Advances from the FHLB, including scheduled maturities subsequent to year end, at December 31 consist of the following (dollars in thousands):
| | | 2004 | 2003 |
Maturing in year endedDecember 31, | | | Amount | | | Weighted Rate | | | Amount | | | Weighted Rate | |
| 2004 | | $ | - | | | - | | $ | 11,000 | | | 2.86 | % |
| 2005 | | | 5,250 | | | 2.39 | % | | 2,000 | | | 1.24 | % |
| 2006 | | | 8,100 | | | 3.61 | % | | 8,700 | | | 3.42 | % |
| 2007 | | | 5,000 | | | 3.46 | % | | 5,400 | | | 3.66 | % |
| 2008 | | | 14,250 | | | 3.05 | % | | 15,250 | | | 3.04 | % |
| 2009 | | | 5,700 | | | 2.87 | % | | - | | | - | |
| Thereafter | | | 11,834 | | | 3.37 | % | | 9,967 | | | 3.40 | % |
| | | $ | 50,134 | | | 3.17 | % | $ | 52,317 | | | 3.13 | % |
OFF-BALANCE SHEET COMMITMENTS
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the liquidity, credit enhancement, and financing needs of its customers. These financial instruments include legally binding commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Credit risk is the principal risk associated with these instruments. The contractual amounts of these instruments represent the amount of credit risk should the instruments be fully drawn upon and the customer defaults.
To control the credit risk associated with entering into commitments and issuing letters of credit, the Company uses the same credit quality, collateral policies, and monitoring controls in making commitments and letters of credit as it does with its lending activities. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation.
Legally binding commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. The financial standby letters of credit issued by the Company are irrevocable. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. At December 31, 2004 and 2003, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material.
Approximately $812,000 and $1,326,000 of total commitments at December 31, 2004 and 2003, respectively, represent commitments to extend credit at fixed rates of interest, which exposes the Company to some degree of interest rate risk. At December 31, the Company’s total contractual amounts of commitments and letters of credit are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| Legally binding commitments to extend credit: | | | | | | | |
| Residential real estate, including prime equity lines | | $ | 20,031 | | $ | 17,890 | |
| Construction and development | | | 24,361 | | | 12,968 | |
| Commercial and industrial | | | 16,557 | | | 14,621 | |
| Consumer and overdraft protection | | | 2,336 | | | 2,373 | |
| | | 63,285 | | | 47,852 | |
| Standby letters of credit | | | 3,529 | | | 3,925 | |
| Total commitments | | $ | 66,814 | | $ | 51,777 | |
LIQUIDITY RISK MANAGEMENT
Liquidity risk is defined as the risk of loss arising from the Company’s inability to meet known near-term and projected long-term funding commitments and cash flow requirements. The objective of liquidity risk management is to ensure the ability of the Company to meet its financial obligations. These obligations are the payment of deposits on demand or at their contractual maturity; the repayment of borrowings as they mature; the payment of lease obligations as they become due; the ability to fund new and existing loan and other commitments; the payment of operating expenses; and the ability to take advantage of new business opportunities. Liquidity is measured and monitored frequently at both the parent company and the Bank levels, allowing management to better understand and react to balance sheet trends. A comprehensive liquidity analysis provides a summary of anticipated changes in loans, core deposits, and wholesale funds. Management also maintains a detailed liquidity contingency plan designed to respond to an overall decline in the condition of the banking industry or a problem specific to the Company.
Liquidity is achieved by the maintenance of assets which can easily be converted to cash; a strong base of core customer deposits; maturing short-term assets; the ability to sell marketable securities; and access to borrowed funds and capital markets. Historically,deposits have been the primary source of funds for lending and investing activities. The amortization and scheduled payment of loans and mortgage-backed securities and maturities of investment securities provide a stable source of funds, while deposit fluctuations and loan prepayments are significantly influenced by the interest rate environment and other market conditions and competitive factors. Management meets frequently and makes changes relative to the mix, maturity and pricing of assets and liabilities in order to minimize the impact on earnings from such external conditions. Deposits are attractive sources of liquidity because of their stability and generally lower cost than other funding.
In addition to deposits and normal cash flows, FHLB advances and short-term borrowings (including purchasing federal funds from other financial institutions or lines of credit through the Federal Reserve Bank) provide liquidity sources based on specific needs or if management determines that these are the best sources of funds to meet current requirements. At December 31, 2004, based on its approved line of credit equal to 25% of total assets and limited to eligible collateral available, the Bank had additional available credit of approximately $1 million from the FHLB. The Bank considers advances from the FHLB to be a reliable and readily available source of funds for both liquidity purposes and asset-liability management and interest rate risk management strategies. The Bank also had short-term lines of credit to purchase unsecured federal funds from unrelated correspondent banks with available balances of $23.1 million at December 31, 2004.
Liquid assets, consisting primarily of cash and due from banks, interest-bearing deposits at banks, federal funds sold, and unpledged investment securities available for sale, accounted for 13% and 16%, respectively, of average assets for each of the years ended December 31, 2004 and 2003. Investment securities are an important tool to the Company’s liquidity management. Securities classified as available for sale may be sold in response to changes in interest rates, liquidity needs, and/or significant prepayment risk. In management’s opinion, the Company maintains adequate levels of liquidity by retaining sufficient liquid assets and assets which can be easily converted into cash and by maintaining access to various sources of funds. The following table summarizes future contractual obligations as of December 31, 2004.
(dollars in thousands) | | | 1 Year or Less | | | >1 to 3 Years | | | >3 to 5 Years | | | Over 5 Years | | | Total | |
| Time deposits | | $ | 59,709 | | $ | 19,833 | | $ | 905 | | $ | - | | $ | 80,447 | |
| FHLB advances | | | 5,250 | | | 13,100 | | | 19,950 | | | 11,834 | | | 50,134 | |
| Operating leases | | | 192 | | | 227 | | | 156 | | | 214 | | | 789 | |
| Total contractual cash obligations | | $ | 65,151 | | $ | 33,160 | | $ | 21,011 | | $ | 12,048 | | $ | 131,370 | |
Summit Financial, the parent holding company, has limited liquidity needs required to pay operating expenses and to provide funding to its consumer finance subsidiary, Freedom Finance. Summit Financial has approximately $5.4 million in available liquidity remaining from its initial public offering and the retention of earnings. A total of $2.2 million of this liquidity was advanced to the Finance Company in the form of an intercompany loan to fund its operations as of December 31, 2004. Additional sources of liquidity for Summit Financial include borrowing funds from unrelated correspondent banks, borrowing from individuals, and payments for management fees and debt service which are made by the Company’s subsidiary on a monthly basis. Liquidity needs of Freedom Finance, primarily for the funding of loan originations, paying operating expenses, and servicing debt, have been met to date through the initial capital investment of $500,000 made by Summit Financial, retention of earnings, borrowings from unrelated private investors, and line of credit facilities provided by Summit Financial and Summit National Bank. The Company’s management believes its liquidity sources are adequate to meet its operating needs.
CAPITAL MANAGEMENT
The Company’s capital serves to support asset growth and provide protection against loss to depositors and creditors. The Company strives to maintain an optimal level of capital, commensurate with its risk profile, on which an attractive return to shareholders will be realized over both the short and long-term, while serving depositors’, creditors’ and regulatory needs. Total shareholders’ equity amounted to $37.3 million, or 11.6% of total assets, at December 31, 2004. This is compared to $32.2 million, or 9.4% of total assets, at December 31, 2003. The $5.1 million increase in total shareholders’ equity resulted principally from retention of earnings of $4.4 million, stock issued pursuant to the Company’s stock option plans totaling $1.2 million, and the increase in unrealized gain on securities available for sale. The Company’s unrealized gain on securities, net of tax, which is included in accumulated other comprehensive income, was $98,000 as of December 31, 2004 as compared to $28,000 as of December 31, 2003. Increases in equity were somewhat offset by the payment of cash dividends totaling $673,000 for the year. Book value per share at December 31, 2004 and 2003 was $8.25 and $7.47, respectively.
The Company and its bank subsidiary are subject to certain regulatory restrictions on the amount of dividends they are permitted to pay. The Company paid cash dividends totaling $0.15 and $0.10 per common share for 2004 and 2003, respectively. The Company presently intends to pay an annual cash dividend on the common stock; however, future dividends will depend upon the Company’s earnings, financial condition, capital position, and such other factors as the Board may deem relevant. Further, the ability of the Company to pay cash dividends is dependent upon its receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. The approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year exceeds that bank’s net profits (as defined by the Comptroller) for that year combined with its retained net profits (as defined by the Comptroller) for the two preceding calendar years. It is currently the Bank’s intention to pay all dividends only from the net income of the current year.
To date, the capital needs of the Company have been met through the retention of earnings, from the proceeds of its initial offering of common stock, and from the proceeds of stock issued pursuant to the Company’s stock option plans. The Company has no commitments or immediate plans for any significant capital expenditures outside of the normal course of business. The Company’s management does not know of any trends, events or uncertainties that may result in the Company’s capital resources materially increasing or decreasing.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. The purpose of these regulations is to quantitatively measure capital against risk-weighted assets, including certain off-balance sheet items. These regulations define the elements of total capital and establish minimum ratios for capital adequacy purposes. To be categorized as “well capitalized”, as defined in the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), Summit Financial and its banking subsidiary must maintain a risk-based Total Capital ratio of at least 10%, a risk-based Tier 1 Capital ratio of at least 6%, and a Tier 1 Leverage ratio of at least 5%, and not be subject to a written agreement, order, or capital directive with any of its regulators. At December 31, 2004, the Company and the Bank exceeded all regulatory required minimum capital ratios, and satisfied the requirements of the well capitalized category established by FDICIA. The following table summarizes capital ratios for the Company and the Bank at December 31, 2004 and 2003.
| | | The Company | The Bank |
| | | | 12/31/04 | | | 12/31/03 | | | 12/31/04 | | | 12/31/03 | |
| Total risk-based capital | | | 15.27 | % | | 13.75 | % | | 13.05 | % | | 12.05 | % |
| Tier 1 risk-based capital | | | 14.02 | % | | 12.50 | % | | 11.80 | % | | 10.80 | % |
| Tier 1 leverage capital | | | 11.39 | % | | 9.92 | % | | 9.57 | % | | 8.57 | % |
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the difference between the interest earned on assets and the interest paid for the liabilities used to support those assets. It is the largest component of the Company’s earnings and changes in net interest income have the greatest impact on net income. Variations in the volume and mix of assets and liabilities and their relative sensitivity to interest rate movements determine changes in net interest income.
During 2004, the Company recorded net interest income of $13.0 million, a 5% increase from the 2003 net interest income of $12.3 million. This is compared to net interest income of $11.6 million for 2002. Fluctuations in net interest income between years is related to changes in the volume of average earning assets and interest-bearing liabilities, combined with changes in average yields and rates of the corresponding assets and liabilities as demonstrated in the tables following under “Average Balance Sheets and Yield/Rates”.
Net interest margin is calculated as net interest income divided by average earning assets. For the year ended December 31, 2004, the Company’s net interest margin was 4.33% (fully tax-equivalent), compared to 4.14% in 2003 and 4.38% for 2002. The margin for 2004 increased 19 basis points from the prior year due primarily to the lower cost of funds related to the continued repricing of deposits and maturity of higher priced FHLB advances to lower current market rates during 2004. Also contributing to the increase in net interest margin is the 22 basis point increase in average prime rate in 2004. The margin for 2003 decreased 24 basis points from the prior year due to the lower yield on earning assets resulting from the 56 basis point reduction in average prime rate during the year. Lower asset yields were partially offset by a continued reduction in the Company’s cost of funds related to repricing deposits and FHLB advances to lower current market rates during 2002 and 2003.
Interest Income
Interest income for 2004 was $17.5 million, which was an increase of $97,000, or 1%, from the $17.4 million for 2003. Interest income for 2002 was $17.8 million. The increase in interest income in 2004 is related to the 1% increase in average earning assets during the year as the average yield on assets was down only slightly. The decrease between 2002 and 2003 is a result of the 12% increase in average earning assets being more than offset by the 81 basis point reduction in the average yield on assets. The tax-equivalent yield on interest-earning assets decreased from 6.63% in 2002 to 5.82% in 2003, and decreased slightly to 5.81% in 2004 due to declines in the general interest rate environment during the period through mid-year 2004.
Interest earned on the loan portfolio was $14.4 million in 2004, $14.0 million in 2003, and $14.9 million in 2002. Loans averaged $232.3 million in 2004 with an average yield of 6.19%, compared to $223.4 million in 2003 with an average yield of 6.27%, and $211.7 million in 2002 with an average yield of 7.04%. During 2004, the Company’s loan portfolio averaged 79% adjustable rates which immediately reprice with changes in the prime lending rate. This is compared to an average of 74% for 2003. Thus, the decline in average yield each year is primarily related to fluctuations in the average prime rate which dropped from 4.68% in 2002 to 4.12% in 2003. Short-term rates began to rise in July 2004 and the prime rate increased 125 basis points to average 4.34% for the year. Loan yields decreased 8 basis points in 2004 due to the increases in prime rate being more than offset by a shift in the portfolio’s mix to a higher percent of variable rate loans and the decline in the average rate on the fixed rate portion of the portfolio as new loans were added or renewed at lower current market rates. The reduction in average rate each year, offset somewhat by the higher level of average loans each year, resulted in lower interest income on loans for 2003 and 2004. The 4% increase in average loans more than offset the rate reduction for 2004 resulting in the 3% increase in interest income on loans for the year.
The second largest component of interest income is earnings from the Company’s investment portfolio which averaged $68.5 million yielding 5.04% (fully tax-equivalent) in 2004. This is compared to average securities of $74.7 million in 2003 yielding 4.95%, and $52.2 million yielding 5.81% for 2002. The fluctuations in the average yield of the investment portfolio each year is related to the timing, maturity distribution and types of securities purchased, called, matured, and sold, combined with fluctuations in the general interest rate environment. The decrease of 8% in average securities during 2004 more than offset the 9 basis point increase in yield and resulted in the decrease in interest income on investments of $298,000, or 9% between 2003 and 2004. The increase in average securities, offset somewhat by lower yields, resulted in an increase in interest income on investments of $616,000, or 23%, between 2002 and 2003.
Interest Expense
The Company’s interest expense for 2004 was $4.6 million, compared to $5.2 million for 2003 and $6.2 million for 2002. Interest-bearing liabilities averaged $253.8 million in 2004 with an average rate of 1.81%, $257.7 million in 2003 with an average rate of 2.00%, and an average of $230.3 million with an average rate of 2.68% during 2002. The 11% decrease in interest expense in 2004 was related to the 19 basis point decrease in cost of funds, combined with the 2% decline in average interest-bearing liabilities. The 16% decrease in interest expense between 2002 and 2003 was related to the 68 basis point decrease in the cost of funds, partially offset by the 12% increase in average interest-bearing liabilities. The reduction in average cost of funds for the each year between 2002 and 2004 was a direct result of declining interest rates throughout the period combined with the maturity of CDs and FHLB advances renewed at lower current market rates.
