Quarterly Report (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 June 30, 2016 .



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)

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months.



Yes	x	No	o

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



Large accelerated filer o	Accelerated filer x	Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

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



Yes	o	No	x

At August 4, 2016 , the Company had 8,609,160 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 June 30, 2016 (unaudited) and December 31, 2015	3

		Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015 (unaudited)	4

		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015 (unaudited)	5

		Consolidated Statements of Changes in Shareholders' Equity for the three and six months ended June 30, 2016 and 2015 (unaudited)	6

		Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015 (unaudited)	7

		Notes to Consolidated Financial Statements (unaudited)	8

	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	35

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	58

	Item 4.	Controls and Procedures	60

Part II.		OTHER INFORMATION

	Item 1.	Legal Proceedings	61

	Item 1A.	Risk Factors	61

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61

	Item 3.	Defaults Upon Senior Securities	61

	Item 4.	Mine Safety Disclosures	61

	Item 5.	Other Information	61

	Item 6.	Exhibits	62

SIGNATURES			63

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



American National Bankshares Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share data)

				(*)
Assets	(Unaudited) June 30, 2016			December 31, 2015
Cash and due from banks	$	21,625		$	19,352
Interest-bearing deposits in other banks	51,716			75,985

Securities available for sale, at fair value	362,800			340,349
Restricted stock, at cost	5,362			5,312
Loans held for sale	4,692			3,266

Loans, net of unearned income	1,057,959			1,005,525
Less allowance for loan losses	(12,674		)	(12,601		)
Net loans	1,045,285			992,924

Premises and equipment, net	22,878			23,567
Other real estate owned, net of valuation allowance $134 in 2016 and $329 in 2015	1,289			2,184
Goodwill	43,872			43,872
Core deposit intangibles, net	2,107			2,683
Bank owned life insurance	17,885			17,658
Accrued interest receivable and other assets	22,140			20,447
Total assets	$	1,601,651		$	1,547,599

Liabilities
Demand deposits -- noninterest bearing	$	321,442		$	322,442
Demand deposits -- interest bearing	205,440			227,030
Money market deposits	252,118			200,495
Savings deposits	116,047			115,383
Time deposits	403,338			397,310
Total deposits	1,298,385			1,262,660

Customer repurchase agreements	53,369			40,611
Long-term borrowings	9,969			9,958
Junior subordinated debt	27,673			27,622
Accrued interest payable and other liabilities	9,551			8,913
Total liabilities	1,398,947			1,349,764

Shareholders' equity
Preferred stock, $5 par, 2,000,000 shares authorized, none outstanding	—			—
Common stock, $1 par, 20,000,000 shares authorized, 8,609,160 shares outstanding at June 30, 2016 and 8,622,007 shares outstanding at December 31, 2015	8,572			8,605
Capital in excess of par value	74,753			75,375
Retained earnings	115,648			111,565
Accumulated other comprehensive income, net	3,731			2,290
Total shareholders' equity	202,704			197,835
Total liabilities and shareholders' equity	$	1,601,651		$	1,547,599

(*) - 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 share and per share data) (Unaudited)
	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Interest and Dividend Income:
Interest and fees on loans	$	11,642	$	11,767	$	23,757	$	23,537
Interest on federal funds sold	—		1		—		5
Interest and dividends on securities:
Taxable	1,150		994		2,234		1,969
Tax-exempt	817		940		1,640		1,900
Dividends	93		85		184		167
Other interest income	67		50		125		98
Total interest and dividend income	13,769		13,837		27,940		27,676
Interest Expense:
Interest on deposits	1,314		1,184		2,611		2,378
Interest on short-term borrowings	1		2		2		5
Interest on long-term borrowings	81		81		162		161
Interest on junior subordinated debt	213		188		421		372
Total interest expense	1,609		1,455		3,196		2,916
Net Interest Income	12,160		12,382		24,744		24,760
Provision for Loan Losses	50		100		100		700
Net Interest Income After Provision for Loan Losses	12,110		12,282		24,644		24,060
Noninterest Income:
Trust fees	961		1,005		1,891		1,957
Service charges on deposit accounts	514		525		1,006		1,022
Other fees and commissions	656		607		1,328		1,195
Mortgage banking income	365		389		657		611
Securities gains, net	222		237		588		547
Brokerage fees	223		211		427		426
Income from Small Business Investment Companies	72		94		238		328
Other	354		190		529		328
Total noninterest income	3,367		3,258		6,664		6,414
Noninterest Expense:
Salaries	4,031		4,308		8,246		8,455
Employee benefits	1,055		1,111		2,169		2,186
Occupancy and equipment	1,059		1,024		2,158		2,196
FDIC assessment	193		195		381		380
Bank franchise tax	256		220		512		455
Core deposit intangible amortization	288		300		576		601
Data processing	459		483		903		945
Software	274		277		571		560
Other real estate owned, net	76		133		209		186
Merger related expense	—		1,502		—		1,861
Other	1,965		2,089		3,849		3,864
Total noninterest expense	9,656		11,642		19,574		21,689
Income Before Income Taxes	5,821		3,898		11,734		8,785
Income Taxes	1,733		1,018		3,518		2,390
Net Income	$	4,088	$	2,880	$	8,216	$	6,395

Net Income Per Common Share:
Basic	$	0.47	$	0.33	$	0.95	$	0.73
Diluted	$	0.47	$	0.33	$	0.95	$	0.73
Average Common Shares Outstanding:
Basic	8,610,156		8,707,504		8,610,998		8,713,528
Diluted	8,619,833		8,715,934		8,616,873		8,722,266

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 June 30,
	2016			2015
Net income	$	4,088		$	2,880

Other comprehensive income (loss):

Unrealized gains (losses) on securities available for sale	583			(2,628		)
Tax effect	(204		)	920

Reclassification adjustment for gains on sales of securities	(222		)	(237		)
Tax effect	78			82

Other comprehensive income (loss)	235			(1,863		)

Comprehensive income	$	4,323		$	1,017



American National Bankshares Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
	Six Months Ended June 30,
	2016			2015
Net income	$	8,216		$	6,395

Other comprehensive income (loss):

Unrealized gains (losses) on securities available for sale	2,805			(1,394		)
Tax effect	(982		)	488

Reclassification adjustment for gains on sales of securities	(588		)	(547		)
Tax effect	206			191

Other comprehensive income (loss)	1,441			(1,262		)

Comprehensive income	$	9,657		$	5,133

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



American National Bankshares Inc.
Consolidated Statements of Changes in Shareholders' Equity
(Dollars in thousands, except per share data) (Unaudited)
	Common Stock			Capital in Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders' Equity
Balance, December 31, 2014	$	7,872		$	57,650		$	104,594		$	3,664		$	173,780

Net income	—			—			6,395			—			6,395

Other comprehensive income (loss)	—			—			—			(1,262		)	(1,262		)

Issuance of common stock (825,586 shares)	826			19,657			—			—			20,483

Stock repurchased (51,982 shares)	(52		)	(1,123		)	—			—			(1,175		)

Stock options exercised (14,642 shares)	15			250			—			—			265

Equity based compensation (26,760 shares)	10			392			—			—			402

Cash dividends paid, $0.46 per share	—			—			(4,005		)	—			(4,005		)

Balance, June 30, 2015	$	8,671		$	76,826		$	106,984		$	2,402		$	194,883

Balance, December 31, 2015	$	8,605		$	75,375		$	111,565		$	2,290		$	197,835

Net income	—			—			8,216			—			8,216

Other comprehensive income	—			—			—			1,441			1,441

Stock repurchased (47,976 shares)	(48		)	(1,155		)	—			—			(1,203		)

Stock options exercised (4,134 shares)	4			97			—			—			101

Vesting of restricted stock (3,046 shares)	3			(3		)	—			—			—

Equity based compensation (30,995 shares)	8			439			—			—			447

Cash dividends paid, $0.48 per share	—			—			(4,133		)	—			(4,133		)

Balance, June 30, 2016	$	8,572		$	74,753		$	115,648		$	3,731		$	202,704

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)
	Six Months Ended June 30,
	2016			2015
Cash Flows from Operating Activities:
Net income	$	8,216		$	6,395
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	100			700
Depreciation	949			882
Net accretion of acquisition accounting adjustments	(1,353		)	(1,957		)
Core deposit intangible amortization	576			601
Net amortization of securities	1,356			1,369
Net gains on sale or call of securities	(588		)	(547		)
Gain on sale of loans held for sale	(514		)	(481		)
Proceeds from sales of loans held for sale	30,465			25,601
Originations of loans held for sale	(31,377		)	(27,224		)
Net loss (gain) on other real estate owned	64			(10		)
Valuation allowance on other real estate owned	76			63
Net loss (gain) on sale of premises and equipment	8			(5		)
Equity based compensation expense	447			402
Net change in bank owned life insurance	(227		)	(228		)
Deferred income tax (benefit) expense	(1,763		)	83
Net change in interest receivable	(858		)	391
Net change in other assets	151			(350		)
Net change in interest payable	13			(40		)
Net change in other liabilities	625			(1,161		)
Net cash provided by operating activities	6,366			4,484

Cash Flows from Investing Activities:
Proceeds from sales of securities available for sale	9,317			7,429
Proceeds from maturities, calls and paydowns of securities available for sale	63,183			57,846
Purchases of securities available for sale	(93,501		)	(60,117		)
Net change in restricted stock	(50		)	(224		)
Net increase in loans	(51,143		)	(26,465		)
Proceeds from sale of premises and equipment	1			42
Purchases of premises and equipment	(269		)	(601		)
Proceeds from sales of other real estate owned	852			1,047
Cash paid in bank acquisition	—			(5,935		)
Cash acquired in bank acquisition	—			18,173
Net cash used in investing activities	(71,610		)	(8,805		)

Cash Flows from Financing Activities:
Net change in demand, money market, and savings deposits	29,697			39,984
Net change in time deposits	6,028			(18,980		)
Net change in customer repurchase agreements	12,758			(3,357		)
Common stock dividends paid	(4,133		)	(4,005		)
Repurchase of common stock	(1,203		)	(1,175		)
Proceeds from exercise of stock options	101			265
Net cash provided by financing activities	43,248			12,732

Net (Decrease) Increase in Cash and Cash Equivalents	(21,996		)	8,411

Cash and Cash Equivalents at Beginning of Period	95,337			67,303

Cash and Cash Equivalents at End of Period	$	73,341		$	75,714

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 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, the valuation of deferred tax assets and liabilities, and the valuation of other real estate owned (OREO).

All significant inter-company transactions and accounts are eliminated in consolidation, with the exception of the AMNB Trust and the MidCarolina Trusts, as detailed in Note 9.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the results of the interim periods. The results of operations for the interim periods are not necessarily indicative of the results that may occur for 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, 2015 .

