-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ONqWjCJ1F7IG3KDmDpPyQBPcmY0Ma0n5+KNv16QRWdfXUQyxj+NDlG7I36Q2Z9/v sIMP1zf1YFT6YmdvYPv+kg== 0000741516-99-000003.txt : 19990323 0000741516-99-000003.hdr.sgml : 19990323 ACCESSION NUMBER: 0000741516-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990322 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN NATIONAL BANKSHARES INC CENTRAL INDEX KEY: 0000741516 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541284688 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-12820 FILM NUMBER: 99569566 BUSINESS ADDRESS: STREET 1: 628 MAIN ST STREET 2: PO BOX 191 CITY: DANVILLE STATE: VA ZIP: 24543 BUSINESS PHONE: 8047925111 MAIL ADDRESS: STREET 1: 628 MAIN STREET CITY: DANVILLE STATE: VA ZIP: 24541 10-K 1 1998 10K FOR AMERICAN NATIONAL BANKSHARES INC. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 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) Registrant's telephone number, including area code: 804-792-5111 ----------------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Title of each class ------------------- None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Title of each class ------------------- Common Stock ($1.00 Par Value) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes X No Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Outstanding at March 9, 1999 ----- ---------------------------- Common Stock ($1.00 Par Value) 3,051,733 Shares State the aggregate market value of the voting stock held by non-affiliates of the registrant Aggregate market value of voting Based upon the price of the most stock held by non-affiliates recent sale known to management as of -------------------------------- ------------------------------------- $81,404,000 March 9, 1999 DOCUMENTS INCORPORATED BY REFERENCE None II-1 CROSS REFERENCE Page ---- PART I ITEM 1 - Business II 4 ITEM 2 - Properties II 5 ITEM 3 - Legal Proceedings There are no legal actions or proceedings pending to which the Corporation is a party. ITEM 4 - Submission of Matters to a Vote of Security Holders None. PART II ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters II 5 ITEM 6 - Selected Financial Data II 6 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations II 7 - 24 ITEM 7A- Quantitative and Qualitative Disclosures about Market Risk II 15 - 18 ITEM 8 - Financial Statements and Supplementary Data Report of Independent Public Accountants II 26 Consolidated Balance Sheets at December 31, 1998 and 1997 II 27 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 1998 II 28 Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three-year period ended December 31, 1998 II 29 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 1998 II 30 Notes to Consolidated Financial Statements II 31 - 43 Quarterly Financial Results for 1998 and 1997 II 24 ITEM 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure There have been no changes in or disagreements with accountants on accounting and financial disclosure. PART III ITEM 10 - Directors and Executive Officers of the Registrant I 3 - 6 ITEM 11 - Executive Compensation I 6, 8 - 11 ITEM 12 - Security Ownership of Certain Beneficial Owners and Management I 3 - 5 ITEM 13 - Certain Relationships and Related Transactions I 10 - 12, II 39 PART IV ITEM 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements (See Item 8 for reference) Exhibit 2.1 Agreement and Plan of Reorganization, dated as of Exhibit 2.1 on Form 8-K September 26, 1995, by and between American National filed September 27, 1995 Bankshares Inc. and Mutual Savings Bank, F.S.B. 2.2 Plan of Merger, dated as of September 26, 1995, by Exhibit 2.2 on form 8-K and between American National Bank and Trust filed September 27, 1995 Company and Mutual Savings Bank, F.S.B. 3.1 Amended and Restated Articles of Incorporation Exhibit 4.1 on Form S-3 dated August 20, 1997 filed August 20, 1997 3.2 Amended Bylaws dated August 20, 1997 Exhibit 4.2 on Form S-3 filed August 20, 1997 II-2 10.1 Agreement between American National Bank and Exhibit 4a on Form 10-K Trust Company and James A. Motley dated filed March 28, 1994 August 26, 1982, as amended August 11, 1987 10.2 Agreement between American National Bank and Trust Exhibit 10.2 on Form 10-K Company and Charles H. Majors dated June 12, 1997 filed March 27, 1998 10.3 Agreement between American National Bank and Trust Exhibit 10.3 on Form 10-K Company and E. Budge Kent, Jr. dated June 12, 1997 filed March 27, 1998 10.4 Agreement between American National Bank and Trust Exhibit 10.4 on Form 10-K Company and David Hyler dated June 12, 1997 filed March 27, 1998 10.5 Agreement between American National Bank and Trust Exhibit 10.5 on Form 10-K Company and Gilmer D. Jefferson dated June 12, 1997 filed March 27, 1998 10.6 Agreement between American National Bank and Trust Exhibit 10.6 on Form 10-K Company and Carl T. Yeatts dated June 12, 1997 filed March 27, 1998 10.7 American National Bankshares Inc. Stock Option Plan dated Exhibit 4.3 on form S-8 August 19, 1997 filed September 17, 1997 10.1 Agreement between American National Bank and Trust Exhibit 10.1 on Form 10-Q Company and T. Allen Liles dated June 1, 1998 filed August 13, 1998 27.0 Financial Data Schedule Exhibit 27 99.1 Text of joint press release, dated September Exhibit 99.1 on Form 8-K 26, 1995, issued by American National Bankshares filed September 27, 1995 Inc. and Mutual Savings Bank, F.S.B. 99.2 American National Bankshares Inc. Dividend Reinvestment Exhibit 99 on Form S-3 Plan dated August 19, 1997 filed August 20, 1997 (b) Reports on Form 8-K No reports on Form 8-K were filed during the fourth quarter of 1998.
II-3 ITEM 1 - Business American National Bankshares Inc. ("the Corporation") is a one-bank holding company, which was organized under the laws of the State of Virginia in 1984. On September 1, 1984, the Corporation acquired all of the outstanding capital stock of American National Bank and Trust Company ("the Bank"), a National Banking Association chartered in 1909 under the laws of the United States. The Bank is the only subsidiary of the Corporation. At December 31, 1999 the Corporation employed 179 persons (FTE). American National Bank and Trust Company The Bank has been operating as a commercial bank in Danville, Virginia since its organization in 1909. On March 14, 1996, the Corporation completed the acquisition of Mutual Savings Bank, F.S.B. ("Mutual") and Mutual was merged with and into American National Bank and Trust Company. In this transaction the Corporation exchanged 879,798 common shares, at an exchange ratio of .705 of a share of the Corporation's common stock, for each of Mutual's 1,248,100 common shares. The operations of the Bank are conducted at eleven offices located throughout the Bank's trade area, which includes the City of Danville, City of Martinsville, Pittsylvania and Henry Counties in Virginia, Town of Yanceyville and the northern half of Caswell County in North Carolina. Seven of these offices are located in Danville, one office each in Gretna, Chatham, and Collinsville, Virginia and Yanceyville, North Carolina. The Bank also has eleven automated teller machines at various locations in the trade area. The Bank offers all services normally offered by a full-service commercial bank, including commercial and individual demand and time deposit accounts, commercial and individual loans and trust services. Competition The Bank's primary service area is generally defined as the City of Danville, City of Martinsville, Pittsylvania and Henry Counties in Virginia, Town of Yanceyville and the northern half of Caswell County in North Carolina. Vigorous competition exists in this service area. The Bank competes not only with other commercial banks but also with diversified financial institutions, money market and mutual funds, and mortgage and finance companies. As of March 22, 1999, there were approximately 17 banks operating in this service area. American National Bank and Trust Company has the largest market share in Danville and Pittsylvania County. No new banks or savings and loan associations have been chartered in the Danville area in the past five years. Several branch offices of existing banks have been opened in this trade area in the past two years. Supervision and Regulation The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956 ("the Act") and is registered as such with the Board of Governors of the Federal Reserve System ("the Federal Reserve Board"). As a bank holding company, the Corporation is required to file with the Federal Reserve Board an annual report and such other information as may be required. The Federal Reserve Board may also make examinations of the Corporation. The operations of the Bank are subject to federal statutes and to regulations of the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation, which insures the Bank's deposits. The primary supervisory authority over the Bank is the Comptroller of the Currency, which regularly examines such areas as reserves, loans, investments, management practices and other aspects of the Bank's operations. These examinations are designed primarily for the protection of the Bank's depositors. In addition to these regular examinations, the Bank must furnish the Comptroller periodic reports containing a full and accurate statement of its affairs. As a national bank, the Bank is a member of the Federal Reserve System and is affected by general fiscal and monetary policies of the Federal Reserve Board. The techniques used by the Federal Reserve Board include setting the reserve requirements of member banks and establishing the discount rate on member bank borrowings. Government Monetary Policies and Economic Controls The policies of the Federal Reserve Board have a direct effect on the amount of bank loans and deposits and the interest rates charged and paid thereon. While current economic conditions, the policies of the Federal Reserve Board (and other regulatory authorities) designed to deal with these conditions and the impact of such conditions and policies upon the future business and earnings of the Bank cannot accurately be predicted, they can materially affect the revenues and income of commercial banks. Foreign Operations The Corporation does not engage in any foreign operations. Executive Officers This information is incorporated by reference to the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders. II-4 ITEM 2 - PROPERTIES The principal executive offices of the Corporation as well as the principal executive offices of the Bank are located at 628 Main Street, Danville, Virginia. As of March 12, 1999 the Bank maintained eleven full service offices. Seven are located within the City of Danville, with others located at Gretna, Chatham, and Collinsville, Virginia and Yanceyville, North Carolina. The Bank owns and operates eleven Automated Teller Machines ("ATMs"). The Bank owns a parking lot for its employees fronting on Ridge Street in close proximity to the main office. The Bank also owns approximately 2.5 acres of land on Piedmont Drive in Danville, opposite of Piedmont Mall for future expansion of its retail banking operations. There are no mortgages or liens against any property of the Bank or the Corporation. Bank Offices Main Office 628 Main Street, Danville, Virginia 24541 Nor-Dan Office 239 Nor-Dan Drive, Danville, Virginia 24540 Riverside Office 1081 Riverside Drive, Danville, Virginia 24540 South Boston Road Office 1407 South Boston Road, Danville, Virginia 24540 South Main Office 1013 South Main Street, Danville, Virginia 24541 Tower Drive Office 103 Tower Drive, Danville, Virginia 24540 West Main Office* 2016 West Main Street, Danville, Virginia 24541 Chatham Office 13880 U.S. Highway 29, Chatham, Virginia 24531 Collinsville Office 2484 Virginia Avenue, Collinsville, Virginia 24078 Gretna Office 109 Main Street, Gretna, Virginia 24557 Yanceyville Office 173 Main Street, Yanceyville, North Carolina 27379 ATM LOCATIONS Drive-Up Riverside Office 1081 Riverside Drive, Danville, Virginia 24540 South Boston Road Office 1407 South Boston Road, Danville, Virginia 24540 Chatham Office 13880 U.S. Highway 29, Chatham, Virginia 24531 Collinsville Office 2484 Virginia Avenue, Collinsville, Virginia 24078 Huffman's Car Wash* 596 West Main Street, Danville, Virginia 24541 Hillcrest Shopping Center* Highways 86 & 158, Yanceyville, North Carolina 27379 Walk-Up Nor-Dan Office 239 Nor-Dan Drive, Danville, Virginia 24540 West Main Office 2016 West Main Street, Danville, Virginia 24541 Danville Regional Medical Ctr* 142 South Main Street, Danville, Virginia 24541 Piedmont Mall* 325 Piedmont Drive, Danville, Virginia 24540 Liberty Fair Mall* 240 Commonwealth Boulevard, Martinsville, Virginia 24112 * Leased
ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters The Corporation's common stock is not traded on any stock exchange but is listed on the OTC (Over The Counter) Bulletin Board under the symbol "AMNB". At March 12, 1999 the Corporation had 1,411 shareholders. The tables below present the high and low sales' prices known to management for the Corporation's common stock and dividends declared for the past two years. Market value and dividends are shown per share and are based on 3,051,733 shares outstanding for 1997 and 1998.
First Second Third Fourth Market Price Quarter Quarter Quarter Quarter - ------------ ------- ------- ------- ------- 1998 Common Stock $28.75 - 32.50 $28.75 - 31.00 $26.00 - 31.00 $27.00 - 33.00 1997 Common Stock $23.50 - 24.75 $23.50 - 27.00 $26.25 - 28.25 $27.25 - 32.00
Per Share First Second Third Fourth Dividends Declared Quarter Quarter Quarter Quarter Total - ------------------ ------- ------- ------- ------- ----- 1998 Common Stock $ .21 $ .24 $ .24 $ .24 $ .93 1997 Common Stock $ .18 $ .21 $ .21 $ .21 $ .81
II-5 Summary of Selected Consolidated Financial Data (in thousands, except per share amounts) American National Bankshares Inc & Subsidiary
1998 1997 1996 1995 1994 Operations Information: ----------- ----------- ----------- ----------- ----------- Interest income: Loans............................................ $ 23,356 $ 22,441 $ 20,335 $ 18,432 $ 14,923 Federal funds sold and other..................... 272 237 435 202 210 Investment securities............................ 9,026 9,050 9,162 7,300 6,701 ----------- ----------- ----------- ----------- ----------- Total interest income.......................... 32,654 31,728 29,932 25,934 21,834 Interest expense................................... 14,472 14,590 14,370 11,484 8,919 ----------- ----------- ----------- ----------- ----------- Net interest income................................ 18,182 17,138 15,562 14,450 12,915 Provision for loan losses.......................... (927) (1,100) (673) (484) (272) Non-interest income................................ 4,029 3,201 2,691 2,035 2,122 Non-interest expense............................... (10,963) (10,245) (10,167) (8,702) (8,150) ----------- ----------- ----------- ----------- ----------- Income before income taxes......................... 10,321 8,994 7,413 7,299 6,615 Income taxes....................................... 3,123 2,725 2,381 2,283 2,106 ----------- ----------- ----------- ----------- ----------- Net income......................................... $ 7,198 $ 6,269 $ 5,032 $ 5,016 $ 4,509 =========== =========== =========== =========== =========== Balance Sheet Information: Investment securities.............................. $163,413 $143,077 $175,757 $149,208 $122,509 Net loans.......................................... 265,698 251,173 233,509 212,684 188,034 Total deposits..................................... 358,325 351,603 361,983 327,342 282,791 Shareholders' equity............................... 54,861 50,003 52,218 48,912 45,045 Total assets....................................... 460,383 423,640 440,158 388,479 337,355 Per Share Information:* Net income (basic and diluted)..................... $ 2.36 $ 1.99 $ 1.54 $ 1.56 $ 1.40 Dividends.......................................... .93 .81 .69 .56 .75 Book value......................................... 17.98 16.39 15.92 15.22 14.02 Ratios: Return on average assets........................... 1.64% 1.47% 1.24% 1.43% 1.37% Return on average shareholders' equity............. 13.79% 12.51% 10.12% 10.62% 10.13% Total risk-based capital/assets.................... 18.04% 18.37% 20.66% 23.67% 25.98% Shareholders' equity/assets........................ 11.92% 11.80% 11.86% 12.59% 13.35% Net charge-offs to average net loans............... .15% .36% .17% .09% .04% Reserve for loan losses to period-end loans, net of unearned income.................... 1.42% 1.29% 1.30% 1.28% 1.29% The financial information for years 1994 through 1995 has been restated to reflect the merger with Mutual Savings Bank, FSB. * Per share amounts are based on average shares outstanding.
