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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
At November 7, 2007, the Company had 6,115,125 shares Common Stock outstanding, $1 par value.
The consolidated financial statements include the amounts and results of operations of American National Bankshares Inc. and its wholly owned subsidiary, American National Bank and Trust Company (collectively referred to as the “Company”).
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company’s financial position as of September 30, 2007; the consolidated statements of income for the three months and nine months ended September 30, 2007 and 2006; the consolidated statements of changes in shareholders’ equity for the nine months ended September 30, 2007 and 2006; and the consolidated statements of cash flows for the nine months ended September 30, 2007 and 2006. Operating results for the nine month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. Certain reclassifications have been made to prior period balances to conform to the current period presentation. The statements should be read in conjunction with the Notes to Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2006.
The following table shows 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 September 30, 2007.
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 Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The unrealized losses are attributable to interest rate changes and not credit concerns of the issuer. The Company has the intent and ability to hold these securities for the time necessary to recover the amortized cost. As of September 30, 2007, the Company held 110 securities that had been in a continuous unrealized loss position for twelve months or more.
The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position at December 31, 2006.
The following is a summary of information pertaining to impaired and nonaccrual loans:
No additional funds are committed to be advanced in connection with impaired loans.
On April 7, 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “Trust”) and a newly formed, wholly owned subsidiary of the Company, issued $20,000,000 of preferred securities (the “Trust Preferred Securities”) in a private placement pursuant to an applicable exemption from registration. The Trust Preferred Securities mature on June 30, 2036, but may be redeemed at the Company’s option beginning on June 30, 2011. The Trust Preferred Securities require quarterly distributions by the Trust to the holder of the Trust Preferred Securities at a fixed rate of 6.66%. Effective June 30, 2011, the rate will reset quarterly at the three-month LIBOR plus 1.35%. Distributions are cumulative and will accrue from the date of original issuance, but may be deferred by the Company from time to time for up to twenty consecutive quarterly periods. The Company has guaranteed the payment of all required distributions on the Trust Preferred Securities.
The proceeds of the Trust Preferred Securities received by the Trust, along with proceeds of $619,000 received by the Trust from the issuance of common securities (the “Trust Common Securities”) by the Trust to the Company, were used to purchase $20,619,000 of the Company’s junior subordinated debt securities (the “Trust Preferred Capital Notes”), issued pursuant to a Junior Subordinated Indenture (the “Indenture”) entered into between the Company and Wilmington Trust Company, as trustee. The proceeds of the Trust Preferred Capital Notes were used to fund the cash portion of the merger consideration to the former shareholders of Community First Financial Corporation in connection with the Company’s acquisition of that company, and for general corporate purposes.
There were no tax benefits associated with stock option activity during the first nine months of 2007 or 2006. Under SFAS 123R, a company may only recognize tax benefits for stock options that ordinarily will result in a tax deduction when the option is exercised (“non-statutory” options). The Company has no non-statutory stock options.
Stock option plan activity for the nine months ended September 30, 2007 is summarized below:
The total intrinsic value of options exercised during the three month and nine month periods ended September 30, 2007 was $87,841 and $195,991, respectively.
Stock options on common stock which were not included in computing diluted earnings per share for the nine month periods ended September 30, 2007 and 2006 because their effects were antidilutive averaged 88,027 and 88,227, respectively.
Community banking involves making loans to and generating deposits from individuals and businesses. All assets and liabilities of the Company are allocated to community banking. Investment income from securities is also allocated to the community banking segment. Loan fee income, service charges from deposit accounts, and non-deposit fees such as automatic teller machine fees and insurance commissions generate additional income for community banking.
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.
Amounts shown in the “Other” column include activities of American National Bankshares Inc. and its subsidiary, AMNB Statutory Trust I, which issued $20,000,000 of preferred securities in 2006. Refer to Note 6 for additional information on the preferred securities. The “Other” column also includes corporate items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments. Intersegment eliminations primarily consist of American National Bankshares Inc.’s investment in American National Bank and Trust Company and related equity earnings.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this discussion is to focus on important factors affecting the financial condition and results of operations of the Company. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.
