Exhibit 13 COMMON STOCK LISTING Current market quotations for the common stock of Summit Financial Group,Inc. are available on the OTC Bulletin Board under the symbol SMMF. COMMON STOCK DIVIDEND AND MARKET PRICE INFORMATION The following table presents cash dividends paid per share and information regarding bid prices per share of Summit's common stock for the periods indicated. The bid prices presented are based on information reported by the OTC Bulletin Board, and may reflect inter-dealer prices, without retail mark-up, mark-down or commission and not represent actual transactions. First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- 2000 Dividends paid $ - $ 0.50 $ - $ 0.70 High Bid 41.00 36.50 36.50 36.75 Low Bid 36.50 30.38 31.00 35.50 1999 Dividends paid $ - $ 0.47 $ - $ 0.48 High Bid 44.75 44.00 40.25 40.50 Low Bid 41.25 40.25 40.00 36.00 Dividends on Summit's common stock are paid on the 15th day of June and December. The record date is the 1st day of each respective month. As of February 15, 2001, there were approximately 1,250 shareholders of record of Summit's common stock. 16 SELECTED FINANCIAL DATA For the Year Ended (unless otherwise noted) (Dollars in thousands, except per share amounts) 2000 1999 1998 (1) 1997 (1) 1996 (1) ------------------------------------------------ -------- -------- -------- -------- -------- Summary of Operations Interest income $ 32,264 $ 25,114 $ 20,638 $ 17,358 $ 16,176 Interest expense 18,276 12,234 10,288 8,880 8,318 Net interest income 13,988 12,880 10,350 8,478 7,858 Provision for loan losses 558 370 615 554 425 Net interest income after provision for loan losses 13,430 12,510 9,735 7,924 7,433 Noninterest income 1,228 821 753 575 576 Noninterest expense 9,865 8,718 6,638 5,256 4,910 Income before income taxes 4,793 4,613 3,850 3,243 3,099 Income taxes 1,543 1,570 1,248 943 688 Net income $ 3,250 $ 3,043 $ 2,602 $ 2,300 $ 2,411 Balance Sheet Data (at year end) Assets $ 481,239 $ 385,767 $ 287,296 $ 235,241 $ 216,376 Securities 176,741 112,770 64,978 59,134 66,531 Loans 274,153 238,299 195,277 145,067 134,180 Deposits 345,962 297,139 228,341 190,051 183,886 Short-term borrowings 9,391 32,348 4,644 7,145 4,377 Long-term borrowings 81,086 17,943 16,469 10,396 3,515 Shareholders' equity 39,773 35,083 35,958 26,190 22,711 Per Share Data Basic earnings $ 3.69 $ 3.39 $ 3.05 $ 3.27 $ 3.52 Diluted earnings 3.69 3.39 3.05 3.27 3.52 Shareholders' equity (at year end) 45.32 39.80 40.05 36.40 33.15 Cash dividends 1.20 0.95 0.89 0.84 0.77 Performance Ratios Return on average equity 8.93% 8.52% 7.44% 9.45% 11.25% Return on average assets 0.75% 0.88% 0.95% 1.01% 1.15% Dividend payout 32.5% 27.3% 30.7% 26.2% 23.3% Equity to assets 8.3% 9.1% 12.5% 11.1% 10.5% (1) - All amounts prior to 1999, with the exception of cash dividends per share, have been restated to give effect to the Potomac merger accounted for as a pooling of interests. 17 Management's Discussion and Analysis of Financial Condition and Results of Operations and Related Statistical Disclosures INTRODUCTION AND SUMMARY The following is management's discussion and analysis of the financial condition and financial results of operations for Summit Financial Group, Inc. ("Company" or "Summit") and its wholly owned subsidiaries, South Branch Valley National Bank ("South Branch"), Capital State Bank, Inc. ("Capital State"), Shenandoah Valley National Bank ("Shenandoah") and Potomac Valley Bank ("Potomac") as of December 31, 2000. This discussion may contain forward looking statements based on management's expectations and actual results may differ materially. Since the primary business activities of Summit are conducted through its wholly owned bank subsidiaries, the following discussion focuses primarily on the financial condition and operations of those entities. All amounts and percentages have been rounded for this discussion. This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto of the Company as of December 31, 2000 and for each of the three years then ended. This annual report contains certain forward-looking statements (as defined in the Private Securities Litigation Act of 1995), which reflect management's beliefs and expectations based on information currently available. These forward-looking statements are inherently subject to significant risks and uncertainties, including changes in general economic and financial market conditions, the Company's ability to effectively carry out its business plans and changes in regulatory or legislative requirements. Other factors that could cause or contribute to such differences are changes in competitive conditions and continuing consolidation in the financial services industry. Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. MERGER AND ACQUISITIONS On December 30, 1999, Summit merged with Potomac, a $94 million asset bank in Petersburg, West Virginia, in a transaction accounted for as a pooling of interests. Summit issued 290,110 shares of common stock to the shareholders of Potomac based upon an exchange ratio of 3.4068 shares of Summit common stock for each outstanding share of Potomac common stock. Summit's prior year consolidated financial statements have been restated to include Potomac. On April 22, 1999, Capital State purchased three branch banking facilities located in Greenbrier County, West Virginia (the "Branches"). The transaction included the Branches' facilities and associated loan and deposit accounts. Total deposits assumed approximated $47.4 million and total loans acquired approximated $8.9 million. This transaction was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities and results of operations of the Branches are reflected in the Company's consolidated financial statements beginning April 23, 1999. The excess purchase price over the fair value of the net assets acquired as of the consummation date approximated $2,267,000, which is included in intangible assets in the accompanying consolidated balance sheets, and is being amortized over a period of 15 years using the straight-line method. On March 31, 1998, Summit acquired 60% of the outstanding common stock of Capital State, a Charleston, West Virginia state chartered bank with total assets approximating $44 million at the time of acquisition, in exchange for 183,465 shares of Summit's common stock. Summit had previously acquired 40% of Capital State's outstanding common stock during 1997. This acquisition was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities and results of operations of Capital State are reflected in the Company's consolidated financial statements beginning April 1, 1998. The excess purchase price over the fair value of the net assets acquired as of the consummation date approximated $1,979,000, which is included in intangible assets in the accompanying consolidated balance sheet as of December 31, 1998. This goodwill is being amortized over a period of 15 years using the straight line method. Refer to Note 2 of the accompanying consolidated financial statements for additional information regarding Summit's merger and acquisitions. NEW BANK SUBSIDIARY On May 14, 1999, Shenandoah was granted a national bank charter and was initially capitalized with $4,000,000, funded by a special dividend in the amount of $3,000,000 from the Company's subsidiary bank, South Branch and from a $1,000,000 term loan from the then unaffiliated institution, Potomac. Shenandoah opened for business on May 17, 1999. Start up costs approximating $90,000 related to the organization of this subsidiary were expensed during 1999. 18 RESULTS OF OPERATIONS Earnings Summary Net income for the three years ended December 31, 2000, 1999, and 1998, was $3,250,000, $3,043,000 and $2,602,000, respectively. On a per share basis, diluted net income was $3.69 in 2000 compared to $3.39 in 1999, and $3.05 in 1998. Return on average equity was 8.93% in 2000 compared to 8.52% in 1999, and 7.44% in 1998. Return on average assets for the year ended December 31, 2000 was 0.75% compared to 0.88% in 1999 and 0.95% in 1998. A summary of the significant factors influencing the Summit's results of operations and related ratios is included in the following discussion. Net Interest Income The major component of Summit's net earnings is net interest income, which is the excess of interest earned on earning assets over the interest expense incurred on interest bearing sources of funds. Net interest income is affected by changes in volume, resulting from growth and alterations of the balance sheet's composition, fluctuations in interest rates and maturities of sources and uses of funds. Management seeks to maximize net interest income through management of its balance sheet components. This is accomplished by determining the optimal product mix with respect to yields on assets and costs of funds in light of projected economic conditions, while maintaining portfolio risk at an acceptable level. Net interest income on a fully tax equivalent basis, average balance sheet amounts, and corresponding average yields on interest earning assets and costs of interest bearing liabilities for the years 2000, 1999 and 1998 are presented in Table I. Table II presents, for the periods indicated, the changes in interest income and expense attributable to (a) changes in volume (changes in volume multiplied by prior period rate) and (b) changes in rate (change in rate multiplied by prior period volume). Changes in interest income and expense attributable to both rate and volume have been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each. Net interest income, adjusted to a fully tax equivalent basis, totaled $14,431,000, $13,223,000 and $10,696,000 for the years ended December 31, 2000, 1999, and 1998, respectively resulting in a net interest margin of 3.5% for 2000 compared to 4.1% and 4.2% for 1999 and 1998, respectively. The net interest margin recognizes earning asset growth by expressing net interest income as a percentage of total average earning assets. During 2000, higher-cost funding in a rising rate environment, combined with a liability sensitive interest rate risk position and a highly competitive market for deposits contributed to the 60 basis point decrease in Summit's net interest margin. In 1999, the yield on interest earning assets decreased 40 basis points from 8.2% in 1998 to 7.8% in 1999, primarily due to lower yields on loans. The cost of interest bearing liabilities likewise declined 40 basis points from 4.8% in 1998 to 4.4% in 1999, which served to minimize most of the impact of the lower yields on interest earning assets. As identified in Table II, despite the Company's contracting net interest margin in 2000 and 1999, tax equivalent net interest income grew $1,208,000 and $2,527,000 during 2000 and 1999, respectively, due primarily to the substantial growth in the volumes of the interest earning assets in both years. The spread between interest earning assets and interest bearing liabilities could continue to contract though, thus negatively impacting the Company's net interest income in 2001. Management continues to monitor the net interest margin through net interest income simulation to minimize the potential for any significant negative impact. The majority of Summit's assets and liabilities are monetary in nature and, therefore, differ greatly from most commercial and industrial entities which have large investments in fixed assets or inventories. Fluctuations in interest rates have a greater effect on the Company's profitability than do the effects of higher costs for goods and services. See the Market Risk Management section for further discussion of the impact changes in market interest rates could have on Summit. 19 Table I - Average Distribution of Assets, Liabilities and Shareholders' Equity, Interest Earnings & Expenses, and Average Rates Dollars in thousands 2000 1999 1998 ----------------------------- ----------------------------- ----------------------------- Average Earnings/ Yield Average Earnings/ Yield Average Earnings/ Yield Balances Expense Rate Balances Expense Rate Balances Expense Rate --------- --------- ----- --------- --------- ----- --------- --------- ----- ASSETS Interest earning assets Loans, net of unearned interest (1) Taxable $ 248,404 $ 21,630 8.7% $ 217,625 $ 18,645 8.6% $ 172,256 $ 15,719 9.1% Tax-exempt (2) 2,211 261 11.8% 1,551 173 11.2% 1,604 182 11.3% Securities Taxable 139,476 9,484 6.8% 84,353 5,288 6.3% 55,933 3,522 6.3% Tax-exempt (2) 13,202 1,046 7.9% 11,135 835 7.5% 11,312 834 7.4% Federal funds sold and interest bearing deposits with other banks 4,305 286 6.6% 10,251 516 5.0% 13,642 727 5.3% --------- --------- ----- --------- --------- ----- --------- --------- ----- 407,598 32,707 8.0% 324,915 25,457 7.8% 254,747 20,984 8.2% Noninterest earning assets Cash and due from banks 8,166 6,860 5,694 Bank premises and equipment 10,666 8,634 6,294 Other assets 8,877 6,402 7,766 Allowance for loan losses (2,414) (2,175) (1,829) --------- --------- --------- Total assets $ 432,893 $ 344,636 $ 272,672 ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Interest bearing liabilities Interest bearing demand deposits $ 60,351 $ 2,027 3.4% $ 56,201 $ 1,717 3.1% $ 40,027 $ 1,246 3.1% Savings deposits 39,738 1,094 2.8% 38,782 1,030 2.7% 31,394 1,048 3.3% Time deposits 187,665 10,476 5.6% 153,617 7,811 5.1% 126,369 7,043 5.6% Short-term borrowings 48,867 3,087 6.3% 13,714 673 4.9% 5,371 232 4.3% Long-term borrowings 28,033 1,592 5.7% 18,818 1,003 5.3% 13,004 719 5.5% --------- --------- ----- --------- --------- ----- --------- --------- ----- 364,654 18,276 5.0% 281,132 12,234 4.4% 216,165 10,288 4.8% Noninterest bearing liabilities Demand deposits 28,017 25,608 19,267 Other liabilities 3,845 2,178 2,244 --------- --------- --------- Total liabilities 396,516 308,918 237,676 Shareholders' equity 36,377 35,718 34,996 --------- --------- --------- Total liabilities and shareholders' equity $ 432,893 $ 344,636 $ 272,672 ========= ========= ========= NET INTEREST EARNINGS $ 14,431 $ 13,223 $ 10,696 ========= ========= ========= NET INTEREST YIELD ON EARNING ASSETS 3.5% 4.1% 4.2% ===== ===== ===== (1) - For purposes of this table, non-accrual loans are included in average loan balances. Included in interest and fees on loans are loan fees of $343,000, $277,000 and $362,000 for the years ended December 31, 2000, 1999 and 1998, respectively. (2) - For purposes of this table, interest income on tax-exempt securities has been adjusted assuming an effective combined Federal and state tax rate of 34% for all years presented. The tax equivalent adjustment results in an increase in interest income of $443,000, $343,000 and $346,000 for the years ended December 31, 2000, 1999 and 1998, respectively. 