10-K 1 a10k2000.txt 10-K AMERICAN NATIONAL BANKSHARES INC. 12/31/2000 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, 2000 ----------------- 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: None ---- SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $1 Par Value NASDAQ National Market -------------------------- -------------------------------------- (Title of each class) (Name of exchange on which registered) 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. X --- The aggregate market value of the voting stock held by non-affiliates of the Registrant at March 9, 2001 was $90,202,290. The number of shares of the Registrant's Common Stock outstanding on March 9, 2001 was 6,030,772. Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 24, 2001 are incorporated by reference in Part III of this report. II-1 CROSS REFERENCE PART I Page ---- ITEM 1 - Business II 5 ITEM 2 - Properties II 6 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 6 ITEM 6 - Selected Financial Data II 7 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations II 8 - 24 ITEM 7A- Quantitative and Qualitative Disclosures about Market Risk II 15 - 18 ITEM 8 - Financial Statements and Supplementary Data Quarterly Financial Results for 2000 and 1999 II 25 Management's Report on Financial Statements II 26 Report of Independent Public Accountants II 27 Consolidated Balance Sheets at December 31, 2000 and 1999 II 28 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2000 II 29 Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three-year period ended December 31, 2000 II 30 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2000 II 31 Notes to Consolidated Financial Statements II 32 - 43 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 - 5 ITEM 11 - Executive Compensation I 8 - 9 ITEM 12 - Security Ownership of Certain Beneficial Owners and Management I 3 - 5 ITEM 13 - Certain Relationships and Related Transactions I 9 - 11 PART IV ITEM 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements (See Item 8 for reference) Exhibit 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 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 II-2 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 10.8 Agreement between American National Bank and Trust Exhibit 4 on Form 10K Company and H. Dan Davis dated March 14, 1996 filed September 27, 1995 10.9 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 10.10 Agreement between American National Bank and Trust Exhibit 10.1 on Form 10-Q Company and James H. Johnson, Jr. dated July 31, 1999 filed November 12, 1999 10.11 Agreement between American National Bank and Trust Exhibit 10.2 on Form 10-Q Company and Earnest C. Jordan dated July 26, 1999 filed November 12, 1999 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 2000.
II-3 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 20, 2001 AMERICAN NATIONAL BANKSHARES INC. By: /s/ 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 20, 2001. /s/ Charles H. Majors President and ----------------------------------- Chief Executive Officer Charles H. Majors /s/ Fred A. Blair Director ----------------------------------- Fred A. Blair /s/ Lester A. Hudson, Jr. Director ----------------------------------- Lester A. Hudson, Jr. /s/ Ben J. Davenport, Jr. Director ----------------------------------- Ben J. Davenport, Jr. /s/ Bill Barker, Jr. Director ----------------------------------- Bill Barker, Jr. /s/ H. Dan Davis Director ----------------------------------- H. Dan Davis /s/ E. Budge Kent Jr. Director ----------------------------------- E. Budge Kent, Jr. /s/ Fred B. Leggett, Jr. Director ----------------------------------- Fred B. Leggett, Jr. /s/ Claude B. Owen, Jr. Director ----------------------------------- Claude B. Owen, Jr. /s/ James A. Motley Director ----------------------------------- James A. Motley /s/ Richard G. Barkhouser Director ----------------------------------- Richard G. Barkhouser /s/ T. Allen Liles Senior Vice President ----------------------------------- Secretary & Treasurer T. Allen Liles II-4 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, 2000 the Corporation employed 197 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. The Bank has two wholly owned subsidiaries to make and sale mortgage loans and to offer non-deposit products such as mutual funds and insurance. The operations of the Bank are conducted at thirteen offices located throughout the Bank's trade area, which includes the Cities of Danville and Martinsville, Town of South Boston, Pittsylvania, Henry, and Halifax 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, Martinsville, Collinsville, and South Boston, Virginia and Yanceyville, North Carolina. The Bank also has fourteen 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 Cities of Danville and Martinsville, Town of South Boston, Pittsylvania, Henry, and Halifax 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 20, 2001, 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 2000 Annual Meeting of Shareholders. II-5 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 20, 2001 the Bank maintained thirteen full service offices. Seven are located within the City of Danville, with others located at Gretna, Chatham, Martinsville, Collinsville, and South Boston, Virginia and Yanceyville, North Carolina. The Bank owns and operates fourteen 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 Airport 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 Gretna Office 109 Main Street, Gretna, Virginia 24557 Martinsville Office * 201 East Main Street, Martinsville, Virginia 24112 Nor-Dan Office 239 Nor-Dan Drive, Danville, Virginia 24540 Riverside Office 1081 Riverside Drive, Danville, Virginia 24540 South Boston Office * 3229 Halifax Road, South Boston, Virginia 24592 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 Yanceyville Office 173 Main Street, Yanceyville, North Carolina 27379 ATM LOCATIONS Drive-Up Airport 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 Franklin Turnpike * 2725 Franklin Turnpike, Danville, Virginia 24540 Hillcrest Shopping Center * Highways 86 & 158, Yanceyville, North Carolina 27379 Huffman's Car Wash * 596 West Main Street, Danville, Virginia 24541 Martinsville Office * 201 East Main Street, Martinsville, Virginia 24112 Riverside Office 1081 Riverside Drive, Danville, Virginia 24540 South Boston Office * 3229 Halifax Road, South Boston, Virginia 24592 Walk-Up Danville Regional Medical Center * 142 South Main Street, Danville, Virginia 24541 Liberty Fair Mall * 240 Commonwealth Boulevard, Martinsville, Virginia 24112 Nor-Dan Office 239 Nor-Dan Drive, Danville, Virginia 24540 Piedmont Mall * 325 Piedmont Drive, Danville, Virginia 24540 West Main Office * 2016 West Main Street, Danville, Virginia 24541 * Leased
ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters The Corporation's common stock is traded on the NASDAQ National Market under the symbol "AMNB". At January 31, 2001 the Corporation had 1,406 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 the shares outstanding for 2000 and 1999.
First Second Third Fourth Market Value Quarter Quarter Quarter Quarter ------------ ------- ------- ------- ------- 2000 Common Stock $11.00 - 18.00 $12.13 - 15.38 $ 9.00 - 16.00 $11.50 - 14.50 1999 Common Stock $13.00 - 16.22 $13.50 - 18.50 $15.00 - 25.00 $16.50 - 23.00
Per Share First Second Third Fourth Dividends Declared Quarter Quarter Quarter Quarter Total ------------------ ------- ------- ------- ------- ----- 2000 Common Stock $ .135 $ .15 $ .15 $ .15 $ .585 1999 Common Stock $ .120 $ .135 $ .135 $ .135 $ .525
II-6 Summary of Selected Consolidated Financial Data (in thousands, except per share amounts) American National Bankshares Inc. & Subsidiary
2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- Operations Information: Interest income: Loans.................................................$ 28,300 $ 23,959 $ 23,356 $ 22,441 $ 20,335 Federal funds sold and other.......................... 179 273 272 237 435 Investment securities................................. 10,127 9,467 9,026 9,050 9,162 --------- --------- --------- --------- --------- Total interest income............................... 38,606 33,699 32,654 31,728 29,932 Interest expense........................................ 17,343 14,736 14,472 14,590 14,370 --------- --------- --------- --------- --------- Net interest income..................................... 21,263 18,963 18,182 17,138 15,562 Provision for loan losses............................... (1,020) (670) (927) (1,100) (673) Non-interest income..................................... 4,778 4,494 4,079 3,225 2,691 Non-interest expense.................................... (12,930) (11,543) (11,013) (10,269) (10,167) --------- --------- --------- --------- --------- Income before income taxes.............................. 12,091 11,244 10,321 8,994 7,413 Income taxes............................................ 3,415 3,320 3,123 2,725 2,381 --------- --------- --------- --------- --------- Net income..............................................$ 8,676 $ 7,924 $ 7,198 $ 6,269 $ 5,032 ========= ========= ========= ========= ========= Balance Sheet Information: Investment securities...................................$162,929 $166,272 $163,413 $143,077 $175,757 Net loans............................................... 335,010 289,606 265,698 251,173 233,509 Total deposits.......................................... 426,588 385,558 358,325 351,603 361,983 Shareholders' equity.................................... 63,338 56,719 54,861 50,003 52,218 Total assets............................................ 541,389 491,391 460,383 423,640 440,158 Per Share Information:* Net income (basic and diluted)..........................$ 1.42 $ 1.30 $ 1.18 $ 1.00 $ .77 Dividends............................................... .585 .525 .465 .405 .345 Book value.............................................. 10.45 9.29 8.99 8.19 7.96 Ratios: Return on average assets................................ 1.70% 1.68% 1.64% 1.47% 1.24% Return on average shareholders' equity.................. 14.74% 14.17% 13.79% 12.51% 10.12% Total risk-based capital/assets......................... 17.09% 17.79% 18.04% 18.37% 20.66% Shareholders' equity/assets............................. 11.70% 11.54% 11.92% 11.80% 11.86% Net charge-offs to average net loans.................... .13% .13% .15% .36% .17% Allowance for loan losses to period-end loans, net of unearned income......................... 1.40% 1.41% 1.42% 1.29% 1.30% * Per share amounts have been restated to reflect the impact of a 2-for-1 stock split effected in the form of a 100% stock dividend issued to stockholders July 15, 1999, with a record date of July 1, 1999.
