UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2019.

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM   TO .

Commission file number:  0-12820

AMERICAN NATIONAL BANKSHARES INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1284688
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
628 Main Street, Danville, Virginia	24541
(Address of principal executive offices)	(Zip Code)

(434) 792-5111

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	AMNB	Nasdaq Global Select Market

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 o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o	Accelerated filer  o
Non-accelerated filer  o	Smaller reporting company x
	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

At July 29, 2019, the Company had 11,143,132 shares of Common Stock outstanding, $1 par value.

AMERICAN NATIONAL BANKSHARES INC.

Index			Page
Part I.		FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Consolidated Balance Sheets as of June 30, 2019 (unaudited) and December 31, 2018	4
		Consolidated Statements of Income (Loss) for the three and six months ended June 30, 2019 and 2018 (unaudited)	5
		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and 2018 (unaudited)	7
		Consolidated Statements of Changes in Shareholders' Equity for the three and six months ended June 30, 2019 and 2018 (unaudited)	9
		Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018 (unaudited)	10
		Notes to Consolidated Financial Statements (unaudited)	11
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	42
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62
	Item 4.	Controls and Procedures	64
Part II.		OTHER INFORMATION
	Item 1.	Legal Proceedings	65
	Item 1A.	Risk Factors	65
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	65
	Item 3.	Defaults Upon Senior Securities	65
	Item 4.	Mine Safety Disclosures	65

2

	Item 5.	Other Information	65
	Item 6.	Exhibits	66
SIGNATURES			67

3

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

American National Bankshares Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share data)
Assets	(Unaudited) June 30, 2019			(*) December 31, 2018
Cash and due from banks	$	34,460		$	29,587
Interest-bearing deposits in other banks	20,454			34,668
Equity securities, at fair value	125			1,830
Securities available for sale, at fair value	334,326			332,653
Restricted stock, at cost	7,796			5,247
Loans held for sale	3,165			640
Loans, net of unearned income	1,836,241			1,357,476
Less allowance for loan losses	(12,786		)	(12,805		)
Net loans	1,823,455			1,344,671
Premises and equipment, net	39,038			26,675
Other real estate owned, net of valuation allowance of $144 in 2019 and $109 in 2018	1,433			869
Goodwill	84,633			43,872
Core deposit intangibles, net	8,613			926
Bank owned life insurance	27,451			18,941
Accrued interest receivable and other assets	33,133			22,287
Total assets	$	2,418,082		$	1,862,866
Liabilities
Demand deposits -- noninterest bearing	$	554,400		$	435,828
Demand deposits -- interest bearing	326,105			234,621
Money market deposits	451,343			401,461
Savings deposits	178,723			132,360
Time deposits	488,526			361,957
Total deposits	1,999,097			1,566,227
Short-term borrowings:
Customer repurchase agreements	37,222			35,243
Other short-term borrowings	13,528			—
Subordinated debt	7,526			—
Junior subordinated debt	27,978			27,927
Accrued interest payable and other liabilities	20,814			10,927
Total liabilities	2,106,165			1,640,324
Shareholders' equity
Preferred stock, $5 par, 2,000,000 shares authorized, none outstanding	—			—
Common stock, $1 par, 20,000,000 shares authorized, 11,141,355 shares outstanding at June 30, 2019 and 8,720,337 shares outstanding at December 31, 2018	11,089			8,668
Capital in excess of par value	160,572			78,172
Retained earnings	141,339			141,537
Accumulated other comprehensive loss, net	(1,083		)	(5,835		)
Total shareholders' equity	311,917			222,542
Total liabilities and shareholders' equity	$	2,418,082		$	1,862,866

(*) -  Derived from audited consolidated financial statements.

The accompanying notes are an integral part of the consolidated financial statements.

4

American National Bankshares Inc.
Consolidated Statements of Income (Loss)
(Dollars in thousands, except per share data) (Unaudited)
	Three Months Ended   June 30,						Six Months Ended   June 30,
	2019			2018			2019			2018
Interest and Dividend Income:
Interest and fees on loans	$	22,629		$	14,766		$	38,267		$	29,423
Interest and dividends on securities:
Taxable	1,980			1,540			3,801			2,864
Tax-exempt	239			423			526			842
Dividends	105			78			189			158
Other interest income	258			185			524			373
Total interest and dividend income	25,211			16,992			43,307			33,660
Interest Expense:
Interest on deposits	3,520			1,873			5,992			3,698
Interest on short-term borrowings	178			2			350			12
Interest on long-term borrowings	14			—			14			—
Interest on subordinated debt	122			—			122			—
Interest on junior subordinated debt	388			329			772			619
Total interest expense	4,222			2,204			7,250			4,329
Net Interest Income	20,989			14,788			36,057			29,331
Provision for (recovery of) loan losses	(10		)	(30		)	6			(74		)
Net Interest Income After Provision for (Recovery of) Loan Losses	20,999			14,818			36,051			29,405
Noninterest Income:
Trust fees	933			945			1,847			1,874
Service charges on deposit accounts	724			592			1,318			1,204
Other fees and commissions	1,015			679			1,723			1,321
Mortgage banking income	586			491			992			941
Securities gains, net	147			289			470			410
Brokerage fees	186			209			333			431
Income (loss) from Small Business Investment Companies	(137		)	171			31			326
Gains (losses) on premises and equipment, net	(87		)	—			(87		)	3
Other	315			187			506			386
Total noninterest income	3,682			3,563			7,133			6,896
Noninterest Expense:
Salaries	7,048			5,095			11,712			10,092
Employee benefits	1,425			1,111			2,655			2,286
Occupancy and equipment	1,431			1,100			2,515			2,228
FDIC assessment	169			132			294			278
Bank franchise tax	412			291			702			572
Core deposit intangible amortization	458			77			513			154
Data processing	717			467			1,249			889
Software	321			354			645			659
Other real estate owned, net	(44		)	25			(31		)	55
Merger related expense	10,871			—			11,322			—
Other	3,508			2,350			5,669			4,491
Total noninterest expense	26,316			11,002			37,245			21,704
Income (Loss) Before Income Taxes	(1,635		)	7,379			5,939			14,597

5

Income Taxes	(405		)	1,399		1,166		2,805
Net Income (Loss)	$	(1,230	)	$	5,980	$	4,773	$	11,792
Net Income (Loss) Per Common Share:
Basic	$	(0.11	)	$	0.69	$	0.48	$	1.36
Diluted	$	(0.11	)	$	0.69	$	0.48	$	1.36
Weighted Average Common Shares Outstanding:
Basic	11,126,800			8,692,107		9,942,566		8,680,739
Diluted	11,126,800			8,704,726		9,952,115		8,695,860

The accompanying notes are an integral part of the consolidated financial statements.

6

American National Bankshares Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
	Three Months Ended   June 30,
	2019			2018
Net income (loss)	$	(1,230	)	$	5,980
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale	4,106			(1,446		)
Tax effect	(920		)	325
Reclassification adjustment for gains on sales or calls of securities available for sale	(136		)	—
Tax effect	31			—
Unrealized losses on cash flow hedges	(1,086		)	(237		)
Tax effect	243			53
Other comprehensive income (loss)	2,238			(1,305		)
Comprehensive income	$	1,008		$	4,675

The accompanying notes are an integral part of the consolidated financial statements.

American National Bankshares Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
	Six Months Ended   June 30,
	2019			2018
Net income	$	4,773		$	11,792
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale	8,075			(5,180		)
Tax effect	(1,809		)	1,186
Reclassification adjustment for gains on sales or calls of securities available for sale	(140		)	(8		)
Tax effect	32			2
Unrealized losses on cash flow hedges	(1,811		)	(237		)
Tax effect	405			53
Other comprehensive income (loss)	4,752			(4,184		)
Comprehensive income	$	9,525		$	7,608

The accompanying notes are an integral part of the consolidated financial statements.

7

American National Bankshares Inc.
Consolidated Statements of Changes in Shareholders' Equity
Three Months Ended June 30, 2019 and 2018
(Dollars in thousands, except per share data) (Unaudited)
	Common Stock		Capital in Excess of Par Value		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
Balance, April 1, 2018	$	8,621	$	76,525	$	131,299		$	(6,605	)	$	209,840
Net income	—		—		5,980			—			5,980
Other comprehensive loss	—		—		—			(1,305		)	(1,305		)
Reclassification for ASU 2016-01 adoption	—		—		—			—			—
Stock options exercised (28,710 shares)	29		661		—			—			690
Vesting of restricted stock	—		—		—			—			—
Equity based compensation (4,384 shares)	4		310		—			—			314
Cash dividends paid, $0.50 per share	—		—		(2,171		)	—			(2,171		)
Balance, June 30, 2018	$	8,654	$	77,496	$	135,108		$	(7,910	)	$	213,348
Balance, April 1, 2019	$	8,705	$	78,738	$	145,351		$	(3,321	)	$	229,473
Net loss	—		—		(1,230		)	—			(1,230		)
Other comprehensive income	—		—		—			2,238			2,238
Issuance of common stock (2,361,686 shares)	2,362		80,108		—			—			82,470
Issuance of replacement options/restricted stock	—		870		—			—			870
Stock options exercised (17,330 shares)	17		271		—			—			288
Vesting of restricted stock	—		—		—			—			—
Equity based compensation (5,770 shares)	5		585		—			—			590
Cash dividends paid, $0.50 per share	—		—		(2,782		)	—			(2,782		)
Balance, June 30, 2019	$	11,089	$	160,572	$	141,339		$	(1,083	)	$	311,917

The accompanying notes are an integral part of the consolidated financial statements.

8

American National Bankshares Inc.
Consolidated Statements of Changes in Shareholders' Equity
Six Months Ended June 30, 2019 and 2018
(Dollars in thousands, except per share data) (Unaudited)
	Common Stock		Capital in Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
Balance, December 31, 2017	$	8,604	$	76,179		$	127,010		$	(3,076	)	$	208,717
Net income	—		—			11,792			—			11,792
Other comprehensive loss	—		—			—			(4,184		)	(4,184		)
Reclassification for ASU 2016-01 adoption	—		—			650			(650		)	—
Stock options exercised (32,010 shares)	32		743			—			—			775
Vesting of restricted stock (10,101 shares)	10		(10		)	—			—			—
Equity based compensation (25,570 shares)	8		584			—			—			592
Cash dividends paid, $0.50 per share	—		—			(4,344		)	—			(4,344		)
Balance, June 30, 2018	$	8,654	$	77,496		$	135,108		$	(7,910	)	$	213,348
Balance, December 31, 2018	$	8,668	$	78,172		$	141,537		$	(5,835	)	$	222,542
Net income	—		—			4,773			—			4,773
Other comprehensive income	—		—			—			4,752			4,752
Issuance of common stock (2,361,686 shares)	2,362		80,108			—			—			82,470
Issuance of replacement options/restricted stock	—		870			—			—			870
Stock options exercised (30,530 shares)	30		548			—			—			578
Vesting of restricted stock (20,285 shares)	20		(20		)	—			—			—
Equity based compensation (28,802 shares)	9		894			—			—			903
Cash dividends paid, $0.50 per share	—		—			(4,971		)	—			(4,971		)
Balance, June 30, 2019	$	11,089	$	160,572		$	141,339		$	(1,083	)	$	311,917

The accompanying notes are an integral part of the consolidated financial statements.

9

American National Bankshares Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
	Six Months Ended   June 30,
	2019			2018
Cash Flows from Operating Activities:
Net income	$	4,773		$	11,792
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for (recovery of) loan losses	6			(74		)
Depreciation	958			933
Net accretion of acquisition accounting adjustments	(1,373		)	(804		)
Core deposit intangible amortization	513			154
Net amortization of securities	613			859
Net gain on sale or call of securities available for sale	(140		)	(8		)
Net change in fair value of equity securities	(330		)	(402		)
Gain on sale of loans held for sale	(992		)	(941		)
Proceeds from sales of loans held for sale	41,962			39,145
Originations of loans held for sale	(43,495		)	(38,861		)
Net gain on other real estate owned	(134		)	(25		)
Valuation allowance on other real estate owned	56			22
Net loss (gain) on sale of premises and equipment	87			(3		)
Equity based compensation expense	903			592
Earnings on bank owned life insurance	(264		)	(214		)
Deferred income tax expense (benefit)	222			(27		)
Net change in interest receivable	229			(62		)
Net change in other assets	8,880			(875		)
Net change in interest payable	93			(2		)
Net change in other liabilities	(2,211		)	(34		)
Net cash provided by operating activities	10,356			11,165
Cash Flows from Investing Activities:
Proceeds from sales of equity securities	317			431
Proceeds from sales of securities available for sale	29,878			22,066
Proceeds from maturities, calls and paydowns of securities available for sale	38,817			16,000
Purchases of securities available for sale	(26,312		)	(66,221		)
Net change in restricted stock	39			647
Net increase in loans	(33,371		)	(2,952		)
Proceeds from sale of premises and equipment	—			24
Purchases of premises and equipment	(1,299		)	(932		)
Proceeds from sales of other real estate owned	1,137			636
Cash paid in bank acquisition	(27		)	—
Cash acquired in bank acquisition	26,283			—
Net cash provided by (used in) investing activities	35,462			(30,301		)
Cash Flows from Financing Activities:
Net change in demand, money market, and savings deposits	(36,239		)	37,585
Net change in time deposits	(14,373		)	(11,565		)
Net change in customer repurchase agreements	1,979			(3,950		)
Net change in other short-term borrowings	(1,355		)	(18,500		)
Net change in long-term borrowings	(778		)	—
Common stock dividends paid	(4,971		)	(4,344		)
Proceeds from exercise of stock options	578			775
Net cash (used in) provided by financing activities	(55,159		)	1
Net Decrease in Cash and Cash Equivalents	(9,341		)	(19,135		)
Cash and Cash Equivalents at Beginning of Period	64,255			52,477
Cash and Cash Equivalents at End of Period	$	54,914		$	33,342

The accompanying notes are an integral part of the consolidated financial statements.

10

AMERICAN NATIONAL BANKSHARES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Accounting Policies

The consolidated financial statements include the accounts of American National Bankshares Inc. (the "Company") and its wholly owned subsidiary, American National Bank and Trust Company (the "Bank"). The Bank offers a wide variety of retail, commercial, secondary market mortgage lending, and trust and investment services which also include non-deposit products such as mutual funds and insurance policies.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") 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 consolidated 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, goodwill and intangible assets, other-than-temporary impairment of securities, accounting for merger and acquisition activity, derivative financial instruments, accounting for acquired loans with specific credit-related deterioration, the valuation of deferred tax assets and liabilities, and the valuation of other real estate owned ("OREO").

All significant inter-company transactions and accounts are eliminated in consolidation, with the exception of the AMNB Trust and the MidCarolina Trusts, as detailed in Note 11.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the results of the interim periods. The results of operations for the interim periods are not necessarily indicative of the results that may occur for any other period. Certain reclassifications have been made to prior period balances to conform to the current period presentation. These reclassifications did not have an impact on net income and were considered immaterial. These statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.

