AMERICAN NATIONAL BANKSHARES INC. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2019.



o	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)

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	AMNB	Nasdaq Global Select Market

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	o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).



Yes	x	No	o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company x
	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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



Yes	o	No	x

At November 1, 2019, the Company had 11,113,336 shares of Common Stock outstanding, $1 par value.

AMERICAN NATIONAL BANKSHARES INC.



Index			Page

Part I.		FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018	4

		Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018 (unaudited)	5

		Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018 (unaudited)	7

		Consolidated Statements of Changes in Shareholders' Equity for the three and nine months ended September 30, 2019 and 2018 (unaudited)	9

		Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018 (unaudited)	10

		Notes to Consolidated Financial Statements (unaudited)	11

	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	41

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	61

	Item 4.	Controls and Procedures	63

Part II.		OTHER INFORMATION

	Item 1.	Legal Proceedings	64

	Item 1A.	Risk Factors	64

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64

	Item 3.	Defaults Upon Senior Securities	64

	Item 4.	Mine Safety Disclosures	64




	Item 5.	Other Information	64

	Item 6.	Exhibits	65

SIGNATURES			66

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



American National Bankshares Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share data)
Assets	(Unaudited) September 30, 2019			(*) December 31, 2018
Cash and due from banks	$	47,025		$	29,587
Interest-bearing deposits in other banks	95,592			34,668

Equity securities, at fair value	—			1,830
Securities available for sale, at fair value	308,490			332,653
Restricted stock, at cost	8,621			5,247
Loans held for sale	5,646			640

Loans, net of unearned income	1,804,447			1,357,476
Less allowance for loan losses	(12,758		)	(12,805		)
Net loans	1,791,689			1,344,671

Premises and equipment, net	39,261			26,675
Other real estate owned, net of valuation allowance of $155 in 2019 and $109 in 2018	1,353			869
Goodwill	84,633			43,872
Core deposit intangibles, net	8,165			926
Bank owned life insurance	27,612			18,941
Accrued interest receivable and other assets	36,442			22,287
Total assets	$	2,454,529		$	1,862,866

Liabilities
Demand deposits -- noninterest bearing	$	604,498		$	435,828
Demand deposits -- interest bearing	323,871			234,621
Money market deposits	450,022			401,461
Savings deposits	176,803			132,360
Time deposits	486,668			361,957
Total deposits	2,041,862			1,566,227

Customer repurchase agreements	38,924			35,243
Subordinated debt	7,521			—
Junior subordinated debt	28,003			27,927
Accrued interest payable and other liabilities	20,973			10,927
Total liabilities	2,137,283			1,640,324

Shareholders' equity
Preferred stock, $5 par, 2,000,000 shares authorized, none outstanding	—			—
Common stock, $1 par, 20,000,000 shares authorized, 11,116,250 shares outstanding at September 30, 2019 and 8,720,337 shares outstanding at December 31, 2018	11,063			8,668
Capital in excess of par value	159,792			78,172
Retained earnings	147,030			141,537
Accumulated other comprehensive loss, net	(639		)	(5,835		)
Total shareholders' equity	317,246			222,542
Total liabilities and shareholders' equity	$	2,454,529		$	1,862,866

(*) - Derived from audited consolidated financial statements.

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



American National Bankshares Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share data) (Unaudited)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Interest and Dividend Income:
Interest and fees on loans	$	22,470		$	15,062		$	60,737		$	44,485
Interest and dividends on securities:
Taxable	1,890			1,568			5,691			4,432
Tax-exempt	134			362			660			1,204
Dividends	135			82			324			240
Other interest income	329			143			853			516
Total interest and dividend income	24,958			17,217			68,265			50,877
Interest Expense:
Interest on deposits	3,655			2,048			9,647			5,746
Interest on short-term borrowings	162			29			512			41
Interest on long-term borrowings	—			—			14			—
Interest on subordinated debt	123			—			245			—
Interest on junior subordinated debt	396			389			1,168			1,008
Total interest expense	4,336			2,466			11,586			6,795
Net Interest Income	20,622			14,751			56,679			44,082
Recovery of loan losses	(12		)	(23		)	(6		)	(97		)
Net Interest Income After Recovery of Loan Losses	20,634			14,774			56,685			44,179
Noninterest Income:
Trust fees	979			1,001			2,826			2,875
Service charges on deposit accounts	783			605			2,101			1,809
Other fees and commissions	1,003			656			2,726			1,977
Mortgage banking income	710			551			1,702			1,492
Securities gains (losses), net	105			(17		)	575			393
Brokerage fees	183			172			516			603
Income from Small Business Investment Companies	143			150			174			476
Gains (losses) on premises and equipment, net	(2		)	63			(89		)	66
Other	267			199			773			585
Total noninterest income	4,171			3,380			11,304			10,276
Noninterest Expense:
Salaries	6,295			5,285			18,007			15,377
Employee benefits	1,367			1,036			4,022			3,322
Occupancy and equipment	1,448			1,069			3,963			3,297
FDIC assessment (credit)	(175		)	134			119			412
Bank franchise tax	411			291			1,113			863
Core deposit intangible amortization	448			56			961			210
Data processing	589			420			1,838			1,309
Software	287			307			932			966
Other real estate owned, net	47			46			16			101
Merger related expense	—			—			11,322			—
Other	3,075			2,260			8,744			6,751
Total noninterest expense	13,792			10,904			51,037			32,608
Income Before Income Taxes	11,013			7,250			16,952			21,847
Income Taxes	2,321			1,465			3,487			4,270
Net Income	$	8,692		$	5,785		$	13,465		$	17,577



Net Income Per Common Share:
Basic	$	0.78	$	0.66	$	1.30	$	2.02
Diluted	$	0.78	$	0.66	$	1.30	$	2.02
Weighted Average Common Shares Outstanding:
Basic	11,127,603		8,712,443		10,341,919		8,691,423
Diluted	11,138,008		8,718,918		10,351,753		8,703,662

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



American National Bankshares Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
	Three Months Ended September 30,
	2019			2018
Net income	$	8,692		$	5,785

Other comprehensive income (loss):

Unrealized gains (losses) on securities available for sale	1,536			(1,965		)
Tax effect	(344		)	440

Reclassification adjustment for gains on sales or calls of securities available for sale	(102		)	(73		)
Tax effect	22			16

Unrealized gains (losses) on cash flow hedges	(862		)	438
Tax effect	194			(98		)

Other comprehensive income (loss)	444			(1,242		)

Comprehensive income	$	9,136		$	4,543

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



American National Bankshares Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
	Nine Months Ended September 30,
	2019			2018
Net income	$	13,465		$	17,577

Other comprehensive income (loss):

Unrealized gains (losses) on securities available for sale	9,611			(7,145		)
Tax effect	(2,153		)	1,626

Reclassification adjustment for gains on sales or calls of securities available for sale	(242		)	(81		)
Tax effect	54			18

Unrealized gains (losses) on cash flow hedges	(2,673		)	201
Tax effect	599			(45		)

Other comprehensive income (loss)	5,196			(5,426		)

Comprehensive income	$	18,661		$	12,151

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



American National Bankshares Inc.
Consolidated Statements of Changes in Shareholders' Equity
Three Months Ended September 30, 2019 and 2018
(Dollars in thousands, except per share data) (Unaudited)
	Common Stock			Capital in Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
Balance, June 30, 2018	$	8,654		$	77,496		$	135,108		$	(7,910	)	$	213,348

Net income	—			—			5,785			—			5,785

Other comprehensive loss	—			—			—			(1,242		)	(1,242		)

Stock options exercised (3,300 shares)	3			83			—			—			86

Vesting of restricted stock (617 shares)	1			(1		)	—			—			—

Equity based compensation (3,004 shares)	3			264			—			—			267

Cash dividends paid, $0.25 per share	—			—			(2,178		)	—			(2,178		)

Balance, September 30, 2018	$	8,661		$	77,842		$	138,715		$	(9,152	)	$	216,066

Balance, June 30, 2019	$	11,089		$	160,572		$	141,339		$	(1,083	)	$	311,917

Net income	—			—			8,692			—			8,692

Other comprehensive income	—			—			—			444			444

Stock repurchased (32,165 shares)	(32		)	(1,106		)	—			—			(1,138		)

Stock options exercised (1,826 shares)	2			29			—			—			31

Vesting of restricted stock (617 shares)	1			(1		)	—			—			—

Equity based compensation (5,234 shares)	3			298			—			—			301

Cash dividends paid, $0.27 per share	—			—			(3,001		)	—			(3,001		)

Balance, September 30, 2019	$	11,063		$	159,792		$	147,030		$	(639	)	$	317,246

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



American National Bankshares Inc.
Consolidated Statements of Changes in Shareholders' Equity
Nine Months Ended September 30, 2019 and 2018
(Dollars in thousands, except per share data) (Unaudited)
	Common Stock			Capital in Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
Balance, December 31, 2017	$	8,604		$	76,179		$	127,010		$	(3,076	)	$	208,717

Net income	—			—			17,577			—			17,577

Other comprehensive loss	—			—			—			(5,426		)	(5,426		)

Reclassification for ASU 2016-01 adoption	—			—			650			(650		)	—

Stock options exercised (35,310 shares)	35			826			—			—			861

Vesting of restricted stock (10,718 shares)	11			(11		)	—			—			—

Equity based compensation (28,574 shares)	11			848			—			—			859

Cash dividends paid, $0.75 per share	—			—			(6,522		)	—			(6,522		)

Balance, September 30, 2018	$	8,661		$	77,842		$	138,715		$	(9,152	)	$	216,066

Balance, December 31, 2018	$	8,668		$	78,172		$	141,537		$	(5,835	)	$	222,542

Net income	—			—			13,465			—			13,465

Other comprehensive income	—			—			—			5,196			5,196

Issuance of common stock (2,361,686 shares)	2,362			80,108			—			—			82,470

Issuance of replacement options/restricted stock	—			870			—			—			870

Stock repurchased (32,165 shares)	(32		)	(1,106		)	—			—			(1,138		)

Stock options exercised (32,356 shares)	32			577			—			—			609

Vesting of restricted stock (20,902 shares)	21			(21		)	—			—			—

Equity based compensation (34,036 shares)	12			1,192			—			—			1,204

Cash dividends paid, $0.77 per share	—			—			(7,972		)	—			(7,972		)

Balance, September 30, 2019	$	11,063		$	159,792		$	147,030		$	(639	)	$	317,246

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



American National Bankshares Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
	Nine Months Ended September 30,
	2019			2018
Cash Flows from Operating Activities:
Net income	$	13,465		$	17,577
Adjustments to reconcile net income to net cash provided by operating activities:
Recovery of loan losses	(6		)	(97		)
Depreciation	1,504			1,366
Net accretion of acquisition accounting adjustments	(2,321		)	(1,002		)
Core deposit intangible amortization	961			210
Net amortization of securities	845			1,262
Net gain on sale or call of securities available for sale	(242		)	(81		)
Net change in fair value of equity securities	(333		)	(312		)
Gain on sale of loans held for sale	(1,702		)	(1,492		)
Proceeds from sales of loans held for sale	72,452			61,772
Originations of loans held for sale	(75,756		)	(60,575		)
Net (gain) loss on other real estate owned	(124		)	5
Valuation allowance on other real estate owned	68			28
Net loss (gain) on sale of premises and equipment	89			(66		)
Equity based compensation expense	1,204			859
Earnings on bank owned life insurance	(425		)	(325		)
Deferred income tax expense	205			203
Net change in interest receivable	995			(1		)
Net change in other assets	4,695			(660		)
Net change in interest payable	29			93
Net change in other liabilities	(2,852		)	136
Net cash provided by operating activities	12,751			18,900

Cash Flows from Investing Activities:
Proceeds from sales of equity securities	445			431
Proceeds from sales of securities available for sale	29,878			57,607
Proceeds from maturities, calls and paydowns of securities available for sale	76,162			23,561
Purchases of securities available for sale	(36,517		)	(66,221		)
Net change in restricted stock	(786		)	871
Net (increase) decrease in loans	(805		)	5,600
Proceeds from sale of premises and equipment	—			233
Purchases of premises and equipment	(2,070		)	(1,322		)
Proceeds from sales of other real estate owned	1,248			808
Cash paid in bank acquisition	(27		)	—
Cash acquired in bank acquisition	26,283			—
Net cash provided by investing activities	93,811			21,568

Cash Flows from Financing Activities:
Net change in demand, money market, and savings deposits	8,384			(1,321		)
Net change in time deposits	(16,103		)	(10,298		)
Net change in customer repurchase agreements	3,681			18,378
Net change in other short-term borrowings	(14,883		)	(24,000		)
Net change in long-term borrowings	(778		)	—
Common stock dividends paid	(7,972		)	(6,522		)
Repurchase of common stock	(1,138		)	—
Proceeds from exercise of stock options	609			861
Net cash used in financing activities	(28,200		)	(22,902		)
Net Increase in Cash and Cash Equivalents	78,362			17,566
Cash and Cash Equivalents at Beginning of Period	64,255			52,477
Cash and Cash Equivalents at End of Period	$	142,617		$	70,043

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

AMERICAN NATIONAL BANKSHARES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Accounting Policies

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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, goodwill and intangible assets, other-than-temporary impairment of securities, accounting for merger and acquisition activity, accounting for acquired loans with specific credit-related deterioration, and the valuation of deferred tax assets and liabilities.

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 11.

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 any other period. 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, 2018.

Adoption of New Accounting Standards

On January 1, 2019, the Company adopted Accounting Standards Update ("ASU") 2016-02, "Leases (Topic 842)." Among other things, in the amendments in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Financial Accounting Standards Board ("FASB") made subsequent amendments to Topic 842 in July 2018 through ASU 2018-10 ("Codification Improvements to Topic 842, Leases.") and ASU 2018-11 ("Leases (Topic 842): Targeted Improvements."). Among these amendments is the provision in ASU 2018-11 that provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity's reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard continue to be in accordance with current GAAP (Topic 840, Leases). The Company adopted using the additional (and optional) transition method. The effect of adopting this standard on January 1, 2019 was an approximately $4.4 million increase in assets and liabilities on the Company's consolidated balance sheet.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting

for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At the FASB’s October 16, 2019 meeting, the board amended the effective date of this ASU for many companies. Public business entities that are Securities and Exchange Commission ("SEC") filers, excluding those meeting the smaller reporting company definition, will retain the initial required implementation date of fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. All other entities will be required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. As a smaller reporting company, the Company has elected to defer adoption until January, 2023. The Company will continue to validate its models that will be used upon future adoption of the standard. The implementation of this ASU will likely result in increases to the Company's reserves when implemented.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are SEC filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement." The amendments in this ASU modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, "Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans." The amendments in this ASU modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure requirements have been deleted while the following disclosure requirements have been added: the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements in paragraph 715-20-50-3, which state that the following information for defined benefit pension plans should be disclosed: the projected benefit obligation ("PBO") and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation ("ABO") and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending after December 15, 2020. Early adoption is permitted. The Company is currently assessing the impact that ASU 2018-14 will have on its consolidated financial statements.

