Edgar Filing: SUMMIT FINANCIAL GROUP INC

Summit Financial Group 3rd Qtr 06 10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 - Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006.

[ ] 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

Summit Financial Group, Inc.

(Exact name of registrant as specified in its charter)

West Virginia		55-0672148
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

	300 North Main Street
	Moorefield, West Virginia	26836
	(Address of principal executive offices)	(Zip Code)

(304) 530-1000

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ

No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filerþ Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o	No þ

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date.

Common Stock, $2.50 par value

7,087,920 shares outstanding as of November 6, 2006

Summit Financial Group, Inc. and Subsidiaries

Table of Contents

			Page
PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Consolidated balance sheets September 30, 2006 (unaudited), December 31, 2005, and September 30, 2005 (unaudited)	4

		Consolidated statements of income for the three months and nine months ended September 30, 2006 and 2005 (unaudited)	5

		Consolidated statements of shareholders’ equity for the nine months ended September 30, 2006 and 2005 (unaudited)	6

		Consolidated statements of cash flows for the nine months ended September 30, 2006 and 2005 (unaudited)	7-8

		Notes to consolidated financial statements (unaudited)	9-22

	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	23-35

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34

	Item 4.	Controls and Procedures	35

Summit Financial Group, Inc. and Subsidiaries

Table of Contents


PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings		36

	Item 1A.	Risk Factors		36

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		37

	Item 3.	Defaults upon Senior Securities		None

	Item 4.	Submission of Matters to a Vote of Security Holders		None

	Item 5.	Other Information		None

	Item 6.	Exhibits

		Exhibit 11.	Statement re: Computation of Earnings per Share - Information contained in Note 2 to the Consolidated Financial Statements on page 9 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

SIGNATURES				38

Summit Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets (unaudited)

	September 30,			December 31,			September 30,
	2006			2005			2005
	(unaudited)			*()**			(unaudited)
ASSETS
Cash and due from banks	$	11,604,346		$	22,535,761		$	20,830,680
Interest bearing deposits with other banks		119,013			1,536,506			2,196,744
Federal funds sold		399,000			3,650,000			3,573,000
Securities available for sale		246,331,602			223,772,298			215,757,195
Loans held for sale		6,509,914			16,584,990			12,695,050
Loans, net		895,265,891			793,766,837			729,431,309
Property held for sale		249,137			378,287			830,145
Premises and equipment, net		23,505,342			23,089,412			21,163,790
Accrued interest receivable		6,079,101			4,835,763			4,392,003
Intangible assets		3,234,308			3,347,672			3,385,460
Other assets		17,192,969			16,034,499			14,847,760
Total assets	$	1,210,490,623		$	1,109,532,025		$	1,029,103,136

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest bearing	$	64,750,662		$	62,631,410		$	69,346,345
Interest bearing		800,311,691			611,269,308			559,572,582
Total deposits		865,062,353			673,900,718			628,918,927
Short-term borrowings		90,422,000			182,028,113			139,680,652
Long-term borrowings		144,274,780			150,911,835			168,041,711
Subordinated debentures owed to unconsolidated subsidiary trusts		19,589,000			19,589,000			11,341,000
Other liabilities		10,512,864			9,299,134			8,692,039
Total liabilities		1,129,860,997			1,035,728,800			956,674,329

Commitments and Contingencies

Shareholders' Equity
Common stock and related surplus, $2.50 par value;
authorized 20,000,000 shares, issued and outstanding
2006 - 7,102,720 shares; issued December 2005 - 7,126,220
shares; issued September 2005 - 7,125,820 shares		18,310,230			18,856,774			18,776,686
Retained earnings		63,159,114			56,214,807			54,912,652
Accumulated other comprehensive income		(839,718	)		(1,268,356	)		(1,260,531	)
Total shareholders' equity		80,629,626			73,803,225			72,428,807

Total liabilities and shareholders' equity	$	1,210,490,623		$	1,109,532,025		$	1,029,103,136

(*) - December 31, 2005 financial information has been extracted from audited consolidated financial statements

See Notes to Consolidated Financial Statements

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)

	Three Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2006			2005			2006			2005
Interest income
Interest and fees on loans
Taxable	$	18,102,418		$	12,422,549		$	50,179,652		$	33,420,963
Tax-exempt		113,551			104,328			315,199			320,841
Interest and dividends on securities
Taxable		2,451,769			1,750,451			6,836,439			5,228,816
Tax-exempt		546,050			533,000			1,594,960			1,603,999
Interest on interest bearing deposits with other banks		2,860			22,743			23,397			68,281
Interest on Federal funds sold		13,482			3,684			29,717			10,960
Total interest income		21,230,130			14,836,755			58,979,364			40,653,860
Interest expense
Interest on deposits		7,760,937			3,508,549			19,321,871			8,951,622
Interest on short-term borrowings		1,777,008			1,314,966			5,571,751			3,124,289
Interest on long-term borrowings and subordinated debentures		2,461,623			2,203,152			7,393,608			6,009,161
Total interest expense		11,999,568			7,026,667			32,287,230			18,085,072
Net interest income		9,230,562			7,810,088			26,692,134			22,568,788
Provision for loan losses		410,000			424,400			1,285,000			1,179,400
Net interest income after provision for loan losses		8,820,562			7,385,688			25,407,134			21,389,388
Other income
Insurance commissions		218,771			222,024			695,734			605,189
Service fees		699,718			711,141			2,056,051			1,908,848
Mortgage origination revenue		4,027,645			7,303,889			16,556,948			20,272,788
Securities gains (losses)		-			38,828			-			44,179
Gain (loss) on sale of assets		(4,290	)		(592	)		(8,165	)		(1,667	)
Other		135,196			189,863			417,727			518,540
Total other income		5,077,040			8,465,153			19,718,295			23,347,877
Other expense
Salaries and employee benefits		4,302,421			5,434,668			14,315,068			15,371,119
Net occupancy expense		564,666			479,174			1,705,782			1,371,132
Equipment expense		553,104			464,691			1,648,470			1,440,885
Supplies		228,839			167,965			688,620			507,100
Professional fees		374,184			230,496			1,148,537			699,179
Postage		1,678,196			1,450,635			5,219,246			4,475,850
Advertising		1,191,490			1,163,782			3,844,639			3,710,634
Amortization of intangibles		37,788			37,788			113,364			113,364
Other		1,439,370			1,448,525			4,775,177			4,118,633
Total other expense		10,370,058			10,877,724			33,458,903			31,807,896
Income before income taxes		3,527,544			4,973,117			11,666,526			12,929,369
Income tax expense		1,046,850			1,700,175			3,580,600			4,129,282
Net income	$	2,480,694		$	3,272,942		$	8,085,926		$	8,800,087

Basic earnings per common share	$	0.35		$	0.46		$	1.13		$	1.24
Diluted earnings per common share	$	0.35		$	0.45		$	1.12		$	1.22

Average common shares outstanding
Basic		7,127,650			7,125,483			7,130,276			7,082,418
Diluted		7,187,274			7,211,331			7,194,351			7,207,937

Dividends per common share	$	-		$	-		$	0.16		$	0.14

See Notes to Consolidated Financial Statements

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited)

													Accumulated
	Preferred			Common									Other			Total
	Stock and			Stock and									Compre-			Share-
	Related			Related			Retained			Treasury			hensive			holders'
	Surplus			Surplus			Earnings			Stock			Income			Equity

Balance, December 31, 2005	$	-		$	18,856,774		$	56,214,807		$	-		$	(1,268,356	)	$	73,803,225
Nine Months Ended September 30, 2006
Comprehensive income:
Net income		-			-			8,085,926			-			-			8,085,926
Other comprehensive income,
net of deferred tax benefit
of $262,714:
Net unrealized gain on
securities of $428,638, net
of reclassification adjustment
for gains included in net
income of $0		-			-			-			-			428,638			428,638
Total comprehensive income																	8,514,564
Exercise of stock options		-			43,543			-			-			-			43,543
Excess tax benefit on stock-based
compensation		-			26,470			-			-			-			26,470
Repurchase of common shares		-			(616,557	)		-			-			-			(616,557	)
Cash dividends declared
($.16 per share)		-			-			(1,141,619	)		-			-			(1,141,619	)

