ITEM 1. BUSINESS
THE COMPANY Summit Financial Corporation (the "Company") was incorporated under the laws of the State of South Carolina on May 26, 1989. The Company, headquartered in Greenville, South Carolina, is a bank holding company formed under the Bank Holding Company Act of 1956, as amended. Subsidiaries of the Company are Summit National Bank (the "Bank", "Summit"), a national bank organized in 1990, and Freedom Finance, Inc. (the "Finance Company", "Freedom"), a consumer finance company organized in 1994. In 1997 the Bank incorporated Summit Investment Services, Inc., an investment and financial planning company, as a wholly-owned subsidiary. The Company has no foreign operations.
The principal role of the Company is to supervise and coordinate the activities of its subsidiaries and to provide then with capital and services of various kinds. The Company derives substantially all of its income from management fees for services performed, interest on advances and loans, and other intercompany payments as appropriate from the subsidiaries. The Company conducts its business from four banking offices and eleven consumer finance offices throughout South Carolina.
At December 31, 2000, the Company had total assets of $249.8 million, total deposits of $209.2 million, loans, net of unearned income, of $180.5 million and shareholders' equity of $21.5 million. This compares with total assets of $191.2 million, total deposits of $158.0 million, loans of $148.2 million and shareholders' equity of $17.6 million at December 31, 1999. The operating results and key financial measures of the Company and its subsidiaries are discussed more fully in "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in this report under Item 7. For a discussion of the financial information on the Company's segments, refer to Note 21 of the Consolidated Financial Statements included in this report under Item 8.
SUMMIT NATIONAL BANK Summit National Bank, headquartered in Greenville, South Carolina, commenced operations in July 1990. The Bank targets individuals and small-to-medium-sized businesses in the Upstate of South Carolina that require a full range of quality banking services typically provided by the larger regional banking concerns, but who prefer the personalized service offered by a locally-based institution. The Bank currently has its headquarters and four full-service branch locations in Greenville and Spartanburg, South Carolina. Summit provides a full range of deposit services that are typically available in most banks and savings and loan associations including checking accounts, NOW accounts, individual retirement accounts, savings and other time deposits of various types ranging from daily money market accounts to longer-term certificates of deposit.
Deposits of the Bank are insured up to $100,000 by the Federal Deposit Insurance Corporation (the "FDIC"). The Company has no material concentration of deposits from any single customer or group of customers. Other services which the Bank offers include safe deposit boxes, bank money orders, wire transfer facilities, remote internet banking and various cash management and electronic banking programs.
The Bank also offers a full range of short to intermediate-term, secured and unsecured commercial and personal loans for business, agriculture, real estate, home improvement and automobiles, credit cards, letters of credit, personal investments and home equity lines of credit. It is the Bank's intent to originate quality, profitable loans which will benefit the area's economy, provide a reasonable return to our shareholders, and promote the growth of the Bank. Management strives to maintain quality in the loan portfolio and to accept only those credit risks which meet the Bank's underwriting standards. No significant portion of the Company's loan portfolio is concentrated within a single industry or group of related industries.
SUMMIT INVESTMENT SERVICES, INC. Summit Investment Services, Inc. commenced operations in November 1997. It provides a full range of nondeposit investment products including annuities and mutual funds, full and discount brokerage services, and financial management services. Summit Investment Services has offices in Greenville and Spartanburg, South Carolina.
FREEDOM FINANCE, INC. The Finance Company makes and services installment loans to individuals with loan principal amounts generally not exceeding $2,000 and with maturities ranging from three to eighteen months. The Finance Company, which is headquartered in Greenville, South Carolina, currently has 11 branch offices throughout South Carolina. The Finance Company's loan customers are primarily in the low-to-moderate income brackets and are engaged in widely diverse occupations. A loan investigation and credit history review is made for each borrower, either through credit reporting agencies or directly by Company employees. Freedom also makes available to borrowers credit life, accident and health, and property insurance directly related to the extension of credit to the individual. The business of the Finance Company is rather seasonal and the amount of loans outstanding increases significantly at the end of each calendar year due to the seasonal loan demand, while the first quarter of the calendar year often results in substantial loan paydowns.
TERRITORY SERVED AND COMPETITION THE BANK: Summit National Bank and its subsidiary, Summit Investment Services, Inc., are located in the Upstate of South Carolina, with offices in Greenville and Spartanburg. The extended market area encompasses Greenville and Spartanburg Counties, with the principal market area being the urban areas of these counties. The Upstate of South Carolina is a highly competitive commercial banking market with at least 30 other banks and other financial institutions represented, including all of the largest banks in the state. The competition among the various financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality and range of services rendered, the convenience of banking facilities, and, in the case of loans to large commercial borrowers, relative lending limits.
Many of the competitor banks in the Bank's market area are subsidiaries of bank holding companies which own banks in other southeastern states. In the conduct of certain areas of business, the Bank may also compete with savings and loan associations, credit unions, insurance companies, securities firms, leasing companies and other financial institutions, some of which are not subject to the same degree of regulation and restrictions as the Bank. The Bank may also compete with out-of-state financial institutions which operate loan production offices, originate mortgages, accept money market deposits, and provide other financial services. The Bank's investment subsidiary competes with larger brokerage houses and financial planners, discount brokers and internet brokerage service providers.
Many of these competitors may have substantially greater resources and lending abilities than the Bank due to their size and these competitors may offer services, such as international banking and trust services, that the Bank is not currently providing. Moreover, most of the competitors have multiple branch networks located throughout the extended market area, while the Bank currently has only four locations, which could be a competitive disadvantage. As a result, the Bank does not generally attempt to compete for the banking relationships of larger corporations, but concentrates its efforts on small and medium-sized businesses and individuals. The Company believes that the Bank is able to compete effectively in this market segment by offering competitive pricing of services and quality, experience and personal treatment in the execution of services.
The Bank and its subsidiary are not dependent upon a single or a very few customers, the loss of which would have a material adverse effect.
THE FINANCE COMPANY: Freedom Finance, Inc. serves its customers from 11 locations throughout South Carolina. Competition between consumer finance companies is not generally as intense as that among banks, however, this segment of the market has become over-served in areas of South Carolina. The amounts, rates, and fees charged on consumer finance loans are regulated by state law according to the type of license granted by the South Carolina State Board of Financial Institutions (the "State Board"). Numerous other finance companies which offer similar types of loans are located in the areas served by Freedom.
The Finance Company competes directly with national, regional and local consumer finance companies. The principal areas of competition in the consumer finance industry are convenience of services to customers, effectiveness of advertising, effectiveness of administration of loans and the cost of borrowed money. Many of the finance companies competing with Freedom may have substantially greater resources and lending abilities than the Finance Company and may have more branches within the specific market areas in which they and the Finance Company compete. The Company believes that the Finance Company is able to compete effectively in its current markets.
EMPLOYEES As of December 31, 2000, the Company and its subsidiaries employed a total of 82 full-time equivalent employees.
MONETARY POLICY The earnings of the Company and its subsidiaries may be affected significantly by the monetary policies of the Federal Reserve Board which regulates the money supply in order to mitigate recessionary and inflationary pressures. Among the techniques used to implement these objectives are open market operations in United States Government securities, changes in the rates paid by banks on bank borrowings, changes in the reserve requirements against bank deposits and limitations on interest rates which banks may pay on time and savings deposits. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits.
SUPERVISION AND REGULATION The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities and other governmental agencies in the state where the Company and its subsidiaries operate. The supervision, regulation and examination to which the Company and its subsidiaries are subject are intended primarily for the protection of depositors or are aimed at carrying out broad public policy goals, rather than for the protection of security holders.
Several of the more significant regulatory provisions applicable to the Company and its subsidiaries are subject are discussed below. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and its subsidiaries.
THE COMPANY The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "BHCA"), and as such, is under the supervisory and regulatory authority of the Board of Governors of the Federal Reserve System (the "Federal Reserve"). As a bank holding company registered under the laws of the South Carolina Bank Holding Company Act, the Company is also subject to regulation by the State Board. Consequently, the Company must receive the approval of the State Board prior to engaging in the acquisition of banking or nonbanking institutions or assets. The Company is also required to file annual reports and other information with the Federal Reserve and the State Board regarding its financial condition, results of operations, management and intercompany relationships and transactions between the Company and its subsidiaries. The BHCA requires prior Federal Reserve approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company.
In November 1999, Congress passed the "Gramm-Leach-Bliley" Financial Services Modernization Act (the "GLB Act") which repealed two provisions of the Glass-Stegall Act that previously separated banking, insurance, and securities activities. The GLB Act creates a new financial services structure, the financial holding company, under the BHCA. Financial holding companies will be able to engage in any activity that is deemed (1) financial in nature, (2) incidental to any such financial activity, or (3) complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The GLB Act specifies certain activities that are deemed to be financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment, or economic advisory services; underwriting, dealing in or making a market in, securities; and any activity currently permitted for bank holding companies by the Federal Reserve Board under section 4(c)(8) of the Bank Holding Company Act. The GLB Act does not authorize banks or their affiliates to engage in commercial activities that are not financial in nature. A bank holding company may elect to be treated as a financial holding company only if all depository institution subsidiaries of the holding company are well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act. On March 23, 2000, the Federal Reserve Bank of Richmond accepted the Company's election to be treated as a financial holding company under the GLB Act.
National banks are also authorized by the GLB Act to engage, through "financial subsidiaries," in any activity that is permissible for a financial holding company (as described above) and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve Board, determines is financial in nature or incidental to any such financial activity, except (1) insurance underwriting, (2) real estate development or real estate investment activities (unless otherwise permitted by law), (3) insurance company portfolio investments and (4) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well managed and well capitalized (after deducting from the bank's capital outstanding investments in financial subsidiaries).
The GLB Act also contains a number of other provisions that will affect the Company's operations and the operations of all financial institutions. One of the new provisions, which became effective on July 1, 2000, relates to the financial privacy of consumers. Federal banking regulators issued final regulations in November 2000 related to consumer privacy which limit the ability of banks and other financial entities to disclose non-public information about consumers to non-affiliated entities. These limitations will require more disclosure to consumers, and in some circumstances, to require consent by the consumer before information is allowed to be provided to a third party.
The GLB Act adopts a system of functional regulation where the primary regulator is determined by the nature of the activity rather than the type of institution. Although the Federal Reserve Board (the "FRB") is the umbrella supervisor of financial holding companies, the GLB Act limits the FRB's power to supervise and conduct examinations of affiliated companies of the financial holding company. Rather, under the provisions of the GLB Act, the securities activities would be regulated by the SEC and other securities regulators, insurance activities by the state insurance authorities, and banking activities by the appropriate bank regulator.
Under the policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. This support may be required at times when the bank holding company may not have the resources to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a U.S. federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment. If a default occurred with respect to a bank, any capital loans to the bank from its parent holding company would be subordinate in right of payment to payment of the bank's depositors and certain of its other obligations.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), requires that a bank holding company guarantee that any "undercapitalized" (as defined in the statute) insured depository institution subsidiary will comply with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would be necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.
Under Section 5(e) of the BHCA, the Federal Reserve has the authority to terminate any activity of a bank holding company that constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution or to terminate its control of such subsidiary. Further, FDICIA grants federal bank regulatory authorities additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divesture may aid a depository institution's financial condition.
In July 1996, South Carolina enacted the South Carolina Banking and Branching Efficiency Act (the "Act") which provides that, except as otherwise expressly permitted by federal law and in limited circumstances specified in the Act, a company may not acquire a South Carolina bank holding company (as defined in the Act) or a bank chartered under the laws of South Carolina unless the company obtains prior approval from the State Board. The company proposing to make the acquisition must file with the State Board a notice or the application that the company filed with the responsible federal bank supervisory agency and pay the fee, if any, prescribed by the State Board. In addition, the company must publish prior notice of the application once in a daily newspaper of general circulation in South Carolina and provide an opportunity for public comment. If the company proposing to make the acquisition is an out-of-state bank holding company, it must qualify to do business in South Carolina or appoint an agent for service of process in South Carolina. The Act also provides that approval of the State Board must be obtained before an interstate bank merger involving a South Carolina bank may be consummated.
The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act") has increased the ability of bank holding companies and banks to operate across state lines. Under the Riegle-Neal Act, with the approval of the Board of Governors of the Federal Reserve System, and subject to nationwide and statewide concentration limits, the Company and any other bank holding company located in South Carolina may acquire or merge with a bank located in any other state and a bank holding company located outside of South Carolina may acquire or merge with any South Carolina-based bank, provided the acquirer is adequately capitalized and adequately managed, as defined in the Riegle-Neal Act. The Interstate Banking Act also permits de novo branching provisions. The legislation preserves the state laws which require that a bank must be in existence for a minimum period of time before being acquired, as long as the requirement is five years or less.
