securities,
net of tax of $237 in 2018
Net pension gain (loss) arising during the period, net of tax of
($249) in 2018, $115 in 2017 and $132 in 2016
Less amortization of prior service cost included in net periodic
pension cost, net of tax of ($24) in 2018, ($38) in 2017 and
($38) in 2016
Other comprehensive income (loss), net of tax of ($635) in
2018, $369 in 2017 and ($402) in 2016
Total Comprehensive Income
See accompanying notes to consolidated financial statements.
Consolidated Statements of Changes in Stockholders’ Equity
Years ended December 31,
2018
2017
2016
$
16,151
$
14,092 $
14,942
(2,246 )
(13 )
891
(936 )
(86 )
546
(6 )
---
213
(71 )
$
(2,390 )
13,761
$
682
14,774 $
$ in thousands, except per share data
Balance at December 31, 2015
Net income
Other comprehensive loss, net of tax of ($402)
Cash dividend ($1.16 per share)
Balance at December 31, 2016
Net income
Other comprehensive income, net of tax of $369
Cash dividend ($1.17 per share)
Reclassification of stranded tax effects from change in
tax rate
Balance at December 31, 2017
Net income
Other comprehensive loss, net of tax of ($635)
Cash dividend ($1.21 per share)
Balance at December 31, 2018
Common Stock
Retained Earnings
Accumulated Other
Comprehensive (Loss)
$
$
$
$
8,698 $
---
---
---
8,698 $
---
---
---
---
8,698 $
---
---
---
8,698 $
171,353 $
14,942
---
(8,071 )
178,224 $
14,092
---
(8,141 )
1,718
185,893 $
16,151
---
(8,419 )
193,625 $
(7,937 ) $
---
(722 )
---
(8,659 ) $
---
682
---
(1,718 )
(9,695 ) $
---
(2,390 )
---
(12,085 ) $
The accompanying notes are an integral part of these consolidated financial statements.
48
(800 )
(121 )
---
271
(72 )
(722 )
14,220
Total
172,114
14,942
(722 )
(8,071 )
178,263
14,092
682
(8,141 )
---
184,896
16,151
(2,390 )
(8,419 )
190,238
Consolidated Statements of Cash Flows
$ in thousands
Cash Flows from Operating Activities
Net income
Adjustment to reconcile net income to net cash provided by operating
activities:
Provision for (recovery of) loan losses
Deferred income tax expense (benefit)
Re-valuation of deferred tax assets
Depreciation of premises and equipment
Amortization of intangibles
Amortization of premiums and accretion of discounts, net
Gain on disposal of fixed assets
Gain on calls and sales of securities available for sale, net
Gain on calls of securities held to maturity, net
Loss and write-down on other real estate owned
Income on investment in BOLI
Gain on sale of mortgage loans held for sale
Origination of mortgage loans held for sale
Sale of mortgage loans held for sale
Contribution to defined benefit plan
Net change in:
Accrued interest receivable
Other assets
Accrued interest payable
Other liabilities
Net cash provided by operating activities
Cash Flows from Investing Activities
Net change in interest-bearing deposits
Proceeds from repayments of mortgage-backed securities
Proceeds from calls, sales and maturities of securities available for sale
Proceeds from calls and maturities of securities held to maturity
Purchases of securities available for sale
Purchases of securities held to maturity
Net change in restricted stock
Purchase of BOLI
Purchases of loan participations
Collections of loan participations
Loan originations and principal collections, net
Proceeds from disposal of other real estate owned
Recoveries on loans charged off
Additions to premises and equipment
Proceeds from sale of premises and equipment
Net cash used in investing activities
49
Years Ended December 31,
2018
2017
2016
$
16,151 $
14,092 $
14,942
(81 )
(382 )
---
766
50
58
---
(17 )
---
489
(901 )
(199 )
(12,626 )
13,013
---
137
2,886
27
404
19,775
7,742
224
50,438
6,430
(25,323 )
---
(20 )
---
(7,853 )
970
(35,536 )
276
235
(1,191 )
---
(3,608 )
157
1,790
1,560
805
68
58
(134 )
(10 )
(4 )
125
(758 )
(211 )
(13,912 )
14,341
(4,507 )
(37 )
(2,537 )
7
101
10,994
29,035
298
13,812
8,975
(40,290 )
(1,319 )
(30 )
(10,000 )
(7,395 )
2,113
(15,951 )
311
287
(261 )
222
(20,193 )
1,650
18
---
801
257
89
---
(186 )
(46 )
355
(597 )
(280 )
(17,090 )
17,526
(811 )
509
438
(1 )
(41 )
17,533
50,543
415
220,581
16,945
(290,296 )
---
(41 )
---
(3,800 )
820
(27,792 )
877
159
(634 )
---
(32,223 )
(continued )
Cash Flows from Financing Activities
Net change in time deposits
Net change in other deposits
Cash dividends paid
Net cash provided by (used in) financing activities
Net change in cash and due from banks
Cash and due from banks at beginning of year
Cash and due from banks at end of year
Supplemental Disclosures of Cash Flow Information
Interest paid on deposits and borrowed funds
Income taxes paid
Supplemental Disclosures of Noncash Activities
Loans charged against the allowance for loan losses
Loans transferred to other real estate owned
Unrealized gain (loss) on securities available for sale
Unrealized net gain on securities transferred from HTM to AFS
Fair value of securities transferred from held-to-maturity to available-for-
sale
Minimum pension liability adjustment
(13,085 )
5,293
(8,419 )
(16,211 )
(15,730 )
32,022
(8,141 )
8,151
(21,147 )
45,730
(8,071 )
16,512
(44 )
12,926
12,882 $
(1,048 )
13,974
12,926 $
1,822
12,152
13,974
5,020 $
1,778
4,118 $
4,092
4,167
3,940
689 $
---
(2,858 )
1,128
119,790
(1,295 )
819 $
97
832
---
---
219
1,806
222
(1,417 )
---
---
293
$
$
$
The accompanying notes are an integral part of these consolidated financial statements.
50
Notes to Consolidated Financial Statements
$ in thousands, except per share data
Note 1: Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of National Bankshares, Inc. (Bankshares) and its wholly-owned
subsidiaries, the National Bank of Blacksburg (NBB), and National Bankshares Financial Services, Inc. (NBFS), (the Company). All
intercompany balances and transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of
America and to general practices within the banking industry. The following is a summary of the more significant accounting policies.
Subsequent events have been considered through the date when the Form 10-K was issued.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and amounts due from banks.
Interest-Bearing Deposits
The Company invests over-night funds in interest-bearing deposits at other banks, including the Federal Home Loan Bank, the
Federal Reserve, and other entities. Interest-bearing deposits are carried at cost.
Securities
Certain debt securities that management has the positive intent and ability to hold to maturity may be classified as “held to maturity”
and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities
not classified as held to maturity or trading, are classified as “available for sale” and recorded at fair value, with unrealized gains and
losses excluded from earnings and reported in other comprehensive income. The Company uses the interest method to recognize
purchase premiums and discounts in interest income over the term of the securities. Gains and losses on the sale of securities are recorded
on the trade date and are determined using the specific identification method.
During 2018, the Company’s held to maturity securities were re-designated as available for sale. At the time of the transfer, the re-
designated securities had a fair value of $119,790 and an unrealized net gain of $1,128. The unrealized gain/loss on the re-designated
securities is included in accumulated other comprehensive income, net of deferred tax.
The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment. The
guidance specifies that if (a) an entity does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not
that the entity will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily
impaired, unless there is a credit loss. When criteria (a) and (b) are met, the entity will recognize the credit component of an other-than-
temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity
debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of
a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing
of future estimated cash flows of the security.
Equity securities with readily-determinable fair values are measured at fair value using the “exit price notion”. Changes in fair
value are recognized in net income. Equity securities without readily-determinable fair values are recorded as other assets at cost less
impairment, if any, and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar
investment of the same issuer.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value on an individual
loan basis. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. The Company releases
mortgage servicing rights when loans are sold on the secondary market.
Loans
The Company, through its banking subsidiary, provides mortgage, commercial, and consumer loans to customers. A substantial
portion of the loan portfolio is represented by mortgage loans, particularly commercial mortgages. The ability of the Company’s debtors
to honor their contracts is dependent upon the real estate and general economic conditions in the Company’s market area.
The Company’s loans are grouped into six segments: real estate construction, consumer real estate, commercial real estate,
commercial non real estate, public sector and IDA, and consumer non real estate. Each segment is subject to certain risks that influence
the establishment of pricing, loan structures, approval requirements, reserves, and ongoing credit management.
Real estate construction loans are subject to general risks from changing commercial building and housing market trends and
economic conditions that may impact demand for completed properties and the costs of completion. Completed properties that do not
sell or become leased within originally expected timeframes may impact the borrower’s ability to service the debt. These risks are
measured by market-area unemployment rates, bankruptcy rates, housing and commercial building market trends, and interest rates.
Risks specific to the borrower are also evaluated, including previous repayment history, debt service ability, and current and projected
loan-to value ratios for the collateral.
51
The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value,
measured generally by analyzing local unemployment and bankruptcy trends, and local housing market trends and interest rates. Risks
specific to a borrower are determined by previous repayment history, loan-to-value ratios and debt-to-income ratios.
The commercial real estate segment includes loans secured by multifamily residential real estate, commercial real estate occupied
by the owner/borrower, and commercial real estate leased to non-owners. Loans in the commercial real estate segment are impacted by
economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings,
business bankruptcy rates, local unemployment rates and interest rate trends that would impact the businesses housed by the commercial
real estate.
Commercial non real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non
real estate loans is subject to economic conditions, generally monitored by local business bankruptcy trends, interest rates, borrower
repayment ability and collateral value (if secured).
Public sector and IDA loans are extended to municipalities and related entities. Credit risk is based upon the entity’s ability to repay
through either a direct obligation or assignment of specific revenues from an enterprise or other economic activity, and interest rate
trends.
Consumer non real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans
are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the
borrower’s ability to repay. If the loan is secured, the company analyzes loan-to-value ratios. All consumer non real estate loans are
analyzed for debt-to-income ratios and previous credit history, as well as for general risks for the portfolio, including local
unemployment rates, personal bankruptcy rates and interest rates.
Risks from delinquency trends and characteristics such as second-lien position and interest-only status, as well as historical charge-
off rates, are analyzed for all segments.
Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, generally are reported
at their outstanding unpaid principal balances adjusted for the allowance for loan losses, any purchase premium or discount, unearned
income and deferred fees or costs. Interest income is accrued on the unpaid principal balance. Unearned income on dealer-originated
loans and loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan
yield using the interest method. Purchase premium or discount is recognized as an adjustment of the related loan yield using the interest
method.
The Company considers multiple factors when determining whether to discontinue accrual of interest on individual loans. Generally
loans are placed in nonaccrual status when collection of interest and/or full principal is considered doubtful. Interest accrual is
discontinued at the time a commercial real estate loan or commercial non-real estate loan is 90 days delinquent unless the credit is well
secured and in the process of collection. Loans within all loan classes that are not restructured but that are impaired and have an
associated impairment loss are placed on nonaccrual. Restructured loans within all classes that allow the borrower to discontinue
payments of principal or interest for more than 90 days are placed on nonaccrual unless the modification provides reasonable assurance
of repayment performance and collateral value supports regular underwriting requirements. Restructured loans within all classes that
maintain current status for at least a six-month period, including history prior to restructuring, may be returned to accrual status.
All interest accrued but not collected for loans of all classes that are placed on nonaccrual or for loans charged off is reversed against
interest income. Any interest payments received on nonaccrual loans of all classes are credited to the principal balance of the loan. Loans
of all classes that have not been restructured and that have been designated nonaccrual are returned to accrual status when all the principal
and interest amounts contractually due are current; future payments are reasonably assured; and for loans that financed the sale of OREO
property, loan-to-value thresholds are met. Loans that have been restructured that have been designated nonaccrual may return to accrual
status after six months of timely repayment performance. The Company reviews nonaccrual loans on an individual loan basis to
determine whether future payments are reasonably assured. In order for this criteria to be satisfied, the Company’s evaluation must
determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as
receipt of new guarantees, increased cash flows that cover the debt service or other resolution.
A loan is considered past due when a payment of principal and/or interest is due but not paid. Credit card payments not received
within 30 days after the statement date, real estate loan payments not received within the payment cycle and all other non-real estate
secured loans for which payment is not made within the required payment cycle are considered 30 days past due. Management closely
monitors past due loans in timeframes of 30-89 days past due and 90 or more days past due.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of probable losses inherent in the Company’s loan portfolio. A
provision for estimated losses is charged to earnings to establish and maintain the allowance for loan losses at a level reflective of the
estimated credit risk. When management determines that a loan balance or portion of a loan balance is not collectible, the loss is charged
against the allowance. Subsequent recoveries, if any, are credited to the allowance.
Management evaluates the allowance each quarter through a methodology that estimates losses on individual impaired loans and
evaluates the effect of numerous factors on the credit risk of groups of homogeneous loans.
Specific allowances are established for individually-evaluated impaired loans based on the excess of the loan balance relative to the
fair value of the loan. Impaired loans are designated as such when current information indicates that it is probable that the Company
will be unable to collect principal or interest when due according to the contractual terms of the loan agreement. Loan relationships
52
exceeding $250,000 in nonaccrual status or that are significantly past due, or for which a credit review identified weaknesses that indicate
principal and interest will not be collected according to the loan terms, as well as troubled debt restructurings, are designated impaired.
This policy is applicable to all loan classes.
Fair value of impaired loans is estimated in one of three ways: (1) the estimated fair value (less selling costs) of the underlying
collateral, (2) the present value of the loan’s expected future cash flows, or (3) the loan’s observable market value. The amount of
recorded investment (unpaid principal net of any interest payments made by the borrower during the nonaccrual period and net of any
partial charge-offs, accrued interest and deferred fees and costs) in an impaired loan that exceeds the fair value is accrued as estimated
loss in the allowance. Impaired loans for which collection of interest or principal is in doubt are placed in nonaccrual status.
General allowances are established for collectively-evaluated loans. Collectively-evaluated loans are grouped into classes based on
similar characteristics. Factors considered in determining general allowances include net charge-off trends, internal risk ratings,
delinquency and nonperforming rates, product mix, underwriting practices, industry trends and economic trends.
The Company’s charge-off policy meets or is more stringent than the minimum standards required by regulators. When available
information confirms that a specific loan or a portion thereof, within any loan class, is uncollectible the amount is charged off against
the allowance for loan losses. Additionally, losses on consumer real estate and consumer non-real estate loans are typically charged off
no later than when the loans are 120-180 days past due, and losses on loans secured by residential real estate or by commercial real
estate are charged off by the time the loans reach 180 days past due, in compliance with regulatory guidelines. Accordingly, secured
loans may be charged down to the estimated value of the collateral, with previously accrued unpaid interest reversed. Subsequent charge-
offs may be required as a result of changes in the market value of collateral or other repayment prospects.