Balance, September 30, 2006	$	-		$	18,310,230		$	63,159,114		$	-		$	(839,718	)	$	80,629,626


Balance, December 31, 2004	$	1,158,471		$	18,123,492		$	47,108,898		$	(627,659	)	$	(55,181	)	$	65,708,021
Nine Months Ended September 30, 2005
Comprehensive income:
Net income		-			-			8,800,087			-			-			8,800,087
Other comprehensive income,
net of deferred tax benefit
of ($738,763):
Net unrealized (loss) on
securities of ($1,232,741), net
of reclassification adjustment
for gains included in net
income of $27,391		-			-			-			-			(1,205,350	)		(1,205,350	)
Total comprehensive income																	7,594,737
Exercise of stock options		-			122,382			-			-			-			122,382
Conversion of preferred shares		(1,158,471	)		1,158,471			-			-			-			-
Retirement of treasury shares		-			(627,659	)		-			627,659			-			-
Cash dividends declared
($.14 per share)		-			-			(996,333	)		-			-			(996,333	)

Balance, September 30, 2005	$	-		$	18,776,686		$	54,912,652		$	-		$	(1,260,531	)	$	72,428,807

See Notes to Consolidated Financial Statements

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

	Nine Months Ended
	September 30,			September 30,
	2006			2005
Cash Flows from Operating Activities
Net income	$	8,085,926		$	8,800,087
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation		1,313,456			1,260,195
Provision for loan losses		1,285,000			1,179,400
Stock compensation expense		26,470			-
Deferred income tax (benefit)		(339,450	)		(229,618	)
Loans originated for sale		(189,951,707	)		(236,456,985	)
Proceeds from loans sold		206,595,684			246,429,843
(Gain) on sales of loans held for sale		(6,568,901	)		(8,393,992	)
Securities (gains)		-			(44,179	)
Loss on disposal of premises, equipment and other assets		8,165			1,667
Amortization of securities premiums, net		97,582			526,624
Amortization of goodwill and purchase accounting
adjustments, net		122,013			122,013
(Decrease) in accrued interest receivable		(1,243,338	)		(740,097	)
(Increase) in other assets		(186,793	)		(747,291	)
Increase in other liabilities		1,194,607			1,725,328
Net cash provided by operating activities		20,438,714			13,432,995
Cash Flows from Investing Activities
Net (increase) decrease in interest bearing deposits
with other banks		1,417,493			141,953
Proceeds from maturities and calls of securities available for sale		8,572,439			7,077,028
Proceeds from sales of securities available for sale		14,921,400			11,307,578
Principal payments received on securities available for sale		18,488,157			24,827,642
Purchases of securities available for sale		(63,964,260	)		(49,995,187	)
Net (increase) decrease in Federal funds sold		3,251,000			(3,525,000	)
Net loans made to customers		(102,833,730	)		(128,177,978	)
Purchases of premises and equipment		(1,763,132	)		(1,647,978	)
Proceeds from sales of premises, equipment and other assets		197,546			99,500
Purchase of life insurance contracts		(880,000	)		(2,500,000	)
Net cash (used in) investing activities		(122,593,087	)		(142,392,442	)
Cash Flows from Financing Activities
Net increase in demand deposit, NOW and
savings accounts		25,773,434			56,922,876
Net increase in time deposits		165,383,132			47,426,912
Net increase (decrease) in short-term borrowings		(91,606,113	)		19,051,438
Proceeds from long-term borrowings		18,551,000			32,764,000
Repayment of long-term borrowings		(25,163,862	)		(24,917,367	)
Exercise of stock options		43,543			122,382
Dividends paid		(1,141,619	)		(996,333	)
Repurchase of Common Stock		(616,557	)		-
Net cash provided by financing activities		91,222,958			130,373,908
Increase (decrease) in cash and due from banks		(10,931,415	)		1,414,461
Cash and due from banks:
Beginning		22,535,761			19,416,219
Ending	$	11,604,346		$	20,830,680

(Continued)

See Notes to Consolidated Financial Statements

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

	Nine Months Ended
	September 30,		September 30,
	2006		2005

Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	31,809,107	$	17,099,549
Income taxes	$	3,856,000	$	3,735,000

Supplemental Schedule of Noncash Investing and Financing Activities
Other assets acquired in settlement of loans	$	49,676	$	295,244

See Notes to Consolidated Financial Statements

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

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

The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from these estimates.

The results of operations for the nine months ended September 30, 2006 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 2005 audited financial statements and Annual Report on Form 10-K. Certain accounts in the consolidated financial statements for December 31, 2005 and September 30, 2005, as previously presented, have been reclassified to conform to current year classifications.

Note 2. Earnings per Share

The computations of basic and diluted earnings per share follow:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Numerator:
Net Income	$	2,480,694	$	3,272,942	$	8,085,926	$	8,800,087

Denominator:
Denominator for basic earnings
per share - weighted average
common shares outstanding		7,127,650		7,125,483		7,130,276		7,082,418

Effect of dilutive securities:
Convertible preferred stock		-		-		-		37,707
Stock options		59,624		85,848		64,075		87,812
		59,624		85,848		64,075		125,519
Denominator for diluted earnings
per share - weighted average
common shares outstanding and
assumed conversions		7,187,274		7,211,331		7,194,351		7,207,937

Basic earnings per share	$	0.35	$	0.46	$	1.13	$	1.24

Diluted earnings per share	$	0.35	$	0.45	$	1.12	$	1.22

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 3. Securities

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September

30, 2006, December 31, 2005, and September 30, 2005 are summarized as follows:

	September 30, 2006
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies
and corporations	$	38,303,725	$	3,474	$	417,259	$	37,889,940
Mortgage-backed securities		141,371,935		292,390		2,807,581		138,856,744
State and political subdivisions		3,758,861		11,478		12,253		3,758,086
Corporate debt securities		2,184,799		18,958		2,527		2,201,230
Federal Reserve Bank stock		669,000		-		-		669,000
Federal Home Loan Bank stock		12,562,500		-		-		12,562,500
Other equity securities		150,410		-		-		150,410
Total taxable		199,001,230		326,300		3,239,620		196,087,910
Tax-exempt:
State and political subdivisions		42,691,242		1,229,296		63,163		43,857,375
Other equity securities		5,975,692		427,384		16,759		6,386,317
Total tax-exempt		48,666,934		1,656,680		79,922		50,243,692
Total	$	247,668,164	$	1,982,980	$	3,319,542	$	246,331,602

	December 31, 2005
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies
and corporations	$	40,227,124	$	33,754	$	426,554	$	39,834,324
Mortgage-backed securities		117,530,036		150,766		2,884,861		114,795,941
State and political subdivisions		3,741,271		219		-		3,741,490
Corporate debt securities		3,294,123		37,063		2,206		3,328,980
Federal Reserve Bank stock		571,500		-		-		571,500
Federal Home Loan Bank stock		15,761,400		-		-		15,761,400
Other equity securities		150,410		-		-		150,410
Total taxable		181,275,864		221,802		3,313,621		178,184,045
Tax-exempt:
State and political subdivisions		38,529,013		1,191,186		74,709		39,645,490
Other equity securities		5,978,611		-		35,848		5,942,763
Total tax-exempt		44,507,624		1,191,186		110,557		45,588,253
Total	$	225,783,488	$	1,412,988	$	3,424,178	$	223,772,298

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	September 30, 2005
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies
and corporations	$	33,407,618	$	59,573	$	176,736	$	33,290,455
Mortgage-backed securities		112,014,499		174,111		1,722,431		110,466,179
State and political subdivisions		3,742,307		1,378		-		3,743,685
Corporate debt securities		4,046,404		61,573		-		4,107,977
Federal Reserve Bank stock		481,500		-		-		481,500
Federal Home Loan Bank stock		16,054,700		-		-		16,054,700
Other equity securities		175,535		-		-		175,535
Total taxable		169,922,563		296,635		1,899,167		168,320,031
Tax-exempt:
State and political subdivisions		40,359,216		1,336,740		53,751		41,642,205
Other equity securities		7,479,584		-		1,684,625		5,794,959
Total tax-exempt		47,838,800		1,336,740		1,738,376		47,437,164
Total	$	217,761,363	$	1,633,375	$	3,637,543	$	215,757,195

The maturities, amortized cost and estimated fair values of securities at September 30, 2006 are summarized as follows:

	Available for Sale
	Amortized		Estimated
	Cost		Fair Value

Due in one year or less	$	51,722,749	$	50,885,728
Due from one to five years		110,746,000		108,889,896
Due from five to ten years		30,718,532		30,776,980
Due after ten years		35,123,281		36,010,771
Equity securities		19,357,602		19,768,227
	$	247,668,164	$	246,331,602

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 4. Loans

Loans are summarized as follows:

	September 30,		December 31,
	2006		2005
Commercial	$	67,352,085	$	63,205,991
Commercial real estate		300,675,588		266,228,999
Construction and development		207,544,988		141,206,211
Residential real estate		284,635,823		285,596,743
Consumer		36,884,746		36,863,170
Other		7,085,912		8,597,768
Total loans		904,179,142		801,698,882
Less unearned income		1,805,904		1,780,315
Total loans net of unearned income		902,373,238		799,918,567
Less allowance for loan losses		7,107,347		6,151,730
Loans, net	$	895,265,891	$	793,766,837

Due to the reclassification of real estate loans to include the construction and development category, real estate loan balances prior to December 31, 2005 conforming to the new classifications are not available.

