10-Q 1 jun200410q.txt 06/2004 10Q - AMERICAN NATL BANKSHARES INC UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2004. -------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . ----- ----- Commission file number 0-12820 ------- AMERICAN NATIONAL BANKSHARES INC. --------------------------------- (Exact name of registrant as specified in its charter) VIRGINIA 54-1284688 -------------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 628 Main Street Danville, Virginia 24541 ---------------------------------------- -------------------- (Address of principal executive offices) (Zip Code) (434) 792-5111 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No ----- ----- At July 30, 2004, the Corporation had 5,593,430 shares Common Stock outstanding, $1 par value. AMERICAN NATIONAL BANKSHARES INC. INDEX
Page No. -------- Index...............................................................................2 Part I. Financial Information Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003..................................................3 Consolidated Statements of Income for the three months ended June 30, 2004 and 2003...........................................4 Consolidated Statements of Income for the six months ended June 30, 2004 and 2003...........................................5 Consolidated Statements of Changes in Shareholders' Equity for the six months ended June 30, 2004 and 2003........................6 Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003...........................................7 Notes to Consolidated Financial Statements...............................9 Item 2. Management's Discussion and Analysis of the Financial Condition and Results of Operations.............................................15 Item 3. Quantitative and Qualitative Disclosures about Market Risk..............25 Item 4. Controls and Procedures.................................................25 Part II. Other Information........................................................26 SIGNATURES ........................................................................27 Exhibits...........................................................................28
2 Consolidated Balance Sheets American National Bankshares Inc. and Subsidiary (In Thousands) --------------------------------------------------------------------------------------------------------------
(Unaudited) (Audited) June 30 December 31 2004 2003 ------------ ------------- ASSETS Cash and due from banks.........................................................$ 14,829 $ 16,236 Interest-bearing deposits in other banks........................................ 1,097 1,652 Securities available for sale, at fair value.................................... 180,052 171,376 Securities held to maturity (market value of $20,371 at June 30, 2004 and $37,455 at December 31, 2003)............................... 19,528 36,103 ----------- ----------- 199,580 207,479 ----------- ----------- Loans held for sale............................................................. 1,059 560 Loans, net of unearned income .................................................. 400,613 406,245 Less allowance for loan losses.................................................. (5,457) (5,292) ----------- ----------- Net loans..................................................................... 395,156 400,953 ----------- ----------- Bank premises and equipment, at cost, less accumulated depreciation of $12,297 in 2004 and $11,807 in 2003........................... 7,710 7,718 Core deposit intangibles, net................................................... 709 934 Accrued interest receivable and other assets.................................... 10,431 8,770 ----------- ----------- Total assets..................................................................$ 630,571 $ 644,302 =========== =========== LIABILITIES and SHAREHOLDERS' EQUITY Liabilities: Demand deposits -- non-interest bearing.......................................$ 75,121 $ 71,027 Demand deposits -- interest bearing........................................... 71,071 69,053 Money market deposits......................................................... 50,434 59,251 Savings deposits.............................................................. 84,393 83,031 Time deposits................................................................. 203,878 219,326 ----------- ----------- Total deposits................................................................ 484,897 501,688 ----------- ----------- Repurchase agreements......................................................... 47,911 47,035 FHLB borrowings............................................................... 23,763 21,000 Accrued interest payable and other liabilities................................ 3,341 2,648 ----------- ----------- Total liabilities............................................................. 559,912 572,371 ----------- ----------- Shareholders' equity: Preferred stock, $5 par, 200,000 shares authorized, none outstanding............................................................ - - Common stock, $1 par, 10,000,000 shares authorized, 5,593,430 shares outstanding at June 30, 2004 and 5,660,419 shares outstanding at December 31, 2003....................... 5,593 5,660 Capital in excess of par value................................................ 9,446 9,437 Retained earnings............................................................. 56,620 55,538 Accumulated other comprehensive income (loss), net............................ (1,000) 1,296 ---------- ---------- Total shareholders' equity.................................................... 70,659 71,931 ---------- ---------- Total liabilities and shareholders' equity....................................$ 630,571 $ 644,302 ========== ========== The accompanying notes are an integral part of the consolidated financial statements.
3 Consolidated Statements of Income American National Bankshares Inc. and Subsidiary (Unaudited) (In Thousands) ---------------------------------------------------------------------------------------------------------
Three Months Ended June 30 ------------------------- 2004 2003 ---------- ---------- Interest Income: Interest and fees on loans....................................................$ 5,572 $ 6,508 Interest on deposits in other banks........................................... 13 11 Income on securities: Federal agencies............................................................ 835 511 Mortgage-backed............................................................. 233 385 State and municipal......................................................... 525 515 Other....................................................................... 232 305 ---------- ---------- Total interest income....................................................... 7,410 8,235 ---------- ---------- Interest Expense: Interest on deposits: Demand...................................................................... 61 61 Money market................................................................ 92 125 Savings..................................................................... 104 212 Time........................................................................ 1,233 1,677 Interest on repurchase agreements............................................. 124 135 Interest on other borrowings.................................................. 250 248 ---------- ---------- Total interest expense...................................................... 1,864 2,458 ---------- ---------- Net Interest Income............................................................. 5,546 5,777 Provision for Loan Losses....................................................... 255 255 ---------- ---------- Net Interest Income After Provision For Loan Losses............................................................... 5,291 5,522 ---------- ---------- Non-Interest Income: Trust and investment services................................................. 743 647 Service charges on deposit accounts........................................... 631 541 Other fees and commissions.................................................... 222 210 Mortgage banking income....................................................... 211 150 Securities gains (losses), net................................................ 14 1 Other......................................................................... 224 66 ---------- ---------- Total non-interest income................................................... 2,045 1,615 ---------- ---------- Non-Interest Expense: Salaries...................................................................... 1,846 1,754 Pension and other employee benefits........................................... 412 522 Occupancy and equipment....................................................... 647 640 Core deposit intangible amortization ......................................... 113 113 Other......................................................................... 931 853 ---------- ---------- Total non-interest expense.................................................. 3,949 3,882 ---------- ---------- Income Before Income Tax Provision.............................................. 3,387 3,255 Income Tax Provision............................................................ 963 947 ---------- ---------- Net Income......................................................................$ 2,424 $ 2,308 ========== ========== --------------------------------------------------------------------------------------------------------- Net Income Per Common Share: Basic...........................................................................$ .43 $ .40 Diluted.........................................................................$ .43 $ .40 --------------------------------------------------------------------------------------------------------- Average Common Shares Outstanding: Basic...........................................................................5,610,462 5,718,821 Diluted.........................................................................5,657,721 5,776,591 --------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements.
