september302011_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, 2011.

¨
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
x
No
¨
  

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
x
No
¨
  

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 8, 2011 the Company had 7,802,976 shares of Common Stock outstanding, $1 par value.

 
 
 

 
 

       
Index
    
Page
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
   
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
 

 
2


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
  
2011
    
2010
  
 Cash and due from banks
   $ 23,450     $ 9,547  
 Interest-bearing deposits in other banks
     30,086       8,967  
                 
 Securities available for sale, at fair value
     311,517       228,295  
 Securities held to maturity (fair value of $2,450 at 9/30/11
                
 and $3,440 at 12/31/10)
     2,383       3,334  
 Total securities
     313,900       231,629  
                 
 Restricted stock, at cost
     6,404       4,062  
 Loans held for sale
     3,359       3,135  
                 
 Loans, net of unearned income
     817,858       520,781  
 Less allowance for loan losses
     (9,086 )     (8,420 )
 Net loans
     808,772       512,361  
                 
 Premises and equipment, net
     26,263       19,509  
 Other real estate owned, net
     5,920       3,716  
 Goodwill
     37,709       22,468  
 Core deposit intangibles, net
     7,142       1,320  
 Accrued interest receivable and other assets
     42,134       16,950  
 Total assets
   $ 1,305,139     $ 833,664  
                 
LIABILITIES and SHAREHOLDERS' EQUITY
                
 Liabilities:
                
 Demand deposits -- noninterest bearing
   $ 170,398     $ 105,240  
 Demand deposits -- interest bearing
     188,480       90,012  
 Money market deposits
     199,172       59,891  
 Savings deposits
     72,428       62,522  
 Time deposits
     433,999       322,433  
 Total deposits
     1,064,477       640,098  
                 
 Short-term borrowings:
                
 Customer repurchase agreements
     43,758       47,084  
 Other short-term borrowings
     -       6,110  
 Long-term borrowings
     10,238       8,488  
 Trust preferred capital notes
     27,190       20,619  
 Accrued interest payable and other liabilities
     8,115       3,178  
 Total liabilities
     1,153,778       725,577  
                 
 Shareholders' equity:
                
 Preferred stock, $5 par, 2,000,000 shares authorized,
                
 1,000,000 shares of Series A preferred stock outstanding
               
 at September 30, 2011 and none issued at December 31, 2010
     5,000       -  
 Common stock, $1 par, 20,000,000 shares authorized,
                
 7,802,976 shares outstanding at September 30, 2011 and
                
 6,127,735 shares outstanding at December 31, 2010
     7,803       6,128  
 Capital in excess of par value
     56,094       27,268  
 Retained earnings
     77,092       74,850  
 Accumulated other comprehensive income (loss), net
     5,372       (159 )
 Total shareholders' equity
     151,361       108,087  
 Total liabilities and shareholders' equity
   $ 1,305,139     $ 833,664  
                 
The accompanying notes are an integral part of the consolidated financial statements.
          
                 
 
 
3

 American National Bankshares Inc. and Subsidiaries
 Consolidated Statements of Income
(Dollars in thousands, except share and per share data) (Unaudited)
       
   
Three Months Ended
  
   
September 30
  
   
2011
    
2010
  
 Interest and Dividend Income:
            
 Interest and fees on loans
   $ 12,510     $ 6,994  
 Interest and dividends on securities:
                
 Taxable
     1,192       1,253  
 Tax-exempt
     1,014       621  
 Dividends
     35       24  
 Other interest income
     28       90  
 Total interest and dividend income
     14,779       8,982  
                 
Interest Expense:
                
 Interest on deposits
     2,079       1,722  
 Interest on short-term borrowings
     82       93  
 Interest on long-term borrowings
     86       65  
 Interest on trust preferred capital notes
     189       343  
 Total interest expense
     2,436       2,223  
                 
 Net Interest Income
     12,343       6,759  
 Provision for Loan Losses
     525       435  
                 
 Net Interest Income After Provision for Loan Losses
     11,818       6,324  
                 
 Noninterest Income:
                
 Trust fees
     921       842  
 Service charges on deposit accounts
     575       478  
 Other fees and commissions
     429       290  
 Mortgage banking income
     374       428  
 Securities gains, net
     -       67  
   Other
     399       136  
 Total noninterest income
     2,698       2,241  
                 
