Edgar Filing: AMERICAN NATIONAL BANKSHARES INC

sept302010_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2010.

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

Commission file number: 0-12820

AMERICAN NATIONAL BANKSHARES INC.

(Exact name of registrant as specified in its charter)

VIRGINIA		54-1284688
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

628 Main Street
Danville, Virginia		24541
(Address of principal executive offices)		(Zip Code)

(434) 792-5111

(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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.

Yes

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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer x 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 Exchange Act)

Yes ¨ No x

At November 4, 2010, the Company had 6,126,374 shares of Common Stock outstanding, $1 par value.

AMERICAN NATIONAL BANKSHARES INC.

Index			Page

Part I.		FINANCIAL INFORMATION

	Item 1	Financial Statements

		Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009		3

		Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009		4-5

		Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2010 and 2009		6

		Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009		7

		Notes to Consolidated Financial Statements		8

	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		24

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk		37

	Item 4.	Controls and Procedures		38

Part II.		OTHER INFORMATION

	Item 1.	Legal Proceedings		39

	Item 1A.	Risk Factors		39

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		39

	Item 3.	Defaults Upon Senior Securities		39

	Item 4.	(Removed and Reserved)		39

	Item 5.	Other Information		39

	Item 6.	Exhibits		39

SIGNATURES

Index

Part I. Financial Information

Item 1. Financial Statements

American National Bankshares Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except share data)

	(Unaudited)			(Audited)
	September 30,			December 31,
ASSETS	2010			2009
Cash and due from banks	$	10,860		$	13,250
Interest-bearing deposits in other banks		16,338			10,693

Securities available for sale, at fair value		209,434			188,795
Securities held to maturity (fair value of $4,675 at
September 30, 2010 and $6,763 at December 31, 2009)		4,501			6,529
Total securities		213,935			195,324

Restricted stock, at cost		4,161			4,362
Loans held for sale		3,952			2,490

Loans, net of unearned income		519,421			527,991
Less allowance for loan losses		(8,542	)		(8,166	)
Net loans		510,879			519,825

Premises and equipment, net		20,142			19,195
Other real estate owned, net		3,987			3,414
Goodwill		22,468			22,468
Core deposit intangibles, net		1,415			1,698
Accrued interest receivable and other assets		16,080			16,254
Total assets	$	824,217		$	808,973

LIABILITIES and SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits -- noninterest bearing	$	101,578		$	101,735
Demand deposits -- interest bearing		91,301			97,025
Money market deposits		53,388			75,554
Savings deposits		62,841			61,873
Time deposits		316,522			268,086
Total deposits		625,630			604,273

Customer repurchase agreements		54,285			65,929
Long-term borrowings		8,525			8,638
Trust preferred capital notes		20,619			20,619
Accrued interest payable and other liabilities		4,290			3,125
Total liabilities		713,349			702,584

Shareholders' equity:
Preferred stock, $5 par, 2,000,000 shares authorized,
none outstanding		-			-
Common stock, $1 par, 20,000,000 shares authorized,
6,126,374 shares outstanding at September 30, 2010 and
6,110,335 shares outstanding at December 31, 2009		6,126			6,110
Capital in excess of par value		27,200			26,962
Retained earnings		74,409			72,208
Accumulated other comprehensive income, net		3,133			1,109
Total shareholders' equity		110,868			106,389
Total liabilities and shareholders' equity	$	824,217		$	808,973

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

Index

American National Bankshares Inc. and Subsidiaries
Consolidated Statements of Income
(Dollars in thousands, except per share and per share data) (Unaudited)

	Three Months Ended
	September 30
	2010		2009
Interest and Dividend Income:
Interest and fees on loans	$	6,994	$	7,666
Interest and dividends on securities:
Taxable		1,253		1,241
Tax-exempt		621		434
Dividends		24		27
Other interest income		90		96
Total interest and dividend income		8,982		9,464

Interest Expense:
Interest on deposits		1,722		1,921
Interest on short-term borrowings		93		135
Interest on long-term borrowings		65		65
Interest on trust preferred capital notes		343		343
Total interest expense		2,223		2,464

