EDGAR 10-K Filing

Company CIK: 811808
Filing Year: 2021
Filename: 811808_10-K_2021_0000811808-21-000009.json

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ITEM 1. BUSINESS
Item 1. Business
Summit Financial Group, Inc. (“Company” or “Summit”) is a $3.11 billion financial holding company headquartered in Moorefield, West Virginia incorporated on March 5, 1987. We provide community banking services primarily in the Eastern Panhandle, Southern and North Central regions of West Virginia, the Northern, Shenandoah Valley and Southwestern regions of Virginia and the Central region of Kentucky. We provide these services through our community bank subsidiary, Summit Community Bank (“Summit Community” or “Bank”).
Community Banking
We provide a wide range of community banking services, including demand, savings and time deposits; commercial, real estate and consumer loans; trust and wealth management services; and cash management services. The deposits of Summit Community are insured by the Federal Deposit Insurance Corporation ("FDIC").
In order to compete with other financial service providers, we principally rely upon personal relationships established by our officers, directors and employees with our clients and specialized services tailored to meet our clients’ needs. We have maintained a strong community orientation by, among other things, supporting the active participation of staff members in local charitable, civic, school, religious and community development activities. We also have a marketing program that primarily utilizes local radio and newspapers to advertise. Banking, like most industries, is becoming more dependent on technology as a means of marketing to customers, including the Internet, which we also utilize. This approach, coupled with continuity of service by the same staff members, enables Summit Community to develop long-term customer relationships, maintain high quality service and respond quickly to customer needs. We believe that our emphasis on local relationship banking, together with a prudent approach to lending, are important factors in our success and growth.
All operational and support functions that are transparent to clients are centralized in order to achieve consistency and cost efficiencies in the delivery of products and services by each banking office. The central office provides services such as data processing, deposit operations, accounting, treasury management, loan administration, loan review, compliance, risk management and internal auditing to enhance our delivery of quality service. We also provide overall direction in the areas of credit policy and administration, strategic planning, marketing, investment portfolio management, human resources administration and other financial and administrative services. The banking offices work closely with us to develop new products and services needed by their customers and to introduce enhancements to existing products and services.
Lending
Our primary lending focus is providing commercial loans to local businesses with annual sales generally up to $75 million and providing owner-occupied real estate loans to individuals. We typically do not seek credit relationships of more than $25 million but will consider larger lending relationships exhibiting above-average credit quality. Under our commercial banking strategy, we focus on offering a broad line of financial products and services to small and medium-sized businesses through full service banking offices. Summit Community Bank has senior management with extensive lending experience. These managers exercise substantial authority over credit and pricing decisions, subject to loan committee approval for larger credits.
We segment our loan portfolio in to the following major lending categories: commercial, commercial real estate, construction and land development, residential real estate, consumer and mortgage warehouse lines of credit. Commercial loans are loans made to commercial borrowers that are not secured by real estate. These encompass loans secured by accounts receivable, inventory and equipment, as well as unsecured loans. Commercial real estate loans consist of commercial mortgages, which generally are secured by nonresidential and multi-family residential properties. Commercial real estate loans are made to many of the same customers and carry similar industry risks as the commercial loan portfolio. Construction and development loans are loans made for the purpose of financing construction or development projects. This portfolio includes commercial and residential land development loans, one-to-four family housing construction, both pre-sold and speculative in nature, multi-family housing construction, non-residential building construction and undeveloped land. Residential real estate loans are mortgage loans to consumers and are secured primarily by a first lien deed of trust. These loans are traditional one-to-four family residential mortgages. Also included in this category of loans are second liens on one-to-four family properties, commercial loans secured by one-to-four family residence and home equity loans. Consumer loans are loans that establish consumer credit that is granted for the consumer’s personal use. These loans include automobile loans and recreational vehicle loans, as well as personal secured and unsecured loans. Our mortgage warehouse lines of credit result solely from a participation arrangement with a regional bank to fund residential mortgage warehouse lines of medium- and large-sized mortgage originators located throughout the United States.
Our loan underwriting guidelines and standards are consistent with the prudent banking practices applicable to the relevant exposure and are updated periodically and presented to the Board of Directors for approval. The purpose of these standards and guidelines are: to grant loans on a sound and collectible basis; to invest available funds in a safe and profitable manner; to serve the legitimate credit needs of our primary market area; and to ensure that all loan applicants receive fair and equal treatment in the lending process. It is the intent of the underwriting guidelines and standards to: minimize losses by carefully investigating the credit history of each applicant; verify the source of repayment and the ability of the applicant to repay; collateralize those loans in which collateral is deemed to be required; exercise care in the documentation of the application, review, approval and origination process; and administer a comprehensive loan collection program.
Our real estate underwriting loan-to-value (“LTV”) policy limits are at or below current bank regulatory guidelines, as follows:
Regulatory
LTV
Guideline Summit
LTV
Policy Limit
Undeveloped land 65% 65%
Land development 75% 70%
Land development - Finished building lots 85% 85%
Construction:
Commercial, multifamily and other non-residential 80% 80%
1-4 family residential, consumer borrower 85% 85%
1-4 family residential, pre-sold commercial borrower 80% 80%
1-4 family residential, spec, commercial borrower 80% 70%
Improved property:
Residential real estate - nonowner occupied 85% 85%
Commercial real estate - owner occupied 85% 85%
Commercial real estate - nonowner occupied 85% 85%
Owner occupied 1-4 family 90% 90%
Home equity 90% 90%
Exceptions are permitted to these regulatory guidelines as long as such exceptions are identified, monitored and reported to the Board of Directors at least quarterly and the total of such exceptions do not exceed 100% of Summit Community’s total regulatory capital, which totaled $302.7 million as of December 31, 2020. As of this date, we had loans approximating $99.9 million which exceeded the above regulatory LTV guidelines, as follows:
Undeveloped land $ 5.8 million
Land development $ 5.8 million
Land development - Finished building lots $ 3.6 million
Construction:
Commercial, multifamily and other non-residential $ 1.3 million
1-4 family residential, consumer borrower $ 0.2 million
1-4 family residential, pre-sold, commercial borrower $ 1.2 million
1-4 family residential, spec, commercial borrower $ 3.7 million
Improved property:
Residential real estate - nonowner occupied $ 9.4 million
Commercial real estate - owner occupied $ 21.0 million
Commercial real estate - nonowner occupied $ 24.8 million
Owner occupied 1-4 family $ 22.6 million
Home equity $ 0.5 million
Our underwriting standards and practice are designed to originate both fixed and variable rate loan products, consistent with the underwriting guidelines discussed above. Adjustable rate and variable rate loans are underwritten, giving consideration both to the loan’s initial rate and to higher assumed rates, commensurate with reasonably anticipated market conditions. Accordingly, we want to insure that adequate primary repayment capacity exists to address both future increases in interest rates and fluctuations in the underlying cash flows available for repayment. Historically, we have not offered “payment option ARM” loans. Further, we have had no loan portfolio products which were specifically designed for “sub-prime” borrowers (defined as consumers with a credit score of less than 599).
Supervision and Regulation
General
We are subject to regulation by the Board of Governors of the Federal Reserve System (“FRB”), the West Virginia Division of Financial Institutions, the Securities and Exchange Commission (the “SEC”) and other federal and state regulators. As a financial holding company, we are subject to the restrictions of the Bank Holding Company Act of 1956, as amended (“BHCA”), are registered pursuant to its provisions and are subject to examination by the FRB. As a financial holding company doing business in West Virginia, we are also subject to regulation by and must submit annual reports to the West Virginia Division of Financial Institutions.
The BHCA prohibits the acquisition by a financial holding company of direct or indirect ownership of more than five percent (5%) of the voting shares of any bank within the United States without prior approval of the FRB. With certain exceptions, a financial holding company is prohibited from acquiring direct or indirect ownership or control of more than five percent (5%) of the voting shares of any company that is not a bank and from engaging directly or indirectly in business unrelated to the business of banking or managing or controlling banks.
The FRB, in its Regulation Y, permits financial holding companies to engage in non-banking activities closely related to banking or managing or controlling banks. Approval of the FRB is necessary to engage in these activities or to make acquisitions of corporations engaging in these activities as the FRB determines whether these acquisitions or activities are in the public interest. In addition, by order, and on a case by case basis, the FRB may approve other non-banking activities.
The BHCA permits us to purchase or redeem our own securities. However, Regulation Y provides that prior notice must be given to the FRB if the total consideration for such purchase or consideration, when aggregated with the net consideration paid by us for all such purchases or redemptions during the preceding 12 months is equal to ten percent (10%) or more of our consolidated net worth. Prior notice is not required if (i) both before and immediately after the redemption, the financial holding company is well capitalized; (ii) the financial holding company is well managed and (iii) the financial holding company is not the subject of any unresolved supervisory issues.
In July 2019, the federal bank regulators adopted final rules (the “Capital Simplifications Rules”) that, among other things, eliminated the standalone prior approval requirement in the Basel III Capital Rules for any repurchase of common stock. In certain circumstances, Summit’s repurchases of its common stock may be subject to a prior approval or notice requirement under other regulations, policies or supervisory expectations of the Federal Reserve Board. Any redemption or repurchase of preferred stock or subordinated debt remains subject to the prior approval of the Federal Reserve Board.
The FRB has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries that represent unsafe and unsound banking practices or which constitute violations of laws or regulations. The FRB also can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1 million for each day the activity continues.
Summit Community, our only bank subsidiary, is subject to West Virginia banking statutes and regulations, and is primarily regulated by the West Virginia Division of Financial Institutions and the FDIC. The Bank is also subject to regulations promulgated by the FRB. As a member of the FDIC, Summit Community’s deposits are insured as required by federal law. Bank regulatory authorities regularly examine revenues, loans, investments, management practices and other aspects of Summit Community. These examinations are conducted primarily to protect depositors and not shareholders. In addition to these regular examinations, the Bank must furnish to regulatory authorities quarterly reports containing full and accurate statements of its affairs.
Because we are a public company, we are subject to regulation by the SEC. SEC regulations require us to disclose certain types of business and financial data on a regular basis to the SEC and to our shareholders. We are required to file annual, quarterly and current reports with the SEC. We prepare and file an annual report on Form 10-K with the SEC that contains detailed financial and operating information, as well as a management response to specific questions about our operations. SEC regulations require that our annual reports to shareholders contain certified financial statements and other specific items such as management’s discussion and analysis of our financial condition and results of operations. We must also file quarterly reports with the SEC on Form 10-Q that contain detailed financial and operating information for the prior quarter and we must file current reports on Form 8-K to provide the pubic with information on recent material events.
In addition to periodic reporting to the SEC, we are subject to proxy rules and tender offer rules issued by the SEC. Our officers, directors and principal shareholders (holding 10% or more of our stock) must also submit reports to the SEC regarding
their holdings of our stock and any changes to such holdings and they are subject to short-swing profit liability. Because we are traded on the NASDAQ, we are also subject to the listing standards of NASDAQ.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
The “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”), which is complex and broad in scope, established the Bureau of Consumer Financial Protection (the “CFPB”), which has extensive regulatory and enforcement powers over consumer financial products and services, and the Financial Stability Oversight Council, which has oversight authority for monitoring systemic risk. We will be required to comply with the Consumer Financial Protection Act and the CFPB’s rules; however, these rules will be enforced by Summit Community's primary regulator, the FDIC, not the CFPB. In addition, the Dodd-Frank Act alters the authority and duties of the federal banking and securities regulatory agencies, implements certain corporate governance requirements for all public companies, including financial institutions with regard to executive compensation, proxy access by shareholders and certain whistleblower provisions and restricts certain proprietary trading and hedge fund and private equity activities of banks and their affiliates. Although the regulations that directly affect our business have been adopted, many of the provisions of the Dodd-Frank Act are subject to final rulemaking by the U.S. financial regulatory agencies and the implications of the Dodd-Frank Act for our business will depend to some extent on how such rules are adopted and implemented by the primary U.S. financial regulatory agencies.
Bank Holding Company Activities
In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the FRB has determined to be so closely related to banking as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the FRB in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the FRB), without prior approval of the FRB.
Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments. Some examples of non-banking activities which presently may be performed by a financial holding company are: making or acquiring, for its own account or the account of others, loans and other extensions of credit; operating as an industrial bank, or industrial loan company, in the manner authorized by state law; servicing loans and other extensions of credit; performing or carrying on any one or more of the functions or activities that may be performed or carried on by a trust company in the manner authorized by federal or state law; acting as an investment or financial advisor; leasing real or personal property; making equity or debt investments in corporations or projects designed primarily to promote community welfare, such as the economic rehabilitation and the development of low income areas; providing bookkeeping services or financially oriented data processing services for the holding company and its subsidiaries; acting as an insurance agent or a broker; acting as an underwriter for credit life insurance, which is directly related to extensions of credit by the financial holding company system; providing courier services for certain financial documents; providing management consulting advice to non-affiliated banks; selling retail money orders having a face value of not more than $1,000, traveler’s checks and U.S. savings bonds; performing appraisals of real estate; arranging commercial real estate equity financing under certain limited circumstances; providing securities brokerage services related to securities credit activities; underwriting and dealing in government obligations and money market instruments; providing foreign exchange advisory and transactional services; and acting, under certain circumstances, as futures commission merchant for non-affiliated persons in the execution and clearance on major commodity exchanges of futures contracts and options.
To maintain financial holding company status, a financial holding company and all of its depository institution subsidiaries must be “well capitalized” and “well managed.” A depository institution subsidiary is considered to be “well capitalized” if it satisfies the requirements for this status discussed in the section captioned “Capital Requirements” included elsewhere in this item. A depository institution subsidiary is considered “well managed” if it received a composite rating and management rating of at least “satisfactory” in its most recent examination. A financial holding company’s status will also depend upon it maintaining its status as “well capitalized” and “well managed’ under applicable FRB regulations. If a financial holding company ceases to meet these capital and management requirements, the FRB’s regulations provide that the financial holding company must enter into an agreement with the FRB to comply with all applicable capital and management requirements. Until the financial holding company returns to compliance, the FRB may impose limitations or conditions on the conduct of its activities and the company may not commence any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the FRB. If the company does not return to compliance within 180 days, the FRB may require divestiture of the holding company’s depository institutions.
Bank holding companies and banks must also be both well capitalized and well managed in order to acquire banks located outside their home state.
In order for a financial holding company to commence any new activity permitted by the BHC Act or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the Community Reinvestment Act. See the section captioned “Community Reinvestment Act” included elsewhere in this item.
The FRB has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
The Dodd-Frank Act amends the BHC Act to require the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The statutory provision is commonly called the “Volcker Rule”. In July, 2019, the federal banking agencies adopted a final rule implementing sections of the Economic Growth, Regulatory Relief and Consumer Protection Act to grant an exclusion from the Volcker Rule for community banks with few than $10 billion in total consolidated assets and total trading assets, as well as liabilities that are equal to or less than five percent of their total consolidated assets. Not only are we now excluded from the Volker Rule due to our asset size, the Volcker Rule has not had a material impact on our operations as we do not generally engage in activities prohibited by the Volcker Rule.
The BHC Act, the Bank Merger Act, the West Virginia Banking Code and other federal and state statutes regulate acquisitions of commercial banks. The BHC Act requires the prior approval of the FRB for the direct or indirect acquisition by a bank holding company of more than 5.0% of the voting shares of a commercial bank or its parent holding company. Under the Bank Merger Act, the prior approval of the FRB or other appropriate bank regulatory authority is required for a member bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act (see the section captioned “Community Reinvestment Act” included elsewhere in this item) and its compliance with fair housing and other consumer protection laws and the effectiveness of the subject organizations in combating money laundering activities.
Dividends
The principal source of our liquidity is dividends from Summit Community. The prior approval of the Federal Reserve is required if the total of all dividends declared by a state-chartered member bank in any calendar year would exceed the sum of the bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus or to fund the retirement of preferred stock. Federal law also prohibits a state-chartered, member bank from paying dividends that would be greater than the bank’s undivided profits. Summit Community is also subject to limitations under West Virginia state law regarding the level of dividends that may be paid.
In addition, the Company and Summit Community are subject to other regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The appropriate federal regulatory authorities have stated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings.
Credit and Monetary Policies and Related Matters
Summit Community is affected by the fiscal and monetary policies of the federal government and its agencies, including the FRB. An important function of these policies is to curb inflation and control recessions through control of the supply of money and credit. The operations of Summit Community are affected by the policies of government regulatory authorities, including the FRB, which regulates money and credit conditions through open-market operations in United States Government and Federal agency securities, adjustments in the discount rate on member bank borrowings and requirements against deposits and regulation of interest rates payable by member banks on time and savings deposits. These policies have a significant influence
on the growth and distribution of loans, investments and deposits, and interest rates charged on loans, or paid for time and savings deposits, as well as yields on investments. The FRB has had a significant effect on the operating results of commercial banks in the past and is expected to continue to do so in the future. Future policies of the FRB and other authorities and their effect on future earnings cannot be predicted.
The FRB has a policy that a financial holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each such subsidiary bank. Under the source of strength doctrine, the FRB may require a financial holding company to contribute capital to a troubled subsidiary bank and may charge the financial holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. This capital injection may be required at times when Summit may not have the resources to provide it. Any capital loans by a holding company to any subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In addition, the Crime Control Act of 1990 provides that in the event of a financial holding company's bankruptcy, any commitment by such holding company to a Federal bank or thrift regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Capital Requirements
Our bank subsidiary, Summit Community, is subject to various regulatory capital requirements administered by the banking regulatory agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, Summit Community must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Summit Community’s 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 Summit Community to maintain minimum amounts and ratios of Common Equity Tier 1("CET1"), 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). Summit Community’s regulatory capital ratios as of December 31, 2020 are set forth in the table in Note 18 of the notes to the consolidated financial statements beginning on page 103. We believe, as of December 31, 2020, that our bank subsidiary met all capital adequacy requirements to which it was subject.
The most recent notifications from the banking regulatory agencies categorized Summit Community as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Summit Community must maintain minimum CET1, Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table in Note 18 of the notes to the consolidated financial statements beginning on page 103.
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, and was fully phased-in by January 1, 2019. As of December 31, 2020, Summit Community’s capital levels remained characterized as "well-capitalized" under the new rules.
On August 28, 2018, the FRB issued an interim final rule expanding the applicability of the FRB's small bank holding company policy statement, as required by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. The interim final rule raises the small bank holding company policy statement's asset threshold from $1 billion to $3 billion in total consolidated assets, and as a result, the Company was exempted from all regulatory capital guidelines, to which it previously had been subject, until such time as its consolidated assets exceed $3 billion.
On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to: (i) address the upcoming implementation of the Current Expected Credit Losses ("CECL") accounting standard under GAAP; and (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations experienced upon adopting CECL. We implemented the CECL accounting standard on January 1, 2020, whereby we increased the allowances for loan credit losses and unfunded commitments by $8.89 million and recorded a cumulative effect adjustment to retained earnings of $7.02 million (net of deferred income taxes of $1.87 million) and elected to recognize the regulatory capital impact of its adoption over the three year period.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") establishes a new regulatory scheme, which ties the level of supervisory intervention by bank regulatory authorities primarily to a depository institution's capital category. Among other things, FDICIA authorizes regulatory authorities to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The relevant capital measures, which reflect changes under the Basel III Capital Rules, are the total capital ratio, the CET1 capital ratio, the Tier 1 capital ratio and the leverage ratio.
A bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a CET1 capital ratio of 6.5% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater and a leverage ratio of 5.0% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a CET1 capital ratio of 4.5% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a CET1 capital ratio less than 4.5%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a CET1 capital ratio less than 3.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.”
Beginning in the first quarter of 2020, a qualifying community banking organization may elect to use the community bank leverage ratio (CBLR) framework to eliminate the requirements for calculating and reporting risk-based capital ratios. A qualifying community organization is a depository institution or its holding company that has less than $10 billion in average total consolidated assets; has off-balance-sheet exposures of 25% or less of total consolidated assets; has trading assets plus trading liabilities of 5% or less of total consolidated assets; and is not an advanced approaches banking organization. Qualifying community banking organizations that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% are considered to have satisfied the risk-based and leverage capital requirements and are considered to have met the well-capitalized ratio requirements for purposes of Section 38 of the FDICIA. Temporary relief was provided to community banks under the Coronavirus Aid, Relief and Economic Security Act to set the community bank leverage ratio at 8% beginning in the second quarter of 2020 and for the remainder of 2020, to 8.5% effective January 1, 2021 and 9% effective January 1, 2022. A qualifying community banking organization may opt into and out of the CBLR framework by completing the associated reporting requirements on its call report. We presently do not anticipate opting into the CBLR framework.
Community Reinvestment Act
Financial holding companies and their subsidiary banks are also subject to the provisions of the Community Reinvestment Act of 1977 (“CRA”). Under the CRA, the FRB (or other appropriate bank regulatory agency) is required, in connection with its examination of a bank, to assess such bank’s record in meeting the credit needs of the communities served by that bank, including low and moderate income neighborhoods. Further, such assessment is also required of any financial holding company that has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch office that will accept deposits, (iv) relocate an office, or (v) merge or consolidate with, or acquire the assets or assume the liabilities of a federally-regulated financial institution. In the case of a financial holding company applying for approval to acquire a bank or other financial holding company, the FRB will assess the record of each subsidiary of the applicant financial holding company and such records may be the basis for denying the application or imposing conditions in connection with approval of the application.
In the most recent CRA examination by the bank regulatory authorities, Summit Community was given a “satisfactory” CRA rating.
In January 2020, the FDIC and the Office of the Comptroller of the Currency (“OCC”) jointly proposed rules that would significantly change existing CRA regulations. The proposed rules are intended to increase bank activity in low- and moderate-income communities where there is significant need for credit, more responsible lending, greater access to banking services, and improvements to critical infrastructure. The proposals change four key areas: (i) clarifying what activities qualify for CRA credit; (ii) updating where activities count for CRA credit; (iii) providing a more transparent and objective method for measuring CRA performance; and (iv) revising CRA-related data collection, record keeping, and reporting. We will continue to evaluate the impact of any changes to the regulations implementing the CRA and their impact to our financial condition, results of operations, and/or liquidity. Although the proposed rules were issued jointly, the FDIC did not join with the OCC when it issued a final rule effective October 1, 2020, revising the existing CRA regulations. As a non-member state bank regulated by the FDIC, Summit Community will not be subject to the revised CRA regulations promulgated by the OCC.
Graham-Leach-Bliley Act of 1999
The enactment of the Graham-Leach-Bliley Act of 1999 (the “GLB Act”) represents a pivotal point in the history of the financial services industry. The GLB Act swept away large parts of a regulatory framework that had its origins in the Depression Era of the 1930s. New opportunities were available for banks, other depository institutions, insurance companies and securities firms to enter into combinations that permit a single financial services organization to offer customers a more complete array of financial products and services. The GLB Act provides a new regulatory framework through the financial holding company, which has as its “umbrella regulator” the FRB. Functional regulation of the financial holding company’s separately regulated subsidiaries is conducted by their primary functional regulators. The GLB Act makes a CRA rating of satisfactory or above necessary for insured depository institutions and their financial holding companies to engage in new financial activities. The GLB Act specifically gives the FRB the authority, by regulation or order, to expand the list of “financial” or “incidental” activities, but requires consultation with the U.S. Treasury Department, and gives the FRB authority to allow a financial holding company to engage in any activity that is “complementary” to a financial activity and does not “pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.”
Under the GLB Act, all financial institutions are required to adopt privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer’s request and establish procedures and practices to protect customer data from unauthorized access. We have established policies and procedures to assure our compliance with all privacy provisions of the GLB Act. Pursuant to Title V of the GLB Act, we, like all other financial institutions, are required to:
•provide notice to our customers regarding privacy policies and practices,
•inform our customers regarding the conditions under which their non-public personal information may be disclosed to non-affiliated third parties and
•give our customers an option to prevent certain disclosure of such information to non-affiliated third parties.
Deposit Acquisition Limitation
Under West Virginia banking law, an acquisition or merger is not permitted if the resulting depository institution or its holding company, including its affiliated depository institutions, would assume additional deposits to cause it to control deposits in the State of West Virginia in excess of twenty five percent (25%) of such total amount of all deposits held by insured depository institutions in West Virginia. This limitation may be waived by the Commissioner of Banking by showing good cause.
Consumer Laws and Regulations
In addition to the banking laws and regulations discussed above, bank subsidiaries are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Home Mortgage Disclosure Act and Regulation C, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Debt Collection Act, the Right to Financial Privacy Act and the Fair Housing Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. Bank subsidiaries must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations.
Dodd-Frank centralized responsibility for consumer financial protection by creating the CFPB and giving it responsibility for implementing, examining and enforcing compliance with federal consumer protection laws. The CFPB has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB’s functions include investigating consumer complaints, rulemaking, supervising and examining banks’ consumer transactions and enforcing rules related to consumer financial products and services including mortgage lending and servicing, fair lending requirements, and automotive finance. Summit Community Bank, as a bank with less than $10 billion in assets, is subject to these federal consumer financial laws, but continues to be examined for compliance by the FDIC, its primary federal banking regulator.
The CFPB has issued final regulations implementing provisions of the Dodd-Frank Act that require all creditors to determine a consumer’s ability to repay a mortgage loan before making a loan. The final rule, referred to as the Ability-to Repay (ATR)/Qualified Mortgage (QM) standards, provide that a lender making a special type of loan, known as a Qualified Mortgage, is entitled to presume that the loan complies with the ATR safe harbor requirements. The rule establishes different types of Qualified Mortgages that are generally identified as loans with restrictions on loan features, limits on fees being charged and underwriting requirements.
USA Patriot Act of 2001
The USA Patriot Act of 2001 and its related regulations require insured depository institutions, broker-dealers and certain other financial institutions to have policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. The statute and its regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition and bank merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants. Summit expects to continue to devote significant resources to its Bank Secrecy Act/anti-money laundering program, particularly as risks persistently emerge and evolve and as regulatory expectations escalate.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“SOA”) addresses, among other issues, corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. SOA requires our Chief Executive Officer and Chief Financial Officer each to certify that Summit’s Quarterly and Annual Reports do not contain any untrue statement of a material fact. The rules have several requirements, including requiring these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal controls; and they have included information in Summit’s Quarterly and Annual Reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.
Furthermore, in response to the directives of the SOA, NASDAQ adopted substantially expanded corporate governance criteria for the issuers of securities quoted on the NASDAQ Capital Market (the market on which our common stock is listed for trading). The NASDAQ rules govern, among other things, the enhancement and regulation of corporate disclosure and internal governance of listed companies and of the authority, role and responsibilities of their boards of directors and, in particular, of “independent” members of such boards of directors, in the areas of nominations, corporate governance, compensation and the monitoring of the audit and internal financial control processes.
Cybersecurity
In 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. We employ an in-depth, layered, defensive approach that leverages people, processes and technology to manage and maintain cybersecurity controls. We employ a variety of preventative and detective tools to monitor, block and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats. Notwithstanding the strength of our defensive measures, the threat from cyber attacks is severe, attacks are sophisticated and increasing in volume and attackers respond rapidly to changes in defensive measures. While to date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers. See Item 1A. Risk Factors for a further discussion of risks related to cybersecurity.
Transactions with Affiliates
Federal law restricts subsidiary banks of a financial holding company from making certain extensions of credit to the parent financial holding company or to any of its subsidiaries; from investing in the holding company stock; and limits the ability of a
subsidiary bank to take its parent company stock as collateral for the loans of any borrower. Additionally, federal law prohibits a financial holding company and its subsidiaries from engaging in certain tie-in arrangements in conjunction with the extension of credit or furnishing of services.
There are various statutory and regulatory limitations, including those set forth in sections 23A and 23B of the Federal Reserve Act and the related Federal Reserve Regulation W, governing the extent to which the bank will be able to purchase assets from or securities of or otherwise finance or transfer funds to us or our non-banking affiliates. Among other restrictions, such transactions between the bank and any one affiliate (including Summit) generally will be limited to ten percent (10%) of the bank’s capital and surplus and transactions between the bank and all affiliates will be limited to twenty percent (20%) of the bank’s capital and surplus. Furthermore, loans and extensions of credit are required to be secured in specified amounts and are required to be on terms and conditions consistent with safe and sound banking practices.
In addition, any transaction by a bank with an affiliate and any sale of assets or provisions of services to an affiliate generally must be on terms that are substantially the same, or at least as favorable, to the bank as those prevailing at the time for comparable transactions with non-affiliated companies.
Incentive Compensation
The Federal Reserve Board reviews, as part of its regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Summit, that are not “large, complex banking organizations.” These reviews are tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The scope and content of the U.S. banking regulators’ policies on incentive compensation are continuing to develop.
The federal bank regulatory agencies issued joint guidance in 2010 on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. In addition, Section 956 of the Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to issue regulations or guidelines requiring covered financial institutions, including the Company and Summit Community, to prohibit incentive-based payment arrangements that encourage inappropriate risks by providing compensation that is excessive or that could lead to material financial loss to the institution. A proposed rule was issued in 2016, but this proposed rule has not been finalized. Also, pursuant to the Dodd-Frank Act, in 2015, the SEC proposed rules that would direct stock exchanges to require listed companies to implement clawback policies to recover incentive-based compensation from current or former executive officers in the event of certain financial restatements and would also require companies to disclose their clawback policies and their actions under those policies. The Company continues to evaluate the proposed rules, both of which are subject to further rulemaking procedures.
The CARES Act and Initiatives Related to COVID-19
In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020 to provide national emergency economic relief measures. Many of the CARES Act’s programs are dependent upon the direct involvement of U.S. financial institutions, such as Summit and Summit Community, and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Federal Reserve and other federal banking agencies, including those with direct supervisory jurisdiction over Summit and Summit Community. Furthermore, as the ongoing COVID-19 pandemic evolves, federal regulatory authorities continue to issue additional guidance with respect to the various CARES Act programs. Congress may enact supplementary COVID-19 response legislation, including amendments to the CARES Act or new bills comparable in scope to the CARES Act. The Company continues to assess the impact of the CARES Act and other statutes, regulations and supervisory guidance related to the COVID-19 pandemic.
Paycheck Protection Program. Section 1102 of the CARES Act created the PPP, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. Summit Community has participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. On December 27, 2020, the President Trump signed into law omnibus federal spending and economic stimulus legislation titled the “Consolidated Appropriations Act” that included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “HHSB Act”). Among other things, the HHSB Act renewed the PPP, allocating $284.45 billion for both new first time PPP loans under the existing PPP and the expansion of existing PPP loans for certain qualified, existing PPP borrowers. First time borrowers and borrowers eligible to obtain a second PPP loan may apply for such loans from January 11, 2021 through March 31, 2021. As of December 31, 2020, Summit Community Bank had funded $101.3 in PPP loans. Those loans have an outstanding balance of $76.7 million as of December 31, 2020.
Loan Forbearance and Deferrals; Foreclosures. Section 4022 of the CARES Act allows, until the earlier of December 31, 2020 or the date the national emergency declared by the President terminates, borrowers with federally-backed one-to-four family mortgage loans experiencing a financial hardship due to the COVID-19 pandemic to request forbearance, regardless of delinquency status, for up to 360 days. Section 4022 also prohibited servicers of federally-backed mortgage loans from initiating foreclosures during the 60-day period beginning March 18, 2020. Further, on August 27, 2020, the FHFA announced that FNMA and FHLMC would extend their single-family moratorium on foreclosures and evictions through December 31, 2020. In addition, President Biden requested that the federal agencies discussed above continue to extend the moratorium on foreclosures on federally-guaranteed mortgages until at least March 31, 2021. Additionally, under Section 4023 of the CARES Act, until the earlier of December 31, 2020 and the date the national emergency declared by the President terminates, borrowers with federally-backed multifamily mortgage loans whose payments were current as of February 1, 2020, but who have since experienced financial hardship due to COVID-19, may request a forbearance for up to 90 days. Borrowers receiving such forbearance may not evict or charge late fees to tenants for its duration. On December 23, 2020, the FHFA announced an extension of forbearance programs for qualifying multifamily properties through March 31, 2021. These regulatory and legislative actions may be expanded, extended and amended as the pandemic and its economic impact continue.
The bank regulatory agencies ensure that adequate flexibility will be given to financial institutions who work with borrowers affected by the COVID-19 pandemic, and indicate that they will not criticize institutions who do so in a safe and sound manner. Further, the bank regulatory agencies have encouraged financial institutions to report accurate information to credit bureaus regarding relief provided to borrowers and have urged the importance of financial institutions to continue assisting those borrowers impacted by the COVID-19 pandemic. Also, on April 3, 2020, the bank regulatory agencies issued a joint policy statement to facilitate mortgage servicers’ ability to place consumers in short-term payment forbearance programs. This policy statement was followed by a final rule, on June 23, 2020, that makes it easier for consumers to transition out of financial hardship caused by the COVID-19 pandemic. The rule makes it clear that servicers do not violate Regulation X (which places restrictions and requirements upon lenders, mortgage brokers, or servicers of home loans related to consumers when they apply and receive mortgage loans) by offering certain COVID-19-related loss mitigation options based on an evaluation of limited application information collected from the borrower. Also, in an attempt to allow individuals and businesses to more quickly access real estate equity, on September 29, 2020, the bank regulatory agencies issued a rule that deferred appraisal and evaluation requirements after the closing of certain residential and CRE transactions through December 31, 2020. On January 20, 2021, upon the inauguration of President Biden, the new Administration issued an Executive Order extending the federal eviction moratorium issued through the Centers for Disease Control and Prevention--which was recently extended by Congress through January 31, 2021--through March 31, 2021. As part of the COVID-19 relief package proposed by the Administration, this eviction moratorium would be further extended through September 30, 2021 if adopted as proposed.
Anti-Money Laundering
The Anti-Money Laundering Act of 2020 (“AMLA”), which amends the Bank Secrecy Act of 1970 (“BSA”), was enacted in January 2021. The AMLA is intended to be a comprehensive reform and modernization to U.S. bank secrecy and anti-money laundering laws. Among other things, it codifies a risk-based approach to anti-money laundering compliance for financial institutions; requires the development of standards for evaluating technology and internal processes for BSA compliance; expands enforcement- and investigation-related authority, including increasing available sanctions for certain BSA violations and instituting BSA whistleblower incentives and protections.