Note 5. Allowance for Loan Losses

An analysis of the allowance for loan losses for the nine month periods ended September 30, 2006 and 2005, and for the year ended December 31, 2005 is as follows:

	Nine Months Ended				Year Ended
	September 30,				December 31,
	2006		2005		2005
Balance, beginning of period	$	6,151,730	$	5,073,286	$	5,073,286
Losses:
Commercial		31,744		19,759		35,809
Commercial real estate		38,542		-		-
Real estate - mortgage		147,471		194,583		204,926
Consumer		114,276		142,557		173,020
Other		243,097		230,172		364,311
Total		575,130		587,071		778,066
Recoveries:
Commercial		1,025		6,495		6,495
Commercial real estate		42,618		24,255		41,228
Real estate - mortgage		6,518		42		42
Consumer		43,628		41,887		55,700
Other		151,958		183,036		273,645
Total		245,747		255,715		377,110
Net losses		329,383		331,356		400,956
Provision for loan losses		1,285,000		1,179,400		1,479,400
Balance, end of period	$	7,107,347	$	5,921,330	$	6,151,730

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 6. Goodwill and Other Intangible Assets

The following tables present our goodwill at September 30, 2006 and other intangible assets at September 30, 2006, December 31, 2005, and September 30, 2005.

	Goodwill Activity by Operating Segment
	Community		Mortgage		Parent and
	Banking		Banking		Other		Total
Balance, January 1, 2006	$	1,488,030	$	-	$	600,000	$	2,088,030
Acquired goodwill, net		-		-		-		-

Balance, September 30, 2006	$	1,488,030	$	-	$	600,000	$	2,088,030

	Unidentifiable Intangible Assets
	September 30,		December 31,		September 30,
	2006		2005		2005
Unidentifiable intangible assets
Gross carrying amount	$	2,267,323	$	2,267,323	$	2,267,323
Less: accumulated amortization		1,121,045		1,007,681		969,893
Net carrying amount	$	1,146,278	$	1,259,642	$	1,297,430

We recorded amortization expense of approximately $113,000 for the nine months ended September 30, 2006 relative to our unidentifiable intangible assets. Annual amortization is expected to be approximately $151,000 for each of the years ending 2006 through 2010.

Note 7. Deposits

The following is a summary of interest bearing deposits by type as of September 30, 2006 and 2005 and December 31, 2005:

	September 30,		December 31,		September 30,
	2006		2005		2005
Interest bearing demand deposits	$	223,992,153	$	200,637,520	$	169,893,431
Savings deposits		44,980,089		44,680,540		45,867,540
Retail time deposits		264,570,379		237,262,760		236,439,907
Brokered time deposits		266,769,070		128,688,488		107,371,704
Total	$	800,311,691	$	611,269,308	$	559,572,582

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Brokered deposits represent certificates of deposit acquired through a third party. The following is a summary of the maturity distribution of certificates of deposit in denominations of $100,000 or more as of September 30, 2006:

	Amount		Percent
Three months or less	$	34,100,049		11.2	%
Three through six months		62,053,077		20.4	%
Six through twelve months		104,912,592		34.4	%
Over twelve months		103,493,514		34.0	%
Total	$	304,559,232		100.0	%

A summary of the scheduled maturities for all time deposits as of September 30, 2006 is as follows:

Three month period ending December 31, 2006	$	111,893,741
Year Ending December 31, 2007		297,821,360
Year Ending December 31, 2008		67,383,091
Year Ending December 31, 2009		28,493,709
Year Ending December 31, 2010		22,817,367
Thereafter		2,930,181
	$	531,339,449

Note 8. Borrowed Funds

Short-term borrowings: A summary of short-term borrowings is presented below:

	Nine Months Ended September 30, 2006
							Federal Funds
							Purchased
	Short-term						and
	FHLB			Repurchase			Lines of
	Advances			Agreements			Credit
Balance at September 30	$	84,399,000		$	5,215,600		$	807,400
Average balance outstanding for the period		141,997,959			5,971,420			908,290
Maximum balance outstanding at
any month end during period		175,407,800			7,036,562			1,164,122
Weighted average interest rate for the period		5.01	%		4.00	%		7.60	%
Weighted average interest rate for balances
outstanding at September 30		5.30	%		4.15	%		7.75	%

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Year Ended December 31, 2005
							Federal Funds
	Short-term						Purchased
	FHLB			Repurchase			and Lines
	Advances			Agreements			of Credit
Balance at December 31	$	175,510,100		$	6,518,013		$	-
Average balance outstanding for the period		130,023,493			8,060,676			888,214
Maximum balance outstanding at
any month end during period		175,510,100			10,881,188			3,395,500
Weighted average interest rate for the period		3.54	%		2.27	%		4.77	%
Weighted average interest rate for balances
outstanding at December 31		4.27	%		3.65	%		-

	Nine Months Ended September 30, 2005
							Federal Funds
							Purchased
	Short-term						and
	FHLB			Repurchase			Lines of
	Advances			Agreements			Credit
Balance at September 30	$	134,540,600		$	5,140,052		$	-
Average balance outstanding for the period		121,567,880			9,002,881			896,127
Maximum balance outstanding at
any month end during period		134,540,600			10,881,188			3,395,500
Weighted average interest rate for the period		3.23	%		2.22	%		4.49	%
Weighted average interest rate for balances
outstanding at September 30		3.97	%		2.94	%		-

Long-term borrowings: Our long-term borrowings of $144,274,780, $150,911,835 and $168,041,711 at September 30, 2006, December 31, 2005, and September 30, 2005 respectively, consisted primarily of advances from the Federal Home Loan Bank (“FHLB”).

These borrowings bear both fixed and variable rates and mature in varying amounts through the year 2016.

The average interest rate paid on long-term borrowings for the nine month period ended September 30, 2006 was 5.34% compared to 4.56% for the first nine months of 2005.

Subordinated Debentures: 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 $19,589,000 at September 30, 2006 and December 31, 2005, and $11,341,000 at September 30, 2005.

In October 2002, we sponsored SFG Capital Trust I, in March 2004, we sponsored SFG Capital Trust II, and in December 2005, we sponsored SFG Capital Trust III, of which 100% of the common equity of each trust is owned by us. SFG Capital Trust I issued $3,500,000 in capital securities and $109,000 in common securities and invested the proceeds in $3,609,000 of debentures. SFG Capital Trust II issued $7,500,000 in capital securities and $232,000 in common securities and invested the proceeds in $7,732,000 of debentures. SFG Capital Trust III issued $8,000,000 in capital securities and $248,000 in common securities and invested the proceeds in $8,248,000 of debentures. Distributions on the capital securities issued by the trusts are payable quarterly at a variable interest rate equal to 3 month LIBOR plus 345 basis points for SFG Capital Trust I, 3 month LIBOR plus 280 basis points for SFG Capital Trust II, and 3 month LIBOR plus 145 basis points for SFG Capital Trust III, and equals the interest rate earned on the debentures held by the trusts, and is recorded as interest expense by us. The capital securities are subject to mandatory redemption in whole or in part, upon repayment of the debentures. We have entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of the guarantee. The debentures of SFG Capital Trust I, SFG Capital Trust II, and SFG Capital Trust III are first redeemable by us in November 2007, March 2009, and March 2011, respectively.