II-7 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. The Corporation has expanded through internal growth and through mergers and acquisitions. On March 14, 1996, the Corporation completed the merger of Mutual Savings Bank, F.S.B. ("Mutual") with $84,718,00 in assets into the Bank. The Mutual merger was accounted for as a pooling of interests. The Bank completed two branch purchases in 1995 and 1996 which added $57,700,000 in deposits and $6,925,000 in loans. The two branch purchases were accounted for as purchases and goodwill of $4,504,000 is being amortized over ten years. The Bank opened branch offices in Chatham and Martinsville, Virginia and closed a limited service branch in Danville during 1999 and opened a branch office in South Boston, Virginia during 2000. Forward-looking Statements This report contains forward-looking statements with respect to the financial condition and results of operations and business of the Corporation and Bank. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Corporation and Bank and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following: - General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances. - Changes in interest rates could reduce net interest income. - Competitive pressures among financial institutions may increase. - Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses that the Corporation and Bank are engaged in. - New products developed or new methods of delivering products could result in a reduction in business and income for the Corporation and Bank. - Adverse changes may occur in the securities market. Stock Split The Corporation issued a 2-for-1 stock split effected in the form of a 100% stock dividend to shareholders of record July 1, 1999, payable on July 15, 1999. All references to the number of common shares and all per share amounts have been adjusted, as appropriate, to retroactively reflect the stock split. Reclassifications Certain prior period information has been restated to conform with 2000 presentation. Performance Summary The Corporation and Bank reported record profitability during 2000. Net income of $8,676,000 for 2000 increased by $752,000 or 9.5% over net income of $7,924,000 for 1999. The economy of the Bank's trade area continues to be stable as evidenced by another year of loan growth. During 2000, net loans increased $45,404,000, or 15.7% while total deposits increased $41,030,000, or 10.6%. Total deposits and repurchase agreements with customers increased $47,806,000, or 11.6%, during 2000. Approximately 66.5% of loan growth and 33.3% of deposit growth during 2000 occurred in the three new locations opened in 1999 and in 2000. II-8 Earnings and Capital Net income per diluted share was $1.42 in 2000, $1.30 in 1999, and $1.18 in 1998. Shareholders' equity increased $6,619,000 in 2000 from the retention of 2000 earnings and from an increase in net unrealized gains on securities available for sale. Shareholders' equity increased $1,858,000 in 1999 from retention of 1999 earnings which was partially offset by an increase in net unrealized losses on securities available for sale. This followed an increase in shareholders' equity of $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 was 11.7% of assets at December 31, 2000 and 11.5% at December 31, 1999. Shareholders' equity was $63,338,000 at December 31, 2000 and $56,719,000 at December 31, 1999. The total market value of American National Bankshares Inc. common stock at $14.50 per share (the last trade recorded on the NASDAQ National Market during 2000) was $87,925,000. The market value of the Corporation's common stock was 139 percent of its book value. Book value per common share was $10.45 at the close of 2000. The Corporation's Board of Directors authorized the repurchase of up to 300,000 shares of the Corporation's common stock between August 16, 2000 and August 15, 2001. The repurchases which may be made through open market purchases or in privately negotiated transactions totaled 40,000 shares during 2000. The return of net income on average total assets was 1.70% in 2000 compared to 1.68% in 1999 and 1.64% in 1998. The return on average shareholders' equity was 14.74% in 2000 compared to 14.17% in 1999 and 13.79% in 1998. Trends and Future Events The economic conditions of the Corporation's trade area remained stable during 2000 as evidenced by another year of loan and deposit growth. The Corporation's net loans grew at a rate of 15.7% during 2000 following a 9.0% increase in 1999. Total deposits increased 10.6% during 2000 following a 7.6% increase in 1999. Net interest income on a taxable equivalent basis increased 11.9% to $22,077,000 in 2000 after a 5.1% increase to $19,733,000 in 1999. The 2000 increase resulted from growth in average interest-earning assets of $40,509,000 and growth in average interest-earning liabilities of $30,321,000. The weighted average yield on interest earning assets increased by .37% while the weighted average cost of interest-bearing liabilities increased by .35% because loan yields increased by more than interest-bearing liability yields in 2000. 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 2000, time deposits increased by $24,384,000, or 12.5%, and money market accounts increased by $10,154,000, or 45.5%. Interest bearing demand deposits increased $2,650,000, or 4.8%, while non-interest bearing demand deposits increased $7,001,000 or 14.7%. Savings deposits decreased $3,159,000, or 4.9%. Repurchase agreements which are short term investments for businesses and individuals and are not included in deposits increased $6,776,000, or 27.2%, during 2000. Total deposits increased $41,030,000 or 10.6% during 2000 after increasing $27,233,000 or 7.6% during 1999. ANB Mortgage Corp. ("ANB Mortgage"), formerly Mutual Mortgage of the Piedmont, Inc., was organized and began operations in 1996 as a wholly owned subsidiary of the Bank to originate and sell mortgage loans. ANB Services Corp. ("ANB Services") was formed as a wholly owned subsidiary of the Bank and began operations in late 1999 to offer non-deposit products such as mutual funds and insurance. The financial condition and results of operations of ANB Mortgage and ANB Services are included in the Consolidated Balance Sheets and Consolidated Statements of Income of the Corporation. The Corporation's stock began trading on the NASDAQ National Market on April 23, 1999 after having been traded on the OTC Bulletin Board. The change to NASDAQ was made to improve the marketability of the stock. The Federal Reserve Board ("FRB") increased short-term interest rates by increasing the federal funds target rate by 1.75% and the discount rate by 1.50% over a period from August, 1999 to May, 2000, and major banks followed by raising the prime lending rate by 1.75% during this same period. The increases in interest rates in 1999 and 2000 were designed to moderate national economic growth which could have been inflationary if left unchecked. The FRB decreased short-term interest rates by lowering the federal funds target rate and the discount rate by 1.00% in early 2001, and the major banks followed by decreasing the prime lending rate by 1.00%. The FRB lowered interest rates to offset perceived economic weaknesses which seemed to be developing in the national and world economy. The FDIC insures deposits of the Bank up to the limits allowed by law. Financial institutions are assessed deposit insurance by the FDIC at an annual rate of between 0 and .27% of insured deposits, depending on a risk classification. Legislation was enacted in 1996 requiring FDIC insured institutions to pay a portion of the interest on obligations issued by the Financing Corporation ("FICO"). For the second quarter of 2000, the effective annual FICO assessment rate was .0202% of insured deposits. II-9 As mandated by the Federal Deposit Insurance Corporation Act of 1991 ("FDICIA"), the following five capital categories are identified 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. Year 2000 Issue The Corporation did not encounter computer or system problems from the transition into the new millennium ("Year 2000"). The Year 2000 problem was widely publicized as the possible failure or malfunction of systems or computer chips that improperly recognized date sensitive information when the year changed to 2000. The Corporation is not aware of Year 2000 problems encountered by major customers, suppliers or hardware and software vendors. No liquidity problems or material withdrawals by depositors of the Bank were experienced during the transition into the Year 2000. Total Year 2000 project costs, primarily incurred before 2000, were approximately $125,000 as had previously been estimated and disclosed. The expenditures did not have a material impact on the Corporation's results of operations, liquidity or capital resources. 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 2000, 1999 and 1998. During 2000, taxable equivalent net interest income increased to $22,077,000, up 11.9% from $19,733,000 in 1999. Taxable equivalent net interest income for 1999 was up 5.1% from $18,780,000 recorded in 1998. The $2,344,000 increase in taxable equivalent net interest income during 2000 consisted of $1,929,000 due to increases in volume and $415,000 attributable to rate. The $953,000 increase in taxable equivalent net interest income during 1999 was the net result of an increase of $1,247,000 due to volume, reduced by $294,000 attributable to rate. The Bank emphasized profitable deposit pricing in 2000 as the deposit yield increased only .31% to 4.22% while the prime rate and the federal funds target rates increased 1% and the loan yield increased .42% to 8.98%. II-10 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 ------------------------------ ------------------------------ ------------------------ 2000 1999 1998 2000 1999 1998 2000 1999 1998 -------- -------- -------- -------- -------- -------- ------ ------ ------ Loans: Commercial $100,298 $ 83,620 $ 75,972 $ 9,273 $ 7,041 $ 6,687 9.25% 8.42% 8.80% Mortgage 165,260 143,281 132,965 14,101 11,773 11,539 8.53 8.22 8.68 Consumer 50,218 53,209 52,738 4,977 5,170 5,165 9.91 9.72 9.79 -------- -------- -------- -------- -------- -------- Total loans 315,776 280,110 261,675 28,351 23,984 23,391 8.98 8.56 8.94 -------- -------- -------- -------- -------- -------- Investment securities: U. S. Government 2,641 13,130 42,813 168 801 2,602 6.36 6.10 6.08 Federal agencies 101,513 89,969 70,009 6,550 5,654 4,485 6.45 6.28 6.41 State and municipal 39,796 36,999 26,526 2,708 2,513 1,909 6.80 6.79 7.20 Other investments 23,420 20,071 9,048 1,464 1,244 593 6.25 6.20 6.55 -------- -------- -------- -------- -------- -------- Total investment securities 167,370 160,169 148,396 10,890 10,212 9,589 6.51 6.38 6.46 -------- -------- -------- -------- -------- -------- Federal funds sold and other 2,879 5,237 5,091 179 273 272 6.22 5.21 5.34 -------- -------- -------- -------- -------- -------- Total interest-earning assets 486,025 445,516 415,162 39,420 34,469 33,252 8.11 7.74 8.02 -------- -------- -------- ------ ------ ------ Other non-earning assets 24,269 24,813 24,991 -------- -------- -------- Total assets $510,294 $470,329 $440,153 ======== ======== ======== Deposits: Demand $ 56,141 $ 54,143 $ 51,116 1,035 1,087 1,204 1.84 2.01 2.36 Money market 24,861 19,250 19,031 865 535 545 3.48 2.78 2.86 Savings 63,739 67,247 67,265 1,671 1,768 1,950 2.62 2.63 2.90 Time 202,890 183,707 174,123 11,095 9,284 9,260 5.47 5.05 5.32 -------- -------- -------- -------- -------- -------- Total deposits 347,631 324,347 311,535 14,666 12,674 12,959 4.22 3.91 4.16 Federal funds purchased - - 188 - - 11 - - 5.85 Repurchase agreements 27,608 20,895 25,261 1,362 876 1,106 4.93 4.19 4.38 Other borrowings 23,397 23,073 7,497 1,315 1,186 396 5.62 5.14 5.28 -------- -------- -------- -------- -------- ------- Total interest-bearing liabilities 398,636 368,315 344,481 17,343 14,736 14,472 4.35 4.00 4.20 -------- -------- -------- -------- -------- ------- ------ ------ ------ Demand deposits 49,126 42,923 40,134 Other liabilities 3,654 3,175 3,334 Shareholders' equity 58,878 55,916 52,204 -------- -------- -------- Total liabilities and Shareholders' equity $510,294 $470,329 $440,153 ======== ======== ======== Interest rate spread 3.76% 3.74% 3.82% ====== ====== ====== Net interest income $ 22,077 $ 19,733 $ 18,780 ======== ======== ======== Taxable equivalent adjustment $ 814 $ 770 $ 598 ======== ======== ======== Net yield on earning assets 4.54% 4.43% 4.52% ====== ====== ======
II-11 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):
2000 vs. 1999 1999 vs. 1998 ------------------------------- ------------------------------- Interest Change Interest Change Increase Attributable to Increase Attributable to ------------------ ------------------ (Decrease) Rate Volume (Decrease) Rate Volume ---------- ------- -------- ---------- ------- -------- Interest income Loans: Commercial $2,232 $ 735 $1,497 $ 354 $ (299) $ 653 Mortgage 2,328 467 1,861 234 (633) 867 Consumer (193) 102 (295) 5 (41) 46 ------- ------- ------- ------- ------- ------- Total loans 4,367 1,304 3,063 593 (973) 1,566 ------- ------- ------- ------- ------- ------- Investment securities: U.S. Government (633) 33 (666) (1,801) 10 (1,811) Federal agencies 896 154 742 1,169 (87) 1,256 State and municipal 195 5 190 604 (113) 717 Other investments 220 11 209 651 (34) 685 ------- ------- ------- ------- ------- ------- Total investment securities 678 203 475 623 (224) 847 ------- ------- ------- ------- ------- ------- Federal funds sold and other (94) 46 (140) 1 (7) 8 ------- ------- ------- ------- ------- ------- Total interest income 4,951 1,553 3,398 1,217 (1,204) 2,421 ------- ------- ------- ------- ------- ------- Interest expense Deposits: Demand (52) (91) 39 (117) (185) 68 Money market 330 153 177 (10) (16) 6 Savings (97) (5) (92) (182) (181) (1) Time 1,811 797 1,014 24 (472) 496 ------- ------- ------- ------- ------- ------- Total deposits 1,992 854 1,138 (285) (854) 569 Federal funds purchased - - - (11) - (11) Repurchase agreements 486 172 314 (230) (45) (185) Other borrowings 129 112 17 790 (11) 801 ------- ------- ------- ------- ------- ------- Total interest expense 2,607 1,138 1,469 264 (910) 1,174 ------- ------- ------- ------- ------- ------- Net interest income $2,344 $ 415 $1,929 $ 953 $ (294) $1,247 ======= ======= ======= ======= ======= =======
Provision and Allowance for Loan Losses The provision for loan losses is an amount added to the allowance 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 allowance in relation to the risks inherent within the loan portfolio. The 2000 provision for loan losses was $1,020,000 and compares with $670,000 in 1999 and $927,000 in 1998. The increase in the provision for loan losses in 2000 was influenced by a 15.7% increase in loans and by slightly higher net charge-offs. Net charge-offs increased to $409,000 in 2000 from $356,000 in 1999 and $383,000 in 1998. The allowance for loan losses totaled $4,746,000 at December 31, 2000, an increase of 14.8% over December 31, 1999. The ratio of the allowance to loans, less unearned income, was 1.40% at December 31, 2000 and 1.41% at December 31, 1999. The Bank's Loan Committee has responsibility for determining the level of the allowance 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 allowance for loan losses 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 allowance for loan losses are identified impaired loans, economic conditions, historical losses, uncertainties regarding new markets, trends and other external factors that existed at the balance sheet date. The sum of these elements is the Loan Committee's recommended level of the allowance for loan losses. II-12 Management has allocated the allowance for loan losses to loan categories as follows (in thousands):
2000 1999 1998 1997 1996 ----------------- ----------------- ----------------- ----------------- ------------------ 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) $1,691 50% $1,190 46% $1,046 47% $ 873 44% $ 886 40% Real estate- residential 177 37 167 39 151 36 129 37 128 38 Consumer 1,304 13 1,503 15 1,525 17 1,173 19 1,152 22 Unallocated 1,574 - 1,275 - 1,099 - 1,102 - 904 - ----- ---- ----- ---- ----- ---- ----- ---- --- ---- Balance at end of year $4,746 100% $4,135 100% $3,821 100% $3,277 100% $3,070 100% ====== ==== ====== ==== ====== ==== ====== ==== ====== ==== Management's criteria for evaluating the adequacy of its allowance for loan losses 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 allowances are assigned to the individual loans which present a greater risk of loan loss. The remaining loan loss allowance 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
2000 1999 1998 ---- ---- ---- Allowance as percentage of outstanding loans, net of unearned income 1.40% 1.41% 1.42% Net charge-offs as percentage of allowance 8.60 8.62 10.02 Net charge-offs as percentage of average loans, net of unearned income .13 .13 .15 Provision as percentage of net charge-offs 250.00 187.91 242.21 Provision as percentage of average loans, net of unearned income .32 .24 .35 Allowance for loan losses to nonperforming loans 32.51X 14.16X 20.11X
