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

FORM 10-Q

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

For the quarterly period ended June 30, 2020
or
☐         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934  For the transition period from ___________ to __________.

Commission File Number 0-16587 
SFGLOGOUSETHISONE.JPG
Summit Financial Group, Inc.
(Exact name of registrant as specified in its charter)
West Virginia
55-0672148
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
300 North Main Street
 
Moorefield
West Virginia
26836
(Address of principal executive offices)
(Zip Code)
(304) 530-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
☑
No
☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes
☑
No
☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o               Accelerated filer þ    Non-accelerated filer o
                  Smaller reporting company ☐     Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
☐
No
☑







Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, Par Value $2.50 per share
SMMF
NASDAQ Global Select Market


Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date.
Common Stock, $2.50 par value
12,976,946 shares outstanding as of August 6, 2020


Table of Contents


 
 
 
Page
PART  I.
FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Consolidated balance sheets June 30, 2020 (unaudited) and
December 31, 2019
4
 
 
 
 
 
 
Consolidated statements of income
for the three months and six months ended June 30, 2020 and 2019 (unaudited)
5
 
 
 
 
 
 
Consolidated statements of comprehensive income
for the three months and six months ended June 30, 2020 and 2019 (unaudited)
6
 
 
 
 
 
 
Consolidated statements of shareholders’ equity
for the three months and six months ended
June 30, 2020 and 2019 (unaudited)
7
 
 
 
 
 
 
Consolidated statements of cash flows
for the six months ended
June 30, 2020 and 2019 (unaudited)
9
 
 
 
 
 
 
Notes to consolidated financial statements (unaudited)
11
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
47
 
 
 
 
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
61
 
 
 
 
 
Item 4.
Controls and Procedures
63
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
64
 
 
 
 
 
Item 1A.
Risk Factors
57
 
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
57
 
 
 
 
 
Item 3.
Defaults upon Senior Securities
None
 
 
 
 
 
Item 4.
Mine Safety Disclosures
None
 
 
 
 
 
Item 5.
Other Information
None
 
 
 
 
 
Item 6.
Exhibits
66
 
 
 
 
EXHIBIT INDEX
 
67
 
 
 
 
SIGNATURES
 
68

3

Item 1. Financial Statements



Consolidated Balance Sheets (unaudited)

 
June 30,
2020
 
December 31,
2019
Dollars in thousands, except per share amounts
(unaudited)
 
(*)
ASSETS
 
 
 

Cash and due from banks
$
16,572

 
$
28,137

Interest bearing deposits with other banks
26,218

 
33,751

Cash and cash equivalents
42,790

 
61,888

Debt securities available for sale
322,539

 
276,355

Debt securities held to maturity (fair value of $81,609)
80,497

 
—

Other investments
8,875

 
12,972

Loans held for sale
4,040

 
1,319

Loans, net of unearned income
2,219,707

 
1,913,499

    Less: allowance for credit losses - loans
(27,166
)
 
(13,074
)
         Loans, net
2,192,541

 
1,900,425

Property held for sale
17,954

 
19,276

Premises and equipment, net
51,847

 
44,168

Accrued interest receivable
11,205

 
8,439

Goodwill and other intangible assets
48,513

 
23,022

Cash surrender value of life insurance policies and annuities
55,315

 
43,603

Other assets
25,235

 
12,025

Total assets
$
2,861,351

 
$
2,403,492

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest bearing
$
443,190

 
$
260,553

Interest bearing
2,008,579

 
1,652,684

Total deposits
2,451,769

 
1,913,237

Short-term borrowings
90,945

 
199,345

Long-term borrowings
708

 
717

Subordinated debentures owed to unconsolidated subsidiary trusts
19,589

 
19,589

Other liabilities
34,909

 
22,840

Total liabilities
2,597,920

 
2,155,728

 
 
 
 
Commitments and Contingencies


 


 
 
 
 
Shareholders' Equity
 

 
 

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

 
—

Common stock and related surplus, $2.50 par value; authorized 20,000,000 shares; issued: 2020 - 12,976,946 shares and 2019 - 12,474,641 shares; outstanding: 2020 - 12,922,045 shares and 2019 - 12,408,542
94,539

 
80,084

Unallocated common stock held by Employee Stock Ownership Plan - 2020 - 54,901 shares and 2019 - 66,099 shares
(593
)
 
(714
)
Retained earnings
166,163

 
165,859

Accumulated other comprehensive income
3,322

 
2,535

Total shareholders' equity
263,431

 
247,764

 
 
 
 
Total liabilities and shareholders' equity
$
2,861,351

 
$
2,403,492


(*) - Derived from audited consolidated financial statements

See Notes to Consolidated Financial Statements


Consolidated Statements of Income (unaudited)


 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands, except per share amounts
 
2020
 
2019
 
2020
 
2019
Interest income
 
 
 
 
 
 
 
 
Interest and fees on loans
 
 
 
 
 
 
 
 
Taxable
 
$
25,466

 
$
24,184

 
$
50,555

 
$
47,090

Tax-exempt
 
158

 
168

 
304

 
314

Interest and dividends on securities
 
 

 
 

 
 

 
 

Taxable
 
1,453

 
1,607

 
3,211

 
3,292

Tax-exempt
 
800

 
789

 
1,352

 
1,689

Interest on interest bearing deposits with other banks
 
60

 
134

 
158

 
365

Total interest income
 
27,937

 
26,882

 
55,580

 
52,750

Interest expense
 
 

 
 

 
 

 
 

Interest on deposits
 
4,186

 
5,967

 
9,537

 
11,531

Interest on short-term borrowings
 
499

 
1,397

 
1,129

 
2,869

Interest on long-term borrowings and subordinated debentures
 
186

 
255

 
405

 
514

Total interest expense
 
4,871

 
7,619

 
11,071

 
14,914

Net interest income
 
23,066

 
19,263

 
44,509

 
37,836

Provision for credit losses
 
3,000

 
300

 
8,250

 
550

Net interest income after provision for credit losses
 
20,066

 
18,963

 
36,259

 
37,286

Noninterest income
 
 

 
 

 
 

 
 

Insurance commissions
 
24

 
606

 
31

 
1,780

Trust and wealth management fees
 
582

 
612

 
1,247

 
1,198

Mortgage origination revenue
 
641

 
164

 
855

 
315

Service charges on deposit accounts
 
882

 
1,224

 
2,145

 
2,405

Bank card revenue
 
1,087

 
893

 
2,020

 
1,707

Realized securities gains, net
 
—

 
1,086

 
1,038

 
1,082

Gain on sale of Summit Insurance Services, LLC
 
—

 
1,906

 
—

 
1,906

Bank owned life insurance and annuities income
 
275

 
248

 
539

 
486

Other
 
107

 
71

 
224

 
161

Total noninterest income
 
3,598

 
6,810

 
8,099

 
11,040

Noninterest expenses
 
 

 
 

 
 

 
 

Salaries, commissions and employee benefits
 
7,930

 
7,576

 
15,601

 
14,923

Net occupancy expense
 
977

 
880

 
1,860

 
1,803

Equipment expense
 
1,360

 
1,219

 
2,789

 
2,398

Professional fees
 
417

 
475

 
804

 
878

Advertising and public relations
 
93

 
155

 
244

 
308

Amortization of intangibles
 
410

 
420

 
839

 
897

FDIC premiums
 
110

 
88

 
275

 
88

Bank card expense
 
560

 
473

 
1,063

 
911

Foreclosed properties expense, net of gains/losses
 
240

 
1,545

 
1,207

 
1,930

Merger-related expenses
 
637

 
382

 
1,425

 
445

Other
 
2,463

 
2,116

 
4,088

 
4,608

Total noninterest expenses
 
15,197

 
15,329

 
30,195

 
29,189

Income before income tax expense
 
8,467

 
10,444

 
14,163

 
19,137

Income tax expense
 
1,518

 
1,880

 
2,708

 
3,481

Net income
 
$
6,949

 
$
8,564

 
$
11,455

 
$
15,656

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.54

 
$
0.68

 
$
0.89

 
$
1.24

Diluted earnings per common share
 
$
0.54

 
$
0.68

 
$
0.88

 
$
1.23

See Notes to Consolidated Financial Statements 


Consolidated Statements of Comprehensive Income (unaudited)


 
For the Three Months Ended 
 June 30,
Dollars in thousands
2020
 
2019
Net income
$
6,949

 
$
8,564

Other comprehensive income (loss):
 

 
 

Net unrealized loss on cashflow hedge of:
2020 - ($1,072), net of deferred taxes of ($257); 2019 - ($545), net of deferred taxes of ($131)
(815
)
 
(414
)
Net unrealized gain on securities available for sale of:
2020 - $4,350, net of deferred taxes of $1,044; 2019 - $2,001, net of deferred taxes of $480 and reclassification adjustment for net realized gains included in net income of $1,086, net of tax of $261
3,306

 
1,521

Total other comprehensive income
2,491

 
1,107

Total comprehensive income
$
9,440

 
$
9,671


 
For the Six Months Ended 
 June 30,
Dollars in thousands
2020
 
2019
Net income
$
11,455

 
$
15,656

Other comprehensive income (loss):
 

 
 

Net unrealized (loss) gain on cashflow hedge of:
2020 - ($2,499), net of deferred taxes of ($600); 2019 - ($557), net of deferred taxes of ($134)
(1,899
)
 
(423
)
Net unrealized gain on securities available for sale of:
2020 - $3,534, net of deferred taxes of $848 and reclassification adjustment for net realized gains included in net income of $1,038, net of tax of $249; 2019 - $5,247, net of deferred taxes of $1,259 and reclassification adjustment for net realized gains included in net income of $1,082, net of tax of $260
2,686

 
3,988

Net unrealized loss on pension plan of:
2019 - ($432), net of deferred taxes of ($104)
—

 
(328
)
Total other comprehensive income
787

 
3,237

Total comprehensive income
$
12,242

 
$
18,893






















See Notes to Consolidated Financial Statements


Consolidated Statements of Shareholders’ Equity (unaudited)


Dollars in thousands, except per share amounts
Common
Stock and
Related
Surplus
 
Unallocated
Common
Stock Held
by ESOP
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
Income
 
Total
Share-
holders'
Equity
 
 
 
 
 
 
 
 
 
 
Balance at March 31, 2020
$
94,439

 
$
(653
)
 
$
161,408

 
$
831

 
$
256,025

 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2020
 

 
 
 
 

 
 

 
 

Net income
—

 
—

 
6,949

 
—

 
6,949

Other comprehensive income
—

 
—

 
—

 
2,491

 
2,491

Vesting of RSUs - 651 shares
—

 
—

 
—

 
—

 
—

Share-based compensation expense
161

 
—

 
—

 
—

 
161

Unallocated ESOP shares committed to be released - 5,599 shares
31

 
60

 
—

 
—

 
91

Retirement of 8,722 shares of common stock
(162
)
 
—

 
—

 
—

 
(162
)
Common stock issuances from reinvested dividends - 4,273 shares
70

 
—

 
—

 
—

 
70

Common stock cash dividends declared ($0.17 per share)
—

 
—

 
(2,194
)
 
—

 
(2,194
)
Balance, June 30, 2020
$
94,539

 
$
(593
)
 
$
166,163

 
$
3,322

 
$
263,431

 
 
 
 
 
 
 
 
 
 
Balance March 31, 2019
$
86,729

 
$
(884
)
 
$
146,671

 
$
1,114

 
$
233,630

 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2019
 

 
 
 
 

 
 

 
 

Net income
—

 
—

 
8,564

 
—

 
8,564

Other comprehensive income
—

 
—

 
—

 
1,107

 
1,107

Exercise of stock options and SARs - 16,815 shares
7

 
—

 
—

 
—

 
7

Share-based compensation expense
149

 
—

 
—

 
—

 
149

Unallocated ESOP shares committed to be released - 5,115 shares
77

 
56

 
—

 
—

 
133

Retirement of 235,717 shares of common stock
(6,076
)
 
—

 
—

 
—

 
(6,076
)
Common stock issuances from reinvested dividends - 2,245 shares
60

 
—

 
—

 
—

 
60

Common stock cash dividends declared ($0.15 per share)
—

 
—

 
(1,873
)
 
—

 
(1,873
)
Balance, June 30, 2019
$
80,946

 
$
(828
)
 
$
153,362

 
$
2,221

 
$
235,701
















See Notes to Consolidated Financial Statements


Consolidated Statements of Shareholders’ Equity (unaudited)


Dollars in thousands, except per share amounts
Common
Stock and
Related
Surplus
 
Unallocated Common Stock Held by ESOP
 
Retained
Earnings
 
Accumulated
Other
Compre-
hensive
Income
(Loss)
 
Total
Share-
holders'
Equity
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2019
$
80,084

 
$
(714
)
 
$
165,859

 
$
2,535

 
$
247,764

 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2020
 

 
 
 
 

 
 

 
 

Impact of adoption of ASC 326
—

 
—

 
(6,756
)
 
—

 
(6,756
)
Net income
—

 
—

 
11,455

 
—

 
11,455

Other comprehensive income
—

 
—

 
—

 
787

 
787

Vesting of RSUs - 651 shares
—

 
—

 
—

 
—

 
—

Share-based compensation expense
323

 
—

 
—

 
—

 
323

Unallocated ESOP shares committed to be released - 11,198 shares
101

 
121

 
—

 
—

 
222

Retirement of 75,333 shares of common stock
(1,444
)
 
—

 
—

 
—

 
(1,444
)
Acquisition of Cornerstone Financial Services, Inc. - 570,000 shares, net of issuance costs
15,354

 
—

 
—

 
—

 
15,354

Common stock issuances from reinvested dividends - 6,987 shares
121

 
—

 
—

 
—

 
121

Common stock cash dividends declared ($0.34 per share)
—

 
—

 
(4,395
)
 
—

 
(4,395
)
Balance, June 30, 2020
$
94,539

 
$
(593
)
 
$
166,163

 
$
3,322

 
$
263,431

 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2018
$
80,431

 
$
(939
)
 
$
141,354

 
$
(1,016
)
 
$
219,830

 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2019
 

 
 
 
 

 
 

 
 

Net income
—

 
—

 
15,656

 
—

 
15,656

Other comprehensive income
—

 
—

 
—

 
3,237

 
3,237

Exercise of stock options and SARs - 17,255 shares
7

 
—

 
—

 
—

 
7

Share-based compensation expense
281

 
—

 
—

 
—

 
281

Unallocated ESOP shares committed to be released - 10,230 shares
142

 
111

 
—

 
—

 
253

Retirement of 360,917 shares of common stock
(8,952
)
 
—

 
—

 
—

 
(8,952
)
Acquisition of Peoples Bankshares, Inc. - 465,931 shares, net of issuance costs
8,918

 
—

 
—

 
—

 
8,918

Common stock issuances from reinvested dividends - 4,554 shares
119

 
—

 
—

 
—

 
119

Common stock cash dividends declared ($0.29 per share)
—

 
—

 
(3,648
)
 
—

 
(3,648
)
Balance, June 30, 2019
$
80,946

 
$
(828
)
 
$
153,362

 
$
2,221

 
$
235,701











See Notes to Consolidated Financial Statements


Consolidated Statements of Cash Flows (unaudited)


 
 
Six Months Ended
Dollars in thousands
 
June 30,
2020
 
June 30,
2019
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
11,455

 
$
15,656

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

 
 

Depreciation
 
1,516

 
1,242

Provision for credit losses
 
8,250

 
550

Share-based compensation expense
 
323

 
281

Deferred income tax benefit
 
(2,984
)
 
(236
)
Loans originated for sale
 
(35,082
)
 
(6,843
)
Proceeds from sale of loans
 
32,917

 
7,080

Gains on loans held for sale
 
(555
)
 
(151
)
Realized securities gains, net
 
(1,038
)
 
(1,082
)
(Gain) loss on disposal of assets
 
(123
)
 
155

Gain on sale of Summit Insurance Services, LLC
 
—

 
(1,906
)
Write-downs of foreclosed properties
 
1,164

 
1,445

Amortization of securities premiums, net
 
1,303

 
1,290

Accretion related to acquisitions, net
 
(800
)
 
(632
)
Amortization of intangibles
 
839

 
897

Earnings on bank owned life insurance and annuities
 
(540
)
 
(590
)
(Increase) decrease in accrued interest receivable
 
(1,843
)
 
229

Decrease (increase) in other assets
 
116

 
(11
)
(Decrease) increase in other liabilities
 
(226
)
 
1,232

Net cash provided by operating activities
 
14,692

 
18,606

Cash Flows from Investing Activities
 
 

 
 

Proceeds from maturities and calls of securities available for sale
 
2,200

 
1,445

Proceeds from sales of securities available for sale
 
74,750

 
114,171

Principal payments received on securities available for sale
 
12,278

 
13,822

Purchases of securities available for sale
 
(41,880
)
 
(46,060
)
Purchases of securities held to maturity
 
(80,732
)
 
—

Purchases of other investments
 
(8,148
)
 
(6,930
)
Proceeds from redemptions of other investments
 
12,365

 
9,142

Net loan originations
 
(230,848
)
 
(85,633
)
Purchases of premises and equipment
 
(6,201
)
 
(5,863
)
Proceeds from disposal of premises and equipment
 
9

 
3

Improvements to property held for sale
 
(1,072
)
 
(33
)
Proceeds from sales of repossessed assets & property held for sale
 
1,494

 
2,403

Purchase of life insurance contracts and annuities
 
(8,456
)
 
—

Proceeds from sale of Summit Insurance Services, LLC
 
—

 
7,117

Cash and cash equivalents from acquisitions, net of cash consideration paid 2020 - $27,215; 2019 - $12,740
 
183,697

 
20,589

Net cash (used in) provided by investing activities
 
(90,544
)
 
24,173

Cash Flows from Financing Activities
 
 

 
 

Net increase in demand deposit, NOW and savings accounts
 
256,358

 
20,505

Net (decrease) increase in time deposits
 
(79,539
)
 
29,954

Net decrease in short-term borrowings
 
(108,400
)
 
(83,741
)
Repayment of long-term borrowings
 
(9
)
 
(9
)
Purchase of interest rate cap
 
(5,850
)
 
—

Proceeds from issuance of common stock, net of issuance costs
 
33

 
40

Purchase and retirement of common stock
 
(1,444
)
 
(8,952
)
Exercise of stock options
 
—

 
7

Dividends paid on common stock
 
(4,395
)
 
(3,648
)
Net cash provided by (used in) financing activities
 
56,754

 
(45,844
)
Decrease in cash and cash equivalents
 
(19,098
)
 
(3,065
)
Cash and cash equivalents:
 
 

 
 

Beginning
 
61,888

 
59,540

Ending
 
$
42,790

 
$
56,475

(Continued)


Consolidated Statements of Cash Flows (unaudited) - continued


 
 
Six Months Ended
Dollars in thousands
 
June 30,
2020
 
June 30,
2019
Supplemental Disclosures of Cash Flow Information
 
 
 
 
Cash payments for:
 
 
 
 
Interest
 
$
11,288

 
$
14,645

Income taxes
 
$
3,745

 
$
3,845

 
 
 
 
 
Supplemental Disclosures of Noncash Investing and Financing Activities
 
 
 
 

Real property and other assets acquired in settlement of loans
 
$
177

 
$
3,937

Right of use assets obtained in exchange for lease obligations
 
$
3,293

 
$
—

 
 
 
 
 
Supplemental Disclosures of Noncash Transactions Included in Acquisition
 
 
 
 
Assets acquired
 
$
171,645

 
$
100,377

Liabilities assumed
 
$
365,379

 
$
114,151




















































See Notes to Consolidated Financial Statements



NOTE 1.  BASIS OF PRESENTATION

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

The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ materially from these estimates. You should carefully consider each risk factor discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019 and the COVID-19 risk factor in Part II. Item 1A Risk Factors of this quarterly report on Form 10-Q.

The results of operations for the six months ended June 30, 2020 are not necessarily indicative of the results to be expected for the full year.  The consolidated financial statements and notes included herein should be read in conjunction with our 2019 audited financial statements and Annual Report on Form 10-K. 