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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:

Year Ending
December 31,	Amount
2006	$	14,816,481
2007		23,318,204
2008		24,585,851
2009		3,911,094
2010		52,674,748
Thereafter		44,557,402
	$	163,863,780

Note 9. Stock Option Plan

On January 1, 2006, we adopted SFAS No. 123R, Share-Based Payment (Revised 2004), which is a revision of SFAS No. 123, Accounting for Stock Issued for Employees. SFAS No. 123R establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. Prior to the adoption of SFAS No. 123R, we reported employee compensation expense under stock option plans only if options were granted below market prices at grant date in accordance with the intrinsic value method of Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. In accordance with APB No. 25, we reported no compensation expense on options granted as the exercise price of the options granted always equaled the market price of the underlying stock on the date of grant. SFAS No. 123R eliminated the ability to account for stock-based compensation using APB No. 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant.

We transitioned to SFAS No. 123R using the modified prospective application method ("modified prospective application"). As permitted under modified prospective application, SFAS No. 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for non-vested awards that were outstanding as of January 1, 2006 will be recognized as the remaining requisite service is rendered during the period of and/or the periods after the adoption of SFAS No. 123R, adjusted for estimated forfeitures. The recognition of compensation cost for those earlier awards is based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures reported by us for periods prior to January 1, 2006.

The Officer Stock Option Plan, which provides for the granting of stock options for up to 960,000 shares of common stock to our key officers, was adopted in 1998 and expires in 2008. Each option granted under the plan vests according to a schedule designated at the grant date and shall have a term of no more than 10 years following the vesting date. Also, the option price per share shall not be less than the fair market value of our common stock on the date of grant.

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

The fair value of our employee stock options granted 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 granted but are not considered by the model. Because our employee stock options 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 at the time of grant. The assumptions used in the Black-Scholes option-pricing model are as follows:

	For the Nine Months
	Ended September 30,
	2006			2005
Risk-free interest rate		4.40	%		3.60	%
Expected dividend yield		1.25	%		1.04	%
Volatility factor		25			20
Expected life of option		8			8

There were no option grants during the first nine months of 2006 or 2005. Therefore, the factors for September 30, 2006 and September 30, 2005 are consistent with amounts reported in our 2005 Annual Report and 2004 Annual Report, respectively.

During the first nine months of 2006, we recognized $26,470 of compensation expense for share-based payment arrangements in our income statement, with a deferred tax asset of $10,000. At September 30, 2006, we had approximately $62,000 total compensation cost related to nonvested awards not yet recognized and we expect to recognize it over the next three years.

The following pro forma disclosures present for the quarter and nine months ended September 30, 2005, our reported net income and basic and diluted earnings per share had we recognized compensation expense for our Officer Stock Option Plan based on the grant date fair values of the options (the fair value method described in Statement of Financial Accounting Standards No. 123). For purposes of computing the pro forma amounts, we estimated the fair value of the options at the date of grant using a Black-Scholes option pricing model. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Quarter Ended			Nine Months Ended
(in thousands, except per share data)	September 30, 2005
Net income:
As reported	$	3,273		$	8,800

Deduct total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects		(37	)		(111	)
Pro forma	$	3,236		$	8,689

Basic earnings per share:
As reported	$	0.46		$	1.24
Pro forma	$	0.45		$	1.22

Diluted earnings per share:
As reported	$	0.45		$	1.22
Pro forma	$	0.44		$	1.20

A summary of activity in our Officer Stock Option Plan during the first nine months of 2006 and 2005 is as follows:

	For the Nine Months Ended
	September 30, 2006					September 30, 2005
				Weighted-					Weighted-
				Average					Average
				Exercise					Exercise
	Options			Price		Options			Price
Outstanding, January 1		361,740		$	17.41		284,100		$	15.09
Granted		-			-		-			-
Exercised		(8,900	)		4.89		(9,460	)		12.94
Forfeited		-			-		-			-
Outstanding, September 30		352,840		$	17.73		274,640		$	15.17

Other information regarding options outstanding and exercisable at September 30, 2006 is as follows:

	Options Outstanding								Options Exercisable
					Wted. Avg.		Aggregate						Aggregate
					Remaining		Intrinsic						Intrinsic
Range of	# of				Contractual		Value		# of				Value
exercise price	shares		WAEP		Life (yrs)		(in thousands)		shares		WAEP		(in thousands)
$4.63 - $6.00		85,400	$	5.35		6.17		1,111		78,600	$	5.30		1,027
6.01 - 10.00		33,640		9.49		9.29		298		19,240		9.49		171
10.01 - 17.50		3,500		17.43		7.42		3		3,500		17.43		3
17.51 - 20.00		51,800		17.79		10.21		30		20,600		17.79		12
20.01 - 25.93		178,500		25.19		8.82		-		178,500		25.19		-

		352,840		17.73				1,442		300,440		18.38		1,213

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 10. 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:

	September 30,
	2006
Commitments to extend credit:
Revolving home equity and
credit card lines	$	33,587,424
Construction loans		97,271,727
Other loans		41,711,519
Standby letters of credit		14,721,512
Total	$	187,292,182

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.

Note 11. Restrictions on Capital

We and our subsidiaries are subject to various regulatory capital requirements administered by the banking regulatory agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we and each of our subsidiaries must meet specific capital guidelines that involve quantitative measures of our and our subsidiaries’ assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. We and each of our subsidiaries’ capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Quantitative measures established by regulation to ensure capital adequacy require us and each of our subsidiaries to maintain minimum amounts and ratios of total 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, 2006, that we and each of our subsidiaries met all capital adequacy requirements to which they were subject.

The most recent notifications from the banking regulatory agencies categorized us and each of our subsidiaries as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, we and each of our subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.

Our actual capital amounts and ratios as well as our subsidiaries’, Summit Community Bank’s (“Summit Community”), and Shenandoah Valley National Bank’s (“Shenandoah”) are presented in the following table.

											To be Well Capitalized
						Minimum Required					under Prompt Corrective
(Dollars in thousands)	Actual					Regulatory Capital					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2006
Total Capital (to risk weighted assets)
Summit	$	104,527		11.1	%	$	75,240		8.0	%	$	94,050		10.0	%
Summit Community		59,938		10.7	%		44,780		8.0	%		55,975		10.0	%
Shenandoah		40,219		10.8	%		29,818		8.0	%		37,272		10.0	%
Tier I Capital (to risk weighted assets)
Summit		97,234		10.3	%		37,620		4.0	%		56,430		6.0	%
Summit Community		55,538		9.9	%		22,390		4.0	%		33,585		6.0	%
Shenandoah		37,326		10.0	%		14,909		4.0	%		22,363		6.0	%
Tier I Capital (to average assets)
Summit		97,234		8.2	%		35,727		3.0	%		59,546		5.0	%
Summit Community		55,538		7.6	%		21,865		3.0	%		36,441		5.0	%
Shenandoah		37,326		8.3	%		13,545		3.0	%		22,575		5.0	%

As of December 31, 2005
Total Capital (to risk weighted assets)
Summit	$	96,837		11.4	%		68,010		8.0	%		85,013		10.0	%
Summit Community		54,550		10.4	%		41,792		8.0	%		52,240		10.0	%
Shenandoah		35,834		11.2	%		25,589		8.0	%		31,986		10.0	%
Tier I Capital (to risk weighted assets)
Summit		90,686		10.7	%		34,005		4.0	%		38,897		6.0	%
Summit Community		50,490		9.7	%		20,896		4.0	%		25,363		6.0	%
Shenandoah		33,743		10.5	%		12,794		4.0	%		13,080		6.0	%
Tier I Capital (to average assets)
Summit		90,686		8.6	%		31,764		3.0	%		52,940		5.0	%
Summit Community		50,490		7.5	%		20,251		3.0	%		33,752		5.0	%
Shenandoah		33,743		9.0	%		11,199		3.0	%		18,664		5.0	%

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 12. Segment Information

We operate two business segments: community banking and mortgage banking. These segments are primarily identified by the products or services offered and the channels through which they are offered. The community banking segment consists of our full service banks which offer customers traditional banking products and services through various delivery channels. The mortgage banking segment consists of our mortgage origination facilities that originate and sell mortgage products. Information for each of our segments is included below:

	For the Quarter Ended September 30, 2006
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total

Condensed Statements of Income
Interest income	$	21,096		$	300		$	-		$	12		$	(178	)	$	21,230
Interest expense		11,569			144			-			464			(178	)		11,999
Net interest income		9,527			156			-			(452	)		-			9,231
Provision for loan losses		260			150			-			-			-			410
Net interest income after provision
for loan losses		9,267			6			-			(452	)		-			8,821
Noninterest income		904			4,027			146			1,462			(1,462	)		5,077
Noninterest expense		4,955			5,168			143			1,566			(1,462	)		10,370
Income before income taxes		5,216			(1,135	)		3			(556	)		-			3,528
Income taxes		1,669			(400	)		3			(225	)		-			1,047
Net income	$	3,547		$	(735	)	$	-		$	(331	)	$	-		$	2,481
Intersegment revenue (expense)	$	(1,235	)	$	(219	)	$	(8	)	$	1,462		$	-		$	-
Average assets	$	1,182,638		$	12,335		$	1,035		$	102,458		$	(104,318	)	$	1,194,148

	For the Quarter Ended September 30, 2005
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total

Condensed Statements of Income
Interest income	$	14,619		$	516		$	-		$	7		$	(305	)	$	14,837
Interest expense		6,805			304			-			223			(305	)		7,027
Net interest income		7,814			212			-			(216	)		-			7,810
Provision for loan losses		360			64			-			-			-			424
Net interest income after provision
for loan losses		7,454			148			-			(216	)		-			7,386
Noninterest income		1,012			7,304			149			1,213			(1,213	)		8,465
Noninterest expense		4,437			5,969			149			1,536			(1,213	)		10,878
Income before income taxes		4,029			1,483			-			(539	)		-			4,973
Income taxes		1,277			578			-			(155	)		-			1,700
Net income	$	2,752		$	905		$	-		$	(384	)	$	-		$	3,273
Intersegment revenue (expense)	$	(841	)	$	(364	)	$	(8	)	$	1,213		$	-		$	-
Average assets	$	974,653		$	24,144		$	926		$	84,086		$	(98,603	)	$	985,206

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	For the Nine Months Ended September 30, 2006
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total

Condensed Statements of Income
Interest income	$	58,394		$	1,274		$	-		$	35		$	(724	)	$	58,979
Interest expense		31,079			689			-			1,243			(724	)		32,287
Net interest income		27,315			585			-			(1,208	)		-			26,692
Provision for loan losses		915			370			-			-			-			1,285
Net interest income after provision
for loan losses		26,400			215			-			(1,208	)		-			25,407
Noninterest income		2,637			16,557			524			4,425			(4,425	)		19,718
Noninterest expense		15,101			17,374			496			4,913			(4,425	)		33,459
Income before income taxes		13,936			(602	)		28			(1,696	)		-			11,666
Income taxes		4,445			(192	)		11			(684	)		-			3,580
Net income	$	9,491		$	(410	)	$	17		$	(1,012	)	$	-		$	8,086
Intersegment revenue (expense)	$	(3,486	)	$	(914	)	$	(25	)	$	4,425		$	-		$	-
Average assets	$	1,149,873		$	17,606		$	1,025		$	99,505		$	(107,825	)	$	1,160,184

	For the Nine Months Ended September 30, 2005
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total

Condensed Statements of Income
Interest income	$	40,151		$	1,303		$	-		$	19		$	(820	)	$	40,653
Interest expense		17,501			816			-			588			(820	)		18,085
Net interest income		22,650			487			-			(569	)		-			22,568
Provision for loan losses		1,035			144			-			-			-			1,179
Net interest income after provision
for loan losses		21,615			343			-			(569	)		-			21,389
Noninterest income		2,606			20,273			469			3,572			(3,572	)		23,348
Noninterest expense		13,007			17,622			418			4,333			(3,572	)		31,808
Income before income taxes		11,214			2,994			51			(1,330	)		-			12,929
Income taxes		3,527			1,108			21			(527	)		-			4,129
Net income	$	7,687		$	1,886		$	30		$	(803	)	$	-		$	8,800
Intersegment revenue (expense)	$	(2,568	)	$	(981	)	$	(23	)	$	3,572		$	-		$	-
Average assets	$	926,954		$	22,471		$	973		$	81,184		$	(94,014	)	$	937,568

Summit Financial Group, Inc. and Subsidiaries

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 our wholly owned subsidiaries, Summit Community Bank (“Summit Community”), Shenandoah Valley National Bank (“Shenandoah”), Summit Mortgage, and Summit Insurance Services, LLC for the periods indicated. This discussion and analysis should be read in conjunction with our 2005 audited financial statements and Annual Report on Form 10-K.

This quarterly report contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Act of 1995) that are based on current expectations that involve a number of risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “estimates” and other similar expressions or future or conditional verbs such as “will”, “should”, “would” and “could” are intended to identify such forward-looking statements.

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 changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; 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 economy.

OVERVIEW

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

Strong growth in our interest earning assets resulted in an increase of 17.47%, or $4,112,000, in our net interest earnings on a tax equivalent basis for the first nine months in 2006 compared to the same period of 2005. While our community banking segment’s net income increased 23.47% for the first nine months of 2006 compared to the same period of 2005, our mortgage banking segment incurred a loss of $410,000 for the first nine months of 2006, compared to net income of $1,886,000 for the first nine months of 2005, as we have experienced a sharp decline in mortgage loan originations during 2006.

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 Note 1 to the consolidated financial statements of our 2005 Annual Report on Form 10-K. These policies, along with the disclosures presented in the other 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.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, we have identified the determination of the allowance for loan losses and the valuation of goodwill 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.

The allowance for loan losses represents our estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on our consolidated balance sheet. To the extent actual outcomes differ from our estimates, additional provisions for loan losses may be required that would negatively impact earnings in future periods. Note 1 to the consolidated financial statements of our 2005 Annual Report on Form 10-K describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses is included in the Asset Quality section of the financial review of the 2005 Annual Report on Form 10-K.

Goodwill is subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. A fair value is determined based on at least one of three various market valuation methodologies. If the fair value equals or exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value is less than the book value, an expense may be required on our books to write down the goodwill to the proper carrying value. During the third quarter, we completed the required annual impairment test for 2006 and determined that no impairment write-offs were necessary. We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Notes 1 and 8 of the consolidated financial statements of our Annual Report on Form 10-K for further discussion of our intangible assets, which include goodwill.

BUSINESS SEGMENT RESULTS

We are organized and managed along two major business segments, as described in Note 12 of the accompanying consolidated financial statements. The results of each business segment are intended to reflect each segment as if it were a stand alone business. Net income by segment follows:

	For the Quarter Ended						For the Nine Months Ended
	September 30,						September 30,
in thousands	2006			2005			2006			2005
Community Banking	$	3,547		$	2,752		$	9,491		$	7,687
Mortgage Banking		(735	)		905			(410	)		1,886
Parent and Other		(331	)		(384	)		(995	)		(773	)
Consolidated net income	$	2,481		$	3,273		$	8,086		$	8,800

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

RESULTS OF OPERATIONS

Earnings Summary

Net income for the nine months ended September 30, 2006 declined 8.11% to $8,086,000, or $1.12 per diluted share as compared to $8,800,000, or $1.22 per diluted share for the nine months ended September 30, 2005. For the quarter ended September 30, 2006, net income declined 24.21% to $2,481,000 from the $3,273,000 net income for the third quarter 2005. Returns on average equity and assets for the first nine months of 2006 were 13.86% and 0.93%, respectively, compared with 16.85% and 1.25% for the same period of 2005.

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.

Our net interest income on a fully tax-equivalent basis totaled $27,643,000 for the nine month period ended September 30, 2006 compared to $23,531,000 for the same period of 2005, representing an increase of $4,112,000 or 17.47%. This increase resulted from growth in interest earning assets, primarily loans, which served to more than offset the 126 basis points increase in the cost of interest bearing liabilities during the same period. Average interest earning assets grew 24.57% from $885,773,000 during the first nine months of 2005 to $1,103,395,000 for the first nine months of 2006. Average interest bearing liabilities grew 25.81% from $800,960,000 at September 30, 2005 to $1,007,694,000 at September 30, 2006 at an average cost for the first nine months of 2006 of 4.28% compared to 3.02% for the same period of 2005.

