-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MYY+HLASPWKr1c63otSM4t1cLdbIYP2CmOmxCUsBrIwQdDIN5dmewA72VsfyEdTY TFDbwv+CPynSdnDq+2Gwjg== 0000741516-04-000006.txt : 20040315 0000741516-04-000006.hdr.sgml : 20040315 20040315095104 ACCESSION NUMBER: 0000741516-04-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN NATIONAL BANKSHARES INC CENTRAL INDEX KEY: 0000741516 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541284688 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-12820 FILM NUMBER: 04667864 BUSINESS ADDRESS: STREET 1: 628 MAIN ST CITY: DANVILLE STATE: VA ZIP: 24541 BUSINESS PHONE: 4347925111 MAIL ADDRESS: STREET 1: 628 MAIN STREET STREET 2: P O BOX 191 CITY: DANVILLE STATE: VA ZIP: 24543 10-K 1 annual10k2003.txt 10(K) 2003 AMERICAN NAT'L BANKSHARES INC UNITED STATES 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, 2003 ----------------- 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: 434-792-5111 -------------------------------------- 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 (229.405 of this chapter) 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ X ] No [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant at June 30, 2003 was $117,125,134. The number of shares of the Registrant's Common Stock outstanding on March 10, 2004 was 5,643,679. Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 27, 2004 are incorporated by reference in Part III of this report. 1 CROSS REFERENCE Page ---- PART I ITEM 1 - Business 5 ITEM 2 - Properties 6 ITEM 3 - Legal Proceedings 7 ITEM 4 - Submission of Matters to a Vote of Security Holders 7 PART II ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters 7 ITEM 6 - Selected Financial Data 9 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 10 ITEM 7A - Quantitative and Qualitative Disclosures about Market Risk 13 ITEM 8 - Financial Statements and Supplementary Data Quarterly Financial Results for 2003 and 2002 30 Management's Report on Financial Statements 31 Reports of Independent Public Accountants 32 Consolidated Balance Sheets at December 31, 2003 and 2002 34 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2003 35 Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three-year period ended December 31, 2003 36 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2003 37 Notes to Consolidated Financial Statements 38 ITEM 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure * ITEM 9A - Controls and Procedures 29 PART III ITEM 10 - Directors and Executive Officers of the Registrant * ITEM 11 - Executive Compensation * ITEM 12 - Security Ownership of Certain Beneficial Owners and Management * ITEM 13 - Certain Relationships and Related Transactions * ITEM 14 - Principal Accounting Fees and Services * PART IV ITEM 15 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements (See Item 8 for reference)
(a)(3) Exhibits 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 April 22, 2003 Exhibit 3.2 on Form 8-K filed April 23, 2003 10.1 Agreement between American National Bank and Trust Exhibit 10.3 on Form 10-K Company and E. Budge Kent, Jr. dated June 12, 1997 filed March 27, 1998 10.2 American National Bankshares Inc. Stock Option Plan dated Exhibit 4.3 on form S-8 August 19, 1997 filed September 17, 1997 10.3 Agreement between American National Bank and Trust Exhibit 4 on Form 10-K Company and H. Dan Davis dated March 14, 1996 filed September 27, 1995 10.4 Agreement between American National Bankshares Inc., Exhibit 10.5 on Form 10-K American National Bank and Trust Company and filed March 25, 2002 Charles H. Majors dated December 18, 2001
2 10.5 Agreement between American National Bankshares Inc., Exhibit 10.6 on Form 10-K American National Bank and Trust Company and filed March 25, 2002 E. Budge Kent, Jr. dated December 18, 2001 10.6 Agreement between American National Bankshares Inc., Exhibit 10.7 on Form 10-K American National Bank and Trust Company and filed March 25, 2002 Dabney T. P. Gilliam, Jr. dated December 18, 2001 10.7 Agreement between American National Bankshares Inc., Exhibit 10.8 on Form 10-K American National Bank and Trust Company and filed March 25, 2002 Jeffrey V. Haley dated December 18, 2001 10.8 Agreement between American National Bankshares Inc., Exhibit 10.9 on Form 10-K American National Bank and Trust Company and filed March 25, 2002 Brad E. Schwartz dated December 18, 2001 10.9 Agreement between American National Bank and Trust Exhibit 10.10 on Form 10-K Company and Charles H. Majors dated January 1, 2002 filed March 25, 2002 11. Refer to EPS calculation in the Notes to Financial Statements Filed herewith 31.1 Section 302 Certification of Charles H. Majors, President and CEO Filed herewith 31.2 Section 302 Certification of Brad E. Schwartz, Senior Vice President and Secretary-Treasurer (CFO) Filed herewith 32.1 Section 906 Certification of Charles H. Majors, President and CEO Filed herewith 32.2 Section 906 Certification of Brad E. Schwartz, Senior Vice President and Secretary-Treasurer (CFO) Filed herewith 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 during the fourth quarter of 2003. - ------------------------------------ * The information required by Item 9 is incorporated herein by reference to the information that appears under the heading "Independent Public Accountants" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. The information required by Item 10 is incorporated herein by reference to the information that appears under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance", "Report of the Audit and Compliance Committee", and "Code of Conduct" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. The information required by Item 11 is incorporated herein by reference to the information that appears under the headings "Comparative Stock Performance", "Report of Human Resources and Compensation Committee on Executive Compensation", and "Executive Compensation" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. 3 The information required by Item 12 is incorporated herein by reference to the information that appears under the headings "Security Ownership" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. The information required by Item 13 is incorporated herein by reference to the information that appears under the heading "Related Party Transactions" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. The information required by Item 14 is incorporated herein by reference to the information that appears under the heading "Independent Public Accountants" in the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. 4 PART I ITEM 1 - BUSINESS American National Bankshares Inc. (the "Corporation") is a one-bank holding company 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, 2003 the Corporation employed 208 full-time equivalent persons, and relations with the employees is considered good. American National Bank and Trust Company The Bank has been operating as a commercial bank headquartered in Danville, Virginia since its organization in 1909. The Bank has expanded through internal growth and through mergers and acquisitions. In 1996 the Corporation completed the merger of Mutual Savings Bank, F.S.B. ("Mutual") with $84,718,000 in assets into the Bank. The Mutual merger was accounted for as a pooling of interests. The Bank completed two retail office purchases in 1995 and 1996 that added $57,700,000 in deposits and $6,925,000 in loans. The two acquisitions were accounted for as purchases and related core deposit intangible assets of $4,504,000 are being amortized over ten years. The Bank opened retail banking offices in Chatham and Martinsville, Virginia, closed a limited service retail office in Danville during 1999 and opened a branch office in South Boston, Virginia during 2000. In March 2002, the Bank opened their fourteenth retail banking office in southern Henry County, Virginia. The Bank has two wholly owned subsidiaries. ANB Mortgage Corp. originates and sells secondary-market mortgage loans. ANB Services Corporation, operating as ANB Investor Services and ANB Insurance Services, offers non-deposit investment products such as mutual funds and a full-line of insurance products through an affiliation with Bankers Insurance LLC. The operations of the Bank are conducted at fourteen offices located throughout the Bank's trade area, which includes the Cities of Danville and Martinsville, Pittsylvania, Henry, and Halifax Counties in Virginia, 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, southern Henry County, and South Boston, Virginia and Yanceyville, North Carolina. The Bank also has twenty 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 consumer demand and time deposit accounts, commercial and consumer loans and trust services. Competition and Markets The Bank's primary service area is generally defined as 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. Vigorous competition exists in this service area. The Bank competes not only with other commercial banks but also with diversified financial institutions, credit unions, money market and mutual funds, mortgage, insurance, and finance companies. American National Bank and Trust Company has the largest deposit market share in both the City of Danville and in Pittsylvania County. The Bank's market areas, primarily in an area known collectively as Southside Virginia, are heavily dependent on manufacturing and are under a great deal of economic pressure. The region has traditionally been the home to textile, furniture, and other manufacturing as well as serving as a hub for tobacco production and distribution. While diversification has occurred in manufacturing in recent years, a textile firm and a tire manufacturing plant in Danville and several large furniture manufacturers in the Henry County/City of Martinsville area employ a significant workforce. Danville's largest employer, Dan River Inc., a textile manufacturer, continues to experience financial hardship. Increased global competition has negatively impacted the textile and furniture industries in the area with several plants closing due to competitive pressures or due to the relocation of some operations to foreign countries. Unemployment as a percent of the workforce remains greater than that of most other regions of Virginia. The area is also known as a center of commerce for the tobacco industry, and the major tobacco companies continue to operate leaf collection and processing facilities in the region. While certain industries have declined and reduced their workforces, the region has been proactive in the area of economic development and attracted some new industry, as well as creating job growth in the education, government, and service sectors. Supervision and Regulation The Corporation is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including the filing of annual, quarterly, and other reports with the Securities and Exchange Commission (the "SEC"). As an Exchange Act reporting company, the Corporation is directly affected by the Sarbannes-Oxley Act of 2002 (the "SOX"), which is aimed at improving corporate governance and reporting procedures. The Corporation is 5 complying with new SEC and other rules and regulations implemented pursuant to SOX and intends to comply with any applicable rules and regulations implemented in the future. The Corporation's common stock is listed on the Nasdaq National market, and the Corporation must comply with the listing requirements and rules of the exchange. The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956 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 Office of the Comptroller of the Currency (the "OCC"), the Federal Reserve Board and the Federal Deposit Insurance Corporation, which insures the Bank's deposits. 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. The primary supervisory authority of the Bank is the Comptroller of the Currency, which regularly examines such areas as reserves, loans, investments, regulatory compliance, information systems, 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 OCC periodic reports containing a full and accurate statement of its affairs. Government Monetary Policies and Economic Controls The policies of the Federal Reserve Board have a direct effect on loan and deposit growth and the interest rates charged and paid thereon. While these policies can materially affect the revenues and income of commercial banks, the impact of such conditions and policies upon the future business and earnings of the Bank cannot accurately be predicted. Foreign Operations The Corporation does not engage in any foreign operations. Internet Access to Corporate Documents The Corporation provides access to their SEC filings through the corporate Web site at www.amnb.com. After accessing the Web site, the filings are available upon selecting the American National Bankshares Inc. icon. Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. Executive Officers This information is incorporated by reference to the Registrant's Proxy Statement for the April 2004 Annual Meeting of Shareholders. ITEM 2 - PROPERTIES The following describes the location and general character of the principal offices and other materially important physical properties of the Corporation. As of December 31, 2003, the Bank maintained fourteen full service retail offices. Seven are located within the City of Danville, with others located at Gretna, Chatham, Martinsville, southern Henry County, Collinsville, and South Boston, Virginia and Yanceyville, North Carolina. The Bank's Trust and Investment Division operates two offices, ANB Mortgage Corp. has two offices, and ANB Investor Services/ANB Insurance Services has one office. The principal executive offices of the Corporation, as well as the principal executive offices of the Bank, are located at 628 Main Street in the business district of Danville, Virginia. This building, owned by the Bank, was originally constructed in 1973 and has three floors totaling 27,000 square feet. The Corporation owns a building located at 103 Tower Drive in Danville, Virginia. This three-story facility totaling 15,000 square feet was constructed in 1985, and serves as a retail banking office, the headquarters and office of ANB Mortgage Corp., as well as housing operations and administrative staff of the Bank. 6 The Corporation owns an office building on 203 Ridge Street, Danville, Virginia, which is currently leased to Bankers Insurance, LLC. The Bank has a minority ownership interest in Bankers Insurance, LLC. The Bank leases a three building office complex in Martinsville, Virginia, that houses a retail banking office, a trust and investment services office, and an office for ANB Mortgage Corp. This office serves as the headquarters for the Martinsville/Henry County market. The Bank also leases the retail banking offices in South Boston, Southern Henry County, and on West Main Street in Danville, Virginia. The Southern Henry County location is a ground lease, and the Bank owns the building. Total lease payments in 2003 for these facilities, as well as for ATM leases at non-retail office locations, were $126,000. The Bank owns eight other retail office locations for a total of ten owned retail office locations. There are no mortgages or liens against any of the properties owned by the Bank or the Corporation. The Bank operates twenty Automated Teller Machines ("ATMs") on owned or leased facilities. There were no directors or officers with any ownership interest in any leased facility of the Bank or the Corporation. ITEM 3 - Legal Proceedings There are no material pending legal proceedings to which the Corporation is a party or to which the property of the Corporation is subject. ITEM 4 - Submission of Matters to a Vote of Security Holders No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Corporation through a solicitation of proxies or otherwise. PART II 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 year end 2003 the Corporation had 1,345 shareholders of record. The tables below present the high and low closing 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 2003 and 2002. Market Price of the Corporation's Common Stock Nasdaq closing price Dividends -------------------- declared 2003 Low High per share - ----------- ------- ------ --------- 4th quarter $ 24.99 $ 27.23 $ .19 3rd quarter $ 24.77 $ 28.11 $ .19 2nd quarter $ 22.87 $ 25.96 $ .19 1st quarter $ 24.30 $ 27.06 $ .18 ------ $ .75 ====== 2002 Low High per share - ----------- ------- ------- --------- 4th quarter $ 25.80 $ 27.24 $ .18 3rd quarter $ 25.81 $ 29.00 $ .18 2nd quarter $ 19.25 $ 27.39 $ .18 1st quarter $ 18.05 $ 20.32 $ .17 ------ $ .71 ====== 7 Stock Option Plan The Corporation maintains a stock option plan (the "Plan") that is designed to attract and retain qualified personnel in key positions, provide employees with a proprietary interest in the Corporation as an incentive to contribute to the success of the Corporation and the Bank and reward employees for outstanding performance and the attainment of targeted goals. The Stock Option Plan provides for the grant of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code of 1986 ("incentive stock options"), as well as non-qualified stock options. The Plan was approved by the Shareholders at the April 1997 Annual Meeting, and is administered by a committee of the Board of Directors of the Corporation, each member of which is a "non-employee director" as defined in Rule 16b-3 under the Securities Exchange Act of 1934. Unless sooner terminated, the Plan is in effect until December 31, 2006. Under the Plan, the committee determines which employees will be granted options, whether such options will be incentive or non-qualified options, the number of shares subject to each option, whether such options may be exercised by delivering other shares of common stock and when such options become exercisable. In general, the per share exercise price of an incentive stock option must be at least equal to the fair market value of a share of common stock on the date the option is granted Stock options shall become vested and exercisable in the manner specified by the committee. In general, each stock option or portion thereof shall be exercisable at any time on or after it vests and is exercisable until ten years after its date of grant
Year Ended December 31, 2003 ------------------------------------------------------------------------ Number of Shares Weighted-Average Number of Shares to be Issued Upon Per Share Exercise Remaining Available Exercise Price of for Future Issuance of Outstanding Outstanding Options Under Options Stock Option Plan ----------------- ------------------- ------------------- Equity compensation plans approved by shareholders 224,037 $18.77 54,544 Equity compensation plans not approved by shareholders - - - ------- ------ ------ Total 224,037 $18.77 54,544 ======= ====== ======
8 ITEM 6 - Summary of Selected Consolidated Financial Data (in thousands, except per share amounts) American National Bankshares Inc. & Subsidiary
2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- Operations Information: Interest income: Interest on deposits in other banks.......................$ 110 $ 248 $ 385 $ 179 $ 273 Securities................................................ 6,840 7,737 9,218 10,127 9,467 Loans..................................................... 25,228 27,150 30,217 28,300 23,959 -------- -------- -------- -------- -------- Total interest income................................... 32,178 35,135 39,820 38,606 33,699 Interest expense............................................ 9,391 12,310 17,502 17,343 14,736 -------- -------- -------- -------- -------- Net interest income......................................... 22,787 22,825 22,318 21,263 18,963 Provision for loan losses................................... 920 873 1,015 1,020 670 Non-interest income......................................... 6,671 5,712 5,668 4,771 4,493 Non-interest expense........................................ 15,111 14,285 13,614 12,923 11,542 -------- -------- -------- -------- -------- Income before income taxes.................................. 13,427 13,379 13,357 12,091 11,244 Income taxes................................................ 3,914 3,918 3,942 3,415 3,320 -------- -------- -------- -------- -------- Net income..................................................$ 9,513 $ 9,461 $ 9,415 $ 8,676 $ 7,924 ======== ======== ======== ======== ======== Balance Sheet Information: Securities..................................................$207,479 $163,824 $156,791 $162,929 $166,272 Net loans................................................... 400,953 400,781 370,006 334,611 289,386 Total deposits.............................................. 501,688 473,562 464,012 426,588 385,558 Shareholders' equity........................................ 71,931 70,736 65,397 63,338 56,719 Total assets................................................ 644,302 605,859 572,887 541,389 491,391 Per Share Information:* Earnings - basic............................................$ 1.67 $ 1.63 $ 1.58 $ 1.42 $ 1.30 Earnings - diluted.......................................... 1.65 1.62 1.58 1.42 1.30 Dividends................................................... .75 .71 .66 .585 .525 Book value.................................................. 12.71 12.24 11.23 10.45 9.29 Ratios: Return on average assets.................................... 1.52% 1.63% 1.69% 1.70% 1.68% Return on average shareholders' equity...................... 13.52% 13.97% 14.49% 14.74% 14.17% Average shareholder's equity/average assets................. 11.27% 11.64% 11.68% 11.54% 11.89% Total risk-based capital/assets............................. 15.99% 15.63% 15.56% 17.09% 17.79% Dividend payout ratio....................................... 44.90% 43.52% 41.68% 41.07% 40.44% Net charge-offs to average net loans........................ .30% .15% .12% .13% .13% Allowance for loan losses to period-end loans, net of unearned income............................. 1.30% 1.38% 1.42% 1.40% 1.41% * 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 shareholders July 15, 1999, with a record date of July 1, 1999.