The Company is an "affiliate" of the Bank within the meaning of the Federal Reserve Act, which imposes restrictions on loans by the Bank to the Company, on investments by the Bank in the stock or securities of the Company, and on the use of such stock or securities as collateral for loans by the Bank to any borrower. The Company and the Bank are subject to Section 23A of the Federal Reserve Act. Section 23A defines "covered transactions", which includes extensions of credit, and limits a bank's covered transactions with any affiliate to 10% of such bank's capital and surplus. All covered transactions with all affiliates cannot in the aggregate exceed 20% of a bank's capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank's affiliates. Finally, Section 23A requires that all of a bank's extensions of credit to an affiliate be appropriately secured by acceptable and adequate collateral, as defined in the regulation. The Company and the Bank are also subject to Section 23B of the Federal Reserve Act, which generally limits covered and other transactions among affiliates to terms and circumstances, including credit standards, that are substantially the same or at least as favorable to a bank holding company, a bank or a subsidiary of either as prevailing at the time for transactions with unaffiliated companies.
THE BANK The Company's subsidiary bank, Summit National Bank, is a nationally chartered financial institution, and as such, is subject to various statutory requirements, supervision and regulation, of which regular bank examinations are a part, promulgated and enforced primarily by the Office of the Comptroller of the Currency (the "Comptroller"). These statutes, rules and regulations relate to insurance of deposits, required reserves, allowable investments, loans, mergers, consolidations, issuance of securities, payment of dividends, establishment of branches, and other aspects of the business of Summit National Bank.
The Comptroller is responsible for overseeing the affairs of all national banks and periodically examines national banks to determine their compliance with law and regulations. The Comptroller monitors all areas of the Bank's operations, including loans, mortgages, issuance of securities, capital adequacy, risk management, payment of dividends, and establishment of branches. In addition, the Comptroller has authority to issue cease and desist orders against national banks which are engaged in unsafe or unsound practice in the conduct of their business. Federal banking laws applicable to all depository financial institutions, among other things, (i) afford federal bank regulatory agencies with powers to prevent unsafe and unsound banking practices; (ii) restrict preferential loans by banks to "insiders" of banks; (iii) require banks to keep information on loans to major shareholders and executive officers; and (iv) bar certain director and officer interlocks between financial institutions.
The Comptroller also administers a number of federal statutes that apply to national banks such as the Depository Institution Management Interlocks Act, the International Lending Supervision Act of 1983 and the Community Reinvestment Act of 1977 ("CRA"). CRA requires that, in connection with their examinations of financial institutions, the Comptroller shall evaluate the record of the Bank in meeting the credit needs of the local community, including low and moderate income neighborhoods, consistent with the safe and sound operation of the Bank. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch facility. The federal banking agencies, including the Comptroller, issued a new joint rule which became effective for the Bank in 1997 related to evaluating an institution's CRA performance. The new rule evaluates institutions based on their actual performance (rather than efforts) in meeting community credit needs. Subject to certain exceptions, the Comptroller assesses the CRA performance of a bank by applying lending, investment, and service tests. The Comptroller assigns a rating to a bank based on the bank's performance under the tests. To evaluate compliance with the lending, investment and service tests, subject to certain exceptions, banks are required to collect and report to the Comptroller extensive demographic and loan data. Summit National Bank received a "satisfactory" rating in its most recent CRA examination.
The Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLB") which provides a central credit facility primarily for member institutions. Members of the FHLB are required to acquire and hold shares of capital stock in, and may obtain advances from, the FHLB. The amount of stock owned is based on the Bank's balance of residential mortgages and the balance of outstanding advances from the FHLB. The FHLB makes advances to members in accordance with policies and procedures established by its Board of Directors. The Bank is authorized to borrow funds from the FHLB to meet demands for withdrawals of deposit accounts, to meet seasonal requirements, to fund expansion of the loan portfolio, or for general asset/liability management. Advances may be made on a secured or unsecured basis depending on a number of factors, including the purpose for which the funds are being borrowed and existing advances. Collateral on secured advances may be in the form of first mortgages on 1-4 family real estate, government securities, or other assets acceptable to the FHLB. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB, and general market conditions.
The Bank is also a member of the FDIC, which currently insures the deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a semiannual statutory deposit insurance assessment to maintain the Bank Insurance Fund and is subject to the rules and regulations of the FDIC. Further, the FDIC is authorized to impose one or more special assessments in any amount deemed necessary to enable repayment of amounts borrowed by the FDIC from the United States Department of the Treasury. The FDIC has broad authority to prohibit a bank from engaging in unsafe or unsound banking practices and may remove or suspend officers or directors of a bank to protect its soundness. The FDIC requires insured banks to maintain specified levels of capital, maintain certain security devices and procedures and to file quarterly reports and other information regarding its operations. The FDIC requires an assessment to be paid by each FDIC-insured institution based on the institution's assessment risk classification, which is determined based on whether the institution is considered "well capitalized", "adequately capitalized", or "undercapitalized", as such terms have been defined in applicable federal regulations adopted to implement the prompt corrective action provisions of FDICIA, and whether such institution is considered by its supervisory agency to be financially sound or to have supervisory concerns.
Pursuant to the authority granted under FDICIA, United States bank regulatory agencies were empowered to impose progressively more restrictive constraints on the operations, management and capital distributions of an insured depository institution, depending on the category in which an institution is classified. Unless a banking institution is well capitalized, it is subject to restrictions on its ability to offer brokered deposits and on certain other aspects of its operations. An undercapitalized banking institution must develop a capital restoration plan and its parent bank holding company must guarantee the bank's compliance with the plan up to the lesser of 5% of the bank's assets at the time it became undercapitalized and the amount needed to comply with the plan. As of December 31, 2000, the Company's bank subsidiary was well capitalized, based on the prompt corrective action guidelines. It should be noted, however, that a bank's capital category is determined solely for the purpose of applying the Comptroller's prompt corrective action regulations and that the capital category may not constitute an accurate representation of the bank's overall financial condition or prospects.
Interest and certain other charges collected or contracted for by the Bank are subject to state usury laws and certain federal laws concerning interest rates. The Bank's operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers; CRA requiring financial institutions to meet their obligations to provide for the total credit needs of the community; the Home Mortgage Disclosure Act of 1975 requiring financial institutions to provide information to enable the public to determine whether it is fulfilling its obligation to meet the housing needs of the community it serves; the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit; the Fair Credit Reporting Act of 1978 governing the use and provisions of information to credit reporting agencies; the Fair Debt Collection Act governing the manner in which consumer debts may be collected; and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
The deposit operations of the Bank are also subject to the Right to Financial Privacy Act which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act which governs automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services.
THE FINANCE COMPANY The Company's subsidiary finance company, Freedom Finance, Inc., is a consumer finance company licensed and regulated by the State Board. Accordingly, the Finance Company is subject to annual examinations by the State Board and various regulatory requirements, including annual reporting, annual license renewal, and other regulations pertaining to the extension of credit. Specifically, state laws and regulations apply to maximum loan amounts, terms, interest rates and credit insurance and other fee charges. These laws and regulations are subject to both repeal and revision from time to time, often in response to pressures exerted by consumer rights groups.
CAPITAL REQUIREMENTS Pursuant to the general supervisory authority conferred by the BHCA and the directives set forth in the International Lending Supervision Act of 1983, the Federal Reserve and Comptroller have adopted risk-based capital adequacy guidelines for banks and bank holding companies subject to their regulation as a means for determining the adequacy of capital based on the risks inherent in carrying various classes of assets and off-balance sheet items. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification 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 the Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulation) to risk-weighted assets (as defined) and to total assets. Management believes, as of December 31, 2000, that the Company and the Bank meet all capital adequacy requirements to which they are subject. At December 31, 2000 and 1999, the Bank is categorized as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized", the Bank must maintain certain total risk-based, Tier I risk-based and Tier I leverage ratios. There are no current conditions or events that management believes would change the Company's or the Bank's category.
The Company's and the Bank's actual capital amounts and ratios at December 31, 2000 and 1999 as well as the minimum calculated amounts for each regulatory defined category are included in this report under Part II, Item 8. "Financial Statements and Supplemental Data" as Note 14 to the Notes to Consolidated Financial Statements.
DIVIDENDS The holders of the Company's common stock are entitled to receive cash dividends when and if declared by the Board of Directors out of the funds legally available therefor. The Company is a legal entity separate and distinct from its subsidiaries and depends in large part for its income available to distribute to shareholders on the payment of cash dividends from its subsidiaries. While the Company is not presently subject to any regulatory restrictions on dividends, the Bank is subject to such regulatory restrictions.
Specifically, approval of the Comptroller of the Currency will be required for any cash dividend to be paid to the Company by the Bank if the total of all cash dividends, including any proposed cash dividend, declared by the Bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus. Additionally, the National Bank Act provides that a national bank cannot pay cash dividends or other distributions to shareholders out of any portion of its common stock or preferred stock accounts and that a bank shall pay no cash dividend in an amount greater than its net profits then on hand, after deduction of its losses and bad debts. As of December 31, 2000, no cash dividends have been declared or paid by the Bank. At December 31, 2000, the Bank had available retained earnings of $10 million.
FUTURE LEGISLATION Changes to federal and state laws and regulations could affect the operating environment of the Company and its subsidiaries in substantial and unpredictable ways. The Company cannot accurately predict what legislation will ultimately be enacted, and, if enacted, the ultimate effect that it, or implementing regulations, would have upon its or its subsidiaries' financial condition or results of operations.
STATISTICAL DISCLOSURES BY BANK HOLDING COMPANIES
The consolidated selected statistical financial data provided on the following pages presents a more detailed review of the Company's and the Bank's business activities. The disclosures are intended to provide information to facilitate analysis and comparison of sources of income and exposures to risk.
Net Interest Income Analysis - ------------------------------- Net interest income, the difference between the interest earned on assets and the interest paid for liabilities used to support those assets, is the principal source of the Company's operating income. Net interest income was $10 million, $8.7 million, and $7.6 million for 2000, 1999, and 1998, respectively. The Company's average interest rate spread is calculated as the difference between the average interest rate earned on interest-earning assets and the average interest paid on interest-bearing liabilities. For the year ended December 31, 2000, the Company's net interest margin was 5.11%, compared to 5.31% in 1999 and 4.95% for 1998. The net interest margin is calculated as net interest income divided by average earning assets. Refer to additional discussion related to the net interest income changes under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The following table presents the average balances, the average yield and the interest income earned on interest-earning assets, and the average rate and the interest paid or accrued on interest-bearing liabilities of the Company for the last three years. Also presented is the average yields and rates for interest-earning assets and interest-bearing liabilities at December 31, 2000. Tabular presentation of all average statistical data is based on daily averages.
Analysis of Changes in Interest Differential - ------------------------------------------------- Net interest income ("NII") is affected by changes in the average interest rate earned on interest-earning assets and the average interest rate paid on interest-bearing liabilities. In addition, net interest income is affected by changes in the volume of interest-earning assets and interest-bearing liabilities. The following table sets forth the dollar amount of increase in interest income and interest expense resulting from changes in (1) volume of interest-earning assets and interest-bearing liabilities (changes in volume times old rate); (2) changes in yields and rates (changes in rate times old volume); and (3) changes in rate-volume (changes in rate times changes in volume).
INTEREST RATE SENSITIVITY ANALYSIS - ------------------------------------- An important aspect of achieving satisfactory levels of net income is the management of the composition and maturities of rate sensitive assets and liabilities in order to optimize net interest income as interest rates earned on assets and paid on liabilities fluctuate from time to time. The interest sensitivity gap (the "gap") is the difference between total interest sensitive assets and liabilities in a given time period. The gap provides an indication of the extent to which the Company's net interest income may be affected by interest rate movements.
The objective of interest sensitivity management is to maintain reasonably stable growth in net interest income despite changes in market interest rates by maintaining the proper mix of interest sensitive assets and liabilities. Management seeks to maintain a general equilibrium between interest sensitive assets and liabilities in order to insulate net interest income from significant adverse changes in market rates.
