UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2015.

☐ 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 incorporation or organization)
  
(I.R.S. Employer 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
☒
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
☒
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  ☐
Accelerated filer  ☒
Non-accelerated filer  o (Do not check if a smaller reporting company)
Smaller reporting company ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes
☐
No
☒
  

At May 6, 2015, the Company had 8,727,696 shares of Common Stock outstanding, $1 par value.

AMERICAN NATIONAL BANKSHARES INC.

Index
    
Page
       
Part I.
FINANCIAL INFORMATION
  
       
 
Item 1.
Financial Statements
  
       
   
       
   
       
   
       
   
       
   
       
   
       
 
Item 2.
       
 
Item 3.
       
 
Item 4.
       
Part II.
OTHER INFORMATION
  
       
 
Item 1.
       
 
Item 1A.
       
 
Item 2.
       
 
Item 3.
       
 
Item 4.
       
 
Item 5.
       
 
Item 6.
       
SIGNATURES
54

2

 
PART I.   FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

American National Bankshares Inc. and Subsidiaries
  
Consolidated Balance Sheets
  
(Dollars in thousands, except share data)
  
 
Assets
  
(Unaudited)
March 31, 2015
    
(*)
December 31, 2014
 
Cash and due from banks
  
$
23,995
    
$
29,272
  
Interest-bearing deposits in other banks
    
75,254
      
38,031
  
Federal funds sold
    
13,616
      
-
  
                 
Securities available for sale, at fair value
    
352,208
      
344,716
  
Restricted stock, at cost
    
5,231
      
4,468
  
Loans held for sale
    
1,936
      
616
  
                 
Loans, net of unearned income
    
965,902
      
840,925
  
Less allowance for loan losses
    
(12,844
)
    
(12,427
)
Net loans
    
953,058
      
828,498
  
                 
Premises and equipment, net
    
24,371
      
23,025
  
Other real estate owned, net of valuation allowance $2,947 in 2015 and $2,971 in 2014
    
2,653
      
2,119
  
Goodwill
    
44,210
      
39,043
  
Core deposit intangibles, net
    
3,583
      
2,045
  
Bank owned life insurance
    
17,261
      
15,193
  
Accrued interest receivable and other assets
    
22,722
      
19,466
  
Total assets
  
$
1,540,098
    
$
1,346,492
  
                 
Liabilities
                
Demand deposits -- noninterest bearing
  
$
289,818
    
$
254,458
  
Demand deposits -- interest bearing
    
229,721
      
193,432
  
Money market deposits
    
202,706
      
174,000
  
Savings deposits
    
110,104
      
90,130
  
Time deposits
    
410,326
      
363,817
  
Total deposits
    
1,242,675
      
1,075,837
  
                 
                 
Customer repurchase agreements
    
53,664
      
53,480
  
Long-term borrowings
    
9,941
      
9,935
  
Trust preferred capital notes
    
27,546
      
27,521
  
Accrued interest payable and other liabilities
    
9,583
      
5,939
  
Total liabilities
    
1,343,409
      
1,172,712
  
                 
Shareholders' equity
                
Preferred stock, $5 par, 2,000,000 shares authorized, none outstanding
    
-
      
-
  
Common stock, $1 par, 20,000,000 shares authorized, 8,727,696 shares outstanding at March 31, 2015 and 7,873,474 shares outstanding at December 31, 2014
    
8,710
      
7,872
  
Capital in excess of par value
    
77,612
      
57,650
  
Retained earnings
    
106,102
      
104,594
  
Accumulated other comprehensive income, net
    
4,265
      
3,664
  
Total shareholders' equity
    
196,689
      
173,780
  
Total liabilities and shareholders' equity
  
$
1,540,098
    
$
1,346,492
  

                                                  (*) -  Derived from audited financial statements.                                              
 
                                                  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
March 31
  
   
2015
    
2014
  
Interest and Dividend Income:
        
Interest and fees on loans
  
$
11,770
    
$
9,847
  
Interest on federal funds sold
    
4
      
-
  
Interest and dividends on securities:
                
Taxable
    
975
      
964
  
Tax-exempt
    
960
      
1,035
  
Dividends
    
82
      
75
  
Other interest income
    
48
      
33
  
Total interest and dividend income
    
13,839
      
11,954
  
                 
Interest Expense:
                
Interest on deposits
    
1,194
      
1,229
  
Interest on short-term borrowings
    
3
      
2
  
Interest on long-term borrowings
    
80
      
80
  
Interest on trust preferred capital notes
    
184
      
184
  
Total interest expense
    
1,461
      
1,495
  
                 
Net Interest Income
    
12,378
      
10,459
  
Provision for Loan Losses
    
600
      
-
  
                 
Net Interest Income After Provision for Loan Losses
    
11,778
      
10,459
  
                 
Noninterest Income:
                
