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

FORM 10 - Q

[X]   [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
                                                                               & #160;   EXCHANGE ACT OF 1934   

For the quarterly period ended September 30, 2006March 31, 2007.
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

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
7,087,9207,084,980 shares outstanding as of November 6, 2006May 4, 2007
 
Summit Financial Group, Inc. and Subsidiaries
Table of Contents


 

   Page
PART I.
FINANCIAL INFORMATION
 
    
 Item 1.Financial Statements 
    
  
Consolidated balance sheets
September 30, 2006March 31, 2007 (unaudited), December 31, 2005,2006, and September 30, 2005March 31, 2006 (unaudited)
4
    
  
Consolidated statements of income
for the three months and nine months ended
September 30,March 31, 2007 and 2006 and 2005 (unaudited)
5
    
  
Consolidated statements of shareholders’ equity
for the ninethree months ended
September 30,March 31, 2007 and 2006 and 2005 (unaudited)
6
    
  
Consolidated statements of cash flows
for the ninethree months ended
September 30,March 31, 2007 and 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
3432
    
 Item 4.
Controls and Procedures
3533

2
Summit Financial Group, Inc. and Subsidiaries
Table of Contents



    
PART II.
OTHER INFORMATION
 
 Item 1.
Legal Proceedings
3634
    
 Item 1A.
Risk Factors
3635
    
 Item 2.
Unregistered Sales of EquityChanges in Securities and Use of Proceeds
37None
    
 Item 3.Defaults upon Senior SecuritiesNone
    
 Item 4.Submission of Matters to a Vote of Security HoldersNone
    
 Item 5.Other InformationNone
    
 Item 6.Exhibits 
    
  Exhibits
Exhibit 11.3.1 By-Laws of Summit Financial Group, Inc. as last amended and restated on April 27, 2007
Exhibit 10.1 Chief Banking Officer Incentive Plan
Exhibit 11Statement re: Computation of Earnings per Share - Information contained in Note 24 to the Consolidated Financial Statements on page 911 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
 3836


 

3
Summit Financial Group, Inc. and Subsidiaries
Consolidated Balance Sheets (unaudited)


 



  
March 31,
 
December 31,
 
March 31,
 
  
2007
 
2006
 
2006
 
  
(unaudited)
 
(*)
 
(unaudited)
 
ASSETS
       
Cash and due from banks $12,232,258 $12,030,969 $14,780,214 
Interest bearing deposits with other banks  105,752  270,589  1,658,080 
Federal funds sold  1,412,000  517,000  607,000 
Securities available for sale  258,172,895  247,874,120  233,804,893 
Loans, net  930,768,989  916,045,185  824,359,382 
Property held for sale  42,000  41,000  268,287 
Premises and equipment, net  22,178,553  22,445,635  22,782,107 
Accrued interest receivable  6,656,344  6,351,575  4,845,037 
Intangible assets  3,158,732  3,196,520  3,309,885 
Other assets  17,027,641  16,343,431  16,699,264 
Assets related to discontinued operations  2,169,610  9,714,749  14,577,381 
Total assets
 $1,253,924,774 $1,234,830,773 $1,137,691,530 
           
LIABILITIES AND SHAREHOLDERS' EQUITY
          
Liabilities          
Deposits          
Non interest bearing $60,644,647 $62,591,493 $62,860,714 
Interest bearing  816,580,699  826,096,142  667,876,124 
Total deposits
  877,225,346  888,687,635  730,736,838 
Short-term borrowings  79,886,486  60,427,675  136,482,684 
Long-term borrowings  182,225,213  174,292,074  163,547,368 
Subordinated debentures owed to unconsolidated subsidiary trusts  19,589,000  19,589,000  19,589,000 
Other liabilities  10,959,819  9,849,834  10,763,518 
Liabilities realted to discontinued operations  1,104,319  2,109,320  755,962 
Total liabilities
  1,170,990,183  1,154,955,538  1,061,875,370 
           
Commitments and Contingencies
          
           
Shareholders' Equity
          
Common stock and related surplus, $2.50 par value;          
authorized 20,000,000 shares, issued and outstanding          
2007 - 7,084,980 shares; issued December 2006 - 7,084,980          
shares; issued March 2006 - 7,134,920 shares  18,028,656  18,020,591  18,905,744 
Retained earnings  64,807,164  62,206,325  59,186,406 
Accumulated other comprehensive income  98,771  (351,681) (2,275,990)
Total shareholders' equity
  82,934,591  79,875,235  75,816,160 
           
Total liabilities and shareholders' equity
 $1,253,924,774 $1,234,830,773 $1,137,691,530 
  
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, 20052006 financial information has been extracted from audited consolidated financial statements


See Notes to Consolidated Financial Statements

4
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 


  
Three Months Ended
 
  
March 31,
 
March 31,
 
  
2007
 
2006
 
Interest income
       
Interest and fees on loans       
Taxable $18,597,172 $15,140,378 
Tax-exempt  115,189  99,745 
Interest and dividends on securities       
Taxable  2,579,027  2,134,877 
Tax-exempt  544,882  511,765 
Interest on interest bearing deposits with other banks  2,692  16,457 
Interest on Federal funds sold  3,185  7,768 
Total interest income
  21,842,147  17,910,990 
Interest expense
       
Interest on deposits  9,028,100  5,153,192 
Interest on short-term borrowings  958,063  1,963,989 
Interest on long-term borrowings and subordinated debentures  2,831,973  2,414,469 
Total interest expense
  12,818,136  9,531,650 
Net interest income
  9,024,011  8,379,340 
Provision for loan losses  390,000  325,000 
Net interest income after provision for loan losses
  8,634,011  8,054,340 
Other income
       
Insurance commissions  206,083  230,066 
Service fees  616,914  630,890 
Gain (loss) on sale of assets  1,828  (3,875)
Other  187,623  146,279 
Total other income
  1,012,448  1,003,360 
Other expense
       
Salaries and employee benefits  3,225,616  3,055,157 
Net occupancy expense  418,298  401,119 
Equipment expense  446,111  449,568 
Supplies  172,118  165,879 
Professional fees  174,334  207,534 
Postage  67,224  55,700 
Advertising  24,551  48,886 
Amortization of intangibles  37,788  37,788 
Other  1,083,306  939,498 
Total other expense
  5,649,346  5,361,129 
Income before income taxes
  3,997,113  3,696,571 
Income tax expense  1,201,050  1,107,850 
Income from continuing operations
 $2,796,063 $2,588,721 
Discontinued Operations
       
Reversal of severance in exit costs  80,011  - 
Operating income(loss)  (371,736) 608,878 
Income from discontinued operations before income tax expense(benefit)
  (291,725) 608,878 
Income tax expense(benefit)  (96,500) 226,000 
Income from discontinued operations
  (195,225) 382,878 
Net Income
 $2,600,838 $2,971,599 
        
Basic earnings from continuing operations per common share
 $0.40 $0.36 
Basic earnings per common share
 $0.37 $0.42 
        
Diluted earnings from continuing operations per common share
 $0.39 $0.36 
Diluted earnings per common share
 $0.36 $0.41 
        
See Notes to Consolidated Financial Statements

5
Summit Financial Group, Inc. and Subsidiaries
Consolidated Statements of Shareholders’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 
      
Accumulated
   
  
Common
   
Other
 
Total
 
  
Stock and
   
Compre-
 
Share-
 
  
Related
 
Retained
 
hensive
 
holders'
 
