UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
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Commission file number 0-12820
AMERICAN NATIONAL BANKSHARES INC.
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(Exact name of registrant as specified in its charter)
VIRGINIA 54-1284688
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
628 Main Street
Danville, Virginia 24541
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 434-792-5111
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $1 Par Value NASDAQ National Market
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(Title of each class) (Name of exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ X ] No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant at June 30, 2004 was $95,997,310. The number of shares of the
Registrant's Common Stock outstanding on March 7, 2005 was 5,501,358.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement of the Registrant for the Annual Meeting of
Shareholders to be held on April 26, 2005 are incorporated by reference in Part
III of this report.
1
CROSS REFERENCE INDEX
Page
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PART I
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ITEM 1 Business 4
ITEM 2 Properties 6
ITEM 3 Legal Proceedings 6
ITEM 4 Submission of Matters to a Vote of Security Holders 6
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PART II
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ITEM 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Securities 7
ITEM 6 Selected Financial Data 9
ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 10
ITEM 7A Quantitative and Qualitative Disclosures about Market Risk 14
ITEM 8 Financial Statements and Supplementary Data
Quarterly Financial Results for 2004 and 2003 29
Management's Report on Financial Statements 30
Reports of Independent Public Accountants 31
Consolidated Balance Sheets at December 31, 2004 and 2003 33
Consolidated Statements of Income for each of the years in the
three-year period ended December 31, 2004 34
Consolidated Statements of Changes in Shareholders' Equity for each of the
years in the three-year period ended December 31, 2004 35
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 2004 36
Notes to Consolidated Financial Statements 37
ITEM 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 30
ITEM 9A Controls and Procedures 30
ITEM 9B Other Information 30
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PART III
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ITEM 10 Directors and Executive Officers of the Registrant *,7
ITEM 11 Executive Compensation *
ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters *
ITEM 13 Certain Relationships and Related Transactions *
ITEM 14 Principal Accountant Fees and Services *
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PART IV
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ITEM 15 Exhibits and Financial Statement Schedules 59
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* The information required by Item 10 is incorporated herein by reference to
the information that appears under the headings "Election of Directors",
"Section 16(a) Beneficial Ownership Reporting Compliance", "Report of the
Audit and Compliance Committee" and "Code of Conduct" in the Registrant's
Proxy Statement for the April 2005 Annual Meeting of Shareholders.
The information required by Item 11 is incorporated herein by reference to
the information that appears under the headings "Comparative Stock
Performance", "Report of the Human Resources and Compensation Committee on
Executive Compensation", and "Executive Compensation" in the Registrant's
Proxy Statement for the April 2005 Annual Meeting of Shareholders.
* The information required by Item 12 is incorporated herein by reference to
the information that appears under the headings "Security Ownership" and
"Section 16(a) Beneficial Ownership Reporting Compliance" in the
Registrant's Proxy Statement for
2
the April 2005 Annual Meeting of Shareholders. The information required by
Item 201(d) of Regulation S-K is disclosed herein. See Item 5, "Market for
Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities."
The information required by Item 13 is incorporated herein by reference to
the information that appears under the heading "Related Party
Transactions"' in the Registrant's Proxy Statement for the April 2005
Annual Meeting of Shareholders.
The information required by Item 14 is incorporated herein by reference to
the information that appears under the heading "Independent Public
Accountants" in the Registrant's Proxy Statement for the April 2005 Annual
Meeting of Shareholders.
3
PART I
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements with respect to the
financial condition, results of operations and business of the Corporation.
These forward-looking statements involve risks and uncertainties and are based
on the beliefs and assumptions of management of the Corporation and on
information available to management at the time these statements and disclosures
were prepared. Factors that may cause actual results to differ materially from
those expected include the following:
o General economic conditions may deteriorate and negatively impact the
ability of borrowers to repay loans and depositors to maintain account
balances.
o Plant closings or layoffs in the Corporation's primary market area could
occur, which might negatively impact the ability of borrowers to repay
loans and depositors to maintain account balances.
o Changes in interest rates could increase or reduce income.
o Competition among financial institutions may increase.
o Businesses that the Corporation is engaged in may be adversely affected by
legislative or regulatory changes, including changes in accounting
standards.
o New products developed or new methods of delivering products could result
in a reduction in business and income for the Corporation.
o Adverse changes may occur in the securities market.
ITEM 1 - BUSINESS
American National Bankshares Inc. (the "Corporation") is a one-bank holding
company organized under the laws of the Commonwealth of Virginia in 1984. On
September 1, 1984, the Corporation acquired all of the outstanding capital stock
of American National Bank and Trust Company (the "Bank"), a national banking
association chartered in 1909 under the laws of the United States. The Bank is
the only subsidiary of the Corporation. At December 31, 2004, the Corporation
employed 213 full-time equivalent persons, and the relationship with employees
is considered good.
American National Bank and Trust Company
The Bank has been operating as a commercial bank headquartered in Danville,
Virginia since its organization in 1909. The Bank has expanded through internal
growth and through mergers and acquisitions. In 1996, the Corporation completed
the merger of Mutual Savings Bank, F.S.B. ("Mutual") into the Bank. The Mutual
merger was accounted for as a pooling of interests. The Bank completed two
retail office purchases in 1995 and 1996 that added $57,700,000 in deposits and
$6,925,000 in loans. The two acquisitions were accounted for as purchases and
related core deposit intangible assets of $4,504,000 are being amortized over
ten years. The Bank opened retail banking offices in Chatham and Martinsville,
Virginia, closed a limited service retail office in Danville during 1999 and
opened a branch office in South Boston, Virginia during 2000. In March 2002, the
Bank opened their fourteenth retail banking office in southern Henry County,
Virginia. During 2004, the Bank opened a loan production office in Greensboro,
North Carolina.
The Bank has two wholly owned subsidiaries. ANB Mortgage Corp. originates
and sells secondary-market mortgage loans. ANB Services Corporation, operating
as ANB Investor Services and ANB Insurance Services, offers non-deposit
investment products including mutual funds, equity securities, and a full-line
of insurance products through an affiliation with Bankers Insurance LLC. In
2005, the Bank intends to discontinue the use of the two subsidiaries and offer
the same products and services through the Bank.
The operations of the Bank are conducted at fourteen retail offices located
throughout the Bank's trade area, which includes the Cities of Danville and
Martinsville, and Pittsylvania, Henry and Halifax Counties in Virginia, and the
northern half of Caswell County in North Carolina. Seven of these offices are
located in Danville, and there is one office each in Gretna, Chatham,
Martinsville, Collinsville, southern Henry County, and South Boston, Virginia
and Yanceyville, North Carolina. Commercial loan services are also provided
through a loan production office located in Greensboro, North Carolina. The Bank
operates eighteen automated teller machines at various locations in the trade
area. The Bank provides a full array of financial products and services,
including commercial, mortgage, and consumer banking; trust and investment
services; and insurance.
Competition and Markets
The Corporation's primary service area is generally defined as the City of
Danville; City of Martinsville; Town of South Boston; Pittsylvania, Henry and
Halifax Counties in Virginia; City of Greensboro; Town of Yanceyville and the
northern half of Caswell County in North Carolina. Vigorous competition exists
in this service area. The Corporation competes not only with other commercial
banks but also with diversified financial institutions, credit unions, money
4
market and mutual fund providers, mortgage lenders, insurance companies, and
finance companies. American National Bank and Trust Company has the largest
deposit market share in both the City of Danville and in Pittsylvania County.
The Corporation's market area, primarily known collectively as Southside
Virginia, is under economic pressure. The region has traditionally been the home
to textile, furniture and other manufacturing, and has served as a hub for
tobacco production and distribution. While diversification has occurred in
manufacturing in recent years, a textile firm and a tire manufacturing plant in
Danville, as well as several large furniture manufacturers in the Henry
County/City of Martinsville area, employ a significant workforce. Danville's
second largest employer, Dan River Inc., a textile manufacturer, filed for
Chapter 11 bankruptcy protection in 2004, and emerged from bankruptcy in early
2005. Increased global competition has negatively impacted the textile and
furniture industries in the area with several plants closing due to competitive
pressures or due to the relocation of some operations to foreign countries.
Unemployment as a percent of the workforce remains greater than that of most
other regions of Virginia. The area is also known as a center of commerce for
the tobacco industry, and the major tobacco companies continue to operate leaf
collection and processing facilities in the region. To offset the negative
impact of the declining textile, furniture and tobacco industries, the region
has been proactive in its economic development activities, which have produced
job growth in the education, government and service sectors. The region is
upgrading broadband Internet access. The Danville Regional Airport is testing
NASA technology to make better use of the nation's general aviation airports.
Research and development activities are conducted at the new Institute for
Advanced Learning and Research, launched through a collaboration between two
Virginia universities, one community college, and other local entities. A
nanotechnology company is opening its manufacturing operations in Danville.
Supervision and Regulation
The Corporation is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), including the
filing of annual, quarterly, and other reports with the Securities and Exchange
Commission (the "SEC"). As an Exchange Act reporting company, the Corporation is
directly affected by the Sarbanes-Oxley Act of 2002 (the "SOX"), which is aimed
at improving corporate governance and reporting procedures. The Corporation is
complying with new SEC and other rules and regulations implemented pursuant to
SOX and intends to comply with any applicable rules and regulations implemented
in the future.
The Corporation's common stock is listed on the Nasdaq National Market, and
the Corporation must comply with the listing requirements and rules of the
exchange.
The Corporation is a bank holding company within the meaning of the Bank
Holding Company Act of 1956 and is registered as such with the Board of
Governors of the Federal Reserve System ("the Federal Reserve Board"). As a bank
holding company, the Corporation is required to file with the Federal Reserve
Board an annual report and such other information as may be required. The
Federal Reserve Board may also make examinations of the Corporation.
The operations of the Bank are subject to federal statutes and to
regulations of the Office of the Comptroller of the Currency (the "OCC"), the
Federal Reserve Board and the Federal Deposit Insurance Corporation, which
insures the Bank's deposits.
The Bank is a member of the Federal Reserve System and is affected by
general fiscal and monetary policies of the Federal Reserve Board. The
techniques used by the Federal Reserve Board include setting the reserve
requirements of member banks and establishing the discount rate on member bank
borrowings.
The primary supervisory authority of the Bank is the Comptroller of the
Currency, which regularly examines such areas as capital adequacy, asset
quality, management practices, earnings, liquidity, regulatory compliance,
information systems, and other aspects of the Bank's operations. These
examinations are designed primarily for the protection of the Bank's depositors.
In addition to these regular examinations, the Bank must furnish the OCC
periodic reports containing a full and accurate statement of its affairs.
Government Monetary Policies and Economic Controls
The policies of the Federal Reserve Board have a direct impact on loan and
deposit growth and the interest rates charged and paid thereon. While these
policies can materially affect the income of commercial banks, the impact of
such conditions and policies upon the future business and earnings of the
Corporation and the Bank cannot accurately be predicted.
Internet Access to Corporate Documents
The Corporation provides access to their SEC filings through the corporate
Web site at www.amnb.com. After accessing the Web site, the filings are
available upon selecting the Investor Relations icon. Reports available include
the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after the reports are electronically filed with the SEC. The SEC
5
maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC at www.sec.gov.
ITEM 2 - PROPERTIES
The following describes the location and general character of the principal
offices and other materially important physical properties of the Corporation.
As of December 31, 2004, the Bank maintained fourteen full service retail
offices. Seven are located within the City of Danville, with others located in
Gretna, Chatham, Martinsville, southern Henry County, Collinsville, and South
Boston, Virginia and Yanceyville, North Carolina. The Bank operates a loan
production office in Greensboro, North Carolina. The Bank leases additional
space in Martinsville for use by its trust and investment services division and
its mortgage lending division.
The principal executive offices of the Corporation, as well as the
principal executive offices of the Bank, are located at 628 Main Street in the
business district of Danville, Virginia. This building, owned by the Bank, was
originally constructed in 1973 and has three floors totaling 27,000 square feet.
The Corporation owns a building located at 103 Tower Drive in Danville,
Virginia. This three-story facility totaling 15,000 square feet was constructed
in 1985 and serves as a retail banking office. It also houses certain of the
Corporation's finance, administrative, and operations staff.
The Corporation owns an office building on 203 Ridge Street, Danville,
Virginia, which is currently leased to Bankers Insurance, LLC. The Bank has a
minority ownership interest in Bankers Insurance, LLC.
The Bank leases a two-building office complex in Martinsville, Virginia,
that houses a retail banking office, a trust and investment services office, and
a mortgage lending office. This building serves as the headquarters for the
Martinsville/Henry County market. The Bank also leases the retail banking
offices in South Boston and on West Main Street in Danville, Virginia, as well
as a loan production office in Greensboro, North Carolina and a storage
warehouse in Danville. Total lease payments in 2004 for these facilities, as
well as for ATM leases at non-retail office locations, were $153,000.
The Bank owns nine other retail office locations for a total of eleven
owned retail office locations. There are no mortgages or liens against any of
the properties owned by the Bank or the Corporation.
The Bank operates eighteen Automated Teller Machines ("ATMs") on owned or
leased facilities.
There were no directors or officers with any ownership interest in any
leased facility of the Bank or the Corporation.
ITEM 3 - LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Corporation is
a party or to which the property of the Corporation is subject.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Corporation through
a solicitation of proxies or otherwise.
6
EXECUTIVE OFFICERS OF THE REGISTRANT
The following lists the executive officers of the registrant, their age as
of December 31, 2004 and their position.
Name Age Position
- ------------------------ --- ------------------------------------------------------------------------------------------
Charles H. Majors 59 President & Chief Executive Officer of the Corporation and the Bank
E. Budge Kent, Jr. 65 Executive Vice President of the Corporation; Executive Vice President and Chief Trust &
Investment Officer of the Bank
R. Helm Dobbins 53 Senior Vice President of the Corporation; Senior Vice President & Chief Credit Officer of
the Bank since June 2003; Executive Vice President and Chief Credit Officer of Citizens
Bank and Trust Co. from 1998 to 2003.
Dabney T.P. Gilliam, Jr. 50 Senior Vice President of the Corporation; Senior Vice President, Chief Banking Officer &
Senior Loan Officer of the Bank
Jeffrey V. Haley 44 Senior Vice President of the Corporation; Senior Vice President & Chief Administrative
Officer of the Bank
Neal A. Petrovich 42 Senior Vice President, Chief Financial Officer, Treasurer and Secretary of the
Corporation; Senior Vice President, Chief Financial Officer and Cashier of the Bank;
Senior Vice President of SouthTrust Bank from 2002 to 2004; Executive Vice President and
Chief Financial Officer of Bank of Tidewater from 1995 to 2002.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF SECURITIES
The Corporation's common stock is traded on the Nasdaq National Market
under the symbol "AMNB". At year end 2004, the Corporation had 1,365
shareholders of record. The table below presents the high and low closing sales
prices known to management for the Corporation's common stock and dividends
declared for the past two years. Market value and dividends are shown per share
and are based on the shares outstanding for 2004 and 2003.
Market Price of the Corporation's Common Stock
NASDAQ closing price Dividends
--------------------------------- Declared
2004 High Low Per Share
- -------------------------- ---------- ---------- ----------
4th quarter $ 25.33 $ 24.06 $ .20
3rd quarter 24.31 21.55 .20
2nd quarter 25.26 21.01 .20
1st quarter 26.75 23.25 .19
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$ .79
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Dividends
Declared
2003 High Low Per Share
- -------------------------- ---------- ---------- ----------
4th quarter $ 27.23 $ 24.99 $ .19
3rd quarter 28.11 24.77 .19
2nd quarter 25.96 22.87 .19
1st quarter 27.06 24.30 .18
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$ .75
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7
The table below presents share repurchase activity during the quarter ended
December 31, 2004.
Repurchases Made During the Quarter Ended December 31, 2004
Total Number of Shares Maximum Number of
Total Number Average Purchased as Part of Shares that May Yet
of Shares Price Paid Publicly Announced Be Purchased Under
Purchased Per share Program the Program
----------- ---------- ---------------------- -------------------
October 1-31, 2004 5,000 $ 25.25 5,000 168,100
November 1-30, 2004 - - -
December 1-31, 2004 - - -
----- ------- -----
5,000 $ 25.25 5,000
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Stock Option Plan
The Corporation maintains a stock option plan (the "Plan") that is designed
to attract and retain qualified personnel in key positions, provide employees
with a proprietary interest in the Corporation as an incentive to contribute to
the success of the Corporation and the Bank and reward employees for outstanding
performance and the attainment of targeted goals. The Stock Option Plan provides
for the grant of incentive stock options intended to comply with the
requirements of Section 422 of the Internal Revenue Code of 1986 ("incentive
stock options"), as well as non-qualified stock options.
The Plan was approved by the shareholders at the 1997 Annual Meeting, and
is administered by a committee of the Board of Directors of the Corporation,
each member of which is a "non-employee director" as defined in Rule 16b-3 under
the Exchange Act. Unless sooner terminated, the Plan is in effect until December
31, 2006. Under the Plan, the committee determines which employees will be
granted options, whether such options will be incentive or non-qualified
options, the number of shares subject to each option, whether such options may
be exercised by delivering other shares of common stock and when such options
become exercisable. In general, the per share exercise price of an incentive
stock option must be at least equal to the fair market value of a share of
common stock on the date the option is granted
Stock options shall become vested and exercisable in the manner specified
by the committee. In general, each stock option or portion thereof shall be
exercisable at any time on or after it vests and is exercisable until ten years
after its date of grant.
Year Ended December 31, 2004
------------------------------------------------------------------------
Number of Shares Weighted-Average Number of Shares
to be Issued Upon Per Share Exercise Remaining Available
Exercise Price of for Future Issuance
of Outstanding Outstanding Options Under
Options Stock Option Plan
----------------- ------------------- -------------------
Equity compensation plans
approved by shareholders 249,396 $19.98 8,472
Equity compensation plans not
approved by shareholders - - -
------- ------ -----
Total 249,396 $19.98 8,472
======= ====== =====
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ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the Corporation
for the last five years:
(in thousands, except per share amounts)
2004 2003 2002 2001 2000
------------ ------------- ------------ ------------ -------------
Results of Operations:
Interest income....................................... $ 30,120 $ 32,178 $ 35,135 $ 39,820 $ 38,606
Interest expense...................................... 7,479 9,391 12,310 17,502 17,343
------------ ------------- ------------ ------------ -------------
Net interest income................................... 22,641 22,787 22,825 22,318 21,263
Provision for loan losses............................. 3,095 920 873 1,015 1,020
Noninterest income.................................... 6,510 6,671 5,712 5,668 4,771
Noninterest expense................................... 15,011 15,111 14,285 13,614 12,923
------------ ------------- ------------ ------------ -------------
Income before income taxes............................ 11,045 13,427 13,379 13,357 12,091
Income taxes.......................................... 3,032 3,914 3,918 3,942 3,415
------------ ------------- ------------ ------------ -------------
Net income............................................ $ 8,013 $ 9,513 $ 9,461 $ 9,415 $ 8,676
============ ============= ============ ============ =============
Period-end Balances:
Securities............................................ $188,163 $207,479 $163,824 $156,791 $162,929
Total loans........................................... 408,240 406,805 407,688 375,593 339,756
Total deposits........................................ 485,272 501,688 473,562 464,012 426,588
Shareholders' equity.................................. 71,000 71,931 70,736 65,397 63,338
Total assets.......................................... 619,065 644,302 605,859 572,887 541,389
Per Share Information:
Earnings - basic...................................... $ 1.43 $ 1.67 $ 1.63 $ 1.58 $ 1.42
Earnings - diluted.................................... 1.42 1.65 1.62 1.58 1.42
Dividends............................................. .79 .75 .71 .66 .585
Book value............................................ 12.86 12.71 12.24 11.23 10.45
Ratios:
Return on average assets............................... 1.26% 1.52% 1.63% 1.69% 1.70%
Return on average shareholders' equity................. 11.15% 13.52% 13.97% 14.49% 14.74%
Average shareholders' equity/average assets............ 11.34% 11.27% 11.64% 11.68% 11.54%
Total risk-based capital/assets........................ 16.73% 15.99% 15.63% 15.56% 17.09%
Dividend payout ratio.................................. 55.05% 44.90% 43.52% 41.68% 41.07%
Net charge-offs to average loans....................... .10% .30% .15% .12% .13%
Allowance for loan losses to period-end loans.......... 1.96% 1.30% 1.38% 1.42% 1.40%
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The purpose of this discussion is to focus on important factors affecting
the financial condition and results of operations of American National
Bankshares Inc. and American National Bank and Trust Company. The discussion and
analysis should be read in conjunction with the Consolidated Financial
Statements and supplemental financial data.
