march312008_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  March 31, 2008.

¨
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 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¨Nox


At May 7, 2008, the Company had 6,097,785 shares Common Stock outstanding, $1 par value.


AMERICAN NATIONAL BANKSHARES INC.
       
Index
    
Page
       
Part I.
  
FINANCIAL INFORMATION
  
       
 
Item 1
Financial Statements (Unaudited)
  
       
   
3
       
   
4
       
   
5
       
   
6
       
   
7
       
 
Item 2.
16
       
 
Item 3.
26
       
 
Item 4.
27
       
Part II.
OTHER INFORMATION
  
       
 
Item 1.
28
       
 
Item 1A.
28
       
 
Item 2.
28
 
.
    
 
Item 3
28
       
 
Item 4.
28
       
 
Item 5
28
       
 
Item 6
28
       
SIGNATURES
  

 
2
 
 Consolidated Balance Sheets
 (Dollars in thousands, except share data)
             
   
(Unaudited)
    
(Audited)
  
   
March 31,
    
December 31,
  
 ASSETS
  
2008
    
2007
  
 Cash and due from banks
   $ 20,310     $ 18,155  
 Interest-bearing deposits in other banks
     4,218       149  
                 
 Securities available for sale, at fair value
     149,636       145,159  
 Securities held to maturity (fair value of $11,380
                
 in 2008 and $12,250 in 2007)
     11,039       11,990  
 Total securities
     160,675       157,149  
                 
 Loans held for sale
     1,681       1,368  
                 
 Loans, net of unearned income
     554,667       551,391  
 Less allowance for loan losses
     (7,425 )     (7,395 )
 Net loans
     547,242       543,996  
                 
 Premises and equipment, net
     13,392       13,348  
 Goodwill
     22,468       22,468  
 Core deposit intangibles, net
     2,358       2,452  
 Accrued interest receivable and other assets
     12,705       13,203  
 Total assets
   $ 785,049     $ 772,288  
                 
LIABILITIES and SHAREHOLDERS' EQUITY
                
 Liabilities:
                
 Demand deposits -- noninterest bearing
   $ 101,195     $ 99,231  
 Demand deposits -- interest bearing
     103,365       104,751  
 Money market deposits
     52,574       50,254  
 Savings deposits
     64,198       62,400  
 Time deposits
     260,207       264,585  
 Total deposits
     581,539       581,221  
                 
 Repurchase agreements
     58,179       47,891  
 FHLB borrowings
     16,125       16,137  
 Trust preferred capital notes
     20,619       20,619  
 Accrued interest payable and other liabilities
     5,714       4,909  
 Total liabilities
     682,176       670,777  
                 
 Shareholders' equity:
                
 Preferred stock, $5 par, 200,000 shares authorized,
                
 none outstanding
     -       -  
 Common stock, $1 par, 10,000,000 shares authorized,
                
 6,100,185 shares outstanding at March 31, 2008 and
                
 6,118,717 shares outstanding at December 31, 2007
     6,100       6,119  
 Capital in excess of par value
     26,472       26,425  
 Retained earnings
     69,866       69,409  
 Accumulated other comprehensive income (loss), net
     435       (442 )
 Total shareholders' equity
     102,873       101,511  
 Total liabilities and shareholders' equity
   $ 785,049     $ 772,288  
                 
The accompanying notes are an integral part of the consolidated financial statements.
          
                 
 
 
3
 
 American National Bankshares Inc. and Subsidiaries
(Dollars in thousands, except per share and per share data) (Unaudited)
 
   
Three Months Ended
  
   
March 31
  
   
2008
    
2007
  
 Interest and Dividend Income:
            
 Interest and fees on loans
   $ 9,444     $ 10,079  
 Interest and dividends on securities:
                
 Taxable
     1,231       1,136  
 Tax-exempt
     432       423  
 Dividends
     77       89  
 Other interest income
     76       171  
 Total interest and dividend income
     11,260       11,898  
                 
Interest Expense:
                
 Interest on deposits
     3,582       3,783  
 Interest on repurchase agreements
     451       426  
 Interest on other borrowings
     159       206  
 Interest on trust preferred capital notes
     343       343  
 Total interest expense
     4,535       4,758  
                 
 Net Interest Income
     6,725       7,140  
 Provision for Loan Losses
     140       303  
                 
 Net Interest Income After Provision for Loan Losses
     6,585       6,837  
                 
 Noninterest Income:
                
 Trust fees
     880       879  
 Service charges on deposit accounts
     565       622  
 Other fees and commissions
     203       200  
 Mortgage banking income
     195       190  
 Brokerage fees
     143       89  
 Securities gains, net
     30       25  
 Other
     119       207  
 Total noninterest income
     2,135       2,212  
                 
 Noninterest Expense:
                
 Salaries
     2,469       2,390  
 Employee benefits
     747       648  
 Occupancy and equipment
     966       829  
 Bank franchise tax
     177       168  
 Core deposit intangible amortization
     94       94  
 Other
     996       1,041  
 Total noninterest expense
     5,449       5,170  
 Income Before Income Taxes
     3,271       3,879  
 Income Taxes
     966       1,175  
 Net Income
   $ 2,305     $ 2,704  
                 
 Net Income Per Common Share:
                
 Basic
   $ 0.38     $ 0.44  
 Diluted
   $ 0.38     $ 0.44  
 Average Common Shares Outstanding:
                
 Basic
     6,107,832       6,156,812  
 Diluted
     6,121,285       6,185,084  
                 
The accompanying notes are an integral part of the consolidated financial statements.
  
                 
 
 
4
 
American National Bankshares Inc. and Subsidiaries
Three Months Ended March 31, 2008 and 2007
 (Dollars in thousands) (Unaudited)
                                     
                           
Accumulated
        
   
Common Stock
    
Capital in
          
Other
    
Total
  
               
Excess of
    
Retained
    
Comprehensive
    
Shareholders'
  
   
Shares
    
Amount
    
Par Value
    
Earnings
    
Income (Loss)
    
Equity
  
                                     
 Balance, December 31, 2006
     6,161,865     $ 6,162     $ 26,414     $ 64,584     $ (2,168 )   $ 94,992  
                                                 
 Net income
     -       -       -       2,704       -       2,704  
                                                 
 Change in unrealized gains on securities
                                                
   available for sale, net of tax of $266
     -       -       -       -       494          
                                                 
 Less:  Reclassification adjustment for gains
                                                
 on securities available for sale, net of
                                                
 tax of $(13)
     -       -       -       -       (25 )        
                                                 
 Other comprehensive income
                                     469       469  
                                                 
 Comprehensive income
                                             3,173  
                                                 
 Stock repurchased and retired
     (11,600 )     (12 )     (50 )     (207 )     -       (269 )
                                                 