This report contains forward-looking statements with respect to the financial condition, results of operations and business of 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. Factors that may cause actual results to differ materially from those expected include the following:
| · | 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 such things as deterioration in credit quality, reduced demand for credit, and reductions in depositors’ account balances. |
| · | Changes in interest rates could increase or reduce income. |
| · | 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. |
| · | Adverse changes may occur in the securities markets. |
Reclassification
In certain circumstances, reclassifications have been made to prior period information to conform to the 2007 presentation.
Critical Accounting Policies
The Company’s critical accounting policies are listed below. A summary of the Company’s significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements in the Company’s 2006 Annual Report on Form 10-K.
The Company’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.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
The allowance for loan losses is an estimate of the losses inherent in the loan portfolio at the balance sheet date. The allowance and reserve is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards (“SFAS”) 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses 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 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. 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 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. 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 unallocated allowance includes estimated losses whose impact on the portfolio has 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.
The reserve for unfunded loan commitments is an estimate of the losses inherent in off-balance-sheet loan commitments at the balance sheet date. It is calculated by multiplying an estimated loss factor by an estimated probability of funding, and then by the period-end amounts for unfunded commitments. The reserve for unfunded loan commitments is included in other liabilities.
Goodwill and Other Intangible Assets
The Company adopted SFAS 142, Goodwill and Other Intangible Assets, effective January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value-based test. Additionally, under SFAS 142, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the assets can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful lives. Branch acquisition transactions were outside the scope of SFAS 142 and, accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS 142. The costs of purchased deposit relationships and other intangible assets, based on independent valuation by a qualified third party, are being amortized over their estimated lives. Core deposit intangible amortization expense charged to operations was $94,000 for the third quarter of 2007 and $134,000 for the same period of 2006, and $283,000 and $307,000 for the nine months ended September 30, 2007 and 2006, respectively.
Non-GAAP Presentations
The Management’s Discussion and Analysis may refer to the efficiency ratio, which is computed by dividing noninterest expense by the sum of net interest income on a taxable equivalent basis and noninterest income (excluding gains on sales of securities or other assets). This is a non-GAAP financial measure which management believes provides investors with important information regarding the Company’s operational efficiency. Comparison of the Company’s efficiency ratio with those of other companies may not be valid because other companies may calculate the efficiency ratio differently.
The analysis of net interest income in this document is performed on a taxable equivalent basis. Management believes the taxable equivalent presentation better reflects total return, as many financial assets have specific tax advantages that modify their effective yields. A reconcilement of taxable equivalent net interest income to net interest income is provided.
New Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but may change current practice for some entities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The Company does not expect the implementation of SFAS 157 to have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. The Company has not yet adopted this standard and does not expect the implementation of SFAS 159 to have a material impact on its consolidated financial statements.
Refer to the Company’s December 31, 2006 Annual Report on Form 10-K for previously announced accounting pronouncements.
Internet Access to Corporate Documents
The Company provides access to its SEC filings through a link on the Investors Relations page of the Company’s web site at www.amnb.com. 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 SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
EXECUTIVE OVERVIEW
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 twenty banking offices and a loan production office.
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-three ATMs, “AmeriLink” Internet banking, and 24-hour “Access American” telephone banking. Additional information is available on the Company’s website at www.amnb.com. The shares of American National Bankshares Inc. are traded on the NASDAQ Global Select Market under the symbol “AMNB.”
The Company specializes in providing financial services to businesses and consumers. Current priorities are to:
| · | continue to operate a highly profitable company |
| · | increase the size of the loan portfolio without sacrificing credit quality or pricing, |
| · | grow checking, savings and money market deposits, |
| · | increase fee income, and |
| · | continue to control costs. |
ANALYSIS OF OPERATING RESULTS
Net Interest Income
Net interest income, the Company’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 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent (“FTE”) basis. Net interest income divided by average earning assets is referred to as the net interest margin. The difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities is referred to as the net interest spread.