Average Balance Sheets and Yield/Rates
The following table presents certain information related to the Company’s average balance sheet, its average yields on assets, and its average costs of liabilities for the last three years. Also presented is the average yields on assets and costs of liabilities at December 31, 2004. Such yields and rates are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been calculated based on daily averages (dollars in thousands).
| | | | | | | 2004 | | | 2003 | | | 2002 | |
| | | Average Yield/Rate at 12/31/04 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans, net of unearned income (1) | | | 6.76 | % | $ | 232,301 | | $ | 14,377 | | | 6.19 | % | $ | 223,365 | | $ | 13,996 | | | 6.27 | % | $ | 211,704 | | $ | 14,914 | | | 7.04 | % |
Investment securities (taxable) (2) | | | 4.35 | % | | 47,517 | | | 2,055 | | | 4.32 | % | | 57,010 | | | 2,459 | | | 4.31 | % | | 37,425 | | | 1,934 | | | 5.17 | % |
Investment securities (non-taxable) (2) (3) | | | 6.57 | % | | 20,950 | | | 922 | | | 6.67 | % | | 17,651 | | | 816 | | | 7.00 | % | | 14,732 | | | 725 | | | 7.46 | % |
| Federal funds sold | | | 2.02 | % | | 4,240 | | | 50 | | | 1.19 | % | | 3,883 | | | 40 | | | 1.03 | % | | 4,913 | | | 80 | | | 1.63 | % |
| Investment in stock (4) | | | 3.80 | % | | 2,949 | | | 111 | | | 3.75 | % | | 2,684 | | | 106 | | | 3.95 | % | | 2,087 | | | 108 | | | 5.17 | % |
| Interest-bearing bank balances | | | 2.07 | % | | 2,096 | | | 27 | | | 1.30 | % | | 2,641 | | | 28 | | | 1.06 | % | | 3,522 | | | 60 | | | 1.70 | % |
| Total earning assets | | | 6.31 | % | | 310,053 | | $ | 17,542 | | | 5.81 | % | | 307,234 | | $ | 17,445 | | | 5.82 | % | | 274,383 | | $ | 17,821 | | | 6.63 | % |
| Non-earning assets | | | | | | 16,466 | | | | | | | | | 15,532 | | | | | | | | | 14,504 | | | | | | | |
| Total average assets | | | | | $ | 326,519 | | | | | | | | $ | 322,766 | | | | | | | | $ | 288,887 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES & SHAREHOLDERS’ EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand | | | 0.64 | % | $ | 26,280 | | $ | 116 | | | 0.44 | % | $ | 23,470 | | $ | 78 | | | 0.33 | % | $ | 21,074 | | $ | 155 | | �� | 0.73 | % |
| Savings and money market | | | 1.44 | % | | 76,764 | | | 849 | | | 1.11 | % | | 72,611 | | | 758 | | | 1.04 | % | | 75,207 | | | 1,163 | | | 1.55 | % |
Time deposits, $100,000 and over | | | 2.25 | % | | 51,905 | | | 1,054 | | | 2.03 | % | | 58,136 | | | 1,353 | | | 2.33 | % | | 49,860 | | | 1,579 | | | 3.17 | % |
| Other time deposits | | | 2.26 | % | | 47,930 | | | 988 | | | 2.06 | % | | 57,831 | | | 1,361 | | | 2.35 | % | | 51,490 | | | 1,701 | | | 3.30 | % |
| Total interest-bearing deposits | | | 1.65 | % | | 202,879 | | | 3,007 | | | 1.48 | % | | 212,048 | | | 3,550 | | | 1.67 | % | | 197,631 | | | 4,598 | | | 2.33 | % |
| FHLB advances | | | 3.13 | % | | 50,356 | | | 1,576 | | | 3.13 | % | | 44,655 | | | 1,590 | | | 3.56 | % | | 32,207 | | | 1,563 | | | 4.85 | % |
Federal funds purchased and other short-term borrowings | | | - | | | 527 | | | 7 | | | 1.34 | % | | 1,030 | | | 16 | | | 1.55 | % | | 441 | | | 13 | | | 2.85 | % |
| Total interest-bearing liabilities | | | 1.96 | % | | 253,762 | | $ | 4,590 | | | 1.81 | % | | 257,733 | | $ | 5,156 | | | 2.00 | % | | 230,279 | | $ | 6,174 | | | 2.68 | % |
| Noninterest-bearing deposits | | | | | | 35,969 | | | | | | | | | 32,132 | | | | | | | | | 29,678 | | | | | | | |
Other noninterest-bearing liabilities | | | | | | 2,137 | | | | | | | | | 2,343 | | | | | | | | | 2,503 | | | | | | | |
| Total liabilities | | | | | | 291,868 | | | | | | | | | 292,208 | | | | | | | | | 262,460 | | | | | | | |
| Shareholders’ equity | | | | | | 34,651 | | | | | | | | | 30,558 | | | | | | | | | 26,427 | | | | | | | |
| Total average liabilities and equity | | | | | $ | 326,519 | | | | | | | | $ | 322,766 | | | | | | | | $ | 288,887 | | | | | | | |
| Net interest margin (5) | | | | | | | | $ | 12,952 | | | 4.33 | % | | | | $ | 12,289 | | | 4.14 | % | | | | $ | 11,647 | | | 4.38 | % |
| Interest rate spread (6) | | | | | | | | | | | | 4.00 | % | | | | | | | | 3.82 | % | | | | | | | | 3.95 | % |
| (1) - Average loans are stated net of unearned income and include nonaccrual loans. Interest recognized on non-accrual loans has been included ininterest income. |
(2) - Average yield on investment securities is computed using historical cost balances; the yield information does not give effect to changes in fair valuethat are reflected as a component of shareholders’ equity. |
| (3) - Yields on nontaxable investment securities have been adjusted to a tax equivalent basis assuming a 34% Federal tax rate. |
| (4) - Includes investments in stock of Federal Reserve Bank, Federal Home Loan Bank, and other equities. |
(5) - Net interest margin is computed by dividing net interest income (adjusted to a tax equivalent basis assuming a 34% Federal tax rate) by total averageearning assets. |
| (6) - Interest rate spread is the difference between the average yield on earning assets and the average rate on interest-bearing liabilities. |
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income, interest expense and net interest income attributable to changes in the volume of interest-earning assets and interest-bearing liabilities and the amount attributable to changes in rates earned and paid on the corresponding assets and liabilities (dollars in thousands).
| | | 2003 - 2004 | | 2002 - 2003 | |
| | | Change Related to | | | | Change Related to | | | |
| | | Volume | | | Rate | | | Rate/ Volume | | | Total Change | | | Volume | | | Rate | | | Rate/ Volume | | | Total Change | |
Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans, net of unearned income | | $ | 560 | | $ | (172 | ) | $ | (7 | ) | $ | 381 | | $ | 821 | | $ | (1,648 | ) | $ | (91 | ) | $ | (918 | ) |
| Investment securities (taxable) | | | (409 | ) | | 6 | | | (1 | ) | | (404 | ) | | 1,012 | | | (320 | ) | | (167 | ) | | 525 | |
| Investment securities (non-taxable) | | | 152 | | | (39 | ) | | (7 | ) | | 106 | | | 144 | | | (44 | ) | | (9 | ) | | 91 | |
| Federal funds sold | | | 4 | | | 6 | | | - | | | 10 | | | (17 | ) | | (29 | ) | | 6 | | | (40 | ) |
| Other | | | 4 | | | 1 | | | (1 | ) | | 4 | | | (8 | ) | | (27 | ) | | 1 | | | (34 | ) |
| Total interest income | | | 311 | | | (198 | ) | | (16 | ) | | 97 | | | 1,952 | | | (2,068 | ) | | (260 | ) | | (376 | ) |
Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand | | | 10 | | | 25 | | | 3 | | | 38 | | | 17 | | | (84 | ) | | (10 | ) | | (77 | ) |
| Savings and money market accounts | | | 43 | | | 46 | | | 2 | | | 91 | | | (40 | ) | | (378 | ) | | 13 | | | (405 | ) |
| Time deposits, $100,000 and over | | | (145 | ) | | (173 | ) | | 19 | | | (299 | ) | | 262 | | | (419 | ) | | (69 | ) | | (226 | ) |
| Other time deposits | | | (233 | ) | | (170 | ) | | 30 | | | (373 | ) | | 209 | | | (489 | ) | | (60 | ) | | (340 | ) |
| Total interest-bearing deposits | | | (325 | ) | | (272 | ) | | 54 | | | (543 | ) | | 448 | | | (1,370 | ) | | (126 | ) | | (1,048 | ) |
| FHLB advances | | | 203 | | | (192 | ) | | (25 | ) | | (14 | ) | | 604 | | | (416 | ) | | (161 | | | 27 | |
| Other | | | (8 | ) | | (2 | ) | | 1 | | | (9 | ) | | 17 | | | (6 | ) | | (8 | ) | | 3 | |
| Total interest expense | | | (130 | ) | | (466 | ) | | 30 | | | (566 | ) | | 1,069 | | | (1,792 | ) | | (295 | ) | | (1,018 | ) |
Net Interest Differential | | $ | 441 | | $ | 268 | | $ | (46 | ) | $ | 663 | | $ | 883 | | $ | (276 | ) | $ | 35 | | $ | 642 | |
Provision for Loan Losses
The provision for loan losses was $436,000 in 2004, $786,000 in 2003, and $847,000 in 2002. A component of the change in the provision each year is the level of net originations as follows: $10.9 million in 2004, $13.7 million in 2003, and $12.2 million in 2002. As discussed under the “Allowance for Loan Losses” section above, other factors influencing the amount charged to the provision each year include the total amount of past due, classified, and “watch list” loans, trends in nonperforming assets, charge-off activity each year, and the percentage of Finance Company loans to the consolidated totals. Thus, in addition to the general economic uncertainty starting prior to 2002 and continuing into 2004, factors contributing to the fluctuations in the level of provision each year included changes in net charge-off activity of 0.10% of average loans in 2004, 0.32% in 2003 and 0.20% in 2002; and the fluctuations in nonperforming assets which amounted to 0.37%, 0.38%, and 0.22% of gross loans plus OREO at December 31, 2004, 2003, and 2002, respectively. Somewhat offsetting the previously mentioned factors and contributing to the lower provision in 2004 are trends in the Bank’s total “watch list” loans, which include classified loans, non-accrual loans, and other assets especially mentioned (“OAEM”) in the Bank’s internal credit grading procedures and periodic reviews. Total watch list loans have decreased totaling 7.9%, 7.6%, and 4.9%, respectively, of gross loans at December 31, 2002, 2003, and 2004. Finally, the percentage of Finance Company loans, which have inherently more risk than do loans of the Bank, has decreased each year representing 1.62%, 1.41%, and 1.26%, respectively, of consolidated loans at December 31, 2002, 2003, and 2004, thus contributing to the lower provisions required each year. Estimates charged to the provision for loan losses are based on management’s judgment as to the amount required to cover probable losses in the loan portfolio, and are adjusted as necessary based on a calculated model quantifying the estimated required balance in the allowance.
Noninterest Income and Expenses
Noninterest income decreased $614,000, or 21%, in 2004 to $2.3 million from $2.9 million in 2003 and $2.7 million in 2002. Fluctuations in service charges and fees on deposit accounts, which decreased 13% in 2004 to $480,000 and decreased slightly in 2003 to $550,000 from $553,000 in 2002, is related to the level of and changes in transaction fees and number of Bank deposit accounts, as well as fluctuations in the volume of transactions subject to service charges, NSF and other fees each year. The decline in 2004 was primarily related to lower service charges ($33,000) due to changes in transaction accounts, and a reduction in NSF fee income ($39,000) related to numerous accounts with recurring overdrafts being closed during the year.
Insurance commission fee income increased $150,000, or 34%, to $588,000 from $438,000 in 2003 and $587,000 in 2002, primarily related to fluctuations in market conditions affecting the volume of annuity product sales made by the Bank’s nondeposit investment subsidiary. In addition, there was one more full time licensed broker during 2004 as compared to 2003 contributing to the higher volume of sales transactions. Offsetting the higher insurance commission fees and contributing to the decrease in total noninterest income for 2004 was the lower gain on sale of securities, which decreased $284,000 to total $83,000. This is compared to gains on sales of $367,000 for 2003 and $117,000 for 2002. Fluctuations in gain on sales of investment securities each year are primarily related to the volume of investment sales each year from the Company’s available for sale investment portfolio. In addition to the volume of transactions, changes in general market interest rates and thus, the market valuations, affect the amount of gain recorded.
The line item “other income” was down $410,000, or 26%, in 2004 and up $161,000, or 11%, in 2003. The decrease in 2004 is primarily related to lower level of mortgage loan referral fees which decreased $223,000 in 2004 as the level of refinancing declined; and (2) the decline of $166,000 in merchant discount and transaction fees related to the Company’s outsourcing the operations of this product in mid-2004 and thereafter, receiving a residual net revenue amount. Additional fluctuations in other income are related to the normal activity of the Bank and the level of transactions each year.
Noninterest expense totaled $8.4 million in 2004, $8.9 million in 2003, and $8.4 million in 2002. The most significant item included in noninterest expense is salaries, wages and benefits which amounted to $5.4 million in 2004, $5.2 million in 2003, and $5.1 million in 2002. The increase of $157,000, or 3%, in 2004 was primarily related to normal annual raises, higher commissions on nondeposit product sales, and increases in group health insurance premiums. These increases were offset somewhat by lower bonus accruals in 2004. The increase of $153,000, or 3%, in 2003 was primarily related to normal annual raises and increases in group health insurance premiums, somewhat offset by lower bonuses in 2003 and lower commission expense on nondeposit product sales due to less volume in 2003.
Occupancy and furniture, fixtures, and equipment expenses decreased slightly (1.8%) in 2004 and remained fairly flat between 2002 and 2003 due to reductions in depreciation for fully depreciated assets being offset by normal increases in utilities, maintenance, and other ongoing occupancy and equipment expenses. There were no significant changes in facilities in any year presented.
Included in the line item “other expenses”, which decreased $572,000, or 24%, in 2004 and increased $279,000, or 13%, between 2002 and 2003, are charges for advertising and public relations; insurance claims and premiums; printing and office support; merchant program expenses; legal and professional services; and other branch and customer related expenses. A majority of these items are related directly to the normal operations of the Bank and fluctuate in relation to the changes in assets, fluctuations in transaction volume, and the number of customer loan and deposit accounts. A significant contribution to the decrease in 2004 and a majority of the increase in 2003 is related to a $166,000 prepayment penalty incurred on the early repayment of higher cost FHLB advances during 2003. Other decreases in 2004 are related to (1) lower advertising and public relations expense of $189,000 related to fewer promotional campaigns as compared to the prior year and a substantial reduction in the frequency of newspaper advertising as compared to the prior year; (2) reductions in consultant and other professional fees ($96,000) related to fewer contracted services and projects in 2004; (3) lower legal fees ($22,000) as there was less required for loan collection matters; and (4) a decline in merchant processing transaction expense of $169,000 due to the Company’s outsourcing the operations of this product in mid-2004 and thereafter, receiving a residual net revenue amount. Decreases in expense were offset somewhat by an increase of $79,000 in expenses associated with other real estate owned. The increase in other expenses for 2003, in addition to the FHLB prepayment penalty previously discussed, is a result of higher legal and consultant fees ($60,000) for collection matters and special projects, and higher advertising ($43,000) related to new marketing campaigns.
Income Taxes
The Company recorded an income tax provision of $2.0 million, $1.8 million, and $1.6 million in 2004, 2003, and 2002, respectively. The effective tax rate in each year was 30.6%, 31.5%, and 31.5%, respectively for the years ended December 31, 2004, 2003, and 2002. The slight decrease in effective rate for 2004 is primarily related to fluctuations in municipal securities and other tax-free income sources.