4 Consolidated Statements of Income American National Bankshares Inc. and Subsidiary (Unaudited) (In Thousands) ---------------------------------------------------------------------------------------------------------
Six Months Ended June 30 ------------------------- 2004 2003 ---------- ---------- Interest Income: Interest and fees on loans....................................................$ 11,313 $ 13,067 Interest on deposits in other banks........................................... 44 36 Income on securities: Federal agencies............................................................ 1,657 1,060 Mortgage-backed............................................................. 466 839 State and municipal......................................................... 1,037 984 Other....................................................................... 474 651 ---------- ---------- Total interest income....................................................... 14,991 16,637 ---------- ---------- Interest Expense: Interest on deposits: Demand...................................................................... 120 129 Money market................................................................ 194 264 Savings..................................................................... 213 437 Time........................................................................ 2,560 3,397 Interest on repurchase agreements............................................. 251 260 Interest on other borrowings.................................................. 491 490 ---------- ---------- Total interest expense...................................................... 3,829 4,977 ---------- ---------- Net Interest Income............................................................. 11,162 11,660 Provision for Loan Losses....................................................... 470 495 ---------- ---------- Net Interest Income After Provision For Loan Losses............................................................... 10,692 11,165 ---------- ---------- Non-Interest Income: Trust and investment services................................................. 1,471 1,253 Service charges on deposit accounts........................................... 1,205 964 Other fees and commissions.................................................... 468 438 Mortgage banking income....................................................... 344 278 Securities gains (losses), net................................................ 119 3 Other......................................................................... 291 141 ---------- ---------- Total non-interest income................................................... 3,898 3,077 ---------- ---------- Non-Interest Expense: Salaries...................................................................... 3,614 3,475 Pension and other employee benefits........................................... 834 970 Occupancy and equipment....................................................... 1,264 1,281 Core deposit intangible amortization ......................................... 225 225 Other......................................................................... 1,813 1,740 ---------- ---------- Total non-interest expense.................................................. 7,750 7,691 ---------- ---------- Income Before Income Tax Provision.............................................. 6,840 6,551 Income Tax Provision............................................................ 1,946 1,909 ---------- ---------- Net Income......................................................................$ 4,894 $ 4,642 ========== ========== --------------------------------------------------------------------------------------------------------- Net Income Per Common Share: Basic...........................................................................$ .87 $ .81 Diluted.........................................................................$ .86 $ .80 --------------------------------------------------------------------------------------------------------- Average Common Shares Outstanding: Basic...........................................................................5,629,370 5,737,354 Diluted.........................................................................5,681,795 5,796,769 --------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements.
5 Consolidated Statements of Changes in Shareholders' Equity American National Bankshares Inc. and Subsidiary Six Months Ended March 31, 2004 and 2003 (Unaudited) (Dollars in Thousands)
Accumulated Common Stock Capital in Other Total ------------------------- Excess of Retained Comprehensive Shareholders' Shares Amount Par Value Earnings Income (Loss) Equity ----------- ------------ ------------ ------------- -------------- ------------- Balance, December 31, 2002...................... 5,780,816 $ 5,781 $ 9,571 $ 53,093 $ 2,291 $ 70,736 Net income...................................... - - - 4,642 - 4,642 Change in unrealized gains (losses) on securities available for sale, net of tax of $(247)...... - - - - (477) -------------- Other comprehensive income.................... (477) (477) ------------- Total comprehensive income.................... 4,165 Stock repurchased and retired................... (100,000) (100) (165) (2,221) - (2,486) Stock options exercised......................... 93 - 1 - - 1 Cash dividends paid............................. - - - (2,118) - (2,118) ----------- ------------ ------------ ------------- -------------- ------------- Balance, June 30, 2003.......................... 5,680,909 $ 5,681 $ 9,407 $ 53,396 $ 1,814 $ 70,298 =========== ============ ============= ============= ============== ============= Balance, December 31, 2003...................... 5,660,419 $ 5,660 $ 9,437 $ 55,538 $ 1,296 $ 71,931 Net income...................................... - - - 4,894 - 4,894 Change in unrealized gains (losses) on securities available for sale, net of tax of $(1,154).... - - - - (2,240) Less: Reclassification adjustment for (gains) losses on securities available for sale, net of tax $(29).................................. - - - - (56) -------------- Other comprehensive income.................... (2,296) (2,296) ------------- Total comprehensive income.................... 2,598 Stock repurchased and retired................... (75,568) (76) (126) (1,621) - (1,823) Stock options exercised......................... 8,579 9 135 - - 144 Cash dividends paid............................. - - - (2,191) - (2,191) ----------- ------------ ------------ ------------- -------------- ------------- Balance, June 30, 2004.......................... 5,593,430 $ 5,593 $ 9,446 $ 56,620 $ (1,000) $ 70,659 =========== ============ ============= ============= ============== ============= The accompanying notes are an integral part of the consolidated financial statements.
