Executive Summary / Key Takeaways

• National Bankshares ($NKSH) is a community-focused bank leveraging a recent acquisition to expand its market reach and enhance growth potential in Virginia.
• First quarter 2025 results demonstrated significant improvement in net income, primarily driven by net interest margin expansion and increased noninterest income.
• The company maintains solid asset quality metrics and strong capital and liquidity positions, providing a stable foundation amidst macroeconomic uncertainty.
• Strategic initiatives, including a planned system upgrade, aim to enhance operational efficiency and product offerings, supporting future performance.
• While facing competition from larger regional banks and fintech, NKSH's local market focus and cost efficiency provide key competitive advantages.

Setting the Scene: Community Roots and Strategic Expansion

National Bankshares, Inc. ($NKSH) operates as a Virginia-based financial holding company, with its core business rooted in community banking through its wholly-owned subsidiary, The National Bank of Blacksburg (NBB). Founded in 1891, NBB, doing business as National Bank, is the primary engine of the company's revenue, serving individuals, businesses, non-profits, and local governments from 28 office locations and one loan production office. A smaller subsidiary, National Bankshares Financial Services, Inc. (NBFS), provides investment and insurance services, though its contribution to overall income is not currently significant.

The strategic trajectory of NKSH took a notable step on June 1, 2024, with the acquisition of Frontier Community Bank (FCB). This merger expanded NKSH's geographic footprint into the Waynesboro, Staunton, and Lynchburg markets in Virginia, a move designed to increase the company's growth potential. The acquisition added approximately $118.7 million in loans, $129.7 million in deposits, and $14.3 million in equity to the balance sheet, while also introducing goodwill and a core deposit intangible asset subject to amortization.

In the competitive landscape, NKSH operates alongside larger regional players such as Atlantic Union Bankshares (AUB), Truist Financial (TFC), and PNC Financial Services (PNC), as well as other community banks like WSFS Financial Corporation (WSFS). While precise, directly comparable market share figures for all niche competitors are not publicly detailed, NKSH's estimated 1-2% aggregate market share in Virginia reflects its localized focus. Larger competitors benefit from greater scale, extensive branch networks, and often more advanced digital platforms, offering faster transaction processing speeds. However, NKSH differentiates itself through a deep-rooted community focus, fostering strong local relationships and providing personalized service, which contributes to higher customer retention in its core markets. The company also demonstrates a degree of operational cost efficiency compared to some larger rivals.

Technologically, NKSH's operations rely on standard banking systems for data processing and ATM services. Recognizing the need to enhance its capabilities, the company is undertaking a system upgrade planned for the second quarter of 2025. This initiative is aimed at providing greater efficiency in operations and expanding product offerings for customers. Conversion expenses related to this upgrade were incurred in the first quarter of 2025 as preparations were made. While specific quantifiable performance metrics or comparative advantages of this technology upgrade are not detailed, the strategic intent is clearly to improve service delivery and operational effectiveness in a competitive environment increasingly influenced by digital capabilities. The broader industry environment, marked by high inflation and shifts in U.S. monetary policy, continues to influence deposit pricing, asset valuations, and loan demand, presenting both challenges and opportunities for NKSH.

Financial Performance: Margin Expansion and Growth Drivers

The first quarter of 2025 showcased a significant improvement in National Bankshares' financial performance compared to the same period in 2024. Net income rose to $3.24 million for the three months ended March 31, 2025, up from $2.17 million in the prior year period. This increase was primarily attributable to expansion in the net interest margin and growth in noninterest income, coupled with the absence of merger-related expenses that impacted the 2024 results.

Net interest income, a key profitability metric for banks, increased to $10.26 million in Q1 2025 from $8.25 million in Q1 2024. The fully taxable equivalent (FTE) net interest margin improved to 2.41% from 2.08%. This margin expansion was driven by an increase in the yield on earning assets, which rose to 4.23% from 3.99%, and a decrease in the cost of interest-bearing liabilities, which fell to 2.38% from 2.54%. The easing of competitive pressure on deposit pricing, influenced by the Federal Reserve's interest rate adjustments in late 2024, contributed positively to the lower funding costs. Management anticipates continued improvement in interest income as existing loans reach their repricing dates in the current interest rate environment.