  
Surplus
 
Earnings
 
Income
 
Equity
 
          
Balance, December 31, 2006
 $18,020,591 $62,206,325 $(351,681)$79,875,235 
Three Months Ended March 31, 2007
         
Comprehensive income:             
Net income  -  2,600,838  -  2,600,838 
Other comprehensive income,             
net of deferred tax expense             
of $276,083:             
Net unrealized gain on             
securities of $450,452, net             
of reclassification adjustment             
for gains included in net             
income of $0  -  -  450,452  450,452 
Total comprehensive income           3,051,290 
Exercise of stock options  8,065  -  -  8,065 
              
Balance, March 31, 2007
 $18,028,656 $64,807,163 $98,771 $82,934,590 
              
              
Balance, December 31, 2005
 $18,856,774 $56,214,807 $(1,268,356)$73,803,225 
Three Months Ended March 31, 2006
         
Comprehensive income:             
Net income  -  2,971,599  -  2,971,599 
Other comprehensive income,             
net of deferred tax benefit             
of ($617,582):             
Net unrealized (loss) on             
securities of ($1,007,634)  -  -  (1,007,634) (1,007,634)
Total comprehensive income           1,963,965 
Exercise of stock options  48,970  -  -  48,970 
              
Balance, March 31, 2006
 $18,905,744 $59,186,406 $(2,275,990)$75,816,160 
 
See Notes to Consolidated Financial Statements


6
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

7
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 
  
Three Months Ended
 
  
March 31,
 
March 31,
 
  
2007
 
2006
 
Cash Flows from Operating Activities
       
Net income $2,600,838 $2,971,599 
Adjustments to reconcile net earnings to net cash       
provided by operating activities:       
Depreciation  385,779  411,139 
Provision for loan losses  640,000  395,000 
Stock compensation expense  8,065  6,617 
Deferred income tax (benefit)  28,200  (127,450)
Loans originated for sale  (8,149,409) (73,051,790)
Proceeds from loans sold  15,674,280  80,031,236 
(Gain) on sales of loans held for sale  (286,302) (2,737,342)
Securities (gains)  -  - 
Reversal of exit costs accrual of discontinued operations  (80,192)   
Loss on disposal of other assets  (1,828) 3,875 
Amortization of securities premiums, net  (14,781) 66,874 
Amortization of goodwill and purchase accounting       
adjustments, net  40,671  40,670 
(Decrease) in accrued interest receivable  (304,957) (21,454)
(Increase) in other assets  (818,316) (281,102)
Increase in other liabilities  526,873  1,695,198 
Net cash provided by (used in) operating activities
  10,248,921  9,403,070 
Cash Flows from Investing Activities
       
Net (increase) decrease in interest bearing deposits       
with other banks  164,837  (121,574)
Proceeds from maturities and calls of securities available for sale  4,484,392  955,937 
Proceeds from sales of securities available for sale  1,623,800  2,905,400 
Principal payments received on securities available for sale  6,817,338  5,585,097 
Purchases of securities available for sale  (22,498,098) (21,145,507)
Net (increase) decrease in Federal funds sold  (895,000) 3,043,000 
Net loans made to customers  (15,361,000) (31,652,753)
Purchases of premises and equipment  (122,839) (798,637)
Proceeds from sales of other assets  85,675  16,695 
Purchase of life insurance contracts  -  (440,000)
Net cash provided by (used in) investing activities
  (25,700,895) (41,652,342)
Cash Flows from Financing Activities
       
Net increase in demand deposit, NOW and       
savings accounts  5,238,895  8,955,789 
Net increase(decrease) in time deposits  (16,754,207) 47,937,426 
Net increase(decrease) in short-term borrowings  19,458,811  (45,545,429)
Proceeds from long-term borrowings  10,000,000  15,000,000 
Repayment of long-term borrowings  (2,290,236) (1,896,415)
Exercise of stock options  -  42,354 
Net cash provided by financing activities
  15,653,263  24,493,725 
Increase (decrease) in cash and due from banks  201,289  (7,755,547)
Cash and due from banks:
       
Beginning  12,030,969  22,535,761 
Ending $12,232,258 $14,780,214 
        
(Continued)

See Notes to Consolidated Financial Statements


87
Summit Financial Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)



  
Three Months Ended
 
  
March 31,
 
March 31,
 
  
2006
 
2005
 
      
Supplemental Disclosures of Cash Flow Information
       
Cash payments for:       
Interest $12,231,731 $8,976,219 
Income taxes $- $- 
        
Supplemental Schedule of Noncash Investing and Financing Activities
   
Other assets acquired in settlement of loans $43,000 $3,000 

See Notes to Consolidated Financial Statements

8
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 ninethree months ended September 30, 2006March 31, 2007 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 20052006 audited financial statements and Annual Report on Form 10-K. Certain accounts in the consolidated financial statements for December 31, 20052006 and September 30, 2005,March 31, 2006, as previously presented, have been reclassified to conform to current year classifications.

Note 2. Significant New Accounting Pronouncements

 In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting and disclosure for uncertain tax positions, as defined. FIN 48 requires that a tax position meet a "probable recognition threshold" for the benefit of the uncertain tax position to be recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either reduction of a current or deferred tax asset or receivable, or recording a current or deferred tax liability. FIN 48 also provides guidance on measurement, derecognition of tax benefits, classification, interim period accounting disclosure, and transition requirements in accounting for uncertain tax positions. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company will be required to apply the provisions of FIN 48 to all tax positions upon initial adoption with any cumulative effect adjustment to be recognized as an adjustment to retained earnings. We adopted the provisions of this statement January 1, 2007, which has not had a material effect on our financial statements.

Note 2. Earnings per Share3. Discontinued Operations

The computationsfollowing table lists the assets and liabilities of basicSummit Mortgage included in the balance sheet as assets and diluted earnings per share follow:liabilities related to discontinued operations.


  
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 

 
9
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


Note 3. Securities
  
March 31,
 
December 31,
 
March 31,
 
  
2007
 
2006
 
2006
 
Assets:
       
Loans held for sale, net 
$
1,189,966
 $8,428,535 $12,342,886 
Loans, net  
133,838
  179,642  662,208 
Premises and equipment, net  
-
  -  694,803 
Property held for sale  
-
  75,000  75,000 
Other assets  
845,806
  1,031,572  802,483 
Total assets 
$
2,169,610
 $9,714,749 $14,577,380 
Liabilities:
          
Accrued expenses and other liabilities 
$
1,104,319
 $2,109,320 $755,962 
Total liabilities 
$
1,104,319
 $2,109,320 $755,962 


The amortized cost, unrealized gains, unrealized lossesresults of Summit Mortgage are presented as discontinued operations in a separate category on the income statements following the results from continuing operations. The income (loss) from discontinued operations for the periods ended March 31, 2007 and estimated fair values of securities at September2006 is presented below.
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 
Statements of Income from Discontinued Operations
   
      
  
For the Quarter Ended March 31,
 
  
2007
 
2006
 
Interest income 
$
112,721
 $562,351 
Interest expense  
45,411
  310,548 
Net interest income  
67,310
  251,803 
Provision for loan losses  
250,000
  70,000 
Net interest income after provision for loan losses  
(182,690
)
 181,803 
        
Noninterest income       
Mortgage origination revenue  
803,056
  6,583,913 
(Loss) on sale of assets  
(50,814
)
 - 
Total noninterest income  
752,242
  6,583,913 
        