In April 2019, the FASB issued ASU 2019-04, "Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments." The amendments in this ASU clarify and improve areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various Transition Resource Group meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its consolidated financial statements.

In May 2019, the FASB issued ASU 2019-05, "Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief." The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.

Note 2 - Acquisitions

On April 1, 2019, the Company completed its acquisition of Roanoke-based HomeTown Bankshares Corporation ("HomeTown") and its wholly-owned subsidiary bank, HomeTown Bank. Pursuant and subject to the terms of the merger agreement, as a result of the merger, the holders of shares of HomeTown common stock received 0.4150 shares of the Company's common stock for each share of HomeTown common stock held immediately prior to the effective date of the merger.

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 accordance with Accounting Standards Codification ("ASC") 350, Intangibles-Goodwill and Other. The following table provides a preliminary assessment of the consideration transferred, assets acquired, and liabilities assumed as of the date of the acquisition (dollars in thousands):



Consideration Paid:
Common shares issued (2,361,686)	$	82,470
Issuance of replacement stock options/restricted stock	753
Cash paid in lieu of fractional shares	27
Value of consideration	83,250

Assets acquired:
Cash and cash equivalents	26,283
Investment securities	34,876
Restricted stock	2,588
Loans	444,324
Premises and equipment	12,554
Deferred income taxes	2,329
Core deposit intangible	8,200
Other real estate owned	1,442
Banked owned life insurance	8,246
Other assets	14,244
Total assets	555,086

Liabilities assumed:
Deposits	483,626
Short-term FHLB advances	14,883
Long-term FHLB advances	778
Subordinated debt	7,530
Other liabilities	5,780
Total liabilities	512,597
Net assets acquired	42,489
Goodwill resulting from merger with HomeTown	$	40,761

The acquired loans were recorded at fair value at the acquisition date without carryover of HomeTown's previously established allowance for loan losses. The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and leases and then applying a market-based discount rate to those cash flows. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, purpose, and lien position. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), and past due status. For valuation purposes, these pools were further disaggregated by maturity, pricing characteristics (e.g., fixed-rate, adjustable-rate) and re-payment structure (e.g., interest only, fully amortizing, balloon). If new information is obtained about facts and circumstances about expected cash flows that existed as of the acquisition date, management will adjust fair values in accordance with accounting for business combinations.

The acquired loans were divided into loans with evidence of credit quality deterioration which are accounted for under ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality, (acquired impaired) and loans that do not meet these criteria, which are accounted for under ASC 310-20, Receivables - Nonrefundable Fees and Other Costs, (acquired performing).

The following table presents the acquired impaired loans receivable at the acquisition date (dollars in thousands):



Contractually required principal and interest at acquisition	$	45,551
Contractual cash flows not expected to be collected (nonaccretable difference)	8,296
Expected cash flows at acquisition	37,255
Interest component of expected cash flows (accretable yield)	4,410
Fair value of acquired loans accounted for under FASB ASC 310-30	$	32,845

Direct costs related to the acquisition were expensed as incurred. During the nine months ended September 30, 2019, the Company incurred $11.3 million in merger and acquisition integration expenses related to the merger, including $9.1 million in data processing termination and conversion costs, $1.7 million in legal and professional fees, $0.4 million in salary related expense, and $0.1 million in other noninterest expenses. The majority of these expenses were related to integration and are deductible for tax purposes.

The following tables present unaudited pro forma information as if the acquisition of HomeTown had occurred on January 1, 2018. These results combine the historical results of HomeTown in the Company's Consolidated Statements of Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2018. In particular, no adjustments have been made to eliminate the amount of HomeTown's provision for credit losses that would not have been necessary had the acquired loans been recorded at fair value as of January 1, 2018. Pro forma adjustments below include the net impact of accretion for 2018 and the elimination of merger-related costs for 2019. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below (dollars in thousands, except per share data):



	Pro forma Three Months Ended
	September 30, 2019		September 30, 2018
Total revenues ⁽¹⁾	$	24,636	$	24,478
Net income	8,608		7,458
Earnings per share	0.77		0.67

(1) Includes net interest income and noninterest income.



	Pro forma Nine Months Ended
	September 30, 2019		September 30, 2018
Total revenues ⁽¹⁾	$	70,404	$	73,897
Net income	21,996		22,213
Earnings per share	1.98		2.01

(1) Includes net interest income and noninterest income.

Note 3 – Securities

The amortized cost and fair value of investments in debt securities at September 30, 2019 were as follows (dollars in thousands):



	September 30, 2019
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	119,682	$	1,837	$	263	$	121,256
Mortgage-backed and CMOs	133,533		1,875		207		135,201
State and municipal	43,012		871		28		43,855
Corporate	8,015		163		—		8,178
Total securities available for sale	$	304,242	$	4,746	$	498	$	308,490

The Company adopted ASU 2016-01 effective January 1, 2018. The Company recognized in income a $333,000 change in the fair value of equity securities during the nine months of 2019. During the nine months ended September 30, 2019, the Company sold $445,000 in equity securities at fair value and had no remaining equity securities at September 30, 2019. The Company had equity securities with a fair value of $2,087,000 at September 30, 2018 and recognized in income a $312,000 change in the fair value of equity securities during the nine months of 2018. During the 2018 period, the Company sold $431,000 in equity securities at fair value.

The amortized cost and fair value of investments in debt securities at December 31, 2018 were as follows (dollars in thousands):



	December 31, 2018
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	137,070	$	442	$	3,473	$	134,039
Mortgage-backed and CMOs	113,883		385		2,401		111,867
State and municipal	80,022		411		531		79,902
Corporate	6,799		68		22		6,845
Total securities available for sale	$	337,774	$	1,306	$	6,427	$	332,653

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 consolidated balance sheets. The FRB requires the Bank to maintain stock with a par value equal to 3.00% of its outstanding capital and an additional 3.00% is on call. The FHLB requires the Bank to maintain stock in an amount equal to 4.25% of outstanding borrowings and a specific percentage of the Bank's total assets. The cost of restricted stock at September 30, 2019 and December 31, 2018 was as follows (dollars in thousands):



	September 30, 2019		December 31, 2018
FRB stock	$	6,406	$	3,621
FHLB stock	2,215		1,626
Total restricted stock	$	8,621	$	5,247

Temporarily Impaired Securities

The following table shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2019. The reference point for determining when securities are in an unrealized loss position is month-end. Therefore, it is possible that a security's market value exceeded its amortized cost on other days during the past twelve-month period.

Available for sale securities that have been in a continuous unrealized loss position, at September 30, 2019, are as follows (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	$	59,141	$	263	$	1,889	$	30	$	57,252	$	233
Mortgage-backed and CMOs	32,617		207		7,468		12		25,149		195
State and municipal	4,579		28		3,428		19		1,151		9
Total	$	96,337	$	498	$	12,785	$	61	$	83,552	$	437

Federal agencies and GSEs: The unrealized losses on the Company's investment in 25 government sponsored entities ("GSE") securities were caused by interest rate increases. Twelve of these securities were in an unrealized loss position for 12 months or more. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2019.

Mortgage-backed securities: The unrealized losses on the Company's investment in 24 GSE mortgage-backed securities were caused by interest rate increases. Seventeen of these securities were in an unrealized loss position for 12 months or more. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2019.

Collateralized Mortgage Obligations: The unrealized losses associated with four private GSE collateralized mortgage obligations ("CMOs") were due to normal market fluctuations. One of these securities was in an unrealized loss position for 12 months or more. The contractual cash flows of that investment is guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the security would not be settled at a price less than the amortized cost basis of the Company's investment. 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 investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider the investment to be other-than-temporarily impaired at September 30, 2019.

State and municipal securities: The unrealized losses on seven state and municipal securities were caused by interest rate increases. Two of these securities were in an unrealized loss position for 12 months or more. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2019.

Corporate securities: There were no corporate bonds in an unrealized loss position at September 30, 2019.

Restricted stock: When evaluating restricted stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider restricted stock to be other-than-temporarily impaired at September 30, 2019, and no impairment has been recognized.

The table below shows estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position, at December 31, 2018 (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	$	103,797	$	3,473	$	14,982	$	8	$	88,815	$	3,465
Mortgage-backed and CMOs	86,852		2,401		5,473		15		81,379		2,386
State and municipal	39,755		531		7,199		18		32,556		513
Corporate	484		22		—		—		484		22
Total	$	230,888	$	6,427	$	27,654	$	41	$	203,234	$	6,386

Other-Than-Temporarily-Impaired Securities

As of September 30, 2019 and December 31, 2018, there were no securities classified as other-than-temporarily impaired.

Realized Gains and Losses

The following table presents the gross realized gains and losses on and the proceeds from the sale of securities available for sale during the three and nine months ended September 30, 2019 and 2018 (dollars in thousands):



	Three Months Ended September 30, 2019			Nine Months Ended September 30, 2019
Realized gains (losses):
Gross realized gains	$	—		$	194
Gross realized losses	—			(54		)
Net realized gains	$	—		$	140
Proceeds from sales of securities	$	—		$	29,878

	Three Months Ended September 30, 2018			Nine Months Ended September 30, 2018
Realized gains (losses):
Gross realized gains	$	237		$	342
Gross realized losses	(164		)	(261		)
Net realized gains	$	73		$	81
Proceeds from sales of securities	$	35,541		$	57,607

Note 4 – Loans

Loans, excluding loans held for sale, at September 30, 2019 and December 31, 2018, were comprised of the following (dollars in thousands):



	September 30, 2019		December 31, 2018
Commercial	$	324,508	$	285,972
Commercial real estate:
Construction and land development	143,788		97,240
Commercial real estate	883,219		655,800
Residential real estate:
Residential	318,833		209,438
Home equity	122,074		103,933
Consumer	12,025		5,093
Total loans	$	1,804,447	$	1,357,476

Acquired Loans

The outstanding principal balance and the carrying amount of these loans, including loans accounted for under ASC 310-30, included in the consolidated balance sheets at September 30, 2019 and December 31, 2018 are as follows (dollars in thousands):



	September 30, 2019		December 31, 2018
Outstanding principal balance	$	437,461	$	63,619
Carrying amount	420,066		58,886

The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies ASC 310-30 to account for interest earned, as of the indicated dates are as follows (dollars in thousands):



	September 30, 2019		December 31, 2018
Outstanding principal balance	$	59,353	$	24,500
Carrying amount	48,733		20,611

The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies ASC 310-30, for the nine months ended September 30, 2019 and the year ended December 31, 2018 (dollars in thousands):



	September 30, 2019			December 31, 2018
Balance at January 1	$	4,633		$	4,890
Additions from merger with HomeTown	4,410			—
Accretion	(2,436		)	(2,362		)
Reclassification from nonaccretable difference	389			956
Other changes, net*	506			1,149
	$	7,502		$	4,633

* This line item represents changes in the cash flows expected to be collected due to the impact of non-credit changes such as prepayment assumptions, changes in interest rates on variable rate acquired impaired loans, and discounted payoffs that occurred in the period.

Past Due Loans

The following table shows an analysis by portfolio segment of the Company's past due loans at September 30, 2019 (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	$	776	$	121	$	39	$	110	$	1,046	$	323,462	$	324,508
Commercial real estate:
Construction and land development	—		—		—		21		21		143,767		143,788
Commercial real estate	865		483		136		299		1,783		881,436		883,219
Residential:
Residential	976		5		648		845		2,474		316,359		318,833
Home equity	321		95		51		171		638		121,436		122,074
Consumer	70		14		—		—		84		11,941		12,025
Total	$	3,008	$	718	$	874	$	1,446	$	6,046	$	1,798,401	$	1,804,447

The following table shows an analysis by portfolio segment of the Company's past due loans at December 31, 2018 (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	$	20	$	—	$	—	$	83	$	103	$	285,869	$	285,972
Commercial real estate:
Construction and land development	—		—		—		27		27		97,213		97,240
Commercial real estate	42		—		—		197		239		655,561		655,800
Residential:
Residential	456		157		72		659		1,344		208,094		209,438
Home equity	126		—		—		124		250		103,683		103,933
Consumer	21		3		—		—		24		5,069		5,093
Total	$	665	$	160	$	72	$	1,090	$	1,987	$	1,355,489	$	1,357,476

Impaired Loans

The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at September 30, 2019 (dollars in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	—	$	—	$	—	$	8	$	—
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	530		527		—		404		29
Residential:
Residential	731		734		—		663		32
Home equity	43		43		—		46		4
Consumer	—		—		—		—		—
	$	1,304	$	1,304	$	—	$	1,121	$	65
With a related allowance recorded:
Commercial	$	52	$	47	$	47	$	55	$	2
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	—		—		—		—		—
Residential
Residential	259		259		27		218		13
Home equity	—		—		—		—		—
Consumer	—		—		—		—		—
	$	311	$	306	$	74	$	273	$	15
Total:
Commercial	$	52	$	47	$	47	$	63	$	2
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	530		527		—		404		29
Residential:
Residential	990		993		27		881		45
Home equity	43		43		—		46		4
Consumer	—		—		—		—		—
	$	1,615	$	1,610	$	74	$	1,394	$	80

In the table above, recorded investment may exceed unpaid principal balance due to acquired loans with a premium and loans with unearned costs that exceed unearned fees.

The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at December 31, 2018 (dollars in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	28	$	28	$	—	$	44	$	14
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	376		373		—		542		36
Residential:
Residential	646		646		—		875		29
Home equity	49		49		—		108		10
Consumer	—		—		—		2		—
	$	1,099	$	1,096	$	—	$	1,571	$	89
With a related allowance recorded:
Commercial	$	62	$	58	$	55	$	354	$	40
Commercial real estate:
Construction and land development	—		—		—		21		—
Commercial real estate	—		—		—		18		—
Residential:
Residential	173		173		9		342		9
Home equity	—		—		—		128		1
Consumer	—		—		—		—		—
	$	235	$	231	$	64	$	863	$	50
Total:
Commercial	$	90	$	86	$	55	$	398	$	54
Commercial real estate:
Construction and land development	—		—		—		21		—
Commercial real estate	376		373		—		560		36
Residential:
Residential	819		819		9		1,217		38
Home equity	49		49		—		236		11
Consumer	—		—		—		2		—
	$	1,334	$	1,327	$	64	$	2,434	$	139

In the table above, recorded investment may exceed unpaid principal balance due to acquired loans with a premium and loans with unearned costs that exceed unearned fees.