20 Table II - Changes in Interest Margin Attributable to Rate and Volume Dollars in thousands 2000 Versus 1999 1999 Versus 1998 ----------------------------- ----------------------------- Increase (Decrease) Increase (Decrease) Due to Change in: Due to Change in: ----------------------------- ----------------------------- Volume Rate Net Volume Rate Net ------- ------- ------- ------- ------- ------- Interest earned on: Loans Taxable $ 2,676 $ 309 $ 2,985 $ 3,935 $(1,009) $ 2,926 Tax-exempt 78 10 88 (6) (3) (9) Securities Taxable 3,715 481 4,196 1,783 (17) 1,766 Tax-exempt 162 49 211 (13) 14 1 Federal funds sold and interest bearing deposits with other banks (361) 131 (230) (173) (38) (211) ------- ------- ------- ------- ------- ------- Total interest earned on interest earning assets 6,270 980 7,250 5,526 (1,053) 4,473 ------- ------- ------- ------- ------- ------- Interest paid on: Interest bearing demand deposits 132 178 310 494 (23) 471 Savings deposits 25 39 64 220 (238) (18) Time deposits 1,849 816 2,665 1,424 (656) 768 Short-term borrowings 2,171 243 2,414 405 36 441 Long-term borrowings 519 70 589 310 (26) 284 ------- ------- ------- ------- ------- ------- Total interest paid on interest bearing liabilities 4,696 1,346 6,042 2,853 (907) 1,946 ------- ------- ------- ------- ------- ------- Net interest income $ 1,574 $ (366) $ 1,208 $ 2,673 $ (146) $ 2,527 ======= ======= ======= ======= ======= ======= Provision for Loan Losses The provision for loan losses represents management's determination of the amount necessary to be charged against the current period's earnings in order to maintain the allowance for loan losses at a level which is considered adequate in relation to the estimated risk inherent in the loan portfolio. The provision for loan losses for each of the years ended December 31, 2000, 1999 and 1998 totaled $558,000, $370,000 and $615,000, respectively. As further discussed in the Loan Portfolio and Asset Quality sections of this analysis, the $188,000 increase in the provision for loan losses in 2000 reflects the continued growth of Summit's loan portfolio. Conversely, the $245,000 reduction in the provision in 1999 compared to 1998 was attributable primarily to the improved credit quality of the Potomac's loan portfolio during the same period. An analysis of the components comprising the allowance for loan losses for each of the past five years, including charge offs and recoveries within each significant loan classification, is presented in Table VIII. Noninterest Income Noninterest income totaled $1,228,000, $821,000 and $753,000, or 0.28%, 0.24% and 0.28% of average assets, in 2000, 1999, and 1998, respectively. Included in noninterest income for 2000 is a $225,000 gain South Branch recognized on the sale of its Petersburg, West Virginia branch office. Further detail regarding noninterest income follows in Table III. 21 Noninterest Expense Noninterest expense totaled $9,865,000, $8,718,000 and $6,638,000 or 2.28%, 2.53% and 2.43% of average assets for each of the years ended December 31, 2000, 1999, and 1998, respectively. Total noninterest expense increased $1,147,000 in 2000 compared to 1999 and $2,080,000 in 1999 compared to 1998. The primary factors contributing to growth in noninterest expense in both years were: operating expenses of Capital State's Greenbrier County branches following their acquisition in April 1999, operating expenses of Shenandoah following its opening in May 1999, and one time expenses associated with the Potomac merger. Table III presents additional information regarding Summit's noninterest expense. Table III - Noninterest Income and Expense In thousands 2000 1999 1998 ------- ------- ------- Noninterest income Insurance commissions $ 110 $ 91 $ 104 Service fees 876 792 518 Securities gains (losses) 2 (236) 8 Gain on sale of branch bank 225 - - Other 15 174 123 ------- ------- ------- Total $ 1,228 $ 821 $ 753 ======= ======= ======= Noninterest expense Salaries and employee benefits $ 4,863 $ 4,359 $ 3,432 Net occupancy expense 628 559 456 Equipment expense 974 716 546 Supplies 303 299 143 Amortization of intangibles 298 269 135 Other 2,799 2,516 1,926 ------- ------- ------- Total $ 9,865 $ 8,718 $ 6,638 ======= ======= ======= Income Tax Expense Income tax expense for the three years ended December 31, 2000, 1999, and 1998 totaled $1,543,000, $1,570,000 and $1,248,000, respectively. Refer to Note 10 of the accompanying consolidated financial statements for further information and additional discussion of the significant components influencing the Company's effective income tax rates. CHANGES IN FINANCIAL POSITION Total average assets in 2000 were $432,893,000, an increase of 25.6% over 1999's average of $344,636,000. Similarly, average assets grew 26.4% in 1999, from $272,672,000 in 1998. The primary factors contributing to these increases are the continued strong growth of Shenandoah following its organization in May 1999 and Capital State's acquisition of the Greenbrier County branches in April 1999. Significant changes in the components of the Summit's balance sheet 2000 and 1999 are discussed below. 22 Securities Securities comprised approximately 36.7% of total assets at December 31, 2000 compared to 29.2% at December 31, 1999. Average securities approximated $152,678,000 for 2000 or 59.9% more than 1999's average of $95,488,000. The growth in the Company's securities portfolio in 1999 reflects increased investments primarily in U. S. Government agency securities and mortgage-backed securities, which were funded principally by the deposit growth of Shenandoah in 2000 and by the $35.1 million in net funds the Company realized in conjunction with the acquisition of Greenbrier County branch banks in 1999. Refer to Note 4 of the accompanying consolidated financial statements for details of amortized cost, the estimated fair values, unrealized gains and losses as well as the security classifications by type. Substantially all securities are classified as available for sale to provide management with flexibility to better manage its balance sheet structure and react to asset/liability management issues as they arise. At December 31, 2000, Summit did not own securities of any one issuer that were not issued by the U.S. Treasury or a U.S. Government agency that exceeded ten percent of shareholders' equity. The maturity distribution of the securities portfolio at December 31, 2000, together with the weighted average yields for each range of maturity, are summarized in Table IV. The stated average yields are actual yields and are not stated on a tax equivalent basis. Table IV - Securities Maturity Analysis (At amortized cost, dollars in thousands) After one After five Within but within but within After one year five years ten years ten years -------------- --------------- --------------- --------------- Amount Yield Amount Yield Amount Yield Amount Yield ------- ----- ------- ----- ------- ----- ------- ----- Available for sale U. S. Treasury securities $ 1,499 6.3% $ - - $ - - $ - - U. S. Government agencies and corporations 2,541 6.2% 44,721 6.7% 31,366 7.0% 2,219 7.5% Mortgage backed securities - U. S. Government agencies and corporations 17,113 6.7% 25,155 6.8% 10,810 6.7% 2,052 6.8% State and political subdivisions 1,951 5.5% 4,032 4.8% 3,192 5.2% 3,222 6.0% Other - - 13,226 7.3% 349 7.6% 11,576 6.3% ------- --- ------- --- ------- --- ------- --- Total available for sale $23,104 6.5% $87,134 6.7% $45,717 6.8% $19,069 6.4% ======= === ======= === ======= === ======= === Held to maturity State and political subdivisions $ 250 5.7% $ 151 4.8% $ - - $ - - ======= ======= ======= ======= 23 Loan Portfolio Table V depicts loan balances by type and the respective percentage of each to total loans at December 31, as follows: Table V - Loans by Type Dollars in thousands 2000 1999 1998 1997 1996 ------------------ ------------------- ------------------ ------------------- ------------------ Percent Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Commercial, financial, and agricultural $104,510 38.1% $ 78,894 33.1% $ 54,359 27.8% $ 42,736 29.5% $ 38,982 29.1% Real estate - construction 2,730 1.0% 2,012 0.8% 1,801 0.9% 144 0.1% 154 0.1% Real estate - mortgage 127,930 46.7% 116,779 49.0% 101,014 51.7% 69,155 47.7% 64,695 48.2% Installment 36,983 13.5% 38,091 16.0% 36,197 18.5% 32,248 22.2% 29,454 22.0% Other 2,001 0.7% 2,524 1.1% 1,906 1.0% 784 0.5% 894 0.7% -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total loans $274,154 100.0% $238,300 100.0% $195,277 100.0% $145,067 100.0% $134,179 100.0% ======== ===== ======== ===== ======== ===== ======== ===== ======== ===== Total net loans averaged $250,615,000 in 2000 and comprised 57.9% of total average assets compared to $219,176,000 or 63.6% of total average assets during 1999. The increase in the dollar volume of loans is primarily attributable to continuation of the Company's strategy which began in 1996 to aggressively seek quality commercial and real estate loans. Refer to Note 5 of the accompanying consolidated financial statements for the Summit's loan maturities and a discussion of the Company's adjustable rate loans as of December 31, 2000. In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities which are disclosed in Note 12 to the accompanying consolidated financial statements but not reflected in the accompanying consolidated financial statements. There have been no significant changes in these type of commitments and contingent liabilities and the Company does not anticipate any material losses as a result of these commitments. Deposits Total deposits at December 31, 2000 increased $48,823,000 or 16.4% compared to December 31, 1999. Average deposits increased $41,563,000, or 15.2% during 2000. This increase resulted primarily from the growth of Shenandoah's deposits. See Table I above for average deposit balance and rate information by deposit type for 2000, 1999 and 1998 and Note 8 of the accompanying consolidated financial statements for a maturity distribution of time deposits as of December 31, 2000. Borrowings Lines of Credit: The Company has remaining available lines of credit from the Federal Home Loan Bank totaling $70,961,000 at December 31, 2000. Management uses these lines primarily to fund loans to customers. Funds acquired through this program are reflected on the consolidated balance sheet in short-term borrowings or long-term borrowings, depending on the repayment terms of the debt agreement. Short-term Borrowings: Total short-term borrowings decreased $22,957,000 from $32,348,000 at December 31, 1999 to $9,391,000 at December 31, 2000, as Summit refinanced substantially all of its short-term Federal Home Loan Bank advances with long-term advances late in 2000. This action was taken to obtain lower funding costs and to reduce the Company's sensitivity to rising interest rates. See Note 9 of the accompanying consolidated financial statements for additional disclosures regarding the Company's short-term borrowings. 