Adoption of New Accounting Standards

On January 1, 2019, the Company adopted Accounting Standards Update ("ASU") 2016-02, "Leases (Topic 842)." Among other things, in the amendments in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Financial Accounting Standards Board ("FASB") made subsequent amendments to Topic 842 in July 2018 through ASU 2018-10 ("Codification Improvements to Topic 842, Leases.") and ASU 2018-11 ("Leases (Topic 842): Targeted Improvements."). Among these amendments is the provision in ASU 2018-11 that provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity's reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard continue to be in accordance with current GAAP (Topic 840, Leases). The Company adopted using the additional (and optional) transition method. The effect of adopting this standard on January 1, 2019 was an approximately $4.4 million increase in assets and liabilities on the Company's consolidated balance sheet.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting

11

for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for Securities and Exchange Commission ("SEC") filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Based on FASB’s July 17, 2019 meeting, an exposure draft is expected that, once finalized, could change implementation dates for many companies. The Company has implemented and completed a significant amount of a project plan addressing the components of this ASU with the assistance of an outside vendor. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are SEC filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement." The amendments in this ASU modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, "Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans." The amendments in this ASU modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure requirements have been deleted while the following disclosure requirements have been added: the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements in paragraph 715-20-50-3, which state that the following information for defined benefit pension plans should be disclosed: the projected benefit obligation ("PBO") and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation ("ABO") and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending after December 15, 2020. Early adoption is permitted. The Company is currently assessing the impact that ASU 2018-14 will have on its consolidated financial statements.

In April 2019, the FASB issued ASU 2019-04, "Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments." The amendments in this ASU clarify and improve areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various Transition Resource Group Meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its consolidated financial statements.

In May 2019, the FASB issued ASU 2019-05, "Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief." The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.

12

Note 2 - Acquisitions

On April 1, 2019, the Company completed its acquisition of Roanoke-based HomeTown Bankshares Corporation ("HomeTown") and its wholly-owned subsidiary bank, HomeTown Bank. Pursuant and subject to the terms of the merger agreement, as a result of the merger, the holders of shares of HomeTown common stock received 0.4150 shares of the Company's common stock for each share of HomeTown common stock held immediately prior to the effective date of the merger.

The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition, in accordance with Accounting Standards Codification ("ASC") 350, Intangibles-Goodwill and Other. The following table provides a preliminary assessment of the consideration transferred, assets acquired, and liabilities assumed as of the date of the acquisition (dollars in thousands):

Consideration Paid:
Common shares issued (2,361,686)	$	82,470
Issuance of replacement stock options/restricted stock	753
Cash paid in lieu of fractional shares	27
Value of consideration	83,250
Assets acquired:
Cash and cash equivalents	26,283
Investment securities	34,876
Restricted stock	2,588
Loans	444,324
Premises and equipment	12,554
Deferred income taxes	2,329
Core deposit intangible	8,200
Other real estate owned	1,442
Banked owned life insurance	8,246
Other assets	14,244
Total assets	555,086
Liabilities assumed:
Deposits	483,626
Short-term FHLB advances	14,883
Long-term FHLB advances	778
Subordinated debt	7,530
Other liabilities	5,780
Total liabilities	512,597
Net assets acquired	42,489
Goodwill resulting from merger with HomeTown	$	40,761

The acquired loans were recorded at fair value at the acquisition date without carryover of HomeTown's previously established allowance for loan losses. The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and leases and then applying a market-based discount rate to those cash flows. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, purpose, and lien position. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), and past due status. For valuation purposes, these pools were further disaggregated by maturity, pricing characteristics (e.g., fixed-rate, adjustable-rate) and re-payment structure (e.g., interest only, fully amortizing, balloon). If new information is obtained about facts and circumstances about expected cash flows that existed as of the acquisition date, management will adjust fair values in accordance with accounting for business combinations.

13

The acquired loans were divided into loans with evidence of credit quality deterioration which are accounted for under ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality, (acquired impaired) and loans that do not meet these criteria, which are accounted for under ASC 310-20, Receivables - Nonrefundable Fees and Other Costs, (acquired performing).

The following table presents the acquired impaired loans receivable at the acquisition date (dollars in thousands):

Contractually required principal and interest at acquisition	$	45,551
Contractual cash flows not expected to be collected (nonaccretable difference)	8,296
Expected cash flows at acquisition	37,255
Interest component of expected cash flows (accretable yield)	4,410
Fair value of acquired loans accounted for under FASB ASC 310-30	$	32,845

Direct costs related to the acquisition were expensed as incurred. During the six months ended June 30, 2019, the Company incurred $11.3 million in merger and acquisition integration expenses related to the merger, including $9.1 million in data processing termination and conversion costs, $1.7 million in legal and professional fees, $0.4 million in salary related expense, and $0.1 million in other noninterest expenses. The majority of these expenses were related to integration and are deductible for tax purposes.

The following table presents unaudited pro forma information as if the acquisition of HomeTown had occurred on January 1, 2018. These results combine the historical results of HomeTown in the Company's Consolidated Statements of Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2018. In particular, no adjustments have been made to eliminate the amount of HomeTown's provision for credit losses that would not have been necessary had the acquired loans been recorded at fair value as of January 1, 2018. Pro forma adjustments below include the net impact of accretion for 2018 and the elimination of merger-related costs for 2019. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below (dollars in thousands, except per share data):

	Pro forma Six Months Ended
	June 30, 2019		June 30, 2018
Total revenues (1)	$	45,768	$	49,419
Net income	13,382		14,755
Earnings per share	1.20		1.33

(1) Includes net interest income and noninterest income.

Note 3 – Securities

The amortized cost and fair value of investments in debt securities at June 30, 2019 were as follows (dollars in thousands):

	June 30, 2019
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	136,066	$	1,594	$	647	$	137,013
Mortgage-backed and CMOs	135,871		1,426		398		136,899
State and municipal	51,559		733		47		52,245
Corporate	8,016		153		—		8,169
Total securities available for sale	$	331,512	$	3,906	$	1,092	$	334,326

The Company adopted ASU 2016-01 effective January 1, 2018 and had equity securities with a fair value of $125,000 at June 30, 2019 and recognized in income a $330,000 change in the fair value of equity securities during the first six months of 2019. During the six months ended June 30, 2019, the Company sold $317,000 in equity securities at fair value. The Company had equity securities with a fair value of $2,177,000 at June 30, 2018 and recognized in income a $402,000 change in the fair value of equity securities during the first six months of 2018.

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The amortized cost and fair value of investments in debt securities at December 31, 2018 were as follows (dollars in thousands):

	December 31, 2018
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	137,070	$	442	$	3,473	$	134,039
Mortgage-backed and CMOs	113,883		385		2,401		111,867
State and municipal	80,022		411		531		79,902
Corporate	6,799		68		22		6,845
Total securities available for sale	$	337,774	$	1,306	$	6,427	$	332,653

Restricted Stock

Due to restrictions placed upon the Bank's common stock investment in the Federal Reserve Bank of Richmond ("FRB") and Federal Home Loan Bank of Atlanta ("FHLB"), these securities have been classified as restricted equity securities and carried at cost.  The restricted securities are not subject to the investment security classification and are included as a separate line item on the Company's consolidated balance sheets.  The FRB requires the Bank to maintain stock with a par value equal to 3.00% of its outstanding capital and an additional 3.00% is on call.  The FHLB requires the Bank to maintain stock in an amount equal to 4.25% of outstanding borrowings and a specific percentage of the Bank's total assets. The cost of restricted stock at June 30, 2019 and December 31, 2018 was as follows (dollars in thousands):

	June 30, 2019		December 31, 2018
FRB stock	$	5,045	$	3,621
FHLB stock	2,751		1,626
Total restricted stock	$	7,796	$	5,247

Temporarily Impaired Securities

The following table shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2019.  The reference point for determining when securities are in an unrealized loss position is month-end.  Therefore, it is possible that a security's market value exceeded its amortized cost on other days during the past twelve-month period.

Available for sale securities that have been in a continuous unrealized loss position, at June 30, 2019, are as follows (dollars in thousands):

	Total				Less than 12 Months				12 Months or More
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Federal agencies and GSEs	$	86,417	$	647	$	2,038	$	28	$	84,379	$	619
Mortgage-backed and CMOs	59,842		398		848		2		58,994		396
State and municipal	10,679		47		—		—		10,679		47
Corporate	—		—		—		—		—		—
Total	$	156,938	$	1,092	$	2,886	$	30	$	154,052	$	1,062

Federal agencies and GSEs: The unrealized losses on the Company's investment in 30 government sponsored entities ("GSE") securities were caused by interest rate increases. Seventeen of these securities were in an unrealized loss position for 12 months or more. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2019.

Mortgage-backed securities: The unrealized losses on the Company's investment in 41 GSE mortgage-backed securities were caused by interest rate increases. Thirty-six of these securities were in an unrealized loss position for 12 months or more. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. Because the

15

decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2019.

Collateralized Mortgage Obligations: The unrealized loss associated with one private GSE collateralized mortgage obligation ("CMO") was due to normal market fluctuations. This one security was in an unrealized loss position for 12 months or more. The contractual cash flows of that investment is guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the security would not be settled at a price less than the amortized cost basis of the Company's investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider the investment to be other-than-temporarily impaired at June 30, 2019.

State and municipal securities:  The unrealized losses on 13 state and municipal securities were caused by interest rate increases. Thirteen of these securities were in an unrealized loss position for 12 months or more. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2019.

Corporate securities:  There were no corporate bonds in an unrealized loss position at June 30, 2019.

Restricted stock: When evaluating restricted stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider restricted stock to be other-than-temporarily impaired at June 30, 2019, and no impairment has been recognized.

The table below shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position, at December 31, 2018 (dollars in thousands):

	Total				Less than 12 Months				12 Months or More
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Federal agencies and GSEs	$	103,797	$	3,473	$	14,982	$	8	$	88,815	$	3,465
Mortgage-backed and CMOs	86,852		2,401		5,473		15		81,379		2,386
State and municipal	39,755		531		7,199		18		32,556		513
Corporate	484		22		—		—		484		22
Total	$	230,888	$	6,427	$	27,654	$	41	$	203,234	$	6,386

Other-Than-Temporarily-Impaired Securities

As of June 30, 2019 and December 31, 2018, there were no securities classified as other-than-temporarily impaired.

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Realized Gains and Losses

The following table presents the gross realized gains and losses on and the proceeds from the sale of securities available for sale during the three and six months ended June 30, 2019 and 2018 (dollars in thousands):

	Three Months Ended June 30, 2019			Six Months Ended June 30, 2019
Realized gains (losses):
Gross realized gains	$	190		$	194
Gross realized losses	(54		)	(54		)
Net realized gains	$	136		$	140
Proceeds from sales of securities	$	29,878		$	29,878
	Three Months Ended June 30, 2018			Six Months Ended June 30, 2018
Realized gains (losses):
Gross realized gains	$	—		$	105
Gross realized losses	—			(97		)
Net realized gains	$	—		$	8
Proceeds from sales of securities	$	—		$	22,066

Note 4 – Loans

Loans, excluding loans held for sale, at June 30, 2019 and December 31, 2018, were comprised of the following (dollars in thousands):

	June 30, 2019		December 31, 2018
Commercial	$	340,427	$	285,972
Commercial real estate:
Construction and land development	152,876		97,240
Commercial real estate	880,146		655,800
Residential real estate:
Residential	328,400		209,438
Home equity	121,905		103,933
Consumer	12,487		5,093
Total loans	$	1,836,241	$	1,357,476

Acquired Loans

The outstanding principal balance and the carrying amount of these loans, including loans accounted for under ASC 310-30, included in the consolidated balance sheets at June 30, 2019 and December 31, 2018 are as follows (dollars in thousands):

	June 30, 2019		December 31, 2018
Outstanding principal balance	$	482,640	$	63,619
Carrying amount	464,419		58,886

The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies ASC 310-30 to account for interest earned, as of the indicated dates are as follows (dollars in thousands):

	June 30, 2019		December 31, 2018
Outstanding principal balance	$	62,006	$	24,500
Carrying amount	51,297		20,611

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The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies ASC 310-30, for the six months ended June 30, 2019 and the year ended December 31, 2018 (dollars in thousands):

	June 30, 2019			December 31, 2018
Balance at January 1	$	4,633		$	4,890
Additions from merger with HomeTown	4,410			—
Accretion	(1,527		)	(2,362		)
Reclassification from nonaccretable difference	222			956
Other changes, net*	283			1,149
	$	8,021		$	4,633

* This line item represents changes in the cash flows expected to be collected due to the impact of non-credit changes such as prepayment assumptions, changes in interest rates on variable rate acquired impaired loans, and discounted payoffs that occurred in the period.

Past Due Loans

The following table shows an analysis by portfolio segment of the Company's past due loans at June 30, 2019 (dollars in thousands):

	30- 59 Days Past Due		60-89 Days Past Due		90 Days + Past Due and Still Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Commercial	$	313	$	1,168	$	4	$	49	$	1,534	$	338,893	$	340,427
Commercial real estate:
Construction and land development	211		130		53		23		417		152,459		152,876
Commercial real estate	1,951		—		465		116		2,532		877,614		880,146
Residential:
Residential	743		841		408		706		2,698		325,702		328,400
Home equity	101		220		—		75		396		121,509		121,905
Consumer	24		—		—		—		24		12,463		12,487
Total	$	3,343	$	2,359	$	930	$	969	$	7,601	$	1,828,640	$	1,836,241

The following table shows an analysis by portfolio segment of the Company's past due loans at December 31, 2018 (dollars in thousands):

	30- 59 Days Past Due		60-89 Days Past Due		90 Days + Past Due and Still Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Commercial	$	20	$	—	$	—	$	83	$	103	$	285,869	$	285,972
Commercial real estate:
Construction and land development	—		—		—		27		27		97,213		97,240
Commercial real estate	42		—		—		197		239		655,561		655,800
Residential:
Residential	456		157		72		659		1,344		208,094		209,438
Home equity	126		—		—		124		250		103,683		103,933
Consumer	21		3		—		—		24		5,069		5,093
Total	$	665	$	160	$	72	$	1,090	$	1,987	$	1,355,489	$	1,357,476

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Impaired Loans

The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at June 30, 2019 (dollars in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	4	$	4	$	—	$	11	$	—
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	348		346		—		362		14
Residential:
Residential	641		640		—		640		17
Home equity	45		45		—		47		3
Consumer	—		—		—		—		—
	$	1,038	$	1,035	$	—	$	1,060	$	34
With a related allowance recorded:
Commercial	$	53	$	49	$	49	$	55	$	2
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	—		—		—		—		—
Residential
Residential	263		263		28		205		9
Home equity	—		—		—		—		—
Consumer	—		—		—		—		—
	$	316	$	312	$	77	$	260	$	11
Total:
Commercial	$	57	$	53	$	49	$	66	$	2
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	348		346		—		362		14
Residential:
Residential	904		903		28		845		26
Home equity	45		45		—		47		3
Consumer	—		—		—		—		—
	$	1,354	$	1,347	$	77	$	1,320	$	45

In the table above, recorded investment may exceed unpaid principal balance due to acquired loans with a premium and loans with unearned costs that exceed unearned fees.

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The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at December 31, 2018 (dollars in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	28	$	28	$	—	$	44	$	14
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	376		373		—		542		36
Residential:
Residential	646		646		—		875		29
Home equity	49		49		—		108		10
Consumer	—		—		—		2		—
	$	1,099	$	1,096	$	—	$	1,571	$	89
With a related allowance recorded:
Commercial	$	62	$	58	$	55	$	354	$	40
Commercial real estate:
Construction and land development	—		—		—		21		—
Commercial real estate	—		—		—		18		—
Residential:
Residential	173		173		9		342		9
Home equity	—		—		—		128		1
Consumer	—		—		—		—		—
	$	235	$	231	$	64	$	863	$	50
Total:
Commercial	$	90	$	86	$	55	$	398	$	54
Commercial real estate:
Construction and land development	—		—		—		21		—
Commercial real estate	376		373		—		560		36
Residential:
Residential	819		819		9		1,217		38
Home equity	49		49		—		236		11
Consumer	—		—		—		2		—
	$	1,334	$	1,327	$	64	$	2,434	$	139

In the table above, recorded investment may exceed unpaid principal balance due to acquired loans with a premium and loans with unearned costs that exceed unearned fees.