RECLASSIFICATION
In certain circumstances, reclassifications have been made to prior period
information to conform to the 2004 presentation.
CRITICAL ACCOUNTING POLICIES
The Corporation's critical accounting policies are listed below. A summary
of the Corporation's significant accounting policies is set forth in Note 1 to
the Consolidated Financial Statements in the Corporation's 2004 Annual Report on
Form 10-K.
The Corporation's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The financial information contained within the statements is, to a
significant extent, financial information that is based on measures of the
financial effects of transactions and events that have already occurred. A
variety of factors could affect the ultimate value that is obtained when earning
income, recognizing an expense, recovering an asset or relieving a liability. In
addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of the transactions would be the same,
the timing of events that would impact those transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses inherent in the
loan portfolio at the balance sheet date. The allowance is based on two basic
principles of accounting: (i) Statement of Financial Accounting Standards
("SFAS" No. 5, Accounting for Contingencies, which requires that losses be
accrued when they are probable of occurring and estimable and (ii) SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, which requires that losses on
impaired loans be accrued based on the differences between the value of
collateral, present value of future cash flows, or values that are observable in
the secondary market, and the loan balance.
The Corporation's allowance for loan losses has three basic components: the
formula allowance, the specific allowance and the unallocated allowance. Each of
these components is determined based upon estimates that can and do change when
the actual events occur. The formula allowance uses a historical loss view as an
indicator of future losses along with various economic factors and, as a result,
could differ from the loss incurred in the future. The specific allowance uses
various techniques to arrive at an estimate of loss for specifically identified
loans. The financial condition of the borrower and the fair market value of
collateral are among the factors used to estimate these losses. The unallocated
allowance includes estimated losses whose impact on the portfolio have yet to be
recognized in either the formula or specific allowance. The use of these values
is inherently subjective and actual losses could be greater or less than the
estimates.
Stock Based Compensation
The Corporation accounts for its stock compensation plan under the
recognition and measurement principles of the Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based compensation cost is reflected in net income, as
all options granted under the plan had an exercise price equal to the market
value of the underlying common stock on the date of grant.
Non-GAAP Presentations
The management's discussion and analysis refers to the efficiency ratio,
which is computed by dividing noninterest expense by the sum of net interest
income on a tax equivalent basis and noninterest income (excluding gains on
sales of securities or other assets). This is a non-GAAP financial measure which
we believe provides investors with important information regarding our
operational efficiency. Comparison of our efficiency ratio with those of other
companies may not be possible because other companies may calculate the
efficiency ratio differently. The Corporation, in referring to its net income,
is referring to income under GAAP.
10
The analysis of net interest income in this document is performed on a tax
equivalent basis. Management believes the tax equivalent presentation better
reflects total return, as many financial assets have specific tax advantages
that modify their effective yields. A reconcilement of tax-equivalent net
interest income to net interest income is provided.
EXECUTIVE OVERVIEW
Net income for the year ended December 31, 2004 was $8.0 million, a
decrease of 15.8% over the $9.5 million earned in 2003. On a basic per share
basis, net earnings totaled $1.43 and on a diluted per share basis earnings
totaled $1.42 for the year 2004. For the year 2003, basic earnings per share
were $1.67 and diluted earnings per share were $1.65.
The decline in earnings was due to two major factors. First, the
Corporation added an additional $2.0 million to its allowance for loan losses
primarily related to a $4.5 million loan secured by a hotel in a major North
Carolina metropolitan area. Although payments on the loan have always been
current, the cash flow and collateral valuation of the hotel has deteriorated;
thus, the loan was deemed impaired and was placed on nonaccrual status at
December 31, 2004. Secondly, the Corporation recorded a $985,000 impairment
charge on $4.5 million of Federal Home Loan Mortgage Corporation ("FHLMC") and
Federal National Mortgage Association ("FNMA") perpetual preferred stock. Based
upon a detailed analysis, the Corporation concluded both securities were
"other-than-temporarily impaired" at December 31, 2004 as defined by accounting
interpretations.
Despite these two significant asset impairments, the Corporation recorded
good profitability measurements in 2004. Two important and commonly used
measures of profitability are return on assets (net income as a percentage of
average total assets) and return on shareholders' equity (net income as a
percentage of average common shareholders' equity). The Corporation's return on
average assets during 2004 was 1.26% which is slightly higher than the
Corporation's peer group average. Return on equity was 11.15%.
The Corporation recognizes that its current market area is marked by slow,
or negative, economic growth, due primarily to declines in manufacturing and
tobacco processing. Consequently, the Corporation's strategic plan calls for
growth in faster-growing, nearby markets. Other current priorities are to:
o increase the size of the Corporation's loan portfolio without sacrificing
credit quality,
o grow checking, savings, and money market deposits,
o increase fee income through our trust, investment, and mortgage banking
services, and
o continue to control costs.
11
ANALYSIS OF OPERATING RESULTS
NET INTEREST INCOME
Net interest income, the Corporation's largest source of revenue, is the
excess of interest income over interest expense. Net interest income is
influenced by a number of factors, including the volume and mix of
interest-earning assets and interest-bearing liabilities, interest rates earned
on earning assets, and interest rates paid on deposits and borrowed funds. For
analytical purposes, net interest income is adjusted to a taxable equivalent
basis to recognize the income tax savings on tax-exempt assets, such as state
and municipal securities. A tax rate of 34% was used in adjusting interest on
tax-exempt assets to a fully taxable equivalent ("FTE") basis. The difference
between income recorded on interest-earning assets and expense recorded on
interest-bearing liabilities is referred to as net interest income. Net interest
income divided by average earning assets is referred to as the net interest
margin. The net interest spread represents the difference between the average
rate earned on earning assets and the average rate paid on interest-bearing
liabilities.
Net interest income on a tax-equivalent basis was stable from 2002 to 2004,
ranging from $23.7 million to $23.8 million. Interest income declined $2.0
million from 2003 to 2004 due primarily to pay-downs of participation loans and
a general decline in interest rates. Interest expense declined $1.9 million
during this same period, due to the lowering of interest rates paid on deposit
accounts and a reduction in higher-cost certificates of deposit. From 2002 to
2003, the positive impact from growth in earning assets was offset by the impact
of lower rates earned on those assets.
The FTE-adjusted net interest margin is a measure used in evaluating the
management of earning assets and interest-bearing liabilities. The FTE-adjusted
net interest margin was 3.90% in 2004, 3.98% in 2003, and 4.28% in 2002. In
addition to the changes in the Corporation's balance sheet, the primary cause of
the net interest margin changes was the rapid drop in interest rates as the
Federal Reserve reduced short-term interest rates to stimulate the economy. The
Federal Reserve lowered the benchmark federal funds rate from 6.50% at the
beginning of 2001 to 1.00% by June 2003. As a result, the Corporation's prime
lending rate declined from 9.50% at the beginning of 2001 to 4.00% by June 2003.
The prime lending rate remained at 4.00%, a historically low rate, until June
2004, when the Federal Reserve began increasing the federal funds rate. From
June 2004 through February 2005, the federal funds rate increased from 1.00% to
2.50%; in turn, the prime lending rate increased from 4.00% to 5.50% during this
time. The increase positively impacted the Corporation's net interest income
during the second half of 2004. Almost half of the Corporation's loan portfolio
is tied to the prime rate.
The following presentation is an analysis of net interest income on a
taxable equivalent basis for the years 2004, 2003, and 2002. Nonaccrual loans
are included in average balances. Interest income on nonaccrual loans, if
recognized, is recorded on a cash basis.
12
Table 1 - Net Interest Income Analysis
(in thousands, except rates)
Average Balance Interest Income/Expense Average Yield/Rate
----------------------------- ---------------------------- ------------------------------
2004 2003 2002 2004 2003 2002 2004 2003 2002
-------- -------- -------- -------- -------- -------- -------- -------- --------
Loans:
Commercial $ 94,643 $115,377 $113,284 $ 4,992 $ 6,723 $ 7,495 5.27 % 5.83 % 6.62 %
Real Estate 290,884 276,133 244,988 16,237 16,129 16,139 5.58 5.84 6.59
Consumer 18,168 27,360 33,122 1,664 2,478 3,641 9.16 9.06 10.99
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total loans 403,695 418,870 391,394 22,893 25,330 27,275 5.67 6.05 6.97
-------- -------- -------- -------- -------- -------- -------- -------- --------
Securities:
Federal agencies 99,263 71,153 43,063 3,169 2,365 1,942 3.19 3.32 4.51
Mortgage-backed 23,842 30,745 40,055 1,046 1,316 2,352 4.39 4.28 5.87
State and municipal 52,247 43,993 39,173 3,059 2,844 2,667 5.85 6.46 6.81
Other 19,776 22,696 26,962 923 1,247 1,629 4.67 5.49 6.04
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total securities 195,128 168,587 149,253 8,197 7,772 8,590 4.20 4.61 5.76
-------- -------- -------- -------- -------- -------- -------- -------- --------
Deposits in other banks 10,092 11,236 15,792 132 110 248 1.31 .98 1.57
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning assets 608,915 598,693 556,439 31,222 33,212 36,113 5.13 5.55 6.49
-------- -------- -------- -------- -------- --------
Non-earning assets 24,676 25,918 25,459
-------- -------- --------
Total assets $633,591 $624,611 $581,898
======== ======== ========
Deposits:
Demand $ 73,338 $ 63,858 $ 59,852 269 225 417 .37 .35 .70
Money market 53,305 47,293 42,369 428 478 775 .80 1.01 1.83
Savings 83,814 80,876 70,073 439 712 1,048 .52 .88 1.50
Time 204,945 230,070 229,074 4,843 6,500 8,607 2.36 2.83 3.76
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total deposits 415,402 422,097 401,368 5,979 7,915 10,847 1.44 1.88 2.70
Repurchase agreements 46,787 40,917 34,183 528 497 635 1.13 1.21 1.86
Other borrowings 20,931 21,578 17,274 972 979 828 4.64 4.54 4.79
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest bearing
liabilities 483,120 484,592 452,825 7,479 9,391 12,310 1.55 1.94 2.72
-------- -------- -------- -------- -------- -------- -------- -------- --------
Noninterest bearing
demand deposits 76,123 66,300 58,075
Other liabilities 2,846 3,352 3,289
Shareholders' equity 71,862 70,367 67,709
-------- -------- --------
Total liabilities and
shareholders' equity $633,951 $624,611 $581,898
======== ======== ========
Interest rate spread 3.58 % 3.61 % 3.77 %
======== ======== ========
Net interest margin 3.90 % 3.98 % 4.28 %
======== ======== ========
Net interest income (taxable equivalent basis) 23,743 23,821 23,803
Less: Taxable equivalent adjustment 1,102 1,034 978
-------- -------- --------
Net interest income $ 22,641 $ 22,787 $ 22,825
======== ======== ========
13
Table 2 presents the dollar amount of changes in interest income and
interest expense, and distinguishes between the changes related to increases or
decreases in average outstanding balances of interest-earning assets and
interest-bearing liabilities (volume), and the changes related to increases or
decreases in average interest rates on such assets and liabilities (rate).
Changes attributable to both volume and rate have been allocated
proportionately.
Table 2 - Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
2004 vs. 2003 2003 vs. 2002
------------------------------------- -------------------------------------
Interest Change Attributable to Interest Change Attributable to
Increase ----------------------- Increase -----------------------
(Decrease) Rate Volume (Decrease) Rate Volume
---------- --------- ---------- ---------- --------- ----------
Interest income
Loans:
Commercial $ (1,731) $ (598) $ (1,133) $ (772) $ (908) $ 136
Real Estate 108 (733) 841 (10) (1,939) 1,929
Consumer (814) 28 (842) (1,163) (585) (578)
---------- --------- ---------- ---------- ---------- ----------
Total loans (2,437) (1,303) (1,134) (1,945) (3,432) 1,487
---------- --------- ---------- ---------- ---------- ----------
Securities:
Federal agencies 804 (97) 901 423 (606) 1,029
Mortgage-backed (270) 32 (302) (1,036) (558) (478)
State and municipal 215 (285) 500 177 (139) 316
Other securities (324) (175) (149) (382) (139) (243)
---------- --------- ---------- ---------- ---------- ----------
Total securities 425 (525) 950 (818) (1,442) 624
---------- --------- ---------- ---------- ---------- ----------
Deposits in other banks 22 34 (12) (138) (78) (60)
---------- --------- ---------- ---------- ---------- ----------
Total interest income (1,990) (1,794) (196) (2,901) (4,952) 2,051
---------- --------- ---------- ---------- ---------- ----------
Interest expense
Deposits:
Demand 44 10 34 (192) (218) 26
Money market (50) (106) 56 (297) (379) 82
Savings (273) (298) 25 (336) (479) 143
Time (1,657) (994) (663) (2,107) (2,144) 37
---------- --------- ---------- ---------- ---------- ----------
Total deposits (1,936) (1,388) (548) (2,932) (3,220) 288
Repurchase agreements 31 (37) 68 (138) (247) 109
Other borrowings (7) 23 (30) 151 (46) 197
---------- --------- ---------- ---------- ----------- ----------
Total interest expense (1,912) (1,402) (510) (2,919) (3,513) 594
---------- --------- ---------- ---------- ----------- ----------
Net interest income $ (78) $ (392) $ 314 $ 18 $ (1,439) $ 1,457
========== ========= ========== ========== =========== ==========
MARKET RISK MANAGEMENT
Effectively managing market risk is essential to achieving the
Corporation's financial objectives. Market risk reflects the risk of economic
loss resulting from adverse changes in interest rates and market prices. The
Corporation is not subject to currency exchange risk or commodity price risk.
As a financial institution, interest rate risk and its impact on net
interest income is the primary market risk exposure. The magnitude of the change
in earnings resulting from interest rate changes is impacted by the time
remaining to maturity on fixed-rate obligations, the contractual ability to
adjust rates prior to maturity, competition, and the general level of interest
rates and customer actions.
The Asset/Liability Investment Committee ("ALCO") is primarily responsible
for establishing asset and liability strategies and for monitoring and
controlling liquidity and interest rate risk. The Corporation's primary
objectives for managing interest rate volatility are to maximize net interest
income while ensuring adequate liquidity and managing interest rate risk within
established policy guidelines. ALCO is also responsible for evaluating the
competitive rate environment and reviewing investment portfolio transactions.
The Corporation's interest rate sensitivity position at December 31, 2004
is illustrated in the following table. The table presents the carrying amount of
assets and liabilities in the periods they are expected to reprice or mature.
14
Table 3 - Interest Rate Sensitivity Gap Analysis
(in thousands)
Within > 1 Year > 3 Year
1 Year to 3 Years to 5 Years > 5 Years Total
-------------- ------------- ------------- ------------- -------------
Interest sensitive assets:
Interest-bearing deposits
with other banks $ 197 $ - $ - $ - $ 197
Securities (1) 29,738 69,851 33,376 54,858 187,823
Loans (2) 276,163 99,004 27,173 5,900 408,240
-------------- ------------- ------------- ------------- -------------
Total interest
sensitive assets 306,098 168,855 60,549 60,758 596,260
-------------- ------------- ------------- ------------- -------------
Interest sensitive liabilities:
NOW and savings deposits 164,009 - - - 164,009
Money market deposits 52,031 - - - 52,031
Time deposits 123,401 51,604 18,960 11 193,976
Repurchase agreements 38,945 - - - 38,945
Other borrowings 3,950 3,000 13,000 1,388 21,338
-------------- ------------- ------------- ------------- -------------
Total interest
sensitive liabilities 382,336 54,604 31,960 1,399 470,299
-------------- ------------- ------------- ------------- -------------
Interest sensitivity gap $ (76,238) $ 114,251 $ 28,589 $ 59,359 $ 125,961
============== ============= ============= ============= =============
Cumulative interest sensitivity gap $ (76,238) $ 38,013 $ 66,602 $ 125,961
============== ============= ============= =============
Percentage cumulative gap
to total interest sensitive assets (12.8)% 6.4 % 11.2 % 21.1 %
- -----------------------------------------
(1) Securities based on amortized cost.
(2) Loans include loans held for sale and are net of unearned income.
Because of inherent limitations in gap analysis, the Corporation uses more
sophisticated interest rate risk measurement techniques. Simulation analysis is
used to measure the sensitivity of projected earnings to changes in interest
rates. The projected changes in net interest income are calculated and monitored
by ALCO as indicators of interest rate risk. Simulation takes into account the
Corporation's current balance sheet volumes and the scheduled maturities and
payments of assets and liabilities. It incorporates numerous assumptions
including growth, changes in the mix of assets and liabilities, projected
prepayments, and average rates earned and paid. Based on this information, the
model projects net interest income under multiple interest rate scenarios.
Management believes the simulation analysis presents a more accurate picture
since certain rate indices that affect liabilities do not change with the same
magnitude over the same period of time as changes in the prime rate or other
indices that affect rates on loans and securities.
Table 4 shows the estimated impact of changes in interest rates up and down
1%, 2% and 3% on net interest income as of December 31, 2004, assuming immediate
and parallel shifts in interest rates.
15
Table 4 - Change in Net Interest Income and Market Value of Portfolio Equity
(in thousands)
2004 2003
------------------------ ------------------------
Changes in Changes in
Change in Net Interest Income (1) Net Interest Income (1)
Interest ------------------------ ------------------------
Rates Amount Percent Amount Percent
----------- ---------- ----------- ---------- -----------
Up 3% $ 1,476 6.31 % $ 2,586 10.99 %
Up 2% 1,094 4.68 1,571 6.67
Up 1% 604 2.58 1,111 4.72
Down 1% (704) (3.01) (842) (3.58)
Down 2% (1,755) (7.51) (2,257) (9.59)
Down 3% (3,030) (12.96) (3,686) (15.66)
(1) Represents the difference between estimated net interest income for the
next 12 months in the new interest rate environment and the current interest
rate environment.
The projected changes in net interest income to changes in interest rates
at December 31, 2004, were within compliance of established policy guidelines.
Net interest income for the next twelve months is projected to increase when
interest rates are higher than current rates and decrease when interest rates
are lower than current rates.