II-6 MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS American National Bankshares Inc. ("the Corporation") was organized in 1984 for the purpose of acquiring all of the outstanding shares of American National Bank and Trust Company ("the Bank"). The Bank was chartered and opened for business in February 1909. Under an agreement and plan of merger, the Bank was acquired by the Corporation on September 1, 1984. On March 14, 1996, the Corporation completed the merger of Mutual Savings Bank, F.S.B. ("Mutual") into the Bank, upon the approval of the shareholders of each company. The Corporation exchanged 879,805 common shares, at an exchange ratio of .705 of a share of the Corporation's common stock for each outstanding share of Mutual common stock, for Mutual's 1,248,100 common shares. The transaction was accounted for as a pooling of interests. The financial position and results of operations of the Corporation and Mutual were combined and the fiscal year of Mutual was conformed to the Corporation's fiscal year. In addition, all prior periods presented have been restated to give effect to the merger. In March 1996 the shareholders of the Corporation approved an amendment to the articles of incorporation to increase the number of authorized shares of the Corporation's common stock from 3,000,000 shares to 10,000,000 shares. On August 25, 1996 the Corporation entered into an agreement with FirstSouth Bank of Burlington, North Carolina to purchase the branch office and associated ATM of FirstSouth Bank located in Yanceyville, (Caswell County) North Carolina. This acquisition was completed October 25, 1996. The transaction was accounted for as a purchase. Performance Summary The Corporation and Bank reported record profitability during 1998. Net income of $7,198,000 for 1998 increased by $929,000 or 15% over net income of $6,269,000 for 1997. The economy of the Bank's trade area continues to be healthy as evidenced by another year of positive loan demand. During 1998, net loans increased $14,525,000, or 6% while total deposits increased $6,722,000, or 2%. Total deposits and repurchase agreements with customers increased $19,706,000, or 5%, during 1998. Earnings and Capital Net income per diluted share was $2.36 in 1998, $1.99 in 1997, and $1.54 in 1996. Shareholders' equity increased $4,858,000 in 1998 from the retention of 1998 earnings and from an increase in net unrealized gains on securities available for sale. Shareholders' equity decreased during 1997 by $2,215,000 or 4% through the repurchase of 228,065 shares of common stock for $6,278,000. The reduction from stock repurchase was offset by retention of 1997 earnings and an increase in net unrealized gains on securities available for sale. This followed an increase in capital of $3,306,000 or 7%, in 1996 from retention of 1996 earnings of $2,889,000, proceeds of $731,000 from exercise of stock options less a reduction of $314,000 in net unrealized gains on securities available for sale. Shareholders' equity was 11.9% of assets at December 31, 1998 and 11.8% at December 31, 1997. Shareholders' equity was $54,861,000 at December 31, 1998 and $50,003,000 at December 31, 1997. The total market value of American National Bankshares Inc. common stock at $33.00 per share (the last trade recorded on the OTC Bulletin Board during 1998) was $100,707,000. The market value of the Corporation's common stock was 184 percent of its book value. Book value per common share was $17.98 at the close of 1998. During 1998, the Corporation increased its reserve for loan losses to $3,821,000, an increase of $544,000 or 17% from 1997. The reserve, as a percentage of loans, was 1.42% at December 31, 1998 and 1.29% at December 31, 1997. The return of net income on average total assets was 1.64% in 1998 compared to 1.47% in 1997 and 1.24% in 1996. The return on average shareholders' equity was 13.79% in 1998 compared to 12.51% in 1997 and 10.12% in 1996. Mergers and Acquisitions On March 14, 1996 American National Bankshares Inc. exchanged .705 of a share of its common stock for each share of Mutual common stock. Based on American National Bankshares stock price as of February 27, 1996 of $27, the transaction represented an exchange value of approximately $19.04 for each share of Mutual common stock. The purchase price was 1.69 times Mutual's June 30, 1995 book value. The merger was accounted for as a pooling of interests. At the consummation of the merger on March 14, 1996, Mutual had total assets of $84,718,000, total deposits of $67,996,000 and shareholders' equity of $15,958,000. II-7 On October 25, 1996 the Bank purchased the branch office and associated ATM of FirstSouth Bank located in Yanceyville, (Caswell County) North Carolina. The Bank assumed $21,405,000 in deposits and purchased $4,775,000 in loans as well as the building, furniture, fixtures and equipment. The Bank paid a premium of $1,516,000, approximately 7% of the deposits assumed. The transaction was accounted for as a purchase and the premium was recorded as a core deposit intangible asset. The Yanceyville branch office is approximately 12 miles from the City of Danville and Management views this as a natural expansion of the Corporation's market area. The Bank already serves many customers who work in the greater Danville area but reside in Yanceyville and Caswell County. Trends and Future Events The economic conditions of the Corporation's trade area have continued to be healthy during 1998 as evidenced by another year of positive loan and deposit growth. The Corporation's net loans grew at a rate of 6% during 1998 following an 8% increase in 1997. Total deposits increased 2% during 1998 following a 3% decline in 1997. The Bank executed a planned strategy to reduce high cost time deposits during 1997. The weighted average yield on interest earning assets remained stable and the weighted average cost of interest-bearing liabilities decreased during 1998 due to growth in loans, due to higher yielding investments and due to lower yields paid on interest-bearing liabilities. As a result of the Corporation's asset and liability strategies and increased loan demand, the Corporation was able to increase its net interest income (interest income less interest expense) by 6%. Although Management believes the Corporation has positioned itself to continue to maintain this level of net interest income into the near future, increased competition and slowing loan and deposit growth could negatively impact net interest income. During 1998, time deposits decreased by $456,000 and savings deposits decreased by $930,000 as falling interest rates and an increasing stock market attracted investment funds. Interest bearing demand deposits increased $3,854,000 or 7%, and non-interest bearing demand deposits increased $3,316,000 or 8%. Money market deposits increased $938,000, or 5%. Repurchase agreements which are short term investments for businesses and individuals and not included in deposits increased $12,984,000, or 72%, during 1998. Total deposits increased $6,722,000 or 2% during 1998 after decreasing $10,380,000 or 3% during 1997. Pursuant to the Agreement and Plan of Reorganization by and between Mutual and the Corporation, Mutual Mortgage of the Piedmont, Inc. ("Mutual Mortgage") was organized in 1996 as a wholly owned subsidiary of American National Bank and Trust Company. The primary purpose of this organization is to originate and sell mortgage loans. Mutual Mortgage began operations on December 2, 1996. Its main office is located in the Bank's branch office building at 103 Tower Drive. The financial condition and results of operations of Mutual Mortgage are included in the Consolidated Balance Sheets and Consolidated Statements of Income of the Corporation. On September 29, 1998 the Federal Reserve Board ("FRB") decreased short term interest rates by cutting federal funds by 1/4% and the major money center banks followed by lowering the prime rate by 1/4%. On October 15 and November 17, 1998 the Federal Reserve decreased short term rates again by cutting federal funds and the discount rate by 1/4%, and major money center banks followed by lowering the prime rate by 1/4% on both occasions. Short and intermediate U.S. Treasury yields had already preceded the Federal Reserve actions by declining more than 1% from June 1998 to October 1998 in response to the global financial crisis, losses in hedge funds and low inflation. The Federal Reserve actions in lowering interest rates were designed to stabilize financial markets and to offset perceived deteriorating economic conditions caused by the global financial crisis. As mandated by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the FDIC adopted regulations effective January 1, 1993, for the transition from a flat-rate insurance assessment system to a risk-based system by January 1, 1994. Pursuant to these regulations, the Bank's deposit insurance assessment was reduced to a minimum $2,000 in 1996 and set at approximately $.01 per $100 of deposits in 1997 and 1998. In addition to the minimum assessment for American National Bank and Trust Company, a one time charge to recapitalize the SAIF fund of the FDIC in the amount of $350,000 was made against the deposits of Mutual during 1996. The Bank must also pay "OAKAR" premiums on the continuing deposits of Mutual. "OAKAR" premiums were assessed at an annual rate of $.17 per $100 of Mutual deposits in 1996 and approximately $.06 per $100 of Mutual deposits in 1997 and 1998. Among other things, FDICIA identifies five capital categories for insured depository institutions: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" and "critically undercapitalized". FDICIA requires the federal banking regulators to take prompt corrective action with respect to insured depository institutions that do not meet minimum capital requirements. Federal banking regulations have established relevant capital requirements for bank holding companies and subsidiary banks. Under the regulations, well capitalized institutions must have Tier I risk-based capital ratios of at least six percent, total risk-based capital ratios of at least ten percent and leverage ratios of at least five percent and not be subject to capital directive orders. Under these guidelines, the Corporation and the Bank have always been and continue to be considered well capitalized. II-8 Certain statements contained above in this section are forward-looking statements that involve a number of risks and uncertainties. In addition to the factors discussed above regarding the local economy and the expansion of the Corporation's market area are other factors that could cause actual results to differ materially. The factors include business conditions, development of new products and services, interest rate trends, future legislation, regulatory controls and the risks described from time to time in the Corporation's SEC reports. Year 2000 Issue The Corporation is aware of the issues associated with the programming code in existing computer systems as the millennium (Year 2000) approaches. The "Year 2000" problem is pervasive and complex as virtually every computer operation and many equipment systems will be affected in some way by the rollover of the two digit year value to 00. The issue is whether computers and systems dependent on computer chips will properly recognize date sensitive information when the year changes to 2000. Systems that do not recognize such information could generate erroneous data or cause a system to fail. Technology hardware, software and other systems used by the Corporation are provided by outside vendors rather than being developed in-house. These outside vendors have been proactive in making systems Year 2000 ready, in testing systems for Year 2000 readiness, in submitting their efforts to regulators for review, and in supplying testing procedures for the Corporation to conduct independent testing. The Corporation is utilizing both internal and external resources to identify, correct or reprogram, and test systems for Year 2000 compliance. The Corporation's readiness plan encompasses both information technology systems and computer chip embedded functions, such as elevators, security systems, and building heating and cooling. A project team is in the latter stages of installing corrected hardware and software and testing systems for Year 2000 readiness. It is anticipated that all Year 2000 corrections and testing will be completed by March 31, 1999, allowing additional time for testing new systems or updated systems during 1999. To date, successful Year 2000 testing has been completed on 95% of the Corporation's mission critical systems. An educational process has been implemented to assist and assure that major customers are Year 2000 ready. Approximately 80% of major customers have responded that they are Year 2000 ready or will be Year 2000 ready in 1999. The project team will continue to monitor readiness of new customers and customers who have not responded to inquiries during 1999. Total Year 2000 project costs will be approximately $125,000 with $30,000 having been spent through December 31, 1998. The remaining expenditures are not expected to have a material impact on the Corporation's results of operations, liquidity or capital resources. The Corporation faces a number of risks related to the Year 2000 date change including legal risks, project management risk, financial risk and outside vendor risk. Legal risk involves failure to meet contractual service agreements, leading to possible punitive actions. Project management risk is failure to adequately address Year 2000 planning and resource needs with missed deadlines and improper allocation of resources. Financial risk relates to lost revenue, asset quality deterioration or even business failure. Outside vendor risk involves failure of communication systems, power or other important services which the Corporation depends upon to operate. A contingency plan has been established to assure readiness in the unlikely event that any critical operating system fails prior to or after the Year 2000. The contingency plan specifies actions to be taken by the Year 2000 project team in the event that a critical system is not timely corrected and tested before Year 2000. Since 95% of mission critical systems have been successfully tested to date, pre Year 2000 contingency plans are not expected to be activated. The contingency plan also assigns responsibility for checking the proper operation of all systems on January 1, 2000, adopts special liquidity measures to be taken before and after Year 2000, and describes implementation of manual processes for lending, deposit operations, and trust services in the event that systems fail. Responsibilities and detail procedures have been established for training on manual systems. Rehearsal sessions of manual system implementation are scheduled in 1999 to assure readiness. The Corporation's operations center, branch office and mortgage banking operation located at Tower Drive are equipped with a diesel generator in the event that electric power supplies fail prior to or after Year 2000. The backup power supply has been tested and will continue to be tested. Net Interest Income Net interest income, the most significant component of earnings, is the excess of interest income over interest expense. For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as state and municipal securities. A tax rate of 34% was used in adjusting interest on tax-exempt securities and loans to a fully taxable equivalent basis for the years 1998, 1997 and 1996. II-9 During 1998, taxable equivalent net interest income increased to $18,780,000, up 7% from $17,622,000 in 1997. Taxable equivalent net interest income for 1997 was up 10% from $15,978,000 recorded in 1996. The $1,158,000 increase in taxable equivalent net interest income during 1998 consisted of $786,000 due to increases in volume and $372,000 attributable to rate. The $1,644,000 increase in taxable equivalent net interest income during 1997 was the net result of an increase of $1,427,000 due to volume and $217,000 attributable to rate. - ----------------------------------------------------------------------------------------------------------------------------------- The following is an analysis of net interest income, on a taxable equivalent basis. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans if recognized is recorded on a cash basis. (in thousands, except rates):
Average Balance Interest Income/Expense Average Yield/Rate ----------------------------- ------------------------- -------------------------- 1998 1997 1996 1998 1997 1996 1998 1997 1996 -------- -------- -------- ------- ------- ------- ------ ------ ------- Loans: Commercial $ 75,972 $ 65,457 $ 59,385 $ 6,687 $ 6,004 $ 5,553 8.80 % 9.17 % 9.35 % Mortgage 132,965 131,004 118,223 11,539 11,366 10,300 8.68 8.68 8.71 Consumer 52,738 52,733 46,227 5,165 5,109 4,532 9.79 9.69 9.80 -------- -------- -------- ------- ------- ------- Total loans 261,675 249,194 223,835 23,391 22,479 20,385 8.94 9.02 9.11 -------- -------- -------- ------- ------- ------- Investment securities: U. S. Government 42,813 66,821 101,138 2,602 4,018 6,022 6.08 6.01 5.95 Federal agencies 70,009 53,507 26,984 4,485 3,471 1,712 6.41 6.49 6.34 State and municipal 26,526 21,349 18,363 1,909 1,582 1,354 7.20 7.41 7.37 Other investments 9,048 6,155 6,357 593 425 440 6.55 6.90 6.92 -------- -------- -------- ------- ------- ------- Total investment securities 148,396 147,832 152,842 9,589 9,496 9,528 6.46 6.42 6.23 -------- -------- -------- ------- ------- ------- Federal funds sold and other 5,091 4,295 8,121 272 237 435 5.34 5.52 5.36 -------- -------- -------- ------- ------- ------- Total interest-earning assets 415,162 401,321 384,798 33,252 32,212 30,348 8.02 8.03 7.89 -------- -------- -------- ------- ------- ------- Other non-earning assets 24,991 24,367 21,905 -------- -------- -------- Total assets $440,153 $425,688 $406,703 ======== ======== ======== Deposits: Demand $ 51,116 $ 48,893 $ 43,012 1,204 1,408 1,246 2.36 2.88 2.90 Money market 19,031 19,463 21,414 545 572 638 2.86 2.94 2.98 Savings 67,265 70,238 65,764 1,950 2,140 2,013 2.90 3.05 3.06 Time 174,123 176,403 172,390 9,260 9,590 9,670 5.32 5.44 5.61 -------- -------- -------- ------- ------- ------- Total deposits 311,535 314,997 302,580 12,959 13,710 13,567 4.16 4.35 4.48 Federal funds purchased 188 773 190 11 44 11 5.85 5.69 5.79 Repurchase agreements 25,261 17,909 16,757 1,106 836 792 4.38 4.67 4.73 Other borrowings 7,497 - - 396 - - 5.28 - - -------- -------- -------- ------- ------- ------- Total interest-bearing liabilities 344,481 333,679 319,527 14,472 14,590 14,370 4.20 4.37 4.50 -------- -------- -------- ------- ------- ------- ------ ------ ------- Demand deposits 40,134 39,752 34,723 Other liabilities 3,334 2,128 2,739 Shareholders' equity 52,204 50,129 49,714 -------- -------- -------- Total liabilities and Shareholders' equity $440,153 $425,688 $406,703 ======== ======== ======== Interest rate spread 3.82 % 3.65 % 3.39 % ====== ====== ======= Net interest income $18,780 $17,622 $15,978 ======= ======= ======= Taxable equivalent adjustment $ 598 $ 484 $ 416 ======= ======= ======= Net yield on earning assets 4.52 % 4.39 % 4.15 % ====== ====== =======
II-10 Changes in Net Interest Income (Rate/Volume Analysis) Net interest income is the product of the volume of average earning assets and the average rates earned, less the volume of average interest-bearing liabilities and the average rates paid. The portion of change relating to both rate and volume is allocated to each of the rate and volume changes based on the relative change in each category. The following table analyzes the changes in both rate and volume components of net interest income on a taxable equivalent basis for the past two years (in thousands):
1998 vs. 1997 1997 vs. 1996 ------------------------------- -------------------------------- Interest Change Interest Change Increase Attributable to Increase Attributable to ------------------ ------------------- (Decrease) Rate Volume (Decrease) Rate Volume ---------- ------- -------- ---------- -------- -------- Interest income Loans: Commercial $ 683 $(250) $ 933 $ 451 $ (108) $ 559 Mortgage 173 3 170 1,066 (67) 1,133 Consumer 56 56 - 577 (62) 639 ------- ------ ------- ------- -------- ------- Total loans 912 (191) 1,103 2,094 (237) 2,331 ------- ------ ------- ------- -------- ------- Investment securities: U.S. Government (1,416) 43 (1,459) (2,004) 59 (2,063) Federal agencies 1,014 (44) 1,058 1,759 39 1,720 State and municipal 327 (47) 374 228 7 221 Other investments 168 (23) 191 (15) (1) (14) -------- ------ ------- ------- -------- ------- Total investment securities 93 (71) 164 (32) 104 (136) -------- ------ ------- ------- -------- ------- Federal funds sold and other 35 (8) 43 (198) 13 (211) -------- ------ ------- ------- -------- ------- Total interest income 1,040 (270) 1,310 1,864 (120) 1,984 -------- ------ ------- ------- -------- ------- Interest expense Deposits: Demand (204) (266) 62 162 (7) 169 Money market (27) (14) (13) (66) (9) (57) Savings (190) (101) (89) 127 (9) 136 Time (330) (207) (123) (80) (302) 222 -------- ------ ------- ------- -------- ------- Total deposits (751) (588) (163) 143 (327) 470 Federal funds purchased (33) 1 (34) 33 - 33 Repurchase agreements 270 (55) 325 44 (10) 54 Other borrowings 396 - 396 - - - -------- ------ ------- ------- -------- ------- Total interest expense (118) (642) 524 220 (337) 557 -------- ------ ------- ------- -------- ------- Net interest income $ 1,158 $ 372 $ 786 $1,644 $ 217 $1,427 ======== ====== ======= ======= ======== =======
II-11 Provision and Reserve for Loan Losses The provision for loan losses is an amount added to the reserve against which loan losses are charged. The amount of the provision is determined by Management based upon its assessment of the size and quality of the loan portfolio and the adequacy of the reserve in relation to the risks inherent within the loan portfolio. The 1998 provision for loan losses was $927,000 and compares with $1,100,000 in 1997 and $673,000 in 1996. The decrease in the provision for loan losses in 1998 was influenced by reduced charge-offs and slower growth in loans. Net charge-offs decreased to $383,000 in 1998 from $893,000 in 1997. Net charge-offs in 1997 were up 132% from $385,000 in 1996 because two commercial loans were written down $402,000 prior to acceptance of $385,000 in real estate collateral. The Bank is marketing the real estate owned through real estate agents. The reserve for loan losses totaled $3,821,000 at December 31, 1998, an increase of 17% over December 31, 1997. The ratio of reserve to loans, less unearned discount, was 1.42% at December 31, 1998 and 1.29% at December 31, 1997. The Bank's Loan Committee has responsibility for determining the level of the reserve for loan losses, subject to the review of the Board of Directors. The Loan Committee has taken economic factors, as well as any other external events that may affect the value and collectability of the loan portfolio, into consideration when making its assessment and recommendation. The methodology used to determine the level of the loan loss reserve on a quarterly basis includes the identification of losses from a review of the Corporation's loan "Watch" list. In addition to these identifiable potential losses, an experience factor for each major category of loans is applied against the remaining portion of the loans considered to have no more than a normal risk of collectability. Additional factors considered in determining the level of the loan loss reserve are economic conditions, historical losses, trends and other external factors. The sum of these elements is the Loan Committee's recommended level of the reserve for loan losses. The economy of the Corporation's trade area, which includes the City of Danville, City of Martinsville, Pittsylvania and Henry Counties in Virginia, Town of Yanceyville and the northern half of Caswell County in North Carolina, is heavily dependent on manufacturing. While diversification has occurred in manufacturing in recent years, an apparel/home fashions textile firm and a tire manufacturing plant in Danville employ a significant workforce. Other important industries include farming, tobacco processing and sales, food processing, furniture manufacturing and sales, specialty glass manufacturing, and packaging tape production. The local economy of the Corporation's trade area continues to be strong at this time and the Corporation's loan losses have not been significant in recent years; however, an inherent risk to the loan portfolio exists if a significant decline occurs in manufacturing along with a corresponding reduction in employment. Management believes the reserve for loan losses is appropriate in view of this geographic concentration. II-12 Mangement has allocated the reserve for loan losses to loan categories as follows (in thousands):