Troubled Debt Restructurings (“TDRs”)
In situations where, for economic or legal reasons related to a borrower’s financial condition, management grants a concession to
the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). These modified
terms may include reduction of the interest rate, extension of the maturity date at an interest rate lower than the current market rate for
a new loan with similar risk, forgiveness of principal or accrued interest or other actions intended to minimize the economic loss.
TDR loans are individually measured for impairment. Troubled debt restructurings may be removed from TDR status, and therefore
from individual evaluation, if the restructuring agreement specifies a contractual interest rate that is a market interest rate at the time of
restructuring and the loan is in compliance with its modified terms one year after the restructure was completed.
Rate Lock Commitments
The Company enters into commitments to originate mortgage loans in which the interest rate on the loan is determined prior to
funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives.
The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 30 to 60 days. The
Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, by committing to
sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan.
As a result, the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes
in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity.
The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock
commitments and best effort contracts are not actively traded in stand-alone markets. The Company determines the fair value of rate
lock commitments and best efforts contracts by measuring the changes in the value of the underlying assets while taking into
consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments
and best efforts contracts, no gain or loss occurs on the rate lock commitments.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is charged to
expense over the estimated useful lives of the assets on the straight-line basis. Depreciable lives include 40 years for premises, 3-10
years for furniture and equipment, and 3 years for computer software. Costs of maintenance and repairs are charged to expense as
incurred and improvements are capitalized.
Other Real Estate Owned
Real estate acquired through or in lieu of foreclosure is held for sale and is initially recorded at fair value less estimated costs to sell
at the date of foreclosure, establishing the cost basis of the asset. Subsequent to foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses
from operations and changes in the valuation allowance are included in other operating expenses.
Goodwill
The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. Goodwill
is subject to at least an annual assessment for impairment by applying a fair value based test. The Company performs its annual analysis
as of September 30 of each fiscal year. Accounting guidance permits preliminary assessment of qualitative factors to determine whether
more substantial impairment testing is required. The Company chose to bypass the preliminary assessment and utilized a two-step
53
process for impairment testing of goodwill. The first step tests for impairment, while the second step, if necessary, measures the
impairment.
The Company’s goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first
technique uses the Company’s market capitalization as an estimate of fair value, the second technique estimates fair value using current
market pricing multiples for companies comparable to NBI, while the third technique uses current market pricing multiples for change-
of-control transactions involving companies comparable to NBI. Certain key judgments were used in the valuation measurement.
Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization
is available. Because most of the Company’s assets are comprised of the subsidiary bank’s equity, the Company’s market capitalization
was used to estimate the Bank’s market capitalization. Other judgments include the assumption that the companies and transactions used
as comparables for the second and third technique were appropriate to the estimate of the Company’s fair value, and that the comparable
multiples are appropriate indicators of fair value, and compliant with accounting guidance.
Each measure indicated that the Company’s fair value exceeded its book value. No indicators of impairment for goodwill were
identified during the years ended December 31, 2018, 2017 and 2016.
Acquired intangible assets (such as core deposit intangibles) are recognized separately from goodwill if the benefit of the asset can
be sold, transferred, licensed, rented, or exchanged, and amortized over its useful life. The Company amortizes on a straight-line basis
intangible assets arising from branch purchase transactions over their useful lives, determined by the Company to be ten to twelve years.
Core deposit intangibles are subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and
measurement provisions required for other long-lived assets held and used. The impairment testing showed that the expected cash flows
of the intangible assets exceeded the carrying value.
Pension Plan
The Company recognizes the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its
statement of financial position and recognizes changes in that funded status in the year in which the changes occur through
comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the
projected benefit obligation.
Income Taxes
Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense
reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or
excess of deductions over revenues. The Company determines deferred income taxes using the asset and liability (or balance sheet)
method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax
bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are
recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination.
The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include
resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold
is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized
upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax
position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the
reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight
of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Tax Cuts and Jobs Act (“the Act”) was enacted in December, 2017 with an effective date of January 1, 2018. Among other
things, the Act lowered the federal corporate income tax rate to 21% from the maximum rate prior to the passage of the Act of 35%.
The change to the tax rate necessitated a re-measurement of deferred tax assets and deferred tax liabilities, including those accounted
for in accumulated other comprehensive income, as of the date of enactment. The re-measurement in 2017 resulted in a $1,560 reduction
in the value of the Company’s net deferred tax asset and a corresponding incremental income tax expense of $1,560.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive
Income (“AOCI”). The Company early adopted this new standard for 2017. In compliance with ASU 2018-01, the Company
reclassified from AOCI to retained earnings stranded tax effects of $1,718. The stranded tax effects were a result of recognizing in tax
expense the re-measurement impact of items that are included in AOCI.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
Trust Assets and Income
Assets (other than cash deposits) held by the Trust Department in a fiduciary or agency capacity for customers are not included in
the consolidated financial statements since such items are not assets of the Company. Trust income is recognized on the accrual basis.
54
Earnings Per Common Share
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number
of common shares outstanding during the period.
The following shows the weighted average number of shares used in computing earnings per common.
Average number of common shares outstanding
2018
2017
2016
6,957,974
6,957,974
6,957,974
As of December 31, 2018 and December 31, 2017, there were no potential common shares outstanding.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business are recorded as liabilities when the
likelihood of loss is probable and reasonably estimated. Management does not believe there are such matters that will have a material
effect on the financial statements.
Advertising
The Company charges advertising costs to expenses as incurred. In 2018, the Company expensed $106, and expensed $148 and
$122 in 2017 and 2016, respectively.
Use of Estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of
America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the
date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of other real estate owned, other-than-temporary impairments of securities,
evaluation of impairment of goodwill, and pension obligations.
Changing economic conditions, adverse economic prospects for borrowers, as well as regulatory agency action as a result of
examination, could cause NBB to recognize additions to the allowance for loan losses and may also affect the valuation of real estate
acquired in connection with foreclosures or in satisfaction of loans.
Accounting Standards Adopted in 2018
ASU No. 2014-09, “Revenue from Contracts with Customers”
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” The standard’s core principle is that
a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration
to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required
to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in
the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to
each separate performance obligation. Subsequent to the issuance of ASU 2014-09, the FASB issued targeted updates to clarify specific
implementation issues including ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),”
ASU No. 2016-10, “Identifying Performance Obligations and Licensing,” ASU No. 2016-12, “Narrow-Scope Improvements and
Practical Expedients,” and ASU No. 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with
Customers.”
For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of
the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in
the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The
Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the full
retrospective approach. There was no impact to net income. Consistent with the full retrospective approach, the Company adjusted
certain prior period amounts, discussed below.
Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted
for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments,
including interest income and expense. The Company completed its overall assessment of revenue streams and review of related
contracts potentially affected by the ASU, including trust and asset management fees, deposit related fees, interchange fees, merchant
income, bank-financed sales of other real estate owned and annuity and insurance commissions. Based on this assessment, the Company
concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue
streams.
The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should
be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that the classification
of certain debit and credit card related costs should change (i.e., cost previously recorded as expense is now recorded as contra-revenue).
55
The Company identified $2,743 previously presented as credit card processing expense for the year ended December 31, 2017 and
$2,817 for the year ended December 31, 2016, and reclassified it to net against credit card fee income.
ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”
In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”
This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making
targeted improvements to GAAP. The provisions of the ASU that apply to the Company are as follows: (1) require equity investments
(except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured
at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do
not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price
changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of
equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a
qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the
requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for
financial instruments measured at amortized cost on the balance sheet; (4) require use of the exit price notion when measuring the fair
value of financial instruments for disclosure purposes; (5) require separate presentation of financial assets and financial liabilities by
measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying
notes to the financial statements; and (6) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset
related to available-for-sale securities in combination with the entity’s other deferred tax assets.
The adoption of ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial
Statements. In accordance with (4) above, the Company measured the fair value of its loan portfolio and time deposit portfolio as of
December 31, 2018 using an exit price notion (see Note 15: Fair Value Measurements).
ASU No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost”
In March 2017, the FASB issued ASU No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic
Postretirement Benefit Cost.” The ASU requires employers to present the service cost component of the net periodic benefit cost in the
same income statement line item (e.g., Salaries and Employee Benefits) as other employee compensation costs arising from services
rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will
present the other components of net periodic benefit cost separately (e.g., Other Noninterest Expense) from the line item that includes
the service cost. The guidance requires retrospective adoption on the presentation of the components of net periodic benefit cost in the
income statement. The guidance provides for prospective adoption on limiting the capitalization of net periodic benefit cost in assets to
the service cost component.
The Company adopted ASU No. 2017-07 on January 1, 2018 and utilized the ASU’s practical expedient allowing entities to estimate
amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan
footnote. The Company re-classified non-servicing components of net periodic pension cost from compensation expense to other
noninterest expense. ASU No. 2017-07 did not have a material impact on the Company’s Consolidated Financial Statements.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU
2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement
date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis;
and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease
term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where
necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The
amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal
years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing,
and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning
of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any
transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full
retrospective transition approach. The FASB made subsequent amendments to Topic 842 in July 2018 through ASU 2018-10
(“Codification Improvements to Topic 842, Leases.”) and ASU 2018-11 (“Leases (Topic 842): Targeted Improvements.”) Among these
amendments is the provision in ASU 2018-11 that provides entities with an additional (and optional) transition method to adopt the new
leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes
a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting
for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in
accordance with current GAAP (Topic 840, Leases). The effect of adopting this standard on January 1, 2019 was an approximate $684
increase in assets and liabilities on our consolidated balance sheet. During the first quarter of 2019, the Company entered two additional
leases that increased the right of use asset and lease liability by $1,529.
56
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit
losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable
forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss
estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will
change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-
for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing
the impact that ASU 2016-13 will have on its consolidated financial statements. The Company is currently assessing the impact that
ASU 2016-13 will have on its consolidated financial statements. The Company has formed a working group to address information
requirements, determine methodology, research forecasts and ensure readiness and compliance with the standard. The Company has
begun calculating and refining concurrent models using CECL methodology. The Company will continue to fine tune assumptions prior
to the effective date.
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for
Goodwill Impairment”. The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating
Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting
unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its
annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has
the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public
business entities that are U.S. Securities and Exchange Commission (SEC) filers should adopt the amendments in this ASU for annual
or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual
goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-
04 to have a material impact on its consolidated financial statements.
In March 2017, the FASB issued ASU 2017
08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310
20), Premium
Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable
debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be
amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are
effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted,
including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a
cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for
a change in accounting principle. The Company does not expect the adoption of ASU 2017-08 to have a material impact on its
consolidated financial statements as we currently have no potential common stock outstanding.
‐
‐
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the
Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add
disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to
develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in
Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim
periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied
retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on
its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, “Compensation—Retirement Benefits—Defined Benefit Plans—General
(Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans.” These amendments
modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure
requirements have been deleted while the following disclosure requirements have been added: the weighted-average interest crediting
rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains
and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements in
paragraph 715-20-50-3, which state that the following information for defined benefit pension plans should be disclosed: The projected
benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation
(ABO) and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending
after December 15, 2020. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-14 to have a material
impact on its consolidated financial statements.
Note 2: Restriction on Cash
The Company’s subsidiary bank is a member of the Federal Reserve System. The Federal Reserve does not require member banks
to hold an average balance in order to purchase services from the Federal Reserve.
57
Note 3: Securities
The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follows:
Available for sale:
U.S. Government agencies and corporations
States and political subdivisions
Mortgage-backed securities
Corporate debt securities
Total securities available for sale
Amortized
Cost
$
$
306,264
118,564
586
6,014
431,428
$
$
December 31, 2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
449 $
1,218
42
---
1,709 $
6,666 $
1,166
---
295
8,127 $
300,047
118,616
628
5,719
425,010
Available for sale:
U.S. Government agencies and corporations
States and political subdivisions
Mortgage-backed securities
Corporate debt securities
$
Total securities available for sale
$
Amortized
Cost
312,604 $
16,853
602
6,016
336,075 $
December 31, 2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
609 $
100
57
188
954 $
5,494 $
119
---
29
5,642 $
Fair Value
307,719
16,834
659
6,175
331,387
The amortized cost and fair value of single maturity securities available for sale at December 31, 2018, by contractual maturity, are
shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are categorized by final
maturity at December 31, 2018.
Available for sale:
Amortized Cost
Fair Value
December 31, 2018
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total securities available for sale
$
$
71,303 $
181,186
85,379
93,560
431,428 $
71,013
177,141
84,584
92,272
425,010
Prior to the second quarter of 2018, the Company designated securities in its portfolio as either available for sale or held to maturity.
During the second quarter of 2018, the Company re-designated all of its held to maturity securities to available for sale. The securities
were re-designated to provide opportunities to maximize asset utilization. At the time of transfer, the securities had a fair value of
$119,790 and an amortized cost of $118,662, resulting in an unrealized gain of $1,128 which was added to accumulated other
comprehensive income at the date of re-designation.
58
At December 31, 2017, the amortized cost and fair value of securities held to maturity, with gross unrealized gains and losses,
follows:
Held to maturity:
U.S. Government agencies and corporations
States and political subdivisions
Mortgage-backed securities
Corporate debt securities
Total securities held to maturity
Amortized
Cost
$
$
3,934 $
122,039
209
982
127,164 $
December 31, 2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
167
2,929
21
5
3,122
$
$
---
173
---
---
173
$
$
Fair Value
4,101
124,795
230
987
130,113
Information pertaining to securities with gross unrealized losses at December 31, 2018 and 2017 aggregated by investment category
and length of time that individual securities have been in a continuous loss position, follows:
December 31, 2018
Less Than 12 Months
12 Months or More
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U. S. Government agencies and corporations
State and political subdivisions
Corporate debt securities
Total temporarily impaired securities
$
$
17,730 $
16,882
4,842
39,454 $
216 $ 259,992 $
352
194
762 $ 281,626 $
20,758
876
6,450
814
101
7,365
December 31, 2017
Less Than 12 Months
12 Months or More
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
U. S. Government agencies and corporations
State and political subdivisions
Corporate debt securities
Total temporarily impaired securities
$
$
68,380 $
18,688
---
87,068 $
871 $ 225,738 $
194
---
2,989
948
1,065 $ 229,675 $
4,623
98
29
4,750
The Company had 359 securities with a fair value of $321,080 that were temporarily impaired at December 31, 2018. The
total unrealized loss on these securities was $8,127. Of the temporarily impaired total, 309 securities with a fair value of $281,626 and
an unrealized loss of $7,365 have been in a continuous loss position for twelve months or more. The Company has determined that
these securities are temporarily impaired at December 31, 2018 for the reasons set out below.