9 AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARY ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The purpose of this discussion is to focus on important factors affecting the Corporation's financial condition and results of operations. The discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes to assist in the evaluation of the Corporation's 2003 performance. ANALYSIS OF OPERATING RESULTS NET INCOME The Corporation reported record profitability during 2003. Net income for the year ended December 31, 2003 was $9,513,000, an increase of 0.55% over the $9,461,000 earned during the same period of 2002. On a basic per share basis, net earnings totaled $1.67 and on a diluted per share basis earnings totaled $1.65 for the year ended December 31, 2003. For the year ended December 31, 2002, basic earnings per share were $1.63 and diluted earnings per share were $1.62. Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on shareholders' equity (net income as a percentage of average common shareholders' equity). The Corporation's returns on average assets were 1.52%, 1.63%, and 1.69% for the years ended December 31, 2003, 2002 and 2001, respectively. The returns on average shareholders' equity were 13.52%, 13.97%, and 14.49% for the last three years. The Corporation's moderate growth in earnings was due to several factors. Net interest income after provision for loan losses declined $86,000, or 0.38%, for 2003 compared to the same period in 2002 due to the lack of year-over-year loan growth, an increase in the allowance for loan losses, and a continued decline in the net interest margin. Non-interest income grew by $960,000, or 16.8%, and was driven by growth in deposit service charges and overdraft/NSF fees, mortgage banking income, and other fees and commissions. Unfortunately, the overall increase in revenue was mostly offset by an increase in non-interest expense of $826,000, or 5.8%. The net effect was an increase in net income of $52,000. NET INTEREST INCOME Net interest income, the Corporation's primary source of revenue, is the excess of interest income over interest expense. Net interest income is influenced by a number of factors, including the volume of interest-earning assets and interest-bearing liabilities, the mix of interest-earning assets and interest-bearing liabilities, the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets. 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. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the "FTE" adjustment) and the cost of the supporting funds is measured by the net interest margin. The FTE-adjusted net interest margin is the primary measure used in evaluating the effectiveness of the management of earning assets and the liabilities funding those assets. The FTE-adjusted net interest margin was 3.98% in 2003, 4.28% in 2002, and 4.39% in 2001. The thirty basis point (0.30%) decrease in net yield during 2003 was primarily the result of U.S. monetary policy that kept rates at historic lows during the year. During 2003, the Federal Reserve decreased the target federal funds rate in June by 0.25%, for a total three year reduction of 5.50%. The continued low target federal funds rate and the related effect on the prime lending rate and U.S. Treasury security rates had a negative impact on net interest income over the past three years. The Wall Street Journal prime rate fell from 4.25% at January 1, 2003 to 4.00% at December 31, 2003, compared to 9.50% at December 31, 2000. Almost half of the loan portfolio is tied to the Wall Street Journal prime rate, with 70.5% of all loans repricing due to maturity or contractual repricing (to the prime rate or a U.S. Treasury index rate) during 2004. While the Corporation's balance sheet is technically liability-sensitive, management feels many of the funding costs are at or very close to market floors, and through the year it remained increasingly difficult to reduce funding costs at the same pace with the customer- or market-driven reductions in asset yields. The resultant decrease in interest income from the lower yields 10 on earning assets exceeded the decrease in interest expense from lower costs of interest-bearing liabilities. The mix of earning assets and liabilities also affects the net interest margin. While the Corporation continues to grow funding liabilities in the lower cost areas of demand deposits, savings accounts, and repurchase agreements, the lack of loan growth forced growth of the investment securities portfolio. The investment securities portfolio earns a lower rate of interest typically than the loan portfolio, and therefore when investment securities grow faster than loans, the overall yield declines. Because the funding rates do not typically move upward to the full extent of the asset indexes, and due to the heavy concentration of earning assets repricing in 2004, Management considers the Corporation's balance sheet to be asset-sensitive. Table 1 demonstrates fluctuations in net interest income and the related yields for the years 2003, 2002, and 2001. Table 1 - Net Interest Income Analysis 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 ------------------------------ ------------------------------ --------------------------- 2003 2002 2001 2003 2002 2001 2003 2002 2001 -------- -------- -------- -------- -------- -------- ------- ------- ------- Loans: Commercial $214,242 $174,172 $139,094 $ 11,966 $ 11,337 $ 11,188 5.59% 6.51% 8.04% Mortgage 177,423 183,297 179,682 10,574 12,383 14,622 5.96 6.76 8.14 Consumer 27,205 33,925 43,609 2,790 3,555 4,541 10.26 10.48 10.41 -------- -------- -------- -------- -------- -------- ------- ------- ------- Total loans 418,870 391,394 362,385 25,330 27,275 30,351 6.05 6.97 8.38 -------- -------- -------- -------- -------- -------- ------- ------- ------- Securities: Federal agencies 71,153 43,063 42,698 2,365 1,942 2,709 3.32 4.51 6.34 Mortgage-backed 30,745 40,055 43,628 1,316 2,352 2,723 4.28 5.87 6.24 State and municipal 43,993 39,173 39,208 2,844 2,667 2,677 6.46 6.81 6.83 Other securities 22,696 26,962 30,947 1,247 1,629 1,959 5.49 6.04 6.33 -------- -------- -------- -------- -------- -------- ------- ------- ------- Total securities 168,587 149,253 156,481 7,772 8,590 10,068 4.61 5.76 6.43 -------- -------- -------- -------- -------- -------- ------- ------- ------- Deposits in other banks 11,236 15,792 11,726 110 248 385 .98 1.57 3.28 -------- -------- -------- -------- -------- -------- ------- ------- ------- Total interest-earning assets 598,693 556,439 530,592 33,212 36,113 40,804 5.55 6.49 7.69 -------- -------- -------- ------- ------- ------- Other non-earning assets 25,918 25,459 25,841 -------- -------- -------- Total assets $624,611 $581,898 $556,433 ======== ======== ======== Deposits: Demand $ 63,858 $ 59,852 $ 56,419 225 417 495 .35 .70 .88 Money market 47,293 42,369 41,225 478 775 1,318 1.01 1.83 3.20 Savings 80,876 70,073 62,792 713 1,049 1,177 .88 1.50 1.87 Time 230,070 229,074 229,050 6,500 8,607 12,617 2.83 3.76 5.51 -------- -------- -------- -------- -------- -------- ------- ------- ------- Total deposits 422,097 401,368 389,486 7,916 10,848 15,607 1.88 2.70 4.01 Repurchase agreements 40,917 34,183 29,814 496 634 1,088 1.21 1.85 3.65 Other borrowings 21,578 17,274 15,491 979 828 807 4.54 4.79 5.21 -------- -------- -------- -------- -------- -------- ------- ------- ------- Total interest-bearing liabilities 484,592 452,825 434,791 9,391 12,310 17,502 1.94 2.72 4.03 -------- -------- -------- -------- -------- -------- ------- ------- ------- Demand deposits 66,300 58,075 52,719 Other liabilities 3,352 3,289 3,941 Shareholders' equity 70,367 67,709 64,982 -------- -------- -------- Total liabilities and Shareholders' equity $624,611 $581,898 $556,433 ======== ======== ======== Interest rate spread 3.61% 3.77% 3.66% ======= ======= ======= Net interest margin 3.98% 4.28% 4.39% ======= ======= ======= Reconcilement to GAPP Net interest income tax equivalent 23,821 23,803 23,302 Less: Taxable equivalent adjustment 1,034 978 984 -------- -------- -------- $ 22,787 $ 22,825 $ 22,318 ======== ======== ========
11 The growth in the volume of loans throughout the year could not offset the decline due to rates, with the tax-equivalent interest income on loans declining by $1,945,000. This was a much smaller decline than the decline that occurred between 2002 and 2001, when the decline was $3,076,000. In 2003 the mortgage loan category accounted for the majority of the net decrease, which was due to the refinancing of existing loans to lower rates, adding new loans at lower market rates, and losing variable rate mortgage loans to the fixed-rate secondary market. Had the prime rate and U.S. Treasury rates remained flat or risen in 2003 to more historically normalized levels, interest income on loans would have been much greater. The growth in the volume of investment securities also could not offset the decline due to rates, with the tax-equivalent interest income on investment securities declining by $818,000. The primary driver of the decline in income was mortgage-backed securities, which declined in volume due to rapid payoffs of the underlying mortgages during the first three quarters of 2003, combined with new volume being added at the current low market rates. Table 2 presents the dollar amount of changes in interest income and interest expense, and distinguishes between the changes related to increases or decreases in average outstanding balances of interest-earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Total interest expense decreased by a net amount of $2,919,000 in 2003, with a decrease of $3,514,000 due to lower rate funding costs in all categories with volume primarily in the savings, repurchase agreements, and other borrowings categories accounting for most of the $595,000 increase in expense due to volume. Time deposits led the decline in interest expense as a majority of these accounts re-priced during the year. Table 2 - 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):
2003 vs. 2002 2002 vs. 2001 ------------------------------------ ----------------------------------- Change Change Interest Attributable to Interest Attributable to Increase ---------------------- Increase ---------------------- (Decrease) Rate Volume (Decrease) Rate Volume ---------- --------- --------- ---------- --------- --------- Interest income Loans: Commercial $ 629 $ (1,750) $ 2,379 $ 149 $ (2,366) $ 2,515 Mortgage (1,809) (1,422) (387) (2,239) (2,528) 289 Consumer (765) (74) (691) (986) 29 (1,015) ---------- --------- ---------- ---------- --------- --------- Total loans (1,945) (3,246) 1,301 (3,076) (4,865) 1,789 ---------- --------- ---------- ---------- --------- --------- Securities: Federal agencies 423 (606) 1,029 (767) (790) 23 Mortgage-backed (1,036) (558) (478) (371) (156) (215) State and municipal 177 (139) 316 (10) (8) (2) Other securities (382) (139) (243) (330) (86) (244) ---------- --------- ---------- ---------- --------- --------- Total securities (818) (1,442) 624 (1,478) (1,040) (438) ---------- --------- ---------- ---------- --------- --------- Deposits in other banks (138) (78) (60) (137) (243) 106 ---------- --------- ---------- ---------- --------- --------- Total interest income (2,901) (4,766) 1,865 (4,691) (6,148) 1,457 ---------- --------- ---------- ---------- --------- --------- Interest expense Deposits: Demand (192) (218) 26 (78) (107) 29 Money market (297) (379) 82 (543) (579) 36 Savings (336) (480) 144 (128) (254) 126 Time (2,107) (2,144) 37 (4,010) (4,011) 1 ---------- --------- ---------- ---------- --------- --------- Total deposits (2,932) (3,221) 289 (4,759) (4,951) 192 Repurchase agreements (138) (247) 109 (454) (595) 141 Other borrowings 151 (46) 197 21 (68) 89 ---------- --------- ---------- ---------- --------- --------- Total interest expense (2,919) (3,514) 595 (5,192) (5,614) 422 ---------- --------- ---------- ---------- --------- --------- Net interest income $ 18 $ (1,252) $ 1,270 $ 501 $ (534) $ 1,035 ========== ========= ========== ========== ========= =========
12 MARKET RISK MANAGEMENT Management spent a great deal of time focusing on the management of the balance sheet in 2003, as rates hit lows not seen since the 1950's. As the holding company for a commercial bank, the Corporation's primary component of market risk is interest rate volatility. The Corporation's primary objectives for managing interest rate volatility 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 composed of executive officers and other selected officers, is responsible for: o Monitoring corporate financial performance; o Meeting liquidity requirements; o Establishing interest rate parameters, indices, and terms for loan and deposit products; o Assessing and evaluating the competitive rate environment; o Reviewing and approving investment portfolio transactions under established policy guidelines; o Monitoring and measuring 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, and 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, simulation analysis is 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 no changes in balance sheet mix. The interest rate sensitivity analysis in Table 3 reflects the Corporation's assets and liabilities on December 31, 2003 that will either be repriced in accordance with market rates, mature or are estimated to mature early or prepay within the periods indicated (in thousands): 13 Table 3 - Interest Rate Sensitivity Analysis
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 $ 1,652 $ - $ - $ - $ - $ 1,652 Securities 35,433 50,705 56,872 18,059 46,410 207,479 Loans 118,812 167,449 113,789 5,376 819 406,245 ----------- ----------- ---------- ----------- --------- --------- Total interest sensitive assets 155,897 218,154 170,661 23,435 47,229 615,376 ----------- ----------- ---------- ----------- --------- --------- Interest sensitive liabilities: NOW and savings deposits 152,084 - - - - 152,084 Money market deposits 59,251 - - - - 59,251 Time deposits 41,910 102,424 53,604 21,295 93 219,326 Repurchase agreements and other borrowings 48,535 1,500 4,000 9,000 5,000 68,035 ----------- ----------- ---------- ----------- --------- --------- Total interest sensitive liabilities 301,780 103,924 57,604 30,295 5,093 498,696 ----------- ----------- ---------- ----------- --------- --------- Interest sensitivity gap $ (145,883) $ 114,230 $ 113,057 $ (6,860) $ 42,136 $ 116,680 =========== =========== ========== =========== ========= ========= Cumulative interest sensitivity gap $ (145,883) $ (31,653) $ 81,404 $ 74,544 $ 116,680 =========== =========== ========== =========== ========= Percentage cumulative gap to total interest sensitive assets (23.7)% (5.1)% 13.2 % 12.1 % 19.0 %
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 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. Table 4 shows the estimated impact of changes in interest rates up and down 1%, 2% and 3% on net interest income and on MVE as of December 31, 2003 (in thousands). The projected changes in net interest income and MVE to changes in interest rates at December 31, 2003, were within compliance of established policy guidelines, except for a decrease in current rates by 300 basis points on December 31, 2003, or three percent. Management does not consider this scenario possible, given the current historically low level of interest rates. These projected changes are based on numerous assumptions of growth and changes in the mix of assets or liabilities. Net interest income for the next twelve months is projected to increase when interest rates are higher than current rates and decrease when interest rates are lower than current rates. The negative one year cumulative interest sensitivity gap of $31,653,000 on December 31, 2003 has declined from the negative one year cumulative interest sensitivity gap of $35,047,000 on December 31, 2002, and the negative one year cumulative interest sensitivity gap of $71,761,000 on December 31, 2001. This decline indicates a more balanced repricing gap position. This negative gap 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 affect liabilities do not change with the same magnitude over the same period of time as changes in the prime rate or other indices that reprice loans and investment securities. 14 Table 4 - Change in Net Interest Income and Market Value of Portfolio Equity Changes in Changes in Market Value Change in Net Interest Income (1) of Portfolio Equity (2) Interest ----------------------- ------------------------ Rates Amount Percent Amount Percent - --------- -------- --------- -------- --------- Up 3% $ 2,586 10.99 % $ (4,514) (4.77)% Up 2% 1,571 6.67 (2,948) (3.11) Up 1% 1,111 4.72 (1,424) (1.50) Down 1% (842) (3.58) 1,273 1.34 Down 2% (2,257) (9.59) 2,264 2.39 Down 3% (3,686) (15.66) 2,262 2.39 (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. While the Corporation cannot predict future interest rates or their exact effects on MVE or net interest income, the 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. Also, the methodology used estimates of various rates of withdrawal for money market deposits, savings, and checking accounts, which may vary significantly from actual experience. Based on the modeling system used by the Corporation to measure the impact of rate changes to net interest income, an increase of just 1% to the federal funds rate, and the resulting changes to the Wall Street Journal prime rate and expected changes to the U.S. Treasury interest rate curve would add, for a full twelve month period, $1,111,000 to pre-tax net interest income. Should the same rates decrease by 1%, pre-tax net interest income would decline by $842,000 for a twelve month period. Management continues to believe interest rates are at or near a floor and anticipates the federal funds and other market interest rates to rise either late in 2004 or early in 2005. The Corporation is also subject to prepayment risk, particularly in falling interest rate environments or in environments where the slope of the yield curve is relatively flat or negative. Such changes in the interest rate environment can cause substantial changes in the level of prepayments of loans, which may also affect the Corporation's interest rate sensitivity gap position. Additionally, credit risk may increase if an interest rate increase adversely affects the ability of many borrowers to service their debt. NON-INTEREST INCOME Non-interest income totaled $6,671,000 in 2003 compared with $5,712,000 in 2002 and $5,668,000 in 2001. This was an increase of 16.8% for 2003, compared to only a 0.8% increase for 2002. The major components of non-interest income are from trust and investment services, service charges on deposit accounts, securities gains or losses, other fees and insurance commissions, mortgage banking income and other income. The Corporation had two important initiatives in 2003 that drove the increase in non-interest income. Service charges on deposit accounts increased primarily due to the introduction of an overdraft/NSF program that allows retail customers to overdraw their accounts without the negative stigma associated with an overdraft. This program was initiated in April of 2003 with broad customer acceptance. ANB Mortgage Corp. also expanded their origination staff during 2003 to take advantage of the low interest rate environment and refinancing boom. The rate environment had a positive impact on loan volume closed, which drove revenue growth in this area. 15 While income from the trust and investment services division continues to be the number one category of non-interest income, there was nominal growth in 2003 as the market values of assets slowly recovered from their lows of the previous two years. Fees from the management of trusts, estates and asset management accounts totaled $2,523,000 in 2003, a slight increase from $2,516,000 of 2002. Trust and investment services fees in 2002 decreased 2.1% from 2001. Declines in the equity