Competition
We engage in highly competitive activities. Each activity and market served involves competition with other banks and savings institutions, as well as with non-banking and non-financial enterprises that offer financial products and services that compete directly with our products and services. We actively compete with other banks, mortgage companies and other financial service companies in our efforts to obtain deposits and make loans, in the scope and types of services offered, in interest rates paid on time deposits and charged on loans and in other aspects of banking.
Of particular note, banking laws limit the total amount we can lend to any one borrower generally to 15 percent of Summit Community’s Tier 1 capital plus its allowance for credit losses. Summit Community evaluated the risks and rewards of lending up to this legal lending limit and established a self-imposed lending limit equal to 85 percent of its legal lending limit. Accordingly, institutions larger than Summit Community have a natural competitive advantage to serve the loan needs of larger clients as their legal lending limits are proportionally greater than ours.
In addition to competing with other banks and mortgage companies, we compete with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, industrial loan associations, insurance companies, small loan companies, finance companies, real estate investment trusts, certain governmental agencies, credit card organizations and other enterprises. In addition, competition for money market accounts
from securities brokers has also intensified. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors, such as money market funds. We take an aggressive competitive posture and intend to continue vigorously competing for market share within our service areas by offering competitive rates and terms on both loans and deposits.
Human Capital Resources
At December 31, 2020, we employed 415 full-time equivalent team members. We have acquired five banks over the last five years resulting in an overall increase of approximately 187 full-time employees. The average tenure of our full-time employees, including time employed by the banks we acquired is 10.47 years, while the average tenure of our executive management team is approximately 23.5 years. We have 6 employees that have been with the Company more than 40 years; 80 employees that have been with the Company more than 20 years and 264 employees that have been with the Company more than 5 years.
Summit's service commitment to customers is a fundamental value of our company, and is embodied in our ‘Service Beyond Expectations’ culture. We recognize the critical role our employees play in implementing our ‘Service Beyond Expectations’ core strategy. The dedication of our employees resulted in Summit Community’s recognition as the number-one “Best-In-State-Bank” in West Virginia by Forbes in 2018. This award was based on a survey of more than 25,000 customers in the United States for their opinions on their current and former banking relationships.
While our employees are focused on providing ‘Service Beyond Expectations’ to our customers and to the community, Summit’s Board of Directors and management team are focused on providing a workplace where employees feel valued and respected, are supported professionally and personally through on the job training, development programs and health and wellness programs, and are recognized and rewarded based on their individual results and performance and the performance of the Company.
Summit values diversity in our employees, customers, suppliers, marketplace, and community. We believe employing a diverse workforce that is reflective of our customers and the communities that we serve helps us to better identify and deliver ‘Service Beyond Expectations’ to meet our customers’ and communities’ particular financial needs. We are committed to attracting, retaining and promoting our employees regardless of sex, sexual orientation, gender identity, race, color, national origin, age, relation and physical ability. We identify and hire the best candidates for all open positions based on qualifying factors for the position and free from discrimination.
Management reviews and monitors our workforce data provided to the U.S. Equal Employment Opportunity Commission to ensure that we are recruiting, promoting and retaining diverse employees. We dedicate resources to promote a safe and inclusive workplace. Our employees participate in various training courses including a course on sexual harassment and a course on accepting each other’s differences. We believe that our diverse workforce is representative of our customers and communities and we will continue to support and promote diversity.
Summit is committed to employee development and retention. We provide professional development opportunities, on the job training and mentoring to all of our employees. We encourage our employees to pursue educational opportunities that will help improve their job skills and performance. Our employees attend training, development and compliance courses offered by the West Virginia Bankers Association, the Community Bankers of West Virginia and the Virginia Bankers Association, and financial and credit risk management courses offered by The Risk Management Association. We also support employees who desire to continue their education in areas that are directly related to their jobs. We reimburse fees for continuing education courses and for certain certifications. We also provide up to $500 per employee in educational assistance annually for those employees who wish to continue their education.
Our compensation and benefits package is designed to attract, motivate and retain employees. In addition to competitive base salaries, the Company provides a variety of short-term, long-term and commission-based incentive compensation programs to reward performance relative to key financial performance of the Company and customer experience metrics. The Company’s long-term compensation program is directly linked to the long-term performance of the Company, its common stock and Summit Community. Summit offers comprehensive health and benefit options to its employees consisting of health, dental, vision, life insurance, disability insurance, paid vacation, paid illness, and holidays. Summit also maintains an Employee Stock Ownership Plan (ESOP) which covers substantially all employees. Under the provisions of the ESOP, employee participants in the ESOP are not permitted to contribute to the ESOP, rather the cost of the ESOP is borne by the Company through annual contributions in amounts determined by the Company’s Board of Directors. Discretionary contributions were made by the Company for 2020 of 5%. As of December 31, 2020, the ESOP owned 4.0% of the Company’s common stock. In addition, the Company has a defined contribution plan with 401(k) provisions covering substantially all employees. Under the provisions of the plan, the Company matches 100% of the participant’s salary reduction contributions, up to 4% of such participant’s compensation. The Company may also make optional contributions at the discretion of the Company’s Board of Directors.
We are committed and focused on the health and safety of our employees, customers, and communities. The COVID-19 pandemic presented challenges to maintain employee and customer safety while continuing to be open for business. In response to this unprecedented crisis, we implemented various plans, strategies and protocols to protect our employees, maintain services for customers, assure the functional continuity of our operating systems, controls and processes, and mitigate the financial risks posed by changing market conditions. In order to protect employees and assure workforce continuity and operational redundancy, we imposed business travel restrictions, enhanced our sanitizing protocols within our facilities and physically separated, to the extent possible, our critical operations workforce.
Summit employees actively share their talents in their communities through volunteer activities in education, economic development, human and health services, and community reinvestment. Bank management and personnel serve in leadership positions on several community development organizations that provide affordable housing assistance, economic development, and community services for low- and moderate-income individuals and families. In addition, Summit Community offers a Bank at School program, which encourages students to save and informs them of the banking system. As of December 30, 2020, the bank had 64 accounts in this program. Even during a pandemic, Summit employees found creative ways to give back to their communities by donating and delivering food to organizations selected by each branch location, collecting and donating food to local food banks/pantries, delivering hand sanitizer to various organizations and handing out gloves and masks at branches to customers.
Available Information
Our Internet website address is www.summitfgi.com and our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K and amendments to such filed reports with the SEC are accessible through this website free of charge as soon as reasonably practicable after we electronically file such reports with the SEC. The information on our website is not and shall not be deemed to be, a part of this report or incorporated into any other filing with the SEC.
These reports are available at the SEC’s website at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.
Statistical Information
The information noted below is provided pursuant to Guide 3 - Statistical Disclosure by Bank Holding Companies.
Description of Information
Page Reference
1.
Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential
a. Average Balance Sheets 35
b. Analysis of Net Interest Earnings 33
c. Rate Volume Analysis of Changes in Interest Income and Expense 37
2.
Investment Portfolio
a. Book Value of Investments 42
b. Maturity Schedule of Investments 42
c. Securities of Issuers Exceeding 10% of Shareholders’ Equity 41
3.
Loan Portfolio
a. Types of Loans 41
b. Maturities and Sensitivity to Changes in Interest Rates 80
c. Risk Elements 44
d. Other Interest Bearing Assets n/a
4.
Summary of Loan Loss Experience 46
5.
Deposits
a. Breakdown of Deposits by Categories, Average Balance and Average Rate Paid 35-36
b. Maturity Schedule of Time Certificates of Deposit and Other Time Deposits of $100,000 or More 94
6.
Return on Equity and Assets 33
7.
Short-term Borrowings 95

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
We, like other financial holding companies, are subject to a number of risks that may adversely affect our financial condition or results of operation, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (i) credit risk, which is the risk of loss due to loan clients or other counterparties not being able to meet their financial obligations under agreed upon terms, (ii) market risk, which is the risk of loss due to changes in the market value of assets and liabilities due to changes in market interest rates, equity prices and credit spreads, (iii) liquidity risk, which is 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, investor and customer perception of financial strength and events unrelated to the Company such as war, terrorism, or financial institution market specific issues and (iv) operational risk, which is the risk of loss due to human error, inadequate or failed internal systems and controls, violations of, or noncompliance with, laws, rules, regulations, prescribed practices, or ethical standards and external influences such as market conditions, fraudulent activities, disasters and security risks.
In addition to the other information included or incorporated by reference into this report, readers should carefully consider that the following important factors, among others, could materially impact our business, future results of operations and future cash flows.
RISKS RELATING TO THE ECONOMIC ENVIRONMENT
Our business, financial condition, liquidity and results of operations have been, and will likely continue to be, adversely affected by the COVID-19 pandemic.
The COVID-19 pandemic has created economic and financial disruptions that have adversely affected, and are likely to continue to adversely affect, our business, financial condition, liquidity and results of operations. Given the ongoing and changing nature of the circumstances, it is not possible to accurately predict the extent, severity or duration of these conditions or when normal economic and operating conditions will resume. For this reason, the extent to which the COVID-19 pandemic affects our business, operations and financial condition, as well as our regulatory capital and liquidity ratios and credit ratings, is highly uncertain and unpredictable and depends on, among other things, new information that may emerge concerning the scope, duration and severity of the COVID-19 pandemic, actions taken by governmental authorities and other parties in response to the pandemic, the scale of distribution and public acceptance of any vaccines for COVID-19 and the effectiveness of such vaccines in stemming or stopping the spread of COVID-19. The adverse impact on the markets in which we operate and on our business, operations and financial condition is expected to remain elevated until the pandemic subsides.
Our business may be adversely affected by conditions in financial markets and economic conditions generally.
Our business is concentrated in West Virginia, the Northern, Shenandoah Valley and Southwestern regions of Virginia and the central region of Kentucky. As a result, our financial condition, results of operations and cash flows are subject to changes if there are changes in the economic conditions in these areas. A prolonged period of economic recession or other adverse economic conditions in these areas could have a negative impact on Summit. A significant decline in general economic conditions nationally, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, pandemic disease, unemployment, changes in securities markets, declines in the housing market, a tightening credit environment or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties and routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, or other institutional firms. Defaults by financial services institutions and even rumors or questions about a financial institution or the financial services industry in general, have led to market wide liquidity problems and could lead to losses or defaults by us or other institutions. Any such losses could adversely affect our financial condition or results of operations.
The value of certain investment securities is volatile and future declines or other-than-temporary impairments could have a materially adverse effect on future earnings and regulatory capital.
Volatility in the fair value for certain investment securities, whether caused by changes in market conditions, interest rates, credit risk of the issuer, the expected yield of the security, or actual defaults in the portfolio could result in significant
fluctuations in the value of the securities as well as any regulatory rulemaking which could exclude or limit the holdings of certain investment securities. This could have a material adverse impact on our accumulated other comprehensive income and shareholders’ equity depending on the direction of the fluctuations. Furthermore, future downgrades, defaults or prepayments, including the liquidation of the underlying collateral in certain securities, could result in future classifications as other-than-temporarily impaired. This could have a material impact on our future earnings, although the impact on shareholders’ equity will be offset by any amount already included in other comprehensive income for securities that were temporarily impaired.
RISKS RELATING TO OUR BUSINESS
We are subject to extensive government regulation and supervision.
The Company and Summit Community are subject to extensive federal and state regulation and supervision, which vests a significant amount of discretion in the various regulatory authorities. Banking regulations are primarily intended to protect depositors and customers, the Federal Deposit Insurance fund and the banking system as a whole, not security holders. These regulations and supervisory guidance affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by Federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties and/or reputation damage. In this regard, government authorities, including the bank regulatory agencies, are pursuing aggressive enforcement actions with respect to compliance and other legal matters involving financial activities, which heightens the risks associated with actual and perceived compliance failures. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
See the section captioned “Supervision and Regulation” included in Item 1. Business on page 1.
We may become subject to additional regulatory restrictions in the event that our regulatory capital levels decline.
Although the Bank is qualified as “well capitalized” under the regulatory framework for prompt corrective action as of December 31, 2020, there is no guarantee that we will not have a decline in our capital category in the future. In the event of such a capital category decline, we would be subject to increased regulatory restrictions that could have a material adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects.
If a bank is classified as undercapitalized, the bank is required to submit a capital restoration plan to the FDIC. Pursuant to FDICIA, an undercapitalized bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new branch office, except under certain circumstances, including the acceptance by the FDIC of a capital restoration plan for the bank. Furthermore, if a state non-member bank is classified as undercapitalized, the FDIC may take certain actions to correct the capital position of the bank; if a bank is classified as significantly undercapitalized or critically undercapitalized, the FDIC would be required to take one or more prompt corrective actions. These actions would include, among other things, requiring sales of new securities to bolster capital; improvements in management; limits on interest rates paid; prohibitions on transactions with affiliates; termination of certain risky activities and restrictions on compensation paid to executive officers. If a bank is classified as critically undercapitalized, FDICIA requires the bank to be placed into conservatorship or receivership within ninety (90) days, unless the Federal Reserve determines that other action would better achieve the purposes of FDICIA regarding prompt corrective action with respect to undercapitalized banks.
Under FDICIA, banks may be restricted in their ability to accept brokered deposits, depending on their capital classification. “Well capitalized” banks are permitted to accept brokered deposits, but all banks that are not well capitalized could be restricted from accepting such deposits. The FDIC may, on a case-by-case basis, permit banks that are adequately capitalized to accept brokered deposits if the FDIC determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. These restrictions could materially and adversely affect our ability to access lower costs funds and thereby decrease our future earnings capacity.
Our financial flexibility could be severely constrained if we are unable to renew our wholesale funding or if adequate financing is not available in the future at acceptable rates of interest. We may not have sufficient liquidity to continue to fund new loan
originations and we may need to liquidate loans or other assets unexpectedly in order to repay obligations as they mature. Our inability to obtain regulatory consent to accept or renew brokered deposits could have a material adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects and our ability to continue as a going concern.
Finally, the capital classification of a bank affects the frequency of examinations of the bank, the deposit insurance premiums paid by such bank and the ability of the bank to engage in certain activities, all of which could have a material adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects. Under FDICIA, the FDIC is required to conduct a full-scope, on-site examination of every bank at least once every twelve (12) months.
Our decisions regarding credit risk could be inaccurate and our allowance for credit losses may be inadequate, which could materially and adversely affect our business, financial condition, results of operations, cash flows and/or future prospects.
Our loan portfolio subjects us to credit risk. Inherent risks in lending also include fluctuations in collateral values and economic downturns. Making loans is an essential element of our business and there is a risk that our loans will not be repaid.
We attempt to maintain an appropriate allowance for credit losses to provide for our estimate of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. As of December 31, 2020, our allowance for credit losses on loans totaled $32.2 million, which represents approximately 1.34% of our total loans. There is no precise method of predicting credit losses and therefore, we always face the risk that losses in future periods will exceed our allowance for credit losses and that we would need to make additional provisions to our allowance for credit losses. Our methodology for the determination of the adequacy of the allowance for credit losses is set forth in Note 7 of the accompanying consolidated financial statements.
The FDIC and the West Virginia Division of Financial Institutions review our allowance for credit and lease losses and may require us to establish additional allowances. Additions to the allowance for credit and lease losses will result in a decrease in our net earnings and capital and could hinder our ability to grow our assets.
We may elect or be compelled to seek additional capital in the future, but capital may not be available when it is needed.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control and on our financial performance. Accordingly, we cannot be assured of our ability to raise additional capital, if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
We rely on funding sources to meet our liquidity needs, such as brokered deposits and FHLB borrowings, which are generally more sensitive to changes in interest rates and can be adversely affected by general economic conditions.
We have frequently utilized, as a source of funds, certificates of deposit obtained through third parties that solicit funds from their customers for deposit with us, or brokered deposits. Brokered deposits, when compared to retail deposits attracted through a branch network, are generally more sensitive to changes in interest rates and volatility in the capital markets and could reduce our net interest spread and net interest margin. In addition, brokered deposit funding sources may be more sensitive to significant changes in our financial condition. As of December 31, 2020, brokered deposits totaled $55.5 million, or approximately 2.1% of our total deposits, compared to brokered deposits in the amount of $150.6 million or approximately 7.9% of our total deposits at December 31, 2019. As of December 31, 2020, approximately $40.7 million in brokered deposits, or approximately 73.4% of our total brokered deposits, mature within one year. Our ability to continue to acquire brokered deposits is subject to our ability to price these deposits at competitive levels, which may increase our funding costs and the confidence of the market. In addition, if our capital ratios fall below the levels necessary to be considered “well capitalized” under current regulatory guidelines, we could be restricted from using brokered deposits as a funding source.
We also have borrowings with the Federal Home Loan Bank of Pittsburgh, or the FHLB. As of December 31, 2020, our FHLB borrowings maturing within one year totaled $140.0 million. If we were unable to borrow from the FHLB in the future, we may be required to seek higher cost funding sources, which could materially and adversely affect our net interest income.
One aspect of our liquidity management process is establishing contingent liquidity funding plans under various scenarios in order to prepare for unexpected liquidity shortages or events. Page 47 of Management’s Discussion and Analysis of Financial Condition and Results of Operations shows three “stressed” liquidity circumstances and our related contingency plans with respect to each.
We pursue a strategy of supplementing internal growth by acquiring other financial companies or their assets and liabilities that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy.
As part of our general growth strategy, we have partially expanded our business through acquisitions. We completed the acquisition of WinFirst Financial Corp. ("WinFirst") on December 14, 2020, Cornerstone Financial Services, Inc. ("Cornerstone") on January 1, 2020, the Peoples Bankshares, Inc. ("Peoples") acquisition on January 1, 2019, the First Century Bankshares, Inc. ("FCB") acquisition in April 2017 and the acquisition of Highland County Bankshares, Inc. ("HCB") in October 2016. We also acquired four branches in the eastern panhandle of West Virginia from MVB Bank, Inc. on April 24, 2020. Although our business strategy emphasizes organic expansion, we continue, from time to time in the ordinary course of business, to engage in preliminary discussions with potential acquisition targets. There can be no assurance that, in the future, we will successfully identify suitable acquisition candidates, complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets. The consummation of any future acquisitions may dilute shareholder value or may have an adverse effect upon our operating results while the operations of the acquired business are being integrated into our operations. In addition, once integrated, acquired operations may not achieve levels of profitability comparable to those achieved by our existing operations, or otherwise perform as expected. Further, transaction-related expenses may adversely affect our earnings. These adverse effects on our earnings and results of operations may have a negative impact on the value of our common stock. Acquiring banks, bank branches or other businesses involves risks commonly associated with acquisitions, including:
•We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
•Prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we will experience this condition in the future;
•The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful.
•To the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill. As discussed below, we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operations and financial condition; and
•To finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or issue additional shares, which could dilute the interests of our existing stockholders.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on those properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
Changes in interest rates could negatively impact our future earnings.
Changes in interest rates could reduce income and cash flow. Our income and cash flow depend primarily on the difference between the interest earned on loans and investment securities and the interest paid on deposits and other borrowings. Interest rates are beyond our control and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the FRB. Changes in monetary policy, including changes in interest rates,
will influence loan originations, purchases of investments, volumes of deposits and rates received on loans and investment securities and paid on deposits. Our results of operations may be adversely affected by increases or decreases in interest rates or by the shape of the yield curve.
Uncertainty relating to LIBOR calculation process and potential phasing out of LIBOR may adversely affect us.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Subsequently, the FRB announced final plans for the production of the Secured Overnight Financing Rate (SOFR), which resulted in the commencement of its published rates by the Federal Reserve Bank of New York on April 3, 2018. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR at this time is uncertain. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have a material adverse effect on our financial condition or results of operations. On November 30, 2020, ICE Benchmark Administration Limited, the administrator of LIBOR, announced that it will consult on its intention to cease the publication of the one week and two month LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining LIBOR settings immediately following the LIBOR publication on June 30, 2023. The outcome of such consultation and its impact on LIBOR could materially affect the economics as well as the timing of the transition away from LIBOR.
The repeal of Federal prohibitions on payment of interest on demand deposits could increase our interest expense as interest rates rise.
All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. We do not yet know what interest rates other institutions may offer as market interest rates begin to increase. Our interest expense will increase and our net interest margin will decrease if we begin offering interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on our business, financial condition and results of operations.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes.
As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We believe we have controls in place to detect and prevent such losses but in some cases multi-party collusion or other sophisticated methods of hiding fraud, may not be readily detected or detectable, and could result in losses that affect our financial condition and results of our operations.
Financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international schemes that could drain an account of a significant amount and require detailed financial forensics to unravel. While we have controls in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are guarantees that we will not experience a loss, potentially a loss that could have a material adverse effect on our financial condition, reputation and results of our operations.
Our information systems may experience failure, interruption or breach in security.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. Any failure, interruption or breach in security of these systems could result in significant disruption to our operations. Information security breaches and cybersecurity-related incidents may include, but are not limited to, attempts to access information, including customer and company information, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer
information), account takeovers, unavailability of service or other events. These types of threats may derive from human error, fraud or malice on the part of external or internal parties, or may result from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. Our technologies, systems, networks and software and those of other financial institutions have been and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to us. Our collection of such customer and company data is subject to extensive regulation and oversight.
Our customers and employees have been and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information or to introduce viruses or other malware through "Trojan horse" programs to our information systems and/or our customers' computers. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology and customer and employee education, such cyber attacks against us or our merchants and our third party service providers remain a serious issue. The pervasiveness of cybersecurity incidents in general and the risks of cyber crime are complex and continue to evolve. More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber attacks and intrusions, or disruptions will occur in the future and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures and thus it is virtually impossible for us to entirely mitigate this risk. While we maintain specific “cyber” insurance coverage, which would apply in the event of various breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage. A security breach or other significant disruption of our information systems or those related to our customers, merchants and our third party vendors, including as a result of cyber attacks, could (i) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers; (ii) result in the unauthorized access to and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers; (iii) result in a violation of applicable privacy, data breach and other laws, subjecting us to additional regulatory scrutiny and expose the us to civil litigation, governmental fines and possible financial liability; (iv) require significant management attention and resources to remedy the damages that result; or (v) harm our reputation or cause a decrease in the number of customers that choose to do business with us. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
We are dependent upon third parties for certain information system, data management and processing services and to provide key components of our business infrastructure.
We outsource certain information system and data management and processing functions to third party providers. These third party service providers are sources of operational and informational security risk to us, including risks associated with operational errors, information system interruptions or breaches and unauthorized disclosures of sensitive or confidential client or customer information. If third party service providers encounter any of these issues, or if we have difficulty communicating with them, we could be exposed to disruption of operations, loss of service or connectivity to customers, reputational damage and litigation risk that could have a material adverse effect on our results of operations or our business.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions.
These services must be available on a continuous and timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.
We often purchase services from vendors under agreements that typically can be terminated on a periodic basis. There can be no assurance, however, that vendors will be able to meet their obligations under these agreements or that we will be able to compel them to do so. Risks of relying on vendors include the following:
•If an existing agreement expires or a certain service is discontinued by a vendor, then we may not be able to continue to offer our customers the same breadth of products and our operating results would likely suffer unless we are able to find an alternate supply of a similar service.
•Agreements we may negotiate in the future may commit us to certain minimum spending obligations. It is possible that we will not be able to create the market demand to meet such obligations.
•If market demand for our products increases suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new arrangements or new sources of supply and may result in substantial delays in meeting market demand.
•We may not be able to control or adequately monitor the quality of services we receive from our vendors. Poor quality services could damage our reputation with our customers.
Potential problems with vendors such as those discussed above could have a significant adverse effect on our business, lead to higher costs and damage our reputation with our customers and, in turn, have a material adverse effect on our financial condition and results of operations.
Our business is dependent on technology and our inability to invest in technological improvements may adversely affect our results of operations, financial condition and cash flows.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success depends in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as create additional efficiencies in its operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers, which may negatively affect our results of operations, financial condition and cash flows.
RISKS RELATING TO AN INVESTMENT IN OUR SECURITIES
Our ability to pay dividends is limited.
We are a separate and distinct legal entity from our subsidiaries. We receive substantially all of our revenue from dividends from our subsidiary bank, Summit Community. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that Summit Community may pay to Summit. Also, Summit’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event Summit Community is unable to pay dividends to us, we may not be able to service debt, pay obligations or pay dividends on our common stock. The inability to receive dividends from Summit Community could have a material adverse effect on our business, financial condition and results of operations.
Our stock price can be volatile.
Stock price volatility may make it more difficult for our shareholders to resell their common stock when they want and at prices they find attractive. Our stock price can fluctuate significantly in response to a variety of factors, including, but not limited to, general market fluctuations, industry factors and general economic and political conditions and events, interest rate changes, credit loss trends, or changes in government regulations.
The trading volume in our common stock is less than that of larger financial services companies.
Although our common stock is listed for trading on the NASDAQ, the trading volume in our common stock is less than that of larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time.
This presence depends on the individual decisions of investors over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fluctuate.
Our executive officers and directors own shares of our common stock, allowing management to have an impact on our corporate affairs.
As of March 2, 2021, our executive officers and directors beneficially own 13.1% (computed in accordance with Exchange Act Rule 13d-3) of the outstanding shares of our common stock. Accordingly, these executive officers and directors will be able to impact the outcome of all matters required to be submitted to our shareholders for approval, including decisions relating to the election of directors, the determination of our day-to-day corporate and management policies and other significant corporate transactions.
There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock.
Our board of directors is authorized to cause us to issue additional classes or series of preferred shares without any action on the part of the shareholders. The board of directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred shares that may be issued, including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our business and other terms. If we issue preferred shares in the future that have a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue preferred shares with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market price of the common stock could be adversely affected.
The market price of our common stock could decline as a result of sales of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.
Holders of our junior subordinated debentures have rights that are senior to those of our shareholders.
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 of these unconsolidated statutory trusts totaled approximately $19.6 million at December 31, 2020 and 2019.
Distributions on the capital securities issued by the trusts are payable quarterly, at the variable interest rates specified in those certain securities. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures.
Payments of the principal and interest on the trust preferred securities of the statutory trusts are conditionally guaranteed by us. The junior subordinated debentures are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on the junior subordinated debentures (and the related trust preferred securities) for up to five (5) years, during which time no dividends may be paid on our common stock.
The capital securities held by our three trust subsidiaries qualify as Tier 1 capital under FRB guidelines. In accordance with these guidelines, trust preferred securities generally are limited to twenty-five percent (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.
On September 22, 2020, we issued and sold $30 million in the aggregate principal amount of subordinated notes (the “subordinated notes”) in a private placement. The subordinated notes mature on September 30, 2030 and bear interest at a fixed rate of 5.00% per year, from and including September 22, 2020 to, but excluding, September 30, 2025, payable quarterly in arrears. From and including September 30, 2025 to, but excluding, the maturity date or earlier redemption date, the interest rate will reset quarterly at a variable rate equal to the then current three-month term SOFR, as published by the Federal Reserve Bank of New York, plus 487 basis points, payable quarterly in arrears. As provided in the subordinated notes, the interest rate on the Notes during the applicable floating rate period may be determined based on a rate other than three-month term SOFR.
Prior to the fifth anniversary of the original date of issue, we may redeem the subordinated notes, in whole but not in part, only under certain limited circumstances set forth in the subordinated notes. On or after the fifth anniversary of the original date of issue, we may redeem the subordinated notes, in whole or in part, at our option, on any interest payment date.
Principal and interest on the subordinated notes are subject to acceleration only in limited circumstances in the case of certain bankruptcy and insolvency-related events with respect to Summit Financial Group. The subordinated notes are unsecured, subordinated obligations of Summit Financial Group, are not obligations of, and are not guaranteed by, any subsidiary of Summit Financial Group, and rank junior in right of payment to the Company’s current and future senior indebtedness. The Notes are intended to qualify as Tier 2 capital of the Company for regulatory capital purposes.
The debentures and subordinated notes are senior to our shares of capital stock. As a result, we must make payments on the debentures and the subordinated notes before any dividends can be paid on our stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the debentures and the subordinated notes must be satisfied before any distributions can be made on our stock. We have the right to defer distributions on the debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on our stock.
In 2020, our total interest payments on the debentures approximated $687,000 and the total interest paid on the subordinated notes from the date of issuance until December 31, 2020 was $412,500. Based on current rates, our quarterly interest payment obligation on the debentures is approximately $126,000 and on the subordinated notes is approximately $375,000
Provisions of our amended and restated articles of incorporation could delay or prevent a takeover of us by a third party.
Our amended and restated articles of incorporation could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or could otherwise adversely affect the price of our common stock. For example, our amended and restated articles of incorporation contain advance notice requirements for nominations for election to our Board of Directors. We also have a staggered board of directors, which means that only one-third (1/3) of our Board of Directors can be replaced by shareholders at any annual meeting.
GENERAL RISKS
The value of our goodwill and other intangible assets may decline.
Goodwill and other intangible assets are subject to a decline, perhaps even significantly, for several reasons including if there is a significant decline in our expected future cash flows, change in the business environment, or a material and sustained decline in the market value of our stock, which may require us to take future charges related to the impairment of that goodwill and other intangible assets in the future, which could have a material adverse effect on our financial condition and results of our operations.
We operate in a very competitive industry and market.
We face aggressive competition not only from banks, but also from other financial services companies, including finance companies and credit unions and, to a limited degree, from other providers of financial services, such as money market mutual funds, brokerage firms and consumer finance companies. A number of competitors in our market areas are larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems and offer a wider array of banking services. Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. Our profitability depends upon our ability to attract loans and deposits. There is a risk that aggressive competition could result in our controlling a smaller share of our markets. A decline in market share could adversely affect our results of operations and financial condition.
We rely heavily on our management team and the unexpected loss of key officers could adversely affect our business, financial condition, results of operations, cash flows and/or future prospects.
Our success has been and will continue to be greatly influenced by our ability to retain the services of existing senior management and, as we expand, to attract and retain qualified additional senior and middle management. Our senior executive officers have been instrumental in the development and management of our business. The loss of the services of any of our senior executive officers could have an adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects.
The negative economic effects caused by terrorist attacks, including cyber attacks, potential attacks and other destabilizing events, would likely contribute to the deterioration of the quality of our loan portfolio and could reduce our customer base, level of deposits and demand for our financial products, such as loans.
High inflation, natural disasters, acts of terrorism, including cyber attacks, an escalation of hostilities or other international or domestic occurrences and other factors could have a negative impact on the economy of the Mid-Atlantic regions in which we operate. An additional economic downturn in our markets would likely contribute to the deterioration of the quality of our loan portfolio by impacting the ability of our customers to repay loans, the value of the collateral securing loans and may reduce the level of deposits in our bank and the stability of our deposit funding sources. An additional economic downturn could also have a significant impact on the demand for our products and services. The cumulative effect of these matters on our results of operations and financial condition could be adverse and material.
Changes in accounting standards could impact reported earnings.
The accounting standard setting bodies, including the Financial Accounting Standards Board and other regulatory bodies, periodically change the financial accounting and reporting standards affecting the preparation of financial statements. These changes are not within our control and could materially impact our financial statements.
Our potential inability to integrate companies we may acquire in the future could have a negative effect on our expenses and results of operations.
On occasion, we may engage in a strategic acquisition when we believe there is an opportunity to strengthen and expand our business. To fully benefit from such acquisition, however, we must integrate the administrative, financial, sales, lending, collections and marketing functions of the acquired company. If we are unable to successfully integrate an acquired company, we may not realize the benefits of the acquisition and our financial results may be negatively affected. A completed acquisition may adversely affect our financial condition and results of operations, including our capital requirements and the accounting treatment of the acquisition. Completed acquisitions may also lead to significant unexpected liabilities after the consummation of these acquisitions.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
Not applicable.

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ITEM 2. PROPERTIES
Item 2. Properties
Our principal executive office is located at 300 North Main Street, Moorefield, West Virginia, in a building owned by Summit Community. Summit Community's operations center is located at 1929 State Route 55, Moorefield, West Virginia in a building that it owns.
Summit Community’s main office and branch locations occupy offices which are either owned or operated under lease arrangements. At December 31, 2020, Summit Community operated 43 banking offices in three states as follows:
Number of Offices
Office Locations by State Owned Leased Total
Summit Community Bank
West Virginia 25 2 27
Virginia 10 4 14
Kentucky - 2 2
We believe that the premises occupied by us and our subsidiary generally are well located and suitably equipped to serve as financial services facilities. See Notes 9 and 10 of our consolidated financial statements beginning on page 92.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
Information required by this item is set forth under the caption "Legal Contingencies" in Note 17 of our consolidated financial statements beginning on page 102.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not applicable.
PART II.

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Dividend and Market Price Information: Our stock trades on the NASDAQ Global Select Market under the symbol “SMMF.”
As of March 1, 2021, there were approximately 1,140 shareholders of record of Summit’s common stock.
Purchases of Summit Equity Securities: We sponsor a qualified Employee Stock Ownership Plan (“ESOP”), which enables eligible employees to acquire shares of our common stock. The cost of the ESOP is borne by us through annual contributions to an Employee Stock Ownership Trust in amounts determined by the Board of Directors. The Employee Stock Ownership Trust makes regular purchases of our common stock as excess funds within the plan are available.
In February 2020, the Board of Directors authorized the open market repurchase of up to 750,000 shares of the issued and outstanding shares of Summit's common stock ("February 2020 Repurchase Plan"). The timing and quantity of purchases under this stock repurchase plan are at the discretion of management. The plan may be discontinued, suspended, or restarted at any time at the Company's discretion.
No repurchases of Company shares were made during the quarter ended December 31, 2020.
Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
October 1, 2020 - October 31, 2020 - $ - - 674,667
November 1, 2020 - November 30, 2020 - - - 674,667
December 1, 2020 - December 31, 2020 - - - 674,667
Performance Graph: Set forth below is a line graph comparing the cumulative total return of Summit's common stock assuming reinvestment of dividends, with that of the NASDAQ Composite Index ("NASDAQ Composite"), and the SNL Small Cap U.S. Bank Index for the five year period ending December 31, 2020.
