FINANCIAL INFORMATION 2002
- --------------------------------------------------
CONTENTS
SELECTED FINANCIAL DATA.........................2
MANAGEMENT'S DISCUSSION
AND ANALYSIS..................................3
Introduction and Summary......................3
Critical Accounting Policies .................3
Results of Operations .......................4
Changes in Financial Position.................7
Asset Quality.................................9
Liquidity....................................12
Market Risk Management.......................12
Contractual Cash Obligations.................12
Off-Balance Sheet Arrangements...............12
Capital Resources............................13
QUARTERLY FINANCIAL
INFORMATION..................................14
REPORT OF INDEPENDENT
AUDITORS.....................................15
CONSOLIDATED FINANCIAL
STATEMENTS...................................16
Consolidated Balance Sheets..................16
Consolidated Statements of Income............17
Consolidated Statements of Shareholders'
Equity.....................................18
Consolidated Statements of Cash
Flows...................................19-20
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS......................21-38
SELECTED FINANCIAL DATA
For the Year Ended
(unless otherwise noted)
- -----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
Summary of Operations
Interest income $ 40,689 $ 37,919 $ 32,264 $ 25,114 $ 20,638
Interest expense 18,842 20,438 18,276 12,234 10,288
---------------------------------------------------------
Net interest income 21,847 17,481 13,988 12,880 10,350
Provision for loan losses 1,215 830 558 370 615
---------------------------------------------------------
Net interest income after provision
for loan losses 20,632 16,651 13,430 12,510 9,735
Noninterest income 1,945 1,810 1,228 821 753
Noninterest expense 12,607 10,737 9,865 8,718 6,638
---------------------------------------------------------
Income before income taxes 9,970 7,724 4,793 4,613 3,850
Income taxes 2,732 2,458 1,543 1,570 1,248
---------------------------------------------------------
Net income $ 7,238 $ 5,266 $ 3,250 $ 3,043 $ 2,602
=========================================================
Balance Sheet Data (at year end)
Assets $ 671,784 $ 591,757 $ 481,239 $ 385,767 $ 287,296
Securities 212,598 207,117 176,741 112,770 64,978
Loans 419,205 347,526 274,153 238,299 195,277
Deposits 458,648 396,205 345,962 297,139 228,341
Short-term borrowings 20,191 24,033 9,391 32,348 4,644
Long-term borrowings 133,787 123,445 81,086 17,943 16,469
Shareholders' equity 52,080 44,287 39,773 35,083 35,957
Per Share Data
Basic earnings $ 4.13 $ 3.00 $ 1.85 $ 1.69 $ 1.53
Diluted earnings 4.11 3.00 1.85 1.69 1.53
Shareholders' equity (at year end) 29.73 25.24 22.66 19.90 20.02
Cash dividends 0.75 0.70 0.60 0.48 0.45
Performance Ratios
Return on average equity 15.15% 12.38% 8.93% 8.52% 7.44%
Return on average assets 1.15% 1.00% 0.75% 0.88% 0.95%
Dividend payout 18.2% 23.3% 32.5% 27.3% 30.7%
Equity to assets 7.8% 7.5% 8.3% 9.1% 12.5%
2
MANAGEMENT'S DISCUSSION AND ANALYSIS
INTRODUCTION AND SUMMARY
The following is a discussion and analysis of our financial condition and
financial results of operations for Summit Financial Group, Inc. ("Company" or
"Summit") and our wholly owned subsidiaries, Summit Community Bank, Capital
State Bank, Inc. ("Capital State"), Shenandoah Valley National Bank
("Shenandoah"), and SFG Capital Trust I as of December 31, 2002. This discussion
may contain forward looking statements based on our expectations and actual
results may differ materially. Since our primary business activities are
conducted through our 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 our accompanying
Consolidated Financial Statements and Notes thereto as of December 31, 2002 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 our 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, our
ability to effectively carry out our 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 we believe the expectations
reflected in such forward-looking statements are reasonable, actual results may
differ materially.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the financial services industry. Application of
these principles requires us to make estimates, assumptions, and judgments that
affect the amounts reported in our financial statements and accompanying notes.
These estimates, assumptions, and judgments are based on information available
as of the date of the financial statements; accordingly, as this information
changes, the financial statements could reflect different estimates,
assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported.
Our most significant accounting policies are presented in Note 1 to the
consolidated financial statements. These policies, along with the disclosures
presented in the other financial statement notes and in this financial review,
provide information on how significant assets and liabilities are valued in the
financial statements and how those values are determined.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions, and estimates underlying those
amounts, we have identified the determination of the allowance for loan losses
and the valuation of goodwill to be the accounting areas that require the most
subjective or complex judgments, and as such could be most subject to revision
as new information becomes available.
The allowance for loan losses represents our estimate of probable credit
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type on
our consolidated balance sheet. To the extent actual outcomes differ from our
estimates, additional provisions for loan losses may be required that would
negatively impact earnings in future periods. Note 1 to the consolidated
financial statements describes the methodology used to determine the allowance
for loan losses and a discussion of the factors driving changes in the amount of
the allowance for loan losses is included in the Asset Quality section of this
financial review.
With the adoption of SFAS No. 142 on January 1, 2002, we discontinued the
amortization of goodwill resulting from acquisitions. Goodwill is now subject to
impairment testing at least annually to determine whether write-downs of the
recorded balances are necessary. A fair value is determined based on at least
one of three various market valuation methodologies. If the fair value equals or
exceeds the book value, no write-down of recorded goodwill is necessary. If the
fair value is less than the book value, an expense may be required on our books
to write down the goodwill to the proper carrying value. During the second
quarter of 2002, we completed the required transitional impairment test and
determined that no impairment write-offs were necessary. We can not assure you
that future goodwill impairment tests will not result in a charge to earnings.
See Notes 1 and 9 of the accompanying consolidated financial statements for
further discussion of our intangible assets, which include goodwill.
3
RESULTS OF OPERATIONS
Earnings Summary
Net income for the three years ended December 31, 2002, 2001 and 2000, was
$7,238,000, $5,266,000, and $3,250,000 respectively. On a per share basis,
diluted net income was $4.11 in 2002 compared to $3.00 in 2001, and $1.85 in
2000. Return on average equity was 15.15% in 2002 compared to 12.38% in 2001,
and 8.93% in 2000. Return on average assets for the year ended December 31, 2002
was 1.15% compared to 1.00% in 2001 and 0.75% in 2000. A summary of the
significant factors influencing our results of operations and related ratios is
included in the following discussion.
Net Interest Income
The major component of our 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. We seek to maximize net interest income through management of
our 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 2002, 2001 and 2000 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
$22,873,000, $18,013,000 and $14,431,000 for the years ended December 31, 2002,
2001 and 2000, respectively. Our net interest margin was 3.9% for 2002 compared
to 3.6% and 3.5% for 2001 and 2000, respectively. The net interest margin
recognizes earning asset growth by expressing net interest income as a
percentage of total average earning assets. Our net interest margin increased 30
basis points in 2002 primarily due to growth in our volumes of interest earning
assets, and the continued downturn of the economy, which has pushed rates down,
thus lowering our cost of funds. We began to see the effects of the lower costs
of funds during 2001, when our net interest margin increased 10 basis points.
That increase in our net interest margin was also due to growth in the volumes
of interest earning assets.
As identified in Table II, tax equivalent net interest income grew
$4,860,000 and $3,582,000 during 2002 and 2001, respectively, due primarily to
the substantial growth in the volumes of the interest earning assets in both
years.
If market interest rates were to rise significantly in 2003, the spread
between interest earning assets and interest bearing liabilities could begin to
narrow again, thus negatively impacting our net interest income. We continue to
monitor the net interest margin through net interest income simulation to
minimize the potential for any significant negative impact. See the Market Risk
Management section for further discussion of the impact changes in market
interest rates could have on us.
4
Table I - Average Distribution of Assets, Liabilities and Shareholders' Equity,
Interest Earnings & Expenses, and Average Rates
Dollars in thousands
2002 2001 2000
------------------------------ ---------------------------- ------------------------------
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 $ 376,745 $ 28,626 7.6% $ 301,030 $ 25,592 8.5% $ 248,404 $ 21,630 8.7%
Tax-exempt (2) 6,268 529 8.4% 3,201 320 10.0% 2,211 261 11.8%
Securities
Taxable 169,728 9,840 5.8% 164,303 10,897 6.6% 139,476 9,484 6.8%
Tax-exempt (2) 34,968 2,572 7.4% 18,526 1,385 7.5% 13,202 1,046 7.9%
Federal funds sold and interest
bearing deposits with other banks 5,458 148 2.7% 7,002 257 3.7% 4,305 286 6.6%
---------------------------- --------------------------- ----------------------------
593,167 41,715 7.0% 494,062 38,451 7.8% 407,598 32,707 8.0%
Noninterest earning assets
Cash and due from banks 8,981 8,872 8,166
Bank premises and equipment 13,079 12,533 10,666
Other assets 16,966 11,552 8,877
Allowance for loan losses (3,649) (2,777) (2,414)
---------- ---------- ----------
Total assets $ 628,544 $ 524,242 $ 432,893
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Interest bearing liabilities
Interest bearing
demand deposits $ 93,001 $ 1,302 1.4% $ 74,430 $ 1,889 2.5% $ 60,351 $ 2,027 3.4%
Savings deposits 45,766 550 1.2% 40,052 893 2.2% 39,738 1,094 2.8%
Time deposits 247,587 9,712 3.9% 224,068 11,984 5.3% 187,665 10,476 5.6%
Short-term borrowings 15,973 326 2.0% 11,879 452 3.8% 48,867 3,087 6.3%
Long-term borrowings and
capital trust securities 134,384 6,952 5.2% 93,231 5,220 5.6% 28,033 1,592 5.7%
---------------------------- --------------------------- ----------------------------
536,711 18,842 3.5% 443,660 20,438 4.6% 364,654 18,276 5.0%
Noninterest bearing liabilities
Demand deposits 39,364 33,679 28,017
Other liabilities 4,687 4,383 3,845
--------- --------- ---------
Total liabilities 580,762 481,722 396,516
Shareholders' equity 47,782 42,520 36,377
--------- --------- ---------
Total liabilities and
shareholders' equity $ 628,544 $ 524,242 $ 432,893
========= ========= =========
NET INTEREST EARNINGS $ 22,873 $ 18,013 $ 14,431
======== ======== ========
NET INTEREST YIELD ON EARNING ASSETS 3.9% 3.6% 3.5%
=== === ===
(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
$288,000, $227,000 and $343,000 for the years ended December 31, 2002, 2001
and 2000 respectively.
(2) - For purposes of this table, interest income on tax-exempt securities and
loans 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 $1,026,000, $533,000 and
$443,000 for the years ended December 31, 2002, 2001 and 2000,
respectively.
