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10-K - 12-31-09 10-K (PDF) - AMERICAN NATIONAL BANKSHARES INC.dec312009_10k.pdf


Washington, D.C. 20549



For the fiscal year ended December 31, 2009

Commission file number 0-12820

(Exact name of registrant as specified in its charter)
(State of incorporation)
(I.R.S. Employer Identification No.)
628 Main Street, Danville, VA
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code

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

Title of Each Class
Name of Exchange on Which Registered
Common Stock, $1 par value
The Nasdaq Stock Market LLC
Securities registered pursuant to section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o   No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o   No  þ

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  þ  No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  o  No  o

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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
   Large accelerated filer  o                                                      Accelerated filer  þ                                                      Non-accelerated filer  o Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)  Yes  o   No  þ
The aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2009, based on the closing price, was $102,460,170.

The number of shares of the registrant’s common stock outstanding on March 12, 2010 was 6,123,275.

Portions of the Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on May 18, 2010, are incorporated by reference in Part III of this report.



Unresolved Staff Comments
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services

*Certain information required by Item 10 is incorporated herein by reference to the information that appears under the headings “Election of Directors,” “Election of Directors – Board Members Serving on Other Publicly Traded Company Boards of Directors,” “Election of Directors – Board of Directors and Committees - The Audit and Compliance Committee,” “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 2010 Annual Meeting of Shareholders.  The information required by Item 401 of regulation S-K on executive officers is disclosed herein.

The information required by Item 11 is incorporated herein by reference to the information that appears under the headings “Compensation Discussion and Analysis,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report” in the Registrant’s Proxy Statement for the 2010 Annual Meeting of Shareholders.

   The information required by Item 12 is incorporated herein by reference to the information that appears under the heading “Security Ownership” in the Registrant’s Proxy Statement for the 2010 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 headings “Related Party Transactions” and “Election of Directors – Board Independence” in the Registrant’s Proxy Statement for the 2010 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 2010 Annual Meeting of Shareholders.

Forward-Looking Statements

This report contains forward-looking statements with respect to the financial condition, results of operations and business of American National Bankshares Inc. and its wholly owned subsidiary, American National Bank and Trust Company (collectively referred to as the “Company”).  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on information available to management at the time these statements and disclosures were prepared.  Forward-looking statements are subject to numerous assumptions, estimates, risks, and uncertainties that could cause actual conditions, events, or results to differ materially from those stated or implied by such forward-looking statements.
A variety of factors, some of which are discussed in more detail in Item 1A – Risk Factors, may affect the operations, performance, business strategy, and results of the Company.  Those factors include but are not limited to the following:
Financial market volatility including the level of interest rates could affect the values of financial instruments and the amount of net interest income earned;
General economic or business conditions, either nationally or in the market areas in which the Company does business, may be less favorable than expected, resulting in deteriorating credit quality, reduced demand for credit, or a weakened ability to generate deposits;
Competition among financial institutions may increase and competitors may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than the Company;
Businesses that the Company is engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards;
The ability to retain key personnel; and
The failure of assumptions underlying the allowance for loan losses.

American National Bankshares Inc. is a one-bank holding company organized under the laws of the Commonwealth of Virginia in 1984.  On September 1, 1984, American National Bankshares Inc. acquired all of the outstanding capital stock of American National Bank and Trust Company, a national banking association chartered in 1909 under the laws of the United States.  American National Bank and Trust Company is the only banking subsidiary of American National Bankshares Inc.  In April 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “Trust”) and a wholly owned subsidiary of American National Bankshares Inc., was formed for the purpose of issuing preferred securities (the “Trust Preferred Securities”) in a private placement pursuant to an applicable exemption from registration.  Proceeds from the securities were used to fund the acquisition of Community First Financial Corporation (“Community First”).   In April 2006, the Company finalized the acquisition of Community First and acquired 100% of its preferred and common stock through a merger transaction.  Community First was a bank holding company headquartered in Lynchburg, Virginia, and through its subsidiary, Community First Bank, operated four banking offices serving the city of Lynchburg and Bedford, Nelson, and Amherst Counties.  The Company entered into the merger agreement with Community First because it believed the merger to be consistent with its expansion strategy to target entry into strong markets that logically extend its existing footprint.  The Company had previously opened a full service banking office in the Lynchburg area and was considering opening additional offices in that area.

      The operations of the Company are conducted at eighteen banking offices and two loan production offices serving Southern and Central Virginia and the northern portion of Central North Carolina.  American National Bank and Trust Company provides a full array of financial products and services, including commercial, mortgage, and consumer banking; trust and investment services; and insurance.  Services are also provided through twenty-five ATMs, “AmeriLink” Internet banking, and 24-hour “Access American” telephone banking.

Competition and Markets

Vigorous competition exists in the Company’s service area.  The Company competes not only with national, regional, and community banks, but also with many other types of financial institutions, including without limitation, savings banks, finance companies, mutual and money market fund providers, brokerage firms, insurance companies, credit unions, and mortgage companies.  The Company has the largest deposit market share in the City of Danville, as well as in the City of Danville and Pittsylvania County, combined.

The Southern Virginia market, in which the Company has a significant presence, is under economic pressure. The region’s economic base has historically been weighted toward the manufacturing sector.  Increased global competition has negatively impacted the textile industry and several manufacturers have closed plants due to competitive pressures or 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.  Companies within these industries, especially furniture manufacturing, have also closed plants for reasons similar to those noted above.  Additional declines in manufacturing production and unemployment could negatively impact the ability of certain borrowers to repay loans.  Also, the current economic and credit crisis, which is resulting in rising unemployment and increasing bankruptcies, foreclosures and bank failures nationally, may further intensify the economic pressure in our markets.

Supervision and Regulation

The Company is extensively regulated under both federal and state law.  The following information describes certain aspects of that regulation applicable to the Company and does not purport to be complete.  Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures, and before the various bank regulatory agencies.  The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to determine with any certainty.  A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations, and earnings of the Company.

American National Bankshares Inc.

American National Bankshares Inc. is qualified as a bank holding company (“BHC”) within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is registered as such with the Board of Governors of the Federal Reserve System (the “FRB”).  As a bank holding company, American National Bankshares Inc. is required to file various reports and additional information with the FRB and is also subject to examinations by the FRB.

The BHC Act prohibits, with certain exceptions, a BHC from acquiring beneficial ownership or control of more than 5% of the voting shares of any company, including a bank, without the FRB’s prior approval and from engaging in any activity other than those of banking, managing or controlling banks or other subsidiaries authorized under the BHC Act, or furnishing services to or performing services for its subsidiaries.  Among the permitted activities is the ownership of shares of any company the activities of which the FRB determines to be so closely related to banking or managing or controlling banks as to be proper incident thereto.

Under FRB policy, a BHC is expected to serve as a source of financial and managerial strength to its subsidiary banks and to commit resources to support those banks.  This support may be required at times when the BHC may not have the resources to provide it.  Under this policy, a BHC is expected to stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial adversity and to maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks.