Noninterest expense       
Salaries and employee benefits  
442,368
  2,102,875 
Net occupancy expense  
(3,880
)
 169,608 
Equipment expense  
21,892
  70,291 
Professional fees  
97,422
  77,507 
Postage  
33
  1,735,774 
Advertising  
97,674
  1,290,429 
Impairment of long-lived assets  
-
  - 
Exit costs  
(80,011
)
 - 
Other  
285,780
  710,354 
Total noninterest expense  
861,278
  6,156,838 
Income (loss) before income tax expense  
(291,726
)
 608,878 
Income tax expense (benefit)  
(96,500
)
 226,000 
Income (loss) from discontinued operations 
$
(195,226
)
$382,878 

Included in liabilities related to discontinued operations in the accompanying consolidated financial statements is an accrual for exit costs related to the discontinuance of the mortgage banking segment. During fourth quarter 2006, we accrued $1,859,000 for exit costs, which was comprised of costs related to operating lease terminations, vendor contract terminations, and severance payments. The changes in that accrual are as follows:
10
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


  
Operating Lease Terminations
 
Vendor Contract Termination
 
Severance Payments
 
Total
 
Balance, December 31, 2006 
$
734,000
 
$
740,000
 
$
385,000
 
$
1,859,000
 
Less:             
Payments from the accrual  (184,863) -  (287,889) 
(472,752
)
Reversal of over accrual  -  -  (80,011) 
(80,011
)
Balance, March 31, 2007
 $549,137 $740,000 $17,100 
$
1,306,237
 


Note 4. Earnings per Share

The computations of basic and diluted earnings per share follow:


  
For the Three Months Ended March 31,
 
  
2007
 2006 
Numerator for both basic and diluted earnings per share:       
Income from continuing operations 
$
2,796,063
 $2,588,721 
Income (loss) from discontinued operations  (195,225) 382,878 
Net Income 
$
2,600,838
 $2,971,599 
        
Denominator       
Denominator for basic earnings per share -       
weighted average common shares outstanding  
7,084,980
  7,128,076 
Effect of dilutive securities:       
Stock options  
62,190
  60,987 
   
62,190
  60,987 
Denominator for diluted earnings per share -       
weighted average common shares outstanding and       
assumed conversions  
7,147,170
  7,189,063 
        
Basic earnings per share from continuing operations 
$
0.40
 
$
0.36
 
Basic earnings per share from discontinued operations  (0.03) 
0.06
 
Basic earnings per share 
$
0.37
 
$
0.42
 
        
Diluted earnings per share from continuing operations 
$
0.39
 
$
0.36
 
Diluted earnings per share from discontinued operations  (0.03) 
0.05
 
Diluted earnings per share 
$
0.36
 
$
0.41
 
  
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 


Note 5. Securities

The maturities, amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September 30,March 31, 2007, December 31, 2006, and March 31, 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 


11
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)



Note 4. Loans

Loans are summarized as follows:
  
March 31, 2007
 
  
Amortized
 
Unrealized
 
Estimated
 
  
Cost
 
Gains
 
Losses
 
Fair Value
 
Available for Sale
         
Taxable:
         
U. S. Government agencies             
and corporations $36,774,275 $7,704 $263,509 $36,518,470 
Mortgage-backed securities  153,538,946  649,600  1,876,262  152,312,284 
State and political subdivisions  3,758,987  25,684  -  3,784,671 
Corporate debt securities  1,679,740  17,968  1,551  1,696,157 
Federal Reserve Bank stock  729,000  -  -  729,000 
Federal Home Loan Bank stock  13,735,100  -  -  13,735,100 
Other equity securities  150,410  -  -  150,410 
Total taxable
  210,366,458  700,956  2,141,322  208,926,092 
Tax-exempt:
             
State and political subdivisions  41,685,349  1,046,096  60,783  42,670,662 
Other equity securities  5,973,746  614,134  11,739  6,576,141 
Total tax-exempt
  47,659,095  1,660,230  72,522  49,246,803 
Total
 $258,025,553 $2,361,186 $2,213,844 $258,172,895 
 

  
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 

  
December 31, 2006
 
  
Amortized
 
Unrealized
 
Estimated
 
  
Cost
 
Gains
 
Losses
 
Fair Value
 
Available for Sale
         
Taxable:
         
U. S. Government agencies             
and corporations $37,671,345 $2,727 $333,799 $37,340,273 
Mortgage-backed securities  146,108,268  470,268  2,262,050  144,316,486 
State and political subdivisions  3,758,978  25,225  -  3,784,203 
Corporate debt securities  1,682,275  18,908  2,274  1,698,909 
Federal Reserve Bank stock  669,000  -  -  669,000 
Federal Home Loan Bank stock  12,093,900  -  -  12,093,900 
Other equity securities  150,410  -  -  150,410 
Total taxable
  202,134,176  517,128  2,598,123  200,053,181 
Tax-exempt:
             
State and political subdivisions  40,329,315  1,026,437  67,709  41,288,043 
Other equity securities  5,974,719  572,752  14,575  6,532,896 
Total tax-exempt
  46,304,034  1,599,189  82,284  47,820,939 
Total
 $248,438,210 $2,116,317 $2,680,407 $247,874,120 
 
12
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


  
March 31, 2006
 
  
Amortized
 
Unrealized
 
Estimated
 
  
Cost
 
Gains
 
Losses
 
Fair Value
 
Available for Sale
         
Taxable:
         
U. S. Government agencies             
and corporations $42,089,023 $13,026 $671,421 $41,430,628 
Mortgage-backed securities  127,013,475  87,964  4,000,383  123,101,056 
State and political subdivisions  3,889,504  -  15,969  3,873,535 
Corporate debt securities  3,290,502  24,114  3,893  3,310,723 
Federal Reserve Bank stock  639,000  -  -  639,000 
Federal Home Loan Bank stock  16,384,900  -  -  16,384,900 
Other equity securities  150,410  -  -  150,410 
Total taxable
  193,456,814  125,104  4,691,666  188,890,252 
Tax-exempt:
             
State and political subdivisions  37,981,230  832,995  127,911  38,686,314 
Other equity securities  5,977,638  269,909  19,220  6,228,327 
Total tax-exempt
  43,958,868  1,102,904  147,131  44,914,641 
Total
 $237,415,682 $1,228,008 $4,838,797 $233,804,893 


Note 6. Goodwill and Other Intangible Assets

The following tables present our goodwillmaturities, amortized cost and estimated fair values of securities at September 30, 2006 and other intangible assets at September 30, 2006, DecemberMarch 31, 2005, and September 30, 2005.2007, are summarized as follows:

 

  
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 
  
Available for Sale
 
  
Amortized
 
Estimated
 
  
Cost
 
Fair Value
 
      
Due in one year or less $57,430,744 $56,497,112 
Due from one to five years  106,222,649  105,669,469 
Due from five to ten years  38,674,141  38,946,187 
Due after ten years  35,109,763  35,869,476 
Equity securities  20,588,256  21,190,651 
  $258,025,553 $258,172,895 

 


  
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 
13
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


Note 6. Loans

Loans are summarized as follows:


  
March 31,
 December 31, March 31, 
  
2007
 2006 2006 
Commercial 
$
69,700,489
 $69,469,550 $66,563,444 
Commercial real estate  
329,561,244
  314,198,436  275,896,117 
Construction and development  
220,429,701
  215,820,164  165,026,192 
Residential real estate  
279,563,537
  282,512,334  281,300,798 
Consumer  
33,845,269
  36,455,257  37,356,618 
Other  
7,208,600
  6,968,465  6,381,884 
Total loans  
940,308,840
  925,424,206  832,525,053 
Less unearned income  
1,757,328
  1,867,613  1,730,728 
Total loans net of unearned income  
938,551,512
  923,556,593  830,794,325 
Less allowance for loan losses  
7,782,523
  7,511,408  6,434,943 
Loans, net
 