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern." This update is intended to provide guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-01, among other things: (1) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (2) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables); and (4) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) 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. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. 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 Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.

During March 2016, the FASB issued ASU No. 2016-05, "Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships." The amendments in this ASU clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria remain intact. The amendments are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASU 2016-05 to have a material impact on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-07, "Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting." The amendments in this ASU eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. In addition, the amendments in this ASU require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Early adoption is permitted. The Company does not expect the adoption of ASU 2016-07 to have a material impact on its consolidated financial statements.

During March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Shares-Based Payment Accounting." The amendments in this ASU simplify several aspects of the accounting for share-based payment award transactions including: (1) income tax consequences; (2) classification of awards as either equity or liabilities; and (3) classification on the statement of cash flows. The amendments are effective for public companies for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is currently assessing the impact that ASU 2016-09 will have on its consolidated financial statements.

During June 2016, the FASB issued ASU No. 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. The amendments in this ASU are effective for Securities and Exchange Commission ("SEC") filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For public companies that are not SEC filers, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.

Note 2 – Acquisition of MainStreet BankShares, Inc.

On January 1, 2015, the Company completed its acquisition of MainStreet BankShares, Inc. ("MainStreet"). The merger of MainStreet with and into the Company was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of August 24, 2014, between the Company and MainStreet, and a related Plan of Merger. Immediately after the merger, Franklin Community Bank, N.A., MainStreet's wholly owned bank subsidiary, merged with and into the Bank.

Pursuant to the MainStreet merger agreement, the former holders of shares of MainStreet common stock received $3.46 in cash and 0.482 shares of the Company's common stock for each share of MainStreet common stock held immediately prior to the effective date of the merger, plus cash in lieu of fractional shares. Each option to purchase shares of MainStreet common stock that was outstanding immediately prior to the effective date of the merger vested upon the merger and was converted into an option to purchase shares of the Company's common stock, adjusted based on a 0.643 exchange ratio. Each share of the Company's common stock outstanding immediately prior to the merger remained outstanding and was unaffected by the merger. The cash portion of the merger consideration was funded through a cash dividend of $6,000,000 from the Bank to the Company, and no borrowing was incurred by the Company or the Bank in connection with the merger. Replacement stock option awards representing 43,086 shares of the Company's common stock were granted in conjunction with the MainStreet acquisition.

MainStreet was the holding company for Franklin Community Bank, N.A. As of January 1, 2015, MainStreet had net loans of approximately $122,000,000 , total assets of approximately $164,000,000 , and total deposits of approximately $137,000,000 . Franklin Community Bank, N.A. provided banking services to its customers from three banking offices located in Rocky Mount, Hardy, and Union Hall, Virginia, which are now branch offices of the Bank.

The net impact of the amortization and accretion of premiums and discounts associated with the Company's acquisition accounting adjustments related to the MainStreet acquisition had the following impact on the Consolidated Statements of Income during the six months ended June 30, 2016 and 2015 (dollars in thousands):



	Six Months Ended
	June 30, 2016			June 30, 2015
Acquired performing loans	$	115		$	216
Purchase acquired impaired loans	370			803
CD valuation	—			—
Brokered CD valuation	—			—
Amortization of core deposit intangible	(124		)	(147		)
Net impact to income before taxes	$	361		$	872

Note 3 – Securities

The amortized cost and fair value of investments in debt and equity securities at June 30, 2016 and December 31, 2015 were as follows (dollars in thousands):



	June 30, 2016
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	100,348	$	381	$	1	$	100,728
Mortgage-backed and CMOs	80,948		1,467		19		82,396
State and municipal	162,905		6,037		7		168,935
Corporate	8,752		87		—		8,839
Equity securities	1,288		614		—		1,902
Total securities available for sale	$	354,241	$	8,586	$	27	$	362,800



	December 31, 2015
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Securities available for sale:
Federal agencies and GSEs	$	81,601	$	170	$	319	$	81,452
Mortgage-backed and CMOs	70,520		799		389		70,930
State and municipal	170,268		5,659		36		175,891
Corporate	10,619		28		57		10,590
Equity securities	1,000		486		—		1,486
Total securities available for sale	$	334,008	$	7,142	$	801	$	340,349

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 Sheet. The FRB requires the Bank to maintain stock with a par value equal to 3.0% of its outstanding capital and an additional 3.0% is on call. The FHLB requires the Bank to maintain stock in an amount equal to 4.5% of outstanding borrowings and a specific percentage of the Bank's total assets. The cost of restricted stock at June 30, 2016 and December 31, 2015 was as follows (dollars in thousands):



	June 30, 2016		December 31, 2015
FRB stock	$	3,547	$	3,535
FHLB stock	1,815		1,777
Total restricted stock	$	5,362	$	5,312

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 June 30, 2016 . The reference point for determining when securities are in an unrealized loss position is month-end. Therefore, it is possible that a security's market value exceeded its amortized cost on other days during the past twelve-month period.

Available for sale securities that have been in a continuous unrealized loss position are as follows (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	$	8,505	$	1	$	8,505	$	1	$	—	$	—
Mortgage-backed and CMOs	2,589		19		648		1		1,941		18
State and municipal	5,064		7		4,244		7		820		—
Total	$	16,158	$	27	$	13,397	$	9	$	2,761	$	18

GSE debt securities: The unrealized loss on the Company's investment in two government sponsored entity ("GSE") securities was caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2016 .

Mortgage-backed securities and CMOs: The unrealized losses on the Company's investment in six GSE mortgage-backed securities and collateralized mortgage obligations ("CMOs") were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2016 .

State and municipal securities : The unrealized losses on seven state and municipal securities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2016 .

Corporate securities : The Company had zero investments with unrealized losses in corporate securities. In prior periods when unrealized losses were shown they were caused by interest rate increases. The contractual terms of those investments did not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company did not intend to sell the investments and it was not more likely than not that the Company would be required to sell the investments before recovery of their amortized cost basis, which may have been maturity, the Company did not consider those investments to be other-than-temporarily impaired at June 30, 2016 .

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 June 30, 2016 , 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, 2015 (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	$	57,711	$	319	$	57,711	$	319	$	—	$	—
Mortgage-backed and CMOs	37,368		389		35,424		346		1,944		43
State and municipal	13,540		36		12,716		34		824		2
Corporate	5,107		57		3,530		29		1,577		28
Total	$	113,726	$	801	$	109,381	$	728	$	4,345	$	73

Other-Than-Temporary-Impaired Securities

As of June 30, 2016 and December 31, 2015 , there were no securities classified as other-than-temporary impaired.

Note 4 – Loans

Loans, excluding loans held for sale, at June 30, 2016 and December 31, 2015 , were comprised of the following (dollars in thousands):



	June 30, 2016		December 31, 2015
Commercial	$	201,381	$	177,481
Commercial real estate:
Construction and land development	89,451		72,968
Commercial real estate	438,164		430,186
Residential real estate:
Residential	216,857		220,434
Home equity	107,007		98,449
Consumer	5,099		6,007
Total loans	$	1,057,959	$	1,005,525

Acquired Loans

The outstanding principal balance and the carrying amount of these loans included in the consolidated balance sheets at June 30, 2016 and December 31, 2015 are as follows (dollars in thousands):



	June 30, 2016		December 31, 2015
Outstanding principal balance	$	123,770	$	145,380
Carrying amount	115,084		135,254

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



	June 30, 2016		December 31, 2015
Outstanding principal balance	$	36,401	$	40,951
Carrying amount	30,302		33,878

The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies FASB ASC 310-30, at June 30, 2016 and December 31, 2015 (dollars in thousands):



	June 30, 2016			December 31, 2015
Balance at January 1	$	7,299		$	1,440
Additions from merger with MainStreet	—			7,140
Accretion	(1,902		)	(4,313		)
Other changes, net	645			3,032
	$	6,042		$	7,299

Past Due Loans

The following table shows an analysis by portfolio segment of the Company's past due loans at June 30, 2016 (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	$	—	$	3	$	—	$	74	$	77	$	201,304	$	201,381
Commercial real estate:
Construction and land development	—		28		—		86		114		89,337		89,451
Commercial real estate	1		—		—		933		934		437,230		438,164
Residential:
Residential	548		258		—		1,688		2,494		214,363		216,857
Home equity	191		57		—		628		876		106,131		107,007
Consumer	29		9		—		3		41		5,058		5,099
Total	$	769	$	355	$	—	$	3,412	$	4,536	$	1,053,423	$	1,057,959

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



	30- 59 Days Past Due		60-89 Days Past Due		90 Days + Past Due and Still Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Commercial	$	137	$	—	$	—	$	90	$	227	$	177,254	$	177,481
Commercial real estate:
Construction and land development	—		—		—		258		258		72,710		72,968
Commercial real estate	135		182		—		2,497		2,814		427,372		430,186
Residential:
Residential	913		398		—		1,731		3,042		217,392		220,434
Home equity	140		12		—		620		772		97,677		98,449
Consumer	53		1		—		9		63		5,944		6,007
Total	$	1,378	$	593	$	—	$	5,205	$	7,176	$	998,349	$	1,005,525

Impaired Loans

The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at June 30, 2016 (dollars in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	3	$	3	$	—	$	3	$	—
Commercial real estate:
Construction and land development	—		—		—		—		—
Commercial real estate	1,577		1,577		—		1,096		40
Residential:
Residential	2		3		—		1		2
Home equity	6		6		—		117		1
Consumer	10		10		—		11		—
	$	1,598	$	1,599	$	—	$	1,228	$	43
With a related allowance recorded:
Commercial *	98		98		—		102		1
Commercial real estate:
Construction and land development	291		291		4		410		10
Commercial real estate	384		384		2		413		7
Residential
Residential	1,415		1,420		22		1,588		9
Home equity*	271		270		—		341		2
Consumer*	1		1		—		15		—
	$	2,460	$	2,464	$	28	$	2,869	$	29
Total:
Commercial	$	101	$	101	$	—	$	105	$	1
Commercial real estate:
Construction and land development	291		291		4		410		10
Commercial real estate	1,961		1,961		2		1,509		47
Residential:
Residential	1,417		1,423		22		1,589		11
Home equity	277		276		—		458		3
Consumer	11		11		—		26		—
	$	4,058	$	4,063	$	28	$	4,097	$	72

*Allowance is reported as zero in the table due to presentation in thousands and rounding.