Under the Gramm-Leach-Bliley Act, a BHC may elect to become a financial holding company and thereby engage in a broader range of financial and other activities than are permissible for traditional BHC’s.  In order to qualify for the election, all of the depository institution subsidiaries of the BHC must be well capitalized, well managed, and have achieved a rating of “satisfactory” or better under the Community Reinvestment Act (the “CRA”).  Financial holding companies are permitted to engage in activities that are “financial in nature” or incidental or complementary thereto as determined by the FRB.  The Gramm-Leach-Bliley Act identifies several activities as “financial in nature,” including insurance underwriting and sales, investment advisory services, merchant banking and underwriting, and dealing or making a market in securities.  American National Bankshares Inc. has not elected to become a financial holding company.

American National Bank and Trust Company

American National Bank and Trust Company is a federally chartered national bank and is a member of the Federal Reserve System.  It is subject to federal regulation by the Office of the Comptroller of the Currency (the “OCC”), the FRB, and the Federal Deposit Insurance Corporation (“FDIC”).

Depository institutions, including American National Bank and Trust Company, are subject to extensive federal and state regulations that significantly affect their business and activities.  Regulatory bodies have broad authority to implement standards and initiate proceedings designed to prohibit deposit institutions from engaging in unsafe and unsound banking practices.  The standards relate generally to operations and management, asset quality, interest rate exposure, and capital.  The agencies are authorized to take action against institutions that fail to meet such standards.

As with other financial institutions, the earnings of American National Bank and Trust Company are affected by general economic conditions and by the monetary policies of the FRB.  The FRB exerts a substantial influence on interest rates and credit conditions, primarily through open market operations in U.S. Government securities, setting the reserve requirements of member banks, and establishing the discount rate on member bank borrowings.  The policies of the FRB have a direct impact on loan and deposit growth and the interest rates charged and paid thereon.  They also impact the source and cost of funds and the rates of return on investments.  Changes in the FRB’s monetary policies have had a significant impact on the operating results of American National Bank and Trust Company and other financial institutions and are expected to continue to do so in the future; however, the exact impact of such conditions and policies upon the future business and earnings cannot accurately be predicted.

Dividend Restrictions and Capital Requirements

For information regarding the limitation on bank dividends and risk-based capital requirements, refer to Note 20 of the consolidated financial statements.  Additional information may be found in the Shareholder’s Equity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FDIC Insurance

American National Bank and Trust Company’s deposits are currently insured up to the following amounts per insured depositor by the Deposit Insurance Fund of the FDIC:

$250,000 for accounts other than retirement accounts and noninterest-bearing transaction accounts;
$250,000 for retirement accounts; and
Unlimited coverage for noninterest-bearing transaction accounts, which applies to deposits in institutions such as American National Bank and Trust Company that are participating in the FDIC’s Temporary Liquidity Guarantee Program.  For FDIC coverage purposes, interest-bearing checking accounts with an interest rate of 0.50% or less are included in the definition of noninterest-bearing transaction accounts.
   The standard insurance amount of $250,000 per depositor is in effect through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except IRAs and other certain retirement accounts, which will remain at $250,000 per depositor.
  The FDIC’s temporary Transaction Account Guarantee Program provides depositors with unlimited coverage for noninterest-bearing transaction accounts at participating FDIC-insured institutions. Noninterest-bearing checking accounts include Demand Deposit Accounts (DDAs) and any transaction account that has unlimited withdrawals and that cannot earn interest. Also included are low-interest NOW accounts (NOW accounts that cannot earn more than 0.5% interest) and IOLTA accounts. This unlimited insurance coverage is temporary and will remain in effect through June 30, 2010.
Under federal law, deposits and certain claims for administrative expenses and employee compensation against insured depository institutions are afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the liquidation or other resolution of such an institution by any receiver appointed by regulatory authorities.  Such priority creditors would include the FDIC.

Under the risk-based deposit premium assessment system of the FDIC, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities.  To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories (referred to as Risk Categories I, II, III and IV) determined by reference to its capital levels and supervisory ratings.  The assessment rates in 2008 ranged, on an annual basis, from 5 to 43 basis points, depending on the insured institution’s risk category as described above.  In late 2008, the FDIC took action to raise assessment rates by 7 basis points in each risk category beginning the first quarter of 2009.  Further, for institutions such as American National Bank and Trust Company that have elected to provide unlimited FDIC coverage for noninterest-bearing transaction accounts, an additional assessment at the annual rate of 10 basis points is due in 2010 for the amount of balances in non-interest bearing transaction accounts that exceed the existing coverage limit of $250,000 for deposit accounts other than retirement accounts and noninterest-bearing transaction accounts.

Under a revised assessment schedule effective April 1, 2009, the FDIC set new initial base assessment rates that range, on an annual basis, from 12 to 45 basis points per $100 of assessable deposits, depending on the insured institution’s risk category as described above.  These initial base assessment rates are subject to possible adjustments, including (1) for all risk categories, a potential increase for unsecured liabilities and potential decrease for long-term unsecured debt and (2) for all risk categories, other than Risk Category I, a potential increase for brokered deposits.

In February 2009, the FDIC proposed that an emergency special assessment up to 20 basis points per $100 of deposits be collected from all insured institutions in September 2009, and in May 2009 further proposed that additional special assessments of up to 5 basis points each be collected as considered necessary thereafter to maintain public confidence in federal deposit insurance.  The Bank paid a special assessment to the FDIC in the second quarter of 2009 of approximately $360,000.  On November 12, 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012.  The FDIC also adopted a uniform three-basis point increase in assessment rates effective on January 1, 2011.  In December 2009, the Bank prepaid an estimated three years deposit insurance premium, totaling approximately $2.9 million, pursuant to an FDIC mandate.  These prepayments were required from all insured depository institutions.

The level of FDIC insurance premium assessments in 2007 and 2008 for American National Bank and Trust Company was reduced by a cumulative total of $499,000 though application of a one-time premium assessment credit that resulted from the provisions of the Federal Deposit Insurance Reform Act of 2005.

The Federal Deposit Insurance Corporation Improvement Act

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the federal banking agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institution is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as defined by the law.  Under regulations established by the federal banking agencies a “well capitalized” institution must have a Tier 1 capital ratio of at least 6%, a total capital ratio of at least 10%, and a leverage ratio of at least 5%, and not be subject to a capital directive order.  An “adequately capitalized” institution must have a Tier 1 capital ratio of a least 4%, a total capital ratio of at least 8%, and a leverage ratio of at least 4%, or 3% in some cases.  Management believes, as of December 31, 2009 and 2008, that the Company met the requirements for being classified as “well capitalized.”