6 Consolidated Statements of Cash Flows American National Bankshares Inc. and Subsidiary (Unaudited) (In Thousands) ---------------------------------------------------------------------------------------------------------
Six Months Ended ------------------------- June 30 2004 2003 ---------- ---------- Cash Flows from Operating Activities: Net income....................................................................$ 4,894 $ 4,642 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses..................................................... 470 495 Depreciation.................................................................. 490 582 Core deposit intangible amortization.......................................... 225 225 Amortization (accretion) of bond premiums and discounts, net.................. 390 471 Gain on sale or call of securities............................................ (119) (3) Gain on loans held for sale................................................... (263) (278) Proceeds from sales of loans held for sale.................................... 13,223 14,044 Originations of loans held for sale........................................... (13,459) (14,587) Loss on sale of real estate owned............................................. 14 - Gain on sale of premises and equipment........................................ (150) - Deferred income taxes (benefit) provision..................................... (109) 7 Increase in interest receivable............................................... (4) (651) Increase in other assets...................................................... (417) (877) Decrease in interest payable.................................................. (114) (102) Increase (decrease) in other liabilities...................................... 807 (35) ---------- ---------- Net cash provided by operating activities..................................... 5,878 3,933 ---------- ---------- Cash Flows from Investing Activities: Proceeds from sales of securities available for sale.......................... 4,567 - Proceeds from maturities and calls of securities available for sale........... 40,266 37,067 Proceeds from maturities and calls of securities held to maturity............. 16,591 2,677 Purchases of securities available for sale.................................... (57,275) (41,766) Net decrease (increase) in loans.............................................. 5,167 (26,464) Proceeds from sale of bank property and equipment............................. 205 - Purchases of bank property and equipment...................................... (537) (345) Proceeds from sales of other real estate owned................................ 198 - ---------- ---------- Net cash provided by (used in) investing activities........................... 9,182 (28,831) ---------- ----------
(Continued on next page) 7 Consolidated Statements of Cash Flows American National Bankshares Inc. and Subsidiary (Unaudited) (In Thousands) ---------------------------------------------------------------------------------------------------------
Six Months Ended ------------------------- June 30 2004 2003 ---------- ---------- Cash Flows from Financing Activities: Net (decrease) increase in demand, money market, and savings deposits........................................................ (1,343) 6,560 Net (decrease) increase in time deposits...................................... (15,448) 10,049 Net increase in repurchase agreements......................................... 876 9,907 Net increase (decrease) in FHLB borrowings.................................... 2,763 (500) Cash dividends paid........................................................... (2,191) (2,118) Repurchase of stock........................................................... (1,823) (2,486) Proceeds from exercise of stock options....................................... 144 1 ---------- ---------- Net cash (used in) provided by financing activities........................... (17,022) 21,413 ---------- ---------- Net (Decrease) in Cash and Cash Equivalents..................................... (1,962) (3,485) Cash and Cash Equivalents at Beginning of Period................................ 17,888 23,477 ---------- ---------- Cash and Cash Equivalents at End of Period......................................$ 15,926 $ 19,992 ========== ========== Supplemental Schedule of Cash and Cash Equivalents: Cash: Cash and due from banks.......................................................$ 14,829 $ 12,039 Interest-bearing deposits in other banks...................................... 1,097 7,953 ---------- ---------- $ 15,926 $ 19,992 ========== ========== Supplemental Disclosure of Cash Flow Information: Interest paid.................................................................$ 3,943 $ 5,080 Income taxes paid.............................................................$ 1,726 $ 1,718 Transfer of loans to other real estate owned..................................$ 160 $ 94 Unrealized loss on securities available for sale..............................$ (3,479) $ (724) The accompanying notes are an integral part of the consolidated financial statements.
8 AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly American National Bankshares' financial position as of June 30, 2004; the consolidated statements of income for the three and six months ended June 30, 2004 and 2003; the consolidated statements of changes in shareholders' equity for the six months ended June 30, 2004 and 2003; and the consolidated statements of cash flows for the six months ended June 30, 2004 and 2003. Operating results for the three month and six month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. 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") and the Bank's two subsidiaries, ANB Mortgage Corp. and ANB Services Corp. 2. STOCK BASED COMPENSATION As of June 30, 2004 the Corporation had a stock-based compensation plan. The Corporation accounts for the plan under the recognition and measurement principles of APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following illustrates the effect on net income and earnings per share for the three month periods ended June 30, 2004, and 2003 had the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, been adopted.
Six Months Ended June 30 ----------------------- 2004 2003 -------- -------- (Dollars in thousands except per share amounts) Net income, as reported $ 4,894 $ 4,642 Deduct: total stock-based employee compensation expense determined based on fair value method of awards (141) (54) -------- -------- Pro forma net income $ 4,753 $ 4,588 ======== ======== Basic earnings per share: As reported $ .87 $ .81 Pro forma $ .85 $ .80 Diluted earning per share: As reported $ .86 $ .80 Pro Forma $ .84 $ .79
The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 2004 and 2003, respectively: price volatility of 33.76% and 34.79%; risk-free interest rates of 3.90% and 2.34%, expected dividend yields of 3.00%, and expected lives of 5 years. There were 5,000 grants in the second quarter of 2004. 9 3. SECURITIES The amortized cost and estimated fair value of debt and equity securities at June 30, 2004 and December 31, 2003 were as follows (in thousands):
June 30, 2004 --------------------------------------------------------------------- Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ------------- --------------- -------------- -------------- Securities held to maturity: Federal agencies $ 1,999 $ 48 $ - $ 2,047 Mortgage-backed 896 39 - 935 State and municipal 16,633 759 3 17,389 --------- -------- -------- --------- Total securities held to maturity 19,528 846 3 20,371 --------- -------- -------- --------- Securities available for sale: Federal agencies 102,022 147 1,212 100,957 Mortgage-backed 23,144 356 225 23,275 State and municipal 36,095 480 596 35,979 Corporate bonds 13,373 471 96 13,748 Restricted stock: FHLBA stock 1,645 - - 1,645 Federal Reserve stock 363 - - 363 Other securities 4,925 - 840 4,085 --------- -------- -------- --------- Total securities available for sale 181,567 1,454 2,969 180,052 --------- -------- -------- --------- Total securities $ 201,095 $ 2,300 $ 2,972 $ 200,423 ========= ======== ======== =========
December 31, 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 ========= ======== ======== =========
10 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 June 30, 2004.