The following table presents the Company's impaired loan balances by portfolio segment, excluding acquired impaired loans, at December 31, 2015 (dollars in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	4	$	4	$	—	$	47	$	—
Commercial real estate:
Construction and land development	205		205		—		220		—
Commercial real estate	1,202		1,206		—		1,504		1
Residential:
Residential	127		124		—		126		—
Home equity	173		173		—		305		—
Consumer	13		13		—		14		—
	$	1,724	$	1,725	$	—	$	2,216	$	1
With a related allowance recorded:
Commercial*	$	91	$	91	$	—	$	99	$	—
Commercial real estate:
Construction and land development	448		449		6		563		26
Commercial real estate	390		391		3		353		17
Residential:
Residential*	1,649		1,690		—		1,034		22
Home equity	397		396		25		327		—
Consumer	8		9		1		11		—
	$	2,983	$	3,026	$	35	$	2,387	$	65
Total:
Commercial	$	95	$	95	$	—	$	146	$	—
Commercial real estate:
Construction and land development	653		654		6		783		26
Commercial real estate	1,592		1,597		3		1,857		18
Residential:
Residential	1,776		1,814		—		1,160		22
Home equity	570		569		25		632		—
Consumer	21		22		1		25		—
	$	4,707	$	4,751	$	35	$	4,603	$	66

*Allowance is reported as zero in the table due to presentation in thousands and rounding.

The following tables show the detail of loans modified as troubled debt restructurings ("TDRs") during the three and six months ended June 30, 2016 included in the impaired loan balances (dollars in thousands):



	Loans Modified as a TDR for the
	Three Months Ended June 30, 2016
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	1	$	24	$	24
Commercial real estate	1	937		937
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	1	2		1
Consumer	—	—		—
Total	3	$	963	$	962



	Loans Modified as a TDR for the
	Six Months Ended June 30, 2016
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	1	$	24	$	24
Commercial real estate	2	1,005		1,003
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	1	2		1
Consumer	—	—		—
Total	4	$	1,031	$	1,028

The following tables show the detail of loans modified as TDRs during the three and six months ended June 30, 2015 included in the impaired loan balances (dollars in thousands):



	Loans Modified as a TDR for the
	Three Months Ended June 30, 2015
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	2	249		249
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	2	51		51
Consumer	—	—		—
Total	4	$	300	$	300



	Loans Modified as a TDR for the
	Six Months Ended June 30, 2015
Loan Type	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	—	$	—	$	—
Commercial real estate	3	256		255
Construction and land development	—	—		—
Home Equity	—	—		—
Residential real estate	4	394		389
Consumer	—	—		—
Total	7	$	650	$	644

During the three and six months ended June 30, 2016 and 2015 , the Company had no loans that subsequently defaulted within twelve 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 $1,208,000 in residential real estate loans in the process of foreclosure at June 30, 2016 and $ 533,000 and $ 643,000 in residential other real estate owned at June 30, 2016 and December 31, 2015 , respectively.

Risk Grades

The following table shows the Company's loan portfolio broken down by internal risk grading as of June 30, 2016 (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	$	200,609	$	86,580	$	426,666	$	199,337	$	104,426
Special Mention	683		818		6,811		12,517		1,548
Substandard	89		2,053		4,687		5,003		1,033
Doubtful	—		—		—		—		—
Total	$	201,381	$	89,451	$	438,164	$	216,857	$	107,007

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity



	Consumer

Performing	$	5,061
Nonperforming	38
Total	$	5,099

The following table shows the Company's loan portfolio broken down by internal risk grading as of December 31, 2015 (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	$	175,963	$	68,853	$	418,719	$	200,008	$	96,142
Special Mention	1,364		1,210		5,860		14,638		1,314
Substandard	154		2,905		5,607		5,788		993
Doubtful	—		—		—		—		—
Total	$	177,481	$	72,968	$	430,186	$	220,434	$	98,449

Consumer Credit Exposure

Credit Risk Profile Based on Payment Activity



	Consumer

Performing	$	5,999
Nonperforming	8
Total	$	6,007

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, or payments are less than 90 days past due, but there are other good reasons to doubt that payment will be made in full.

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

Changes in the allowance for loan losses and the reserve for unfunded lending commitments as of the indicated dates and periods are presented below (dollars in thousands):



	Six Months Ended June 30, 2016			Year Ended December 31, 2015			Six Months Ended June 30, 2015
Allowance for Loan Losses
Balance, beginning of period	$	12,601		$	12,427		$	12,427
Provision for loan losses	100			950			700
Charge-offs	(158		)	(1,200		)	(630		)
Recoveries	131			424			296
Balance, end of period	$	12,674		$	12,601		$	12,793

Reserve for Unfunded Lending Commitments
Balance, beginning of period	$	184		$	163		$	163
Provision for unfunded commitments	12			21			13
Charge-offs	—			—			—
Balance, end of period	$	196		$	184		$	176

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 six months ended June 30, 2016 (dollars in thousands):



	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2015:	$	2,065		$	6,930		$	3,546		$	60		$	12,601
Charge-offs	(40		)	—			(40		)	(78		)	(158		)
Recoveries	12			16			36			67			131
Provision for loan losses	184			(55		)	(32		)	3			100
Balance at June 30, 2016:	$	2,221		$	6,891		$	3,510		$	52		$	12,674

Balance at June 30, 2016:

Allowance for Loan Losses
Individually evaluated for impairment	$	—		$	6		$	22		$	—		$	28
Collectively evaluated for impairment	2,216			6,760			3,253			52			12,281
Acquired impaired loans	5			125			235			—			365
Total	$	2,221		$	6,891		$	3,510		$	52		$	12,674

Loans
Individually evaluated for impairment	$	101		$	2,252		$	1,694		$	11		$	4,058
Collectively evaluated for impairment	200,730			511,742			306,055			5,072			1,023,599
Acquired impaired loans	550			13,621			16,115			16			30,302
Total	$	201,381		$	527,615		$	323,864		$	5,099		$	1,057,959

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, 2015 (dollars in thousands):



	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Total
Allowance for Loan Losses
Balance at December 31, 2014:	$	1,818		$	6,814		$	3,715		$	80		$	12,427
Charge-offs	(175		)	(482		)	(323		)	(220		)	(1,200		)
Recoveries	32			124			139			129			424
Provision for loan losses	390			474			15			71			950
Balance at December 31, 2015:	$	2,065		$	6,930		$	3,546		$	60		$	12,601

Balance at December 31, 2015:

Allowance for Loan Losses
Individually evaluated for impairment	$	—		$	9		$	26		$	—		$	35
Collectively evaluated for impairment	2,065			6,750			3,284			60			12,159
Acquired impaired loans	—			171			236			—			407
Total	$	2,065		$	6,930		$	3,546		$	60		$	12,601

Loans
Individually evaluated for impairment	$	95		$	2,245		$	2,346		$	21		$	4,707
Collectively evaluated for impairment	176,798			487,177			297,281			5,684			966,940
Acquired impaired loans	588			13,732			19,256			302			33,878
Total	$	177,481		$	503,154		$	318,883		$	6,007		$	1,005,525

The allowance for loan losses is allocated to loan segments based upon historical loss factors, risk grades on individual loans, portfolio analysis of smaller balance homogenous 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, 2016.

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 MainStreet acquisition in January 2015 were $1,839,000 and are being amortized on an accelerated basis over 120 months .

The changes in the carrying amount of goodwill and intangibles for the six months ended June 30, 2016 , are as follows (dollars in thousands):



	Goodwill		Intangibles
Balance at December 31, 2015	$	43,872	$	2,683
Additions	—		—
Amortization	—		(576		)
Impairment	—		—
Balance at June 30, 2016	$	43,872	$	2,107

Note 7 – Short-term Borrowings

Short-term borrowings consist of customer repurchase agreements, overnight borrowings from the FHLB, and Federal Funds purchased. The Company has federal funds lines of credit established with two correspondent banks in the amounts of $15,000,000 , each, and, additionally, has access to the FRB's discount window. Customer repurchase agreements are collateralized by securities of the U.S. Government or its agencies 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 solely of customer repurchase agreements at June 30, 2016 and December 31, 2015 (dollars in thousands):



	June 30, 2016		December 31, 2015

Customer repurchase agreements	$	53,369	$	40,611
	$	53,369	$	40,611

Note 8 – 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 June 30, 2016 , $424,116,000 in eligible collateral was pledged under the blanket floating lien agreement which covers both short-term and long-term borrowings.

Long-term borrowings consisted of the following fixed rate, long-term advances as of June 30, 2016 and December 31, 2015 (dollars in thousands):



June 30, 2016					December 31, 2015
Due by	Advance Amount		Weighted Average Rate		Due by	Advance Amount		Weighted Average Rate

November 30, 2017	$	9,969	2.98	%	November 30, 2017	$	9,958	2.98	%

The advance due in November 2017 is net of a fair value discount of $31,000 . The original discount recorded on July 1, 2011, was a result of the merger with MidCarolina. The adjustment to the face value is being amortized into interest expense over the life of the borrowing. There were no long-term borrowings acquired in the MainStreet acquisition and no borrowings were incurred to fund the acquisition.

In the regular course of conducting its business, the Company takes deposits from political subdivisions of the states of Virginia and North Carolina. At June 30, 2016 , the Bank's public deposits totaled $160,185,000 . 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 June 30, 2016 , the Company had $70,000,000 in letters of credit with the FHLB outstanding, as well as $142,438,000 in agency, state, and municipal securities pledged to provide collateral for such deposits.

Note 9 – 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. Initially, the securities required quarterly distributions by the trust to the holder of the Trust Preferred Securities at a fixed rate of 6.66% . Effective September 30, 2011, the rate resets quarterly at the three-month LIBOR plus 1.35% . 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 June 30, 2016 and December 31, 2015 (dollars in thousands):

Issuing Entity

Date Issued

Interest Rate

Maturity Date

Principal Amount

June 30, 2016

December 31, 2015

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

4,237

4,209

MidCarolina Trust II

12/3/2003

Libor plus

2.95%

10/7/2033

2,817

2,794

27,673

27,622

The principal amounts reflected above for the MidCarolina Trusts are net of fair value adjustments of $918,000 and $946,000 , respectively at June 30, 2016 and December 31, 2015 . 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 10 – Stock Based Compensation

The Company's 2008 Stock Incentive Plan ("2008 Plan") was adopted by the Board of Directors of the Company on February 19, 2008, and approved by shareholders on April 22, 2008, at the Company's 2008 Annual Meeting of Shareholders. The 2008 Plan provides for the granting of restricted stock awards and incentive and non-statutory options to employees and directors on a periodic basis, at the discretion of the Board of Directors or a Board designated committee. The 2008 Plan authorizes the issuance of up to 500,000 shares of common stock. The 2008 Plan replaced the Company's stock option plan that was approved by the shareholders at the 1997 Annual Meeting, which expired in 2006.