As required by FDICIA, the federal banking agencies also have adopted guidelines prescribing safety and soundness standards relating to, among other things, internal controls and information systems, internal audit systems, loan documentation, credit underwriting, and interest rate exposure.  In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.  In addition, the agencies adopted regulations that authorize, but do not require, an institution which has been notified that it is not in compliance with safety and soundness standard to submit a compliance plan.  If, after being so notified, an institution fails to submit an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt corrective action provisions described above.

Community Reinvestment and Consumer Protection Laws

In connection with its lending activities, the Company is subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population.  These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act.

    The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods.  Furthermore, such assessment is also required of banks that have applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch.  In the case of a BHC applying for approval to acquire a bank or BHC, the record of each subsidiary bank of the applicant BHC is subject to assessment in considering the application.  Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.”  The Company was rated “outstanding” in its most recent CRA evaluation.

Anti-Money Laundering Legislation
    The Company is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001.  Among other things, these laws and regulations require the Company to take steps to prevent the use of the Company for facilitating the flow of illegal or illicit money, to report large currency transactions, and to file suspicious activity reports.  The Company is also required to carry out a comprehensive anti-money laundering compliance program.  Violations can result in substantial civil and criminal sanctions.  In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and BHC acquisitions.

Emergency Economic Stabilization Act of 2008

In accordance with its stated purpose of restoring liquidity and stability to the financial system of the United States, the Emergency Economic Stabilization Act of 2008 established the Troubled Asset Relief Program (“TARP”), under which the United States Department of the Treasury (“UST”) is authorized to purchase preferred stock from qualified financial institutions.  The Company meets the requirements to be considered a qualified financial institution.  Under TARP, for organizations like the Company, the federal government’s purchase limitation is generally defined as 3% of risk-weighted assets, or about $18 million for the Company.  The terms of the preferred stock generally provide that:

Cumulative dividends will be paid at a rate of 5% for the first five years and 9% thereafter;
Any increase in the dividend rate paid on common stock during the first three years will require the consent of the UST;
Any repurchase of common stock will require the consent of the UST;
Conditions and limitations will be placed on executive compensation; and
UST will receive warrants, with a term of 10 years, to purchase a number of shares of common stock having an aggregate market price equal to 15% of the preferred stock amount on the day of investment.

After considering the appropriateness of applying under UST’s capital purchase program under TARP, the Company elected not to participate.  The Company believes its current and projected capital position is sufficient to meet the growth plans and credit needs of the communities it serves without government support.


At December 31, 2009, the Company employed 238 full-time equivalent persons.  The relationship with employees is considered to be good.
Internet Access to Company Documents

The Company provides access to its Securities and Exchange Commission (the “SEC”) filings through a link on the Investor Relations page of the Company’s website at  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 filed electronically with the SEC. The information on the Company’s website is not incorporated into this Annual Report on Form 10-K.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at

Executive Officers of the Registrant

The following lists, as of December 31, 2009, the named executive officers of the registrant, their ages, and their positions.

Name                                                             Age                                               Position
Charles H. Majors
President and Chief Executive Officer of the Company.

William W. Traynham
Senior Vice President, Chief Financial Officer, Treasurer and Secretary of American National Bankshares Inc. since April 2009; Executive Vice President, Chief Financial Officer, and Cashier of American National Bank and Trust Company since April 2009; prior thereto, President and Chief Financial Officer of Community Bankshares Inc. and Chief Financial Officer of Community Resource Bank, NA from 1992 until the sale of the company in 2008.

Jeffrey V. Haley
Senior Vice President of American National Bankshares Inc.; President of Trust and Financial Services and Executive Vice President of American National Bank and Trust Company since July 2008; prior thereto, Executive Vice President and Chief Operating Officer of American National Bank and Trust Company since November 2005; prior thereto, Senior Vice President and Chief Administrative Officer of American National Bank and Trust Company.

R. Helm Dobbins
Senior Vice President of American National Bankshares Inc.; Executive Vice President and Chief Credit Officer of American National Bank and Trust Company since November 2005; prior thereto, Senior Vice President and Chief Credit Officer of American National Bank and Trust Company since June 2003.

S. Cabell Dudley, Jr.
Senior Vice President of American National Bankshares Inc. since December 2008; Executive Vice President and Chief Lending Officer of American National Bank and Trust Company since July 2008; prior thereto, Senior Vice President and Commercial Relationship Manager since March 2006; prior thereto, Senior Vice President of Wachovia Bank.

Dabney T. P. Gilliam, Jr.
Senior Vice President of American National Bankshares Inc. since December 2008; Executive Vice President and Chief Administrative Officer of American National Bank and Trust Company since July 2008; prior thereto, Senior Vice President of American National Bank and Trust Company since February 2007; prior thereto, Chief Financial Officer of RACO, Inc. from January 2006 to February 2007; prior thereto, Senior Vice President, Senior Loan Officer and Chief Banking Officer of American National Bank and Trust Company.

The Company’s business is subject to interest rate risk and variations in interest rates may negatively affect financial performance.

Changes in the interest rate environment may reduce the Company’s profits.  It is expected that the Company will continue to realize income from the differential or “spread” between the interest earned on loans, securities, and other interest earning assets, and interest paid on deposits, borrowings and other interest bearing liabilities.  Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest earning assets and interest bearing liabilities.  In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations.  Management cannot ensure that it can minimize the Company’s interest rate risk.  While an increase in the general level of interest rates may increase the loan yield and the net interest margin, it may adversely affect the ability of certain borrowers with variable rate loans to pay the interest and principal of their obligations.  Accordingly, changes in levels of market interest rates could materially and adversely affect the net interest spread, asset quality, loan origination volume, and overall profitability of the Company.
The Company faces strong competition from financial services companies and other companies that offer banking services which could negatively affect the Company’s business.

Increased competition may result in reduced business for the Company.  Ultimately, the Company may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that the Company offers in its service area.  These competitors include national, regional, and community banks.  The Company also faces competition from many other types of financial institutions, including without limitation, savings banks, finance companies, mutual and money market fund providers, brokerage firms, insurance companies, credit unions, and mortgage companies.  In particular, competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs and conduct extensive promotional and advertising campaigns.

Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain loans and deposits, and range and quality of products and services provided, including new technology-driven products and services.  Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services.  If the Company is unable to attract and retain banking customers, it may be unable to continue to grow loan and deposit portfolios and its results of operations and financial condition may otherwise be adversely affected.

Changes in economic conditions could materially and negatively affect the Company’s business.

The Company’s business is directly impacted by factors such as economic, political, and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies, and inflation, all of which are beyond the Company’s control.  A deterioration in economic conditions, whether caused by national or local concerns, especially within the Company’s market area, could result in the following consequences, any of which could hurt business materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for products and services may decrease; low cost or noninterest bearing deposits may decrease; and collateral for loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans.