The cumulative total shareholder return assumes a $100 investment on December 31, 2015 in the common stock of Summit and each index and the cumulative return is measured as of each subsequent fiscal year-end. There is no assurance that Summit's common stock performance will continue in the future with the same or similar trends as depicted in the graph.
For the Year Ended
Index 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020
Summit Financial Group, Inc. 100.00 236.77 230.75 173.10 248.34 210.63
NASDAQ Composite 100.00 108.87 141.13 137.12 187.44 271.64
SNL Small Cap U.S. Bank 100.00 141.78 148.70 133.26 161.62 139.75
The Stock Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that Summit specifically incorporates it by reference into such filing.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data
The following consolidated selected financial data is derived from our audited financial statements as of and for each of the five (5) years ended December 31, 2020. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes contained elsewhere in this report.
For the Year Ended
(unless otherwise noted)
Dollars in thousands, except per share amounts 2020 2019 2018 2017 2016
Summary of Operations
Interest income $ 115,003 $ 107,071 $ 95,409 $ 84,527 $ 64,091
Interest expense 19,521 29,987 25,612 18,380 15,084
Net interest income 95,482 77,084 69,797 66,147 49,007
Provision for credit losses 14,500 1,550 2,250 1,250 500
Net interest income after provision for credit losses 80,982 75,534 67,547 64,897 48,507
Noninterest income 20,083 19,203 17,422 14,427 11,600
Noninterest expense 62,311 55,154 49,873 57,745 34,802
Income before income taxes 38,754 39,583 35,096 21,579 25,305
Income tax expense 7,428 7,717 7,024 9,664 8,008
Net income $ 31,326 $ 31,866 $ 28,072 $ 11,915 $ 17,297
Balance Sheet Data (at year end)
Assets $ 3,106,384 $ 2,403,492 $ 2,200,586 $ 2,134,240 $ 1,758,647
Debt securities available for sale 286,127 276,355 293,147 328,586 266,405
Debt securities held to maturity 99,914 - - - -
Loans, net 2,379,907 1,900,425 1,682,005 1,593,744 1,307,862
Deposits 2,595,651 1,913,237 1,634,826 1,600,601 1,295,519
Short-term borrowings 140,146 199,345 309,084 250,499 224,461
Long-term borrowings 699 717 735 45,751 46,670
Shareholders' equity 281,580 247,764 219,830 201,505 155,360
Credit Quality
Net loan charge-offs $ 1,703 $ 1,523 $ 1,768 $ 359 $ 298
Nonperforming assets 35,923 30,803 36,462 36,861 39,090
Allowance for credit losses on loans 32,246 13,074 13,047 12,565 11,674
Allowance for credit losses on unfunded loan commitments 4,190 - - - -
Per Share Data
Earnings per share
Basic earnings $ 2.42 $ 2.55 $ 2.27 $ 1.00 $ 1.62
Diluted earnings 2.41 2.53 2.26 1.00 1.61
Book value per common share (at year end) 21.76 19.97 17.85 16.30 14.47
Tangible book value per common share (at year end) 17.50 18.11 15.75 14.08 13.20
Cash dividends 0.68 0.59 0.53 0.44 0.40
Performance Ratios
Return on average equity 11.80 % 13.43 % 13.43 % 6.40 % 11.53 %
Return on average tangible equity 14.73 % 15.65 % 16.09 % 8.01 % 12.38 %
Return on average assets 1.13 % 1.40 % 1.32 % 0.59 % 1.08 %
Equity to assets 9.1 % 10.3 % 10.0 % 9.4 % 8.8 %
Tangible common equity to tangible assets 7.4 % 9.4 % 8.9 % 8.3 % 8.1 %
Dividend payout ratio 28.2 % 23.1 % 23.3 % 44.0 % 24.7 %

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
This annual report contains comments or information that constitute forward looking statements (within the meaning of the Private Securities Litigation Act of 1995) that are based on current expectations that involve a number of risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “estimates” and other similar expressions or future or conditional verbs such as “will”, “should”, “would” and “could” are intended to identify such forward-looking statements. 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. 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.
Although we believe the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. Factors that might cause such a difference include: the effect of the COVID-19 crisis, including the negative impacts and disruptions on the communities we serve, and the domestic and global economy, which may have an adverse effect on our business; current and future economic and market conditions, including the effects of declines in housing prices, high unemployment rates, U.S. fiscal debt, budget and tax matters, geopolitical matters, and any slowdown in global economic growth; fiscal and monetary policies of the Federal Reserve; future provisions for credit losses on loans and debt securities; changes in nonperforming assets; changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; the successful integration of operations of our acquisitions; changes in banking laws and regulations; changes in tax laws; the impact of technological advances; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national and local economies. We undertake no obligation to revise these statements following the date of this filing.
DESCRIPTION OF BUSINESS
We are a $3.11 billion community-based financial services company providing a full range of banking and other financial services to individuals and businesses through our our community bank, Summit Community Bank, Inc., which has a total of 42 banking offices located in West Virginia,Virginia and Kentucky. We have a trust and wealth management division offering trust services and other non-bank financial products principally within our community bank's market area.
OVERVIEW
Our primary source of income is net interest income from loans and deposits. Business volumes tend to be influenced by the overall economic factors including market interest rates, business spending and consumer confidence, as well as competitive conditions within the marketplace.
Key Items in 2020
•Our earnings per diluted share decreased from $2.53 in 2019 to $2.41 in 2020.
•Our return on average equity declined to 11.80% from 13.43% and return on average tangible equity decreased from 15.65% to 14.73%.
•2020 net income was $31.33 million ($2.41 per diluted share) compared to $31.87 million ($2.53 per diluted share) in 2019.
•Net interest margin increased 5 basis points in 2020, principally due to a 74 basis point decrease in cost of interest bearing funds compared to a 60 basis point decrease in our yield on interest earning assets.
•Net revenues increased $19.3 million, or 20.0 percent during 2020 primarily as result of increased interest income related to loan growth and the Cornerstone Financial Services, Inc. ("Cornerstone"), MVB Bank branches, and WinFirst Financial Corp. ("WinFirst") acquisitions.
•We achieved loan growth, excluding mortgage warehouse lines of credit, acquired loans and PPP loans, of 5.6 percent, or $100.4 million during 2020.
•Nonperforming assets declined to their lowest level since 2008, representing 1.16 percent of total assets at year end 2020 compared to 1.28 percent at the prior year end.
•During 2020, provisions for credit losses increased by $13.0 million, which reflects recently adopted credit loss accounting rules requiring us to record all estimated future losses in our loan portfolio, and this contributed significantly to our credit loss provision for 2020 as we recorded our estimate of credit losses expected to result from the COVID-19 pandemic.
•Cash dividends paid on our common stock in 2020 totaled $0.68 per share compared to $0.59 paid per share in 2019.
•We completed three acquisitions during 2020:
◦On January 1, 2020, we acquired Cornerstone Financial Services, Inc. ("Cornerstone") and its subsidiary, Cornerstone Bank. At consummation, Cornerstone had total assets of $195.0 million, loans of $39.8 million and deposits of $173.0 million.
◦On April 24, 2020, we acquired four branch banking offices of MVB Bank, Inc. in the Eastern Panhandle of West Virginia. At consummation, these branches had total assets of $188.1 million, loans of $35.1 million and deposits of $173.0 million.
◦On December 14, 2020, we completed our acquisition of WinFirst Corp. ("WinFirst") and its subsidiary WinFirst Bank, headquartered in Winchester, Kentucky. At consummation, WinFirst had total assets of $143.4 million, loans of $123.8 million and deposits of $103.6 million..
OUTLOOK
The year just concluded represents another significant milestone relative to Summit’s goal to be a consistent growth, high-performing community banking institution. Our solid lending activity and strong core operating performance of the past year offer significant evidence of our progress. In addition, our acquisition strategy continued to present us with significant opportunities for ongoing performance enhancement. Looking forward to 2021, while we could be challenged by a variety of potential economic uncertainties, we anticipate sustaining our recent positive trends with respect to: revenue growth, loan portfolio growth, a relatively stable net interest margin, low overhead, and stability in overall levels of problem assets.
COVID-19 IMPACTS
Overview
Our business has been, and continues to be, impacted by COVID-19. In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the President of the United States. Efforts to limit the spread of COVID-19 have led to shelter-in-place orders, the closure of non-essential businesses, travel restrictions, supply chain disruptions and prohibitions on public gatherings, among other things, throughout many parts of the United States and, in particular, the markets in which we operate. As the current pandemic is ongoing and dynamic in nature, there are many uncertainties related to COVID-19 including, among other things, its ultimate geographic spread; its severity; the duration of the outbreak; the impact to our clients, employees and vendors; the impact to the financial services and banking industry; and the impact to the economy as a whole as well as the effect of actions taken, or that may yet be taken, by governmental authorities to contain the outbreak or to mitigate its impact (both economic and health-related). COVID-19 has negatively affected, and is expected to continue to negatively affect, our business, financial position and operating results. In light of the uncertainties and continuing developments discussed herein, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material.
Impact on our Operations
The resulting closures of non-essential businesses and related economic disruption has impacted our operations as well as the operations of our clients. In West Virginia and Virginia, financial services have been identified as essential services, and accordingly, our business remains open, with appropriate safety protocols implemented. To address the issues arising as a result of COVID-19, we have implemented various plans, strategies and protocols to protect our employees, maintain services for clients, assure the functional continuity of our operating systems, controls and processes, and mitigate financial risks posed by changing market conditions. In order to protect employees and assure workforce continuity and operational redundancy, we imposed business travel restrictions, enhanced our sanitizing protocols within our facilities and physically separated, to the extent possible, our critical operations workforce that cannot work remotely.
Impact on our Financial Position and Results of Operations
Lending and Credit Risks
COVID-19 has had a material impact on our loan credit risks for 2020. While we have not yet experienced any material charge-offs related to COVID-19, our allowance for credit losses ACL computation and resulting provision for credit losses are significantly impacted by the estimated potential future economic impact of the COVID-19 crisis. Due to deteriorated forecasted economic scenarios since the pandemic was declared in early March, our need for additional ACL increased significantly. Should economic conditions worsen, we could experience further increases in our ACL and record additional credit loss expense.
We have taken actions to identify and assess our COVID-19 related credit exposures by asset classes and borrower types. Depending on the demonstrated need of the client, in certain cases, we are either modifying to interest only or deferring the full loan payment. Accordingly, the following tables summarize the aggregate balances of loans the Company has modified as result of COVID-19 as of December31, 2020 classified by types of loans and impacted borrowers.
Loan Balances Modified Due to COVID-19 as of December 31, 2020
Dollars in thousands 12/31/2020 Interest Only
Payments Payment
Deferral Total Loans
Modified Percentage of
Loans Modified
Hospitality industry $ 121,502 $ 40,513 $ 12,930 $ 53,443 44.0 %
Non-owner occupied retail stores 135,405 7,223 447 7,670 5.7 %
Owner-occupied retail stores 126,451 2,317 1,246 3,563 2.8 %
Restaurants 7,481 - - - - %
Oil & gas industry 17,152 - - - - %
Other commercial 1,134,759 12,006 286 12,292 1.1 %
Total Commercial Loans 1,542,750 62,059 14,909 76,968 5.0 %
Residential 1-4 family personal 305,093 159 1,754 1,913 0.6 %
Residential 1-4 family rentals 194,612 148 73 221 0.1 %
Home equity 81,588 - - - - %
Total Residential Real Estate Loans 581,293 307 1,827 2,134 0.4 %
Consumer 33,906 48 143 191 0.6 %
Mortgage warehouse lines 251,810 - - - 0.0 %
Credit cards and overdrafts 2,394 - - - 0.0 %
Total Loans $ 2,412,153 $ 62,414 $ 16,879 $ 79,293 3.3 %
Modified loans with deferred payments will continue to accrue interest during the deferral period unless otherwise classified as nonperforming. Consistent with bank regulatory guidance and Section 401(3) of the CARES Act, borrowers that were otherwise current on loan payments that were granted COVID-19 related financial hardship payment deferrals will continue to be reported as current loans throughout the agreed upon deferral periods. COVID-19 related loan modifications are also deemed to be insignificant borrower concessions, and therefore, such modified loans were not classified as troubled-debt restructured loans for any of the periods presented. We anticipate that COVID-19 related loan modifications will continue throughout much of 2021.
Our loan interest income could be reduced due to COVID-19. While interest and fees will still accrue to income, through normal accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact.
Capital and Liquidity
Although there is a high degree of uncertainty around the magnitude and duration of the economic impact of the COVID-19 pandemic, management believes that our financial position, including high levels of capital and liquidity, will allow us to successfully endure the negative economic impacts of the crisis. Our capital management activities, coupled with our historically strong earnings performance and prudent dividend practices, have allowed us to build and maintain strong capital reserves. At December 31, 2020, all of Summit’s regulatory capital ratios significantly exceeded well-capitalized standards. More specifically, the Company bank subsidiary’s Tier 1 Leverage Ratio, a common measure to evaluate a financial institutions capital strength, was 9.5% at December 30, 2020, which is well in excess of the well-capitalized regulatory minimum of 5.0%.
In addition, management believes the Company’s liquidity position is strong. The Company’s bank subsidiary maintains a funding base largely comprised of core noninterest bearing demand deposit accounts and low cost interest-bearing transactional deposit accounts with clients that operate or reside within the footprint of its branch bank network. At December 31, 2020, the Company’s cash and cash equivalent balances were $99.8 million. In addition, Summit maintains an available-for-sale securities portfolio, comprised primarily of highly liquid U.S. agency securities, highly-rated municipal securities and U.S. agency-backed mortgage backed securities, which serves as a ready source of liquidity. At December 31, 2020, the Company’s available-for-sale securities portfolio totaled $286.1 million, $123.3 million of which was unpledged as collateral. The Company bank subsidiary’s unused borrowing capacity at the Federal Home Loan Bank of Pittsburgh at December 31, 2020 was $721.4 million, and it maintained $168.1 million of borrowing availability at the Federal Reserve Bank of Richmond’s discount window.
The COVID-19 crisis is expected to continue to impact our financial results, as well as demand for our services and products throughout 2021. The short and long-term implications of the COVID-19 crisis, and related monetary and fiscal stimulus measures, on our future revenues, earnings results, allowance for credit losses, capital reserves and liquidity are unknown at present.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. Application of these principles requires us to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.
Our most significant accounting policies are presented in the notes to the accompanying consolidated financial statements. 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 losses, fair value measurements and accounting for acquired loans to be the accounting areas that require the most subjective or complex judgments and as such could be most subject to revision as new information becomes available.
Allowance for Credit Losses: The allowance for credit losses represents our estimate of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on loans individually evaluated, estimated losses on pools of homogeneous loans based on historical loss experience and consideration of current and future economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on our consolidated balance sheet. To the extent forecasted economic conditions change considerably and/or actual outcomes differ from our estimates, additional provisions for credit losses may be required that would negatively impact earnings in future periods. Note 7 to the accompanying consolidated financial statements describes the methodology used to determine the allowance for credit losses for loans and a discussion of the factors driving changes in the amount of the allowance for credit losses for loans is included in the Asset Quality section of this financial review. Note 7 to the accompanying consolidated financial statements describes our policies and methodology used to calculate the allowance for credit losses for off-balance-sheet credit exposures.
Fair Value Measurements: Fair value is based upon the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants, including, but not limited to, property held for sale, individually evaluated collateral dependent loans and derivatives. Based on the observability of the inputs used in the valuation techniques, we classify our financial assets and liabilities measured and disclosed at fair value in accordance with a three-level hierarchy (e.g., Level 1, Level 2 and Level 3) . Fair value determination requires that we make a number of significant judgments. In determining the fair value of financial instruments, we use market prices of the same or similar instruments whenever such prices are available. We do not use prices involving distressed sellers in determining fair value. If observable market prices are unavailable or impracticable to obtain, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques
incorporate our assessments regarding assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risks inherent in a particular valuation technique and the risk of nonperformance.
Fair value is used on a recurring basis for certain assets and liabilities in which fair value is the primary basis of accounting. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes.
Accounting for Acquired Loans: Loans acquired are initially recorded at their acquisition date fair values. The fair value of the acquired loans are based on the present value of the expected cash flows, including principal, interest and prepayments. Periodic principal and interest cash flows are adjusted for expected losses and prepayments, then discounted to determine the present value and summed to arrive at the estimated fair value. Fair value estimates involve assumptions and judgments as to credit risk, interest rate risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.
Acquired loans are divided into loans with evidence of credit quality deterioration (acquired impaired ("PCI") before adoption of ASC 326 and purchased credit deteriorated ("PCD") post adoption) and loans that do not meet this criteria (acquired performing). Acquired impaired loans (PCI) have experienced a deterioration of credit quality from origination to acquisition for which it is probable that we will be unable to collect all contractually required payments receivable, including both principal and interest. In the assessment of credit quality, numerous assumptions, interpretations and judgments must be made, based on internal and third-party credit quality information and ultimately the determination as to the probability that all contractual cash flows will not be able to be collected. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved.
Subsequent to the acquisition date, we continue to estimate the amount and timing of cash flows expected to be collected on acquired impaired loans (PCI). Increases in expected cash flows will generally result in a recovery of any previously recorded allowance for credit losses, to the extent applicable, and/or a reclassification from the nonaccretable difference to accretable yield, which will be recognized prospectively. The present value of any decreases in expected cash flows after the acquisition date will generally result in an impairment charge recorded as a provision for credit losses, resulting in an increase to the allowance for credit losses.
ASC 326 replaced the concept of purchased credit impaired loans (PCI assets) with the concept of purchased financial assets with credit deterioration (PCD assets). A PCD asset is recorded at the purchase price plus the allowance for credit losses expected at the time of acquisition. Under this method, there is no credit loss expense affecting net income on acquisition. Changes in estimates of expected credit losses after acquisition are recognized as credit loss expense (or reversal of credit loss expense) in subsequent periods as they arise.
An asset is considered a PCD asset if, on the acquisition date, it has experienced a more-than-insignificant deterioration in credit quality since loan origination. FASB did not define the term “more-than-insignificant deterioration in credit quality”. They did however, state that they did not intend for PCD accounting to be limited to financial assets that are considered nonaccrual or impaired under legacy US GAAP; instead, it intended the term to include additional assets that have experienced a more-than-insignificant deterioration in credit quality since loan origination. Therefore the determination of what constitutes a PCD asset is left to management judgement.
Summit Community Bank has determined the following would constitute a “more-than-insignificant deterioration in credit quality”:
•Nonaccrual status
•Greater than 60 days past due at any time since loan origination
•Risk rating of OLEM, Substandard, Doubtful or Loss
We established a materiality limit of $50,000 for evaluating loans for PCD status. Subsequent to the acquisition date of PCD assets, we continue to estimate the amount and timing of cash flows expected to be collected on these acquired loans. Increases in expected cash flows will generally result in a recovery of any previously recorded allowance for credit losses, to the extent applicable. The present value of any decreases in expected cash flows after the acquisition date will generally result in additional provision for expected credit losses, resulting in an increase to the allowance for credit losses.
For acquired performing loans, the difference between the acquisition date fair value and the contractual amounts due at the acquisition date represents the fair value adjustment. Fair value adjustments may be discounts (or premiums) to a loan’s cost basis and are accreted (or amortized) to interest income over the loan’s remaining life using the level yield method. Based on ASC 326, a purchased financial asset that does not qualify as a PCD asset is accounted for similar to an originated financial asset. Generally, this means that an entity recognizes the allowance for credit losses for non-PCD assets through net income at
acquisition. These purchased performing loans are accounted for through our CECL methodology as basically we would a new origination. Therefore, upon adoption of ASC 326, accounting for purchased performing acquired loans results in the bank recognizing a fair value adjustment to the loan at acquisition and also establishing a provision for excepted credit losses as in the same manner of an originated asset.
See Note 3 and Note 7 of the accompanying consolidated financial statements for additional information regarding our acquired loans.
RESULTS OF OPERATIONS
Earnings Summary
Net income decreased 1.7% during 2020 to $31.3 million, compared to $31.9 million in 2019, which was 13.5% more than 2018's $28.1 million. Net income was $2.41, $2.53 and $2.26 per diluted share for 2020, 2019 and 2018, respectively, representing a 4.7% decrease in 2020 and 11.9% increase in 2019. Return on average equity was 11.80% in 2020 compared to 13.43% in both 2019 and 2018. Return on average assets for the year ended December 31, 2020 was 1.13% compared to 1.40% in 2019 and 1.32% in 2018.
2020 net income was positively impacted by higher net interest income of $18.4 million (or $1.42 per diluted share), $1.5 million (or $0.12 per diluted share) higher realized securities gains and a $2.0 million increase (or $0.16 per diluted share) in mortgage origination revenue. The $13.0 million increase in provision for credit losses (or $1.00 per diluted share), lower insurance commission revenue of $1.7 million (or $0.13 per diluted share) as result of the sale of our former insurance subsidiary during 2019 (which generated a 2019 gain of $1.9 million pre-tax, or $0.15 per diluted share) and higher salaries and employee benefits of $3.1 million (or $0.24 per diluted share) partially offset these positive impacts.
2019 net income was positively impacted by higher net interest income of $7.3 million (or $0.58 per diluted share), $1.3 million (or $0.10 per diluted share) higher realized securities gains and the $1.9 million pre-tax (or $0.15 per diluted share) gain recognized on the sale of our former insurance subsidiary, Summit Insurance Services, LLC. Lower insurance commission revenue of $2.4 million (or $0.19 per diluted share) and higher writedowns of OREO properties of $1.3 million (or $0.10 per diluted share) partially offset these positive impacts.
2018 net income was positively impacted by higher net interest income of $3.7 million (or $0.29 per diluted share), $790,000 growth in trust and wealth management fees ($0.06 per diluted share), $522,000 increased deposit account-related fees ($0.08 per diluted share) and $2.6 million ($0.25 per diluted share) in lower income tax expense as result of the Tax Cuts and Jobs Act's (“TCJA”) lower income tax rates. Excluding 2017's litigation charge, higher total noninterest expense of $2.0 million ($0.16 per diluted share) partially offset these positive impacts.
Net Interest Income
The major component of our net earnings is net interest income, which is the excess of interest earned on earning assets over the interest expense incurred on interest bearing sources of funds. Net interest income is affected by changes in volume, resulting from growth and alterations of the balance sheet's composition, fluctuations in interest rates and maturities of sources and uses of funds. We seek to maximize net interest income through management of our balance sheet components. This is accomplished by determining the optimal product mix with respect to yields on assets and costs of funds in light of projected economic conditions, while maintaining portfolio risk at an acceptable level.
Net interest income on a fully tax equivalent basis, average balance sheet amounts and corresponding average yields on interest earning assets and costs of interest bearing liabilities for the years 2016 through 2020 are presented in Table I. Table II presents, for the periods indicated, the changes in interest income and expense attributable to (a) changes in volume (changes in volume multiplied by prior period rate) and (b) changes in rate (change in rate multiplied by prior period volume). Changes in interest income and expense attributable to both rate and volume have been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.
Net interest income on a fully tax equivalent basis totaled $96.5 million, $78.0 million and $71.1 million for the years ended December 31, 2020, 2019 and 2018, respectively, representing an increase of 23.7% in 2020 and 9.7% in 2019. During 2020, 2019 and 2018, the volumes of both interest earning assets and interest bearing liabilities increased.
During 2020, our earnings on interest earning assets increased $8.0 million due to higher volumes while the cost of interest bearing liabilities decreased $10.5 million due to lower cost of funds.
During 2019, our earnings on interest earning assets increased $11.3 million due to both higher volumes and higher yields, while the cost of interest bearing liabilities increased $4.4 million due to higher cost of funds.
During 2018, our earnings on interest earning assets increased $9.7 million due to both higher volumes and higher yields, while the cost of interest bearing liabilities increased $7.2 million due to higher cost of funds.
Total average earning assets increased 21.9% to $2.60 billion for 2020 from $2.13 billion in 2019. Total average interest bearing liabilities increased 17.2% to $2.09 billion at December 31, 2020, compared to $1.78 billion at December 31, 2019.
Our net interest margin was 3.71% for 2020 compared to 3.66% and 3.57% for 2019 and 2018, respectively. Our net interest margin increased 5 basis points during 2020 due to higher volumes of interest earning assets and lower cost of interest bearing funds. Our net interest margin increased 9 basis points during 2019 as the yields on interest earning assets increased 20 basis points while the cost of funds increased 16 basis points.
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 earning assets, primarily 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 discussion of the impact changes in market interest rates could have on us. Further analysis of our yields on interest earning assets and interest bearing liabilities are presented in Tables I and II below.
Table I - Average Balance Sheet and Net Interest Income Analysis
Interest Earnings & Expenses and Average Yields/Rates
Dollars in thousands 2020 2019 2018 2017 2016
ASSETS
Interest earning assets
Loans, net of unearned interest (1)
Taxable $ 2,150,294 $ 1,782,477 $ 1,626,725 $ 1,480,601 $ 1,177,445
Tax-exempt (2) 15,352 15,315 15,776 14,899 14,628
Securities
Taxable 256,893 205,340 170,912 200,596 202,795
Tax-exempt (2) 122,386 90,823 136,913 129,342 79,571
Interest bearing deposits with other banks 56,399 39,408 38,148 43,400 19,211
2,601,324 2,133,363 1,988,474 1,868,838 1,493,650
Noninterest earning assets
Cash and due from banks 16,139 12,939 9,517 8,492 3,968
Premises and equipment 50,418 41,778 36,025 31,750 21,858
Other assets 143,284 107,456 107,856 109,456 90,957
Allowance for credit losses on loans (26,915) (13,225) (12,830) (12,196) (10,836)
Total assets $ 2,784,250 $ 2,282,311 $ 2,129,042 $ 2,006,340 $ 1,599,597
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Interest bearing liabilities
Interest bearing demand deposits $ 789,064 $ 586,938 $ 471,725 $ 358,225 $ 220,708
Savings deposits 539,625 317,569 320,184 363,949 306,312
Time deposits 598,085 660,910 621,659 609,156 491,652
Short-term borrowings 130,411 194,450 228,142 205,743 190,876
Long-term borrowings and subordinated
debentures 28,396 20,315 44,132 65,629 92,343
2,085,581 1,780,182 1,685,842 1,602,702 1,301,891
Noninterest bearing liabilities
Demand deposits 401,502 244,559 218,541 200,707 128,894
Other liabilities 31,712 20,341 15,574 16,669 18,795
Total liabilities 2,518,795 2,045,082 1,919,957 1,820,078 1,449,580
Shareholders' equity - preferred - - - - -
Shareholders' equity - common 265,455 237,229 209,085 186,262 150,017
Total shareholders' equity 265,455 237,229 209,085 186,262 150,017
Total liabilities and shareholders' equity $ 2,784,250 $ 2,282,311 $ 2,129,042 $ 2,006,340 $ 1,599,597
Net Interest Income
Net Interest Margin
(1)For purposes of this table, nonaccrual loans are included in average loan balances. Included in interest and fees on loans are loan fees of $1,210,000, $960,000, $839,000, $998,000 and $528,000 for the years ended December 31, 2020, 2019, 2018, 2017 and 2016, respectively.
(2)For purposes of this table, interest income on tax-exempt securities and loans has been adjusted assuming a Federal tax rate of 21% for 2020, 2019 and 2018 , 35% for 2017 and 34% for 2016. The taxable equivalent adjustment results in an increase in interest income of $997,000, $922,000, $1,280,000, $2,413,000 and $1,589,000 for the years ended December 31, 2020, 2019, 2018, 2017 and 2016, respectively.
Interest Earnings/Expense Average Yield/Rate
Dollars in thousands 2020 2019 2018 2017 2016 2020 2019 2018 2017 2016
ASSETS
Interest earning assets
Loans, net of unearned interest (1)
Taxable $ 104,986 $ 96,499 $ 84,716 $ 74,365 $ 56,439 4.88 % 5.41 % 5.21 % 5.02 % 4.79 %
Tax-exempt (2) 732 780 718 835 820 4.77 % 5.09 % 4.55 % 5.60 % 5.61 %
Securities
Taxable 5,996 6,511 5,341 5,071 4,395 2.33 % 3.17 % 3.13 % 2.53 % 2.17 %
Tax-exempt (2) 4,020 3,608 5,375 6,060 3,853 3.28 % 3.97 % 3.93 % 4.69 % 4.84 %
Interest bearing deposits with other banks 266 595 539 609 173 0.47 % 1.51 % 1.41 % 1.40 % 0.90 %
Total assets 116,000 107,993 96,689 86,940 65,680 4.46 % 5.06 % 4.86 % 4.65 % 4.40 %
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Interest bearing liabilities
Interest bearing demand deposits 2,187 6,394 4,205 1,169 376 0.28 % 1.09 % 0.89 % 0.33 % 0.17 %
Savings deposits 4,178 3,969 3,233 2,563 2,296 0.77 % 1.25 % 1.01 % 0.70 % 0.75 %
Time deposits 9,679 13,334 10,237 7,478 6,292 1.62 % 2.02 % 1.65 % 1.23 % 1.28 %
Short-term borrowings 2,330 5,303 5,993 4,473 2,288 1.79 % 2.73 % 2.63 % 2.17 % 1.20 %
Long-term borrowings subordinated
debentures 1,147 987 1,944 2,697 3,832 4.04 % 4.86 % 4.40 % 4.11 % 4.15 %
Total interest bearing liabilities 19,521 29,987 25,612 18,380 15,084 0.94 % 1.68 % 1.52 % 1.15 % 1.16 %
Net Interest Income $ 96,479 $ 78,006 $ 71,077 $ 68,560 $ 50,596
Net Interest Margin 3.71 % 3.66 % 3.57 % 3.67 % 3.39 %
Table II - Changes in Interest Margin Attributable to Rate and Volume
2020 Versus 2019 2019 Versus 2018
Increase (Decrease) Increase (Decrease)
Due to Change in: Due to Change in:
Dollars in thousands Volume Rate Net Volume Rate Net
Interest earned on
Loans
Taxable $ 18,589 $ (10,102) $ 8,487 $ 8,338 $ 3,445 $ 11,783
Tax-exempt 2 (50) (48) (21) 83 62
Securities
Taxable 1,425 (1,940) (515) 1,091 79 1,170
Tax-exempt 1,109 (697) 412 (1,830) 63 (1,767)
Interest bearing deposits with other banks
189 (518) (329) 18 38 56
Total interest earned on interest earning assets 21,314 (13,307) 8,007 7,596 3,708 11,304
Interest paid on
Interest bearing demand deposits 1,683 (5,890) (4,207) 1,146 1,043 2,189
Savings deposits 2,091 (1,882) 209 (26) 762 736
Time deposits (1,187) (2,468) (3,655) 678 2,419 3,097
Short-term borrowings (1,452) (1,521) (2,973) (912) 222 (690)
Long-term borrowings and subordinated debentures 347 (187) 160 (1,140) 183 (957)
Total interest paid on interest bearing liabilities 1,482 (11,948) (10,466) (254) 4,629 4,375
Net interest income $ 19,832 $ (1,359) $ 18,473 $ 7,850 $ (921) $ 6,929
Noninterest Income
Noninterest income totaled 0.72%, 0.84% and 0.82% of average assets in 2020, 2019 and 2018, respectively. Noninterest income totaled $20.1 million in 2020 compared to $19.2 million in 2019 and $17.4 million in 2018. The 2020 increase is primarily due to increased mortgage origination revenue and increased gains realized on securities while the 2019 increase is primarily due to gains realized on securities and the sale of Summit Insurance Services. Further detail regarding noninterest income is reflected in the following table.
Table III - Noninterest Income
Dollars in thousands 2020 2019 2018
Insurance commissions $ 202 $ 1,911 $ 4,320
Trust and wealth management fees 2,495 2,564 2,653
Mortgage origination revenue 2,799 770 768
Service charges on deposit accounts 4,588 5,094 4,631
Bank card revenue 4,494 3,536 3,152
Realized securities gains (losses), net 3,472 1,938 622
Gain on sale of Summit Insurance Services, LLC - 1,906 -
Bank owned life insurance income 1,567 1,044 1,022
Other 466 440 254
Total $ 20,083 $ 19,203 $ 17,422
Noninterest Expense
Noninterest expense totaled $62.3 million, $55.2 million and $49.9 million, or 2.2%, 2.4% and 2.3% of average assets for each of the years ended December 31, 2020, 2019 and 2018. Total noninterest expense increased $7.2 million in 2020 compared to 2019 and increased $5.3 million in 2019 compared to 2018. Our most notable changes in noninterest expense during 2020 were increased salaries, commissions and employee benefits, increased FDIC premiums, increased merger expenses and increases in other expenses. Table IV below presents a summary of our noninterest expenses for the past 3 years and the related year-over-year changes in each such expense.
Table IV - Noninterest Expense
Change Change
Dollars in thousands 2020 $
% 2019 $
% 2018
Salaries, commissions and employee benefits
$ 32,211 $ 3,145 10.8 % $ 29,066 $ 1,588 5.8 % $ 27,478
Net occupancy expense 3,963 546 16.0 % 3,417 53 1.6 % 3,364
Equipment expense 5,765 793 15.9 % 4,972 561 12.7 % 4,411
Professional fees 1,538 (140) (8.3) % 1,678 71 4.4 % 1,607
Advertising and public relations 596 (102) (14.6) % 698 44 6.7 % 654
Amortization of intangibles 1,659 (42) (2.5) % 1,701 30 1.8 % 1,671
FDIC premiums 856 768 872.7 % 88 (742) (89.4) % 830
Bank card expense 2,225 405 22.3 % 1,820 345 23.4 % 1,475
Foreclosed properties expense, net of gains/losses
2,490 (8) (0.3) % 2,498 1,148 85.0 % 1,350
Merger-related expense 1,671 1,054 170.8 % 617 473 328.5 % 144
Other 9,337 738 8.6 % 8,599 1,710 24.8 % 6,889
Total $ 62,311 $ 7,157 13.0 % $ 55,154 $ 5,281 10.6 % $ 49,873
Salaries, commissions and employee benefits: These expenses are 10.8% higher in 2020 compared to 2019 primarily due to general merit increases and an increase in our average annual full-time equivalent employees, primarily those in conjunction with the Cornerstone and MVB Bank branches acquisitions in early 2020. These expenses are 5.8% higher in 2019 compared to 2018 primarily due to general merit increases and the increased average number of annual full-time equivalent employees related to the PBI acquisition in Q1 2019.