The Corporation cannot predict future interest rates or their exact effects
on net interest income. Computations of prospective effects of hypothetical
interest rate changes are based on numerous assumptions, including relative
levels of market interest rates, asset and liability prepayments and balance
sheet composition and should not be relied upon as indicative of actual results.
Certain limitations are inherent in such computations. Certain assets and
liabilities may react differently than projected to changes in market interest
rates. The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while rates on other
types of assets and liabilities may lag behind changes in market interest rates.
Also, the methodology uses estimates of various rates of withdrawal for money
market deposits, savings, and checking accounts, which may vary significantly
from actual experience.
Based on the modeling system used by the Corporation to measure the impact
of rate changes to net interest income, an increase of 1% to the federal funds
rate, and the resulting changes to the Wall Street Journal prime rate and
expected changes to the U.S. Treasury interest rate curve would add, for a full
twelve month period, $604,000 to net interest income. Should the same rates
decrease by 1%, pre-tax net interest income would decline by $704,000 for a
twelve month period.
The Corporation is also subject to prepayment risk, particularly in falling
interest rate environments or in environments where the slope of the yield curve
is relatively flat or negative. Such changes in the interest rate environment
can cause substantial changes in the level of prepayments of loans, which may
also affect the Corporation's interest rate sensitivity gap position.
Additionally, credit risk may increase if an interest rate increase adversely
affects the ability of many borrowers to service their debt.
NONINTEREST INCOME
Noninterest income totaled $6.5 million in 2004 compared with $6.7 million
in 2003 and $5.7 million in 2002. This represented a decrease of 2.4% for 2004,
compared to an increase of 16.8% for 2003. The primary reason for the decline in
2004 was a $985,000 impairment charge on $4.5 million of FHLMC and FNMA
perpetual preferred stock. Based upon a detailed analysis, the Corporation
concluded both securities were "other-than-temporarily impaired" at December 31,
2004 as defined by accounting interpretations. Excluding this impairment charge,
2004 noninterest income would have increased 12.4% over 2003.
Fees from the management of trusts, estates and asset management accounts
totaled $3.0 million in 2004, an increase of 18.0% over 2003. Trust fees in 2003
increased 0.3% from 2002. Fees in 2004 included income from the Corporation's
trust office in Martinsville, which expanded in 2004. Increases in the equity
markets also had a positive influence on 2004 fee income from trust activities.
Declines in the equity markets placed pressure on the growth in fee income in
2003 and 2002. The Corporation's trust and investment services division managed
assets with an approximate market value of $349 million at December 31, 2004,
$338 million at December 31, 2003, and $298 million at December 31, 2002.
16
Service charges on deposit accounts were $2.4 million in 2004, an increase
of $248,000 or 11.5% from 2003. Service charges during 2003 totaled $2.2 million
which was an increase of $457,000, or 26.8%, from 2002. The introduction of an
overdraft protection program during 2003 was the primary reason for the
increased fee income in 2003 and 2004.
Other fees and commissions were $888,000 in 2004, $914,000 in 2003, and
$816,000 in 2002. Non-customer ATM fees, debit and merchant credit card fees,
safe deposit box rent, brokerage investment commissions and insurance
commissions represent the majority of the income in this category. In 2004,
income earned from the sale of consumer investment and insurance products
declined. The increase in 2003 resulted primarily from growth in retail
investment fees, interchange income from debit card transactions, and
non-customer ATM transaction fees.
Mortgage banking income represents fees from originating, selling, and to a
lesser extent, brokering residential mortgage loans. Mortgage banking income was
$612,000 in 2004, $571,000 in 2003, and $361,000 in 2002. Fee income rose in
2004 due to an improvement in the average yield earned per loan. Fee income
increased in 2003 versus 2002 due to increased loan volume and increased yields.
Increased refinance activity occurred in 2003 and 2004, contributing to the
volume of loans originated and sold. Changes in interest rates directly impact
the volume of refinance activity and, in turn, the amount of mortgage banking
fee income earned.
Securities are sold from time to time for balance sheet management purposes
or because an investment no longer meets the Corporation's policy requirements.
Net gains on sales of securities were $157,000 in 2004, $115,000 in 2003, and
$39,000 in 2002.
An other-than-temporary impairment charge of $985,000 on $4.5 million of
FHLMC and FNMA perpetual preferred stock was charged to earnings in the fourth
quarter of 2004. This was done after a thorough analysis of recent public
disclosures about FHLMC and FNMA, the length of time the market value of the
securities had been less than cost, the amount of the loss in comparison with
the amortized cost, the results of an impairment analysis recently completed by
an outside party, and accounting interpretations.
Other income increased from $385,000 in 2003 to $451,000 in 2004 due
primarily to fee gains from the sale or disposal of real estate, including a
former branch site. Other income increased $111,000 from 2002 to 2003 due
largely to increases in check order income and dividends from an equity interest
in a title insurance agency. The mortgage refinance boom of 2003 was the primary
reason the dividend returns on the Corporation's investment in the title agency
increased. 2003 other income also included funds from the Virginia Department of
Transportation highway department to compensate the Corporation for a taking of
property at one of the Danville retail banking offices.
NONINTEREST EXPENSE
Noninterest expense for 2004 was $15.0 million compared with $15.1 million
in 2003 and $14.3 million in 2002. Noninterest expense includes salaries,
pension, health insurance and other employee benefits, occupancy and equipment
expense, bank franchise tax expense, core deposit intangible amortization and
other expenses.
Salaries were $6.8 million in both 2004 and 2003. The impact of additional
staff members and pay raises was offset by a decline in profit sharing and
incentive expense. The Corporation did not meet its profitability goals in 2004;
therefore, no profit sharing expense was accrued or paid. Salary expense of $6.8
million in 2003 increased $325,000, or 5.0%, over 2002 due to additional
staffing as well as salary increases for existing staff.
Pension and other employee benefits declined $115,000 from 2003 to 2004,
due primarily to a reduction in profit sharing expense. Pension and other
employee benefits increased $343,000 from 2002 to 2003, due to increased
premiums on medical insurance and higher pension costs. Other benefit cost
increases could be traced to additional staffing or plan participation as social
security taxes, Medicare taxes, and 401k contribution expenses increased.
Occupancy and equipment expense declined $56,000 or 2.2% in 2004 over 2003,
due to a decline in depreciation expense. Occupancy and equipment expense
increased marginally in 2003, primarily driven by increases in computer software
maintenance and other small increases relating to facility utilities expenses.
Bank franchise tax expense was $555,000 in 2004, compared with $547,000 in
2003 and $513,000 in 2002. This expense is based in large part on the level of
shareholders' equity at each year-end.
Core deposit intangible expense of $450,000 represents the amortization of
the premium paid for deposits acquired at the Gretna office in 1995 and the
Yanceyville office in 1996. The core deposit intangible continues to be
amortized on a straight-line basis over a ten-year period based on management's
conclusion that the purchase did not constitute the acquisition of a business.
17
The amortization will be complete in 2005 for the Gretna office and 2006 for the
Yanceyville office.
Other expense increased $112,000 or 3.8% from 2003 to 2004. The largest
contributor to this change was an increase in professional fees, which included
an increase in legal fees of $33,000 due to additional loan collection
activities, and a $32,000 increase in audit expense due primarily to costs of
complying with the requirements of the Sarbanes-Oxley Act ("SOX"). With the
exception of documenting information technology controls, management chose to
use internal staff to perform the documentation and testing requirements of SOX.
The audit expense referred to above includes only direct expenses paid to an
outside firm for technology controls documentation and those paid to the
Corporation's public accounting firm to audit management's assessment of
internal controls. It does not include internal costs associated with SOX.
Management continues to focus on controlling overhead expenses in relation
to income growth. The efficiency ratio, a productivity measure used to determine
how well noninterest expense is managed, was 48.5%, 49.7%, and 48.4% for 2004,
2003, and 2002, respectively. A lower efficiency ratio indicates more favorable
expense efficiency. Leaders in expense efficiency in the banking industry have
achieved ratios in the 45-55% range while the peer group average is
approximately 60%. The Corporation's strategy of expanding into higher growth
markets could negatively impact the efficiency ratio in the short term.
INCOME TAX PROVISION
Applicable income taxes on 2004 earnings amounted to $3.0 million,
resulting in an effective tax rate of 27.5%, compared to 29.2% in 2003 and 29.3%
in 2002. The Corporation was subject to a blended Federal tax rate of 34.1% in
2004, 34.3% in 2003, and 34.2% in 2002. The major difference between the
statutory rate and the effective rate results from income that is not taxable
for Federal income tax purposes. The primary non-taxable income is that of state
and municipal securities and industrial revenue bonds or loans. The decrease in
the effective tax rate for 2004 as compared to 2003 was a result of the increase
in earnings from tax-exempt assets as a percentage of total income.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL
GENERAL
Average assets were $633.6 million in 2004, compared with $624.6 million in
2003. Average loans declined $15.2 million, or 3.6% from 2003 to 2004,
reflecting strong competition in our market, pay-downs of participation loans,
and more stringent underwriting requirements. Average deposits increased $3.1
million or 0.6% as redemptions of higher cost certificates of deposit offset
most of the increase in demand, money market, and savings deposits. Average
certificates of deposit declined $25.1 million, or 10.9% from 2003 to 2004 due
in large part to high rates of interest for certificates of deposit offered by
competitors. During 2004, the Corporation chose not to be aggressive in its
certificate of deposit pricing, instead focusing on growth in low cost deposits.
The Corporation will continue to focus on growing low cost deposits through its
business development efforts aimed at expanding customer relationships.
SECURITIES
The securities portfolio consists primarily of investments for which an
active market exists. The securities portfolio generates income, plays a primary
role in the management of interest rate sensitivity, provides a source of
liquidity, and is used to meet collateral requirements.
The securities portfolio consists of two components, securities held to
maturity and securities available for sale. Securities are classified as held to
maturity based on management's intent and the Corporation's ability, at the time
of purchase, to hold such securities to maturity. These securities are carried
at amortized cost. Securities which may be sold in response to changes in market
interest rates, changes in prepayment or credit risk, liquidity needs, or other
factors are classified as available for sale and are carried at estimated fair
value.
An other-than-temporary impairment charge of $985,000 on $4.5 million of
FHLMC and FNMA perpetual preferred stock was charged to earnings in the fourth
quarter of 2004. This was done after a thorough analysis of recent public
disclosures about FHLMC and FNMA, the length of time the market value of the
securities had been less than cost, the amount of the loss in comparison with
the amortized cost, the results of an impairment analysis recently completed by
an outside party, and accounting interpretations.
18
Table 5 - Securities Portfolio
This table presents information on the amortized cost, maturities and taxable equivalent yields of securities at the end of
the last 3 years (in thousands, except yields):
- --------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
---------------------------- ---------------------------- ----------------------------
Taxable Taxable Taxable
Amortized Equivalent Amortized Equivalent Amortized Equivalent
Cost Yield Cost Yield Cost Yield
------------- ------------ ------------- ----------- ------------- -----------
Federal Agencies:
Within 1 year $ 12,012 3.98% $ 18,033 1.40% $ 1,000 2.55%
1 to 5 years 56,456 2.87 63,199 3.24 40,650 4.17
5 to 10 years 18,997 3.80 33,670 2.81 17,642 3.13
Over 10 years - - - - - -
------------- ------------ ------------- ----------- ------------- ----------
Total 87,465 3.22 114,902 2.82 59,292 3.83
------------- ------------ ------------- ----------- ------------- ----------
Mortgage-backed:
Within 1 year 24 5.62 - - 1,144 6.48
1 to 5 years 3,770 4.32 1,259 3.13 281 6.62
5 to 10 years 13,482 4.47 8,958 4.95 14,429 4.81
Over 10 years 12,033 4.32 10,703 4.71 19,499 5.87
------------- ------------ ------------- ----------- ------------- ----------
Total 29,309 4.39 20,920 4.72 35,353 5.46
------------- ------------ ------------- ----------- ------------- ----------
State and Municipal:
Within 1 year 3,849 5.89 2,150 6.71 3,204 6.76
1 to 5 years 18,730 6.03 17,019 6.11 17,720 6.44
5 to 10 years 26,886 4.97 26,689 5.14 14,678 6.56
Over 10 years 4,257 6.15 3,912 6.52 3,677 6.97
------------- ------------ ------------- ----------- ------------- ----------
Total 53,722 5.51 49,770 5.65 39,279 6.56
------------- ------------ ------------- ----------- ------------- ----------
Other Securities:
Within 1 year 2,706 6.03 2,003 6.15 5,219 6.45
1 to 5 years 8,070 5.58 10,891 6.02 13,434 6.13
5 to 10 years - - - - - -
Over 10 years 6,551 2.43 7,029 2.91 7,335 5.17
------------- ------------ ------------- ----------- ------------- ----------
Total 17,327 4.46 19,923 4.94 25,988 5.92
------------- ------------ ------------- ----------- ------------- ----------
Total portfolio $187,823 4.17% $205,515 3.91% $159,912 5.20%
============= ============ ============= =========== ============= ==========
The securities portfolio declined from $205.5 million at year-end 2003 to
$187.8 million at year-end 2004, as investment maturities were used to fund
redemptions of time deposits. The securities portfolio grew from $159.9 at
year-end 2002 to $205.5 at year-end 2003, due to deposit increases. The
securities portfolio at December 31, 2003 also included a $15.0 million
short-term investment used to offset a large customer deposit made in December
2003. Note 2 of the consolidated financial statements provides details of the
amortized cost, unrealized gains and losses, and estimated fair value of each
category of the investment portfolio as of December 31, 2004 and 2003. The state
and municipal securities portfolio is diversified among many different issues
and localities.
LOANS
The Corporation focuses its lending efforts on commercial loans to small
and medium-sized businesses, construction and commercial real estate loans,
equity lines and mortgages. Average loans declined $15.2 million, or 3.6% from
2003 to 2004, reflecting strong competition in our market, pay-downs of
participation loans, and more stringent underwriting requirements. Loans held
for sale are loans originated and in process of being sold to the secondary
market. These loans totaled $971,000 at December 31, 2004 and $560,000 at
December 31, 2003. The discussion below excludes loans held for sale.
Despite the decline in average loans from 2003 to 2004, loan growth was
strong during the latter part of 2004. Total loans ended the year at $407.3
million, up slightly from $406.2 million at December 31, 2003. Loans outstanding
19
in the Corporation's Greensboro, North Carolina loan production office, opened
in April 2004, were approximately $6.9 million at December 31, 2004. The
majority of those loans were to provide financing for residential construction
and development activities. During 2004, loan production across all the
Corporation's market was strongest in construction, land development, and
commercial real estate lending. Commercial and industrial loans continued to
decline due to a softening of demand for those types of loans. Consumer loans
continued to decline due to strong competition from other financial institutions
and captive finance companies. Management anticipates this trend to continue in
2005 and considers the loan portfolio to be diversified as it consists of 33.0%
in residential real estate loans, 44.6% in other real estate secured loans
including commercial real estate, multi-family, farmland and construction and
land development loans, 18.6% in commercial, industrial and agricultural loans,
and 3.8% in consumer loans as of December 31, 2004.
The Corporation does not participate in highly leveraged lending
transactions, as defined by the bank regulators and there are no loans of this
nature recorded in the loan portfolio. The Corporation has no foreign loans in
its portfolio. At December 31, 2004, the Corporation had no loan concentrations
(loans to borrowers engaged in similar activities) which exceeded 10% of total
loans (in thousands):
Table 6 illustrates loans by type. Table 7 presents the maturity schedule
of selected loan types.
Table 6 - Loans
(in thousands)
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Real estate loans:
Construction and land development $ 34,101 $ 12,790 $ 9,208 $ 10,282 $ 9,284
Secured by farmland 2,853 3,430 1,485 1,110 1,616
Secured by 1-4 family residential
properties 134,292 136,229 129,905 126,607 121,449
Secured by multi-family (5 or more)
residential properties 9,033 6,801 6,329 6,385 5,023
Secured by nonfarm, nonresidential
properties 135,767 126,164 107,263 88,648 67,312
Loans to farmers 1,442 1,618 1,844 1,452 1,625
Commercial and industrial loans 70,336 91,419 113,575 98,324 83,428
Consumer loans 15,248 23,581 32,008 36,077 44,389
Loans for nonrated industrial
development obligations 4,069 4,077 4,745 6,436 5,590
Deposit overdrafts 128 136 41 19 40
-------- -------- -------- -------- --------
Loans - net of unearned income $407,269 $406,245 $406,403 $375,340 $339,756
======== ======== ======== ======== ========
Table 7 - Scheduled Loan Maturities
(in thousands)
Commercial
and Real Estate
Agricultural Construction Total
------------ ------------ ----------
1 year or less $ 19,821 $ 19,302 $ 39,123
1-5 years 34,564 2,968 37,532
After 5 years 21,462 11,831 33,293
------------ ------------ ----------
Total $ 75,847 $ 34,101 $ 109,948
============ ============ ==========
Of the loans due after one year, $11,309 have predetermined interest rates
and $59,516 have floating or adjustable interest rates.
20
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The purpose of the allowance for loan losses is to provide for losses
inherent in the loan portfolio. The allowance is increased by the provision for
losses and by recoveries from losses. Charge-offs of loan balances decrease the
allowance.
The Corporation's lenders are responsible for assigning risk ratings to
loans using the parameters set forth in the Corporation's Credit Policy. The
risk ratings are reviewed for accuracy, on a sample basis, by the Corporation's
Loan Review department, which operates independently of loan production. These
risk ratings are used in calculating the level of the allowance for loan losses.
The Corporation's Credit Committee has responsibility for determining the
level and adequacy of the allowance for loan losses, subject to review by the
Board of Directors. Among other factors, the Committee on a quarterly basis
considers the Corporation's historical loss experience; the size and composition
of the loan portfolio; individual risk ratings; nonperforming loans, impaired
loans, and other problem credits; the value and adequacy of collateral and
guarantors; and national and local economic conditions.
A significant portion of the Corporation's trade area, which includes the
City of Danville, City of Martinsville, Town of South Boston, Pittsylvania,
Henry and Halifax Counties in Virginia, Town of Yanceyville and the northern
half of Caswell County in North Carolina, is under economic pressure. The region
has traditionally been heavily dependent on manufacturing. While diversification
has occurred in manufacturing in recent years, a textile firm and a tire
manufacturing plant in Danville employ a significant workforce. Increased global
competition has negatively impacted the textile industry in the area with
several manufacturers closing due to competitive pressures or due to the
relocation of some operations to foreign countries. Other important industries
include farming, tobacco processing and sales, food processing, furniture
manufacturing and sales, specialty glass manufacturing, and packaging tape
production. An inherent risk to the loan portfolio exists if significant
declines continue in the manufacturing sector along with a corresponding
reduction in employment.
There are additional risks of future loan losses that cannot be precisely
quantified or attributed to particular loans or classes of loans. Since those
factors include general economic trends as well as conditions affecting
individual borrowers, the allowance for loan losses is an estimate. The sum of
these elements is the Credit Committee's recommended level for the allowance.
The unallocated portion of the allowance is based on loss factors that cannot be
associated with specific loans or loan categories. These factors include
management's subjective evaluation of such conditions as credit quality trends,
collateral values, portfolio concentrations, specific industry conditions in the
regional economy, regulatory examination results, internal audit and loan review
findings, and recent loss experiences in particular portfolio segments. The
unallocated portion of the allowance for losses reflects management's attempt to
ensure that the overall reserve appropriately reflects a margin for the
imprecision necessarily inherent in estimates of credit losses.