At December 31, 2000, on a cumulative basis through 12 months, rate-sensitive liabilities exceed rate-sensitive assets, resulting in a 12 month period liability sensitive position at the end of 2000 of $751,000. When the effective change ratio (the historical relative movement of each asset's and liability's rates in relation to a 100 basis point change in the prime rate) is applied to the interest gap position, the Company is actually in an asset sensitive position over a 12 month period and the entire repricing lives of the assets and liabilities. This is primarily due to the fact that over 60% of the loan portfolio moves immediately on a one-to-one ratio with a change in the prime rate, while the deposit accounts do not increase or decrease as much relative to a prime rate movement.
The following table presents a measure, in a number of time frames, of the interest sensitivity gap by subtracting interest-sensitive liabilities from interest-sensitive assets.
At December 31, 2000, approximately 69% of the Company's interest-earning assets reprice or mature within one year, as compared to approximately 86% of the interest-bearing liabilities.
Asset-liability management is the process by which the Company monitors and controls the mix and maturities of its assets and liabilities. The essential purposes of asset-liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities. The Bank has established an Asset-Liability Management Committee which uses a variety of tools to analyze interest rate sensitivity, including a static gap presentation and a simulation model. A "static gap" presentation (as in the above table) reflects the difference between total interest-sensitive assets and liabilities within certain time periods. While the static gap is a widely-used measure of interest sensitivity, it is not, in management's opinion, a true indicator of a company's sensitivity position. It presents a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of savings and core time deposits may contractually change within a relatively short time frame, but those rates are significantly less interest-sensitive than market-based rates such as those paid on non-core deposits. Accordingly, a liability sensitive gap position is not as indicative of a company's true interest sensitivity as would be the case for an organization which depends to a greater extent on purchased funds to support earning assets. Net interest income would also be impacted by other significant factors in a given interest rate environment, including the spread between the prime rate and the incremental borrowing cost and the volume and mix of earning asset growth. Accordingly, the Bank uses a simulation model, among other techniques, to assist in achieving consistent growth in net interest income while managing interest rate risk. The model takes into account interest rate changes as well as changes in the mix and volume of assets and liabilities. The model simulates the Company's balance sheet and income statement under several different rate scenarios. The model's inputs (such as interest rates and levels of loans and deposits) are updated as necessary throughout the year in order to maintain a current forecast as assumptions change. The forecast presents information over a 12 month period. It reports a base case in which interest rates remain flat and reports variations that occur when rates increase and decrease 100 basis points. According to the model, the Company is presently positioned so that net interest income will increase slightly if interest rates rise in the near term and will decrease slightly if interest rates decline in the near term.
INVESTMENT PORTFOLIO - --------------------- The Company maintains a portfolio of investment securities consisting primarily of U.S. Treasury securities, U.S. government agencies, mortgage-backed securities, and state and municipal securities. The investment portfolio is designed to enhance liquidity while providing acceptable rates of return. The following table sets forth the amortized cost and the fair value of the investment securities of the Company at December 31, 2000, 1999, and 1998. There were no investments categorized as "held to maturity" as defined in Statement of Financial Accounting Standards ("SFAS") 115, "Accounting for Certain Investments in Debt and Equity Securities".
Included in the "Other assets" on the consolidated balance sheet in this report under Part II, Item 8, "Financial Statements and Supplemental Data" are amounts for stock owned by the Bank as follows:
The amount of Federal Reserve Bank stock owned is based on the Bank's capital levels. The amount of Federal Home Loan Bank ("FHLB") stock owned is determined based on the Bank's balances of residential mortgages and advances from the FHLB. No ready market exists for these stocks and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value.
The following table indicates the estimated fair value of each investment security category by maturity as of December 31, 2000. The weighted average yield for each range of maturities at December 31, 2000 is also shown. All securities are classified as "Available for Sale" as defined in SFAS No. 115.
The weighted average yields shown in the previous table are calculated using historical cost balances and effective yields for the scheduled maturity of each security. The yield calculations do not give effect to changes in fair value that are reflected as a component of shareholders' equity.
At year end, the average maturity of the security portfolio was 6.1 years, the average duration of the portfolio was 4.2 years, and the average adjusted tax equivalent yield on the portfolio for the year ended December 31, 2000 was 6.86%. Certain securities contain call provisions which could decrease their anticipated maturity. Certain securities also contain rate adjustment provisions which could either increase or decrease their yields.
Decisions involving securities are based upon management's expectations of interest rate movements, overall market conditions, the composition and structure of the balance sheet, and computer-based simulations of the financial impacts of alternative rate/maturity scenarios. The Company does not purchase or hold securities for trading purposes. However, securities may be sold prior to their maturity as all securities in the Bank's portfolio at December 31, 2000 were classified as "available for sale" and recorded on the Company's balance sheet at estimated fair value.
LOANS - ----- The loan portfolio is the Company's principal earning asset. The following table shows the composition of the loan portfolio at December 31 for each year presented.
The Company makes loans to individuals and small to mid-sized businesses for various personal and commercial purposes primarily in the Upstate of South Carolina. The Company has a diversified loan portfolio and the Company's loan portfolio is not dependent upon any specific economic segment. The Company regularly monitors its credit concentrations based on loan purpose, industry, and customer base. As of December 31, 2000, there were no material concentrations of credit risk within the Company's loan portfolio.
The Company's real estate loans are primarily owner-occupied commercial facilities and other loans secured by both commercial and residential real estate located within the Company's primary market area. The Company does not actively pursue long-term, fixed rate mortgage loans for retention in its loan portfolio. Commercial loans are spread through a variety of industries, with no industry or group of related industries accounting for a significant portion of the commercial loan portfolio. These loans may be made on either a secured or unsecured basis. When taken, collateral generally consists of liens on inventories, receivables, equipment, and furniture and fixtures. Unsecured commercial loans are generally short-term with emphasis on repayment strengths and low debt-to-worth ratios. At December 31, 2000, the Company had no foreign loans.
A significant portion of the installment and other consumer loans are secured by automobiles and other personal assets. Consumer finance loans are those originated by the Company's consumer finance subsidiary, Freedom Finance, Inc. These loans generally carry a higher risk of nonpayment than do the other categories of loans, but the increased risk is substantially offset by the smaller amounts of such loans and the higher rates charged thereon, as well as a higher allocation of the allowance for loan losses related to Freedom's loan portfolio.
LOAN MATURITY AND INTEREST SENSITIVITY - ------------------------------------------ The following table shows the maturity distribution and interest sensitivity of the Company's loan portfolio at December 31, 2000.
NONPERFORMING ASSETS AND POTENTIAL PROBLEM LOANS - ----------------------------------------------------- The Company's nonperforming assets consist of loans on nonaccrual basis, loans which are contractually past due 90 days or more on which interest is still being accrued, and other real estate owned ("OREO"). Generally, loans of the Bank are placed on nonaccrual status when loans become 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the loan is doubtful. Payments of interest on loans which are classified as nonaccrual are recognized as income when received. Loans of the Finance Company are not classified as nonaccrual, but are charged-off when such become 150 days contractually past due or earlier if the loan is deemed uncollectible.
The following table summarizes the nonperforming assets at December 31 for each year presented.
The amount of foregone interest income that would have been recorded on non-accrual loans had these loans performed according to their contractual terms amounted to approximately $6,000 and $4,000 during 2000 and 1999, respectively, while interest income recognized on these loans was approximately $15,000 and $17,000 during 2000 and 1999, respectively.
At December 31, 2000, the carrying value of loans that are considered to be impaired under SFAS 114 totaled $1,462,000, which includes the $218,000 non-accrual loan. There were no impaired loans at December 31 for any other year presented. The increase in impaired loans is primarily related to one large commercial loan. The average balance of impaired loans was $1,457,000 for the year ended December 31, 2000 and there was no impairment allowance required at year end. Interest income recognized on impaired loans during 2000 was approximately $143,000.
Management maintains a list of potential problem loans which includes nonaccrual loans, loans past due in excess of 90 days which are still accruing interest, and other loans which are credit graded (either internally, by external audits or by regulatory examinations) as "substandard", "doubtful", or "loss". A loan is added to the list when management becomes aware of information about possible credit problems of borrowers that causes doubts as to the ability of such borrowers to comply with the current loan repayment terms. The total amount of loans outstanding at December 31, 2000 determined to be potential problem loans, based upon management's internal designations, was $7.9 million, or 4.4%, of the loan portfolio at year end, compared to $8.4 million or 5.7% of the loan portfolio at December 31, 1999. The amount of potential problem loans at December 31, 2000 does not represent management's estimate of potential losses since the majority of such loans are considered adequately secured by real estate or other collateral. Management believes that the allowance for loan losses as of December 31, 2000 was adequate to absorb any losses related to the nonperforming loans and problem loans as of that date.
Management continues to monitor closely the levels on nonperforming and problem loans and will attempt to address the weaknesses in these credits to enhance the amount of ultimate collection or recovery on these assets. Should increases in the overall level of nonperforming and potential problem loans accelerate from the current trend, management will adjust the methodology for determining the allowance for loan losses and will increase the provision for loan losses accordingly. This would likely decrease net income.
PROVISION AND ALLOWANCE FOR LOAN LOSSES, LOAN LOSS EXPERIENCE - --------------------------------------------------------------------- The allowance for loan losses is based on management's periodic evaluation of the loan portfolio and reflects an amount that, in management's opinion, is adequate to absorb probable losses inherent in the loan portfolio at December 31, 2000. The allowance is established through charges to earnings in the form of a provision for loan losses. Loan losses and recoveries are charged or credited directly to the allowance. The amount charged to the provision for loan losses by the Company is based on management's judgment and is dependent upon growth in the loan portfolios; the total amount of past due loans; nonperforming loans; known loan deteriorations and/or concentrations of credit; trends in portfolio volume, maturity and composition; projected collateral values; general economic conditions; and management's assessment of probable losses based upon internal credit grading of the loans and periodic reviews and assessments of credit risk associated with particular loans.
In assessing the adequacy of the allowance, management relies predominately on its ongoing review of the loan portfolio, which is undertaken both to ascertain whether there are losses which must be charged-off and to assess the risk characteristics of the portfolio in the aggregate. The Bank attempts to deal with credit risks through the establishment of, and adherence to, internal credit policies. These policies include loan officer and loan committee credit limits, periodic documentation examination, and follow-up procedures for any exceptions to credit policies. Loans that are determined to involve any more than the normal risk of collection are placed in a special review status. The Company's methodology for evaluating the adequacy of the allowance for loan losses consists of a three-tiered process. The first tier includes specific allocations set aside for internally graded credits as defined in the Bank's loan policy. The second tier is the allocation for past due and problem credits not considered in the first tier. Finally, the third tier is the general portion of the allowance which applies appropriate loss factors to segments of the loan portfolio as defined in the loan policy. The loss factors applied in the third tier may be adjusted as appropriate given consideration of local economic conditions, exposure concentration that may exist in the portfolio, changes in trends of past due loans, problem loans and charge-offs, and anticipated loan growth.
The following table sets forth certain information with respect to changes in the Company's allowance for loan losses arising from charge-offs, recoveries, and provision for the years ended December 31.
On December 31, 2000, the allowance for loan losses was $2.6 million, or 1.42% of outstanding loans. This is compared to a $2.2 million allowance for loan losses at December 31, 1999, or 1.46% of outstanding loans at that date. For the year ended December 31, 2000, the Company reported consolidated net charge-offs of $257,000, or 0.16% of average loans. This is compared to consolidated net charge-offs of $109,000, or 0.08% of average loans, for the year ended December 31, 1999. During 2000, the Company charged a total of $654,000 to expense through its provision for loan losses, compared to $445,000 for 1999 and $290,000 for 1998. The change in the provision each year was directly related to the level of net originations in each year as follows: $32.6 million in 2000, $17.6 million in 1999, $12.1 million in 1998, $16.0 million in 1997, and $27.1 million in 1996. Also impacting the amount charged to the provision each year are trends in past due, classified and problem loans as well as the amount of each at year end; concentrations of credit risk in the loan portfolio; local and national economic conditions and anticipated trends; and the total outstanding loans and charge-off activity of the Finance Company which generally have higher inherent risk than do loans of the Bank. An additional consideration in the increase to the provision for 2000 was the Bank's move into a new market and the resulting rapid growth creating higher risk. Estimates charged to the provision for loan losses are based on management's judgment as to the amount required to cover probable losses inherent in the loan portfolio and are adjusted as necessary.