Equipment: The 2020 and 2019 increases in equipment expense are primarily increased depreciation and amortization related to various technological upgrades, both hardware and software, including interactive teller machine upgrades made during the past three years and also recent acquisitions.
FDIC premiums: The decrease in FDIC premiums for 2019 is due to the FDIC's Small Bank Assessment Credits resulting from the reserve ratio meeting the required 1.38 percent threshold. Balance sheet growth and the full utilization of this credit during 2020 resulted in increased FDIC premiums for 2020.
Merger-related expense: These expenses are comprised of data processing conversion costs, employee severance costs, write-downs of equipment and professional and legal fees related to recent acquisitions.
Foreclosed properties expense, net of gains/losses: Foreclosed properties expense, net of gains/losses increased for 2019 and continued at the higher levels during 2020, primarily as a result of higher writedowns of theses properties to their estimated fair values.
Other: The 2020 increase in other expenses is primarily due to a $448,000 increase in service charges related to mortgage warehouse lines due to our increased participations and $267,000 increase in debit card costs due to increased usage by customers. The increase in other expenses for 2019 is largely due to a $1.0 million increase in deferred director compensation plan expenses. Under the plan, the directors optionally defer their director fees into a "phantom" investment plan whereby the company recognizes expense or benefit relative to the phantom returns or losses of such investments. Also increasing was ATM expense, up $213,000 due to increased usage by customers.
Income Tax Expense
Income tax expense for the years ended December 31, 2020, 2019 and 2018 totaled $7.4 million, $7.7 million and $7.0 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for 2020, 2019 and 2018 were 19.2%, 19.5% and 20.0%, respectively. Refer to Note 15 of the accompanying consolidated financial statements for further information and additional discussion of the significant components influencing our effective income tax rates.
CHANGES IN FINANCIAL POSITION
Our average assets increased during 2020 to $2.78 billion, an increase of 22.0% above 2019's average of $2.28 billion, and our year end December 31, 2020 assets were $702.9 million more than December 31, 2019. Average assets increased 7.2% in 2019, from 2018's average of $2.13 billion.
Table V - Summary of Significant Changes in Financial Position 2020 versus 2019
Balance
December 31, Impact of Cornerstone Acquisition Impact of MVB Branches Acquisition Impact of WinFirst Acquisition Other Changes Balance
December 31,
Dollars in thousands 2019 2020
Assets
Cash and cash equivalents $ 61,888 $ 46,034 $ 137,654 $ (8,675) $ (137,114) $ 99,787
Debt securities available for sale 276,355 90,028 - 1,632 (81,888) 286,127
Debt securities held to maturity - - - - 99,914 99,914
Other investments 12,972 349 - 3,138 (2,274) 14,185
Loans, net 1,900,425 39,461 33,942 122,786 283,293 2,379,907
Property held for sale 19,276 10 - 146 (3,844) 15,588
Premises and equipment 44,168 664 2,334 144 5,227 52,537
Goodwill and other intangibles 23,022 11,539 14,790 7,287 (1,515) 55,123
Cash surrender value of life insurance
policies and annuities 43,603 2,715 - 2,072 11,048 59,438
Other assets 21,783 1,186 114 686 20,009 43,778
Total assets $ 2,403,492 $ 191,986 $ 188,834 $ 129,216 $ 192,856 $ 3,106,384
Liabilities
Deposits $ 1,913,237 $ 173,266 $ 188,732 $ 104,664 $ 215,752 $ 2,595,651
Short-term borrowings 199,345 - - 3,000 (62,199) 140,146
Long-term borrowings 717 - - 21,282 (21,300) 699
Subordinated debentures - - - - 29,364 29,364
Subordinated debentures owed to
unconsolidated subsidiary trusts
19,589 - - - - 19,589
Other liabilities 22,840 3,279 102 270 12,864 39,355
Shareholders' equity 247,764 15,441 - - 18,375 281,580
Total liabilities and shareholders' equity $ 2,403,492 $ 191,986 $ 188,834 $ 129,216 $ 192,856 $ 3,106,384
Table VI - Summary of Significant Changes in Financial Position 2019 versus 2018
Balance
December 31, Impact of PBI Acquisition Other Changes Balance
December 31,
Dollars in thousands 2018 2019
Assets
Cash and cash equivalents $ 59,540 $ 33,329 $ (30,981) $ 61,888
Debt securities available for sale 293,147 55,113 (71,905) 276,355
Other investments 16,635 72 (3,735) 12,972
Loans, net 1,682,005 41,398 177,022 1,900,425
Property held for sale 21,432 - (2,156) 19,276
Premises and equipment 37,553 815 5,800 44,168
Goodwill and other intangibles 25,842 3,983 (6,803) 23,022
Cash surrender value of life insurance policies 42,386 - 1,217 43,603
Other assets 22,046 939 (1,202) 21,783
Total assets $ 2,200,586 $ 135,649 $ 67,257 $ 2,403,492
Liabilities
Deposits $ 1,634,826 $ 112,379 $ 166,032 $ 1,913,237
Short-term borrowings 309,084 - (109,739) 199,345
Long-term borrowings 735 - (18) 717
Subordinated debentures owed to
unconsolidated subsidiary trusts
19,589 - - 19,589
Other liabilities 16,522 1,533 4,785 22,840
Shareholders' equity 219,830 21,737 6,197 247,764
Total liabilities and shareholders' equity $ 2,200,586 $ 135,649 $ 67,257 $ 2,403,492
As highlighted in table V, the majority of the changes in our financial position in 2020 versus 2019 resulted due to the acquisitions of Cornerstone, MVB branches, and WinFirst. Other changes in financial position are discussed below.
Cash and Cash Equivalents
The 2020 net reduction of $137.1 million is primarily attributable to repayments of short-term Federal Home Loan Bank ("FHLB") advances, maturing brokered CDs, funding of $101.3 million of PPP loans and the cash consideration of $36.0 million paid in conjunction with the Cornerstone and WinFirst acquisitions. The 2019 net reduction of $31.0 million is primarily attributable to repayments of short-term Federal Home Loan Bank ("FHLB") advances and the cash consideration of $12.7 million paid in conjunction with the PBI acquisition.
Loan Portfolio
Table VII depicts gross loan balances by type and the respective percentage of each to total loans at December 31, as follows:
Table VII - Loans by Type
2020 2019 2018 2017 2016
Dollars in thousands Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total
Commercial $ 298,759 12.3 % $ 207,392 10.8 % $ 194,527 11.5 % $ 190,270 11.8 % $ 119,256 8.9 %
Commercial real estate
1,039,811 43.0 % 907,887 47.4 % 833,392 49.1 % 737,961 45.8 % 586,014 49.6 %
Construction and development
199,950 8.3 % 122,455 6.4 % 94,155 5.5 % 101,022 6.3 % 89,069 6.9 %
Residential mortgage
581,954 24.1 % 502,764 26.2 % 491,441 28.9 % 500,720 31.1 % 406,293 31.7 %
Mortgage warehouse lines
251,814 10.4 % 126,235 6.6 % 39,140 2.3 % 30,757 1.9 % 85,963 - %
Consumer 35,428 1.4 % 36,651 1.9 % 32,569 1.9 % 36,302 2.3 % 25,524 1.8 %
Other 11,080 0.5 % 14,121 0.7 % 12,903 0.8 % 13,245 0.8 % 9,499 1.1 %
Total loans $ 2,418,796 100.0 % $ 1,917,505 100.0 % $ 1,698,127 100.0 % $ 1,610,277 100.0 % $ 1,321,618 100.0 %
Total loans averaged $2.2 billion in 2020, which represented 78% of total average assets compared to $1.8 billion in 2019, or 79% of total average assets. We experienced 20.9% loan growth, excluding mortgage warehouse lines, which increased $373.1 million (of which $196.2 million were acquired loans) in 2020, primarily in the commercial real estate and construction and development portfolios primarily due to additional commercial lending staff, following 2019's growth of 7.9% and 2018's growth of 5.1%. Mortgage warehouse lines of credit grew $125.6 million in 2020 as we expanded our existing line participations and established several new participations in light of strong mortgage refinance and home purchase activity nationally. Refer to Note 7 of the accompanying consolidated financial statements for our loan maturities and a discussion of our adjustable rate loans as of December 31, 2020.
In the normal course of business, we make various commitments and incur certain contingent liabilities, which are disclosed in Note 16 of the accompanying consolidated financial statements but not reflected in the accompanying consolidated financial statements. There have been no significant changes in these types of commitments and contingent liabilities and we do not anticipate any material losses as a result of these commitments.
Debt Securities
Debt securities comprised approximately 12.4% of total assets at December 31, 2020 compared to 11.5% at December 31, 2019. Average debt securities approximated $379.3 million for 2020 or 28.1% more than 2019's average of $296.2 million. At December 31, 2019, we did not own debt securities of any one issuer that were not issued by the U.S. Treasury or a U.S. Government agency that exceeded ten percent of shareholders’ equity. Refer to Note 5 of the accompanying consolidated financial statements for details of amortized cost, the estimated fair values, unrealized gains and losses as well as the debt security classifications by type.
Debt securities available for sale: The 2020 net decrease of $81.9 million in securities available for sale is principally a result of sales of a large portion of the acquired Cornerstone securities portfolio and the sales of a portion of our tax-exempt municipals securities, whose proceeds were used to fund loan growth and calls and maturities of brokered and direct CDs. The 2019 net decrease of $71.9 million in securities available for sale is principally a result of sales of the acquired PBI securities portfolio and the sales of a portion of our tax-exempt municipals securities, whose proceeds were used to pay down short-term FHLB advances and fund loan growth.
The following table presents the fair value of our available for sale securities portfolio by type at December 31, 2020, 2019 and 2018.
Table VIII - Fair Value of Debt Securities Available for Sale
December 31
Dollars in thousands 2020 2019 2018
Debt Securities Available for Sale
Taxable debt securities
U.S. Government and agencies and corporations $ 35,157 $ 20,864 $ 26,140
Residential mortgage-backed securities:
Government-sponsored agencies 59,046 70,975 80,309
Nongovernment-sponsored entities 16,687 10,229 614
State and political subdivisions 50,905 49,973 19,243
Corporate debt securities 26,427 18,200 14,512
Asset-backed securities 46,126 $ 33,014 25,175
Total taxable debt securities 234,348 203,255 165,993
Tax-exempt debt securities
State and political subdivisions 51,779 73,100 127,154
Total tax-exempt debt securities 51,779 73,100 127,154
Total debt securities available for sale $ 286,127 $ 276,355 $ 293,147
The maturity distribution of the available for sale securities portfolio at December 31, 2020, together with the weighted average yields for each range of maturity, is summarized in Table IX. The stated average yields are stated on a tax equivalent basis.
Table IX - Debt Securities Available for Sale Maturity Analysis
After one After five
Within but within but within After
one year five years ten years ten years
(At amortized cost, dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
U. S. Government agencies and corporations
$ 369 4.0 % $ 4,514 2.1 % $ 14,013 1.4 % $ 16,294 2.0 %
Residential mortgage backed securities:
Government sponsored agencies
18,257 2.0 % 33,174 2.6 % 4,116 1.9 % 1,852 2.8 %
Nongovernment sponsored entities
7,295 3.0 % 5,813 2.5 % 1,590 1.6 % 2,101 1.6 %
State and political subdivisions
552 3.6 % 10,367 2.8 % 14,262 3.2 % 69,526 3.0 %
Corporate debt securities 1,999 1.6 % 4,501 2.8 % 10,037 3.1 % 9,946 3.9 %
Asset-backed securities 6,260 0.9 % 24,184 0.9 % 15,730 0.8 % 405 0.9 %
Total $ 34,732 2.1 % $ 82,553 2.1 % $ 59,748 2.0 % $ 100,124 3.0 %
Debt securities held to maturity: During second quarter 2020, we invested in various municipal securities that we have classified as held to maturity as we have the positive intent and ability to hold them to maturity. Accordingly, they are carried at cost, adjusted for amortization of premiums and accretion of discounts.
The following table presents the fair value of our held to maturity securities portfolio by type at December 31, 2020.
Table X - Fair Value of Debt Securities Held to Maturity
December 31
Dollars in thousands 2020
Held to Maturity
Tax-exempt debt securities
State and political subdivisions $ 103,157
Total debt securities held to maturity $ 103,157
The maturity distribution of the held to maturity securities portfolio at December 31, 2020, together with the weighted average yields for each range of maturity, is summarized in Table XI. The stated average yields are stated on a tax equivalent basis.
Table XI - Debt Securities Held to Maturity - Maturity Analysis
After one After five
Within but within but within After
one year five years ten years ten years
(At amortized cost, dollars in
thousands) Amount Yield Amount Yield Amount Yield Amount Yield
State and political subdivisions
$ - - % $ - - % $ 2,038 2.5 % $ 97,876 2.4 %
Total $ - - % $ - - % $ 2,038 2.5 % $ 97,876 2.4 %
Deposits
Total deposits at December 31, 2020 increased $682.4 million or 35.7% compared to December 31, 2019. Total deposits at December 31, 2019 increased $278.4 million or 17.0% compared to December 31, 2018. Deposits acquired in conjunction with the purchases of Cornerstone, MVB Bank branches and WinFirst in 2020 and PBI in 2019 totaled $466.7 million and $102.9 million, respectively. We have strengthened our focus on growing core transaction accounts. Excluding acquired deposits, core transaction accounts grew $225.8 million or 25.3% during 2020 while our internet-only high yielding savings product increased $101.0 million and brokered CDs decreased $95.1 million due to maturities and calls.
Table XII - Deposits
Dollars in thousands 2020 2019 2018 2017 2016
Noninterest bearing demand $ 440,818 $ 260,553 $ 222,120 $ 217,493 $ 149,737
Interest bearing demand 934,185 630,351 523,257 410,606 262,591
Savings 621,168 418,096 284,173 358,168 337,348
Time deposits 599,480 604,237 605,276 614,334 545,843
Total deposits $ 2,595,651 $ 1,913,237 $ 1,634,826 $ 1,600,601 $ 1,295,519
See Table I for average deposit balance and rate information by deposit type for the past five years and Note 12 of the accompanying consolidated financial statements for a maturity distribution of time deposits as of December 31, 2020.
Borrowings
Lines of Credit: We have a remaining available line of credit from the Federal Home Loan Bank of Pittsburgh (“FHLB”) totaling $721.4 million at December 31, 2020. We use this line primarily to fund loans to customers. Funds acquired through this program are reflected on the consolidated balance sheet in short-term borrowings or long-term borrowings, depending on the repayment terms of the debt agreement. We also had $168.1 million available on a short term line of credit with the Federal Reserve Bank at December 31, 2020, which is primarily secured by consumer loans, construction loans and commercial and industrial loans and a $6 million available line of credit with a correspondent bank.
Short-term Borrowings: Total short-term borrowings consisting primarily of advances from the FHLB having original maturities of 30 days or less decreased $59.2 million from $199.3 million at December 31, 2019 to $140.1 million at December 31, 2020. See Note 13 of the accompanying consolidated financial statements for additional disclosures regarding our short-term borrowings.
Long-term Borrowings: Long-term borrowings historically have been used to fund our loan growth, however, as a result of prolonged low short-term interest rates following the economic downturn of 2008, long-term borrowings have been reduced significantly as we have replaced maturing long-term borrowings with short-term funding. Total long-term borrowings of $699,000 and $717,000 at December 31, 2020 and 2019 consisted of a long-term FHLB advance. Refer to Note 13 of the accompanying consolidated financial statements for additional information regarding our long-term borrowings.
Subordinated debentures: We issued $30 million of subordinated debt in Q3 2020 in a private placement transaction. The subordinated debt qualifies as Tier 2 capital under Federal Reserve Board guidelines, until the debt is within 5 years of its maturity; thereafter the amount qualifying as Tier 2 capital is reduced by 20 percent each year until maturity. This subordinated debt, bears interest at a fixed rate of 5.00% per year, from and including September 22, 2020 to, but excluding, September 30, 2025, payable quarterly in arrears. From and including September 30, 2025 to, but excluding, the maturity date or earlier redemption date, the interest rate will reset quarterly at a variable rate equal to the then current three-month term Secured Overnight Financing Rate (“SOFR”), as published by the Federal Reserve Bank of New York, plus 487 basis points, payable quarterly in arrears. As provided in the Notes, the interest rate on the Notes during the applicable floating rate period may be determined based on a rate other than three-month term SOFR. This debt has a 10 year term and generally, is not prepayable by us within the first five years.
Shareholders' equity
Changes in shareholders' equity are a result of net income, other comprehensive income, dividends and issuances of our stock in conjunction with acquisitions.
ASSET QUALITY
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 troubled debt restructurings ("TDRs") are excluded from nonperforming loans.
Table XIII presents a summary of nonperforming assets at December 31, as follows:
Table XIII - Nonperforming Assets
Dollars in thousands 2020 2019 2018 2017 2016
Accruing loans past due 90 days or more
Commercial $ - $ - $ - $ - $ -
Commercial real estate - - - 237 -
Residential construction & development - - - - -
Residential real estate - - - - -
Consumer 2 42 36 37 -
Other - - - - -
Total accruing loans 90+ days past due 2 42 36 274 -
Nonaccrual loans
Commercial 525 764 935 696 298
Commercial real estate 14,237 5,800 3,238 2,927 4,845
Commercial construction & development - - - - -
Residential construction & development 235 326 3,198 3,569 4,465
Residential real estate 5,264 4,404 7,506 7,656 4,815
Consumer 72 74 112 201 151
Other - 100 - - -
Total nonaccrual loans 20,333 11,468 14,989 15,049 14,574
Foreclosed properties
Commercial - - - - -
Commercial real estate 2,581 1,930 1,762 1,789 1,749
Commercial construction & development 4,154 4,601 6,479 7,392 8,610
Residential construction & development 7,791 11,169 11,543 11,182 13,265
Residential real estate 1,062 1,576 1,648 1,107 880
Total foreclosed properties 15,588 19,276 21,432 21,470 24,504
Repossessed assets - 17 5 68 12
Total nonperforming assets $ 35,923 $ 30,803 $ 36,462 $ 36,861 $ 39,090
Total nonperforming loans as a percentage of total loans
0.84 % 0.60 % 0.89 % 0.95 % 1.10 %
Total nonperforming assets as a percentage of total assets
1.16 % 1.28 % 1.66 % 1.73 % 2.22 %
Allowance for credit losses on loans as a percentage of nonperforming loans 158.57 % 113.58 % 86.84 % 82.00 % 80.10 %
Allowance for credit losses on loans as a percentage of period end loans 1.34 % 0.68 % 0.77 % 0.78 % 0.88 %
Refer to Note 7 for information regarding our past due loans, loans individually evaluated, nonaccrual loans and troubled debt restructurings.
We monitor our concentrations in higher-risk lending areas in accordance with the Interagency Guidance for Concentrations in Commercial Real Estate Lending issued in 2006. This guidance establishes concentration guidelines of 100% of Tier 1 Capital plus the allowance for credit losses for lending in construction, land development and other land loans. It further establishes a guideline of 300% of Tier 1 Capital plus the allowance for credit losses for lending in construction, land development and other land loans plus loans secured by non-owner occupied non-farm non-residential properties. As of December 31, 2020, Summit Community Bank was within the recommended limits of 100% and 300%, respectively.
We maintain the allowance for credit losses on loans at a level considered adequate to cover an estimate of the full amount of expected credit losses relative to loans. The allowance is comprised of three distinct reserve components: (1) specific reserves related to loans individually evaluated, (2) quantitative reserves related to loans collectively evaluated and (3) qualitative reserves related to loans collectively evaluated. A summary of the methodology we employ on a quarterly basis with respect to each of these components in order to evaluate the overall adequacy of our allowance for credit losses on loans is provided in Note 7 of the accompanying financial statements.
Relationship between Allowance for Credit Losses, Net Charge-offs and Nonperforming Loans
In analyzing the relationship among the allowance for credit losses, net loan charge-offs and nonperforming loans, it is helpful to understand the process of how loans are treated as the probability of collection changes over time. Allowances are established at origination through the allowance for credit losses to estimate the expected credit loss over the life of the financial assets based on risk characteristics inherent in the loan. (Please refer to Note 7 for detail on how allowance for credit losses are established.)
Generally, loans are placed on nonaccrual status (and become non-performing) when principal or interest is greater than 90 days past due based upon the loan’s contractual term. As a loan deteriorates in credit quality, if the loan balance is material the loan may be individually evaluated through the allowance for credit losses on loans (" ACLL") instead of on a collective basis with other loans as it may no longer have similar risk characteristics. The allowance for credit losses on an individually evaluated loan are established based on the fair value of the underlying collateral for collateral dependent loans or based on the present value of future cash flows for loans deemed not to be collateral dependent. Therefore, as loan credit quality deteriorates the allowance for credit loss may change.
Charge-offs, if necessary, are recognized as deemed appropriate based on loan-type. Commercial-related loans or portions thereof, are charged off to the ACLL when the loss has been confirmed. This determination is made on a case by case basis considering many factors, including the prioritization of our claim in bankruptcy, expectations of the workout/restructuring of the loan and valuation of the borrower’s equity. We deem a loss confirmed when a loan or a portion of a loan is classified “loss” in accordance with bank regulatory classification guidelines, which state, “Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.”
Consumer loans are generally charged to the ACLL upon reaching specified stages of delinquency, in accordance with the Federal Financial Institutions Examination Council policy. For example, credit card loans are charged off by the end of the month in which the account becomes 180 days past due or within 60 days from receiving notification about a specified event (e.g., bankruptcy of the borrower), whichever is earlier. Residential mortgage loans are generally charged off to net realizable value no later than when the account becomes 180 days past due. Other consumer loans, if collateralized, are generally charged off to net realizable value at 120 days past due.
Expected credit losses are reflected in the ACLL through a charge to provision for credit losses. When we deem all or a portion of a financial asset to be uncollectible the appropriate amount is written off and the ACLL is reduced by the same amount. The Company applies judgement to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted. Subsequent recoveries, if any, are credit to the ACLL when received.
At December 31, 2020 and 2019, our allowance for credit losses on loans totaled $32.2 million, or 1.34% of total loans and $13.1 million, or 0.68% of total loans, respectively. The allowance for credit losses on loans is considered adequate to cover all estimated future losses in our loan portfolio.
Table XIV presents an allocation of the allowance for credit losses on loans by loan type at each respective year end date, as follows:
Table XIV - Allocation of the Allowance for Credit Losses on Loans
2019 2019 2018 2017 2016
Dollars in thousands Amount % of loans in each category to total loans Amount % of loans in each category to total loans Amount % of loans in each category to total loans Amount % of loans in each category to total loans Amount % of loans in each category to total loans
Commercial $ 2,304 12.3 % $ 1,146 10.8 % $ 1,705 11.5 % $ 1,303 11.8 % $ 934 8.9 %
Commercial real estate
10,841 43.0 % 8,639 47.4 % 7,956 49.1 % 7,374 45.8 % 5,547 49.6 %
Construction and development
8,732 8.3 % 842 6.4 % 403 5.5 % 794 6.3 % 2,287 6.9 %
Residential real estate 10,015 24.1 % 1,961 26.2 % 2,636 28.9 % 2,621 31.1 % 2,682 31.7 %
Mortgage warehouse lines
- 10.4 % - 6.6 % - 2.3 % - 1.9 % - - %
Consumer 216 1.4 % 135 1.9 % 79 1.9 % 210 2.3 % 121 1.8 %
Other 138 0.5 % 351 0.7 % 268 0.8 % 263 0.8 % 103 1.1 %
Total $ 32,246 100.0 % $ 13,074 100.0 % $ 13,047 100.0 % $ 12,565 100.0 % $ 11,674 100.0 %
A reconciliation of the activity in the allowance for credit losses on loans follows:
Table XV - Allowance for Credit Losses on Loans
Dollars in thousands 2020 2019 2018 2017 2016
Balance, beginning of year $ 13,074 $ 13,047 $ 12,565 $ 11,674 $ 11,472
Losses
Commercial 33 281 248 23 489
Commercial real estate 1,348 172 657 70 303
Construction and development 7 2 259 36 136
Residential real estate 416 1,003 913 519 344
Mortgage warehouse lines - - - - -
Consumer 280 285 244 389 98
Other 525 360 282 251 185
Total 2,609 2,103 2,603 1,288 1,555
Recoveries
Commercial 33 17 16 124 73
Commercial real estate 250 22 23 180 48
Construction and development 42 108 270 278 840
Residential real estate 275 144 263 164 145
Mortgage warehouse lines - - - - -
Consumer 158 168 141 82 76
Other 148 121 122 101 75
Total 906 580 835 929 1,257
Net losses 1,703 1,523 1,768 359 298
Provision for credit losses 12,743 1,550 2,250 1,250 500
CECL adoption Day 1 adjustment 6,926 - - - -
Acquired PCD loans adjustment 1,206 - - - -
Balance, end of year $ 32,246 $ 13,074 $ 13,047 $ 12,565 $ 11,674
Net losses as a % of average loans 0.08 % 0.08 % 0.11 % 0.02 % 0.02 %
At December 31, 2020 and 2019, we had approximately $15.6 million and $19.3 million, respectively, in property held for sale 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 loss. Refer to Note 8 of the accompanying consolidated financial statements for additional information regarding our property held for sale.
LIQUIDITY AND CAPITAL RESOURCES
Bank Liquidity: Liquidity reflects our ability to ensure the availability of adequate funds to meet loan commitments and deposit withdrawals, as well as provide for other transactional requirements. Liquidity is provided primarily by excess funds at correspondent banks, non-pledged securities and available lines of credit with the FHLB, Federal Reserve Bank of Richmond and correspondent banks, which totaled approximately $1.2 billion or 37.7% of total consolidated assets at December 31, 2020.
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 borrow approximately $862.1 million, which is collateralized by $1.16 billion of residential mortgage loans, commercial loans, mortgage backed securities and securities of U. S. Government agencies and corporations. At December 31, 2020, we had available borrowing capacity of $721.4 million on our FHLB line. We also maintain a credit line with the Federal Reserve Bank of Richmond as a contingency liquidity vehicle. The amount available on this line at December 31, 2020 was approximately $168 million, which is secured by a pledge of $336.9 million of our consumer loans, construction loans and commercial and industrial loan portfolios. We have a $6 million unsecured line of credit with a correspondent bank. Also, we classify nearly 75% of our securities as available for sale to enable us to liquidate them if the need arises. During 2020, our loan growth was funded primarily by deposits as our loans increased approximately $498.7 million, while total deposits increased $682.4 million. The additional excess deposit growth was used to pay down short-term FHLB borrowings and an assumed WinFirst long-term FHLB advance.
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.
One aspect of our liquidity management process is establishing contingent liquidity funding plans under various scenarios in order to prepare for unexpected liquidity shortages or events. The following represents three “stressed” liquidity circumstances and our related contingency plans with respect to each.
Scenario 1 - Summit Community’s capital status becomes less than “well capitalized”. Banks which are less than “well capitalized” in accordance with regulatory capital guidelines are prohibited from issuing new brokered deposits without first obtaining a waiver from the FDIC to do so. In the event Summit Community’s capital status were to fall below well capitalized and was not successful in obtaining the FDIC’s waiver to issue new brokered deposits, Summit Community:
•Would have limited amounts of maturing brokered deposits to replace in the short-term, as we have limited our brokered deposits maturing in any one quarter to no more than $50 million.
•Presently has $1.2 billion in available sources of liquid funds which could be drawn upon to fund maturing brokered deposits until Summit Community had restored its capital to well capitalized status.
•Would first seek to restore its capital to well capitalized status through capital contributions from Summit, its parent holding company.
•Would generally have no more than $100 million in brokered deposits maturing in any one year time frame, which is well within its presently available sources of liquid funds, if in the event Summit does not have the capital resources to restore Summit Community’s capital to well capitalized status. One year would give Summit Community ample time to raise alternative funds either through retail deposits or the sale of assets and obtain capital resources to restore it to well capitalized status.
Scenario 2 - Summit Community’s credit quality deteriorates such that the FHLB restricts further advances. If in the event that the Bank’s credit quality deteriorated to the point that further advances under its line with the FHLB were restricted, Summit Community:
•Would severely curtail lending and other growth activities until such time as access to this line could be restored, thus eliminating the need for net new advances.
•Would still have available current liquid funding sources secured by unemcumbered loans and securities totaling $552 million aside from its FHLB line, which would result in a funding source of approximately $362 million.
Scenario 3 - A competitive financial institution offers a retail deposit program at interest rates significantly above current market rates in Summit Community’s market areas. If a competitive financial institution offered a retail deposit program at rates well in excess of current market rates in Summit Community’s market area, the Bank:
•Presently has $1.2 billion in available sources of liquid funds which could be drawn upon immediately to fund any “net run off” of deposits from this activity.
•Would severely curtail lending and other growth activities so as to preserve the availability of as much contingency funds as possible.
•Would begin offering its own competitive deposit program when deemed prudent so as to restore the retail deposits lost to the competition.
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. Refer to page 14 of Item 1A. Risk Factors for further discussion of our liquidity risk.
Growth and Expansion: During 2020, we spent approximately $8.5 million on capital expenditures for premises and equipment. We expect our capital expenditures to approximate $3.0 - $3.5 million in 2021, primarily for new branch site construction and equipment and technological upgrades.
Capital Compliance: Our capital position is strong. Stated as a percentage of total assets, our equity ratio was 9.1% at December 31, 2020 compared to 10.3% at December 31, 2019. Our subsidiary bank, Summit Community Bank, had Tier 1 risk-based, Total risk-based and Tier 1 leverage capital in excess of the minimum “well capitalized” levels of $78.1 million, $50.5 million and $132.4 million, respectively. We intend to maintain Summit Community Bank's capital ratios at levels that would be considered to be “well capitalized” in accordance with regulatory capital guidelines. See Note 18 of the accompanying consolidated financial statements for further discussion of our regulatory capital.
During 2020, we retained $22.5 million of earnings and the net change in accumulated other comprehensive income was $2.9 million, principally resulting from $3.7 million unrealized net gains on securities available for sale.
On July 30, 2015, our Employee Stock Ownership Plan ("ESOP") purchased 225,000 shares of Summit Financial Group Inc. common stock, which is shown as a reduction of shareholders' equity, similar to a purchase of treasury stock. When the shares are committed to be released and become available for allocation to plan participants, the then fair value of such shares will be charged to compensation expense. Unallocated shares owned by the Company’s ESOP are not considered to be outstanding for the purpose of computing earnings per share.
Dividends: Cash dividends per share totaled $0.68 and $0.59 during 2020 and 2019, respectively, representing dividend payout ratios of 28.2% and 23.1%, respectively. It is our intention to continue to pay dividends on a quarterly basis during 2021. Future dividend amounts will depend on the earnings and financial condition of our subsidiary bank as well as general economic conditions.
The primary source of funds for the dividends paid to our shareholders is dividends received from our subsidiary bank. Dividends paid by our subsidiary bank are subject to restrictions by banking law and regulations and require approval by the bank’s regulatory agency if dividends declared in any year exceed the bank’s current year's net income, as defined, plus its retained net profits of the two preceding years. In addition, cash dividends depend on the earnings and financial condition of our subsidiary bank and our capital adequacy as well as general economic conditions. During 2021, the net retained profits available for distribution to Summit as dividends without regulatory approval are approximately $57.0 million.
Contractual Cash Obligations: During our normal course of business, we incur contractual cash obligations. The following table summarizes our contractual cash obligations at December 31, 2020.
Table XVI - Contractual Cash Obligations
Dollars in thousands Long Term Debt and Subordinated Debentures Operating Leases
2021 $ 20 $ 677
2022 21 639
2023 22 441
2024 22 391
2025 24 340
Thereafter 50,179 1,585
Total $ 50,288 $ 4,073
Off-Balance Sheet Arrangements: We are involved with some off-balance sheet arrangements that have or are reasonably likely to have an effect on our financial condition, liquidity, or capital. These arrangements at December 31, 2020 are presented in the following table. Refer to Note 17 of the accompanying consolidated financial statements for further discussion of our off-balance sheet arrangements.
Table XVII - Off-Balance Sheet Arrangements
Dollars in thousands
Commitments to extend credit
Revolving home equity and credit card lines $ 90,125
Construction loans 135,841
Other loans 308,290
Standby letters of credit 15,124
Total $ 549,380
LIBOR AND OTHER BENCHMARK RATES
Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (LIBOR) after 2021, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates ("IBOR") and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates ("ARRs") and could cause disruptions in a variety of markets. We will continue to monitor developments related to ARRs, however at this time, we do not anticipate any material adverse impact to our business operation or financial results during the period of transition from IBORs to ARRs.
QUARTERLY FINANCIAL DATA
A summary of our selected quarterly financial data is as follows:
First Second Third Fourth
Dollars in thousands, except per share amounts Quarter Quarter Quarter Quarter
Interest income $ 27,643 $ 27,937 $ 29,246 $ 30,176
Net interest income 21,443 23,066 24,766 26,206
Net income 4,506 6,949 9,620 10,251
Basic earnings per share $ 0.35 $ 0.54 $ 0.74 $ 0.79
Diluted earnings per share $ 0.35 $ 0.54 $ 0.74 $ 0.79
First Second Third Fourth
Dollars in thousands, except per share amounts Quarter Quarter Quarter Quarter
Interest income $ 25,868 $ 26,882 $ 27,279 $ 27,072
Net interest income 18,573 19,263 19,420 19,828
Net income 7,092 8,564 8,061 8,149
Basic earnings per share $ 0.56 $ 0.68 $ 0.65 $ 0.66
Diluted earnings per share $ 0.56 $ 0.68 $ 0.65 $ 0.65

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. 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 embedded options. The principal objective of asset/liability management is to minimize interest rate risk and our actions in this regard are taken under the guidance of our Asset/Liability Management Committee (“ALCO”). The ALCO is comprised of members of the Board of Directors and of members of senior management. 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 at December 31, 2020 is well-matched over the near term, but asset sensitive over the long term. The nature of our lending and funding activities tends to drive our interest rate risk position to being liability sensitive. That is, liabilities are likely to reprice faster than assets, resulting in a decrease in net interest income in a rising rate environment, while a falling interest rate environment would produce an increase in net interest income. Net interest income is also subject to changes in the shape of the yield curve. In general, a flat yield curve results 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 rates is assumed to gradually take place over a 12 month period 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 December 31, 2020. 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) 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 Interest Rates 0 - 12 Months 13 - 24 Months
Down 100 basis points (1) -0.3 % -5.7 %
Up 200 basis points (1) -2.2 % -1.7 %
Up 200 basis points (2) -1.4 % 4.1 %
(1) assumes a parallel shift in the yield curve over 12 months, with no change thereafter
(2) assumes a parallel shift in the yield curve over 24 months, with no change thereafter
REPORT OF MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
Summit Financial Group, Inc. is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on management’s best estimates and judgments.
