september302012_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, 2012.

¨
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 7, 2012, the Company had 7,843,221shares 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, 2012 and December 31, 2011
 
3
       
   
Consolidated Statements of Income for the three months ended September 30, 2012 and 2011
 
4
   
Consolidated Statements of Income for the nine months ended September 30, 2012 and 2011
 
5
   
Consolidated Statements of Comprehensive Income for the three months and nine months ended September 30, 2012 and 2011
6
 
   
Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2012 and 2011
7
       
   
Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011
8
       
   
Notes to Consolidated Financial Statements
9
       
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
37
       
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
57
       
 
Item 4.
Controls and Procedures
57
       
Part II.
OTHER INFORMATION
  
       
 
Item 1.
Legal Proceedings
58
       
 
Item 1A.
Risk Factors
58
       
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
58
       
 
Item 3.
Defaults Upon Senior Securities
58
       
 
Item 4.
Mine Safety Disclosures
58
       
 
Item 5.
Other Information
58
       
 
Item 6.
Exhibits
58
       
SIGNATURES
  

 
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
  
2012
    
2011
  
 Cash and due from banks
   $ 25,740     $ 22,561  
 Interest-bearing deposits in other banks
     41,900       6,332  
                 
 Securities available for sale, at fair value
     327,994       333,366  
 Restricted stock, at cost
     5,284       6,019  
 Loans held for sale
     8,118       6,330  
                 
 Loans, net of unearned income
     797,818       824,758  
 Less allowance for loan losses
     (11,998 )     (10,529 )
 Net loans
     785,820       814,229  
                 
 Premises and equipment, net
     24,885       25,674  
 Other real estate owned, net
     6,259       5,353  
 Goodwill
     39,043       38,899  
 Core deposit intangibles, net
     5,081       6,595  
 Bank owned life insurance
     13,380       13,058  
 Accrued interest receivable and other assets
     22,203       26,290  
 Total assets
   $ 1,305,707     $ 1,304,706  
                 
 Liabilities
                
 Demand deposits -- noninterest bearing
   $ 215,012     $ 179,148  
 Demand deposits -- interest bearing
     152,706       189,212  
 Money market deposits
     164,266       182,347  
 Savings deposits
     78,665       74,193  
 Time deposits
     441,778       433,854  
 Total deposits
     1,052,427       1,058,754  
                 
 Short-term borrowings:
                
 Customer repurchase agreements
     45,761       45,575  
 Other short-term borrowings
     -       3,000  
 Long-term borrowings
     10,111       10,206  
 Trust preferred capital notes
     27,292       27,212  
 Accrued interest payable and other liabilities
     8,071       7,130  
 Total liabilities
     1,143,662       1,151,877  
                 
 Shareholders' equity
                
 Preferred stock, $5 par, 2,000,000 shares authorized,
                
 none outstanding
     -       -  
 Common stock, $1 par, 20,000,000 shares authorized,
                
 7,843,221 shares outstanding at September 30, 2012 and
                
 7,806,869 shares outstanding at December 31, 2011
     7,843       7,807  
 Capital in excess of par value
     57,045       56,395  
 Retained earnings
     88,478       81,797  
 Accumulated other comprehensive income, net
     8,679       6,830  
 Total shareholders' equity
     162,045       152,829  
 Total liabilities and shareholders' equity
   $ 1,305,707     $ 1,304,706  
                 
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
  
   
2012
    
2011
  
 Interest and Dividend Income:
            
 Interest and fees on loans
   $ 11,421     $ 12,510  
 Interest and dividends on securities:
                
 Taxable
     995       1,192  
 Tax-exempt
     1,059       1,014  
 Dividends
     52       35  
 Other interest income
     19       28  
 Total interest and dividend income
     13,546       14,779  
                 
Interest Expense:
                
 Interest on deposits
     1,725       2,079  
 Interest on short-term borrowings
     33       82  
 Interest on long-term borrowings
     84       86  
 Interest on trust preferred capital notes
     204       189  
 Total interest expense
     2,046       2,436  
                 
