NATIONAL BANKSHARES INC 10-Q

Item 2. 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 financial condition and results of operations of the Company. Please refer to the financial statements and other information included in this report as well as the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 (“2023 Form 10-K”) for an understanding of the following discussion and analysis. References in the following discussion and analysis to “we” or “us” refer to the Company unless the context indicates that the reference is to the Bank. Cautionary Statement Regarding Forward-Looking Statements We make forward-looking statements in this Form 10-Q that are subject to significant risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for credit losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals, and are based upon 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, effects of or changes in: • interest rates, • the ability to maintain adequate liquidity by retaining deposit customers and secondary funding sources, especially if the Company’s or banking industry’s reputation becomes damaged, • the adequacy of the level of the Company’s allowance for credit losses, the amount of credit loss provisions required in future periods, and the failure of assumptions underlying the allowance for credit losses, • general and local economic conditions, • monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury, the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve, the Consumer Financial Protection Bureau and the Federal Deposit Insurance Corporation (“FDIC”), and the impact of any policies or programs implemented pursuant to financial reform legislation, • unanticipated increases in the level of unemployment in the Company’s market, • 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 market, • the real estate market in the Company’s market, • laws, regulations and policies impacting financial institutions, • technological risks and developments, and cyber-threats, attacks or events, • the Company’s technology initiatives, • geopolitical conditions, including acts or threats of terrorism and/or military conflicts, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, • the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues, and other catastrophic events, • the Company's ability to identify, attract, and retain experienced management, relationship managers, and support personnel, particularly in a competitive labor environment, • performance by the Company’s counterparties or vendors, • applicable accounting principles, policies and guidelines, and • risks associated with mergers, acquisitions, and other expansion activities. On June 1, 2024, the Company and the Bank acquired Frontier Community Bank (“FCB”). In addition to the factors described above, the Company’s operations, performance, business strategy and results may be affected by the following factors: • the businesses of the Company and Frontier may not be integrated successfully after the merger or such integration may be more difficult, time-consuming or more costly than expected; • the cost savings and synergies contemplated by the merger may not be fully realized or realized within the expected timeframe; • revenues following the merger may be lower than expected; • customer and employee relationships and business operations may be disrupted by the merger. 32 Table of Contents 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 the 2023 Form 10-K. Overview 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. NBI common stock is listed on the Nasdaq Capital Market and is traded under the symbol “NKSH.” NBI has two wholly-owned subsidiaries; the National Bank of Blacksburg ("NBB") and National Bankshares Financial Services, Inc. ("NBFS"). NBB is a community bank and does business as National Bank from 27 office locations and two loan production offices. NBB is the source of nearly all of the Company’s revenue. 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. The Company expects construction of a new branch in Roanoke, Virginia to be completed during the fourth quarter of 2024. The full service branch will expand our already successful loan production office and enhance our business opportunities in the Roanoke Valley. Critical Accounting Policies The Company’s consolidated financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, 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. Critical accounting policies are most important to the portrayal of the Company’s financial condition or results of operations and require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. If conditions occur that differ from our assumptions, depending upon the severity of such differences, the Company’s financial condition or results of operations may be materially impacted. The Company has designated the following policies as critical: those governing the allowance for credit losses, goodwill, the pension plan, core deposit intangibles and loans acquired in a business combination. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed. For information on the allowance for credit losses, goodwill and the pension plan, please refer to the Company’s 2023 Form 10-K, Note 1: Summary of Significant Accounting Policies. For information on policies governing core deposit intangibles and loans acquired in a business combination, please refer to Note 1: General and Summary of Significant Accounting Policies of this Form 10-Q report. Acquisition of Frontier Community Bank On June 1, 2024, the Company and the Bank acquired FCB, a Virginia chartered commercial bank headquartered in Waynesboro, Virginia. FCB’s balances and results of operations are included in the Company’s consolidated results beginning on the Acquisition Date. The acquisition was made pursuant to an Agreement and Plan of Merger, dated January 23, 2024, by and among the Company, the Bank and FCB under which FCB merged with and into the Bank (the “FCB Merger Agreement”). Pursuant to the terms of the FCB Merger Agreement, at the effective time of the acquisition, each share of FCB common stock was converted into either $14.48 in cash or 0.4250 shares of the Company’s common stock, with FCB shareholders having the ability to elect the merger consideration to be received, subject to the allocation and proration procedures set forth in the FCB Merger Agreement. The Company issued 464,855 shares of common stock and paid $2,050 to former FCB shareholders in the acquisition. As a result of the transaction, the Bank expanded its operations into the Waynesboro, Staunton and Lynchburg, Virginia markets. Please refer to Note 2: Business Combination in Part I, Item 1 of this report for additional information of the acquisition of FCB. Non-GAAP Financial Measures This report refers to certain financial measures that are computed under a basis other than GAAP (“non-GAAP”). The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. The methodology for determining these non-GAAP measures may differ among companies. Non-GAAP measures are supplemental and not a substitute for, or more important than, financial measures prepared in accordance with GAAP. Details on non-GAAP measures follow. 33 Table of Contents Net Interest Margin The Company uses the net interest margin to measure profit on interest generating activities, as a percentage of total interest-earning assets. The Company’s net interest margin is calculated on a fully taxable equivalent (“FTE”) basis. The portion of interest income that is nontaxable is grossed up to the tax equivalent by adding the tax benefit based on a tax rate of 21%. Annualized FTE net interest income is divided by total average earning assets to calculate the net interest margin. The following tables present the reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, for the periods indicated. Three Months Ended September 30, Net Interest Margin, FTE 2024 2023 Interest income (GAAP) $ 18,666 $ 14,679 Add: FTE adjustment 241 229 Interest income, FTE (non-GAAP) 18,907 14,908 Interest expense (GAAP) 9,218 6,039 Net interest income, FTE (non-GAAP) $ 9,689 $ 8,869 Average balance of interest-earning assets $ 1,754,031 $ 1,581,042 Net interest margin 2.20 % 2.23 % Nine Months Ended September 30, Net Interest Margin, FTE 2024 2023 Interest income (GAAP) $ 51,805 $ 43,320 Add: FTE adjustment 729 648 Interest income, FTE (non-GAAP) 52,534 43,968 Interest expense (GAAP) 25,412 14,517 Net interest income, FTE (non-GAAP) $ 27,122 $ 29,451 Average balance of interest-earning assets $ 1,694,186 $ 1,605,202 Net interest margin 2.14 % 2.45 % Efficiency Ratio The efficiency ratio is computed by dividing noninterest expense by the sum of FTE net interest income and noninterest income, excluding certain items the Company’s management deems unusual or non-recurring. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. The components of the efficiency ratio calculation for the periods indicated are summarized in the following table. Three Months Ended September 30, Efficiency Ratio 2024 2023 Noninterest expense (GAAP) $ 8,499 $ 7,435 Less: merger-related expense (150 ) – Less: proxy-related expense (2) – (2 ) Adjusted noninterest expense (non-GAAP) $ 8,349 $ 7,433 Noninterest income (GAAP) $ 2,272 $ 2,115 Net interest income, FTE (non-GAAP) 9,689 8,869 Total income for efficiency ratio (non-GAAP) $ 11,961 $ 10,984 Efficiency ratio 69.80 % 67.67 % 34 Table of Contents Nine Months Ended September 30, Efficiency Ratio 2024 2023 Noninterest expense (GAAP) $ 26,388 $ 22,665 Less: merger-related expense (2,891 ) – Less: contract termination expense (1) (173 ) – Less: proxy-related expense (2) – (786 ) Adjusted noninterest expense (non-GAAP) $ 23,324 $ 21,879 Noninterest income (GAAP) $ 6,717 $ 7,105 Less: realized securities loss, net – 3,332 Less: gain on sale of investment (3) – (2,971 ) Less: gain on BOLI settlement – (1,037 ) Adjusted noninterest income (non-GAAP) 6,717 6,429 Net interest income, FTE (non-GAAP) 27,122 29,451 Total income for efficiency ratio (non-GAAP) $ 33,839 $ 35,880 Efficiency ratio 68.93 % 60.98 % (1) Contract termination expense was recorded to reflect the Company’s notification to a vendor that it intends to end its relationship in 2025. (2) Included in professional services in the Consolidated Statements of Income. (3) Sale of VISA Class B shares. Adjusted Return on Average Assets and Adjusted Return on Average Equity The adjusted return on average assets and adjusted return on average equity are measures of profitability, calculated by annualizing net income and dividing by average year-to-date assets or equity, respectively. Larger nonrecurring income or expenses are not annualized, in order to reduce distortion within the ratios. The tables below present the reconciliation of adjusted annualized net income, which is not a measurement under GAAP, for the periods indicated. Three Months Ended September 30, Annualized Net Income for Ratio Calculation 2024 2023 Net income per GAAP $ 2,676 $ 3,074 Less: items not annualized: Proxy-related expense, net of tax of $0 for the period ended September 30, 2023 – 2 ACL recovery, net of tax of $84 for the period ended September 30, 2023 – (317 ) Merger-related expense, net of tax of $6 for the period ended September 30, 2024 144 – Total non-annualized items 144 (315 ) Adjusted net income $ 2,820 $ 2,759 Adjusted net income, annualized $ 11,219 $ 10,946 Add: total non-annualized items (144 ) 315 Annualized net income for ratio calculation (non-GAAP) $ 11,075 $ 11,261 Return on average assets (GAAP) 0.59 % 0.77 % Adjusted return on average assets (non-GAAP) 0.61 % 0.71 % Return on average equity (GAAP) 6.82 % 9.63 % Adjusted return on average equity (non-GAAP) 7.09 % 8.89 % 35 Table of Contents Nine Months Ended September 30, 2024 2023 Net income per GAAP $ 4,544 $ 11,506 Less: items not annualized: Partnership income net of tax of ($35) and ($44) for the periods ended September 30, 2024 and 2023, respectively (134 ) (164 ) Realized securities gain, net of tax of $700 for the period ended September 30, 2023 – 2,632 Proxy-related expense, net of tax of $165 for the period ended September 30, 2023 – 621 Gain on sale of investment, net of tax of ($624) for the period ended September 30, 2023 – (2,347 ) Gain on BOLI settlement – (1,037 ) ACL provision (recovery), net of tax of $271 and ($82) for the periods ended September 30, 2024 and 2023, respectively(1) 1,019 (307 ) Merger-related expense, net of tax of $417 for the period ended September 30, 2024 2,474 – Contract termination expense, net of tax of $36 for the period ended September 30, 2024 137 – Total non-annualized items 3,496 (602 ) Adjusted net income $ 8,040 $ 10,904 Adjusted net income, annualized $ 10,740 $ 14,579 Add: total non-annualized items (3,496 ) 602 Annualized net income for ratio calculation (non-GAAP) $ 7,244 $ 15,181 Return on average assets (GAAP) 0.35 % 0.95 % Adjusted return on average assets (non-GAAP) 0.42 % 0.94 % Return on average equity (GAAP) 4.23 % 12.13 % Adjusted return on average equity (non-GAAP) 5.05 % 11.97 % (1) Upon acquisition of FCB, the Company recorded a provision for credit losses of $1,290 to establish an ACL for non-PCD loans. After the acquisition date, credit risk for FCB non-PCD loans is recognized according to the company's normal ACL and provision processes. As of the reporting dates, the Company did not expect to record a provision or recovery of similar magnitude for the remainder of 2024 or 2023. Performance Summary The following table presents the Company’s key performance indicators for the periods indicated. Three Months Ended September 30, 2024 2023 Net Income $ 2,676 $ 3,074 Return on average assets 0.59 % 0.77 % Adjusted return on average assets (1) 0.61 % 0.71 % Return on average equity 6.82 % 9.63 % Adjusted return on average equity (1) 7.09 % 8.89 % Basic net income per common share $ 0.42 $ 0.52 Fully diluted net income per common share (2) $ 0.42 $ 0.52 Net interest margin (1) 2.20 % 2.23 % Efficiency ratio (1) 69.80 % 67.67 % 36 Table of Contents Nine Months Ended September 30, 2024 Nine Months Ended September 30, 2023 Twelve Months Ended December 31, 2023 Net Income $ 4,544 $ 11,506 $ 15,691 Return on average assets 0.35 % 0.95 % 0.97 % Adjusted return on average assets (1) 0.42 % 0.94 % 0.97 % Return on average equity 4.23 % 12.13 % 12.59 % Adjusted return on average equity (1) 5.05 % 11.97 % 12.59 % Basic net income per common share $ 0.75 $ 1.95 $ 2.66 Fully diluted net income per common share (2) $ 0.75 $ 1.95 $ 2.66 Net interest margin (1) 2.14 % 2.45 % 2.38 % Efficiency ratio (1) 68.93 % 60.98 % 61.01 % (1) See “Non-GAAP Financial Measures” above. (2) As of September 30, 2024, the Company had 4,379 unvested shares of restricted stock outstanding with a one year vesting period. Net income for the three and nine months ended September 30, 2024 decreased when compared with the comparable period of 2023, due to net interest margin compression, merger related expenses and contract termination expense. The net interest margin as well as key noninterest income and expense items are discussed below. Net Interest Income The following tables show 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 interest margin for the periods indicated. Three Months Ended September 30, 2024 2023 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest-earning assets: Loans (1)(2)(4)(5)(6) $ 994,744 $ 13,285 5.31 % $ 843,546 $ 9,924 4.67 % Taxable securities (6)(7) 625,908 4,203 2.67 % 640,578 4,084 2.53 % Nontaxable securities (1)(6) 63,197 453 2.85 % 64,415 461 2.84 % Federal funds sold 918 12 5.20 % – – – Interest-bearing deposits 69,264 954 5.48 % 32,503 439 5.36 % Total interest-earning assets $ 1,754,031 $ 18,907 4.29 % $ 1,581,042 $ 14,908 3.74 % Interest-bearing liabilities: Interest-bearing demand deposits $ 852,126 $ 5,488 2.56 % $ 799,772 $ 4,358 2.16 % Savings deposits 176,354 221 0.50 % 192,702 226 0.47 % Time deposits 308,247 3,509 4.53 % 163,476 1,452 3.52 % Borrowings – – – 207 3 5.75 % Total interest-bearing liabilities $ 1,336,727 $ 9,218 2.74 % $ 1,156,157 $ 6,039 2.07 % Net interest income and interest rate spread $ 9,689 1.55 % $ 8,869 1.67 % Net interest margin 2.20 % 2.23 % 37 Table of Contents Nine Months Ended September 30, 2024 2023 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest-earning assets: Loans (1)(3)(4)(5)(6) $ 919,369 $ 35,108 5.10 % $ 850,543 $ 29,068 4.57 % Taxable securities (6)(7) 629,748 12,718 2.70 % 657,575 12,268 2.49 % Nontaxable securities (1)(6) 63,730 1,373 2.88 % 65,649 1,425 2.90 % Federal funds sold 702 23 4.38 % – – – Interest-bearing deposits 80,637 3,312 5.49 % 31,435 1,207 5.13 % Total interest-earning assets $ 1,694,186 $ 52,534 4.14 % $ 1,605,202 $ 43,968 3.66 % Interest-bearing