Trust fees
    
952
      
1,122
  
Service charges on deposit accounts
    
497
      
413
  
Other fees and commissions
    
588
      
444
  
Mortgage banking income
    
222
      
263
  
Gains on sales of securities
    
310
      
39
  
Other
    
587
      
422
  
Total noninterest income
    
3,156
      
2,703
  
                 
Noninterest Expense:
                
Salaries
    
4,147
      
3,538
  
Employee benefits
    
1,075
      
975
  
Occupancy and equipment
    
1,172
      
936
  
FDIC assessment
    
185
      
164
  
Bank franchise tax
    
235
      
222
  
Core deposit intangible amortization
    
301
      
331
  
Data processing
    
462
      
348
  
Software
    
283
      
262
  
Other real estate owned, net
    
53
      
16
  
Merger related expense
    
359
      
-
  
Other
    
1,775
      
1,631
  
Total noninterest expense
    
10,047
      
8,423
  
Income Before Income Taxes
    
4,887
      
4,739
  
Income Taxes
    
1,372
      
1,289
  
Net Income
  
$
3,515
    
$
3,450
  
                 
Net Income Per Common Share:
                
Basic
  
$
0.40
    
$
0.44
  
Diluted
  
$
0.40
    
$
0.44
  
Weighted Average Common Shares Outstanding:
                
Basic
    
8,723,633
      
7,904,759
  
Diluted
    
8,732,679
      
7,917,601
  

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

4
American National Bankshares Inc. and Subsidiaries
  
Consolidated Statements of Comprehensive Income
  
(Dollars in thousands) (Unaudited)
  
 
   
Three Months Ended
March 31
  
   
2015
    
2014
  
         
Net income
  
$
3,515
    
$
3,450
  
                 
Other comprehensive income:
                
                 
Unrealized gains on securities available for sale
    
1,234
      
1,809
  
Income tax expense
    
(432
)
    
(633
)
                 
Reclassification adjustment for gains on sales of securities
    
(310
)
    
(39
)
Income tax expense
    
109
      
14
  
                 
Other comprehensive income
    
601
      
1,151
  
                 
Comprehensive income
  
$
4,116
    
$
4,601
  

                                                   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
  
Three Months Ended March 31, 2015 and 2014
  
(Dollars in thousands except per share data) (Unaudited)
  
 
   
Common
Stock
    
Capital in
Excess of
Par Value
    
Retained
Earnings
    
Accumulated
Other
Comprehensive
Income
    
Total
Shareholders'
Equity
  
                     
                     
Balance, December 31, 2013
  
$
7,891
    
$
58,050
    
$
99,090
    
$
2,520
    
$
167,551
  
                                         
Net income
    
-
      
-
      
3,450
      
-
      
3,450
  
                                         
Other comprehensive income
    
-
      
-
      
-
      
1,151
      
1,151
  
                                         
Equity based compensation
    
14
      
152
      
-
      
-
      
166
  
                                         
Cash dividends declared, $0.23 per share
    
-
      
-
      
(1,819
)
    
-
      
(1,819
)
                                         
Balance, March 31, 2014
  
$
7,905
    
$
58,202
    
$
100,721
    
$
3,671
    
$
170,499
  
                                         
Balance, December 31, 2014
  
$
7,872
    
$
57,650
    
$
104,594
    
$
3,664
    
$
173,780
  
                                         
Net income
    
-
      
-
      
3,515
      
-
      
3,515
  
                                         
Other comprehensive income
    
-
      
-
      
-
      
601
      
601
  
                                         
Issuance of common stock
    
826
      
19,657
      
-
      
-
      
20,483
  
                                         
Stock options exercised
    
9
      
153
      
-
      
-
      
162
  
                                         
Equity based compensation
    
3
      
152
      
-
      
-
      
155
  
                                         
Cash dividends declared, $0.23 per share
    
-
      
-
      
(2,007
)
    
-
      
(2,007
)
                                         
Balance, March 31, 2015
  
$
8,710
    
$
77,612
    
$
106,102
    
$
4,265
    
$
196,689
  

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


6
American National Bankshares Inc. and Subsidiaries
  
Consolidated Statements of Cash Flows
  
Three Months Ended March 31, 2015 and 2014
  
(Dollars in thousands) (Unaudited)
  
 
   
2015
    
2014
  
Cash Flows from Operating Activities:
        
Net income
  
$
3,515
    
$
3,450
  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Provision for loan losses
    
600
      
-
  
Depreciation
    
440
      
434
  
Net accretion of purchase accounting adjustments
    
(1,113
)
    
(896
)
Core deposit intangible amortization
    
301
      
331
  
Net amortization (accretion) of securities
    
680
      
668
  
Gains on sales of securities
    
(310
)
    