Return on Equity and Assets
The return on average shareholders’ equity ratio (net income divided by average total equity) and the return on average assets ratio (net income divided by average total assets) for the years ended December 31 are presented in the following table.
| | | | 2004 | | | 2003 | | | 2002 | |
| Return on average assets | | | 1.36 | % | | 1.18 | % | | 1.19 | % |
| Return on average shareholders’ equity | | | 12.81 | % | | 12.46 | % | | 13.02 | % |
| Average shareholders’ equity as a percent ofaverage assets | | | 10.61 | % | | 9.47 | % | | 9.15 | % |
MARKET RISK AND ASSET-LIABILITY MANAGEMENT
The Company’s primary earnings source is its net interest income; therefore, the Company devotes significant time and has invested in resources to assist in the management of market risk. The Company’s net interest income is affected by changes in market interest rates, and by the level and composition of earning assets and interest-bearing liabilities. The Company’s objectives in its asset-liability management are to utilize its capital effectively, to provide adequate liquidity and enhance net interest income, without taking undue risks or subjecting the Company unduly to interest rate fluctuations. The Company takes a coordinated approach to the management of its capital, liquidity, and interest rate risk.
Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk inherent in its lending, investment, deposit, and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Other types of market risks, such as foreign currency exchange rate risk, and equity and commodity price risk, do not arise in the normal course of the Company’s business. Interest rate risk is the exposure to changes in market interest rates. The major source of the Company’s interest rate risk is the difference in the maturity and repricing characteristics between core banking assets and liabilities — loans and deposits. This difference, or mismatch, poses a risk to net interest income. The Company attempts to control the mix and maturities of assets and liabilities to maintain a reasonable balance between exposure to interest rate fluctuations and earnings and to achieve consistent growth in net interest income, while maintaining adequate liquidity and capital. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on earning assets and interest-bearing liabilities do not change at the same speed, to the same extent, or on the same basis.
The Company monitors the interest rate sensitivity of its balance sheet position and controls this risk by identifying and quantifying exposures in its near-term sensitivity through the use of simulation and valuation models, as well as its long-term gap position, reflecting the known or assumed maturity, repricing, and other cash flow characteristics of assets and liabilities. The Company’s simulation analysis involves dynamically modeling interest income and expense from current assets and liabilities over a specified time period under various interest rate scenarios and balance sheet structures, primarily to measure the sensitivity of net interest income over relatively short (e.g., < 2-year) time horizons. As the future path of interest rates cannot be known in advance, management uses simulation analysis to project earnings under various interest rate scenarios including reasonable or “most likely”, as well as deliberately extreme and perhaps unlikely, scenarios. Key assumptions in these simulation analyses relate to the behavior of interest rates and spreads, changes in the mix and volume of assets and liabilities, repricing and/or runoff of deposits, and, most importantly, the relative sensitivity of the Company’s assets and liabilities to changes in market interest rates. This relative sensitivity is important to consider as the Company’s core deposit base has not been subject to the same degree of interest rate sensitivity as its assets, the majority of which are based on external indices and change in concert with market interest rates. According to the model, the Company is presently positioned so that net interest income will increase in the short-term if interest rates rise and will decrease in the short-term if interest rates decline.
The Company monitors and considers methods of managing the rate sensitivity and repricing characteristics of the balance sheet components in order to minimize the impact of sudden and sustained changes in interest rates. Accordingly, the Company performs a valuation analysis involving projecting future cash flows from current assets and liabilities to determine the Economic Value of Equity (“EVE”) which is the estimated net present value of those discounted cash flows. EVE represents the market value of equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for certain off-balance sheet items, over a range of assumed changes in market interest rates. The sensitivity of EVE to changes in the level of interest rates is a measure of the sensitivity of long-term earnings to changes in interest rates, and is used primarily to measure the exposure of earnings and equity to changes in interest rates over a relatively long (e.g., > 2 years) time horizon.
The Company’s market risk exposure is measured using interest rate sensitivity analysis by computing estimated changes in EVE in the event of a range of assumed changes in market interest rates. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 - 300 basis points increase or decrease in the market interest rates. The Company’s Board of Directors has adopted an interest rate risk policy which establishes maximum allowable decreases in EVE in the event of a sudden and sustained increase or decrease in market interest rates. The following table presents the Company’s projected change in EVE for the various rate shock levels as of year end. At December 31, 2004, the Company’s estimated changes in EVE were within the limits established by the Board.(dollars in thousands)
| | | | | | December 31, 2004 | December 31, 2003 |
Change in Interest Rates | | | Policy Limit | | | Economic Value of Equity (000s) | | | Percent Change | | | Economic Value of Equity (000s) | | | Percent Change | |
| 300 basis point rise | | | 40.00 | % | $ | 37,231 | | | 0.09 | % | $ | 25,094 | | | 22.08 | % |
| 200 basis point rise | | | 25.00 | % | $ | 37,225 | | | 0.11 | % | $ | 27,159 | | | 15.67 | % |
| 100 basis point rise | | | 10.00 | % | $ | 37,193 | | | 0.19 | % | $ | 29,617 | | | 8.04 | % |
| No change | | | 0.00 | % | $ | 37,265 | | | 0.00 | % | $ | 32,205 | | | 0.00 | % |
| 100 basis point decline | | | 10.00 | % | $ | 35,855 | | | 3.78 | % | $ | 30,205 | | | 6.21 | % |
| 200 basis point decline | | | 25.00 | % | $ | 33,653 | | | 9.69 | % | $ | 28,851 | | | 10.41 | % |
| 300 basis point decline | | | 40.00 | % | $ | 31,470 | | | 15.55 | % | $ | 27,331 | | | 15.13 | % |
A traditional gap analysis is also prepared based on the maturity and repricing characteristics of earning assets and interest-bearing liabilities for selected time bands. The mismatch between repricings or maturities within a time band is commonly referred to as the “gap” for that period. A positive gap (asset sensitive) where interest rate sensitive assets exceed interest rate sensitive liabilities generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite result on net interest income. However, the traditional gap analysis does not assess the relative sensitivity of assets and liabilities to changes in interest rates and other factors that could have an impact on interest rate sensitivity or net interest income, and is thus not, in management’s opinion, a true indicator of the Company’s interest rate sensitivity position.
The Company’s balance sheet structure is primarily short-term in nature with a substantial portion of assets and liabilities maturing within one year. The Company’s gap analysis, presented below, indicates a positive twelve month gap as of December 31, 2004 of $20.9 million. When the “effective change ratio” (the historical relative movement of each asset’s and liability’s rates in relation to a 100 basis point change in the prime rate) is applied to the interest gap position, the Company actually has a somewhat higher asset sensitive position over a 12 month period and the entire repricing lives of the assets and liabilities. This is primarily due to the fact that in excess of 75% of the loan portfolio moves immediately on a one-to-one ratio with a change in the prime lending rate, while the deposit rates do not increase or decrease as much or as quickly relative to a prime rate movement. The Company’s asset sensitive position means that assets reprice faster than the liabilities, which causes a decrease in the short-term in the net interest income and net interest margin in periods of declining rates as experienced in 2002 through 2003, until the fixed rate deposits mature and are repriced at then lower current market rates, thus narrowing the difference between what the Company earns on its assets and what it pays on its liabilities. Given the Company’s current balance sheet structure, the opposite effect (that is, an increase in net interest income and net interest margin) is realized in the short-term in a rising rate environment, as experienced starting in the latter half of 2004.
The following is the Company’s gap analysis as of December 31, 2004 (dollars in thousands).
| | | Assets and Liabilities Repricing Within |
| | | | 3 Months or Less | | | 4 to 12 Months | | | 1 to 5 Years | | | Over 5 Years | | | Total | |
Earning assets: | | | | | | | | | | | | | | | | |
| Loans, net of unearned income | | $ | 194,059 | | $ | 5,827 | | $ | 39,948 | | $ | 2,626 | | $ | 242,460 | |
| Investment securities (1) | | | - | | | - | | | 1,349 | | | 58,489 | | | 59,838 | |
| Federal funds sold and other | | | 365 | | | - | | | - | | | - | | | 365 | |
| Total | | | 194,424 | | | 5,827 | | | 41,297 | | | 61,115 | | | 302,663 | |
| | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
| Interest-bearing demand deposits (2) | | | 114,374 | | | - | | | - | | | - | | | 114,374 | |
| Time deposits, $100,000 and over | | | 9,796 | | | 21,510 | | | 7,619 | | | - | | | 38,925 | |
| Other time deposits | | | 5,697 | | | 22,706 | | | 13,119 | | | - | | | 41,522 | |
| FHLB advances | | | 1,750 | | | 3,500 | | | 33,050 | | | 11,834 | | | 50,134 | |
| Total | | | 131,617 | | | 47,716 | | | 53,788 | | | 11,834 | | | 244,955 | |
| Period interest sensitivity gap | | $ | 62,807 | | $ | (41,889 | ) | $ | (12,491 | ) | $ | 49,281 | | $ | 57,708 | |
| Cumulative interest sensitivity gap | | $ | 62,807 | | $ | 20,918 | | $ | 8,427 | | $ | 57,708 | | | | |
| (1) - Presented at market value as all investment securities are classified as “available for sale”; includes the Bank’s investment in stock of Federal Reserve Bank, Federal Home Loan Bank, and other equities. |
| (2) - Includes interest-bearing checking accounts, money market accounts, and regular savings accounts. |
ACCOUNTING, REPORTING AND REGULATORY MATTERS
On March 9, 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments” (“SAB 105”). SAB 105 provides recognition guidance for entities that issue loan commitments that are required to be accounted for as derivative instruments. SAB 105 indicates that the expected future cash flows related to the associated servicing of the loan and any other internally-developed intangible assets should not be considered when recognizing a loan commitment at inception or through its life. SAB 105 also discusses disclosure requirements for loan commitments and is effective for loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. The Company currently does not include the associated servicing of the loan when recognizing loan commitments at inception and throughout its life. The adoption of SAB 105 had no impact on the Company.
In March 2004, the FASB issued EITF No. 03-1 (“EITF 03-1”), “The Meaning of Other-Than-Temporary Impairment and Its Application of Certain Investments,” which provided guidance for evaluating whether an investment is other-than-temporarily impaired and its application to investments classified as either available for sale or held to maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost or equity method of accounting. In September 2004, the FASB issued FASB Staff Position (“FSP”) EITF No. 03-1-1, a delay of the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1 until the FASB issues final guidance, expected in the first quarter of 2005. Paragraphs 10 through 20 of EITF 03-1 provide guidance on when impairment of debt and equity securities is considered other-than-temporary. This guidance generally states impairment is considered other-than-temporary unless the holder of the security has both the intent and ability to hold the security until the fair value recovers and evidence supporting the recovery outweighs evidence to the contrary. We are currently evaluating the impact of the initial adoption of this guidance on the financial condition or results of operations of the Company. The Company adopted the guidance of EITF 03-1, excluding paragraphs 10-20 effective as of December 31, 2004. As a result of this adoption, the Company provides additional disclosures, which are found in Note 3 to the consolidated financial statements contained in Item 8 of this report. The initial adoption of this issuance, which excludes paragraphs 10-20, did not have a material impact on the financial condition or results of operations of the Company.