markets placed pressure on the growth in fee income in 2003 and 2002. The Bank's trust and investment services division managed assets with an approximate market value of $338,000,000 at December 31, 2003 and $297,630,000 at December 31, 2002, compared to $334,942,000 at year end 2001. Only in the fourth quarter of 2003 did asset values grow back to the levels of year-end 2001. Service charges on deposit accounts were $2,163,000 in 2003, an increase of $457,000, or 26.8%, from 2002. Service charges during 2002 totaled $1,706,000, which was a 23.2% increase from 2001. As noted above, the main reason for the increase was the introduction of an overdraft/NSF program. Changes in the fee structure and additional accounts obtained contributed to the remaining portion of the growth in income in 2003, and to all the increase in income in 2002. Service charge pricing on deposit accounts is typically changed annually to reflect current costs and competition. Other fees and commissions were $914,000 in 2003, $816,000 in 2002, and $749,000 in 2001. Non-customer ATM fees, debit and credit card fees, safe deposit box rent, brokerage investment commissions and insurance commissions represent the majority of the income in this category. The increase in 2003 resulted primarily from additional earnings at ANB Investor Services, increases in interchange income from debit card transactions, and growth in non-customer ATM transaction fees. Mortgage banking income represents fees from originating and selling residential mortgage loans through ANB Mortgage Corp., a wholly owned subsidiary of the Bank, which began operations in December 1996. Mortgage banking income was $571,000 in 2003, $361,000 in 2002, and $365,000 in 2001. Both loan volume and the yield per loan were higher in 2003, contributing to the increase in revenue. Securities gains of $115,000 in 2003 were up from $39,000 in 2002, but down considerably from the $367,000 in net gains recorded in 2001. In 2003 Management sold certain securities that either no longer met the investment strategy of the Corporation or were considered a positive swap of like-kind securities at a slightly longer maturity. A portion of the gains were due to pre-maturity calls at a premium or at par. The large volume of gains in 2001 was primarily the result of pre-maturity calls of U.S. government agency investment securities during a period of rapid interest rate decline. Other income was $386,000 in 2003, an increase of 41.1% from the $273,000 recorded in 2002, which in turn was an increase of 17.8% from $232,000 recorded in 2001. Check order income and dividends from an equity interest in a title agency account for the majority of other income. The mortgage refinance boom of 2003 was the primary reason the dividend returns on the Corporation's investment in the title agency increased. Also in other income were funds from the highway department to compensate the Corporation for encroachment at one of the Danville retail banking offices. NON-INTEREST EXPENSE Non-interest expense for 2003 was $15,111,000, a 5.8% increase from the $14,285,000 reported in 2002, which in turn increased 4.9%, over $13,614,000 in 2001. Non-interest expense includes salaries, pension, health insurance and other employee benefits, occupancy and equipment expense, core deposit intangible amortization and other expenses. The majority of the increase in this area was due to additional pension expense and healthcare insurance premium increases. Salaries of $6,844,000 in 2003 increased $324,000, or 5.0%, over 2002 due to additional staffing as well as salary increases for existing staff. Salaries of $6,520,000 in 2002 increased only $136,000, and were held to only a 2.1% increase from 2001 through more efficient staffing. Pension and other employee benefits totaled $1,814,000 in 2003, an increase of 23.3% from the $1,471,000 recorded in 2002, which in turn was an increase of 5.8% from the $1,391,000 reported in 2001. The increases in both years are due to two major items that were outside of the control of management: increased premiums on medical insurance and higher pension costs. Other benefit cost increases could be traced to additional staffing or plan participation as social security taxes, Medicare taxes, and 401k contribution expenses increased. Pension expense in 2003 was $531,000, compared to $296,000 in 2002 and $209,000 in 2001. A large number of withdrawals in 2002 related to retirement payouts and a lower interest rate environment, combined with the general decline in the market value of the assets under management and the returns on those assets, created the large 79.4% increase in pension expense in 2003 when compared to 2002. Health care insurance expenses continued to increase at a much 16 higher rate than overall inflation, with expense net of employee health care contributions of $537,000 in 2003 compared to $496,000 in 2002. Occupancy and equipment expense increased only marginally to $2,513,000 in 2003. The 2.2% increase was primarily driven by increases in computer software maintenance and other small increases relating to facility utilities expenses. Core deposit intangible expense of $450,000 represents the amortization of the premium paid for deposits acquired at the Gretna office in 1995 and the Yanceyville office in 1996. The core deposit intangible continues to be amortized on a straight-line basis over a ten-year period based on management's conclusion that the purchase did not constitute the acquisition of a business. The amortization will be complete in 2005 for the Gretna office and 2006 for the Yanceyville office. Other expense was $3,490,000 in 2003, an increase of 3.1% over the $3,385,000 reported in 2002, which increased from $3,074,000 recorded in 2001. The increase in 2003 was due to increased marketing expenses, ATM and Visa network fees, and Virginia bank franchise taxes, which was partially offset by a reduction in professional expenses. Management continued to focus on controlling overhead expenses in relation to income growth. The efficiency ratio, a productivity measure used to determine how well non-interest expense is managed, was 49.7%, 48.4%, and 47.6% for 2003, 2002, and 2001, respectively. A lower efficiency ratio indicates more favorable expense efficiency. Leaders in expense efficiency in the banking industry have achieved ratios in the 45-55% range while the majority of the industry remains in the 55-70% range. The efficiency ratio is calculated by dividing non-interest expense by the sum of taxable equivalent net interest income and non-interest income. INCOME TAX PROVISION Applicable income taxes on 2003 earnings amounted to $3,914,000, resulting in an effective tax rate of 29.2% compared to $3,918,000, or 29.3% in 2002, and $3,941,000, or 29.5% in 2001. The Corporation was subject to a blended Federal tax rate of 34.3% in 2003, and a Federal tax rate of 34.2% in 2002 and 2001. The major difference between the statutory rate and the effective rate results from income that is not taxable for Federal income tax purposes. The primary non-taxable income is that of state and municipal securities and industrial revenue bonds or loans. The decrease in the effective tax rate for 2003 as compared to 2002 was a result of the increase in earnings from tax-exempt assets, such as loans to municipalities or investment obligations of state and political subdivisions, as a percentage of total income. Financial Condition, Liquidity and Capital Resources GENERAL Total assets increased 6.3% to $644,302,000 at December 31, 2003 when compared to assets of $605,859,000 at December 31, 2002. Asset growth has been concentrated in the investment securities portfolio. Portfolio loan growth was flat for 2003. Portfolio loans exclude loans held for sale, which are loans originated for the secondary market by ANB Mortgage Corp. that have closed but not funded. Even with loan growth flat overall, commercial and commercial real estate loans increased while there was a decline in residential mortgage and consumer loans. The increase in investment securities primarily occurred in the U.S. Government Agency and municipal securities portfolios. Total liabilities grew 7.0% to $572,371,000 at December 31, 2003 when compared to $535,124,000 at December 31, 2002. Total deposits increased $28,125,000 or 5.9% during 2003 and retail repurchase agreement accounts increased $10,879,000 or 30.1%. Retail repurchase agreements are used by commercial accounts to earn interest on short-term funds and mature daily. Management considers these accounts to be core funding. The deposit growth and resultant mix again shifted to lower cost deposits during the year such as non-interest checking, interest checking, savings, and money market accounts. Borrowed fixed-rate advances from the Federal Home Loan Bank of Atlanta declined $1,000,000 as one fixed-rate advance matured. SECURITIES The securities 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. The securities portfolio plays a primary role in the management of interest rate sensitivity and generates substantial 17 interest income. In addition, the portfolio serves as a source of liquidity and is used to meet collateral requirements. The securities portfolio consists of two components, securities held to maturity and securities available for sale. Securities are classified as held to maturity based on management's intent and the Corporation's ability, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost. Securities which may be sold in response to changes in market interest rates, changes in securities' prepayment risk, increases in loan demand, general liquidity needs, and other similar factors are classified as available for sale and are carried at estimated fair value. Table 5 - Investment Portfolio This table presents information on the amortized cost, maturities and taxable equivalent yields of securities at the end of the last 3 years (in thousands, except yields):
2003 2002 2001 ------------------------- --------------------------- -------------------------- Taxable Taxable Taxable Book Equivalent Book Equivalent Book Equivalent Value Yield Value Yield Value Yield --------- ---------- --------- ---------- ---------- ---------- Federal Agencies: Within 1 year $ 18,033 1.40 % $ 1,000 2.55 % $ - - % 1 to 5 years 63,199 3.24 40,650 4.17 28,192 5.35 5 to 10 years 33,670 2.81 17,642 3.13 5,000 6.12 Over 10 years - - - - - - --------- ---------- --------- ---------- --------- ---------- Total 114,902 2.82 59,292 3.83 33,192 5.47 --------- ---------- --------- ---------- --------- ---------- Mortgage-backed: Within 1 year - - 1,144 6.48 1,881 6.87 1 to 5 years 1,259 3.13 281 6.62 4,141 6.72 5 to 10 years 8,958 4.95 14,429 4.81 6,175 6.19 Over 10 years 10,703 4.71 19,499 5.87 31,909 6.25 --------- ---------- --------- ---------- --------- ---------- Total 20,920 4.72 35,353 5.46 44,106 6.31 --------- ---------- --------- ---------- --------- ---------- State and Municipal: Within 1 year 2,150 6.71 3,204 6.76 1,501 7.89 1 to 5 years 17,019 6.11 17,720 6.44 17,310 7.33 5 to 10 years 26,689 5.14 14,678 6.56 19,324 7.54 Over 10 years 3,912 6.52 3,677 6.97 531 7.79 --------- ---------- --------- ----------- --------- ---------- Total 49,770 5.65 39,279 6.56 38,666 7.46 --------- ---------- --------- ----------- --------- ---------- Other Securities: Within 1 year 2,003 6.15 5,219 6.45 10,525 2.10 1 to 5 years 10,891 6.02 13,434 6.13 17,790 6.50 5 to 10 years - - - - 3,098 6.32 Over 10 years 7,029 2.91 7,335 5.17 7,430 5.51 --------- ---------- --------- ----------- ------------- ---------- Total 19,923 4.94 25,988 5.92 38,843 5.10 --------- ---------- --------- ----------- ------------- ---------- Total portfolio $ 205,515 3.91 % $ 159,912 5.20 % $154,807 6.11 % ========= ========== ========= =========== ============= ==========
At December 31, 2003 total securities at amortized cost were $205,515,000, an increase of 28.5% from year-end 2002. A portion of the increase, $15,000,000, was a short-term investment used to offset a large customer deposit that deposited in the Bank between December 2003 and January 2004. Excluding this short-term investment, securities growth would have been 19.1%, or $30,603,000. Securities of U.S. government agencies represented 55.9% of the securities portfolio book value, mortgage securities issued by U.S. government corporations were 10.2%, obligations of state and municipal subdivisions were 24.2%, and other investments were 9.7%. The $15,000,000 short term investment was invested in U.S. government agency securities. 18 As of December 31, 2003, there was a net unrealized gain of $1,964,000 related to the available for sale investment portfolio compared to $3,912,000 at year-end 2002. The market value of securities held to maturity at December 31, 2003 was more than the book value by $1,352,000. Note 2 of the consolidated financial statements provides details of the amortized cost, unrealized gains and losses, and estimated fair value of each category of the investment portfolio as of December 31, 2003 and 2002. The state and municipal securities were diversified among many different issues and localities. Loan Portfolio The Corporation's lending activities are its principal source of income. Loans, net of unearned income declined $158,000 or 0.04% during 2003 after increasing $31,063,000 or 8.3% in 2002. Loans held for sale are loans originated for the secondary market by ANB Mortgage Corp. that have closed but not funded declined from $1,285,000 to $560,000 from 2002 to 2003. The discussion below excludes loans held for sale. While loan growth was flat on a year to year basis, there was strong loan growth through mid-year 2003. Loans grew $13,349,000 in the first quarter of 2003 and an additional $12,895,000 in the second quarter of 2003. Loans began to decline in the later half of the year as loans dropped ($12,731,000) in the third quarter of 2003 and an additional ($13,671,000) in the fourth quarter of 2003. The loan growth in the first half of the year was offset by the payoff of approximately $18,000,000 in out of market participation loans and a decline in overall loan volume and line of credit activity. The primary increases in types of loans in 2003 were in loans secured by real estate, which were offset by declines in commercial and industrial and consumer loans. Real estate loans secured by non-farm, nonresidential properties and real estate loans secured by 1-4 family property increased at a greater pace than other loans. Management considers the loan portfolio diversified as it consists of 33.5% in residential real estate loans, 36.7% in other real estate secured loans including commercial real estate, multi-family, farmland and construction and land development loans, 24.0% in commercial, industrial and agricultural loans, and 5.8% in consumer loans as of December 31, 2003, as detailed in Table 6 and 7 (in thousands) classified by type. 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. At December 31, 2003, the Bank had no loan concentrations (loans to borrowers engaged in similar activities) which exceeded 10% of total loans. Table 6 - Loans
2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- Real estate loans: Construction and land development $ 12,790 $ 9,208 $ 10,282 $ 9,284 $ 7,317 Secured by farmland 3,430 1,485 1,110 1,616 1,306 Secured by 1-4 family residential properties 136,229 129,905 126,607 121,449 108,994 Secured by multi-family (5 or more) residential properties 6,801 6,329 6,385 5,023 4,532 Secured by nonfarm, nonresidential properties 126,164 107,263 88,648 67,312 54,170 Loans to farmers 1,618 1,844 1,452 1,625 2,468 Commercial and industrial loans 91,419 113,575 98,324 83,428 66,459 Consumer loans 23,581 32,008 36,077 44,389 45,235 Loans for nonrated industrial development obligations 4,077 4,745 6,436 5,590 3,236 Deposit overdrafts 136 41 19 40 24 -------- -------- -------- -------- -------- Loans - net of unearned income $406,245 $406,403 $375,340 $339,756 $293,741 ======== ======== ======== ======== ========
19 Table 7 - Scheduled Loan Maturities Commercial and Real Estate Agricultural Construction Total ------------ ------------ ----- 1 year or less $ 27,088 $ 1,347 $ 28,435 1-5 years 55,208 10,416 65,624 After 5 years 14,818 1,027 15,845 -------- -------- -------- Total $ 97,114 $ 12,790 $109,904 ======== ======== ======== Of the loans due after one year, $14,904 have predetermined interest rates and $66,954 have floating or adjustable interest rates. ALLOWANCE AND PROVISION FOR LOAN LOSSES The allowance for loan losses is to provide for losses inherent in the loan portfolio. The Bank's Credit Committee has responsibility for determining the level of the allowance for loan losses, subject to review by the Board of Directors. Among other factors, the Committee on a quarterly basis considers the Corporation's historical loss experience, the size and composition of the loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits including impaired loans and the Corporation's loan "Watch" list, and national and local economic conditions. 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, a 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 manufacturers closing due to competitive pressures or due to the 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. An inherent risk to the loan portfolio exists if significant declines continue in the manufacturing sector along with a corresponding reduction in employment. There are additional risks of future loan losses that cannot be precisely quantified or attributed to particular loans or classes of loans. Since those factors include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The sum of these elements is the Credit Committee's recommended level for the allowance. The unallocated portion of the allowance is based on loss factors that cannot be associated with specific loans or loan categories. These factors include management's subjective evaluation of such conditions as credit quality trends, collateral values, portfolio concentrations, specific industry conditions in the regional economy, regulatory examination results, internal audit and loan review findings, recent loss experiences in particular portfolio segments, etc. The unallocated portion of the allowance for losses reflects management's attempt to ensure that the overall reserve appropriately reflects a margin for the imprecision necessarily inherent in estimates of credit losses. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies. In 2003, the Corporation accrued $920,000 in provision for loan losses compared to $873,000 in 2002 and $1,015,000 in 2001. The provision for loan losses in 2003 was considered adequate when considering the lack of loan portfolio growth along with the increase in net loans charged-off in 2003, the growth in non-performing loans, and the status of general market conditions. Loans charged off during 2003 amounted to $1,457,000 compared to $740,000 in 2002 and $602,000 in 2001. Recoveries amounted to $207,000, $155,000, and $175,000 in 2003, 2002, and 2001, respectively. Net charge-offs increased to $1,250,000 in 2003 from $585,000 in 2002 and $427,000 in 2001. The ratio of net charge-offs to average outstanding loans was 0.30% in 2003, 0.15% in 2002, and 0.12% in 2001. In 2003 one large commercial loan was partially charged-off in the amount of $744,000, which amounted to 50% of the 20 remaining balance of an outstanding non-accrual loan. Management is working with this customer on a primary and secondary source of repayment of this amount and the remaining balance due, including interest due but not accrued. Management considers the charge-off levels of 2003 to be greater than historical averages due to this one loan. Table 10 presents the Corporation's loan loss and recovery experience (in thousands) for the past five years. The allowance for loan losses totaled $5,292,000 at December 31, 2002, a decrease of 5.9% over December 31, 2002. The ratio of the allowance to loans, less unearned income, was 1.30% at December 31, 2003 and 1.38% at December 31, 2002. The decrease in the allowance to loans ratio is supported by the fact that one of the loans previously supported in the allowance was charged-off, the continued decline in the consumer loan portfolio which has historically driven the majority of the net loan losses, and the overall condition of the portfolio. Management believes that the allowance for loan losses is adequate to absorb any inherent losses on existing loans in the Corporation's loan portfolio at December 31, 2003. Table 8 - Allocation of Allowance for Loan Losses Management has allocated the allowance for loan losses to loan categories as follows (in thousands):