U.S. Government agencies. The unrealized losses of $6,450 on US Government agency securities stemmed from 267 securities with
a fair value of $259,992. The unrealized losses were caused by interest rate and market fluctuations. The contractual terms of the
investment do not permit the issuer to settle the security at a price less than the cost basis of the investment. The Company is monitoring
bond market trends to develop strategies to address unrealized losses. Because the Company does not intend to sell the investment and
it is not likely that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be at
maturity, the Company does not consider this investment to be other-than-temporarily impaired.
States and political subdivisions. This category exhibits unrealized losses of $814 on 41 securities with a fair value of $20,758. The
Company reviewed financial statements and cash flows for the each of the securities in continuous loss position for more than 12 months.
The Company’s analysis determined that the unrealized losses are primarily the result of interest rate and market fluctuations and not
associated with impaired financial status. The contractual terms of the investment do not permit the issuer to settle the securities at a
price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments and it is not likely
that the Company will be required to sell any of the investments before recovery of its amortized cost basis, which may be at maturity,
the Company does not consider these investments to be other-than-temporarily impaired.
Corporate debt securities. The unrealized loss of $101 on one corporate debt security with a fair value of $876 was caused by market
and interest rate fluctuations and is not associated with impaired financial status. The contractual terms of the investment do not permit
the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell the
59
investment and it is not likely that the Company will be required to sell the investment before recovery of its amortized cost basis, which
may be at maturity, the Company does not consider the investment to be other-than-temporarily impaired.
Restricted stock. The Company holds restricted stock of $1,220 as of December 31, 2018 and $1,200 as of December 31, 2017.
Restricted stock is reported separately from available-for-sale securities and held-to-maturity securities. As a member of the Federal
Reserve and the Federal Home Loan Bank (“FHLB”) of Atlanta, NBB is required to maintain certain minimum investments in the
common stock of those entities. Required levels of investment are based upon NBB’s capital and a percentage of qualifying assets. The
Company purchases stock from or sells stock back to the correspondents based on their calculations. The stock is held by member
institutions only and is not actively traded.
Redemption of FHLB stock is subject to certain limitations and conditions. At its discretion, the FHLB may declare dividends on
the stock. In addition to dividends, NBB also benefits from its membership with FHLB through eligibility to borrow from the FHLB,
using as collateral NBB’s capital stock investment in the FHLB and qualifying NBB real estate mortgage loans totaling $513,578 at
December 31, 2018. Management reviews for impairment based upon the ultimate recoverability of the cost basis of the FHLB stock,
and at December 31, 2018, management did not determine any impairment.
Management regularly monitors the credit quality of the investment portfolio. Changes in ratings are noted and follow-up research
on the issuer is undertaken when warranted. Management intends to carefully monitor any changes in bond quality.
Pledged Securities
At December 31, 2018 and 2017, securities with a carrying value of $196,062 and $194,980, respectively, were pledged to secure
municipal deposits and for other purposes as required or permitted by law.
Realized Securities Gains and Losses
During 2018, the Company sold one security for that resulted in a gain of $16. During 2017, the Company sold a small investment
in community bank stock that resulted in a gain of $4. The investment was classified as available for sale and had a book value of
$189. All other realized gains and losses on securities during 2018, 2017 and 2016 resulted from calls of securities. Information
pertaining to realized gains and losses on sold and called securities follows:
Available for sale
Held to maturity
Available for sale
Held to maturity
$
$
For the year ended December 31, 2018
Proceeds
Book Value
Gross Gain
Gross Loss
Net Gain
17,287 $
6,430
17,270 $
6,430
17 $
---
--- $
---
For the year ended December 31, 2017
Proceeds
Book Value
Gross Gain
Net Gain
13,620 $
8,975
13,614 $
8,971
Gross Loss
--- $
---
10 $
4
17
---
10
4
Available for sale
Held to maturity
$
220,520 $
16,160
220,334 $
16,114
Proceeds
Book Value
Gross Gain
For the year ended December 31, 2016
Gross Loss
--- $
---
186 $
46
Net Gain
186
46
Note 4: Related Party Transactions
In the ordinary course of business, the Company, through its banking subsidiary, has granted loans to related parties, including
executive officers and directors of Bankshares and its subsidiaries. Total funded credit extended to related parties amounted to $18,700
at December 31, 2018 and $12,600 at December 31, 2017. During 2018, there was a change in related party relationships that resulted
in a decrease of $782. During 2018, total principal additions were $9,213 and principal payments were $2,331. The Company held
$6,911 in deposits for related parties as of December 31, 2018 and $15,612 as of December 31, 2017. The Company leases to a director
a small office space. The lease payments totaled $5 in 2018 and $5 in 2017.
Note 5: Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
The allowance for loan losses methodology incorporates individual evaluation of impaired loans and collective evaluation of groups
of non-impaired loans. The Company performs ongoing analysis of the loan portfolio to determine credit quality and to identify impaired
loans. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying
collateral.
60
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that
all amounts will not be collected when due according to the contractual terms of the loan agreement. Impaired loans are those loans that
have been modified in a troubled debt restructure (“TDR” or “restructure”) and larger, usually non-homogeneous loans that are in
nonaccrual or exhibit payment history or financial status that indicate that collection probably will not occur when due according to the
loan’s terms. Generally, impaired loans are given risk ratings that indicate higher risk, such as “classified” or “special mention.” Impaired
loans are individually evaluated to determine appropriate reserves and are measured at the lower of the invested amount or the fair value.
Impaired loans that are not troubled debt restructures and for which fair value measurement indicates an impairment loss are designated
nonaccrual. A restructured loan that maintains current status for at least six months may be in accrual status. Please refer to Note 1:
Summary of Significant Accounting Policies for additional information on evaluation of impaired loans and associated specific reserves,
and policies regarding nonaccruals, past due status and charge-offs.
Troubled debt restructurings impact the estimation of the appropriate level of the allowance for loan losses. If the restructuring
included forgiveness of a portion of principal or accrued interest, the charge-off is included in the historical charge-off rates applied to
the collective evaluation methodology. Restructured loans are individually evaluated for impairment, and the amount of a restructured
loan’s book value in excess of its fair value is accrued as a specific allocation in the allowance for loan losses. If a TDR loan payment
exceeds 90 days past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below
those that were used in the fair value measurement. TDRs, as well as all impaired loans, that are determined to be collateral dependent
are charged down to fair value. Deficiencies indicated by impairment measurements for TDRs that are not collateral dependent may be
accrued in the allowance for loan losses or charged off if deemed uncollectible.
Collectively-Evaluated Loans
The Company evaluated characteristics in the loan portfolio and determined major segments and smaller classes within each
segment. These characteristics include collateral type, repayment sources, and (if applicable) the borrower’s business model. The
methodology for calculating reserves for collectively-evaluated loans is applied at the class level.
Portfolio Segments and Classes
The segments and classes used in determining the allowance for loan losses are as follows.
Real Estate Construction
Construction, residential
Construction, other
Consumer Real Estate
Equity lines
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate
Multifamily real estate
Commercial real estate, owner-occupied
Commercial real estate, other
Commercial Non Real Estate
Commercial and Industrial
Public Sector and IDA
Public sector and IDA
Consumer Non Real Estate
Credit cards
Automobile
Other consumer loans
Historical Loss Rates
The Company’s allowance methodology for collectively-evaluated loans applies historical loss rates by class to current class
balances as part of the process of determining required reserves. Class loss rates are calculated as the net charge-offs for the class as a
percentage of average class balance. The Company averages loss rates for the most recent 8 quarters to determine the historical loss rate
for each class.
Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance
(“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”).
Classified loans are those with risk ratings of “substandard” or lower. Net charge-offs in both calculations include charge-offs and
recoveries of classified and non-classified loans as well as those associated with impaired loans. Class historical loss rates are applied
to non-classified loan balances at the reporting date, and classified historical loss rates are applied to classified balances at the reporting
date.
Risk Factors
In addition to historical loss rates, risk factors pertinent to credit risk for each class are analyzed to estimate reserves for collectively-
evaluated loans. Factors include changes in national and local economic and business conditions, the nature and volume of classes within
the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system.
61
The analysis of certain factors results in standard allocations to all segments and classes. These factors include the risk from changes
in lending policies, loan officers’ average years of experience, unemployment levels, bankruptcy rates, interest rate environment, and
competition/legal/regulatory environments. Factors analyzed for each class, with resultant allocations based upon the level of risk
assessed for each class, include the risk from changes in loan review, levels of past due loans, levels of nonaccrual loans, current class
balance as a percentage of total loans, and the percentage of high risk loans within the class. Additionally, factors specific to each
segment are analyzed and result in allocations to the segment. Please refer to Note 1: Summary of Significant Accounting Policies of
Form 10-K for a discussion of risk factors pertinent to each class.
Real estate construction loans are subject to general risks from changing commercial building and housing market trends and
economic conditions that may impact demand for completed properties and the costs of completion. These risks are measured by market-
area unemployment rates, bankruptcy rates, building market trends, and interest rates.
The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value,
measured generally by analyzing local unemployment and bankruptcy trends, local housing market trends, and interest rates.
The commercial real estate segment includes loans secured by multifamily residential real estate, commercial real estate occupied
by the owner/borrower, and commercial real estate leased to non-owners. Loans in the commercial real estate segment are impacted by
economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings,
business bankruptcy rates, local unemployment and interest rate trends that would impact the businesses housed by the commercial real
estate.
Commercial non real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non
real estate loans is subject to economic conditions, generally monitored by local business bankruptcy trends, and interest rates.
Public sector and IDA loans are extended to municipalities and related entities. Credit risk is based upon the entity’s ability to repay
and interest rate trends.
Consumer non real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans
are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the
borrower’s ability to repay, measured by average unemployment, average personal bankruptcy rates and interest rates.
Factor allocations applied to each class are increased for loans rated special mention and increased to a greater extent for loans rated
classified. The Company allocates additional reserves for “high risk” loans. High risk loans include junior liens, interest only and high
loan to value loans.
A detailed analysis showing the allowance roll-forward by portfolio segment and related loan balance by segment follows:
Activity in the Allowance for Loan Losses by Segment for the year ended December 31, 2018
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
Balance, December 31, 2017 $
Charge-offs
Recoveries
337 $
---
---
2,027 $
(38 )
3
3,044 $
---
49
1,072 $
(107 )
22
419 $
---
---
707 $
(544 )
161
319 $ 7,925
(689 )
---
235
---
Provision for (recovery of)
loan losses
Balance, December 31, 2018 $
61
398 $
57
2,049 $
(295 )
2,798 $
(385
)
602 $
164
583 $
426
750 $
(109
(81 )
)
210 $ 7,390
Activity in the Allowance for Loan Losses by Segment for the year ended December 31, 2017
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
Balance, December 31, 2016 $
Charge-offs
Recoveries
Provision for (recovery of)
loan losses
Balance, December 31, 2017 $
438 $
---
---
1,830 $
(146 )
1
3,738 $
(139 )
131
1,063 $
(82 )
23
(101 )
337 $
342
2,027 $
(686 )
3,044 $
68
1,072 $
330 $
---
---
89
419 $
644 $
(452 )
132
383
707 $
257 $ 8,300
(819 )
---
287
---
62
157
319 $ 7,925
62
Activity in the Allowance for Loan Losses by Segment for the year ended December 31, 2016
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
Balance, December 31, 2015 $
Charge-offs
Recoveries
576 $
(29 )
---
1,866 $
(133 )
2
4,109 $
(488 )
83
655 $
(883 )
10
436 $
---
---
627 $
(273 )
64
28 $ 8,297
(1,806 )
---
159
---
Provision for (recovery of)
loan losses
Balance, December 31, 2016 $
(109 )
438 $
95
1,830 $
34
3,738 $
(1,281
)
1,063 $
(106 )
330 $
226
644 $
229
1,650
257 $ 8,300
Allowance for Loan Losses by Segment and Evaluation Method as of
December 31, 2018
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
$
---
$
4 $
---
$
135
$
---
$
---
$
---
$
139
Individually evaluated
for impairment
Collectively evaluated
for impairment
Individually evaluated
for impairment
Collectively evaluated
for impairment
Total
$
398 $
2,049 $
2,798 $
398
2,045
2,798
467
602 $
583
750
583
$
750 $
210
210 $
7,251
7,390
Loans by Segment and Evaluation Method as of
December 31, 2018
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer
Non Real
Estate
Unallocated
Total
$
---
$
1,452 $
4,340
$ 1,015
$
---
$
13
$
---
$
6,820
Total
$
37,845 $ 175,456 $ 353,546 $ 46,535
37,845
174,004
349,206
45,520
60,777
$ 60,777
36,225
$
36,238
$
---
703,577
--- $ 710,397
Allowance for Loan Losses by Segment and Evaluation Method as of
December 31, 2017
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
$
---
$
16 $
---
$
160
$
---
$
1
$
---
$
177
337
2,011
3,044
912
1,072 $
419
706
419
$
707 $
319
319 $
7,748
7,925
Individually evaluated
for impairment
Collectively evaluated
for impairment
Total
$
337 $
2,027 $
3,044 $
63
Loans by Segment and Evaluation Method as of
December 31, 2017
Real Estate
Construction
Consumer
Real Estate
Commercial
Real Estate
Commercial
Non Real
Estate
Public
Sector and
IDA
Consumer Non
Real Estate
Unallocated
Total
$
2,882
$
1,267 $
6,516
$
1,229
$
---
$
30
$
---
$
11,924
165,698
51,443
31,812
34,694 $ 166,965 $ 340,414 $ 40,518 $ 51,443
333,898
39,289
34,618
$
34,648 $
656,758
---
--- $ 668,682
Individually evaluated
for impairment
Collectively evaluated
for impairment
Total
$
A summary of ratios for the allowance for loan losses follows:
Ratio of allowance for loan losses to the end of period loans, net of unearned income and
deferred fees and costs
Ratio of net charge-offs to average loans, net of unearned income and deferred fees and
costs
A summary of nonperforming assets follows:
Nonperforming assets:
Nonaccrual loans
Restructured loans in nonaccrual
Total nonperforming loans
Other real estate owned, net
Total nonperforming assets
Ratio of nonperforming assets to loans, net of unearned income and deferred fees and
costs, plus other real estate owned
Ratio of allowance for loan losses to nonperforming loans(1)
December 31,
2018
2017
1.04 %
1.19 %
0.07 %
0.08 %
December 31,
2018
2017
311
$
3,109
3,420
2,052
$ 5,472
$
6
2,763
2,769
2,817
$ 5,586
0.77 %
216.08 %
0.83 %
286.20 %
(1) The Company defines nonperforming loans as total nonaccrual and restructured loans that are nonaccrual. Loans 90 days past due
and still accruing and accruing restructured loans are excluded.