1998 1997 1996 1995 1994 ----------------- ----------------- ----------------- ----------------- ----------------- Percent Percent Percent Percent Percent of loans of loans of loans of loans of loans in each in each in each in each in each category category category category category to total to total to total to total to total Amount loans Amount loans Amount loans Amount loans Amount loans ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- Commercial (including commercial real estate) $1,046 47% $ 873 44% $ 886 40% $ 888 43% $ 858 42% Real estate- residential 151 36 129 37 128 38 146 38 121 39 Consumer 1,525 17 1,173 19 1,152 22 549 19 291 19 Unallocated 1,099 - 1,102 - 904 - 1,174 - 1,184 - Balance at end of year $3,821 100% $3,277 100% $3,070 100% $2,757 100% $2,454 100% ======= ======== ====== ======== ====== ======== ====== ======== ====== ========
Management's criteria for evaluating the adequacy of its loan loss reserve includes individual evaluation of significant loans and overall portfolio analyses for more homogeneous, smaller balance loan portfolios. Based on management's evaluation, estimated loan loss reserves are assigned to the individual loans which present a greater risk of loan loss. The remaining loan loss reserve is allocated to the remaining loans on an overall portfolio basis based on historical loss experience. The assessed risk of loan loss is higher in the commercial and consumer loan categories as these categories contain loans which are more significant to the Corporation and to the individual borrowers, thereby exposing the Corporation to a greater risk of loss in the event of downturns in the financial position of individual borrowers. The remaining loan categories are typically for lesser amounts and are distributed over a much larger population of borrowers, thereby reducing the Corporation's risk of loan loss. - ----------------------------------------------------------------------------------------------------------------------------------- Loan Losses - Ratios
1998 1997 1996 ------- ------- ------- Reserve as percentage of outstanding loans, net of unearned income 1.42% 1.29% 1.30% Net charge-offs as percentage of reserve 10.02 27.23 12.58 Net charge-offs as percentage of average loans, net of unearned income .15 .36 .17 Provision as percentage of net charge-offs 242.21 123.26 174.40 Provision as percentage of average loans, net of unearned income .35 .44 .30 Reserve for loan losses to nonperforming loans 20.11X 8.34X 93.03X
II-13 Non-Interest Income Non-interest income totaled $4,029,000 in 1998 compared with $3,201,000 in 1997 and $2,691,000 in 1996. This was an increase of 26% during 1998 after an increase of 19% during 1997 and a 32% increase in 1996. The major components of non-interest income are trust and investment services, service charges on deposit accounts, non-deposit fees and insurance commissions, mortgage banking income and other income. Trust and investment services which includes fees from management of trusts, estates and investments totaled $2,165,000 in 1998, an increase of $277,000, or 15%, from 1997. The increase in 1998 came from growth in investments under management for customers due to a healthy equities market and from new business. Fees from the closing of several large estates in 1996 were not repeated in 1997, resulting in no increase in trust and investment fees in 1997 over 1996. Service charges on deposit accounts were $902,000 in 1998, an increase of $116,0000, or 15%, from 1997. Service charges during 1997 totaled $786,000, which was a 31% increase from 1996. A change in the fee structure and additional accounts obtained contributed to the growth in income in 1998 and 1997. Service charge pricing on deposit accounts is typically changed annually to reflect current costs and competition. Non-deposit fees and insurance commissions were $288,000 in 1998, an increase of 85% from the $156,000 reported in 1997 which was up from $106,000 reported in 1996. The large increases in 1998 and 1997 resulted from non-customer ATM fees that began in September 1997 and totaled $131,000 in 1998 and from increasing insurance sales. Mortgage banking income represents fees from originating and selling residential mortgage loans through a wholly owned subsidiary of the Bank which began in December 1996. Mortgage banking income increased 95% to $429,000 in 1998 from $220,000 in 1997 because of a favorable interest rate environment which positively impacted mortgage loan originations and from fine tuning and expansion of mortgage production operations. Other income was $245,000 in 1998, an increase of 63% from the $150,000 recorded in 1997, which in turn was an increase of 70% from the $88,000 recorded in 1996. Other income in 1998 included $104,000 in gain from insurance settlement on the life of a former officer. Other income also includes gains on the sale of securities which were $18,000 in 1998, $31,000 in 1997 and none in 1996. Non-Interest Expense Non-interest expense of $10,964,000 in 1998, increased $719,000 or 7% over $10,245,000 in 1997, which in turn increased $78,000 or 1% over $10,167,000 in 1996. Non-interest expense includes salaries, pension and other employee benefits, occupancy and equipment expense, FDIC insurance expense, postage and printing, merger related expense and other expenses. Salaries totaled $5,127,000 for 1998, an increase of $316,000, or 7% over 1997. The increase in 1998 salaries includes additional incentive compensation of $208,000 due to increased profits. Salaries of $4,811,000 in 1997 increased $728,000, or 18% over 1996. Salaries increased $276,000, or 7% of the 18% increase for 1997, from inclusion of a full year of salaries in 1997 at the Yanceyville branch office purchased on October 25,1996 and at Mutual Mortgage which began operations in late 1996. Pension and other employee benefits totaled $1,140,000 in 1998, an increase of 6% over the $1,076,000 recorded in 1997, which in turn was an increase of 18% from the $913,000 reported in 1996. The percentage increases in 1998 and 1997 approximate the percentage increases in salaries in 1998 and 1997. The total occupancy and equipment expense was $1,664,000 for 1998, an increase of 16% over $1,437,000 reported for 1997. This, in turn, was an increase of 19% over $1,212,000 recorded in 1996. The increase in 1998 reflects higher depreciation, maintenance and licensing fees on technology equipment of approximately $1,215,000 purchased during 1998 to improve product delivery systems and increase productivity. The increase in 1997 was primarily the cumulative result of adding the Yanceyville branch office in October 1996 and Mutual Mortgage in December 1996. FDIC insurance expense decreased to $74,000 in 1998 from $78,000 in 1997 which was down 83% from $467,000 in 1996. The FDIC reduced the deposit insurance assessment rate in 1996 and 1997 but assessed the Bank a one-time $350,000 FDIC charge on the Mutual deposits to recapitalize the SAIF fund in 1996. Postage and printing expense was $448,000 in 1998, an increase of 4% from the $429,000 recorded in 1997, which in turn was an increase of 8% from the $397,000 recorded in 1996. The increase in 1997 was primarily related to the branch office purchased and the mortgage operation started in 1996. Core deposit intangible expense represents amortization of premiums paid for deposits at the Yanceyville and Gretna offices. The increase to $450,000 in 1998 and 1997 from $318,000 in 1996 represents a full year of amortization for both offices which is calculated on a straight line basis over ten years. Merger-related expense for 1996 was $1,056,000. This included non-recurring items such as legal services, financial advisory services, accounting services, regulatory fees, data conversion costs and signage. Also included were losses on II-14 securities held by Mutual at the time of the merger which were not compatible with the Corporation's investment program. There were no merger related expenses recorded in 1998 and 1997. Other expense was $2,061,000 in 1998, an increase of 5% over the $1,964,000 reported in 1997. The increase of $97,000 in 1998 primarily resulted from special sales and service training provided to all employees and from increased trust and mortgage banking expenses related to generating higher non-interest income. Other expenses in 1997 increased 14% from the $1,721,000 recorded in 1996. The increase of $243,000 in 1997 reflects additional franchise tax of $78,000, higher professional services of $61,000 from special projects, and increases from the newly acquired branch and the new mortgage operation. Income Taxes The provision for income taxes (total of current and deferred) was $3,123,000 in 1998, compared with $2,725,000 in 1997 and $2,381,000 in 1996. In each year, the Corporation was subject to a Federal tax rate of 34%. The major difference between the statutory rate and the effective rate results from income which 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. Refer to Note 9 of the Consolidated Financial Statements for a reconciliation of the statutory Federal income tax rate of 34% to the effective tax rates for 1998, 1997, and 1996. Capital Management Regulatory agencies issued risk-based capital guidelines which were fully effective in 1992. The guidelines were established to more appropriately consider the credit risk inherent in the assets and off-balance sheet activities of a financial institution in the assessment of capital adequacy. Under the guidelines, total capital has been defined as core (Tier I) capital and supplementary (Tier II) capital. The Corporation's Tier I capital consists primarily of shareholder's equity, while Tier II capital consists of the reserve for loan losses. The definition of assets has been modified to include items on and off the balance sheet, with each item being assigned a "risk-weight" for the determination of the ratio of capital to risk-adjusted assets. The guidelines require that total capital (Tier I and Tier II) of 8% be held against total risk-adjusted assets, at least half of which (4%) must be Tier I capital. At December 31, 1998, the Corporation's Tier I and Total capital ratios were 16.79% and 18.04%, respectively. At December 31, 1997, these ratios were 17.14% and 18.37%, respectively. The ratios for both years were well in excess of the regulatory requirements. The Corporation's leverage ratios (shareholders' equity divided by year-end assets) were 11.07% and 10.74% at December 31, 1998 and 1997, respectively. The leverage ratio has a regulatory minimum of 3%, with most institutions required to maintain a ratio 100 to 200 basis points above the 3% minimum depending upon risk profiles and other factors. The Corporation's 1998 capital formation rate (net income less dividends declared, divided by average shareholders' equity) was 8.4%. This compares with 7.5% in 1997 and 5.6% in 1996. These ratios evidence the Corporation's attainment of its goal of meeting future capital requirements by retaining a portion of operating earnings while providing steadily increasing cash dividends. Prior to 1996 the Corporation paid cash dividends on a semi-annual basis. In 1996 the Corporation began paying dividends on a quarterly basis and the Board of Directors declared regular quarterly dividends totaling $.93 and $.81 per share of common stock in 1998 and 1997, respectively. The Board of Directors reviews the Corporation's dividend policy regularly and increases dividends when justified by earnings after considering future capital needs. Asset and Liability Management The Corporation's primary objectives for asset and liability management are to identify opportunities to maximize net interest income while ensuring adequate liquidity and carefully managing interest rate risk. The Asset/Liability Investment Committee ("ALCO"), which is primarily composed of executive officers, is responsible for: Monitoring corporate financial performance; Meeting liquidity requirements; Establishing interest rate parameters, indices, and terms for loan and deposit products; Assessing and evaluating the competitive rate environment; Reviewing and approving investment portfolio transactions under established policy guidelines; Monitoring and measuring interest rate risk. II-15 Liquidity Liquidity is the measure of the Corporation's ability to generate sufficient funds to meet customer demands for loans and the withdrawal of deposit balances. The Corporation, in its normal course of business, maintains cash reserves and has an adequate flow of funds from loan payments and maturing investment securities to meet present liquidity needs. Management monitors and plans the Corporation's liquidity position for future periods. Liquidity is provided from cash and amounts due from banks, federal funds sold, interest-bearing deposits in other banks, repayments from loans, seasonal increases in deposits, lines of credit from two correspondent banks and two federal agency banks and a planned structured continuous maturity of investments. Management believes that these factors provide sufficient and timely liquidity for the foreseeable future. Expansion of the Corporation's earning assets is based largely on the growth of deposits from individuals and small and medium size businesses. These deposits are more stable in number and size than large denomination certificates of deposit. In addition, the Corporation's customers have relatively stable requirements for funds. The Corporation's major source of funds and liquidity is its deposit base. The mix of the deposit base (time deposits versus demand, money market and savings) is constantly subject to change. During 1998, as shown in the Consolidated Balance Sheets, the deposit mix changed with a decline in higher cost time deposits of $456,000, an increase in demand deposits of $7,170,000, a decline in savings deposits of $930,000 and an increase in money market accounts of $938,000. During 1997, time deposits declined while deposits subject to immediate withdrawal remained stable. The Consolidated Statements of Cash Flows appearing in the financial statement section shows a net increase in cash and cash equivalents of $1,025,000 during 1998. This increase was the result of a combination of $9,105,000 provided by operating activities, $36,448,000 net cash used in investing activities, and $28,368,000 net cash provided by financing activities. A net increase in deposits, repurchase agreements and FHLB borrowings provided cash from financing activities while cash dividends paid used net cash in financing activities. The cash provided by operating and financing activities, more than adequately supplied the Corporation's liquidity needs at all times during 1998. Liquidity strategies are implemented and monitored by ALCO on a day to day basis. The Committee uses a simulation model to assess the future liquidity needs of the Corporation and manage the investment of funds. Interest Rate Risk Interest rate risk refers to the exposure of the Corporation's earnings and market value of portfolio equity ("MVE") to changes in interest rates. The magnitude of the change in earnings and MVE resulting from interest rate changes is controlled by the time remaining to maturity on fixed-rate obligations, the contractual ability to adjust rates prior to maturity, competition, the general level of interest rates and customer actions. There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on the Corporation's earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities. In determining the appropriate level of interest rate risk, ALCO reviews the changes in net interest income and MVE given various changes in interest rates. The Corporation also considers the most likely interest rate scenarios, local economics, liquidity needs, business strategies, and other factors in determining the appropriate levels of interest rate risk. To effectively measure and manage interest rate risk, interest rate sensitivity and simulation analysis are used to determine the impact on net interest income and MVE from changes in interest rates. Interest rate sensitivity analysis presents the amount of assets and liabilities that are estimated to reprice through specified periods if there are not changes in balance sheet mix. The interest rate sensitivity table, below, reflects the Corporation's assets and liabilities on December 31, 1998 that will either be repriced in accordance with market rates, mature or are estimated to mature early or prepay within the periods indicated. II-16 Interest Rate Sensitivity Analysis December 31, 1998 (in thousands)
Over 3 Over 6 3 Months Months Over 1 Months - 6 - 12 Year - Over 5 or Less Months Months 5 Years Years Total --------- --------- --------- --------- --------- --------- Interest sensitive assets: Interest bearing deposits with other banks $ 706 $ -- $ -- $ -- $ -- $ 706 Investment securities 19,651 5,608 18,743 73,000 46,411 163,413 Loans 110,138 24,644 43,242 85,663 5,990 269,677 --------- --------- --------- --------- --------- --------- Total interest sensitive assets 130,495 30,252 61,985 158,663 52,401 433,796 --------- --------- --------- --------- --------- --------- Interest sensitive liabilities: NOW and savings deposits 124,504 -- -- -- -- 124,504 Money market deposits 18,089 -- -- -- -- 18,089 Time deposits 37,644 29,628 42,158 61,194 37 170,661 Repurchase agreements and other borrowings 31,023 -- -- 13,000 -- 44,023 --------- --------- --------- --------- --------- --------- Total interest sensitive liabilites 211,260 29,628 42,158 74,194 37 357,277 --------- --------- --------- --------- --------- --------- Interest sensitivity gap $ (80,765) $ 624 $ 19,827 $ 84,469 $ 52,364 $ 76,519 ========= ========= ========= ========= ========= ========= Cumulative interest sensitivity gap $ (80,765) $ (80,141) $ (60,314) $ 24,155 $ 76,519 ========= ========= ========= ========= ========= Percentage cumulative gap to total interest sensitive assets (18.6)% (18.5)% (13.9)% 5.6 % 17.6 %
Of the loans in the above table that either mature or can be repriced in periods over 1 year, $46,664 have adjustable rates and $44,989 have fixed rates. Investment security prepayments were estimated using recent market information. - -------------------------------------------------------------------------------- Because of inherent limitations in interest rate sensitivity analysis, ALCO uses more sophisticated interest rate risk measurement techniques. Simulation analysis is used to subject the current repricing conditions to rising and falling interest rates in increments and decrements of 1%, 2% and 3% to determine how net interest income changes for the next twelve months. ALCO also measures the effects of changes in interest rates on the MVE by discounting future cash flows of deposits and loans using new rates at which deposits and loans would be made to similar depositors and borrowers. Market value changes on the investment portfolio are estimated by discounting future cash flows and using duration analysis. Loan and investment security prepayments are estimated using current market information. The following table shows the estimated impact of changes in interest rates up and down 1%, 2% and 3% on net interest income and on MVE. II-17 Change in Net Interest Income and Market Value of Portfolio Equity December 31, 1998 (in thousands) Changes in Changes in Market Value Change in Net Interest Income (1) of Portfolio Equity (2) Interest ----------------------- ----------------------- Rates Amount Percent Amount Percent - ---------- -------------------------------------------------------- Up 3% $ 2,562 14.43 % $ 1,044 1.90 % Up 2% 1,772 9.98 1,434 2.61 Up 1% 854 4.81 1,192 2.17 Down 1% (581) (3.27) (831) (1.51) Down 2% (1,257) (7.08) (2,672) (4.87) Down 3% (1,806) (10.17) (4,516) (8.23) (1) Represents the difference between estimated net interest income for the next 12 months in the new interest rate environment and the current interest rate environment. (2) Represents the difference between market value of portfolio equity in the new interest rate environment and the current interest rate environment, and then adjusted for income taxes using a 34% tax rate. The negative one year cumulative interest sensitivity gap of $60,314,000 in the interest rate sensitivity analysis normally implies that the Corporation's net interest income would rise if rates decline and fall if rates increase. The simulation analysis presents a more accurate picture since certain rate indices that reprice deposits do not change with the same magnitude over the same period of time as changes in the prime or indices that reprice many loans. While the Corporation cannot predict future interest rates or their effects on MVE or net interest income, the above analysis indicates that a change in interest rates of plus or minus 3% is unlikely to have a material adverse effect on net interest income and MVE in future periods. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, prepayments and deposit run-offs and should not be relied upon as indicative of actual results. Certain limitations are inherent in such computations. Certain assets and liabilities may react differently than projected to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag behind changes in market interest rates. In the event of a change in interest rates, loan prepayments and early deposit withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, credit risk may increase if an interest rate increase adversely affects the ability of many borrowers to service their debt. INVESTMENT PORTFOLIO The investment portfolio consists primarily of securities for which an active market exists. The Bank's policy is to invest primarily in securities of the U. S. Government and its agencies and in other high grade fixed income securities to minimize credit risk. II-18 The following table presents information on the book and market values, maturities and taxable equivalent yields of investment securities at the end of the last 3 years (in thousands, except yields and footnote): - ------------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 --------------------------------- ---------------------------------- ---------------------------------- Taxable Taxable Taxable Book Market Equivalent Book Market Equivalent Book Market Equivalent Value Value Yield Value Value Yield Value Value Yield --------- ---------- ---------- --------- --------- ---------- --------- --------- ---------- U.S. Government: Within 1 year $ 25,000 $25,075 6.00 % $ 19,001 $19,004 6.24 % $ 32,073 $ 32,060 5.69 % 1 to 5 years 7,018 7,166 6.26 32,144 32,188 6.06 62,907 62,922 6.18 --------- ---------- ---------- --------- --------- --------- Total 32,018 32,241 6.06 51,145 51,192 6.13 94,980 94,982 6.02 --------- ---------- ---------- --------- --------- --------- Federal Agencies: Within 1 year 2,005 2,021 6.10 5,995 5,993 5.51 750 750 3.98 1 to 5 years 41,292 42,376 6.59 37,002 37,191 6.51 30,075 30,115 6.32 6 to 10 years 10,906 11,020 6.19 17,913 17,930 6.67 21,103 21,022 6.67 After 10 years 20,511 20,573 6.00 918 922 7.20 930 936 7.24 --------- --------- ---------- --------- --------- --------- Total 74,714 75,990 6.36 61,828 62,036 6.47 52,858 52,823 6.47 --------- --------- ---------- --------- --------- --------- State and Municipal: Within 1 year 499 503 6.40 521 520 9.24 744 748 9.47 1 to 5 years 5,326 5,516 8.21 4,297 4,412 8.42 3,119 3,178 7.79 6 to 10 years 20,848 21,690 7.44 12,247 12,535 8.19 11,318 11,502 7.78 After 10 years 8,791 9,065 7.42 5,339 5,438 8.07 6,836 6,857 7.71 --------- --------- ---------- --------- --------- --------- Total 35,464 36,774 7.54 22,404 22,905 8.23 22,017 22,285 7.82 --------- --------- ---------- --------- --------- --------- Other Investments: Within 1 year -- -- -- -- -- -- -- -- -- 1 to 5 years 6,119 6,246 6.65 3,168 3,168 6.52 427 427 6.52 6 to 10 years 10,921 10,991 6.20 2,042 2,042 7.95 2,998 2,998 6.97 After 10 years 2,482 2,501 7.12 2,490 2,490 6.96 2,477 2,477 7.12 --------- --------- ---------- --------- --------- -------- Total 19,522 19,738 6.46 7,700 7,700 7.06 5,902 5,902 7.01 --------- --------- ---------- --------- --------- -------- Total portfolio $161,718 $164,743 6.57 % $143,077 $143,833 6.64 % $175,757 $175,992 6.38 % ========= ========= ========= ========= ========= =========