In comparison to the third quarter of 2006, net interest income on a taxable equivalent basis decreased $200,000, or 2.6% in the third quarter of 2007 due primarily to an increase in rates paid on deposits and repurchase agreements, which caused interest expense to rise. For the nine months ended September 30, 2007, net interest income increased $488,000 or 2.2% as compared to the first nine months of 2006. Average interest earning assets increased $6,926,000, or 1.0% for the first nine months of 2007 in comparison to the same period in 2006 due largely to the acquisition of Community First Financial Corporation in April 2006. The positive effect of this increase in earning assets was somewhat offset by the impact of paying higher rates on deposits and repurchase agreements. The Company’s net interest margin, on a fully taxable equivalent basis, was 4.27% during the third quarter of 2007, compared to 4.26% during the same quarter of 2006. The net interest margin was 4.22% for the nine months ended September 30, 2007, compared to 4.17% for the same period in 2006.
The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the third quarter 2007 and 2006. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans, if recognized, is recorded on a cash basis or when the loan returns to accrual status.
Net Interest Income Analysis |
| For the Three Months Ended September 30, 2007 and 2006 |
(in thousands, except yields and rates) |
(Unaudited) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | Interest | | | | | | | |
| | | Average Balance | | | Income/Expense | | | Yield/Rate | |
| | | | | | | | | | | | | | | | | | | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Loans: | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 89,531 | | | $ | 86,944 | | | $ | 1,774 | | | $ | 1,715 | | | | 7.93 | % | | | 7.89 | % |
| Real estate | | | 449,172 | | | | 445,943 | | | | 8,496 | | | | 8,221 | | | | 7.57 | | | | 7.37 | |
| Consumer | | | 10,702 | | | | 13,104 | | | | 253 | | | | 297 | | | | 9.46 | | | | 9.07 | |
| Total loans | | | 549,405 | | | | 545,991 | | | | 10,523 | | | | 10,233 | | | | 7.66 | | | | 7.50 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal agencies | | | 64,738 | | | | 96,205 | | | | 732 | | | | 990 | | | | 4.52 | | | | 4.12 | |
| Mortgage-backed | | | 24,489 | | | | 21,426 | | | | 304 | | | | 252 | | | | 4.97 | | | | 4.70 | |
| State and municipal | | | 45,414 | | | | 46,749 | | | | 624 | | | | 667 | | | | 5.50 | | | | 5.71 | |
| Other | | | 6,655 | | | | 10,670 | | | | 97 | | | | 160 | | | | 5.83 | | | | 6.00 | |
| Total securities | | | 141,296 | | | | 175,050 | | | | 1,757 | | | | 2,069 | | | | 4.97 | | | | 4.73 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits in other banks | | | 18,093 | | | | 8,510 | | | | 236 | | | | 112 | | | | 5.22 | | | | 5.26 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest earning assets | | | 708,794 | | | | 729,551 | | | | 12,516 | | | | 12,414 | | | | 7.06 | | | | 6.81 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Nonearning assets | | | 63,266 | | | | 66,895 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 772,060 | | | $ | 796,446 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand | | $ | 107,259 | | | $ | 109,868 | | | | 405 | | | | 445 | | | | 1.51 | | | | 1.62 | |
| Money market | | | 54,203 | | | | 49,211 | | | | 379 | | | | 321 | | | | 2.80 | | | | 2.61 | |
| Savings | | | 65,162 | | | | 77,597 | | | | 220 | | | | 267 | | | | 1.35 | | | | 1.38 | |
| Time | | | 260,803 | | | | 272,807 | | | | 3,000 | | | | 2,666 | | | | 4.60 | | | | 3.91 | |
| Total deposits | | | 487,427 | | | | 509,483 | | | | 4,004 | | | | 3,699 | | | | 3.29 | | | | 2.90 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Repurchase agreements | | | 48,427 | | | | 42,670 | | | | 478 | | | | 376 | | | | 3.95 | | | | 3.52 | |
| Other borrowings | | | 29,932 | | | | 38,114 | | | | 465 | | | | 570 | | | | 6.21 | | | | 5.98 | |
| Total interest bearing liabilities | | | 565,786 | | | | 590,267 | | | | 4,947 | | | | 4,645 | | | | 3.50 | | | | 3.15 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest bearing demand deposits | | | 103,477 | | | | 107,064 | | | | | | | | | | | | | | | | | |