Trust and Investment Services fee revenue is largely dependent on the fair market value of assets under management and on trading volumes in the brokerage business. General economic conditions and their subsequent effect on the securities markets tend to act in correlation.  When general economic conditions deteriorate, consumer and corporate confidence in securities markets erodes, and Trust and Investment Service revenues are negatively impacted as asset values and trading volumes decrease.

A downturn in the real estate market could materially and negatively affect the Company’s business.

A downturn in the real estate market could negatively affect the Company’s business because significant portions of its loans are secured by real estate (approximately 82% as of December 31, 2009). The ability to recover on defaulted loans by selling the real estate collateral could then be diminished and the Company would be more likely to suffer losses.

Substantially all of the Company’s real property collateral is located in its market area.  If there is a significant decline in real estate values, especially in our market area, the collateral for loans would provide significantly less security.  Real estate values could be affected by, among other things, a continued economic slowdown and an increase in interest rates.

The Company is dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect the Company’s prospects.

The Company currently depends heavily on the services of a number of key management personnel.  The loss of key personnel could materially and adversely affect the results of operations and financial condition.  The Company’s success also depends in part on the ability to attract and retain additional qualified management personnel.  Competition for such personnel is strong in the banking industry and the Company may not be successful in attracting or retaining the personnel it requires.

The Company is subject to extensive regulation which could adversely affect its business.

The Company’s operations are subject to extensive regulation by federal, state, and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of the Company’s operations.  Because the Company’s business is highly regulated, the laws, rules, and regulations applicable to it are subject to regular change. There are currently proposed laws, rules, and regulations that, if adopted, would impact the Company’s operations. There can be no assurance that these proposed laws, rules, and regulations, or any other laws, rules, or regulations, will not be adopted in the future, which could (i) make compliance much more difficult and expensive, (ii) restrict the ability to originate, broker or sell loans, or accept certain deposits, (iii) further limit or restrict the amount of commissions, interest, or other charges earned on loans originated by the Company, or (iv) otherwise adversely affect the Company’s business or prospects for business.

The primary source of the Company’s income from which it pays cash dividends is the receipt of dividends from its subsidiary bank.

The availability of dividends from the Company is limited by various statutes and regulations.  It is possible, depending upon the financial condition of the subsidiary bank and other factors, that the Office of the Comptroller of the Currency could assert that payment of dividends or other payments is an unsafe or unsound practice.  In the event American National Bank & Trust Company was unable to pay dividends to American National Bankshares Inc., the holding company would likely have to reduce or stop paying common stock dividends.  The Company’s failure to pay dividends on its common stock could have a material adverse effect on the market price of the common stock.

A limited trading market exists for the Company’s common stock which could lead to price volatility.

The Company’s common stock is approved for quotation on the NASDAQ Global Select Market, but the trading volume has generally been modest. The limited trading market for the common stock may cause fluctuations in the stock’s market value to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market.  In addition, even if a more active market in the Company’s common stock develops, management cannot ensure that such a market will continue or that shareholders will be able to sell their shares.

The allowance for loan losses may not be adequate to cover actual losses.

In accordance with accounting principles generally accepted in the United States, an allowance for loan losses is maintained to provide for loan losses.  The allowance for loan losses may not be adequate to cover actual credit losses, and future provisions for credit losses could materially and adversely affect operating results.  The allowance for loan losses is based on prior experience, as well as an evaluation of the risks in the current portfolio.  The amount of future losses is susceptible to changes in economic, operating, and other conditions, including changes in interest rates, all of which are beyond the Company’s control; and these losses may exceed current estimates.  Federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and allowance for loan losses.  While management believes that the allowance for loan losses is adequate to cover current losses, it cannot make assurances that it will not further increase the allowance for loan losses or that regulators will not require it to increase this allowance.  Either of these occurrences could adversely affect earnings.

The allowance for loan losses requires management to make significant estimates that affect the financial statements. Due to the inherent nature of this estimate, management cannot provide assurance that it will not significantly increase the allowance for loan losses which could materially and adversely affect earnings.

The Company is exposed to operational risk.

The Company is exposed to many types of operational risks, including reputation, legal, and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, clerical or record-keeping errors, and errors resulting from faulty or disabled computer or telecommunications systems.

Negative public opinion can result from the actual or alleged conduct in any number of activities, including lending practices, corporate governance, and acquisitions, and from actions taken by government regulators and community organizations in response to those activities.  Negative public opinion can adversely affect the Company’s ability to attract and retain customers and can expose it to litigation and regulatory action.

Certain errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process its transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.  The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.

Changes in accounting standards could impact reported earnings.
    From time to time there are changes in the financial accounting and reporting standards that govern the preparation of the Company’s financial statements.  These changes can materially impact how the Company records and reports its financial condition and results of operations.  In some instances, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

The Company’s information systems may experience an interruption or breach in security.
   The Company relies heavily on communications and information systems to conduct business.  Any failure, interruption, or breach in security of these systems could result in failures or disruptions in the Company’s relationship management, general ledger, deposit, loan, and other systems.  While the Company has policies and procedures designed to prevent or limit the effect of such failure, interruption, or security breach, there can be no assurance that they will not occur or, if they do occur, that they will be adequately addressed.  Any such occurrences could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the company to civil litigation and possible financial liability, any of which could have a material adverse affect on the Company’s financial condition and results of operations.

Recent Negative Developments in the Financial Industry and Credit Markets May Adversely Affect the Company’s Operations and Results.

Negative developments in 2007 and 2008 in the credit markets have resulted in uncertainty in the financial markets in general and an economic downturn during 2009 which is continuing into early 2010.  Loan portfolio quality has deteriorated at many institutions, and the Company also has experienced some deterioration.  In addition, the value of real estate collateral supporting many home mortgages, including mortgages held by the Company, has declined and may continue to decline.  Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets.  As a result, the potential exists for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations.  Negative developments in the financial industry and credit markets, and the impact of new legislation in response to those developments, may negatively impact the Company’s operations by restricting its business operations, including its ability to originate or sell loans, and adversely impact its financial performance.  In addition, these risks could affect the value of the Company’s loan portfolio as well as the value of its investment portfolio, which would also negatively affect its financial performance.

Increase in FDIC insurance premiums may adversely affect our earnings.
     During 2008 and 2009, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the DIF.  In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: deposit accounts are currently insured up to $250,000 per customer (up from $100,000) and non-interest bearing transactional accounts at institutions , such as American National Bank & Trust Company, participating in the Transaction Account Guarantee Program are currently fully insured (unlimited coverage).  These programs have placed additional stress on the DIF.
      In order to maintain a strong funding position and restore reserve ratios of the Deposit Insurance Fund, the FDIC has increased assessment rates of insured institutions.  In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years’ worth of premiums to replenish the Deposit Insurance Fund.
   The Company may be required to pay even higher FDIC premiums than the recently increased levels.  Further, on January 12, 2010, the FDIC requested comments on a proposed rule tying assessment rates of FDIC-insured institutions to the institution’s employee compensation programs.  The exact requirements of such a rule are not yet known, but such a rule could have a negative impact on our earnings. The Company must pay for the FDIC insurance and these announced increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact our earnings.