Net Interest Income		6,759		7,000
Provision for Loan Losses		435		492

Net Interest Income After Provision for Loan Losses		6,324		6,508

Noninterest Income:
Trust fees		842		813
Service charges on deposit accounts		478		536
Other fees and commissions		290		257
Mortgage banking income		428		361
Securities gains, net		67		1
Foreclosed real estate gains, net		5		-
Other		136		151
Total noninterest income		2,246		2,119

Noninterest Expense:
Salaries		2,596		2,471
Employee benefits		564		806
Occupancy and equipment		732		701
FDIC assessment		203		203
Bank franchise tax		168		160
Core deposit intangible amortization		94		94
Other		1,179		1,163
Total noninterest expense		5,536		5,598

Income Before Income Taxes		3,034		3,029
Income Taxes		806		862
Net Income	$	2,228	$	2,167

Net Income Per Common Share:
Basic	$	0.36	$	0.36
Diluted	$	0.36	$	0.35
Average Common Shares Outstanding:
Basic		6,125,359		6,104,505
Diluted		6,131,129		6,111,913

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

Index

American National Bankshares Inc. and Subsidiaries
Consolidated Statements of Income
(Dollars in thousands, except per share and per share data) (Unaudited)

	Nine Months Ended
	September 30
	2010			2009
Interest and Dividend Income:
Interest and fees on loans	$	21,220		$	23,617
Interest and dividends on securities:
Taxable		3,844			3,594
Tax-exempt		1,641			1,236
Dividends		71			70
Other interest income		268			287
Total interest and dividend income		27,044			28,804

Interest Expense:
Interest on deposits		5,004			6,628
Interest on short-term borrowings		297			548
Interest on long-term borrowings		192			276
Interest on trust preferred capital notes		1,030			1,030
Total interest expense		6,523			8,482

Net Interest Income		20,521			20,322
Provision for Loan Losses		1,005			1,334

Net Interest Income After Provision for Loan Losses		19,516			18,988

Noninterest Income:
Trust fees		2,455			2,338
Service charges on deposit accounts		1,440			1,549
Other fees and commissions		856			750
Mortgage banking income		1,017			1,215
Securities gains, net		42			2
Foreclosed real estate (losses), net		(279	)		(1,222	)
Other		398			474
Total noninterest income		5,929			5,106

Noninterest Expense:
Salaries		7,590			7,734
Employee benefits		1,837			2,451
Occupancy and equipment		2,209			2,165
FDIC assessment		597			984
Bank franchise tax		503			483
Core deposit intangible amortization		283			283
Other		3,607			3,694
Total noninterest expense		16,626			17,794

Income Before Income Taxes		8,819			6,300
Income Taxes		2,392			1,659
Net Income	$	6,427		$	4,641

Net Income Per Common Share:
Basic	$	1.05		$	0.76
Diluted	$	1.05		$	0.76
Average Common Shares Outstanding:
Basic		6,122,876			6,094,261
Diluted		6,128,481			6,098,221

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

Index

American National Bankshares Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
Nine Months Ended September 30, 2010 and 2009
(Dollars in thousands) (Unaudited)

													Accumulated
	Common Stock						Capital in						Other			Total
							Excess of			Retained			Comprehensive			Shareholders'
	Shares			Amount			Par Value			Earnings			Income (Loss)			Equity

Balance, December 31, 2008		6,085,628		$	6,086		$	26,491		$	71,090		$	(1,367	)	$	102,300

Net income		-			-			-			4,641			-			4,641

Change in unrealized gains on securities
available for sale, net of tax, $979		-			-			-			-			1,822

Less: Reclassification adjustment for gains
on securities available for sale, net of
tax, $0		-			-			-			-			(2	)

Other comprehensive income														1,820			1,820

Total comprehensive income																	6,461

Stock repurchased and retired		(7,600	)		(8	)		(33	)		(80	)		-			(121	)

