-----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, UbGUUviAJSmwH8sTRv1EuxXoB7/bSMk0lbiMy5MQSkOUCdV8KR0XC428hyjgH2EH tvw24BIMdJzNzKnPgwvnmw== 0000741516-05-000010.txt : 20050316 0000741516-05-000010.hdr.sgml : 20050316 20050316102535 ACCESSION NUMBER: 0000741516-05-000010 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050316 DATE AS OF CHANGE: 20050316 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: 05683640 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 annual10k2004.txt 2004 ANNUAL REPOT 10K AMER 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, 2004 ----------------- 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, 2004 was $95,997,310. The number of shares of the Registrant's Common Stock outstanding on March 7, 2005 was 5,501,358. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 26, 2005 are incorporated by reference in Part III of this report. 1 CROSS REFERENCE INDEX Page ---- PART I - ------ ITEM 1 Business 4 ITEM 2 Properties 6 ITEM 3 Legal Proceedings 6 ITEM 4 Submission of Matters to a Vote of Security Holders 6 - ---------------------------------------------------------------------------------------------------------------------- PART II - ------- ITEM 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Securities 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 14 ITEM 8 Financial Statements and Supplementary Data Quarterly Financial Results for 2004 and 2003 29 Management's Report on Financial Statements 30 Reports of Independent Public Accountants 31 Consolidated Balance Sheets at December 31, 2004 and 2003 33 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2004 34 Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three-year period ended December 31, 2004 35 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2004 36 Notes to Consolidated Financial Statements 37 ITEM 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 30 ITEM 9A Controls and Procedures 30 ITEM 9B Other Information 30 - ---------------------------------------------------------------------------------------------------------------------- PART III - -------- ITEM 10 Directors and Executive Officers of the Registrant *,7 ITEM 11 Executive Compensation * ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters * ITEM 13 Certain Relationships and Related Transactions * ITEM 14 Principal Accountant Fees and Services * - --------------------------------------------------------------------------------------------------------------------- PART IV - ------- ITEM 15 Exhibits and Financial Statement Schedules 59 - --------------------------------------
* The information required by Item 10 is incorporated herein by reference to the information that appears under the headings "Election of Directors", "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 2005 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 the Human Resources and Compensation Committee on Executive Compensation", and "Executive Compensation" in the Registrant's Proxy Statement for the April 2005 Annual Meeting of Shareholders. * 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 2 the April 2005 Annual Meeting of Shareholders. The information required by Item 201(d) of Regulation S-K is disclosed herein. See Item 5, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities." 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 2005 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 2005 Annual Meeting of Shareholders. 3 PART I FORWARD-LOOKING STATEMENTS This report contains forward-looking statements with respect to the financial condition, results of operations and business 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 on information available to management 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 Corporation's primary market area could occur, which might 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 Competition among financial institutions may increase. o Businesses that the Corporation is 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. o Adverse changes may occur in the securities market. ITEM 1 - BUSINESS American National Bankshares Inc. (the "Corporation") is a one-bank holding company organized under the laws of the Commonwealth 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, 2004, the Corporation employed 213 full-time equivalent persons, and the relationship with 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") 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. During 2004, the Bank opened a loan production office in Greensboro, North Carolina. 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 including mutual funds, equity securities, and a full-line of insurance products through an affiliation with Bankers Insurance LLC. In 2005, the Bank intends to discontinue the use of the two subsidiaries and offer the same products and services through the Bank. The operations of the Bank are conducted at fourteen retail offices located throughout the Bank's trade area, which includes the Cities of Danville and Martinsville, and 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, and there is one office each in Gretna, Chatham, Martinsville, Collinsville, southern Henry County, and South Boston, Virginia and Yanceyville, North Carolina. Commercial loan services are also provided through a loan production office located in Greensboro, North Carolina. The Bank operates eighteen automated teller machines at various locations in the trade area. The Bank provides a full array of financial products and services, including commercial, mortgage, and consumer banking; trust and investment services; and insurance. Competition and Markets The Corporation'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; City of Greensboro; Town of Yanceyville and the northern half of Caswell County in North Carolina. Vigorous competition exists in this service area. The Corporation competes not only with other commercial banks but also with diversified financial institutions, credit unions, money 4 market and mutual fund providers, mortgage lenders, insurance companies, 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 Corporation's market area, primarily known collectively as Southside Virginia, is under economic pressure. The region has traditionally been the home to textile, furniture and other manufacturing, and has served 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, as well as several large furniture manufacturers in the Henry County/City of Martinsville area, employ a significant workforce. Danville's second largest employer, Dan River Inc., a textile manufacturer, filed for Chapter 11 bankruptcy protection in 2004, and emerged from bankruptcy in early 2005. 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. To offset the negative impact of the declining textile, furniture and tobacco industries, the region has been proactive in its economic development activities, which have produced job growth in the education, government and service sectors. The region is upgrading broadband Internet access. The Danville Regional Airport is testing NASA technology to make better use of the nation's general aviation airports. Research and development activities are conducted at the new Institute for Advanced Learning and Research, launched through a collaboration between two Virginia universities, one community college, and other local entities. A nanotechnology company is opening its manufacturing operations in Danville. 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 Sarbanes-Oxley Act of 2002 (the "SOX"), which is aimed at improving corporate governance and reporting procedures. The Corporation is 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. 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 capital adequacy, asset quality, management practices, earnings, liquidity, regulatory compliance, information systems, 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 impact on loan and deposit growth and the interest rates charged and paid thereon. While these policies can materially affect the income of commercial banks, the impact of such conditions and policies upon the future business and earnings of the Corporation and the Bank cannot accurately be predicted. 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 Investor Relations 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 the SEC. The SEC 5 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. 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, 2004, the Bank maintained fourteen full service retail offices. Seven are located within the City of Danville, with others located in Gretna, Chatham, Martinsville, southern Henry County, Collinsville, and South Boston, Virginia and Yanceyville, North Carolina. The Bank operates a loan production office in Greensboro, North Carolina. The Bank leases additional space in Martinsville for use by its trust and investment services division and its mortgage lending division. 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. It also houses certain of the Corporation's finance, administrative, and operations staff. 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 two-building office complex in Martinsville, Virginia, that houses a retail banking office, a trust and investment services office, and a mortgage lending office. This building serves as the headquarters for the Martinsville/Henry County market. The Bank also leases the retail banking offices in South Boston and on West Main Street in Danville, Virginia, as well as a loan production office in Greensboro, North Carolina and a storage warehouse in Danville. Total lease payments in 2004 for these facilities, as well as for ATM leases at non-retail office locations, were $153,000. The Bank owns nine other retail office locations for a total of eleven 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 eighteen 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. 6 EXECUTIVE OFFICERS OF THE REGISTRANT The following lists the executive officers of the registrant, their age as of December 31, 2004 and their position.
Name Age Position - ------------------------ --- ------------------------------------------------------------------------------------------ Charles H. Majors 59 President & Chief Executive Officer of the Corporation and the Bank E. Budge Kent, Jr. 65 Executive Vice President of the Corporation; Executive Vice President and Chief Trust & Investment Officer of the Bank R. Helm Dobbins 53 Senior Vice President of the Corporation; Senior Vice President & Chief Credit Officer of the Bank since June 2003; Executive Vice President and Chief Credit Officer of Citizens Bank and Trust Co. from 1998 to 2003. Dabney T.P. Gilliam, Jr. 50 Senior Vice President of the Corporation; Senior Vice President, Chief Banking Officer & Senior Loan Officer of the Bank Jeffrey V. Haley 44 Senior Vice President of the Corporation; Senior Vice President & Chief Administrative Officer of the Bank Neal A. Petrovich 42 Senior Vice President, Chief Financial Officer, Treasurer and Secretary of the Corporation; Senior Vice President, Chief Financial Officer and Cashier of the Bank; Senior Vice President of SouthTrust Bank from 2002 to 2004; Executive Vice President and Chief Financial Officer of Bank of Tidewater from 1995 to 2002.
PART II ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF SECURITIES The Corporation's common stock is traded on the Nasdaq National Market under the symbol "AMNB". At year end 2004, the Corporation had 1,365 shareholders of record. The table below presents 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 2004 and 2003. Market Price of the Corporation's Common Stock
NASDAQ closing price Dividends --------------------------------- Declared 2004 High Low Per Share - -------------------------- ---------- ---------- ---------- 4th quarter $ 25.33 $ 24.06 $ .20 3rd quarter 24.31 21.55 .20 2nd quarter 25.26 21.01 .20 1st quarter 26.75 23.25 .19 ---------- $ .79 ==========
Dividends Declared 2003 High Low Per Share - -------------------------- ---------- ---------- ---------- 4th quarter $ 27.23 $ 24.99 $ .19 3rd quarter 28.11 24.77 .19 2nd quarter 25.96 22.87 .19 1st quarter 27.06 24.30 .18 ---------- $ .75 ==========
7 The table below presents share repurchase activity during the quarter ended December 31, 2004. Repurchases Made During the Quarter Ended December 31, 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 ----------- ---------- ---------------------- ------------------- October 1-31, 2004 5,000 $ 25.25 5,000 168,100 November 1-30, 2004 - - - December 1-31, 2004 - - - ----- ------- ----- 5,000 $ 25.25 5,000 ===== ======= =====
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 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 Exchange Act. 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, 2004 ------------------------------------------------------------------------ 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 249,396 $19.98 8,472 Equity compensation plans not approved by shareholders - - - ------- ------ ----- Total 249,396 $19.98 8,472 ======= ====== =====
8 ITEM 6 - SELECTED FINANCIAL DATA The following table sets forth selected financial data for the Corporation for the last five years: (in thousands, except per share amounts)
2004 2003 2002 2001 2000 ------------ ------------- ------------ ------------ ------------- Results of Operations: Interest income....................................... $ 30,120 $ 32,178 $ 35,135 $ 39,820 $ 38,606 Interest expense...................................... 7,479 9,391 12,310 17,502 17,343 ------------ ------------- ------------ ------------ ------------- Net interest income................................... 22,641 22,787 22,825 22,318 21,263 Provision for loan losses............................. 3,095 920 873 1,015 1,020 Noninterest income.................................... 6,510 6,671 5,712 5,668 4,771 Noninterest expense................................... 15,011 15,111 14,285 13,614 12,923 ------------ ------------- ------------ ------------ ------------- Income before income taxes............................ 11,045 13,427 13,379 13,357 12,091 Income taxes.......................................... 3,032 3,914 3,918 3,942 3,415 ------------ ------------- ------------ ------------ ------------- Net income............................................ $ 8,013 $ 9,513 $ 9,461 $ 9,415 $ 8,676 ============ ============= ============ ============ ============= Period-end Balances: Securities............................................ $188,163 $207,479 $163,824 $156,791 $162,929 Total loans........................................... 408,240 406,805 407,688 375,593 339,756 Total deposits........................................ 485,272 501,688 473,562 464,012 426,588 Shareholders' equity.................................. 71,000 71,931 70,736 65,397 63,338 Total assets.......................................... 619,065 644,302 605,859 572,887 541,389 Per Share Information: Earnings - basic...................................... $ 1.43 $ 1.67 $ 1.63 $ 1.58 $ 1.42 Earnings - diluted.................................... 1.42 1.65 1.62 1.58 1.42 Dividends............................................. .79 .75 .71 .66 .585 Book value............................................ 12.86 12.71 12.24 11.23 10.45 Ratios: Return on average assets............................... 1.26% 1.52% 1.63% 1.69% 1.70% Return on average shareholders' equity................. 11.15% 13.52% 13.97% 14.49% 14.74% Average shareholders' equity/average assets............ 11.34% 11.27% 11.64% 11.68% 11.54% Total risk-based capital/assets........................ 16.73% 15.99% 15.63% 15.56% 17.09% Dividend payout ratio.................................. 55.05% 44.90% 43.52% 41.68% 41.07% Net charge-offs to average loans....................... .10% .30% .15% .12% .13% Allowance for loan losses to period-end loans.......... 1.96% 1.30% 1.38% 1.42% 1.40%
9 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The purpose of this discussion is to focus on important factors affecting the financial condition and results of operations of American National Bankshares Inc. and American National Bank and Trust Company. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data. RECLASSIFICATION In certain circumstances, reclassifications have been made to prior period information to conform to the 2004 presentation. 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 2004 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 the 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 the transactions would be the same, the timing of events that would impact those transactions could change. Allowance for Loan Losses The allowance for loan losses is an estimate of the losses inherent in the loan portfolio at the balance sheet date. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards ("SFAS" No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows, or values that are observable in the secondary market, and the loan balance. The Corporation's allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change 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 loans. The financial condition of the borrower and the fair market value of collateral are among the factors used to estimate these losses. The unallocated allowance includes estimated losses whose impact on the portfolio have yet to be recognized in either the formula or specific allowance. The use of these values is inherently subjective and actual losses could be greater or less than the estimates. Stock Based Compensation The Corporation accounts for its stock compensation plan under the recognition and measurement principles of the Accounting Principles Board ("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 the plan 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 noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income (excluding gains on sales of securities or other assets). 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 GAAP. 10 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. EXECUTIVE OVERVIEW Net income for the year ended December 31, 2004 was $8.0 million, a decrease of 15.8% over the $9.5 million earned in 2003. On a basic per share basis, net earnings totaled $1.43 and on a diluted per share basis earnings totaled $1.42 for the year 2004. For the year 2003, basic earnings per share were $1.67 and diluted earnings per share were $1.65. The decline in earnings was due to two major factors. First, the Corporation added an additional $2.0 million to its allowance for loan losses primarily related to a $4.5 million loan secured by a hotel in a major North Carolina metropolitan area. Although payments on the loan have always been current, the cash flow and collateral valuation of the hotel has deteriorated; thus, the loan was deemed impaired and was placed on nonaccrual status at December 31, 2004. Secondly, the Corporation recorded a $985,000 impairment charge on $4.5 million of Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") perpetual preferred stock. Based upon a detailed analysis, the Corporation concluded both securities were "other-than-temporarily impaired" at December 31, 2004 as defined by accounting interpretations. Despite these two significant asset impairments, the Corporation recorded good profitability measurements in 2004. 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 return on average assets during 2004 was 1.26% which is slightly higher than the Corporation's peer group average. Return on equity was 11.15%. The Corporation recognizes that its current market area is marked by slow, or negative, economic growth, due primarily to declines in manufacturing and tobacco processing. Consequently, the Corporation's strategic plan calls for growth in faster-growing, nearby markets. Other current priorities are to: o increase the size of the Corporation's loan portfolio without sacrificing credit quality, o grow checking, savings, and money market deposits, o increase fee income through our trust, investment, and mortgage banking services, and o continue to control costs. 11 ANALYSIS OF OPERATING RESULTS NET INTEREST INCOME Net interest income, the Corporation's largest 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 and mix of interest-earning assets and interest-bearing liabilities, interest rates earned on earning assets, and interest rates paid on deposits and borrowed funds. 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 assets to a fully taxable equivalent ("FTE") basis. The difference between income recorded on interest-earning assets and expense recorded on interest-bearing liabilities is referred to as net interest income. Net interest income divided by average earning assets is referred to as the net interest margin. The net interest spread represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities. Net interest income on a tax-equivalent basis was stable from 2002 to 2004, ranging from $23.7 million to $23.8 million. Interest income declined $2.0 million from 2003 to 2004 due primarily to pay-downs of participation loans and a general decline in interest rates. Interest expense declined $1.9 million during this same period, due to the lowering of interest rates paid on deposit accounts and a reduction in higher-cost certificates of deposit. From 2002 to 2003, the positive impact from growth in earning assets was offset by the impact of lower rates earned on those assets. The FTE-adjusted net interest margin is a measure used in evaluating the management of earning assets and interest-bearing liabilities. The FTE-adjusted net interest margin was 3.90% in 2004, 3.98% in 2003, and 4.28% in 2002. In addition to the changes in the Corporation's balance sheet, the primary cause of the net interest margin changes was the rapid drop in interest rates as the Federal Reserve reduced short-term interest rates to stimulate the economy. The Federal Reserve lowered the benchmark federal funds rate from 6.50% at the beginning of 2001 to 1.00% by June 2003. As a result, the Corporation's prime lending rate declined from 9.50% at the beginning of 2001 to 4.00% by June 2003. The prime lending rate remained at 4.00%, a historically low rate, until June 2004, when the Federal Reserve began increasing the federal funds rate. From June 2004 through February 2005, the federal funds rate increased from 1.00% to 2.50%; in turn, the prime lending rate increased from 4.00% to 5.50% during this time. The increase positively impacted the Corporation's net interest income during the second half of 2004. Almost half of the Corporation's loan portfolio is tied to the prime rate. The following presentation is an analysis of net interest income on a taxable equivalent basis for the years 2004, 2003, and 2002. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans, if recognized, is recorded on a cash basis. 12 Table 1 - Net Interest Income Analysis (in thousands, except rates)