liabilities: Interest-bearing demand deposits $ 839,211 $ 15,747 2.51 % $ 834,575 $ 10,846 1.74 % Savings deposits 175,670 672 0.51 % 200,170 506 0.34 % Time deposits 268,313 8,991 4.48 % 131,398 2,865 2.92 % Borrowings 76 2 3.52 % 8,287 300 4.84 % Total interest-bearing liabilities $ 1,283,270 $ 25,412 2.65 % $ 1,174,430 $ 14,517 1.65 % Net interest income and interest rate spread $ 27,122 1.49 % $ 29,451 2.01 % Net interest margin 2.14 % 2.45 % (1) Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 21%. (2) Included in interest income are loan fees of $44 and $56 for the three months ended September 30, 2024 and 2023, respectively. (3) Included in interest income are loan fees of $147 and $162 for the nine months ended September 30, 2024 and 2023, respectively. (4) Nonaccrual loans are included in average balances for yield computations. (5) Includes loans held for sale. (6) Daily averages are shown at amortized cost. (7) Includes restricted stock. In September, 2024, the Federal Reserve cut its target interest rate by 50 basis points. This cut had an immediate impact on deposits with pricing based on the prime interest rate. Competitive pressure for deposits began in 2023 and continues to contribute to higher cost of funds and compressed net interest margin when results for the three and nine months ended September 30, 2024 are compared with the same periods of 2023. However, the Company expects the interest rate cut to benefit deposit costs during the fourth quarter of 2024. While the interest rate cut is expected to reduce deposit costs, current interest rates are still at a level that will allow interest income and the yield on earning assets to grow as adjustable loans reach repricing dates. Noninterest Income Three Months Ended September 30, 2024 2023 Percent Change Service charges on deposit accounts $ 753 $ 642 17.29 % Other service charges and fees 82 151 (45.70 )% Credit and debit card fees, net 344 395 (12.91 )% Trust income 580 505 14.85 % BOLI income 295 253 16.60 % Gain on sale of mortgage loans 50 22 127.27 % Other income 168 147 14.29 % Total noninterest income $ 2,272 $ 2,115 7.42 % 38 Table of Contents Nine Months Ended September 30, 2024 2023 Percent Change Service charges on deposit accounts $ 2,150 $ 1,871 14.91 % Other service charges and fees 176 253 (30.43 )% Credit and debit card fees, net 1,141 1,276 (10.58 )% Trust income 1,596 1,431 11.53 % BOLI income 822 1,771 (53.59 )% Gain on sale of investment – 2,971 NM Gain on sale of mortgage loans 132 93 41.94 % Other income 700 771 (9.21 )% Realized securities loss, net – (3,332 ) NM Total noninterest income $ 6,717 $ 7,105 (5.46 )% Service charges on deposit accounts increased when the three and nine months ended September 30, 2024 are compared with the comparable periods of 2023, due to changes in fee structure. Other service charges and fees decreased when the three and nine months ended September 30, 2024 are compared with the comparable periods of 2023, due to lower fees associated with letters of credit and one time fee income received in 2023. Credit and debit card fees, net, decreased when the three and nine months ended September 30, 2024 are compared with the comparable periods of 2023, due to higher processing fees. Trust income increased due to higher volume, when the three and nine months ended September 30, 2024 are compared with the comparable periods of 2023. BOLI income increased when the three month period ended September 30, 2024 is compared with the comparable period of 2023 due to income from the BOLI policies acquired with the FCB merger. BOLI income decreased when the nine month period ended September 30, 2024 is compared with the comparable period of 2023 due to the settlement of a policy in the second quarter of 2023. The Company recorded a gain on the sale of an investment and a loss on the sale of securities during the second quarter of 2023. The sale of securities is discussed in more detail under the Securities section below. Other income includes revenue from investment and insurance sales, adjustments to partnership basis and other miscellaneous components. During 2023, the Company recognized an incentive payment from a vendor. These areas fluctuate with market conditions and competitive factors. Noninterest Expense Three Months Ended September 30, 2024 2023 Percent Change Salaries and employee benefits $ 4,953 $ 4,462 11.00 % Occupancy, furniture and fixtures 641 547 17.18 % Data processing and ATM 1,054 978 7.77 % FDIC assessment 211 190 11.05 % Intangible asset amortization 102 – NM Net costs of other real estate owned – 14 NM Franchise taxes 373 339 10.03 % Professional services 254 251 1.20 % Merger-related expenses 150 – NM Other operating expenses 761 654 16.36 % Total noninterest expense $ 8,499 $ 7,435 14.31 % 39 Table of Contents Nine Months Ended September 30, 2024 2023 Percent Change Salaries and employee benefits $ 14,106 $ 13,361 5.58 % Occupancy, furniture and fixtures 1,741 1,500 16.07 % Data processing and ATM 2,807 2,730 2.82 % FDIC assessment 590 561 5.17 % Intangible asset amortization 137 – NM Net costs of other real estate owned – 29 NM Franchise taxes 1,081 1,072 0.84 % Professional services 766 1,555 (50.74 )% Merger-related expenses 2,891 – NM Contract termination expenses 173 – NM Other operating expenses 2,096 1,857 12.87 % Total noninterest expense $ 26,388 $ 22,665 16.43 % Noninterest expense increased when the three and nine months ended September 30, 2024 are compared with the comparable periods of 2023. Key noninterest expense changes include occupancy, furniture and