(39
)
Gain on sale of loans held for sale
    
(166
)
    
(215
)
Proceeds from sales of loans held for sale
    
9,329
      
13,745
  
Originations of loans held for sale
    
(10,483
)
    
(12,159
)
Net gain on other real estate owned
    
(27
)
    
(49
)
Valuation allowance on other real estate owned
    
22
      
24
  
Net gain on sale of premises and equipment
    
(5
)
    
-
  
Equity based compensation expense
    
155
      
166
  
Net change in bank owned life insurance
    
(113
)
    
-
  
Deferred income tax  expense (benefit)
    
(143
)
    
94
  
Net change in interest receivable
    
219
      
344
  
Net change in other assets
    
(56
)
    
(565
)
Net change in interest payable
    
(1
)
    
(43
)
Net change in other liabilities
    
569
      
1,143
  
Net cash provided by operating activities
    
3,413
      
6,433
  
                 
Cash Flows from Investing Activities:
                
Proceeds from sales of securities available for sale
    
3,820
      
2,061
  
Proceeds from maturities, calls and paydowns of securities available for sale
    
24,979
      
22,540
  
Purchases of securities available for sale
    
(16,936
)
    
(26,459
)
Net change in restricted stock
    
(25
)
    
360
  
Net (increase) decrease in loans
    
(9,865
)
    
12,225
  
Proceeds from sale of premises and equipment
    
42
      
-
  
Purchases of premises and equipment
    
(348
)
    
(119
)
Proceeds from sales of other real estate owned
    
316
      
232
  
Cash paid in bank acquisition
    
(5,935
)
    
-
  
Cash acquired in bank acquisition
    
18,173
      
-
  
Net cash provided by investing activities
    
14,221
      
10,840
  
                 
Cash Flows from Financing Activities:
                
Net change in demand, money market, and savings deposits
    
37,878
      
5,164
  
Net change in time deposits
    
(8,289
)
    
(11,590
)
Net change in customer repurchase agreements
    
184
      
(5,325
)
Net change in long-term borrowings
    
-
      
(38
)
Common stock dividends paid
    
(2,007
)
    
(1,819
)
       Proceeds from exercise of stock options
    
162
      
-
  
Net cash provided by (used in) financing activities
    
27,928
      
(13,608
)
                 
Net Increase in Cash and Cash Equivalents
    
45,562
      
3,665
  
                 
Cash and Cash Equivalents at Beginning of Period
    
67,303
      
67,681
  
                 
Cash and Cash Equivalents at End of Period
  
$
112,865
    
$
71,346
  

                                                   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. (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 ("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, the valuation of foreclosed real estate, goodwill and intangible assets, the valuation of deferred tax assets, other-than-temporary impairments of securities, and acquired loans with specific credit-related deterioration.
 
        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 results of the interim periods. The results of operations for the interim periods are not necessarily indicative of the results that may occur for the year ending December 31, 2015.  Certain reclassifications have been made to prior period balances to conform to the current period presentation. These reclassifications did not have an impact on net income and were considered immaterial. These statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014.

Note 2 – Merger with MainStreet

         
On January 1, 2015, the Company completed its acquisition of MainStreet BankShares, Inc. ("MainStreet"). The merger of MainStreet with and into the Company was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of August 24, 2014, between the Company and MainStreet, and a related Plan of Merger. Immediately after the merger, Franklin Community Bank, N.A., MainStreet's wholly owned bank subsidiary, merged with and into the Bank.  Pursuant to the MainStreet merger agreement, holders of shares of MainStreet common stock received $3.46 in cash and 0.482 shares of the Company's common stock for each share of MainStreet common stock held immediately prior to the effective date of the merger, plus cash in lieu of fractional shares.  Each option to purchase shares of MainStreet common stock that was outstanding immediately prior to the effective date of the merger vested upon the merger and was converted into an option to purchase shares of the Company's common stock, adjusted based on a 0.643 exchange ratio. Each share of the Company's common stock outstanding immediately prior to the merger remained outstanding and was unaffected by the merger. The cash portion of the merger consideration was funded through a cash dividend of $6,000,000 from the Bank to the Company, and no borrowing was incurred by the Company or the Bank in connection with the merger. Replacement stock option awards representing 43,086 shares of the Company's common stock were granted in conjunction with the MainStreet acquisition.  The value of the consideration transferred with the replacement awards was not determined as of March 31, 2015; therefore, the amounts of the consideration transferred and goodwill recorded in connection with the merger will be adjusted for the value of the replacement awards in the second quarter of 2015.

    The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition.
 
        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).

