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SUMMIT FINANCIAL GROUP, INC. - Quarter Report: 2017 September (Form 10-Q)

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 September 30, 2017
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 
sfglogousethisonea39.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
12,428,342 shares outstanding as of November 1, 2017



Table of Contents


 
 
 
Page
PART  I.
FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Consolidated balance sheets September 30, 2017 (unaudited),
December 31, 2016 and September 30, 2016 (unaudited)
 
 
 
 
 
 
Consolidated statements of income
for the three months and nine months ended September 30, 2017 and 2016 (unaudited)
 
 
 
 
 
 
Consolidated statements of comprehensive income
for the three months and nine months ended September 30, 2017 and 2016 (unaudited)
 
 
 
 
 
 
Consolidated statements of shareholders’ equity
for the nine months ended
September 30, 2017 and 2016 (unaudited)
 
 
 
 
 
 
Consolidated statements of cash flows
for the nine months ended
September 30, 2017 and 2016 (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)

 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Dollars in thousands, except per share amounts
(unaudited)
 
(*)
 
(unaudited)
ASSETS
 
 
 

 
 
Cash and due from banks
$
9,220

 
$
4,262

 
$
25,067

Interest bearing deposits with other banks
41,994

 
42,354

 
9,432

Cash and cash equivalents
51,214

 
46,616

 
34,499

Securities available for sale
328,726

 
266,542

 
262,102

Other investments
12,170

 
12,942

 
13,182

Loans held for sale
220

 
176

 

Loans, net
1,559,328

 
1,307,862

 
1,234,605

Property held for sale
22,622

 
24,504

 
24,767

Premises and equipment, net
34,220

 
23,737

 
21,802

Accrued interest receivable
7,979

 
6,167

 
5,470

Goodwill and other intangible assets
27,879

 
13,652

 
7,348

Cash surrender value of life insurance policies
41,076

 
39,143

 
38,504

Other assets
15,702

 
17,306

 
15,357

Total assets
$
2,101,136

 
$
1,758,647

 
$
1,657,636

 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

 
 

Liabilities
 

 
 

 
 

Deposits
 

 
 

 
 

Non interest bearing
$
215,910

 
$
149,737

 
$
122,652

Interest bearing
1,400,858

 
1,145,782

 
1,034,132

Total deposits
1,616,768

 
1,295,519

 
1,156,784

Short-term borrowings
202,988

 
224,461

 
234,657

Long-term borrowings
45,755

 
46,670

 
74,146

Subordinated debentures owed to unconsolidated subsidiary trusts
19,589

 
19,589

 
19,589

Other liabilities
17,254

 
17,048

 
18,640

Total liabilities
1,902,354

 
1,603,287

 
1,503,816

 
 
 
 
 
 
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: 2017 - 12,428,342 shares, December 2016 - 10,883,509 shares and September 2016 - 10,857,801 shares; outstanding: 2017 - 12,311,723 shares, December 2016 - 10,736,970 shares and September 2016 - 10,701,841 shares
80,496

 
46,757

 
46,114

Unallocated common stock held by Employee Stock Ownership Plan - 2017 - 116,619 shares, December 2016 - 146,539 shares and September 2016 - 155,960 shares
(1,260
)
 
(1,583
)
 
(1,684
)
Retained earnings
119,157

 
113,448

 
109,808

Accumulated other comprehensive income (loss)
389

 
(3,262
)
 
(418
)
Total shareholders' equity
198,782

 
155,360

 
153,820

 
 
 
 
 
 
Total liabilities and shareholders' equity
$
2,101,136

 
$
1,758,647

 
$
1,657,636


(*) - 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 September 30,
 
For the Nine Months Ended September 30,
Dollars in thousands, (except per share amounts)
 
2017
 
2016
 
2017
 
2016
Interest income
 
 
 
 
 
 
 
 
Interest and fees on loans
 
 
 
 
 
 
 
 
Taxable
 
$
19,387

 
$
14,009

 
$
54,487

 
$
40,788

Tax-exempt
 
103

 
133

 
391

 
412

Interest and dividends on securities
 
 

 
 

 
 

 
 

Taxable
 
1,283

 
1,138

 
3,742

 
3,284

Tax-exempt
 
1,114

 
621

 
2,855

 
1,857

Interest on interest bearing deposits with other banks
 
149

 
5

 
466

 
13

Total interest income
 
22,036

 
15,906

 
61,941

 
46,354

Interest expense
 
 

 
 

 
 

 
 

Interest on deposits
 
2,963

 
2,209

 
7,987

 
6,533

Interest on short-term borrowings
 
1,160

 
675

 
3,233

 
1,334

Interest on long-term borrowings and subordinated debentures
 
681

 
985

 
2,012

 
2,937

Total interest expense
 
4,804

 
3,869

 
13,232

 
10,804

Net interest income
 
17,232

 
12,037

 
48,709

 
35,550

Provision for loan losses
 
375

 

 
875

 
500

Net interest income after provision for loan losses
 
16,857

 
12,037

 
47,834

 
35,050

Noninterest income
 
 

 
 

 
 

 
 

Insurance commissions
 
1,043

 
1,016

 
3,000

 
3,030

Trust and wealth management fees
 
589

 
126

 
1,284

 
358

Service fees related to deposit accounts
 
1,863

 
1,138

 
4,737

 
3,175

Realized securities gains, net
 
26

 
61

 
58

 
836

Bank owned life insurance income
 
255

 
258

 
758

 
772

Other
 
224

 
150

 
659

 
430

Total noninterest income
 
4,000

 
2,749

 
10,496

 
8,601

Noninterest expenses
 
 

 
 

 
 

 
 

Salaries, commissions and employee benefits
 
6,610

 
4,819

 
18,555

 
14,265

Net occupancy expense
 
847

 
525

 
2,239

 
1,576

Equipment expense
 
1,093

 
716

 
2,859

 
2,059

Professional fees
 
373

 
270

 
1,012

 
1,171

Advertising and public relations
 
137

 
93

 
393

 
280

Amortization of intangibles
 
448

 
50

 
974

 
150

FDIC premiums
 
310

 
200

 
815

 
800

Merger-related expenses
 
11

 
80

 
1,575

 
345

Foreclosed properties expense
 
171

 
100

 
397

 
317

Gain on sales of foreclosed properties, net
 
(29
)
 
(169
)
 
(111
)
 
(451
)
Write-downs of foreclosed properties
 
91

 
134

 
538

 
503

Litigation settlement
 

 

 
9,900

 

Other
 
2,385

 
1,601

 
6,253

 
4,395

Total noninterest expenses
 
12,447

 
8,419

 
45,399

 
25,410

Income before income tax expense
 
8,410

 
6,367

 
12,931

 
18,241

Income tax expense
 
2,480

 
2,086

 
3,339

 
5,655

Net income
 
$
5,930

 
$
4,281

 
$
9,592

 
$
12,586

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.48

 
$
0.40

 
$
0.81

 
$
1.18

Diluted earnings per common share
 
$
0.48

 
$
0.40

 
$
0.81

 
$
1.18

See Notes to Consolidated Financial Statements 

Table of Contents
4


Consolidated Statements of Comprehensive Income (unaudited)


 
For the Three Months Ended 
 September 30,
Dollars in thousands
2017
 
2016
Net income
$
5,930

 
$
4,281

Other comprehensive income (loss):
 

 
 

Net unrealized gain on cashflow hedge of:
2017 - $497, net of deferred taxes of $184; 2016 - $965, net of deferred taxes of $357
313

 
608

Net unrealized gain (loss) on securities available for sale of:
2017 - $608, net of deferred taxes of $225 and reclassification adjustment for net realized gains included in net income of $26, net of tax of $10; 2016 - ($1,437), net of deferred taxes of ($532) and reclassification adjustment for net realized gains included in net income of $61, net of tax of $23
383

 
(905
)
Total other comprehensive income (loss)
696

 
(297
)
Total comprehensive income
$
6,626

 
$
3,984


 
For the Nine Months Ended 
 September 30,
Dollars in thousands
2017
 
2016
Net income
$
9,592

 
$
12,586

Other comprehensive income:
 

 
 

Net unrealized gain (loss) on cashflow hedge of:
2017 - $1,556, net of deferred taxes of $576; 2016 - ($2,114), net of deferred taxes of ($782)
980

 
(1,332
)
Net unrealized gain on securities available for sale of:
2017 - $3,892, net of deferred taxes of $1,440 and reclassification adjustment for net realized gains included in net income of $58, net of tax of $21; 2016 - $2,175, net of deferred taxes of $805 and reclassification adjustment for net realized gains included in net income of $836, net of tax of $309
2,452

 
1,370

Net unrealized gain on other post-retirement benefits of:
2017 - $348, net of deferred taxes of $129
219

 

Total other comprehensive income
3,651

 
38

Total comprehensive income
$
13,243

 
$
12,624






















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
Income
(Loss)
 
Total
Share-
holders'
Equity
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
46,757

 
$
(1,583
)
 
$
113,448

 
$
(3,262
)
 
$
155,360

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 

 
 
 
 

 
 

 
 

Net income

 

 
9,592

 

 
9,592

Other comprehensive income

 

 

 
3,651

 
3,651

Exercise of stock options - 2,000 shares
12

 

 

 

 
12

Share-based compensation expense
285

 

 

 

 
285

Unallocated ESOP shares committed to be released - 29,920 shares
358

 
323

 

 

 
681

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

 

 

 

 
32,968

Common stock issuances from reinvested dividends - 4,921 shares
116

 

 

 

 
116

Common stock cash dividends declared ($0.33 per share)

 

 
(3,883
)
 

 
(3,883
)
Balance, September 30, 2017
$
80,496

 
$
(1,260
)
 
$
119,157

 
$
389

 
$
198,782

 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015
$
45,741

 
$
(1,964
)
 
$
100,423

 
$
(456
)
 
$
143,744

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 

 
 
 
 

 
 

 
 

Net income

 

 
12,586

 

 
12,586

Other comprehensive income

 

 

 
38

 
38

Share-based compensation expense
150

 

 

 

 
150

Unallocated ESOP shares committed to be released - 25,862 shares
148

 
280

 

 

 
428

Common stock issuances from reinvested dividends - 4,235 shares
75

 

 

 

 
75

Common stock cash dividends declared ($0.30 per share)

 

 
(3,201
)
 

 
(3,201
)
Balance, September 30, 2016
$
46,114

 
$
(1,684
)
 
$
109,808

 
$
(418
)
 
$
153,820






















See Notes to Consolidated Financial Statements

Table of Contents
6


Consolidated Statements of Cash Flows (unaudited)


 
 
Nine Months Ended
Dollars in thousands
 
September 30,
2017
 
September 30,
2016
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
9,592

 
$
12,586

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

 
 

Depreciation
 
1,364

 
884

Provision for loan losses
 
875

 
500

Share-based compensation expense
 
285

 
150

Deferred income tax benefit
 
(364
)
 
(235
)
Loans originated for sale
 
(11,305
)
 
(7,068
)
Proceeds from sale of loans
 
11,492

 
8,001

Gains on loans held for sale
 
(231
)
 
(154
)
Realized securities gains, net
 
(58
)
 
(836
)
Gain on disposal of assets
 
(93
)
 
(480
)
Write-downs of foreclosed properties
 
538

 
503

Amortization of securities premiums, net
 
3,125

 
3,329

(Accretion) amortization related to acquisitions, net
 
(870
)
 
9

Amortization of intangibles
 
974

 
150

Earnings on bank owned life insurance
 
(425
)
 
(772
)
(Increase) decrease in accrued interest receivable
 
(752
)
 
75

Decrease (increase) in other assets
 
1,539

 
(762
)
(Decrease) increase in other liabilities
 
(221
)
 
673

Net cash provided by operating activities
 
15,465

 
16,553

Cash Flows from Investing Activities
 
 

 
 

Proceeds from maturities and calls of securities available for sale
 
2,610

 
630

Proceeds from sales of securities available for sale
 
131,345

 
63,641

Principal payments received on securities available for sale
 
24,349

 
27,696

Purchases of securities available for sale
 
(118,346
)
 
(73,595
)
Purchases of other investments
 
(13,116
)
 
(15,389
)
Proceeds from redemptions of other investments
 
13,274

 
10,942

Net loan originations
 
(26,099
)
 
(156,744
)
Purchases of premises and equipment
 
(5,672
)
 
(1,199
)
Proceeds from disposal of premises and equipment
 

 
43

Proceeds from sales of repossessed assets & property held for sale
 
4,463

 
3,659

Cash and cash equivalents acquired in acquisition, net of $14,989 cash consideration paid
 
39,053

 

Net cash provided by (used in) investing activities
 
51,861

 
(140,316
)
Cash Flows from Financing Activities
 
 

 
 

Net (decrease) increase in demand deposit, NOW and savings accounts
 
(9,812
)
 
54,830

Net (decrease) increase in time deposits
 
(19,305
)
 
35,243

Net (decrease) increase in short-term borrowings
 
(28,782
)
 
63,263

Repayment of long-term borrowings
 
(915
)
 
(1,435
)
Net proceeds from issuance of common stock
 
(43
)
 
75

Exercise of stock options
 
12

 

Dividends paid on common stock
 
(3,883
)
 
(3,201
)
Net cash provided by (used in) financing activities
 
(62,728
)
 
148,775

Increase in cash and cash equivalents
 
4,598

 
25,012

Cash and cash equivalents:
 
 

 
 

Beginning
 
46,616

 
9,487

Ending
 
$
51,214

 
$
34,499

 
(Continued)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 

Table of Contents
7


Consolidated Statements of Cash Flows (unaudited) - continued


 
 
Nine Months Ended
Dollars in thousands
 
September 30,
2017
 
September 30,
2016
Supplemental Disclosures of Cash Flow Information
 
 
 
 
Cash payments for:
 
 
 
 
Interest
 
$
13,055

 
$
10,889

Income taxes
 
$
3,557

 
$
5,768

 
 
 
 
 
Supplemental Disclosures of Noncash Investing and Financing Activities
 
 
 
 

Real property and other assets acquired in settlement of loans
 
$
289

 
$
2,053


























































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 nine months and quarter ended September 30, 2017 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 2016 audited financial statements and Annual Report on Form 10-K. 