NOTE 2.  SIGNIFICANT NEW AUTHORITATIVE ACCOUNTING GUIDANCE

Recently Adopted
During June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. Accounting Standards Codification Topic 326 ("ASC 326"), Financial Instruments - Credit Losses, as amended, among other things, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques previously applied are still permitted, although the inputs to those techniques have changed to reflect the full amount of expected credit losses. In addition, ASC 326 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration.

We adopted ASC 326 on January 1, 2020 using the modified retrospective approach. Results for the periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable US GAAP. We recorded a net reduction of retained earnings of $6.76 million upon adoption. The transition adjustment includes an increase in the allowance for credit losses for loans ("ACLL") of $6.93 million and an increase in the allowance for credit losses on off-balance sheet credit exposures of $2.43 million, net of the corresponding increases in deferred tax assets of $2.13 million. The adjustments to the allowance for credit losses ("ACL") for both loans and off-balance sheet credit exposures are combined and reported on our income statement as credit loss expense. Further information regarding our policies and methodology used to estimate the ACLL is presented in Note 6 - Loans and Allowance for Credit Losses for Loans. Further information regarding our policies and methodology used to estimate the ACL on off-balance-sheet credit exposures is presented in Note 11 - Commitments and Contingencies.

We adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (“PCD”) that were previously classified as purchased credit impaired (“PCI”) and accounted for under ASC 310-30. In accordance with the standard, we did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. The remaining credit discount on the PCI loans was recorded as an offset to the ACLL at the time of adoption and is netted in the above adjustment. The remaining adjustment for noncredit factors on these loans will be accreted into interest income on a level-yield method over the life of the loans.

Additionally, we evaluated each acquired loan for PCD status at the time of adoption. We identified loans with a net balance of $9.4 million that should be considered PCD. We considered the remaining discount at the time of adoption to be for noncredit factors on these loans and it will be accreted into interest income on a level-yield method over the life of the loans.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure


requirements in Topic 820 are also removed or modified. The amendments were effective for us January 1, 2020 and did not have a material impact on our consolidated financial statements.

In March 2020 (revised April 2020), various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus ("COVID-19"). The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASC 310-40, Receivables - Troubled Debt Restructurings by Creditors, (“ASC 310-40”), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to the COVID-19 crisis to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance is expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time. See Note 6 of the accompanying consolidated financial statements for disclosure of the impact to date.

Pending Adoption

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes. The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. We are currently assessing the impact that ASU 2019-12 will have on our consolidated financial statements.

In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. We do not expect the adoption of ASU 2020-01 to have a material impact on our consolidated financial statements.

In March 2020, the Financial Accounting Standards Board (FASB) issued ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. At this time, we do not anticipate any material adverse impact to our business operation or financial results during the period of transition.



















NOTE 3.  FAIR VALUE MEASUREMENTS

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.
 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
June 30, 2020
 
Level 1
 
Level 2
 
Level 3
Securities available for sale
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
38,139

 
$
—

 
$
38,139

 
$
—

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
66,062

 
—

 
66,062

 
—

Nongovernment sponsored entities
12,635

 
—

 
12,635

 
—

State and political subdivisions
62,159

 
—

 
62,159

 
—

Corporate debt securities
22,656

 
—

 
22,656

 
—

Asset-backed securities
45,304

 
—

 
45,304

 
—

Tax-exempt state and political subdivisions
75,584

 
—

 
75,584

 
—

Total securities available for sale
$
322,539

 
$
—

 
$
322,539

 
$
—

 
 
 
 
 
 
 
 
Derivative financial assets
 
 
 
 
 
 
 
Interest rate cap
$
4,643

 
$
—

 
$
4,643

 
$
—

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
3,583

 
$
—

 
$
3,583

 
$
—

 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2019
 
Level 1
 
Level 2
 
Level 3
Securities available for sale
 
 
 
 
 
 
 
U.S. Government sponsored agencies
$
20,864

 
$
—

 
$
20,864

 
$
—

Mortgage backed securities:
 

 
 

 
 

 
 

Government sponsored agencies
70,975

 
—

 
70,975

 
—

Nongovernment sponsored entities
10,229

 
—

 
10,229

 
—

State and political subdivisions
49,973

 
—

 
49,973

 
—

Corporate debt securities
18,200

 
—

 
18,200

 
—

Asset-backed securities
33,014

 
—

 
33,014

 
—

Tax-exempt state and political subdivisions
73,100

 
—

 
73,100

 
—

Total securities available for sale
$
276,355

 
$
—

 
$
276,355

 
$
—

 
 
 
 
 
 
 
 
Derivative financial liabilities
 

 
 

 
 

 
 

Interest rate swaps
$
988

 
$
—

 
$
988

 
$
—



We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  Assets measured at fair value on a nonrecurring basis are included in the table below.
 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
June 30, 2020
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
4,040

 
$
—

 
$
4,040

 
$
—

 
 
 
 
 
 
 
 
Collateral-dependent loans with an ACLL
 

 
 

 
 

 
 

Commercial
$
8

 
$
—

 
$
8

 
$
—

Commercial real estate
1,146

 
—

 
1,146

 
—

Construction and development
422

 
—

 
422

 
—

Residential real estate
162

 
—

 
162

 
—

Total collateral-dependent loans with an ACLL
$
1,738

 
$
—

 
$
1,738

 
$
—

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
1,125

 
$
—

 
$
1,125

 
$
—

Construction and development
14,720

 
—

 
13,998

 
722

Residential real estate
539

 
—

 
539

 
—

Total property held for sale
$
16,384

 
$
—

 
$
15,662

 
$
722




Collateral dependent loans with an ACLL were categorized as impaired loans with specific reserves prior to the adoption of ASC 326.
 
Balance at
 
Fair Value Measurements Using:
Dollars in thousands
December 31, 2019
 
Level 1
 
Level 2
 
Level 3
Residential mortgage loans held for sale
$
1,319

 
$
—

 
$
1,319

 
$
—

 
 
 
 
 
 
 
 
Collateral-dependent impaired loans
 

 
 

 
 

 
 

Commercial
$
4,831

 
$
—

 
$
4,831

 
$
—

Commercial real estate
1,863

 
—

 
1,863

 
—

Construction and development
425

 
—

 
425

 
—

Residential real estate
692

 
—

 
566

 
126

Total collateral-dependent impaired loans
$
7,811

 
$
—

 
$
7,685

 
$
126

 
 
 
 
 
 
 
 
Property held for sale
 

 
 

 
 

 
 

Commercial real estate
$
1,304

 
$
—

 
$
1,304

 
$
—

Construction and development
12,182

 
—

 
12,182

 
—

Residential real estate
705

 
—

 
705

 
—

Total property held for sale
$
14,191

 
$
—

 
$
14,191

 
$
—




The carrying values and estimated fair values of our financial instruments are summarized below:
 
 
June 30, 2020
 
Fair Value Measurements Using:
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Level 1
Level 2
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
42,790

 
$
42,790

 
$
—

$
42,790

$
—

Securities available for sale
 
322,539

 
322,539

 
—

322,539

—

Securities held to maturity
 
80,497

 
81,609

 
—

81,609

—

Other investments
 
8,875

 
8,875

 
—

8,875

—

Loans held for sale, net
 
4,040

 
4,040

 
—

4,040

—

Loans, net
 
2,192,541

 
2,191,443

 
—

1,738

2,189,705

Accrued interest receivable
 
11,205

 
11,205

 
—

11,205

—

Derivative financial assets
 
4,643

 
4,643

 
—

4,643

—

     Cash surrender value of life insurance policies and annuities
 
55,315

 
55,315

 
—

55,315

—

 
 
$
2,722,445

 
$
2,722,459

 
$
—

$
532,754

$
2,189,705

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
2,451,769

 
$
2,454,997

 
$
—

$
2,454,997

$
—

Short-term borrowings
 
90,945

 
90,945

 
—

90,945

—

Long-term borrowings
 
708

 
890

 
—

890

—

Subordinated debentures owed to unconsolidated
  subsidiary trusts
 
19,589

 
19,589

 
—

19,589

—

Accrued interest payable
 
1,017

 
1,017

 
—

1,017

—

Derivative financial liabilities
 
3,583

 
3,583

 
—

3,583

—

 
 
$
2,567,611

 
$
2,571,021

 
$
—

$
2,571,021

$
—





 
 
December 31, 2019
 
Fair Value Measurements Using:
Dollars in thousands
 
Carrying
Value
 
Estimated
Fair
Value
 
Level 1
Level 2
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
61,888

 
$
61,888

 
$
—

$
61,888

$
—

Securities available for sale
 
276,355

 
276,355

 
—

276,355

—

Other investments
 
12,972

 
12,972

 
—

12,972

—

Loans held for sale, net
 
1,319

 
1,319

 
—

1,319

—

Loans, net
 
1,900,425

 
1,901,020

 
—

7,685

1,893,335

Accrued interest receivable
 
8,439

 
8,439

 
—

8,439

—

Cash surrender value of life insurance policies
 
43,603

 
43,603

 
—

43,603

—

 
 
$
2,305,001

 
$
2,305,596

 
$
—

$
412,261

$
1,893,335

Financial liabilities
 
 

 
 

 
 

 

 
Deposits
 
$
1,913,237

 
$
1,918,610

 
$
—

$
1,918,610

$
—

Short-term borrowings
 
199,345

 
199,345

 
—

199,345

—

Long-term borrowings
 
717

 
854

 
—

854

—

Subordinated debentures owed to unconsolidated
  subsidiary trusts
 
19,589

 
19,589

 
—

19,589

—

Accrued interest payable
 
1,234

 
1,234

 
—

1,234

—

Derivative financial liabilities
 
988

 
988

 
—

988

—

 
 
$
2,135,110

 
$
2,140,620

 
$
—

$
2,140,620

$
—




NOTE 4.  EARNINGS PER SHARE

The computations of basic and diluted earnings per share follow:
 
 
For the Three Months Ended June 30,
 
 
2020
 
2019
Dollars in thousands,except per share amounts
 
Net Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Net Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
6,949

 
 
 
 
 
$
8,564

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
6,949

 
12,911,979

 
$
0.54

 
$
8,564

 
12,539,095

 
$
0.68

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 
 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
4,227

 
 

 
 
 
5,052

 
 

Stock appreciation rights (SARs)
 
 
 
27,598

 
 
 
 
 
55,924

 
 
Restricted stock units (RSUs)
 
 
 
—

 
 
 
 
 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
6,949

 
12,943,804

 
$
0.54

 
$
8,564

 
12,600,071

 
$
0.68




 
 
For the Six Months Ended June 30,
 
 
2020
 
2019
Dollars in thousands,except per share amounts
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
 
Income
(Numerator)
 
Common
Shares
(Denominator)
 
Per
Share
Net income
 
$
11,455

 
 
 
 
 
$
15,656

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
11,455

 
12,940,590

 
$
0.89

 
$
15,656

 
12,627,806

 
$
1.24

 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilutive securities:
 
 

 
 
 
 

 
 
 
 
 
 

Stock options
 
 
 
4,371

 
 

 
 
 
5,182

 
 

Stock appreciation rights (SARs)
 
 
 
38,001

 
 
 
 
 
55,877

 
 
Restricted stock units (RSUs)
 
 
 
183

 
 
 
 
 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
11,455

 
12,983,146

 
$
0.88

 
$
15,656

 
12,688,865

 
$
1.23



Stock option and stock appreciation right (SAR) grants are disregarded in this computation if they are determined to be anti-dilutive.  All stock options were dilutive for the six months ended June 30, 2020 and our anti-dilutive stock options for the quarter ended June 30, 2020 were 300 shares. Our anti-dilutive stock options for the three and six months ended June 30, 2019 were 7,700 shares. Our anti-dilutive SARs for the three and six months ended June 30, 2020 and June 30, 2019 were 222,740 and 84,615, respectively. Our anti-dilutive RSUs for the quarter and six months ended June 30, 2020 were 15,733 and 13,780, respectively.

NOTE 5.  DEBT SECURITIES

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at June 30, 2020 and December 31, 2019 are summarized as follows:
 
June 30, 2020
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
38,201

 
$
388

 
$
450

 
$
38,139

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
64,206

 
2,260

 
404

 
66,062

Nongovernment-sponsored entities
12,820

 
159

 
344

 
12,635

State and political subdivisions
 

 
 

 
 

 
 

General obligations
17,607

 
710

 
5

 
18,312

Water and sewer revenues
10,724

 
552

 
2

 
11,274

Lease revenues
5,310

 
411

 
—

 
5,721

Income tax revenues
5,057

 
392

 
—

 
5,449

University revenues
5,912

 
548

 
—

 
6,460

Other revenues
13,988

 
989

 
34

 
14,943

Corporate debt securities
23,304

 
37

 
685

 
22,656

Asset-backed securities
47,763

 
—

 
2,459

 
45,304

Total taxable debt securities
244,892

 
6,446

 
4,383

 
246,955

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
36,328

 
3,289

 
—

 
39,617

Water and sewer revenues
8,873

 
627

 
1

 
9,499

Lease revenues
7,306

 
722

 
—

 
8,028

Transportation revenues
6,600

 
290

 
—

 
6,890

Other revenues
10,865

 
699

 
14

 
11,550

Total tax-exempt debt securities
69,972

 
5,627

 
15

 
75,584

Total securities available for sale
$
314,864

 
$
12,073

 
$
4,398

 
$
322,539




 
June 30, 2020
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Held to Maturity
 
 
 
 
 
 
 
Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
66,626

 
918

 
34

 
67,510

Water and sewer revenues
6,644

 
86

 
—

 
6,730

Sales tax revenues
2,923

 
—

 
2

 
2,921

Other revenues
4,304

 
146

 
2

 
4,448

Total tax-exempt debt securities
80,497

 
1,150

 
38

 
81,609

Total securities held to maturity
$
80,497

 
$
1,150

 
$
38

 
$
81,609


 
December 31, 2019
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
Taxable debt securities
 
 
 
 
 
 
 
U.S. Government and agencies and corporations
$
21,036

 
$
212

 
$
384

 
$
20,864

Residential mortgage-backed securities:
 

 
 

 
 

 
 

Government-sponsored agencies
70,379

 
1,031

 
435

 
70,975

Nongovernment-sponsored entities
10,253

 
17

 
41

 
10,229

State and political subdivisions
 

 
 

 
 

 
 

General obligations
12,603

 
25

 
171

 
12,457

Water and sewer revenues
7,170

 
71

 
114

 
7,127

Lease revenues
5,310

 
25

 
77

 
5,258

University revenues
5,917

 
164

 
16

 
6,065

Other revenues
18,831

 
344

 
109

 
19,066

Corporate debt securities
18,268

 
81

 
149

 
18,200

          Asset-backed securities
33,826

 
—

 
812

 
33,014

Total taxable debt securities
203,593

 
1,970

 
2,308

 
203,255

Tax-exempt debt securities
 

 
 

 
 

 
 

State and political subdivisions
 

 
 

 
 

 
 

General obligations
36,673

 
2,526

 
—

 
39,199

Water and sewer revenues
9,565

 
633

 
—

 
10,198

Lease revenues
8,455

 
598

 
—

 
9,053

Other revenues
13,929

 
728

 
7

 
14,650

Total tax-exempt debt securities
68,622

 
4,485

 
7

 
73,100

Total securities available for sale
$
272,215

 
$
6,455

 
$
2,315

 
$
276,355




The below information is relative to the five states where issuers with the highest volume of state and political subdivision securities held in our portfolio are located.  We own no such securities of any single issuer which we deem to be a concentration.
 
June 30, 2020
 
Amortized
 
Unrealized
 
Estimated
Dollars in thousands
Cost
 
Gains
 
Losses
 
Fair Value
 
 
 
 
 
 
 
 
Available for Sale
 
 
 
 
 
 
 
California
$
32,464

 
$
1,811

 
$
48

 
$
34,227

Texas
28,261

 
1,099

 
—

 
29,360

Florida
16,289

 
692

 
4

 
16,977

Michigan
15,117

 
842

 
—

 
15,959

New York
13,332

 
922

 
—

 
14,254







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

The maturities, amortized cost and estimated fair values of securities at June 30, 2020, are summarized as follows:
Dollars in thousands
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
32,467

 
$
32,616

Due from one to five years
 
88,501

 
89,412

Due from five to ten years
 
78,187

 
78,589

Due after ten years
 
115,709

 
121,922

Available for Sale
 
$
314,864

 
$
322,539



Dollars in thousands
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
1,001

 
$
1,002

Due from one to five years
 
—

 
—

Due from five to ten years
 
2,059

 
2,083

Due after ten years
 
77,437

 
78,524

Held to Maturity
 
$
80,497

 
$
81,609



The proceeds from sales, calls and maturities of securities available for sale, including principal payments received on mortgage-backed obligations, and the related gross gains and losses realized, for the six months ended June 30, 2020 and 2019 are as follows:
 
 
Proceeds from
 
Gross realized
Dollars in thousands
Sales
 
Calls and
Maturities
 
Principal
Payments
 
Gains
 
Losses
For the Six Months Ended 
 June 30,
 
 
 
 
 
 
 
 
 
2020
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
74,750

 
$
2,200

 
$
12,278

 
$
1,038

 
$
—

 
 
 
 
 
 
 
 
 
 
 
2019
 
 
 
 
 
 
 
 
 
 
Securities available for sale
$
114,171

 
$
1,445

 
$
13,822

 
$
1,213

 
$
131



We held 87 available for sale securities and 7 held to maturity securities having an unrealized loss at June 30, 2020.  We do not intend to sell these securities, and it is more likely than not that we will not be required to sell these securities before recovery of their amortized cost bases.  We believe that this decline in value is primarily attributable to the lack of market liquidity and to changes in market interest rates and is not due to credit quality.  Accordingly, no other-than-temporary impairment charge to earnings is warranted at this time.

An allowance for credit losses on held to maturity securities is a contra-asset valuation account, calculated in accordance with ASC 326, that is deducted from the amortized cost basis of held-to-maturity securities to present management's best estimate of the net amount expected to be collected. Held to maturity securities are charged-off against the allowance when deemed uncollectible by management. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management measures expected credit losses on held to maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. Management has made the accounting policy election to exclude accrued interest receivable on held to maturity securities from the estimate of credit losses. At June 30, 2020, no allowance for credit losses on held to maturity securities has been recognized.

Provided below is a summary of securities available for sale and held to maturity which were in an unrealized loss position at June 30, 2020 and December 31, 2019.