8

     
Consideration Paid:
    
Common shares issued (825,586)
  
$
20,483
  
Cash paid to shareholders
    
5,935
  
Value of consideration
    
26,418
  
         
Assets acquired:
        
Cash and cash equivalents
    
18,173
  
Investment securities
    
18,800
  
Restricted stock
    
738
  
Loans
    
114,902
  
Premises and equipment
    
1,475
  
Deferred income taxes
    
2,683
  
Core deposit intangible
    
1,839
  
Other real estate owned
    
168
  
Banked owned life insurance
    
1,955
  
Other assets
    
917
  
Total assets
    
161,650
  
         
Liabilities assumed:
        
Deposits
    
137,323
  
Other liabilities
    
3,076
  
Total liabilities
    
140,399
  
Net assets acquired
    
21,251
  
Goodwill resulting from merger with MainStreet
  
$
5,167
  
 
        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 $122,300,000 loan portfolio at a fair value discount of $7,400,000. The estimated fair value of the performing portion of the portfolio was $105,800,000. 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.
 
       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 expectations 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 as of January 1, 2015 (dollars in thousands).


Contractually required principal and interest at acquisition
  
$
13,504
  
Contractual cash flows not expected to be collected (nonaccretable difference)
    
3,298
  
Expected cash flows at acquisition
    
10,206
  
Interest component of expected cash flows (accretable yield)
    
1,208
  
Fair value of acquired loans accounted for under FASB ASC 310-30
  
$
8,998
  

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

In connection with the merger with MainStreet, the Company acquired an investment portfolio with a fair value of $18,800,000. 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 MainStreet, the Company recorded a deferred income tax asset of $2,700,0000 related to tax attributes of MainStreet, along with the effects of fair value adjustments resulting from applying the acquisition method of accounting.

In connection with the merger with MainStreet, the Company acquired other real estate owned with a fair value of $168,000. Other real estate owned was measured at fair value less estimated cost to sell.

9
In connection with the merger with MainStreet, the Company acquired premises and equipment with a fair value of $1,400,000.

The fair value of savings and transaction deposit accounts acquired from MainStreet 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, and brokered. 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 of $290,000 will be accreted to reduce interest expense over the average remaining maturities of the respective pools, which is estimated to be 12 months.

A core deposit intangible of $1,800,000 was recognized in connection with the merger with MainStreet. This intangible will be amortized over a 10 year period on an accelerated cost recovery basis.
 
Direct costs related to the acquisition were expensed as incurred. During the entire year of 2011, the Company incurred $359,000 in merger and acquisition expenses.
 
The following table presents unaudited pro forma information as if the merger with MainStreet had occurred on January 1, 2014. This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit intangible 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 MainStreet occurred in 2014.  In particular, expected operational cost savings are not reflected in the pro forma amounts (dollars in thousands):.

   
Pro forma
  
   
Three Months Ended
  
   
March 31,
    
March 31,
  
 
  
2015
    
2014
  
Net interest income
  
$
11,980
    
$
12,420
  
Provision for loan loss
    
(600
)
    
-
  
Non-interest income
    
3,156
      
2,914
  
Non-interest expense and income taxes
    
(11,134
)
    
(11,439
)
Net income
  
$
3,402
    
$
3,895
  

Note 3 – Securities
 
        The amortized cost and fair value of investments in debt and equity securities at March 31, 2015 and December 31, 2014 were as follows (dollars in thousands):

   
March 31, 2015
  
   
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
 
Fair Value
  
Securities available for sale:
                
Federal agencies and GSEs
  
$
78,383
    
$
513
    
$
9
    
$
78,887
  
Mortgage-backed and CMOs
    
63,514
      
1,400
      
65
      
64,849
  
State and municipal
    
190,539
      
7,717
      
56
      
198,200
  
Corporate
    
8,854
      
66
      
13
      
8,907
  
Equity securities
    
1,000
      
365
      
-
      
1,365
  
Total securities available for sale
  
$
342,290
    
$
10,061
    
$
143
    
$
352,208
  

10
   
December 31, 2014
  
   
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
 
Fair Value
  
Securities available for sale:
                
Federal agencies and GSEs
  
$
81,958
    
$
252
    
$
104
    
$
82,106
  
Mortgage-backed and CMOs
    
56,289
      
1,248
      
112
      
57,425
  
State and municipal
    
188,060
      
7,523
      
90
      
195,493
  
Corporate
    
8,416
      
16
      
53
      
8,379
  
Equity securities
    
1,000
      
313
      
-
      
1,313
  
Total securities available for sale
  
$
335,723
    
$
9,352
    
$
359
    
$
344,716
  

Restricted Stock

Due to restrictions placed upon the Bank's common stock investment in the Federal Reserve Bank of Richmond ("FRB") and Federal Home Loan Bank of Atlanta ("FHLB"), these securities have been classified as restricted equity securities and carried at cost.  The restricted securities are not subject to the investment security classification and are included as a separate line item on the Company's balance sheet.  The FRB requires the Bank to maintain stock with a par value equal to 6.0% of its common stock and paid-in surplus.  One-half of this amount is paid to the FRB and the remaining half is subject to call when deemed necessary by the Board of Governors of the Federal Reserve System.  The FHLB requires the Bank to maintain stock in an amount equal to a specific percentage of the Bank's total assets and 4.5% of outstanding borrowings. The Bank also owns common stock in CBB Financial Corporation and Pacific Coast Bankers Bankshares, which both provide services to community banks. The cost of restricted stock at March 31, 2015 and December 31, 2014 were as follows (dollars in thousands):