Our net yield on interest earning assets decreased to 3.35% for the nine month period ended September 30, 2006, compared to 3.55% for the same period in 2005. On a quarterly basis, our net interest margin increased slightly to 3.33% at September 30, 2006, from 3.32% for the quarter ended June 30, 2006. The positive impact to net interest income of our growth in interest earning assets was somewhat offset by increased cost of interest bearing liabilities, which tend to move more proportionately with rate increases by the Fed. The yields on earning assets increased 98 basis points, while the cost of our interest bearing funds increased by 126 basis points.

We anticipate modest growth in our net interest income to continue over the near term due to growth in the volume of interest earning assets. However, if market interest rates remain significantly unchanged, or go lower over the next 12 to 18 months, the spread between interest earning assets and interest bearing liabilities could narrow such that its impact could not be offset by growth in earning assets. See the “Market Risk Management” section for further discussion of the impact changes in market interest rates could have on us. Further analysis of our yields on interest earning assets and interest bearing liabilities are presented in Tables I and II below.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Table I - Average Balance Sheet and Net Interest Income Analysis
(Dollars in thousands)
	For the Nine Months Ended
	September 30, 2006								September 30, 2005
	Average			Earnings/		Yield/			Average			Earnings/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest earning assets
Loans, net of unearned income
Taxable	$	857,851		$	50,180		7.82	%	$	663,287		$	33,421		6.74	%
Tax-exempt (1)		8,373			476		7.60	%		8,884			485		7.30	%
Securities
Taxable		189,768			6,837		4.82	%		162,852			5,229		4.29	%
Tax-exempt (1)		45,950			2,385		6.94	%		47,984			2,402		6.69	%
Federal funds sold and interest
bearing deposits with other banks		1,453			52		4.78	%		2,766			79		3.82	%
Total interest earning assets		1,103,395			59,930		7.26	%		885,773			41,616		6.28	%

Noninterest earning assets
Cash & due from banks		13,760								16,567
Premises and equipment		23,552								20,730
Other assets		26,160								20,008
Allowance for loan losses		(6,683	)							(5,510	)
Total assets	$	1,160,184							$	937,568

Interest bearing liabilities
Interest bearing demand deposits	$	213,518		$	5,410		3.39	%	$	141,168		$	1,868		1.77	%
Savings deposits		40,826			311		1.02	%		48,699			235		0.65	%
Time deposits		428,224			13,601		4.25	%		308,334			6,849		2.97	%
Short-term borrowings		148,876			5,572		5.00	%		131,459			3,124		3.18	%
Long-term borrowings
and capital trust securities		176,250			7,393		5.61	%		171,300			6,009		4.69	%
Total interest bearing liabilities		1,007,694			32,287		4.28	%		800,960			18,085		3.02	%

Noninterest bearing liabilities
and shareholders' equity
Demand deposits		64,618								60,252
Other liabilities		10,059								6,707
Shareholders' equity		77,813								69,649
Total liabilities and
shareholders' equity	$	1,160,184							$	937,568
Net interest earnings				$	27,643							$	23,531
Net yield on interest earning assets							3.35	%							3.55	%

(1) - Interest income on tax-exempt securities has been adjusted assuming an effective tax rate of 34% for both periods presented. The tax equivalent adjustment resulted in an

increase in interest income of $951,000 and $962,000 for the periods ended September 30, 2006 and 2005, respectively.

[

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Table II - Changes in Interest Margin Attributable to Rate and Volume
(Dollars in thousands)
	For the Nine Months Ended
	September 30, 2006 versus September 30, 2005
	Increase (Decrease)
	Due to Change in:
	Volume			Rate			Net
Interest earned on:
Loans
Taxable	$	10,822		$	5,937		$	16,759
Tax-exempt		(29	)		20			(9	)
Securities
Taxable		925			683			1,608
Tax-exempt		(104	)		87			(17	)
Federal funds sold and interest
bearing deposits with other banks		(44	)		17			(27	)
Total interest earned on
interest earning assets		11,570			6,744			18,314

Interest paid on:
Interest bearing demand
deposits		1,271			2,271			3,542
Savings deposits		(43	)		119			76
Time deposits		3,207			3,545			6,752
Short-term borrowings		459			1,989			2,448
Long-term borrowings and capital
trust securities		178			1,206			1,384
Total interest paid on
interest bearing liabilities		5,072			9,130			14,202

Net interest income	$	6,498		$	(2,386	)	$	4,112

Noninterest Income

Total noninterest income decreased to $5,077,000 for the third quarter of 2006, compared to $8,465,000 for the same period of 2005 due to a sharp decline in mortgage origination revenue. Mortgage origination revenue declined to $4,027,000 for the third quarter of 2006, compared to $7,304,000 for the same period of 2005. This revenue includes mortgage loan origination and sales activity conducted through Summit Mortgage. Further detail regarding noninterest income is reflected in the following table. Also, refer to Note 12 of the accompanying consolidated financial statements for our segment information.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Noninterest Income
Dollars in thousands	For the Quarter Ended				For the Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
Insurance commissions	$	219	$	222	$	696	$	605
Service fees		700		711		2,056		1,909
Mortgage origination revenue		4,027		7,304		16,557		20,273
Securities gains (losses)		-		39		-		44
Other		131		189		409		517
Total	$	5,077	$	8,465	$	19,718	$	23,348

Insurance commissions: These commissions increased 15.04% for nine months ended September 30, 2006 over the same period of 2005 primarily due to increased commercial lines commissions earned by Summit Insurance Services, LLC.

Service fees: Total service fees increased 7.70% for the nine months ended September 30, 2006 compared to the same period of 2005. This increase was primarily attributable to an increase in overdraft and nonsufficient funds (NSF) fees due to increased overdrafts by customers.

Mortgage origination revenue: The following table shows our mortgage origination segment’s loan activity:

	For the Quarter Ended				For the Nine Months Ended
	September 30,				September 30,
Dollars in thousands	2006		2005		2006		2005
Loans originated
1st mortgage
Amount	$	14,045	$	18,771	$	38,809	$	43,565
Number		78		104		210		240
2nd mortgage
Amount	$	35,500	$	65,089	$	150,833	$	192,840
Number		803		1,463		3,279		4,213
Total
Amount	$	49,545	$	83,860	$	189,642	$	236,405
Number		881		1,567		3,489		4,453

Loans sold
Amount	$	52,496	$	87,071	$	198,186	$	235,254
Number		935		1,566		3,660		4,410

Summit Mortgage originates loans solely for the purpose of selling them. We do not service these loans, therefore there is no servicing intangible associated with this segment. Our mortgage banking revenue consists entirely of two components: 1) fees collected at the time of origination and 2) the gains we receive when selling the loans. The breakout of these fees and gains follows:

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Mortgage Origination Revenue

For the Quarter Ended

For the Nine Months Ended

September 30,

Dollars in thousands

2006

2005

2006

2005

Origination fees, net

2,560

4,279

9,988

11,879

Gains

1,467

3,025

6,569

8,394

Total

4,027

7,304

16,557

20,273

Loan originations in the third quarter of 2006 were $49.5 million, a decline of 40.9 percent from the prior-year third quarter. For the nine months ended September 30, 2006, loan originations were $189,642,000 as compared to $236,405,000 for the same period of 2005, a decrease of 19.8%. The decrease in activity is principally the result of reduced response rates to our direct mail marketing programs. We continue to revise these programs seeking to improve their efficiency. Also, we believe that several other factors have contributed to this business segment’s slowdown, including changes in the legal environment within the industry, increased competition in the overall market for the types of mortgage products offered by Summit Mortgage, and the payment of legal expenses arising from legal compliance reviews and litigation defense. Management is currently conducting an intense review of this business segment, but does not anticipate profitability during 4^th quarter 2006. Further, we continue to evaluate this business segment strategically.

Other: Other income decreased 30.69% for the third quarter of 2006 and 20.89% for the nine months ended September 30, 2006 compared to the same respective periods of 2005. Our increase in debit card and ATM income due to increased card usage by customers was more than offset by decreases in both financial services revenue and derivative income.