In December 2004, the FASB issues SFAS No. 123R, “Share-Based Payment” as a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and superseding APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for a) equity instruments of the enterprise or b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25 and generally requires instead that such transactions be recognized in the income statement as the grant-date fair value of stock options or other equity-based compensation issued to employees. The fair value calculations are accounted for using a either a lattice model or a closed-form model. The guidance also provides for classifying awards as either liabilities or equity, which impacts when and if the awards must be remeasured to fair value subsequent to the grant date. SFAS No. 123R is effective for most public companies’ interim or annual periods beginning after June 15, 2005 and is effective for nonpublic companies for annual periods beginning after December 15, 2005. We have not yet completed our evaluation of the impact that this Statement will have on our financial position and results of operations
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Market Risk and Asset-Liability Management” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for quantitative and qualitative disclosures about market risk, which information is incorporated herein by reference.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
| | | December 31, | |
| | | | 2004 | | | 2003 | |
ASSETS | | | | | | | |
| Cash and due from banks | | $ | 6,548 | | $ | 9,854 | |
| Interest-bearing bank balances | | | 147 | | | 341 | |
| Federal funds sold | | | 218 | | | 201 | |
| Investment securities available for sale | | | 59,838 | | | 90,887 | |
| Investment in Federal Home Loan Bank and other stock | | | 3,326 | | | 3,004 | |
Loans, net of unearned income and net of allowancefor loan losses of $3,649 and $3,437 | | | 238,811 | | | 228,365 | |
| Premises and equipment, net | | | 4,805 | | | 4,070 | |
| Accrued interest receivable | | | 1,430 | | | 1,505 | |
| Other assets | | | 5,815 | | | 5,694 | |
| | | $ | 320,938 | | $ | 343,921 | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | |
| Deposits: | | | | | | | |
| Noninterest-bearing demand | | $ | 36,897 | | $ | 37,037 | |
| Interest-bearing demand | | | 32,478 | | | 23,542 | |
| Savings and money market | | | 81,896 | | | 73,245 | |
| Time deposits, $100,000 and over | | | 38,925 | | | 65,200 | |
| Other time deposits | | | 41,522 | | | 57,988 | |
| | | | 231,718 | | | 257,012 | |
| Federal Home Loan Bank advances | | | 50,134 | | | 52,317 | |
| Accrued interest payable | | | 581 | | | 841 | |
| Other liabilities | | | 1,240 | | | 1,546 | |
| Total liabilities | | | 283,673 | | | 311,716 | |
| | | | | | | | |
| Shareholders' equity: | | | | | | | |
Common stock, $1.00 par value; 20,000,000 sharesauthorized; 4,515,553 | | | | | | | |
| and 4,312,925 shares issued and outstanding | | | 4,516 | | | 4,313 | |
| Additional paid-in capital | | | 26,993 | | | 25,791 | |
| Retained earnings | | | 5,868 | | | 2,102 | |
| Accumulated other comprehensive income, net of tax | | | 98 | | | 28 | |
| Nonvested restricted stock | | | (210 | ) | | (29 | ) |
| Total shareholders' equity | | | 37,265 | | | 32,205 | |
| | | $ | 320,938 | | $ | 343,921 | |
| | | | | | | | |
| See accompanying notes to consolidated financial statements. | | | | | | | |
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, except Per Share Data)
| | | For the year ended December 31, | |
| | | | 2004 | | | 2003 | | | 2002 | |
Interest Income: | | | | | | | | | | |
| Loans | | $ | 14,377 | | $ | 13,996 | | $ | 14,914 | |
| Taxable securities | | | 2,055 | | | 2,459 | | | 1,934 | |
| Nontaxable securities | | | 922 | | | 816 | | | 725 | |
| Federal funds sold | | | 50 | | | 40 | | | 80 | |
| Other | | | 138 | | | 134 | | | 168 | |
| | | | 17,542 | | | 17,445 | | | 17,821 | |
Interest Expense: | | | | | | | | | | |
| Deposits | | | 3,007 | | | 3,550 | | | 4,598 | |
| Federal Home Loan Bank advances | | | 1,576 | | | 1,590 | | | 1,563 | |
| Federal funds purchased | | | 7 | | | 16 | | | 5 | |
| Other short-term borrowings | | | - | | | - | | | 8 | |
| | | | 4,590 | | | 5,156 | | | 6,174 | |
| Net interest income | | | 12,952 | | | 12,289 | | | 11,647 | |
Provision for loan losses | | | 436 | | | 786 | | | 847 | |
| Net interest income after provision for loan losses | | | 12,516 | | | 11,503 | | | 10,800 | |
Noninterest Income: | | | | | | | | | | |
| Service charges and fees on deposit accounts | | | 480 | | | 550 | | | 553 | |
| Insurance commission fee income | | | 588 | | | 438 | | | 587 | |
| Gain on sale of investment securities | | | 83 | | | 367 | | | 117 | |
| Other income | | | 1,165 | | | 1,575 | | | 1,414 | |
| | | | 2,316 | | | 2,930 | | | 2,671 | |
Noninterest Expense: | | | | | | | | | | |
| Salaries, wages and benefits | | | 5,370 | | | 5,213 | | | 5,060 | |
| Occupancy | | | 682 | | | 666 | | | 644 | |
| Furniture, fixtures and equipment | | | 608 | | | 647 | | | 673 | |
| Other expenses | | | 1,774 | | | 2,346 | | | 2,067 | |
| | | | 8,434 | | | 8,872 | | | 8,444 | |
| Income before income taxes | | | 6,398 | | | 5,561 | | | 5,027 | |
| Income taxes | | | 1,959 | | | 1,754 | | | 1,585 | |
Net income | | $ | 4,439 | | $ | 3,807 | | $ | 3,442 | |
| | | | | | | | | | | |
Net income per common share: | | | | | | | | | | |
| Basic | | $ | 1.00 | | $ | 0.89 | | $ | 0.82 | |
| Diluted | | $ | 0.90 | | $ | 0.79 | | $ | 0.73 | |
Average shares outstanding: | | | | | | | | | | |
| Basic | | | 4,419,000 | | | 4,256,000 | | | 4,176,000 | |
| Diluted | | | 4,924,000 | | | 4,842,000 | | | 4,744,000 | |
| | | | | | | | | | | |
| See accompanying notes to consolidated financial statements. | | | | | | |
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2004, 2003 and 2002
(Dollars in Thousands)
| | | | | | | | | Accumulated | | | | | |
| | | | | Additional | | | | other | | Nonvested | | Total | |
| | | Common | | paid-in | | Retained | | comprehensive | | restricted | | shareholders' | |
| | | stock | | capital | | earnings | | income, net | | stock | | equity | |
| Balance at December 31, 2001 | | $ | 3,793 | | $ | 18,409 | | $ | 2,379 | | $ | 203 | | | ($183 | ) | $ | 24,601 | |
| Net income for the year ended December 31, 2002 | | | - | | | - | | | 3,442 | | | - | | | - | | | 3,442 | |
| Other comprehensive income: | | | | | | | | | | | | | | | | | | | |
| Unrealized holding gains on securities arising | | | | | | | | | | | | | | | | | | | |
| during the period, net of taxes of $287 | | | - | | | - | | | - | | | 469 | | | - | | | | |
| Less: reclassification adjustment for gains | | | | | | | | | | | | | | | | | | | |
| included in net income, net of tax of $45 | | | - | | | - | | | - | | | (72 | ) | | | | | | |
| Other comprehensive income | | | - | | | - | | | - | | | 397 | | | - | | | 397 | |
| Comprehensive income | | | - | | | - | | | - | | | - | | | - | | | 3,839 | |
| Stock options exercised, including tax benefit of $33 | | | 30 | | | 148 | | | - | | | - | | | - | | | 178 | |
| Amortization of deferred compensation | | | | | | | | | | | | | | | | | | | |
| on restricted stock | | | - | | | - | | | - | | | - | | | 128 | | | 128 | |
| Issuance of 5% stock dividend | | | 190 | | | 2,765 | | | (2,955 | ) | | - | | | - | | | - | |
| Cash in lieu of fractional shares | | | - | | | - | | | (4 | ) | | - | | | - | | | (4 | ) |
| Balance at December 31, 2002 | | | 4,013 | | | 21,322 | | | 2,862 | | | 600 | | | (55 | ) | | 28,742 | |
| Net income for the year ended December 31, 2003 | | | - | | | - | | | 3,807 | | | - | | | - | | | 3,807 | |
| Other comprehensive loss: | | | | | | | | | | | | | | | | | | | |
| Unrealized holding losses on securities arising | | | | | | | | | | | | | | | | | | | |
| during the period, net of taxes of ($210) | | | - | | | - | | | - | | | (345 | ) | | - | | | | |
| Less: reclassification adjustment for gains | | | | | | | | | | | | | | | | | | | |
| included in net income, net of tax of $140 | | | - | | | - | | | - | | | (227 | ) | | | | | | |
| Other comprehensive loss | | | - | | | - | | | - | | | (572 | ) | | - | | | (572 | ) |
| Comprehensive income | | | - | | | - | | | - | | | - | | | - | | | 3,235 | |
| Stock options exercised, including tax benefit of $193 | | | 95 | | | 544 | | | - | | | - | | | - | | | 639 | |
| Amortization of deferred compensation | | | | | | | | | | | | | | | | | | | |
| on restricted stock | | | - | | | - | | | - | | | - | | | 26 | | | 26 | |
| Cash dividends declared ($0.10 per common share) | | | - | | | - | | | (430 | ) | | - | | | - | | | (430 | ) |
| Issuance of 5% stock dividend | | | 205 | | | 3,925 | | | (4,130 | ) | | - | | | - | | | - | |
| Cash in lieu of fractional shares | | | - | | | - | | | (7 | ) | | - | | | - | | | (7 | ) |
| Balance at December 31, 2003 | | | 4,313 | | | 25,791 | | | 2,102 | | | 28 | | | (29 | ) | | 32,205 | |
| Net income for the year ended December 31, 2004 | | | - | | | - | | | 4,439 | | | - | | | - | | | 4,439 | |
| Other comprehensive income: | | | | | | | | | | | | | | | | | | | |
| Unrealized holding gains on securities arising | | | | | | | | | | | | | | | | | | | |
| during the period, net of taxes of $74 | | | - | | | - | | | - | | | 121 | | | - | | | | |
| Less: reclassification adjustment for gains | | | | | | | | | | | | | | | | | | | |
| included in net income, net of tax of $31 | | | - | | | - | | | - | | | (51 | ) | | | | | | |
| Other comprehensive income | | | - | | | - | | | - | | | 70 | | | - | | | 70 | |
| Comprehensive income | | | - | | | - | | | - | | | - | | | - | | | 4,509 | |
| Stock options exercised, including tax benefit of $269 | | | 189 | | | 964 | | | - | | | - | | | - | | | 1,153 | |
| Stock issued pursuant to restricted stock plan | | | 14 | | | 238 | | | - | | | - | | | (252 | ) | | - | |
| Amortization of deferred compensation | | | | | | | | | | | | | | | | | | | |
| on restricted stock | | | - | | | - | | | - | | | - | | | 71 | | | 71 | |
| Cash dividends declared ($0.15 per common share) | | | - | | | - | | | (673 | ) | | - | | | - | | | (673 | ) |
Balance at December 31, 2004 | | $ | 4,516 | | $ | 26,993 | | $ | 5,868 | | $ | 98 | | | ($210 | ) | $ | 37,265 | |
| | | | | | | | | | | | | | | | | | | | |
| See accompanying notes to consolidated financial statements. | | | | | | | | | | | | |
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
| | | For the year ended December 31, | |
| | | | 2004 | | | 2003 | | | 2002 | |
Cash flows from operating activities: | | | | | | | | | | |
| Net income | | $ | 4,439 | | $ | 3,807 | | $ | 3,442 | |
Adjustments to reconcile net income to net cashprovided by operating activities: | | | | | | | | | | |
| Provision for loan losses | | | 436 | | | 786 | | | 847 | |
| Depreciation | | | 388 | | | 435 | | | 488 | |
| Net gain on sale and disposal of equipment and vehicles | | | (36 | ) | | (30 | ) | | - | |
| Net gain on sale of investment securities | | | (83 | ) | | (367 | ) | | (117 | ) |
| Net amortization of net premium on investment securities | | | 110 | | | 257 | | | 221 | |
| Amortization of deferred compensation on restricted stock | | | 71 | | | 26 | | | 128 | |
| Increase in other assets | | | (77 | ) | | (260 | ) | | (222 | ) |
| (Decrease) increase in other liabilities | | | (297 | ) | | 231 | | | 64 | |
| Deferred income taxes | | | (12 | ) | | 11 | | | (156 | ) |
| Net cash provided by operating activities | | | 4,939 | | | 4,896 | | | 4,695 | |
Cash flows from investing activities: | | | | | | | | | | |
| Purchases of investment securities | | | (9,773 | ) | | (89,706 | ) | | (48,930 | ) |
| Proceeds from sales of investment securities | | | 28,973 | | | 29,547 | | | 19,945 | |
| Proceeds from maturities of investment securities | | | 11,935 | | | 31,924 | | | 13,456 | |
| Purchases of Federal Home Loan Bank stock | | | (709 | ) | | (861 | ) | | (685 | ) |
| Redemptions of Federal Home Loan Bank stock | | | 387 | | | 275 | | | - | |
| Purchase of bank-owned life insurance | | | - | | | (1,500 | ) | | - | |
| Net increase in loans | | | (10,882 | ) | | (13,720 | ) | | (12,174 | ) |
| Purchases of premises and equipment | | | (1,123 | ) | | (327 | ) | | (238 | ) |
| Proceeds from sale of equipment and vehicles | | | 36 | | | 49 | | | - | |
| Net cash provided by (used in) investing activities | | | 18,844 | | | (44,319 | ) | | (28,626 | ) |
Cash flows from financing activities: | | | | | | | | | | |
| Net (decrease) increase in deposit accounts | | | (25,294 | ) | | 26,497 | | | 11,737 | |
| Proceeds from Federal Home Loan Bank advances | | | 11,500 | | | 29,500 | | | 25,500 | |
| Repayments of Federal Home Loan Bank advances | | | (13,683 | ) | | (17,783 | ) | | (11,800 | ) |
| Repayments of other short-term borrowings | | | - | | | - | | | (500 | ) |
| Cash dividends paid | | | (673 | ) | | (430 | ) | | - | |
| Proceeds from stock options exercised | | | 884 | | | 446 | | | 145 | |
| Cash paid in lieu of fractional shares | | | - | | | (7 | ) | | (4 | ) |
| Net cash (used in) provided by financing activities | | | (27,266 | ) | | 38,223 | | | 25,078 | |
| Net (decrease) increase in cash and cash equivalents | | | (3,483 | ) | | (1,200 | ) | | 1,147 | |
| Cash and cash equivalents, beginning of year | | | 10,396 | | | 11,596 | | | 10,449 | |
| Cash and cash equivalents, end of year | | $ | 6,913 | | $ | 10,396 | | $ | 11,596 | |
| | | | | | | | | | | |
Supplemental Information: | | | | | | | | | | |
| Cash paid during the period for interest | | $ | 4,850 | | $ | 5,321 | | $ | 6,362 | |
| Cash paid during the period for income taxes | | | 1,675 | | | 1,590 | | | 1,610 | |
Change in fair market value of investment securitiesavailable for sale, net of income taxes | | | 70 | | | (572 | ) | | 397 | |
| Stock option tax benefit | | | 269 | | | 193 | | | 33 | |
| | | | | | | | | | | |
| See accompanying notes to consolidated financial statements. | | | | | | | | | | |
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2004, 2003 and 2002
Note 1 -Summary of Significant Accounting Policies
Principles of Consolidation -Summit Financial Corporation (“the Company”), a South Carolina corporation, is the parent holding company for Summit National Bank (“the Bank”), a nationally chartered bank, and Freedom Finance, Inc. (“the Finance Company”), a consumer finance company. Summit Investment Services, Inc. is a wholly-owned subsidiary of the Bank which provides financial management services and nondeposit product sales. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates -The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) which requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of income and expense during the reporting period. Actual results could differ from these estimates and assumptions.
Cash and cash equivalents - For the purpose of reporting cash flows, cash includes currency and coin, cash items in process of collection and due from banks. Included in cash and cash equivalents are federal funds sold and overnight investments. The Company considers the amounts included in the balance sheet line items, “Cash and due from banks”, “Interest-bearing bank balances” and “Federal funds sold” to be cash and cash equivalents. These accounts totaled $6,913,000 and $10,396,000 at December 31, 2004 and 2003, respectively.
Investment Securities - Investment securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities”. At the time of purchase, investment securities are classified by management into one of three categories as follows: (1) Investments Held to Maturity: securities which the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading Securities: securities that are bought and held principally for the purpose of selling them in the near future, which are reported at fair value with unrealized gains and losses included in earnings; and (3) Investments Available for Sale: securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of income taxes. The amortization of premiums and accretion of discounts on investment securities are recorded as adjustments to interest income. Gains or losses on sales of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Unrealized losses on securities, reflecting a decline in value or impairment judged by the Company to be other than temporary, are charged to income in the consolidated statements of income.
Loans - -Loans of the Bank are carried at principal amount outstanding, reduced by an allowance for loan losses. The Bank recognizes interest income daily based on the principal amount outstanding using the simple interest method. The accrual of interest is generally discontinued on loans of the Bank which become 90 days past due as to principal or interest or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Management may elect to continue accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balances and accrued interest and the loan is in the process of collection. Amounts received on nonaccrual loans generally are applied against principal prior to the recognition of any interest income. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.
Loans of the Finance Company are carried at the gross amount outstanding, reduced by unearned interest, deferred insurance income and other deferred fees, and an allowance for loan losses. Unearned interest and fees are deferred at the time the loans are made and accreted to income using the “Rule of 78’s” method. The results of this method are not materially different from those obtained by using the simple interest method. Charges for late payments are credited to income when collected. Loans of the Finance Company are generally charged-off when they become 150 days contractually past due or when it is determined that collection is doubtful.
Loan Origination and Commitment Fees - The Company accounts for loan origination fees and direct costs of loan originations in accordance with SFAS 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Direct Costs of Leases”. SFAS 91 generally limits the definition of loan origination costs to the direct costs attributable to originating a loan, which are principally actual personnel costs. Pursuant to SFAS 91, loan commitment fees, net of certain direct origination costs, are deferred and recognized as an adjustment of yield by the interest method over the related loan’s life, or if the commitment expires unexercised, recognized in income upon expiration.
Allowance for Loan Losses - It is the Company’s policy to provide a valuation allowance for estimated losses on loans based upon past loss experience, trends in the level of delinquent and specific problem loans, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions in the Bank’s primary market areas. The allowance for loan losses is established through a provision for loan losses charged to operations and reflects an amount that, in management’s opinion, is adequate to absorb inherent losses in the existing portfolio. Additions to the allowance are based on management’s evaluation of the loan portfolio and specific loans, in addition to other factors which, in management’s judgment, deserve recognition in estimating loan losses. Loans are charged-off when, in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance and subsequent recoveries are added to the allowance. Management believes that the allowance is adequate to absorb probable losses inherent in the loan portfolio. While management uses the information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ from the assumptions used in making the evaluations. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustments based upon information that is available to them at the time of their examination.
Impaired Loans -The Company accounts for impaired loans in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan”. Loans are considered to be impaired when, in management’s judgment, the collection of all amounts of principal and interest is not probable in accordance with the terms of the loan agreement. SFAS 114 requires that impaired loans be recorded at fair value, which is determined based upon the present value of expected cash flows discounted at the loan’s effective interest rate, the market price of the loan, if available, or the value of the underlying collateral. All cash receipts on impaired loans are applied to principal until such time as the principal is brought current, and thereafter according to the contractual terms of the agreement. After principal has been satisfied, future cash receipts are applied to interest income, to the extent that any interest has been foregone. As a practical matter, the Bank determines which loans are impaired through a loan review process and provides a specific reserve which is a component of the allowance for loan losses as discussed above.