Management considers the allowance for loan losses adequate to cover probable losses inherent in the loan portfolio at December 31, 2000. It must be emphasized, however, that the determination of the allowance for loan losses using the Company's procedures and methods rests upon various judgments and assumptions about future economic conditions and other factors affecting loans. While it is the Company's policy to provide for loan losses in the current period in which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, industry trends, and conditions affecting individual borrowers, management's judgement of the allowance is necessarily approximate and imprecise. No assurance can be given that the Company will not in any particular period sustain loan losses which would be sizable in relationship to the amount reserved or that subsequent evaluation of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. The allowance for loan losses is also subject to review and approval by various regulatory agencies through their periodic examinations of the Company's subsidiaries. Such examinations could result in required changes to the allowance for loan losses. No adjustments in the allowance or significant adjustments to the Bank's internal classified loans were made as a result of the Bank's most recent examination performed by the Office of the Comptroller of the Currency.
COMPOSITION OF ALLOWANCE FOR LOAN LOSSES - --------------------------------------------- The table below presents an allocation of the allowance for loan losses for each of the years ended December 31 by the different loan categories. However, the breakdown is based on a number of qualitative factors and the amounts presented are not necessarily indicative of actual amounts which will be charged to any particular category.
DEPOSITS - -------- The Company has a large, stable base of time deposits, principally certificates of deposit and individual savings and retirement accounts obtained primarily from customers in South Carolina. The Company does not purchase brokered deposits. At December 31, 2000, the Company had no foreign deposits.
The maturity distribution of certificates of deposit greater than or equal to $100,000 as of December 31, 2000 is as follows (dollars in thousands):
RETURN ON EQUITY AND ASSETS - ------------------------------- The return on average shareholders' equity ratio (net income divided by average total equity) and the return on average assets ratio (net income divided by average total assets) for the years ended December 31, 2000, 1999, and 1998 are presented in the following table. The Company has not paid a cash dividend since its inception. The holders of common stock are entitled to receive dividends when and as declared by the Board of Directors. The Company's present policy is to retain all earnings for the operation of the Company until such time as future earnings support cash dividend payments.
ITEM 2.
ITEM 2. PROPERTIES
The operations of the Company and the Bank do not require any substantial investment in fixed assets. The principal executive offices for the Company, the Bank and the Finance Company are located at 937 North Pleasantburg Drive, Greenville, South Carolina. In addition, this site serves as the Bank's main branch. The building at this location is approximately 7,500 square feet in area and is situated on a one-acre lot. The Company executed a lease for the land and building and assigned the lease to the Bank effective on the Bank's commencement of operations. The initial term of the lease commenced April 1, 1990 and renewal options were exercised in April 1995 and September 1998. The term of current renewal of the lease is five years. The lease provides that the Company will be responsible for real property taxes, insurance, utilities and maintenance with respect to the premises. During 1995, the Bank completed construction on approximately .63 acres of land at 2201 Augusta Road, Greenville, South Carolina of its second full service bank branch. The facility is approximately 6,500 square feet and is fully owned and occupied by the Bank. During April 1998, the Company entered into an agreement to lease a facility for a branch located at 800 East North Street, Greenville, South Carolina. This facility, which was occupied in October 1998, is approximately 8,000 square feet and serves as the third full service bank branch and as the Bank's operations facility. The lease has an initial term of seven years and includes a renewal option for an additional seven year period. During 2000, the Bank purchased a 1.1 acre parcel of land for construction of a fourth branch in Spartanburg, South Carolina. The branch facility is currently under construction and is estimated to be completed by mid-2001.
The 11 Finance Company branches throughout South Carolina are housed in leased facilities averaging 1,200 square feet each with lease terms from three to ten years. The lease agreements have various renewal options under substantially the same terms as the original agreements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Although the Company is from time to time a party to various legal proceedings arising out of the ordinary course of business, management believes there is no litigation or proceeding threatened or pending against the Company that could reasonably be expected to result in a materially adverse change in the business or financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders in the fourth quarter of the Company's fiscal year ending December 31, 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Summit Financial Corporation's common stock is traded in the Small-Cap market on the NASDAQ system under the symbol SUMM. As of March 1, 2001 there were approximately 390 shareholders of record of the common stock. The number of shareholders does not reflect the number of persons or entities who hold their stock in nominee or "street" name through various brokerage firms.
The following table presents the high and low stock prices for the Company's common stock for each full quarterly period within the two most recent fiscal years. The source for the following information was the Nasdaq market. Stock price data has been restated to reflect all 5% stock dividends issued.
The Company has not paid any cash dividends. The holders of common stock are entitled to receive dividends when and as declared by the Board of Directors. The Company's present policy is to retain all earnings for the operation of the Company until such time as future earnings support cash dividend payments. Accordingly, the Company does not anticipate paying cash dividends in the foreseeable future. For information on dividend restrictions, refer to Part II, Item 8. "Financial Statements and Supplementary Data", Note 14 under Notes to Consolidated Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA The information presented below should be read in conjunction with the consolidated financial statements, the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained under Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is presented to provide the reader with an understanding of the financial condition and results of operations of Summit Financial Corporation and its subsidiaries, Summit National Bank and Freedom Finance, Inc.
FORWARD-LOOKING STATEMENTS
This report may contain certain "forward-looking statements", within the meaning of Section 27A of the Securities Exchange Act of l934, as amended, that represent the Company's expectations or beliefs concerning future events. Such forward-looking statements are about matters that are inherently subject to certain risks, uncertainties, and assumptions. Factors that could influence the matters discussed in certain forward-looking statements include the relative levels of market interest rates, loan prepayments and deposit decline rates, the timing and amount of revenues that may be recognized by the Company, continuation of current revenue, expense and charge-off trends, legal and regulatory changes, and general changes in the economy. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those expected or projected. These forward-looking statements speak only as of the date of the document. The Company assumes no obligation to update any forward-looking statements. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them.
GENERAL
Summit Financial Corporation (the "Company") is a financial institution holding company headquartered in Greenville, South Carolina. The Company offers a broad range of financial services through its wholly-owned subsidiary, Summit National Bank (the "Bank," or "Summit"). The Bank is a nationally chartered commercial bank which operates principally in the Upstate of South Carolina. The Bank received its charter and commenced operations in July 1990. In 1997, the Bank incorporated Summit Investment Services, Inc. as a wholly-owned subsidiary to provide a wider range of investment products and financial planning services. The Bank currently has four full service offices in Greenville and Spartanburg, South Carolina. Summit provides a full range of banking services to individuals and businesses, including the taking of time and demand deposits, making loans, and offering nondeposit investment services. The Bank emphasizes close personal contact with its customers and strives to provide a consistently high level of service to both individual and corporate customers.
Freedom Finance, Inc. (the "Finance Company" or "Freedom,") is a wholly-owned subsidiary of the Company which is operating as a consumer finance company headquartered in Greenville, South Carolina. The Finance Company primarily makes and services installment loans to individuals with loan principal amounts generally not exceeding $2,000 and with maturities ranging from three to eighteen months. Freedom operates eleven branches throughout South Carolina.
INCOME STATEMENT REVIEW
GENERAL The Company reported record earnings in 2000 which were up 10% from 1999. Net income totaled $2.7 million, or $0.69 diluted earnings per share in 2000 compared with $2.4 million, or $0.62 diluted earnings per share in 1999 and $1.9 million or $0.48 diluted earnings per share for 1998. The improvement in net income and earnings per share between 1999 and 2000 resulted primarily from the growth in earning assets. Increases in other income also contributed to the higher net income in 2000.
NET INTEREST INCOME Net interest income is the difference between the interest earned on assets and the interest paid for the liabilities used to support those assets. It is the largest component of the Company's earnings and changes in net interest income have the greatest impact on net income. Variations in the volume and mix of assets and liabilities and their relative sensitivity to interest rate movements determine changes in net interest income.
During 2000 the Company recorded net interest income of $10.0 million, a 15% increase from the 1999 net interest income of $8.7 million. This is compared to net interest income of $7.6 million for 1998. The increase in net interest income in 2000 is directly related to the increase in the average earning assets and interest-bearing liability volume of the Bank of 19% and 18%, respectively, offset somewhat by the 20 basis point decrease in net interest margin during the year. Net interest income increased in 1999 related to the higher average loan and interest-bearing deposit volume of the Bank which was up from 1998 by 15% and 7%, respectively, combined with the overall reduction in the cost of funds in 1999.
For the year ended December 31, 2000, the Company's net interest margin was 5.11%, compared to 5.31% in 1999 and 4.95% for 1998. The net interest margin is calculated as net interest income divided by average earning assets. The margin for 2000 decreased 20 basis points from the prior year due primarily to the higher cost of funds related to the general rise in interest rates during 2000 and promotions offered on certificates of deposit ("CDs") during the year. The margins between 1999 and 1998 increased 36 basis points due to the reduction in the cost of funds as CDs with higher rates matured and were replaced with lower market rate deposits during the declining rate period between late 1998 and mid-year 1999.
INTEREST INCOME Interest income for 2000 was $19.4 million, which was a $4.0 million or 26% increase over the $15.4 million for 1999. Interest income for 1998 was $14.4 million. The increases each year are primarily a result of the higher levels of earning assets which averaged $201.2 million, $169.7 million and $158.0 million in 2000, 1999 and 1998, respectively. Changes in average yield on earning assets also affect the interest income reported each year. The average yield, on a fully tax equivalent basis, decreased from 9.26% in 1998 to 9.21% in 1999, and increased to 9.78% in 2000 due to fluctuations in the general interest rate environment during the three year period.
The majority of the increase in average earning assets between 1998 and 1999 and between 1999 and 2000 was in loans, which are the Company's highest yielding assets that accounted for 79% of average earning assets for the year ended 2000. Consolidated loans averaged $159.7 million in 2000 with an average yield of 10.57%, compared to $139.0 million in 1999 with an average yield of 9.84%, and $120.5 million in 1998 with an average yield of 10.19%. Approximately 68% of the Company's loan portfolio adjusts immediately with changes in the prime lending rate. The average loan rate dropped in 1999 as compared to 1998 as a direct result of the decline in the prime rate which averaged 8.36% in 1998 and 8.00% in 1999. The prime rate increased in 2000 to average 9.23% resulting in increases in the average yield on loans in 2000. The higher level of average loans each year, combined with the effect of fluctuations in average yield, resulted in increases in interest income on loans of $1.4 million or 11% between 1998 and 1999, and $3.2 million or 23% between 1999 and 2000.
The second largest component of earning assets is the Company's investment portfolio which averaged $28.7 million yielding 6.86% in 2000. This is compared to average securities of $26.3 million in 1999 yielding 6.50%, and $27.5 million yielding 6.47% for 1998. The increase in the average yield of the investment portfolio is related to the timing, maturity distribution and types of securities purchased, combined with fluctuations in the general interest rate environment. The changes in the level of average securities each year, combined with increases in average rate, resulted in an increase in interest income on investments of $251,000 or 17% between 1999 and 2000 and a decrease of $117,000 or 7% between 1998 and 1999.
INTEREST EXPENSE The Company's interest expense for 2000 was $9.4 million, compared to $6.6 million for 1999 and $6.8 million for 1998. The 42% increase in interest expense in 2000 was related to the 18% increase in average interest-bearing liabilities, combined with the 92 basis point increase in the cost of funds. The reduction in the interest expense in 1999 from 1998 was a result of the 7% increase in average interest-bearing liabilities being more than offset by the 49 basis point reduction in the cost of funds. The higher average cost of funds in 2000 was primarily a result of the maturity of CDs renewed at higher current market rates as the prime rate increased in the latter half of 1999 and into 2000, combined with promotional rates offered on CDs during 2000. Interest-bearing liabilities averaged $168.5 million in 2000 with an average rate of 5.57%, compared to $142.4 million in 1999 with an average rate of 4.65%, and an average of $132.3 million with an average rate of 5.14% during 1998.
PROVISION FOR LOAN LOSSES The provision for loan losses was $654,000 in 2000, $445,000 in 1999, and $290,000 in 1998. The change in the provision each year was directly related to the level of net originations in each year as follows: $32.6 million in 2000, $17.6 million in 1999, and $12.1 million in 1998. Other factors influencing the amount charged to the provision each year is the total amount of past due and classified loans and the total outstanding loans and charge-off activity of the Finance Company, which have higher inherent risk than do loans of the Bank. Estimates charged to the provision for loan losses are based on management's judgment as to the amount required to cover inherent losses in the loan portfolio and are adjusted as necessary.
NONINTEREST INCOME AND EXPENSES Noninterest income increased $286,000 or 18%, to $1.8 million in 2000 from $1.6 million in 1999 and $1.4 million in 1998. Credit card fees and income, the largest single item in noninterest income, rose 11% to $376,000 in 2000 from $338,000 in 1999 and $298,000 in 1998. The increase is related to the higher volume of transactions and merchant activity in the Bank's credit card portfolio each year. The higher amount in service charges and fees on deposit accounts, which increased approximately 50% in 2000 to $369,000 from $247,000 in 1999 and $203,000 in 1998, is related to the increases in the transaction fees and the higher number of Bank deposit accounts and transactions subject to service charges and fees.
