june302010_10q.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2010.

¨
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:  0-12820

AMERICAN NATIONAL BANKSHARES INC.
(Exact name of registrant as specified in its charter)

VIRGINIA
 
54-1284688
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
628 Main Street
   
Danville, Virginia
 
24541
(Address of principal executive offices)
 
(Zip Code)

(434) 792-5111
(Registrant's telephone number, including area code)

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months.
 
 
Yes
¨
No
¨
 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o                                                                Accelerated filer  x                                                      Non-accelerated filer  o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes                      ¨           No                      x

At August 4, 2010, the Company had 6,124,892 shares of Common Stock outstanding, $1 par value.

 
 

 

 
 

AMERICAN NATIONAL BANKSHARES INC.
       
Index
   
Page
       
Part I.
 
FINANCIAL INFORMATION
 
       
 
Item 1
Financial Statements
 
       
   
Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009
3
       
   
Consolidated Statements of Income for the three and six months ended June 30, 2010 and 2009
4-5
       
   
Consolidated Statements of Changes in Shareholders' Equity for the six months ended June 30, 2010 and 2009
6
       
   
Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009
7
       
   
Notes to Consolidated Financial Statements
8
       
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
24
       
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
37
       
 
Item 4.
Controls and Procedures
38
       
Part II.
OTHER INFORMATION
 
       
 
Item 1.
Legal Proceedings
39
       
 
Item 1A.
Risk Factors
39
       
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
39
       
 
Item 3.
Defaults Upon Senior Securities
39
       
 
Item 4.
(Removed and Reserved)
39
       
 
Item 5.
Other Information
39
       
 
Item 6.
Exhibits
39
       
SIGNATURES
 


 
2

 

Part I.  Financial Information
Item 1. Financial Statements


 American National Bankshares Inc. and Subsidiaries
 
 Consolidated Balance Sheets
 
 (Dollars in thousands, except share data)
 
             
   
(Unaudited)
   
(Audited)
 
   
June 30,
   
December 31,
 
 ASSETS
 
2010
   
2009
 
 Cash and due from banks
  $ 11,398     $ 13,250  
 Interest-bearing deposits in other banks
    22,705       10,693  
                 
 Securities available for sale, at fair value
    211,574       188,795  
 Securities held to maturity (fair value of $5,028 at June 30,
               
 2010 and $6,763 at December 31, 2009)
    4,823       6,529  
 Total securities
    216,397       195,324  
                 
 Restricted stock, at cost
    4,362       4,362  
 Loans held for sale
    2,879       2,490  
                 
 Loans, net of unearned income
    519,416       527,991  
 Less allowance for loan losses
    (8,135 )     (8,166 )
 Net loans
    511,281       519,825  
                 
 Premises and equipment, net
    19,658       19,195  
 Other real estate owned, net
    3,730       3,414  
 Goodwill
    22,468       22,468  
 Core deposit intangibles, net
    1,509       1,698  
 Accrued interest receivable and other assets
    16,257       16,254  
 Total assets
  $ 832,644     $ 808,973  
                 
LIABILITIES and SHAREHOLDERS' EQUITY
               
 Liabilities:
               
 Demand deposits -- noninterest bearing
  $ 100,099     $ 101,735  
 Demand deposits -- interest bearing
    92,771       97,025  
 Money market deposits
    81,247       75,554  
 Savings deposits
    64,425       61,873  
 Time deposits
    291,609       268,086  
 Total deposits
    630,151       604,273  
                 
 Customer repurchase agreements
    61,665       65,929  
 Long-term borrowings
    8,563       8,638  
 Trust preferred capital notes
    20,619       20,619  
 Accrued interest payable and other liabilities
    2,886       3,125  
 Total liabilities
    723,884       702,584  
                 
 Shareholders' equity:
               
 Preferred stock, $5 par, 2,000,000 shares authorized,
               
 none outstanding
    -       -  
 Common stock, $1 par, 20,000,000 shares authorized,
               
 6,124,892 shares outstanding at June 30, 2010 and
               
 6,110,335 shares outstanding at December 31, 2009
    6,125       6,110  
 Capital in excess of par value
    27,131       26,962  
 Retained earnings
    73,590       72,208  
 Accumulated other comprehensive income, net
    1,914       1,109  
 Total shareholders' equity
    108,760       106,389  
 Total liabilities and shareholders' equity
  $ 832,644     $ 808,973  
                 
The accompanying notes are an integral part of the consolidated financial statements.
         

 
3

 


 American National Bankshares Inc. and Subsidiaries
 
 Consolidated Statements of Income
 
(Dollars in thousands, except per share and per share data) (Unaudited)
 
   
Three Months Ended
 
   
June 30
 
   
2010
   
2009
 
 Interest and Dividend Income:
           
 Interest and fees on loans
  $ 7,071     $ 7,917  
 Interest and dividends on securities:
               
 Taxable
    1,275       1,233  
 Tax-exempt
    554       416  
 Dividends
    24       21  
 Other interest income
    87       103  
 Total interest and dividend income
    9,011       9,690  
                 
Interest Expense:
               
 Interest on deposits
    1,647       2,180  
 Interest on short-term borrowings
    99       177  
 Interest on long-term borrowings
    63       80  
 Interest on trust preferred capital notes
    344       344  
 Total interest expense
    2,153       2,781  
                 
 Net Interest Income
    6,858       6,909  
 Provision for Loan Losses
    285       492  
                 
 Net Interest Income After Provision for Loan Losses
    6,573       6,417  
                 
 Noninterest Income:
               
 Trust fees
    801       767  
 Service charges on deposit accounts
    483       511  
 Other fees and commissions
    288       251  
 Mortgage banking income
    343       568  
 Brokerage fees
    22       73  
 Securities gains (losses), net
    4       1  
 Foreclosed real estate gains (losses), net      
    (281 )     (43 )
Other
    102       125  
 Total noninterest income
    1,762       2,253  
                 
 Noninterest Expense:
               
 Salaries
    2,596       2,732  
 Employee benefits
    633       832  
 Occupancy and equipment
    698       724  
 FDIC assessment
    199       564  
 Bank franchise tax
    168       160  
 Core deposit intangible amortization
    95       95  
Other
    1,204       1,214  
 Total noninterest expense
    5,593       6,321  
                 
 Income Before Income Taxes
    2,742       2,349  
 Income Taxes
    728       643  
 Net Income
  $ 2,014     $ 1,706  
                 
 Net Income Per Common Share:
               
 Basic
  $ 0.33     $ 0.28  
 Diluted
  $ 0.33     $ 0.28  
 Average Common Shares Outstanding:
               
 Basic
    6,123,790       6,096,034  
 Diluted
    6,129,943       6,097,047  
                 
The accompanying notes are an integral part of the consolidated financial statements.
 

 
4

 


 American National Bankshares Inc. and Subsidiaries
 
 Consolidated Statements of Income
 
(Dollars in thousands, except per share and per share data) (Unaudited)
 
   
Six Months Ended
 
   
June 30
 
   
2010
   
2009
 
 Interest and Dividend Income:
           
 Interest and fees on loans
  $ 14,226     $ 15,951  
 Interest and dividends on securities:
               
 Taxable
    2,591       2,353  
 Tax-exempt
    1,020       802  
 Dividends
    47       43  
 Other interest income
    178       191  
 Total interest and dividend income
    18,062       19,340  
                 
Interest Expense:
               
 Interest on deposits
    3,282       4,707  
 Interest on short-term borrowings
    204       413  
 Interest on long-term borrowings
    127       211  
 Interest on trust preferred capital notes
    687       687  
 Total interest expense
    4,300       6,018  
                 
 Net Interest Income
    13,762       13,322  
 Provision for Loan Losses
    570       842  
                 
 Net Interest Income After Provision for Loan Losses
    13,192       12,480  
                 
 Noninterest Income:
               
 Trust fees
    1,613       1,525  
 Service charges on deposit accounts
    962       1,013  
 Other fees and commissions
    566       493  
 Mortgage banking income
    589       854  
 Brokerage fees
    43       130  
 Securities gains (losses), net
    (25 )     1  
 Foreclosed real estate gains (losses), net
    (284 )     (1,222 )
   Other
    219       193  
 Total noninterest income
    3,683       2,987  
                 
 Noninterest Expense:
               
 Salaries
    4,994       5,263  
 Employee benefits
    1,273       1,645  
 Occupancy and equipment
    1,477       1,464  
 FDIC assessment
    394       781  
 Bank franchise tax
    335       323  
 Core deposit intangible amortization
    189       189  
   Other
    2,428       2,531  
 Total noninterest expense
    11,090       12,196  
                 
 Income Before Income Taxes
    5,785       3,271  
 Income Taxes
    1,586       797  
 Net Income
  $ 4,199     $ 2,474  
                 
 Net Income Per Common Share:
               
 Basic
  $ 0.69     $ 0.41  
 Diluted
  $ 0.69     $ 0.41  
 Average Common Shares Outstanding:
               
 Basic
    6,121,615       6,089,055  
 Diluted
    6,127,137       6,091,291  
                 
The accompanying notes are an integral part of the consolidated financial statements.
 