NOTE 2.  SIGNIFICANT NEW AUTHORITATIVE ACCOUNTING GUIDANCE

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 securities available-for-sale. ASU 2016-01 will be effective for us on January 1, 2018 and is not expected to have a significant impact on our financial statements.

ASU 2016-02, Leases (Topic 842) will, among other things, require lessees to recognize a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and 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. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, Revenue from Contracts with Customers. ASU 2016-02 will be effective for us on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. While our full evaluation of the potential impact of ASU 2016-02 is ongoing, preliminarily, we expect that its adoption will not be significant to our financial statements.

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, requires 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 and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective on January 1, 2020. An implementation committee has been formed and continues to plan for the standards' implementation and evaluate the impact of ASU 2016-13 on our financial statements.

ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments provides guidance related to certain cash flow issues in order to reduce the current and potential future diversity in practice. ASU 2016-15 will be effective for us on January 1, 2018 and is not expected to have a significant impact on our financial statements.


Table of Contents
9


ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business-inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs. The amendments in this ASU provide a screen to determine when a set is not a business. If the screen is not met, the amendments (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The ASU provides a framework to assist entities in evaluating whether both an input and a substantive process are present. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The amendments in this ASU should be applied prospectively on or after the effective date. No disclosures are required at transition. We do not expect the adoption of ASU 2017-01 to have a material impact on our consolidated financial statements.

ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost requires an employer that offers defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715 to report the service cost component of net periodic benefit cost in the same line item(s) as other compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component. If the other components of net periodic benefit cost are not presented on a separate line or lines, the line item(s) used in the income statement must be disclosed. In addition, only the service cost component will be eligible for capitalization as part of an asset, when applicable. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. We do not expect the adoption of ASU 2017-07 to have a material impact on our consolidated financial statements.
ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities shortens the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. We are currently assessing the impact that ASU 2017-08 will have on our consolidated financial statements.
During May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting which provides guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718.  The amendments are effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. We are currently assessing the impact that ASU 2017-09 will have on our consolidated financial statements.
During August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU modify the designation and measurement guidance for hedge accounting as well as provide for increased transparency regarding the presentation of economic results on both the financial statements and related footnotes. Certain aspects of hedge effectiveness assessments will also be simplified upon implementation of this update. The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. We do not expect the adoption of ASU 2017-12 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
September 30, 2017
 
Level 1
 
Level 2
 
Level 3
Available for sale securities
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
24,135

 
$

 
$
24,135

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
121,759

 

 
121,759

 

Nongovernment sponsored entities
2,755

 

 
2,755

 

State and political subdivisions
13,435

 

 
13,435

 

Corporate debt securities
16,190

 

 
16,190

 

Other equity securities
137

 

 
137

 

Tax-exempt state and political subdivisions
150,315

 

 
150,315

 

Total available for sale securities
$
328,726

 
$

 
$
328,726

 
$

 
 
 
 
 
 
 
 
Derivative financial assets
 
 
 
 
 
 
 
Interest rate swaps
$
125

 
$

 
$
125

 
$

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
3,056

 
$

 
$
3,056

 
$



 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
Available for sale securities
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
15,174

 
$

 
$
15,174

 
$

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
138,846

 

 
138,846

 

Nongovernment sponsored entities
4,653

 

 
4,653

 

Corporate debt securities
18,170

 

 
18,170

 

Other equity securities
137

 

 
137

 

Tax-exempt state and political subdivisions
89,562

 

 
89,562

 

Total available for sale securities
$
266,542

 
$

 
$
266,542

 
$

 
 
 
 
 
 
 
 
Derivative financial assets
 
 
 
 
 
 
 
Interest rate swaps
$
200

 
$

 
$
200

 
$

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
4,611

 
$

 
$
4,611

 
$



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.

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11


 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
September 30, 2017
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
220

 
$

 
$
220

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Commercial real estate
$
518

 
$

 
$
518

 
$

Construction and development
945

 

 
945

 

Residential real estate
203

 

 
203

 

Total collateral-dependent impaired loans
$
1,666

 
$

 
$
1,666

 
$

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
1,476

 
$

 
$
1,292

 
$
184

Construction and development
16,627

 

 
16,627

 

Residential real estate
352

 

 
352

 

Total property held for sale
$
18,455

 
$

 
$
18,271

 
$
184



 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
176

 
$

 
$
176

 
$

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Construction and development
$
945

 
$

 
$
945

 
$

Residential real estate
130

 

 
130

 

Total collateral-dependent impaired loans
$
1,075

 
$

 
$
1,075

 
$

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
976

 
$

 
$
976

 
$

Construction and development
19,327

 

 
19,327

 

Residential real estate
279

 

 
279

 

Total property held for sale
$
20,582

 
$

 
$
20,582

 
$



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

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

Securities:  Estimated fair values of securities are based on quoted market prices, where available.  If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities.

Other investments: Other investments consists of FHLB stock, which does not have readily determinable fair values and is carried at cost and an investment in a limited partnership which owns interests in a diversified portfolio of qualified affordable housing projects which is reflected at its carrying value.
 
Loans held for sale:  The carrying values of loans held for sale approximate their estimated fair values.

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

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

Deposits:  The estimated fair values of demand deposits (i.e. non-interest bearing checking, NOW, money market and savings accounts) and other variable rate deposits approximate their carrying values.  Fair values of fixed maturity deposits are

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12


estimated using a discounted cash flow methodology at rates currently offered for deposits with similar remaining maturities.  Any intangible value of long-term relationships with depositors is not considered in estimating the fair values disclosed.

Short-term borrowings:  The carrying values of short-term borrowings approximate their estimated fair values.

Long-term borrowings:  The fair values of long-term borrowings are estimated by discounting scheduled future payments of principal and interest at current rates available on borrowings with similar terms.

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

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

Off-balance sheet instruments:  The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit standing of the counter parties.  The amounts of fees currently charged on commitments and standby letters of credit are deemed insignificant and therefore, the estimated fair values and carrying values are not shown below.

The carrying values and estimated fair values of our financial instruments are summarized below:
 
 
September 30, 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
 
$
51,214

 
$
51,214

 
$

$
51,214

$

Securities available for sale
 
328,726

 
328,726

 

328,726


Other investments
 
12,170

 
12,170

 

12,170


Loans held for sale, net
 
220

 
220

 

220


Loans, net
 
1,559,328

 
1,557,227

 

1,666

1,555,561

Accrued interest receivable
 
7,979

 
7,979

 

7,979


Derivative financial assets
 
125

 
125

 

125


 
 
$
1,959,762

 
$
1,957,661

 
$

$
402,100

$
1,555,561

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
1,616,768

 
$
1,637,258

 
$

$
1,637,258

$

Short-term borrowings
 
202,988

 
202,988

 

202,988


Long-term borrowings
 
45,755

 
46,962

 

46,962


Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 

19,589


Accrued interest payable
 
912

 
912

 

912


Derivative financial liabilities
 
3,056

 
3,056

 

3,056


 
 
$
1,889,068

 
$
1,910,765

 
$

$
1,910,765

$



Table of Contents
13


 
 
December 31, 2016
 
Fair Value Measurements Using:
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Level 1
Level 2
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
46,616

 
$
46,616

 
$

$
46,616

$

Securities available for sale
 
266,542

 
266,542

 

266,542


Other investments
 
12,942

 
12,942

 

12,942


Loans held for sale, net
 
176

 
176

 

176


Loans, net
 
1,307,862

 
1,321,235

 

1,075

1,320,160

Accrued interest receivable
 
6,167

 
6,167

 

6,167


Derivative financial assets
 
200

 
200

 

200


 
 
$
1,640,505

 
$
1,653,878

 
$

$
333,718

$
1,320,160

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
1,295,519

 
$
1,309,820

 
$

$
1,309,820

$

Short-term borrowings
 
224,461

 
224,461

 

224,461


Long-term borrowings
 
46,670

 
49,013

 

49,013


Subordinated debentures owed to unconsolidated subsidiary trusts
 
19,589

 
19,589

 

19,589


Accrued interest payable
 
736

 
736

 

736


Derivative financial liabilities
 
4,611

 
4,611

 

4,611


 
 
$
1,591,586

 
$
1,608,230

 
$

$
1,608,230

$



NOTE 4.  EARNINGS PER SHARE

The computations of basic and diluted earnings per share follow:
 
 
For the Three Months Ended September 30,
 
 
2017
 
2016
Dollars in thousands,
except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
5,930

 
 
 
 
 
$
4,281

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
5,930

 
12,299,987

 
$
0.48

 
$
4,281

 
10,692,423

 
$
0.40

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 
 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
10,911

 
 

 
 
 
12,865

 
 

Stock appreciation rights (SARs)
 
 
 
8,061

 
 
 
 
 
21,851

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
5,930

 
12,318,959

 
$
0.48

 
$
4,281

 
10,727,139

 
$
0.40


 
 
For the Nine Months Ended September 30,
 
 
2017
 
2016
Dollars in thousands,
except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
9,592

 
 
 
 
 
$
12,586

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
9,592

 
11,781,342

 
$
0.81

 
$
12,586

 
10,682,129

 
$
1.18

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 

 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
11,336

 
 

 
 
 
8,774

 
 

Stock appreciation rights (SARs)
 
 
 
14,324

 
 
 
 
 
1,443

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
9,592

 
11,807,002

 
$
0.81

 
$
12,586

 
10,692,346

 
$
1.18



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14


Stock option and stock appreciation right (SAR) grants are disregarded in this computation if they are determined to be anti-dilutive.  Our anti-dilutive stock options for the quarter and nine months ended September 30, 2017 were 23,400 shares, and totaled 33,600 for the three months ended September 30, 2016 and 57,000 for the nine months ended September 30, 2016. Our anti-dilutive SARs for three and nine months ended September 30, 2017 were 87,615.

NOTE 5.  SECURITIES

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September 30, 2017, December 31, 2016, and September 30, 2016 are summarized as follows:
 
September 30, 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
$
23,591

 
$
608

 
$
64

 
$
24,135

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
120,898

 
1,580

 
719

 
121,759

Nongovernment-sponsored entities
2,714

 
49

 
8

 
2,755

State and political subdivisions
 

 
 

 
 

 
 

General obligations
2,803

 
11

 
1

 
2,813

Other revenues
10,568

 
83

 
29

 
10,622

Corporate debt securities
16,326

 

 
136

 
16,190

Total taxable debt securities
176,900

 
2,331

 
957

 
178,274

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
70,714

 
1,382

 
510

 
71,586

Water and sewer revenues
25,049

 
433

 
74

 
25,408

Lease revenues
14,250

 
283

 
71

 
14,462

Electric revenues
6,226

 
76

 
23

 
6,279

University revenues
5,290

 
3

 
22

 
5,271

Other revenues
26,831

 
593

 
115

 
27,309

Total tax-exempt debt securities
148,360

 
2,770

 
815

 
150,315

Equity securities
137

 

 

 
137

Total available for sale securities
$
325,397

 
$
5,101

 
$
1,772

 
$
328,726

 
December 31, 2016
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
14,580

 
$
642

 
$
48

 
$
15,174

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
138,451

 
1,554

 
1,159

 
138,846

Nongovernment-sponsored entities
4,631

 
44

 
22

 
4,653

Corporate debt securities
18,295

 
23

 
148

 
18,170

Total taxable debt securities
175,957

 
2,263

 
1,377

 
176,843

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
49,449

 
569

 
1,388

 
48,630

Water and sewer revenues
9,087

 
63

 
149

 
9,001

Lease revenues
9,037

 
7

 
201

 
8,843

Electric revenues
3,247

 
10

 
48

 
3,209

Sales tax revenues
2,870

 

 
34

 
2,836

Other revenues
17,321

 
93

 
371

 
17,043

Total tax-exempt debt securities
91,011

 
742

 
2,191

 
89,562

Equity securities
137

 

 

 
137

Total available for sale securities
$
267,105

 
$
3,005

 
$
3,568

 
$
266,542



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15


 
September 30, 2016
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities:
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
14,818

 
$
921

 
$
47

 
$
15,692

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
132,913

 
2,556

 
264

 
135,205

Nongovernment-sponsored agencies
5,382

 
48

 
29

 
5,401

State and political subdivisions:


 


 


 


       Water and sewer revenues
250

 

 

 
250

Corporate debt securities
20,003

 
49

 
149

 
19,903

Total taxable debt securities
173,366

 
3,574

 
489

 
176,451

Tax-exempt debt securities:
 

 
 

 
 

 
 

State and political subdivisions:


 


 


 


        General obligations
47,014

 
2,221

 
115

 
49,120

        Water and sewer revenues
7,980

 
265

 
11

 
8,234

        Lease revenues
7,392

 
321

 
38

 
7,675

        Sales tax revenues
2,880

 
124

 

 
3,004

        Other revenues
16,869

 
701

 
29

 
17,541

Total tax-exempt debt securities
82,135

 
3,632

 
193

 
85,574

Equity securities
77

 

 

 
77

Total available for sale securities
$
255,578

 
$
7,206

 
$
682

 
$
262,102


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.
 