Insurance commission fee income increased $83,000 between 1999 and 2000 and decreased $32,000 between 1998 and 1999 related to fluctuations in the level of activity for both the Bank and the Finance Company. Included in insurance commissions is income from annuity sales made in the Bank's nondeposit investment sales department and earned commissions on credit-related insurance products generated by the Finance Company.
The remainder of the changes in other income is primarily related to the level of activity in the Bank's nondeposit financial services and brokerage department which resulted in increased income of $58,000 in 2000 and a decrease of $29,000 in 1999. Other fluctuations each year are related to the higher level of activity and transactions of the Bank generating other income in the normal course of business.
Total noninterest expenses were $7.4 million in 2000, $6.5 million in 1999, and $5.8 million in 1998. A majority of the increased expenditures each year reflects the cost of additional personnel hired to support the Company's growth and new bank branches opened in the fourth quarter of 1998 and the second quarter of 2000. The most significant item included in noninterest expenses is salaries, wages and benefits which amounted to $4.3 million in 2000, $3.5 million in 1999, and $3.2 million in 1998. The increase of $780,000 in 2000 was a result of (1) normal annual raises and replacement of staff; (2) higher profitability-related bonus and incentives; and (3) additional staff, including three officers, added starting in April 2000 at the new branch location. The increase of $332,000 in 1999 was a result of (1) normal annual raises and increases in bonuses and incentive payments; and (2) additional branch, support and lending staff added in the normal course of business in late 1998 and throughout 1999.
Occupancy and furniture, fixtures, and equipment expenses increased $82,000 or 7% to $1.3 million in 2000 from $1.2 million in 1999 and increased $172,000 from $1.0 million in 1998. The increase each year was related primarily to the expenses associated with new branch facilities which commenced in late 1998 and mid-2000.
Included in the line item "other expenses", which decreased $26,000 or 1% between 1999 and 2000, and increased $190,000 or 12% between 1998 and 1999, are charges for insurance claims and premiums; printing and office support; credit card expenses; professional services; advertising and public relations; and other branch and customer related expenses. A majority of these items are related directly to the normal operations of the Bank and are related to the increase in assets, the higher level of transaction volume, and the larger number of customer accounts. The reduction in 2000 is primarily related to the Bank's expenses returning to a normal level after additional expenses were incurred in 1999 related to higher repossession and collection costs; advertising expenses associated with marketing new internet banking products; and Y2K preparation expenses.
INCOME TAXES The Company recorded an income tax provision of $1.2 million, $936,000, and $1.0 million in 2000, 1999, and 1998, respectively. The effective tax rate in each year was 31%, 28%, and 35%, respectively. The change in effective rate each year is primarily related to fluctuations in the level of tax-free municipal investments.
BALANCE SHEET REVIEW
INVESTMENT SECURITIES At December 31, 2000, the Company's total investment portfolio had a fair value of $32.4 million, which is an increase of 23% from the $26.5 million invested as of the end of 1999. The investment portfolio consists primarily of securities of United States government agencies, mortgage-backed securities, and state and municipal obligations. The Company has no trading account securities. At the 2000 year end, the portfolio had a weighted average life of approximately 6.1 years and an average duration of 4.2 years. Investment securities averaged $28.7 million yielding 6.86% in 2000, compared to the 1999 average of $26.3 million yielding 6.50%. Securities are the second largest earning asset of the Company at 14% and 16% of average earning assets for 2000 and 1999, respectively.
LOANS The loan portfolio consists primarily of commercial and industrial loans; commercial loans secured by real estate; loans secured by one-to-four family residential mortgages; and consumer loans. Substantially all of these loans are located in the Upstate of South Carolina and are concentrated in the Company's market area. At December 31, 2000, the Company had no loans for highly leveraged transactions and no foreign loans. The Bank's primary focus has been on commercial lending to small and medium-sized businesses in its marketplace. Commercial loans are spread throughout a variety of industries, with no industry or group of related industries accounting for a significant portion of the commercial loan portfolio.
As of December 31, 2000, the Company had total loans outstanding, net of unearned income, of $180.5 million which represents an increase of $32.3 million or 22% from the 1999 outstanding loans of $148.2 million. Outstanding loans represent the largest component of earning assets at 79% of average earning assets for 2000 compared to 82% for 1999. Gross loans were 72% and 77%, respectively, of total assets at December 31, 2000 and 1999. The 22% increase in loans between 1999 and 2000 is attributable to internal growth and the Bank's expansion into a new market during 2000 as the Company did not purchase any loans during the year. Freedom's outstanding loans, net of unearned income, totaled $3.5 million, or 1.9% of consolidated loans at December 31, 2000. This is compared to $3.2 million or 2.1% of consolidated loans at December 31, 1999.
For 2000, the Company's loans averaged $159.7 million with a yield of 10.57%. This is compared to $139.0 million average loans with a yield of 9.84% in 1999. The increase in the loan yield reflects the general increasing rate environment experienced through 2000. The interest rates charged on loans of the Bank vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government policy and regulations also influence interest rates. Loans of the Finance Company are regulated under state laws which establish the maximum loan amounts and interest rates, and the types and maximum amounts of fees, insurance premiums, and other costs that may be charged.
The allowance for loan losses is established through charges in the form of a provision for loan losses. Loan losses and recoveries are charged or credited directly to the allowance. The amount charged to the provision for loan losses by the Bank and the Finance Company is based on management's judgment as to the amounts required to maintain an adequate allowance. The level of this allowance is dependent upon growth in the loan portfolios; the total amount of past due loans; nonperforming loans; and known loan deteriorations and/or concentrations of credit. Other factors affecting the allowance are trends in portfolio volume, maturity and composition; collateral values; and general economic conditions. Finally, management's assessment of probable losses based upon internal credit grading of the loans and periodic reviews and assessments of credit risk associated with particular loans is considered in establishing the allowance amount.
Management maintains an allowance for loan losses which it believes adequate to cover inherent losses in the loan portfolio. However, management's judgment is based upon a number of assumptions about future events which are believed to be reasonable, but which may or may not prove valid. There are risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Management uses the best information available to make evaluations, however, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making evaluations. The Company is also subject to regulatory examinations and determinations as to the adequacy of the allowance, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance in comparison to a group of peer companies identified by the regulatory agencies.
The allowance for loan losses totaled $2.6 million or 1.42% of total loans at the end of 2000. This is compared to a $2.2 million allowance or 1.46% of total loans at December 31, 1999. For the year ended December 31, 2000, the Company reported net charge-offs of $257,000 or 0.16% of consolidated average loans. This is compared to consolidated net charge-offs of $109,000 or 0.08% of average loans for the year ended December 31, 1999.
Loans past due 90 days and greater totaled $122,000 or 0.07% of gross loans at December 31, 2000 compared to $130,000 or 0.09% of gross loans at December 31, 1999. Loans on non-accrual totaled $218,000 and $147,000, respectively, at December 31, 2000 and 1999. Generally, loans of the Bank are placed on non-accrual status at the earlier of when they are 90 days past due or when the collection of the loan becomes doubtful. Loans of the Finance Company are not classified as non-accrual, but are charged-off when such become 150 days contractually past due or earlier if the loan is deemed uncollectible. At December 31, 2000 and 1999, the Bank held no other real estate owned acquired in partial or total satisfaction of problem loans. At December 31, 2000, loans considered to be impaired under Statement of Financial Accounting Standards 114 totaled $1.5 million, which includes the $218,000 non-accrual loan. There were no impaired loans at December 31, 1999.
INTEREST-BEARING LIABILITIES During 2000, interest-bearing liabilities averaged $168.5 million with an average rate of 5.57% compared to $142.4 million with an average rate of 4.65% in 1999. The increase in the average rate reflects the general increasing rate environment experienced throughout 2000. In pricing deposits, the Company considers its liquidity needs, the direction and levels of interest rates and local market conditions. At December 31, 2000, interest-bearing deposits comprised approximately 83% of total deposits and 91% of interest-bearing liabilities. The remainder of interest-bearing liabilities consists principally of Federal Home Loan Bank advances.
The Company uses its deposit base as a primary source with which to fund earning assets. Deposits increased 32% from $158.0 million at December 31, 1999 to $209.2 million as of year end 2000. The increase was primarily in the non-interest-bearing demand accounts, money market accounts and time deposits greater than $100,000. Noninterest-bearing deposits, which increased 49% during the year, averaged 12.4% of total deposits for the year 2000 compared to 12.7% in 1999.
The Company's core deposit base consists of consumer and commercial money market accounts, checking accounts, savings and retirement accounts, NOW accounts, and non-jumbo time deposits (less than $100,000). Although such core deposits continue to be interest sensitive for both the Company and the industry as a whole, these deposits continue to provide the Company with a large and stable source of funds. The Company closely monitors its reliance on certificates of deposit greater than $100,000, which are generally considered less stable and more interest rate sensitive than core deposits. Certificates of deposit in excess of $100,000 represented 22% and 18%, respectively, of total deposits at December 31, 2000 and 1999. The Company has no brokered deposits.
CAPITAL RESOURCES
Total shareholders' equity amounted to $21.5 million, or 8.6% of total assets, at December 31, 2000. This is compared to $17.6 million, or 9.2% of total assets, at December 31, 1999. The $3.9 million increase in total shareholders' equity resulted principally from retention of earnings and stock issued pursuant to the Company's stock option plans, combined with the decrease in unrealized loss on investments available for sale.
Book value per share at December 31, 2000 and 1999 was $5.98 and $5.16, respectively. On November 20, 2000, the Company issued its ninth 5% stock dividend to shareholders of record as of November 6, 2000. This dividend resulted in the issuance of approximately 171,000 shares of the Company's $1.00 par value common stock. All weighted average share and per share data has been restated to reflect all stock dividends.
To date, the capital needs of the Company have been met through the retention of earnings and from the proceeds of its initial offering of common stock. The Company believes that the rate of asset growth will not negatively impact the capital base. The Company has no commitments or immediate plans for any significant capital expenditures outside of the normal course of business. The Company's management does not know of any trends, events or uncertainties that may result in the Company's capital resources materially increasing or decreasing.
The following table sets forth various capital ratios for the Company and the Bank at December 31, 2000 and 1999. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. At December 31, 2000 and 1999, the Company and the Bank were in compliance with each of the applicable regulatory capital requirements. The Bank exceeded the "well-capitalized" standard under the regulatory framework for prompt corrective action.
LIQUIDITY
Liquidity management involves meeting the cash flow requirements of the Company. The Company must maintain an adequate liquidity position in order to respond to the short-term demand for funds caused by withdrawals from deposit accounts, maturities of other borrowings, extensions of credit, and for the payment of operating expenses. Maintaining an adequate level of liquidity is accomplished through a combination of liquid assets, those which can easily be converted into cash, and access to additional sources of funds. The Company's primary liquid assets are cash and due from banks, federal funds sold, unpledged investment securities available for sale, other short-term investments and maturing loans. These primary liquidity sources accounted for 15% and 13% of average assets for each of the years ended December 31, 2000 and 1999, respectively. In management's opinion, the Company maintains adequate levels of liquidity by retaining sufficient liquid assets and assets which can be easily converted into cash and by maintaining access to various sources of funds. The primary sources of funds available through the Bank include advances from the Federal Home Loan Bank, purchasing federal funds from other financial institutions, lines of credit through the Federal Reserve Bank, and increasing deposits by raising rates paid.
Summit Financial Corporation ("Summit Financial"), the parent holding company, has limited liquidity needs. Summit Financial requires liquidity to pay limited operating expenses and to provide funding to its consumer finance subsidiary, Freedom Finance. Summit Financial has approximately $2.8 million in available liquidity remaining from its initial public offering and the retention of earnings. A total of $1.8 million of this liquidity was advanced to the Finance Company to fund its operations as of December 31, 2000. Summit Financial also has an available line of credit totaling $2.5 million with an unaffiliated financial institution, all of which was available at December 31, 2000. Further sources of liquidity for Summit Financial include borrowings from individuals, and management fees and debt service which are paid by its subsidiary on a monthly basis.
Liquidity needs of Freedom Finance, primarily for the funding of loan originations, paying operating expenses, and servicing debt, have been met to date through the initial capital investment of $500,000 made by Summit Financial, borrowings from an unrelated private investor, and line of credit facilities provided by Summit Financial and Summit National Bank.