64
A summary of loans past due 90 days or more and impaired loans follows:
Loans past due 90 days or more and still accruing
Ratio of loans past due 90 days or more and still accruing to loans, net of unearned income and
$
deferred fees and costs
Accruing restructured loans
Impaired loans:
Impaired loans with no valuation allowance
Impaired loans with a valuation allowance
Total impaired loans
Valuation allowance
Impaired loans, net of allowance
Average recorded investment in impaired loans(1)
Income recognized on impaired loans, after designation as impaired
Amount of income recognized on a cash basis
$
$
$
$
$
$
$
$
December 31,
2018
35
$
2017
51
0.00 %
2,552
0.01 %
$ 5,134
5,667
1,153
6,820
(139 ) $
6,681
9,788
250
---
$ 10,444
1,480
$ 11,924
(177 )
$ 11,747
$ 13,344
528
$
---
$
(1)
Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.
No interest income was recognized on nonaccrual loans for the years ended December 31, 2018, 2017 or 2016. Nonaccrual loans
that meet the Company’s balance thresholds are designated as impaired.
A detailed analysis of investment in impaired loans, associated reserves and interest income recognized, by loan class follows:
Impaired Loans as of December 31, 2018
(A)
Total
Recorded
Investment(1)
Recorded
Investment(1) in (A)
for Which There is
No Related
Allowance
Recorded
Investment(1) in
(A) for Which
There is a Related
Allowance
Principal
Balance
Related
Allowance
Consumer Real Estate(2)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
$
728 $
144
593
Commercial Real Estate(2)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(2)
Commercial and Industrial
Consumer Non Real Estate(2)
Automobile
Total
485
1,363
2,867
719 $
143
590
483
1,363
2,494
719 $
---
590
483
1,363
2,494
--- $
143
---
---
---
---
1,018
1,015
5
1,010
13
$ 7,211 $
13
6,820 $
13
5,667 $
---
1,153 $
65
---
4
---
---
---
---
135
---
139
Impaired Loans as of December 31, 2017
(A)
Total
Recorded
Investment(1)
Recorded
Investment(1) in (A)
for Which There is
No Related
Allowance
Recorded
Investment(1) in
(A) for Which
There is a Related
Allowance
Principal
Balance
Related
Allowance
$ 2,882 $
2,882 $
2,882 $
--- $
---
10
6
---
---
---
---
160
1
177
178
174
---
---
---
---
1,103
25
1,480 $
Real Estate Construction(2)
Construction other
Consumer Real Estate(2)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(2)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(2)
Commercial and Industrial
Consumer Non Real Estate(2)
807
174
347
303
3,619
2,921
768
174
325
303
3,611
2,602
1,236
1,229
590
---
325
303
3,611
2,602
126
Automobile
Total
30
$ 12,319 $
30
11,924 $
5
10,444 $
(1) Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.
(2) Only classes with impaired loans are shown.
66
Consumer Real Estate(2)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(2)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(2)
Commercial and Industrial
Consumer Non Real Estate(2)
Automobile
Total
Average Investment and Interest Income for
Impaired Loans
For the Year Ended
December 31, 2018
Average Recorded
Investment(1)
Interest Income
Recognized
1,202
159
808
491
3,038
2,744
1,326
20
$
9,788
$
41
9
23
20
75
54
27
1
250
(1) Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.
(2) Only classes with impaired loans are shown.
Real Estate Construction(2)
Construction other
Consumer Real Estate(2)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(2)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(2)
Commercial and Industrial
Consumer Non Real Estate(2)
Automobile
Total
Average Investment and Interest Income for
Impaired Loans
For the Year Ended
December 31, 2017
Average Recorded
Investment(1)
Interest Income
Recognized
$
3,298 $
781
185
329
748
4,047
2,638
1,282
36
13,344 $
$
177
57
11
1
16
200
---
64
2
528
(1) Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.
(2) Only classes with impaired loans are shown.
67
Average Investment and Interest Income for
Impaired Loans
For the Year Ended
December 31, 2016
Average Recorded
Investment(1)
Interest Income
Recognized
Real Estate Construction(2)
Construction 1-4 family residential
$
462 $
Consumer Real Estate(2)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(2)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(2)
Commercial and Industrial
Consumer Non Real Estate(2)
Automobile
Total
642
207
74
1,366
4,342
3,947
541
4
11,585
$
$
10
38
13
4
12
206
263
7
---
553
(1) Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status.
(2) Only classes with impaired loans are shown.
68
An analysis of past due and nonaccrual loans follows:
December 31, 2018
30 – 89
Days Past
Due
90 or More
Days Past Due
90 or More
Days Past Due
and Still
Accruing
Nonaccruals
(Including
Impaired
Nonaccruals)
Consumer Real Estate(1)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(1)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(1)
Commercial and Industrial
Consumer Non Real Estate (1)
Credit cards
Automobile
Other consumer loans
Total
December 31, 2017
647
11
---
291
325
---
10
5
296
50
1,635 $
$
119
---
---
192
---
---
2
---
29
4
346 $
---
---
---
---
---
---
2
---
29
4
35
$
278
---
451
192
---
2,494
5
---
---
---
3,420
30 – 89
Days Past
Due
90 or More
Days Past Due
90 or More
Days Past Due
and Still
Accruing
Nonaccruals
(Including
Impaired
Nonaccruals)
Consumer Real Estate(1)
Residential closed-end first liens
Residential closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate(1)
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
Commercial Non Real Estate(1)
Commercial and Industrial
Consumer Non Real Estate (1)
Credit cards
Automobile
Other consumer loans
Total
637
188
66
303
402
---
131
7
375
154
2,263 $
$
(1) Only classes with past due or nonaccrual loans are presented
16
---
---
---
---
2,602
---
12
22
6
2,658 $
11
---
---
---
---
---
---
12
22
6
51
$
145
---
6
---
---
2,602
15
---
1
---
2,769
The estimate of credit risk for non-impaired loans is obtained by applying allocations for internal and external factors. The
allocations are increased for loans that exhibit greater credit quality risk.
Credit quality indicators, which the Company terms risk grades, are assigned through the Company’s credit review function for
larger loans and selective review of loans that fall below credit review thresholds. Loans that do not indicate heightened risk are graded
as “pass.” Loans that appear to have elevated credit risk because of frequent or persistent past due status, which is less than 75 days, or
that show weakness in the borrower’s financial condition are risk graded “special mention.” Loans with frequent or persistent
69
delinquency exceeding 75 days or that have a higher level of weakness in the borrower’s financial condition are graded “classified.”
Classified loans have regulatory risk ratings of “substandard” and “doubtful.” Allocations are increased by 50% and by 100% for loans
with grades of “special mention” and “classified,” respectively.
Determination of risk grades was completed for the portfolio as of December 31, 2018 and 2017.
The following displays non-impaired gross loans by credit quality indicator:
December 31, 2018
Real Estate Construction
Construction, 1-4 family residential
Construction, other
Consumer Real Estate
Equity lines
Closed-end first liens
Closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate
Multifamily residential real estate
Commercial real estate owner-occupied
Commercial real estate, other
Commercial Non Real Estate
Commercial and Industrial
Public Sector and IDA
States and political subdivisions
Consumer Non Real Estate
Credit cards
Automobile
Other consumer
Total
Special
Mention
(Excluding
Impaired)
Classified
(Excluding
Impaired)
Pass
$
9,264 $
28,560
--- $
21
16,026
92,253
3,954
60,157
98,582
123,225
127,156
45,420
60,777
5,724
18,598
11,691
$
701,387 $
38
994
---
---
---
211
---
54
---
---
133
4
1,455 $
---
---
---
582
---
---
---
32
---
46
---
---
71
4
735
70
December 31, 2017
Real Estate Construction
Construction, 1-4 family residential
Construction, other
Consumer Real Estate
Equity lines
Closed-end first liens
Closed-end junior liens
Investor-owned residential real estate
Commercial Real Estate
Multifamily residential real estate
Commercial real estate owner-occupied
Commercial real estate, other
Commercial Non Real Estate
Commercial and Industrial
Public Sector and IDA
States and political subdivisions
Consumer Non Real Estate
Credit cards
Automobile
Other consumer
Total
Special
Mention
(Excluding
Impaired)
Classified
(Excluding
Impaired)
Pass
$
10,396 $
21,416
--- $
---
16,673
85,975
4,483
55,410
95,894
130,256
106,612
38,904
51,443
5,493
16,059
12,692
$
651,706 $
39
2,400
29
66
127
246
---
220
---
---
218
16
3,361 $
---
---
---
355
12
256
---
763
--
165
---
---
116
24
1,691
Sales, Purchases and Reclassification of Loans
The Company finances mortgages under “best efforts” contracts with mortgage purchasers. The mortgages are designated as held
for sale upon initiation. There have been no major reclassifications from portfolio loans to held for sale. Occasionally, the Company
purchases or sells participations in loans. All participation loans purchased met the Company’s normal underwriting standards at the
time the participation was entered. Participation loans are included in the appropriate portfolio balances to which the allowance
methodology is applied.
71
Troubled Debt Restructurings
From time to time the Company modifies loans in troubled debt restructurings (“TDRs”). The following tables present restructurings
by class that occurred during the years ended December 31, 2018, 2017 and 2016.
Note: Only classes with restructured loans are presented.
Restructurings that occurred during the year ended
December 31, 2018
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment(1)
$
2,882
$
2,882
715
22
594
4,213
$
715
22
594
4,213
$
Number of
Contracts
2
2
1
8
13
Construction Real Estate
Construction, other
Commercial Real Estate
Commercial real estate, owner occupied
Consumer Real Estate
Closed-end first liens
Investor-owned residential real estate
Total
(1) Post-modification outstanding recorded investment considers amounts immediately following the modification. Amounts do not
reflect balances at the end of the period.
The Company restructured 13 loans during the twelve month period ended December 31, 2018.
Each of the construction loans were restructured to extend the maturity and interest only period for each loan. As of December 31,
2018, the loans have been converted to permanent financing at market terms and are no longer considered TDR or individually evaluated
for impairment.
Two commercial real estate loans were restructured to provide a 12-month interest-only period without reducing the interest rate.
When the interest-only period expires, the commercial real estate loans will be re-amortized for a longer term. The impairment
measurements were based upon the present value of cash flows and did not result in a specific allocation for either loan.
The investor owned residential real estate loans were restructured to provide payment relief. Seven loans were restructured from
amortizing to interest-only for a period of 12 months, when the loans will be reevaluated. The impairment measurements were based
on the fair value of collateral and did not result in specific allocations. The other investor owned residential real estate restructure
consolidated debt at a longer term, provided a rate reduction and capitalized interest. The impairment measurement was based upon the
present value of cash flows and did not result in a specific allocation. The loan is in nonaccrual status and all payments made during the
nonaccrual period are credited fully to principal, reducing the book balance below the present value of cash flows.
One residential closed-end first lien loan was restructured to provide payment relief by restructuring from amortizing to interest-
only for a period of 12 months, when the loan will be reevaluated. The impairment measurement was based on the fair value of collateral
and did not result in a specific allocation.
None of the restructures completed during the twelve months ended December 31, 2018 forgave principal or interest.
72
Restructurings that occurred during the year ended
December 31, 2017
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment(1)
Number of
Contracts
1
1
4
4
10
$
8
$
132
1,221
26
1,387
$
$
8
132
1,221
26
1,387
Consumer Real Estate
Closed-end first lien
Commercial Real Estate
Commercial real estate, other
Commercial Non Real Estate
Commercial and industrial
Consumer Non Real Estate
Automobile
Total
(1) Post-modification outstanding recorded investment considers amounts immediately following the modification. Amounts do not
reflect balances at the end of the period.
Each of the restructurings completed during the twelve months ended December 31, 2017 provided payment relief to the borrowers.
The consumer real estate loan was modified to provide payment relief by extending the term. Impairment measurement was based on
the present value of cash flows and did not result in a specific allocation.
The commercial real estate loan restructuring reduced debt service by lowering the interest rate slightly and changing the interest
method from variable to fixed. Interest was capitalized and the loan was re-amortized over a longer term. Impairment measurement,
based on the present value of cash flows, did not result in a specific allocation. The loan is in nonaccrual status and all payments made
during the nonaccrual period are credited fully to principal, reducing the book balance below the present value of cash flows.
The four commercial non-real estate loans were restructured to reduce monthly debt service by increasing the amortization period.
Three of the commercial non-real estate loans received rate reductions, and on one commercial non-real estate loan, the interest method
was changed from variable to fixed. Impairment measurement, based on the present value of cash flows, indicated a specific reserve
for two of the commercial non-real estate loans.
The four automobile loans were restructured pursuant to Chapter 13 bankruptcy requirements, reducing the interest rate and re-
amortizing over a longer term to provide monthly debt service relief. One automobile loan restructuring included forgiveness of a small
amount of principal to comply with the bankruptcy plan. Impairment measurement for all the restructured automobile loans was based
on the present value of cash flows method and resulted in small specific allocations for each loan which totaled $1.
Restructurings that occurred during the year ended
December 31, 2016
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment(1)
$
3,008
$
3,008
29
5
3,042
$
$
30
5
3,043
Number of
Contracts
2
1
1
4
Commercial Real Estate
Commercial real estate, other
Commercial Non Real Estate
Commercial and industrial
Consumer Non Real Estate
Automobile
Total
(1) Post-modification outstanding recorded investment considers amounts immediately following the modification. Amounts do not
reflect balances at the end of the period.
73
During the twelve-month period ended December 31, 2016, the Company identified four loans as troubled debt restructurings. Two
commercial real estate loans were originally modified in troubled debt restructurings in 2014 to provide payment relief by lowering the
interest rate and allowing interest-only payments. The restructurings completed in 2016 lowered the interest rate from the 2014
restructured terms and returned the loans to amortization with payments of principal and interest. The loans were in nonaccrual status
prior to the 2016 restructuring and will remain in nonaccrual until they have met the Company's policy to return to accrual status. The
Company also identified during the year ended December 31, 2016 one commercial non-real estate loan and one automobile loan
modified in troubled debt restructurings. The modifications provided payment relief by extending the maturity date and capitalizing
interest. The loans are in nonaccrual status. Each of the four troubled debt restructurings are collateral dependent and the fair value is
measured using the collateral method. Impairment measurement did not result in any specific allocations.
Of the Company’s TDR’s that defaulted in 2018, 2017 and 2016, none were modified within 12 months prior to default. The
company defines default as one or more payments that occur more than 90 days past the due date, charge-off or foreclosure.
Note 6: Premises and Equipment
A summary of the cost and accumulated depreciation of premises and equipment follows:
December 31,
2018
2017
Premises
Furniture and equipment
Premises and equipment
Accumulated depreciation
Premises and equipment, net
$
$
$
13,244 $
5,606
18,850 $
(10,204 )
8,646 $
12,434
5,238
17,672
(9,451 )
8,221
Depreciation expense for the years ended December 2018, 2017 and 2016 amounted to $766, $805 and $801, respectively. In
December 2017, the Company sold its Marion branch office and realized a gain on the sale of fixed assets of $134.
The Company leases certain branch facilities under noncancellable operating leases. The future minimum lease payments under
these leases (with initial or remaining lease terms in excess of one year) as of December 31, 2018 are as follows: $346 in 2019, $192
in 2020, $172 in 2021, $175 in 2022, $177 in 2023 and $872 thereafter.