Less than 12 Months 12 Months or More Total ------------------------ ----------------------- ----------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss -------- ---------- --------- ---------- -------- ---------- Federal agencies $ 68,931 $ 1,071 $ 8,869 $ 141 $ 77,800 $ 1,212 Mortgage-backed 12,399 204 1,738 21 14,137 225 State and municipal 23,181 582 188 17 23,369 599 Corporate bonds 2,452 96 - - 2,452 96 Preferred stock - - 3,660 840 3,660 840 -------- ------- --------- -------- -------- ------- Total $106,963 $ 1,953 $ 14,455 $ 1,019 $121,418 $ 2,972 ======== ======= ========= ======== ======== =======
The unrealized loss position is considered temporary and is due to the general decline in interest rates.The unrealized loss of these securities is based solely on interest rate changes and not due to credit rating changes. Those issues in an unrealized loss position for more than 12 months consist primarily 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. 4. LOANS Outstanding loans, excluding loans held for sale, were composed of the following (in thousands):
June 30 December 31 2004 2003 ------------ ----------- Real Estate loans Construction and land development $ 16,610 $ 12,790 Secured by farmland 3,173 3,430 Secured by 1-4 family residential properties 137,635 136,229 Secured by multi-family residential properties 9,320 6,801 Secured by nonfarm, nonresidential properties 131,104 126,164 Loans to farmers 2,251 1,618 Commercial and industrial loans 78,647 91,419 Consumer loans 17,571 23,581 Loans for nonrated industrial development obligations 4,142 4,077 Deposit overdrafts 160 136 --------- --------- Loans, net of unearned income $ 400,613 $ 406,245 ========= =========
5. ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses for the six months ended June 30 was as follows (in thousands): June 30 June 30 2004 2003 ------------- ------------- Balance, January 1 $ 5,292 $ 5,622 Provisions charged against income 470 495 Recoveries of loans charged off 114 160 Loans charged off (419) (286) -------- -------- Balance at end of period $ 5,457 $ 5,991 ======== ======== 11 6. 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.
Three Months Ended June 30 ------------------------------------------------- 2004 2003 ---------------------- --------------------- Per Per Share Share Shares Amount Shares Amount --------- ------ --------- ------ Basic earnings per share 5,610,462 $ .43 5,718,821 $ .40 Effect of dilutive securities, stock options 47,259 - 57,770 - --------- ------ --------- ------ Diluted earnings per share 5,657,721 $ .43 5,776,591 $ .40 ========= ====== ========= ======
Six Months Ended June 30 ------------------------------------------------- 2004 2003 ---------------------- --------------------- Per Per Share Share Shares Amount Shares Amount --------- ------ --------- ------ Basic earnings per share 5,629,370 $ .87 5,737,354 $ .81 Effect of dilutive securities, stock options 52,425 (.01) 59,415 (.01) --------- ------ --------- ------ Diluted earnings per share 5,681,795 $ .86 5,796,769 $ .80 ========= ====== ========= ======
7. DEFINED BENEFIT PLAN Components of Net Period Benefit Cost (in thousands) Six Months Ended June 30 ------------------- 2004 2003 ------- ------- Service cost $ 216 $ 189 Interest cost 180 165 Expected return on plan assets (226) (145) Amortization of prior service cost (11) (11) Amortization of net obligation at transition - (2) Amortization of the net (gain) loss 41 62 ------- ------- Net periodic benefits cost $ 200 $ 258 ======= ======= During the six months ended June 30, 2004, $357,000 in contributions were made. The Corporation plans no additional contributions for the year ending December 31, 2004. 8. 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. All assets and liabilities of the Bank are allocated to community banking. Investment income from fixed income investments is another 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 and liabilities and operating results of the Bank's two subsidiaries, ANB Mortgage Corp. and ANB Services Corp., are included in the community banking segment. 12 ANB Mortgage Corp. performs 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 and 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. Unaudited segment information for the three and six month periods ended June 30, 2004 and 2003 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. 13 Three Months Ended June 30, 2004 ----------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------ ------------ -------- Interest income $ 7,410 $ - $ 22 $ (22) $ 7,410 Interest expense 1,864 - 22 (22) 1,864 Non-interest income - external customers 1,041 743 261 - 2,045 Non-interest income - internal customers - 12 - (12) - Income before income tax provision 2,959 378 50 - 3,387 Depreciation and amortization 352 6 1 - 359 Total assets 629,716 - 2,513 (1,658) 630,571 Capital expenditures 138 9 - - 147
Three Months Ended June 30, 2003 ----------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------ ------------ -------- Interest income $ 8,235 $ - $ 13 $ (13) $ 8,235 Interest expense 2,458 - 13 (13) 2,458 Non-interest income - external customers 772 647 196 - 1,615 Non-interest income - internal customers - 12 - (12) - Income before income tax provision 2,911 315 29 - 3,255 Depreciation and amortization 397 6 1 - 404 Total assets 629,189 - 3,392 (1,281) 631,300 Capital expenditures 239 - - - 239
Six Months Ended June 30, 2004 ----------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------ ------------ -------- Interest income $ 14,991 $ - $ 30 $ (30) $ 14,991 Interest expense 3,829 - 30 (30) 3,829 Non-interest income - external customers 1,956 1,471 471 - 3,898 Non-interest income - internal customers - 24 - (24) - Income before income tax provision 5,994 811 35 - 6,840 Depreciation and amortization 701 11 3 - 715 Total assets 629,716 - 2,513 (1,658) 630,571 Capital expenditures 508 29 - - 537
Six Months Ended June 30, 2003 ----------------------------------------------------------------------
Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ---------- ------ ------------ -------- Interest income $ 16,637 $ - $ 24 $ (24) $ 16,637 Interest expense 4,977 - 24 (24) 4,977 Non-interest income - external customers 1,443 1,253 381 - 3,077 Non-interest income - internal customers - 24 - (24) - Income before income tax provision 5,893 614 44 - 6,551 Depreciation and amortization 792 12 3 - 807 Total assets 629,189 - 3,392 (1,281) 631,300 Capital expenditures 342 3 - - 345