 Stock options exercised
     6,558       7       92       -       -       99  
                                                 
 Cash dividends declared
     -       -       -       (1,355 )     -       (1,355 )
                                                 
 Balance, March 31, 2007
     6,156,823     $ 6,157     $ 26,456     $ 65,726     $ (1,699 )   $ 96,640  
                                                 
                                                 
 Balance, December 31, 2007
     6,118,717     $ 6,119     $ 26,425     $ 69,409     $ (442 )   $ 101,511  
                                                 
 Net income
     -       -       -       2,305       -       2,305  
                                                 
 Change in unrealized gains on securities
                                                
   available for sale, net of tax of $481
     -       -       -       -       897          
                                                 
 Less:  Reclassification adjustment for gains
                                                
 on securities available for sale, net of
                                                
 tax of $(10)
     -       -       -       -       (20 )        
                                                 
 Other comprehensive income
                                     877       877  
                                                 
 Comprehensive income
                                             3,182  
                                                 
 Stock repurchased and retired
     (28,800 )     (29 )     (124 )     (446 )     -       (599 )
                                                 
 Stock options exercised
     10,268       10       171       -       -       181  
                                                 
 Cash dividends declared
     -       -       -       (1,402 )     -       (1,402 )
                                                 
 Balance, March 31, 2008
     6,100,185     $ 6,100     $ 26,472     $ 69,866     $ 435     $ 102,873  
                                                 
The accompanying notes are an integral part of the consolidated financial statements.
                          
 

5

 American National Bankshares Inc. and Subsidiaries
Three Months Ended March 31, 2008 and 2007
 (Dollars in thousands)  (Unaudited)
             
   
2008
    
2007
  
 Cash Flows from Operating Activities:
            
 Net income
   $ 2,305     $ 2,704  
 Adjustments to reconcile net income to net
                
 cash provided by operating activities:
                
 Provision for loan losses
     140       303  
 Depreciation
     353       282  
 Core deposit intangible amortization
     94       94  
   Net  (accretion) of bond premiums and discounts
     (64 )     (26 )
 Net gain on sale or call of securities
     (30 )     (25 )
 Gain on loans held for sale
     (166 )     (134 )
 Proceeds from sales of loans held for sale
     8,279       6,384  
 Originations of loans held for sale
     (8,426 )     (6,605 )
 Net loss on foreclosed real estate
     7       -  
 Gain on sale of premises and equipment
     -       (9 )
 Deferred income tax expense (benefit)
     13       (253 )
 Net change in interest receivable
     223       (135 )
 Net change in other assets
     (292 )     802  
 Net change in interest payable
     (63 )     (53 )
 Net change in other liabilities
     868       (581 )
 Net cash provided by operating activities
     3,241       2,748  
                 
 Cash Flows from Investing Activities:
                
 Proceeds from sales of securities available for sale
     -       215  
 Proceeds from maturities and calls of securities available for sale
     15,342       13,522  
 Proceeds from maturities and calls of securities held to maturity
     952       398  
 Purchases of securities available for sale
     (18,377 )     (2,748 )
 Net change in loans
     (3,386 )     (1,106 )
 Purchases of bank property and equipment
     (397 )     (594 )
 Proceeds from sales of foreclosed real estate
     75       -  
 Net cash (used in) provided by investing activities
     (5,791 )     9,687  
                 
 Cash Flows from Financing Activities:
                
 Net change in demand, money market, and savings deposits
     4,696       18,137  
 Net change in time deposits
     (4,378 )     (20,631 )
 Net change in repurchase agreements
     10,288       11,158  
 Net change in FHLB borrowings
     (12 )     (37 )
 Cash dividends paid
     (1,402 )     (1,355 )
 Repurchase of stock
     (599 )     (269 )
 Proceeds from exercise of stock options
     181       99  
 Net cash provided by financing activities
     8,774       7,102  
                 
 Net Increase in Cash and Cash Equivalents
     6,224       19,537  
                 
 Cash and Cash Equivalents at Beginning of Period
     18,304       26,124  
                 
 Cash and Cash Equivalents at End of Period
   $ 24,528     $ 45,661  
                 
The accompanying notes are an integral part of the consolidated financial statements.
  
 

 
6
AMERICAN NATIONAL BANKSHARES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
Note 1 – Basis of Presentation

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

In April 2006, AMNB Statutory Trust I, a Delaware statutory trust (the “Trust”) and a wholly owned subsidiary of the Company was formed for the purpose of issuing preferred securities (the “Trust Preferred Securities”) in a private placement pursuant to an applicable exemption from registration.  Proceeds from the securities were used to fund the acquisition of Community First Financial Corporation.  In accordance with FASB Interpretation No. 46R, Consolidation of Variable Interest Entities, the Corporation did not eliminate through consolidation the Corporation’s $619,000 equity investment in the Trust.  Instead, the Corporation reflected this equity investment in the “Trust Preferred Capital Notes” line item in the consolidated balance sheets.

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

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 March 31, 2008; the consolidated statements of income for the three months ended March 31, 2008 and 2007; the consolidated statements of changes in shareholders’ equity for the three months ended March 31, 2008 and 2007; and the consolidated statements of cash flows for the three months ended March 31, 2008 and 2007.  Operating results for the three month periods ended March 31, 2008 are not necessarily indicative of the results that may occur for the year ending December 31, 2008.  Certain reclassifications have been made to prior period balances to conform to the current period presentation.  The statements should be read in conjunction with the Notes to Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2007.

 
 
Note 2 - New Accounting Pronouncements
 
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.  SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities.  Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows.  SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early application permitted. The Company does not expect the implementation of SFAS 161 to have a material impact on its consolidated financial statements.

 
Adoption of New Accounting Standards:

In the first quarter of 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.  SFAS 159 permits entities to choose, at specified election dates, to measure eligible items at fair value (the “fair value option”) and requires an entity to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Upfront costs and fees related to items for which the fair value option is elected shall be recognized in earnings as incurred and not deferred.  SFAS 159 was effective for fiscal years beginning after November 15, 2007.  The adoption of SFAS 159 did not have a material effect on the Company’s financial position or results of operations.

7
In the first quarter of 2008, the Company adopted SFAS No. 157, Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS 157 does not require any new fair value measurements but may change current practice for some entities.  This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years.  Further discussion on this standard can be found in Note 12 to the consolidated financial statements.

Refer to the Company’s December 31, 2007 Annual Report on Form 10-K for previously announced accounting pronouncements.