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 six months ended June 30, 2016 is as follows:



	Option Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value ($000)
Outstanding at December 31, 2015	67,871		$	24.47
Acquired in acquisition	—		—
Granted	—		—
Exercised	(4,134	)	24.30
Forfeited	—		—
Expired	—		—
Outstanding at June 30, 2016	63,737		$	24.48	2.14 years	$	97
Exercisable at June 30, 2016	63,737		$	24.48	2.14 years	$	97

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. As of June 30, 2016 , there was 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 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. Restricted stock granted in 2016 cliff vests at the end of a 36 month period beginning on the date of the grant. Nonvested restricted stock activity for the six months ended June 30, 2016 is summarized in the following table.



Restricted Stock	Shares		Weighted Average Grant Date Value
Nonvested at December 31, 2015	41,563		$	22.15
Granted	24,091		22.77
Vested	(19,219	)	21.47
Forfeited	(547	)	21.98
Nonvested at June 30, 2016	45,888		$	22.76

As of June 30, 2016 and December 31, 2015 , there was $640,000 and $594,000 , respectively, in unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan. The weighted average period over which this cost is expected to be recognized is 1.71 years . The share based compensation expense for nonvested restricted stock was $249,000 and $173,000 during the first six months of 2016 and 2015 , respectively .

Starting in 2010, the Company began offering its outside directors alternatives with respect to director compensation. The regular monthly board retainer can be received in the form of either (a) $1,667 in cash or (b) shares of immediately vested, but restricted stock with a market value of $2,083 . Monthly meeting fees can also be received as $725 per meeting in cash or $900 in immediately vested, but restricted stock. For 2016 , all 13 outside directors have elected to receive stock in lieu of cash for either all or part of their monthly retainer board fees. Only outside directors receive board fees. The Company issued 7,451 and 5,953 shares and recognized share based compensation expense of $198,000 and $135,000 during the first six months of 2016 and 2015 , respectively.

Note 11 – Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on weighted average number of shares of potentially dilutive common stock. Potentially dilutive common stock had no effect on income available to common shareholders. 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 tables present basic and diluted earnings per share for the three and six month periods ended June 30, 2016 and 2015 .



	Three Months Ended June 30,
	2016			2015
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	8,610,156	$	0.47	8,707,504	$	0.33
Effect of dilutive securities - stock options	9,677	—		8,430	—
Diluted earnings per share	8,619,833	$	0.47	8,715,934	$	0.33



	Six Months Ended June 30,
	2016			2015
	Shares	Per Share Amount		Shares	Per Share Amount
Basic earnings per share	8,610,998	$	0.95	8,713,528	$	0.73
Effect of dilutive securities - stock options	5,875	—		8,738	—
Diluted earnings per share	8,616,873	$	0.95	8,722,266	$	0.73

Outstanding stock options on common stock that were not included in computing diluted earnings per share for the six month periods ended June 30, 2016 and 2015 because their effects were anti-dilutive, averaged 30,571 and 79,726 shares, respectively.

Note 12 – Employee Benefit Plans

The following information for the six months ended June 30, 2016 and 2015 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	Six months ended June 30,
	2016			2015
Service cost	$	—		$	—
Interest cost	134			148
Expected return on plan assets	(192		)	(230		)
Recognized net actuarial loss	114			308

Net periodic cost	$	56		$	226

Note 13 – Fair Value of Financial Instruments

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 FASB ASC 820, the fair value of an instrument is the price that would be received to sell an asset or paid to transfer a 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 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 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 : 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).

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



	Fair Value Measurements at June 30, 2016 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2016		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	100,728	$	—	$	100,728	$	—
Mortgage-backed and CMOs	82,396		—		82,396		—
State and municipal	168,935		—		168,935		—
Corporate	8,839		—		8,839		—
Equity securities	1,902		—		1,902		—
Total	$	362,800	$	—	$	362,800	$	—



	Fair Value Measurements at December 31, 2015 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2015		Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Federal agencies and GSEs	$	81,452	$	—	$	81,452	$	—
Mortgage-backed and CMOs	70,930		—		70,930		—
State and municipal	175,891		—		175,891		—
Corporate	10,590		—		10,590		—
Equity securities	1,486		—		—		1,486
Total	$	340,349	$	—	$	338,863	$	1,486



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Total Realized / Unrealized Gains (Losses) Included in
	Balances as of January 1, 2016		Net Income		Other Comprehensive Income		Purchases, Sales, Issuances and Settlements, Net		Transfer In (Out) of Level 3			Balances as of June 30, 2016
Securities available for sale:
Equity	$	1,486	$	—	$	93	$	—	$	(1,579	)	$	—

The Company's investment in preferred securities ,a level 3 input, was converted into common stock, a level 1 input, at June 29, 2016.

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 six month period ended June 30, 2016 or the year ended December 31, 2015 . Gains and losses on the sale of loans are recorded within income from mortgage banking 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 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). 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 other real estate owned are the same as impaired loans. Any fair value adjustments are recorded in the period incurred as a valuation allowance against other real estate owned with the associated expense included in other real estate owned 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 June 30, 2016 Using
	Balance at June 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2016		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	4,692	$	—	$	4,692	$	—
Impaired loans, net of valuation allowance	2,432		—		—		2,432
Other real estate owned, net	1,289		—		—		1,289



	Fair Value Measurements at December 31, 2015 Using
	Balance at December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2015		Level 1		Level 2		Level 3
Assets:
Loans held for sale	$	3,266	$	—	$	3,266	$	—
Impaired loans, net of valuation allowance	2,948		—		—		2,948
Other real estate owned, net	2,184		—		—		2,184

The following tables summarize the Company's quantitative information about Level 3 fair value measurements at the dates indicated:

Quantitative Information About Level 3 Fair Value Measurements at June 30, 2016



Assets	Valuation Technique	Unobservable Input	Weighted Rate

Impaired loans	Discounted appraised value	Selling cost	8	%

Other real estate owned, net	Discounted appraised value	Selling cost	6	%

Quantitative Information About Level 3 Fair Value Measurements at December 31, 2015



Assets	Valuation Technique	Unobservable Input	Weighted Rate

Securities available for sale	Third party model based techniques	Stock price in different rate environments	49	%

Impaired loans	Discounted appraised value	Selling cost	6	%
	Discounted cash flow analysis	Market rate for borrower (discount rate)	4	%

Other real estate owned, net	Discounted appraised value	Selling cost	6	%

The carrying values and estimated fair values of the Company's financial instruments at June 30, 2016 are as follows (dollars in thousands):



	Fair Value Measurements at June 30, 2016 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	73,341	$	73,341	$	—	$	—	$	73,341
Securities available for sale	362,800				362,477		—		362,477
Restricted stock	5,362		—		5,362		—		5,362
Loans held for sale	4,692		—		4,692		—		4,692
Loans, net of allowance	1,045,285		—		—		1,048,001		1,048,001
Bank owned life insurance	17,885		—		17,885		—		17,885
Accrued interest receivable	4,974		—		4,974		—		4,974

Financial Liabilities:
Deposits	$	1,298,385	$	—	$	895,047	$	405,688	$	1,300,735
Repurchase agreements	53,369		—		53,369		—		53,369
Other borrowings	9,969		—		—		10,285		10,285
Junior subordinated debt	27,673		—		—		26,856		26,856
Accrued interest payable	668		—		668		—		668

The carrying values and estimated fair values of the Company's financial instruments at December 31, 2015 are as follows (dollars in thousands):



	Fair Value Measurements at December 31, 2015 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
Financial Assets:
Cash and cash equivalents	$	95,337	$	95,337	$	—	$	—	$	95,337
Securities available for sale	340,349		—		338,863		1,486		340,349
Restricted stock	5,312		—		5,312		—		5,312
Loans held for sale	3,266		—		3,266		—		3,266
Loans, net of allowance	992,924		—		—		994,808		994,808
Bank owned life insurance	17,658		—		17,658		—		17,658
Accrued interest receivable	4,116		—		4,116		—		4,116

Financial Liabilities:
Deposits	$	1,262,660	$	—	$	865,350	$	396,551	$	1,261,901
Repurchase agreements	40,611		—		40,611		—		40,611
Other borrowings	9,958		—		—		10,293		10,293
Junior subordinated debt	27,622		—		—		22,940		22,940
Accrued interest payable	655		—		655		—		655

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and cash equivalents . The carrying amount is a reasonable estimate of fair value.

Securities . Fair values are based on quoted market prices or dealer quotes.

Restricted stock. The carrying value of restricted stock approximates fair value based on the redemption provisions of the respective entity.

Loans held for sale . The carrying amount is a reasonable estimate of fair value.

Loans. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed-rate loans are estimated based upon discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable.

Bank owned life insurance. Bank owned life insurance represents insurance policies on officers, directors, and past directors of the Company. The cash values of the policies are estimates using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.

Accrued interest receivable . The carrying amount is a reasonable estimate of fair value.

Deposits . The fair value of demand deposits, savings deposits, and money market deposits equals the carrying value. The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposit instruments would be offered to depositors for the same remaining maturities.

Repurchase agreements . The carrying amount is a reasonable estimate of fair value.

Other borrowings. The fair values of other borrowings are estimated using discounted cash flow analysis based on the interest rates for similar types of borrowing arrangements.

Junior subordinated debt . Fair value is calculated by discounting the future cash flows using the estimated current interest rates at which similar securities would be issued.

Accrued interest payable . The carrying amount is a reasonable estimate of fair value.

Off-balance sheet instruments . The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2016 and December 31, 2015 , the fair value of off-balance sheet instruments was deemed immaterial, and therefore was not included in the previous table.

The Company assumes interest rate risk (the risk that interest rates will change) in its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rates change and that change may be either favorable or unfavorable to the Company.

Note 14 – 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 on trust preferred securities and corporate items.