   
March 31,
    
December 31,
  
 
  
2015
    
2014
  
FRB stock
  
$
3,177
    
$
2,742
  
FHLB stock
    
1,802
      
1,625
  
CBB Financial Corporation stock
    
150
      
101
  
 Pacific Coast Bankers Bankshares stock
    
102
      
-
  
   Total restricted stock
  
$
5,231
    
$
4,468
  
 
 
Temporarily Impaired Securities
 
      The following table shows 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 March 31, 2015.  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 (dollars in thousands).


   
Total
    
Less than 12 Months
    
12 Months or More
  
   
Fair
Value
    
Unrealized
Loss
    
Fair
Value
    
Unrealized
Loss
    
Fair
Value
    
Unrealized
Loss
  
Federal agencies and GSEs
  
$
7,589
    
$
9
    
$
5,492
    
$
6
    
$
2,097
    
$
3
  
Mortgage-backed and CMOs
    
7,335
      
65
      
5,095
      
39
      
2,240
      
26
  
State and municipal
    
13,213
      
56
      
13,213
      
56
      
-
      
-
  
Corporate
    
2,778
      
13
      
1,162
      
1
      
1,616
      
12
  
Total
  
$
30,915
    
$
143
    
$
24,962
    
$
102
    
$
5,953
    
$
41
  

Federal Agencies and GSE debt securities: The unrealized losses on the Company's investment in four government sponsored entities ("GSE") 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 March 31, 2015.

Mortgage-backed securities and CMOs: The unrealized losses on the Company's investment in 13 GSE mortgage-backed securities and collateralized mortgage obligations ("CMOs") 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 March 31, 2015.

11
State and municipal securities:  The unrealized losses on 14 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 March 31, 2015.

Corporate securities:  The unrealized losses on three investments in corporate 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 March 31, 2015.

Restricted stock: When evaluating restricted stock for impairment, its value is based on the ultimate recoverablity of the par value rather than by recognizing temporary declines in value. The company does not consider restricted stock to be other-than-temoraily impaired at March 31, 2015, and no impairment has been recognized.
 
        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, 2014 (dollars in thousands):

   
Total
    
Less than 12 Months
    
12 Months or More
  
   
Fair
Value
    
Unrealized
Loss
    
Fair
Value
    
Unrealized
Loss
    
Fair
Value
    
Unrealized
Loss
  
Federal agencies and GSEs
  
$
28,979
    
$
104
    
$
21,449
    
$
35
    
$
7,530
    
$
69
  
Mortgage-backed and CMOs
    
7,182
      
112
      
1,171
      
13
      
6,011
      
99
  
State and municipal
    
20,542
      
90
      
15,836
      
60
      
4,706
      
30
  
Corporate
    
5,032
      
53
      
2,273
      
4
      
2,759
      
49
  
Total
  
$
61,735
    
$
359
    
$
40,729
    
$
112
    
$
21,006
    
$
247
  

Other-Than-Temporary-Impaired Securities
 
        As of March 31, 2015 and December 31, 2014, there were no securities classified as having other-than-temporary impairment.

Note 4 – Loans

Segments
 
        Loans, excluding loans held for sale, as of March 31, 2015 and December 31, 2014 were comprised of the following (dollars in thousands):

   
March 31, 2015
    
December 31, 2014
  
         
Commercial
  
$
146,280
    
$
126,981
  
Commercial real estate:
                
Construction and land development
    
68,069
      
50,863
  
Commercial real estate
    
436,562
      
391,472
  
Residential real estate:
                
Residential
    
211,261
      
175,293
  
Home equity
    
97,811
      
91,075
  
Consumer
    
5,919
      
5,241
  
Total loans
  
$
965,902
    
$
840,925
  

 

12
Acquired Loans
 
         Interest income, including accretion, on loans acquired from MidCarolina Financial Corporation ("MidCarolina") and MainStreet for the three months ended March 31, 2015 was approximately $4,675,000. This included $1,070,000 in accretion income. The outstanding principal balance and the carrying amount of these loans included in the consolidated balance sheets at March 31, 2015 and December 31, 2014 are as follows (dollars in thousands):
 