Note 3  – Securities

The amortized cost and estimated fair value of investments in debt and equity securities at March 31, 2008 and December 31, 2007 were as follows:

   
March 31, 2008
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
  Debt securities:
                        
Federal agencies
   $ 51,719     $ 1,919     $ -     $ 53,638  
Mortgage-backed
     51,168       839       98       51,909  
State and municipal
     37,291       706       21       37,976  
Corporate
     1,485       -       89       1,396  
  Equity securities:
                                
FHLB stock – restricted
     2,115       -       -       2,115  
Federal Reserve stock – restricted
     1,429       -       -       1,429  
FNMA and FHLMC preferred stock
     1,346       -       267       1,079  
Other
     94       -       -       94  
Total securities available for sale
     146,647       3,464       475       149,636  
                                 
Debt securities held to maturity:
                                
Mortgage-backed
     297       12       -       309  
State and municipal
     10,742       329       -       11,071  
Total securities held to maturity
     11,039       341       -       11,380  
 
Total securities
   $ 157,686     $ 3,805     $ 475     $ 161,016  

 
8
 
 
   
December 31, 2007
  
(in thousands)
  
Amortized
    
Unrealized
    
Unrealized
    
Estimated
  
   
Cost
    
Gains
    
Losses
    
Fair Value
  
Securities available for sale:
                        
  Debt securities:
                        
Federal agencies
   $ 55,350     $ 1,059     $ 33     $ 56,376  
Mortgage-backed
     45,346       565       97       45,814  
State and municipal
     36,343       258       113       36,488  
Corporate
     1,485       -       40       1,445  
  Equity securities:
                                
FHLB stock – restricted
     2,125       -       -       2,125  
Federal Reserve stock – restricted
     1,429       -       -       1,429  
FNMA and FHLMC preferred stock
     1,346       42       -       1,388  
Other
     94       -       -       94  
Total securities available for sale
     143,518       1,924       283       145,159  
                                 
Debt securities held to maturity:
                                
Mortgage-backed
     308       11       -       319  
State and municipal
     11,682       256       7       11,931  
Total securities held to maturity
     11,990       267       7       12,250  
 
Total securities
   $ 155,508     $ 2,191     $ 290     $ 157,409  


The tables below show 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 March 31, 2008 and December 31, 2007.  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.

Management evaluates securities for other-than-temporary impairment quarterly, and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for anticipated recovery in fair value.  As of March 31, 2008, the Company held 21 securities that had been in a continuous unrealized loss position for twelve months or more.  The Company has reviewed these securities, in accordance with its accounting policy, for other-than-temporary impairment, and does not consider the balances presented in the table to be other-than-temporarily impaired as of March 31, 2008.


March 31, 2008

   
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
   $ 13,276     $ 98     $ 12,158     $ 84     $ 1,118     $ 14  
State and municipal
     2,342       21       2,342       21       -       -  
Corporate
     1,397       89       -       -       1,397       89  
Preferred stock
     1,079       267       1,079       267       -       -  
  Total
   $ 18,094     $ 475     $ 15,579     $ 372     $ 2,515     $ 103  



9


December 31, 2007

   
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
  
Federal agencies
   $ 7,459     $ 33     $ -     $ -     $ 7,459     $ 33  
Mortgage-backed
     10,194       97       3,508       35       6,686       62  
State and municipal
     17,858       120       2,087       12       15,771       108  
Corporate
     1,445       40       -       -       1,445       40  
  Total
   $ 36,956     $ 290     $ 5,595     $ 47     $ 31,361     $ 243  


Note 4 - Loans

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

 
(in thousands)
  
March 31,
2008
    
December 31,
2007
  
             
Construction and land development
   $ 72,001     $ 69,803  
Commercial real estate
     198,698       198,332  
Residential real estate
     138,384       133,899  
Home equity
     48,958       48,313  
     Total real estate
     458,041       450,347  
                 
Commercial and industrial
     87,199       91,028  
Consumer
     9,427       10,016  
Total loans
   $ 554,667     $ 551,391  

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

   
March 31,
    
December 31,
  
(in thousands)
  
2008
    
2007
  
             
Impaired loans with a valuation allowance
   $ 2,838     $ 3,092  
Impaired loans without a valuation allowance
     689       473  
Total impaired loans
   $ 3,527     $ 3,565  
                 
Allowance provided for impaired loans,
                
    included in the allowance for loan losses
   $ 1,374     $ 1,499  
                 
Nonaccrual loans excluded from the impaired loan disclosure
   $ 1,523     $ 1,329  


   
Three Months
Ended March 31,
    
Three Months
Ended March 31,
  
(in thousands)
  
2008
    
2007
  
             
Average balance in impaired loans
   $ 3,647     $ 1,587  
Interest income recognized on impaired loans
   $ 49     $ 4  
Interest income recognized on nonaccrual loans
   $ -     $ -  
Interest on nonaccrual loans had they been accruing
   $ 73     $ 75  
Loans past due 90 days and still accruing interest
   $ -     $ -  
 
 
10
No additional funds are committed to be advanced in connection with impaired loans.

Foreclosed real estate was $550,000 at March 31, 2008 and $632,000 December 31, 2007, and is included in other assets on the Consolidated Balance Sheets.


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

Changes in the allowance for loan losses and the reserve for unfunded lending commitments for the three months ended March 31, 2008 and 2007, and for the year ended December 31, 2007, are presented below:

 
 
(in thousands)
  
Three Months Ended
March 31,
    
Year
Ended
December 31,
    
Three Months Ended
March 31,
  
   
2008
    
2007
    
2007
  
Allowance for Loan Losses
                  
  Balance, beginning of period
   $ 7,395     $ 7,264     $ 7,264  
  Provision for loan losses
     140       403       303  
  Charge-offs
     (170 )     (515 )     (49 )
  Recoveries
     60       243       72  
  Balance, end of period
   $ 7,425     $ 7,395     $ 7,590  
                         
Reserve for unfunded lending commitments
                        
  Balance, beginning of period
   $ 151       123     $ 123  
  Provision for unfunded commitments
     42       28       8  
  Balance, end of period
   $ 193     $ 151     $ 131  
                         

The reserve for unfunded loan commitments in included in other liabilities.


Note 6 – Goodwill and Other Intangible Assets

In January 2002, the Company adopted SFAS 142, Goodwill and Other Intangible Assets.  Accordingly, goodwill is no longer subject to amortization, but is subject to at least an annual assessment for impairment by applying a fair value test.   A fair value-based test was performed during the third quarter of 2007 that determined the market value of the Company’s shares exceeds the consolidated carrying value, including goodwill; therefore, there has been no impairment recognized in the value of goodwill.

The changes in the carrying amount of goodwill for the quarter ended March 31, 2007, are as follows (in thousands):

Balance as of December 31, 2007
   $ 22,468  
Goodwill recorded during the period
     -  
Impairment losses
     -  
Balance as of March 31, 2008
   $ 22,468  
         

Core deposit intangible assets resulting from an acquisition were originally recorded at $3,112,000 in April 2006, and are being amortized over 99 months.
 