24 Long-term Borrowings: Total long-term borrowings of $81,086,000 at December 31, 2000, consisting entirely of funds borrowed on available lines of credit from the Federal Home Loan Bank, increased $63,143,000 compared to the $17,943,000 outstanding at December 31, 1999. These borrowings were made principally to fund the refinancing of short-term advances discussed above and to fund the Company's loan growth. Refer to Note 9 of the accompanying consolidated financial statements for additional information regarding the Summit's long-term borrowings. ASSET QUALITY Table VI presents a summary of non-performing loans at December 31, as follows. Table VI - Nonperforming Loans Dollars in thousands 2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Nonaccrual loans $ 568 $ 522 $ 783 $ 220 $ 343 Accruing loans past due 90 days or more 267 476 431 402 545 Restructured loans - - - 55 55 ------ ------ ------ ------ ------ Total $ 835 $ 998 $1,214 $ 677 $ 943 ====== ====== ====== ====== ====== Percentage of total loans 0.3% 0.4% 0.6% 0.5% 0.7% ====== ====== ====== ====== ====== As illustrated in Table VI, the quality of the Summit's loan portfolio remains sound. The total of nonaccrual loans and loans past due 90 days or more and still accruing interest declined from $998,000 at December 31, 1999 to $835,000 at December 31, 2000, despite the growth in the loan portfolio previously discussed. Refer to Note 5 of the accompanying consolidated financial statements for additional discussion of non-accrual loans and to Note 6 for a discussion of impaired loans which are included in the above balances. Summit maintains an allowance for loan losses at a level considered adequate to provide for losses that can be reasonably anticipated. The Company conducts quarterly evaluations of its loan portfolio to determine its adequacy. The evaluation is based on assessments of specifically identified loans, loss experience factors, current and anticipated economic conditions and other factors to identify and estimate inherent losses from homogeneous pools of loans. In addition, the Company conducts comprehensive, ongoing reviews of its loan portfolio, which encompass the identification of all potential problem credits to be included on an internally generated watch list. The identification of loans for inclusion on the watch list is facilitated through the use of various sources, including past due loan reports, previous internal and external loan evaluations, classified loans identified as part of regulatory agency loan reviews and reviews of new loans representative of current lending practices. Once this list is reviewed to ensure it is complete, management reviews the specific loans for collectibility, performance and collateral protection. In addition, a grade is assigned to the individual loans utilizing internal grading criteria, which is somewhat similar to the criteria utilized by each subsidiary bank's primary regulatory agency. Based on the results of these reviews, specific reserves for potential losses are identified and the allowance for loan losses is adjusted appropriately through a provision for loan losses. While there may be some loans or portions of loans identified as potential problem credits which are not specifically identified as either nonaccrual or accruing loans past due 90 or more days, they are considered by management to be insignificant to the overall disclosure and are, therefore, not specifically quantified within this discussion. In addition, management feels these additional loans do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. Also, these loans do not represent material credits about which management is aware of any information which would cause the borrowers to not comply with the loan repayment terms. Specific reserves are allocated to non-performing loans based on the quarterly evaluation of expected loan loss reserve requirements as determined by management. In addition, a portion of the reserve is determined through the use of loan loss experience factors which do not provide for identification of specific potential problem loans. As noted above, some of the loans, which are not deemed significant, are included in the watch list of potential problem loans and have specific reserves allocated to them. 25 The allocated portion of the subsidiary banks' allowance for loan losses is established on a loan-by-loan and pool-by-pool basis. The unallocated portion is for inherent losses that probably exist as of the evaluation date, but which have not been specifically identified by the processes used to establish the allocated portion due to inherent imprecision in the objective processes management utilizes to identify probable and estimable losses. This unallocated portion is subjective and requires judgment based on various qualitative factors in the loan portfolio and the market in which the Company operates. At December 31, 2000 and 1999, respectively, the unallocated portion of the allowance approximated $94,000 and $92,000, or 3.7% and 4.1% of the total allowance. This unallocated portion of the allowance is considered necessary based on consideration of the known risk elements in certain pools of loans in the loan portfolio and management's assessment of the economic environment in which the Company operates. More specifically, while loan quality remains good, the subsidiary banks have typically experienced greater losses within certain homogeneous loan pools when the Company's market area has experienced economic downturns or other significant negative factors or trends, such as increases in bankruptcies, unemployment rates or past due loans. At December 31, 2000 and 1999, Summit's allowance for loan losses totaled $2,571,000 and $2,232,000, respectively, representing 0.94% of gross loans as of both year end dates, and is considered adequate to cover inherent losses in the Company's loan portfolio. Table VII presents an allocation of the allowance for loan losses by loan type at each respective year end date, as follows. Table VII - Allocation of the Allowance for Loan Losses Dollars in thousands 2000 1999 1998 1997 1996 ----------------- ------------------- ------------------ ------------------- ------------------- % of % of % of % of % of loans in loans in loans in loans in loans in each each each each each category category category category category to total to total to total to total to total Amount loans Amount loans Amount loans Amount loans Amount loans ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Commercial, financial and agricultural $1,037 38.1% $ 951 33.3% $ 861 27.8% $ 584 29.5% $ 620 29.1% Real estate 127 47.7% 383 49.5% 366 52.7% 302 47.8% 303 48.3% Installment 1,086 13.5% 596 16.1% 739 18.5% 513 22.2% 364 22.0% Other 227 0.7% 210 1.1% 61 1.0% 23 0.5% 11 0.6% Unallocated 94 - 92 - 86 - 67 - 69 - ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- $2,571 100.0% $2,232 100.0% $2,113 100.0% $1,489 100.0% $1,367 100.0% ====== ===== ====== ===== ====== ===== ====== ===== ====== ===== At December 31, 2000, the Company had approximately $36,000 in other real estate owned which was obtained as the result of foreclosure proceedings and $36,000 in other repossessed assets which was obtained as the result of auto repossessions. These repossessions have been insignificant throughout 2000 and management does not anticipate any material losses on any of the items currently held in other real estate owned or other repossessed assets. 26 A reconciliation of the activity in the allowance for loan losses follows: Table VIII - Allowance for Loan Losses In thousands 2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Balance, beginning of year $2,232 $2,113 $1,489 $1,367 $1,514 Losses: Commercial financial & agriculture - 165 183 93 391 Real estate - mortgage 63 32 1 30 13 Installment 175 144 204 371 197 Other 49 37 25 67 10 ------ ------ ------ ------ ------ Total 287 378 413 561 611 ------ ------ ------ ------ ------ Recoveries: Commercial financial & agriculture 2 40 3 52 6 Real estate - mortgage 2 10 22 15 2 Installment 53 71 118 60 28 Other 11 6 7 2 3 ------ ------ ------ ------ ------ Total 68 127 150 129 39 ------ ------ ------ ------ ------ Net losses 219 251 263 432 572 ------ ------ ------ ------ ------ Allowance of purchased subsidiary - - 272 - - Provision for loan losses 558 370 615 554 425 ------ ------ ------ ------ ------ Balance, end of year $2,571 $2,232 $2,113 $1,489 $1,367 ====== ====== ====== ====== ====== LIQUIDITY Liquidity reflects the Company's ability to ensure the availability of adequate funds to meet loan commitments and deposit withdrawals, as well as provide for other transactional requirements. Liquidity is provided primarily by funds invested in cash and due from banks (net of float and reserves), Federal funds sold, non-pledged securities, and available lines of credit with the Federal Home Loan Bank, the total of which approximated at December 31, 2000 $143 million, or 30% of total consolidated assets. The Company's liquidity position is monitored continuously to ensure that day-to-day as well as anticipated funding needs are met. Management is not aware of any trends, commitments, events or uncertainties that have resulted in or are reasonably likely to result in a material change to Summit's liquidity. MARKET RISK MANAGEMENT Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. Interest rate risk is Summit's primary market risk and results from timing differences in the repricing of assets, liabilities and off-balance sheet instruments, changes in relationships between rate indices and the potential exercise of imbedded options. The principal objective of asset/liability management is to minimize interest rate risk and the Company's actions in this regard are taken under the guidance of its Asset/Liability Management Committee ("ALCO"), which is comprised of members of senior management and members of the Board of Directors. The ALCO actively formulates the economic assumptions that the Company uses in its financial planning and budgeting process and establishes policies which control and monitor the Company's sources, uses and prices of funds. Some amount of interest rate risk is inherent and appropriate to the banking business. Summit's net income is affected by changes in the absolute level of interest rates. The Company's interest rate risk position is liability sensitive; that is, liabilities are likely to reprice faster than assets, resulting in a decrease in net income in a rising rate environment. Conversely, net income should increase in a falling interest rate environment. Net income is also subject to changes in the shape of the yield curve. In general, a flattening yield curve would result in a decline in Company earnings due to the compression of earning asset yields and funding rates, while a steepening would result in increased earnings as margins widen. 27 Several techniques are available to monitor and control the level of interest rate risk. Summit primarily uses earnings simulations modeling to monitor interest rate risk. The earnings simulation model forecasts the effects on net interest income under a variety of interest rate scenarios that incorporate changes in the absolute level of interest rates and changes in the shape of the yield curve. Assumptions used to project yields and rates for new loans and deposits are derived from historical analysis. Securities portfolio maturities and prepayments are reinvested in like instruments. Mortgage loan prepayment assumptions are developed from industry estimates of prepayment speeds. Noncontractual deposit repricings are modeled on historical patterns. As of December 31, 2000, Summit's earnings simulation model projects net interest income would decrease by approximately 5.0% if rates rise evenly by 200 basis points over the next year, as compared to projected stable rate net interest income. Conversely, the model projects that if rates fall evenly by 200 basis points over the next year, Company net interest income would rise by approximately 2.0%, as compared to projected stable rate net interest income. These projected changes are well within Summit's ALCO policy limit of +/- 10%. CAPITAL RESOURCES Summit's capital position remains strong, despite its continued growth. Stated as a percentage of total assets, the Company's equity ratio was 8.3% and 9.1% at December 31, 2000 and 1999, respectively. The Company's risk weighted tier I capital, total capital and leverage capital ratios approximated 11.9%, 12.8% and 8.2%, respectively, at December 31, 2000, all of which are well in excess of the minimum guidelines to be "well capitalized" under the regulatory prompt corrective action provisions. The Company's subsidiary banks are also subject to minimum capital ratios as further discussed in Note 13 of the accompanying consolidated financial statements. Cash dividends per share rose 26.3% to $1.20 in 2000 compared to $0.95 in 1999, representing dividend payout ratios of 32.5% and 27.3% for 2000 and 1999, respectively. It is the intention of management and the Board of Directors to continue to pay dividends on a similar schedule during 2001. Future cash dividends will depend on the earnings, financial condition and the business of the subsidiary banks as well as general economic conditions; however, management is not presently aware of any reason dividend payments should not continue. Dividends paid by the Summit's subsidiary banks are subject to restrictions by banking regulations. The most restrictive provision requires approval by the regulatory agency if dividends declared in any year exceed the year's net income, as defined, plus the retained net profits of the two preceding years. As of December 31, 2000, no significant retained profits are available for distribution to Summit as dividends from its subsidiary banks without regulatory approval. Management is presently not aware of any circumstances, conditions or events which would reasonably preclude the approval of dividend requests for its subsidiary banks' net retained profits in 2001. 