 Net Interest Income
     11,500       12,343  
 Provision for Loan Losses
     333       525  
                 
 Net Interest Income After Provision for Loan Losses
     11,167       11,818  
                 
 Noninterest Income:
                
 Trust fees
     926       921  
 Service charges on deposit accounts
     414       575  
 Other fees and commissions
     421       429  
 Mortgage banking income
     615       374  
     Other
     314       399  
 Total noninterest income
     2,690       2,698  
                 
 Noninterest Expense:
                
 Salaries
     3,933       3,676  
 Employee benefits
     780       731  
 Occupancy and equipment
     929       916  
 FDIC assessment
     84       94  
 Bank franchise tax
     173       206  
 Core deposit intangible amortization
     421       545  
 Foreclosed real estate, net
     412       (32 )
 Merger related expenses
     (30 )     390  
     Other
     2,178       2,038  
 Total noninterest expense
     8,880       8,564  
                 
 Income Before Income Taxes
     4,977       5,952  
 Income Taxes
     1,338       1,823  
 Net Income
     3,639       4,129  
 Dividends on preferred stock
     -       51  
 Net income available to common shareholders
   $ 3,639     $ 4,078  
                 
 Net Income Per Common Share:
                
 Basic
   $ 0.46     $ 0.52  
 Diluted
   $ 0.46     $ 0.52  
 Average Common Shares Outstanding:
                
 Basic
     7,838,314       7,800,614  
 Diluted
     7,855,537       7,806,668  
                 
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
  
   
2012
    
2011
  
 Interest and Dividend Income:
            
 Interest and fees on loans
   $ 37,224     $ 25,807  
 Interest and dividends on securities:
                
 Taxable
     3,130       3,446  
 Tax-exempt
     3,218       2,557  
 Dividends
     155       88  
 Other interest income
     47       112  
 Total interest and dividend income
     43,774       32,010  
                 
Interest Expense:
                
 Interest on deposits
     5,291       5,246  
 Interest on short-term borrowings
     127       244  
 Interest on long-term borrowings
     252       144  
 Interest on trust preferred capital notes
     616       829  
 Total interest expense
     6,286       6,463  
                 
 Net Interest Income
     37,488       25,547  
 Provision for Loan Losses
     1,799       1,198  
                 
 Net Interest Income After Provision for Loan Losses
     35,689       24,349  
                 
 Noninterest Income:
                
 Trust fees
     2,774       2,727  
 Service charges on deposit accounts
     1,315       1,396  
 Other fees and commissions
     1,323       1,083  
 Mortgage banking income
     1,665       792  
 Securities gains (losses), net
     160       (18 )
     Other
     1,487       677  
 Total noninterest income
     8,724       6,657  
                 
 Noninterest Expense:
                
 Salaries
     11,853       8,707  
 Employee benefits
     2,657       1,896  
 Occupancy and equipment
     2,942       2,311  
 FDIC assessment
     530       496  
 Bank franchise tax
     538       557  
 Core deposit intangible amortization
     1,514       734  
 Foreclosed real estate, net
     430       174  
 Merger related expenses
     19       1,534  
     Other
     7,157       4,646  
 Total noninterest expense
     27,640       21,371  
                 
 Income Before Income Taxes
     16,773       9,635  
 Income Taxes
     4,685       2,716  
 Net Income
     12,088       6,919  
 Dividends on preferred stock
     -       51  
 Net income available to common shareholders
   $ 12,088     $ 6,868  
                 
 Net Income Per Common Share:
                
 Basic
   $ 1.54     $ 1.02  
 Diluted
   $ 1.54     $ 1.02  
 Average Common Shares Outstanding:
                
 Basic
     7,830,928       6,705,607  
 Diluted
     7,846,659       6,712,960  
                 
The accompanying notes are an integral part of the consolidated financial statements.
  