Note 7: Deposits
The aggregate amounts of time deposits in denominations of $250 or more at December 31, 2018 and 2017 were $14,277 and
$14,283, respectively. At December 31, 2018 the scheduled maturities of time deposits are as follows:
2019
2020
2021
2022
2023
Thereafter
Total time deposits
$
53,455
40,653
2,593
2,327
2,771
---
101,799
At December 31, 2018 and 2017, overdraft demand deposits reclassified to loans totaled $240 and $255, respectively.
Note 8: Employee Benefit Plans
401(k) Plan
The Company has a Retirement Accumulation Plan qualifying under IRS Code Section 401(k), in which NBI, NBB and NBFS are
participating employers. Eligible participants may contribute up to 100% of their total annual compensation to the plan, subject to certain
limits based on federal tax laws. Employee contributions are matched by the employer based on a percentage of an employee’s total
annual compensation contributed to the plan. For the years ended December 31, 2018, 2017 and 2016, the Company contributed $364,
$340 and $315, respectively, to the plan.
Employee Stock Ownership Plan
The Company has a non-leveraged Employee Stock Ownership Plan (ESOP) which enables employees of NBI and its subsidiaries
who have one year of service and who have attained the age of 21 prior to the plan’s January 1 and July 1 enrollment dates to own NBI
common stock. Contributions to the ESOP, which are not mandatory, are determined annually by the Board of Directors. Contribution
74
expense amounted to $300, $200 and $150 in the years ended December 31, 2018, 2017 and 2016, respectively. Dividends on ESOP
shares are charged to retained earnings. As of December 31, 2018, the number of shares held by the ESOP was 192,250. All shares held
by the ESOP are treated as outstanding in computing the Company’s basic net income per share. Upon reaching age 55 with ten years
of plan participation, a vested participant has the right to diversify 50% of his or her allocated ESOP shares and NBI or the ESOP, with
the agreement of the Trustee, is obligated to purchase those shares. The ESOP contains a put option which allows a withdrawing
participant to require the Company or the ESOP, if the plan administrator agrees, to purchase his or her allocated shares if the shares are
not readily tradable on an established market at the time of distribution.
Salary Continuation Plan
The Company has a non-qualified Salary Continuation Plan for certain key officers. The plan provides the participating officers
with supplemental retirement income, payable for the greater of 15 years after retirement or the officer’s lifetime. The expense accrued
for the plans in 2018, 2017, and 2016, based on the present value of the retirement benefits, amounted to $255, $272, and $242,
respectively. The plan is unfunded. However bank-owned life insurance has been acquired on the life of the key employees in amounts
sufficient to discharge the obligations of the agreement.
Defined Benefit Plan
The Company’s defined benefit pension plan covers substantially all employees. The plan benefit formula is based upon the length
of service of retired employees and a percentage of qualified W-2 compensation during their final years of employment. Information
pertaining to activity in the plan is as follows:
Change in benefit obligation
Projected benefit obligation at beginning of year
Service cost
Interest cost
Actuarial loss
Benefits paid
Projected benefit obligation at end of year
Change in plan assets
Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contribution
Benefits paid
Fair value of plan assets at end of year
December 31,
2018
2017
2016
$ 23,492 $ 21,059 $
868
802
(423 )
(1,051 )
$ 23,688
692
743
1,417
(419 )
$ 23,492
$ 23,428
(591 )
---
(1,051 )
$ 21,786
$ 17,038
2,302
4,507
(419 )
$ 23,428
$
$
$
20,427
694
757
198
(1,017 )
21,059
16,131
1,113
811
(1,017 )
17,038
Funded status at the end of the year
$ (1,902 ) $
(64 ) $
(4,021 )
Amounts recognized in the Consolidated Balance Sheet
Deferred tax asset
Other liabilities
Total amounts recognized in the Consolidated Balance Sheet
Amounts recognized in accumulated other comprehensive (loss), net
Net loss
Prior service cost
Deferred tax asset
Amount recognized
399 $
$
(1,902 )
$ (1,503 ) $
13 $
(64 )
(51 ) $
1,407
(4,021 )
(2,614 )
$ (9,107 ) $
230
1,864
$ (7,013 ) $
(7,923 ) $
340
1,592
(5,991 ) $
(8,250 )
449
2,730
(5,071 )
(continued )
75
Accrued/Prepaid benefit cost, net
Benefit obligation
Fair value of assets
Unrecognized net actuarial loss
Unrecognized prior service cost
Deferred tax liability
Prepaid benefit cost included in other assets
Components of net periodic benefit cost
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic benefit cost
$ (23,688 ) $ (23,492 ) $
21,786
9,107
(230 )
(1,465 )
$ 5,510
23,428
7,923
(340 )
(1,579 )
$ 5,940 $
(21,059 )
17,038
8,250
(449 )
(1,323 )
2,457
$
868 $
802
(1,601 )
(110 )
585
544 $
692 $
743
(1,097 )
(110 )
540
768 $
694
757
(1,110 )
(110 )
572
803
$
Other changes in plan assets and benefit obligations recognized in other
comprehensive loss
Net (gain) loss
Amortization of prior service cost
Deferred income tax expense (benefit)
Total recognized
$ 1,184 $
110
(272 )
$ 1,022 $
(328 ) $
110
46
(172 ) $
(377 )
110
93
(174 )
Total recognized in net periodic benefit cost and other comprehensive loss
$ 1,838 $
550 $
536
Weighted average assumptions at end of the year
Discount rate used for net periodic pension cost
Discount rate used for disclosure
Expected return on plan assets
Rate of compensation increase
Long Term Rate of Return
3.50 %
4.00 %
7.50 %
3.00 %
4.00 %
3.50 %
7.50 %
3.00 %
4.00 %
4.00 %
7.50 %
3.00 %
The Company, as plan sponsor, selects the expected long-term rate-of-return-on-assets assumption in consultation with its
investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested
or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of
inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to
recent experience, which may not continue over the measurement period, but higher significance is placed on current forecasts of future
long-term economic conditions.
Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, and solely for this purpose, the
plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is
given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment
and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).
The Company, as plan sponsor, has adopted a Pension Administrative Committee Policy (the Policy) for monitoring the investment
management of its qualified plans. The Policy includes a statement of general investment principles and a listing of specific investment
guidelines, to which the committee may make documented exceptions. The guidelines state that, unless otherwise indicated, all
investments that are permitted under the Prudent Investor Rule shall be permissible investments for the defined benefit pension plan.
All plan assets are to be invested in marketable securities. Certain investments are prohibited, including commodities and future
contracts, private placements, repurchase agreements, options and derivatives. The Policy establishes quality standards for fixed income
investments and mutual funds included in the pension plan trust. The Policy also outlines diversification standards.
76
The preferred target allocation for the assets of the defined benefit pension plan is 65% in equity securities and 35% in fixed income
securities. Equity securities include investments in large-cap and mid-cap companies primarily located in the United States, although a
small number of international large-cap companies are included. There are also investments in mutual funds holding the equities of
large-cap and mid-cap U.S. companies. Fixed income securities include U.S. government agency securities and corporate bonds from
companies representing diversified industries. There are no investments in hedge funds, private equity funds or real estate.
Fair value measurements of the pension plan’s assets at December 31, 2018 follow:
Asset Category
Total
Fair Value Measurements at December 31, 2018
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
$
1,917
$
1,917
$
---
$
Cash
Equity securities:
U. S. companies
International companies
Equities mutual funds (1)
U. S. government agencies and corporations
State and political subdivisions
Corporate bonds – investment grade (2)
Total pension plan assets
$
8,782
471
2,174
50
202
8,190
21,786
$
8,782
471
2,174
---
---
---
13,344
$
---
---
---
50
202
8,190
8,442
$
(1) This category comprises actively managed equity funds invested in large-cap and mid-cap U.S. companies.
(2) This category represents investment grade bonds of U.S. issuers from diverse industries.
Asset Category
Total
Fair Value Measurements at December 31, 2017
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
$
4,454
$
4,454
$
---
$
Cash
Equity securities:
U. S. companies
International companies
Equities mutual funds (1)
U. S. government agencies and corporations
State and political subdivisions
Corporate bonds – investment grade (2)
Total pension plan assets
$
9,892
106
1,962
51
231
6,732
23,428
$
9,892
106
1,962
---
---
---
16,414
$
---
---
---
51
231
6,732
7,014
$
---
---
---
---
---
---
---
---
---
---
---
---
---
---
---
---
(1) This category comprises actively managed equity funds invested in large-cap and mid-cap U.S. companies.
(2) This category represents investment grade bonds of U.S. issuers from diverse industries.
The Company’s required minimum pension contribution for 2019 has not yet been determined.
Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:
2019
2020
2021
2022
2023
2024 - 2028
77
$ 4,315
$ 1,687
768
$
$ 1,289
844
$
$ 8,306
Note 9: Income Taxes
The Company files United States federal income tax returns, and Virginia, West Virginia and North Carolina state income tax
returns. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities
for years prior to 2015.
Allocation of income tax expense between current and deferred portions is as follows:
Years ended December 31,
2018
2017
2016
Current
Deferred expense (benefit)
Deferred tax adjustment for enacted change in tax rate
Total income tax expense
$
$
2,942
(382 )
---
2,560
$
$
2,943
1,790
1,560
6,293
$
$
3,934
18
---
3,952
Income tax expense for 2017 includes a downward adjustment of net deferred tax assets in the amount of $1,560, recorded as a
result of the enactment of the Tax Cuts and Jobs Act on December 22, 2017. The Company’s marginal tax rate prior to the enactment
of the Act is 35%. Effective January 1, 2018, the Company’s tax rate is 21%.
The following is a reconciliation of the “expected” income tax expense, computed by applying the U.S. Federal income tax rate of
21% to 2018 income before tax expense and 35% to 2017 and 2016 income before income tax expense, with the reported income tax
expense:
Computed “expected” income tax expense
Tax impact of enacted change in tax rate
Tax-exempt interest income
Nondeductible interest expense
Other, net
Reported income tax expense
Years ended December 31,
2018
2017
2016
$
$
3,929 $
---
(1,255 )
69
(183 )
2,560 $
7,135 $
1,560
(2,144 )
89
(347 )
6,293 $
6,613
---
(2,234 )
92
(519 )
3,952
78
The components of net deferred tax assets, included in other assets, are as follows:
December 31,
2018
2017
Deferred tax assets:
Allowance for loan losses and unearned fee income
Valuation allowance on other real estate owned
Defined benefit plan
Deferred compensation and other liabilities
Discount accretion of securities
Net unrealized loss on securities available for sale
Total deferred tax assets
Deferred tax liabilities:
Fixed assets
Deposit intangibles
Defined benefit plan, prepaid portion
Discount accretion of securities
Total deferred tax liabilities
Net deferred tax assets
$
$
$
$
1,683 $
223
1,864
1,308
---
1,348
6,426 $
(365 ) $
(1,169 )
(1,465 )
(70 )
(3,069 )
3,357 $
1,773
156
1,592
863
---
984
5,368
(388 )
(1,059 )
(1,579 )
(2 )
(3,028 )
2,340
During 2018, the company re-designated its securities held to maturity as available for sale. The unrealized gain or loss on the re-
designated securities is now recognized in accumulated other comprehensive income and the tax effects are included in deferred tax
assets, net unrealized loss on securities available for sale.
The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 2018
and 2017.
Note 10: Restrictions on Dividends
The Company’s principal source of funds for dividend payments is dividends received from its subsidiary bank. For the years ended
December 31, 2018, 2017 and 2016, dividends received from the subsidiary bank were $9,419, $8,141 and $9,071, respectively. National
Bankshares Financial Services provided $350 in dividends to Bankshares in 2016.
Substantially all of Bankshares’ retained earnings are undistributed earnings of its sole banking subsidiary, which are restricted by
various regulations administered by federal bank regulatory agencies. Bank regulatory agencies restrict, unless prior approval is
obtained, the total dividend payments of a bank in any calendar year to the bank’s retained net income of that year to date, as defined,
combined with its retained net income of the preceding two years, less any required transfers to surplus. At December 31, 2018, NBB’s
retained net income, which was free of such restriction, amounted to approximately $19,979.
Note 11: Minimum Regulatory Capital Requirement
In August, 2018, the Federal Reserve updated the Small Bank Holding Company Policy Statement (“the Statement”), in compliance
with The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (“EGRRCPA”). The Statement, among other
things, exempts bank holding companies that fall below a certain asset threshold from reporting consolidated regulatory capital ratios
and from minimum regulatory capital requirements. The interim final rule expands the exemption to bank holding companies with
consolidated total assets of less than $3 billion. Prior to August 2018, the statement exempted bank holding companies with consolidated
total assets of less than $1 billion. As a result of the interim final rule, the Company qualifies as of August, 2018 as a small bank holding
company and is no longer subject to regulatory capital requirements on a consolidated basis.
The subsidiary bank continues to be subject to various regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices.
The capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and
other factors.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective on January 1,
2015 (subject to a phase-in period continuing through January 1, 2019 for certain provisions). Basel III Capital Rules established
quantitative measures to ensure capital adequacy. The rules set forth minimum amounts and ratios for Common Equity Tier 1 capital
79
(“CET1”), Tier 1 capital and Total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to
adjusted quarterly average assets (as defined).
The Bank’s CET1 capital include common stock and related surplus and retained earnings. Basel III Capital Rules provide an
option to exclude components of accumulated other comprehensive income (loss) from CET1 capital. Once made, the election is final
and cannot be changed. The Bank elected to exclude components of accumulated other comprehensive income from CET1 capital.
Tier 1 Capital includes CET1 capital and additional Tier 1 capital components. At December 31, 2018 and 2017, the Bank did not
hold any additional Tier 1 capital beyond CET1 capital.
Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital includes the allowance for loan losses.
The Bank’s risk-weighted assets were $816,660 at December 31, 2018 and $805,656 as of December 31, 2017. Management
believes, as of December 31, 2018 and 2017, that the Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2018, the most recent notifications from the Office of the Comptroller of the Currency categorized the Bank
as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution
must maintain minimum total risk-based, Tier 1 risk-based, Common Equity Tier 1 risk-based and Tier 1 leverage ratios, as set forth in
the following tables. There are no conditions or events since these notifications that management believes have changed the Bank’s
category.
The Bank’s capital amounts and ratios as of December 31, 2018 and 2017 are presented in the following tables.