 
5

 


American National Bankshares Inc. and Subsidiaries
 
Consolidated Statements of Changes in Shareholders' Equity
 
Six Months Ended June 30, 2010 and 2009
 
 (Dollars in thousands) (Unaudited)
 
                                     
                           
Accumulated
       
   
Common Stock
   
Capital in
         
Other
   
Total
 
               
Excess of
   
Retained
   
Comprehensive
   
Shareholders'
 
   
Shares
   
Amount
   
Par Value
   
Earnings
   
Income (Loss)
   
Equity
 
                                     
 Balance, December 31, 2008
    6,085,628     $ 6,086     $ 26,491     $ 71,090     $ (1,367 )   $ 102,300  
                                                 
 Net income
    -       -       -       2,474       -       2,474  
                                                 
 Change in unrealized gains on securities
                                               
   available for sale, net of tax, $232
    -       -       -       -       432          
                                                 
Less: Reclassification adjustment for gains
                                         
 on securities available for sale, net of
                                               
 tax, $0
    -       -       -       -       (1 )        
                                                 
 Other comprehensive income
                                    431       431  
                                                 
 Total comprehensive income
                                            2,905  
                                                 
 Stock repurchased and retired
    (7,600 )     (8 )     (33 )     (80 )     -       (121 )
                                                 
 Stock options exercised
    22,302       22       283       -       -       305  
                                                 
 Stock option expense
    -       -       31       -       -       31  
                                                 
 Cash dividends declared, $0.46 per share
    -       -       -       (2,802 )     -       (2,802 )
                                                 
 Balance, June 30, 2009
    6,100,330     $ 6,100     $ 26,772     $ 70,682     $ (936 )   $ 102,618  
                                                 
 Balance, December 31, 2009
    6,110,335     $ 6,110     $ 26,962     $ 72,208     $ 1,109     $ 106,389  
                                                 
 Net income
    -       -       -       4,199       -       4,199  
                                                 
 Change in unrealized gains on securities
                                               
   available for sale, net of tax, $424
    -       -       -       -       789          
                                                 
Add: Reclassification adjustment for losses
                                         
 on impairment of securites, net of tax, $11
    -       -       -       -       20          
                                                 
Less: Reclassification adjustment for gains
                                         
 on securities available for sale, net of
                                               
 tax of $(2)
    -       -       -       -       (4 )        
                                                 
 Other comprehensive gain
                                    805       805  
                                                 
 Total comprehensive income
                                            5,004  
                                                 
 Stock options exercised
    2,813       3       43       -       -       46  
                                                 
 Stock option expense
    -       -       32       -       -       32  
                                                 
 Equity based compensation
    11,744       12       94       -       -       106  
                                                 
 Cash dividends declared, $0.46 per share
    -       -               (2,817 )     -       (2,817 )
                                                 
 Balance, June 30, 2010
    6,124,892     $ 6,125     $ 27,131     $ 73,590     $ 1,914     $ 108,760  
                                                 
The accompanying notes are an integral part of the consolidated financial statements.
                 

 
6

 


 American National Bankshares Inc. and Subsidiaries
 
 Consolidated Statements of Cash Flows
 
 Six Months Ended June 30, 2010 and 2009
 
 (Dollars in thousands)  (Unaudited)
 
             
   
2010
   
2009
 
 Cash Flows from Operating Activities:
           
 Net income
  $ 4,199     $ 2,474  
 Adjustments to reconcile net income to net
               
 cash provided by (used in) operating activities:
               
 Provision for loan losses
    570       842  
 Depreciation
    636       566  
 Core deposit intangible amortization
    189       189  
 Net amortization (accretion) of bond premiums and discounts
    126       (144 )
 Net gain on sale or call of securities
    (6 )     (1 )
 Impairment of securities
    31       -  
 Gain on loans held for sale
    (523 )     (752 )
 Proceeds from sales of loans held for sale
    20,911       30,756  
 Originations of loans held for sale
    (20,777 )     (38,648 )
 Net loss (gain) on foreclosed real estate
    3       (17 )
 Net change in valuation allowance on foreclosed real estate
    281       1,239  
 Stock-based compensation expense
    32       31  
 Equity based compensation
    106       -  
 Deferred income tax benefit
    (110 )     (510 )
 Net change in interest receivable
    (313 )     (149 )
 Net change in other assets
    310       1,199  
 Net change in interest payable
    (36 )     (211 )
 Net change in other liabilities
    (526 )     1,327  
 Net cash provided by (used in) operating activities
    5,103       (1,809 )
                 
 Cash Flows from Investing Activities:
               
 Proceeds from maturities and calls of securities available for sale
    54,604       48,188  
 Proceeds from maturities and calls of securities held to maturity
    1,145       411  
 Purchases of securities available for sale
    (75,735 )     (58,393 )
 Net decrease in loans
    7,252       12,202  
 Purchases of bank property and equipment
    (1,099 )     (2,349 )
 Proceeds from sales of foreclosed real estate
    122       190  
 Net cash provided by (used in) investing activities
    (13,711 )     249  
                 
 Cash Flows from Financing Activities:
               
 Net change in demand, money market, and savings deposits
    2,355       8,873  
 Net change in time deposits
    23,523       17,220  
 Net change in repurchase agreements
    (4,264 )     7,696  
 Net change in short-term borrowings
    -       (7,850 )
 Net change in long-term borrowings
    (75 )     (5,075 )
 Cash dividends paid
    (2,817 )     (2,802 )
 Repurchase of stock
    -       (121 )
 Proceeds from exercise of stock options
    46       305  
 Net cash provided by financing activities
    18,768       18,246  
                 
 Net Increase in Cash and Cash Equivalents
    10,160       16,686  
                 
 Cash and Cash Equivalents at Beginning of Period
    23,943       24,098  
                 
 Cash and Cash Equivalents at End of Period
  $ 34,103     $ 40,784  
                 
The accompanying notes are an integral part of the consolidated financial statements.
         

 
7

 

AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
Note 1 – Basis of Presentation

The consolidated financial statements include the accounts of American National Bankshares Inc. and its wholly owned subsidiary, American National Bank and Trust Company (collectively referred to as the “Company”).  American National Bank offers a wide variety of retail, commercial, secondary market mortgage lending, and trust and investment services which also include non-deposit products such as mutual funds and insurance policies.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the 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 and the valuation of foreclosed real estate.

In April 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “Trust”) and a wholly owned subsidiary of the Company was formed for the purpose of issuing preferred securities (the “Trust Preferred Securities”) in a private placement pursuant to an applicable exemption from registration.  Proceeds from the securities were used to fund the acquisition of Community First Financial Corporation (“Community First”) which occurred in April 2006.  Refer to Note 9 for further details concerning this variable interest entity.

All significant inter-company transactions and accounts are eliminated in consolidation, with the exception of the Trust, as detailed in Note 9.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company’s financial position as of June 30, 2010; the consolidated statements of income for the three and six months ended June 30, 2010 and 2009; the consolidated statements of changes in shareholders’ equity for the six months ended June 30, 2010 and 2009; and the consolidated statements of cash flows for the six months ended June 30, 2010 and 2009.  Operating results for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results that may occur for the year ending December 31, 2010.  Certain reclassifications have been made to prior period balances to conform to the current period presentation. These statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2009.
 
 
 
Note 2 – Recent Accounting Pronouncements

In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”, was adopted into Codification in December 2009 through the issuance of Accounting Standards Updated (“ASU”) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets.  The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 
8

 
In June 2009, the FASB issued new guidance relating to the variable interest entities.  The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 is effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In October 2009, the FASB issued Accounting Standards Update No. 2009-15 (ASU 2009-15), “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-04, Accounting for Various Topics – Technical Corrections to SEC Paragraphs. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residual method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2010, the FASB issued Accounting Standards Update No. 2010-08, “Technical Corrections to Various Topics.” ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.”  ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events.  An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated.  ASU 2010-09 is effective immediately. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

   In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements.  The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010.  Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures, will be required for periods beginning after December 15, 2010.  The Company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.
 
Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for previously announced accounting pronouncements.


 
9

 

Note 3 – Securities

The amortized cost and estimated fair value of investments in debt and equity securities at June 30, 2010 and December 31, 2009 were as follows:

 
 
June 30, 2010
 
(in thousands)
 
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available for sale:
                       
Federal agencies & GSE
  $ 75,460     $ 1,207     $ -     $ 76,667  
Mortgage-backed & CMO’s
    49,499       1,853       271       51,081  
State and municipal
    79,256       2,556       109       81,703  
Corporate
    1,967       156       -       2,123  
Total securities available for sale
    206,182       5,772       380       211,574  
                                 
Securities held to maturity:
                               
Mortgage-backed & CMO’s
    172       17       -       189  
State and municipal
    4,651       188       -       4,839  
Total securities held to maturity
    4,823       205       -       5,028  
Total securities
  $ 211,005     $ 5,977     $ 380     $ 216,602  

 
 
December 31, 2009
 
(in thousands)
 
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available for sale:
                       
Federal agencies & GSE
  $ 81,279     $ 1,474     $ 7     $ 82,746  
Mortgage-backed & CMO’s
    41,365       1,535       310       42,590  
State and municipal
    58,035       1,442       181       59,296  
Corporate
    3,962       201       -       4,163  
Total securities available for sale
    184,641       4,652       498       188,795  
                                 
Securities held to maturity:
                               
Mortgage-backed & CMO’s
    199       14       -       213  
State and municipal
    6,330       220       -       6,550  
Total securities held to maturity
    6,529       234       -       6,763  
Total securities
  $ 191,170     $ 4,886     $ 498     $ 195,558  
 
Temporarily Impaired Securities
 
The following table shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2010.  The reference point for determining when securities are in an unrealized loss position is month-end.  Therefore, it is possible that a security’s market value exceeded its amortized cost on other days during the past twelve-month period.
 
   Available for sale and held to maturity securities that have been in a continuous unrealized loss position are as follows:
 
   
Total
   
Less than 12 Months
   
12 Months or More
 
(in thousands)
 
Estimated
Fair
Value
   
Unrealized
Loss
   
Estimated
Fair
Value
   
Unrealized
Loss
   
Estimated
Fair
Value
   
Unrealized
Loss
 
GSE debt securities
  $ 13,002     $ -     $ 13,002     $ -     $ -     $ -  
Mortgage-backed
    5,173       13       5,173       13       -       -  
CMO’s
    2,615       258       846       13       1,769       245  
State and municipal
    12,286       109       11,859       96       427       13  
  Total
  $ 33,076     $ 380     $ 30,880     $ 122     $ 2,196     $ 258  

 
 
10

 
GSE debt securities. The unrealized losses on the three investments in GSEs (“government sponsored entities”) were caused by interest rate increases and aggregate less than $1,000. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2010.
 