 
5
 

 American National Bankshares Inc. and Subsidiaries
  
Consolidated Statements of Comprehensive Income
  
September 30, 2012
  
 (Dollars in thousands)  (Unaudited)
  
   
Three Months Ended
  
   
September 30
  
   
2012
    
2011
  
             
 Net income
   $ 3,639     $ 4,129  
                 
 Other comprehensive income:
                
                 
 Unrealized gains on securities available for sale
     2,396       4,336  
 Income tax (expense)
     (838 )     (1,517 )
                 
 Other comprehensive income
     1,558       2,819  
                 
Comprehensive income
   $ 5,197     $ 6,948  
                 
                 
                 
   
Nine Months Ended
  
   
September 30
  
      2012       2011  
                 
 Net income
   $ 12,088     $ 6,919  
                 
 Other comprehensive income:
                
                 
 Unrealized gains on securities available for sale
     3,004       8,491  
 Income tax (expense)
     (1,051 )     (2,972 )
                 
 Reclassification adjustment for (gains) losses on securities
     (160 )     18  
 Income tax expense (benefit)
     56       (6 )
                 
 Other comprehensive income
     1,849       5,531  
                 
Comprehensive income
   $ 13,937     $ 12,450  
                 
The accompanying notes are an integral part of the consolidated financial statements.
        

 
6
 
American National Bankshares Inc. and Subsidiaries
  
Consolidated Statements of Changes in Shareholders' Equity
  
Nine Months Ended September 30, 2012 and 2011
  
 (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, 2010
   $ -     $ 6,128     $ 27,268     $ 74,850     $ (159 )   $ 108,087  
                                                 
 Net income
     -       -       -       6,919       -       6,919  
                                                 
 Other comprehensive income
     -       -       -       -       5,531       5,531  
                                                 
 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 option 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  
                                                 
 Balance, December 31, 2011
   $ -     $ 7,807     $ 56,395     $ 81,797     $ 6,830     $ 152,829  
                                                 
 Net income
             -       -       12,088       -       12,088  
                                                 
 Other comprehensive income
     -       -       -       -       1,849       1,849  
                                                 
 Stock options exercised
     -       7       111       -       -       118  
                                                 
 Equity based compensation
     -       29       539       -       -       568  
                                                 
 Cash dividends declared, $0.69 per share
     -       -               (5,407 )     -       (5,407 )
                                                 
 Balance, September 30, 2012
   $ -     $ 7,843     $ 57,045     $ 88,478     $ 8,679     $ 162,045  
                                                 
The accompanying notes are an integral part of the consolidated financial statements.
                  


 
7
 

 American National Bankshares Inc. and Subsidiaries
  
 Consolidated Statements of Cash Flows
  
Nine Months Ended September 30, 2012 and 2011
  
 (Dollars in thousands)  (Unaudited)
  
             
   
2012
    
2011
  
 Cash Flows from Operating Activities:
            
 Net income
   $ 12,088     $ 6,919  
 Adjustments to reconcile net income to net
                
 cash provided by operating activities:
                
 Provision for loan losses
     1,799       1,198  
 Depreciation
     1,315       770  
 Core deposit intangible amortization
     1,514       734  
 Net amortization (accretion) of securities
     2,480       1,086  
 Net accretion of fair value adjustments
     (6,914 )     (1,328 )
 Net (gain) loss on sale or call of securities
     (160 )     18  
 Gain on loans held for sale
     (1,469 )     (697 )
 Proceeds from sales of loans held for sale
     70,077       32,503  
 Originations of loans held for sale
     (70,396 )     (31,917 )
 Net gain on foreclosed real estate
     (170 )     (185 )
 Valuation allowance on foreclosed real estate
     279       359  
 Net gain on sale of premises and equipment
     (504 )     -  
 Stock-based compensation expense
     -       48  
 Equity based compensation
     568       375  
 Deferred income tax expense (benefit)
     2,657       (92 )
 Net change in interest receivable
     202       825  
 Net change in other assets
     (233 )     865  
 Net change in interest payable
     (77 )     (164 )
 Net change in other liabilities
     1,018       1,263  
 Net cash provided by operating activities
     14,074       12,580  
                 