 
June 30, 2020
 
 
 
Less than 12 months
 
12 months or more
 
Total
Dollars in thousands
# of securities in loss position
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
Taxable debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
34
 
$
16,401

 
$
65

 
$
13,092

 
$
385

 
$
29,493

 
$
450

Residential mortgage-backed securities:
 
 
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
10
 
2,626

 
26

 
10,218

 
378

 
12,844

 
404

Nongovernment-sponsored entities
6
 
5,203

 
59

 
3,462

 
285

 
8,665

 
344

State and political subdivisions:
 
 
 

 
 

 
 

 
 

 
 

 
 

General obligations
1
 
501

 
5

 
—

 
—

 
501

 
5

Water and sewer revenues
1
 
1,113

 
2

 
—

 
—

 
1,113

 
2

Other revenues
1
 
1,095

 
34

 
—

 
—

 
1,095

 
34

Corporate debt securities
11
 
8,941

 
569

 
1,884

 
116

 
10,825

 
685

Asset-backed securities
21
 
14,956

 
474

 
30,348

 
1,985

 
45,304

 
2,459

Tax-exempt debt securities
 
 
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 
 
 

 
 

 
 

 
 

 
 

 
 

Water and sewer revenues
1
 
558

 
1

 
—

 
—

 
558

 
1

Other revenues
1
 
145

 
14

 
—

 
—

 
145

 
14

Total available to sale
87
 
$
51,539

 
$
1,249

 
$
59,004

 
$
3,149

 
$
110,543

 
$
4,398


 
June 30, 2020
 
 
 
Less than 12 months
 
12 months or more
 
Total
Dollars in thousands
# of securities in loss position
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
Tax-exempt debt securities
 
 
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 
 
 

 
 

 
 

 
 

 
 

 
 

General obligations
4
 
6,662

 
34

 
—

 
—

 
6,662

 
34

Sales tax revenues
2
 
2,921

 
2

 
—

 
—

 
2,921

 
2

Other revenues
1
 
630

 
2

 
—

 
—

 
630

 
2

Total held to maturity
7
 
$
10,213

 
$
38

 
$
—

 
$
—

 
$
10,213

 
$
38





 
December 31, 2019
 
 
 
Less than 12 months
 
12 months or more
 
Total
Dollars in thousands
# of securities in loss position
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
 
Estimated
Fair Value
 
Unrealized
Loss
Taxable debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and
      corporations
15
 
$
—

 
$
—

 
$
14,903

 
$
384

 
$
14,903

 
$
384

Residential mortgage-backed securities:
 
 
 

 
 

 
 

 
 

 
 

 
 

Government-sponsored agencies
21
 
12,298

 
96

 
15,174

 
339

 
27,472

 
435

Nongovernment-sponsored entities
4
 
8,323

 
41

 
—

 
—

 
8,323

 
41

State and political subdivisions:
 
 
 

 
 

 
 

 
 

 
 

 
 

General obligations
10
 
10,581

 
171

 
—

 
—

 
10,581

 
171

Water and sewer revenues
4
 
4,421

 
114

 
—

 
—

 
4,421

 
114

Lease revenues
4
 
4,235

 
77

 
—

 
—

 
4,235

 
77

University revenues
1
 
1,307

 
16

 
—

 
—

 
1,307

 
16

Other revenues
6
 
6,517

 
109

 
—

 
—

 
6,517

 
109

Corporate debt securities
6
 
1,686

 
3

 
3,739

 
146

 
5,425

 
149

   Asset-backed securities
15
 
3,441

 
34

 
29,573

 
778

 
33,014

 
812

Tax-exempt debt securities
 
 
 

 
 

 
 

 
 

 
 

 
 

State and political subdivisions:
 
 
 

 
 

 
 

 
 

 
 

 
 

Other revenues
2
 
1,183

 
7

 
—

 
—

 
1,183

 
7

Total
88
 
$
53,992

 
$
668

 
$
63,389

 
$
1,647

 
$
117,381

 
$
2,315




NOTE 6.  LOANS AND ALLOWANCE FOR CREDIT LOSSES FOR LOANS

Loans are generally stated at the amount of unpaid principal, reduced by unearned discount and the ACLL. Interest on loans is accrued daily on the outstanding balances.  Loan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the related loan yield over its contractual life.

Generally, loans are placed on nonaccrual status when principal or interest is greater than 90 days past due based upon the loan's contractual terms. Interest on nonaccrual loans is recognized primarily using the cost-recovery method.  Loans may be returned to accrual status when repayment is reasonably assured and there has been demonstrated performance under the terms of the loan or, if applicable, the terms of the restructured loans.

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


The following table presents the amortized cost of loans held for investment:
Dollars in thousands
 
June 30,
2020
 
December 31,
2019
Commercial
 
$
323,788

 
$
220,452

Commercial real estate - owner occupied
 
 

 
 

Professional & medical
 
100,370

 
81,973

Retail
 
119,794

 
100,993

Other
 
115,979

 
93,253

Commercial real estate - non-owner occupied
 
 
 
 
Hotels & motels
 
119,204

 
128,665

Mini-storage
 
55,828

 
50,913

Multifamily
 
144,583

 
164,398

Retail
 
109,078

 
102,989

Other
 
164,474

 
182,242

Construction and development
 
 

 
 

Land & land development
 
92,706

 
84,112

Construction
 
48,116

 
37,523

Residential 1-4 family real estate
 
 

 
 

Personal residence
 
267,170

 
260,843

Rental - small loan
 
104,055

 
101,080

Rental - large loan
 
76,360

 
63,986

Home equity
 
88,929

 
76,568

Mortgage warehouse lines
 
252,472

 
126,237

Consumer
 
34,640

 
35,021

Other
 
 
 
 
Credit cards
 
1,573

 
1,453

Overdrafts
 
588

 
798

Total loans, net of unearned fees
 
2,219,707

 
1,913,499

Less allowance for credit losses - loans
 
27,166

 
13,074

Loans, net
 
$
2,192,541

 
$
1,900,425



Allowance for Credit Losses - Loans
The ACLL is a valuation allowance, estimated at each balance sheet date in accordance with ASC 326, that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of the ACLL represents our best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability over the loans’ contractual terms, adjusted for expected prepayments when appropriate (the “life-of-loan” concept). The contractual term excludes expected extensions, renewals and modifications unless (i) management has a reasonable expectation that a troubled debt restructuring will be executed with an individual borrower or (ii) such extension or renewal options are not unconditionally cancellable by us and, in such cases, the borrower is likely to meet applicable conditions and likely to request extension or renewal. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. The ACLL losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty, but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.
Expected credit losses are reflected in the ACLL through a charge to provision for credit losses. When we deem all or a portion of a financial asset to be uncollectible the appropriate amount is written off and the ACLL is reduced by the same amount. The Company applies judgment to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted. Subsequent recoveries, if any, are credited to the ACLL when received.
Loan Pools. In calculating the ACLL, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type/purpose of loan, underlying collateral, geographical similarity and historical/expected credit loss patterns. In developing these loan pools for the purposes of modeling expected credit losses, we also analyzed the degree of correlation in how loans within each portfolio respond when subjected to varying economic conditions


and scenarios as well as other portfolio stress factors. We have identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses:
▪
Commercial
•
Commercial real estate - owner occupied
▪
Professional & medical
▪
Retail
▪
Other
•
Commercial real estate - non-owner occupied
▪
Hotels & motels
▪
Mini-storage
▪
Multifamily
▪
Retail
▪
Other
•
Construction & development
▪
Land & land development
▪
Construction
•
Residential 1-4 family real estate
▪
Personal residence
▪
Rental - small loan
▪
Rental - large loan
▪
Home equity
•
Mortgage warehouse lines
•
Consumer
•
Other
▪
Credit cards
▪
Overdrafts

Residential 1-4 family rentals are classified as small loan if the original loan amount is less than $600,000 and classified as large loan if the original loan amount equals or exceeds $600,000.

We periodically reassess each pool to ensure the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.

The Company’s methodology for estimating the ACLL considers available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. The methodology applies historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual lives of the financial assets that are reasonable and supportable, to the identified pools of financial assets with similar risk characteristics for which the historical loss experience was observed. Our methodology reverts to historical loss information immediately when it can no longer develop reasonable and supportable forecasts.

Loss-Rate Method. We use a loss-rate (“cohort”) method to estimate expected credit losses for all loan pools. The cohort method identifies and captures the balances of pooled loans with similar risk characteristics, as of a point in time to form a cohort, then tracks the respective losses generated by that cohort of loans over their remaining lives, or until the loans are “exhausted” (reached an acceptable stage at which a significant majority of all losses are expected to have been recognized). This method encompasses loan balances for as long as the loans are outstanding, so while significant history is required to represent the life-of-loan concept, this method does not require as much history due to its inclusion of loan balances in multiple cohort periods.
Qualitative Factors. We qualitatively adjust our loan loss rates for risk factors that are not otherwise considered within our model but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) adjustments may increase or decrease our estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk.
One Q-Factor adjustment to our loss rates is consideration of reasonable and supportable forecasts of economic conditions. In arriving at a reasonable and supportable economic forecast, we primarily consider the forecasted unemployment rates for the U.S., West Virginia and Virginia as loss drivers for each segmented loan pool. Secondarily, we consider the following forecasted economic data for one or more of our segmented loan pools depending on the nature of the underlying loan pool: housing price indices (U.S., West Virginia & Virginia), single-family housing starts (West Virginia & Virginia), multi-family housing starts (West Virginia &


Virginia), personal income growth (U.S., West Virginia & Virginia), U.S. consumer confidence, rental vacancy rates (U.S.), and U.S. % change in gross domestic product.
Other risks that we may consider in making Q-Factor adjustments include, among other things, the impact of (i) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries, (ii) changes in the nature and volume of the loan pools and in the terms of the underlying loans, (iii) changes in the experience, ability, and depth of our lending management and staff, (iv) changes in volume and severity of past due financial assets, the volume of non-accrual assets, and the volume and severity of adversely classified or graded assets, (v) changes in the quality of our credit review function, (vi) changes in the value of the underlying collateral for loans that are non-collateral dependent, (vii) the existence, growth, and effect of any concentrations of credit and (viii) other external factors such as the regulatory, legal and technological environments; competition; and events such as natural disasters or health pandemics.

Collateral Dependent Loans. We may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. We reevaluate the fair value of collateral supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent loans is evaluated by appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice.

Troubled Debt Restructuring. A loan that has been modified or renewed is considered a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. The Company’s ACLL reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company has determined that a TDR is reasonably expected no later than the point when the lender concludes that modification is the best course of action and it is at least reasonably possible that the troubled borrower will accept some form of concession from the lender to avoid a default. TDRs that are considered material ($500,000 and greater) are evaluated individually to determine the required ACLL. TDRs that are not considered material may be included in the Company’s existing pools based on the underlying risk characteristics of the loan to measure the ACLL.



The following table presents the activity in the ACLL by portfolio segment during the first six months of 2020:
 
For the Six Months Ended June 30, 2020
 
Allowance for Credit Losses - Loans
Dollars in thousands
Beginning
Balance
Prior to
Adoption of
ASC 326
Impact of
Adoption
of ASC
326
Provision
for
Credit
Losses -
Loans

Adjustment
for PCD
Acquired
Loans
Charge-
offs
Recoveries
Ending
Balance
Commercial
$
1,221

$
1,064

$
1,053

$
—

$
(99
)
$
16

$
3,255

Commercial real estate - owner occupied
 
 
 
 
 
 
 
  Professional & medical
1,058

(390
)
784

—

—

—

1,452

  Retail
820

(272
)
540

153

—

116

1,357

  Other
821

(137
)
402

—

—

—

1,086

Commercial real estate - non-owner occupied
 
 
 
 
 
 
 
  Hotels & motels
1,235

(936
)
1,654

—

—

—

1,953

  Mini-storage
485

(311
)
57

—

—

—

231

  Multifamily
1,534

8

(838
)
—

—

4

708

  Retail
964

279

471

—

(343
)
2

1,373

  Other
1,721

(1,394
)
(12
)
—

—

—

315

Construction and development
 
 
 
 
 
 
 
  Land & land development
600

2,136

1,213

111

(4
)
6

4,062

  Construction
242

996

606

—

—

—

1,844

Residential 1-4 family real estate
 
 
 
 
 
 
 
  Personal residence
1,275

1,282

356

146

(7
)
37

3,089

  Rental - small loan
532

1,453

81

—

(27
)
117

2,156

  Rental - large loan
49

2,884

(98
)
—

—

—

2,835

  Home equity
138

308

635

—

(24
)
9

1,066

Mortgage warehouse lines
—

—

—

—

—

—

—

Consumer
379

(238
)
202

—

(176
)
68

235

Other
 
 
 
 
 
 
 
  Credit cards
—

12

26

—

(30
)
6

14

  Overdrafts
—

182

74

—

(206
)
85

135

Total
$
13,074

$
6,926

$
7,206

$
410

$
(916
)
$
466

$
27,166



The following table presents, as of June 30, 2020 segregated by loan portfolio segment, details of the loan portfolio and the ACLL calculated in accordance with our credit loss accounting methodology for loans described above.


 
June 30, 2020
 
Loan Balances
 
Allowance for Credit Losses - Loans
Dollars in thousands
Loans Individually Evaluated
Loans Collectively Evaluated
Total
 
Loans Individually Evaluated
Loans Collectively Evaluated
Total
Commercial
$
4,885

$
318,903

$
323,788

 
$
23

$
3,232

$
3,255

Commercial real estate - owner occupied
 
 
 
 
 
 
 
  Professional & medical
3,819

96,551

100,370

 
1,117

335

1,452

  Retail
6,557

113,237

119,794

 
—

1,357

1,357

  Other
—

115,979

115,979

 
—

1,086

1,086

Commercial real estate - non-owner occupied
 
 
 
 
 
 
 
  Hotels & motels
—

119,204

119,204

 
—

1,953

1,953

  Mini-storage
—

55,828

55,828

 
—

231

231

  Multifamily
—

144,583

144,583

 
—

708

708

  Retail
2,516

106,562

109,078

 
57

1,316

1,373

  Other
5,282

159,192

164,474

 
—

315

315

Construction and development
 
 
 
 
 
 
 
  Land & land development
1,641

91,065

92,706

 
584

3,478

4,062

  Construction
—

48,116

48,116

 
—

1,844

1,844

Residential 1-4 family real estate
 
 
 
 
 
 
 
  Personal residence
611

266,559

267,170

 
—

3,089

3,089

  Rental - small loan
781

103,274

104,055

 
50

2,106

2,156

  Rental - large loan
4,448

71,912

76,360

 
—

2,835

2,835

  Home equity
523

88,406

88,929

 
—

1,066

1,066

Consumer
—

34,640

34,640

 
—

235

235

Other
 
 

 
 
 
 
Credit cards
—

1,573

1,573

 
—

14

14

Overdrafts
—

588

588

 
—

135

135

Mortgage warehouse lines
—

252,472

252,472

 
—

—

—

             Total
$
31,063

$
2,188,644

$
2,219,707

 
$
1,831

$
25,335

$
27,166



The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses, and the related ACLL allocated to those loans:


 
June 30, 2020
Dollars in thousands
Real Estate
Secured
Loans
Non-Real Estate
Secured Loans
Total Loans
Allowance for Credit Losses
- Loans
Commercial
$
—

$
4,885

$
4,885

$
23

Commercial real estate - owner occupied
 
 
 
 
  Professional & medical
1,599

—

1,599

881

  Retail
2,268

—

2,268

—

  Other
—

—

—

—

Commercial real estate - non-owner occupied
 
 
 
 
  Hotels & motels
—

—

—

—

  Mini-storage
—

—

—

—

  Multifamily
—

—

—

—

  Retail
651

—

651

50

  Other
2,922

—

2,922

—

Construction and development
 
 
 
 
  Land & land development
1,006

—

1,006

584

  Construction
—

—

—

—

Residential 1-4 family real estate
 
 
 
 
  Personal residence
611

—

611

—

  Rental - small loan
781

—

781

50

  Rental - large loan
4,448

—

4,448

—

  Home equity
—

—

—

—

Consumer
—

—

—

—

Other
 
 
 
 
Credit cards
—

—

—

—

Overdrafts
—

—

—

—

             Total
$
14,286

$
4,885

$
19,171

$
1,588




The following table presents the activity in the ACLL by portfolio segment for the year ended December 31, 2019, as determined in accordance with ASC 310 prior to the January 1, 2020 adoption of ASC 326:

 
For the Year Ended December 31, 2019
 
Allowance for Credit Losses - Loans
Dollars in thousands
Beginning
 Balance
Charge-
offs
Recoveries
Provision
Ending
Balance
Commercial
$
1,705

$
(281
)
$
17

$
(295
)
$
1,146

Commercial real estate
 
 
 
 
 
Owner occupied
2,214

(2
)
21

467

2,700

Non-owner occupied
5,742

(170
)
1

366

5,939

Construction and development
 
 
 
 
 
   Land & land development
339

(2
)
108

155

600

Construction
64

—

—

178

242

Residential real estate
 
 
 
 
 
Non-jumbo
2,090

(979
)
125

576

1,812

Jumbo
379

—

—

(368
)
11

Home equity
167

(24
)
19

(24
)
138

Mortgage warehouse lines
—

—

—

—

—

Consumer
79

(285
)
168

173

135

Other
268

(360
)
121

322

351

Total
$
13,047

$
(2,103
)
$
580

$
1,550

$
13,074




The following table presents the contractual aging of the amortized cost basis of past due loans by class as of June 30, 2020 and December 31, 2019.
 
At June 30, 2020
 
Past Due
 
90 days or more and Accruing
Dollars in thousands
30-59 days
60-89 days
90 days or more
Total
Current
Commercial
$
141

$
138

$
418

$
697

$
323,091

$
—

Commercial real estate - owner occupied
 

 

 

 

 

 

  Professional & medical
—

318

1,737

2,055

98,315

—

  Retail
56

111

2,444

2,611

117,183

—

  Other
265

194

149

608

115,371

—

Commercial real estate - non-owner occupied
 
 
 
 
 
 
  Hotels & motels
—

—

—

—

119,204

—

  Mini-storage
—

—

—

—

55,828

—

  Multifamily
165

—

213

378

144,205

—

  Retail
—

—

827

827

108,251

—

  Other
—

234

52

286

164,188

—

Construction and development
 

 

 

 

 

 

  Land & land development
—

8

14

22

92,684

—

  Construction
—

—

—

—

48,116

—

Residential 1-4 family real estate
 

 

 

 

 

 

  Personal residence
1,536

246

1,225

3,007

264,163

—

  Rental - small loan
309

259

1,274

1,842

102,213

—

  Rental - large loan
—

—

1,120

1,120

75,240

—

  Home equity
342

250

134

726

88,203

—

Mortgage warehouse lines
—

—

—

—

252,472

—

Consumer
126

38

24

188

34,452

—

Other
 
 
 
 
 
 
Credit cards
2

—

2

4

1,569

2

Overdrafts
—

—

—

—

588

—

Total
$
2,942

$
1,796

$
9,633

$
14,371

$
2,205,336

$
2

 


 
At December 31, 2019
 
Past Due
 
90 days or more and Accruing
Dollars in thousands
30-59 days
60-89 days
90 days or more
Total
Current
Commercial
$
216

$
—

$
483

$
699

$
219,753

$
—

Commercial real estate - owner occupied
 

 

 

 

 

 

  Professional & medical
—

137

1,602

1,739

80,234

—

  Retail
118

—

2,434

2,552

98,441

—

  Other
—

—

—

—

93,253

—

Commercial real estate - non-owner occupied
 
 
 
 
 
 
  Hotels & motels
—

—

—

—

128,665

—

  Mini-storage
—

—

—

—

50,913

—

  Multifamily
809

—

7

816

163,582

—

  Retail
71

179

968

1,218

101,771

—

  Other
—

—

387

387

181,855

—

Construction and development
 
 

 

 

 

 

  Land & land development
208

28

188

424

83,688

—

  Construction
—

—

138

138

37,385

—

Residential 1-4 family real estate
 

 

 

 

 

 

  Personal residence
3,361

806

937

5,104

255,739

—

  Rental - small loan
810

21

940

1,771

99,309

—

  Rental - large loan
—

—

—

—

63,986

—

  Home equity
760

—

223

983

75,585

—

Mortgage warehouse lines
—

—

—

—

126,237

—

Consumer
190

79

70

339

34,682

—

Other
 
 
 
 
 
 
Credit cards
19

6

42

67

1,386

42

Overdrafts
—

—

—

—

798

—

Total
$
6,562

$
1,256

$
8,419

$
16,237

$
1,897,262

$
42



Nonaccrual loans:  The following table presents the nonaccrual loans included in the net balance of loans at June 30, 2020 and December 31, 2019.