II-13 The economy of the Corporation's trade area, which includes the City of Danville, City of Martinsville, Town of South Boston, Pittsylvania, Henry and Halifax 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. Increased global competition has negatively impacted the textile industry in the area with several plants closing due to competitive pressures or due to relocation of some operations to foreign countries. 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 remain stable 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 allowance for loan losses is appropriate in view of the risks inherent in Corporation's geographic region at the balance sheet date. Non-Interest Income Non-interest income totaled $4,778,000 in 2000 compared with $4,495,000 in 1999 and $4,080,000 in 1998. This was an increase of 6.3% during 2000 after an increase of 10.2% during 1999. The major components of non-interest income are trust and investment services, service charges on deposit accounts, other 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 $2,658,000 in 2000, an increase of $127,000, or 5.0%, from 1999. Trust and investment services fees in 1999 increased 16.9% from 1998. The increase in 2000 primarily resulted from new business and the 1999 increase came from a combination of growth in investments under management for customers due to a healthy equities market and from new business. Service charges on deposit accounts were $1,114,000 in 2000, an increase of $144,000, or 14.8%, from 1999. Service charges during 1999 totaled $970,000, which was a 7.5% increase from 1998. A change in the fee structure and additional accounts obtained contributed to the growth in income in 2000 and 1999. Service charge pricing on deposit accounts is typically changed annually to reflect current costs and competition. Other fees and insurance commissions were $592,000 in 2000, $464,000 in 1999, and $427,000 in 1998. The increase in 2000 resulted primarily from the addition of brokerage investment services. Non customer ATM fees, debit and credit card fees, safe deposit box rents, brokerage investment commissions and insurance commissions represent most of the income in this category. Mortgage banking income represents fees from originating and selling residential mortgage loans through a wholly owned subsidiary of the Bank which began operations in December 1996. Mortgage banking income declined to $240,000 in 2000 from $332,000 in 1999 after peaking at $429,000 in 1998. Low intermediate and long-term interest rates in 1998 encouraged heavy mortgage refinancing and purchase activity by borrowers. As interest rates rose in 1999 and again in 2000, mortgage lending declined as fewer borrowers qualified for loans or desired loans at higher rates. Other income was $174,000 in 2000, a decline of 11.2% from the $196,000 recorded in 1999, which in turn was an increase of 25.6% from $156,000 recorded in 1998. Other income in 1999 included $94,000 in gains from the sale of real estate owned, and 1998 other income included a gain of $104,000 from a life insurance settlement. Check order income and dividends from equity investments in two insurance companies account for over 90% of 2000 other income. Non-Interest Expense Non-interest expense of $12,930,000 in 2000, increased $1,387,000, or 12.0%, over $11,543,000 in 1999, which in turn increased $529,000, or 4.8%, over $11,014,000 in 1998. Non-interest expense includes salaries, pension and other employee benefits, occupancy and equipment expense, core deposit intangible amortization and other expenses. Salaries of $6,071,000 in 2000 increased $496,000, or 8.9%, over 1999 due primarily to additional compensation for new branch offices in South Boston for one quarter and Martinsville for a full year versus four months in 1999 and due to merit increases. Salaries of $5,575,000 in 1999 increased $448,000, or 8.7%, over 1998 due to new branch offices in Chatham and Martinsville and due to increased incentive compensation and merit increases. Pension and other employee benefits totaled $1,154,000 in 2000, an increase of 20.8% from the $955,000 recorded in 1999, which in turn was a decrease of 16.2% from the $1,140,000 reported in 1998. The decline in 1999 resulted from a decrease in supplemental retirement expense. Occupancy and equipment expense of $2,189,000 for 2000 increased $293,000, or 15.5%, over $1,896,000 recorded in 1999 which increased 13.9% from $1,664,000 recorded in 1998. The higher occupancy and equipment expense resulted from the addition of three new branches in 1999 and 2000 and from higher depreciation, maintenance and licensing fees on new technology equipment designed to improve product delivery and increase productivity. II-14 Core deposit intangible expense represents amortization of premiums paid for deposits at the Yanceyville and Gretna offices which is calculated on a straight line basis over ten years. Other expense was $3,066,000 in 2000, an increase of 15.0% over the $2,667,000 reported in 1999 which increased from $2,633,000 recorded in 1998. The 2000 increase primarily resulted from expenses related to three new branches opened in 1999 and 2000 and from related income growth. The efficiency ratio, a productivity measure used to determine how well non-interest expense is managed, was 46.5%, 45.8%, and 46.2% for 2000, 1999, and 1998, respectively. A lower efficiency ratio indicates more favorable expense efficiency. Leaders in expense efficiency in the banking industry have achieved ratios in the mid-to-high 40% range while the majority of the industry remains in the 55-65% range. The efficiency ratio is calculated by dividing non-interest expense, excluding intangible amortization, by the sum of taxable equivalent net interest income and non-interest income. Income Taxes The provision for income taxes (total of current and deferred) was $3,415,000 in 2000, compared with $3,320,000 in 1999 and $3,123,000 in 1998. 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 8 of the Consolidated Financial Statements for a reconciliation of the statutory Federal income tax rate of 34% to the effective tax rates for 2000, 1999, and 1998. 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 allowance 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, 2000, the Corporation's Tier I and total capital ratios were 16.02% and 17.09%, respectively. At December 31, 1999, these ratios were 16.57% and 17.79%, respectively. The ratios for both years were well in excess of the regulatory requirements. The Corporation's leverage ratios (Tier 1 capital divided by average quarterly assets less intangible assets) were 11.59% and 11.52% at December 31, 2000 and 1999, 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 2000 capital formation rate (net income less dividends declared, divided by average shareholders' equity) was 8.7%. This compares with 8.4% in 1999 and in 1998. 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 $.585 and $.525 per share of common stock in 2000 and 1999, 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 federal agency banks and a correspondent bank and maturing 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 2000, as shown in the Consolidated Balance Sheets, the deposit mix changed with an increase in higher cost time deposits of $24,384,000, an increase in demand deposits of $9,651,000, a decline in savings deposits of $3,159,000 and an increase in money market accounts of $10,154,000. Deposit mix trends in 1999 were similar to 2000, except growth in money market and demand deposits were higher in 2000 than in 1999. The Consolidated Statements of Cash Flows appearing in the financial statement section shows a net increase in cash and cash equivalents of $7,780,000 during 2000. This increase was the result of a combination of $9,905,000 provided by operating activities, $40,804,000 net cash used in investing activities, and $38,679,000 net cash provided by financing activities. A net increase in deposits and repurchase agreements provided cash from financing activities while cash dividends paid, repurchase of stock and a reduction in FHLB borrowings 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 2000. 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 impacted 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, 2000 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, 2000 (in thousands)
3 Months > 3 Months > 1 Year > 3 Year or Less to 1 Year to 3 Years to 5 Years > 5 Years Total --------- ----------- ----------- ----------- ---------- -------- Interest sensitive assets: Interest bearing deposits with other banks $ 8,678 $ - $ - $ - $ - $ 8,678 Investment securities 4,760 40,040 37,417 42,095 38,128 162,440 Loans 137,460 63,691 92,556 35,202 10,847 339,756 --------- --------- --------- --------- --------- --------- Total interest sensitive assets 150,898 103,731 129,973 77,297 48,975 510,874 --------- --------- --------- --------- --------- --------- Interest sensitive liabilities: NOW and savings deposits 119,859 - - - - 119,859 Money market deposits 32,480 - - - - 32,480 Time deposits 38,153 111,850 59,479 10,265 6 219,753 Repurchase agreements and other borrowings 31,730 - 3,000 13,000 - 47,730 --------- --------- --------- --------- --------- --------- Total interest sensitive liabilities 222,222 111,850 62,479 23,265 6 419,822 --------- --------- --------- --------- --------- --------- Interest sensitivity gap $(71,324) $ (8,119) $ 67,494 $ 54,032 $ 48,969 $ 91,052 ========= ========= ========= ========= ========= ========= Cumulative interest sensitivity gap $(71,324) $(79,443) $(11,949) $ 42,083 $ 91,052 ========= ========= ========= ========= ========= Percentage cumulative gap to total interest sensitive assets (14.0)% (15.6)% (2.3)% 8.2 % 17.8 % Of the loans in the above table that either mature or can be repriced in periods over 1 year, $92,283 have adjustable rates and $46,322 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. Change in Net Interest Income and Market Value of Portfolio Equity December 31, 2000 (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% $ 150 .70 % $ 5 .01 % Up 2% 199 .92 439 .68 Up 1% 141 .65 537 .84 Down 1% (358) (1.66) (1,347) (2.10) Down 2% (809) (3.75) (3,561) (5.54) Down 3% (1,370) (6.35) (6,374) (9.92) (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. II-17 The negative one year cumulative interest sensitivity gap of $79,443,000 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, asset and liability prepayments and composition 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. At December 31, 2000 securities available for sale (at amortized cost) totaled $119,864,000 and included $77,506,000 in federal agencies, $18,270,000 in state and municipal, and $24,088,000 in other securities. A net unrealized gain of $489,000 related to these securities at December 31, 2000. At December 31, 1999, securities available for sale (at amortized cost) totaled $124,519,000 and included $7,002,000 in U.S. Government securities, $77,016,000 in federal agencies, $19,324,000 in state and municipal and $21,177,000 in other securities. A net unrealized loss of $2,647,000 related to these securities at December 31, 1999. Securities held to maturity totaled $42,576,000 and $44,400,000 at December 31, 2000 and 1999, respectively and had respective estimated fair values of $42,920,000 and $43,634,000. Of the amount at December 31, 2000, $21,958,000 or 51.6% were federal agencies and $20,618,000 or 48.4% were state and municipal securities. Securities held to maturity at December 31, 2000 consisted of $10,855,000 due in one year or less, $13,337,000 due after one year through five years, $12,534,000 due in five years through ten years and $5,850,000 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, 2000 was more than the book value by $344,000. No losses are anticipated since the Corporation has the ability and intent to hold these securities until their respective maturities. Loan Portfolio Loans, net of unearned income increased $46,015,000 or 15.7% during 2000. As shown in schedule A on page II-20, the primary increases in types of loans in 2000 were real estate loans secured by 1 - 4 family residential properties, real estate loans secured by nonfarm, nonresidential properties and commercial and industrial loans. The loan portfolio is diversified and consists of 60.2% mortgage loans, 26.7% commercial loans and 13.1% consumer loans. Note 10 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 2000 or 1999. 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. II-18 INVESTMENT PORTFOLIO 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): -----------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998 ---------------------------------- ---------------------------------- ---------------------------------- 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 $ - $ - - % $ 7,002 $ 7,020 6.63 % $ 25,000 $ 25,075 6.00 % 1 to 5 years - - - - - - 7,018 7,166 6.26 --------- --------- -------- -------- -------- --------- Total - - - 7,002 7,020 6.63 32,018 32,241 6.06 --------- --------- -------- -------- -------- --------- Federal Agencies: Within 1 year 20,517 20,583 7.08 - - - 2,005 2,021 6.10 1 to 5 years 50,937 51,357 6.82 62,609 62,016 6.87 41,292 42,376 6.59 6 to 10 years 4,080 4,079 6.73 10,591 10,209 6.59 10,906 11,020 6.19 After 10 years 23,930 23,849 6.20 27,449 26,513 6.20 20,511 20,573 6.00 -------- -------- -------- -------- -------- -------- Total 99,464 99,868 6.72 100,649 98,738 6.66 74,714 75,990 6.36 -------- -------- -------- -------- -------- -------- State and Municipal: Within 1 year 2,210 2,216 7.76 1,599 1,601 7.54 499 503 6.40 1 to 5 years 12,080 12,247 7.64 9,789 9,853 7.88 5,326 5,516 8.21 6 to 10 years 22,352 22,822 7.44 24,008 23,541 7.41 20,848 21,690 7.44 After 10 years 2,246 2,275 7.39 4,695 4,479 7.28 8,791 9,065 7.42 -------- -------- -------- -------- -------- -------- Total 38,888 39,560 7.52 40,091 39,474 7.51 35,464 36,774 7.54 -------- -------- -------- -------- -------- -------- Other Investments: Within 1 year 2,045 2,048 6.29 - - - - - - 1 to 5 years 9,056 9,008 6.77 9,539 9,276 6.62 6,119 6,246 6.65 6 to 10 years 7,557 7,359 6.23 8,966 8,364 6.25 10,921 10,991 6.20 After 10 years 5,430 5,430 6.36 2,672 2,634 6.16 2,482 2,501 7.12 -------- -------- -------- -------- -------- -------- Total 24,088 23,845 6.47 21,177 20,274 6.41 19,522 19,738 6.46 -------- -------- -------- -------- -------- -------- Total portfolio $162,440 $163,273 6.87 % $168,919 $165,506 6.83 % $161,718 $164,743 6.57 % ======== ======== ======== ======== ======== ========
II-19 The total of outstanding real estate loans at December 31, 2000 was $204,684,000. This consisted of $121,449,000 or 59.3% in loans secured by 1-4 family residential properties, $67,312,000 or 32.9% in loans secured by non-farm, non-residential properties, $9,284,000 or 4.5% in construction and land development, $1,616,000 or .8% in loans secured by farmland and $5,023,000 of other real estate loans. Nonperforming real estate loans at December 31, 2000 and 1999 were $65,000 and $107,000, respectively. There were no real estate loans on accrual status and past due 90 days or more at December 31, 2000 and $3,000 at December 31, 1999. 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 an allowance for loan losses, which is available to absorb losses inherent in the loan portfolio. The allowance is increased by the provision for losses and by recoveries from losses. Charge-offs decrease the allowance. The adequacy of the allowance for loan losses is determined on a quarterly basis. Various factors as defined in the previous section "Provision and Allowance for Loan Losses" are considered in determining the adequacy of the allowance. 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 were $30,000, $30,000 and $385,000 at December 31, 2000, 1999 and 1998, respectively. At December 31, 2000 and 1999, loans in a nonaccrual or restructured status totaled approximately $146,000 and $292,000, respectively. As shown in schedule C on page II-22, loans on accrual status and past due 90 days or more have decreased to $239,000 in 2000 from $287,000 in 1999. The total of nonperforming loans and loans past due 90 days or more at December 31, 2000 was $385,000, a decrease of $194,000 from the $579,000 reported at December 31, 1999. Net charge-offs as a percentage of average loans were .13% in 2000 and 1999. 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 .11% of total loans at December 31, 2000 and .20% at December 31, 1999. 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):
2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- Real estate loans: Construction and land development $ 9,284 $ 7,317 $ 8,104 $ 4,442 $ 3,640 Secured by farmland 1,616 1,306 1,491 1,274 1,169 Secured by 1-4 family residential properties 121,449 108,994 95,711 94,294 90,192 Secured by multi-family (5 or more) residential properties 5,023 4,532 2,268 1,521 772 Secured by nonfarm, nonresidential properties 67,312 54,170 44,251 41,277 35,289 Loans to farmers 1,625 2,468 2,293 2,761 2,672 Commercial and industrial loans 83,428 66,459 67,154 57,971 49,247 Consumer loans 44,389 45,235 46,337 48,499 50,909 Loans for nonrated industrial development obligations 5,590 3,236 1,895 2,398 2,565 All other loans 40 24 15 13 124 -------- -------- -------- -------- -------- Loans - net of unearned income $339,756 $293,741 $269,519 $254,450 $236,579 ======== ======== ======== ======== ======== There were no foreign loans outstanding during any of the above periods.