   
March 31, 2015
    
December 31, 2014
  
Outstanding principal balance
  
$
189,911
    
$
84,892
  
Carrying amount
    
177,105
      
78,111
  
 
        The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies FASB ASC 310-30, to account for interest earned, at March 31, 2015 and December 31, 2014 are as follows (dollars in thousands):

   
March 31, 2015
    
December 31, 2014
  
Outstanding principal balance
  
$
27,843
    
$
18,357
  
Carrying amount
    
21,758
      
14,933
  
 
      The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies FASB ASC 310-30, for the three months ended March 31, 2015 (dollars in thousands):

   
Accretable Yield
  
Balance at December 31, 2014
  
$
1,440
  
Additions from merger with MainStreet
    
1,208
  
Accretion
    
(268
)
Reclassification from nonaccretable difference
    
2,851
  
Balance at March 31, 2015
  
$
5,231
  

Past Due Loans
 
      The following table shows an analysis by portfolio segment of the Company's past due loans at March 31, 2015 (dollars in thousands):

                             
   
30- 59 Days
Past Due
    
60-89 Days
Past Due
    
90 Days +
Past Due
and Still
Accruing
    
Non-
Accrual
Loans
    
Total
Past
Due
    
Current
    
Total
Loans
  
                             
Commercial
  
$
51
    
$
-
    
$
-
    
$
157
    
$
208
    
$
146,072
    
$
146,280
  
Commercial real estate:
                                                        
Construction and land development
    
108
      
-
      
-
      
572
      
680
      
67,389
      
68,069
  
Commercial real estate
    
341
      
-
      
-
      
3,242
      
3,583
      
432,979
      
436,562
  
Residential:
                                                        
Residential
    
776
      
177
      
-
      
678
      
1,631
      
209,630
      
211,261
  
Home equity
    
98
      
424
      
-
      
432
      
954
      
96,857
      
97,811
  
Consumer
    
2
      
1
      
-
      
42
      
45
      
5,874
      
5,919
  
Total
  
$
1,376
    
$
602
    
$
-
    
$
5,123
    
$
7,101
    
$
958,801
    
$
965,902
  

13
 
        The following table shows an analysis by portfolio segment of the Company's past due loans at December 31, 2014 (dollars in thousands):

   
30- 59 Days
Past Due
    
60-89 Days
Past Due
    
90 Days +
Past Due
and Still
Accruing
    
Non-
Accrual
Loans
    
Total
Past
Due
    
Current
    
Total
Loans
  
                             
Commercial
  
$
114
    
$
165
    
$
-
    
$
-
    
$
279
    
$
126,702
    
$
126,981
  
Commercial real estate:
                                                        
Construction and land development
    
44
      
269
      
-
      
279
      
592
      
50,271
      
50,863
  
Commercial real estate
    
257
      
-
      
-
      
3,010
      
3,267
      
388,205
      
391,472
  
Residential:
                                                        
Residential
    
390
      
325
      
-
      
560
      
1,275
      
174,018
      
175,293
  
Home equity
    
223
      
60
      
-
      
262
      
545
      
90,530
      
91,075
  
Consumer
    
1
      
42
      
-
      
1
      
44
      
5,197
      
5,241
  
Total
  
$
1,029
    
$
861
    
$
-
    
$
4,112
    
$
6,002
    
$
834,923
    
$
840,925
  


Impaired Loans
 
       The following table presents the Company's impaired loan balances by portfolio segment, excluding loans acquired with deteriorated credit quality, at March 31, 2015 (dollars in thousands):

   
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
With no related allowance recorded:
                    
Commercial
  
$
157
    
$
157
    
$
-
    
$
160
    
$
-
  
Commercial real estate:
                                        
Construction and land development
    
1,111
      
1,161
      
-
      
1,115
      
8
  
Commercial real estate
    
414
      
475
      
-
      
420
      
-
  
Residential:
                                        
Residential
    
658
      
658
      
-
      
642
      
4
  
Home equity
    
758
      
759
      
-
      
553
      
4
  
Consumer
    
43
      
42
      
-
      
43
      
-
  
   
$
3,141
    
$
3,252
    
$
-
    
$
2,933
    
$
16
  
With a related allowance recorded:
                                        
Commercial
    
6
      
6
      
-
      
6
      
-
  
Commercial real estate:
                                        
Construction and land development
    
-
      
-
      
-
      
-
      
-
  
Commercial real estate
    
1,941
      
2,011
      
104
      
1,946
      
3
  
Residential
                                        
Residential
    
183
      
183
      
12
      
183
      
2
  
Home equity
    
8
      
8
      
-
      
8
      
-
  
Consumer
    
14
      
14
      
-
      
15
      
-
  
   
$
2,152
    
$
2,222
    
$
116
    
$
2,158
    
$
5
  
Total:
                                        