The allowance is also subject to regulatory examinations and determination
as to adequacy, which may take into account such factors as the methodology used
to calculate the allowance and the size of the allowance in comparison to peer
banks identified by regulatory agencies.
In December 2004, the Corporation added an additional $2.0 million to its
allowance for loan losses primarily related to a $4.5 million loan secured by a
hotel in a major North Carolina metropolitan area. Although payments on the loan
have always been current, the cash flow and collateral valuation of the hotel
has deteriorated; thus, the loan was deemed impaired and was placed on
nonaccrual status at December 31, 2004.
Due primarily to the provision needed for the hotel loan noted above, the
provision for loan losses increased significantly from $920,000 in 2003 to $3.1
million in 2004. The provision for loan losses was $873,000 in 2002.
Loans charged off, net of recoveries, totaled $405,000 in 2004, $1,250,000
in 2003, and $585,000 in 2002. The ratio of net charge-offs to average loans was
0.10% in 2004, 0.30% in 2003, and 0.15% in 2002. In 2003, a partial charge-off
of one commercial loan accounted for $744,000 of the net charge-offs for that
year. Table 10 presents the Corporation's loan loss and recovery experience for
the past five years.
The allowance for loan losses totaled $8.0 million at December 31, 2004, an
increase of $2.7 million over December 31, 2003. The increase was primarily
attributable to the additional provision related to the hotel loan discussed
above. The ratio of the allowance to loans, less unearned income, at December
31, 2004, 2003, and 2002, was 1.96%, 1.30%, and 1.38%, respectively. Management
believes that the allowance for loan losses is adequate to absorb losses
inherent in the Corporation's loan portfolio at December 31, 2004.
21
The allowance for loan losses is allocated to loan types based upon
historical loss factors; risk grades on individual loans; portfolio analyses of
smaller balance, homogenous loans; and qualitative factors. Qualitative factors
include trends in delinquencies, nonaccruals, and loss rates; trends in volume
and terms of loans, effects of changes in risk selection, underwriting
standards, and lending policies; experience of lending officers and other
lending staff; national and local economic trends and conditions; and
concentrations of credit. The assessed risk of loan loss is higher in the
commercial and consumer loan categories than in the residential real estate
categories. Table 8 summarizes the allocation of the allowance for loan losses
for the past five years.
Table 8 - Allocation of Allowance for Loan Losses
Management has allocated the allowance for loan losses to loan categories
as follows (in thousands):
2004 2003 2002 2001 2000
------------------ ----------------- ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Amount loans Amount loans Amount loans Amount loans Amount loans
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Commercial
(including
commercial
real estate) $5,927 61 % $2,881 59 % $3,196 59 % $2,005 55 % $1,691 50 %
Real estate-
residential 1,231 35 848 35 781 33 236 35 177 37
Consumer 816 4 1,141 6 1,247 8 1,276 10 1,304 13
Unallocated 8 - 422 - 398 - 1,817 - 1,574 -
-------- -------- -------- -------- -------- -------- -------- -------- --------- --------
Balance at
end of year $7,982 100 % $5,292 100 % $5,622 100 % $5,334 100 % $4,746 100 %
======== ======== ======== ======== ======== ======== ======== ======== ========= ========
Table 9 - Asset Quality Ratios
2004 2003 2002 2001 2000
-------- -------- --------- --------- --------
Allowance to loans 1.96 % 1.30 % 1.38 % 1.42 % 1.40 %
Net charge-offs to allowance 5.07 23.62 10.41 8.00 8.60
Net charge-offs to average loans .10 .30 .15 .12 .13
Nonperforming assets to assets 1.35 .56 .09 .16 .12
Nonperforming loans to year-end loans 1.99 .82 .13 .22 .11
Provision to net charge-offs 764.20 73.60 149.23 237.72 250.00
Provision to average loans .77 .22 .22 .28 .32
Allowance to nonperforming loans .98 X 1.60 X 10.41 X 6.46 X 12.33 X
22
Table 10 - Summary of Loan Loss Experience
(dollars in thousands)
2004 2003 2002 2001 2000
------------ ------------ ----------- ----------- ------------
Balance at beginning of period $5,292 $5,622 $5,334 $4,746 $4,135
------------ ------------ ----------- ----------- ------------
Charge-offs:
Commercial loans 169 1,004 343 141 141
Real estate loans 129 80 33 59 9
Consumer loans 357 373 364 402 417
------------ ------------ ----------- ----------- ------------
655 1,457 740 602 567
------------ ------------ ----------- ----------- ------------
Recoveries:
Commercial loans 45 105 28 75 32
Real estate loans 49 - 3 3 1
Consumer loans 156 102 124 97 125
------------ ------------ ----------- ----------- ------------
250 207 155 175 158
------------ ------------ ----------- ----------- ------------
Net charge-offs 405 1,250 585 427 409
Provision for loan losses 3,095 920 873 1,015 1,020
------------ ------------ ----------- ----------- ------------
Balance at end of period $7,982 $5,292 $5,622 $5,334 $4,746
============ ============ =========== =========== ============
Percentage of net charge-offs
to average loans .10% .30% .15% .12% .13%
============ ============ =========== =========== ============
ASSET QUALITY, CREDIT RISK MANAGEMENT AND NONPERFORMING ASSETS
The Corporation identifies specific credit exposures through its periodic
analysis of the loan portfolio and monitors general exposures from economic
trends, market values and other external factors. The Corporation maintains an
allowance for loan losses, which is available to absorb losses inherent in the
loan portfolio. The adequacy of the allowance for loan losses is determined on a
quarterly basis. Various factors as defined in the previous section "Allowance
and Provision for Loan Losses" are considered in determining the adequacy of the
allowance.
The Corporation uses certain general practices to manage its credit risk.
These practices include (a) appropriate lending limits for loan officers, (b) an
established loan approval process, (c) careful underwriting of loan requests,
including analysis of borrowers, collateral, and market risks, (d) regular
monitoring of the portfolio, (d) review of loans by a Loan Review department
which operates independently of loan production, (e) regular meetings of a
Credit Committee to discuss portfolio and policy changes, and (f) regular
meetings of an Asset Quality Committee which reviews the status of individual
loans.
Loans are generally placed on nonaccrual status when any portion of
principal or interest is 90 days past due or collection is uncertain. Unless
loans are secured and in the process of collection, they are normally charged
off after a delinquency of 120 days. Under the Corporation's policy, a
nonaccruing loan may be restored to accrual status when none of its principal
and interest is past due and unpaid, the borrower has shown a reasonable
sustained ability to service the debt, and the Corporation expects repayment of
the remaining contractual principal and interest or when it otherwise becomes
secured and in the process of collection.
In 2003, the Corporation reorganized its lending and credit functions. A
new Chief Credit Officer position was created, a new credit policy manual was
implemented, new lending committee structures were introduced, and a new risk
grading methodology was adopted. This new risk grading system has better focused
management on identifying loan portfolio risks. The decline in several asset
quality measurements on a year-to-year basis can be partially explained by the
more rigorous approach management is taking using the new risk grading process.
These systems were considered necessary to support future loan growth in
existing and new markets.
During 2003, the Corporation began moving consumer loans, generally, to
nonaccrual status after they reached 90 days past due; the previous system
typically did not place these loans on nonaccrual status, but normally charged
them off when they reached 180 days past due. New internal limits were also
23
placed on time and demand loan renewals. Both of these changes, along with the
changes to the risk grading system, increased the number of reported
nonperforming loans.
In December 2004, the Corporation added an additional $2.0 million to its
allowance for loan losses primarily related to a $4.5 million loan secured by a
hotel in a major North Carolina metropolitan area. Although payments on the loan
have always been current, the cash flow and collateral valuation of the hotel
has deteriorated; thus, the loan was deemed impaired and was placed on
nonaccrual status at December 31, 2004.
Nonperforming loans include loans on which interest is no longer accrued,
accruing loans that are contractually past due 90 days or more as to principal
and interest payments, and loans classified as troubled debt restructurings.
Nonperforming assets include nonperforming loans and foreclosed real estate.
Nonperforming loans as a percentage of total loans increased from 0.81% at
December 31, 2003 to 1.99% at December 31, 2004. The placement of the hotel loan
discussed above onto nonaccrual status at December 31, 2004 was the primary
reason for the increase. Nonperforming loans to total loans were .13% at
December 31, 2002. The following table summarizes nonperforming assets at
December 31.
Table 11 - Nonperforming Assets
(in thousands)
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Nonaccruing loans:
Real Estate $7,005 $1,870 $ 293 $ 414 $ 65
Commercial 853 1,236 - 115 67
Agricultural 12 8 8 39 14
Consumer 243 148 - - -
------ ------ ------ ------ ------
Total nonaccruing loans 8,113 3,262 301 568 146
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Restructured loans: - - - - -
------ ------ ------ ------ ------
Loans past due 90 days and
accruing interest:
Real Estate - - - - -
Commercial - - 33 33 49
Agricultural - - 1 8 14
Consumer - 53 205 217 176
------ ------ ------ ------ ------
Total past due loans - 53 239 258 239
------ ------ ------ ------ ------
Total nonperforming loans 8,113 3,315 540 826 385
------ ------ ------ ------ ------
Foreclosed real estate 221 303 30 117 245
------ ------ ------ ------ ------
Total nonperforming assets $8,334 $3,618 $ 570 $ 943 $ 630
====== ====== ====== ====== ======
Nonaccrual loans include impaired loans on nonaccrual status of $5.8
million at December 31, 2004, $2.5 million at December 31, 2003, and $54,000 at
December 31, 2002. There were no impaired loans at December 31, 2001 or 2000.
As of December 31, 2004, loans totaling $6.3 million were considered
impaired according to Financial Accounting Statement No. 114 "Accounting by
Creditors for Impairment of a Loan" and later amended by Financial Accounting
Statement No. 118 "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures." There were $2.5 million of such loans as of
December 31, 2003. The hotel loan discussed above is the primary reason for the
increase. A loan is considered impaired if it is probable that the lender will
be unable to collect all amounts due under the contractual terms of the loan
agreement.
Foreclosed real estate totaled $221,000 at December 31, 2004 and $303,000
at December 31, 2003.
The Corporation has a commercial real estate loan in the amount of $3.0
million to a textile manufacturer who filed for reorganization under Chapter 11
of the Bankruptcy Code on March 31, 2004. In conjunction with the filing, the
borrower secured debtor-in-possession financing from its primary lender. During
the bankruptcy period, the borrower was required by court order to make monthly
interest payments to the Corporation from the date of the filing, and such
24
payments are current. The borrower emerged from bankruptcy in February 2005. The
loan is in process of being placed on a fifteen-year amortization schedule. It
is secured by a first deed of trust on a commercial property appraised for an
amount exceeding the loan balance.
LIQUIDITY
Liquidity is the measure of the Corporation's ability to generate
sufficient funds to meet customer demands for loans and the withdrawal of
deposit balances. Liquidity is provided from cash and amounts due from banks,
federal funds sold, interest-bearing deposits in other banks, loan repayments,
increases in deposits, lines of credit from the Federal Home Loan Bank of
Atlanta ("FHLB") and two correspondent banks, and maturing investments.
Management believes that these factors provide sufficient and timely liquidity
for the foreseeable future.
Management monitors and plans the Corporation's liquidity position for
future periods. Liquidity strategies are implemented and monitored by ALCO. The
Committee uses a simulation and budget model to assess the future liquidity
needs of the Corporation and manage the investment of funds.
The Corporation's net liquid assets, which includes cash and due from banks
and unpledged securities available-for-sale, less the Corporation's reserve
requirement, to net liabilities ratio was 19.7% at December 31, 2004 and 21.3%
at December 31, 2003. Both of these ratios are considered to reflect adequate
liquidity for the respective periods.
The Corporation has credit availability equal to 30% of assets with FHLB
that equaled $185.5 million, with $164.2 million available at December 31, 2004.
Borrowings outstanding under this line of credit were $21.3 million and $21.0
million, respectively, at December 31, 2004 and December 31, 2003. Under the
terms of its collateral agreement with the FHLB, the Corporation provides a
blanket lien covering all of its residential first mortgage loans, second
mortgage loans and home equity lines of credit. In addition, the Corporation
pledges as collateral its capital stock in the FHLB and deposits with the FHLB.
The Corporation has fixed-rate term borrowing contracts with the FHLB as of
December 31, 2004 in the following final maturities:
Amount Expiration Date
---------- ---------------
$2,000,000 2005
$2,000,000 2006
$1,000,000 2007
$8,000,000 2008
$5,000,000 2009
$1,388,000 2014
The Corporation also has federal funds lines of credit facilities
established with two other banks in the amounts of $12,000,000 and $5,000,000,
as well as access to the Federal Reserve Bank of Richmond's discount window
should a liquidity crisis occur. The Corporation considers these as backup
sources of funds.
DEPOSITS
The Corporation's major source of funds is its customer deposit base.
During 2004, the Corporation did not strive to retain high-cost certificates of
deposit ("time deposits"). Instead, it focused on growing lower cost checking,
savings, and money market accounts ("core deposits"). The results of this
strategy are evident in Table 12. Core deposits increased $28.3 million, or
10.9% in 2004, after rising $28.0 million, or 12.1% in 2003. Growth in core
deposits provides the Corporation with lower-cost funding and helps solidify and
expand its customer relationships. Average time deposits declined $25.1 million,
or 10.9%, during 2004, after increasing by 0.4% in 2003. Certificates of deposit
of $100,000 or more are detailed in Table 13 and declined in 2004 from the
balance of $61.4 million at December 31, 2003.
25
Table 12 - Deposits
(in thousands)
2004 2003 2002
--------------------------- --------------------------- ---------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------ ------------ ------------ ------------ ------------- ------------
Demand deposits -
noninterest bearing $ 76,123 - % $ 66,300 - % $ 58,075 - %
Demand deposits -
interest bearing 73,338 .37% 63,858 .35% 59,852 .70%
Money market 53,305 .80% 47,293 1.01% 42,369 1.83%
Savings 83,814 .52% 80,876 .88% 70,073 1.50%
Time 204,945 2.36% 230,070 2.83% 229,074 3.76%
------------ ------------ ------------ ------------ ------------- ------------
$491,525 1.21% $488,397 1.62% $459,443 2.36%
============ ============ =============
Table 13 - Certificates of Deposit
(in thousands)
Certificates of deposit at December 31, 2004 in amounts of $100,000 or more
were classified by maturity as follows:
3 months or less $ 9,219
Over 3 through 6 months 6,839
Over 6 through 12 months 14,454
Over 12 months 22,642
-------
$53,154
=======
OFF-BALANCE SHEET TRANSACTIONS
The Corporation enters into certain financial transactions in the ordinary
course of performing traditional banking services that result in off-balance
sheet transactions. These off-balance sheet transactions include commitments to
extend credit, standby letters of credit, and commitments to purchase
securities. The Corporation does not have any off-balance sheet subsidiaries or
special purpose entities. Off-balance sheet transactions were as follows (in
thousands):
Off-Balance Sheet Transactions December 31, 2004 December 31, 2003
------------------------------------- ----------------- -----------------
Commitments to extend credit $ 130,862 $ 124,905
Standby letters of credit 4,849 3,477
Commitments to purchase securities - 700
Mortgage loan locked-rate commitments $ 2,818 $ 1,019
Commitments to extend credit to customers represent legally binding
agreements with fixed expiration dates or other termination clauses. Since many
of the commitments are expected to expire without being funded, the total
commitment amounts do not necessarily represent future liquidity requirements.
Standby letters of credit are conditional commitments issued by the Corporation
guaranteeing the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements. The
Corporation does not have any off-balance sheet subsidiaries or special purpose
entities.
26
CONTRACTUAL OBLIGATIONS
The following items are contractual obligations of the Corporation as of
December 31, 2004 (in thousands):
Payments Due by Period
----------------------------------------------------------
More than
Contractual Obligations Total Under 1 Year 1-3 Years 3-5 Years 5 years
----------------------- ------- ------------ --------- --------- ---------
FHLB advances $21,338 $ 1,950 $ 4,000 $ 14,000 $ 1,388
Repurchase agreements 38,945 38,945 - - -
Operating leases 476 146 186 108 36
Purchase obligations - - - - -
CAPITAL
Shareholders' equity was $71.9 million at December 31, 2003 and $71.0
million at December 31, 2004. During 2004, shareholders' equity was increased by
net income and proceeds from the exercise of stock options; shareholders' equity
was decreased by dividends, stock repurchases, and a decrease in accumulated
other comprehensive income.
The Corporation's Board of Directors declared and paid quarterly dividends
totaling $.79 and $.75 per share of common stock in 2004 and 2003, respectively.
Cash dividends totaled $4,411,000 and represented a 55.1% payout of 2004 net
income, compared to 44.9% in 2003 and 43.5% in 2002. The Corporation intends to
pay dividends that are competitive in the banking industry while maintaining an
adequate level of capital to support growth.
On August 17, 2004, the Corporation's board of directors approved the
extension of its stock repurchase plan, begun in 2000, to include the repurchase
of up to 250,000 shares of the Corporation's common stock between August 18,
2004 and August 16, 2005. The stock may be purchased in the open market or in
privately negotiated transactions as management and the board of directors
determine to be in the best interest of the Corporation. Since August 16, 2000,
the number of shares repurchased is displayed in the table below:
Shares Average
Repurchased Price
----------- --------
2000 40,000 $14.10
2001 254,366 18.08
2002 45,100 23.26
2003 125,000 25.03
2004 159,968 23.67
---------- --------
Total 624,434 $21.02
========== ========
One measure of a financial institution's capital strength is the ratio of
shareholder's equity to assets. Shareholders' equity was 11.5% of assets at
December 31, 2004 and 11.2% at December 31, 2003. In addition to this
measurement, banking regulators have defined minimum regulatory capital ratios
for financial institutions. These ratios take into account risk factors
identified by those regulatory authorities associated with the assets and
off-balance sheet activities of financial institutions. The guidelines require
percentages, or "risk weights" be applied to those assets and off-balance-sheet
assets in relation to their perceived risk. Under the guidelines, capital
strength is measured in two tiers. Tier I capital consists primarily of
shareholder's equity, while Tier II capital consists of qualifying allowance for
loan losses. Total capital is the total of Tier I and Tier II capital. Another
indicator of capital adequacy is the leverage ratio, which is computed by
dividing Tier I capital by average quarterly assets less intangible assets.
The guidelines require that total capital (Tier I plus Tier II) of 8% be
held against total risk-adjusted assets, at least half of which (4%) must be
Tier I capital. At December 31, 2004, the Corporation's Tier I and total capital
ratios were 15.48% and 16.73%, respectively. At December 31, 2003, these ratios
were 14.85% and 15.99%, respectively. The ratios for both years were well in
excess of the regulatory requirements. The Corporation's leverage ratios were
11.02% and 10.76% at December 31, 2004 and 2003, respectively. The leverage
ratio has a regulatory minimum of 3%, with most institutions required to
maintain a ratio one to two percent above the 3% minimum depending upon risk
profiles and other factors.
27
As mandated by the Federal Deposit Insurance Corporation Act of 1991
("FDICIA"), the following five capital categories are identified for insured
depository institutions: "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized" and "critically
undercapitalized". FDICIA requires the federal banking regulators to take prompt
corrective action with respect to insured depository institutions that do not
meet minimum capital requirements. Under the regulations, well capitalized
institutions must have Tier I risk-based capital ratios of at least 6%, total
risk-based capital ratios of at least 10%, and leverage ratios of at least 5%
and not be subject to capital directive orders. Under these guidelines, the
Corporation and the Bank exceeded the minimum ratios to be considered well
capitalized at December 31, 2004 and 2003.