Average Balance Interest Income/Expense Average Yield/Rate ----------------------------- ---------------------------- ------------------------------ 2004 2003 2002 2004 2003 2002 2004 2003 2002 -------- -------- -------- -------- -------- -------- -------- -------- -------- Loans: Commercial $ 94,643 $115,377 $113,284 $ 4,992 $ 6,723 $ 7,495 5.27 % 5.83 % 6.62 % Real Estate 290,884 276,133 244,988 16,237 16,129 16,139 5.58 5.84 6.59 Consumer 18,168 27,360 33,122 1,664 2,478 3,641 9.16 9.06 10.99 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total loans 403,695 418,870 391,394 22,893 25,330 27,275 5.67 6.05 6.97 -------- -------- -------- -------- -------- -------- -------- -------- -------- Securities: Federal agencies 99,263 71,153 43,063 3,169 2,365 1,942 3.19 3.32 4.51 Mortgage-backed 23,842 30,745 40,055 1,046 1,316 2,352 4.39 4.28 5.87 State and municipal 52,247 43,993 39,173 3,059 2,844 2,667 5.85 6.46 6.81 Other 19,776 22,696 26,962 923 1,247 1,629 4.67 5.49 6.04 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total securities 195,128 168,587 149,253 8,197 7,772 8,590 4.20 4.61 5.76 -------- -------- -------- -------- -------- -------- -------- -------- -------- Deposits in other banks 10,092 11,236 15,792 132 110 248 1.31 .98 1.57 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets 608,915 598,693 556,439 31,222 33,212 36,113 5.13 5.55 6.49 -------- -------- -------- -------- -------- -------- Non-earning assets 24,676 25,918 25,459 -------- -------- -------- Total assets $633,591 $624,611 $581,898 ======== ======== ======== Deposits: Demand $ 73,338 $ 63,858 $ 59,852 269 225 417 .37 .35 .70 Money market 53,305 47,293 42,369 428 478 775 .80 1.01 1.83 Savings 83,814 80,876 70,073 439 712 1,048 .52 .88 1.50 Time 204,945 230,070 229,074 4,843 6,500 8,607 2.36 2.83 3.76 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total deposits 415,402 422,097 401,368 5,979 7,915 10,847 1.44 1.88 2.70 Repurchase agreements 46,787 40,917 34,183 528 497 635 1.13 1.21 1.86 Other borrowings 20,931 21,578 17,274 972 979 828 4.64 4.54 4.79 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest bearing liabilities 483,120 484,592 452,825 7,479 9,391 12,310 1.55 1.94 2.72 -------- -------- -------- -------- -------- -------- -------- -------- -------- Noninterest bearing demand deposits 76,123 66,300 58,075 Other liabilities 2,846 3,352 3,289 Shareholders' equity 71,862 70,367 67,709 -------- -------- -------- Total liabilities and shareholders' equity $633,951 $624,611 $581,898 ======== ======== ======== Interest rate spread 3.58 % 3.61 % 3.77 % ======== ======== ======== Net interest margin 3.90 % 3.98 % 4.28 % ======== ======== ======== Net interest income (taxable equivalent basis) 23,743 23,821 23,803 Less: Taxable equivalent adjustment 1,102 1,034 978 -------- -------- -------- Net interest income $ 22,641 $ 22,787 $ 22,825 ======== ======== ========
13 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). Changes attributable to both volume and rate have been allocated proportionately. Table 2 - Changes in Net Interest Income (Rate/Volume Analysis) (in thousands)
2004 vs. 2003 2003 vs. 2002 ------------------------------------- ------------------------------------- Interest Change Attributable to Interest Change Attributable to Increase ----------------------- Increase ----------------------- (Decrease) Rate Volume (Decrease) Rate Volume ---------- --------- ---------- ---------- --------- ---------- Interest income Loans: Commercial $ (1,731) $ (598) $ (1,133) $ (772) $ (908) $ 136 Real Estate 108 (733) 841 (10) (1,939) 1,929 Consumer (814) 28 (842) (1,163) (585) (578) ---------- --------- ---------- ---------- ---------- ---------- Total loans (2,437) (1,303) (1,134) (1,945) (3,432) 1,487 ---------- --------- ---------- ---------- ---------- ---------- Securities: Federal agencies 804 (97) 901 423 (606) 1,029 Mortgage-backed (270) 32 (302) (1,036) (558) (478) State and municipal 215 (285) 500 177 (139) 316 Other securities (324) (175) (149) (382) (139) (243) ---------- --------- ---------- ---------- ---------- ---------- Total securities 425 (525) 950 (818) (1,442) 624 ---------- --------- ---------- ---------- ---------- ---------- Deposits in other banks 22 34 (12) (138) (78) (60) ---------- --------- ---------- ---------- ---------- ---------- Total interest income (1,990) (1,794) (196) (2,901) (4,952) 2,051 ---------- --------- ---------- ---------- ---------- ---------- Interest expense Deposits: Demand 44 10 34 (192) (218) 26 Money market (50) (106) 56 (297) (379) 82 Savings (273) (298) 25 (336) (479) 143 Time (1,657) (994) (663) (2,107) (2,144) 37 ---------- --------- ---------- ---------- ---------- ---------- Total deposits (1,936) (1,388) (548) (2,932) (3,220) 288 Repurchase agreements 31 (37) 68 (138) (247) 109 Other borrowings (7) 23 (30) 151 (46) 197 ---------- --------- ---------- ---------- ----------- ---------- Total interest expense (1,912) (1,402) (510) (2,919) (3,513) 594 ---------- --------- ---------- ---------- ----------- ---------- Net interest income $ (78) $ (392) $ 314 $ 18 $ (1,439) $ 1,457 ========== ========= ========== ========== =========== ==========
MARKET RISK MANAGEMENT Effectively managing market risk is essential to achieving the Corporation's financial objectives. Market risk reflects the risk of economic loss resulting from adverse changes in interest rates and market prices. 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 magnitude of the change in earnings 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. 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. The Corporation's primary objectives for managing interest rate volatility are to maximize net interest income while ensuring adequate liquidity and managing interest rate risk within established policy guidelines. ALCO is also responsible for evaluating the competitive rate environment and reviewing investment portfolio transactions. The Corporation's interest rate sensitivity position at December 31, 2004 is illustrated in the following table. The table presents the carrying amount of assets and liabilities in the periods they are expected to reprice or mature. 14 Table 3 - Interest Rate Sensitivity Gap Analysis (in thousands)
Within > 1 Year > 3 Year 1 Year to 3 Years to 5 Years > 5 Years Total -------------- ------------- ------------- ------------- ------------- Interest sensitive assets: Interest-bearing deposits with other banks $ 197 $ - $ - $ - $ 197 Securities (1) 29,738 69,851 33,376 54,858 187,823 Loans (2) 276,163 99,004 27,173 5,900 408,240 -------------- ------------- ------------- ------------- ------------- Total interest sensitive assets 306,098 168,855 60,549 60,758 596,260 -------------- ------------- ------------- ------------- ------------- Interest sensitive liabilities: NOW and savings deposits 164,009 - - - 164,009 Money market deposits 52,031 - - - 52,031 Time deposits 123,401 51,604 18,960 11 193,976 Repurchase agreements 38,945 - - - 38,945 Other borrowings 3,950 3,000 13,000 1,388 21,338 -------------- ------------- ------------- ------------- ------------- Total interest sensitive liabilities 382,336 54,604 31,960 1,399 470,299 -------------- ------------- ------------- ------------- ------------- Interest sensitivity gap $ (76,238) $ 114,251 $ 28,589 $ 59,359 $ 125,961 ============== ============= ============= ============= ============= Cumulative interest sensitivity gap $ (76,238) $ 38,013 $ 66,602 $ 125,961 ============== ============= ============= ============= Percentage cumulative gap to total interest sensitive assets (12.8)% 6.4 % 11.2 % 21.1 % - ----------------------------------------- (1) Securities based on amortized cost. (2) Loans include loans held for sale and are net of unearned income.
Because of inherent limitations in gap analysis, the Corporation uses more sophisticated interest rate risk measurement techniques. Simulation analysis is used to measure the sensitivity of projected earnings to changes in interest rates. The projected changes in net interest income are calculated and monitored by ALCO as indicators of interest rate risk. Simulation takes into account the Corporation's current balance sheet volumes and the scheduled maturities and payments of assets and liabilities. It incorporates numerous assumptions including growth, changes in the mix of assets and liabilities, projected prepayments, and average rates earned and paid. Based on this information, the model projects net interest income under multiple interest rate scenarios. Management believes 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 affect rates on loans and securities. Table 4 shows the estimated impact of changes in interest rates up and down 1%, 2% and 3% on net interest income as of December 31, 2004, assuming immediate and parallel shifts in interest rates. 15 Table 4 - Change in Net Interest Income and Market Value of Portfolio Equity (in thousands) 2004 2003 ------------------------ ------------------------ Changes in Changes in Change in Net Interest Income (1) Net Interest Income (1) Interest ------------------------ ------------------------ Rates Amount Percent Amount Percent ----------- ---------- ----------- ---------- ----------- Up 3% $ 1,476 6.31 % $ 2,586 10.99 % Up 2% 1,094 4.68 1,571 6.67 Up 1% 604 2.58 1,111 4.72 Down 1% (704) (3.01) (842) (3.58) Down 2% (1,755) (7.51) (2,257) (9.59) Down 3% (3,030) (12.96) (3,686) (15.66) (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. The projected changes in net interest income to changes in interest rates at December 31, 2004, were within compliance of established policy guidelines. 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 Corporation cannot predict future interest rates or their exact effects on net interest income. 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 balance sheet 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 uses 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 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, $604,000 to net interest income. Should the same rates decrease by 1%, pre-tax net interest income would decline by $704,000 for a twelve month period. 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. NONINTEREST INCOME Noninterest income totaled $6.5 million in 2004 compared with $6.7 million in 2003 and $5.7 million in 2002. This represented a decrease of 2.4% for 2004, compared to an increase of 16.8% for 2003. The primary reason for the decline in 2004 was a $985,000 impairment charge on $4.5 million of FHLMC and FNMA perpetual preferred stock. Based upon a detailed analysis, the Corporation concluded both securities were "other-than-temporarily impaired" at December 31, 2004 as defined by accounting interpretations. Excluding this impairment charge, 2004 noninterest income would have increased 12.4% over 2003. Fees from the management of trusts, estates and asset management accounts totaled $3.0 million in 2004, an increase of 18.0% over 2003. Trust fees in 2003 increased 0.3% from 2002. Fees in 2004 included income from the Corporation's trust office in Martinsville, which expanded in 2004. Increases in the equity markets also had a positive influence on 2004 fee income from trust activities. Declines in the equity markets placed pressure on the growth in fee income in 2003 and 2002. The Corporation's trust and investment services division managed assets with an approximate market value of $349 million at December 31, 2004, $338 million at December 31, 2003, and $298 million at December 31, 2002. 16 Service charges on deposit accounts were $2.4 million in 2004, an increase of $248,000 or 11.5% from 2003. Service charges during 2003 totaled $2.2 million which was an increase of $457,000, or 26.8%, from 2002. The introduction of an overdraft protection program during 2003 was the primary reason for the increased fee income in 2003 and 2004. Other fees and commissions were $888,000 in 2004, $914,000 in 2003, and $816,000 in 2002. Non-customer ATM fees, debit and merchant credit card fees, safe deposit box rent, brokerage investment commissions and insurance commissions represent the majority of the income in this category. In 2004, income earned from the sale of consumer investment and insurance products declined. The increase in 2003 resulted primarily from growth in retail investment fees, interchange income from debit card transactions, and non-customer ATM transaction fees. Mortgage banking income represents fees from originating, selling, and to a lesser extent, brokering residential mortgage loans. Mortgage banking income was $612,000 in 2004, $571,000 in 2003, and $361,000 in 2002. Fee income rose in 2004 due to an improvement in the average yield earned per loan. Fee income increased in 2003 versus 2002 due to increased loan volume and increased yields. Increased refinance activity occurred in 2003 and 2004, contributing to the volume of loans originated and sold. Changes in interest rates directly impact the volume of refinance activity and, in turn, the amount of mortgage banking fee income earned. Securities are sold from time to time for balance sheet management purposes or because an investment no longer meets the Corporation's policy requirements. Net gains on sales of securities were $157,000 in 2004, $115,000 in 2003, and $39,000 in 2002. An other-than-temporary impairment charge of $985,000 on $4.5 million of FHLMC and FNMA perpetual preferred stock was charged to earnings in the fourth quarter of 2004. This was done after a thorough analysis of recent public disclosures about FHLMC and FNMA, the length of time the market value of the securities had been less than cost, the amount of the loss in comparison with the amortized cost, the results of an impairment analysis recently completed by an outside party, and accounting interpretations. Other income increased from $385,000 in 2003 to $451,000 in 2004 due primarily to fee gains from the sale or disposal of real estate, including a former branch site. Other income increased $111,000 from 2002 to 2003 due largely to increases in check order income and dividends from an equity interest in a title insurance agency. The mortgage refinance boom of 2003 was the primary reason the dividend returns on the Corporation's investment in the title agency increased. 2003 other income also included funds from the Virginia Department of Transportation highway department to compensate the Corporation for a taking of property at one of the Danville retail banking offices. NONINTEREST EXPENSE Noninterest expense for 2004 was $15.0 million compared with $15.1 million in 2003 and $14.3 million in 2002. Noninterest expense includes salaries, pension, health insurance and other employee benefits, occupancy and equipment expense, bank franchise tax expense, core deposit intangible amortization and other expenses. Salaries were $6.8 million in both 2004 and 2003. The impact of additional staff members and pay raises was offset by a decline in profit sharing and incentive expense. The Corporation did not meet its profitability goals in 2004; therefore, no profit sharing expense was accrued or paid. Salary expense of $6.8 million in 2003 increased $325,000, or 5.0%, over 2002 due to additional staffing as well as salary increases for existing staff. Pension and other employee benefits declined $115,000 from 2003 to 2004, due primarily to a reduction in profit sharing expense. Pension and other employee benefits increased $343,000 from 2002 to 2003, due to 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. Occupancy and equipment expense declined $56,000 or 2.2% in 2004 over 2003, due to a decline in depreciation expense. Occupancy and equipment expense increased marginally in 2003, primarily driven by increases in computer software maintenance and other small increases relating to facility utilities expenses. Bank franchise tax expense was $555,000 in 2004, compared with $547,000 in 2003 and $513,000 in 2002. This expense is based in large part on the level of shareholders' equity at each year-end. 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. 17 The amortization will be complete in 2005 for the Gretna office and 2006 for the Yanceyville office. Other expense increased $112,000 or 3.8% from 2003 to 2004. The largest contributor to this change was an increase in professional fees, which included an increase in legal fees of $33,000 due to additional loan collection activities, and a $32,000 increase in audit expense due primarily to costs of complying with the requirements of the Sarbanes-Oxley Act ("SOX"). With the exception of documenting information technology controls, management chose to use internal staff to perform the documentation and testing requirements of SOX. The audit expense referred to above includes only direct expenses paid to an outside firm for technology controls documentation and those paid to the Corporation's public accounting firm to audit management's assessment of internal controls. It does not include internal costs associated with SOX. Management continues to focus on controlling overhead expenses in relation to income growth. The efficiency ratio, a productivity measure used to determine how well noninterest expense is managed, was 48.5%, 49.7%, and 48.4% for 2004, 2003, and 2002, 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 peer group average is approximately 60%. The Corporation's strategy of expanding into higher growth markets could negatively impact the efficiency ratio in the short term. INCOME TAX PROVISION Applicable income taxes on 2004 earnings amounted to $3.0 million, resulting in an effective tax rate of 27.5%, compared to 29.2% in 2003 and 29.3% in 2002. The Corporation was subject to a blended Federal tax rate of 34.1% in 2004, 34.3% in 2003, and 34.2% in 2002. 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 2004 as compared to 2003 was a result of the increase in earnings from tax-exempt assets as a percentage of total income. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL GENERAL Average assets were $633.6 million in 2004, compared with $624.6 million in 2003. Average loans declined $15.2 million, or 3.6% from 2003 to 2004, reflecting strong competition in our market, pay-downs of participation loans, and more stringent underwriting requirements. Average deposits increased $3.1 million or 0.6% as redemptions of higher cost certificates of deposit offset most of the increase in demand, money market, and savings deposits. Average certificates of deposit declined $25.1 million, or 10.9% from 2003 to 2004 due in large part to high rates of interest for certificates of deposit offered by competitors. During 2004, the Corporation chose not to be aggressive in its certificate of deposit pricing, instead focusing on growth in low cost deposits. The Corporation will continue to focus on growing low cost deposits through its business development efforts aimed at expanding customer relationships. SECURITIES The securities portfolio consists primarily of investments for which an active market exists. The securities portfolio generates income, plays a primary role in the management of interest rate sensitivity, provides 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 prepayment or credit risk, liquidity needs, or other factors are classified as available for sale and are carried at estimated fair value. An other-than-temporary impairment charge of $985,000 on $4.5 million of FHLMC and FNMA perpetual preferred stock was charged to earnings in the fourth quarter of 2004. This was done after a thorough analysis of recent public disclosures about FHLMC and FNMA, the length of time the market value of the securities had been less than cost, the amount of the loss in comparison with the amortized cost, the results of an impairment analysis recently completed by an outside party, and accounting interpretations. 18 Table 5 - Securities 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): - --------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 ---------------------------- ---------------------------- ---------------------------- Taxable Taxable Taxable Amortized Equivalent Amortized Equivalent Amortized Equivalent Cost Yield Cost Yield Cost Yield ------------- ------------ ------------- ----------- ------------- ----------- Federal Agencies: Within 1 year $ 12,012 3.98% $ 18,033 1.40% $ 1,000 2.55% 1 to 5 years 56,456 2.87 63,199 3.24 40,650 4.17 5 to 10 years 18,997 3.80 33,670 2.81 17,642 3.13 Over 10 years - - - - - - ------------- ------------ ------------- ----------- ------------- ---------- Total 87,465 3.22 114,902 2.82 59,292 3.83 ------------- ------------ ------------- ----------- ------------- ---------- Mortgage-backed: Within 1 year 24 5.62 - - 1,144 6.48 1 to 5 years 3,770 4.32 1,259 3.13 281 6.62 5 to 10 years 13,482 4.47 8,958 4.95 14,429 4.81 Over 10 years 12,033 4.32 10,703 4.71 19,499 5.87 ------------- ------------ ------------- ----------- ------------- ---------- Total 29,309 4.39 20,920 4.72 35,353 5.46 ------------- ------------ ------------- ----------- ------------- ---------- State and Municipal: Within 1 year 3,849 5.89 2,150 6.71 3,204 6.76 1 to 5 years 18,730 6.03 17,019 6.11 17,720 6.44 5 to 10 years 26,886 4.97 26,689 5.14 14,678 6.56 Over 10 years 4,257 6.15 3,912 6.52 3,677 6.97 ------------- ------------ ------------- ----------- ------------- ---------- Total 53,722 5.51 49,770 5.65 39,279 6.56 ------------- ------------ ------------- ----------- ------------- ---------- Other Securities: Within 1 year 2,706 6.03 2,003 6.15 5,219 6.45 1 to 5 years 8,070 5.58 10,891 6.02 13,434 6.13 5 to 10 years - - - - - - Over 10 years 6,551 2.43 7,029 2.91 7,335 5.17 ------------- ------------ ------------- ----------- ------------- ---------- Total 17,327 4.46 19,923 4.94 25,988 5.92 ------------- ------------ ------------- ----------- ------------- ---------- Total portfolio $187,823 4.17% $205,515 3.91% $159,912 5.20% ============= ============ ============= =========== ============= ==========
The securities portfolio declined from $205.5 million at year-end 2003 to $187.8 million at year-end 2004, as investment maturities were used to fund redemptions of time deposits. The securities portfolio grew from $159.9 at year-end 2002 to $205.5 at year-end 2003, due to deposit increases. The securities portfolio at December 31, 2003 also included a $15.0 million short-term investment used to offset a large customer deposit made in December 2003. 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, 2004 and 2003. The state and municipal securities portfolio is diversified among many different issues and localities. LOANS The Corporation focuses its lending efforts on commercial loans to small and medium-sized businesses, construction and commercial real estate loans, equity lines and mortgages. Average loans declined $15.2 million, or 3.6% from 2003 to 2004, reflecting strong competition in our market, pay-downs of participation loans, and more stringent underwriting requirements. Loans held for sale are loans originated and in process of being sold to the secondary market. These loans totaled $971,000 at December 31, 2004 and $560,000 at December 31, 2003. The discussion below excludes loans held for sale. Despite the decline in average loans from 2003 to 2004, loan growth was strong during the latter part of 2004. Total loans ended the year at $407.3 million, up slightly from $406.2 million at December 31, 2003. Loans outstanding 19 in the Corporation's Greensboro, North Carolina loan production office, opened in April 2004, were approximately $6.9 million at December 31, 2004. The majority of those loans were to provide financing for residential construction and development activities. During 2004, loan production across all the Corporation's market was strongest in construction, land development, and commercial real estate lending. Commercial and industrial loans continued to decline due to a softening of demand for those types of loans. Consumer loans continued to decline due to strong competition from other financial institutions and captive finance companies. Management anticipates this trend to continue in 2005 and considers the loan portfolio to be diversified as it consists of 33.0% in residential real estate loans, 44.6% in other real estate secured loans including commercial real estate, multi-family, farmland and construction and land development loans, 18.6% in commercial, industrial and agricultural loans, and 3.8% in consumer loans as of December 31, 2004. 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, 2004, the Corporation had no loan concentrations (loans to borrowers engaged in similar activities) which exceeded 10% of total loans (in thousands): Table 6 illustrates loans by type. Table 7 presents the maturity schedule of selected loan types. Table 6 - Loans (in thousands)
2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- Real estate loans: Construction and land development $ 34,101 $ 12,790 $ 9,208 $ 10,282 $ 9,284 Secured by farmland 2,853 3,430 1,485 1,110 1,616 Secured by 1-4 family residential properties 134,292 136,229 129,905 126,607 121,449 Secured by multi-family (5 or more) residential properties 9,033 6,801 6,329 6,385 5,023 Secured by nonfarm, nonresidential properties 135,767 126,164 107,263 88,648 67,312 Loans to farmers 1,442 1,618 1,844 1,452 1,625 Commercial and industrial loans 70,336 91,419 113,575 98,324 83,428 Consumer loans 15,248 23,581 32,008 36,077 44,389 Loans for nonrated industrial development obligations 4,069 4,077 4,745 6,436 5,590 Deposit overdrafts 128 136 41 19 40 -------- -------- -------- -------- -------- Loans - net of unearned income $407,269 $406,245 $406,403 $375,340 $339,756 ======== ======== ======== ======== ========
Table 7 - Scheduled Loan Maturities (in thousands) Commercial and Real Estate Agricultural Construction Total ------------ ------------ ---------- 1 year or less $ 19,821 $ 19,302 $ 39,123 1-5 years 34,564 2,968 37,532 After 5 years 21,462 11,831 33,293 ------------ ------------ ---------- Total $ 75,847 $ 34,101 $ 109,948 ============ ============ ========== Of the loans due after one year, $11,309 have predetermined interest rates and $59,516 have floating or adjustable interest rates. 20 ALLOWANCE AND PROVISION FOR LOAN LOSSES The purpose of the allowance for loan losses is to provide for 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 Corporation's lenders are responsible for assigning risk ratings to loans using the parameters set forth in the Corporation's Credit Policy. The risk ratings are reviewed for accuracy, on a sample basis, by the Corporation's Loan Review department, which operates independently of loan production. These risk ratings are used in calculating the level of the allowance for loan losses. The Corporation's Credit Committee has responsibility for determining the level and adequacy 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; individual risk ratings; nonperforming loans, impaired loans, and other problem credits; the value and adequacy of collateral and guarantors; and national and local economic conditions. A significant portion 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 under economic pressure. The region has traditionally been 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. 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, and recent loss experiences in particular portfolio segments. 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 December 2004, the Corporation added an additional $2.0 million to its allowance for loan losses primarily related to a $4.5 million loan secured by a hotel in a major North Carolina metropolitan area. Although payments on the loan have always been current, the cash flow and collateral valuation of the hotel has deteriorated; thus, the loan was deemed impaired and was placed on nonaccrual status at December 31, 2004. Due primarily to the provision needed for the hotel loan noted above, the provision for loan losses increased significantly from $920,000 in 2003 to $3.1 million in 2004. The provision for loan losses was $873,000 in 2002. Loans charged off, net of recoveries, totaled $405,000 in 2004, $1,250,000 in 2003, and $585,000 in 2002. The ratio of net charge-offs to average loans was 0.10% in 2004, 0.30% in 2003, and 0.15% in 2002. In 2003, a partial charge-off of one commercial loan accounted for $744,000 of the net charge-offs for that year. Table 10 presents the Corporation's loan loss and recovery experience for the past five years. The allowance for loan losses totaled $8.0 million at December 31, 2004, an increase of $2.7 million over December 31, 2003. The increase was primarily attributable to the additional provision related to the hotel loan discussed above. The ratio of the allowance to loans, less unearned income, at December 31, 2004, 2003, and 2002, was 1.96%, 1.30%, and 1.38%, respectively. Management believes that the allowance for loan losses is adequate to absorb losses inherent in the Corporation's loan portfolio at December 31, 2004. 21 The allowance for loan losses is allocated to loan types based upon historical loss factors; risk grades on individual loans; portfolio analyses of smaller balance, homogenous loans; and qualitative factors. Qualitative factors include trends in delinquencies, nonaccruals, and loss rates; trends in volume and terms of loans, effects of changes in risk selection, underwriting standards, and lending policies; experience of lending officers and other lending staff; national and local economic trends and conditions; and concentrations of credit. The assessed risk of loan loss is higher in the commercial and consumer loan categories than in the residential real estate categories. Table 8 summarizes the allocation of the allowance for loan losses for the past five years. Table 8 - Allocation of Allowance for Loan Losses Management has allocated the allowance for loan losses to loan categories as follows (in thousands):
2004 2003 2002 2001 2000 ------------------ ----------------- ------------------ ------------------ ------------------ 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) $5,927 61 % $2,881 59 % $3,196 59 % $2,005 55 % $1,691 50 % Real estate- residential 1,231 35 848 35 781 33 236 35 177 37 Consumer 816 4 1,141 6 1,247 8 1,276 10 1,304 13 Unallocated 8 - 422 - 398 - 1,817 - 1,574 - -------- -------- -------- -------- -------- -------- -------- -------- --------- -------- Balance at end of year $7,982 100 % $5,292 100 % $5,622 100 % $5,334 100 % $4,746 100 % ======== ======== ======== ======== ======== ======== ======== ======== ========= ========
Table 9 - Asset Quality Ratios
2004 2003 2002 2001 2000 -------- -------- --------- --------- -------- Allowance to loans 1.96 % 1.30 % 1.38 % 1.42 % 1.40 % Net charge-offs to allowance 5.07 23.62 10.41 8.00 8.60 Net charge-offs to average loans .10 .30 .15 .12 .13 Nonperforming assets to assets 1.35 .56 .09 .16 .12 Nonperforming loans to year-end loans 1.99 .82 .13 .22 .11 Provision to net charge-offs 764.20 73.60 149.23 237.72 250.00 Provision to average loans .77 .22 .22 .28 .32 Allowance to nonperforming loans .98 X 1.60 X 10.41 X 6.46 X 12.33 X
22 Table 10 - Summary of Loan Loss Experience (dollars in thousands)
2004 2003 2002 2001 2000 ------------ ------------ ----------- ----------- ------------ Balance at beginning of period $5,292 $5,622 $5,334 $4,746 $4,135 ------------ ------------ ----------- ----------- ------------ Charge-offs: Commercial loans 169 1,004 343 141 141 Real estate loans 129 80 33 59 9 Consumer loans 357 373 364 402 417 ------------ ------------ ----------- ----------- ------------ 655 1,457 740 602 567 ------------ ------------ ----------- ----------- ------------ Recoveries: Commercial loans 45 105 28 75 32 Real estate loans 49 - 3 3 1 Consumer loans 156 102 124 97 125 ------------ ------------ ----------- ----------- ------------ 250 207 155 175 158 ------------ ------------ ----------- ----------- ------------ Net charge-offs 405 1,250 585 427 409 Provision for loan losses 3,095 920 873 1,015 1,020 ------------ ------------ ----------- ----------- ------------ Balance at end of period $7,982 $5,292 $5,622 $5,334 $4,746 ============ ============ =========== =========== ============ Percentage of net charge-offs to average loans .10% .30% .15% .12% .13% ============ ============ =========== =========== ============
ASSET QUALITY, CREDIT RISK MANAGEMENT AND NONPERFORMING ASSETS 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 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. The Corporation uses certain general practices to manage its credit risk. These practices include (a) appropriate lending limits for loan officers, (b) an established loan approval process, (c) careful underwriting of loan requests, including analysis of borrowers, collateral, and market risks, (d) regular monitoring of the portfolio, (d) review of loans by a Loan Review department which operates independently of loan production, (e) regular meetings of a Credit Committee to discuss portfolio and policy changes, and (f) regular meetings of an Asset Quality Committee which reviews the status of individual loans. Loans are generally placed on nonaccrual status when any portion of principal or interest is 90 days past due or collection is uncertain. Unless loans are secured and in the process of collection, they are normally charged off after a delinquency of 120 days. Under the Corporation's policy, a nonaccruing 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 secured and in the process of collection. In 2003, the Corporation reorganized its lending and credit functions. A new Chief Credit Officer position was created, a new credit policy manual was 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 rigorous 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 began moving consumer loans, generally, to nonaccrual status after they reached 90 days past due; the previous system typically did not place these loans on nonaccrual status, but normally charged them off when they reached 180 days past due. New internal limits were also 23 placed on time and demand loan renewals. Both of these changes, along with the changes to the risk grading system, increased the number of reported nonperforming loans. In December 2004, the Corporation added an additional $2.0 million to its allowance for loan losses primarily related to a $4.5 million loan secured by a hotel in a major North Carolina metropolitan area. Although payments on the loan have always been current, the cash flow and collateral valuation of the hotel has deteriorated; thus, the loan was deemed impaired and was placed on nonaccrual status at December 31, 2004. Nonperforming loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and loans classified as troubled debt restructurings. Nonperforming assets include nonperforming loans and foreclosed real estate. Nonperforming loans as a percentage of total loans increased from 0.81% at December 31, 2003 to 1.99% at December 31, 2004. The placement of the hotel loan discussed above onto nonaccrual status at December 31, 2004 was the primary reason for the increase. Nonperforming loans to total loans were .13% at December 31, 2002. The following table summarizes nonperforming assets at December 31. Table 11 - Nonperforming Assets (in thousands) 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Nonaccruing loans: Real Estate $7,005 $1,870 $ 293 $ 414 $ 65 Commercial 853 1,236 - 115 67 Agricultural 12 8 8 39 14 Consumer 243 148 - - - ------ ------ ------ ------ ------ Total nonaccruing loans 8,113 3,262 301 568 146 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Restructured loans: - - - - - ------ ------ ------ ------ ------ Loans past due 90 days and accruing interest: Real Estate - - - - - Commercial - - 33 33 49 Agricultural - - 1 8 14 Consumer - 53 205 217 176 ------ ------ ------ ------ ------ Total past due loans - 53 239 258 239 ------ ------ ------ ------ ------ Total nonperforming loans 8,113 3,315 540 826 385 ------ ------ ------ ------ ------ Foreclosed real estate 221 303 30 117 245 ------ ------ ------ ------ ------ Total nonperforming assets $8,334 $3,618 $ 570 $ 943 $ 630 ====== ====== ====== ====== ====== Nonaccrual loans include impaired loans on nonaccrual status of $5.8 million at December 31, 2004, $2.5 million at December 31, 2003, and $54,000 at December 31, 2002. There were no impaired loans at December 31, 2001 or 2000. As of December 31, 2004, loans totaling $6.3 million 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 $2.5 million of such loans as of December 31, 2003. The hotel loan discussed above is the primary reason for the increase. 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. Foreclosed real estate totaled $221,000 at December 31, 2004 and $303,000 at December 31, 2003. The Corporation has a commercial real estate loan in the amount of $3.0 million to 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 secured debtor-in-possession financing from its primary lender. During the bankruptcy period, the borrower was required by court order to make monthly interest payments to the Corporation from the date of the filing, and such 24 payments are current. The borrower emerged from bankruptcy in February 2005. The loan is in process of being placed on a fifteen-year amortization schedule. It is secured by a first deed of trust on a commercial property appraised for an amount exceeding the loan balance. 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. Liquidity is provided from cash and amounts due from banks, federal funds sold, interest-bearing deposits in other banks, loan repayments, increases in deposits, lines of credit from the Federal Home Loan Bank of Atlanta ("FHLB") and two correspondent banks, and maturing investments. Management believes that these factors provide sufficient and timely liquidity for the foreseeable future. Management monitors and plans the Corporation's liquidity position for future periods. Liquidity strategies are implemented and monitored by 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 and unpledged securities available-for-sale, less the Corporation's reserve requirement, to net liabilities ratio was 19.7% at December 31, 2004 and 21.3% at December 31, 2003. Both of these ratios are considered to reflect adequate liquidity for the respective periods. The Corporation has credit availability equal to 30% of assets with FHLB that equaled $185.5 million, with $164.2 million available at December 31, 2004. Borrowings outstanding under this line of credit were $21.3 million and $21.0 million, respectively, at December 31, 2004 and December 31, 2003. Under the terms of its collateral agreement with the FHLB, the Corporation provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans and home equity lines of credit. In addition, the Corporation pledges as collateral its capital stock in the FHLB and deposits with the FHLB. The Corporation has fixed-rate term borrowing contracts with the FHLB as of December 31, 2004 in the following final maturities: Amount Expiration Date ---------- --------------- $2,000,000 2005 $2,000,000 2006 $1,000,000 2007 $8,000,000 2008 $5,000,000 2009 $1,388,000 2014 The Corporation 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 Corporation considers these as backup sources of funds. DEPOSITS The Corporation's major source of funds is its customer deposit base. During 2004, the Corporation did not strive to retain high-cost certificates of deposit ("time deposits"). Instead, it focused on growing lower cost checking, savings, and money market accounts ("core deposits"). The results of this strategy are evident in Table 12. Core deposits increased $28.3 million, or 10.9% in 2004, after rising $28.0 million, or 12.1% in 2003. Growth in core deposits provides the Corporation with lower-cost funding and helps solidify and expand its customer relationships. Average time deposits declined $25.1 million, or 10.9%, during 2004, after increasing by 0.4% in 2003. Certificates of deposit of $100,000 or more are detailed in Table 13 and declined in 2004 from the balance of $61.4 million at December 31, 2003. 25 Table 12 - Deposits (in thousands)