fixtures, professional services, merger-related expenses, and contract termination expenses. Occupancy, furniture and fixtures expense increased when compared with 2023 due to the addition of assets acquired in the FCB merger and the receipt of a one-time insurance reimbursement during 2023. Professional services include legal and other expenses for the Company’s response to a proxy contest from an activist shareholder during 2023, which amounted to $786 for the nine months ended September 30, 2023. During 2024, the Company recorded expenses associated with its acquisition of FCB, including executive and employee severance benefits and legal and consulting fees. During the second quarter of 2024, the Company recorded a contract termination expense when it gave formal notification to a vendor that it intends to end its relationship in 2025. Included in various categories of noninterest expense are expenses to manage cybersecurity risk. The cost of these measures was $92 for the three months ended September 30, 2024 and $141 for the three months ended September 30, 2023. For the nine months ended September 30, 2024, the total cybersecurity expense was $276 compared to $424 for the nine months ended September 30, 2023. The Company places high priority on cybersecurity. The decrease in expense reflects renegotiation of contracts and licensing. Income Tax The Company’s income tax expense for the three months ended September 30, 2024 was $550. For the three months ended September 30, 2023, the Company recorded an income tax expense of $617. For the nine months ended September 30, 2024, the Company’s income tax expense was $891 and effective tax rate was 16.39%. For the nine months ended September 30, 2023, the Company’s income tax expense was $2,105 and effective tax rate was 15.47%. A significant portion of the merger related expense was not tax deductible, resulting in an increase to the Company’s effective tax rate for 2024. During 2023, the Company recognized a gain on the settlement of a BOLI policy that was not taxable. Asset Quality Key indicators of the Company’s asset quality are presented in the following table. September 30, 2024 September 30, 2023 December 31, 2023 Nonaccrual loans $ 2,283 $ 2,981 $ 2,629 Loans past due 90 days or more, and still accruing 71 31 188 Other real estate owned – 662 – ACLL to loans net of unearned income and deferred fees and costs 1.03 % 1.20 % 1.06 % Net charge-off ratio 0.04 % – 0.02 % Ratio of nonperforming assets to loans, net of unearned income and deferred fees and costs, plus other real estate owned 0.23 % 0.43 % 0.31 % Ratio of ACLL to nonperforming loans 452.39 % 341.53 % 345.91 % For information on the Company’s policies on the ACLL, please refer to the Company’s 2023 Form 10-K, Note 1: Summary of Significant Accounting Policies. The Company’s risk analysis as of September 30, 2024 determined an ACLL of $10,328, or 1.03% of loans net of unearned income and deferred fees and costs. This compares with an allowance of $9,094 as of December 31, 2023, or 1.06% of loans. To determine the 40 Table of Contents appropriate level of the ACLL, the Company considers credit risk for individually evaluated loans and for groups of loans evaluated collectively. Individually Evaluated Loans Individually evaluated loans were $10,713 as of September 30, 2024, a slight increase from $10,544 as of December 31, 2023. As of September 30, 2024, four individually evaluated loans were collateral dependent but were adequately collateralized and did not result in an individual allocation. The remaining individually evaluated loans were measured using the discounted cash flow method, resulting in an allocation of $85. Collectively Evaluated Loans Collectively evaluated loans totaled $991,528, with an ACLL of $10,243 as of September 30, 2024. As of December 31, 2023, collectively evaluated loans totaled $846,631, with an allowance of $8,522. Collectively evaluated loans are divided into classes based upon risk characteristics. Utilizing historical loss information and peer data, the Company calculates probability of default and loss given default for each class, which is adjusted for a reasonable and supportable forecast. Cash flow projections based on each loan’s contractual terms are modified by the adjusted probability of default and loss given default for its class. Loan classes are allocated additional loss estimates based upon the Company’s analysis of qualitative factors including economic measures, asset quality indicators, loan characteristics, and changes to internal Company policies and management. Reasonable and Supportable Forecast The Company applies national unemployment forecasts to project cash flows. The Company determined that 12 months represents a reasonable and supportable forecast period as of September 30, 2024, and set a period of 12 months to revert to historical losses on a straight-line basis. The forecast applied as of September 30, 2024 projects that unemployment will rise over the next 12 months to a higher level than the forecast applied as of December 31, 2023. The higher unemployment forecast increased the required level of the ACLL when September 30, 2024 is compared with December 31, 2023. Qualitative Factors: Economic The Company sources economic data pertinent to its market from the most recently available publications, including business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes. Higher bankruptcy filings indicate heightened credit risk and increase the ACLL, while lower bankruptcy filings have a beneficial impact on credit risk. Compared with data available