Commercial
  
$
163
    
$
163
    
$
-
    
$
166
    
$
-
  
Commercial real estate:
                                        
Construction and land development
    
1,111
      
1,161
      
-
      
1,115
      
8
  
Commercial real estate
    
2,355
      
2,486
      
104
      
2,366
      
3
  
Residential:
                                        
Residential
    
841
      
841
      
12
      
825
      
6
  
Home equity
    
766
      
767
      
-
      
561
      
4
  
Consumer
    
57
      
56
      
-
      
58
      
-
  
   
$
5,293
    
$
5,474
    
$
116
    
$
5,091
    
$
21
  


14
 
        The following table presents the Company's impaired loan balances by portfolio segment, excluding loans acquired with deteriorated credit quality, at December 31, 2014 (dollars in thousands):

   
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
With no related allowance recorded:
                    
Commercial
  
$
7
    
$
7
    
$
-
    
$
12
    
$
1
  
Commercial real estate:
                                        
Construction and land development
    
280
      
325
      
-
      
448
      
-
  
Commercial real estate
    
1,520
      
1,797
      
-
      
1,844
      
-
  
Residential:
                                        
Residential
    
603
      
603
      
-
      
723
      
8
  
Home equity
    
256
      
256
      
-
      
316
      
-
  
   Consumer
    
1
      
1
      
-
      
2
      
-
  
   
$
2,667
    
$
2,989
    
$
-
    
$
3,345
    
$
9
  
With a related allowance recorded:
                                        
Commercial
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
Commercial real estate:
                                        
Construction and land development
    
576
      
577
      
12
      
593
      
34
  
Commercial real estate
    
1,275
      
1,422
      
149
      
1,297
      
8
  
Residential:
                                        
Residential
    
4
      
4
      
1
      
4
      
-
  
Home equity
    
-
      
-
      
-
      
-
      
-
  
   Consumer
    
15
      
15
      
3
      
17
      
1
  
   
$
1,870
    
$
2,018
    
$
165
    
$
1,911
    
$
43
  
Total:
                                        
Commercial
  
$
7
    
$
7
    
$
-
    
$
12
    
$
1
  
Commercial real estate:
                                        
Construction and land development
    
856
      
902
      
12
      
1,041
      
34
  
Commercial real estate
    
2,795
      
3,219
      
149
      
3,141
      
8
  
Residential:
                                        
Residential
    
607
      
607
      
1
      
727
      
8
  
Home equity
    
256
      
256
      
-
      
316
      
-
  
   Consumer
    
16
      
16
      
3
      
19
      
1
  
   
$
4,537
    
$
5,007
    
$
165
    
$
5,256
    
$
52
  


The following table shows the detail of loans modified as troubled debt restructurings ("TDRs")  during the three months ended March 31, 2015  included in the impaired loan balances. There were no loans modified as TDRs during the three months ended March 31, 2014 (dollars in thousands):


   
Loans Modified as a TDR for the
Three Months Ended March 31, 2015
  
 Loan Type  
Number of
Contracts
    
Pre-Modification
Outstanding Recorded
Investment
    
Post-Modification
Outstanding Recorded
Investment
  
Commercial
    
-
    
$
-
    
$
-
  
Commercial real estate
    
1
      
8
      
8
  
   Construction and land development
    
-
      
-
      
-
  
   Home Equity
    
2
      
341
      
341
  
   Residential real estate
    
-
      
-
      
-
  
Consumer
    
-
      
-
      
-
  
Total
    
3
    
$
349
    
$
349
  

       During the three months ended March 31, 2015 and 2014, the Company had no loans that subsequently defaulted within twelve months of modification as a TDR. The Company defines defaults as one or more payments that occur more than 90 days past the due date, charge-off or foreclosure subsequent to modification.
 
15
Residential Real Estate in Process of Foreclosure

The company had $111,000 in residential real estate in the process of foreclosure.

Risk Grades
 
        The following table shows the Company's loan portfolio broken down by internal risk grading as of March 31, 2015 (dollars in thousands):

Commercial and Consumer Credit Exposure
Credit Risk Profile by Internally Assigned Grade

   
Commercial
    
Commercial
Real Estate
Construction
    
Commercial
Real Estate
Other
    
Residential
    
Home
Equity
  
                     
Pass
  
$
143,138
    
$
60,150
    
$
417,148
    
$
191,888
    
$
94,742
  
Special Mention
    
2,727
      
3,621
      
11,153
      
13,990
      
2,015
  
Substandard
    
415
      
4,298
      
8,261
      
5,383
      
1,054
  
Doubtful
    
-
      
-
      
-
      
-
      
-
  
Total
  
$
146,280
    
$
68,069
    
$
436,562
    
$
211,261
    
$
97,811
  

Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity

 
Consumer
  
   
Performing
  
$
5,877
  
Nonperforming
    
42
  
Total
  
$
5,919
  
 
      The following table shows the Company's loan portfolio broken down by internal risk grading as of December 31, 2014 (dollars in thousands):