 Cash Flows from Investing Activities:
                
 Proceeds from sales of securities available for sale
     4,209       2,099  
 Proceeds from maturities and calls of securities available for sale
     52,328       56,405  
 Proceeds from maturities and calls of securities held to maturity
     -       961  
 Purchases of securities available for sale
     (50,641 )     (84,725 )
 Net change in restricted stock
     735       (505 )
 Net decrease in loans
     27,475       30,018  
 Proceeds from sale of premises and equipment
     572       (114 )
 Purchases of premises and equipment
     (594 )     (549 )
 Proceeds from sales of foreclosed real estate
     4,720       1,896  
 Purchases of foreclosed real estate
     -       (51 )
 Cash paid in bank acquisition
     -       (12 )
 Cash acquired in bank acquisiton
       -       34,783  
 Net cash provided by investing activities
     38,804       40,206  
                 
 Cash Flows from Financing Activities:
                
 Net change in demand, money market, and savings deposits
     (14,251 )     31,502  
 Net change in time deposits
     8,335       (27,212 )
 Net change in customer repurchase agreements
     186       (3,326 )
 Net change in other short-term borrowings
     (3,000 )     (6,110 )
 Net change in long-term borrowings
     (112 )     (8,114 )
 Common stock dividends paid
     (5,407 )     (4,626 )
 Preferred stock dividends paid
     -       (51 )
 Proceeds from exercise of stock options
     118       173  
 Net cash used in financing activities
     (14,131 )     (17,764 )
                 
 Net Increase in Cash and Cash Equivalents
     38,747       35,022  
                 
 Cash and Cash Equivalents at Beginning of Period
     28,893       18,514  
                 
 Cash and Cash Equivalents at End of Period
   $ 67,640     $ 53,536  
                 
The accompanying notes are an integral part of the consolidated financial statements.
          

 
8
 

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. (the “Company”) and its wholly owned subsidiary, American National Bank and Trust Company (the “Bank”).  The 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, goodwill and intangible assets, pension obligations, other than temporary impairment, the fair value of financial instruments, and the valuation of foreclosed real estate.

In April 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “AMNB 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.

On July 1, 2011, the Company completed its merger with MidCarolina Financial Corporation (“MidCarolina”).  MidCarolina was headquartered in Burlington, North Carolina, and engaged in banking operations through its subsidiary bank, MidCarolina Bank.

In July 2011, and in connection with its acquisition of MidCarolina, the Company assumed the liabilities of the MidCarolina I and MidCarolina Trust II, two separate Delaware statutory trusts (the “MidCarolina Trusts”), which were also formed for the purpose of issuing preferred securities.  Refer to Note 9 for further details concerning these entities.

All significant inter-company transactions and accounts are eliminated in consolidation, with the exception of the AMNB Trust and the MidCarolina Trusts, 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, 2012; the consolidated statements of income for the three and nine months ended September 30, 2012 and 2011; the consolidated statements of comprehensive income for the three and nine months ended September 30, 2012 and 2011; the consolidated statements of changes in shareholders’ equity for the nine months ended September 30, 2012 and 2011; and the consolidated statements of cash flows for the nine months ended September 30, 2012 and 2011.  Operating results for the three and nine month periods ended September 30, 2012 are not necessarily indicative of the results that may occur for the year ending December 31, 2012.  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, 2011.
 
 
Note 2 –Merger with MidCarolina

On July 1, 2011, the Company completed its merger with MidCarolina Financial Corporation pursuant to the Agreement and Plan of Reorganization, dated December 15, 2010, between the Company 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 significantly 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 the Company’s common stock for each share of MidCarolina common stock held immediately prior to the effective date of 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 Company 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 the Company for each MidCarolina preferred share held immediately before the merger.  The Company’s Series A preferred stock was issued with terms, preferences, rights and limitations that are identical in all material respects to the MidCarolina Series A preferred stock.