$
930,768,989
 $916,045,185 $824,359,382 



Note 7. Allowance for Loan Losses

An analysis of the allowance for loan losses for the three month periods ended March 31, 2007 and 2006, and for the year ended December 31, 2006 is as follows:


  
Three Months Ended
 
Year Ended
 
  
March 31,
 
December 31,
 
  
2007
 
2006
 
2006
 
Balance, beginning of period
 $7,511,408 $6,111,713 $6,111,713 
Losses:
          
Commercial  50,000  -  31,744 
Commercial real estate  40,000  -  185,436 
Real estate - mortgage  -  -  35,011 
Consumer  49,416  72,724  199,505 
Other  67,028  47,410  289,159 
Total
  206,444  120,134  740,855 
Recoveries:
          
Commercial  20,737  1,025  1,269 
Commercial real estate  4,400  19,447  45,918 
Real estate - mortgage  123  82  6,518 
Consumer  14,240  15,970  62,535 
Other  48,059  81,840  179,310 
Total
  87,559  118,364  295,550 
Net losses  118,885  1,770  445,305 
Provision for loan losses  390,000  325,000  1,845,000 
Balance, end of period
 $7,782,523 $6,434,943 $7,511,408 

14
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


Note 8. Goodwill and Other Intangible Assets

The following tables present our goodwill at March 31, 2007 and other intangible assets at March 31, 2007, December 31, 2006, and March 31, 2006.

  
Goodwill Activity
 
Balance, January 1, 2007 $2,088,030 
Acquired goodwill, net  - 
     
Balance, March 31, 2007 $2,088,030 

  
Unidentifiable Intangible Assets
 
  
March 31,
 
December 31,
 
March 31,
 
  
2007
 
2006
 
2006
 
Unidentifiable intangible assets          
Gross carrying amount $2,267,323 $2,267,323 $2,267,323 
Less: accumulated amortization  1,196,621  1,158,833  1,045,468 
Net carrying amount $1,070,702 $1,108,490 $1,221,855 

We recorded amortization expense of approximately $38,000 for the three months ended March 31, 2007 relative to our unidentifiable intangible assets. Annual amortization is expected to be approximately $151,000 for each of the years ending 2007 through 2011.


Note 9. Deposits

The following is a summary of interest bearing deposits by type as of March 31, 2007 and 2006 and December 31, 2006:

  
March 31,
 
December 31,
 
March 31,
 
  
2007
 
2006
 
2006
 
Interest bearing demand deposits 
$
230,634,293
 $220,166,660 $214,571,646 
Savings deposits  
44,712,689
  47,983,961  39,474,064 
Retail time deposits  
287,439,479
  278,321,917  243,645,391 
Brokered time deposits  
253,794,238
  279,623,604  170,185,023 
Total 
$
816,580,699
 $826,096,142 $667,876,124 

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:March 31, 2007:
 

  
Amount
 
Percent
 
Three months or less $67,885,301  23.3%
Three through six months  58,151,193  20.0%
Six through twelve months  53,407,632  18.4%
Over twelve months  111,555,130  38.3%
Total $290,999,256  100.0%
  
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%




1415
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)

 
A summary of the scheduled maturities for all time deposits as of March 31, 2007 is as follows:


  
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 month period ending December 31, 2007 $375,116,669 
Year Ending December 31, 2008  97,064,945 
Year Ending December 31, 2009  42,130,644 
Year Ending December 31, 2010  23,265,877 
Year Ending December 31, 2011  2,118,020 
Thereafter  1,537,562 
  $541,233,717 



Note 10. Borrowed Funds

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

  
Quarter Ended March 31, 2007
 
      
Federal Funds
 
  
Short-term
   
Purchased
 
  
FHLB
 
Repurchase
 
and Lines
 
  
Advances
 
Agreements
 
of Credit
 
Balance at March 31 $71,132,900 $7,358,186 $1,395,400 
Average balance outstanding for the period  64,449,678  6,507,188  1,458,241 
Maximum balance outstanding at          
any month end during period  71,132,900  7,358,185  1,625,900 
Weighted average interest rate for the period  5.36% 4.09% 7.51%
Weighted average interest rate for balances          
outstanding at March 31  5.35% 4.13% 7.75%

  
Year Ended December 31, 2006
 
      
Federal Funds
 
  
Short-term
   
Purchased
 
  
FHLB
 
Repurchase
 
and Lines
 
  
Advances
 
Agreements
 
of Credit
 
Balance at December 31 $54,765,000 $4,730,575 $932,100 
Average balance outstanding for the period  123,952,970  5,792,863  1,025,717 
Maximum balance outstanding at          
any month end during period  175,407,800  7,036,562  1,171,200 
Weighted average interest rate for the period  5.08% 4.03% 7.49%
Weighted average interest rate for balances          
outstanding at December 31  5.39% 4.08% 7.75%
16
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


  
Quarter Ended March 31, 2006
 
      
Federal Funds
 
  
Short-term
   
Purchased
 
  
FHLB
 
Repurchase
 
and Lines
 
  
Advances
 
Agreements
 
of Credit
 
Balance at March 31 $128,538,400 $7,036,562 $907,722 
Average balance outstanding for the period  165,480,730  6,594,377  305,069 
Maximum balance outstanding at          
any month end during period  175,407,800  7,036,562  907,722 
Weighted average interest rate for the period  4.56% 3.72% 6.40%
Weighted average interest rate for balances          
outstanding at March 31  4.79% 4.00% 7.25%

 

  
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$182,225,213, $174,292,074 and $168,041,711$163,547,368 at September 30, 2006,March 31, 2007, December 31, 2005,2006, and September 30, 2005March 31, 2006 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 ninethree month period ended September 30, 2006March 31, 2007 was 5.34%5.54% compared to 4.56%5.03% for the first ninethree months of 2005.2006.

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,March 31, 2007, December 31, 2006, and DecemberMarch 31, 2005, and $11,341,000 at September 30, 2005.2006.

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.
 
15
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.
17
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


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
  
Amount
 
2006 $14,816,481 
2007  23,318,204  $21,029,707 
2008  24,585,851   52,376,851 
2009  3,911,094   28,911,094 
2010  52,674,748   52,939,159 
2011  2,465,409 
Thereafter  44,557,402   44,091,993 
 $163,863,780  $201,814,213 

 
Note 9.11. 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 eliminatedeliminates 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.
16
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 ninethree 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.2007or 2006.
 
17
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 

18
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


During first quarter 2007, we recognized $8,000 of compensation expense for share-based payment arrangements in our income statement, with a deferred tax asset of $3,000, compared to $6,600 compensation expense for first quarter 2006 with a deferred tax asset of $2,250. At March 31, 2007, we had approximately $36,000 total compensation cost related to nonvested awards not yet recognized and we expect to recognize it over the next two years.