Stock options exercised		29,299			29			395			-			-			424

Stock option expense		-			-			47			-			-			47

Cash dividends declared, $0.69 per share		-			-			-			(4,206	)		-			(4,206	)

Balance, September 30, 2009		6,107,327		$	6,107		$	26,900		$	71,445		$	453		$	104,905

Balance, December 31, 2009		6,110,335		$	6,110		$	26,962		$	72,208		$	1,109		$	106,389

Net income		-			-			-			6,427			-			6,427

Change in unrealized gains on securities
available for sale, net of tax, $1,105		-			-			-			-			2,051

Add: Reclassification adjustment for losses
on impairment of securities, net of tax, $11		-			-			-			-			20

Less: Reclassification adjustment for gains
on securities available for sale, net of
tax of $(26)		-			-			-			-			(47	)

Other comprehensive income														2,024			2,024

Total comprehensive income																	8,451

Stock options exercised		2,855			3			44			-			-			47

Stock option expense		-			-			47			-			-			47

Equity based compensation		13,184			13			147			-			-			160

Cash dividends declared, $0.69 per share		-			-						(4,226	)		-			(4,226	)

Balance, September 30, 2010		6,126,374		$	6,126		$	27,200		$	74,409		$	3,133		$	110,868

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

Index

American National Bankshares Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2010 and 2009
(Dollars in thousands) (Unaudited)

	2010			2009
Cash Flows from Operating Activities:
Net income	$	6,427		$	4,641
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Provision for loan losses		1,005			1,334
Depreciation		941			877
Core deposit intangible amortization		283			283
Net amortization (accretion) of bond premiums and discounts		296			(180	)
Net gain on sale or call of securities		(73	)		(2	)
Impairment of securities		31			-
Gain on loans held for sale		(902	)		(1,074	)
Proceeds from sales of loans held for sale		36,195			53,564
Originations of loans held for sale		(36,755	)		(54,566	)
Net gain on foreclosed real estate		(2	)		(17	)
Net change in valuation allowance on foreclosed real estate		281			1,239
Stock-based compensation expense		47			47
Equity based compensation		160			-
Deferred income tax benefit		(311	)		(727	)
Net change in interest receivable		(451	)		(496	)
Net change in other assets		624			945
Net change in interest payable		(45	)		(318	)
Net change in other liabilities		432			1,082
Net cash provided by operating activities		8,183			6,632

Cash Flows from Investing Activities:
Proceeds from sales of securities available for sale		815			-
Proceeds from sales of securities held to maturity		184			-
Proceeds from maturities and calls of securities available for sale		88,858			55,248
Proceeds from maturities and calls of securities held to maturity		1,299			583
Purchases of securities available for sale		(106,706	)		(100,525	)
Net decrease in loans		6,933			29,238
Purchases of bank property and equipment		(1,888	)		(3,138	)
Proceeds from sales of foreclosed real estate		156			317
Net cash used in investing activities		(10,349	)		(18,277	)

Cash Flows from Financing Activities:
Net change in demand, money market, and savings deposits		(27,079	)		2,882
Net change in time deposits		48,436			4,275
Net change in repurchase agreements		(11,644	)		19,598
Net change in short-term borrowings		-			(3,850	)
Net change in long-term borrowings		(113	)		(5,112	)
Cash dividends paid		(4,226	)		(4,206	)
Repurchase of stock		-			(121	)
Proceeds from exercise of stock options		47			424
Net cash provided by financing activities		5,421			13,890

Net Increase in Cash and Cash Equivalents		3,255			2,245

Cash and Cash Equivalents at Beginning of Period		23,943			24,098

Cash and Cash Equivalents at End of Period	$	27,198		$	26,343

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

Index

AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

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

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of foreclosed real estate.

In April 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “Trust”) and a wholly owned subsidiary of the Company 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”) which occurred in April 2006. Refer to Note 9 for further details concerning this variable interest entity.

All significant inter-company transactions and accounts are eliminated in consolidation, with the exception of the Trust, as detailed in Note 9.