The Company's management believes its liquidity sources are adequate to meet its operating needs and does not know of any trends, events or uncertainties that may result in a significant adverse affect on the Company's liquidity position.
EFFECT OF INFLATION AND CHANGING PRICES
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and results of operations in terms of historical dollars, without consideration of changes in the relative purchasing power over time due to inflation. Unlike most other industries, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect in a financial institution's performance than does the effect of inflation.
The yield on a majority of the Company's earning assets adjusts simultaneously with changes in the general level of interest rates. Approximately 48% of the Company's liabilities at December 31, 2000 had been issued with fixed terms and can be repriced only at maturity. During periods of rising interest rates, as experienced through 2000, the Company's assets reprice faster than the supporting liabilities. This causes an increase in the net interest margin until the fixed rate deposits mature and are repriced at then higher current market rates, thus narrowing the difference between what the Company earns on its assets and what it pays on its liabilities. Given the Company's current balance sheet structure, the opposite effect (that is, a decrease in net interest income) is realized in a falling rate environment.
ACCOUNTING, REPORTING AND REGULATORY MATTERS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes, for the first time, comprehensive accounting and reporting standards for derivative instruments and hedging activities. For accounting purposes, SFAS 133 comprehensively defines a derivative instrument. SFAS 133 requires that all derivative instruments be recorded in the statement of financial position at fair value. The accounting for the gain or loss due to change in fair value of the derivative instrument depends on whether the derivative instrument qualifies as a hedge. If the derivative does not qualify as a hedge, the gains or losses are reported in earnings when they occur. However, if the derivative instrument qualifies as a hedge, the accounting varies based on the type of risk being hedged.
SFAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of SFAS 133", delayed the effective date of this statement for one year. SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of Statement No. 133", addresses a limited number of issues causing implementation difficulties for entities that apply SFAS 133. SFAS 133 applies to all entities and is effective as of the beginning of the first quarter of the fiscal year beginning after June 15, 2000. The Company adopted SFAS 133 effective January 1, 2001 with no material impact on its financial statements.
INTEREST RATE SENSITIVITY
Achieving consistent growth in net interest income, which is affected by fluctuations in interest rates, is the primary goal of the Company's asset/liability function. The Company attempts to control the mix and maturities of assets and liabilities to maintain a reasonable balance between exposure to interest rate fluctuations and earnings and to achieve consistent growth in net interest income, while maintaining adequate liquidity and capital. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent or on the same basis. The Company's asset/liability mix is sufficiently balanced so that the effect of interest rates moving in either direction is not expected to be significant over time.
The Company's Asset/Liability Committee ("ALCO") uses a simulation model, among other techniques, to assist in achieving consistent growth in net interest income while managing interest rate risk. The model takes into account, over a 12 month period or longer if necessary, interest rate changes as well as changes in the mix and volume of assets and liabilities. The model simulates the Company's balance sheet and income statement under several different rate scenarios and rate shocks. The model's inputs (such as interest rates and levels of loans and deposits) are updated as necessary throughout the year in order to maintain a current forecast as assumptions change. According to the model, the Company is presently positioned so that net interest income will increase slightly if interest rates rise in the near term and will decrease slightly if interest rates decline in the near term.
The Company also uses interest rate sensitivity gap analysis to monitor the relationship between the maturity and repricing of its interest-earning assets and interest-bearing liabilities. Interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within the same time period. The static interest sensitivity gap position, while not a complete measure of interest sensitivity, is also reviewed periodically to provide insights related to static repricing structure of assets and liabilities. At December 31, 2000, on a cumulative basis through 12 months, rate-sensitive liabilities exceed rate-sensitive assets, resulting in a 12 month period liability sensitive position of approximately $751,000. When the effective change ratio (the historical relative movement of each asset's and liability's rates in relation to a 100 basis point change in the prime rate) is applied to the interest gap position, the Company is actually in an asset sensitive position over a 12 month period and the entire repricing lives of the assets and liabilities. This is primarily due to the fact that approximately 68% of the loan portfolio moves immediately on a one-to-one ratio with a change in the prime rate, while the deposit accounts do not increase or decrease as much relative to a prime rate movement. The Company's asset sensitive position means that assets reprice faster than the liabilities, which generally results in increases in the net interest income during periods of rising rates and decreases in net interest income when market rates decline.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, investing, deposit gathering and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks, including credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk and it could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.
The Bank's ALCO monitors and considers methods of managing the rate and sensitivity repricing characteristics of the balance sheet components consistent with maintaining acceptable levels of changes in net portfolio value ("NPV") and net interest income. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items over a range of assumed changes in market interest rates. A primary purpose of the Company's asset and liability management is to manage interest rate risk to effectively invest the Company's capital and to preserve the value created by its core business operations. As such, certain management monitoring processes are designed to minimize the impact of sudden and sustained changes in interest rates on NPV and net interest income.
The Company's exposure to interest rate risk is reviewed on a periodic basis by the Board of Directors and the ALCO which is charged with the responsibility to maintain the level of sensitivity of the Company's net portfolio value within Board approved limits. Interest rate risk exposure is measured using interest rate sensitivity analysis by computing estimated changes in NPV of its cash flows from assets, liabilities, and off-balance sheet items in the event of a range of assumed changes in market interest rates. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 - 300 basis points increase or decrease in the market interest rates. The Company's Board of Directors has adopted an interest rate risk policy which establishes maximum allowable decreases in NPV in the event of a sudden and sustained increase or decrease in market interest rates.
The following table presents the Company's projected change in NPV for the various rate shock levels as of year end. At December 31, 2000, the Company's estimated changes in NPV were within the limits established by the Board.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SUMMIT FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - Summit Financial Corporation (the "Company"), a South Carolina corporation, is the parent holding company for Summit National Bank (the "Bank"), a nationally chartered bank, and Freedom Finance, Inc. (the "Finance Company"), a consumer finance company. Summit Investment Services, Inc. is a wholly-owned subsidiary of the Bank which provides financial management services and nondeposit product sales. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES - The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") which requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of income and expense during the reporting period. Actual results could differ from these estimates and assumptions.
INVESTMENT SECURITIES - At the time of purchase, investment securities are classified by management into three categories as follows: (1) Investments Held to Maturity: securities which the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading Securities: securities that are bought and held principally for the purpose of selling them in the near future, which are reported at fair value with unrealized gains and losses included in earnings; and (3) Investments Available for Sale: securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of income taxes. The amortization of premiums and accretion of discounts on investment securities are recorded as adjustments to interest income. Gains or losses on sales of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Unrealized losses on securities, reflecting a decline in value or impairment judged by the Company to be other than temporary, are charged to income in the consolidated statements of income.
LOANS AND INTEREST INCOME - Loans of the Bank are carried at principal amounts, reduced by an allowance for loan losses. The Bank recognizes interest income daily based on the principal amount outstanding using the simple interest method. The accrual of interest is generally discontinued on loans of the Bank which become 90 days past due as to principal or interest or when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Management may elect to continue accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balances and accrued interest and the loan is in the process of collection. Amounts received on nonaccrual loans generally are applied against principal prior to the recognition of any interest income. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.
Loans of the Finance Company are carried at the gross amount outstanding, reduced by unearned interest, insurance income and other deferred fees, and an allowance for loan losses. Unearned interest and fees are deferred at the time the loans are made and accreted to income using the "Rule of 78's" method. The results from the use of the "Rule of 78's" method are not materially different from those obtained by using the simple interest method. Charges for late payments are credited to income when collected. Loans of the Finance Company are generally charged-off when they become 150 days past due or when it is determined that collection is doubtful.
IMPAIRMENT OF LOANS - Loans are considered to be impaired when, in management's judgment, the collection of all amounts of principal and interest is not probable in accordance with the terms of the loan agreement. The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards ("SFAS") 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS 118 in the areas of disclosure requirements and methods of recognizing income. SFAS 114 requires that impaired loans be recorded at fair value, which is determined based upon the present value of expected cash flows discounted at the loan's effective interest rate, the market price of the loan, if available, or the value of the underlying collateral. All cash receipts on impaired loans are applied to principal until such time as the principal is brought current, and thereafter according to the contractual terms of the agreement. After principal has been satisfied, future cash receipts are applied to interest income, to the extent that any interest has been foregone. As a practical matter, the Bank determines which loans are impaired through a loan review process.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is established through a provision for loan losses charged to operations and reflects an amount that, in management's opinion, is adequate to absorb inherent losses in the existing portfolio. Additions to the allowance are based on management's evaluation of the loan portfolio under current economic conditions, past loan loss experience, and such other factors which, in management's judgement, deserve recognition in estimating loan losses. Loans are charged-off when, in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance and subsequent recoveries are added to the allowance. Management believes that the allowance is adequate. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustments based upon information that is available to them at the time of their examination.
LOAN FEES - Loan origination fees and direct costs of loan originations are deferred and recognized as an adjustment of yield by the interest method based on the contractual terms of the loan. Loan commitment fees are deferred and recognized as an adjustment of yield over the related loan's life, or if the commitment expires unexercised, recognized in income upon expiration.
PREMISES AND EQUIPMENT - Premises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation is recorded using the straight-line method over the estimated useful life of the related assets as follows: building, 40 years; furniture and fixtures, 7 years; equipment and computer hardware and software, 3 to 7 years; and vehicles, 3 years. Amortization of leasehold improvements is recorded using the straight-line method over the lesser of the estimated useful life of the asset or the term of the respective lease. Additions to premises and equipment and major replacements or betterments are added at cost. Maintenance, repairs and minor replacements are charged to operating expense as incurred. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in income.
INTANGIBLE ASSETS - Intangible assets consist primarily of goodwill and customer lists resulting from the Finance Company's branch acquisitions. On an ongoing basis, the Company evaluates the carrying value of these intangible assets and determines whether these assets have been impaired based upon an undiscounted cash flow approach. Amortization of intangibles is provided by using the straight-line method over the estimated economic lives of the assets, which is generally from 5 to 7 years. Intangible assets are included in "Other assets" on the accompanying consolidated balance sheets and have unamortized balances of $340,000 and $497,000 at December 31, 2000 and 1999, respectively, with related amortization of $157,000 for each of the years ended December 31, 2000, 1999, and 1998.
STOCK-BASED COMPENSATION - The Company reports stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion ("APB") 25, "Accounting for Stock Issued to Employees", which measures compensation expense as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. SFAS 123, "Accounting for Stock-Based Compensation", encourages but does not require companies to record compensation cost for stock-based compensation plans at fair value. The Company follows the disclosure-only provisions of SFAS 123.
PER SHARE DATA - Earnings per share ("EPS") are computed in accordance with SFAS 128, "Earnings per Share." SFAS 128 requires companies to report basic and diluted EPS. Basic EPS includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Shares of restricted stock that are unvested are not included in weighted average shares outstanding. Diluted EPS reflects the potential dilution of securities that could occur if the Company's dilutive stock options were exercised. Weighted average share and per share data have been restated to reflect all 5% stock dividends.
REPORTING COMPREHENSIVE INCOME - As of January 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income." SFAS 130 requires that all items that are required to be recognized under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The disclosure requirements of SFAS 130 have been included in the Company's consolidated statements of shareholders' equity and comprehensive income.
INCOME TAXES - Income taxes are accounted for in accordance with SFAS 109, "Accounting for Income Taxes". Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce deferred tax assets if it is determined to be "more likely than not" that all or some portion of the potential deferred tax asset will not be realized.
RECLASSIFICATIONS - Certain amounts in the 1999 and 1998 consolidated financial statements have been reclassified to conform with the 2000 presentations. These reclassifications had no impact on shareholders' equity or net income as previously reported.
NOTE 2 - STATEMENT OF CASH FLOWS For the purpose of reporting cash flows, cash includes currency and coin, cash items in process of collection and due from banks. Included in cash and cash equivalents are federal funds sold and overnight investments. The Company considers the amounts included in the balance sheet line items, "Cash and due from banks", "Interest-bearing bank balances" and "Federal funds sold" to be cash and cash equivalents. These accounts totaled $29,395,000 and $9,821,000 at December 31, 2000 and 1999, respectively.
The following summarizes supplemental cash flow data for the years ended December 31:
NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANKS The Company's banking subsidiary is required to maintain average reserve balances with the Federal Reserve Bank based upon a percentage of deposits. The amount of the required reserve balance at December 31, 2000 and 1999 was $850,000 and $834,000, respectively.
NOTE 4 - INVESTMENT SECURITIES The aggregate amortized cost, fair value, and gross unrealized gains and losses of investment securities available for sale at December 31 were as follows:
The amortized cost and estimated fair value of investment securities available for sale at December 31, 2000, by contractual maturity, are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties. Fair value of securities was determined using quoted market prices.