 
11
Note 7 – Stock Based Compensation

A summary of stock option transactions for the three months ended March 31, 2008, is as follows:

   
 
 
 
Option
Shares
    
 
 
Weighted Average
Exercise Price
    
Weighted Average Remaining Contractual Term
    
 
 
Average Intrinsic Value
($000)
  
Outstanding at December  31, 2007
     174,871     $ 21.15              
Granted
     -       -              
Exercised
     (10,268 )     17.68              
Forfeited
     -        -              
Outstanding at March 31, 2008
     164,603     $ 21.37       4.3     $ 331  
Exercisable at March 31, 2008
     164,603     $ 21.37       4.3     $ 331  

The total intrinsic value of options exercised during the three month period ended March 31, 2008 was $44,000.

Effective January 1, 2006, the Company adopted SFAS 123R, Share Based Payment, using the modified prospective method and as such, results for prior periods have not been restated.  All options were fully vested prior to January 1, 2006; therefore, adoption of SFAS 123R resulted in no compensation expense.  No options have been granted since the January 1, 2006 adoption date.  There was no tax benefit associated with stock option activity during 2007, 2006, or 2005.  Under SFAS 123R, a company may only recognize tax benefits for stock options that ordinarily will result in a tax deduction when the option is exercised (“non-statutory” options).  The Company has no non-statutory stock options.

 
Note 8 – Earnings Per Share
The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potentially dilutive common stock.  Potentially dilutive common stock had no effect on income available to common shareholders.

   
Three Months Ended
  
   
March 31,
  
   
2008
    
2007
  
         
Per
          
Per
  
         
Share
          
Share
  
   
Shares
    
Amount
    
Shares
    
Amount
  
Basic
     6,107,832     $ .38       6,156,812     $ .44  
Effect of dilutive securities - stock options
     13,453       -       28,272       -  
Diluted
     6,121,285     $ .38       6,185,084     $ .44  

Stock options on common stock which were not included in computing diluted earnings per share for the three month periods ended March 31, 2008 and 2007, because their effects were antidilutive, averaged 93,027 and 88,027, respectively.
 
 
12

Note 9 – Employee Benefit Plans

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

Components of Net Periodic Benefit Cost
  
Three Months Ended
  
(in thousands)
  
March 31,
  
   
2008
    
             2007
  
Service cost
   $ 181     $ 164  
Interest cost
     128       105  
Expected return on plan assets
     (164 )     (141 )
Amortization of prior service cost
     -       (1 )
Recognized net actuarial loss
     28       38  
                 
Net periodic benefit cost
   $ 173     $ 165  

 
    The Company's maximum estimated contribution for 2008 is $7,100,000.
Note 10 – Segment and Related Information

In accordance with SFAS 131, Disclosures About Segments of an Enterprise and Related Information, reportable segments include community banking and trust and investment services.

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

Trust and investment services include estate planning, trust account administration, investment management, and retail brokerage.  Investment management services include purchasing equity, fixed income, and mutual fund investments for customer accounts.  The trust and investment services division receives fees for investment and administrative services.  Fees are also received by this division for individual retirement accounts managed for the community banking segment.

Amounts shown in the “Other” column include activities of American National Bankshares Inc. and its subsidiary, AMNB Statutory Trust I.  Refer to Note 1 for additional information on AMNB Statutory Trust I.  The “Other” column also includes corporate items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments. Intersegment eliminations primarily consist of American National Bankshares Inc.’s investment in American National Bank and Trust Company and related equity earnings.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies.  All intersegment sales prices are market based.

Segment information as of and for the three month periods ended March 31, 2008 and 2007, is shown in the following table.

13
 
 
  Three Months Ended March 31, 2008
         
Trust and
                    
(in thousands)
  
Community
    
Investment
          
Intersegment
        
   
Banking
    
Services
    
Other
    
Eliminations
    
Total
  
Interest income
   $ 11,260     $ -     $ -     $ -     $ 11,260  
Interest expense
     4,192       -       343       -       4,535  
Noninterest income
     1,096       1,023       16       -       2,135  
Operating income before income taxes
     3,111       566       (406 )     -       3,271  
Depreciation and amortization
     440       6       1       -       447  
Total assets
     784,257       -       792               785,049  
Capital expenditures
     397       -       -       -       397  
                                         
                                         
  Three Months Ended March 31, 2007
           
Trust and
                          
(in thousands)
  
Community
    
Investment
            
Intersegment
          
   
Banking
    
Services
    
Other
    
Eliminations
    
Total
  
Interest income
   $ 11,898     $ -     $ -     $ -     $ 11,898  
Interest expense
     4,415       -       343       -       4,758  
Noninterest income
     1,205       968       39       -       2,212  
Operating income before income taxes
     3,762       498       (381 )     -       3,879  
Depreciation and amortization
     370       5       1       -       376  
Total assets
     786,768       -       776               787,544  
Capital expenditures
     592       2       -       -       594  
                                         

 
 
 Note 11 – Supplemental Cash Flow Information
 
   
Three Months Ended
  
  (in thousands)     March 31,  
   
2008
    
2007
  
 Supplemental Schedule of Cash and Cash Equivalents:
            
 Cash and due from banks
   $ 20,310     $ 22,844  
 Interest-bearing deposits in other banks
     4,218       22,817  
                 
    $ 24,528     $ 45,661  
                 
 Supplemental Disclosure of Cash Flow Information:
                
 Cash paid for:                
     Interest paid on deposits and borrowed funds
   $ 4,598     $ 4,468  
     Income taxes
     72       -  
 Noncash investing and financing activities:                
     Unrealized gain on securities available for sale
     1,349       722  
                 
 

Note 12 – Fair Value Measurements

During the first quarter of 2008, the Company adopted SFAS 157, Fair Value Measurements.  Under SFAS 157, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement.  The fair value hierarchy in SFAS 157 prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or liability, into three levels.  It gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.  The three levels are defined as follows:
 

 
14
·  
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
·  
Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
·  
Level 3 inputs are unobservable inputs for the asset or liability.
 
Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  Level 1 securities would include highly liquid government bonds such as U.S. Treasury securities.  The fair value for Level 2 securities is estimated by using pricing models, quoted prices of similar securities with similar characteristics, discounted cash flow, or other valuation methodologies.  The pricing models are primarily industry-standard models that consider various assumptions, including time value, yield curve, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures.  These assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.  Level 2 securities would include U.S. agency securities, mortgage-backed agency and non-agency securities, obligations of states and political subdivisions, and certain corporate, asset backed, and other securities.  In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.  All of the Company’s securities are considered to be Level 2 securities as of March 31, 2008.