5
Table II - Changes in Interest Margin Attributable to Rate and Volume
Dollars in thousands
2002 Versus 2001 2001 Versus 2000
------------------------------ ------------------------------
Increase (Decrease) Increase (Decrease)
Due to Change in: Due to Change in:
------------------------------ ------------------------------
Volume Rate Net Volume Rate Net
------------------------------ ------------------------------
Interest earned on:
Loans
Taxable $ 5,956 $(2,922) $ 3,034 $ 4,484 $ (522) $ 3,962
Tax-exempt 266 (57) 209 104 (45) 59
Securities
Taxable 351 (1,408) (1,057) 1,651 (238) 1,413
Tax-exempt 1,210 (23) 1,187 401 (62) 339
Federal funds sold and interest
bearing deposits with other banks (50) (59) (109) 132 (161) (29)
------------------------------ ------------------------------
Total interest earned on
interest earning assets 7,733 (4,469) 3,264 6,772 (1,028) 5,744
------------------------------ ------------------------------
Interest paid on:
Interest bearing demand
deposits 395 (982) (587) 417 (555) (138)
Savings deposits 113 (456) (343) 9 (210) (201)
Time deposits 1,163 (3,435) (2,272) 1,962 (454) 1,508
Short-term borrowings 125 (251) (126) (1,728) (907) (2,635)
Long-term borrowings and
capital trust securities 2,155 (423) 1,732 3,651 (23) 3,628
------------------------------ ------------------------------
Total interest paid on
interest bearing liabilities 3,951 (5,547) (1,596) 4,311 (2,149) 2,162
------------------------------ ------------------------------
Net interest income $ 3,782 $ 1,078 $ 4,860 $ 2,461 $ 1,121 $ 3,582
============================== ==============================
Provision for Loan Losses
The provision for loan losses represents our 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, 2002, 2001 and 2000
totaled $1,215,000, $830,000 and $558,000, respectively. As further discussed in
the Loan Portfolio and Risk Elements sections of this analysis, we increased the
provision for loan losses $385,000 in 2002 and $272,000 in 2001 in order to keep
up with the continued growth of our loan portfolio. 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 $1,945,000, $1,810,000 and $1,228,000, or 0.31%,
0.34% and 0.28% of average assets, in 2002, 2001, and 2000, respectively.
Included in noninterest income for 2002 is losses on securities of $140,000 and
also $357,000 in mortgage origination revenue. Included in noninterest income
for 2001 is $379,000 securities gain. Further detail regarding noninterest
income follows in Table III.
Noninterest Expense
Noninterest expense totaled $12,606,000, $10,737,000 and $9,865,000 or
2.01%, 2.04% and 2.28% of average assets for each of the years ended December
31, 2002, 2001 and 2000, respectively. Total noninterest expense increased
$1,869,000 in 2002 compared to 2001 and $872,000 in 2001 compared to 2000. The
primary factor contributing to growth in noninterest expense in both 2002 and
2001 was an increase in salaries and employee benefits expense as a result of
general merit raises, and the addition of new staff positions required as a
result of our growth. Further detail regarding noninterest expense follows in
Table III.
6
Table III - Noninterest Income and Expense
Dollars in thousands
2002 2001 2000
---------------------------------
Noninterest income
Insurance commissions $ 187 $ 105 $ 110
Service fees 1,341 1,055 876
Mortgage origination revenue 357 73 -
Securities gains (losses) (140) 379 2
Gain on sale of branch bank - - 225
Other 200 198 15
---------------------------------
Total $ 1,945 $ 1,810 $ 1,228
=================================
Noninterest expense
Salaries and employee benefits $ 6,864 $ 5,670 $ 4,863
Net occupancy expense 784 706 628
Equipment expense 1,248 1,171 974
Supplies 475 330 303
Advertising expenses 369 278 229
Professional fees 434 454 447
Amortization of intangibles 151 282 298
Other 2,282 1,846 2,123
---------------------------------
Total $ 12,607 $ 10,737 $ 9,865
=================================
Income Tax Expense
Income tax expense for the three years ended December 31, 2002, 2001 and
2000 totaled $2,732,000, $2,457,000 and $1,543,000, respectively. Refer to Note
12 of the accompanying consolidated financial statements for further information
and additional discussion of the significant components influencing our
effective income tax rates.
CHANGES IN FINANCIAL POSITION
Total average assets in 2002 were $628,544,000, an increase of 19.9% over
2001's average of $524,242,000. Similarly, average assets grew 21.1% in 2001,
from $432,893,000 in 2000. The primary growth in 2002 was in loans throughout
our company during the year. Significant changes in the components of our
balance sheet in 2002 and 2001 are discussed below.
Securities
Securities comprised approximately 31.6% of total assets at December 31,
2002 compared to 35.0% at December 31, 2001. Average securities approximated
$204,696,000 for 2002 or 12.0% more than 2001's average of $182,829,000. The
growth in our securities portfolio in 2002 reflects increased investments
primarily in tax-exempt municipals and corporate debt securities, which were
funded principally by increased deposits, primarily at Shenandoah. 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.
All of our securities are classified as available for sale to provide us
with flexibility to better manage our balance sheet structure and react to
asset/liability management issues as they arise. Pursuant to SFAS No. 115,
anytime that we carry a bond with an unrealized loss that has been determined to
be "other than temporary", we must recognize that loss in income. Due to a
decrease in the credit rating of one of our corporate bonds during 2002, we
recognized a $213,000 write down on that security, as we felt that the loss was
other than temporary. At December 31, 2002, we 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, 2002, 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.
7
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
---------------------------------------------------------------------------------------------------
U. S. Government agencies
and corporations $ 3,655 5.3% $ 20,748 5.6% $ 8,296 6.6% $ - 0.0%
Mortgage backed securities 57,355 4.9% 30,586 5.3% 2,336 6.4% 3,745 7.1%
State and political
subdivisions 1,638 5.6% 6,947 5.0% 5,765 5.2% 25,104 5.1%
Corporate debt securities 6,024 7.1% 21,347 5.7% 347 4.5% 245 9.9%
Other - - - - - - 13,297 3.6%
-------- -------- -------- --------
Total $ 68,672 5.1% $ 79,628 5.4% $ 16,744 6.3% $ 42,391 4.8%
======== ======== ======== ========
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
2002 2001 2000 1999 1998
---------------- ----------------- ---------------- ----------------- ----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
---------------- ----------------- ---------------- ---------------- ----------------
Commercial, financial,
and agricultural $206,567 49.4% $148,041 42.8% $108,114 39.4% $ 78,894 33.1% $ 54,359 27.8%
Real estate - construction 4,494 1.1% 2,394 0.7% 2,729 1.0% 2,012 0.8% 1,801 0.9%
Real estate - mortgage 161,006 38.5% 149,050 43.1% 124,326 45.3% 116,779 49.0% 101,014 51.7%
Consumer 39,841 9.5% 40,777 11.8% 36,983 13.5% 38,091 16.0% 36,197 18.5%
Other 6,390 1.5% 5,750 1.6% 2,001 0.8% 2,524 1.1% 1,906 1.1%
---------------- ---------------- --------------- ---------------- ----------------
Total loans $418,298 100.0% $346,012 100.0% $274,153 100.0% $238,300 100.0% $195,277 100.0%
================ ================ ================ ================ ================
Total net loans averaged $383,013,000 in 2002 and comprised 60.9% of total
average assets compared to $304,231,000 or 58.0% of total average assets during
2001. The increase in the dollar volume of loans is primarily attributable to
continuation of our 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
our loan maturities and a discussion of our adjustable rate loans as of December
31, 2002.
In the normal course of business, we make various commitments and incur
certain contingent liabilities, which are disclosed in Note 14 of the
accompanying consolidated financial statements but not reflected in the
accompanying consolidated financial statements. There have been no significant
changes in these types of commitments and contingent liabilities and we do not
anticipate any material losses as a result of these commitments.
8
Property Held for Sale
At December 31, 2002, we had $1,859,650 classified as property held for
sale. This primarily consists of the land and building associated with two of
our facilities that we plan to sell during 2003. See Note 7 of the accompanying
consolidated financial statements for more details. SFAS No. 144 requires that
we record this property at the lower of carrying value or estimated fair value.
Our anticipated sale prices of these properties is slightly greater than our
carrying value, thus no impairment charges have been recorded.
Deposits
Total deposits at December 31, 2002 increased $62,443,000 or 15.8% compared
to December 31, 2001. Average deposits increased $47,804,000, or 14.1% during
2002. This increase resulted primarily from the growth of Shenandoah's deposits.
See Table I for average deposit balance and rate information by deposit
type for 2002, 2001 and 2000 and Note 10 of the accompanying consolidated
financial statements for a maturity distribution of time deposits as of December
31, 2002.
Borrowings
Lines of Credit: We have available lines of credit from various
correspondent banks totaling $15,100,000 at December 31, 2002. These lines are
utilized when temporary day to day funding needs arise. They are reflected on
the consolidated balance sheet as short-term borrowings. We also have remaining
available lines of credit from the Federal Home Loan Bank totaling $67,225,000
at December 31, 2002. We use 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 $3,842,000
from $24,033,000 at December 31, 2001 to $20,191,000 at December 31, 2002. See
Note 11 of the accompanying consolidated financial statements for additional
disclosures regarding our short-term borrowings.
Long-term Borrowings: Total long-term borrowings of $133,787,000 at
December 31, 2002, consisting primarily of funds borrowed on available lines of
credit from the Federal Home Loan Bank, increased $10,342,000 compared to the
$123,445,000 outstanding at December 31, 2001. These borrowings were made
principally to fund our loan growth. Refer to Note 11 of the accompanying
consolidated financial statements for additional information regarding our
long-term borrowings.
Capital Trust Securities
In October 2002, we issued $3,500,000 in capital trust securities (see Note
15 of the accompanying consolidated financial statements for further information
regarding the structure and terms of these securities), which under regulatory
capital requirements qualify, within certain limitations, as Tier I capital.
Accordingly, these securities were issued to boost our capital to support our
growth in 2002, principally at Shenandoah.
ASSET QUALITY
Table VI presents a summary of non-performing assets at December 31, as
follows:
Table VI - Nonperforming Assets
Dollars in thousands
2002 2001 2000 1999 1998
-------------------------------------------------------------
Nonaccrual loans $ 917 $ 788 $ 568 $ 522 $ 783
Accruing loans past due
90 days or more 574 328 267 476 431
Restructured loans - - - - -
--------------------------------------------------------
Total nonperforming loans $ 1,491 $ 1,116 $ 835 $ 998 $ 1,214
========================================================
Foreclosed properties 81 81 - - -
Nonaccrual securities 421 - - - -
--------------------------------------------------------
Total nonperforming assets $ 1,993 $ 1,197 $ 835 $ 998 $ 1,214
========================================================
Total nonperforming loans
as a percentage of total loans 0.4% 0.3% 0.3% 0.4% 0.6%
========================================================
Total nonperforming assets
as a percentage of total assets 0.3% 0.2% 0.2% 0.3% 0.4%
========================================================
9
As illustrated in Table VI, the quality of our loan portfolio remains
sound. Despite an increase in total nonaccrual loans and accruing loans past due
90 days or more from $1,116,000 at December 31, 2001 to $1,491,000 at December
31, 2002, nonperforming loans remain at historically moderate levels in relation
to the loan portfolio's size and substantially below recent industry averages.
Refer to Note 6 of the accompanying consolidated financial statements for a
discussion of impaired loans which are included in the above balances.
Included in the net balance of loans are non-accrual loans amounting to
$917,000 and $788,000 at December 31, 2002 and 2001, respectively. If these
loans had been on accrual status throughout 2002, the amount of interest income
that we would have recognized would have been $77,000. The actual amount of
interest income recognized in 2002 on these loans was $20,000.
We maintain an allowance for loan losses at a level considered adequate to
provide for losses that can be reasonably anticipated. We conduct quarterly
evaluations of our 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, we
conduct comprehensive, ongoing reviews of our loan portfolio, which encompasses
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,
we review 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, we consider them to be insignificant to
the overall disclosure and are, therefore, not specifically quantified within
this discussion. In addition, we feel these additional loans do not represent or
result from trends or uncertainties which we reasonably expect will materially
impact future operating results, liquidity or capital resources. Also, these
loans do not represent material credits about which we are aware of any
information which would cause the borrowers to not comply with the loan
repayment terms.
We allocate specific reserves to non-performing loans based on the
quarterly evaluation of expected loan loss reserve requirements. 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.