14 ITEM 2. AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The purpose of this discussion is to focus on important factors affecting the Corporation's financial condition and results of operations. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data. This report contains forward-looking statements with respect to the financial condition, results of operations and business of the Corporation and Bank. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Corporation and Bank and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following: o General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain account balances. o Plant closings or layoffs in the Bank's primary market area could occur, which could negatively impact the ability of borrowers to repay loans and depositors to maintain account balances. o Changes in interest rates could increase or reduce income. o Competitive pressures among financial institutions may increase. o The businesses that the Corporation and Bank are engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards. 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. 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. 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. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified 15 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 within 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 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 16 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 believes 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 is provided. New Accounting Pronouncements No new accounting pronouncements have been issued since December 31, 2003. Refer to the Corporation's December 31, 2003 Annual Report on Form 10-K for previously announced accounting pronouncements. 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. RESULTS OF OPERATIONS NET INCOME The Corporation's net income for the first six months of 2004 was $4,894,000, an increase of 5.4% over the $4,642,000 earned during the same period of 2003. On a basic and diluted per share basis, net earnings totaled $0.87 and $0.86, respectively, for the first six months of 2004. This compared favorably to the basic and diluted earnings per share of $0.81 and $0.80, respectively, recorded for the first six months of 2003. Both earnings per share measurement increases were due to an increase in non-interest income which more 17 than offset a decline in net interest income, combined with a lower number of shares outstanding due to stock repurchases under the Corporation's stock repurchase program. On an annualized basis, return on average total assets was 1.53% for the first six months of 2004 compared to 1.52% for the same period in 2003. Annualized return on average common shareholders' equity was 13.57% and 13.18% for the first six months of 2004 and 2003, respectively. The Corporation's net income for the second quarter of 2004 was $2,424,000, an increase of 5.0% over the $2,308,000 earned during the same period of 2003. The earnings improvement is attributable to increases in non-interest income and control of non-interest expense. On a basic and diluted per share basis, net earnings totaled $0.43 for the second quarter of 2004, which was a 7.5% increase over the $0.40 earned for the same period of 2003. On an annualized basis, return on average total assets was 1.52% for the second quarter of 2004 compared to 1.49% for the same period in 2003. Return on average common shareholders' equity was 13.51% and 13.14% for the second quarter of 2004 and 2003, respectively. NET INTEREST INCOME Net interest income on a fully taxable equivalent ("FTE") basis was $11,712,000 for the six month period ending June 30, 2004 compared to $12,174,000 for the same period of 2003, a decline of 3.8% or $462,000. The interest rate spread decreased to 3.51% from 3.76%, while the net interest margin (yield on earning assets) decreased to 3.82% from 4.15% for the first six months of 2004 compared to the same period of 2003. Yields on earning assets declined due primarily to reductions in general market interest rates. These reductions lowered the rates on existing variable rate loans, new loans originated, and new securities purchased. Interest-bearing liability costs declined at a slower pace than interest-earning assets as many liability accounts were priced at what management considers "floor" rates of between one percent and two tenths of one percent. Average year-to-date interest-earning assets increased 4.7% or $27,513,000 while average interest-bearing liabilities grew 3.3%, or $15,605,000 between June 30, 2004 and June 30, 2003. During this time, low cost non-interest bearing demand deposit growth and growth in shareholder's equity funded the difference between earning asset growth and interest-bearing deposit growth. The funding mix continued to shift to lower cost transaction accounts including savings accounts, interest-bearing demand deposits, non-interest bearing demand deposits, and retail repurchase agreements. During the first six months of 2004, the Federal Reserve held interest rates unchanged. These historically low rates kept the prime lending rate at 4.00% during the six months ending June 30, 2004, which was lower than the 4.25% prime lending rate that was in effect during most of the six month period in 2003. On June 30, 2004, the Federal Reserve Bank's Financial Open Market Committee raised the benchmark federal funds rate 25 basis points to 1.25%. This increase did not affect our interest income in the current period but will in future periods. Many of the Corporation's assets reprice at the prime lending rate or at a rate based on the rates on U.S. Treasury securities. When comparing the second quarter of 2004 to the first quarter of 2004, the interest rate spread and net interest margin declined slightly. The interest rate spread declined from 3.52% in the first quarter of 2004 to 3.49% during the second quarter of 2004. The net interest margin declined from 3.84% in the first quarter of 2004 to 3.80% during the second quarter of 2004. These declines were due to loans and investment security portfolio yields declining at a faster pace than the cost of interest bearing liabilities. The following tables demonstrate fluctuations in net interest income and the related yields for the three and six month periods of 2004 compared to similar prior year periods. Net interest income is 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 or when the loan returns to accrual status (in thousands, except rates): 18 Net Interest Income and Rate / Volume Analysis For the Three Months Ended June 30, 2004 and 2003