Actual
Amount
Ratio
Minimum Capital
Requirement(1)
Amount
Ratio
Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount
Ratio
December 31, 2018
Total capital (to risk weighted assets)
Tier 1 capital (to risk weighted assets)
Common Equity Tier 1 capital (to risk weighted assets)
Tier 1 capital (to average assets)
$
$
$
$
202,238 24.764 % $ 80,645
194,823 23.856 % $ 64,312
194,823 23.856 % $ 52,062
194,823 15.788 % $ 49,359
9.875 % $ 81,666 10.000 %
8.000 %
7.875 % $ 65,333
6.500 %
6.375 % $ 53,083
5.000 %
4.000 % $ 61,699
Actual
Minimum Capital
Requirement(1)
Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2017
Total capital (to risk weighted assets)
Tier 1 capital (to risk weighted assets)
Common Equity Tier 1 capital (to risk weighted assets)
Tier 1 capital (to average assets)
$
$
$
$
195,903
187,978
187,978
187,978
24.316 % $ 74,523
23.332 % $ 58,410
23.332 % $ 46,325
15.254 % $ 49,293
9.250 % $ 80,566 10.000 %
8.000 %
7.250 % $ 64,452
6.500 %
5.750 % $ 52,368
5.000 %
4.000 % $ 61,616
(1) Except with regard to the Bank’s Tier 1 capital to average assets ratio, the minimum capital requirement includes the current
phased-in portion of the Basel III Capital Rules capital conservation buffer (1.25%) which is added to the minimum capital
requirements for capital adequacy purposes. The capital conservation buffer is being phased in through four equal annual
installments of .0625% from 2016 to 2019, with full implementation in January 2019 (2.5%). The Bank’s capital conservation
buffer must consist of additional CET1 above regulatory minimum requirement. Failure to maintain the prescribed levels would
result in limitations on capital distributions and discretionary bonuses to executives.
80
December 31,
2018
2017
$
$
$
$
44 $
357
189,692
396
841
191,330 $
1,092 $
190,238
191,330 $
46
503
184,336
168
820
185,873
977
184,896
185,873
Years Ended December 31,
2018
2017
2016
$
$
9,419 $
---
---
10
9,429
8,141 $
---
4
1,018
9,163
9,421
2
---
987
10,410
1,244
1,986
1,992
8,185
308
8,493
7,658
16,151 $
7,177
383
7,560
6,532
8,418
628
9,046
5,896
14,092 $ 14,942
Note 12: Condensed Financial Statements of Parent Company
Financial information pertaining only to NBI (Parent) is as follows:
Condensed Balance Sheets
Assets
Cash due from subsidiaries
Interest-bearing deposits
Investments in subsidiaries
Refundable income taxes
Other assets
Total assets
Liabilities and Stockholders’ Equity
Other liabilities
Stockholders’ equity
Total liabilities and stockholders’ equity
Condensed Statements of Income
Income
Dividends from subsidiaries
Interest on securities – taxable
Realized securities gains, net
Other income
Total income
Expenses
Other expenses
Income before income tax benefit and equity in undistributed net income of
subsidiaries
Applicable income tax benefit
Income before equity in undistributed net income of subsidiaries
Equity in undistributed net income of subsidiaries
Net income
81
Condensed Statements of Cash Flows
Cash Flows from Operating Expenses
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Years ended December 31,
2018
2017
2016
$
16,151 $
14,092 $
14,942
Equity in undistributed net income of subsidiaries
Amortization of premiums and accretion of discounts, net
Gain on sale of securities
Net change in refundable income taxes due from subsidiaries
Net change in other assets
Net change in other liabilities
Net cash provided by operating activities
Cash Flows from Investing Activities
Net change in interest-bearing deposits
Maturities, sales and calls of securities available for sale
Maturities and calls of securities held to maturity
Capital distribution to subsidiary
Net cash provided by (used in) investing activities
Cash Flows from Financing Activities
Cash dividends paid
Net cash used in financing activities
Net change in cash
Cash due from subsidiaries at beginning of year
Cash due from subsidiaries at end of year
(7,658 )
---
---
(228 )
(109 )
115
8,271
146
---
---
---
146
(6,532 )
---
(4 )
(146 )
(156 )
(40 )
7,214
807
192
---
(100 )
899
(8,419 )
(8,419 )
(2 )
46
44 $
$
(8,141 )
(8,141 )
(28 )
74
46 $
(5,896 )
1
---
(223 )
219
(227 )
8,816
(1,140 )
---
450
---
(690 )
(8,071 )
(8,071 )
55
19
74
Note 13: Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and interest rate
locks. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated
balance sheets.
The Company’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Company
uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The
Company may require collateral or other security to support the following financial instruments with credit risk.
At December 31, 2018 and 2017, financial instruments outstanding whose contract amounts represent credit risk were:
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit
Standby letters of credit
Mortgage loans sold with potential recourse
December 31,
2018
2017
$
145,635 $
16,092
13,013
161,222
16,351
14,130
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The
commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily
represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on
management’s credit evaluation of the customer.
82
Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are
commitments for possible future extensions of credit. Some of these commitments are uncollateralized and do not contain a specified
maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third
party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial
properties.
The Company originates mortgage loans for sale to secondary market investors subject to contractually specified and limited
recourse provisions. In 2018, the Company originated $12,626 and sold $13,013 to investors, compared to $13,912 originated and
$14,341 sold in 2017. Every contract with each investor contains certain recourse language. In general, the Company may be required
to repurchase a previously sold mortgage loan if there is major noncompliance with defined loan origination or documentation standards,
including fraud, negligence or material misstatement in the loan documents. Repurchase may also be required if necessary governmental
loan guarantees are canceled or never issued, or if an investor is forced to buy back a loan after it has been resold as a part of a loan
pool. In addition, the Company may have an obligation to repurchase a loan if the mortgagor defaults early in the loan term. This
potential default period is approximately twelve months after sale of a loan to the investor.
At December 31, 2018, the Company had locked-rate commitments to originate mortgage loans amounting to approximately $915
and loans held for sale of $72. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Company
does not expect any counterparty to fail to meet its obligations.
The Company maintains cash accounts in other commercial banks. The Company had $41 in deposits with correspondent
institutions at December 31, 2018 that was not insured by the Federal Deposit Insurance Corporation.
Note 14: Concentrations of Credit Risk
The Company does a general banking business, serving the commercial and personal banking needs of its customers. NBB’s primary
service area is defined as the counties of Montgomery, Giles, Carroll, Grayson, Pulaski, Tazewell, Smyth, Wythe, Roanoke and
Washington and the cities of Galax, Radford and Roanoke in southwest Virginia, and Mercer, Monroe and McDowell counties in West
Virginia. For loan purposes, our trade area also includes the Virginia cities of Roanoke, Salem and Bristol and counties of Botetourt
and Craig, the southernmost tip of West Virginia adjacent to the counties of Giles, Buchanan, Russell and Bland, the North Carolina
counties of Surry and Alleghany, and the Tennessee city of Bristol and counties of Washington and Sullivan. Substantially all of NBB’s
loans are made in its primary service area. Additionally, the Company occasionally participates in loans in nearby higher growth
metropolitan areas. Loans outside of the primary service area are a small percentage of the loan portfolio, are appropriately underwritten
and are not considered out of trade area exceptions. The ultimate collectability of the bank’s loan portfolio and the ability to realize the
value of any underlying collateral, if needed, is influenced by the economic conditions of the market area. The Company’s operating
results are therefore closely correlated with the economic trends within this area.
Commercial real estate as of December 31, 2018 and 2017 represented approximately 50% and 51% of the loan portfolio, at
$353,546 and $340,414, respectively. Included in commercial real estate are loans for college housing and professional office buildings
that comprised $184,203 and $247,198 as of December 31, 2018 and 2017 respectively, corresponding to approximately 26% of the
loan portfolio at December 31, 2018 and 37% of the loan portfolio at December 31, 2017. Loans secured by residential real estate were
$175,456, or approximately 25% of the portfolio, and $166,965, or 25% of the portfolio at December 31, 2018 and 2017, respectively.
The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase
real and personal property are generally collateralized by the related property and with loan amounts established based on certain
percentage limitations of the property’s total stated or appraised value. Credit approval is primarily a function of collateral and the
evaluation of the creditworthiness of the individual borrower or project based on available financial information. Management considers
the concentration of credit risk to be minimal.
Note 15: Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement
date. U.S. GAAP requires that valuation techniques maximize the use of the observable inputs and minimize the use of the unobservable
inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the
underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:
Level 1 – Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 – Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted
prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which
significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 – Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable
in the market.
83
Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for
the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement
of the instrument. Accounting guidance for fair value excludes certain financial instruments and all nonfinancial instruments from its
disclosure requirements. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair
value of the Company.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded
at fair value on a recurring basis in the financial statements:
Securities Available for Sale
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market
prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation
techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable
market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities
by using pricing models that consider observable market data (Level 2). The carrying value of restricted Federal Reserve Bank and
Federal Home Loan Bank stock approximates fair value based upon the redemption provisions of each entity and is therefore excluded
from the following table.
The following tables present the balances of financial assets measured at fair value on a recurring basis as of December 31, 2018
and 2017:
Description
U.S. Government agencies and corporations $
States and political subdivisions
Mortgage-backed securities
Corporate debt securities
Balance as of
December 31,
2018
300,047 $
118,616
628
5,719
425,010 $
$
Total securities available for sale
Description
U.S. Government agencies and corporations $
States and political subdivisions
Mortgage-backed securities
Corporate debt securities
Total securities available for sale
$
Balance as of
December 31,
2017
307,719 $
16,834
659
6,175
331,387 $
Fair Value Measurements at December 31, 2018 Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Unobservable
Inputs
(Level 3)
Significant
Other
Observable
Inputs
(Level 2)
--- $ 300,047 $
118,616
---
628
---
---
5,719
--- $ 425,010 $
Significant
Other
Observable
Inputs
(Level 2)
--- $ 307,719 $
---
---
---
--- $ 331,387 $
16,834
659
6,175
---
---
---
---
---
---
---
---
---
---
Fair Value Measurements at December 31, 2017 Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Unobservable
Inputs
(Level 3)
Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value
of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on
a nonrecurring basis in the financial statements:
Loans Held for Sale
Loans held for sale are carried at the lower of cost or fair value. These loans currently consist of one-to-four family residential loans
originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans
using observable market data which is not materially different than cost due to the short duration between origination and sale (Level
2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were
recorded on loans held for sale during the years ended December 31, 2018 and 2017.
84
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that
all amounts due will not be collected according to the contractual terms of the loan agreement. Troubled debt restructurings are impaired
loans. Impaired loans are measured at fair value on a nonrecurring basis. If an individually-evaluated impaired loan’s balance exceeds
fair value, the amount is allocated to the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as
provision for loan losses on the Consolidated Statements of Income.
The fair value of an impaired loan and measurement of associated loss is based on one of three methods: the observable market
price of the loan, the present value of projected cash flows, or the fair value of the collateral. The observable market price of a loan is
categorized as a Level 1 input. The present value of projected cash flows method results in a Level 3 categorization because the
calculation relies on the Company’s judgment to determine projected cash flows, which are then discounted at the current rate of the
loan, or the rate prior to modification if the loan is a troubled debt restructure.
Loans measured using the fair value of collateral method may be categorized in Level 2 or Level 3. Collateral may be in the form
of real estate or business assets including equipment, inventory, and accounts receivable. Most collateral is real estate. The Company
bases collateral method fair valuation upon the “as-is” value of independent appraisals or evaluations. Valuations for impaired loans
secured by residential 1-4 family properties with outstanding principal balances greater than $250 are based on an appraisal. Appraisals
are also used to value impaired loans secured by commercial real estate with outstanding principal balances greater than $500.
Collateral-method impaired loans secured by residential 1-4 family property with outstanding principal balances of $250 or less, or
secured by commercial real estate with outstanding principal balances of $500 or less, are valued using an internal evaluation.
The value of real estate collateral is determined by a current (less than 24 months of age) appraisal or internal evaluation utilizing
an income or market valuation approach. Appraisals conducted by an independent, licensed appraiser outside of the Company using
observable market data is categorized as Level 2. If a current appraisal cannot be obtained prior to a reporting date and an existing
appraisal is discounted to obtain an estimated value, or if declines in value are identified after the date of the appraisal, or if an appraisal
is discounted for estimated selling costs, the valuation of real estate collateral is categorized as Level 3. Valuations derived from internal
evaluations are categorized as Level 3. The value of business equipment is based upon an outside appraisal (Level 2) if deemed
significant, or the net book value on the applicable business’ financial statements (Level 3) if not considered significant. Likewise,
values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).
As of December 31, 2018 and December 31, 2017, the fair value measurements for impaired loans with specific allocations were
primarily based upon the present value of expected future cash flows.
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the
period.
Date
Description
Balance
December 31, 2018
Assets:
Impaired loans net of
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Carrying value
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31, 2017
Impaired loans net of
valuation allowance
1,303
---
---
valuation allowance
$
1,014 $
---
$
---
$
1,014
1,303
The following table presents information about Level 3 Fair Value Measurements for impaired loans.
Impaired Loans
December 31, 2018
December 31, 2017
Valuation Technique
Present value of cash flows
Present value of cash flows
Unobservable Input
Discount rate
Discount rate
Range
(Weighted Average)
5.50% - 7.25% (6.05%)
5.50% - 13.25% (5.92%)
Other Real Estate Owned
Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. Valuation of other real estate
owned is determined using current appraisals from independent parties, a Level 2 input. If current appraisals cannot be obtained prior
to reporting dates, or if declines in value are identified after a recent appraisal is received, appraisal values are discounted, resulting in
Level 3 estimates. If the Company markets the property with a realtor, estimated selling costs reduce the fair value, resulting in a
valuation based on Level 3 inputs.
85
The following table summarizes the Company’s other real estate owned that were measured at fair value on a nonrecurring basis
during the period.
Date
Description
Balance
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Carrying Value
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31, 2018
December 31, 2017
Assets:
Other real estate owned net
of valuation allowance
Other real estate owned net
of valuation allowance
$
2,052
$
---
$
--- $
2,817
---
---
2,052
2,817
The following table presents information about Level 3 Fair Value Measurements for December 31, 2018.
Valuation Technique
Unobservable Input
Range
(Weighted Average)
Other real estate owned
Other real estate owned
Discounted appraised value Selling cost
Discounted appraised value
Discount for lack of marketability
and age of appraisal
0.00%(1) – 6.00% (0.12%)
0.00% - 50.05% (1.45%)
The following table presents information about Level 3 Fair Value Measurements for December 31, 2017.
Valuation Technique
Unobservable Input
Range
(Weighted Average)
Other real estate owned
Other real estate owned
Discounted appraised value Selling cost
Discounted appraised value
Discount for lack of marketability
and age of appraisal
2.00%(1) – 6.01% (4.72%)
1.68% - 68.33% (11.07%)
(1) The Company markets other real estate owned both independently and with local realtors. Properties marketed by realtors are
discounted by selling costs. Properties that the Company markets independently are not discounted by selling costs.
The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial
instruments as of December 31, 2018 and December 31, 2017. For short-term financial assets such as cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its
expected realization. For non-marketable equity securities such as Federal Home Loan Bank and Federal Reserve Bank stock, the
carrying amount is a reasonable estimate of fair value as these securities can only be redeemed or sold at their par value and only to the
respective issuing government-supported institution or to another member institution. For financial liabilities such as noninterest-bearing
demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products
having no stated maturity. Fair values for December 31, 2018 are estimated under the exit price notion in accordance with the prospective
adoption of ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” Fair values for December 31,
2017 are estimated under the guidance in effect for that period, which did not require use of the exit price notion.