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 we
utilize 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 we operate. At December 31, 2002 and
2001, respectively, the unallocated portion of the allowance approximated
$62,000 and $152,000, or 1.5% and 4.9% 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 our
assessment of the economic environment in which we operate. More specifically,
while loan quality remains good, the subsidiary banks have typically experienced
greater losses within certain homogeneous loan pools when our 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, 2002 and 2001, our allowance for loan losses totaled
$4,053,000, or 0.97% of total loans and $3,110,000 or 0.89% of total loans,
respectively, and is considered adequate to cover inherent losses in our loan
portfolio. Table VII presents an allocation of the allowance for loan losses by
loan type at each respective year end date, as follows:
10
Table VII - Allocation of the Allowance for Loan Losses
Dollars in thousands
2002 2001 2000 1999 1998
------------------ ------------------ ----------------- ------------------ -----------------
% 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 $ 2,054 49.4% $ 1,036 42.8% $ 1,037 39.4% $ 951 33.1% $ 861 27.8%
Real estate 939 39.6% 985 43.8% 127 46.3% 383 49.8% 366 52.6%
Installment 998 9.5% 937 11.8% 1,313 13.5% 806 16.0% 800 18.5%
Other - 1.5% - 1.6% - 0.8% - 1.1% - 1.1%
Unallocated 62 - 152 - 94 - 92 - 86 -
----------------- ----------------- ----------------- ----------------- ------- ---------
$ 4,053 100.0% $ 3,110 100.0% $ 2,571 100.0% $ 2,232 100.0% $ 2,113 100.0%
================= ================= ================= ================= =================
At December 31, 2002, we had approximately $81,000 in other real estate
owned which was obtained as the result of foreclosure proceedings. Foreclosures
have been insignificant throughout 2002 and we do not anticipate any material
losses on the property currently held in other real estate owned.
A reconciliation of the activity in the allowance for loan losses follows:
Table VIII - Allowance for Loan Losses
Dollars in thousands
2002 2001 2000 1999 1998
--------------------------------------------------------
Balance, beginning of year $ 3,110 $ 2,571 $ 2,232 $ 2,113 $ 1,489
Losses:
Commercial financial & agriculture 138 108 - 165 183
Real estate - mortgage 30 47 63 32 1
Consumer 173 191 175 144 204
Other 75 76 49 37 25
--------------------------------------------------------
Total 416 422 287 378 413
--------------------------------------------------------
Recoveries:
Commercial financial & agriculture 39 10 2 40 3
Real estate - mortgage 17 1 2 10 22
Consumer 71 99 53 71 118
Other 17 21 11 6 7
--------------------------------------------------------
Total 144 131 68 127 150
--------------------------------------------------------
Net losses 272 291 219 251 263
--------------------------------------------------------
Allowance of purchased subsidiary - - - - 272
Provision for loan losses 1,215 830 558 370 615
--------------------------------------------------------
Balance, end of year $ 4,053 $ 3,110 $ 2,571 $ 2,232 $ 2,113
========================================================
11
LIQUIDITY
Liquidity reflects our 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, which totaled approximately $116 million or 17% of total consolidated
assets at December 31, 2002.
We continuously monitor our liquidity position to ensure that day-to-day as
well as anticipated funding needs are met. We are not aware of any trends,
commitments, events or uncertainties that have resulted in or are reasonably
likely to result in a material change to our 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 our 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 our actions in
this regard are taken under the guidance of our Asset/Liability Management
Committee ("ALCO"). The ALCO is comprised of members of senior management and
members of the Board of Directors. The ALCO actively formulates the economic
assumptions that we use in our financial planning and budgeting process and
establishes policies which control and monitor our sources, uses and prices of
funds.
Some amount of interest rate risk is inherent and appropriate to the
banking business. Our net income is affected by changes in the absolute level of
interest rates. Our 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. Also, net income would decrease 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 our earnings due to the compression of earning asset yields and
funding rates, while a steepening would result in increased earnings as margins
widen.
Several techniques are available to monitor and control the level of
interest rate risk. We primarily use 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, 2002, our earnings simulation model projects net
interest income would decrease by approximately 1.3% if rates rise evenly by 200
basis points over the next year, as compared to projected stable rate net
interest income. Also, the model projects that if rates fall evenly by 200 basis
points over the next year, our net interest income would decrease by
approximately 0.4%, as compared to projected stable rate net interest income.
These projected changes are well within our ALCO policy limit of +/- 10%.
CONTRACTUAL CASH OBLIGATIONS
During our normal course of business, we incur contractual cash
obligations. The following table summarizes our contractual cash obligations at
December 31, 2002.
Long Capital
Term Trust
Debt Securities
- -------------------------------------------------------
2003 $ 4,935,414 $ -
2004 18,901,198 -
2005 8,000,038 -
2006 7,807,554 -
2007 3,860,365 -
Thereafter 90,282,451 3,500,000
- -------------------------------------------------------
Total $ 133,787,020 $ 3,500,000
=======================================================
OFF-BALANCE SHEET ARRANGEMENTS
We are involved with some off-balance sheet arrangements that have or are
reasonably likely to have an effect on our financial condition, liquidity, or
capital. These arrangements at December 31, 2002 are presented in the following
table.
December 31,
- ----------------------------------------------
2002
- ----------------------------------------------
Commitments to extend credit:
Revolving home equity and
credit card lines $ 15,025,781
Construction loans 24,144,256
Other loans 17,499,115
Standby letters of credit 2,475,000
- ----------------------------------------------
Total $ 59,144,152
=============================================
12
CAPITAL RESOURCES
Our capital position remains strong, despite our continued growth. Stated
as a percentage of total assets, our equity ratio was 7.8% and 7.5% at December
31, 2002 and 2001, respectively. Our risk weighted tier I capital, total capital
and leverage capital ratios approximated 10.8%, 11.7% and 7.4%, respectively, at
December 31, 2002, all of which are in excess of the minimum guidelines to be
"well capitalized" under the regulatory prompt corrective action provisions. Our
subsidiary banks are also subject to minimum capital ratios as further discussed
in Note 16 of the accompanying consolidated financial statements.
Cash dividends per share rose 7.14% to $0.75 in 2002 compared to $0.70 in
2001, representing dividend payout ratios of 18.2% and 23.3% for 2002 and 2001,
respectively. It is our intention to continue to pay dividends on a similar
schedule during 2003. Future cash dividends will depend on the earnings and
financial condition of our subsidiary banks as well as general economic
conditions.
The primary source of funds for the dividends paid to our shareholders is
dividends received from our subsidiary banks. Dividends paid by our subsidiary
banks are subject to restrictions by banking regulations. The most restrictive
provision requires approval by the respective bank's regulatory agency if
dividends declared in any year exceed the bank's current year's net income, as
defined, plus its retained net profits of the two preceding years. During 2003,
the net retained profits available for distribution to Summit as dividends
without regulatory approval are approximately $8,802,000, plus net income for
the interim periods through the date of declaration.
On February 21, 2003, our Board of Directors authorized a 2-for-1 split of
our common stock to be effected in the form of a 100% stock dividend which was
distributed on March 14, 2003 to shareholders of record as of March 3, 2003.
13
QUARTERLY FINANCIAL INFORMATION
- ------------------------------------------------------------------------------------------------------------
First Second Third Fourth Full
(Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Year
- ------------------------------------------------------------------------------------------------------------
2002
Interest income $ 9,835 $ 10,043 $ 10,345 $ 10,466 $ 40,689
Interest expense 4,655 4,690 4,803 4,694 18,842
Net interest income 5,180 5,353 5,542 5,772 21,847
Provision for loan losses 293 307 307 308 1,215
Securities gains (losses) 53 12 9 (214) (140)
Other noninterest income 309 563 592 621 2,085
Noninterest expense 2,977 3,288 3,115 3,227 12,607
Income before income taxes 2,272 2,333 2,721 2,644 9,970
Income taxes 641 693 798 600 2,732
Net income 1,631 1,640 1,923 2,044 7,238
Basic earnings per share 0.93 0.93 1.10 1.17 4.13
Diluted earnings per share 0.92 0.93 1.09 1.16 4.11
Dividends paid per share - 0.37 - 0.38 0.75
2001
Interest income $ 9,126 $ 9,380 $ 9,636 $ 9,777 $ 37,919
Interest expense 5,304 5,200 5,115 4,819 20,438
Net interest income 3,822 4,180 4,521 4,958 17,481
Provision for loan losses 145 180 228 277 830
Securities gains (losses) 84 93 204 (2) 379
Other noninterest income 281 305 356 489 1,431
Noninterest expense 2,521 2,764 2,742 2,710 10,737
Income before income taxes 1,521 1,634 2,111 2,458 7,724
Income taxes 512 435 673 1,112 2,732
Net income 1,009 1,199 1,438 1,620 5,266
Basic earnings per share 0.57 0.68 0.82 0.92 3.00
Diluted earnings per share 0.57 0.68 0.82 0.92 3.00
Dividends paid per share - 0.35 - 0.35 0.70
14
REPORT OF INDEPENDENT AUDITORS
[ARNETT & FOSTER, P.L.L.C. 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, 2002 and 2001, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Summit
Financial Group, Inc. and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Arnett & Foster, P.L.L.C.