September 30, 2017
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
 
 
 
 
 
 
 
 
Texas
$
20,215

 
$
440

 
$
71

 
$
20,584

Michigan
18,823

 
235

 
212

 
18,846

California
15,314

 
260

 
64

 
15,510

Illinois
12,463

 
244

 
38

 
12,669

Pennsylvania
10,603

 
91

 
79

 
10,615


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 September 30, 2017, are summarized as follows:
Dollars in thousands
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
46,461

 
$
46,984

Due from one to five years
 
82,524

 
83,284

Due from five to ten years
 
33,110

 
33,119

Due after ten years
 
163,165

 
165,202

Equity securities
 
137

 
137

 
 
$
325,397

 
$
328,726


The proceeds from sales, calls and maturities of available for sale securities, including principal payments received on mortgage-backed obligations, and the related gross gains and losses realized, for the nine months ended September 30, 2017 and 2016 are as follows:

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16


 
 
Proceeds from
 
Gross realized
Dollars in thousands
Sales
 
Calls and
Maturities
 
Principal
Payments
 
Gains
 
Losses
For the Nine Months Ended 
 September 30,
 
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
131,345

 
$
2,610

 
$
24,349

 
$
416

 
$
358

 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
63,641

 
$
630

 
$
27,696

 
$
1,117

 
$
281


We held 81 available for sale securities having an unrealized loss at September 30, 2017.  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 September 30, 2017 and December 31, 2016.

 
September 30, 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
$
5,374

 
$
(25
)
 
$
2,712

 
$
(39
)
 
$
8,086

 
$
(64
)
Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
29,222

 
(316
)
 
13,476

 
(403
)
 
42,698

 
(719
)
Nongovernment-sponsored entities

 

 
949

 
(8
)
 
949

 
(8
)
State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
734

 
(1
)
 

 

 
734

 
(1
)
Other revenues
4,816

 
(29
)
 

 

 
4,816

 
(29
)
Corporate debt securities
3,014

 
(39
)
 
1,653

 
(97
)
 
4,667

 
(136
)
Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
14,204

 
(164
)
 
10,236

 
(346
)
 
24,440

 
(510
)
Water and sewer revenues
6,702

 
(74
)
 

 

 
6,702

 
(74
)
Lease revenues
571

 
(2
)
 
1,061

 
(69
)
 
1,632

 
(71
)
Electric revenues
2,146

 
(23
)
 

 

 
2,146

 
(23
)
University revenues
3,508

 
(22
)
 

 

 
3,508

 
(22
)
Other revenues
4,279

 
(42
)
 
1,278

 
(73
)
 
5,557

 
(115
)
Total temporarily impaired securities
74,570

 
(737
)
 
31,365

 
(1,035
)
 
105,935

 
(1,772
)
Total
$
74,570

 
$
(737
)
 
$
31,365

 
$
(1,035
)
 
$
105,935

 
$
(1,772
)



Table of Contents
17


 
December 31, 2016
 
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
$
763

 
$
(5
)
 
$
2,575

 
$
(43
)
 
$
3,338

 
$
(48
)
Residential mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
55,388

 
(985
)
 
8,389

 
(174
)
 
63,777

 
(1,159
)
Nongovernment-sponsored entities
97

 

 
3,013

 
(22
)
 
3,110

 
(22
)
Corporate debt securities
968

 
(31
)
 
3,136

 
(117
)
 
4,104

 
(148
)
Tax-exempt debt securities
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 

 
 

 
 

 
 

 
 

 
 

General obligations
33,115

 
(1,388
)
 

 

 
33,115

 
(1,388
)
Water and sewer revenues
4,761

 
(149
)
 

 

 
4,761

 
(149
)
Lease revenues
7,011

 
(201
)
 

 

 
7,011

 
(201
)
Electric revenues
1,973

 
(48
)
 

 

 
1,973

 
(48
)
Sales tax revenues
2,836

 
(34
)
 

 

 
2,836

 
(34
)
Other revenues
8,445

 
(371
)
 

 

 
8,445

 
(371
)
Total temporarily impaired securities
115,357

 
(3,212
)
 
17,113

 
(356
)
 
132,470

 
(3,568
)
Total
$
115,357

 
$
(3,212
)
 
$
17,113

 
$
(356
)
 
$
132,470

 
$
(3,568
)


NOTE 6.  LOANS

Loans are summarized as follows:
Dollars in thousands
 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Commercial
 
$
187,193

 
$
119,088

 
$
110,466

Commercial real estate
 
 

 
 

 
 

Owner-occupied
 
239,840

 
203,047

 
192,254

Non-owner occupied
 
464,543

 
381,921

 
367,196

Construction and development
 
 

 
 

 
 

Land and land development
 
71,412

 
72,042

 
65,430

Construction
 
28,756

 
16,584

 
11,276

Residential real estate
 
 

 
 

 
 

Non-jumbo
 
355,642

 
265,641

 
228,777

Jumbo
 
61,253

 
65,628

 
57,276

Home equity
 
82,720

 
74,596

 
75,161

Mortgage warehouse lines
 
33,525

 
85,966

 
108,983

Consumer
 
36,915

 
25,534

 
19,756

Other
 
9,994

 
9,489

 
9,649

Total loans, net of unearned fees
 
1,571,793

 
1,319,536

 
1,246,224

Less allowance for loan losses
 
12,465

 
11,674

 
11,619

Loans, net
 
$
1,559,328

 
$
1,307,862

 
$
1,234,605


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


Table of Contents
18


 
 
Acquired Loans
Dollars in thousands
 
Purchased Credit Impaired
 
Purchased Performing
 
Total
Outstanding balance
 
$
6,393

 
$
238,314

 
$
244,707

 
 
 
 
 
 
 
Recorded investment
 
 
 
 
 
 
Commercial
 
$
11

 
$
31,430

 
$
31,441

Commercial real estate
 
 
 
 
 
 
Owner-occupied
 
695

 
23,084

 
23,779

Non-owner occupied
 
1,846

 
35,704

 
37,550

Construction and development
 
 
 
 
 
 
Land and land development
 

 
9,080

 
9,080

Construction
 

 
2,226

 
2,226

Residential real estate
 
 
 
 
 
 
Non-jumbo
 
1,861

 
114,756

 
116,617

Jumbo
 
1,005

 
3,443

 
4,448

Home equity
 

 
3,431

 
3,431

Consumer
 

 
13,050

 
13,050

Other
 

 
236

 
236

Total recorded investment
 
$
5,418

 
$
236,440

 
$
241,858


The following table presents a summary of the change in the accretable yield of the PCI loan portfolio for the period from January 1, 2017 to September 30, 2017:
Dollars in thousands
 
 
Accretable yield, January 1, 2017
 
$
290

Accretion
 
(135
)
Additions for First Century Bankshares, Inc. acquisition
 
661

Reclassification of nonaccretable difference due to improvement in expected cash flows
 

Other changes, net
 
(13
)
Accretable yield, September 30, 2017
 
$
803


The following table presents the contractual aging of the recorded investment in past due loans by class as of September 30, 2017 and 2016 and December 31, 2016.
 
At September 30, 2017
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
204

 
$
175

 
$
65

 
$
444

 
$
186,749

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
469

 
45

 
740

 
1,254

 
238,586

 

Non-owner occupied
177

 
252

 
1,969

 
2,398

 
462,145

 

Construction and development
 

 
 

 
 

 
 

 
 

 
 

Land and land development
268

 
21

 
3,880

 
4,169

 
67,243

 

Construction

 

 

 

 
28,756

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
4,860

 
2,062

 
4,837

 
11,759

 
343,883

 

Jumbo

 

 

 

 
61,253

 

Home equity
50

 
290

 
657

 
997

 
81,723

 

Mortgage warehouse lines

 

 

 

 
33,525

 

Consumer
387

 
173

 
405

 
965

 
35,950

 
35

Other
56

 

 

 
56

 
9,938

 

Total
$
6,471

 
$
3,018

 
$
12,553

 
$
22,042

 
$
1,549,751

 
$
35

 

Table of Contents
19


 
At December 31, 2016
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
90

 
$
86

 
$
165

 
$
341

 
$
118,747

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
93

 

 
509

 
602

 
202,445

 

Non-owner occupied
340

 

 
65

 
405

 
381,516

 

Construction and development
 
 
 

 
 

 
 

 
 

 
 

Land and land development
423

 
129

 
3,852

 
4,404

 
67,638

 

Construction

 

 

 

 
16,584

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
4,297

 
1,889

 
3,287

 
9,473

 
256,168

 

Jumbo

 

 

 

 
65,628

 

Home equity

 
302

 
57

 
359

 
74,237

 

Mortgage warehouse lines

 

 

 

 
85,966

 

Consumer
308

 
84

 
150

 
542

 
24,992

 

Other

 

 

 

 
9,489

 

Total
$
5,551

 
$
2,490

 
$
8,085

 
$
16,126

 
$
1,303,410

 
$


 
At September 30, 2016
 
Past Due
 
 
 
> 90 days and Accruing
Dollars in thousands
30-59 days
 
60-89 days
 
> 90 days
 
Total
 
Current
 
Commercial
$
301

 
$
138

 
$
602

 
$
1,041

 
$
109,425

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

Owner-occupied
251

 

 
505

 
756

 
191,498

 

Non-owner occupied
311

 
78

 

 
389

 
366,807

 

Construction and development
 

 
 

 
 

 
 

 
 

 
 

Land and land development
238

 

 
3,731

 
3,969

 
61,461

 

Construction

 

 

 

 
11,276

 

Residential mortgage
 

 
 

 
 

 
 

 
 

 
 

Non-jumbo
1,932

 
1,488

 
2,762

 
6,182

 
222,595

 

Jumbo

 

 

 

 
57,276

 

Home equity

 
136

 
318

 
454

 
74,707

 

Mortgage warehouse lines

 

 

 

 
108,983

 

Consumer
135

 
44

 
148

 
327

 
19,429

 
21

Other

 

 

 

 
9,649

 

Total
$
3,168

 
$
1,884

 
$
8,066

 
$
13,118

 
$
1,233,106

 
$
21


Nonaccrual loans:  The following table presents the nonaccrual loans included in the net balance of loans at September 30, 2017, December 31, 2016 and September 30, 2016.

Table of Contents
20


 
 
September 30,
 
December 31,
Dollars in thousands
 
2017
 
2016
 
2016
Commercial
 
$
757

 
$
846

 
$
298

Commercial real estate
 
 

 
 

 
 

Owner-occupied
 
740

 
505

 
509

Non-owner occupied
 
2,033

 
4,362

 
4,336

Construction and development
 
 

 
 

 
 

Land & land development
 
3,931

 
4,360

 
4,465

Construction
 

 

 

Residential mortgage
 
 

 
 

 
 

Non-jumbo
 
7,309

 
3,680

 
4,621

Jumbo
 

 

 

Home equity
 
773

 
494

 
194

Mortgage warehouse lines
 

 

 

Consumer
 
494

 
148

 
151

Total
 
$
16,037

 
$
14,395

 
$
14,574

 
Impaired loans:  Impaired loans include the following:

Loans which we risk-rate (consisting of 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 our accounting policy are met, the loan would continue to be evaluated for an asset-specific allowance for loan losses and we would continue to report the loan in the impaired loan table below.

Table of Contents
21


The following tables present loans individually evaluated for impairment at September 30, 2017, December 31, 2016 and September 30, 2016.
 
September 30, 2017
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
254

 
$
254

 
$

 
$
264

 
$
10

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
7,138

 
7,141

 

 
4,869

 
185

Non-owner occupied
9,884

 
9,886

 

 
10,142

 
511

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
5,029

 
5,029

 

 
4,729

 
87

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
4,200

 
4,210

 

 
4,294

 
209

Jumbo
3,581

 
3,580

 

 
3,605

 
171

Home equity
524

 
523

 

 
523

 
25

Mortgage warehouse lines

 

 

 

 

Consumer
29

 
29

 

 
34

 
3

Total without a related allowance
$
30,639

 
$
30,652

 
$

 
$
28,460

 
$
1,201

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$
259

 
$
259

 
$
259

 
$
266

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
2,448

 
2,448

 
127

 
2,456

 
121

Non-owner occupied
1,014

 
1,018

 
501

 
2

 

Construction and development
 

 
 

 
 

 
 

 
 

Land & land development
1,470

 
1,470

 
525

 
1,482

 
56

Construction

 

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
Non-jumbo
1,728

 
1,729

 
217

 
1,681

 
82

Jumbo
841

 
842

 
15

 
847

 
42

Home equity

 

 

 

 

Mortgage warehouse lines

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
7,760

 
$
7,766

 
$
1,644

 
$
6,734

 
$
301

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
27,496

 
$
27,505

 
$
1,412

 
$
24,210

 
$
970

Residential real estate
10,874

 
10,884

 
232

 
10,950

 
529

Consumer
29

 
29

 

 
34

 
3

Total
$
38,399

 
$
38,418

 
$
1,644

 
$
35,194

 
$
1,502







Table of Contents
22


 
December 31, 2016
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
285

 
$
285

 
$

 
$
247

 
$
10

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
520

 
520

 

 
534

 
31

Non-owner occupied
10,203

 
10,205

 

 
10,675

 
294

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
5,227

 
5,227

 

 
5,270

 
80

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
4,055

 
4,065

 

 
3,910

 
193

Jumbo
3,640

 
3,639

 

 
3,693

 
175

Home equity
524

 
523

 

 
523

 
22

Mortgage warehouse lines

 

 

 

 

Consumer
44

 
44

 

 
50

 
5

Total without a related allowance
$
24,498

 
$
24,508

 
$

 
$
24,902

 
$
810

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$

 
$

 
$

 
$

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
6,864

 
6,864

 
347

 
6,879

 
269

Non-owner occupied
1,311

 
1,311

 
197

 
1,327

 
43

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
2,066

 
2,066

 
585

 
2,074

 
80

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
2,055

 
2,057

 
251

 
1,851

 
78

Jumbo
853

 
853

 
24

 
862

 
44

Home equity

 

 

 

 

Mortgage warehouse lines

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
13,149

 
$
13,151

 
$
1,404

 
$
12,993

 
$
514

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
26,476

 
$
26,478

 
$
1,129

 
$
27,006

 
$
807

Residential real estate
11,127

 
11,137

 
275

 
10,839

 
512

Consumer
44

 
44

 

 
50

 
5

Total
$
37,647

 
$
37,659

 
$
1,404

 
$
37,895

 
$
1,324





 

Table of Contents
23


 
September 30, 2016
Dollars in thousands
Recorded
Investment
 
Unpaid
Principal Balance
 
Related
Allowance
 
Average
Impaired
Balance
 
Interest Income
Recognized
while impaired
 
 
 