as of December 31, 2023, business and personal bankruptcies filings increased slightly. Residential vacancy rates and housing inventory impact the Company’s residential construction customers and the consumer real estate market. Higher levels increase credit risk. The residential vacancy rate available as of September 30, 2024 increased from the data incorporated into the December 31, 2023 calculation. Housing data available as of September 30, 2024 showed higher inventory than as of December 31, 2023, resulting in a higher allocation. Qualitative Factors: Asset Quality Indicators Accruing past due loans are analyzed at the class level and compared with previous levels. Increases in past due loans indicate heightened credit risk. Accruing loans past due 30-89 days were 0.33% of total loans as of September 30, 2024, an increase from 0.19% as of December 31, 2023. Qualitative Factors: Other Considerations The Company considers other factors that impact credit risk, including the interest rate environment, the competitive, legal and regulatory environments, changes in lending policies and loan review, changes in lending management, and high risk loans. The interest rate environment impacts variable rate loans. The Federal Reserve’s substantial interest rate increases between March 2022 and July 2023 have increased and are expected to continue to increase payments on the Company’s variable rate loans as they reach contractual repricing dates, despite the Federal Reserve's recent reduction in their target rate. The Company allocates additional reserve each time the Federal Reserve increases rates, under the expectation that higher payments may increase credit risk. After the rate increase has been in effect for one year, the allocation may be removed if management deems that the impact of the change has become integrated to the portfolio. As of September 30, 2024, the Company reduced its allocation from December 31, 2023 . The competitive, legal and regulatory environments were evaluated for changes that would affect credit risk. Higher competition for loans increases credit risk, while lower competition decreases credit risk. Competition remained at similar levels to those at December 31, 2023. The legal and regulatory environments also remain in a similar posture to December 31, 2023. Lending policies, loan review procedures and management’s experience influence credit risk. Policies and procedures remain similar to those at December 31, 2023. The Company added an allocation to account for absorption of FCB acquired loans and integration of FCB lenders. 41 Table of Contents Levels of high risk loans are considered in the determination of the level of the ACLL. 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 increased from the level at December 31, 2023. Unallocated Surplus The unallocated surplus as of September 30, 2024 is $83, or 0.81% in excess of the calculated requirement. The unallocated surplus at December 31, 2023 was $350, or 4.00% in excess of the calculated requirement. The surplus provides some mitigation of current economic uncertainty that may impact credit risk. Conclusion The calculation of the appropriate level for the ACLL incorporates analysis of multiple factors and requires management’s prudent and informed judgment. The Company augmented the calculated requirement with an unallocated surplus. Based on analysis of historical indicators, asset quality and economic factors, management believes the level of ACLL is reasonable for the credit risk in the loan portfolio as of September 30, 2024. ACL on Unfunded Commitments The ACL on unfunded commitments was $241, or 0.14% of unfunded commitments as of September 30, 2024. The ACL on unfunded commitments was $259, or 0.16% as of December 31, 2023. Provision for (Recovery of) Credit Losses The provision for credit losses represents charges to earnings necessary to maintain an adequate allowance. The adequacy of the ACLL is reviewed quarterly and adjustments are made as determined necessary. The Company recorded a provision for credit losses on loans of $5 and a recovery of credit losses on unfunded commitments of $10 for the three months ended September 30, 2024, compared with a recovery of credit losses on loans of $401 for the three months ended September 30, 2023 and a provision of $30 for unfunded commitments. The Company recorded a provision for credit losses on loans of $1,312 and a recovery of credit losses on unfunded commitments of $25 for the nine months ended September 30, 2024, compared with a recovery of credit losses on loans of $389 for the nine months ended September 30, 2023 and a provision of $21 for unfunded commitments. Upon acquisition of FCB in June 2024, the Company recorded a provision for credit losses of $1,290 to establish an allowance on non-PCD loans. Loan Modifications In the ordinary course of business the Company modifies loan terms on a case-by-case basis for a variety of reasons. Modifications may include rate reductions, payment extensions of varying lengths of time, a change in amortization term or method or other arrangements. Modifications to consumer loans generally involve short-term payment extensions to accommodate specific, temporary circumstances. Modifications to commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. The Company reviews modifications to determine whether the borrower is experiencing financial difficulty, including indicators of default, bankruptcy, going concern, insufficient projected cash flows and inability to obtain financing from other sources. If a modification is made to