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, 2010; the consolidated statements of income for the three and nine months ended September 30, 2010 and 2009; the consolidated statements of changes in shareholders’ equity for the nine months ended September 30, 2010 and 2009; and the consolidated statements of cash flows for the nine months ended September 30, 2010 and 2009. Operating results for the three and nine month periods ended September 30, 2010 are not necessarily indicative of the results that may occur for the year ending December 31, 2010. Certain reclassifications have been made to prior period balances to conform to the current period presentation. These statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2009.

Note 2 – Recent Accounting Pronouncements

In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”, was adopted into Codification in December 2009 through the issuance of Accounting Standards Update (ASU) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASU 2009-16 was effective for transfers on or after January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued new guidance relating to variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 was effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

Index

In October 2009, the FASB issued ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-04, Accounting for Various Topics – Technical Corrections to SEC Paragraphs. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residential method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 is effective immediately. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures, will be required for periods beginning or after December 15, 2010. The Company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.

On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.” This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.

Index

On September 17, 2010, the SEC issued Release No. 33-9144, “Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis.” This interpretive release is intended to improve discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. This release was issued in conjunction with a proposed rule, “Short-Term Borrowings Disclosures,” that would require public companies to disclose additional information to investors about their short-term borrowing arrangements. Release No. 33-9144 was effective on September 28, 2010.

Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for previously announced accounting pronouncements.

Note 3 – Securities

The amortized cost and estimated fair value of investments in debt and equity securities at September 30, 2010 and December 31, 2009 were as follows:

	September 30, 2010
(in thousands)	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale:
Federal agencies & GSE	$	48,480	$	1,170	$	-	$	49,650
Mortgage-backed & CMO’s		56,474		1,664		379		57,759
State and municipal		95,241		4,637		11		99,867
Corporate		1,970		188		-		2,158
Total securities available for sale		202,165		7,659		390		209,434

Securities held to maturity:
State and municipal		4,501		174		-		4,675
Total securities held to maturity		4,501		174		-		4,675
Total securities	$	206,666	$	7,833	$	390	$	214,109

	December 31, 2009
(in thousands)	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale:
Federal agencies & GSE	$	81,279	$	1,474	$	7	$	82,746
Mortgage-backed & CMO’s		41,365		1,535		310		42,590
State and municipal		58,035		1,442		181		59,296
Corporate		3,962		201		-		4,163
Total securities available for sale		184,641		4,652		498		188,795

Securities held to maturity:
Mortgage-backed & CMO’s		199		14		-		213
State and municipal		6,330		220		-		6,550
Total securities held to maturity		6,529		234		-		6,763
Total securities	$	191,170	$	4,886	$	498	$	195,558

Index

Temporarily Impaired Securities

The following table shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010. The reference point for determining when securities are in an unrealized loss position is month-end. Therefore, it is possible that a security’s market value exceeded its amortized cost on other days during the past twelve-month period.

Available for sale and held to maturity securities that have been in a continuous unrealized loss position, at September 30, 2010, are as follows:

	Total				Less than 12 Months				12 Months or More
(in thousands)	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
Mortgage-backed	$	18,088	$	159	$	18,088	$	159	$	-	$	-
CMO’s		2,057		220		767		3		1,290		217
State and municipal		1,813		11		1,813		11		-		-
Total	$	21,958	$	390	$	20,668	$	173	$	1,290	$	217

GSE residential mortgage-backed securities. The unrealized losses on the Company's investment in nine GSE mortgage-backed securities and one collateralized mortgage obligation (“CMO”) were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency or GSE of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2010.

Private-Label Residential Mortgage-Backed Securities: The unrealized losses associated with four private residential collateralized mortgage obligations are primarily driven by higher projected collateral losses, wider credit spreads and changes in interest rates. We assess for credit impairment using a cash flow model. Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our credit enhancement, we expect to recover the remaining amortized cost basis of three of these four securities. See Other than Temporarily Impaired Securities in the following section regarding one of these issues.

State and municipal securities: The unrealized losses on the four investments in state and municipal securities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2010.