The Corporation's stock began trading on the Nasdaq National Market on
April 23, 1999 after having been traded on the OTC Bulletin Board. The total
market value of American National Bankshares Inc. common stock at December 31,
2004, at $24.21 per share (the last trade recorded on the Nasdaq National Market
during 2004) was $133,667,000, compared to $147,624,000 at December 31, 2003
when the stock was last traded at $26.08 per share.
IMPACT OF INFLATION AND CHANGING PRICES
The majority of assets and liabilities of a financial institution are
monetary in nature and therefore differ greatly from most commercial and
industrial companies that have significant investments in fixed assets or
inventories. The most significant effect of inflation is on other expenses that
tend to rise during periods of inflation. Changes in interest rates have a
greater impact on a financial institution's profitability than do the effects of
higher costs for goods and services. Through its balance sheet management
practices, the Corporation has the ability to react to those changes and measure
and monitor its interest rate and liquidity risk.
28
Table 14 - Quarterly Financial Results
(in thousands, except per share amounts)
Fourth Third Second First
2004 Quarter Quarter Quarter Quarter
---- ----------- ------------ ----------- ------------
Interest income......................................... $7,720 $7,409 $7,410 $7,581
Interest expense........................................ 1,867 1,783 1,864 1,965
----------- ------------ ----------- ------------
Net interest income................................... 5,853 5,626 5,546 5,616
Provision for loan losses............................... 2,370 255 255 215
----------- ------------ ----------- ------------
Net interest income after provision................... 3,483 5,371 5,291 5,401
Noninterest income...................................... 876 1,736 2,045 1,853
Noninterest expense..................................... 3,415 3,846 3,949 3,801
----------- ------------ ----------- ------------
Income before income tax provision.................... 944 3,261 3,387 3,453
Income tax provision.................................... 164 922 963 983
----------- ------------ ----------- ------------
Net income............................................ $ 780 $2,339 $2,424 $2,470
=========== ============ =========== ============
Per common share:
Net income (basic).................................... $ .14 $ .42 $ .43 $ .44
Net income (diluted).................................. $ .14 $ .42 $ .43 $ .43
Cash dividends........................................ $ .20 $ .20 $ .20 $ .19
Fourth Third Second First
2003 Quarter Quarter Quarter Quarter
---- ----------- ------------ ----------- ------------
Interest income......................................... $7,697 $7,844 $8,235 $8,402
Interest expense........................................ 2,138 2,276 2,458 2,519
----------- ------------ ----------- ------------
Net interest income................................... 5,559 5,568 5,777 5,883
Provision for loan losses............................... 255 170 255 240
----------- ------------ ----------- ------------
Net interest income after provision................... 5,304 5,398 5,522 5,643
Noninterest income...................................... 1,794 1,800 1,615 1,462
Noninterest expense..................................... 3,618 3,802 3,882 3,809
----------- ------------ ----------- ------------
Income before income tax provision.................... 3,480 3,396 3,255 3,296
Income tax provision.................................... 1,014 991 947 962
----------- ------------ ----------- ------------
Net income............................................ $2,466 $2,405 $2,308 $2,334
=========== ============ =========== ============
Per common share:
Net income (basic).................................... $ .44 $ .42 $ .40 $ .41
Net income (diluted).................................. $ .43 $ .42 $ .40 $ .40
Cash dividends........................................ $ .19 $ .19 $ .19 $ .18
29
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9B - OTHER INFORMATION
None
ITEM 9A - CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Corporation's management, including the Chief Executive Officer and
Chief Financial Officer, evaluated the Corporation's disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act") as of December 31, 2004. Based on this
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Corporation's disclosure controls and procedures are effective. There
were no significant changes in the Corporation's internal controls over
financial reporting that occurred during the quarter ended December 31, 2004
that have materially affected or are reasonably likely to materially affect the
Corporation's internal control over financial reporting.
Management's Annual Report on Internal Control Over Financial Reporting
Management of the Corporation is responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control
is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States of America. Management regularly monitors its internal control
over financial reporting, and actions are taken to correct deficiencies as they
are identified.
Management assessed the Corporation's internal control over financial
reporting as of December 31, 2004. This assessment was based on criteria
described in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on its assessment,
management concluded that the Corporation maintained effective internal control
over financial reporting as of December 31, 2004 based on the specified
criteria.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Further, because of changes
in conditions, internal control effectiveness may vary over time.
The Corporation's independent registered public accounting firm, Yount,
Hyde and Barbour, P.C., audited management's assessment of the effectiveness of
internal control over financial reporting as of December 31, 2004, as stated in
their report included herein. Yount, Hyde and Barbour, P.C. also audited the
Corporation's financial statements as of and for the year ended December 31,
2004.
/s/ Charles H. Majors
- -------------------------------------
Charles H. Majors
President and Chief Executive Officer
/s/ Neal A. Petrovich
- --------------------------------------
Neal A. Petrovich
Senior Vice President and
Chief Financial Officer
February 25, 2005
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
American National Bankshares Inc.
Danville, Virginia
We have audited the accompanying consolidated balance sheets of American
National Bankshares Inc. and subsidiary as of December 31, 2004 and 2003, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
2004. We also have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control Over Financial Reporting
appearing under Item 9A, that American National Bankshares Inc. and subsidiary
maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control-- Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). American National Bankshares Inc. and subsidiary's management
is responsible for these financial statements, for maintaining effective
internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on these financial statements, an opinion on
management's assessment, and an opinion on the effectiveness of the
Corporation's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A corporation's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A corporation's
internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the corporation; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the corporation are being made only in accordance with authorizations of
management and directors of the corporation; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the corporation's assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
31
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of American
National Bankshares Inc. and subsidiary as of December 31, 2004 and 2003, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, management's assessment that American National Bankshares Inc. and
subsidiary maintained effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our
opinion, American National Bankshares Inc. and subsidiary maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
/s/Yount, Hyde & Barbour, P.C.
- ------------------------------
Winchester, Virginia
February 25, 2005
32
American National Bankshares Inc. and Subsidiary
Consolidated Balance Sheets
December 31, 2004 and 2003
(Dollars in thousands, except share data)
- --------------------------------------------------------------------------------------------------------
2004 2003
---------- ----------
ASSETS
Cash and due from banks ........................................................$ 12,371 $ 16,236
Interest-bearing deposits in other banks........................................ 197 1,652
Securities available for sale, at fair value.................................... 165,958 171,376
Securities held to maturity (fair value of $23,088
in 2004 and $37,455 in 2003).................................................. 22,205 36,103
---------- ----------
Total securities.............................................................. 188,163 207,479
---------- ----------
Loans held for sale............................................................. 971 560
Loans, net of unearned income .................................................. 407,269 406,245
Less allowance for loan losses.................................................. (7,982) (5,292)
---------- ----------
Net loans..................................................................... 399,287 400,953
---------- ----------
Bank premises and equipment, at cost, less accumulated
depreciation of $12,362 in 2004 and $11,807 in 2003........................... 7,517 7,718
Core deposit intangibles, net................................................... 484 934
Accrued interest receivable and other assets.................................... 10,075 8,770
---------- ----------
Total assets..................................................................$ 619,065 $ 644,302
========== ==========
LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits -- noninterest bearing........................................$ 75,256 $ 71,027
Demand deposits -- interest bearing........................................... 80,793 69,053
Money market deposits......................................................... 52,031 59,251
Savings deposits.............................................................. 83,216 83,031
Time deposits................................................................. 193,976 219,326
---------- ----------
Total deposits.............................................................. 485,272 501,688
---------- ----------
Repurchase agreements......................................................... 38,945 47,035
FHLB borrowings............................................................... 21,338 21,000
Accrued interest payable and other liabilities................................ 2,510 2,648
---------- ----------
Total liabilities........................................................... 548,065 572,371
---------- ----------
Shareholders' equity:
Preferred stock, $5 par, 200,000 shares authorized,
none outstanding............................................................ - -
Common stock, $1 par, 10,000,000 shares authorized,
5,521,164 shares outstanding at December 31, 2004 and
5,660,419 shares outstanding at December 31, 2003........................... 5,521 5,660
Capital in excess of par value................................................ 9,474 9,437
Retained earnings............................................................. 55,780 55,538
Accumulated other comprehensive income, net................................... 225 1,296
---------- ----------
Total shareholders' equity.................................................. 71,000 71,931
---------- ----------
Total liabilities and shareholders' equity..................................$ 619,065 $ 644,302
========== ==========
The accompanying notes are an integral part of the consolidated financial statements.
33
American National Bankshares Inc. and Subsidiary
Consolidated Statements of Income
For the Years Ended December 31, 2004, 2003 and 2002
(Dollars in thousands, except per share data)
- ---------------------------------------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
Interest Income:
Interest and fees on loans.......................................$ 22,791 $ 25,228 $ 27,150
Interest and dividends on securities:
Taxable........................................................ 5,028 4,771 5,737
Tax-exempt..................................................... 2,006 1,838 1,664
Dividends...................................................... 163 231 336
Other interest income............................................ 132 110 248
----------- ----------- -----------
Total interest income.......................................... 30,120 32,178 35,135
----------- ----------- -----------
Interest Expense:
Interest on deposits............................................. 5,979 7,915 10,847
Interest on repurchase agreements................................ 528 497 635
Interest on other borrowings..................................... 972 979 828
----------- ----------- -----------
Total interest expense......................................... 7,479 9,391 12,310
----------- ----------- -----------
Net Interest Income................................................ 22,641 22,787 22,825
Provision for Loan Losses.......................................... 3,095 920 873
----------- ----------- -----------
Net Interest Income After Provision
for Loan Losses.................................................. 19,546 21,867 21,952
----------- ----------- -----------
Noninterest Income:
Trust and investment services.................................... 2,976 2,523 2,516
Service charges on deposit accounts.............................. 2,411 2,163 1,706
Other fees and commissions....................................... 888 914 816
Mortgage banking income.......................................... 612 571 361
Securities gains, net............................................ 157 115 39
Impairment of securities......................................... (985) - -
Other............................................................ 451 385 274
----------- ----------- -----------
Total noninterest income....................................... 6,510 6,671 5,712
----------- ----------- -----------
Noninterest Expense:
Salaries......................................................... 6,795 6,844 6,519
Pension and other employee benefits.............................. 1,699 1,814 1,471
Occupancy and equipment ......................................... 2,457 2,513 2,460
Bank franchise tax............................................... 555 547 513
Core deposit intangible amortization............................. 450 450 450
Other ........................................................... 3,055 2,943 2,872
----------- ----------- -----------
Total noninterest expense...................................... 15,011 15,111 14,285
----------- ----------- -----------
Income Before Income Tax Provision................................. 11,045 13,427 13,379
Income Tax Provision............................................... 3,032 3,914 3,918
----------- ----------- ----------
Net Income.........................................................$ 8,013 $ 9,513 $ 9,461
=========== =========== ===========
Net Income Per Common Share:
Basic............................................................$ 1.43 $ 1.67 $ 1.63
Diluted..........................................................$ 1.42 $ 1.65 $ 1.62
Average Common Shares Outstanding:
Basic........................................................... 5,591,839 5,702,625 5,800,302
Diluted......................................................... 5,642,056 5,764,127 5,850,349
The accompanying notes are an integral part of the consolidated financial statements.
34
American National Bankshares Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
For the Years Ended December 31, 2004, 2003 and 2002
(Dollars in thousands)
Accumulated
Common Stock Capital in Other Total
---------------------- Excess of Retained Comprehensive Shareholders'
Shares Amount Par Value Earnings Income Equity
----------- ---------- ---------- ----------- ------------- ---------------
Balance, December 31, 2001........................ 5,821,956 $ 5,822 $ 9,588 $ 48,678 $ 1,309 $ 65,397
Net income........................................ - - - 9,461 - 9,461
Other comprehensive income, net of tax:
Change in unrealized gains on securities
available for sale, net of tax of $656.......... - - - - 1,273
Minimum pension liability adjustment,
net of tax of $150.............................. (291)
-------------
Other comprehensive income.................... 982 982
---------------
Comprehensive income.......................... 10,443
Stock repurchased and retired..................... (45,100) (45) (74) (929) - (1,048)
Stock options exercised........................... 3,960 4 57 - - 61
Cash dividends declared and paid.................. - - - (4,117) - (4,117)
----------- ---------- ---------- ----------- ------------- ---------------
Balance, December 31, 2002........................ 5,780,816 5,781 9,571 53,093 2,291 70,736
Net income........................................ - - - 9,513 - 9,513
Other comprehensive loss, net of tax:
Change in unrealized gains (losses) on securities
available for sale, net of tax of $(639)........ - - - - (1,229)
Less: Reclassification adjustment for gains
on securities available for sale, net of
tax of ($29)............................... - - - - (57)
Minimum pension liability adjustment,
net of tax of ($150)............................ 291
-------------
Other comprehensive loss...................... (995) (995)
---------------
Comprehensive income.......................... 8,518
Stock repurchased and retired..................... (125,000) (125) (207) (2,796) - (3,128)
Stock options exercised........................... 4,603 4 73 - - 77
Cash dividends declared and paid.................. - - - (4,272) - (4,272)
----------- ---------- ---------- ----------- ------------- ---------------
Balance, December 31, 2003........................ 5,660,419 5,660 9,437 55,538 1,296 71,931
Net income........................................ - - - 8,013 - 8,013
Other comprehensive income (loss), net of tax:
Change in unrealized gains (losses) on securities
available for sale, net of tax of $(849)........ - - - - (1,648)
Add: Reclassification adjustment for losses
on impairment of securities, net of tax of
$335........................................ 650
Less: Reclassification adjustment for gains
on securities available for sale, net of
tax of ($38)............................... - - - - (73)
-------------
Other comprehensive loss...................... (1,071) (1,071)
---------------
Comprehensive income.......................... 6,942
Stock repurchased and retired..................... (159,968) (160) (267) (3,360) - (3,787)
Stock options exercised........................... 20,713 21 304 - - 325
Cash dividends declared and paid.................. - - - (4,411) - (4,411)
----------- ---------- ---------- ----------- ------------- ---------------
Balance, December 31, 2004........................ 5,521,164 $ 5,521 $ 9,474 $ 55,780 $ 225 $ 71,000
=========== ========== ========== =========== ============= ===============
The accompanying notes are an integral part of the consolidated financial statements.
35
American National Bankshares Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003 and 2002
(Dollars in thousands)
2004 2003 2002
---------- ---------- ----------
Cash Flows from Operating Activities:
Net income................................................... $ 8,013 $ 9,513 $ 9,461
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses.................................... 3,095 920 873
Depreciation................................................. 966 1,135 1,144
Core deposit intangible amortization......................... 450 450 450
Net amortization of securities............................... 609 1,063 295
Gain on sale or call of securities........................... (157) (115) (39)
Impairment of securities..................................... 985 - -
Gain on sale of loans held for sale.......................... (457) (552) (361)
Proceeds from sales of loans held for sale................... 21,733 30,332 17,764
Originations of loans held for sale.......................... (21,687) (29,055) (18,435)
Loss on sale of other real estate owned...................... 23 6 1
Valuation allowance on other real estate owned............... 10 - -
(Gain) loss on sale of premises and equipment................ (172) (42) 16
Deferred income taxes (benefit) provision ................... (1,309) 395 48
Decrease (increase) in interest receivable................... 336 (567) (66)
Decrease (increase) in other assets.......................... 138 (872) (518)
Decrease in interest payable................................. (137) (230) (359)
(Decrease) increase in other liabilities..................... (1) (87) 23
---------- ---------- ----------
Net cash provided by operating activities.................. 12,438 12,294 10,297
---------- ---------- ----------
Cash Flows from Investing Activities:
Proceeds from maturities and calls of securities available
for sale................................................... 63,724 71,843 54,414
Proceeds from sales of securities available for sale......... 6,652 3,104 1,052
Proceeds from maturities and calls of securities held to
maturity................................................... 17,675 5,678 6,197
Purchases of securities available for sale................... (68,035) (112,180) (63,531)
Purchases of securities held to maturity..................... (3,760) (14,996) (3,492)
Net increase in loans........................................ (1,619) (1,369) (31,812)
Proceeds from sales of bank premises and equipment........... 227 43 -
Purchases of bank premises and equipment..................... (820) (687) (1,470)
Proceeds from sales of other real estate owned............... 239 10 261
Purchases of other real estate owned......................... - (13) (11)
---------- ---------- ----------
Net cash provided by (used in) investing activities........ 14,283 (48,567) (38,392)
---------- ---------- ----------
Cash Flows from Financing Activities:
Net increase in demand, money market,
and savings deposits....................................... 8,934 33,339 16,370
Net decrease in time deposits................................ (25,350) (5,213) (6,820)
Net (decrease) increase in repurchase agreements............. (8,090) 10,880 8,978
Net increase (decrease) in FHLB borrowings................... 338 (1,000) 9,000
Cash dividends paid.......................................... (4,411) (4,272) (4,117)
Repurchase of stock.......................................... (3,787) (3,128) (1,048)
Proceeds from exercise of stock options...................... 325 77 61
---------- ---------- ----------
Net cash (used in) provided by financing activities........ (32,041) 30,683 22,424
---------- ---------- ----------
Net Decrease in Cash and Cash Equivalents...................... (5,320) (5,590) (5,671)
Cash and Cash Equivalents at Beginning of Period............... 17,888 23,478 29,149
----------- ---------- ----------
Cash and Cash Equivalents at End of Period..................... $ 12,568 $ 17,888 $ 23,478
=========== ========== ==========
Supplemental Schedule of Cash and Cash Equivalents:
Cash:
Cash and due from banks.................................... $ 12,371 $ 16,236 $ 16,757
Interest-bearing deposits in other banks................... 197 1,652 6,721
----------- ---------- ----------
$ 12,568 $ 17,888 $ 23,478
=========== ========== ==========
Supplemental Disclosure of Cash Flow Information:
Interest paid................................................ $ 7,617 $ 9,621 $ 12,669
Income taxes paid............................................ $ 3,763 $ 3,630 $ 4,012
Transfer of loans to other real estate owned................. $ 190 $ 277 $ 164
Unrealized gain (loss) on securities available for sale...... $ (1,624) $ (1,948) $ 1,928
The accompanying notes are an integral part of the consolidated financial statements.
36
American National Bankshares Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
1. Summary of Significant Accounting Policies:
Nature of Operations and Consolidation
The consolidated financial statements include the amounts and results of
operations of American National Bankshares Inc. the ("Corporation") and its
wholly owned subsidiary, American National Bank and Trust Company the ("Bank").
The Corporation offers a wide variety of retail, commercial and trust banking
services through its offices located in the trade area of the Cities of Danville
and Martinsville, the Counties of Pittsylvania, Henry and Halifax in Virginia,
and the County of Caswell in North Carolina. The Corporation also originates
commercial loans through its loan production office in Greensboro, North
Carolina. ANB Mortgage Corp., a wholly owned subsidiary of the Bank, offers
secondary market mortgage lending. ANB Services Corp., another wholly owned
subsidiary of the Bank, offers non-deposit products such as mutual funds and
insurance products. All significant inter-company transactions and accounts are
eliminated in consolidation.