a borrower experiencing financial difficulty, the loan’s risk rating is downgraded to special mention or classified, resulting in individual evaluation for the ACLL. Please refer to Note 3: Loans and Allowance for Credit Losses in Part I, Item 1 of this report for more information on loans modified for borrowers experiencing financial difficulty. Modifications for Borrowers Who Were Not Experiencing Financial Difficulty During the three and nine months ended September 30, 2024 and 2023, the Company modified loans in the normal course of business for borrowers who were not experiencing financial difficulty. During the three months ended September 30, 2024, the Company modified 205 loans totaling $42,969. During the nine months ended September 30, 2024, the Company modified 637 loans totaling $86,905. During the three months ended September 30, 2023, the Company provided 186 modifications to loans totaling $23,054. For the nine months ended September 30, 2023, the Company provided 581 modifications to loans totaling $65,089. Key Assets and Liabilities NBI’s key assets and liabilities and their change from December 31, 2023 are shown in the following table. 42 Table of Contents September 30, 2024 December 31, 2023 Percent Change Interest-bearing deposits $ 33,707 $ 73,636 (54.22 )% Securities available for sale, at fair value and restricted stock 624,120 619,865 0.69 % Loans, net 991,331 847,552 16.96 % Total assets 1,785,033 1,655,370 7.83 % Deposits 1,602,953 1,503,972 6.58 % Average Balances Year-to-date daily averages for the major balance sheet categories are as follows: Assets September 30, 2024 December 31, 2023 Percent Change Interest-bearing deposits $ 80,637 $ 37,660 114.12 % Securities available for sale, at fair value and restricted stock 611,037 620,535 (1.53 )% Loans, net 909,345 840,590 8.18 % Total assets 1,726,898 1,613,854 7.00 % Liabilities and stockholders’ equity Noninterest-bearing demand deposits $ 286,643 $ 299,748 (4.37 )% Interest-bearing demand deposits 839,211 826,112 1.59 % Savings deposits 175,670 195,592 (10.19 )% Time deposits 268,313 150,395 78.41 % Stockholders’ equity 143,444 124,641 15.09 % Increased customer deposits resulted in increased investment in interest bearing deposit assets. Changes in securities, loans, deposits and stockholders’ equity are discussed below. Securities September 30, 2024 December 31, 2023 Percent Change Amortized cost $ 685,472 $ 697,786 (1.76 )% Unrealized loss, net (63,201 ) (79,185 ) 20.19 % Securities available for sale, at fair value $ 622,271 $ 618,601 0.59 % Securities available for sale are presented at fair value as of each reporting date. The fair value of bonds moves inversely to interest rate changes and expectations of interest rate changes. Most of the Company’s securities were purchased during periods prior to the Federal Reserve’s interest rate increases that began in March of 2022. The Federal Reserve's cut to its target rate in September 2024 improved the unrealized loss on securities when September 30, 2024 is compared with December 31, 2023. The Company’s analysis of the securities portfolio determined no identifiable credit risk as of September 30, 2024 and no ACL has been recorded. Please refer to Note 1: General and Summary of Significant Accounting Policies of the 2023 Form 10-K and Note 4: Securities in Part I, Item 1 of this report for additional information on the securities portfolio. Loans September 30, 2024 December 31, 2023 Percent Change Real estate construction $ 71,920 $ 55,379 29.87 % Consumer real estate 306,012 241,564 26.68 % Commercial real estate 473,018 419,130 12.86 % Commercial non real estate 52,699 41,555 26.82 % Public sector and IDA 58,109 60,551 (4.03 )% Consumer non real estate 40,483 38,996 3.81 % Less: unearned income and deferred fees and costs (582 ) (529 ) 10.02 % Loans, net of unearned income and deferred fees and costs $ 1,001,659 $ 856,646 16.93 % The increase from December 31, 2023 reflects the acquisition of FCB. The higher interest rate environment continues to restrain loan demand. The Company is positioned to make every loan that meets its underwriting standards. 43 Table of Contents Deposits September 30, 2024 December 31, 2023 Percent Change Noninterest-bearing demand deposits $ 296,469 $ 281,215 5.42 % Interest-bearing demand deposits 819,947 821,661 (0.21 )% Savings deposits 176,460 177,856 (0.78 )% Time deposits 310,077 223,240 38.90 % Total deposits $ 1,602,953 $ 1,503,972 6.58 % The Company’s depositors within its market area are diverse, including individuals, businesses and municipalities. The Company does not have any brokered deposits. Depositors are insured up to the FDIC maximum of $250 thousand. Municipal deposits, which account for approximately 22% of the Company’s deposits, have additional security from bonds pledged as collateral, in accordance with state regulation. Of the Company’s non-municipal deposits, approximately 22% are uninsured. Borrowings The Company acquired FHLB borrowings in the FCB merger, which were repaid upon completion of the merger. Capital Resources September 30, 2024 December 31, 2023 Percent Change Common stock and additional paid in capital $ 21,796 $ 7,404 194.38 % Retained earnings 198,225 197,984 0.12 % Accumulated other comprehensive loss (52,239 ) (64,866 ) (19.47 )% Total stockholders’ equity $ 167,782 $ 140,522 19.40 % The increase in stockholders’ equity reflects the stock consideration issued to acquire FCB. The Company paid dividends to shareholders in June 2024. The Company qualifies as a small bank holding company under the Federal Reserve’s