A summary of activity in our Officer Stock Option Plan during the first quarters of 2007 and 2006 is as follows:

  
March 31, 2007
 
March 31, 2006
 
    
Weighted-
   
Weighted-
 
    
Average
   
Average
 
    
Exercise
   
Exercise
 
  
Options
 
Price
 
Options
 
Price
 
Outstanding, January 1
  349,080 $17.83  361,740 $17.41 
Granted  -  -  -  - 
Exercised  -  -  (8,700) 4.87 
Forfeited  -  -  -  - 
Outstanding, March 31
  349,080 $17.83  353,040 $17.72 


Other information regarding options outstanding and exercisable at March 31, 2007 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  83,600 $5.34  5.60  1297  83,600 $5.34  1,297 
6.01 - 10.00  31,680  9.49  8.76  360  24,480  9.49  278 
10.01 - 17.50  3,500  17.43  6.92  12  3,500  17.43  12 
17.51 - 20.00  51,800  17.79  9.72  159  31,000  17.79  95 
20.01 - 25.93  178,500  25.19  8.32  -  178,500  25.19  - 
                       
   349,080  17.83     1,828  321,080  18.02  1,682 



Note 10.12. Commitments and Contingencies

Off-Balance Sheet Arrangements

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

Many of our lending relationships contain both funded and unfunded elements. The funded portion is reflected on our balance sheet. The unfunded portion of these commitments is not recorded on our balance sheet until a draw is made under the loan facility. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.
19
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)

A summary of the total unfunded, or off-balance sheet, credit extension commitments follows:
 

 
September 30,
  
March 31,
 
 
2006
  
2007
 
Commitments to extend credit:
Commitments to extend credit:
Commitments to extend credit:
Revolving home equity and        
credit card lines 
$
33,587,424
  
$
34,023,333
 
Construction loans  
97,271,727
   
88,947,000
 
Other loans  
41,711,519
   
32,560,000
 
Standby letters of credit
  
14,721,512
   
13,928,392
 
Total
 
$
187,292,182
  
$
169,458,725
 
 

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 11.13. 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.
19
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,March 31, 2007, 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%

 
20
Summit Financial Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)


(Dollars in thousands)
             
          
To be Well Capitalized
 
      
Minimum Required
 
under Prompt Corrective
 
  
Actual
 
Regulatory Capital
 
Action Provisions
 
  
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
As of March 31, 2007
                   
Total Capital (to risk weighted assets)                   
Summit $107,421  11.0%$78,105  8.0%$97,631  10.0%
Summit Community  63,062  10.9% 46,107  8.0% 57,634  10.0%
Shenandoah  42,518  10.9% 31,335  8.0% 39,168  10.0%
Tier I Capital (to risk weighted assets)                   
Summit  98,676  10.1% 39,052  4.0% 58,579  6.0%
Summit Community  58,381  10.1% 23,053  4.0% 34,580  6.0%
Shenandoah  38,454  9.8% 15,667  4.0% 23,501  6.0%
Tier I Capital (to average assets)                   
Summit  98,676  8.0% 37,101  3.0% 61,835  5.0%
Summit Community  58,381  7.7% 22,745  3.0% 37,908  5.0%
Shenandoah  38,454  8.0% 14,345  3.0% 23,909  5.0%
                    
As of December 31, 2006
                   
Total Capital (to risk weighted assets)                   
Summit $104,231  10.8% 76,991  8.0% 96,239  10.0%
Summit Community  60,813  10.6% 46,032  8.0% 57,540  10.0%
Shenandoah  41,243  10.9% 30,355  8.0% 37,944  10.0%
Tier I Capital (to risk weighted assets)                   
Summit  96,028  10.0% 38,495  4.0% 57,743  6.0%
Summit Community  56,170  9.8% 23,016  4.0% 34,524  6.0%
Shenandoah  37,683  9.9% 15,178  4.0% 22,766  6.0%
Tier I Capital (to average assets)                   
Summit  96,028  7.9% 36,492  3.0% 60,820  5.0%
Summit Community  56,170  7.5% 22,383  3.0% 37,305  5.0%
Shenandoah  37,683  8.0% 14,097  3.0% 23,495  5.0%

Note 12. Segment Information14. Subsequent Events

We operate two business segments: community bankingAs announced on April 12, 2007, we entered into an Agreement 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 consistsPlan 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:Reorganization (the “Agreement”) with Greater Atlantic Financial Corporation, Inc. (“Greater Atlantic”), headquartered in Reston, Virginia.


  
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 
Under the terms of the Agreement, we will pay $4.60 per share in cash and stock for the outstanding common stock of Great Atlantic, subject to adjustment based on Greater Atlantic’s shareholders’ equity at the end of the month in which the sale of the Pasadena branch office is completed. If, at that month-end, Greater Atlantic’s shareholders’ equity, as adjusted in accordance with the terms of the Agreement, is less than $6.7 million, then the total aggregate value of the transaction consideration will be decreased dollar-for-dollar. If Greater Atlantic’s month end adjusted shareholders’ equity exceeds $6.7 million, then the aggregate value of the transaction consideration will be increased dollar-for-dollar, but only to the extent that the amount in excess of $6.7 million is attributable to the sale of the Pasadena branch office, net of all taxes, if any, Greater Atlantic would be required to pay. Greater Atlantic has entered into a definitive agreement with another financial institution to sell its Pasadena, Maryland branch office for a deposit premium of 8.5%, prior to the close to of its transaction with Summit. At March 31, 2007, the deposits at the Pasadena branch office approximated $50.9 million, resulting in a present deposit premium of $4.3 million. The aggregate value of the final transaction consideration will be determined before proxy solicitation materials are sent to Greater Atlantic’s shareholders for purposes of soliciting their vote on the transaction.


  
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 



21
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 
 

The final transaction consideration will be paid 70% in the form of Summit common stock and 30% in cash. The exchange ratio for determining the number of shares of Summit common stock to be issued for each share of Greater Atlantic’s common stock will be based on the average closing price of Summit’s common stock for the twenty trading days before the closing date of the transaction (“Summit’s Average Closing Stock Price”), subject to a “collar”. The collar ranges from $17.82 per share to $24.10 per share. If Summit’s Average Closing Stock Price falls within this range, then Greater Atlantic shareholders will receive shares of Summit’s common stock based on an exchange ratio equal to 70% of the final per share transaction consideration divided by Summit’s Average Closing Stock Price. However, if Summit’s Average Closing Stock Price is less than $17.82 per share, the exchange ratio will equal 70% of the final per share transaction consideration divided by $17.82; and if Summit’s Average Closing Stock Price is more than $24.10 per share, then the exchange ratio will equal 70% of the final per share transaction consideration divided by $24.10.
  
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 
Consummation of the Merger is subject to approval of the shareholders of Greater Atlantic and the receipt of all required regulatory approvals, as well as other customary conditions. This acquisition is expected to close during fourth quarter of this year.
Also, as previously announced on April 27, 2007, we entered into an Agreement and Plan of Reorganization (the “Agreement”) with Kelly Insurance Agency, Inc. and Kelly Property and Casualty Inc. (collectively, the “Kelly Agencies”) headquartered in Leesburg, Virginia.
Under the terms of the Agreement, we will pay $6.2 million for the outstanding common stock of the Kelly Agencies, subject to adjustment based on the Kelly Agencies’ working capital as of the closing date. If, at closing, the Kelly Agencies’ working capital, determined in accordance with the terms of the Agreement, is less than $135,000, then the deal’s aggregate consideration will be decreased dollar-for-dollar. If the Kelly Agencies’ working capital at closing exceeds $135,000, then the deal’s aggregate consideration will be increased dollar-for-dollar.
The final transaction consideration will be paid 100% in the form of Summit common stock. The exchange ratio for determining the number of shares of Summit common stock to be issued for each share of Kelly Agencies’ common stock will be based on the average closing price of Summit’s common stock for the five trading days before the closing date of the transaction (“Summit’s Average Closing Stock Price”). The Kelly Insurance Agencies’ shareholders will receive shares of Summit’s common stock based on an exchange ratio equal to the final per share transaction consideration divided by Summit’s Average Closing Stock Price.
Consummation of the Agreement is subject to approval of the shareholders of the Kelly Agencies and the receipt of all required regulatory approvals, as well as other customary conditions. This acquisition is expected to close during third quarter of this year.