Cash and Cash Equivalents
Cash includes cash on hand and cash with correspondent banks. Cash
equivalents are short-term, highly liquid investments that are readily
convertible to cash with original maturities of three months or less and that
are subject to an insignificant risk of change in value. Cash and cash
equivalents are carried at cost.
Securities
The Corporation classifies securities as either held to maturity or
available for sale.
Debt securities acquired that management has both the positive intent and
ability to be held to maturity are classified as held to maturity and recorded
at amortized cost.
Securities which may be used to meet liquidity needs arising from
unanticipated deposit and loan fluctuations, changes in regulatory capital and
investment requirements, or unforeseen changes in market conditions, including
interest rates, market values or inflation rates, are classified as available
for sale. Securities available for sale are reported at estimated fair value,
with unrealized gains and losses excluded from earnings and reported in other
comprehensive income, net of tax. Purchase premiums and discounts are recognized
in interest income using the interest method over the terms of the securities.
Declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary are reflected in
earnings as realized impairment losses. In estimating other-than-temporary
impairment losses, management considers (1) the length of time and the extent to
which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the
Corporation to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. Gains or losses
realized from the sale of securities available for sale are recorded on the
trade date and are determined by using the specific identification method.
The Corporation does not permit the purchase or sale of trading account
securities.
Loans Held for Sale
Secondary market mortgage loans are designated as held for sale at the time
of their origination. These loans are pre-sold with servicing released and the
Corporation does not retain any interest or obligation after the loans are sold.
These loans consist primarily of fixed-rate, single-family residential mortgage
loans which meet the underwriting characteristics of certain
government-sponsored enterprises (conforming loans). In addition, the
Corporation requires a firm purchase commitment from a permanent investor before
a loan can be committed, thus limiting interest rate risk. Loans held for sale
are carried at the lower of cost or estimated fair value in the aggregate. Gains
on sales of loans are recognized at the loan closing date and are included in
noninterest income for the period.
37
Rate Lock Commitments
The Corporation enters into commitments to originate secondary market
mortgage loans whereby the interest rate on the loan is determined prior to
funding (rate lock commitments). Rate lock commitments on mortgage loans that
are intended to be sold are considered to be derivatives. The period of time
between issuance of a loan commitment and closing and sale of the loan generally
ranges from 30 to 60 days. The Corporation protects itself from changes in
interest rates through the use of best efforts forward delivery commitments, by
committing to sell a loan at the time the borrower commits to an interest rate
with the intent that the buyer has assumed interest rate risk on the loan. As a
result, the Corporation is not exposed to losses nor will it realize significant
gains related to its rate lock commitments due to changes in interest rates. The
correlation between the rate lock commitments and the best efforts contracts is
very high due to their similarity.
The market value of rate lock commitments and best efforts contracts is not
readily ascertainable with precision because rate lock commitments and best
efforts contracts are not actively traded in stand-alone markets. The
Corporation determines the fair value of rate lock commitments and best efforts
contracts by measuring the change in the value of the underlying assets while
taking into consideration the probability that the rate lock commitments will
close. Because of the high correlation between rate lock commitments and best
efforts contracts, no gain or loss occurs on the rate lock commitments.
Loans
The Corporation grants mortgage, commercial and consumer loans to
customers. A substantial portion of the loan portfolio is secured by real
estate. The ability of the Corporation's debtors to honor their contracts is
dependent upon the real estate and general economic conditions in the
Corporation's market area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are reported at their
outstanding unpaid principal balances adjusted for the allowance for loan
losses, and any deferred fees or costs. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain direct origination
costs, are deferred and recognized as an adjustment of the related loan yield
using the interest method.
The accrual of interest on all loans is discontinued at the time the loan
is 90 days delinquent unless the credit is well-secured and in process of
collection. Loans are typically charged off when the loan is 120 days past due,
unless secured and in process of collection. In all cases, loans are placed on
nonaccrual or charged-off at an earlier date if collection of principal or
interest is considered doubtful.
All interest accrued but not collected for loans that are placed on
nonaccrual or charged-off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all
the principal and interest amounts contractually due are brought current and
future payments are reasonably assured.
A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment and establishing a specific allowance include payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments when due. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan-by-loan basis for commercial and construction loans by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's obtainable market price, or the fair value
of the collateral if the loan is collateral dependent.
Generally, large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. The Corporation's policy for recognizing
interest income on impaired loans is consistent with its nonaccrual policy.
Allowance for Loan Losses
The allowance for loan losses is management's best estimate of probable
credit losses that are inherent in the loan portfolio at the balance sheet date.
The Corporation determines the allowance based on an ongoing evaluation.
Increases to the allowance are made by charges to the provision for loan losses,
which is reflected in the Consolidated Statements of Income. Loan balances
deemed to be uncollectible are charged-off against the allowance. Recoveries of
previously charged-off amounts are credited to the allowance.
38
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the loan portfolio in light of
historical charge-off experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. The
allowance for loan losses has three basic components: the formula allowance, the
specific allowance, and the unallocated allowance. Each of these components is
determined based upon estimates that can and do change when the actual events
occur. The formula allowance uses a historical loss view as an indicator of
future losses along with various economic factors and, as a result, could differ
from the loss incurred in the future. The specific allowance uses various
techniques to arrive at an estimate of loss for specifically identified impaired
loans. The unallocated allowance captures losses whose impact on the portfolio
have occurred but have yet to be recognized in either the formula or specific
allowance. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available and actual losses could be greater or less than the estimates.
Bank Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less
accumulated depreciation and amortization. Premises and equipment are
depreciated over their estimated useful lives ranging from three years to
thirty-nine years; leasehold improvements are amortized over the lives of the
respective leases or the estimated useful life of the leasehold improvement,
which ever is less. Software is amortized over three years. Depreciation and
amortization are recorded on the straight-line method.
Costs of maintenance and repairs are charged to expense as incurred. Costs
of replacing structural parts of major units are considered individually and are
expensed or capitalized as the facts dictate. Gains and losses on routine
dispositions are reflected in current operations.
Intangible Assets
Premiums paid on acquisitions of deposits (core deposit intangibles) are
shown in the "Consolidated Balance Sheets". Such assets are being amortized on a
straight-line basis over 10 years. At December 31, 2004, the Corporation had
$484,000 recorded as core deposit intangibles, net of amortization. The
Corporation recorded core deposit intangible amortization of approximately
$450,000 for each of the three years ended December 31, 2004. Core deposit
intangibles are periodically reviewed for impairment. As of December 31, 2004,
no impairment had been identified. In October 2002, the Financial Accounting
Standards Board ("FASB") issued Statement No. 147, Acquisitions of Certain
Financial Institutions. After reviewing this statement, the Corporation decided
to continue amortization of the core deposit intangible assets related to two
previous branch office acquisitions.
Trust Assets
Securities and other property held by the trust segment in a fiduciary or
agency capacity are not assets of the Corporation and are not included in the
accompanying consolidated financial statements.
Foreclosed Real Estate
Foreclosed real estate is included in other assets and represent other real
estate that has been acquired through loan foreclosures or deeds received in
lieu of loan payments. Generally, such properties are appraised at the time
booked, and they are recorded at the lower of cost or fair value less estimated
selling costs. When appropriate, adjustments to cost are charged or credited to
the allowance for foreclosed properties.
Income Taxes
The Corporation uses the balance sheet method to account for deferred
income tax assets and liabilities. Under this method, the net deferred tax asset
or liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws.
Defined Benefit Plan
The Corporation has a pension plan for its employees. Benefits are
generally based upon years of service and the employees' compensation. The
Corporation's funding policy is to make the maximum contribution permitted by
the Employee Retirement Income Security Act.
39
Stock Option Plan
The Corporation has a stock option plan, which is described more fully in
Note 7. The Corporation accounts for the plan under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based compensation cost is
reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Corporation had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based compensation (in thousands, except per share data):
2004 2003 2002
-------- -------- --------
Net income, as reported $ 8,013 $ 9,513 $ 9,461
Deduct: total stock-based compensation
expense determined under fair value
based method for all awards (634) (136) (169)
-------- -------- --------
Pro forma net income $ 7,379 $ 9,377 $ 9,292
Earnings per share:
Basic, as reported $ 1.43 $ 1.67 $ 1.63
Basic, pro forma $ 1.32 $ 1.64 $ 1.60
Diluted, as reported $ 1.42 $ 1.65 $ 1.62
Diluted, pro forma $ 1.31 $ 1.63 $ 1.59
Earnings Per Share
Basic earnings per share represent income available to common shareholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflect additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
Potential common shares that may be issued by the Corporation relate solely to
outstanding stock options, and are determined using the treasury method.
Shareholders' Equity
During 2004, the Corporation repurchased 159,968 shares of its common stock
in the open market and in private transactions at prices between $21.55 and
$26.00 per share. During 2003, the Corporation repurchased 125,000 shares of its
common stock in the open market at prices between $23.95 and $26.05 per share.
From the inception of the stock repurchase plan through December 31, 2004, the
Corporation has purchased and retired 624,434 shares of its common stock.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Although certain changes in assets
and liabilities, such as unrealized gains and losses on available for sale
securities and minimum pension liability adjustments, are reported as a separate
component of the equity section of the balance sheet, such items, along with net
income, are components of comprehensive income.
Advertising and Marketing Costs
Advertising and marketing costs are expensed as incurred. Advertising and
marketing costs for the years ended December 31, 2004, 2003 and 2002 were
$172,000, $170,000, and $137,000, respectively.
Use of Estimates in the Preparation of Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Material estimates that are particularly susceptible to
significant change in the near term relate to the determination of the allowance
for loan losses and the valuation of foreclosed real estate.
40
Reclassifications
Certain reclassifications have been made in prior years' financial
statements to conform to classifications used in the current year.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
This Interpretation provides guidance with respect to the identification of
variable interest entities when the assets, liabilities, non-controlling
interests, and results of operations of a variable interest entity need to be
included in a company's consolidated financial statements. An entity is deemed a
variable interest entity, subject to the interpretation, if the equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
or in cases in which the equity investors lack one or more of the essential
characteristics of a controlling financial interest, which include the ability
to make decisions about the entity's activities through voting rights, the
obligations to absorb the expected losses of the entity if they occur, or the
right to receive the expected residual returns of the entity if they occur. Due
to significant implementation issues, the FASB modified the wording of FIN 46
and issued FIN 46R in December of 2003. FIN 46R deferred the effective date for
the provisions of FIN 46 to entities other than Special Purpose Entities
("SPEs") until financial statements issued for periods ending after March 15,
2004. SPEs were subject to the provisions of either FIN 46 or FIN 46R as of
December 15, 2003. The Corporation has no investments in variable interest
entities; therefore the adoption of FIN 46 and FIN 46R did not have a material
effect on the Corporation's consolidated financial position or consolidated
results of operations.
In December 2003, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired
in a Transfer." The SOP is effective for loans acquired in fiscal years
beginning after December 15, 2004. The scope of the SOP applies to unhealthy
"problem" loans that have been acquired, either individually in a portfolio, or
in a business acquisition. The SOP addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities (loans) acquired in a
transfer if those differences are attributable, at least in part, to credit
quality. The SOP does not apply to loans originated by the Corporation. The
Corporation intends to adopt the provisions of SOP 03-3 effective January 1,
2005, and does not expect the initial implementation to have any effect on its
consolidated financial position or consolidated results of operations.
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105,
"Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments, including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, "Scope Exceptions: When a
Loan Commitment is included in the Scope of Statement 133." Furthermore, SAB 105
disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into after March 31, 2004. The Corporation has adopted the provisions of SAB
105. Since the provisions of SAB 105 affect only the timing of the recognition
of mortgage banking income, management does not anticipate that this guidance
will have a material adverse effect on either the Corporation's consolidated
financial position or consolidated results of operations.
Emerging Issues Task Force Issue No. ("EITF") 03-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments" was
issued and is effective March 31, 2004. The EITF 03-1 provides guidance for
determining the meaning of "other-than-temporarily impaired" and its application
to certain debt and equity securities within the scope of Statement of Financial
Accounting Standards No. 115 "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115") and investments accounted for under the cost
method. The guidance requires that investments which have declined in value due
to credit concerns or solely due to changes in interest rates must be recorded
as other-than-temporarily impaired unless the company can assert and demonstrate
its intention to hold the security for a period of time sufficient to allow for
a recovery of fair value up to or beyond the cost of the investment which might
mean maturity. This issue also requires disclosures assessing the ability and
intent to hold investments in instances in which an investor determines that an
investment with a fair value less than cost is not other-than-temporarily
impaired. On September 30, 2004, FASB decided to delay the effective date for
the measurement and recognition guidance contained in Issue 03-1. This delay
does not suspend the requirement to recognize other-than-temporary impairments
as required by existing authoritative literature. The disclosure guidance in
Issue 03-1 was not delayed. During 2004, the Corporation recorded an
other-than-temporary impairment charge in accordance with EIFT 03-1 and FAS 115
in connection with its investments in FHLMC and FNMA perpetual preferred stock.
41
EITF No. 03-16, "Accounting for Investments in Limited Liability Companies
was ratified by the Board and is effective for reporting periods beginning after
June 15, 2004." APB Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock," prescribes the accounting for investments in
common stock of corporations that are not consolidated. AICPA Accounting
Interpretation 2, "Investments in Partnerships Ventures," of Opinion 18,
indicates that "many of the provisions of the Opinion would be appropriate in
accounting" for partnerships. In EITF Abstracts, Topic No. D-46, "Accounting for
Limited Partnership Investments," the SEC staff clarified its view that
investments of more than 3 to 5 percent are considered to be more than minor
and, therefore, should be accounted for using the equity method. Limited
liability companies ("LLCs") have characteristics of both corporations and
partnerships, but are dissimilar from both in certain respects. Due to those
similarities and differences, diversity in practice exists with respect to
accounting for non-controlling investments in LLCs. The consensus reached was
that an LLC should be viewed as similar to a corporation or similar to a
partnership for purposes of determining whether a non-controlling investment
should be accounted for using the cost method or the equity method of
accounting. Management does not anticipate that this guidance will have a
material adverse effect on either the Corporation's consolidated financial
position or consolidated results of operations.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment." This Statement
establishes standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. The Statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. The Statement requires a
public entity to measure the cost of employee services received in exchange for
an award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award - the
requisite service period (usually the vesting period). The entity will initially
measure the cost of employee services received in exchange for an award of
liability instruments based on its current fair value; the fair value of that
award will be remeasured subsequently at each reporting date through the
settlement date. Changes in fair value during the requisite service period will
be recognized as compensation cost over that period. The grant-date fair value
of employee share options and similar instruments will be estimated using
option-pricing models adjusted for the unique characteristics of those
instruments (unless observable market prices for the same or similar instruments
are available). If an equity award is modified after the grant date, incremental
compensation cost will be recognized in an amount equal to the excess of the
fair value of the modified award over the fair value of the original award
immediately before the modification. This Statement is effective for public
entities that do not file as small business issuers--as of the beginning of the
first interim or annual reporting period that begins after June 15, 2005. Under
the transition method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under Statement 123 for either recognition or pro forma
disclosures. For periods before the required effective date, entities may elect
to apply a modified version of retrospective application under which financial
statements for prior periods are adjusted on a basis consistent with the pro
forma disclosures required for those periods by Statement 123. Currently, the
adoption of this Statement would have no material effect on the Corporation's
consolidated financial position or consolidated results of operations, as all
outstanding stock options were fully vested as of December 31, 2004.
42
2. Securities:
The amortized cost and estimated fair value of investments in debt and equity securities at December 31, 2004 and 2003
were as follows (in thousands):
December 31, 2004
------------------------------------------------------------------------
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
Securities available for sale:
Federal agencies $ 83,969 $ 107 $ 755 $ 83,321
Mortgage-backed 28,608 402 77 28,933
State and municipal 35,714 658 88 36,284
Corporate bonds 10,776 295 42 11,029
Equity securities:
FHLB stock - restricted 2,248 - - 2,248
Federal Reserve stock - restricted 363 - - 363
FNMA & FHLMC preferred stock 3,515 - 160 3,355
Other securities 425 - - 425
---------- ---------- ---------- ----------
Total securities available for sale 165,618 1,462 1,122 165,958
---------- ---------- ---------- ----------
Securities held to maturity:
Federal agencies 3,496 5 10 3,491
Mortgage-backed 701 36 - 737
State and municipal 18,008 860 8 18,860
---------- ---------- ---------- ----------
Total securities held to maturity 22,205 901 18 23,088
---------- ---------- ---------- ----------
Total securities $ 187,823 $ 2,363 $ 1,140 $ 189,046
========== ========== ========== ==========
December 31, 2003
------------------------------------------------------------------------
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
Securities available for sale:
Federal agencies $ 97,906 $ 676 $ 200 $ 98,382
Mortgage-backed 19,693 572 65 20,200
State and municipal 31,890 933 43 32,780
Corporate bonds 12,894 751 3 13,642
Equity securities:
FHLB stock - restricted 1,741 - - 1,741
Federal Reserve stock - restricted 363 - - 363
FNMA & FHLMC preferred stock 4,500 - 657 3,843
Other securities 425 - - 425
---------- ---------- ---------- ----------
Total securities available for sale 169,412 2,932 968 171,376
---------- ---------- ---------- ----------
Securities held to maturity:
Federal agencies 16,996 100 1 17,095
Mortgage-backed 1,227 62 - 1,289
State and municipal 17,880 1,191 - 19,071
---------- ---------- ---------- ----------
Total securities held to maturity 36,103 1,353 1 37,455
---------- ---------- ---------- ----------
Total securities $ 205,515 $ 4,285 $ 969 $ 208,831
========== ========== ========== ==========
The amortized cost and estimated fair value of investments in securities at
December 31, 2004, by contractual maturity, are shown below (in thousands).
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Because mortgage-backed securities have both known
principal repayment terms as well as unknown principal repayments due to
potential borrower pre-payments, it is difficult to accurately predict the final
maturity of these investments. Mortgage-backed securities have been shown
separately below (in thousands):
43
Available for Sale Held to Maturity
------------------------------ -----------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
--------- ---------- --------- ----------
Due in one year or less $ 15,137 $ 15,184 $ 3,430 $ 3,461
Due after one year
through five years 73,190 73,111 10,066 10,465
Due after five years
through ten years 41,310 41,485 4,573 4,788
Due after ten years 822 854 3,435 3,637
Equity securities 6,551 6,391 - -
Mortgage-backed securities 28,608 28,933 701 737
--------- --------- -------- --------
$ 165,618 $ 165,958 $ 22,205 $ 23,088
========= ========= ======== ========
Gross realized gains and losses from the call of all securities or the sale
of securities available for sale for the years ended December 31, 2004, 2003 and
2002 are as follows (in thousands):
2004 2003 2002
------ ------ ------
Realized gains $ 167 $ 115 $ 39
Realized (losses) $ (10) $ - $ -
Proceeds from the maturities, payments, calls, and sales of securities
available for sale were $70,375,000, $74,947,000 and $55,466,000 in 2004, 2003
and 2002. Proceeds from the maturities, payments, and calls of securities held
to maturity were $17,675,000, $5,678,000 and $6,197,000 in 2004, 2003 and 2002.
Net gains from the sale of securities available for sale were $141,000 and gains
from the call of securities prior to maturity were $16,000 in 2004. Gains from
the sale of securities available for sale were $85,000 and gains from the call
of securities prior to maturity were $30,000 in 2003. Gains from the sale of
securities available for sale were $3,000 and gains from the call of securities
prior to maturity were $36,000 in 2002.