| Other liabilities | | | 4,870 | | | | 5,468 | | | | | | | | | | | | | | | | | |
| Shareholders' equity | | | 97,927 | | | | 93,647 | | | | | | | | | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 772,060 | | | $ | 796,446 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread | | | | | | | | | | | | | | | | | | | 3.56 | % | | | 3.66 | % |
| Net interest margin | | | | | | | | | | | | | | | | | | | 4.27 | % | | | 4.26 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income (taxable equivalent basis) | | | | | | | | 7,569 | | | | 7,769 | | | | | | | | | |
| Less: Taxable equivalent adjustment | | | | | | | | | | | 223 | | | | 263 | | | | | | | | | |
| Net interest income | | | | | | | | | | $ | 7,346 | | | $ | 7,506 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Net Interest Income Analysis |
| For the Nine Months Ended September 30, 2007 and 2006 |
(in thousands, except yields and rates) |
| (Unaudited) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | Interest | | | | | | | |
| | | Average Balance | | | Income/Expense | | | Yield/Rate | |
| | | | | | | | | | | | | | | | | | | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Loans: | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 90,117 | | | $ | 86,946 | | | $ | 5,286 | | | $ | 4,749 | | | | 7.82 | % | | | 7.28 | % |
| Real estate | | | 447,366 | | | | 410,231 | | | | 25,025 | | | | 21,696 | | | | 7.46 | | | | 7.05 | |
| Consumer | | | 10,495 | | | | 12,689 | | | | 742 | | | | 871 | | | | 9.43 | | | | 9.15 | |
| Total loans | | | 547,978 | | | | 509,866 | | | | 31,053 | | | | 27,316 | | | | 7.56 | | | | 7.14 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal agencies | | | 71,931 | | | | 97,630 | | | | 2,337 | | | | 2,832 | | | | 4.33 | | | | 3.87 | |
| Mortgage-backed | | | 21,680 | | | | 21,614 | | | | 792 | | | | 742 | | | | 4.87 | | | | 4.58 | |
| State and municipal | | | 45,664 | | | | 47,160 | | | | 1,886 | | | | 1,980 | | | | 5.51 | | | | 5.60 | |
| Other | | | 7,794 | | | | 11,523 | | | | 342 | | | | 473 | | | | 5.85 | | | | 5.47 | |
| Total securities | | | 147,069 | | | | 177,927 | | | | 5,357 | | | | 6,027 | | | | 4.86 | | | | 4.52 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits in other banks | | | 14,760 | | | | 15,088 | | | | 575 | | | | 535 | | | | 5.19 | | | | 4.73 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest earning assets | | | 709,807 | | | | 702,881 | | | | 36,985 | | | | 33,878 | | | | 6.95 | | | | 6.43 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Nonearning assets | | | 63,977 | | | | 52,420 | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 773,784 | | | $ | 755,301 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand | | $ | 109,469 | | | $ | 107,051 | | | | 1,245 | | | | 1,148 | | | | 1.52 | | | | 1.43 | |
| Money market | | | 52,881 | | | | 47,361 | | | | 1,084 | | | | 834 | | | | 2.73 | | | | 2.35 | |
| Savings | | | 67,255 | | | | 79,874 | | | | 685 | | | | 712 | | | | 1.36 | | | | 1.19 | |
| Time | | | 259,891 | | | | 252,420 | | | | 8,633 | | | | 6,850 | | | | 4.43 | | | | 3.62 | |
| Total deposits | | | 489,496 | | | | 486,706 | | | | 11,647 | | | | 9,544 | | | | 3.17 | | | | 2.61 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Repurchase agreements | | | 46,912 | | | | 41,683 | | | | 1,353 | | | | 1,020 | | | | 3.85 | | | | 3.26 | |
| Other borrowings | | | 33,487 | | | | 31,476 | | | | 1,528 | | | | 1,345 | | | | 6.08 | | | | 5.70 | |
| Total interest bearing liabilities | | | 569,895 | | | | 559,865 | | | | 14,528 | | | | 11,909 | | | | 3.40 | | | | 2.84 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest bearing demand deposits | | | 101,949 | | | | 102,177 | | | | | | | | | | | | | | | | | |
| Other liabilities | | | 4,979 | | | | 3,728 | | | | | | | | | | | | | | | | | |
| Shareholders' equity | | | 96,961 | | | | 89,531 | | | | | | | | | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 773,784 | | | $ | 755,301 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread | | | | | | | | | | | | | | | | | | | 3.55 | % | | | 3.59 | % |