 
 
 
 
 
 
 
Without a related allowance
 
 
 
 
 
 
 
 
 
Commercial
$
791

 
$
790

 
$

 
$
400

 
$
9

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
4,914

 
4,914

 

 
4,932

 
188

Non-owner occupied
10,394

 
10,396

 

 
10,831

 
456

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
6,181

 
6,181

 

 
6,207

 
104

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
3,852

 
3,861

 

 
3,732

 
170

Jumbo
3,683

 
3,682

 

 
3,711

 
176

Home equity
713

 
713

 

 
710

 
21

Mortgage warehouse lines

 

 

 

 

Consumer
48

 
48

 

 
52

 
5

Total without a related allowance
$
30,576

 
$
30,585

 
$

 
$
30,575

 
$
1,129

 
 
 
 
 
 
 
 
 
 
With a related allowance
 

 
 

 
 

 
 

 
 

Commercial
$
19

 
$
19

 
$
19

 
$
6

 
$

Commercial real estate
 

 
 

 
 

 
 

 
 

Owner-occupied
2,499

 
2,499

 
12

 
2,491

 
112

Non-owner occupied
1,321

 
1,321

 
132

 
1,332

 
43

Construction and development
 
 
 

 
 

 
 

 
 

Land & land development
1,140

 
1,141

 
492

 
1,155

 
58

Construction

 

 

 

 

Residential real estate
 

 
 

 
 

 
 

 
 

Non-jumbo
2,617

 
2,619

 
216

 
2,329

 
103

Jumbo
859

 
859

 
25

 
864

 
43

Home equity

 

 

 

 

Mortgage warehouse lines

 

 

 

 

Consumer

 

 

 

 

Total with a related allowance
$
8,455

 
$
8,458

 
$
896

 
$
8,177

 
$
359

 
 
 
 
 
 
 
 
 
 
Total
 

 
 

 
 

 
 

 
 

Commercial
$
27,259

 
$
27,261

 
$
655

 
$
27,354

 
$
970

Residential real estate
11,724

 
11,734

 
241

 
11,346

 
513

Consumer
48

 
48

 

 
52

 
5

Total
$
39,031

 
$
39,043

 
$
896

 
$
38,752

 
$
1,488


Included in impaired loans are TDRs of $29.1 million, of which $28.3 million were current with respect to restructured contractual payments at September 30, 2017, and $28.6 million, of which $28.1 million were current with respect to restructured contractual payments at December 31, 2016.  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 nine months ended September 30, 2017 and September 30, 2016 . 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.


Table of Contents
24


 
For the Three Months Ended 
 September 30, 2017
 
For the Three Months Ended 
 September 30, 2016
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 real estate
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
1

 
$
2,302

 
$
2,302

 

 
$

 
$

Non-owner occupied
1

 
148

 
148

 

 

 

Construction and development
 
 
 
 
 
 
 
 
 
 
 
Land & land development
1

 
438

 
438

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo

 

 

 
1

 
307

 
307

Total
3

 
$
2,888

 
$
2,888

 
1

 
$
307

 
$
307


 
For the Nine Months Ended 
 September 30, 2017
 
For the Nine Months Ended 
 September 30, 2016
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 real estate
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
1

 
$
2,302

 
$
2,302

 

 
$

 
$

Non-owner occupied
1

 
148

 
148

 

 

 

Construction and development
 
 
 
 
 
 
 
 
 
 
 
Land & land development
1

 
438

 
438

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
5

 
1,086

 
1,086

 
4

 
702

 
702

Consumer

 

 

 
1

 
2

 
2

Total
8

 
$
3,974

 
$
3,974

 
5

 
$
704

 
$
704


During the three months and nine months ended September 30, 2017, four non-jumbo residential real estate loans and one land & land development loan that had been restructured within the past twelve months defaulted. 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. 

The following tables detail the activity regarding TDRs by loan type, net of fees, for the three months and nine months ended September 30, 2017, and the related allowance on TDRs.
For the Three Months Ended September 30, 2017
 
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 July 1, 2017
$
2,639

 
$

 
$
438

 
$
7,315

 
$
5,245

 
$
6,200

 
$
4,456

 
$
523

 
$

 
$
34

 
$

 
$
26,850

Additions
438

 

 

 
2,302

 
148

 

 

 

 

 

 

 
2,888

Charge-offs

 

 

 

 

 

 

 

 

 

 

 

Net (paydowns) advances
(15
)
 

 
(12
)
 
(31
)
 
(45
)
 
(621
)
 
(33
)
 

 

 
(5
)
 

 
(762
)
Transfer into foreclosed properties

 

 

 

 

 

 

 

 

 

 

 

Refinance out of TDR status

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2017
$
3,062

 
$

 
$
426

 
$
9,586

 
$
5,348

 
$
5,579

 
$
4,423

 
$
523

 
$

 
$
29

 
$

 
$
28,976

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to troubled debt restructurings
$
461

 
$

 
$
259

 
$
127

 
$

 
$
217

 
$
15

 
$

 
$

 
$

 
$

 
$
1,079



Table of Contents
25


For the Nine Months Ended September 30, 2017
 
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, 2017
$
3,337

 
$

 
$
711

 
$
7,383

 
$
6,714

 
$
5,417

 
$
4,493

 
$
523

 
$

 
$
44

 
$

 
$
28,622

Additions
438

 

 

 
2,302

 
148

 
1,086

 

 

 

 

 

 
3,974

Charge-offs

 

 

 

 
(65
)
 

 

 

 

 

 

 
(65
)
Net (paydowns) advances
(713
)
 

 
(285
)
 
(99
)
 
(1,449
)
 
(924
)
 
(70
)
 

 

 
(15
)
 

 
(3,555
)
Transfer into foreclosed properties

 

 

 

 

 

 

 

 

 

 

 

Refinance out of TDR status

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2017
$
3,062

 
$

 
$
426

 
$
9,586

 
$
5,348

 
$
5,579

 
$
4,423

 
$
523

 
$

 
$
29

 
$

 
$
28,976

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance related to troubled debt restructurings
$
461

 
$

 
$
259

 
$
127

 
$

 
$
217

 
$
15

 
$

 
$

 
$

 
$

 
$
1,079


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
9/30/2017
 
12/31/2016
 
9/30/2017
 
12/31/2016
 
9/30/2017
 
12/31/2016
 
9/30/2017
 
12/31/2016
 
9/30/2017
 
12/31/2016
 
9/30/2017
12/31/2016
Pass
$
64,744

 
$
64,144

 
$
28,756

 
$
16,584

 
$
183,966

 
$
117,214

 
$
232,329

 
$
201,113

 
$
454,433

 
$
375,181

 
$
33,525

$
85,966

OLEM (Special Mention)
1,593

 
2,097

 

 

 
2,468

 
1,471

 
3,578

 
567

 
1,722

 
1,381

 


Substandard
5,075

 
5,801

 

 

 
759

 
403

 
3,933

 
1,367

 
8,388

 
5,359

 


Doubtful

 

 

 

 

 

 

 

 

 

 


Loss

 

 

 

 

 

 

 

 

 

 


Total
$
71,412

 
$
72,042

 
$
28,756

 
$
16,584

 
$
187,193

 
$
119,088

 
$
239,840

 
$
203,047

 
$
464,543

 
$
381,921

 
$
33,525

$
85,966

 
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
9/30/2017
 
12/31/2016
 
9/30/2016
 
9/30/2017
 
12/31/2016
 
9/30/2016
Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
$
348,333

 
$
261,020

 
$
225,097

 
$
7,309

 
$
4,621

 
$
3,680

Jumbo
61,253

 
65,628

 
57,276

 

 

 

Home Equity
81,947

 
74,402

 
74,667

 
773

 
194

 
494

Consumer
36,349

 
25,368

 
19,574

 
566

 
166

 
182

Other
9,994

 
9,489

 
9,649

 

 

 

Total
$
537,876

 
$
435,907

 
$
386,263

 
$
8,648

 
$
4,981

 
$
4,356




Table of Contents
26


NOTE 7.  ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses for the nine month periods ended September 30, 2017 and 2016, and for the year ended December 31, 2016 is as follows:
 
 
Nine Months Ended 
 September 30,
 
Year Ended 
 December 31,
Dollars in thousands
 
2017
 
2016
 
2016
Balance, beginning of year
 
$
11,674

 
$
11,472

 
$
11,472

Charge-offs:
 
 
 
 
 
 
Commercial
 
23

 
379

 
489

Commercial real estate
 
 
 
 
 
 
Owner occupied
 
3

 
179

 
179

Non-owner occupied
 
65

 
122

 
124

Construction and development
 
 
 
 
 
 
Land and land development
 
3

 
50

 
127

Construction
 
21

 

 
9

Residential real estate
 
 
 
 
 
 
Non-jumbo
 
200

 
119

 
169

Jumbo
 
2

 

 

Home equity
 
95

 
117

 
175

Mortgage warehouse lines
 

 

 

Consumer
 
147

 
61

 
98

Other
 
179

 
128

 
185

Total
 
738

 
1,155

 
1,555

Recoveries:
 
 

 
 

 
 

Commercial
 
13

 
69

 
73

Commercial real estate
 
 
 
 
 
 
Owner occupied
 
82

 
25

 
31

Non-owner occupied
 
92

 
13

 
17

Construction and development
 
 
 
 
 
 
Land and land development
 
246

 
514

 
840

Construction
 

 

 

Real estate - mortgage
 
 
 
 
 
 
Non-jumbo
 
50

 
58

 
136

Jumbo
 

 
6

 
6

Home equity
 
29

 
3

 
3

Mortgage warehouse lines
 

 

 

Consumer
 
64

 
55

 
76

Other
 
78

 
59

 
75

Total
 
654

 
802

 
1,257

Net charge-offs
 
84


353


298

Provision for loan losses
 
875

 
500

 
500

Balance, end of period
 
$
12,465


$
11,619


$
11,674

 
 

Table of Contents
27


Activity in the allowance for loan losses by loan class during the first nine months of 2017 is as follows:
 
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
)
$
13

$
293

$
1,217

 
$
259

$
958

$

$
1,217

 
$
513

$
186,669

$
11

$
187,193

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
2,109

(3
)
82

121

2,309

 
127

2,178

4

2,309

 
9,586

229,559

695

239,840

Non-owner occupied
3,438

(65
)
92

1,709

5,174

 
501

4,670

3

5,174

 
10,898

451,799

1,846

464,543

Construction and development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land and land development
2,263

(3
)
246

(1,858
)
648

 
525

123


648

 
6,499

64,913


71,412

Construction
24

(21
)

13

16

 

16


16

 

28,756


28,756

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-jumbo
2,174

(200
)
50

24

2,048

 
217

1,829

2

2,048

 
5,928

347,853

1,861

355,642

Jumbo
95

(2
)

(15
)
78

 
15

63


78

 
4,422

55,826

1,005

61,253

Home equity
413

(95
)
29

261

608

 

608


608

 
524

82,196


82,720

Mortgage warehouse lines





 




 

33,525


33,525

Consumer
121

(147
)
64

177

215

 

215


215

 
29

36,886


36,915

Other
103

(179
)
78

150

152

 

152


152

 

9,994


9,994

Total
$
11,674

$
(738
)
$
654

$
875

$
12,465

 
$
1,644

$
10,812

$
9

$
12,465

 
$
38,399

$
1,527,976

$
5,418

$
1,571,793


NOTE 8.  GOODWILL AND OTHER INTANGIBLE ASSETS

Effective July 1, 2017, we early adopted ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The adoption of ASU 2017-04 had no impact on our consolidated financial statements.

During third quarter 2017, we performed the qualitative assessment of the goodwill of our community banking and insurance services reporting units and determined that the fair values of the reporting units were more likely than not greater than their carrying values.  In performing the qualitative assessments, we considered certain events and circumstances specific to each reporting unit, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair values of our community banking or insurance services reporting units are less than their carrying values.  No indicators of impairment for either reporting unit were noted as of September 30, 2017.

The following tables present our goodwill by reporting unit at September 30, 2017 and other intangible assets by reporting unit at September 30, 2017 and December 31, 2016.

 
 
Goodwill Activity
Dollars in thousands
 
Community Banking
 
Insurance Services
 
Total
Balance, January 1, 2017
 
$
6,280

 
$
4,710

 
$
10,990

Reclassifications to goodwill
 
31

 

 
31

Acquired goodwill, net
 
4,252

 

 
4,252

Balance, September 30, 2017
 
$
10,563

 
$
4,710

 
$
15,273


Table of Contents
28


 
 
Other Intangible Assets
 
 
September 30, 2017
 
December 31, 2016
Dollars in thousands
 
Community
Banking
 
Insurance
Services
 
Total
 
Community
Banking
 
Insurances
Services
 
Total
Identifiable intangible assets
 
 

 
 

 
 

 
 

 
 

 
 

Gross carrying amount
 
$
12,528

 
$
3,000

 
$
15,528

 
$
1,610

 
$
3,000

 
$
4,610

Less: accumulated amortization
 
872

 
2,050

 
2,922

 
47

 
1,900

 
1,947

Net carrying amount
 
$
11,656

 
$
950

 
$
12,606

 
$
1,563

 
$
1,100

 
$
2,663


We recorded amortization expense of approximately $974,000 for the nine months ended September 30, 2017 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
2017
 
$
1,210

 
$
200

2018
 
1,471

 
200

2019
 
1,368

 
200

2020
 
1,265

 
200

2021
 
1,162

 
200


NOTE 9.  DEPOSITS

The following is a summary of interest bearing deposits by type as of September 30, 2017 and 2016 and December 31, 2016:
Dollars in thousands
 
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Demand deposits, interest bearing
 
$
397,843

 
$
262,591

 
$
212,172

Savings deposits
 
362,653

 
337,348

 
321,563

Time deposits
 
640,362

 
545,843

 
500,397

Total
 
$
1,400,858

 
$
1,145,782

 
$
1,034,132


Included in time deposits are deposits acquired through a third party (“brokered deposits”) totaling $219.8 million, $205.7 million and $178.9 million at September 30, 2017, December 31, 2016, and September 30, 2016, respectively.