 Noninterest Expense:
                
 Salaries
     3,676       2,596  
 Employee benefits
     731       564  
 Occupancy and equipment
     916       732  
 FDIC assessment
     94       203  
 Bank franchise tax
     206       168  
 Core deposit intangible amortization
     545       94  
 Foreclosed real estate, net
     (261 )     (5 )
 Merger related expenses
     390       -  
   Other
     2,267       1,179  
 Total noninterest expense
     8,564       5,531  
                 
 Income Before Income Taxes
     5,952       3,034  
 Income Taxes
     1,823       806  
 Net Income
     4,129       2,228  
 Dividends on preferred stock
     51       -  
 Net income available to common shareholders
   $ 4,078     $ 2,228  
                 
 Net Income Per Common Share:
                
 Basic
   $ 0.52     $ 0.36  
 Diluted
   $ 0.52     $ 0.36  
 Average Common Shares Outstanding:
                
 Basic
     7,800,614       6,125,359  
 Diluted
     7,806,668       6,131,129  
                 
The accompanying notes are an integral part of the consolidated financial statements.
  
 
4

 American National Bankshares Inc. and Subsidiaries
 Consolidated Statements of Income
(Dollars in thousands, except share and per share data) (Unaudited)
 
   
Nine Months Ended
  
   
September 30
  
   
2011
    
2010
  
 Interest and Dividend Income:
            
 Interest and fees on loans
   $ 25,807     $ 21,220  
 Interest and dividends on securities:
                
 Taxable
     3,446       3,844  
 Tax-exempt
     2,557       1,641  
 Dividends
     88       71  
 Other interest income
     112       268  
 Total interest and dividend income
     32,010       27,044  
                 
Interest Expense:
                
 Interest on deposits
     5,246       5,004  
 Interest on short-term borrowings
     244       297  
 Interest on long-term borrowings
     144       192  
 Interest on trust preferred capital notes
     829       1,030  
 Total interest expense
     6,463       6,523  
                 
 Net Interest Income
     25,547       20,521  
 Provision for Loan Losses
     1,198       1,005  
                 
 Net Interest Income After Provision for Loan Losses
     24,349       19,516  
                 
 Noninterest Income:
                
 Trust fees
     2,727       2,455  
 Service charges on deposit accounts
     1,396       1,440  
 Other fees and commissions
     1,083       856  
 Mortgage banking income
     792       1,017  
 Securities gains (losses), net
     (18 )     42  
  Other
     677       398  
 Total noninterest income
     6,657       6,208  
                 
 Noninterest Expense:
                
 Salaries
     8,707       7,590  
 Employee benefits
     1,896       1,837  
 Occupancy and equipment
     2,311       2,209  
 FDIC assessment
     496       597  
 Bank franchise tax
     557       503  
 Core deposit intangible amortization
     734       283  
 Foreclosed real estate, net
     174       279  
    Merger related expenses
     1,534       -  
  Other
     4,962       3,607  
 Total noninterest expense
     21,371       16,905  
                 
 Income Before Income Taxes
     9,635       8,819  
 Income Taxes
     2,716       2,392  
 Net Income
     6,919       6,427  
 Dividends on preferred stock
     51       -  
 Net income available to common shareholders
   $ 6,868     $ 6,427  
                 
 Net Income Per Common Share:
                
 Basic
   $ 1.02     $ 1.05  
 Diluted
   $ 1.02     $ 1.05  
 Average Common Shares Outstanding:
                
 Basic
     6,705,607       6,122,876  
 Diluted
     6,712,960       6,128,481  
                 
The accompanying notes are an integral part of the consolidated financial statements.
  