28 QUARTERLY FINANCIAL INFORMATION First Second Third Fourth Full (Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Year - ------------------------------------------------- ------- ------- ------- ------- ------- 2000 Interest income $ 7,291 $ 7,800 $ 8,335 $ 8,837 $32,263 Interest expense 3,749 4,329 4,912 5,286 18,276 Net interest income 3,542 3,471 3,423 3,551 13,987 Provision for loan losses 128 128 140 161 557 Securities gains (losses) - - - 2 2 Gain on sale of branch bank - 225 - - 225 Other noninterest income 260 274 289 178 1,001 Noninterest expense 2,307 2,524 2,476 2,558 9,865 Income before income taxes 1,367 1,318 1,096 1,012 4,793 Net income 929 934 743 644 3,250 Basic earnings per share 1.05 1.06 0.84 0.73 3.69 Diluted earnings per share 1.05 1.06 0.84 0.73 3.69 Dividends paid per share - 0.50 - 0.70 1.20 1999 Interest income $ 5,355 $ 6,110 $ 6,653 $ 6,996 $25,114 Interest expense 2,586 2,973 3,283 3,392 12,234 Net interest income 2,769 3,137 3,370 3,604 12,880 Provision for loan losses 98 62 98 112 370 Securities gains (losses) - - - (236) (236) Other noninterest income 211 274 340 232 1,057 Noninterest expense 1,764 2,262 2,383 2,309 8,718 Income before income taxes 1,118 1,087 1,229 1,179 4,613 Net income 724 703 886 730 3,043 Basic earnings per share 0.81 0.78 0.99 0.81 3.39 Diluted earnings per share 0.81 0.78 0.99 0.81 3.39 Dividends paid per share - 0.47 - 0.48 0.95 29 [ARNETT & FOSTER, PLLC LETTERHEAD] To the Board of Directors Summit Financial Group, Inc. Moorefield, West Virginia We have audited the accompanying consolidated balance sheets of Summit Financial Group, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 Group, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and cash flows for each of the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles. /s/ Arnett & Foster, PLLC Charleston, West Virginia February 16, 2001 30 SUMMIT FINANCIAL GROUP,INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, ------------ 2000 1999 ------------- ------------- Cash and due from banks $ 7,091,871 $ 7,010,196 Interest bearing deposits with other banks 473,000 5,800,987 Federal funds sold 1,811,000 2,845,216 Securities available for sale 176,340,410 111,972,963 Securities held to maturity 400,835 796,820 Loans, net 271,582,652 236,067,648 Premises and equipment, net 12,246,821 8,997,027 Accrued interest receivable 3,760,701 2,439,767 Intangible assets 3,634,472 3,954,039 Other assets 3,897,339 5,882,777 Total assets $ 481,239,101 $ 385,767,440 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Non interest bearing $ 30,031,409 $ 27,381,875 Interest bearing 315,930,441 269,756,745 ------------- ------------- Total deposits 345,961,850 297,138,620 ------------- ------------- Short-term borrowings 9,390,814 32,348,030 Long-term borrowings 81,085,929 17,942,540 Other liabilities 5,027,307 3,255,630 ------------- ------------- Total liabilities 441,465,900 350,684,820 ------------- ------------- Commitments and Contingencies Shareholders' Equity Common stock, $2.50 par value; authorized 5,000,000 shares; issued 2000 - 890,390 shares; 1999 - 890,517 shares 2,225,978 2,226,293 Capital surplus 10,482,873 10,533,674 Retained earnings 26,765,097 24,570,174 Less cost of shares acquired for the treasury 2000 - 12,835; 1999 - 9,115 (517,725) (384,724) Accumulated other comprehensive income 816,978 (1,862,797) ------------- ------------- Total shareholders' equity 39,773,201 35,082,620 ------------- ------------- Total liabilities and shareholders' equity $ 481,239,101 $ 385,767,440 ============= ============= See notes to consolidated financial statements 31 SUMMIT FINANCIAL GROUP,INC. AND SUBSIDIARIES Consolidated Statements of Income For the Year Ended December 31, ------------------------------- 2000 1999 1998 ------------ ------------ ------------ Interest and fees on loans Taxable $ 21,630,083 $ 18,645,426 $ 15,718,725 Tax-exempt 172,714 114,424 120,307 Interest and dividends on securities Taxable 9,484,352 5,287,779 3,521,984 Tax-exempt 690,674 550,855 550,709 Interest on interest bearing deposits with other banks 68,748 186,623 71,624 Interest on Federal Funds sold 216,944 329,285 655,114 Total interest income 32,263,515 25,114,392 20,638,463 Interest expense ------------ ------------ ------------ Interest on deposits 13,596,688 10,558,788 9,337,784 Interest on short-term borrowings 3,087,018 672,488 231,544 Interest on long-term borrowings 1,592,352 1,002,750 718,634 ------------ ------------ ------------ Total interest expense 18,276,058 12,234,026 10,287,962 ------------ ------------ ------------ Net interest income 13,987,457 12,880,366 10,350,501 Provision for loan losses 557,500 370,000 615,000 ------------ ------------ ------------ Net interest income after provision for loan losses 13,429,957 12,510,366 9,735,501 Other income ------------ ------------ ------------ Insurance commissions 109,802 91,363 103,493 Service fees 875,964 791,940 518,375 Securities gains (losses) 2,364 (235,945) 8,160 Gain on sale of branch bank 224,629 - - Other 15,568 173,574 122,517 ------------ ------------ ------------ Total other income 1,228,327 820,932 752,545 ------------ ------------ ------------ Other expenses Salaries and employee benefits 4,863,257 4,358,944 3,432,197 Net occupancy expense 627,834 559,242 455,876 Equipment expense 974,474 716,547 545,582 Supplies 302,652 298,878 142,967 Amortization of intangibles 297,683 268,986 135,461 Other 2,799,082 2,515,622 1,926,109 ------------ ------------ ------------ Total other expenses 9,864,982 8,718,219 6,638,192 ------------ ------------ ------------ Income before income tax expense 4,793,302 4,613,079 3,849,854 Income tax expense 1,543,383 1,569,950 1,247,689 ------------ ------------ ------------ Net income $ 3,249,919 $ 3,043,129 $ 2,602,165 ============ ============ ============ Basic earnings per common share $ 3.69 $ 3.39 $ 3.05 ============ ============ ============ Diluted earnings per common share $ 3.69 $ 3.39 $ 3.05 ============ ============ ============ Average common shares outstanding Basic 880,423 897,811 854,430 ------------ ------------ ------------ Diluted 880,423 897,811 854,430 ------------ ------------ ------------ See notes to consolidated financial statements 32 SUMMIT FINANCIAL GROUP,INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity For the Years Ended December 31, 2000, 1999 and 1998 Accumulated Other Total Common Capital Retained Treasury Comprehensive Shareholders' Stock Surplus Earnings Stock Income Equity Balance, December 31, 1997 $ 1,808,878 $ 3,723,186 $ 20,555,057 $ (166,970) $ 269,257 $ 26,189,408 Comprehensive income: Net income - - 2,602,165 - - 2,602,165 Other comprehensive income, net of deferred taxes of $127,567: Net unrealized gain on securities of $206,984, net of reclassification adjustment for gains included in net income of $5,018 - - - - 201,966 201,966 Total comprehensive income - - - - 2,804,131 Issuance of 183,465 shares of common stock at $43.50 per share as consideration for the acquisition of Capital State Bank, Inc. 458,663 7,522,065 - - - 7,980,728 Cost of 5,000 shares of common stock acquired for the treasury - - - (217,754) - (217,754) Cash dividends declared: Summit ($.89 per share) - - (528,450) - - (528,450) Potomac - - (270,000) - - (270,000) ------------ ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1998 2,267,541 11,245,251 22,358,772 (384,724) 471,223 35,958,063 Comprehensive income: Net income - - 3,043,129 - - 3,043,129 Other comprehensive income, net of deferred taxes of $1,452,357: Net unrealized (loss) on securities of $(2,477,947), net of reclassification adjustment for (losses) included in net income of $(143,927) - - - - (2,334,020) (2,334,020) Total comprehensive income - - - - 709,109 Dissenting shares (41,248) (711,577) - - - (752,825) Cash dividends declared: Summit ($.95 per share) - - (561,727) - - (561,727) Potomac - - (270,000) - - (270,000) ------------ ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1999 2,226,293 10,533,674 24,570,174 (384,724) (1,862,797) 35,082,620 Comprehensive income: Net income - - 3,249,919 - - 3,249,919 Other comprehensive income, net of deferred taxes of $1,667,374: Net unrealized gain on securities of $2,681,241, net of reclassification adjustment for (gains) included in net income of $(1,466) - - - - 2,679,775 2,679,775 Total comprehensive income - - - - 5,929,694 Cost of 3,720 shares acquired for the treasury - - - (133,001) - (133,001) Purchase of fractional shares (315) (4,531) - - - (4,846) Dissenting shares (46,270) (46,270) Cash dividends declared ($1.20 per share - - (1,054,996) - - (1,054,996) ------------ ------------ ------------ ------------ ------------ ------------ Balance, December 31, 2000 $ 2,225,978 $ 10,482,873 $ 26,765,097 $ (517,725) $ 816,978 $ 39,773,201 See notes to consolidated financial statements 33 SUMMIT FINANCIAL GROUP,INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Year Ended December 31, ------------------------------- 2000 1999 1998 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,249,919 $ 3,043,129 $ 2,602,165 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 731,073 584,212 480,168 Provision for loan losses 557,500 370,000 615,000 Deferred income tax expense (benefit) (107,377) 93,662 (75,177) Security (gains) losses (2,364) 235,945 (8,160) (Gain) on disposal of premises and equipment - - (9,709) (Gain) loss on sale of other assets 18,212 3,709 (22,117) (Gain) loss on sale of branch (224,629) - - Amortization of securities premiums (accretion - of discounts), net (97,821) 184,399 71,652 Amortization of goodwill and purchase accounting adjustments, net 215,982 123,742 98,460 (Increase) decrease in accrued interest receivable (1,350,002) (633,554) (20,956) (Increase) decrease in other assets 42,409 (2,242,887) 402,443 Increase (decrease) in other liabilities 530,716 1,901,227 (145,685) ------------ ------------ ------------ Net cash provided by operating activities 3,563,618 3,663,584 3,988,084 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities and calls of securities held to maturity 140,000 349,871 6,035,000 Principal payments received on securities held to maturity 254,281 384,326 135,320 Proceeds from maturities and calls of securities available for sale 2,930,109 13,706,762 13,115,000 Proceeds from sales of securities available for sale 11,506,633 4,062,879 613,160 Principal payments received on securities available for sale 4,670,845 4,990,386 5,686,747 Purchases of securities available for sale (75,662,408) (76,831,440) (20,689,274) Purchase of common stock of affiliate - - (90,465) Net (increase) decrease in federal funds sold 1,034,216 7,897,529 8,580,972 Net loans made to customers (42,357,660) (34,671,292) (25,875,615) Purchases of premises and equipment (4,204,622) (1,809,722) (1,003,586) Proceeds from sales of premises and equipment - 252,295 10,693 Proceeds from sales of other assets 206,804 233,400 154,424 (Purchased) proceeds from interest bearing deposits with other banks 5,327,987 (3,959,485) (585,502) Purchase of life insurance contracts (1,000,000) (1,246,000) - Net cash acquired/paid in acquisitions (divestitures) (820,679) 35,071,461 985,617 ------------ ------------ ------------ Net cash (used in) investing activities (97,974,494) (51,569,030) (12,927,509) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase in demand deposit, NOW and savings accounts 7,242,600 12,830,849 3,088,670 Net increase in time deposits 49,055,716 8,747,170 2,342,627 Net increase (decrease) in short-term borrowings (22,957,216) 27,703,887 (2,500,867) Proceeds from long-term borrowings 70,000,000 4,500,000 9,636,337 Repayments of long-term borrowings (6,856,611) (3,026,335) (3,563,310) Purchase of treasury stock (133,001) - (217,754) Dividends paid (1,054,996) (831,727) (798,450) Purchase of fractional shares (4,846) - - Payment to dissenting shareholders (799,095) - - ------------ ------------ ------------ Net cash provided by financing activities 94,492,551 49,923,844 7,987,253 ------------ ------------ ------------ Increase (decrease) in cash and due from banks 81,675 2,018,398 (952,172) Cash and due from banks: Beginning 7,010,196 4,991,798 5,943,970 ------------ ------------ ------------ Ending $ 7,091,871 $ 7,010,196 $ 4,991,798 ============ ============ ============ See notes to consolidated financial statements 34 SUMMIT FINANCIAL GROUP,INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows-continued 2000 1999 1998 ------------ ------------ ------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 17,465,019 $ 11,903,226 $ 10,309,618 ============ ============ ============ Income taxes $ 1,671,210 $ 1,498,692 $ 1,173,607 ============ ============ ============ SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Other assets acquired in settlement of loans $ 111,350 $ 77,115 $ 167,723 ============ ============ ============ Sales (purchases) of securities pending settlement, net $ (2,026,074) $ 1,336,009 $ - ============ ============ ============ Acquisition of Greenbrier County branches: Net cash and cash equivalents received in acquisition of Greenbrier County branches $ - $(35,071,460) $ - Fair value of assets acquired (principally loans and premises and equipment) $ - $ 12,382,196 $ - Deposits and other liabilities assumed - (47,453,656) - ------------ ------------ ------------ $ - $(35,071,460) $ - ============ ============ ============ Acquisition of Capital State Bank, Inc.: Prior acquisition of 40% of the outstanding common shares purchased for cash $ - $ - $ 5,363,946 Acquisition of 60% of the outstanding common shares in exchange for 183,465 shares of Company common stock - - 7,980,728 ------------ ------------ ------------ $ - $ - $ 13,344,674 ============ ============ ============ Fair value of assets acquired (principally loans and securities) $ - $ - $ 46,720,306 Deposits and other liabilities assumed - - (33,375,632) ------------ ------------ ------------ $ - $ - $ 13,344,674 ============ ============ ============ Sale of Petersburg Branch: Net cash and cash equilvalents paid to buyer $ 820,679 $ - $ - ------------ ------------ ------------ Fair value of assets sold: Loans 6,173,806 - - Property & equipment 223,755 - - Other 28,645 - - ------------ ------------ ------------ 6,426,206 - - Deposits and other liabilities sold 7,246,885 - - ------------ ------------ ------------ $ 820,679 $ - $ - ============ ============ ============ See notes to consolidated financial statements 35 NOTE 1. SIGNIFICANT ACCOUNTING POLICIES Nature of business: Summit Financial Group, Inc. ("Summit" or "Company") is a bank holding company with operations in Hardy, Grant, Pendleton, Kanawha and Greenbrier Counties of West Virginia and in Frederick County, Virginia. Through its four wholly owned bank subsidiaries, Summit provides loan and deposit services primarily to individuals and small businesses. Name change: Effective December 30, 1999, the Company changed its name from South Branch Valley Bancorp, Inc. to Summit Financial Group, Inc. Basis of financial statement presentation: The accounting and reporting policies of Summit and its subsidiaries conform to generally accepted accounting principles and to general practices within the banking industry. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. Principles of consolidation: The accompanying consolidated financial statements include the accounts of Summit and its subsidiaries, South Branch Valley National Bank, Capital State Bank, Inc., Shenandoah Valley National Bank and Potomac Valley Bank. All significant accounts and transactions among these entities have been eliminated. Presentation of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Cash flows from federal funds sold, demand deposits, NOW accounts, savings accounts and short-term borrowings are reported on a net basis, since their original maturities are less than three months. Cash flows from loans and certificates of deposit and other time deposits are reported net. Securities: Debt and equity securities are classified as "held to maturity", "available for sale" or "trading" according to management's intent. The appropriate classification is determined at the time of purchase of each security and re-evaluated at each reporting date. Securities held to maturity - Certain debt securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts. Securities available for sale - Securities not classified as "held to maturity" or as "trading" are classified as "available for sale." Securities classified as "available for sale" are those securities the Bank intends to hold for an indefinite period of time, but not necessarily to maturity. "Available for sale" securities are reported at estimated fair value net of unrealized gains or losses, which are adjusted for applicable income taxes, and reported as a separate component of shareholders' equity. Trading securities - There are no securities classified as "trading" in the accompanying consolidated financial statements. Realized gains and losses on sales of securities are recognized on the specific identification method. Amortization of premiums and accretion of discounts are computed using the interest method. Loans and allowance for loan losses: Loans are stated at the amount of unpaid principal, reduced by unearned discount and allowance for loan losses. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The subsidiary banks make continuous credit reviews of the loan portfolio and consider current economic conditions, historical loan loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance for loan losses. Loans are charged against the allowance for loan losses when management believes that collectibility is unlikely. While management uses the best information available to make its evaluation, future adjustments may be necessary if there are significant changes in conditions. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the specific loan agreement. Impaired loans, other than certain large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, are required to be reported at the present value of expected future cash flows discounted using the loan's original effective interest rate or, alternatively, at the loan's observable market price, or at the fair value of the loan's collateral if the loan is collateral dependent. The method selected to measure impairment is made on a loan-by-loan basis, unless foreclosure is deemed to be probable, in which case the fair value of the collateral method is used. 36 Generally, after management's evaluation, loans are placed on non-accrual status when principal or interest is greater than 90 days past due based upon the loan's contractual terms. Interest is accrued daily on impaired loans unless the loan is placed on non-accrual status. Impaired loans are placed on non-accrual status when the payments of principal and interest are in default for a period of 90 days, unless the loan is both well-secured and in the process of collection. Interest on non-accrual loans is recognized primarily using the cost-recovery method. Unearned interest on discounted loans is amortized to income over the life of the loans, using methods which approximate the interest method. For all other loans, interest is accrued daily on the outstanding balances. Loan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the related loan yield over its contractual life at South Branch Valley National Bank and Shenandoah Valley National Bank. Certain loan fees and direct loan costs are recognized as income or expense when incurred at Capital State Bank, Inc. and Potomac Valley Bank. Generally accepted accounting principles require that such fees and costs be deferred and amortized as adjustments of the related loan's yield over the contractual life of the loan. This method of recognition of loan fees and direct loan costs produces results which are not materially different from those that would be recognized had Statement of Financial Accounting Standards No. 91 been adopted. Premises and equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method for premises and equipment over the estimated useful lives of the assets. The estimated useful lives employed are on average 30 years for premises and 3 to 10 years for furniture and equipment. Repairs and maintenance expenditures are charged to operating expenses as incurred. Major improvements and additions to premises and equipment, including construction period interest costs, are capitalized. Total interest capitalized during the period was approximately $38,000. No interest was capitalized during 1999 and 1998. Other real estate: Other real estate consists primarily of real estate held for resale which was acquired through foreclosure on loans secured by such real estate. At the time of acquisition, these properties are recorded at fair value with any write down being charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value, less cost to sell. Expenses incurred in connection with operating these properties are generally insignificant and are charged to operating expenses. Gains and losses on the sales of these properties are credited or charged to operating income in the year of the transactions. Other real estate acquired through foreclosure with carrying values of $36,110 and $114,655, at December 31, 2000 and 1999, is included in other assets in the accompanying consolidated balance sheets. Income taxes: The consolidated provision for income taxes includes Federal and state income taxes and is based on pretax net income reported in the consolidated financial statements, adjusted for transactions that may never enter into the computation of income taxes payable. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Valuation allowances are established when deemed necessary to reduce deferred tax assets to the amount expected to be realized. Stock-based compensation: In accordance with Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its employee stock options. Basic and diluted earnings per share: Basic earnings per share is computed by dividing net income by the weighted-average number shares of common stock outstanding, while diluted earnings per share is computed by dividing net income by the weighted-average number of shares outstanding increased by the number of shares of common stock which would be issued assuming the exercise of employee stock options. Trust services: Assets held in an agency or fiduciary capacity are not assets of the Company and are not included in the accompanying consolidated balance sheets. Trust services income is recognized on the cash basis in accordance with customary banking practice. Reporting such income on a cash basis rather than the accrual basis does not have a material effect on net income. Derivative instruments and hedging activities: The FASB has issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities", as amended by SFAS 137 and SFAS 138 (collectively "SFAS 133"). SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000, with early adoption allowed. The Company elected to adopt SFAS 133 on December 31, 1999. 37 SFAS 133 Requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of hedge transaction. o For fair-value hedge transactions in which the Company is hedging changes in fair value of an asset, liability, or a firm commitment, changes in the fair value of the derivative instrument are generally offset in the income statement by changes in the hedged item's fair value. o For cash-flow hedge transactions in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument are reported in other comprehensive income. The gains and losses on the derivative instrument, which, are reported in comprehensive income are reclassified to earnings in the periods in which earnings are impacted by the variability of cash flows of the hedged item. The ineffective portion of all hedges is recognized in current period earnings. Other derivative instruments used for risk management purposes do not meet the hedge accounting criteria and, therefore, do not qualify for hedge accounting. These derivative instruments are accounted for at fair value with changes in fair value recorded in the income statement. During 2000 the Company was party to instruments that qualified for fair-value hedge accounting and other instruments that were held for risk management purposes that did not qualify for hedge accounting. During 1999 and 1998 the Company was not party to any derivative financial instruments as defined by SFAS 133. Reclassifications: Certain accounts in the consolidated financial statements for 1999 and 1998, as previously presented, have been reclassified to conform to current year classifications. NOTE 2. ACQUISTIONS AND NEW SUBSIDIARY On December 30, 1999, the Company merged with Potomac Valley Bank ("Potomac"), a $94 million asset bank in Petersburg, West Virginia, in a transaction accounted for as a pooling of interests. Summit issued 290,110 shares of common stock to the shareholders of Potomac based upon an exchange ratio of 3.4068 shares of Summit common stock for each outstanding share of Potomac common stock. Summit's prior year consolidated financial statements have been restated to include Potomac. Effective April 22, 1999, Capital State Bank, Inc., a subsidiary of Summit, purchased three branch banking facilities ("Branches") located in Greenbrier County, West Virginia. The transaction included the Branches' facilities and associated loan and deposit accounts, and was accounted for using the purchase method of accounting. Total deposits assumed approximated $47.4 million and total loans acquired approximated $8.9 million. This transaction was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities and results of operations of the Branches are reflected in the Company's consolidated financial statements beginning April 23, 1999. The excess purchase price over the fair value of the net assets acquired as of the consummation date approximated $2,267,000, which is included in intangible assets in the accompanying consolidated balance sheet, and is being amortized over a period of 15 years using the straight-line method. During the first half of 1997, the Company purchased approximately 40% of the outstanding common shares of Capital State Bank, Inc. To facilitate the funding of this investment, the Company issued and sold 34,317 shares of its common stock at $43.50 per share to seven directors of the Company in a limited stock offering. Additionally, the Company obtained two long-term borrowings from two unaffiliated financial institutions totaling $3,500,000. On March 31, 1998, the Company acquired the remaining 60% of Capital State's outstanding common shares for 183,465 shares of Summit common stock valued at approximately $7.91 million. This acquisition was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities and results of operations of Capital State are reflected in the Company's consolidated financial statements beginning April 1, 1998. The excess purchase price over the fair value of the net assets acquired as of the consummation date approximated $1,979,000, which is included in intangible assets in the accompanying consolidated balance sheet. This goodwill is being amortized over a period of 15 years using the straight line method. The following presents certain pro forma condensed consolidated financial information of Summit, using the purchase method of accounting, after giving effect to the acquisitions noted above as if they had been consummated at the beginning of the periods presented (in thousands, except per share data). Years Ended December 31, 1999 1998 ------------------- ------------------- As Pro As Pro Reported Forma Reported Forma ------------------- ------------------- Total interest income $25,114 $25,966 $20,638 $24,247 Total interest expense 12,234 12,710 10,288 12,227 Net interest income 12,880 13,286 10,350 12,020 Net income 3,043 3,115 2,602 2,849 Basic and diluted earnings per share $3.39 $3.47 $3.05 $3.33 38 NOTES TO CONSOLIDATED FINANCIAL STATMENTS This pro forma information has been included for comparative purposes only and may not be indicative of the combined results of operations that actually would have occurred had the transaction been consummated at the beginning of the periods presented, or which will be attained in the future. On May 14, 1999, Shenandoah Valley National Bank, a subsidiary of Summit, was granted a national bank charter and was initially capitalized with $4,000,000, funded by a special dividend in the amount of $3,000,000 from the Company's subsidiary bank, South Branch Valley National Bank, and from a $1,000,000 term loan from the then unaffiliated institution, Potomac Valley Bank. Shenandoah Valley National Bank opened for business on May 17, 1999. Start up costs approximating $90,000 related to the organization of this subsidiary were expensed during 1999. Note 3. Cash Concentration At December 31, 1999 and 1998, the Company had concentrations totaling $10,352,593 and $8,551,123, respectively, with unaffiliated financial institutions consisting of due from bank account balances and Federal funds sold. Deposits with correspondent banks are generally unsecured and have limited insurance under current banking insurance regulations. There were no concentrations at December 31, 2000. note 4. Securities The amortized cost, unrealized gains and losses, and estimated fair values of securities at December 31, 2000 and 1999, are summarized as follows: 39 2000 ---- Amortized Unrealized