II-19 At December 31, 1998 securities available for sale (at amortized cost) totaled $103,841,000 and included $19,030,000 in U. S. Government securities, $49,843,000 in federal agencies, $15,446,000 in state and municipal, and $19,522,000 in other securities. A net unrealized gain of $1,118,000 related to these securities at December 31, 1998. At December 31, 1997, securities available for sale (at amortized cost) totaled $81,526,000 and included $35,033,000 in U. S. Government securities, $28,950,000 in federal agencies, $9,914,000 in state and municipal and $7,629,000 in other securities. A net unrealized gain of $621,000 related to these securities at December 31, 1997. Securities held to maturity totaled $57,877,000 and $60,611,000 at December 31, 1998 and 1997, respectively and had respective estimated fair values of $59,207,000 and $61,367,000. Of the amount at December 31, 1998, $12,988,000, or 22%, were U. S. Government direct obligations, $24,871,000 or 43% were federal agencies and $20,018,000 or 35% were state and municipal securities. Securities held to maturity at December 31, 1998 consisted of $14,992,000 due in one year or less, $22,647,000 due after one year through five years, $13,515,000 due in five years through ten years and $6,723,000 due after ten years. The state and municipal securities were diversified among many different issues and localities. The market value of securities held to maturity at December 31, 1998 exceeded the book value by $1,330,000. No losses are anticipated since the Corporation has the ability and intent to hold these securities until their respective maturities. Loan Portfolio Total gross loans increased $14,884,000 or 6% during 1998. As shown in schedule A below, the primary increases in types of loans were construction and land development loans, real estate loans secured by nonfarm, nonresidential properties, real estate loans secured by 1 - 4 family residential properties, and commercial and industrial loans. The loan portfolio is diversified and consists of 56% mortgage loans, 26% commercial loans and 18% consumer loans. Note 11 of the Consolidated Financial Statements presents related party loan activity. A substantial portion of the loan additions and payments result from floorplan activity by two automobile dealerships owned separately by two of the Corporation's Directors. The Corporation does not participate in highly leveraged lending transactions, as defined by the bank regulators and there are no loans of this nature recorded in the loan portfolio. The Corporation has no foreign loans in its portfolio. Real Estate Loans Commercial real estate loans have received considerable attention in recent years by the bank regulators and the news media. The concerns have been in real estate values in certain areas of the country and the quality of banks' commercial real estate portfolios. It is difficult to measure commercial real estate values within the Corporation's trade area due to the light sales activity. Commercial real estate values did not escalate to levels seen in other areas of the state and country during the ten years prior to the last recession and management has not detected a significant change in values within the Corporation's trade area during 1998 or 1997. Management has confined its real estate lending to its trade area and has always taken a conservative approach in its lending practice to maintain equity in real estate loans. The Corporation is conforming to the real estate appraisal guidelines set forth by the Comptroller of the Currency. The total of outstanding real estate loans at December 31, 1998 was $151,825,000. This consisted of $95,711,000 or 63% in loans secured by 1-4 family residential properties, $44,251,000 or 29% in loans secured by non-farm, non-residential properties, $8,104,000 or 5% in construction and land development, $1,491,000 or 1% in loans secured by farmland and $2,268,000 of other real estate loans. Nonperforming real estate loans at December 31, 1998 and 1997 were $58,000 and $281,000, respectively. There were no real estate loans on accrual status and past due 90 days or more at December 31, 1998 or at December 31, 1997. Asset Quality The Corporation identifies specific credit exposures through its periodic analysis of the loan portfolio and monitors general exposures from economic trends, market values and other external factors. The Corporation maintains a reserve for loan losses, which is available to absorb losses inherent in the loan portfolio. The reserve is increased by the provision for losses and by recoveries from losses. Charge-offs decrease the reserve. The adequacy of the reserve for loan losses is determined on a quarterly basis. Various factors as defined in the previous section "Provision and Reserve for Loan Losses" are considered in determining the adequacy of the reserve. II-20 Loans, other than consumer, are generally placed on nonaccrual status when any portion of principal or interest is 90 days past due or collectability is uncertain. Unless loans are in the process of collection, income recognized on consumer loans is discontinued and the loans are charged off after a delinquency of 90 days. Under the Corporation's policy a nonaccruing loan may be restored to accrual status when none of its principal and interest is due and unpaid and the Corporation expects repayment of the remaining contractual principal and interest or when it otherwise becomes well secured and in the process of collection. Nonperforming assets include loans on which interest is no longer accrued, loans classified as troubled debt restructurings and foreclosed properties. Foreclosed properties of $385,000 at December 31, 1998 and 1997 include two commercial real estate properties. There were no foreclosed properties held at the close of 1996. At December 31, 1998 and 1997, loans in a nonaccrual or restructured status totaled approximately $190,000 and $393,000, respectively. As shown in schedule C below, loans on accrual status and past due 90 days or more have increased to $249,000 in 1998 from $181,000 in 1997. The total of nonperforming loans and loans past due 90 days or more at December 31, 1998 was $439,000, a decrease of $135,000 from the $574,000 reported at December 31, 1997. Net charge-offs as a percentage of average loans decreased to .15% in 1998 from .36% in 1997. Two commercial real estate loan charge-offs resulted in the higher 1997 ratio. Management considers charge-off levels of .10% to .40% to be within reasonable norms from a historical perspective. Management has in place an aggressive program to control loan delinquencies, and the level of past due loans and nonperforming loans is considered to be within an acceptable range. Total nonperforming loans and loans past due 90 days or more represent .16% of total loans at December 31, 1998 and .23% at December 31, 1997. Total nonperforming loans and past due loans 90 days or more on an accrual status is considered low by industry standards. A. The following table presents the year-end balances of loans, classified by type (in thousands):
1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- Real estate loans: Construction and land development $ 8,104 $ 4,458 $ 3,640 $ 5,499 $ 4,130 Secured by farmland 1,491 1,276 1,169 1,032 872 Secured by 1-4 family residential properties 95,711 94,472 90,495 81,667 75,691 Secured by multi-family (5 or more) residential properties 2,268 1,522 772 751 518 Secured by nonfarm, nonresidential properties 44,251 41,368 35,289 33,950 29,003 Loans to farmers 2,293 2,761 2,672 2,529 2,173 Commercial and industrial loans 67,154 57,980 49,247 46,902 41,804 Loans to individuals for personal expenditures 46,494 48,545 51,066 42,063 36,027 Loans for nonrated industrial development obligations 1,895 2,398 2,565 1,901 2,155 All other loans 15 13 124 61 255 ------- -------- ------- ------- ------- Total loans $269,676 $254,793 $237,039 $216,355 $192,628 ======== ======== ======== ======== ======== There were no foreign loans outstanding during any of the above periods.
II-21 B. An analysis of the loan maturity and interest rate sensitivity is as follows:
Remaining Maturities or First Repricing Opportunities (in thousands) ------------------------------------------------------- Over 1 Over 1 Year Year to Five or Less 5 Years Years Total Percent --------- --------- -------- ---------- Commercial, financial and agricultural $ 74,117 $ 5,558 $ 225 $ 79,900 29.6% Mortgage 84,794 46,660 5,040 136,494 50.6% Consumer 19,113 33,445 725 53,283 19.8% --------- --------- ------- --------- -------- $178,024 $85,663 $5,990 $269,677 100.0% ========= ========= ======= ========= ======== Rate Sensitivity: Pre-determined rate 19,490 39,093 5,896 64,479 23.9% Floating or adjustable rate 158,534 46,570 94 205,198 76.1% --------- --------- ------- --------- -------- 178,024 85,663 5,990 269,677 100.0% ========= ========= ======= ========= ======== Percent 66.0% 31.8% 2.2% 100.0%
Certain short term loans and demand loans within the commercial, financial and agricultural classifications are anticipated to be curtailed prior to any renewal. Normally these loans are expected to be paid within one year and all such loans have been classified within the one year category. Any rollovers allowed depend upon the Bank's loan policy after a reappraisal of the borrower's creditworthiness at the date of maturity. C. Nonperforming loans and loans past due 90 days or more (in thousands, except ratios):
1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ Nonaccruing loans: Real Estate $ 58 $281 $ 14 $290 $ 36 Commercial 132 102 - - 40 Agricultural - 10 19 16 - ------ ------ ------ ------ ------ Total nonaccruing loans 190 393 33 306 76 ------ ------ ------ ------ ------ Restructured loans: Commercial - - - - 109 ------ ------ ------ ------ ------ Total restructured loans - - - - 109 ====== ====== ====== ====== ====== Total nonperforming loans $190 $393 $ 33 $306 $185 ====== ====== ====== ====== ====== Loans on accrual status past due 90 days or more: Real Estate $ - $ - $ - $ 23 $ - Consumer 235 160 241 95 112 Revolving credit 4 5 3 6 1 Commercial 3 - 225 22 - Agricultural 7 16 10 15 - ====== ====== ====== ====== ====== Total past due loans $249 $181 $479 $161 $113 ====== ====== ====== ====== ====== Asset Quality Ratios: Reserve for loan losses to year-end net loans 1.42% 1.29% 1.30% 1.28% 1.29% Nonperforming loans to year-end net loans .07% .15% .01% .14% .10% Reserve for loan losses to nonperforming loans 8.34X 8.34X 93.03X 9.01X 13.26X
At December 31, 1998, the Bank had no loan concentrations (loans to borrowers engaged in similar activities) which exceeded 10% of total loans. II-22 Summary of Loan Loss Experience An analysis of the reserve for losses is set forth in the following table (in thousands):
1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Balance at beginning of period $3,277 $3,070 $2,757 $2,454 $2,256 -------- -------- -------- -------- -------- Charge-offs: Commercial loans 68 452 9 - 5 Real estate loans - - - - 14 Consumer loans 440 540 493 241 112 -------- -------- -------- -------- -------- 508 992 502 241 131 -------- -------- -------- -------- -------- Recoveries: Commercial loans 9 - 3 - - Real estate loans - - - - 4 Consumer loans 116 99 114 60 53 -------- ------- -------- -------- -------- 125 99 117 60 57 -------- ------- -------- -------- -------- Net charge-offs 383 893 385 181 74 Provision for loan losses 927 1,100 673 484 272 Other - - 25 - - -------- ------- -------- -------- -------- Balance at end of period $3,821 $3,277 $3,070 $2,757 $2,454 ======== ======= ======== ======== ======== Percent of net charge-offs to average net loans outstanding during the period .15% .36% .17% .09% 0.04% ======== ======= ======== ======== ========
The reserve for loan losses is based upon the quality of loans as determined by management taking into consideration historical loan loss experience, diversification of the loan portfolio, amount of secured and unsecured loans, banking industry standards and averages, and general economic conditions. At the time that collection of the outstanding balance of specific loans together with related interest is considered doubtful, such loans are placed in a nonaccruing status. Deposits The following table presents the average balances of deposits and the average rates paid on those deposits for the past 3 years (in thousands):
1998 1997 1996 --------------------- --------------------- --------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate --------- --------- --------- --------- --------- --------- Demand deposits - non-interest bearing $ 40,134 - % $ 39,752 - % $ 34,723 - % Demand deposits - interest bearing 51,116 2.36% 48,893 2.88% 43,012 2.90% Money market 19,031 2.86% 19,463 2.94% 21,414 2.98% Savings 67,265 2.90% 70,238 3.05% 65,764 3.06% Time 174,123 5.32% 176,403 5.44% 172,390 5.61% --------- --------- --------- $351,669 3.69% $354,749 3.87% $337,303 4.02% ========= ========= =========
Certificates of Deposit Certificates of deposit at the end of 1998 in amounts of $100,000 or more were classified by maturity as follows (in thousands): 3 months or less $ 8,590 Over 3 through 6 months 5,239 Over 6 through 12 months 5,508 Over 12 months 13,514 ------- $32,851 ======= Return on Assets and Shareholders' Equity The following table presents certain rates of return and percentages for the past 3 years: 1998 1997 1996 ------ ------ ------ Return on average assets 1.64% 1.47% 1.24% Return on average shareholder's equity 13.79% 12.51% 10.12% Dividend payout ratio 39.43% 40.08% 44.97% Average shareholders' equity to average assets 11.86% 11.78% 12.22% II-23 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 industrial companies that have significant investments in fixed assets. Due to this fact, the effects of inflation on the Corporation's balance sheet are minimal, meaning that there are no substantial increases or decreases in net purchasing power over time. The most significant effect of inflation is on other expenses which tend to rise during periods of general inflation. Management feels that the most significant impact on financial results is changes in interest rates and the Corporation's ability to react to those changes. As discussed previously, management is attempting to measure, monitor and control interest rate risk. Quarterly Financial Results (in thousands, except per share amounts) American National Bankshares Inc. and Subsidiary
Fourth Third Second First 1998 Quarter Quarter Quarter Quarter ------- ------- ------- ------- Interest income....................................... $8,346 $8,244 $8,093 $7,971 Interest expense...................................... 3,651 3,702 3,587 3,532 ------- ------- ------- ------- Net interest income................................. 4,695 4,542 4,506 4,439 Provision for loan losses............................. 249 203 223 252 ------- ------- ------- ------- Net interest income after provision................. 4,446 4,339 4,283 4,187 Non-interest income................................... 1,164 989 980 896 Non-interest expense.................................. 2,850 2,692 2,748 2,673 ------- ------- ------- ------- Income before income tax provision.................. 2,760 2,636 2,515 2,410 Income tax provision.................................. 801 809 764 749 ------- ------- ------- ------- Net income.......................................... $1,959 $1,827 $1,751 $1,661 ======= ======= ======= ======= Per common share: Net income.......................................... $ .64 $ .60 $ .58 $ .54 Cash dividends...................................... $ .24 $ .24 $ .24 $ .21 1997 Interest income....................................... $8,053 $7,916 $7,883 $7,876 Interest expense...................................... 3,665 3,629 3,619 3,677 ------- ------- ------- ------- Net interest income................................. 4,388 4,287 4,264 4,199 Provision for loan losses............................. 338 262 257 243 ------- ------- ------- ------- Net interest income after provision................. 4,050 4,025 4,007 3,956 Non-interest income................................... 845 835 783 738 Non-interest expense.................................. 2,722 2,466 2,542 2,515 ------- ------- ------- ------- Income before income tax provision.................. 2,173 2,394 2,248 2,179 Income tax provision.................................. 630 749 704 642 ------- ------- ------- ------- Net income.......................................... $1,543 $1,645 $1,544 $1,537 ======= ======= ======= ======= Per common share: Net income.......................................... $ .50 $ .54 $ .48 $ .47 Cash dividends...................................... $ .21 $ .21 $ .21 $ .18
II-24 MANAGEMENT'S REPORT ON FINANCIAL STATEMENTS The following consolidated financial statements and related notes to consolidated financial statements of American National Bankshares Inc. and Subsidiary were prepared by Management which has the primary responsibility for the integrity of the financial information. The statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and include amounts that are based on Management's best estimates and judgement. Financial information elsewhere in this Annual Report is presented on a basis consistent with that in the financial statements. In meeting its responsibility for the fair presentation of the financial statements, Management relies on the Corporation's comprehensive system of internal accounting controls. This system provides reasonable assurance that assets are safeguarded and transactions are recorded to permit the preparation of appropriate financial information. The system of internal controls is characterized by an effective control-oriented environment within the Corporation which is augmented by written policies and procedures, internal audits and the careful selection and training of qualified personnel. The functioning of the accounting system and related internal accounting controls is under the general oversight of the Audit and Compliance Committee of the Board of Directors which is comprised of three outside directors. The accounting system and related controls are reviewed by an extensive program of internal audits. The Audit and Compliance Committee meets regularly with the internal auditors to review their work and ensure that they are properly discharging their responsibilities. In addition, the Committee reviews and approves the scope and timing of the internal audits and any findings with respect to the system of internal controls. The Audit and Compliance Committee also meets periodically with representatives of Arthur Andersen LLP, the Corporation's independent public accountants, to discuss the results of their audit as well as other audit and financial matters. Reports of examinations conducted by the Office of the Comptroller of the Currency are also reviewed by the committee members. The responsibility of Arthur Andersen LLP is limited to an expression of their opinion as to the fairness of the financial statements presented. Their opinion is based on an audit conducted in accordance with generally accepted auditing standards as described in the second paragraph of their report. /s/ Charles H. Majors President and Chief Executive Officer /s/ T. Allen Liles Senior Vice President, Secretary, Treasurer and Chief Financial Officer January 21, 1999 II-25 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To American National Bankshares Inc.: We have audited the accompanying consolidated balance sheets of American National Bankshares Inc. (a Virginia corporation) and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American National Bankshares Inc. and Subsidiary as of December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Charlotte, North Carolina, January 21, 1999 II-26 Consolidated Balance Sheets December 31, 1998 and 1997 American National Bankshares Inc. and Subsidiary - -----------------------------------------------------------------------------------------------------------
ASSETS 1998 1997 ------------- ------------- Cash and due from banks ..................................................... $ 14,071,687 $ 13,386,440 Interest-bearing deposits in other banks .................................... 706,245 366,110 Investment securities: Securities available for sale (at market value)............................ 105,535,523 82,466,034 Securities held to maturity (market value of $59,207,124 in 1998 and $61,367,264 in 1997)......................................... 57,877,279 60,610,993 ------------- ------------- Total investment securities............................................ 163,412,802 143,077,027 ------------- ------------- Loans ....................................................................... 269,676,596 254,792,918 Less Unearned income.......................................................... (157,315) (343,211) Reserve for loan losses.................................................. (3,821,447) (3,277,179) ------------- ------------- Net loans............................................................ 265,697,834 251,172,528 ------------- ------------- Bank premises and equipment, at cost, less accumulated depreciation of $7,164,459 in 1998 and $6,349,589 in 1997 ................. 7,603,080 6,514,286 Accrued interest receivable and other assets ................................ 8,891,186 9,123,469 ------------- ------------- Total assets......................................................... $460,382,834 $423,639,860 ============= ============= LIABILITIES and SHAREHOLDERS' EQUITY Liabilities: Demand deposits -- non-interest bearing.................................... $ 45,070,732 $ 41,754,876 Demand deposits -- interest bearing........................................ 55,883,458 52,029,224 Money market deposits...................................................... 18,089,331 17,151,352 Savings deposits........................................................... 68,620,629 69,550,353 Time deposits.............................................................. 170,660,739 171,117,111 ------------- ------------- Total deposits ..................................................... 358,324,889 351,602,916 ------------- ------------- Federal funds purchased.................................................... -- 1,500,000 Repurchase agreements...................................................... 31,022,834 18,038,964 FHLB Borrowings............................................................ 13,000,000 -- Accrued interest payable and other liabilities............................. 3,174,465 2,495,215 ------------- ------------- Total liabilities.................................................... 405,522,188 373,637,095 ------------- ------------- Shareholders' equity: Preferred stock, $5 par, 200,000 shares authorized, none outstanding......................................................... -- -- Common stock, $1 par,10,000,000 shares authorized, 3,051,733 shares outstanding in 1998 and 1997 ........................... 3,051,733 3,051,733 Capital in excess of par value............................................. 9,892,304 9,892,304 Retained earnings.......................................................... 40,798,323 36,438,185 Accumulated other comprehensive income - net unrealized gains on securities available for sale ................... 1,118,286 620,543 ------------- ------------- Total shareholders' equity........................................... 54,860,646 50,002,765 ------------- ------------- Total liabilities and shareholders' equity........................... $460,382,834 $423,639,860 ============= ============= The accompanying notes to consolidated financial statements are an integral part of these balance sheets.