A summary of the scheduled maturities for all time deposits as of September 30, 2017 is as follows:
Dollars in thousands
 
Three month period ending December 31, 2017
$
81,870

Year ending December 31, 2018
232,020

Year ending December 31, 2019
140,028

Year ending December 31, 2020
88,444

Year ending December 31, 2021
54,858

Thereafter
43,142

Total
$
640,362


The following is a summary of the maturity distribution of all certificates of deposit in denominations of $100,000 or more as of September 30, 2017:
Dollars in thousands
Amount
 
Percent
Three months or less
$
52,185

 
11.9
%
Three through six months
54,568

 
12.4
%
Six through twelve months
66,426

 
15.1
%
Over twelve months
265,855

 
60.6
%
Total
$
439,034

 
100.00
%



Table of Contents
29


NOTE 10.  BORROWED FUNDS

Short-term borrowings:    A summary of short-term borrowings is presented below:
 
Nine Months Ended September 30,
 
2017
 
2016
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 September 30
$
199,500

 
$
3,488

 
$
231,200

 
$
3,457

Average balance outstanding for the period
196,728

 
3,474

 
177,239

 
3,455

Maximum balance outstanding at any month end during period
229,300

 
3,488

 
231,200

 
3,457

Weighted average interest rate for the period
1.10
%
 
1.03
%
 
0.59
%
 
0.50
%
Weighted average interest rate for balances
 

 
 

 
 

 
 

     outstanding at September 30
1.32
%
 
1.25
%
 
0.54
%
 
0.50
%

Long-term borrowings:  Our long-term borrowings of $45.8 million, $46.7 million and $74.1 million at September 30, 2017, December 31, 2016, and September 30, 2016 respectively, consisted primarily 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 September 30,
 
Balance at 
 December 31,
Dollars in thousands
2017
 
2016
 
2016
Long-term FHLB advances
$
755

 
$
792

 
$
767

Long-term repurchase agreements
45,000

 
72,000

 
45,000

Term loan

 
1,354

 
903

Total
$
45,755

 
$
74,146

 
$
46,670

 
At December 31, 2016, the term loan was secured by the common stock of our subsidiary bank, had a variable interest rate of prime minus 50 basis points and matured in second quarter 2017. 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 nine month period ended September 30, 2017 was 4.32% compared to 4.43% for the first nine months of 2016.

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 September 30, 2017, December 31, 2016, and September 30, 2016.

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:

Table of Contents
30


Dollars in thousands
 
 
Long-term
borrowings
 
Subordinated
debentures owed
to unconsolidated
subsidiary trusts
Year Ending December 31,
2017
 
$
4

 
$

 
2018
 
45,017

 

 
2019
 
18

 

 
2020
 
19

 

 
2021
 
20

 

 
Thereafter
 
677

 
19,589

 
 
 
$
45,755

 
$
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 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. We 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 three months ended September 30, 2017 or the first nine months of 2016.

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 nine months of 2017 and 2016, our share-based compensation expense was $285,000 and $150,000 and the related deferred tax benefits were approximately $105,000 and $56,000.


Table of Contents
31


A summary of activity in our Plans during the first nine months of 2017 and 2016 is as follows:
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
Options/SARs
 
Weighted-Average
Exercise Price
 
Options/SARs
 
Weighted-Average
Exercise Price
Outstanding, January 1
217,857

 
$
13.56

 
244,147

 
$
14.05

Granted
87,615

 
26.01

 

 

Exercised
(2,000
)
 
6.21

 

 

Forfeited

 

 

 

Expired

 

 

 

Outstanding, September 30
303,472

 
$
17.20

 
244,147

 
$
14.05



Other information regarding awards outstanding and exercisable at September 30, 2017 is as follows:
 
Options/SARs Outstanding
 
Options/SARs Exercisable
Range of
exercise price
# of
awards
 
WAEP
 
Wted. Avg.
Remaining
Contractual
Life (yrs)
 
Aggregate
Intrinsic
Value
(in thousands)
 
# of
awards
 
WAEP
 
Aggregate
Intrinsic
Value
(in thousands)
$2.54 - $6.00
5,000

 
$
2.54

 
5.83
 
$
116

 
5,000

 
$
2.54

 
$
116

6.01 - 10.00
5,640

 
8.91

 
1.29
 
94

 
5,640

 
8.91

 
94

10.01 - 17.50
166,717

 
12.01

 
7.57
 
2,275

 
66,687

 
12.01

 
910

17.51 - 20.00
15,100

 
17.81

 
0.78
 
119

 
15,100

 
17.81

 
119

20.01 - 25.93
111,015

 
25.99

 
7.64
 

 
23,400

 
25.93

 

 
303,472

 
17.20

 
 
 
$
2,604

 
115,827

 
15.02

 
$
1,239


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
 
September 30,
2017
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
68,616

Construction loans
 
56,715

Other loans
 
104,778

Standby letters of credit
 
3,469

Total
 
$
233,578


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

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

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

Litigation

On May 13, 2014, the ResCap Liquidating Trust (“ResCap”), as successor to Residential Funding Company, LLC f/k/a Residential Funding Corporation (“RFC”), filed a complaint against Summit Financial Mortgage, LLC (“Summit Mortgage”), a former residential mortgage subsidiary of Summit whose operations were discontinued in 2007, in the United States Bankruptcy Court for the Southern District of New York and subsequently amended its complaint on July 25, 2014.

Furthermore, on January 23, 2017, ResCap, as successor to RFC (together with RFC, the "RFC Parties"), filed a complaint against Summit Community Bank, Inc., as successor to Shenandoah Valley Community Bank (“Summit”), in the United States District Court for the District of Minnesota (collectively, the “ResCap Litigation”). Additional information regarding the ResCap Litigation is included under the caption “Legal Contingencies” in Note 17 of our consolidated financial statements beginning on page 92 of our Form 10-K for the year ended December 31, 2016.

On April 24, 2017, Summit Community Bank, Inc. entered into a Settlement and Release Agreement (the “Settlement Agreement”) with the RFC parties with respect to the Rescap Litigation.  Under the Settlement Agreement, Summit Community Bank paid $9.9 million to fully resolve all claims by the RFC Parties, and to avoid the further costs, disruption, and distraction of defending the Rescap Litigation. Summit recorded a charge to noninterest expense in its consolidated statement of income for the three months ended March 31, 2017 to recognize this settlement.  
We are not a party to any other litigation except for matters that arise in the normal course of business.  While it is impossible to ascertain the ultimate resolution or range of financial liability 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 September 30, 2017, 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 September 30, 2017, 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 2015 Annual Report on Form 10-K for further discussion of Basel III.

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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 September 30, 2017 and December 31, 2016 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 September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
$
176,666

 
10.8
%
 
$
114,506

 
7.0
%
 
$
106,327

 
6.5
%
Summit Community
 
194,410

 
11.8
%
 
115,328

 
7.0
%
 
107,090

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
195,666

 
11.9
%
 
139,761

 
8.5
%
 
131,540

 
8.0
%
Summit Community
 
194,410

 
11.8
%
 
140,041

 
8.5
%
 
131,803

 
8.0
%
Total Capital (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
Summit
 
208,130

 
12.7
%
 
172,076

 
10.5
%
 
163,882

 
10.0
%
Summit Community
 
206,874

 
12.6
%
 
172,395

 
10.5
%
 
164,186

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
195,666

 
9.5
%
 
82,386

 
4.0
%
 
102,982

 
5.0
%
Summit Community
 
194,410

 
9.4
%
 
82,728

 
4.0
%
 
103,410

 
5.0
%
 
 
 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, 2016
 
 

 
 

 
 

 
 

CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
146,494

 
10.5
%
 
97,663

 
7.0
%
 
90,687

 
6.5
%
Summit Community
 
165,747

 
11.9
%
 
97,498

 
7.0
%
 
90,534

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
164,357

 
11.8
%
 
118,393

 
8.5
%
 
111,428

 
8.0
%
Summit Community
 
165,747

 
11.9
%
 
118,391

 
8.5
%
 
111,427

 
8.0
%
Total Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
176,031

 
12.6
%
 
146,693

 
10.5
%
 
139,707

 
10.0
%
Summit Community
 
177,421

 
12.7
%
 
146,687

 
10.5
%
 
139,702

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
164,357

 
9.4
%
 
69,939

 
4.0
%
 
87,424

 
5.0
%
Summit Community
 
165,747

 
9.5
%
 
69,788

 
4.0
%
 
87,235

 
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.

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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 September 30, 2017
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
17,408

 
$

 
$

 
$
(176
)
 
$

 
$
17,232

Provision for loan losses
 
375

 

 

 

 

 
375

Net interest income after provision
for loan losses
 
17,033

 

 

 
(176
)
 

 
16,857

Other income
 
2,408

 
589

 
1,003

 
491

 
(491
)
 
4,000

Other expenses
 
10,844

 
546

 
814

 
734

 
(491
)
 
12,447

Income (loss) before income taxes
 
8,597

 
43

 
189

 
(419
)
 

 
8,410

Income tax expense (benefit)
 
2,482

 
16

 
92

 
(110
)
 

 
2,480

Net income (loss)
 
$
6,115

 
$
27

 
$
97

 
$
(309
)
 
$

 
$
5,930

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

 
$
(40
)
 
$
491

 
$

 
$

Average assets
 
$
2,110,832

 
$

 
$
6,288

 
$
217,928

 
$
(246,788
)
 
$
2,088,260

Capital expenditures
 
$
1,497

 
$

 
$

 
$

 
$

 
$
1,497


 
 
Three Months Ended September 30, 2016
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
12,197

 
$

 
$

 
$
(160
)
 
$

 
$
12,037

Provision for loan losses
 

 

 

 

 

 

Net interest income after provision
for loan losses
 
12,197

 

 

 
(160
)
 

 
12,037

Other income
 
1,622

 
126

 
1,001

 
389

 
(389
)
 
2,749

Other expenses
 
7,249

 
100

 
902

 
557

 
(389
)
 
8,419

Income (loss) before income taxes
 
6,570

 
26

 
99

 
(328
)
 

 
6,367

Income tax expense (benefit)
 
2,145

 
10

 
40

 
(109
)
 

 
2,086

Net income (loss)
 
$
4,425

 
$
16

 
$
59

 
$
(219
)
 
$

 
$
4,281

Inter-segment revenue (expense)
 
$
(361
)
 
$

 
$
(28
)
 
$
389

 
$

 
$

Average assets
 
$
1,609,343

 
$

 
$
6,005

 
$
175,581

 
$
(201,875
)
 
$
1,589,054

Capital expenditures
 
$
766

 
$

 
$

 
$

 
$

 
$
766




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35


 
 
Nine Months Ended September 30, 2017
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
49,220

 
$

 
$

 
$
(511
)
 
$

 
$
48,709

Provision for loan losses
 
875

 

 

 

 

 
875

Net interest income after provision
for loan losses
 
48,345

 




(511
)



47,834

Other income
 
6,280

 
1,284

 
2,932

 
1,473

 
(1,473
)
 
10,496

Other expenses
 
41,351

 
1,219

 
2,495

 
1,807

 
(1,473
)
 
45,399

Income (loss) before income taxes
 
13,274

 
65


437


(845
)



12,931

Income tax expense (benefit)
 
3,386

 
24

 
190

 
(261
)
 

 
3,339

Net income (loss)
 
$
9,888

 
$
41

 
$
247

 
$
(584
)
 
$


$
9,592

Inter-segment revenue (expense)
 
$
(1,353
)
 
$

 
$
(120
)
 
$
1,473

 
$

 
$

Average assets
 
$
1,994,042

 
$

 
$
6,197

 
$
203,459

 
$
(232,211
)
 
$
1,971,487

Capital expenditures
 
$
5,544

 
$

 
$
36

 
$
92

 
$

 
$
5,672


 
 
Nine Months Ended September 30, 2016
Dollars in thousands
 
Community
Banking
 
Trust and
Wealth Management
 
Insurance
Services
 
Parent
 
Eliminations
 
Total
Net interest income
 
$
36,028

 
$

 
$

 
$
(478
)
 
$

 
$
35,550

Provision for loan losses
 
500

 

 

 

 

 
500

Net interest income after provision
for loan losses
 
35,528

 

 

 
(478
)
 


35,050

Other income
 
5,240

 
358

 
3,003

 
1,166

 
(1,166
)
 
8,601

Other expenses
 
21,735

 
335

 
2,771

 
1,735

 
(1,166
)
 
25,410

Income (loss) before income taxes
 
19,033

 
23

 
232

 
(1,047
)
 


18,241

Income tax expense (benefit)
 
5,888

 
9

 
95

 
(337
)
 

 
5,655

Net income (loss)
 
$
13,145

 
$
14

 
$
137

 
$
(710
)
 
$


$
12,586

Inter-segment revenue (expense)
 
$
(1,081
)
 
$

 
$
(85
)
 
$
1,166

 
$

 
$

Average assets
 
$
1,565,099

 
$

 
$
5,951

 
$
172,840

 
$
(199,962
)
 
$
1,543,928

Capital expenditures
 
$
1,099

 
$

 
$
9

 
$
91

 
$

 
$
1,199


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

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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 September 30, 2017 and December 31, 2016 follows:
 
September 30, 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

 
$

 
$
3,056

 
$

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
20,103

 
$
125

 
$

 
$


 
December 31, 2016
 
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

 
$

 
$
4,611

 
$

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
20,507

 
$
200

 
$

 
$


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. Partnering with FCB not only expands Summit’s community banking footprint into southwest West Virginia and southwestern Virginia, it also notably will provide us the opportunity to offer trust services throughout our Bank’s market area, a capability which we currently do not possess. Pursuant to the Agreement and Plan of Merger dated June 1, 2016, FCB's shareholders received cash in the amount of $22.50 per share or 1.2433 shares of Summit common stock, or a combination of cash and Summit stock, subject to proration to result in approximately 35% cash and 65% stock consideration in the aggregate. Total stock consideration was $33.1 million or 1,537,912 shares of Summit common stock and cash consideration was $15.0 million. FCB's assets and liabilities approximated $406 million and $361 million, respectively, at March 31, 2017.