 
5

American National Bankshares Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
Nine Months Ended September 30, 2011 and 2010
 (Dollars in thousands) (Unaudited)
                                     
                           
Accumulated
        
               
Capital in
          
Other
    
Total
  
   
Preferred
    
Common
    
Excess of
    
Retained
    
Comprehensive
    
Shareholders'
  
   
Stock
    
Stock
    
Par Value
    
Earnings
    
Income (Loss)
    
Equity
  
                                     
 Balance, December 31, 2009
   $ -     $ 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 securites, net of tax, $11
     -       -       -       -       20          
                                                 
Less: Reclassification adjustment for gains
                                          
 on securities available for sale, net of
                                                
 tax, $(26)
     -       -       -       -       (47 )        
                                                 
 Other comprehensive income
                                     2,024       2,024  
                                                 
 Total comprehensive income
                                             8,451  
                                                 
 Stock options exercised
     -       3       44       -       -       47  
                                                 
 Stock based compensation expense
     -       -       47       -       -       47  
                                                 
 Equity based compensation
     -       13       147       -       -       160  
                                                 
 Cash dividends declared, $0.69 per share
     -       -               (4,226 )     -       (4,226 )
                                                 
 Balance, September 30, 2010
   $ -     $ 6,126     $ 27,200     $ 74,409     $ 3,133     $ 110,868  
                                                 
 Balance, December 31, 2010
   $ -     $ 6,128     $ 27,268     $ 74,850     $ (159 )   $ 108,087  
                                                 
 Net income
     -       -       -       6,919               6,919  
                                                 
 Change in unrealized gains on securities
                                                
   available for sale, net of tax, $2,972
     -       -       -       -       5,519          
                                                 
Less: Reclassification adjustment for losses
                                          
 on securities available for sale, net of
                                                
 tax, $6
     -       -       -       -       12          
                                                 
 Other comprehensive income
                                     5,531       5,531  
                                                 
 Total comprehensive income
                                             12,450  
                                                 
 Issuance of common stock
             1,626       28,279               -       29,905  
                                                 
 Issuance of preferred stock
     5,000       -       -       -       -       5,000  
                                                 
 Stock options exercised
     -       11       162       -       -       173  
                                                 
 Stock based compensation expense
     -       -       48       -       -       48  
                                                 
 Equity based compensation
     -       38       337       -       -       375  
                                                 
 Dividends on preferred stock
     -       -       -       (51 )     -       (51 )
                                                 
 Cash dividends declared, $0.69 per share
     -       -       -       (4,626 )             (4,626 )
                                                 
 Balance, September 30, 2011
   $ 5,000     $ 7,803     $ 56,094     $ 77,092     $ 5,372     $ 151,361  
                                                 
The accompanying notes are an integral part of the consolidated financial statements.
    
 
6

 American National Bankshares Inc. and Subsidiaries
 Consolidated Statements of Cash Flows
 Nine Months Ended September 30, 2011 and 2010
 (Dollars in thousands)  (Unaudited)
     Nine Months Ended  
     September 30,  
   
2011
    
2010
  
 Cash Flows from Operating Activities:
            
 Net income
   $ 6,919     $ 6,427  
 Adjustments to reconcile net income to net
                
 cash provided by operating activities:
                
 Provision for loan losses
     1,198       1,005  
 Depreciation
     770       941  
 Core deposit intangible amortization
     734       283  
 Net amortization of securities
     1,086       296  
 Net (gain) loss on sale or call of securities
     18       (73 )
 Impairment of securities
     -       31  
 Gain on loans held for sale
     (95 )     (902 )
 Proceeds from sales of loans held for sale
     31,901       36,195  
 Originations of loans held for sale
     (31,917 )     (36,755 )
 Net gain on foreclosed real estate
     (185 )     (2 )
 Net change in valuation allowance on foreclosed real estate
     359       281  
 Stock-based compensation expense
     48       47  
 Equity based compensation
     375       160  
 Deferred income tax benefit
     (92 )     (311 )
 Net change in interest receivable
     825       (451 )
 Net change in other assets
     865       624  
 Net change in interest payable
     (164 )     (45 )
 Net change in other liabilities
     1,263       432  
 Net cash provided by operating activities
     13,908       8,183  
                 
 Cash Flows from Investing Activities:
                
 Proceeds from sales of securities available for sale
     2,099       815  
 Proceeds from sales of securities held to maturity
     -       184  
 Proceeds from maturities and calls of securities available for sale
     56,405       88,858  
 Proceeds from maturities and calls of securities held to maturity
     961       1,299  
 Purchases of securities available for sale
     (85,230 )     (106,706 )
 Net change in loans
     28,818       6,933  
 Proceeds from sale of premises and equipment
     (114 )     -  
 Purchases of premises and equipment
     (549 )     (1,888 )
 Proceeds from sales of foreclosed real estate
     1,896       156  
 Purchases of foreclosed real estate
     (51 )     -  
 Cash paid in bank acquisition
     (12 )     -  
 Cash acquired in bank acquisition
     34,783       -  
 Net cash provided by (used in) investing activities
     39,006       (10,349 )
                 