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The following tables show the detail of loans modified as troubled debt restructurings ("TDRs") during the three and six months ended June 30, 2019 included in the impaired loan balances (dollars in thousands).

	Loans Modified as a TDR for the
	Three Months Ended June 30, 2019
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	—	—		—
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	1	207		207
Consumer	—	—		—
Total	1	$	207	$	207

	Loans Modified as a TDR for the
	Six Months Ended June 30, 2019
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	—	—		—
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	1	207		207
Consumer	—	—		—
Total	1	$	207	$	207

The TDR modification in 2019 was extension of the loan maturity.

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The following tables show the detail of loans modified as TDRs during the three and six months ended June 30, 2018 included in the impaired loan balances (dollars in thousands):

	Loans Modified as a TDR for the
	Three Months Ended June 30, 2018
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	—	—		—
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	—	—		—
Consumer	—	—		—
Total	—	$	—	$	—

	Loans Modified as a TDR for the
	Six Months Ended June 30, 2018
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	—	—		—
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	1	11		11
Consumer	—	—		—
Total	1	$	11	$	11

The TDR modification in 2018 was extension of the loan maturity.

During the three and six months ended June 30, 2019 and 2018, the Company had no loans that subsequently defaulted within 12 months of modification. The Company defines defaults as one or more payments that occur more than 90 days past the due date, charge-off or foreclosure subsequent to modification.

Residential Real Estate in Process of Foreclosure

The Company had $203,000 and $112,000 in residential real estate loans in the process of foreclosure at June 30, 2019 and December 31, 2018, respectively. The Company had $351,000 and $719,000 in residential OREO at June 30, 2019 and December 31, 2018, respectively.

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Risk Grades

The following table shows the Company's loan portfolio broken down by internal risk grading as of June 30, 2019 (dollars in thousands):

Commercial and Consumer Credit Exposure

Credit Risk Profile by Internally Assigned Grade

	Commercial		Construction and Land Development		Commercial Real Estate Other		Residential		Home Equity
Pass	$	327,393	$	146,539	$	835,625	$	315,392	$	121,511
Special Mention	11,295		3,993		32,446		7,782		—
Substandard	1,739		2,344		12,075		5,226		394
Doubtful	—		—		—		—		—
Total	$	340,427	$	152,876	$	880,146	$	328,400	$	121,905

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity

	Consumer
Performing	$	12,487
Nonperforming	—
Total	$	12,487

The following table shows the Company's loan portfolio broken down by internal risk grading as of December 31, 2018 (dollars in thousands):

Commercial and Consumer Credit Exposure

Credit Risk Profile by Internally Assigned Grade

	Commercial		Construction and Land Development		Commercial Real Estate Other		Residential		Home Equity
Pass	$	285,092	$	93,000	$	647,519	$	204,261	$	103,541
Special Mention	154		1,840		4,403		1,685		—
Substandard	726		2,400		3,878		3,492		392
Doubtful	—		—		—		—		—
Total	$	285,972	$	97,240	$	655,800	$	209,438	$	103,933

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity

	Consumer
Performing	$	5,093
Nonperforming	—
Total	$	5,093

Loans classified in the Pass category typically are fundamentally sound and risk factors are reasonable and acceptable.

Loans classified in the Special Mention category typically have been criticized internally, by loan review or the loan officer, or by external regulators under the current credit policy regarding risk grades.

Loans classified in the Substandard category typically have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are typically characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Loans classified in the Doubtful category typically have all the weaknesses inherent in loans classified as substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts,

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conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur that may salvage the debt.

Consumer loans are classified as performing or nonperforming.  A loan is nonperforming when payments of interest and principal are past due 90 days or more.

Note 5 – Allowance for Loan Losses and Reserve for Unfunded Lending Commitments

Changes in the allowance for loan losses and the reserve for unfunded lending commitments at and for the indicated dates and periods are presented below (dollars in thousands):

	Six Months Ended   June 30, 2019			Year Ended December 31, 2018			Six Months Ended   June 30, 2018
Allowance for Loan Losses
Balance, beginning of period	$	12,805		$	13,603		$	13,603
Provision for (recovery of) loan losses	6			(103		)	(74		)
Charge-offs	(123		)	(1,020		)	(174		)
Recoveries	98			325			153
Balance, end of period	$	12,786		$	12,805		$	13,508
Reserve for Unfunded Lending Commitments
Balance, beginning of period	$	217		$	206		$	206
Provision for unfunded commitments	99			11			13
Charge-offs	—			—			—
Balance, end of period	$	316		$	217		$	219

The reserve for unfunded loan commitments is included in other liabilities.

The following table presents changes in the Company's allowance for loan losses by portfolio segment and the related loan balance total by segment at and for the six months ended June 30, 2019 (dollars in thousands):

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2018:	$	2,537		$	7,246		$	2,977		$	45		$	12,805
Provision for (recovery of) loan losses	178			(119		)	(99		)	46			6
Charge-offs	(11		)	(6		)	(20		)	(86		)	(123		)
Recoveries	11			7			26			54			98
Balance at June 30, 2019:	$	2,715		$	7,128		$	2,884		$	59		$	12,786
Balance at June 30, 2019:
Allowance for Loan Losses
Individually evaluated for impairment	$	49		$	—		$	28		$	—		$	77
Collectively evaluated for impairment	2,666			7,097			2,699			59			12,521
Acquired impaired loans	—			31			157			—			188
Total	$	2,715		$	7,128		$	2,884		$	59		$	12,786
Loans
Individually evaluated for impairment	$	57		$	348		$	949		$	—		$	1,354
Collectively evaluated for impairment	338,629			999,082			433,407			12,472			1,783,590
Acquired impaired loans	1,741			33,592			15,949			15			51,297
Total	$	340,427		$	1,033,022		$	450,305		$	12,487		$	1,836,241

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The following table presents changes in the Company's allowance for loan losses by portfolio segment and the related loan balance total by segment at and for the year ended December 31, 2018 (dollars in thousands):

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2017:	$	2,413		$	8,321		$	2,825		$	44		$	13,603
Provision for (recovery of) loan losses	842			(1,074		)	89			40			(103		)
Charge-offs	(787		)	(11		)	(86		)	(136		)	(1,020		)
Recoveries	69			10			149			97			325
Balance at December 31, 2018:	$	2,537		$	7,246		$	2,977		$	45		$	12,805
Balance at December 31, 2018:
Allowance for Loan Losses
Individually evaluated for impairment	$	55		$	—		$	9		$	—		$	64
Collectively evaluated for impairment	2,482			7,211			2,822			45			12,560
Acquired impaired loans	—			35			146			—			181
Total	$	2,537		$	7,246		$	2,977		$	45		$	12,805
Loans
Individually evaluated for impairment	$	90		$	376		$	868		$	—		$	1,334
Collectively evaluated for impairment	285,431			742,365			302,657			5,078			1,335,531
Acquired impaired loans	451			10,299			9,846			15			20,611
Total	$	285,972		$	753,040		$	313,371		$	5,093		$	1,357,476

The allowance for loan losses is allocated to loan segments based upon historical loss factors, risk grades on individual loans, and qualitative factors.  Qualitative factors include trends in delinquencies, nonaccrual loans, 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, other lending staff and loan review; national, regional, and local economic trends and conditions; legal, regulatory and collateral factors; and concentrations of credit.

Note 6 – Goodwill and Other Intangible Assets

The Company records as goodwill the excess of the purchase price over the fair value of the identifiable net assets acquired. Impairment testing is performed annually, as well as when an event triggering impairment may have occurred. The Company performs its annual analysis as of June 30 each fiscal year. Accounting guidance permits preliminary assessment of qualitative factors to determine whether more substantial impairment testing is required. The Company chose to bypass the preliminary assessment and utilized a two-step process for impairment testing of goodwill. The first step tests for impairment, while the second step, if necessary, measures the impairment.  No indicators of impairment were identified as of June 30, 2019.

Core deposit intangibles resulting from the acquisition of MidCarolina Financial Corporation ("MidCarolina") in July 2011 were $6,556,000 and are being amortized on an accelerated basis over 108 months. Core deposit intangibles resulting from the acquisition of MainStreet BankShares, Inc. in January 2015 were $1,839,000 and are being amortized on an accelerated basis over 120 months. Core deposit intangibles resulting from the acquisition of HomeTown in April 2019 were $8,200,000 and are being amortized on an accelerated basis over 120 months.

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The changes in the carrying amount of goodwill and intangibles for the six months ended June 30, 2019, are as follows (dollars in thousands):

	Goodwill		Intangibles
Balance at December 31, 2018	$	43,872	$	926
Additions	40,761		8,200
Amortization	—		(513		)
Impairment	—		—
Balance at June 30, 2019	$	84,633	$	8,613

Note 7 – Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 "Leases (Topic 842)" and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and, consistent with such elections, did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company's 2018 Form 10-K, the implementation of the new standard resulted in recognition of a right-of-use asset and lease liability of $4.4 million at the date of adoption, which is related to the Company's lease of premises used in operations. In connection with the HomeTown merger, the Company added $1.8 million to the right-of-use asset and lease liability. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Company's consolidated balance sheets.

Lease liabilities represent the Company's obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company's incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company's right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company's long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company's leases, as of and for the three and six months ended June 30, 2019 (dollars in thousands):

	June 30, 2019
Lease liabilities	$	5,771
Right-of-use assets	$	5,758
Weighted average remaining lease term	8.50 years
Weighted average discount rate	3.20		%

	Three Months Ended June 30, 2019
Lease cost
Operating lease cost	$	283
Short-term lease cost	1
Total lease cost	284
Cash paid for amounts included in the measurement of lease liabilities	$	274

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	Six Months Ended June 30, 2019
Lease cost
Operating lease cost	$	494
Short-term lease cost	2
Total lease cost	496
Cash paid for amounts included in the measurement of lease liabilities	$	483

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows (dollars in thousands):

Lease payments due	As of June 30, 2019
Six months ending December 31, 2019	$	530
Twelve months ending December 31, 2020	950
Twelve months ending December 31, 2021	934
Twelve months ending December 31, 2022	912
Twelve months ending December 31, 2023	809
Twelve months ending December 31, 2024	491
Thereafter	2,022
Total undiscounted cash flows	$	6,648
Discount	(877		)
Lease liabilities	$	5,771

Note 8 – Short-term Borrowings

Short-term borrowings may consist of customer repurchase agreements, overnight borrowings from the FHLB, and federal funds purchased.  The Company has federal funds lines of credit established with two correspondent banks in the amount of $15,000,000 each, and with one correspondent bank in the aggregate amount of $17,500,000, and has access to the FRB's discount window. Customer repurchase agreements are collateralized by securities of the U.S. Government or GSEs.  They mature daily.  The interest rates may be changed at the discretion of the Company. The securities underlying these agreements remain under the Company's control. FHLB overnight borrowings contain floating interest rates that may change daily at the discretion of the FHLB.  Federal funds purchased are unsecured overnight borrowings from other financial institutions. Short-term borrowings consisted of the following at June 30, 2019 and December 31, 2018 (dollars in thousands):

	June 30, 2019		December 31, 2018
Customer repurchase agreements	$	37,222	$	35,243
FHLB borrowings	13,528		—
Total short-term borrowings	$	50,750	$	35,243

Note 9 – Long-term Borrowings

Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans, home equity lines of credit, and commercial real estate loans.  In addition, the Company pledges as collateral its capital stock in the FHLB and deposits with the FHLB.  The Company has a line of credit with the FHLB equal to 30% of the Company's assets, subject to the amount of collateral pledged.  As of June 30, 2019, $602,513,000 in eligible collateral was pledged under the blanket floating lien agreement which covers both short-term and long-term borrowings.

There were no long-term borrowings with FHLB as of June 30, 2019 or December 31, 2018. 

In the regular course of conducting its business, the Company takes deposits from political subdivisions of the states of Virginia and North Carolina. At June 30, 2019, the Bank's public deposits totaled $244,960,000.  The Company is required to provide collateral to secure the deposits that exceed the insurance coverage provided by the Federal Deposit Insurance Corporation. This collateral can be provided in the form of certain types of government or agency bonds or letters of credit

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from the FHLB. At June 30, 2019, the Company had $190,250,000 in letters of credit with the FHLB outstanding, of which $190,000,000, as well as $92,384,000 in agency, state, and municipal securities, was pledged to provide collateral for such deposits.

Note 10 – Subordinated Debt

On April 1, 2019, in connection with the HomeTown merger, the Company assumed $7,500,000 in aggregate principal amount of fixed-to-floating rate subordinated notes issued to various institutional accredited investors. The notes have a maturity date of December 30, 2025 and have an annual fixed interest rate of 6.75% until December 30, 2020. Thereafter, the notes will have a floating interest rate based on LIBOR. Interest will be paid semi-annually, in arrears, on June 30 and December 30 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on March 30, June 30, September 30 and December 30 throughout the floating interest rate period or earlier redemption date.

The indebtedness evidenced by the notes, including principal and interest, is unsecured and subordinate and junior in right of the Company's payments to general and secured creditors and depositors of the bank. The notes are redeemable, without penalty, on or after December 30, 2020 and, in certain limited circumstances, prior to that date. The notes limit the Company from declaring or paying any dividend, or making any distribution on capital stock or other equity securities of any kind of the Company if the Company is not "well capitalized" for regulatory purposes, immediately prior to the declaration of such dividend or distribution, except for dividends payable solely in shares of common stock of the Company.

The carrying value of the subordinated debt includes a fair value adjustment of $26,000 at June 30, 2019. The original fair value adjustment of $30,000 was recorded as a result of the acquisition of HomeTown on April 1, 2019, and is being amortized into interest expense through December 30, 2020.

Note 11 – Junior Subordinated Debt

On April 7, 2006, AMNB Statutory Trust I, a Delaware statutory trust and a wholly owned unconsolidated subsidiary of the Company, issued $20,000,000 of preferred securities (the "Trust Preferred Securities") in a private placement pursuant to an applicable exemption from registration.  The Trust Preferred Securities mature on June 30, 2036, but may be redeemed at the Company's option beginning on September 30, 2011.  Distributions are cumulative and will accrue from the date of original issuance, but may be deferred by the Company from time to time for up to 20 consecutive quarterly periods.  The Company has guaranteed the payment of all required distributions on the Trust Preferred Securities. The proceeds of the Trust Preferred Securities received by the trust, along with proceeds of $619,000 received by the trust from the issuance of common securities by the trust to the Company, were used to purchase $20,619,000 of the Company's junior subordinated debt securities (the "Junior Subordinated Debt"), issued pursuant to junior subordinated debentures entered into between the Company and Wilmington Trust Company, as trustee.  The proceeds of the Junior Subordinated Debt were used to fund the cash portion of the merger consideration to the former shareholders of Community First Financial Corporation in connection with the Company's acquisition of that company in 2006, and for general corporate purposes.