The Company relies on other companies to provide key components of our business infrastructure.

   Third parties provide key component of our business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, Internet connections and network access.  While we have selected these third party vendors carefully, we do not control their actions.  Any problem caused by these third parties, including those resulting from disruptions in communication services proved by a vendor, failure of a vendor to handle current or higher volumes, failures of a vendor to provide services for any reason or poor performance of services, could adversely affect our ability to deliver products and services to our customers and otherwise conduct our business.  Financial or operational difficulties of a third party vendor could also hurt our operations if those difficulties interface with the vendor’s ability to serve us.  Replacing these third party vendors could also create significant delay and expense.  Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations.

As of December 31, 2009, the Company maintained eighteen banking offices located in Danville, Pittsylvania County, Martinsville, Henry County, Halifax County, Lynchburg, Bedford County, Campbell County, and Nelson County in Virginia and Caswell County in North Carolina.  The Company also operates two loan production offices.
The principal executive offices of the Company are located at 628 Main Street in the business district of Danville, Virginia.  This building, owned by the Company, was originally constructed in 1973 and has three floors totaling approximately 27,000 square feet.

The Company owns a building located at 103 Tower Drive in Danville, Virginia.  This three-story facility serves as an operations center for data processing and deposit operations.

The Company has an office at 445 Mount Cross Road in Danville, Virginia where it consolidated two banking offices in January 2009 and gained additional administrative space.

The Company owns ten other retail offices and two closed offices, for a total of fifteen owned buildings.  There are no mortgages or liens against any of the properties owned by the Company.  The Company operates twenty-five Automated Teller Machines (“ATMs”) on owned or leased facilities.  The Company leases six of the retail office locations and a storage warehouse.

There are no material pending legal proceedings to which the Company is a party or to which the property of the Company is subject.

No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Company through a solicitation of proxies or otherwise.


    The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol “AMNB.”  At December 31, 2009, the Company had 1,611 shareholders of record.  The following table presents the high and low closing sales prices for the Company’s common stock and dividends declared for the past two years.

Market Price of the Company’s Common Stock
Closing Price
Per Share
4th quarter
  $ 22.76     $ 19.79     $ 0.23  
3rd quarter
    23.50       19.67       0.23  
2nd quarter
    21.42       15.11       0.23  
1st quarter
    17.58       14.61        0.23  
                    $ 0.92  
Closing Price
Per Share
4th quarter
  $ 18.25     $ 14.01     $ 0.23  
3rd quarter
    18.20       15.80       0.23  
2nd quarter
    22.00       17.45       0.23  
1st quarter
    22.64       18.65        0.23  
                    $ 0.92  

Stock Compensation Plans

The Company maintains the 2008 Stock Incentive Plan (“2008 Plan”), which is designed to attract and retain qualified personnel in key positions, provide employees with an equity interest in the Company as an incentive to contribute to the success of the Company, and reward employees for outstanding performance and the attainment of targeted goals.  The 2008 Plan was adopted by the Board of Directors of the Company on February 19, 2008 and approved by the stockholders on April 22, 2008 at the Company’s 2008 Annual Meeting.  The 2008 Plan provides for the granting of restricted stock awards and incentive and non-statutory options to employees and directors on a periodic basis, at the discretion of the Board or a Board designated committee.  The 2008 Plan authorized the issuance of up to 500,000 shares of common stock.

The 2008 Plan is administered by a committee of the Board of Directors of the Company comprised of independent directors.  Under the 2008 Plan, the committee determines which employees will be granted restricted stock awards and options, whether such options will be incentive or non-statutory 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.  Restricted stock would be granted under terms and conditions established by the committee.

Stock options become vested and exercisable in the manner specified by the committee.  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.  As of December 31, 2009, 104,353 shares remain exercisable under the 1997 Option Plan and 27,750 shares are vested and exercisable under the 2008 Plan.  There were 6,000 stock options awarded in 2009.  Options granted in 2009 vest one third each year at December 31, 2009, 2010, and 2011.

The December 31, 2009 position of the Company’s equity investment compensation plan is summarized below:

December 31, 2009
Number of Shares
to be Issued Upon Exercise
of Outstanding Options
Weighted-Average Per Share Exercise Price of Outstanding Options
Number of Shares Remaining Available for Future Issuance Under
Stock Compensation Plans
Equity compensation plans approved by shareholders
    162,603     $ 21.39       441,000  
Equity compensation plans not approved by shareholders
     -         -        -  
    162,603     $ 21.39       441,000  

Comparative Stock Performance

The following graph compares the Company’s cumulative total return to its shareholders with the returns of two indexes for the five-year period ended December 31, 2009.  The cumulative total return was calculated taking into consideration changes in stock price, cash dividends, stock dividends, and stock splits since December 31, 2004.  The indexes are the NASDAQ Composite Index; the SNL Bank $500 Million-$1Billlion Index, which includes bank holding companies with assets of $500 million to $1 billion and is published by SNL Financial, LC.
American National Bankshares Inc.
Period Ending
American National Bankshares Inc.
    100.00       99.46       103.53       92.43       82.84       112.16  
NASDAQ Composite
    100.00       101.37       111.03       121.92       72.49       104.31  
SNL Bank $500M-$1B
    100.00       104.29       118.61       95.04       60.90       58.00  

Russell 2000

The Company was added to the Russell 3000 Index and the Russell 2000 Index on June 29, 2009 when Russell Investments reconstituted its comprehensive set of U. S. and Global equity indexes. The Russell indexes are widely used by investment managers as index funds and performance benchmarks for investment strategies. The indexes are reconstituted annually in late May and are comprised of the 3,000 largest U. S. stocks by market capitalization. The largest 1,000 companies comprise the Russell 1000 and the next 2,000 companies comprise the Russell 2000.