Charleston, West Virginia
January 29, 2003
15
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
December 31,
- --------------------------------------------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 11,470,311 $ 11,776,231
Interest bearing deposits with other banks 2,185,369 2,261,826
Federal funds sold 3,390,135 1,848,129
Securities available for sale 212,597,975 206,967,097
Securities held to maturity - 150,280
Loans held for sale 906,900 1,513,400
Loans, net 414,245,082 342,902,029
Property held for sale, net 1,859,650 81,000
Premises and equipment, net 11,199,037 12,911,507
Accrued interest receivable 4,025,167 3,874,002
Intangible assets 3,201,128 3,352,281
Other assets 6,703,636 4,118,975
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 671,784,390 $ 591,756,757
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest bearing $ 46,312,596 $ 38,685,688
Interest bearing 412,334,977 357,519,290
- --------------------------------------------------------------------------------------------------------------------
Total deposits 458,647,573 396,204,978
- --------------------------------------------------------------------------------------------------------------------
Short-term borrowings 20,191,103 24,032,790
Long-term borrowings 133,787,020 123,444,531
Company-obligated mandatorily redeemable capital securities of subsidiary
trust holding solely subordinated debentures of the Company 3,500,000 -
Other liabilities 3,578,898 3,787,111
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 619,704,594 547,469,410
- --------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies
Shareholders' Equity
Preferred stock, $1.00 par value; authorized
250,000 shares; no shares issued - -
Common stock, $2.50 par value; authorized 5,000,000;
issued 2002 - 1,780,830 shares; 2001 - 1,780,780 shares 4,452,075 4,451,950
Capital surplus 8,257,966 8,256,901
Retained earnings 36,726,583 30,803,543
Less cost of shares acquired for the treasury
2002 - 28,970 shares; 2001 - 26,470 shares (619,711) (532,479)
Accumulated other comprehensive income 3,262,883 1,307,432
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 52,079,796 44,287,347
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 671,784,390 $ 591,756,757
====================================================================================================================
See notes to consolidated financial statements
16
Consolidated Statements of Income
For the Year Ended December 31,
- --------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
Interest income
Interest and fees on loans
Taxable $ 28,626,505 $ 25,592,985 $ 21,630,083
Tax-exempt 348,840 210,744 172,714
Interest and dividends on securities
Taxable 9,840,024 10,896,837 9,484,352
Tax-exempt 1,724,616 961,270 690,674
Interest on interest bearing deposits with other banks 92,417 22,983 68,748
Interest on Federal Funds sold 56,495 234,342 216,944
- --------------------------------------------------------------------------------------------------------------------------
Total interest income 40,688,897 37,919,161 32,263,515
- --------------------------------------------------------------------------------------------------------------------------
Interest expense
Interest on deposits 11,563,915 14,765,031 13,596,688
Interest on short-term borrowings 326,650 452,340 3,087,018
Interest on long-term borrowings and capital trust securities 6,951,485 5,220,402 1,592,352
- --------------------------------------------------------------------------------------------------------------------------
Total interest expense 18,842,050 20,437,773 18,276,058
- --------------------------------------------------------------------------------------------------------------------------
Net interest income 21,846,847 17,481,388 13,987,457
Provision for loan losses 1,215,000 830,000 557,500
- --------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 20,631,847 16,651,388 13,429,957
- --------------------------------------------------------------------------------------------------------------------------
Noninterest income
Insurance commissions 186,888 105,179 109,802
Service fees 1,340,542 1,054,799 875,964
Mortgage origination revenue 357,486 72,783 -
Securities gains (losses) (140,308) 379,048 2,364
Gain on sale of branch bank - - 224,629
Other 200,410 197,741 15,568
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,945,018 1,809,550 1,228,327
- --------------------------------------------------------------------------------------------------------------------------
Noninterest expenses
Salaries and employee benefits 6,863,690 5,670,072 4,863,257
Net occupancy expense 783,705 706,346 627,834
Equipment expense 1,247,593 1,170,491 974,474
Supplies 474,666 329,813 302,652
Professional fees 434,074 454,393 447,389
Amortization of intangibles 151,152 282,192 297,683
Other 2,651,557 2,124,034 2,351,693
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 12,606,437 10,737,341 9,864,982
- --------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 9,970,428 7,723,597 4,793,302
Income tax expense 2,732,130 2,457,135 1,543,383
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 7,238,298 $ 5,266,462 $ 3,249,919
=========================================================================================================================
Basic earnings per common share $ 4.13 $ 3.00 $ 1.85
=========================================================================================================================
Diluted earnings per common share $ 4.11 $ 3.00 $ 1.85
=========================================================================================================================
Average common shares outstanding
Basic 1,753,982 1,754,449 1,760,845
=========================================================================================================================
Diluted 1,763,040 1,755,142 1,760,845
=========================================================================================================================
See notes to consolidated financial statements
17
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 2002, 2001 and 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Capital Retained Treasury Comprehensive Shareholders'
Stock Surplus Earnings Stock Income Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $ 4,452,265 $ 8,307,702 $ 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 7,440 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 ($0.60 per share) - - (1,054,996) - - (1,054,996)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 4,451,950 8,256,901 26,765,097 (517,725) 816,978 39,773,201
Comprehensive income:
Net income - - 5,266,462 - - 5,266,462
Other comprehensive income,
net of deferred taxes of $300,601:
Net unrealized gain on
securities of $725,464, net
of reclassification adjustment
for gains included in net
income of $235,010 - - - - 490,454 490,454
----------
Total comprehensive income - - - - 5,756,916
Cost of 800 shares acquired
for the treasury - - - (14,754) - (14,754)
Cash dividends declared ($0.70 per share) - - (1,228,016) - - (1,228,016)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 4,451,950 8,256,901 30,803,543 (532,479) 1,307,432 44,287,347
Comprehensive income:
Net income - - 7,238,298 - - 7,238,298
Other comprehensive income,
net of deferred taxes of $1,198,502:
Net unrealized gain on
securities of $1,868,460, net
of reclassification adjustment
for (losses) included in net
income of ($86,991) - - - - 1,955,451 1,955,451
----------
Total comprehensive income - - - - - 9,193,749
Exercise of stock options 125 1,065 - - - 1,190
Cost of 2,500 shares acquired
for the treasury - - - (87,232) - (87,232)
Cash dividends declared ($0.75 per share) - - (1,315,258) - - (1,315,258)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $ 4,452,075 $ 8,257,966 $ 36,726,583 $ (619,711) $ 3,262,883 $ 52,079,796
====================================================================================================================================
See notes to consolidated financial statements
18
Consolidated Statements of Cash Flows
For the Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,238,298 $ 5,266,462 $ 3,249,919
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation 1,026,485 899,554 731,073
Provision for loan losses 1,215,000 830,000 557,500
Deferred income tax expense (benefit) (779,570) (277,540) (107,377)
Loans originated for sale (19,446,545) - -
Proceeds from loans sold 20,053,045 - -
Security (gains) losses 140,308 (379,048) (2,364)
(Gain) loss on disposal of premises, equipment and other assets 8,770 91,695 18,212
(Gain) loss on sale of branch - - (224,629)
Amortization of securities premiums (accretion
of discounts), net 389,007 (291,338) (97,821)
Amortization of goodwill and purchase
accounting adjustments, net 174,330 284,901 215,982
(Increase) decrease in accrued interest receivable (151,165) (113,301) (1,350,002)
(Increase) decrease in other assets (267,021) (38,028) 42,409
Increase (decrease) in other liabilities (455,917) 786,508 530,716
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 9,145,025 7,059,865 3,563,618
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities and calls of
securities held to maturity 150,000 250,000 140,000
Principal payments received on
securities held to maturity - - 254,281
Proceeds from maturities and calls of
securities available for sale 14,386,000 56,133,634 2,930,109
Proceeds from sales of
securities available for sale 26,934,632 40,206,987 11,506,633
Principal payments received on
securities available for sale 50,602,473 26,554,708 4,670,845
Purchases of securities available for sale (94,970,210) (154,138,998) (75,662,408)
Net (increase) decrease in federal funds sold (1,542,006) (37,129) 1,034,216
Net loans made to customers (72,627,710) (73,781,647) (42,357,660)
Purchases of premises and equipment (1,124,723) (1,705,880) (4,204,622)
Proceeds from sales of premises, equipment and other assets 60,700 134,239 206,804
(Purchases of) proceeds from interest bearing deposits with other banks 76,457 (1,788,826) 5,327,987
Purchases of life insurance contracts (2,250,000) (74,200) (1,000,000)
Net cash acquired/paid in acquisitions (divestitures) - - (820,679)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) investing activities (80,304,387) (108,247,112) (97,974,494)
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposit,
NOW and savings accounts 28,835,408 27,161,535 7,242,600
Net increase in time deposits 33,753,264 22,952,264 49,055,716
Net increase (decrease) in short-term borrowings (3,841,687) 14,641,976 (22,957,216)
Proceeds from long-term borrowings 26,590,000 42,738,000 70,000,000
Repayments of long-term borrowings (16,461,443) (379,398) (6,856,611)
Net proceeds from issuance of trust preferred securities 3,379,200 - -
Purchases of treasury stock (87,232) (14,754) (133,001)
Exercise of stock options 1,190 - -
Dividends paid (1,315,258) (1,228,016) (1,054,996)
Purchase of fractional shares - - (4,846)
Payment to dissenting shareholders - - (799,095)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 70,853,442 105,871,607 94,492,551
- ------------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and due from banks (305,920) 4,684,360 81,675
Cash and due from banks:
Beginning 11,776,231 7,091,871 7,010,196
- ------------------------------------------------------------------------------------------------------------------------------------
Ending $ 11,470,311 $ 11,776,231 $ 7,091,871
====================================================================================================================================
See notes to consolidated financial statements
19
Consolidated Statements of Cash Flows-continued
For the Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash payments for:
Interest $ 18,863,103 $ 20,699,231 $ 17,465,019
====================================================================================================================================
Income taxes $ 3,245,289 $ 2,442,000 $ 1,671,210
====================================================================================================================================
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Other assets acquired in settlement of loans $ 63,675 $ 127,870 $ 111,350
====================================================================================================================================
Sales (purchases) of securities pending settlement, net $ - $ - $ (2,026,074)
====================================================================================================================================
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
- ------------------------------------------------------------------------------------------------------------------------------------
$ - $ - $ -
====================================================================================================================================
See notes to consolidated financial statements
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Nature of business: Summit Financial Group, Inc. ("We", "Summit" or
"Company") is a bank holding company with operations in Hardy, Grant, Pendleton,
Kanawha and Greenbrier Counties of West Virginia and in Frederick, Loudoun and
Rockingham Counties of Virginia. Through our three wholly owned bank
subsidiaries, we provide loan and deposit services primarily to individuals and
small businesses.
Basis of financial statement presentation: Our accounting and reporting
policies conform to accounting principles generally accepted in the United
States of America and to general practices within the banking industry.
Use of estimates: We must make estimates and assumptions that affect the
reported amounts and disclosures in preparing our financial statements in
conformity with accounting principles generally accepted in the United States of
America. Actual results could differ from those estimates.
Principles of consolidation: The accompanying consolidated financial
statements include the accounts of Summit and its subsidiaries, Summit Community
Bank, Capital State Bank, Inc., Shenandoah Valley National Bank and SFG Capital
Trust I. 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: We classify debt and equity securities 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 we have 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 that we intend 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 generally stated at the
amount of unpaid principal, reduced by unearned discount and allowance for loan
losses. Loans held for sale are valued at the lower of aggregate carrying cost
or fair value.
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. Our 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 we believe that collectibility is unlikely. While
we use the best information available to make our 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 we 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.
Generally, after our 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.
21
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.
Property held for sale: Property held for sale consists of premises
qualifying as held for sale under Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, and of
real estate acquired through foreclosure on loans secured by such real estate.
Qualifying premises are transferred to property held for sale at the lower of
carrying value or estimated fair value less anticipated selling costs.
Foreclosed property is recorded at the estimated fair value less anticipated
selling costs based upon the property's appraised value at the date of
foreclosure, with any difference between the fair value of foreclosed property
and the carrying value of the related loan charged to the allowance for loan
losses. We perform periodic valuations of property held for sale subsequent to
transfer. Gains or losses not previously recognized resulting from the sale of
property held for sale is recognized on the date of sale. Changes in value
subsequent to transfer are recorded in noninterest income. Depreciation is not
recorded on property held for sale. Expenses incurred in connection with
operating foreclosed properties are charged to noninterest expense.
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 2000 was approximately
$38,000. No interest was capitalized during 2001 or 2002.
Intangible assets: In June 2001, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets ("SFAS 142"), which addresses the accounting and
reporting for acquired goodwill and other intangible assets. Under the
provisions of SFAS 142, goodwill and certain other intangible assets with
indefinite useful lives are no longer amortized into net income over an
estimated life, but rather are tested at least annually for impairment based on
specific guidance provided in the new standard. However, SFAS 142 did not
supersede Statement of Financial Accounting Standards No. 72, Accounting for
Certain Acquisitions of Banking or Thrift Institutions ("SFAS 72"), and
therefore, any goodwill accounted for in accordance with SFAS 72 will continue
to be amortized. SFAS 142 also requires that intangible assets determined to
have definite useful lives be amortized over their estimated useful lives and
also be subject to impairment testing.
In October 2002, the FASB issued Statement of Financial Accounting
Standards No. 147, Acquisitions of Certain Financial Institutions ("SFAS 147").
SFAS 147 removes acquisitions of financial institutions from the scope of SFAS
72 and requires that these transactions be accounted for in accordance with FASB
Statement No. 141, Business Combinations, and SFAS 142. In addition, SFAS 147
clarifies that the acquisition of a less-than-whole financial institution (e.g.
a branch acquisition) that meets the definition of a business should be
accounted for as a business combination, otherwise the transaction should be
accounted for as an acquisition of net assets that does not result in the
recognition of goodwill. SFAS 147 also amends FASB Statement No. 144, Accounting
for Impairment or Disposal of Long-Lived Assets, to include in its scope
long-term customer-relationship intangible assets of financial institutions such
as depositor- and borrower- relationship intangible assets. SFAS 147 was
effective on October 1, 2002 and has not materially impacted our financial
position or our results of operations.