The assets and liabilities of FCB were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date as additional information relative to the acquisition date fair values becomes available. We recognized goodwill of $4.25 million in connection with the acquisition, which is not amortized for financial reporting purposes but is subject to annual impairment testing. The core deposit intangible represents the value of long-term deposit relationships acquired in this transaction and will be amortized over an estimated weighted average life of 15 years using an accelerated method which approximates the estimated run-off of the acquired deposits. The following table details the total consideration paid on April 1, 2017 in connection with the acquisition of FCB, the fair values of the assets acquired and liabilities assumed and the resulting goodwill.

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Dollars in thousands
 
As Recorded by FCB
 
Estimated Fair Value Adjustments
 
Estimated Fair Values as Recorded by Summit
Cash consideration
 
 
 
 
 
$
14,989

Stock consideration
 
 
 
 
 
33,127

Total consideration
 
 
 
 
 
48,116

 
 
 
 
 
 
 
Identifiable assets acquired:
 
 
 
 
 
 
Cash and cash equivalents
 
$
54,042

 
$

 
$
54,042

Securities available for sale, at fair value
 
101,022

 
295

 
101,317

Loans
 
 
 
 
 
 
Purchased performing
 
224,809

 
(2,693
)
 
222,116

Purchased credit impaired
 
4,167

 
(540
)
 
3,627

Allowance for loan losses
 
(2,511
)
 
2,511

 

Premises and equipment
 
10,396

 
(4,222
)
 
6,174

Property held for sale
 
4,596

 
(2,219
)
 
2,377

Goodwill
 
5,183

 
(5,183
)
 

Core deposit intangibles
 

 
10,916

 
10,916

Other assets
 
4,450

 
652

 
5,102

Total identifiable assets acquired
 
406,154

 
(483
)
 
405,671

 
 
 
 
 
 
 
Identifiable liabilities assumed:
 
 
 
 
 
 
Deposits
 
349,726

 
807

 
350,533

Other liabilities
 
11,216

 
58

 
11,274

Total identifiable liabilities assumed
 
360,942

 
865

 
361,807

 
 
 
 
 
 
 
Net identifiable assets acquired
 
$
45,212

 
$
(1,348
)
 
$
43,864

 
 
 
 
 
 
 
Goodwill resulting from acquisition
 
 
 
 
 
$
4,252

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented above.
Cash and cash equivalents: The carrying amount of these assets approximates their fair value based on the short-term nature of these assets.

Securities: Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair value estimates are based on observable inputs including quoted market prices for similar instruments, quoted market prices that are not in an active market or other inputs that are observable in the market.

Loans: Fair values for loans are based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, collectibility, fixed or variable interest rate, term of loan, amortization status and current market rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns, if any.

Premises and equipment: The fair value of FCB's real property was determined based upon appraisals by licensed appraisers. The fair value of tangible personal property, which is not material, was assumed to equal the carrying value by FCB.

Property held for sale: The fair value of FCB's property held for sale was determined on a property by property basis based upon the lessor of the properties present asking price or its appraised value by licensed appraisers, less estimated costs to sell.

Core deposit intangible: This intangible asset represents the value of the relationships with deposit customers. The fair value was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected

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customer attrition rates, cost of the deposit base, reserve requirements and the net maintenance cost attributable to customer deposits.

Deposits: The fair values of the demand and savings deposits by definition equal the amount payable on demand at the acquisition date. The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered to the contractual interest rates on such time deposits.

Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition without the carryover of the related allowance for loan losses. Purchased credit-impaired (PCI) loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are identified as of the date of acquisition based upon evidence of credit quality such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments of principal and interest at acquisition and the cash flows expected to be collected at acquisition is accounted for as a "nonaccretable difference". For purposes of determining the nonaccretable difference, no prepayments are generally assumed in determining contractually required payments of principal and interest or cash flows expected to be collected. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows may result in a reversal of the provision for loan losses to the extent of prior charges, or a transfer from nonaccretable difference to accretable yield. Further, any excess of cash flows expected at acquisition over the estimated fair value is accounted for as accretable yield and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

Loans not designated PCI loans as of the acquisition date are designated purchased performing loans. We account for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition.

The PCI loan portfolio related to the FCB acquisition was recorded at estimated fair value on the date of acquisition, April 1, 2017, as follows:
Dollars in thousands
 
Acquired Loans -PCI
Contractual principal and interest due
 
$
4,885

Nonaccretable difference
 
(597
)
Expected cash flows
 
4,288

Accretable yield
 
(661
)
Purchase credit impaired loans - estimated fair value
 
$
3,627


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 for cash consideration of $21.8 million. HCB's assets and liabilities approximated $123 million and $107 million, respectively, at September 30, 2016.

Pro Forma

The following table estimates the pro forma revenue, net income and diluted earnings per share of the combined entities of Summit, HCB and FCB as if the acquisitions had taken place on January 1, 2016. All acquisition related expenses were excluded from the pro forma information. We expect to achieve operational cost savings and other efficiencies as a result of the acquisitions which are not reflected in the pro forma amounts below.
 
 
Summit, HCB & FCB Pro Forma
 
 
For the Nine Months Ended September 30,
Dollars in thousands, except per share amounts
 
2017
 
2016
Total revenues, net of interest expense
 
$
64,313

 
$
61,457

Net income
 
$
11,176

 
$
15,017

Diluted earnings per share
 
$
0.95

 
$
1.23


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39


The following presents the financial effects of adjustments recognized in the statement of income for the three and nine months ended September 30, 2017 related to business combinations that occurred during 2016 or 2017.
 
Income increase (decrease)
Dollars in thousands
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
Interest and fees on loans
$
224

 
$
712

Interest expense on deposits
76

 
167

Amortization of intangibles
(399
)
 
(825
)
Income before income tax expense
$
(99
)
 
$
54



NOTE 17. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following is changes in accumulated other comprehensive income (loss) by component, net of tax, for the three and nine months ending September 30, 2017 and 2016.
 
 
For the Three Months Ended 
 September 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
 
$
219

 
$
(2,238
)
 
$
1,712

 
$
(307
)
Other comprehensive income before reclassification
 

 
313

 
399

 
712

Amounts reclassified from accumulated other comprehensive income
 

 

 
(16
)
 
(16
)
Net current period other comprehensive income
 

 
313

 
383

 
696

Ending balance
 
$
219

 
$
(1,925
)
 
$
2,095

 
$
389


 
 
For the Three Months Ended 
 September 30, 2016
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
 
$

 
$
(5,135
)
 
$
5,014

 
$
(121
)
Other comprehensive income before reclassification
 

 
608

 
(867
)
 
(259
)
Amounts reclassified from accumulated other comprehensive income
 

 

 
(38
)
 
(38
)
Net current period other comprehensive income (loss)
 

 
608

 
(905
)
 
(297
)
Ending balance
 
$

 
$
(4,527
)
 
$
4,109

 
$
(418
)

 
 
For the Nine Months Ended 
 September 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

 
980

 
2,489

 
3,688

Amounts reclassified from accumulated other comprehensive income
 

 

 
(37
)
 
(37
)
Net current period other comprehensive income
 
219

 
980

 
2,452

 
3,651

Ending balance
 
$
219

 
$
(1,925
)
 
$
2,095

 
$
389


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40


 
 
For the Nine Months Ended 
 September 30, 2016
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
 
$

 
$
(3,195
)
 
$
2,739

 
$
(456
)
Other comprehensive income (loss) before reclassification
 

 
(1,332
)
 
1,897

 
565

Amounts reclassified from accumulated other comprehensive income
 

 

 
(527
)
 
(527
)
Net current period other comprehensive income
 

 
(1,332
)
 
1,370

 
38

Ending balance
 
$

 
$
(4,527
)
 
$
4,109

 
$
(418
)

NOTE 18. INCOME TAXES

Our income tax expense for the three months ended September 30, 2017 and September 30, 2016 totaled $2.5 million and $2.1 million, respectively. For the nine months ended September 30, 2017 and September 30, 2016 our income tax expense totaled $3.3 million and $5.7 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for the quarters ended September 30, 2017 and 2016 was 29.5% and 32.8%, respectively, and for the nine months ended September 30, 2017 and 2016 were 25.8% and 31.0%, respectively. A reconciliation between the statutory income tax rate and our effective income tax rate for the three and nine months ended September 30, 2017 and 2016 is as follows:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Dollars in thousands
Percent
 
Percent
 
Percent
 
Percent
Applicable statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
Tax-exempt interest and dividends, net
(5.1
)%
 
(4.2
)%
 
(8.8
)%
 
(4.4
)%
State income taxes (benefit), net of Federal income tax benefit
1.8
 %
 
1.7
 %
 
1.8
 %
 
1.6
 %
Other, net
(2.2
)%
 
0.3
 %
 
(2.2
)%
 
(1.2
)%
Effective income tax rate
29.5
 %
 
32.8
 %
 
25.8
 %
 
31.0
 %

The components of applicable income tax expense for the three and nine months ended September 30, 2017 and 2016 are as follows:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
Dollars in thousands
2017
2016
 
2017
2016
Current
 
 
 
 
 
Federal
$
2,436

$
1,992

 
$
3,315

$
5,439

State
251

171

 
388

451

 
2,687

2,163

 
3,703

5,890

Deferred
 

 
 
 

 

Federal
(190
)
(76
)
 
(333
)
(234
)
State
(17
)
(1
)
 
(31
)
(1
)
 
(207
)
(77
)
 
(364
)
(235
)
Total
$
2,480

$
2,086

 
$
3,339

$
5,655


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41

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 2016 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 October 1, 2016, we acquired Highland County Bankshares, Inc. ("HCB") and its subsidiary, First and Citizens Bank, headquartered in Monterey, Virginia. On April 1, 2017, we acquired First Century Bankshares, Inc. ("FCB") and its subsidiary, First Century Bank, headquartered in Bluefield, West Virginia. Since results of the two acquisitions are included in our results from the acquisition dates forward, comparisons to prior periods are significantly impacted by the acquired companies' results.

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 two recent acquisitions, interest earning assets increased by 27.39% for the first nine months in 2017 compared to the same period of 2016 while our net interest earnings on a tax equivalent basis increased 37.42%.  Our tax equivalent net interest margin increased 27 basis points as our yield on interest earning assets increased 23 basis points while our cost of interest bearing funds decreased 3 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 September 30,
 
Nine Months Ended September 30,
Dollars in thousands
 
2017
 
2016
 
2017
 
2016
Community banking
 
$
6,115

 
$
4,425

 
$
9,888

 
$
13,145

Trust and wealth management
 
27

 
16

 
41

 
14

Insurance services
 
97

 
59

 
247

 
137

Parent
 
(309
)
 
(219
)
 
(584
)
 
(710
)
Consolidated net income
 
$
5,930

 
$
4,281

 
$
9,592

 
$
12,586


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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42



Our most significant accounting policies are presented in the notes to the consolidated financial statements of our 2016 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 2016 Form 10-K. There have been no significant changes in our application of critical accounting policies since December 31, 2016.

RESULTS OF OPERATIONS

Earnings Summary

Net income for the nine months ended September 30, 2017 decreased to $9.6 million, or $0.81 per diluted share compared to $12.6 million, or $1.18 per diluted share for the same period of 2016.  Net income for the quarter ended September 30, 2017 was $5.9 million, or $0.48 per diluted share, compared to $4.3 million, or $0.40 per diluted share for the same period of 2016. The decrease for the nine months ended September 30, 2017 was 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 both the nine months and quarter ended September 30, 2017, compared to earnings for the same periods of 2016, were positively impacted by increased net interest income and increased fee income including trust and wealth management fees and fees related to deposit accounts while being negatively impacted by smaller gains realized on sales of securities, smaller gains on sales of foreclosed properties, and generally higher operating expenses due to the two recent acquisitions mentioned below. Returns on average equity and assets for the first nine months of 2017 were 7.06% and 0.65%, respectively, compared with 11.29% and 1.09% for the same period of 2016.

FCB’s results of operations are included in our consolidated results of operations from the date of acquisition, and therefore our third quarter and nine months ended September 30, 2017 results reflect increased levels of average balances, income and expense as compared to the same periods of 2016 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 $350.0 million.

HCB’s results of operations are included in our consolidated results of operation from the date of acquisition, and therefore our third quarter and nine months ended September 30, 2017 results reflect increased levels of average balances, income and expense as compared to the same periods of 2016 results. At consummation (prior to fair value acquisition adjustments), HCB had total assets of $122.8 million, loans of $60.8 million, and deposits of $106.9 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 HCB and FCB acquisitions and recent FOMC increases to its target Federal funds rate, we have experienced higher levels of net interest income and an increased net interest margin.

For the quarter ended September 30, 2017, our net interest income on a fully tax-equivalent basis increased $5.5 million to $17.9 million compared to $12.4 million for the quarter end September 30, 2016. Our tax-equivalent earnings on interest earning assets increased $6.4 million, while the cost of interest bearing liabilities increased $0.9 million (see Tables I and III).

Our net interest income on a fully tax-equivalent basis totaled $50.5 million for the nine months ended September 30, 2017, or $13.7 million or 37.4% more than the $36.7 million for the nine months ended September 30, 2016.  Our tax-equivalent earnings on interest earning assets increased $16.2 million, while the cost of interest bearing liabilities also increased $2.4 million (see Tables II and III).


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43


For the three months ended September 30, 2017 average interest earning assets increased 30.7% to $1.94 billion compared to $1.49 billion for the three months ended September 30, 2016, while average interest bearing liabilities increased 28.2% from $1.29 billion at September 30, 2016 to $1.66 billion at September 30, 2017.