2004 2003 2002 --------------------------- --------------------------- --------------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------------ ------------ ------------ ------------ ------------- ------------ Demand deposits - noninterest bearing $ 76,123 - % $ 66,300 - % $ 58,075 - % Demand deposits - interest bearing 73,338 .37% 63,858 .35% 59,852 .70% Money market 53,305 .80% 47,293 1.01% 42,369 1.83% Savings 83,814 .52% 80,876 .88% 70,073 1.50% Time 204,945 2.36% 230,070 2.83% 229,074 3.76% ------------ ------------ ------------ ------------ ------------- ------------ $491,525 1.21% $488,397 1.62% $459,443 2.36% ============ ============ =============
Table 13 - Certificates of Deposit (in thousands) Certificates of deposit at December 31, 2004 in amounts of $100,000 or more were classified by maturity as follows: 3 months or less $ 9,219 Over 3 through 6 months 6,839 Over 6 through 12 months 14,454 Over 12 months 22,642 ------- $53,154 ======= 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. These off-balance sheet transactions include commitments to extend credit, standby letters of credit, and commitments to purchase securities. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities. Off-balance sheet transactions were as follows (in thousands): Off-Balance Sheet Transactions December 31, 2004 December 31, 2003 ------------------------------------- ----------------- ----------------- Commitments to extend credit $ 130,862 $ 124,905 Standby letters of credit 4,849 3,477 Commitments to purchase securities - 700 Mortgage loan locked-rate commitments $ 2,818 $ 1,019 Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future liquidity requirements. Standby letters of credit are conditional commitments issued by the Corporation guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities. 26 CONTRACTUAL OBLIGATIONS The following items are contractual obligations of the Corporation as of December 31, 2004 (in thousands):
Payments Due by Period ---------------------------------------------------------- More than Contractual Obligations Total Under 1 Year 1-3 Years 3-5 Years 5 years ----------------------- ------- ------------ --------- --------- --------- FHLB advances $21,338 $ 1,950 $ 4,000 $ 14,000 $ 1,388 Repurchase agreements 38,945 38,945 - - - Operating leases 476 146 186 108 36 Purchase obligations - - - - -
CAPITAL Shareholders' equity was $71.9 million at December 31, 2003 and $71.0 million at December 31, 2004. During 2004, shareholders' equity was increased by net income and proceeds from the exercise of stock options; shareholders' equity was decreased by dividends, stock repurchases, and a decrease in accumulated other comprehensive income. The Corporation's Board of Directors declared and paid quarterly dividends totaling $.79 and $.75 per share of common stock in 2004 and 2003, respectively. Cash dividends totaled $4,411,000 and represented a 55.1% payout of 2004 net income, compared to 44.9% in 2003 and 43.5% in 2002. The Corporation intends to pay dividends that are competitive in the banking industry while maintaining an adequate level of capital to support growth. On August 17, 2004, the Corporation's board of directors approved the extension of its stock repurchase plan, begun in 2000, to include the repurchase of up to 250,000 shares of the Corporation's common stock between August 18, 2004 and August 16, 2005. The stock may be purchased in the open market or in privately negotiated transactions as management and the board of directors determine to be in the best interest of the Corporation. Since August 16, 2000, the number of shares repurchased is displayed in the table below: Shares Average Repurchased Price ----------- -------- 2000 40,000 $14.10 2001 254,366 18.08 2002 45,100 23.26 2003 125,000 25.03 2004 159,968 23.67 ---------- -------- Total 624,434 $21.02 ========== ======== One measure of a financial institution's capital strength is the ratio of shareholder's equity to assets. Shareholders' equity was 11.5% of assets at December 31, 2004 and 11.2% at December 31, 2003. In addition to this measurement, banking regulators have defined minimum regulatory capital ratios for financial institutions. These ratios take into account risk factors identified by those regulatory authorities associated with the assets and off-balance sheet activities of financial institutions. The guidelines require percentages, or "risk weights" be applied to those assets and off-balance-sheet assets in relation to their perceived risk. Under the guidelines, capital strength is measured in two tiers. Tier I capital consists primarily of shareholder's equity, while Tier II capital consists of qualifying allowance for loan losses. Total capital is the total of Tier I and Tier II capital. Another indicator of capital adequacy is the leverage ratio, which is computed by dividing Tier I capital by average quarterly assets less intangible 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, 2004, the Corporation's Tier I and total capital ratios were 15.48% and 16.73%, respectively. At December 31, 2003, these ratios were 14.85% and 15.99%, respectively. The ratios for both years were well in excess of the regulatory requirements. The Corporation's leverage ratios were 11.02% and 10.76% at December 31, 2004 and 2003, 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. 27 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 exceeded the minimum ratios to be considered well capitalized at December 31, 2004 and 2003. 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 total market value of American National Bankshares Inc. common stock at December 31, 2004, at $24.21 per share (the last trade recorded on the Nasdaq National Market during 2004) was $133,667,000, compared to $147,624,000 at December 31, 2003 when the stock was last traded at $26.08 per share. IMPACT OF INFLATION AND CHANGING PRICES The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. The most significant effect of inflation is on other expenses that tend to rise during periods of inflation. Changes in interest rates have a greater impact on a financial institution's profitability than do the effects of higher costs for goods and services. Through its balance sheet management practices, the Corporation has the ability to react to those changes and measure and monitor its interest rate and liquidity risk. 28 Table 14 - Quarterly Financial Results (in thousands, except per share amounts)
Fourth Third Second First 2004 Quarter Quarter Quarter Quarter ---- ----------- ------------ ----------- ------------ Interest income......................................... $7,720 $7,409 $7,410 $7,581 Interest expense........................................ 1,867 1,783 1,864 1,965 ----------- ------------ ----------- ------------ Net interest income................................... 5,853 5,626 5,546 5,616 Provision for loan losses............................... 2,370 255 255 215 ----------- ------------ ----------- ------------ Net interest income after provision................... 3,483 5,371 5,291 5,401 Noninterest income...................................... 876 1,736 2,045 1,853 Noninterest expense..................................... 3,415 3,846 3,949 3,801 ----------- ------------ ----------- ------------ Income before income tax provision.................... 944 3,261 3,387 3,453 Income tax provision.................................... 164 922 963 983 ----------- ------------ ----------- ------------ Net income............................................ $ 780 $2,339 $2,424 $2,470 =========== ============ =========== ============ Per common share: Net income (basic).................................... $ .14 $ .42 $ .43 $ .44 Net income (diluted).................................. $ .14 $ .42 $ .43 $ .43 Cash dividends........................................ $ .20 $ .20 $ .20 $ .19
Fourth Third Second First 2003 Quarter Quarter Quarter Quarter ---- ----------- ------------ ----------- ------------ 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 Noninterest income...................................... 1,794 1,800 1,615 1,462 Noninterest 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
29 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9B - OTHER INFORMATION None ITEM 9A - CONTROLS AND PROCEDURES Disclosure Controls and Procedures The Corporation's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the Corporation's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of December 31, 2004. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are effective. There were no significant changes in the Corporation's internal controls over financial reporting that occurred during the quarter ended December 31, 2004 that have materially affected or are reasonably likely to materially affect the Corporation's internal control over financial reporting. Management's Annual Report on Internal Control Over Financial Reporting Management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management regularly monitors its internal control over financial reporting, and actions are taken to correct deficiencies as they are identified. Management assessed the Corporation's internal control over financial reporting as of December 31, 2004. This assessment was based on criteria described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, management concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2004 based on the specified criteria. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, because of changes in conditions, internal control effectiveness may vary over time. The Corporation's independent registered public accounting firm, Yount, Hyde and Barbour, P.C., audited management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2004, as stated in their report included herein. Yount, Hyde and Barbour, P.C. also audited the Corporation's financial statements as of and for the year ended December 31, 2004. /s/ Charles H. Majors - ------------------------------------- Charles H. Majors President and Chief Executive Officer /s/ Neal A. Petrovich - -------------------------------------- Neal A. Petrovich Senior Vice President and Chief Financial Officer February 25, 2005 30 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the 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, 2004 and 2003, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004. We also have audited management's assessment, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A, that American National Bankshares Inc. and subsidiary maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). American National Bankshares Inc. and subsidiary's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management's assessment, and an opinion on the effectiveness of the Corporation's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A corporation's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A corporation's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 31 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, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management's assessment that American National Bankshares Inc. and subsidiary maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, American National Bankshares Inc. and subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). /s/Yount, Hyde & Barbour, P.C. - ------------------------------ Winchester, Virginia February 25, 2005 32 American National Bankshares Inc. and Subsidiary Consolidated Balance Sheets December 31, 2004 and 2003 (Dollars in thousands, except share data) - --------------------------------------------------------------------------------------------------------
2004 2003 ---------- ---------- ASSETS Cash and due from banks ........................................................$ 12,371 $ 16,236 Interest-bearing deposits in other banks........................................ 197 1,652 Securities available for sale, at fair value.................................... 165,958 171,376 Securities held to maturity (fair value of $23,088 in 2004 and $37,455 in 2003).................................................. 22,205 36,103 ---------- ---------- Total securities.............................................................. 188,163 207,479 ---------- ---------- Loans held for sale............................................................. 971 560 Loans, net of unearned income .................................................. 407,269 406,245 Less allowance for loan losses.................................................. (7,982) (5,292) ---------- ---------- Net loans..................................................................... 399,287 400,953 ---------- ---------- Bank premises and equipment, at cost, less accumulated depreciation of $12,362 in 2004 and $11,807 in 2003........................... 7,517 7,718 Core deposit intangibles, net................................................... 484 934 Accrued interest receivable and other assets.................................... 10,075 8,770 ---------- ---------- Total assets..................................................................$ 619,065 $ 644,302 ========== ========== LIABILITIES and SHAREHOLDERS' EQUITY Liabilities: Demand deposits -- noninterest bearing........................................$ 75,256 $ 71,027 Demand deposits -- interest bearing........................................... 80,793 69,053 Money market deposits......................................................... 52,031 59,251 Savings deposits.............................................................. 83,216 83,031 Time deposits................................................................. 193,976 219,326 ---------- ---------- Total deposits.............................................................. 485,272 501,688 ---------- ---------- Repurchase agreements......................................................... 38,945 47,035 FHLB borrowings............................................................... 21,338 21,000 Accrued interest payable and other liabilities................................ 2,510 2,648 ---------- ---------- Total liabilities........................................................... 548,065 572,371 ---------- ---------- Shareholders' equity: Preferred stock, $5 par, 200,000 shares authorized, none outstanding............................................................ - - Common stock, $1 par, 10,000,000 shares authorized, 5,521,164 shares outstanding at December 31, 2004 and 5,660,419 shares outstanding at December 31, 2003........................... 5,521 5,660 Capital in excess of par value................................................ 9,474 9,437 Retained earnings............................................................. 55,780 55,538 Accumulated other comprehensive income, net................................... 225 1,296 ---------- ---------- Total shareholders' equity.................................................. 71,000 71,931 ---------- ---------- Total liabilities and shareholders' equity..................................$ 619,065 $ 644,302 ========== ========== The accompanying notes are an integral part of the consolidated financial statements.
33 American National Bankshares Inc. and Subsidiary Consolidated Statements of Income For the Years Ended December 31, 2004, 2003 and 2002 (Dollars in thousands, except per share data) - ---------------------------------------------------------------------------------------------------------------
2004 2003 2002 ----------- ----------- ----------- Interest Income: Interest and fees on loans.......................................$ 22,791 $ 25,228 $ 27,150 Interest and dividends on securities: Taxable........................................................ 5,028 4,771 5,737 Tax-exempt..................................................... 2,006 1,838 1,664 Dividends...................................................... 163 231 336 Other interest income............................................ 132 110 248 ----------- ----------- ----------- Total interest income.......................................... 30,120 32,178 35,135 ----------- ----------- ----------- Interest Expense: Interest on deposits............................................. 5,979 7,915 10,847 Interest on repurchase agreements................................ 528 497 635 Interest on other borrowings..................................... 972 979 828 ----------- ----------- ----------- Total interest expense......................................... 7,479 9,391 12,310 ----------- ----------- ----------- Net Interest Income................................................ 22,641 22,787 22,825 Provision for Loan Losses.......................................... 3,095 920 873 ----------- ----------- ----------- Net Interest Income After Provision for Loan Losses.................................................. 19,546 21,867 21,952 ----------- ----------- ----------- Noninterest Income: Trust and investment services.................................... 2,976 2,523 2,516 Service charges on deposit accounts.............................. 2,411 2,163 1,706 Other fees and commissions....................................... 888 914 816 Mortgage banking income.......................................... 612 571 361 Securities gains, net............................................ 157 115 39 Impairment of securities......................................... (985) - - Other............................................................ 451 385 274 ----------- ----------- ----------- Total noninterest income....................................... 6,510 6,671 5,712 ----------- ----------- ----------- Noninterest Expense: Salaries......................................................... 6,795 6,844 6,519 Pension and other employee benefits.............................. 1,699 1,814 1,471 Occupancy and equipment ......................................... 2,457 2,513 2,460 Bank franchise tax............................................... 555 547 513 Core deposit intangible amortization............................. 450 450 450 Other ........................................................... 3,055 2,943 2,872 ----------- ----------- ----------- Total noninterest expense...................................... 15,011 15,111 14,285 ----------- ----------- ----------- Income Before Income Tax Provision................................. 11,045 13,427 13,379 Income Tax Provision............................................... 3,032 3,914 3,918 ----------- ----------- ---------- Net Income.........................................................$ 8,013 $ 9,513 $ 9,461 =========== =========== =========== Net Income Per Common Share: Basic............................................................$ 1.43 $ 1.67 $ 1.63 Diluted..........................................................$ 1.42 $ 1.65 $ 1.62 Average Common Shares Outstanding: Basic........................................................... 5,591,839 5,702,625 5,800,302 Diluted......................................................... 5,642,056 5,764,127 5,850,349 The accompanying notes are an integral part of the consolidated financial statements.