 
GSE residential mortgage-backed securities. The unrealized losses on the Company's investment in three GSE mortgage-backed securities and one collateralized mortgage obligation (“CMO”) were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency or GSE of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2010.
 
 
Private-Label Residential Mortgage-Backed Securities: The unrealized losses associated with four private residential collateralized mortgage obligations are primarily driven by higher projected collateral losses, wider credit spreads and changes in interest rates. We assess for credit impairment using a cash flow model. Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our credit enhancement, we expect to recover the remaining amortized cost basis of three of these four securities. See Other than Temporarily Impaired Securities below regarding one of these issues.
 
 
State and municipal securities:  The unrealized losses on the 15 investments in state and municipal securities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2010.
 
The Company’s investment in restricted stock of $4,362,000 at June 30, 2010, shown as a separate line item on the consolidated balance sheets, includes $2,812,000 in stock of the Federal Home Loan Bank of Atlanta (“FHLB”).  FHLB stock is generally viewed as a long-term and restricted investment security, carried at cost, because there is no market for the stock, other than the FHLB or member institutions.  Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.  The FHLB did temporarily suspend dividends and repurchases of excess capital stock in 2009. However, they have recently resumed both activities on a limited basis. The Company does not consider this investment to be other-than-temporarily impaired at June 30, 2010 and no impairment has been recognized.

Other than Temporarily Impaired Securities

One variable rate CMO was downgraded below investment grade to CCC status by Standard and Poor’s during the first quarter 2010.  Based upon a review of the security by an independent advisory firm, the Company elected to recognize an impairment charge to earnings of $31,000 in the first quarter. The impairment charge was based on a review of recent actual historical performance and an estimate of expected annual ongoing losses of 0.91% and loss on loans sixty days or greater of 6.41%. The Other Comprehensive Income (“OCI”) adjustment was based on an estimated 15% fair value return based on current market conditions.  The investment was reviewed again for other than temporarily impairment (“OTTI”) in the second quarter.  No additional impairment was deemed necessary at this time.

 
11

 
The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position, at December 31, 2009.

   
Total
   
Less than 12 Months
   
12 Months or More
 
(in thousands)
 
Estimated
Fair
Value
   
Unrealized
Loss
   
Estimated
Fair
Value
   
Unrealized
Loss
   
Estimated
Fair
Value
   
Unrealized
Loss
 
GSE debt securities
  $ 28,918     $ 7     $ 28,918     $ 7     $ -     $ -  
Mortgage-backed
    7,294       95       7,294       95       -       -  
CMO’s
    2,151       215       -       -       2,151       215  
State and municipal
    7,420       181       6,991       145       429       36  
  Total
  $ 45,783     $ 498     $ 43,203     $ 247     $ 2,580     $ 251  

 
Note 4 - Loans

Loans, excluding loans held for sale, were comprised of the following:

 
(in thousands)
 
June 30,
2010
   
December 31,
2009
 
             
Construction and land development
  $ 40,039     $ 40,371  
Commercial real estate
    202,602       208,066  
Residential real estate
    119,410       121,639  
Home equity
    63,992       64,678  
     Total real estate
    426,043       434,754  
                 
Commercial and industrial
    86,924       86,312  
Consumer
    6,449       6,925  
Total loans
  $ 519,416     $ 527,991  

The following is a summary of information pertaining to impaired and nonaccrual loans:

   
June 30,
   
December 31,
 
(in thousands)
 
2010
   
2009
 
             
Impaired loans with a valuation allowance
  $ -     $ 1,284  
Impaired loans without a valuation allowance
    1,995       2,540  
Total impaired loans
  $ 1,995     $ 3,824  
                 
Allowance provided for impaired loans,
               
  included in the allowance for loan losses
  $ -     $ 796  
                 
Nonaccrual loans excluded from the impaired loan disclosure
  $ 2,083     $ 1,885  

   
Six Months
Ended
   
Six Months
Ended
 
(in thousands)
 
June 30, 2010
   
June 30, 2009
 
             
Average balance in impaired loans
  $ 3,452     $ 3,348  
Interest income recognized on impaired loans
    -       83  
Interest income recognized on nonaccrual loans
    -       -  
Interest on nonaccrual loans had they been accruing
    134       202  
Loans past due 90 days and still accruing interest
    8       -  

 
12

 
No additional funds are committed to be advanced in connection with impaired loans.

Foreclosed real estate was $3,730,000 at June 30, 2010 and $3,414,000 December 31, 2009.

 
Note 5 – Allowance for Loan Losses and Reserve for Unfunded Lending Commitments

Changes in the allowance for loan losses and the reserve for unfunded lending commitments for the six months ended June 30, 2010 and 2009, and for the year ended December 31, 2009, are presented below:



 
 
(in thousands)
 
Six Months
Ended
June 30,
   
Year
Ended
December 31,
   
Six Months
 Ended
June 30,
 
   
2010
   
2009
   
2009
 
Allowance for Loan Losses
                 
  Balance, beginning of period
  $ 8,166     $ 7,824     $ 7,824  
  Provision for loan losses
    570       1,662       842  
  Charge-offs
    (732 )     (1,601 )     (798 )
  Recoveries
    131       281       66  
  Balance, end of period
  $ 8,135     $ 8,166     $ 7,934  
                         
Reserve for unfunded lending commitments
                       
  Balance, beginning of period
  $ 260       475     $ 475  
  Provision for unfunded commitments
    (29 )     -       (12 )
  Charge-offs
    -       (215 )     (215 )
  Balance, end of period
  $ 231     $ 260     $ 248  
                         

  The reserve for unfunded loan commitments is included on the consolidated balance sheet in other liabilities.


Note 6 – Goodwill and Other Intangible Assets

In January 2002, the Company adopted SFAS No. 142 (ASC 805), “Goodwill and Other Intangible Assets”.  Accordingly, goodwill is no longer subject to amortization, but is subject to at least an annual assessment for impairment by applying a fair value test.   A fair value-based test was performed during the third quarter as of June 30, 2010 that determined there has been no impairment in the value of goodwill.
 
  The changes in the carrying amount of goodwill for the quarter ended June 30, 2010, are as follows (in thousands):

Balance as of December 31, 2009
  $ 22,468  
Goodwill recorded during the period
    -  
Impairment losses
    -  
Balance as of June 30, 2010
  $ 22,468  
 
   Core deposit intangible assets resulting from an acquisition were originally recorded at $3,112,000 in April 2006, and are being amortized over 99 months.  The net core deposit intangible at June 30, 2010 was $1,509,000.


 
13

 

Note 7 – Short-term Borrowings

Short-term borrowings consist of customer repurchase agreements, overnight borrowings from the FHLB, and Federal Funds purchased.  Customer repurchase agreements are collateralized by securities of the U.S. Government or its agencies and they mature daily.  The interest rates are generally fixed but may be changed at the discretion of the Company. The securities underlying these agreements remain under the Company’s control. FHLB overnight borrowings have floating interest rates that may change daily at the discretion of the FHLB.  Federal Funds purchased are unsecured overnight borrowings from other financial institutions.  Customer repurchase agreements were $61,665,000 at June 30, 2010 and $65,929,000 at December 31, 2009.

Note 8 – Long-term Borrowings

Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans and home equity lines of credit.  In addition, the Company pledges as collateral its capital stock in the FHLB and deposits with the FHLB.  The Company has a line of credit with the FHLB equal to 30% of the Company’s assets, subject to the amount of collateral pledged.  As of June 30, 2010, $91,588,000 in 1-4 family residential mortgage loans and $58,167,000 in home equity lines of credit were pledged under the blanket floating lien agreement which covers both short-term and long-term borrowings.  Long-term borrowings consisted of the following fixed rate, long term advances as of June 30, 2010 and December 31, 2009 (in thousands):

  June 30, 2010     December 31, 2009  
 
 
Due by
 
Advance
 Amount
   
Weighted
Average
Rate
 
 
 
Due by
 
Advance
 Amount
   
Weighted
Average
Rate
 
                           
March 2011
  $ 8,000       2.93  
March 2011
  $ 8,000       2.93  
April 2014
    563       3.78  
April 2014
    638       3.78  
    $ 8,563       2.99 %     $ 8,638       2.99 %

In the regular course of conducting its business, the Company takes deposits from political subdivisions of Virginia and North Carolina. At June 30, 2010, the Bank’s public deposits totaled $87,634,000. The Company is required to provide collateral to secure the deposits that exceed the insurance coverage provided by the Federal Deposit Insurance Corporation. This collateral can be provided in the form of certain types of government, agency, or GSE bonds or letters of credit from the FHLB. At June 30, 2010, the Company had $40 million in letters of credit with the FHLB outstanding to provide collateral for such deposits. The Company had also pledged $31,009,000 of its investment portfolio for the same purpose.

Note 9 – Trust Preferred Capital Notes

On April 7, 2006, AMNB Statutory Trust I, a Delaware statutory trust and a newly formed, wholly owned subsidiary of the Company, issued $20,000,000 of preferred securities in a private placement pursuant to an applicable exemption from registration.  The Trust Preferred Securities mature on June 30, 2036, but may be redeemed at the Company’s option beginning on June 30, 2011.  The securities require quarterly distributions by the Trust to the holder of the Trust Preferred Securities at a fixed rate of 6.66%.  Effective June 30, 2011, the rate will reset quarterly at the three-month LIBOR plus 1.35%.  Distributions are cumulative and will accrue from the date of original issuance, but may be deferred by the Company from time to time for up to twenty consecutive quarterly periods.  The Company has guaranteed the payment of all required distributions on the Trust Preferred Securities.