Loans Held for Sale and Mortgage Loan Derivative Contracts

Loans held for sale and mortgage loan derivative contracts are measured at fair value based upon published rates from one of the Company’s mortgage loan investors.


At March 31, 2008, the Company’s assets and liabilities at fair value are allocated between Levels 1, 2 and 3 as follows:

    Level 1   Level 2   Level 3  
Total
Securities available for sale
    
-
     $ 149,636       -     $ 149,636  
Securities held to maturity
     -       11,380       -       11,380  
Loans held for sale
     -       1,681       -       1,681  
Mortgage loan derivative contracts:
                                
      Gross positive fair value
     -       61       -       61  
      Gross negative fair value
     -       (61 )     -       (61 )


15
 
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The purpose of this discussion is to focus on important factors affecting the financial condition and results of operations of the Company.  The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.

Forward-Looking Statements

This report contains forward-looking statements with respect to the financial condition, results of operations and business of American National Bankshares Inc. and its wholly owned subsidiary, American National Bank and Trust Company (collectively referred to as the “Company”).  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on information available to management at the time these statements and disclosures were prepared.  Forward-looking statements are subject to numerous assumptions, estimates, risks, and uncertainties that could cause actual conditions, events, or results to differ materially fro those stated or implied by such forward-looking statements.
 
A variety of factors may affect the operations, performance, business strategy, and results of the Company.  Those factors include but are not limited to the following:
 
·  
Financial market volatility including the level of interest rates could affect the values of financial instruments and the amount of net interest income earned;
·  
General economic or business conditions, either nationally or in the market areas in which the Company does business, may be less favorable than expected, resulting in deteriorating credit quality, reduced demand for credit, or a weakened ability to generate deposits;
·  
Competition among financial institutions may increase and competitors may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than the Company;
·  
Businesses that the Company is engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards;
·  
The ability to retain key personnel; and
·  
The failure of assumptions underlying the allowance for loan losses.


Reclassification

In certain circumstances, reclassifications have been made to prior period information to conform to the 2008 presentation.


Critical Accounting Policies

The accounting and reporting policies followed by the Company conform with U.S. generally accepted accounting principles (“GAAP”) and they conform to general practices within the banking industry.  The Company’s critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses and (2) goodwill impairment.  A summary of the Company’s significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements in the Company’s 2007 Annual Report on Form 10-K.

The financial information contained within the Company’s financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred.  A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset, or relieving a liability.  In addition, GAAP itself may change from one previously acceptable method to another method.
 
16

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

The allowance for loan losses is an estimate of the losses inherent in the loan portfolio at the balance sheet date.  The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards (“SFAS”) 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows, or values observable in the secondary market, and the loan balance.

The Company’s allowance for loan losses has three basic components:  the formula allowance, the specific allowance and the unallocated allowance.  Each of these components is determined based upon estimates that can and do change.  The formula allowance uses a historical loss view as an indicator of future losses along with various qualitative factors, including levels and trends in delinquencies, nonaccrual loans, charge-offs and recoveries; trends in volume and terms of loans; effects of changes in underwriting standards; experience of lending staff and economic conditions; and portfolio concentrations. In the formula allowance, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans.  The adjusted loss factor is multiplied by the period-end balances for each risk-grade category.  The formula allowance is calculated for a range of outcomes.  The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. The unallocated allowance includes estimated losses whose impact on the portfolio has yet to be recognized in either the formula or specific allowance.  The use of these values is inherently subjective and actual losses could be greater or less than the estimates.

The reserve for unfunded loan commitments is an estimate of the losses inherent in off-balance-sheet loan commitments at the balance sheet date.  It is calculated by multiplying an estimated loss factor by an estimated probability of funding, and then by the period-end amounts for unfunded commitments.  The reserve for unfunded loan commitments is included in other liabilities.

Goodwill Impairment

The Company tests goodwill on an annual basis or more frequently if events or circumstances indicate that there may have been impairment.  If the carrying amount of goodwill exceeds its implied fair value, the Company would recognize an impairment loss in an amount equal to that excess.  The goodwill impairment test requires management to make judgments in determining the assumptions used in the calculations.  The goodwill impairment testing conducted by the Company in 2007 indicated that goodwill is not impaired and is properly recorded in the financial statements.


Non-GAAP Presentations

The analysis of net interest income in this document is performed on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets.



Internet Access to Corporate Documents

The Company provides access to its SEC filings through a link on the Investors Relations page of the Company’s web site at www.amnb.com.  Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are filed electronically with the SEC.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

 
17
EXECUTIVE OVERVIEW

American National Bankshares Inc. is the holding company of American National Bank and Trust Company, a community bank serving Southern and Central Virginia and the northern portion of Central North Carolina with twenty banking offices and a loan production office.  The Bank also manages $476 million of assets in its Trust and Investment Services Division.

American National Bank and Trust Company provides a full array of financial products and services, including commercial, mortgage, and consumer banking; trust and investment services; and insurance.  Services are also provided through twenty-three ATMs, “AmeriLink” Internet banking, and 24-hour “Access American” telephone banking.

Additional information is available on the Company’s website at www.amnb.com.  The shares of American National Bankshares Inc. are traded on the NASDAQ Global Select Market under the symbol “AMNB.”

The Company’s mission, vision, and guiding principles are as follows:
Mission
We provide quality financial services with exceptional customer service.

Vision
We will enhance the value of our shareholders’ investment by being our communities’ preferred provider of relationship-based financial services.

Guiding Principles
To achieve our vision and carry out our mission, we:
·  
operate a sound, efficient, and highly profitable company,
·  
identify and respond to our internal and external customers’ needs and expectations in an ever changing financial services environment,
·  
provide quality sales and quality service to our customers,
·  
produce profitable growth,
·  
provide an attractive return for our shareholders,
·  
furnish positive leadership for the well-being of all communities we serve,
·  
continuously develop a challenging and rewarding work environment for our employees, and
·  
conduct our work with integrity and professionalism.


RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and other funding sources.  Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.  The following discussion of net interest income is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets, such as certain state and municipal securities.  A tax rate of 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.  Net interest income divided by average earning assets is referred to as the net interest margin. The net interest spread represents the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities.

 
18

 
In comparison to the first quarter of 2007, net interest income on a taxable equivalent basis decreased $418,000, or 5.7%.  This decrease was due primarily to reductions in interest rates.  Since September 2007, the Federal Open Market Committee of the Federal Reserve Board has reduced the intended federal funds rate six times by a total of 3.00% and, as a result, rates earned on loans fell more quickly than rates paid on deposits.  The Company’s net interest margin, on a fully taxable equivalent basis, was 3.88% during the first quarter of 2008, compared to 4.13% during the same quarter of 2007.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the first quarter 2008 and 2007.  Nonaccrual loans are included in average balances.  Interest income on nonaccrual loans, if recognized, is recorded on a cash basis or when the loan returns to accrual status.