Securities sold under agreements to repurchase: We generally account for
securities sold under agreements to repurchase as collateralized financing
transactions and record them at the amounts at which the securities were sold,
plus accrued interest. Securities, generally U.S. government and Federal agency
securities, pledged as collateral under these financing arrangements cannot be
sold or repledged by the secured party. The fair value of collateral provided is
continually monitored and additional collateral is provided as needed.
Advertising: We expense advertising costs as they are incurred.
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.
22
Stock-based compensation: In accordance with Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, we have
elected to follow Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for our
employee stock options.
Basic and diluted earnings per share: Basic earnings per share is computed
by dividing net income by the weighted-average number of shares of common stock
outstanding. 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 our
assets 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: We adopted Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Financial
Instruments and Hedging Activities, as amended by SFAS 138 (collectively SFAS
133) during the year ended December 31, 1999.
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.
Fair-value hedges - For transactions in which we are 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.
Cash-flow hedges - For transactions in which we are 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 2002, 2001, and 2000 we were 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.
Reclassifications: Certain accounts in the consolidated financial
statements for 2001 and 2000, as previously presented, have been reclassified to
conform to current year classifications.
NOTE 2. SIGNIFICANT NEW ACCOUNTING PRONOUNCEMENTS
Guarantees: In November 2002, the FASB issued FASB Interpretation No. 45
(FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. This interpretation
expands the disclosures to be made by a guarantor in its financial statements
about its obligations under certain guarantees and requires the guarantor to
recognize a liability for the fair value of an obligation assumed under a
guarantee. FIN 45 clarifies the requirements of SFAS 5, Accounting for
Contingencies, relating to guarantees. In general, FIN 45 applies to contracts
or indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, liability, or equity security of the guaranteed party.
Certain guarantee contracts are excluded from both the disclosure and
recognition requirements of this interpretation, including, among others,
guarantees relating to employee compensation, residual value guarantees under
capital lease arrangements, commercial letters of credit, loan commitments,
subordinated interests in an SPE, and guarantees of a company's own future
performance. Other guarantees are subject to the disclosure requirements of FIN
45 but not to the recognition provisions and include, among others, a guarantee
accounted for as a derivative instrument under SFAS 133, a parent's guarantee of
debt owed to a third party by its subsidiary or vice versa, and a guarantee
which is based on performance, not price.
23
The disclosure requirements of FIN 45 are effective for us as of December
31, 2002, and require disclosure of the nature of the guarantee, the maximum
potential amount of future payments that the guarantor could be required to make
under the guarantee, and the current amount of the liability, if any, for the
guarantor's obligations under the guarantee. The recognition requirements of FIN
45 are to be applied prospectively to guarantees issued or modified after
December 31, 2002. Significant guarantees that have been entered into by us are
disclosed in Note 14. We do not expect the requirements of FIN 45 to have a
material impact on results of operations, financial position, or liquidity.
Acquisitions of certain financial institutions: In October 2002, the FASB
issued SFAS 147, Acquisitions of Certain Financial Institutions, which provides
guidance on the accounting for the acquisition of a financial institution and
supersedes the specialized accounting guidance provided in SFAS 72, Accounting
for Certain Acquisitions of Banking or Thrift Institutions. SFAS 147 became
effective upon issuance and requires companies to cease amortization of
unidentified intangible assets associated with certain branch acquisitions and
reclassify these assets to goodwill. SFAS 147 also modifies SFAS 144 to include
in its scope long-term customer-relationship intangible assets and thus subject
those intangible assets to the same undiscounted cash flow recoverability test
and impairment loss recognition and measurement provisions required for other
long-lived assets.
Accounting for long-lived assets: SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, was issued in October 2001. It addresses how
and when to measure impairment on long-lived assets and how to account for
long-lived assets that an entity plans to dispose of either through sale,
abandonment, exchange, or distribution to owners. The statement's provisions
supersede SFAS 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of, which addressed asset impairment, and
certain provisions of APB Opinion 30 related to reporting the effects of the
disposal of a business segment and requires expected future operating losses
from discontinued operations to be recorded in the period in which the losses
are incurred rather than the measurement date. Under SFAS 144, more dispositions
may qualify for discontinued operations treatment in the income statements. The
provisions of SFAS 144 became effective for us on January 1, 2002, and did not
have a material impact on results of operations, financial position, or
liquidity.
Asset retirement obligations: In August 2001, the FASB issued SFAS 143,
Accounting for Asset Retirement Obligations. SFAS 143 requires an entity to
record a liability for an obligation associated with the retirement of an asset
at the time the liability is incurred by capitalizing the cost as part of the
carrying value of the related asset and depreciating it over the remaining
useful life of that asset. The standard is effective for us beginning January 1,
2003, and its adoption is not expected to have a material impact on results of
operations, financial position, or liquidity.
Goodwill and other intangible assets: On January 1, 2002, we adopted SFAS
142, Goodwill and Other Intangible Assets, which addresses the accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
Opinion 17, Intangible Assets. Notes 1 and 9 provide further detail on the
accounting for goodwill and intangible assets under the standard and the impact
of the adoption on the financial statements. The standard's adoption had no
impact on liquidity.
Note 3. CASH CONCENTRATION
At December 31, 2002 and 2001, we had concentrations totaling $10,490,628
and $8,349,385, respectively, with unaffiliated financial institutions. These
concentrations consisted 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.
note 4. SECURITIES
The amortized cost, unrealized gains and losses, and
estimated fair values of securities at December 31, 2002 and 2001, are
summarized as follows:
24
2002
- ---------------------------------------------------------------------------------------------------
Amortized Unrealized Estimated
--------------------
Cost Gains Losses Fair Value
- ---------------------------------------------------------------------------------------------------
Available for sale
Taxable:
U. S. Government agencies
and corporations $ 32,699,059 $ 1,121,860 $ - $ 33,820,919
Mortgage-backed securities 94,022,894 1,925,599 168,040 95,780,453
State and political subdivisions 5,450,901 94,315 - 5,545,216
Corporate debt securities 27,961,831 1,163,744 7,352 29,118,223
Federal Reserve Bank stock 397,000 - - 397,000
Federal Home Loan Bank stock 7,738,200 - - 7,738,200
Other equity securities 88,348 - - 88,348
- ---------------------------------------------------------------------------------------------------
Total taxable 168,358,233 4,305,518 175,392 172,488,359
- ---------------------------------------------------------------------------------------------------
Tax-exempt:
State and political subdivisions 34,003,131 1,166,600 101,629 35,068,102
Federal Reserve Bank stock 8,400 - - 8,400
Other equity securities 5,065,152 106,169 138,207 5,033,114
- ---------------------------------------------------------------------------------------------------
Total tax-exempt 39,076,683 1,272,769 239,836 40,109,616
- ---------------------------------------------------------------------------------------------------
Total $ 207,434,916 $ 5,578,287 $ 415,228 $ 212,597,975
===================================================================================================
2001
- ---------------------------------------------------------------------------------------------------
Amortized Unrealized Estimated
--------------------
Cost Gains Losses Fair Value
- ---------------------------------------------------------------------------------------------------
Available for sale
Taxable:
U. S. Government agencies
and corporations $ 36,987,640 $ 1,133,062 $ 37,477 $ 38,083,225
Mortgage-backed securities 103,002,225 999,540 801,923 103,199,842
State and political subdivisions 4,957,792 15,511 20,549 4,952,754
Corporate debt securities 21,690,167 1,028,726 31,948 22,686,945
Federal Reserve Bank stock 341,300 - - 341,300
Federal Home Loan Bank stock 6,946,800 - - 6,946,800
Other equity securities 306,625 - 53,280 253,345
- ---------------------------------------------------------------------------------------------------
Total taxable 174,232,549 3,176,839 945,177 176,464,211
- ---------------------------------------------------------------------------------------------------
Tax-exempt:
State and political subdivisions 25,857,242 279,303 445,895 25,690,650
Federal Reserve Bank stock 4,100 - - 4,100
Other equity securties 4,823,109 - 14,973 4,808,136
- ---------------------------------------------------------------------------------------------------
Total tax-exempt 30,684,451 279,303 460,868 30,502,886
- ---------------------------------------------------------------------------------------------------
Total available for sale $ 204,917,000 $ 3,456,142 $1,406,045 $206,967,097
===================================================================================================
Held to maturity
Tax exempt:
State and political subdivisions $ 150,280 $ 1,410 $ 157 $ 151,533
- ---------------------------------------------------------------------------------------------------
25
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 at par value.
Mortgage-backed 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 18 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, 2002, are summarized as follows:
Amortized Estimated
Cost Fair Value
- ----------------------------------------------------------------------
Due in one year or less $ 68,671,644 $ 69,333,452
Due from one to five years 79,628,129 82,762,131
Due from five to ten years 16,743,720 17,476,576
Due after ten years 29,094,323 29,760,754
Equity securities 13,297,100 13,265,062
- ----------------------------------------------------------------------
Total $ 207,434,916 $ 212,597,975
======================================================================
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
- ---------------------------------------------------------------------------------------------------------
2002
Securities available for sale $ 26,934,632 $ 14,386,000 $ 50,602,473 $ 319,235 $ 246,543
Securities held to maturity - 150,000 - - -
- ---------------------------------------------------------------------------------------------------------
$ 26,934,632 $ 14,536,000 $ 50,602,473 $ 319,235 $ 246,543
=========================================================================================================
2001
Securities available for sale $ 40,206,987 $ 56,133,634 $ 26,554,708 $ 459,653 80,605
Securities held to maturity - 250,000 - - -
- ---------------------------------------------------------------------------------------------------------
$ 40,206,987 $ 56,383,634 $ 26,554,708 $ 459,653 $ 80,605
=========================================================================================================
2000
Securities available for sale $ 11,506,633 $ 2,930,109 $ 4,670,845 $ 2,364 $ -
Securities held to maturity - 140,000 - - -
- ---------------------------------------------------------------------------------------------------------
$ 11,506,633 $ 3,070,109 $ 4,670,845 $ 2,364 $ -
=========================================================================================================
At December 31, 2002 and 2001, securities with estimated fair values of
$50,738,382 and $52,179,931, respectively, were pledged to secure public
deposits, and for other purposes required or permitted by law.
During 2002, due to a decrease in the credit rating of one of our
mortgage-backed securities, we realized a $213,000 write down of that security,
as this decline is deemed to be other than temporary.
NOTE 5. LOANS
Loans are summarized as follows:
2002 2001
- -------------------------------------------------------------------
Commercial $ 34,745,430 $ 26,464,421
Commercial real estate 171,822,280 121,576,437
Residential - construction 4,493,569 2,393,754
Residential - mortgage 161,005,744 149,050,426
Consumer 40,655,422 41,508,960
Other 6,389,812 5,750,048
- -------------------------------------------------------------------
Total loans 419,112,257 346,744,046
Less unearned income 814,044 731,769
- -------------------------------------------------------------------
Total loans net of unearned income 418,298,213 346,012,277
Less allowance for loan losses 4,053,131 3,110,248
- -------------------------------------------------------------------
Loans, net $414,245,082 $ 342,902,029
===================================================================
26
The following presents loan maturities at December 31, 2002.