Noninterest Expense

Total noninterest expense increased approximately $1,651,000, or 5.2% to $33,459,000 during the first nine months of 2006 as compared to the same period in 2005 and declined $508,000 or 4.7% for third quarter 2006 compared to third quarter 2005. The primary factors contributing to the nine month growth in noninterest expense were 1) an increase in postage expense due to the postal service rate increase and 2) an increase in professional fees, as a result of increased legal expenses arising from legal compliance reviews and litigation defense. The quarterly decrease is primarily attributable to decreased salaries and employee benefits due to lower commissions earned by Summit Mortgage employees and reduced performance based incentives paid to both Company management and

Summit Mortgage management. Table III below shows the breakdown of these changes by segment. Also, refer to Note 12 of the accompanying consolidated financial statements for our segment information.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Table III - Noninterest Expense

Dollars in thousands

For the Quarter Ended September 30,

For the Nine Months Ended September 30,

Change

Community Banking and Other

2006

2005

2006

2005

Salaries and employee benefits

2,817

0.7

2,797

8,921

881

11.0

8,040

Net occupancy expense

388

7.8

360

1,179

166

16.4

1,013

Equipment expense

475

12.8

421

1,421

116

8.9

1,305

Supplies

214

52.9

140

603

174

40.6

429

Professional fees

188

(13

)

-6.5

201

641

100

18.5

541

Postage

33.8

207

19.7

173

Advertising

(45

)

-41.3

109

263

(51

)

-16.2

314

Amortization of intangibles

0.0

113

0.0

113

Other

927

152

19.6

775

2,737

479

21.2

2,258

Total

5,202

293

6.0

4,909

16,085

1,899

13.4

14,186

Change

Mortgage Banking

2006

2005

2006

2005

Salaries and employee benefits

1,485

(1,153

)

-43.7

2,638

5,394

(1,937

)

-26.4

7,331

Net occupancy expense

177

48.7

119

527

169

47.2

358

Equipment expense

77.3

227

66.9

136

Supplies

(13

)

-46.4

10.3

Professional fees

186

157

541.4

508

350

221.5

158

Postage

1,587

204

14.8

1,383

5,012

709

16.5

4,303

Advertising

1,128

6.9

1,055

3,582

185

5.4

3,397

Other

512

(161

)

-23.9

673

2,038

177

9.5

1,861

Total

5,168

(801

)

-13.4

5,969

17,374

(248

)

-1.4

17,622

Change

Consolidated

2006

2005

2006

2005

Salaries and employee benefits

4,302

(1,133

)

-20.8

5,435

14,315

(1,056

)

-6.9

15,371

Net occupancy expense

565

18.0

479

1,706

335

24.4

1,371

Equipment expense

553

18.9

465

1,648

207

14.4

1,441

Supplies

229

36.3

168

689

182

35.9

507

Professional fees

374

144

62.6

230

1,149

450

64.4

699

Postage

1,678

227

15.6

1,451

5,219

743

16.6

4,476

Advertising

1,192

2.4

1,164

3,845

134

3.6

3,711

Amortization of intangibles

0.0

113

0.0

113

Other

1,439

)

-0.6

1,448

4,775

656

15.9

4,119

Total

10,370

(508

)

-4.7

10,878

33,459

1,651

5.2

31,808

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Community Banking, Parent and Other Segments

Total noninterest expense for our community banking segment, parent, and other increased $293,000, or 6.0% for the third quarter of 2006, compared to the same period of 2005 and $1,899,000, or 13.4% for the nine months ended September 30, 2006 versus the same period of 2005. The major factors contributing to these increases follow.

Salaries and employee benefits: Salaries and employee benefits expense increased 11.0% for the nine months ended September 30, 2006 compared to the same period of 2005 due to additional staffing requirements needed as a result of our growth, including opening a new community banking office in Warrenton, Virginia in mid-2005 and one in Martinsburg, West Virginia during second quarter 2006. Also included in this increase are general merit raises.

Other: Other expenses increased 19.6% for third quarter 2006 compared to third quarter 2005, and 21.3% for the nine months ended September 30, 2006 compared to the same period of 2005. These increases include $79,000 of losses in fraudulent checks during the nine months ended September 30, 2006.

Mortgage Banking Segment

Total noninterest expense for our mortgage banking segment decreased 13.4% for the third quarter of 2006 compared to third quarter 2005 and 1.4% for the nine months ended September 30, 2006 compared to the same period of 2005.

Salaries and employee benefits: The decrease of $1,153,000 in salaries and employee benefits for the quarter ended September 30, 2006 and $1,937,000 for the nine months ended September 30, 2006 is comprised primarily of 1) lower loan officer commissions paid due to decreased loan production and 2) a decrease in profitability based incentive compensation paid to Summit Mortgage management.

Net occupancy expense: Net occupancy expense increased 48.7% for the third quarter 2006 compared to the same period of 2005 and 47.2% for the first nine months of 2006 compared to comparable period of 2005 due to the relocation of our Summit Mortgage headquarters to Chesapeake, Virginia in late 2005.

Professional fees: Professional fees increased 541.4% for the third quarter 2006, compared to the third quarter 2005, and 221.5% for the nine months ended September 30, 2006 compared to the same period of 2005. This increase is primarily attributable to increased legal expenses arising from legal compliance reviews and litigation defense.

Postage: The increase in postage expense of $204,000 and $709,000 for the quarter and nine months ended September 30, 2006, respectively, was primarily the result of a rate increase by the US Postal Service.

Other: The decrease of $161,000, or 23.9%, in other expenses for third quarter 2006 compared to third quarter 2005 is primarily attributable to decreased loan origination costs directly related to the number of loans originated.

Credit Experience

The provision for loan losses represents charges to earnings necessary to maintain an adequate allowance for potential future loan losses. 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.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

We recorded a $1,285,000 provision for loan losses for the first nine months of 2006, compared to $1,179,000 for the same period in 2005. Net loan charge offs for the first nine months of 2006 were $329,000, as compared to $331,000 over the same period of 2005. At September 30, 2006, the allowance for loan losses totaled $7,107,000 or 0.78% of loans, both portfolio and held for sale, net of unearned income, compared to $6,152,000 or 0.75% at December 31, 2005. Our asset quality remains sound. As illustrated in Table IV below, our non-performing assets and loans past due 90 days or more and still accruing interest have increased during the past 12 months, but still remain at a historically moderate level.

Table IV - Summary of Past Due Loans and Non-Performing Assets
(Dollars in thousands)
	September 30,						December 31,
	2006			2005			2005
Accruing loans past due 90 days or more	$	728		$	371		$	799
Nonperforming assets:
Nonaccrual loans		1,239			646			750
Foreclosed properties		249			830			378
Repossessed assets		6			32			17
Total	$	2,222		$	1,879		$	1,944
Total nonperforming loans as a
percentage of total loans		0.22	%		0.14	%		0.19	%
Total nonperforming assets as a
percentage of total assets		0.18	%		0.18	%		0.18	%

FINANCIAL CONDITION

Our total assets were $1,210,491,000 at September 30, 2006, compared to $1,109,532,000 at December 31, 2005, representing a 9.1% increase. Table V below serves to illustrate significant changes in our financial position between December 31, 2005 and September 30, 2006.

Table V - Summary of Significant Changes in Financial Position
(Dollars in thousands)

	Balance								Balance
	December 31,		Increase (Decrease)						September 30,
	2005		Amount			Percentage			2006
Assets
Securities available for sale	$	223,772		22,560			10.1	%	$	246,332
Loans, net of unearned income		799,919		102,454			12.8	%		902,373

Liabilities
Deposits	$	673,901	$	191,161			28.4	%	$	865,062
Short-term borrowings		182,028		(91,606	)		-50.3	%		90,422
Long-term borrowings
and subordinated debentures		170,501		(6,637	)		-3.9	%		163,864

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Loan growth during the first nine months of 2006, occurring principally in the commercial and real estate portfolios, was funded primarily by deposits, including brokered certificates of deposit.

Refer to Notes 3, 4, 7, and 8 of the notes to the accompanying consolidated financial statements for additional information with regard to changes in the composition of our securities, loans, deposits and borrowings between September 30, 2006 and December 31, 2005.