 
 
June 30,
 
December 31,
 
 
2020
 
2019
Dollars in thousands
 
Nonaccrual
Nonaccrual
with No
Allowance for
Credit Losses
- Loans
 
Nonaccrual
Nonaccrual
with No
Allowance for
Credit Losses
- Loans
Commercial
 
$
789

$
—

 
$
864

$
76

Commercial real estate - owner occupied
 
 

 
 
 

 
  Professional & medical
 
1,737

—

 
1,602

—

  Retail
 
2,556

2,269

 
2,552

2,262

  Other
 
384

—

 
43

—

Commercial real estate - non-owner occupied
 
 
 
 
 
 
  Hotels & motels
 
—

—

 
—

—

  Mini-storage
 
54

—

 
57

—

  Multifamily
 
213

—

 
38

31

  Retail
 
827

167

 
1,120

527

  Other
 
52

—

 
388

40

Construction and development
 
 

 
 
 

 
  Land & land development
 
14

—

 
188

—

  Construction
 
—

—

 
138

—

Residential 1-4 family real estate
 
 

 
 
 

 
  Personal residence
 
2,413

—

 
2,485

423

  Rental - small loan
 
2,154

81

 
1,635

150

  Rental - large loan
 
1,120

1,120

 
—

—

  Home equity
 
186

—

 
284

—

Mortgage warehouse lines
 
—

—

 
—

—

Consumer
 
27

—

 
74

—

Other
 
 
 
 
 
 
Credit cards
 
—

—

 
—

—

Overdrafts
 
—

—

 
—

—

Total
 
$
12,526

$
3,637

 
$
11,468

$
3,509


 
Credit Quality Indicators: We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk.  We internally grade all commercial loans at the time of loan origination. In addition, we perform an annual loan review on all non-homogenous commercial loan relationships with an aggregate exposure of $5.0 million, at which time these loans are re-graded. We use the following definitions for our risk grades:

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

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

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

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

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


Management considers the guidance in ASC 310-20 when determining whether a modification, extension, or renewal of loan constitutes a current period origination. Generally, current period renewals of credit are reunderwritten at the point of renewal and considered current period originations for purposes of the table below. As of June 30, 2020, based on the most recent analysis performed, the risk category of loans based on year of origination is as follows:
 
 
June 30, 2020
Dollars in thousands
 
Risk Rating
2020
2019
2018
2017
2016
Prior
Revolvi-
ng
Revolving- Term
Total
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 
Pass
$
122,162

$
42,472

$
25,792

$
23,244

$
14,459

$
13,816

$
72,786

$
—

$
314,731

 
 
 
Special Mention
51

43

1,963

85

111

924

415

—

3,592

 
 
 
Substandard
1,018

204

228

9

77

105

3,824

—

5,465

Total Commercial
 
 
123,231

42,719

27,983

23,338

14,647

14,845

77,025

—

323,788

 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Real Estate
   - Owner Occupied
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Professional & medical
 
Pass
5,887

14,501

2,617

27,485

3,869

35,706

3,005

—

93,070

 
 
 
Special Mention
—

319

—

—

—

5,244

—

—

5,563

 
 
 
Substandard
—

—

—

—

138

1,599

—

—

1,737

Total Professional & Medical
 
 
5,887

14,820

2,617

27,485

4,007

42,549

3,005

—

100,370

 
 
 
 
 
 
 
 
 
 
 
 
 
Retail
 
Pass
19,077

40,260

5,274

11,386

6,172

30,886

2,713

—

115,768

 
 
 
Special Mention
—

—

—

589

7

874

—

—

1,470

 
 
 
Substandard
—

—

—

—

—

2,556

—

—

2,556

Total Retail
 
 
19,077

40,260

5,274

11,975

6,179

34,316

2,713

—

119,794

 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
Pass
13,854

15,167

17,207

9,665

13,522

35,497

9,457

—

114,369

 
 
 
Special Mention
—

—

—

—

—

793

—

—

793

 
 
 
Substandard
—

—

—

360

—

415

42

—

817

Total Other
 
 
13,854

15,167

17,207

10,025

13,522

36,705

9,499

—

115,979

 
 
 
 
 
 
 
 
 
 
 
 
 
Total Commercial Real Estate -
   Owner Occupied
 
 
38,818

70,247

25,098

49,485

23,708

113,570

15,217

—

336,143

 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Real Estate
   - Non-Owner Occupied
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hotels & motels
 
Pass
3,457

61,307

18,043

9,921

10,483

14,836

1,157

—

119,204

 
 
 
Special Mention
—

—

—

—

—

—

—

—

—

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Hotels & Motels
 
 
3,457

61,307

18,043

9,921

10,483

14,836

1,157

—

119,204

 
 
 
 
 
 
 
 
 
 
 
 
 
Mini-storage
 
Pass
3,983

19,825

15,114

4,066

7,325

5,283

178

—

55,774

 
 
 
Special Mention
—

—

—

—

—

54

—

—

54

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Mini-storage
 
 
3,983

19,825

15,114

4,066

7,325

5,337

178

—

55,828

 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily
 
Pass
6,409

27,156

27,150

19,154

11,384

50,324

2,692

—

144,269

 
 
 
Special Mention
—

—

—

—

—

101

—

—

101

 
 
 
Substandard
—

—

—

—

—

213

—

—

213

Total Multifamily
 
 
6,409

27,156

27,150

19,154

11,384

50,638

2,692

—

144,583

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
June 30, 2020
Dollars in thousands
 
Risk Rating
2020
2019
2018
2017
2016
Prior
Revolvi-
ng
Revolving- Term
Total
Retail
 
Pass
8,037

24,175

12,349

8,486

5,838

42,831

5,965

—

107,681

 
 
 
Special Mention
—

—

—

176

—

570

—

—

746

 
 
 
Substandard
—

—

—

—

—

651

—

—

651

Total Retail
 
 
8,037

24,175

12,349

8,662

5,838

44,052

5,965

—

109,078

 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
Pass
16,462

21,089

52,054

11,150

27,806

30,271

2,280

—

161,112

 
 
 
Special Mention
—

—

—

—

—

388

—

—

388

 
 
 
Substandard
—

—

—

—

—

2,974

—

—

2,974

Total Other
 
 
16,462

21,089

52,054

11,150

27,806

33,633

2,280

—

164,474

 
 
 
 
 
 
 
 
 
 
 
 
 
Total Commercial Real Estate -
   Non-Owner Occupied
 
 
38,348

153,552

124,710

52,953

62,836

148,496

12,272

—

593,167

 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land & land development
 
Pass
4,997

30,603

9,448

4,896

6,844

24,147

9,750

—

90,685

 
 
 
Special Mention
—

—

21

—

—

697

—

—

718

 
 
 
Substandard
—

—

—

—

15

1,288

—

—

1,303

Total Land & land development
 
 
4,997

30,603

9,469

4,896

6,859

26,132

9,750

—

92,706

 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
 
Pass
14,807

21,312

4,941

6,162

—

—

894

—

48,116

 
 
 
Special Mention
—

—

—

—

—

—

—

—

—

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Construction
 
 
14,807

21,312

4,941

6,162

—

—

894

—

48,116

 
 
 
 
 
 
 
 
 
 
 
 
 
Total Construction and
   Development
 
 
19,804

51,915

14,410

11,058

6,859

26,132

10,644

—

140,822

 
 
 
 
 
 
 
 
 
 
 
 
 
Residential 1-4 Family Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Personal residence
 
Pass
18,052

29,477

26,425

20,200

24,107

124,972

—

—

243,233

 
 
 
Special Mention
109

188

63

355

76

12,784

—

—

13,575

 
 
 
Substandard
—

157

529

379

370

8,927

—

—

10,362

Total Personal Residence
 
 
18,161

29,822

27,017

20,934

24,553

146,683

—

—

267,170

 
 
 
 
 
 
 
 
 
 
 
 
 
Rental - small loan
 
Pass
8,540

18,345

13,621

11,812

11,493

29,373

4,312

—

97,496

 
 
 
Special Mention
202

486

251

3

200

1,999

435

—

3,576

 
 
 
Substandard
—

—

—

—

71

2,903

9

—

2,983

Total Rental - Small Loan
 
 
8,742

18,831

13,872

11,815

11,764

34,275

4,756

—

104,055

 
 
 
 
 
 
 
 
 
 
 
 
 
Rental - large loan
 
Pass
12,811

6,130

10,941

5,589

8,403

23,459

3,116

—

70,449

 
 
 
Special Mention
—

1,430

—

—

—

33

—

—

1,463

 
 
 
Substandard
—

—

—

—

1,120

3,328

—

—

4,448

Total Rental - Large Loan
 
 
12,811

7,560

10,941

5,589

9,523

26,820

3,116

—

76,360

 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
 
Pass
85

—

91

60

132

1,824

84,570

—

86,762

 
 
 
Special Mention
—

—

—

40

—

152

1,335

—

1,527

 
 
 
Substandard
—

—

—

—

—

336

304

—

640

Total Home Equity
 
 
85

—

91

100

132

2,312

86,209

—

88,929



 
 
June 30, 2020
Dollars in thousands
 
Risk Rating
2020
2019
2018
2017
2016
Prior
Revolvi-
ng
Revolving- Term
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Residential 1-4 Family Real
   Estate
 
 
39,799

56,213

51,921

38,438

45,972

210,090

94,081

—

536,514

 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage warehouse lines
 
Pass
—

—

—

—

—

—

252,472

—

252,472

 
 
 
Special Mention
—

—

—

—

—

—

—

—

—

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Mortgage Warehouse Lines
 
 
—

—

—

—

—

—

252,472

—

252,472

 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer
 
Pass
7,173

12,350

6,153

2,466

1,700

1,914

711

—

32,467

 
 
 
Special Mention
410

636

318

209

93

69

17

—

1,752

 
 
 
Substandard
126

153

25

19

63

7

28

—

421

Total Consumer
 
 
7,709

13,139

6,496

2,694

1,856

1,990

756

—

34,640

 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit cards
 
Pass
1,573

—

—

—

—

—

—

—

1,573

 
 
 
Special Mention
—

—

—

—

—

—

—

—

—

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Credit Cards
 
 
1,573

—

—

—

—

—

—

—

1,573

 
 
 
 
 
 
 
 
 
 
 
 
 
Overdrafts
 
Pass
588

—

—

—

—

—

—

—

588

 
 
 
Special Mention
—

—

—

—

—

—

—

—

—

 
 
 
Substandard
—

—

—

—

—

—

—

—

—

Total Overdrafts
 
 
588

—

—

—

—

—

—

—

588

 
 
 
 
 
 
 
 
 
 
 
 
 
Total Other
 
 
2,161

—

—

—

—

—

—

—

2,161

 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
$
269,870

$
387,785

$
250,618

$
177,966

$
155,878

$
515,123

$
462,467

$
—

$
2,219,707


At June 30, 2020, we had TDRs of $25.1 million, of which $22.1 million were current with respect to restructured contractual payments. At December 31, 2019, our TDRs totaled $25.7 million, of which $22.9 million were current with respect to restructured contractual payments.  There were no commitments to lend additional funds under these restructurings at either balance sheet date.

The following table presents by class the TDRs that were restructured during the six months ended June 30, 2020 and June 30, 2019. Generally, the modifications were extensions of term, modifying the payment terms from principal and interest to interest only for an extended period, or reduction in interest rate.  TDRs are evaluated individually for allowance for credit loss purposes if the loan balance exceeds $500,000, otherwise, smaller balance TDR loans are included in the pools to determine ACLL. There were no restructurings during second quarter of 2020 or 2019.





 
For the Six Months Ended 
 June 30, 2020
 
For the Six Months Ended 
 June 30, 2019
Dollars in thousands
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
 
Number of
Modifications
 
Pre-modification
Recorded
Investment
 
Post-modification
Recorded
Investment
Commercial real estate - owner occupied
 
 
 
 
 
 
 
 
 
 
 
  Other
1

 
$
361

 
$
361

 
1

 
$
325

 
$
325

Commercial real estate - non-owner occupied
 
 
 
 
 
 
 
 
 
 
 
  Multifamily
—

 
—

 
—

 
1

 
35

 
35

  Retail
—

 
—

 
—

 
2

 
162

 
162

  Other
—

 
—

 
—

 
1

 
127

 
127

Residential 1-4 family real estate
 
 
 
 
 
 
 
 
 
 
 
  Personal residence
—

 
—

 
—

 
3

 
151

 
151

  Rental - small loan
—

 
—

 
—

 
4

 
259

 
259

Consumer
—

 
—

 
—

 
1

 
16

 
16

Total
1

 
$
361

 
$
361

 
13

 
$
1,075

 
$
1,075



The following tables present defaults during the stated period of TDRs that were restructured during the prior 12 months. For purposes of these tables, a default is considered as either the loan was past due 30 days or more at any time during the period, or the loan was fully or partially charged off during the period.

 
For the Three Months Ended 
 June 30, 2020
 
For the Three Months Ended 
 June 30, 2019
Dollars in thousands
Number
of
Defaults
 
Recorded
Investment
at Default Date
 
Number
of
Defaults
 
Recorded
Investment
at Default Date
Commercial real estate - owner occupied
 
 
 
 
 
 
 
  Other
1

 
$
361

 
—

 
$
—

Commercial real estate - non-owner occupied
 
 
 
 
 
 
 
  Other
—

 
—

 
1

 
126

Residential 1-4 family real estate
 
 
 
 
 
 
 
   Personal residence
—

 
—

 
1

 
47

   Rental - small loan
—

 
—

 
3

 
146

Total
1

 
$
361

 
5

 
$
319



 
For the Six Months Ended 
 June 30, 2020
 
For the Six Months Ended 
 June 30, 2019
Dollars in thousands
Number
of
Defaults
 
Recorded
Investment
at Default Date
 
Number
of
Defaults
 
Recorded
Investment
at Default Date
Commercial real estate - owner occupied
 
 
 
 
 
 
 
Other
1

 
$
361

 
—

 
$
—

Commercial real estate - non-owner occupied
 
 
 
 
 
 
 
Other
—

 
—

 
1

 
126

Residential 1-4 family real estate
 
 
 
 
 
 
 
Personal residence
—

 
—

 
1

 
47

Rental - small loan
—

 
—

 
3

 
146

Total
1

 
$
361

 
5

 
$
319




As of June 30, 2020, we had executed 618 modifications to interest only or principal and interest deferrals on outstanding loan balances of $360 million in connection with the COVID-19 relief provided by the CARES Act. These modifications and deferrals were generally no more than 6 months in duration and were not considered troubled debt restructurings based on interagency guidance issued in March 2020.



On January 1, 2020, we purchased loans, for which there was, at the time of acquisition, more than significant deterioration of credit quality since origination (PCD loans). The carrying amount of these loans at acquisition is as follows:

Dollars in thousands
 
January 1, 2020
Purchase price of PCD loans at acquisition
 
$
1,877

Allowance for credit losses - loans at acquisition
 
410

Non-credit discount at acquisition
 
159

Par value of PCD loans at acquisition
 
1,308



NOTE 7.  GOODWILL AND OTHER INTANGIBLE ASSETS

In accordance with ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, during first quarter 2020, we evaluated recent potential triggering events that might be indicators that our goodwill was impaired. The events include, among others, the economic disruption and uncertainty surrounding the COVID-19 pandemic. We performed Step 1 of the goodwill impairment test and determined that there were no indicators of impairment noted as of March 31, 2020.

The following tables present our goodwill activity for the quarter ending June 30, 2020 and the balance of other intangible assets at June 30, 2020 and December 31, 2019.

Dollars in thousands
 
Goodwill Activity
Balance, January 1, 2020
 
$
12,658

Acquired goodwill
 
25,488

Balance, June 30, 2020
 
$
38,146



 
 
Other Intangible Assets
Dollars in thousands
 
June 30, 2020
December 31, 2019
Identifiable intangible assets
 
 

 
 

Gross carrying amount
 
$
15,569

 
$
14,727

Less: accumulated amortization
 
(5,202
)
 
(4,363
)
Net carrying amount
 
$
10,367

 
$
10,364



We recorded amortization expense of $410,000 and $839,000 for the three and six months ended June 30, 2020 and $420,000 and $897,000 for the three and six months ended June 30, 2019, relative to our identifiable intangible assets.  

Amortization relative to our identifiable intangible assets is expected to approximate the following during the next five years and thereafter:
 
Core Deposit
Dollars in thousands
Intangible
Six month period ending December 31, 2020
$
820

Year ending December 31, 2021
1,532

Year ending December 31, 2022
1,396

Year ending December 31, 2023
1,260

Year ending December 31, 2024
1,124

Thereafter
4,165



NOTE 8.  DEPOSITS

The following is a summary of interest bearing deposits by type as of June 30, 2020 and December 31, 2019:
Dollars in thousands
 
June 30,
2020
 
December 31,
2019
Demand deposits, interest bearing
 
$
830,258

 
$
630,351

Savings deposits
 
561,029

 
418,096

Time deposits
 
617,292

 
604,237

Total
 
$
2,008,579

 
$
1,652,684





Included in time deposits are deposits acquired through a third party (“brokered deposits”) totaling $90.3 million and $150.6 million at June 30, 2020 and December 31, 2019, respectively.

A summary of the scheduled maturities for all time deposits as of June 30, 2020 is as follows:
Dollars in thousands
 
Six month period ending December 31, 2020
$
226,631

Year ending December 31, 2021
275,409

Year ending December 31, 2022
53,469

Year ending December 31, 2023
23,610

Year ending December 31, 2024
15,380

Thereafter
22,793

Total
$
617,292



The aggregate amount of time deposits in denominations that meet or exceed the FDIC insurance limit of $250,000 totaled $179.2 million at June 30, 2020 and $198.1 million at December 31, 2019.




NOTE 9.  BORROWED FUNDS

Short-term borrowings:    A summary of short-term borrowings is presented below:
 
Six Months Ended June 30,
 
2020
 
2019
Dollars in thousands
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
 
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
Balance at June 30
$
90,800

 
$
145

 
$
225,200

 
$
143

Average balance outstanding for the period
107,530

 
145

 
192,895

 
777

Maximum balance outstanding at any month end during period
161,600

 
145

 
225,200

 
143

Weighted average interest rate for the period
1.10
%
 
0.83
%
 
2.72
%
 
2.48
%
Weighted average interest rate for balances
 

 
 

 
 

 
 

     outstanding at June 30
0.39
%
 
0.25
%
 
2.51
%
 
2.50
%

 
Year Ended December 31, 2019
Dollars in thousands
Short-term
FHLB
Advances
 
Federal Funds
Purchased
and Lines
of Credit
Balance at December 31
$
199,200

 
145

Average balance outstanding for the period
193,992

 
458

Maximum balance outstanding at any month end
    during period
237,400

 
145

Weighted average interest rate for the period
2.48
%
 
2.43
%
Weighted average interest rate for balances
 
 
 
     outstanding at December 31
1.83
%
 
1.75
%

Long-term borrowings:  Our long-term borrowings of $708,000 and $717,000 at June 30, 2020 and December 31, 2019, respectively, consisted of a 5.34% fixed rate advance from the Federal Home Loan Bank (“FHLB”), maturing in 2026. This FHLB advance is collateralized by a blanket lien of $1.22 billion of residential mortgage loans, certain commercial loans, mortgage backed securities and securities of U.S. Government agencies and corporations.
 
Subordinated debentures owed to unconsolidated subsidiary trusts:  We have three statutory business trusts that were formed for the purpose of issuing mandatorily redeemable securities (the “capital securities”) for which we are obligated to third party investors and investing the proceeds from the sale of the capital securities in our junior subordinated debentures (the


“debentures”).  The debentures held by the trusts are their sole assets.  Our subordinated debentures totaled $19.6 million at June 30, 2020 and December 31, 2019.

The capital securities held by SFG Capital Trust I, SFG Capital Trust II, and SFG Capital Trust III qualify as Tier 1 capital under Federal Reserve Board guidelines.  In accordance with these Guidelines, trust preferred securities generally are limited to 25% of Tier 1 capital elements, net of goodwill.  The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital.
 
A summary of the maturities of all long-term borrowings and subordinated debentures for the next five years and thereafter is as follows:
Dollars in thousands
 
 
Long-term
borrowings
 
Subordinated
debentures owed
to unconsolidated
subsidiary trusts
Year Ending December 31,
2020
 
$
9

 
$
—

 
2021
 
20

 
—

 
2022
 
21

 
—

 
2023
 
22

 
—

 
2024
 
23

 
—

 
Thereafter
 
613

 
19,589

 
 
 
$
708

 
$
19,589


NOTE 10.  SHARE-BASED COMPENSATION

Under the 2014 Long-Term Incentive Plan (“2014 LTIP”), stock options, SARs and RSUs have generally been granted with an exercise price equal to the fair value of Summit's common stock on the grant date. We periodically grant employee stock options to individual employees.