Estimated --------------------- Cost Gains Losses Fair Value ------------ ------------ ------------ ------------- Available for Sale Taxable: U. S. Treasury securities $ 1,499,026 $ 2,850 $ - $ 1,501,876 U. S. Government agencies - and corporations 80,847,229 805,826 262,259 81,390,796 Mortgage-backed securities - U. S. Government agencies and corporations 55,129,636 661,521 244,570 55,546,587 State and political subdivisions 2,979,364 12,245 - 2,991,609 Corporate debt securities 15,198,567 292,153 809 15,489,911 Federal Reserve Bank stock 236,300 - - 236,300 Federal Home Loan Bank stock 4,375,900 - - 4,375,900 Other equity securities 306,625 - 124,500 182,125 ------------ ------------ ------------ ------------ Total taxable 160,572,647 1,774,595 632,138 161,715,104 ------------ ------------ ------------ ------------ Tax-exempt: State and political subdivisions 9,417,015 182,014 - 9,599,029 Federal Reserve Bank stock 4,100 - 4,100 Other equity securities 5,028,978 - 6,801 5,022,177 ------------ ------------ ------------ Total tax-exempt 14,450,093 182,014 6,801 14,625,306 ------------ ------------ ------------ ------------ Total $175,022,740 $ 1,956,609 $ 638,939 $176,340,410 ============ ============ ============ ============ Held to maturity Tax exempt: State and political subdivisions $ 400,835 $ 2,213 $ - $ 403,048 ============ ============ == ============ 40 1999 ---- Amortized Unrealized Estimated -------------------- Cost Gains Losses Fair Value ------------ ------------ ------------ ------------- Available for Sale Taxable: U. S. Treasury securities $ 1,495,012 $ 4,323 $ 2,303 $ 1,497,032 U. S. Government agencies and corporations 59,181,180 7,881 1,724,889 57,464,172 Mortgage-backed securities - U. S. Government agencies and corporations 32,690,109 8,336 1,037,123 31,661,322 State and political subdivisions 1,395,327 154 5,318 1,390,163 Corporate debt securities 4,057,202 - 72,545 3,984,657 Federal Reserve Bank stock 234,150 - - 234,150 Federal Home Loan Bank stock 2,842,800 - - 2,842,800 Other equity securities 306,625 - 66,375 240,250 ------------ ------------ ------------ ------------ Total taxable 102,202,405 20,694 2,908,553 99,314,546 ------------ ------------ ------------ ------------ Tax-exempt: State and political subdivisions 9,774,662 42,679 147,174 9,670,167 Federal Reserve Bank stock 6,250 6,250 Other equity securties 3,020,000 - 38,000 2,982,000 ------------ ------------ ------------ ------------ Total tax-exempt 12,800,912 42,679 185,174 12,658,417 ------------ ------------ ------------ ------------ Total $115,003,317 $ 63,373 $ 3,093,727 $111,972,963 ============ ============ ============ ============ Held to maturity: Taxable: U. S. Government agencies and corporations $ - $ - $ - $ - Mortgage-backed securities - U. S. Government agencies and corporations 255,310 374 - 255,684 ------------ ------------ ------------ ------------ Total taxable 255,310 374 255,684 ------------ ------------ ------------ ------------ Tax exempt: - State and political subdivisions 541,510 4,421 - 545,931 ------------ ------------ ------------ ------------ Total $ 796,820 $ 4,795 $ - $ 801,615 ============ ============ ============ ============ 41 Federal Reserve Bank stock and Federal Home Loan Bank stock are equity securities which are included in securities available for sale in the accompanying consolidated financial statements. Such securities are carried at cost, since they may only be sold back to the respective Federal Reserve Bank or Federal Home Loan Bank or another member at par value. Mortgage-backed obligations of U.S. Government agencies and corporations and Small Business Administration guaranteed loan participation certificates are included in securities at December 31, 2000 and 1999. These obligations, having contractual maturities ranging from 1 to 30 years, are reflected in the following maturity distribution schedules based on their anticipated average life to maturity, which ranges from 1 to 9 years. Accordingly, discounts are accreted and premiums are amortized over the anticipated average life to maturity of the specific obligation. The maturities, amortized cost and estimated fair values of securities at December 31, 2000, are summarized as follows: Available for Sale ------------------------------ Amortized Estimated Cost Fair Value ------------ ------------ Due in one year or less $ 23,103,944 $ 23,306,020 Due from one to five years 87,133,068 89,057,714 Due from five to ten years 45,716,960 45,989,125 Due after ten years 9,116,862 8,166,943 Equity securities 9,951,906 9,820,608 ------------ ------------ Total $175,022,740 $176,340,410 ============ ============ Held to Maturity ----------------------------- Amortized Estimated Cost Fair Value --------- ---------- Due in one year or less $250,187 $250,703 Due from one to five years 150,648 152,345 Due from five to ten years - - Due after ten years - - Equity securities - - -------- -------- Total $400,835 $403,048 ======== ======== 42 The proceeds from sales, calls and maturities of securities, including principal payments received on mortgage-backed obligations and the related gross gains and losses realized are as follows: Proceeds from Gross Realized ----------------------------------- ----------------- Years Ended Calls and Principal December 31, Sales Maturities Payments Gains Losses - ------------------------------------------------------------------------------------------ 2000 Securities $ 11,506,633 $ 2,930,109 $ 4,670,845 $ 2,364 $ - available for sale Securities held to maturity - 140,000 - - - ------------ ----------- ----------- ------- --------- $ 11,506,633 $ 3,070,109 $ 4,670,845 $ 2,364 $ - ============ =========== =========== ======= ========= 1999 Securities $ 4,062,879 $ 13,706,762 $ 4,990,386 $ 828 $ 236,773 available for sale Securities held to maturity - 349,871 384,326 - - ------------ ------------ ----------- ------ --------- $ 4,062,879 $ 14,056,633 $ 5,374,712 $ 828 $ 236,773 ============ ============ =========== ====== ========= 1998 Securities $ 613,160 $ 13,115,000 $ 5,686,747 $ 8,610 $ - available for sale Securities held to maturity - 6,035,000 135,320 - - ---------- ------------ ----------- ------- --------- $ 613,160 $ 19,150,000 $ 5,822,067 $ 8,610 $ - ========== ============ =========== ======= ========= 43 At December 31, 2000 and 1999, securities with amortized costs of $39,856,005 and $27,001,621, respectively, with estimated fair values of $40,062,343 and $20,139,693, respectively, were pledged to secure public deposits, and for other purposes required or permitted by law. NOTE 5. LOANS Loans are summarized as follows: 2000 1999 ------------ ------------ Commercial, financial and agricultural $104,509,907 $ 78,894,072 Real estate - construction 2,729,408 2,012,243 Real estate - mortgage 127,929,968 116,778,905 Installment 37,586,562 38,666,563 Other 2,000,900 2,522,980 Total loans 274,756,745 238,874,763 Less unearned income 603,317 575,560 Total loans net of unearned income 274,153,428 238,299,203 Less allowance for loan losses 2,570,776 2,231,555 ------------ ------------- Loans, net $271,582,652 $ 236,067,648 ============ ============= Included in the net balance of loans are non-accrual loans amounting to $567,795 and $521,977 at December 31, 2000 and 1999, respectively. If interest on non-accrual loans had been accrued, such income would have approximated $14,745 $33,121 and $42,987 for the years ended December 31, 2000, 1999 and 1998, respectively. The following presents loan maturities at December 31, 2000. Within After 1 but After 1 Year Within 5 Years 5 Years ------------ -------------- ------------ Commercial,financial and agricultural $ 17,383,932 $ 31,491,064 $ 55,634,911 Real estate - construction 131,779 64,000 2,533,629 Real estate - mortgage 10,085,888 14,394,152 103,449,928 Installment loans 5,483,581 25,823,128 6,279,853 Other 856,041 1,008,406 136,453 ------------ ------------ ------------ $ 33,941,221 $ 72,780,750 $ 168,034,774 ============ ============ ============ Loans due after one year with: Variable rates $ 79,936,181 Fixed rates 160,879,343 ------------ $240,815,524 ============ Concentrations of credit risk: The Company grants commercial, residential and consumer loans to customers primarily located in the Eastern Panhandle and South Central counties of West Virginia, and the Northern counties of Virginia. Although the Company strives to maintain a diverse loan portfolio, exposure to credit losses can be adversely impacted 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS by downturns in local economic and employment conditions. Major employment within the Company's market area is diverse, but primarily includes government, health care, education, poultry and various professional, financial and related service industries. The Company evaluates the credit worthiness of each of its customers on a case-by-case basis and the amount of collateral it obtains is based upon management's credit evaluation. Loans to related parties: Summit and its subsidiaries have had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, principal officers, their immediate families and affiliated companies in which they are principal stockholders (commonly referred to as related parties), all of which have been, in the opinion of management, on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. The following presents the activity with respect to related party loans aggregating $60,000 or more to any one related party (other changes represent additions to and changes in director and executive officer status): 2000 1999 ------------ ------------ Balance, beginning $ 9,864,644 $ 10,066,896 Additions 998,305 5,808,627 Amounts collected (2,134,963) (3,953,176) Other changes, net 278,111 (2,057,703) ------------ ------------ Balance, ending $ 9,006,097 $ 9,864,644 ============ ============ NOTE 6. ALLOWANCE FOR LOAN LOSSES An analysis of the allowance for loan losses for the years ended December 31, 2000, 1999 and 1998 is as follows: 2000 1999 1998 ---------- ---------- ---------- Balance, beginning of year $2,231,555 $2,113,201 $1,489,117 Losses: Commercial,financial and agricultural - 164,783 182,517 Real estate - mortgage 62,839 31,892 1,057 Installment 174,719 144,099 204,415 Other 48,521 37,407 25,209 ---------- ---------- ---------- Total 286,079 378,181 413,198 ---------- ---------- ---------- Recoveries: Commercial,financial and agricultural 2,031 40,115 3,030 Real estate - mortgage 1,603 9,820 22,219 Installment 53,165 70,998 117,996 Other 11,001 5,602 7,235 ---------- ---------- ---------- Total 67,800 126,535 150,480 ---------- ---------- ---------- Net losses 218,279 251,646 262,718 Allowance of purchased subsidiary - - 271,802 Provision for loan losses 557,500 370,000 615,000 ---------- ---------- ---------- Balance, end of year $2,570,776 $2,231,555 $2,113,201 ========== ========== ========== The Company's total recorded investment in impaired loans at December 31, 2000 and 1999 approximated $982,539 and $345,817, respectively, for which the related allowance for loan losses determined in accordance with generally accepted accounting principles approximated $250,000 and $73,900, respectively. The Company's average investment in such loans approximated $1,010,355 and $475,222 for the years ended December 31, 2000 and 1999, respectively. All impaired loans at December 31, 1999 were collateral dependent, and accordingly, the fair value of the loan's collateral was used to measure the impairment of each loan. Impaired loans at December 31, 2000 included loans that were collateral dependent, for which the fair value of the loans collateral was used to measure impairment, and a loan that was not collateral dependent, for which the impairment was measured based on management's best estimate of discounted cash flows. For purposes of evaluating impairment, the Company considers groups of smaller-balance, homogeneous loans to include: mortgage loans secured by residential property, other than those which significantly exceed the Company's typical residential mortgage loan amount (currently those in excess of $100,000); small balance commercial loans (currently those less than $50,000); and installment loans to individuals, exclusive of those loans in excess of $50,000. For the years ended December 31, 2000 and 1999, the Company recognized approximately $111,025 and $400, respectively, in interest income on impaired loans. Using a cash-basis method of accounting, the Company would have recognized approximately the same amount of interest income on such loans. 45 NOTE 7. PREMISES AND EQUIPMENT The major categories of premises and equipment and accumulated depreciation at December 31, 2000 and 1999, are summarized as follows: 2000 1999 ----------- ----------- Land $ 2,495,920 $ 2,529,741 Buildings and improvements 9,152,420 6,737,044 Furniture and equipment 5,333,525 3,843,450 ----------- ----------- 16,981,865 13,110,235 Less accumulated depreciation 4,735,044 4,113,208 ----------- ----------- Premises and equipment, net $12,246,821 $ 8,997,027 =========== =========== Depreciation expense for the years ended December 31, 2000, 1999 and 1998 totaled $731,073, $584,212 and $480,168, respectively. NOTE 8. DEPOSITS The following is a summary of interest bearing deposits by type as of December 31, 2000 and 1999: 2000 1999 Demand deposits, interest bearing $ 69,038,854 $ 62,741,925 Savings deposits 37,729,798 42,099,321 Certificates of deposit 190,986,834 149,440,839 Individual retirement accounts 18,174,955 15,474,660 ------------ ------------ Total $315,930,441 $269,756,745 ============ ============ Time certificates of deposit and IRA's in denominations of $100,000 or more totaled $50,840,006 and $39,883,962 at December 31, 2000 and 1999, respectively. Interest paid on time certificates of deposit and Individual Retirement Accounts in denominations of $100,000 or more were $2,623,640, $1,823,421 and $1,506,154 for the years ended December 31, 2000, 1999 and 1998, respectively. The following is a summary of the maturity distribution of certificates of deposit and IRA's in denominations of $100,000 or more as of December 31, 2000: Amount Percent ----------- ------- Three months or less $13,156,335 25.9% Three through six months 16,106,236 31.7% Six through twelve months 13,623,247 26.8% Over twelve months 7,954,188 15.6% ----------- ------ Total $50,840,006 100.0% =========== ====== A summary of the scheduled maturities for all time deposits as of December 31, 2000, follows: 2001 $172,020,578 2002 23,583,886 2003 8,567,582 2004 3,603,773 2005 970,257 Thereafter 415,713 ------------ $209,161,789 ============ At December 31, 2000, deposits of related parties including directors, executive officers, and their related interests of the Company approximated $6,500,000. NOTE 9. BORROWED FUNDS Short-term borrowings: A summary of short-term borrowings is presented below: . 