The following table sets forth selected financial data for the Company for the last five years:
(in thousands, except per share amounts and ratios)
Results of Operations:
Interest income
  $ 38,061     $ 42,872     $ 48,597     $ 45,070     $ 32,479  
Interest expense
    10,789       15,839       19,370       16,661       8,740  
Net interest income
    27,272       27,033       29,227       28,409       23,739  
Provision for loan losses
    1,662       1,620       403       58       465  
Noninterest income
    7,043       7,913       8,822       8,458       7,896  
Noninterest expense
    23,318       22,124       21,326       20,264       17,079  
Income before income tax provision
    9,335       11,202       16,320       16,545       14,091  
Income tax provision
    2,525       3,181       4,876       5,119       4,097  
Net income
  $ 6,810     $ 8,021     $ 11,444     $ 11,426     $ 9,994  
Period-end Balances:
  $ 199,686     $ 140,816     $ 157,149     $ 162,621     $ 165,629  
Loans, net of unearned income
    527,991       571,110       551,391       542,228       417,087  
    604,273       589,138       581,221       608,528       491,651  
    808,973       789,184       772,288       777,720       623,503  
Shareholders' equity
    106,389       102,300       101,511       94,992       73,419  
Shareholders' equity - tangible (a)
    82,223       77,757       76,591       69,695       73,287  
Per Share Information:
Earnings - basic
  $ 1.12     $ 1.32     $ 1.86     $ 1.91     $ 1.83  
Earnings - diluted
    1.12       1.31       1.86       1.90       1.81  
    0.92       0.92       0.91       0.87       0.83  
Book value
    17.41       16.81       16.59       15.42       13.49  
Book value - tangible (a)
    13.46       12.78       12.52       11.31       13.47  
Return on average assets
    0.84 %     1.02 %     1.48 %     1.51 %     1.61 %
Return on average shareholders' equity
    6.57       7.79       11.69       12.72       13.95  
Return on average tangible equity (b)
    8.94       10.60       16.09       16.60       14.35  
Net interest margin - taxable equivalent
    3.81       3.87       4.24       4.20       4.17  
Average shareholders' equity / average assets
    12.79       13.10       12.65       11.85       11.57  
Dividend payout ratio
    82.40       69.89       48.82       45.58       45.39  
Net charge-offs to average loans
    0.24       0.21       0.05       0.10       0.56  
Allowance for loan losses to period-end loans
    1.55       1.37       1.34       1.34       1.46  
Nonperforming assets to total assets
    0.87       0.91       0.42       0.45       0.72  
(a) - Excludes goodwill and other intangible assets.
(b) - Excludes amortization expense, net of tax, of intangible assets.


The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the past three years.  The discussion and analysis are intended to supplement and highlight information contained in the accompanying Consolidated Financial Statements and the selected financial data presented elsewhere in this Annual Report on Form 10-K.


In certain circumstances, reclassifications have been made to prior period information to conform to the 2009 presentation.


The accounting and reporting policies followed by the Company conform with U.S. generally accepted accounting principles (“GAAP”) and they conform to general practices within the banking industry.  The Company’s critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses and (2) goodwill impairment.  A summary of the Company’s significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements.

The financial information contained within the Company’s financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred.  A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset, or relieving a liability.  In addition, GAAP itself may change from one previously acceptable method to another method.

Allowance for Loan Losses

The 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) the requirement that losses be accrued when they are probable of occurring and estimable and (ii) and the requirement that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows, or values observable in the secondary market, and the loan balance.

The Company’s allowance for loan losses has two basic components:  the formula allowance and the specific allowance.  Each of these components is determined based upon estimates that can and do change. The formula allowance uses a historical loss view as an indicator of future losses along with various qualitative factors, including levels and trends in delinquencies, nonaccrual loans, charge-offs and recoveries; trends in volume and terms of loans; effects of changes in underwriting standards; experience of lending staff and local, regional and national economic conditions; and portfolio concentrations. In the formula allowance, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans.  Allowance calculations for consumer loans are calculated on a product basis rather than by risk grade. The adjusted loss factor is multiplied by the period-end balances for each risk-grade category.  The formula allowance is calculated for a range of outcomes.  The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. The use of these values is inherently subjective and actual losses could be greater or less than the estimates.

Goodwill Impairment

The Company tests goodwill on an annual basis or more frequently if events or circumstances indicate that there may have been impairment.  If the carrying amount of goodwill exceeds its implied fair value, the Company would recognize an impairment loss in an amount equal to that excess.  The goodwill impairment test requires management to make judgments in determining the assumptions used in the calculations.  The goodwill impairment testing conducted by the Company in 2009 indicated that goodwill is not impaired and is properly recorded in the financial statements.


The analysis of net interest income in this document is performed on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets.


American National Bankshares Inc. is the holding company of American National Bank and Trust Company, a community bank serving Southern and Central Virginia and the northern portion of Central North Carolina with eighteen banking offices and two loan production offices

American National Bank and Trust Company provides a full array of financial products and services, including commercial, mortgage, and consumer banking; trust and investment services; and insurance.  Services are also provided through twenty-five ATMs, “AmeriLink” Internet banking, and 24-hour “Access American” telephone banking.

Additional information is available on the Company’s website at  The information on the Company’s website is not incorporated into this Annual Report on Form 10-K.  The shares of American National Bankshares Inc. are traded on the NASDAQ Global Select Market under the symbol “AMNB.”


Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits.  Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.  The following discussion of net interest income is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets, such as certain state and municipal securities.  A tax rate of 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.  Net interest income divided by average earning assets is referred to as the net interest margin. The net interest spread represents the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities.

Net interest income on a taxable equivalent basis increased $313,000 or 1.1% in 2009 from 2008, following a $2,226,000 or 7.4% decrease in 2008 from 2007.  The increase in net interest income in 2009 was primarily due to a 0.88% reduction in interest rates paid on deposits.  The decrease in net interest income in 2008 was primarily due to 1.21% decrease in the yield on loans, the largest component of earnings assets. The net interest margin was 3.81% for 2009, 3.87% for 2008, and 4.24% for 2007. During 2008, the Federal Open Market Committee of the FRB reduced the intended federal funds rate seven times from 4.25% to 0.25%, where it remained for the duration of 2009 and into early 2010.   This historically low rate environment has had a dramatic effect on the Company’s net interest margin.

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

Table 1 - Net Interest Income Analysis
(in thousands, except yields and rates)
Average Balance
Interest Income/Expense
Average Yield/Rate
  $ 88,551     $ 91,117     $ 89,673     $ 4,213     $ 5,515     $ 6,980       4.76 %     6.05 %     7.78 %
Real Estate
    463,093       467,508       449,683       26,294       29,712       33,621       5.68       6.36       7.48  
    7,623       8,774       10,420       659       795       975       8.64       9.06       9.36  
Total loans
    559,267       567,399       549,776       31,166       36,022       41,576       5.57       6.35       7.56  
Federal agencies
    52,694       45,660       68,521       2,139       2,215       3,032       4.06       4.85       4.42  
    40,363       47,997       25,406       2,100       2,433       1,255       5.20       5.07       4.94  
State and municipal
    52,687       45,573       46,069       2,972       2,505       2,530       5.64       5.50       5.49  
    7,493       6,141       7,484       261       277       438       3.48       4.51       5.85  
Total securities
    153,237       145,371       147,480       7,472       7,430       7,255       4.88       5.11       4.92  
Deposits in other banks
    28,804       9,239       13,431       378       301       679       1.31       3.26       5.06  
Total interest earning assets
    741,308       722,009       710,687       39,016       43,753       49,510       5.26       6.06       6.97  
Nonearning assets
    68,832       63,859       62,952                                                  
Total assets
  $ 810,140     $ 785,868     $ 773,639                                                  
  $ 98,576     $ 109,492     $ 107,834       290       803       1,550       0.29       0.73       1.44  
Money market
    72,918       53,659       52,843       527       1,011       1,429       0.72       1.88       2.70  
    62,219       61,620       66,246       148       331       845       0.24       0.54       1.28  
    273,301       258,773       261,286       7,434       10,135       11,711       2.72       3.92       4.48  
Total deposits
    507,014       483,544       488,209       8,399       12,280       15,535       1.66       2.54       3.18  
Customer repurchase
    63,115       52,264       48,088       670       1,377       1,841       1.06       2.63       3.83  
Other short-term borrowings
    1,037       9,818       346       5       252       19       0.48       2.57       5.49  
Long-term borrowings
    30,849       34,235       32,245       1,715       1,930       1,975       5.56       5.64       6.12  
Total interest bearing
    602,015       579,861       568,888       10,789       15,839       19,370       1.79       2.73       3.40  
Noninterest bearing
demand deposits
    99,686       98,157       102,003                                                  
Other liabilities
    4,814       4,933       4,894                                                  
Shareholders' equity
    103,625       102,917       97,854                                                  
Total liabilities and
   shareholders' equity
  $ 810,140     $ 785,868     $ 773,639                                                  
Interest rate spread
                                                    3.47 %     3.33 %     3.57 %
Net interest margin
                                                    3.81 %     3.87 %     4.24 %
Net interest income (taxable equivalent basis)
              28,227       27,914       30,140                          
Less: Taxable equivalent adjustment
                      955       881       913                          
Net interest income
                          $ 27,272     $ 27,033     $ 29,227                          