II-20 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 $ 94,014 $ 19,304 $ 3,636 $116,954 34.4% Mortgage 88,896 79,109 6,571 174,576 51.4% Consumer 18,241 29,345 640 48,226 14.2% -------- -------- ------- -------- ------ $201,151 $127,758 $10,847 $339,756 100.0% ======== ======== ======= ======== ====== Rate Sensitivity: Pre-determined rate $ 19,687 $ 38,038 $ 8,284 $ 66,009 19.4% Floating or adjustable rate 181,464 89,720 2,563 273,747 80.6% -------- -------- ------- -------- ------ $201,151 $127,758 $10,847 $339,756 100.0% ======== ======== ======= ======== ====== Percent 59.2% 37.6% 3.2% 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. II-21 C. Nonperforming loans and loans past due 90 days or more (in thousands, except ratios):
2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Nonaccruing loans: Real Estate $ 65 $107 $ 58 $281 $ 14 Commercial 67 131 132 102 - Agricultural 14 54 - 10 19 ---- ---- ---- ---- ---- Total nonaccruing loans 146 292 190 393 33 ---- ---- ---- ---- ---- Restructured loans: Commercial - - - - - ---- ---- ---- ---- ---- Total restructured loans - - - - - ---- ---- ---- ---- ---- Total nonperforming loans $146 $292 $190 $393 $ 33 ==== ==== ==== ==== ==== Loans on accrual status past due 90 days or more: Real Estate $ - $ 3 $ - $ - $ - Consumer 169 226 235 160 241 Revolving credit 7 6 4 5 3 Commercial 49 44 3 - 225 Agricultural 14 8 7 16 10 ---- ---- ---- ---- ---- Total past due loans $239 $287 $249 $181 $479 ==== ==== ==== ==== ==== Asset Quality Ratios: Allowance for loan losses to year-end net loans 1.40% 1.41% 1.42% 1.29% 1.30% Nonperforming loans to year-end net loans .04% .10% .07% .15% .01% Allowance for loan losses to nonperforming loans 32.51% X 14.16% X 20.11% X 8.34X 93.03X
At December 31, 2000, 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 loan loss allowance is set forth in the following table (in thousands):
2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Balance at beginning of period $4,135 $3,821 $3,277 $3,070 $2,757 ------ ------ ------ ------ ------ Charge-offs: Commercial loans 141 34 68 452 9 Real estate loans 9 - - - - Consumer loans 417 475 440 540 493 ------ ------ ------ ------ ------ 567 509 508 992 502 ------ ------ ------ ------ ------ Recoveries: Commercial loans 32 40 9 - 3 Real estate loans 1 - - - - Consumer loans 125 113 116 99 114 ------ ------ ------ ------ ------ 158 153 125 99 117 ------ ------ ------ ------ ------ Net charge-offs 409 356 383 893 385 Provision for loan losses 1,020 670 927 1,100 673 Other - - - - 25 ------ ------ ------ ------ ------ Balance at end of period $4,746 $4,135 $3,821 $3,277 $3,070 ====== ====== ====== ====== ====== Percent of net charge-offs to average net loans outstanding during the period .13% .13% .15% .36% .17% ====== ====== ====== ====== ======
The allowance 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 nonaccuring status. II-23 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):
2000 1999 1998 ----------------------- ----------------------- ----------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate --------- --------- --------- --------- --------- --------- Demand deposits - non-interest bearing $ 49,126 - % $ 42,923 - % $ 40,134 - % Demand deposits - interest bearing 56,141 1.84% 54,143 2.01% 51,116 2.36% Money market 24,861 3.48% 19,250 2.78% 19,031 2.86% Savings 63,739 2.62% 67,247 2.63% 67,265 2.90% Time 202,890 5.47% 183,707 5.05% 174,123 5.32% -------- -------- -------- $396,757 3.70% $367,270 3.45% $351,669 3.69% ======== ======== ========
Certificates of Deposit Certificates of deposit at the end of 2000 in amounts of $100,000 or more were classified by maturity as follows (in thousands): 3 months or less $ 8,426 Over 3 through 6 months 30,141 Over 6 through 12 months 14,766 Over 12 months 3,028 ------- $56,361 ======= Return on Assets and Shareholders' Equity The following table presents certain rates of return and percentages for the past 3 years: 2000 1999 1998 ------ ------ ------ Return on average assets 1.70% 1.68% 1.64% Return on average shareholder's equity 14.74% 14.17% 13.79% Dividend payout ratio 41.07% 40.44% 39.43% Average shareholders' equity to average assets 11.54% 11.89% 11.86% 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. II-24 Quarterly Financial Results (in thousands, except per share amounts) American National Bankshares Inc. and Subsidiary
Fourth Third Second First Quarter Quarter Quarter Quarter -------- -------- -------- -------- 2000 ---- Interest income....................................... $10,189 $ 9,853 $ 9,497 $ 9,067 Interest expense...................................... 4,687 4,527 4,179 3,950 ------- ------- ------- -------- Net interest income................................. 5,502 5,326 5,318 5,117 Provision for loan losses............................. 180 290 335 215 ------- ------- ------- ------- Net interest income after provision................. 5,322 5,036 4,983 4,902 Non-interest income................................... 1,275 1,186 1,142 1,175 Non-interest expense.................................. 3,538 3,172 3,097 3,123 ------- ------- ------- ------- Income before income tax provision.................. 3,059 3,050 3,028 2,954 Income tax provision.................................. 868 860 848 839 ------- ------- ------- ------- Net income.......................................... $ 2,191 $ 2,190 $ 2,180 $ 2,115 ======= ======= ======= ======= Per common share: Net income (basic)................................... $ .36 $ .36 $ .36 $ .35 Net income (diluted)................................. $ .36 $ .36 $ .36 $ .35 Cash dividends....................................... $ .150 $ .150 $ .150 $ .135 1999 ---- Interest income........................................ $ 8,816 $ 8,435 $ 8,286 $ 8,162 Interest expense....................................... 3,839 3,720 3,605 3,572 ------- ------- ------- ------- Net interest income.................................. 4,977 4,715 4,681 4,590 Provision for loan losses.............................. 190 120 180 180 ------- ------- ------- ------- Net interest income after provision.................. 4,787 4,595 4,501 4,410 Non-interest income.................................... 1,161 1,161 1,075 1,097 Non-interest expense................................... 3,044 2,927 2,792 2,780 ------- ------- ------- ------- Income before income tax provision................... 2,904 2,829 2,784 2,727 Income tax provision................................... 858 841 818 803 ------- ------- ------- ------- Net income........................................... $ 2,046 $ 1,988 $ 1,966 $ 1,924 ======= ======= ======= ======= Per common share: Net income (basic)................................... $ .34 $ .33 $ .32 $ .32 Net income (diluted)................................. $ .33 $ .33 $ .32 $ .32 Cash dividends....................................... $ .135 $ .135 $ .135 $ .120
II-25 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. Charles H. Majors President and Chief Executive Officer T. Allen Liles Senior Vice President, Secretary, Treasurer and Chief Financial Officer February 7, 2001 II-26 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, 2000 and 1999, 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, 2000. 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 auditing standards generally accepted in the United States. 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, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Charlotte, North Carolina, February 7, 2001 II-27 Consolidated Balance Sheets December 31, 2000 and 1999 American National Bankshares Inc. and Subsidiary -----------------------------------------------------------------------------------------------------------------
2000 1999 ------------- -------------- ASSETS Cash and due from banks ........................................................$ 16,392,313 $ 13,885,239 Interest-bearing deposits in other banks........................................ 8,678,150 3,405,705 Investment securities: Securities available for sale (at market value)............................... 120,353,348 121,872,335 Securities held to maturity (market value of $42,919,727 in 2000 and $43,634,211 in 1999)............................................ 42,575,797 44,399,759 -------------- -------------- Total investment securities................................................... 162,929,145 166,272,094 -------------- -------------- Loans, net of unearned income .................................................. 339,756,374 293,740,806 Less allowance for loan losses.................................................. (4,746,429) (4,134,893) -------------- -------------- Net loans..................................................................... 335,009,945 289,605,913 -------------- -------------- Bank premises and equipment, at cost, less accumulated depreciation of $8,518,452 in 2000 and $8,170,506 in 1999..................... 7,868,410 8,051,550 Accrued interest receivable and other assets.................................... 10,510,858 10,170,303 -------------- -------------- Total assets..................................................................$ 541,388,821 $ 491,390,804 ============== ============== LIABILITIES and SHAREHOLDERS' EQUITY Liabilities: Demand deposits -- non-interest bearing.......................................$ 54,495,780 $ 47,495,400 Demand deposits -- interest bearing........................................... 58,272,932 55,622,893 Money market deposits......................................................... 32,480,105 22,326,340 Savings deposits.............................................................. 61,586,380 64,744,947 Time deposits................................................................. 219,753,122 195,368,539 -------------- -------------- Total deposits................................................................ 426,588,319 385,558,119 -------------- -------------- Repurchase agreements......................................................... 31,729,600 24,954,333 FHLB Borrowings............................................................... 16,000,000 21,000,000 Accrued interest payable and other liabilities................................ 3,732,619 3,159,802 -------------- -------------- Total liabilities............................................................. 478,050,538 434,672,254 -------------- -------------- Shareholders' equity: Preferred stock, $5 par, 200,000 shares authorized, none outstanding............................................................ - - Common stock, $1 par,10,000,000 shares authorized, 6,063,772 shares outstanding at December 31, 2000 and 6,103,701 shares outstanding at December 31, 1999........................... 6,063,772 6,103,701 Capital in excess of par value................................................ 9,831,428 9,895,359 Retained earnings............................................................. 47,119,966 42,466,592 Accumulated other comprehensive income (loss) - net unrealized gains (losses) on securities available for sale.............. 323,117 (1,747,102) -------------- -------------- Total shareholders' equity.................................................... 63,338,283 56,718,550 -------------- -------------- Total liabilities and shareholders' equity....................................$ 541,388,821 $ 491,390,804 ============== ============== The accompanying notes to consolidated financial statements are an integral part of these balance sheets.