During first quarter 2019, we granted 109,819 SARs that become exercisable ratably over five years (20% per year) and expire ten years after the grant date and granted 28,306 SARS that become exercisable ratably over seven years (14.29% per year) and expire ten years after the grant date.

The fair value of our employee stock options and SARs granted under the Plans is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options and SARs granted but are not considered by the model. Because our employee stock options and SARs have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and SARs at the time of grant. The assumptions used to value SARs granted during 2019 were as follows:
 
5-year vesting SARs
7-year vesting SARs
Risk-free interest rate
2.43
%
2.51
%
Expected dividend yield
2.30
%
2.30
%
Expected common stock volatility
35.71
%
40.84
%
Expected life
5.5 years

7.0 years





A summary of our SAR and stock option activity the first six months of 2020 and 2019 is as follows:
 
For the Six Months Ended June 30,
 
2020
 
Options/SARs
 
Aggregate
Intrinsic
Value (in thousands)
 
Remaining
Contractual
Term (Yrs.)
 
Weighted-Average
Exercise Price
Outstanding, January 1
330,703

 
 
 
 
 
$
20.44

Granted
—

 
 
 
 
 
—

Exercised
—

 
 
 
 
 
—

Forfeited
—

 
 
 
 
 
—

Expired
—

 
 
 
 
 
—

Outstanding, June 30
330,703

 
$
529

 
6.83
 
$
20.44

 
 
 
 
 
 
 
 
Exercisable, June 30
179,375

 
$
529

 
5.77
 
$
17.03


 
For the Six Months Ended June 30,
 
2019
 
Options/SARs
 
Aggregate
Intrinsic
Value (in thousands)
 
Remaining
Contractual
Term (Yrs.)
 
Weighted-Average
Exercise Price
Outstanding, January 1
232,091

 
 
 
 
 
$
17.36

Granted
138,125

 
 
 
 
 
23.94

Exercised
(31,413
)
 
 
 
 
 
11.83

Forfeited
—

 
 
 
 
 
—

Expired
—

 
 
 
 
 
—

Outstanding, June 30
338,803

 
$
2,132

 
7.66
 
$
20.56

 
 
 
 
 
 
 
 
Exercisable, June 30
112,989

 
$
1,189

 
5.84
 
$
16.32



Grants of RSUs include time-based vesting conditions that generally vest ratably over a period of 3 to 5 years. During second quarter 2020, we granted 10,995 RSUs which will vest ratably over 4 years. During first quarter 2020, we granted 1,846 RSUs which will fully vest on the 2 anniversary of the grant date. During 2019, we granted 2,892 RSUs which will vest ratably over 3 years. A summary of our RSU activity and related information is as follows.
Dollars in thousands, except per share amounts
RSUs
 
Weighted Average Grant Date Fair Value
Nonvested, December 31, 2019
2,892

 
25.93

Granted
12,841

 
18.19

Forfeited
—

 
—

Vested
(651
)
 
25.60

Nonvested, June 30, 2020
15,082

 
20.45



We recognize compensation expense based on the estimated number of stock awards expected to actually vest, exclusive of the awards expected to be forfeited.  During the first six months of 2020 and 2019, total stock compensation expense for all share-based arrangements was $323,000 and $281,000 and the related deferred tax benefits were approximately $78,000 and $67,000.

NOTE 11.  COMMITMENTS AND CONTINGENCIES

Off-Balance Sheet Arrangements

We are a party to certain financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.  The contract amounts of these instruments reflect the extent of involvement that we have in this class of financial instruments.



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

A summary of the total unfunded, or off-balance sheet, credit extension commitments follows:
Dollars in thousands
 
June 30,
2020
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
88,119

Construction loans
 
135,086

Other loans
 
267,152

Standby letters of credit
 
11,430

Total
 
$
501,787



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

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

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

Allowance For Credit Losses - Off-Balance-Sheet Credit Exposures

The ACL on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC 326, representing expected credit losses over the contractual period for which we are exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. Off-balance-sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit detailed in the table above. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining life of the commitment or other off-balance-sheet exposure. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management's best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. Estimating credit losses on amounts expected to be funded uses the same methodology as described for loans in Note 6 - Loans and Allowance for Credit Losses as if such commitments were funded.

The impact to the ACL on off-balance sheet credit exposures upon adoption of ASC 326 was $2.43 million, followed by a six month 2020 provision of $1.04 million resulting in a June 30, 2020 balance of $3.47 million.
Litigation

We are not a party to litigation except for matters that arise in the normal course of business.  While it is impossible to ascertain the ultimate resolution or range of financial liability, if any, with respect to these contingent matters, in the opinion of management, after consultation with legal counsel, the outcome of these matters will not have a significant adverse effect on the consolidated financial statements.

NOTE 12.  REGULATORY MATTERS

Our bank subsidiary, Summit Community Bank, Inc. (“Summit Community”), is subject to various regulatory capital requirements administered by the banking regulatory agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, Summit Community must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  Our


bank subsidiary’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require Summit Community to maintain minimum amounts and ratios of Common Equity Tier 1("CET1"), Total capital and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).  We believe, as of June 30, 2020, that our bank subsidiary met all capital adequacy requirements to which they were subject.

The most recent notifications from the banking regulatory agencies categorized Summit Community as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, Summit Community must maintain minimum CET1, Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.
In December 2018, the federal bank regulatory agencies approved a final rule modifying their regulatory capital rules to provide an option to phase-in over a period of three years the day-one regulatory capital effects of the implementation of ASC 326. In March 2020, those agencies approved a final rule providing an option to delay the estimated impact on regulatory capital. We elected this optional phase-in period upon adoption of ASC 326 on January 1, 2020 and elected to delay the estimated impact. The initial impact of adoption as well as 25% of the quarterly increases in the allowance for credit losses subsequent to adoption (collectively the “transition adjustments”) will be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three year period, with 75% recognized in year three, 50% recognized in year four, and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed.
The following tables present Summit's, as well as Summit Community's, actual and required minimum regulatory capital amounts and ratios as of June 30, 2020 and December 31, 2019. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended.
 
 
 Actual
 
Minimum Required Capital - Basel III
 
Minimum Required To Be Well Capitalized
Dollars in thousands
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of June 30, 2020
 
 
 
 
 
 
 
 
 
 
 
 
CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
$
222,944

 
9.7
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
242,345

 
10.5
%
 
161,563

 
7.0
%
 
150,023

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
241,944

 
10.5
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
242,345

 
10.5
%
 
196,184

 
8.5
%
 
184,644

 
8.0
%
Total Capital (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
Summit
 
261,472

 
11.3
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
261,874

 
11.4
%
 
241,200

 
10.5
%
 
229,714

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
241,944

 
9.0
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
242,345

 
9.0
%
 
107,709

 
4.0
%
 
134,636

 
5.0
%

 
 
 Actual
 
Minimum Required Capital - Basel III Fully Phased-in
 
Minimum Required To Be Well Capitalized
Dollars in thousands
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of December 31, 2019
 
 

 
 

 
 

 
 

CET1 (to risk weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
Summit
 
224,679

 
11.1
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
244,045

 
12.1
%
 
141,183

 
7.0
%
 
131,099

 
6.5
%
Tier I Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
243,679

 
12.1
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
244,045

 
12.1
%
 
171,437

 
8.5
%
 
161,352

 
8.0
%
Total Capital (to risk weighted assets)
 
 

 
 

 
 

 
 

 
 

Summit
 
256,753

 
12.7
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
257,119

 
12.7
%
 
212,579

 
10.5
%
 
202,456

 
10.0
%
Tier I Capital (to average assets)
 
 

 
 

 
 

 
 

 
 

 
 

Summit
 
243,679

 
10.5
%
 
N/A

 
N/A

 
N/A

 
N/A

Summit Community
 
244,045

 
10.6
%
 
92,092

 
4.0
%
 
115,116

 
5.0
%





NOTE  13.  DERIVATIVE FINANCIAL INSTRUMENTS

Cash flow hedges

We have entered into four pay-fixed/receive LIBOR interest rate swaps as follows:

•
A $30 million notional interest rate swap expiring on October 18, 2020, was designated as a cash flow hedge of $30 million of variable rate Federal Home Loan Bank advances.  Under the terms of this swap we will pay a fixed rate of 2.89% and receive a variable rate equal to one month LIBOR.   

•
A $40 million notional interest rate swap expiring on October 18, 2021, was designated as a cash flow hedge of $40 million of variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 2.19% and receive a variable rate equal to three month LIBOR.

•
A $20 million notional interest rate swap with an effective date of October 18, 2021 and expiring on October 18, 2023, was designated as a cash flow hedge of $20 million of forecasted variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 1.07% and receive a variable rate equal to three month LIBOR.

•
A $20 million notional interest rate swap with an effective date of October 18, 2021 and expiring on October 18, 2024, was designated as a cash flow hedge of $20 million of forecasted variable rate Federal Home Loan Bank advances. Under the terms of this swap we will pay a fixed rate of 1.1055% and receive a variable rate equal to three month LIBOR.

In addition, we have entered into one interest rate cap to hedge the risk of variability in its cash flows above .75% of the three month LIBOR benchmark interest rate.

•
A $100 million notional interest rate cap with an effective date of July 20, 2020 and expiring on April 18, 2030, was designated as a cash flow hedge of $100 million of forecasted fixed rate Federal Home Loan Bank advances. Under the terms of this cap we will hedge the variability of cash flows when three month LIBOR is above .75%.

Fair value hedges

We have entered into two pay fixed/receive variable interest rate swaps to hedge fair value variability of two commercial fixed rate loans with the same principal, amortization, and maturity terms of the underlying loans, which are designated as fair value hedges as follows:

•
Under the terms of a $9.95 million original notional interest rate swap expiring January 15, 2025, we will pay a fixed rate of 4.33% and receive a variable rate equal to one month LIBOR plus 2.40 percent.

•
Under the terms of a $11.3 million original notional interest rate swap expiring January 15, 2026, we will pay a fixed rate of 4.30% and receive a variable rate equal to one month LIBOR plus 2.18 percent.

A summary of our derivative financial instruments as of June 30, 2020 and December 31, 2019 follows:


 
June 30, 2020
 
Notional
Amount
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Short term borrowings
$
110,000

 
$
—

 
$
2,091

 
$
—

 
 
 
 
 
 
 
 
Interest rate cap
 
 
 
 
 
 
 
Short term borrowings
$
100,000

 
$
4,643

 
$
—

 
$
—

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
18,504

 
$
—

 
$
1,492

 
$
—


 
December 31, 2019
 
Notional
Amount
 
Derivative Fair Value
 
Net Ineffective
Dollars in thousands
 
Asset
 
Liability
 
Hedge Gains/(Losses)
CASH FLOW HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
Short term borrowings
$
70,000

 
$
—

 
$
679

 
$
—

 
 
 
 
 
 
 
 
FAIR VALUE HEDGES
 
 
 
 
 
 
 
Pay-fixed/receive-variable interest rate swaps
 
 
 
 
 
 
 
Commercial real estate loans
$
18,809

 
$
—

 
$
309

 
$
—



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

NOTE 14. ACQUISITIONS

Cornerstone Financial Services Inc. Acquisition

On January 1, 2020, Summit Community Bank, Inc. ("SCB"), a wholly-owned subsidiary of Summit, acquired 100% of the ownership of Cornerstone Financial Services Inc. ("Cornerstone") and its subsidiary Cornerstone Bank, headquartered in West Union, West Virginia. With this transaction, Summit further expands its footprint into the central region of West Virginia. Pursuant to the Agreement and Plan of Merger dated September 17, 2019, Cornerstone's shareholders received cash in the amount of $5,700.00 per share or 228 shares of Summit common stock, or a combination of cash and Summit stock, subject to proration to result in approximately 50% cash and 50% stock consideration in the aggregate. Total stock consideration was $15.4 million or 570,000 shares of Summit common stock and cash consideration was $14.3 million. Cornerstone's assets and liabilities approximated $195 million and $176 million, respectively, at December 31, 2019 and was deemed immaterial to our financial statements.

We accounted for the acquisition using the acquisition method of accounting in accordance with ASC 805, Business Combinations and accordingly, the assets and liabilities of Cornerstone were recorded at their acquisition date respective fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date as additional information relative to the acquisition date fair values becomes available. We recognized preliminary goodwill of $10.82 million in connection with the acquisition (not deductible for income tax purposes), which is not amortized for financial reporting purposes, but is subject to annual impairment testing. The core deposit intangible represents the value of long-term deposit relationships acquired in this transaction and will be amortized over an estimated weighted average life of 10 years using an accelerated method which approximates the estimated run-off of the acquired deposits. The following table details the total consideration paid on January 1, 2020 in connection with the acquisition of Cornerstone, the fair values of the assets acquired and liabilities assumed and the resulting preliminary goodwill.


(Dollars in thousands)
 
As Recorded by Cornerstone
 
Estimated Fair Value Adjustments
 
Estimated Fair Values as Recorded by Summit
Cash consideration
 
 
 
 
 
$
14,250

Stock consideration
 
 
 
 
 
15,441

Total consideration
 
 
 
 
 
29,691

 
 
 
 
 
 
 
Identifiable assets acquired:
 
 
 
 
 
 
Cash and cash equivalents
 
$
60,285

 
$
—

 
$
60,285

Securities available for sale, at fair value
 
90,154

 
(47
)
 
90,107

Loans
 
 
 
 
 


Purchased performing
 
37,965

 
188

 
38,153

Purchased credit deteriorated
 
1,877

 
(569
)
 
1,308

Allowance for loan losses
 
(312
)
 
312

 
—

Premises and equipment
 
807

 
(142
)
 
665

Property held for sale
 
10

 
—

 
10

Core deposit intangibles
 
—

 
717

 
717

Other assets
 
4,263

 
(474
)
 
3,789

Total identifiable assets acquired
 
$
195,049

 
$
(15
)
 
$
195,034

 
 
 
 
 
 
 
Identifiable liabilities assumed:
 
 
 
 
 
 
Deposits
 
173,030

 
239

 
173,269

Other liabilities
 
3,303

 
(407
)
 
2,896

Total identifiable liabilities assumed
 
$
176,333

 
$
(168
)
 
$
176,165

 
 
 
 
 
 
 
Net identifiable assets acquired
 
$
18,716

 
$
153

 
$
18,869

 
 
 
 
 
 
 
Preliminary goodwill resulting from acquisition
 
 
 
 
 
$
10,822





MVB Bank Branches Acquisition

On April 24, 2020, SCB expanded its presence in the Eastern Panhandle of West Virginia by acquiring three MVB Bank locations in Berkeley County, West Virginia and one MVB Bank location in Jefferson County, West Virginia. Summit assumed certain deposits and loans totaling approximately $195.0 million and $35.3 million, respectively. The purchase price was $50.3 million consisting of (i) the average daily closing balance of the deposits for the thirty (30) day period prior to the closing multiplied by 8.00%, (ii) the aggregate amount of cash on hand as of the closing date, (iii) the aggregate net book value of all assets being assumed (excluding cash on hand, real property and accrued interest with respect to the loans acquired), (iv) the appraised value of the real property acquired, and (v) accrued interest with respect to the loans acquired.

This acquisition was determined to constitute a business combination in accordance with ASC 805, Business Combinations,and accordingly we accounted for the acquisition using the acquisition method of accounting, recording the assets and liabilities of MVB Bank at their acquisition date respective fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date as additional information relative to the acquisition date fair values becomes available. We recognized preliminary goodwill of $14.67 million in connection with the acquisition (deductible for income tax purposes), which is not amortized for financial reporting purposes, but is subject to annual impairment testing. The core deposit intangible represents the value of long-term deposit relationships acquired in this transaction and will be amortized over an estimated weighted average life of 10 years using an accelerated method which approximates the estimated run-off of the acquired deposits. The following table details the total consideration paid on April 24, 2020 in connection with the acquisition of the MVB Bank branches, the fair values of the assets acquired and liabilities assumed and the resulting preliminary goodwill.



(Dollars in thousands)
 
As Recorded by MVB
 
Estimated Fair Value Adjustments
 
Estimated Fair Values as Recorded by Summit
Cash consideration
 
 
 
 
 
$
12,965

Total consideration
 
 
 
 
 
12,965

 
 
 
 
 
 
 
Identifiable assets acquired:
 
 
 
 
 
 
Cash and cash equivalents
 
$
800

 
$
—

 
$
800

Loans
 
 
 
 
 
 
Purchased performing
 
35,127

 
(1,185
)
 
33,942

Premises and equipment
 
2,376

 
(42
)
 
2,334

Core deposit intangibles
 
—

 
125

 
125

Other assets
 
114

 
—

 
114

Total identifiable assets acquired
 
$
38,417

 
$
(1,102
)
 
$
37,315

 
 
 
 
 
 
 
Identifiable liabilities assumed:
 
 
 
 
 
 
Deposits
 
188,134

 
598

 
188,732

Other liabilities
 
102

 
—

 
102

Total identifiable liabilities assumed
 
$
188,236

 
$
598

 
$
188,834

 
 
 
 
 
 
 
Net liabilities assumed
 
$
(149,819
)
 
$
(1,700
)
 
$
(151,519
)
 
 
 
 
 
 
 
Net cash received from MVB
 
 
 
 
 
136,854

 
 
 
 
 
 
 
Preliminary goodwill resulting from acquisition
 
 
 
 
 
$
14,665



The following is a description of the methods used to determine the fair values of significant assets and liabilities presented for both transactions above.
Cash and cash equivalents: The carrying amount of these assets approximates their fair value based on the short-term nature of these assets, with the exception of certificates of deposits held at other banks, which were adjusted to fair value based upon current interest rates.

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

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

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

Core deposit intangible: This intangible asset represents the value of the relationships with deposit customers. The fair value was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, reserve requirements and the net maintenance cost attributable to customer deposits.

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

Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition without the carryover of the related allowance for loan losses.



Prior to adoption of ASC 326 on January 1, 2020, loans acquired in a business combination that had evidence of credit deterioration since origination and for which it was probable at the date of acquisition that we would not collect all contractually required principal and interest payments were considered purchased credit-impaired (PCI) loans. When determining fair value, PCI loans were identified as of the date of acquisition based upon evidence of credit quality such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments of principal and interest at acquisition and the cash flows expected to be collected at acquisition was accounted for as a"nonaccretable difference," and was available to absorb future credit losses on those loans. For purposes of determining the nonaccretable difference, no prepayments were generally assumed in determining contractually required payments of principal and interest or cash flows expected to be collected. Subsequent decreases to the expected cash flows generally resulted in a provision for loan losses. Subsequent significant increases in cash flows could have resulted in a reversal of the provision for loan losses to the extent of prior charges, or a transfer from nonaccretable difference to accretable yield. Further, any excess of cash flows expected at acquisition over the estimated fair value was accounted for as accretable yield and was recognized as interest income over the remaining life of the loan when there was a reasonable expectation about the amount and timing of such cash flows.

Subsequent to adoption of ASC 326 on January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered purchased credit deteriorated (“PCD”) loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial allowance for credit losses is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. All loans considered to be PCI prior to January 1, 2020 were converted to PCD on that date.

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

The following presents the financial effects of adjustments recognized in the statements of income for the three and six months ended June 30, 2020 and 2019 related to business combinations that occurred during 2016, 2017, 2019 and 2020.
 
Income increase (decrease)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Dollars in thousands
2020
 
2019
 
2020
2019
Interest and fees on loans
$
264

 
$
425

 
$
519

$
467

Interest expense on deposits
188

 
82

 
286

170

Amortization of intangibles
(410
)
 
(404
)
 
(839
)
(830
)
Income before income tax expense
$
42

 
$
103

 
$
(34
)
$
(193
)




NOTE 15. ACCUMULATED OTHER COMPREHENSIVE INCOME

The following is changes in accumulated other comprehensive income by component, net of tax, for the three and six months ending June 30, 2020 and 2019.