    Table 2 presents the dollar amount of changes in interest income and interest expense, and distinguishes between changes resulting from fluctuations in average balances of interest earning assets and interest bearing liabilities (volume), and changes resulting from fluctuations 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)
2009 vs. 2008
2008 vs. 2007
Attributable to
Attributable to
Interest income
  $ (1,302 )   $ (1,151 )   $ (151 )   $ (1,465 )   $ (1,576 )   $ 111  
Real Estate
    (3,418 )     (3,140 )     (278 )     (3,909 )     (5,200 )     1,291  
    (136 )     (35 )     (101 )     (180 )     (30 )     (150 )
Total loans
    (4,856 )     (4,326 )     (530 )     (5,554 )     (6,806 )     1,252  
Federal agencies
    (76 )     (390 )     314       (817 )     270       (1,087 )
    (333 )     63       (396 )     1,178       34       1,144  
State and municipal
    467       67       400       (25 )     2       (27 )
Other securities
    (16 )     (70 )     54       (161 )     (90 )     (71 )
Total securities
    42       (330 )     372       175       216       (41 )
Deposits in other banks
    77       (263 )     340       (378 )     (201 )     (177 )
Total interest income
    (4,737 )     (4,919 )     182       (5,757 )     (6,791 )     1,034  
Interest expense
    (513 )     (440 )     (73 )     (747 )     (770 )     23  
Money market
    (484 )     (765 )     281       (418 )     (440 )     22  
    (183 )     (186 )     3       (514 )     (459 )     (55 )
    (2,701 )     (3,243 )     542       (1,576 )     (1,464 )     (112 )
Total deposits
    (3,881 )     (4,634 )     753       (3,255 )     (3,133 )     (122 )
Customer repurchase
    (707 )     (949 )     242       (464 )     (613 )     149  
Other borrowings
    (462 )     181       (643 )     188       (427 )     615  
Total interest expense
    (5,050 )     (5,402 )     352       (3,531 )     (4,173 )     642  
Net interest income
  $ 313     $ 483     $ (170 )   $ (2,226 )   $ (2,618 )   $ 392  

Noninterest Income

Noninterest income is generated from a variety of sources, including fee-based deposit services, trust and investment services, mortgage banking, and retail brokerage.  Noninterest income also includes net gains or losses on sales, calls, or impairment of investment securities.  It also includes net gains or losses related to foreclosed real estate.
2009 compared to 2008

Noninterest income was $7,043,000 in 2009, down $807,000 or 11% from 2008, resulting primarily from $1,475,000 in write downs associated with foreclosed real estate. Of that amount, approximately $1.2 million was related to a single real estate development and acquisition relationship. The major source of noninterest income was trust fees, which totaled $3,153,000 for 2009, down 9.1% from 2008, resulting mostly from declines in the stock market. The level of the stock market is a primary driver in trust fee income. The second major source of noninterest income was service charges on deposit accounts, which totaled $2,085,000 for 2009, down 10.3% from 2008, mostly related to declining volumes of returned check fees. Mortgage banking income totaled $1,605,000 for 2009, up 104% from 2008, related to historically low interest rates and a recently enacted homebuyers’ tax credit.
2008 compared to 2007

Noninterest income was $7,913,000 in 2008, down 10.3% from 2007, resulting from decreases in most revenue sources and losses of $450,000 on securities. Trust fees, which totaled $3,467,000 for 2008, were down 3.1% from 2007. Service charges on deposit accounts, which totaled $2,324,000 for 2008, were down 8.2% from 2007, mostly related to declining volumes of returned check fees. Mortgage banking income totaled $788,000 for 2008, was down 17.4% from 2007. Securities losses in 2008 and impairment of securities in 2007 were primarily related to the impairment and subsequent sale of shares the Company held in Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock.

Noninterest Expense
2009 compared to 2008

 Noninterest expense was $23,318,000 in 2009, up $1,194,000 or 5.4% over 2008. The increase in FDIC insurance expense accounted for $1,006,000 or 84.3% of this increase.

Salaries expense totaled $10,048,000 for 2009, up 2.6% from 2008. This increase resulted from small salary increases, increased incentive payments, and increased commission payments related to the higher volume of secondary market mortgage loans sold. It was mitigated by a mid-year reduction in force that impacted less than five percent of the Company’s employees.

Benefits expense totaled $3,201,000 for 2009, up 6.7% from 2008. This increase resulted primarily from an increase in costs associated with the Company’s defined benefit program. At year-end 2009 the Company converted its existing defined benefit program to a cash balance program. Management expects the conversion will save significant costs in the future.

Occupancy and equipment expense totaled $2,927,000 for 2009, up 5% from 2008.This increase resulted primarily from an increase in depreciation and premises expense related to the mid-year opening of a newly constructed  branch in Martinsville.

FDIC insurance totaled $1,186,000 for 2009, up 559% or $1,006,000 from 2008. The increase resulted from the aggregate impact of premium increases driven by overall market conditions, the expiration of premium credits in 2008, and the imposition of special assessment in the second quarter of 2009 of approximately $360,000. In December 2009 the Company paid, at the mandate of the FDIC, an estimated three-year deposit premium of $2.9 million which will be amortized to expense over the upcoming three fiscal years.

2008 compared to 2007

Noninterest expense was $22,124,000 in 2008, up 3.7% over 2007, due primarily to increased health insurance costs and provision for unfunded lending commitments.