 
14

 
The proceeds of the Trust Preferred Securities received by the Trust, along with proceeds of $619,000 received by the Trust from the issuance of common securities by the Trust to the Company, were used to purchase $20,619,000 of the Company’s junior subordinated debt securities (the “Trust Preferred Capital Notes”), issued pursuant to a Junior Subordinated Indenture entered into between the Company and Wilmington Trust Company, as trustee.  The proceeds of the Trust Preferred Capital Notes were used to fund the cash portion of the merger consideration to the former shareholders of Community First in connection with the Company’s acquisition of that company and for general corporate purposes.  In accordance with FASB ASC 810-10-15-14, the Corporation did not eliminate through consolidation the Corporation’s $619,000 equity investment in AMNB Statutory Trust I.  Instead, the Corporation reflected this equity investment in the “Accrued interest receivable and other assets” line item in the consolidated balance sheets.


Note 10 – Share Based Compensation

Stock Options

A summary of stock option transactions for the six months ended June 30, 2010, is as follows:

   
 
 
Option
Shares
   
 
Weighted Average
Exercise Price
   
Weighted Average Remaining Contractual Term
   
 
Average Intrinsic Value
($000)
 
Outstanding at December  31, 2009
    162,603     $ 21.39              
Granted
    -       -              
Exercised
    (2,813 )     16.31              
Forfeited
    (200 )      24.50              
Outstanding at June 30, 2010
    159,590     $ 21.48       5.1     $ 306  
Exercisable at June 30, 2010
    129,090     $ 22.56       4.3     $ 168  
 
  The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting period. As of June 30, 2010, there was $95,000 in total unrecognized compensation expense related to nonvested stock option grants. .

Restricted Stock
 
  The Company from time-to-time grants shares of restricted stock to key employees and non-employee directors.  These awards help align the interests of these employees and directors with the interests of the shareholders of the Company by providing economic value directly related to increases in the value of the Company’s stock.  The value of the stock awarded is established as the fair market value of the stock at the time of the grant.  The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants. 
 
  The Company made its first restricted grant to executive officers in the first quarter 2010. These grants cliff vest over a 24 month period. On January 19, 2010, the Company issued 8,712 shares of restricted stock to its six executive officers and three regional executives.


 
15

 

 
  Nonvested restricted stock for the six months ended June 30, 2010 is summarized in the following table. 

Restricted Stock
 
Shares
   
Grant date fair
value
 
             
Nonvested at January 1, 2010
    -       -  
Granted
    8,712     $ 21.36  
Vested
    -       -  
Forfeited
     -       -  
Nonvested at June 30, 2010
    8,712     $ 21.36  
                 
 
  As of June 30, 2010, there was $140,000 of total unrecognized compensation cost related to nonvested restricted stock granted under the plan.  This cost is expected to be recognized over the next 21 months. 
 
  Starting in 2010, the Company has begun offering its directors an option on director compensation. Their regular monthly retainer could be received as $1,000 per month in cash or $1,250 in immediately vested, but restricted stock. Eight of twelve directors elected to receive stock in lieu of cash for their retainer fees. Only outside directors receive board fees. The Company issued 3,032 shares and recognized share based compensation expense of $60,000 during the six-month period.


Note 11 – Earnings Per Share
 
  The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potentially dilutive common stock.  Potentially dilutive common stock had no effect on income available to common shareholders.

   
Three Months Ended
 
   
June 30,
 
   
2010
   
2009
 
         
Per
         
Per
 
         
Share
         
Share
 
   
Shares
   
Amount
   
Shares
   
Amount
 
Basic
    6,123,790     $ .33       6,096,034     $ .28  
Effect of dilutive securities - stock options
    6,153       -       1,013       -  
Diluted
    6,129,943     $ .33       6,097,047     $ .28  

   
Six Months Ended
 
   
June 30,
 
   
2010
   
2009
 
         
Per
         
Per
 
         
Share
         
Share
 
   
Shares
   
Amount
   
Shares
   
Amount
 
Basic
    6,121,615     $ .69       6,089,055     $ .41  
Effect of dilutive securities - stock options
    5,522       -       2,236       -  
Diluted
    6,127,137     $ .69       6,091,291     $ .41  
 
  Stock options on common stock which were not included in computing diluted earnings per share for the six month periods ended June 30, 2010 and 2009, because their effects were antidilutive, averaged 82,627 and 106,511, respectively.


 
16

 


 
Note 12 – Employee Benefit Plans
 
  Following is information pertaining to the Company’s non-contributory defined benefit pension plan.

Components of Net Periodic Benefit Cost
 
Three Months Ended
   
Six Months Ended
 
(in thousands)
 
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 23     $ 184     $ 46     $ 368  
Interest cost
    117       146       234       292  
Expected return on plan assets
    (135 )     (203 )     (270 )     (406 )
Recognized net actuarial loss
    57       111       114       222  
                                 
Net periodic benefit cost
  $ 62     $ 238     $ 124     $ 476  

   The Company’s does not anticipate contributing to the plan for 2010.

Note 13 – Segment and Related Information

The Company has two reportable segments, community banking and trust and investment services.

Community banking involves making loans to and receiving deposits from individuals and businesses.  All assets and liabilities of the Company are allocated to community banking.  Investment income from securities is also allocated to the community banking segment.  Loan fee income, service charges from deposit accounts, and non-deposit fees such as automated teller machine fees and insurance commissions generate additional income for community banking.

Trust and investment services include estate planning, trust account administration, investment management, and retail brokerage.  Investment management services include purchasing equity, fixed income, and mutual fund investments for customer accounts. The trust and investment services division receives fees for investment and administrative services.

Amounts shown in the “Other” column includes activities of American National Bankshares Inc. which are primarily debt service on trust preferred securities and corporate items. Intersegment eliminations primarily consist of American National Bankshares Inc.’s interest income on deposits held by its banking subsidiary.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies.

Segment information as of and for the six month periods ended June 30, 2010 and 2009, is shown in the following table.

 
 
17

 
                       Six Months Ended June 30, 2010  
         
Trust and
                   
(in thousands)
 
Community
   
Investment
         
Intersegment
       
   
Banking
   
Services
   
Other
   
Eliminations
   
Total
 
Interest income
  $ 18,062     $ -     $ 74     $ (74 )   $ 18,062  
Interest expense
    3,687       -       687       (74 )     4,300  
Noninterest income
    2,006       1,656       21       -       3,683  
Operating income before income taxes
    5,447       1,080       (742 )     -       5,785  
Depreciation and amortization
    817       8       0       -       825  
Total assets
    831,971       -       673       -       832,644  
Capital expenditures
    1,098       1       -       -       1,099  
                                         
                                         
          Six Months Ended June 30, 2009    
           
Trust and
                         
(in thousands)
 
Community
   
Investment
           
Intersegment
         
   
Banking
   
Services
   
Other
   
Eliminations
   
Total
 
Interest income
  $ 19,340     $ -     $ 159     $ (159 )   $ 19,340  
Interest expense
    5,490       -       687       (159 )     6,018  
Noninterest income
    1,305       1,654       28       -       2,987  
Operating income before income taxes
    2,878       1,063       (670 )     -       3,271  
Depreciation and amortization
    746       8       1       -       755  
Total assets
    810,728       -       755       -       811,483  
Capital expenditures
    2,341       8       -       -       2,349  
                                         
                                         
             Three Months Ended June 30, 2010    
           
Trust and
                         
(in thousands)
 
Community
   
Investment
           
Intersegment
         
   
Banking
   
Services
   
Other
   
Eliminations
   
Total
 
Interest income
  $ 9,011     $ -     $ 37     $ (37 )   $ 9,011  
Interest expense
    1,846       -       344       (37 )     2,153  
Noninterest income
    927       824       11       -       1,762  
Operating income before income taxes
    2,563       532       (353 )     -       2,742  
Depreciation and amortization
    403       4       -       -       407  
Total assets
    831,971       -       673       -       832,644  
Capital expenditures
    826       -       -       -       826  
                                         
                                         
                                           Three Months Ended June 30, 2009    
           
Trust and
                         
(in thousands)
 
Community
   
Investment
           
Intersegment
         
   
Banking
   
Services
   
Other
   
Eliminations
   
Total
 
Interest income
  $ 9,690     $ -     $ 79     $ (79 )   $ 9,690  
Interest expense
    2,516       -       344       (79 )     2,781  
Noninterest income
    1,398       839       16       -       2,253  
Operating income before income taxes
    2,135       557       (343 )     -       2,349  
Depreciation and amortization
    379       4       -       -       383  
Total assets
    810,728       -       755       -       811,483  
Capital expenditures
    1,160       -       -       -       1,160  

 
18

 


Note 14 – Fair Value of Financial Instruments

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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.

The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.


 
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.
 
 
      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).  Federal Reserve Bank of Richmond and Federal Home Loan Bank stocks are carried at cost since no ready market exists and there is no quoted market value.  The Company is required to own stock in these entities as long as it is a member.  Therefore, they have been excluded from the table below.

 
19

 
 
  The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 (in thousands):

         
Fair Value Measurements at June 30, 2010 Using
 
   
 
Balance as of June 30,
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
Description
 
2010
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
Securities available for sale
  $ 211,574     $ -     $ 211,146     $ 428  


         
Fair Value Measurements at December 31, 2009 Using
 
   
 
Balance as of December 31,
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
Description
 
2009
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
Securities available for sale
  $ 188,795     $ -     $ 188,795     $ -  
 
  Certain 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 assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at estimated 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 year ended June 30, 2010.  Gains and losses on the sale of loans are recorded within income from mortgage banking on the Consolidated Statements of Income.

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 according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
 
 
 
20

 
 
Other real estate owned:  Certain assets such as other real estate owned (“OREO”) are measured at fair value less cost to sell.  We believe that the fair value component in our valuation of OREO follows the provisions of accounting standards.