LIQUIDITY

Liquidity reflects our ability to ensure the availability of adequate funds to meet loan commitments and deposit withdrawals, as well as provide for other transactional requirements. Liquidity is provided primarily by funds invested in cash and due from banks, Federal funds sold, non-pledged securities, and available lines of credit with the FHLB, the total of which approximated $268 million, or 22.2% of total assets at September 30, 2006 versus $125 million, or 11.3% of total assets at December 31, 2005.

Our liquidity position is monitored continuously 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.

CAPITAL RESOURCES

One of our continuous goals is maintenance of a strong capital position. Through management of our capital resources, we seek to provide an attractive financial return to our shareholders while retaining sufficient capital to support future growth. Shareholders’ equity at September 30, 2006 totaled $80,630,000 compared to $73,803,000 at December 31, 2005.

Refer to Note 11 of the notes to the accompanying consolidated financial statements for information regarding regulatory restrictions on our capital as well as our subsidiaries’ capital.

On August 8, 2006, the Board of Directors authorized the open market repurchase of up to 225,000 shares (approximately 3%) of the issued and outstanding shares of Summit’s common stock. During third quarter 2006, we repurchased 32,400 shares under this plan.

CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations. The following table summarizes our contractual cash obligations at September 30, 2006.

	Long		Capital
	Term		Trust		Operating
	Debt		Securities		Leases
2006	$	14,816,481	$	-	$	271,544
2007		23,318,204		-		1,066,920
2008		24,585,851		-		982,772
2009		3,911,094		-		431,349
2010		52,674,748		-		116,263
Thereafter		44,557,402		19,589,000		257,140
Total	$	163,863,780	$	19,589,000	$	3,125,988

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

OFF-BALANCE SHEET ARRANGEMENTS

We are involved with some off-balance sheet arrangements that have or are reasonably likely to have an effect on our financial condition, liquidity, or capital. These arrangements at September 30, 2006 are presented in the following table.

	September 30,
	2006
Commitments to extend credit:
Revolving home equity and
credit card lines	$	33,587,424
Construction loans		97,271,727
Other loans		41,711,519
Standby letters of credit		14,721,512
Total	$	187,292,182

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 liability sensitive in year one, with asset sensitivity over the longer period. That is, in the first year, liabilities are likely to reprice faster than assets,

resulting in a decrease in net income in a rising rate and environment, and beyond the first year, assets are likely to reprice faster than liabilities, resulting in an increase in net income in a rising rate environment. Our net income would increase modestly in a falling interest rate environment. Net income is also subject to changes in the shape of the yield curve. In general, a flattening yield curve would result in a decline in our earnings due to the compression of earning asset yields and funding rates, while a steepening would result in increased earnings as margins widen.

Several techniques are available to monitor and control the level of interest rate risk. We primarily use earnings simulations modeling to monitor interest rate risk. The earnings simulation model forecasts the effects on net interest income under a variety of interest rate scenarios that incorporate changes in the absolute level of interest rates and changes in the shape of the yield curve. Each increase or decrease in interest rates is assumed to take place over the next 12 months, 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.

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

The following table shows our projected earnings sensitivity as of September 30, 2006 which is well within our ALCO policy limit of - 10%:

Change in	Estimated % Change in Net
Interest Rates	Interest Income Over:
(basis points)	12 Months			24 Months
Down 200 (1)		1.41	%		3.09	%
Down 200, steepening yield curve (2)		2.37	%		8.98	%
Up 100 (1)		-1.07	%		-0.07	%
Up 200 (1)		-2.94	%		-6.33	%

(1) assumes a parallel shift in the yield curve

(2) assumes steepening curve whereby short term rates decline by 200 basis points while long term rates decline by 50 basis points

CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, have conducted as of September 30, 2006, an evaluation of the effectiveness of disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures as of September 30, 2006 were effective. There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

Item 1. Legal Proceedings

We are involved in various legal actions arising in the ordinary course of business. In the opinion of counsel, the outcome of these matters will not have a significant adverse effect on the consolidated financial statements.

On December 26, 2003, two of our subsidiaries, Summit Financial, LLC and Shenandoah Valley National Bank, and various employees of Summit Financial, LLC were served with a Petition for Temporary Injunction and a Bill of Complaint filed in the Circuit Court of Fairfax County, Virginia by Corinthian Mortgage Corporation. The filings allege various claims against Summit Financial, LLC and Shenandoah Valley National Bank arising out of the hiring of former employees of Corinthian Mortgage Corporation (“Corinthian “) and the alleged use of trade secrets. The individual defendants have also been sued based on allegations arising out of their former employment relationship with Corinthian and their employment with Summit Financial, LLC. Summit Financial, LLC now operates as Summit Mortgage, a division of Shenandoah Valley National Bank.

The plaintiff seeks damages in the amount proven at trial on each claim and punitive damages in the amount of $350,000 on each claim. Plaintiff also seeks permanent and temporary injunctive relief prohibiting the alleged use of trade secrets by Summit Financial and the alleged solicitation of Corinthian’s employees. On January 22, 2004, we successfully defeated the Petition for Temporary Injunction brought against us by Corinthian. The Circuit Court of Fairfax County, Virginia denied Corinthian’s petition.

After consultation with legal counsel, we believe that significant and meritorious defenses exist as to all the claims. We will continue to evaluate the claims in the Corinthian lawsuit and intend to vigorously defend against them. Management, at the present time, is unable to estimate the impact, if any, an adverse decision may have on our results of operations or financial condition.

On October 13, 2006, Corinthian filed a Motion to Amend its Complaint. Among other things, Corinthian will seek to add Summit Financial Group, Inc as a defendant in the case. The Motion to Amend will be heard on November 17, 2006. The Company does not intend to oppose the filing of the Motion to Amend, but will file appropriate responsive pleadings if the motion is granted.

On January 4, 2006, Mary Forrest, an individual, filed suit in the United States District Court for the Eastern District of Wisconsin, Milwaukee Division, against our subsidiary, Shenandoah Valley National Bank (“Shenandoah”). Further, on May 19, 2006, Marti L. Klutho, an individual, filed suit in the United States District Court for the Eastern District of Missouri, Eastern Division, also against Shenandoah. The plaintiffs in each case claim that Shenandoah violated the Federal Fair Credit Reporting Act (“FCRA”) alleging that Shenandoah used information contained in their consumer reports, without extending a “firm offer of credit” within the meaning of the FCRA. Plaintiffs request statutory damages. These cases are purported class actions. Presently, we do not have final information as to the size of the alleged classes. Responsive pleadings have been filed, and discovery is in the initial stages. We will continue to evaluate the claims in these lawsuits and intend to vigorously defend against them. Management, at the present time, is unable to estimate the impact, if any, an adverse decision may have on our results of operations or financial condition.

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, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

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

(a) Not applicable.

(b) Not applicable.

(c) In August 2006, the Board of Directors authorized the open market repurchase of up to 225,000 shares (approximately 3%) of the issued and outstanding shares of Summit’s common stock (“August 2006 Repurchase Plan”). The timing and quantity of purchases under this stock repurchase plan will be at the discretion of management, and the plan may be discontinued, or suspended and reinitiated, at any time.

The following table sets forth certain information regarding Summit’s purchase of its common stock under the Repurchase Plan and Summit’s Employee Stock Ownership Plan during the quarter ended September 30, 2006.

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 (b)		Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs (c)
July 1, 2006 - July 31, 2006		2,000	$	18.60		-		225,000
August 1, 2006 - August 31, 2006		25,000		19.03		18,000		207,000
September 1, 2006 - September 30, 2006		17,600		19.04		14,400		192,600

(a) Includes shares repurchased under the August 2006 Repurchase Plan and shares acquired under the Company’s Employee Stock Ownership Plan (the ESOP).

(b) Included in total number of shares purchased [column (a)].

SIGNATURES

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

	SUMMIT FINANCIAL GROUP, INC.
	(registrant)




	By:	/s/ H. Charles Maddy, III
	H. Charles Maddy, III,
	President and Chief Executive Officer



	By:	/s/ Robert S. Tissue
	Robert S. Tissue,
	Senior Vice President and Chief Financial Officer



	By:	/s/ Julie R. Cook
	Julie R. Cook,
	Vice President and Chief Accounting Officer


Date: November 6, 2006