We, as management of Summit Financial Group, Inc., are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles and in conformity with the Federal Financial Institutions Examination Council instructions for consolidated Reports of Condition and Income (call report instructions). The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
The Audit Committee, consisting entirely of independent directors, meets regularly with management, internal auditors and the independent registered public accounting firm and reviews audit plans and results, as well as management’s actions taken in discharging responsibilities for accounting, financial reporting and internal control. Yount, Hyde & Barbour, P.C., independent registered public accounting firm and the internal auditors have direct and confidential access to the Audit Committee at all times to discuss the results of their examinations.
Management assessed the Corporation’s system of internal control over financial reporting as of December 31, 2020. In making this assessment, we used the criteria for effective internal control over financial reporting set forth in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013. Based on this assessment, management concludes that, as of December 31, 2020, its system of internal control over financial reporting is effective and meets the criteria of the Internal Control-Integrated Framework. Yount, Hyde & Barbour, P.C., independent registered public accounting firm, has issued an attestation report on the Corporation’s internal control over financial reporting.
Management is also responsible for compliance with the federal and state laws and regulations concerning dividend restrictions and federal laws and regulations concerning loans to insiders designated by the FDIC as safety and soundness laws and regulations.
/s/ H. Charles Maddy, III /s/ Robert S. Tissue /s/ Julie R. Markwood
President and Chief Executive Officer Executive Vice President and Chief Financial Officer Senior Vice President and Chief Accounting Officer
Moorefield, West Virginia
March 11, 2021
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Summit Financial Group, Inc.
Moorefield, West Virginia
Opinion on the Internal Control over Financial Reporting
We have audited Summit Financial Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the consolidated financial statements of the Company and our report dated March 11, 2021 expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Report of Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ YOUNT, HYDE & BARBOUR, P.C.
Winchester, Virginia
March 11, 2021

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Summit Financial Group, Inc.
Moorefield, West Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Summit Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 11, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Adoption of New Accounting Standard
As discussed in Notes 2 and 7 to the financial statements, the Company changed its method of accounting for credit losses in 2020 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses - Loans Collectively Evaluated for Impairment
Description of the Matter
As discussed in Note 2 (Significant New Authoritative Accounting Guidance) and Note 7 (Loans and Allowance for Credit Losses Loans) to the financial statements, the Company changed its method of accounting for credit losses on January 1, 2020 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. Accounting Standards Codification Topic 326 (ASC 326) requires, among other provisions, the measurement of all expected credit losses for loans based on historical experience, current conditions, and reasonable and supportable forecasts. The allowance for credit losses - loans (ACLL) is a valuation allowance that represents management’s current best estimate of expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability of loans over the loans’ contractual terms (“life of loan” concept). The Company adopted ASC 326 using the modified retrospective approach resulting in an increase in the ACLL of $6.93 million.
The Company’s ACLL related to loans collectively evaluated for impairment was $28.52 million, the total ACLL was $32.25 million, and total loans, net of unearned fees, were $2.41 billion as of December 31, 2020. The Company’s methodology applies historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual life of the loans that are reasonable and supportable, to the identified pools of loans with similar risk characteristics. Loans are segmented into pools based upon similar characteristics and risk profiles and based on the degree of correlation of how loans within each pool respond to various economic conditions. The Company uses a loss-rate, or cohort, method to estimate expected credit losses for the identified loan pools. The cohort method tracks respective losses generated by that cohort of loans over their remaining lives. Loss rates are adjusted for qualitative factors that are not otherwise considered within the model. The qualitative factors considered by management include reasonable and supportable forecasts of economic conditions; trends in credit quality; volume and concentrations of credit; and changes in lending policy, underwriting standards, and management. Management exercised significant judgment when assessing the qualitive factors in estimating the ACLL.
We identified the measurement of the ACLL as a critical audit matter as auditing this estimate involved especially complex and subjective auditor judgment in evaluating and testing management’s adoption of an inherently complex accounting standard and estimation process that requires significant management judgment.
How We Addressed the Matter in Our Audit
The primary audit procedures we performed to address this critical audit matter included:
•Obtaining an understanding and testing the design and operating effectiveness of the Company’s ACLL methodology, internal controls, and management review controls related to collectively evaluated loans, including the process for selection, implementation, and ongoing maintenance of:
◦The cohort method as the expected loss model, including identification of loan pools, model validation, monitoring, and the completeness and accuracy of key data inputs and assumptions.
◦Qualitative factors, including sources of reasonable and supportable economic forecasts and other key inputs.
◦Governance and management review processes.
•Substantively testing management’s process for measuring the ACLL related to collectively evaluated loans, including:
◦Evaluating the conceptual soundness, assumptions, and key data inputs of the Company’s ACLL expected loss rate methodology, including the identification of loan pools and related cohort loss rates.
◦Evaluating the methodology’s qualitative factors, including:
▪The completeness and accuracy of the data inputs used as a basis for the qualitative factors.
▪The reasonableness of management’s judgments related to the determination of qualitative factors.
▪The directional consistency and reasonableness of the qualitative factor adjustments.
◦Testing the mathematical accuracy of the calculation, including the application of the cohort loss rates and qualitative factors.
/s/ YOUNT, HYDE & BARBOUR, P.C.
We have served as the Company’s auditor since 2016.
Winchester, Virginia
March 11, 2021
Consolidated Balance Sheets
December 31,
Dollars in thousands 2020 2019
ASSETS
Cash and due from banks $ 19,522 $ 28,137
Interest bearing deposits with other banks 80,265 33,751
Cash and cash equivalents 99,787 61,888
Debt securities available for sale (at fair value) 286,127 276,355
Debt securities held to maturity (at amortized cost; estimated fair value - $103,157)
99,914 -
Less: allowance for credit losses - -
Debt securities held to maturity, net 99,914 -
Other investments 14,185 12,972
Loans held for sale 1,998 1,319
Loans net of unearned fees 2,412,153 1,913,499
Less: allowance for credit losses (32,246) (13,074)
Loans, net 2,379,907 1,900,425
Property held for sale 15,588 19,276
Premises and equipment, net 52,537 44,168
Accrued interest and fees receivable 11,989 8,439
Goodwill and other intangible assets, net 55,123 23,022
Cash surrender value of life insurance policies and annuities 59,438 43,603
Other assets 29,791 12,025
Total assets $ 3,106,384 $ 2,403,492
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 440,818 $ 260,553
Interest bearing 2,154,833 1,652,684
Total deposits 2,595,651 1,913,237
Short-term borrowings 140,146 199,345
Long-term borrowings 699 717
Subordinated debentures 29,364 -
Subordinated debentures owed to unconsolidated subsidiary trusts 19,589 19,589
Other liabilities 39,355 22,840
Total liabilities 2,824,804 2,155,728
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: 2020 - 12,985,708 shares, 2019 - 12,474,641 shares; outstanding: 2020 - 12,942,004 shares, 2019 - 12,408,542 shares
94,964 80,084
Unallocated common stock held by Employee Stock Ownership Plan -
2020 - 43,704 shares, 2019 - 66,099 shares
(472) (714)
Retained earnings 181,643 165,859
Accumulated other comprehensive income 5,445 2,535
Total shareholders' equity 281,580 247,764
Total liabilities and shareholders' equity $ 3,106,384 $ 2,403,492
See Notes to Consolidated Financial Statements
Consolidated Statements of Income
For the Year Ended December 31,
Dollars in thousands (except per share amounts) 2020 2019 2018
Interest income
Interest and fees on loans
Taxable $ 104,986 $ 96,500 $ 84,716
Tax-exempt 578 615 567
Interest and dividends on securities
Taxable 5,997 6,511 5,341
Tax-exempt 3,176 2,850 4,246
Interest on interest bearing deposits with other banks 266 595 539
Total interest income 115,003 107,071 95,409
Interest expense
Interest on deposits 16,044 23,697 17,675
Interest on short-term borrowings 2,330 5,303 5,993
Interest on long-term borrowings and subordinated debentures 1,147 987 1,944
Total interest expense 19,521 29,987 25,612
Net interest income 95,482 77,084 69,797
Provision for credit losses 14,500 1,550 2,250
Net interest income after provision for credit losses 80,982 75,534 67,547
Noninterest income
Insurance commissions 202 1,911 4,320
Trust and wealth management fees 2,495 2,564 2,653
Mortgage origination revenue 2,799 770 768
Service charges on deposit accounts 4,588 5,094 4,631
Bank card revenue 4,494 3,536 3,152
Realized securities gains, net 3,472 1,938 622
Gain on sale of Summit Insurance Services, LLC - 1,906 -
Bank owned life insurance and annuities income 1,567 1,044 1,022
Other 466 440 254
Total noninterest income 20,083 19,203 17,422
Noninterest expenses
Salaries, commissions and employee benefits 32,211 29,066 27,478
Net occupancy expense 3,963 3,417 3,364
Equipment expense 5,765 4,972 4,411
Professional fees 1,538 1,678 1,607
Advertising and public relations 596 698 654
Amortization of intangibles 1,659 1,701 1,671
FDIC premiums 856 88 830
Bank card expense 2,225 1,820 1,475
Foreclosed properties expense, net 2,490 2,498 1,350
Merger-related expenses 1,671 617 144
Other 9,337 8,599 6,889
Total noninterest expenses 62,311 55,154 49,873
Income before income tax expense 38,754 39,583 35,096
Income tax expense 7,428 7,717 7,024
Net income $ 31,326 $ 31,866 $ 28,072
Basic earnings per common share $ 2.42 $ 2.55 $ 2.27
Diluted earnings per common share $ 2.41 $ 2.53 $ 2.26
See Notes to Consolidated Financial Statements
Consolidated Statements of Comprehensive Income
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
Net income $ 31,326 $ 31,866 $ 28,072
Other comprehensive income (loss):
Net unrealized (loss) gain on cashflow hedges of:
2020 - $(808), net of deferred taxes of $(194); 2019 - $(268), net of deferred taxes of $(64); 2018 - $1,645, net of deferred taxes of $395
(614) (204) 1,250
Net unrealized gain (loss) on debt securities available for sale of:
2020 - $4,830, net of deferred taxes of $1,159 and reclassification adjustment for net realized gains included in net income of $3,472, net of tax of $833
3,671
2019 - $5,244 net of deferred taxes of $1,258 and reclassification adjustment for net realized gains included in net income of $1,938, net of tax of $465
3,986
2018 - $(4,920), net of deferred taxes of $(1,181) and reclassification adjustment for net realized gains included in net income of $622, net of tax of $149
(3,739)
Net unrealized loss on other post-retirement benefits of:
2020 - $(116), net of deferred taxes of $(28); 2019 - $(120), net of deferred taxes of $(29); 2018- $(341), net of deferred taxes of $(82)
(88) (91) (259)
Net unrealized loss on pension plan of:
2020 - $(78), net of deferred taxes of $(19); 2019 - $(184), net of deferred taxes of $(44)
(59) (140) -
Total other comprehensive income (loss) 2,910 3,551 (2,748)
Total comprehensive income $ 34,236 $ 35,417 $ 25,324
See Notes to Consolidated Financial Statements
Consolidated Statements of Shareholders’ Equity
For the Years Ended December 31, 2020, 2019 and 2018
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, 2017 $ 81,098 $ (1,152) $ 119,827 $ 1,732 $ 201,505
Net income - - 28,072 - 28,072
Other comprehensive loss (2,748) (2,748)
Exercise of stock options - 6,800 shares
122 - - - 122
Share-based compensation expense 391 - - - 391
Unallocated ESOP shares committed to
be released - 19,780 shares
272 213 - - 485
Purchase and retirement of 82,423 shares of common stock
(1,689) - - - (1,689)
Common stock issuances from reinvested dividends - 10,214 shares
237 - - - 237
Common stock cash dividends declared ($0.53 per share)
- - (6,545) - (6,545)
Balance, December 31, 2018 80,431 (939) 141,354 (1,016) 219,830
Net income - - 31,866 - 31,866
Other comprehensive income 3,551 3,551
Exercise of stock options and SARs - 17,366 shares
7 - - - 7
Share-based compensation expense 590 - - - 590
Unallocated ESOP shares committed to be released - 20,855 shares
305 225 - - 530
Purchase and retirement of 417,577 shares of common stock
(10,405) - - - (10,405)
Acquisition of Peoples Bankshares, Inc. - 465,931 shares, net of issuance costs
8,918 - - - 8,918
Common stock issuances from reinvested dividends - 9,034 shares
238 - - - 238
Common stock cash dividends declared ($0.59 per share)
- - (7,361) - (7,361)
Balance, December 31, 2019 80,084 (714) 165,859 2,535 247,764
Impact of adoption of ASC 326 - - (6,756) - (6,756)
Net income - - 31,326 - 31,326
Other comprehensive income 2,910 2,910
Exercise of SARs - 499 shares
- - - - -
Vesting of RSUs - 964 shares
- - - - -
Share-based compensation expense 527 - - - 527
Unallocated ESOP shares committed to be released - 22,395 shares
178 242 - - 420
Purchase and retirement of 75,333 shares of common stock
(1,444) - - - (1,444)
Acquisition of Cornerstone Financial Services, Inc. - 570,000 shares, net of issuance costs
15,354 - - - 15,354
Common stock issuances from reinvested dividends - 14,937 shares
265 - - - 265
Common stock cash dividends declared ($0.68 per share)
- - (8,786) - (8,786)
Balance, December 31, 2020 $ 94,964 $ (472) $ 181,643 $ 5,445 $ 281,580
See Notes to Consolidated Financial Statements
Consolidated Statements of Cash Flows
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 31,326 $ 31,866 $ 28,072
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 3,223 2,614 2,168
Provision for credit losses 14,500 1,550 2,250
Share-based compensation expense 527 590 391
Deferred income tax (benefit) expense (4,201) 103 (349)
Loans originated for sale (97,805) (22,518) (15,939)
Proceeds from sale of loans 98,933 22,004 15,834
Gains on loans held for sale (1,806) (405) (295)
Realized securities gains, net (3,472) (1,938) (622)
Loss (gain) on disposal of assets 221 (236) 74
Gain on sale of Summit Insurance Services, LLC - (1,906) -
Write-downs of foreclosed properties 1,783 2,075 776
Amortization of securities premiums, net 3,024 2,263 3,412
Accretion related to acquisition adjustments, net (1,571) (998) (580)
Amortization of intangibles 1,659 1,701 1,671
Earnings on bank owned life insurance and annuities (1,716) (1,148) (1,028)
(Increase) decrease in accrued interest receivable (1,996) 699 (378)
Decrease (increase) in other assets 314 133 (320)
Increase in other liabilities 1,738 4,478 3,384
Net cash provided by operating activities 44,681 40,927 38,521
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities and calls of debt securities available for sale 3,525 1,871 1,145
Proceeds from maturities and calls of debt securities held to maturity 1,000 - -
Proceeds from sales of debt securities available for sale 124,809 142,423 107,559
Principal payments received on debt securities available for sale 24,654 22,870 24,814
Purchases of debt securities available for sale (64,740) (90,341) (105,789)
Purchases of debt securities held to maturity (101,994) - -
Purchases of other investments (14,700) (18,228) (14,550)
Proceeds from redemptions of other investments 16,461 21,412 11,717
Net loan originations (301,654) (181,615) (92,189)
Purchases of premises and equipment (8,637) (9,218) (5,545)
Proceeds from disposal of premises and equipment 293 860 42
Improvements to property held for sale (1,352) (512) (1,304)
Proceeds from sale of repossessed assets and property held for sale 4,191 5,271 2,365
Proceeds from sale of Summit Insurance Services, LLC
- 7,117 -
Cash and cash equivalents from acquisitions, net of cash consideration paid - 2020 - $48,920; 2019 - $12,740
175,013 20,589 -
Purchases of life insurance contracts and annuities (9,332) (69) -
Net cash used in investing activities (152,463) (77,570) (71,735)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposit, NOW and savings accounts 376,704 204,757 43,282
Net decrease in time deposits (160,373) (38,409) (8,853)
Net (decrease) increase in short-term borrowings (62,199) (109,739) 58,585
Repayment of long-term borrowings (21,301) (18) (45,016)
Proceeds from subordinated debt 30,000 - -
Purchase of interest rate caps (7,098) - -
Proceeds from issuance of common stock, net of issuance costs 178 159 237
Purchase and retirement of common stock (1,444) (10,405) (1,689)
Exercise of stock options - 7 122
Dividends paid on common stock (8,786) (7,361) (6,545)
Net cash provided by financing activities 145,681 38,991 40,123
See Notes to Consolidated Financial Statements
Consolidated Statements of Cash Flows - continued
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
Increase in cash and cash equivalents 37,899 2,348 6,909
Cash and cash equivalents
Beginning 61,888 59,540 52,631
Ending $ 99,787 $ 61,888 $ 59,540
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash payments for:
Interest $ 19,975 $ 29,855 $ 25,426
Income taxes $ 11,440 $ 7,850 $ 7,539
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES
Real property and other assets acquired in settlement of loans $ 1,146 $ 4,600 $ 1,822
Right of use assets obtained in exchange for lease obligations $ 5,147 $ 902 $ -
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS INCLUDED IN ACQUISITION
Assets acquired $ 302,333 $ 100,377 $ -
Liabilities assumed $ 494,596 $ 114,151 $ -
See Notes to Consolidated Financial Statements
NOTE 1. BASIS OF PRESENTATION
We are a financial holding company headquartered in Moorefield, West Virginia. We offer community banking and trust and wealth management services through our community bank subsidiary, Summit Community Bank (“Summit Community”). We provide commercial and retail banking services primarily in the Eastern Panhandle, Southern and North Central regions of West Virginia, the Northern, Shenandoah Valley and Southwestern regions of Virginia and the Central region of Kentucky.
Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry.
Use of estimates: We must make estimates and assumptions that affect the reported amounts and disclosures in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates.
Principles of consolidation: The accompanying consolidated financial statements include the accounts of Summit and its wholly-owned subsidiary. All significant accounts and transactions among these entities have been eliminated.
Comprehensive income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, cash flow hedges, other post-retirement benefits and pension plans, which are recognized as separate components of equity.
Cash and cash equivalents: Cash and cash equivalents includes cash on hand, amounts due from banks (including cash items in process of clearing), interest bearing deposits with other banks and federal funds sold.
Loans held for sale: Loans held for sale are valued at the lower of aggregate carrying cost or fair value. Gains or losses realized on the sales of loans are recognized in other income at the time of sale.
Cash surrender value of life insurance policies: We have purchased life insurance policies on certain employees. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Presentation of cash flows: For purposes of reporting, cash flows from demand deposits, NOW accounts, savings accounts and short-term borrowings are reported on a net basis, since their original maturities are less than three months. Cash flows from loans and certificates of deposit and other time deposits are reported net.
Advertising: Advertising costs are expensed as incurred.
Trust services: Assets held in an agency or fiduciary capacity are not our assets and are not included in the accompanying consolidated balance sheets. Trust services income is recognized on the cash basis in accordance with customary banking practice. Reporting such income on a cash basis does not produce results that are materially different from those that would result from use of the accrual basis.
Transfer of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from us, the transferee obtains the right (free of condition that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity date.
Unconsolidated subsidiary trusts: In accordance with accounting principles generally accepted in the United States, we do not consolidate subsidiary trusts which issue guaranteed preferred beneficial interests in subordinated debentures (Trust Preferred Securities). The Trust Preferred Securities qualify as Tier 1 capital for regulatory purposes. See Note 13 of our Notes to Consolidated Financial Statements for a discussion of our subordinated debentures owed to unconsolidated subsidiary trusts.
Significant accounting policies: The following table identifies our other significant accounting policies and the Note and page where a detailed description of each policy can be found.
Acquisitions Note 3 Page 63
Fair Value Measurements Note 4 Page 68
Debt Securities Note 5 Page 73
Other Investments Note 6 Page 78
Loans and Allowance for Credit Losses on Loans Note 7 Page 78
Property Held for Sale Note 8 Page 92
Premises and Equipment Note 9 Page 92
Lease Commitments Note 10 Page 93
Goodwill and Other Intangible Assets Note 11 Page 93
Securities Sold Under Agreements to Repurchase Note 13 Page 95
Derivative Financial Instruments Note 14 Page 96
Income Taxes Note 15 Page 98
Employee Benefit Plans Note 16 Page 100
Share-Based Compensation Note 16 Page 100
Earnings Per Share Note 19 Page 105
Accumulated Other Comprehensive Income Note 20 Page 105
Revenue Recognition Note 21 Page 106
NOTE 2. SIGNIFICANT NEW AUTHORITATIVE ACCOUNTING GUIDANCE
Recently Adopted
During June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. Accounting Standards Codification Topic 326 ("ASC 326"), Financial Instruments - Credit Losses, as amended, among other things, 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. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques previously applied are still permitted, although the inputs to those techniques have changed to reflect the full amount of expected credit losses. In addition, ASC 326 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration.
We adopted ASC 326 on January 1, 2020 using the modified retrospective approach. Results for the periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable US GAAP. We recorded a net reduction of retained earnings of $6.76 million upon adoption. The transition adjustment includes an increase in the allowance for credit losses on loans ("ACLL") of $6.93 million and an increase in the allowance for credit losses on off-balance sheet credit exposures of $2.43 million, net of the corresponding increases in deferred tax assets of $2.13 million. The adjustments to the allowance for credit losses ("ACL") for both loans and off-balance sheet credit exposures are combined and reported on our income statement as credit loss expense. Further information regarding our policies and methodology used to estimate the ACLL is presented in Note 7 - Loans and Allowance for Credit Losses for Loans. Further information regarding our policies and methodology used to estimate the ACL on off-balance-sheet credit exposures is presented in Note 17 - Commitments and Contingencies.
We adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (“PCD”) that were previously classified as purchased credit impaired (“PCI”) and accounted for under ASC 310-30. In accordance with the standard, we did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. The remaining credit discount on the PCI loans was recorded as an offset to the ACLL at the time of adoption and is netted in the above adjustment. The remaining adjustment for noncredit factors on these loans will be accreted into interest income on a level-yield method over the life of the loans.
Additionally, we evaluated each acquired loan for PCD status at the time of adoption. We identified loans with a net balance of $9.4 million that should be considered PCD. We considered the remaining discount at the time of adoption to be for noncredit factors on these loans and it will be accreted into interest income on a level-yield method over the life of the loans.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments were effective for us January 1, 2020 and did not have a material impact on our consolidated financial statements.
In March 2020 (revised April 2020), various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus ("COVID-19"). The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASC 310-40, Receivables - Troubled Debt Restructurings by Creditors, (“ASC 310-40”), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to the COVID-19 crisis to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance continues to impact our financial statements; however, this impact cannot be quantified at this time. See Note 7 of the accompanying consolidated financial statements for disclosure of the impact to date.
Pending Adoption
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes. The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. We are currently assessing the impact that ASU 2019-12 will have on our consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2020-01 to have a material impact on our consolidated financial statements.
In March 2020, the Financial Accounting Standards Board (FASB) issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. At this time, we do not anticipate any material adverse impact to our business operation or financial results during the period of transition.
In October 2020, the FASB issued ASU 2020-08 Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable fees and Other Costs which clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is not permitted. All entities should apply ASU No. 2020-08 on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. We do not expect the adoption of ASU 2020-06 to have a material impact on our consolidated financial statements.
NOTE 3. ACQUISITIONS
Cornerstone Financial Services Inc. Acquisition
On January 1, 2020, Summit Community Bank, Inc. ("SCB"), a wholly-owned subsidiary of Summit, acquired 100% of the ownership of Cornerstone Financial Services Inc. ("Cornerstone") and its subsidiary Cornerstone Bank, headquartered in West Union, West Virginia. With this transaction, Summit further expands its footprint into the central region of West Virginia. Pursuant to the Agreement and Plan of Merger dated September 17, 2019, Cornerstone's shareholders received cash in the amount of $5,700.00 per share or 228 shares of Summit common stock, or a combination of cash and Summit stock, subject to proration to result in approximately 50% cash and 50% stock consideration in the aggregate. Total stock consideration was
$15.4 million or 570,000 shares of Summit common stock and cash consideration was $14.3 million. Cornerstone's assets and liabilities approximated $195 million and $176 million, respectively, at December 31, 2019.
We accounted for the acquisition using the acquisition method of accounting in accordance with ASC 805, Business Combinations and accordingly, the assets and liabilities of Cornerstone were recorded at their acquisition date respective 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. We recognized goodwill of $10.82 million in connection with the acquisition (not deductible for income tax purposes), which is not amortized for financial reporting purposes, but is subject to annual impairment testing or upon a triggering event. 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 10 years using an accelerated method which approximates the estimated run-off of the acquired deposits. The following table details the total consideration paid on January 1, 2020 in connection with the acquisition of Cornerstone, the fair values of the assets acquired and liabilities assumed and the resulting preliminary goodwill.
(Dollars in thousands) As Recorded by Cornerstone Estimated Fair Value Adjustments Estimated Fair Values as Recorded by Summit
Cash consideration $ 14,250
Stock consideration 15,441
Total consideration 29,691
Identifiable assets acquired:
Cash and cash equivalents $ 60,284 $ - $ 60,284
Securities available for sale, at fair value 90,075 (47) 90,028
Loans
Purchased performing
37,965 188 38,153
Purchased credit deteriorated
1,877 (569) 1,308
Allowance for credit losses on loans (312) 312 -
Premises and equipment 806 (142) 664
Property held for sale 10 - 10
Core deposit intangibles - 717 717
Other assets 4,324 (74) 4,250
Total identifiable assets acquired
$ 195,029 $ 385 $ 195,414
Identifiable liabilities assumed:
Deposits 173,027 239 173,266
Other liabilities 3,286 (7) 3,279
Total identifiable liabilities assumed
$ 176,313 $ 232 $ 176,545
Net identifiable assets acquired $ 18,716 $ 153 $ 18,869
Goodwill resulting from acquisition $ 10,822
MVB Bank Branches Acquisition
On April 24, 2020, SCB expanded its presence in the Eastern Panhandle of West Virginia by acquiring three MVB Bank locations in Berkeley County, West Virginia and one MVB Bank location in Jefferson County, West Virginia. Summit assumed certain deposit liabilities and acquired certain assets totaling approximately $188.2 million and $38.4 million, respectively. The purchase price, equaling the average daily closing balance of the deposits for the thirty (30) day period prior to the closing multiplied by 8.00%, totaled $13.0 million.
This acquisition was determined to constitute a business combination in accordance with ASC 805, Business Combinations,and accordingly we accounted for the acquisition using the acquisition method of accounting, recording the assets and liabilities of MVB Bank at their acquisition date respective fair values. The fair values of assets and liabilities 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 preliminary goodwill of $14.7 million in connection with the acquisition (deductible for income tax purposes), 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 10 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 24, 2020 in connection with the acquisition of the MVB Bank branches, the fair values of the assets acquired and liabilities assumed and the resulting preliminary goodwill.
(Dollars in thousands) As Recorded by MVB Bank Estimated Fair Value Adjustments Estimated Fair Values as Recorded by Summit
Cash consideration $ 12,965
Total consideration 12,965
Identifiable assets acquired:
Cash and cash equivalents $ 800 $ - $ 800
Loans
Purchased performing
35,127 (1,185) 33,942
Premises and equipment 2,376 (42) 2,334
Core deposit intangibles - 125 125
Other assets 114 - 114
Total identifiable assets acquired
$ 38,417 $ (1,102) $ 37,315
Identifiable liabilities assumed:
Deposits 188,134 598 188,732
Other liabilities 102 - 102
Total identifiable liabilities assumed
$ 188,236 $ 598 $ 188,834
Net liabilities assumed $ (149,819) $ (1,700) $ (151,519)
Net cash received from MVB Bank 136,854
Preliminary goodwill resulting from acquisition $ 14,665
WinFirst Financial Corp. Acquisition
On December 15, 2020, Summit Community Bank, Inc. acquired 100% of the ownership of WinFirst Financial Corp. ("WinFirst") and its subsidiary WinFirst Bank, headquartered in Winchester, Kentucky. Pursuant to the Agreement and Plan of Merger dated September 28, 2020, WinFirst's shareholders received $328.05 for each share of WinFirst common stock they owned, or approximately $21.7 million in the aggregate. With this transaction, Summit expanded its footprint into Kentucky. At acquisition, WinFirst's assets and liabilities approximated $143 million and $127 million, respectively.
We accounted for the acquisition using the acquisition method of accounting in accordance with ASC 805, Business Combinations and accordingly, the assets and liabilities of WinFirst were recorded at their respective acquisition date fair values. The fair values of assets and liabilities 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 preliminary goodwill of $7.21 million in connection with the acquisition (deductible for income tax purposes), 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 10 years using an accelerated method which approximates the estimated run-off of the acquired deposits. The following table details the total consideration paid on December 15, 2020 in connection with the acquisition of WinFirst, the fair values of the assets acquired and liabilities assumed and the resulting preliminary goodwill.
(Dollars in thousands) As Recorded by WinFirst Estimated Fair Value Adjustments Estimated Fair Values as Recorded by Summit
Cash consideration $ 21,705
Total consideration 21,705
Identifiable assets acquired:
Cash and cash equivalents $ 13,030 $ - $ 13,030
Securities available for sale, at fair value 1,613 19 1,632
Loans
Purchased performing
123,754 (968) 122,786
Purchased credit deteriorated
- - -
Allowance for credit losses on loans (1,227) 1,227 -
Premises and equipment 171 (27) 144
Property held for sale 196 (50) 146
Core deposit intangibles - 81 81
Other assets 5,898 (2) 5,896
Total identifiable assets acquired
$ 143,435 $ 280 $ 143,715
Identifiable liabilities assumed:
Deposits 103,599 1,065 104,664
Short-term borrowings 3,000 - 3,000
Long-term borrowings 20,585 697 21,282
Other liabilities 270 - 270
Total identifiable liabilities assumed
$ 127,454 $ 1,762 $ 129,216
Net identifiable assets acquired $ 15,981 $ (1,482) $ 14,499
Preliminary goodwill resulting from acquisition $ 7,206
The following is a description of the methods used to determine the fair values of significant assets and liabilities presented for each transaction above.
Cash and cash equivalents: The carrying amount of these assets approximates their fair value based on the short-term nature of these assets, with the exception of certificates of deposits held at other banks, which were adjusted to fair value based upon current interest rates.
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 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.
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 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 credit losses on loans.
Prior to adoption of ASC 326 on January 1, 2020, loans acquired in a business combination that had evidence of credit deterioration since origination and for which it was probable at the date of acquisition that we would not collect all contractually required principal and interest payments were considered purchased credit-impaired (PCI) loans. When determining fair value, PCI loans were 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 was accounted for as a"nonaccretable difference," and was available to absorb future credit losses on those loans. For purposes of determining the nonaccretable difference, no prepayments were 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 generally resulted in a provision for credit losses. Subsequent significant increases in cash flows could have resulted in a reversal of the provision for credit 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 was accounted for as accretable yield and was recognized as interest income over the remaining life of the loan when there was a reasonable expectation about the amount and timing of such cash flows.
Subsequent to adoption of ASC 326 on January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered purchased credit deteriorated (“PCD”) loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial allowance for credit losses is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. All loans considered to be PCI prior to January 1, 2020 were converted to PCD on that date.
Loans not designated PCD 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 credit losses established at the acquisition date for purchased performing loans. A provision for credit losses is recorded for any deterioration in these loans subsequent to the acquisition.
Peoples Bankshares, Inc.
On January 1, 2019, Summit Community Bank, Inc. acquired 100% of the ownership of Peoples Bankshares, Inc. ("PBI") and its subsidiary First Peoples Bank, Inc., headquartered in Mullens, West Virginia, for consideration of 465,931 shares of Summit common stock and $12.7 million cash. With this transaction, Summit expanded its footprint into Wyoming and Raleigh counties of West Virginia. PBI's assets and liabilities approximated $133 million and $113 million, respectively, at December 31, 2018.
The revenues and earnings of our acquired entities during 2020 and 2019, as if the business combinations occurred as of the beginning of the comparable prior annual reporting period, are impracticable to provide because each acquisition was integrated into our existing operations and financial information relative to the acquired entities is not maintained.
During 2020, we purchased loans, for which there was, at the time of acquisition, more than significant deterioration of credit quality since origination (PCD loans). The carrying amount of these loans at acquisition is as follows:
Dollars in thousands For the Year Ended December 31, 2020
Purchase price of PCD loans at acquisition $ 12,649
Allowance for credit losses - loans at acquisition 796
Non-credit discount at acquisition 568
Par value of PCD loans at acquisition 11,285
NOTE 4. FAIR VALUE MEASUREMENTS
In accordance with ASC 820 Fair Value Measurements, fair value is based upon the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy is utilized to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs used to measure fair value are as follows:
Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and our creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value is set forth below. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis include the following:
Debt Securities Available for Sale: Debt Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Certain trust preferred securities classified as corporate debt securities are Level 3 due to limited market trades of these classes of securities.
Derivative Financial Instruments: Derivative financial instruments are recorded at fair value on a recurring basis. Fair value measurement is based on pricing models run by a third-party, utilizing observable market-based inputs. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. As a result, we classify interest rate swaps as Level 2.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.