Average interest earning assets increased 27.4% from $1.44 billion during the first nine months of 2016 to $1.84 billion for the first nine months of 2017, while average interest bearing liabilities increased 25.6% from $1.26 billion at September 30, 2016 to $1.58 billion at September 30, 2017.

For the quarter ended September 30, 2017, our net interest margin increased to 3.65%, compared to 3.32% for the same period of 2016, as the yields on earning assets increased 27 basis points, while the cost of our interest bearing funds decreased by 4 basis points. Our net interest margin increased to 3.67% for the nine months ended September 30, 2017, compared to 3.40% for the same period of 2016, as the yields on earning assets increased 23 basis points, while the cost of our interest bearing funds decreased by 3 basis points.
 
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 3.59% for the three months ended September 30, 2017 and 3.61% for the nine months ended September 30, 2017.

Assuming no significant unanticipated changes in market interest rates, we expect growth in our net interest income to continue over the near term primarily due to continuing expected growth in loans.  We continue to monitor the net interest margin through net interest income simulation to minimize the potential for any significant negative impact.  See the “Market Risk Management” section for further discussion of the impact changes in market interest rates could have on us.  Further analysis of our yields on interest earning assets and interest bearing liabilities are presented in Tables I, II and III below.

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44


Table I - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended
 
September 30, 2017
 
September 30, 2016
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
$
1,539,945

 
$
19,387

 
4.99
%
 
$
1,187,205

 
$
14,008

 
4.69
%
Tax-exempt (2)
16,314

 
158

 
3.84
%
 
14,300

 
202

 
5.62
%
Securities
 

 
 

 
 

 
 
 
 
 
 
Taxable
198,913

 
1,283

 
2.56
%
 
198,411

 
1,139

 
2.28
%
Tax-exempt (2)
145,599

 
1,714

 
4.67
%
 
77,489

 
941

 
4.83
%
Federal funds sold and interest bearing deposits with other banks
42,926

 
149

 
1.38
%
 
10,029

 
5

 
0.2
%
Total interest earning assets
1,943,697

 
22,691

 
4.63
%
 
1,487,434

 
16,295

 
4.36
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
Cash & due from banks
9,591

 
 

 
 

 
3,938

 
 
 
 
Premises and equipment
33,667

 
 

 
 

 
21,613

 
 
 
 
Property held for sale
23,185

 
 
 
 
 
23,311

 
 
 
 
Other assets
90,538

 
 

 
 

 
64,325

 
 
 
 
Allowance for loan losses
(12,418
)
 
 

 
 

 
(11,567
)
 
 
 
 
Total assets
$
2,088,260

 
 

 
 

 
$
1,589,054

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
Interest bearing demand deposits
$
384,539

 
$
323

 
0.33
%
 
211,264

 
85

 
0.16
%
Savings deposits
365,150

 
637

 
0.69
%
 
316,358

 
608

 
0.76
%
Time deposits
636,424

 
2,003

 
1.25
%
 
481,060

 
1,516

 
1.25
%
Short-term borrowings
205,536

 
1,160

 
2.24
%
 
189,760

 
675

 
1.42
%
Long-term borrowings and capital trust securities
65,346

 
681

 
4.13
%
 
94,106

 
985

 
4.16
%
Total interest bearing liabilities
1,656,995

 
4,804

 
1.15
%
 
1,292,548

 
3,869

 
1.19
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
Demand deposits
217,760

 
 

 
 

 
124,490

 
 
 
 
Other liabilities
17,414

 
 

 
 

 
20,280

 
 
 
 
Total liabilities
1,892,169

 
 

 
 

 
1,437,318

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity
196,091

 
 

 
 

 
151,736

 
 
 
 
Total liabilities and shareholders' equity
$
2,088,260

 
 

 
 

 
$
1,589,054

 
 
 
 
Net interest earnings
 

 
$
17,887

 
 

 
 
 
$
12,426

 
 
Net yield on interest earning assets
 
 

 
3.65
%
 
 
 
 
 
3.32
%

(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 35% and 34% for the three months ended September 30, 2017 and 2016. The tax equivalent adjustment resulted in an increase in interest income of $655,000 and $389,000 for the three months ended September 30, 2017 and 2016, respectively.



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45


Table II - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended
 
September 30, 2017
 
September 30, 2016
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
$
1,452,840

 
$
54,487

 
5.01
%
 
$
1,134,463

 
$
40,788

 
4.8
%
Tax-exempt (2)
14,223

 
602

 
5.66
%
 
14,890

 
624

 
5.6
%
Securities
 

 
 

 
 
 
 
 
 
 
 
Taxable
199,995

 
3,742

 
2.50
%
 
206,437

 
3,284

 
2.12
%
Tax-exempt (2)
124,860

 
4,392

 
4.70
%
 
76,155

 
2,814

 
4.94
%
Federal funds sold and interest bearing deposits with other banks
43,862

 
466

 
1.42
%
 
9,093

 
13

 
0.19
%
Total interest earning assets
1,835,780

 
63,689

 
4.64
%
 
1,441,038

 
47,523

 
4.41
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
Cash & due from banks
8,071

 
 

 
 

 
3,819

 
 
 
 
Premises and equipment
30,904

 
 

 
 

 
21,575

 
 
 
 
Property held for sale
24,393

 
 
 
 
 
24,365

 
 
 
 
Other assets
84,390

 
 

 
 

 
64,648

 
 
 
 
Allowance for loan losses
(12,051
)
 
 

 
 

 
(11,517
)
 
 
 
 
Total assets
$
1,971,487

 
 

 
 

 
$
1,543,928

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
Interest bearing demand deposits
$
342,358

 
$
722

 
0.28
%
 
208,755

 
248

 
0.16
%
Savings deposits
365,068

 
1,879

 
0.69
%
 
296,458

 
1,663

 
0.75
%
Time deposits
602,175

 
5,386

 
1.20
%
 
474,691

 
4,622

 
1.3
%
Short-term borrowings
200,929

 
3,233

 
2.15
%
 
180,694

 
1,334

 
0.99
%
Long-term borrowings and capital trust securities
65,725

 
2,012

 
4.09
%
 
94,574

 
2,937

 
4.15
%
Total interest bearing liabilities
1,576,255

 
13,232

 
1.12
%
 
1,255,172

 
10,804

 
1.15
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
Demand deposits
196,019

 
 

 
 

 
121,701

 
 
 
 
Other liabilities
17,990

 
 

 
 

 
18,423

 
 
 
 
Total liabilities
1,790,264

 
 

 
 

 
1,395,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity
181,223

 
 

 
 

 
148,632

 
 
 
 
Total liabilities and shareholders' equity
$
1,971,487

 
 

 
 

 
$
1,543,928

 
 
 
 
Net interest earnings
 

 
$
50,457

 
 

 
 
 
$
36,719

 
 
Net yield on interest earning assets
 
 

 
3.67
%
 
 
 
 
 
3.40
%

(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 35% and 34% for the periods ended September 30, 2017 and 2016. The tax equivalent adjustment resulted in an increase in interest income of $1,748,000 and $1,169,000 for the periods ended September 30, 2017 and 2016, respectively.

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46


Table III - Changes in Interest Margin Attributable to Rate and Volume
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30, 2017 vs. September 30, 2016
 
September 30, 2017 vs. September 30, 2016
 
 
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
 
$
4,425

 
$
954

 
$
5,379

 
$
11,839

 
$
1,860

 
$
13,699

Tax-exempt
 
26

 
(70
)
 
(44
)
 
(29
)
 
7

 
(22
)
Securities
 
 

 
 
 
 
 
 

 
 

 
 

Taxable
 
3

 
141

 
144

 
(105
)
 
563

 
458

Tax-exempt
 
805

 
(32
)
 
773

 
1,717

 
(139
)
 
1,578

Federal funds sold and interest bearing deposits with other banks
 
51

 
93

 
144

 
169

 
284

 
453

Total interest earned on interest earning assets
 
5,310

 
1,086

 
6,396

 
13,591

 
2,575

 
16,166

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 

 
 
 
 
 
 

 
 

 
 

Interest bearing demand deposits
 
103

 
135

 
238

 
215

 
259

 
474

Savings deposits
 
90

 
(61
)
 
29

 
361

 
(145
)
 
216

Time deposits
 
493

 
(6
)
 
487

 
1,160

 
(396
)
 
764

Short-term borrowings
 
60

 
425

 
485

 
164

 
1,735

 
1,899

Long-term borrowings and capital trust securities
 
(298
)
 
(5
)
 
(303
)
 
(886
)
 
(39
)
 
(925
)
Total interest paid on interest bearing liabilities
 
448

 
488

 
936

 
1,014

 
1,414

 
2,428

 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
4,862

 
$
598

 
$
5,460

 
$
12,577

 
$
1,161

 
$
13,738



Noninterest Income

Total noninterest income for the three months ended September 30, 2017 increased 45.5% compared to same period in 2016 and increased 22.0% for the nine months ended September 30, 2017 compared to the same period in 2016 principally due to increased trust and wealth management fees and service fees on deposit accounts as a result of the HCB and FCB acquisitions. Further detail regarding noninterest income is reflected in the following table.
Table IV - Noninterest Income
 
 
 
 
 
 
 
 
For the Quarter Ended September 30,
 
For the Nine Months Ended September 30,
Dollars in thousands
2017
 
2016
 
2017
 
2016
Insurance commissions
$
1,043

 
$
1,016

 
$
3,000

 
$
3,030

Trust and wealth management fees
589

 
126

 
1,284

 
358

Service fees related to deposit accounts
1,863

 
1,138

 
4,737

 
3,175

Realized securities gains
26

 
61

 
58

 
836

Bank owned life insurance income
255

 
258

 
758

 
772

Other
224

 
150

 
659

 
430

Total
$
4,000

 
$
2,749

 
$
10,496

 
$
8,601


Noninterest Expense

Total noninterest expense increased 78.7% for the nine months ended September 30, 2017, as compared to the same period in 2016, with the litigation settlement and higher salaries, commissions, and employee benefits having the largest negative impact.  Table V below shows the breakdown of the changes.

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Table V - Noninterest Expense
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended September 30,
 
For the Nine Months Ended September 30,
 
 
 
Change
 
 
 
 
 
Change
 
 
Dollars in thousands
2017
 
 $
 
%
 
2016
 
2017
 
 $
 
%
 
2016
Salaries, commissions, and employee benefits
$
6,610

 
$
1,791

 
37.2
 %
 
$
4,819

 
$
18,555

 
$
4,290

 
30.1
 %
 
$
14,265

Net occupancy expense
847

 
322

 
61.3
 %
 
525

 
2,239

 
663

 
42.1
 %
 
1,576

Equipment expense
1,093

 
377

 
52.7
 %
 
716

 
2,859

 
800

 
38.9
 %
 
2,059

Professional fees
373

 
103

 
38.1
 %
 
270

 
1,012

 
(159
)
 
(13.6
)%
 
1,171

Advertising and public relations
137

 
44

 
47.3
 %
 
93

 
393

 
113

 
40.4
 %
 
280

Amortization of intangibles
448

 
398

 
796.0
 %
 
50

 
974

 
824

 
549.3
 %
 
150

FDIC premiums
310

 
110

 
55.0
 %
 
200

 
815

 
15

 
1.9
 %
 
800

Merger-related expenses
11

 
(69
)
 
(86.3
)%
 
80

 
1,575

 
1,230

 
N/A

 
345

Foreclosed properties expense
171

 
71

 
71.0
 %
 
100

 
397

 
80

 
25.2
 %
 
317

(Gain) loss on sales of foreclosed properties
(29
)
 
140

 
N/A

 
(169
)
 
(111
)
 
340

 
(75.4
)%
 
(451
)
Write-downs of foreclosed properties
91

 
(43
)
 
(32.1
)%
 
134

 
538

 
35

 
7.0
 %
 
503

Litigation settlement

 

 
N/A

 

 
9,900

 
9,900

 
N/A

 

Other
2,385

 
784

 
49.0
 %
 
1,601

 
6,253

 
1,858

 
42.3
 %
 
4,395

Total
$
12,447

 
$
4,028

 
47.8
 %
 
$
8,419

 
$
45,399

 
$
19,989

 
78.7
 %
 
$
25,410


Salaries, commissions, and employee benefits: These expenses are 37.2% and 30.1% higher in the first three and nine months of 2017, respectively, compared to first three and nine months of 2016 due to an increase in number of employees, primarily those in conjunction with the HCB and FCB acquisitions, and general merit raises.

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 during 2017 as a result of the additional amortization of the core deposit intangibles associated with the HCB and FCB acquisitions.

FDIC premiums: FDIC premiums increased 55.0% and 1.9% during the three and nine months ended September 30, 2017 as a result of the significant increase in our balance sheet due to recent acquisitions, partially offset by lower premium rates caused by the FDIC's change in the factors used to compute its deposit insurance rates, effective the second half of 2016. The lower effective premium rates are expected to continue.

Merger-related expense: These expenses are comprised of data processing conversion costs, employee severance costs, write-downs of equipment and legal fees related to the HCB and FCB acquisitions. Such costs are not expected to continue for the remainder of 2017.

Foreclosed properties expense: Management expects foreclosed properties expense to trend lower than in recent years due to lower levels of foreclosed properties.

Other: The increase in other expenses is primarily due to increased operating expenses as a result of the acquisitions of FCB and HCB and due to a charge for a municipal tax assessment.

Income Taxes

Our income tax expense for the three months ended September 30, 2017 and September 30, 2016 totaled $2.5 million and $2.1 million, respectively. For the nine months ended September 30, 2017 and September 30, 2016 our income tax expense totaled $3.3 million and $5.7 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for the quarters ended September 30, 2017 and 2016 was 29.5% and 32.8%, respectively, and for the nine months ended September 30, 2017 and 2016 were 25.8% and 31.0%, respectively. These decreases in effective rate are primarily attributable to our increased portfolio of tax-exempt municipal securities. Refer to Note 18 of the accompanying notes to consolidated financial statements for further information regarding our income taxes.