There were no loans modified as troubled debt restructurings ("TDRs") during the three months ended September 30, 2019 and 2018. During each of the nine months ended September 30, 2019 and 2018, there was one residential real estate loan modified as a TDR. These were included in the impaired loan balances and were extensions of the loan maturity with a pre- and post-modification outstanding recorded investment of $207,000 for 2019 and $11,000 for 2018.

During the three and nine months ended September 30, 2019 and 2018, the Company had no loans that subsequently defaulted within 12 months of modification. 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.

Residential Real Estate in Process of Foreclosure

The Company had $73,000 and $112,000 in residential real estate loans in the process of foreclosure at September 30, 2019 and December 31, 2018, respectively. The Company had $301,000 and $719,000 in residential OREO at September 30, 2019 and December 31, 2018, respectively.

Risk Grades

The following table shows the Company's loan portfolio broken down by internal risk grading as of September 30, 2019 (dollars in thousands):

Commercial and Consumer Credit Exposure

Credit Risk Profile by Internally Assigned Grade



	Commercial		Construction and Land Development		Commercial Real Estate Other		Residential		Home Equity
Pass	$	310,172	$	135,296	$	835,255	$	304,644	$	121,531
Special Mention	12,614		5,851		35,415		9,189		—
Substandard	1,722		2,641		12,549		5,000		543
Doubtful	—		—		—		—		—
Total	$	324,508	$	143,788	$	883,219	$	318,833	$	122,074

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity



	Consumer
Performing	$	12,025
Nonperforming	—
Total	$	12,025

The following table shows the Company's loan portfolio broken down by internal risk grading as of December 31, 2018 (dollars in thousands):

Commercial and Consumer Credit Exposure

Credit Risk Profile by Internally Assigned Grade



	Commercial		Construction and Land Development		Commercial Real Estate Other		Residential		Home Equity
Pass	$	285,092	$	93,000	$	647,519	$	204,261	$	103,541
Special Mention	154		1,840		4,403		1,685		—
Substandard	726		2,400		3,878		3,492		392
Doubtful	—		—		—		—		—
Total	$	285,972	$	97,240	$	655,800	$	209,438	$	103,933

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity



	Consumer
Performing	$	5,093
Nonperforming	—
Total	$	5,093

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.

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.

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 at and for the indicated dates and periods are presented below (dollars in thousands):



	Nine Months Ended September 30, 2019			Year Ended December 31, 2018			Nine Months Ended September 30, 2018
Allowance for Loan Losses
Balance, beginning of period	$	12,805		$	13,603		$	13,603
Recovery of loan losses	(6		)	(103		)	(97		)
Charge-offs	(189		)	(1,020		)	(202		)
Recoveries	148			325			284
Balance, end of period	$	12,758		$	12,805		$	13,588

Reserve for Unfunded Lending Commitments
Balance, beginning of period	$	217		$	206		$	206
Provision for unfunded commitments	90			11			12
Balance, end of period	$	307		$	217		$	218

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

The following table presents changes in the Company's allowance for loan losses by portfolio segment and the related loan balance total by segment at and for the nine months ended September 30, 2019 (dollars in thousands):



	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2018:	$	2,537		$	7,246		$	2,977		$	45		$	12,805
Provision for (recovery of) loan losses	31			(4		)	(99		)	66			(6		)
Charge-offs	(11		)	(6		)	(20		)	(152		)	(189		)
Recoveries	12			8			34			94			148
Balance at September 30, 2019:	$	2,569		$	7,244		$	2,892		$	53		$	12,758

Balance at September 30, 2019:

Allowance for Loan Losses
Individually evaluated for impairment	$	47		$	—		$	27		$	—		$	74
Collectively evaluated for impairment	2,522			7,213			2,720			53			12,508
Acquired impaired loans	—			31			145			—			176
Total	$	2,569		$	7,244		$	2,892		$	53		$	12,758

Loans
Individually evaluated for impairment	$	52		$	530		$	1,033		$	—		$	1,615
Collectively evaluated for impairment	323,128			994,224			424,737			12,010			1,754,099
Acquired impaired loans	1,328			32,253			15,137			15			48,733
Total	$	324,508		$	1,027,007		$	440,907		$	12,025		$	1,804,447

The following table presents changes in the Company's allowance for loan losses by portfolio segment and the related loan balance total by segment at and for the year ended December 31, 2018 (dollars in thousands):



	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2017:	$	2,413		$	8,321		$	2,825		$	44		$	13,603
Provision for (recovery of) loan losses	842			(1,074		)	89			40			(103		)
Charge-offs	(787		)	(11		)	(86		)	(136		)	(1,020		)
Recoveries	69			10			149			97			325
Balance at December 31, 2018:	$	2,537		$	7,246		$	2,977		$	45		$	12,805

Balance at December 31, 2018:

Allowance for Loan Losses
Individually evaluated for impairment	$	55		$	—		$	9		$	—		$	64
Collectively evaluated for impairment	2,482			7,211			2,822			45			12,560
Acquired impaired loans	—			35			146			—			181
Total	$	2,537		$	7,246		$	2,977		$	45		$	12,805

Loans
Individually evaluated for impairment	$	90		$	376		$	868		$	—		$	1,334
Collectively evaluated for impairment	285,431			742,365			302,657			5,078			1,335,531
Acquired impaired loans	451			10,299			9,846			15			20,611
Total	$	285,972		$	753,040		$	313,371		$	5,093		$	1,357,476

The allowance for loan losses is allocated to loan segments based upon historical loss factors, risk grades on individual loans, and qualitative factors. Qualitative factors include trends in delinquencies, nonaccrual loans, and loss rates; trends in volume and terms of loans, effects of changes in risk selection, underwriting standards, and lending policies; experience of lending officers, other lending staff and loan review; national, regional, and local economic trends and conditions; legal, regulatory and collateral factors; and concentrations of credit.

Note 6 – Goodwill and Other Intangible Assets

The Company records as goodwill the excess of the purchase price over the fair value of the identifiable net assets acquired. Impairment testing is performed annually, as well as when an event triggering impairment may have occurred. The Company performs its annual analysis as of June 30 each fiscal year. Accounting guidance permits preliminary assessment of qualitative factors to determine whether more substantial impairment testing is required. The Company chose to bypass the preliminary assessment and utilized a two-step process for impairment testing of goodwill. The first step tests for impairment, while the second step, if necessary, measures the impairment. No indicators of impairment were identified as of June 30, 2019.

Core deposit intangibles resulting from the acquisition of MidCarolina Financial Corporation ("MidCarolina") in July 2011 were $6,556,000 and are being amortized on an accelerated basis over 108 months. Core deposit intangibles resulting from the acquisition of MainStreet BankShares, Inc. in January 2015 were $1,839,000 and are being amortized on an accelerated basis over 120 months. Core deposit intangibles resulting from the acquisition of HomeTown in April 2019 were $8,200,000 and are being amortized on an accelerated basis over 120 months.

The changes in the carrying amount of goodwill and intangibles for the nine months ended September 30, 2019, are as follows (dollars in thousands):



	Goodwill		Intangibles
Balance at December 31, 2018	$	43,872	$	926
Additions	40,761		8,200
Amortization	—		(961		)
Impairment	—		—
Balance at September 30, 2019	$	84,633	$	8,165

Note 7 – Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 "Leases (Topic 842)" and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and, consistent with such elections, did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company's 2018 Form 10-K, the implementation of the new standard resulted in recognition of a right-of-use asset and lease liability of $4.4 million at the date of adoption, which is related to the Company's lease of premises used in operations. In connection with the HomeTown merger, the Company added $1.8 million to the right-of-use asset and lease liability. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Company's consolidated balance sheets.

Lease liabilities represent the Company's obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company's incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company's right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company's long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company's leases, as of and for the three and nine months ended September 30, 2019 (dollars in thousands):



	September 30, 2019
Lease liabilities	$	5,542
Right-of-use assets	$	5,520
Weighted average remaining lease term	8.33 years
Weighted average discount rate	3.21		%



	Three Months Ended September 30, 2019
Lease cost
Operating lease cost	$	283
Short-term lease cost	1
Total lease cost	284

Cash paid for amounts included in the measurement of lease liabilities	$	274



	Nine Months Ended September 30, 2019
Lease cost
Operating lease cost	$	777
Short-term lease cost	2
Total lease cost	779

Cash paid for amounts included in the measurement of lease liabilities	$	757

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows (dollars in thousands):



Lease payments due	As of September 30, 2019
Three months ending December 31, 2019	$	256
Twelve months ending December 31, 2020	950
Twelve months ending December 31, 2021	934
Twelve months ending December 31, 2022	912
Twelve months ending December 31, 2023	809
Twelve months ending December 31, 2024	491
Thereafter	2,022
Total undiscounted cash flows	$	6,374
Discount	(832		)
Lease liabilities	$	5,542

Note 8 – Short-term Borrowings

Short-term borrowings may consist of customer repurchase agreements, overnight borrowings from the FHLB, and federal funds purchased. The Company has federal funds lines of credit established with one correspondent bank in the amount of $15,000,000 and another correspondent bank in the amount of $10,000,000, and has access to the FRB's discount window. Customer repurchase agreements are collateralized by securities of the U.S. Government or GSEs. They mature daily. The interest rates may be changed at the discretion of the Company. The securities underlying these agreements remain under the Company's control. FHLB overnight borrowings contain floating interest rates that may change daily at the discretion of the FHLB. Federal funds purchased are unsecured overnight borrowings from other financial institutions. Short-term borrowings consisted of the following at September 30, 2019 and December 31, 2018 (dollars in thousands):



	September 30, 2019		December 31, 2018
Customer repurchase agreements	$	38,924	$	35,243

Note 9 – Long-term Borrowings

Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans, home equity lines of credit, and commercial real estate loans. In addition, the Company pledges as collateral its capital stock in the FHLB and deposits with the FHLB. The Company has a line of credit with the FHLB equal to 30% of the Company's assets, subject to the amount of collateral pledged. As of September 30, 2019, $754,944,000 in eligible collateral was pledged under the blanket floating lien agreement which covers both short-term and long-term borrowings.

There were no long-term borrowings with FHLB as of September 30, 2019 or December 31, 2018.

In the regular course of conducting its business, the Company takes deposits from political subdivisions of the states of Virginia and North Carolina. At September 30, 2019, the Bank's public deposits totaled $219,291,000. The Company is required to provide collateral to secure the deposits that exceed the insurance coverage provided by the Federal Deposit Insurance Corporation. This collateral can be provided in the form of certain types of government or agency bonds or letters of credit from the FHLB. At September 30, 2019, the Company had $190,000,000 in letters of credit with the FHLB outstanding, as well as $74,426,000 in agency, state, and municipal securities, pledged to provide collateral for such deposits.

Note 10 – Subordinated Debt

On April 1, 2019, in connection with the HomeTown merger, the Company assumed $7,500,000 in aggregate principal amount of fixed-to-floating rate subordinated notes issued to various institutional accredited investors. The notes have a maturity date of December 30, 2025 and have an annual fixed interest rate of 6.75% until December 30, 2020. Thereafter, the notes will have a floating interest rate based on LIBOR. Interest will be paid semi-annually, in arrears, on June 30 and December 30 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on March 30, June 30, September 30 and December 30 throughout the floating interest rate period or earlier redemption date.

The indebtedness evidenced by the notes, including principal and interest, is unsecured and subordinate and junior in right of the Company's payments to general and secured creditors and depositors of the bank. The notes are redeemable, without penalty, on or after December 30, 2020 and, in certain limited circumstances, prior to that date. The notes limit the Company from declaring or paying any dividend, or making any distribution on capital stock or other equity securities of any kind of the Company if the Company is not "well capitalized" for regulatory purposes, immediately prior to the declaration of such dividend or distribution, except for dividends payable solely in shares of common stock of the Company.

The carrying value of the subordinated debt includes a fair value adjustment of $21,000 at September 30, 2019. The original fair value adjustment of $30,000 was recorded as a result of the acquisition of HomeTown on April 1, 2019, and is being amortized into interest expense through December 30, 2020.

Note 11 – Junior Subordinated Debt

On April 7, 2006, AMNB Statutory Trust I, a Delaware statutory trust and a wholly owned unconsolidated subsidiary of the Company, issued $20,000,000 of preferred securities (the "Trust Preferred Securities") in a private placement pursuant to an applicable exemption from registration. The Trust Preferred Securities mature on June 30, 2036, but may be redeemed at the Company's option beginning on September 30, 2011. Distributions are cumulative and will accrue from the date of original issuance, but may be deferred by the Company from time to time for up to 20 consecutive quarterly periods. The Company has guaranteed the payment of all required distributions on the Trust Preferred Securities. The proceeds of the Trust Preferred Securities received by the trust, along with proceeds of $619,000 received by the trust from the issuance of common securities by the trust to the Company, were used to purchase $20,619,000 of the Company's junior subordinated debt securities (the "Junior Subordinated Debt"), issued pursuant to junior subordinated debentures entered into between the Company and Wilmington Trust Company, as trustee. The proceeds of the Junior Subordinated Debt were used to fund the cash portion of the merger consideration to the former shareholders of Community First Financial Corporation in connection with the Company's acquisition of that company in 2006, and for general corporate purposes.

On July 1, 2011, in connection with the MidCarolina merger, the Company assumed $8,764,000 in junior subordinated debt to MidCarolina Trust I and MidCarolina Trust II, two separate Delaware statutory trusts (the "MidCarolina Trusts"), to fully and unconditionally guarantee the preferred securities issued by the MidCarolina Trusts. These long-term obligations, which currently qualify as Tier 1 capital, constitute a full and unconditional guarantee by the Company of the MidCarolina Trusts' obligations. The MidCarolina Trusts were not consolidated in the Company's financial statements.

In accordance with ASC 810-10-15-14, Consolidation – Overall – Scope and Scope Exceptions, the Company did not eliminate through consolidation the Company's $619,000 equity investment in AMNB Statutory Trust I or the $264,000 equity investment in the MidCarolina Trusts. Instead, the Company reflected this equity investment in the "Accrued interest receivable and other assets" line item in the consolidated balance sheets.