 Cash Flows from Financing Activities:
                
 Net change in demand, money market, and savings deposits
     31,502       (27,079 )
 Net change in time deposits
     (27,371 )     48,436  
 Net change in repurchase agreements
     (3,326 )     (11,644 )
 Net change in short-term borrowings
     (6,110 )     -  
 Net change in long-term borrowings
     (8,108 )     (113 )
 Net change in trust preferred capital notes
     25       -  
 Common stock dividends paid
     (4,626 )     (4,226 )
 Preferred stock dividends paid
     (51 )     -  
 Proceeds from exercise of stock options
     173       47  
 Net cash (used in) provided by financing activities
     (17,892 )     5,421  
                 
 Net Increase in Cash and Cash Equivalents
     35,022       3,255  
                 
 Cash and Cash Equivalents at Beginning of Period
     18,514       23,943  
                 
 Cash and Cash Equivalents at End of Period
   $ 53,536     $ 27,198  
                 
The accompanying notes are an integral part of the consolidated financial statements.
          

 
7
 
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 (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the 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.
 
In July 2011, and in connection with its acquisition of MidCarolina Financial Corporation, the Company assumed the liabilities of the MidCarolina Statutory Trust I and II which was also formed for the purpose of issuing preferred securities.  Refer to Note 9 for further details concerning these variable interest entities.
 
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, 2011; the consolidated statements of income for the three and nine months ended September 30, 2011 and 2010; the consolidated statements of changes in shareholders’ equity for the nine months ended September 30, 2011 and 2010; and the consolidated statements of cash flows for the nine months ended September 30, 2011 and 2010.  Operating results for the three and nine month periods ended September 30, 2011 are not necessarily indicative of the results that may occur for the year ending December 31, 2011.  Refer to Note 2 regarding the merger of MidCarolina Financial Corporation into American National Bankshares Inc. as of July 1, 2011.  This transaction will be reported as of July 1 and prior periods will not be restated.  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, 2010.
 
 
Note 2 – Completed Merger

On July 1, 2011, American National Bankshares Inc. (“American National”) completed its merger with MidCarolina Financial Corporation (“MidCarolina”) pursuant to the Agreement and Plan of Reorganization, dated December 15, 2010, between American National and MidCarolina (the “merger agreement”).  MidCarolina was headquartered in Burlington, North Carolina, and engaged in banking operations through its subsidiary bank, MidCarolina Bank.  The transaction has expanded the Company’s footprint in North Carolina, adding eight branches in Alamance and Guilford Counties.
       
        Pursuant to the terms of the merger agreement, as a result of the merger, the holders of shares of MidCarolina common stock received 0.33 shares of American National common stock for each share of MidCarolina common stock held immediately prior to the effective date of the merger. Each share of American National common stock outstanding immediately prior to the merger has continued to be outstanding after the merger. Each option to purchase a share of MidCarolina common stock outstanding immediately prior to the effective date of the merger was converted into an option to purchase shares of American National common stock, adjusted for the 0.33 exchange ratio. Additionally, the holders of shares of noncumulative perpetual Series A preferred stock of MidCarolina received one share of a newly authorized noncumulative perpetual Series A preferred stock of American National for each MidCarolina preferred share held immediately before the merger.  The American National Series A preferred stock has terms, preferences, rights and limitations that are identical in all material respects to the MidCarolina Series A preferred stock.
 
 
8
 
American National issued 1,626,157 shares of additional common stock in connection with the MidCarolina merger. This represents 20.9% of the now outstanding shares of American National.
 
In connection with the transaction, MidCarolina Bank was merged with and into American National Bank and Trust Company. The former offices of MidCarolina Bank are expected to operate under the name “MidCarolina Bank, a division of American National Bank and Trust Company” until early 2012.

The merger with MidCarolina was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration paid were recorded at their estimated fair values as of the merger date. The excess of consideration paid over the fair value of net assets acquired was recorded as goodwill in the amount of approximately $15.2 million, which will not be amortizable and is not deductible for tax purposes. American National allocated the total balance of goodwill to its community banking segment. The Company also recorded $6.5 million in core deposit intangibles which will be amortized over nine years using a declining balance method.