Balance at Fair Value Measurements Using:
Dollars in thousands December 31, 2020 Level 1 Level 2 Level 3
Debt securities available for sale
U.S. Government sponsored agencies $ 35,157 $ - $ 35,157 $ -
Mortgage backed securities:
Government sponsored agencies 59,046 - 59,046 -
Nongovernment sponsored entities 16,687 - 16,687 -
State and political subdivisions 50,905 - 50,905 -
Corporate debt securities 26,427 - 26,427 -
Asset-backed securities 46,126 - 46,126 -
Tax-exempt state and political subdivisions 51,779 - 51,779 -
Total debt securities available for sale $ 286,127 $ - $ 286,127 $ -
Derivative financial assets
Interest rate caps $ 6,653 $ - $ 6,653 $ -
Derivative financial liabilities
Interest rate swaps $ 2,747 $ - $ 2,747 $ -
Balance at Fair Value Measurements Using:
Dollars in thousands December 31, 2019 Level 1 Level 2 Level 3
Debt securities available for sale
U.S. Government sponsored agencies $ 20,864 $ - $ 20,864 $ -
Mortgage backed securities:
Government sponsored agencies 70,975 - 70,975 -
Nongovernment sponsored entities 10,229 - 10,229 -
State and political subdivisions 49,973 - 49,973 -
Corporate debt securities 18,200 - 18,200 -
Asset-backed securities 33,014 - 33,014 -
Tax-exempt state and political subdivisions 73,100 - 73,100 -
Total debt securities available for sale $ 276,355 $ - $ 276,355 $ -
Derivative financial liabilities
Interest rate swaps $ 988 $ - $ 988 $ -
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.
Loans Held for Sale: Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, we classify loans subject to nonrecurring fair value adjustments as Level 2.
Collateral Dependent Loans with an ACLL: In accordance with ASC 326 effective January 1, 2020, we may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. We reevaluate the fair value of collateral supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent
loans is evaluated by appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice.
Prior to adoption of ASC 326, we did not record loans at fair value on a recurring basis. However, from time to time, a loan was considered impaired and an allowance for credit loss was established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement were considered impaired. Once a loan was identified as individually impaired, management measured impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the discounted cash flows or collateral value exceeded the recorded investments in such loans. These loans were carried at recorded loan investment and therefore are not included in the following tables of loans measured at fair value. Impaired loans internally graded as substandard or doubtful were evaluated using the fair value of collateral method. All other impaired loans were measured for impairment using the discounted cash flows method. Impaired loans where an allowance is established based on the fair value of collateral were included in the fair value hierarchy. When the fair value of the collateral was based on an observable market price or a current appraised value, we recorded the impaired loan as nonrecurring Level 2. When a current appraised value was not available and there was no observable market price, we recorded the impaired loan as nonrecurring Level 3.
When impaired loans were deemed required to be included in the fair value hierarchy, management immediately began the process of evaluating the estimated fair value of the underlying collateral to determine if a related specific allowance for credit losses or charge-off is necessary. Current appraisals were ordered once a loan was deemed impaired if the existing appraisal was more than twelve months old, or more frequently if there was known deterioration in value. For recently identified impaired loans, a current appraisal may not have been available at the financial statement date. Until the current appraisal was obtained, the original appraised value was discounted, as appropriate, to compensate for the estimated depreciation in the value of the loan’s underlying collateral since the date of the original appraisal. Such discounts were generally estimated based upon management’s knowledge of sales of similar collateral within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends. When a new appraisal was received (which was generally within 3 months of a loan being identified as impaired), management then re-evaluated the fair value of the collateral and adjusted any specific allocated allowance for credit losses on loans, as appropriate. In addition, management also assigned a discount of 7-10% for the estimated costs to sell the collateral.
Property Held for Sale: Property held for sale consists of real estate acquired in foreclosure or other settlement of loans. Foreclosed assets are initially recorded at fair value, less estimated selling costs, when acquired establishing a new cost basis. Such assets are carried on the balance sheet at the lower of the investment in the real estate or its fair value less estimated selling costs. The fair value of foreclosed properties is determined on a nonrecurring basis generally utilizing current appraisals performed by an independent, licensed appraiser applying an income or market value approach using observable market data (Level 2). Updated appraisals of foreclosed properties are generally obtained if the existing appraisal is more than 18 months old or more frequently if there is a known deterioration in value. However, if a current appraisal is not available, the original appraised value is discounted, as appropriate, to compensate for the estimated depreciation in the value of the real estate since the date of its original appraisal. Such discounts are generally estimated based upon management’s knowledge of sales of similar property within the applicable market area and its knowledge of other real estate market-related data as well as general economic trends (Level 3). Upon foreclosure, any fair value adjustment is charged against the allowance for credit losses on loans. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense in the consolidated statements of income.
Assets measured at fair value on a nonrecurring basis are included in the tables below.
Balance at Fair Value Measurements Using:
Dollars in thousands December 31, 2020 Level 1 Level 2 Level 3
Residential mortgage loans held for sale $ 1,998 $ - $ 1,998 $ -
Collateral-dependent loans with an ACLL
Commercial $ 8 $ - $ 8 $ -
Commercial real estate 9,914 - 9,914 -
Construction and development 1,576 - 1,576 -
Residential real estate 597 - 597 -
Total collateral-dependent loans with an ACLL $ 12,095 $ - $ 12,095 $ -
Property held for sale
Commercial real estate $ 1,557 $ - $ 1,557 $ -
Construction and development 11,595 - 10,974 621
Residential real estate 476 - 476 -
Total property held for sale $ 13,628 $ - $ 13,007 $ 621
Balance at Fair Value Measurements Using:
Dollars in thousands December 31, 2019 Level 1 Level 2 Level 3
Residential mortgage loans held for sale $ 1,319 $ - $ 1,319 $ -
Collateral-dependent impaired loans
Commercial $ 4,831 - $ 4,831 $ -
Commercial real estate 1,863 - 1,863 -
Construction and development 425 - 425 -
Residential real estate 692 - 566 126
Total collateral-dependent impaired loans $ 7,811 $ - $ 7,685 $ 126
Property held for sale
Commercial real estate $ 1,304 $ - $ 1,304 $ -
Construction and development 12,182 - 12,182 -
Residential real estate 705 - 705 -
Total property held for sale $ 14,191 $ - $ 14,191 $ -
ASC Topic 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the cash surrender value of life insurance policies. The methodologies for other financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis are discussed below:
Loans: The estimated fair value approximates carrying value for variable-rate loans that reprice frequently and with no significant change in credit risk. The fair value of fixed-rate loans and variable-rate loans which reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. An overall valuation adjustment is made for specific credit risks as well as general portfolio credit risk.
Other Investments: The carrying value of other investments, consisting principally of Federal Home Loan Bank stock, is a reasonable estimate of fair value of this stock. This stock is non-transferable and can only be redeemed at its par value by FHLB.
Deposits: The estimated fair value approximates carrying value for demand deposits. The fair value of fixed-rate deposit liabilities with defined maturities is estimated by discounting future cash flows using the interest rates currently offered for deposits of similar remaining maturities. The estimated fair value of deposits does not take into account the value of our long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, and not considered financial instruments. Nonetheless, we would likely realize a core deposit premium if our deposit portfolio were sold in the principal market for such deposits.
Borrowed Funds: The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated using quoted market prices, if available, or by discounting future cash flows using current interest rates for similar financial instruments.
The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of December 31, 2020 and December 31, 2019.
At December 31,
2020 Fair Value Measurements Using:
Dollars in thousands Carrying
Value Estimated
Fair
Value Level 1 Level 2 Level 3
Financial assets
Cash and cash equivalents $ 99,787 $ 99,787 $ - $ 99,787 $ -
Debt aecurities available for sale 286,127 286,127 - 286,127 -
Debt securities held to maturity 99,914 103,157 - 103,157 -
Other investments 14,185 14,185 - 14,185 -
Loans held for sale, net 1,998 1,998 - 1,998 -
Loans, net 2,379,907 2,384,275 - 12,095 2,372,180
Accrued interest receivable 11,989 11,989 - 11,989 -
Cash surrender value of life insurance policies and
annuities 59,438 59,438 - 59,438 -
Derivative financial assets 6,653 6,653 - 6,653 -
$ 2,959,998 $ 2,967,609 $ - $ 595,429 $ 2,372,180
Financial liabilities
Deposits $ 2,595,651 $ 2,597,326 $ - $ 2,597,326 $ -
Short-term borrowings 140,146 140,146 - 140,146 -
Long-term borrowings 699 866 - 866 -
Subordinated debentures 29,364 29,364 - 29,364 -
Subordinated debentures owed to unconsolidated subsidiary trusts
19,589 19,589 - 19,589 -
Accrued interest payable 745 745 - 745 -
Derivative financial liabilities 2,747 2,747 - 2,747 -
$ 2,788,941 $ 2,790,783 $ - $ 2,790,783 $ -
At December 31
2019 Fair Value Measurements Using:
Dollars in thousands Carrying
Value Estimated
Fair
Value Level 1 Level 2 Level 3
Financial assets
Cash and cash equivalents $ 61,888 $ 61,888 $ - $ 61,888 $ -
Securities available for sale 276,355 276,355 - 276,355 -
Other investments 12,972 12,972 - 12,972 -
Loans held for sale, net 1,319 1,319 - 1,319 -
Loans, net 1,900,425 1,901,020 - 7,685 1,893,335
Accrued interest receivable 8,439 8,439 - 8,439 -
Cash surrender value of life insurance policies 43,603 43,603 - 43,603 -
$ 2,305,001 $ 2,305,596 $ - $ 412,261 $ 1,893,335
Financial liabilities
Deposits $ 1,913,237 $ 1,918,610 $ - $ 1,918,610 $ -
Short-term borrowings 199,345 199,345 - 199,345 -
Long-term borrowings 717 854 - 854 -
Subordinated debentures owed to unconsolidated subsidiary trusts
19,589 19,589 - 19,589 -
Accrued interest payable 1,234 1,234 - 1,234 -
Derivative financial liabilities 988 988 - 988 -
$ 2,135,110 $ 2,140,620 $ - $ 2,140,620 $ -
NOTE 5. DEBT SECURITIES
We classify debt securities as held to maturity, available for sale or trading according to management’s intent. The appropriate classification is determined at the time of purchase of each security and re-evaluated at each reporting date.
Debt securities held to maturity: Certain debt securities for which we have the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts.
Debt securities available for sale: Debt securities not classified as "held to maturity" or as "trading" are classified as "available for sale." Securities classified as "available for sale" are those securities that we intend to hold for an indefinite period of time, but not necessarily to maturity. "Available for sale" securities are reported at estimated fair value net of unrealized gains or losses, which are adjusted for applicable income taxes and reported as a separate component of shareholders' equity.
Debt trading securities: There are no securities classified as "trading" in the accompanying financial statements.
Allowance for Credit Losses - Debt Securities Available for Sale: For debt securities available for sale in an unrealized loss position, we first assess whether (i) we intend to sell or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Adjustments to the allowance are reported in our income statement as a component of the provision for credit losses. We have elected to exclude accrued interest receivable on available-for-sale securities from the estimate of credit losses. Debt securities available for sale are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible or when either of the aforementioned criteria regarding intent or requirement to sell is met.
Allowance for Credit Losses - Debt Securities Held to Maturity: The allowance for credit losses on debt securities held to maturity is a contra-asset valuation account, calculated in accordance with ASC 326, that is deducted from the amortized cost basis of debt securities held to maturities to present our best estimate of the net amount expected to be collected. Debt securities held to maturity are charged-off against the allowance when deemed uncollectible. Adjustments to the allowance are reported in our income statement as a component of the provision for credit losses. We measure expected credit losses on debt securities held to maturity on a collective basis by major security type with each type sharing similar risk characteristics and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. We made the accounting policy election to exclude accrued interest receivable on debt securities held to maturity from the estimate of credit losses.
Prior to the adoption of ASC 326, declines in the fair value of debt securities held to maturity and available for sale below their cost that were deemed to be other than temporary were reflected in earnings as realized losses. In estimating other-than-temporary impairment losses prior to January 1, 2020, management considered, among other things, (i) the length of time and the extent to which the fair value had been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) the intent and our ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Realized gains and losses on sales of securities are recognized on the specific identification method. Amortization of premiums and accretion of discounts are computed using the interest method.
Debt Securities Available for Sale
The amortized cost, unrealized gains, unrealized losses and estimated fair values of debt securities available for sale at December 31, 2020 and 2019, are summarized as follows:
December 31, 2020
Amortized Unrealized
Dollars in thousands Cost Gains Losses Fair Value
Debt Securities Available for Sale
Taxable debt securities
U.S. Government and agencies and corporations $ 35,190 $ 361 $ 394 $ 35,157
Residential mortgage-backed securities:
Government-sponsored agencies 57,399 1,996 349 59,046
Nongovernment-sponsored entities 16,799 132 244 16,687
State and political subdivisions
General obligations 15,065 804 4 15,865
Water and sewer revenues 10,176 620 - 10,796
Lease revenues 4,825 341 - 5,166
College and university revenues 3,022 315 - 3,337
Income tax revenues 5,052 376 - 5,428
Other revenues 9,406 907 - 10,313
Corporate debt securities 26,483 56 112 26,427
Asset-backed securities 46,579 172 625 46,126
Total taxable debt securities 229,996 6,080 1,728 234,348
Tax-exempt debt securities
State and political subdivisions
General obligations 22,213 2,416 9 24,620
Water and sewer revenues 8,266 709 - 8,975
Lease revenues 7,195 799 - 7,994
Other revenues 9,487 711 8 10,190
Total tax-exempt debt securities 47,161 4,635 17 51,779
Total debt securities available for sale $ 277,157 $ 10,715 $ 1,745 $ 286,127
December 31, 2019
Amortized Unrealized
Dollars in thousands Cost Gains Losses Fair Value
Debt Securities Available for Sale
Taxable debt securities
U.S. Government and agencies and corporations $ 21,036 $ 212 $ 384 $ 20,864
Residential mortgage-backed securities:
Government-sponsored agencies 70,379 1,031 435 70,975
Nongovernment-sponsored entities 10,253 17 41 10,229
State and political subdivisions
General obligations 12,603 25 171 12,457
Water and sewer revenues 7,170 71 114 7,127
Lease revenues 5,310 25 77 5,258
College and university revenues 5,917 164 16 6,065
Other revenues 18,831 344 109 19,066
Corporate debt securities 18,268 81 149 18,200
Asset-backed securities 33,826 - 812 33,014
Total taxable debt securities 203,593 1,970 2,308 203,255
Tax-exempt debt securities
State and political subdivisions
General obligations 36,673 2,526 - 39,199
Water and sewer revenues 9,565 633 - 10,198
Lease revenues 8,455 598 - 9,053
Other revenues 13,929 728 7 14,650
Total tax-exempt debt securities 68,622 4,485 7 73,100
Total debt securities available for sale $ 272,215 $ 6,455 $ 2,315 $ 276,355
Accrued interest receivable on debt securities available for sale totaled $1.7 million and $1.9 million at December 31, 2020 and 2019, respectively and is included in accrued interest and fees receivable in the accompanying consolidated balance sheets.
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.
December 31, 2020
Amortized Unrealized
Dollars in thousands Cost Gains Losses Fair Value
California $ 14,569 $ 1,386 $ - $ 15,955
Texas 11,978 896 - 12,874
New York 10,441 947 - 11,388
Virginia 8,151 566 - 8,717
Florida 7,728 589 4 8,313
Management performs pre-purchase and ongoing analysis to confirm that all investment securities meet applicable credit quality standards. We principally use credit ratings from Nationally Recognized Statistical Rating Organizations (“NRSROs”) to support analyses of our portfolio of securities issued by state and political subdivisions, as we generally do not purchase securities that are rated below the six highest NRSRO rating categories. In addition to considering a security’s NRSRO rating, we also assess or confirm through an internal review of an issuer’s financial information and other applicable information that: 1) the issuer’s risk of default is low; 2) the characteristics of the issuer’s demographics and economic environment are satisfactory; and 3) the issuer’s budgetary position and stability of tax or other revenue sources are sound.
The 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 are as follows:
Dollars in thousands Proceeds from Gross realized
Calls and Principal
Years ended December 31, Sales Maturities Payments Gains Losses
2020 $ 124,809 $ 3,525 $ 24,654 $ 3,489 $ 17
2019 142,423 1,871 22,870 2,270 332
2018 107,559 1,145 24,814 1,785 1,163
Residential mortgage-backed obligations having contractual maturities ranging from 4 to 48 years are included in the following maturity distribution schedules based on their anticipated average life to maturity, which ranges from 1 month to 17 years. Accordingly, discounts are accreted and premiums are amortized over the anticipated average life to maturity of the specific obligation.
The maturities, amortized cost and estimated fair values of securities available for sale at December 31, 2020, are summarized as follows:
Dollars in thousands Amortized
Cost
Fair Value
Due in one year or less $ 34,731 $ 35,192
Due from one to five years 82,553 84,313
Due from five to ten years 59,749 60,645
Due after ten years 100,124 105,977
Total $ 277,157 $ 286,127
At December 31, 2020 and 2019, securities with estimated fair values of $162.8 million and $86.1 million respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
Provided below is a summary of debt securities available for sale which were in an unrealized loss position and for which an allowance for credit losses has not been recorded at December 31, 2020 and 2019.
Less than 12 months 12 months or more Total
Dollars in thousands # of securities in loss position
Fair Value Unrealized
Loss
Fair Value Unrealized
Loss
Fair Value Unrealized
Loss
Taxable debt securities
U.S. Government agencies and corporations
36 $ 12,611 $ 54 $ 14,384 $ 340 $ 26,995 $ 394
Residential mortgage-backed
securities:
Government-sponsored agencies 10 3,127 34 8,593 315 11,720 349
Nongovernment-sponsored entities 6 6,770 35 2,751 209 9,521 244
State and political subdivisions:
General obligations 1 362 4 - - 362 4
Corporate debt securities 6 3,952 16 1,904 96 5,856 112
Asset-backed securities 16 2,010 2 31,862 623 33,872 625
Tax-exempt debt securities
State and political subdivisions:
General obligations 1 924 9 - - 924 9
Other revenues 2 415 1 151 7 566 8
Total 78 $ 30,171 $ 155 $ 59,645 $ 1,590 $ 89,816 $ 1,745
Less than 12 months 12 months or more Total
Dollars in thousands # of securities in loss position
Fair Value Unrealized
Loss
Fair Value Unrealized
Loss
Fair Value Unrealized
Loss
Taxable debt securities
U.S. Government agencies and corporations
15 $ - $ - $ 14,903 $ 384 $ 14,903 $ 384
Residential mortgage-backed
securities:
Government-sponsored agencies 21 12,298 96 15,174 339 27,472 435
Nongovernment-sponsored entities 4 8,323 41 - - 8,323 41
State and political subdivisions:
General obligations 10 10,581 171 - - 10,581 171
Water and sewer revenues 4 4,421 114 - - 4,421 114
Lease revenues 4 4,235 77 - - 4,235 77
College and university revenues 1 1,307 16 - - 1,307 16
Other revenues 6 6,517 109 - - 6,517 109
Corporate debt securities 6 1,686 3 3,739 146 5,425 149
Asset-backed securities 15 3,441 34 29,573 778 33,014 812
Tax-exempt debt securities
State and political subdivisions:
Other revenues 2 1,183 7 - - 1,183 7
Total 88 $ 53,992 $ 668 $ 63,389 $ 1,647 $ 117,381 $ 2,315
We do not intend to sell the above 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 changes in market interest rates, and in some cases limited market liquidity and is not due to credit quality as none of these securities are in default and all carry above investment grade ratings. Accordingly, no allowance for credit losses has been recognized relative to these securities.
Debt Securities Held to Maturity
The amortized cost, unrealized gains, unrealized losses and estimated fair values of debt securities held to maturity at December 31, 2020 are summarized as follows:
December 31, 2020
Amortized Unrealized Estimated
Dollars in thousands Cost Gains Losses Fair Value
Debt Securities Held to Maturity
Tax-exempt debt securities
State and political subdivisions
General obligations $ 73,179 $ 2,524 $ - $ 75,703
Water and sewer revenues 8,375 256 - 8,631
Lease revenues 4,395 88 - 4,483
Sales tax revenues 4,649 94 3 4,740
Other revenues 9,316 309 25 9,600
Total Debt Securities Held to Maturity $ 99,914 $ 3,271 $ 28 $ 103,157
Accrued interest receivable on debt securities held to maturity totaled $1.2 million at December 31, 2020 and is included in accrued interest and fees receivable in the accompanying consolidated balance sheets.
The below information is relative to the five states where issuers with the highest volume of state and political subdivision securities held in our held to maturity portfolio are located. We own no such securities of any single issuer which we deem to be a concentration.
December 31, 2020
Amortized Unrealized Estimated
Dollars in thousands Cost Gains Losses Fair Value
Texas $ 15,695 $ 600 $ - $ 16,295
California 10,081 377 - 10,458
Pennsylvania 8,786 186 - 8,972
Florida 7,724 299 - 8,023
Michigan 7,160 144 3 7,301
The following table displays the amortized cost of held to maturity securities by credit rating at December 31, 2020.
Dollars in thousands AAA AA A BBB Below Investment Grade
Tax-exempt state and political subdivisions $ 15,735 $ 76,585 $ 7,594 $ - $ -
We owned no past due or nonaccrual held to maturity debt securities at December 31, 2020.
The maturities, amortized cost and estimated fair values of debt securities held to maturity at December 31, 2020, are summarized as follows:
Dollars in thousands Amortized
Cost Estimated
Fair Value
Due in one year or less $ - $ -
Due from one to five years - -
Due from five to ten years 2,038 2,105
Due after ten years 97,876 101,052
Total $ 99,914 $ 103,157
The proceeds from calls and maturities of debt securities held to maturity totaled $1.0 million for the year ended December 31, 2020.
NOTE 6. OTHER INVESTMENTS
Equity securities are carried at fair value, with changes in fair value reported in net income. Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment. Our equity securities totaled $407,000 at December 31, 2020 and $137,000 at December 31, 2019.
We are a member bank of the Federal Home Loan Bank ("FHLB") system. Members are required to own a certain amount of stock based on the level of borrowings from FHLB and other factors. FHLB stock is carried at cost and periodically evaluated for impairment based on ultimate recovery of par value. Dividends are reported as income as earned. This stock totaled $9.8 million and $8.9 million at December 31, 2020 and 2019.
We have invested in four limited partnerships which own interests in diversified portfolios of qualified affordable housing projects. Also, we have purchased substantially all the interest in a limited liability company owning a qualified rehabilitated multi-family housing project. As result of these investments, Summit is allocated its proportional share of each investees’ operating losses and Federal Low-Income Housing and Rehabilitation Tax Credits. We use the proportional amortization method to account for each of these investments, whereby the cost of the investment is amortized in proportion to the amount of tax credits and other tax benefits received, and the net investment performance is recognized in the consolidated statement of income as a component of the provision for current income taxes. As of December 31, 2020 and 2019, our carrying value of these investments totaled $3.9 million and $3.9 million, respectively. For the years ended December 31, 2020, 2019 and 2018, we realized $746,000, $669,000 and $1,544,000, respectively, in tax credits and other tax benefits on these investments, against which we amortized these investments $549,000, $552,000 and $1.27 million and recognized income tax benefits of $248,000, $177,000 and $286,000.
NOTE 7. LOANS AND ALLOWANCE FOR CREDIT LOSSES ON LOANS
Loans are generally stated at the amount of unpaid principal, reduced by unearned discount and the ACLL. Interest on loans is accrued daily on the outstanding balances. Loan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the related loan yield over its contractual life.
Loans
The following table presents the amortized cost of loans held for investment:
Dollars in thousands 2020 2019
Commercial $ 306,885 $ 220,452
Commercial real estate - owner occupied
Professional & medical 107,151 81,973
Retail 126,451 100,993
Other 118,258 93,253
Commercial real estate - non-owner occupied
Hotels & motels 121,502 128,665
Mini-storage 60,550 50,913
Multifamily 175,988 164,398
Retail 135,405 102,989
Other 192,120 182,242
Construction and development
Land & land development 107,342 84,112
Construction 91,100 37,523
Residential 1-4 family real estate
Personal residence 305,093 260,843
Rental - small loan 120,426 101,080
Rental - large loan 74,185 63,986
Home equity 81,588 76,568
Mortgage warehouse lines 251,810 126,237
Consumer 33,906 35,021
Other
Credit cards 1,855 1,453
Overdrafts 538 798
Total loans, net of unearned fees 2,412,153 1,913,499
Less allowance for credit losses - loans 32,246 13,074
Loans, net $ 2,379,907 $ 1,900,425
Accrued interest and fees receivable on loans totaled $9.1 million and $6.5 million at December 31, 2020 and 2019, respectively and is included in accrued interest and fees receivable in the accompany consolidated balance sheets.
The following presents loan maturities at December 31, 2020:
Within After 1 but After
Dollars in thousands 1 Year within 5 Years 5 Years
Commercial $ 96,960 $ 145,709 $ 64,216
Commercial real estate - owner occupied
Professional & medical 1,888 18,814 86,449
Retail 8,908 8,658 108,885
Other 8,205 10,542 99,511
Commercial real estate - non-owner occupied
Hotels & motels 2,806 27,809 90,887
Mini-storage 170 1,267 59,113
Multifamily 19,406 10,708 145,874
Retail 7,599 19,869 107,937
Other 18,942 54,440 118,738
Construction and development
Land & land development 33,200 38,682 35,460
Construction 5,697 37,643 47,760
Residential 1-4 family real estate
Personal residence 3,826 12,087 289,180
Rental - small loan 11,755 11,667 97,004
Rental - large loan 7,097 8,740 58,348
Home equity 364 4,404 76,820
Mortgage warehouse lines 251,810 - -
Consumer 3,941 23,435 6,530
Other
Credit cards 1,855 - -
Overdrafts 538 - -
$ 484,967 $ 434,474 $ 1,492,712
Loans due after one year with:
Variable rates $ 941,137
Fixed rates 986,049
$ 1,927,186
COVID-19 Loan Deferments. Certain borrowers are currently unable to meet their contractual payment obligations because of the adverse effects of COVID-19. To help mitigate these effects, loan customers may apply for a deferral of payments, or portions thereof, for up to 90 days. After 90 days, customers may apply for an additional deferral, and a small proportion of our customers have requested such an additional deferral. In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as troubled debt restructurings, nor are loans granted payment deferrals related to COVID-19 reported as past due or placed on non-accrual status (provided the loans were not past due or on non-accrual status prior to the deferral). At December 31, 2020, we had 42 loans in COVID-19 related deferment with an aggregate outstanding balance of approximately $79.3 million.
Past Due Loans and Non-Accrual Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. In determining whether or not a borrower may be unable to meet payment obligations for each class of loans, we consider the borrower’s debt service capacity through the analysis of current financial information, if available, and/or current information with regards to our collateral position. Regulatory provisions would typically require the placement of a loan on non-accrual status if (i) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.
The following tables present the contractual aging of the amortized cost basis of past due loans by class.
At December 31, 2020
Past Due 90 days or more and Accruing
Dollars in thousands 30-59 days 60-89 days 90 days or more Total Current
Commercial $ 60 $ - $ 318 $ 378 $ 306,507 $ -
Commercial real estate - owner occupied
Professional & medical 220 - 457 677 106,474 -
Retail 54 - 2,259 2,313 124,138 -
Other - - 150 150 118,108 -
Commercial real estate - non-owner occupied
Hotels & motels - - - - 121,502 -
Mini-storage - - - - 60,550 -
Multifamily - - - - 175,988 -
Retail - - 657 657 134,748 -
Other - - 315 315 191,805 -
Construction and development
Land & land development 47 - 70 117 107,225 -
Construction - - - - 91,100 -
Residential 1-4 family real estate
Personal residence 3,750 1,071 1,656 6,477 298,616 -
Rental - small loan 1,129 487 719 2,335 118,091 -
Rental - large loan 769 - - 769 73,416 -
Home equity 758 - 197 955 80,633 -
Mortgage warehouse lines - - - - 251,810 -
Consumer 190 44 72 306 33,600 -
Other
Credit cards 5 - 2 7 1,848 2
Overdrafts - - - - 538 -
Total $ 6,982 $ 1,602 $ 6,872 $ 15,456 $ 2,396,697 $ 2
At December 31, 2019
Past Due 90 days or more and Accruing
Dollars in thousands 30-59 days 60-89 days 90 days or more Total Current
Commercial $ 216 $ - $ 483 $ 699 $ 219,753 $ -
Commercial real estate - owner occupied
Professional & medical - 137 1,602 1,739 80,234 -
Retail 118 - 2,434 2,552 98,441 -
Other - - - - 93,253 -
Commercial real estate - non-owner occupied
Hotels & motels - - - - 128,665 -
Mini-storage - - - - 50,913 -
Multifamily 809 - 7 816 163,582 -
Retail 71 179 968 1,218 101,771 -
Other - - 387 387 181,855 -
Construction and development
Land & land development 208 28 188 424 83,688 -
Construction - - 138 138 37,385 -
Residential 1-4 family real estate
Personal residence 3,361 806 937 5,104 255,739 -
Rental - small loan 810 21 940 1,771 99,309 -
Rental - large loan - - - - 63,986 -
Home equity 760 - 223 983 75,585 -
Mortgage warehouse lines - - - - 126,237 -
Consumer 190 79 70 339 34,682 -
Other
Credit cards 19 6 42 67 1,386 42
Overdrafts - - - - 798 -
Total $ 6,562 $ 1,256 $ 8,419 $ 16,237 $ 1,897,262 $ 42
The following tables present the nonaccrual loans included in the net balance of loans.
December 31, December 31,
2020 2019
Dollars in thousands Nonaccrual Nonaccrual
with No
Allowance for
Credit Losses
- Loans Nonaccrual Nonaccrual
with No
Allowance for
Credit Losses
- Loans
Commercial $ 525 $ - $ 864 $ 76
Commercial real estate - owner occupied
Professional & medical 536 - 1,602 -
Retail 12,193 2,258 2,552 2,262
Other 384 - 43 -
Commercial real estate - non-owner occupied
Hotels & motels - - - -
Mini-storage - - 57 -
Multifamily - - 38 31
Retail 809 657 1,120 527
Other 315 - 388 40
Construction and development
Land & land development 70 - 188 -
Construction 165 - 138 -
Residential 1-4 family real estate
Personal residence 3,424 - 2,485 423
Rental - small loan 1,603 108 1,635 150
Rental - large loan - - - -
Home equity 236 - 284 -
Mortgage warehouse lines - - - -
Consumer 73 - 74 -
Other
Credit cards - - - -
Overdrafts - - - -
Total $ 20,333 $ 3,023 $ 11,468 $ 3,509
Troubled Debt Restructurings. The restructuring of a loan is considered a troubled debt restructuring (“TDR”) if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules, payment deferrals, reductions in collateral and other actions intended to minimize potential losses.
At December 31, 2020, we had TDRs of $24.5 million, of which $20.5 million were current with respect to restructured contractual payments. At December 31, 2019, our TDRs totaled $25.7 million, of which $22.9 million were current with respect to restructured contractual payments. 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 years ended December 31, 2020 and 2019. 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. TDRs are evaluated individually for allowance for credit loss purposes if the loan balance exceeds $500,000, otherwise, smaller balance TDR loans are included in the pools to determine ACLL.
2020 2019
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
Other
1 $ 361 $ 361 1 $ 325 $ 325
Commercial real estate - non-owner occupied
Multifamily
- - - 1 35 35
Retail
- - - 2 162 162
Other
- - - 1 126 126
Residential 1-4 family real estate
Personal residence
1 48 48 3 151 151
Rental - small loan
1 399 399 4 259 259
Consumer - - - 1 16 16
Total 3 $ 808 $ 808 13 $ 1,074 $ 1,074
The following tables present defaults during the stated period of TDRs that were restructured during the prior 12 months. For purposes of these tables, a default is considered as either the loan was past due 30 days or more at any time during the period, or the loan was fully or partially charged off during the period.
2020 2019
Dollars in thousands Number
of
Defaults Recorded
Investment
at Default Date Number
of
Defaults Recorded
Investment
at Default Date
Commercial real estate - owner occupied
Other 1 $ 361 - $ -
Commercial real estate - non-owner occupied
Retail - - 1 52
Other - - 1 126
Residential 1-4 family real estate
Personal residence 1 48 2 122
Rental - small loan 1 399 1 52
Total 3 $ 808 5 $ 352
Credit Quality Indicators: We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. We internally grade all commercial loans at the time of loan origination. In addition, we perform an annual loan review on all non-homogenous commercial loan relationships with an aggregate exposure of $5.0 million, at which time these loans are re-graded. We use the following definitions for our risk grades:
Pass: Loans graded as Pass are loans to borrowers of acceptable credit quality and risk. They are higher quality loans that do not fit any of the other categories described below.
OLEM (Special Mention): Commercial loans categorized as OLEM are potentially weak. The credit risk may be relatively minor yet represent a risk given certain specific circumstances. If the potential weaknesses are not monitored or mitigated, the asset may weaken or inadequately protect our position in the future.
Substandard: Commercial loans categorized as Substandard are inadequately protected by the borrower’s ability to repay, equity and/or the collateral pledged to secure the loan. These loans have identified weaknesses that could hinder normal repayment or collection of the debt. These loans are characterized by the distinct possibility that we will sustain some loss if the identified weaknesses are not mitigated.
Doubtful: Commercial loans categorized as Doubtful have all the weaknesses inherent in those loans classified as Substandard, with the added elements that the full collection of the loan is improbable and the possibility of loss is high.
Loss: Loans classified as loss are considered to be non-collectible and of such little value that their continuance as a bankable asset is not warranted. This does not mean that the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future.