A description of the junior subordinated debt securities outstanding payable to the trusts is shown below as of September 30, 2019 and December 31, 2018 (dollars in thousands):

Issuing Entity

Date Issued

Interest Rate

Maturity Date

Principal Amount

September 30, 2019

December 31, 2018

AMNB Trust I

4/7/2006

Libor plus

1.35%

6/30/2036

20,619

MidCarolina Trust I

10/29/2002

Libor plus

3.45%

11/7/2032

4,419

4,377

MidCarolina Trust II

12/3/2003

Libor plus

2.95%

10/7/2033

2,965

2,931

28,003

27,927

The principal amounts reflected above for the MidCarolina Trusts are net of fair value adjustments of $1,380,000 and $1,456,000 at September 30, 2019 and December 31, 2018, respectively. The original fair value adjustments of $1,197,000 and $1,021,000 were recorded as a result of the acquisition of MidCarolina on July 1, 2011, and are being amortized into interest expense over the remaining lives of the respective borrowings.

Note 12 - Derivative Financial Instruments and Hedging Activities

The Company uses derivative financial instruments ("derivatives") primarily to manage risks to the Company associated with changing interest rates. The Company's derivatives are hedging instruments in a qualifying hedge accounting relationship (cash flow or fair value hedge).

The Company designates derivatives as cash flow hedges when they are used to manage exposure to variability in cash flows on variable rate borrowings such as the Company's trust preferred capital notes. The Company uses interest rate swap agreements as part of its hedging strategy by exchanging variable-rate interest payments on a notional amount equal to the principal amount of the borrowings for fixed-rate interest payments, with such interest rates set based on benchmarked interest rates.

All interest rate swaps were entered into with counterparties that met the Company's credit standards and the agreements contain collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in these derivative contracts is not significant.

Terms and conditions of the interest rate swaps vary and amounts receivable or payable are recognized as accrued under the terms of the agreements. The Company assesses the effectiveness of each hedging relationship on a periodic basis. In accordance with ASC 815, Derivatives and Hedging, the effective portions of the derivatives' unrealized gains or losses are recorded as a component of other comprehensive income. Based on the Company's assessment, its cash flow hedges are highly effective, but to the extent that any ineffectiveness exists in the hedge relationships, the amounts would be recorded in interest income and interest expense in the Company's consolidated statements of income.

The following tables present information on the Company's derivative financial instruments as of September 30, 2019 and December 31, 2018 (dollars in thousands):



	September 30, 2019
	Notional Amount		Positions	Assets		Liabilities		Cash Collateral Pledged
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	28,500	3	$	—	$	3,477	$	3,950



	December 31, 2018
	Notional Amount		Positions	Assets		Liabilities		Cash Collateral Pledged
Cash flow hedges:
Interest rate swaps:
Variable-rate to fixed-rate swaps with counterparty	$	28,500	3	$	—	$	804	$	650

Note 13 – Stock Based Compensation

The Company's 2018 Equity Compensation Plan (the "2018 Plan") was adopted by the Board of Directors of the Company on February 20, 2018, and approved by shareholders on May 15, 2018, at the Company's 2018 Annual Meeting of Shareholders. The 2018 Plan provides for the granting of restricted stock awards, incentive and non-statutory options, and other equity-based awards to employees and directors at the discretion of the Compensation Committee of the Board of Directors. The 2018 Plan authorizes the issuance of up to 675,000 shares of common stock. The 2018 Plan replaced the Company's stock incentive plan that was approved by the shareholders at the 2008 Annual Meeting that expired in February 2018 (the "2008 Plan").

Stock Options

Accounting guidance requires that compensation cost relating to share-based payment transactions be recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued.

A summary of stock option transactions for the nine months ended September 30, 2019 is as follows:



	Option Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value ($000)
Outstanding at December 31, 2018	13,200		$	21.97
Issued in HomeTown acquisition	40,753		16.63
Granted	—		—
Exercised	(32,356	)	18.81
Forfeited	(2,075	)	16.63
Expired	(830	)	16.63
Outstanding at September 30, 2019	18,692		$	16.63	5.22 years	$	352
Exercisable at September 30, 2019	14,276		$	16.63	5.22 years	$	269

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options' vesting period. No stock options have been granted since 2009. Replacement stock option awards representing 40,753 shares of the Company's common stock were issued in conjunction with the HomeTown acquisition. As of September 30, 2019, there were no unrecognized compensation expenses related to nonvested stock option grants.

Restricted Stock

The Company from time-to-time grants shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of the shareholders of the Company by providing economic value directly related to increases in the value of the Company's common stock. The value of the stock awarded is established as the fair value of the Company's common stock at the time of the grant. The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants. The majority of the restricted stock granted cliff vests at the end of a 36-month period beginning on the date of the grant. The remainder vests one-third each year beginning on the date of the grant. Nonvested restricted stock activity for the nine months ended September 30,

2019 is summarized in the following table.



Restricted Stock	Shares		Weighted Average Grant Date Value Per Share
Nonvested at December 31, 2018	52,798		$	31.71
Issued in HomeTown acquisition	7,137		27.28
Granted	22,274		32.79
Vested	(22,727	)	23.56
Forfeited	(1,366	)	33.22
Nonvested at September 30, 2019	58,116		$	34.73

As of September 30, 2019 and December 31, 2018, there was $902,000 and $647,000, respectively, in unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan and the 2018 Plan. The weighted average period over which this cost is expected to be recognized is 1.50 years. The share based compensation expense for nonvested restricted stock was $737,000 and $437,000 during the nine months of 2019 and 2018, respectively. The expense for the nine months of 2019 included $257,000 of accelerated compensation expense as a result of the HomeTown merger.

The Company offers its outside directors alternatives with respect to director compensation. For 2019, the regular quarterly board retainer will be received in the form of shares of immediately vested, but restricted stock with a market value of $7,500. Monthly meeting fees can be received as $725 per meeting in cash or $900 in immediately vested, but restricted stock. Only outside directors receive board fees. The Company issued 13,128 and 10,865 shares and recognized share based compensation expense of $467,000 and $422,000 during the nine months of 2019 and 2018, respectively.

Note 14 – Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of potentially dilutive common stock. Potentially dilutive common stock had no effect on income available to common shareholders. Nonvested restricted shares are included in the computation of basic earnings per share as the holder is entitled to full shareholder benefits during the vesting period including voting rights and sharing in nonforfeitable dividends. The following table presents basic and diluted earnings per share for the three and nine month periods ended September 30, 2019 and 2018.



	Three Months Ended September 30,
	2019			2018
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	11,127,603	$	0.78	8,712,443	$	0.66
Effect of dilutive securities - stock options	10,405	—		6,475	—
Diluted earnings per share	11,138,008	$	0.78	8,718,918	$	0.66



	Nine Months Ended September 30,
	2019			2018
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	10,341,919	$	1.30	8,691,423	$	2.02
Effect of dilutive securities - stock options	9,834	—		12,239	—
Diluted earnings per share	10,351,753	$	1.30	8,703,662	$	2.02

Outstanding stock options on common stock whose effects are anti-dilutive are not included in computing diluted earnings per share. There were no anti-dilutive stock options for the three and nine month periods ended September 30, 2019 and 2018.

Note 15 – Employee Benefit Plans

The following information for the nine months ended September 30, 2019 and 2018 pertains to the Company's non-contributory defined benefit pension plan which was frozen in 2009. If lump sum payments exceed the service cost plus interest cost, an additional settlement charge will apply (dollars in thousands):



Components of Net Periodic Benefit Cost	Nine Months Ended September 30,
	2019			2018
Service cost	$	—		$	—
Interest cost	61			51
Expected return on plan assets	(68		)	(64		)
Recognized loss due to settlement	19			25
Recognized net actuarial loss	65			68
Net periodic cost	$	77		$	80

Note 16 – Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the fair value measurements and disclosures topic of ASC 820, Fair Value Measurement, fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.



Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and financial liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available for sale and equity securities: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). If no observable market data is available, valuations are based upon third party

model based techniques (Level 3). There were no securities recorded with a Level 3 valuation at September 30, 2019 or December 31, 2018.

Derivative asset (liability) - cash flow hedges: Cash flow hedges are recorded at fair value on a recurring basis. Cash flow hedges are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. All of the Company's cash flow hedges are classified as Level 2.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at the dates indicated (dollars in thousands):



	Fair Value Measurements at September 30, 2019 Using
	Balance at September 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2019		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	121,256	$	—	$	121,256	$	—
Mortgage-backed and CMOs	135,201		—		135,201		—
State and municipal	43,855		—		43,855		—
Corporate	8,178		—		8,178		—
Total securities available for sale	$	308,490	$	—	$	308,490	$	—
Liabilities:
Derivative - cash flow hedges	$	3,477	$	—	$	3,477	$	—



	Fair Value Measurements at December 31, 2018 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2018		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	134,039	$	—	$	134,039	$	—
Mortgage-backed and CMOs	111,867		—		111,867		—
State and municipal	79,902		—		79,902		—
Corporate	6,845		—		6,845		—
Total securities available for sale	$	332,653	$	—	$	332,653	$	—
Equity securities	$	1,830	$	—	$	1,830	$	—
Liabilities:
Derivative - cash flow hedges	$	804	$	—	$	804	$	—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the nine month period ended September 30, 2019 or the year ended December 31, 2018. Gains and losses on the sale of loans are recorded within mortgage banking income on the consolidated statements of income.

Impaired loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected when due. The measurement of the loss associated with impaired loans can be based on either the observable market price of the loan, the present value of projected cash flows or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2). The present value of projected cash flows method results in a Level 3 categorization because the calculation relies on the Company's judgment to determine projected cash flows, which are then discounted at the current rate of the loan, or the rate prior to modification if the loan is a TDR. However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

Other real estate owned: Measurement for fair values for OREO are the same as impaired loans. Any fair value adjustments are recorded in the period incurred as a valuation allowance against OREO with the associated expense included in OREO expense, net on the consolidated statements of income.

The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis at the dates indicated (dollars in thousands):



	Fair Value Measurements at September 30, 2019 Using
	Balance at September 30,	Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
Description	2019	Level 1	Level 2	Level 3
Assets:
Impaired loans, net of valuation allowance	237	—	—	237
Other real estate owned, net	1,353	—	—	1,353



	Fair Value Measurements at December 31, 2018 Using
	Balance at December 31,	Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
Description	2018	Level 1	Level 2	Level 3
Assets:
Impaired loans, net of valuation allowance	171	—	—	171
Other real estate owned, net	869	—	—	869

Quantitative Information About Level 3 Fair Value Measurements as of September 30, 2019 and December 31, 2018:



Assets	Valuation Technique	Unobservable Input	Rate

Impaired loans	Discounted appraised value	Selling cost	8.00%
	Discounted cash flow analysis	Market rate for borrower (discount rate)	3.25% - 9.80%

Other real estate owned, net	Discounted appraised value	Selling cost	8.00%

ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The carrying values and the exit pricing concept fair values of the Company's financial instruments at September 30, 2019 are as follows (dollars in thousands):



	Fair Value Measurements at September 30, 2019 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Value		Level 1		Level 2		Level 3		Fair Value Balance
Financial Assets:
Cash and cash equivalents	$	142,617	$	142,617	$	—	$	—	$	142,617
Securities available for sale	308,490		—		308,490		—		308,490
Restricted stock	8,621		—		8,621		—		8,621
Loans held for sale	5,646		—		5,646		—		5,646
Loans, net of allowance	1,791,689		—		—		1,782,466		1,782,466
Bank owned life insurance	27,612		—		27,612		—		27,612
Accrued interest receivable	6,610		—		6,610		—		6,610

Financial Liabilities:
Deposits	$	2,041,862	$	—	$	2,043,915	$	—	$	2,043,915
Repurchase agreements	38,924		—		38,924		—		38,924
Subordinated debt	7,521		—		7,583		—		7,583
Junior subordinated debt	28,003		—		—		24,150		24,150
Accrued interest payable	1,398		—		1,398		—		1,398
Derivative - cash flow hedges	3,477		—		3,477		—		3,477

The carrying values and the exit pricing concept fair values of the Company's financial instruments at December 31, 2018 are as follows (dollars in thousands):



	Fair Value Measurements at December 31, 2018 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying Value		Level 1		Level 2		Level 3		Fair Value Balance
Financial Assets:
Cash and cash equivalents	$	64,255	$	64,255	$	—	$	—	$	64,255
Equity securities	1,830				1,830				1,830
Securities available for sale	332,653		—		332,653		—		332,653
Restricted stock	5,247		—		5,247		—		5,247
Loans held for sale	640		—		640		—		640
Loans, net of allowance	1,344,671		—		—		1,334,236		1,334,236
Bank owned life insurance	18,941		—		18,941		—		18,941
Accrued interest receivable	5,449		—		5,449		—		5,449

Financial Liabilities:
Deposits	$	1,566,227	$	—	$	1,570,721	$	—	$	1,570,721
Repurchase agreements	35,243		—		35,243		—		35,243
Junior subordinated debt	27,927		—		—		22,577		22,577
Accrued interest payable	795		—		795		—		795
Derivative - cash flow hedges	804		—		804		—		804

Note 17 – Segment and Related Information

The Company has two reportable segments, 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 automated teller machine fees and insurance commissions generate additional income for the community banking segment.

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 segment receives fees for investment and administrative services.

Amounts shown in the "Other" column includes activities of the Company which are primarily debt service and corporate items.