34 American National Bankshares Inc. and Subsidiary Consolidated Statements of Changes in Shareholders' Equity For the Years Ended December 31, 2004, 2003 and 2002 (Dollars in thousands)
Accumulated Common Stock Capital in Other Total ---------------------- Excess of Retained Comprehensive Shareholders' Shares Amount Par Value Earnings Income Equity ----------- ---------- ---------- ----------- ------------- --------------- Balance, December 31, 2001........................ 5,821,956 $ 5,822 $ 9,588 $ 48,678 $ 1,309 $ 65,397 Net income........................................ - - - 9,461 - 9,461 Other comprehensive income, net of tax: Change in unrealized gains on securities available for sale, net of tax of $656.......... - - - - 1,273 Minimum pension liability adjustment, net of tax of $150.............................. (291) ------------- Other comprehensive income.................... 982 982 --------------- Comprehensive income.......................... 10,443 Stock repurchased and retired..................... (45,100) (45) (74) (929) - (1,048) Stock options exercised........................... 3,960 4 57 - - 61 Cash dividends declared and paid.................. - - - (4,117) - (4,117) ----------- ---------- ---------- ----------- ------------- --------------- Balance, December 31, 2002........................ 5,780,816 5,781 9,571 53,093 2,291 70,736 Net income........................................ - - - 9,513 - 9,513 Other comprehensive loss, net of tax: Change in unrealized gains (losses) on securities available for sale, net of tax of $(639)........ - - - - (1,229) Less: Reclassification adjustment for gains on securities available for sale, net of tax of ($29)............................... - - - - (57) Minimum pension liability adjustment, net of tax of ($150)............................ 291 ------------- Other comprehensive loss...................... (995) (995) --------------- Comprehensive income.......................... 8,518 Stock repurchased and retired..................... (125,000) (125) (207) (2,796) - (3,128) Stock options exercised........................... 4,603 4 73 - - 77 Cash dividends declared and paid.................. - - - (4,272) - (4,272) ----------- ---------- ---------- ----------- ------------- --------------- Balance, December 31, 2003........................ 5,660,419 5,660 9,437 55,538 1,296 71,931 Net income........................................ - - - 8,013 - 8,013 Other comprehensive income (loss), net of tax: Change in unrealized gains (losses) on securities available for sale, net of tax of $(849)........ - - - - (1,648) Add: Reclassification adjustment for losses on impairment of securities, net of tax of $335........................................ 650 Less: Reclassification adjustment for gains on securities available for sale, net of tax of ($38)............................... - - - - (73) ------------- Other comprehensive loss...................... (1,071) (1,071) --------------- Comprehensive income.......................... 6,942 Stock repurchased and retired..................... (159,968) (160) (267) (3,360) - (3,787) Stock options exercised........................... 20,713 21 304 - - 325 Cash dividends declared and paid.................. - - - (4,411) - (4,411) ----------- ---------- ---------- ----------- ------------- --------------- Balance, December 31, 2004........................ 5,521,164 $ 5,521 $ 9,474 $ 55,780 $ 225 $ 71,000 =========== ========== ========== =========== ============= =============== The accompanying notes are an integral part of the consolidated financial statements.
35 American National Bankshares Inc. and Subsidiary Consolidated Statements of Cash Flows For the Years Ended December 31, 2004, 2003 and 2002 (Dollars in thousands)
2004 2003 2002 ---------- ---------- ---------- Cash Flows from Operating Activities: Net income................................................... $ 8,013 $ 9,513 $ 9,461 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses.................................... 3,095 920 873 Depreciation................................................. 966 1,135 1,144 Core deposit intangible amortization......................... 450 450 450 Net amortization of securities............................... 609 1,063 295 Gain on sale or call of securities........................... (157) (115) (39) Impairment of securities..................................... 985 - - Gain on sale of loans held for sale.......................... (457) (552) (361) Proceeds from sales of loans held for sale................... 21,733 30,332 17,764 Originations of loans held for sale.......................... (21,687) (29,055) (18,435) Loss on sale of other real estate owned...................... 23 6 1 Valuation allowance on other real estate owned............... 10 - - (Gain) loss on sale of premises and equipment................ (172) (42) 16 Deferred income taxes (benefit) provision ................... (1,309) 395 48 Decrease (increase) in interest receivable................... 336 (567) (66) Decrease (increase) in other assets.......................... 138 (872) (518) Decrease in interest payable................................. (137) (230) (359) (Decrease) increase in other liabilities..................... (1) (87) 23 ---------- ---------- ---------- Net cash provided by operating activities.................. 12,438 12,294 10,297 ---------- ---------- ---------- Cash Flows from Investing Activities: Proceeds from maturities and calls of securities available for sale................................................... 63,724 71,843 54,414 Proceeds from sales of securities available for sale......... 6,652 3,104 1,052 Proceeds from maturities and calls of securities held to maturity................................................... 17,675 5,678 6,197 Purchases of securities available for sale................... (68,035) (112,180) (63,531) Purchases of securities held to maturity..................... (3,760) (14,996) (3,492) Net increase in loans........................................ (1,619) (1,369) (31,812) Proceeds from sales of bank premises and equipment........... 227 43 - Purchases of bank premises and equipment..................... (820) (687) (1,470) Proceeds from sales of other real estate owned............... 239 10 261 Purchases of other real estate owned......................... - (13) (11) ---------- ---------- ---------- Net cash provided by (used in) investing activities........ 14,283 (48,567) (38,392) ---------- ---------- ---------- Cash Flows from Financing Activities: Net increase in demand, money market, and savings deposits....................................... 8,934 33,339 16,370 Net decrease in time deposits................................ (25,350) (5,213) (6,820) Net (decrease) increase in repurchase agreements............. (8,090) 10,880 8,978 Net increase (decrease) in FHLB borrowings................... 338 (1,000) 9,000 Cash dividends paid.......................................... (4,411) (4,272) (4,117) Repurchase of stock.......................................... (3,787) (3,128) (1,048) Proceeds from exercise of stock options...................... 325 77 61 ---------- ---------- ---------- Net cash (used in) provided by financing activities........ (32,041) 30,683 22,424 ---------- ---------- ---------- Net Decrease in Cash and Cash Equivalents...................... (5,320) (5,590) (5,671) Cash and Cash Equivalents at Beginning of Period............... 17,888 23,478 29,149 ----------- ---------- ---------- Cash and Cash Equivalents at End of Period..................... $ 12,568 $ 17,888 $ 23,478 =========== ========== ========== Supplemental Schedule of Cash and Cash Equivalents: Cash: Cash and due from banks.................................... $ 12,371 $ 16,236 $ 16,757 Interest-bearing deposits in other banks................... 197 1,652 6,721 ----------- ---------- ---------- $ 12,568 $ 17,888 $ 23,478 =========== ========== ========== Supplemental Disclosure of Cash Flow Information: Interest paid................................................ $ 7,617 $ 9,621 $ 12,669 Income taxes paid............................................ $ 3,763 $ 3,630 $ 4,012 Transfer of loans to other real estate owned................. $ 190 $ 277 $ 164 Unrealized gain (loss) on securities available for sale...... $ (1,624) $ (1,948) $ 1,928 The accompanying notes are an integral part of the consolidated financial statements.
36 American National Bankshares Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2004, 2003 and 2002 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 Corporation 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. The Corporation also originates commercial loans through its loan production office in Greensboro, 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, offers 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. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. 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 impairment losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. 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. The Corporation does not permit the purchase or sale of trading account securities. Loans Held for Sale Secondary market mortgage loans are designated as held for sale at the time of their origination. These loans are pre-sold with servicing released and the Corporation 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 Corporation 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 noninterest income for the period. 37 Rate Lock Commitments The Corporation enters into commitments to originate secondary market 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. The Corporation 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, the Corporation 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. 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. The Corporation 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 secured by real estate. 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. 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. Loans are typically charged off when the loan is 120 days past due, unless secured and in process of collection. 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. 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. Generally, large groups of smaller balance homogeneous loans are collectively evaluated for impairment. The Corporation's policy for recognizing interest income on impaired loans is consistent with its nonaccrual policy. Allowance for Loan Losses The allowance for loan losses is management's best estimate of probable credit losses that are inherent in the loan portfolio at the balance sheet date. The Corporation determines the allowance based on an ongoing evaluation. Increases to the allowance are made by charges to the provision for loan losses, which is reflected in the Consolidated Statements of Income. Loan balances deemed to be uncollectible are charged-off against the allowance. Recoveries of previously charged-off amounts are credited to the allowance. 38 The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the loan portfolio in light of historical charge-off 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. 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, 2004, the Corporation had $484,000 recorded as core deposit intangibles, net of amortization. The Corporation recorded core deposit intangible amortization of approximately $450,000 for each of the three years ended December 31, 2004. Core deposit intangibles are periodically reviewed for impairment. As of December 31, 2004, no impairment had been identified. In October 2002, the Financial Accounting Standards Board ("FASB") 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. Trust Assets Securities and other property held by the trust segment in a fiduciary or agency capacity are not assets of the Corporation and are not included in the accompanying consolidated financial statements. Foreclosed Real Estate Foreclosed real estate is 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. 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. 39 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, except per share data): 2004 2003 2002 -------- -------- -------- Net income, as reported $ 8,013 $ 9,513 $ 9,461 Deduct: total stock-based compensation expense determined under fair value based method for all awards (634) (136) (169) -------- -------- -------- Pro forma net income $ 7,379 $ 9,377 $ 9,292 Earnings per share: Basic, as reported $ 1.43 $ 1.67 $ 1.63 Basic, pro forma $ 1.32 $ 1.64 $ 1.60 Diluted, as reported $ 1.42 $ 1.65 $ 1.62 Diluted, pro forma $ 1.31 $ 1.63 $ 1.59 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 2004, the Corporation repurchased 159,968 shares of its common stock in the open market and in private transactions at prices between $21.55 and $26.00 per share. 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. From the inception of the stock repurchase plan through December 31, 2004, the Corporation has purchased and retired 624,434 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 for the years ended December 31, 2004, 2003 and 2002 were $172,000, $170,000, and $137,000, 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. 40 Reclassifications Certain reclassifications have been made in prior years' financial statements to conform to classifications used in the current year. New Accounting Pronouncements In January 2003, the Financial Accounting Standards Board 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 when the assets, liabilities, non-controlling interests, and results of operations of a variable interest entity need to be included in a company's consolidated financial statements. An entity is deemed a variable interest entity, subject to the interpretation, if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or in cases in which 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. Due to significant implementation issues, the FASB modified the wording of FIN 46 and issued FIN 46R in December of 2003. FIN 46R deferred the effective date for the provisions of FIN 46 to entities other than Special Purpose Entities ("SPEs") until financial statements issued for periods ending after March 15, 2004. SPEs were subject to the provisions of either FIN 46 or FIN 46R as of December 15, 2003. The Corporation has no investments in variable interest entities; therefore the adoption of FIN 46 and FIN 46R did not have a material effect on the Corporation's consolidated financial position or consolidated results of operations. In December 2003, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The scope of the SOP applies to unhealthy "problem" loans that have been acquired, either individually in a portfolio, or in a business acquisition. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The SOP does not apply to loans originated by the Corporation. The Corporation intends to adopt the provisions of SOP 03-3 effective January 1, 2005, and does not expect the initial implementation to have any effect on its consolidated financial position or consolidated results of operations. On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments ("IRLC"), subject to SFAS No. 149 and Derivative Implementation Group Issue C13, "Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133." Furthermore, SAB 105 disallows the inclusion of the values of a servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The Corporation has adopted the provisions of SAB 105. Since the provisions of SAB 105 affect only the timing of the recognition of mortgage banking income, management does not anticipate that this guidance will have a material adverse effect on either the Corporation's consolidated financial position or consolidated results of operations. Emerging Issues Task Force Issue No. ("EITF") 03-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of "other-than-temporarily impaired" and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115") and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the ability and intent to hold investments in instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired. On September 30, 2004, FASB decided to delay the effective date for the measurement and recognition guidance contained in Issue 03-1. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure guidance in Issue 03-1 was not delayed. During 2004, the Corporation recorded an other-than-temporary impairment charge in accordance with EIFT 03-1 and FAS 115 in connection with its investments in FHLMC and FNMA perpetual preferred stock. 41 EITF No. 03-16, "Accounting for Investments in Limited Liability Companies was ratified by the Board and is effective for reporting periods beginning after June 15, 2004." APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock," prescribes the accounting for investments in common stock of corporations that are not consolidated. AICPA Accounting Interpretation 2, "Investments in Partnerships Ventures," of Opinion 18, indicates that "many of the provisions of the Opinion would be appropriate in accounting" for partnerships. In EITF Abstracts, Topic No. D-46, "Accounting for Limited Partnership Investments," the SEC staff clarified its view that investments of more than 3 to 5 percent are considered to be more than minor and, therefore, should be accounted for using the equity method. Limited liability companies ("LLCs") have characteristics of both corporations and partnerships, but are dissimilar from both in certain respects. Due to those similarities and differences, diversity in practice exists with respect to accounting for non-controlling investments in LLCs. The consensus reached was that an LLC should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a non-controlling investment should be accounted for using the cost method or the equity method of accounting. Management does not anticipate that this guidance will have a material adverse effect on either the Corporation's consolidated financial position or consolidated results of operations. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment." This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). The entity will initially measure the cost of employee services received in exchange for an award of liability instruments based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. This Statement is effective for public entities that do not file as small business issuers--as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. Under the transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or pro forma disclosures. For periods before the required effective date, entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by Statement 123. Currently, the adoption of this Statement would have no material effect on the Corporation's consolidated financial position or consolidated results of operations, as all outstanding stock options were fully vested as of December 31, 2004. 42 2. Securities: The amortized cost and estimated fair value of investments in debt and equity securities at December 31, 2004 and 2003 were as follows (in thousands):
December 31, 2004 ------------------------------------------------------------------------ Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ---------- ---------- ---------- ---------- Securities available for sale: Federal agencies $ 83,969 $ 107 $ 755 $ 83,321 Mortgage-backed 28,608 402 77 28,933 State and municipal 35,714 658 88 36,284 Corporate bonds 10,776 295 42 11,029 Equity securities: FHLB stock - restricted 2,248 - - 2,248 Federal Reserve stock - restricted 363 - - 363 FNMA & FHLMC preferred stock 3,515 - 160 3,355 Other securities 425 - - 425 ---------- ---------- ---------- ---------- Total securities available for sale 165,618 1,462 1,122 165,958 ---------- ---------- ---------- ---------- Securities held to maturity: Federal agencies 3,496 5 10 3,491 Mortgage-backed 701 36 - 737 State and municipal 18,008 860 8 18,860 ---------- ---------- ---------- ---------- Total securities held to maturity 22,205 901 18 23,088 ---------- ---------- ---------- ---------- Total securities $ 187,823 $ 2,363 $ 1,140 $ 189,046 ========== ========== ========== ==========
December 31, 2003 ------------------------------------------------------------------------ Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ---------- ---------- ---------- ---------- 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 Equity securities: FHLB stock - restricted 1,741 - - 1,741 Federal Reserve stock - restricted 363 - - 363 FNMA & FHLMC preferred stock 4,500 - 657 3,843 Other securities 425 - - 425 ---------- ---------- ---------- ---------- Total securities available for sale 169,412 2,932 968 171,376 ---------- ---------- ---------- ---------- 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 ---------- ---------- ---------- ---------- Total securities $ 205,515 $ 4,285 $ 969 $ 208,831 ========== ========== ========== ==========
The amortized cost and estimated fair value of investments in securities at December 31, 2004, 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. Mortgage-backed securities have been shown separately below (in thousands): 43
Available for Sale Held to Maturity ------------------------------ ----------------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value --------- ---------- --------- ---------- Due in one year or less $ 15,137 $ 15,184 $ 3,430 $ 3,461 Due after one year through five years 73,190 73,111 10,066 10,465 Due after five years through ten years 41,310 41,485 4,573 4,788 Due after ten years 822 854 3,435 3,637 Equity securities 6,551 6,391 - - Mortgage-backed securities 28,608 28,933 701 737 --------- --------- -------- -------- $ 165,618 $ 165,958 $ 22,205 $ 23,088 ========= ========= ======== ========
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, 2004, 2003 and 2002 are as follows (in thousands): 2004 2003 2002 ------ ------ ------ Realized gains $ 167 $ 115 $ 39 Realized (losses) $ (10) $ - $ - Proceeds from the maturities, payments, calls, and sales of securities available for sale were $70,375,000, $74,947,000 and $55,466,000 in 2004, 2003 and 2002. Proceeds from the maturities, payments, and calls of securities held to maturity were $17,675,000, $5,678,000 and $6,197,000 in 2004, 2003 and 2002. Net gains from the sale of securities available for sale were $141,000 and gains from the call of securities prior to maturity were $16,000 in 2004. Gains from the sale of securities available for sale were $85,000 and gains from the call of securities prior to maturity were $30,000 in 2003. Gains from the sale of securities available for sale were $3,000 and gains from the call of securities prior to maturity were $36,000 in 2002. Securities with a carrying value of approximately $67,692,000 and $65,953,000 at December 31, 2004 and 2003 were pledged to secure public deposits, repurchase agreements and for other purposes as required by law. Corporate bonds consist of investment grade debt securities, primarily issued by financial services companies. 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, 2004.