Other Real Estate Owned -Other real estate owned, included in “Other assets” in the accompanying consolidated balance sheets, is comprised of real estate properties acquired in partial or total satisfaction of problem loans. In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the property is classified as held for sale when the sale is probable and is expected to occur within one year. The property is initially carried at the lower of cost or estimated fair value less estimated selling costs. Principal losses existing at the time of acquisition of such properties are charged against the allowance for loan losses. Interest losses are charged to interest income. Subsequent write-downs that may be required to the carrying value of these properties and gains and losses realized from the sale of other real estate owned are included in other noninterest income. Costs related to the development and improvement of such property are capitalized, whereas the costs related to holding the property are charged to expense. Other real estate owned (“OREO”) totaled $217,000 and $125,000 at December 31, 2004 and 2003, respectively.
Off-Balance Sheet Commitments- In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of legally binding commitments to extend credit and letters of credit. Such financial instruments are recorded in the financial statements when they are funded.
Premises and Equipment -Premises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation is recorded using the straight-line method over the estimated useful life of the related assets as follows: building, 40 years; furniture and fixtures, 7 years; equipment and computer hardware and software, 3 to 7 years; and vehicles, 3 years. Amortization of leasehold improvements is recorded using the straight-line method over the lesser of the estimated useful life of the asset or the term of the respective lease. Additions to premises and equipment and major replacements or betterments are added at cost. Maintenance, repairs and minor replacements are charged to operating expense as incurred. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in income.
Per Share Data - Earnings per share (“EPS”) are computed in accordance with SFAS 128, “Earnings per Share.” SFAS 128 requires companies to report basic and diluted EPS. Basic EPS includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Shares of restricted stock that are unvested are not included in weighted average shares outstanding. Diluted EPS reflects the potential dilution of securities that could occur if the Company’s dilutive stock options were exercised and thus resulted in the issuance of common stock. Also included in diluted weighted average shares outstanding is unvested restricted stock. The Company has issued twelve 5% stock dividends between 1993 and 2003. The basic and diluted average number of shares outstanding and earnings per share information for prior reporting periods have been restated to reflect the effect of all stock dividends.
Intangible Assets -As of January 1, 2002, the Company adopted SFAS 142,“Goodwill and Other Intangible Assets”. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS 142. The Company’s intangible assets, totaling $187,000 in both years presented, consist of goodwill resulting from the Finance Company’s branch and loan acquisitions accounted for as purchases, and are included in “Other assets” on the accompanying consolidated balance sheets.
Income Taxes -Income taxes are accounted for in accordance with SFAS 109, “Accounting for Income Taxes”. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized.
Reporting Comprehensive Income- The Company reports comprehensive income in accordance with SFAS 130, “Reporting Comprehensive Income.” SFAS 130 requires that all items that are required to be recognized under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The disclosure requirements of SFAS 130 have been included in the Company’s consolidated statements of shareholders’ equity and comprehensive income.
Fair Value of Financial Instruments - SFAS 107, “Disclosures about Fair Value of Financial Instruments”, requires disclosures about the fair value of all financial instruments, whether or not recognized in the balance sheet, when it is practicable to estimate fair value. 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. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized through immediate settlement of the instrument. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity, or contractual obligations which require the exchange of cash or other financial instruments. Certain financial instruments and all non-financial instruments are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment, and other assets and liabilities. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
Disclosures Regarding Segments - SFAS 131, “Disclosures about Segments of an Enterprise and Related Information” establishes standards for the way that public businesses report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has two reportable operating segments, Summit National Bank and Freedom Finance, Inc.
Stock-Based Compensation - The Company reports stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees”, which measures compensation expense as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. SFAS 123, “Accounting for Stock-Based Compensation”, encourages but does not require companies to record compensation cost for stock-based compensation plans at fair value. The Company follows the disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock-based option plans as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation is as follows:
(dollars, except per share, in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Net income, as reported | | $ | 4,439 | | $ | 3,807 | | $ | 3,442 | |
Less - total stock-based employeecompensation expense determined under fair value based method, net of taxes | | | 124 | | | 170 | | | 216 | |
| Proforma net income | | $ | 4,315 | | $ | 3,637 | | $ | 3,226 | |
Basic earnings per share: | | | | | | | | | | |
| As reported | | $ | 1.00 | | $ | 0.89 | | $ | 0.82 | |
| Proforma | | $ | 0.98 | | $ | 0.85 | | $ | 0.77 | |
Diluted earnings per share: | | | | | | | | | | |
| As reported | | $ | 0.90 | | $ | 0.79 | | $ | 0.73 | |
| Proforma | | $ | 0.88 | | $ | 0.75 | | $ | 0.68 | |
The weighted average fair value per share of options, calculated using the Black-Scholes option-pricing model, granted in 2004, 2003 and 2002 amounted to $2.57, $3.73 and $7.66, respectively. For purposes of the proforma calculation, compensation expense is recognized on a straight line basis over six years. In calculating the proforma disclosures, the fair values of options granted were estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants:
| | | | 2004 | | | 2003 | | | 2002 | |
| Historical volatility | | | 46.0 | % | | 49.6 | % | | 49.5 | % |
| Risk-free interest rate | | | 3.61 | % | | 3.35 | % | | 2.70 | % |
| Expected life of options | | | 6.1 years | | | 5.8 years | | | 5.7 years | |
| Dividend yield | | | 0.80 | % | | 0.60 | % | | N/A | |
Reclassifications - -Certain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform with the 2004 presentations. These reclassifications had no impact on shareholders’ equity or net income as previously reported.
Note 2 - Restrictions on Cash and Due From Banks
The Company’s bank subsidiary is required to maintain average reserve balances, net of vault cash, with the Federal Reserve Bank of Richmond against outstanding domestic deposits and certain other liabilities. The required reserves, which are reported in “Cash and due from banks” on the accompanying consolidated balance sheets, were $2,458,000 and $1,957,000 at December 31, 2004 and 2003, respectively.
Note 3 - Investment Securities
All investment securities are classified as “Available for Sale” in each year presented. There are no securities classified as “Held to Maturity” or “Trading” in any year presented. The aggregate amortized cost, estimated fair value, and gross unrealized gains and losses of investment securities available for sale at December 31 are as follows:
(dollars in thousands) | | 2004 | 2003 |
| | | | Amortized | | Gross Unrealized | | Estimated Fair | | | Amortized | | Gross Unrealized | | Estimated Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | | | Cost | | | Gains | | | Losses | | | Value | |
| U.S. government agencies | | $ | 9,771 | | $ | - | | | ($135 | ) | $ | 9,636 | | $ | 23,520 | | $ | 49 | | | ($397 | ) | $ | 23,172 | |
| Mortgage-backed securities | | | 30,199 | | | 34 | | | (166 | ) | | 30,067 | | | 44,054 | | | 132 | | | (237 | ) | | 43,949 | |
| State and municipal securities | | | 19,710 | | | 530 | | | (105 | ) | | 20,135 | | | 23,268 | | | 666 | | | (168 | ) | | 23,766 | |
| | | $ | 59,680 | | $ | 564 | | | ($406 | ) | $ | 59,838 | | $ | 90,842 | | $ | 847 | | | ($802 | ) | $ | 90,887 | |
The estimated fair value and gross unrealized losses of investment securities available for sale at December 31, 2004 for securities with unrealized losses, and the period of time the securities have been in a loss position, are presented in the following table.
(dollars in thousands) | | | Less than 12 months | | | 12 months or longer | | | Total | |
| | | # | | | Fair Value | | | Unrealized Losses | | | # | | | Fair Value | | | Unrealized Losses | | | # | | | Fair Value | | | Unrealized Losses | |
| U.S. government agencies | | | 1 | | $ | 1,491 | | | ($9 | ) | | 5 | | $ | 8,145 | | | ($126 | ) | | 6 | | $ | 9,636 | | | ($135 | ) |
| Mortgage-backed securities | | | 11 | | | 18,531 | | | (145 | ) | | 2 | | | 2,062 | | | (21 | ) | | 13 | | | 20,593 | | | (166 | ) |
| State and municipal securities | | | 4 | | | 1,547 | | | (13 | ) | | 6 | | | 2,296 | | | (92 | ) | | 10 | | | 3,843 | | | (105 | ) |
| | | | 16 | | $ | 21,569 | | | ($167 | ) | | 13 | | $ | 12,503 | | | ($239 | ) | | 29 | | $ | 34,072 | | | ($406 | ) |
The unrealized losses on investments in U.S. government agencies, mortgage-backed securities and state and municipal securities summarized above are considered to be temporary impairments in value attributable to increases in interest rates, rather than changes in credit quality. The agency securities and agency mortgage-backed securities carry the implied guarantee of the U.S. Government and the state and municipal securities all have a credit rating of at least AA and are generally insured as well. The Company has demonstrated an ability to hold securities until maturity, thus an actual loss may not be realized.
The amortized cost and estimated fair value of investment securities available for sale at December 31, by contractual maturity, are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties. Estimated fair value of securities was determined using quoted market prices.
(dollars in thousands) | | 2004 | 2003 |
| | | | Amortized Cost | | | Estimated FairValue | | | AmortizedCost | | | Estimated FairValue | |
| Due in one year or less | | $ | - | | $ | - | | $ | - | | $ | - | |
| Due after one year, through five years | | | 1,362 | | | 1,349 | | | 1,153 | | | 1,181 | |
| Due after five years, through ten years | | | 15,457 | | | 15,337 | | | 31,684 | | | 31,297 | |
| Due after ten years | | | 42,861 | | | 43,152 | | | 58,005 | | | 58,409 | |
| | | $ | 59,680 | | $ | 59,838 | | $ | 90,842 | | $ | 90,887 | |
The change in the net unrealized gain on securities available for sale, net of taxes, recorded in shareholders’ equity for the year ended December 31, 2004 was $70,000. Investment securities with an approximate book value of $34,326,000 and $43,788,000 at December 31, 2004 and 2003, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. Estimated fair values of securities pledged were $34,125,000 and $43,870,000 at December 31, 2004 and 2003, respectively.
Note 3 - Investment Securities - continued
Information related to the sale of securities classified as available for sale for each year is as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Proceeds from sales of securities | | $ | 28,972 | | $ | 29,547 | | $ | 19,945 | |
| Gross realized gains on securities sold | | | 358 | | | 391 | | | 159 | |
| Gross realized losses on securities sold | | | 275 | | | 24 | | | 42 | |
Note 4 - Investments in Stock
Summit National Bank, as a member of the Federal Reserve Bank (“FRB”) and the Federal Home Loan Bank of Atlanta (“FHLB”), is required to own capital stock in these organizations. The amount of stock owned is based on the Bank’s capital levels in the case of the FRB and totaled $255,000 at December 31, 2004 and 2003. The amount of FHLB stock owned is determined based on the Bank’s balances of residential mortgages and advances from the FHLB and totaled $2,938,000 and $2,616,000 at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, the Bank owns $133,000 of stock in The Bankers Bank located in Atlanta, Georgia. No ready market exists for these stocks and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value.
Note 5 -Loans and Allowance for Loan Losses
A summary of loans by classification at December 31 is as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| Commercial and industrial | | $ | 31,999 | | $ | 33,370 | |
| Commercial secured by real estate | | | 81,943 | | | 74,845 | |
| Real estate - residential mortgages | | | 63,657 | | | 64,921 | |
| Real estate - construction | | | 56,254 | | | 49,313 | |
| Installment and other consumer loans | | | 5,182 | | | 5,845 | |
| Consumer finance, net of unearned incomeof $982 and $1,033 | | | 3,049 | | | 3,267 | |
| Other loans and overdrafts | | | 376 | | | 241 | |
| | | 242,460 | | | 231,802 | |
| Less - allowance for loan losses | | | (3,649 | ) | | (3,437 | ) |
| | | $ | 238,811 | | $ | 228,365 | |
The Company’s loan portfolio is composed of loans to individuals and small and medium-sized businesses for various personal and commercial purposes primarily in the Upstate of South Carolina and diversified as to borrowers. The Company regularly monitors its credit concentrations based on loan purpose, industry, and customer base. Industry concentrations parallel the mix of economic activity in the Company’s markets, the most significant of which are the commercial real estate, textile, and automobile and trucking industries. Although the portfolio is affected by economic conditions, repayment of loans therein is not excessively dependent on any specific economic segment. As of December 31, 2004, there were no material concentrations of credit risk within the Company’s loan portfolio as determined by management.
Changes in the allowance for loan losses for the years ended December 31 are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Balance, beginning of year | | $ | 3,437 | | $ | 3,369 | | $ | 2,937 | |
| Provision for losses | | | 436 | | | 786 | | | 847 | |
| Loans charged-off | | | (576 | ) | | (1,074 | ) | | (647 | ) |
| Recoveries of loans previously charged-off | | | 352 | | | 356 | | | 232 | |
| Balance, end of year | | $ | 3,649 | | $ | 3,437 | | $ | 3,369 | |
Note 5 -Loans and Allowance for Loan Losses - continued
Nonperforming assets and impaired loans at December 31 are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Accruing loans, past due in excess of 90 days | | $ | 156 | | $ | 170 | | $ | 187 | |
| Nonaccrual loans, not considered impaired | | | 531 | | | 587 | | | 293 | |
| Loans considered impaired under SFAS 114 | | | - | | | - | | | - | |
| Other real estate owned | | | 217 | | | 125 | | | - | |
There were no loans considered impaired during 2004, 2003, or 2002. The amount of foregone interest income that would have been recorded had the nonaccrual loans performed according to their contractual terms amounted to approximately $20,000, $27,000 and $10,000 during 2004, 2003 and 2002, respectively. Interest income recognized on nonaccrual and impaired loans was approximately $33,000, $33,000 and $15,000 during 2004, 2003 and 2002, respectively.
Note 6 - Premises and Equipment
A summary of premises and equipment at December 31 is as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| Land | | $ | 1,651 | | $ | 1,043 | |
| Building and leasehold improvements | | | 3,339 | | | 3,336 | |
| Furniture, fixtures, equipment and software | | | 3,183 | | | 3,084 | |
| Vehicles | | | 194 | | | 188 | |
| Construction and assets in process | | | 431 | | | 98 | |
| | | | 8,798 | | | 7,749 | |
| Less - accumulated depreciation | | | (3,993 | ) | | (3,679 | ) |
| | | $ | 4,805 | | $ | 4,070 | |
Depreciation expense charged to operations totaled $388,000, $435,000, and $488,000 in 2004, 2003, and 2002, respectively.
Note 7 -Deposits
The scheduled maturities of time deposits subsequent to December 31 each year end are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| 2004 | | $ | - | | $ | 112,891 | |
| 2005 | | | 59,709 | | | 4,237 | |
| 2006 | | | 16,293 | | | 5,169 | |
| 2007 | | | 3,540 | | | 670 | |
| 2008 | | | 151 | | | 221 | |
| 2009 | | | 754 | | | - | |
| Thereafter | | | - | | | - | |
| | | $ | 80,447 | | $ | 123,188 | |
At December 31, 2004, the remaining maturity of time deposits in denominations in excess of $100,000 is $9,796,000 in three months or less; $5,898,000 in over three through six months; $15,612,000 in over six through 12 months; and $7,619,000 in over 12 months.
Note 8 -Federal Home Loan Bank Advances
Federal Home Loan Bank (“FHLB”) advances represent borrowings from the FHLB of Atlanta by the Bank pursuant to a line of credit collateralized by a blanket lien on qualifying loans secured by first mortgages on 1-4 family residences, home equity lines of credit, multi-family real estate, and commercial real estate. Advances have various maturity dates, terms and repayment schedules with fixed or variable rates of interest, payable monthly on maturities of one year or less and payable quarterly on maturities over one year.