Segment information as of and for the three and six months ended June 30, 2016 and 2015 (unaudited), is shown in the following tables (dollars in thousands):



	Three Months Ended June 30, 2016
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	13,754	$	—	$	15		$	—		$	13,769
Interest expense	1,396		—		213			—			1,609
Noninterest income	2,177		1,184		6			—			3,367
Income (loss) before income taxes	5,566		679		(424		)	—			5,821
Net income (loss)	3,891		477		(280		)	—			4,088
Depreciation and amortization	759		3		—			—			762
Total assets	1,597,722		—		230,456			(226,527		)	1,601,651
Goodwill	43,872		—		—			—			43,872
Capital expenditures	120		—		—			—			120



	Three Months Ended June 30, 2015
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	13,822	$	—	$	15		$	—		$	13,837
Interest expense	1,267		—		188			—			1,455
Noninterest income	2,038		1,215		5			—			3,258
Income (loss) before income taxes	3,647		573		(322		)	—			3,898
Net income (loss)	2,671		422		(213		)	—			2,880
Depreciation and amortization	739		3		—			—			742
Total assets	1,522,208		—		222,526			(220,378		)	1,524,356
Goodwill	44,210		—		—			—			44,210
Capital expenditures	232		21		—			—			253



	Six Months Ended June 30, 2016
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	27,910	$	—	$	30		$	—		$	27,940
Interest expense	2,775		—		421			—			3,196
Noninterest income	4,335		2,318		11			—			6,664
Income (loss) before income taxes	11,182		1,334		(782		)	—			11,734
Net income (loss)	7,798		934		(516		)	—			8,216
Depreciation and amortization	1,519		6		—			—			1,525
Total assets	1,597,722		—		230,456			(226,527		)	1,601,651
Goodwill	43,872		—		—			—			43,872
Capital expenditures	269		—		—			—			269



	Six Months Ended June 30, 2015
	Community Banking		Trust and Investment Services		Other			Intersegment Eliminations			Total
Interest income	$	27,646	$	—	$	30		$	—		$	27,676
Interest expense	2,544		—		372			—			2,916
Noninterest income	4,021		2,383		10			—			6,414
Income (loss) before income taxes	8,154		1,223		(592		)	—			8,785
Net income (loss)	5,896		890		(391		)	—			6,395
Depreciation and amortization	1,477		6		—			—			1,483
Total assets	1,522,208		—		222,526			(220,378		)	1,524,356
Goodwill	44,210		—		—			—			44,210
Capital expenditures	580		21		—			—			601

Note 15 – Supplemental Cash Flow Information



	Six Months Ended June 30,
	2016		2015
Supplemental Schedule of Cash and Cash Equivalents:
Cash and due from banks	$	21,625	$	24,548
Interest-bearing deposits in other banks	51,716		50,758
Federal funds sold	—		408
Cash and Cash Equivalents	$	73,341	$	75,714

Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Interest on deposits and borrowed funds	$	3,183	$	2,905
Income taxes	3,397		2,415
Noncash investing and financing activities:
Transfer of loans to other real estate owned	97		1,047
Unrealized gains on securities available for sale	2,217		(1,941		)

Non-cash transactions related to acquisitions:

Assets acquired:
Investment securities	—		18,800
Restricted stock	—		738
Loans	—		114,902
Premises and equipment	—		1,475
Deferred income taxes	—		2,683
Core deposit intangible	—		1,839
Other real estate owned	—		168
Bank owned life insurance	—		1,955
Other assets	—		917

Liabilities assumed:
Deposits	—		137,323
Other liabilities	—		3,076

Consideration:
Issuance of common stock	—		20,483

Note 16 – Accumulated Other Comprehensive Income

Changes in each component of accumulated other comprehensive income ("AOCI") for the three and six months ended June 30, 2016 and 2015 (unaudited) were as follows (dollars in thousands):



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

Balance at March 31, 2015	$	6,446		$	(2,181	)	$	4,265

Net unrealized gains on securities available for sale, net of tax, $(920)	(1,708		)	—			(1,708		)

Reclassification adjustment for gains on securities, net of tax, $(82)	(155		)	—			(155		)

Balance at June 30, 2015	$	4,583		$	(2,181	)	$	2,402

Balance at March 31, 2016	$	5,328		$	(1,832	)	$	3,496

Net unrealized gains on securities available for sale, net of tax, $204	379			—			379

Reclassification adjustment for gains on securities, net of tax, $(78)	(144		)	—			(144		)

Balance at June 30, 2016	$	5,563		$	(1,832	)	$	3,731



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

Balance at December 31, 2014	$	5,845		$	(2,181	)	$	3,664

Net unrealized gains on securities available for sale, net of tax, $(488)	(906		)	—			(906		)

Reclassification adjustment for gains on securities, net of tax, $(191)	(356		)	—			(356		)

Balance at June 30, 2015	$	4,583		$	(2,181	)	$	2,402

Balance at December 31, 2015	$	4,122		$	(1,832	)	$	2,290

Net unrealized losses on securities available for sale, net of tax, $982	1,823			—			1,823

Reclassification adjustment for gains on securities, net of tax, $(206)	(382		)	—			(382		)

Balance at June 30, 2016	$	5,563		$	(1,832	)	$	3,731

Reclassifications Out of Accumulated Other Comprehensive Income

For the three and six months ended June 30, 2016 and 2015

(dollars in thousands)



For the Three Months Ended June 30, 2016	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 gain on sale of securities	$	222		Securities gains, net
	(78		)	Income taxes
Total reclassifications	$	144		Net of tax



For the Three Months Ended June 30, 2015	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 gain on sale of securities	$	237		Securities gains, net
	(82		)	Income taxes
Total reclassifications	$	155		Net of tax



For the Six Months Ended June 30, 2016	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 gain on sale of securities	$	588		Securities gains, net
	(206		)	Income taxes
Total reclassifications	$	382		Net of tax



For the Six Months Ended June 30, 2015	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 gain on sale of securities	$	547		Securities gains, net
	(191		)	Income taxes
Total reclassifications	$	356		Net of tax

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, 2015 , may affect the operations, performance, business strategy, and results of the Company. Those factors include, but are not limited to, the following:


•	Financial market volatility, including the level of interest rates, could affect the values of financial instruments and the amount of net interest income earned;


•	General economic or business conditions, either nationally or in the market areas in which the Company does business, may be less favorable than expected, resulting in deteriorating credit quality, reduced demand for credit, or a weakened ability to generate deposits;


•	Competition among financial institutions may increase, and competitors may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than the Company;


•	Businesses that the Company is engaged in may be adversely affected by legislative or regulatory changes, including changes in accounting standards;


•	The ability to retain key personnel;


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


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

Reclassification

In certain circumstances, reclassifications have been made to prior period information to conform to the 2015 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'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 and (4) goodwill impairment. 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, 2015 .

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 FASB 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. Acquired loans deemed impaired and considered collateral dependent, with the timing of the sale of loan collateral indeterminate, remain on non-accrual status and have no accretable yield.

Goodwill Impairment

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 years ended December 31, 2015 , 2014 , and 2013 .

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 impact to net interest income and pretax income from accretable and amortizable fair value adjustments attributable to the merger with MidCarolina Financial Corporation ("MidCarolina") in July 2011 and the merger with MainStreet BankShares, Inc. ("MainStreet") in January 2015.

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.

RESULTS OF OPERATIONS

Earnings Performance

Three months ended June 30, 2016 and 2015

For the quarter ended June 30, 2016 , the Company reported net income of $4,088,000 compared to $2,880,000 for the comparable quarter in 2015 . The $1,208,000 or 41.9% increase was primarily related to non-recurring MainStreet acquisition expenses, which totaled $1,502,000 for the second quarter of 2015.



SUMMARY INCOME STATEMENT
(Dollars in thousands)

Three Months Ended June 30,	2016			2015			$ Change			% Change
Interest income	$	13,769		$	13,837		$	(68	)	(0.5	)%
Interest expense	(1,609		)	(1,455		)	(154		)	10.6
Net interest income	12,160			12,382			(222		)	(1.8	)
Provision for loan losses	(50		)	(100		)	50			(50.0	)
Noninterest income	3,367			3,258			109			3.3
Noninterest expense	(9,656		)	(11,642		)	1,986			(17.1	)
Income tax expense	(1,733		)	(1,018		)	(715		)	70.2

Net income	$	4,088		$	2,880		$	1,208		41.9

Six months ended June 30, 2016 and 2015

For the six month period ended June 30, 2016 , the Company reported net income of $8,216,000 compared to $6,395,000 for the comparable period in 2015 . The $1,821,000 or 28.5% increase in earnings was primarily related to non-recurring MainStreet acquisition expenses, which totaled $1,861,000 for the first half of 2015.



SUMMARY INCOME STATEMENT
(Dollars in thousands)

Six months ended June 30,	2016			2015			$ Change			% Change
Interest income	$	27,940		$	27,676		$	264		1.0	%
Interest expense	(3,196		)	(2,916		)	(280		)	9.6
Net interest income	24,744			24,760			(16		)	(0.1	)
Provision for loan losses	(100		)	(700		)	600			(85.7	)
Noninterest income	6,664			6,414			250			3.9
Noninterest expense	(19,574		)	(21,689		)	2,115			(9.8	)
Income tax expense	(3,518		)	(2,390		)	(1,128		)	47.2

Net income	$	8,216		$	6,395		$	1,821		28.5

Net Interest Income

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

Three months ended June 30, 2016 and 2015

Net interest income on a taxable equivalent basis decreased $268,000 or 2.1%, for the second quarter of 2016 compared to the same quarter of 2015 . The decrease was a result of the decline in accretion income but was offset by increased average loans, securities and time deposits in the 2016 quarter compared to the 2015 quarter.

For the second quarter of 2016 , the Company's yield on interest-earning assets was 3.89%, compared to 4.11% for the second quarter of 2015 . The cost of interest-bearing liabilities was 0.61% compared to 0.56%, primarily related to an eight basis point increase in the cost of time deposits. The interest rate spread was 3.28% compared to 3.55%. The net interest margin, on a fully taxable equivalent basis, was 3.45% compared to 3.69%, a decrease of twenty-four basis points (0.24%).