On July 1, 2011, in connection with the MidCarolina merger, the Company assumed $8,764,000 in junior subordinated debt to MidCarolina Trust I and MidCarolina Trust II, two separate Delaware statutory trusts (the "MidCarolina Trusts"), to fully and unconditionally guarantee the preferred securities issued by the MidCarolina Trusts. These long-term obligations, which currently qualify as Tier 1 capital, constitute a full and unconditional guarantee by the Company of the MidCarolina Trusts' obligations. The MidCarolina Trusts were not consolidated in the Company's financial statements.

In accordance with ASC 810-10-15-14, Consolidation – Overall – Scope and Scope Exceptions, the Company did not eliminate through consolidation the Company's $619,000 equity investment in AMNB Statutory Trust I or the $264,000 equity investment in the MidCarolina Trusts.  Instead, the Company reflected this equity investment in the "Accrued interest receivable and other assets" line item in the consolidated balance sheets.

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A description of the junior subordinated debt securities outstanding payable to the trusts is shown below as of June 30, 2019 and December 31, 2018 (dollars in thousands):

Issuing Entity	Date Issued	Interest Rate		Maturity Date	Principal Amount
					June 30, 2019		December 31, 2018
AMNB Trust I	4/7/2006	Libor plus	1.35%	6/30/2036	$	20,619	$	20,619
MidCarolina Trust I	10/29/2002	Libor plus	3.45%	11/7/2032	4,405		4,377
MidCarolina Trust II	12/3/2003	Libor plus	2.95%	10/7/2033	2,954		2,931
					$	27,978	$	27,927

The principal amounts reflected above for the MidCarolina Trusts are net of fair value adjustments of $1,405,000 and $1,456,000 at June 30, 2019 and December 31, 2018, respectively. The original fair value adjustments of $1,197,000 and $1,021,000 were recorded as a result of the acquisition of MidCarolina on July 1, 2011, and are being amortized into interest expense over the remaining lives of the respective borrowings.

Note 12 - Derivative Financial Instruments and Hedging Activities

The Company uses derivative financial instruments ("derivatives") primarily to manage risks to the Company associated with changing interest rates. The Company's derivatives are hedging instruments in a qualifying hedge accounting relationship (cash flow or fair value hedge).

The Company designates derivatives as cash flow hedges when they are used to manage exposure to variability in cash flows on variable rate borrowings such as the Company's trust preferred capital notes. The Company uses interest rate swap agreements as part of its hedging strategy by exchanging variable-rate interest payments on a notional amount equal to the principal amount of the borrowings for fixed-rate interest payments, with such interest rates set based on benchmarked interest rates.

All interest rate swaps were entered into with counterparties that met the Company's credit standards and the agreements contain collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in these derivative contracts is not significant.

Terms and conditions of the interest rate swaps vary and amounts receivable or payable are recognized as accrued under the terms of the agreements. The Company assesses the effectiveness of each hedging relationship on a periodic basis. In accordance withASC 815, Derivatives and Hedging, the effective portions of the derivatives' unrealized gains or losses are recorded as a component of other comprehensive income. Based on the Company's assessment, its cash flow hedges are highly effective, but to the extent that any ineffectiveness exists in the hedge relationships, the amounts would be recorded in interest income and interest expense in the Company's consolidated statements of income.

The following tables present information on the Company's derivative financial instruments as of June 30, 2019 and December 31, 2018 (dollars in thousands):

	June 30, 2019
	Notional Amount		Positions	Assets		Liabilities		Cash Collateral Pledged
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	28,500	3	$	—	$	2,615	$	2,650

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	December 31, 2018
	Notional Amount		Positions	Assets		Liabilities		Cash Collateral Pledged
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	28,500	3	$	—	$	804	$	650

Note 13 – Stock Based Compensation

The Company's 2018 Equity Compensation Plan (the "2018 Plan") was adopted by the Board of Directors of the Company on February 20, 2018, and approved by shareholders on May 15, 2018, at the Company's 2018 Annual Meeting of Shareholders.  The 2018 Plan provides for the granting of restricted stock awards, incentive and non-statutory options, and other equity-based awards to employees and directors at the discretion of the Compensation Committee of the Board of Directors.  The 2018 Plan authorizes the issuance of up to 675,000 shares of common stock. The 2018 Plan replaced the Company's stock incentive plan that was approved by the shareholders at the 2008 Annual Meeting that expired in February 2018 (the "2008 Plan").

Stock Options

Accounting guidance requires that compensation cost relating to share-based payment transactions be recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued.

A summary of stock option transactions for the six months ended June 30, 2019 is as follows:

	Option Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value ($000)
Outstanding at December 31, 2018	13,200		$	21.97
Issued in HomeTown acquisition	40,753		16.63
Granted	—		—
Exercised	(30,530	)	18.94
Forfeited	(1,660	)	16.63
Expired	—		—
Outstanding at June 30, 2019	21,763		$	16.63	5.07 years	$	481
Exercisable at June 30, 2019	17,264		$	16.63	4.96 years	$	382

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options' vesting period.  No stock options have been granted since 2009. Replacement stock option awards representing 40,753 shares of the Company's common stock were issued in conjunction with the HomeTown acquisition.  As of June 30, 2019, there were no unrecognized compensation expenses related to nonvested stock option grants.

Restricted Stock

The Company from time-to-time grants shares of restricted stock to key employees and non-employee directors.  These awards help align the interests of these employees and directors with the interests of the shareholders of the Company by providing economic value directly related to increases in the value of the Company's common stock.  The value of the stock awarded is established as the fair value of the Company's common stock at the time of the grant.  The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants. The majority of the restricted stock granted cliff vests at the end of a 36-month period beginning on the date of the grant. The remainder vests one-third each year beginning on the date of the grant. Nonvested restricted stock activity for the six months ended June 30, 2019 is

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summarized in the following table.

Restricted Stock	Shares		Weighted Average Grant Date Value Per Share
Nonvested at December 31, 2018	52,798		$	31.71
Issued in HomeTown acquisition	7,137		27.28
Granted	18,926		32.33
Vested	(22,110	)	23.46
Forfeited	(1,200	)	34.04
Nonvested at June 30, 2019	55,551		$	34.58

As of June 30, 2019 and December 31, 2018, there was $1,033,000 and $647,000, respectively, in unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan and the 2018 Plan.  The weighted average period over which this cost is expected to be recognized is 1.69 years.  The share based compensation expense for nonvested restricted stock was $585,000 and $292,000 during the first six months of 2019 and 2018, respectively. The expense for the first six months of 2019 included $257,000 of accelerated compensation expense as a result of the HomeTown merger.

The Company offers its outside directors alternatives with respect to director compensation. For 2019, the regular quarterly board retainer will be received in the form of shares of immediately vested, but restricted stock with a market value of $7,500. Monthly meeting fees can be received as $725 per meeting in cash or $900 in immediately vested, but restricted stock.  Only outside directors receive board fees. The Company issued 8,793 and 7,861 shares and recognized share based compensation expense of $318,000 and $300,000 during the first six months of 2019 and 2018, respectively.

Note 14 – Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of potentially dilutive common stock. Potentially dilutive common stock had no effect on income available to common shareholders. Nonvested restricted shares are included in the computation of basic earnings per share as the holder is entitled to full shareholder benefits during the vesting period including voting rights and sharing in nonforfeitable dividends. The following table presents basic and diluted earnings per share for the three and six month periods ended June 30, 2019 and 2018.

	Three Months Ended June 30,
	2019				2018
	Shares	Per Share Amount			Shares	Per Share Amount
Basic earnings per share	11,126,800	$	(0.11	)	8,692,107	$	0.69
Effect of dilutive securities - stock options	—	—			12,619	—
Diluted earnings per share	11,126,800	$	(0.11	)	8,704,726	$	0.69

	Six Months Ended June 30,
	2019			2018
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	9,942,566	$	0.48	8,680,739	$	1.36
Effect of dilutive securities - stock options	9,549	—		15,121	—
Diluted earnings per share	9,952,115	$	0.48	8,695,860	$	1.36

Outstanding stock options on common stock whose effects are anti-dilutive are not included in computing diluted earnings per share. There were no anti-dilutive stock options for the three and six month periods ended June 30, 2019 and 2018.

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Note 15 – Employee Benefit Plans

The following information for the six months ended June 30, 2019 and 2018 pertains to the Company's non-contributory defined benefit pension plan which was frozen in 2009.  If lump sum payments exceed the service cost plus interest cost, an additional settlement charge will apply (dollars in thousands):

Components of Net Periodic Benefit Cost	Six Months Ended June 30,
	2019			2018
Service cost	$	—		$	—
Interest cost	58			51
Expected return on plan assets	(68		)	(64		)
Recognized loss due to settlement	19			25
Recognized net actuarial loss	65			68
Net periodic cost	$	74		$	80

Note 16 – Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the fair value measurements and disclosures topic of ASC 820, Fair Value Measurement, fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company'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. The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

 The following describes the valuation techniques used by the Company to measure certain financial assets and financial liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale and equity securities: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). If no observable market data is available, valuations are based upon third party

32

model based techniques (Level 3). There were no securities recorded with a Level 3 valuation at June 30, 2019 or December 31, 2018.

Derivative asset (liability) - cash flow hedges: Cash flow hedges are recorded at fair value on a recurring basis. Cash flow hedges are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. All of the Company's cash flow hedges are classified as Level 2.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at the dates indicated (dollars in thousands):

	Fair Value Measurements at June 30, 2019 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2019		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	137,013	$	—	$	137,013	$	—
Mortgage-backed and CMOs	136,899		—		136,899		—
State and municipal	52,245		—		52,245		—
Corporate	8,169		—		8,169		—
Total securities available for sale	$	334,326	$	—	$	334,326	$	—
Equity securities	$	125	$	—	$	125	$	—
Liabilities:
Derivative - cash flow hedges	$	2,615	$	—	$	2,615	$	—

	Fair Value Measurements at December 31, 2018 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2018		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	134,039	$	—	$	134,039	$	—
Mortgage-backed and CMOs	111,867		—		111,867		—
State and municipal	79,902		—		79,902		—
Corporate	6,845		—		6,845		—
Total securities available for sale	$	332,653	$	—	$	332,653	$	—
Equity securities	$	1,830	$	—	$	1,830	$	—
Liabilities:
Derivative - cash flow hedges	$	804	$	—	$	804	$	—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the six month period ended June 30, 2019 or the year ended December 31, 2018. Gains and losses on the sale of loans are recorded within mortgage banking income on the consolidated statements of income.

33

Impaired loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected when due. The measurement of the loss associated with impaired loans can be based on either the observable market price of the loan, the present value of projected cash flows or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the Company's collateral is real estate.  The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2).  The present value of projected cash flows method results in a Level 3 categorization because the calculation relies on the Company's judgment to determine projected cash flows, which are then discounted at the current rate of the loan, or the rate prior to modification if the loan is a TDR. However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value.  The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data.  Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3).  Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis.  Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

Other real estate owned:  Measurement for fair values for OREO are the same as impaired loans. Any fair value adjustments are recorded in the period incurred as a valuation allowance against OREO with the associated expense included in OREO expense, net on the consolidated statements of income.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis at the dates indicated (dollars in thousands):

	Fair Value Measurements at June 30, 2019 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2019		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	3,165	$	—	$	3,165	$	—
Impaired loans, net of valuation allowance	239		—		—		239
Other real estate owned, net	1,433		—		—		1,433

	Fair Value Measurements at December 31, 2018 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2018		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	640	$	—	$	640	$	—
Impaired loans, net of valuation allowance	171		—		—		171
Other real estate owned, net	869		—		—		869

Quantitative Information About Level 3 Fair Value Measurements as of June 30, 2019 and December 31, 2018:

Assets	Valuation Technique	Unobservable Input	Rate
Impaired loans	Discounted appraised value	Selling cost	8.00%
	Discounted cash flow analysis	Market rate for borrower (discount rate)	3.25% - 9.80%
Other real estate owned, net	Discounted appraised value	Selling cost	8.00%

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ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The carrying values and the exit pricing concept fair values of the Company's financial instruments at June 30, 2019 are as follows (dollars in thousands):

	Fair Value Measurements at June 30, 2019 Using
		Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs	Fair Value
	Carrying Value	Level 1	Level 2	Level 3	Balance
Financial Assets:
Cash and cash equivalents	54,914	54,914	—	—	54,914
Equity securities	125	—	125	—	125
Securities available for sale	334,326	—	334,326	—	334,326
Restricted stock	7,796	—	7,796	—	7,796
Loans held for sale	3,165	—	3,165	—	3,165
Loans, net of allowance	1,823,455	—	—	1,811,890	1,811,890
Bank owned life insurance	27,451	—	27,451	—	27,451
Accrued interest receivable	7,375	—	7,375	—	7,375
Financial Liabilities:
Deposits	1,999,097	—	2,000,234	—	2,000,234
Repurchase agreements	37,222	—	37,222	—	37,222
Other short-term borrowings	13,528	—	13,528	—	13,528
Subordinated debt	7,526	—	7,568	—	7,568
Junior subordinated debt	27,978	—	—	24,528	24,528
Accrued interest payable	1,462	—	1,462	—	1,462
Derivative - cash flow hedges	2,615	—	2,615	—	2,615

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The carrying values and the exit pricing concept fair values of the Company's financial instruments at December 31, 2018 are as follows (dollars in thousands):

	Fair Value Measurements at December 31, 2018 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	64,255	$	64,255	$	—	$	—	$	64,255
Equity securities	1,830				1,830				1,830
Securities available for sale	332,653		—		332,653		—		332,653
Restricted stock	5,247		—		5,247		—		5,247
Loans held for sale	640		—		640		—		640
Loans, net of allowance	1,344,671		—		—		1,334,236		1,334,236
Bank owned life insurance	18,941		—		18,941		—		18,941
Accrued interest receivable	5,449		—		5,449		—		5,449
Financial Liabilities:
Deposits	$	1,566,227	$	—	$	1,570,721	$	—	$	1,570,721
Repurchase agreements	35,243		—		35,243		—		35,243
Junior subordinated debt	27,927		—		—		22,577		22,577
Accrued interest payable	795		—		795		—		795
Derivative - cash flow hedges	804		—		804		—		804

Note 17 – Segment and Related Information

The Company has two reportable segments, 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 Company are allocated to community banking.  Investment income from securities is also allocated to the community banking segment.  Loan fee income, service charges from deposit accounts, and non-deposit fees such as automated teller machine fees and insurance commissions generate additional income for the community banking segment.

Trust and investment services include estate planning, trust account administration, investment management, and retail brokerage.  Investment management services include purchasing equity, fixed income, and mutual fund investments for customer accounts. The trust and investment services segment receives fees for investment and administrative services.

Amounts shown in the "Other" column includes activities of the Company which are primarily debt service and corporate items. 