Total qualifying loans of the Bank pledged to the FHLB for advances at December 31, 2004 were approximately $73 million. In addition, investment securities with a book value and market value of $9 million are pledged to the FHLB for advances. The Bank has adopted the policy of pledging excess collateral to facilitate future advances. At December 31, 2004, the Bank had a total credit facility with the FHLB equal to 25% of the Bank’s total assets, limited to qualifying collateral. Available credit at December 31, 2004 was approximately $1 million.
At December 31, 2004 fixed rate FHLB advances had initial maturities from one to ten years. At December 31, 2004, included in the four, five, and greater than five year maturities, detailed below, were advances totaling $17 million subject to call provisions at the option of the FHLB with call dates ranging from February 2005 to March 2008. Call provisions are more likely to be exercised by the FHLB when rates rise. Advances totaling $4,000,000 at December 31, 2004 were at variable rates based on three month LIBOR and were priced at from 2.16% to 2.46% as of year end, depending on the reset date.
Advances from the FHLB, including scheduled maturities subsequent to year end, at December 31 consist of the following (dollars in thousands):
| | | 2004 | 2003 |
Maturing in year endedDecember 31, | | | Amount | | | Weighted Rate | | | Amount | | | Weighted Rate | |
| 2004 | | $ | - | | | - | | $ | 11,000 | | | 2.86 | % |
| 2005 | | | 5,250 | | | 2.39 | % | | 2,000 | | | 1.24 | % |
| 2006 | | | 8,100 | | | 3.61 | % | | 8,700 | | | 3.42 | % |
| 2007 | | | 5,000 | | | 3.46 | % | | 5,400 | | | 3.66 | % |
| 2008 | | | 14,250 | | | 3.05 | % | | 15,250 | | | 3.04 | % |
| 2009 | | | 5,700 | | | 2.87 | % | | - | | | - | |
| Thereafter | | | 11,834 | | | 3.37 | % | | 9,967 | | | 3.40 | % |
| | | $ | 50,134 | | | 3.17 | % | $ | 52,317 | | | 3.13 | % |
Note 9 -Short-Term Borrowings
Federal funds purchased represent unsecured overnight borrowings from other financial institutions by the Bank. These borrowings bear interest at the prevailing market rate for federal funds purchased. Average interest rates on federal funds purchased were 1.34%, 1.55%, and 1.95% for the years ended December 31, 2004, 2003, and 2002, respectively. There were no outstanding balances of federal funds purchased at December 31, 2004 or 2003. Average balances were $527,000, $1,030,000, and $236,000 for 2004, 2003, and 2002, respectively. The maximum balance of federal funds purchased at any time during 2004, 2003, and 2002 was $10.0 million, $11.5 million, and $5.5 million, respectively. At December 31, 2004, the Bank had short-term lines of credit to purchase unsecured federal funds from unrelated banks with available balances totaling $23.1 million. These lines are generally available to be outstanding up to ten consecutive days for general corporate purposes of the Bank and have specified repayment deadlines after disbursement of funds. All of the lenders have reserved the right to withdraw these lines at their option.
Other short-term borrowings outstanding during 2002 consisted of a term loan agreement with an unrelated individual. This loan had an initial term of six months and matured during 2002. This term loan was unsecured and paid interest at a fixed rate. The weighted average interest rate on short-term borrowings outstanding for the year ended December 31, 2002 was 3.88%.
Note 10 -Income Taxes
The provision for income taxes for the years ended December 31 is as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Current: | | | | | | | | | | |
| Federal | | $ | 1,754 | | $ | 1,558 | | $ | 1,584 | |
| State | | | 217 | | | 185 | | | 157 | |
| | | 1,971 | | | 1,743 | | | 1,741 | |
| Deferred: | | | | | | | | | | |
| Federal | | | (15 | ) | | 7 | | | (160 | ) |
| State | | | 3 | | | 4 | | | 4 | |
| | | | (12 | ) | | 11 | | | (156 | ) |
| Total tax provision | | $ | 1,959 | | $ | 1,754 | | $ | 1,585 | |
Income taxes are different than tax expense computed by applying the statutory federal tax rate of 34% to income before income taxes. The reasons for the differences for years ended December 31 are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
| Tax expense at statutory rate | | $ | 2,175 | | $ | 1,891 | | $ | 1,709 | |
| State tax, net of federal benefit | | | 145 | | | 125 | | | 106 | |
| Effect of tax exempt interest | | | (294 | ) | | (260 | ) | | (227 | ) |
| Effect of tax exempt earnings on bank-owned life insurance | | | (55 | ) | | (51 | ) | | (39 | ) |
| Other, net | | | (12 | ) | | 49 | | | 36 | |
| Total | | $ | 1,959 | | $ | 1,754 | | $ | 1,585 | |
The sources and tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| Deferred tax assets: | | | | | | | |
| Allowance for loan losses deferred for tax purposes | | $ | 1,196 | | $ | 1,139 | |
| Book depreciation and amortization in excess of tax | | | 21 | | | 19 | |
| Nonqualified retirement plan expense deferred for tax purposes | | | 164 | | | 128 | |
| Gross deferred tax assets | | | 1,381 | | | 1,286 | |
| Deferred tax liabilities: | | | | | | | |
| Unrealized net gains on securities available for sale | | | (60 | ) | | (17 | ) |
| Compensation expense deferred for financial reporting | | | (86 | ) | | (12 | ) |
| Other | | | (9 | ) | | - | |
| Gross deferred tax liabilities | | | (155 | ) | | (29 | ) |
| Net deferred tax asset | | $ | 1,226 | | $ | 1,257 | |
The net deferred tax asset is included in “Other assets” in the accompanying consolidated balance sheets. A portion of the change in the net deferred tax asset relates to unrealized gains and losses on securities available for sale for which a current period deferred tax expense of $43,000 has been recorded directly to shareholders’ equity. The balance of the change in the net deferred tax asset results from the current period deferred tax benefit of ($12,000). In management’s opinion, it is more likely than not that the results of future operations will generate sufficient income to realize the net deferred tax asset and no valuation allowance is considered necessary at December 31, 2004.
Note 11 -Other Income and Other Expenses
The components of other operating income and other operating expenses for the years ended December 31 are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | | | 2002 | |
Other Income: | | | | | | | | | | |
| Late charges and other loan fees | | $ | 303 | | $ | 274 | | $ | 274 | |
| Merchant discount income | | | 262 | | | 428 | | | 450 | |
| Mortgage origination fees | | | 101 | | | 325 | | | 267 | |
| Nondeposit product sales commission | | | 98 | | | 99 | | | 110 | |
| Other | | | 401 | | | 449 | | | 313 | |
| | | $ | 1,165 | | $ | 1,575 | | $ | 1,414 | |
Other Expenses: | | | | | | | | | | |
| Advertising and public relations | | $ | 124 | | $ | 313 | | $ | 271 | |
| Stationary, printing and office support | | | 386 | | | 382 | | | 357 | |
| Merchant and credit card service expense | | | 185 | | | 354 | | | 386 | |
| Legal and professional fees | | | 364 | | | 466 | | | 395 | |
| Other | | | 715 | | | 831 | | | 658 | |
| | | $ | 1,774 | | $ | 2,346 | | $ | 2,067 | |
Note 12 -Common Stock and Per Share Information
As of December 31, 2004, there were approximately 994,000 common shares reserved for issuance under stock compensation benefit plans, of which approximately 355,000 were available for issuance.
The following is a reconciliation of the denominators of the basic and diluted per share computations for net income. There was no required adjustment to the numerator from the net income reported on the accompanying consolidated statements of income.
| | 2004 | 2003 | 2002 |
| | | | Basic | | | Diluted | | | Basic | | | Diluted | | | Basic | | | Diluted | |
| Net income | | $ | 4,439,000 | | $ | 4,439,000 | | $ | 3,807,000 | | $ | 3,807,000 | | $ | 3,442,000 | | $ | 3,442,000 | |
| Average shares outstanding | | | 4,419,000 | | | 4,419,000 | | | 4,256,000 | | | 4,256,000 | | | 4,176,000 | | | 4,176,000 | |
Effect of dilutive securities: Stock options Unvested restricted stock | | | - - | | | 488,000 17,000 | | | - - | | | 580,000 6,000 | | | - - | | | 549,000 19,000 | |
| | | 4,419,000 | | | 4,924,000 | | | 4,256,000 | | | 4,842,000 | | | 4,176,000 | | | 4,744,000 | |
| Per share amount | | $ | 1.00 | | $ | 0.90 | | $ | 0.89 | | $ | 0.79 | | $ | 0.82 | | $ | 0.73 | |
Note 13 -Stock Compensation Plans
The Company has a Restricted Stock Plan for awards to certain key employees. Under the Restricted Stock Plan, the Company may grant common stock to its employees for up to 326,000 shares, with 230,000 shares available for grant at December 31, 2004. All shares granted under the Restricted Stock Plan are subject to restrictions as to continuous employment for a specified time period following the date of grant. During this period, the holder is entitled to full voting rights and dividends. The restrictions as to transferability of shares granted under this plan vest over a period of five years at a rate of 20% per year on each anniversary date of the grant. At December 31, 2004, there were 96,000 shares of common stock outstanding which were issued under the Restricted Stock Plan, of which 17,000 shares were unvested. Deferred compensation representing the fair market value of the stock at the date of grant is amortized over the five-year vesting period as the restrictions lapse. Included in the accompanying consolidated statements of income under the caption “Salaries, wages and benefits” is $71,000, $26,000, and $128,000 of amortized deferred compensation for the years ended December 31, 2004, 2003 and 2002, respectively.
Note 13 -Stock Compensation Plans - continued
The Company has two Incentive Stock Option Plans, one approved in 1989 (which has expired and no additional grants may be made under it) and one approved in 2000, and a nonqualified Non-Employee Stock Option Plan (collectively referred to as stock-based option plans). Under the Incentive Stock Option Plans, options are periodically granted to employees with an exercise price not less than the fair market value of the shares at the date of grant. Options granted are exercisable for a period of ten years from the date of grant and become exercisable at a rate of 20% each year on the first five anniversaries of the date of grant. At December 31, 2004, 261,000 shares of common stock are reserved under the Incentive Stock Option Plans, and 79,000 of these reserved shares are available to be granted under the 2000 Plan.
Under the Non-Employee Stock Option Plan, options have been granted with an exercise price not less than the fair market value of the shares at the date of grant to eligible non-employee directors as a retainer for their services as directors. Options granted are exercisable for a period of ten years from the date of grant. Options granted in 1995 became exercisable one year after the date of grant. Options granted in 1996 become exercisable over a period of nine years at a rate of 11.1% per year on each of the first nine anniversaries of the date of grant. The Non-Employee Stock Option Plan authorizes the granting of stock options up to a maximum of 407,000 shares of common stock. At December 31, 2004, 46,000 reserved shares of common stock are available to be issued under this plan.
All outstanding options, option price, and option activity for all stock-based option plans have been retroactively restated to reflect the effects of all 5% stock dividends issued.
A summary of the activity under the stock-based option plans for the years ended December 31 and information about stock options outstanding under the stock-based option plans at December 31, 2004 is as follows:
| | 2004 | 2003 | 2002 |
| | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | |
| Outstanding, January 1 | | | 863,277 | | $ | 5.87 | | | 968,221 | | $ | 5.67 | | | 1,000,386 | | $ | 5.61 | |
| Granted | | | 2,750 | | $ | 18.32 | | | 4,641 | | $ | 17.48 | | | 4,190 | | $ | 13.91 | |
| Canceled | | | (2,250 | ) | $ | 10.78 | | | (10,489 | ) | $ | 5.25 | | | (3,739 | ) | $ | 9.55 | |
| Exercised | | | (188,627 | ) | $ | 4.68 | | | (99,096 | ) | $ | 4.50 | | | (32,616 | ) | $ | 4.46 | |
| Outstanding, December 31 | | | 675,150 | | $ | 6.24 | | | 863,277 | | $ | 5.87 | | | 968,221 | | $ | 5.67 | |
| Exercisable, December 31 | | | 608,609 | | $ | 6.06 | | | 735,002 | | $ | 5.64 | | | 759,367 | | $ | 5.33 | |
| | | Options Outstanding | Options Exercisable |
Range of Exercise Price | | | Number of Options Outstanding | | | Weighted Average Remaining Contractual Life | | | Weighted Average Exercise Price | | | Nuber of Options Exercisable | | | Weighted Average Exercise Price | |
| $3.61 - $4.83 | | | 253,009 | | | 0.9 years | | $ | 4.78 | | | 226,948 | | $ | 4.78 | |
| $5.25 - $5.33 | | | 221,449 | | | 2.0 years | | $ | 5.33 | | | 221,449 | | $ | 5.33 | |
| $7.20 - $8.64 | | | 152,068 | | | 5.3 years | | $ | 7.91 | | | 120,234 | | $ | 7.91 | |
| $9.16 - $11.94 | | | 36,144 | | | 3.5 years | | $ | 11.59 | | | 36,144 | | $ | 11.59 | |
| $12.14 - $13.91 | | | 5,530 | | | 5.6 years | | $ | 13.48 | | | 2,994 | | $ | 13.12 | |
| $17.86 - $18.32 | | | 6,950 | | | 9.0 years | | $ | 18.04 | | | 840 | | $ | 17.86 | |
| $3.61 - $18.32 | | | 675,150 | | | 2.5 years | | $ | 6.24 | | | 608,609 | | $ | 6.06 | |
Note 14 -Employee Benefit Plans
The Company maintains an employee benefit plan for all eligible employees of the Company and its subsidiaries under the provisions of Internal Revenue Code Section 401K. The Summit Retirement Savings Plan (“the Plan”) allows for employee contributions and, upon annual approval of the Board of Directors, the Company matches employee contributions from one percent to a maximum of six percent of deferred compensation. The matching contributions as a percent of deferred compensation were 6% for each year 2004, 2003, and 2002. A total of $188,000, $164,000, and $179,000, respectively, in 2004, 2003, and 2002 was charged to operations for the Company’s matching contribution. Employees are immediately vested in their contributions to the Plan and become fully vested in the employer matching contribution after completion of six years of service, as defined in the Plan.
During 1998, Summit National Bank entered into salary continuation agreements with several key management employees. Under the agreements, the Bank is obligated to provide for each such executive officer or his beneficiaries, during a period of 20 years after the employee’s death, disability, or retirement, annual benefits ranging from $43,000 to $130,000. The estimated present value of future benefits to be paid is being accrued over the period from the effective date of the agreements until the expected retirement dates of the participants. The expense incurred and amount accrued for this nonqualified salary continuation plan, which is an unfunded plan, for the years ended December 31, 2004, 2003 and 2002 amounted to $110,000, $87,000 and $69,000, respectively. To partially finance benefits to be paid under this plan, the Bank purchased, and is the beneficiary of, several life insurance policies. Proceeds from the insurance policies are payable to the Company upon the death of the participant. The cash surrender value of these policies included in the accompanying consolidated balance sheets in “Other assets” was $3,876,000 and $3,737,000 at December 31, 2004 and 2003, respectively.
Note 15 -Regulatory Restrictions
The ability of the Company to pay cash dividends is dependent upon its receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. The approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year exceeds that bank’s net profits (as defined by the Comptroller) for that year combined with its retained net profits (as defined by the Comptroller) for the two preceding calendar years. The Bank paid cash dividends of $0.76 and $0.51, respectively, per common share totaling $646,000 and $434,000, respectively, for the year ended December 31, 2004 and 2003. It is currently the Bank’s intention to pay all dividends only from the net income of the current year.