Less than 12 Months 12 Months or More Total --------------------- ----------------------- ---------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss -------- ---------- -------- ---------- -------- ---------- Federal agencies $ 57,916 $ 639 $ 8,880 $ 126 $ 66,796 $ 765 Mortgage-backed 9,596 74 1,358 3 10,954 77 State and municipal 7,869 89 198 7 8,067 96 Corporate bonds 1,442 42 - - 1,442 42 Preferred stock - - 3,355 160 3,355 160 -------- ---------- -------- ---------- -------- ---------- Total $ 76,823 $ 844 $ 13,791 $ 296 $ 90,614 $1,140 ======== ========== ======== ========== ======== ==========
Management evaluates securities for other-than-temporary impairment quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At December 31, 2004, the Corporation held six debt securities and two equity securities having continuous unrealized loss positions for more than twelve months. Of the six debt securities, five represented AAA-rated investments in bonds issued by FHLB, FHLMC, and FNMA. The remaining debt security represented an investment in a AAA-rated municipal bond. The unrealized losses are primarily attributable to interest rate changes. An other-than-temporary impairment charge of $985,000 on $4,500,000 of Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") perpetual preferred stock was charged to earnings in the fourth quarter of 2004. This was done after a thorough analysis of recent public disclosures about FHLMC and FNMA, the length of time the market value of the 44 securities had been less than cost, the amount of the loss in comparison with the amortized cost, the results of an impairment analysis recently completed by an outside party, and accounting interpretations. After the impairment charge, the total amount of continuous unrealized losses for more than twelve months on these two securities was $160,000, which is primarily attributable to interest rate changes. The Corporation has the intent and ability to hold these securities for the time necessary to recover the amortized cost. 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 ======== ========== ======== ========== ======== ==========
3. Loans and Allowance for Loan Losses: Loans, excluding loans held for sale, at December 31, 2004 and 2003 were comprised of the following (in thousands):
2004 2003 --------- --------- Real Estate loans Construction and land development $ 34,101 $ 12,790 Secured by farmland 2,853 3,430 Secured by 1 - 4 family residential properties 134,292 136,229 Secured by multi-family (5 or more) residential properties 9,033 6,801 Secured by nonfarm, nonresidential properties 135,767 126,164 Loans to farmers 1,442 1,618 Commercial and industrial loans 70,336 91,419 Consumer loans 15,248 23,581 Loans for nonrated industrial development obligations 4,069 4,077 Deposit overdrafts 128 136 --------- --------- Loans, net of unearned income $ 407,269 $ 406,245 ========= =========
The following is a summary of information pertaining to impaired loans (in thousands): 2004 2003 ------- ------- Impaired loans for which an allowance has been provided $ 6,310 $ 2,548 Impaired loans for which no allowance has been provided - - ------- ------- Total impaired loans $ 6,310 $ 2,548 ======= ======= Allowance provided for impaired loans, included in the allowance for loan losses $ 3,151 $ 521 ======= ======= 2004 2003 2002 ------- ------- ------- Average balance in impaired loans $ 3,527 $ 1,385 $ 158 ======= ======= ======= Interest income recognized $ 71 $ - $ - ======= ======= ======= No additional funds are committed to be advanced in connection with impaired loans. 45 Nonaccrual loans excluded from impaired loan disclosure amounted to $2,810,000 and $714,000 at December 31, 2004 and 2003, respectively. If interest on nonaccrual loans had been accrued, such income would have approximated $146,000, $45,000 and $20,000 for 2004, 2003 and 2002, respectively. Loans past due 90 days and still accruing interest amounted to $0, $53,000, and $239,000 as of December 31, 2004, 2003 and 2002, respectively. Foreclosed real estate was $221,000 at December 31, 2004 and $303,000 at December 31, 2003 and is recorded as other assets on the Consolidated Balance Sheets. The loan portfolio is concentrated primarily in the immediate geographic region. The Corporation had $316.0 million of loans secured by real estate at December 31, 2004. There were no concentrations of loans to any individual, group of individuals, business, or industry that exceeded 10% of total loans at December 31, 2004. An analysis of the allowance for loan losses is as follows (in thousands): 2004 2003 2002 -------- -------- -------- Balance, beginning of year $ 5,292 $ 5,622 $ 5,334 Provision for loan losses 3,095 920 873 Charge-offs (655) (1,457) (740) Recoveries 250 207 155 -------- -------- -------- Balance, end of year $ 7,982 $ 5,292 $ 5,622 ======== ======== ======== 4. Premises and Equipment: Major classifications of premises and equipment are summarized as follows (in thousands): December 31 ----------------------- 2004 2003 --------- --------- Land $ 1,725 $ 1,603 Buildings 8,265 7,670 Leasehold Improvements 351 878 Equipment 9,537 9,374 --------- --------- 19,878 19,525 Accumulated Depreciation (12,361) (11,807) --------- --------- Bank Premises and Equipment, net $ 7,517 $ 7,718 ========= ========= Depreciation expense for the years ended December 31, 2004, 2003 and 2002 amounted to $966,000, $1,135,000 and $1,144,000, respectively. 5. Deposits: The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2004 and 2003 was $53,154,000 and $61,367,000 respectively. At December 31, 2004, the scheduled maturities of CDs are as follows (in thousands): 2005 $ 123,766 2006 34,282 2007 17,003 2008 11,333 2009 7,581 Thereafter 11 --------- $ 193,976 ========= 46 6. Borrowings: Short-term borrowings consist of the following at December 31, 2004 and 2003 (in thousands): 2004 2003 --------- --------- Repurchase agreements $ 38,945 $ 47,035 Short-term FHLB borrowings 1,950 - --------- --------- Total $ 40,895 $ 47,035 ========= ========= Weighted interest rate 1.50% 1.05% Average for the year ended December 31: Outstanding $ 47,567 $ 41,168 Interest rate 1.13% 1.21% Maximum month-end outstanding $ 51,026 $ 49,362 Short-term borrowings consist of repurchase agreements and overnight borrowings from the Federal Home Loan Bank of Atlanta ("FHLB"). 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 FHLB, the Bank provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans and home equity lines of credit (HELOCs). In addition, the Bank pledges as collateral its capital stock in the FHLB and deposits with the FHLB. As of December 31, 2004, $85,346,000 1-4 family residential mortgage loans were pledged under the blanket floating lien agreement. At December 31, 2004 and 2003, fixed-rate long term advances (in thousands) mature as follows:
Weighted Weighted Due by 2004 Average Due by 2003 Average December 31 Advance Amount Rate December 31 Advance Amount Rate ----------- -------------- -------- ----------- -------------- -------- 2005 $ 2,000,000 3.53% 2004 $ 3,000,000 2.67% 2006 2,000,000 4.08 2005 2,000,000 3.53 2007 1,000,000 4.33 2006 2,000,000 4.08 2008 8,000,000 5.25 2007 1,000,000 4.33 2009 5,000,000 5.26 2008 8,000,000 5.25 2014 1,387,500 3.78 2009 5,000,000 5.26 ------------ ------------ $ 19,387,500 4.80% $ 21,000,000 4.56% ============ ============
All of the above advances are at fixed rates; however at December 31, 2004, $13,000,000 of convertible advances are included in the table whereby the FHLB 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 Corporation has the option to repay these advances if the FHLB converts the interest rate. These advances are included in the year in which they mature. 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 2004, 2003 and 2002 were $6.40, $9.30, and $8.78, respectively. The estimated fair value of each option granted is calculated using the Black-Scholes option-pricing model. The weighted-average assumptions used in the model were a dividend yield of 3.23% in 2004; expected life of 6.82 years in 2004 and 5.00 years in 2003 and 2002; expected stock volatility of 31.08%, 34.58%, and 36.76% in years 2004, 2003, and 2002, respectively; and a risk free interest rate of 3.89%, 3.21%, and 4.08% in 2004, 2003, and 2002, respectively. At December 31, 2004, and 2003, the Corporation had 8,472 shares and 54,544 shares, respectively, of its authorized common stock reserved for its option plan. The options have a maximum term of ten years from the date of the option grant. All options were fully vested as December 31, 2004. 47 A summary of stock option transactions under the plan follows: Option Wtd. Avg. Shares Exercise Price --------- -------------- Outstanding at December 31, 2001 151,450 $15.47 Granted 35,700 22.58 Exercised (3,960) 15.47 Forfeited (800) 14.37 --------- ------ Outstanding at December 31, 2002 182,390 16.87 Granted 46,450 26.01 Exercised (4,603) 16.51 Forfeited (200) 14.00 --------- ------ Outstanding at December 31, 2003 224,037 18.77 Granted 55,800 24.22 Exercised (20,713) 15.72 Forfeited (9,728) 25.49 --------- ------ Outstanding at December 31, 2004 249,396 $19.98 ========= The following table summarizes information related to stock options outstanding on December 31, 2004: Weighted- Average Weighted- Number of Remaining Average Number of Range of Outstanding Contractual Exercise Options Exercise Prices Options Life Price Exercisable --------------- ----------- ----------- --------- ----------- $13.38 to 15.00 62,014 4.1 yrs $ 13.73 62,014 15.01 to 20.00 79,032 5.0 17.89 79,032 20.01 to 25.00 59,800 9.8 24.21 59,800 25.01 to 26.20 48,550 8.7 26.18 48,550 ------- ------- 249,396 6.7 yrs $ 19.98 249,396 ======= ======= 8. Income Taxes: The components of the Corporation's net deferred tax assets as of December 31, 2004 and December 31, 2003, were as follows (in thousands): 2004 2003 ------- ------- Deferred tax assets: Allowance for loan losses $ 2,714 $ 1,799 Deferred compensation 243 250 Core deposit intangible 456 405 Preferred stock impairment 335 - Other 66 22 ------- ------- Total deferred tax assets 3,814 2,476 ------- ------- Deferred tax liabilities: Depreciation 483 414 Accretion of discounts on securities 17 18 Prepaid pension 491 506 Net unrealized gains on securities 116 668 Other 126 150 ------- ------- Total deferred tax liabilities 1,233 1,756 ------- ------- Net deferred tax assets $ 2,581 $ 720 ======= ======= The provision for income taxes consists of the following (in thousands): 2004 2003 2002 -------- -------- -------- Taxes currently payable $ 4,341 $ 3,519 $ 3,870 Deferred tax expense (benefit) (1,309) 395 48 -------- -------- -------- $ 3,032 $ 3,914 $ 3,918 ======== ======== ======== 48 The effective tax rates differ from the statutory federal income tax rates due to the following items: 2004 2003 2002 -------- -------- -------- Federal statutory rate 34.1 % 34.3 % 34.2 % Nontaxable interest income (6.6) (5.0) (4.9) Other - (0.1) - -------- -------- -------- 27.5 % 29.2 % 29.3 % ======== ======== ======== 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 potential dilutive common stock. Potential dilutive common stock had no effect on income available to common shareholders.
2004 2003 2002 ---------------------------- -------------------------- ---------------------------- Per Share Per Share Per Share Shares Amount Shares Amount Shares Amount -------------- ------------- ------------ ------------- ------------- -------------- Basic earnings per share 5,591,839 $ 1.43 5,702,625 $ 1.67 5,800,302 $ 1.63 Effect of dilutive securities, stock options 50,217 61,502 50,047 -------------- ------------ ------------- Dilutied earnings per share 5,642,056 $ 1.42 5,764,127 $ 1.65 5,850,349 $ 1.62 ============== ============ =============
Stock options on common stock which were not included in computing diluted EPS in 2004, 2003, and 2002 because their effects were antidilutive averaged 4,685 shares, 453 shares, and 82 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, 2004 and 2003, the following financial instruments were outstanding whose contract amounts represent credit risk: 2004 2003 ------------- ------------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 130,862,000 $ 124,905,000 Standby letters of credit 4,849,000 3,477,000 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 holds collateral supporting those commitments if deemed necessary. 49 At December 31, 2004, ANB Mortgage Corp. had locked-rate commitments to originate mortgage loans amounting to approximately $1,847,000 and loans held for sale of $971,000. ANB Mortgage Corp. has entered into commitments, on a best-effort basis, to sell loans of approximately $2,818,000. Risks arise from the possible inability of counterparties to meet the terms of their contracts. ANB Mortgage Corp. does not expect any counterparties to fail to meet its obligations. The Corporation does not have any off-balance sheet subsidiaries or special purpose entities. There were no commitments to purchase securities at December 31, 2004 or December 31, 2003. Other commitments: - ------------------ The Corporation has entered into operating leases for several of its branch and ATM facilities. The minimum annual rental payments under these leases at December 31, 2004, (in thousands) are as follows: Minimum Lease Year Payments -------------------- ------------- 2005 $ 146 2006 113 2007 73 2008 59 2009 49 2010 and thereafter 36 ----- $ 476 ===== Rent expense under these leases for each of the years ended December 31, 2004, 2003, and 2002, was $146,000, $126,000, and $121,000, 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 $4,941,000 at December 31, 2004 and $3,679,000 at December 31, 2003. The Corporation originates and sells residential real estate loans to investors. Based on certain pre-defined criteria, including borrower non-payment or fraud, the Corporation may be required to repurchase loans back from the investor. Since the inception of the Corporation's secondary market mortgage loan program, no loans have been repurchased. 11. Related Party Transactions: In the ordinary course of business, the Corporation's directors provide the Corporation with substantial amounts of business, and some are among its largest depositors and borrowers. Management believes that all such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans to similar, unrelated borrowers, and do not involve more than a normal risk of collectibility or present other unfavorable features. As of December 31, 2004, none of these loans were restructured, past due, or on nonaccrual status. An analysis of these loans for 2004 is as follows (in thousands): Balance, beginning of year $ 18,811 Additions 24,504 Repayments (20,783) --------- Balance, end of year $ 22,532 ========= 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 Corporation 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, 2004, 2003 and 2002 (in thousands):
2004 2003 2002 --------- --------- --------- Change in benefit obligation: Benefit obligation at beginning of year $ 5,710 $ 4,875 $ 4,837 Service cost 432 377 319 Interest cost 361 330 336 Plan amendments - 17 - Actuarial loss 257 155 274 Benefits paid (132) (44) (891) --------- --------- --------- Benefit obligation at end of year $ 6,628 $ 5,710 $ 4,875 ========= ========= ========= Accumulated benefit obligation, end of year $ 4,958 $ 4,241 $ 3,546 Change in plan assets: Fair value of plan assets at beginning of year $ 5,652 $ 3,431 $ 4,360 Actual return on plan assets 399 587 (692) Employer contributions 357 1,678 654 Benefits paid (132) (44) (891) --------- --------- --------- Fair value of plan assets at end of year $ 6,276 $ 5,652 $ 3,431 ========= ========= ========= Deferred asset (gain) loss $ (54) $ (298) $ 1,037 Prepaid pension cost: Funded status $ (352) $ (58) $ (1,445) Unrecognized net actuarial loss 1,832 1,603 1,871 Unrecognized net obligation at transition - - (5) Unrecognized prior service cost (35) (57) (96) --------- --------- --------- Prepaid benefit cost included in other assets $ 1,445 $ 1,488 $ 325 ========= ========= =========
Major assumptions and net periodic pension cost include the following:
2004 2003 2002 --------- --------- --------- Components of net periodic benefit cost: Service cost $ 432 $ 377 $ 319 Interest cost 361 330 337 Expected return on plan assets (452) (289) (346) Amortization of prior service cost (23) (22) (24) Amortization of net obligation at transition - (5) (12) Recognized net actuarial gain 82 125 7 --------- --------- --------- Net periodic benefit cost $ 400 $ 516 $ 281 ========= ========= ========= Amounts recognized in the statement of financial position: Prepaid asset $ 1,445 $ 1,488 $ 325 Accrued benefit liability - - (441) Deferred income tax benefit - - 150 Accumulated other comprehensive income, net - - 291 --------- --------- --------- Net amount recognized $ 1,445 $ 1,488 $ 325 ========= ========= ========= 2004 2003 2002 --------- --------- --------- Weighted-average assumptions for benefit obligations: Discount rate Pre-retirement 6.00% 6.50% 6.75% Post-retirement 6.00% 6.00% 6.00% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 4.00% 4.00% 4.00%
51 2004 2003 2002 --------- --------- --------- Weighted-average assumptions for net periodic benefit cost: Discount rate Pre-retirement 6.50% 6.75% 7.00% Post-retirement 6.00% 6.00% 6.00% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 4.00% 4.00% 4.00%
The Corporation 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 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 to 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). Below is a description of the plan's assets. The plan's weighted-average asset allocations at October 31, 2004, and October 31, 2003, by asset category are as follows: Asset Category 2004 2003 -------------- ------- ------- Fixed Income 25.8% 22.4% Equity 72.6 77.5 Other 1.6 .1 ------- ------- 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 Corporation's Trust and Investment Services Division. No derivatives are used to manage the assets. Equity securities do not include holdings in the Corporation. Projected benefit payments for years 2005 to 2014 are as follows (in thousands): Year Amount ---- ------ 2005 $ - 2006 111 2007 113 2008 163 2009 193 2010-2014 2,198 The Corporation's best estimate of the maximum contribution expected to be paid to the plan during 2005 is $333,000. A 401(k) savings plan was adopted in 1995 that covers substantially all full-time employees of the Corporation. The Corporation matches a portion of the contribution made by employee participants after at least one year of service. The Corporation contributed $156,000, $151,000 and $136,000 to the 401(k) plan in 2004, 2003 and 2002, respectively. These amounts are included in pension and other employee benefits expense for the respective years. In 1982, the Board of Directors of the Corporation 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 52 retirement. The liabilities under these agreements are being accrued over the officers' remaining periods 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 $55,000, $84,000 and $77,000 for years 2004, 2003 and 2002, respectively. 13. Fair Value of Financial Instruments: The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107, "Disclosures About Fair Value of Financial Instruments" excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation. The estimated fair values of the Corporation's assets are as follows (in thousands):
December 31, 2004 December 31, 2003 ------------------------------ ---------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------- ---------- ---------- ---------- Financial assets: Cash and due from banks $ 12,568 $ 12,568 $ 17,888 $ 17,888 Securities available for sale 165,958 165,958 171,376 171,376 Securities held to maturity 22,205 23,088 36,103 37,455 Loans held for sale 971 971 560 560 Loans, net of allowance 399,287 398,364 400,953 407,128 Accrued interest receivable 3,786 3,786 4,123 4,123 Financial liabilities: Deposits $ 485,272 $ 484,739 $ 501,688 $ 503,409 Repurchase agreements 38,945 38,945 47,035 47,035 Other borrowings 21,338 22,101 21,000 22,328 Accrued interest payable 698 698 835 835 Off balance sheet instruments: Commitments to extend credit $ - $ - $ - $ - Standby letters of credit - 48 - 35 Rate lock commitments - - - -