| Net interest margin | | | | | | | | | | | | | | | | | | | 4.22 | % | | | 4.17 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income (taxable equivalent basis) | | | | | | | | 22,457 | | | | 21,969 | | | | | | | | | |
| Less: Taxable equivalent adjustment | | | | | | | | | | | 688 | | | | 733 | | | | | | | | | |
| Net interest income | | | | | | | | | | $ | 21,769 | | | $ | 21,236 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Allowance and Provision for Loan Losses
The purpose of the allowance for loan losses is to provide for probable losses in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance.
The Company’s lenders are responsible for assigning risk ratings to loans using the parameters set forth in the Company’s Credit Policy. The risk ratings are reviewed for accuracy, on a sample basis, by the Company’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 Credit Committee has responsibility for determining the level and adequacy of the allowance for loan losses. Among other factors, the Committee, on a quarterly basis, considers the Company’s historical loss experience; the size and composition of the loan portfolio; individual risk ratings; nonperforming loans; impaired loans; other problem credits; the value and adequacy of collateral and guarantors; and national and local economic conditions. The Audit and Compliance Committee and the Board of Directors also review the allowance calculation quarterly.
No single statistic, formula or measurement determines the adequacy of the allowance. Management makes difficult, subjective, and complex judgments about matters that are inherently uncertain, and different amounts would be reported under different conditions or using different assumptions. For analytical purposes, management allocates a portion of the allowance to specific loan categories and specific loans (the allocated allowance). The entire allowance is used to absorb credit losses inherent in the loan portfolio, including identified and unidentified losses.
The allowance is supplemented to adjust for imprecision (particularly in commercial, commercial real estate and construction lending) and to provide for a range of possible outcomes inherent in estimates used for the allocated allowance. This reflects the result of management’s judgment of risks inherent in the portfolio, economic uncertainties and other qualitative factors, including economic trends in the Company’s regions.
The relationships and ratios used in calculating the allowance, including the qualitative factors, may change from period to period. Furthermore, management cannot provide assurance that, in any particular period, the Company will not have sizeable credit losses in relation to the amount reserved. Management may find it necessary to significantly adjust the allowance, considering current factors at the time, including economic conditions, industry trends and ongoing internal and external examination processes.
The Southside 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 local 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. Additional declines in manufacturing production and unemployment could negatively impact the ability of certain borrowers to repay loans.
The allowance is subject to regulatory examinations and determinations 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.
The provision for loan losses decreased from $125,000 in the third quarter of 2006 to $0 in the third quarter of 2007, and decreased from $605,000 during the first nine months of 2006 to $303,000 for the first nine months of 2007.
The allowance for loan losses was $7,334,000 at September 30, 2007, an increase of 1.0% over the $7,264,000 recorded at December 31, 2006. The allowance represented 1.32% of loans at September 30, 2007, in comparison to 1.34% at December 31, 2006. Management believes the allowance for loan losses is adequate to absorb losses inherent in the Company’s loan portfolio at September 30, 2007. The decrease in the provision for loan losses allowed management to maintain directional consistency of the allowance with the improvement in the performance of the loan portfolio. More information regarding loan quality is provided in the “Asset Quality, Credit Risk Management, and Nonperforming Assets” section.