2003 2002 2002 2000 1999 ---------------- ---------------- ---------------- ---------------- ---------------- 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) $2,881 59% $3,196 59% $2,005 55% $1,691 50% $1,190 46% Real estate- residential 848 35 781 33 236 35 177 37 167 39 Consumer 1,141 6 1,247 8 1,276 10 1,304 13 1,503 15 Unallocated 422 - 398 - 1,817 - 1,574 - 1,275 - ------ ------- ------ ------- ------ ------- ------ ------- ------- ------- Balance at end of year $5,292 100% $5,622 100% $5,334 100% $4,746 100% $4,135 100% ====== ======= ====== ======= ====== ======= ====== ======= ====== =======
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 non-real estate secured 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. Table 9 - Loan Loss Ratios
2003 2002 2001 ------- -------- ------- Allowance as percentage of outstanding loans, net of unearned income 1.30% 1.38% 1.42% Net charge-offs as percentage of allowance 23.62 10.41 8.00 Net charge-offs as percentage of average loans, net of unearned income .30 .15 .12 Provision as percentage of net charge-offs 73.60 149.23 237.72 Provision as percentage of average loans, net of unearned income .22 .22 .28 Allowance for loan losses to nonperforming loans 1.60X 10.41X 6.46X
21 Table 10 - Summary of Loan Loss Experience (in thousands)
2003 2002 2001 2000 1999 ------ ------ ------ ------ ------ Balance at beginning of period $5,622 $5,334 $4,746 $4,135 $3,821 ------ ------ ------ ------ ------ Charge-offs: Commercial loans 1,004 343 141 141 34 Real estate loans 80 33 59 9 - Consumer loans 373 364 402 417 475 ------ ------ ------ ------ ------ 1,457 740 602 567 509 ------ ------ ------ ------ ------ Recoveries: Commercial loans 105 28 75 32 40 Real estate loans - 3 3 1 - Consumer loans 102 124 97 125 113 ------- ------ ------ ------- ------ 207 155 175 158 153 ------ ------ ------ ------- ------ Net charge-offs 1,250 585 427 409 356 Provision for loan losses 920 873 1,015 1,020 670 ------ ------ ------ ------ ------ Balance at end of period $5,292 $5,622 $5,334 $4,746 $4,135 ====== ====== ====== ====== ====== Percent of net charge-offs to average net loans outstanding during the period .30% .15% .12% .13% .13% ====== ====== ====== ====== ======
ASSET QUALITY AND NON-PERFORMING LOANS 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 of loan balances 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 "Allowance and Provision for Loan Losses" are considered in determining the adequacy of the allowance. Loans are generally placed on non-accrual 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, consumer loans are normally charged off after a delinquency of 120 days. Under the Corporation's policy, a non-accruing loan may be restored to accrual status when none of its principal and interest is past due and unpaid, the borrower has shown a reasonable sustained ability to service the debt, 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. In 2003 the Corporation spent considerable time and energy to improve the operations of the lending and credit functions. A new Chief Credit Officer position was created in 2003, and during the second half of 2003 a new credit policy manual was created and implemented, new lending committee structures were introduced, and a new risk grading methodology was adopted. This new risk grading system has better focused management on identifying loan portfolio risks. The decline in several asset quality measurements on a year-to-year basis can be partially explained by the more aggressive approach management is taking using the new risk grading process. These systems were considered necessary to support future loan growth in existing and new markets. During 2003 the Corporation moved consumer loans to non-accrual after they were past due for 90 days, versus the previous system that typically did not place these loans on non-accrual but typically charged-off these loans when they reached 180 days past due. New internal limits have also been placed on time and demand loan renewals. Both of these changes, along with the changes to the risk grading system, have increased the number of reported non-performing loans. 22 Non-performing loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and loans classified as troubled debt restructurings are detailed in Table 11. Total non-performing loans as a percentage of net loans were 0.81% at December 31, 2003 and 0.13% at December 31, 2002. Total non-performing loans are considered high by management based on the Corporation's historical average, yet remain in-line and only slightly above industry averages. Loans on accrual status and past due 90 days or more at December 31, 2003 were $53,000 compared with $239,000 at December 31, 2002. There were no loans classified as troubled debt restructurings on December 31, 2003 or December 31, 2002. Loans in a non-accrual status at December 31, 2003 were $3,262,000 compared with $301,000 at December 31, 2002. Two commercial loan customers make up the majority of the non-accrual loan total, and the Corporation currently believes both customers have adequate collateral should the secondary source of repayment need to be liquidated. The Corporation continues to work with these borrowers, as well as others placed on non-accrual, to rectify their status. Table 11 - Nonperforming Loans (Amounts are in thousands, except ratios)
2003 2002 2001 2000 1999 ------- -------- -------- -------- -------- Nonaccruing loans: Real Estate $ 1,870 $ 293 $ 414 $ 65 $ 107 Commercial 1,236 - 115 67 131 Agricultural 8 8 39 14 54 Consumer 148 - - - - ------- -------- -------- -------- -------- Total nonaccruing loans 3,262 301 568 146 292 ------- -------- -------- -------- -------- Restructured loans: Total restructured loans - - - - - ------- -------- -------- -------- -------- Loans past due 90 days and accruing interest: Real Estate - - - - 3 Commercial - 33 33 49 44 Agricultural - 1 8 14 8 Consumer 53 205 217 176 232 ------- -------- -------- -------- -------- Total past due loans 53 239 258 239 287 ------- -------- -------- -------- -------- Total nonperforming loans $ 3,315 $ 540 $ 826 $ 385 $ 579 ======= ======== ======== ======== ======== Asset Quality Ratios: Allowance for loan losses to year-end net loans 1.30% 1.38% 1.42% 1.40% 1.41% Nonperforming loans to year-end net loans .81% .13% .22% .11% .20% Allowance for loan losses to nonperforming loans 1.60X 10.41X 6.46X 12.33X 7.14X
As of December 31, 2003 loans totaling $2,548,000 were considered impaired according to Financial Accounting Statement No. 114 "Accounting by Creditors for Impairment of a Loan" and later amended by Financial Accounting Statement No. 118 "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures". There were $54,000 in loans in this category as of December 31, 2002. All impaired loans for 2003 and 2002 are also shown above in the non-accrual loan total. A loan is considered impaired if it is probable that the lender will be unable to collect all amounts due under the contractual terms of the loan agreement 23 The gross amount of interest income that would have been recorded on non-accrual loans for the year ending December 31, 2003, if all such loans had been accruing interest at the original contractual rate, was $45,000. There were eight properties held due to loan foreclosure (other real estate owned) as of December 31, 2003 totaling $303,000, compared to one piece of property held at December 31, 2002, for $30,000. 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. Liquidity is provided from cash and amounts due from banks, federal funds sold, interest-bearing deposits in other banks, repayments from loans, increases in deposits, lines of credit from the Federal Home Loan Bank and two correspondent banks, and maturing investments. Management believes that these factors provide sufficient and timely liquidity for the foreseeable future. Management also takes into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit. Management monitors and plans the Corporation's liquidity position for future periods. Liquidity strategies are implemented and monitored by the Bank's Asset/Liability Investment Committee ("ALCO"). The Committee uses a simulation and budget model to assess the future liquidity needs of the Corporation and manage the investment of funds. The Corporation's net liquid assets, which includes cash and due from banks, unpledged government securities, unpledged other securities with remaining maturities of less than two years, less the Bank's reserve requirement, to net liabilities ratio was 21.9% at December 31, 2003 and 19.1% at December 31, 2002. Both of these ratios are considered to reflect adequate liquidity for the respective periods. The Bank has a line of credit equal to 15% of assets with the Federal Home Loan Bank of Atlanta that equaled approximately $96,550,000 with $75,550,000 available at December 31, 2003. Should the Bank ever desire to increase its line of credit beyond the current 15% limit, the FHLB may allow borrowings of up to 40% of total assets once the bank meets specific eligibility and collateral requirements. Borrowings outstanding under this line of credit were $21,000,000 and $22,000,000 respectively, at December 31, 2003 and December 31, 2002. The Bank maintains otherwise unencumbered qualifying assets (principally 1-4 family residential mortgage) under the terms of its collateral agreement in the amount of at least as much as its advances from the FHLBA. The Bank's FHLBA stock is also pledged to secure these advances. As of December 31, 2003, $89,112,000 of 1-4 family residential mortgage loans were pledged under the blanket floating lien agreement. The Bank has fixed-rate term borrowing contracts outstanding as of December 31, 2003, with the following final maturities: Amount Expiration Date ---------- --------------- $3,000,000 2004 2,000,000 2005 2,000,000 2006 1,000,000 2007 8,000,000 2008 $5,000,000 2009 The Bank also has federal funds lines of credit facilities established with two other banks in the amounts of $12,000,000 and $5,000,000, as well as access to the Federal Reserve Bank of Richmond's discount window should a liquidity crisis occur. The Bank has not used the facilities in the past year and considers these as backup sources of funds. DEPOSITS The Corporation's major source of funds and liquidity is its deposit base. Table 12 presents the average balances of deposits and the average rates paid on those deposits for the past 3 years (in thousands). 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 24 in number and size than large denomination certificates of deposit. In addition, the Corporation's customers have relatively stable requirements for funds. The mix of the deposit base (time deposits versus demand, money market and savings) is constantly subject to change. During 2003 the deposit mix changed with average balance increases in savings accounts of $10,803,000, followed by an increase in non-interest bearing demand deposits of $8,225,000, an increase in money market deposit accounts of $4,924,000, an increase in interest-bearing demand deposits of $4,006,000, and a $996,000 increase in time deposits. The higher growth in transaction accounts was widespread in the industry, as customers continued to place more of their funds into savings and demand deposit accounts due to the historically low rate environment and the past several years of disappointing equity market performance. Certificates of deposit of $100,000 or more are detailed in Table 13 and grew only slightly in 2003 from the balance of $60,077,000 at December 31, 2002. Table 12 - Deposits
2003 2002 2001 -------------------- -------------------- -------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate -------- ------- -------- ------- -------- ------- Demand deposits - non-interest bearing $ 66,300 -% $ 58,075 -% $ 52,719 -% Demand deposits - interest bearing 63,858 .35 59,852 .70 56,419 .88 Money market 47,293 1.01 42,369 1.83 41,225 3.20 Savings 80,876 .88 70,073 1.50 62,792 1.87 Time 230,070 2.83 229,074 3.76 229,050 5.51 --------- ------- --------- ------- -------- ------- $ 488,397 1.62% $459,443 2.36% $442,205 3.53% ========= ========= ========
Table 13 - Certificates of Deposit Certificates of deposit at the end of 2003 in amounts of $100,000 or more were classified by maturity as follows (in thousands): 3 months or less $ 12,284 Over 3 through 6 months 11,017 Over 6 through 12 months 18,007 Over 12 months 20,059 -------- $ 61,367 ======== OFF-BALANCE SHEET TRANSACTIONS The Corporation enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. The off-balance sheet transactions recognized as of December 31, 2003 were commitments to extent credit, standby letters of credit, and commitments to purchase securities. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities (in thousands). Off-Balance Sheet Transactions December 31, 2003 December 31, 2002 ---------------------------------- ----------------- ----------------- Commitments to extend credit $124,905 $107,771 Standby letters of credit 3,477 3,489 Commitments to purchase securities 700 - Commitments to extend credit represent legally binding agreements to lend to customers 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. Standby letters of credit are conditional commitments issued by the Bank guaranteeing the performance of a customer to a third party. Those guarantees 25 are primarily issued to support public and private borrowing arrangements. The commitments to purchase securities were made to purchase securities yet to be issued. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities. CONTRACTUAL OBLIGATIONS The following items are contractual obligations of the Corporation as of December 31, 2003 (in thousands):
Payments Due by Period -------------------------------------------------------- Less Than More Than Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years - ----------------------- ------- --------- --------- ---------- --------- FHLB advances $21,000 $ 3,000 $ 4,000 $ 9,000 $ 5,000 Repurchase agreements 47,035 47,035 - - - Operating leases 466 116 154 113 84 Purchase obligations 700 - - - -
CAPITAL RESOURCES The following table displays the changes in shareholders' equity (in thousands), from December 31, 2002, to December 31, 2003. A more detailed analysis of changes in capital resources is contained in the Consolidated Changes in Shareholders Equity in the financial statements section of this 10-K. Shareholders' Equity, December 31, 2002 $ 70,736 Net earnings 9,513 Exercise of stock options 76 Repurchase of common stock (3,128) Cash dividends paid (4,272) Net change in net unrealized losses on AFS securities (1,229) Reclassification adjustment for securities gains (56) Net Change in Minimum Pension Liability 291 --------- Shareholders' Equity, December 31, 2003 $ 71,931 ========= The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Corporation's capital is reviewed by management on an ongoing basis. Management seeks to maintain a structure that will ensure an adequate level of capital to support anticipated asset growth and absorb potential losses. 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, 250,000 shares of the Corporation's common stock between August 29, 2001 and August 28, 2002, 250,000 shares between August 21, 2002 and August 19, 2003, and 250,000 shares between August 20, 2003 and August 17, 2004. During 2003, the Corporation repurchased 125,000 shares of its common stock in the open market at an average per share price of $25.03. During 2002, the Corporation repurchased 45,100 shares of its common stock in the open market at an average per share price of $23.26. During 2001, the Corporation repurchased 254,366 shares of its common stock, in the open market at an average per share price of $18.08. From the inception of the stock repurchase plan through December 31, 2003, the Corporation has purchased and retired 464,466 shares of its common stock. Regulatory agencies issued risk-based capital guidelines 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. Federal regulatory risk-based capital ratio guidelines require percentages to be applied to various assets, including off-balance-sheet assets, in relation to their perceived risk. 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. 26 The guidelines require that total capital (Tier I plus Tier II) of 8% be held against total risk-adjusted assets, at least half of which (4%) must be Tier I capital. At December 31, 2003, the Corporation's Tier I and total capital ratios were 14.85% and 15.99%, respectively. At December 31, 2002, these ratios were 14.41% and 15.63%, respectively. The ratios for both years were well in excess of the regulatory requirements. 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. Under the regulations, well capitalized institutions must have Tier I risk-based capital ratios of at least 6%, total risk-based capital ratios of at least 10% and leverage ratios of at least 5% and not be subject to capital directive orders. Under these guidelines, the Corporation and the Bank have always been and continue to be considered well capitalized. The Corporation's leverage ratios (Tier 1 capital divided by average quarterly assets less intangible assets) were 10.76% and 11.00% at December 31, 2003 and 2002, respectively. The leverage ratio has a regulatory minimum of 3%, with most institutions required to maintain a ratio one to two percent above the 3% minimum depending upon risk profiles and other factors. The Board of Directors declared regular quarterly dividends totaling $.75 and $.71 per share of common stock in 2003 and 2002, respectively. Cash dividends totaled $4,272,000 and represented a 44.9% payout of 2003 net income, compared to 43.5% in 2002. The Board of Directors reviews the Corporation's dividend policy regularly and increases dividends when justified by earnings after considering future capital needs. Shareholders' equity was 11.2% of assets at December 31, 2003 and 11.7% at December 31, 2002. Shareholders' equity was $71,931,000 at December 31, 2003 and $70,736,000 at December 31, 2002. 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 the Nasdaq National Market was made to improve the marketability of the stock. The total market value of American National Bankshares Inc. common stock at December 31, 2003, at $26.08 per share (the last trade recorded on the Nasdaq National Market during 2003) was $147,624,000, compared to $150,301,000 at December 31, 2002 when the stock was last traded at $26.00 per share. The decline in market capitalization is primarily due to the stock repurchase program reducing the number of shares outstanding between year end 2002 and year end 2003. The market value of the Corporation's common stock was 205 percent of its book value with book value per common share at $12.71 on December 31, 2003. 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 that 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. CRITICAL ACCOUNTING POLICIES The Corporation's critical accounting policies are listed below. A summary of the Corporation's significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements in the Corporation's 2003 Annual Report on Form 10-K. The Corporation's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. 