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 June 30, 2016 and 2015 . 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 (in thousands, except rates)
	Three Months Ended June 30,

	Average Balance				Income/Expense				Yield/Rate
	2016		2015		2016		2015		2016		2015
Loans:
Commercial	$	200,000	$	155,752	$	1,976	$	1,760	3.97	%	4.53	%
Real estate	844,914		807,605		9,591		9,841		4.54		4.87
Consumer	5,166		11,562		140		205		10.90		7.11
Total loans	1,050,080		974,919		11,707		11,806		4.46		4.85

Securities:
Federal agencies & GSEs	100,205		86,815		446		324		1.78		1.49
Mortgage-backed & CMOs	81,379		61,738		425		334		2.09		2.16
State and municipal	164,788		185,848		1,472		1,720		3.57		3.70
Other	14,692		15,412		130		125		3.54		3.24
Total securities	361,064		349,813		2,473		2,503		2.74		2.86

Federal funds sold	—		6,480		—		1		—		0.06
Deposits in other banks	53,548		66,236		67		50		0.50		0.30

Total interest-earning assets	1,464,692		1,397,448		14,247		14,360		3.89		4.11

Non-earning assets	127,569		133,419

Total assets	$	1,592,261	$	1,530,867

Deposits:
Demand	$	229,639	$	237,102	43		22		0.08		0.04
Money market	221,508		195,578		91		61		0.17		0.13
Savings	117,408		109,397		14		14		0.05		0.05
Time	403,830		403,854		1,166		1,087		1.16		1.08
Total deposits	972,385		945,931		1,314		1,184		0.54		0.50

Customer repurchase agreements	47,607		51,417		1		2		0.01		0.02
Long-term borrowings	37,624		37,499		294		269		3.13		2.87
Total interest-bearing
liabilities	1,057,616		1,034,847		1,609		1,455		0.61		0.56

Noninterest bearing demand deposits	323,135		290,695
Other liabilities	9,825		8,662
Shareholders' equity	201,685		196,663
Total liabilities and
shareholders' equity	$	1,592,261	$	1,530,867

Interest rate spread									3.28	%	3.55	%
Net interest margin									3.45	%	3.69	%

Net interest income (taxable equivalent basis)					12,638		12,905
Less: Taxable equivalent adjustment					478		523
Net interest income					$	12,160	$	12,382



Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Three Months Ended June 30,
	2016 vs. 2015
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate			Volume
Loans:
Commercial	$	216		$	(240	)	$	456
Real estate	(250		)	(692		)	442
Consumer	(65		)	79			(144		)
Total loans	(99		)	(853		)	754
Securities:
Federal agencies	122			68			54
Mortgage-backed	91			(12		)	103
State and municipal	(248		)	(58		)	(190		)
Other securities	5			11			(6		)
Total securities	(30		)	9			(39		)
Federal funds sold	(1		)	(1		)	—
Deposits in other banks	16			27			(11		)
Total interest income	(114		)	(818		)	704

Interest expense
Deposits:
Demand	21			22			(1		)
Money market	30			21			9
Savings	—			(1		)	1
Time	79			79			—
Total deposits	130			121			9
Customer repurchase agreements	(1		)	(1		)	—
Other borrowings	25			24			1
Total interest expense	154			144			10
Net interest income (taxable equivalent basis)	$	(268	)	$	(962	)	$	694

Six months ended June 30, 2016 and 2015

Net interest income on a taxable equivalent basis decreased $88,000 or 0.34%, for the six months ended June 30, 2016 compared to the same period of 2015 . This change was primarily driven by a decrease in accretion income but was positively impacted by increased average loans, securities and time deposits during the 2016 period.

For the first six months of 2016 , the Company's yield on interest-earning assets was 4.01%, compared to 4.13% for the same period of 2015 . The cost of interest-bearing liabilities was 0.62% compared to 0.57%, mostly related to an eleven basis point increase in the cost of time deposits. The interest rate spread was 3.39% compared to 3.56%. The net interest margin, on a fully taxable equivalent basis, was 3.56% compared to 3.71%, a decrease of fifteen basis points (0.15%).

Net interest income for the first six months of 2016 and 2015 was positively impacted by acquisition related accretion income. For the 2016 period, acquisition related accretion income was $1,353,000 or 5.5% of total net interest income. For the 2015 period, acquisition related accretion income was $1,957,000 or 7.9% of net interest income.

The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the six months ended June 30, 2016 and 2015 . 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 (in thousands, except rates)
	Six Months Ended June 30,

	Average Balance				Income/Expense						Yield/Rate
	2016		2015		2016			2015			2016			2015
Loans:
Commercial	$	194,137	$	147,482	$	3,830		$	3,586		3.99	%		4.90	%
Real estate	834,943		804,507		19,681			19,560			4.71			4.86
Consumer	5,336		13,434		371			445			14.06			6.68
Total loans	1,034,416		965,423		23,882			23,591			4.63			4.89

Securities:
Federal agencies & GSEs	94,244		80,866		824			569			1.75			1.41
Mortgage-backed & CMOs	78,635		63,637		825			712			2.10			2.24
State and municipal	165,349		188,020		2,964			3,483			3.59			3.70
Other	15,810		15,293		278			248			3.52			3.24
Total securities	354,038		347,816		4,891			5,012			2.76			2.88

Federal funds sold	—		10,508		—			5			—			0.10
Deposits in other banks	56,157		66,425		125			98			0.45			0.30

Total interest-earning assets	1,444,611		1,390,172		28,898		28,706			4.01			4.13

Non-earning assets	127,081		134,521

Total assets	$	1,571,692	$	1,524,693

Deposits:
Demand	$	230,504	$	224,955	80			40			0.07			0.04
Money market	213,391		199,236		166			132			0.16			0.13
Savings	117,529		108,545		28			26			0.05			0.05
Time	399,904		409,283		2,337			2,180			1.18			1.07
Total deposits	961,328		942,019		2,611			2,378			0.55			0.51

Customer repurchase agreements	46,008		52,294		2			5			0.01			0.02
Long-term borrowings	37,609		37,484		583			533			3.10			2.84
Total interest-bearing
liabilities	1,044,945		1,031,797		3,196			2,916			0.62			0.57

Noninterest bearing demand deposits	316,699		286,855
Other liabilities	9,443		9,665
Shareholders' equity	200,605		196,376
Total liabilities and
shareholders' equity	$	1,571,692	$	1,524,693

Interest rate spread											3.39	%		3.56	%
Net interest margin											3.56	%		3.71	%

Net interest income (taxable equivalent basis)					25,702			25,790
Less: Taxable equivalent adjustment					958			1,030
Net interest income					$	24,744		$	24,760



Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
	Six Months Ended June 30,
	2016 vs. 2015
				Change
	Increase			Attributable to
Interest income	(Decrease)			Rate			Volume
Loans:
Commercial	$	244		$	(756	)	$	1,000
Real estate	121			(606		)	727
Consumer	(74		)	299			(373		)
Total loans	291			(1,063		)	1,354
Securities:
Federal agencies	255			152			103
Mortgage-backed	113			(47		)	160
State and municipal	(519		)	(110		)	(409		)
Other securities	30			21			9
Total securities	(121		)	16			(137		)
Federal funds sold	(5		)	(3		)	(2		)
Deposits in other banks	27			44			(17		)
Total interest income	192			(1,006		)	1,198

Interest expense
Deposits:
Demand	40			39			1
Money market	34			24			10
Savings	2			—			2
Time	157			208			(51		)
Total deposits	233			271			(38		)
Customer repurchase agreements	(3		)	(2		)	(1		)
Other borrowings	50			48			2
Total interest expense	280			317			(37		)
Net interest income (taxable equivalent basis)	$	(88	)	$	(1,323	)	$	1,235

Noninterest Income, three months ended June 30, 2016 and 2015

For the quarter ended June 30, 2016 , noninterest income increased $109,000 or 3.3% compared to the comparable 2015 quarter. Details of individual accounts are shown in the table below.



	Three Months Ended June 30,
	(Dollars in thousands)
	2016		2015		$ Change			% Change
Noninterest income:
Trust fees	$	961	$	1,005	$	(44	)	(4.4	)%
Service charges on deposit accounts	514		525		(11		)	(2.1	)
Other fees and commissions	656		607		49			8.1
Mortgage banking income	365		389		(24		)	(6.2	)
Securities gains, net	222		237		(15		)	(6.3	)
Brokerage fees	223		211		12			5.7
Income from Small Business Investment Companies (SBICs)	72		94		(22		)	(23.4	)
Other	354		190		164			86.3
Total noninterest income	$	3,367	$	3,258	$	109		3.3

Trust income decreased slightly due to volatility early in the year in the equity markets. Service charge income was virtually unchanged for the 2016 quarter compared to the 2015 quarter. Other fees and commissions were positively impacted by higher levels of debit card transaction volume. Mortgage banking income and securities gains decreased slightly in the 2016 quarter. Income from Small Business Investment Companies ("SBICs") reflected a $22,000 decrease compared to the 2015 quarter; this category of income is highly unpredictable. Other income increased $164,000 compared to the same quarter of 2015 primarily from additional income from investments in limited partnerships.

Noninterest Income, six months ended June 30, 2016 and 2015

For the six months ended June 30, 2016 , noninterest income increased $250,000 or 3.9% compared to the comparable 2015 period. Details of individual accounts are shown in the table below.



	Six Months Ended June 30,
	(Dollars in thousands)
	2016		2015		$ Change			% Change
Noninterest income:
Trust fees	$	1,891	$	1,957	$	(66	)	(3.4	)%
Service charges on deposit accounts	1,006		1,022		(16		)	(1.6	)
Other fees and commissions	1,328		1,195		133			11.1
Mortgage banking income	657		611		46			7.5
Securities gains, net	588		547		41			7.5
Brokerage fees	427		426		1			0.2
Income from Small Business Investment Companies (SBICs)	238		328		(90		)	(27.4	)
Other	529		328		201			61.3
Total noninterest income	$	6,664	$	6,414	$	250		3.9

Trust income decreased slightly for the 2016 period compared to the 2015 period primarily due to volatility early in the year in the equity markets. Other fees and commissions was positively impacted by higher levels of debit card transaction volume. Mortgage banking income was higher in the 2016 period, based on greater loan demand in existing markets and the impact of the MainStreet acquisition. Income from SBICs reflected a $90,000 decrease compared to the 2015 period; this category of income is highly unpredictable. Other income increased $201,000 compared to the 2015 period primarily due to the additional income from investments in limited partnerships during the three months ended June 30, 2016.

Noninterest Expense, three months ended June 30, 2016 and 2015

For the three months ended June 30, 2016 , noninterest expense decreased $1,986,000 or 17.1%. Details of individual accounts are shown in the table below.



	Three Months Ended June 30,
	(Dollars in thousands)
	2016		2015		$ Change			% Change
Noninterest Expense
Salaries	$	4,031	$	4,308	$	(277	)	(6.4	)%
Employee benefits	1,055		1,111		(56		)	(5.0	)
Occupancy and equipment	1,059		1,024		35			3.4
FDIC assessment	193		195		(2		)	(1.0	)
Bank franchise tax	256		220		36			16.4
Core deposit intangible amortization	288		300		(12		)	(4.0	)
Data processing	459		483		(24		)	(5.0	)
Software	274		277		(3		)	(1.1	)
Other real estate owned, net	76		133		(57		)	(42.9	)
Merger related expenses	—		1,502		(1,502		)	(100.0	)
Other	1,965		2,089		(124		)	(5.9	)
Total noninterest expense	$	9,656	$	11,642	$	(1,986	)	(17.1	)

Salaries and employee benefits expense decreased in the 2016 quarter as compared to 2015 quarter due to a decrease in full-time equivalent employees related to the integration of the MainStreet acquisition. Full time equivalent employees at the end of the 2016 quarter were 302, down from 322 for the prior year quarter. Other real estate owned expenses decreased during the 2016 quarter as a result of a reduction in the number of foreclosed properties. The largest component of the decrease in expense was the second quarter of 2015 nonrecurring merger related expenses of $1.5 million, which was 75.6% of the overall reduction.