2000 ---- Federal Short-term Funds Repurchase FHLB Purchased Agreements Advances ----------- ----------- ----------- Balance at December 31 $ 1,252,000 $ 6,187,914 $ 1,950,900 Average balance outstanding for the year 3,922,918 7,450,110 37,489,925 Maximum balance outstanding at any month end 1,252,000 12,758,541 72,702,003 Weighted average interest rate for the year 7.03% 5.13% 7.13% Weighted average interest rate for balances outstanding at December 31 7.00% 4.95% 6.63% 1999 ---- Federal Short-term Funds Repurchase FHLB Purchased Agreements Advances ---------- ----------- ----------- Balance at December 31 $ - $ 6,053,030 $26,295,000 Average balance outstanding for the year 231,681 4,136,697 9,509,159 Maximum balance outstanding at any month end 3,061,000 6,953,086 27,390,000 Weighted average interest rate for the year 4.58% 4.01% 5.21% Weighted average interest rate for balances outstanding at December 31 - % 4.25% 4.05% 46 Federal funds purchased and repurchase agreements mature the next business day. The securities underlying the repurchase agreements are under the Company's control and secure the total outstanding daily balances. Summit's subsidiary banks are members of the Federal Home Loan Bank ("FHLB"). Membership in the FHLB makes available short-term and long-term advances under collateralized borrowing arrangements with each subsidiary bank. All FHLB advances are collateralized primarily by similar amounts of residential mortgage loans. At December 31, 2000, Summit's subsidiary banks had combined additional borrowings availability of $70,961,000 from the FHLB. Short-term FHLB advances are granted for terms of 1 to 364 days and bear interest at a fixed or variable rate set at the time of the funding request. Long-term borrowings: The Company's long-term borrowings of $81,085,929 and $17,942,540 as of December 31, 2000 and 1999, respectively, consisted of advances from the FHLB. These borrowings bear both fixed and variable interest rates and mature in varying amounts through the year 2010. The average interest rate paid on long-term borrowings during 2000 and 1999 approximated 5.68% and 5.33%, respectively. A summary of the maturities of all long-term borrowings for the next five years and thereafter is as follows: Year Ending December 31, Amount ------------ ----------- 2001 $ 378,081 2002 1,150,840 2003 424,973 2004 860,592 2005 12,323,714 Thereafter 65,947,729 ----------- $81,085,929 =========== NOTE 10. INCOME TAXES The components of applicable income tax expense (benefit) for the years ended December 31, 2000, 1999 and 1998, are as follows: 2000 1999 1998 ----------- ----------- ----------- Current Federal $ 1,446,490 $ 1,362,370 $ 1,154,774 State 204,270 154,585 168,092 ----------- ----------- ----------- 1,650,760 1,516,955 1,322,866 ----------- ----------- ----------- Deferred Federal (107,568) 15,892 (57,863) State 191 37,103 (17,314) ----------- ----------- ----------- (107,377) 52,995 (75,177) ----------- ----------- ----------- Total $ 1,543,383 $ 1,569,950 $ 1,247,689 =========== =========== =========== Reconciliation between the amount of reported income tax expense and the amount computed by multiplying the statutory income tax rates by book pretax income for the years ended December 31, 2000, 1999 and 1998 is as follows: 47 2000 1999 1998 --------------------- -------------------- -------------------- Amount Percent Amount Percent Amount Percent ----------- ------- ----------- ------- ----------- ------- Computed tax at applicable statutory rate $ 1,629,723 34 $ 1,568,447 34 $ 1,308,950 34 Increase (decrease) in taxes resulting from: Tax-exempt interest, net (216,212) (5) (425,763) (9) (196,508) (5) State income taxes, net of Federal income tax benefit 134,818 3 140,354 3 109,575 3 Change in deferred tax valuation allowance - - 271,733 6 61,965 2 Nondeductible amortization of goodwill 26,568 1 40,763 1 33,415 1 Other, net (31,514) (1) (25,584) (1) (69,708) (2) ----------- ------ ----------- ------- ----------- ------- Applicable income taxes $ 1,543,383 32 $ 1,569,950 34 $ 1,247,689 33 =========== ====== =========== ======= =========== ======= 48 Deferred income taxes reflect the impact of "temporary differences" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured for tax purposes. Deferred tax assets and liabilities represent the future tax return consequences of temporary differences, which will either be taxable or deductible when the related assets and liabilities are recovered or settled. Valuation allowances are established when deemed necessary to reduce deferred tax assets to the amount expected to be realized. The tax effects of temporary differences, which give rise to the Company's deferred tax assets and liabilities as of December 31, 2000 and 1999, are as follows: 2000 1999 ----------- ----------- Deferred tax assets Allowance for loan losses $ 704,251 $ 622,125 Deferred compensation 156,095 106,439 Other deferred costs and accrued expenses 78,771 52,010 Deductible goodwill - 38,463 Net operating loss carryforwards - 3,181 Net unrealized loss on securities (500,715) 1,155,268 Net unrealized loss on invest rate caps 44,552 - ----------- ----------- 482,954 1,977,486 Deferred tax liabilities Depreciation 63,208 32,322 Accretion on tax-exempt securities 12,756 9,670 Purchase accounting adjustments 145,387 125,285 ----------- ----------- 221,351 167,277 ----------- ----------- Net deferred tax assets (liabilities) $ 261,603 $ 1,810,209 =========== =========== The income tax expense (benefit) on realized securities gains (losses) was $910, $(90,839), and $(3,141) for the years ended December 31, 2000, 1999 and 1998, respectively. NOTE 11. EMPLOYEE BENEFITS Retirement Plans: The Company has defined contribution profit-sharing plans with 401(k) provisions covering substantially all employees. Contributions to the plans are at the discretion of the Board of Directors. Contributions made to the plans and charged to expense were $150,777, $178,770, and $137,628 for the years ended December 31, 2000, 1999 and 1998, respectively. Employee Stock Ownership Plan: The Company has an Employee Stock Ownership Plan ("ESOP") which enables eligible employees to acquire shares of the Company's common stock. The cost of the ESOP is borne by the Company through annual contributions to an Employee Stock Ownership Trust in amounts determined by the Board of Directors. The expense recognized by the Company is based on cash contributed or committed to be contributed by the Company to the ESOP during the year. Contributions to the ESOP for the years ended December 31, 2000, 1999 and 1998 were $137,588, $66,615, and $54,559, respectively. Dividends paid by the Company to the ESOP are reported as a reduction to retained earnings. The ESOP owns 13,578 shares of the Company's common stock, all of which were purchased at the prevailing market price and are considered outstanding for earnings per share computations. The trustees of the Retirement Plans and ESOP are also members of the Company's Board of Directors. Directors Deferred Compensation Plan: The Company's subsidiary banks, South Branch Valley National Bank, Capital State Bank, and Shenandoah Valley National Bank as well as the Company itself, has established non-qualified deferred compensation plans for directors who voluntarily elect to defer payment of retainer, meeting and committee fees earned. The liability for deferred directors' compensation at December 31, 2000 and 1999, approximated $284,026 and $267,777, respectively, which is included in other liabilities in the accompanying consolidated balance sheets. Supplemental Executive Retirement Plan: In May 1999, South Branch Valley National Bank entered into a non-qualified Supplemental Executive Retirement Plan ("SERP") with certain senior officers which provides participating officers with an income benefit payable at retirement age or death. During 2000 Capital State Bank and Shenandoah Valley National Bank adopted similar plans. The liabilities accrued for the SERP at December 31, 2000 and 1999 were $66,368 and $12,336 respectively, which are included in other liabilities. In addition, the subsidiary banks have purchased certain life insurance contracts to fund the liabilities arising under these plan. At December 31, 2000 and 1999, the cash surrender value of these insurance contracts was $2,370,708 and $1,281,998, respectively. Stock Option Plan: Summit has an Officer Stock Option Plan, which provides for the granting of stock options for up to 120,000 shares of common stock to key Company officers. Each option granted under the plan vests according to a schedule designated at the grant date and shall have a term of no more than 10 years following the vesting date. Also, the option price per share shall not be less than the fair market value of Summit's common stock on the date of grant. Accordingly, no compensation expense is recognized for options granted under the Plan. 49 The following pro forma disclosures present for 2000 and 1999 (the first year for which any options were outstanding), Summit's reported net income and basic and diluted earnings per share had the Company recognized compensation expense for its Officer Stock Option Plan based on the grant date fair values of the options (the fair value method described in Statement of Financial Accounting Standards No. 123). 2000 ---- As Pro Reported Forma --------- ------- Net income (in thousands) $ 3,250 $ 3,222 Basic earnings per share $ 3.69 $ 3.66 Diluted earnings per share $ 3.69 $ 3.66 1999 ---- As Pro Reported Forma --------- ------- Net income (in thousands) $ 3,043 $ 3,017 Basic earnings per share $ 3.39 $ 3.36 Diluted earnings per share $ 3.39 $ 3.36 For purposes of computing the above pro forma amounts, Summit estimated the fair value of the options at the date of grant using a Black-Scholes option pricing model using the following weighted-average assumptions for grants in each respective year: risk free interest rates of 6.50% for 2000 and 5.25% for 1999; dividend yields of 3.25% for 2000 and 2.0% for 1999; volatility factors of the expected market price of Summit's common stock of 20 for 2000 and 1999; and an expected option life of 10 years for 2000 and 1999. The weighted-average grant date fair value of options granted during 2000 and 1999 was $10.07 and $12.86, respectively. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. A summary of activity in Summit's Officer Stock Option Plan during 2000 and 1999 is as follows: Weighted- Average Exercise Options Price ------- ------- Outstanding, January 1, 1999 - $ - Granted 7,500 41.65 Exercised - - Forfeited - - Outstanding, December 31, 1999 7,500 $ 41.65 Granted 4,500 37.00 Exercised - - Forfeited - - Outstanding, December 31, 2000 12,000 $ 39.91 Exercisable Options: December 31, 2000 3,900 $ 40.58 December 31, 1999 1,500 $ 41.65 The exercise prices for all options outstanding at December 31, 2000 ranged from $37.00 to $41.65. The weighted-average remaining contractual life of those options at December 31, 2000 was 10.5 years. NOTE 12. COMMITMENTS AND CONTINGENCIES Financial instruments with off-balance sheet risk: The Company is a party of certain financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. Such financial instruments consist solely of commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position. The contract amounts of these instruments reflect the extent of involvement the Company has in this class of financial instruments. The Company's total contract amount of commitments to extend credit at December 31, 2000 and 1999, approximated $27,776,257 and $18,040,810, respectively. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. 