Under current Federal Reserve regulations, the Bank is limited in the amount it may loan to the Company, the Finance Company, or other affiliates. Loans made by the Bank to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20%, of the Bank’s capital, surplus, and undivided profits, after adding back the allowance for loan losses. Based on these limitations, approximately $6.9 million was available for loans to the Company and the Finance Company at December 31, 2004. Certain collateral restrictions also apply to loans from the Bank to its affiliates.
Note 16 -Regulatory Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The Company and the Bank are required to maintain minimum amounts and ratios of total risk-based capital, Tier I capital, and Tier I leverage capital as set forth in the table following. Management believes, as of December 31, 2004, that the Company and the Bank meet all capital adequacy requirements to which they are subject. At December 31, 2004 and 2003, the Bank is categorized as “well capitalized” under the regulatory framework for prompt corrective action. There are no current conditions or events that management believes would change the Company’s or the Bank’s risk-based capital regulatory-defined category.
Note 16 -Regulatory Capital Requirements - continued
The following table presents the Company’s and the Bank’s actual capital amounts and ratios at December 31, 2004 and 2003 as well as the minimum calculated amounts for each regulatory defined category. (dollars in thousands)
| | | Actual | To Be Categorized “Adequately Capitalized” | To Be Categorized “Well Capitalized” |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
As of December 31, 2004 | | | | | | | | | | | | | | | | | | | |
The Company | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 40,511 | | | 15.27 | % | $ | 21,228 | | | 8.00 | % | N.A. |
| Tier 1 capital to risk-weighted assets | | $ | 37,190 | | | 14.02 | % | $ | 10,614 | | | 4.00 | % | N.A. |
| Tier 1 capital to average assets | | $ | 37,190 | | | 11.39 | % | $ | 13,061 | | | 4.00 | % | N.A. |
The Bank | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 34,246 | | | 13.05 | % | $ | 20,994 | | | 8.00 | % | $ | 26,242 | | | 10.00 | % |
| Tier 1 capital to risk-weighted assets | | $ | 30,963 | | | 11.80 | % | $ | 10,497 | | | 4.00 | % | $ | 15,745 | | | 6.00 | % |
| Tier 1 capital to average assets | | $ | 30,963 | | | 9.57 | % | $ | 12,939 | | | 4.00 | % | $ | 16,174 | | | 5.00 | % |
As of December 31, 2003 | | | | | | | | | | | | | | | | | | | |
The Company | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 35,223 | | | 13.75 | % | $ | 20,486 | | | 8.00 | % | N.A. |
| Tier 1 capital to risk-weighted assets | | $ | 32,019 | | | 12.50 | % | $ | 10,243 | | | 4.00 | % | N.A. |
| Tier 1 capital to average assets | | $ | 32,019 | | | 9.92 | % | $ | 12,911 | | | 4.00 | % | N.A. |
The Bank | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 30,522 | | | 12.05 | % | $ | 20,269 | | | 8.00 | % | $ | 25,336 | | | 10.00 | % |
| Tier 1 capital to risk-weighted assets | | $ | 27,354 | | | 10.80 | % | $ | 10,134 | | | 4.00 | % | $ | 15,202 | | | 6.00 | % |
| Tier 1 capital to average assets | | $ | 27,354 | | | 8.57 | % | $ | 12,772 | | | 4.00 | % | $ | 15,965 | | | 5.00 | % |
Note 17 -Contingent Liabilities and Commitments
In the normal course of business, the Company and its subsidiaries are periodically subject to various pending or threatened lawsuits in which claims for monetary damages may be asserted. In the opinion of the Company’s management, after consultation with legal counsel, none of this litigation should have a material adverse effect on the Company’s financial position or results of operations.
The Company leases branch facilities for both the Bank and the Finance Company. These leases have initial terms of from two to ten years and various renewal options under substantially the same terms with certain rate escalations. Rent expense charged to operations totaled $296,000, $294,000, and $290,000, respectively, for the years ended December 31, 2004, 2003, and 2002. The annual minimum rental commitments under the terms of the Company’s noncancellable leases subsequent to December 31, 2004 are(dollars in thousands):
| 2005 | | $ | 192 | |
| 2006 | | | 140 | |
| 2007 | | | 87 | |
| 2008 | | | 78 | |
| 2009 | | | 78 | |
| Thereafter | | | 214 | |
| | | $ | 789 | |
Note 18 -Related Party Transactions Directors, executive officers, and associates of such persons are customers of and have transactions with the Company’s bank subsidiary in the ordinary course of business. Included in such transactions are outstanding loans and commitments, all of which are made under substantially the same credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. All loans to related parties were current and performing in accordance with contractual terms at December 31, 2004. The aggregate dollar amount of loans outstanding to related parties was approximately $4,846,000 and $4,925,000 at December 31, 2004 and 2003, respectively. During 2004, new loans and advances on lines of credit of approximately $829,000 were made, and payments on these loans and lines totaled approximately $908,000. At December 31, 2004, there were commitments to extend additional credit to related parties in the amount of approximately $2,019,000.
Note 19 -Off-Balance Sheet Financial Instruments
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the liquidity, credit enhancement, and financing needs of its customers. These financial instruments include legally binding commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Credit risk is the principal risk associated with these instruments. The contractual amounts of these instruments represent the amount of credit risk should the instruments be fully drawn upon and the customer defaults.
To control the credit risk associated with entering into commitments and issuing letters of credit, the Company uses the same credit quality, collateral policies, and monitoring controls in making commitments and letters of credit as it does with its lending activities. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation.
Legally binding commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. The financial standby letters of credit issued by the Company are irrevocable. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. At December 31, 2004 and 2003, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material.
At December 31, the Company’s total contractual amounts of commitments and letters of credit are as follows:
(dollars in thousands) | | | 2004 | | | 2003 | |
| Legally binding commitments to extend credit: | | | | | | | |
| Commercial and industrial | | $ | 16,557 | | $ | 14,621 | |
| Residential real estate, including prime equity lines | | | 20,031 | | | 17,890 | |
| Construction and development | | | 24,361 | | | 12,968 | |
| Consumer and overdraft protection | | | 2,336 | | | 2,373 | |
| | | | 63,285 | | | 47,852 | |
| Standby letters of credit | | | 3,529 | | | 3,925 | |
| Total commitments | | $ | 66,814 | | $ | 51,777 | |
Approximately $812,000 and $1,326,000 of total commitments at December 31, 2004 and 2003, respectively, represent commitments to extend credit at fixed rates of interest, which exposes the Company to some degree of interest rate risk.
Note 20 - Segment Information
The Company reports information about its operating segments in accordance with SFAS 131, “Disclosures about Segments of an Enterprise and Related Information”. Summit Financial Corporation is the parent holding company for Summit National Bank (“Bank”), a nationally chartered bank, and Freedom Finance, Inc. (“Finance”), a consumer finance company. The Company considers the Bank and the Finance Company separate business segments. Financial performance for each segment is detailed in the following tables. Included in the “Corporate” column are amounts for general corporate activities and eliminations of intersegment transactions.
(dollars in thousands) | | | Bank | | | Finance | | | Corporate | | | Total | |
At and for the year endedDecember 31, 2004 | | | | | | | | | | | | | |
| Interest income | | $ | 15,851 | | $ | 1,696 | | $ | (5 | ) | $ | 17,542 | |
| Interest expense | | | 4,590 | | | 126 | | | (126 | ) | | 4,590 | |
| Net interest income | | | 11,261 | | | 1,570 | | | 121 | | | 12,952 | |
| Provision for loan losses | | | 135 | | | 301 | | | - | | | 436 | |
| Noninterest income | | | 2,005 | | | 371 | | | (60 | ) | | 2,316 | |
| Noninterest expenses | | | 7,025 | | | 1,374 | | | 35 | | | 8,434 | |
| Income before income taxes | | | 6,106 | | | 266 | | | 26 | | | 6,398 | |
| Income taxes | | | 1,851 | | | 98 | | | 10 | | | 1,959 | |
| Net income | | $ | 4,255 | | $ | 168 | | $ | 16 | | $ | 4,439 | |
| Net loans | | $ | 236,154 | | $ | 2,829 | | $ | (172 | ) | $ | 238,811 | |
| Total assets | | $ | 317,843 | | $ | 3,301 | | $ | (206 | ) | $ | 320,938 | |
(dollars in thousands) | | | Bank | | | Finance | | | Corporate | | | Total | |
At and for the year endedDecember 31, 2003 | | | | | | | | | | | | | |
| Interest income | | $ | 15,642 | | $ | 1,829 | | $ | (26 | ) | $ | 17,445 | |
| Interest expense | | | 5,156 | | | 147 | | | (147 | ) | | 5,156 | |
| Net interest income | | | 10,486 | | | 1,682 | | | 121 | | | 12,289 | |
| Provision for loan losses | | | 450 | | | 336 | | | - | | | 786 | |
| Noninterest income | | | 2,654 | | | 336 | | | (60 | ) | | 2,930 | |
| Noninterest expenses | | | 7,476 | | | 1,367 | | | 29 | | | 8,872 | |
| Income before income taxes | | | 5,214 | | | 315 | | | 32 | | | 5,561 | |
| Income taxes | | | 1,626 | | | 116 | | | 12 | | | 1,754 | |
| Net income | | $ | 3,588 | | $ | 199 | | $ | 20 | | $ | 3,807 | |
| Net loans | | $ | 225,968 | | $ | 3,038 | | $ | (641 | ) | $ | 228,365 | |
| Total assets | | $ | 341,033 | | $ | 3,596 | | $ | (708 | ) | $ | 343,921 | |
(dollars in thousands) | | | Bank | | | Finance | | | Corporate | | | Total | |
At and for the year endedDecember 31, 2002 | | | | | | | | | | | | | |
| Interest income | | $ | 15,931 | | $ | 1,924 | | $ | (34 | ) | $ | 17,821 | |
| Interest expense | | | 6,166 | | | 184 | | | (176 | ) | | 6,174 | |
| Net interest income | | | 9,765 | | | 1,740 | | | 142 | | | 11,647 | |
| Provision for loan losses | | | 530 | | | 317 | | | - | | | 847 | |
| Noninterest income | | | 2,394 | | | 337 | | | (60 | ) | | 2,671 | |
| Noninterest expenses | | | 7,037 | | | 1,379 | | | 28 | | | 8,444 | |
| Income before income taxes | | | 4,592 | | | 381 | | | 54 | | | 5,027 | |
| Income taxes | | | 1,423 | | | 142 | | | 20 | | | 1,585 | |
| Net income | | $ | 3,169 | | $ | 239 | | $ | 34 | | $ | 3,442 | |
| Net loans | | $ | 213,318 | | $ | 3,298 | | $ | (1,185 | ) | $ | 215,431 | |
| Total assets | | $ | 298,484 | | $ | 3,938 | | $ | (216 | ) | $ | 302,206 | |
Note 21 -Fair Value of Financial Instruments
The Company estimates the fair value of financial instruments in accordance with SFAS 107, “Disclosures about Fair Value of Financial Instruments”. Fair value is assumed to approximate book value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, interest-bearing bank balances, and federal funds sold. Fair value of investment securities is estimated based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Fair value for variable rate loans that reprice frequently and for loans that mature in less that one year is based on the carrying value, reduced by an estimate of credit losses inherent in the portfolio. Fair value of fixed rate real estate, consumer, commercial and other loans maturing after one year is based on the discounted present value of the estimated future cash flows, reduced by an estimate of credit losses inherent in the portfolio. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality. The estimated fair market value of commitments to extend credit and standby letters of credit are equal to their carrying value as the majority of these off-balance sheet instruments have relatively short terms to maturity and are written with variable rates of interest.
Fair value for demand deposit accounts and variable rate interest-bearing accounts is equal to the carrying value. Fair value of certificate of deposit accounts are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for FHLB advances is based on discounted cash flows using the current market rate.
The Company has used management’s best estimate of fair values based on the above assumptions. Thus, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income tax or other expenses which would be incurred in an actual sale or settlement are not taken into consideration in the fair values presented.
The estimated fair values of the Company’s financial instruments as of December 31 are as follows (dollars in thousands):
| | | 2004 | 2003 |
| | | | Carrying Amount | | | Estimated Fair Value | | | Carrying Amount | | | Estimated Fair Value | |
Financial Assets: | | | | | | | | | | | | | |
| Cash and due from banks | | $ | 6,548 | | $ | 6,548 | | $ | 9,854 | | $ | 9,854 | |
| Interest-bearing bank balances | | | 147 | | | 147 | | | 341 | | | 341 | |
| Federal funds sold | | | 218 | | | 218 | | | 201 | | | 201 | |
| Investment securities available for sale | | | 59,838 | | | 59,838 | | | 90,887 | | | 90,887 | |
| Investment in FHLB and other stock | | | 3,326 | | | 3,326 | | | 3,004 | | | 3,004 | |
| Loans, net | | | 238,811 | | | 239,055 | | | 228,365 | | | 235,651 | |
Financial Liabilities: | | | | | | | | | | | | | |
| Deposits | | | 231,718 | | | 231,581 | | | 257,012 | | | 257,872 | |
| Federal Home Loan Bank advances | | | 50,134 | | | 50,473 | | | 52,317 | | | 52,148 | |
Note 22 -Quarterly Operating Results (unaudited)
Consolidated quarterly operating data for the years ended December 31 is summarized as follows (per share data has been restated to reflect all 5% stock dividends issued)(dollars in thousands, exceptper share data):
| | | 2004 | 2003 |
| | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
| Interest income | | $ | 4,443 | | $ | 4,198 | | $ | 4,282 | | $ | 4,619 | | $ | 4,329 | | $ | 4,424 | | $ | 4,280 | | $ | 4,412 | |
| Interest expense | | | 1,179 | | | 1,138 | | | 1,100 | | | 1,173 | | | 1,368 | | | 1,363 | | | 1,207 | | | 1,218 | |
| Net interest income | | | 3,264 | | | 3,060 | | | 3,182 | | | 3,446 | | | 2,961 | | | 3,061 | | | 3,073 | | | 3,194 | |
| Provision for loan losses | | | 210 | | | (50 | ) | | 33 | | | 243 | | | 173 | | | 229 | | | 100 | | | 284 | |
| Net interest income after provision | | | 3,054 | | | 3,110 | | | 3,149 | | | 3,203 | | | 2,788 | | | 2,832 | | | 2,973 | | | 2,910 | |
| Noninterest income | | | 620 | | | 599 | | | 548 | | | 549 | | | 761 | | | 855 | | | 758 | | | 556 | |
| Noninterest expenses | | | 2,242 | | | 2,106 | | | 2,044 | | | 2,042 | | | 2,223 | | | 2,148 | | | 2,316 | | | 2,185 | |
| Income before taxes | | | 1,432 | | | 1,603 | | | 1,653 | | | 1,710 | | | 1,326 | | | 1,539 | | | 1,415 | | | 1,281 | |
| Income taxes | | | 445 | | | 483 | | | 505 | | | 526 | | | 417 | | | 480 | | | 445 | | | 412 | |
| Net income | | $ | 987 | | $ | 1,120 | | $ | 1,148 | | $ | 1,184 | | $ | 909 | | $ | 1,059 | | $ | 970 | | $ | 869 | |
Net income per share: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.23 | | $ | 0.25 | | $ | 0.26 | | $ | 0.26 | | $ | 0.21 | | $ | 0.25 | | $ | 0.23 | | $ | 0.20 | |
| Diluted | | $ | 0.20 | | $ | 0.23 | | $ | 0.23 | | $ | 0.24 | | $ | 0.19 | | $ | 0.22 | | $ | 0.20 | | $ | 0.18 | |
Average common sharesoutstanding: | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 4,320,000 | | | 4,432,000 | | | 4,448,000 | | | 4,476,000 | | | 4,213,000 | | | 4,253,000 | | | 4,262,000 | | | 4,296,000 | |
| Diluted | | | 4,857,000 | | | 4,944,000 | | | 4,941,000 | | | 4,952,000 | | | 4,781,000 | | | 4,842,000 | | | 4,843,000 | | | 4,899,000 | |
Note 23 -Parent Company Financial Information
The following is condensed financial information of Summit Financial Corporation (parent company only) at December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003, and 2002.