The Company’s investment in restricted stock of $4,161,000 at September 30, 2010, shown as a separate line item on the consolidated balance sheets, includes $2,610,000 in stock of the Federal Home Loan Bank of Atlanta (“FHLB”). FHLB stock is generally viewed as a long-term and restricted investment security, carried at cost, because there is no market for the stock, other than the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The FHLB did temporarily suspend dividends and repurchases of excess capital stock in 2009. However, they have recently resumed both activities on a limited basis. The Company does not consider this investment to be other-than-temporarily impaired at September 30, 2010 and no impairment has been recognized.

Index

Other than Temporarily Impaired Securities

One variable rate CMO was downgraded below investment grade to CCC status by Standard and Poor’s during the first quarter 2010. Based upon a review of the security by an independent advisory firm, the Company elected to recognize an impairment charge to earnings of $31,000 in the first quarter. The impairment charge was based on a review of recent actual historical performance and an estimate of expected annual ongoing losses of 0.91% and loss on loans sixty days or greater of 6.41%. The Other Comprehensive Income (“OCI”) adjustment was based on an estimated 15% fair value return based on current market conditions. The investment was reviewed again for other than temporarily impairment (“OTTI”) in the second and third quarter. No additional impairment was deemed necessary.

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, 2009.

	Total				Less than 12 Months				12 Months or More
(in thousands)	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
GSE debt securities	$	28,918	$	7	$	28,918	$	7	$	-	$	-
Mortgage-backed		7,294		95		7,294		95		-		-
CMO’s		2,151		215		-		-		2,151		215
State and municipal		7,420		181		6,991		145		429		36
Total	$	45,783	$	498	$	43,203	$	247	$	2,580	$	251

Note 4 - Loans

Loans, excluding loans held for sale, were comprised of the following:

(in thousands)	September 30, 2010		December 31, 2009

Construction and land development	$	42,602	$	40,371
Commercial real estate		206,142		208,066
Residential real estate		118,554		121,639
Home equity		64,847		64,678
Total real estate		432,145		434,754

Commercial and industrial		80,818		86,312
Consumer		6,458		6,925
Total loans	$	519,421	$	527,991

The following is a summary of information pertaining to impaired and nonaccrual loans:

	September 30,		December 31,
(in thousands)	2010		2009

Impaired loans with a valuation allowance	$	-	$	1,284
Impaired loans without a valuation allowance		1,766		2,540
Total impaired loans	$	1,766	$	3,824

Index

	September 30,		December 31,
(in thousands)	2010		2009

Allowance provided for impaired loans,
included in the allowance for loan losses	$	-	$	796

Nonaccrual loans excluded from the impaired loan disclosure	$	2,144	$	1,885

	Nine Months Ended		Nine Months Ended
(in thousands)	September 30, 2010		September 30, 2009

Average balance in impaired loans	$	2,928	$	3,409
Interest income recognized on impaired loans		-		100
Interest income recognized on nonaccrual loans		-		-
Interest on nonaccrual loans had they been accruing		196		148
Loans past due 90 days and still accruing interest		-		-

No additional funds are committed to be advanced in connection with impaired loans.

Foreclosed real estate was $3,987,000 at September 30, 2010 and $3,414,000 December 31, 2009.

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

Changes in the allowance for loan losses and the reserve for unfunded lending commitments for the nine months ended September 30, 2010 and 2009, and for the year ended December 31, 2009, are presented below:

(in thousands)	Nine Months Ended September 30,			Year Ended December 31,			Nine Months Ended September 30,
	2010			2009			2009
Allowance for Loan Losses
Balance, beginning of period	$	8,166		$	7,824		$	7,824
Provision for loan losses		1,005			1,662			1,334
Charge-offs		(869	)		(1,601	)		(1,116	)
Recoveries		240			281			218
Balance, end of period	$	8,542		$	8,166		$	8,260

Reserve for unfunded lending commitments
Balance, beginning of period	$	260			475		$	475
Provision for unfunded commitments		(30	)		-			(11	)
Charge-offs		-			(215	)		(215	)
Balance, end of period	$	230		$	260		$	249

The reserve for unfunded loan commitments is included on the consolidated balance sheet in other liabilities.