The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis during the period (in thousands):

         
Fair Value Measurements at June 30, 2010 Using
 
   
 
Balance as of
June 30,
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
Description
 
2010
   
Level 1
   
Level 2
   
Level 3
 
Assets
                       
Impaired loans, net of valuation allowance
    -       -       -       -  
Other real estate owned
    3,730       -       3,730       -  


         
Fair Value Measurements at December 31, 2009 Using
 
   
 
Balance as of December 31,
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
Description
 
2009
   
Level 1
   
Level 2
   
Level 3
 
Assets
                       
Impaired loans, net of valuation allowance
    488       -       488       -  
Other real estate owned
    3,414       -       3,414       -  

 
   
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
 
       
 Total Realized / Unrealized Gains
(Losses) Included in
             
   
Balances as of
January 1, 2010
 
Net Income
   
Other Comprehensive Income
 
Purchases, Sales, Issuances and Settlements, Net
 
Transfer In (Out) of Level 3
 
Balances as of
June 30, 2010
 
Securities available for sale
                                   
 Private label Collateralized Mortgage Obligation (ARM)
  $ -     $ (31 )   $ (201 )   $ (9 )   $ 684     $ 443  
                                                 
 Total assets
  $ -     $ (31 )   $ (201 )   $ (9 )   $ 684     $ 443  

 
 
21

 
 
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:

 
   
June 30, 2010
   
December 31, 2009
 
(in thousands)
 
Carrying
Amount
   
Estimated
Fair
Value
   
Carrying
 Amount
   
Estimated
Fair
Value
 
Financial assets:
                       
Cash and due from banks
  $ 34,103     $ 34,103     $ 23,943     $ 23,943  
Securities available for sale
    211,574       211,574       188,795       188,795  
Securities held to maturity
    4,823       5,028       6,529       6,673  
Loans held for sale
    2,879       2,879       2,490       2,490  
Loans, net of allowance
    511,281       513,160       519,825       528,631  
Accrued interest receivable
    3,584       3,584       3,268       3,268  
                                 
Financial liabilities:
                               
Deposits
  $ 630,151     $ 632,450     $ 604,273     $ 607,015  
Repurchase agreements
    61,665       61,665       65,929       65,929  
Other borrowings
    8,563       8,554       8,638       8,620  
Trust preferred capital notes
    20,619       20,532       20,619       20,640  
Accrued interest payable
    841       841       899       899  
                                 

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and cash equivalents.  The carrying amount is a reasonable estimate of fair value.

Securities.  Fair values are based on quoted market prices or dealer quotes.

Loans held for sale.  The carrying amount is a reasonable estimate of fair value.

Loans.  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for fixed-rate loans are estimated based upon discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Accrued interest receivable.  The carrying amount is a reasonable estimate of fair value.

Deposits.  The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposit instruments would be offered to depositors for the same remaining maturities.

Repurchase agreements.  The carrying amount is a reasonable estimate of fair value.

Other borrowings.  The fair values of long-term borrowings are estimated using discounted cash flow analyses based on the interest rates for similar types of borrowing arrangements.

 
Trust preferred capital notes.  Fair value is calculated by discounting the future cash flows using the estimated current interest rates at which similar securities would be issued.

Accrued interest payable.  The carrying amount is a reasonable estimate of fair value.

Off-balance sheet instruments.  The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  At June 30, 2010 and December 31, 2009, the fair value of off balance sheet instruments was deemed immaterial, and therefore was not included in the previous table.

 
22

 
The Company assumes interest rate risk in its normal operations.  As a result, the fair values of the Company’s financial instruments will change when interest rates change and that change may be either favorable or unfavorable to the Company.


Note 15 – Supplemental Cash Flow Information

 
   
Six Months Ended
 
      June 30,
   
2010
   
2009
 
 Supplemental Schedule of Cash and Cash Equivalents:
           
 Cash and due from banks
  $ 11,398     $ 13,905  
 Interest-bearing deposits in other banks
    22,705       26,879  
                 
    $ 34,103     $ 40,784  
                 
 Supplemental Disclosure of Cash Flow Information:
               
 Cash paid for:
               
 Interest on deposits and borrowed funds
  $ 4,358     $ 6,296  
 Income taxes
    2,285       505  
 Noncash investing and financing activities:
               
 Transfer of loans to other real estate owned
    722       1,134  
 Unrealized gain on securities available for sale
    1,238       663  


 
23

 

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The purpose of this discussion is to focus on important factors affecting the financial condition and results of operations of the Company.  The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.


Forward-Looking Statements

This report contains forward-looking statements with respect to the financial condition, results of operations and business of American National Bankshares Inc. and its wholly owned subsidiary, American National Bank and Trust Company (the “Bank”) (collectively referred to as the “Company”).  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on information available to management at the time these statements and disclosures were prepared.  Forward-looking statements are subject to numerous assumptions, estimates, risks, and uncertainties that could cause actual conditions, events, or results to differ materially from those stated or implied by such forward-looking statements.
 
A variety of factors may affect the operations, performance, business strategy, and results of the Company.  Those factors include but are not limited to the following:
 
·  
Financial market volatility including the level of interest rates could affect the values of financial instruments and the amount of net interest income earned;
·  
General economic or business conditions, either nationally or in the market areas in which the Company does business, may be less favorable than expected, resulting in deteriorating credit quality, reduced demand for credit, or a weakened ability to generate deposits;
·  
Competition among financial institutions may increase and competitors may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than the Company;
·  
Businesses that the Company is engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards;
·  
The ability to retain key personnel; and
·  
The failure of assumptions underlying the allowance for loan losses.

Reclassification

In certain circumstances, reclassifications have been made to prior period information to conform to the 2009 presentation.


Critical Accounting Policies

The accounting and reporting policies followed by the Company conform with U.S. generally accepted accounting principles (“GAAP”) and they conform to general practices within the banking industry.  The Company’s critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses and (2) goodwill impairment.  A summary of the Company’s significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements in the Company’s 2009 Annual Report on Form 10-K.

The financial information contained within the Company’s financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred.  A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset, or relieving a liability.  In addition, GAAP itself may change from one previously acceptable method to another method.

 
24

 

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

The allowance for loan losses is an estimate of the losses inherent in the loan portfolio at the balance sheet date.  The allowance is based on two basic principles of accounting: FASB Topic 450-25 Contingencies - Recognition which requires that losses be accrued when they are probable of occurring and estimable and FASB Topic 310-10 Receivables – Overall – Subsequent Measurement which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows, or values observable in the secondary market, and the loan balance.

The Company’s allowance for loan losses has three basic components:  the formula allowance, the specific allowance and the unallocated allowance.  Each of these components is determined based upon estimates that can and do change.  The formula allowance uses a historical loss view as an indicator of future losses along with various qualitative factors, including levels and trends in delinquencies, nonaccrual loans, charge-offs and recoveries; trends in volume and terms of loans; effects of changes in underwriting standards; experience of lending staff and economic conditions; and portfolio concentrations. In the formula allowance, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans.  The adjusted loss factor is multiplied by the period-end balances for each risk-grade category.  The formula allowance is calculated for a range of outcomes.  The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. The unallocated allowance includes estimated losses whose impact on the portfolio has yet to be recognized in either the formula or specific allowance.  The use of these values is inherently subjective and actual losses could be greater or less than the estimates.

The reserve for unfunded loan commitments is an estimate of the losses inherent in off-balance-sheet loan commitments at the balance sheet date.  It is calculated by multiplying an estimated loss factor by an estimated probability of funding, and then by the period-end amounts for unfunded commitments.  The reserve for unfunded loan commitments is included in other liabilities.

Goodwill Impairment

The Company tests goodwill on an annual basis or more frequently if events or circumstances indicate that there may have been impairment.  If the carrying amount of goodwill exceeds its implied fair value, the Company would recognize an impairment loss in an amount equal to that excess.  The goodwill impairment test requires management to make judgments in determining the assumptions used in the calculations.  The goodwill impairment testing conducted by the Company in 2010 indicated that goodwill is not impaired and is properly recorded in the financial statements.  No events or circumstances since December 31, 2009 have occurred that would question the impairment of goodwill.

Non-GAAP Presentations

The analysis of net interest income in this document is performed on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets.


Internet Access to Corporate Documents

The Company provides access to its Securities and Exchange Commission (“SEC”) filings through a link on the Investors Relations page of the Company’s web site at www.amnb.com.  Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are filed electronically with the SEC.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

 
25

 

RESULTS OF OPERATIONS

Earnings Performance

Three months ended June 30, 2010 and 2009

For the quarter ended June 30, 2010, the Company reported net income of $2,014,000 compared to $1,706,000 for the comparable quarter in 2009. The $308,000 or 18.1% increase in earnings was primarily due to:
 
 
·  
a $207,000 decrease in provision for loan losses, primarily related to the decline in overall loan volume,

·  
a $491,000 decrease in noninterest income, primarily related to reduction in income from sale of secondary market mortgages and write downs of foreclosed assets, and

·  
a $728,000 decrease in expenses, related to reductions in personnel and benefits costs and to the FDIC special assessment levied in the 2009 quarter.
 
SUMMARY INCOME STATEMENT
 
(dollars in thousands)
 
For the three months ended
June 30,
 
2010
   
2009
   
$ change
   
% change
 
                         
Interest income
  $ 9,011     $ 9,690     $ (679 )     -7.0 %
Interest expense
    (2,153 )     (2,781 )     628       -22.6 %
Net interest income
    6,858       6,909       (51 )     -0.7 %
Provision for loan losses
    (285 )     (492 )     207       -42.1 %
Noninterest income
    1,762       2,253       (491 )     -21.8 %
Noninterest expense
    (5,593 )     (6,321 )     728       -11.5 %
Income tax expense
    (728 )     (643 )     (85 )     13.2 %
                                 
Net income
  $ 2,014     $ 1,706     $ 308       18.1 %

Six months ended June 30, 2010 and 2009

For the six month period ended June 30, 2010, the Company reported net income of $4,199,000 compared to $2,474,000 for the comparable quarter in 2009. The $1,725,000 or 69.7% increase in earnings was primarily due to:
 
 
·  
a $440,000 increase in net interest income, primarily related to declining deposit rates,

·  
a $272,000 decrease in provision for loan losses, primarily related to the decline in loan volume,

·  
a $696,000 increase in noninterest income, related to various factors, the largest of which was a $1.2 million other real estate write down in the 2009 period, and

·  
a $1,106,000 decrease in expenses, related to reductions in personnel and benefits costs and to the FDIC special assessment levied in the 2009 quarter.