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. The Company evaluates each customer's credit worthiness on a 50 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. Collateral held varies but may include accounts receivable, inventory, equipment or real estate. Litigation: The Company is involved in various legal actions arising in the ordinary course of business. In the opinion of counsel, the outcome of these matters will not have a significant adverse effect on the consolidated financial statements. Employment Agreements: The Company has various employment agreements with its chief executive officer and certain other executive officers. These agreements contain change in control provisions that would entitle the officers to receive compensation in the event there is a change in control in the Company (as defined) and a termination of their employment without cause (as defined). Note 13. Restrictions on capital and dividends The primary source of funds for the dividends paid by Summit is dividends received from its subsidiary banks. Dividends paid by the subsidiary banks are subject to restrictions by banking regulations. The most restrictive provision requires approval by their regulatory agencies if dividends declared in any year exceed the year's net income, as defined, plus the net retained profits of the two preceding years. As of December 31, 2000 there were no significant retained profits available for distribution to Summit as dividends without regulatory approval. The Company and its subsidiaries are subject to various regulatory capital requirements administered by the banking regulatory agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and each of its subsidiaries must meet specific capital guidelines that involve quantitative measures of the Company's and its subsidiaries' assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and each of its subsidiaries' capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and each of its subsidiaries to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that the Company and each of its subsidiaries met all capital adequacy requirements to which they were subject. The most recent notifications from the banking regulatory agencies categorized the Company and each of its subsidiary banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and each of its subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. Summit's and its subsidiary banks', South Branch Valley National Bank's ("SBVNB"), Capital State Bank, Inc.'s ("CSB"), Shenandoah Valley National Bank's ("SVNB") and Potomac Valley Bank's ("PVB") actual capital amounts and ratios are also presented in the following tables (dollar amounts in thousands). 51 Minimum To be Well Required Capitalized under Regulatory Prompt Corrective Actual Capital Action Provisions --------------- ------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------ ----- ------- ----- As of December 31, 2000 Total Capital (to risk weighted assets) Company $37,900 12.8% 23,669 8.0% $29,586 10.0% SBVNB 12,751 10.6% 9,623 8.0% 12,029 10.0% SVNB 6,521 17.1% 3,051 8.0% 3,813 10.0% CSB 7,679 11.0% 5,585 8.0% 6,981 10.0% Potomac 8,483 13.0% 5,220 8.0% 6,525 10.0% Tier I Capital (to risk weighted assets) Company 35,329 11.9% 11,875 4.0% 17,813 6.0% SBVNB 11,460 9.5% 4,825 4.0% 7,238 6.0% SVNB 6,405 16.8% 1,525 4.0% 2,288 6.0% CSB 7,135 10.2% 2,798 4.0% 4,197 6.0% Potomac 7,863 12.0% 2,621 4.0% 3,932 6.0% Tier I Capital (to average assets) Company 35,329 8.2% 12,925 3.0% 21,542 5.0% SBVNB 11,460 7.1% 4,842 3.0% 8,070 5.0% SVNB 6,405 8.3% 2,315 3.0% 3,858 5.0% CSB 7,135 6.2% 3,452 3.0% 5,754 5.0% Potomac 7,863 7.1% 3,322 3.0% 5,537 5.0% 52 Minimum To be Well Required Capitalized under Regulatory Prompt Corrective Actual Capital Action Provisions ------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------- ----- ------- ----- As of December 31, 1999 Total Capital (to risk weighted assets) Summit $35,186 14.8% $19,052 8.0% $23,815 10.0% SBVNB 11,952 10.8% 8,886 8.0% 11,108 10.0% SVNB 3,926 25.8% 1,219 8.0% 1,524 10.0% CSB 7,064 12.9% 4,372 8.0% 5,465 10.0% PVB 12,894 21.0% 4,904 8.0% 6,130 10.0% Tier I Capital (to risk weighted assets) Summit 32,954 13.8% 9,526 4.0% 14,289 6.0% SBVNB 10,781 9.7% 4,443 4.0% 6,665 6.0% SVNB 3,896 25.6% 609 4.0% 914 6.0% CSB 6,660 12.2% 2,186 4.0% 3,279 6.0% PVB 12,267 20.0% 2,452 4.0% 3,678 6.0% Tier I Capital (to average assets) Summit 32,954 8.7% 11,413 3.0% 19,021 5.0% SBVNB 10,781 7.0% 4,653 3.0% 7,755 5.0% SVNB 3,896 11.6% 1,005 3.0% 1,675 5.0% CSB 6,660 6.7% 2,965 3.0% 4,942 5.0% PVB 12,267 13.3% 2,773 3.0% 4,621 5.0% 53 NOTE 14. BRANCH SALE On December 17, 1999, a subsidiary of Summit, South Branch Valley National Bank entered into an agreement to sell its branch banking facility ("Branch") located in Petersburg, West Virginia. The sale included the Branch's facility and selected loans and deposit accounts. The final settlement of this transaction resulted in approximately $6.4 million of asset transfers, with the buyer assuming approximately $7.2 million in liabilities, requiring a cash payment to the purchaser of approximately $.8 million. NOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS During 2000 the Company purchased interest rate caps with a notional amount of $50 million. These caps are used to offset interest rate risk relating to certain variable rate long-term debt. These interest rate caps do not meet the criteria for hedge accounting and are marked to market at the end of each period with changes in market value being charged to earnings. The total amount paid for these caps was $158,500 and the cumulative market adjustments, and the amount charged to earnings in 2000 were $124,446. During 2000 the Company entered into interest rate swap agreements where by the Company will pay a variable rate of USD-LIBOR and receive a fixed rate of 7.18% with a notional amount of $2,000,000 and a term of three years, expiring June 4, 2003. These instruments were used to hedge the fair value of certain certificates of deposit issued by the subsidiary banks. The swap agreement and the related hedged certificates are marked to market at the end of each reporting period and the net impact of the adjustments, the ineffective portion of the hedge, is reflected in other income in the accompanying financial statements. The net of the amounts earned on the fixed rate leg of the swap and amounts due on the variable rate leg of the swap are reflected as an adjustment in the Company's cost of funds. During 2000 there was no ineffectiveness of the hedge transaction reflected in earnings. The total amount reflected as an adjustment to interest expense during 2000 was $6,100. NOTE 16. FAIR VALUE OF FINANCIAL INSTRUMENTS The following summarizes the methods and significant assumptions used by the Company in estimating its fair value disclosures for financial instruments. Cash and due from banks: The carrying values of cash and due from banks approximate their estimated fair value. Interest bearing deposits with other banks: The fair values of interest bearing deposits with other banks are estimated by discounting scheduled future receipts of principal and interest at the current rates offered on similar instruments with similar remaining maturities. Federal funds sold: The carrying values of Federal funds sold approximate their estimated fair values. Securities: Estimated fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities. Loans: The estimated fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms to borrowers of similar credit quality. No prepayments of principal are assumed. Accrued interest receivable and payable: The carrying values of accrued interest receivable and payable approximate their estimated fair values. Deposits: The estimated fair values of demand deposits (i.e. non interest bearing checking NOW, Super NOW, money market and savings accounts) and other variable rate deposits approximate their carrying values. Fair values of fixed maturity deposits are estimated using a discounted cash flow methodology at rates currently offered for deposits with similar remaining maturities. Any intangible value of long-term relationships with depositors is not considered in estimating the fair values disclosed. Short-term borrowings: The carrying values of short-term borrowings approximate their estimated fair values. Long-term borrowings: The fair values of long-term borrowings are estimated by discounting scheduled future payments of principal and interest at current rates available on borrowings with similar terms. Off-balance sheet instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit standing of the counter parties. The amounts of fees currently charged on commitments and standby letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values are not shown below. The carrying values and estimated fair values of the Company's financial instruments are summarized below: 2000 1999 ---------------------------- ---------------------------- Estimated Estimated Carrying Fair Carrying Fair Cost Value Cost Value ------------- ------------ ------------ ------------- Financial assets: Cash and due from banks $ 7,091,877 $ 7,091,871 $ 7,010,196 $ 7,018,196 Interest bearing deposits, other banks 473,000 473,000 5,800,987 5,800,987 Federal funds sold 1,811,000 1,811,000 2,845,216 2,845,216 Securities available fo 176,340,140 176,340,410 111,972,963 111,972,963 Securities held to maturity 400,835 403,048 796,820 801,615 Loans 271,582,652 264,244,272 236,067,648 235,303,880 Accrued interest receivab 3,760,301 3,760,701 2,439,767 2,439,767 ------------ ------------ ------------ ------------- $ 461,459,805 $ 454,124,302 $ 366,933,597 $ 366,182,624 ============= ============= ============= ============= Financial liabilities: Deposits $ 345,961,850 $ 346,779,838 $ 297,138,620 $ 298,005,504 Short-term borrowings 9,390,814 9,390,814 31,348,030 31,348,030 Long-term borrowings 81,085,929 86,626,954 18,942,540 18,942,540 Accrued interest payable 2,105,533 2,105,533 1,309,002 1,309,002 ------------- ------------- ------------- ------------- $ 438,544,126 $ 444,903,139 $ 348,738,192 $ 349,605,076 ============= ============= ============= ============= 54 NOTE 17. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY The investment of the Company in its wholly-owned subsidiaries is presented on the equity method of accounting. Information relative to the Company's balance sheets at December 31, 2000 and 1999, and the related statements of income and cash flows for the years ended December 31, 2000, 1999 and 1998, are presented as follows: Balance Sheets December 31, ------------ 2000 1999 ------------ ------------ Assets Cash and due from banks $ 396,077 $ 193,831 Investment in bank subsidiaries, eliminated in consolidation 37,397,800 35,881,307 Securities available for sale 182,125 240,249 Furniture and equipment 1,794,607 212,018 Other assets 283,290 339,819 ------------ ------------ Total assets $ 40,053,899 $ 36,867,224 ============ ============ Liabilities and Shareholders' Equity Long-term borrowings $ - $ 1,000,000 Other liabilities 280,698 784,604 ------------ ------------ Total liabilities 280,698 1,784,604 ------------ ------------ Common stock, $2.50 par value, authorized 2,000,000 shares; issued 1999 - 890,517 shares, 1998 - 907,016 shares 2,225,978 2,226,293 Capital surplus 10,482,873 10,533,674 Retained earnings 26,765,097 24,570,174 Less cost of shares acquired for the treasury 1998-9,115 shares; 1997-4,115 shares (517,725) (384,724) Accumulated other comprehensive income 816,978 (1,862,797) ------------ ------------ Total shareholders' equity 39,773,201 35,082,620 ------------ ------------ Total liabilities and shareholder $ 40,053,899 $ 36,867,224 ============ ============ Statements of Income 2000 1999 1998 ----------- ----------- ----------- Income Dividends from bank subsidiaries $ 7,220,000 $ 4,240,000 $ 1,570,000 Other dividends and interest income 27,671 28,265 7,454 Management fees from bank subsidiaries 1,387,150 548,317 55,000 Securities gains - - 4,110 ----------- Total income 8,634,821 4,816,582 1,636,564 ----------- ----------- ----------- Expense Interest expense 2,736 51,431 56,689 Operating expenses 1,850,362 794,692 184,057 ----------- ----------- ----------- Total expenses 1,853,098 846,123 240,746 ----------- ----------- ----------- Income before income taxes and equity in undistributed income of bank subsidiaries 6,781,723 3,970,459 1,395,818 Income tax (benefit) (167,845) (99,600) (72,200) ----------- ----------- ----------- Income before equity in undistributed income of bank subsidiaries 6,949,568 4,070,059 1,468,018 Equity in (distributed) undistributed income of bank subsidiaries (3,699,649) (1,026,930) 1,134,147 ----------- ----------- ----------- Net income $ 3,249,919 $ 3,043,129 $ 2,602,165 =========== =========== =========== 55 Statements of Cash Flows 2000 1999 1998 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,249,919 $ 3,043,129 $ 2,602,165 Adjustments to reconcile net earnings to net cash provided by operating activities: Equity in undistributed net income of bank subsidiaries 3,699,649 1,026,930 (1,134,147) Deferred tax expense 19,055 Depreciation 121,693 48,913 1,396 Securities gains/(losses) - - (4,110) (Increase) decrease in other assets 59,231 (213,783) 8,893 Increase (decrease) in other liabilities 248,919 31,779 (26,439) ----------- ----------- ----------- Net cash provided by operating activities 7,398,466 3,936,968 1,447,758 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of securities available for sale - - 204,110 Purchases of securities available for sale - - (300,000) Purchase of common stock of affiliate - - (90,465) Investment in Shenandoah Valley National Bank (2,500,000) (4,000,000) - Proceeds from sales of premises and equipment - 62,870 - Purchases of furniture and equipment (1,704,282) (197,835) (127,363) ----------- ----------- ----------- Net cash (used in) investing activities (4,204,282) (4,134,965) (313,718) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid to shareholders (1,054,996) (831,727) (798,450) Purchases of fractional shares (4,846) - - Payments to dissenting shareholders (799,095) - - Purchase of treasury stock (133,001) - (217,754) Proceeds from long-term borrowings - 1,000,000 - Repayment of long-term borrowings (1,000,000) - (39,874) ----------- ----------- Net cash provided by (used in) financing activities (2,991,938) 168,273 (1,056,078) ----------- ----------- ----------- Increase (decrease) in cash 202,246 (29,724) 77,962 Cash: Beginning 193,831 223,555 145,593 ----------- ----------- ----------- Ending $ 396,077 $ 193,831 $ 223,555 =========== =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 2,736 $ 40,333 $ 83,128 =========== =========== =========== SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES Issuance of 183,465 shares of Company common stock in connection with acquisition of Capital State Bank, Inc. $ - $ - $ 7,980,728 ----------- ----------- ----------- 56