Index

Note 6 – Goodwill and Other Intangible Assets

In January 2002, the Company adopted SFAS No. 142 (ASC 805), “Goodwill and Other Intangible Assets”. Accordingly, goodwill is no longer subject to amortization, but is subject to at least an annual assessment for impairment by applying a fair value test. A fair value-based test was performed during the third quarter as of June 30, 2010 that determined there has been no impairment in the value of goodwill.

The changes in the carrying amount of goodwill for the quarter ended September 30, 2010, are as follows (in thousands):

Balance as of December 31, 2009	$	22,468
Goodwill recorded during the period		-
Impairment losses		-
Balance as of September 30, 2010	$	22,468

Core deposit intangible assets resulting from an acquisition were originally recorded at $3,112,000 in April 2006, and are being amortized over 99 months. The net core deposit intangible at September 30, 2010 was $1,415,000.

Note 7 – Short-term Borrowings

Short-term borrowings consist of customer repurchase agreements, overnight borrowings from the FHLB, and Federal Funds purchased. Customer repurchase agreements are collateralized by securities of the U.S. Government or its agencies and they mature daily. The interest rates are generally fixed but may be changed at the discretion of the Company. The securities underlying these agreements remain under the Company’s control. FHLB overnight borrowings have floating interest rates that may change daily at the discretion of the FHLB. Federal Funds purchased are unsecured overnight borrowings from other financial institutions. Customer repurchase agreements were $54,285,000 at September 30, 2010 and $65,929,000 at December 31, 2009.

Note 8 – Long-term Borrowings

Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans and home equity lines of credit. In addition, the Company pledges as collateral its capital stock in the FHLB and deposits with the FHLB. The Company has a line of credit with the FHLB equal to 30% of the Company’s assets, subject to the amount of collateral pledged. As of September 30, 2010, $91,665,000 in 1-4 family residential mortgage loans and $60,091,000 in home equity lines of credit were pledged under the blanket floating lien agreement which covers both short-term and long-term borrowings. Long-term borrowings consisted of the following fixed rate, long term advances as of September 30, 2010 and December 31, 2009 (in thousands):


September 30, 2010						December 31, 2009
Due by	Advance Amount		Weighted Average Rate			Due by	Advance Amount		Weighted Average Rate

March 2011	$	8,000		2.93		March 2011	$	8,000		2.93
April 2014		525		3.78		April 2014		638		3.78
	$	8,525		2.98	%		$	8,638		2.99	%

Index

In the regular course of conducting its business, the Company takes deposits from political subdivisions of Virginia and North Carolina. At September 30, 2010, the Bank’s public deposits totaled $70,665,000. The Company is required to provide collateral to secure the deposits that exceed the insurance coverage provided by the Federal Deposit Insurance Corporation. This collateral can be provided in the form of certain types of government, agency, or GSE bonds or letters of credit from the FHLB. At September 30, 2010, the Company had $20 million in letters of credit with the FHLB outstanding to provide collateral for such deposits. The Company had also pledged $86,789,000 of its investment portfolio for the same purpose.

Note 9 – Trust Preferred Capital Notes

On April 7, 2006, AMNB Statutory Trust I, a Delaware statutory trust and a newly formed, wholly owned subsidiary of the Company, issued $20,000,000 of preferred securities in a private placement pursuant to an applicable exemption from registration. The Trust Preferred Securities mature on September 30, 2036, but may be redeemed at the Company’s option beginning on September 30, 2011. The securities require quarterly distributions by the Trust to the holder of the Trust Preferred Securities at a fixed rate of 6.66%. Effective September 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 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 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 in connection with the Company’s acquisition of that company and for general corporate purposes. In accordance with FASB ASC 810-10-15-14, the Corporation did not eliminate through consolidation the Corporation’s $619,000 equity investment in AMNB Statutory Trust I. Instead, the Corporation reflected this equity investment in the “Accrued interest receivable and other assets” line item in the consolidated balance sheets.