Noninterest Expense, six months ended June 30, 2016 and 2015

For the six months ended June 30, 2016 , noninterest expense decreased $2,115,000 or 9.8%. Details of individual accounts are shown in the table below.



	Six months ended June 30,
	(Dollars in thousands)
	2016		2015		$ Change			% Change
Noninterest Expense
Salaries	$	8,246	$	8,455	$	(209	)	(2.5	)%
Employee benefits	2,169		2,186		(17		)	(0.8	)
Occupancy and equipment	2,158		2,196		(38		)	(1.7	)
FDIC assessment	381		380		1			0.3
Bank franchise tax	512		455		57			12.5
Core deposit intangible amortization	576		601		(25		)	(4.2	)
Data processing	903		945		(42		)	(4.4	)
Software	571		560		11			2.0
Other real estate owned, net	209		186		23			12.4
Merger related expenses	—		1,861		(1,861		)	(100.0	)
Other	3,849		3,864		(15		)	(0.4	)
Total noninterest expense	$	19,574	$	21,689	$	(2,115	)	(9.8	)

Salaries and employee benefits expense decreased in the 2016 period as compared to the 2015 period due to a decrease in full-time equivalent employees related to the integration of the MainStreet acquisition. The largest component of the decrease in expense was the 2015 nonrecurring merger related expenses of $1.9 million, which was 88.0% of the overall reduction.

Non-GAAP Financial Measures

The efficiency ratio is calculated by dividing noninterest expense excluding gains or losses on the sale of OREO by net interest income including tax equivalent income on nontaxable loans and securities and noninterest income and excluding (i) gains or losses on securities and (ii) gains or losses on sale of premises and equipment. The efficiency ratio for the 2016 quarter was 60.91% compared to 72.76% for the 2015 quarter. The Company expects continued improvement in this ratio in coming quarters. 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 U.S. 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 June 30,
	2016			2015
Efficiency Ratio
Noninterest expense	$	9,656		$	11,642
Subtract: loss on sale OREO	(37		)	$	(58	)
	$	9,619		$	11,584

Net interest income	$	12,160		$	12,382
Tax equivalent adjustment	479			$	523
Noninterest income	3,367			$	3,258
Subtract: gain on securities	(222		)	$	(237	)
Add/Subtract: (gain)/loss on sale of fixed assets	8			$	(5	)
	$	15,792		$	15,921

Efficiency ratio	60.91		%	72.76		%

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 2016 and 2015 is 35%. 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 (in thousands):



	Three Months Ended June 30,
	2016			2015
Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income
GAAP measures:
Interest income - loans	$	11,707		$	11,806
Interest income - investments and other	2,540			2,554
Interest expense - deposits	(1,314		)	(1,184		)
Interest expense - other borrowings	(1		)	(2		)
Interest expense - junior subordinated debt	(294		)	(269		)
Total net interest income	$	12,638		$	12,905
Less non-GAAP measures:
Tax benefit realized on non-taxable interest income - loans	$	(65	)	$	(21	)
Tax benefit realized on non-taxable interest income - municipal securities	(413		)	(502		)
Total benefit realized on non-taxable interest income	$	(478	)	$	(523	)

Income Taxes

The effective tax rate for the second quarter of 2016 was 29.77% compared to 26.12% for the second quarter of 2015 . The effective tax rate is lower than the statutory rate of 35% due to income that is not taxable for federal income tax purposes. The primary non-taxable income is that of state and municipal securities and loans. The increase in the effective tax rate of 3.65% is primarily related to a lower level of tax exempt municipal securities income.

The effective tax rate for the first six months of 2016 was 29.98% compared to 27.21% for the same period of 2015 .

Fair Value Impact to Net Income

The following table presents the impact for the three and six month periods ended June 30, 2016 of the accretable and amortizable fair value adjustments attributable to the July 2011 acquisition of MidCarolina and the January 2015 acquisition of MainStreet on net interest income and pretax income (dollars in thousands):



					June 30, 2016
	Income Statement Effect	Premium (Discount) Balance on December 31, 2015			Three Months Ended			Six Months Ended			Remaining Premium (Discount) Balance
Interest income/(expense):
Acquired performing loans	Income	$	(3,061	)	$	216		$	473		$	(2,588	)
Purchase acquired impaired loans	Income	(7,066		)	167			942			(6,124		)
FHLB advances	Expense	42			(6		)	(11		)	31
Junior subordinated debt	Expense	1,761			(25		)	(51		)	1,710
Net interest income					352			1,353

Non-interest (expense)
Amortization of core deposit intangible	Expense	$	2,683		(288		)	(576		)	$	2,107
Net non-interest expense					(288		)	(576		)

Change in pretax income					$	64		$	777

The following table presents the impact for the three and six month periods ended June 30, 2015 of the accretable and amortizable fair value adjustments attributable to the two acquisitions mentioned above on net interest income and pretax income (dollars in thousands):



					June 30, 2015
	Income Statement Effect	Premium (Discount) Balance on December 31, 2014			Additions			Three Months Ended			Six Months Ended			Remaining Premium (Discount) Balance
Interest income/(expense):
Acquired performing loans	Income	$	(3,358	)	$	(4,270	)	$	807		$	1,714		$	(5,914	)
Purchase acquired impaired loans	Income	(1,440		)	(1,208		)	(4		)	159			(2,489		)
FHLB Advances	Expense	65			—			(5		)	(11		)	54
Junior subordinated debt	Expense	1,862			—			(26		)	(51		)	1,811
CD valuation	Expense	—			(288		)	72			144			(144		)
Brokered CD valuation	Expense	—			(2		)	—			2			—
Net interest income					(5,768		)	844			1,957

Non-interest (expense)
Amortization of core deposit intangible	Expense	$	2,045		1,839			(300		)	$	(601	)	$	3,283
Net non-interest expense					1,839			(300		)	(601		)

Change in pretax income					$	(3,929	)	$	544		$	1,356

During the first quarter 2016, the Company received two substantial payoffs of acquired impaired loans from the MidCarolina acquisition that resulted in $460,000 in cash-basis accretion income. This represented approximately 34% of the total fair value related impact to net interest income for the first six months of 2016.

Generally accepted accounting principles for business combinations require the acquired balance sheet to be valued at fair value at the time of the merger. In the context of acquiring a commercial bank, most of the balance sheet is interest rate sensitive and this can generate significant discounts or premiums to contractual values. These discounts or premiums will have a potentially significant impact to net interest income and to net income.

The table below summarizes the impact of the fair value acquisition related accounting adjustments on net interest income and total pretax income of the MidCarolina ("MC" for the table below only) and MainStreet ("MS" for the table below only) acquisitions for the three and six month periods indicated (dollars in thousands):



Three Months Ended June 30,	2016									2015

	MC			MS			Total			MC			MS		Total

Net interest income	$	178		$	174		$	352		$	528		316		$	844
Core deposit amortization	(226		)	(62		)	(288		)	(227		)	(73	)	(300		)
Total pretax income	$	(48	)	$	112		$	64		$	301		243		$	544

Six Months Ended June 30,	2016									2015

	MC			MS			Total			MC			MS		Total

Net interest income	$	868		$	485		$	1,353		$	938		1,019		$	1,957
Core deposit amortization	(452		)	(124		)	(576		)	(454		)	(147	)	(601		)
Total pretax income	$	416		$	361		$	777		$	484		872		$	1,356

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 acquisitions 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. During the reported periods, inflation and interest rates have been low.

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, is used to meet collateral requirements for public deposits, and facilitates commercial customers' repurchase agreements. The portfolio consists primarily of high credit quality, very liquid securities. Federal agency and U. S. government sponsored enterprises, mortgage-backed securities, state and municipal securities, and corporates comprise the portfolio.

The available for sale securities portfolio was $362,800,000 at June 30, 2016 , compared to $340,349,000 at December 31, 2015 , an increase of $22,451,000 or 6.6%. At June 30, 2016 , the available for sale portfolio had an amortized cost of $354,241,000 resulting in a net unrealized gain of $8,559,000. At December 31, 2015 , the available for sale portfolio had an amortized cost of $334,008,000, resulting in a net unrealized gain of $6,341,000.

The Company is cognizant of the continuing historically low and recently volatile interest rate environment and has elected to maintain a defensive asset liability strategy of purchasing high quality taxable securities of relatively short duration and somewhat longer-term tax exempt securities, whose market values are not as volatile in rising rate environments as similar termed taxable investments.

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 deploy its cash 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 $1,057,959 at June 30, 2016 , compared to $1,005,525,000 at December 31, 2015 , an increase of $52,434,000 or 5.2%. The increase is a result of organic growth in the Bank's markets.

Loans held for sale totaled $4,692,000 at June 30, 2016 and $3,266,000 at December 31, 2015 . Loan production volume was $31,377,000 for the six month period ending June 30, 2016 and $59,030,000 for the year ended December 31, 2015. These loans were approximately 60% purchase and 40% refinancing.

Management of the loan portfolio is organized around classes. Each class is comprised of various loan types that are reflective of operational and regulatory management and reporting requirements. The following table presents the Company's loan portfolio by class as of June 30, 2016 and December 31, 2015 (dollars in thousands):



	June 30, 2016		December 31, 2015
Commercial	$	201,381	$	177,481
Commercial real estate:
Construction and land development	89,451		72,968
Commercial real estate	438,164		430,186
Residential real estate:
Residential	216,857		220,434
Home equity	107,007		98,449
Consumer	5,099		6,007
Total loans	$	1,057,959	$	1,005,525

Provision for Loan Losses

Provision for loan losses was $100,000 for the six month period ended June 30, 2016 , compared to $700,000 for the same period ended June 30, 2015 . The need for additional provision in the six month period ended June 30, 2016 was mitigated by improvement in various qualitative factors used in the determination of the allowance, notably asset quality and local economic conditions. Provision expense in the 2015 period was unusually large as a result of the quarterly review of expected cash flows from certain purchased credit impaired loans.

Allowance for Loan Losses ("ALLL")

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 June 30, 2016 , the ALLL was $12,674,000 compared to $12,601,000 at December 31, 2015 . The ALLL as a percentage of total loans was 1.20% and 1.25%, respectively.

As part of the Company's methodology to evaluate the adequacy of its ALLL, the Company computes its ASC 450 loan balance by reducing total loans by acquired loans and loans that were evaluated for impairment individually or smaller balance nonaccrual loans evaluated for impairment in homogeneous pools. 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 1.31% at June 30, 2016 , compared to 1.40% at December 31, 2015 . On a dollar basis, the reserve was $12,281,000 at June 30, 2016 , compared to $12,159,000 at December 31, 2015 . The percentage of the reserve to total loans has declined due to improving local economic conditions and continued improvement in asset quality. 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 0.70% at June 30, 2016 , compared to 0.74% at December 31, 2015 . On a dollar basis, the reserve was $28,000 at June 30, 2016 , compared to $35,000 at December 31, 2015 . There is ongoing turnover in the composition of the impaired loan population, which decreased by a net $649,000 over December 31, 2015 . Newly evaluated impaired loans did not have an impact on the overall impairment allowance.