 
19
 
 
Net Interest Income Analysis
                             For the Three Months Ended March 31, 2008 and 2007
(in thousands, except rates)
                                     
               
Interest
              
   
Average Balance
    
Income/Expense
    
Yield/Rate
  
                                     
   
2008
    
2007
    
2008
    
2007
    
2008
    
2007
  
Loans:
                                    
Commercial
   $ 85,632     $ 88,962     $ 1,466     $ 1,693       6.85 %     7.61 %
Real estate
     460,429       444,854       7,777       8,165       6.76       7.34  
Consumer
     9,524       10,346       217       242       9.11       9.36  
Total loans
     555,585       544,162       9,460       10,100       6.81       7.42  
                                                 
Securities:
                                                
Federal agencies
     50,064       82,257       597       857       4.77       4.17  
Mortgage-backed
     47,405       20,001       603       241       5.09       4.82  
State and municipal
     47,847       45,963       656       634       5.48       5.52  
Other
     6,383       8,783       99       129       6.20       5.87  
Total securities
     151,699       157,004       1,955       1,861       5.15       4.74  
                                                 
Deposits in other banks
     10,224       13,261       76       171       2.97       5.16  
                                                 
Total interest earning assets
     717,508       714,427       11,491       12,132       6.41       6.79  
                                                 
Non-earning assets
     62,696       64,431                                  
                                                 
Total assets
   $ 780,204     $ 778,858                                  
                                                 
Deposits:
                                                
Demand
   $ 107,994     $ 110,115       225       424       0.83       1.54  
Money market
     51,320       52,140       294       349       2.29       2.68  
Savings
     63,184       68,927       116       235       0.73       1.36  
Time
     263,700       262,624       2,947       2,775       4.47       4.23  
Total deposits
     486,198       493,806       3,582       3,783       2.95       3.06  
                                                 
Repurchase agreements
     54,624       46,254       451       426       3.30       3.68  
Other borrowings
     33,870       36,720       502       549       5.93       5.98  
                                                 
Total interest bearing liabilities
     574,692       576,780       4,535       4,758       3.16       3.30  
                                                 
Noninterest bearing
                                                
demand deposits
     97,212       101,011                                  
Other liabilities
     5,958       5,735                                  
Shareholders' equity
     102,342       95,332                                  
Total liabilities and
                                                
shareholders' equity
   $ 780,204     $ 778,858                                  
                                                 
Interest rate spread
                                     3.25 %     3.49 %
Net interest margin
                                     3.88 %     4.13 %
                                                 
Net interest income (taxable equivalent basis)
               6,956       7,374                  
Less: Taxable equivalent adjustment
                     231       234                  
Net interest income
                   $ 6,725     $ 7,140                  
                                                 


20
 
Changes in Net Interest Income (Rate/Volume Analysis)
  (in thousands)
                   
   
Three months ended March 31
  
   
2008 vs. 2007
  
         
Change
  
   
Increase
    
Attributable to
  
Interest income
  
(Decrease)
    
Rate
    
Volume
  
  Loans:
                  
    Commercial
   $ (227 )   $ (165 )   $ (62 )
    Real estate
     (388 )     (667 )     279  
    Consumer
     (25 )     (6 )     (19 )
      Total loans
     (640 )     (838 )     198  
  Securities:
                        
    Federal agencies
     (260 )     111       (371 )
    Mortgage-backed
     362       14       348  
    State and municipal
     22       (4 )     26  
    Other securities
     (30 )     7       (37 )
      Total securities
     94       128       (34 )
  Deposits in other banks
     (95 )     (62 )     (33 )
      Total interest income
     (641 )     (772 )     131  
                         
Interest expense
                        
  Deposits:
                        
    Demand
     (199 )     (191 )     (8 )
    Money market
     (55 )     (50 )     (5 )
    Savings
     (119 )     (101 )     (18 )
    Time
     172       161       11  
      Total deposits
     (201 )     (181 )     (20 )
                         
  Repurchase agreements
     25       (47 )     72  
  Other borrowings
     (47 )     (5 )     (42 )
      Total interest expense
     (223 )     (233 )     10  
Net interest income
   $ (418 )   $ (539 )   $ 121  
                         
 
 
Noninterest Income

      Noninterest income decreased 3.5% from $2,212,000 in the first quarter of 2007 to $2,135,000 in the first quarter of 2008, due primarily to a decrease in service charge income.

Fees from the management of trusts, estates, and asset management accounts totaled $880,000 in the first quarter of 2008 as compared to $879,000 for the same period in 2007.  Volatility in the financial markets negatively impacted account asset values, which offset the income from new account activity.  A substantial portion of Trust fees are earned based on account values.

Service charges on deposit accounts were $565,000, a decline of $57,000 or 9.2% from the first quarter of 2007, primarily due to a drop in customer overdraft activity.

Brokerage fees increased 60.7% to $143,000 in the first quarter of 2008, from $89,000 in the first quarter of 2007, due to increased retail investment activity.
 
 
21

Mortgage banking income and other fees and commissions increased 2.6% and 1.5%, respectively over the first quarter of 2007.

Other noninterest income decreased $88,000 in the first quarter of 2008 from the comparable quarter of 2007, due primarily to a decrease in revenue from the Company’s investments in insurance companies.
 
Noninterest income
            
   
Three Months Ended
  
   
March 31,
  
(in thousands)
  
2008
    
2007
  
             
Trust fees
   $ 880     $ 879  
Service charges on deposit accounts
     565       622  
Other fees and commissions
     203       200  
Mortgage banking income
     195       190  
Brokerage fees
     143       89  
Securities gains, net
     30       25  
Gain from sale of bankcard processor
     39       -  
Bank owned life insurance
     33       33  
Check order charges
     29       32  
Investment in insurance companies
     6       91  
Other
     12       51  
    $ 2,135     $ 2,212  
                 
 

 
Noninterest Expense

Noninterest expense increased $279,000 or 5.4% from the first quarter of 2007 to 2008, due in large part to increases in employee benefits and occupancy and equipment expenses.

Salaries increased $79,000 or 3.3% in the first quarter of 2008 as compared to the same period in 2007, due primarily to general salary increases.

Employee benefits increased $99,000 or 15.3% over the same period last year primarily due to increases in employee insurance expenses.

Occupancy and equipment expense increased $137,000 in the first quarter of 2008 as compared to the same period in 2007.   This increase was due primarily to investments in new operational technology, costs associated with the Company’s new offices at Smith Mountain Lake and Bedford, Virginia, and $44,000 in one-time costs associated with the termination of a lease.