Commercial and Consumer Credit Exposure
Credit Risk Profile by Internally Assigned Grade

   
Commercial
    
Commercial
Real Estate
Construction
    
Commercial
Real Estate
Other
    
Residential
    
Home
Equity
  
                     
Pass
  
$
125,405
    
$
45,534
    
$
382,607
    
$
165,367
    
$
88,646
  
Special Mention
    
1,569
      
569
      
4,889
      
6,709
      
1,801
  
Substandard
    
7
      
4,760
      
3,976
      
3,217
      
628
  
Doubtful
    
-
      
-
      
-
      
-
      
-
  
Total
  
$
126,981
    
$
50,863
    
$
391,472
    
$
175,293
    
$
91,075
  

Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity

   
Consumer
  
     
Performing
  
$
5,240
  
Nonperforming
    
1
  
Total
  
$
5,241
  
 
        Loans classified in the Pass category typically are fundamentally sound and risk factors are reasonable and acceptable.
 
        Loans classified in the Special Mention category typically have been criticized internally, by loan review or the loan officer, or by external regulators under the current credit policy regarding risk grades.
 
16
        Loans classified in the Substandard category typically have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are typically characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected.
        Loans classified in the Doubtful category typically have all the weaknesses inherent in loans classified as substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur that may salvage the debt.
        Consumer loans are classified as performing or nonperforming.  A loan is nonperforming when payments of interest and principal are past due 90 days or more, or payments are less than 90 days past due, but there are other good reasons to doubt that payment will be made in full.

Note 5 – Allowance for Loan Losses and Reserve for Unfunded Lending Commitments
 
        Changes in the allowance for loan losses and the reserve for unfunded lending commitments as of the indicated dates and periods are presented below (dollars in thousands):
 
        The reserve for unfunded loan commitments is included in other liabilities.

   
Three Months Ended
March 31, 2015
    
Year Ended
December 31, 2014
    
Three Months Ended
March 31, 2014
  
             
Allowance for Loan Losses
            
Balance, beginning of period
  
$
12,427
    
$
12,600
    
$
12,600
  
Provision for loan losses
    
600
      
400
      
-
  
Charge-offs
    
(309
)
    
(964
)
    
(73
)
Recoveries
    
126
      
391
      
87
  
Balance, end of period
  
$
12,844
    
$
12,427
    
$
12,614
  
                         
Reserve for Unfunded Lending Commitments
                        
Balance, beginning of period
  
$
163
    
$
210
    
$
210
  
Provision for (recovery of) loan losses
    
6
      
(47
)
    
7
  
Charge-offs
    
-
      
-
      
-
  
Balance, end of period
  
$
169
    
$
163
    
$
217
  

17
 
      The following table presents the Company's allowance for loan losses by portfolio segment and the related loan balance total by segment at March 31, 2015 (dollars in thousands):

   
Commercial
    
Commercial
Real Estate
    
Residential
Real Estate
    
Consumer
    
Unallocated
    
Total
  
                         
                         
Allowance for Loan Losses
                        
Balance as of December 31, 2014
  
$
1,818
    
$
6,814
    
$
3,715
    
$
80
    
$
-
    
$
12,427
Charge-offs
    
-
      
(267
)
    
(7
 
)
    
(35
 
)
  
-
      
(309
 
)
Recoveries
    
9
      
57
      
27
      
33
      
-
      
126
  
Provision for loan losses
    
1
      
434
      
156
      
(2
 
)
    
11
      
600
  
Balance as of March 31, 2015
  
$
1,828
    
$
7,038
    
$
3,891
    
$
76
    
$
11
    
$
12,844
  
                                                 
Balance as of March 31, 2015:
                                                
                                                 
Allowance for Loan Losses
                                                
Individually evaluated for impairment
  
$
-
    
$
104
    
$
12
    
$
-
    
$
-
    
$
116
  
Collectively evaluated for impairment
    
1,826
      
6,496
      
3,397
      
76
      
11
      
11,806
  
Loans acquired with deteriorated credit quality
    
2
      
438
      
482
      
-
      
-
      
922
  
Total
  
$
1,828
    
$
7,038
    
$
3,891
    
$
76
    
$
11
    
$
12,844
  
                                                 
Loans
                                                
Individually evaluated for impairment
  
$
163
    
$
3,466
    
$
1,607
    
$
57
    
$
-
    
$
5,293
  
Collectively evaluated for impairment
    
145,874