The specific allowance does not include reserves related to acquired loans with deteriorated credit quality. This reserve was $365,000 at June 30, 2016 compared to $407,000 at December 31, 2015 . 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 decrease in this impairment for the current period is related to the recasting of expected cash flows during the quarter, which utilized lifetime default probabilities and loss given default estimates. This recast also incorporated an upward migration in risk grades for loans in the acquired portfolio. The following table presents the Company's loan loss and recovery experience for the periods indicated (dollars in thousands):



Summary of Loan Loss Experience
	Six Months Ended June 30, 2016		Year Ended December 31, 2015
Balance at beginning of period	$	12,601	$	12,427

Charge-offs:
Construction and land development	—		20
Commercial real estate	—		462
Residential real estate	—		15
Home equity	40		308
Total real estate	40		805
Commercial and industrial	40		175
Consumer	78		220
Total charge-offs	158		1,200

Recoveries:
Construction and land development	5		81
Commercial real estate	11		43
Residential real estate	28		121
Home equity	8		18
Total real estate	52		263
Commercial and industrial	12		32
Consumer	67		129
Total recoveries	131		424

Net charge-offs (recoveries)	27		776
Provision for loan losses	100		950
Balance at end of period	$	12,674	$	12,601

Asset Quality Indicators

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



Asset Quality Ratios
	June 30, 2016		December 31, 2015
Allowance to loans	1.20	%	1.25	%
ASC 450 (FAS 5) ALLL	1.31		1.40
Net charge-offs (recoveries) to allowance (1)	0.42		6.16
Net charge-offs (recoveries) to average loans (1)	0.01		0.08
Nonperforming assets to total assets	0.29		0.48
Nonperforming loans to loans	0.32		0.52
Provision to net charge-offs (recoveries) (1)	370.37		122.42
Provision to average loans (1)	0.02		0.10
Allowance to nonperforming loans	371.45		242.09

(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 0.32% at June 30, 2016 and 0.52% at December 31, 2015 .

Nonperforming assets include nonperforming loans and OREO. Nonperforming assets represented 0.29% of total assets at June 30, 2016 , down from 0.48% at December 31, 2015 . This decrease was related primarily to the decreases in OREO and net charge-offs.

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.

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 June 30, 2016 and December 31, 2015 (dollars in thousands):



Nonperforming Assets
	June 30, 2016		December 31, 2015
Nonaccrual loans:
Real estate	$	3,335	$	5,106
Commercial	74		90
Consumer	3		9
Total nonaccrual loans	3,412		5,205

Loans past due 90 days
and accruing interest:	—		—

Total nonperforming loans	3,412		5,205

Other real estate owned	1,289		2,184

Total nonperforming assets	$	4,701	$	7,389

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 June 30, 2016 and December 31, 2015 (dollars in thousands):



Impaired Loans
	June 30, 2016		December 31, 2015
Accruing	$	1,877	$	1,171
Nonaccruing	2,181		3,536
Total impaired loans	$	4,058	$	4,707

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 was $2,620,000 in TDRs at June 30, 2016 compared to $1,958,000 at December 31, 2015 .

Other Real Estate Owned

Other real estate owned was $1,289,000 and $2,184,000 as of June 30, 2016 and December 31, 2015 , 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 June 30, 2016 and December 31, 2015 (dollars in thousands):



Other Real Estate Owned
	June 30, 2016		December 31, 2015
Construction and land development	$	140	$	886
1-4 family residential	533		643
Commercial real estate	616		655
	$	1,289	$	2,184

Deposits

The Company's deposits consist primarily of checking, money market, savings, and consumer time deposits. Total deposits were $1,298,385,000 at June 30, 2016 compared to $1,262,660,000 at December 31, 2015 , an increase of $35,725,000 or 2.8%. This growth is mostly in non-maturity, core deposits, the heart of our balance sheet.

The Company's primary focus on the liability side of the balance sheet is growing core deposits and their affiliated relationships. The continuing challenge in this ongoing low rate environment is to fund the Bank in a cost effective and competitive manner. The Company's cost of deposits for the second quarter of 2016 was 0.54%, up from 0.50% for the second quarter of 2015 .

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 $202,704,000 at June 30, 2016 compared to $197,835,000 at December 31, 2015 , an increase of $4,869,000 or 2.5%.

The Company paid cash dividends of $0.48 per share during the first six months of 2016 while the aggregate basic and diluted earnings per share for the same period was $0.95 per share.

In July 2013, the Board of Governors of the Federal Reserve System issued final rules that make technical changes to its capital rules to align them with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final rules maintain the general structure of the prompt corrective action framework in effect at such time while incorporating certain increased minimum requirements. Effective January 1, 2015, the final rules require the Company and the Bank to comply with the following minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the Company and the Bank to maintain such minimum ratios plus a 2.5% "capital conservation buffer" (other than for the leverage ratio). The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. Management believes the Company and the Bank will be compliant with the fully phased-in requirements when they become effective January 1, 2019.

The following table provides information on the regulatory capital ratios for the Company and the Bank at June 30, 2016 and December 31, 2015 . Management believes, as of June 30, 2016 , that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject.



	Percentage At June 30, 2016		Percentage At December 31, 2015
Risk-Based Capital Ratios:	Company	Bank	Company	Bank

Common equity tier 1 capital ratio	12.45	14.09	12.88	14.58
Tier 1 capital ratio	14.69	14.09	15.23	14.58
Total capital ratio	15.75	15.13	16.34	15.67

Leverage Capital Ratio:

Tier 1 leverage ratio	11.79	11.30	12.05	11.54

Stock Repurchase Plan

On November 19, 2015, 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. The share purchase limit was established at such number to equal to approximately 3.5% of the 8,622,000 shares then outstanding at the time the Board approved the program.

In the six month period ended June 30, 2016 , the Company repurchased 47,976 shares at an average cost of $25.07 per share, for a total cost of $1,203,000. During the same period in 2015, the Company repurchased 51,982 shares at an average cost of $22.61 per share, for a total cost of $1,175,000.

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. At June 30, 2016 , principal advance obligations to the FHLB, net of acquisition related fair value adjustments, consisted of $9,969,000 in fixed-rate, long-term advances compared to $9,958,000 in fixed-rate, long-term advances at December 31, 2015 . The Company also had outstanding $70,700,000 in letters of credit at June 30, 2016 and at December 31, 2015 . The letters of credit provide the Bank with alternate collateral for securing public entity deposits above Federal Deposit Insurance Company ("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 7 and long-term borrowings are discussed in Note 8 in the Consolidated Financial Statements included in this report.

The Company has federal funds lines of credit established with two correspondent banks in the amounts of $15,000,000 each, and has access to the Federal Reserve Bank's discount window. There were no amounts outstanding under these facilities at June 30, 2016 .

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. CDARS are classified as brokered deposits; however, they are generally derived from customers with whom the Company has or wishes to have a direct and ongoing relationship. As a result, management considers these deposits functionally, though not technically, core deposits. 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. Deposits through the CDARS program as of June 30, 2016 and December 31, 2015 , were $26,549,000 and $23,633,000, 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 June 30, 2016 and at December 31, 2015 were as follows (dollars in thousands):



	June 30, 2016		December 31, 2015
Commitments to extend credit	$	333,733	$	301,360
Standby letters of credit	4,210		4,286
Mortgage loan rate-lock commitments	10,721		5,365

Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future funding requirements. Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Management

Effectively managing market risk is essential to achieving the Company's financial objectives. Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices. The Company is generally not subject to currency exchange risk or commodity price risk. The Company's primary market risk exposure is interest rate risk; however, market risk also includes liquidity risk. Both are discussed 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 June 30, 2016 is asset sensitive. Management expects that the general direction of market interest rates will be stable to up, though volatility, sometimes substantial, is anticipated in the short-term.

Earnings Simulation

The following tables show the estimated impact of changes in interest rates on net interest income as of June 30, 2016 (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
	June 30, 2016
	Change in Net Interest Income
Change in interest rates	Amount			Percent
Up 4.00%	$	6,755		13.7	%
Up 3.00%	5,165			10.5
Up 2.00%	3,487			7.1
Up 1.00%	1,747			3.5
Flat	—			—
Down 0.25%	(800		)	(1.6	)
Down 0.50%	(1,424		)	(2.9	)

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 June 30, 2016 (dollars in thousands):



Estimated Changes in Economic Value of Equity
	June 30, 2016
Change in interest rates	Amount		$ Change			% Change
Up 4.00%	$	253,903	$	70,491		38.4	%
Up 3.00%	246,887		63,475			34.6
Up 2.00%	235,258		51,846			28.3
Up 1.00%	214,558		31,146			17.0
Flat	183,412		—			—
Down 0.25%	173,976		(9,436		)	(5.1	)
Down 0.50%	170,909		(12,503		)	(6.8	)

Due to the current low 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, 2015 . 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 June 30, 2016 . 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 June 30, 2016 , 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, 2015 filed with the SEC on March 15, 2016.

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

On November 19, 2015, 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 June 30, 2016 , as detailed below. Under the share repurchase program, the Company has the remaining authority to repurchase up to 238,323 shares of the Company's common stock as of June 30, 2016 .



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

April 30, 2016	—	$	—	—	247,412
May 31, 2016	9,089	26.31		9,089	238,323
June 30, 2016	—	—		—	238,323
Total	9,089	$	26.31	9,089

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

11.0 Refer to EPS calculation in the Notes to Financial Statements

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

31.2 Section 302 Certification of William W. Traynham, Executive Vice President and Chief Financial Officer

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

32.2 Section 906 Certification of William W. Traynham, Executive Vice President and Chief Financial Officer

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015 , (ii) the Consolidated Statements of Income for the three and six months ended June 30, 2016 and June 30, 2015 , (iii) the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and June 30, 2015 , (iv) the Consolidated Statements of Changes in Shareholders' Equity for the six months ended June 30, 2016 and June 30, 2015 , (v) the Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015 , 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.






	/s/ Jeffrey V. Haley
	Jeffrey V. Haley
	President and Chief Executive Officer
Date - August 8, 2016	(principal executive officer)

	/s/ William W. Traynham
	William W. Traynham
	Executive Vice President and
	Chief Financial Officer
Date - August 8, 2016	(principal financial officer)

	/s/ Cathy W. Liles
	Cathy W. Liles
	Senior Vice President and
	Chief Accounting Officer
Date - August 8, 2016	(principal accounting officer)

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