Segment information as of and for the three and nine months ended September 30, 2019 and 2018 (unaudited), is shown in the following tables (dollars in thousands):



	Three Months Ended September 30, 2019
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	24,841	$	—	$	117		$	—		$	24,958
Interest expense	3,818		—		518			—			4,336
Noninterest income	2,995		1,162		14			—			4,171
Income (loss) before income taxes	11,150		589		(726		)	—			11,013
Net income (loss)	8,807		458		(573		)	—			8,692
Depreciation and amortization	992		2		—			—			994
Total assets	2,441,553		24		356,511			(343,559		)	2,454,529
Goodwill	84,633		—		—			—			84,633
Capital expenditures	771		—		—			—			771



	Three Months Ended September 30, 2018
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	17,124	$	—	$	93		$	—		$	17,217
Interest expense	2,078		—		388			—			2,466
Noninterest income	2,287		1,173		(80		)	—			3,380
Income (loss) before income taxes	7,228		634		(612		)	—			7,250
Net income (loss)	5,763		506		(484		)	—			5,785
Depreciation and amortization	487		2		—			—			489
Total assets	1,796,677		18		244,124			(234,328		)	1,806,491
Goodwill	43,872		—		—			—			43,872
Capital expenditures	390		—		—			—			390



	Nine Months Ended September 30, 2019
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	67,942	$	—	$	323		$	—		$	68,265
Interest expense	10,174		—		1,412			—			11,586
Noninterest income	7,598		3,342		364			—			11,304
Income (loss) before income taxes	18,096		1,628		(2,772		)	—			16,952
Net income (loss)	14,477		1,293		(2,305		)	—			13,465
Depreciation and amortization	2,459		6		—			—			2,465
Total assets	2,441,553		24		356,511			(343,559		)	2,454,529
Goodwill	84,633		—		—			—			84,633
Capital expenditures	2,063		7		—			—			2,070



	Nine Months Ended September 30, 2018
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	50,604	$	—	$	273		$	—		$	50,877
Interest expense	5,787		—		1,008			—			6,795
Noninterest income	6,461		3,479		336			—			10,276
Income (loss) before income taxes	21,325		1,654		(1,132		)	—			21,847
Net income (loss)	17,141		1,330		(894		)	—			17,577
Depreciation and amortization	1,568		8		—			—			1,576
Total assets	1,796,677		18		244,124			(234,328		)	1,806,491
Goodwill	43,872		—		—			—			43,872
Capital expenditures	1,322		—		—			—			1,322

Note 18 – Supplemental Cash Flow Information

Supplemental cash flow information as of and for the nine months ended September 30, 2019 and 2018 is shown in the following table (dollars in thousands):



	Nine Months Ended September 30,
	2019			2018
Supplemental Schedule of Cash and Cash Equivalents:
Cash and due from banks	$	47,025		$	32,688
Interest-bearing deposits in other banks	95,592			37,355
Cash and Cash Equivalents	$	142,617		$	70,043

Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Interest on deposits and borrowed funds	$	10,983		$	6,702
Income taxes	3,577			3,776
Noncash investing and financing activities:
Transfer of loans to other real estate owned	234			532
Transfer from premises and equipment to other assets	445			—
Increase in operating lease right-of-use asset upon adoption of ASU 2016-02	4,413			—
Increase in operating lease liability upon adoption of ASU 2016-02	4,413			—
Unrealized gains (losses) on securities available for sale	9,369			(7,226		)
Unrealized (losses) gains on cash flow hedges	(2,673		)	201

Non-cash transactions related to acquisitions:

Assets acquired:
Investment securities	34,876			—
Restricted stock	2,588			—
Loans	444,324			—
Premises and equipment	12,554			—
Deferred income taxes	2,329			—
Core deposit intangible	8,200			—
Other real estate owned	1,442			—
Bank owned life insurance	8,246			—
Other assets	14,244			—

Liabilities assumed:
Deposits	483,626			—
Short-term FHLB advances	14,883			—
Long-term FHLB advances	778			—
Subordinated debt	7,530			—
Other liabilities	5,780			—

Consideration:
Issuance of common stock	82,470			—
Fair value of replacement stock options/restricted stock	753			—

Note 19 – Accumulated Other Comprehensive Income (Loss)

Changes in each component of accumulated other comprehensive income (loss) ("AOCI") for the three and nine months ended September 30, 2019 and 2018 (unaudited) were as follows (dollars in thousands):



For the Three Months Ended	Net Unrealized Gains (Losses) on Securities			Unrealized Losses on Cash Flow Hedges			Adjustments Related to Pension Benefits			Accumulated Other Comprehensive Income (Loss)

Balance at June 30, 2018	$	(5,446	)	$	(184	)	$	(2,280	)	$	(7,910	)

Net unrealized losses on securities available for sale, net of tax, $(440)	(1,525		)	—			—			(1,525		)

Reclassification adjustment for realized gains on securities, net of tax, $(16)	(57		)	—			—			(57		)

Unrealized losses on cash flow hedges, net of tax, $98	—			340			—			340

Balance at September 30, 2018	$	(7,028	)	156			$	(2,280	)	$	(9,152	)

Balance at June 30, 2019	$	2,185		$	(2,030	)	$	(1,238	)	$	(1,083	)

Net unrealized gains on securities available for sale, net of tax, $344	1,192			—			—			1,192

Reclassification adjustment for realized gains on securities, net of tax, $(22)	(80		)	—			—			(80		)

Unrealized losses on cash flow hedges, net of tax, $(194)	—			(668		)	—			(668		)

Balance at September 30, 2019	$	3,297		$	(2,698	)	$	(1,238	)	$	(639	)



For the Nine Months Ended	Net Unrealized Gains (Losses) on Securities			Unrealized Losses on Cash Flow Hedges			Adjustments Related to Pension Benefits			Accumulated Other Comprehensive Income (Loss)

Balance at December 31, 2017	$	(796	)	$	—		$	(2,280	)	$	(3,076	)

Net unrealized gains on securities available for sale, net of tax, $(1,626)	(5,519		)	—			—			(5,519		)

Reclassification adjustment for realized gains on securities, net of tax, $(18)	(63		)	—			—			(63		)

Reclassification for ASU 2016-01 adoption	(650		)	—			—			(650		)

Unrealized losses on cash flow hedges, net of tax, $45	—			156			—			156

Balance at September 30, 2018	$	(7,028	)	$	156		$	(2,280	)	$	(9,152	)

Balance at December 31, 2018	$	(3,973	)	$	(624	)	$	(1,238	)	$	(5,835	)

Net unrealized losses on securities available for sale, net of tax, $2,153	7,458			—			—			7,458

Reclassification adjustment for realized gains on securities, net of tax, $(54)	(188		)	—			—			(188		)

Unrealized losses on cash flow hedges, net of tax, $(599)	—			(2,074		)	—			(2,074		)

Balance at September 30, 2019	$	3,297		$	(2,698	)	$	(1,238	)	$	(639	)

Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

For the Three and Nine Months ended September 30, 2019 and 2018

(dollars in thousands)



For the Three Months Ended September 30, 2019	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gains on calls of securities	$	102		Securities gains, net
	(22		)	Income taxes
Total reclassifications	$	80		Net of tax



For the Three Months Ended September 30, 2018	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gains on sales and calls of securities	$	73		Securities gains, net
	(16		)	Income taxes
Total reclassifications	$	57		Net of tax



For the Nine Months Ended September 30, 2019	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented

Details about AOCI Components
Available for sale securities:
Realized gains on sales and calls of securities	$	242		Securities gains, net
	(54		)	Income taxes
	$	188		Net of tax



For the Nine Months Ended September 30, 2018	Amount Reclassified from AOCI			Affected Line Item in the Statement of Where Net Income is Presented
Details about AOCI Components
Available for sale securities:
Realized gains on sales and calls of securities	$	81		Securities gains, net
	(18		)	Income taxes
	63			Net of tax
Reclassification for ASU 2016-01 adoption	650			*
Total reclassifications	$	713

* Reclassification from AOCI to retained earnings for unrealized holding gains on equity securities due to adoption of ASU 2016-01.

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. (the "Company") and its wholly owned subsidiary, American National Bank and Trust Company (the "Bank"). 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 from those stated or implied by such forward-looking statements.

A variety of factors, some of which are discussed in more detail in Item 1A – Risk Factors of the Company's Annual Report on Form 10-K for the year ended December 31, 2018, 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 and tax laws;


•	cybersecurity threats or attacks, the implementation of new technologies, and the ability to develop and maintain reliable electronic systems;


•	the ability to retain key personnel;


•	the failure of assumptions underlying the allowance for loan losses; and


•	risks associated with mergers and acquisitions and other expansion activities.

On April 1, 2019, the Company announced the completion of its acquisition of Roanoke-based HomeTown Bankshares Corporation ("HomeTown"). In addition to the factors described above, the Company's operations, performance, business strategy and results may be affected by the following factors:


•	cost savings from the merger may not be fully realized or realized within the expected timeframe;


•	the businesses of the Company and/or HomeTown may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected;


•	revenues following the merger may be lower than expected; and


•	customer and employee relationships and business operations may be disrupted by the merger.

Reclassification

In certain circumstances, reclassifications have been made to prior period information to conform to the 2019 presentation. There were no material reclassifications.

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 evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as needed. Management has discussed the Company's critical accounting policies and estimates with the Audit Committee of the Board of Directors. The Company's critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses, (2) mergers and acquisitions, (3) acquired loans with specific credit-related deterioration, (4) goodwill and intangible assets, (5) deferred tax assets and liabilities, and (6) other-than-temporary impairment of securities. A summary of the Company's significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K for the year ended December 31, 2018.

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.

Allowance for Loan Losses

The purpose of the allowance for loan losses ("ALLL") is to provide for probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance.

The goal of the Company is to maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and the provision for loan loss expense.

The Company uses certain practices to manage its credit risk. These practices include (1) appropriate lending limits for loan officers, (2) a loan approval process, (3) careful underwriting of loan requests, including analysis of borrowers, cash flows, collateral, and market risks, (4) regular monitoring of the portfolio, including diversification by type and geography, (5) review of loans by the Loan Review department, which operates independently of loan production, (6) regular meetings of the Credit Committee to discuss portfolio and policy changes and make decisions on large or unusual loan requests, and (7) regular meetings of the Asset Quality Committee which reviews the status of individual loans.

Risk grades are assigned as part of the loan origination process. From time to time, risk grades may be modified as warranted by the facts and circumstances surrounding the credit.

Calculation and analysis of the ALLL is prepared quarterly by the Finance Department. The Company's Credit Committee, Risk and Compliance Committee, Audit Committee, and the Board of Directors review the allowance for adequacy.

The Company's ALLL has two basic components: the formula allowance and the specific allowance. Each of these components is determined based upon estimates and judgments.

The formula allowance uses historical loss experience 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, economic conditions, portfolio concentrations, regulatory, legal, competition, quality of loan review system, and value of underlying collateral. In the formula allowance for commercial and commercial real estate loans, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans. The period-end balances for each loan risk-grade category are multiplied by the adjusted loss factor. Allowance calculations for residential real estate and consumer loans are calculated based on historical losses for each product category without regard to risk grade. This loss rate is combined with qualitative factors resulting in an adjusted loss factor for each product category.

The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. These include:


•	The present value of expected future cash flows discounted at the loan's effective interest rate. The effective interest rate on a loan is the rate of return implicit in the loan (that is, the contractual interest rate adjusted for any net deferred loan fees or costs and any premium or discount existing at the origination or acquisition of the loan);


•	The loan's observable market price, or


•	The fair value of the collateral, net of estimated costs to dispose, if the loan is collateral dependent.

The use of these computed values is inherently subjective and actual losses could be greater or less than the estimates.

No single statistic, formula, or measurement determines the adequacy of the allowance. Management makes subjective and complex judgments about matters that are inherently uncertain, and different amounts would be reported under different conditions or using different assumptions. For analytical purposes, management allocates a portion of the allowance to specific loan categories and specific loans. However, the entire allowance is used to absorb credit losses inherent in the loan portfolio, including identified and unidentified losses.

The relationships and ratios used in calculating the allowance, including the qualitative factors, may change from period to period as facts and circumstances evolve. Furthermore, management cannot provide assurance that in any particular period the Bank will not have sizable credit losses in relation to the amount reserved. Management may find it necessary to significantly adjust the allowance, considering current factors at the time.

Mergers and Acquisitions

Business combinations are accounted for under the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions.

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of costs to the Company include systems conversions, integration planning consultants and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. These acquisition-related costs have been and will be included within the consolidated statements of income classified within the noninterest expense caption.

Acquired Loans with Specific Credit-Related Deterioration

Acquired loans with specific credit deterioration are accounted for by the Company in accordance with ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality. Certain acquired loans, those for which specific credit-related deterioration, since origination, is 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 a reasonable expectation about the timing and amount of cash flows to be collected. In accounting for acquired impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments.

Goodwill and Intangible Assets

The Company performs its annual analysis as of June 30 each fiscal year. Accounting guidance permits preliminary assessment of qualitative factors to determine whether more substantial impairment testing is required. The Company chose to bypass the preliminary assessment and utilized a two-step process for impairment testing of goodwill. The first step tests for impairment, while the second step, if necessary, measures the impairment. No indicators of impairment were identified during the nine months ended September 30, 2019 or 2018.

Deferred Tax Assets and Liabilities

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed.

Other-than-temporary Impairment of Securities

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

Non-GAAP Presentations

Non-GAAP presentations are provided because the Company believes these may be valuable to investors. These include (1) the analysis of net interest income presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets and (2) the calculation of the efficiency ratio.

Internet Access to Corporate Documents

The Company provides access to its Securities and Exchange Commission ("SEC") filings through a link on the Investor Relations page of the Company's web site at www.amnb.com. Reports available include annual reports 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 information on the Company's website is not incorporated into this report or any other filing the Company makes 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.

Completed Acquisition

On April 1, 2019, the Company announced the completion of its acquisition of HomeTown. The combination deepens the Company's footprint in the Roanoke, Virginia metropolitan area and creates a presence in the New River Valley with an office in Christiansburg, Virginia. After completion of the merger and with two office consolidations, the Company has eight offices in the combined Roanoke/New River Valley market area. As a result of the merger, the holders of shares of HomeTown common stock received 0.4150 shares of the Company's common stock for each share of HomeTown common stock held immediately prior to the effective date of the merger. Following completion of the merger, HomeTown's subsidiary bank, HomeTown Bank, was merged with and into the Bank.

RESULTS OF OPERATIONS

Earnings Performance

Three months ended September 30, 2019 and 2018

For the quarter ended September 30, 2019, the Company reported net income of $8,692,000 compared to $5,785,000 for the comparable quarter in 2018. The $2,907,000 or 50.3% increase was primarily related to the April 1, 2019 acquisition of HomeTown.



SUMMARY INCOME STATEMENT
(Dollars in thousands)

Three Months Ended September 30,	2019			2018			$ Change			% Change
Interest income	$	24,958		$	17,217		$	7,741		45.0	%
Interest expense	(4,336		)	(2,466		)	(1,870		)	75.8
Net interest income	20,622			14,751			5,871			39.8
Recovery of loan losses	12			23			(11		)	(47.8	)
Noninterest income	4,171			3,380			791			23.4
Noninterest expense	(13,792		)	(10,904		)	(2,888		)	26.5
Income tax expense	(2,321		)	(1,465		)	(856		)	58.4

Net income	$	8,692		$	5,785		$	2,907		50.3

Nine months Ended September 30, 2019 and 2018

For the nine month period ended September 30, 2019, the Company reported net income of $13,465,000 compared to $17,577,000 for the comparable period in 2018. The $4,112,000 or 23.4% decrease was primarily due to $11,322,000 in

one-time merger related expense in the 2019 period.