The fair values listed below are preliminary estimates and are subject to adjustment, however, while they are not expected to be materially different than those shown, any material adjustments to the estimates will be reflected, retroactively, as of the date of the merger.
 
        In connection with the merger, the consideration paid, and the fair value of identifiable assets acquired and liabilities assumed as of the merger date are summarized in the following table:

(dollars in thousands)
      
Consideration Paid:
      
           Common shares issued (1,626,157)
   $ 29,905  
           Cash paid to Shareholders
     12  
           Preferred shares issued (5,000)
     5,000  
                   Value of consideration
     34,917  
         
Assets acquired:
        
           Cash and cash equivalents
     34,783  
           Investment securities
     51,442  
           Loans held for sale
     113  
           Loans, net of unearned income
     327,112  
           Premises and equipment, net
     6,861  
           Deferred income taxes
     15,626  
           Core deposit intangible
     6,556  
           Other assets
     17,673  
                    Total assets
     460,166  
         
Liabilities assumed:
        
           Deposits
     420,248  
           FHLB advances
     9,858  
           Other borrowings
     6,546  
           Other liabilities
     3,838  
           Total Liabilities
     440,490  
Net assets acquired
     19,676  
Goodwill resulting from merger with MidCarolina
   $ 15,241  
         
 
        In many cases, the fair values of assets acquired and liabilities assumed were determined by estimating the cash flows expected to result from those assets and liabilities and discounting them at appropriate market rates. The most significant category of assets for which this procedure was used was that of acquired loans. The Company acquired the $367.4 million loan portfolio at a fair value discount of $40.3 million. The performing portion of the portfolio estimated fair value was $289.2 million. The excess of expected cash flows above the fair value of the performing portion of loans will be accreted to interest income over the remaining lives of the loans in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ ASC”) 310-20 (formerly SFAS 91).
 
 
9

 
        Certain loans, those for which specific credit-related deterioration, since origination, was identified, are recorded at fair value, reflecting the present value of the amounts expected to be collected. Income recognition on these loans is based on reasonable expectation about the timing and amount of cash flows to be collected. Acquired loans deemed impaired and considered collateral dependent, with the timing of the sale of loan collateral indeterminate, remain on non-accrual status and have no accretable yield.

The following tables details the acquired loans that are accounted for in accordance with FASB ASC 310-30 (formerly Statement of Position (“SOP”) 03-3) as of July 1, 2011:
 
Contractually required principal and interest at acquisition
   $ 56,869  
Contractual cash flows not expected to be collected (nonaccretable difference)
     15,433  
Expected cash flows at acquisition
     41,436  
Interest component of expected cash flows (accretable discount)
     3,547  
Fair value of acquired loans accounted for under FASB ASC 310-30
   $ 37,889  
         

 
        In accordance with GAAP, there was no carryover of the allowance for loan losses that had been previously recorded by MidCarolina.

In connection with the merger with MidCarolina, the Company acquired an investment portfolio with a fair value of $51.4 million. The fair value of the investment portfolio was determined by taking into account market prices obtained from independent valuation sources.

In connection with the merger with MidCarolina, the Company recorded a deferred income tax asset of $15.6 million related to MidCarolina’s valuation allowance on foreclosed real estate and bad debt expenses, as well as other tax attributes of the acquired company, along with the effects of fair value adjustments resulting from applying the acquisition method of accounting.

The fair value of savings and transaction deposit accounts acquired from MidCarolina was assumed to approximate their carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit accounts were valued by comparing the contractual cost of the portfolio to an identical portfolio bearing current market rates. The portfolio was segregated into pools based on segments: retail, Individual Retirement Accounts Brokered, and CDARs. For each segment, the projected cash flows from maturing certificates were then calculated based on contractual rates and prevailing market rates. The valuation adjustment for each segment is equal to the present value of the difference of these two cash flows, discounted at the assumed market rate for a certificate with a corresponding maturity. This valuation adjustment will be accreted to increase interest expense over the remaining maturities of the respective pools.