Segment information as of and for the three and six months ended June 30, 2019 and 2018 (unaudited), is shown in the following tables (dollars in thousands):

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	Three Months Ended June 30, 2019
	Community Banking			Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	25,102		$	—	$	109		$	—		$	25,211
Interest expense	3,712			—		510			—			4,222
Noninterest income	2,543			1,119		20			—			3,682
Income (loss) before income taxes	(574		)	559		(1,620		)	—			(1,635		)
Net income (loss)	(327		)	455		(1,358		)	—			(1,230		)
Depreciation and amortization	1,009			2		—			—			1,011
Total assets	2,407,232			—		351,130			(340,280		)	2,418,082
Goodwill	84,633			—		—			—			84,633
Capital expenditures	906			—		—			—			906

	Three Months Ended June 30, 2018
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	16,900	$	—	$	92		$	—		$	16,992
Interest expense	1,874		—		330			—			2,204
Noninterest income	2,111		1,155		297			—			3,563
Income (loss) before income taxes	7,071		567		(259		)	—			7,379
Net income (loss)	5,725		459		(204		)	—			5,980
Depreciation and amortization	541		3		—			—			544
Total assets	1,814,730		—		241,617			(231,816		)	1,824,531
Goodwill	43,872		—		—			—			43,872
Capital expenditures	587		—		—			—			587

	Six Months Ended June 30, 2019
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	43,101	$	—	$	206		$	—		$	43,307
Interest expense	6,356		—		894			—			7,250
Noninterest income	4,603		2,180		350			—			7,133
Income (loss) before income taxes	6,946		1,039		(2,046		)	—			5,939
Net income (loss)	5,670		835		(1,732		)	—			4,773
Depreciation and amortization	1,467		4		—			—			1,471
Total assets	2,407,232		—		351,130			(340,280		)	2,418,082
Goodwill	84,633		—		—			—			84,633
Capital expenditures	1,292		7		—			—			1,299

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	Six Months Ended June 30, 2018
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	33,480	$	—	$	180		$	—		$	33,660
Interest expense	3,709		—		620			—			4,329
Noninterest income	4,174		2,306		416			—			6,896
Income (loss) before income taxes	14,097		1,020		(520		)	—			14,597
Net income (loss)	11,378		824		(410		)	—			11,792
Depreciation and amortization	1,081		6		—			—			1,087
Total assets	1,814,730		—		241,617			(231,816		)	1,824,531
Goodwill	43,872		—		—			—			43,872
Capital expenditures	932		—		—			—			932

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Note 18 – Supplemental Cash Flow Information

Supplemental cash flow information as of and for the six months ended June 30, 2019 and 2018 is shown in the following table (dollars in thousands):

	Six Months Ended   June 30,
	2019			2018
Supplemental Schedule of Cash and Cash Equivalents:
Cash and due from banks	$	34,460		$	24,042
Interest-bearing deposits in other banks	20,454			9,300
Cash and Cash Equivalents	$	54,914		$	33,342
Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Interest on deposits and borrowed funds	$	6,583		$	4,332
Income taxes	1,532			2,548
Noncash investing and financing activities:
Transfer of loans to other real estate owned	181			532
Transfer from premises and equipment to other assets	445			—
Increase in operating lease right-of-use asset upon adoption of ASU 2016-02	4,413			—
Increase in operating lease liability upon adoption of ASU 2016-02	4,413			—
Unrealized gains (losses) on securities available for sale	7,935			(5,188		)
Unrealized losses on cash flow hedges	(1,811		)	(237		)
Non-cash transactions related to acquisitions:
Assets acquired:
Investment securities	34,876			—
Restricted stock	2,588			—
Loans	444,324			—
Premises and equipment	12,554			—
Deferred income taxes	2,329			—
Core deposit intangible	8,200			—
Other real estate owned	1,442			—
Bank owned life insurance	8,246			—
Other assets	14,244			—
Liabilities assumed:
Deposits	483,626			—
Short-term FHLB advances	14,883			—
Long-term FHLB advances	778			—
Subordinated debt	7,530			—
Other liabilities	5,780			—
Consideration:
Issuance of common stock	82,470			—
Fair value of replacement stock options/restricted stock	753			—

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Note 19 – Accumulated Other Comprehensive Income (Loss)

Changes in each component of accumulated other comprehensive income (loss) ("AOCI") for the three and six months ended June 30, 2019 and 2018 (unaudited) were as follows (dollars in thousands):

For the Three Months Ended	Net Unrealized Gains (Losses) on Securities			Unrealized Losses on Cash Flow Hedges			Adjustments Related to Pension Benefits			Accumulated Other Comprehensive Income (Loss)
Balance at March 31, 2018	$	(4,325	)	$	—		$	(2,280	)	$	(6,605	)
Net unrealized losses on securities available for sale, net of tax, $(325)	(1,121		)	—			—			(1,121		)
Unrealized losses on cash flow hedges, net of tax, $(53)	—			(184		)	—			(184		)
Balance at June 30, 2018	$	(5,446	)	(184		)	$	(2,280	)	$	(7,910	)
Balance at March 31, 2019	$	(896	)	$	(1,187	)	$	(1,238	)	$	(3,321	)
Net unrealized gains on securities available for sale, net of tax, $920	3,186			—			—			3,186
Reclassification adjustment for realized gains on securities, net of tax, $(31)	(105		)	—			—			(105		)
Unrealized losses on cash flow hedges, net of tax, $(243)	—			(843		)	—			(843		)
Balance at June 30, 2019	$	2,185		$	(2,030	)	$	(1,238	)	$	(1,083	)

For the Six Months Ended	Net Unrealized Gains (Losses) on Securities			Unrealized Losses on Cash Flow Hedges			Adjustments Related to Pension Benefits			Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2017	$	(796	)	$	—		$	(2,280	)	$	(3,076	)
Net unrealized gains on securities available for sale, net of tax, $(1,186)	(3,994		)	—			—			(3,994		)
Reclassification adjustment for realized gains on securities, net of tax, $(2)	(6		)	—			—			(6		)
Reclassification for ASU 2016-01 adoption	(650		)	—			—			(650		)
Unrealized losses on cash flow hedges, net of tax, $(53)	—			(184		)	—			(184		)
Balance at June 30, 2018	$	(5,446	)	$	(184	)	$	(2,280	)	$	(7,910	)
Balance at December 31, 2018	$	(3,973	)	$	(624	)	$	(1,238	)	$	(5,835	)
Net unrealized losses on securities available for sale, net of tax, $1,809	6,266			—			—			6,266
Reclassification adjustment for gains on sales of securities, net of tax, $(32)	(108		)	—			—			(108		)
Unrealized losses on cash flow hedges, net of tax, $(405)	—			(1,406		)	—			(1,406		)
Balance at June 30, 2019	$	2,185		$	(2,030	)	$	(1,238	)	$	(1,083	)

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Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

For the Three and Six Months ended June 30, 2019 and 2018

(dollars in thousands)

For the Three Months Ended June 30, 2019	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gain on call of securities	$	136		Securities gains, net
	(31		)	Income taxes
Total reclassifications	$	105		Net of tax

For the Three Months Ended June 30, 2018	Amount Reclassified from AOCI		Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gain on sale of securities	$	—	Securities gains, net
	—		Income taxes
Total reclassifications	$	—	Net of tax

For the Six Months Ended June 30, 2019	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gain on call of securities	$	140		Securities gains, net
	(32		)	Income taxes
	$	108		Net of tax

For the Six Months Ended June 30, 2018	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gain on sale of securities	$	8		Securities gains, net
	(2		)	Income taxes
	6			Net of tax
Reclassification for ASU 2016-01 adoption	650			*
Total reclassifications	$	656

* Reclassification from AOCI to retained earnings for unrealized holding gains on equity securities due to adoption of ASU 2016-01.

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ITEM 2 - 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 the Company.  The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.

Forward-Looking Statements

This report contains forward-looking statements with respect to the financial condition, results of operations and business of American National Bankshares Inc. (the "Company") and its wholly owned subsidiary, American National Bank and Trust Company (the "Bank").  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on information available to management at the time these statements and disclosures were prepared.  Forward-looking statements are subject to numerous assumptions, estimates, risks, and uncertainties that could cause actual conditions, events, or results to differ materially from those stated or implied by such forward-looking statements.

A variety of factors, some of which are discussed in more detail in Item 1A – Risk Factors of the Company's Annual Report on Form 10-K for the year ended December 31, 2018, may affect the operations, performance, business strategy, and results of the Company.  Those factors include, but are not limited to, the following:

• financial market volatility, including the level of interest rates, could affect the values of financial instruments and the amount of net interest income earned;

• general economic or business conditions, either nationally or in the market areas in which the Company does business, may be less favorable than expected, resulting in deteriorating credit quality, reduced demand for credit, or a weakened ability to generate deposits;

• competition among financial institutions may increase, and competitors may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than the Company;

• businesses that the Company is engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards and tax laws;

• cybersecurity threats or attacks, the implementation of new technologies, and the ability to develop and maintain reliable electronic systems;

• the ability to retain key personnel;

• the failure of assumptions underlying the allowance for loan losses; and

• risks associated with mergers and acquisitions and other expansion activities.

On April 1, 2019, the Company announced the completion of its acquisition of Roanoke-based HomeTown Bankshares Corporation ("HomeTown"). In addition to the factors described above, the Company's operations, performance, business strategy and results may be affected by the following factors:

• cost savings from the merger may not be fully realized or realized within the expected timeframe;

• the businesses of the Company and/or HomeTown may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected;

• revenues following the merger may be lower than expected; and

• customer and employee relationships and business operations may be disrupted by the merger.

Reclassification

In certain circumstances, reclassifications have been made to prior period information to conform to the 2018 presentation.  There were no material reclassifications.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies followed by the Company conform with U.S. generally accepted accounting principles ("GAAP") and they conform to general practices within the banking industry.  The Company's critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses, (2) mergers and acquisitions, (3) acquired loans with specific credit-related deterioration, (4) goodwill and intangible assets, (5) other real estate owned, (6) deferred tax assets and liabilities, (7) other-than-temporary impairment of securities, and (8) derivative financial instruments.  A summary of the Company's significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K for the year ended December 31, 2018.

The financial information contained within the Company's financial 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

42

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.

Allowance for Loan Losses

The purpose of the allowance for loan losses ("ALLL") is to provide for probable losses inherent in the loan portfolio.  The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans.  Loan charge-offs decrease the allowance.

The goal of the Company is to maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and the provision for loan loss expense.

The Company uses certain practices to manage its credit risk.  These practices include (1) appropriate lending limits for loan officers, (2) a loan approval process, (3) careful underwriting of loan requests, including analysis of borrowers, cash flows, collateral, and market risks, (4) regular monitoring of the portfolio, including diversification by type and geography, (5) review of loans by the Loan Review department, which operates independently of loan production, (6) regular meetings of the Credit Committee to discuss portfolio and policy changes and make decisions on large or unusual loan requests, and (7) regular meetings of the Asset Quality Committee which reviews the status of individual loans.

Risk grades are assigned as part of the loan origination process. From time to time, risk grades may be modified as warranted by the facts and circumstances surrounding the credit.

Calculation and analysis of the ALLL is prepared quarterly by the Finance Department.  The Company's Credit Committee, Risk and Compliance Committee, Audit Committee, and the Board of Directors review the allowance for adequacy.

The Company's ALLL has two basic components:  the formula allowance and the specific allowance.  Each of these components is determined based upon estimates and judgments.

The formula allowance uses historical loss experience as an indicator of future losses, along with various qualitative factors, including levels and trends in delinquencies, nonaccrual loans, charge-offs and recoveries, trends in volume and terms of loans, effects of changes in underwriting standards, experience of lending staff, economic conditions, portfolio concentrations, regulatory, legal, competition, quality of loan review system, and value of underlying collateral. In the formula allowance for commercial and commercial real estate loans, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans.  The period-end balances for each loan risk-grade category are multiplied by the adjusted loss factor.  Allowance calculations for residential real estate and consumer loans are calculated based on historical losses for each product category without regard to risk grade. This loss rate is combined with qualitative factors resulting in an adjusted loss factor for each product category.

The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. These include:

• The present value of expected future cash flows discounted at the loan's effective interest rate.  The effective interest rate on a loan is the rate of return implicit in the loan (that is, the contractual interest rate adjusted for any net deferred loan fees or costs and any premium or discount existing at the origination or acquisition of the loan);

• The loan's observable market price, or

• The fair value of the collateral, net of estimated costs to dispose, if the loan is collateral dependent.

The use of these computed values is inherently subjective and actual losses could be greater or less than the estimates.

No single statistic, formula, or measurement determines the adequacy of the allowance.  Management makes subjective and complex judgments about matters that are inherently uncertain, and different amounts would be reported under different conditions or using different assumptions.  For analytical purposes, management allocates a portion of the allowance to specific loan categories and specific loans.  However, the entire allowance is used to absorb credit losses inherent in the loan portfolio, including identified and unidentified losses.

The relationships and ratios used in calculating the allowance, including the qualitative factors, may change from period to period as facts and circumstances evolve.  Furthermore, management cannot provide assurance that in any particular period the Bank will not have sizable credit losses in relation to the amount reserved.  Management may find it necessary to significantly adjust the allowance, considering current factors at the time.

43

Mergers and Acquisitions

Business combinations are accounted for under the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions.

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of costs to the Company include systems conversions, integration planning consultants and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. These acquisition-related costs have been and will be included within the consolidated statements of income classified within the noninterest expense caption.

Acquired Loans with Specific Credit-Related Deterioration

Acquired loans with specific credit deterioration are accounted for by the Company in accordance with ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality. Certain acquired loans, those for which specific credit-related deterioration, since origination, is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected. Income recognition on these loans is based on a reasonable expectation about the timing and amount of cash flows to be collected. In accounting for acquired impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments.

Goodwill and Intangible Assets

The Company performs its annual analysis as of June 30 each fiscal year. Accounting guidance permits preliminary assessment of qualitative factors to determine whether more substantial impairment testing is required. The Company chose to bypass the preliminary assessment and utilized a two-step process for impairment testing of goodwill. The first step tests for impairment, while the second step, if necessary, measures the impairment.  No indicators of impairment were identified during the six months ended June 30, 2019 or 2018.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of similar properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. The Company may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further deterioration in market conditions.

Deferred Tax Assets and Liabilities

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion of the deferred tax asset will not be realized.  "More likely than not" is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed.

Other-than-temporary Impairment of Securities

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

44

Derivative Financial Instruments

The Company uses derivatives primarily to manage risk associated with changing interest rates. The Company's derivative financial instruments consist of interest rate swaps that qualify as cash flow hedges of the Company's trust preferred notes. The Company recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheets. The effective portion of the gain or loss on the Company's cash flow hedges is reported as a component of other comprehensive income, net of deferred income taxes, and is reclassified into earnings in the same period or periods during which the hedged transactions affect earnings.

Non-GAAP Presentations

Non-GAAP presentations are provided because the Company believes these may be valuable to investors. These include (1) the analysis of net interest income presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets and (2) the calculation of the efficiency ratio.

Internet Access to Corporate Documents

The Company provides access to its Securities and Exchange Commission ("SEC") filings through a link on the Investor Relations page of the Company's web site at www.amnb.com.  Reports available include annual reports 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 filed electronically with the SEC.  The information on the Company's website is not incorporated into this report or any other filing the Company makes with the SEC.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

Completed Acquisition

On April 1, 2019, the Company announced the completion of its acquisition of HomeTown. The combination deepens the Company's footprint in the Roanoke, Virginia metropolitan area and creates a presence in the New River Valley with an office in Christiansburg, Virginia. After completion of the merger and with two office consolidations, the Company has eight offices in the combined Roanoke/New River Valley market area. As a result of the merger, the holders of shares of HomeTown common stock received 0.4150 shares of the Company's common stock for each share of HomeTown common stock held immediately prior to the effective date of the merger. Following completion of the merger, HomeTown's subsidiary bank, HomeTown Bank, was merged with and into the Bank.