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Credit Experience

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

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

We recorded $875,000 and $500,000 provision for loan losses for the first nine months of 2017 and 2016. The increase is primarily due to organic loan growth.

As illustrated in Table VII below, our non-performing assets have decreased since year end 2016.
Table VII - Summary of Non-Performing Assets
 
 
 
 
 
 
 
 
September 30,
 
December 31,
Dollars in thousands
 
2017
 
2016
 
2016
Accruing loans past due 90 days or more
 
$
35

 
$
21

 
$

Nonaccrual loans
 
 

 
 

 
 

Commercial
 
757

 
846

 
298

Commercial real estate
 
2,773

 
4,867

 
4,845

Commercial construction and development
 

 

 

Residential construction and development
 
3,931

 
4,360

 
4,465

Residential real estate
 
8,082

 
4,174

 
4,815

Consumer
 
494

 
148

 
151

Total nonaccrual loans
 
16,037

 
14,395

 
14,574

Foreclosed properties
 
 

 
 

 
 

Commercial
 

 

 

Commercial real estate
 
1,988

 
1,749

 
1,749

Commercial construction and development
 
7,392

 
8,664

 
8,610

Residential construction and development
 
11,852

 
13,741

 
13,265

Residential real estate
 
1,390

 
613

 
880

Total foreclosed properties
 
22,622

 
24,767

 
24,504

Repossessed assets
 
12

 
12

 
12

Total nonperforming assets
 
$
38,706

 
$
39,195

 
$
39,090

Total nonperforming loans as a percentage of total loans
 
1.02
%
 
1.16
%
 
1.10
%
Total nonperforming assets as a percentage of total assets
 
1.84
%
 
2.36
%
 
2.22
%
Allowance for loan losses as a percentage of nonperforming loans
 
77.56
%
 
80.60
%
 
80.10
%
Allowance for loan losses as a percentage of period end loans
 
0.79
%
 
0.93
%
 
0.88
%

The following table details the activity regarding our foreclosed properties for the three and nine months ended September 30, 2017 and 2016.
Table VIII - Foreclosed Property Activity
 
 
 
 
 
 
For the Three Months Ended 
 September 30,
 
For the Nine Months Ended 
 September 30,
Dollars in thousands
2017
 
2016
 
2017
 
2016
Beginning balance
$
23,592

 
$
23,425

 
$
24,504

 
$
25,567

Acquisitions
157

 
1,880

 
2,723

 
2,014

Improvements
50

 

 
269

 
463

Disposals
(1,086
)
 
(404
)
 
(4,336
)
 
(2,774
)
Writedowns to fair value
(91
)
 
(134
)
 
(538
)
 
(503
)
Balance September 30
$
22,622

 
$
24,767

 
$
22,622

 
$
24,767


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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 2016 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.

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 September 30, 2017, December 31, 2016, and September 30, 2016, respectively, our allowance for loan losses totaled $12.5 million, or 0.79% of total loans; $11.7 million, or 0.88% of total loans; and $11.6 million, or 0.93% of total loans. If the acquired FCB and HCB loans are excluded, the allowance for loan losses to total loans ratio at September 30, 2017 and December 31, 2016 would have been 0.93% and 0.92%, respectively. The allowance for loan losses is considered adequate to cover our estimate of probable credit losses inherent in our loan portfolio. The 2017 and late 2016 decline in the allowance for loan losses as a percentage of total loans is a result of lower average loan losses experienced.  Lower losses caused our historical charge-off factor of the quantitative reserve calculation to decline, thus requiring fewer quantitative reserves.  Also contributing to this decline are purchased loans.  Purchased loans are recorded on the balance sheet at estimated fair value on the date of acquisition without carryover of any related allowance for loan losses. Instead, the applicable fair value adjustment relative to each purchased loan includes a credit mark to provide for future, life-of-loan estimated credit losses at the date of acquisition.

Due to the loan portfolio acquired in conjunction with the FCB acquisition having a higher relative percentage of past due loans than that of Summit’s legacy portfolio, we experienced an overall increase in loans past due during the quarter ended September 30, 2017 (see Note 6 of the accompanying Notes to the Consolidated Financial Statements). Again, in accordance with acquisition accounting principles, these past due loans were recorded at fair value, which included a discount adjustment as applicable for each such loan’s estimated future credit losses at the time of acquisition; accordingly, the past quarter’s increased levels of past due loans did not significantly impact the balance of our allowance for loan losses at September 30, 2017.

At September 30, 2017, December 31, 2016, and September 30, 2016, we had approximately $22.6 million, $24.5 million and $24.8 million, respectively, in other real estate owned which was obtained as the result of foreclosure proceedings.  Although foreclosed property is recorded at fair value less estimated costs to sell, the prices ultimately realized upon their sale may or may not result in us recognizing additional losses.


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FINANCIAL CONDITION

Our total assets were $2.10 billion at September 30, 2017, compared to $1.76 billion at December 31, 2016, representing a 19.5% increase.  Table IX below is a summary of significant changes in our financial position between December 31, 2016 and September 30, 2017, resulting from both the FCB acquisition and other changes.
Table IX - Summary of Significant Changes in Financial Position
 
 
 
 
Increase (Decrease)
 
 
 
 
Balance
December 31,
 
Impact of FCB Acquisition
 
Other Changes
 
Balance
September 30,
Dollars in thousands
 
2016
 
 
 
2017
Assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
46,616

 
$
39,053

 
$
(34,455
)
 
$
51,214

Securities available for sale
 
266,542

 
100,735

 
(38,551
)
 
328,726

Other investments
 
12,942

 
582

 
(1,354
)
 
12,170

Loans, net
 
1,307,862

 
225,743

 
25,723

 
1,559,328

Property held for sale
 
24,504

 
2,377

 
(4,259
)
 
22,622

Premises and equipment
 
23,737

 
6,174

 
4,309

 
34,220

Goodwill and other intangibles
 
13,652

 
15,056

 
(829
)
 
27,879

Cash surrender value of life insurance
policies
 
39,143

 
1,509

 
424

 
41,076

Other assets
 
23,649

 
3,593

 
(3,341
)
 
23,901

Total Assets
 
$
1,758,647

 
$
394,822

 
$
(52,333
)
 
$
2,101,136

 
 
 
 
 
 
 
 
 
Liabilities
 
 

 
 
 
 

 
 

Deposits
 
$
1,295,519

 
$
350,533

 
$
(29,284
)
 
$
1,616,768

Short-term borrowings
 
224,461

 
7,309

 
(28,782
)
 
202,988

Long-term borrowings
 
46,670

 

 
(915
)
 
45,755

Subordinated debentures owed to
unconsolidated subsidiary trusts
 
19,589

 

 

 
19,589

Other liabilities
 
17,048

 
3,853

 
(3,647
)
 
17,254

 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
155,360

 
33,127

 
10,295

 
198,782

 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
1,758,647

 
$
394,822

 
$
(52,333
)
 
$
2,101,136


The following is a discussion of the other significant changes in our financial position during the first nine months of 2017 exclusive of the impact of the FCB acquisition:

Cash and cash equivalents and short-term borrowings: Net reduction of $34.5 million in cash and cash equivalents is primarily attributable to repayments of short-term Federal Home Loan Bank advances and the cash consideration of $15.0 million paid in conjunction with the FCB acquisition.

Securities available for sale: The net decrease of $38.6 million in securities available for sale is principally a result of a restructuring of the securities portfolio acquired from FCB wherein $94 million of the portfolio was sold, but only $54 million of the sale proceeds were reinvested.

Deposits: The net change in our deposits during the first nine months of 2017 resulted primarily from net reductions of $10 million in our time deposits, $37 million in our internet-only high yielding savings product and $8 million in our regular savings accounts, partially offset by an increase of $32 million in interest bearing checking accounts.

Shareholders' equity: Other significant 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 September 30, 2017 and December 31, 2016.


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Our total assets were $2.10 billion at September 30, 2017, compared to $1.66 billion at September 30, 2016, representing a 26.8% increase.  Table X below is a summary of significant changes in our financial position between September 30, 2016 and September 30, 2017, resulting from both the HCB and FCB acquisitions and other changes

Table X - Summary of Significant Changes in Financial Position
 
 
 
 
Increase (Decrease)
 
 
 
 
Balance
September 30,
 
Impact of HCB Acquisition
 
Impact of FCB Acquisition
 
Other Changes
 
Balance
September 30,
Dollars in thousands
 
2016
 
 
 
 
2017
Assets
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
34,499

 
$
31,409

 
$
39,053

 
$
(53,747
)
 
$
51,214

Securities available for sale
 
262,102

 
5,932

 
100,735

 
(40,043
)
 
328,726

Other investments
 
13,182

 

 
582

 
(1,594
)
 
12,170

Loans, net
 
1,234,605

 
60,847

 
225,743

 
38,133

 
1,559,328

Property held for sale
 
24,767

 
23

 
2,377

 
(4,545
)
 
22,622

Premises and equipment
 
21,802

 
1,617

 
6,174

 
4,627

 
34,220

Goodwill and other intangibles
 
7,348

 
6,401

 
15,056

 
(926
)
 
27,879

Cash surrender value of life insurance policies
 
38,504

 
351

 
1,509

 
712

 
41,076

Other assets
 
20,827

 
514

 
3,593

 
(1,033
)
 
23,901

Total Assets
 
$
1,657,636

 
$
107,094

 
$
394,822

 
$
(58,416
)
 
$
2,101,136

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 

 
 
 
 
 
 

 
 

Deposits
 
$
1,156,784

 
$
106,762

 
$
350,533

 
$
2,689

 
$
1,616,768

Short-term borrowings
 
234,657

 

 
7,309

 
(38,978
)
 
202,988

Long-term borrowings
 
74,146

 

 

 
(28,391
)
 
45,755

Subordinated debentures owed to
unconsolidated subsidiary trusts
 
19,589

 

 

 

 
19,589

Other liabilities
 
18,640

 
332

 
3,853

 
(5,571
)
 
17,254

 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
153,820

 

 
33,127

 
11,835

 
198,782

 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
1,657,636

 
$
107,094

 
$
394,822

 
$
(58,416
)
 
$
2,101,136


Cash and cash equivalents and short-term borrowings: Net reduction of $53.7 million in cash and cash equivalents is primarily attributable to repayments of short-term Federal Home Loan Bank advances and the cash consideration of $21.8 million and $15.0 million paid in conjunction with the HCB and FCB acquisitions, respectively.

Securities available for sale: The net decrease of $40.0 million in securities available for sale is principally a result of a restructuring of the securities portfolio acquired from FCB wherein $94 million of the portfolio was sold, but only $54 million of the sale proceeds were reinvested.

Long-term borrowings: The $28.4 million reduction in long-term borrowings was primarily the result of a maturing structured repurchase agreement in late 2016.

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

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 $916 million or 43.61% of total consolidated assets at September 30, 2017.


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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 $731 million.  As of September 30, 2017 and December 31, 2016, these advances totaled approximately $200 million and $222 million, respectively.  At September 30, 2017, we had additional borrowing capacity of $531 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 September 30, 2017 was approximately $159 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 September 30, 2017 totaled $198.8 million compared to $155.4 million at December 31, 2016.

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.

CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations.  The following table summarizes our contractual cash obligations at September 30, 2017.
Table XI - Contractual Cash Obligations
 
 
Dollars in thousands
 
Long
Term
Debt
 
Capital
Trust
Securities
 
Operating
Leases
2017
 
$
4

 
$

 
$
72

2018
 
45,017

 

 
221

2019
 
18

 

 
188

2020
 
19

 

 
52

2021
 
20

 

 
31

Thereafter
 
677

 
19,589

 
138

Total
 
$
45,755

 
$
19,589

 
$
702


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 September 30, 2017 are presented in the following table.
Table XII - Off-Balance Sheet Arrangements
 
September 30,
Dollars in thousands
 
2017
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
68,616

Construction loans
 
56,715

Other loans
 
104,778

Standby letters of credit
 
3,469

Total
 
$
233,578


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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 slightly liability sensitive over the next twelve months, however we are asset sensitive thereafter.  The nature of our lending and funding activities tends to drive our interest rate risk position to being liability sensitive.  That is, absent any changes in the volumes of our interest earning assets or interest bearing liabilities, liabilities are likely to reprice faster than assets, resulting in a decrease in net income in a rising rate environment.  Net income would increase in a falling interest rate environment.  Net income is also subject to changes in the shape of the yield curve.  In general, a flattening yield curve would result in a decline in our earnings due to the compression of earning asset yields and funding rates, while a steepening would result in increased earnings as margins widen.

Several techniques are available to monitor and control the level of interest rate risk.  We primarily use earnings simulations modeling to monitor interest rate risk.  The earnings simulation model forecasts the effects on net interest income under a variety of interest rate scenarios that incorporate changes in the absolute level of interest rates and changes in the shape of the yield curve.  Each increase or decrease in interest rates is assumed to gradually take place over the next 12 months, and then remain stable, except for the up 400 scenario, which assumes a gradual increase in rates over 24 months.  Assumptions used to project yields and rates for new loans and deposits are derived from historical analysis.  Securities portfolio maturities and prepayments are reinvested in like instruments.  Mortgage loan prepayment assumptions are developed from industry estimates of prepayment speeds.  Noncontractual deposit repricings are modeled on historical patterns.

The following table presents the estimated sensitivity of our net interest income to changes in interest rates, as measured by our earnings simulation model as of September 30, 2017.  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)
 
-0.10
 %
 
0.80
%
Up 200 basis points (1)
 
-0.70
 %
 
3.40
%
Up 400 basis points (2)
 
0.07
 %
 
1.39
%
 
 
 
 
 
(1) assumes a parallel shift in the yield curve over 12 months
(2) assumes a parallel shift in the yield curve over 24 months


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Item 4. Controls and Procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, has conducted as of September 30, 2017, 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 September 30, 2017 were effective.  There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

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55

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, 2016.

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 16 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:
November 3, 2017
 
 




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