FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 2003
Commission File Number 000-19235
SUMMIT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0892056
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
Post Office Box 1087
937 North Pleasantburg Drive
Greenville, South Carolina 29602
(Address, including zip code, of principal executive offices)
(864) 242-2265
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of April 23, 2003, 4,056,090 shares of $1.00 par value common stock were
outstanding.
SUMMIT FINANCIAL CORPORATION
FORM 10-Q FOR QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS OF INFORMATION REQUIRED IN REPORT
PART I. FINANCIAL INFORMATION
Item 1.
Consolidated Balance Sheets
March 31, 2003 and December 31, 2002 . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income
Three months ended March 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Shareholders' Equity and Comprehensive Income
Three months ended March 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
Three months ended March 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . 6
Condensed Notes to Consolidated Financial Statements March 31, 2003 . . . . . . . . . 7
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3.
Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . 24
Item 4.
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
PART II. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
SECTION 302 CERTIFICATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Exhibit 99.1 SECTION 906 CEO CERTIFICATION. . . . . . . . . . . . . . . . . . . . . . 29
Exhibit 99.2 SECTION 906 CFO CERTIFICATION. . . . . . . . . . . . . . . . . . . . . . 30
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
March 31, December 31,
2003 2002
----------- --------------
ASSETS
Cash and due from banks. . . . . . . . . . . . . . . $ 11,332 $ 6,929
Interest-bearing bank balances . . . . . . . . . . . 4,584 2,176
Federal funds sold . . . . . . . . . . . . . . . . . 8,543 2,491
Investments available for sale . . . . . . . . . . . 70,952 63,464
Investment in Federal Home Loan Bank and other stock 2,623 2,418
Loans, net of unearned income and net of
allowance for loan losses of $3,545 and $3,369. . . 215,879 215,431
Premises and equipment, net. . . . . . . . . . . . . 4,151 4,197
Accrued interest receivable. . . . . . . . . . . . . 1,303 1,418
Other assets . . . . . . . . . . . . . . . . . . . . 3,855 3,682
----------- --------------
$ 323,222 $ 302,206
=========== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand. . . . . . . . . . . . . $ 35,597 $ 33,342
Interest-bearing demand . . . . . . . . . . . . . . 25,941 24,943
Savings and money market. . . . . . . . . . . . . . 70,814 73,933
Time deposits, $100,000 and over. . . . . . . . . . 58,092 48,791
Other time deposits . . . . . . . . . . . . . . . . 58,799 49,506
----------- --------------
249,243 230,515
Federal Home Loan Bank advances. . . . . . . . . . . 41,700 40,600
Accrued interest payable . . . . . . . . . . . . . . 791 1,006
Other liabilities. . . . . . . . . . . . . . . . . . 1,750 1,343
----------- --------------
293,484 273,464
----------- --------------
Shareholders' equity:
Common stock, $1.00 par value; 20,000,000
shares authorized; issued and
outstanding 4,055,257 and 4,013,486 shares . . . . 4,055 4,013
Additional paid-in capital. . . . . . . . . . . . . 21,482 21,322
Retained earnings . . . . . . . . . . . . . . . . . 3,771 2,862
Accumulated other comprehensive income, net of tax. 479 600
Nonvested resticted stock . . . . . . . . . . . . . (49) (55)
----------- --------------
Total shareholders' equity. . . . . . . . . . . 29,738 28,742
----------- --------------
$ 323,222 $ 302,206
=========== ==============
<FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars, except per share data, in Thousands)
(Unaudited)
For the Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
Interest Income:
Loans. . . . . . . . . . . . . . . . . . . . $ 3,572 $ 3,768
Taxable investment securities. . . . . . . . 527 462
Nontaxable investment securities . . . . . . 170 174
Federal funds sold . . . . . . . . . . . . . 20 21
Other. . . . . . . . . . . . . . . . . . . . 40 40
---------- ----------
4,329 4,465
---------- ----------
Interest Expense:
Deposits . . . . . . . . . . . . . . . . . . 951 1,210
Federal Home Loan Bank advances. . . . . . . 415 392
Other borrowings . . . . . . . . . . . . . . 2 9
---------- ----------
1,368 1,611
---------- ----------
Net interest income. . . . . . . . . . . 2,961 2,854
Provision for loan losses . . . . . . . . . . 173 125
---------- ----------
Net interest income after
provision for loan losses . . . . . . . 2,788 2,729
---------- ----------
Noninterest Income:
Service charges and fees on deposit accounts 137 127
Credit card service fees and income. . . . . 95 112
Insurance commission fee income. . . . . . . 98 219
Gain on sale of investment securities. . . . 174 16
Other income . . . . . . . . . . . . . . . . 257 208
---------- ----------
761 682
---------- ----------
Noninterest Expense:
Salaries, wages and benefits . . . . . . . . 1,314 1,367
Occupancy. . . . . . . . . . . . . . . . . . 169 160
Furniture, fixtures and equipment. . . . . . 160 182
Other operating expenses . . . . . . . . . . 580 564
---------- ----------
2,223 2,273
---------- ----------
Income before income taxes. . . . . . . . . . 1,326 1,138
Income taxes. . . . . . . . . . . . . . . . . 417 365
---------- ----------
Net income. . . . . . . . . . . . . . . . . . $ 909 $ 773
========== ==========
Net income per share:
Basic. . . . . . . . . . . . . . . . . . . $ .23 $ .19
Diluted. . . . . . . . . . . . . . . . . . $ .20 $ .18
Average shares outstanding:
Basic. . . . . . . . . . . . . . . . . . . 4,012,072 3,964,137
Diluted. . . . . . . . . . . . . . . . . . 4,553,725 4,409,277
<FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(Dollars in Thousands)
(Unaudited)
Accumulated
other
Additional comprehensive Nonvested Total
Common paid-in Retained (loss) restricted shareholders'
stock capital earnings income, net stock equity
------- ----------- --------- --------------- ----------- ---------------
Balance at December 31, 2001. . . . . . . . . $ 3,793 $ 18,409 $ 2,379 $ 203 ($183) $ 24,601
Net income for the three months
ended March 31, 2002 . . . . . . . . . . . . - - 773 - - 773
Other comprehensive loss:
Unrealized holding losses arising during
the period, net of tax of ($299). . . . . . - - - (487) - -
Less: reclassification adjustment for gains
included in net income, net of tax of ($6). - - - (10) - -
---------------
Other comprehensive loss . . . . . . . . . . - - - (497) - (497)
--------------- ---------------
Comprehensive income. . . . . . . . . . . . . - - - - - 276
---------------
Stock options exercised . . . . . . . . . . . 3 16 - - - 19
Amortization of deferred
compensation on restricted stock . . . . . . - - - - 32 32
------- ----------- --------- --------------- ----------- ---------------
Balance at March 31, 2002 . . . . . . . . . . $ 3,796 $ 18,425 $ 3,152 ($294) ($151) $ 24,928
======= =========== ========= =============== =========== ===============
Balance at December 31, 2002. . . . . . . . . $ 4,013 $ 21,322 $ 2,862 $ 600 ($55) $ 28,742
Net income for the three months
ended March 31, 2003 . . . . . . . . . . . . - - 909 - - 909
Other comprehensive loss:
Unrealized holding losses arising during
the period, net of tax of ($8). . . . . . . - - - (13) - -
Less: reclassification adjustment for gains
included in net income, net of tax of ($66) - - - (108) - -
---------------
Other comprehensive loss . . . . . . . . . . - - - (121) - (121)
--------------- ---------------
Comprehensive income. . . . . . . . . . . . . - - - - - 788
---------------
Stock options exercised . . . . . . . . . . . 42 160 - - - 202
Amortization of deferred
compensation on restricted stock . . . . . . - - - - 6 6
------- ----------- --------- --------------- ----------- ---------------
Balance at March 31, 2003 . . . . . . . . . . $ 4,055 $ 21,482 $ 3,771 $ 479 ($49) $ 29,738
======= =========== ========= =============== =========== ===============
<FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
For the Three Months Ended
March 31,
--------------------
2003 2002
--------- --------
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 909 $ 773
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses . . . . . . . . . . . . . . . . 173 125
Depreciation and amortization . . . . . . . . . . . . . . 111 135
Gain on sale of investments available for sale. . . . . . (174) (16)
Net amortization of net premium on investments. . . . . . 65 51
Amortization of deferred compensation on restricted stock 6 32
Decrease in other assets. . . . . . . . . . . . . . . . . 55 15
Increase in other liabilities . . . . . . . . . . . . . . 192 259
Deferred income taxes . . . . . . . . . . . . . . . . . . (39) (73)
--------- --------
Net cash provided by operating activities . . . . . . . . . . 1,298 1,301
--------- --------
Cash flows from investing activities:
Purchases of securities available for sale. . . . . . . . . (28,602) (5,057)
Proceeds from maturities of securities
available for sale . . . . . . . . . . . . . . . . . . . . 8,410 2,376
Proceeds from sales of securities available for sale. . . . 12,618 2,489
Purchases of investments in FHLB and other stock. . . . . . (205) (350)
Net increase in loans . . . . . . . . . . . . . . . . . . . (621) (2,321)
Purchases of premises and equipment . . . . . . . . . . . . (65) (27)
--------- --------
Net cash used in investing activities . . . . . . . . . . . . (8,465) (2,890)
--------- --------
Cash flows from financing activities:
Net increase in deposit accounts. . . . . . . . . . . . . . 18,728 9,282
Proceeds from Federal Home Loan Bank advances . . . . . . . 7,000 4,000
Repayments of Federal Home Loan Bank advances . . . . . . . (5,900) -
Proceeds from employee stock options exercised. . . . . . . 202 19
--------- --------
Net cash provided by financing activities . . . . . . . . . . 20,030 13,301
--------- --------
Net increase in cash and cash equivalents . . . . . . . . . . 12,863 11,712
Cash and cash equivalents, beginning of period. . . . . . . . 11,596 10,449
--------- --------
Cash and cash equivalents, end of period. . . . . . . . . . . $ 24,459 $22,161
========= ========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for interest. . . . . . . . . . . $ 1,583 $ 1,885
Cash paid during the period for income taxes. . . . . . . . . $ 45 $ 37
Change in market value of investment securities
available for sale, net of income taxes. . . . . . . . . . . ($121) ($497)
<FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMIT FINANCIAL CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
NOTE 1 - BASIS OF PRESENTATION:
The unaudited consolidated financial statements include the accounts of
Summit Financial Corporation (the "Company"), a South Carolina corporation, and
its wholly-owned subsidiaries, Summit National Bank (the "Bank"), a nationally
chartered bank, and Freedom Finance, Inc. (the "Finance Company"), a consumer
finance company. Also included are the accounts of Summit Investment Services,
Inc. (the "Investment Company") which is a wholly-owned subsidiary of the Bank.
All significant intercompany items related to the consolidated subsidiaries have
been eliminated.
Through its bank subsidiary, which commenced operations in July 1990, the
Company provides a full range of banking services, including the taking of
demand and time deposits and the making of commercial and consumer loans. The
Bank currently has four full service branch locations in Greenville and
Spartanburg, South Carolina. In 1997, the Bank incorporated the Investment
Company as a wholly-owned subsidiary to offer nondeposit products and financial
management services. The Finance Company commenced operations in November 1994
and makes and services small installment loans to individuals from its eleven
offices throughout South Carolina.
The consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America
("GAAP") which requires management to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities at the date of the
financial statements. In addition, the estimates affect the reported income and
expense during the reporting period. Actual results could differ from these
estimates and assumptions.
The significant accounting policies followed by the Company for interim
reporting are consistent with the accounting policies followed for annual
financial reporting. The unaudited consolidated financial statements of the
Company at March 31, 2003 and for the three month periods ended March 31, 2003
and 2002 were prepared in accordance with the instructions for Form 10-Q. In
the opinion of management, all adjustments (consisting only of items of a normal
recurring nature) necessary for a fair presentation of the financial position at
March 31, 2003, and the results of operations and cash flows for the periods
ended March 31, 2003 and 2002 have been included. The information contained in
the footnotes included in the Company's latest annual report on Form 10-K for
the year ended December 31, 2002 should be referred to in connection with the
reading of these unaudited interim consolidated financial statements. Certain
interim 2002 amounts have been reclassified to conform with the statement
presentations for the interim 2003 period and to reflect the effect of the 5%
stock dividend paid in December 2002.
The results for the three month period ended March 31, 2003 are not necessarily
indicative of the results that may be expected for the full year or any other
interim period.
NOTE 2 - CASH FLOW INFORMATION:
For the purposes of reporting cash flows, cash includes currency and
coin, cash items in process of collection and due from banks. Included in cash
and cash equivalents are federal funds sold and overnight investments. The
Company considers the amounts included in the balance sheet line items, "Cash
and due from banks", "Interest-bearing bank balances" and "Federal funds sold"
to be cash and cash equivalents. These accounts totaled $24,459,000 and
$22,161,000 at March 31, 2003 and 2002, respectively.
NOTE 3 - NONPERFORMING ASSETS:
Loans past due in excess of 90 days and still accruing interest amounted to
approximately $171,000, $187,000, and $116,000 at March 31, 2003, December 31,
2002, and March 31, 2002, respectively. Non-accrual loans at March 31, 2003
totaled $604,000 compared to $293,000 at December 31, 2002. There were no
non-accrual loans at March 31, 2002. There were no impaired loans or other real
estate acquired in full or partial satisfaction of loans outstanding at March
31, 2003, December 31, 2002 or March 31, 2002.
NOTE 4 - STOCK COMPENSATION PLANS:
At March 31, 2003, the Company had three stock-based employee and director
option plans, which are described more fully in Note 14 of the Notes to
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for December 31, 2002. The Company reports stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
("APB") Opinion 25, "Accounting for Stock Issued to Employees", which measures
compensation expense as the excess, if any, of the quoted market price of the
Company's stock at the date of the grant over the amount an employee must pay to
acquire the stock. SFAS 123, "Accounting for Stock-Based Compensation",
encourages but does not require companies to record compensation cost for
stock-based compensation plans at fair value. The Company follows the
disclosure-only provisions of SFAS 123. Accordingly, no compensation cost has
been recognized for the stock-based option plans as all options granted under
the plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect
on net income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee and non-employee
compensation.
For the Quarter
Ended
March 31,
(dollars, except per share, in thousands) 2003 2002
Net income, as reported . . . . . . . . . $ 909 $ 773
Less - total stock-based employee
compensation expense determined under
fair value based method, net of taxes. . 42 54
----- -----
Proforma net income . . . . . . . . . . . $ 867 $ 719
===== =====
Earnings per share:
Basic - as reported. . . . . . . . . . $0.23 $0.19
Basic - proforma . . . . . . . . . . . $0.22 $0.18
Diluted - as reported. . . . . . . . . $0.20 $0.18
Diluted - proforma . . . . . . . . . . $0.19 $0.16
NOTE 5 - INTANGIBLE ASSETS:
As of January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other
Intangible Assets". SFAS 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually in accordance with the provisions of SFAS 142. The
Company's intangible assets consist of goodwill resulting from the Finance
Company's branch acquisitions and are included in "Other assets" on the
accompanying consolidated balance sheets. The balance of goodwill at March 31,
2003 and December 31, 2002 was $187,000. There was no amortization expense
charged in any period presented.
NOTE 6 - PER SHARE INFORMATION:
The following is a reconciliation of the denominators of the basic and
diluted per share computations for net income for the three months ended March
31, 2003 and 2002. There is no required reconciliation of the numerator from
the net income reported on the accompanying statements of income. All average
share and per share data have been restated to reflect all stock dividends as of
the earliest period presented.
Three Months Ended March 31,
2003 2003 2002 2002
BASIC DILUTED BASIC DILUTED
---------- ---------- ---------- ----------
Net Income . . . . . . . . . . $ 909,000 $ 909,000 $ 773,000 $ 773,000
---------- ---------- ---------- ----------
Average shares outstanding . . 4,012,072 4,012,072 3,964,137 3,964,137
Effect of Dilutive Securities:
Stock options. . . . . . . - 536,096 - 423,940
Unvested restricted stock. - 5,557 - 21,200
---------- ---------- ---------- ----------
4,012,072 4,553,725 3,964,137 4,409,277
========== ========== ========== ==========
Per-share amount . . . . . . . $ 0.23 $ 0.20 $ 0.19 $ 0.18
========== ========== ========== ==========
NOTE 7 - SEGMENT INFORMATION:
The Company reports information about its operating segments in accordance
with SFAS 131, "Disclosures about Segments of an Enterprise and Related
Information". Summit Financial Corporation is the parent holding company for
Summit National Bank ("Bank"), a nationally chartered bank, and Freedom Finance,
Inc. ("Finance"), a consumer finance company. The Company considers the Bank
and the Finance Company separate business segments.
Financial performance for each segment is detailed in the following tables.
Included in the "Corporate" column are amounts for general corporate activities
and eliminations of intersegment transactions.
At and for the three months ended March 31, 2003
Bank Finance Corporate Total
Interest income. . . . . . $ 3,844 $ 492 ($7) $ 4,329
Interest expense . . . . . 1,368 39 (39) 1,368
-------- -------- ----------- --------
Net interest income. . . . 2,476 453 32 2,961
Provision for loan losses. 110 63 0 173
Noninterest income . . . . 685 91 (15) 761
Noninterest expense. . . . 1,860 355 8 2,223
-------- -------- ----------- --------
Income before income taxes 1,191 126 9 1,326
Income taxes . . . . . . . 366 48 3 417
-------- -------- ----------- --------
Net income . . . . . . . . $ 825 $ 78 $ 6 $ 909
======== ======== =========== ========
Net loans. . . . . . . . . $213,528 $ 2,946 ($595) $215,879
======== ======== =========== ========
Total assets . . . . . . . $319,031 $ 3,435 $ 756 $323,222
======== ======== =========== ========
At and for the three months ended March 31, 2002
Bank Finance Corporate Total
Interest income. . . . . . $ 3,950 $ 520 ($5) $ 4,465
Interest expense . . . . . 1,606 45 (40) 1,611
-------- -------- ----------- --------
Net interest income. . . . 2,344 475 35 2,854
Provision for loan losses. 50 75 0 125
Noninterest income . . . . 606 91 (15) 682
Noninterest expense. . . . 1,902 369 2 2,273
-------- -------- ----------- --------
Income before income taxes 998 122 18 1,138
Income taxes . . . . . . . 313 45 7 365
-------- -------- ----------- --------
Net income . . . . . . . . $ 685 $ 77 $ 11 $ 773
======== ======== =========== ========
Net loans. . . . . . . . . $203,750 $ 3,056 ($506) $206,300
======== ======== =========== ========
Total assets . . . . . . . $283,237 $ 3,627 $ 101 $286,965
======== ======== =========== ========
SUMMIT FINANCIAL CORPORATION
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information presents management's discussion and analysis of
the financial condition and results of operations of Summit Financial
Corporation ("the Company" or "Summit Financial"), a financial holding company,
and its wholly-owned subsidiaries, Summit National Bank ("the Bank" or "Summit")
and Freedom Finance, Inc. ("the Finance Company" or "Freedom"). The Bank, which
is the principal subsidiary, owns all the outstanding shares of Summit
Investment Services, Inc. Throughout this discussion and analysis, the term
"the Company" refers to Summit Financial Corporation and its subsidiaries.
This discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes and with the statistical
information and financial data appearing in this report as well as the Annual
Report of Summit Financial Corporation (the "Company") on Form 10K for the year
ended December 31, 2002. Certain reclassifications have been made to prior
years' financial data to conform to current financial statement presentations as
well as to reflect the effect of the 5% stock dividend paid in December 2002.
Results of operations for the three month period ended March 31, 2003 are not
necessarily indicative of results to be attained for any other period.
FORWARD-LOOKING STATEMENTS
Certain statements contained herein are "forward-looking statements"
identified as such for purposes of the safe harbor provided in Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements include, but
are not limited to, statements as to industry trends, future results of
operations or financial position, borrowing capacity and future liquidity,
future investment results, future credit exposure, future loan losses and plans
and objectives for future operations, and other statements that do not relate
strictly to historical facts. These statements are not historical facts, but
instead are based on current expectations, estimates and projections about the
Company, are subject to numerous assumptions, risks and uncertainties, and
represent only management's belief regarding future events, many of which, by
their nature, are inherently uncertain and outside the Company's control. Any
forward-looking statements made speak only as of the date on which such
statements are made. The Company disclaims any obligation to update any
forward-looking statements. Forward-looking statements are not guarantees of
future performance and it is possible that actual results and financial position
may differ, possibly materially, from the anticipated results and financial
condition indicated in or implied by these forward-looking statements.
Factors that could cause actual results to differ from those indicated by
any forward-looking statements include, but are not limited to, the following:
- Inflation, interest rates, market and monetary fluctuations;
- Geopolitical developments and any future acts or threats of war or
terrorism;
- The effects of, and changes in trade, monetary and fiscal policies and
laws, including interest policies of the Federal Reserve;
- A decline in general economic conditions and the strength of the local
economies in which the Company operates;
- The financial condition of the Company's borrowers and potential
deterioration of credit quality;
- Competitive pressures on loan and deposit pricing and demand;
- Changes in technology and their impact on the marketing of products
and services;
- The timely development and effective marketing of competitive new
products and services;
- The impact of changes in financial service laws and regulations,
including laws concerning taxes, banking, securities and insurance;
- Changes in accounting principles, policies, and guidelines;
- The Company's success at managing the risks involved in the foregoing
as well as other risks and uncertainties detailed from time to time in press
releases and other public filings.
CRITICAL ACCOUNTING POLICIES
The preparation of consolidated financial statements requires management to
make estimates and assumptions in the application of certain of its accounting
policies about the effect of matters that are inherently uncertain. These
estimates and assumptions affect the reported amounts of certain assets,
liabilities, revenues and expenses. Different amounts could be reported under
different conditions, or if different assumptions were used in the application
of these accounting policies. The Company considers its policies regarding the
allowance for loan losses to be its most critical accounting policy due to the
significant degree of management judgment involved. This significant accounting
policy is detailed in the "Allowance for Loan Losses" section of this discussion
and analysis and in Note 1 of the Notes to Consolidated Financial Statements
included in the Company's 10-K for December 31, 2002.
OVERVIEW
Summit Financial Corporation (the "Company") is a financial institution
holding company headquartered in Greenville, South Carolina. The Company offers
a broad range of financial services through its wholly-owned subsidiary, Summit
National Bank (the "Bank," or "Summit"). The Bank is a nationally chartered
commercial bank which operates principally in the Upstate of South Carolina.
The Bank received its charter and commenced operations in July 1990. In 1997,
the Bank incorporated Summit Investment Services, Inc. as a wholly-owned
subsidiary to provide a wider range of investment products and financial
planning services. The Bank currently has four full service offices in
Greenville and Spartanburg, South Carolina. Summit provides a full range of
banking services to individuals and businesses, including the taking of time and
demand deposits, making loans, and offering nondeposit investment services. The
Bank emphasizes close personal contact with its customers and strives to provide
a consistently high level of service to both individual and corporate customers.
Freedom Finance, Inc. (the "Finance Company" or "Freedom,") is a
wholly-owned subsidiary of the Company which is operating as a consumer finance
company headquartered in Greenville, South Carolina. The Finance Company
primarily makes and services installment loans to individuals with loan
principal amounts generally not exceeding $2,000 and with maturities ranging
from three to eighteen months. Freedom operates eleven branches throughout
South Carolina.
BALANCE SHEET ACTIVITY
Total assets increased $21.0 million or 7% from December 31, 2002 to March
31, 2003 to total $323.2 million. Deposits increased approximately $18.7
million or 8% during the period to total $249.2 million. A majority of the
increase in deposits was in the time deposit categories which increased $18.6
million. The increase in deposits funded the $7.5 million increase in
investment securities and the $8.5 million in federal funds sold and
interest-bearing deposits during the same period.
ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING ASSETS
The allowance for loan losses is established through charges in the form of
a provision for loan losses based on management's periodic evaluation of the
loan portfolio. Loan losses and recoveries are charged or credited directly to
the allowance. The amount of the allowance reflects management's opinion of an
adequate level to absorb probable losses inherent in the loan portfolio at March
31, 2003. The amount charged to the provision and the level of the allowance is
based on management's judgment and is dependent upon growth in the loan
portfolio, the total amount of past due loans and nonperforming loans, known
loan deteriorations, and concentrations of credit. Other factors affecting the
allowance are trends in portfolio volume, maturity and composition, collateral
values, and general economic conditions. Finally, management's assessment of
probable losses based upon internal credit grading of the loans and periodic
reviews and assessments of credit risk associated with particular loans is
considered in establishing the allowance amount. The Company considers its
policies regarding the allowance for loan losses to be its most critical
accounting policy due to the significant degree of management judgment involved.
In assessing the adequacy of the allowance and the amount charged to the
provision, management relies predominately on its ongoing review of the loan
portfolio, which is undertaken both to ascertain whether there are losses which
must be charged-off, and to assess the risk characteristics of the portfolio in
the aggregate as well as the credit risk associated with particular loans. The
Company's methodology for evaluating the adequacy of the allowance for loan
losses incorporates management's current judgments about the credit quality of
the loan portfolio through a disciplined and consistently applied process. The
methodology includes segmentation of the loan portfolio into reasonable
components based on loan purpose for calculation of the most accurate reserve.
Appropriate reserve estimates are determined for each segment based on a review
of individual loans, application of historical loss factors for each segment,
and adjustment factors applied as considered necessary. The adjustment factors
are applied consistently and are quantified for consideration of national and
local economic conditions; exposure to concentrations that may exist in the
portfolio; impact of off-balance sheet risk; alterations of lending policies and
procedures; the total amount of and changes in trends of past due loans,
nonperforming loans, problem loans and charge-offs; the total amount of and
changes in trends of the Bank's internally graded "watch list" loans which
include classified loans and OAEM; variations in the nature, maturity,
composition, and growth of the loan portfolio; changes in trends of collateral
value; entry into new markets; and other factors which may impact the current
credit quality of the loan portfolio.
Management maintains an allowance for loan losses which it believes
adequate to cover probable losses in the loan portfolio. It must be emphasized,
however, that the determination of the allowance for loan losses using the
Company's procedures and methods rests upon various judgments and assumptions
about future economic conditions, events, and other factors affecting loans
which are believed to be reasonable, but which may or may not prove valid.
While it is the Company's policy to provide for the loan losses in the current
period in which a loss is considered probable, there are additional risks of
future losses which cannot be quantified precisely or attributed to particular
loans or classes of loans. Because these risks include the state of the
economy, industry trends, and conditions affecting individual borrowers,
management's judgment of the allowance is necessarily approximate and imprecise.
No assurance can be given that the Company will not in any particular period
sustain loan losses which would be sizable in relationship to the amount
reserved or that subsequent evaluation of the loan portfolio, in light of
conditions and factors then prevailing, will not require significant changes in
the allowance for loan losses or future charges to earnings. The allowance for
loan losses is also subject to review by various regulatory agencies through
their periodic examinations of the Company's subsidiaries. Such examination
could result in required changes to the allowance for loan losses. No
adjustment in the allowance or significant adjustments to the Bank's internal
classified loans were made as a result of the Bank's most recent examination
performed by the Office of the Comptroller of the Currency.
The allowance for loan losses totaled $3.5 million, or 1.62% of total
loans, at March 31, 2003. This is compared to an allowance of $3.4 million, or
1.54% of total loans, at December 31, 2002. For the quarter ended March 31,
2003, the Company reported net recoveries of previously charged-off loans of
$2,000 due primarily to the recovery of one significant loan, compared to net
charge-offs of $67,000, or 0.13% (annualized) of average loans, for the
comparable quarter of 2002.
The Company's nonperforming assets consist of loans on nonaccrual
basis, loans which are contractually past due 90 days or more on which interest
is still being accrued, and other real estate owned ("OREO"). Loans past due 90
days and greater at March 31, 2003, December 31, 2002, and March 31, 2002
totaled $171,000, or 0.08% of gross loans, $187,000, or 0.09% of gross loans,
and $116,000 or 0.06% of gross loans, respectively. Total nonaccrual loans at
March 31, 2003 were $604,000 or 0.28% of gross loans, compared to $293,000 or
0.13% of gross loans at December 31, 2002. Generally, loans of the Bank are
placed on non-accrual status at the earlier of when they are 90 days past due or
when the collection of the loan becomes doubtful. Loans of the Finance Company
are not classified as nonaccrual, but are charged-off when such become 150 days
contractually past due or earlier if the loan is deemed uncollectible.
There were no loans considered to be impaired under Statement of Financial
Accounting Standards 114 and no other real estate owned acquired in partial or
total satisfaction of problem loans ("OREO") at March 31, 2003, December 31,
2002, or March 31, 2002.
Management maintains a list of potential problem loans which includes
non-accrual loans, loans past due in excess of 90 days which are still accruing
interest, and other loans which are credit graded (either internally, by
independent review or regulatory examinations) as "substandard", "doubtful", or
"loss". A loan is added to the list when management becomes aware of
information about possible credit problems of borrowers that causes doubts as to
the ability of such borrowers to comply with the current loan repayment terms.
The total amount of loans outstanding at March 31, 2003 determined to be
potential problem loans based upon management's internal designations, was $4.2
million or 2.0% of the loan portfolio at March 31, 2003, compared to $3.1
million or 1.4% of the loan portfolio at December 31, 2002, and $1.3 million or
0.6% of the loan portfolio at March 31, 2002. The amount of potential problem
loans at March 31, 2003 does not represent management's estimate of potential
losses since the majority of such loans are considered adequately secured by
real estate or other collateral. The increase in the amount of classified loans
in 2002 and the first quarter of 2003 is primarily related to the deterioration
of general economic conditions during that period and management's proactive
approach to more closely monitor credits. Management believes that the
allowance for loan losses as of March 31, 2003 was adequate to absorb any losses
related to the nonperforming loans and potential problem loans as of that date.
Management continues to monitor closely the levels of nonperforming and
potential problem loans, and will address the weaknesses in these credits to
enhance the amount of ultimate collection or recovery on these assets. Should
increases in the overall level of nonperforming and potential problem loans
accelerate from the current trend, management will adjust the methodology for
determining the allowance for loan losses and will increase the provision for
loan losses accordingly. This would likely decrease net income.
EARNINGS REVIEW FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
GENERAL
The Company reported consolidated net income for the three months ended
March 31, 2003 of $909,000, compared to net income of $773,000 for the three
months ended March 31, 2002, or an improvement of approximately $136,000 or 18%.
Contributors to increased earnings for the first quarter of 2003 were the 10%
growth in average earning assets, the 15% reduction in interest expense due to
lower cost of funds, the 12% increase in noninterest income which was primarily
related to gains on sales of investment securities, and the 2% reduction in
overhead expenses. The increases in income were somewhat offset by the 38%
increase in the provision for loan losses due to the trends of increasing
nonaccrual and classified loans.
NET INTEREST INCOME
Net interest income, the difference between the interest earned and
interest paid, is the largest component of the Company's earnings and changes in
it have the greatest impact on net income. Variations in the volume and mix of
assets and liabilities and their relative sensitivity to interest rate movements
determine changes in net interest income. During the three months ended March
31, 2003, the Company recorded net interest income of $3.0 million, a 4%
increase from the net interest income of $2.9 million for the three months ended
March 31, 2002. The increase in this amount is directly related to the increase
in the average earning asset and interest-bearing liability volume of the
Company of 10.4% and 10.1% respectively, offset by the 29 basis point decrease
in the net interest margin for the Company.
For the three months ended March 31, 2003 and 2002, the Company's net
interest margin was 4.23% and 4.52%, respectively. The net interest margin is
calculated as annualized net interest income divided by year-to-date average
earning assets. The decrease in net interest margin is related primarily to the
86 basis point reduction in the average yield on assets related to the
decreasing interest rate environment throughout 2003. The lower yields were
offset somewhat by the 67 basis point reduction in the average cost of funds
related to maturity of higher priced deposits and borrowings which were renewed
at lower current market rates. During the period between the first quarter of
2002 and 2003, the average prime rate decreased 50 basis points resulting in an
average prime rate of 4.25% for the first quarter of 2003 compared to 4.75% for
the first quarter of the prior year.
INTEREST INCOME
For the three months ended March 31, 2003, the Company's earning assets
averaged $292.0 million and had an average yield of 6.13%. This compares to
average earning assets of $264.4 million for the first three months of 2002,
yielding approximately 6.99%. Thus, the 10% increase in volume of average
earning assets, offset by the 86 basis point decrease in average yield, accounts
for the $136,000 (3%) decrease in interest income between the first quarters of
2002 and 2003.
Gross loans comprised approximately 75% of the Company's average earning
assets for the first three months of 2003 and compared to 78% for the first
quarter of 2002. The majority of the Company's loans are tied to the prime rate
(over 60% of the Bank's loan portfolio is at floating rates at March 31, 2003),
which averaged 4.25% and 4.75% for the three months ended March 31, 2003 and
2002, respectively. During the first three months of 2003, loans averaged
$218.5 million, yielding an average of 6.63%, compared to $207.5 million,
yielding an average of 7.37% for the first three months of 2002. The 74 basis
point decrease in the average yield on loans is directly related to the
reductions in the general interest rate environment and lower prime lending rate
during 2002. The higher level of average loans (which increased 5%), was more
than offset by the lower average yields and resulted in the reduction in
interest income on loans of $196,000 or 5%.
Investment securities averaged $59.9 million or 20% of average earning
assets and yielded 5.32% (tax equivalent basis) during the first three months of
2003, compared to average securities of $47.0 million yielding 6.25% (tax
equivalent basis) for the three months ended March 31, 2002. The decrease in
the average yield of the investment portfolio is related to the general declines
in market interest rates, the portfolio mix, and the timing of security calls
and maturities which were reinvested at lower current market rate instruments.
The 27% increase in average securities, offset somewhat by the decrease in
yield, resulted in the increase of interest income on securities of $61,000 or
10%.
INTEREST EXPENSE
The Company's interest expense for the three months ended March 31, 2003
was $1.4 million. The decrease in interest expense of $243,000, or 15%, from
the comparable three months in 2002 of $1.6 million was related primarily to the
67 basis point decrease in the average rate on liabilities, offset somewhat by
the 10.1% increase in the level of average interest-bearing liabilities.
Interest-bearing liabilities averaged $246.3 million for the first three months
of 2003 with an average rate of 2.25%. This is compared to average
interest-bearing liabilities of $223.7 million with an average rate of 2.92% for
the three months ended March 31, 2002. The decrease in average rate on
liabilities is directly related to the general reductions in market interest
rates and the maturities of fixed rate deposits and borrowings which were
renewed at lower current market rates.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $173,000 for the first quarter of 2003,
compared to $125,000 for the comparable period of 2002. As discussed further
under the "Allowance for Loan Losses" section above, in addition to the level of
net originations, other factors influencing the amount charged to the provision
each period include (1) trends in and the total amount of past due, classified,
nonperforming, and "watch list" loans; (2) trends in and the total amount of net
chargeoffs, (3) concentrations of credit risk in the loan portfolio, and (4)
local and national economic conditions and anticipated trends. Thus, in
addition to the general economic uncertainty throughout 2002 and into 2003,
factors contributing to the higher provision each for the first quarter of 2003
included increases in nonperforming assets which amounted to 0.28% and 0.22% of
gross loans at March 31, 2003 and December 31, 2002, respectively. There were
no nonperforming assets at March 31, 2002. Further, the Bank's total "watch
list" loans, which include classified loans, non-accrual loans, and other assets
especially mentioned ("OAEM") in the Bank's internal credit grading procedures
and periodic reviews, have fluctuated from 8.1% of gross loans at March 31,
2002, to 7.9% of gross loans at December 31, 2002, and 8.2% as of the first
quarter end of 2003. Estimates charged to the provision for loan losses are
based on management's judgment as to the amount required to cover probable
losses in the loan portfolio and are adjusted as necessary based on a calculated
model quantifying the estimated required balance in the allowance.
NONINTEREST INCOME AND EXPENSES
Noninterest income, which is primarily related to service charges on
customers' deposit accounts; credit card merchant discount fees; commissions on
nondeposit investment product sales and insurance product sales; mortgage
origination fees; and gains on sales of investment securities, was $761,000 for
the three months ended March 31, 2003 compared to $682,000 for the first three
months of 2002, or an increase of 12%. The increase is primarily related to
higher levels of transactions in the available for sale investment portfolio
generating gains on sales. The higher levels of gains were offset somewhat by
reductions in nondeposit insurance product sales commissions based on a lower
level of activity in 2003.
For the three months ended March 31, 2003, noninterest expense was $2.2
million which is a decrease of 2% from the amount incurred for the three months
ended March 31, 2002 of $2.3 million. The most significant item included in
other expenses is salaries, wages and benefits which totaled $1.3 million for
the three months ended March 31, 2003 as compared to $1.4 million for the three
months ended March 31, 2002. The decrease of $53,000 or 4% is primarily a
result of lower commission on nondeposit product sales due to the reduced volume
of activity and lower bonus accrual for 2003. These decreases were partially
offset by normal annual raises and annual increases in the cost of benefit
plans.
Occupancy and furniture, fixtures, and equipment ("FFE") expenses decreased
a total of $13,000 or 4% between the first three months of 2002 and 2003. The
decrease was primarily related to lower depreciation as numerous assets became
fully depreciated in 2002. There were no significant changes in or additions to
property and premises between the two quarterly periods.
Included in the line item "other operating expenses", which increased
$16,000 or 3% from the comparable period of 2002, are charges for OCC
assessments; property and bond insurance; ATM switch fees; credit card expenses;
professional services; education and seminars; advertising and public relations;
and other branch and customer related expenses. Increases in advertising and
consultant and professional fees were offset by lower legal and loan collection
expenses in 2003 and reductions in merchant expense. These fluctuations and
others related to deposit related expenses are a result of normal activity of
the Company and normal changes in the volume and nature of transactions.
INCOME TAXES
For the three months ended March 31, 2003, the Company reported $417,000 in
income tax expense, or an effective tax rate of 31.4%. This is compared to
income tax expense of $365,000 for the same period of the prior year, or an
effective tax rate of 32.1%. The slight reduction in effective tax rate is
primarily related to the level of tax-free municipal securities in each period.
CAPITAL MANAGEMENT
The Company's capital serves to support asset growth and provide
protection against loss to depositors and creditors. The Company strives to
maintain an optimal level of capital, commensurate with its risk profile, on
which an attractive return to shareholders will be realized over both the short
and long-term, while serving depositors', creditors' and regulatory needs.
Total shareholders' equity amounted to $29.7 million, or 9.2% of total assets,
at March 31, 2003. This is compared to $28.7 million, or 9.5% of total assets,
at December 31, 2002. The $1 million increase in total shareholders' equity
resulted principally from retention of earnings and stock issued pursuant to the
Company's stock option plans, offset somewhat by the decrease in unrealized gain
on investment securities available for sale during the year. Book value per
share at March 31, 2003 and December 31, 2002 was $7.33 and $7.16, respectively.
Tangible book value per share at March 31, 2003 and December 31, 2002 was $7.29
and $7.11, respectively. Tangible book value was less than book value as a
result of the purchase premiums associated with branch acquisitions of Freedom
Finance.
On December 5, 2002, the Company issued its eleventh consecutive 5% stock
dividend to shareholders of record as of November 22, 2002. This dividend
resulted in the issuance of approximately 190,000 shares of the Company's $1.00
par value common stock. Weighted average share and per share data has been
restated to reflect all stock dividends issued.
To date, the capital needs of the Company have been met through the
retention of earnings, from the proceeds of its initial offering of common
stock, and from the proceeds of stock issued pursuant to the Company's stock
option plans. The Company believes that the rate of asset growth will not
negatively impact the capital base. The Company has no commitments or immediate
plans for any significant capital expenditures outside of the normal course of
business. The Company's management does not know of any trends, events or
uncertainties that may result in the Company's capital resources materially
increasing or decreasing.
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. The purpose of these
regulations is to quantitatively measure capital against risk-weighted assets,
including certain off-balance sheet items. These regulations define the
elements of total capital and establish minimum ratios for capital adequacy
purposes. To be categorized as "well capitalized", as defined in the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), Summit
Financial and its banking subsidiary must maintain a risk-based Total Capital
ratio of at least 10%, a risk-based Tier 1 Capital ratio of at least 6%, and a
Tier 1 Leverage ratio of at least 5%, and not be subject to a written agreement,
order, or capital directive with any of its regulators. At March 31, 2003, the
Company and the Bank exceeded all regulatory required minimum capital ratios,
and satisfied the requirements of the well capitalized category established by
FDICIA. There are no current conditions or events that management believes
would change the Company's or the Bank's category. The following table
summarizes capital ratios for the Company and the Bank at March 31, 2003 and
December 31, 2002.
RISK-BASED CAPITAL CALCULATION
TO BE TO BE
CATEGORIZED CATEGORIZED
"ADEQUATELY "WELL
ACTUAL CAPITALIZED" CAPITALIZED"
--------------- --------------- --------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
AS OF MARCH 31, 2003
THE COMPANY
Total capital to risk-weighted assets. $32,132 13.41% $19,170 8.00% N.A.
Tier 1 capital to risk-weighted assets $29,121 12.15% $ 9,585 4.00% N.A.
Tier 1 capital to average assets . . . $29,121 9.49% $12,281 4.00% N.A.
THE BANK
Total capital to risk-weighted assets. $27,988 11.82% $18,936 8.00% $23,670 10.00%
Tier 1 capital to risk-weighted assets $25,025 10.57% $ 9,468 4.00% $14,202 6.00%
Tier 1 capital to average assets . . . $25,025 8.24% $12,141 4.00% $15,176 5.00%
AS OF DECEMBER 31, 2002
THE COMPANY
Total capital to risk-weighted assets. $30,946 13.20% $18,754 8.00% N.A.
Tier 1 capital to risk-weighted assets $28,010 11.95% $ 9,377 4.00% N.A.
Tier 1 capital to average assets . . . $28,010 9.70% $11,555 4.00% N.A.
THE BANK
Total capital to risk-weighted assets. $27,099 11.69% $18,543 8.00% $23,179 10.00%
Tier 1 capital to risk-weighted assets $24,199 10.44% $ 9,271 4.00% $13,907 6.00%
Tier 1 capital to average assets . . . $24,199 8.48% $11,411 4.00% $14,263 5.00%
LIQUIDITY
Liquidity risk is defined as the risk of loss arising from the
Company's inability to meet known near-term and projected long-term funding
commitments and cash flow requirements. The objective of liquidity risk
management is to ensure the ability of the Company to meet its financial
obligations. These obligations are the payment of deposits on demand or at
their contractual maturity; the repayment of borrowings as they mature; the
payment of lease obligations as they become due; the ability to fund new and
existing loan and other commitments; the payment of operating expenses; and the
ability to take advantage of new business opportunities. Liquidity is achieved
by the maintenance of assets which can easily be converted to cash; a strong
base of core customer deposits; maturing short-term assets; the ability to sell
marketable securities; and access to borrowed funds and capital markets.
Liquidity is measured and monitored frequently at both the parent company and
the Bank levels, allowing management to better understand and react to balance
sheet trends. A comprehensive liquidity analysis provides a summary of
anticipated changes in loans, core deposits, and wholesale funds. Management
also maintains a detailed liquidity contingency plan designed to respond to an
overall decline in the condition of the banking industry or a problem specific
to the Company.
Liquid assets consist primarily of cash and due from banks,
interest-bearing deposits at banks, federal funds sold, and unpledged investment
securities available for sale, which accounted for 18% and 16%, respectively, of
average assets for each of the quarterly periods ended March 31, 2003 and 2002.
Investment securities are an important tool to the Company's liquidity
management. Securities classified as available for sale may be sold in response
to changes in interest rates, liquidity needs, and/or significant prepayment
risk. The Company's primary sources of liquidity include cash flow from
operations, core deposits, borrowings, and short-term liquid assets. In
management's opinion, the Company maintains adequate levels of liquidity by
retaining sufficient liquid assets and assets which can be easily converted into
cash and by maintaining access to various sources of funds. The primary sources
of funds available through the Bank include advances from the Federal Home Loan
Bank, purchasing federal funds from other financial institutions, lines of
credit through the Federal Reserve Bank, and increasing deposits by raising
rates paid. At March 31, 2003, based on its approved line of credit equal to
20% of total assets and eligible collateral available, the Bank had additional
available credit of approximately $18 million from the FHLB. Further, the Bank
had short-term lines of credit to purchase unsecured federal funds from
unrelated correspondent banks with available balances of $17.5 million at March
31, 2003.
Summit Financial, the parent holding company, has limited liquidity
needs required to pay operating expenses and to provide funding to its consumer
finance subsidiary, Freedom Finance. Summit Financial has approximately $3.6
million in available liquidity remaining from its initial public offering and
the retention of earnings. A total of $2.2 million of this liquidity was
advanced to the Finance Company, in the form of an intercompany loan, to fund
its operations as of March 31, 2003. Summit Financial also has an available
line of credit totaling $2.5 million from an unaffiliated financial institution,
all of which was available at March 31, 2003. Additional sources of liquidity
for Summit Financial include borrowing funds from unrelated correspondent banks,
borrowing from individuals, and payments for management fees and debt service
which are made by the Company's subsidiary on a monthly basis.
Liquidity needs of Freedom Finance, primarily for the funding of loan
originations, paying operating expenses, and servicing debt, have been met to
date through the initial capital investment of $500,000 made by Summit
Financial, retention of earnings, borrowings from unrelated private investors,
and line of credit facilities provided by Summit Financial and Summit National
Bank. The Company's management believes its liquidity sources are adequate to
meet its operating needs.
OFF-BALANCE SHEET COMMITMENTS
The Company is party to financial instruments with off-balance sheet
risk in the normal course of business to meet the liquidity, credit enhancement,
and financing needs of its customers. These financial instruments include
legally binding commitments to extend credit and standby letters of credit and
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the balance sheet. Credit risk is the principal
risk associated with these instruments. The contractual amounts of these
instruments represent the amount of credit risk should the instruments be fully
drawn upon and the customer defaults.
To control the credit risk associated with entering into commitments and
issuing letters of credit, the Company uses the same credit quality, collateral
policies, and monitoring controls in making commitments and letters of credit as
it does with its lending activities. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation.
Legally binding commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments may expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. Standby letters of credit
obligate the Company to meet certain financial obligations of its customers, if,
under the contractual terms of the agreement, the customers are unable to do so.
The financial standby letters of credit issued by the Company are irrevocable.
Payment is only guaranteed under these letters of credit upon the borrower's
failure to perform its obligations to the beneficiary. As such, there are no
"stand-ready obligations" in any of the letters of credit issued by the Company
and the contingent obligations are accounted for in accordance with SFAS 5,
"Accounting for Contingencies".
At March 31, the Company's total contractual amounts of commitments and
letters of credit are as follows:
(dollars in thousands) 2003 2002
- ---------------------------------------------- ------- -------
Legally binding commitments to extend credit:
Commercial and industrial . . . . . . . . . $16,810 $20,466
Residential real estate, including prime
equity lines. . . . . . . . . . . . . . . 18,091 15,767
Construction and development. . . . . . . . 15,462 8,451
Consumer and overdraft protection . . . . . 2,359 2,512
------- -------
52,722 47,196
Standby letters of credit. . . . . . . . . . . 4,095 5,503
------- -------
Total commitments. . . . . . . . . . . . . . . $56,817 $52,699
======= =======
EFFECT OF INFLATION AND CHANGING PRICES
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America which
require the measurement of financial position and results of operations in terms
of historical dollars, without consideration of changes in the relative
purchasing power over time due to inflation. Unlike most industries, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates generally have a more significant effect in
the financial institution's performance than does the effect of inflation.
The yield on a majority of the Company's earning assets adjusts
simultaneously with changes in the general level of interest rates. Given the
Company's asset-sensitive balance sheet position, assets reprice faster than
liabilities, which generally results in decreases in net interest income during
periods of declining interest rates. This may cause a decrease in the net
interest margin until the fixed rate deposits mature and are repriced at lower
current market rates, thus narrowing the difference between what the Company
earns on its assets and what it pays on its liabilities. The opposite effect
(that is, an increase in net interest income) is generally realized in a rising
rate environment. The degree of interest rate sensitivity of the Company's
assets and liabilities and the differences in timing of repricing assets and
liabilities provides an indication of the extent to which the Company's net
interest income may be affected by interest rate movements.
MARKET RISK AND ASSET-LIABILITY MANAGEMENT
The Company's primary earnings source is its net interest income;
therefore, the Company devotes significant time and has invested in resources to
assist in the management of market risk. The Company's net interest income is
affected by changes in market interest rates, and by the level and composition
of earning assets and interest-bearing liabilities. The Company's objectives in
its asset-liability management are to utilize its capital effectively, to
provide adequate liquidity and enhance net interest income, without taking undue
risks or subjecting the Company unduly to interest rate fluctuations. The
Company takes a coordinated approach to the management of its capital,
liquidity, and interest rate risk.
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises principally from interest rate risk
inherent in its lending, investment, deposit, and borrowing activities.
Management actively monitors and manages its interest rate risk exposure. Other
types of market risks, such as foreign currency exchange rate risk, and equity
and commodity price risk, do not arise in the normal course of the Company's
business.
Interest rate risk is the exposure to changes in market interest rates.
The major source of the Company's interest rate risk is the difference in the
maturity and repricing characteristics between core banking assets and
liabilities - loans and deposits. This difference, or mismatch, poses a risk to
net interest income. The Company attempts to control the mix and maturities of
assets and liabilities to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings and to achieve consistent growth in net
interest income, while maintaining adequate liquidity and capital. A sudden and
substantial increase or decrease in interest rates may adversely impact the
Company's earnings to the extent that the interest rates on earning assets and
interest-bearing liabilities do not change at the same speed, to the same
extent, or on the same basis.
The Company monitors the interest rate sensitivity of its balance
sheet position and controls this risk by identifying and quantifying exposures
in its near-term sensitivity through the use of simulation and valuation models,
as well as its long-term gap position, reflecting the known or assumed maturity,
repricing, and other cash flow characteristics of assets and liabilities. The
Company's simulation analysis involves dynamically modeling interest income and
expense from current assets and liabilities over a specified time period under
various interest rate scenarios and balance sheet structures, primarily to
measure the sensitivity of net interest income over relatively short (e.g., less
than 2-year) time horizons. As the future path of interest rates cannot be
known in advance, management uses simulation analysis to project earnings under
various interest rate scenarios including reasonable or "most likely", as well
as deliberately extreme and perhaps unlikely, scenarios. Key assumptions in
these simulation analyses relate to the behavior of interest rates and spreads,
changes in the mix and volume of assets and liabilities, repricing and/or runoff
of deposits, and, most importantly, the relative sensitivity of the Company's
assets and liabilities to changes in market interest rates. This relative
sensitivity is important to consider as the Company's core deposit base has not
been subject to the same degree of interest rate sensitivity as its assets, the
majority of which are based on external indices and change in concert with
market interest rates. According to the model, the Company is presently
positioned so that net interest income will increase in the short-term if
interest rates rise and will decrease in the short-term if interest rates
decline.
A traditional gap analysis is also prepared based on the maturity and
repricing characteristics of earning assets and interest-bearing liabilities for
selected time bands. The mismatch between repricings or maturities within a
time band is commonly referred to as the "gap" for that period. A positive gap
(asset sensitive) where interest rate sensitive assets exceed interest rate
sensitive liabilities generally will result in the net interest margin
increasing in a rising rate environment and decreasing in a falling rate
environment. A negative gap (liability sensitive) will generally have the
opposite result on net interest income. However, the traditional gap analysis
does not assess the relative sensitivity of assets and liabilities to changes in
interest rates and other factors that could have an impact on interest rate
sensitivity or net interest income, and is thus not, in management's opinion, a
true indicator of the Company's interest rate sensitivity position.
The Company's balance sheet structure is primarily short-term in nature
with a substantial portion of assets and liabilities maturing within one year.
The Company's gap analysis indicates a negative 12 month gap as of March 31,
2003 of $30.2 million. However, when the "effective change ratio" (the
historical relative movement of each asset's and liability's rates in relation
to a 100 basis point change in the prime rate) is applied to the interest gap
position, the Company is actually asset sensitive over a 12 month period and the
entire repricing lives of the assets and liabilities. This is primarily due to
the fact that in excess of 60% of the loan portfolio moves immediately on a
one-to-one ratio with a change in the prime lending rate, while the deposit
rates do not increase or decrease as much or as quickly relative to a prime rate
movement. The Company's asset sensitive position means that assets reprice
faster than the liabilities, which causes a decrease in the short-term in the
net interest income and net interest margin in periods of declining rates until
the fixed rate deposits mature and are repriced at then lower current market
rates, thus narrowing the difference between what the Company earns on its
assets and what it pays on its liabilities. Given the Company's current balance
sheet structure, the opposite effect (that is, an increase in net interest
income and net interest margin) is realized in the short-term in a rising rate
environment.
The Company monitors and considers methods of managing the rate
sensitivity and repricing characteristics of the balance sheet components in
order to minimize the impact of sudden and sustained changes in interest rates.
Accordingly, the Company also performs a valuation analysis involving projecting
future cash flows from current assets and liabilities to determine the Economic
Value of Equity ("EVE") which is the estimated net present value of those
discounted cash flows. EVE represents the market value of equity and is equal
to the market value of assets minus the market value of liabilities, with
adjustments made for certain off-balance sheet items, over a range of assumed
changes in market interest rates. The sensitivity of EVE to changes in the
level of interest rates is a measure of the sensitivity of long-term earnings to
changes in interest rates, and is used primarily to measure the exposure of
earnings and equity to changes in interest rates over a relatively long (e.g.,
greater than 2 years) time horizon.
The Company's market risk exposure is measured using interest rate
sensitivity analysis by computing estimated changes in EVE in the event of a
range of assumed changes in market interest rates. This analysis assesses the
risk of loss in market risk sensitive instruments in the event of a sudden and
sustained 100 - 300 basis points increase or decrease in the market interest
rates. The Company's Board of Directors has adopted an interest rate risk
policy which establishes maximum allowable decreases in EVE in the event of a
sudden and sustained increase or decrease in market interest rates.
At December 31, 2002, the Company's estimated changes in EVE were within
the limits established by the Board. As of March 31, 2003, there was no
substantial change from the interest rate sensitivity analysis or the market
value of portfolio equity for various changes in interest rates calculated as of
December 31, 2002. The foregoing disclosures related to the market risk of the
Company should be read in conjunction with the Company's audited consolidated
financial statements, related notes and management's discussion and analysis of
financial condition and results of operations for the year ended December 31,
2002 included in the Company's 2002 Annual Report on Form 10-K.
ACCOUNTING, REPORTING AND REGULATORY MATTERS
In September 2002, SFAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities," was issued which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS 146 applies to
costs associated with an exit activity that does not involve an entity newly
acquired in a business combination or with a disposal activity covered by SFAS
144, "Accounting for the Impairment or Disposal of Long-Lived Assets". Those
costs include, but are not limited to, the following: a) termination benefits
provided to current employees that are involuntarily terminated under the terms
of a benefit arrangement that, in substance, is not an ongoing benefit
arrangement or an individual deferred compensation contract; b) costs to
terminate a contract that is not a capital lease; and c) costs to consolidate
facilities or relocate employees. SFAS 146 does not apply to costs associated
with the retirement of a long-lived asset covered by SFAS 143, "Accounting for
Asset Retirement Obligations". A liability for a cost associated with an exit
or disposal activity shall be recognized and measured initially at its fair
value in the period in which the liability is incurred. A liability for a cost
associated with an exit or disposal activity is incurred when the definition of
a liability is met. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. The Company adopted SFAS 146 with no material effect on
the Company.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
disclosure to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN 45 clarifies that a guarantor is required to
disclose (a) the nature of the guarantee; (b) the maximum potential amount of
future payments under the guarantee; (c) the carrying amount of the liability;
and (d) the nature and extent of any recourse provisions or available collateral
that would enable the guarantor to recover the amounts paid under the guarantee.
FIN 45 also clarifies that a guarantor is required to recognize, at inception of
a guarantee, a liability for the obligation it has undertaken in issuing the
guarantee at its inception. The Company adopted FIN 45 with no material effect
on the Company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which addresses consolidation by
business enterprises of variable interest entities. Under FIN 46, an enterprise
that holds significant variable interest in a variable interest entity but is
not the primary beneficiary is required to disclose the nature, purpose, size,
and activities of the variable interest entity, its exposure to loss as a result
of the variable interest holder's involvement with the entity, and the nature of
its involvement with the entity and date when the involvement began. The
primary beneficiary of a variable interest entity is required to disclose the
nature, purpose, size, and activities of the variable interest entity, the
carrying amount and classification of consolidated assets that are collateral
for the variable interest entity's obligations, and any lack of recourse by
creditors (or beneficial interest holders) of a consolidated variable interest
entity to the general creditors (or beneficial interest holders) of a
consolidation variable interest entity to the general credit of the primary
beneficiary. FIN 46 is effective for the first fiscal year or interim period
beginning after June 15, 2003. The impact to the Company upon adoption is
currently not known.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk and Asset-Liability Management" in Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations for
quantitative and qualitative disclosures about market risk, which information is
incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission ("SEC"). Based upon their evaluation
of those controls and procedures performed within 90 days of the filing date of
this report, the chief executive officer and the chief financial officer of the
Company concluded that the Company's disclosure controls and procedures were
adequate and effective in timely alerting management to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic SEC filings.
(b) Changes in Internal Controls
The Company made no significant changes in its internal controls or, to
management's knowledge, other factors that could significantly affect these
controls subsequent to the date of the evaluation of those controls by the chief
executive officer and chief financial officer.
SUMMIT FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Corporation and its subsidiaries from time to time may be involved as
plaintiff or defendant in various legal actions incident to its business. There
are no material actions currently pending.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to the shareholders for a vote at any time during the
first quarter of 2003.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
None
(b) Reports on Form 8-K:
On April 23, 2003, the Company filed a Form 8-K related to the earnings press
release dated April 22, 2003, which included selected financial data for the
quarter ended March 31, 2003 and for other selected periods.
SUMMIT FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUMMIT FINANCIAL CORPORATION
Dated: May 7, 2003
/s/ J. Randolph Potter
- -------------------------
J. Randolph Potter, President
and Chief Executive Officer
Dated: May 7, 2003
/s/ Blaise B. Bettendorf
- ---------------------------
Blaise B. Bettendorf, Senior Vice President
and Chief Financial Officer
CERTIFICATION
I, J. Randolph Potter, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Summit Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 7, 2003
/s/ J. Randolph Potter
- -------------------------
J. Randolph Potter, President and Chief Executive Officer
CERTIFICATION
I, Blaise B. Bettendorf certify that:
1. I have reviewed this quarterly report on Form 10-Q of Summit Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 7, 2003
/s/ Blaise B. Bettendorf
- ---------------------------
Blaise B. Bettendorf, Senior Vice President
and Chief Financial Officer