 
26

 
 
SUMMARY INCOME STATEMENT
 
(dollars in thousands)
 
For the six months ended
June 30,
 
2010
   
2009
   
$ change
   
% change
 
                         
Interest income
  $ 18,062     $ 19,340     $ (1,278 )     -6.6 %
Interest expense
    (4,300 )     (6,018 )     1,718       -28.5 %
Net interest income
    13,762       13,322       440       3.3 %
Provision for loan losses
    (570 )     (842 )     272       -32.3 %
Noninterest income
    3,683       2,987       696       23.3 %
Noninterest expense
    (11,090 )     (12,196 )     1,106       -9.1 %
Income tax expense
    (1,586 )     (797 )     (789 )     99.0 %
                                 
Net income
  $ 4,199     $ 2,474     $ 1,725       69.7 %

Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and other funding sources.  Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.  The following discussion of net interest income is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets, such as certain state and municipal securities.  A tax rate of 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.  Net interest income divided by average earning assets is referred to as the net interest margin. The net interest spread represents the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities.


Three months ended June 30, 2010 and 2009

Net interest income on a taxable equivalent basis increased slightly to $43,000 or 0.6%, for the second quarter of 2010 compared to the same quarter of 2009.  Changes in the rate paid and volume of time deposits were the primary drivers of this change in net interest income, as indicated by the Rate/Volume Analysis shown later in this section.

For the second quarter of 2010 and 2009, the Company’s yield on earnings assets was 5.00% compared to 5.33%. The cost of interest bearing liabilities was 1.42% compared to 1.83%. The interest rate spread was 3.58% compared to 3.50%. The net interest margin, on a fully taxable equivalent basis, was 3.85% compared to 3.84%. Yields and rates generally fell between periods, but most of the improvement in spread and margin was related to reductions in liability pricing, notably time deposits.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the three months ended June 30, 2010 and 2009.  Nonaccrual loans are included in average balances.  Interest income on nonaccrual loans, if recognized, is recorded on a cash basis or when the loan returns to accrual status.
 
 
 
27

 
 
Net Interest Income Analysis
 
  For the Three Months Ended June 30, 2010 and 2009  
(in thousands, except rates)
 
                                     
               
Interest
             
   
Average Balance
   
Income/Expense
   
Yield/Rate
 
                                     
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Loans:
                                   
Commercial
  $ 78,673     $ 91,701     $ 939     $ 1,100       4.77 %     4.80 %
Real estate
    437,856       470,859       6,033       6,669       5.51       5.67  
Consumer
    6,485       7,881       137       175       8.45       8.88  
Total loans
    523,014       570,441       7,109       7,944       5.44       5.57  
                                                 
Securities:
                                               
Federal agencies
    66,019       46,225       525       525       3.18       4.54  
Mortgage-backed & CMO's
    45,651       41,382       479       550       4.20       5.32  
State and municipal
    79,622       51,718       1,079       731       5.42       5.65  
  Other
    6,997       8,251       61       72       3.49       3.49  
Total securities
    198,289       147,576       2,144       1,878       4.33       5.09  
                                                 
Deposits in other banks
    25,576       26,882       87       103       1.36       1.53  
                                                 
Total interest-earning assets
    746,879       744,899       9,340       9,925       5.00       5.33  
                                                 
Non-earning assets
    71,861       67,505                                  
                                                 
Total assets
  $ 818,740     $ 812,404                                  
                                                 
Deposits:
                                               
Demand
  $ 96,098     $ 92,447       21       42       0.09       0.18  
Money market
    82,372       78,143       101       148       0.49       0.76  
Savings
    64,561       62,557       22       37       0.14       0.24  
  Time
    271,932       280,729       1,503       1,953       2.21       2.78  
Total deposits
    514,963       513,876       1,647       2,180       1.28       1.70  
                                                 
Customer repurchase agreements
    62,072       60,876       99       176       0.64       1.16  
Other short-term borrowings
    -       1,553       -       1       -       0.26  
Long-term borrowings
    29,212       30,460       407       424       5.57       5.57  
Total interest-bearing
                                               
liabilities
    606,247       606,765       2,153       2,781       1.42       1.83  
                                                 
Noninterest bearing
                                               
demand deposits
    100,493       98,258                                  
Other liabilities
    3,873       4,519                                  
Shareholders' equity
    108,127       102,862                                  
Total liabilities and
                                               
shareholders' equity
  $ 818,740     $ 812,404                                  
                                                 
Interest rate spread
                                    3.58 %     3.50 %
Net interest margin
                                    3.85 %     3.84 %
                                                 
Net interest income (taxable equivalent basis)
              7,187       7,144                  
Less: Taxable equivalent adjustment
                    329       235                  
Net interest income
                  $ 6,858     $ 6,909                  

 
28

 
 

Changes in Net Interest Income (Rate/Volume Analysis)
 
(in thousands)
 
                   
   
Three months ended June 30
 
   
2010 vs. 2009
 
   
Interest
   
Change
 
   
Increase
   
Attributable to
 
Interest income
 
(Decrease)
   
Rate
   
Volume
 
  Loans:
                 
    Commercial
  $ (161 )   $ (5 )   $ (156 )
    Real Estate
    (636 )     (178 )     (458 )
    Consumer
    (38 )     (8 )     (30 )
      Total loans
    (835 )     (191 )     (644 )
  Securities:
                       
    Federal agencies
    -       (185 )     185  
    Mortgage-backed
    (71 )     (124 )     53  
    State and municipal
    348       (31 )     379  
    Other securities
    (11 )     -       (11 )
      Total securities
    266       (340 )     606  
  Deposits in other banks
    (16 )     (11 )     (5 )
      Total interest income
    (585 )     (542 )     (43 )
                         
Interest expense
                       
  Deposits:
                       
    Demand
    (21 )     (23 )     2  
    Money market
    (47 )     (55 )     8  
    Savings
    (15 )     (16 )     1  
    Time
    (450 )     (390 )     (60 )
      Total deposits
    (533 )     (484 )     (49 )
                         
  Customer repurchase agreements
    (77 )     (80 )     3  
  Other borrowings
    (18 )     20       (38 )
      Total interest expense
    (628 )     (544 )     (84 )
Net interest income
  $ 43     $ 2     $ 41  
 
 
Six months ended June 30, 2010 and 2009

Net interest income on a taxable equivalent basis increased $589,000 or 4.28%, for the six months ended June 30, 2010 compared to the comparable period in 2009.  This increase was due primarily to changes in rates and volumes of liabilities, especially time deposits.

For the first six months of 2010 and 2009, the Company’s yield on earnings assets was 5.03% compared to 5.35%. The cost of interest bearing liabilities was 1.43% compared to 1.99%. The interest rate spread was 3.60% compared to 3.36%. The net interest margin, on a fully taxable equivalent basis, was 3.86% compared to 3.72%. Yields and rates generally fell between periods, but most of the improvement in spread and margin was related to reductions in liability pricing, notably time deposits.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the six months ended June 30, 2010 and 2009.  Nonaccrual loans are included in average balances.  Interest income on nonaccrual loans, if recognized, is recorded on a cash basis or when the loan returns to accrual status.
 
 
29

 
Net Interest Income Analysis
 
For the Six Months Ended June 30, 2010 and 2009
 
(in thousands, except rates)
 
                                     
               
Interest
             
   
Average Balance
   
Income/Expense
   
Yield/Rate
 
                                     
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Loans:
                                   
Commercial
  $ 78,974     $ 93,887     $ 1,892     $ 2,200       4.79 %     4.69 %
Real estate
    437,550       470,106       12,128       13,448       5.54       5.72  
Consumer
    6,628       7,888       271       353       8.18       8.95  
Total loans
    523,152       571,881       14,291       16,001       5.46       5.60  
                                                 
Securities:
                                               
Federal agencies
    65,886       45,997       1,076       1,046       3.27       4.55  
Mortgage-backed & CMO's
    44,722       42,962       980       1,112       4.38       5.18  
State and municipal
    73,614       47,247       2,006       1,335       5.45       5.65  
   Other
    7,308       6,641       130       105       3.56       3.16  
Total securities
    191,530       142,847       4,192       3,598       4.38       5.04  
                                                 
Deposits in other banks
    28,094       25,237       178       191       1.27       1.51  
                                                 
Total interest-earning assets
    742,776       739,965       18,661       19,790       5.02       5.35  
                                                 
Non-earning assets
    72,882       68,106                                  
                                                 
Total assets
  $ 815,658     $ 808,071                                  
                                                 
Deposits:
                                               
Demand
  $ 96,578     $ 102,397       42       232       0.09       0.45  
Money market
    81,595       71,433       191       346       0.47       0.97  
Savings
    63,686       61,927       44       77       0.14       0.25  
   Time
    269,256       276,600       3,005       4,052       2.23       2.93  
Total deposits
    511,115       512,357       3,282       4,707       1.28       1.84  
                                                 
Customer repurchase agreements
    63,005       58,477       204       409       0.65       1.40  
Other short-term borrowings
    -       1,811       -       4       -       0.44  
Long-term borrowings
    29,230       32,418       814       898       6       5.54  
Total interest-bearing
                                               
liabilities
    603,350       605,063       4,300       6,018       1.43       1.99  
                                                 