II-28 Consolidated Statements of Income For The Years Ended December 31, 2000, 1999 and 1998 American National Bankshares Inc. and Subsidiary ----------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998 -------------- -------------- -------------- Interest Income: Interest and fees on loans....................................................$ 28,300,030 $ 23,959,012 $ 23,356,412 Interest on federal funds sold and other...................................... 179,215 273,702 271,524 Income on investment securities: U S Government.............................................................. 167,977 800,693 2,601,437 Federal agencies............................................................ 6,550,271 5,653,811 4,485,157 State and municipal ........................................................ 1,944,604 1,767,782 1,346,014 Other investments........................................................... 1,464,462 1,244,133 593,363 -------------- -------------- -------------- Total interest income..................................................... 38,606,559 33,699,133 32,653,907 -------------- -------------- -------------- Interest Expense: Interest on deposits: Demand...................................................................... 1,034,845 1,086,744 1,203,786 Money market................................................................ 865,024 534,801 545,061 Savings..................................................................... 1,671,108 1,768,148 1,949,958 Time........................................................................ 11,094,637 9,283,865 9,260,295 Interest on repurchase agreements............................................. 1,362,104 876,291 1,116,315 Interest on other borrowings.................................................. 1,315,507 1,186,636 396,183 -------------- -------------- -------------- Total interest expense...................................................... 17,343,225 14,736,485 14,471,598 -------------- -------------- -------------- Net Interest Income............................................................. 21,263,334 18,962,648 18,182,309 Provision for Loan Losses....................................................... 1,020,000 670,000 927,000 -------------- -------------- -------------- Net Interest Income After Provision For Loan Losses............................................................... 20,243,334 18,292,648 17,255,309 -------------- -------------- -------------- Non-Interest Income: Trust and investment services................................................. 2,657,802 2,531,491 2,165,437 Service charges on deposit accounts........................................... 1,113,548 970,383 902,060 Other fees and commissions..................................................... 591,724 464,045 427,235 Mortgage banking income....................................................... 240,390 332,490 428,991 Other income.................................................................. 174,417 196,305 155,971 -------------- -------------- -------------- Total non-interest income................................................... 4,777,881 4,494,714 4,079,694 -------------- -------------- -------------- Non-Interest Expense: Salaries...................................................................... 6,071,352 5,575,472 5,126,819 Pension and other employee benefits........................................... 1,154,352 955,164 1,140,252 Occupancy and equipment ...................................................... 2,188,769 1,895,799 1,663,880 Core deposit intangible amortization.......................................... 449,816 449,816 449,816 Other ........................................................................ 3,065,631 2,666,880 2,633,106 -------------- -------------- -------------- Total non-interest expense.................................................. 12,929,920 11,543,131 11,013,873 -------------- -------------- -------------- Income Before Income Tax Provision.............................................. 12,091,295 11,244,231 10,321,130 Income Tax Provision............................................................ 3,414,930 3,319,881 3,122,881 -------------- -------------- -------------- Net Income......................................................................$ 8,676,365 $ 7,924,350 $ 7,198,249 ============== ============== ============== Net Income Per Common Share: * Basic......................................................................... $1.42 $1.30 $1.18 Diluted....................................................................... $1.42 $1.30 $1.18 Average Common Shares Outstanding: Basic......................................................................... 6,096,037 6,103,485 6,103,466 Diluted....................................................................... 6,101,415 6,118,540 6,105,318 * - Per share amounts have been restated to reflect the impact of a 2-for-1 stock split effected in the form of a dividend issued July 1, 1999. The accompanying notes to consolidated financial statements are an integral part of these statements.
II-29 CONSOLIDATED STATEMENTS of CHANGES in SHAREHOLDERS' EQUITY For the Years Ended December 31, 2000, 1999 and 1998 American National Bankshares Inc. and Subsidiary
Common Stock Accumulated ------------------------- Capital in Other Total Excess of Retained Comprehensive Shareholders' Shares Amount Par Value Earnings Income (Loss) Equity ----------- ----------- ----------- ------------ ------------- ------------- 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 declared and paid.......... - - - (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 Net income................................ - - - 7,924,350 - 7,924,350 Change in unrealized losses on securities available for sale, net of tax.......... - - - - (2,865,388) (2,865,388) ------------ Comprehensive income.................. 5,058,962 Common stock issued in 2 for 1 stock split................................... 3,051,733 3,051,733 - (3,051,733) - - Stock options exercised................... 235 235 3,055 - - 3,290 Cash dividends declared and paid.......... - - - (3,204,348) - (3,204,348) ---------- ----------- ----------- ------------ ----------- ------------ Balance, December 31, 1999................ 6,103,701 6,103,701 9,895,359 42,466,592 (1,747,102) 56,718,550 Net income................................ - - - 8,676,365 - 8,676,365 Change in unrealized gains on securities available for sale, net of tax.......... - - - - 2,070,219 2,070,219 ------------ Comprehensive income.................. 10,746,584 Stock repurchase.......................... (40,000) (40,000) (64,854) (459,334) - (564,188) Stock options exercised................... 71 71 923 - - 994 Cash dividends declared and paid.......... - - - (3,563,657) - (3,563,657) ---------- ----------- ----------- ----------- ----------- ------------ Balance, December 31, 2000................ 6,063,772 $ 6,063,772 $ 9,831,428 $47,119,966 $ 323,117 $63,338,283 ========== =========== =========== =========== =========== ============ The accompanying notes to consolidated financial statements are an integral part of these statements.
II-30 Consolidated Statements of Cash Flows For the Years Ended December 31, 2000, 1999 and 1998 American National Bankshares Inc. and Subsidiary
2000 1999 1998 ------------- ------------- ------------- Cash Flows from Operating Activities: Net income....................................................................$ 8,676,365 $ 7,924,350 $ 7,198,249 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses................................................. 1,020,000 670,000 927,000 Depreciation.............................................................. 1,116,688 1,029,875 814,870 Core deposit intangible amortization...................................... 449,816 449,816 449,816 Amortization (accretion) of premiums and discounts on investment securities................................................ (49,789) 77,488 (42,918) Loss (gain) on sale of securities......................................... 1,751 (7,970) (18,300) Gain on sale of loans..................................................... (240,390) (332,490) (428,991) Gain on sale of real estate owned......................................... - (94,462) - Gain on sale of property and equipment.................................... - (6,150) - Deferred income taxes benefit............................................. (415,002) (211,558) (312,768) Increase in interest receivable........................................... (529,596) (1,282) (159,538) Increase in other assets.................................................. (697,250) (394,986) (1,639) Increase (decrease) in interest payable................................... 284,949 176,627 (21,910) Increase (decrease) in other liabilities.................................. 287,868 (191,290) 701,160 ------------- ------------- ------------- Net cash provided by operating activities................................. 9,905,410 9,087,968 9,105,031 ------------- ------------- ------------- Cash Flows from Investing Activities: Proceeds from maturities, calls, and sales of securities .................... 14,261,280 50,241,341 47,430,116 Purchases of securities available for sale................................... (7,504,500) (51,708,123) (55,738,003) Purchases of securities held to maturity..................................... (229,097) (5,803,523) (11,212,515) Net increase in loans........................................................ (46,183,642) (24,245,589) (15,023,315) Proceeds from sale of real estate owned...................................... - 449,462 - Purchases of real estate owned............................................... (215,000) - - Purchases of property and equipment.......................................... (933,548) (1,472,195) (1,903,664) ------------- ------------- ------------- Net cash used in investing activities........................................ (40,804,507) (32,538,627) (36,447,381) ------------- ------------- ------------- Cash Flows from Financing Activities: Net increase in demand, money market, and savings deposits....................................................... 16,645,617 2,525,430 7,178,345 Net increase (decrease) in time deposits..................................... 24,384,583 24,707,800 (456,372) Net (decrease) increase in FHLB borrowings................................... (5,000,000) 8,000,000 13,000,000 Net increase (decrease) in federal funds purchased and repurchase agreements.................................................. 6,775,267 (6,068,501) 11,483,870 Cash dividends paid.......................................................... (3,563,657) (3,204,348) (2,838,111) Repurchase of stock.......................................................... (564,188) - - Proceeds from exercise of stock options...................................... 994 3,290 - ------------- ------------- ------------- Net cash provided by financing activities.................................... 38,678,616 25,963,671 28,367,732 ------------- ------------- ------------- Net Increase in Cash and Cash Equivalents....................................... 7,779,519 2,513,012 1,025,382 Cash and Cash Equivalents at Beginning of Period................................ 17,290,944 14,777,932 13,752,550 ------------- ------------- ------------- Cash and Cash Equivalents at End of Period......................................$ 25,070,463 $ 17,290,944 $ 14,777,932 ============= ============= ============= Supplemental Schedule of Cash and Cash Equivalents: Cash: Cash and due from banks.....................................................$ 16,392,313 $ 13,885,239 $ 14,071,687 Interest-bearing deposits in other banks.................................... 8,678,150 3,405,705 706,245 ------------- ------------- ------------- $ 25,070,463 $ 17,290,944 $ 14,777,932 ============= ============= ============= Supplemental Disclosure of Cash Flow Information: Interest paid.................................................................$ 17,058,276 $ 14,559,858 $ 14,493,509 Income taxes paid.............................................................$ 3,788,800 $ 3,786,339 $ 2,950,000 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-31 Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 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 Cities of Danville and Martinsville, Town of South Boston, the Counties of Pittsylvania, Henry, and Halifax in Virginia and the County of Caswell in North Carolina. ANB Mortgage Corp., a wholly owned subsidiary of the Bank, commenced mortgage lending operations in December 1996. ANB Services Corp., another wholly owned subsidiary of the Bank, was formed in October 1999 to offer non-deposit products such as mutual funds and insurance products. 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. 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. 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, consumer and commercial loans 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. Allowance for Loan Losses The allowance for loan losses is an estimate of losses inherent in the loan portfolio as determined by management taking into consideration identified impaired loans, historical loan loss experience, diversification of the loan portfolio, amounts 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 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, 2000, the Bank had $2,284,000 recorded as core deposit intangibles, net of amortization. The Bank recorded core deposit intangible amortization of approximately $450,000 for each of the three years ended December 31, 2000. Core deposit intangibles are periodically reviewed for impairment. As of December 31, 2000, no impairment had been identified. II-32 Foreclosed Properties Foreclosed properties are included in other assets and 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 The Corporation uses the asset and liability method to account for income taxes. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the income tax basis of the Corporation's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. 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. The Corporation issued a 2-for-1 stock split effected in the form of a 100% stock dividend to shareholders of record July 1, 1999, payable on July 15, 1999. All references to the number of common shares and all per share amounts have been adjusted, as appropriate, to retroactively reflect the stock split. Reclassifications Certain reclassifications have been made in prior years' financial statements to conform to classifications used in the current year. New Accounting Pronouncements. 