Management considers the guidance in ASC 310-20 when determining whether a modification, extension, or renewal of loan constitutes a current period origination. Generally, current period renewals of credit are reunderwritten at the point of renewal and considered current period originations for purposes of the table below. As of December 31, 2020, based on the most recent analysis performed, the risk category of loans based on year of origination is as follows:
December 31, 2020
Dollars in thousands Risk Rating 2020 2019 2018 2017 2016 Prior Revolvi-
ng Revolving- Term Total
Commercial Pass $ 112,335 $ 46,323 $ 20,936 $ 16,723 $ 11,087 $ 12,336 $ 78,107 $ - $ 297,847
Special Mention 9 38 1,956 77 201 909 407 - 3,597
Substandard 1,039 177 215 29 40 56 3,885 - 5,441
Total Commercial 113,383 46,538 23,107 16,829 11,328 13,301 82,399 - 306,885
Commercial Real Estate
- Owner Occupied
Professional & medical Pass 19,454 16,414 2,540 26,578 3,322 28,905 3,079 - 100,292
Special Mention 1,171 - - - - 5,152 - - 6,323
Substandard 79 321 - - 136 - - - 536
Total Professional & Medical 20,704 16,735 2,540 26,578 3,458 34,057 3,079 - 107,151
Retail Pass 28,351 28,547 5,238 10,288 6,041 31,087 2,199 - 111,751
Special Mention - - - 432 3 824 - - 1,259
Substandard - 10,524 - 157 - 2,360 400 - 13,441
Total Retail 28,351 39,071 5,238 10,877 6,044 34,271 2,599 - 126,451
Other Pass 28,712 13,722 17,699 9,845 13,119 32,486 1,496 - 117,079
Special Mention - - - - - 694 - - 694
Substandard - - - - - 444 41 - 485
Total Other 28,712 13,722 17,699 9,845 13,119 33,624 1,537 - 118,258
Total Commercial Real Estate -
Owner Occupied 77,767 69,528 25,477 47,300 22,621 101,952 7,215 - 351,860
Commercial Real Estate
- Non-Owner Occupied
Hotels & motels Pass 3,428 23,821 18,894 9,880 7,389 14,252 3,160 - 80,824
Special Mention 2,994 37,398 - - - 286 - - 40,678
Substandard - - - - - - - - -
Total Hotels & Motels 6,422 61,219 18,894 9,880 7,389 14,538 3,160 - 121,502
Mini-storage Pass 10,159 19,022 15,046 3,986 6,228 4,780 170 - 59,391
Special Mention - - - - - 50 - - 50
Substandard - - - - - 1,109 - - 1,109
December 31, 2020
Dollars in thousands Risk Rating 2020 2019 2018 2017 2016 Prior Revolvi-
ng Revolving- Term Total
Total Mini-storage 10,159 19,022 15,046 3,986 6,228 5,939 170 - 60,550
Multifamily Pass 39,814 27,090 27,198 19,294 10,762 47,751 2,844 - 174,753
Special Mention - - - - - 48 - - 48
Substandard - 1,187 - - - - - - 1,187
Total Multifamily 39,814 28,277 27,198 19,294 10,762 47,799 2,844 - 175,988
Retail Pass 44,359 27,357 11,169 9,361 4,414 30,381 6,502 - 133,543
Special Mention - - - - 446 540 - - 986
Substandard - - - 152 - 724 - - 876
Total Retail 44,359 27,357 11,169 9,513 4,860 31,645 6,502 - 135,405
Other Pass 75,272 20,483 24,663 10,626 26,989 28,293 1,794 - 188,120
Special Mention - - - - - 142 - - 142
Substandard - - - - - - - - -
Doubtful - - 576 - - 3,282 - - 3,858
Total Other 75,272 20,483 25,239 10,626 26,989 31,717 1,794 - 192,120
Total Commercial Real Estate -
Non-Owner Occupied 176,026 156,358 97,546 53,299 56,228 131,638 14,470 - 685,565
Construction and Development
Land & land development Pass 27,084 25,468 10,943 4,149 6,370 21,882 9,320 - 105,216
Special Mention - 70 12 - - 644 - - 726
Substandard - - 6 - 11 1,383 - - 1,400
Total Land & land development 27,084 25,538 10,961 4,149 6,381 23,909 9,320 - 107,342
Construction Pass 50,060 34,480 2,833 885 - - 1,325 - 89,583
Special Mention - - - - - - - - -
Substandard - 1,352 - - - 165 - - 1,517
Total Construction 50,060 35,832 2,833 885 - 165 1,325 - 91,100
Total Construction and
Development 77,144 61,370 13,794 5,034 6,381 24,074 10,645 - 198,442
Residential 1-4 Family Real Estate
Personal residence Pass 51,120 31,415 27,052 23,069 23,759 126,293 - - 282,708
Special Mention - 242 131 267 254 12,020 - - 12,914
Substandard - 46 849 540 126 7,910 - - 9,471
Total Personal Residence 51,120 31,703 28,032 23,876 24,139 146,223 - - 305,093
Rental - small loan Pass 18,762 20,113 14,512 10,705 10,941 34,643 4,047 - 113,723
Special Mention 110 253 251 3 192 1,749 62 - 2,620
Substandard - 1,163 - - 46 2,874 - - 4,083
Total Rental - Small Loan 18,872 21,529 14,763 10,708 11,179 39,266 4,109 - 120,426
December 31, 2020
Dollars in thousands Risk Rating 2020 2019 2018 2017 2016 Prior Revolvi-
ng Revolving- Term Total
Rental - large loan Pass 16,926 5,484 9,456 5,323 9,133 20,515 2,188 - 69,025
Special Mention - 1,430 - - - 32 - - 1,462
Substandard - - - - - 3,698 - - 3,698
Total Rental - Large Loan 16,926 6,914 9,456 5,323 9,133 24,245 2,188 - 74,185
Home equity Pass 429 565 347 502 89 2,174 74,974 - 79,080
Special Mention - - - 40 - 96 1,596 - 1,732
Substandard - - 32 28 - 424 292 - 776
Total Home Equity 429 565 379 570 89 2,694 76,862 - 81,588
Total Residential 1-4 Family Real
Estate 87,347 60,711 52,630 40,477 44,540 212,428 83,159 - 581,292
Mortgage warehouse lines Pass - - - - - - 251,810 - 251,810
Special Mention - - - - - - - - -
Substandard - - - - - - - - -
Total Mortgage Warehouse Lines - - - - - - 251,810 - 251,810
Consumer Pass 12,785 9,257 4,239 1,609 1,237 1,516 822 - 31,465
Special Mention 991 454 214 155 70 49 18 - 1,951
Substandard 245 127 31 6 51 4 26 - 490
Total Consumer 14,021 9,838 4,484 1,770 1,358 1,569 866 - 33,906
Other
Credit cards Pass 1,855 - - - - - - - 1,855
Special Mention - - - - - - - - -
Substandard - - - - - - - - -
Total Credit Cards 1,855 - - - - - - - 1,855
Overdrafts Pass 538 - - - - - - - 538
Special Mention - - - - - - - - -
Substandard - - - - - - - - -
Total Overdrafts 538 - - - - - - - 538
Total Other 2,393 - - - - - - - 2,393
Total $ 548,081 $ 404,343 $ 217,038 $ 164,709 $ 142,456 $ 484,962 $ 450,564 $ - $ 2,412,153
Allowance for Credit Losses - Loans
The ACLL is a valuation allowance, estimated at each balance sheet date in accordance with ASC 326, that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of the ACLL represents our best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability over the loans’ contractual terms, adjusted for expected prepayments when appropriate (the “life-of-loan” concept). The contractual term excludes expected extensions, renewals and modifications unless (i) management has a reasonable expectation that a troubled debt restructuring will be executed with an individual borrower or (ii) such
extension or renewal options are not unconditionally cancellable by us and, in such cases, the borrower is likely to meet applicable conditions and likely to request extension or renewal. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. The ACLL losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty, but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.
Expected credit losses are reflected in the ACLL through a charge to provision for credit losses. When we deem all or a portion of a financial asset to be uncollectible the appropriate amount is written off and the ACLL is reduced by the same amount. The Company applies judgment to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted. Subsequent recoveries, if any, are credited to the ACLL when received.
Loan Pools. In calculating the ACLL, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type/purpose of loan, underlying collateral, geographical similarity and historical/expected credit loss patterns. In developing these loan pools for the purposes of modeling expected credit losses, we also analyzed the degree of correlation in how loans within each portfolio respond when subjected to varying economic conditions and scenarios as well as other portfolio stress factors. We have identified the pools of financial assets with similar risk characteristics for measuring expected credit losses as presented in the table of amortized cost of loans held for investment above.
We periodically reassess each pool to ensure the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.
Residential 1-4 family rentals are classified as small loan if the original loan amount is less than $600,000 and classified as large loan if the original loan amount equals or exceeds $600,000.
The Company’s methodology for estimating the ACLL considers available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. The methodology applies historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual lives of the financial assets that are reasonable and supportable, to the identified pools of financial assets with similar risk characteristics for which the historical loss experience was observed. Our methodology reverts to historical loss information immediately when it can no longer develop reasonable and supportable forecasts.
Loss-Rate Method. We use a loss-rate (“cohort”) method to estimate expected credit losses for all loan pools. The cohort method identifies and captures the balances of pooled loans with similar risk characteristics, as of a point in time to form a cohort, then tracks the respective losses generated by that cohort of loans over their remaining lives, or until the loans are “exhausted” (reached an acceptable stage at which a significant majority of all losses are expected to have been recognized). This method encompasses loan balances for as long as the loans are outstanding, so while significant history is required to represent the life-of-loan concept, this method does not require as much history due to its inclusion of loan balances in multiple cohort periods.
Qualitative Factors. We qualitatively adjust our loan loss rates for risk factors that are not otherwise considered within our model but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) adjustments may increase or decrease our estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk.
One Q-Factor adjustment to our loss rates is consideration of reasonable and supportable forecasts of economic conditions. In arriving at a reasonable and supportable economic forecast, we primarily consider the forecasted unemployment rates for the U.S., West Virginia and Virginia as loss drivers for each segmented loan pool. Secondarily, we consider the following forecasted economic data for one or more of our segmented loan pools depending on the nature of the underlying loan pool: housing price indices (U.S., West Virginia & Virginia), single-family housing starts (West Virginia & Virginia), multi-family housing starts (West Virginia & Virginia), personal income growth (U.S., West Virginia & Virginia), U.S. consumer confidence, rental vacancy rates (U.S.), and U.S. % change in gross domestic product.
Other risks that we may consider in making Q-Factor adjustments include, among other things, the impact of (i) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and
recoveries, (ii) changes in the nature and volume of the loan pools and in the terms of the underlying loans, (iii) changes in the experience, ability, and depth of our lending management and staff, (iv) changes in volume and severity of past due financial assets, the volume of non-accrual assets, and the volume and severity of adversely classified or graded assets, (v) changes in the quality of our credit review function, (vi) changes in the value of the underlying collateral for loans that are non-collateral dependent, (vii) the existence, growth, and effect of any concentrations of credit and (viii) other external factors such as the regulatory, legal and technological environments; competition; and events such as natural disasters or health pandemics.
Collateral Dependent Loans. We may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. We reevaluate the fair value of collateral supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent loans is evaluated by appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice.
The following table presents the activity in the ACLL by portfolio segment during the twelve months of 2020:
For the Year Ended December 31, 2020
Allowance for Credit Losses - Loans
Dollars in thousands Beginning
Balance
Prior to
Adoption of
ASC 326 Impact of
Adoption
of ASC
326 Provision
for
Credit
Losses -
Loans
Adjustment
for PCD
Acquired
Loans Charge-
offs Recoveries Ending
Balance
Commercial $ 1,221 $ 1,064 $ 85 $ - $ (99) $ 33 $ 2,304
Commercial real estate - owner occupied
Professional & medical
1,058 (390) 1,290 1 (1,005) - 954
Retail
820 (272) 2,311 152 - 162 3,173
Other 821 (137) (104) 1 - 29 610
Commercial real estate - non-owner occupied
Hotels & motels
1,235 (936) 1,836 - - - 2,135
Mini-storage
485 (311) 48 115 - - 337
Multifamily
1,534 8 (155) 122 - 38 1,547
Retail
964 279 (22) 101 (343) 2 981
Other
1,721 (1,394) 700 58 - 19 1,104
Construction and development
Land & land development
600 2,136 1,202 111 (7) 42 4,084
Construction 242 996 3,159 251 - - 4,648
Residential 1-4 family real estate
Personal residence 1,275 1,282 980 182 (252) 92 3,559
Rental - small loan 532 1,453 657 96 (140) 138 2,736
Rental - large loan 49 2,884 58 16 - - 3,007
Home equity 138 308 246 - (24) 45 713
Mortgage warehouse lines
- - - - - - -
Consumer 379 (238) 166 - (239) 148 216
Other
Credit cards - 12 35 - (40) 10 17
Overdrafts - 182 251 - (460) 148 121
Total
$ 13,074 $ 6,926 $ 12,743 $ 1,206 $ (2,609) $ 906 $ 32,246
The following table presents, as of December 31, 2020 segregated by loan portfolio segment, details of the loan portfolio and the ACLL calculated in accordance with our credit loss accounting methodology for loans described above.
December 31, 2020
Loan Balances Allowance for Credit Losses - Loans
Dollars in thousands Loans Individually Evaluated Loans Collectively Evaluated (1) Total Loans Individually Evaluated Loans Collectively Evaluated Total
Commercial $ 4,851 $ 302,034 $ 306,885 $ 8 $ 2,296 $ 2,304
Commercial real estate - owner occupied
Professional & medical 2,171 104,980 107,151 223 731 954
Retail 17,458 108,993 126,451 2,258 915 3,173
Other - 118,258 118,258 - 610 610
Commercial real estate - non-owner occupied
Hotels & motels - 121,502 121,502 - 2,135 2,135
Mini-storage 1,109 59,441 60,550 111 226 337
Multifamily 1,187 174,801 175,988 135 1,412 1,547
Retail 3,473 131,932 135,405 - 981 981
Other 5,857 186,263 192,120 129 975 1,104
Construction and development
Land & land development 1,891 105,451 107,342 623 3,461 4,084
Construction 1,352 89,748 91,100 135 4,513 4,648
Residential 1-4 family real estate
Personal residence - 305,093 305,093 - 3,559 3,559
Rental - small loan 1,300 119,126 120,426 102 2,634 2,736
Rental - large loan 3,288 70,897 74,185 - 3,007 3,007
Home equity 523 81,065 81,588 - 713 713
Consumer - 33,906 33,906 - 216 216
Other
Credit cards - 1,855 1,855 - 17 17
Overdrafts - 538 538 - 121 121
Mortgage warehouse lines - 251,810 251,810 - - -
Total $ 44,460 $ 2,367,693 $ 2,412,153 $ 3,724 $ 28,522 $ 32,246
1) Included in the loans collectively evaluated are $83.9 million in fully guaranteed or cash secured loans, which are excluded from the pools collectively evaluated and carry no allowance.
The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses, and the related ACLL allocated to those loans:
December 31, 2020
Dollars in thousands Real Estate
Secured
Loans Non-Real Estate
Secured Loans Total Loans Allowance for Credit Losses
- Loans
Commercial $ - $ 4,851 $ 4,851 $ 8
Commercial real estate - owner occupied
Professional & medical 2,171 - 2,171 223
Retail 17,458 - 17,458 2,258
Other - - - -
Commercial real estate - non-owner occupied
Hotels & motels - - - -
Mini-storage 1,109 - 1,109 111
Multifamily 1,187 - 1,187 135
Retail 3,473 - 3,473 -
Other 5,857 - 5,857 129
Construction and development
Land & land development 1,891 - 1,891 623
Construction 1,352 - 1,352 135
Residential 1-4 family real estate
Personal residence - - - -
Rental - small loan 1,300 - 1,300 102
Rental - large loan 3,288 - 3,288 -
Home equity 523 - 523 -
Consumer - - - -
Other
Credit cards - - - -
Overdrafts - - - -
Total $ 39,609 $ 4,851 $ 44,460 $ 3,724
The following table presents the activity in the ACLL by portfolio segment for the year ended December 31, 2019, as determined in accordance with ASC 310 prior to the January 1, 2020 adoption of ASC 326:
For the Year Ended December 31, 2019
Allowance for Credit Losses - Loans
Dollars in thousands Beginning
Balance Charge-
offs Recoveries Provision Ending
Balance
Commercial $ 1,705 $ (281) $ 17 $ (295) $ 1,146
Commercial real estate
Owner occupied 2,214 (2) 21 467 2,700
Non-owner occupied
5,742 (170) 1 366 5,939
Construction and development
Land & land development
339 (2) 108 155 600
Construction 64 - - 178 242
Residential real estate
Non-jumbo 2,090 (979) 125 576 1,812
Jumbo 379 - - (368) 11
Home equity 167 (24) 19 (24) 138
Mortgage warehouse lines
- - - - -
Consumer 79 (285) 168 173 135
Other 268 (360) 121 322 351
Total
$ 13,047 $ (2,103) $ 580 $ 1,550 $ 13,074
Industry concentrations: At December 31, 2020 and 2019, we had no concentrations of loans to any single industry in excess of 10% of total loans.
Loans to related parties: We have had, and may be expected to have in the future, banking transactions in the ordinary course of business with our directors, principal officers, their immediate families and affiliated companies in which they are principal
shareholders (commonly referred to as related parties). These transactions have been, in our opinion, on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others.
The following presents the activity with respect to related party loans aggregating $60,000 or more to any one related party (other changes represent additions to and changes in director and executive officer status):
Dollars in thousands 2020 2019
Balance, beginning $ 51,292 $ 43,899
Additions 17,641 37,947
Amounts collected (13,992) (30,203)
Other changes, net 151 (351)
Balance, ending $ 55,092 $ 51,292
NOTE 8. PROPERTY HELD FOR SALE
Property held for sale consists of premises held for sale and real estate acquired through foreclosure on loans secured by such real estate. Qualifying premises are transferred to property held for sale at estimated fair value less anticipated selling costs, establishing a new cost basis. Foreclosed properties are recorded at the estimated fair value less anticipated selling costs based upon the property’s appraised value at the date of foreclosure, with any difference between the fair value of foreclosed property and the carrying value of the related loan charged to the allowance for credit losses. We perform periodic valuations of property held for sale subsequent to transfer. Changes in value subsequent to transfer are recorded in noninterest expense. Gains or losses resulting from the sale of property held for sale is recognized on the date of sale and is included in noninterest expense. Depreciation is not recorded on property held for sale. Expenses incurred in connection with operating foreclosed properties are charged to noninterest expense.
The following table presents the activity of property held for sale during 2020, 2019 and 2018.
Dollars in thousands 2020 2019 2018
Beginning balance $ 19,276 $ 21,432 $ 21,470
Acquisitions 1,132 4,549 1,804
Acquisition of WinFirst 146 - -
Capitalized improvements 1,352 512 1,304
Dispositions (4,535) (5,142) (2,370)
Valuation adjustments (1,783) (2,075) (776)
Balance at year end $ 15,588 $ 19,276 $ 21,432
At December 31, 2020, our foreclosed properties of consumer residential real estate totaled $1.1 million.
NOTE 9. PREMISES AND EQUIPMENT
Land is carried at cost, while premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method for premises and equipment over the estimated useful lives of the assets. The estimated useful lives employed are on average 30 years for premises and 3 to 10 years for furniture and equipment. Repairs and maintenance expenditures are charged to operating expenses as incurred. Major improvements and additions to premises and equipment, including construction period interest costs, are capitalized. No interest was capitalized during 2020, 2019, or 2018.
The major categories of premises and equipment and accumulated depreciation at December 31, 2020 and 2019 are summarized as follows:
Dollars in thousands 2020 2019
Land $ 12,172 $ 10,645
Buildings and improvements 41,602 34,885
Furniture and equipment 28,768 25,616
82,542 71,146
Less accumulated depreciation (30,005) (26,978)
Total premises and equipment, net $ 52,537 $ 44,168
Depreciation expense for the years ended December 31, 2020, 2019 and 2018 approximated $3.22 million, $2.61 million and $2.17 million, respectively.
NOTE 10. LEASE COMMITMENTS
We lease certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $606,000 in 2020, $306,000 in 2019 and $351,000 in 2018. On January 1, 2019, we adopted ASU No. 2016-02, Leases (Topic 842) and its related amendments requiring the recognition of certain operating leases on our balance sheet as lease right-of-use assets (reported as a component of other assets) and related lease liabilities (reported as a component of other liabilities).
The components of total lease expense in 2020 and 2019 were as follows:
Dollars in thousands 2020 2019
Amortization of lease right-of-use assets $ 540 $ 130
Short-term lease expense 66 176
Total $ 606 $ 306
Right-of-use lease assets totaled $5.5 million and $798,000 at December 31, 2020 and 2019, respectively, and are reported as a component of other assets on our accompanying consolidated balance sheets. The related lease liabilities totaled $5.6 million and $805,000 at December 31, 2020 and 2019, respectively, and are reported as a component of other liabilities in the accompanying consolidated balance sheets. Lease payments under operating leases that were applied to our operating lease liability totaled $358,000 during 2020 and $95,000 during 2019. The following table reconciles future undiscounted lease payments due under non-cancelable operating leases (those amounts subject to recognition) to the aggregate operating lessee lease liability as of December 31, 2020:
Future Lease Payments
Dollars in thousands
2021 $ 677
2022 639
2023 441
2024 391
2025 340
Thereafter 1,585
Total undiscounted operating lease liability $ 4,073
Imputed interest 1,527
Total operating lease liability included in the accompanying balance sheet $ 5,600
Weighted average lease term in years 12 years
Weghted average discount rate 1.57 %
NOTE 11. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and certain other intangible assets with indefinite useful lives are not amortized into net income over an estimated life, but rather are tested at least annually for impairment. Intangible assets determined to have definite useful lives are amortized over their estimated useful lives and also are subject to impairment testing.
In accordance with ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, during first quarter 2020, we evaluated recent potential triggering events that might be indicators that our goodwill was impaired. The events included, among others, the economic disruption and uncertainty surrounding the COVID-19 pandemic. We determined that there were no indicators of impairment noted as of March 31, 2020.
The following table presents our goodwill activity by reporting unit for 2020.
Dollars in thousands Goodwill Activity
Balance, January 1, 2020 $ 12,658
Reclassifications to goodwill 144
Acquired goodwill, net 32,693
Balance, December 31, 2020 $ 45,495
In addition, at December 31, 2020 and December 31, 2019, we had $9.63 million and $10.36 million in unamortized identified intangible assets comprised of core deposit intangibles.
Other Intangible Assets
Dollars in thousands December 31, 2020 December 31, 2019
Identified intangible assets
Gross carrying amount $ 15,650 $ 14,727
Less: accumulated amortization 6,022 4,363
Net carrying amount $ 9,628 $ 10,364
Amortization relative to our identified intangible assets is as follows:
Core Deposit Customer
Dollars in thousands Intangible Intangible
Actual:
2018 $ 1,471 $ 200
2019 1,634 67
2020 1,659 -
Expected:
2021 1,547 -
2022 1,409 -
2023 1,272 -
2024 1,134 -
2025 998 -
Thereafter 3,198 -
NOTE 12. DEPOSITS
The following is a summary of interest bearing deposits by type as of December 31, 2020 and 2019:
Dollars in thousands 2020 2019
Demand deposits, interest bearing $ 934,185 $ 630,351
Savings deposits 621,168 418,096
Time deposits 599,480 604,237
Total $ 2,154,833 $ 1,652,684
Included in time deposits are deposits acquired through a third party (“brokered deposits”) totaling $55.5 million and $150.6 million at December 31, 2020 and 2019, respectively.
A summary of the scheduled maturities for all time deposits as of December 31, 2020 is as follows:
Dollars in thousands Amount
2021 $ 421,771
2022 93,702
2023 46,084
2024 16,106
2025 13,055
Thereafter 8,762
Total $ 599,480
Time certificates of deposit in denominations of $100,000 or more totaled $352.3 million and $387.8 million at December 31, 2020 and 2019, respectively. The following is a summary of the maturity distribution of all certificates of deposit in denominations of $100,000 or more as of December 31, 2020:
Dollars in thousands Amount Percent
Three months or less $ 82,827 23.5 %
Three through six months 72,428 20.6 %
Six through twelve months 94,144 26.7 %
Over twelve months 102,931 29.2 %
Total $ 352,330 100.00 %
The aggregate amount of time deposits in denominations that meet or exceed the FDIC insurance limit of $250,000 totaled $81.4 million and $198.1 million at December 31, 2020 and 2019.
At December 31, 2020 and 2019, our deposits of related parties including directors, executive officers and their related interests approximated $51.7 million and $31.2 million.
NOTE 13. BORROWED FUNDS
Our subsidiary bank is a member of the Federal Home Loan Bank (“FHLB”). Membership in the FHLB makes available short-term and long-term advances under collateralized borrowing arrangements with each subsidiary bank. All FHLB advances are collateralized by a blanket lien of $1.23 billion of residential mortgage loans, certain commercial loans, mortgage backed securities and securities of U. S. Government agencies and corporations. We had $168.1 million available on a short term line of credit with the Federal Reserve Bank at December 31, 2020, which is primarily secured by a pledge of $337.0 million of our consumer loans, construction loans and commercial and industrial loan portfolios. We also had $6 million available on an unsecured line of credit with a correspondent bank.
At December 31, 2020, our subsidiary bank had additional borrowings availability of $721.4 million from the FHLB. Short-term FHLB advances are granted for terms of 1 to 365 days and bear interest at a fixed or variable rate set at the time of the funding request.
Short-term borrowings: At December 31, 2020, we had $174.1 million borrowing availability through credit lines and Federal funds purchased agreements. Federal funds purchased mature the next business day. A summary of short-term borrowings is presented below.
2020 2019
Dollars in thousands Short-term
FHLB
Advances Federal Funds
Purchased Short-term
FHLB
Advances Federal Funds
Purchased
Balance at December 31 $ 140,000 $ 146 $ 199,200 $ 145
Average balance outstanding for the period 130,241 170 193,992 458
Maximum balance outstanding at any month end during period
215,700 146 237,400 145
Weighted average interest rate for the period 0.67 % 0.50 % 2.48 % 2.43 %
Weighted average interest rate for balances
outstanding at December 31 0.35 % 0.25 % 1.83 % 1.75 %
Long-term borrowings: Our long-term borrowings of $699,000 and $717,000 at December 31, 2020 and 2019, respectively, consisted of a fixed rate advance from the Federal Home Loan Bank (“FHLB”) maturing in 2026. The average interest rate paid on long-term borrowings during 2020 and 2019 was 5.34%.
Subordinated debentures: We issued $30 million of subordinated debentures, net of $664,000 debt issuance costs, during third quarter 2020 in a private placement transaction. The subordinated debt qualifies as Tier 2 capital under Federal Reserve Board guidelines, until the debt is within 5 years of its maturity; thereafter the amount qualifying as Tier 2 capital is reduced by 20 percent each year until maturity. This subordinated debt bears interest at a fixed rate of 5.00% per year, from and including September 22, 2020 to, but excluding, September 30, 2025, payable quarterly in arrears. From and including September 30, 2025 to, but excluding, the maturity date or earlier redemption date, the interest rate will reset quarterly at a variable rate equal to the then current three-month term Secured Overnight Financing Rate (“SOFR”), as published by the Federal Reserve Bank of New York, plus 487 basis points, payable quarterly in arrears. As provided in the Notes, the interest rate on the Notes during
the applicable floating rate period may be determined based on a rate other than three-month term SOFR. This debt has a 10 years term and generally, is not prepayable by us within the first five years.
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 December 31, 2020 and 2019.
In October 2002, we sponsored SFG Capital Trust I, in March 2004, we sponsored SFG Capital Trust II and in December 2005, we sponsored SFG Capital Trust III, of which 100% of the common equity of each trust is owned by us. SFG Capital Trust I issued $3.5 million in capital securities and $109,000 in common securities and invested the proceeds in $3.61 million of debentures. SFG Capital Trust II issued $7.5 million in capital securities and $232,000 in common securities and invested the proceeds in $7.73 million of debentures. SFG Capital Trust III issued $8.0 million in capital securities and $248,000 in common securities and invested the proceeds in $8.25 million of debentures. Distributions on the capital securities issued by the trusts are payable quarterly at a variable interest rate equal to 3 month LIBOR plus 345 basis points for SFG Capital Trust I, 3 month LIBOR plus 280 basis points for SFG Capital Trust II and 3 month LIBOR plus 145 basis points for SFG Capital Trust III and equals the interest rate earned on the debentures held by the trusts and is recorded as interest expense by us. The capital securities are subject to mandatory redemption in whole or in part, upon repayment of the debentures. We have entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of the guarantee. The debentures of each Capital Trust are redeemable by us quarterly.
The capital securities held by SFG Capital Trust I, SFG Capital Trust II and SFG Capital Trust III qualify as Tier 1 capital under Federal Reserve Board guidelines. In accordance with these Guidelines, trust preferred securities generally are limited to 25% of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital.
A summary of the maturities of all long-term borrowings and subordinated debentures for the next five years and thereafter is as follows:
Dollars in thousands Long-term
borrowings Subordinated
debentures Subordinated
debentures owed
to unconsolidated
subsidiary trusts
2021 $ 20 $ - $ -
2022 21 - -
2023 22 - -
2024 22 - -
2025 24 - -
Thereafter 590 30,000 19,589
Total $ 699 $ 30,000 $ 19,589
NOTE 14. DERIVATIVE FINANCIAL INSTRUMENTS
We use derivative instruments primarily to protect against the risk of adverse interest rate movements on the cash flows of certain assets and liabilities. Derivative instruments represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based upon a notional amount and an underlying as specified in the contract. A notional amount represents the number of units of a specific item, such as currency units. An underlying represents a variable, such as an interest rate or price index. The amount of cash or other asset delivered from one party to the other is determined based upon the interaction of the notional amount of the contract with the underlying. Derivatives can also be implicit in certain contracts and commitments.
As with any financial instrument, derivative instruments have inherent risks, primarily market and credit risk. Market risk associated with changes in interest rates is managed by establishing and monitoring limits as to the degree of risk that may be undertaken as part of our overall market risk monitoring process. Credit risk occurs when a counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement. Credit risk is managed by monitoring the size and maturity structure of the derivative portfolio and applying uniform credit standards to all activities with credit risk.
All derivative instruments are recorded on the balance sheet at fair value in either other assets or other liabilities. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and the type of hedge transaction.
Fair Value Hedges: For transactions in which we are hedging changes in fair value of an asset, liability, or a firm commitment, changes in the fair value of the derivative instrument are generally offset in the income statement by changes in the hedged item’s fair value.
Cash Flow Hedges: For transactions in which we are hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument are reported in other comprehensive income. The gains and losses on the derivative instrument, which are reported in comprehensive income, are reclassified to earnings in the periods in which earnings are impacted by the variability of cash flows of the hedged item.
The ineffective portion of all hedges is recognized in current period earnings.
Our derivatives are governed by the terms of ISDA Master netting agreements and Credit Support Annexes. The ISDA Master agreements allow counterparties to offset trades in a gain against trades in a loss to determine net exposure and allow for the right of offset in the event of either a default or an additional termination event. Credit Support Annexes govern the terms of daily collateral posting practices. Collateral practices mitigate the potential loss impact to affected parties by requiring liquid collateral to be posted on a scheduled basis to secure the aggregate net unsecured exposure. In addition to collateral, the right of offset allows counterparties to offset net derivative values with a defaulting party against certain other contractual receivables from other obligations due to the defaulting party in determining the net termination amount.
Cash Flow Hedges
We have entered into three pay-fixed/receive LIBOR interest rate swaps as follows:
•A $40 million notional interest rate swap expiring on October 18, 2021, was designated as a cash flow hedge of $40 million of variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 2.19% and receive a variable rate equal to one month LIBOR.
•A $20 million notional interest rate swap with an effective date of October 18, 2021 and expiring on October 18, 2023, was designated as a cash flow hedge of $20 million of forecasted variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 1.07% and receive a variable rate equal to three month LIBOR.
•A $20 million notional interest rate swap with an effective date of October 18, 2021 and expiring on October 18, 2024, was designated as a cash flow hedge of $20 million of forecasted variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 1.11% and receive a variable rate equal to three month LIBOR.
•A $30 million notional interest rate swap that expired October 18, 2020, was designated as a cash flow hedge of $30 million of variable rate Federal Home Loan Bank advances. Under the terms of the swap we paid a fixed rate of 2.89% and received a variable rate equal to one month LIBOR.
In addition, we have entered into two interest rate caps as follows:
•A $100 million notional interest rate cap with an effective date of July 20, 2020 and expiring on April 18, 2030, was designated as a cash flow hedge of $100 million of forecasted fixed rate Federal Home Loan Bank advances. Under the terms of this cap we will hedge the variability of cash flows when three month LIBOR is above .75%.
•A $100 million notional interest rate cap with an effective date of December 29, 2020 and expiring on December 18, 2025, was designated as a cash flow hedge of $100 million of certain indexed interest bearing demand deposit accounts. Under the terms of this cap we will hedge the variability of cash flows when the indexed rate on the hedged
Fair Value Hedges
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 as follows:
• Under the terms of a $9.95 million original notional interest rate swap expiring January 15, 2025, we will pay a fixed rate of 4.33% and receive a variable rate equal to one month LIBOR plus 2.40 percent.
•Under the terms of a $11.3 million original notional interest rate swap expiring January 15, 2026, we will pay a fixed rate of 4.30% and receive a variable rate equal to one month LIBOR plus 2.18 percent .
A summary of our derivative financial instruments as of December 31, 2020 and 2019 follows:
December 31, 2020
Derivative Fair Value Net Ineffective
Dollars in thousands Notional
Amount Asset Liability Hedge Gains/(Losses)
CASH FLOW HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Short term borrowings $ 80,000 $ - $ 1,457 $ -
Interest rate caps hedging :
Short term borrowings $ 100,000 $ 5,652 $ - $ -
Indexed interest bearing demand deposit accounts 100,000 1,001 - -
FAIR VALUE HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Commercial real estate loans $ 18,192 $ - $ 1,290 $ -
December 31, 2019
Derivative Fair Value Net Ineffective
Dollars in thousands Notional
Amount Asset Liability Hedge Gains/(Losses)
CASH FLOW HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Short term borrowings $ 70,000 $ - $ 679 $ -
FAIR VALUE HEDGES
Pay-fixed/receive-variable interest rate swaps hedging:
Commercial real estate loans $ 18,809 $ - $ 309 $ -
NOTE 15. INCOME TAXES
Income taxes, computed on the separate return basis with the benefit of filing a consolidated return being recorded at the holding company, include Federal and state income taxes and are based on pretax net income reported in the consolidated financial statements, adjusted for transactions that may never enter into the computation of income taxes payable (permanent differences). Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Valuation allowances are established, when deemed necessary, to reduce deferred tax assets to the amount expected to be realized.