After 1
Within but within After
1Year 5 Years 5 Years
- -----------------------------------------------------------------------
Commercial $ 14,046,246 $ 14,131,868 $ 6,567,316
Commercial real estate 22,666,145 20,095,307 129,060,828
Residential-construction 1,208,108 2,020,016 1,265,445
Residential-mortgage 7,504,130 7,562,629 145,938,985
Consumer 3,970,864 30,265,641 6,418,917
Other 425,482 2,603,021 3,361,309
- -----------------------------------------------------------------------
$ 49,820,975 $ 76,678,482 $ 292,612,800
=======================================================================
Loans due after one year with:
Variable rates $ 98,040,519
Fixed rates 271,250,763
---------------
$ 369,291,282
===============
Concentrations of credit risk: We grant 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 we strive to maintain a diverse loan portfolio, exposure to credit
losses can be adversely impacted by downturns in local economic and employment
conditions. Major employment within our market area is diverse, but primarily
includes government, health care, education, poultry and various professional,
financial and related service industries.
We evaluate the credit worthiness of each of our customers on a
case-by-case basis and the amount of collateral we obtain is based upon this
credit evaluation.
Loans to related parties: We have had, and may be expected to have in the
future, banking transactions in the ordinary course of business with our
directors, principal officers, their immediate families and affiliated companies
in which they are principal stockholders (commonly referred to as related
parties). These transactions have been, in our opinion, 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):
2002 2001
- -----------------------------------------------------------------
Balance, beginning $ 4,789,067 $ 3,200,585
Additions 3,273,101 2,644,408
Amounts collected (2,317,872) (1,055,926)
Other changes, net (23,178) -
- -----------------------------------------------------------------
Balance, ending $ 5,721,118 $ 4,789,067
=================================================================
NOTE 6. ALLOWANCE FOR LOAN
LOSSES
An analysis of the allowance for loan losses for the years ended December
31, 2002, 2001 and 2000 is as follows:
2002 2001 2000
- ----------------------------------------------------------------------------
Balance, beginning of year $ 3,110,248 $ 2,570,776 $ 2,231,555
Losses:
Commercial 105,650 38,624 -
Commercial real estate 31,500 69,233 -
Residential - mortgage 30,400 46,977 62,839
Consumer 173,430 190,804 174,719
Other 74,899 75,643 48,521
- ----------------------------------------------------------------------------
Total 415,879 421,281 286,079
- ----------------------------------------------------------------------------
Recoveries:
Commercial 39,251 2,672 1,136
Commercial real estate - 7,500 895
Residential - mortgage 16,489 728 1,603
Consumer 70,568 98,940 53,165
Other 17,454 20,913 11,001
- ----------------------------------------------------------------------------
Total 143,762 130,753 67,800
- ----------------------------------------------------------------------------
Net losses 272,117 290,528 218,279
Provision for loan losses 1,215,000 830,000 557,500
- ----------------------------------------------------------------------------
Balance, end of year $ 4,053,131 $ 3,110,248 $ 2,570,776
============================================================================
Our total recorded investment in impaired loans at December 31, 2002 and
2001 approximated $904,215 and $568,001, respectively. All impaired loans had a
related allowance for loan losses determined in accordance with accounting
principles generally accepted in the United States of America. That allowance
approximated $160,000 at December 31, 2002 and $50,000 at December 31, 2001. Our
average investment in such loans approximated $714,664, $579,884, and $1,010,355
for the years ended December 31, 2002, 2001, and 2000 respectively. Impaired
loans at December 31, 2002 and 2001 included loans that were collateral
dependent, for which the fair values of the loans' collateral were used to
measure impairment.
For purposes of evaluating impairment, we consider groups of
smaller-balance, homogeneous loans to include: mortgage loans secured by
residential property, other than those which significantly exceed our typical
residential mortgage loan amount (currently those in excess of $100,000); small
balance commercial loans (currently those less than $50,000); and consumer
loans, exclusive of those loans in excess of $50,000.
27
For the years ended December 31, 2002, 2001, and 2000, we recognized no
interest income on impaired loans after the date that the loans were deemed to
be impaired. Using a cash-basis method of accounting, we would have recognized
approximately the same amount of interest income on such loans.
NOTE 7. PROPERTY HELD FOR SALE
Property held for sale at December 31, 2002 and 2001 is as follows:
2002 2001
- ----------------------------------------------------------------------
Land $ 673,227 $ -
Buildings and improvements 1,818,455 -
Foreclosed property 81,000 81,000
- ----------------------------------------------------------------------
2,572,682 81,000
Less accumulated depreciation 713,032 -
- ----------------------------------------------------------------------
Total property held for sale $ 1,859,650 $ 81,000
======================================================================
We have signed a contract for the future sale of our primary branch
facility in Petersburg, West Virginia. We expect the sale to occur by the end of
2003. Our intent is to build a new facility in Petersburg during 2003. We also
intend to sell our corporate headquarters located in Moorefield, West Virginia
in early 2003. We also plan to construct new corporate headquarters in
Moorefield in 2003. Planning for the replacement facilities is ongoing, and the
exact cost has not yet been determined.
NOTE 8. PREMISES AND EQUIPMENT
The major categories of premises and equipment and accumulated depreciation
at December 31, 2002 and 2001, are summarized as follows:
2002 2001
- ------------------------------------------------------------------------
Land $ 2,060,736 $ 2,733,963
Buildings and improvements 7,930,317 9,321,401
Furniture and equipment 6,992,299 6,428,818
- ------------------------------------------------------------------------
16,983,352 18,484,182
Less accumulated depreciation 5,784,315 5,572,675
- ------------------------------------------------------------------------
Total premises and equipment $11,199,037 $ 12,911,507
========================================================================
Depreciation expense for the years ended December 31, 2002, 2001 and 2000
totaled $1,026,485, $899,554 and $731,073, respectively.
NOTE 9. INTANGIBLE ASSETS
We adopted the provisions of SFAS 142 as required effective January 1,
2002. During the second quarter of 2002, we performed the required transitional
impairment test of goodwill as of January 1, 2002, and did not record an
impairment loss as a result of this test. Due to no longer having to amortize
goodwill against earnings, our net income increased by approximately $131,000,
or $0.07 per diluted share in 2002.
The following presents our consolidated results of operations adjusted as
though the adoption of SFAS 142 occurred as of January 1, 2000.
Years Ended December 31,
2002 2001 2000
- -------------------------------------------------------------------------------
Reported net income $ 7,238,298 $ 5,266,462 $ 3,249,919
Add back goodwill amortization
net of applicable tax effect - 131,040 131,040
- -------------------------------------------------------------------------------
Adjusted net income $ 7,238,298 $ 5,397,502 $ 3,380,959
===============================================================================
Basic earnings per share
Reported net income $ 4.13 $ 3.00 $ 1.85
Add back goodwill amortization
net of applicable tax effect - 0.07 0.07
- -------------------------------------------------------------------------------
Adjusted net income $ 4.13 $ 3.07 $ 1.92
===============================================================================
Diluted earnings per share
Reported net income $ 4.11 $ 3.00 $ 1.85
Add back goodwill amortization
net of applicable tax effect - 0.07 0.07
- -------------------------------------------------------------------------------
Adjusted net income $ 4.11 $ 3.07 $ 1.92
===============================================================================
In addition, at December 31, 2002 and December 31, 2001, we had $1,713,098
and $1,864,251, respectively, in unamortized acquired intangible assets
consisting entirely of unidentifiable intangible assets recorded in accordance
with SFAS 72.
2002 2001
- --------------------------------------------------------------------
Unidentifiable intangible assets
Gross carrying amount $ 2,267,323 $ 2,267,323
Less: accumulated amortization 554,225 403,072
- --------------------------------------------------------------------
Net carrying amount $ 1,713,098 $ 1,864,251
Goodwill 1,488,030 1,488,030
- --------------------------------------------------------------------
Total intangible assets $ 3,201,128 $ 3,352,281
====================================================================
28
We recorded amortization expense of $151,152 for the year ended December
31, 2002 relative to our unidentifiable intangible assets. Annual amortization
is expected to be approximately $151,000 for each of the years ending 2003
through 2007.
NOTE 10. DEPOSITS
The following is a summary of interest bearing deposits by type as of
December 31, 2002 and 2001:
2002 2001
- -------------------------------------------------------------------
Demand deposits, interest bearing $ 99,752,155 $ 81,509,961
Savings deposits 46,732,252 43,765,947
Certificates of deposit 241,439,194 211,116,608
Individual Retirement Accounts 24,411,376 21,126,774
- -------------------------------------------------------------------
Total $ 412,334,977 $ 357,519,290
===================================================================
Time certificates of deposit and Individual Retirement Account's (IRA's) in
denominations of $100,000 or more totaled $70,304,610 and $56,924,692 at
December 31, 2002 and 2001, respectively. Interest paid on time certificates of
deposit and IRA's in denominations of $100,000 or more were $2,428,040,
$3,057,697 and $2,623,640 for the years ended December 31, 2002, 2001 and 2000,
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, 2002:
Amount Percent
- ---------------------------------------------------------
Three months or less $ 11,726,315 16.7%
Three through six months 9,805,631 13.9%
Six through twelve months 20,458,422 29.1%
Over twelve months 28,314,242 40.3%
- ---------------------------------------------------------
Total $ 70,304,610 100.0%
=========================================================
A summary of the scheduled maturities for all time deposits as of December
31, 2002, follows:
2003 $ 146,655,968
2004 77,935,085
2005 20,800,038
2006 4,944,468
2007 14,697,355
Thereafter 817,656
- -------------------------------------
Total $ 265,850,570
=====================================
At December 31, 2002, our deposits of related parties including directors,
executive officers, and their related interests approximated $14,090,867.
NOTE 11. BORROWED FUNDS
Federal Home Loan Bank borrowings: Our 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, certain commercial loans,
mortgage backed securities and securities of U. S. Government agencies and
corporations.
At December 31, 2002, our subsidiary banks had combined additional
borrowings availability of $67,225,000 from the FHLB. Short-term FHLB advances
are granted for terms of 1 to 365 days and bear interest at a fixed or variable
rate set at the time of the funding request.
Short-term borrowings: At December 31,2002, we had $15,100,000 borrowing
availability through credit lines and Federal funds purchased agreements. A
summary of short-term borrowings is presented below:
2002
- ------------------------------------------------------------------------------
Federal Funds
Short-term Purchased
FHLB Repurchase and Lines
Advances Agreements of Credit
- ------------------------------------------------------------------------------
Balance at December 31 $ 11,595,000 $ 8,596,103 $ -
Average balance outstanding
for the year 6,057,233 8,960,391 934,768
Maximum balance outstanding
at any month end 11,595,000 10,778,052 2,370,000
Weighted average interest
rate for the year 2.21% 1.71% 4.19%
Weighted average interest
rate for balances
outstanding at December 31 1.48% 1.57% -
2001
- ------------------------------------------------------------------------------
Federal Funds
Short-term Purchased
FHLB Repurchase and Lines
Advances Agreements of Credit
- ------------------------------------------------------------------------------
Balance at December 31 $ 14,778,200 $ 8,213,590 $ 1,041,000
Average balance outstanding
for the year 3,069,203 7,351,836 1,458,355
Maximum balance outstanding
at any month end 14,778,200 9,080,068 4,298,000
Weighted average interest
rate for the year 4.42% 3.30% 5.10%
Weighted average interest
rate for balances
outstanding at December 31 1.99% 1.83% 4.14%
29
Federal funds purchased and repurchase agreements mature the next business
day. The securities underlying the repurchase agreements are under our control
and secure the total outstanding daily balances.