Securities with a carrying value of approximately $67,692,000 and
$65,953,000 at December 31, 2004 and 2003 were pledged to secure public
deposits, repurchase agreements and for other purposes as required by law.
Corporate bonds consist of investment grade debt securities, primarily
issued by financial services companies.
The table below shows (in thousands) gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2004.
Less than 12 Months 12 Months or More Total
--------------------- ----------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
-------- ---------- -------- ---------- -------- ----------
Federal agencies $ 57,916 $ 639 $ 8,880 $ 126 $ 66,796 $ 765
Mortgage-backed 9,596 74 1,358 3 10,954 77
State and municipal 7,869 89 198 7 8,067 96
Corporate bonds 1,442 42 - - 1,442 42
Preferred stock - - 3,355 160 3,355 160
-------- ---------- -------- ---------- -------- ----------
Total $ 76,823 $ 844 $ 13,791 $ 296 $ 90,614 $1,140
======== ========== ======== ========== ======== ==========
Management evaluates securities for other-than-temporary impairment
quarterly, and more frequently when economic or market concerns warrant such
evaluation. Consideration is given to the length of time and the extent to which
the fair value has been less than cost, the financial condition and near-term
prospects of the issuer, and the intent and ability of the Corporation to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. At December 31, 2004, the Corporation held
six debt securities and two equity securities having continuous unrealized loss
positions for more than twelve months. Of the six debt securities, five
represented AAA-rated investments in bonds issued by FHLB, FHLMC, and FNMA. The
remaining debt security represented an investment in a AAA-rated municipal bond.
The unrealized losses are primarily attributable to interest rate changes.
An other-than-temporary impairment charge of $985,000 on $4,500,000 of
Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage
Association ("FNMA") perpetual preferred stock was charged to earnings in the
fourth quarter of 2004. This was done after a thorough analysis of recent public
disclosures about FHLMC and FNMA, the length of time the market value of the
44
securities had been less than cost, the amount of the loss in comparison with
the amortized cost, the results of an impairment analysis recently completed by
an outside party, and accounting interpretations. After the impairment charge,
the total amount of continuous unrealized losses for more than twelve months on
these two securities was $160,000, which is primarily attributable to interest
rate changes. The Corporation has the intent and ability to hold these
securities for the time necessary to recover the amortized cost.
The table below shows (in thousands) gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2003.
Less than 12 Months 12 Months or More Total
--------------------- ----------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
-------- ---------- -------- ---------- -------- ----------
Federal agencies $ 36,737 $ 201 $ - $ - $ 36,737 $ 201
Mortgage-backed 6,588 65 - - 6,588 65
State and municipal 5,368 43 - - 5,368 43
Corporate bonds 534 3 - - 534 3
Preferred stock 1,668 332 2,175 325 3,843 657
-------- ---------- -------- ---------- -------- ----------
Total $ 50,895 $ 644 $ 2,175 $ 325 $ 53,070 $ 969
======== ========== ======== ========== ======== ==========
3. Loans and Allowance for Loan Losses:
Loans, excluding loans held for sale, at December 31, 2004 and 2003 were
comprised of the following (in thousands):
2004 2003
--------- ---------
Real Estate loans
Construction and land development $ 34,101 $ 12,790
Secured by farmland 2,853 3,430
Secured by 1 - 4 family residential properties 134,292 136,229
Secured by multi-family (5 or more) residential properties 9,033 6,801
Secured by nonfarm, nonresidential properties 135,767 126,164
Loans to farmers 1,442 1,618
Commercial and industrial loans 70,336 91,419
Consumer loans 15,248 23,581
Loans for nonrated industrial development obligations 4,069 4,077
Deposit overdrafts 128 136
--------- ---------
Loans, net of unearned income $ 407,269 $ 406,245
========= =========
The following is a summary of information pertaining to impaired loans (in
thousands):
2004 2003
------- -------
Impaired loans for which an allowance
has been provided $ 6,310 $ 2,548
Impaired loans for which no allowance
has been provided - -
------- -------
Total impaired loans $ 6,310 $ 2,548
======= =======
Allowance provided for impaired loans,
included in the allowance for loan losses $ 3,151 $ 521
======= =======
2004 2003 2002
------- ------- -------
Average balance in impaired loans $ 3,527 $ 1,385 $ 158
======= ======= =======
Interest income recognized $ 71 $ - $ -
======= ======= =======
No additional funds are committed to be advanced in connection with
impaired loans.
45
Nonaccrual loans excluded from impaired loan disclosure amounted to
$2,810,000 and $714,000 at December 31, 2004 and 2003, respectively. If interest
on nonaccrual loans had been accrued, such income would have approximated
$146,000, $45,000 and $20,000 for 2004, 2003 and 2002, respectively.
Loans past due 90 days and still accruing interest amounted to $0, $53,000,
and $239,000 as of December 31, 2004, 2003 and 2002, respectively.
Foreclosed real estate was $221,000 at December 31, 2004 and $303,000 at
December 31, 2003 and is recorded as other assets on the Consolidated Balance
Sheets.
The loan portfolio is concentrated primarily in the immediate geographic
region. The Corporation had $316.0 million of loans secured by real estate at
December 31, 2004. There were no concentrations of loans to any individual,
group of individuals, business, or industry that exceeded 10% of total loans at
December 31, 2004.
An analysis of the allowance for loan losses is as follows (in thousands):
2004 2003 2002
-------- -------- --------
Balance, beginning of year $ 5,292 $ 5,622 $ 5,334
Provision for loan losses 3,095 920 873
Charge-offs (655) (1,457) (740)
Recoveries 250 207 155
-------- -------- --------
Balance, end of year $ 7,982 $ 5,292 $ 5,622
======== ======== ========
4. Premises and Equipment:
Major classifications of premises and equipment are summarized as follows
(in thousands):
December 31
-----------------------
2004 2003
--------- ---------
Land $ 1,725 $ 1,603
Buildings 8,265 7,670
Leasehold Improvements 351 878
Equipment 9,537 9,374
--------- ---------
19,878 19,525
Accumulated Depreciation (12,361) (11,807)
--------- ---------
Bank Premises and Equipment, net $ 7,517 $ 7,718
========= =========
Depreciation expense for the years ended December 31, 2004, 2003 and 2002
amounted to $966,000, $1,135,000 and $1,144,000, respectively.
5. Deposits:
The aggregate amount of time deposits in denominations of $100,000 or more
at December 31, 2004 and 2003 was $53,154,000 and $61,367,000 respectively.
At December 31, 2004, the scheduled maturities of CDs are as follows (in
thousands):
2005 $ 123,766
2006 34,282
2007 17,003
2008 11,333
2009 7,581
Thereafter 11
---------
$ 193,976
=========
46
6. Borrowings:
Short-term borrowings consist of the following at December 31, 2004 and
2003 (in thousands):
2004 2003
--------- ---------
Repurchase agreements $ 38,945 $ 47,035
Short-term FHLB borrowings 1,950 -
--------- ---------
Total $ 40,895 $ 47,035
========= =========
Weighted interest rate 1.50% 1.05%
Average for the year ended December 31:
Outstanding $ 47,567 $ 41,168
Interest rate 1.13% 1.21%
Maximum month-end outstanding $ 51,026 $ 49,362
Short-term borrowings consist of repurchase agreements and overnight
borrowings from the Federal Home Loan Bank of Atlanta ("FHLB"). Repurchase
agreements are borrowings collateralized by securities of the U.S. Government or
its agencies and mature daily. The securities underlying these agreements remain
under the Corporation's control.
Under the terms of its collateral agreement with the FHLB, the Bank
provides a blanket lien covering all of its residential first mortgage loans,
second mortgage loans and home equity lines of credit (HELOCs). In addition, the
Bank pledges as collateral its capital stock in the FHLB and deposits with the
FHLB. As of December 31, 2004, $85,346,000 1-4 family residential mortgage loans
were pledged under the blanket floating lien agreement. At December 31, 2004 and
2003, fixed-rate long term advances (in thousands) mature as follows:
Weighted Weighted
Due by 2004 Average Due by 2003 Average
December 31 Advance Amount Rate December 31 Advance Amount Rate
----------- -------------- -------- ----------- -------------- --------
2005 $ 2,000,000 3.53% 2004 $ 3,000,000 2.67%
2006 2,000,000 4.08 2005 2,000,000 3.53
2007 1,000,000 4.33 2006 2,000,000 4.08
2008 8,000,000 5.25 2007 1,000,000 4.33
2009 5,000,000 5.26 2008 8,000,000 5.25
2014 1,387,500 3.78 2009 5,000,000 5.26
------------ ------------
$ 19,387,500 4.80% $ 21,000,000 4.56%
============ ============
All of the above advances are at fixed rates; however at December 31, 2004,
$13,000,000 of convertible advances are included in the table whereby the FHLB
has the option at a predetermined time to convert the fixed interest rate to an
adjustable rate tied to LIBOR (London Inter Bank Offering Rate). The Corporation
has the option to repay these advances if the FHLB converts the interest rate.
These advances are included in the year in which they mature.
7. Stock Options:
The Corporation's 1997 Stock Option Plan ("Option Plan") provides for the
granting of incentive and non-qualified options to employees on a periodic
basis, at the discretion of the Board or a Board designated committee. The
Option Plan authorizes the issuance of up to 300,000 shares of common stock and
has a term of ten years.
The weighted average fair values of options at their grant date during
2004, 2003 and 2002 were $6.40, $9.30, and $8.78, respectively. The estimated
fair value of each option granted is calculated using the Black-Scholes
option-pricing model. The weighted-average assumptions used in the model were a
dividend yield of 3.23% in 2004; expected life of 6.82 years in 2004 and 5.00
years in 2003 and 2002; expected stock volatility of 31.08%, 34.58%, and 36.76%
in years 2004, 2003, and 2002, respectively; and a risk free interest rate of
3.89%, 3.21%, and 4.08% in 2004, 2003, and 2002, respectively.
At December 31, 2004, and 2003, the Corporation had 8,472 shares and 54,544
shares, respectively, of its authorized common stock reserved for its option
plan. The options have a maximum term of ten years from the date of the option
grant. All options were fully vested as December 31, 2004.
47
A summary of stock option transactions under the plan follows:
Option Wtd. Avg.
Shares Exercise Price
--------- --------------
Outstanding at December 31, 2001 151,450 $15.47
Granted 35,700 22.58
Exercised (3,960) 15.47
Forfeited (800) 14.37
--------- ------
Outstanding at December 31, 2002 182,390 16.87
Granted 46,450 26.01
Exercised (4,603) 16.51
Forfeited (200) 14.00
--------- ------
Outstanding at December 31, 2003 224,037 18.77
Granted 55,800 24.22
Exercised (20,713) 15.72
Forfeited (9,728) 25.49
--------- ------
Outstanding at December 31, 2004 249,396 $19.98
=========
The following table summarizes information related to stock options
outstanding on December 31, 2004:
Weighted-
Average Weighted-
Number of Remaining Average Number of
Range of Outstanding Contractual Exercise Options
Exercise Prices Options Life Price Exercisable
--------------- ----------- ----------- --------- -----------
$13.38 to 15.00 62,014 4.1 yrs $ 13.73 62,014
15.01 to 20.00 79,032 5.0 17.89 79,032
20.01 to 25.00 59,800 9.8 24.21 59,800
25.01 to 26.20 48,550 8.7 26.18 48,550
------- -------
249,396 6.7 yrs $ 19.98 249,396
======= =======
8. Income Taxes:
The components of the Corporation's net deferred tax assets as of December
31, 2004 and December 31, 2003, were as follows (in thousands):
2004 2003
------- -------
Deferred tax assets:
Allowance for loan losses $ 2,714 $ 1,799
Deferred compensation 243 250
Core deposit intangible 456 405
Preferred stock impairment 335 -
Other 66 22
------- -------
Total deferred tax assets 3,814 2,476
------- -------
Deferred tax liabilities:
Depreciation 483 414
Accretion of discounts on securities 17 18
Prepaid pension 491 506
Net unrealized gains on securities 116 668
Other 126 150
------- -------
Total deferred tax liabilities 1,233 1,756
------- -------
Net deferred tax assets $ 2,581 $ 720
======= =======
The provision for income taxes consists of the following (in thousands):
2004 2003 2002
-------- -------- --------
Taxes currently payable $ 4,341 $ 3,519 $ 3,870
Deferred tax expense (benefit) (1,309) 395 48
-------- -------- --------
$ 3,032 $ 3,914 $ 3,918
======== ======== ========
48
The effective tax rates differ from the statutory federal income tax rates
due to the following items:
2004 2003 2002
-------- -------- --------
Federal statutory rate 34.1 % 34.3 % 34.2 %
Nontaxable interest income (6.6) (5.0) (4.9)
Other - (0.1) -
-------- -------- --------
27.5 % 29.2 % 29.3 %
======== ======== ========
9. Earnings Per Share:
The following shows the weighted average number of shares used in computing
earnings per share and the effect on weighted average number of shares of
potential dilutive common stock. Potential dilutive common stock had no effect
on income available to common shareholders.
2004 2003 2002
---------------------------- -------------------------- ----------------------------
Per Share Per Share Per Share
Shares Amount Shares Amount Shares Amount
-------------- ------------- ------------ ------------- ------------- --------------
Basic earnings per share 5,591,839 $ 1.43 5,702,625 $ 1.67 5,800,302 $ 1.63
Effect of dilutive securities,
stock options 50,217 61,502 50,047
-------------- ------------ -------------
Dilutied earnings per share 5,642,056 $ 1.42 5,764,127 $ 1.65 5,850,349 $ 1.62
============== ============ =============
Stock options on common stock which were not included in computing diluted
EPS in 2004, 2003, and 2002 because their effects were antidilutive averaged
4,685 shares, 453 shares, and 82 shares, respectively.
10. Commitments and Contingent Liabilities:
Financial instruments with off-balance-sheet risk:
- --------------------------------------------------
The Corporation is party to credit-related financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. Such commitments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets.
The Corporation's exposure to credit loss is represented by the contractual
amount of these commitments. The Corporation follows the same credit policies in
making commitments as it does for on-balance-sheet instruments.
At December 31, 2004 and 2003, the following financial instruments were
outstanding whose contract amounts represent credit risk:
2004 2003
------------- -------------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $ 130,862,000 $ 124,905,000
Standby letters of credit 4,849,000 3,477,000
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Corporation evaluates each customer's
credit worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Corporation, is based on management's credit evaluation
of the customer.
Unfunded commitments under commercial lines of credit and revolving credit
lines are commitments for possible future extensions of credit to existing
customers. These lines of credit are uncollateralized and usually do not contain
a specified maturity date and may not be drawn upon to the total extent to which
the Corporation is committed.
Standby letters of credit are conditional commitments issued by the
Corporation to guarantee the performance of a customer to a third party. Those
letters of credit are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Corporation holds collateral supporting those commitments if deemed
necessary.
49
At December 31, 2004, ANB Mortgage Corp. had locked-rate commitments to
originate mortgage loans amounting to approximately $1,847,000 and loans held
for sale of $971,000. ANB Mortgage Corp. has entered into commitments, on a
best-effort basis, to sell loans of approximately $2,818,000. Risks arise from
the possible inability of counterparties to meet the terms of their contracts.
ANB Mortgage Corp. does not expect any counterparties to fail to meet its
obligations.
The Corporation does not have any off-balance sheet subsidiaries or special
purpose entities.
There were no commitments to purchase securities at December 31, 2004 or
December 31, 2003.
Other commitments:
- ------------------
The Corporation has entered into operating leases for several of its branch
and ATM facilities. The minimum annual rental payments under these leases at
December 31, 2004, (in thousands) are as follows:
Minimum Lease
Year Payments
-------------------- -------------
2005 $ 146
2006 113
2007 73
2008 59
2009 49
2010 and thereafter 36
-----
$ 476
=====
Rent expense under these leases for each of the years ended December 31,
2004, 2003, and 2002, was $146,000, $126,000, and $121,000, respectively.
The Bank is a member of the Federal Reserve System and is required to
maintain certain levels of its cash and cash equivalents as reserves based on
regulatory requirements. This reserve requirement was approximately $4,941,000
at December 31, 2004 and $3,679,000 at December 31, 2003.
The Corporation originates and sells residential real estate loans to
investors. Based on certain pre-defined criteria, including borrower non-payment
or fraud, the Corporation may be required to repurchase loans back from the
investor. Since the inception of the Corporation's secondary market mortgage
loan program, no loans have been repurchased.
11. Related Party Transactions:
In the ordinary course of business, the Corporation's directors provide the
Corporation with substantial amounts of business, and some are among its largest
depositors and borrowers. Management believes that all such loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable loans to similar, unrelated borrowers, and
do not involve more than a normal risk of collectibility or present other
unfavorable features. As of December 31, 2004, none of these loans were
restructured, past due, or on nonaccrual status.
An analysis of these loans for 2004 is as follows (in thousands):
Balance, beginning of year $ 18,811
Additions 24,504
Repayments (20,783)
---------
Balance, end of year $ 22,532
=========
12. Employee Benefit Plans:
The retirement plan is a non-contributory defined benefit pension plan
which covers substantially all employees who are 21 years of age or older and
who have had at least one year of service. Advanced funding is accomplished by
using the actuarial cost method known as the collective aggregate cost method.
The Corporation uses October 31 as a measurement date to determine
postretirement benefit obligations. All dollar amounts are shown in thousands,
unless otherwise noted.
50
The following table sets forth the plan's status as of December 31, 2004, 2003 and 2002 (in thousands):
2004 2003 2002
--------- --------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year $ 5,710 $ 4,875 $ 4,837
Service cost 432 377 319
Interest cost 361 330 336
Plan amendments - 17 -
Actuarial loss 257 155 274
Benefits paid (132) (44) (891)
--------- --------- ---------
Benefit obligation at end of year $ 6,628 $ 5,710 $ 4,875
========= ========= =========
Accumulated benefit obligation, end of year $ 4,958 $ 4,241 $ 3,546
Change in plan assets:
Fair value of plan assets at beginning of year $ 5,652 $ 3,431 $ 4,360
Actual return on plan assets 399 587 (692)
Employer contributions 357 1,678 654
Benefits paid (132) (44) (891)
--------- --------- ---------
Fair value of plan assets at end of year $ 6,276 $ 5,652 $ 3,431
========= ========= =========
Deferred asset (gain) loss $ (54) $ (298) $ 1,037
Prepaid pension cost:
Funded status $ (352) $ (58) $ (1,445)
Unrecognized net actuarial loss 1,832 1,603 1,871
Unrecognized net obligation at transition - - (5)
Unrecognized prior service cost (35) (57) (96)
--------- --------- ---------
Prepaid benefit cost included in other assets $ 1,445 $ 1,488 $ 325
========= ========= =========
Major assumptions and net periodic pension cost include the following:
2004 2003 2002
--------- --------- ---------
Components of net periodic benefit cost:
Service cost $ 432 $ 377 $ 319
Interest cost 361 330 337
Expected return on plan assets (452) (289) (346)
Amortization of prior service cost (23) (22) (24)
Amortization of net obligation at transition - (5) (12)
Recognized net actuarial gain 82 125 7
--------- --------- ---------
Net periodic benefit cost $ 400 $ 516 $ 281
========= ========= =========
Amounts recognized in the statement of financial position:
Prepaid asset $ 1,445 $ 1,488 $ 325
Accrued benefit liability - - (441)
Deferred income tax benefit - - 150
Accumulated other comprehensive income, net - - 291
--------- --------- ---------
Net amount recognized $ 1,445 $ 1,488 $ 325
========= ========= =========
2004 2003 2002
--------- --------- ---------
Weighted-average assumptions for benefit obligations:
Discount rate
Pre-retirement 6.00% 6.50% 6.75%
Post-retirement 6.00% 6.00% 6.00%
Expected return on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase 4.00% 4.00% 4.00%
51
2004 2003 2002
--------- --------- ---------
Weighted-average assumptions for net periodic benefit cost:
Discount rate
Pre-retirement 6.50% 6.75% 7.00%
Post-retirement 6.00% 6.00% 6.00%
Expected return on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase 4.00% 4.00% 4.00%
The Corporation selects the expected long-term rate-of-return-on-assets
assumption in consultation with their investment advisors and actuary. This rate
is intended to reflect the average rate of earnings expected to be earned on the
funds invested or to be invested to provide plan benefits. Historical
performance is reviewed, especially with respect to real rates of return (net of
inflation), for the major asset classes held or anticipated to be held by the
trust, and for the trust itself. Undue weight is not given to recent experience
that may not continue over the measurement period and higher significance is
placed on forecasts of future long-term economic conditions.