 
22
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,operating units, 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 20052006 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 theThe Private Securities Litigation Act of 1995)1995 indicates that are based on current expectationsthe disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by us. Our following discussion and analysis of financial condition and results of operations contains certain forward-looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, we note that a numbervariety of risksfactors could cause our actual results and uncertainties. Words such as “expects”, “anticipates”, “believes”, “estimates” andexperience to differ materially from the anticipated results or other similar expressions or future or conditional verbs such as “will”, “should”, “would” and “could” are intended to identify suchexpectations expressed in those forward-looking statements.

Although we believe the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. Factors that might cause such a difference include 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 growthGrowth in our interest earning assets resulted in an increase of 17.47%5.37%, or $4,112,000,$480,000, in our net interest earnings on a tax equivalent basis for the first ninethree months in 20062007 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 20052006 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.
23
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 20052006 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 20052006 Annual Report on Form 10-K.
23
Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations


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 completedwill complete the required annual impairment test for 2006 and determined that no impairment write-offs were necessary.2007. We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Notes 1 and 89 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 


24
Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations


RESULTS OF OPERATIONS

Earnings Summary

Net incomeIncome from continuing operations for the nine monthsquarter ended September 30, 2006 declined 8.11%March 31, 2007 grew 8.00% to $8,086,000,$2,796,000, or $1.12$0.39 per diluted share as compared to $8,800,000,$2,589,000, or $1.22$0.36 per diluted share for the nine months ended September 30, 2005. For the quarter ended September 30, 2006,March 31, 2006. Consolidated net income, declined 24.21% to $2,481,000 fromwhich includes the $3,273,000 net incomeresults of discontinued operations, for the third quarter 2005.periods ended March 31, 2007 and 2006 was $2,601,000 and 2,972,000, respectively. Returns on average equity and assets for the first ninethree months of 20062007 were 13.86%12.72% and 0.93%0.83%, respectively, compared with 16.85%15.60% and 1.25%1.05% for the same period of 2005.2006.

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 consolidated net interest income on a fully tax-equivalent basis totaled $27,643,000$9,416,000 for the ninethree month period ended September 30, 2006March 31, 2007 compared to $23,531,000$8,936,000 for the same period of 2005,2006, representing an increase of $4,112,000$480,000 or 17.47%5.37%. This increase resulted from growth in interest earning assets, primarily loans, which served to more than offset the 12680 basis points increase in the cost of interest bearing liabilities during the same period. Average interest earning assets grew 24.57%11.52% from $885,773,000$1,070,582,000 during the first ninethree months of 20052006 to $1,103,395,000$1,193,946,000 for the first ninethree months of 2006.2007. Average interest bearing liabilities grew 25.81%11.81% from $800,960,000$977,829,000 at September 30, 2005March 31, 2006 to $1,007,694,000$1,093,276,000 at September 30, 2006March 31, 2007, at an average costyield for the first ninethree months of 20062007 of 4.28%4.75% compared to 3.02%3.95% for the same period of 2005.2006.

Our consolidated net yield on interest earning assetsmargin decreased to 3.35%3.20% for the ninethree month period ended September 30, 2006,March 31, 2007, compared to 3.55%3.39% for the same period in 2005. On a quarterly basis, our2006. Our net interest margin increased slightlydecreased 5 basis points compared to 3.33% at September 30, 2006, from 3.32% for the quarter ended June 30, 2006. The positive impactlinked quarter. Our margin continues to net interest income ofbe affected by our loan growth in interest earning assets was somewhat offset by increasedan extremely competitive environment. The current competitive pressures are causing loan rates to be lower. Also, our loan growth is at a faster pace than we have been able to grow lower cost of interest bearing liabilities, which tendretail funds, causing us to moverely more proportionately with rate increases byon higher cost, non-retail deposit funding vehicles. The current competitive and market conditions are also causing deposit rates to be higher. For the Fed. Thethree months ended March 31, 2007 compared to March 31, 2006, the yields on earning assets increased 9855 basis points, while the cost of our interest bearing funds increased by 12680 basis points.

We anticipate modest growth in our net interest income to continue over the near term due toas the growth in the volume of interest earning assets.assets will more than offset the expected continued decline in our net interest margin. 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.

25
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
Table I - Average Balance Sheet and Net Interest Income Analysis
 
Table I - Average Balance Sheet and Net Interest Income Analysis
       
(Dollars in thousands)
(Dollars in thousands)
 
(Dollars in thousands)
       
 
For the Nine Months Ended
  
For the Three Months Ended
 
 
September 30, 2006
 
September 30, 2005
  
March 31, 2007
 
March 31, 2006
 
 
Average
 
Earnings/
 
Yield/
 
Average
 
Earnings/
 
Yield/
  
Average
 
Earnings/
 
Yield/
 
Average
 
Earnings/
 
Yield/
 
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
  
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% $928,979 $18,665 8.15%$829,381 $15,392 7.53%
Tax-exempt (1)  8,373 476 7.60% 8,884 485 7.30%  8,917 173 7.87% 8,244 150 7.38%
Securities                              
Taxable  189,768 6,837 4.82% 162,852 5,229 4.29%  208,315 2,577 5.02% 186,586 2,135 4.64%
Tax-exempt (1)  45,950 2,385 6.94% 47,984 2,402 6.69%  47,289 814 6.98% 44,077 767 7.06%
Federal funds sold and interest                              
bearing deposits with other banks  1,453  52  4.78% 2,766  79  3.82%  446  5  4.55% 2,294  24  4.24%
Total interest earning assets
  1,103,395  59,930  7.26% 885,773  41,616  6.28%  1,193,946  22,234  7.55% 1,070,582  18,468  7.00%
                              
Noninterest earning assets
                              
Cash & due from banks  13,760      16,567       13,099      14,449     
Premises and equipment  23,552      20,730       22,332      23,361     
Other assets  26,160      20,008       26,993      24,659     
Allowance for loan losses  (6,683)       (5,510)        (8,135)       (6,338)      
Total assets
 $1,160,184       $937,568        $1,248,235       $1,126,713       
                              
Interest bearing liabilities
                              
Interest bearing demand deposits $213,518 $5,410 3.39%$141,168 $1,868 1.77% $221,924 $2,066 3.78%$204,161 $1,543 3.07%
Savings deposits  40,826 311 1.02% 48,699 235 0.65%  46,407 217 1.90% 43,067 73 0.69%
Time deposits  428,224 13,601 4.25% 308,334 6,849 2.97%  556,525 6,745 4.92% 374,170 3,537 3.83%
Short-term borrowings  148,876 5,572 5.00% 131,459 3,124 3.18%  72,415 958 5.37% 172,380 1,964 4.62%
Long-term borrowings                              
and capital trust securities  176,250  7,393  5.61% 171,300  6,009  4.69%  196,005  2,832  5.86% 184,051  2,415  5.32%
Total interest bearing liabilities
  1,007,694  32,287  4.28% 800,960  18,085  3.02%  1,093,276  12,818  4.75% 977,829  9,532  3.95%
                              