SUMMIT FINANCIAL CORPORATION
Condensed Balance Sheets
(Dollars in Thousands)
| | | December 31, | |
| | | | 2004 | | | 2003 | |
Assets | | | | | | | |
| Cash | | $ | 3,173 | | $ | 1,791 | |
| Investment in bank subsidiary | | | 31,061 | | | 27,382 | |
| Investment in nonbank subsidiary | | | 821 | | | 653 | |
| Due from subsidiaries | | | 2,236 | | | 2,428 | |
| Other assets | | | 25 | | | - | |
| | | $ | 37,316 | | $ | 32,254 | |
Liabilities and Shareholders’ Equity | | | | | | | |
| Accruals and other liabilities | | $ | 51 | | $ | 49 | |
| Due to subsidiaries | | | - | | | - | |
| Shareholders’ equity | | | 37,265 | | | 32,205 | |
| | | $ | 37,316 | | $ | 32,254 | |
Note 23 -Parent Company Financial Information - continued
SUMMIT FINANCIAL CORPORATION
Condensed Statements of Income
(Dollars in Thousands)
| | | For the Years Ended December 31, | |
| | | | 2004 | | | 2003 | | | 2002 | |
| Interest income | | $ | 121 | | $ | 121 | | $ | 142 | |
| Interest expense | | | - | | | - | | | - | |
| Net interest income | | | 121 | | | 121 | | | 142 | |
| Noninterest expenses | | | 95 | | | 89 | | | 88 | |
| Net operating income | | | 26 | | | 32 | | | 54 | |
| Equity in undistributed net incomeof subsidiaries | | | 4,423 | | | 3,787 | | | 3,408 | |
| Income before taxes | | | 4,449 | | | 3,819 | | | 3,462 | |
| Income taxes | | | 10 | | | 12 | | | 20 | |
| Net income | | $ | 4,439 | | $ | 3,807 | | $ | 3,442 | |
SUMMIT FINANCIAL CORPORATION
Condensed Statements of Cash Flows
(Dollars in Thousands)
| | For the Years Ended December 31, | |
| | | | 2004 | | | 2003 | | | 2002 | |
Operating activities: | | | | | | | | | | |
| Net income | | $ | 4,439 | | $ | 3,807 | | $ | 3,442 | |
| Adjustments to reconcile net income to net cashprovided by operating activities: | | | | | | | | | | |
| Equity in undistributed net income of subsidiaries | | | (4,423 | ) | | (3,787 | ) | | (3,408 | ) |
| (Increase) decrease in other assets | | | (25 | ) | | - | | | 2 | |
| Increase in other liabilities | | | 2 | | | 10 | | | 4 | |
| Amortization of deferred compensation | | | 71 | | | 26 | | | 128 | |
| Net cash provided by operating activities | | | 64 | | | 56 | | | 168 | |
Investing activities: | | | | | | | | | | |
| Net decrease in due from subsidiaries | | | 461 | | | 33 | | | 8 | |
| Net (decrease) increase in due to subsidiaries | | | - | | | (14 | ) | | 12 | |
| Net cash provided by investing activities | | | 461 | | | 19 | | | 20 | |
Financing activities: | | | | | | | | | | |
| Employee stock options exercised | | | 884 | | | 446 | | | 145 | |
| Cash dividends declared ($0.15 per common share) | | | (673 | ) | | (430 | ) | | - | |
| Cash dividends received from subsidiary | | | 646 | | | 434 | | | - | |
| Cash paid in lieu of fractional shares | | | - | | | (7 | ) | | (4 | ) |
| Net cash provided by financing activities | | | 857 | | | 443 | | | 141 | |
| Net increase in cash and cash equivalents | | | 1,382 | | | 518 | | | 329 | |
| Balance, beginning of year | | | 1,791 | | | 1,273 | | | 944 | |
| Balance, end of year | | $ | 3,173 | | $ | 1,791 | | $ | 1,273 | |
REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM
The Board of Directors
Summit Financial Corporation
We have audited the accompanying consolidated balance sheets of Summit Financial Corporation and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Summit Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
| Greenville, South Carolina | /s/ KPMG LLP |
| February 22, 2005 | |
MANAGEMENT’S REPORT
Primary responsibility for the integrity and objectivity of the Company’s consolidated financial statements rests with management. The accompanying consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and accordingly include amounts that are based on management’s best estimates and judgments. Non-financial information included in the Summary Annual Report to Shareholders has also been prepared by management and is consistent with the consolidated financial statements.
To assure that financial information is reliable and data is presented fairly in the financial statements, management has established and maintains an internal control structure which is supplemented by a program of internal audits. The internal control structure is designed to provide reasonable assurance that assets are safeguarded and transactions are executed, recorded and reported in accordance with management intentions and authorizations. The internal control structure includes disclosure controls and procedures and internal controls over financial reporting.
To assure the effective administration of the system of internal controls, the Company develops and widely disseminates written policies and procedures, provides adequate communication channels and fosters an environment conducive to the effective functioning of internal controls. All employees of the Company are informed of the need to conduct our business affairs in accordance with the highest ethical standards. The Company has set forth a written code of business conduct and ethics and communicated it to all employees.
The Audit Committee, composed entirely of outside directors, meets periodically (separately and jointly) with Company management, the internal auditor, and the independent auditors, KPMG LLP, to review matters relative to the quality of financial reporting, internal control, and the nature, timing, extent and results of the audit efforts. KPMG LLP, have audited the Company’s consolidated financial statements in accordance with standards of the Public Company Accounting Oversight Board (United States), as described in their report.
 |  |
| J. Randolph Potter | Blaise B. Bettendorf |
President and Chief Executive Officer | Senior Vice President and Chief Financial Officer |
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES There have been no changes in or disagreements with accountants on accounting and financial disclosure as defined by Item 304 of Regulation S-K.
(a) Evaluation of Disclosure Controls and Procedures
The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, (“the Exchange Act”) as of the end of the period covered by this report. Based upon this evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are designed and effective to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes in Internal Controls
There was no significant change in the Company’s “internal control over financial reporting” (as such term is defined in Rule 13a-15(f) under the Exchange Act) that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
There was no information required to be disclosed by the Company in a report on Form 8-K during the fourth quarter of 2004 that was not disclosed.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is set forth under the headings “Proposal 1 - Election of Directors”, “Executive Officers and Compensation”, “Section 16(a) Beneficial Ownership Reporting Compliance”, and “Audit Committee Matters” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
The Company has adopted a Code of Ethics for its directors, chief executive officer, chief financial officer, controller and all employees. A copy of the Company’s Code of Ethics will be furnished to any interested party, without charge, upon written request to: Ms. Blaise B. Bettendorf, CFO, Summit Financial Corporation, Post Office Box 1087, Greenville, South Carolina, 29602.
The information required by this item is set forth under the headings “Directors’ Compensation”, “Executive Officers and Compensation”, “Compensation Committee Report”, and “Stock Performance Graph” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
(a) Security Ownership of Certain Beneficial Owners
The information required by this item is set forth under the headings “Stock Ownership” and “Proposal 1 - Election of Directors” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
(b) Security Ownership of Management
The information required by this item is set forth under the headings “Stock Ownership” and “Proposal 1 - Election of Directors” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
(c) Change in Control
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.
(d) Equity Compensation Plan Information as of December 31, 2004
EQUITY COMPENSATION PLAN INFORMATION
(a) Plan Category | | | (b) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants, and Rights | | | (c) Weighted-Average Price of Outstanding Options, Warrants, and Rights | | | (d) Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (excluding securities in column (a)) | |
| Equity compensation plansapproved by shareholders | | | 675,150 | | $ | 6.24 | | | 354,323 | |
| Equity compensation plansnot approved by shareholders | | | N/A | | | N/A | | | N/A | |
| Total | | | 675,150 | | $ | 6.24 | | | 354,323 | |
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the heading “Compensation Committee Interlocks and Insider Participation” and “Transactions with Management” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth under the heading “Audit Committee Matters” in the definitive Proxy Statement of the Company filed in connection with its 2005 Annual Meeting of Shareholders, which information is incorporated herein by reference.
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| 1. | The following consolidated financial statements and report of independent auditors of the Company are included in Part II, Item 8 hereof: |
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income For The Years Ended December 31, 2004, 2003 and 2002
Consolidated Statements of Shareholders’ Equity And Comprehensive Income For The Years Ended December 31, 2004, 2003, and 2002
Consolidated Statements of Cash Flows For The Years Ended December 31, 2004, 2003, and 2002
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
| 2. | Financial statement schedules required by Regulation S-X: |
All other consolidated financial statements or schedules have been omitted since the required information is included in the consolidated financial statements or notes thereto referenced above, or is not applicable or required.
| 3. | Exhibits required by Item 601 of Regulation S-K: |
| 3.1 | Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 filed with the Registrant's Registration Statement on Form S-1 Under The Securities Act of 1933, File No. 33-31466). |
| 3.2 | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 filed with the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003, File No. 000-19235). |
| 4. | Form of Certificate for Common Stock (incorporated by reference to Exhibit 4 filed with the Registrant's Registration Statement on Amendment No. 1 To Form S-1 Under The Securities Act of 1933, File No. 33-31466). |
| 10.1 *** | Summit Financial Corporation Incentive Stock Plan (incorporated by reference to Exhibit 10.1 filed with the Registrant's Registration Statement on Form S-1 Under The Securities Act of 1933, File No. 33-31466). |
| 10.2 | Lease Agreement for North Pleasantburg Drive Bank Site (incorporated by reference to Exhibit 10.2 filed with the Registrant's Registration Statement on Form S-1 Under The Securities Act of 1933, File No. 33-31466). |
| 10.3 *** | Employment Agreement of J. Randolph Potter dated December 21, 1998 (incorporated by reference to Exhibit 10.3 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998, File No. 000-19235). |
| 10.4 *** | Employment Agreement of Blaise B. Bettendorf dated December 21, 1998 (incorporated by reference to Exhibit 10.4 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998, File No. 000-19235). |
| 10.5 *** | Summit Financial Corporation Restricted Stock Plan (incorporated by reference to Exhibit 10.5 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993, File No. 000-19235). |
| 10.6 *** | Summit Financial Corporation Non-Employee Stock Option Plan (incorporated by reference to Exhibit 10.6 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1994, File No. 000-19235). |
| 10.7 *** | Employment Agreement of James B. Schwiers dated September 2, 1999 (incorporated by reference to Exhibit 10.7 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-19235). |
| 10.8 *** | Summit Financial Corporation 1999 Incentive Stock Plan (incorporated by reference to Exhibit 10.8 filed the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-19235). |
10.9 *** | Employment Agreement of James G. Bagnal dated April 20, 2001 (incorporated by reference to Exhibit 10.9 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 000-19235). |
10.10 | Lease Agreement for East North Street Bank Site (incorporated by reference to Exhibit 10.10 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 000-19235). |
10.11 *** | Salary Continuation Agreement of J. Randolph Potter dated September 9, 1998 (incorporated by reference to Exhibit 10.11 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 000-19235). |
10.12 *** | Salary Continuation Agreement of Blaise B. Bettendorf dated September 9, 1998 (incorporated by reference to Exhibit 10.12 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 000-19235). |
10.13 *** | Salary Continuation Agreement of James B. Schwiers dated September 9, 1998 (incorporated by reference to Exhibit 10.13 filed with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 000-19235). |
| 21. | Subsidiaries of Summit Financial Corporation: |
| | Summit National Bank, a nationally chartered bank, incorporated in South Carolina |
| | Summit Investment Services, Inc., a subsidiary of Summit National Bank, incorporated in South Carolina |
| | Freedom Finance, Inc., a consumer finance company, incorporated in South Carolina |
| 23. | Consent of KPMG LLP with regard to S-8 Registration Statements for Summit Financial Corporation Restricted Stock Plan (as filed with the Securities and Exchange Commission, “SEC”, August 23, 1994, File No. 33-83538); Summit Financial Corporation Incentive Stock Option Plan (as filed with the SEC July 19, 1995, File No. 33-94962); Summit Financial Corporation 1995 Non-Employee Stock Option Plan (as filed with the SEC July 19, 1995, File No. 33-94964) and Summit Financial Corporation 1999 Incentive Stock Option Plan (as filed with the SEC November 21,2003, File No. 333-101367). |
| 31.1 | Rule 13a - 14(a) Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. |
| 31.2 | Rule 13a - 14(a) Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. |
| 32.1 | Section 1350 Certificate of Chief Executive Officer furnished pursuant to Section 906 of the Sarbanes Oxley Act of 2002. |
| 32.2 | Section 1350 Certificate of Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes Oxley Act of 2002. |
*** - Management contracts or compensatory plan or arrangement.
The exhibits listed above will be furnished to any security holder upon written request to Ms. Blaise B. Bettendorf, Chief Financial Officer, Summit Financial Corporation, Post Office Box 1087, Greenville, South Carolina 29602. The Registrant will charge a fee of $.50 per page for photocopying such exhibit.
Pursuant to the requirements of Section 13 or 15(d) 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.
| | SUMMIT FINANCIAL CORPORATION |
| | |
| Dated: February 22, 2005 | J. Randolph Potter, President |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE | TITLE | DATE |
| | | |
/s/ J. Randolph Potter | President, Chief Executive Officer and Director | February 22, 2005 |
| J. Randolph Potter | | |
| | | |
/s/ Blaise B. Bettendorf | Senior Vice President (Principal Financial and Accounting Officer) | February 22, 2005 |
| Blaise B. Bettendorf | | |
| | | |
| /s/ C. Vincent Brown | Chairman, Director | February 22, 2005 |
| C. Vincent Brown | | |
| | | |
| /s/ David C. Poole | Secretary, Director | February 22, 2005 |
| David C. Poole | | |
| | | |
| /s/ James G. Bagnal, III | Director | February 22, 2005 |
| James G. Bagnal, III | | |
| | | |
| /s/ Ivan E. Block | Director | February 22, 2005 |
| Ivan E. Block | | |
| | | |
| /s/ J. Earle Furman, Jr. | Director | February 22, 2005 |
| J. Earle Furman, Jr. | | |
| | | |
| _/s/ John W. Houser | Director | February 22, 2005 |
| John W. Houser | | |
| | | |
| /s/ T. Wayne McDonald | Director | February 22, 2005 |
| T. Wayne McDonald | | |
| | | |
| /s/ Allen H. McIntyre | Director | February 22, 2005 |
| Allen H. McIntyre | | |
| | | |
| _/s/ Larry A. McKinney | Director | February 22, 2005 |
| Larry A. McKinney | | |
| | | |
| /s/ James B. Schwiers | Director | February 22, 2005 |
| James B. Schwiers | | |
61