The fair value of the Federal Home Loan Bank of Atlanta (“FHLB”) advances was determined based on the discounted cash flows of further payments.This adjustment to the face value of the borrowings will be accreted to increase interest expense over the remaining lives of the respective borrowings.

Direct costs related to the acquisition were expensed as incurred. During the nine months ended September 30, 2011, the Company incurred $1.5 million in merger and acquisition integration expenses related to the transaction, including $1.3 million in professional services, $130 thousand in technology and communications, $22 thousand in advertising and marketing, and $26 thousand in other non-interest expenses.

The following table presents unaudited pro forma information as if the merger with MidCarolina had occurred on January 1, 2010. This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles and related income tax effects. It also reflects the removal of $5.1 million in merger related expenses reflected on the books of both banks.


The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger with MidCarolina occurred in 2010. In particular, expected operational cost savings are not reflected in the pro forma amounts.
 
 
10
 
   
Pro forma
   
Nine Months Ended
   
September 30,
  
(in thousands)
  
2011
    
2010
  
Net interest income
   $ 38,185     $ 37,925  
Provision for loan loss
     (3,598 )     (6,023 )
Non-interest income
     6,354       8,094  
Non-interest expense and income taxes
     (31,635 )     (31,022 )
Net income
   $ 9,306     $ 8,974  
                 
 
Note 3 – Securities

The amortized cost and estimated fair value of investments in debt and equity securities at September 30, 2011 and December 31, 2010 were as follows:

 
  
September 30, 2011
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
Federal agencies & GSE
   $ 33,519     $ 734     $ -     $ 34,253  
Mortgage-backed & private label CMOs
     95,675       1,688       393       96,970  
State and municipal
     169,548       8,405       44       177,909  
Corporate
     2,301       84       -       2,385  
Total securities available for sale
     301,043       10,911       437       311,517  
                                 
Securities held to maturity:
                                
State and municipal
     2,383       67       -       2,450  
Total securities held to maturity
     2,383       67       -       2,450  
Total Securities
   $ 303,426     $ 10,978     $ 437     $ 313,967  

 
  
December 31, 2010
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
Federal agencies & GSE
   $ 57,292     $ 785     $ -     $ 58,077  
Mortgage-backed &  private label CMOs
     62,128       1,273       419       62,982  
State and municipal
     104,937       1,582       1,421       105,098  
Corporate
     1,974       164       -       2,138  
Total securities available for sale
     226,331       3,804       1,840       228,295  
                                 
Securities held to maturity:
                                
State and municipal
     3,334       106       -       3,440  
Total securities held to maturity
     3,334       106       -       3,440  
Total Securities
   $ 229,665     $ 3,910     $ 1,840     $ 231,735  
 
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, 2011.  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 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
   $ 22,891     $ 183     $ 22,891     $ 183     $ -     $ -  
CMOs
     8,907       210       8,809       193       98       17  
State and municipal
     2,580       44       2,580       44       -       -  
  Total
   $ 34,378     $ 437     $ 34,280     $ 420     $ 98     $ 17  
 
 
11
 
Mortgage-backed securities:  The unrealized losses on the Company's investment in 11 Government-Sponsored Enterprise (“GSE”) mortgage-backed securities and one Government National Mortgage Association (“GNMA”) mortgage-backed securities were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by a GSE or agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost bases 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, 2011.
 
 
Collateralized Mortgage Obligations (“CMOs”): The unrealized loss associated with one private label residential CMO, with a book value of $115,000, is 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 when needed.  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, 2011.
 
 
The unrealized loss associated with eight CMOs was caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost bases 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, 2011.
 
 
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, 2011.
 
The Company’s investment in FHLB stock totaled $3,545,000 at September 30, 2011.  FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs 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 Company does not consider this investment to be other-than-temporarily impaired at September 30, 2011 and no impairment has been recognized.  FHLB stock is shown in restricted stock on the balance sheet and is not a part of the available for sale securities portfolio.

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, 2010.

   
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
   $ 22,106     $ 216     $ 22,106     $ 216     $ -     $ -  
Private label CMOs
     1,583       203       1,031       18       552       185  
State and municipal
     46,532       1,421       46,532       1,421       -       -  
  Total
   $ 70,221     $ 1,840     $ 69,669     $ 1,655     $ 552     $ 185  

Other-Than-Temporary Impaired Securities

There were no other-than-temporary impaired securities held at September 30, 2011.  One variable rate CMO which was impaired, held at December 31, 2010, was sold during the second quarter of 2011.  During 2010, the Company had recognized an impairment charge to earnings of $31,000.  The sale during the second quarter of 2011 resulted in an additional loss of $46,000.
 