Noninterest bearing liabilities
                              
and shareholders' equity
                              
Demand deposits  64,618      60,252       61,288      63,308     
Other liabilities  10,059      6,707       11,881      9,395     
Shareholders' equity  77,813        69,649         81,790        76,181       
Total liabilities and
                              
shareholders' equity
 $1,160,184       $937,568        $1,248,235       $1,126,713       
Net interest earnings
    $27,643       $23,531        $9,416       $8,936    
Net yield on interest earning assets
        3.35%       3.55%
Net yield on interest earning assets
    3.20%       3.39%

 
(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.
(1) - Interest income on tax-exempt securities has been adjusted assuming an effective tax rate of 34% for all periods presented.
        The tax equivalent adjustment resulted in an increase in interest income of $319,000 and $305,000 for the periods ended
        March 31, 2007 and March 31, 2006, respectively.
 [
26
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 Quarter Ended
 
  
March 31, 2007 versus March 31, 2006
 
  
Increase (Decrease)
 
  
Due to Change in:
 
  
Volume
 
Rate
 
Net
 
Interest earned on:
       
Loans       
Taxable $1,938 $1,335 $3,273 
Tax-exempt  12  11  23 
Securities          
Taxable  261  181  442 
Tax-exempt  55  (8) 47 
Federal funds sold and interest          
bearing deposits with other banks  (20) 1  (19)
Total interest earned on          
interest earning assets  2,246  1,520  3,766 
           
Interest paid on:
          
Interest bearing demand          
deposits  142  381  523 
Savings deposits  6  138  144 
Time deposits  2,032  1,176  3,208 
Short-term borrowings  (1,283) 277  (1,006)
Long-term borrowings and capital          
trust securities  163  254  417 
Total interest paid on       
interest bearing liabilities  1,060  2,226  3,286 
        
Net interest income
 $1,186 $(706)$480 
 

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 decreasedfrom continuing operations increased to $5,077,000$1,012,000 for the thirdfirst quarter of 2006,2007, compared to $8,465,000$1,003,000 for the same period of 20052006. Other income increased $41,000 for the first quarter 2007 due to a sharp declineincreases in mortgage origination revenue. Mortgage originationfinancial services revenue declinedand debit card income due 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.increased customer activity. 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.




27
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:


28
Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations
Noninterest Income
     
  
For the Quarter Ended
 
  
March 31,
 
Dollars in thousands
 
2007
 
2006
 
Insurance commissions $206 $230 
Service fees  617  631 
(Loss) on sale of assets  2  (4)
Other  187  146 
Total $1,012 $1,003 


Mortgage Origination Revenue
       
  
For the Quarter Ended
 
For the Nine Months Ended
 
  
September 30,
 
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 4th 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 for continuing operations increased approximately $1,651,000,$288,000, or 5.2%5.4% to $33,459,000$5,649,000 during the first ninethree months of 20062007 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 salaries2006. 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.expense represented the largest category of expense growth. 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.

increases.
29
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,
  
For the Quarter Ended March 31,
 
   
Change
     
Change
      
Change
   
Community Banking and Other
 
2006
 $ % 
2005
 
2006
  $  % 
2005
 
 
2007
             $ % 
2006
 
Salaries and employee benefits 
$
2,817
 
$
20
 
0.7
%
$
2,797
 
$
8,921
 
$
881
 
11.0
%
$
8,040
  
$
3,226
 
$
171
  
5.6
%
$3,055 
Net occupancy expense  
388
 
28
 
7.8
%
 
360
  
1,179
 
166
 
16.4
%
 
1,013
   
418
  
17
  
4.2
%
 401 
Equipment expense  
475
 
54
 
12.8
%
 
421
  
1,421
 
116
 
8.9
%
 
1,305
   
446
  
(4
)
 
-0.9
%
 450 
Supplies  
214
 
74
 
52.9
%
 
140
  
603
 
174
 
40.6
%
 
429
   
172
  
6
  
3.6
%
 166 
Professional fees  
188
 
(13
)
 
-6.5
%
 
201
  
641
 
100
 
18.5
%
 
541
   
174
  
(33
)
 
-15.9
%
 207 
Postage  
91
 
23
 
33.8
%
 
68
  
207
 
34
 
19.7
%
 
173
 
Advertising  
64
 
(45
)
 
-41.3
%
 
109
  
263
 
(51
)
 
-16.2
%
 
314
 
Amortization of intangibles  
38
 
-
 
0.0
%
 
38
  
113
 
-
 
0.0
%
 
113
   
38
  
-
  
0.0
%
 38 
Other  
927
  
152
  
19.6
%
 
775
  
2,737
  
479
  
21.2
%
 
2,258
   
1,175
  
131
  
12.5
%
 1,044 
Total
 
$
5,202
 
$
293
  
6.0
%
$
4,909
 
$
16,085
 
$
1,899
  
13.4
%
$
14,186
  
$
5,649
 
$
288
  
5.4
%
$5,361 
                     

 
    
Change
     
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
  
58
  
48.7
%
 
119
  
527
  
169
  
47.2
%
 
358
 
Equipment expense  
78
  
34
  
77.3
%
 
44
  
227
  
91
  
66.9
%
 
136
 
Supplies  
15
  
(13
)
 
-46.4
%
 
28
  
86
  
8
  
10.3
%
 
78
 
Professional fees  
186
  
157
  
541.4
%
 
29
  
508
  
350
  
221.5
%
 
158
 
Postage  
1,587
  
204
  
14.8
%
 
1,383
  
5,012
  
709
  
16.5
%
 
4,303
 
Advertising  
1,128
  
73
  
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
     
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
  
86
  
18.0
%
 
479
  
1,706
  
335
  
24.4
%
 
1,371
 
Equipment expense  
553
  
88
  
18.9
%
 
465
  
1,648
  
207
  
14.4
%
 
1,441
 
Supplies  
229
  
61
  
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
  
28
  
2.4
%
 
1,164
  
3,845
  
134
  
3.6
%
 
3,711
 
Amortization of intangibles  
38
  
-
  
0.0
%
 
38
  
113
  
-
  
0.0
%
 
113
 
Other  
1,439
  
(9
)
 
-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
 

30
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 The 5.6% growth in salaries and employee benefits expense increased 11.0% for the nine months ended September 30, 2006 compared to the same period of 2005was primarily 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%12.5% for thirdfirst quarter 20062007 compared to thirdfirst 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 legalincludes $30,000 of merger 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 numberupcoming merger of loans originated.our two subsidiary banks, an increase of $60,000 in FDIC insurance premiums, and an increase of $30,000 in ATM expense.

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.

We recorded a $390,000 provision for loan losses for the first three months of 2007, compared to $325,000 for the same period in 2006. Net loan charge offs for the first three months of 2007 were $119,000, as compared to $2,000 over the same period of 2006. At March 31, 2007, the allowance for loan losses totaled $7,783,000 or 0.83% of loans, net of unearned income, compared to $7,511,000 or 0.81% of loans, net of unearned income at December 31, 2006.
3128
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
Overall, 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 have shown a slight decrease between December 31, 2006 and March 31, 2007, and still remain at a historically moderate level.