SUMMARY INCOME STATEMENT
(Dollars in thousands)

Nine Months Ended September 30,	2019			2018			$ Change			% Change
Interest income	$	68,265		$	50,877		$	17,388		34.2	%
Interest expense	(11,586		)	(6,795		)	(4,791		)	70.5
Net interest income	56,679			44,082			12,597			28.6
Recovery of loan losses	6			97			(91		)	(93.8	)
Noninterest income	11,304			10,276			1,028			10.0
Noninterest expense	(51,037		)	(32,608		)	(18,429		)	56.5
Income tax expense	(3,487		)	(4,270		)	783			(18.3	)

Net income	$	13,465		$	17,577		$	(4,112	)	(23.4	)

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 21% 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 weighted rate earned on average earning assets and the weighted rate paid on average interest-bearing liabilities.

Three months ended September 30, 2019 and 2018

Net interest income on a taxable equivalent basis increased $5,815,000 or 39.1% for the third quarter of 2019 compared to the same quarter of 2018. This improvement in net interest income was primarily related to an increase in the average balance of loans for the 2019 quarter compared to the 2018 quarter. Average loan balances for the 2019 quarter were up $491.3 million or 36.9% over the 2018 quarter, primarily due to the HomeTown acquisition in which we acquired $444.3 million in loans on April 1, 2019. Loan yields for the quarter were 40 basis points higher than the 2018 quarter.

For the third quarter of 2019, the Company's yield on interest-earning assets was 4.53%, compared to 4.09% for the third quarter of 2018. The cost of interest-bearing liabilities was 1.13% compared to 0.84%, primarily related to a 27 basis point (0.27%) increase in the cost of deposits. The interest rate spread was 3.40% compared to 3.25%. The net interest margin, on a fully taxable equivalent basis, was 3.75% compared to 3.51%, an increase of 24 basis points (0.24%). The increase in net interest margin was driven by a $514.0 million (30.3%) increase in average earning assets, enhanced by a $144.7 million (34.1%) increase in average noninterest bearing deposits, and partially offset by a $325.0 million (29.0%) increase in average interest bearing deposits.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the three months ended September 30, 2019 and 2018. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans is only recognized when the loan returns to accrual status or at full payment of principal.



	Net Interest Income Analysis (dollars in thousands)
	Three Months Ended September 30,

	Average Balance				Income/Expense				Yield/Rate
	2019		2018		2019		2018		2019		2018
Loans:
Commercial	$	320,802	$	268,296	$	3,820	$	2,715	4.72	%	4.01	%
Real estate	1,489,155		1,057,097		18,487		12,317		4.97		4.66
Consumer	11,679		4,949		209		76		7.10		6.09
Total loans	1,821,636		1,330,342		22,516		15,108		4.94		4.54

Securities:
Federal agencies and GSEs	127,956		128,284		767		732		2.40		2.28
Mortgage-backed and CMOs	133,121		107,817		851		604		2.56		2.24
State and municipal	45,830		84,147		330		583		2.88		2.77
Other securities	16,295		15,072		242		180		5.94		4.78
Total securities	323,202		335,320		2,190		2,099		2.71		2.50

Deposits in other banks	63,097		28,250		329		143		2.07		2.01

Total interest-earning assets	2,207,935		1,693,912		25,035		17,350		4.53		4.09

Non-earning assets	218,743		117,719

Total assets	$	2,426,678	$	1,811,631

Deposits:
Demand	$	324,058	$	231,339	119		12		0.15		0.02
Money market	453,873		377,074		1,415		839		1.24		0.88
Savings	176,673		132,450		94		10		0.21		0.03
Time	489,343		378,066		2,027		1,187		1.64		1.25
Total deposits	1,443,947		1,118,929		3,655		2,048		1.00		0.73

Customer repurchase agreements	39,470		11,896		150		17		1.51		0.57
Other short-term borrowings	1,986		2,176		12		12		2.42		2.21
Long-term borrowings	35,806		27,886		519		389		5.80		5.58
Total interest-bearing
liabilities	1,521,209		1,160,887		4,336		2,466		1.13		0.84

Noninterest bearing demand deposits	568,706		424,016
Other liabilities	21,783		11,674
Shareholders' equity	314,980		215,054
Total liabilities and
shareholders' equity	$	2,426,678	$	1,811,631

Interest rate spread									3.40	%	3.25	%
Net interest margin									3.75	%	3.51	%

Net interest income (taxable equivalent basis)					20,699		14,884
Less: Taxable equivalent adjustment					77		133
Net interest income					$	20,622	$	14,751



Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Three Months Ended September 30,
	2019 vs. 2018
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate		Volume
Loans:
Commercial	$	1,105		$	524	$	581
Real estate	6,170			852		5,318
Consumer	133			14		119
Total loans	7,408			1,390		6,018
Securities:
Federal agencies and GSEs	35			37		(2		)
Mortgage-backed and CMOs	247			93		154
State and municipal	(253		)	22		(275		)
Other securities	62			47		15
Total securities	91			199		(108		)
Deposits in other banks	186			4		182
Total interest income	7,685			1,593		6,092

Interest expense
Deposits:
Demand	107			100		7
Money market	576			382		194
Savings	84			80		4
Time	840			437		403
Total deposits	1,607			999		608
Customer repurchase agreements	133			55		78
Other short-term borrowings	—			1		(1		)
Long-term borrowings	130			16		114
Total interest expense	1,870			1,071		799
Net interest income (taxable equivalent basis)	$	5,815		$	522	$	5,293

Nine months Ended September 30, 2019 and 2018

Net interest income on a taxable equivalent basis increased $12,448,000 or 28.0% for the nine months ended September 30, 2019 compared to the same period of 2018. This improvement in net interest income was primarily related to an increase in the average balance of loans for the 2019 period compared to the 2018 period. Average loan balances for the 2019 period were up $335.2 million or 25.2% over the 2018 period, primarily due to the HomeTown acquisition. Loan yields for the period were 40 basis points higher than the 2018 period.

For the nine months of 2019, the Company's yield on interest-earning assets was 4.45%, compared to 4.03% for the same period of 2018. The cost of interest-bearing liabilities was 1.09% compared to 0.77%, primarily related to a 29 basis point (0.29%) increase in the cost of deposits. The interest rate spread was 3.36% compared to 3.26%. The net interest margin, on a fully taxable equivalent basis, was 3.70% compared to 3.49%, an increase of 21 basis points (0.21%). The increase in net interest margin was driven by a $354.0 million (20.8%) increase in average earning assets, enhanced by a $102.1 million (24.6%) increase in average noninterest bearing deposits, and partially offset by a $207.1 million (18.2%) increase in average interest bearing deposits.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the nine months ended September 30, 2019 and 2018. 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.



	Net Interest Income Analysis (dollars in thousands)
	Nine Months Ended September 30,

	Average Balance				Income/Expense				Yield/Rate
	2019		2018		2019		2018		2019		2018
Loans:
Commercial	$	302,750	$	264,983	$	10,609	$	7,811	4.69	%	3.94	%
Real estate	1,354,358		1,062,075		49,782		36,594		4.90		4.59
Consumer	9,638		4,528		485		229		6.73		6.76
Total loans	1,666,746		1,331,586		60,876		44,634		4.87		4.47

Securities:
Federal agencies and GSEs	135,937		119,597		2,475		1,956		2.43		2.18
Mortgage-backed and CMOs	124,258		108,473		2,353		1,812		2.52		2.23
State and municipal	64,084		87,365		1,348		1,870		2.80		2.85
Other securities	16,160		15,126		653		531		5.39		4.68
Total securities	340,439		330,561		6,829		6,169		2.67		2.49

Deposits in other banks	46,902		37,981		853		516		2.43		1.82

Total interest-earning assets	2,054,087		1,700,128		68,558		51,319		4.45		4.03

Non-earning assets	189,256		118,487

Total assets	$	2,243,343	$	1,818,615

Deposits:
Demand	$	299,769	$	236,734	245		36		0.11		0.02
Money market	432,980		394,005		3,962		2,424		1.22		0.82
Savings	163,525		131,789		201		30		0.16		0.03
Time	451,258		377,915		5,239		3,256		1.55		1.15
Total deposits	1,347,532		1,140,443		9,647		5,746		0.96		0.67

Customer repurchase agreements	39,265		11,829		461		19		1.57		0.21
Other short-term borrowings	3,502		1,536		51		22		1.94		1.91
Long-term borrowings	33,107		27,861		1,427		1,008		5.75		4.82
Total interest-bearing
liabilities	1,423,406		1,181,669		11,586		6,795		1.09		0.77

Noninterest bearing demand deposits	516,698		414,643
Other liabilities	20,595		10,035
Shareholders' equity	282,644		212,268
Total liabilities and
shareholders' equity	$	2,243,343	$	1,818,615

Interest rate spread									3.36	%	3.26	%
Net interest margin									3.70	%	3.49	%

Net interest income (taxable equivalent basis)					56,972		44,524
Less: Taxable equivalent adjustment					293		442
Net interest income					$	56,679	$	44,082



Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Nine Months Ended September 30,
	2019 vs. 2018
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate			Volume
Loans:
Commercial	$	2,798		$	1,594		$	1,204
Real estate	13,188			2,576			10,612
Consumer	256			(1		)	257
Total loans	16,242			4,169			12,073
Securities:
Federal agencies and GSEs	519			235			284
Mortgage-backed and CMOs	541			259			282
State and municipal	(522		)	(32		)	(490		)
Other securities	122			84			38
Total securities	660			546			114
Deposits in other banks	337			199			138
Total interest income	17,239			4,914			12,325

Interest expense
Deposits:
Demand	209			197			12
Money market	1,538			1,279			259
Savings	171			162			9
Time	1,983			1,272			711
Total deposits	3,901			2,910			991
Customer repurchase agreements	442			323			119
Other short-term borrowings	29			—			29
Long-term borrowings	419			211			208
Total interest expense	4,791			3,444			1,347
Net interest income (taxable equivalent basis)	$	12,448		$	1,470		$	10,978

Noninterest Income, three months ended September 30, 2019 and 2018

For the quarter ended September 30, 2019, noninterest income increased $791,000 or 23.4% compared to the comparable 2018 quarter. Details of individual accounts are shown in the table below.



	Three Months Ended September 30,
	(Dollars in thousands)
	2019			2018			$ Change			% Change
Noninterest income:
Trust fees	$	979		$	1,001		$	(22	)	(2.2	)%
Service charges on deposit accounts	783			605			178			29.4
Other fees and commissions	1,003			656			347			52.9
Mortgage banking income	710			551			159			28.9
Securities gains (losses), net	105			(17		)	122			(717.6	)
Brokerage fees	183			172			11			6.4
Income from SBICs	143			150			(7		)	(4.7	)
Gains (losses) on premises and equipment, net	(2		)	63			(65		)	(103.2	)
Other	267			199			68			34.2
Total noninterest income	$	4,171		$	3,380		$	791		23.4

Service charge income increased $178,000 in the third quarter of 2019 compared to the third quarter of 2018, primarily due to the HomeTown acquisition. Other fees and commissions increased $347,000 in the 2019 quarter compared to the 2018 quarter, mostly on the strength of debit card fee revenue. Mortgage banking income increased $159,000 in the 2019 quarter compared to the 2018 quarter, primarily due to increased volume. Net securities gains increased $122,000 in the 2019 quarter compared to the same quarter in 2018.

Noninterest Income, nine months ended September 30, 2019 and 2018

For the nine months ended September 30, 2019, noninterest income increased $1,028,000 or 10.0% compared to the comparable 2018 period. Details of individual accounts are shown in the table below.



	Nine Months Ended September 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest income:
Trust fees	$	2,826		$	2,875	$	(49	)	(1.7	)%
Service charges on deposit accounts	2,101			1,809		292			16.1
Other fees and commissions	2,726			1,977		749			37.9
Mortgage banking income	1,702			1,492		210			14.1
Securities gains, net	575			393		182			46.3
Brokerage fees	516			603		(87		)	(14.4	)
Income from SBICs	174			476		(302		)	(63.4	)
Gains (losses) on premises and equipment, net	(89		)	66		(155		)	(234.8	)
Other	773			585		188			32.1
Total noninterest income	$	11,304		$	10,276	$	1,028		10.0

Service charge income increased $292,000 in the nine months of 2019 compared to the nine months of 2018, primarily due to the HomeTown merger. Other fees and commissions increased $749,000 in the 2019 period compared to the 2018 period, mostly on the strength of debit card fee revenue. Mortgage banking income increased $210,000 in the 2019 period compared to the 2018 period, primarily due to increased volume. Net securities gains increased $182,000 in the 2019 period compared to the same period in 2018. Income from Small Business Investment Companies ("SBICs") reflected a $302,000 decrease compared to the 2018 quarter; this category of income is highly unpredictable.

Noninterest Expense, three months ended September 30, 2019 and 2018

For the three months ended September 30, 2019, noninterest expense increased $2,888,000 or 26.5%. Details of individual accounts are shown in the table below.



	Three Months Ended September 30,
	(Dollars in thousands)
	2019			2018		$ Change			% Change
Noninterest Expense
Salaries	$	6,295		$	5,285	$	1,010		19.1	%
Employee benefits	1,367			1,036		331			31.9
Occupancy and equipment	1,448			1,069		379			35.5
FDIC assessment (credit)	(175		)	134		(309		)	(230.6	)
Bank franchise tax	411			291		120			41.2
Core deposit intangible amortization	448			56		392			700.0
Data processing	589			420		169			40.2
Software	287			307		(20		)	(6.5	)
Other real estate owned, net	47			46		1			2.2
Other	3,075			2,260		815			36.1
Total noninterest expense	$	13,792		$	10,904	$	2,888		26.5

Salaries expense and employee benefits combined increased $1,341,000 in the 2019 quarter as compared to the 2018 quarter. Total full-time equivalent employees ("FTEs") were 365 at the end of the third quarter of 2019, up from 316 at the end of the third quarter of 2018, for an increase of 49 FTEs due to the HomeTown acquisition. Occupancy and equipment expense increased $379,000 in the 2019 quarter compared to the 2018 quarter, primarily due to the HomeTown acquisition. The Federal Deposit Insurance Corporation ("FDIC") assessment expense in the 2019 quarter was positively impacted by the Small Bank Assessment Credit, which reduced insurance expense $330,000. Core deposit intangible amortization increased $392,000 in the 2019 quarter compared to the same quarter in 2018 due to the HomeTown acquisition.

Noninterest Expense, nine months ended September 30, 2019 and 2018

For the nine months ended September 30, 2019, noninterest expense increased $18,429,000 or 56.5%. Details of individual accounts are shown in the table below.