Small Bank Holding Company Policy Statement, which exempts bank holding companies with less than $3 billion in assets from reporting consolidated regulatory capital ratios and from minimum regulatory capital requirements. NBB is subject to various capital requirements administered by banking agencies, including an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments. Risk-based capital ratios are calculated in compliance with OCC rules based on the Basel III Capital Rules. The Bank’s ratios are well above the required minimums as of September 30, 2024. Capital ratios for NBB are shown in the following tables. NBB Regulatory Capital Minimum Ratios Regulatory Capital Minimum Ratios with Capital Conservation Buffer Common Equity Tier I Capital Ratio 16.55 % 4.50 % 7.00 % Tier I Capital Ratio 16.55 % 6.00 % 8.50 % Total Capital Ratio 17.40 % 8.00 % 10.50 % Leverage Ratio 11.08 % 4.00 % 4.00 % 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 FHLB advances. As of September 30, 2024, the Company had $293,379 of borrowing capacity from the FHLB and the Company had $178,582 of unused capacity at the Federal Reserve Bank discount window. Periodically during 2023, the Company accessed FHLB borrowings. The advances were fully repaid, due to the success of the Company’s deposit strategy. As of September 30, 2024, the Company did not have purchased deposits, discount window borrowings or short-term borrowings. 44 Table of Contents The Company considers its security portfolio for typical liquidity needs, within accounting, legal and strategic parameters. 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 Bank discount window. As of September 30, 2024, the Company is considered well capitalized and does not have any restrictions on purchased deposits or borrowing ability at the Federal Reserve Bank 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. As of September 30, 2024, the Company’s liquidity is sufficient to meet projected trends. 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. As of September 30, 2024, 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 internally-set target range. As of September 30, 2024, the loan to deposit ratio was 62.49%. 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. Off-Balance Sheet Arrangements In the normal course of business, NBB extends lines of credit and letters of credit to its customers. Depending on their needs, customers may draw upon lines of credit at any time in any amount up to a pre-approved limit. Financial letters of credit guarantee payments to facilitate customer purchases. Performance letters of credit guarantee payment if the customer fails to complete a specific obligation. 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 would be able to access multiple options, including its lines of credit with correspondents, raising additional deposits, or selling securities available for sale or loans. The Company estimates an ACL on unfunded loan commitments under the current expected credit losses model. The Company sells mortgages on the secondary market. Our agreement with the purchaser provides for strict underwriting and documentation requirements. Violation of the representations and warranties of the agreement would entitle the purchaser to recourse provisions. The Company has determined that its risk in this area is not significant because of the low volume of secondary market mortgage loans and high underwriting standards. The Company estimates a potential loss reserve for recourse provisions that is not material as of September 30, 2024. To date, no recourse provisions have been invoked. If funds were needed, the Company would access the same sources as noted above for funding lines and letters of credit. There were no material changes in off-balance sheet arrangements during the three and nine months ended September 30, 2024. Contractual Obligations The Company had no finance lease or purchase obligations and no long-term debt at September 30, 2024. Item 3. Quantitative a nd Qualitative Disclosures About Market Risk Not applicable. Item 4. Controls an d 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. In conducting the evaluation of the effectiveness of its disclosure controls and procedures as of September 30, 2024, the Company has excluded the operations of FCB as permitted by the guidance issued by the Office of the Chief Accountant of the Securities and Exchange Commission (not to extend more than one year beyond the date of the acquisition or for more than one annual reporting period). The merger was completed on June 1, 2024. See "Note 2. Business Combinations" for further discussion of the merger and its impact on the Company’s consolidated financial statements. 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 September 30, 2024 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 45 Table of Contents 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) that occurred during the three months ended September 30, 2024, that have materially affected, or are reasonably likely to materially affect, the Company’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. Part I I Other Information Item 1. Legal P roceedings There are no pending or threatened legal proceedings to which the Company or any of its subsidiaries is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company. Item 1A. Ris k Factors Please refer to the “Risk Factors” previously disclosed in Item 1A of the 2023 Form 10-K and the factors discussed under “Cautionary Statement Regarding Forward-Looking Statements” in Part I. Item 2 of this Form 10-Q.