Noninterest bearing
                                               
demand deposits
    99,676       95,748                                  
Other liabilities
    3,818       4,406                                  
Shareholders' equity
    107,814       102,854                                  
Total liabilities and
                                               
shareholders' equity
  $ 814,658     $ 808,071                                  
                                                 
Interest rate spread
                                    3.59 %     3.36 %
Net interest margin
                                    3.87 %     3.72 %
                                                 
Net interest income (taxable equivalent basis)
              14,361       13,772                  
Less: Taxable equivalent adjustment
                    599       450                  
Net interest income
                  $ 13,762     $ 13,322                  

 
30

 


Changes in Net Interest Income (Rate/Volume Analysis)
 
(in thousands)
 
                   
   
Six months ended June 30
 
   
2010 vs. 2009
 
   
Interest
   
Change
 
   
Increase
   
Attributable to
 
Interest income
 
(Decrease)
   
Rate
   
Volume
 
  Loans:
                 
    Commercial
  $ (308 )   $ 48     $ (356 )
    Real Estate
    (1,320 )     (409 )     (911 )
    Consumer
    (82 )     (29 )     (53 )
      Total loans
    (1,710 )     (390 )     (1,320 )
  Securities:
                       
    Federal agencies
    30       (345 )     375  
    Mortgage-backed
    (132 )     (176 )     44  
    State and municipal
    671       (49 )     720  
    Other securities
    25       14       11  
      Total securities
    594       (556 )     1,150  
  Deposits in other banks
    (13 )     (33 )     20  
      Total interest income
    (1,129 )     (979 )     (150 )
                         
Interest expense
                       
  Deposits:
                       
    Demand
    (190 )     (178 )     (12 )
    Money market
    (155 )     (199 )     44  
    Savings
    (33 )     (35 )     2  
    Time
    (1,047 )     (942 )     (105 )
      Total deposits
    (1,425 )     (1,354 )     (71 )
                         
  Repurchase agreements
    (205 )     (235 )     30  
  Other borrowings
    (88 )     49       (137 )
      Total interest expense
    (1,718 )     (1,540 )     (178 )
Net interest income
  $ 589     $ 561     $ 28  


Noninterest Income

All comparisons discussed below are between the second quarter 2010 and the second quarter of 2009, unless otherwise noted.

Noninterest income decreased to $1,762,000 in 2010 from $2,253,000 in 2009, a $491,000 or 21.8% reduction. The major factors impacting that change are discussed below.

Fees from the management of trusts, estates, and asset management accounts increased to $801,000 in 2010 from $767,000 in 2009, a $34,000 or 4.4% increase.  A substantial portion of Trust fees are earned based on account market values, so changes in the equity markets may have a large and potentially volatile impact on revenue.

Service charges on deposit accounts decreased to $483,000 in 2010 from $511,000 in 2009, a $28,000 or 5.5% decline. This reduction was primarily the result of lower deposit account fee volume.

 
31

 
Other fees and commissions increased to $288,000 in 2010 from $251,000 in 2009, an increase of $37,000 or 14.7% due primarily to increases in VISA check card and insurance income. Management expects this income category will decline after implementation of recent banking reform legislation, which is expected to have a negative impact on electronic banking fee income.

Mortgage banking income decreased to $343,000 in 2010 from $568,000 in 2009, a decline of $225,000 or 39.6%. This business area boomed in 2009, but volume has decreased in 2010 with the expiration of the home buyer tax credit and the overall slowdown in the real estate market.

Brokerage fees decreased to $22,000 in 2010 from $73,000 in 2009, a $51,000 or 69.9% decline. The reduction was due to a decline in retail investment activity and personnel turnover.

Securities gains increased to $4,000 for 2010 from $1,000 in 2009. This change was related to gains on early calls of selected government securities.

Foreclosed real estate losses were $281,000 for 2010 compared to $43,000 in 2009.  The major driver in this increased loss in the second quarter of 2010 was a $253,000 charge adjusting the appraised value of certain foreclosed real estate. That same property was written down $1.2 million in the first quarter of 2009.

Noninterest income for the six month period ended June 30, 2010 increased to $3,683,000 compared to $2,987,000 for the 2009 period, $696,000 or 23.3% increase. The biggest driver in this improvement was the other real estate write down, mentioned in the preceding paragraph.

Noninterest Expense

All comparisons discussed below are between the second quarter 2010 and the second quarter of 2009, unless otherwise noted.

Noninterest expense was $5,593,000 for 2010 compared to $6,321,000 for 2009, a $728,000 or 11.5% decrease. The major factors impacting that change are discussed below.
 
 
Salaries were $2,596,000 for 2010 compared to $2,732,000 for 2009, a $136,000 or 5% decrease.  This is primarily the result of a mid-2009 management decision to reduce the number of full time equivalent employees in the Bank by approximately 5% of the workforce. This was accomplished through a combination of retirements, unfilled vacancies, and a small number of layoffs.

Employee benefits were $633,000 for 2010 compared to $832,000 for 2009, a $199,000 or 23.9% decrease. This was due primarily to the change in the Company’s defined benefit plan to a cash balance plan, which was effective December 31, 2009.

FDIC insurance assessment was $199,000 for 2010 compared to $564,000 for 2009, a $365,000 or 64.7% decrease. The decrease was driven by the second quarter 2009 special FDIC insurance assessment, which cost the Company approximately $360,000.

Noninterest expense in the six months ended June 30, 2010 was $11,090,000 compared to $12,196,000 for the same period in 2009, for a decrease of $1,106,000 or 9.1%. This decrease was the result of the same factors discussed above for the quarter.


 
32

 


Income Taxes

The effective tax rate for the second quarter of 2010 was 26.5% compared to 27.4% for the second quarter of 2009.

The effective tax rate for the six months ended June 30, 2010 was 27.4% compared to 24.4% for the same period of 2009.

The effective tax rate is lower than the statutory rate primarily due to income that is not taxable for Federal income tax purposes.  The primary non-taxable income is that of state and municipal securities and industrial revenue bonds or loans. However, in the first quarter of 2009, the effective tax rate was also impacted by the $1.2 million valuation adjustment on certain foreclosed real estate.


Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories.  The most significant effect of inflation is on noninterest expense, which tends to rise during periods of inflation.  Changes in interest rates have a greater impact on a financial institution’s profitability than do the effects of higher costs for goods and services.  Through its balance sheet management practices, the Company has the ability to react to those changes and measure and monitor its interest rate and liquidity risk.  During the reported periods, inflation and interest rates have been very low.




CHANGES IN FINANCIAL POSITION

BALANCE SHEET ANALYSIS

Securities

The securities portfolio generates income, plays a major role in the management of interest rate sensitivity, provides a source of liquidity, is used to meet collateral requirements for public deposits, and facilitates commercial customers’ repurchase agreements.  The portfolio consists primarily of high quality, investment-grade securities.  Federal agency and U. S. government sponsored enterprises, mortgage-backed securities, and state and municipal securities comprise the majority of the portfolio.

The available for sale securities portfolio was $211,574,000 at June 30, 2010 compared to $188,795,000 at December 31, 2009, a $22,779,000 or 12.1% increase.

The held to maturity securities portfolio decreased to $4,823,000 at June 31, 2010 from $6,529,000 at December 31, 2009, a $1,706,000 or 26.1% decline. As a practical matter, virtually any new security purchase is classified as available for sale.

At June 30, 2010, the available for sale portfolio had an estimated fair value of $211,574,000 and an amortized cost of $206,182,000, resulting in a net unrealized gain of $5,392,000.

At the same dates, the held to maturity portfolio had an estimated fair value of $5,028,000 and an amortized cost of $4,823,000, resulting in a net unrealized gain of $205,000.

 
33

 
At June 30, 2010, mortgage-backed securities consist principally of obligations of U.S. Government sponsored enterprises.  CMOs (collateralized mortgage obligations) issued by non-U.S. Government sponsored enterprises, as of June 30, 2010, had an amortized cost of $2,014,000 and an estimated fair value of $1,769,000; resulting in an estimated net unrealized loss of $245,000. One of these bonds, with a $629,000 book value was downgraded in the first quarter by Standard and Poor’s to CCC status. After reviewing the security, management elected to take an OTTI charge of $31,000 against the bond. The current estimated market value of the security is $428,000, resulting in an estimated unrealized loss of $201,000.

The current economic challenges on a local, regional and national level have resulted in a significant slowdown in business activity throughout 2009 and continuing into 2010. This slowdown has manifested itself on the Company’s balance sheet with a moderate reduction in the size of our loan portfolio, a slight increase in deposits and a substantial increase in our investment portfolio. The Company is cognizant of the historically low interest rate environment and has elected to maintain an investment strategy of purchasing high quality taxable securities of relatively short duration and longer term tax exempt securities, whose market values are not as volatile in rising rate environments as similar termed taxable investments.

Loans

The loan portfolio consists primarily of commercial and residential real estate loans, commercial loans, construction and land development loans, and home equity loans. Loans were $519,416,000 at June 30, 2010 compared to $527,991,000 at December 31, 2009, an $8,575,000 or 1.6% decrease. Management considers the decline in the loan portfolio primarily the result of the current economic climate and the overall slowdown in business activity and, secondarily, the Company’s deliberate decision to maintain a conservative risk profile in consideration of long term asset quality.


Allowance for Loan Losses, Asset Quality, and Credit Risk Management

The allowance for loan losses was $8,135,000 at June 30, 2010 compared to $8,166,000 at December 31, 2009.  At the same dates, the allowance was 1.57% of loans compared to 1.55%. The dollar amount of the reserve is slightly decreased during the period and is directionally consistent with the decrease in total loans, although not consistent in percentage magnitude. Management considers the size of the allowance appropriate because of continuing deterioration and negative trends in the local and regional economy, including unemployment, delinquency and foreclosure rates in Virginia and North Carolina. Bank management is aware of the possible financial impact of extended economic stress in our marketplace and has incorporated that into its qualitative assessment of the allowance for loan loss.