Salaries expense totaled $9,792,000 for 2008, up 1.1% from 2007. This increase resulted from very limited salary increases, but was mitigated by decreased incentive payments and decreased commission payments related to the lower volumes of secondary market mortgage loans sold.

Benefits expense totaled $3,001,000 for 2008, up 9.2% from 2007. This increase resulted primarily from an increase in costs associated with the Company’s group insurance program.

Occupancy and equipment expense totaled $2,788,000 for 2008, down 6.5% from 2007.This decrease resulted primarily from declining depreciation and repairs expense.

Other expense totaled $5,292,000 for 2008, up 10.7% from 2007. This increase resulted primarily from an increase in provision for off-balance sheet credit risk of $296,000.

Income Taxes

Income taxes on 2009 earnings amounted to $2,525,000, resulting in an effective tax rate of 27.0%, compared to 28.4% in 2008 and 29.9% in 2007.  The Company was subject to a statutory, blended, Federal tax rate of 34.0% in 2009, 34.1% in 2008, and 34.4% in 2007.  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.

Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories.  The most significant effect of inflation is on noninterest 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 Company has the ability to react to those changes and measure and monitor its interest rate and liquidity risk.

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

Interest Rate Risk Management
Interest rate risk and its impact on net interest income is a primary market risk exposure.  The Company manages its exposure to fluctuations in interest rates through policies approved by its Asset/Liability Investment Committee (“ALCO”) and Board of Directors, both of which receive and review periodic reports of the Company’s interest rate risk position.
 The Company uses simulation analysis to measure the sensitivity of projected earnings to changes in interest rates.  Simulation takes into account current balance sheet volumes and the scheduled repricing dates and maturities of assets and liabilities.  It incorporates numerous assumptions including growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid.  Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

A balance sheet is considered asset sensitive when its earning assets (loans and securities) reprice faster or to a greater extent than its liabilities (deposits and borrowings).  An asset sensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when they decline.  Based on the Company’s simulation analysis, management believes the Company’s interest sensitivity position at December 31, 2009 is asset sensitive.

The interest rate sensitivity position at December 31, 2009 is illustrated in the following table.  The carrying amounts of assets and liabilities are presented in the periods they are expected to reprice or mature.

Table 3 - Interest Rate Sensitivity Gap Analysis
December 31, 2009
(dollars in thousands)
> 1 Year
> 3 Year
1 Year
to 3 Years
to 5 Years
> 5 Years
Interest sensitive assets:
Interest bearing deposits
with other banks
  $ 2,405     $ 8,288     $ -     $ -     $ 10,693  
    41,217       38,643       30,172       89,654       199,686  
Loans (1)
    322,558       81,753       80,826       45,344       530,481  
Total interest
sensitive assets
    366,180       128,684       110,998       134,998       740,860  
Interest sensitive liabilities:
Checking and savings deposits
    158,898       -       -       -       158,898  
Money market deposits
    75,554       -       -       -       75,554  
Time deposits
    177,818       62,222       27,905       141       268,086  
Customer repurchase agreements
    65,929       -       -       -       65,929  
Federal Home Loan Bank advances
    -       8,000       638       -       8,638  
Trust preferred capital notes
    -       20,619       -       -       20,619  
Total interest
sensitive liabilities
    478,199       90,841       28,543       141       597,724  
Interest sensitivity gap
  $ (112,019 )   $ 37,843     $ 82,455     $ 134,857     $ 143,136  
Cumulative interest sensitivity gap
  $ (112,019 )   $ (74,176 )   $ 8,279     $ 143,136          
Percentage cumulative gap
to total interest sensitive assets
    (15.1 ) %     (10.0 ) %     1.1 %     19.3 %        
(1) Loans include loans held for sale and are net of unearned income.

Table 4 shows the estimated impact of changes in interest rates on net interest income as of December 31, 2009, assuming gradual and parallel changes in interest rates, and consistent levels of assets and liabilities.  Net interest income for the following twelve months is projected to increase when interest rates are higher than current rates.  Due to the current low interest rate environment, no measurement was considered necessary for a further decline in interest rates.

Table 4 - Estimated Changes in Net Interest Income
(dollars in thousands)
December 31, 2009
Change in
Changes in
Net interest Income (1)
Up  4.0%
  $ 4,982       16.4 %
Up  3.0%
    3,615       11.9  
Up  2.0%
    2,307       7.6  
Up  1.0%
    934       3.1  
No change
    -       -  
(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.

Management cannot predict future interest rates or their exact effect on net interest income.  Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results.  Certain limitations are inherent in such computations.  Assets and liabilities may react differently than projected to changes in market interest rates.   The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag changes in market interest rates.  Interest rate shifts may not be parallel.

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

Liquidity Risk Management

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

Liquidity sources include cash and amounts due from banks, deposits in other banks, loan repayments, increases in deposits, lines of credit from the Federal Home Loan Bank of Atlanta (“FHLB”), federal funds lines of credit from two correspondent banks, access to the Federal Reserve Bank of Richmond’s discount window, and maturities and sales of securities.  Management believes that these sources provide sufficient and timely liquidity.

The Company has a line of credit with the FHLB, equal to 30% of the Company’s assets, subject to the amount of collateral pledged.  Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans and home equity lines of credit.  In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB.  Borrowings under the line were $8,638,000 at December 31, 2009 and $21,637,000 at December 31, 2008.  In addition, the Company had outstanding against this line $40 million in FHLB letters of credit used to provide collateral for public deposits in Virginia.

The Company had fixed-rate term borrowing contracts with the FHLB as of December 31, 2009, with the following final maturities:
Expiration Date
$ 8,000,000       2011  
  638,000       2014  
The Company has federal funds lines of credit established with two other banks in the amounts of $15,000,000 and $5,000,000, and has access to the Federal Reserve Bank’s discount window.  There were no balances outstanding under these facilities at December 31, 2009 or 2008.



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

During 2008, the Company sold all its remaining preferred shares in FNMA and FHLMC.
The following table presents information on the amortized cost, maturities, and taxable equivalent yields of securities at the end of the last three years.

Table 5 - Securities Portfolio
(in thousands, except yields)
December 31,
Federal Agencies:
Within 1 year
$ 32,498   1.76 % $ 8,240   4.58 % $ 4,000       3.46 %
1 to 5 years
  42,404   3.13     29,719   4.95     45,170       4.79  
5 to 10 years
  6,377   4.58     5,372   5.15     6,180       5.46  
  81,279   2.70     43,331   4.91     55,350       4.77  
Within 1 year
  393   3.66     746   3.91     108       3.43  
1 to 5 years
  4,081   4.89     3,435   4.95     3,461       4.33  
5 to 10 years
  14,014   4.97     12,730   4.81     14,411       4.85  
Over 10 years
  23,076   4.78     28,482   5.08     27,674       5.34  
  41,564   4.84     45,393   4.97     45,654       5.10