Summit Financial (SMMF) 10-Q 2004 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 – Q

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

For the quarterly period endedSeptember 30, 2004.

or

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
	EXCHANGE ACT OF 1934For the transition period from                   to                   .

Commission File Number0-16587

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. Yesx Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yeso Nox

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
3,514,570 shares outstanding as of November 4, 2004

Summit Financial Group, Inc. and Subsidiaries

Table of Contents

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets September 30, 2004 (unaudited), December 31, 2003, and September 30, 2003 (unaudited)		4
Consolidated statements of income for the three months and nine months ended September 30, 2004 and 2003 (unaudited)		5
Consolidated statements of shareholders’ equity for the nine months ended September 30, 2004 and 2003 (unaudited)		6
Consolidated statements of cash flows for the nine months ended September 30, 2004 and 2003 (unaudited)		7-8
Notes to consolidated financial statements (unaudited)		9-23
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24-32
Item 3. Quantitative and Qualitative Disclosures about Market Risk		32
Item 4. Controls and Procedures		32

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Summit Financial Group, Inc. and Subsidiaries
Table of Contents
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	None
Item 3. Defaults upon Senior Securities	None
Item 4. Submission of Matters to a Vote of Security Holders	None
Item 5. Other Information	None
Item 6. Exhibits
Exhibits
Exhibit 11. Statement re: Computation of Earnings per Share - - Information contained in Note 3 to the Consolidated Financial Statements on page 10 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		34
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

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Summit Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

	September 30,			December 31,			September 30,
	2004			2003			2003
	(unaudited)			(*)			(unaudited)
ASSETS
Cash and due from banks	$	12,372,452		$	14,412,120		$	11,370,800
Interest bearing deposits with other banks		3,163,714			3,141,092			3,681,418
Federal funds sold		1,000			244,000			99,000
Securities available for sale		209,702,259			235,409,228			223,606,544
Loans held for sale		12,096,649			6,352,836			709,400
Loans, net		586,200,670			498,340,211			473,779,481
Property held for sale		756,181			480,000			1,276,798
Premises and equipment, net		20,438,860			17,846,269			14,476,797
Accrued interest receivable		3,762,409			3,778,139			3,564,869
Goodwill		2,088,030			1,488,030			1,488,030
Other intangible assets		1,448,583			1,561,946			1,599,734
Other assets		10,215,068			8,411,333			8,630,058
Total assets	$	862,245,875		$	791,465,204		$	744,282,929
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non interest bearing	$	50,884,765		$	51,004,403		$	47,034,511
Interest bearing		484,936,943			460,797,017			427,920,074
Total deposits		535,821,708			511,801,420			474,954,585
Short-term borrowings		77,518,423			49,714,246			41,049,045
Long-term borrowings		166,992,593			164,646,208			165,526,033
Subordinated debentures owed to unconsolidated subsidiary trusts		11,341,000			3,609,000			3,609,000
Other liabilities		5,282,750			4,506,787			3,642,742
Total liabilities		796,956,474			734,277,661			688,781,405
Commitments and Contingencies
Shareholders’ Equity
Preferred stock, $1.00 par value; authorized 250,000 shares, issued 2004 - 33,400 shares		33,400			—			—
Common stock, $2.50 par value; authorized 20,000,000 shares, issued 2004 -3,572,510 shares; December 2003 - 3,566,960 shares; September 2003 - 3,562,760 shares		8,931,275			8,917,400			8,906,900
Capital surplus		5,022,151			3,845,906			3,814,906
Retained earnings		50,800,508			43,427,000			41,741,298
Less cost of shares acquired for the treasury - 57,940 shares		(627,659	)		(627,659	)		(627,659	)
Accumulated other comprehensive income		1,129,726			1,624,896			1,666,079
Total shareholders’ equity		65,289,401			57,187,543			55,501,524
Total liabilities and shareholders’ equity	$	862,245,875		$	791,465,204		$	744,282,929