RESULTS OF OPERATIONS

Earnings Performance

Three months ended June 30, 2019 and 2018

For the quarter ended June 30, 2019, the Company reported a net loss of $1,230,000 compared to net income of $5,980,000 for the comparable quarter in 2018. The $7,210,000 or 120.6% decrease was primarily due to $10,871,000 in one-time merger related expense in the 2019 quarter.

SUMMARY INCOME STATEMENT
(Dollars in thousands)
Three Months Ended June 30,	2019			2018			$ Change			% Change
Interest income	$	25,211		$	16,992		$	8,219		48.4	%
Interest expense	(4,222		)	(2,204		)	(2,018		)	91.6
Net interest income	20,989			14,788			6,201			41.9
Provision for loan losses	10			30			(20		)	(66.7	)
Noninterest income	3,682			3,563			119			3.3
Noninterest expense	(26,316		)	(11,002		)	(15,314		)	139.2
Income tax (benefit) expense	405			(1,399		)	1,804			(128.9	)
Net income (loss)	$	(1,230	)	$	5,980		$	(7,210	)	(120.6	)

45

Six months ended June 30, 2019 and 2018

For the six month period ended June 30, 2019, the Company reported net income of $4,773,000 compared to $11,792,000 for the comparable period in 2018. The $7,019,000 or 59.5% decrease was primarily due to $11,322,000 in one-time merger related expense in the 2019 period.

SUMMARY INCOME STATEMENT
(Dollars in thousands)
Six Months Ended June 30,	2019			2018			$ Change			% Change
Interest income	$	43,307		$	33,660		$	9,647		28.7	%
Interest expense	(7,250		)	(4,329		)	(2,921		)	67.5
Net interest income	36,057			29,331			6,726			22.9
Provision for (recovery of) loan losses	(6		)	74			(80		)	(108.1	)
Noninterest income	7,133			6,896			237			3.4
Noninterest expense	(37,245		)	(21,704		)	(15,541		)	71.6
Income tax expense	(1,166		)	(2,805		)	1,639			(58.4	)
Net income	$	4,773		$	11,792		$	(7,019	)	(59.5	)

Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and other funding sources.  Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.  The following discussion of net interest income is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets, such as certain state and municipal securities.  A tax rate of 21% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.  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 weighted rate earned on average earning assets and the weighted rate paid on average interest-bearing liabilities.

Three months ended June 30, 2019 and 2018

Net interest income on a taxable equivalent basis increased $6,152,000 or 41.2%, for the second quarter of 2019 compared to the same quarter of 2018.  This improvement in net interest income was primarily related to an increase in the average balance of loans for the 2019 quarter compared to the 2018 quarter. Loan balances for the 2019 quarter were up $494.7 million or 37.4% over the 2018 quarter. Of the increase in balances, $444.3 million represents loans acquired in the HomeTown merger and $50.4 million (3.8%) represents growth in the other parts of our franchise.

For the second quarter of 2019, the Company's yield on interest-earning assets was 4.58%, compared to 4.02% for the second quarter of 2018.  The cost of interest-bearing liabilities was 1.10% compared to 0.75%, primarily related to a 30 basis point (0.30%) increase in the cost of deposits. The interest rate spread was 3.48% compared to 3.27%. The net interest margin, on a fully taxable equivalent basis, was 3.82% compared to 3.50%, an increase of 32 basis points (0.32%). The increase in net interest margin was driven by a $504.1 million (29.5%) increase in average earning assets, enhanced by a $140.3 million (33.4%) increase in average noninterest bearing deposits, and partially offset by a $317.9 million (27.7%) increase in average interest bearing deposits.

46

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the three months ended June 30, 2019 and 2018.  Nonaccrual loans are included in average balances. Interest income on nonaccrual loans is only recognized when the loan returns to accrual status or at full payment of principal.

	Net Interest Income Analysis (dollars in thousands)
	Three Months Ended June 30,
	Average Balance				Income/Expense				Yield/Rate
	2019		2018		2019		2018		2019		2018
Loans:
Commercial	$	321,263	$	267,996	$	3,899	$	2,652	4.87	%	3.97	%
Real estate	1,485,665		1,052,105		18,578		12,087		5.00		4.60
Consumer	12,188		4,327		201		77		6.61		7.14
Total loans	1,819,116		1,324,428		22,678		14,816		4.99		4.48
Securities:
Federal agencies and GSEs	140,516		127,033		858		707		2.44		2.23
Mortgage-backed and CMOs	127,718		108,789		809		609		2.53		2.24
State and municipal	68,185		91,636		480		653		2.82		2.85
Other securities	18,087		15,028		233		176		5.15		4.68
Total securities	354,506		342,486		2,380		2,145		2.69		2.51
Deposits in other banks	37,651		40,309		258		185		2.75		1.84
Total interest-earning assets	2,211,273		1,707,223		25,316		17,146		4.58		4.02
Non-earning assets	222,675		118,637
Total assets	$	2,433,948	$	1,825,860
Deposits:
Demand	$	335,879	$	246,493	112		13		0.13		0.02
Money market	448,722		395,135		1,394		802		1.25		0.81
Savings	179,375		132,190		98		10		0.22		0.03
Time	499,637		371,883		1,916		1,048		1.54		1.13
Total deposits	1,463,613		1,145,701		3,520		1,873		0.96		0.66
Customer repurchase agreements	35,657		11,347		140		1		1.57		0.04
Other short-term borrowings	7,627		247		38		1		1.99		1.62
Long-term borrowings	36,301		27,861		524		329		5.77		4.72
Total interest-bearing
liabilities	1,543,198		1,185,156		4,222		2,204		1.10		0.75
Noninterest bearing demand deposits	559,944		419,620
Other liabilities	23,525		8,828
Shareholders' equity	307,281		212,256
Total liabilities and
shareholders' equity	$	2,433,948	$	1,825,860
Interest rate spread									3.48	%	3.27	%
Net interest margin									3.82	%	3.50	%
Net interest income (taxable equivalent basis)					21,094		14,942
Less: Taxable equivalent adjustment					105		154
Net interest income					$	20,989	$	14,788

47

Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Three Months Ended June 30,
	2019 vs. 2018
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate			Volume
Loans:
Commercial	$	1,247		$	664		$	583
Real estate	6,491			1,147			5,344
Consumer	124			(6		)	130
Total loans	7,862			1,805			6,057
Securities:
Federal agencies and GSEs	151			72			79
Mortgage-backed and CMOs	200			86			114
State and municipal	(173		)	(8		)	(165		)
Other securities	57			19			38
Total securities	235			169			66
Deposits in other banks	73			86			(13		)
Total interest income	8,170			2,060			6,110
Interest expense
Deposits:
Demand	99			93			6
Money market	592			471			121
Savings	88			83			5
Time	868			445			423
Total deposits	1,647			1,092			555
Customer repurchase agreements	139			132			7
Other short-term borrowings	37			—			37
Long-term borrowings	195			83			112
Total interest expense	2,018			1,307			711
Net interest income (taxable equivalent basis)	$	6,152		$	753		$	5,399

Six months ended June 30, 2019 and 2018

Net interest income on a taxable equivalent basis increased $6,633,000 or 22.4%, for the six months ended June 30, 2019 compared to the same period of 2018. This improvement in net interest income was primarily related to an increase in the average balance of loans for the 2019 period compared to the 2018 period. Average loan balances for the 2019 period were up $255.8 million or 19.2% over the 2018 period, primarily due to the HomeTown acquisition.

For the first six months of 2019, the Company's yield on interest-earning assets was 4.41%, compared to 3.99% for the same period of 2018. The cost of interest-bearing liabilities was 1.06% compared to 0.73%, primarily related to a 28 basis point (0.28%) increase in the cost of deposits. The interest rate spread was 3.35% compared to 3.26%. The net interest margin, on a fully taxable equivalent basis, was 3.67% compared to 3.48%, an increase of 19 basis points (0.19%). The increase in net interest margin was driven by a $272.6 million (16.0%) increase in average earning assets, enhanced by a $80.4 million (19.6%) increase in average noninterest bearing deposits, and partially offset by a $147.1 million (12.8%) increase in average interest bearing deposits.

48

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the six months ended June 30, 2019 and 2018. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans, if recognized, is recorded on a cash basis or when the loan returns to accrual status.

	Net Interest Income Analysis (dollars in thousands)
	Six Months Ended June 30,
	Average Balance				Income/Expense				Yield/Rate
	2019		2018		2019		2018		2019		2018
Loans:
Commercial	$	293,575	$	263,300	$	6,790	$	5,096	4.66	%	3.90	%
Real estate	1,285,842		1,064,605		31,294		24,277		4.87		4.56
Consumer	8,601		4,313		276		153		6.47		7.15
Total loans	1,588,018		1,332,218		38,360		29,526		4.84		4.44
Securities:
Federal agencies and GSEs	139,993		115,182		1,708		1,224		2.44		2.13
Mortgage-backed and CMOs	119,754		108,808		1,502		1,208		2.51		2.22
State and municipal	73,362		89,000		1,018		1,287		2.78		2.89
Other securities	16,090		15,153		411		351		5.11		4.63
Total securities	349,199		328,143		4,639		4,070		2.66		2.48
Deposits in other banks	38,670		42,926		524		373		2.73		1.75
Total interest-earning assets	1,975,887		1,703,287		43,523		33,969		4.41		3.99
Non-earning assets	174,270		118,878
Total assets	$	2,150,157	$	1,822,165
Deposits:
Demand	$	287,424	$	239,477	126		24		0.09		0.02
Money market	422,359		402,612		2,548		1,585		1.22		0.79
Savings	156,843		131,453		107		20		0.14		0.03
Time	431,900		377,838		3,211		2,069		1.50		1.10
Total deposits	1,298,526		1,151,380		5,992		3,698		0.93		0.65
Customer repurchase agreements	39,161		11,795		311		2		1.60		0.03
Other short-term borrowings	3,865		1,210		39		10		2.02		1.65
Long-term borrowings	32,142		27,848		908		619		5.65		4.45
Total interest-bearing
liabilities	1,373,694		1,192,233		7,250		4,329		1.06		0.73
Noninterest bearing demand deposits	490,263		409,878
Other liabilities	19,992		9,202
Shareholders' equity	266,208		210,852
Total liabilities and
shareholders' equity	$	2,150,157	$	1,822,165
Interest rate spread									3.35	%	3.26	%
Net interest margin									3.67	%	3.48	%
Net interest income (taxable equivalent basis)					36,273		29,640
Less: Taxable equivalent adjustment					216		309
Net interest income					$	36,057	$	29,331

49

Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Six Months Ended June 30,
	2019 vs. 2018
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate			Volume
Loans:
Commercial	$	1,694		$	1,066		$	628
Real estate	7,017			1,716			5,301
Consumer	123			(16		)	139
Total loans	8,834			2,766			6,068
Securities:
Federal agencies and GSEs	484			197			287
Mortgage-backed and CMOs	294			166			128
State and municipal	(269		)	(50		)	(219		)
Other securities	60			37			23
Total securities	569			350			219
Deposits in other banks	151			191			(40		)
Total interest income	9,554			3,307			6,247
Interest expense
Deposits:
Demand	102			96			6
Money market	963			882			81
Savings	87			82			5
Time	1,142			816			326
Total deposits	2,294			1,876			418
Customer repurchase agreements	309			294			15
Other short-term borrowings	29			3			26
Long-term borrowings	289			184			105
Total interest expense	2,921			2,357			564
Net interest income (taxable equivalent basis)	$	6,633		$	950		$	5,683

50

Noninterest Income, three months ended June 30, 2019 and 2018

For the quarter ended June 30, 2019, noninterest income increased $119,000 or 3.3% compared to the comparable 2018 quarter. Details of individual accounts are shown in the table below.

	Three Months Ended June 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest income:
Trust fees	$	933		$	945	$	(12	)	(1.3	)%
Service charges on deposit accounts	724			592		132			22.3
Other fees and commissions	1,015			679		336			49.5
Mortgage banking income	586			491		95			19.3
Securities gains, net	147			289		(142		)	(49.1	)
Brokerage fees	186			209		(23		)	(11.0	)
Income from SBICs	(137		)	171		(308		)	(180.1	)
Losses on premises and equipment, net	(87		)	—		(87		)	(100.0	)
Other	315			187		128			68.4
Total noninterest income	$	3,682		$	3,563	$	119		3.3

Service charge income increased $132,000 in the second quarter of 2019 compared to the second quarter of 2018, primarily due to the HomeTown merger. Other fees and commissions increased $336,000 in the 2019 quarter compared to the 2018 quarter. This revenue category was up in virtually all of the Company's markets, but the largest driver was check card income in the Company's new HomeTown region. Mortgage banking income increased $95,000 in the 2019 quarter compared to the 2018 quarter based on increased volume related to some dips in mortgage interest rates. Net securities gains decreased $142,000 in the 2019 quarter compared to the same quarter in 2018 due to the sale of most of the Company's equity investments, thus significantly reducing the accounting volatility in this revenue category. Income from Small Business Investment Companies ("SBICs") reflected a $308,000 decrease compared to the 2018 quarter; this category of income is highly unpredictable.

Noninterest Income, six months ended June 30, 2019 and 2018

For the six months ended June 30, 2019, noninterest income increased $237,000 or 3.4% compared to the comparable 2018 period. Details of individual accounts are shown in the table below.

	Six Months Ended June 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest income:
Trust fees	$	1,847		$	1,874	$	(27	)	(1.4	)%
Service charges on deposit accounts	1,318			1,204		114			9.5
Other fees and commissions	1,723			1,321		402			30.4
Mortgage banking income	992			941		51			5.4
Securities gains, net	470			410		60			14.6
Brokerage fees	333			431		(98		)	(22.7	)
Income from SBICs	31			326		(295		)	(90.5	)
Gains (losses) on premises and equipment, net	(87		)	3		(90		)	(3,000.0	)
Other	506			386		120			31.1
Total noninterest income	$	7,133		$	6,896	$	237		3.4

Service charge income increased $114,000 in the first six months of 2019 compared to the first six months of 2018, primarily due to the HomeTown merger. Other fees and commissions increased $402,000 in the 2019 period compared to the 2018 period. This revenue category was up in virtually all of the Company's markets, but the largest driver was check card income in the Company's new HomeTown region. Mortgage banking income increased $51,000 in the 2019 period compared to the 2018 period based on increased volume related to some dips in mortgage interest rates. Net securities gains increased $60,000 in the 2019 period compared to the same period in 2018. Gains were primarily related to unrealized

51

changes in the fair value of equity securities held by the Company. Brokerage fees decreased due to market volatility. Income from SBICs reflected a $295,000 decrease compared to the 2018 period.

Noninterest Expense, three months ended June 30, 2019 and 2018

For the three months ended June 30, 2019, noninterest expense increased $15,314,000 or 139.2%. Details of individual accounts are shown in the table below.