The change in the unrealized gain on securities available for sale, net of taxes, recorded in shareholders' equity for the year ended December 31, 2000 was $595,000. Investment securities with an approximate book value of $15,987,000 and $13,045,000 at December 31, 2000 and 1999, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. Estimated fair values of securities pledged were $16,011,000 and $12,717,000 at December 31, 2000 and 1999, respectively. There were no securities classified as "Held to Maturity" in any year presented. Information related to the sale of securities classified as available for sale for each year is as follows:
NOTE 5 - INVESTMENTS REQUIRED BY LAW Summit National Bank, as a member of the Federal Reserve Bank ("FRB") and the Federal Home Loan Bank of Atlanta ("FHLB"), is required to own capital stock in these organizations. The Bank's equity investments required by law are included in the accompanying consolidated balance sheets in "Other assets". The amount of stock owned is based on the Bank's capital levels in the case of the FRB and totaled $255,000 at December 31, 2000 and 1999. The amount of FHLB stock owned is determined based on the Bank's balances of residential mortgages and advances from the FHLB and totaled $1,000,000 and $550,000 at December 31, 2000 and 1999, respectively. No ready market exists for these stocks and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value.
NOTE 6 - LOANS AND ALLOWANCE FOR LOAN LOSSES A summary of loans by classification at December 31 is as follows:
Unearned income on consumer finance loans totaled $1,057,000 and $939,000 at December 31, 2000 and 1999, respectively.
Loans past due in excess of 90 days and still accruing interest amounted to approximately $122,000 and $130,000 at December 31, 2000 and 1999, respectively. At December 31, 2000 and 1999 the Company had approximately $218,000 and $147,000, respectively, in non-accrual loans. There were no non-accrual loans at December 31, 1998. The amount of foregone interest income that would have been recorded had these loans performed according to their contractual terms amounted to approximately $6,000 and $4,000 during 2000 and 1999, respectively, while interest income recognized on these loans was approximately $15,000 and $17,000 during 2000 and 1999, respectively.
At December 31, 2000, the carrying value of loans that are considered to be impaired under SFAS 114 totaled $1,462,000, which includes the $218,000 non-accrual loan. There were no impaired loans at December 31, 1999 or 1998. The average balance of impaired loans was $1,457,000 for the year ended December 31, 2000 and there was no impairment allowance required at year end. Interest income recognized on impaired loans during 2000 was approximately $143,000. There were no foreclosed loans or other real estate owned in any year presented.
Changes in the allowance for loan losses for the years ended December 31 were as follows:
The Company makes loans to individuals and small- to mid-sized businesses for various personal and commercial purposes primarily in the Upstate of South Carolina. The Company has a diversified loan portfolio and the Company's loan portfolio is not dependent upon any specific economic segment. The Company regularly monitors its credit concentrations based on loan purpose, industry, and customer base. As of December 31, 2000, there were no material concentrations of credit risk within the Company's loan portfolio.
Directors, executive officers, and associates of such persons are customers of and have transactions with the Company's bank subsidiary in the ordinary course of business. Included in such transactions are outstanding loans and commitments, all of which are made under substantially the same credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. All loans to related parties were current and performing in accordance with contractual terms at December 31, 2000.
The aggregate dollar amount of loans outstanding to related parties was approximately $5,805,000 and $4,434,000 at December 31, 2000 and 1999, respectively. During 2000, new loans and advances on lines of credit of approximately $2,328,000 were made, and payments on these loans and lines totaled approximately $957,000. At December 31, 2000, there were commitments to extend additional credit to related parties in the amount of approximately $2,508,000.
Under current Federal Reserve regulations, the Bank is limited in the amount it may loan to the Company, the Finance Company, or other affiliates. Loans made by the Bank to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20%, of the Bank's capital, surplus and undivided profits, after adding back the allowance for loan losses. Based on these limitations, approximately $4.2 million was available for loans to the Company and the Finance Company at December 31, 2000. Certain collateral restrictions also apply to loans from the Bank to its affiliates.
NOTE 7 - PREMISES, EQUIPMENT AND LEASES A summary of premises and equipment at December 31 is as follows:
Depreciation expense charged to operations totaled $478,000, $496,000, and $403,000 in 2000, 1999 and 1998, respectively. The Company leases branch facilities for both the Bank and the Finance Company. These leases have initial terms of from two to ten years and various renewal options under substantially the same terms with certain rate escalations. Rent expense charged to operations totaled $297,000, $271,000, and $226,000, respectively, for the years ended December 31, 2000, 1999, and 1998. The annual minimum rental commitments under the terms of the Company's noncancellable leases at December 31, 2000 are as follows: (dollars in thousands)
NOTE 8 - DEPOSITS The scheduled maturities of time deposits subsequent to December 31, 2000 are as follows: (dollars in thousands)
The remaining maturity of time deposits in denominations in excess of $100,000 is $13,868,000 in three months or less; $8,063,000 in over three through six months; $19,090,000 in over six through twelve months; and $5,502,000 in over twelve months.
NOTE 9 - FHLB ADVANCES FHLB advances represent borrowings from the FHLB of Atlanta by the Bank pursuant to a line of credit collateralized by a blanket lien on qualifying loans secured by first mortgages on 1-4 family residences. These advances have various maturity dates, terms and repayment schedules with fixed or variable rates of interest, payable monthly on maturities of one year or less and payable quarterly on maturities over one year.
At December 31, 2000 fixed rate FHLB advances ranged from 5.01% to 7.48% with initial maturities from one to ten years. Variable rate advances based on 3 month LIBOR had a rate of 6.53% at December 31, 2000. Interest rates ranged from 5.01% to 5.77% at December 31, 1999. The weighted-average interest rate on FHLB advances outstanding at December 31, 2000 and 1999 was 6.31% and 5.32%, respectively. At December 31, 2000, advances totaling $10 million were subject to call features at the option of the FHLB with call dates ranging from March 2001 to June 2003. Call provisions are more likely to be exercised by the FHLB when rates rise. Scheduled maturities of FHLB advances subsequent to December 31, 2000 are $3,000,000 in 2001; $1,000,000 in 2002; $7,000,000 in 2003; $3,000,000 in 2004; $1,000,000 in 2005; and $1,000,000 thereafter.
Total qualifying loans of the Bank pledged to the FHLB for advances at December 31, 2000 were approximately $32 million. The Bank has adopted the policy of pledging excess collateral to facilitate future advances. At December 31, 2000, based on eligible collateral available, the Bank had additional available credit of approximately $8 million from the FHLB.
NOTE 10 - OTHER BORROWINGS Federal funds purchased represent unsecured overnight borrowings from other financial institutions by the Bank. These borrowings bear interest at the prevailing market rate for federal funds purchased. Average interest rates on federal funds purchased were 6.04%, 5.02%, and 5.40% for the years ended December 31, 2000, 1999, and 1998 respectively. At December 31, 2000, the Bank had short-term lines of credit to purchase unsecured federal funds from unrelated banks with available balances totaling $15,500,000. The interest rate on any borrowings under these lines would be the prevailing market rate for federal funds purchased. These lines are available to be outstanding up to ten consecutive days for general corporate purposes of the Bank and have specified repayment deadlines after disbursement of funds. All of the lenders have reserved the right to withdraw these lines at their option.
Other short-term borrowings consist of a term loan agreement with an unrelated individual which has a maturity of less than one year. This term loan is unsecured and bears interest at a fixed rate. The weighted average interest rate on short-term borrowings outstanding at December 31, 2000, 1999 and 1998 was 7.41%, 6.50%, and 6.91%, respectively.
The Company has a line of credit arrangement with a commercial bank for the purpose of funding the loan receivables of the Finance Company. The line, which is for a total of $2.5 million, is secured by the common stock of the Bank and bears interest at the prime lending rate less 50 basis points. The line requires quarterly interest payments and matures in October 2001. Under the terms of the line, the Company is required to meet certain covenants, including minimum capital levels and other performance ratios. The Company believes it is in compliance with these covenants. There was no outstanding balance on the line at December 31, 2000 or 1999.
The components of other interest expense for each of the years ended December 31 presented in the accompanying consolidated statements of income is as follows:
NOTE 11 - INCOME TAXES The provision for income taxes for the years ended December 31 is as follows:
Income taxes are different than tax expense computed by applying the statutory federal tax rate of 34% to income before income taxes. The reasons for the differences for years ended December 31 are as follows:
The sources and tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 were as follows:
The net deferred tax asset is included in "Other assets" in the accompanying consolidated balance sheets. A portion of the change in the net deferred tax asset relates to unrealized gains and losses on securities available for sale for which a current period deferred tax expense of ($365,000) has been recorded directly to shareholders' equity. The balance of the change in the net deferred tax asset results from the current period deferred tax benefit of $200,000. The decreases in the valuation allowance for each of the years ended December 31, 2000 and 1999 were based on actual earnings of the Company for those years. In management's opinion, it is more likely than not that the results of future operations will generate sufficient income to realize the net deferred tax asset and no valuation allowance is considered necessary at December 31, 2000.
NOTE 12 - OTHER INCOME AND OTHER EXPENSES The components of other operating income for the years ended December 31 are as follows:
The components of other operating expenses for the years ended December 31 are as follows:
NOTE 13 - CAPITAL STOCK AND PER SHARE INFORMATION On November 20, 2000, the Company issued a 5% stock dividend. The dividend was issued to all shareholders of record on November 6, 2000 and resulted in the issuance of 171,119 shares of common stock of the Company. All average share and per share data have been retroactively restated to reflect the stock dividend as of the earliest period presented.
As of December 31, 2000, there were approximately 790,000 common shares reserved for issuance under stock compensation benefit plans, of which approximately 246,000 were available for issuance.
The following is a reconciliation of the denominators of the basic and diluted per share computations for net income. There was no required adjustment to the numerator from the net income reported on the accompanying statements of income.
NOTE 14 - REGULATORY CAPITAL REQUIREMENTS AND DIVIDEND RESTRICTIONS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The Company and the Bank are required to maintain minimum amounts and ratios of total risk-based capital, Tier I capital, and Tier I leverage capital as set forth in the table following. Management believes, as of December 31, 2000, that the Company and the Bank meet all capital adequacy requirements to which they are subject. At December 31, 2000 and 1999, the Bank is categorized as "well capitalized" under the regulatory framework for prompt corrective action. There are no current conditions or events that management believes would change the Company's or the Bank's category.
The following table presents the Company's and the Bank's actual capital amounts and ratios at December 31, 2000 and 1999 as well as the minimum calculated amounts for each regulatory defined category.
The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. The approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year exceeds the Bank's net profits (as defined by the Comptroller) for that year combined with its retained net profits (as defined by the Comptroller) for the two preceding calendar years. As of December 31, 2000, no cash dividends have been declared or paid by the Bank and the Bank had available retained earnings of $10 million.
NOTE 15 - STOCK COMPENSATION PLANS The Company has a Restricted Stock Plan for awards to certain key employees. Under the Restricted Stock Plan, the Company may grant common stock to its employees for up to approximately 281,000 shares. All shares granted under the Restricted Stock Plan are subject to restrictions as to continuous employment for a specified time period following the date of grant. During this period, the holder is entitled to full voting rights and dividends. The restrictions as to transferability of shares granted under this plan vest over a period of 5 years at a rate of 20% on each anniversary date of the grant. At December 31, 2000, there were 73,044 shares of restricted stock outstanding. Deferred compensation representing the difference between the fair market value of the stock at the date of grant and the cash paid for the stock is amortized over a five-year vesting period as the restrictions lapse. Included in the accompanying consolidated statements of income under the caption "Salaries, wages and benefits" is $128,000, $101,000, and $101,000 of amortized deferred compensation for the years ended December 31, 2000, 1999 and 1998, respectively.
The Company has two Incentive Stock Option Plans (one approved in 1989 and one in 1999) and a Non-Employee Stock Option Plan (collectively referred to as stock-based option plans). Under the Incentive Stock Option Plans, options are periodically granted to employees at a price not less than the fair market value of the shares at the date of grant. Options granted are exercisable for a period of ten years from the date of grant and become exercisable at a rate of 20% each year on the first five anniversaries of the date of grant. The Incentive Stock Option Plans authorize the granting of stock options up to a maximum of approximately 958,000 shares of common stock, however, 800,000 of these reserved shares are under the 1989 Plan which has expired. At December 31, 2000, approximately 6,000 option shares were available to be granted under these plans.