Note 10 – Share Based Compensation

Stock Options

A summary of stock option transactions for the nine months ended September 30, 2010, is as follows:

	Option Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Average Intrinsic Value ($000)
Outstanding at December 31, 2009		162,603		$	21.39
Granted		-			-
Exercised		(2,855	)		16.33
Forfeited		(200	)		24.50
Outstanding at September 30, 2010		159,548		$	21.48		4.9	$	348
Exercisable at September 30, 2010		129,048		$	22.57		4.1	$	194

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting period. As of September 30, 2010, there was $79,000 in total unrecognized compensation expense related to nonvested stock option grants.

Index

Restricted Stock

The Company from time-to-time grants shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of the shareholders of the Company by providing economic value directly related to increases in the value of the Company’s stock. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants.

The Company made its first restricted grant to executive officers in the first quarter 2010. These grants cliff vest over a 24 month period. On January 19, 2010, the Company issued 8,712 shares of restricted stock to its six executive officers and three regional executives.

Nonvested restricted stock for the nine months ended September 30, 2010 is summarized in the following table.

Restricted Stock	Shares		Grant date fair value

Nonvested at January 1, 2010		-		-
Granted		8,712	$	21.36
Vested		-		-
Forfeited		-		-
Nonvested at September 30, 2010		8,712	$	21.36

As of September 30, 2010, there was $116,000 of total unrecognized compensation cost related to nonvested restricted stock granted under the plan. This cost is expected to be recognized over the next 15 months.

Starting in 2010, the Company has begun offering its directors an option on director compensation. Their regular monthly retainer could be received as $1,000 per month in cash or $1,250 in immediately vested, but restricted stock. Eight of twelve directors elected to receive stock in lieu of cash for their retainer fees. Only outside directors receive board fees. The Company issued 4,472 shares and recognized share based compensation expense of $90,000 during the nine-month period.

Note 11 – Earnings Per Share

The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potentially dilutive common stock. Potentially dilutive common stock had no effect on income available to common shareholders.

	Three Months Ended
	September 30,
	2010				2009
			Per				Per
			Share				Share
	Shares		Amount		Shares		Amount
Basic		6,125,359	$	.36		6,104,505	$	.36
Effect of dilutive securities - stock options		5,770		-		7,408		(.01	)
Diluted		6,131,129	$	.36		6,111,913	$	.35

	Nine Months Ended
	September 30,
	2010				2009
			Per				Per
			Share				Share
	Shares		Amount		Shares		Amount
Basic		6,122,876	$	1.05		6,094,261	$	.76
Effect of dilutive securities - stock options		5,605		-		3,960		-
Diluted		6,128,481	$	1.05		6,098,221	$	.76

Stock options on common stock which were not included in computing diluted earnings per share for the nine month periods ended September 30, 2010 and 2009, because their effects were antidilutive, averaged 82,627 and 82,827, respectively.

Index

Note 12 – Employee Benefit Plans

Following is information pertaining to the Company’s non-contributory defined benefit pension plan.

Components of Net Periodic Benefit Cost	Three Months Ended						Nine Months Ended
(in thousands)	September 30,						September 30,
	2010			2009			2010			2009
Service cost	$	23		$	184		$	69		$	552
Interest cost		117			146			351			438
Expected return on plan assets		(135	)		(203	)		(405	)		(609	)
Recognized net actuarial loss		57			111			171			333

Net periodic benefit cost	$	62		$	238		$	186		$	714

The Company’s does not anticipate contributing to the plan for 2010.

Note 13 – Segment and Related Information

The Company has two reportable segments, community banking and trust and investment services.

Community banking involves making loans to and receiving deposits from individuals and businesses. All assets and liabilities of the Company are allocated to community banking. Investment income from securities is also allocated to the community banking segment. Loan fee income, service charges from deposit accounts, and non-deposit fees such as automated teller machine fees and insurance commissions generate additional income for community banking.