	Three Months Ended June 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest Expense
Salaries	$	7,048		$	5,095	$	1,953		38.3	%
Employee benefits	1,425			1,111		314			28.3
Occupancy and equipment	1,431			1,100		331			30.1
FDIC assessment	169			132		37			28.0
Bank franchise tax	412			291		121			41.6
Core deposit intangible amortization	458			77		381			494.8
Data processing	717			467		250			53.5
Software	321			354		(33		)	(9.3	)
Other real estate owned, net	(44		)	25		(69		)	(276.0	)
Merger related expenses	10,871			—		10,871			100.0
Other	3,508			2,350		1,158			49.3
Total noninterest expense	$	26,316		$	11,002	$	15,314		139.2

Salaries expense increased $1,953,000 in the 2019 quarter as compared to the 2018 quarter. Total full-time equivalent employees were 371 at the end of the second quarter of 2019, up from 323 at the end of the second quarter of 2018, for an increase of 48 FTEs. Merger related expenses, which are related to the HomeTown acquisition and are nonrecurring in nature, totaled $10,871,000 during the second quarter of 2019. The largest expense was related to data processing conversion and termination fees and are expected in any merger. The conversion occurred within thirty days of the merger date. The timing of the conversion was expedited to ensure a smooth transition and positioned the bank to recognize future synergies earlier than originally anticipated.

Noninterest Expense, six months ended June 30, 2019 and 2018

For the six months ended June 30, 2019, noninterest expense increased $15,541,000 or 71.6%. Details of individual accounts are shown in the table below.

	Six Months Ended June 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest Expense
Salaries	$	11,712		$	10,092	$	1,620		16.1	%
Employee benefits	2,655			2,286		369			16.1
Occupancy and equipment	2,515			2,228		287			12.9
FDIC assessment	294			278		16			5.8
Bank franchise tax	702			572		130			22.7
Core deposit intangible amortization	513			154		359			233.1
Data processing	1,249			889		360			40.5
Software	645			659		(14		)	(2.1	)
Other real estate owned, net	(31		)	55		(86		)	(156.4	)
Merger related expenses	11,322			—		11,322			100.0
Other	5,669			4,491		1,178			26.2
Total noninterest expense	$	37,245		$	21,704	$	15,541		71.6

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Salaries expense increased $1,620,000 in the 2019 period as compared to the 2018 period. Total full-time equivalent employees were 371 at the end of the 2019 period, up from 323 at the end of the 2018 period, for an increase of 48 FTEs. Merger related expenses, which are related to the HomeTown acquisition and are nonrecurring in nature, totaled $11,332,000 during the 2019 period.

Non-GAAP Financial Measures

The efficiency ratio is calculated by dividing noninterest expense excluding (1) gains or losses on the sale of other real estate owned ("OREO"), (2) core deposit intangible amortization and (3) merger related expense by net interest income including tax equivalent income on nontaxable loans and securities and noninterest income and excluding (1) gains or losses on securities and (2) gains or losses on sale of premises and equipment. The efficiency ratio for the 2019 quarter was 60.94% compared to 59.96% for the 2018 quarter. The Company expects gradual improvement in this ratio in coming quarters. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands):

	Three Months Ended June 30,
	2019			2018
Efficiency Ratio
Noninterest expense	$	26,316		$	11,002
Add/subtract: loss/(gain) on sale of OREO	76			(3		)
Subtract: core deposit intangible amortization	(458		)	(77		)
Subtract merger related expense	(10,871		)	—
	$	15,063		$	10,922
Net interest income	$	20,989		$	14,788
Tax equivalent adjustment	105			154
Noninterest income	3,682			3,563
Add/subtract: (gain)/loss on securities	(147		)	(289		)
Add/subtract: (gain)/loss on fixed assets	87			—
	$	24,716		$	18,216
Efficiency ratio	60.94		%	59.96		%

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Net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both the 2019 and 2018 quarters is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (dollars in thousands):

	Three Months Ended June 30,
	2019			2018
Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income
Non-GAAP measures:
Interest income - loans	$	22,678		$	14,816
Interest income - investments and other	2,638			2,330
Interest expense - deposits	(3,519		)	(1,873		)
Interest expense - customer repurchase agreements	(140		)	(1		)
Interest expense - other short-term borrowings	(39		)	(1		)
Interest expense - long-term borrowings	(524		)	(329		)
Total net interest income	$	21,094		$	14,942
Less non-GAAP measures:
Tax benefit realized on non-taxable interest income - loans	$	(49	)	$	(50	)
Tax benefit realized on non-taxable interest income - municipal securities	(56		)	(104		)
GAAP measures	$	20,989		$	14,788

Income Taxes

The effective tax rate for the second quarter of 2019 was (24.77)% compared to 18.96% for the second quarter of 2018. The effective tax rate for the six months ended June 30, 2019 and 2018 was 19.63% and 19.22%, respectively. The income tax benefit in the second quarter of 2019 was due to a net loss of $1,230,000 resulting primarily from $10,871,000 of merger related expense during the quarter. The majority of these expenses are tax deductible. The effective income tax rate for the 2019 quarter was a benefit of 24.8%, compared to provision of 19.0% for the same quarter of 2018. The 2019 quarter was impacted by $10,871,000 in merger related expense, which generated a $1,635,000 pretax loss.

The effective tax rate is ordinarily lower than the statutory rate of 21% for the 2018 and 2019 quarters and the six month periods due to the benefit of tax-exempt interest and the exercise of stock options.

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Fair Value Impact to Pretax Income

The following table presents the impact for the three and six month periods ended June 30, 2019 of the accretable and amortizable fair value adjustments attributable to the July 2011 acquisition of MidCarolina Financial Corporation ("MidCarolina"), the January 2015 acquisition of MainStreet BankShares, Inc. ("MainStreet"), and the April 2019 acquisition of HomeTown on net interest income and pretax income (dollars in thousands):

		June 30, 2019
	Income Statement Effect	Accretion (Amortization) Three Months Ended			Accretion (Amortization) Six Months Ended
Interest income/(expense):
Acquired performing loans	Income	$	842		$	919
Acquired impaired loans	Income	153			357
Time deposits	Contra Expense	144			144
Subordinated debt	Contra Expense	4			4
Junior subordinated debt	Expense	(25		)	(51		)
Net interest income		1,118			1,373
Noninterest (expense):
Amortization of core deposit intangible	Expense	(458		)	(513		)
Change in pretax income		$	660		$	860

During the second quarter of 2019, the Company received $225,000 in cash basis accretion income related to the early payoff of several acquired loans, compared to $231,000 for the comparable quarter of 2018. For the six month period ended June 30, 2019, cash basis accretion income was $396,000, compared to $486,000 for the same period in 2018.The HomeTown acquisition was effective April 1, 2019. The financial impact of that acquisition was significant for the June 2019 quarter and management expects the impact to income will be significant in the upcoming quarters.

The following table presents the impact for the three and six month periods ended June 30, 2018 of the accretable and amortizable fair value adjustments attributable to the acquisitions of MidCarolina and MainStreet on net interest income and pretax income (dollars in thousands):

		June 30, 2018
	Income Statement Effect	Accretion (Amortization) Three Months Ended			Accretion (Amortization) Six Months Ended
Interest income/(expense):
Acquired performing loans	Income	$	112		$	215
Acquired impaired loans	Income	291			640
Junior subordinated debt	Expense	(26		)	(51		)
Net interest income		377			804
Noninterest (expense):
Amortization of core deposit intangible	Expense	(77		)	(154		)
Change in pretax income		$	300		$	650

The MidCarolina acquisition was effective July 1, 2011 and the MainStreet acquisition was effective January 1, 2015. Management expects that the acquisition accounting financial impact of these acquisitions will continue to decline in future quarters.

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 noninterest expense, which tends to rise during periods of inflation.  Changes in interest

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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 Company has the ability to react to those changes and measure and monitor its interest rate and liquidity risk. Price inflation has been consistently modest over the past several years.

CHANGES IN FINANCIAL POSITION

BALANCE SHEET ANALYSIS

Securities

The securities portfolio generates income, plays a major role in the management of interest rate sensitivity, provides a source of liquidity, and is used to meet collateral requirements. The securities portfolio consists primarily of high credit quality investments, mostly federal agency, mortgage-backed, and state and municipal securities.

The available for sale securities portfolio was $334,326,000 at June 30, 2019, compared to $332,653,000 at December 31, 2018, an increase of $1,673,000 or 0.5%. At June 30, 2019, the available for sale portfolio had an amortized cost of $331,512,000 resulting in a net unrealized gain of $2,814,000. At December 31, 2018, the available for sale portfolio had an amortized cost of $337,774,000, resulting in a net unrealized loss of $5,121,000. The Company recognized a $330,000 change in the fair value of equity securities for the six months ended June 30, 2019. During the six months ended June 30, 2018, the Company recognized a $402,000 change in the fair value of equity securities.

The Company is cognizant of the continuing historically low, but possibly flat to decreasing rate environment and has elected to execute an asset liability strategy of purchasing high quality taxable securities of somewhat greater duration and average life than previously. The objective is to improve yield and duration on the portfolio in advance of any major market moves. In early 2019 indications are that market rates have peaked and the yield curve has flattened.

During the six months ended June 30, 2019, the Company sold $29,878,000 in par value bonds and realized a net gain of $127,000. This compares to the six months ended June 30, 2018, when the Company sold $22,025,000 in par value bonds and realized a net gain of $8,000. During the six months ended June 30, 2019, the Company sold $317,000 in equity securities at fair value.

The Company manages its investment portfolio on an aggregate portfolio basis for purposes of monitoring and controlling average life and duration. Accordingly, some individual purchases may fall outside these overall guidelines. The Company will continue to purchase high quality, relatively low optionality bonds to the maximum extent practical and prudent, consistent with its liquidity and asset liability strategies, and regulatory requirements.

Loans

The loan portfolio consists primarily of commercial and residential real estate loans, commercial loans to small and medium-sized businesses, construction and land development loans, and home equity loans.

Total loans were $1,836,241,000 at June 30, 2019, compared to $1,357,476,000 at December 31, 2018, an increase of $478,765,000 or 35.3%. Of this increase, $444,324,000 was related to the HomeTown merger and $34,441,000 or 2.5% represents growth throughout the rest of the Company's franchise.

Average loans were $1,819,116,000 for the second quarter of 2019, compared to $1,324,428,000 for the second quarter of 2018, an increase of $494,688,000 or 37.4% primarily related to the HomeTown acquisition but also due to organic growth of approximately $50,364,000 or 3.8%.

Loans held for sale totaled $3,165,000 at June 30, 2019 and $640,000 at December 31, 2018. Loan production volume was $43,495,000 for the six month period ended June 30, 2019 and $38,861,000 for the same period of 2018. These loans were approximately 70% purchase and 30% refinancing.

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Management of the loan portfolio is organized around portfolio segments. Each segment is comprised of various loan types that are reflective of operational and regulatory reporting requirements. The following table presents the Company's loan portfolio by segment as of June 30, 2019 and December 31, 2018 (dollars in thousands):

	June 30, 2019		December 31, 2018
Commercial	$	340,427	$	285,972
Commercial real estate:
Construction and land development	152,876		97,240
Commercial real estate	880,146		655,800
Residential real estate:
Residential	328,400		209,438
Home equity	121,905		103,933
Consumer	12,487		5,093
Total loans	$	1,836,241	$	1,357,476

Provision for Loan Losses

The Company had a provision for loan losses of $6,000 for the six month period ended June 30, 2019, compared to a negative provision of $74,000 for the same period ended June 30, 2018. The $6,000 provision related to adjustments on the specific reserves for the impaired loan loss allowance. The need for any additional provision in the six month period ended June 30, 2019 was mitigated by continued high asset quality, low charge offs, and improvement in various qualitative factors, notably economic, political and regulatory, used in computing the allowance for loan losses.

Allowance for Loan Losses

The purpose of the ALLL is to provide for probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance.

At June 30, 2019, the ALLL was $12,786,000, compared to $12,805,000 at December 31, 2018. The ALLL as a percentage of total loans at such dates was 0.70% and 0.94%, respectively. The primary reason for the large change in this ratio was the acquisition of $444.3 million in loans related to the April 2019 HomeTown acquisition. These loans do not have an ALLL. However, as part of the merger valuation process they do have a credit mark of $10.7 million and a liquidity mark of $4 million.

As part of the Company's methodology to evaluate the adequacy of its ALLL, the Company computed its ASC 450 loan balance by reducing total loans by acquired loans and loans that were evaluated for impairment individually. The FASB ASC 450 loan loss reserve balance is the total ALLL reduced by allowances associated with these other pools of loans.

The general allowance, ASC 450 (FAS 5) reserves to FASB ASC 450 loans, was 0.92% at June 30, 2019, compared to 0.97% at December 31, 2018. On a dollar basis, the reserve was $12,521,000 at June 30, 2019, compared to $12,560,000 at December 31, 2018. This segment of the allowance represents by far the largest portion of the loan portfolio and the largest aggregate risk.

The specific allowance, ASC 310-40 (FAS 114) reserves to FASB ASC 310-40 loans, was 5.68% at June 30, 2019, compared to 4.78% at December 31, 2018. On a dollar basis, the reserve was $77,000 at June 30, 2019, compared to $64,000 at December 31, 2018. There is ongoing turnover in the composition of the impaired loan population, which increased by a net $20,000 over December 31, 2018.

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The specific allowance does not include reserves related to acquired loans with deteriorated credit quality. This reserve was $188,000 at June 30, 2019 compared to $181,000 at December 31, 2018. This is the only portion of the reserve related to acquired impaired loans. Cash flow expectations for these loans are reviewed on a quarterly basis and unfavorable changes in those estimates relative to the initial estimates can result in the need for additional loan loss provision. The following table presents the Company's loan loss and recovery experience for the periods indicated (dollars in thousands):

Summary of Loan Loss Experience
	Six Months Ended June 30, 2019		Year Ended December 31, 2018
Balance at beginning of period	$	12,805	$	13,603
Charge-offs:
Construction and land development	—		—
Commercial real estate	6		11
Residential real estate	20		—
Home equity	—		86
Total real estate	26		97
Commercial and industrial	11		787
Consumer	86		136
Total charge-offs	123		1,020
Recoveries:
Construction and land development	—		4
Commercial real estate	7		6
Residential real estate	14		45
Home equity	12		104
Total real estate	33		159
Commercial and industrial	11		69
Consumer	54		97
Total recoveries	98		325
Net charge-offs	25		695
Provision for (recovery of) loan losses	6		(103		)
Balance at end of period	$	12,786	$	12,805

Asset Quality Indicators

The following table provides qualitative indicators relevant to the Company's loan portfolio for the six month period and year indicated below.

Asset Quality Ratios
	June 30, 2019		December 31, 2018
Allowance to loans	0.70	%	0.94	%
ASC 450 (FAS 5) ALLL to ASC 450 loans	0.92		0.97
Net charge-offs to allowance (1)	0.39		5.43
Net charge-offs to average loans (1)	0.00		0.05
Nonperforming assets to total assets	0.14		0.11
Nonperforming loans to loans	0.10		0.09
Provision to net charge-offs (1)	24.00		(14.82	)
Provision to average loans (1)	0.00		(0.01	)
Allowance to nonperforming loans	673.30		1,101.98

(1) - Annualized.

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Nonperforming Assets (Loans and Other Real Estate Owned)

Nonperforming loans include loans on which interest is no longer accrued and accruing loans that are contractually past due 90 days or more. Nonperforming loans include loans originated and loans acquired.

Nonperforming loans to total loans were 0.10% at June 30, 2019 and 0.09% at December 31, 2018.

Nonperforming assets include nonperforming loans and OREO.  Nonperforming assets represented 0.14% and 0.11% of total assets at June 30, 2019 and December 31, 2018, respectively. 

In most cases, it is the policy of the Company that any loan that becomes 90 days past due will automatically be placed on nonaccrual loan status, accrued interest reversed out of income, and further interest accrual ceased. Any payments received on such loans will be credited to principal. In some cases a loan in process of renewal may become 90 days past due. In these instances the loan may still be accruing because of a delayed renewal process in which the customer has not been billed. In accounting for acquired impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments.