Noninterest income saw a healthy increase of 16.19%, totaling $2.56 million in Q1 2025 compared to $2.20 million in Q1 2024. This growth was broad-based. Service charges on deposit accounts increased by $61 thousand to $736 thousand, reflecting higher deposit levels. Credit and debit card fees, net, rose by $43 thousand to $417 thousand due to increased transaction volume. Trust income grew by $76 thousand to $579 thousand, benefiting from higher assets under management. BOLI income increased by $34 thousand to $292 thousand, incorporating income from policies acquired in the FCB merger. Other income also saw a notable increase of $124 thousand to $443 thousand, driven by insurance income and a vendor incentive payment.

Total noninterest expense increased by 11.22% to $8.63 million in Q1 2025 from $7.76 million in Q1 2024. This rise largely reflects the integration of FCB operations. Salaries and employee benefits increased by $722 thousand to $5.19 million due to the addition of FCB employees. Occupancy, furniture, and fixtures expense rose by $117 thousand to $656 thousand, reflecting additional acquired assets and higher maintenance costs. Data processing and ATM expenses, along with FDIC assessments, increased due to the expenses associated with the acquired branches and a larger assessment base. Professional services also saw an increase, related to higher fees for the expanded asset base and system considerations tied to the FCB acquisition. Notably, the Q1 2024 period included $484 thousand in merger-related expenses, while Q1 2025 included $97 thousand in intangible asset amortization and $46 thousand in conversion expenses related to the upcoming system upgrade. The effective income tax rate decreased to 17.07% in Q1 2025 from 19.24% in Q1 2024, partly due to the non-tax deductible nature of the 2024 merger expenses.

Asset Quality, Balance Sheet Dynamics, and Liquidity

National Bankshares maintains a solid asset quality profile, which is critical for a community bank's stability. As of March 31, 2025, nonaccrual loans totaled $2.17 million, a slight decrease from $2.22 million at December 31, 2024. Loans past due 90 days or more and still accruing also decreased to $166 thousand from $548 thousand over the same period. The ratio of nonperforming loans to loans, net of deferred fees and costs, improved to 0.22% at March 31, 2025, from 0.22% at December 31, 2024. The net charge-off ratio remained low at 0.02% for the three months ended March 31, 2025, compared to 0.03% for the year ended December 31, 2024.

The allowance for credit losses on loans (ACLL) stood at $10.49 million, or 1.05% of loans net of deferred fees and costs, as of March 31, 2025, slightly up from $10.26 million, or 1.04%, at December 31, 2024. The determination of the ACLL involves management's judgment based on historical loss data, peer data, and adjustments for a reasonable and supportable forecast and qualitative factors. The forecast applied as of March 31, 2025, projects stable unemployment over the next 12 months at a lower level than the prior forecast, which had a beneficial impact on the calculated ACLL. However, increases in business bankruptcy filings and housing inventory, along with an increase in total high-risk loans, led to higher allocations under qualitative factors. A decrease in accruing loans past due 30-89 days (from 0.30% to 0.19%) had a positive impact. The company maintains an unallocated surplus of $35 thousand, or 0.33% in excess of the calculated requirement, to mitigate current economic uncertainty.

The total loan portfolio, net of deferred fees and costs, grew to $1.00 billion at March 31, 2025, from $988.0 million at December 31, 2024. This increase is attributed to organic growth, with the company stating it is positioned to make every loan that meets its underwriting standards. The portfolio is diversified across real estate construction, consumer real estate, commercial real estate, commercial non-real estate, public sector/IDA, and consumer non-real estate loans.

Total deposits increased to $1.66 billion at March 31, 2025, from $1.64 billion at December 31, 2024. This growth was seen across noninterest-bearing demand deposits ($301.15 million), interest-bearing demand deposits ($879.22 million), and savings deposits ($178.74 million), partially offset by a decrease in time deposits ($298.66 million). The company's depositor base is diverse, including individuals, businesses, and municipalities, with approximately 24% being municipal deposits secured by pledged bonds and approximately 23% of non-municipal deposits being uninsured. The company does not utilize brokered deposits.

The securities portfolio, held as available for sale and reported at fair value, totaled $596.25 million at March 31, 2025, compared to $601.90 million at December 31, 2024. The portfolio continues to hold a net unrealized loss position of $68.99 million, down from $78.60 million at the end of 2024. This unrealized loss is primarily due to noncredit-related factors, specifically changes in interest rates. The company's analysis found no identifiable credit risk within the portfolio, and management does not intend to sell these securities, believing it is more likely than not that they will not have to sell before a recovery of cost as securities approach maturity or market yields decline.