Noninterest Income
Noninterest income rose 6.5% from $2,138,000 in the third quarter of 2006 to $2,276,000 in the third quarter of 2007. Noninterest income increased $613,000, or 9.7% for the nine months ended September 30, 2007, as compared to the first nine months of 2006. The quarter and year-to-date increase was due in large part to growth in trust fees, mortgage banking revenue, brokerage fees, and gains on securities. The year-to-date increase was also due to a $32,000 increase in income recognized from the cash value of bank owned life insurance and an increase in check charges of $15,000 as compared to the same period in 2006.
Fees from the management of trusts, estates, and asset management accounts totaled $861,000 in the third quarter of 2007, up 2.1% from $843,000 for the same period in 2006. Trust fee income on a year-to-date basis increased $181,000, or 7.3%, when compared to the same period in 2006. These increases were due primarily to new account activity and to fee schedule adjustments made in early 2007.
Mortgage banking income represents fees from originating, selling, and brokering residential mortgage loans. Mortgage banking income was $240,000 for the third quarter of 2007, an increase of 39.5% from the third quarter of 2006. Mortgage banking income increased $251,000, or 49.4% for the nine months ended September 30, 2007 as compared to the same period in 2006. Both quarter and year-to-date increase was due to an increase in volume.
Brokerage fees represent income earned from the sale of investment products. Brokerage fees were $191,000 for the third quarter of 2007, an increase of 105.4% from the third quarter in 2006. Brokerage fees increased $112,000, or 34.3% on a year-to-date basis in comparison to the same period in 2006. The quarterly and year-to-date increase was due to an increase in volume.
Gains on securities totaled $45,000 in the third quarter of 2007, compared with $9,000 in the third quarter of 2006. Gains on securities for the first nine months of 2007 were $134,000, as compared to $47,000 during the same period in 2006.
Noninterest Expense
Noninterest expense increased $262,000, or 5.1%, from the third quarter of 2006 to the same period in 2007. For the nine months ended September 30, 2007, noninterest expense increased $1,141,000 or 7.7%.
Salary expense increased $25,000 or 1.1% in the third quarter of 2007 as compared to the same period in 2006, while employee benefit expense increased 20% or $130,000 over the same period. Personnel expense associated with a new branch office located at Smith Mountain Lake, Virginia and higher health insurance claims was partially offset with reductions in profit sharing and incentive plan expense. Salary expense increased $418,000 or 6.1% for the nine months ended September 30, 2007 as compared to the same period of 2006. Employee benefit expense increased $193,000 or 9.7% over the same period. This increase was largely attributable to the new Smith Mountain Lake office, increased health insurance claims, and additional personnel acquired with Community First Bank in April 2006.
Occupancy and equipment expense increased $106,000 in the third quarter of 2007 as compared to the same period in 2006. This increase is primarily due to depreciation expense on new technology and other capital purchases and the costs associated with new branch offices opened at Smith Mountain Lake, and Bedford, Virginia. Occupancy and equipment expense increased $395,000 for the nine months ended September 30, 2007 as compared to the same period of 2006. This increase can be attributed to the four branches acquired from Community First in addition to the expenses for the Smith Mountain Lake and Bedford offices.
Bank franchise tax expense decreased $6,000 during the third quarter of 2007 in comparison to the same period of 2006, but increased $17,000 on a year-to-date basis when compared to the same period in 2006. The increase is due primarily to the acquisition of Community First in April 2006.
Other noninterest expense increased $7,000 in the third quarter of 2007 in comparison to the same quarter of 2006, and increased $118,000 for the first nine months of 2007 in comparison to the first nine months of 2006, due primarily to the additional branches acquired from Community First and the Smith Mountain Lake office. Expenses for advertising and public relations, ATM and Visa network fees, Internet banking fees, professional services, automobile, courier service, recruiting and hiring, and tuition and training were categories that reflected increases for the nine month period.
Income Tax Provision
The effective tax rate for the third quarter of 2007 was 30.9% compared to 29.55% for the same period of 2006. The effective tax rate is lower than the statutory rate primarily due to the effect of the Company’s ownership of tax-exempt securities and loans.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL
Securities
Average securities decreased $33,754,000, or 19.3% during the third quarter of 2007, as compared to the same period in 2006. Maturing investments were used to pay-down borrowings and to fund reductions in high-rate certificates of deposit acquired from Community First in 2006 and decreases in other deposits.