86
December 31, 2018
Estimated Fair Value
Carrying
Amount
Level 1
Level 2
Level 3
Financial assets:
Cash and due from banks
Interest-bearing deposits
Securities
Restricted securities
Mortgage loans held for sale
Loans, net
Accrued interest receivable
Bank-owned life insurance
Financial liabilities:
Deposits
Accrued interest payable
$
12,882 $
43,491
425,010
1,220
72
702,409
5,160
34,657
$
1,051,942 $
89
12,882 $
43,491
---
---
---
---
---
---
--- $
---
--- $
---
425,010
1,220
72
---
5,160
34,657
950,143 $
89
December 31, 2017
Estimated Fair Value
---
---
---
---
---
684,565
---
---
101,749
---
Financial assets:
Cash and due from banks
Interest-bearing deposits
Securities
Restricted securities
Mortgage loans held for sale
Loans, net
Accrued interest receivable
Bank-owned life insurance
Financial liabilities:
Deposits
Accrued interest payable
Carrying
Amount
Level 1
Level 2
Level 3
$
12,926 $
51,233
458,551
1,200
260
660,144
5,297
33,756
$
1,059,734 $
62
12,926 $
51,233
---
---
---
---
---
---
--- $
---
--- $
---
461,500
1,200
260
---
5,297
33,756
944,850 $
62
---
---
---
---
---
656,399
---
---
113,053
---
87
Note 16: Components of Accumulated Other Comprehensive Income (Loss)
The following table summarizes the activity related to each component of accumulated other comprehensive income (loss):
Balance at December 31, 2015
Unrealized holding loss on available for sale securities net of
tax of ($431)
Reclassification adjustment, net of tax of ($65)
Net pension gain, net of tax of $132
Less amortization of prior service cost included in net
periodic pension cost, net of tax of ($38)
Balance at December 31, 2016
Unrealized holding gain on available for sale securities net of
$
tax of $296
Reclassification adjustment, net of tax of ($4)
Net pension gain, net of tax of $115
Less amortization of prior service cost included in net
periodic pension cost, net of tax of ($38)
Reclassification of stranded tax effects from change in tax
rate
tax of ($595)
Transfer from held-to-maturity to available-for-sale
securities, net of tax of $237
Reclassification adjustment, net of tax of ($4)
Net pension loss, net of tax of ($249)
Less amortization of prior service cost included in net
periodic pension cost, net of tax of ($24)
Balance at December 31, 2018
Net Unrealized
Gain (Loss) on
Securities
Adjustments Related
to Pension Benefits
Accumulated Other
Comprehensive
Income (Loss)
$
(2,667 ) $
(5,270 ) $
(7,937 )
(800 )
(121 )
---
---
---
271
---
(3,588 ) $
(72 )
(5,071 ) $
546
(6 )
---
---
(656 )
(2,246 )
891
(13 )
---
---
---
213
(71 )
(1,062 )
(5,991 ) $
---
---
---
(936 )
(800)
(121 )
271
(72 )
(8,659 )
546
(6 )
213
(71 )
(1,718 )
(9,695 )
(2,246 )
891
(13 )
(936 )
Balance at December 31, 2017
Unrealized holding loss on available for sale securities net of
$
(3,704 ) $
---
(5,072 ) $
$
(86 )
(7,013 ) $
(86 )
(12,085 )
The following table provides information regarding reclassifications out of accumulated other comprehensive income (loss) for
the years ended December 31, 2018, 2017 and 2016:
Component of Accumulated Other Comprehensive Income (Loss)
Reclassification out of unrealized gains and losses on available-for-sale securities:
Realized securities gain, net
Income tax benefit
$
Realized gain on available-for-sale securities, net of tax, reclassified out of
accumulated other comprehensive income (loss)
Amortization of defined benefit pension items:
Prior service costs(1)
Income tax benefit
$
$
December 31,
2018
2017
2016
(17 ) $
(4 )
$
(10 )
(4 )
(186 )
(65 )
(13
) $
)
(6
$
(121
)
(110 ) $
(24 )
$
(109 )
(38 )
(110 )
(38 )
Amortization of defined benefit pension items, net of tax, reclassified out of
accumulated other comprehensive income (loss)
$
(86
) $
)
(71
$
(72
)
(1) This accumulated other comprehensive income (loss) component is included in the computation of net periodic benefit cost.
(For additional information, see Note 8, "Employee Benefit Plans.")
88
Note 17. Intangible Assets and Goodwill
In accounting for goodwill and intangible assets, the Company conducts an impairment review at least annually and more frequently
if certain impairment indicators are evident. Accounting guidance provides the option of performing a preliminary assessment of qualitative
factors before performing more substantial testing for impairment. If the preliminary assessment indicates that it is more likely than not that
fair value is below carrying value, a two-step test is employed to determine impairment. The Company opted not to perform the preliminary
assessment and employed the two-step test to determine impairment. Based on the testing for impairment of goodwill and intangible assets,
there were no impairment charges for 2018, 2017 or 2016.
Information concerning goodwill and intangible assets for years ended December 31, 2018 and 2017 is presented in the following
table:
Gross Carrying Value
Accumulated Amortization
Net Carrying Value
December 31, 2018
Amortizable core deposit intangibles
Unamortizable goodwill
Intangible assets and goodwill
December 31, 2017
Amortizable core deposit intangibles
Unamortizable goodwill
Intangible assets and goodwill
Note 18: Revenue Recognition
$
$
$
$
16,257 $
5,848
22,105 $
16,257 $
5,848
22,105 $
16,257 $
---
16,257 $
16,207 $
---
16,207 $
---
5,848
5,848
50
5,848
5,898
On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all
subsequent ASUs that modified Topic 606. As stated in Note 1 Summary of Significant Accounting Policies, the implementation of the
new standard did not have a material impact on the measurement or recognition of revenue. Results for reporting periods beginning after
January 1, 2018 and comparative periods are presented under Topic 606.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition,
certain noninterest income streams such as financial guarantees, derivatives, and certain credit card fees are outside the scope of the
guidance. Topic 606 is applicable to noninterest revenue streams such as service charges on deposit accounts, other service charges and
fees, credit and debit card fees, trust income, and annuity and insurance commissions. However, the recognition of these revenue streams
did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with
customers. Noninterest revenue streams within the scope of Topic 606 are discussed below.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of monthly service fees, overdraft and nonsufficient funds fees, ATM fees, wire transfer
fees, and other deposit account related fees. The Company’s performance obligation for monthly service fees is generally satisfied, and the
related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is primarily
received immediately or in the following month through a direct charge to customers’ accounts. ATM fees are primarily generated when a
Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Wire transfer fees, overdraft and
nonsufficient funds fees and other deposit account related fees are transactional based, and therefore, the Company’s performance obligation
is satisfied, and related revenue recognized, at a point in time.
Other Service Charges and Fees
Other service charges include safety deposit box rental fees, check ordering charges, and other service charges. Safe deposit box rental
fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals
and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.
Check ordering charges are transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue
recognized, at a point in time.
Credit and Debit Card Fees
Credit and debit card fees are primarily comprised of interchange fee income and, prior to mid-2017, merchant services income. The
Company sold its merchant services income in mid-2017. Interchange fees are earned whenever the Company’s debit and credit cards are
processed through card payment networks such as Visa. Merchant services income mainly represents fees charged to merchants to process
their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for interchange
89
fee income and merchant services income are largely satisfied, and related revenue recognized, when the services are rendered or upon
completion. Payment is typically received immediately or in the following month. In compliance with Topic 606, credit and debit card fee
income is presented net of associated expense.
Trust Income
Trust income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The
Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-
end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end
through a direct charge to customers’ accounts. The Company does not earn performance-based incentives. Estate management fees are
based upon the size of the estate. A partial fee is recognized half-way through the estate administration and the remainder of the fee is
recognized when remaining assets are distributed and the estate is closed.
Insurance and Investment
Insurance income primarily consists of commissions received on insurance product sales. The Company acts as an intermediary
between the Company’s customer and the insurance carrier. The Company’s performance obligation is generally satisfied upon the issuance
of the insurance policy. Shortly after the insurance policy is issued, the carrier remits the commission payment to the Company, and the
Company recognizes the revenue.
Investment income consists of recurring revenue streams such as commissions from sales of mutual funds and other investments.
Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied
its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on
a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined.
The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the years ended
December 31, 2018 and 2017.
Noninterest Income
In-scope of Topic 606:
Service charges on deposit accounts
Other service charges and fees
Credit and debit card fees
Trust income
Insurance and Investment (included within Other Income on the
Consolidated Statements of Income)
Noninterest Income (in-scope of Topic 606)
Noninterest Income (out-of-scope of Topic 606)
Total noninterest income
2018
December 31,
2017
2016
$
$
$
2,678
132
1,431
1,565
460
6,266
1,463
7,729
$
$
$
2,776
205
1,205
1,530
398
6,114
1,522
7,636
$
$
$
2,458
212
981
1,346
415
5,412
1,703
7,115
90
Exhibit 21
Subsidiaries of the Registrant
Registrant: National Bankshares Inc.
Incorporated under the laws of the Commonwealth of Virginia
Subsidiaries of National Bankshares Inc.:
The National Bank of Blacksburg
Chartered under the laws of the United States
National Bankshares Financial Services, Inc.
Incorporated under the laws of the Commonwealth of Virginia
NB Operating, Inc.
Incorporated under the laws of the Commonwealth of Virginia
91
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
National Bankshares, Inc.
Blacksburg, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of National Bankshares, Inc. and subsidiaries (the Company) as of
December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity
and cash flows for each of the three years in the period ended December 31, 2018, and the related notes to the consolidated financial
statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the
financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of
America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB),
the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report
dated March 13, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the
Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to
be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of
the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits
to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that
our audits provide a reasonable basis for our opinion.
/s/ YOUNT, HYDE & BARBOUR, P.C.
We have served as the Company’s auditor since 2000.
Winchester, Virginia
March 13, 2019
92
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
National Bankshares, Inc.
Blacksburg, Virginia
Opinion on the Internal Control over Financial Reporting
We have audited National Bankshares, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December
31, 2018, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB),
the consolidated balance sheets as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive
income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the
related notes to the consolidated financial statements of the Company, and our report dated March 13, 2019 expressed an unqualified
opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting in the accompanying Management’s Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on
our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company
in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and
the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also
included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ YOUNT, HYDE & BARBOUR, P.C.
Winchester, Virginia
March 13, 2019
93
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement No. 333-79979 on Form S-8 of National Bankshares, Inc.
of our reports dated March 13, 2019 relating to the consolidated financial statements and the effectiveness of internal control over
financial reporting, appearing in the Annual Report on Form 10-K of National Bankshares, Inc. and subsidiaries for the year ended
December 31, 2018.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
March 13, 2019
94
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company's management evaluated, with the participation of the Company's principal executive officer and principal financial
officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on that evaluation,
the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and
procedures are effective as of December 31, 2018 to ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the
Company's management, including the Company's principal executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosure.
There were no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange
Act) during the year ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
Because of the inherent limitations in all control systems, the Company believes that no system of controls, no matter how well
designed and operated, can provide absolute assurance that all control issues have been detected.
Internal Control Over Financial Reporting
Management's Report on Internal Control Over Financial Reporting
To the Stockholders of National Bankshares, Inc.:
Management is responsible for the preparation and fair presentation of the financial statements included in this annual report. The
financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America
and reflect management's judgments and estimates concerning effects of events and transactions that are accounted for or disclosed.
Management is also responsible for establishing and maintaining adequate internal control over financial reporting. The Company's
internal control over financial reporting includes those policies and procedures that pertain to the Company's ability to record, process,
summarize and report reliable financial data. Management recognizes that there are inherent limitations in the effectiveness of any
internal control over financial reporting, including the possibility of human error and the circumvention or overriding of internal control.
Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary
over time.
In order to ensure that the Company's internal control over financial reporting is effective, management regularly assesses such
controls and did so most recently for its financial reporting as of December 31, 2018. This assessment was based on criteria for effective
internal control over financial reporting described in Internal Control Integrated Framework issued by the Committee of Sponsoring
Organizations (COSO, 2013) of the Treadway Commission. Based on this assessment, management believes the Company maintained
effective internal control over financial reporting as of December 31, 2018.
The Board of Directors, acting through its Audit Committee, is responsible for the oversight of the Company's accounting policies,
financial reporting and internal control. The Audit Committee of the Board of Directors is comprised entirely of outside directors who
are independent of management. The Audit Committee is responsible for the appointment and compensation of the independent
registered public accounting firm and approves decisions regarding the appointment or removal of the Company Auditor. It meets
periodically with management, the independent registered public accounting firm and the internal auditors to ensure that they are
carrying out their responsibilities. The Audit Committee is also responsible for performing an oversight role by reviewing and
monitoring the financial, accounting and auditing procedures of the Company in addition to reviewing the Company's financial reports.
The independent registered public accounting firm and the internal auditors have full and unlimited access to the Audit Committee, with
or without management, to discuss the adequacy of internal control over financial reporting, and any other matter which they believe
should be brought to the attention of the Audit Committee. The Company's independent registered public accounting firm has also issued
an attestation report on the effectiveness of internal control over financial reporting.
95
Item 9B. Other Information
None.
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Executive Officers of the Company
The following is a list of names and ages of all executive officers of Bankshares; their terms of office as officers; the positions and offices
within Bankshares held by each officer; and each person’s principal occupation or employment during the past five years.
Name
F. Brad Denardo
Age
66
David K. Skeens
52
Lara E. Ramsey
50
Paul M. Mylum
Mark A. Smith
Rebecca M. Melton
52
52
48
Offices and Positions Held
National Bankshares, Inc.: President and Chief Executive Officer, September
1, 2017 to present; Executive Vice President, 2008 to August 31, 2017.
The National Bank of Blacksburg: Chairman, September 2017 to Present;
President & CEO, July 2014 to Present; Executive Vice President/Chief
Operating Officer, 2002 to July 2014.
National Bankshares Financial Services, Inc.: Chairman, President and CEO
of National Bankshares Financial Services, Inc., September 1, 2017 to
Present; Treasurer, June 2011 to Present.
National Bankshares, Inc.: Treasurer and Chief Financial Officer, January
2009 to Present.
The National Bank of Blacksburg: Senior Vice President/Operations & Risk
Management & CFO, 2009 to Present; Senior Vice President/Operations &
Risk Management, 2008-2009; Vice President/Operations & Risk
Management, 2004-2008.
National Bankshares, Inc.: Corporate Secretary, June 1, 2016 to Present.
National Bankshares, Inc.: Senior Vice President/Administration, June 2011
to Present.
National Bankshares, Inc.: Vice President/Human Resources, January 2001 –
June 2011.