A tax position that meets a "probable recognition threshold" for the benefit of the uncertain tax position is recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either reduction of a current or deferred tax asset or receivable, or recording a current or deferred tax liability. We concluded that there were no significant uncertain tax positions requiring recognition in the consolidated financial statements. The evaluation was performed for the years ended 2017 through 2020, the tax years which remain subject to examination by major tax jurisdictions.
The components of applicable income tax expense(benefit) for the years ended December 31, 2020, 2019 and 2018, are as follows:
Dollars in thousands 2020 2019 2018
Current
Federal $ 10,189 $ 6,676 $ 6,400
State 1,440 938 973
11,629 7,614 7,373
Deferred
Federal (3,673) 88 (304)
State (528) 15 (45)
(4,201) 103 (349)
Total $ 7,428 $ 7,717 $ 7,024
Reconciliation between the amount of reported income tax expense and the amount computed by multiplying the statutory income tax rates by book pretax income for the years ended December 31, 2020, 2019 and 2018 is as follows:
2020 2019 2018
Dollars in thousands Amount Percent Amount Percent Amount Percent
Computed tax at applicable
statutory rate
$ 8,138 21 $ 8,313 21 $ 7,370 21
Increase (decrease) in taxes
resulting from:
Tax-exempt interest
and dividends, net (788) (2) (728) (2) (1,011) (3)
Non-deductible merger-related expenses
29 - - - - -
Low-income housing and rehabilitation tax credits (248) (1) (177) - (286) (1)
State income taxes, net
of Federal income tax benefit
720 2 753 2 734 2
Other, net (423) (1) (444) (1) 217 1
Applicable income taxes $ 7,428 19 $ 7,717 20 $ 7,024 20
Deferred income taxes reflect the impact of "temporary differences" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured for tax purposes. Deferred tax assets and liabilities represent the future tax return consequences of temporary differences, which will either be taxable or deductible when the related assets and liabilities are recovered or settled.
The tax effects of temporary differences, which give rise to our deferred tax assets and liabilities as of December 31, 2020 and 2019, are as follows:
Dollars in thousands 2020 2019
Deferred tax assets
Allowance for credit losses $ 8,553 $ 3,017
Depreciation - 29
Foreclosed properties 2,703 2,659
Deferred compensation 4,384 3,296
Other deferred costs and accrued expenses 1,053 534
Net unrealized loss on derivative financial instruments 357 163
Total 17,050 9,698
Deferred tax liabilities
Depreciation 288 -
Accretion on tax-exempt securities 19 62
Net unrealized gain on debt securities available for sale 2,153 994
Other post-retirement benefits - 15
Acquisition accounting adjustments and goodwill 2,241 2,099
Total 4,701 3,170
Net deferred tax assets $ 12,349 $ 6,528
We may from time to time be assessed interest or penalties associated with tax liabilities by major tax jurisdictions, although any such assessments are estimated to be minimal and immaterial. To the extent we have received an assessment for interest and/or penalties; it has been classified in the consolidated statements of income as a component of other noninterest expense.
We are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2017 through 2019. Tax years 2018 through 2019 remain subject to West Virginia State examination.
NOTE 16. EMPLOYEE BENEFITS
Retirement Plans: We have defined contribution profit-sharing plans with 401(k) provisions covering substantially all employees. Contributions to the plans are at the discretion of the Board of Directors. Contributions made to the plans and charged to expense were $678,000, $616,000 and $622,000 for the years ended December 31, 2020, 2019 and 2018, respectively.
Employee Stock Ownership Plan: We have an Employee Stock Ownership Plan (“ESOP”), which enables eligible employees to acquire shares of our common stock. The cost of the ESOP is borne by us through annual contributions to an Employee Stock Ownership Trust in amounts determined by the Board of Directors.
The expense recognized by us is based on cash contributed or committed to be contributed by us to the ESOP during the year. Contributions to the ESOP for the years ended December 31, 2020, 2019 and 2018 were $816,000, $721,000 and $646,000 respectively. Dividends paid by us to the ESOP are reported as a reduction of retained earnings. The ESOP owned 514,457 shares of our common stock at December 31, 2020 and 527,705 shares of common stock at December 31, 2019, all of which were purchased at the prevailing market price. All but 43,704 unallocated shares at December 31, 2020 are considered outstanding for earnings per share computations.
The purchase of unallocated ESOP shares is shown as a reduction of shareholders' equity, similar to a purchase of treasury stock. The loan receivable from the ESOP to the Company is not reported as an asset nor is the debt of the ESOP reported as a liability on the Company's Consolidated Balance Sheets. Cash dividends on allocated shares (those credited to ESOP participants' accounts) are recorded as a reduction of shareholders' equity and distributed directly to participants' accounts. Cash dividends on unallocated shares (those held by the ESOP not yet credited to participants' accounts) are used to pay a portion of the ESOPs debt service requirements.
Unallocated ESOP shares will be allocated to ESOP participants ratably as the ESOP's loan is repaid. When the shares are committed to be released and become available for allocation to plan participants, the then fair value of such shares will be charged to compensation expense.
The ESOP shares as of December 31 are as follows:
At December 31,
2020 2019
Allocated shares 448,358 440,751
Shares committed to be released 22,395 20,855
Unallocated shares 43,704 66,099
Total ESOP shares 514,457 527,705
Market value of unallocated shares (in thousands)
$ 965 $ 1,791
Supplemental Executive Retirement Plan: We have certain non-qualified Supplemental Executive Retirement Plans (“SERP”) with certain senior officers, which provide participating officers with an income benefit payable at retirement age or death. The liabilities accrued for the SERP’s at December 31, 2020 and 2019 were $9.6 million and $6.7 million, respectively, which are included in other liabilities. Included in salaries, commissions and employee benefits was $787,000, $712,000 and $669,000 expense related to these SERPs for the years December 31, 2020, 2019 and 2018, respectively.
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 ("RSUs"), stock appreciation rights ("SARs"), performance units, other share-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, SARs and RSUs 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 share based compensation to individual employees.
During 2019, we granted 28,306 SARs with a $9.74 grant date fair value per SAR that become exercisable ratably over seven years (14.3% per year) and expire ten years after the grant date. Also during 2019, we granted 109,819 SARs with a $8.41 grant date fair value per SAR that become exercisable ratably over five years (20% per year) and expire ten years after the grant date. There were no grants of SARs or stock options 2018 or 2020.
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 granted in 2019 are as follows:
2019 grant with 7 year expiration 2019 grant with 5 year expiration
Risk-free interest rate 2.51 % 2.43 %
Expected dividend yield 2.30 % 2.30 %
Expected common stock volatility 40.84 % 35.71 %
Expected life 7 years 5.5 years
A summary of SAR and option activity during 2018, 2019 and 2020 is as follows:
Weighted Average
Dollars in thousands, except per share amounts SARs/Options Aggregate
Intrinsic Value Remaining Contractual Term (Yrs.)
Exercise Price
Outstanding, December 31, 2017 250,291 $ 17.75
Granted - -
Exercised (6,800) 17.79
Forfeited (3,200) 25.50
Expired (8,200) 25.54
Outstanding, December 31, 2018 232,091 $ 17.36
Granted 138,125 23.94
Exercised (31,613) 11.83
Forfeited - -
Expired (7,900) 25.83
Outstanding, December 31, 2019 330,703 $ 20.44
Granted - -
Exercised (1,400) 12.01
Forfeited - -
Expired (100) 18.26
Outstanding, December 31, 2020 329,203 $ 1,118 6.34 $ 20.47
Exercisable Options/SARs:
December 31, 2020 177,875 $ 1,118 5.27 $ 17.07
December 31, 2019 104,889 1,203 5.74 $ 15.62
December 31, 2018 95,924 583 6.04 $ 14.82
The total intrinsic value of options and SARs exercised in 2020, 2019 and 2018 was $9,000, $442,000 and $24,000, respectively. The total fair value of options and SARs vested during 2020, 2019 and 2018 was $596,000, $396,000 and $396,000, respectively.
Grants of RSUs include time-based vesting conditions that generally vest ratable over a period of 3 to 5 years. During 2020, we granted 2,763 RSUs which will fully vest on the two years anniversary of the grant date and 10,995 RSUs which will vest ratably over 4 years. During 2019, we granted 2,892 RSUs which will vest ratably over 3 years. A summary of our RSU activity and related information is as follows.
Dollars in thousands, except per share amounts RSUs Weighted Average Grant Date Fair Value
Nonvested, December 31, 2018 - $ -
Granted 2,892 25.93
Forfeited - -
Vested - -
Nonvested, December 31, 2019 2,892 25.93
Granted 13,758 19.63
Forfeited - -
Vested (964) 25.93
Nonvested, December 31, 2020 15,686 $ 20.40
Total stock compensation expense for all share-based arrangements totaled $527,000, $590,000 and $391,000 for the years ended December 31, 2020, 2019 and 2018, respectively, and the related income tax benefits recognized in 2020, 2019 and 2018 were $127,000, $142,000 and $94,000 respectively. We recognize compensation expense based on the estimated number of stock awards expected to actually vest, exclusive of the awards expected to be forfeited. At December 31, 2020, our total unrecognized compensation expense related to all nonvested awards not yet recognized totaled $1.39 million and is expected to be recognized over the next 1.62 years.
NOTE 17. 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 December 31,
2020 December 31,
Commitments to extend credit:
Revolving home equity and credit card lines $ 90,125 $ 69,200
Construction loans 135,841 119,456
Other loans 308,290 225,637
Standby letters of credit 15,124 12,078
Total $ 549,380 $ 426,371
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if we deem necessary upon extension of credit, is based on our credit evaluation. Collateral held varies but may include accounts receivable, inventory, equipment or real estate.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party and generally are of a term of no greater than one year.
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.
Allowance For Credit Losses - Off-Balance-Sheet Credit Exposures
The ACL on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC 326, representing expected credit losses over the contractual period for which we are exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. Off-balance-sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit detailed in the table above. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining life of the commitment or other off-balance-sheet exposure. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management's best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. Estimating credit losses on amounts expected to be funded uses the same methodology as described for loans in Note 7.
The impact to the ACL on off-balance sheet credit exposures upon adoption of ASC 326 was $2.43 million, followed by a 2020 provision of $1.76 million resulting in a December 31, 2020 balance of $4.19 million.
Employment Agreements
We have various employment agreements with our executive officers and other key employees. These agreements contain change in control provisions that would entitle the officers to receive compensation in the event there is a change in control in the Company (as defined) and a termination of their employment without cause (as defined).
Legal Contingencies
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 18. REGULATORY MATTERS
The primary source of funds for our dividends paid to our shareholders is dividends received from our subsidiaries. Dividends paid by the subsidiary bank are subject to restrictions by banking law and regulations and require approval by the bank’s regulatory agency if dividends declared in any year exceed the bank’s current year's net income, as defined, plus its retained net profits of the two preceding years. During 2021, the Bank will have $57.0 million plus net income for the interim periods through the date of declaration, available for dividends for distribution to us.
Our subsidiary bank may be required to maintain reserve balances with the Federal Reserve Bank. The required reserve balance was $1,992,000 at December 31, 2019 and zero at December 31, 2020.
Our bank subsidiary, Summit Community Bank, Inc. (“Summit Community”), is subject to various regulatory capital requirements administered by the banking regulatory agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, Summit Community must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our bank subsidiary’s 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 Summit Community to maintain minimum amounts and ratios of Common Equity Tier 1("CET1"), 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 December 31, 2020, that our bank subsidiary met all capital adequacy requirements to which they were subject.
The most recent notifications from the banking regulatory agencies categorized Summit Community as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Summit Community must maintain minimum CET1, Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.
In December 2018, the federal bank regulatory agencies approved a final rule modifying their regulatory capital rules to provide an option to phase-in over a period of three years the day-one regulatory capital effects of the implementation of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. We elected to this optional phase-in period upon adoption of the ASU effective January 1, 2020.
The following tables present Summit's, as well as Summit Community's, actual and required minimum regulatory capital amounts and ratios as of December 31, 2020 and December 31, 2019. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended.
Actual
Minimum Required Capital - Basel III Minimum Required To Be Well Capitalized
Dollars in thousands Amount Ratio Amount Ratio Amount Ratio
As of December 31, 2020
CET1 (to risk weighted assets)
Summit $ 233,768 9.3 % N/A N/A N/A N/A
Summit Community 279,540 11.1 % 176,286 7.0 % 163,695 6.5 %
Tier I Capital (to risk weighted assets)
Summit 252,768 10.0 % N/A N/A N/A N/A
Summit Community 279,540 11.1 % 214,062 8.5 % 201,470 8.0 %
Total Capital (to risk weighted assets)
Summit 305,309 12.1 % N/A N/A N/A N/A
Summit Community 302,716 12.0 % 264,877 10.5 % 252,263 10.0 %
Tier I Capital (to average assets)
Summit 252,768 8.6 % N/A N/A N/A N/A
Summit Community 279,540 9.5 % 117,701 4.0 % 147,126 5.0 %
As of December 31, 2019
CET1 (to risk weighted assets)
Summit 224,679 11.1 % N/A N/A N/A N/A
Summit Community 244,045 12.1 % 141,183 7.0 % 131,099 6.5 %
Tier I Capital (to risk weighted assets)
Summit 243,679 12.1 % N/A N/A N/A N/A
Summit Community 244,045 12.1 % 171,437 8.5 % 161,352 8.0 %
Total Capital (to risk weighted assets)
Summit 256,753 12.7 % N/A N/A N/A N/A
Summit Community 257,119 12.7 % 212,579 10.5 % 202,456 10.0 %
Tier I Capital (to average assets)
Summit 243,679 10.5 % N/A N/A N/A N/A
Summit Community 244,045 10.6 % 92,092 4.0 % 115,116 5.0 %
NOTE 19. EARNINGS PER SHARE
The computations of basic and diluted earnings per share follow:
For the Year Ended December 31,
2020 2019 2018
Common Common Common
Dollars in thousands, Income Shares Per Income Shares Per Income Shares Per
except per share amounts (Numerator) (Denominator) Share (Numerator) (Denominator) Share (Numerator) (Denominator) Share
Net income $ 31,326 $ 31,866 $ 28,072
Basic EPS $ 31,326 12,935,430 $ 2.42 $ 31,866 12,516,474 $ 2.55 $ 28,072 12,364,468 $ 2.27
Effect of dilutive securities:
Stock options 4,320 4,935 7,071
SARs 34,785 53,737 53,034
RSUs
850 - -
Diluted EPS $ 31,326 12,975,385 $ 2.41 $ 31,866 12,575,146 $ 2.53 $ 28,072 12,424,573 $ 2.26
Stock option and SAR grants are disregarded in this computation if they are determined to be anti-dilutive. At December 31, 2020, our anti-dilutive options were 200 and our anti-dilutive SARs totaled 222,740. All outstanding stock options were dilutive and our anti-dilutive SARs totaled 222,740 at December 31, 2019. Our anti-dilutive stock options were 7,700 and anti-dilutive SARs totaled 87,615 were dilutive at December 31, 2018.
NOTE 20. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following are the changes in accumulated other comprehensive income (loss) by component, net of tax, for the years ended December 31, 2020 and 2019.
December 31, 2020
Dollars in thousands Gains and Losses on Pension Plan Gains on Other Post-Retirement Benefits Gains and Losses on Cash Flow Hedges Unrealized Gains and Losses on Debt Securities Available for Sale Total
Beginning balance $ (140) $ 48 $ (518) $ 3,145 $ 2,535
Other comprehensive income (loss) before reclassification, net of tax (59) (88) (614) 6,310 5,549
Amounts reclassified from accumulated other comprehensive income, net of tax - - - (2,639) (2,639)
Net current period other comprehensive income (loss) (59) (88) (614) 3,671 2,910
Ending balance $ (199) $ (40) $ (1,132) $ 6,816 $ 5,445
December 31, 2019
Dollars in thousands Gains and Losses on Pension Plan Gains on Other Post-Retirement Benefits Gains and Losses on Cash Flow Hedges Unrealized Gains and Losses on Debt Securities Available for Sale Total
Beginning balance $ - $ 139 $ (314) $ (841) $ (1,016)
Other comprehensive income (loss) before reclassification, net of tax (140) (91) (204) 5,459 5,024
Amounts reclassified from accumulated other comprehensive income (loss), net of tax - - - (1,473) (1,473)
Net current period other comprehensive income (loss) (140) (91) (204) 3,986 3,551
Ending balance $ (140) 48 $ (518) $ 3,145 $ 2,535
December 31, 2018
Dollars in thousands Gains and Losses on Pension Plan Gains on Other Post-Retirement Benefits Gains and Losses on Cash Flow Hedges Unrealized Gains and Losses on Available-for-Sale Securities Total
Beginning balance $ - $ 398 $ (1,564) $ 2,898 $ 1,732
Other comprehensive income (loss) before reclassification, net of tax - (259) 1,250 (3,266) (2,275)
Amounts reclassified from accumulated other comprehensive income (loss), net of tax - - - (473) (473)
Net current period other comprehensive income (loss) - (259) 1,250 (3,739) (2,748)
Ending balance $ - $ 139 $ (314) $ (841) $ (1,016)
NOTE 21. REVENUE FROM CONTRACTS WITH CUSTOMERS
Interest income, loan fees, realized securities gains and losses, bank owned life insurance income and mortgage banking revenue are not in the scope of ASC Topic 606, Revenue from Contracts with Customers. With the exception of gains or losses on sales of foreclosed properties, all of our revenue from contracts with customers in the scope of ASC 606 is recognized within Noninterest Income in the Consolidated Statements of Income. Incremental costs of obtaining a contract are expensed when incurred when the amortization period is one year or less.
A description of our significant sources of revenue accounted for under ASC 606 follows:
Service fees on deposit accounts are fees we charge our deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which are earned based on specific transactions or customer activity within a customer’s deposit account, are recognized at the time the related transaction or activity occurs, as it is at this point when we fulfill the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which Summit satisfied the performance obligation. Overdraft fees are recognized when the overdraft occurs. Service fees on deposit accounts are paid through a direct charge to the customer’s account.
Bank card revenue is comprised of interchange revenue and ATM fees. Interchange revenue is earned when Summit’s debit and credit cardholders conduct transactions through Mastercard and other payment networks. Interchange fees represent a percentage of the underlying cardholder’s transaction value and are generally recognized daily, concurrent with the transaction processing services provided to the cardholder. ATM fees are earned when a non-Summit cardholder uses a Summit ATM. ATM fees are recognized daily, as the related ATM transactions are settled.
Trust and wealth management fees consist of 1) trust fees and 2) commissions earned from an independent, third-party broker-dealer. We earn trust fees from our contracts with trust clients to administer or manage assets for investment. Trust fees are earned over time (generally monthly) as Summit provides the contracted services and are assessed based on the value of assets under management at each month-end. We earn commissions from investment brokerage services provided to our clients by an independent, third-party broker-dealer. We receive monthly commissions from the third-party broker-dealer based upon client activity for the previous month.
Insurance commissions principally consisted of commissions we earned as agents of insurers for selling group employee benefit and property and casualty insurance products to clients. Group employee benefit insurance commissions were recognized over time (generally monthly) as the related customary implied servicing obligations of group policyholders were fulfilled. Property and casualty insurance commissions were recognized using methods which approximated the time of placement of the underlying policy. We were paid insurance commissions ratably as the related policy premiums were paid by clients.
The following table illustrates our total non-interest income segregated by revenues within the scope of ASC Topic 606 and those which are within the scope of other ASC Topics:
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
Service fees on deposit accounts $ 4,588 $ 5,094 $ 4,631
Bank card revenue 4,494 3,536 3,152
Trust and wealth management fees 2,495 2,564 2,653
Insurance commissions 202 1,911 4,320
Other 365 292 246
Net revenue from contracts with customers 12,144 13,397 15,002
Non-interest income within the scope of other ASC topics 7,939 5,806 2,420
Total noninterest income $ 20,083 $ 19,203 $ 17,422
NOTE 22. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Information relative to our parent company balance sheets at December 31, 2020 and 2019 and the related statements of income and cash flows for the years ended December 31, 2020, 2019 and 2018, are presented as follows:
Balance Sheets
December 31,
Dollars in thousands 2020 2019
Assets
Cash $ 5,937 $ 2,185
Investment in subsidiaries 327,354 267,132
Other investments 7 77
Premises and equipment 97 146
Other assets 1,837 1,317
Total assets $ 335,232 $ 270,857
Liabilities and Shareholders' Equity
Subordinated debentures $ 29,364 $ -
Subordinated debentures owed to unconsolidated subsidiary trusts 19,589 19,589
Other liabilities 4,699 3,504
Total liabilities 53,652 23,093
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: 12,985,708 shares 2020, 12,474,641 shares 2019; outstanding: 12,942,004 shares 2020, 12,408,542 shares 2019
94,964 80,084
Unallocated common stock held by Employee Stock Ownership Plan - 2020 - 43,704 shares, 2019 - 66,099 shares
(472) (714)
Retained earnings 181,643 165,859
Accumulated other comprehensive income 5,445 2,535
Total shareholders' equity 281,580 247,764
Total liabilities and shareholders' equity $ 335,232 $ 270,857
Statements of Income
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
Income
Dividends from subsidiaries $ 10,000 $ 16,757 $ 10,600
Other dividends and interest income 33 54 28
Management and service fees from subsidiaries 1,856 1,542 1,555
Total income 11,889 18,353 12,183
Expense
Interest expense 1,109 949 899
Operating expenses 3,306 3,755 2,565
Total expenses 4,415 4,704 3,464
Income before income taxes and equity in
undistributed income of subsidiaries 7,474 13,649 8,719
Income tax (benefit) (519) (276) (374)
Income before equity in undistributed income of subsidiaries 7,993 13,925 9,093
Equity in undistributed income of subsidiaries 23,333 17,941 18,979
Net income $ 31,326 $ 31,866 $ 28,072
Statements of Cash Flows
For the Year Ended December 31,
Dollars in thousands 2020 2019 2018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 31,326 $ 31,866 $ 28,072
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiaries (23,333) (17,941) (18,979)
Deferred tax benefit (141) (18) (8)
Depreciation 57 50 41
Share-based compensation expense 211 274 181
Earnings on bank owned life insurance 1 - 7
(Increase) decrease in other assets (285) 491 (375)
Increase in other liabilities 977 807 1,036
Net cash provided by operating activities 8,813 15,529 9,975
CASH FLOWS FROM INVESTING ACTIVITIES
Investment from subsidiaries (25,000) - -
Purchases of premises and equipment (9) (123) (86)
Proceeds from sale of premises and equipment - 53 13
Net cash used in investing activities (25,009) (70) (73)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid on common stock (8,786) (7,361) (6,545)
Exercise of stock options - 7 122
Proceeds from subordinated debt 30,000 - -
Purchase and retirement of common stock (1,444) (10,405) (1,689)
Proceeds from issuance of common stock, net of issuance costs 178 159 237
Net cash provided by ( used in) financing activities 19,948 (17,600) (7,875)
Increase (decrease) in cash 3,752 (2,141) 2,027
Cash:
Beginning 2,185 4,326 2,299
Ending $ 5,937 $ 2,185 $ 4,326
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 1,145 $ 961 $ 875

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Disclosure Controls and Procedures: Our management, including the Chief Executive Officer and Chief Financial Officer, have conducted as of December 31, 2020, 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 December 31, 2020 were effective.
Management’s Report on Internal Control Over Financial Reporting: Information required by this item is set forth on page 51.
Attestation Report of the Registered Public Accounting Firm: Information required by this item is set forth on page 52.
Changes in Internal Control Over Financial Reporting: There were no changes in our internal control over financial reporting during the quarter ended December 31, 2020, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None
PART III.

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance
Information required by this item is set forth under the caption “Delinquent Section 16(a) Reports”, under the headings "NOMINEES WHOSE TERMS EXPIRE IN 2024", “DIRECTORS WHOSE TERMS EXPIRE IN 2023", “DIRECTORS WHOSE TERMS EXPIRE IN 2022” and “EXECUTIVE OFFICERS” and under the captions “Family Relationships”, “Director Qualifications and Review of Director Nominees”, “Compensation and Nominating Committee” and “Audit and Compliance Committee” in our 2021 Proxy Statement and is incorporated herein by reference.
We have adopted a Code of Ethics that applies to our chief executive officer, chief financial officer, chief accounting officer and all directors, officers and employees. We have posted this Code of Ethics on our internet website at www.summitfgi.com under “Governance Documents”. Any amendments to or waivers from any provision of the Code of Ethics applicable to the chief executive officer, chief financial officer, or chief accounting officer will be disclosed by timely posting such information on our internet website.
There have been no material changes to the procedures by which shareholders may recommend nominees since the disclosure of the procedures in our 2020 proxy statement.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
Information required by this item is set forth under the heading "COMPENSATION DISCUSSION AND ANALYSIS", “EXECUTIVE COMPENSATION” and "COMPENSATION AND NOMINATING COMMITTEE REPORT" in our 2021 Proxy Statement and is incorporated herein by reference.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table provides information on our equity compensation plans as of December 31, 2020.
Plan Category Number of securities to be issued upon exercise of outstanding options, warrants and rights (#) (1) Weighted-average exercise price of outstanding options, warrants and rights ($) Number of securities remaining available for future issuance under equity compensation plans (#) (2)
Equity compensation plans approved by stockholders 67,069 $ 20.47 104,651
Equity compensation plans not approved by stockholders - - -
Total 67,069 $ 20.47 104,651
(1) The number of securities issuable upon exercise of currently outstanding options and SARs includes 5,200 options awarded under the 1998 Officer Stock Option Plan and the 2009 Officer Stock Option Plan, 46,183 shares issuable, based upon our December 31, 2019 closing stock price of $22.08, relative to 324,003 SARs issued under the Summit Financial Group, Inc. 2014 Long-Term Incentive Plan and 15,686 shares issuable pursuant to outstanding RSUs. Since RSUs have no exercise price, they are not included in the weighted average exercise price calculation.
(2) Under the Summit Financial Group, Inc. 2014 Long-Term Incentive Plan, approved by our shareholders on May 15, 2014, we may make equity awards up to 500,000 shares of common stock. During 2020, we issued 13,758 RSUs. During 2019, we issued 138,125 stock appreciation rights with an exercise price of $23.94 and 2,892 RSUs. During 2017, we issued 87,615 stock appreciation rights with an exercise price of $26.01. During 2015, we issued 166,717 stock appreciation rights with an exercise price of $12.01.
The remaining information required by this item is set forth under the caption “Security Ownership of Directors and Officers” and under the headings "NOMINEES WHOSE TERMS EXPIRE IN 2024", “DIRECTORS WHOSE TERMS EXPIRE IN 2023”, “DIRECTORS WHOSE TERMS EXPIRE IN 2022”, “PRINCIPAL SHAREHOLDERS” and “EXECUTIVE OFFICERS” in our 2021 Proxy Statement and is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions and Director Independence
Information required by this item is set forth under the captions “Transactions with Related Persons” and “Independence of Directors and Nominees” in our 2021 Proxy Statement and is incorporated herein by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accounting Fees and Services
Information required by this item is set forth under the caption “Fees to Independent Registered Public Accounting Firm” in our 2021 Proxy Statement and is incorporated herein by reference.
PART IV.

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits, Financial Statement Schedules
All financial statements and financial statement schedules required to be filed by this Form or by Regulation S-X, which are applicable to the Registrant, have been presented in the financial statements and notes thereto in Item 8 in Management’s Discussion and Analysis of Financial Condition and Results of Operation in Item 7 or elsewhere in this filing where appropriate. The listing of exhibits follows:
Exhibit Number Exhibit Description Incorporated by Reference*
Filed Herewith Form Exhibit Filing Date
(2) Plan of acquisition, reorganization, arrangement, liquidation or succession:
(i) Agreement and Plan of Merger dated as of September 17, 2019 by and between Summit Financial Group, Inc. and Cornerstone Financial Services, Inc.
8-K 2.1 9/18/2019
(ii) Purchase and Assumption Agreement dated as of November 21, 2019 by and between Summit Community Bank, Inc. and MVB Bank, Inc.
8-K 2.1 11/22/2019
(3) Articles of Incorporation and By-Laws:
(i) Amended and Restated Articles of Incorporation of Summit Financial Group, Inc.
10-Q 3.i 5/10/2006
(ii) Articles of Amendment 2009
8-K 3.1 9/30/2009
(iii) Articles of Amendment 2011
8-K 3.1 11/4/2011
(iv) Amended and Restated By-laws of Summit Financial Group, Inc.
8-K 3.1 3/27/2020
(4) Instruments Defining the Rights of Securities Holders, Including Indentures
(i) Description of Registrant's Securities
10-K 4.1 3/6/2020
(10) Material Contracts
(i) Amended and Restated Employment Agreement with H. Charles Maddy, III
10-K 10.1 3/16/2009
(ii) First Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/4/2010
(iii) Second Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 12/14/2010
(iv) Third Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/23/2012
(v) Fourth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/21/2013
(vi) Fifth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/25/2014
(vii) Sixth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/23/2015
(viii) Seventh Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/17/2016
(ix) Eighth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/15/2017
(x) Ninth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/9/2018
(xi) Tenth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/7/2019
(xii) Eleventh Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/12/2020
(xiii) Twelfth Amendment to Amended and Restated Employment Agreement with H. Charles Maddy, III
8-K 10.1 2/17/2021
(xiv) Change in Control Agreement with H. Charles Maddy, III
10-K 10.2 3/16/2009
(xv) Executive Salary Continuation Agreement with H. Charles Maddy, III
10-K 10.3 3/16/2009
(xvi) Form of Amended and Restated Employment Agreement entered into with Robert S. Tissue, Patrick N. Frye and Scott C. Jennings
10-K 10.4 3/16/2009
(xvii) First Amendment to Amended and Restated Employment Agreement with Patrick N. Frye
10-K 10.8 3/1/2012
Exhibit Number Exhibit Description Incorporated by Reference*
Filed Herewith Form Exhibit Filing Date
(xviii) Form of Executive Salary Continuation Agreement entered into with Robert S. Tissue, Patrick N. Frye and Scott C. Jennings
10-K 10.5 3/16/2009
(xix) Amended and Restated Employment Agreement with Bradford E. Ritchie
10-K 10.12 3/1/2012
(xx) Executive Salary Continuation Agreement with Bradford E. Ritchie
10-K 10.13 3/1/2012
(xxi) Form of Indemnification Agreement between Summit and each Director of Summit
8-K 1.01 2/12/2009
(xxii) 1998 Officers Stock Option Plan
10-QSB 10 8/17/1998
(xxiii) Summit Financial Group, Inc. Directors Deferral Plan
10-K 10.10 3/14/2006
(xxiv) Amendment No. 1 to Directors Deferral Plan
10-K 10.11 3/14/2006
(xxv) Amendment No. 2 to Directors Deferral Plan
10-K 10.14 3/16/2009
(xxvi) Summit Community Bank, Inc. Amended and Restated Directors Deferral Plan
10-K 10.15 3/16/2009
(xxvii) Rabbi Trust for The Summit Financial Group, Inc. Directors Deferral Plan
10-K 10.16 3/16/2009
(xxviii) Amendment No. One to Rabbi Trust for Summit Financial Group, Inc. Directors Deferral Plan
10-K 10.2 3/16/2009
(xxix) Amendment No. One to Rabbi Trust for Summit Community Bank, Inc. (successor in interest to Capital State Bank, Inc.) Directors Deferral Plan
10-K 10.2 3/16/2009
(xxx) Amendment No. One to Rabbi Trust for Summit Community Bank, Inc. (successor in interest to Shenandoah Valley National Bank, Inc.) Directors Deferral Plan
10-K 10.2 3/16/2009
(xxxi) Amendment No. One to Rabbi Trust for Summit Community Bank, Inc. (successor in interest to South Branch Valley National Bank) Directors Deferral Plan
10-K 10.2 3/16/2009
(xxxii) Form of Non-Qualified Stock Option Grant Agreement
10-Q 10.3 5/10/2006
(xxxiii) Form of First Amendment to Non-Qualified Stock Option Grant Agreement
10-Q 10.4 5/10/2006
(xxxiv) 2009 Officer Stock Option Plan
8-K 10.1 5/14/2009
(xxxv) SFGI 2014 Long-Term Incentive Plan
S-8 4 9/25/2014
(xxxvi) Form of Summit Financial Group, Inc. 2014 Long-Term Incentive Plan Stock-Settled Stock Appreciation Rights Agreement 2015 award
8-K 10.1 4/29/2015
(xxxvii) Form of Summit Financial Group, Inc. 2014 Long-Term Incentive Plan Stock-Settled Stock Appreciation Rights Agreement 2017 award
8-K/A 10.3 2/15/2017
(xxxxiii) Form of Summit Financial Group, Inc. 2014 Long-Term Incentive Plan Stock-Settled Stock Appreciation Rights Agreement 2019 award
8-K 10.3 2/7/2019
(xxxxiv) Securities Purchase Agreement with Castle Creek Capital Partners V, LP
8-K 10.1 8/25/2014
(xxxxv) Executive Officer Management Incentive Plan 2021
8-K 10.2 2/27/2021
(10.1) Board Attendance and Compensation Policy, as amended
X
(21) Subsidiaries of Registrant
10-K 21 3/16/2009
(23) Consent of Yount, Hyde & Barbour, P.C.
X
(24) Power of Attorney
X
(31.1) Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer
X
(31.2) Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer
X
(32.1)** Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer
X
(32.2)** Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer
X
(101) Interactive date file (XBRL) X
* The SEC reference number for all exhibits incorporated by reference is 0-16587.
** Furnished, not filed.