Bank franchise tax expense increased $9,000 in the first quarter of 2008 in comparison to the same quarter of 2007.

Other noninterest expense decreased $45,000 in the first quarter of 2008 compared to the same quarter of 2007.
 
 
22
 
Noninterest expense
            
   
Three Months Ended
  
   
March 31,
  
(in thousands)
  
2008
    
2007
  
             
Salaries
   $ 2,469     $ 2,390  
Employee benefits
     747       648  
Occupancy and equipment
     966       829  
Bank franchise tax
     177       168  
Core deposit intangible amortization
     94       94  
Professional fees
     184       199  
Telephone
     101       92  
Postage
     93       71  
ATM network fees
     74       88  
Stationery and printing supplies
     68       78  
Trust services contracted
     50       50  
Internet banking fees
     49       45  
Advertising and marketing
     47       71  
Contributions
     30       36  
Automobile
     29       27  
Courier service
     25       26  
Correspondent bank fees
     21       42  
FDIC assessment
     17       18  
Loan expenses
     16       29  
Other
     192       169  
    $ 5,449     $ 5,170  
 
 
Income Taxes

The effective tax rate for the first quarter of 2008 was 29.5% compared to 30.3% for the same period of 2007.  The effective tax rate is lower than the statutory rate primarily due to income that is not taxable for Federal income tax purposes.  The primary non-taxable income is that of state and municipal securities and industrial revenue bonds or loans.

Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories.  The most significant effect of inflation is on noninterest expenses that tend to rise during periods of inflation.  Changes in interest rates have a greater impact on a financial institution’s profitability than do the effects of higher costs for goods and services.  Through its balance sheet management practices, the Company has the ability to react to those changes and measure and monitor its interest rate and liquidity risk.


BALANCE SHEET ANALYSIS

Securities

The securities portfolio generates income, plays a primary role in the management of interest rate sensitivity, provides a source of liquidity, and is used to meet collateral requirements.  The portfolio consists primarily of high quality, investment-grade securities.  Federal agency, mortgage-backed, and state and municipal securities comprise the majority of the portfolio.

23
The securities portfolio increased from $157,149,000 at December 31, 2007 to $160,675,000 at March 31, 2008.

At March 31, 2008, mortgage-backed securities consist principally of obligations of U.S. Government agencies and sponsored entities.  Mortgage-backed securities issued by non-U.S. Government agencies and sponsored entities as of March 31, 2008, had an amortized cost of $3,533,000 and an estimated fair value of $3,536,000; all are rated AAA as of March 31, 2008.

State and municipal bonds with an aggregate amortized cost of $37,291,000 and an estimated fair value of $37,976,000 at March 31, 2008, consisted of investment-grade obligations of various municipalities.

Corporate bonds with an aggregate amortized cost of $1,485,000 and an aggregate estimated fair value of $1,396,000 at March 31, 2008, consisted of two investment-grade bonds issued by financial firms.


Loans

The loan portfolio consists primarily of commercial and residential real estate loans, commercial loans to small and medium-sized businesses, construction and land development loans, and home equity loans. Loans not held for sale increased from $551,391,000 at December 31, 2007 to $554,667,000 at March 31, 2008.


Allowance for Loan Losses, Asset Quality, and Credit Risk Management

The allowance for loan losses increased slightly from $7,395,000 at December 31, 2007 to $7,425,000 at March 31, 2008.  The allowance was 1.34% of loans at both periods.  Annualized net charge-offs represented .08% of total loans during the first quarter of 2008, below industry averages.

Nonperforming loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and any loans classified as troubled debt restructurings.  Nonperforming assets include nonperforming loans and foreclosed real estate.  Nonperforming loans represented .50% of total loans at March 31, 2008, and .68% at December 31, 2007.   There were no troubled debt restructurings at March 31, 2008 or December 31, 2007.

The following table summarizes nonperforming assets (in thousands):
 
   
March 31,
    
December 31,
  
   
2008
    
2007
  
Loans 90 days or more past due
   $ -     $ -  
Nonaccrual loans
     2,772       2,639  
     Nonperforming loans
     2,772       2,639  
Foreclosed real estate
     550       632  
Nonperforming assets
   $ 3,322     $ 3,271  
                 

Deposits

The Company’s deposits consist primarily of checking, money market, savings, and consumer time deposits.  Deposits increased modestly from $581,221,000 at December 31, 2007 to $581,539,000 at March 31, 2008.  Deposits plus customer repurchase agreements increased $10,606,000, or 1.69% between the two dates.  Deposit growth continues to be challenging in the banking industry due largely to intense competition for customer funds.

24

Shareholders’ Equity

The Company’s goal with capital management is to generate attractive returns on equity and pay high dividends while maintaining capital sufficient to be classified as “well capitalized” under regulatory capital ratios and to support growth.

Shareholders’ equity increased from $101,511,000 at December 31, 2007 to $102,873,000 at March 31, 2008.  The increase was largely the result of net income and comprehensive income.  These increases were partially offset by dividends and the effect of share repurchases.  In the first quarter of 2008, the Company declared and paid a quarterly cash dividend of $.23 per share.

One measure of a financial institution’s capital level is the ratio of shareholders’ equity to assets.  Average shareholders’ equity was 13.12% of average assets for the quarter ended March 31, 2008 and 12.24% for the quarter ended March 31, 2007.  In addition to this measurement, banking regulators have defined minimum regulatory capital ratios that the Company and its banking subsidiary are required to maintain.  These ratios take into account risk factors identified by those regulatory authorities associated with the assets and off-balance sheet activities of financial institutions.  The guidelines require percentages, or “risk weights,” be applied to those assets and off-balance sheet assets in relation to their perceived risk.  Under the guidelines, capital strength is measured in two tiers.  Tier I capital consists primarily of shareholders’ equity and trust preferred capital notes, while Tier II capital consists of qualifying allowance for loan losses. “Total” capital is the total of Tier I and Tier II capital.  Another regulatory indicator of capital adequacy is the leverage ratio, which is computed by dividing Tier I capital by average quarterly assets less intangible assets.

The regulatory guidelines require that minimum total capital (Tier I plus Tier II) of 8% be held against total risk-adjusted assets, at least half of which (4%) must be Tier I capital.  At March 31, 2008, the Company's Tier I and total capital ratios were 17.01% and 18.26%, respectively.  At December 31, 2007, these ratios were 17.03% and 18.28%, respectively.  The ratios for both periods were in excess of the regulatory requirements.  The Company's leverage ratio was 12.91% and 12.98% at March 31, 2007 and December 31, 2006, respectively.  The leverage ratio has a regulatory minimum of 4%, with most institutions required to maintain a ratio of 4-5%, depending upon risk profiles and other factors.