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 11 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. SFAS No. 133 was subsequently amended by SFAS No. 137 in June 1999 and by SFAS No. 138 in June 2000. The statement, as amended, 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, 2000. Adoption is not expected to have a material impact on the Corporation. In September 2000, the Financial Accounting Standards Board issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". This statement revises the criteria for accounting for securitizations, other financial-assets transfers and collateral and introduces new disclosures. This statement is effective for fiscal years ending after March 31, 2001. The adoption of this statement is not expected to have a material effect on the Corporation's consolidated financial statements. II-33 2. Parent Company Financial Information: Condensed parent company financial information is as follows (in thousands): As of December 31 Condensed Balance Sheets 2000 1999 ------------------------ -------- -------- Assets Cash $ 612 $ 211 Investment in Subsidiary 62,270 56,024 Other Assets 456 484 -------- -------- Total Assets $ 63,338 $ 56,719 ======== ======== Liabilities $ - $ - Shareholders' Equity 63,338 56,719 -------- -------- Total Liabilities and Shareholders Equity $ 63,338 $ 56,719 ======== ======== For the Year Ended December 31 Condensed Statements of Income 2000 1999 1998 ------------------------------ --------- --------- -------- Dividends from Subsidiary $ 4,640 $ 3,857 $ 2,903 Expenses (140) (16) (44) Income Before Equity in Undistributed Earnings of Subsidiary 4,500 3,841 2,859 Equity in Undistributed Earnings of Subsidiary 4,176 4,083 4,339 --------- --------- --------- Net Income $ 8,676 $ 7,924 $ 7,198 ========= ========= ========= For the Year Ended December 31 Condensed Statements of Cash Flows 2000 1999 1998 ---------------------------------- --------- --------- --------- Cash provided by dividends received from Subsidiary $ 4,640 $ 3,857 $ 2,903 Cash used for payment of dividends (3,564) (3,204) (2,838) Cash used for repurchase of stock (564) - - Other (111) (497) (19) --------- --------- --------- Net increase in cash $ 401 $ 156 $ 46 ========== ========= ========= II-34 3. Investment Securities: The amortized cost and estimated fair value of investments in debt securities at December 31, 2000 and 1999 were as follows (in thousands): 2000 ---------------------------------------- Amortized Estimated Cost Gains Losses Fair Value --------- ------ ------ ---------- Securities held to maturity: U.S. Government $ - $ - $ - $ - Federal agencies 21,958 66 (69) 21,955 State and municipal 20,618 369 (22) 20,965 --------- ------ ------- -------- Total securities held to maturity 42,576 435 (91) 42,920 --------- ------ ------- -------- Securities available for sale: U.S. Government - - - - Federal agencies 77,506 662 (255) 77,913 State and municipal 18,270 384 (59) 18,595 Corporate bonds and other 24,088 38 (281) 23,845 --------- ------ ------- -------- Total securities available for sale 119,864 1,084 (595) 120,353 --------- ------ ------- -------- Total securities $ 162,440 $1,519 $ (686) $163,273 ========= ====== ======= ======== 1999 ----------------------------------------- Amortized Estimated Cost Gains Losses Fair Value --------- ------ ------ ---------- Securities held to maturity: U.S. Government $ - $ - $ - $ - Federal agencies 23,633 15 (401) 23,247 State and municipal 20,767 115 (495) 20,387 --------- ------ -------- -------- Total securities held to maturity 44,400 130 (896) 43,634 --------- ------ -------- -------- Securities available for sale: U.S. Government 7,002 18 - 7,020 Federal agencies 77,016 103 (1,628) 75,491 State and municipal 19,324 107 (344) 19,087 Corporate bonds and other 21,177 - (903) 20,274 --------- ------ -------- -------- Total securities available for sale 124,519 228 (2,875) 121,872 --------- ------ -------- -------- Total securities $ 168,919 $ 358 $(3,771) $165,506 ========= ====== ======== ======== II-35 The amortized cost and estimated fair value of investments in debt securities at December 31, 2000, 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. Corporate bonds consist of high quality debt securities, primarily issued in the financial services industry. Held to Maturity Available for Sale ---------------------- ----------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value --------- ---------- --------- ---------- Due in one year or less $ 10,855 $ 10,891 $ 13,917 $ 13,956 Due after one year through five years 13,337 13,487 58,736 59,125 Due after five years through ten years 12,534 12,744 21,455 21,516 Due after ten years 5,850 5,798 25,756 25,756 -------- -------- -------- -------- $ 42,576 $ 42,920 $119,864 $120,353 ======== ======== ======== ======== Proceeds from calls exercised by the issuers of investments in debt securities were $65,000 in 2000, $8,592,000 in 1999 and $14,753,000 in 1998. Proceeds from sales of investments in debt securities were $0 in 2000, $3,946,000 in 1999 and $0 in 1998. The Bank recognized losses of $2,000 on called securities during 2000, gains of $8,000 on sale of securities in 1999, and gains of $18,000 on called securities during 1998. Investment securities with a book value of approximately $54,002,000 at December 31, 2000 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, $39,786,000 was pledged to secure repurchase agreements. 4. Loans: Outstanding loans at December 31, 2000 and 1999 were composed of the following (in thousands): 2000 1999 -------- -------- Real Estate loans Construction and land development $ 9,284 $ 7,317 Secured by farmland 1,616 1,306 Secured by 1 - 4 family residential properties 121,449 108,994 Secured by multi-family (5 or more) residential properties 5,023 4,532 Secured by nonfarm, nonresidential properties 67,312 54,170 Loans to farmers 1,625 2,468 Commercial and industrial loans 83,428 66,459 Consumer loans 44,389 45,235 Loans for nonrated industrial development obligations 5,590 3,236 All other loans 40 24 -------- -------- Loans, net of unearned income $339,756 $293,741 ======== ======== 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, 2000 and 1999, loans in a nonaccrual or restructured status totaled approximately $146,000 and $292,000, respectively. Interest income on nonaccrual loans, if recognized, is recorded on a cash basis. For the years 2000, 1999 and 1998, the 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 $15,000, $23,000 and $14,000, respectively. No interest payments were recorded in 2000, 1999 or 1998 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 allowance for loan losses using methods similar to those prescribed in SFAS No. 114. As a result of adopting these statements, no additional allowance for loan losses was required as of January 1, 1995. II-36 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. As of December 31, 2000 and 1999, the Bank had not identified any loans as impaired. The loan portfolio is concentrated primarily in the immediate geographic region which is the Corporation's trade area consisting of the Cities of Danville and Martinsville, Town of South Boston, and Pittsylvania, Henry, and Halifax 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, 2000. An analysis of the allowance for loan losses is as follows (in thousands): 2000 1999 1998 -------- -------- -------- Balance, beginning of year $ 4,135 $ 3,821 $ 3,277 Provision for loan losses charged to expense 1,020 670 927 Charge-offs (567) (509) (508) Recoveries 158 153 125 -------- -------- -------- Balance, end of year $ 4,746 $ 4,135 $ 3,821 ======== ======== ======== 5. Time Deposits: Included in time deposits are certificates of deposit in denominations of $100,000 or more totaling $56,361,000, $45,887,000 and $32,851,000 at December 31, 2000, 1999 and 1998, respectively. Interest expense on such deposits during 2000, 1999 and 1998 was $2,781,000, $1,566,000 and $1,436,000, respectively. 6. Short-Term Borrowings: Repurchase agreements of $31,730,000 and $24,954,000 comprised short-term borrowings at December 31, 2000 and 1999, respectively. Repurchase agreements are borrowings collateralized by securities of the U.S. Government or its agencies and mature daily. In addition, the Bank has 15% of assets, or approximately $81,140,000, in credit availability with the FHLB at December 31, 2000 which is secured by qualifying mortgages or other acceptable security. 7. Stock Options: The Company uses the intrinsic value method in determining compensation expense for stock options which represents the excess of the market price of stock over the exercise price on the measurement date. 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 the 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): 2000 1999 1998 ------- ------- ------- Net Income: As reported $ 8,676 $ 7,924 $ 7,198 Pro forma 8,369 7,623 7,036 Earnings per share As reported $ 1.42 $ 1.30 $ 1.18 Pro forma 1.37 1.25 1.15 The weighted average fair values of options at their grant date during 2000, 1999 and 1998 were $7.25, $6.62 and $7.53, respectively. The estimated fair value of each option granted is calculated using the Black-Scholes option-pricing model. The following summarizes the weighted-average of the assumptions used in the model. 2000 1999 1998 ------ ------ ------ Risk-free interest rate 6.17% 5.29% 5.41% Expected years until exercise 5.50 5.50 5.50 Expected stock volatility 47.95% 38.32% 15.59% II-37 At December 31, 2000, and 1999, the Corporation had 300,000 shares of its authorized but unissued common stock reserved for its incentive and nonqualified stock option plan. These options vest from immediately to three years and have a maximum term of ten years. A summary of stock option transactions under the plan follows: Option Option Price Shares Per Share --------- -------------- Outstanding at December 31, 1997 32,000 $14.00 Granted 42,000 $15.63 - 18.75 Exercised - - Forfeited (2,200) $14.00 --------- -------------- Outstanding at December 31, 1998 71,800 $14.00 - 18.75 Granted 71,000 $13.69 - 20.00 Exercised (235) $14.00 Forfeited (3,965) $13.69 - 14.00 --------- -------------- Outstanding at December 31, 1999 138,600 $13.69 - 20.00 Granted 17,400 $13.25 - 15.50 Exercised (71) $14.00 Forfeited ( 4,229) $13.69 - 14.00 --------- -------------- Outstanding at December 31, 2000 151,700 $13.25 - 20.00 ========= ============== The following table summarizes information related to stock options outstanding on December 31, 2000: Number of Options Outstanding Number of Options Exercisable Exercise Prices at December 31, 2000 at December 31, 2000 --------------- ----------------------------- ----------------------------- $13.25 3,000 3,000 13.38 10,000 10,000 13.69 51,500 51,500 14.00 24,800 24,800 15.50 4,400 4,400 15.63 14,000 14,000 17.00 6,000 6,000 17.19 14,000 14,000 18.75 14,000 14,000 20.00 10,000 10,000 ------- ------- 151,700 151,700 ======= ======= 8. Income Taxes: The components of the Corporation's net deferred tax assets as of December 31, 2000 and December 31, 1999, were as follows (in thousands): 2000 1999 ------- -------- Deferred tax assets: Allowance for loan losses $ 1,431 $ 1,211 Net unrealized losses on securities - 900 Deferred compensation 279 269 Other 297 235 ------- -------- 2,007 2,615 Valuation allowance - (171) ------- -------- Total deferred tax assets 2,007 2,444 ------- -------- Deferred tax liabilities: Depreciation 256 251 Net unrealized gains on securities 166 - Accretion of discount 106 67 Other 71 91 ------- -------- Total deferred tax liabilities 599 409 ------- -------- Net deferred tax assets $ 1,408 $ 2,035 ======= ======== II-38 The provision for income taxes consists of the following (in thousands): 2000 1999 1998 -------- -------- -------- Taxes currently payable $ 3,830 $ 3,532 $ 3,436 Deferred tax benefit (415) (212) (313) -------- -------- -------- $ 3,415 $ 3,320 $ 3,123 ======== ======== ======== The effective rates of the provision differ from the statutory federal income tax rates due to the following items: 2000 1999 1998 ------ ------ ------ Federal statutory rate 34.0% 34.0% 34.0% Nontaxable interest income (4.7) (4.5) (3.8) Other (1.1) - .1 ------ ------ ------ 28.2% 29.5% 30.3% ====== ====== ====== 9. 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 $85,489,000 and $86,931,000 at December 31, 2000 and 1999, 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 $800,000 in commitments to purchase securities when issued at December 31, 2000 and none at December 31, 1999. 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, 2000 and 1999 the Bank had $1,531,000 and $1,193,000 in outstanding standby letters of credit. Commercial letters of credit amounted to $60,000 at December 31, 2000. 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, 2000, this reserve requirement was approximately $1,821,000. 10. 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 $14,793,000 and $10,188,000 at December 31, 2000 and 1999, respectively. The maximum amount of loans outstanding to the officers, directors and their business interests at any month-end during 2000, 1999 and 1998 was approximately 4.5% 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, 2000, none of these loans were restructured, nor were any related party loans charged off during 2000. An analysis of these loans for 2000 is as follows (in thousands): Balance, beginning of year $ 10,188 Additions 27,857 Repayments (23,252) --------- Balance, end of year $ 14,793 ========= 11. 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. II-39 The following table sets forth the plan's funded status as of December 31, 2000 and 1999 (in thousands): 2000 1999 -------- -------- Change in benefit obligation: Benefit obligation at beginning of year $ 4,462 $ 3,920 Service cost 238 233 Interest cost 322 274 Actuarial gain (83) 78 Benefits paid (817) (43) -------- -------- Benefit obligation at end of year $ 4,122 $ 4,462 ======== ======== Change in plan assets Fair value of plan assets at beginning of year $ 5,053 $ 4,549 Actual return on plan assets 151 547 Employer contributions 66 - Benefits paid (817) (43) -------- -------- Fair value of plan assets at end of year $ 4,453 $ 5,053 ======== ======== Funded status $ 331 $ 591 Unrecognized net actuarial gain (288) (470) Unrecognized net obligation at transition (30) (42) Unrecognized prior service cost (144) (168) -------- -------- Prepaid asset $ (131) $ (89) ======== ======== Major assumptions and net periodic pension cost include the following (in thousands): Weighted-average assumptions: 2000 1999 1998 ------ ------ ------ Discount rate: Post-retirement 6.00% 6.00% 6.00% Pre-retirement 7.50 7.00 7.00 Expected return on plan assets 8.00 8.00 8.00 Rate of compensation increase 4.00 4.00 4.00 Components of net periodic benefit cost: Service cost $ 238 $ 233 $ 198 Interest cost 322 274 240 Expected return on plan assets (404) (364) (304) Amortization of prior service cost (24) (24) (24) Amortization of net obligation at transition (12) (12) (12) Recognized net actuarial gain (12) - - ------ ------ ------ Net periodic benefit cost $ 108 $ 107 $ 98 ====== ====== ====== A non-contributory deferred compensation plan was adopted in 1982 by the Board of Directors of the Bank which covers certain key executives. The expense for this plan was $110,000, $63,000 and $151,000 for years 2000, 1999 and 1998, respectively. A 401(k) savings plan was adopted in 1995 which covers substantially all full-time employees of the Bank. The Bank matches a portion of the contribution made by employee participants after at least one year of service. The Bank contributed $110,000, $108,000 and $92,000 to the 401(k) plan in 2000, 1999 and 1998, respectively. These amounts are included in pension and other employee benefits expense for the respective years. II-40 12. Fair Value of Financial Instruments: The estimated fair values of the Corporation's assets are as follows (in thousands): December 31, 2000 ------------------------ Carrying Fair Amount Value --------- --------- Financial assets: Cash and federal funds sold $ 25,071 $ 25,071 Investment securities 162,929 163,273 Other 10,511 10,511 Loans, net 335,010 335,392 Financial liabilities: Deposits $ 426,588 $ 425,900 Repurchase agreements 31,730 31,730 Other borrowings 16,000 16,034 Other liabilities 3,733 3,733 Off balance sheet instruments: Commitments to extend credit - - Standby letters of credit - 20 December 31, 1999 ------------------------ Carrying Fair Amount Value --------- --------- Financial assets: Cash and federal funds sold $ 17,291 $ 17,291 Investment securities 166,272 165,506 Other 10,170 10,170 Loans, net 289,606 288,839 Financial liabilities: Deposits $ 385,558 $ 384,666 Repurchase agreements 24,954 24,954 Other borrowings 21,000 20,383 Other liabilities 3,160 3,160 Off balance sheet instruments: Commitments to extend credit - - Standby letters of credit - 15 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. II-41 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. Off balance sheet 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, 2000 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. 13. 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, $8,259,000 plus an additional amount equal to the Bank's net income for 2000 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, 2000 and 1999 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, 2000: Total Capital Corporation $64,787 17.09% $30,333 >8.0% Bank 63,713 16.82% 30,296 >8.0% $37,870 >10.0% Tier I Capital Corporation 60,731 16.02% 15,167 >4.0% Bank 59,663 15.75% 15,148 >4.0% 22,722 >6.0% Leverage Capital Corporation 60,731 11.59% 15,725 >3.0% Bank 59,663 11.39% 15,711 >3.0% 26,185 >5.0% As of December 31, 1999: Total Capital Corporation $59,868 17.79% $26,915 >8.0% Bank 59,173 17.61% 26,876 >8.0% $33,595 >10.0% Tier I Capital Corporation 55,733 16.57% 13,457 >4.0% Bank 55,038 16.38% 13,438 >4.0% 20,157 >6.0% Leverage Capital Corporation 55,733 11.52% 14,508 >3.0% Bank 55,038 11.39% 14,493 >3.0% 24,155 >5.0%
