SMMF-2015.03.31-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10 – Q

[X]         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015
or
[  ]         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934  For the transition period from ___________ to __________.

Commission File Number 0-16587 

Summit Financial Group, Inc.
(Exact name of registrant as specified in its charter)
West Virginia
55-0672148
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
300 North Main Street
 
Moorefield, West Virginia
26836
(Address of principal executive offices)
(Zip Code)
(304) 530-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities and 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 þ
No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ
No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o               Accelerated filer o
Non-accelerated filer o                  Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o
No þ

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date.

Common Stock, $2.50 par value
10,586,242 shares outstanding as of April 30, 2015



Table of Contents


 
 
 
Page
PART  I.
FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Consolidated balance sheets
March 31, 2015 (unaudited), December 31, 2014,
and March 31, 2014 (unaudited)
 
 
 
 
 
 
Consolidated statements of income
for the three months ended
March 31, 2015 and 2014 (unaudited)
 
 
 
 
 
 
Consolidated statements of comprehensive
income for the three months ended
March 31, 2015 and 2014 (unaudited)
 
 
 
 
 
 
Consolidated statements of shareholders’ equity
for the three months ended
March 31, 2015 and 2014 (unaudited)
 
 
 
 
 
 
Consolidated statements of cash flows
for the three months ended
March 31, 2015 and 2014 (unaudited)
 
 
 
 
 
 
Notes to consolidated financial statements (unaudited)
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
 
 
 
 
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
 
Item 4.
Controls and Procedures

2


Table of Contents


PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
 
 
 
 
 
Item 1A.
Risk Factors
 
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None
 
 
 
 
 
Item 3.
Defaults upon Senior Securities
None
 
 
 
 
 
Item 4.
Mine Safety Disclosures
None
 
 
 
 
 
Item 5.
Other Information
None
 
 
 
 
 
Item 6.
Exhibits
 
 
 
 
SIGNATURES
 
 
 
 
 
EXHIBIT INDEX
 


3


Consolidated Balance Sheets (unaudited)




 
 
March 31,
2015
 
December 31,
2014
 
March 31,
2014
Dollars in thousands
 
(unaudited)
 
(*)
 
(unaudited)
ASSETS
 
 
 
 

 
 
Cash and due from banks
 
$
3,850

 
$
3,728

 
$
3,827

Interest bearing deposits with other banks
 
8,437

 
8,782

 
13,424

Cash and cash equivalents
 
12,287

 
12,510

 
17,251

Securities available for sale
 
282,135

 
282,834

 
281,865

Other investments
 
7,247

 
6,183

 
6,610

Loans held for sale, net
 
85

 
527

 

Loans, net
 
1,039,669

 
1,019,842

 
962,714

Property held for sale
 
34,368

 
37,529

 
52,241

Premises and equipment, net
 
20,208

 
20,060

 
20,457

Accrued interest receivable
 
5,564

 
5,838

 
5,410

Intangible assets
 
7,648

 
7,698

 
7,861

Cash surrender value of life insurance policies
 
36,961

 
36,700

 
35,881

Other assets
 
14,320

 
13,847

 
15,827

Total assets
 
$
1,460,492

 
$
1,443,568

 
$
1,406,117

 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 

 
 

 
 

Liabilities
 
 

 
 

 
 

Deposits
 
 

 
 

 
 

Non interest bearing
 
$
117,049

 
$
115,427

 
$
99,445

Interest bearing
 
941,259

 
945,887

 
953,185

Total deposits
 
1,058,308

 
1,061,314

 
1,052,630

Short-term borrowings
 
148,985

 
123,633

 
68,974

Long-term borrowings
 
77,013

 
77,490

 
123,492

Subordinated debentures
 
5,000

 
16,800

 
16,800

Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 
19,589

Other liabilities
 
15,708

 
13,098

 
10,105

Total liabilities
 
1,324,603

 
1,311,924

 
1,291,590

 
 
 
 
 
 
 
Commitments and Contingencies
 


 


 


 
 
 
 
 
 
 
Shareholders' Equity
 
 

 
 

 
 

Preferred stock and related surplus - authorized 250,000 shares;
 
 

 
 

 
 

Series 2009, 8% Non-cumulative convertible preferred stock,
par value $1.00; issued December 2014 - 3,610 shares, and March 2014 - 3,710 shares
 

 
3,419

 
3,519

Series 2011, 8% Non-cumulative convertible preferred stock,
par value $1.00; issued December 2014 - 11,914 shares, and March 2014 - 11,914 shares
 

 
5,764

 
5,764

Common stock and related surplus - authorized 20,000,000 shares; $2.50 par value; issued and outstanding 2015 - 10,586,242 shares, December 2014 - 8,301,746 shares, and March 2014 - 7,457,222 shares
 
43,072

 
32,670

 
24,691

Retained earnings
 
91,176

 
87,719

 
79,330

Accumulated other comprehensive income
 
1,641

 
2,072

 
1,223

Total shareholders' equity
 
135,889

 
131,644

 
114,527

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
1,460,492

 
$
1,443,568

 
$
1,406,117

(*) - December 31, 2014 financial information has been extracted from audited consolidated financial statements
See Notes to Consolidated Financial Statements

Table of Contents
4


Consolidated Statements of Income (unaudited)


 
 
Three Months Ended
Dollars in thousands, except per share amounts
 
March 31,
2015
 
March 31,
2014
Interest income
 
 
 
 
Interest and fees on loans
 
 
 
 
Taxable
 
$
12,733

 
$
12,145

Tax-exempt
 
115

 
71

Interest and dividends on securities
 
 

 
 

Taxable
 
1,282

 
1,282

Tax-exempt
 
612

 
570

Interest on interest bearing deposits with other banks
 
1

 
2

Total interest income
 
14,743

 
14,070

Interest expense
 
 

 
 

Interest on deposits
 
2,071

 
2,241

Interest on short-term borrowings
 
112

 
53

Interest on long-term borrowings and subordinated debentures
 
1,040

 
1,738

Total interest expense
 
3,223

 
4,032

Net interest income
 
11,520

 
10,038

Provision for loan losses
 
250

 
1,000

Net interest income after provision for loan losses
 
11,270

 
9,038

Other income
 
 

 
 

Insurance commissions
 
1,128

 
1,181

Service fees related to deposit accounts
 
976

 
1,043

Realized securities gains (losses)
 
480

 
(22
)
Bank owned life insurance income
 
261

 
270

Other
 
294

 
311

Total other income
 
3,139

 
2,783

Other expense
 
 

 
 

Salaries, commissions, and employee benefits
 
4,187

 
3,980

Net occupancy expense
 
499

 
541

Equipment expense
 
535

 
566

Professional fees
 
335

 
316

Amortization of intangibles
 
50

 
88

FDIC premiums
 
330

 
502

Foreclosed properties expense
 
208

 
254

Loss on sale of foreclosed properties
 
150

 
75

Write-down of foreclosed properties
 
572

 
928

Other
 
1,338

 
1,248

Total other expense
 
8,204

 
8,498

Income before income taxes
 
6,205

 
3,323

Income tax expense
 
1,920

 
934

Net Income
 
4,285

 
2,389

Dividends on preferred shares
 

 
193

Net Income applicable to common shares
 
$
4,285

 
$
2,196

 
 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.49

 
$
0.29

Diluted earnings per common share
 
$
0.41

 
$
0.25






See Notes to Consolidated Financial Statements 

Table of Contents
5


Consolidated Statement of Comprehensive Income (unaudited)


 
For the Three Months Ended 
 March 31,
Dollars in thousands
2015
 
2014
Net income
$
4,285

 
$
2,389

Other comprehensive income (loss):
 

 
 

Net unrealized (loss) on cashflow hedge of:
2015 - ($1,412), net of deferred taxes of ($522); 2014 - ($1,211), net of deferred taxes of ($448)
(890
)
 
(763
)
Net unrealized gain on available for sale debt securities of:
2015 - $729, net of deferred taxes of $270 and reclassification adjustment for net realized gains included in net income of $480; 2014 - $3,186, net of deferred taxes of $1,179 and reclassification adjustment for net realized (losses) included in net income of ($22)
459

 
2,007

Total comprehensive income
$
3,854

 
$
3,633










































See Notes to Consolidated Financial Statements

Table of Contents
6


Consolidated Statements of Shareholders’ Equity (unaudited)


Dollars in thousands, except per share amounts
Series 2009
Preferred
Stock and
Related
Surplus
 
Series 2011
Preferred
Stock and
Related
Surplus
 
Common
Stock and
Related
Surplus
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
Income
 
Total
Share-
holders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2014
$
3,419

 
$
5,764

 
$
32,670

 
$
87,719

 
$
2,072

 
$
131,644

 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2015
 

 
 

 
 

 
 

 
 

 
 

Comprehensive income:
 

 
 

 
 

 
 

 
 

 
 

Net income

 

 

 
4,285

 

 
4,285

Other comprehensive (loss)

 

 

 

 
(431
)
 
(431
)
Total comprehensive income
 

 
 

 
 

 
 

 
 

 
3,854

Conversion of Series 2009 Preferred Stock to Common Stock
(3,419
)
 

 
3,413

 

 

 
(6
)
Conversion of Series 2011 Preferred Stock to Common Stock

 
(5,764
)
 
5,757

 

 

 
(7
)
Issuance of 237,753 shares of Common Stock

 

 
2,298

 

 

 
2,298

Retirement of 100,000 shares of Common Stock

 

 
(1,080
)
 

 

 
(1,080
)
Reinvested dividends

 

 
14

 
(14
)
 

 

Common Stock cash dividends declared ($0.08 per share)

 

 

 
(814
)
 

 
(814
)
Balance, March 31, 2015
$

 
$

 
$
43,072

 
$
91,176

 
$
1,641

 
$
135,889

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2013
$
3,519

 
$
5,776

 
$
24,664

 
$
77,134

 
$
(21
)
 
$
111,072

 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2014
 

 
 

 
 

 
 

 
 

 
 

Comprehensive income:
 

 
 

 
 

 
 

 
 

 
 

Net income

 

 

 
2,389

 

 
2,389

Other comprehensive income

 

 

 

 
1,244

 
1,244

Total comprehensive income
 

 
 

 
 

 
 

 
 

 
3,633

Exercise of stock options

 

 
15

 

 

 
15

Conversion of Series 2011 Preferred Stock to Common Stock

 
(12
)
 
12

 

 

 

Series 2009 Preferred Stock cash dividends declared ($20.00 per share)

 

 

 
(74
)
 

 
(74
)
Series 2011 Preferred Stock cash dividends declared ($10.00 per share)

 

 

 
(119
)
 

 
(119
)
Balance, March 31, 2014
$
3,519

 
$
5,764

 
$
24,691

 
$
79,330

 
$
1,223

 
$
114,527






See Notes to Consolidated Financial Statements

Table of Contents
7


Consolidated Statements of Cash Flows (unaudited)


 
 
Three Months Ended
Dollars in thousands
 
March 31,
2015
 
March 31,
2014
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
4,285

 
$
2,389

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 

 
 

Depreciation
 
260

 
277

Provision for loan losses
 
250

 
1,000

Deferred income tax (benefit) expense
 
81

 
(144
)
Loans originated for sale
 
(536
)
 
(124
)
Proceeds from loans sold
 
978

 
445

Securities (gains) losses
 
(480
)
 
22

Loss on disposal of assets
 
152

 
75

Write down of foreclosed properties
 
572

 
928

Amortization of securities premiums (accretion of discounts), net
 
1,252

 
1,214

Amortization of intangibles, net
 
53

 
91

Decrease in accrued interest receivable
 
274

 
259

Increase in cash surrender value of bank owned life insurance
 
(261
)
 
(270
)
Increase in other assets
 
(746
)
 
(76
)
Increase in other liabilities
 
1,420

 
1,028

Net cash provided by operating activities
 
7,554

 
7,114

Cash Flows from Investing Activities
 
 

 
 

Proceeds from maturities and calls of securities available for sale
 
365

 
2,051

Proceeds from sales of securities available for sale
 
26,835

 
18,157

Principal payments received on securities available for sale
 
8,621

 
8,782

Purchases of securities available for sale
 
(35,166
)
 
(20,122
)
Purchases of other investments
 
(2,736
)
 
(692
)
Proceeds from sales & redemptions of other investments
 
1,671

 
1,897

Net principal payments received on loans
 
(20,822
)
 
(27,942
)
Purchases of premises and equipment
 
(409
)
 
(110
)
Proceeds from sales of other repossessed assets & property held for sale
 
3,595

 
1,514

Net cash (used in) investing activities
 
(18,046
)
 
(16,465
)
Cash Flows from Financing Activities
 
 

 
 

Net increase (decrease) in demand deposit, NOW and savings accounts
 
(1,706
)
 
51,336

Net decrease in time deposits
 
(1,313
)
 
(2,518
)
Net increase in short-term borrowings
 
25,352

 
6,205

Repayment of long-term borrowings
 
(477
)
 
(40,024
)
Repayment of subordinated debt
 
(11,800
)
 

Net proceeds from issuance of common stock
 
2,298

 

Retirement of common stock
 
(1,080
)
 

Exercise of stock options
 

 
15

Dividends paid on common stock
 
(814
)
 

Dividends paid on preferred stock
 
(191
)
 
(194
)
Net cash provided by financing activities
 
10,269

 
14,820

Increase (decrease) in cash and cash equivalents
 
(223
)
 
5,469

Cash and cash equivalents:
 
 

 
 

Beginning
 
12,510

 
11,782

Ending
 
$
12,287

 
$
17,251

(Continued)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 

Table of Contents
8


Consolidated Statements of Cash Flows (unaudited) - continued


 
 
Three Months Ended
Dollars in thousands
 
March 31,
2015
 
March 31,
2014
Supplemental Disclosures of Cash Flow Information
 
 
 
 
Cash payments for:
 
 
 
 
Interest
 
$
3,242

 
$
4,272

Income taxes
 
$
128

 
$

 
 
 
 
 
Supplemental Schedule of Noncash Investing and Financing Activities
 
 
 
 

Other assets acquired in settlement of loans
 
$
714

 
$
1,297


























































See Notes to Consolidated Financial Statements

Table of Contents
9



NOTE 1.  BASIS OF PRESENTATION

We, Summit Financial Group, Inc. and subsidiaries, prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-Q and Regulation S-X.  Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for annual year end financial statements.  In our opinion, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature.

The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ materially from these estimates.

The results of operations for the quarter ended March 31, 2015 are not necessarily indicative of the results to be expected for the full year.  The consolidated financial statements and notes included herein should be read in conjunction with our 2014 audited financial statements and Annual Report on Form 10-K.  Certain accounts in the consolidated financial statements for December 31, 2014 and March 31, 2014, as previously presented, have been reclassified to conform to current year classifications.

NOTE 2.  SIGNIFICANT NEW AUTHORITATIVE ACCOUNTING GUIDANCE

ASU 2014-1, Investments (Topic 323) - Accounting for Investments in Affordable Housing Projects revises the necessary criteria that need to be met in order for an entity to account for investments in affordable housing projects net of the provision for income taxes. It also changes the method of recognition from an effective amortization approach to a proportional amortization approach. Additional disclosures were also set forth in this update. ASU 2014-1 was effective for us on January 1, 2015 and did not have a significant impact on our financial statements.

ASU 2014-4, Receivables (Topic 310) - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure clarifies that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. ASU 2014-4 was effective for us on January 1, 2015 and did not have a significant impact on our financial statements.

ASU 2014-11, Transfers and Servicing (Topic 860) - Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures requires that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, ASU 2014-11 requires separate accounting for repurchase financings, which entails the transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. ASU 2014-11 requires entities to disclose certain information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements. In addition, ASU 2014-11 requires disclosures related to collateral, remaining contractual tenor and of the potential risks associated with repurchase agreements, securities lending transactions and repurchase-to-maturity transactions. ASU 2014-11 was effective for us on January 1, 2015 and did not have a significant impact on our financial statements.

ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) - Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. ASU 2015-01 is effective for us beginning January 1, 2016, though early adoption is permitted, and is not expected to have a significant impact on our financial statements.

ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs specifies that debt issuance costs related to a recognized liability are to be reported in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. ASU 2015-03 is effective for years beginning after December 31, 2015 and is not expected to have a material impact on our financial statements.

NOTE 3.  FAIR VALUE MEASUREMENTS


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10


ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value.

Level 1:Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3:Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
        
Accordingly, securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, and impaired loans held for investment.  These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Available-for-Sale Securities:  Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.  Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds.  Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities.

Derivative Financial Instruments:  Derivative financial instruments are recorded at fair value on a recurring basis. Fair value measurement is based on pricing models run by a third-party, utilizing observable market-based inputs.  All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  As a result, we classify interest rate swaps as Level 2.

Loans Held for Sale:  Loans held for sale are carried at the lower of cost or market value.  The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics.  As such, we classify loans subject to nonrecurring fair value adjustments as Level 2.

Loans:  We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan loss is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement are considered impaired.  Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, Accounting by Creditors for Impairment of a Loan.  The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the discounted cash flows or collateral value exceeds the recorded investments in such loans. These loans are carried at recorded loan investment, and therefore are not included in the following tables of loans measured at fair value. Impaired loans internally graded as substandard, doubtful, or loss are evaluated using the fair value of collateral method.  All other impaired loans are measured for impairment using the discounted cash flows method. In accordance with ASC Topic 310, impaired loans where an allowance is established based on the fair value of collateral requires classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan as nonrecurring Level 2. When a current appraised value is not available and there is no observable market price, we record the impaired loan as nonrecurring Level 3.  

When impaired loans are deemed required to be included in the fair value hierarchy, management immediately begins the process of evaluating the estimated fair value of the underlying collateral to determine if a related specific allowance for loan losses or charge-off is necessary.  Current appraisals are ordered once a loan is deemed impaired if the existing appraisal is more than twelve months old, or more frequently if there is known deterioration in value. For recently identified impaired

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11


loans, a current appraisal may not be available at the financial statement date. Until the current appraisal is obtained, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the loan’s underlying collateral since the date of the original appraisal.  Such discounts are generally estimated based upon management’s knowledge of sales of similar collateral within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends.  When a new appraisal is received (which generally are received within 3 months of a
loan being identified as impaired), management then re-evaluates the fair value of the collateral and adjusts any specific allocated allowance for loan losses, as appropriate.  In addition, management also assigns a discount of 7–10% for the estimated costs to sell the collateral.

Foreclosed properties:  Foreclosed properties consists of real estate acquired in foreclosure or other settlement of loans. Such assets are carried on the balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs.  The fair value of foreclosed properties is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2).  Updated appraisals of foreclosed properties are generally obtained if the existing appraisal is more than 18 months old or more frequently if there is a known deterioration in value.  However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal.  Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends (Level 3).  Upon foreclosure, any fair value adjustment is charged against the allowance for loan losses.  Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.
 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
March 31, 2015
 
Level 1
 
Level 2
 
Level 3
Available for sale securities
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
22,837

 
$

 
$
22,837

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
156,815

 

 
156,815

 

Nongovernment sponsored entities
11,068

 

 
11,068

 

State and political subdivisions
8,470

 

 
8,470

 

Corporate debt securities
6,665

 

 
2,876

 
3,789

Other equity securities
7

 

 
7

 

Tax-exempt state and political subdivisions
76,273

 

 
76,273

 

Total available for sale securities
$
282,135

 
$

 
$
278,346

 
$
3,789

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
4,292

 
$

 
$
4,292

 
$

 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
Available for sale securities
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
23,174

 
$

 
$
23,174

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
149,777

 

 
149,777

 

Nongovernment sponsored entities
12,145

 

 
12,145

 

State and political subdivisions
8,694

 

 
8,694

 

Corporate debt securities
3,776

 

 

 
3,776

Other equity securities
7

 

 
7

 

Tax-exempt state and political subdivisions
85,261

 

 
85,261

 

Total available for sale securities
$
282,834

 
$

 
$
279,058

 
$
3,776

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
2,911

 
$

 
$
2,911

 
$




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12


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  Assets measured at fair value on a nonrecurring basis are included in the table below.
 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
March 31, 2015
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
85

 
$

 
$
85

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Commercial
$

 
$

 
$

 
$

Commercial real estate
170

 

 
170

 

Construction and development
722

 

 
722

 

Residential real estate
1,424

 

 
1,424

 

Total collateral-dependent impaired loans
$
2,316

 
$

 
$
2,316

 
$

 
 
 
 
 
 
 
 
Foreclosed properties
 

 
 

 
 

 
 

Commercial real estate
2,346

 

 
2,346

 

Construction and development
20,198

 

 
20,124

 
74

Residential real estate
1,669

 

 
773

 
896

Total foreclosed properties
$
24,213

 
$

 
$
23,243

 
$
970



 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
527

 
$

 
$
527

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Commercial
$
44

 

 
$

 
$
44

Commercial real estate
344

 

 
344

 

Construction and development
852

 

 
852

 

Residential real estate
312

 

 
312

 

Total collateral-dependent impaired loans
$
1,552

 
$

 
$
1,508

 
$
44

 
 
 
 
 
 
 
 
Foreclosed properties
 

 
 

 
 

 
 

Commercial real estate
3,892

 

 
3,892

 

Construction and development
20,952

 

 
20,841

 
111

Residential real estate
2,025

 

 
2,025

 

Total foreclosed properties
$
26,869

 
$

 
$
26,758

 
$
111


ASC Topic 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.  The following summarizes the methods and significant assumptions we used in estimating our fair value disclosures for financial instruments.

Cash and cash equivalents:  The carrying values of cash and cash equivalents approximate their estimated fair value.

Interest bearing deposits with other banks:  The carrying values of interest bearing deposits with other banks approximate their estimated fair values.

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.

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13



Loans:  The estimated fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms to borrowers of similar credit quality.  No prepayments of principal are assumed.

Accrued interest receivable and payable:  The carrying values of accrued interest receivable and payable approximate their estimated fair values.

Deposits:  The estimated fair values of demand deposits (i.e. non-interest bearing checking, NOW, 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.

Subordinated debentures:  The carrying values of subordinated debentures approximate their estimated fair values.

Subordinated debentures owed to unconsolidated subsidiary trusts:  The carrying values of subordinated debentures owed to unconsolidated subsidiary trusts approximate their estimated fair values.

Derivative financial instruments:  The fair value of the interest rate swaps is valued using independent pricing models.

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:
 
 
March 31, 2015
 
December 31, 2014
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Carrying
Value
 
Estimated
Fair
Value
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
12,287

 
$
12,287

 
$
12,510

 
$
12,510

Securities available for sale
 
282,135

 
282,135

 
282,834

 
282,834

Other investments
 
7,247

 
7,247

 
6,183

 
6,183

Loans held for sale, net
 
85

 
85

 
527

 
527

Loans, net
 
1,039,669

 
1,054,159

 
1,019,842

 
1,033,890

Accrued interest receivable
 
5,564

 
5,564

 
5,838

 
5,838

 
 
$
1,346,987

 
$
1,361,477

 
$
1,327,734

 
$
1,341,782

Financial liabilities
 
 

 
 

 
 

 
 

Deposits
 
$
1,058,308

 
$
1,075,963

 
$
1,061,314

 
$
1,078,406

Short-term borrowings
 
148,985

 
148,985

 
123,633

 
123,633

Long-term borrowings
 
77,013

 
84,146

 
77,490

 
84,732

Subordinated debentures
 
5,000

 
5,000

 
16,800

 
16,800

Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 
19,589

 
19,589

Accrued interest payable
 
828

 
828

 
812

 
812

Derivative financial liabilities
 
4,292

 
4,292

 
2,911

 
2,911

 
 
$
1,314,015

 
$
1,338,803

 
$
1,302,549

 
$
1,326,883


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14



NOTE 4.  EARNINGS PER SHARE

The computations of basic and diluted earnings per share follow:
 
 
For the Three Months Ended March 31,
 
 
2015
 
2014
Dollars in thousands,
except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
4,285

 
 
 
 
 
$
2,389

 
 
 
 
Less preferred stock dividends
 

 
 
 
 
 
(193
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic EPS
 
$
4,285

 
8,815,961

 
$
0.49

 
$
2,196

 
7,453,370

 
$
0.29

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 
 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
8,567

 
 

 
 
 
9,762

 
 

Series 2011 convertible
preferred stock
 

 
1,158,250

 
 

 
119

 
1,491,250

 
 

Series 2009 convertible
preferred stock
 

 
510,545

 
 
 
74

 
674,545

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted EPS
 
$
4,285

 
10,493,323

 
$
0.41

 
$
2,389

 
9,628,927

 
$
0.25


Stock option grants and the convertible preferred shares are disregarded in this computation if they are determined to be anti-dilutive.  Our anti-dilutive stock options at March 31, 2015 and 2014 totaled 128,900 shares and 143,000 shares, respectively.

NOTE 5.  SECURITIES

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at March 31, 2015, December 31, 2014, and March 31, 2014 are summarized as follows:
 
March 31, 2015
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
21,650

 
$
1,227

 
$
40

 
$
22,837

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
153,904

 
3,412

 
501

 
156,815

Nongovernment-sponsored entities
11,034

 
105

 
71

 
11,068

State and political subdivisions
 

 
 

 
 

 
 

General obligations
1,617

 
34

 

 
1,651

Water and sewer revenues
1,969

 
21

 

 
1,990

Lottery/casino revenues
3,084

 
9

 
28

 
3,065

Other revenues
1,697

 
67

 

 
1,764

Corporate debt securities
6,675

 

 
10

 
6,665

Total taxable debt securities
201,630

 
4,875

 
650

 
205,855

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
47,947

 
2,050

 
136

 
49,861

Water and sewer revenues
10,302

 
278

 
1

 
10,579

Special tax revenues
2,272

 
53

 

 
2,325

Lottery/casino revenues
2,800

 
163

 

 
2,963

Other revenues
10,246

 
313

 
14

 
10,545

Total tax-exempt debt securities
73,567

 
2,857

 
151

 
76,273

Equity securities
7

 

 

 
7

Total available for sale securities
$
275,204

 
$
7,732

 
$
801

 
$
282,135



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15



 
December 31, 2014
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
22,153

 
$
1,073

 
$
52

 
$
23,174

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
147,951

 
2,599

 
773

 
149,777

Nongovernment-sponsored entities
12,051

 
142

 
48

 
12,145

State and political subdivisions
 

 
 

 
 

 
 

General obligations
1,975

 
2

 
33

 
1,944

Water and sewer revenues
1,976

 
14

 
7

 
1,983

Other revenues
4,696

 
73

 
2

 
4,767

Corporate debt securities
3,776

 

 

 
3,776

Total taxable debt securities
194,578

 
3,903

 
915

 
197,566

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
49,515

 
2,338

 
12

 
51,841

Water and sewer revenues
11,258

 
244

 
3

 
11,499

Lease revenues
4,617

 
75

 
10

 
4,682

Lottery/casino revenues
3,811

 
206

 
9

 
4,008

Other revenues
12,845

 
404

 
18

 
13,231

Total tax-exempt debt securities
82,046

 
3,267

 
52

 
85,261

Equity securities
7

 

 

 
7

Total available for sale securities
$
276,631

 
$
7,170

 
$
967

 
$
282,834

 
March 31, 2014
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities:
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
27,658

 
$
736

 
$
78

 
$
28,316

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
142,644

 
2,230

 
1,060

 
143,814

Nongovernment-sponsored agencies
10,429

 
377

 
19

 
10,787

State and political subdivisions:


 


 


 


       General obligations
5,681

 
7

 
209

 
5,479

       Water and sewer revenues
2,389

 
8

 
60

 
2,337

        Other revenues
3,021

 

 
106

 
2,915

Corporate debt securities
3,977

 
25

 
4

 
3,998

Total taxable debt securities
195,799

 
3,383

 
1,536

 
197,646

Tax-exempt debt securities:
 

 
 

 
 

 
 

State and political subdivisions:


 


 


 


        General obligations
45,761

 
1,109

 
504

 
46,366

        Water and sewer revenues
14,033

 
64

 
110

 
13,987

        Lease revenues
9,079

 
47

 
168

 
8,958

        Lottery/casino revenues
4,428

 
102

 
79

 
4,451

        Other revenues
10,334

 
115

 
69

 
10,380

Total tax-exempt debt securities
83,635

 
1,437

 
930

 
84,142

Equity securities
77

 

 

 
77

Total available for sale securities
$
279,511

 
$
4,820

 
$
2,466

 
$
281,865


The below information is relative to the five states where issuers with the highest volume of state and political subdivision securities held in our portfolio are located.  We own no such securities of any single issuer which we deem to be a concentration.

Table of Contents
16


 
March 31, 2015
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
 
 
 
 
 
 
 
 
West Virginia
$
13,083

 
$
314

 
$
1

 
$
13,396

Illinois
12,503

 
378

 
26

 
12,855

California
10,999

 
527

 
25

 
11,501

Ohio
7,621

 
39

 
26

 
7,634

Washington
5,845

 
283

 
40

 
6,088


Management performs pre-purchase and ongoing analysis to confirm that all investment securities meet applicable credit quality standards.  Prior to July 1, 2013, we principally used credit ratings from Nationally Recognized Statistical Rating Organizations (“NRSROs”) to support analyses of our portfolio of securities issued by state and political subdivisions, as we generally do not purchase securities that are rated below the six highest NRSRO rating categories.  Beginning July 1, 2013, in addition to considering a security’s NRSRO rating, we now also assess or confirm through an internal review of an issuer’s financial information and other applicable information that:  1) the issuer’s risk of default is low; 2) the characteristics of the issuer’s demographics and economic environment are satisfactory; and 3) the issuer’s budgetary position and stability of tax or other revenue sources are sound.

The maturities, amortized cost and estimated fair values of securities at March 31, 2015, are summarized as follows:
Dollars in thousands
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
63,900

 
$
65,018

Due from one to five years
 
98,613

 
100,486

Due from five to ten years
 
24,470

 
25,230

Due after ten years
 
88,214

 
91,394

Equity securities
 
7

 
7

 
 
$
275,204

 
$
282,135


The proceeds from sales, calls and maturities of available for sale securities, including principal payments received on mortgage-backed obligations, and the related gross gains and losses realized, for the three months ended March 31, 2015 are as follows:
 
 
Proceeds from
 
Gross realized
Dollars in thousands
 
Sales
 
Calls and
Maturities
 
Principal
Payments
 
Gains
 
Losses
Securities available for sale
 
$
26,835

 
$
365

 
$
8,621

 
$
549

 
$
69


We held 44 available for sale securities having an unrealized loss at March 31, 2015.  We do not intend to sell these securities, and it is more likely than not that we will not be required to sell these securities before recovery of their amortized cost bases.  We believe that this decline in value is primarily attributable to the lack of market liquidity and to changes in market interest rates and not due to credit quality.  Accordingly, no additional other-than-temporary impairment charge to earnings is warranted at this time.


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17


Provided below is a summary of securities available for sale which were in an unrealized loss position at March 31, 2015 and December 31, 2014, including debt securities for which a portion of other-than-temporary impairment has been recognized in other comprehensive income.
 
March 31, 2015
 
Less than 12 months
 
12 months or more
 
Total
Dollars in thousands
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
Temporarily impaired securities
 
 
 
 
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$

 
$

 
$
3,599

 
$
40

 
$
3,599

 
$
40

Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
26,814

 
457

 
4,080

 
44

 
30,894

 
501

Nongovernment-sponsored entities
6,718

 
71

 

 

 
6,718

 
71

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

Lottery/casino revenues
1,834

 
28

 

 

 
1,834

 
28

Corporate debt securities
2,875

 
10

 

 

 
2,875

 
10

Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
10,165

 
136

 

 

 
10,165

 
136

Water and sewer revenues
284

 
1

 

 

 
284

 
1

Other revenues
573

 
8

 
267

 
6

 
840

 
14

Total temporarily impaired securities
49,263

 
711

 
7,946

 
90

 
57,209

 
801

Total other-than-temporarily
 

 
 

 
 

 
 

 
 

 
 

impaired securities

 

 

 

 

 

Total
$
49,263

 
$
711

 
$
7,946

 
$
90

 
$
57,209

 
$
801







Table of Contents
18


 
December 31, 2014
 
Less than 12 months
 
12 months or more
 
Total
Dollars in thousands
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
Temporarily impaired securities
 
 
 
 
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$

 
$

 
$
3,912

 
$
(52
)
 
$
3,912

 
$
(52
)
Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
36,825

 
(535
)
 
21,915

 
(238
)
 
58,740

 
(773
)
Nongovernment-sponsored entities
5,488

 
(44
)
 
2,163

 
(4
)
 
7,651

 
(48
)
State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations

 

 
316

 
(33
)
 
316

 
(33
)
Water and sewer revenues

 

 
817

 
(7
)
 
817

 
(7
)
Other revenues
1,098

 
(2
)
 

 

 
1,098

 
(2
)
Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
3,708

 
(8
)
 
438

 
(4
)
 
4,146

 
(12
)
Water and sewer revenues
721

 
(3
)
 

 

 
721

 
(3
)
Lease revenues

 

 
1,168

 
(10
)
 
1,168

 
(10
)
Lottery/casino revenues

 

 
1,126

 
(9
)
 
1,126

 
(9
)
Other revenues
1,247

 
(8
)
 
846

 
(10
)
 
2,093

 
(18
)
Total temporarily impaired securities
49,087

 
(600
)
 
32,701

 
(367
)
 
81,788

 
(967
)
Total other-than-temporarily
 

 
 

 
 

 
 

 
 

 
 

impaired securities

 

 

 

 

 

Total
$
49,087

 
$
(600
)
 
$
32,701

 
$
(367
)
 
$
81,788

 
$
(967
)

NOTE 6.  LOANS

Loans are generally stated at the amount of unpaid principal, reduced by unearned discount and allowance for loan losses. Interest on loans 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. We categorize residential real estate loans in excess of $600,000 as jumbo loans.

Generally, loans are placed on nonaccrual 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 nonaccrual status.  Impaired loans are placed on nonaccrual 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 nonaccrual loans is recognized primarily using the cost-recovery method.  Loans may be returned to accrual status when repayment is reasonably assured and there has been demonstrated performance under the terms of the loan or, if applicable, the terms of the restructured loans.

Commercial-related loans or portions thereof (which are risk-rated) are charged off to the allowance for loan losses when the loss has been confirmed.  This determination is made on a case by case basis considering many factors, including the prioritization of our claim in bankruptcy, expectations of the workout/restructuring of the loan and valuation of the borrower’s equity.  We deem a loss confirmed when a loan or a portion of a loan is classified “loss” in accordance with bank regulatory classification guidelines, which state, “Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted”.
 
Consumer-related loans are generally charged off to the allowance for loan losses upon reaching specified stages of delinquency, in accordance with the Federal Financial Institutions Examination Council policy.  For example, credit card loans are charged off by the end of the month in which the account becomes 180 days past due or within 60 days from receiving notification about a specified event (e.g., bankruptcy of the borrower), which ever is earlier.  Residential mortgage loans are generally charged off to net realizable value no later than when the account becomes 180 days past due.  Other consumer loans, if collateralized, are generally charged off to net realizable value at 120 days past due.




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19


Loans are summarized as follows:
Dollars in thousands
 
March 31,
2015
 
December 31,
2014
 
March 31,
2014
Commercial
 
$
89,928

 
$
88,590

 
$
93,517

Commercial real estate
 
 

 
 

 
 

Owner-occupied
 
180,269

 
157,783

 
150,025

Non-owner occupied
 
325,764

 
317,136

 
297,197

Construction and development
 
 

 
 

 
 

Land and land development
 
66,558

 
67,881

 
67,342

Construction
 
19,094

 
28,591

 
18,327

Residential real estate
 
 

 
 

 
 

Non-jumbo
 
219,938

 
220,071

 
215,665

Jumbo
 
50,492

 
52,879

 
51,406

Home equity
 
68,894

 
67,115

 
56,161

Consumer
 
18,485

 
19,456

 
19,106

Other
 
11,074

 
11,507

 
5,037

Total loans, net of unearned fees
 
1,050,496

 
1,031,009

 
973,783

Less allowance for loan losses
 
10,827

 
11,167

 
11,069

Loans, net
 
$
1,039,669

 
$
1,019,842

 
$
962,714


The following table presents the contractual aging of the recorded investment in past due loans by class as of March 31, 2015 and 2014 and December 31, 2014.
 
At March 31, 2015
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
388

 
$

 
$
744

 
$
1,132

 
$
88,796

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
119

 

 
629

 
748

 
179,521

 

Non-owner occupied
664

 

 
406

 
1,070

 
324,694

 

Construction and development
 

 
 

 
 

 
 

 
 

 
 

Land and land development
1,376

 
1,361

 
4,980

 
7,717

 
58,841

 

Construction

 

 

 

 
19,094

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
2,891

 
1,090

 
1,888

 
5,869

 
214,069

 

Jumbo

 

 
713

 
713

 
49,779

 

Home equity
395

 

 
172

 
567

 
68,327

 

Consumer
139

 
62

 
22

 
223

 
18,262

 

Other

 

 

 

 
11,074

 

Total
$
5,972

 
$
2,513

 
$
9,554

 
$
18,039

 
$
1,032,457

 
$

 

Table of Contents
20


 
At December 31, 2014
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
328

 
$
117

 
$
330

 
$
775

 
$
87,815

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
121

 
194

 
801

 
1,116

 
156,667

 

Non-owner occupied
146

 

 
406

 
552

 
316,584

 

Construction and development
 
 
 

 
 

 
 

 
 

 
 

Land and land development
346

 
2,002

 
4,253

 
6,601

 
61,280

 

Construction

 

 

 

 
28,591

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
4,104

 
2,719

 
1,498

 
8,321

 
211,750

 

Jumbo

 

 
2,626

 
2,626

 
50,253

 

Home equity
1,067

 
94

 
83

 
1,244

 
65,871

 

Consumer
260

 
42

 
63

 
365

 
19,091

 

Other

 

 

 

 
11,507

 

Total
$
6,372

 
$
5,168

 
$
10,060

 
$
21,600

 
$
1,009,409

 
$


 
At March 31, 2014
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
52

 
$
50

 
$
796

 
$
898

 
$
92,619

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied

 
236

 
125

 
361

 
149,664

 

Non-owner occupied
1,076

 

 
768

 
1,844

 
295,353

 

Construction and development
 

 
 

 
 

 
 

 
 

 
 

Land and land development
754

 

 
6,123

 
6,877

 
60,465

 

Construction

 

 

 

 
18,327

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
2,780

 
804

 
1,821

 
5,405

 
210,260

 

Jumbo
712

 

 

 
712

 
50,694

 

Home equity
75

 

 
69

 
144

 
56,017

 

Consumer
207

 
32

 
45

 
284

 
18,822

 

Other

 

 

 

 
5,037

 

Total
$
5,656

 
$
1,122

 
$
9,747

 
$
16,525

 
$
957,258

 
$


Nonaccrual loans:  The following table presents the nonaccrual loans included in the net balance of loans at March 31, 2015, December 31, 2014 and March 31, 2014.
 
 
March 31,
 
December 31,
Dollars in thousands
 
2015
 
2014
 
2014
Commercial
 
$
788

 
$
866

 
$
392

Commercial real estate
 
 

 
 

 
 

Owner-occupied
 
934

 
2,404

 
1,218

Non-owner occupied
 
406

 
430

 
626

Construction and development
 
 

 
 

 
 

Land & land development
 
5,333

 
10,252

 
4,619

Construction
 

 

 

Residential mortgage
 
 

 
 

 
 

Non-jumbo
 
3,429

 
2,593

 
2,663

Jumbo
 
713

 

 
2,626

Home equity
 
349

 
297

 
267

Consumer
 
65

 
73

 
83

Total
 
$
12,017

 
$
16,915

 
$
12,494

 

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21


Impaired loans:  Impaired loans include the following:

Loans which we risk-rate (consisting of loan relationships having aggregate balances in excess of $2.0 million, or loans exceeding $500,000 and exhibiting credit weakness) through our normal loan review procedures and which, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement.   Risk-rated loans with insignificant delays or insignificant short falls in the amount of payments expected to be collected are not considered to be impaired.

Loans that have been modified in a troubled debt restructuring.

Both commercial and consumer loans are deemed impaired upon being contractually modified in a troubled debt restructuring. Troubled debt restructurings typically result from our loss mitigation activities and occur when we grant a concession to a borrower who is experiencing financial difficulty in order to minimize our economic loss and to avoid foreclosure or repossession of collateral.  Once restructured in a troubled debt restructuring, a loan is generally considered impaired until its maturity, regardless of whether the borrower performs under the modified terms.  Although such a loan may be returned to accrual status if the criteria set forth in our accounting policy are met, the loan would continue to be evaluated for an asset-specific allowance for loan losses and we would continue to report the loan in the impaired loan table below.

The table below sets forth information about our impaired loans.

Method Used to Measure Impairment of Impaired Loans
 
 
Dollars in thousands
 
 
 
 
 
 
 
 
March 31,
 
December 31,
 
Method used to measure impairment
Loan Category
2015
 
2014
 
2014
 
Commercial
$
44

 
$
899

 
$
132

 
Fair value of collateral
 
337

 

 
362

 
Discounted cash flow
Commercial real estate
 

 
 

 
 
 
 
Owner-occupied
5,665

 
4,856

 
1,683

 
Fair value of collateral
 
9,056

 
7,598

 
9,124

 
Discounted cash flow
Non-owner occupied
1,633

 
518

 
508

 
Fair value of collateral
 
6,184

 
5,259

 
5,999

 
Discounted cash flow
Construction and development
 
 
 
 
 
 
 
Land & land development
11,733

 
16,107

 
11,998

 
Fair value of collateral
 
2,286

 
1,457

 
2,310

 
Discounted cash flow
Residential mortgage
 

 
 
 
 
 
 
Non-jumbo
1,719

 
3,450

 
1,676

 
Fair value of collateral
 
4,677

 
2,603

 
5,252

 
Discounted cash flow
Jumbo
5,672

 
6,644

 
7,594

 
Fair value of collateral
 
884

 
2,086

 
886

 
Discounted cash flow
Home equity
186

 
186

 
285

 
Fair value of collateral
 
523

 

 
523

 
Discounted cash flow
Consumer
2

 
40

 
2

 
Fair value of collateral
 
78

 

 
82

 
Discounted cash flow
Total
$
50,679

 
$
51,703

 
$
48,416

 
 


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22


The following tables present loans individually evaluated for impairment at March 31, 2015, December 31, 2014 and March 31, 2014.
 
March 31, 2015
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
381

 
$
381

 
$

 
$
381

 
$
21

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
9,312

 
9,312

 

 
5,364

 
180

Non-owner occupied
5,183

 
5,185

 

 
3,858

 
180

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
13,121

 
13,121

 

 
13,121

 
436

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
3,763

 
3,772

 

 
3,772

 
167

Jumbo
5,669

 
5,672

 

 
5,672

 
235

Home equity
710

 
709

 

 
709

 
31

Consumer
80

 
80

 

 
80

 
7

Total without a related allowance
$
38,219

 
$
38,232

 
$

 
$
32,957

 
$
1,257

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$

 
$

 
$

 
$

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
5,409

 
5,409

 
255

 
5,409

 
215

Non-owner occupied
2,632

 
2,632

 
21

 
2,632

 
123

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
898

 
898

 
176

 
898

 

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
2,623

 
2,624

 
276

 
2,624

 
119

Jumbo
883

 
884

 
43

 
884

 
44

Home equity

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
12,445

 
$
12,447

 
$
771

 
$
12,447

 
$
501

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
36,936

 
$
36,938

 
$
452

 
$
31,663

 
$
1,155

Residential real estate
13,648

 
13,661

 
319

 
13,661

 
596

Consumer
80

 
80

 

 
80

 
7

Total
$
50,664

 
$
50,679

 
$
771

 
$
45,404

 
$
1,758







Table of Contents
23


 
December 31, 2014
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
370

 
$
369

 
$

 
$
430

 
$
27

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
5,362

 
5,361

 

 
5,309

 
192

Non-owner occupied
3,645

 
3,647

 

 
4,420

 
199

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
13,410

 
13,410

 

 
14,149

 
483

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
4,289

 
4,300

 

 
3,853

 
185

Jumbo
7,589

 
7,594

 

 
7,761

 
241

Home equity
809

 
808

 

 
265

 
14

Consumer
84

 
84

 

 
36

 
2

Total without a related allowance
$
35,558

 
$
35,573

 
$

 
$
36,223

 
$
1,343

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$
125

 
$
125

 
$
81

 
$
38

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
5,446

 
5,446

 
287

 
5,461

 
216

Non-owner occupied
2,860

 
2,860

 
74

 
1,003

 
40

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
898

 
898

 
46

 
933

 
42

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
2,627

 
2,628

 
282

 
2,093

 
98

Jumbo
885

 
886

 
46

 
892

 
45

Home equity

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
12,841

 
$
12,843

 
$
816

 
$
10,420

 
$
441

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
32,116

 
$
32,116

 
$
488

 
$
31,743

 
$
1,199

Residential real estate
16,199

 
16,216

 
328

 
14,864

 
583

Consumer
84

 
84

 

 
36

 
2

Total
$
48,399

 
$
48,416

 
$
816

 
$
46,643

 
$
1,784





 

Table of Contents
24


 
March 31, 2014
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
824

 
$
824

 
$

 
$
824

 
$
27

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
7,836

 
7,836

 

 
7,836

 
231

Non-owner occupied
5,035

 
5,037

 

 
5,037

 
249

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
11,793

 
11,793

 

 
11,793

 
323

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
3,209

 
3,217

 

 
3,217

 
140

Jumbo
7,828

 
7,833

 

 
7,833

 
401

Home equity
186

 
186

 

 
186

 
11

Consumer
40

 
40

 

 
40

 
3

Total without a related allowance
$
36,751

 
$
36,766

 
$

 
$
36,766

 
$
1,385

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$
75

 
$
75

 
$
18

 
$
75

 
$
5

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
4,618

 
4,618

 
324

 
4,618

 
213

Non-owner occupied
740

 
740

 
85

 
740

 
28

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
5,771

 
5,771

 
2,553

 
5,771

 
40

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
2,835

 
2,836

 
337

 
2,836

 
134

Jumbo
896

 
897

 
56

 
897

 
45

Home equity

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
14,935

 
$
14,937

 
$
3,373

 
$
14,937

 
$
465

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
36,692

 
$
36,694

 
$
2,980

 
$
36,694

 
$
1,116

Residential real estate
14,954

 
14,969

 
393

 
14,969

 
731

Consumer
40

 
40

 

 
40

 
3

Total
$
51,686

 
$
51,703

 
$
3,373

 
$
51,703

 
$
1,850


A modification of a loan is considered a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession that we would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of both.  A loan continues to be classified as a TDR for the life of the loan.  Included in impaired loans are TDRs of $32.9 million, of which $30.2 million were current with respect to restructured contractual payments at March 31, 2015, and $34.7 million, of which $32.2 million were current with respect to restructured contractual payments at December 31, 2014.  There were no commitments to lend additional funds under these restructurings at either balance sheet date.

There were no TDRs that were restructured during the three months ended March 31, 2015 or 2014.  Generally, modifications are extensions of term, modifying the payment terms from principal and interest to interest only for an extended period, or reduction in interest rate.  All TDRs are evaluated individually for allowance for loan loss purposes.



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25


The following table presents defaults during the stated period of TDRs that were restructured during the past twelve months.  For purposes of these tables, a default is considered as either the loan was past due 30 days or more at any time during the period, or the loan was fully or partially charged off during the period. 
 
For the Three Months Ended 
 March 31, 2015
Dollars in thousands
Number
of
Defaults
 
Recorded
Investment
at Default Date
Commercial
1

 
$
27

Commercial real estate


 


Owner-occupied

 

Non-owner occupied

 

Construction and development

 


Land & land development

 

Construction

 

Residential real estate


 


Non-jumbo
3

 
833

Jumbo

 

Home equity

 

Consumer
1

 
17

Total
5

 
$
877


The following table details the activity regarding TDRs by loan type for the three months and three months ended March 31, 2015, and the related allowance on TDRs.
For the Three Months Ended March 31, 2015
 
Construction & Land Development
 
 
 
Commercial Real Estate
 
Residential Real Estate
 
 
 
 
 
 
Dollars in thousands
Land &
Land
Develop-
ment
 
Construc-
tion
 
Commer-
cial
 
Owner
Occupied
 
Non-
Owner
Occupied
 
Non-
jumbo
 
Jumbo
 
Home
Equity
 
Con-
sumer
 
Other
 
Total
Troubled debt restructurings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance January 1, 2015
$
5,786

 
$

 
$
410

 
$
9,501

 
$
6,219

 
$
6,245

 
$
5,937

 
$
523

 
$
50

 
$

 
$
34,671

Additions

 

 

 

 

 

 

 

 

 

 

Charge-offs

 

 

 

 

 

 

 

 

 

 

Net (paydowns) advances
(28
)
 

 
(29
)
 
(73
)
 
(35
)
 
(423
)
 
(1,206
)
 

 
(4
)
 

 
(1,798
)
Transfer into foreclosed properties

 

 

 

 

 

 

 

 

 

 

Refinance out of TDR status

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2015
$
5,758

 
$

 
$
381

 
$
9,428

 
$
6,184

 
$
5,822

 
$
4,731

 
$
523

 
$
46

 
$

 
$
32,873

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to troubled debt restructurings
$
168

 
$

 
$

 
$
209

 
$
21

 
$
276

 
$
43

 
$

 
$

 
$

 
$
717


We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk.  We internally grade all commercial loans at the time of loan origination. In addition, we perform an annual loan review on all non-homogenous commercial loan relationships with an aggregate exposure of $2 million, at which time these loans are re-graded. We use the following definitions for our risk grades:

Pass: Loans graded as Pass are loans to borrowers of acceptable credit quality and risk. They are higher quality loans that do not fit any of the other categories described below.


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26


OLEM (Special Mention):  Commercial loans categorized as OLEM are potentially weak. The credit risk may be relatively minor yet represent a risk given certain specific circumstances. If the potential weaknesses are not monitored or mitigated, the asset may weaken or inadequately protect our position in the future.

Substandard:   Commercial loans categorized as Substandard are inadequately protected by the borrower’s ability to repay, equity, and/or the collateral pledged to secure the loan. These loans have identified weaknesses that could hinder normal repayment or collection of the debt. These loans are characterized by the distinct possibility that we will sustain some loss if the identified weaknesses are not mitigated.

Doubtful:  Commercial loans categorized as Doubtful have all the weaknesses inherent in those loans classified as Substandard, with the added elements that the full collection of the loan is improbable and the possibility of loss is high.

Loss:  Loans classified as loss are considered to be non-collectible and of such little value that their continuance as a bankable asset is not warranted. This does not mean that the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future.

The following table presents the recorded investment in construction and development, commercial, and commercial real estate loans which are generally evaluated based upon the internal risk ratings defined above.
Loan Risk Profile by Internal Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and Development
 
 
 
 
 
Commercial Real Estate
 
Land and Land Development
 
Construction
 
Commercial
 
Owner Occupied
 
Non-Owner Occupied
Dollars in thousands
3/31/2015
 
12/31/2014
 
3/31/2015
 
12/31/2014
 
3/31/2015
 
12/31/2014
 
3/31/2015
 
12/31/2014
 
3/31/2015
 
12/31/2014
Pass
$
52,284

 
$
53,873

 
$
19,094

 
$
28,591

 
$
87,582

 
$
86,361

 
$
177,752

 
$
155,189

 
$
315,360

 
$
306,710

OLEM (Special Mention)
2,452

 
1,673

 

 

 
1,702

 
1,837

 
1,275

 
1,064

 
3,798

 
8,933

Substandard
11,822

 
12,335

 

 

 
644

 
392

 
1,242

 
1,530

 
6,606

 
1,493

Doubtful

 

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

 

Total
$
66,558

 
$
67,881

 
$
19,094

 
$
28,591

 
$
89,928

 
$
88,590

 
$
180,269

 
$
157,783

 
$
325,764

 
$
317,136

 
The following table presents the recorded investment in consumer, residential real estate, and home equity loans, which are generally evaluated based on the aging status of the loans, which was previously presented, and payment activity.
 
Performing
 
Nonperforming
Dollars in thousands
3/31/2015
 
12/31/2014
 
3/31/2014
 
3/31/2015
 
12/31/2014
 
3/31/2014
Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
$
216,509

 
$
217,408

 
$
213,071

 
$
3,429

 
$
2,663

 
$
2,594

Jumbo
49,779

 
50,253

 
51,406

 
713

 
2,626

 

Home Equity
68,545

 
66,848

 
55,865

 
349

 
267

 
296

Consumer
18,420

 
19,373

 
19,033

 
65

 
83

 
73

Other
11,074

 
11,507

 
5,037

 

 

 

Total
$
364,327

 
$
365,389

 
$
344,412

 
$
4,556

 
$
5,639

 
$
2,963


Loan commitments:  ASC Topic 815, Derivatives and Hedging, requires that commitments to make mortgage loans should be accounted for as derivatives if the loans are to be held for sale, because the commitment represents a written option and accordingly is recorded at the fair value of the option liability.

NOTE 7.  ALLOWANCE FOR LOAN LOSSES

We maintain the allowance for loan losses at a level considered adequate to provide for estimated probable credit losses inherent in the loan portfolio.  The allowance is comprised of three distinct reserve components:  (1) specific reserves related to loans individually evaluated, (2) quantitative reserves related to loans collectively evaluated, and (3) qualitative reserves related to loans collectively evaluated.  A summary of the methodology we employ on a quarterly basis with respect to each of these components in order to evaluate the overall adequacy of our allowance for loan losses is as follows:


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27


Specific Reserve for Loans Individually Evaluated

First, we identify loan relationships having aggregate balances in excess of $500,000 and that may also have credit weaknesses.  Such loan relationships are identified primarily through our analysis of internal loan evaluations, past due loan reports, and loans adversely classified by regulatory authorities.  Each loan so identified is then individually evaluated to determine whether it is impaired – that is, 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 underlying loan agreement.  Substantially all of our impaired loans historically have been collateral dependent, meaning repayment of the loan is expected or is considered to be provided solely from the sale of the loan’s underlying collateral.  For such loans, we measure impairment based on the fair value of the loan’s collateral, which is generally determined utilizing current appraisals.  A specific reserve is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over the fair value of its underlying collateral, less estimated costs to sell. Our policy is to re-evaluate the fair value of collateral dependent loans at least every twelve months unless there is a known deterioration in the collateral’s value, in which case a new appraisal is obtained. Beginning in 2014, for purposes of loans that have been modified in a troubled debt restructuring and not internally graded as substandard, doubtful, or loss("performing TDRs") we began measuring impairment using the discounted cash flows method. Under this method, a specific reserve is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over its discounted cash flows.
 
Quantitative Reserve for Loans Collectively Evaluated
 
Second, we stratify the loan portfolio into the following ten loan pools:  land and land development, construction, commercial, commercial real estate -- owner-occupied, commercial real estate -- non-owner occupied, conventional residential mortgage, jumbo residential mortgage, home equity, consumer, and other.  Quantitative reserves relative to each loan pool are established as follows:  for all loan segments detailed above an allocation equaling 100% of the respective pool’s average 12 month historical net loan charge-off rate (determined based upon the most recent twelve quarters) is applied to the aggregate recorded investment in the pool of loans.
 
Qualitative Reserve for Loans Collectively Evaluated
 
Third, we consider the necessity to adjust our average historical net loan charge-off rates relative to each of the above ten loan pools for potential risks factors that could result in actual losses deviating from prior loss experience.  For example, if we observe a significant increase in delinquencies within the conventional mortgage loan pool above historical trends, an additional allocation to the average historical loan charge-off rate is applied.  Such qualitative risk factors considered are:  (1) levels of and trends in delinquencies and impaired loans, (2) levels of and trends in charge-offs and recoveries, (3)trends in volume and term of loans, (4) effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures, and practice, (5) experience, ability, and depth of lending management and other relevant staff, (6) national and local economic trends and conditions, (7) industry conditions, and (8) effects of changes in credit concentrations.


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An analysis of the allowance for loan losses for the three month periods ended March 31, 2015 and 2014, and for the year ended December 31, 2014 is as follows:
 
 
Three Months Ended 
 March 31,
 
Year Ended 
 December 31,
Dollars in thousands
 
2015
 
2014
 
2014
 
 
 
 
 
 
 
Balance, beginning of year
 
$
11,167

 
$
12,659

 
$
12,659

Losses:
 
 
 
 
 
 
Commercial
 
77

 
390

 
390

Commercial real estate
 
 
 
 
 
 
Owner occupied
 
266

 
11

 
11

Non-owner occupied
 

 

 

Construction and development
 
 
 
 
 
 
Land and land development
 
180

 
2,376

 
3,535

Construction
 

 

 

Residential real estate
 
 
 
 
 
 
Non-jumbo
 
160

 
9

 
435

Jumbo
 

 
8

 
65

Home equity
 
32

 

 
14

Consumer
 
43

 
45

 
265

Other
 
24

 
23

 
118

Total
 
782

 
2,862

 
4,833

Recoveries:
 
 

 
 

 
 

Commercial
 
2

 
6

 
34

Commercial real estate
 
 
 
 
 
 
Owner occupied
 
3

 
7

 
40

Non-owner occupied
 
2

 
3

 
318

Construction and development
 
 
 
 
 
 
Land and land development
 
11

 
26

 
298

Construction
 

 

 

Real estate - mortgage
 
 
 
 
 
 
Non-jumbo
 
7

 
20

 
87

Jumbo
 
95

 
163

 
163

Home equity
 
1

 
2

 
4

Consumer
 
49

 
20

 
74

Other
 
22

 
25

 
73

Total
 
192

 
272

 
1,091

Net losses
 
590


2,590


3,742

Provision for loan losses
 
250

 
1,000

 
2,250

Balance, end of period
 
$
10,827


$
11,069


$
11,167

 
 

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29


Activity in the allowance for loan losses by loan class during the first three months of 2015 is as follows:
 
Construction & Land Development
 
 
 
Commercial Real Estate
 
Residential Real Estate
 
 
 
 
 
 
Dollars in thousands
Land &
Land
Develop-
ment
 
Construc-
tion
 
Commer-
cial
 
Owner
Occupied
 
Non-
Owner
Occupied
 
Non-
jumbo
 
Jumbo
 
Home
Equity
 
Con-
sumer
 
Other
 
Total
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
3,417

 
$
427

 
$
1,204

 
$
927

 
$
1,316

 
$
1,280

 
$
2,081

 
$
187

 
$
97

 
$
231

 
$
11,167

Charge-offs
180

 

 
77

 
266

 

 
160

 

 
32

 
43

 
24

 
782

Recoveries
11

 

 
2

 
3

 
2

 
7

 
95

 
1

 
49

 
22

 
192

Provision
370

 
(183
)
 
9

 
571

 
(25
)
 
125

 
(613
)
 
103

 
(24
)
 
(83
)
 
250

Ending balance
$
3,618


$
244


$
1,138


$
1,235


$
1,293


$
1,252


$
1,563


$
259


$
79


$
146


$
10,827

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans individually
evaluated for impairment
$
176

 
$

 
$

 
$
255

 
$
21

 
$
276

 
$
43

 
$

 
$

 
$

 
$
771

Loans collectively
evaluated for impairment
3,442

 
244

 
1,138

 
980

 
1,272

 
976

 
1,520

 
259

 
79

 
146

 
10,056

Total
$
3,618

 
$
244

 
$
1,138

 
$
1,235

 
$
1,293

 
$
1,252

 
$
1,563

 
$
259

 
$
79

 
$
146

 
$
10,827

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans individually
evaluated for impairment
$
14,019

 
$

 
$
381

 
$
14,721

 
$
7,817

 
$
6,347

 
$
6,556

 
$
709

 
$
79

 
$

 
$
50,629

Loans collectively
evaluated for impairment
52,539

 
19,094

 
89,547

 
165,548

 
317,947

 
213,591

 
43,936

 
68,185

 
18,406

 
11,074

 
$
999,867

Total
$
66,558

 
$
19,094

 
$
89,928

 
$
180,269

 
$
325,764

 
$
219,938

 
$
50,492

 
$
68,894

 
$
18,485

 
$
11,074

 
$
1,050,496


NOTE 8.  GOODWILL AND OTHER INTANGIBLE ASSETS

The following tables present our goodwill by reporting unit at March 31, 2015 and other intangible assets by reporting unit at March 31, 2015 and December 31, 2014.
 
 
Goodwill Activity
Dollars in thousands
 
Community Banking
 
Insurance Services
 
Total
Balance, January 1, 2014
 
$
1,488

 
$
4,710

 
$
6,198

Acquired goodwill, net
 

 

 

Balance, March 31, 2015
 
$
1,488

 
$
4,710

 
$
6,198

 
 
Other Intangible Assets
 
 
March 31, 2015
 
December 31, 2014
Dollars in thousands
 
Community
Banking
 
Insurance
Services
 
Total
 
Community
Banking
 
Insurances
Services
 
Total
Unidentifiable intangible assets
 
 
 
 
 
 
 
 
 
 
 
 
Gross carrying amount
 
$
2,268

 
$

 
$
2,268

 
$
2,268

 
$

 
$
2,268

Less: accumulated amortization
 
2,268

 

 
2,268

 
2,268

 

 
2,268

Net carrying amount
 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Identifiable intangible assets
 
 

 
 

 
 

 
 

 
 

 
 

Gross carrying amount
 
$

 
$
3,000

 
$
3,000

 
$

 
$
3,000

 
$
3,000

Less: accumulated amortization
 

 
1,550

 
1,550

 

 
1,500

 
1,500

Net carrying amount
 
$

 
$
1,450

 
$
1,450

 
$

 
$
1,500

 
$
1,500


We recorded amortization expense of approximately $50,000 for the three months ended March 31, 2015 relative to our other intangible assets.  Annual amortization is expected to approximate $200,000 for each of the years ending 2015 through 2019.


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30


NOTE 9.  DEPOSITS

The following is a summary of interest bearing deposits by type as of March 31, 2015 and 2014 and December 31, 2014:
Dollars in thousands
 
March 31,
2015
 
December 31,
2014
 
March 31,
2014
Demand deposits, interest bearing
 
$
196,606

 
$
204,030

 
$
195,898

Savings deposits
 
257,687

 
253,578

 
228,854

Time deposits
 
486,966

 
488,279

 
528,433

Total
 
$
941,259

 
$
945,887

 
$
953,185


Included in time deposits are deposits acquired through a third party (“brokered deposits”) totaling $139.5 million, $146.9 million and $160.4 million at March 31, 2015, December 31, 2014, and March 31, 2014, respectively.

A summary of the scheduled maturities for all time deposits as of March 31, 2015 is as follows:
Dollars in thousands
 
Nine month period ending December 31, 2015
$
143,413

Year ending December 31, 2016
144,477

Year ending December 31, 2017
57,461

Year ending December 31, 2018
46,888

Year ending December 31, 2019
35,457

Thereafter
59,270

Total
$
486,966


The following is a summary of the maturity distribution of all certificates of deposit in denominations of $100,000 or more as of March 31, 2015:
Dollars in thousands
Amount
 
Percent
Three months or less
$
42,686

 
11.9
%
Three through six months
25,577

 
7.1
%
Six through twelve months
58,303

 
16.3
%
Over twelve months
232,072

 
64.7
%
Total
$
358,638

 
100.00
%

NOTE 10.  BORROWED FUNDS

Short-term borrowings:    A summary of short-term borrowings is presented below:
 
Three Months Ended March 31,
 
2015
 
2014
Dollars in thousands
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
 
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
Balance at March 31
$
141,550

 
$
7,435

 
$
60,000

 
$
8,974

Average balance outstanding for the period
139,590

 
5,189

 
66,205

 
8,971

Maximum balance outstanding at any month end during period
141,780

 
7,435

 
80,000

 
8,974

Weighted average interest rate for the period
0.31
%
 
0.25
%
 
0.28
%
 
0.25
%
Weighted average interest rate for balances
 

 
 

 
 

 
 

     outstanding at March 31
0.32
%
 
0.25
%
 
0.31
%
 
0.25
%


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31


 
Year Ended December 31, 2014
Dollars in thousands
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
 Balance at December 31
$
120,950

 
$
2,683

Average balance outstanding for the period
94,982

 
5,804

Maximum balance outstanding at any month end during period
136,800

 
8,976

Weighted average interest rate for the period
0.31
%
 
0.25
%
Weighted average interest rate for balances outstanding at December 31
0.31
%
 
0.25
%

Long-term borrowings:  Our long-term borrowings of $77.0 million, $77.5 million and $123.5 million at March 31, 2015, December 31, 2014, and March 31, 2014 respectively, consisted primarily of advances from the Federal Home Loan Bank (“FHLB”) and structured reverse repurchase agreements with two unaffiliated institutions. 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.
 
Balance at March 31,
 
Balance at 
 December 31,
Dollars in thousands
2015
 
2014
 
2014
Long-term FHLB advances
$
951

 
$
42,576

 
$
977

Long-term reverse repurchase agreements
72,000

 
72,000

 
72,000

Term loan
4,062

 
8,916

 
4,513

Total
$
77,013

 
$
123,492

 
$
77,490

 
The term loan at March 31, 2015 is secured by the common stock of our subsidiary bank and bears a variable interest rate of prime minus 50 basis points with a final maturity of 2017. Our long term FHLB borrowings and reverse repurchase agreements bear both fixed and variable rates and mature in varying amounts through the year 2026.

The average interest rate paid on long-term borrowings for the three month period ended March 31, 2015 was 4.32% compared to 3.95% for the first three months of 2014.

Subordinated debentures:  We have subordinated debt totaling $5.0 million at March 31, 2015 and $16.8 million at December 31, 2014, and March 31, 2014.  The subordinated debt qualifies as Tier 2 capital under Federal Reserve Board guidelines until the debt is within 5 years of its maturity; thereafter the amount qualifying as Tier 2 capital is reduced by 20 percent each year until maturity.  During 2009, we issued $6.8 million in subordinated debt, of which $5 million was issued to an affiliate of a director of Summit.  We also issued $1.0 million and $0.8 million to two unrelated parties.  These three issuances bear an interest rate of 10 percent per annum, a term of 10 years, and are not prepayable by us within the first five years.  During 2008, we issued $10 million of subordinated debt to an unrelated institution, which bears a variable interest rate of 1 month LIBOR plus 275 basis points and a term of 7.5 years.

During first quarter 2015, we prepaid in full the $6.8 million subordinated debentures issued in 2009 and prepaid $5.0 million of the subordinated debentures issued in 2008.

Subordinated debentures owed to unconsolidated subsidiary trusts:  We have three statutory business trusts that were formed for the purpose of issuing mandatorily redeemable securities (the “capital securities”) for which we are obligated to third party investors and investing the proceeds from the sale of the capital securities in our junior subordinated debentures (the “debentures”).  The debentures held by the trusts are their sole assets.  Our subordinated debentures totaled $19.6 million at March 31, 2015, December 31, 2014, and March 31, 2014.

In October 2002, we sponsored SFG Capital Trust I, in March 2004, we sponsored SFG Capital Trust II, and in December 2005, we sponsored SFG Capital Trust III, of which 100% of the common equity of each trust is owned by us.  SFG Capital Trust I issued $3.5 million in capital securities and $109,000 in common securities and invested the proceeds in $3.61 million of debentures. SFG Capital Trust II issued $7.5 million in capital securities and $232,000 in common securities and invested the proceeds in $7.73 million of debentures. SFG Capital Trust III issued $8.0 million in capital securities and $248,000 in common securities and invested the proceeds in $8.25 million of debentures.  Distributions on the capital securities issued by the trusts are payable quarterly at a variable interest rate equal to 3 month LIBOR plus 345basis points for SFG Capital Trust I, 3 month LIBOR plus 280basis points for SFG Capital Trust II, and 3 month LIBOR plus 145basis points for SFG Capital Trust III, and equals the interest rate earned on the debentures held by the trusts, and is recorded as interest expense by us.  The

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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 of each Capital Trust are redeemable by us quarterly.

The capital securities held by SFG Capital Trust I, SFG Capital Trust II, and SFG Capital Trust III qualify as Tier 1 capital under Federal Reserve Board guidelines.  In accordance with these Guidelines, trust preferred securities generally are limited to 25% of Tier 1 capital elements, net of goodwill.  The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital.
 
A summary of the maturities of all long-term borrowings and subordinated debentures for the next five years and thereafter is as follows:
Dollars in thousands
 
 
Long-term
borrowings
 
Subordinated
debentures
 
Subordinated
debentures owed
to unconsolidated
subsidiary trusts
Year Ending December 31,
2015
 
$
1,432

 
$
5,000

 
$

 
2016
 
28,911

 

 

 
2017
 
918

 

 

 
2018
 
45,017

 

 

 
2019
 
18

 

 

 
Thereafter
 
717

 

 
19,589

 
 
 
$
77,013

 
$
5,000

 
$
19,589



NOTE 11.  SHARE BASED COMPENSATION

The 2014 Long-Term Incentive Plan (“2014 LTIP”) was adopted by our shareholders in May 2014 to enhance the ability of the Company to attract and retain exceptionally qualified individuals to serve as key employees. The LTIP provides for the issuance of up to 500,000 shares of common stock, in the form of equity awards including stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, other stock-based awards or any combination thereof,  to our key employees.  No awards have been granted under the 2014 LTIP.

Stock options awarded under the 2009 Officer Stock Option Plan and the 1998 Officer Stock Option Plan (collectively, the “Plans”) were not altered by the 2014 LTIP, and remain subject to the terms of the Plans.  However, under the terms of the 2014 LTIP, all shares of common stock remaining issuable under the Plans at the time the 2014 LTIP was adopted ceased to be available for future issuance.
 
The fair value of our employee stock options granted under the Plans is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options granted but are not considered by the model. Because our employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options at the time of grant.  There were no options granted during the first three months of 2015 or 2014.

We recognize compensation expense based on the estimated number of stock awards expected to actually vest, exclusive of the awards expected to be forfeited.  During the first three months of 2015 and 2014, our stock compensation expense and related deferred taxes were insignificant.


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A summary of activity in our Plans during the first three months of 2015 and 2014 is as follows:
 
For the Three Months Ended March 31,
 
2015
 
2014
 
Options
 
Weighted-Average
Exercise Price
 
Options
 
Weighted-Average
Exercise Price
Outstanding, January 1
157,170

 
$
20.43

 
185,410

 
$
19.59

Granted

 

 

 

Exercised

 

 
(3,200
)
 
4.63

Forfeited

 

 

 

Expired

 

 
(2,300
)
 
17.43

Outstanding, March 31
157,170

 
$
20.43

 
179,910

 
$
19.88



Other information regarding options outstanding and exercisable at March 31, 2015 is as follows:
 
Options Outstanding
 
Options Exercisable
Range of
exercise price
# of
shares
 
WAEP
 
Wted. Avg.
Remaining
Contractual
Life (yrs)
 
Aggregate
Intrinsic
Value
(in thousands)
 
# of
shares
 
WAEP
 
Aggregate
Intrinsic
Value
(in thousands)
2.54 - $6.00
10,750

 
$
4.36

 
4.46

 
$
81

 
9,750

 
$
4.55

 
$
72

6.01 - 10.00
17,520

 
8.93

 
2.65

 
53

 
17,520

 
8.93

 
53

10.01 - 17.50

 

 

 

 

 

 

17.51 - 20.00
30,900

 
17.80

 
2.26

 

 
30,900

 
17.80

 

20.01 - 25.93
98,000

 
25.08

 
1.54

 

 
98,000

 
25.08

 

 
157,170

 
20.43

 
 

 
$
134

 
156,170

 
20.54

 
$
125


NOTE 12.  COMMITMENTS AND CONTINGENCIES

Off-Balance Sheet Arrangements

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.

Many of our lending relationships contain both funded and unfunded elements.  The funded portion is reflected on our balance sheet.  The unfunded portion of these commitments is not recorded on our balance sheet until a draw is made under the loan facility.  Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.

A summary of the total unfunded, or off-balance sheet, credit extension commitments follows:
Dollars in thousands
 
March 31,
2015
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
54,768

Construction loans
 
24,633

Other loans
 
44,935

Standby letters of credit
 
2,599

Total
 
$
126,935


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.

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34



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.

Legal Contingencies

On May 13, 2014, the ResCap Liquidating Trust (“ResCap”), as successor to Residential Funding Company, LLC f/k/a Residential Funding Corporation (“RFC”), filed a complaint against Summit Financial Mortgage, LLC (“Summit Mortgage”), a former residential mortgage subsidiary of Summit whose operations were discontinued in 2007, in the United States Bankruptcy Court for the Southern District of New York and subsequently amended its complaint on July 25, 2014. The Amended Complaint asserts the following three causes of action related to Summit Mortgage’s origination and subsequent sale of mortgage loans to Residential Funding Corporation:  1) Summit Mortgage breached its representations and warranties made in the contract governing the sale of the mortgage loans to RFC;  2) an indemnification claim against Summit Mortgage for damages paid by ResCap to settle claims in RFC’s bankruptcy proceeding which allegedly relate to mortgage loans Summit Mortgage sold to RFC; 3) a claim for damages against Summit Community Bank, Inc., former parent of Summit Mortgage, arising out of a guaranty in which the Bank guaranteed Summit Mortgage’s full performance under the contract governing the sale of mortgage loans to RFC. Summit has filed a motion to dismiss the case. Based upon the applicable statute of limitations, the Court granted our motion to dismiss the breach of contract claim with respect to loans Summit sold to RFC prior to March 14, 2006. The court otherwise denied our motion to dismiss on the grounds that the other arguments raised factual questions that could not be decided on a motion to dismiss. An estimate as to possible loss resulting from the Amended Complaint cannot be provided at this time because such an estimate cannot be made. Summit intends to defend these claims vigorously.
 
We are not a party to any other litigation except for matters that arise in the normal course of business.  While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, in the opinion of management, the outcome of these matters will not have a significant adverse effect on the consolidated financial statements.

NOTE 13.  PREFERRED STOCK

On March 12, 2015, we converted all outstanding shares of our 8% Non-Cumulative Convertible Preferred Stock, Series 2009, $1.00 par value, with a liquidation preference of $1,000 per share (the “Series 2009 Preferred Stock”) and our 8% Non-Cumulative Convertible Preferred Stock, Series 2011, $1.00 par value, with a liquidation preference of $500 per share (the “Series 2011 Preferred Stock”) to common shares.

NOTE 14.  COMMON STOCK ISSUANCES

We entered into a Securities Purchase Agreement ("SPA") with Castle Creek Capital Partners V, LP ("Castle Creek") on August 25, 2014. In accordance with the terms of the SPA, we agreed to sell 1,057,137 shares of common stock (representing approximately 9.9% of our outstanding common stock) at the price of $9.75 per share to Castle Creek in a private placement. The private placement with Castle Creek consisted of two (2) closings. The first closing for the purchase of 819,384 shares of common stock at an aggregate price of $7,988,994 was consummated on November 25, 2014. The second closing for the purchase of 237,753 shares of common stock at an aggregate price of $2,318,092 was consummated on March 17, 2015 and was conditioned upon, among other things, the conversion into shares of common stock of all of the outstanding shares of our 8% Non-Cumulative Convertible Preferred Stock, Series 2009 and our 8% Non-Cumulative Convertible Preferred Stock, Series 2011 ("the Conversions"), in accordance with the terms of our Articles of Incorporation, as amended.

We also agreed under the terms of the SPA to commence, following the second closing of the sale of Common Stock to Castle Creek under the SPA, a rights offering (the “Rights Offering”) to the holders of record of the Common Stock as of a date selected by Summit’s Board of Directors. In the Rights Offering, all holders of Common Stock as of the record date, excluding Castle Creek, will be offered non-transferable rights (“Rights”) to purchase shares of Common Stock at the same per share purchase price of $9.75 used in the Private Placement to Castle Creek. The aggregate number of shares that will be offered for sale in connection with the Rights Offering is 256,410 and, if all shares offered are purchased, the Company expects to yield total gross proceeds of $2.5 million, prior to any fees and expenses associated with the sale. The Rights have been distributed to all of the holders of the Common Stock, excluding Castle Creek, on a pro rata basis, based on the number of shares of Common

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Stock owned by each shareholder as of April 10, 2015, the record date used in connection with the Rights Offering. The Rights Offering expires May 29, 2015.

NOTE 15.  REGULATORY MATTERS

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.  We 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.

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 March 31, 2015, that we and each of our subsidiaries met all capital adequacy requirements to which they were subject.

The most recent notifications from the banking regulatory agencies categorized us and each of our subsidiaries 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-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.
The Basel III Capital Rules became effective for us on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of March 31, 2015, our capital levels remained characterized as "well-capitalized" under the new rules. See the Capital Requirements section included in Part I Item 1 Business of our 2014 Annual Report on Form 10-K for further discussion of Basel III.
The following table presents Summit's, as well as our subsidiary, Summit Community Bank's ("Summit Community"), actual and required minimum capital amounts and ratios as of March 31, 2015 under the Basel III Capital Rules. The minimum required capital levels presented below as of March 31, 2015 reflect the minimum required capital levels (inclusive of the full capital conservation buffers) that will be effective as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
 
 
 Actual
 
Minimum Required Capital - Basel III Fully Phased-in
 
Minimum Required To Be Well Capitalized
Dollars in thousands
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
$
127,848

 
11.4
%
 
$
78,503

 
7.0
%
 
$
72,896

 
6.5
%
Summit Community
 
151,685

 
13.5
%
 
78,651

 
7.0
%
 
73,034

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
146,848

 
13.1
%
 
95,283

 
8.5
%
 
89,678

 
8.0
%
Summit Community
 
151,685

 
13.5
%
 
95,505

 
8.5
%
 
89,887

 
8.0
%
Total Capital (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
Summit
 
157,675

 
14.1
%
 
117,418

 
10.5
%
 
111,826

 
10.0
%
Summit Community
 
162,512

 
14.5
%
 
117,681

 
10.5
%
 
112,077

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
146,848

 
10.1
%
 
58,158

 
4.0
%
 
72,697

 
5.0
%
Summit Community
 
151,685

 
10.5
%
 
57,785

 
4.0
%
 
72,231

 
5.0
%

Summit's, as well as Summit Community's, actual capital amounts and ratios as of December 31, 2014, as computed under the regulatory capital rules then in effect, are presented in the following table.

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 Actual
 
Minimum Required Capital
 
Minimum Required To Be Well Capitalized
Dollars in thousands
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of December 31, 2014
 
 

 
 

 
 

 
 

Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
141,589

 
13.3
%
 
42,583

 
4.0
%
 
63,875

 
6.0
%
Summit Community
 
150,653

 
14.2
%
 
42,437

 
4.0
%
 
63,656

 
6.0
%
Total Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
158,196

 
14.9
%
 
84,937

 
8.0
%
 
106,172

 
10.0
%
Summit Community
 
161,820

 
15.3
%
 
84,612

 
8.0
%
 
105,765

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
141,589

 
9.9
%
 
57,208

 
4.0
%
 
71,510

 
5.0
%
Summit Community
 
150,653

 
10.6
%
 
56,850

 
4.0
%
 
71,063

 
5.0
%


NOTE  16.  SEGMENT INFORMATION

We operate two business segments:  community banking and insurance & financial services.  These segments are primarily identified by the products or services offered.  The community banking segment consists of our full service banks which offer customers traditional banking products and services through various delivery channels.  The insurance & financial services segment includes three insurance agency offices that sell insurance products.  The accounting policies discussed throughout the notes to the consolidated financial statements apply to each of our business segments.

Inter-segment revenue and expense consists of management fees allocated to the community banking and the insurance & financial services segments for all centralized functions that are performed by the parent, including overall direction in the areas of strategic planning, investment portfolio management, asset/liability management, financial reporting and other financial and administrative services.  Information for each of our segments is included below:
 
 
Three Months Ended March 31, 2015
Dollars in thousands
 
Community
Banking
 
Insurance &
Financial
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
11,751

 
$

 
$
(231
)
 
$

 
$
11,520

Provision for loan losses
 
250

 

 

 

 
250

Net interest income after provision for loan losses
 
11,501




(231
)



11,270

Other income
 
1,849

 
1,290

 
283

 
(283
)
 
3,139

Other expenses
 
6,857

 
1,055

 
575

 
(283
)
 
8,204

Income (loss) before income taxes
 
6,493


235


(523
)



6,205

Income tax expense (benefit)
 
2,035

 
64

 
(179
)
 

 
1,920

Net income (loss)
 
4,458

 
171

 
(344
)
 


4,285

Dividends on preferred shares
 

 

 

 

 

Net income (loss) applicable to common shares
 
$
4,458

 
$
171

 
$
(344
)
 
$

 
$
4,285

Inter-segment revenue (expense)
 
$
(256
)
 
$
(27
)
 
$
283

 
$

 
$

Average assets
 
$
1,488,109

 
$
5,893

 
$
168,954

 
$
(208,885
)
 
$
1,454,071



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Three Months Ended March 31, 2014
Dollars in thousands
 
Community
Banking
 
Insurance &
Financial
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
10,511

 
$

 
$
(473
)
 
$

 
$
10,038

Provision for loan losses
 
1,000

 

 

 

 
1,000

Net interest income after provision for loan losses
 
9,511

 

 
(473
)
 


9,038

Other income
 
1,410

 
1,373

 
293

 
(293
)
 
2,783

Other expenses
 
7,349

 
1,028

 
414

 
(293
)
 
8,498

Income (loss) before income taxes
 
3,572

 
345

 
(594
)
 


3,323

Income tax expense (benefit)
 
982

 
121

 
(169
)
 

 
934

Net income (loss)
 
2,590

 
224

 
(425
)
 


2,389

Dividends on preferred shares
 

 

 
193

 

 
193

Net income (loss) applicable to common shares
 
$
2,590

 
$
224

 
$
(618
)
 
$

 
$
2,196

Inter-segment revenue (expense)
 
$
(264
)
 
$
(29
)
 
$
293

 
$

 
$

Average assets
 
$
1,442,219

 
$
5,978

 
$
160,346

 
$
(216,040
)
 
$
1,392,503


NOTE  17.  DERIVATIVE FINANCIAL INSTRUMENTS

We use derivative instruments primarily to protect against the risk of adverse interest rate movements on the cash flows of certain liabilities and the fair values of certain assets.  Derivative instruments represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based upon a notional amount and an underlying as specified in the contract.  A notional amount represents the number of units of a specific item, such as currency units.  An underlying represents a variable, such as an interest rate or price index.  The amount of cash or other asset delivered from one party to the other is determined based upon the interaction of the notional amount of the contract with the underlying.  Derivatives can also be implicit in certain contracts and commitments.

As with any financial instrument, derivative instruments have inherent risks, primarily market and credit risk.  Market risk associated with changes in interest rates is managed by establishing and monitoring limits as to the degree of risk that may be undertaken as part of our overall market risk monitoring process.  Credit risk occurs when a counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement.  Credit risk is managed by monitoring the size and maturity structure of the derivative portfolio, and applying uniform credit standards to all activities with credit risk.
 
In accordance with ASC 815, Derivatives and Hedging, all derivative instruments are 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 – For risk management purposes that 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.
 

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We have entered into three forward-starting, pay-fixed/receive LIBOR interest rate swaps.  $40 million notional with an effective date of July 18, 2016, was designated as a cash flow hedge of $40 million of forecasted variable rate Federal Home Loan Bank advances.  Under the terms of this swap we will pay a fixed rate of 2.98% for a 3 year period.  $30 million notional with an effective date of April 18, 2016, was designated as a cash flow hedge of $30 million of forecasted variable rate Federal Home Loan Bank advances.  Under the terms of this swap we will pay a fixed rate of 2.89% for a 4.5 year period.   $40 million notional with an effective date of October 18, 2016,  was designated as a cash flow hedge of $40 million of forecasted variable rate Federal Home Loan Bank advances.  Under the terms of the swap we will pay a fixed rate of 2.84% for a 3 year period.

On January 15, 2015, we entered into a $9.95 million notional pay fixed/receive variable interest rate swap to hedge the fair value variability of a commercial fixed rate loan with the same principal, amortization, and maturity terms of the underlying loan, which is designated as a fair value hedge. Under the terms of the swap, we will pay a fixed rate of 4.33% for a 10 year period.

A summary of our derivative financial instruments as of March 31, 2015 and December 31, 2014 follows:
 
March 31, 2015
 
 
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
Notional
Amount
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Long term borrowings
$
110,000

 
$

 
$
4,323

 
$

 
March 31, 2015
 
 
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
Notional
Amount
 
Asset
 
Liability
 
Hedge Gains/(Losses)
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial loan
$
9,950

 
$
31

 
$

 
$


 
December 31, 2014
 
 
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
Notional
Amount
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
Long term borrowings
$
110,000

 
$

 
$
2,911

 
$


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Management's Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The following discussion and analysis focuses on significant changes in our financial condition and results of operations of Summit Financial Group, Inc. (“Company” or “Summit”) and our operating segments, Summit Community Bank (“Summit Community”), and Summit Insurance Services, LLC for the periods indicated.  See Note 14 of the accompanying consolidated financial statements for our segment information.  This discussion and analysis should be read in conjunction with our 2014 audited financial statements and Annual Report on Form 10-K.

The Private Securities Litigation Act of 1995 indicates that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by us.  Our following discussion and analysis of financial condition and results of operations contains certain forward-looking statements that involve risk and uncertainty.  In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in those forward-looking statements.

OVERVIEW

Our primary source of income is net interest income from loans and deposits.  Business volumes tend to be influenced by the overall economic factors including market interest rates, business spending, and consumer confidence, as well as competitive conditions within the marketplace.

Interest earning assets increased by 6.18% for the first three months in 2015 compared to the same period of 2014 while our net interest earnings on a tax equivalent basis increased 14.72%.  Our tax equivalent net interest margin increased 26 basis points as our reduced cost of interest bearing funds continues to positively impact our net interest earnings.

BUSINESS SEGMENT RESULTS

We are organized and managed along two major business segments, as described in Note 14 of the accompanying consolidated financial statements.  The results of each business segment are intended to reflect each segment as if it were a stand alone business.  Net income by segment follows:
 
 
Three Months Ended March 31,
Dollars in thousands
 
2015
 
2014
Community banking
 
$
4,458

 
$
2,590

Insurance & financial services
 
171

 
224

Parent
 
(344
)
 
(618
)
Consolidated net income
 
$
4,285

 
$
2,196


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 the notes to the consolidated financial statements of our 2014 Annual Report on Form 10-K.  These policies, along with the other disclosures presented in the 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, the valuation of goodwill, fair value measurements and deferred tax assets 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.

Allowance for Loan Losses:  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

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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 6 to the consolidated financial statements of our 2014 Annual Report on Form 10-K 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 the financial review of the 2014 Annual Report on Form 10-K.

Goodwill:  Goodwill is subject to an analysis by reporting unit at least annually to determine whether write-downs of the recorded balances are necessary.  Initially, an assessment of qualitative factors (Step 0) is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary.  However, if we conclude otherwise, then we are required to perform the first step (Step 1) of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.  If the fair value is less than the carrying value, an expense may be required on our books to write down the goodwill to the proper carrying value.  Step 2 of impairment testing, which is necessary only if the reporting unit does not pass Step 1, compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill for the reporting unit.  The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination.

Community Banking – During third quarter 2014, we performed the Step 0 assessment of our goodwill of our community banking reporting unit and determined that it was not more likely than not that the fair value was less than its carrying value.  In performing the qualitative Step 0 assessments, we considered certain events and circumstances  such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value is less than its carrying amount. No indicators of impairment were noted as of September 30, 2014.
 
Insurance Services – During third quarter 2014, we performed the Step 0 assessment of our goodwill of our insurance services reporting unit.  We considered certain events and circumstances specific to the reporting unit, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value of our insurance services reporting unit is less than its carrying value and deemed it necessary to perform the further 2-step impairment test.  We performed an internal valuation utilizing the income approach to determine the fair value of our insurance services reporting unit.  This methodology consisted of discounting the expected future cash flows of this unit based upon a forecast of its operations considering long-term key business drivers such as anticipated commission revenue growth.  The long term growth rate used in determining the terminal value was estimated at 2%, and a discount rate of 10.0% was applied to the insurance services unit’s estimated future cash flows.  We did not fail this Step 1 test as of September 30, 2014, therefore Step 2 testing was not necessary.
 
We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Note 9 of the consolidated financial statements of our Annual Report on Form 10-K for further discussion of our intangible assets, which include goodwill.

Fair Value Measurements:  ASC Topic 820 Fair Value Measurements and Disclosures provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Based on the observability of the inputs used in the valuation techniques, we classify our financial assets and liabilities measured and disclosed at fair value in accordance with the three-level hierarchy (e.g., Level 1, Level 2 and Level 3) established under ASC Topic 820. Fair value determination in accordance with this guidance requires that we make a number of significant judgments. In determining the fair value of financial instruments, we use market prices of the same or similar instruments whenever such prices are available. We do not use prices involving distressed sellers in determining fair value. If
observable market prices are unavailable or impracticable to obtain, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques incorporate our assessments regarding assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risks inherent in a particular valuation technique and the risk of nonperformance.
 

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Fair value is used on a recurring basis for certain assets and liabilities in which fair value is the primary basis of accounting. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes in accordance with ASC Topic 825 Financial Instruments.
 
Deferred Income Tax Assets:  At March 31, 2015, we had net deferred tax assets of $10.5 million. Based on our ability to offset the net deferred tax asset against taxable income in carryback years and expected future taxable income in carryforward years, there was no impairment of the deferred tax asset at March 31, 2015.  All available evidence, both positive and negative, was considered to determine whether, based on the weight of that evidence, impairment should be recognized. However, our forecast process includes judgmental and quantitative elements that may be subject to significant change. If our forecast of taxable income within the carryback/carryforward periods available under applicable law is not sufficient to cover the amount of net deferred tax assets, such assets may become impaired.

Earnings Summary

Net income applicable to common shares for the three months ended March 31, 2015 increased to $4.3 million, or $0.41 per diluted share as compared to $2.2 million or $0.25 per diluted share for the same period of 2014. Earnings for the quarter ended March 31, 2015 were positively impacted by increased net interest income and lower provisions for loan losses.  Included in earnings for the three months ended March 31, 2015 was $150,000 in losses on the sales of foreclosed properties, and $572,000 of charges resulting from the write down of a portion of our foreclosed properties to fair value.  Returns on average equity and assets for the first three months of 2015 were 12.79% and 1.18%, respectively, compared with 8.46% and 0.69% for the same period of 2014.

Net Interest Income

Net interest income is the principal component of our earnings and represents the difference between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds.  Fluctuations in interest rates as well as changes in the volume and mix of earning assets and interest bearing liabilities can materially impact net interest income.

Our net interest income on a fully tax-equivalent basis totaled $11.9 million for the three months ended March 31, 2015, or $551,000 or 4.9% higher compared to the $11.3 million for the linked quarter and $1.5 million or 14.7% more than the $10.4 million for the same period of 2014.  Compared to the linked quarter, our tax-equivalent earnings on interest earning assets increased $273,000, while the cost of interest bearing liabilities declined $278,000 (see Table II).  Compared to the prior year first quarter, our tax-equivalent earnings on interest earning assets increased $717,000, while the cost of interest bearing liabilities declined $809,000

Average interest earning assets increased 2.1% from $1.32 billion during the fourth quarter of 2014 to $1.34 billion for the first three months of 2015.  Average interest bearing liabilities increased 0.6% from $1.18 billion at December 31, 2014 to $1.19 billion at March 31, 2015, at an average cost for the first three months of 2015 of 1.10% compared to 1.17% for the linked quarter. The growth in interest earning assets outpaced the growth in interest bearing liabilities, and was funded primarily by reductions in property held for sale, short term borrowings, and equity issuances.

Average interest earning assets increased 6.2% from $1.26 billion during the first three months of 2014 to $1.34 billion for the first three months of 2015, while average interest bearing liabilities increased only 1.3% from $1.18 billion at March 31, 2014 to $1.19 billion at March 31, 2015. The growth in interest earning assets outpaced the growth in interest bearing liabilities, and was funded primarily by reductions in property held for sale, growth in noninterest bearing deposits, and growth in equity.

Our consolidated net interest margin increased to 3.59% for the three months ended March 31, 2015, compared to 3.42% for the linked quarter and 3.33% for the same period in 2014. For the three months ended March 31, 2015 compared to December 31, 2014, the yields on earning assets increased 9 basis points, while the cost of our interest bearing funds decreased by 7 basis points. For the three months ended March 31, 2015 compared to March 31, 2014, the yields on earning assets decreased 5 basis points, while the cost of our interest bearing funds decreased by 29 basis points.

Assuming no significant change in market interest rates, we anticipate modest growth in our net interest income to continue over the near term due to growth in the volume of interest earning assets, primarily loans, coupled with expected moderate improvement in net interest margin over the same period.  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.  Further analysis of our yields on interest earning assets and interest bearing liabilities are presented in Tables I and II below.

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Table I - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2015
 
December 31, 2014
 
March 31, 2014
Dollars in thousands
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
Interest earning assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned fees (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
1,035,610

 
$
12,734

 
4.99
%
 
$
1,006,641

 
$
12,562

 
4.95
%
 
$
957,482

 
$
12,145

 
5.14
%
Tax-exempt (2)
12,567

 
174

 
5.62
%
 
9,488

 
158

 
6.61
%
 
5,830

 
108

 
7.51
%
Securities
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Taxable
211,471

 
1,281

 
2.46
%
 
207,577

 
1,127

 
2.15
%
 
216,900

 
1,281

 
2.4
%
Tax-exempt (2)
76,012

 
927

 
4.95
%
 
83,729

 
995

 
4.71
%
 
75,437

 
864

 
4.64
%
Federal funds sold and interest bearing deposits with other banks
7,081

 
1

 
0.06
%
 
8,102

 
2

 
0.10
%
 
8,923

 
2

 
0.09
%
Total interest earning assets
1,342,741

 
15,117

 
4.57
%
 
1,315,537

 
14,844

 
4.48
%
 
1,264,572

 
14,400

 
4.62
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Cash & due from banks
3,679

 
 

 
 

 
3,654

 
 
 
 
 
3,897

 
 
 
 
Premises and equipment
20,203

 
 

 
 

 
20,149

 
 
 
 
 
20,582

 
 
 
 
Property held for sale
36,791

 
 
 
 
 
44,742

 
 
 
 
 
52,901

 
 
 
 
Other assets
61,894

 
 

 
 

 
62,725

 
 
 
 
 
63,520

 
 
 
 
Allowance for loan losses
(11,237
)
 
 

 
 

 
(11,239
)
 
 
 
 
 
(12,969
)
 
 
 
 
Total assets
$
1,454,071

 
 

 
 

 
$
1,435,568

 
 
 
 
 
$
1,392,503

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
199,840

 
$
58

 
0.12
%
 
$
199,932

 
$
60

 
0.12
%
 
186,982

 
52

 
0.11
%
Savings deposits
254,398

 
428

 
0.68
%
 
254,986

 
443

 
0.69
%
 
208,529

 
319

 
0.62
%
Time deposits
485,975

 
1,585

 
1.32
%
 
489,884

 
1,627

 
1.32
%
 
530,117

 
1,870

 
1.43
%
Short-term borrowings
144,779

 
112

 
0.31
%
 
124,001

 
97

 
0.31
%
 
75,177

 
53

 
0.29
%
Long-term borrowings and capital trust securities
105,741

 
1,040

 
3.99
%
 
114,533

 
1,274

 
4.41
%
 
174,559

 
1,738

 
4.04
%
Total interest bearing liabilities
1,190,733

 
3,223

 
1.10
%
 
1,183,336

 
3,501

 
1.17
%
 
1,175,364

 
4,032

 
1.39
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
115,198

 
 

 
 

 
113,926

 
 
 
 
 
95,138

 
 
 
 
Other liabilities
14,096

 
 

 
 

 
11,633

 
 
 
 
 
9,037

 
 
 
 
Total liabilities
1,320,027

 
 

 
 

 
1,308,895

 
 
 
 
 
1,279,539

 
 
 
 
Shareholders' equity - preferred
7,244

 
 

 
 

 
9,249

 
 
 
 
 
9,291

 
 
 
 
Shareholders' equity - common
126,800

 
 

 
 

 
117,424

 
 
 
 
 
103,673

 
 
 
 
Total liabilities and shareholders' equity
$
1,454,071

 
 

 
 

 
$
1,435,568

 
 
 
 
 
$
1,392,503

 
 
 
 
Net interest earnings
 

 
$
11,894

 
 

 
 
 
$
11,343

 
 
 
 
 
$
10,368

 
 
Net yield on interest earning assets
 
 

 
3.59
%
 
 
 
 
 
3.42
%
 
 
 
 
 
3.33
%
(1)
- For purposes of this table, nonaccrual loans are included in average loan balances.
(2)
- Interest income on tax-exempt securities and loans has been adjusted assuming an effective tax rate of 34% for all periods presented. The tax equivalent adjustment resulted in an increase in interest income of $374,000 and $331,000 for the periods ended March 31, 2015 and March 31, 2014, respectively.

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Table II - Changes in Interest Margin Attributable to Rate and Volume
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended
 
For the Three Months Ended
 
 
 
March 31, 2015 versus December 31, 2014
 
March 31, 2015 versus March 31, 2014
 
 
 
Increase (Decrease) Due to Change in:
 
Increase (Decrease) Due to Change in:
 
Dollars in thousands
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
 
$
358

 
$
(186
)
 
$
172

 
$
969

 
$
(380
)
 
$
589

 
Tax-exempt
 
45

 
(29
)
 
16

 
99

 
(33
)
 
66

 
Securities
 
 

 
 
 
 
 
 

 
 

 
 

 
Taxable
 
21

 
133

 
154

 
(32
)
 
32

 

 
Tax-exempt
 
(94
)
 
26

 
(68
)
 
7

 
56

 
63

 
Federal funds sold and interest bearing deposits with other banks
 

 
(1
)
 
(1
)
 

 
(1
)
 
(1
)
 
Total interest earned on interest earning assets
 
330

 
(57
)
 
273

 
1,043

 
(326
)
 
717

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 

 
 
 
 
 
 

 
 

 
 

 
Interest bearing demand deposits
 

 
(2
)
 
(2
)
 
4

 
2

 
6

 
Savings deposits
 
(1
)
 
(14
)
 
(15
)
 
75

 
34

 
109

 
Time deposits
 
(13
)
 
(29
)
 
(42
)
 
(150
)
 
(135
)
 
(285
)
 
Short-term borrowings
 
16

 
(1
)
 
15

 
53

 
6

 
59

 
Long-term borrowings and capital trust securities
 
(93
)
 
(141
)
 
(234
)
 
(677
)
 
(21
)
 
(698
)
 
Total interest paid on interest bearing liabilities
 
(91
)
 
(187
)
 
(278
)
 
(695
)
 
(114
)
 
(809
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
421

 
$
130

 
$
551

 
$
1,738

 
$
(212
)
 
$
1,526

 

Noninterest Income

Total noninterest income increased to $3.1 million for the first three months of 2015, compared to $2.8 million for the same period of 2014.  Further detail regarding noninterest income is reflected in the following table.
Table III - Noninterest Income
 
 
 
 
For the Quarter Ended March 31,
Dollars in thousands
2015
 
2014
Insurance commissions
$
1,128

 
$
1,181

Service fees related to deposit accounts
976

 
1,043

Realized securities gains (losses)
480

 
(22
)
Bank owned life insurance income
261

 
270

Other
294

 
311

Total
$
3,139

 
$
2,783


Noninterest Expense

Total noninterest expense decreased 3.5% for the three months ended March 31, 2015, as compared to the same period in 2014, with lower write-downs of foreclosed properties and lower FDIC premiums having the largest positive impacts.  Table IV below shows the breakdown of the changes.

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Table IV - Noninterest Expense
 
 
 
 
 
For the Quarter Ended March 31,
 
 
 
Change
 
 
Dollars in thousands
2015
 
 $
 
%
 
2014
Salaries, commissions, and employee benefits
$
4,187

 
$
207

 
5.2
 %
 
$
3,980

Net occupancy expense
499

 
(42
)
 
(7.8
)%
 
541

Equipment expense
535

 
(31
)
 
(5.5
)%
 
566

Professional fees
335

 
19

 
6.0
 %
 
316

Amortization of intangibles
50

 
(38
)
 
(43.2
)%
 
88

FDIC premiums
330

 
(172
)
 
(34.3
)%
 
502

Foreclosed properties expense
208

 
(46
)
 
(18.1
)%
 
254

Loss on sales of foreclosed properties
150

 
75

 
100.0
 %
 
75

Write-downs of foreclosed properties
572

 
(356
)
 
(38.4
)%
 
928

Other
1,338

 
90

 
7.2
 %
 
1,248

Total
$
8,204

 
$
(294
)
 
(3.5
)%
 
$
8,498


Salaries, commissions, and employee benefits: These expenses are 5.2% higher in first quarter 2015 compared to first quarter 2014 due to an increase in number of employees and increased incentive accruals based upon performance. In accordance with our policies, substantially all salary and wage merit raises are awarded at the beginning of the second quarter of each year. We anticipate an average 3% increase in salaries and wages beginning April 1, 2015.

FDIC premiums: FDIC premiums decreased 34.3% during the first three months of 2015, reflecting a reduction in rate due to Summit Community's release from its MOU in late 2014. These lower levels will continue throughout 2015.

Write-downs of foreclosed properties: Management anticipates write-downs of foreclosed properties to their fair values to trend lower in 2015 than in recent years.

Credit Experience

As a result of a historically slow economic recovery, our foreclosed properties portfolio remains elevated.   Prior elevated levels of nonperforming loans have returned to acceptable levels. Management expects a net reduction in foreclosed properties at a percentage similar to that experienced during 2014.

For purposes of this discussion, we define nonperforming assets to include foreclosed properties, other repossessed assets, and nonperforming loans, which is comprised of loans 90 days or more past due and still accruing interest and nonaccrual loans. Performing TDRs are excluded from nonperforming loans.

The provision for loan losses represents charges to earnings necessary to maintain an adequate allowance for probable credit losses inherent in the loan portfolio. Our determination of the appropriate level of the allowance is based on an ongoing analysis of credit quality and loss potential in the loan portfolio, change in the composition and risk characteristics of the loan portfolio, and the anticipated influence of national and local economic conditions.  The adequacy of the allowance for loan losses is reviewed quarterly and adjustments are made as considered necessary.

We recorded $250,000 and $1.0 million provisions for loan losses for the first three months of 2015 and 2014, respectively.  This decline is a result of lower average loan losses experienced over the past twelve quarters. Lower losses cause our historical charge-off factor of the quantitative reserve calculation to decline, thus requiring fewer quantitative reserves.


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As illustrated in Table V below, our non-performing assets have decreased since year end 2014.
Table V - Summary of Non-Performing Assets
 
 
 
 
 
 
 
 
March 31,
 
December 31,
Dollars in thousands
 
2015
 
2014
 
2014
Accruing loans past due 90 days or more
 
$

 
$

 
$

Nonaccrual loans
 
 

 
 

 
 

Commercial
 
788

 
866

 
392

Commercial real estate
 
1,340

 
2,834

 
1,844

Commercial construction and development
 

 
3,653

 

Residential construction and development
 
5,333

 
6,599

 
4,619

Residential real estate
 
4,491

 
2,890

 
5,556

Consumer
 
65

 
73

 
83

Total nonaccrual loans
 
12,017

 
16,915

 
12,494

Foreclosed properties
 
 

 
 

 
 

Commercial
 
110

 

 
110

Commercial real estate
 
3,657

 
8,523

 
5,204

Commercial construction and development
 
10,191

 
11,097

 
10,179

Residential construction and development
 
17,590

 
20,640

 
19,267

Residential real estate
 
2,819

 
11,981

 
2,769

Total foreclosed properties
 
34,367

 
52,241

 
37,529

Repossessed assets
 
55

 
28

 
221

Total nonperforming assets
 
$
46,439

 
$
69,184

 
$
50,244

Total nonperforming loans as a percentage of total loans
 
1.14
%
 
1.74
%
 
1.21
%
Total nonperforming assets as a percentage of total assets
 
3.18
%
 
4.92
%
 
3.48
%
Allowance for loan losses as a percentage of nonperforming loans
 
90.10
%
 
65.44
%
 
89.38
%
Allowance for loan losses as a percentage of period end loans
 
1.03
%
 
1.14
%
 
1.08
%

The following table details the activity regarding our foreclosed properties for the three months ended March 31, 2015 and 2014.
Table VI - Foreclosed Property Activity
 
 
For the Three Months Ended 
 March 31,
Dollars in thousands
2015
 
2014
Beginning balance
$
37,529

 
$
53,392

Acquisitions
714

 
1,277

Improvements
16

 

Disposals
(3,320
)
 
(1,500
)
Writedowns to fair value
(572
)
 
(928
)
Balance March 31
$
34,367

 
$
52,241

 
 
Refer to Note 6 of the accompanying consolidated financial statements for information regarding our past due loans, impaired loans, nonaccrual loans, and troubled debt restructurings and to Note 7 for a summary of the methodology we employ on a quarterly basis to evaluate the overall adequacy of our allowance for loan losses.

Relationship between Allowance for Loan Losses, Net Charge-offs and Nonperforming Loans

In analyzing the relationship between the allowance for loan losses, net loan charge-offs and nonperforming loans, it is helpful to understand the process of how loans are treated as they deteriorate over time. Reserves for loans are established at origination through the quantitative and qualitative reserve process discussed in the accompanying Note 7 to the financial statements.

Charge-offs, if necessary, are typically recognized in a period after the reserves were established. If the previously established reserves exceed that needed to satisfactorily resolve the problem credit, a reduction in the overall level of the reserve could be

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recognized. In summary, if loan quality deteriorates, the typical credit sequence is periods of reserve building, followed by periods of higher net charge-offs.

Consumer loans are generally charged off to the allowance for loan losses upon reaching specified stages of delinquency, in accordance with the Federal Financial Institutions Examination Council policy.  For example, credit card loans are charged off by the end of the month in which the account becomes 180 days past due or within 60 days from receiving notification about a specified event (e.g., bankruptcy of the borrower), whichever is earlier.  Residential mortgage loans are generally charged off to net realizable value no later than when the account becomes 180 days past due.  Other consumer loans, if collateralized, are generally charged off to net realizable value at 120 days past due.

Commercial-related loans (which are risk-rated) are charged off to the allowance for loan losses when the loss has been confirmed. This determination includes many factors, including the prioritization of our claim in bankruptcy, expectations of the workout/restructuring of the loan and valuation of the borrower’s equity.
 
Substantially all of our nonperforming loans are secured by real estate. The majority of these loans were underwritten in accordance with our loan-to-value policy guidelines which range from 70-85% at the time of origination. The fair values of the underlying collateral value or the discounted cash flows remain in excess of the recorded investment in many of our nonperforming loans, and therefore, no specific reserve allocation is required.

At March 31, 2015, December 31, 2014, and March 31, 2014, our allowance for loan losses totaled $10.8 million, or 1.03% of total loans, $11.2 million, or 1.08% of total loans and $11.1 million, or 1.14% of total loans, respectively, and is considered adequate to cover our estimate of probable credit losses inherent in our loan portfolio.

At March 31, 2015, December 31, 2014, and March 31, 2014, we had approximately $34.4 million, $53.4 million and $52.2 million, respectively, in other real estate owned which was obtained as the result of foreclosure proceedings.  Although foreclosed property is recorded at fair value less estimated costs to sell, the prices ultimately realized upon their sale may or may not result in us recognizing loss.

FINANCIAL CONDITION

Our total assets were $1.460 billion at March 31, 2015, compared to $1.444 billion at December 31, 2014, representing a 1.2% increase.  Table VIII below serves to illustrate significant changes in our financial position between December 31, 2014 and March 31, 2015.
Table VIII - Summary of Significant Changes in Financial Position
 
 
Balance
December 31,
 
Increase (Decrease)
 
Balance
March 31,
Dollars in thousands
 
2014
 
Amount
 
Percentage
 
2015
Assets
 
 
 
 
 
 
 
 
Securities available for sale
 
$
282,834

 
(699
)
 
(0.2
)%
 
$
282,135

Loans, net of unearned interest
 
1,019,842

 
19,827

 
1.9
 %
 
1,039,669

Liabilities
 
 

 
 

 
 

 
 

Deposits
 
$
1,061,314

 
$
(3,006
)
 
(0.3
)%
 
$
1,058,308

Short-term borrowings
 
123,633

 
25,352

 
20.5
 %
 
148,985

Long-term borrowings
 
77,490

 
(477
)
 
(0.6
)%
 
77,013

Subordinated debentures
 
16,800

 
(11,800
)
 
(70.2
)%
 
5,000


Loan growth of 1.9% during the first three months of 2015 occurred principally in the commercial real estate portfolio, and was funded primarily with short-term borrowings.
 
Deposits decreased approximately $3.0 million during the first three months of 2015; savings deposits increased approximately $4.1 million while checking accounts and time deposits decreased $5.8 million and $1.3 million, respectively.

The decrease in subordinated debentures is attributable to the prepayment of subordinated debentures during the first three months of 2015.
 
Refer to Notes 5, 6, 9, and 10 of the notes to the accompanying consolidated financial statements for additional information with regard to changes in the composition of our securities, loans, deposits and borrowings between March 31, 2015 and December 31, 2014.

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LIQUIDITY AND CAPITAL RESOURCES

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 of Pittsburgh (“FHLB”) and Federal Reserve Bank of Richmond, which totaled approximately $625 million or 42.82% of total consolidated assets at March 31, 2015.

Our liquidity strategy is to fund loan growth with deposits and other borrowed funds while maintaining an adequate level of short- and medium-term investments to meet normal daily loan and deposit activity.  As a member of the FHLB, we have access to approximately $506 million.  As of March 31, 2015 and December 31, 2014, these advances totaled approximately $143 million and $122 million, respectively.  At March 31, 2015, we had additional borrowing capacity of $363 million through FHLB programs.  We have established a line with the Federal Reserve Bank to be used as a contingency liquidity vehicle.  The amount available on this line at March 31, 2015 was approximately $101 million, which is secured by a pledge of our consumer and commercial and industrial loan portfolios.  We have a $6 million unsecured line of credit with a correspondent bank.  Also, we classify all of our securities as available for sale to enable us to liquidate them if the need arises.
 
Liquidity risk represents the risk of loss due to the possibility that funds may not be available to satisfy current or future commitments based on external market issues, customer or creditor perception of financial strength, and events unrelated to Summit such as war, terrorism, or financial institution market specific issues.  The Asset/Liability Management Committee (“ALCO”), comprised of members of senior management and certain members of the Board of Directors, oversees our liquidity risk management process.   The ALCO develops and recommends policies and limits governing our liquidity to the Board of
Directors for approval with the objective of ensuring that we can obtain cost-effective funding to meet current and future obligations, as well as maintain sufficient levels of on-hand liquidity, under both normal and “stressed” circumstances.
 
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.

One of our continuous goals is maintenance of a strong capital position.  Through management of our capital resources, we seek to provide an attractive financial return to our shareholders while retaining sufficient capital to support future growth.  Shareholders’ equity at March 31, 2015 totaled $135.9 million compared to $131.6 million at December 31, 2014.

Summit had outstanding $3.7 million of 8% non-cumulative convertible preferred stock issued in 2009 and an additional $5.8 million of 8% non-cumulative convertible preferred stock issued in 2011 that was fully converted to common stock on March 12, 2015.

On August 25, 2014, we agreed to sell 1,057,137 shares of common stock (representing approximately 9.9% of our outstanding common stock) at the price of $9.75 per share to Castle Creek Capital Partners V, LP ("Castle Creek") in a private placement. The private placement with Castle Creek consisted of two (2) closings. The first closing for the purchase of 819,384 shares of common stock at an aggregate price of $7,988,994 was consummated on November 25, 2014. The second closing for the purchase of 237,753 shares of common stock at an aggregate price of $2,318,092 was consummated on March 17, 2017 and was conditioned upon, among other things, the conversion into shares of common stock of all of the outstanding shares of our 8% Non-Cumulative Convertible Preferred Stock, Series 2009 and our 8% Non-Cumulative Convertible Preferred Stock, Series 2011 ("the Conversions"), in accordance with the terms of our Articles of Incorporation, as amended.

We have also agreed under the terms of the SPA to commence, following the second closing of the sale of Common Stock to Castle Creek under the SPA, a rights offering (the “Rights Offering”) to the holders of record of the Common Stock as of a date selected by Summit’s Board of Directors. In the Rights Offering, all holders of Common Stock as of the record date, excluding Castle Creek, will be offered non-transferable rights (“Rights”) to purchase shares of Common Stock at the same per share purchase price of $9.75 used in the Private Placement to Castle Creek. The aggregate number of shares that will be offered for sale in connection with the Rights Offering is 256,410 and, if all shares offered are purchased, the Company expects to yield total gross proceeds of $2.5 million, prior to any fees and expenses associated with the sale. The Rights have been distributed to all of the holders of the Common Stock, excluding Castle Creek, on a pro rata basis, based on the number of shares of Common Stock owned by each shareholder as of April 10, 2015, the record date used in connection with the Rights Offering. The Rights Offering expires May 29, 2015.

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48



On March 30, 2015, we repurchased 100,000 shares of our common stock from First Bank of Charleston, Inc. in a privately negotiated transaction for an aggregate purchase price of $1,080,000 and retired the shares.

Refer to Note 15 of the notes to the accompanying consolidated financial statements for additional information regarding regulatory restrictions on our capital as well as our subsidiaries’ capital.

CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations.  The following table summarizes our contractual cash obligations at March 31, 2015.
Table IX - Contractual Cash Obligations
 
 
 
 
Dollars in thousands
 
Long
Term
Debt
 
Capital
Trust
Securities
 
Operating
Leases
2015
 
$
6,432

 
$

 
$
62

2016
 
28,911

 

 
128

2017
 
918

 

 
90

2018
 
45,017

 

 
45

2019
 
18

 

 

Thereafter
 
717

 
19,589

 

Total
 
$
82,013

 
$
19,589

 
$
325


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 March 31, 2015 are presented in the following table.
Table X - Off-Balance Sheet Arrangements
 
March 31,
Dollars in thousands
 
2015
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
54,768

Construction loans
 
24,633

Other loans
 
44,935

Standby letters of credit
 
2,599

Total
 
$
126,935



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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”), which 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.  The nature of our lending and funding activities tends to drive our interest rate risk position to being liability sensitive.  That is, absent any changes in the volumes of our interest earning assets or interest bearing liabilities, liabilities are likely to reprice faster than assets, resulting in a decrease in net income in a rising rate environment.  Net income would increase in a falling interest rate environment.  Net income is also subject to changes in the shape of the yield curve.  In general, a flattening yield curve would result in a decline in 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.  Each increase or decrease in interest rates is assumed to gradually take place over the next 12 months, and then remain stable, except for the up 400 scenario, which assumes a gradual increase in rates over 24 months.  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.

The following table presents the estimated sensitivity of our net interest income to changes in interest rates, as measured by our earnings simulation model as of March 31, 2015.  The sensitivity is measured as a percentage change in net interest income given the stated changes in interest rates (gradual change over 12 months, stable thereafter for the down 100 and the up 200 scenarios, and gradual change over 24 months for the up 400 scenario) compared to net interest income with rates unchanged in the same period.  The estimated changes set forth below are dependent on the assumptions discussed above and are well within our ALCO policy limits shown below relative to reductions in net interest income over the ensuing twelve month period.
 
 
 
Estimated % Change in
Net Interest Income over:
Change in
 
 
0 - 12 Months
 
13 - 24 Months
Interest Rates
Policy

 
Actual

 
Actual

Down 100  basis points (1)
-7
 %
 
-0.42
 %
 
-3.65
 %
Up 200 basis points (1)
-10
 %
 
-4.82
 %
 
-8.16
 %
Up 400 basis points (2)
-15
 %
 
-3.95
 %
 
-10.51
 %
(1)
assumes a parallel shift in the yield curve over 12 months
(2)
assumes a parallel shift in the yield curve over 24 months


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CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, has conducted as of March 31, 2015, an evaluation of the effectiveness of disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures as of March 31, 2015 were effective.  There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

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Part II. Other Information




Item 1.  Legal Proceedings

Refer to Note 12 of the Notes to the Consolidated Financial Statements in Part I, Item 1 for information regarding legal proceedings not reportable under this Item.

Item 1A.  Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 6. Exhibits

Exhibit 3.i
Amended and Restated Articles of Incorporation of Summit Financial Group, Inc.
 
 
Exhibit 3.ii
Articles of Amendment 2009
 
 
Exhibit 3.iii
Articles of Amendment 2011
 
 
Exhibit 3.iv
Amended and Restated By-Laws of Summit Financial Group, Inc.
 
 
Exhibit 11
Statement re: Computation of Earnings per Share – Information contained in Note 4 to the Consolidated Financial Statements on page 15 of this Quarterly Report is incorporated herein by reference.
 
 
Exhibit 31.1
Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer
 
 
Exhibit 31.2
Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer
 
 
Exhibit 32.1
Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer
 
 
Exhibit 32.2
Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer
 
 
Exhibit 101
Interactive Data File (XBRL)


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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 GROUP, INC.
 
 
(registrant)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ H. Charles Maddy, III
 
 
H. Charles Maddy, III,
 
 
President and Chief Executive Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ Robert S. Tissue
 
 
Robert S. Tissue,
 
 
Senior Vice President and Chief Financial Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ Julie R. Cook
 
 
Julie R. Cook,
 
 
Vice President and Chief Accounting Officer
 
 
 
 
 
 
 
 
Date:
May 4, 2015
 
 




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53


EXHIBIT INDEX


Exhibit No.
Description
Page
Number
(3)
Articles of Incorporation and By-laws:
 
 
(i)  Amended and Restated Articles of Incorporation of Summit Financial Group, Inc.
(a)
 
(ii)  Articles of Amendment 2009
(b)
 
(iii)  Articles of Amendment 2011
(c)
 
(iv)  Amended and Restated By-laws of Summit Financial Group, Inc.
(d)
11
Statement re:  Computation of Earnings per Share
15
 
 
 
31.1
Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer
 
 
 
 
31.2
Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer
 
 
 
 
32.1*
Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer
 
 
 
 
32.2*
Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer
 
101**
Interactive data file (XBRL)
 

*Furnished, not filed.
** As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

(a)
Incorporated by reference to Exhibit 3.i of Summit Financial Group, Inc.’s filing on Form 10-Q dated March 31, 2006.
(b)
Incorporated by reference to Exhibit 3.1 of Summit Financial Group, Inc.’s filing on Form 8-K dated September 30, 2009.
(c)
Incorporated by reference to Exhibit 3.1 of Summit Financial Group, Inc.’s filing on Form 8-K dated November 3, 2011.
(d)
Incorporated by reference to Exhibit 3.2 of Summit Financial Group, Inc.’s filing on Form 10-Q dated June 30, 2006.


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