The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments: Cash and cash equivalents. The carrying amount is a reasonable estimate of fair value. Securities. Fair values are based on quoted market prices or dealer quotes. 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. Accrued interest receivable. The carrying amount is a reasonable estimate of fair value. 53 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 value 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 interest rates will change) in its normal operations. As a result, the fair values of the Corporation's financial instruments will change when interest rates 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 also includes 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, 2004, the Corporation's Tier I and total capital ratios were 15.48% and 16.73%, respectively. At December 31, 2003, these ratios were 14.85% and 15.99%, respectively. The ratios for both years were well in excess of the regulatory requirements. Management believes, as of December 31, 2004 and 2003, that the Corporation and the Bank met 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, $6,855,000 as of December 31, 2004. 54 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, 2004 Total Capital Corporation $ 75,504 16.73% $ 36,097 >8.0% Bank 73,724 16.36% 36,050 >8.0% $ 45,063 >10.0% Tier I Capital Corporation 69,842 15.48% 18,048 >4.0% Bank 68,747 15.26% 18,025 >4.0% 27,038 >6.0% Leverage Capital Corporation 69,842 11.02% 19,022 >3.0% Bank 68,747 10.86% 18,993 >3.0% 31,654 >5.0% 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%
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. 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, 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 secondary mortgage banking and ANB Services Corp. performs retail investment and insurance sales. Trust and investment services include estate planning, trust account administration, and investment management. Investment management services include purchasing equity, fixed income and mutual fund investments for customer accounts. The trust and investment services division receives fees for investment and administrative services. 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 2004, 2003 and 2002 is shown in the following table (in thousands). The "Other" column includes corporate 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. 55
2004 ---------------------------------------------------------------------- Trust and Community Investment Intersegment Banking Services Other Eliminations Total --------- ----------- ---------- ------------ --------- Interest income $ 30,120 $ - $ 53 $ (53) $ 30,120 Interest expense 7,479 - 53 (53) 7,479 Noninterest income - external customers 2,712 2,976 822 - 6,510 Noninterest income - internal customers - 48 - (48) - Operating income before income taxes 9,321 1,694 30 - 11,045 Depreciation and amortization 1,389 21 6 - 1,416 Total assets 618,325 - 2,444 (1,704) 619,065 Capital expenditures 790 29 - - 819
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 Noninterest income - external customers 3,314 2,523 834 - 6,671 Noninterest 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 Noninterest income - external customers 2,564 2,516 632 - 5,712 Noninterest 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
56 16. Parent Corporation Financial Information: Condensed Parent Corporation financial information is as follows (in thousands): As of December 31 ----------------------- 2004 2003 -------- --------- Condensed Balance Sheets ------------------------ Assets Cash $ 802 $ 1,397 Investment in subsidiary 69,562 69,912 Other assets 636 622 -------- --------- Total Assets $ 71,000 $ 71,931 ======== ========= Liabilities $ - $ - Shareholders' equity 71,000 71,931 -------- -------- Total Liabilities and Shareholders' Equity $ 71,000 $ 71,931 ======== ======== For the Year Ended December 31 -------------------------------- 2004 2003 2002 -------- -------- -------- Condensed Statements of Income ------------------------------ Dividends from subsidiary $ 7,400 $ 7,078 $ 6,000 Income 15 4 10 Expenses 179 159 145 Income taxes (benefit) (56) (52) - -------- -------- -------- Income before equity in undistributed earnings of subsidiary 7,292 6,975 5,865 Equity in undistributed earnings of subsidiary 721 2,538 3,596 -------- -------- -------- Net Income $ 8,013 $ 9,513 $ 9,461 ======== ======== ======== For the Year Ended December 31 -------------------------------- 2004 2003 2002 -------- -------- -------- Condensed Statements of Cash Flows ---------------------------------- Cash provided by dividends received from subsidiary $ 7,400 $ 7,078 $ 6,000 Cash used for payment of dividends (4,411) (4,272) (4,117) Cash used for repurchase of stock (3,787) (3,128) (1,049) Proceeds from exercise of options 326 76 61 Other (123) (139) (239) -------- -------- -------- Net (decrease) increase in cash $ (595) $ (385) $ 656 ======== ======== ======== 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, 2005 AMERICAN NATIONAL BANKSHARES INC. By: /s/Charles H. Majors - ------------------------------ President and Chief Executive 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, 2005. /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/Claude B. Owen, Jr. Director - ------------------------------ Claude B. Owen, Jr. /s/Neal A. Petrovich - ------------------------------ Senior Vice President and Neal A. Petrovich Chief Financial Officer 58 PART IV Item 15. Exhibits and Financial Statements Schedules (a)(1) Financial Statements (See Item 8 for reference) (a)(3) Exhibits EXHIBIT INDEX -------------
Exhibit # Description Location - ------- -------------------------------------------------------------- ----------------------- 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 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 10.4 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 10.5 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 10.6 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 10.7 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 10.8 Agreement between American National Bankshares Inc., American National Bank and Trust Company and R. Helm Dobbins dated June 17, 2003 Filed herewith 10.9 Agreement between American National Bankshares Inc., American National Bank and Trust Company and Neal A. Petrovich dated June 15, 2004 Filed herewith 11. Refer to EPS calculation in the Notes to Financial Statements Filed herewith 21.1 Subsidiaries of the registrant Filed herewith 31.1 Section 302 Certification of Charles H. Majors, President and CEO Filed herewith 31.2 Section 302 Certification of Neal A. Petrovich, Senior Vice President and CFO Filed herewith 32.1 Section 906 Certification of Charles H. Majors, President and CEO Filed herewith 32.2 Section 906 Certification of Neal A. Petrovich, Senior Vice President and CFO Filed herewith
59 99.2 American National Bankshares Inc. Dividend Reinvestment Exhibit 99 on Form S-3 Plan dated August 19, 1997 filed August 20, 1997
60 EX-21 2 ex2110k2004.txt EXHIBIT 21 10K 2004 Exhibit 21.1 Subsidiaries of the Registrant Registrant: American National Bankshares Inc. Chartered under the laws of the United States Subsidiary of American National Bankshares Inc.: American National Bank and Trust Company Incorporated under the laws of the Commonwealth of Virginia Subsidiaries of American National Bank and Trust Company: ANB Services Corporation. Doing business as ANB Investor Services and ANB Insurance Services Incorporated under the laws of the Commonwealth of Virginia ANB Mortgage Corp. Incorporated under the laws of the Commonwealth of Virginia EX-31 3 ex3110k2004.txt EXHIBITS 31 10K 2004 Exhibit 31.1 CERTIFICATIONS -------------- 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and 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 report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) 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 15, 2005 /s/Charles H. Majors - ------------------------------------- Charles H. Majors, President and Chief Executive Officer Exhibit 31.2 CERTIFICATIONS -------------- I, Neal A. Petrovich, 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and 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 report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) 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 15, 2005 /s/ Neal A. Petrovich - ------------------------- Neal A. Petrovich, Senior Vice President and Chief Financial Officer EX-32 4 ex3210k2004.txt EXHIBITS 32 10K 2004 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 "Corporation") for the period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Charles H. Majors, President and Chief Executive Officer of the Corporation, 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 Corporation. /s/Charles H. Majors - ------------------------------------- Charles H. Majors President and Chief Executive Officer March 15, 2005 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 "Corporation") for the period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Neal A. Petrovich, Senior Vice President and Chief Financial Officer of the Corporation, 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 Corporation. /s/Neal A. Petrovich - ------------------------- Neal A. Petrovich Senior Vice President and Chief Financial Officer March 15, 2005 EX-10 5 ex10s10k2004.txt EXHIBITS 10 10K 2004 Exhibit 10.1 EXECUTIVE SEVERANCE AGREEMENT ----------------------------- THIS EXECUTIVE SEVERANCE AGREEMENT is between AMERICAN NATIONAL BANKSHARES INC., a Virginia corporation (the "Parent"), AMERICAN NATIONAL BANK AND TRUST COMPANY, a national banking association, (the "Company") and R. HELM DOBBINS ("Executive"). WHEREAS, the Company recognizes that there is a possibility of a Change in Control of the Parent, the Company or both; and WHEREAS, the Parent and the Company recognize that the mere possibility of a Change in Control of the Parent or the Company may create uncertainty on the part of senior management or a distraction of senior management from its day-to-day operating responsibilities; and WHEREAS, the Parent and the Company recognize that outstanding management is essential to advancing the interests of the Parent and the Company and their shareholders and that the Parent and the Company can better recruit and retain outstanding management by providing certain assurances in the event of a Change in Control; and WHEREAS, in the event of a Change in Control of the Parent, the Company or both, the best interests of the Parent and the Company and their shareholders require a continuity of the Parent's and the Company's business with a minimum of disruption; NOW THEREFORE, in consideration of the foregoing premises and the mutual covenants contained herein, the Parent, the Company and the Executive agree as follows: 1. Effective Date. The Effective Date of this Agreement is June 17, 2003. -------------- 2. Term of Agreement. The Term of this Agreement shall begin on a Control ----------------- Change Date and end on the earlier of (i) the day before the third anniversary of the Control Change Date and (ii) the date that the Executive attains age sixty-five (65). 3. Minimum Cash Compensation. During the Term of this Agreement, the total ------------------------- amount payable to the Executive by the Parent and the Company as base salary, "profit sharing" bonus and "incentive compensation" bonus, on an annualized basis, shall not be less than the amounts prescribed below: (a) The Executive's total annual base salary from the Parent and the Company shall not be less than the annualized rate of total base salary payable to the Executive immediately before the Control Change Date. (b) The total annualized "profit sharing" bonus from the Parent and the Company, expressed as a percentage of the Executive's then total base salary, shall not be less than the "profit sharing" bonus, expressed as a percentage of the Executive's then total base salary, payable to the Executive for the four quarters immediately preceding the Control Change Date. (c) The total annualized "incentive compensation" bonus from the Parent and the Company, expressed as a percentage of the Executive's then total base salary, shall not be less than the "incentive compensation" bonus, expressed as a percentage of the Executive's then total base salary, payable to the Executive for the calendar year ending immediately preceding the Control Change Date. 4. Termination Without Cause. This paragraph 4 describes the amounts ------------------------- payable to the Executive if the Parent and the Company terminates the Executive's employment without Cause during the Term of this Agreement. (a) If such termination is effective before the first anniversary of the Control Change Date, the Executive shall be entitled to receive the Termination Benefits during the period beginning with the Executive's termination of employment and ending on the second anniversary of the Control Change Date or the last day of the Term of this Agreement, whichever occurs first. (b) If such termination is effective on or after the first anniversary of the Control Change Date, the Executive shall be entitled to receive the Termination Benefits during the period beginning with the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. 5. Executive's Resignation. This paragraph 5 describes the amounts payable ----------------------- to the Executive upon his resignation from the employ of the Parent and the Company during the Term of this Agreement. (a) During the period beginning on the Control Change Date and ending on the last day of the third month ending after the Control Change Date, the Executive may resign from the employ of both the Parent and the Company if (i) the Parent or the Company breaches the obligation set forth in paragraph 3 or (ii) the Parent or the Company notifies the Executive that he will be required to relocate his office more than thirty (30) miles from Danville, Virginia. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. (b) During the period beginning on the first day of the fourth month beginning after the Control Change Date and ending on the first anniversary of the Control Change Date, the Executive may resign from the employ of both the Parent and the Company, for any reason or no reason. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the 2 Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. (c) During the period beginning on the first anniversary of the Control Change Date and ending on the last day of the Term of this Agreement, the Executive may resign from the employ of both the Parent and the Company if (i) the Parent or the Company breaches the obligation set forth in paragraph 3, (ii) the Parent or the Company notifies the Executive that he will be required to relocate his office more than thirty (30) miles from Danville, Virginia or (iii) the Executive's duties, title or responsibilities with respect to the Parent or the Company are reduced from the duties, title or responsibilities assigned to the Executive as of the first anniversary of the Control Change Date. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. 6. Maximum Benefit. No amounts will be payable and no benefits will be --------------- provided under this Agreement to the extent that such payments or benefits, together with other payments or benefits under other plans, agreements or arrangements, would make the Executive liable for the payment of an excise tax under Section 4999 of the Internal Revenue Code of 1986, as amended, or any successor provision. The amounts otherwise payable and the benefits otherwise to be provided under this Agreement shall be reduced to the extent necessary to avoid the imposition of such excise tax liability; provided, however, that the Executive shall have the right to direct which payments or benefits under this Agreement shall be reduced in order to avoid any such excise tax liability. 7. Cause. The Parent and the Company shall be deemed to have "Cause" to ----- terminate the Executive's employment under this Agreement if the Parent or the Company determines that the Executive (i) has failed or refused to perform a material duty of his position, (ii) is guilty of personal dishonesty, gross incompetence, willful misconduct, a breach of fiduciary duty involving personal profit, willful violation of any law, rule or regulation (other than traffic violations or similar offenses), unethical business practices in connection with the Parent's or the Company's business, misappropriation of the Parent's or the Company's assets (determined on a reasonable basis), or is subject to a final cease-and-desist order, or has been convicted of a felony or a misdemeanor involving moral turpitude or (iii) is guilty of a material breach of any employment agreement between the Parent and the Executive of the Company and the Executive. 8. Change in Control. A "Change in Control" of the Parent or the Company ----------------- occurs if: (a) Any person, including a "group" (as defined in section 13(d)(3) of the Securities Exchange Act of 1934, as amended, as in effect on the Effective Date (the "Exchange Act") is or becomes, directly or indirectly, the owner or 3 beneficial owner of Parent or Company securities (other than as a result of an issuance of securities initiated by the Parent or the Company, a tender offer initiated by the Parent or the Company or open market purchases approved by the Parent's or the Company's Board of Directors (the "Board"), as long as the majority of the Parent's or the Company's Board approving the purchases are directors at the time the purchases are made), having more than fifty (50%) of the combined voting power of the then outstanding Parent or Company securities that may be cast for the election of the Parent's or the Company's directors; or (b) During any period of twenty-four (24) consecutive months, individuals who at the beginning of such period constitute the Parent's or the Company's Board and any new director (other than a director designated by a person who has entered into an agreement with the Parent or the Company to effect a transaction described in subparagraphs 8(a), 8(c) or 8(d) or any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act or other actual or threatened solicitation of proxies or consents) whose election by the Parent or the Board or nomination for election by the Parent's or the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of such period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority of the Parent's or the Company Board; or (c) There is consummated a reorganization, merger, or consolidation involving the Parent or the Company that requires the approval of the Parent's or the Company's shareholders, other than a reorganization, merger or consolidation with respect to which all or substantially all of the individuals and entities who were beneficial owners, immediately prior to such reorganization, merger or consolidation, of the combined voting power of the Parent's or the Company's then outstanding securities beneficially owned, directly or indirectly, immediately after such reorganization, merger or consolidation, more than fifty percent (50%) of the combined voting power of the securities of the corporation resulting from such reorganization, merger or consolidation in substantially the same proportions as their respective ownership, immediately prior to such reorganizations, merger or consolidation, of the combined voting power of the Parent's or the Company's securities; or (d) The Parent's or the Company's shareholders approve (i) the sale or disposition by the Parent or the Company (other than to a subsidiary of the Parent or the Company) of more than fifty percent (50%) of the assets of the Parent or the Company (including a sale or disposition that is effected through condemnation proceedings) or (ii) a complete liquidation or dissolution of the Parent or the Company. 9. Control Change Date. A "Control Change Date" is the date on which a ------------------- Change in Control of the Parent or the Company occurs. If a Change in Control of the Parent or the Company occurs as the result of a series of transactions or events, the Control Change Date is the date of the last of the transactions or events in the series. 