 
 
For the Three Months Ended June 30, 2020
Dollars in thousands
 
Gains and Losses on Pension Plan
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
(140
)
 
$
48

 
$
(1,602
)
 
$
2,525

 
$
831

Other comprehensive income (loss) before reclassification
 
—

 
—

 
(815
)
 
3,306

 
2,491

Amounts reclassified from accumulated other comprehensive income
 
—

 
—

 
—

 
—

 
—

Net current period other comprehensive income (loss)
 
—

 
—

 
(815
)
 
3,306

 
2,491

Ending balance
 
$
(140
)
 
$
48

 
$
(2,417
)
 
$
5,831

 
$
3,322


 
 
For the Three Months Ended June 30, 2019
Dollars in thousands
 
Gains and Losses on Pension Plan
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
(328
)
 
$
139

 
$
(323
)
 
$
1,626

 
$
1,114

Other comprehensive income (loss) income before reclassification
 
—

 
—

 
(414
)
 
2,346

 
1,932

Amounts reclassified from accumulated other comprehensive income
 
—

 
—

 
—

 
(825
)
 
(825
)
Net current period other comprehensive income (loss)
 
—

 
—

 
(414
)
 
1,521

 
1,107

Ending balance
 
$
(328
)
 
$
139

 
$
(737
)
 
$
3,147

 
$
2,221


 
 
For the Six Months Ended June 30, 2020
Dollars in thousands
 
Gains and Losses on Pension Plan
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
(140
)
 
$
48

 
$
(518
)
 
$
3,145

 
$
2,535

Other comprehensive income (loss) before reclassification
 
—

 
—

 
(1,899
)
 
3,475

 
1,576

Amounts reclassified from accumulated other comprehensive income
 
—

 
—

 
—

 
(789
)
 
(789
)
Net current period other comprehensive income (loss)
 
—

 
—

 
(1,899
)
 
2,686

 
787

Ending balance
 
$
(140
)
 
$
48

 
$
(2,417
)
 
$
5,831

 
$
3,322


 
 
For the Six Months Ended June 30, 2019
Dollars in thousands
 
Gains and Losses on Pension Plan
 
Gains and Losses on Other Post-Retirement Benefits
 
Gains and Losses on Cash Flow Hedges
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Total
Beginning balance
 
$
—

 
$
139

 
$
(314
)
 
$
(841
)
 
$
(1,016
)
Other comprehensive income (loss) before reclassification
 
(328
)
 
—

 
(423
)
 
4,810

 
4,059

Amounts reclassified from accumulated other comprehensive income
 
—

 
—

 
—

 
(822
)
 
(822
)
Net current period other comprehensive income (loss)
 
(328
)
 
—

 
(423
)
 
3,988

 
3,237

Ending balance
 
$
(328
)
 
$
139

 
$
(737
)
 
$
3,147

 
$
2,221











NOTE 16. INCOME TAXES

Our income tax expense for the three months ended June 30, 2020 and June 30, 2019 totaled $1.5 million and $1.9 million, respectively. For the six months ended June 30, 2020 and June 30, 2019 our income tax expense totaled $2.7 million and $3.5 million. Our effective tax rate (income tax expense as a percentage of income before taxes) for the three months ended June 30, 2020 and 2019 was 17.9% and 18.0%, respectively, and for the six months ended June 30, 2020 and 2019 were 19.0% and 18.2%, respectively. A reconciliation between the statutory income tax rate and our effective income tax rate for the three and six months ended June 30, 2020 and 2019 is as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
Dollars in thousands
Percent
 
Percent
 
Percent
 
Percent
Applicable statutory rate
21.0
 %
 
21.0
 %
 
21.0
 %
 
21.0
 %
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
Tax-exempt interest and dividends, net
(2.4
)%
 
(1.9
)%
 
(2.5
)%
 
(2.2
)%
State income taxes, net of Federal income tax benefit
1.6
 %
 
1.6
 %
 
1.8
 %
 
1.8
 %
Low-income housing and rehabilitation tax credits
(1.1
)%
 
(0.9
)%
 
(0.7
)%
 
(0.7
)%
Other, net
(1.2
)%
 
(1.8
)%
 
(0.6
)%
 
(1.7
)%
Effective income tax rate
17.9
 %
 
18.0
 %
 
19.0
 %
 
18.2
 %


The components of applicable income tax expense for the three and six months ended June 30, 2020 and 2019 are as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands
2020
2019
 
2020
2019
Current
 
 
 
 
 
Federal
$
3,723

$
1,596

 
$
4,992

$
3,247

State
512

206

 
700

470

 
4,235

1,802

 
5,692

3,717

Deferred
 

 
 
 

 

Federal
(2,377
)
68

 
(2,609
)
(206
)
State
(340
)
10

 
(375
)
(30
)
 
(2,717
)
78

 
(2,984
)
(236
)
Total
$
1,518

$
1,880

 
$
2,708

$
3,481



NOTE 17. REVENUE FROM CONTRACTS WITH CUSTOMERS

Interest income, loan fees, realized securities gains and losses, bank owned life insurance income and mortgage banking revenue are not in the scope of ASC Topic 606, Revenue from Contracts with Customers. With the exception of gains or losses on sales of foreclosed properties, all of our revenue from contracts with customers in the scope of ASC 606 is recognized within Noninterest Income in the Consolidated Statements of Income. Incremental costs of obtaining a contract are expensed when incurred when the amortization period is one year or less.
The following table illustrates our total non-interest income segregated by revenues within the scope of ASC Topic 606 and those which are within the scope of other ASC Topics: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Dollars in thousands
 
2020
 
2019
 
2020
 
2019
Service fees on deposit accounts
 
$
882

 
$
1,224

 
$
2,145

 
$
2,405

Bank card revenue
 
1,087

 
893

 
2,020

 
1,707

Trust and wealth management fees
 
582

 
612

 
1,247

 
1,198

Insurance commissions
 
24

 
606

 
31

 
1,780

Other
 
112

 
70

 
223

 
158

Net revenue from contracts with customers
 
2,687

 
3,405

 
5,666

 
7,248

Non-interest income within the scope of other ASC topics
 
911

 
3,405

 
2,433

 
3,792

Total noninterest income
 
$
3,598

 
$
6,810

 
$
8,099

 
$
11,040




Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The following discussion and analysis focuses on significant changes in our financial condition and results of operations of Summit Financial Group, Inc. (“Company” or “Summit”) and its operating subsidiary, Summit Community Bank (“Summit Community”), for the periods indicated.   This discussion and analysis should be read in conjunction with our 2019 audited consolidated financial statements and Annual Report on Form 10-K.

The Private Securities Litigation Act of 1995 indicates that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by us.  This Quarterly Report on Form 10-Q contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Act of 1995) that are based on current expectations that involve a number of risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “estimates” and other similar expressions or future or conditional verbs such as “will”, “should”, “would” and “could” are intended to identify such forward-looking statements.

Although we believe the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. Factors that might cause such a difference include: the effect of the COVID-19 crisis, including the negative impacts and disruptions on the communities we serve, and the domestic and global economy, which may have an adverse effect on our business; current and future economic and market conditions, including the effects of declines in housing prices, high unemployment rates, U.S. fiscal debt, budget and tax matters, geopolitical matters, and any slowdown in global economic growth; fiscal and monetary policies of the Federal Reserve; future provisions for credit losses on loans and debt securities; changes in nonperforming assets; changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; the successful integration of operations of our acquisitions; changes in banking laws and regulations; changes in tax laws; the impact of technological advances; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national and local economies. We undertake no obligation to revise these statements following the date of this filing.

OVERVIEW

On January 1, 2020, we acquired Cornerstone Financial Service, Inc. ("Cornerstone") and its subsidiary, Cornerstone Bank, Inc., headquartered in West Union, West Virginia and on April 24, 2020, we acquired four MVB Bank ("MVB") branches in the eastern panhandle of West Virginia. Cornerstone's and MVB's results are included in our financial statements from the acquisition dates forward, impacting comparisons to the prior-year periods. On May 1, 2019, we sold our insurance agency, Summit Insurance Services, LLC ("SIS"). Accordingly, their results are included in our financial statements only until date of sale, impacting comparisons to the first half of the prior-year.

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

Primarily due to our Cornerstone and MVB branch acquisitions and organic loan growth, average interest earning assets increased by 15.87% for the first six months in 2020 compared to the same period of 2019 while our net interest earnings on a tax equivalent basis increased 17.15%.  Our tax equivalent net interest margin increased 3 basis points as our yield on interest earning assets decreased 49 basis points while our cost of interest bearing funds decreased 57 basis points.

COVID-19 IMPACTS

Overview

Our business has been, and continues to be, impacted by the recent and ongoing outbreak of COVID-19. In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the President of the United States. Efforts to limit the spread of COVID-19 have led to shelter-in-place orders, the closure of non-essential businesses, travel restrictions, supply chain disruptions and prohibitions on public gatherings, among other things, throughout many parts of the United States and, in particular, the markets in which we operate. As the current pandemic is ongoing and dynamic in nature, there are many uncertainties related to COVID-19 including, among other things, its ultimate geographic spread; its severity; the duration of the outbreak; the impact to our clients, employees and vendors; the impact to the financial services and banking industry; and the impact to the economy as a whole as well the effect of actions taken, or that may yet be taken, by governmental authorities to contain the outbreak or to mitigate its impact (both economic and health-related). COVID-19 has negatively affected, and is expected to continue to negatively affect, our business, financial position and operating results. In light of the uncertainties and


continuing developments discussed herein, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material.

Impact on our Operations 
The resulting closures of non-essential businesses and related economic disruption has impacted our operations as well as the operations of our clients. In West Virginia and Virginia, financial services have been identified as essential services, and accordingly, our business remains open, with appropriate safety protocols implemented. To address the issues arising as a result of COVID-19, we have implemented various plans, strategies and protocols to protect our employees, maintain services for clients, assure the functional continuity of our operating systems, controls and processes, and mitigate financial risks posed by changing market conditions. In order to protect employees and assure workforce continuity and operational redundancy, we imposed business travel restrictions, enhanced our sanitizing protocols within our facilities and physically separated, to the extent possible, our critical operations workforce that cannot work remotely.
Impact on our Financial Position and Results of Operations

Lending and Credit Risks

COVID-19 has had a material impact on our loan credit risks for first half 2020. While we have not yet experienced any charge-offs related to COVID-19, our allowance for credit losses ACL computation and resulting provision for credit losses are significantly impacted by the estimated potential future economic impact of the COVID-19 crisis. Due to deteriorated forecasted economic scenarios since the pandemic was declared in early March, our need for additional ACL increased significantly. Should economic conditions worsen, we could experience further increases in our ACL and record additional credit loss expense.
We have taken actions to identify and assess our COVID-19 related credit exposures by asset classes and borrower types. Depending on the demonstrated need of the client, in certain cases, we are either modifying to interest only or deferring the full loan payment for up to six months. Accordingly, the following table summarizes the aggregate balances of loans the Company has modified as result of COVID-19 through June 30, 2020 classified by types of loans and impacted borrowers.
 
 
Loan Balances Modified Due to COVID-19 through June 30, 2020
Dollars in thousands
Total Loan
Balance as of
6/30/2020
Interest Only
Payments (6
Months or Less)
Payment
Deferral (6
Months or Less)
Total Loans
Modified
Percentage of
Loans Modified
Hospitality industry
$
119,204

$
55,849

$
43,030

$
98,879

82.9
%
Non-owner occupied retail stores
109,078

38,354

13,802

52,156

47.8
%
Owner-occupied retail stores
119,794

21,956

9,372

31,328

26.2
%
Restaurants
8,126

2,392

1,877

4,269

52.5
%
Oil & gas industry
31,977

914

4,378

5,292

16.5
%
Other commercial
1,005,740

88,285

34,634

122,919

12.2
%
Total Commercial Loans
1,393,919

207,750

107,093

314,843

22.6
%
Residential 1-4 family personal
267,170

3,933

13,404

17,337

6.5
%
Residential 1-4 family rentals
180,415

20,348

6,032

26,380

14.6
%
Home equity
88,929

—

569

569

0.6
%
Total Residential Real Estate Loans
536,514

24,281

20,005

44,286

8.3
%
Consumer
34,640

595

605

1,200

3.5
%
Mortgage warehouse lines
252,472

—

—

—

0.0
%
Credit cards and overdrafts
2,162

—

—

—

0.0
%
Total Loans
$
2,219,707

$
232,626

$
127,703

$
360,329

16.2
%
Modified loans with deferred payments will continue to accrue interest during the deferral period unless otherwise classified as nonperforming. Consistent with bank regulatory guidance, borrowers that were otherwise current on loan payments that were granted COVID-19 related financial hardship payment deferrals will continue to be reported as current loans throughout the agreed upon deferral periods. COVID-19 related loan modifications are also deemed to be insignificant borrower concessions, and therefore, such modified loans were not classified as troubled-debt restructured loans as of June 30, 2020. We anticipate that COVID-19 related loan modifications will continue throughout 2020.
Our loan interest income could be reduced due to COVID-19.  While interest and fees will still accrue to income, through normal accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would


need to be reversed.  In such a scenario, interest income in future periods could be negatively impacted.  At this time, we are unable to project the materiality of such an impact.
Summit is participating in the Paycheck Protection Program (“PPP”), a $660 billion low-interest business loan program funded by the U.S. Treasury Department and administered by the U.S. Small Business Administration. The PPP Loan Program provides U.S. government guarantees for lenders, as well as loan forgiveness incentives for borrowers that predominately utilize the loan proceeds to cover employee compensation-related business costs. Through July 9, 2020, Summit had approved 770 PPP loans totaling $99.9 million. While we anticipate high levels of client utilization of the PPP loan program, our liquidity resources are adequate to meet the funding requirements of these loans.

Capital and Liquidity

Although there is a high degree of uncertainty around the magnitude and duration of the economic impact of the COVID-19 pandemic, management believes that our financial position, including high levels of capital and liquidity, will allow us to successfully endure the negative economic impacts of the crisis. Our capital management activities, coupled with our historically strong earnings performance and prudent dividend practices, have allowed us to build and maintain strong capital reserves. At June 30, 2020, all of Summit’s regulatory capital ratios significantly exceeded well-capitalized standards. More specifically, the Company bank subsidiary’s Tier 1 Leverage Ratio, a common measure to evaluate a financial institutions capital strength, was 9.0% at June 30, 2020, which is well in excess of the well-capitalized regulatory minimum of 5.0%.

In addition, management believes the Company’s liquidity position is strong. The Company’s bank subsidiary maintains a funding base largely comprised of core noninterest bearing demand deposit accounts and low cost interest-bearing transactional deposit accounts with clients that operate or reside within the footprint of its branch bank network. At June 30, 2020, the Company’s cash and cash equivalent balances were $42.8 million. In addition, Summit maintains an available-for-sale securities portfolio, comprised primarily of highly liquid U.S. agency securities, highly-rated municipal securities and U.S. agency-backed mortgage backed securities, which serves as a ready source of liquidity. At June 30, 2020, the Company’s available-for-sale securities portfolio totaled $322.5 million, $175.1 million of which was unpledged as collateral. The Company bank subsidiary’s unused borrowing capacity at the Federal Home Loan Bank of Pittsburgh at June 30, 2020 was $758.3 million, and it maintained $171.6 million of borrowing availability at the Federal Reserve Bank of Richmond’s discount window. Through July 2020, we have not experienced significant draws on clients’ available commercial lines of credit and home equity lines of credit due to the COVID-19 crisis, nor has it observed any significant or unusual client activity that portends unmanageable levels of stress on the our liquidity profile.
The COVID-19 crisis is expected to continue to impact our financial results, as well as demand for our services and products during the second half of 2020 and potentially beyond. The short and long-term implications of the COVID-19 crisis, and related monetary and fiscal stimulus measures, on our future revenues, earnings results, allowance for credit losses, capital reserves and liquidity are unknown at present.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry.  Application of these principles requires us to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and accompanying notes.  These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments.  Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

Our most significant accounting policies are presented in the notes to the consolidated financial statements of our 2019 Annual Report on Form 10-K.  These policies, along with the other disclosures presented in the financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, we have identified the determination of ACL in accordance with the ASC 326 (as adopted on January 1, 2020), fair value measurements and accounting for acquired loans to be the accounting areas that require the most subjective or complex judgments and as such could be most subject to revision as new information becomes available. Refer to Note 6 of the accompanying consolidated financial statements for a discussion of the methodogy we employ regarding the ACL.



For additional information regarding critical accounting policies, refer to Critical Accounting Policies section in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2019 Form 10-K. There have been no significant changes in our application of critical accounting policies since December 31, 2019.

RESULTS OF OPERATIONS

Earnings Summary

Net income for the six months ended June 30, 2020 decreased to $11.5 million or $0.88 per diluted share from $15.7 million or $1.23 per diluted share for the same period of 2019. Net income for the three months ended June 30, 2020 was $6.9 million, or $0.54 per diluted share, compared to $8.6 million, or $0.68 per diluted share for the same period of 2019. The decreased earnings for the six and three months ended June 30, 2020 were primarily attributable to increased provision for credit losses, increased merger-related expenses and fewer insurance commissions due to the sale of our insurance subsidiary in second quarter 2019 (which resulted in a $1.9 million pretax gain on sale during second quarter 2019). Partially offsetting these negative factors were increased net interest income and fewer writedowns on foreclosed properties. Also negatively impacting net income for the three months ended June 30, 2020 were fewer gains on sales of securities. Returns on average equity and assets for the first six months of 2020 were 8.83% and 0.78%, respectively, compared with 13.46% and 1.39% for the same period of 2019.

Cornerstone’s and MVB's results of operations are included in our consolidated results of operations from the date of acquisition, and therefore our 2020 results reflect increased levels of average balances, income and expense as compared to the same periods of 2019 results. At consummation (prior to fair value acquisition adjustments), Cornerstone had total assets of $195.0 million, net loans of $39.8 million, and deposits of $173.0 million; the MVB branch transaction consisted primarily of $35.1 million loans acquired and $188.1 million deposits assumed. Also impacting comparability of results is the sale of SIS. Their results are included in our financial statements only until date of sale, impacting comparisons to the prior-year three and six months ended June 30, however, historically SIS's results of operations accounted for less than $0.01 per share of the company's quarterly earnings.

Net Interest Income

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

Q2 2020 compared to Q1 2020

For the quarter ended June 30, 2020, our net interest income on a fully taxable-equivalent basis increased $1.7 million to $23.32 million compared to $21.63 million for the quarter end March 31, 2020. Our taxable-equivalent earnings on interest earning assets increased $363,000, while the cost of interest bearing liabilities decreased $1.3 million (see Tables I and II).

For the three months ended June 30, 2020 average interest earning assets increased to $2.55 billion compared to $2.32 billion for the three months ended March 31, 2020, while average interest bearing liabilities increased to $2.02 billion for the three months ended June 30, 2020 from $1.85 billion for the three months ended March 31, 2020.

For the quarter ended June 30, 2020, our net interest margin decreased to 3.68%, compared to 3.76% for the linked quarter, as the both the yields on earning assets and the cost of our interest bearing funds decreased by 38 basis points. At acquisition, Cornerstone's and MVB's deposit costs were significantly lower than Summit's cost of deposits, thus positively impacting our overall cost of funds.

Excluding the impact of accretion and amortization of fair value acquisition accounting adjustments related to the interest earning assets and interest bearing liabilities acquired by merger, Summit's net interest margin was 3.61% and 3.70% for the three months ended June 30, 2020 and March 31, 2020.





Q2 2020 compared to Q2 2019



For the quarter ended June 30, 2020, our net interest income on a fully taxable-equivalent basis increased $3.8 million to $23.32 million compared to $19.52 million for the quarter end June 30, 2019. Our taxable-equivalent earnings on interest earning assets increased $1.1 million, while the cost of interest bearing liabilities decreased $2.7 million (see Tables I and II).