Under the Non-Employee Stock Option Plan, options have been granted, at a price not less than the fair market value of the shares at the date of grant, to eligible non-employee directors as a retainer for their services as directors. Options granted are exercisable for a period of ten years from the date of grant. Options granted on January 1, 1995 became exercisable one year after the date of grant. Options granted on January 1, 1996 become exercisable over a period of nine years at a rate of 11.1% on each of the first nine anniversaries of the date of grant. The Non-Employee Stock Option Plan authorizes the granting of stock options up to a maximum of approximately 352,000 shares of common stock. At December 31, 2000, approximately 31,000 option shares were available to be granted under this plan.
All outstanding options and option activity for all stock-based option plans have been retroactively restated to reflect the effects of all 5% stock dividends issued.
A summary of the activity under the stock-based option plans for the year ended December 31 is as follows:
The following table summarizes information about stock options outstanding under the stock-based option plans at December 31, 2000:
The Company follows APB 25 to account for its stock-based option plans. Accordingly, no compensation cost has been recognized for the stock-based option plans. Had compensation cost for the Company's incentive and non-employee stock option plans been determined based on the fair value at the grant date for awards in 2000, 1999, and 1998 consistent with the provisions of SFAS 123, the Company's net income and diluted earnings per share would have been reduced to the proforma amounts as follows:
The weighted average fair value per share of options granted in 2000, 1999, and 1998 amounted to $5.32, $7.64, and $8.34, respectively. Fair values were estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants: expected volatility of 63.5%, 79.5%, and 49.1% for 2000, 1999 and 1998, respectively; risk-free interest rate of 4.95%, 6.00%, and 4.54% for 2000, 1999, and 1998, respectively; and expected lives of the options of 4.9 years, 4.6 years, and 7.5 years for 2000, 1999, and 1998, respectively. There were no cash dividends in any year.
NOTE 16 - CONTINGENT LIABILITIES In the normal course of business, the Company and its subsidiaries are periodically subject to various pending or threatened lawsuits in which claims for monetary damages may be asserted. In the opinion of the Company's management, after consultation with legal counsel, none of this litigation should have a material adverse effect on the Company's financial position or results of operations.
NOTE 17 - EMPLOYEE BENEFIT PLANS The Company maintains an employee benefit plan for all eligible employees of the Company and its subsidiaries under the provisions of Internal Revenue Code Section 401K. The Summit Retirement Savings Plan (the "Plan") allows for employee contributions and, upon annual approval of the Board of Directors, the Company matches employee contributions from one percent to a maximum of six percent of deferred compensation. The matching contributions as a percent of deferred compensation were 6% for each year 2000, 1999 and 1998. A total of $124,000, $113,000, and $106,000, respectively, in 2000, 1999, and 1998 was charged to operations for the Company's matching contribution. Employees are immediately vested in their contributions to the Plan and become fully vested in the employer matching contribution after completion of five years of service, as defined in the Plan.
During 1998, Summit National Bank entered into salary continuation agreements with several key management employees, all of whom are officers. Under the agreements, the Bank is obligated to provide for each such employee or his beneficiaries, during a period of 20 years after the employee's death, disability, or retirement, annual benefits ranging from $38,000 to $113,000. The estimated present value of future benefits to be paid is being accrued over the period from the effective date of the agreements until the expected retirement dates of the participants. The expense incurred and amount accrued for this nonqualified salary continuation plan, which is an unfunded plan, for the years ended December 31, 2000, 1999 and 1998 amounted to $56,000, $52,000 and $49,000, respectively. To partially finance benefits under this plan, the Bank purchased and is the beneficiary of life insurance policies. Proceeds from the insurance policies are payable to the Company upon the death of the participant. The cash surrender value of these policies included in the accompanying consolidated balance sheets in "Other assets" was $1,919,000 and $1,831,000 at December 31, 2000 and 1999, respectively.
NOTE 18 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments.
The Company uses the same credit and collateral policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
At December 31, 2000 the Company's commitments to extend additional credit, including obligations under the Company's revolving credit card program, totaled approximately $48,580,000, of which approximately $5,326,000 represents commitments to extend credit at fixed rates of interest. Commitments to extend credit at fixed rates expose the Company to some degree of interest rate risk. Included in the Company's total commitments are standby letters of credit. Letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party and totaled $3,576,000 at December 31, 2000. The credit risk involved in the underwriting of letters of credit is essentially the same as that involved in extending loan facilities to customers.
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 107, "Disclosures about Fair Value of Financial Instruments", requires disclosure of fair value information, whether or not recognized in the statement of financial position, when it is practicable to estimate fair value. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity, or contractual obligations which require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock, premises and equipment, and other assets and liabilities.
Fair value approximates book value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, interest-bearing bank balances, federal funds sold, federal funds purchased, and other short-term borrowings. Fair value of investment securities is estimated based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Fair value for variable rate loans that reprice frequently and for loans that mature in less that one year is based on the carrying value, reduced by an estimate of credit losses inherent in the portfolio. Fair value of fixed rate real estate, consumer, commercial and other loans maturing after one year is based on the discounted present value of the estimated future cash flows, reduced by an estimate of credit losses inherent in the portfolio. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality.
Fair value for demand deposit accounts and variable rate interest-bearing accounts is equal to the carrying value. Certificate of deposit accounts maturing during 2001 are valued at their carrying value. Certificate of deposit accounts maturing after 2001 are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for FHLB advances is based on discounted cash flows using the current market rate.
The estimated fair market value of commitments to extend credit and standby letters of credit are equal to their carrying value as the majority of these off-balance sheet instruments have relatively short terms to maturity and are written with variable rates of interest.
The Company has used management's best estimate of fair values based on the above assumptions. Thus, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income tax or other expenses which would be incurred in an actual sale or settlement are not taken into consideration in the fair values presented.
The estimated fair values of the Company's financial instruments as of December 31 are as follows:
NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED) Consolidated quarterly operating data for the years ended December 31 is summarized as follows (per share data has been restated to reflect all 5% stock dividends issued):
NOTE 21 - SEGMENT INFORMATION The Company reports information about its operating segments in accordance with SFAS 131, "Disclosures about Segments of an Enterprise and Related Information". Summit Financial Corporation is the parent holding company for Summit National Bank ("Bank"), a nationally chartered bank, and Freedom Finance, Inc. ("Finance"), a consumer finance company. Through its bank subsidiary, which commenced operations in July 1990, the Company provides a full range of banking services, including offering demand and time deposits, commercial and consumer loans, and nondeposit investment services. The Bank currently has four full-service branches in Greenville and Spartanburg, South Carolina. The Finance Company commenced operations in November 1994 and makes and services small, short-term installment loans and related credit insurance products to individuals from its eleven offices throughout South Carolina. The Company considers the Bank and the Finance Company separate business segments. Financial performance for each segment is detailed in the following tables. Included in the "Corporate" column are amounts for general corporate activities and eliminations of intersegment transactions.
NOTE 22 - PARENT COMPANY FINANCIAL INFORMATION The following is condensed financial information of Summit Financial Corporation (parent company only) at December 31, 2000 and 1999 and for the years ended December 31, 2000, 1999 and 1998.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Summit Financial Corporation
We have audited the accompanying consolidated balance sheets of Summit Financial Corporation and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Summit Financial Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Greenville, South Carolina January 19, 2001
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
There has been no changes in or disagreements with accountants on accounting and financial disclosure as defined by Item 304 of Regulation S-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is set forth under the headings "Election of Directors", "Executive Officers and Compensation", and "Section 16(a) Beneficial Ownership Reporting Compliance" in the definitive Proxy Statement of the Company filed in connection with its 2001 Annual Meeting of the Shareholders, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the headings "Directors' Compensation" and "Executive Officers and Compensation" in the definitive Proxy Statement of the Company filed in connection with its 2001 Annual Meeting of Shareholders, which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth under the headings "Stock Ownership" and "Election of Directors" in the definitive Proxy Statement of the Company filed in connection with its 2001 Annual Meeting of Shareholders, which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the headings "Compensation Committee Interlocks and Insider Participation" and "Transactions with Management" in the definitive Proxy Statement of the Company filed in connection with its 2001 Annual Meeting of Shareholders, which information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of documents filed as a part of this report:
1. Financial Statements:
The following consolidated financial statements and report of independent auditors of the Company are included in Part I, Item 8 hereof:
Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Income For The Years Ended December 31, 2000, 1999, and 1998 Consolidated Statements of Shareholders' Equity And Comprehensive Income For The Years Ended December 31, 2000, 1999, and 1998 Consolidated Statements of Cash Flows For The Years Ended December 31, 2000, 1999, and 1998 Notes to Consolidated Financial Statements Report of Independent Auditors
2. Financial Statement Schedules:
All other consolidated financial statements or schedules have been omitted since the required information is included in the consolidated financial statements or notes thereto referenced in Item 14(a)1 above, or is not applicable or required.
3. Exhibits (numbered in accordance with Item 601 of Regulation S-K):
3.1 Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 filed with the Registrant's Registration Statement on Form S-1 under The Securities Act of 1933, File No. 33-31466).
3.2 Bylaws, as amended (incorporated by reference to Exhibit 3.2 filed with the Registrant's Registration Statement on Amendment No. 1 To Form S-1 under The Securities Act of 1933, File No. 33-31466).
4. Form of Certificate for Common Stock (incorporated by reference to Exhibit 4 filed with the Registrant's Registration Statement on Amendment No. 1 To Form S-1 under The Securities Act of 1933, File No. 33-31466).
10.1 Summit Financial Corporation Incentive Stock Plan (incorporated by reference to Exhibit 10.1 filed with the Registrant's Registration Statement on Form S-1 under The Securities Act of 1933, File No. 33-31466).
10.2 Lease Agreement for North Pleasantburg Drive Bank Site (incorporated by reference to Exhibit 10.2 filed with the Registrant's Registration Statement on Form S-1 under The Securities Act of 1933, File No. 33-31466).
10.3 Employment Agreement of J. Randolph Potter dated December 21, 1998 (incorporated by reference to Exhibit 10.3 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 000-19235).
10.4 Employment Agreement of Blaise B. Bettendorf dated December 21, 1998 (incorporated by reference to Exhibit 10.4 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 000-19235).
10.5 Summit Financial Corporation Restricted Stock Plan (incorporated by reference to Exhibit 10.5 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 000-19235).
10.6 Summit Financial Corporation Non-Employee Stock Option Plan (incorporated by reference to Exhibit 10.6 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994, File No. 000-19235).
10.7 Employment Agreement of James B. Schwiers dated September 2, 1999 (incorporated by reference to Exhibit 10.7 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-19235).
10.8 Summit Financial Corporation 1999 Incentive Stock Plan (incorporated by reference to Exhibit 10.8 filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-19235).
10.9 Employment Agreement of James G. Bagnal dated April 20, 2000.
10.10 Lease Agreement for East north Street Bank Site
10.11 Salary Continuation Agreement of J. Randolph Potter dated September 9, 1998.
10.12 Salary Continuation Agreement of Blaise B. Bettendorf dated September 9, 1998.
10.13 Salary Continuation Agreement of James B. Schwiers dated September 9, 1998.
21 Subsidiaries of Summit Financial Corporation: Summit National Bank, a nationally chartered bank, incorporated in South Carolina Summit Investment Services, Inc., a subsidiary of Summit National Bank, incorporated in South Carolina Freedom Finance, Inc., a consumer finance company, incorporated in South Carolina
23 Consent of KPMG LLP with regard to S-8 Registration Statements for Summit Financial Corporation Restricted Stock Plan (as filed with the Securities and Exchange Commission, "SEC", August 23, 1994, File No. 33-83538); Summit Financial Corporation Incentive Stock Option Plan (as filed with the SEC July 19, 1995, File No. 33-94962); and Summit Financial Corporation 1995 Non-Employee Stock Option Plan (as filed with the SEC July 19, 1995, File No. 33-94964).
NOTE: The exhibits listed above will be furnished to any security holder upon written request to Ms. Blaise B. Bettendorf, Chief Financial Officer, Summit Financial Corporation, Post Office Box 1087, Greenville, South Carolina 29602. The Registrant will charge a fee of $.25 per page for photocopying such exhibit.
(b) No reports on Form 8-K were filed by the Registrant during the fourth quarter of 2000.
(c) Exhibits required to be filed with this report, which have not been previously filed as indicated in Item 14(a) above, are submitted as a separate section of this report.
(d) Not applicable.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUMMIT FINANCIAL CORPORATION /s/ J. Randolph Potter --------------------------- Dated: March 19, 2001 J. Randolph Potter, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.