II-27 Consolidated Statements of Income For The Years Ended December 31, 1998, 1997 and 1996 American National Bankshares Inc. and Subsidiary - -----------------------------------------------------------------------------------------------------------------
1998 1997 1996 ----------- ----------- ----------- Interest Income: Interest and fees on loans........................................... $23,356,412 $22,441,097 $20,334,588 Interest on federal funds sold and other............................. 271,524 237,204 434,674 Income on investment securities: U S Government..................................................... 2,601,437 4,018,344 6,022,023 Federal agencies................................................... 4,485,157 3,470,483 1,711,974 State and municipal ............................................... 1,346,014 1,136,496 988,159 Other investments.................................................. 593,363 424,521 440,374 ----------- ----------- ----------- Total interest income............................................ 32,653,907 31,728,145 29,931,792 ----------- ----------- ----------- Interest Expense: Interest on deposits: Demand............................................................. 1,203,786 1,408,255 1,245,678 Money market....................................................... 545,061 571,873 637,954 Savings............................................................ 1,949,958 2,140,158 2,012,717 Time............................................................... 9,260,295 9,589,470 9,670,514 Interest on fed funds and repos...................................... 1,116,315 880,392 803,099 Interest on other borrowings......................................... 396,183 -- - ----------- ----------- ----------- Total interest expense........................................... 14,471,598 14,590,148 14,369,962 ----------- ------------ ----------- Net Interest Income.................................................... 18,182,309 17,137,997 15,561,830 Provision for Loan Losses.............................................. 927,000 1,100,000 673,291 ----------- ----------- ----------- Net Interest Income After Provision For Loan Losses...................................................... 17,255,309 16,037,997 14,888,539 ----------- ----------- ----------- Non-Interest Income: Trust and investment services........................................ 2,165,437 1,888,341 1,896,266 Service charges on deposit accounts.................................. 902,060 786,270 600,606 Non-deposit fees and insurance commissions........................... 287,704 155,697 106,015 Mortgage banking income.............................................. 428,991 220,293 -- Other income......................................................... 245,238 150,374 88,355 ----------- ----------- ----------- Total non-interest income.......................................... 4,029,430 3,200,975 2,691,242 ----------- ----------- ----------- Non-Interest Expense: Salaries............................................................. 5,126,819 4,810,783 4,083,106 Pension and other employee benefits.................................. 1,140,252 1,076,144 912,935 Occupancy and equipment ............................................. 1,663,880 1,437,285 1,211,974 FDIC insurance ...................................................... 73,911 77,801 466,663 Postage and printing................................................. 447,609 429,128 397,409 Core deposit intangible amortization................................. 449,816 450,179 317,961 Merger related ...................................................... -- -- 1,055,695 Other ............................................................... 2,061,322 1,963,680 1,721,321 ----------- ----------- ----------- Total non-interest expense......................................... 10,963,609 10,245,000 10,167,064 ----------- ----------- ----------- Income Before Income Tax Provision..................................... 10,321,130 8,993,972 7,412,717 Income Tax Provision................................................... 3,122,881 2,724,780 2,380,529 ----------- ----------- ----------- Net Income............................................................. $ 7,198,249 $ 6,269,192 $ 5,032,188 =========== =========== =========== Net Income Per Common Share: Basic................................................................ $ 2.36 $ 1.99 $ 1.54 Diluted.............................................................. $ 2.36 $ 1.99 $ 1.54 Average Common Shares Outstanding: Basic................................................................ 3,051,733 3,144,834 3,267,038 Diluted.............................................................. 3,052,659 3,144,834 3,267,038 The accompanying notes to consolidated financial statements are an integral part of these statements.
II-28 CONSOLIDATED STATEMENTS of CHANGES in SHAREHOLDERS' EQUITY For the Years Ended December 31, 1998, 1997 and 1996 American National Bankshares Inc. and Subsidiary
Common Stock Accumulated ------------------------- Capital in Other Total Excess of Retained Comprehensive Shareholders' Shares Amount Par Value Earnings Income Equity ----------- ----------- ----------- ------------ ------------- -------------- Balance, December 31, 1995............... 3,213,641 $3,213,641 $9,966,711 $35,223,572 $ 628,067 $49,031,991 Net income............................... -- -- -- 5,032,188 -- 5,032,188 Change in unrealized gains on securities available for sale, net of tax......... -- -- -- -- (314,456) (314,456) -------------- Comprehensive income..................... 4,717,732 Exercise of stock options................ 66,270 66,270 668,192 -- -- 734,462 Cash paid for fractional shares.......... (113) (113) (3,318) -- -- (3,431) Cash dividends, at $.69 per share........ -- -- -- (2,263,060) -- (2,263,060) ------------ ----------- ----------- ------------ ------------- -------------- Balance, December 31, 1996............... 3,279,798 3,279,798 10,631,585 37,992,700 313,611 52,217,694 Net income............................... -- -- -- 6,269,192 -- 6,269,192 Change in unrealized gains on securities available for sale, net of tax......... -- -- -- -- 306,932 306,932 -------------- Comprehensive income..................... 6,576,124 Stock repurchase......................... (228,065) (228,065) (739,281) (5,310,752) - (6,278,098) Cash dividends, at $.81 per share........ -- -- -- (2,512,955) - (2,512,955) ------------ ----------- ----------- ------------ ------------- -------------- Balance, December 31, 1997............... 3,051,733 3,051,733 9,892,304 36,438,185 620,543 50,002,765 Net income............................... -- -- -- 7,198,249 -- 7,198,249 Change in unrealized gains on securities available for sale, net of tax......... -- -- -- -- 497,743 497,743 -------------- Comprehensive income..................... 7,695,992 Cash dividends, at $.93 per share........ -- -- -- (2,838,111) -- (2,838,111) ------------ ----------- ----------- -------------- ------------ -------------- Balance, December 31, 1998............... 3,051,733 $3,051,733 $9,892,304 $40,798,323 $ 1,118,286 $54,860,646 ============ =========== =========== ============== ============ ============== The accompanying notes to consolidated financial statements are an integral part of these statements.
II-29 Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996 American National Bankshares Inc. and Subsidiary
1998 1997 1996 ------------- ------------- ------------- Cash Flows from Operating Activities: Net income.............................................................. $ 7,198,249 $ 6,269,192 $ 5,032,188 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses........................................... 927,000 1,100,000 673,291 Depreciation........................................................ 814,870 720,446 562,299 Core deposit intangible amortization................................ 449,816 450,179 317,961 Amortization (accretion) of premiums and discounts on investment securities.......................................... (42,918) (56,111) 36,737 (Gain) loss on sale of securities................................... (18,300) (30,912 338,103 Gain on sale of loans............................................... (428,991) (220,293) -- Gain on sale of real estate owned................................... -- -- -- Gain on sale of property and equipment.............................. -- -- (32,015) Deferred income taxes benefit....................................... (312,768) (154,749) (61,225) Reconciliation of fiscal year of merged company to calendar year.... -- -- (379,006) (Increase) decrease in interest receivable.......................... (159,538) 311,723 (227,123) Increase in other assets............................................ (1,639) (203,721) (112,123) (Decrease) increase in interest payable............................. (21,910) (224,020) 522,644 Increase (decrease) in other liabilities............................ 701,160 246,124 (324,563) ------------- ------------- ------------- Net cash provided by operating activities........................... 9,105,031 8,207,858 6,347,168 ------------- ------------- ------------- Cash Flows from Investing Activities: Acquisition of branch operations........................................ -- -- 14,866,883 Proceeds from maturities, calls, and sales of securities ............... 47,430,116 53,402,611 56,166,496 Purchases of securities available for sale.............................. (55,738,003) (20,170,962) (28,709,857) Purchases of securities held to maturity................................ (11,212,515) -- (53,916,004) Net increase in loans................................................... (15,023,315) (18,542,833) (16,108,172) Proceeds from sale of property and equipment............................ -- -- 158,047 Purchases of property and equipment..................................... (1,903,664) (849,981) (993,541) ------------- ------------- ------------- Net cash (used in) provided by investing activities..................... (36,447,381) 13,838,835 (28,536,148) ------------- ------------- ------------- Cash Flows from Financing Activities: Net increase in demand, money market, and savings deposits.................................................. 7,178,345 10,271 8,929,414 Net (decrease) increase in time deposits................................ (456,372) (10,389,947) 3,186,875 Net increase in Federal Home Loan Bank borrowings....................... 13,000,000 -- -- Net increase (decrease) in federal funds purchased and repurchase agreements............................................. 11,483,870 (3,945,317) 13,912,246 Cash dividends paid..................................................... (2,838,111) (2,512,955) (2,263,060) Cash paid in lieu of fractional shares.................................. -- -- (3,431) Repurchase of stock..................................................... -- (6,278,098) -- Proceeds from exercise of stock options................................. -- -- 460,000 ------------- ------------- -------------- Net cash provided by (used in) financing activities..................... 28,367,732 (23,116,046) 24,222,044 ------------- ------------- -------------- Net Increase (Decrease) in Cash and Cash Equivalents..................... 1,025,382 (1,069,353) 2,033,064 Cash and Cash Equivalents at Beginning of Period.......................... 13,752,550 14,821,903 12,788,839 ------------- ------------- -------------- Cash and Cash Equivalents at End of Period................................ $ 14,777,932 $ 13,752,550 $ 14,821,903 ============= ============= ============== Supplemental Schedule of Cash and Cash Equivalents: Cash: Cash and due from banks............................................... $ 14,071,687 $ 13,386,440 $ 14,622,925 Interest-bearing deposits in other banks.............................. 706,245 366,110 198,978 ------------- ------------- -------------- $ 14,777,932 $ 13,752,550 $ 14,821,903 ============= ============= ============== Supplemental Disclosure of Cash Flow Information: Interest paid........................................................... $ 14,493,509 $ 14,814,169 $ 13,746,911 Income taxes paid....................................................... $ 2,950,000 $ 2,953,355 $ 2,600,939 Transfer of loans to other real estate owned............................ $ 385,000 $ -- $ -- The accompanying notes to consolidated financial statements are an integral part of these statements.