Table IV - Summary of Past Due Loans and Non-Performing Assets
 
(Dollars in thousands)   
  
March 31,
 
December 31,
 
  
2007
 
2006
 
2006
 
Accruing loans past due 90 days or more $4,233 $1,046 $4,638 
Nonperforming assets:          
Nonaccrual loans  241  401  638 
Foreclosed properties  42  268  77 
Repossessed assets  1  3  - 
Total $4,517 $1,718 $5,353 
Total nonperforming loans as a          
percentage of total loans  0.48% 0.17% 0.57%
Total nonperforming assets as a          
percentage of total assets  0.36% 0.15% 0.43%

However, we have experienced an upward trend in our internally classified assets. This trend has primarily been in residential real estate development loans due to the recent slowdown in the sales of newly constructed homes. The ratio of internally classified loans to total loans increased from 4.13% at December 31, 2006 to 6.45% at March 31, 2007. This increase is primarily due to two customer relationships. Management downgraded these two relationships, as they fell outside of our internal lending policy guidelines but does not expect any material future losses related to these two relationships. Refer to the Asset Quality section of the financial review of the 2006 Annual Report on Form 10-K for further discussion of the processes related to internally classified loans
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$1,253,925,000 at September 30, 2006,March 31, 2007, compared to $1,109,532,000$1,234,831,000 at December 31, 2005,2006, representing a 9.1%1.5% increase. Table V below serves to illustrate significant changes in our financial position between December 31, 20052006 and September 30, 2006.March 31, 2007.
 


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 
 
3229
Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations

Table V - Summary of Significant Changes in Financial Position
 
(Dollars in thousands)
 
          
  
Balance
     
Balance
 
  
December 31,
 
Increase (Decrease)
 
March 31,
 
  
2006
 
Amount
 
Percentage
 
2007
 
Assets
         
Securities available for sale $247,874  10,299  4.2%$258,173 
Loans, net of unearned income  916,045  14,724  1.6% 930,769 
              
Liabilities
             
Deposits $888,688 $(11,463) -1.3%$877,225 
Short-term borrowings  60,428  19,458  32.2% 79,886 
Long-term borrowings             
and subordinated debentures  193,881  7,933  4.1% 201,814 


Loan growth during the first ninethree months of 2006,2007, occurring principally in the commercial and real estate portfolios, was funded primarilyboth by borrowings from the FHLB and deposits, including brokered certificates of deposit.

Deposits decreased approximately $11 million during the first quarter of 2007. This decrease was primarily in brokered deposits, which were replaced with FHLB short-term borrowings, which is reflected in their $19 million increase.

Refer to Notes 3, 4,6, 7, 9, and 810 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, 2006March 31, 2007 and December 31, 2005.2006.

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$215 million, or 22.2%17.2% of total assets at September 30, 2006March 31, 2007 versus $125$275 million, or 11.3%22.3% of total assets at December 31, 2005.2006.

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.
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Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations

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, 2006March 31, 2007 totaled $80,630,000$82,935,000 compared to $73,803,000$79,875,000 at December 31, 2005.2006.

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.March 31, 2007.

  
Long
 
Capital
   
  
Term
 
Trust
 
Operating
 
  
Debt
 
Securities
 
Leases
 
2007 $21,029,707 $- $836,447 
2008  52,376,851  -  997,070 
2009  28,911,094  -  431,349 
2010  52,939,159  -  123,389 
2011  2,465,409  -  88,620 
Thereafter  24,502,993  19,589,000  199,395 
Total
 $182,225,213 $19,589,000 $2,676,270 


  
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 

 
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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, 2006March 31, 2007 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 
  
March 31,
 
  
2007
 
Commitments to extend credit:
 
Revolving home equity and   
credit card lines $34,023,333 
Construction loans  88,947,000 
Other loans  32,560,000 
Standby letters of credit
  13,928,392 
Total
 $169,458,725 
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Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations


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.sensitive. That is, absent any changes in the first year,volumes of our interest earning assets or interest bearing liabilities, liabilities are likely to reprice faster than assets,
resulting in a decrease in net income in a rising rate 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 netNet 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 gradually 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.


The following table shows our projected earnings sensitivity as of March 31, 2007 which is well within our ALCO policy limit of +/- 10%:

Change in
 
Estimated % Change in Net
 
Interest Rates
 
Interest Income Over:
 
(basis points)
 
0 - 12 Months
 
13 - 24 Months
 
Down 200 (1)  1.60% 4.70%
Down 200, steepening yield curve (2)  2.59% 9.23%
Up 100 (1)  -0.80% -0.82%
Up 200 (1)  -2.03% -7.09%
(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
 
3432
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, havehas conducted as of September 30, 2006,March 31, 2007, 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, 2006March 31, 2007 were effective. There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



 
3533
Summit Financial Group, Inc. and Subsidiaries
Part II. Other InformationManagement’s Discussion and Analysis of Financial Condition and

Results of Operations


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.its proprietary information. 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. In an 8-K filed on November 15, 2006, Summit Financial, LLC now operatesannounced it would close its mortgage operations which at the time operated as Summit Mortgage, a division of Shenandoah Valley National Bank.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.$350,000..  Plaintiff also seeks permanent and temporary injunctive relief prohibiting the alleged use of trade secretsproprietary information 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.petition for a temporary injunction

On November 20, 2006, Corinthian filed an Amended Complaint. Among other things, Corinthian sought to add Summit Financial Group, Inc as a defendant in the case and requested damages in the amount of $20 million dollars. After consultation with legal counsel, we believe that significant and meritorious defenses exist as to all the claims.claims including with respect to plaintiff’s claim for damages. 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. However, an adverse decision resulting in a large damage award could have a significant negative impact on Summit’s regulatory capital thereby limiting Summit’s near term growth and its ability to pay dividends to its shareholders.
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 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

In the size of the alleged classes. ResponsiveForrest case, responsive pleadings have been filed, written discovery has been exchanged by the parties, and discoveryplaintiff's deposition has been taken. Plaintiff moved for to certify the case as a class action. Her motion was denied on the ground that plaintiff is not an adequate class representative. Plaintiff thereafter requested permission to appeal to the United States Court of Appeals for the Seventh Circuit, and her request was denied. Although the denial does not dispose of the certification issue with finality, this is currently a single plaintiff case. This case and certain other similar cases pending in the initial stages. WeEastern District of Wisconsin have been stayed awaiting a ruling from the United States Supreme Court on the issue of what constitutes a "willful" violation under the FCRA. The prosecution and defense of these cases will continue to evaluateresume when the claims in these lawsuits and intendSupreme Court case is decided. The Company intends to vigorously defend against them. Management, atthis case. However, because the present time,Company's investigation and discovery are not complete and the Supreme Court case has not been decided, management is unable to estimate the impact, in any, of an adverse decision.
34
Summit Financial Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and
Results of Operations
In the Klutho case, responsive pleadings have been filed. No discovery has been undertaken. Plaintiff has not moved for class certification. The Company moved for judgment on the pleadings, claiming that plaintiff has no legally viable claim. The Company's motion has been taken under advisement and awaits ruling. The Company intends to vigorously defend this case. However, because the Company's motion has not yet been decided and investigation and discovery, if necessary, are not complete, management is unable to estimate the impact, if any, of an adverse decision may have on our results of operations or financial condition.decision.

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, 2005,2006, 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.
 

36
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)].
(c) Shares available to be repurchased under the August 2006 Repurchase Plan.



3735



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/
/s/ H. Charles Maddy, III
 
 H. Charles Maddy, III,
 President and Chief Executive Officer
    
    
    
 By: /s/
/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, 2006May 9, 2007
   



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