27 Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses along with various economic factors and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified loans. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The unallocated allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. Core Deposit Intangibles In July, 2001, the Financial Accounting Standards Board issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which impacted the accounting for goodwill and other intangible assets. Statement 141 eliminated the pooling method of accounting for business combinations and required that intangible assets that meet certain criteria be reported separately from goodwill. Statement 142 eliminated the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. SFAS 142 allows certain intangibles arising from Bank and Thrift acquisitions to be amortized over their estimated useful lives. The Financial Accounting Standards Board issued Statement No. 147, Acquisitions of Certain Financial Institutions, an Amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9 in October 2002. FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method, provided interpretive guidance on the application of the purchase method to acquisitions of financial institutions. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5 of Statement 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to acquisitions with the scope of this Statement. In addition, this Statement amends FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement 144 requires for other long-lived assets that are held and used. Paragraph 5 of this Statement, which relates to the application of the purchase method of accounting, is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The provisions in paragraph 6 related to accounting for the impairment or disposal of certain long-term customer-relationship intangible assets are effective on October 1, 2002. Transition provisions for previously recognized unidentifiable intangible assets in paragraphs 8-14 are effective on October 1, 2002, with earlier application permitted. This Statement clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill. The transition provisions state that if the transaction that gave rise to the unidentifiable intangible asset was a business combination, the carrying amount of that asset shall be reclassified to goodwill as of the later of the date of acquisition or the date Statement 142 was first applied (fiscal years beginning after December 15, 2001). Any previously issued interim statements that reflect amortization of the unidentifiable intangible asset subsequent to the Statement 142 application date shall be restated to remove that amortization expense. The carrying amounts 28 of any recognized intangible assets that meet the recognition criteria of Statement 141 that have been included in the amount reported as an unidentifiable intangible asset and for which separate accounting records have been maintained shall be reclassified and accounted for as assets apart from the unidentifiable intangible asset and shall not be reclassified to goodwill. Upon adoption of these Statements, the Corporation re-evaluated its intangible assets that arose from branch acquisitions prior to July 1, 2001. The intangible assets arising from the premium paid for deposits acquired at the Gretna office in 1995 and the Yanceyville office in 1996 are classified as core deposit intangibles and continue to be amortized over their estimated lives based on management's determination that a business was not acquired in either of the two purchases. Stock Based Compensation The Corporation accounts for its stock compensation plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Non-GAAP Presentations The management's discussion and analysis refers to the efficiency ratio, which is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income. This is a non-GAAP financial measure which we believe provides investors with important information regarding our operational efficiency. Comparison of our efficiency ratio with those of other companies may not be possible because other companies may calculate the efficiency ratio differently. The Corporation, in referring to its net income, is referring to income under accounting principals generally accepted in the United States of America, or "GAAP". The analysis of net interest income in this document is performed on a tax equivalent basis. Management feels the tax equivalent presentation better reflects total return, as many financial assets have specific tax advantages that modify their effective yields. A reconcilement of tax-equivalent net interest income to net interest income under generally accepted accounting principals, or "GAAP", is provided in those statements. FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Corporation. 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: o General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances. o Changes in interest rates could reduce net interest income. o Competitive pressures among financial institutions may increase. o Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses that the Corporation and Bank are engaged in. o New products developed or new methods of delivering products could result in a reduction in business and income for the Corporation and Bank. o Adverse changes may occur in the securities market. ITEM 9A - CONTROLS AND PROCEDURES For the period ending December 31, 2003, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation's management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are effective in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in periodic SEC filings. There have been no significant changes in the Corporation's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Corporation carries out its evaluation. 29 The Audit and Compliance Committee pre-approves all audit, audit related, and tax services on an annual basis, and in addition, authorizes individual engagements that exceed pre-established thresholds. Any additional engagement that falls below the pre-established thresholds must be reported by management at the Audit and Compliance Committee meeting immediately following the initiation of such an engagement. Table 14 - Quarterly Financial Results American National Bankshares Inc. and Subsidiary (in thousands, except per share amounts)
Fourth Third Second First Quarter Quarter Quarter Quarter ------- ------- ------- ------- 2003 ---- Interest income..........................................$ 7,697 $ 7,844 $ 8,235 $ 8,402 Interest expense......................................... 2,138 2,276 2,458 2,519 ------- ------- ------- ------- Net interest income.................................... 5,559 5,568 5,777 5,883 Provision for loan losses................................ 255 170 255 240 ------- ------- ------- ------- Net interest income after provision.................... 5,304 5,398 5,522 5,643 Non-interest income...................................... 1,794 1,800 1,615 1,462 Non-interest expense..................................... 3,618 3,802 3,882 3,809 ------- ------- ------- ------- Income before income tax provision..................... 3,480 3,396 3,255 3,296 Income tax provision..................................... 1,014 991 947 962 ------- ------- ------- ------- Net income.............................................$ 2,466 $ 2,405 $ 2,308 $ 2,334 ======= ======= ======= ======= Per common share: Net income (basic).....................................$ .44 $ .42 $ .40 $ .41 Net income (diluted)...................................$ .43 $ .42 $ .40 $ .40 Cash dividends.........................................$ .19 $ .19 $ .19 $ .18
Fourth Third Second First Quarter Quarter Quarter Quarter ------- ------- ------- ------- 2002 ---- Interest income..........................................$ 8,654 $ 8,893 $ 8,787 $ 8,801 Interest expense......................................... 2,788 2,972 3,126 3,424 ------- ------- ------- ------- Net interest income.................................... 5,866 5,921 5,661 5,377 Provision for loan losses................................ 240 214 236 183 ------- ------- ------- ------- Net interest income after provision.................... 5,626 5,707 5,425 5,194 Non-interest income...................................... 1,438 1,434 1,445 1,395 Non-interest expense..................................... 3,548 3,660 3,579 3,498 ------- ------- ------- ------- Income before income tax provision..................... 3,516 3,481 3,291 3,091 Income tax provision..................................... 1,050 1,020 956 892 ------- ------- ------- ------- Net income.............................................$ 2,466 $ 2,461 $ 2,335 $ 2,199 ======= ======= ======= ======= Per common share: Net income (basic).....................................$ .43 $ .42 $ .40 $ .38 Net income (diluted)...................................$ .42 $ .42 $ .40 $ .38 Cash dividends.........................................$ .18 $ .18 $ .18 $ .17
30 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 judgment. 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 Yount, Hyde and Barbour, PC, 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 Yount, Hyde and Barbour, PC is limited to an expression of their opinion as to the fairness of the financial statements presented. Their opinion is based on an audit conducted in accordance with generally accepted auditing standards as described in the second paragraph of their report. /s/ Charles H. Majors - ------------------------------------- Charles H. Majors President and Chief Executive Officer /s/ Brad E. Schartz - ------------------------------------------- Brad E. Schwartz Senior Vice President, Secretary, Treasurer & Chief Financial Officer January 20, 2004 31 INDEPENDENT AUDITORS REPORT To the Shareholders and Board of Directors American National Bankshares Inc. Danville, Virginia We have audited the accompanying consolidated balance sheets of American National Bankshares Inc. and subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the two years ended December 31, 2003. 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. The financial statements of American National Bankshares Inc. for the year ended December 31, 2001 were audited by other auditors who have ceased operations and whose report, dated January 15, 2002, expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American National Bankshares Inc. and subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the two years ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. Yount, Hyde and Barbour, P.C. Winchester, Virginia January 15, 2004 32 INDEPENDENT AUDITORS REPORT 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, 2001 and 2000, 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, 2001. 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, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Raleigh, North Carolina January 15, 2002 NOTE: This Report was not re-issued with the consent of Arthur Andersen, the Corporation's independent auditor for the accompanying consolidated balance sheet of American National Bankshares Inc. (a Virginia corporation) and Subsidiary as of December 31, 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the one year period ended December 31, 2001. Arthur Andersen has ceased operations and was not available to provide consent of re-issuance. 33 Consolidated Balance Sheets December 31, 2003 and 2002 American National Bankshares Inc. and Subsidiary - ----------------------------------------------------------------------------------------------------------------
2003 2002 -------------- -------------- ASSETS Cash and due from banks ........................................................$ 16,235,473 $ 16,757,283 Interest-bearing deposits in other banks........................................ 1,651,598 6,720,335 Securities available for sale, at fair value.................................... 171,375,898 137,046,119 Securities held to maturity (market value of $37,455,348 in 2003 and $28,219,299 in 2002).............................................. 36,103,384 26,777,747 -------------- -------------- Total securities.............................................................. 207,479,282 163,823,866 -------------- -------------- Loans held for sale............................................................. 560,153 1,285,020 Loans, net of unearned income .................................................. 406,245,090 406,403,107 Less allowance for loan losses.................................................. (5,292,054) (5,622,150) -------------- -------------- Net loans..................................................................... 400,953,036 400,780,957 -------------- -------------- Bank premises and equipment, at cost, less accumulated depreciation of $11,807,226 in 2003 and $10,673,195 in 2002................... 7,717,896 8,167,476 Core deposit intangibles, net................................................... 934,054 1,383,870 Accrued interest receivable and other assets.................................... 8,770,209 6,940,494 -------------- --------------- Total assets..................................................................$ 644,301,701 $ 605,859,301 ============== =============== LIABILITIES and SHAREHOLDERS' EQUITY Liabilities: Demand deposits -- non-interest bearing.......................................$ 71,027,387 $ 69,102,211 Demand deposits -- interest bearing........................................... 69,053,315 62,679,718 Money market deposits......................................................... 59,250,981 43,830,781 Savings deposits.............................................................. 83,030,520 73,410,623 Time deposits................................................................. 219,325,638 224,539,145 -------------- --------------- Total deposits................................................................ 501,687,841 473,562,478 -------------- --------------- Repurchase agreements........................................................... 47,034,727 36,155,251 FHLB Borrowings................................................................. 21,000,000 22,000,000 Accrued interest payable and other liabilities.................................. 2,648,508 3,405,913 -------------- --------------- Total liabilities............................................................. 572,371,076 535,123,642 -------------- --------------- Shareholders' equity: Preferred stock, $5 par, 200,000 shares authorized, none outstanding............................................................ - - Common stock, $1 par, 10,000,000 shares authorized, 5,660,419 shares outstanding at December 31, 2003 and 5,780,816 shares outstanding at December 31, 2002........................... 5,660,419 5,780,816 Capital in excess of par value................................................ 9,435,955 9,571,508 Retained earnings............................................................. 55,538,097 53,092,527 Accumulated other comprehensive income, net................................... 1,296,154 2,290,808 -------------- --------------- Total shareholders' equity.................................................... 71,930,625 70,735,659 -------------- --------------- Total liabilities and shareholders' equity....................................$ 644,301,701 $ 605,859,301 ============== =============== The accompanying notes are an integral part of the consolidated financial statements.
34 Consolidated Statements of Income For The Years Ended December 31, 2003, 2002 and 2001 American National Bankshares Inc. and Subsidiary - -------------------------------------------------------------------------------------------------------------
2003 2002 2001 ------------ ------------ ------------- Interest Income: Interest and fees on loans....................................$ 25,227,958 $ 27,149,521 $ 30,216,549 Interest on deposits in other banks........................... 109,903 248,270 385,019 Income on securities: Federal agencies............................................ 2,364,821 1,941,974 2,709,097 Mortgage-backed............................................. 1,315,703 2,351,830 2,723,146 State and municipal ........................................ 1,961,091 1,887,506 1,916,297 Other investments........................................... 1,198,179 1,555,947 1,869,711 ------------ ------------ ------------ Total interest income....................................... 32,177,655 35,135,048 39,819,819 ------------ ------------ ------------ Interest Expense: Interest on deposits: Demand...................................................... 225,270 416,924 494,930 Money market................................................ 477,819 775,051 1,318,002 Savings..................................................... 712,599 1,048,564 1,176,704 Time........................................................ 6,499,902 8,606,409 12,617,362 Interest on repurchase agreements............................. 496,612 634,996 1,087,823 Interest on other borrowings.................................. 978,884 827,800 806,869 ------------ ------------ ------------ Total interest expense...................................... 9,391,086 12,309,744 17,501,690 ------------ ------------ ------------ Net Interest Income............................................. 22,786,569 22,825,304 22,318,129 Provision for Loan Losses....................................... 920,000 873,000 1,015,000 ------------ ------------ ------------ Net Interest Income After Provision For Loan Losses............................................... 21,866,569 21,952,304 21,303,129 ------------ ------------ ------------ Non-Interest Income: Trust and investment services................................. 2,522,840 2,515,937 2,569,125 Service charges on deposit accounts........................... 2,163,130 1,706,137 1,385,339 Other fees and commissions.................................... 913,937 816,360 749,072 Mortgage banking income....................................... 571,209 360,669 365,349 Securities gains, net......................................... 115,115 39,334 367,035 Other income.................................................. 385,622 273,281 231,998 ------------ ------------ ------------ Total non-interest income..................................... 6,671,853 5,711,718 5,667,918 ------------ ------------ ------------ Non-Interest Expense: Salaries...................................................... 6,843,994 6,519,552 6,383,811 Pension and other employee benefits........................... 1,814,108 1,470,682 1,390,591 Occupancy and equipment ...................................... 2,512,588 2,459,647 2,316,282 Core deposit intangible amortization.......................... 449,816 449,816 449,816 Other ........................................................ 3,490,339 3,384,839 3,073,702 ------------ ------------ ------------ Total non-interest expense.................................... 15,110,845 14,284,536 13,614,202 ------------ ------------ ------------ Income Before Income Tax Provision.............................. 13,427,577 13,379,486 13,356,845 Income Tax Provision............................................ 3,914,187 3,918,191 3,941,474 ------------ ------------ ------------ Net Income......................................................$ 9,513,390 $ 9,461,295 $ 9,415,371 ============ ============ ============ Net Income Per Common Share: Basic.........................................................$ 1.67 $ 1.63 $ 1.58 Diluted.......................................................$ 1.65 $ 1.62 $ 1.58 Average Common Shares Outstanding: Basic......................................................... 5,702,625 5,800,302 5,949,811 Diluted....................................................... 5,764,127 5,850,349 5,973,153 The accompanying notes are an integral part of the consolidated financial statements.