II-30 Notes to Consolidated Financial Statements December 31, 1998, 1997 and 1996 American National Bankshares Inc. and Subsidiary 1. Summary of Accounting Policies: Consolidation The consolidated financial statements include the amounts and results of operations of American National Bankshares Inc. ("the Corporation") and its wholly owned subsidiary, American National Bank and Trust Company ("the Bank"). The Bank offers a wide variety of retail, commercial and trust banking services through its offices located in the trade area of the City of Danville, Virginia, the Counties of Pittsylvania and Henry in Virginia and the County of Caswell in North Carolina. Mutual Mortgage of the Piedmont, Inc., a wholly owned subsidiary of the Bank, commenced mortgage lending operations in December 1996. All significant intercompany transactions and accounts are eliminated in consolidation. Investment Securities The Corporation classifies investment securities in one of three categories: held to maturity, available for sale and trading. Debt securities acquired with both the intent and ability to be held to maturity are classified as held to maturity and reported at amortized cost. Gains or losses realized from the sale of any securities held to maturity are determined by specific identification and are included in non-interest income. Securities which may be used to meet liquidity needs arising from unanticipated deposit and loan fluctuations, changes in regulatory capital and investment requirements, or unforeseen changes in market conditions, including interest rates, market values or inflation rates, are classified as available for sale. Securities available for sale are reported at estimated fair value, with unrealized gains and losses reported as a separate component of shareholders' equity, net of tax. Gains or losses realized from the sale of securities available for sale are determined by specific identification and are included in non-interest income. The Corporation does not permit the purchase or sale of trading account securities. If such securities were permitted, market adjustments, fees, gains or losses and income earned on trading account securities would be included in non-interest income. Gains or losses realized from the sale of trading securities would be determined by specific identification and included in non-interest income. Premiums and discounts on investment securities are amortized using the interest method. Loans Loans are stated at the principal amount outstanding, net of unearned income. Mortgage and commercial loans accrue interest on the unpaid balance of the loans. Consumer loans made prior to April 1, 1994 earn interest on the level yield method based on the daily outstanding balance. Consumer loans made subsequent to April 1, 1994 accrue interest on the unpaid balance of the loans. The net amount of nonrefundable loan origination fees and direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using the effective interest method. Reserve for Loan Losses The reserve for loan losses is an estimate of losses inherent in the loan portfolio as determined by management taking into consideration historical loan loss experience, diversification of the loan portfolio, amount of secured and unsecured loans, banking industry standards and averages, and general economic conditions. Ultimate losses may vary from current estimates. These estimates are reviewed periodically and as adjustments become necessary, they are reported in earnings in the periods in which they become reasonably estimable. Bank Premises and Equipment Additions and major replacements are added to bank premises and equipment at cost. Maintenance and repair costs are charged to expense when incurred. Premises and equipment are depreciated using primarily accelerated methods II-31 over estimated lives generally as follows: buildings, 10 to 50 years; and furniture and equipment, 3 to 10 years. Intangible Assets Premiums paid on acquisitions of deposits (core deposit intangibles) are included in other assets in the "Consolidated Balance Sheets". Such assets are being amortized on a straight line basis over 10 years. At December 31, 1998, the Bank had $3,183,000 recorded as core deposit intangibles, net of amortization. For the years ended December 31, 1998, 1997 and 1996, the Bank recorded core deposit intangible amortization of approximately $450,000, $450,000 and $318,000, respectively. Foreclosed Properties Foreclosed properties are included in other assets, and they represent other real estate that has been acquired through loan or in-substance foreclosures or deeds received in lieu of loan payments. Generally, such properties are appraised annually, and they are recorded at the lower of cost or fair value less estimated selling costs. When appropriate, adjustments to cost are charged or credited to the allowance for foreclosed properties. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles 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. Income Taxes Deferred income taxes are provided where different accounting methods have been used for reporting income for income tax and for financial reporting purposes. Earnings Per Share The Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", in 1998. This statement requires the dual presentation of basic and diluted earnings per share which are equal for the Corporation for all periods presented. No restatement of prior periods was required. New Accounting Pronouncements In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued which establishes standards for reporting and displaying comprehensive income and its components. This statement requires comprehensive income and its components, as recognized under the accounting standards, to be displayed in a financial statement with the same prominence as other financial statements. The disclosure requirements of SFAS No. 130 have been included in the Corporation's Consolidated Statements of Changes in Shareholders' Equity. The FASB also issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", in June 1997, which establishes new standards for reporting information about operating segments in annual and interim financial statements. This statement also requires descriptive information about the way operating segments are determined, the products and services provided by the segments and the nature of differences between reportable segment measurements and those used for the consolidated entity. The disclosure requirements of SFAS No.131 have been adopted and are included in Note 15 to the Consolidated Financial Statements. In February, 1998, SFAS No. 132, "Employers' Disclosures about Pension and Other Postretirement Benefits", was issued, amending FASB Statements No. 87, 88, and 106. This Statement does not change the measurement or recognition of pension and postretirement benefit plans but standardizes disclosure requirements. The new disclosure requirements of SFAS No. 132 have been adopted and are included in Note 12 to the Consolidated Financial Statements. In June, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards requiring balance sheet recognition of all derivative instruments at fair value. The statement specifies that changes in the fair value of derivative instruments be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows derivative gains and losses to offset related results on hedged items in the income statement. Companies must formally document, designate and assess the effectiveness of transactions utilizing hedge accounting. The statement is effective for fiscal years beginning after June 15, 1999, and cannot be applied retroactively. Adoption is not expected to have a material impact on the Corporation. II-32 2. Parent Company Financial Information: Condensed parent company financial information is as follows (in thousands): As of December 31 ----------------- Condensed Balance Sheets 1998 1997 ------------------------ ---- ---- Assets: Investment in Subsidiary $54,831 $49,969 Other Assets 30 34 ------- ------- Total Assets $54,861 $50,003 ======= ======= Shareholders' Equity $54,861 $50,003 ======= ======= For the Year Ended December 31 ----------------------- Condensed Statements of Income 1998 1997 1996 ------------------------------ ---- ---- ---- Dividends from Subsidiary $2,903 $8,820 $2,283 Expenses (44) (33) (2) ------ ------ ------ Income Before Equity in Undistributed Earnings of Subsidiary 2,859 8,787 2,281 Equity in Undistributed (Distributions in Excess of) Earnings of Subsidiary 4,339 (2,518) 2,751 ------ ------ ------ Net Income $7,198 $6,269 $5,032 ====== ====== ====== For the Year Ended December 31 ------------------------ Condensed Statements of Cash Flows 1998 1997 1996 ---------------------------------- ---- ---- ---- Cash provided by dividends received from Subsidiary $2,903 $8,820 $2,283 Cash used for payment of dividends (2,838) (2,513) 2,263) Cash used for repurchase of stock -- (6,278) -- Other (19) (33) (11) ------ ------ ------ Net increase (decrease) in cash $ 46 $ ( 4) $ 9 ====== ====== ====== 3. Mergers and Acquisitions: On March 14, 1996, the Corporation completed the acquisition of Mutual Savings Bank, F.S.B. ("Mutual") upon the approval of the shareholders of each company. The Corporation exchanged approximately 879,805 common shares, at an exchange ratio of .705 of a share of the Corporation's common stock, for each of Mutual's 1,248,100 common shares (which includes the exercise of all outstanding stock options). The transaction was accounted for as a pooling of interests. The financial position and results of operations of the Corporation and Mutual were combined and the fiscal year of Mutual was conformed to the Corporation's fiscal year. In addition, all prior periods presented were restated to give effect to the merger. In October 1996, the Corporation acquired the branch office of FirstSouth Bank located in Yanceyville, North Carolina. In addition to the branch facilities and an ATM located in Yanceyville, the Corporation acquired $4,775,000 in loans and assumed deposits of $21,405,000. This transaction was accounted for as a purchase. II-33 4. Investment Securities: The amortized cost and estimated fair value of investments in debt securities at December 31, 1998 and 1997 were as follows (in thousands): 1998 ----------------------------------------------- Amortized Estimated Cost Gains Losses Fair Value ------------ -------- -------- ---------- Securities held to maturity: U.S. Government $ 12,988 $ 33 $ -- $ 13,021 Federal agencies 24,871 598 -- 25,469 State and municipal 20,018 713 (14) 20,717 ------------ -------- -------- ---------- Total securities held to maturity 57,877 1,344 (14) 59,207 ------------ -------- -------- ---------- Securities available for sale: U.S. Government 19,030 190 -- 19,220 Federal agencies 49,843 689 (11) 50,521 State and municipal 15,446 633 (22) 16,057 Other 19,522 230 (14) 19,738 ------------ -------- -------- ---------- Total securities available for sale 103,841 1,742 (47) 105,536 ------------ -------- -------- ---------- Total securities $161,718 $3,086 $ (61) $164,743 ============ ======== ======== ========== 1997 ---------------------------------------------- Amortized Estimated Cost Gains Losses Fair Value ----------- -------- -------- ---------- Securities held to maturity: U.S. Government $ 15,935 $ 47 $ -- $ 15,982 Federal agencies 32,610 262 (54) 32,818 State and municipal 12,066 503 (2) 12,567 ---------- -------- -------- ---------- Total securities held to maturity 60,611 812 (56) 61,367 ---------- -------- -------- ---------- Securities available for sale: U.S. Government 35,033 177 -- 35,210 Federal agencies 28,950 313 (45) 29,218 State and municipal 9,914 424 -- 10,338 Other 7,629 75 (4) 7,700 ---------- -------- -------- ---------- Total securities available for sale 81,526 989 (49) 82,466 ---------- -------- -------- ---------- Total securities $142,137 $1,801 $ (105) $143,833 ========== ======== ======== ========== II-34 The amortized cost and estimated fair value of investments in debt securities at December 31, 1998, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Held to Maturity Available for Sale ------------------------- ------------------------ Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value ---------- ------------ ---------- ----------- Due in one year or less $ 14,992 $ 15,042 $ 12,512 $ 12,557 Due after one year through five years 22,647 23,305 37,108 37,999 Due after five years through ten years 13,515 13,984 29,160 29,717 Due after ten years 6,723 6,876 25,061 25,263 ========== =========== ========== ========== $ 57,877 $ 59,207 $103,841 $105,536 ========== =========== ========== ========== Proceeds from calls exercised by the issuers of investments in debt securities were $14,753,000 in 1998, $1,236,000 in 1997 and $1,804,000 in 1996. Proceeds from sales of investments in debt securities were $0 in 1998, $24,823,000 in 1997 and $19,234,000 in 1996. The Bank recognized gains of $18,000 on called securities during 1998, losses of $13,000 and gains of $44,000 on sale of securities during 1997 and losses of $592,000 and gains of $254,000 on sales of securities during 1996. Investment securities with a book value of approximately $49,989,000 at December 31, 1998 were pledged to secure deposits of the U. S. Government, state and political sub-divisions and for other purposes as required by law. Of this amount, $37,537,000 was pledged to secure repurchase agreements. 5. Loans: Outstanding loans at December 31, 1998 and 1997 were composed of the following (in thousands): 1998 1997 ---- ---- Real Estate loans: Construction and land development $ 8,104 $ 4,458 Secured by farmland 1,491 1,276 Secured by 1 - 4 family residential properties 95,711 94,472 Secured by multi-family (5 or more) residential properties 2,268 1,522 Secured by nonfarm, nonresidential properties 44,251 41,368 Loans to farmers 2,293 2,761 Commercial and industrial loans 67,154 57,980 Loans to individuals for personal expenditures 46,494 48,545 Loans for nonrated industrial development obligations 1,895 2,398 All other loans 15 13 -------- -------- Total loans $269,676 $254,793 ======== ======== Loans, other than consumer, are generally placed on nonaccrual status when any portion of principal or interest is 90 days past due or collectability is uncertain. Unless loans are in the process of collection, income recognition on consumer loans is discontinued and the loans are charged off after a delinquency of 90 days. At December 31, 1998, 1997 and 1996, loans in a nonaccrual or restructured status totaled approximately $190,000, $393,000 and $33,000, respectively. Interest income on nonaccrual loans, if recognized, is recorded on a cash basis. For the years 1998, 1997 and 1996, the II-35 gross amount of interest income that would have been recorded on nonaccrual loans and restructured loans, if all such loans had been accruing interest at the original contractual rate, was $14,000, $18,000 and $40,000, respectively. No interest payments were recorded in 1998, 1997 or 1996 as interest income for all such nonperforming loans. Under the Corporation's policy a nonaccruing loan may be restored to accrual status when none of its principal and interest is due and unpaid and the Corporation expects repayment of the remaining contractual principal and interest or when it otherwise becomes well secured and in the process of collection. As of January 1, 1995, the Bank adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which was amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". SFAS No. 114, as amended, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or as a practical expedient, at the loan's observable market price or the fair value of the collateral, if the loan is collateral-dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. The Bank had previously measured the reserve for loan losses using methods similar to those prescribed in SFAS No. 114. As a result of adopting these statements, no additional reserve for loan losses was required as of January 1, 1995. For purposes of applying SFAS No. 114, commercial loans on nonaccrual status are evaluated for impairment on an individual basis. Management assesses the current economic condition and the historical repayment patterns of the creditor in determining whether delays in repayment on the loans are considered to be insignificant shortfalls or indicators of impairment. Those loans for which management considers it probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement are considered to be impaired. All loans made by the Bank other than commercial loans are excluded from the scope of SFAS No. 114 as they are considered smaller-balance homogeneous loans that are collectively evaluated for impairment. Interest income is recognized on impaired loans in the same manner as loans on nonaccrual status. The Bank did not identify any loans as impaired at December 31, 1998. The loan portfolio is concentrated primarily in the immediate geographic region which is the Corporation's trade area consisting of the City of Danville, City of Martinsville, Pittsylvania and Henry Counties in Virginia, Town of Yanceyville and the northern half of Caswell County in North Carolina. There were no concentrations of loans to any individual, group of individuals, businesses or industry that exceeded 10% of the outstanding loans at December 31, 1998. An analysis of the reserve for loan losses is as follows (in thousands): 1998 1997 1996 ---- ---- ---- Balance, beginning of year $3,277 $3,070 $2,757 Provision for loan losses charged to expense 927 1,100 673 Charge-offs (508) (992) (502) Recoveries 125 99 117 Other -- -- 25 ------ ------ ------ Balance, end of year $3,821 $3,277 $3,070 ====== ====== ====== 6. Time Deposits: Included in time deposits are certificates of deposit in denominations of $100,000 or more totaling $32,851,000, $32,815,000 and $34,472,000 at December 31, 1998, 1997 and 1996, respectively. Interest expense on such deposits during 1998, 1997 and 1996 was $1,436,000, $1,570,000 and $1,392,000, respectively. 7. Short-Term Borrowings: Short-Term borrowings at December 31, 1998 and 1997 were composed of the following (in thousands): As of December 31 ----------------- 1998 1997 ---- ---- Federal funds purchased $ -- $ 1,500 Repurchase agreements 31,023 18,039 ------- ------- Total short-term borrowings $31,023 $19,539 ======= ======= Federal funds purchased represent unsecured borrowings from other banks and generally mature daily. Repurchase agreements are borrowings collateralized by securities of the U.S. Government or its agencies and mature daily. II-36 8. Stock Options: In October 1995, SFAS No. 123, "Accounting for Stock-Based Compensation" was issued. SFAS No. 123 is effective for fiscal years beginning after December 15, 1995. SFAS No.123 encourages companies to adopt the fair value method for compensation expense recognition related to employee stock options. Existing accounting requirements of Accounting Principles Board Opinion No. 25 (APB No. 25) use the intrinsic value method in determining compensation expense, which represents the excess of the market price of stock over the exercise price on the measurement date. The Corporation elected to remain under APB No. 25 for accounting for stock options. Since the exercise price of all options granted was equal to or exceeded the market value of the stock at the date of grant, no compensation expense has been recognized. The following table reflects pro forma net income and earnings per share had the Corporation elected to adopt the fair value approach of SFAS No. 123 (in thousands, except per share data): 1998 1997 ---- ---- Net Income: As reported $7,198 $6,269 Pro forma 7,036 6,240 Basic earnings per share As reported $ 2.36 $ 1.99 Pro forma 2.31 1.98 At December 31, 1998 and 1997, the Corporation had 150,000 shares of its authorized but unissued common stock reserved for its incentive and nonqualified stock option plan. A summary of stock option transactions under the plan follows: Option Option Price Shares Per Share ------ ------------ Outstanding at December 31, 1996 -- -- Granted 16,800 $28.00 Exercised -- -- Forfeited 800 28.00 ------ ------------- Outstanding at December 31, 1997 16,000 $28.00 Granted 21,000 $31.25-$37.50 Exercised -- -- Forfeited 1,100 $28.00 ------ ------------- Outstanding at December 31, 1998 35,900 $28-$37.50 ====== ============= The following table summarizes information related to stock options outstanding on December 31, 1998: Exercise Number of Options Outstanding Number of Options Exercisable Prices at December 31, 1998 at December 31, 1998 -------- ----------------------------- ----------------------------- $28.00 14,900 14,900 $31.25 7,000 7,000 $34.375 7,000 -- $37.50 7,000 -- II-37 9. Income Taxes: The components of the Corporation's net deferred tax assets as of December 31, 1998 and December 31, 1997, were as follows (in thousands): December 31 December 31 ----------- ----------- 1998 1997 ---- ---- Deferred tax assets: Reserve for loan losses $1,096 $ 911 Deferred compensation 274 247 Other 196 201 ------ ------ 1,566 1,359 Valuation allowance (153) (136) ------ ------ Total deferred tax assets 1,413 1,223 ------ ------ Deferred tax liabilities: Depreciation 241 230 Net unrealized gains 576 320 Accretion of discount 137 211 Other 117 171 ------ ------ Total deferred tax liabilities 1,071 932 ------ ------ Net deferred tax assets $ 342 $ 291 ====== ====== The provision for income taxes consists of the following (in thousands): 1998 1997 1996 ---- ---- ---- Taxes currently payable $3,436 $2,880 $2,442 Deferred tax benefit (313) (155) (61) ------ ------ -- --- $3,123 $2,725 $2,381 ====== ====== ====== The effective rates of the provision differ from the statutory federal income tax rates due to the following items: 1998 1997 1996 ---- ---- ---- Federal statutory rate 34.0% 34.0% 34.0% Non-taxable interest income (3.8) (3.6) (3.6) Non-deductible merger expenses -- -- 2.3 Other .1 ( .1) ( .6) ----- ----- ----- 30.3% 30.3% 32.1% ===== ===== ===== 10. Commitments and Contingent Liabilities: The consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business to meet the financing needs of customers. These include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amount recognized in the Consolidated Balance Sheets. The extent of the Bank's involvement in various commitments or contingent liabilities is expressed by the contract or notional amounts of such instruments. Commitments to extend credit, which amounted to $67,466,000 and $64,774,000 at December 31, 1998 and 1997, respectively, represent legally binding agreements to lend to a customer 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 liquidity requirements. There were $952,000 in commitments at December 31, 1998 and none at December 31, 1997 to purchase securities when issued. Standby letters of credit are conditional commitments issued by the Bank guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. At December 31, 1998 and 1997 the Bank had $682,000 and $1,500,000 in outstanding standby letters of credit. II-38 Management and the Corporation's counsel are not aware of any pending litigation against the Corporation and believe that there are no contingent liabilities outstanding that will result in a material adverse effect on the Corporation's consolidated financial position or consolidated results of operations. The Bank is a member of the Federal Reserve System and is required to maintain certain levels of its cash and due from bank balances as reserves based on regulatory requirements. At December 31, 1998, this reserve requirement was approximately $5,946,000. 