	Nine Months Ended September 30,
	(Dollars in thousands)
	2019		2018		$ Change			% Change
Noninterest Expense
Salaries	$	18,007	$	15,377	$	2,630		17.1	%
Employee benefits	4,022		3,322		700			21.1
Occupancy and equipment	3,963		3,297		666			20.2
FDIC assessment	119		412		(293		)	(71.1	)
Bank franchise tax	1,113		863		250			29.0
Core deposit intangible amortization	961		210		751			357.6
Data processing	1,838		1,309		529			40.4
Software	932		966		(34		)	(3.5	)
Other real estate owned, net	16		101		(85		)	(84.2	)
Merger related expenses	11,322		—		11,322			100.0
Other	8,744		6,751		1,993			29.5
Total noninterest expense	$	51,037	$	32,608	$	18,429		56.5

Salaries expense and employee benefits combined increased $3,330,000 in the 2019 period as compared to the 2018 period. Total FTEs were 365 at the end of the 2019 period, up from 316 at the end of the 2018 period, for an increase of 49 FTEs due to the HomeTown acquisition. Occupancy and equipment expense increased $666,000 in the 2019 period compared to the 2018 period, primarily due to the HomeTown acquisition. The FDIC assessment expense in the 2019 period

was positively impacted by the Small Bank Assessment Credit, which reduced insurance expense $330,000; due to the remaining credit, the Company does not expect an expense in the fourth quarter of 2019 and expects the expense in the first quarter of 2020 to be reduced by approximately $70,000. Core deposit intangible amortization increased $751,000 in the 2019 period compared to the same period in 2018 due to the HomeTown acquisition. Data processing expense increased $529,000 in the 2019 period compared to the 2018 period. Merger related expenses, which are related to the HomeTown acquisition and are nonrecurring in nature, totaled $11,332,000 during the 2019 period.

Non-GAAP Financial Measures

The efficiency ratio is calculated by dividing noninterest expense excluding (1) gains or losses on the sale of other real estate owned ("OREO"), (2) core deposit intangible amortization and (3) merger related expense by net interest income including tax equivalent income on nontaxable loans and securities and noninterest income and excluding (a) gains or losses on securities and (b) gains or losses on sale of premises and equipment. The efficiency ratio for the 2019 quarter was 53.79% compared to 59.35% for the 2018 quarter. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands):



	Three Months Ended September 30,
	2019			2018
Efficiency Ratio
Noninterest expense	$	13,792		$	10,904
Add/subtract: loss/(gain) on sale of OREO	(22		)	(36		)
Subtract: core deposit intangible amortization	(448		)	(56		)
Subtract merger related expense	—			—
	$	13,322		$	10,812

Net interest income	$	20,622		$	14,751
Tax equivalent adjustment	77			133
Noninterest income	4,171			3,380
Add/subtract: (gain)/loss on securities	(105		)	17
Add/subtract: (gain)/loss on fixed assets	2			(63		)
	$	24,767		$	18,218

Efficiency ratio	53.79		%	59.35		%

Net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both the 2019 and 2018 quarters is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (dollars in thousands):



	Three Months Ended September 30,
	2019			2018
Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income
Non-GAAP measures:
Interest income - loans	$	22,516		$	15,108
Interest income - investments and other	2,519			2,242
Interest expense - deposits	(3,655		)	(2,048		)
Interest expense - customer repurchase agreements	(150		)	(17		)
Interest expense - other short-term borrowings	(12		)	(12		)
Interest expense - long-term borrowings	(519		)	(389		)
Total net interest income	$	20,699		$	14,884
Less non-GAAP measures:
Tax benefit realized on non-taxable interest income - loans	$	(46	)	$	(46	)
Tax benefit realized on non-taxable interest income - municipal securities	(31		)	(87		)
GAAP measures	$	20,622		$	14,751

Income Taxes

The effective tax rate for the third quarter of 2019 was 21.08% compared to 20.21% for the third quarter of 2018. The effective tax rate for the nine months ended September 30, 2019 and 2018 was 20.57% and 19.55%, respectively.

The effective tax rate is ordinarily lower than the statutory rate of 21% due to the benefit of tax-exempt interest and excess tax benefits recognized on the exercise of stock options and the vesting of restricted stock.

Fair Value Impact to Pretax Income

The following table presents the impact for the three and nine month periods ended September 30, 2019 of the accretable and amortizable fair value adjustments attributable to the July 2011 acquisition of MidCarolina Financial Corporation ("MidCarolina"), the January 2015 acquisition of MainStreet BankShares, Inc. ("MainStreet"), and the April 2019 acquisition of HomeTown on net interest income and pretax income (dollars in thousands):



		September 30, 2019
	Income Statement Effect	Accretion (Amortization) Three Months Ended			Accretion (Amortization) Nine Months Ended
Interest income/(expense):
Acquired performing loans	Income	$	737		$	1,656
Acquired impaired loans	Income	104			461
Time deposits	Contra Expense	128			272
Subordinated debt	Contra Expense	4			8
Junior subordinated debt	Expense	(25		)	(76		)
Net interest income		948			2,321

Noninterest (expense):
Amortization of core deposit intangible	Expense	(448		)	(961		)

Change in pretax income		$	500		$	1,360

The HomeTown acquisition was effective April 1, 2019. The impact for the quarter ended September 30, 2019 related to the HomeTown merger on net interest income was $764,000 and on income before taxes was $371,000. The impact for the

nine months ended September 30, 2019 related to the HomeTown merger on net interest income was $1,648,000 and on income before taxes was $852,000.

During the third quarter of 2019, the Company received $148,000 in cash basis accretion income related to the early payoff of several acquired loans, compared to $59,000 for the comparable quarter of 2018. For the nine month period ended September 30, 2019, cash basis accretion income was $544,000, compared to $545,000 for the same period in 2018.

The following table presents the impact for the three and nine month periods ended September 30, 2018 of the accretable and amortizable fair value adjustments attributable to the acquisitions of MidCarolina and MainStreet on net interest income and pretax income (dollars in thousands):



		September 30, 2018
	Income Statement Effect	Accretion (Amortization) Three Months Ended			Accretion (Amortization) Nine Months Ended
Interest income/(expense):
Acquired performing loans	Income	$	123		$	338
Acquired impaired loans	Income	100			740
Junior subordinated debt	Expense	(25		)	(76		)
Net interest income		198			1,002

Noninterest (expense):
Amortization of core deposit intangible	Expense	(56		)	(210		)

Change in pretax income		$	142		$	792

The MidCarolina acquisition was effective July 1, 2011 and the MainStreet acquisition was effective January 1, 2015. Management expects that the acquisition accounting financial impact of these mergers will continue to decline in future quarters.

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 expense, which tends 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. Price inflation has been consistently modest over the past several years.

CHANGES IN FINANCIAL POSITION

BALANCE SHEET ANALYSIS

Securities

The securities portfolio generates income, plays a major role in the management of interest rate sensitivity, provides a source of liquidity, and is used to meet collateral requirements. The securities portfolio consists primarily of high credit quality investments, mostly federal agency, mortgage-backed, and state and municipal securities.

The available for sale securities portfolio was $308,490,000 at September 30, 2019, compared to $332,653,000 at December 31, 2018, a decrease of $24,163,000 or 7.3%. At September 30, 2019, the available for sale portfolio had an amortized cost of $304,242,000 resulting in a net unrealized gain of $4,248,000. At December 31, 2018, the available for sale portfolio had an amortized cost of $337,774,000, resulting in a net unrealized loss of $5,121,000. The Company recognized a $333,000 change in the fair value of equity securities for the nine months ended September 30, 2019. During the nine months ended September 30, 2018, the Company recognized a $312,000 change in the fair value of equity securities.

The Company is cognizant of the continuing historically low and currently decreasing rate environment and has elected to execute an asset liability strategy of purchasing high quality taxable securities of somewhat greater duration and average life than previously held. The objective is to improve yield and duration on the portfolio in advance of any major market moves. During 2019, indications are that market rates have peaked and the yield curve has flattened.

During the nine months ended September 30, 2019, the Company sold $29,878,000 in par value bonds and realized a net gain of $242,000. This compares to the nine months ended September 30, 2018, when the Company sold $57,607,000 in par value bonds and realized a net gain of $81,000. During the nine months ended September 30, 2019, the Company sold $445,000 in equity securities at fair value and had no remaining equity securities at September 30, 2019. During the nine months ended September 30, 2018, the Company sold $431,000 in equity securities at fair value

The Company manages its investment portfolio on an aggregate portfolio basis for purposes of monitoring and controlling average life and duration. Accordingly, some individual purchases may fall outside these overall guidelines. The Company will continue to purchase high quality, relatively low optionality bonds to the maximum extent practical and prudent, consistent with its liquidity and asset liability strategies, and regulatory requirements.

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.

Total loans were $1,804,447,000 at September 30, 2019, compared to $1,357,476,000 at December 31, 2018, an increase of $446,971,000 or 32.9%. Of this increase, $444,324,000 was related to the HomeTown merger and $2,647,000 represents growth throughout the rest of the Company's franchise.

Average loans were $1,821,636,000 for the third quarter of 2019, compared to $1,330,342,000 for the third quarter of 2018, an increase of $491,294,000 or 36.9% primarily related to the HomeTown acquisition but also due to organic growth.

Loans held for sale totaled $5,646,000 at September 30, 2019 and $640,000 at December 31, 2018. Loan production volume was $75,756,000 for the nine month period ended September 30, 2019 and $60,575,000 for the same period of 2018. These loans were approximately 60% purchase and 40% refinancing.

Management of the loan portfolio is organized around portfolio segments. Each segment is comprised of various loan types that are reflective of operational and regulatory reporting requirements. The following table presents the Company's loan portfolio by segment as of September 30, 2019 and December 31, 2018 (dollars in thousands):



	September 30, 2019		December 31, 2018
Commercial	$	324,508	$	285,972
Commercial real estate:
Construction and land development	143,788		97,240
Commercial real estate	883,219		655,800
Residential real estate:
Residential	318,833		209,438
Home equity	122,074		103,933
Consumer	12,025		5,093
Total loans	$	1,804,447	$	1,357,476

Provision for Loan Losses

The Company had a negative provision for loan losses of $6,000 for the nine month period ended September 30, 2019, compared to a negative provision of $97,000 for the same period ended September 30, 2018. The negative provision in both periods related to adjustments on the specific reserves for the impaired loan loss allowance. The need for any additional provision in the nine month period ended September 30, 2019 was mitigated by continued high asset quality, low charge-offs, and a third quarter $31.8 million decline in loan balances outstanding. Net charge-offs for the three months ended September 30, 2019 were $16,000 compared to a net recovery of $103,000 for the 2018 quarter. For the nine months ended September 30, 2019, net charge-offs were $41,000 compared to a net recovery of $82,000 for the 2018 period.

Allowance for Loan Losses

The purpose of the ALLL is to provide for probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance.

At September 30, 2019, the ALLL was $12,758,000, compared to $12,805,000 at December 31, 2018. The ALLL as a percentage of total loans at such dates was 0.71% and 0.94%, respectively. The primary reason for the large change in this ratio was the acquisition of $444.3 million in loans related to the April 2019 HomeTown acquisition. These loans do not have an

ALLL at acquisition date. However, as part of the merger valuation process they were given a credit mark of $10.7 million and a liquidity and interest rate mark of $4.0 million.

As part of the Company's methodology to evaluate the adequacy of its ALLL, the Company computed its ASC 450 loan balance by reducing total loans by acquired loans and loans that were evaluated for impairment individually. The FASB ASC 450 loan loss reserve balance is the total ALLL reduced by allowances associated with these other pools of loans.

The general allowance, ASC 450 (FAS 5) reserves to FASB ASC 450 loans, was 0.91% at September 30, 2019, compared to 0.97% at December 31, 2018. On a dollar basis, the reserve was $12,508,000 at September 30, 2019, compared to $12,560,000 at December 31, 2018. This segment of the allowance represents by far the largest portion of the loan portfolio and the largest aggregate risk.

The specific allowance, ASC 310-40 (FAS 114) reserves to FASB ASC 310-40 loans, was 4.60% at September 30, 2019, compared to 4.78% at December 31, 2018. On a dollar basis, the reserve was $74,000 at September 30, 2019, compared to $64,000 at December 31, 2018. There is ongoing turnover in the composition of the impaired loan population, which increased by a net $281,000 over December 31, 2018.

The specific allowance does not include reserves related to acquired loans with deteriorated credit quality. This reserve was $176,000 at September 30, 2019 compared to $181,000 at December 31, 2018. This is the only portion of the reserve related to acquired impaired loans. Cash flow expectations for these loans are reviewed on a quarterly basis and unfavorable changes in those estimates relative to the initial estimates can result in the need for additional loan loss provision. The following table presents the Company's loan loss and recovery experience for the periods indicated (dollars in thousands):



Summary of Loan Loss Experience
	Nine Months Ended September 30, 2019			Year Ended December 31, 2018
Balance at beginning of period	$	12,805		$	13,603

Charge-offs:
Construction and land development	—			—
Commercial real estate	6			11
Residential real estate	20			—
Home equity	—			86
Total real estate	26			97
Commercial and industrial	11			787
Consumer	152			136
Total charge-offs	189			1,020

Recoveries:
Construction and land development	—			4
Commercial real estate	8			6
Residential real estate	19			45
Home equity	15			104
Total real estate	42			159
Commercial and industrial	12			69
Consumer	94			97
Total recoveries	148			325

Net charge-offs	41			695
Recovery of loan losses	(6		)	(103		)
Balance at end of period	$	12,758		$	12,805

Asset Quality Indicators

The following table provides qualitative indicators relevant to the Company's loan portfolio for the nine month period and year indicated below.



Asset Quality Ratios
	September 30, 2019		December 31, 2018
Allowance to loans	0.71	%	0.94	%
ASC 450 (FAS 5) ALLL to ASC 450 loans	0.91		0.97
Net charge-offs to allowance ⁽¹⁾	0.43		5.43
Net charge-offs to average loans ⁽¹⁾	0.00		0.05
Nonperforming assets to total assets	0.15		0.11
Nonperforming loans to loans	0.13		0.09
Provision to net charge-offs ⁽¹⁾	(14.63	)	(14.82	)
Provision to average loans ⁽¹⁾	0.00		(0.01	)
Allowance to nonperforming loans	549.91		1,101.98

(1) - Annualized.

Nonperforming Assets (Loans and Other Real Estate Owned)

Nonperforming loans include loans on which interest is no longer accrued and accruing loans that are contractually past due 90 days or more. Nonperforming loans include loans originated and loans acquired.

Nonperforming loans to total loans were 0.13% at September 30, 2019 and 0.09% at December 31, 2018.