4 10. Termination Benefits. The "Termination Benefits" payable in accordance -------------------- with paragraphs 4 and 5 are the following payments and benefits: (a) Continued payment of the Executive's base salary for the applicable period specified in paragraph 4 or 5 at the rate in effect on the date of the Executive's termination of employment (but not less than the rate of base salary required under paragraph 3). (b) Payment each month during the applicable period specified in paragraph 4 or 5 of a pro rata amount of the annualized "profit sharing" bonus in the amount required under paragraph 3. (c) Payment each month during the applicable period specified in paragraph 4 or 5 of a pro rata amount of the annualized "incentive compensation" bonus in the amount required under paragraph 3. (d) Continued participation in the Parent's and the Company's health, dental, vision, long-term disability and life insurance programs or plans for the applicable period specified in paragraph 4 or 5 on the same terms and conditions as applied to the Executive immediately before his termination of employment; provided, however, that if such coverage cannot be provided under the terms of a Parent or Company program or plan, the Parent or the Company shall obtain separate insurance coverage that provides the Executive the same or comparable benefits and the portion of the insurance premium charged to the Executive for such separate insurance coverage shall not exceed the Executive's cost for such coverage under the Parent's and the Company's program or plan immediately before this termination of employment. (e) A single sum payment equal to the difference between (i) the present value of the benefits that the Executive would have accrued under the Parent's or the Company's defined benefit pension plan based on his actual service and assuming continued service during the applicable period specified in paragraph 4 or 5 and (ii) the present value of the benefit payable to the Executive under the Parent's or the Company's defined benefit pension plan. The amount of the payment required under the preceding sentence shall be calculated by the actuary of the Parent's or the Company's defined benefit pension plan using the actuarial assumptions and methods in effect for purposes of determining the funded status of such plan and shall assume that amounts payable under this Agreement are recognized as compensation for purposes of such plan. 11. Successors. This Agreement shall inure to the benefit of, and be ---------- enforceable by, the Executive's legal representatives and heirs. This Agreement shall inure to the benefit of, and be binding upon, the Parent and the Company and their successors and assigns. The Parent and the Company shall require any successor to the Parent or the Company (whether direct or indirect, by merger, purchase, consolidation or otherwise) to all or substantially all of the business or assets of the Parent or the Company to assume expressly and agree to perform the Parent or the Company's obligations under this Agreement. References in this Agreement to the "Parent" and to the "Company" include the Parent and 5 the Company as defined above and any successor to their business or assets that is obligated to perform this Agreement by operation or law or otherwise. 12. Entire Agreement. This Agreement sets forth the entire agreement of the ---------------- parties with respect to the termination of the Executive's employment on or after a Control Change Date and supersedes all prior agreements, arrangements and understandings with respect thereto between the Parent, the Company and the Executive. No modification, amendment or termination of this Agreement, nor any waiver of its provisions, shall be valid or enforceable unless in writing and signed by both parties. 13. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which will be deemed an original and all of which constitute an instrument. 14. Headings. The headings herein are for convenience only and will not -------- affect the interpretation of this Agreement. 15. Governing Law. This Agreement will be governed by, and construed in ------------- accordance with, the laws of the Commonwealth of Virginia (other than its choice of law provisions to the extent that they would require the application of the laws of another State). WITNESS, the following signatures as of the indicated dates. AMERICAN NATIONAL BANKSHARES INC. Dated: June 17, 2003 By: /s/Charles H. Majors ------------- -------------------------------------- Title: President & Chief Executive Officer ----------------------------------- AMERICAN NATIONAL BANK AND TRUST COMPANY Dated: June 17, 2003 By: /s/Charles H. Majors ------------- -------------------------------------- Title: President & Chief Executive Officer ----------------------------------- R. HELM DOBBINS Dated: June 17, 2003 By: /s/R. Helm Dobbins ------------- -------------------------------------- 6 Exhibit 10.2 EXECUTIVE SEVERANCE AGREEMENT ----------------------------- THIS EXECUTIVE SEVERANCE AGREEMENT is between AMERICAN NATIONAL BANKSHARES INC., a Virginia corporation (the "Parent"), AMERICAN NATIONAL BANK AND TRUST COMPANY, a national banking association, (the "Company") and NEAL A. PETROVICH ("Executive"). WHEREAS, the Company recognizes that there is a possibility of a Change in Control of the Parent, the Company or both; and WHEREAS, the Parent and the Company recognize that the mere possibility of a Change in Control of the Parent or the Company may create uncertainty on the part of senior management or a distraction of senior management from its day-to-day operating responsibilities; and WHEREAS, the Parent and the Company recognize that outstanding management is essential to advancing the interests of the Parent and the Company and their shareholders and that the Parent and the Company can better recruit and retain outstanding management by providing certain assurances in the event of a Change in Control; and WHEREAS, in the event of a Change in Control of the Parent, the Company or both, the best interests of the Parent and the Company and their shareholders require a continuity of the Parent's and the Company's business with a minimum of disruption; NOW THEREFORE, in consideration of the foregoing premises and the mutual covenants contained herein, the Parent, the Company and the Executive agree as follows: 1. Effective Date. The Effective Date of this Agreement is June 15, 2004. -------------- 2. Term of Agreement. The Term of this Agreement shall begin on a Control ----------------- Change Date and end on the earlier of (i) the day before the third anniversary of the Control Change Date and (ii) the date that the Executive attains age sixty-five (65). 3. Minimum Cash Compensation. During the Term of this Agreement, the total ------------------------- amount payable to the Executive by the Parent and the Company as base salary, "profit sharing" bonus and "incentive compensation" bonus, on an annualized basis, shall not be less than the amounts prescribed below: (a) The Executive's total annual base salary from the Parent and the Company shall not be less than the annualized rate of total base salary payable to the Executive immediately before the Control Change Date. (b) The total annualized "profit sharing" bonus from the Parent and the Company, expressed as a percentage of the Executive's then total base salary, shall not be less than the "profit sharing" bonus, expressed as a percentage of the Executive's then total base salary, payable to the Executive for the four quarters immediately preceding the Control Change Date. (c) The total annualized "incentive compensation" bonus from the Parent and the Company, expressed as a percentage of the Executive's then total base salary, shall not be less than the "incentive compensation" bonus, expressed as a percentage of the Executive's then total base salary, payable to the Executive for the calendar year ending immediately preceding the Control Change Date. 4. Termination Without Cause. This paragraph 4 describes the amounts ------------------------- payable to the Executive if the Parent and the Company terminates the Executive's employment without Cause during the Term of this Agreement. (a) If such termination is effective before the first anniversary of the Control Change Date, the Executive shall be entitled to receive the Termination Benefits during the period beginning with the Executive's termination of employment and ending on the second anniversary of the Control Change Date or the last day of the Term of this Agreement, whichever occurs first. (b) If such termination is effective on or after the first anniversary of the Control Change Date, the Executive shall be entitled to receive the Termination Benefits during the period beginning with the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. 5. Executive's Resignation. This paragraph 5 describes the amounts payable ----------------------- to the Executive upon his resignation from the employ of the Parent and the Company during the Term of this Agreement. (a) During the period beginning on the Control Change Date and ending on the last day of the third month ending after the Control Change Date, the Executive may resign from the employ of both the Parent and the Company if (i) the Parent or the Company breaches the obligation set forth in paragraph 3 or (ii) the Parent or the Company notifies the Executive that he will be required to relocate his office more than thirty (30) miles from Danville, Virginia. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. (b) During the period beginning on the first day of the fourth month beginning after the Control Change Date and ending on the first anniversary of the Control Change Date, the Executive may resign from the employ of both the Parent and the Company, for any reason or no reason. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the 2 Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. (c) During the period beginning on the first anniversary of the Control Change Date and ending on the last day of the Term of this Agreement, the Executive may resign from the employ of both the Parent and the Company if (i) the Parent or the Company breaches the obligation set forth in paragraph 3, (ii) the Parent or the Company notifies the Executive that he will be required to relocate his office more than thirty (30) miles from Danville, Virginia or (iii) the Executive's duties, title or responsibilities with respect to the Parent or the Company are reduced from the duties, title or responsibilities assigned to the Executive as of the first anniversary of the Control Change Date. If the Executive resigns in accordance with the preceding sentence, he shall be entitled to receive the Termination Benefits for the period beginning on the date of the Executive's termination of employment and ending on the last day of the twelfth (12th) month thereafter or the last day of the Term of this Agreement, whichever occurs first. 6. Maximum Benefit. No amounts will be payable and no benefits will be --------------- provided under this Agreement to the extent that such payments or benefits, together with other payments or benefits under other plans, agreements or arrangements, would make the Executive liable for the payment of an excise tax under Section 4999 of the Internal Revenue Code of 1986, as amended, or any successor provision. The amounts otherwise payable and the benefits otherwise to be provided under this Agreement shall be reduced to the extent necessary to avoid the imposition of such excise tax liability; provided, however, that the Executive shall have the right to direct which payments or benefits under this Agreement shall be reduced in order to avoid any such excise tax liability. 7. Cause. The Parent and the Company shall be deemed to have "Cause" to ----- terminate the Executive's employment under this Agreement if the Parent or the Company determines that the Executive (i) has failed or refused to perform a material duty of his position, (ii) is guilty of personal dishonesty, gross incompetence, willful misconduct, a breach of fiduciary duty involving personal profit, willful violation of any law, rule or regulation (other than traffic violations or similar offenses), unethical business practices in connection with the Parent's or the Company's business, misappropriation of the Parent's or the Company's assets (determined on a reasonable basis), or is subject to a final cease-and-desist order, or has been convicted of a felony or a misdemeanor involving moral turpitude or (iii) is guilty of a material breach of any employment agreement between the Parent and the Executive of the Company and the Executive. 8. Change in Control. A "Change in Control" of the Parent or the Company ----------------- occurs if: (a) Any person, including a "group" (as defined in section 13(d)(3) of the Securities Exchange Act of 1934, as amended, as in effect on the Effective Date (the "Exchange Act") is or becomes, directly or indirectly, the owner or 3 beneficial owner of Parent or Company securities (other than as a result of an issuance of securities initiated by the Parent or the Company, a tender offer initiated by the Parent or the Company or open market purchases approved by the Parent's or the Company's Board of Directors (the "Board"), as long as the majority of the Parent's or the Company's Board approving the purchases are directors at the time the purchases are made), having more than fifty (50%) of the combined voting power of the then outstanding Parent or Company securities that may be cast for the election of the Parent's or the Company's directors; or (b) During any period of twenty-four (24) consecutive months, individuals who at the beginning of such period constitute the Parent's or the Company's Board and any new director (other than a director designated by a person who has entered into an agreement with the Parent or the Company to effect a transaction described in subparagraphs 8(a), 8(c) or 8(d) or any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act or other actual or threatened solicitation of proxies or consents) whose election by the Parent or the Board or nomination for election by the Parent's or the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of such period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority of the Parent's or the Company Board; or (c) There is consummated a reorganization, merger, or consolidation involving the Parent or the Company that requires the approval of the Parent's or the Company's shareholders, other than a reorganization, merger or consolidation with respect to which all or substantially all of the individuals and entities who were beneficial owners, immediately prior to such reorganization, merger or consolidation, of the combined voting power of the Parent's or the Company's then outstanding securities beneficially owned, directly or indirectly, immediately after such reorganization, merger or consolidation, more than fifty percent (50%) of the combined voting power of the securities of the corporation resulting from such reorganization, merger or consolidation in substantially the same proportions as their respective ownership, immediately prior to such reorganizations, merger or consolidation, of the combined voting power of the Parent's or the Company's securities; or (d) The Parent's or the Company's shareholders approve (i) the sale or disposition by the Parent or the Company (other than to a subsidiary of the Parent or the Company) of more than fifty percent (50%) of the assets of the Parent or the Company (including a sale or disposition that is effected through condemnation proceedings) or (ii) a complete liquidation or dissolution of the Parent or the Company. 9. Control Change Date. A "Control Change Date" is the date on which a ------------------- Change in Control of the Parent or the Company occurs. If a Change in Control of the Parent or the Company occurs as the result of a series of transactions or events, the Control Change Date is the date of the last of the transactions or events in the series. 4 10. Termination Benefits. The "Termination Benefits" payable in accordance -------------------- with paragraphs 4 and 5 are the following payments and benefits: (a) Continued payment of the Executive's base salary for the applicable period specified in paragraph 4 or 5 at the rate in effect on the date of the Executive's termination of employment (but not less than the rate of base salary required under paragraph 3). (b) Payment each month during the applicable period specified in paragraph 4 or 5 of a pro rata amount of the annualized "profit sharing" bonus in the amount required under paragraph 3. (c) Payment each month during the applicable period specified in paragraph 4 or 5 of a pro rata amount of the annualized "incentive compensation" bonus in the amount required under paragraph 3. (d) Continued participation in the Parent's and the Company's health, dental, vision, long-term disability and life insurance programs or plans for the applicable period specified in paragraph 4 or 5 on the same terms and conditions as applied to the Executive immediately before his termination of employment; provided, however, that if such coverage cannot be provided under the terms of a Parent or Company program or plan, the Parent or the Company shall obtain separate insurance coverage that provides the Executive the same or comparable benefits and the portion of the insurance premium charged to the Executive for such separate insurance coverage shall not exceed the Executive's cost for such coverage under the Parent's and the Company's program or plan immediately before this termination of employment. (e) A single sum payment equal to the difference between (i) the present value of the benefits that the Executive would have accrued under the Parent's or the Company's defined benefit pension plan based on his actual service and assuming continued service during the applicable period specified in paragraph 4 or 5 and (ii) the present value of the benefit payable to the Executive under the Parent's or the Company's defined benefit pension plan. The amount of the payment required under the preceding sentence shall be calculated by the actuary of the Parent's or the Company's defined benefit pension plan using the actuarial assumptions and methods in effect for purposes of determining the funded status of such plan and shall assume that amounts payable under this Agreement are recognized as compensation for purposes of such plan. 11. Successors. This Agreement shall inure to the benefit of, and be ---------- enforceable by, the Executive's legal representatives and heirs. This Agreement shall inure to the benefit of, and be binding upon, the Parent and the Company and their successors and assigns. The Parent and the Company shall require any successor to the Parent or the Company (whether direct or indirect, by merger, purchase, consolidation or otherwise) to all or substantially all of the business or assets of the Parent or the Company to assume expressly and agree to perform the Parent or the Company's obligations under this Agreement. References in this Agreement to the "Parent" and to the "Company" include the Parent and 5 the Company as defined above and any successor to their business or assets that is obligated to perform this Agreement by operation or law or otherwise. 12. Entire Agreement. This Agreement sets forth the entire agreement of the ---------------- parties with respect to the termination of the Executive's employment on or after a Control Change Date and supersedes all prior agreements, arrangements and understandings with respect thereto between the Parent, the Company and the Executive. No modification, amendment or termination of this Agreement, nor any waiver of its provisions, shall be valid or enforceable unless in writing and signed by both parties. 13. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which will be deemed an original and all of which constitute an instrument. 14. Headings. The headings herein are for convenience only and will not -------- affect the interpretation of this Agreement. 15. Governing Law. This Agreement will be governed by, and construed in ------------- accordance with, the laws of the Commonwealth of Virginia (other than its choice of law provisions to the extent that they would require the application of the laws of another State). WITNESS, the following signatures as of the indicated dates. AMERICAN NATIONAL BANKSHARES INC. Dated: June 15, 2004 By: /s/Charles H. Majors ------------- -------------------------------------- Title: President & Chief Executive Officer ----------------------------------- AMERICAN NATIONAL BANK AND TRUST COMPANY Dated: June 15, 2004 By: /s/Charles H. Majors ------------- -------------------------------------- Title: President & Chief Executive Officer ----------------------------------- NEAL A. PETROVICH Dated: June 15, 2004 By: /s/Neal A. Petrovich ------------- -------------------------------------- 6 -----END PRIVACY-ENHANCED MESSAGE-----