11. Related Party Transactions: The Directors provide the Bank with substantial amounts of business, and many are among its largest depositors and borrowers. The total amount of loans outstanding to the executive officers, directors and their business interests was $9,572,000 and $11,825,000 at December 31, 1998 and 1997, respectively. The maximum amount of loans outstanding to the officers, directors and their business interests at any month-end during 1998, 1997 and 1996 was approximately 4.0% of gross loans. Management believes that all such loans are made on substantially the same terms, including interest rates, as those prevailing at the time for comparable loans to similar, unrelated borrowers, and do not involve more than a normal risk of collectability. As of December 31, 1998, none of these loans were restructured, nor were any related party loans charged off during 1998. An analysis of these loans for 1998 is as follows (in thousands): Balance, beginning of year $11,825 Additions 18,204 Repayments (20,457) ------- Balance, end of year $ 9,572 ======= 12. Employee Benefit Plans: The Bank's retirement plan is a non-contributory defined benefit pension plan which covers substantially all employees of the Bank who are 21 years of age or older and who have had at least one year of service. Advanced funding is accomplished by using the actuarial cost method known as the collective aggregate cost method. The following table sets forth the plan's funded status as of December 31, 1998 and 1997 (in thousands): 1998 1997 ---- ---- Change in benefit obligation: Benefit obligation at beginning of year $ 3,431 $ 3,913 Service cost 198 193 Interest cost 240 274 Actuarial gain 175 145 Benefits paid (124) (1,094) -------- -------- Benefit obligation at end of year $ 3,920 $ 3,431 ======== ======== Change in plan assets: Fair value of plan assets at beginning of year $ 3,796 $ 3,782 Actual return on plan assets 877 1,058 Employer contributions -- 50 Benefits paid (124) (1,094) -------- -------- Fair value of plan assets at end of year $ 4,549 $ 3,796 ======== ======== Funded status $ 629 $ 365 Unrecognized net actuarial gain (365) 34 Unrecognized net obligation at transition (54) (67) Unrecognized prior service cost (192) (216) -------- -------- Prepaid benefit cost $ 18 $ 116 ======== ======== II-39 Major assumptions and net periodic pension cost include the following (in thousands): 1998 1997 1996 ---- ---- ---- Weighted-average assumptions: Discount rate: Post-retirement 6.00% 6.00% 6.00% Pre-retirement 7.00 7.00 7.00 Expected return on plan assets 8.00 8.00 6.25 Rate of compensation increase 4.00 4.00 4.00 Components of net periodic benefit cost: Service cost $ 198 $ 193 $ 125 Interest cost 240 274 186 Expected return on plan assets (304) (303) (204) Amortization of prior service cost (24) (24) (24) Amortization of net obligation at transition (12) (12) (12) Recognized net actuarial gain -- 23 9 ------ ------ ------ Net periodic benefit cost $ 98 $ 151 $ 80 ====== ====== ====== During 1996, Mutual's non-contributory defined benefit pension plan was terminated and settled with payments to Mutual employees. As a result of this transaction, the Bank recorded a net curtailment and settlement gain of $102,000 during 1996. A non-contributory deferred compensation plan was adopted in 1982 by the Board of Directors of the Bank which covers certain key executives. This plan is being funded primarily by insurance and the expense was $151,000, $129,000 and $122,000 for years 1998, 1997 and 1996. A 401(k) savings plan was adopted in 1995 which covers substantially all full-time employees of the Bank who have at least one year of service. The Bank matches a portion of the contribution made by employee participants. The Bank contributed $92,000, $87,000 and $83,000 in 1998, 1997 and 1996, respectively. These amounts are included in pension and other employee benefits expense for the respective years. 13. Fair Value of Financial Instruments: The estimated fair values of the Corporation's financial instruments are as follows (in thousands): December 31, 1998 ------------------------ Carrying Fair Amount Value Financial assets: ---------- ---------- Cash and federal funds sold $ 14,778 $ 14,778 Investment securities 163,413 164,743 Other 16,494 16,494 Loans, net 265,698 266,882 Financial liabilities: Deposits $(358,325) $(360,117) Repurchase agreements (31,023) (31,023) Other borrowings (13,000) (13,432) Other liabilities (3,174) (3,174) Unrecognized financial instruments: Commitments to extend credit -- -- Standby letters of credit -- (9) II-40 December 31, 1997 ------------------------ Carrying Fair Amount Value Financial assets: ---------- ---------- Cash and federal funds sold $ 13,752 $ 13,752 Investment securities 143,077 143,833 Other 15,638 15,638 Loans, net 251,173 251,805 Financial liabilities: Deposits $(351,603) $(352,156) Federal funds purchased and repurchase agreements (19,539) (19,539) Unrecognized financial instruments: Commitments to extend credit $ -- $ -- Standby letters of credit -- (19) The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value: Cash and federal funds sold The carrying amount is a reasonable estimate of fair value. Investment securities and other For marketable securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Other Assets The carrying amount is a reasonable estimate of fair value. Loans Due to the repricing characteristics of revolving credit lines, home equity loans and adjustable demand loans, the carrying amount of these loans is a reasonable estimate of fair value. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Prepayment rates are taken into consideration in the calculation. Deposits The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-maturity 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 at current rates. Federal funds purchased and repurchase agreements The carrying amount is a reasonable estimate of fair value. Other Liabilities The carrying amount is a reasonable estimate of fair value. II-41 Unrecognized financial instruments The fair value of commitments to extend credit is estimated using the fees currently charged (if any) to enter into agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. At December 31, 1998 no fees were charged for commitments to extend credit. All such commitments were subject to current market rates and pose no known credit exposure. As a result, no fair value has been estimated for these commitments. 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. 14. Dividend Restrictions and Capital: The approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year exceeds the bank's net income, as defined, for that year combined with its retained net income for the preceding two calendar years. Under this formula, the Bank can distribute as dividends, without the approval of the Comptroller of the Currency, $1,821,000 plus an additional amount equal to the Bank's net income for 1999 up to the date of any dividend declaration. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets. At December 31, 1998 and 1997 these ratios were above the minimums as follows (in thousands). To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes: Action Provisions: ------------------- ------------------- ------------------- Amount Ratio Amount Ratio Amount Ratio --------- ------- --------- ------- --------- ------- As of December 31, 1998: Total Capital Corporation $54,326 18.04% $24,097 >8.0% $30,122 >10.0% Bank 54,271 18.02% 24,095 >8.0% 30,119 >10.0% Tier I Capital Corporation 50,560 16.79% 12,049 >4.0% 18,073 >6.0% Bank 50,505 16.77% 12,048 >4.0% 18,071 >6.0% Leverage Capital Corporation 50,560 11.07% 13,701 >3.0% 22,835 >5.0% Bank 50,505 11.06% 13,700 >3.0% 22,833 >5.0% As of December 31, 1997: Total Capital Corporation $49,026 18.37% $21,353 >8.0% $26,691 >10.0% Bank 48,992 18.36% 21,351 >8.0% 26,688 >10.0% Tier I Capital Corporation 45,749 17.14% 10,676 >4.0% 16,015 >6.0% Bank 45,715 17.13% 10,675 >4.0% 16,013 >6.0% Leverage Capital Corporation 45,749 10.74% 12,779 >3.0% 21,298 >5.0% Bank 45,715 10.73% 12,778 >3.0% 21,297 >5.0%
II-42 15. Segment and Related Information: The Corporation adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", in 1998. Comparable prior period information is presented for 1997 and 1996. Reportable segments include community banking and trust and investment services. Community banking involves making loans to and generating deposits from individuals and businesses in the markets where the Bank has offices. All assets and liabilities of the Bank are allocated to community banking. Investment income from fixed income investments is a major source of income in addition to loan interest income. Service charges from deposit accounts and non-deposit fees such as automatic teller machine fees and insurance commissions generate additional income for community banking. Trust and investment services includes estate and trust planning and administration and investment management for various entities. The trust and investment services division of the Bank manages trusts, estates and purchases equity, fixed income and mutual fund investments for customer accounts. The trust and investment services division receives fees for investment and administrative services. Fees are also received by this division for individual retirement accounts managed for the community banking segment. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. All intersegment sales prices are market based. Segment information for the years 1998, 1997 and 1996 is shown in the following table (in thousands). The "Other" column includes corporate related items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments.
1998 - ------------------------------------------------------------------------------------------------------ Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ -------- Interest income $ 32,654 $ -- $ 38 $ (38) $ 32,654 Interest expense 14,472 -- 38 (38) 14,472 Non-interest income - external customers 1,437 2,165 427 -- 4,029 Non-interest income - internal customers -- 52 - (52) -- Operating income before income taxes 8,958 1,400 7,205 (7,242) 10,321 Depreciation and amortization 1,205 42 18 -- 1,265 Total assets 460,657 -- 56,529 (56,803) 460,383 Capital expenditures 1,898 -- 6 -- 1,904 1997 - ------------------------------------------------------------------------------------------------------ Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ -------- Interest income $ 31,728 $ -- $ 19 $ (19) $ 31,728 Interest expense 14,590 -- 19 (19) 14,590 Non-interest income - external customers 1,092 1,888 221 -- 3,201 Operating income before income taxes 7,829 1,299 6,168 (6,302) 8,994 Depreciation and amortization 1,126 30 15 -- 1,171 Total assets 423,921 -- 50,619 (50,900) 423,640 Capital expenditures 832 -- 18 -- 850 1996 - ------------------------------------------------------------------------------------------------------ Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ -------- Interest income $ 29,932 $ -- $ -- $ -- $ 29,932 Interest expense 14,370 -- -- -- 14,370 Non-interest income - external customers 795 1,896 -- -- 2,691 Operating income before income taxes 6,111 1,379 4,957 (5,034) 7,413 Depreciation and amortization 867 12 1 -- 880 Total assets 440,549 -- 52,667 (53,058) 440,158 Capital expenditures 967 -- 27 -- 994
II-43 SIGNATURES Pursuant to the requirements of Sections 13 or 15(d) 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. March 22, 1999 AMERICAN NATIONAL BANKSHARES INC. By: /s/ T. Allen Liles -------------------------------------------- T. Allen Liles Senior Vice President, Secretary & Treasurer Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 22, 1999. /s/ Charles H. Majors ------------------------------- Charles H. Majors President and Chief Executive Officer /s/ B. Carrington Bidgood ------------------------------- B. Carrington Bidgood Director /s/ Fred A. Blair ------------------------------- Fred A. Blair Director /s/ Lester A. Hudson, Jr. ------------------------------- Lester A. Hudson, Jr. Director /s/ Ben J. Davenport, Jr. ------------------------------- Ben J. Davenport, Jr. Director /s/ Bill Barker, Jr. ------------------------------- Bill Barker, Jr. Director /s/ H. Dan Davis ------------------------------- H. Dan Davis Director /s/ E. Budge Kent, Jr. ------------------------------- E. Budge Kent, Jr. Director /s/ Fred B. Leggett, Jr. ------------------------------- Fred B. Leggett, Jr. Director /s/ Claude B. Owen, Jr. ------------------------------- Claude B. Owen, Jr. Director /s/ James A. Motley -------------------------------- James A. Motley Director /s/ Richard G. Barkhouser -------------------------------- Richard G. Barkhouser Director /s/ Landon R. Wyatt, Jr. -------------------------------- Landon R. Wyatt, Jr. Director /s/ T. Allen Liles -------------------------------- T. Allen Liles Senior Vice President Secretary & Treasurer II-44 AMERICAN NATIONAL BANKSHARES INC. 628 Main Street Post Office Box 191 Danville, Virginia 24543 NOTICE OF ANNUAL MEETING OF SHAREHOLDERS To be held April 27, 1999 NOTICE is hereby given that the Annual Meeting of Shareholders of American National Bankshares Inc. ("the Corporation") will be held as follows: Place: The Wednesday Club 1002 Main Street Danville, VA 24541 Date: April 27, 1999 Time: 11:30 a.m. THE ANNUAL MEETING IS BEING HELD FOR THE FOLLOWING PURPOSES: 1. To elect four (4) directors of the Corporation to fill the vacancies created by the expiration of the terms of the Directors of Class III. 2. To transact any other business that may properly come before the meeting or any adjournment thereof. The record date for the determination of shareholders entitled to notice of and to vote at the Annual Meeting is the close of business on March 12, 1999. IT IS IMPORTANT THAT YOUR SHARES ARE REPRESENTED AT THE MEETING. ACCORDINGLY, PLEASE SIGN, DATE AND MAIL THE ENCLOSED PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING. IF YOU DO ATTEND THE ANNUAL MEETING, YOU MAY REVOKE YOUR PROXY AND VOTE YOUR SHARES IN PERSON. Sincerely, Charles H. Majors President and Chief Executive Officer Dated: March 22, 1999 I-1 AMERICAN NATIONAL BANKSHARES INC. 628 Main Street P. O. Box 191 Danville, Virginia 24543 PROXY STATEMENT Annual Meeting of Shareholders To be held April 27, 1999 INTRODUCTION This Proxy Statement is furnished in conjunction with the solicitation by the Board of Directors of American National Bankshares Inc. ("the Corporation") of the accompanying proxy to be used at the Annual Meeting of Shareholders of the Corporation and at any adjournments thereof. The meeting will be held on Tuesday, April 27, 1999, 11:30 a.m. at The Wednesday Club, 1002 Main Street, Danville, Virginia, for the purposes set forth below and in the Notice of Annual Meeting of Shareholders. Shares represented by properly executed proxy, if such proxies are received in time and not revoked, will be voted at the Annual Meeting as set forth therein. Any shareholder may attend the Annual Meeting, revoke the proxy and vote in person. INFORMATION AS TO VOTING SECURITIES The Board of Directors has set March 12, 1999 as the record date for the determination of shareholders entitled to notice of and to vote at the Annual Meeting. Shareholders of record on that date will be entitled to vote on the matters described herein. As of March 12, 1999, the Corporation had 1,411 shareholders of record. No one individual or entity owns directly and indirectly more than 5% of the outstanding Corporation Common Stock except Ambro and Company, the nominee name in which American National Bank and Trust Company ("the Bank"), the corporation's banking subsidiary, registers securities it holds in a fiduciary capacity, which held 578,570 shares (18.9587%) on March 12, 1999. The number of shares of common stock, there being no other issued class of stock, outstanding and entitled to vote at the Annual Shareholders' Meeting is 3,051,733. There are 578,570 shares held of record by Ambro and Company which amount represents 18.9587% of the outstanding securities, and only 349,557 of these shares may be voted by the existing co-fiduciaries. The remaining shares may not be voted by the Bank but co-fiduciaries may be qualified for the sole purpose of voting all or a portion of the shares at the Annual Meeting. CUMULATIVE VOTING Shareholders of the Corporation shall not have cumulative voting rights. VOTING OF PROXIES If the enclosed proxy is properly executed, dated, returned and not revoked, it will be voted in accordance with the specification made by the shareholder. If a specification is not made, it will be voted "FOR" the proposals set forth below and in the notice of Annual Meeting of Shareholders. Fred B. Leggett, Jr., Claude B. Owen, Jr., or Fred A. Blair, or any of them, will act as proxies on behalf of the Board of Directors. I-2 EXPENSES OF SOLICITATION The Corporation will pay the cost of preparing, assembling and mailing this Proxy Statement and the enclosed material. Proxies may also be solicited personally or by telephone by the Corporation and the Bank's officers without additional compensation. PURPOSES OF THE ANNUAL MEETING As set forth in the Notice of Annual Meeting of Shareholders, the Board of Directors is seeking proxies in connection with the following proposals to be set forth before the shareholders: 1. To elect four (4) directors of the Corporation to fill the vacancies created by the expiration of the terms of the Directors of Class III. 2. To transact any other business that may properly come before the meeting or any adjournment thereof. ELECTION OF DIRECTORS Four Directors of Class III are to be elected at the Annual Meeting of Shareholders to serve until the Annual Meeting in 2002 and until their respective successors are duly elected and qualified. Management proposes that the four (4) nominees listed in this Proxy Statement as Directors of Class III be elected. The nominees for whom the persons named as proxies intend to vote as directors, unless otherwise indicated on the form of proxy, and certain information with regard to their ownership of the common stock of the Corporation and memberships on various committees of the Board of Directors of the Corporation, are set forth below. NOMINEES Directors of Class III to be elected for a term expiring in 2002 Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since March 12, 1999 of Class Richard G. Barkhouser (68) 1980 82,412 - Direct (1) 2.6958 President, Barkhouser 7,260 - Family .2375 Motors, Inc., Danville, Relationship (4) VA, automobile dealership H. Dan Davis (61) 1996 43,600 - Direct (1) 1.4262 Senior Consultant to the 20,352 - Family .6657 Corporation and the Bank Relationship (4) since January, 1998; prior thereto, Executive Vice President of the Corporation and Senior Vice President of the Bank since March, 1996; prior thereto, President and Chief Executive Officer of Mutual Savings Bank, F.S.B since January, 1995; prior thereto, President and Chief Operations Officer of Mutual Savings Bank, F.S.B Lester A. Hudson, Jr. (59) 1984 4,902 - Direct (1) .1604 Chairman, H & E Associates, Greenville, SC, investments, since June, 1995; prior thereto Vice Chairman, Wunda Weve Carpets, Inc., Greenville, SC, carpet manufacturer I-3 Charles H. Majors (53) 1981 7,230 - Direct (1)(5) .2365 President and Chief 1,247 - Family .0408 Executive Officer of Relationship (4) the Corporation and the Bank DIRECTORS CONTINUING IN OFFICE Directors of Class I to continue in office until 2000 Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since March 12, 1999 of Class Willie G. Barker, Jr. (61) 1996 14,100 - Direct (1) .4621 Retired President of Dibrell Brothers, Inc., Danville, VA, leaf tobacco and flowers Ben J. Davenport, Jr. (56) 1992 6,430 - Direct (1)(2) .2103 Chairman, First Piedmont Corporation, Chatham, VA, waste management James A. Motley (70) 1975 7,310 - Direct (1)(2) .2391 Retired Chairman and Chief 5,242 - Family .1715 Executive Officer of Relationship (4) the Corporation and the Bank Landon R. Wyatt, Jr. (73) 1965 4,540 - Direct (1) .1485 President, Wyatt Buick 9,070 - Family .2968 Sales Co., Danville, VA, Relationship (4) automobile dealership Directors of Class II to continue in office until 2001 Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since March 12, 1999 of Class Fred A. Blair (52) 1992 1,909 - Direct (1) .0624 President, Blair 225 - Family .0074 Construction, Inc., Relationship (3) Gretna, VA, commercial building contractor E. Budge Kent, Jr. (60) 1979 15,649 - Direct (1)(6) .5119 Senior Vice President 679 - Family .0222 of the Corporation and Relationship (4) Senior Vice President & Trust Officer of the Bank Fred B. Leggett, Jr. (62) 1994 8,623 - Direct (1)(2) .2821 Retired Chairman and 3,192 - Family .1044 Chief Executive Officer, Relationship (4) Leggett Stores, Danville, VA, retail department stores, since March, 1996; prior thereto, Chairman and Chief Executive Officer, Leggett Stores, Danville, VA, since December, 1994; prior thereto, Executive Vice President, Leggett Stores I-4 Claude B. Owen, Jr. (53) 1984 5,716 - Direct (1) .1870 Chairman & Chief 2,100 - Family .0687 Executive Officer of Relationship (4) DIMON Incorporated, Danville, VA, leaf tobacco, since May, 1995; prior thereto, Chairman, President & Chief Executive Officer, Dibrell Brothers, Inc., Danville, VA, leaf tobacco & flowers All Executive officers and directors, 224,064 - Direct (1)(2)(7) 7.3295 including nominees and directors 49,927 - Family 1.6332 named above (14 in group) Relationship (3)(4) (1) Individual exercises sole voting and investment power over shares held. (2) Shared voting and investment power. (3) Sole voting and investment power as custodian for minor children. (4) Can exercise no voting or investment power. (5) Includes 2,100 shares that Mr. Majors has the right to acquire through the exercise of stock options. (6) Includes 1,100 shares that Mr. Kent has the right to acquire through the exercise of stock options. (7) Includes 5,300 shares that the Named Executive Officers have the right to acquire through the exercise of stock options. All of the above nominees and directors have been engaged in the occupations listed during the last five years. There exists no family relationship between any director or nominee. Mr. Owen is a director of DIMON Incorporated and Richfood Holdings Inc. Mr. Hudson is a director of American Electric Power Company, Inc. Mr. Motley and Mr. Davenport are directors of Intertape Polymer Group Inc. The stock of these corporations is registered with the Securities and Exchange Commission. EXECUTIVE OFFICERS Mr. Charles H. Majors and Mr. E. Budge Kent, Jr., together with the two senior vice presidents listed below, are the executive officers of the Corporation and the Bank. Principal Occupation and Name Age Business Experience - ---- --- ------------------------------------------------ T. Allen Liles 46 Senior Vice President, Secretary, Treasurer and Chief Financial Officer of the Corporation and Senior Vice President, Cashier and Chief Financial Officer of the Bank; Officer of the Bank since 1997 Carl T. Yeatts 60 Senior Vice President of the Corporation and Senior Vice President and Senior Loan Officer of the Bank; Officer of the Bank since 1964 All executive officers serve one-year terms of office. I-5 BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD The Board of Directors held 14 Board Meetings during the year 1998. These meetings were either the Corporation Board Meetings and/or the Bank Board Meetings. In addition to meeting as a group to review the Corporation and Bank's business, certain members of the Board are appointed to serve on various standing committees. Among those committees are the Audit and Compliance Committee, Salary Committee and Directors' Nominating Committee. All incumbent directors attended more than 75% of the aggregate of all meetings of the Board of Directors and Committees on which they served. Audit and Compliance Committee. The Audit and Compliance Committee, which currently consists of Messrs. Barker, Blair and Motley, reviews significant audit, accounting, and compliance principles, policies and practices, meets with the Corporation and Bank's independent auditors to discuss the results of their annual audit and reviews the performance of the internal auditing and compliance functions. The Audit and Compliance Committee held four meetings in 1998. Salary Committee. The Salary Committee currently consists of Messrs. Barkhouser, Bidgood, Hudson and Leggett. The Salary Committee makes recommendations to the Board of Directors for officers' compensation and promotions, directors' fees and related personnel matters. The Salary Committee held two meetings in 1998. Directors' Nominating Committee. The Committee's function is to search for potential qualified directors, to review the qualifications of potential directors as suggested by Directors, Management, Shareholders and others, and to make recommendations to the entire Board for nominations of such individuals to the shareholders. A shareholder may recommend nominees for director by writing to the President of the Corporation and providing the proposed nominee's full name, address, qualifications and other relevant biographical information. Members of the present committee are Messrs. Barkhouser, Owen and Wyatt. The Directors' Nominating Committee held two meetings in 1998. REPORT OF SALARY COMMITTEE ON EXECUTIVE COMPENSATION The Salary Committee of the Board of Directors, which is composed of four independent outside directors, is responsible for making recommendations to the Board of Directors concerning compensation. The Salary Committee considers a variety of factors and criteria in arriving at its recommendations for compensation of executive officers. In making its recommendations regarding compensation, the Committee attempts to align the interests of the Bank's executive officers with those of the shareholders. The Committee believes that increases in profits, dividends, and net equity improve shareholder market value and, accordingly, compensation should be structured to enhance the long-term profitability of the Bank. Officer compensation generally consists of salary and participation in the Bank's profit sharing plan. A description of the profit sharing plan is included in Note (2) under the Summary Compensation Table. Certain officers received incentive compensation in 1998 due to the attainment of certain earnings by the Corporation. Certain officers may be eligible to receive incentive compensation if certain earnings are attained in 1999. Certain key executive officers are eligible to participate in the Executive Compensation Continuation Plan described below under "Deferred Compensation Plan". All compensation is paid by the Bank and no officer receives an additional compensation from the Corporation. In 1997, the Board of Directors and the shareholders approved the stock option plan described below under Note (3) of the Summary Compensation Table. In considering officer compensation (other than the Chief Executive Officer), the Committee receives and considers recommendations from the Chief Executive Officer. The Committee conducts an annual evaluation of the performance and effectiveness of the Chief Executive Officer. The Chief Executive Officer's compensation then is determined by the Committee after consideration of the Bank's performance and the resulting benefit to the shareholders. Salary Committee Richard G. Barkhouser B. Carrington Bidgood Lester A. Hudson, Jr. Fred B. Leggett, Jr. I-6 OTHER INFORMATION Comparative Company Performance The following graph compares American National Bankshares Inc.'s cumulative total return to its shareholders with the returns of two indexes for the five-year period ended December 31, 1998. The two indexes are the S & P 500 Total Return published by Standard & Poor's Corporation and the Independent Community Bank Index, consisting of 23 independent banks located in the states of Florida, Georgia, North Carolina, South Carolina, Tennessee, West Virginia, and Virginia. The Independent Community Bank Index is published by the Carson Medlin Company. 1993 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- ---- American National Bankshares Inc. 100 108 104 89 118 130 Independent Bank Index 100 119 151 191 280 296 S & P 500 Index 100 101 139 171 228 294 I-7 EXECUTIVE COMPENSATION The following tables set forth the annual and long-term compensation awarded to, earned by, or paid to executive officers of the Corporation and the Bank ("Named Executive Officers") during 1998, 1997 and 1996. SUMMARY COMPENSATION TABLE
Long-Term Compensation --------------------------------- Annual Compensation Awards Payouts ----------------------------------- ---------------------- ------- Other Restricted Securities Annual Stock Underlying LTIP All Other Name and Salary(1) Bonus(2) Compensation Awards Options/ Payouts Compensation Principal Position Year ($) ($) ($) ($) SARS(#)(3) ($) ($)(4) - ------------------ ---- --------- -------- ------------ ---------- ---------- ------- ------------ Charles H. Majors 1998 165,409 34,956 -- -- 6,000 -- 4,860 President & Chief Executive 1997 153,855 19,038 -- -- 100 -- 4,500 Officer 1996 144,071 10,670 -- -- -- -- 4,212 E. Budge Kent, Jr. 1998 104,088 19,252 -- -- 3,000 -- 3,000 Senior Vice President of the 1997 97,292 10,910 -- -- -- 100 2,730 Corporation; Senior Vice 1996 90,623 6,634 -- -- -- -- 2,619 President and Trust Officer of the Bank T. Allen Liles 1998 91,079 18,318 -- -- 3,000 -- -- Senior Vice President, Secretary, Treasurer and Chief Financial Officer of the Corporation; Senior Vice President, Cashier and Chief Financial Officer of the Bank (effctive January 1, 1998) Carl T. Yeatts 1998 103,131 19,252 -- -- 3,000 -- 3,000 Senior Vice President of the 1997 89,682 10,562 -- -- 100 -- 2,610 Corporation; Senior Vice 1996 85,747 6,323 -- -- -- -- 2,496 President and Senior Loan Officer of the Bank
(1) Includes salary deferrals contributed by the employee to the 401(k) Plan and taxable compensation for term life insurance over $50,000. (2) Includes accrued payments of profit sharing (bonus) and incentive compensation participations. In 1998, the profit sharing (bonus) plan provided that an amount equal to 6.50% of the Bank's net income (after taxes, but before deducting profit sharing and its related tax effect), less the Bank's 401(k)contributions, be paid to officers and employees who are in the Bank's employ at quarter end. Incentive compensation represented payments to full-time employees based on the Corporation attaining certain earnings increase. The total expense, paid or accrued, for the profit sharing (bonus) plan and incentive compensation payments for the year 1998 amounted to $501,817. (3) The Corporation grants options pursuant to the Corporation's Stock Option Plan approved by the shareholders at the 1997 annual meeting. (4) Includes matching contributions to the 401(k) Plan made by the Bank. Effective July 1, 1995, the Bank adopted a 401(k) Plan which covers substantially all full-time employees who are 21 years of age or older and who have had at least one year of service. An employee may defer a portion of his or her salary, not to exceed the lesser of 15% of compensation or $10,000. The Bank will make a matching contribution in the amount of 50% of the first 6% of compensation so deferred. I-8 - ----------------------------------------------------------------------------------------------------------------------------------- Option Grants in Respect of Last Fiscal Year
Potential Realizable Value Number of % of Total At Assumed Annual Securities Options Exercise Rates of Stock Price Underlying Granted to or Base Appreciation for Options Employees in Price Vesting Expiration Option Term Name Granted Fiscal Year ($/Share) Date Date 5% ($) 10% ($) - ---- ---------- ------------- --------- -------- ---------- ------- ------- Charles H. Majors 2,000 9.52% 31.25 12/31/98 2/17/08 39,306 99,609 President and Chief 2,000 9.52% 34.38 12/31/99 2/17/08 33,046 93,349 Executive Officer 2,000 9.52% 37.50 12/31/00 2/17/08 26,806 87,109 E. Budge Kent, Jr. 1,000 4.76% 31.25 12/31/98 2/17/08 19,653 49,804 Senior Vice President 1,000 4.76% 34.38 12/31/99 2/17/08 16,523 46,674 of the Corporation; Senior 1,000 4.76% 37.50 12/31/00 2/17/08 13,403 43,554 Vice President and Trust Officer of the Bank T. Allen Liles 1,000 4.76% 31.25 12/31/98 2/17/08 19,653 49,804 Senior Vice President, Secretary, 1,000 4.76% 34.38 12/31/99 2/17/08 16,523 46,674 Treasurer and Chief Financial 1,000 4.76% 37.50 12/31/00 2/17/08 13,403 43,554
AGGREGATE OPTIONS EXERCISED IN 1998 AND YEAR-END OPTION VALUES
Number of Securities Value of Unexercised Underlying Unexercised In-The-Money Shares Options at Options at Acquired on Value December 31, 1998 (#) December 31, 1998 ($) (a) Exercise (#) Realized ($) Exercisable/Unexercisable Exercisable/Unexercisable ------------ ------------ ------------------------- -------------------------- Charles H. Majors -- -- 2,100 4,000 4,000 -- E. Budge Kent, Jr. -- -- 1,100 2,000 2,250 -- T. Allen Liles -- -- 1,000 2,000 1,750 -- Carl T. Yeatts -- -- 1,100 2,000 2,250 --
(a) Value of unexercised in-the-money options is calculated by multiplying the number of unexercised options at December 31, 1998 by the difference in the closing price of the Corporation's common stock reported on December 31, 1998 and the exercise price of the unexercised in-the-money options. - -------------------------------------------------------------------------------- I-9 OPTION REPRICING No action was taken in 1998 to lower the exercise price of an option held by the Named Executive Officers. SALARY COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Salary Committee of the Bank, during 1998, was composed of Messrs. Barkhouser, Bidgood, Hudson, and Leggett. None of the members of the Salary Committee were officers or employees of the Corporation or its subsidiaries during 1998 or in prior years. None of the executive officers of the Corporation or Bank served as a member of the Board of Directors or as a member of the Compensation Committee (or other Board Committee performing equivalent functions) of another entity during 1998, which entity had an executive officer serving on the Board of Directors or as a member of the Salary Committee of the Corporation or the Bank. Consequently, there are no interlocking relationships between the Corporation or Bank and other entities that might affect the determination of the compensation of executive officers of the Corporation or Bank. Retirement Plan. The Bank's retirement plan is a non-contributory defined benefit pension plan which covers substantially all employees of the Bank who are 21 years of age or older and who have had at least one year of service. Advanced funding is accomplished by using the actuarial cost method known as the collective aggregate cost method. As of December 31, 1998, the normal retirement benefit formula was 1.3% per year of service times compensation plus .65% per year of service times compensation in excess of social security covered compensation. At normal retirement, the monthly benefit is calculated based on any consecutive five-year period which will produce the highest average rate of basic monthly compensation. Basic monthly compensation includes salary but excludes incentive and bonus compensation. Annual compensation at December 31, 1998 was also limited to $160,000 by Internal Revenue regulations. Cash benefits under the plan generally commence on retirement at age 65, death, or termination of employment. Partial vesting of the retirement benefits under the plan occurs after three years of service and full vesting occurs after seven years of service. The following table illustrates the estimated annual benefits payable to an employee retiring on December 31, 1998 at normal retirement age in the following specified compensation and years of service classifications: Estimated Annual Retirement Benefit 5 Year Years of Service Average ---------------- Salary 15 20 25 30 35 -------- -- -- -- -- -- $ 50,000 $11,583 $15,444 $19,305 $ 23,166 $ 27,027 75,000 18,896 25,194 31,493 37,791 44,090 100,000 26,208 34,944 43,680 52,416 61,152 125,000 33,521 44,694 55,868 67,041 78,215 150,000 40,833 54,444 68,055 81,666 95,277 175,000 48,146 64,194 80,243 96,291 112,340 200,000 55,458 73,944 92,430 110,916 129,402 I-10 As of December 31, 1998, the Named Executive Officers have completed the following years of credited service under the Bank's retirement Plan: Charles H. Majors 6 E. Budge Kent, Jr. 35 T. Allen Liles 1 Carl T. Yeatts 35 Deferred Compensation Plan. The Board of Directors of the Bank adopted the Executive Compensation Continuation Plan, a non-contributory deferred compensation plan, in 1982. Under the plan, certain key executives who, in the opinion of the Board of Directors, are making substantial contributions to the overall growth and success of the Bank and who must be retained in order to expand and continue satisfactory long term growth are eligible to receive benefits afforded by the plan. Under agreements with eligible key executives pursuant to this plan, if any such executive dies or retires while employed by the Bank, such executive or his designated beneficiary will receive annual payments commencing at death or retirement and continuing for 10 years. Retirement age under existing agreements begins on or after age 62. As of December 31, 1998, the Named Executive Officers or their designated beneficiaries are eligible to receive the following annual retirement benefits for ten years after meeting the age requirement of 62: Annual Benefit Years to Name or 10 Years(in $) Vesting ---- ----------------- -------- Charles H. Majors 50,000 9 E. Budge Kent, Jr. 25,000 2 T. Allen Liles 25,000 16 Carl T. Yeatts 25,000 2 Directors' Compensation. In 1998, non-officer directors, except Mr. Davis, received a monthly retainer of $500 and attendance fees of $200 for each regular Board meeting and $400 for each Committee meeting attended. The aggregate total amount paid to non-officer directors, excluding Mr. Davis, for the year 1998 was $101,900. Mr. Davis was a Named Executive Officer in previous years but elected to become a senior consultant and retire as an officer, effective December 31, 1997. Mr. Davis can receive $5,500 per month through March 2003 for services as a consultant. No additional compensation is paid to Mr. Davis for service on the Board of Directors or for attending Committee meetings. Non-officer directors are excluded from the Bank's retirement plan and, therefore, do not qualify for pension benefits. I-11 Indebtedness of and Transactions with Management Some of the directors and officers of the Corporation and the companies with which they are associated were customers of, and had banking transactions with, the Bank in the ordinary course of the Bank's business during 1998. All loans and commitments to loan included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in the opinion of the management of the Bank, do not involve more than a normal risk of collectibility or present other unfavorable features. During the year 1998, the highest aggregate amount of outstanding loans, direct and indirect, to the directors and officers was $10,402,841 or 21% of equity capital and this peak amount occurred on January 31, 1998. Independent Public Accountants The Board of Directors of the Corporation, pursuant to the recommendation of its Audit and Compliance Committee, selected Arthur Andersen, LLP, independent public accountants, to audit the financial statements of the Corporation and the Bank for the year 1998. Arthur Andersen, LLP was first engaged by the Bank in 1978 as its independent public accountant. A representative of Arthur Andersen, LLP will be present at the shareholders' meeting and this representative will have an opportunity to make a statement if he so desires. He will be available to respond to appropriate questions. Shareholder Proposals Any shareholder proposal intended to be presented at next year's Annual Meeting must be received at the principal office of the Corporation (Post Office Box 191, Danville, Virginia 24543) for inclusion in the proxy statement for the 2000 annual meeting not later than January 3, 2000. The proposals should be mailed to the Corporation by Certified Return Receipt Requested mail. Other Business The Board of Directors knows of no other matters which may properly be brought before the Annual Meeting. However, if any other matters should properly come before the Annual Meeting, it is the intention of the persons named in the enclosed form of proxy to vote such proxy in accordance with their best judgment on such matters. By Order of the Board of Directors Charles H. Majors President and Chief Executive Officer March 22, 1999 I-12 EX-27 2 FDS-AMERICAN NATIONAL BANKSHARES INC & SUBSIDIARY
9 1000 3-MOS 6-MOS 9-MOS 12-MOS YEAR DEC-31-1998 DEC-31-1998 DEC-31-1998 DEC-31-1998 DEC-31-1998 JAN-01-1998 APR-01-1998 JUL-01-1998 OCT-01-1998 JAN-01-1998 MAR-31-1998 JUN-30-1998 SEP-01-1998 DEC-31-1998 DEC-31-1998 $13,979 $13,043 $12,538 $14,072 $14,072 20 80 16,431 706 706 0 0 0 0 0 0 0 0 0 0 86,311 84,352 89,152 105,536 105,536 61,311 60,715 63,258 57,877 57,877 62,227 61,685 64,838 59,207 59,207 258,779 260,455 264,980 269,677 269,677 3,465 3,637 3,739 3,821 3,821 432,233 430,555 458,188 460,383 460,383 353,903 347,629 357,927 358,325 358,325 0 6,025 0 0 0 27,278 21,795 33,405 34,197 34,197 0 3,000 13,000 13,000 13,000 0 0 0 0 0 0 0 0 0 0 3,052 3,052 3,052 3,052 3,052 48,000 49,054 50,804 51,809 51,809 432,233 430,555 458,188 460,383 460,383 5,743 5,822 5,898 5,893 23,356 2,185 2,259 2,252 2,330 9,026 43 12 94 123 272 7,971 8,093 8,244 8,346 32,654 3,263 3,266 3,276 3,154 12,959 3,532 3,587 3,702 3,651 14,472 4,439 4,506 4,542 4,695 18,182 252 223 203 249 927 0 0 0 0 18 2,673 2,748 2,692 2,850 10,963 2,410 2,515 2,636 2,760 10,321 2,410 2,515 2,636 2,760 10,321 0 0 0 0 0 0 0 0 0 0 1,661 1,751 1,827 1,959 7,198 .54 .58 .60 .64 2.36 .54 .58 .60 .64 2.36 4.55 4.55 4.45 4.53 4.52 107 99 274 190 190 205 38 256 249 249 0 0 0 0 0 0 0 0 0 0 3,277 3,465 3,637 3,739 3,277 103 78 132 195 508 39 27 31 28 125 3,465 3,637 3,739 3,821 3,821 2,416 2,511 2,441 2,722 2,722 0 0 0 0 0 1,049 1,126 1,298 1,099 1,099
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