For the three months ended June 30, 2020 average interest earning assets increased 20.9% to $2.55 billion compared to$2.11 billion for the three months ended June 30, 2019, while average interest bearing liabilities increased 14.6% from $1.76 billion for the three months ended June 30, 2019 to $2.02 billion for the three months ended June 30, 2020.

For the quarter ended June 30, 2020, our net interest margin decreased to 3.68%, compared to 3.72% for the same period of 2019, as the yields on earning assets decreased 72 basis points, while the cost of our interest bearing funds decreased by 77 basis points.

Excluding the impact of accretion and amortization of fair value acquisition accounting adjustments related to the interest earning assets and interest bearing liabilities acquired by merger, Summit's net interest margin was 3.62% for the three months ended June 30, 2019.


Table I - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended
 
June 30, 2020
 
March 31, 2020
 
June 30, 2019
Dollars in thousands
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
Interest earning assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned fees (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
2,118,158

 
$
25,466

 
4.84
%
 
$
1,935,473

 
$
25,089

 
5.21
%
 
$
1,749,032

 
$
24,184

 
5.55
%
Tax-exempt (2)
17,244

 
200

 
4.66
%
 
14,873

 
185

 
5.00
%
 
14,695

 
213

 
5.81
%
Securities
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
Taxable
248,792

 
1,453

 
2.35
%
 
258,889

 
1,757

 
2.73
%
 
203,049

 
1,607

 
3.17
%
Tax-exempt (2)
120,385

 
1,012

 
3.38
%
 
70,239

 
699

 
4.00
%
 
100,307

 
999

 
3.99
%
Federal funds sold and interest bearing deposits with other banks
41,776

 
60

 
0.58
%
 
35,648

 
98

 
1.11
%
 
38,214

 
134

 
1.41
%
Total interest earning assets
2,546,355

 
28,191

 
4.45
%
 
2,315,122

 
27,828

 
4.83
%
 
2,105,297

 
27,137

 
5.17
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Cash & due from banks
16,672

 
 

 
 

 
14,422

 
 
 
 
 
14,124

 
 
 
 
Premises and equipment
50,457

 
 

 
 

 
46,151

 
 
 
 
 
41,318

 
 
 
 
Property held for sale
18,122

 
 
 
 
 
19,354

 
 
 
 
 
23,149

 
 
 
 
Other assets
122,233

 
 

 
 

 
101,492

 
 
 
 
 
86,493

 
 
 
 
Allowance for loan losses
(25,799
)
 
 

 
 

 
(20,452
)
 
 
 
 
 
(13,260
)
 
 
 
 
Total assets
$
2,728,040

 
 

 
 

 
$
2,476,089

 
 
 
 
 
$
2,257,121

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
764,852

 
$
369

 
0.19
%
 
$
643,955

 
$
1,081

 
0.68
%
 
$
575,240

 
$
1,731

 
1.21
%
Savings deposits
512,634

 
1,200

 
0.94
%
 
449,021

 
1,337

 
1.20
%
 
305,342

 
921

 
1.21
%
Time deposits
625,717

 
2,617

 
1.68
%
 
615,102

 
2,933

 
1.92
%
 
673,272

 
3,315

 
1.97
%
Short-term borrowings
95,744

 
499

 
2.10
%
 
119,607

 
630

 
2.12
%
 
187,120

 
1,397

 
2.99
%
Long-term borrowings and capital trust securities
20,299

 
186

 
3.69
%
 
20,304

 
219

 
4.34
%
 
20,317

 
255

 
5.03
%
Total interest bearing liabilities
2,019,246

 
4,871

 
0.97
%
 
1,847,989

 
6,200

 
1.35
%
 
1,761,291

 
7,619

 
1.74
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
417,992

 
 

 
 

 
339,340

 
 
 
 
 
241,811

 
 
 
 
Other liabilities
32,238

 
 

 
 

 
28,400

 
 
 
 
 
19,750

 
 
 
 
Total liabilities
2,469,476

 
 

 
 

 
2,215,729

 
 
 
 
 
2,022,852

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity
258,564

 
 

 
 

 
260,360

 
 
 
 
 
234,269

 
 
 
 
Total liabilities and shareholders' equity
$
2,728,040

 
 

 
 

 
$
2,476,089

 
 
 
 
 
$
2,257,121

 
 
 
 
Net interest earnings
 

 
$
23,320

 
 

 
 
 
$
21,628

 
 
 
 
 
$
19,518

 
 
Net yield on interest earning assets
 
 

 
3.68
%
 
 
 
 
 
3.76
%
 
 
 
 
 
3.72
%

(1)
- For purposes of this table, nonaccrual loans are included in average loan balances.
(2)
- Interest income on tax-exempt securities and loans has been adjusted assuming a Federal tax rate of 21% for all periods presented. The tax equivalent adjustment resulted in an increase in interest income of $254,000, $185,000, and $255,000 for the three months ended June 30, 2020, March 31, 2020 and June 30, 2019, respectively.




Table II - Changes in Net Interest Income Attributable to Rate and Volume
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended
 
For the Quarter Ended
 
 
June 30, 2020 vs. March 31, 2020
 
June 30, 2020 vs. June 30, 2019
 
 
Increase (Decrease) Due to Change in:
 
Increase (Decrease) Due to Change in:
Dollars in thousands
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
 
$
2,277

 
$
(1,900
)
 
$
377

 
$
4,654

 
$
(3,372
)
 
$
1,282

Tax-exempt
 
29

 
(14
)
 
15

 
33

 
(46
)
 
(13
)
Securities
 
 

 
 
 
 
 
 
 
 

 
 

Taxable
 
(67
)
 
(237
)
 
(304
)
 
316

 
(470
)
 
(154
)
Tax-exempt
 
435

 
(122
)
 
313

 
181

 
(168
)
 
13

Federal funds sold and interest bearing deposits with other banks
 
15

 
(53
)
 
(38
)
 
11

 
(85
)
 
(74
)
Total interest earned on interest earning assets
 
2,689

 
(2,326
)
 
363

 
5,195

 
(4,141
)
 
1,054

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 

 
 
 
 
 
 

 
 

 
 

Interest bearing demand deposits
 
174

 
(886
)
 
(712
)
 
436

 
(1,798
)
 
(1,362
)
Savings deposits
 
174

 
(311
)
 
(137
)
 
518

 
(239
)
 
279

Time deposits
 
50

 
(366
)
 
(316
)
 
(225
)
 
(473
)
 
(698
)
Short-term borrowings
 
(124
)
 
(7
)
 
(131
)
 
(556
)
 
(342
)
 
(898
)
Long-term borrowings and capital trust securities
 
—

 
(33
)
 
(33
)
 
—

 
(69
)
 
(69
)
Total interest paid on interest bearing liabilities
 
274

 
(1,603
)
 
(1,329
)
 
173

 
(2,921
)
 
(2,748
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
2,415

 
$
(723
)
 
$
1,692

 
$
5,022

 
$
(1,220
)
 
$
3,802





Table III - Average Balance Sheet and Net Interest Income Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended
 
June 30, 2020
 
June 30, 2019
Dollars in thousands
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
 
Average
Balance
 
Earnings/
Expense
 
Yield/
Rate
Interest earning assets
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned fees (1)
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
2,026,814

 
$
50,555

 
5.02
%
 
$
1,730,801

 
$
47,090

 
5.49
%
Tax-exempt (2)
16,059

 
385

 
4.82
%
 
14,801

 
397

 
5.41
%
Securities
 

 
 

 
 

 
 
 
 
 
 
Taxable
253,840

 
3,211

 
2.54
%
 
199,759

 
3,292

 
3.32
%
Tax-exempt (2)
95,313

 
1,710

 
3.61
%
 
107,586

 
2,138

 
4.01
%
Federal funds sold and interest bearing deposits with other banks
38,712

 
159

 
0.83
%
 
44,910

 
365

 
1.64
%
Total interest earning assets
2,430,738

 
56,020

 
4.63
%
 
2,097,857

 
53,282

 
5.12
%
Noninterest earning assets
 

 
 

 
 

 
 
 
 
 
 
Cash & due from banks
15,548

 
 

 
 

 
13,005

 
 
 
 
Premises and equipment
48,303

 
 

 
 

 
39,887

 
 
 
 
Property held for sale
18,738

 
 
 
 
 
21,381

 
 
 
 
Other assets
111,866

 
 

 
 

 
89,953

 
 
 
 
Allowance for loan losses
(24,342
)
 
 

 
 

 
(13,287
)
 
 
 
 
Total assets
$
2,600,851

 
 

 
 

 
$
2,248,796

 
 
 
 
Interest bearing liabilities
 

 
 

 
 

 
 
 
 
 
 
Interest bearing demand deposits
$
704,404

 
$
1,450

 
0.41
%
 
$
566,183

 
$
3,395

 
1.21
%
Savings deposits
480,827

 
2,537

 
1.06
%
 
307,990

 
1,819

 
1.19
%
Time deposits
620,409

 
5,550

 
1.80
%
 
663,853

 
6,317

 
1.92
%
Short-term borrowings
107,675

 
1,129

 
2.11
%
 
193,672

 
2,869

 
2.99
%
Long-term borrowings and capital trust securities
20,301

 
405

 
4.01
%
 
20,319

 
514

 
5.10
%
Total interest bearing liabilities
1,933,616

 
11,071

 
1.15
%
 
1,752,017

 
14,914

 
1.72
%
Noninterest bearing liabilities and shareholders' equity
 

 
 

 
 

 
 
 
 
 
 
Demand deposits
378,667

 
 

 
 

 
244,984

 
 
 
 
Other liabilities
29,106

 
 

 
 

 
19,096

 
 
 
 
Total liabilities
2,341,389

 
 

 
 

 
2,016,097

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' equity - common
259,462

 
 

 
 

 
232,689

 
 
 
 
Total liabilities and shareholders' equity
$
2,600,851

 
 

 
 

 
$
2,248,786

 
 
 
 
Net interest earnings
 

 
$
44,949

 
 

 
 
 
$
38,368

 
 
Net yield on interest earning assets
 
 

 
3.72
%
 
 
 
 
 
3.69
%

(1)
- For purposes of this table, nonaccrual loans are included in average loan balances.
(2)
- Interest income on tax-exempt securities and loans has been adjusted assuming a Federal tax rate of 21%. The tax equivalent adjustment resulted in an increase in interest income of $440,000 and $532,000 for the six months ended June 30, 2020 and 2019, respectively.



Table IV - Changes in Net Interest Income Attributable to Rate and Volume
 
 
 
 
 
 
 
For the Six Months Ended
 
 
June 30, 2020 versus June 30, 2019
 
 
Increase (Decrease) Due to Change in:
Dollars in thousands
 
Volume
 
Rate
 
Net
Interest earned on:
 
 
 
 
 
 
Loans
 
 
 
 
 
 
Taxable
 
$
7,618

 
$
(4,153
)
 
$
3,465

Tax-exempt
 
32

 
(44
)
 
(12
)
Securities
 
 

 
 

 
 

Taxable
 
782

 
(862
)
 
(80
)
Tax-exempt
 
(232
)
 
(196
)
 
(428
)
Federal funds sold and interest bearing deposits with other banks
 
(45
)
 
(162
)
 
(207
)
Total interest earned on interest earning assets
 
8,155

 
(5,417
)
 
2,738

 
 
 
 
 
 
 
Interest paid on:
 
 

 
 

 
 

Interest bearing demand deposits
 
685

 
(2,631
)
 
(1,946
)
Savings deposits
 
931

 
(213
)
 
718

Time deposits
 
(401
)
 
(366
)
 
(767
)
Short-term borrowings
 
(1,049
)
 
(691
)
 
(1,740
)
Long-term borrowings and capital trust securities
 
—

 
(109
)
 
(109
)
Total interest paid on interest bearing liabilities
 
166

 
(4,010
)
 
(3,844
)
 
 
 
 
 
 
 
Net interest income
 
$
7,989

 
$
(1,407
)
 
$
6,582



Noninterest Income

Total noninterest income for the six months ended June 30, 2020 decreased 26.6% compared to the same period of 2019 principally due to lower insurance commissions due to the sale of SIS and the gain on sale of SIS recognized in 2019. On a quarterly basis, total noninterest income was 47.2% lower in 2020 compared to 2019 as second quarter 2019 included the gain on sale of SIS and higher realized securities gains. Further detail regarding noninterest income is reflected in the following table.
Table V - Noninterest Income
 
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
For the Six Months Ended June 30,
Dollars in thousands
2020
 
2019
 
2020
 
2019
Insurance commissions
$
24

 
$
606

 
$
31

 
$
1,780

Trust and wealth management fees
582

 
612

 
1,247

 
1,198

Mortgage origination revenue
641

 
164

 
855

 
315

Service charges on deposit accounts
882

 
1,224

 
2,145

 
2,405

Bank card revenue
1,087

 
893

 
2,020

 
1,707

Realized securities gains
—

 
1,086

 
1,038

 
1,082

Gain on sale of Summit Insurance Services, LLC
—

 
1,906

 
—

 
1,906

Bank owned life insurance income
275

 
248

 
539

 
486

Other
107

 
71

 
224

 
161

Total
$
3,598

 
$
6,810

 
$
8,099

 
$
11,040






Noninterest Expense

Total noninterest expense decreased 0.9% for the three months ended June 30, 2020 compared to the same period of 2019 and increased 3.4% for the six months ended June 30, 2020 as compared to the same period of 2019 with lower foreclosed properties expense being partially offset by higher salaries, commissions, and employee benefits and increased merger expenses. Table VI below shows the breakdown of the changes.
Table VI - Noninterest Expense
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarter Ended June 30,
 
For the Six Months Ended June 30,
 
 
 
Change
 
 
 
 
 
Change
 
 
Dollars in thousands
2020
 
 $
 
%
 
2019
 
2020
 
 $
 
%
 
2019
Salaries, commissions, and employee benefits
$
7,930

 
$
354

 
4.7
 %
 
$
7,576

 
$
15,601

 
$
678

 
4.5
 %
 
$
14,923

Net occupancy expense
977

 
97

 
11.0
 %
 
880

 
1,860

 
57

 
3.2
 %
 
1,803

Equipment expense
1,360

 
141

 
11.6
 %
 
1,219

 
2,789

 
391

 
16.3
 %
 
2,398

Professional fees
417

 
(58
)
 
(12.2
)%
 
475

 
804

 
(74
)
 
(8.4
)%
 
878

Advertising and public relations
93

 
(62
)
 
(40.0
)%
 
155

 
244

 
(64
)
 
(20.8
)%
 
308

Amortization of intangibles
410

 
(10
)
 
(2.4
)%
 
420

 
839

 
(58
)
 
(6.5
)%
 
897

FDIC premiums
110

 
22

 
25.0
 %
 
88

 
275

 
187

 
212.5
 %
 
88

     Bank card expense
560

 
87

 
18.4
 %
 
473

 
1,063

 
152

 
16.7
 %
 
911

Foreclosed properties expense, net of losses
240

 
(1,305
)
 
(84.5
)%
 
1,545

 
1,207

 
(723
)
 
(37.5
)%
 
1,930

Merger-related expenses
637

 
255

 
66.8
 %
 
382

 
1,425

 
980

 
220.2
 %
 
445

Other
2,463

 
347

 
16.4
 %
 
2,116

 
4,088

 
(520
)
 
(11.3
)%
 
4,608

Total
$
15,197

 
$
(132
)
 
(0.9
)%
 
$
15,329

 
$
30,195

 
$
1,006

 
3.4
 %
 
$
29,189


Salaries, commissions, and employee benefits: The increases in these expenses for the three and six months ended June 30, 2020 compared to the same periods of 2019 are primarily due to an increase in number of employees, resulting from the Cornerstone and MVB branch acquisitions, and general merit raises.

Equipment: The increase in equipment expense is primarily increased depreciation and amortization related to various technological upgrades, both hardware and software, made during the past two years and also the Cornerstone and MVB branch acquisitions.

FDIC premiums: For the 2020 periods, FDIC premiums increased as we fully utilized our FDIC's Small Bank Assessment Credits resulting from the reserve ratio meeting the required 1.38 percent threshold and also due to a higher assessment base due to growth in our balance sheet. We expect increased assessments to continue throughout 2020.

Foreclosed properties expense, net of losses: The 2020 decreases in foreclosed properties expense, net of losses is primarily due to fewer writedowns of foreclosed properties to their fair value.

Merger-related expenses: Merger-related expenses during 2020 are related to the Cornerstone and MVB branch acquisitions.

Other: The decrease in other expenses for the six months ended June 30, 2020 is largely due to income related to deferred director compensation plan expense of $100,000 in 2020 compared to $594,000 expense in the comparable period of 2019 as a result of the stock market's deterioration during early 2020. Under the plan, the directors optionally defer their director fees into a "phantom" investment plan whereby the company recognizes expense or benefit relative to the phantom returns or losses of such investments. This deferred director compensation expense increased to $383,000 for the quarter ended June 30, 2020 compared to $110,000 for the quarter ended June 30, 2019 as the stock market improved.

Income Taxes

Our income tax expense for the three months ended June 30, 2020 and June 30, 2019 totaled $1.5 million and $1.9 million, respectively. For the six months ended June 30, 2020 and June 30, 2019, our income taxes totaled $2.7 million and $3.5 million, respectively. Our effective tax rate (income tax expense as a percentage of income before taxes) for the quarters ended


June 30, 2020 and 2019 was 17.9% and 18.0%, respectively and for the six months ended June 30, 2020 and June 30, 2019 was 19.0% and 18.2%, respectively. Refer to Note 16 of the accompanying financial statements for further information regarding our income taxes.

Credit Experience

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

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

We recorded $8.25 million and $550,000 provisions for credit losses (for both funded loans and unfunded commitments) for the first six months of 2020 and 2019. The projected economic impact of COVID-19 on our loss drivers over the reasonable and supportable forecast period created the need for $7.2 million of additional ACL, which includes the ACL for unfunded commitments. Approximately $1.1 million of the provision was result of additional ACLL due to the acquisition of Cornerstone and MVB loans. Changes in loan volume and the mix in the underlying portfolio were insignificant to the ACL for the quarter.

As illustrated in Table VII below, our non-performing assets have decreased slightly since year end 2019.
Table VII - Summary of Non-Performing Assets
 
 
 
 
 
 
 
 
June 30,
 
December 31,
Dollars in thousands
 
2020
 
2019
 
2019
Accruing loans past due 90 days or more
 
$
2

 
$
208

 
$
42

Nonaccrual loans
 
 

 
 

 
 

Commercial
 
754

 
948

 
764

Commercial real estate
 
5,822

 
6,544

 
5,800

Commercial construction and development
 
—

 
—

 
—

Residential construction and development
 
14

 
66

 
326

Residential real estate
 
5,873

 
5,517

 
4,404

Consumer
 
27

 
92

 
74

Other
 
35

 
100

 
100

Total nonaccrual loans
 
12,525

 
13,267

 
11,468

Foreclosed properties
 
 

 
 

 
 

Commercial
 
—

 
—

 
—

Commercial real estate
 
1,774

 
1,544

 
1,930

Commercial construction and development
 
4,511

 
4,910

 
4,601

Residential construction and development
 
10,645

 
13,132

 
11,169

Residential real estate
 
1,024

 
1,804

 
1,576

Total foreclosed properties
 
17,954

 
21,390

 
19,276

Repossessed assets
 
—

 
12

 
17

Total nonperforming assets
 
$
30,481

 
$
34,877

 
$
30,803

Total nonperforming loans as a percentage of total loans
 
0.56
%
 
0.74
%
 
0.60
%
Total nonperforming assets as a percentage of total assets
 
1.07
%
 
1.52
%
 
1.28
%
Allowance for credit losses-loans as a percentage of nonperforming loans
 
216.85
%
 
97.60
%
 
113.58
%
Allowance for credit losses-loans as a percentage of period end loans
 
1.22
%
 
0.72
%
 
0.68
%

The following table details the activity regarding our foreclosed properties for the three and six months ended June 30, 2020 and 2019.