Loans
Average loans were $549,405,000 during the third quarter of 2007, compared with $545,991,000 in the third quarter of 2006, a 0.6% increase. Average loans increased $38,112,000, or 7.5% for the nine months ended September 30, 2007 from the same period in 2006, due in large part to the acquisition of Community First in 2006.
Asset Quality, Credit Risk Management, and Nonperforming Assets
Management identifies specific credit risks through its periodic analysis of the loan portfolio and monitors general risks arising from economic trends, market values, and other external factors. The Company 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 section "Allowance and Provision for Loan Losses" are considered in determining the adequacy of the allowance.
The Company uses certain practices to manage its credit risk. These practices include (a) appropriate lending limits for loan officers, (b) a loan approval process, (c) careful underwriting of loan requests, including analysis of borrowers, collateral, and market risks, (d) regular monitoring of the portfolio, including diversification by type and geography, (e) review of loans by a Loan Review department which operates independently of loan production, (f) regular meetings of a Credit Committee to discuss portfolio and policy changes, and (g) regular meetings of an Asset Quality Committee which reviews the status of individual loans.
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 any loans classified as troubled debt restructurings. Nonperforming assets include nonperforming loans and foreclosed real estate. Nonperforming loans represented 0.47% of total loans at September 30, 2007, and 0.63% at December 31, 2006.
The following table summarizes nonperforming assets:
| (in thousands) | | September 30, 2007 | | | December 31, 2006 | |
| Loans 90 days or more past due | | $ | 157 | | | $ | - | |
| Nonaccrual loans | | | 2,454 | | | | 3,425 | |
| Nonperforming loans | | | 2,611 | | | | 3,425 | |
| Foreclosed real estate | | | 632 | | | | 99 | |
| Nonperforming assets | | $ | 3,243 | | | $ | 3,524 | |
There were no troubled debt restructurings at September 30, 2007 or December 31, 2006.
Liquidity and FHLB Borrowings
Liquidity is the measure of the Company’s ability to generate sufficient funds to meet cash needs such as customer demands for loans and the withdrawal of deposit balances. 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”) and two correspondent banks, and maturities and sales of securities. Management believes that these sources provide sufficient and timely liquidity.
Management monitors and forecasts the liquidity position for future periods. Liquidity strategies are implemented and monitored by an Asset/Liability Investment Committee. The Committee uses a simulation and budget model to manage the future liquidity needs of the Company.
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. Borrowings under the line were $8,975,000 at September 30, 2007. Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans. In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB.
The Company had fixed-rate term borrowing contracts with the FHLB as of September 30, 2007, with the following final maturities:
| Amount (in thousands) | | Expiration Date |
| | | |
| $ | 3,000 | | June 2008 |
| | 5,000 | | April 2009 |
| | 975 | | March 2014 |
| $ | 8,975 | | |
The Company also 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 amounts outstanding under these facilities at September 30, 2007.
Deposits
Average deposits were $590,904,000 during the third quarter of 2007, down 4.2% from $616,547,000 during the same quarter of 2006. The Company has allowed high-rate certificates of deposit issued by Community First to mature. Additionally, savings and demand deposits declined due primarily to intense competition for bank deposits.
Off-Balance-Sheet Activities
The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance-sheet transactions. Other than AMNB Statutory Trust I, formed in 2006 to issue Trust Preferred Securities, the Company does not have any off-balance-sheet subsidiaries. Refer to Note 6 for discussion of AMNB Statutory Trust I. Off-balance-sheet transactions were as follows (in thousands):
| | September 30, 2007 | | December 31, 2006 |
| | | | |
| Commitments to extend credit | $ | 146,747 | | $ | 155,038 |
| Standby letters of credit | | 7,183 | | | 3,125 |
| Mortgage loan rate-lock commitments | | 1,823 | | | 2,246 |
Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future funding requirements. Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements.