Annualized net charge-offs represented 0.20% of total loans during the second quarter of 2010 compared to 0.26% in the first quarter of 2010 and 0.28% in the second quarter of 2009.

Nonperforming loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and any loans classified as troubled debt restructurings.  Nonperforming assets include nonperforming loans and foreclosed real estate.  Nonperforming assets represented 0.93% and 0.87% of total assets, respectively, at June 30, 2010 and December 31, 2009.  There were no troubled debt restructurings at June 30, 2010 and December 31, 2009.


 
34

 


The following table summarizes nonperforming assets (in thousands):

   
June 30,
   
December 31,
 
   
2010
   
2009
 
Loans 90 days or more past due
  $ 8     $ -  
Nonaccrual loans
    4,005       3,642  
     Nonperforming loans
    4,013       3,642  
Foreclosed real estate
    3,730       3,414  
Nonperforming assets
  $ 7,743     $ 7,056  
                 

Premises and equipment

Premises and equipment were $19,658,000 at June 30, 2010 compared to $19,195,000, at December 31, 2009, a $463,000 or 2.4% increase. Most of this increase was related to the construction of a new branch in South Boston, Virginia, whose completion is expected by September 2010.


Deposits

The Company’s deposits consist primarily of checking, money market, savings, and consumer time deposits.  Total deposits were $630,151,000 at June 30, 2010 compared to $604,273,000 at December 31, 2009, a $25,878,000 or 4.3% increase. Core deposit growth continues to be an ongoing strategic goal and challenge for the Company and the community banking industry in general.


Shareholders’ Equity

The Company’s capital management strategy is to be classified as “well capitalized” under regulatory capital ratios and provide as high as possible total return to our shareholders.

Shareholders’ equity was $108,760,000 at June 30, 2010 compared to $106,389,000 at December 31, 2009, an increase of $2,371,000 or 2.2%.

The Company paid cash dividends of $0.23 per share during the second quarter of 2010 while the basic and diluted earnings per share for the same period were $0.33 per share.  The Company paid cash dividends of $0.46 per share for the first half of 2010 while the basic and diluted earnings per share were $0.69 per share.  The Company’s current capital position provided the Board of Directors with the strategic flexibility to temporarily pay a cash dividend relatively high relative to current earnings.

Banking regulators have defined minimum regulatory capital ratios that the Company and its banking subsidiary are required to maintain.  These ratios take into account risk factors identified by those regulatory authorities associated with the assets and off-balance sheet activities of financial institutions.  The guidelines require percentages, or “risk weights,” be applied to those assets and off-balance sheet assets in relation to their perceived risk.  Under the guidelines, capital strength is measured in two tiers.  Tier I capital consists primarily of shareholders’ equity and trust preferred capital notes, while Tier II capital consists of qualifying allowance for loan losses. “Total” capital is the combination of Tier I and Tier II capital.  Another regulatory indicator of capital adequacy is the leverage ratio, which is computed by dividing Tier I capital by average quarterly assets less intangible assets.

The regulatory guidelines require that minimum total capital (Tier I plus Tier II) of 8% be held against total risk-adjusted assets, at least half of which (4%) must be Tier I capital.  At June 30, 2010, the Company's Tier I and total capital ratios were 18.18% and 19.43%, respectively.  At December 31, 2009, these ratios were 17.56% and 18.82%, respectively.  The ratios for both periods were in excess of the regulatory requirements.  The Company's leverage ratio was 12.95% and 12.81% at June 30, 2010 and December 31, 2009, respectively.  The leverage ratio has a regulatory minimum of 4%, with most institutions required to maintain a ratio of 4-5%, depending upon risk profiles and other factors.

 
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As mandated by bank regulations, the following five capital categories are identified for insured depository institutions:  "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized."  These regulations require the federal banking regulators to take prompt corrective action with respect to insured depository institutions that do not meet minimum capital requirements. Under the regulations, well capitalized institutions must have Tier I risk-based capital ratios of at least 6%, total risk-based capital ratios of at least 10%, and leverage ratios of at least 5%, and not be subject to capital directive orders. Management believes, as of June 30, 2010, that the Company met the requirements to be considered “well capitalized."

 
Off-Balance-Sheet Activities

The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions.  Other than AMNB Statutory Trust I, formed in 2006 to issue Trust Preferred Securities, the Company does not have any off-balance sheet subsidiaries.  Off-balance sheet transactions were as follows (in thousands):


   
June 30,
2010
   
December 31,
2009
 
             
Commitments to extend credit
  $ 133,353     $ 133,692  
Standby letters of credit
    1,986       2,624  
Mortgage loan rate-lock commitments
    3,980       2,054  

Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates or other termination clauses.  Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future funding requirements.  Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements.

 
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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Management

Effectively managing market risk is essential to achieving the Company’s financial objectives.  Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices.  The Company is not subject to currency exchange risk or commodity price risk.  The Company’s primary market risk exposure is interest rate risk; however, market risk also includes liquidity risk.  Both are discussed below.

Interest Rate Risk Management
 
Interest rate risk and its impact on net interest income is a primary market risk exposure.  The Company manages its exposure to fluctuations in interest rates through policies approved by its Asset/Liability Investment Committee (“ALCO”) and Board of Directors, both of which receive and review periodic reports of the Company’s interest rate risk position.
 
 The Company uses simulation analysis to measure the sensitivity of projected earnings to changes in interest rates.  Simulation takes into account current balance sheet volumes and the scheduled repricing dates and maturities of assets and liabilities.  It incorporates numerous assumptions including growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid.  Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

A balance sheet is considered asset sensitive when its earning assets (loans and securities) reprice faster than its liabilities (deposits and borrowings).  An asset sensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when they decline.  Based on the Company’s simulation analysis, management believes the Company’s interest sensitivity position is asset sensitive.  The simulation projects that if rates increase over a 12 month period by one percent, net interest income is expected to increase by 4.3%. Management has no expectation that market rates will decline in the near term, given the prevailing economy.

Liquidity Risk Management

Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities.  Liquidity management involves maintaining the Company’s ability to meet the daily cash flow requirements of its customers, whether they are borrowers requiring funds to meet their credit needs or depositors desiring to withdraw funds.  Additionally, the parent company requires cash for various operating needs including dividends to shareholders, stock repurchases, the servicing of debt, and the payment of general corporate expenses.  The Company manages its exposure to fluctuations in interest rates through policies approved by the ALCO and Board of Directors, both of which receive periodic reports of the Company’s interest rate risk position.  The Company uses a simulation and budget model to manage the future liquidity needs of the Company.

Liquidity sources include cash and amounts due from banks, deposits in other banks, loan repayments, increases in deposits, lines of credit from the Federal Home Loan Bank of Atlanta (“FHLB”) and  the Federal Reserve Bank’s discount window, federal funds lines of credit from two correspondent banks, and maturities and sales of securities.  Management believes that these sources provide sufficient and timely liquidity.

The Company has a line of credit with the FHLB, equal to 30% of the Company’s assets, subject to the amount of collateral pledged.  Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans and home equity lines of credit.  In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB.  At June 30, 2010, principal obligations to the FHLB consisted of $8,563,000 in fixed-rate, long-term advances compared to $8,638,000 at December 31, 2009.  In addition, for the same periods, the Company had outstanding $40 million in letters of credit. The letters of credit provide the Bank with alternate collateral for securing public entity deposits above FDIC insurance levels, thereby providing less need for pledging from the bond portfolio.

 
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The Company had fixed-rate term borrowing contracts with the FHLB as of June 30, 2010, with the following final maturities (in thousands):

Amount
 
Maturity Date
$ 4,000,000  
March 2011
  4,000,000  
April 2011
  563,000  
March 2014
$ 8,563,000    

The Company has federal funds lines of credit established with two other banks in the amounts of $15,000,000 and $10,000,000, and has access to the Federal Reserve Bank’s discount window.  There were no amounts outstanding under these facilities at June 30, 2010.

There have been no material changes to market risk as disclosed in the Company’s 2009 Annual Report on Form 10-K.  Refer to those disclosures for further information.


ITEM 4.  CONTROLS AND PROCEDURES

 
Disclosure Controls and Procedures
 
 
The Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated 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 June 30 , 2010. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.  There were no significant changes in the Company's internal controls over financial reporting that occurred during the quarter ended June 30, 2010 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
 

 
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PART II
 
OTHER INFORMATION

Item:
 
1.
Legal Proceedings
The nature of the business of the Company ordinarily results in a certain amount of litigation. The Company is involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Company.

       1A.
Risk Factors
 
There have been no material changes to the risk factors disclosed in the Company’s 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 12, 2010.

 
2.  
Unregistered Sales of Equity Securities and Use of Proceeds
None

 
3.
Defaults Upon Senior Securities
 
None

 
4.  
(Removed and Reserved)

5.      Other Information
(a)  Required 8-K disclosures
None
(b)  Changes in Nominating Process
None

 
6.
Exhibits
 
  3.1     
Articles of Incorporation (as amended June 1, 2010)
 
  3.2
Bylaws (as amended May 18, 2010)
 
11.
Refer to EPS calculation in the Notes to Financial Statements
 
31.1
Section 302 Certification of Charles H. Majors, President and Chief Executive Officer
 
31.2
Section 302 Certification of William W. Traynham, Senior Vice President and Chief Financial Officer
 
32.1
Section 906 Certification of Charles H. Majors, President and Chief Executive Officer
 
32.2
Section 906 Certification of William W. Traynham, Senior Vice President and Chief Financial Officer


 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

AMERICAN NATIONAL BANKSHARES INC.
     
     
     
 
/s/ Charles H. Majors
 
 
Charles H. Majors
 
Date – August 5, 2010
President and Chief Executive Officer
 
     
 
/s/ William W. Traynham
 
 
William W. Traynham
 
 
Senior Vice President and
 
Date – August 5, 2010
Chief Financial Officer
 


 
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