Interest Average Balance Income/Expense Yield/Rate ------------------------- ------------------------ --------------------- 2004 2003 2004 2003 2004 2003 ---------- ---------- ---------- --------- -------- -------- Loans: Commercial $ 94,014 $ 123,046 $ 1,237 $ 1,753 5.26% 5.70% Real Estate 293,191 275,880 3,937 4,138 5.37 6.00 Consumer 18,512 28,454 424 644 9.16 9.05 ---------- ---------- ---------- --------- -------- -------- Total loans 405,717 427,380 5,598 6,535 5.52 6.12 ---------- ---------- ---------- --------- -------- -------- Securities: Federal agencies 105,592 60,260 835 511 3.16 3.39 Mortgage-backed 22,139 36,271 233 385 4.21 4.25 State and municipal 52,635 43,480 769 750 5.84 6.90 Other 20,765 23,175 238 316 4.58 5.45 ---------- ---------- ---------- --------- -------- -------- Total securities 201,131 163,186 2,075 1,962 4.13 4.81 ---------- ---------- ---------- --------- -------- -------- Deposits in other banks 5,570 3,970 13 11 .93 1.11 ---------- ---------- ---------- --------- -------- -------- Total interest-earning assets 612,418 594,536 7,686 8,508 5.02 5.72 ---------- --------- -------- -------- Non-earning assets 25,472 25,950 ---------- ---------- Total assets $ 637,890 $ 620,486 ========== ========== Interest-bearing deposits: Demand $ 72,794 $ 62,118 61 61 .34 .39 Money market 51,965 44,481 92 125 .71 1.12 Savings 83,847 81,273 104 212 .50 1.04 Time 208,766 232,932 1,233 1,677 2.36 2.88 ---------- ---------- ---------- --------- -------- -------- Total interest-bearing deposits 417,372 420,804 1,490 2,075 1.43 1.97 Repurchase agreements 47,980 39,489 124 135 1.03 1.37 Other borrowings 22,222 22,426 250 248 4.50 4.42 ---------- ---------- ---------- --------- -------- -------- Total interest-bearing liabilities 487,574 482,719 1,864 2,458 1.53 2.04 ---------- --------- --------- -------- Demand deposits 75,664 63,912 Other liabilities 2,897 3,587 Shareholders' equity 71,755 70,268 ---------- ---------- Total liabilities and shareholders' equity $ 637,890 $ 620,486 ========== ========== Interest rate spread 3.49% 3.68% ======== ======== Net interest margin 3.80% 4.07% ========= ======== Reconcilement to GAAP --------------------- Net interest income - tax equivalent 5,822 6,050 Less: Taxable equivalent adjustment 276 273 ---------- --------- Net interest income - per GAPP $ 5,546 $ 5,777 ========== =========
19 Net Interest Income and Rate / Volume Analysis For the Six Months Ended June 30, 2004 and 2003
Interest Average Balance Income/Expense Yield/Rate ------------------------- ------------------------ --------------------- 2004 2003 2004 2003 2004 2003 ---------- ---------- ---------- --------- -------- -------- Loans: Commercial $ 109,962 $ 122,157 $ 2,696 $ 3,651 4.90% 5.98% Real Estate 276,843 267,206 7,752 8,126 5.60 6.08 Consumer 20,076 29,607 916 1,341 9.13 9.06 ---------- ---------- ---------- --------- -------- -------- Total loans 406,881 418,970 11,364 13,118 5.59 6.26 ---------- ---------- ---------- --------- -------- -------- Securities: Federal agencies 103,859 59,331 1,657 1,060 3.19 3.57 Mortgage-backed 21,131 35,778 466 839 4.41 4.69 State and municipal 51,523 41,560 1,519 1,419 5.90 6.83 Other 20,336 23,991 491 679 4.83 5.66 ---------- ---------- ---------- --------- -------- -------- Total securities 196,849 160,660 4,133 3,997 4.20 4.98 ---------- ---------- ---------- --------- -------- -------- Deposits in other banks 9,829 6,416 44 36 .90 1.12 ---------- ---------- ---------- --------- -------- -------- Total interest-earning assets 613,559 586,046 15,541 17,151 5.07 5.85 ---------- --------- -------- -------- Non-earning assets 25,797 26,072 ---------- ---------- Total assets $ 639,356 $ 612,118 ========== ========== Interest-bearing deposits: Demand $ 71,724 $ 62,367 120 129 .33 .41 Money market 53,146 45,465 194 264 .73 1.16 Savings 83,802 78,747 213 437 .51 1.11 Time 212,423 230,204 2,560 3,397 2.41 2.95 ---------- ---------- ---------- --------- -------- -------- Total interest-bearing deposits 421,095 416,783 3,087 4,227 1.47 2.03 Repurchase agreements 48,628 37,065 251 260 1.03 1.40 Other borrowings 21,819 22,089 491 490 4.50 4.44 ---------- ---------- ---------- --------- -------- -------- Total interest-bearing liabilities 491,542 475,937 3,829 4,977 1.56 2.09 ---------- --------- --------- -------- Demand deposits 73,146 62,379 Other liabilities 2,563 3,388 Shareholders' equity 72,105 70,414 ---------- ---------- Total liabilities and shareholders' equity $ 639,356 $ 612,118 ========== ========== Interest rate spread 3.51% 3.76% ======== ======== Net interest margin 3.82% 4.15% ========= ======== Reconcilement to GAAP --------------------- Net interest income - tax equivalent 11,712 12,174 Less: Taxable equivalent adjustment 550 514 ---------- --------- Net interest income - per GAPP $ 11,162 $ 11,660 ========== =========
20 PROVISION AND RESERVE FOR LOAN LOSSES The purpose of 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 the review of 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, the Bank's loan "Watch" list, and national and local economic conditions. The provision for loan losses was $470,000 for the first six months of 2004 versus $495,000 for the same period in 2003. Net charged off loans were $305,000 for the first six months of 2004 versus $126,000 for the same period in 2003. The annualized ratio of net charge-offs to average outstanding loans was .15% in 2004 and .06% in 2003. The reserve for loan losses totaled $5,457,000 at June 30, 2004, an increase of 3.1% over the $5,292,000 recorded at December 31, 2003. The ratio of reserves to loans, less unearned discount, was 1.36% at June 30, 2004 versus 1.30% at December 31, 2003. 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 June 30, 2004. More information regarding loan quality is provided in the Asset Quality section. NON-INTEREST INCOME Non-interest income for the three months ended June 30, 2004, was $2,045,000, an increase of 26.6% from $1,615,000 reported in the same period of 2003. Trust and investment services income increased 14.8% due to higher trust values, new accounts, and increased management fees. Service charges on deposit accounts grew 16.6% or $90,000 with the majority of the increase due to a new consumer overdraft management product. Mortgage banking revenue increased 40.7% or $61,000 due to strong demand for mortgage refinancing, and other income increased 239.3% due to a $150,000 gain on the sale of a branch office which had not been in operation for several years. Non-interest income for the first six months of 2004 was $3,898,000, an increase of 26.7% from the $3,077,000 reported in the same period of 2003. The comparative increase was due to increases in trust and investment services income, service charges on deposit accounts, mortgage banking income, gains on the sale/call of securities, and the gain on the sale of the branch office. Trust and investment services income of $1,471,000 during the first six months of 2004 was up 17.4% compared to the same period in 2003 due to growth in new trust business, increased management fees, and improvements in the market value of the assets under management. The Bank's trust division manages accounts whose market values approximated $351,000,000 at June 30, 2004, up from $314,000,000 at June 30, 2003. Service charges on deposit accounts grew 25.0% or $241,000 in the first six months of 2004 when compared to the same period in 2003, with the majority of the increase due to a new consumer overdraft management product. Mortgage banking revenue increased 23.7% or $66,000 in the first six months of 2004 when compared to the same period in 2003 due to strong demand for mortgage refinancing. Mortgage banking revenue has been positively impacted by the low interest rate environment, which resulted in significant refinance activity. As interest rates increase, refinance activity is expected to decline. NON-INTEREST EXPENSE Non-interest expense for the three months ended June 30, 2004 was $3,949,000, an increase of 1.7% from the $3,882,000 reported for the same period of 2003. Salary expense increased 5.2% while pension and other employee benefits decreased 21.1% to $412,000. Benefits expense declined due to a reduction in employee health care costs because of lower claims experience and reduced pension funding. 