 
12
 
 
Note 4 - Loans
 
Loans, excluding loans held for sale, were comprised of the following:

   
September 30,
    
December 31,
  
(in thousands)
  
2011
    
2010
  
             
Commercial
   $ 133,731     $ 85,051  
Commercial real estate:
                
Construction and land development
     53,723       37,168  
Commercial real estate
     347,865       210,393  
Residential real estate:
                
Residential
     172,454       119,398  
Home equity
     100,231       61,064  
Consumer
     9,854       7,707  
Total loans
   $ 817,858     $ 520,781  
                 


Interest income on loans acquired from MidCarolina for the third quarter of 2011 was approximately $6.0 million. The outstanding principal balance and the carrying amount of these loans included in the consolidated balance sheet at September 30, 2011 are as follows:
 
     September 30,  
(in thousands)
    2011  
Oustanding principal balance
   $ 343,259  
Carrying amount
     304,769  

 
The outstanding principal balance and related carrying amount of acquired loans, for which the Company applies ASC 310-30 (formerly SOP 03-3), to account for interest earned, as of the indicated dates is as follows:
 
   
September 30,
    
December 31,
  
(in thousands)
  
2011
    
2010
  
Oustanding principal balance
   $ 55,113     $ 390  
Carrying amount
     36,502       166  
 
The following table presents changes in the accretable discount on acquired loans, for which the Company applies ASC 310-30 (formerly SOP 03-3), for the nine months ended September 30, 2011.
 
   
Accretable
  
(in thousands)
  
Discount
  
Balance at December 31, 2010
   $ 27  
Recorded at acquisition, July 1, 2011
     3,547  
Accretion
     (580 )
Balance at September 30, 2011
   $ 2,994  
         
 
 
13
 
        The following table shows an analysis by portfolio class of the Company’s past due loans at September 30, 2011 and December 31, 2010. It is the operating policy of the Company that any loan past due 90 days will be transferred to nonaccrual loan status, therefore there are no loans reported in the 90 days and accruing column below.
 
At September 30, 2011
          
90 Days +
                          
               
Past Due
    
Non-
    
Total
              
   
30- 59 Days
    
60-89 Days
    
and Still
    
Accrual
    
Past
          
Total
  
(in thousands)
  
Past Due
    
Past Due
    
Accruing
    
Loans
    
Due
    
Current
    
Loans
  
                                           
Commercial
   $ 154     $ 275     $ -     $ 1,840     $ 2,269     $ 131,462     $ 133,731  
Commercial real estate:
                                                        
Construction and land development
     187       292       -       6,669       7,148       46,575       53,723  
Commercial real estate
     2,001       32       -       1,331       3,364       344,501       347,865  
Residential:
                                                        
Residential
     554       89       -       3,499       4,142       168,312       172,454  
Home equity
     231       70       -       56       357       99,874       100,231  
Consumer:
                                                        
Consumer
     35       16       -       60       111       9,743       9,854  
Total
   $ 3,162     $ 774     $ -     $ 13,455     $ 17,391     $ 800,467     $ 817,858  
                                                         
 

At December 31, 2010
          
90 Days +
                          
               
Past due
    
Non-
    
Total
              
   
30- 59 Days
    
60-89 Days
    
and Still
    
Accrual
    
Past
          
Total
  
(in thousands)
  
Past Due
    
Past Due
    
Accruing
    
Loans
    
Due
    
Current
    
Loans
  
                                           
Commercial
   $ -     $ 46     $ -     $ 401     $ 447     $ 84,604     $ 85,051  
Commercial real estate:
                                                        
Construction and land development
     -       40       -       59       99       37,069       37,168  
Commercial real estate
     572       175       -       614       1,361       209,032       210,393  
Residential:
                                                        
Residential
     742       704       -       1,419       2,865       116,533       119,398  
Home equity
     15       23       -       97       135       60,929       61,064  
Consumer:
                                                        
Consumer
     8       72       -       7       87