Because assets are held in a qualified trust, anticipated returns are not
reduced for taxes. Further, solely for this purpose, the plan is assumed to
continue in force and not terminate during the period during which assets are
invested. However, consideration is given to the potential impact of current and
future investment policy, cash flow into and out of the trust, and expenses
(both investment and non-investment) typically paid from plan assets (to the
extent such expenses are not explicitly estimated within periodic cost).
Below is a description of the plan's assets. The plan's weighted-average
asset allocations at October 31, 2004, and October 31, 2003, by asset category
are as follows:
Asset Category 2004 2003
-------------- ------- -------
Fixed Income 25.8% 22.4%
Equity 72.6 77.5
Other 1.6 .1
------- -------
Total 100.0% 100.0%
======= =======
The investment policy and strategies for plan assets can best be described
as a growth and income strategy. The target allocation is for 75% of the assets
to be invested in large and mid capitalization equity securities with the
remaining 25% invested in fixed income investments. Diversification is
accomplished by limiting the holding in any one equity issuer to no more than 5%
of total equities. Exchange traded funds are used to provide diversified
exposure to the small capitalization and international equity markets. All fixed
income investments are rated as investment grade, with the majority of these
assets invested in corporate issues. The assets are managed by the Corporation's
Trust and Investment Services Division. No derivatives are used to manage the
assets. Equity securities do not include holdings in the Corporation.
Projected benefit payments for years 2005 to 2014 are as follows (in
thousands):
Year Amount
---- ------
2005 $ -
2006 111
2007 113
2008 163
2009 193
2010-2014 2,198
The Corporation's best estimate of the maximum contribution expected to be
paid to the plan during 2005 is $333,000.
A 401(k) savings plan was adopted in 1995 that covers substantially all
full-time employees of the Corporation. The Corporation matches a portion of the
contribution made by employee participants after at least one year of service.
The Corporation contributed $156,000, $151,000 and $136,000 to the 401(k) plan
in 2004, 2003 and 2002, respectively. These amounts are included in pension and
other employee benefits expense for the respective years.
In 1982, the Board of Directors of the Corporation adopted deferred
compensation agreements with certain key officers providing for annual payments
to each ranging from $25,000 to $50,000 per year for ten years upon their
52
retirement. The liabilities under these agreements are being accrued over the
officers' remaining periods of employment so that, on the date of their
retirement, the then-present value of the annual payments would have been
accrued. The expense for this plan was $55,000, $84,000 and $77,000 for years
2004, 2003 and 2002, respectively.
13. Fair Value of Financial Instruments:
The fair value of a financial instrument is the current amount that would
be exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Corporation's various
financial instruments. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. Accordingly, the
fair value estimates may not be realized in an immediate settlement of the
instrument. SFAS 107, "Disclosures About Fair Value of Financial Instruments"
excludes certain financial instruments and all non-financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Corporation. The estimated fair values of the Corporation's assets are as
follows (in thousands):
December 31, 2004 December 31, 2003
------------------------------ ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
Financial assets:
Cash and due from banks $ 12,568 $ 12,568 $ 17,888 $ 17,888
Securities available for sale 165,958 165,958 171,376 171,376
Securities held to maturity 22,205 23,088 36,103 37,455
Loans held for sale 971 971 560 560
Loans, net of allowance 399,287 398,364 400,953 407,128
Accrued interest receivable 3,786 3,786 4,123 4,123
Financial liabilities:
Deposits $ 485,272 $ 484,739 $ 501,688 $ 503,409
Repurchase agreements 38,945 38,945 47,035 47,035
Other borrowings 21,338 22,101 21,000 22,328
Accrued interest payable 698 698 835 835
Off balance sheet instruments:
Commitments to extend credit $ - $ - $ - $ -
Standby letters of credit - 48 - 35
Rate lock commitments - - - -
The following methods and assumptions were used by the Corporation in
estimating fair value disclosures for financial instruments:
Cash and cash equivalents. The carrying amount is a reasonable estimate of fair
value.
Securities. Fair values are based on quoted market prices or dealer quotes. The
carrying value of restricted stock approximates fair value.
Loans Held for Sale. The carrying amount is a reasonable estimate of fair
value.
Loans. For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. Fair values for
certain mortgage loans (e.g., one-to-four family residential), credit card
loans, and other consumer loans are based on quoted market prices of similar
loans sold in conjunction with securitization transactions, adjusted for
differences in loan characteristics. Fair values for other loans (e.g.,
commercial real estate and investment property mortgage loans, commercial and
industrial loans) are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. Fair values for nonperforming loans are estimated
using discounted cash flow analyses or underlying collateral values, where
applicable.
Accrued interest receivable. The carrying amount is a reasonable estimate of
fair value.
53
Deposits. The fair value of demand deposits, savings deposits, and money market
deposits equals the carrying value. The fair value of fixed-rate certificates of
deposit is estimated by discounting the future cash flows using the current
rates at which similar deposit instruments would be offered to depositors for
the same remaining maturities at current rates.
Repurchase agreements. The carrying amount is a reasonable estimate of fair
value.
Other borrowings. The fair value of the Corporation's long-term borrowings are
estimated using discounted cash flow analyses based on the Corporation's
incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest payable. The carrying amount is a reasonable estimate of fair
value.
Off balance sheet instruments. The fair value of commitments to extend credit is
estimated using the fees currently charged (if any) to enter into agreements,
taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. Fees are generally not charged to extend
credit. All such commitments were subject to current market rates and pose no
known credit exposure. As a result, no fair value has been estimated for these
commitments. The fair value of letters of credit is based on fees currently
charged for similar agreements or on the estimated cost to terminate them or
otherwise settle the obligations with the counterparties at the reporting date.
The Corporation assumes interest rate risk (the risk that interest rates
will change) in its normal operations. As a result, the fair values of the
Corporation's financial instruments will change when interest rates change and
that change may be either favorable or unfavorable to the Corporation.
Management attempts to match maturities of assets and liabilities to the extent
believed necessary to minimize interest rate risk. However, borrowers with fixed
rate obligations are less likely to prepay in a rising rate environment and more
likely to prepay in a falling rate environment. Conversely, depositors who are
receiving fixed rates are more likely to withdraw funds before maturity in a
rising rate environment and less likely to do so in a falling rate environment.
Management monitors rates and maturities of assets and liabilities and attempts
to minimize interest rate risk by adjusting terms of new loans and deposits and
by investing in securities with terms that mitigate the Corporation's overall
interest rate risk.
14. Dividend Restrictions and Regulatory Capital:
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Corporation's and the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Corporation and the Bank must meet specific capital
guidelines that involve quantitative measures of the Corporation's and the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Corporation's and the Bank's capital
amounts and classification are subject to qualitative judgments by the
regulators concerning components, risk weighting, and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
Under the guidelines, total capital has been defined as core (Tier I)
capital and supplementary (Tier II) capital. The Corporation's Tier I capital
consists primarily of shareholders' equity, while Tier II capital also includes
the allowance for loan losses. The definition of assets has been modified to
include items on and off the balance sheet, with each item being assigned a
"risk-weight" for the determination of the ratio of capital to risk-adjusted
assets.
The guidelines require that total capital (Tier I plus Tier II) of 8% be
held against total risk-adjusted assets, at least half of which (4%) must be
Tier I capital. At December 31, 2004, the Corporation's Tier I and total capital
ratios were 15.48% and 16.73%, respectively. At December 31, 2003, these ratios
were 14.85% and 15.99%, respectively. The ratios for both years were well in
excess of the regulatory requirements. Management believes, as of December 31,
2004 and 2003, that the Corporation and the Bank met all regulatory capital
adequacy requirements to which they are subject.
The approval of the Comptroller of the Currency is required if the total of
all dividends declared by a national bank in any calendar year exceeds the
bank's net income, as defined, for that year combined with its retained net
income for the preceding two calendar years. Under this formula, the Bank can
distribute as dividends, without the approval of the Comptroller of the
Currency, $6,855,000 as of December 31, 2004.
54
The following table provides summary information regarding regulatory capital (in thousands):
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
----------------------- ----------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ -------- ------ -------- ------
As of December 31, 2004
Total Capital
Corporation $ 75,504 16.73% $ 36,097 >8.0%
Bank 73,724 16.36% 36,050 >8.0% $ 45,063 >10.0%
Tier I Capital
Corporation 69,842 15.48% 18,048 >4.0%
Bank 68,747 15.26% 18,025 >4.0% 27,038 >6.0%
Leverage Capital
Corporation 69,842 11.02% 19,022 >3.0%
Bank 68,747 10.86% 18,993 >3.0% 31,654 >5.0%
As of December 31, 2003
Total Capital
Corporation $ 74,222 15.99% $ 37,137 >8.0%
Bank 71,867 15.50% 37,092 >8.0% $ 46,364 >10.0%
Tier I Capital
Corporation 68,930 14.85% 18,569 >4.0%
Bank 67,248 14.50% 18,546 >4.0% 27,819 >6.0%
Leverage Capital
Corporation 68,930 10.76% 19,221 >3.0%
Bank 67,248 10.51% 19,194 >3.0% 31,989 >5.0%
15. Segment and Related Information:
In accordance with SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", reportable segments include community
banking and trust and investment services. Community banking involves making
loans to and generating deposits from individuals and businesses. All assets and
liabilities of the Bank are allocated to community banking. Investment income
from fixed income investments is another major source of income. Loan fee
income, service charges from deposit accounts and non-deposit fees such as
automatic teller machine fees and insurance commissions generate additional
income for community banking. The assets, liabilities and operating results of
the Bank's two subsidiaries, ANB Mortgage Corp. and ANB Services Corp. are
included in the other segment. ANB Mortgage Corp. performs secondary mortgage
banking and ANB Services Corp. performs retail investment and insurance sales.
Trust and investment services include estate planning, trust account
administration, and investment management. Investment management services
include purchasing equity, fixed income and mutual fund investments for customer
accounts. The trust and investment services division receives fees for
investment and administrative services. Fees are also received by this division
for individual retirement accounts managed for the community banking segment.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. All intersegment sales prices
are market based.
Segment information for the years 2004, 2003 and 2002 is shown in the
following table (in thousands). The "Other" column includes corporate items,
results of insignificant operations and, as it relates to segment profit (loss),
income and expense not allocated to reportable segments. Inter-segment
eliminations primarily consist of the Corporation's investment in the Bank and
related equity earnings.
55
2004
----------------------------------------------------------------------
Trust and
Community Investment Intersegment
Banking Services Other Eliminations Total
--------- ----------- ---------- ------------ ---------
Interest income $ 30,120 $ - $ 53 $ (53) $ 30,120
Interest expense 7,479 - 53 (53) 7,479
Noninterest income - external customers 2,712 2,976 822 - 6,510
Noninterest income - internal customers - 48 - (48) -
Operating income before income taxes 9,321 1,694 30 - 11,045
Depreciation and amortization 1,389 21 6 - 1,416
Total assets 618,325 - 2,444 (1,704) 619,065
Capital expenditures 790 29 - - 819
2003
----------------------------------------------------------------------
Trust and
Community Investment Intersegment
Banking Services Other Eliminations Total
--------- ----------- ---------- ------------ ---------
Interest income $ 32,178 $ - $ 55 $ (55) $ 32,178
Interest expense 9,391 - 55 (55) 9,391
Noninterest income - external customers 3,314 2,523 834 - 6,671
Noninterest income - internal customers - 48 - (48) -
Operating income before income taxes 11,975 1,326 126 - 13,427
Depreciation and amortization 1,555 24 6 - 1,585
Total assets 643,863 - 1,902 (1,463) 644,302
Capital expenditures 682 3 2 - 687
2002
----------------------------------------------------------------------
Trust and
Community Investment Intersegment
Banking Services Other Eliminations Total
--------- ----------- ---------- ------------ ---------
Interest income $ 35,135 $ - $ 31 $ (31) $ 35,135
Interest expense 12,310 - 31 (31) 12,310
Noninterest income - external customers 2,564 2,516 632 - 5,712
Noninterest income - internal customers - 48 - (48) -
Operating income before income taxes 11,798 1,543 38 - 13,379
Depreciation and amortization 1,570 21 3 - 1,594
Total assets 604,482 - 2,468 (1,091) 605,859
Capital expenditures 1,331 16 123 - 1,470
56
16. Parent Corporation Financial Information:
Condensed Parent Corporation financial information is as follows (in
thousands):
As of December 31
-----------------------
2004 2003
-------- ---------
Condensed Balance Sheets
------------------------
Assets
Cash $ 802 $ 1,397
Investment in subsidiary 69,562 69,912
Other assets 636 622
-------- ---------
Total Assets $ 71,000 $ 71,931
======== =========
Liabilities $ - $ -
Shareholders' equity 71,000 71,931
-------- --------
Total Liabilities and Shareholders' Equity $ 71,000 $ 71,931
======== ========
For the Year Ended
December 31
--------------------------------
2004 2003 2002
-------- -------- --------
Condensed Statements of Income
------------------------------
Dividends from subsidiary $ 7,400 $ 7,078 $ 6,000
Income 15 4 10
Expenses 179 159 145
Income taxes (benefit) (56) (52) -
-------- -------- --------
Income before equity in undistributed
earnings of subsidiary 7,292 6,975 5,865
Equity in undistributed earnings
of subsidiary 721 2,538 3,596
-------- -------- --------
Net Income $ 8,013 $ 9,513 $ 9,461
======== ======== ========
For the Year Ended
December 31
--------------------------------
2004 2003 2002
-------- -------- --------
Condensed Statements of Cash Flows
----------------------------------
Cash provided by dividends received
from subsidiary $ 7,400 $ 7,078 $ 6,000
Cash used for payment of dividends (4,411) (4,272) (4,117)
Cash used for repurchase of stock (3,787) (3,128) (1,049)
Proceeds from exercise of options 326 76 61
Other (123) (139) (239)
-------- -------- --------
Net (decrease) increase in cash $ (595) $ (385) $ 656
======== ======== ========
57
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
March 15, 2005 AMERICAN NATIONAL BANKSHARES INC.
By: /s/Charles H. Majors
- ------------------------------
President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 15, 2005.
/s/Charles H. Majors
- ------------------------------ President and
Charles H. Majors Chief Executive Officer
/s/Willie G. Barker, Jr. Director
- ------------------------------
Willie G. Barker, Jr.
/s/Richard G. Barkhouser Director
- ------------------------------
Richard G. Barkhouser
/s/Fred A. Blair Director
- ------------------------------
Fred A. Blair
/s/Ben J. Davenport, Jr. Director
- ------------------------------
Ben J. Davenport, Jr.
/s/H. Dan Davis Director
- ------------------------------
H. Dan Davis
/s/Michael P. Haley Director
- ------------------------------
Michael P. Haley
/s/Lester A. Hudson, Jr. Director
- ------------------------------
Lester A. Hudson, Jr.
/s/E. Budge Kent, Jr. Director
- ------------------------------
E. Budge Kent, Jr.
/s/Fred B. Leggett, Jr. Director
- ------------------------------
Fred B. Leggett, Jr.
/s/Franklin W. Maddux Director
- ------------------------------
Franklin W. Maddux
/s/Claude B. Owen, Jr. Director
- ------------------------------
Claude B. Owen, Jr.
/s/Neal A. Petrovich
- ------------------------------ Senior Vice President and
Neal A. Petrovich Chief Financial Officer
58
PART IV
Item 15. Exhibits and Financial Statements Schedules
(a)(1) Financial Statements (See Item 8 for reference)
(a)(3) Exhibits
EXHIBIT INDEX
-------------
Exhibit
# Description Location
- ------- -------------------------------------------------------------- -----------------------
3.1 Amended and Restated Articles of Incorporation Exhibit 4.1 on Form S-3
dated August 20, 1997 filed August 20, 1997
3.2 Amended Bylaws dated April 22, 2003 Exhibit 3.2 on Form 8-K
filed April 23, 2003
10.1 Agreement between American National Bank and Trust Exhibit 10.3 on Form 10-K
Company and E. Budge Kent, Jr. dated June 12, 1997 filed March 27, 1998
10.2 American National Bankshares Inc. Stock Option Plan dated Exhibit 4.3 on form S-8
August 19, 1997 filed September 17, 1997
10.3 Agreement between American National Bankshares Inc., Exhibit 10.5 on Form 10-K
American National Bank and Trust Company and filed March 25, 2002
Charles H. Majors dated December 18, 2001
10.4 Agreement between American National Bankshares Inc., Exhibit 10.6 on Form 10-K
American National Bank and Trust Company and filed March 25, 2002
E. Budge Kent, Jr. dated December 18, 2001
10.5 Agreement between American National Bankshares Inc., Exhibit 10.7 on Form 10-K
American National Bank and Trust Company and filed March 25, 2002
Dabney T. P. Gilliam, Jr. dated December 18, 2001
10.6 Agreement between American National Bankshares Inc., Exhibit 10.8 on Form 10-K
American National Bank and Trust Company and filed March 25, 2002
Jeffrey V. Haley dated December 18, 2001
10.7 Agreement between American National Bank and Trust Exhibit 10.10 on Form 10-K
Company and Charles H. Majors dated January 1, 2002 filed March 25, 2002
10.8 Agreement between American National Bankshares Inc.,
American National Bank and Trust Company and
R. Helm Dobbins dated June 17, 2003 Filed herewith
10.9 Agreement between American National Bankshares Inc.,
American National Bank and Trust Company and
Neal A. Petrovich dated June 15, 2004 Filed herewith
11. Refer to EPS calculation in the Notes to Financial Statements Filed herewith
21.1 Subsidiaries of the registrant Filed herewith
31.1 Section 302 Certification of Charles H. Majors, President and CEO Filed herewith
31.2 Section 302 Certification of Neal A. Petrovich, Senior Vice President
and CFO Filed herewith
32.1 Section 906 Certification of Charles H. Majors, President and CEO Filed herewith
32.2 Section 906 Certification of Neal A. Petrovich, Senior Vice President
and CFO Filed herewith
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99.2 American National Bankshares Inc. Dividend Reinvestment Exhibit 99 on Form S-3
Plan dated August 19, 1997 filed August 20, 1997
60