Shareholders’ Equity
One measure of a financial institution’s capital level is the ratio of shareholders’ equity to assets. Average shareholders’ equity was 12.68% of average assets at September 30, 2007 and 11.76% at September 30, 2006. 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 shareholders’ 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 regulatory guidelines require that minimum 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 September 30, 2007, the Company's Tier I and total capital ratios were 16.79% and 18.05%, respectively. At December 31, 2006, these ratios were 16.18% and 17.45%, respectively. The ratios for both periods were in excess of the regulatory requirements. The Company's leverage ratios were 12.81% and 12.15% at September 30, 2007 and December 31, 2006, respectively. The leverage ratio has a regulatory minimum of 4%, with most institutions required to maintain a ratio of 4-5%, depending upon risk profiles and other factors.
As mandated by bank regulations, the following five capital categories are identified for insured depository institutions: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." These regulations require 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. Management believes, as of September 30, 2007, that the Company met the requirements to be considered “well capitalized.”
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 Company has the ability to react to those changes and measure and monitor its interest rate and liquidity risk.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management
Effectively managing market risk is essential to achieving the Company’s financial objectives. Market risk reflects the risk of economic loss resulting from adverse changes in interest rates and market prices. The Company is generally 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.
The Company’s Asset/Liability Investment Committee (“ALCO”) is primarily responsible for establishing asset and liability strategies and for monitoring and controlling liquidity and interest rate risk within established policy guidelines. ALCO is also responsible for evaluating the competitive interest rate environment and reviewing investment securities transactions.
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 maturities and payments 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, the model projects net interest income under multiple interest rate scenarios.
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. 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. The Company is 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 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 increase if an interest rate increase adversely affects the ability of borrowers to service their debt.
There have been no material changes to market risk as disclosed in the Company’s 2006 Annual Report on Form 10-K. Refer to those disclosures for further information.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934), as amended (the "Exchange Act") as of September 30, 2007. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms. There were no significant changes in the Company's internal controls over financial reporting that occurred during the quarter ended September 30, 2007 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. PART II
OTHER INFORMATION
Item:
The nature of the business of the Company ordinarily results in a certain amount of litigation. The Company is involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Company.
There have been no material changes to the risk factors disclosed in the Company's 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2007.
2. Unregistered Sales of Equity Securities and Use of Proceeds
| Repurchases made for the Quarter Ended September 30, 2007 |
| Dates | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Program | Maximum Number of Shares that May Yet Be Purchased Under the Program |
| | | | | |
| July 1–31 | 2,500 | $ 22.49 | 2,500 | 93,300 |
| August 1-15 | 18,500 | 20.96 | 18,500 | 74,800 |
| August 16-31 | 4,100 | 21.36 | 4,100 | 120,900 |
| September 1-30 | 3,800 | 21.26 | 3,800 | 117,100 |
| | | | | |
| On August 21, 2007, the Company’s board of directors approved the extension of its stock repurchase plan, begun in 2000, to include the repurchase of up to 125,000 shares of the Company’s common stock between August 22, 2007 and August 19, 2008. The stock may be purchased in the open market or in privately negotiated transactions as management determines to be in the best interest of the Company. |
| 4. | Submission of Matters to a Vote of Security Holders |
None
(a) Required 8-K disclosures
None
(b) Changes in Nominating Process
None
| 11. | Refer to EPS calculation in the Notes to Financial Statements |
| 31.1 | Section 302 Certification of Charles H. Majors, President and Chief Executive Officer |
| 31.2 | Section 302 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer |
| 32.1 | Section 906 Certification of Charles H. Majors, President and Chief Executive Officer |
| 32.2 | Section 906 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AMERICAN NATIONAL BANKSHARES INC.
| | | |
| | | |
| | | |
| | /s/ Charles H. Majors | |
| | Charles H. Majors | |
| Date – November 8, 2007 | President and Chief Executive Officer | |
| | | |
| | /s/ Neal A. Petrovich | |
| | Neal A. Petrovich | |
| | Senior Vice President and | |
| Date – November 8, 2007 | Chief Financial Officer | |