Table VIII - Foreclosed Property Activity
 
 
 
 
 
 
For the Three Months Ended 
 June 30,
 
For the Six Months Ended 
 June 30,
Dollars in thousands
2020
 
2019
 
2020
 
2019
Beginning balance
$
18,287

 
$
24,393

 
$
19,276

 
$
21,432

Acquisitions
37

 
247

 
173

 
3,903

Improvements
487

 
32

 
1,072

 
33

Disposals
(639
)
 
(2,086
)
 
(1,403
)
 
(2,533
)
Writedowns to fair value
(218
)
 
(1,196
)
 
(1,164
)
 
(1,445
)
Balance March 31
$
17,954

 
$
21,390

 
$
17,954

 
$
21,390

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

Substantially all of our nonperforming loans are secured by real estate. The majority of these loans were underwritten in accordance with our loan-to-value policy guidelines which range from 70-85% at the time of origination.

At June 30, 2020 and December 31, 2019, our allowance for loan credit losses totaled $27.2 million, or 1.22% of total loans and $13.1 million, or 0.68% of total loans. The allowance for loan credit losses is considered adequate to cover an estimate of the full amount of expected credit losses relative to loans.

At June 30, 2020 and December 31, 2019 we had approximately $18.0 million and $19.3 million in foreclosed properties which were obtained as the result of foreclosure proceedings.  Although foreclosed property is recorded at fair value less estimated costs to sell, the prices ultimately realized upon their sale may or may not result in us recognizing additional gains or losses.



FINANCIAL CONDITION

Our total assets were $2.86 billion at June 30, 2020 and $2.40 billion at December 31, 2019.  Table IX below is a summary of significant changes in our financial position between December 31, 2019 and June 30, 2020.
Table IX - Summary of Significant Changes in Financial Position
 
 
 
 
Increase (Decrease)
 
 
 
 
Balance
December 31,
 
Impact of Cornerstone Acquisition
 
Impact of MVB Branches Acquisition
 
Other Changes
 
Balance
Dollars in thousands
 
2019
 
 
 
 
June 30, 2020
Assets
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
61,888

 
$
46,034

 
137,667

 
$
(202,799
)
 
$
42,790

Securities available for sale
 
276,355

 
90,028

 
—

 
(43,844
)
 
322,539

Securities held to maturity
 
—

 
—

 
—

 
80,497

 
80,497

Other investments
 
12,972

 
349

 
—

 
(4,446
)
 
8,875

Loans, net
 
1,900,425

 
39,461

 
33,942

 
218,713

 
2,192,541

Property held for sale
 
19,276

 
10

 
—

 
(1,332
)
 
17,954

Premises and equipment
 
44,168

 
664

 
2,321

 
4,694

 
51,847

Goodwill and other intangibles
 
23,022

 
11,539

 
14,790

 
(838
)
 
48,513

Cash surrender value of life insurance policies
 
43,603

 
2,715

 
—

 
8,997

 
55,315

Other assets
 
21,783

 
1,186

 
114

 
17,397

 
40,480

Total assets
 
$
2,403,492

 
$
191,986

 
$
188,834

 
$
77,039

 
$
2,861,351

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 

 
 
 
 
 
 

 
 

Deposits
 
$
1,913,237

 
$
173,266

 
188,732

 
$
176,534

 
$
2,451,769

Short-term borrowings
 
199,345

 
—

 
—

 
(108,400
)
 
90,945

Long-term borrowings
 
717

 
—

 
—

 
(9
)
 
708

Subordinated debentures owed to
unconsolidated subsidiary trusts
 
19,589

 
—

 
—

 
—

 
19,589

Other liabilities
 
22,840

 
3,279

 
102

 
8,688

 
34,909

 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
247,764

 
15,441

 
—

 
226

 
263,431

 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,403,492

 
$
191,986

 
188,834

 
$
77,039

 
$
2,861,351


The following is a discussion of the significant changes in our financial position during the first six months of 2020:

Cash and cash equivalents: Net reduction of $202.8 million is primarily attributable to repayments of short-term Federal Home Loan Bank ("FHLB") advances, funding of $99.9 million of PPP loans and the cash consideration of $14.3 million paid in conjunction with the Cornerstone acquisition.

Securities available for sale: The net decrease of $43.8 million in securities available for sale is principally a result of sales of a large portion of the acquired Cornerstone securities portfolio and the sales of a portion of our tax-exempt municipals securities, whose proceeds were used to fund loan growth and calls and maturities of brokered and direct CDs.

Securities held to maturity: During second quarter 2020, we invested in various municipal securities that we have classified as held to maturity as we have the positive intent and ability to hold them to maturity. Accordingly, they are carried at cost, adjusted for amortization of premiums and accretion of discounts.

Loans: Mortgage warehouse lines of credit grew $126.2 million during first half 2020 as we expanded our existing line participations and established two new participations in light of strong mortgage refinance and home purchase activity nationally. Excluding mortgage warehouse lines of credit and Cornerstone and MVB loans acquired, organic loan growth was $106.6 million during the first six months of 2020, of which $99.9 growth was PPP loans.

Other assets: During 2020, the largest increases in Other assets are as follows:
•
Right-of-use asset increased $3.1 million due to a new operating lease entered into for a Reston, Virginia location


•
Net derivative assets increased $4.6 million due to a newly entered interest rate cap
•
Deferred tax assets have increased $5.5 million primarily due to deferred taxes related to increased allowance for credit losses

Deposits: During the first six months of 2020, noninterest bearing checking deposits increased $182.6 million, interest bearing checking deposits grew $199.9 million, savings deposits grew $142.9 million, and retail CDs increased $84.2 million while brokered CDs declined $60.3 million and Direct CDs decreased $17.3 million.

Short-term borrowings: The net decrease in short-term borrowings was attributable to repayments of short-term FHLB advances primarily using cash acquired in conjunction with the Cornerstone and MVB branches acquisitions and proceeds from sales of securities.

Shareholders' equity: Changes in shareholders' equity are a result of net income, other comprehensive income, dividends and the impact on retained earnings for adoption of ASC 326 on January 1, 2020.

Refer to Notes 5, 6, 8, and 9 of the notes to the accompanying consolidated financial statements for additional information with regard to changes in the composition of our securities, loans, deposits and borrowings between June 30, 2020 and December 31, 2019.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity reflects our ability to ensure the availability of adequate funds to meet loan commitments and deposit withdrawals, as well as provide for other transactional requirements.  Liquidity is provided primarily by funds invested in cash and due from banks (net of float and reserves), Federal funds sold, non-pledged securities, and available lines of credit with the Federal Home Loan Bank of Pittsburgh (“FHLB”) and Federal Reserve Bank of Richmond, which totaled approximately $1.2 billion or 41.43% of total consolidated assets at June 30, 2020.

Our liquidity strategy is to fund loan growth with deposits and other borrowed funds while maintaining an adequate level of short- and medium-term investments to meet normal daily loan and deposit activity.  As a member of the FHLB, we have access to approximately $850 million.  As of June 30, 2020 and December 31, 2019, these advances totaled approximately $92 million and $200 million, respectively.  At June 30, 2020, we had additional borrowing capacity of $758 million through FHLB programs.  We have established a line with the Federal Reserve Bank to be used as a contingency liquidity vehicle.  The amount available on this line at June 30, 2020 was approximately $172 million, which is secured by a pledge of certain consumer and our commercial and industrial loan portfolios.  We have a $6 million unsecured line of credit with a correspondent bank.  Also, we classify all of our securities as available for sale to enable us to liquidate them if the need arises.
 
Liquidity risk represents the risk of loss due to the possibility that funds may not be available to satisfy current or future commitments based on external market issues, customer or creditor perception of financial strength, and events unrelated to Summit such as war, terrorism, pandemic or financial institution market specific issues.  The Asset/Liability Management Committee (“ALCO”), comprised of members of senior management and certain members of the Board of Directors, oversees our liquidity risk management process.   The ALCO develops and recommends policies and limits governing our liquidity to the Board of Directors for approval with the objective of ensuring that we can obtain cost-effective funding to meet current and future obligations, as well as maintain sufficient levels of on-hand liquidity, under both normal and “stressed” circumstances.
 
We continuously monitor our liquidity position to ensure that day-to-day as well as anticipated funding needs are met.  We are not aware of any trends, commitments, events or uncertainties that have resulted in or are reasonably likely to result in a material change to our liquidity.

One of our continuous goals is maintenance of a strong capital position.  Through management of our capital resources, we seek to provide an attractive financial return to our shareholders while retaining sufficient capital to support future growth.  Shareholders’ equity at June 30, 2020 totaled $263.4 million compared to $247.8 million at December 31, 2019.

Refer to Note 12 of the notes to the accompanying consolidated financial statements for additional information regarding regulatory restrictions on our capital as well as our subsidiaries’ capital.






CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations.  The following table summarizes our contractual cash obligations at June 30, 2020.
Table X - Contractual Cash Obligations
 
 
Dollars in thousands
 
Long
Term
Debt
 
Capital
Trust
Securities
 
Operating
Leases
2019
 
$
9

 
$
—

 
$
297

2020
 
20

 
—

 
480

2021
 
21

 
—

 
443

2022
 
22

 
—

 
305

2023
 
23

 
—

 
261

Thereafter
 
613

 
19,589

 
1,325

Total
 
$
708

 
$
19,589

 
$
3,111


OFF-BALANCE SHEET ARRANGEMENTS

We are involved with some off-balance sheet arrangements that have or are reasonably likely to have an effect on our financial condition, liquidity, or capital.  These arrangements at June 30, 2020 are presented in the following table.

Table XI - Off-Balance Sheet Arrangements
 
June 30,
Dollars in thousands
 
2020
Commitments to extend credit:
 
 
Revolving home equity and credit card lines
 
$
88,119

Construction loans
 
135,086

Other loans
 
267,152

Standby letters of credit
 
11,430

Total
 
$
501,787






























Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market Risk Management

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices.  Interest rate risk is our primary market risk and results from timing differences in the repricing of assets, liabilities and off-balance sheet instruments, changes in relationships between rate indices and the potential exercise of imbedded options.  The principal objective of asset/liability management is to minimize interest rate risk and our actions in this regard are taken under the guidance of our Asset/Liability Management Committee (“ALCO”), which is comprised of members of senior management and members of the Board of Directors.  The ALCO actively formulates the economic assumptions that we use in our financial planning and budgeting process and establishes policies which control and monitor our sources, uses and prices of funds.

Some amount of interest rate risk is inherent and appropriate to the banking business.  Our net income is affected by changes in the absolute level of interest rates.  Our interest rate risk position is well-matched over the near-term. That is, absent any changes in the volumes of our interest earning assets or interest bearing liabilities, assets are likely to reprice faster than liabilities, resulting in an increase in net income in a rising rate environment.  Net income would decrease in a falling interest rate environment.  Net income is also subject to changes in the shape of the yield curve.  In general, a flattening yield curve would decrease our earnings due to the compression of earning asset yields and funding rates, while a steepening would increase earnings as margins widen.

Several techniques are available to monitor and control the level of interest rate risk.  We control interest rate risk principally by matching the maturities of our interest earning assets with similar maturing interest bearing liabilities and by hedging adverse risk exposures with derivative financial instruments such as interest rate swaps and caps. We primarily use earnings simulations modeling to monitor interest rate risk.  The earnings simulation model forecasts the effects on net interest income under a variety of interest rate scenarios that incorporate changes in the absolute level of interest rates and changes in the shape of the yield curve.  Each increase or decrease in interest rates is assumed to gradually take place over either the next 12 months or the next 24 months (as footnoted in table below), and then remain stable.  Assumptions used to project yields and rates for new loans and deposits are derived from historical analysis.  Securities portfolio maturities and prepayments are reinvested in like instruments.  Mortgage loan prepayment assumptions are developed from industry estimates of prepayment speeds.  Noncontractual deposit repricings are modeled on historical patterns.

The following table presents the estimated sensitivity of our net interest income to changes in interest rates, as measured by our earnings simulation model as of June 30, 2020.  The sensitivity is measured as a percentage change in net interest income given the stated changes in interest rates (gradual change over 12 months, stable thereafter) compared to net interest income with rates unchanged in the same period.  The estimated changes set forth below are dependent on the assumptions discussed above.

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

 
Actual

Down 100  basis points (1)
 
0.54
 %
 
-4.12
 %
Up 200 basis points (1)
 
-2.75
 %
 
-3.50
 %
Up 200 basis points (2)
 
-1.45
 %
 
-5.31
 %
 
 
 
 
 
(1) assumes a parallel shift in the yield curve over 12 months, with no change thereafter
(2) assumes a parallel shift in the yield curve over 24 months, with no change thereafter




Item 4. Controls and Procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, has conducted as of June 30, 2020, an evaluation of the effectiveness of disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures as of June 30, 2020 were effective.  There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information




Item 1.  Legal Proceedings

Refer to Note 11 of the Notes to the Consolidated Financial Statements in Part I, Item 1 for information regarding legal proceedings not reportable under this Item.

Item 1A.  Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019. The following risk factor is provided to supplement that discussion.

Our business, financial condition, liquidity and results of operations have been, and will likely continue to be, adversely affected by the COVID-19 pandemic.

In March 2020, the World Health Organization declared COVID-19 as a global pandemic. The COVID-19 pandemic has created economic and financial disruptions that have adversely affected, and are likely to continue to adversely affect, our business, financial condition, liquidity and results of operations. The extent to which the COVID-19 pandemic will continue to negatively affect our business, financial condition, liquidity and results of operations will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our plans, the direct and indirect impact of the pandemic on our employees, clients, counterparties and service providers, as well as other market participants, and actions taken by governmental authorities and other third parties in response to the pandemic.

The COVID-19 pandemic has contributed to:

•
Severe unemployment and business disruption and decreased consumer confidence and commercial activity generally, leading to an increased risk of delinquencies, defaults and foreclosures.
•
Higher and more volatile credit loss expense and high potential for increased charge-offs.
•
Ratings downgrades, credit deterioration and defaults in many industries, particularly restaurants, hospitality, entertainment, energy and commercial real estate.
•
A sudden and significant reduction in the valuation of the equity, fixed-income and commodity markets and the significant increase in the volatility of those markets.
•
A decrease in the rates and yields on U.S. Treasury securities, which may lead to decreased net interest income.
•
A reduction in the value of the assets that we manage or otherwise administer or service for others, affecting related fee income and demand for our services.

Our financial position and results of operations are particularly susceptible to the ability of our loan customers to meet loan obligations, the availability of our workforce and the availability of our critical vendors. While its effects continue to materialize, the COVID-19 crisis has resulted in a significant decrease in commercial activity throughout our market area as well as nationally. This decrease in commercial activity may cause our clients and vendors to be unable to meet existing payment or other obligations to us. The national public health crisis arising from the COVID-19 crisis and public expectations about it, combined with certain pre-existing factors, including, but not limited to, international trade disputes, inflation risks and oil price volatility, could further destabilize the financial markets and geographies in which we operate. The resulting economic pressure on consumers and uncertainty regarding the sustainability of any economic improvements has impacted the creditworthiness of potential and current borrowers. Borrower loan defaults that adversely affect our earnings correlate with severely deteriorating economic conditions including the unemployment rate, which, in turn, are likely to impact our borrowers' creditworthiness and our ability to make loans.

In addition, the economic pressures and uncertainties arising from the COVID-19 crisis may result in specific changes in consumer and business spending and borrowing and saving habits, affecting the demand for loans and other products and services we offer. Consumers affected by COVID-19 may continue to demonstrate changed behavior even after the crisis is over. For example, consumers may decrease discretionary spending on a permanent or long-term basis, certain industries may take longer to recover -- particularly those that rely on travel or large gatherings -- as consumers may be hesitant to return to full social interaction. We lend to customers operating in such industries including restaurants, hotels/lodging, entertainment, energy, retail and commercial real estate, among others, that have been significantly impacted by COVID-19, and we are continuing to monitor these customers closely.

Any disruption to our ability to deliver financial products or services to, or interact with, our clients could result in losses or increased operational costs, harm our reputation or result in regulatory fines, penalties and other sanctions. The COVID-19 crisis could still greatly affect our routine and essential operations due to further limited access to or closures of our branch facilities


and other physical offices; and government or regulatory agency orders, among other things. The business and operations of our third-party service providers, many of whom perform critical services for our business, could also be significantly impacted, which in turn could impact us.

The Federal Reserve has taken various actions and the U.S. government has enacted several fiscal stimulus measures to counteract the economic disruption caused by the COVID-19 pandemic and provide economic assistance to individual households and businesses, stabilize the markets and support economic growth. The success of these measures is unknown and they may not be sufficient to fully mitigate the negative impact of the COVID-19 pandemic.

We face an increased risk of litigation and governmental, regulatory and third-party scrutiny as a result of the effects of COVID-19 on market and economic conditions and actions governmental authorities take in response to those conditions. Furthermore, various governmental programs such as the Payroll Protection Plan loan program are complex and our participation may lead to additional litigation and governmental, regulatory and third-party scrutiny, negative publicity and damage to our reputation.
The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

In February 2020, the Board of Directors authorized the open market repurchase of up to 750,000 shares of the issued and outstanding shares of Summit's common stock ("February 2020 Repurchase Plan"). The timing and quantity of purchases under this stock repurchase plan are at the discretion of management. The plan may be discontinued, suspended, or restarted at any time at the Company's discretion.

The following table sets forth certain information regarding Summit’s purchase of its common stock under the Repurchase Plan for the quarter ended June 30, 2020.
Period
Total Number of Shares Purchased (a)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
April 1, 2020 - April 30, 2020
8,722

 
$
18.69

 
8,722

 
674,667

May 1, 2020 - May 31, 2020
—

 
—

 
—

 
—

June 1, 2020 - June 30, 2020
—

 
—

 
—

 
—


(a)  Shares purchased under the February 2020 Repurchase Plan.





Item 6. Exhibits
Exhibit 3.i
Amended and Restated Articles of Incorporation of Summit Financial Group, Inc.
 
 
Exhibit 3.ii
Articles of Amendment 2009
 
 
Exhibit 3.iii
Articles of Amendment 2011
 
 
Exhibit 3.iv
Amended and Restated By-Laws of Summit Financial Group, Inc.
 
 
Exhibit 11
Statement re: Computation of Earnings per Share – Information contained in Note 4 to the Consolidated Financial Statements on page 13 of this Quarterly Report is incorporated herein by reference.
 
 
Exhibit 31.1
Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer
 
 
Exhibit 31.2
Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer
 
 
Exhibit 32.1
Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer
 
 
Exhibit 32.2
Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer
 
 
Exhibit 101
Interactive Data File (XBRL)


EXHIBIT INDEX



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

(a)
Incorporated by reference to Exhibit 3.i of Summit Financial Group, Inc.’s filing on Form 10-Q dated March 31, 2006.
(b)
Incorporated by reference to Exhibit 3.1 of Summit Financial Group, Inc.’s filing on Form 8-K dated September 30, 2009.
(c)
Incorporated by reference to Exhibit 3.1 of Summit Financial Group, Inc.’s filing on Form 8-K dated November 3, 2011.
(d)
Incorporated by reference to Exhibit 3.1 of Summit Financial Group, Inc.’s filing on Form 10-Q dated March 26, 2020.



SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
SUMMIT FINANCIAL GROUP, INC.
 
 
(registrant)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ H. Charles Maddy, III
 
 
 
H. Charles Maddy, III,
 
 
 
President and Chief Executive Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ Robert S. Tissue
 
 
 
Robert S. Tissue,
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
/s/ Julie R. Markwood
 
 
 
Julie R. Markwood,
 
 
 
Senior Vice President and Chief Accounting Officer
 
 
 
 
 
 
 
 
Date:
August 7, 2020
 
 




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