Nonperforming assets include nonperforming loans and OREO. Nonperforming assets represented 0.15% and 0.11% of total assets at September 30, 2019 and December 31, 2018, respectively.

In most cases, it is the policy of the Company that any loan that becomes 90 days past due will automatically be placed on nonaccrual loan status, accrued interest reversed out of income, and further interest accrual ceased. Any payments received on such loans will be credited to principal. In some cases a loan in process of renewal may become 90 days past due. In these instances the loan may still be accruing because of a delayed renewal process in which the customer has not been billed. In accounting for acquired impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments.

Loans will only be restored to full accrual status after six consecutive months of payments that were each less than 30 days delinquent. The Company strictly adheres with this policy before restoring a loan to normal accrual status.

The following table presents the Company's nonperforming assets as of September 30, 2019 and December 31, 2018 (dollars in thousands):



Nonperforming Assets
	September 30, 2019		December 31, 2018
Nonaccrual loans:
Real estate	$	1,336	$	1,007
Commercial	110		83
Total nonaccrual loans	1,446		1,090

Loans past due 90 days and accruing interest:
Real estate	835		72
Commercial	39		—
Total past due 90 days and accruing interest	874		72

Total nonperforming loans	2,320		1,162

Other real estate owned	1,353		869

Total nonperforming assets	$	3,673	$	2,031

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The following table shows loans that were considered impaired, exclusive of acquired impaired loans, as of September 30, 2019 and December 31, 2018 (dollars in thousands):



Impaired Loans
	September 30, 2019		December 31, 2018
Accruing	$	991	$	848
Nonaccruing	624		486
Total impaired loans	$	1,615	$	1,334

Troubled Debt Restructurings ("TDRs")

TDRs exist whenever the Company makes a concession to a customer based on the customer's financial distress that would not have otherwise been made in the normal course of business.

There were $1,093,000 in TDRs at September 30, 2019 compared to $1,090,000 at December 31, 2018. These loans are included in the impaired loan table above.

Other Real Estate Owned

Other real estate owned was $1,353,000 and $869,000 as of September 30, 2019 and December 31, 2018, respectively. OREO is initially recorded at fair value, less estimated costs to sell, at the date of foreclosure. Loan losses resulting from foreclosure are charged against the ALLL at that time. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the new cost basis or fair value, less estimated costs to sell with any additional write-downs charged against earnings. For significant assets, these valuations are typically outside annual appraisals. The following table shows the Company's OREO as of September 30, 2019 and December 31, 2018 (dollars in thousands):



Other Real Estate Owned
	September 30, 2019		December 31, 2018
Construction and land development	$	629	$	78
1-4 family residential	301		719
Commercial real estate	423		72
	$	1,353	$	869

Deposits

The Company's deposits consist primarily of checking, money market, savings, and consumer and commercial time deposits. Total deposits were $2,041,862,000 at September 30, 2019 compared to $1,566,227,000 at December 31, 2018, an increase of $475,635,000 or 30.4%. This increase resulted from, $483,626,000 of deposits acquired in the HomeTown merger, and a $7,991,000 deposit reduction throughout the franchise.

Average interest bearing deposits were $1,443,947,000 for the third quarter of 2019, compared to $1,118,929,000 for the third quarter of 2018, an increase of $325,018,000 or 29.0%. This increase is attributable to $364,158,000 of deposits acquired in the HomeTown acquisition and a reduction of legacy deposits during the same period. Average noninterest bearing deposits for the 2019 quarter were $568,706,000, compared to $424,016,000 for the 2018 quarter, an increase of $144,690,000 or 34.1%. Of this increase, $119,468,000 represents deposits acquired in the HomeTown merger.

The Company's primary focus on the liability side of the balance sheet is growing core deposits and their affiliated relationships. The challenge in this changing rate environment is to fund the Bank in a cost effective and competitive manner. The Company's cost of deposits for the third quarter of 2019 was 1.00%, up from 0.73% for the third quarter of 2018.

Subordinated Debt

The Company had $7,521,000 in subordinated notes, acquired in the HomeTown merger, outstanding at September 30, 2019. These notes accrue at 6.75% until December 30, 2020. Thereafter, the notes will have a floating interest rate based on LIBOR.

Junior Subordinated Debt

The Company had three junior subordinated notes in the amounts of $20,619,000, $4,419,000, and $2,965,000 outstanding at September 30, 2019. These notes accrue at 1.35%, 3.45%, and 2.95%, respectively, above the 90-day LIBOR rate, adjusted quarterly. To add stability to net interest income and manage exposure to interest rate movement, the Company entered into three interest rate swaps in June 2018 on these notes. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for receipt of variable rate payments over the ten year life of the contracts. The effective interest rates on the swapped notes were 4.33%, 6.44%, and 5.93%, respectively at September 30, 2019.

Shareholders' Equity

The Company's capital management strategy is to be classified as "well capitalized" under regulatory capital ratios and provide as high as possible total return to shareholders.

Shareholders' equity was $317,246,000 at September 30, 2019 compared to $222,542,000 at December 31, 2018, an increase of $94,704,000 or 42.6%. Of this increase, $83,250,000 is attributable to the HomeTown merger.

The Company paid cash dividends of $0.77 per share during the nine months of 2019 while the aggregate basic and diluted earnings per share for the same period was $1.38.

Effective January 1, 2015, the Company and the Bank became subject to the Basel III Capital Rules. The Basel III Capital Rules require the Company and the Bank to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets. The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. In addition, to be well capitalized under the "prompt corrective action" regulations pursuant to Section 38 of the FDIA, the Bank must have the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.

The following table provides information on the regulatory capital ratios for the Company and the Bank at September 30, 2019 and December 31, 2018. Management believes, as of September 30, 2019, that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject.



	Percentage At September 30, 2019				Percentage At December 31, 2018
Risk-Based Capital Ratios:	Company		Bank		Company		Bank

Common equity tier 1 capital ratio	11.63	%	12.36	%	12.55	%	13.68	%
Tier 1 capital ratio	13.08		12.36		14.46		13.68
Total capital ratio	14.15		13.04		15.35		14.57

Leverage Capital Ratio:

Tier 1 leverage ratio	10.85		10.26		11.62		10.99

Stock Repurchase Program

On January 19, 2018, the Company filed a Form 8-K with the SEC to announce the approval by its Board of Directors of a stock repurchase program. The plan authorizes the repurchase of up to 300,000 shares of the Company's common shares over a two year period.

In the nine month period ended September 30, 2019, the Company repurchased 32,165 shares at an average cost of $35.38 per share, for a total cost of $1,138,000. The Company did not repurchase any shares in the nine month period ended September 30, 2018.

Liquidity

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 in a timely manner. Liquidity management involves maintaining the Company's ability to meet the daily cash flow requirements of its customers, whether they are borrowers requiring funds or depositors desiring to withdraw funds. Additionally, the Company requires cash for various operating needs including dividends to shareholders, 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 Asset Liability Committee ("ALCO") and Board of Directors, both of which receive periodic reports of the Company's interest rate risk and liquidity position. The Company uses a computer simulation model to assist in the management of the future liquidity needs of the Company.

Liquidity sources include on balance sheet and off balance sheet sources.

Balance sheet liquidity sources include cash, amounts due from banks, loan repayments, and increases in deposits. The Company also maintains a large, high quality, very liquid bond portfolio, which is generally 50% to 60% unpledged and would, accordingly, be available for sale if necessary.

Off balance sheet sources include lines of credit from the Federal Home Loan Bank of Atlanta ("FHLB"), federal funds lines of credit, and access to the Federal Reserve Bank of Richmond's discount window.

The Company has a line of credit with the FHLB, equal to 30% of the Bank'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, second mortgage loans, home equity lines of credit, and commercial real estate loans. In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB. The Company had $190,000,000 outstanding in letters of credit at September 30, 2019 and $190,250,000 outstanding at December 31, 2018. $190,000,000 of these letters of credit provide the Bank with alternate collateral for securing public entity deposits above FDIC insurance levels, thereby providing less need for collateral pledging from the securities portfolio, and thereby maximizing on balance sheet liquidity.

Short-term borrowings are discussed in Note 8 and long-term borrowings are discussed in Note 9 in the Consolidated Financial Statements included in this report.

The Company has federal funds lines of credit established with one correspondent bank in the amount of $15,000,000 and another correspondent bank in the amount of $10,000,000, and has access to the Federal Reserve Bank of Richmond's discount window.

The Company has a relationship with Promontory Network, the sponsoring entity for the Certificate of Deposit Account Registry Service® ("CDARS"). Through CDARS, the Company is able to provide deposit customers with access to aggregate FDIC insurance in amounts exceeding $250,000. This gives the Company the ability, as and when needed, to attract and retain large deposits from insurance conscious customers. With CDARS, the Company has the option to keep deposits on balance sheet or sell them to other members of the network. Additionally, subject to certain limits, the Bank can use CDARS to purchase cost-effective funding without collateralization and in lieu of generating funds through traditional brokered CDs or the FHLB. In this manner, CDARS can provide the Company with another funding option. Thus, CDARS serves as a deposit-gathering tool and an additional liquidity management tool. Under the Economic Growth, Regulatory Relief, and Consumer Protection Act signed into law on May 24, 2018, a well-capitalized bank with a CAMELS rating of 1 or 2 may hold reciprocal deposits up to the lesser of 20 percent of its total liabilities or $5 billion without those deposits being treated as brokered deposits. Deposits through the CDARS program as of September 30, 2019 and December 31, 2018, were $16,616,000 and $22,431,000, respectively.

Management believes that these sources provide sufficient and timely liquidity, both on and off the balance sheet.

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 subsidiaries to issue trust preferred securities, the Company does not have any off-balance sheet subsidiaries. Off-balance sheet transactions at September 30, 2019 and at December 31, 2018 were as follows (dollars in thousands):



	September 30, 2019		December 31, 2018
Commitments to extend credit	$	526,311	$	362,586
Standby letters of credit	11,395		15,555
Mortgage loan rate-lock commitments	17,617		9,710

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. The increase in commitments from December 31, 2018 to September 30, 2019 is primarily attributable to the HomeTown merger. 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 in the following sections.

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 the ALCO and Board of Directors, both of which receive and review periodic reports of the Company's interest rate risk position.

The Company uses computer 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 instrument level optionality, 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 relatively 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 at September 30, 2019 is asset sensitive. Management expects that the general direction of market interest rates will be decreasing the remainder of 2019.

Earnings Simulation

The following table shows the estimated impact of changes in interest rates on net interest income as of September 30, 2019 (dollars in thousands), assuming gradual and parallel changes in interest rates, and consistent levels of assets and liabilities. Net interest income for the following twelve months is projected to increase when interest rates are higher than current rates.



Estimated Changes in Net Interest Income
	September 30, 2019
	Change in Net Interest Income
Change in interest rates	Amount			Percent
Up 4.00%	$	12,255		14.9	%
Up 3.00%	9,274			11.3
Up 2.00%	6,302			7.7
Up 1.00%	3,277			4.0
Flat	—			—
Down 0.25%	(804		)	(1.0	)
Down 1.00%	(4,814		)	(5.8	)

Management cannot predict future interest rates or their exact effect on net interest income. Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Certain limitations are inherent in such computations. Assets and liabilities may react differently than projected to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag changes in market interest rates. Interest rate shifts may not be parallel.

Changes in interest rates can cause substantial changes in the amount of prepayments of loans and mortgage-backed securities, which may in turn affect the Company's interest rate sensitivity position. Additionally, credit risk may rise if an interest rate increase adversely affects the ability of borrowers to service their debt.

Economic Value Simulation

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The economic value simulation uses instantaneous rate shocks to the balance sheet.

The following table reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the quarterly period ended September 30, 2019 (dollars in thousands):



Estimated Changes in Economic Value of Equity
	September 30, 2019
Change in interest rates	Amount		$ Change			% Change
Up 4.00%	$	430,771	$	154,899		56.1	%
Up 3.00%	405,167		129,295			46.9
Up 2.00%	372,906		97,034			35.2
Up 1.00%	330,886		55,014			19.9
Flat	275,872		—			—
Down 0.25%	259,527		(16,345		)	(5.9	)
Down 1.00%	204,894		(70,978		)	(25.7	)

Due to the current decreasing interest rate environment, no measurement was considered necessary for a further decline in interest rates. There have been no material changes to market risk as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018. 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 September 30, 2019. 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 September 30, 2019, that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on March 9, 2019.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On January 16, 2018, the Company's Board of Directors authorized a share repurchase program of up to 300,000 shares of the Company's outstanding common stock for a period of two years. Repurchases may be made through open market purchases or in privately negotiated transactions, and shares repurchased will be returned to the status of authorized and unissued shares of common stock. The actual timing, number, and value of shares repurchased under the program will be determined by management.

Shares of the Company's common stock were repurchased during the three months ended September 30, 2019, as detailed below. Under the share repurchase program, the Company has the remaining authority to repurchase up to 267,835 shares of the Company's common stock as of September 30, 2019.



Period Beginning on First Day of Month Ended	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under Plans or Programs

July 31, 2019	10,323	$	35.90	10,323	289,677
August 31, 2019	15,062	35.63		15,062	274,615
September 30, 2019	6,780	34.05		6,780	267,835
Total	32,165	$	35.38	32,165

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

(a) Required 8-K disclosures

None

(b) Changes in Nominating Process

None

ITEM 6. EXHIBITS


31.1	Section 302 Certification of Jeffrey V. Haley, President and Chief Executive Officer.


31.2	Section 302 Certification of Jeffrey W. Farrar, Executive Vice President, Chief Operating Officer and Chief Financial Officer.


32.1	Section 906 Certification of Jeffrey V. Haley, President and Chief Executive Officer.


32.2	Section 906 Certification of Jeffrey W. Farrar, Executive Vice President, Chief Operating Officer and Chief Financial Officer.

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iii) the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iv) the Consolidated Statements of Changes in Shareholders' Equity for the three and nine months ended September 30, 2019 and September 30, 2018, (v) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018, and (vi) the Notes to the Consolidated Financial Statements (furnished herewith).

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.






	By:	/s/ Jeffrey V. Haley
		Jeffrey V. Haley
		President and Chief Executive Officer
Date - November 12, 2019		(principal executive officer)

	By:	/s/ Jeffrey W. Farrar
		Jeffrey W. Farrar
		Executive Vice President,
		Chief Operating Officer and
		Chief Financial Officer
Date - November 12, 2019		(principal financial officer)

	By:	/s/ Cathy W. Liles
		Cathy W. Liles
		Senior Vice President and
		Chief Accounting Officer
Date - November 12, 2019		(principal accounting officer)