 
9
 
The Company issued 1,626,157 shares of additional common stock in connection with the MidCarolina merger. This represents 20.7% of the outstanding shares of the Company as of September 30, 2012.

In connection with the transaction, MidCarolina Bank was merged with and into the Bank.

On November 15, 2011, the Company repurchased all 5,000 shares of the Series A preferred stock issued in the merger. The shares had a $1,000 liquidation preference per share. While the Series A preferred stock was subject to redemption at 104.5% of par during the twelve month period beginning August 15, 2011, the Company paid 62% of par, or an aggregate purchase price of $3.1 million, to repurchase all 5,000 outstanding shares from the sole holder of the securities.

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 originally recorded as goodwill in the amount of approximately $16.4 million, which will not be amortizable and is not deductible for tax purposes.  The Company allocated the total balance of goodwill to its community banking segment. The Company also recorded $6.6 million in core deposit intangibles which will be amortized over nine years using a declining balance method.

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  
        Fair Value of Options
     132  
Preferred shares issued (5,000)
     5,000  
 Value of consideration
     35,049  
         
Assets acquired:
        
Cash and cash equivalents
     34,783  
         Investment securities
     51,442  
           Loans held for sale
     113  
 Loans, net of unearned income
     328,123  
 Premises and equipment, net
     5,708  
           Deferred income taxes
     15,310  
           Core deposit intangible
     6,556  
           Other real estate owned
     3,538  
           Other assets
     13,535  
                      Total assets
     459,108  
         
Liabilities assumed:
        
            Deposits
     420,248  
            FHLB advances
     9,858  
            Other borrowings
     6,546  
            Other liabilities
     3,982  
                       Total Liabilities
     440,634  
Net assets acquired
     18,474  
Goodwill resulting from merger with MidCarolina
   $ 16,575  

 
10
 

The following table details the changes in the fair value of net assets acquired and liabilities assumed from the amounts originally reported in the Form 10-K for the period ending December 31, 2011 (in thousands).


Goodwill at December 31, 2011
   $ 16,431  
         
Effect of adjustments to:
        
Other liabilities
     144  
Goodwill at June 30, 2012
   $ 16,575  
         
 
      The increase in goodwill made during 2012 was due to a change in estimated tax refunds due to MidCarolina.

      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 $39.9 million. The estimated fair value of the performing portion of the portfolio was $286.5 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).

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 table 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 (in thousands).

 
Contractually required principal and interest at acquisition
    
 $ 56,681
Contractual cash flows not expected to be collected (nonaccretable difference)
  
    17,472
Expected cash flows at acquisition
    
    39,209
Interest component of expected cash flows (accretable discount)
  
     1,663
Fair value of acquired impaired loans accounted for under FASB ASC 310-30
  
 $ 37,546
 
In accordance with U.S. 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 $15.3 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.

In connection with the merger with MidCarolina, the Company acquired other real estate owned with a fair value of $3.5 million. Other real estate owned was measured at fair value less estimated cost to sell.

In connection with the merger with MidCarolina, the Company acquired premises and equipment with a fair value of $5.7 million. Property appraisals for all owned locations were obtained. The fair value adjustment will be amortized as expense over the remaining lives of the properties. The Company also acquired several lease obligations in connection with the merger. The unfavorable lease position will be amortized over the remaining lives of the leases.

 
11
 
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 Certificate of Deposit Account Registry Service (often referred to as “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 reduce 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 future payments. This adjustment to the face value of the borrowings will be amortized to increase interest expense over the remaining lives of the respective borrowings.

The fair value of junior subordinated debentures (Other Borrowings) was determined based on the fair value of similar debt or equity instruments with reasonably comparable terms. This adjustment to the face value of the borrowings will be amortized to increase interest expense over the remaining lives of the respective borrowings.