21 Non-interest expense for the first six months of 2004 was $7,750,000, a 0.8% increase from the $7,691,000 reported for the same period last year. Salary expense increased 4.0% to $3,614,000 while pension and other employee benefits decreased 14.0% to $834,000. The salary increase is due to general salary increases. As mentioned above, benefits expense declined due to a reduction in employee health care costs because of lower claims experience and reduced pension funding. Core deposit intangible amortization of $225,000 for the first six months of 2004 and 2003 represents the amortization of the premium paid for deposits acquired at the Gretna office in 1995 and Yanceyville office in 1996. These are being amortized on a ten year straight-line basis. The efficiency ratio, a productivity measure used to determine how well non-interest expense is managed, was 50.48% and 50.44% for the six months ended June 30, 2004 and 2003, respectively. A lower efficiency ratio generally indicates better expense efficiency. Leaders in expense efficiency in the banking industry have achieved ratios in the 45% to 55% range while the majority of the industry remains at higher levels. INCOME TAX PROVISION The income tax provision for the first six months of 2004 was $1,946,000, an increase of $37,000 from the $1,909,000 reported a year earlier. The effective tax rate for the first six months of 2004 was 28.5% compared to 29.1% for the same period of 2003. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES GENERAL Loans declined $5,632,000, or 1.4% from December 31, 2003 to June 30, 2004 due primarily to strong competition in the market. Demand deposits increased $6,112,000, or 4.4% and savings deposits increased $1,362,000, or 1.6%. Money market deposits declined $8,817,000, or 14.9%. One large money market customer maintained a balance of $12,735,000 on December 31, 2003 and closed their account in May 2004 due to the sale of their business. Excluding this one account, money market deposits would have increased $3,918,000. Time deposits declined $15,448,000 due in large part to high rates of interest for certificates of deposit offered by competitors. During the first half of 2004, the Bank chose not to be aggressive in its certificate of deposit pricing, instead focusing on growth in low cost deposits. The Bank will continue to focus on growing low cost deposits through its business development efforts aimed at expanding customer relationships. ASSET QUALITY 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. Loans in a non-accrual status at June 30, 2004 were $4,088,000 compared with $3,262,000 at December 31, 2003, and $2,607,000 on June 30, 2003. The majority of the non-accrual loans, and the increase in their balances from the year ago period, are related to two commercial loan relationships. Management is working closely with the borrowers to improve the Bank's collateral position and status of these loans. There were no loans classified as troubled debt restructurings on June 30, 2004, December 31, 2003 or June 30, 2003. The following table summarizes non-performing assets: 22
June 30 December 31 June 30 2004 2003 2003 ---------- ----------- ---------- 90 days past due $ - $ 53 $ 285 Non-accrual 4,088 3,262 2,607 OREO 251 303 124 ------- ------ ------- Non-performing assets $ 4,339 $3,618 $ 3,016 ======= ====== =======
Total non-performing loans as a percentage of total loans were 1.02% at June 30, 2004, 0.81% at December 31, 2003, and 0.67% at June 30, 2003. Properties received due to loan foreclosures ("OREO") totaled $251,000 at June 30, 2004, $303,000 at December 31, 2003, and $124,000 at June 30, 2003. The gross amount of interest income that would have been recorded on non-accrual loans as of June 30, 2004, if all such loans had been accruing interest at the original contractual rate, was $94,000 for the six month period ending June 30, 2004. $23,000 of interest payments received on one non-accrual loan was recorded as interest income during the six months ended June 30, 2004. No other interest payments on non-accrual loans were recorded as interest income during that reporting period. The Bank has a commercial real estate loan in the amount of $3,004,000 from a textile manufacturer who filed for reorganization under Chapter 11 of the Bankruptcy Code on March 31, 2004. In conjunction with the filing, the borrower has secured debtor-in-possession financing from its primary lender. Under the current court order, the borrower is to make monthly interest payments to the Bank from the date of the filing, and such payments are current. The loan is secured by a first deed of trust on a commercial property recently appraised for an amount sufficiently exceeding the loan balance. LIQUIDITY Management monitors and plans the Corporation's liquidity position for future periods. Liquidity is provided generally from loan payments, increases in deposits, lines of credit from two correspondent banks and two federal agency banks, and a structured maturity schedule of investments. Additionally, all securities classified as available for sale are eligible to satisfy liquidity needs. Management believes 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. 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 19.7% at June 30, 2004 and 21.9% at December 31, 2003. Both of these ratios reflect adequate liquidity for the respective periods. The Bank has a line of credit equal to 30% of assets with the Federal Home Loan Bank of Atlanta (FHLB) that equaled approximately $188,999,000 with $165,237,000 available at June 30, 2004. Should the Bank ever desire to increase their line of credit beyond the current 30% limit, the FHLB would allow borrowings of up to 40% of total assets once the Bank meets specific eligibility requirements. 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, and has access to the Federal Reserve Bank's discount window. The Bank has not used these facilities in the past year and considers these as backup sources of funds. 