35 Consolidated Statements of Changes in Shareholders' Equity For the Years Ended December 31, 2003, 2002 and 2001 American National Bankshares Inc. and Subsidiary
Accumulated Common Stock Capital in Other Total ------------------------- Excess of Retained Comprehensive Shareholders' Shares Amount Par Value Earnings Income Equity ----------- ------------ ------------ ------------- -------------- ------------- Balance, December 31, 2000...................... 6,063,772 $ 6,063,772 $ 9,831,428 $ 47,119,966 $ 323,117 $ 63,338,283 Net income...................................... - - - 9,415,371 - 9,415,371 Change in unrealized gains (losses) on securities available for sale, net of tax of $507,906 - - - - 985,937 985,937 ------------ Comprehensive income.......................... 10,401,308 Stock repurchased and retired................... (254,366) (254,366) (412,413) (3,933,272) - (4,600,051) Stock options exercised......................... 12,550 12,550 169,487 - - 182,037 Cash dividends declared and paid................ - - - (3,924,304) - (3,924,304) ----------- ------------ ------------ ------------- ------------- ------------- Balance, December 31, 2001...................... 5,821,956 5,821,956 9,588,502 48,677,761 1,309,054 65,397,273 Net income...................................... - - - 9,461,295 - 9,461,295 Other comprehensive income (loss), net of tax: Change in unrealized gains (losses) on securities available for sale, net of tax of $655,634.... - - - - 1,272,701 Minimum pension liability adjustment, net of tax of $149,882........................ (290,947) ------------- Other comprehensive income.................... 981,754 981,754 ------------- Comprehensive income.......................... 10,443,049 Stock repurchased and retired................... (45,100) (45,100) (74,278) (929,432) - (1,048,810) Stock options exercised......................... 3,960 3,960 57,284 - - 61,244 Cash dividends declared and paid................ - - - (4,117,097) - (4,117,097) ----------- ------------ ------------ ------------- ------------- ------------- Balance, December 31, 2002...................... 5,780,816 5,780,816 9,571,508 53,092,527 2,290,808 70,735,659 Net income...................................... - - - 9,513,390 - 9,513,390 Other comprehensive income (loss), net of tax: Change in unrealized gains (losses) on securities available for sale, net of tax of $(638,683).. - - - - (1,229,244) Less: Reclassification adjustment for (gains) losses on securities available for sale, net of tax of $29,032................................ - - - - (56,357) Minimum pension liability adjustment, net of tax of ($149,882)...................... 290,947 ------------- Other comprehensive income (loss)............. (994,654) (994,654) ------------- Comprehensive income.......................... 8,518,736 Stock repurchased and retired................... (125,000) (125,000) (206,967) (2,796,233) - (3,128,200) Stock options exercised......................... 4,603 4,603 71,414 - - 76,017 Cash dividends declared and paid................ - - - (4,271,587) - (4,271,587) ----------- ------------ ------------ ------------- ------------- ------------- Balance, December 31, 2003..................... 5,660,419 $ 5,660,419 $ 9,435,955 $ 55,538,097 $ 1,296,154 $ 71,930,625 ============ ============= ============ ============= ============= ============= The accompanying notes are an integral part of the consolidated financial statements.
36 Consolidated Statements of Cash Flows For the Years Ended December 31, 2003, 2002 and 2001 American National Bankshares Inc. and Subsidiary
2003 2002 2001 ------------- ------------- ------------- Cash Flows from Operating Activities: Net income......................................................................$ 9,513,390 $ 9,461,295 $ 9,415,371 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses..................................................... 920,000 873,000 1,015,000 Depreciation.................................................................. 1,135,160 1,143,865 1,171,113 Core deposit intangible amortization.......................................... 449,816 449,816 449,816 Amortization (accretion) of bond premiums and discounts....................... 1,062,935 295,169 74,916 Gain on sale or call of securities............................................ (115,115) (39,334) (367,035) Gain on loans held for sale................................................... (552,527) (360,669) (365,349) Proceeds from sales of loans held for sale.................................... 30,331,809 17,764,033 17,523,936 Originations of loans held for sale........................................... (29,054,415) (18,435,363) (17,012,797) Loss on sale of real estate owned............................................. 6,208 1,192 19,950 (Gain) loss on sale of premises and equipment................................. (42,386) 15,618 (2,000) Deferred income taxes provision (benefit)..................................... 395,091 48,656 (356,927) (Increase) decrease in interest receivable.................................... (566,956) (65,834) 863,391 (Increase) decrease in other assets........................................... (872,059) (518,118) 87,036 Decrease in interest payable.................................................. (229,628) (359,459) (312,404) Decrease (increase) in other liabilities...................................... (86,947) 23,201 (118,873) ------------- ------------- ------------- Net cash provided by operating activities..................................... 12,294,376 10,297,068 12,085,144 ------------- ------------- ------------- Cash Flows from Investing Activities: Proceeds from maturities and calls of securities available for sale........... 71,843,288 54,414,161 62,114,339 Proceeds from sales of securities available for sale.......................... 3,103,750 1,052,500 - Proceeds from maturities and calls of securities held to maturity............. 5,677,594 6,196,585 13,644,822 Purchases of securities available for sale....................................(112,179,943) (63,531,500) (67,267,483) Purchases of securities held to maturity...................................... (14,995,806) (3,492,307) (567,376) Net increase in loans......................................................... (1,369,071) (31,812,761) (36,496,485) Proceeds from sales of bank premises and equipment............................ 43,352 - - Purchases of bank premises and equipment...................................... (686,546) (1,469,533) (1,158,129) Proceeds from sales of other real estate owned................................ 9,913 261,126 195,050 Purchases of other real estate owned.......................................... (12,523) (10,895) - ------------- ------------- ------------- Net cash used in investing activities......................................... (48,565,992) (38,392,624) (29,535,262) ------------- ------------- ------------- Cash Flows from Financing Activities: Net increase in demand, money market, and savings deposits........................................................ 33,338,870 16,370,118 25,818,018 Net (decrease) increase in time deposits...................................... (5,213,507) (6,819,423) 11,605,446 Net increase (decrease) in repurchase agreements.............................. 10,879,476 8,978,493 (4,552,842) Net (decrease) increase in FHLB borrowings.................................... (1,000,000) 9,000,000 (3,000,000) Cash dividends paid........................................................... (4,271,587) (4,117,097) (3,924,304) Repurchase of stock........................................................... (3,128,200) (1,048,810) (4,600,051) Proceeds from exercise of stock options....................................... 76,017 61,244 182,037 ------------- ------------- ------------- Net cash provided by financing activities..................................... 30,681,069 22,424,525 21,528,304 ------------- ------------- ------------- Net (Decrease) Increase in Cash and Cash Equivalents.......................... (5,590,547) (5,671,031) 4,078,186 Cash and Cash Equivalents at Beginning of Period.............................. 23,477,618 29,148,649 25,070,463 ------------- ------------- ------------- Cash and Cash Equivalents at End of Period....................................$ 17,887,071 $ 23,477,618 $ 29,148,649 ============= ============= ============= Supplemental Schedule of Cash and Cash Equivalents: Cash: Cash and due from banks.....................................................$ 16,235,473 $ 16,757,283 $ 14,797,926 Interest-bearing deposits in other banks.................................... 1,651,598 6,720,335 14,350,723 ------------- ------------- ------------- $ 17,887,071 $ 23,477,618 $ 29,148,649 ============= ============= ============= Supplemental Disclosure of Cash Flow Information: Interest paid.................................................................$ 9,620,715 $ 12,669,203 $ 17,814,094 Income taxes paid.............................................................$ 3,630,200 $ 4,012,453 $ 4,363,234 Transfer of loans to other real estate owned..................................$ 276,992 $ 164,287 $ 87,136 Unrealized gain (loss) on securities available for sale.......................$ (1,948,000) $ 1,928,000 $ 1,494,000 The accompanying notes are an integral part of the consolidated financial statements.
37 American National Bankshares Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 1. Summary of Significant Accounting Policies: Nature of Operations and 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, 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, offers secondary market mortgage lending. 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 inter-company transactions and accounts are eliminated in consolidation. Cash and Cash Equivalents Cash includes cash on hand and cash with correspondent banks. Cash equivalents are short-term, highly liquid investments that are readily convertible to cash with original maturities of three months or less and that are subject to an insignificant risk of change in value. Cash and cash equivalents are carried at cost. Securities The Corporation classifies securities as either held to maturity or available for sale. Debt securities acquired that management has both the positive intent and ability to be held to maturity are classified as held to maturity and recorded 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 excluded from earnings and reported in other comprehensive income, net of tax. Gains or losses realized from the sale of securities available for sale are recorded on the trade date and are determined by using the specific identification method Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. The Corporation does not permit the purchase or sale of trading account securities. Premiums and discounts on securities are recognized in interest income using the interest method over the terms of the securities. Loans Held for Sale Loans originated by ANB Mortgage Corp. are designated as held for sale at the time of their origination. These loans are pre-sold with servicing released and the Bank does not retain any interest or obligation after the loans are sold. These loans consist primarily of fixed-rate, single-family residential mortgage loans which meet the underwriting characteristics of certain government-sponsored enterprises (conforming loans). In addition, the Bank requires a firm purchase commitment from a permanent investor before a loan can be committed, thus limiting interest rate risk. Loans held for sale are carried at the lower of cost or estimated fair value in the aggregate. Gains on sales of loans are recognized at the loan closing date and are included in non-interest income for the period. Rate Lock Commitments ANB Mortgage Corp. enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 30 to 60 days. ANB Mortgage Corp. protects itself from changes in interest rates through the use of best efforts forward delivery commitments, by committing to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, ANB Mortgage Corp. is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity. 38 The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets. ANB Mortgage Corp. determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying assets while taking into consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments. Loans The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by real estate loans. The ability of the Corporation's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the Corporation's market area. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest on all loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Consumer loans are typically charged off when the loan is 120 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The allowance for loan losses has three basic components: the formula allowance, the specific allowance, and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses along with various economic factors and, as a result, could differ from the loss incurred in the future. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. The unallocated allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available and actual losses could be greater or less than the estimates. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment and establishing a specific allowance include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures. 39 Bank Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment are depreciated over their estimated useful lives ranging from three years to thirty-nine years; leasehold improvements are amortized over the lives of the respective leases or the estimated useful life of the leasehold improvement, which ever is less. Software is amortized over three years. Depreciation and amortization are recorded on the straight-line method. Costs of maintenance and repairs are charged to expense as incurred. Costs of replacing structural parts of major units are considered individually and are expensed or capitalized as the facts dictate. Gains and losses on routine dispositions are reflected in current operations. Intangible Assets Premiums paid on acquisitions of deposits (core deposit intangibles) are shown in the "Consolidated Balance Sheets". Such assets are being amortized on a straight-line basis over 10 years. At December 31, 2003, the Bank had $934,000 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, 2003. Core deposit intangibles are periodically reviewed for impairment. As of December 31, 2003, no impairment had been identified. In October 2002, the Financial Accounting Standards Board issued Statement No. 147, Acquisitions of Certain Financial Institutions. After reviewing this statement, the Corporation decided to continue amortization of the core deposit intangible assets related to two previous branch office acquisitions. Foreclosed Properties Foreclosed properties are included in other assets and represent other real estate that has been acquired through loan foreclosures or deeds received in lieu of loan payments. Generally, such properties are appraised at the time booked, 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. The amount of foreclosed properties at December 31, 2003 and 2002 were $303,000 and $30,000, respectively. Income Taxes The Corporation uses the balance sheet method to account for deferred income tax assets and liabilities. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Defined Benefit Plan The Corporation has a pension plan for its employees. Benefits are generally based upon years of service and the employees' compensation. The Corporation's funding policy is to make the maximum contribution permitted by the Employee Retirement Income Security Act. Stock Option Plan The Corporation has a stock option plan, which is described more fully in Note 7. The Corporation accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation (in thousands): 2003 2002 2001 -------- -------- -------- Net income, as reported $ 9,513 $ 9,461 $ 9,415 Deduct: total stock-based compensation expense determined under fair value based method for all awards (136) (169) (160) -------- -------- -------- Pro forma net income $ 9,377 $ 9,292 $ 9,255 ======== ======== ======== Earnings per share: Basic, as reported $ 1.67 $ 1.63 $ 1.58 Basic, pro forma $ 1.64 $ 1.60 $ 1.56 Diluted, as reported $ 1.65 $ 1.62 $ 1.58 Diluted, pro forma $ 1.63 $ 1.59 $ 1.55 40 Earnings Per Share Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury method. Shareholders' Equity During 2003, the Corporation repurchased 125,000 shares of its common stock, in the open market at prices between $23.95 and $26.05 per share. During 2002, the Corporation repurchased 45,100 shares of its common stock, in the open market at prices between $19.55 and $26.05 per share. From the inception of the stock repurchase plan through December 31, 2003, the Corporation has purchased and retired 464,466 shares of its common stock. Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and minimum pension liability adjustments, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Advertising and Marketing Costs Advertising and marketing costs are expensed as incurred. Advertising and marketing costs as of December 31, 2003, 2002 and 2001 were $170,000, $137,000, and $156,000, respectively. Use of Estimates in the Preparation of Financial Statements The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of foreclosed real estate. Reclassifications Certain reclassifications have been made in prior years' financial statements to conform to classifications used in the current year. New Accounting Pronouncements In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," which amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. The provisions of the Statement were effective December 31, 2002. Management currently intends to continue to account for stock-based compensation under the intrinsic value method set forth in Accounting Principles Board ("APB") Opinion 25 and related interpretations. For this reason, the transition guidance of SFAS No. 148 does not have an impact on the Corporation's consolidated financial position or consolidated results of operations. The Statement does amend existing guidance with respect to required disclosures, regardless of the method of accounting used. The revised disclosure requirements are presented herein. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition requirements of the Interpretation were effective beginning January 1, 2003. The initial adoption of the Interpretation did not materially affect the Corporation, and management does not anticipate that the recognition requirements of this Interpretation will have a materially adverse impact on either the Corporation's consolidated financial position or consolidated results of operations in the future. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). This Interpretation provides guidance with respect to the identification of variable interest entities and when the assets, liabilities, noncontrolling interests, and results of operations of a variable interest entity need to be included in a corporation's consolidated 41 financial statements. The Interpretation requires consolidation by business enterprises of variable interest entities in cases where (a) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, or (b) in cases where the equity investors lack one or more of the essential characteristics of a controlling financial interest, which include the ability to make decisions about the entity's activities through voting rights, the obligations to absorb the expected losses of the entity if they occur, or the right to receive the expected residual returns of the entity if they occur. Management has evaluated the Corporation's investments in variable interest entities and potential variable interest entities or transactions. The implementation of FIN 46 did not have a significant impact on either the Corporation's consolidated financial position or consolidated results of operations. Interpretive guidance relating to FIN 46 is continuing to evolve and the Corporation's management will continue to assess various aspects of consolidations and variable interest entity accounting as additional guidance becomes available. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." The Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003 and is not expected to have an impact on the Corporation's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. Adoption of the Statement did not result in an impact on the Corporation's consolidated financial statements. In November 2003, the FASB's Emerging Issues Task Force ("EITF") reached a consensus on a new disclosure requirement related to unrealized losses on investment securities. The new disclosure requires a table of securities which have unrealized losses as of the reporting date. The table must distinguish between those securities which have been in a continuous unrealized loss position for twelve months or more and those securities which have been in a continuous unrealized loss position for less than twelve months. The table is to include the aggregate unrealized losses of securities whose fair values are below book values as of the reporting date, and the aggregate fair value of securities whose fair values are below book values as of the reporting date. In addition to the quantitative disclosure, FASB requires a narrative discussion that provides sufficient information to allow financial statement users to understand the quantitative disclosures and the information that was considered in determining whether impairment was not other-than-temporary. The new disclosure requirements apply to fiscal years ending after December 15, 2003. The Corporation has included the required disclosures in their consolidated financial statements. In December 2003, the FASB issued a revised version of SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits an amendment of FASB Statements No. 87, 88 and 106." This Statement revises employers' disclosures about pension plans and other postretirement benefits. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, No. 88, and No. 106. This Statement retains the disclosure requirements contained in the original FASB Statement No. 132, which it replaces. However, it requires additional disclosures to those in the original Statement 132 about the assets, obligations, cash flows, and net periodic benefit costs of defined benefit pension plans and other defined benefit postretirement plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. The disclosures for earlier annual periods presented for comparative purposes are required to be restated for (a) the percentages of each major category of plan assets held, (b) the accumulated benefit obligation, and (c) the assumptions used in the accounting for the plans. This Statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim-period disclosures required by this Statement are effective for interim periods beginning after December 15, 2003. The Corporation has included the required disclosures in its consolidated financial statements. 42 2. Securities: The amortized cost and estimated fair value of investments in debt and equity securities at December 31, 2003 and 2002 were as follows (in thousands):
2003 ---------------------------------------------------------------------- Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ----------- ---------- ---------- ---------- Securities held to maturity: Federal agencies $ 16,996 $ 100 $ 1 $ 17,095 Mortgage-backed 1,227 62 - 1,289 State and municipal 17,880 1,191 - 19,071 ---------- ------- ------ ---------- Total securities held to maturity 36,103 1,353 1 37,455 ---------- ------- ------ ---------- Securities available for sale: Federal agencies 97,906 676 200 98,382 Mortgage-backed 19,693 572 65 20,200 State and municipal 31,890 933 43 32,780 Corporate bonds 12,894 751 3 13,642 Restricted stock: FHLBA stock 1,741 - - 1,741 Federal Reserve stock 363 - - 363 Other securities 4,925 - 657 4,268 ---------- ------- ------ ---------- Total securities available for sale 169,412 2,932 968 171,376 ---------- ------- ------ ---------- Total securities $ 205,515 $ 4,285 $ 969 $ 208,831 ========== ======= ====== ==========
2002 ---------------------------------------------------------------------- Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ----------- ---------- ---------- ---------- Securities held to maturity: Federal agencies $ 1,996 $ 173 $ - $ 2,169 Mortgage-backed 4,126 144 - 4,270 State and municipal 20,656 1,124 - 21,780 ---------- ------- ------ ---------- Total securities held to maturity 26,778 1,441 - 28,219 ---------- ------- ------ ---------- Securities available for sale: Federal agencies 57,296 900 2 58,194 Mortgage-backed 31,227 1,235 - 32,462 State and municipal 18,623 908 - 19,531 Corporate bonds 18,671 947 9 19,609 Restricted stock: FHLBA stock 2,029 - - 2,039 Federal Reserve stock 363 - - 363 Other securities 4,925 - 67 4,858 ---------- ------- ------ ---------- Total securities available for sale 133,134 3,990 78 137,046 ---------- ------- ------ ---------- Total securities $ 159,912 $ 5,431 $ 78 $ 165,265 ========== ======= ====== ==========
43 The amortized cost and estimated fair value of investments in securities at December 31, 2003, 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. Because mortgage-backed securities have both known principal repayment terms as well as unknown principal repayments due to potential borrower pre-payments, it is difficult to accurately predict the final maturity of these investments. The majority of mortgage-backed securities held have a stated final maturity of greater than ten years and these investments are listed separately below.