Liquidity remains sufficient, supported by diverse sources including deposits, loan repayments, securities, and borrowing capacity. As of March 31, 2025, NKSH had significant unused borrowing capacity, including $295.79 million from the FHLB and $176.16 million at the Federal Reserve Bank discount window, with no outstanding purchased deposits or borrowings. The company's well-capitalized status ensures unrestricted access to these funding sources. Liquidity is managed through stress testing, maintaining a loan-to-deposit ratio within an internal target range (60.52% at March 31, 2025), and laddering the securities portfolio based on projected funding needs.

Capital Strength and Outlook

National Bankshares maintains a strong capital position, which is a key indicator of financial health and regulatory compliance. Total stockholders equity increased to $167.28 million at March 31, 2025, from $156.41 million at December 31, 2024. This increase was primarily driven by a decrease in the accumulated other comprehensive loss related to unrealized losses on securities available for sale, coupled with net income generated during the quarter.

While National Bankshares, Inc. qualifies as a small bank holding company and is exempt from consolidated regulatory capital ratios, its subsidiary bank, NBB, is subject to Basel III Capital Rules administered by the OCC. As of March 31, 2025, NBB's regulatory capital ratios significantly exceeded minimum requirements, including the capital conservation buffer, indicating a well-capitalized status. The Common Equity Tier I Capital Ratio was 15.62%, Tier I Capital Ratio was 15.62%, Total Capital Ratio was 16.50%, and Leverage Ratio was 10.29%. This robust capital base provides a buffer against potential losses and supports future growth initiatives.

Looking ahead, the results from the first quarter of 2025 suggest positive momentum, particularly in net interest margin expansion. The integration of the FCB acquisition is expected to contribute to growth potential by expanding the company's market presence. The planned system upgrade in the second quarter of 2025 is anticipated to enhance operational efficiency and product offerings, which could further support performance. However, the company remains exposed to macroeconomic risks, including potential impacts of inflation and monetary policy on customer behavior and credit quality. Competitive pressures in both deposit and loan markets persist. Management's focus on maintaining strong asset quality, managing liquidity prudently, and leveraging the expanded footprint are key factors for navigating the current environment and realizing future growth.

Risks and Challenges

Investing in National Bankshares, like any financial institution, involves inherent risks. The company explicitly highlights the risks associated with high inflation and U.S. monetary policy, noting their potential impact on customer demand, loan repayment ability, credit risk, and asset valuations. The rapid and significant increase in interest rates between 2022 and 2023 created intense competition for deposits and negatively affected the fair value of the securities portfolio, risks that, while somewhat eased by recent rate adjustments, could re-emerge.

Credit risk remains a significant factor, influenced by general and local economic conditions, unemployment levels, and the quality of the loan portfolio. Although asset quality metrics are currently solid and the ACLL is deemed reasonable by management, adverse economic shifts could necessitate increased provisions for credit losses. The integration of the FCB acquisition, while strategic, carries operational risks, including the successful integration of systems and personnel, which is partially addressed by the ongoing system upgrade but also introduces conversion-related risks. Competition from larger, more technologically advanced institutions and agile fintech companies poses a continuous challenge to market share and profitability. Cybersecurity threats are also a persistent risk, requiring ongoing investment and vigilance.

Conclusion

National Bankshares ($NKSH) presents an investment narrative centered on a resilient community banking model strategically enhanced by recent expansion. The acquisition of Frontier Community Bank has broadened its market reach, positioning the company for increased growth potential. The strong performance in the first quarter of 2025, marked by notable net interest margin expansion and growth in noninterest income, underscores the company's ability to generate earnings in a dynamic rate environment.

With solid asset quality, robust capital levels, and ample liquidity, NKSH appears well-positioned to manage potential macroeconomic headwinds and competitive pressures. Strategic investments in operational technology aim to drive future efficiency and service enhancements. While challenges from larger competitors and the broader economic climate persist, NKSH's deep local ties, disciplined underwriting, and focus on operational efficiency provide a foundation for stability and potential value creation for investors. The successful integration of acquired operations and the realization of benefits from the system upgrade will be key factors to monitor in the coming periods.