II-42 14. 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. 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 2000, 1999 and 1998 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. Intersegment eliminations primarily consist of the Corporation's investment in the Bank and related equity earnings. 2000 ----------------------------------------------------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ----- ------------ ----- Interest income $ 38,606 $ - $ 22 $ (22) $ 38,606 Interest expense 17,343 - 22 (22) 17,343 Non-interest income - external customers 1,779 2,658 341 - 4,778 Non-interest income - internal customers - 54 - (54) - Operating income before income taxes 10,588 1,791 8,528 (8,816) 12,091 Depreciation and amortization 1,516 40 11 - 1,567 Total assets 541,273 - 64,135 (64,019) 541,389 Capital expenditures 906 19 9 - 934
1999 ----------------------------------------------------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ----- ------------ ----- Interest income $ 33,669 $ - $ 30 $ (30) $ 33,669 Interest expense 14,736 - 30 (30) 14,736 Non-interest income - external customers 1,629 2,532 334 - 4,495 Non-interest income - internal customers - 52 - (52) - Operating income before income taxes 9,558 1,781 7,846 (7,941) 11,244 Depreciation and amortization 1,416 48 15 - 1,479 Total assets 491,151 - 57,241 (57,001) 491,391 Capital expenditures 1,466 - 6 - 1,472
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 1,487 2,165 427 - 4,079 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
II-43 American National Bankshares Inc. 628 Main Street Post Office Box 191 Danville, Virginia 24543 Notice of Annual Meeting of Shareholders To be held April 24, 2001 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 24, 2001 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 II. 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 9, 2001. 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, 2001 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 24, 2001 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 24, 2001, 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. INFORMATION AS TO VOTING SECURITIES The Board of Directors has set March 9, 2001 as the record date for the determination of shareholders entitled to notice of and to vote at the Annual Meeting. Only shareholders of record on that date will be entitled to vote on the matters described herein. As of March 9, 2001, the Corporation had 1,385 shareholders of record. To the Corporation's knowledge, no one individual or entity owns directly or indirectly more than 5% of the Corporation's common stock ("the 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 1,195,151 shares on March 9, 2001. The number of shares of the Common Stock, there being no other class of stock, outstanding and entitled to vote at the Annual Shareholders' Meeting is 6,030,772. There are 1,195,151 shares held of record by Ambro and Company which amount represents 19.8175% of the outstanding securities, and only 431,666 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. A majority of the votes entitled to be cast on matters to be considered at the Annual Meeting constitutes a quorum. If a share is represented for any purpose at the Annual Meeting, it is deemed to be present for quorum purposes for all matters considered at the Annual Meeting. Abstentions and shares held of record by a broker or its nominee ("Broker Shares") that are voted on any matter are included in determining the number of votes present or represented at the Annual Meeting. Broker Shares that are not voted on any matter at the Annual Meeting will not be included in determining whether a quorum is present. Directors are elected by a plurality of the votes cast by holders of the Common Stock at a meeting at which a quorum is present. Votes that are withheld and Broker Shares that are not voted in the election of directors will not be included in determining the number of votes cast. This proxy statement and the enclosed form of proxy were first mailed to shareholders on or about March 22, 2001. 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. Shareholder's may revoke their proxy by delivering a written notice of revocation to the Corporation at its principal office to the attention of T. Allen Liles, Secretary, at any time before the proxy is exercised or by attending the meeting and voting in person. Richard G. Barkhouser, H. Dan Davis, or James A. Motley, 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 II. 2. To transact any other business that may properly come before the meeting or any adjournment thereof. ELECTION OF DIRECTORS Four Directors of Class II are to be elected at the Annual Meeting of Shareholders to serve until the Annual Meeting in 2004 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 II 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 and memberships on various committees of the Board of Directors of the Corporation, are set forth below. NOMINEES Directors of Class II to be elected for a term expiring in 2004
Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since January 31, 2001 of Class -------------------- -------- ---------------------- -------- Fred A. Blair (54) 1992 4,082 - Direct (1) .0673 President, Blair Construction, Inc., 300 - Family Relationship (3) .0049 Gretna, VA, commercial building contractor E. Budge Kent, Jr. (62) 1979 41,897 - Direct (1)(6) .6897 Senior Vice President of the 1,262 - Family Relationship (4) .0208 Corporation and Executive Vice President & Chief Trust & Investment Officer of the Bank Fred B. Leggett, Jr. (64) 1994 18,509 - Direct (1)(2) .3052 Retired Chairman and Chief Executive 12,768 - Family Relationship (4) .2106 Officer, Leggett Stores, Danville, VA, retail department stores Claude B. Owen, Jr. (55) 1984 11,432 - Direct (1) .1885 Retired Chairman & Chief Executive 4,200 - Family Relationship (4) .0693 Officer of DIMON Incorporated, Danville, VA, leaf tobacco dealer, since May, 1999; prior thereto, Chairman & Chief Executive Officer of DIMON Incorporated, Danville, VA
I-3 DIRECTORS CONTINUING IN OFFICE Directors of Class III to continue in office until 2002
Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since January 31, 2001 of Class -------------------- -------- ---------------------- -------- Richard G. Barkhouser (70) 1980 164,824 - Direct (1) 2.7182 President, Barkhouser Motors, Inc., 14,520 - Family Relationship (4) .2395 Danville, VA, automobile dealership H. Dan Davis (63) 1996 87,400 - Direct (1)(8) 1.4413 Senior Consultant to the Corporation 40,704 - Family Relationship (4) .6712 and the Bank since January, 1998; prior thereto, Executive Vice President of the Corporation and Senior Vice President of the Bank Lester A. Hudson, Jr. (61) 1984 9,804 - Direct (1) .1617 Professor of Management, Clemson University, Clemson, SC, since January, 1998; prior thereto, Chairman, H & E Associates, Greenville, SC, investments Charles H. Majors (55) 1981 53,590 - Direct (1)(5) .8777 President and Chief Executive Officer 2,856 - Family Relationship (4) .0468 of the Corporation and the Bank
Directors of Class I to continue in office until 2003
Amount of Common Stock Director Owned Beneficially and Name, Principal of Bank Nature of Ownership on Percent Occupation and (Age) Since January 31, 2001 of Class -------------------- -------- ---------------------- -------- Willie G. Barker, Jr. (63) 1996 28,200 - Direct (1) .4651 President, Barklea, Inc., Danville, VA, tobacco warehouse Ben J. Davenport, Jr. (58) 1992 21,884 - Direct (1)(2) .3609 Chairman, First Piedmont Corporation, Chatham, VA, waste management James A. Motley (72) 1975 14,620 - Direct (1)(2) .2411 Retired Chairman and Chief Executive 10,484 - Family Relationship (4) .1729 Officer of the Corporation and the Bank All Named Executive Officers and 519,681 - Direct (1)(2)(7)(8) 8.4644 directors including nominees and 87,222 - Family Relationship (3)(4) 1.4207 directors named above (13 in group)
(1) Individual exercises sole voting and investment power over shares held. (2) Shared voting and investment power. I-4 (3) Sole voting and investment power as custodian for minor children. (4) Can exercise no voting or investment power. (5) Includes 42,200 shares that Mr. Majors has the right to acquire through the exercise of stock options. (6) Includes 11,200 shares that Mr. Kent has the right to acquire through the exercise of stock options. (7) Includes 75,600 shares that the Named Executive Officers have the right to acquire through the exercise of stock options. (8) Includes 200 shares that Mr. Davis has 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. Hudson is a director of American Electric Power Company, Inc. Mr. Davenport is a director of Intertape Polymer Group Inc. EXECUTIVE OFFICERS Mr. Charles H. Majors and Mr. E. Budge Kent, Jr., together with the two senior vice presidents listed below, were the executive officers of the Corporation and the Bank as of December 31, 2000.
Name Age Principal Occupation and Business Experience ---- --- -------------------------------------------- T. Allen Liles 48 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 62 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. BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD The Board of Directors held 14 Board Meetings during the year 2000. 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's and the 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 Leggett, reviews significant audit, accounting, and compliance principles, policies and practices, meets with the Corporation's 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 2000. Salary Committee. The Salary Committee currently consists of Messrs. Barkhouser, Davenport, and Hudson. The Salary Committee approves compensation of certain officers and makes recommendations to the Board of Directors for other officers' compensation and promotions, directors' fees, and related personnel matters. The Salary Committee held two meetings in 2000. 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 complying with any applicable provisions of the Corporation's bylaws and 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 Leggett. The Directors' Nominating Committee held two meetings in 2000. I-5 REPORT OF SALARY COMMITTEE ON EXECUTIVE COMPENSATION The Salary Committee of the Board of Directors, which is composed of three independent outside directors, is responsible for making recommendations to the Board of Directors concerning compensation of the Chief Executive Officer and for approving the compensation of the other executive officers. The Salary Committee considers a variety of factors and criteria in arriving at its decisions and recommendations for compensation of executive officers. In making its decisions and 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 earnings per share, dividends, and net equity improve shareholder market value and, accordingly, compensation should be structured to enhance the profitability of the Corporation and the total return to the shareholders. Executive officer compensation generally consists of salary, participation in the Bank's profit sharing plan, and incentive compensation. The profit sharing and incentive compensation plans are approved by the Board of Directors, upon recommendation by the Salary Committee. A description of the profit sharing plan is included in Note (2) under Executive Compensation. Executive officers received incentive compensation in 2000 due to the attainment of certain earnings by the Corporation. They may be eligible to receive incentive compensation if certain earnings are attained in 2001. 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 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 "Executive Compensation". In considering executive 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 recommended to the Board of Directors by the Committee after consideration of the Bank's performance and the resulting benefit to the shareholders. Salary Committee Richard G. Barkhouser Ben J. Davenport, Jr. Lester A. Hudson, Jr. REPORT OF AUDIT AND COMPLIANCE COMMITTEE The primary function of the Audit and Compliance Committee of the Board of Directors is to assist the Board in fulfilling its oversight responsibilities by reviewing the financial information, which will be provided to the shareholders and others, the systems of internal controls, which management and the Board of Directors have established, and the audit and compliance process. The Committee strives to provide an open avenue of communication between the Board of Directors, management, the internal auditors, the compliance officers, and the independent accountants. Each of the three Directors who serve on the Audit and Compliance Committee satisfy the definition of independent director under rules established by the National Association of Securities Dealers, Inc. listing standards. The Board of Directors adopted a written charter for the Committee in June, 2000, which is attached to this proxy statement as Exhibit A. The Committee held four meetings in 2000. The Audit and Compliance Committee has reviewed and discussed with management the Corporation's audited consolidated financial statements as of and for the year ended December 31, 2000. The Committee has discussed with Arthur Andersen LLP, the Corporation's independent accountants during calendar year 2000, the matters required to be discussed by Statement of Auditing Standards No. 61, Communications with Audit Committees, as amended, by the Auditing Standards Board of the American Institute of Certified Public Accountants. The Committee received from Arthur Andersen LLP and reviewed the written disclosures and the letter required by Independence Standard No. 1 and has discussed with Arthur Andersen LLP their independence. Arthur Andersen LLP performed services for auditing the Corporation's 2000 annual report and reviewing the Corporation's quarterly reports on Form 10-Q. The fees for such services amounted to $76,500 and the fees for other services, primarily tax related, amounted to $13,300. I-6 Based on the reviews and discussions referred to above, the Audit and Compliance Committee recommended to the Board of Directors that the Corporation's audited consolidated financial statements be included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2000 and be filed with the U. S. Securities and Exchange Commission. Audit and Compliance Committee Willie G. Barker, Jr. Fred A. Blair Fred B. Leggett, Jr. OTHER INFORMATION Comparative Company Performance The following graph compares the Corporation's cumulative total return to its shareholders with the returns of three indexes for the five-year period ended December 31, 2000. The three indexes are the Standard & Poor's 500 Stock Index, the NASDAQ Index, and the Carson Medlin Company's Independent Index, consisting of 23 independent banks located in the states of Florida, Georgia, North Carolina, South Carolina, Tennessee, West Virginia, and Virginia. 1995 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- ---- American National Bankshares Inc. 100 85 114 125 144 118 Independent Bank Index 100 128 193 204 185 191 S&P 500 Index 100 123 164 211 255 232 NASDAQ Index 100 123 151 213 395 238 I-7 Executive Compensation The following tables set forth the annual and long-term compensation awarded to, earned by, or paid to executive officers of the Corporation and the Bank ("Named Executive Officers") during 2000, 1999, and 1998. SUMMARY COMPENSATION TABLE