Held to Maturity Available for Sale ----------------------------- ---------------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value --------- ---------- --------- ---------- Due in one year or less $ 16,423 $ 16,443 $ 5,763 $ 5,855 Due after one year through five years 9,255 9,851 81,854 83,352 Due after five years through ten years 6,044 6,494 54,315 54,840 Due after ten years 3,154 3,378 7,787 7,129 Mortgage-backed securities 1,227 1,289 19,693 20,200 --------- ---------- --------- ---------- $ 36,103 $ 37,455 $ 169,412 $ 171,376 ========= ========== ========= ==========
Gross realized gains and losses from the call of all securities or the sale of securities available for sale for the years ended December 31, 2003 and 2002 are as follows: 2003 2002 ----- ----- Realized gains $ 115 $ 39 Realized (losses) - - Proceeds from the maturities, payments, and calls of securities held to maturity were $5,678,000 and $6,197,000 in 2003 and 2002. Proceeds from the maturities, payments, calls, and sales of securities available for sale were $74,947,000 and $55,467,000 in 2003 and 2002. Gains from the call of securities prior to maturity were $30,000 and gains from the sale of securities available for sale were $85,000 in 2003. Gains from the call of securities prior to maturity were $36,000 and gains from the sale of securities available for sale were $3,000 in 2002. Securities with a book value of approximately $65,953,000 and $57,525,000 at December 31, 2003 and 2002 were pledged to secure public deposits, repurchase agreements and for other purposes as required by law. Corporate bonds consist of high quality debt securities, primarily issued in the financial services industry. The table below shows (in thousands) gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003.
Less than 12 Months 12 Months or More Total ----------------------------- -------------------------- --------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss -------------- -------------- ------------ ------------- ------------- ------------- Federal agencies $ 36,737 $ 201 $ - $ - $ 36,737 $ 201 Mortgage-backed 6,588 65 - - 6,588 65 State and municipal 5,368 43 - - 5,368 43 Corporate bonds 534 3 - - 534 3 Preferred stock 1,668 332 2,175 325 3,843 657 -------- ----- --------- -------- -------- ----- Total $ 50,895 $ 644 $ 2,175 $ 325 $ 53,070 $ 969 ======== ===== ========= ======== ======== =====
The unrealized loss position is considered temporary and is due to the general decline in interest rates. Those issues in a unrealized loss position for more than 12 months consists of $4,500,000 in preferred stocks. These are a $2,000,000 FHLMC preferred 1.66% where the interest rate adjusts every 2 years based on 2 year Treasury plus 10 basis points with a maximum rate of 11.0%; and $2,500,000 FNMA preferred 3.54% where the interest rate adjusts every 2 years based on 2 year Treasury less 16 basis points with a maximum rate of 11.0%. 70% of the dividends on these issues are tax exempt. Management intends to hold these until maturity. 44 3. Loans: Outstanding loans, excluding loans held for sale, at December 31, 2003 and 2002 were composed of the following (in thousands):
2003 2002 ---------- ---------- Real Estate loans Construction and land development $ 12,790 $ 9,208 Secured by farmland 3,430 1,485 Secured by 1 - 4 family residential properties 136,229 129,905 Secured by multi-family (5 or more) residential properties 6,801 6,329 Secured by nonfarm, nonresidential properties 126,164 107,263 Loans to farmers 1,618 1,844 Commercial and industrial loans 91,419 113,575 Consumer loans 23,581 32,008 Loans for nonrated industrial development obligations 4,077 4,745 Deposit overdrafts 136 41 ---------- ---------- Loans, net of unearned income $ 406,245 $ 406,403 ========== ==========
Certain loans are impaired under FASB Statement No. 114 when, based on current information and events, it is likely that an institution will be unable to collect all amounts due (i.e., both principal and interest) according to the contractual terms of the original loan agreement. No additional funds are committed to be advanced in connection with impaired loans. The following is a summary of information pertaining to impaired loans (in thousands): 2003 2002 ------- ---- Impaired loans for which an allowance has been provided $ 2,548 $ - Impaired loans for which no allowance has been provided - 54 ------- ---- Total impaired loans $ 2,548 $ 54 ======= ==== Allowance provided for impaired loans, included in the allowance for loan losses $ 521 $ - ======= ==== 2003 2002 2001 ------- ----- ----- Average balance in impaired loans $ 1,385 $ 158 $ 160 ======= ===== ===== Interest income recognized $ - $ - $ - ======= ===== ===== Nonaccrual loans excluded from impaired loan disclosure under FASB 114 amounted to $714,000 and $453,000 at December 31, 2003, 2002 and 2001, respectively. If interest on impaired and nonaccrual loans had been accrued, such income would have approximated $45,000, $20,000 and $33,000 for 2003, 2002 and 2001, respectively. Loans past due 90 days and still accruing interest amounted to $53,000, $239,000, and $258,000 as of December 31, 2003, 2002 and 2001, respectively. Properties received due to loan foreclosures were $303,000 at December 31, 2003 and $30,000 at December 31, 2002 and are recorded as other assets on the Consolidated Balance Sheets. The loan portfolio is concentrated primarily in the immediate geographic region. 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, 2003. 45 An analysis of the allowance for loan losses is as follows (in thousands):
2003 2002 2001 -------- -------- -------- Balance, beginning of year $ 5,622 $ 5,334 $ 4,746 Provision for loan losses charged to expense 920 873 1,015 Charge-offs (1,457) (740) (602) Recoveries 207 155 175 -------- -------- -------- Balance, end of year $ 5,292 $ 5,622 $ 5,334 ======== ======== ========
4. Premises and Equipment: Major classifications of premises and equipment are summarized as follows (in thousands):
As of December 31 ------------------------- 2003 2002 --------- --------- Land $ 1,603 $ 1,604 Buildings 7,670 7,375 Leasehold Improvements 878 865 Equipment 9,374 8,996 --------- --------- 19,525 18,840 Less Accumulated Depreciation (11,807) (10,673) --------- --------- Total Premises and Equipment, net of accumulated depreciation $ 7,718 $ 8,167 ========= =========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001 amounted to $1,135,000, $1,144,000 and $1,171,000, respectively. 5. Deposits: The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2003 and 2002 was $61,367,000 and $60,077,000, respectively. At December 31, 2003, the scheduled maturities of CDs are as follows (in thousands): 2004 $ 144,334 2005 38,558 2006 15,046 2007 12,794 2008 8,501 Thereafter 93 --------- $ 219,326 ========= 6. Borrowings: Short-term borrowings consist of the following at December 31, 2003 and 2002 (in thousands): 2003 2002 --------- --------- Repurchase agreements $ 47,035 $ 36,155 Short-term FHLB borrowings - - --------- --------- Total $ 47,035 $ 36,155 ========= ========= Weighted interest rate 1.05% 1.52% Average for the year ended December 31: Outstanding $ 41,168 $ 34,500 Interest rate 1.21% 1.85% Maximum month-end outstanding $ 49,362 $ 40,091 46 Short-term borrowings consist of repurchase agreements and overnight borrowings from the Federal Home Loan Bank of Atlanta ("FHLBA"). Repurchase agreements are borrowings collateralized by securities of the U.S. Government or its agencies and mature daily. The securities underlying these agreements remain under the Corporation's control. Under the terms of its collateral agreement with the Federal Home Loan Bank of Atlanta, the Bank maintains otherwise unencumbered qualifying assets (principally 1-4 family residential mortgage loans and U.S. Government and Agency notes and bonds) in the amount of at least as much as its advances from the FHLBA. The Bank's FHLBA stock is also pledged to secure these advances. As of December 31, 2003, $89,112,000 1-4 family residential mortgage loans were pledged under the blanket floating lien agreement. At December 31, 2003 and 2002, fixed-rate long term advances (in thousands) mature as follows:
Weighted Weighted Due by 2003 Average Due by 2002 Average December 31 Advance Amount Rate December 31 Advance Amount Rate ----------- -------------- -------- ----------- -------------- -------- 2003 $ - - 2003 $ 1,000,000 2.14% 2004 3,000,000 2.67% 2004 3,000,000 2.67 2005 2,000,000 3.53 2005 2,000,000 3.53 2006 2,000,000 4.08 2006 2,000,000 4.08 2007 1,000,000 4.33 2007 1,000,000 4.33 2008 8,000,000 5.25 2008 8,000,000 5.25 2009 5,000,000 5.26 2009 5,000,000 5.26% -------------- -------- -------------- -------- $ 21,000,000 4.56% $ 22,000,000 4.45% ============== ======== ============== ========
All of the above advances are at fixed rates; however at December 31, 2003 $13,000,000 of convertible advances are included in the table whereby the FHLBA has the option at a predetermined time to convert the fixed interest rate to an adjustable rate tied to LIBOR (London Inter Bank Offering Rate). The Bank has the option to repay these advances if the FHLBA converts the interest rate. These advances are included in the year in which they mature. The Bank has a line of credit equal to 15% of the Bank's assets with the FHLBA that equaled approximately $96,550,000 at December 31, 2003. 7. Stock Options: The Corporation's 1997 Stock Option Plan ("Option Plan") provides for the granting of incentive and non-qualified options to employees on a periodic basis, at the discretion of the Board or a Board designated committee. The Option Plan authorizes the issuance of up to 300,000 shares of common stock and has a term of ten years. The weighted average fair values of options at their grant date during 2003, 2002 and 2001 were $9.30, $8.78, and $9.03, 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: 2003 2002 2001 ------ ------ ------ Risk-free interest rate 3.21% 4.08% 4.52% Expected years until exercise 5.00 5.00 5.50 Expected stock volatility 34.58% 36.76% 40.10% At December 31, 2003, and 2002, the Corporation had 54,544 shares and 100,794 shares, respectively, of its authorized common stock reserved for its incentive and nonqualified stock option plan. These options vest from immediately to two years and have a maximum term of ten years from the date of the option grant. A summary of stock option transactions under the plan follows: Option Option Price Shares Per Share --------- -------------- Outstanding at December 31, 2000 151,700 $13.25 - 20.00 Granted 23,800 16.50 Exercised (12,550) 13.25 - 17.19 Forfeited (11,500) 13.56 - 18.75 --------- Outstanding at December 31, 2001 151,450 13.38 - 20.00 Granted 35,700 19.95 - 26.10 Exercised (3,960) 14.00 - 17.19 Forfeited (800) 14.00 - 15.50 --------- Outstanding at December 31, 2002 182,390 13.38 - 26.10 Granted 46,450 24.00 - 26.20 Exercised (4,603) 14.00 - 17.19 Forfeited (200) 14.00 --------- Outstanding at December 31, 2003 224,037 $13.38 - 26.20 ========= 47 The following table summarizes information related to stock options outstanding on December 31, 2003:
Number of Average Life of Number of Options Exercise Price Outstanding Options Outstanding Options Exercisable ----------------- ------------------- ------------------- ----------------- $ 13.38 - $ 26.20 224,037 6.8 years 171,937
8. Income Taxes: The components of the Corporation's net deferred tax assets as of December 31, 2003 and December 31, 2002, were as follows (in thousands): 2003 2002 ------- ------- Deferred tax assets: Allowance for loan losses $ 1,799 $ 1,912 Deferred compensation 250 257 Core deposit intangible 405 354 Pension liability - 150 Other 22 11 ------- ------- Total deferred tax assets 2,476 2,684 ------- ------- Deferred tax liabilities: Depreciation 414 388 Accretion of discount 18 20 Prepaid pension 506 111 Loan loss recapture - 81 Net unrealized gains on securities 668 1,330 Other 150 151 ------- ------- Total deferred tax liabilities 1,756 2,081 ------- ------- Net deferred tax assets $ 720 $ 603 ======= ======= The provision for income taxes consists of the following (in thousands): 2003 2002 2001 ------- ------- ------- Taxes currently payable $ 3,519 $ 3,870 $ 4,298 Deferred tax expense (benefit) 395 48 (357) ------- ------- -------- $ 3,914 $ 3,918 $ 3,941 ======= ======= ======== The effective tax rates differ from the statutory federal income tax rates due to the following items: 2003 2002 2001 ------ ------ ------ Federal statutory rate 34.3% 34.2% 34.2% Nontaxable interest income (5.0) (4.9) (4.9) Other ( .1) - .2 ------ ------ ------ 29.2% 29.3% 29.5% ====== ====== ====== 9. Earnings Per Share: The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential dilutive common stock had no effect on income available to common shareholders. 48
2003 2002 2001 ---------------------- ----------------------- ---------------------- Per Share Per Share Per Share Shares Amount Shares Amount Shares Amount --------- --------- --------- --------- --------- --------- Basic earnings per share 5,702,625 $ 1.67 5,800,302 $ 1.63 5,949,811 $ 1.58 Effect of dilutive securities, stock options 61,502 50,047 23,342 --------- --------- --------- Dilutied earnings per share 5,764,127 $ 1.65 5,850,349 $ 1.62 5,973,153 $ 1.58 ========= ========= =========
Stock options on common stock which were not included in computing diluted EPS in 2003, 2002, and 2001 because their effects were antidilutive were 453 shares, 82 shares, and 1,157 shares, respectively. 10. Commitments and Contingent Liabilities: Financial instruments with off-balance-sheet risk: - -------------------------------------------------- The Corporation is party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Corporation's exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments. At December 31, 2003 and 2002, the following financial instruments were outstanding whose contract amounts represent credit risk: 2003 2002 ------------- ------------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 124,905,000 $ 107,771,000 Standby letters of credit $ 3,477,000 $ 3,489,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation, is based on management's credit evaluation of the customer. Unfunded commitments under commercial lines of credit and revolving credit lines are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Corporation is committed. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation generally holds collateral supporting those commitments if deemed necessary. At December 31, 2003, ANB Mortgage Corp. had locked-rate commitments to originate mortgage loans amounting to approximately $1,019,000 and loans held for sale of $560,000. ANB Mortgage Corp. has entered into commitments, on a best-effort basis to sell loans of approximately $1,579,000. Risks arise from the possible inability of counterparties to meet the terms of their contracts. ANB Mortgage Corp. does not expect any counterparty to fail to meet its obligations. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities. There was $700,000 in commitments to purchase securities at December 31, 2003 and none at December 31, 2002. 49 Concentration of credit risk: - ----------------------------- The Corporation is principally a local lender and therefore has a significant concentration of residential and commercial real estate loans as well as consumer and commercial business loans to borrowers who reside in and/or which are collateralized by real estate located primarily in our trade area. Other commitments: - ------------------ The Bank has entered into operating leases for several of its branch and ATM facilities. The minimum annual rental payments under these leases at December 31, 2003, (in thousands) are as follows: Minimum Lease Year Payments ------------------- ------------- 2004 $ 116 2005 85 2006 69 2007 59 2008 54 2009 and thereafter $ 84 Rent expense under these leases for each of the years ended December 31, 2003, 2002, and 2001, were $126,000, $121,000, and $119,000, respectively. The Bank is a member of the Federal Reserve System and is required to maintain certain levels of its cash and cash equivalents as reserves based on regulatory requirements. This reserve requirement was approximately $3,679,000 at December 31, 2003 and $3,098,000 at December 31, 2002. ANB Mortgage Corp. originates and sells residential real estate loans to investors. Based on certain pre-defined criteria, including borrower non-payment or fraud, ANB Mortgage Corp. may be required to repurchase loans back from the investor. Since the inception of ANB Mortgage Corp. no loans have been repurchased. 11. Related Party Transactions: The Corporation's Directors provide the Bank with substantial amounts of business, and many are among its largest depositors and borrowers. The maximum amount of loans outstanding to total loans for officers, directors and their business interests at any month-end during 2003 was 5.5% and during 2002 was 5.5%. 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, 2003, none of these loans were restructured, nor were any related party loans charged off during 2003. An analysis of these loans for 2003 is as follows (in thousands): Balance, beginning of year $ 21,414 Additions 32,554 Repayments (35,157) --------- Balance, end of year $ 18,811 ========= 12. Employee Benefit Plans: The retirement plan is a non-contributory defined benefit pension plan which covers substantially all employees who are 21 years of age or older and who have had at least one year of service. Advanced funding is accomplished by using the actuarial cost method known as the collective aggregate cost method. The Company uses October 31 as a measurement date to determine postretirement benefit obligations. All dollar amounts are shown in thousands, unless otherwise noted. 50 The following table sets forth the plan's status as of December 31, 2003 and 2002 (in thousands):
2003 2002 ------- ------- Change in benefit obligation: Benefit obligation at beginning of year $ 4,875 $ 4,837 Service cost 377 319 Interest cost 330 336 Plan amendments 17 - Actuarial (gain) loss 155 274 Benefits paid (44) (891) -------- -------- Benefit obligation at end of year $ 5,710 $ 4,875 ======== ======== Accumulated benefit obligation, end of year $ 4,241 $ 3,546 Change in plan assets: Fair value of plan assets at beginning of year $ 3,431 $ 4,360 Actual return on plan assets 587 (692) Employer contributions 1,678 654 Benefits paid (44) (891) -------- -------- Fair value of plan assets at end of year $ 5,652 $ 3,431 ======== ======== Deferred asset (gain) loss $ (298) $ 1,037 Prepaid pension cost: Funded status $ (58) $(1,445) Unrecognized net actuarial (gain) loss 1,603 1,871 Unrecognized net obligation at transition - (5) Unrecognized prior service cost (57) (96) -------- -------- (Accrued) benefit cost included in other liabilities $ 1,488 $ 325 ======== ======== Amounts recognized in the statement of financial position: Prepaid asset $ 1,488 $ 325 Accrued benefit liability - (441) Deferred income tax benefit - 150 Accumulated other comprehensive income, net - 291 -------- -------- Net amount recognized $ 1,488 $ 325 ======== ========
Major assumptions and net periodic pension cost include the following:
2003 2002 ------- ------- Components of net periodic benefit cost: Service cost $ 377 $ 319 Interest cost 330 337 Expected return on plan assets (289) (346) Amortization of prior service cost (22) (24) Amortization of net obligation at transition (5) (12) Recognized net actuarial gain 125 7 ------- ------- Net periodic benefit cost $ 516 $ 281 ======= ======= Weighted-average assumptions for benefit obligations: Discount rate Pre-retirement 6.50% 6.75% Post-retirement 6.00% 6.00% Expected return on plan assets 8.00% 8.00% Rate of compensation increase 4.00% 4.00%
51
2003 2002 ------- ------- Weighted-average assumptions for net periodic benefit cost: Discount rate Pre-retirement 6.75% 7.00% Post-retirement 6.00% 6.00% Expected return on plan assets 8.00% 8.00% Rate of compensation increase 4.00% 4.00%
The Company selects the expected long-term rate-of-return-on-assets assumption in consultation with their investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period and higher significance is placed on current forecasts of future long-term economic conditions. Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).