Long-term borrowings: Our long-term borrowings of $133,787,020 and
$123,444,531 as of December 31, 2002 and 2001, respectively, consisted primarily
of advances from the FHLB. These borrowings bear both fixed and variable
interest rates and mature in varying amounts through the year 2016. The average
interest rate paid on long-term borrowings during 2002 and 2001 approximated
5.17% and 5.60%, 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
- -----------------------------------------
2003 $ 4,935,414
2004 18,901,198
2005 8,000,038
2006 7,807,554
2007 3,860,365
Thereafter 90,282,451
- -----------------------------------------
Total $ 133,787,020
=========================================
NOTE 12. INCOME TAXES
The components of applicable income tax expense (benefit) for the years
ended December 31, 2002, 2001 and 2000, are as follows:
2002 2001 2000
- -----------------------------------------------------------------
Current
Federal $3,130,200 $ 2,458,645 $ 1,446,490
State 381,500 276,030 204,270
- -----------------------------------------------------------------
3,511,700 2,734,675 1,650,760
- -----------------------------------------------------------------
Deferred
Federal (507,220) (261,060) (107,568)
State (272,350) (16,480) 191
- -----------------------------------------------------------------
(779,570) (277,540) (107,377)
- -----------------------------------------------------------------
Total $2,732,130 $ 2,457,135 $ 1,543,383
=================================================================
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, 2002, 2001 and 2000 is as follows:
2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
- -------------------------------------------------------------------------------------------------------
Computed
tax at applicable
statutory rate $ 3,389,946 34 $ 2,626,023 34 $ 1,629,723 34
Increase (decrease)
in taxes
resulting from:
Tax-exempt interest
and dividends, net (614,955) (6) (280,989) (4) (216,212) (5)
State income
taxes, net of
Federal income
tax benefit 251,790 3 182,180 2 134,818 3
Purchased state income tax credit (240,000) (2) - - - -
Nondeductible amortization
of goodwill 1,561 - 41,155 1 26,568 1
Other, net (56,212) (1) (111,234) (1) (31,514) (1)
- -------------------------------------------------------------------------------------------------------
Applicable income taxes $ 2,732,130 27 $ 2,457,135 32 $ 1,543,383 32
=======================================================================================================
30
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.
On December 31, 2002, we purchased $700,000 of West Virginia income tax
credits for $460,000, which is reflected as a reduction in our 2002 state income
tax expense and a deferred tax benefit.
The tax effects of temporary differences, which give rise to our deferred
tax assets and liabilities as of December 31, 2002 and 2001, are as follows:
2002 2001
- ---------------------------------------------------------------------------
Deferred tax assets
Allowance for loan losses $ 1,317,350 $ 922,437
Deferred compensation 259,439 178,529
Purchased state tax credits 240,000 -
Other deferred costs and accrued expenses 246,786 210,287
- ---------------------------------------------------------------------------
2,063,575 1,311,253
- ---------------------------------------------------------------------------
Deferred tax liabilities
Depreciation 169,709 119,922
Accretion on tax-exempt securities 21,585 13,680
Purchase accounting adjustments 143,952 147,952
Net unrealized gain on securities and
other financial instruments 1,819,488 743,071
- ---------------------------------------------------------------------------
2,154,734 1,024,625
- ---------------------------------------------------------------------------
Net deferred tax assets (liabilities) $ (91,159) $ 286,628
===========================================================================
NOTE 13. EMPLOYEE BENEFITS
Retirement Plans: We have 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 $190,124, $185,694 and $150,777 for the years
ended December 31, 2002, 2001 and 2000, respectively.
Employee Stock Ownership Plan: We have an Employee Stock Ownership Plan
("ESOP"), which enables eligible employees to acquire shares of our common
stock. The cost of the ESOP is borne by us through annual contributions to an
Employee Stock Ownership Trust in amounts determined by the Board of Directors.
The expense recognized by us is based on cash contributed or committed to
be contributed by us to the ESOP during the year. Contributions to the ESOP for
the years ended December 31, 2002, 2001 and 2000 were $199,593, $151,897 and
$137,588, respectively. Dividends paid by us to the ESOP are reported as a
reduction to retained earnings. The ESOP owned 43,350 shares of our common stock
at December 31, 2002, 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 our Board
of Directors.
Directors Deferred Compensation Plan: We, as well as each of our subsidiary
banks, have 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, 2002
and 2001, approximated $407,863 and $332,811, respectively, which is included in
other liabilities in the accompanying consolidated balance sheets. In addition,
we have purchased certain life insurance contracts to fund the liabilities
arising under these plans. At December 31, 2002 and 2001, the cash surrender
value of these insurance contracts was $315,442 and $280,075, respectively, and
is included in other assets in the accompanying consolidated balance sheets.
Supplemental Executive Retirement Plan: In May 1999, Summit Community 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 and during 2002,
Summit Financial Group, Inc. adopted a similar plan. The liabilities accrued for
the SERP's at December 31, 2002 and 2001 were $282,275 and $144,818
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 plans. At December 31, 2002 and 2001, the cash
surrender value of these insurance contracts was $4,867,085 and $2,497,306,
respectively, and is included in other assets in the accompanying consolidated
balance sheets.
Stock Option Plan: The Officer Stock Option Plan, which provides for the
granting of stock options for up to 240,000 shares of common stock to our key
officers, was adopted in 1998 and expires in 2008. 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 our common stock on
the date of grant. Accordingly, no compensation expense is recognized for
options granted under the Plan.
31
The following pro forma disclosures present for 2002, 2001 and 2000, our
reported net income and basic and diluted earnings per share had we recognized
compensation expense for our 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).
(in thousands, except per share data) Years Ended December 31,
- -------------------------------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------------
Net income:
As reported $ 7,238 $ 5,266 $ 3,250
Deduct total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects (21) (25) (28)
- -------------------------------------------------------------------------
Pro forma $ 7,217 $ 5,241 $ 3,222
=========================================================================
Basic earnings per share:
As reported $ 4.13 $ 3.00 $ 1.85
=========================================================================
Pro forma $ 4.12 $ 2.99 $ 1.83
=========================================================================
Diluted earnings per share:
As reported $ 4.11 $ 3.00 $ 1.85
=========================================================================
Pro forma $ 4.10 $ 2.99 $ 1.83
=========================================================================
For purposes of computing the above pro forma amounts, we 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 3.80% for 2002, 4.50% for 2001
and 6.50% for 2000; dividend yields of 2.00% for 2002, 2.50% for 2001 and 3.25%
for 2000; volatility factors of the expected market price of our common stock of
23 for 2002 and 20 for 2001 and 2000; and an expected option life of 8 years for
2002 and 2001, and 10 years for 2000. The weighted-average grant date fair value
of options granted during 2002, 2001 and 2000 was $10.04, $5.61 and $5.04,
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 our Officer Stock Option Plan during 2000, 2001
and 2002 is as follows:
Weighted-
Average
Exercise
Options Price
- ----------------------------------------------------------------------
Outstanding, January 1, 2000 15,000 $ 20.83
Granted 9,000 18.50
Exercised - -
Forfeited - -
- ----------------------------------------------------------------------
Outstanding, December 31, 2000 24,000 $ 19.96
Granted 8,500 23.80
Exercised - -
Forfeited - -
- ----------------------------------------------------------------------
Outstanding, December 31, 2001 32,500 $ 20.96
Granted 9,000 37.95
Exercised (50) 23.80
Forfeited - -
- ----------------------------------------------------------------------
Outstanding, December 31, 2002 41,450 $ 24.65
======================================================================
Exercisable Options:
December 31, 2002 19,050 $ 20.43
December 31, 2001 12,600 $ 20.16
December 31, 2000 7,800 $ 20.29
======================================================================
NOTE 14. COMMITMENTS AND CONTINGENCIES
Financial instruments with off-balance sheet risk: We are a party to
certain financial instruments with off-balance-sheet risk in the normal course
of business to meet the financing needs of our customers. 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 that we have in
this class of financial instruments. A summary of the contractual amount of
significant commitments follows:
December 31,
- ------------------------------------------------------------
2002 2001
- ------------------------------------------------------------
Commitments to extend credit:
Revolving home equity and
credit card lines $ 15,025,781 $ 11,191,694
Construction loans 24,144,256 19,233,515
Other loans 17,499,115 16,638,888
Standby letters of credit 2,475,000 1,302,483
- ------------------------------------------------------------
Total $ 59,144,152 $ 48,366,580
============================================================
32
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. We evaluate each customer's credit worthiness
on a case-by-case basis. The amount of collateral obtained, if we deem necessary
upon extension of credit, is based on our credit evaluation. Collateral held
varies but may include accounts receivable, inventory, equipment or real estate.
Standby letters of credit are conditional commitments issued to guarantee
the performance of a customer to a third party. Standby letters of credit
generally are contingent upon the failure of the customer to perform according
to the terms of the underlying contract with the third party.
Our 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. We use the same
credit policies in making commitments and conditional obligations as we do for
on-balance sheet instruments.
Litigation: We are 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: We have various employment agreements with our 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 15. COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY DEBENTURES OF THE COMPANY
In October 2002, $3,500,000 of Company-obligated mandatorily redeemable
capital securities (the "Capital Securities") of subsidiary trusts holding
solely junior subordinated debt securities of the Company (the debentures) were
issued by our statutory business trust - SFG Capital Trust I, of which 100% of
the common equity is owned by us. The trust was formed for the purpose of
issuing the capital securities and investing the proceeds from the sale of such
capital securities in the debentures. The debentures held by the trust are the
sole asset of the trust. Distributions on the capital securities issued by the
trust are payable semi-annually at a variable interest rate equal to 3 month
LIBOR plus 345 basis points, which is equal to the interest rate being earned by
the trust on the debentures held by the trust and are recorded as interest
expense by us. The capital securities are subject to mandatory redemption in
whole or in part, upon repayment of the debentures. We have entered into
agreements which, taken collectively, fully and unconditionally guarantee the
capital securities subject to the terms of the guarantee.
The debentures held by SFG Capital Trust I qualify as Tier 1 capital under
Federal Reserve Board guidelines and are first redeemable, whole, or in part, by
us on November 7, 2007.
Note 16. REGULATORY MATTERS
The primary source of funds for our dividends paid to our shareholders is
dividends received from our 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. During 2003, our subsidiaries have
$8,802,000 plus net income for the interim periods through the date of
declaration, available for dividends for distribution to us.
We and our 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,
we and each of our subsidiaries must meet specific capital guidelines that
involve quantitative measures of our and our subsidiaries' assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting
practices. Our and each of our subsidiaries' capital amounts and classifications
are also subject to qualitative judgments by the regulators about components,
risk weightings and other factors. Failure to meet these minimum capital
requirements can result in certain mandatory and possible additional
discretionary actions by regulators that could have a material impact on our
financial position and results of operations.
Quantitative measures established by regulation to ensure capital adequacy
require us and each of our 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). We believe, as of December 31, 2002, that we and each of our
subsidiaries met all capital adequacy requirements to which we were subject.
The most recent notifications from the banking regulatory agencies
categorized us and each of our subsidiary banks as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, we and each of our subsidiaries must maintain minimum total risk-
33
based, Tier I risk-based, and Tier I leverage ratios as set forth in the table
below.
Our subsidiary banks are required to maintain noninterest bearing reserve
balances with the Federal Reserve Bank. The required reserve balance was
$2,943,000 at December 31, 2002.
Summit's and its subsidiary banks', Summit Community Bank ("SCB"), Capital
State Bank, Inc.'s ("CSB") and Shenandoah Valley National Bank's ("SVNB") actual
capital amounts and ratios are also presented in the following table (dollar
amounts in thousands).
To be Well Capitalized
Minimum Required under Prompt Corrective
Actual Regulatory Capital Action Provisions
--------------------- -------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------ --------- ------- --------- -------
As of December 31, 2002
Total Capital (to risk weighted assets)
Summit $ 53,114 11.7% $ 36,310 8.0% $ 45,388 10.0%
SCB* 25,916 11.1% 18,661 8.0% 23,327 10.0%
CSB 11,041 10.7% 8,247 8.0% 10,309 10.0%
SVNB 12,816 11.0% 9,304 8.0% 11,630 10.0%
Tier I Capital (to risk weighted assets)
Summit 49,043 10.8% 18,155 4.0% 27,233 6.0%
SCB* 23,708 10.2% 9,334 4.0% 14,001 6.0%
CSB 10,146 9.8% 4,124 4.0% 6,187 6.0%
SVNB 11,848 10.2% 4,651 4.0% 6,976 6.0%
Tier I Capital (to average assets)
Summit 49,043 7.4% 20,012 3.0% 33,353 5.0%
SCB* 23,708 7.0% 10,161 3.0% 16,934 5.0%
CSB 10,146 6.8% 4,457 3.0% 7,428 5.0%
SVNB 11,848 6.7% 5,289 3.0% 8,815 5.0%
As of December 31, 2001
Total Capital (to risk weighted assets)
Summit $ 42,695 11.3% $ 30,173 8.0% $ 37,716 10.0%
SBVNB* 14,014 10.4% 10,811 8.0% 13,514 10.0%
CSB 9,407 10.4% 7,208 8.0% 9,011 10.0%
SVNB 10,386 13.7% 6,065 8.0% 7,581 10.0%
PVB* 9,273 12.1% 6,121 8.0% 7,651 10.0%
Tier I Capital (to risk weighted assets)
Summit 39,585 10.5% 15,080 4.0% 22,620 6.0%
SBVNB* 12,564 9.3% 5,404 4.0% 8,106 6.0%
CSB 8,754 9.7% 3,602 4.0% 5,404 6.0%
SVNB 9,978 13.2% 3,033 4.0% 4,549 6.0%
PVB* 8,674 11.3% 3,062 4.0% 4,593 6.0%
Tier I Capital (to average assets)
Summit 39,585 7.1% 16,797 3.0% 27,995 5.0%
SBVNB* 12,564 7.0% 5,369 3.0% 8,949 5.0%
CSB 8,754 6.7% 3,902 3.0% 6,504 5.0%
SVNB 9,978 8.1% 3,709 3.0% 6,182 5.0%
PVB* 8,674 7.0% 3,739 3.0% 6,231 5.0%
*SBVNB and PVB merged to form SCB effective January 18, 2002.
34
NOTE 17. EARNINGS PER SHARE
The computations of basic and diluted earnings per share follow:
For the Year Ended December 31,
- ----------------------------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------
Numerator:
Net Income $ 7,238,298 $ 5,266,462 $ 3,249,919
============================================================================
Denominator
Denominator for basic earnings
per share-weighted average
common shares outstanding 1,753,982 1,754,449 1,760,845
Effect of dilutive securities:
Stock options 9,058 693 -
- ----------------------------------------------------------------------------
Denominator for diluted earnings
per share-weighted average
common shares outstanding and
assumed conversions 1,763,040 1,755,142 1,760,845
============================================================================
Basic earnings per share $ 4.13 $ 3.00 $ 1.85
============================================================================
Diluted earnings per share $ 4.11 $ 3.00 $ 1.85
============================================================================
NOTE 18. DERIVATIVE FINANCIAL INSTRUMENTS
During 2000 we purchased interest rate caps (caps) with a notional amount
of $50 million. These caps are used to offset our overall interest rate risk
relative to rising interest rates. 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 2001 was $34,054. These interest rate caps expired
during the fourth quarter of 2002 with no impact on earnings throughout the
year.
During 2000 we entered into an interest rate swap whereby we will pay a
variable rate of 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. This instrument
was used to hedge the fair value of certain certificates of deposit issued by
the subsidiary banks. The swap agreement and the related hedged certificates of
deposit 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 consolidated 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 our cost of
funds. During 2002 and 2001, there was no ineffectiveness of the hedge
transaction reflected in earnings.
During 2002, we entered into an interest rate swap whereby we will pay a
variable rate of LIBOR and receive a fixed rate of 4.73% on a notional amount of
$6,000,000 and 5.03% on a notional amount of $4,000,000. The $6,000,000 notional
contract has a term of 3 1/2 years, expiring November 28, 2005, and the
$4,000,000 notional contract has a term of 4 1/2 years, expiring November 27,
2006. These two instruments were used to hedge our exposure to rising interest
rates on our long-term borrowings with Federal Home Loan Bank. These agreements
and the related hedged borrowings are marked to market at the end of each
reporting period. The net of the amounts earned on the fixed rate leg of the
swaps and amounts due on the variable rate leg of the swaps are reflected as an
adjustment in our cost of funds.
NOTE 19. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summarizes the methods and significant assumptions we used in
estimating our 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 held for sale: The carrying values of loans held for sale approximate
their estimated fair values.
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.
35
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, 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.
Company-obligated mandatorily redeemable capital securities of subsidiary
trust holding solely subordinated debentures of the Company: The carrying values
of company-obligated mandatorily redeemable capital securities of subsidiary
trust holding solely subordinated debentures of the Company approximate their
estimated fair values.
Derivative financial instruments: The fair values of the interest rate caps
and swaps are based on quoted market prices of like products.
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 our financial instruments
are summarized below:
2002 2001
------------------------------ ------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
Financial assets:
Cash and due from banks $ 11,470,311 $ 11,470,311 $ 11,776,231 $ 11,776,231
Interest bearing deposits,
other banks 2,185,369 2,185,369 2,261,826 2,261,826
Federal funds sold 3,390,135 3,390,135 1,848,129 1,848,129
Securities available for sale 212,597,975 212,597,975 206,967,097 206,967,097
Securities held to maturity - - 150,280 151,533
Loans held for sale 906,900 906,900 1,513,400 1,513,400
Loans 414,245,082 421,530,990 342,902,029 348,254,152
Accrued interest receivable 4,025,167 4,025,167 3,874,002 3,874,002
Derivative financial assets 279,729 279,729 202,989 202,989
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$ 649,100,668 $ 656,386,576 $ 571,495,983 $ 576,849,359
================================================================
Financial liabilities:
Deposits $ 458,647,573 $ 463,620,899 $ 396,204,978 $ 398,497,103
Short-term borrowings 20,191,103 20,191,103 24,032,790 24,032,790
Long-term borrowings 133,787,020 148,947,561 123,444,531 128,123,663
Company-obligated mandatorily
redeemable capital securities of
subsidiary trust holding solely
subordinated debentures of the Company 3,500,000 3,500,000 - -
Accrued interest payable 1,827,932 1,827,932 1,848,985 1,848,985
Derivative financial liabilities 392,046 392,046 164,779 164,779
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$ 618,345,674 $ 638,479,541 $ 545,696,063 $ 552,667,320
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36
NOTE 20. CONDENSED FINANCIAL STATMENTS OF PARENT COMPANY
Our investment in our wholly-owned subsidiaries is presented on the equity
method of accounting. Information relative to our balance sheets at December 31,
2002 and 2001, and the related statements of income and cash flows for the years
ended December 31, 2002, 2001 and 2000, are presented as follows:
Balance Sheets December 31,
- --------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------
Assets
Cash and due from banks $ 149,979 $ 181,931
Investment in subsidiaries,
eliminated in consolidation 52,347,781 44,675,976
Securities available for sale 88,348 253,345
Premises and equipment 2,199,115 2,401,815
Accrued interest receivable 1,021 -
Other assets 1,030,224 77,014
- --------------------------------------------------------------------------------
Total assets $ 55,816,468 $ 47,590,081
================================================================================
Liabilities and Shareholders' Equity
Short-term borrowings $ - $ 1,000,000
Long-term borrowings - 1,900,000
Subordinated debentures held by subsidiary trust 3,609,000 -
Other liabilities 127,672 402,734
- --------------------------------------------------------------------------------
Total liabilities 3,736,672 3,302,734
- --------------------------------------------------------------------------------
Common stock, $2.50 par value, authorized
5,000,000 shares; issued 1,780,830 shares 4,452,075 4,451,950
Capital surplus 8,257,966 8,256,901
Retained earnings 36,726,583 30,803,543
Less cost of shares acquired for the treasury
2001 - 28,970 shares; 2000 - 26,470 shares (619,711) (532,479)
Accumulated other comprehensive income 3,262,883 1,307,432
- --------------------------------------------------------------------------------
Total shareholders' equity 52,079,796 44,287,347
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 55,816,468 $ 47,590,081
================================================================================
Statements of Income For the Year Ended December 31,
- ---------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------
Income
Dividends from bank subsidiaries $ 2,400,000 $ 2,300,000 $ 7,220,000
Other dividends and interest income 37,486 14,327 27,671
Management and service fees from bank subsidiaries 2,775,120 2,268,600 1,387,150
- ---------------------------------------------------------------------------------------------
Total income 5,212,606 4,582,927 8,634,821
- ---------------------------------------------------------------------------------------------
Expense
Interest expense 173,131 79,064 2,736
Operating expenses 3,207,443 2,646,600 1,850,362
- ---------------------------------------------------------------------------------------------
Total expenses 3,380,574 2,725,664 1,853,098
- ---------------------------------------------------------------------------------------------
Income before income taxes and equity in
undistributed income of bank subsidiaries 1,832,032 1,857,263 6,781,723
Income tax (benefit) (467,300) (175,900) (167,845)
- ---------------------------------------------------------------------------------------------
Income before equity in undistributed income
of bank subsidiaries 2,299,332 2,033,163 6,949,568
Equity in (distributed) undistributed
income of bank subsidiaries 4,938,966 3,233,299 (3,699,649)
- ---------------------------------------------------------------------------------------------
Net income $ 7,238,298 $ 5,266,462 $ 3,249,919
=============================================================================================
37
Statements of Cash Flows For the Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,238,298 $ 5,266,462 $ 3,249,919
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Equity in (undistributed) distributed net income of
bank subsidiaries (4,938,966) (3,233,299) 3,699,649
Deferred tax expense (benefit) (215,300) 34,600 19,055
Depreciation 327,303 269,083 121,693
(Increase) decrease in other assets (393,750) 169,034 59,231
Increase (decrease) in other liabilities (43,903) 122,035 248,919
- ---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,973,682 2,627,915 7,398,466
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in bank subsidiaries (700,000) (3,600,000) (2,500,000)
Proceeds sales of available for sale securities 300,000 - -
Purchase of available for sale securities (81,723) - -
Proceeds from sales of premises and equipment - 14,807 -
Purchases of furniture and equipment (126,811) (891,098) (1,704,282)
Purchase of life insurance contracts (475,000) (23,000) -
- ---------------------------------------------------------------------------------------------------------
Net cash (used in) investing activities (1,083,534) (4,499,291) (4,204,282)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders (1,315,258) (1,228,016) (1,054,996)
Purchases of fractional shares - - (4,846)
Payments to dissenting shareholders - - (799,095)
Exercise of stock options 1,190 - -
Purchase of treasury stock (87,232) (14,754) (133,001)
Net increase (decrease) in short-term borrowings (1,000,000) 1,000,000 -
Net proceeds from long-term borrowings 4,379,200 1,900,000 -
Repayment of long-term borrowings (2,900,000) - (1,000,000)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities (922,100) 1,657,230 (2,991,938)
- ---------------------------------------------------------------------------------------------------------
Increase (decrease) in cash (31,952) (214,146) 202,246
Cash:
Beginning 181,931 396,077 193,831
- ---------------------------------------------------------------------------------------------------------
Ending $ 149,979 $ 181,931 $ 396,077
=========================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash payments for:
Interest $ 143,345 $ 75,038 $ 2,736
=========================================================================================================
38