Long-Term Compensation --------------------------------- Annual Compensation Awards Payouts -------------------------------------- ----------------------- ------- Other Restricted Securities Annual Stock Underlying LTIP All Other Name and Salary (1) Bonus (2) Compensation Awards Options/ Payouts Compensation Principal Position Year ($) ($) ($) ($) SARS(#)(3) ($) ($)(4) ------------------ ---- ---------- --------- ------------ ---------- ---------- ------- ------------ Charles H. Majors 2000 197,477 37,932 0 0 10,000 0 5,100 President & Chief Executive 1999 182,988 37,483 0 0 20,000 0 5,000 Officer of the Corporation and 1998 165,409 34,956 0 0 12,000 0 4,860 the Bank E. Budge Kent, Jr. 2000 110,899 20,895 0 0 0 0 3,240 Senior Vice President of the 1999 109,088 20,834 0 0 5,000 0 3,120 Corporation; Senior Vice President 1998 104,088 19,252 0 0 6,000 0 3,000 and Trust Officer of the Bank T. Allen Liles 2000 100,630 19,349 0 0 0 0 3,000 Senior Vice President, Secretary, 1999 96,276 20,618 0 0 5,000 0 2,862 Treasurer and Chief Financial 1998 91,079 18,318 0 0 6,000 0 0 Officer of the Corporation; Senior Vice President, Cashier and Chief Financial Officer of the Bank Carl T. Yeatts 2000 110,899 22,200 0 0 0 0 3,240 Senior Vice President of the 1999 107,843 21,675 0 0 5,000 0 3,120 Corporation; Senior Vice 1998 103,131 19,252 0 0 6,000 0 3,000 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 2000, 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 on December 31, 2000. Incentive compensation represented payments to full-time officers based on the Corporation attaining certain earnings increase and officers meeting certain strategic goals. The total expense, paid or accrued, for the profit sharing (bonus) plan and incentive compensation payments for the year 2000 amounted to $723,912. (3) The Corporation grants options pursuant to the Corporation's Stock Option Plan approved by the shareholders at the 1997 annual meeting. Options granted prior to July 1, 1999 have been restated to reflect the impact of a 2-for-1 stock split. (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. An employee may defer a portion of his or her salary, not to exceed the lesser of 15% of compensation or $10,500. After one year of service, the Bank will make a matching contribution in the amount of 50% of the first 6% of compensation so deferred. I-8 OPTION GRANTS IN RESPECT OF LAST FISCAL YEAR Potential Realizable Value Number of % of Total at Assumed Annual Securities Options Exercise Rates of Stock Price Underlying Granted to or Base Appreciation for Options Employees in Price Vesting Expiration Optional Term -------------------- Name Granted Fiscal Year ($/Share) Date Date 5% ($) 10% ($) ---- ---------- ----------- --------- ------- ---------- ------ ------- Charles H. Majors 10,000 57.47% 13.38 12-31-00 12-19-10 84,115 213,163 President & Chief Executive Officer of the Corporation and the Bank
AGGREGATE OPTIONS EXERCISED IN 2000 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, 2000 (#) December 31, 2000 ($) (a) Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable ------------ ------------ ----------- ------------- ----------- ------------- Charles H. Majors 0 0 42,200 0 19,475 0 E. Budge Kent, Jr. 0 0 11,200 0 4,163 0 T. Allen Liles 0 0 11,000 0 4,063 0 Carl T. Yeatts 0 0 11,200 0 4,163 0
(a) Value of unexercised in-the-money options is calculated by multiplying the number of unexercised options at December 31, 2000 by the difference in the closing price of the Corporation's common stock reported on December 31, 2000 and the exercise price of the unexercised in-the-money options. Option Repricing No action was taken in 2000 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 2000, was composed of Messrs. Barkhouser, Davenport, and Hudson. Mr. Leggett served as a member of the committee from January 1 until April 25, 2000. None of the members of the Salary Committee were officers or employees of the Corporation or its subsidiaries during 2000 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 2000, 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. I-9 Pension Plan Table The following table illustrates the estimated annual benefits payable to an employee retiring on December 31, 2000 at normal retirement age in the following specified compensation and years of service classifications: 5 Year Years of Service Average Salary 15 20 25 30 35 ------ -- -- -- -- -- $ 50,000 $ 11,203 $ 14,937 $ 18,671 $ 22,406 $ 26,140 75,000 18,515 24,687 30,859 37,031 43,202 100,000 25,828 34,437 43,046 51,656 60,265 125,000 33,140 44,187 55,234 66,281 77,327 150,000 40,453 53,937 67,421 80,906 94,390 175,000 47,765 63,687 79,609 95,531 111,452 200,000 55,078 73,437 91,796 110,156 128,515 225,000 62,390 83,187 103,984 124,781 145,577 250,000 69,703 92,937 116,171 139,406 162,640 275,000 77,015 102,687 128,359 154,031 179,702 As of December 31, 2000, the Named Executive Officers have completed the following years of credited service under the Bank's retirement plan: Charles H. Majors 8 E. Budge Kent, Jr. 36 T. Allen Liles 3 Carl T. Yeatts 36 Retirement Plan. The Bank's retirement plan is a non-contributory defined benefit pension plan which covers salaried and regular hourly 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, 2000, 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 with years of service limited to 35. 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, 2000 was also limited to $170,000 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. 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. I-10 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, 2000, 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 for 10 Years (in $) Vesting ---- ------------------- ------- Charles H. Majors 50,000 7 E. Budge Kent, Jr. 25,000 0 T. Allen Liles 25,000 14 Carl T. Yeatts 25,000 0 Directors' Compensation. In 2000, non-officer directors, except Mr. Davis, received a monthly retainer of $500 and attendance fees of $400 for each Board meeting and Committee meeting attended. The aggregate total amount paid to non-officer directors, excluding Mr. Davis, for the year 2000 was $146,800. 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. 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 2000. 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 2000, the highest aggregate amount of outstanding loans, direct and indirect, to the directors and officers was $17,793,000 or 23% of equity capital and this peak amount occurred on December 31, 2000. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Corporation's executive officers and directors, and persons who own more than 10% of the Common Stock, to file reports of ownership and changes in ownership on Forms 3, 4, and 5 with the SEC and the Nasdaq National Market. Executive officers, directors, and owners of more than 10% of the Common Stock are required by regulation to furnish the Corporation with copies of all Forms 3, 4, and 5 they file. Based solely on the Corporation's review of the copies of such forms it has received and written representations from certain reporting persons who were not required to file a Form 5 for 2000, the Corporation believes that all of its directors and executive officers complied with all Section 16(a) filing requirements applicable to them with respect to transactions during 2000. To the Corporation's knowledge, there were no owners of more than 10% of the common stock. 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 2000. 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. I-11 Shareholder Proposals Under the regulations of the Securities and Exchange Commission, any shareholder desiring to make a proposal to be acted upon at next year's annual meeting of shareholders must present such proposal to the Corporation at its principal office in Danville, Virginia, not later than November 26, 2001, in order for such proposal to be considered for inclusion in the Corporation's proxy statement. In addition to any other applicable requirements, for business to be properly brought before next year's Annual Meeting by a shareholder, even if the proposal is not to be included in the Corporation's proxy statement, the Corporation's bylaws provide that the shareholder must give notice in writing to the Secretary of the Corporation not later than January 27, 2002. As to each such matter, the notice must contain (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name, record address of, and class, series and number of shares beneficially owned by, the shareholder proposing such business and (iii) any material interest of the shareholder in such business. 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, 2001 I-12 Appendix A AMERICAN NATIONAL BANKSHARES INC. AUDIT AND COMPLIANCE COMMITTEE CHARTER Purpose The Audit and Compliance Committee (the "Committee") is a committee of the Board of Directors. Its primary function is to assist the board in fulfilling its oversight responsibilities by reviewing the financial information, which will be provided to the shareholders and others, the systems of internal controls, which Management and the Board of Directors have established, and the audit and compliance process. In doing so, it is the responsibility of the Committee to provide an open avenue of communication between the Board of Directors, Management, the internal auditors, the compliance officers and the independent accountants. Organization 1. The Committee shall be appointed annually by the Board of Directors. 2. The Committee shall consist of at least three members. 3. Only independent directors may be members of the Committee. An independent director is a director who meets the independence and experience requirements of the NASDAQ Stock Market, Inc. 4. At least one member of the Committee shall have a background in financial reporting, accounting or auditing, or other comparable experience or background which results in the individual's financial sophistication, including being or having been a Chief Executive Officer, Chief Financial Officer, or other senior officer with financial oversight responsibilities (however, the lack of any such member shall not invalidate or otherwise affect the actions taken by the Committee). 5. The Committee shall appoint one of the members of the Committee as Chairman. It is the responsibility of the Chairman to schedule and preside at all meetings of the Committee and to insure that the Committee has a written agenda for its meetings. In meeting its responsibilities, the Committee shall: A. General 1. Have the power to conduct or authorize investigations into any matters within the Committee's scope of responsibilities. The Committee shall have unrestricted access to members of Management and relevant information. The Committee may retain independent counsel, accountants or others to assist it in the conduct of any investigation. 2. Meet four times per year or more frequently as circumstances require. 3. Report Committee actions to the Board of Directors with recommendations, as the Committee may deem appropriate. 4. Review and assess annually the Committee's formal charter and recommend to the Board of Directors any needed revisions thereto. 5. Meet at least annually with the independent accountants, the internal auditors and Management in separate sessions to discuss any matters that the Committee believes should be discussed privately with the Committee. 6. Provide for inclusion in the Company's proxy statement or other SEC filings of any report from the Committee required by applicable laws and regulations and stating among other things whether the Committee has: - Reviewed and discussed the audited financial statements with management. - Discussed with the independent auditors the matters required to be discussed by SAS 61. - Received disclosures from the auditors regarding the auditors' independence as required by Independence Standards Board Standard No. I and discussed with the auditors their independence. I-13 - Recommend to the Board of Directors that the audited financial statements be included in the Company's Annual Report on Form 10-K. B. Internal Controls and Risk Assessment 1. Review and evaluate the effectiveness of the Company's process for assessing significant risks or exposures and the steps Management has taken to monitor and control such risks to the Company. 2. Consider and review with Management the internal audit and compliance functions and the independent accountants. 3. Assess the effectiveness of or weaknesses in the Company's internal controls including the status and adequacy of information systems and security. 4. Review any related significant findings and recommendations of the independent accountants, the internal auditors and compliance officers together with Management's responses including the timetable for implementation of recommendations to correct weaknesses in the internal controls. 5. Receive periodic information from the independent accountants regarding the independence of the independent accountants, discuss such information with the independent accountants, and, if so determined by the Committee, recommend that the Board take appropriate actions to satisfy itself of the independent accountants' independence. 6. Instruct the independent accountants to communicate directly to the Committee any serious difficulties or disputes with Management. The independent accountants are responsible to the Committee and, ultimately, to the Board of Directors. C. Internal Audit and Compliance 1. Evaluate the internal audit and compliance processes for establishing the annual internal audit and compliance plans and the appropriate focus on risk. 2. Evaluate the audit and compliance scope and role of internal audit and compliance. 3. Consider and review with Management: - Significant findings and Management's response including the timetable for implementation to correct weaknesses. - Any difficulties encountered in the course of audits and compliance reviews such as restrictions on the scope of work or access to information. - Any changes required in the planned scope of audits and compliance reviews. - The internal audit and compliance budgets. - The evaluation of the audit and compliance staff. D. Compliance with Laws and Regulations 1. Ascertain whether the Company has an effective process for determining risks and exposure from asserted and unasserted litigation and claims from noncompliance with laws and regulations. 2. Review with the Company's general counsel and others, as necessary, any legal, tax, or regulatory matters that may have a material impact on Company operations and the financial statements. 3. Discuss with Management, the internal auditors, the compliance officers and the Company's independent accountants the status and adequacy of management information systems including the significant risks and major controls over such risks. I-14 E. Financial Reporting 1. Insure that the independent accountants review the Company's quarterly financial statements prior to the filing of its Form 10Q. 2. Advise Management, based upon its review and discussion, whether anything has come to the Committee's attention that causes it to believe that the audited financial statements included in the company's Form 10-K contain an untrue statement of material fact or omit to state a necessary material fact. 3. Review with Management and the independent accountants at the completion of the annual examination: - The Company's annual financial statements and related footnotes. - The independent accountants' audit of the financial statements and their report. - Any significant changes required in the independent accountant's audit plan. - Any difficulties or disputes with Management encountered during the audit. - The Company's accounting principles. - Other matters related to conduct, which should be communicated to the Committee under generally accepted auditing standards. F. External Auditor 1. Recommend to the Board of Directors the independent accountants to be selected, approve compensation of the independent accountants and review and, if appropriate, recommend to the Board of Directors the discharge of the independent accountants. 2. Review the scope and approach of the annual audit with the independent accountants. 3. Assess the independent accountant's process for identifying and responding to key audit and internal control risks. G. Compliance with Codes of Ethical Conduct 1. Review and monitor, as appropriate, with the independent accountants the administration of and compliance with, the Company's code of conduct and the Foreign Corrupt Practices Act. While the Committee has the responsibilities and the powers set forth in this Charter, it is not the duty of the Committee to plan or conduct audits or to determine that the Company's financial statements are complete and accurate and are in accordance with generally accepted accounting principles. This is the responsibility of Management and the independent accountants. Nor is it the duty of the Committee to conduct investigations, to resolve disagreements, if any, between Management and the independent accountants or to assure compliance with laws and regulations and the Company's code of conduct. I-15