As mandated by bank regulations, the following five capital categories are identified for insured depository institutions:  "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized."  These regulations require the federal banking regulators to take prompt corrective action with respect to insured depository institutions that do not meet minimum capital requirements. Under the regulations, well capitalized institutions must have Tier I risk-based capital ratios of at least 6%, total risk-based capital ratios of at least 10%, and leverage ratios of at least 5%, and not be subject to capital directive orders. Management believes, as of March 31, 2008, that the Company met the requirements to be considered “well capitalized.”


Off-Balance-Sheet Activities

The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions.  Other than AMNB Statutory Trust I, formed in 2006 to issue Trust Preferred Securities, the Company does not have any off-balance sheet subsidiaries.  Off-balance sheet transactions were as follows (in thousands):


   
March 31,
2008
    
December 31,
2007
  
             
Commitments to extend credit
   $ 148,460     $ 144,301  
Standby letters of credit
     6,251       6,222  
Mortgage loan rate-lock commitments
     4,115       2,215  
 
 
25
Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates or other termination clauses.  Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future funding requirements.  Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Management

Effectively managing market risk is essential to achieving the Company’s financial objectives.  Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices.  The Company is generally not subject to currency exchange risk or commodity price risk.  The Company’s primary market risk exposure is interest rate risk; however, market risk also includes liquidity risk.  Both are discussed below.

Interest Rate Risk Management
 
Interest rate risk and its impact on net interest income is a primary market risk exposure.  The Company manages its exposure to fluctuations in interest rates through policies approved by its Asset/Liability Investment Committee (“ALCO”) and Board of Directors, both of which receive and review periodic reports of the Company’s interest rate risk position.
 
 The Company uses simulation analysis to measure the sensitivity of projected earnings to changes in interest rates.  Simulation takes into account current balance sheet volumes and the scheduled repricing dates and maturities of assets and liabilities.  It incorporates numerous assumptions including growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid.  Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

A balance sheet is considered asset sensitive when its earning assets (loans and securities) reprice faster or to a greater extent than its liabilities (deposits and borrowings).  An asset sensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when they decline.  Based on the Company’s simulation analysis, management believes the Company’s interest sensitivity position is asset sensitive.

Liquidity Risk Management

Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities.  Liquidity management involves maintaining the Company’s ability to meet the daily cash flow requirements of its customers, whether they are borrowers requiring funds to meet their credit needs or depositors desiring to withdraw funds.  Additionally, the parent company requires cash for various operating needs including dividends to shareholders, stock repurchases, the servicing of debt, and the payment of general corporate expenses.  The Company manages its exposure to fluctuations in interest rates through policies approved by the ALCO and Board of Directors, both of which receive periodic reports of the Company’s interest rate risk position.  The Company uses a simulation and budget model to manage the future liquidity needs of the Company.

26
Liquidity sources include cash and amounts due from banks, deposits in other banks, loan repayments, increases in deposits, lines of credit from the FHLB, federal funds lines of credit from two correspondent banks, and maturities and sales of securities.  Management believes that these sources provide sufficient and timely liquidity.

The Company has a line of credit with the FHLB, equal to 30% of the Company’s assets, subject to the amount of collateral pledged.  Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans and home equity lines of credit.  In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB.  At March 31, 2008, principal obligations to the FHLB consisted of $3,225,000 in floating-rate, overnight borrowings and $12,900,000 in fixed-rate, long-term advances.  FHLB borrowings were $16,137,000 at December 31, 2007, consisting of $7,200,000 in floating-rate, overnight borrowings and $8,937,000 in fixed-rate, long-term advances.
 
The Company had fixed-rate term borrowing contracts with the FHLB as of March 31, 2008, with the following final maturities:

Amount
  
Expiration Date
$ 3,000,000  
June 2008
  5,000,000  
April 2009
  4,000,000  
March 2011
     900,000  
March 2014
$ 2,900,000    

The Company has federal funds lines of credit established with two other banks in the amounts of $15,000,000 and $10,000,000, and has access to the Federal Reserve Bank’s discount window.  There were no amounts outstanding under these facilities at March 31, 2008.

 
There have been no material changes to market risk as disclosed in the Company’s 2007 Annual Report on Form 10-K.  Refer to those disclosures for further information.
 


ITEM 4.  CONTROLS AND PROCEDURES

 
Disclosure Controls and Procedures
 
 
The Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934), as amended (the "Exchange Act") as of March 31, 2008. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.  There were no significant changes in the Company's internal controls over financial reporting that occurred during the quarter ended March 31, 2008 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
 
27
 
PART II
 
OTHER INFORMATION

Item:
 
1.
The nature of the business of the Company ordinarily results in a certain amount of litigation. The Company is involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that these proceedings will not have a material adverse effect on the consolidated financial position or consolidated results of operations of the Company.

  1A.       
 
There have been no material changes to the risk factors disclosed in the Company’s 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2008.

2.      Unregistered Sales of Equity Securities and Use of Proceeds

Repurchases Made for the Quarter Ended March 31, 2008
  
 
 
 
Dates
  
 
Total Number of Shares Purchased
    
 
 
Average Price Paid Per share
    
Total Number of Shares Purchased as Part of Publicly
Announced
Program
    
Maximum Number of Shares that May Yet Be Purchased Under the Program
  
                         
                                January 1–31
     5,000     $ 19.69       5,000       104,700  
                                February 1-29
     20,400       21.03       20,400       84,300  
                                March 1-31
     3,400       21.06       3,400       80,900  
                                 

 
On August 22, 2007, the Company’s board of directors approved the extension of its stock repurchase plan, begun in 2000, to include the repurchase of up to 125,000 shares of the Company’s common stock between August 22, 2007 and August 19, 2008.  The stock may be purchased in the open market or in privately negotiated transactions as management determines to be in the best interest of the Company.

 
3.
 
None

4.     
None

5.      Other Information
(a)  Required 8-K disclosures
None
(b)  Changes in Nominating Process
None

 
6.
 
11.
Refer to EPS calculation in the Notes to Financial Statements
 
31.1
Section 302 Certification of Charles H. Majors, President and Chief Executive Officer
 
31.2
Section 302 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer
 
32.1
Section 906 Certification of Charles H. Majors, President and Chief Executive Officer
 
32.2
Section 906 Certification of Neal A. Petrovich, Senior Vice President and Chief Financial Officer


28
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

AMERICAN NATIONAL BANKSHARES INC.

     
     
     
 
/s/ Charles H. Majors
  
 
Charles H. Majors
  
Date – May 9, 2008
President and Chief Executive Officer
  
     
 
/s/ Neal A. Petrovich
  
 
Neal A. Petrovich
  
 
Senior Vice President and
  
Date – May 9, 2008
Chief Financial Officer
  


29