2003 2002 ------- ------- Information for pension plans with an accumulated benefit obligation in excess of plan assets: Projected benefit obligation $ 5,710 $ 4,876 Accumulated benefit obligation 4,241 3,546 Fair value of plan assets 5,652 3,431 Additional Information: Pension Benefits ----------------------- 2003 2002 ------- ------- Increase in minimum liability included in other comprehensive income $ N/A $ 441
Below is a description of the plan's assets. The plan's weighted-average asset allocations at December 31, 2003, and December 31, 2002, by asset category are as follows: 2003 2002 -------- -------- Asset Category Money Market and Equivalents .1% 10.1% Equity Securities 77.5 60.9 Debt Securities 22.4 29.0 Real Estate - - Other - - -------- -------- Total 100.0% 100.0% ======== ======== The Investment policy and strategies for plan assets can best be described as a growth and income strategy. The Target allocation is for 75% of the assets to be invested in large and mid capitalization equity securities with the remaining 25% invested in fixed income investments. Diversification is accomplished by limiting the holding in any one equity issuer to no more than 5% of total equities. Exchange traded funds are used to provide diversified exposure to the small capitalization and international equity markets. All fixed income investments are rated as investment grade, with the majority of these assets invested in corporate issues. The Assets are managed by the Trust Division of American National Bank and Trust Company. No derivatives are used to manage the assets. Equity securities do not include holdings in the Corporation. 52 A 401(k) savings plan was adopted in 1995 that 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 $151,000, $136,000 and $116,000 to the 401(k) plan in 2003, 2002 and 2001, respectively. These amounts are included in pension and other employee benefits expense for the respective years. In 1982, the Board of Directors of the Bank adopted deferred compensation agreements with certain key officers providing for annual payments to each ranging from $25,000 to $50,000 per year for ten years upon their retirement. The liabilities under these agreements are being accrued over the officers' remaining period of employment so that, on the date of their retirement, the then-present value of the annual payments would have been accrued. The expense for this plan was $84,000, $77,000 and $68,000 for years 2003, 2002 and 2001, respectively. 13. Fair Value of Financial Instruments: The estimated fair values of the Corporation's assets are as follows (in thousands):
December 31, 2003 December 31, 2002 ------------------------------ -------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------- ---------- ---------- ---------- Financial assets: Cash and due from banks $ 17,887 $ 17,887 $ 23,478 $ 23,478 Securities, available for sale 171,376 171,376 137,046 137,046 Securities held to maturity 36,103 37,455 26,778 28,219 Loans held for sale 560 560 1,285 1,285 Loans, net of allowance 400,953 407,128 400,781 408,792 Accrued interest receivable 4,123 4,123 3,556 3,556 Financial liabilities: Deposits $ 501,688 $ 503,409 $ 473,562 $ 474,102 Repurchase agreements 47,035 47,035 36,155 36,155 Other borrowings 21,000 22,328 22,000 24,884 Accrued interest payable 835 835 1,065 1,065 Off balance sheet instruments: Commitments to extend credit $ - $ - $ - $ - Standby letters of credit - 35 - 35 Rate lock commitments - - - -
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 cash equivalents. The carrying amount is a reasonable estimate of fair value. Securities. Fair values are based on quoted market prices or dealer quotes. The carrying value of restricted stock approximates fair value. Loans Held for Sale. The carrying amount is a reasonable estimate of fair value. Loans. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. 53 Accrued interest receivable. The carrying amount is a reasonable estimate of fair value. Deposits. The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposit instruments would be offered to depositors for the same remaining maturities at current rates. Repurchase agreements. The carrying amount is a reasonable estimate of fair value. Other borrowings. The fair vales of the Corporation's long-term borrowings are estimated using discounted cash flow analyses based on the Corporation's incremental borrowing rates for similar types of borrowing arrangements. Accrued interest payable. 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. Fees are generally not charged 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. The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Corporation's overall interest rate risk. 14. Dividend Restrictions and Regulatory Capital: The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of the Corporation's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's and the Bank's capital amounts and classification are subject to qualitative judgments by the regulators concerning components, risk weighting, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. 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 shareholders' 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 plus 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, 2003, the Corporation's Tier I and total capital ratios were 14.85% and 15.99%, respectively. At December 31, 2002, these ratios were 14.41% and 15.63%, respectively. The ratios for both years were well in 54 excess of the regulatory requirements. Management believes, as of December 31, 2003, that the Corporation and the Bank meet all regulatory capital adequacy requirements to which they are subject. 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, $4,131,000 plus an additional amount equal to the Bank's net income for 2003 up to the date of any dividend declaration. The following table provides summary information regarding regulatory capital (in thousands):
To Be Well Minimum Capitalized Under Capital Prompt Corrective Actual Requirement Action Provisions ----------------------- ---------------------- -------------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of December 31, 2003 Total Capital Corporation $ 74,222 15.99% $ 37,137 >8.0% Bank 71,867 15.50% 37,092 >8.0% $ 46,364 >10.0% Tier I Capital Corporation 68,930 14.85% 18,569 >4.0% Bank 67,248 14.50% 18,546 >4.0% 27,819 >6.0% Leverage Capital Corporation 68,930 10.76% 19,221 >3.0% Bank 67,248 10.51% 19,194 >3.0% 31,989 >5.0% As of December 31, 2002 Total Capital Corporation $ 72,021 15.63% $ 36,863 >8.0% Bank 69,328 15.06% 36,816 >8.0% $ 46,020 >10.0% Tier I Capital Corporation 66,399 14.41% 18,431 >4.0% Bank 64,359 13.98% 18,408 >4.0% 27,612 >6.0% Leverage Capital Corporation 66,399 11.00% 18,103 >3.0% Bank 64,359 10. 68% 18,076 >3.0% 30,126 >5.0%
15. Segment and Related Information: In accordance with SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", 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. Loan fee 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. The assets, liabilities and operating results of the Bank's two subsidiaries, ANB Mortgage Corp. and ANB Services Corp. are included in the other segment. ANB Mortgage Corp. performs 55 secondary mortgage banking and ANB Services Corp. performs retail investment and insurance sales. Trust and investment services include 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 2003, 2002 and 2001 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. Inter-segment eliminations primarily consist of the Corporation's investment in the Bank and related equity earnings.
2003 ----------------------------------------------------------------------- Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ --------- Interest income $ 32,178 $ - $ 55 $ (55) $ 32,178 Interest expense 9,391 - 55 (55) 9,391 Non-interest income - external customers 3,314 2,523 834 - 6,671 Non-interest income - internal customers - 48 - (48) - Operating income before income taxes 11,975 1,326 126 - 13,427 Depreciation and amortization 1,555 24 6 - 1,585 Total assets 643,863 - 1,902 (1,463) 644,302 Capital expenditures 682 3 2 - 687
2002 ----------------------------------------------------------------------- Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ --------- Interest income $ 35,135 $ - $ 31 $ (31) $ 35,135 Interest expense 12,310 - 31 (31) 12,310 Non-interest income - external customers 2,564 2,516 632 - 5,712 Non-interest income - internal customers - 48 - (48) - Operating income before income taxes 11,798 1,543 38 - 13,379 Depreciation and amortization 1,570 21 3 - 1,594 Total assets 604,482 - 2,468 (1,091) 605,859 Capital expenditures 1,331 16 123 - 1,470
2001 ----------------------------------------------------------------------- Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------- ------------ --------- Interest income $ 39,820 $ - $ 30 $ (30) $ 39,820 Interest expense 17,502 - 30 (30) 17,502 Non-interest income - external customers 2,509 2,569 590 - 5,668 Non-interest income - internal customers - 54 - (54) - Operating income before income taxes 11,697 1,656 4 - 13,357 Depreciation and amortization 1,586 25 10 - 1,621 Total assets 572,567 - 1,209 (889) 572,887 Capital expenditures 1,141 16 1 - 1,158
56 16. Parent Company Financial Information: Condensed parent company financial information is as follows (in thousands): As of December 31 ---------------------- Condensed Balance Sheets 2003 2002 ------------------------ -------- -------- Assets Cash $ 1,782 $ 1,126 Assets Cash $ 1,397 $ 1,782 Investment in Subsidiary 69,912 68,369 Other Assets 622 585 -------- -------- Total Assets $ 71,931 $ 70,736 ======== ======== Liabilities $ - $ - Shareholders' Equity 71,931 70,736 -------- -------- Total Liabilities and Shareholders' Equity $ 71,931 $ 70,736 ======== ========
For the Year Ended December 31 ------------------------------------- Condensed Statements of Income 2003 2002 2001 ------------------------------ --------- --------- --------- Dividends from Subsidiary $ 7,078 $ 6,000 $ 8,985 Income 4 10 - Expenses 159 145 105 Income taxes (benefit) (52) - - --------- --------- --------- Income Before Equity in Undistributed Earnings of Subsidiary 6,975 5,865 8,880 Equity in Undistributed Earnings of Subsidiary 2,538 3,596 535 --------- --------- --------- Net Income $ 9,513 $ 9,461 $ 9,415 ========= ========= =========
For the Year Ended December 31 ------------------------------------- Condensed Statements of Cash Flows 2003 2002 2001 ---------------------------------- --------- --------- --------- Cash provided by dividends received from Subsidiary $ 7,078 $ 6,000 $ 8,985 Cash used for payment of dividends (4,272) (4,117) (3,924) Cash used for repurchase of stock (3,128) (1,049) (4,600) Process from exercise of options 76 61 182 Other (139) (239) (129) --------- --------- --------- Net (decrease) increase in cash $ (385) $ 656 $ 514 ========= ========= =========
57 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 15, 2004 AMERICAN NATIONAL BANKSHARES INC. By: /s/ Brad E. Schwartz ------------------------------------------- Senior Vice President, Secretary, Treasurer & Chief Financial Officer 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 15, 2004. /s/ Charles H. Majors - ----------------------------- President and Charles H. Majors Chief Executive Officer /s/ Willie G. Barker, Jr. Director - ----------------------------- Willie G. Barker, Jr. /s/ Richard G. Barkhouser Director - ----------------------------- Richard G. Barkhouser /s/ Fred A. Blair Director - ----------------------------- Fred A. Blair /s/ Ben J. Davenport, Jr. Director - ----------------------------- Ben J. Davenport, Jr. /s/ H. Dan Davis Director - ----------------------------- H. Dan Davis /s/ Michael P. Haley Director - ----------------------------- Michael P. Haley /s/ Lester A. Hudson, Jr. Director - ----------------------------- Lester A. Hudson, Jr. /s/ E. Budge Kent, Jr. Director - ----------------------------- E. Budge Kent, Jr. /s/ Fred B. Leggett, Jr. Director - ----------------------------- Fred B. Leggett, Jr. /s/ Franklin W. Maddux Director - ----------------------------- Franklin W. Maddux /s/ James A. Motley Director - ----------------------------- James A. Motley /s/ Claude B. Owen, Jr. Director - ----------------------------- Claude B. Owen, Jr. /s/ Brad E. Schwartz - ----------------------------- Senior Vice President, Secretary, Treasurer Brad E. Schwartz & Chief Financial Officer 58 EX-31 2 ex3110k2003.txt EXHIBIT 31 10(K) 2003 Exhibit 31.1 SECTION 302 CERTIFICATION* I, Charles H. Majors, certify that: 1. I have reviewed this annual report on Form 10-K of American National Bankshares Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 10, 2004 /s/ Charles H. Majors - ------------------------------------- Charles H. Majors, President and Chief Executive Officer Exhibit 31.2 SECTION 302 CERTIFICATION* I, Brad E. Schwartz, certify that: 1. I have reviewed this annual report on Form 10-K of American National Bankshares Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 10, 2004 /s/ Brad E. Schwartz - ------------------------------------------- Brad E. Schwartz, Senior Vice President, Secretary, Treasurer & Chief Financial Officer EX-32 3 ex3210k2003.txt EXHIBITS 32 10(K) 2003 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANNES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of American National Bankshares Inc. (the "Company") for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Charles H. Majors, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbannes-Oxley Act of 2002, that: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Charles H. Majors - ------------------------------------- Charles H. Majors President and Chief Executive Officer March 10, 2004 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANNES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of American National Bankshares Inc. (the "Company") for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Charles H. Majors, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbannes-Oxley Act of 2002, that: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Brad E. Schwartz - --------------------------------------------- Brad E. Schwartz Senior Vice-President and Secretary-Treasurer (Chief Financial Officer) March 10, 2004 -----END PRIVACY-ENHANCED MESSAGE-----