The National Bank of Blacksburg: Senior Vice President/Chief Lending
Officer, August 2016 to Present.
The National Bank of Blacksburg: Senior Vice President/Loans, August
2012—August 2016.
The National Bank of Blacksburg: Senior Vice President/Chief Credit Officer,
April 2016 to October 2018.
The National Bank of Blacksburg: Senior Vice President/Chief Credit Officer,
November 2018 to Present.
Year Elected an
Officer/Director
1989
2009
2016
2012
2016
2018
Information with respect to the directors of Bankshares is set out under the caption “Election of Directors” of Bankshares’ Proxy
Statement for the 2019 Annual Meeting of Stockholders to be held on May 14, 2019 (“Proxy Statement”) which information is incorporated
herein by reference.
The Board of Directors of Bankshares has a standing audit committee made up entirely of independent directors, as that term is defined
in the NASDAQ Stock Market Listing Rules. In 2018, Dr. Lewis chaired the Audit Committee and its members were Mr. Ball, Dr. Dooley,
Mr. Reynolds and Mr. Webb. Each member of the Audit Committee has extensive business experience; however, the Committee has
identified Dr. Lewis as its financial expert, since he has a professional background which involves financial oversight responsibilities.
Dr. Lewis oversaw the preparation of financial statements in his past role as President of New River Community College. He previously
served as the College’s Chief Financial Officer. The Audit Committee’s Charter is available on the Company’s web site at
www.nationalbankshares.com.
The Board of Directors of Bankshares has a Board Risk Committee tasked with setting a risk tolerance and overseeing risks and risk
management throughout the Company. In response to the cybersecurity incidents experienced in 2016 and 2017, the Board of Directors
96
and Board Risk Committee increased their oversight of cybersecurity risk, including receiving monthly updates in greater detail and
providing direction for incident response and ongoing capital investment to mitigate risk.
Certain information required by Item 10 is incorporated herein by reference to the Company’s Proxy under the headings “Election of
Directors”, “Stock Ownership of Directors and Executive Officers”, “Section 16(a) Beneficial Ownership Reporting Compliance”,
“Corporate Governance Matters” and “Code of Ethics”. The Company and each of its subsidiaries have adopted codes of ethics for
directors, officers and employees, specifically including the Chief Executive Officer and Chief Financial Officer of Bankshares. These
Codes of Ethics are available on the Company’s web site at www.nationalbankshares.com.
Item 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference to the information that appears under the headings
“Compensation Discussion and Analysis,” “Compensation Committee Interlocks and Insider Participation,” “Compensation Committee
Report” and “Pay Ratio” in the Company’s Proxy Statement for the Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is incorporated herein by reference to the information that appears under the heading “Stock
Ownership of Directors and Executive Officers” in the Company’s Proxy Statement for the Annual Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is incorporated herein by reference to the information that appears under the headings “Directors
Independence and Certain Transactions with Officers and Directors” and “Election of Directors – Director Independence” in the Company’s
Proxy Statement for the Annual Meeting of Shareholders. As of December 31, 2018 there were no shares available for issuance or exercise,
and there are no equity compensation plans in effect.
Item 14. Principal Accounting Fees and Services
The information required by Item 14 is incorporated herein by reference to the information that appears under the heading
“Independent Public Accountants” in the Company’s Proxy Statement for the Annual Meeting of Shareholders.
97
Part IV
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements
The following consolidated financial statements of National Bankshares, Inc. are included in Item 8:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets – As of December 31, 2018 and 2017
Consolidated Statements of Income – Years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income – Years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Changes in Stockholders’ Equity – Years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows – Years ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules
Certain schedules to the consolidated financial statements have been omitted if they were not required by Article 9 of Regulation S-X or
if, under the related instructions, they were inapplicable, or if the information is contained elsewhere in this Annual Report on Form
10-K.
(a) (3) Exhibits
A list of the exhibits filed or incorporated in this Annual Report by reference is as follows:
Exhibit No.
3(i)
Description
Amended and Restated Articles of Incorporation of National Bankshares,
Inc.
3(ii)
Amended By-laws of National Bankshares, Inc.
Page No. in
Sequential System
(incorporated herein by reference to Exhibit
3.1 of the Form 8K for filed on March 16,
2006)
(incorporated herein by reference to Exhibit
3(ii) of the Form 8K filed on July 9, 2014)
4
*10(i)
*10(ii)
*10(iii)
*10(iv)
*10(v)
*10(vi)
*10(vii)
*10(viii)
*10(ix)
National Bankshares, Inc. 1999 Stock Option Plan
Executive Employment Agreement dated March 11, 2015, between
National Bankshares, Inc. and James G. Rakes
Employee Lease Agreement dated August 14, 2002, between National
Bankshares, Inc. and The National Bank of Blacksburg
Specimen copy of certificate for National Bankshares, Inc. common stock (incorporated herein by reference to Exhibit
4(a) of the Annual Report on Form 10K for
fiscal year ended December 31, 1993)
(incorporated herein by reference to Exhibit
4.3 of the Form S-8, filed as Registration No.
333-79979 with the Commission on June 4,
1999)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 11, 2015)
(incorporated herein by reference to Exhibit
10 of Form 10Q for the period ended
September 30, 2002)
(incorporated herein by reference to Exhibit
10.2 of the Form 8K filed on March 11, 2015)
(incorporated herein by reference to Exhibit
99 of the Form 8K filed on February 8, 2006)
(incorporated herein by reference to Exhibit
99 of the Form 8K filed on February 8, 2006)
(incorporated herein by reference to Exhibit
10.2 of the Form 8K filed on January 25,
2012)
(incorporated herein by reference to Exhibit
10 of the Form 8K filed on December 19,
2007)
(incorporated herein by reference to Exhibit
10 of the Form 8K filed on December 19,
2007)
Executive Employment Agreement dated March 11, 2015, between
National Bankshares, Inc. and F. Brad Denardo
Salary Continuation Agreement dated February 8, 2006, between The
National Bank of Blacksburg and James G. Rakes
Salary Continuation Agreement dated February 8, 2006, between The
National Bank of Blacksburg and F. Brad Denardo
Salary Continuation Agreement dated February 8, 2006, between
The National Bank of Blacksburg and David K. Skeens
First Amendment, dated December 19, 2007, to The National Bank of
Blacksburg Salary Continuation Agreement for James G. Rakes
First Amendment, dated December 19, 2007, to The National Bank of
Blacksburg Salary Continuation Agreement for F. Brad Denardo
98
*10(x)
First Amendment, dated December 19, 2007, to The National Bank of
Blacksburg Salary Continuation Agreement for David K. Skeens
*10(xi)
*10(xii)
Second Amendment, dated June 12, 2008, to The National Bank of
Blacksburg Salary Continuation Agreement for F. Brad Denardo
Second Amendment, dated December 17, 2008, to The National Bank of
Blacksburg Salary Continuation Agreement for James G. Rakes
*10(xiii)
Second Amendment, dated June 12, 2008, to The National Bank of
Blacksburg Salary Continuation Agreement for David K. Skeens
*10(xiv)
Third Amendment, dated December 17, 2008, to The National Bank of
Blacksburg Salary Continuation Agreement for F. Brad Denardo
*10(xv)
Third Amendment, dated January 20 2012, to The National Bank of
Blacksburg Salary Continuation Agreement for David K. Skeens
*10(xvi)
*10(xvii)
*10(xviii)
*10(xix)
*10(xx)
*10(xxi)
+21
+23
+31(i)
+31(ii)
+32(i)
+32(ii)
+101
Salary Continuation Agreement dated May 24, 2013 between
The National Bank of Blacksburg and Paul A. Mylum
Second Salary Continuation Agreement dated July 1, 2016 between
The National Bank of Blacksburg and F. Brad Denardo
Salary Continuation Agreement dated February 6, 2006 between
The National Bankshares, Inc. and Lara E. Ramsey
First Amendment, dated December 19, 2007, to National Bankshares, Inc.
Salary Continuation Agreement for Lara E. Ramsey
Second Amendment, dated June 12, 2008, to National Bankshares, Inc.
Salary Continuation Agreement for Lara E. Ramsey
Third Amendment, dated June 22, 2016, to National Bankshares, Inc.
Salary Continuation Agreement for Lara E. Ramsey
Subsidiaries of the Registrant
Consent of Yount, Hyde & Barbour, P.C. to incorporation by reference of
independent auditor’s report included in this Form 10-K, into registrant’s
registration statement on Form S-8
Section 906 Certification of Chief Executive Officer
Section 906 Certification of Chief Financial Officer
18 U.S.C. Section 1350 Certification of Chief Executive Officer
18 U.S.C. Section 1350 Certification of Chief Financial Officer
The following materials from National Bankshares, Inc.’s Annual Report
on Form 10-K for the year ended December 31, 2018, formatted in
XBRL (Extensible Business Reporting Language), furnished herewith:
(i) Consolidated Balance Sheets, (ii) Consolidated Statements of
Operations, (iii) Consolidated Statements of Changes in Shareholders’
Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to
Consolidated Financial Statements.
(incorporated herein by reference to Exhibit
10.2 of the Form 8K filed on January 25,
2012)
(incorporated herein by reference to Exhibit
10 of the Form 8K filed on June 12, 2008)
(incorporated herein by reference to Exhibit
10(iii) of the Annual Report on Form 10K for
fiscal year ended December 31, 2008)
(incorporated herein by reference to Exhibit
10.2 of the Form 8K filed on January 25,
2012)
(incorporated herein by reference to Exhibit
10(iii) of the Annual Report on Form 10K for
fiscal year ended December 31, 2008)
(incorporated herein by reference to Exhibit
10.2 of the Form 8K filed on January 25,
2012)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 8, 2018)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on July 20, 2016)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 6, 2017)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 6, 2017)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 6, 2017)
(incorporated herein by reference to Exhibit
10.1 of the Form 8K filed on March 6, 2017)
Included herein
Included herein
Page 102
Page 103
Page 104
Page 104
Included herein
*Indicates a management contract or compensatory plan required to be filed herein.
+Filed with this Annual Report on Form 10-K.
Item 16. Summary Information
Not applicable.
99
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, National Bankshares, Inc. has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NATIONAL BANKSHARES, INC.
/s/ F. BRAD DENARDO
F. Brad Denardo
President and Chief Executive Officer
(Principal Executive Officer)
/s/ DAVID K. SKEENS
David K. Skeens
Treasurer and Chief Financial Officer
(Principal Financial Officer)
(Principal Accounting Officer)
Date: March 13, 2019
Date
03/13/2019
Title
Director
03/13/2019
03/13/2019
President and CEO, National Bankshares, Inc.
Director
Director
03/13/2019
Director
03/13/2019
Director
03/13/2019
Director
03/13/2019
Director
03/13/2019
Director
03/13/2019
Director
100
(continued)
/s/ L. J. BALL
L. J. Ball
/s/ F. B. DENARDO
F. B. Denardo
/s/ J. E. DOOLEY
J. E. Dooley
/s/ M.E. DYE
M. E. Dye
/s/ N. V. FITZWATER, III
N. V. Fitzwater, III
/s/ C. E. GREEN, III
C. E. Green, III
/s/ M. R. JOHNSON
M. R. Johnson
/s/ J. M. LEWIS
J. M. Lewis
/s/ M. G. MILLER
M. G. Miller
/s/ W. A. PEERY
W. A. Peery
/s/ J. G. RAKES
J. G. Rakes
/s/ G. P. REYNOLDS
G. P. Reynolds
/s/ J. C. THOMPSON
J. C. Thompson
/s/ J. L. WEBB, JR.
J. L. Webb, Jr.
03/13/2019
Director
03/13/2019
Chairman of the Board, National Bankshares, Inc.
Director
03/13/2019
Director
03/13/2019
Director
03/13/2019
Director
101
Exhibit No. 31(i)
CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES OXLEY ACT OF 2002
I, F. Brad Denardo, President and Chief Executive Officer of National Bankshares, Inc., certify that:
1.
I have reviewed this annual report on Form 10-K of National Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the
period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a – 15 (e) and 15d – 15 (e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in which this report is being prepared; and
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles; and
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluations; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial reporting.
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: March 13, 2019
/s/ F. BRAD DENARDO
F. Brad Denardo
President and Chief Executive Officer
(Principal Executive Officer)
102
Exhibit 31(ii)
I, David K. Skeens, Treasurer and Chief Financial Officer of National Bankshares, Inc., certify that:
1.
I have reviewed this annual report on Form 10-K of National Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the
period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a – 15 (e) and 15d – 15 (e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in which this report is being prepared; and
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purpose in accordance with generally accepted accounting principles; and
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluations; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial reporting.
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: March 13, 2019
/s/ DAVID K. SKEENS
David K. Skeens
Treasurer and
Chief Financial Officer
(Principal Financial Officer)
103
Exhibit 32(i)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO U.S.C. SECTION 1350
In connection with the Form 10-K of National Bankshares, Inc. for the year ended December 31, 2018, I, F. Brad Denardo,
Chairman, President and Chief Executive Officer of National Bankshares, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and belief that:
(1) such Form 10-K for the year ended December 31, 2018, fully complies with the requirements of section 13(a) or 15(d) of the
Securities Act of 1934; and
(2) the information contained in such Form 10-K for the year ended December 31, 2018, fairly presents in all material respects,
the financial condition and results of operations of National Bankshares, Inc.
Dated: March 13, 2019
Exhibit 32(ii)
/s/ F. BRAD DENARDO
F. Brad Denardo
President and Chief Executive Officer
(Principal Executive Officer)
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO U.S.C. SECTION 1350
In connection with the Form 10-K of National Bankshares, Inc. for the year ended December 31, 2018, I, David K. Skeens, Treasurer
and Chief Financial Officer of National Bankshares, Inc., hereby certify pursuant to 18 U. S. C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and belief that:
(1) such Form 10-K for the year ended December 31, 2018, fully complies with the requirements of section 13(a) or 15(d) of the
Securities Act of 1934; and
(2) the information contained in such Form 10-K for the year ended December 31, 2018, fairly presents in all material respects,
the financial condition and results of operations of National Bankshares, Inc.
Dated: March 13, 2019
/s/ DAVID K. SKEENS
David K. Skeens
Treasurer and
Chief Financial Officer
(Principal Financial Officer)
104
Index of Exhibits
The following exhibits are filed with this Annual Report on Form 10-K.
Exhibit No.
21
23
31(i)
31(ii)
32(i)
32(ii)
Title
Subsidiaries of the Registrant
Consent of Yount, Hyde & Barbour, P.C.
Section 906 Certification of Chief Executive Officer
Section 906 Certification of Chief Financial Officer
18 U.S.C. Section 1350 Certification of Chief Executive Officer
18 U.S.C. Section 1350 Certification of Chief Financial Officer
Page Number
Page 91
Page 94
Page 102
Page 103
Page 104
Page 104
105
National Bankshares
National Bankshares, Inc.
101 Hubbard Street
Blacksburg, Virginia 24060
www.nationalbankshares.com