Direct costs related to the acquisition were expensed as incurred. During the entire year of 2011, the Company incurred $1,600,000 in merger and acquisition expenses. During 2012, the Company incurred $19,000 in merger related expense.

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. 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.

 
   
Nine Months Ended
  
   
Pro Forma
  
   
September 30,
  
(dollars in thousands)
  
2011
  
Net interest income
   $ 39,772  
Provision for loan loss
     (3,598 )
Non-interest income
     7,712  
Non-interest expense
     (30,070 )
Income taxes
     (4,182 )
Net income
   $ 9,634  


 
12
 
Note 3 – Securities

The amortized cost and estimated fair value of investments in debt and equity securities at September 30, 2012 and December 31, 2011 were as follows:
 
 
  
September 30, 2012
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
Federal agencies and GSEs
   $ 29,739     $ 351     $ -     $ 30,090  
Mortgage-backed and CMOs
     88,937       2,240       129       91,048  
State and municipal
     185,534       13,805       5       199,334  
Corporate
     7,353       169       -       7,522  
Total securities available for sale
   $ 311,563     $ 16,565     $ 134     $ 327,994  

 
  
December 31, 2011
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
Federal agencies and GSEs
   $ 32,071     $ 608     $ -     $ 32,679  
Mortgage-backed and CMOs
     102,444       1,874       414       103,904  
State and municipal
     182,952       11,454       1       194,405  
Corporate
     2,312       66       -       2,378  
    Total securities available for sale
   $ 319,779     $ 14,002     $ 415     $ 333,366  
 
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, 2012.  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 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
   $ 6,738     $ 56     $ 2,953     $ 8     $ 3,785     $ 48  
CMOs
     2,568       73       -       -       2,568       73  
State and municipal
     2,597       5       2,597       5       -       -  
  Total
   $ 11,903     $ 134     $ 5,550     $ 13     $ 6,353     $ 121  
 
GSE residential mortgage-backed securities:  The unrealized losses on the Company's investment in five GSE mortgage-backed securities were 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 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 basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2012.
 
 
13
 
 
Collateralized Mortgage Obligations (“CMOs”): The unrealized loss associated with one CMO was caused by interest rate increases. The contractual cash flows of these 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 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 basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2012.
 
 
State and municipal securities:  The unrealized losses on six 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 basis 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 basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2012.
 
The Company’s investment in FHLB stock totaled $2,417,000 at September 30, 2012.  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 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 Company does not consider this investment to be other-than-temporarily impaired at September 30, 2012 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, 2011.

   
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
   $ 28,431     $ 266     $ 28,431     $ 266     $ -     $ -  
Private label CMOs
     3,375       148       3,306       115       69       33  
State and municipal
     401       1       401       1       -       -  
  Total
   $ 32,207     $ 415     $ 32,138     $ 382     $ 69     $ 33  

Other-Than-Temporary-Impaired Securities

As of September 30, 2012 and December 31, 2011, there were no securities classified as having other-than-temporary impairment.

Note 4 - Loans

Segments

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

   
September 30,
    
December 31,
  
(in thousands)
  
2012
    
2011
  
             
Commercial
   $ 126,339     $ 134,166  
Commercial real estate:
                
Construction and land development
     50,688       54,433  
Commercial real estate
     356,692       351,961  
Residential real estate:
                
Residential
     162,404       179,812  
Home equity
     95,008       96,195  
Consumer
     6,687       8,191  
Total loans
   $ 797,818     $ 824,758  
 
 
14
 
Acquired Loans

Interest income, including accretion, on loans acquired from MidCarolina for the three months ended September 30, 2012 was approximately $4.9 million and $17.8 million for the nine months ended September 30, 2012. The outstanding principal balance and the carrying amount of these loans included in the consolidated balance sheet at September 30, 2012 and December 31, 2011 are as follows:

             
   
September 30,
    
December 31,
  
(in thousands)
  
2012
    
2011
  
Oustanding principal balance
   $ 248,089     $ 321,002  
Carrying amount
     229,792       293,569  
 
The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies ASC 310-30 (formerly SOP 03-3), to account for interest earned, at September 30, 2012 and December 31, 2011 are as follows:
 
   
September 30,
    
December 31,
  
(in thousands)
  
2012
    
2011
  
Oustanding principal balance
   $ 30,457     $ 45,760  
Carrying amount
     22,904       34,027  
 
The following table presents changes in the accretable discount on acquired impaired loans, for which the Company applies ASC 310-30 (formerly SOP 03-3), for the nine months ended September 30, 2012. The accretion reflected below includes $1,899,000 related to loan payoffs.


   
Accretable
  
(in thousands)
  
Discount
  
Balance at December 31, 2011
   $ 1,056  
Accretion
     (71 )
Reclassification from nonaccretable difference
     2,130  
Balance at September 30, 2012
   $ 3,115  

 
15
 


Past Due Loans

The following table shows an analysis by portfolio segment of the Company’s past due loans at September 30, 2012.
 
               
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
   $ 268     $ -     $ -     $ 1,159     $ 1,427     $ 124,912     $ 126,339  
Commercial real estate:
                                                        
Construction and land development
     9       201       -       1,107       1,317       49,371       50,688  
Commercial real estate
     134       326       -       3,035       3,495       353,197       356,692  
Residential:
                                                        
Residential
     611       147       -       1,948       2,706       159,698       162,404  
Home equity
     314       -       -       566       880       94,128       95,008  
Consumer
     47       5       -       -       52       6,635       6,687  
Total
   $ 1,383     $ 679     $ -     $ 7,815     $ 9,877     $ 787,941     $ 797,818  

The following table shows an analysis by portfolio segment of the Company’s past due loans at December 31, 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
   $ 98     $ 99     $ -     $ 1,820     $ 2,017     $ 132,149     $ 134,166  
Commercial real estate:
                                                        
Construction and land development
     1,086       1,163       -       5,819       8,066       46,367       54,433  
Commercial real estate
     1,052       471       -       2,115       3,638       348,323       351,961  
Residential:
                                                        
Residential
     1,519       741       -       3,476       5,735       174,077       179,812  
Home equity
     270       243       197       244       954       95,241       96,195  
Consumer
     126       7       -       49       181       8,010       8,191  
Total
   $ 4,151     $ 2,724     $ 197     $ 13,523     $ 20,591     $ 804,167     $ 824,758  

 
16
 


Impaired Loans

The following table presents the Company’s impaired loan balances by portfolio segment excluding loans acquired with deteriorated credit quality at September 30, 2012.

 
         
Unpaid
          
Average
    
Interest
  
(in thousands)
  
Recorded
    
Principal
    
Related
    
Recorded
    
Income
  
   
Investment
    
Balance
    
Allowance
    
Investment
    
Recognized
  
With no related allowance recorded:
                              
Commercial
   $ 150     $ 382     $ -     $ 185     $ -  
Commercial real estate:
                                        
Construction and land development
     1,283       1,315       -       1,543       -  
Commercial real estate
     212       212       -       554       7  
Residential:
                                        
Residential
     274       541       -       1,057       -  
Home equity
     -       -       -       -       -  
Consumer
     -       -       -       -       -  
    $ 1,919     $ 2,450     $ -     $ 3,339     $ 7  
With an related allowance recorded:
                                        
Commercial
     249       249       246       112       7  
Commercial real estate:
                                        
Construction and land development
     -       -       -       -       -  
Commercial real estate
     232       232       68       104       11  
Residential
                                        
Residential
     -       -       -       -       -  
Home equity
     -       -       -       -       -  
Consumer
     21       21       21       7       -  
    $ 502     $ 502     $ 335     $ 223     $ 18  
Total: