Document
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 June 30, 2018
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 
sfglogousethisonea53.jpg

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, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o               Accelerated filer þ    Non-accelerated filer o
                  Smaller reporting company o     Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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
12,470,334 shares outstanding as of August 3, 2018



Table of Contents


 
 
 
Page
PART  I.
FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Consolidated balance sheets June 30, 2018 (unaudited) and
December 31, 2017
 
 
 
 
 
 
Consolidated statements of income
for the three months and six months ended June 30, 2018 and 2017 (unaudited)
 
 
 
 
 
 
Consolidated statements of comprehensive income
for the three months and six months ended June 30, 2018 and 2017 (unaudited)
 
 
 
 
 
 
Consolidated statements of shareholders’ equity
for the six months ended
June 30, 2018 and 2017 (unaudited)
 
 
 
 
 
 
Consolidated statements of cash flows
for the six months ended
June 30, 2018 and 2017 (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
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
 
 
 
 
EXHIBIT INDEX
 
 
 
 
 
SIGNATURES
 

2


Item 1. Financial Statements



Consolidated Balance Sheets (unaudited)

 
June 30,
2018
 
December 31,
2017
Dollars in thousands, except per share amounts
(unaudited)
 
(*)
ASSETS
 
 
 

Cash and due from banks
$
8,314

 
$
9,641

Interest bearing deposits with other banks
38,097

 
42,990

Cash and cash equivalents
46,411

 
52,631

Securities available for sale
283,221

 
328,723

Other investments
12,844

 
14,934

Loans held for sale
135

 

Loans, net
1,617,373

 
1,593,744

Property held for sale
21,606

 
21,470

Premises and equipment, net
36,017

 
34,209

Accrued interest receivable
8,425

 
8,329

Goodwill and other intangible assets
26,665

 
27,513

Cash surrender value of life insurance policies
41,932

 
41,358

Other assets
13,023

 
11,329

Total assets
$
2,107,652

 
$
2,134,240

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non interest bearing
$
217,134

 
$
217,493

Interest bearing
1,422,862

 
1,383,108

Total deposits
1,639,996

 
1,600,601

Short-term borrowings
202,429

 
250,499

Long-term borrowings
20,743

 
45,751

Subordinated debentures owed to unconsolidated subsidiary trusts
19,589

 
19,589

Other liabilities
15,016

 
16,295

Total liabilities
1,897,773

 
1,932,735

 
 
 
 
Commitments and Contingencies


 


 
 
 
 
Shareholders' Equity
 

 
 

Preferred stock, $1.00 par value, authorized 250,000 shares

 

Common stock and related surplus, $2.50 par value; authorized 20,000,000 shares; issued: 2018 - 12,470,334 shares and 2017 - 12,465,296 shares; outstanding: 2018 - 12,373,747 shares and 2017 - 12,358,562
81,572

 
81,098

Unallocated common stock held by Employee Stock Ownership Plan - 2018 - 96,587 shares and 2017 - 106,734 shares
(1,043
)
 
(1,152
)
Retained earnings
130,336

 
119,827

Accumulated other comprehensive (loss) income
(986
)
 
1,732

Total shareholders' equity
209,879

 
201,505

 
 
 
 
Total liabilities and shareholders' equity
$
2,107,652

 
$
2,134,240


(*) - Derived from audited consolidated financial statements



See Notes to Consolidated Financial Statements

Table of Contents
3


Consolidated Statements of Income (unaudited)


 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands, (except per share amounts)
 
2018
 
2017
 
2018
 
2017
Interest income
 
 
 
 
 
 
 
 
Interest and fees on loans
 
 
 
 
 
 
 
 
Taxable
 
$
20,820

 
$
19,550

 
$
41,043

 
$
35,100

Tax-exempt
 
142

 
167

 
286

 
288

Interest and dividends on securities
 
 

 
 

 
 

 
 

Taxable
 
1,240

 
1,330

 
2,612

 
2,459

Tax-exempt
 
1,063

 
1,019

 
2,082

 
1,741

Interest on interest bearing deposits with other banks
 
134

 
165

 
274

 
317

Total interest income
 
23,399

 
22,231

 
46,297

 
39,905

Interest expense
 
 

 
 

 
 

 
 

Interest on deposits
 
4,309

 
2,634

 
7,858

 
5,024

Interest on short-term borrowings
 
1,242

 
1,079

 
2,648

 
2,073

Interest on long-term borrowings and subordinated debentures
 
573

 
670

 
1,258

 
1,331

Total interest expense
 
6,124

 
4,383

 
11,764

 
8,428

Net interest income
 
17,275

 
17,848

 
34,533

 
31,477

Provision for loan losses
 
750

 
250

 
1,250

 
500

Net interest income after provision for loan losses
 
16,525

 
17,598

 
33,283

 
30,977

Noninterest income
 
 

 
 

 
 

 
 

Insurance commissions
 
1,013

 
988

 
2,126

 
1,957

Trust and wealth management fees
 
672

 
595

 
1,339

 
695

Service charges on deposit accounts
 
1,116

 
1,064

 
2,207

 
1,747

Bank card revenue
 
801

 
683

 
1,550

 
1,216

Realized securities gains, net
 
87

 
90

 
819

 
32

Bank owned life insurance income
 
249

 
253

 
523

 
503

Other
 
210

 
243

 
459

 
346

Total noninterest income
 
4,148

 
3,916

 
9,023

 
6,496

Noninterest expenses
 
 

 
 

 
 

 
 

Salaries, commissions and employee benefits
 
6,922

 
6,758

 
13,744

 
11,945

Net occupancy expense
 
840

 
826

 
1,672

 
1,393

Equipment expense
 
1,071

 
1,031

 
2,153

 
1,766

Professional fees
 
385

 
354

 
719

 
639

Advertising and public relations
 
188

 
148

 
291

 
256

Amortization of intangibles
 
413

 
429

 
848

 
526

FDIC premiums
 
240

 
295

 
480

 
505

Bank card expense
 
361

 
381

 
696

 
718

Foreclosed properties expense, net of losses
 
350

 
224

 
675

 
590

Litigation settlement
 

 

 

 
9,900

Merger-related expenses
 

 
1,455

 

 
1,564

Other
 
1,965

 
2,035

 
3,771

 
3,151

Total noninterest expenses
 
12,735

 
13,936

 
25,049

 
32,953

Income before income tax expense
 
7,938

 
7,578

 
17,257

 
4,520

Income tax expense
 
1,658

 
2,300

 
3,534

 
858

Net income
 
$
6,280

 
$
5,278

 
$
13,723

 
$
3,662

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.51

 
$
0.43

 
$
1.11

 
$
0.32

Diluted earnings per common share
 
$
0.51

 
$
0.43

 
$
1.10

 
$
0.32


See Notes to Consolidated Financial Statements 

Table of Contents
4


Consolidated Statements of Comprehensive Income (unaudited)


 
For the Three Months Ended 
 June 30,
Dollars in thousands
2018
 
2017
Net income
$
6,280

 
$
5,278

Other comprehensive (loss) income:
 

 
 

Net unrealized gain on cashflow hedge of:
2018 - $496, net of deferred taxes of $119; 2017 - $270, net of deferred taxes of $100
377

 
170

Net unrealized (loss) gain on securities available for sale of:
2018 - ($625), net of deferred taxes of ($150) and reclassification adjustment for net realized gains included in net income of $87, net of tax of $21; 2017 - $2,983, net of deferred taxes of $1,104 and reclassification adjustment for net realized gains included in net income of $90, net of tax of $33
(475
)
 
1,879

Net unrealized gain on other post-retirement benefits of:
2017 - $348, net of deferred taxes of $129

 
219

Total other comprehensive (loss) income
(98
)
 
2,268

Total comprehensive income
$
6,182

 
$
7,546


 
For the Six Months Ended 
 June 30,
Dollars in thousands
2018
 
2017
Net income
$
13,723

 
$
3,662

Other comprehensive (loss) income:
 

 
 

Net unrealized gain on cashflow hedge of:
2018 - $1,437, net of deferred taxes of $345; 2017 - $1,059, net of deferred taxes of $392
1,092

 
667

Net unrealized (loss) gain on securities available for sale of:
2018 - ($5,013), net of deferred taxes of ($1,203) and reclassification adjustment for net realized gains included in net income of $819, net of tax of $197; 2017 - $3,286, net of deferred taxes of $1,216 and reclassification adjustment for net realized gains included in net income of $32, net of tax of $12
(3,810
)
 
2,070

Net unrealized gain on other post-retirement benefits of:
2017 - $348, net of deferred taxes of $129

 
219

Total other comprehensive (loss) income
(2,718
)
 
2,956

Total comprehensive income
$
11,005

 
$
6,618




















See Notes to Consolidated Financial Statements

Table of Contents
5


Consolidated Statements of Shareholders’ Equity (unaudited)


Dollars in thousands (except per share amounts)
Common
Stock and
Related
Surplus
 
Unallocated Common Stock Held by ESOP
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
(Loss)
 
Total
Share-
holders'
Equity
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
81,098

 
$
(1,152
)
 
$
119,827

 
$
1,732

 
$
201,505

 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2018
 

 
 
 
 

 
 

 
 

Net income

 

 
13,723

 

 
13,723

Other comprehensive loss

 

 

 
(2,718
)
 
(2,718
)
Exercise of stock options - 200 shares
4

 

 

 

 
4

Share-based compensation expense
193

 

 

 

 
193

Unallocated ESOP shares committed to be released - 10,147 shares
151

 
109

 

 

 
260

Common stock issuances from reinvested dividends - 4,838 shares
126

 

 

 

 
126

Common stock cash dividends declared ($0.26 per share)

 

 
(3,214
)
 

 
(3,214
)
Balance, June 30, 2018
$
81,572

 
$
(1,043
)
 
$
130,336

 
$
(986
)
 
$
209,879

 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
46,757

 
$
(1,583
)
 
$
113,448

 
$
(3,262
)
 
$
155,360

 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017
 

 
 
 
 

 
 

 
 

Net income

 

 
3,662

 

 
3,662

Other comprehensive income

 

 

 
2,956

 
2,956

Exercise of stock options - 2,000 shares
12

 

 

 

 
12

Share-based compensation expense
184

 

 

 

 
184

Unallocated ESOP shares committed to be released - 19,711 shares
240

 
213

 

 

 
453

Acquisition of First Century Bankshares, Inc. - 1,537,912 shares, net of issuance costs
32,968

 

 

 

 
32,968

Common stock issuances from reinvested dividends - 3,133 shares
69

 

 

 

 
69

Common stock cash dividends declared ($0.22 per share)

 

 
(2,532
)
 

 
(2,532
)
Balance, June 30, 2017
$
80,230

 
$
(1,370
)
 
$
114,578

 
$
(306
)
 
$
193,132





















See Notes to Consolidated Financial Statements

Table of Contents
6


Consolidated Statements of Cash Flows (unaudited)


 
 
Six Months Ended
Dollars in thousands
 
June 30,
2018
 
June 30,
2017
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
13,723

 
$
3,662

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

 
 

Depreciation
 
1,058

 
851

Provision for loan losses
 
1,250

 
500

Share-based compensation expense
 
193

 
184

Deferred income tax benefit
 
(193
)
 
(157
)
Loans originated for sale
 
(7,764
)
 
(7,948
)
Proceeds from sale of loans
 
7,775

 
7,220

Gains on loans held for sale
 
(146
)
 
(149
)
Realized securities gains, net
 
(819
)
 
(32
)
Gain on disposal of assets
 
(16
)
 
(80
)
Write-downs of foreclosed properties
 
420

 
447

Amortization of securities premiums, net
 
1,872

 
2,054

Accretion related to acquisitions, net
 
(310
)
 
(573
)
Amortization of intangibles
 
848

 
526

Earnings on bank owned life insurance
 
(574
)
 
(538
)
Increase in accrued interest receivable
 
(96
)
 
(343
)
Increase in other assets
 
(1,210
)
 
(371
)
Increase (decrease) in other liabilities
 
1,358

 
(1,634
)
Net cash provided by operating activities
 
17,369

 
3,619

Cash Flows from Investing Activities
 
 

 
 

Proceeds from maturities and calls of securities available for sale
 
1,050

 
2,010

Proceeds from sales of securities available for sale
 
69,235

 
111,176

Principal payments received on securities available for sale
 
13,393

 
16,355

Purchases of securities available for sale
 
(44,243
)
 
(97,230
)
Purchases of other investments
 
(5,938
)
 
(10,879
)
Proceeds from redemptions of other investments
 
7,397

 
9,830

Net loan originations
 
(26,200
)
 
(4,609
)
Purchases of premises and equipment
 
(2,866
)
 
(4,175
)
Proceeds from disposal of premises and equipment
 
12

 

Proceeds from sales of repossessed assets & property held for sale
 
1,225

 
3,375

Cash and cash equivalents acquired in acquisition, net of $14,989 cash consideration paid
 

 
39,053

Net cash provided by investing activities
 
13,065

 
64,906

Cash Flows from Financing Activities
 
 

 
 

Net increase (decrease) in demand deposit, NOW and savings accounts
 
25,848

 
(6,279
)
Net increase (decrease) in time deposits
 
13,661

 
(25,763
)
Net decrease in short-term borrowings
 
(48,071
)
 
(26,043
)
Repayment of long-term borrowings
 
(25,008
)
 
(910
)
Net proceeds from issuance of common stock
 
126

 
(90
)
Exercise of stock options
 
4

 
12

Dividends paid on common stock
 
(3,214
)
 
(2,532
)
Net cash used in financing activities
 
(36,654
)
 
(61,605
)
(Decrease) increase in cash and cash equivalents
 
(6,220
)
 
6,920

Cash and cash equivalents:
 
 

 
 

Beginning
 
52,631

 
46,616

Ending
 
$
46,411

 
$
53,536

 
(Continued)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 

Table of Contents
7


Consolidated Statements of Cash Flows (unaudited) - continued


 
 
Six Months Ended
Dollars in thousands
 
June 30,
2018
 
June 30,
2017
Supplemental Disclosures of Cash Flow Information
 
 
 
 
Cash payments for:
 
 
 
 
Interest
 
$
11,713

 
$
8,388

Income taxes
 
$
4,066

 
$
2,621

 
 
 
 
 
Supplemental Disclosures of Noncash Investing and Financing Activities
 
 
 
 

Real property and other assets acquired in settlement of loans
 
$
906

 
$
188

Supplemental Disclosures of Noncash Transactions Included in Acquisition
 
 
 
 
Assets acquired
 
$

 
$
350,894

Liabilities assumed
 
$

 
$
361,045























































See Notes to Consolidated Financial Statements

Table of Contents
8



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 three and six months ended June 30, 2018 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 2017 audited financial statements and Annual Report on Form 10-K. 

NOTE 2.  SIGNIFICANT NEW AUTHORITATIVE ACCOUNTING GUIDANCE

Recently Adopted
We adopted ASU 2014-09, Revenue from Contracts with Customers: Topic 606, and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. We concluded that ASU 2014-09 did not materially change the method in which we currently recognize revenue for these revenue streams. We also completed our evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on our evaluation, we determined that any classification changes are immaterial to both revenue and expense.
ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. ASU 2016-01 was effective for us on January 1, 2018 and did not have a significant impact on our financial statements. In accordance with (iv) above, we measure the fair value of our loan portfolio using exit price notion (see Note 3. Fair Value Measurements).

Pending Adoption
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.

Table of Contents
9


While we are currently assessing the impact of the adoption of this pronouncement, we expect the primary impact to our consolidated financial position upon adoption will be the recognition, on a discounted basis, of our minimum commitments under non-cancellable operating leases on our consolidated balance sheets resulting in the recording of right of use assets and lease obligations. Our current minimum commitments under long-term operating leases are disclosed in Note 12, Commitments and Contingencies.
During June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. We will adopt the guidance by the first quarter of 2020 with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. In this regard, we have thus far formed a cross-functional implementation team comprised of personnel from risk management, operations and information technology, loan administration and finance and engaged a third-party to assist us. The implementation team has developed a project plan and is staying informed about the broader industry's perspectives and insights, and is identifying and researching key decision points. We are in the process of preparing a readiness assessment and gap analysis relative to required data which will serve to direct our areas of focus. We will continue to evaluate the impact the new standard will have on our consolidated financial statements as the final impact will be dependent, among other items, upon the loan portfolio composition and credit quality at the adoption date, as well as economic conditions, financial models used and forecasts at that time.
In March of 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This guidance shortens the amortization period for premiums on certain callable debt securities to the earliest call date (with an explicit, noncontingent call feature that is callable at a fixed price and on a preset date), rather than contractual maturity date as currently required under GAAP. The ASU does not impact instruments without preset call dates such as mortgage-backed securities.  For instruments with contingent call features, once the contingency is resolved and the security is callable at a fixed price and preset date, the security is within the scope of the ASU.  ASU 2017-08 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, and early adoption is permitted.  The adoption of the new pronouncement will not have a significant impact on our consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities which will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. It is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. We are assessing the impact of ASU 2017-12 and do not expect it to have a material impact on our consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, Compensation- Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The amendments expand the scope of Topic 718 to include share-based payments issued to non-employees for goods or services, which were previously excluded. The amendments will align the accounting for share-based payments to nonemployees and employees more similarly and are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2018-07 to have a material impact on our consolidated financial statements.




10


NOTE 3.  FAIR VALUE MEASUREMENTS

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
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
Securities available for sale
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
28,682

 
$

 
$
28,682

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
76,505

 

 
76,505

 

Nongovernment sponsored entities
821

 

 
821

 

State and political subdivisions
18,975

 

 
18,975

 

Corporate debt securities
10,725

 

 
10,725

 

Other equity securities
137

 

 
137

 

Tax-exempt state and political subdivisions
147,376

 

 
147,376

 

Total securities available for sale
$
283,221

 
$

 
$
283,221

 
$

 
 
 
 
 
 
 
 
Derivative financial assets
 
 
 
 
 
 
 
Interest rate swaps
$
927

 
$

 
$
927

 
$

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
620

 
$

 
$
620

 
$



 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
Securities available for sale
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
31,613

 
$

 
$
31,613

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
121,321

 

 
121,321

 

Nongovernment sponsored entities
2,077

 

 
2,077

 

State and political subdivisions
17,677

 

 
17,677

 

Corporate debt securities
16,245

 

 
16,245

 

Other equity securities
137

 

 
137

 

Tax-exempt state and political subdivisions
139,653

 

 
139,653

 

Total securities available for sale
$
328,723

 
$

 
$
328,723

 
$

 
 
 
 
 
 
 
 
Derivative financial assets
 
 
 
 
 
 
 
Interest rate swaps
$
312

 
$

 
$
312

 
$

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
2,057

 
$

 
$
2,057

 
$



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.

Table of Contents
11


 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
135

 
$

 
$
135

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Construction and development
$
648

 
$

 
$
648

 
$

Residential real estate
785

 

 
785

 

Total collateral-dependent impaired loans
$
1,433

 
$

 
$
1,433

 
$

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
1,733

 
$

 
$
1,733

 
$

Construction and development
16,673

 

 
16,673

 

Residential real estate
439

 

 
439

 

Total property held for sale
$
18,845

 
$

 
$
18,845

 
$



 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Commercial real estate
$
518

 
$

 
$
518

 
$

Construction and development
940

 

 
940

 

Residential real estate
203

 

 
203

 

Total collateral-dependent impaired loans
$
1,661

 
$

 
$
1,661

 
$

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
1,493

 
$

 
$
1,493

 
$

Construction and development
16,177

 

 
16,177

 

Residential real estate
322

 

 
322

 

Total property held for sale
$
17,992

 
$

 
$
17,992

 
$



The carrying values and estimated fair values of our financial instruments are summarized below:
 
 
June 30, 2018
 
Fair Value Measurements Using:
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Level 1
Level 2
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
46,411

 
$
46,411

 
$

$
46,411

$

Securities available for sale
 
283,221

 
283,221

 

283,221


Other investments
 
12,844

 
12,844

 

12,844


Loans held for sale, net
 
135

 
135

 

135


Loans, net
 
1,617,373

 
1,611,346

 

1,433

1,609,913

Accrued interest receivable
 
8,425

 
8,425

 

8,425


Derivative financial assets
 
927

 
927

 

927


 
 
$
1,969,336

 
$
1,963,309

 
$

$
353,396

$
1,609,913

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
1,639,996

 
$
1,634,320

 
$

$
1,634,320

$

Short-term borrowings
 
202,429

 
202,429

 

202,429


Long-term borrowings
 
20,743

 
20,929

 

20,929


Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 

19,589


Accrued interest payable
 
967

 
967

 

967


Derivative financial liabilities
 
620

 
620

 

620


 
 
$
1,884,344

 
$
1,878,854

 
$

$
1,878,854

$



Table of Contents
12


 
 
December 31, 2017
 
Fair Value Measurements Using:
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Level 1
Level 2
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
52,631

 
$
52,631

 
$

$
52,631

$

Securities available for sale
 
328,723

 
328,723

 

328,723


Other investments
 
14,934

 
14,934

 

14,934


Loans held for sale, net
 

 

 



Loans, net
 
1,593,744

 
1,592,821

 

1,661

1,591,160

Accrued interest receivable
 
8,329

 
8,329

 

8,329


Derivative financial assets
 
312

 
312

 

312


 
 
$
1,998,673

 
$
1,997,750

 
$

$
406,590

$
1,591,160

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
1,600,601

 
$
1,620,033

 
$

$
1,620,033

$

Short-term borrowings
 
250,499

 
250,499

 

250,499


Long-term borrowings
 
45,751

 
46,530

 

46,530


Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 

19,589


Accrued interest payable
 
987

 
987

 

987


Derivative financial liabilities
 
2,057

 
2,057

 

2,057


 
 
$
1,919,484

 
$
1,939,695

 
$

$
1,939,695

$



NOTE 4.  EARNINGS PER SHARE

The computations of basic and diluted earnings per share follow:
 
 
For the Three Months Ended June 30,
 
 
2018
 
2017
Dollars in thousands,
except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
6,280

 
 
 
 
 
$
5,278

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
6,280

 
12,366,522

 
$
0.51

 
$
5,278

 
12,288,514

 
$
0.43

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 
 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
7,814

 
 

 
 
 
10,593

 
 

Stock appreciation rights (SARs)
 
 
 
57,648

 
 
 
 
 
80

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
6,280

 
12,431,984

 
$
0.51

 
$
5,278

 
12,299,187

 
$
0.43


 
 
For the Six Months Ended June 30,
 
 
2018
 
2017
Dollars in thousands,
except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
13,723

 
 
 
 
 
$
3,662

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
13,723

 
12,362,679

 
$
1.11

 
$
3,662

 
11,517,721

 
$
0.32

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 

 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
7,668

 
 

 
 
 
11,549

 
 

Stock appreciation rights (SARs)
 
 
 
55,405

 
 
 
 
 
17,455

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
13,723

 
12,425,751

 
$
1.10

 
$
3,662

 
11,546,725

 
$
0.32



Table of Contents
13



Stock option and stock appreciation right (SAR) grants are disregarded in this computation if they are determined to be anti-dilutive.  There were no anti-dilutive stock options for the three and six months ended June 30, 2018. Our anti-dilutive stock options for the three and six months ended June 30, 2017 were 23,400 shares. Our anti-dilutive SARs for the three and six months ended June 30, 2018 and June 30, 2017 were 87,615.

NOTE 5.  SECURITIES

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at June 30, 2018 and December 31, 2017 are summarized as follows:
 
June 30, 2018
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
28,830

 
$
224

 
$
372

 
$
28,682

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
77,142

 
662

 
1,299

 
76,505

Nongovernment-sponsored entities
820

 
6

 
5

 
821

State and political subdivisions
 

 
 

 
 

 
 

General obligations
6,086

 

 
208

 
5,878

Other revenues
13,468

 
1

 
372

 
13,097

Corporate debt securities
10,893

 

 
168

 
10,725

Total taxable debt securities
137,239

 
893

 
2,424

 
135,708

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
74,920

 
741

 
512

 
75,149

Water and sewer revenues
21,858

 
203

 
105

 
21,956

Lease revenues
12,366

 
162

 
4

 
12,524

Sales tax revenues
5,235

 
32

 
29

 
5,238

Other revenues
32,664

 
226

 
381

 
32,509

Total tax-exempt debt securities
147,043

 
1,364

 
1,031

 
147,376

Equity securities
137

 

 

 
137

Total securities available for sale
$
284,419

 
$
2,257

 
$
3,455

 
$
283,221



Table of Contents
14


 
December 31, 2017
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
31,260

 
$
498

 
$
145

 
$
31,613

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
120,948

 
1,276

 
903

 
121,321

Nongovernment-sponsored entities
2,045

 
39

 
7

 
2,077

State and political subdivisions
 

 
 

 
 

 
 

General obligations
6,090

 

 
55

 
6,035

Other revenues
11,657

 
47

 
62

 
11,642

Corporate debt securities
16,375

 

 
130

 
16,245

Total taxable debt securities
188,375

 
1,860

 
1,302

 
188,933

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
65,560

 
1,530

 
198

 
66,892

Water and sewer revenues
23,108

 
566

 
3

 
23,671

Lease revenues
13,024

 
451

 
2

 
13,473

Electric revenues
6,205

 
128

 

 
6,333

Sales tax revenues
4,126

 
140

 

 
4,266

University revenues
5,272

 
38

 
9

 
5,301

Other revenues
19,101

 
616

 

 
19,717

Total tax-exempt debt securities
136,396

 
3,469

 
212

 
139,653

Equity securities
137

 

 

 
137

Total securities available for sale
$
324,908

 
$
5,329

 
$
1,514

 
$
328,723


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.
 
June 30, 2018
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
 
 
 
 
 
 
 
 
California
$
20,384

 
$
215

 
$
154

 
$
20,445

Texas
19,978

 
226

 
97

 
20,107

Michigan
15,800

 
108

 
216

 
15,692

New York
13,605

 
127

 
176

 
13,556

West Virginia
12,119

 
92

 
97

 
12,114


Management performs pre-purchase and ongoing analysis to confirm that all investment securities meet applicable credit quality standards.  

The maturities, amortized cost and estimated fair values of securities at June 30, 2018, are summarized as follows:
Dollars in thousands
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
28,893

 
$
28,891

Due from one to five years
 
49,496

 
49,248

Due from five to ten years
 
46,075

 
44,936

Due after ten years
 
159,818

 
160,009

Equity securities
 
137

 
137

 
 
$
284,419

 
$
283,221


The proceeds from sales, calls and maturities of securities available for sale, including principal payments received on mortgage-backed obligations, and the related gross gains and losses realized, for the six months ended June 30, 2018 and 2017 are as follows:

Table of Contents
15


 
 
Proceeds from
 
Gross realized
Dollars in thousands
Sales
 
Calls and
Maturities
 
Principal
Payments
 
Gains
 
Losses
For the Six Months Ended 
 June 30,
 
 
 
 
 
 
 
 
 
2018
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
69,235

 
$
1,050

 
$
13,393

 
$
1,637

 
$
818

 
 
 
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
111,176

 
$
2,010

 
$
16,355

 
$
230

 
$
198


We held 117 available for sale securities having an unrealized loss at June 30, 2018.  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 other-than-temporary impairment charge to earnings is warranted at this time.

Provided below is a summary of securities available for sale which were in an unrealized loss position at June 30, 2018 and December 31, 2017.

 
June 30, 2018
 
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
$
19,787

 
$
(318
)
 
$
2,003

 
$
(54
)
 
$
21,790

 
$
(372
)
Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
17,563

 
(559
)
 
15,311

 
(740
)
 
32,874

 
(1,299
)
Nongovernment-sponsored entities
13

 

 
585

 
(5
)
 
598

 
(5
)
State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
5,878

 
(208
)
 

 

 
5,878

 
(208
)
Other revenues
11,474

 
(344
)
 
781

 
(28
)
 
12,255

 
(372
)
Corporate debt securities
960

 
(40
)
 
3,661

 
(128
)
 
4,621

 
(168
)
Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
26,460

 
(370
)
 
3,898

 
(142
)
 
30,358

 
(512
)
Water and sewer revenues
5,960

 
(105
)
 

 

 
5,960

 
(105
)
Lease revenues
1,121

 
(4
)
 

 

 
1,121

 
(4
)
Sales tax revenues
2,265

 
(29
)
 

 

 
2,265

 
(29
)
Other revenues
21,495

 
(381
)
 

 

 
21,495

 
(381
)
Total temporarily impaired securities
112,976

 
(2,358
)
 
26,239

 
(1,097
)
 
139,215

 
(3,455
)
Total
$
112,976

 
$
(2,358
)
 
$
26,239

 
$
(1,097
)
 
$
139,215

 
$
(3,455
)



Table of Contents
16


 
December 31, 2017
 
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
$
10,864

 
$
(91
)
 
$
2,394

 
$
(54
)
 
$
13,258

 
$
(145
)
Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
32,156

 
(269
)
 
22,584

 
(634
)
 
54,740

 
(903
)
Nongovernment-sponsored entities
5

 

 
810

 
(7
)
 
815

 
(7
)
State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
6,035

 
(55
)
 

 

 
6,035

 
(55
)
Other revenues
7,532

 
(62
)
 

 

 
7,532

 
(62
)
Corporate debt securities
3,008

 
(39
)
 
1,659

 
(91
)
 
4,667

 
(130
)
Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
2,999

 
(20
)
 
9,937

 
(178
)
 
12,936

 
(198
)
Water and sewer revenues
282

 
(3
)
 

 

 
282

 
(3
)
Lease revenues
569

 
(2
)
 

 

 
569

 
(2
)
University revenues
1,749

 
(9
)
 

 

 
1,749

 
(9
)
Total temporarily impaired securities
65,199

 
(550
)
 
37,384

 
(964
)
 
102,583

 
(1,514
)
Total
$
65,199

 
$
(550
)
 
$
37,384

 
$
(964
)
 
$
102,583

 
$
(1,514
)


NOTE 6.  LOANS

Loans are summarized as follows:
Dollars in thousands
 
June 30,
2018
 
December 31,
2017
Commercial
 
$
171,410

 
$
189,981

Commercial real estate
 
 

 
 

Owner-occupied
 
262,174

 
250,202

Non-owner occupied
 
503,047

 
484,902

Construction and development
 
 

 
 

Land and land development
 
74,018

 
67,219

Construction
 
25,711

 
33,412

Residential real estate
 
 

 
 

Non-jumbo
 
343,044

 
354,101

Jumbo
 
66,831

 
62,267

Home equity
 
82,409

 
84,028

Mortgage warehouse lines
 
54,332

 
30,757

Consumer
 
34,249

 
36,202

Other
 
12,728

 
13,238

Total loans, net of unearned fees
 
1,629,953

 
1,606,309

Less allowance for loan losses
 
12,580

 
12,565

Loans, net
 
$
1,617,373

 
$
1,593,744


The outstanding balance and the recorded investment of acquired loans included in the consolidated balance sheet at June 30, 2018 and December 31, 2017 are as follows:


Table of Contents
17


 
 
Acquired Loans
 
 
June 30, 2018
 
December 31, 2017
Dollars in thousands
 
Purchased Credit Impaired
 
Purchased Performing
 
Total
 
Purchased Credit Impaired
 
Purchased Performing
 
Total
Outstanding balance
 
$
5,259

 
$
173,814

 
$
179,073

 
$
5,923

 
$
220,131

 
$
226,054

 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
$

 
$
11,192

 
$
11,192

 
$
9

 
$
25,125

 
$
25,134

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
 
689

 
19,073

 
19,762

 
689

 
21,893

 
22,582

Non-owner occupied
 
1,319

 
29,153

 
30,472

 
1,837

 
33,293

 
35,130

Construction and development
 
 
 
 
 
 
 
 
 
 
 
 
Land and land development
 

 
6,365

 
6,365

 

 
7,512

 
7,512

Construction
 

 

 

 

 
2,760

 
2,760

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
 
1,429

 
92,203

 
93,632

 
1,485

 
109,570

 
111,055

Jumbo
 
982

 
3,314

 
4,296

 
999

 
3,400

 
4,399

Home equity
 

 
2,923

 
2,923

 

 
3,311

 
3,311

Consumer
 

 
7,837

 
7,837

 

 
11,229

 
11,229

Other
 

 
135

 
135

 

 
211

 
211

Total recorded investment
 
$
4,419

 
$
172,195

 
$
176,614

 
$
5,019

 
$
218,304

 
$
223,323


The following table presents a summary of the change in the accretable yield of the purchased credit impaired ("PCI") loan portfolio for the three months and six months ended June 30, 2018 and 2017:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands
 
2018
 
2017
 
2018
 
2017
Accretable yield
 
$
708

 
$
245

 
$
745

 
$
290

Accretion
 
(32
)
 
(55
)
 
(69
)
 
(86
)
Additions for First Century Bankshares, Inc. acquisition
 

 
661

 

 
661

Reclassification of nonaccretable difference due to improvement
    in expected cash flows
 

 

 

 

Other changes, net
 

 

 

 
(14
)
Accretable yield, June 30
 
$
676

 
$
851

 
$
676

 
$
851


Table of Contents
18



The following table presents the contractual aging of the recorded investment in past due loans by class as of June 30, 2018 and December 31, 2017.
 
At June 30, 2018
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
278

 
$
191

 
$
576

 
$
1,045

 
$
170,365

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
55

 

 
437

 
492

 
261,682

 

Non-owner occupied
465

 
281

 
2,214

 
2,960

 
500,087

 

Construction and development
 

 
 

 
 

 
 

 
 

 
 

Land and land development
101

 
168

 
3,229

 
3,498

 
70,520

 

Construction

 

 

 

 
25,711

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
3,978

 
1,226

 
4,207

 
9,411

 
333,633

 
284

Jumbo

 

 

 

 
66,831

 

Home equity
254

 
9

 
397

 
660

 
81,749

 

Mortgage warehouse lines

 

 

 

 
54,332

 

Consumer
269

 
76

 
89

 
434

 
33,815

 
33

Other

 

 

 

 
12,728

 

Total
$
5,400

 
$
1,951

 
$
11,149

 
$
18,500

 
$
1,611,453

 
$
317

 
 
At December 31, 2017
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
488

 
$
98

 
$
229

 
$
815

 
$
189,166

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
626

 
162

 
507

 
1,295

 
248,907

 

Non-owner occupied
369

 
150

 
2,065

 
2,584

 
482,318

 
237

Construction and development
 
 
 

 
 

 
 

 
 

 
 

Land and land development
1,132

 

 
3,563

 
4,695

 
62,524

 

Construction

 

 

 

 
33,412

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
4,220

 
2,379

 
4,451

 
11,050

 
343,051

 

Jumbo

 

 

 

 
62,267

 

Home equity
1,978

 

 
530

 
2,508

 
81,520

 

Mortgage warehouse lines

 

 

 

 
30,757

 

Consumer
417

 
196

 
167

 
780

 
35,422

 
37

Other

 

 

 

 
13,238

 

Total
$
9,230

 
$
2,985

 
$
11,512

 
$
23,727

 
$
1,582,582

 
$
274


Nonaccrual loans:  The following table presents the nonaccrual loans included in the net balance of loans at June 30, 2018 and December 31, 2017.

Table of Contents
19


 
 
June 30,
 
December 31,
Dollars in thousands
 
2018
 
2017
Commercial
 
$
954

 
$
696

Commercial real estate
 
 

 
 

Owner-occupied
 
639

 
726

Non-owner occupied
 
2,599

 
2,201

Construction and development
 
 

 
 

Land & land development
 
3,233

 
3,569

Construction
 

 

Residential mortgage
 
 

 
 

Non-jumbo
 
7,443

 
6,944

Jumbo
 

 

Home equity
 
514

 
712

Mortgage warehouse lines
 

 

Consumer
 
77

 
201

Total
 
$
15,459

 
$
15,049

 
Impaired loans:  Impaired loans include the following:

Loans which we risk-rate (loan relationships having aggregate balances in excess of $2.5 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, 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 accounting principles generally accepted in the United States 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.

Table of Contents
20


The following tables present loans individually evaluated for impairment at June 30, 2018 and December 31, 2017.
 
June 30, 2018
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
464

 
$
464

 
$

 
$
266

 
$
10

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
4,679

 
4,685

 

 
2,714

 
129

Non-owner occupied
9,684

 
9,689

 

 
9,723

 
489

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
5,007

 
5,007

 

 
5,104

 
112

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
3,602

 
3,612

 

 
3,332

 
152

Jumbo
3,510

 
3,509

 

 
3,514

 
167

Home equity
523

 
523

 

 
523

 
29

Mortgage warehouse lines

 

 

 

 

Consumer
13

 
13

 

 
14

 
1

Total without a related allowance
$
27,482

 
$
27,502

 
$

 
$
25,190

 
$
1,089

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$

 
$

 
$

 
$

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
6,737

 
6,737

 
161

 
6,746

 
274

Non-owner occupied
194

 
196

 
14

 
263

 
18

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
1,077

 
1,078

 
430

 
1,083

 
54

Construction

 

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
Non-jumbo
2,989

 
2,989

 
540

 
2,263

 
100

Jumbo
829

 
829

 
109

 
831

 
49

Home equity

 

 

 

 

Mortgage warehouse lines

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
11,826

 
$
11,829

 
$
1,254

 
$
11,186

 
$
495

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
27,842

 
$
27,856

 
$
605

 
$
25,899

 
$
1,086

Residential real estate
11,453

 
11,462

 
649

 
10,463

 
497

Consumer
13

 
13

 

 
14

 
1

Total
$
39,308

 
$
39,331

 
$
1,254

 
$
36,376

 
$
1,584


The table above does not include PCI loans.



Table of Contents
21




 
December 31, 2017
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
243

 
$
243

 
$

 
$
259

 
$
13

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
7,109

 
7,111

 

 
5,149

 
265

Non-owner occupied
9,105

 
9,106

 

 
9,736

 
684

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
5,018

 
5,018

 

 
4,743

 
329

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
4,190

 
4,199

 

 
4,214

 
240

Jumbo
3,555

 
3,554

 

 
3,592

 
228

Home equity
523

 
523

 

 
523

 
35

Mortgage warehouse lines

 

 

 

 

Consumer
17

 
17

 

 
28

 
3

Total without a related allowance
$
29,760

 
$
29,771

 
$

 
$
28,244

 
$
1,797

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$
252

 
$
252

 
$
252

 
$
262

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
2,436

 
2,436

 
125

 
2,451

 
161

Non-owner occupied
1,338

 
1,344

 
517

 
676

 
43

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
1,464

 
1,464

 
524

 
1,477

 
74

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
1,717

 
1,718

 
158

 
1,691

 
100

Jumbo
838

 
839

 
14

 
845

 
57

Home equity

 

 

 

 

Mortgage warehouse lines

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
8,045

 
$
8,053

 
$
1,590

 
$
7,402

 
$
435

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
26,965

 
$
26,974

 
$
1,418

 
$
24,753

 
$
1,569

Residential real estate
10,823

 
10,833

 
172

 
10,865

 
660

Consumer
17

 
17

 

 
28

 
3

Total
$
37,805

 
$
37,824

 
$
1,590

 
$
35,646

 
$
2,232


The table above does not include PCI loans.


Table of Contents
22


Included in impaired loans are TDRs of $27.8 million, of which $27.6 million were current with respect to restructured contractual payments at June 30, 2018, and $28.4 million, all of which were current with respect to restructured contractual payments at December 31, 2017.  There were no commitments to lend additional funds under these restructurings at either balance sheet date.

The following table presents by class the TDRs that were restructured during the three and six months ended June 30, 2018 and June 30, 2017 . Generally, the modifications were 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.

 
For the Three Months Ended 
 June 30, 2018
 
For the Three Months Ended 
 June 30, 2017
Dollars in thousands
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
 
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
Commercial
2

 
$
157

 
$
157

 

 
$

 
$

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
5

 
741

 
741

 
1

 
206

 
206

Total
7

 
$
898

 
$
898

 
1

 
$
206

 
$
206


 
For the Six Months Ended 
 June 30, 2018
 
For the Six Months Ended 
 June 30, 2017
Dollars in thousands
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
 
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
Commercial
2

 
$
157

 
$
157

 

 
$

 
$

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
6

 
805

 
805

 
5

 
1,087

 
1,087

Total
8

 
$
962

 
$
962

 
5

 
$
1,087

 
$
1,087


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 
 June 30, 2018
 
For the Six Months Ended 
 June 30, 2018
Dollars in thousands
Number
of
Defaults
 
Recorded
Investment
at Default Date
 
Number
of
Defaults
 
Recorded
Investment
at Default Date
Commercial
2

 
$
157

 
2

 
$
157

Commercial real estate


 


 


 


Owner-occupied
1

 
2,302

 
1

 
2,302

Non-owner occupied
1

 
341

 
1

 
341

Construction and development

 


 


 


Land & land development
1

 
438

 
1

 
438

Residential real estate


 


 


 


Non-jumbo
2

 
506

 
3

 
712

Total
7

 
$
3,744

 
8

 
$
3,950




Table of Contents
23


The following tables detail the activity regarding TDRs by loan type, net of fees, for the three and six months ended June 30, 2018, and the related allowance on TDRs.
For the Three Months Ended June 30, 2018
 
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
 
Mortgage Warehouse Lines
 
Con-
sumer
 
Other
 
Total
Troubled debt restructurings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance April 1, 2018
$
2,968

 
$

 
$
142

 
$
9,474

 
$
5,478

 
$
4,519

 
$
4,354

 
$
523

 
$

 
$
15

 
$

 
$
27,473

Additions

 

 
157

 

 

 
741

 

 

 

 

 

 
898

Charge-offs

 

 

 

 

 
(55
)
 

 

 

 

 

 
(55
)
Net (paydowns) advances
(20
)
 

 
(6
)
 
(41
)
 
(172
)
 
(233
)
 
(15
)
 

 

 
(2
)
 

 
(489
)
Transfer into foreclosed properties

 

 

 

 

 

 

 

 

 

 

 

Refinance out of TDR status

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2018
$
2,948

 
$

 
$
293

 
$
9,433

 
$
5,306

 
$
4,972

 
$
4,339

 
$
523

 
$

 
$
13

 
$

 
$
27,827

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to troubled debt restructurings
$
430

 
$

 
$

 
$
161

 
$
14

 
$
165

 
$
108

 
$

 
$

 
$

 
$

 
$
878


For the Six Months Ended June 30, 2018
 
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
 
Mortgage Warehouse Lines
 
Con-
sumer
 
Other
 
Total
Troubled debt restructurings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance January 1, 2018
$
3,043

 
$

 
$
412

 
$
9,545

 
$
5,234

 
$
5,195

 
$
4,393

 
$
523

 
$

 
$
18

 
$

 
$
28,363

Additions

 

 
157

 

 

 
805

 

 

 

 

 

 
962

Charge-offs

 

 

 

 

 
(55
)
 

 

 

 

 

 
(55
)
Net (paydowns) advances
(95
)
 

 
(276
)
 
(112
)
 
72

 
(973
)
 
(54
)
 

 

 
(5
)
 

 
(1,443
)
Transfer into foreclosed properties

 

 

 

 

 

 

 

 

 

 

 

Refinance out of TDR status

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2018
$
2,948

 
$

 
$
293

 
$
9,433

 
$
5,306

 
$
4,972

 
$
4,339

 
$
523

 
$

 
$
13

 
$

 
$
27,827

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to troubled debt restructurings
$
430

 
$

 
$

 
$
161

 
$
14

 
$
165

 
$
108

 
$

 
$

 
$

 
$

 
$
878


The following table presents the recorded investment in construction and development, commercial, and commercial real estate loans which are generally evaluated based upon our internal risk ratings.
Loan Risk Profile by Internal Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and Development
 
 
 
 
 
Commercial Real Estate
 
 
 
 
Land and Land Development
 
Construction
 
Commercial
 
Owner Occupied
 
Non-Owner Occupied
 
Mortgage Warehouse Lines
Dollars in thousands
6/30/2018
 
12/31/2017
 
6/30/2018
 
12/31/2017
 
6/30/2018
 
12/31/2017
 
6/30/2018
 
12/31/2017
 
6/30/2018
 
12/31/2017
 
6/30/2018
12/31/2017
Pass
$
68,747

 
$
60,850

 
$
25,585

 
$
33,412

 
$
164,582

 
$
186,941

 
$
255,289

 
$
242,702

 
$
494,277

 
$
474,522

 
$
54,332

$
30,757

OLEM (Special Mention)
798

 
1,397

 
126

 

 
6,095

 
2,267

 
1,748

 
3,534

 
1,779

 
2,221

 


Substandard
4,473

 
4,972

 

 

 
733

 
773

 
5,137

 
3,966

 
6,991

 
8,159

 


Doubtful

 

 

 

 

 

 

 

 

 

 


Loss

 

 

 

 

 

 

 

 

 

 


Total
$
74,018

 
$
67,219

 
$
25,711

 
$
33,412

 
$
171,410

 
$
189,981

 
$
262,174

 
$
250,202

 
$
503,047

 
$
484,902

 
$
54,332

$
30,757


Table of Contents
24


 
The following table presents the recorded investment and payment activity in consumer, residential real estate, and home equity loans, which are generally evaluated based on the aging status of the loans.
 
Performing
 
Nonperforming
Dollars in thousands
6/30/2018
 
12/31/2017
 
6/30/2018
 
12/31/2017
Residential real estate
 
 
 
 
 
 
 
Non-jumbo
$
335,600

 
$
347,183

 
$
7,444

 
$
6,918

Jumbo
66,831

 
62,267

 

 

Home Equity
81,895

 
83,316

 
514

 
712

Consumer
34,139

 
35,932

 
110

 
270

Other
12,728

 
13,238

 

 

Total
$
531,193

 
$
541,936

 
$
8,068

 
$
7,900




Table of Contents
25


NOTE 7.  ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses for the six month period ended June 30, 2018 and for the year ended December 31, 2017 is as follows:
 
 
June 30,
 
December 31,
Dollars in thousands
 
2018
 
2017
Balance, beginning of year
 
$
12,565

 
$
11,674

Charge-offs:
 
 
 
 
Commercial
 
50

 
23

Commercial real estate
 
 
 
 
Owner occupied
 
38

 
5

Non-owner occupied
 
500

 
65

Construction and development
 
 
 
 
Land and land development
 
220

 
3

Construction
 

 
33

Residential real estate
 
 
 
 
Non-jumbo
 
393

 
359

Jumbo
 

 
2

Home equity
 
25

 
158

Mortgage warehouse lines
 

 

Consumer
 
120

 
389

Other
 
139

 
251

Total
 
1,485

 
1,288

Recoveries:
 
 

 
 

Commercial
 
13

 
124

Commercial real estate
 
 
 
 
Owner occupied
 
13

 
89

Non-owner occupied
 

 
91

Construction and development
 
 
 
 
Land and land development
 
15

 
278

Construction
 
1

 

Residential real estate
 
 
 
 
Non-jumbo
 
64

 
134

Jumbo
 

 

Home equity
 
2

 
30

Mortgage warehouse lines
 

 

Consumer
 
79

 
82

Other
 
63

 
101

Total
 
250

 
929

Net charge-offs
 
1,235


359

Provision for loan losses
 
1,250

 
1,250

Balance, end of period
 
$
12,580


$
12,565

 
 

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26


The following table presents the activity in the allowance for loan losses, balance in the allowance for loan losses and recorded investment in loans by portfolio segment and based on impairment during the first six months of 2018 and for the year ended 2017:
 
For the Six Months Ended June 30, 2018
 
At June 30, 2018
 
At June 30, 2018
 
Allowance for loan losses
 
Allowance related to:
 
Loans
 
Beginning
 Balance
Charge-
offs
Recoveries
Provision
Ending
Balance
 
Loans
individua-
lly
evaluated
 for
impairm-
ent
Loans
collective-
ly
evaluated
for
impairm-
ent
Loans
acquired
 with
deteriora-
ted credit
quality (PCI)
Total
 
Loans
individua-
lly
evaluated
for
impairm-
ent
Loans
collective-
ly
evaluated
for
impairm-
ent
Loans
acquired
with
deteriora-
ted credit
quality (PCI)
Total
Commercial
$
1,303

$
(50
)
$
13

$
(329
)
$
937

 
$

$
937

$

$
937

 
$
464

$
170,946

$

$
171,410

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
2,424

(38
)
13

47

2,446

 
161

2,285


2,446

 
11,416

250,069

689

262,174

Non-owner occupied
4,950

(500
)

501

4,951

 
14

4,932

5

4,951

 
9,878

491,850

1,319

503,047

Construction and development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land and land development
641

(220
)
15

183

619

 
430

189


619

 
6,084

67,934


74,018

Construction
153


1

(29
)
125

 

125


125

 

25,711


25,711

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
1,911

(393
)
64

820

2,402

 
540

1,859

3

2,402

 
6,591

335,024

1,429

343,044

Jumbo
72



364

436

 
109

327


436

 
4,339

61,510

982

66,831

Home equity
638

(25
)
2

(344
)
271

 

271


271

 
523

81,886


82,409

Mortgage warehouse lines





 




 

54,332


54,332

Consumer
210

(120
)
79

37

206

 

206


206

 
13

34,236


34,249

Other
263

(139
)
63


187

 

187


187

 

12,728


12,728

Total
$
12,565

$
(1,485
)
$
250

$
1,250

$
12,580

 
$
1,254

$
11,318

$
8

$
12,580

 
$
39,308

$
1,586,226

$
4,419

$
1,629,953


 
For the Year Ended December 31, 2017
 
At December 31, 2017
 
At December 31, 2017
 
Allowance for loan losses
 
Allowance related to:
 
Loans
 
Beginning
 Balance
Charge-
offs
Recoveries
Provision
Ending
Balance
 
Loans
individua-
lly
evaluated
 for
impairm-
ent
Loans
collective-
ly
evaluated
for
impairm-
ent
Loans
acquired
 with
deteriora-
ted credit
quality (PCI)
Total
 
Loans
individua-
lly
evaluated
for
impairm-
ent
Loans
collective-
ly
evaluated
for
impairm-
ent
Loans
acquired
with
deteriora-
ted credit
quality (PCI)
Total
Commercial
$
934

$
(23
)
$
124

$
268

$
1,303

 
$
252

$
1,051

$

$
1,303

 
$
495

$
189,477

$
9

$
189,981

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
2,109

(5
)
89

231

2,424

 
125

2,299


2,424

 
9,545

239,968

689

250,202

Non-owner occupied
3,438

(65
)
91

1,486

4,950

 
517

4,432

1

4,950

 
10,443

472,622

1,837

484,902

Construction and development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land and land development
2,263

(3
)
278

(1,897
)
641

 
524

117


641

 
6,482

60,737


67,219

Construction
24

(33
)

162

153

 

153


153

 

33,412


33,412

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
2,174

(359
)
134

(38
)
1,911

 
158

1,747

6

1,911

 
5,907

346,709

1,485

354,101

Jumbo
95

(2
)

(21
)
72

 
14

58


72

 
4,393

56,875

999

62,267

Home equity
413

(158
)
30

353

638

 

638


638

 
523

83,505


84,028

Mortgage warehouse lines





 




 

30,757


30,757

Consumer
121

(389
)
82

396

210

 

210


210

 
17

36,185


36,202

Other
103

(251
)
101

310

263

 

263


263

 

13,238


13,238

Total
$
11,674

$
(1,288
)
$
929

$
1,250

$
12,565

 
$
1,590

$
10,968

$
7

$
12,565

 
$
37,805

$
1,563,485

$
5,019

$
1,606,309



NOTE 8.  GOODWILL AND OTHER INTANGIBLE ASSETS

The following tables present our goodwill by reporting unit at June 30, 2018 and other intangible assets by reporting unit at June 30, 2018 and December 31, 2017.


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27


 
 
Goodwill Activity
Dollars in thousands
 
Community Banking
 
Insurance Services
 
Total
Balance, January 1, 2018
 
$
10,562

 
$
4,710

 
$
15,272

Reclassifications to goodwill
 

 

 

Acquired goodwill, net
 

 

 

Balance, June 30, 2018
 
$
10,562

 
$
4,710

 
$
15,272

 
 
Other Intangible Assets
 
 
June 30, 2018
 
December 31, 2017
Dollars in thousands
 
Community
Banking
 
Insurance
Services
 
Total
 
Community
Banking
 
Insurances
Services
 
Total
Identifiable intangible assets
 
 

 
 

 
 

 
 

 
 

 
 

Gross carrying amount
 
$
12,598

 
$
3,000

 
$
15,598

 
$
12,598

 
$
3,000

 
$
15,598

Less: accumulated amortization
 
2,005

 
2,200

 
4,205

 
1,257

 
2,100

 
3,357

Net carrying amount
 
$
10,593

 
$
800

 
$
11,393

 
$
11,341

 
$
900

 
$
12,241


We recorded amortization expense of $848,000 and $526,000 for the six months ended June 30, 2018 and 2017, respectively, relative to our identifiable intangible assets.  

Amortization relative to our identifiable intangible assets is expected to approximate the following during the next five years:

 
 
Core Deposit
 
Customer
Dollars in thousands
 
Intangible
 
Intangible
2018
 
$
1,471

 
$
200

2019
 
1,368

 
200

2020
 
1,265

 
200

2021
 
1,162

 
200

2022
 
1,060

 
100


NOTE 9.  DEPOSITS

The following is a summary of interest bearing deposits by type as of June 30, 2018 and December 31, 2017:
Dollars in thousands
 
June 30,
2018
 
December 31,
2017
Demand deposits, interest bearing
 
$
472,041

 
$
410,606

Savings deposits
 
322,940

 
358,168

Time deposits
 
627,881

 
614,334

Total
 
$
1,422,862

 
$
1,383,108


Included in time deposits are deposits acquired through a third party (“brokered deposits”) totaling $238.7 million and $216.9 million at June 30, 2018 and December 31, 2017, respectively.


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28


A summary of the scheduled maturities for all time deposits as of June 30, 2018 is as follows:
Dollars in thousands
 
Six month period ending December 31, 2018
$
116,750

Year ending December 31, 2019
208,584

Year ending December 31, 2020
128,825

Year ending December 31, 2021
73,802

Year ending December 31, 2022
38,142

Thereafter
61,778

Total
$
627,881


The following is a summary of the maturity distribution of all certificates of deposit in denominations of $100,000 or more as of June 30, 2018:
Dollars in thousands
Amount
 
Percent
Three months or less
$
25,243

 
5.8
%
Three through six months
35,519

 
8.2
%
Six through twelve months
89,158

 
20.5
%
Over twelve months
284,088

 
65.5
%
Total
$
434,008

 
100.00
%


NOTE 10.  BORROWED FUNDS

Short-term borrowings:    A summary of short-term borrowings is presented below:
 
Six Months Ended June 30,
 
2018
 
2017
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 June 30
$
199,900

 
$
2,529

 
$
202,250

 
$
3,478

Average balance outstanding for the period
211,884

 
3,497

 
194,071

 
3,469

Maximum balance outstanding at any month end during period
262,000

 
3,523

 
229,300

 
3,478

Weighted average interest rate for the period
1.87
%
 
1.65
%
 
0.98
%
 
0.91
%
Weighted average interest rate for balances
 

 
 

 
 

 
 

     outstanding at June 30
2.19
%
 
2.00
%
 
1.30
%
 
1.25
%

 
Year Ended December 31, 2017
Dollars in thousands
Short-term
FHLB
Advances
 
Short-term
Repurchase
Agreements
 
Federal Funds
Purchased
and Lines
of Credit
Balance at December 31
$
247,000

 
$

 
3,499

Average balance outstanding for the period
201,712

 
519

 
3,512

Maximum balance outstanding at any month end
    during period
247,000

 

 
3,499

Weighted average interest rate for the period
1.19
%
 
0.12
%
 
1.10
%
Weighted average interest rate for balances
 
 
 
 
 
     outstanding at December 31
1.60
%
 
%
 
1.50
%

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29




Long-term borrowings:  Our long-term borrowings of $20.7 million and $45.8 million at June 30, 2018 and December 31, 2017, respectively, consisted of advances from the Federal Home Loan Bank (“FHLB”) and structured repurchase agreements with 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 June 30,
 
Balance at 
 December 31,
Dollars in thousands
2018
 
2017
Long-term FHLB advances
$
743

 
$
751

Long-term repurchase agreements
20,000

 
45,000

Total
$
20,743

 
$
45,751

 
Our long term FHLB borrowings and 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 six month period ended June 30, 2018 was 4.26% compared to 4.29% for the first six months of 2017.

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 June 30, 2018 and December 31, 2017.

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 owed
to unconsolidated
subsidiary trusts
Year Ending December 31,
2018
 
$
20,008

 
$

 
2019
 
18

 

 
2020
 
18

 

 
2021
 
20

 

 
2022
 
21

 

 
Thereafter
 
658

 
19,589

 
 
 
$
20,743

 
$
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 ("SARs"), performance units, other stock-based awards or any combination thereof,  to our key employees. 

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

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30


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.
 
Under the 2014 LTIP and the Plans, stock options and SARs have generally been granted with an exercise price equal to the fair value of Summit's common stock on the grant date. We periodically grant employee stock options to individual employees. During first quarter 2017, we granted 53,309 SARs that become exercisable ratably over five years (20% per year) and expire ten years after the grant date and granted 34,306 SARS that become exercisable ratably over seven years (14.29% per year) and expire ten years after the grant date. There were no grants of stock options or SARs during the six months ended June 30, 2018.

The fair value of our employee stock options and SARs 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 and SARs granted but are not considered by the model. Because our employee stock options and SARs 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 and SARs at the time of grant. The assumptions used to value SARs issued during 2017 were as follows:
 
5-year vesting SARs
7-year vesting SARs
Risk-free interest rate
2.16
%
2.24
%
Expected dividend yield
1.45
%
1.45
%
Expected common stock volatility
60.05
%
59.60
%
Expected life
6.5 years

7.0 years


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 six months of 2018 and 2017, our share-based compensation expense was $193,000 and $184,000 and the related deferred tax benefits were approximately $46,000 and $68,000.

A summary of activity in our Plans during the first six months of 2018 and 2017 is as follows:
 
For the Six Months Ended June 30,
 
2018
 
Options/SARs
 
Aggregate
Intrinsic
Value
 
Remaining
Contractual
Term (Yrs.)
 
Weighted-Average
Exercise Price
Outstanding, January 1
250,291

 
 
 
 
 
$
17.75

Granted

 
 
 
 
 

Exercised
(200
)
 
 
 
 
 
17.79

Forfeited
(3,000
)
 
 
 
 
 
26.01

Expired

 
 
 
 
 

Outstanding, June 30
247,091

 
$
2,272

 
6.83
 
$
17.65

 
 
 
 
 
 
 
 
Exercisable, June 30
110,924

 
$
1,225

 
5.72
 
$
15.80



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31


 
For the Six Months Ended June 30,
 
2017
 
Options/SARs
 
Aggregate
Intrinsic
Value
 
Remaining
Contractual
Term (Yrs.)
 
Weighted-Average
Exercise Price
Outstanding, January 1
217,857

 
 
 
 
 
$
13.56

Granted
87,615

 
 
 
 
 
26.01

Exercised
(2,000
)
 
 
 
 
 
6.21

Forfeited

 
 
 
 
 

Expired

 
 
 
 
 

Outstanding, June 30
303,472

 
$
1,900

 
7.36
 
$
17.20

 
 
 
 
 
 
 
 
Exercisable, June 30
115,827

 
$
900

 
5.26
 
$
15.02


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
 
June 30,
2018
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
70,196

Construction loans
 
62,975

Other loans
 
141,754

Standby letters of credit
 
6,179

Total
 
$
281,104


Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  We evaluate each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if we deem necessary upon extension of credit, is based on our credit evaluation.  Collateral held varies but may include accounts receivable, inventory, equipment or real estate.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.



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32


Litigation

We are not a party to 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 if any, 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.  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 Common Equity Tier ("CET1") 1, Total capital 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 June 30, 2018, 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 CET1, 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 June 30, 2018, 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 2017 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 June 30, 2018 and December 31, 2017 under the Basel III Capital Rules. The minimum required capital levels presented below 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 June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
$
186,881

 
11.0
%
 
$
118,924

 
7.0
%
 
$
110,430

 
6.5
%
Summit Community
 
205,204

 
12.0
%
 
119,702

 
7.0
%
 
111,152

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
205,881

 
12.1
%
 
144,627

 
8.5
%
 
136,120

 
8.0
%
Summit Community
 
205,204

 
12.0
%
 
145,353

 
8.5
%
 
136,803

 
8.0
%
Total Capital (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
Summit
 
218,461

 
12.8
%
 
179,206

 
10.5
%
 
170,673

 
10.0
%
Summit Community
 
217,784

 
12.8
%
 
178,651

 
10.5
%
 
170,144

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
205,881

 
9.9
%
 
83,184

 
4.0
%
 
103,980

 
5.0
%
Summit Community
 
205,204

 
9.8
%
 
83,757

 
4.0
%
 
104,696

 
5.0
%

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33


 
 
 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 December 31, 2017
 
 

 
 

 
 

 
 

CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
177,010

 
10.6
%
 
116,893

 
7.0
%
 
108,544

 
6.5
%
Summit Community
 
195,008

 
11.7
%
 
116,671

 
7.0
%
 
108,338

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
196,010

 
11.8
%
 
141,194

 
8.5
%
 
132,888

 
8.0
%
Summit Community
 
195,008

 
11.7
%
 
141,672

 
8.5
%
 
133,339

 
8.0
%
Total Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
208,575

 
12.5
%
 
175,203

 
10.5
%
 
166,860

 
10.0
%
Summit Community
 
207,573

 
12.5
%
 
174,361

 
10.5
%
 
166,058

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
196,010

 
9.4
%
 
83,409

 
4.0
%
 
104,261

 
5.0
%
Summit Community
 
195,008

 
9.4
%
 
82,982

 
4.0
%
 
103,728

 
5.0
%


NOTE  14.  SEGMENT INFORMATION

We operate three business segments:  community banking, insurance services and trust and wealth management 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 services segment includes two insurance agency offices that sell insurance products.  The trust and wealth management segment includes Summit Community Bank's trust division and other non-bank investment 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, insurance services and trust and wealth management 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 June 30, 2018
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
17,495

 
$

 
$

 
$
(220
)
 
$

 
$
17,275

Provision for loan losses
 
750

 

 

 

 

 
750

Net interest income after provision
for loan losses
 
16,745

 

 

 
(220
)
 

 
16,525

Other income
 
2,467

 
672

 
1,009

 
389

 
(389
)
 
4,148

Other expenses
 
10,922

 
484

 
953

 
765

 
(389
)
 
12,735

Income (loss) before income taxes
 
8,290

 
188

 
56

 
(596
)
 

 
7,938

Income tax expense (benefit)
 
1,717

 
45

 
16

 
(120
)
 

 
1,658

Net income (loss)
 
$
6,573

 
$
143

 
$
40

 
$
(476
)
 
$

 
$
6,280

Inter-segment revenue (expense)
 
$
(359
)
 
$

 
$
(30
)
 
$
389

 
$

 
$

Average assets
 
$
2,128,314

 
$

 
$
6,055

 
$
229,129

 
$
(252,067
)
 
$
2,111,431

Capital expenditures
 
$
917

 
$

 
$
1

 
$
76

 
$

 
$
994



Table of Contents
34


 
 
Three Months Ended June 30, 2017
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
18,017

 
$

 
$

 
$
(169
)
 
$

 
$
17,848

Provision for loan losses
 
250

 

 

 

 

 
250

Net interest income after provision
for loan losses
 
17,767

 

 

 
(169
)
 

 
17,598

Other income
 
2,364

 
595

 
957

 
491

 
(491
)
 
3,916

Other expenses
 
12,441

 
529

 
807

 
650

 
(491
)
 
13,936

Income (loss) before income taxes
 
7,690

 
66

 
150

 
(328
)
 

 
7,578

Income tax expense (benefit)
 
2,336

 
25

 
58

 
(119
)
 

 
2,300

Net income (loss)
 
$
5,354

 
$
41

 
$
92

 
$
(209
)
 
$

 
$
5,278

Inter-segment revenue (expense)
 
$
(451
)
 
$

 
$
(40
)
 
$
491

 
$

 
$

Average assets
 
$
2,118,423

 
$

 
$
6,189

 
$
212,193

 
$
(242,486
)
 
$
2,094,319

Capital expenditures
 
$
1,057

 
$

 
$
32

 
$
92

 
$

 
$
1,181


 
 
Six Months Ended June 30, 2018
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
34,944

 
$

 
$

 
$
(411
)
 
$

 
$
34,533

Provision for loan losses
 
1,250

 

 

 

 

 
1,250

Net interest income after provision
for loan losses
 
33,694

 

 

 
(411
)
 

 
33,283

Other income
 
5,561

 
1,339

 
2,123

 
778

 
(778
)
 
9,023

Other expenses
 
21,575

 
1,009

 
1,849

 
1,394

 
(778
)
 
25,049

Income (loss) before income taxes
 
17,680

 
330

 
274

 
(1,027
)
 

 
17,257

Income tax expense (benefit)
 
3,574

 
79

 
67

 
(186
)
 

 
3,534

Net income (loss)
 
$
14,106

 
$
251

 
$
207

 
$
(841
)
 
$

 
$
13,723

Inter-segment revenue (expense)
 
$
(718
)
 
$

 
$
(60
)
 
$
778

 
$

 
$

Average assets
 
$
2,138,326

 
$

 
$
6,020

 
$
226,851

 
$
(250,165
)
 
$
2,121,032

Capital expenditures
 
$
2,767

 
$

 
$
13

 
$
86

 
$

 
$
2,866



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35


 
 
Six Months Ended June 30, 2017
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
31,812

 
$

 
$

 
$
(335
)
 
$

 
$
31,477

Provision for loan losses
 
500

 

 

 

 

 
500

Net interest income after provision
for loan losses
 
31,312

 

 

 
(335
)
 

 
30,977

Other income
 
3,871

 
695

 
1,930

 
982

 
(982
)
 
6,496

Other expenses
 
30,508

 
673

 
1,681

 
1,073

 
(982
)
 
32,953

Income (loss) before income taxes
 
4,675

 
22

 
249

 
(426
)
 

 
4,520

Income tax expense (benefit)
 
903

 
9

 
98

 
(152
)
 

 
858

Net income (loss)
 
$
3,772

 
$
13

 
$
151

 
$
(274
)
 
$

 
$
3,662

Inter-segment revenue (expense)
 
$
(902
)
 
$

 
$
(80
)
 
$
982

 
$

 
$

Average assets
 
$
1,934,268

 
$

 
$
6,216

 
$
196,622

 
$
(224,803
)
 
$
1,912,303

Capital expenditures
 
$
4,049

 
$

 
$
35

 
$
91

 
$

 
$
4,175



NOTE  15.  DERIVATIVE FINANCIAL INSTRUMENTS

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.

We have entered into two pay fixed/receive variable interest rate swaps to hedge fair value variability of two commercial fixed rate loans with the same principal, amortization, and maturity terms of the underlying loans, which are designated as fair value hedges. Under the terms of a $9.95 million original notional swap with an effective date of January 15, 2015, we will pay a fixed rate of 4.33% for a 10 year period. Under the terms of a $11.3 million original notional swap with an effective date of December 18, 2015, we will pay a fixed rate of 4.30% for a 10 year period.

A summary of our derivative financial instruments as of June 30, 2018 and December 31, 2017 follows:
 
June 30, 2018
 
Notional
Amount
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Short term borrowings
$
110,000

 
$

 
$
620

 
$

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
19,685

 
$
927

 
$

 
$



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36


 
December 31, 2017
 
Notional
Amount
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
Short term borrowings
$
110,000

 
$

 
$
2,057

 
$

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
19,965

 
$
312

 
$

 
$


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 16. ACQUISITIONS

FCB Acquisition

On April 1, 2017, Summit Community Bank, Inc. ("SCB"), a wholly-owned subsidiary of Summit, acquired 100% of the ownership of First Century Bankshares, Inc. ("FCB") and its subsidiary First Century Bank, headquartered in Bluefield, West Virginia. FCB's assets and liabilities approximated $406 million and $361 million, respectively, at March 31, 2017.

HCB Acquisition

On October 1, 2016, Summit Community Bank, Inc. ("SCB"), a wholly-owned subsidiary of Summit, acquired 100% of the ownership of Highland County Bankshares, Inc. ("HCB") and its subsidiary First and Citizens Bank, headquartered in Monterey, Virginia. HCB's assets and liabilities approximated $123 million and $107 million, respectively, at September 30, 2016.

The following presents the financial effects of adjustments recognized in the statement of income for the three months and six months ended June 30, 2018 and 2017 related to business combinations that occurred during 2016 and 2017.

 
Income increase (decrease)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Dollars in thousands
2018
 
2017
 
2018
 
2017
Interest and fees on loans
$
56

 
$
345

 
$
201

 
$
488

Interest expense on deposits
53

 
87

 
114

 
91

Amortization of intangibles
(363
)
 
(379
)
 
(748
)
 
(426
)
Income before income tax expense
$
(254
)
 
$
53

 
$
(433
)
 
$
153


Pending Peoples Acquisition

On July 24, 2018, we entered into a Definitive Merger Agreement with Peoples Bankshares, Inc. ("Peoples"). Pursuant to the terms of the merger agreement, Summit will acquire all of the outstanding shares of common stock of Peoples in exchange for cash in the amount of $47.00 per share or 1.7193 shares of Summit common stock. Peoples shareholders will have a right to receive cash, Summit’s common stock or a combination of cash and Summit common stock, subject to proration to result in approximately 50% cash and 50% stock consideration in the aggregate. Total merger consideration received by Peoples shareholders is subject to an adjustment if Peoples’ adjusted shareholders’ equity as of the effective date of the merger deviates from the range mutually determined by the parties. Peoples' assets approximated $131 million at March 31, 2018.
We anticipate the acquisition will close in the first quarter of 2019, subject to customary closing conditions, including regulatory approval and approval of Peoples' shareholders. Following the consummation of the merger, Peoples' wholly-owned subsidiary First Peoples Bank, Inc. will be consolidated with Summit's subsidiary, Summit Community Bank, Inc.

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37



NOTE 17. ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

The following is changes in accumulated other comprehensive (loss) income by component, net of tax, for the three and six months ending June 30, 2018 and 2017.
 
 
For the Three Months Ended 
 June 30, 2018
Dollars in thousands
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
398

 
$
(849
)
 
$
(437
)
 
$
(888
)
Other comprehensive income (loss) before reclassification
 

 
377

 
(409
)
 
(32
)
Amounts reclassified from accumulated other comprehensive income
 

 

 
(66
)
 
(66
)
Net current period other comprehensive income (loss)
 

 
377

 
(475
)
 
(98
)
Ending balance
 
$
398

 
$
(472
)
 
$
(912
)
 
$
(986
)

 
 
For the Three Months Ended 
 June 30, 2017
Dollars in thousands
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$

 
$
(2,408
)
 
$
(166
)
 
$
(2,574
)
Other comprehensive income before reclassification
 
219

 
170

 
1,936

 
2,325

Amounts reclassified from accumulated other comprehensive income
 

 

 
(57
)
 
(57
)
Net current period other comprehensive income
 
219

 
170

 
1,879

 
2,268

Ending balance
 
$
219

 
$
(2,238
)
 
$
1,713

 
$
(306
)

 
 
For the Six Months Ended 
 June 30, 2018
Dollars in thousands
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
398

 
$
(1,564
)
 
$
2,898

 
$
1,732

Other comprehensive income (loss) before reclassification
 

 
1,092

 
(3,188
)
 
(2,096
)
Amounts reclassified from accumulated other comprehensive income
 

 

 
(622
)
 
(622
)
Net current period other comprehensive income (loss)
 

 
1,092

 
(3,810
)
 
(2,718
)
Ending balance
 
$
398

 
$
(472
)
 
$
(912
)
 
$
(986
)

 
 
For the Six Months Ended 
 June 30, 2017
Dollars in thousands
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$

 
$
(2,905
)
 
$
(357
)
 
$
(3,262
)
Other comprehensive income before reclassification
 
219

 
667

 
2,090

 
2,976

Amounts reclassified from accumulated other comprehensive income
 

 

 
(20
)
 
(20
)
Net current period other comprehensive income
 
219

 
667

 
2,070

 
2,956

Ending balance
 
$
219

 
$
(2,238
)
 
$
1,713

 
$
(306
)

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38




NOTE 18. INCOME TAXES

Our income tax expense for the three months ended June 30, 2018 and June 30, 2017 totaled $1.7 million and $2.3 million, respectively. For the six months ended June 30, 2018 and June 30, 2017 our income tax expense totaled $3.5 million and $0.9 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for the quarters ended June 30, 2018 and 2017 was 20.9% and 30.3%, respectively, and for the six months ended June 30, 2018 and 2017 were 20.5% and 19.0%, respectively. A reconciliation between the statutory income tax rate and our effective income tax rate for the three and six months ended June 30, 2018 and 2017 is as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Dollars in thousands
Percent
 
Percent
 
Percent
 
Percent
Applicable statutory rate
21.0
 %
 
35.0
 %
 
21.0
 %
 
35.0
 %
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
Tax-exempt interest and dividends, net
(3.2
)%
 
(5.5
)%
 
(2.9
)%
 
(15.7
)%
State income taxes (benefit), net of Federal income tax benefit
2.3
 %
 
2.1
 %
 
2.2
 %
 
1.8
 %
Low-income housing and rehabilitation tax credits
(1.2
)%
 
 %
 
(1.1
)%
 
 %
Other, net
2.0
 %
 
(1.3
)%
 
1.3
 %
 
(2.1
)%
Effective income tax rate
20.9
 %
 
30.3
 %
 
20.5
 %
 
19.0
 %

The components of applicable income tax expense for the three and six months ended June 30, 2018 and 2017 are as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands
2018
2017
 
2018
2017
Current
 
 
 
 
 
Federal
$
1,464

$
(1,299
)
 
$
3,217

$
879

State
233

(52
)
 
510

136

 
1,697

(1,351
)
 
3,727

1,015

Deferred
 

 
 
 

 

Federal
(34
)
3,354

 
(167
)
(143
)
State
(5
)
297

 
(26
)
(14
)
 
(39
)
3,651

 
(193
)
(157
)
Total
$
1,658

$
2,300

 
$
3,534

$
858


NOTE 19. REVENUE FROM CONTRACTS WITH CUSTOMERS

Interest income, loan fees, realized securities gains and losses, bank owned life insurance income and mortgage banking revenue are not in the scope of ASC Topic 606, Revenue from Contracts with Customers. With the exception of gains or losses on sales of foreclosed properties, all of our revenue from contracts with customers in the scope of ASC 606 is recognized within Noninterest Income in the Consolidated Statements of Income. Incremental costs of obtaining a contract are expensed when incurred when the amortization period is one year or less. As of June 30, 2018, remaining performance obligations consisted of insurance products with an original expected length of one year or less.
A description of our significant sources of revenue accounted for under ASC 606 follows:
Service fees on deposit accounts are fees we charge our deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which are earned based on specific transactions or customer activity within a customer’s deposit account, are recognized at the time the related transaction or activity occurs, as it is at this point when we fulfill the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which Summit satisfied the performance obligation. Overdraft fees are recognized when the overdraft occurs. Service fees on deposit accounts are paid through a direct charge to the customer’s account.

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39


Bank card revenue is comprised of interchange revenue and ATM fees. Interchange revenue is earned when Summit’s debit and credit cardholders conduct transactions through Mastercard and other payment networks. Interchange fees represent a percentage of the underlying cardholder’s transaction value and are generally recognized daily, concurrent with the transaction processing services provided to the cardholder. ATM fees are earned when a non-Summit cardholder uses a Summit ATM. ATM fees are recognized daily, as the related ATM transactions are settled.
Trust and wealth management fees consist of 1) trust fees and 2) commissions earned from an independent, third-party broker-dealer. We earn trust fees from our contracts with trust clients to administer or manage assets for investment. Trust fees are earned over time (generally monthly) as Summit provides the contracted services and are assessed based on the value of assets under management at each month-end. We earn commissions from investment brokerage services provided to our clients by an independent, third-party broker-dealer. We receive monthly commissions from the third-party broker-dealer based upon client activity for the previous month.
Insurance commissions principally consist of commissions we earn as agents of insurers for selling group employee benefit and property and casualty insurance products to clients. Group employee benefit insurance commissions are recognized over time (generally monthly) as the related customary implied servicing obligations of group policyholders are fulfilled. Property and casualty insurance commissions are recognized using methods which approximate the time of placement of the underlying policy. We are paid insurance commissions ratably as the related policy premiums are paid by clients.
The following table illustrates our total non-interest income segregated by revenues within the scope of ASC Topic 606 and those which are within the scope of other ASC Topics: 
Dollars in thousands
 
Three Months Ended June 30, 2018
 
Six Months Ended 
 June 30, 2018
Service fees on deposit accounts
 
$
1,116

 
$
2,207

Bank card revenue
 
801

 
1,550

Trust and wealth management fees
 
672

 
1,339

Insurance commissions
 
1,013

 
2,126

Other
 
58

 
137

Net revenue from contracts with customers
 
3,660

 
7,359

Non-interest income within the scope of other ASC topics
 
488

 
1,664

Total noninterest income
 
$
4,148

 
$
9,023


Gain or loss on sale of foreclosed properties is recorded when control of the property transfers to the buyer, which generally occurs at the time of transfer of the deed. If Summit finances the sale of a foreclosed property to the buyer, we assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the foreclosed property is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. For the three and six months ended June 30, 2018, net gains (losses) on sales of foreclosed properties were $(58,000) and $6,000 .

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40

Item 2. 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 its operating subsidiaries, 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 2017 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

On April 1, 2017, we acquired First Century Bankshares, Inc. ("FCB") and its subsidiary, First Century Bank, headquartered in Bluefield, West Virginia. FCB's results are included in our financial statements from the acquisition date forward, significantly impacting comparisons to the prior-year six-month period.

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.

Primarily due to our FCB acquisition, average interest earning assets increased by 11.26% for the first six months in 2018 compared to the same period of 2017 while our net interest earnings on a tax equivalent basis increased 7.96%.  Our tax equivalent net interest margin increased 9 basis points as our yield on interest earning assets increased 14 basis points while our cost of interest bearing funds increased 30 basis points.

We recorded a charge of $9.9 million, or $6.2 million after-tax, to noninterest expense in the first quarter of 2017 to recognize our full resolution of the ResCap Litigation which had been pending since 2014.
BUSINESS SEGMENT RESULTS

We are organized and managed along three 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 June 30,
 
Six Months Ended June 30,
Dollars in thousands
 
2018
 
2017
 
2018
 
2017
Community banking
 
$
6,573

 
$
5,354

 
$
14,106

 
$
3,772

Trust and wealth management
 
143

 
41

 
251

 
13

Insurance services
 
40

 
92

 
207

 
151

Parent
 
(476
)
 
(209
)
 
(841
)
 
(274
)
Consolidated net income
 
$
6,280

 
$
5,278

 
$
13,723

 
$
3,662


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.

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Our most significant accounting policies are presented in the notes to the consolidated financial statements of our 2017 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, accounting for acquired loans 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.

For additional information regarding critical accounting policies, refer to Critical Accounting Policies section in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2017 Form 10-K. There have been no significant changes in our application of critical accounting policies since December 31, 2017.

RESULTS OF OPERATIONS

Earnings Summary

Net income for the six months ended June 30, 2018 increased to $13.7 million or $1.10 per diluted share from $3.7 million or $0.32 per diluted share for the same period of 2017. Net income for the three months ended June 30, 2018 was $6.3 million, or $0.51 per diluted share, compared to $5.3 million, or $0.43 per diluted share for the same period of 2017. The decreased earnings for the six months ended June 30, 2017 were primarily attributable to the charge for a $9.9 million pre-tax litigation settlement recognized in the first quarter of 2017. Otherwise, net income for the six months ended June 30, 2018, compared to the same period of 2017, was positively impacted by increased net interest income, increased fee income including trust and wealth management fees and fees related to deposit accounts, larger gains on sales of securities and no merger expenses being incurred during 2018 while being negatively impacted by generally higher operating expenses due to the FCB acquisition.  Net income for the quarter ended June 30, 2018, compared to the same period of 2017, was positively impacted by increased fee income including trust and wealth management fees and fees related to deposit accounts and no merger expenses being incurred during 2018. Returns on average equity and assets for the first six months of 2018 were 13.43% and 1.29%, respectively, compared with 4.22% and 0.38% for the same period of 2017.

FCB’s results of operations are included in our consolidated results of operations from the date of acquisition, and therefore our quarter ended June 30, 2018 results reflect increased levels of average balances, income and expense as compared to the same periods of 2017 results. At consummation (prior to fair value acquisition adjustments), FCB had total assets of $406.2 million, net loans of $226.5 million, and deposits of $349.7 million.

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. Due to increases in interest earnings assets and interest bearing liabilities from the FCB acquisition and recent FOMC increases to its target Federal funds rate, we have experienced higher levels of net interest income but a decreased net interest margin for the six months ended June 30, 2018 compared to June 30, 2017.

Q2 2018 compared to Q1 2018

For the quarter ended June 30, 2018, our net interest income on a fully taxable-equivalent basis increased $29,000 to $17.60 million compared to $17.57 million for the quarter end March 31, 2018. Our taxable-equivalent earnings on interest earning assets increased $513,000, while the cost of interest bearing liabilities increased $484,000 (see Tables I and II).

For the three months ended June 30, 2018 average interest earning assets decreased 1.0% to $1.97 billion compared to $1.99 billion for the three months ended March 31, 2018, while average interest bearing liabilities decreased 1.8% from $1.70 billion for the three months ended March 31, 2018 to $1.67 billion for the three months ended June 30, 2018.

For the quarter ended June 30, 2018, our net interest margin remained unchanged at 3.58%, compared to the linked quarter, as the yields on earning assets increased 14 basis points, while the cost of our interest bearing funds increased by 25 basis points.


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Excluding the impact of accretion and amortization of fair value acquisition accounting adjustments related to the interest earning assets and interest bearing liabilities acquired from FCB and HCB, Summit's net interest margin was 3.56% and 3.53% for the three months ended June 30, 2018 and March 31, 2018.

Q2 2018 compared to Q2 2017

For the quarter ended June 30, 2018, our net interest income on a fully taxable-equivalent basis decreased $890,000 to $17.60 million compared to $18.49 million for the quarter end June 30, 2017. Our taxable-equivalent earnings on interest earning assets increased $850,000, while the cost of interest bearing liabilities increased $1.7 million (see Tables I and II).

For the three months ended June 30, 2018 average interest earning assets increased 1.3% to $1.97 billion compared to $1.95 billion for the three months ended June 30, 2017, while average interest bearing liabilities increased 0.5% from $1.66 billion for the three months ended June 30, 2017 to $1.67 billion for the three months ended June 30, 2018.

For the quarter ended June 30, 2018, our net interest margin decreased to 3.58%, compared to 3.81% for the same period of 2017, as the yields on earning assets increased 12 basis points, while the cost of our interest bearing funds increased by 41 basis points. The decline in yields on earning assets is primarily due to lower taxable-equivalent yields on tax-exempt interest earning assets resulting from reduction in the corporate income tax rate upon enactment of Tax Cuts and Jobs Act ("TCJA").

Excluding the impact of accretion and amortization of fair value acquisition accounting adjustments related to the interest earning assets and interest bearing liabilities acquired from FCB and HCB, Summit's net interest margin was 3.56% and 3.72% for the three months ended June 30, 2018 and 2017.




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43


Table I - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended
 
June 30, 2018
 
March 31, 2018
 
June 30, 2017
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
$
1,618,726

 
$
20,820

 
5.16
%
 
$
1,611,813

 
$
20,223

 
5.09
%
 
$
1,537,317

 
$
19,550

 
5.1
%
Tax-exempt (2)
15,800

 
180

 
4.57
%
 
16,307

 
182

 
4.53
%
 
13,030

 
257

 
7.91
%
Securities
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
Taxable
160,632

 
1,240

 
3.10
%
 
191,713

 
1,372

 
2.90
%
 
214,601

 
1,330

 
2.49
%
Tax-exempt (2)
136,984

 
1,346

 
3.94
%
 
132,306

 
1,290

 
3.95
%
 
133,130

 
1,568

 
4.72
%
Federal funds sold and interest bearing deposits with other banks
38,936

 
134

 
1.38
%
 
39,656

 
140

 
1.43
%
 
47,937

 
165

 
1.38
%
Total interest earning assets
1,971,078

 
23,720

 
4.83
%
 
1,991,795

 
23,207

 
4.69
%
 
1,946,015

 
22,870

 
4.71
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Cash & due from banks
9,100

 
 

 
 

 
9,962

 
 
 
 
 
10,101

 
 
 
 
Premises and equipment
35,721

 
 

 
 

 
34,586

 
 
 
 
 
34,441

 
 
 
 
Property held for sale
21,435

 
 
 
 
 
21,326

 
 
 
 
 
25,748

 
 
 
 
Other assets
86,638

 
 

 
 

 
85,799

 
 
 
 
 
89,980

 
 
 
 
Allowance for loan losses
(12,541
)
 
 

 
 

 
(12,737
)
 
 
 
 
 
(11,966
)
 
 
 
 
Total assets
$
2,111,431

 
 

 
 

 
$
2,130,731

 
 
 
 
 
$
2,094,319

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
457,016

 
$
901

 
0.79
%
 
$
423,095

 
$
632

 
0.44
%
 
$
378,350

 
$
252

 
0.27
%
Savings deposits
332,809

 
798

 
0.96
%
 
346,358

 
717

 
0.75
%
 
389,847

 
616

 
0.63
%
Time deposits
640,626

 
2,610

 
1.63
%
 
622,543

 
2,200

 
1.32
%
 
628,358

 
1,766

 
1.13
%
Short-term borrowings
187,475

 
1,242

 
2.66
%
 
243,686

 
1,405

 
2.24
%
 
200,209

 
1,079

 
2.16
%
Long-term borrowings and capital trust securities
52,147

 
573

 
4.40
%
 
65,338

 
686

 
4.16
%
 
65,692

 
670

 
4.09
%
Total interest bearing liabilities
1,670,073

 
6,124

 
1.47
%
 
1,701,020

 
5,640

 
1.22
%
 
1,662,456

 
4,383

 
1.06
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
219,134

 
 

 
 

 
210,883

 
 
 
 
 
221,245

 
 
 
 
Other liabilities
15,608

 
 

 
 

 
16,771

 
 
 
 
 
20,490

 
 
 
 
Total liabilities
1,904,815

 
 

 
 

 
1,928,674

 
 
 
 
 
1,904,191

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity
206,616

 
 

 
 

 
202,057

 
 
 
 
 
190,128

 
 
 
 
Total liabilities and shareholders' equity
$
2,111,431

 
 

 
 

 
$
2,130,731

 
 
 
 
 
$
2,094,319

 
 
 
 
Net interest earnings
 

 
$
17,596

 
 

 
 
 
$
17,567

 
 
 
 
 
$
18,487

 
 
Net yield on interest earning assets
 
 

 
3.58
%
 
 
 
 
 
3.58
%
 
 
 
 
 
3.81
%

(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 a Federal tax rate of 21% for the three months ended June 30, 2018 and March 31, 2018 and 35% for the three months ended June 30, 2017. The tax equivalent adjustment resulted in an increase in interest income of $322,000, $310,000, and $639,000 for the three months ended June 30, 2018, March 31, 2018, and June 30, 2017, respectively.


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Table II - Changes in Interest Margin Attributable to Rate and Volume
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended
 
For the Quarter Ended
 
 
June 30, 2018 vs. March 31, 2018
 
June 30, 2018 vs. June 30, 2017
 
 
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
 
$
141

 
$
456

 
$
597

 
$
1,045

 
$
225

 
$
1,270

Tax-exempt
 
(4
)
 
2

 
(2
)
 
47

 
(124
)
 
(77
)
Securities
 
 

 
 
 
 
 
 

 
 

 
 

Taxable
 
(225
)
 
93

 
(132
)
 
(376
)
 
286

 
(90
)
Tax-exempt
 
59

 
(3
)
 
56

 
44

 
(266
)
 
(222
)
Federal funds sold and interest bearing deposits with other banks
 
(2
)
 
(4
)
 
(6
)
 
(31
)
 

 
(31
)
Total interest earned on interest earning assets
 
(31
)
 
544

 
513

 
729

 
121

 
850

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 

 
 
 
 
 
 

 
 

 
 

Interest bearing demand deposits
 
56

 
213

 
269

 
62

 
587

 
649

Savings deposits
 
(27
)
 
108

 
81

 
(100
)
 
282

 
182

Time deposits
 
71

 
339

 
410

 
35

 
809

 
844

Short-term borrowings
 
(346
)
 
183

 
(163
)
 
(72
)
 
235

 
163

Long-term borrowings and capital trust securities
 
(138
)
 
25

 
(113
)
 
(146
)
 
49

 
(97
)
Total interest paid on interest bearing liabilities
 
(384
)
 
868

 
484

 
(221
)
 
1,962

 
1,741

 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
353

 
$
(324
)
 
$
29

 
$
950

 
$
(1,841
)
 
$
(891
)




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Table III - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended
 
June 30, 2018
 
June 30, 2017
Dollars in thousands
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
Interest earning assets
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned fees (1)
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
1,615,289

 
$
41,043

 
5.12
%
 
$
1,408,566

 
$
35,100

 
5.03
%
Tax-exempt (2)
16,052

 
362

 
4.55
%
 
13,161

 
443

 
6.79
%
Securities
 

 
 

 
 

 
 
 
 
 
 
Taxable
176,091

 
2,612

 
2.99
%
 
200,544

 
2,459

 
2.47
%
Tax-exempt (2)
134,658

 
2,635

 
3.95
%
 
114,320

 
2,678

 
4.72
%
Federal funds sold and interest bearing deposits with other banks
39,294

 
274

 
1.41
%
 
44,338

 
317

 
1.44
%
Total interest earning assets
1,981,384

 
46,926

 
4.78
%
 
1,780,929

 
40,997

 
4.64
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
Cash & due from banks
9,528

 
 

 
 

 
7,298

 
 
 
 
Premises and equipment
35,156

 
 

 
 

 
29,500

 
 
 
 
Property held for sale
21,381

 
 
 
 
 
25,007

 
 
 
 
Other assets
86,222

 
 

 
 

 
81,433

 
 
 
 
Allowance for loan losses
(12,639
)
 
 

 
 

 
(11,864
)
 
 
 
 
Total assets
$
2,121,032

 
 

 
 

 
$
1,912,303

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
Interest bearing demand deposits
$
440,149

 
$
1,533

 
0.70
%
 
$
320,918

 
$
399

 
0.25
%
Savings deposits
339,546

 
1,515

 
0.90
%
 
365,026

 
1,242

 
0.69
%
Time deposits
631,634

 
4,810

 
1.54
%
 
584,767

 
3,383

 
1.17
%
Short-term borrowings
215,425

 
2,648

 
2.48
%
 
198,587

 
2,073

 
2.11
%
Long-term borrowings and capital trust securities
58,706

 
1,258

 
4.32
%
 
65,918

 
1,331

 
4.07
%
Total interest bearing liabilities
1,685,460

 
11,764

 
1.41
%
 
1,535,216

 
8,428

 
1.11
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
Demand deposits
215,031

 
 

 
 

 
184,968

 
 
 
 
Other liabilities
16,188

 
 

 
 

 
18,454

 
 
 
 
Total liabilities
1,916,679

 
 

 
 

 
1,738,638

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity - common
204,353

 
 

 
 

 
173,665

 
 
 
 
Total liabilities and shareholders' equity
$
2,121,032

 
 

 
 

 
$
1,912,303

 
 
 
 
Net interest earnings
 

 
$
35,162

 
 

 
 
 
$
32,569

 
 
Net yield on interest earning assets
 
 

 
3.58
%
 
 
 
 
 
3.69
%

(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 a Federal tax rate of 21% and 35% for the six months ended June 30, 2018 and 2017, respectively. The tax equivalent adjustment resulted in an increase in interest income of $629,000 and $1,091,000 for the six months ended June 30, 2018 and 2017, respectively.


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Table IV - Changes in Interest Margin Attributable to Rate and Volume
 
 
 
 
 
 
 
For the Six Months Ended
 
 
June 30, 2018 versus June 30, 2017
 
 
Increase (Decrease) Due to Change in:
Dollars in thousands
 
Volume
 
Rate
 
Net
Interest earned on:
 
 
 
 
 
 
Loans
 
 
 
 
 
 
Taxable
 
$
5,240

 
$
703

 
$
5,943

Tax-exempt
 
84

 
(165
)
 
(81
)
Securities
 
 

 
 

 
 

Taxable
 
(323
)
 
476

 
153

Tax-exempt
 
435

 
(478
)
 
(43
)
Federal funds sold and interest bearing deposits with other banks
 
(35
)
 
(8
)
 
(43
)
Total interest earned on interest earning assets
 
5,401

 
528

 
5,929

 
 
 
 
 
 
 
Interest paid on:
 
 

 
 

 
 

Interest bearing demand deposits
 
194

 
940

 
1,134

Savings deposits
 
(92
)
 
365

 
273

Time deposits
 
288

 
1,139

 
1,427

Short-term borrowings
 
186

 
389

 
575

Long-term borrowings and capital trust securities
 
(152
)
 
79

 
(73
)
Total interest paid on interest bearing liabilities
 
424

 
2,912

 
3,336

 
 
 
 
 
 
 
Net interest income
 
$
4,977

 
$
(2,384
)
 
$
2,593


Noninterest Income

Total noninterest income for the six months ended June 30, 2018 increased 38.9% compared to same period in 2017 principally due to increased trust and wealth management fees and service fees on deposit accounts as a result of the FCB acquisition and increased gains on sales of securities. Further detail regarding noninterest income is reflected in the following table.
Table III - Noninterest Income
 
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands
2018
 
2017
 
2018
 
2017
Insurance commissions
$
1,013

 
$
988

 
$
2,126

 
$
1,957

Trust and wealth management fees
672

 
595

 
1,339

 
695

Service charges on deposit accounts
1,116

 
1,064

 
2,207

 
1,747

Bank card revenue
801

 
683

 
1,550

 
1,216

Realized securities gains
87

 
90

 
819

 
32

Bank owned life insurance income
249

 
253

 
523

 
503

Other
210

 
243

 
459

 
346

Total
$
4,148

 
$
3,916

 
$
9,023

 
$
6,496


Noninterest Expense

Total noninterest expense was nearly unchanged for the quarter ended June 30, 2018 compared to the quarter ended June 30, 2017 if merger expenses are excluded from the quarter ended June 30, 2017. Total noninterest expense decreased 24.0% for the six months ended June 30, 2018, as compared to the same period in 2017. Excluding the $9.9 million litigation charge during 2017, total noninterest expense increased 8.7% with higher salaries, commissions, and employee benefits having the largest

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negative impact and no merger expenses during 2018 having the largest positive impact.  Table VI below shows the breakdown of the changes.
Table VI - Noninterest Expense
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
For the Six Months Ended June 30,
 
 
 
Change
 
 
 
 
 
Change
 
 
Dollars in thousands
2018
 
 $
 
%
 
2017
 
2018
 
 $
 
%
 
2017
Salaries, commissions, and employee benefits
$
6,922

 
$
164

 
2.4
 %
 
$
6,758

 
$
13,744

 
$
1,799

 
15.1
 %
 
$
11,945

Net occupancy expense
840

 
14

 
1.7
 %
 
826

 
1,672

 
279

 
20.0
 %
 
1,393

Equipment expense
1,071

 
40

 
3.9
 %
 
1,031

 
2,153

 
387

 
21.9
 %
 
1,766

Professional fees
385

 
31

 
8.8
 %
 
354

 
719

 
80

 
12.5
 %
 
639

Advertising and public relations
188

 
40

 
27.0
 %
 
148

 
291

 
35

 
13.7
 %
 
256

Amortization of intangibles
413

 
(16
)
 
(3.7
)%
 
429

 
848

 
322

 
61.2
 %
 
526

FDIC premiums
240

 
(55
)
 
(18.6
)%
 
295

 
480

 
(25
)
 
(5.0
)%
 
505

     Bank card expense
361

 
(20
)
 
(5.2
)%
 
381

 
696

 
(22
)
 
(3.1
)%
 
718

Foreclosed properties expense, net of losses
350

 
126

 
56.3
 %
 
224

 
675

 
85

 
14.4
 %
 
590

Litigation settlement

 

 
 %
 

 

 
(9,900
)
 
N/A

 
9,900

Merger-related expenses

 
(1,455
)
 
(100.0
)%
 
1,455

 

 
(1,564
)
 
N/A

 
1,564

Other
1,965

 
(70
)
 
(3.4
)%
 
2,035

 
3,771

 
620

 
19.7
 %
 
3,151

Total
$
12,735

 
$
(1,201
)
 
(8.6
)%
 
$
13,936

 
$
25,049

 
$
(7,904
)
 
(24.0
)%
 
$
32,953


Salaries, commissions, and employee benefits: These expenses are 15.1% higher in the first six months of 2018 compared to first six months of 2017 due to an increase in number of employees, primarily those in conjunction with the FCB acquisition, and general merit raises.

Net occupancy expense: The increase in net occupancy expense for the six months ended June 30, 2018 is primarily due to the acquired FCB locations.

Equipment: The increase in equipment expense is primarily increased depreciation and amortization related to various technological upgrades, both hardware and software, made during the past two years and also the FCB acquisition in Q2 2017.

Amortization of intangibles: Amortization of intangibles increased for the six months ended June 30, 2018 as a result of the additional amortization of the core deposit intangible associated with the FCB acquisition.

Litigation settlement: We recorded a $9.9 million pre-tax charge in Q1 2017 as full resolution of the ResCap Litigation which had been pending since 2014.

Other: The increase in other expenses for the six months ended June 30, 2018 is primarily due to increased operating expenses as a result of the acquisition of FCB.

Income Taxes

Our income tax expense for the three months ended June 30, 2018 and June 30, 2017 totaled $1.7 million and $2.3 million, respectively. For the six months ended June 30, 2018 and June 30, 2017 our income tax expense totaled $3.5 million and $0.9 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for the quarters ended June 30, 2018 and 2017 was 20.9% and 30.3%, respectively and for the six months ended June 30, 2018 and June 30, 2017 was 20.5% and 19.0%. This decrease in effective rate is primarily attributable to the recent enactment of the TCJA and our increased portfolio of tax-exempt municipal securities. Refer to Note 18 on page 38 for further information regarding our income taxes.

Credit Experience

For purposes of this discussion, nonperforming assets 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.


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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 $1,250,000 and $500,000 provision for loan losses for the first six months of 2018 and 2017. The increase is primarily due to recent trending higher loss experience.

As illustrated in Table VII below, our non-performing assets have increased since year end 2017.
Table VII - Summary of Non-Performing Assets
 
 
 
 
 
 
 
 
June 30,
 
December 31,
Dollars in thousands
 
2018
 
2017
 
2017
Accruing loans past due 90 days or more
 
$
317

 
$
62

 
$
274

Nonaccrual loans
 
 

 
 

 
 

Commercial
 
954

 
786

 
696

Commercial real estate
 
3,238

 
2,051

 
2,927

Commercial construction and development
 

 

 

Residential construction and development
 
3,233

 
3,613

 
3,569

Residential real estate
 
7,957

 
6,860

 
7,656

Consumer
 
77

 
329

 
201

Total nonaccrual loans
 
15,459

 
13,639

 
15,049

Foreclosed properties
 
 

 
 

 
 

Commercial
 

 

 

Commercial real estate
 
1,818

 
2,126

 
1,789

Commercial construction and development
 
6,815

 
7,527

 
7,392

Residential construction and development
 
11,517

 
12,402

 
11,182

Residential real estate
 
1,456

 
1,537

 
1,107

Total foreclosed properties
 
21,606

 
23,592

 
21,470

Repossessed assets
 
12

 
57

 
68

Total nonperforming assets
 
$
37,394

 
$
37,350

 
$
36,861

Total nonperforming loans as a percentage of total loans
 
0.97
%
 
0.88
%
 
0.95
%
Total nonperforming assets as a percentage of total assets
 
1.77
%
 
1.78
%
 
1.73
%
Allowance for loan losses as a percentage of nonperforming loans
 
79.74
%
 
90.01
%
 
82.00
%
Allowance for loan losses as a percentage of period end loans
 
0.77
%
 
0.80
%
 
0.78
%

The following table details the activity regarding our foreclosed properties for the three and six months ended June 30, 2018 and 2017.
Table VIII - Foreclosed Property Activity
 
 
 
 
 
 
For the Three Months Ended 
 June 30,
 
For the Six Months Ended 
 June 30,
Dollars in thousands
2018
 
2017
 
2018
 
2017
Beginning balance
$
21,442

 
$
23,491

 
$
21,470

 
$
24,504

Acquisitions
262

 
2,434

 
906

 
2,566

Improvements
694

 

 
795

 
219

Disposals
(629
)
 
(2,304
)
 
(1,145
)
 
(3,250
)
Writedowns to fair value
(163
)
 
(29
)
 
(420
)
 
(447
)
Balance March 31
$
21,606

 
$
23,592

 
$
21,606

 
$
23,592

 
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 8 of the notes to the consolidated financial statements of our 2017 Annual Report on Form 10-K for a summary of the methodology we employ on a quarterly basis to evaluate the overall adequacy of our allowance for loan losses.


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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 June 30, 2018 and December 31, 2017, our allowance for loan losses totaled $12.6 million, or 0.77% of total loans and $12.6 million, or 0.78% of total loans. If the acquired FCB and HCB loans are excluded, the allowance for loan losses to total loans ratio at June 30, 2018 and December 31, 2017 would have been 0.87% and 0.91%, respectively. The allowance for loan losses is considered adequate to cover our estimate of probable credit losses inherent in our loan portfolio.

At June 30, 2018 and December 31, 2017 we had approximately $21.6 million and $21.5 million in foreclosed properties 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 additional losses.

FINANCIAL CONDITION

Our total assets were $2.11 billion at June 30, 2018 and $2.13 billion at December 31, 2017.  Table IX below is a summary of significant changes in our financial position between December 31, 2017 and June 30, 2018.
Table IX - Summary of Significant Changes in Financial Position
 
 
Balance
December 31,
 
Increase (Decrease)
 
Balance
June 30,
Dollars in thousands
 
2017
 
 
2018
Assets
 
 
 
 
 
 
Cash and cash equivalents
 
$
52,631

 
$
(6,220
)
 
$
46,411

Securities available for sale
 
328,723

 
(45,502
)
 
283,221

Other investments
 
14,934

 
(2,090
)
 
12,844

Loans, net
 
1,593,744

 
23,629

 
1,617,373

Property held for sale
 
21,470

 
136

 
21,606

Premises and equipment
 
34,209

 
1,808

 
36,017

Goodwill and other intangibles
 
27,513

 
(848
)
 
26,665

Cash surrender value of life insurance
policies
 
41,358

 
574

 
41,932

Other assets
 
19,658

 
1,925

 
21,583

Total Assets
 
$
2,134,240

 
$
(26,588
)
 
$
2,107,652

 
 
 
 
 
 
 
Liabilities
 
 

 
 

 
 

Deposits
 
$
1,600,601

 
$
39,395

 
$
1,639,996

Short-term borrowings
 
250,499

 
(48,070
)
 
202,429

Long-term borrowings
 
45,751

 
(25,008
)
 
20,743

Subordinated debentures owed to
unconsolidated subsidiary trusts
 
19,589

 

 
19,589

Other liabilities
 
16,295

 
(1,279
)
 
15,016

 
 
 
 
 
 
 
Shareholders' Equity
 
201,505

 
8,374

 
209,879

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,134,240

 
$
(26,588
)
 
$
2,107,652


The following is a discussion of the significant changes in our financial position during the first six months of 2018:

Securities available for sale: The net decrease of $45.5 million in securities available for sale is principally a result of sales of our lowest yielding mortgage-backed and municipal securities which funded loan growth, primarily in the commercial real estate portfolio.

Loans: Excluding mortgage warehouse lines of credit, loans are unchanged for the six months ended June 30, 2018, as the increase in commercial real estate loans has been offset by declines in commercial loans and residential mortgage loans.


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Deposits and short-term borrowings: The net change in our deposits during the first six months of 2018 resulted primarily from a net increase of $36 million in brokered certificates of deposit issued strategically prior to anticipated higher funding costs, $61 million growth in interest bearing checking accounts (primarily our indexed T-fund checking product), a $24 million reduction in direct certificates of deposit and $35 million decline in savings accounts. This net increase in deposits was used to pay off short-term FHLB advances.

Long-term borrowings: The decline in long-term borrowings resulted from the maturity of a long-term repurchase agreement during May 2018.

Shareholders' equity: Changes in shareholders' equity are a result of net income, other comprehensive income and dividends.

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 June 30, 2018 and December 31, 2017.

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 $934 million or 44.33% of total consolidated assets at June 30, 2018.

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 $762 million.  As of June 30, 2018 and December 31, 2017, these advances totaled approximately $201 million and $248 million, respectively.  At June 30, 2018, we had additional borrowing capacity of $561 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 June 30, 2018 was approximately $157 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 June 30, 2018 totaled $209.9 million compared to $201.5 million at December 31, 2017.

Refer to Note 13 of the notes to the accompanying consolidated financial statements for additional information regarding regulatory restrictions on our capital as well as our subsidiaries’ capital.









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CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations.  The following table summarizes our contractual cash obligations at June 30, 2018.
Table X - Contractual Cash Obligations
 
 
Dollars in thousands
 
Long
Term
Debt
 
Capital
Trust
Securities
 
Operating
Leases
2018
 
$
20,008

 
$

 
$
141

2019
 
18

 

 
200

2020
 
18

 

 
53

2021
 
20

 

 
31

2022
 
21

 

 
32

Thereafter
 
658

 
19,589

 
106

Total
 
$
20,743

 
$
19,589

 
$
563


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 June 30, 2018 are presented in the following table.
Table XI - Off-Balance Sheet Arrangements
 
June 30,
Dollars in thousands
 
2018
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
70,196

Construction loans
 
62,975

Other loans
 
141,754

Standby letters of credit
 
6,179

Total
 
$
281,104


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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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 modestly asset sensitive over the next twenty-four months. That is, absent any changes in the volumes of our interest earning assets or interest bearing liabilities, assets are likely to reprice faster than liabilities, resulting in an increase in net income in a rising rate environment.  Net income would decrease in a falling interest rate environment.  Net income is also subject to changes in the shape of the yield curve.  In general, a flattening yield curve would decrease our earnings due to the compression of earning asset yields and funding rates, while a steepening would increase 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 June 30, 2018.  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.

 
 
Estimated % Change in
Net Interest Income over:
Change in
 
0 - 12 Months
 
13 - 24 Months
Interest Rates
 
Actual

 
Actual

Down 100  basis points (1)
 
0.20
 %
 
1.60
 %
Up 200 basis points (1)
 
-0.60
 %
 
0.60
 %
Up 400 basis points (2)
 
-0.24
 %
 
-2.72
 %
 
 
 
 
 
(1) assumes a parallel shift in the yield curve over 12 months, with no change thereafter
(2) assumes a parallel shift in the yield curve over 24 months


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Item 4. Controls and Procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, has conducted as of June 30, 2018, 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 June 30, 2018 were effective.  There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2018 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, 2017.

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 13 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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EXHIBIT INDEX


Exhibit No.
Description
Page
Number
(3)
Articles of Incorporation and By-laws:
 
 
(a)
 
(b)
 
(c)
 
(d)
11
15
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32.1*
 
 
 
 
32.2*
 
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 3.1 of Summit Financial Group, Inc.’s filing on Form 10-Q dated March 31, 2007.


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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. Markwood
 
 
 
Julie R. Markwood,
 
 
 
Vice President and Chief Accounting Officer
 
 
 
 
 
 
 
 
Date:
August 7, 2018
 
 




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