Loans will only be restored to full accrual status after six consecutive months of payments that were each less than 30 days delinquent. The Company strictly adheres with this policy before restoring a loan to normal accrual status.

The following table presents the Company's nonperforming assets as of June 30, 2019 and December 31, 2018 (dollars in thousands):

Nonperforming Assets
	June 30, 2019		December 31, 2018
Nonaccrual loans:
Real estate	$	920	$	1,007
Commercial	49		83
Total nonaccrual loans	969		1,090
Loans past due 90 days and accruing interest:
Real estate	926		72
Commercial	4		—
Total past due 90 days and accruing interest	930		72
Total nonperforming loans	1,899		1,162
Other real estate owned	1,433		869
Total nonperforming assets	$	3,332	$	2,031

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The following table shows loans that were considered impaired, exclusive of acquired impaired loans, as of June 30, 2019 and December 31, 2018 (dollars in thousands):

Impaired Loans
	June 30, 2019		December 31, 2018
Accruing	$	1,016	$	848
Nonaccruing	338		486
Total impaired loans	$	1,354	$	1,334

Troubled Debt Restructurings ("TDRs")

TDRs exist whenever the Company makes a concession to a customer based on the customer's financial distress that would not have otherwise been made in the normal course of business.

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There were $1,225,000 in TDRs at June 30, 2019 compared to $1,090,000 at December 31, 2018. These loans are included in the impaired loan table above.

Other Real Estate Owned

Other real estate owned was $1,433,000 and $869,000 as of June 30, 2019 and December 31, 2018, respectively. OREO is initially recorded at fair value, less estimated costs to sell, at the date of foreclosure. Loan losses resulting from foreclosure are charged against the ALLL at that time. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the new cost basis or fair value, less estimated costs to sell with any additional write-downs charged against earnings.  For significant assets, these valuations are typically outside annual appraisals. The following table shows the Company's OREO as of June 30, 2019 and December 31, 2018 (dollars in thousands):

Other Real Estate Owned
	June 30, 2019		December 31, 2018
Construction and land development	$	646	$	78
1-4 family residential	351		719
Commercial real estate	436		72
	$	1,433	$	869

Deposits

The Company's deposits consist primarily of checking, money market, savings, and consumer and commercial time deposits.  Total deposits were $1,999,097,000 at June 30, 2019 compared to $1,566,227,000 at December 31, 2018, an increase of $432,870,000 or 27.6%. Of the increase, $483,626,000 represents deposits acquired in the HomeTown merger. Legacy deposits were down slightly during the same period.

Average interest bearing deposits were $1,463,613,000 for the second quarter of 2019, compared to $1,145,701,000 for the second quarter of 2018, an increase of $317,912,000 or 27.7%. Of this increase, $364,158,000 represents deposits acquired in the HomeTown acquisition, while legacy deposits were down during the same period. Average noninterest bearing deposits for the 2019 quarter were $559,944,000, compared to $419,620,000 for the 2018 quarter, an increase of $140,324,000 or 33.4%. Of this increase, $119,468,000 represents deposits acquired in the HomeTown merger; the remaining $20,856,000 or 5.0% represents growth in other parts of the Company's franchise.

The Company's primary focus on the liability side of the balance sheet is growing core deposits and their affiliated relationships. The increasing challenge in this rate environment is to fund the Bank in a cost effective and competitive manner. The Company's cost of deposits for the second quarter of 2019 was 0.96%, up from 0.66% for the second quarter of 2018.

Subordinated Debt

The Company had $7,526,000 in subordinated notes, acquired in the HomeTown merger, outstanding at June 30, 2019. These notes accrue at 6.75% until December 30, 2020. Thereafter, the notes will have a floating interest rate based on LIBOR.

Junior Subordinated Debt

The Company had three junior subordinated notes in the amounts of $20,619,000, $4,405,000, and $2,954,000 outstanding at June 30, 2019. These notes accrue at 1.35%, 3.45%, and 2.95%, respectively, above the 90-day LIBOR rate, adjusted quarterly. To add stability to net interest income and manage exposure to interest rate movement, the Company entered into three interest rate swaps in June 2018 on these notes. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for receipt of variable rate payments over the ten year life of the contracts. The effective interest rates on the swapped notes were 4.33%, 6.44%, and 5.93%, respectively at June 30, 2019.

Shareholders' Equity

The Company's capital management strategy is to be classified as "well capitalized" under regulatory capital ratios and provide as high as possible total return to shareholders.

Shareholders' equity was $311,917,000 at June 30, 2019 compared to $222,542,000 at December 31, 2018, an increase of $89,375,000 or 40.2%.  Of this increase, $83,250,000 is attributable to the HomeTown merger.

The Company paid cash dividends of $0.50 per share during the first six months of 2019 while the aggregate basic and diluted earnings per share for the same period was $0.48.

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Effective January 1, 2015, the Company and the Bank became subject to the Basel III Capital Rules. The Basel III Capital Rules require the Company and the Bank to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets. The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. In addition, to be well capitalized under the "prompt corrective action" regulations pursuant to Section 38 of the FDIA, the Bank must have the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.

The following table provides information on the regulatory capital ratios for the Company and the Bank at June 30, 2019 and December 31, 2018. Management believes, as of June 30, 2019, that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject.

	Percentage At June 30, 2019				Percentage At December 31, 2018
Risk-Based Capital Ratios:	Company		Bank		Company		Bank
Common equity tier 1 capital ratio	11.13	%	12.34	%	12.55	%	13.68	%
Tier 1 capital ratio	12.55		12.34		14.46		13.68
Total capital ratio	13.59		13.00		15.35		14.57
Leverage Capital Ratio:
Tier 1 leverage ratio	10.57		10.40		11.62		10.99

Stock Repurchase Program

On January 19, 2018, the Company filed a Form 8-K with the SEC to announce the approval by its Board of Directors of a stock repurchase program. The plan authorizes the repurchase of up to 300,000 shares of the Company's common shares over a two year period.

In the six month periods ended June 30, 2019 and 2018, the Company did not repurchase any shares.

Liquidity

Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities in a timely manner.  Liquidity management involves maintaining the Company's ability to meet the daily cash flow requirements of its customers, whether they are borrowers requiring funds or depositors desiring to withdraw funds.  Additionally, the Company requires cash for various operating needs including dividends to shareholders, the servicing of debt, and the payment of general corporate expenses.  The Company manages its exposure to fluctuations in interest rates through policies approved by the Asset Liability Committee ("ALCO") and Board of Directors, both of which receive periodic reports of the Company's interest rate risk and liquidity position.  The Company uses a computer simulation model to assist in the management of the future liquidity needs of the Company. 

Liquidity sources include on balance sheet and off balance sheet sources.

Balance sheet liquidity sources include cash, amounts due from banks, loan repayments, and increases in deposits. The Company also maintains a large, high quality, very liquid bond portfolio, which is generally 50% to 60% unpledged and would, accordingly, be available for sale if necessary.     

Off balance sheet sources include lines of credit from the Federal Home Loan Bank of Atlanta ("FHLB"), federal funds lines of credit, and access to the Federal Reserve Bank of Richmond's discount window. 

The Company has a line of credit with the FHLB, equal to 30% of the Bank's assets, subject to the amount of collateral pledged.  Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans, home equity lines of credit, and commercial real estate loans.  In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB.  The Company had $190,250,000

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outstanding in letters of credit at June 30, 2019 and December 31, 2018. $190,000,000 of these letters of credit provide the Bank with alternate collateral for securing public entity deposits above Federal Deposit Insurance Corporation insurance levels, thereby providing less need for collateral pledging from the securities portfolio, and thereby maximizing on balance sheet liquidity.

Short-term borrowings are discussed in Note 8 and long-term borrowings are discussed in Note 9 in the Consolidated Financial Statements included in this report.

The Company has federal funds lines of credit established with two correspondent banks in the amount of $15,000,000 each and with one correspondent bank in the aggregate amount of $17,500,000, and has access to the Federal Reserve Bank's discount window. 

The Company has a relationship with Promontory Network, the sponsoring entity for the Certificate of Deposit Account Registry Service® ("CDARS"). Through CDARS, the Company is able to provide deposit customers with access to aggregate Federal Deposit Insurance Corporation insurance in amounts exceeding $250,000.  This gives the Company the ability, as and when needed, to attract and retain large deposits from insurance conscious customers.  With CDARS, the Company has the option to keep deposits on balance sheet or sell them to other members of the network.  Additionally, subject to certain limits, the Bank can use CDARS to purchase cost-effective funding without collateralization and in lieu of generating funds through traditional brokered CDs or the FHLB.  In this manner, CDARS can provide the Company with another funding option. Thus, CDARS serves as a deposit-gathering tool and an additional liquidity management tool.  Under the Economic Growth, Regulatory Relief, and Consumer Protection Act signed into law on May 24, 2018, a well-capitalized bank with a CAMELS rating of 1 or 2 may hold reciprocal deposits up to the lesser of 20 percent of its total liabilities or $5 billion without those deposits being treated as brokered deposits. Deposits through the CDARS program as of June 30, 2019 and December 31, 2018, were $17,106,000 and $22,431,000, respectively.

Management believes that these sources provide sufficient and timely liquidity, both on and off the balance sheet.

Off-Balance Sheet Activities

The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions.  Other than subsidiaries to issue trust preferred securities, the Company does not have any off-balance sheet subsidiaries.  Off-balance sheet transactions at June 30, 2019 and at December 31, 2018 were as follows (dollars in thousands):

	June 30, 2019		December 31, 2018
Commitments to extend credit	$	530,977	$	362,586
Standby letters of credit	15,009		15,555
Mortgage loan rate-lock commitments	21,146		9,710

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 funding requirements.  The increase in commitments from December 31, 2018 to June 30, 2019 is primarily attributable to the HomeTown merger. Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Management

Effectively managing market risk is essential to achieving the Company's financial objectives.  Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices.  The Company is generally not subject to currency exchange risk or commodity price risk.  The Company's primary market risk exposure is interest rate risk; however, market risk also includes liquidity risk.  Both are discussed in the following sections.

Interest Rate Risk Management

Interest rate risk and its impact on net interest income is a primary market risk exposure.  The Company manages its exposure to fluctuations in interest rates through policies approved by the ALCO and Board of Directors, both of which receive and review periodic reports of the Company's interest rate risk position.

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The Company uses computer simulation analysis to measure the sensitivity of projected earnings to changes in interest rates.  Simulation takes into account current balance sheet volumes and the scheduled repricing dates instrument level optionality, and maturities of assets and liabilities.  It incorporates numerous assumptions including growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid.  Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

A balance sheet is considered asset sensitive when its earning assets (loans and securities) reprice faster or to a greater extent than its liabilities (deposits and borrowings).  An asset sensitive balance sheet will produce relatively more net interest income when interest rates rise and less net interest income when they decline.  Based on the Company's simulation analysis, management believes the Company's interest sensitivity position at June 30, 2019 is asset sensitive. Management expects that the general direction of market interest rates will be flat to decreasing the remainder of 2019.

Earnings Simulation

The following table shows the estimated impact of changes in interest rates on net interest income as of June 30, 2019 (dollars in thousands), assuming gradual and parallel changes in interest rates, and consistent levels of assets and liabilities.   Net interest income for the following twelve months is projected to increase when interest rates are higher than current rates.

Estimated Changes in Net Interest Income
	June 30, 2019
	Change in Net Interest Income
Change in interest rates	Amount			Percent
Up 4.00%	$	12,438		14.6	%
Up 3.00%	9,385			11.0
Up 2.00%	6,315			7.4
Up 1.00%	3,240			3.8
Flat	—			—
Down 0.25%	(848		)	(1.0	)
Down 1.00%	(4,393		)	(5.2	)

Management cannot predict future interest rates or their exact effect on net interest income.  Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results.  Certain limitations are inherent in such computations.  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 changes in market interest rates.  Interest rate shifts may not be parallel.

Changes in interest rates can cause substantial changes in the amount of prepayments of loans and mortgage-backed securities, which may in turn affect the Company's interest rate sensitivity position.  Additionally, credit risk may rise if an interest rate increase adversely affects the ability of borrowers to service their debt.

Economic Value Simulation

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The economic value simulation uses instantaneous rate shocks to the balance sheet.

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The following table reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the quarterly period ended June 30, 2019 (dollars in thousands):

Estimated Changes in Economic Value of Equity
	June 30, 2019
Change in interest rates	Amount		$ Change			% Change
Up 4.00%	$	436,222	$	123,749		39.6	%
Up 3.00%	416,547		104,074			33.3
Up 2.00%	391,648		79,175			25.3
Up 1.00%	358,090		45,617			14.6
Flat	312,473		—			—
Down 0.25%	298,370		(14,103		)	(4.5	)
Down 1.00%	251,672		(60,801		)	(19.5	)

Due to the current stable to decreasing interest rate environment, no measurement was considered necessary for a further decline in interest rates. There have been no material changes to market risk as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.  Refer to those disclosures for further information.

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the Company'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 June 30, 2019.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.  There were no significant changes in the Company's internal controls over financial reporting that occurred during the quarter ended June 30, 2019, that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.

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PART II.OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

The nature of the business of the Company ordinarily results in a certain amount of litigation. The Company is involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Company.

ITEM 1A.  RISK FACTORS

There have been no material changes to the risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on March 9, 2019.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On January 16, 2018, the Company's Board of Directors authorized a share repurchase program of up to 300,000 shares of the Company's outstanding common stock for a period of two years.  Repurchases may be made through open market purchases or in privately negotiated transactions, and shares repurchased will be returned to the status of authorized and unissued shares of common stock.  The actual timing, number, and value of shares repurchased under the program will be determined by management.

No shares of the Company's common stock were repurchased during the three months ended June 30, 2019. Under the share repurchase program, the Company has the remaining authority to repurchase up to 300,000 shares of the Company's common stock as of June 30, 2019.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable

ITEM 5.  OTHER INFORMATION

(a)  Required 8-K disclosures

None

(b)  Changes in Nominating Process

None

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ITEM 6.  EXHIBITS

31.1        Section 302 Certification of Jeffrey V. Haley, President and Chief Executive Officer.

31.2        Section 302 Certification of William W. Traynham, Executive Vice President and Chief Financial Officer.

32.1        Section 906 Certification of Jeffrey V. Haley, President and Chief Executive Officer.

32.2        Section 906 Certification of William W. Traynham, Executive Vice President and Chief Financial Officer.

101 Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Income (Loss) for the three and six months ended June 30, 2019 and June 30, 2018, (iii) the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and June 30, 2018, (iv) the Consolidated Statements of Changes in Shareholders' Equity for the three and six months ended June 30, 2019 and June 30, 2018, (v) the Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and June 30, 2018, and (vi) the Notes to the Consolidated Financial Statements (furnished herewith).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

AMERICAN NATIONAL BANKSHARES INC.

	By:	/s/ Jeffrey V. Haley
		Jeffrey V. Haley
		President and Chief Executive Officer
Date - August 5, 2019		(principal executive officer)
	By:	/s/ William W. Traynham
		William W. Traynham
		Executive Vice President and
		Chief Financial Officer
Date - August 5, 2019		(principal financial officer)
	By:	/s/ Cathy W. Liles
		Cathy W. Liles
		Senior Vice President and
		Chief Accounting Officer
Date - August 5, 2019		(principal accounting officer)

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