23 Borrowings outstanding under the FHLB line of credit were $23,763,000 at June 30, 2004 and $21,000,000 at December 31, 2003. The Bank utilizes various borrowing plans to take advantage of short term and long term funding needs. As of June 30, 2004, $2,800,000 was outstanding in a daily rate credit plan for short term purposes. The Bank also has eight fixed rate term borrowing contracts outstanding with the following final maturities: Amount Expiration Date ----------- --------------- $ 1,500,000 July 2004 3,000,000 July 2005 1,000,000 July 2006 1,000,000 July 2007 3,000,000 June 2008 5,000,000 August 2008 5,000,000 April 2009 1,462,500 March 2014 ----------- $20,962,500 =========== 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 as of June 30, 2004 and December 31, 2003 were commitments to extent credit and standby letters of credit only. Commitments to extend credit, which amounted to $111,930,000 at June 30, 2004 and $124,905,000 at December 31, 2003, 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. As of June 30, 2004 and December 31, 2003, there were no commitments outstanding to purchase securities. Standby letters of credit are conditional commitments issued by the Bank guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. At June 30, 2004 and December 31, 2003, the Bank had $3,559,000 and $3,477,000, respectively, in outstanding standby letters of credit. CAPITAL RESOURCES During the second quarter of 2004, the Corporation declared and paid a quarterly cash dividend of $.20 per share. The dividend totaled $1,119,000 and represented a 46.2% payout of second quarter 2004 net income. 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 between August 29, 2001 and August 28, 2003, 250,000 shares between August 21, 2003 and August 19, 2004, and 250,000 shares between August 20, 2004 and August 17, 2004 The repurchases, which may be made through open market purchases or in privately negotiated transactions, were 32,200 shares during the first quarter and 43,368 shares during the second quarter of 2004 and total 540,034 shares since purchases began on August 16, 2000. 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. Tier I capital includes shareholders' equity and Tier II capital includes certain components of nonpermanent preferred stock and subordinated debt. The Corporation had no preferred stock or subordinated debt outstanding. Banks and bank holding companies must have a Tier I capital ratio of at least 4% and a total ratio, including Tier I and Tier II 24 capital, of at least 8%. As of June 30, 2004 the Corporation had a ratio of 15.72% for Tier I and a ratio of 16.94% for total capital. At December 31, 2003 these ratios were 14.85% and 15.99%, respectively. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The effective management of market risk is essential to achieving the Corporation's objectives. Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Corporation is not subject to currency exchange risk or commodity price risk. As a financial institution, interest rate risk and its impact on net interest income is the primary market risk exposure. The Asset/Liability Investment Committee ("ALCO") is primarily responsible for establishing asset and liability strategies and for monitoring and controlling liquidity and interest rate risk. ALCO uses computer simulation analysis to measure the sensitivity of earnings and market value of equity to changes in interest rates. The projected changes in net interest income and market value of portfolio equity ("MVE") to changes in interest rates are calculated and monitored by ALCO as indicators of interest rate risk. The projected changes in net interest income and MVE to changes in interest rates at June 30, 2004 and December 31, 2003 were within compliance of established policy guidelines. 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. There have been no material changes in the Corporation's interest sensitivity position since December 31, 2003. Refer to the December 31, 2003 Annual Report on Form 10-K. ITEM 4. CONTROLS AND PROCEDURES We maintain a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. Within the 90 days prior to the date of this report, 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 carried out its evaluation. 25 PART II OTHER INFORMATION Item: 1. Legal Proceedings The nature of the business of the Corporation's banking subsidiary ordinarily results in a certain amount of litigation. The subsidiary of the Corporation is involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that the liabilities arising from these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Corporation. 2. Changes in securities, use of proceeds and issuer purchases or equity securities
Issuer Purchases of Equity Securities for the Three Months Ended June 30, 2004 -------------------------------------------------------------------------------------------------------- Total Number of Shares Maximum Number of Total Number Average Purchased as Part of Shares that May Yet of Shares Price Paid Publicly Announced Be Purchased Under Purchased Per share Program the Program ------------ ---------- ---------------------- ------------------- April 1 - 30, 2004 5,918 $24.67 5,918 196,882 May 1 - 31, 2004 28,950 23.34 28,950 167,932 June 1 - 30, 2004 8,500 22.39 8,500 159,432 ------ ------ 43,368 $23.29 43,368 ====== ======
On August 19, 2003, the Corporation's board of directors authorized the repurchase of up to 250,000 shares of the Corporation's common stock between August 20, 2003 and August 17, 2004. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine to be in the best interest of the Corporation. 3. Defaults upon senior securities None 4. Submission of matters to a vote of security holders At the Corporation's Annual Shareholders Meeting held on April 27, 2004, the following business was transacted: (1) Election of Directors All the nominees for election to the Board of Directors were elected to serve until the 2007 Annual Meeting of Shareholders. Affirmative Votes Votes Withheld ----------------- -------------- Fred A. Blair 4,079,331 5,839 E. Budge Kent, Jr. 4,079,331 5,839 Fred B. Leggett, Jr. 4,079,331 5,839 Claude B. Owen, Jr. 4,068,989 16,181 5. Other information None 26 6. Exhibits and Reports on Form 8-K (a) Exhibits - 11. Refer to EPS calculation in the Notes to Financial Statements 31.1 Section 302 Certification of Charles H. Majors, President and CEO 31.2 Section 302 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer 32.1 Section 906 Certification of Charles H. Majors, President and CEO 32.2 Section 906 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer (b) Reports on Form 8-K - Form 8-K filed April 6, 2004 to announce the resignation of Brad E. Schwartz as the Corporation's Senior Vice President and Chief Financial Officer, as well as the Secretary to the Corporation. Form 8-K filed April 21, 2004 to announce the Corporation's first quarter 2004 financial results. Form 8-K filed April 27, 2004 to announce the election of directors at the Corporation's annual shareholders meeting and to announce the opening of a loan production office in Greensboro, North Carolina. Form 8-K filed on April 29, 2004 to announce the appointment of Neal A. Petrovich as Senior Vice President and Chief Financial Officer of the Corporation. Form 8-K filed on May 18, 2004 to announce quarterly dividend of $0.20 per share. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN NATIONAL BANKSHARES INC. /s/ Charles H. Majors ------------------------------------- Charles H. Majors Date - July 30, 2004 President and Chief Executive Officer /s/ Neal A. Petrovich ------------------------------------- Neal A. Petrovich Senior Vice President and Date - July 30, 2004 Chief Financial Officer 27