(*) — December 31, 2003 financial information has been extracted from audited consolidated financial statements

See Notes to Consolidated Financial Statements

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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,
	2004			2003		2004			2003
Interest income
Interest and fees on loans
Taxable	$	9,217,361		$	7,797,099	$	26,068,692		$	22,827,468
Tax-exempt		117,153			79,868		323,839			242,412
Interest and dividends on securities
Taxable		1,721,219			1,888,120		5,459,491			5,948,662
Tax-exempt		545,597			486,581		1,649,723			1,442,439
Interest on interest bearing deposits with other banks		32,063			37,868		94,858			115,199
Interest on Federal funds sold		1,074			3,985		2,377			17,660
Total interest income		11,634,467			10,293,521		33,598,980			30,593,840
Interest expense
Interest on deposits		2,450,508			2,466,649		7,254,208			7,608,580
Interest on short-term borrowings		317,243			113,039		692,043			285,848
Interest on long-term borrowings and subordinated debentures		1,805,352			1,771,798		5,191,979			5,387,835
Total interest expense		4,573,103			4,351,486		13,138,230			13,282,263
Net interest income		7,061,364			5,942,035		20,460,750			17,311,577
Provision for loan losses		292,500			232,500		757,500			682,500
Net interest income after provision for loan losses		6,768,864			5,709,535		19,703,250			16,629,077
Other income
Insurance commissions		184,329			64,963		344,889			149,832
Service fees		574,949			403,188		1,646,494			1,131,137
Mortgage origination revenue		7,732,451			210,789		18,665,770			533,564
Securities gains (losses)		(35,657	)		—		1,403			106,410
Gain (loss) on sale of assets		(17,002	)		4,388		(29,183	)		2,747
Other		105,440			126,604		289,253			256,303
Total other income		8,544,510			809,932		20,918,626			2,179,993
Other expense
Salaries and employee benefits		5,054,952			2,141,611		13,480,698			5,940,432
Net occupancy expense		408,402			223,188		1,098,845			628,324
Equipment expense		432,551			326,401		1,302,995			937,238
Supplies		176,601			119,873		472,263			351,795
Professional fees		188,067			151,351		569,653			427,507
Postage		1,702,901			102,966		4,490,669			203,714
Advertising		1,228,655			88,836		3,493,981			201,153
Amortization of intangibles		37,788			37,788		113,364			113,364
Other		1,537,324			604,621		3,752,081			1,772,890
Total other expense		10,767,241			3,796,635		28,774,549			10,576,417
Income before income taxes		4,546,133			2,722,832		11,847,327			8,232,653
Income tax expense		1,420,115			879,675		3,596,065			2,517,075
Net income	$	3,126,018		$	1,843,157	$	8,251,262		$	5,715,578
Basic earnings per common share	$	0.89		$	0.53	$	2.35		$	1.63
Diluted earnings per common share	$	0.87		$	0.52	$	2.30		$	1.61
Average common shares outstanding
Basic		3,513,086			3,504,820		3,511,317			3,504,373
Diluted		3,606,290			3,554,700		3,581,763			3,549,988
Dividends per common share	$	—		$	—	$	0.25		$	0.20

See Notes to Consolidated Financial Statements

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Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited)

													Accumulated
													Other			Total
													Compre-			Share-
	Preferred		Common		Capital		Retained			Treasury			hensive			holders’
	Stock		Stock		Surplus		Earnings			Stock			Income			Equity
Balance, December 31, 2003	$	—	$	8,917,400	$	3,845,906	$	43,427,000		$	(627,659	)	$	1,624,896		$	57,187,543
Nine Months Ended September 30, 2004
Comprehensive income:
Net income		—		—		—		8,251,262			—			—			8,251,262
Other comprehensive income, net of deferred tax benefit of ($303,491):
Net unrealized (loss) on securities of ($496,040), net of reclassification adjustment for gains included in net income of $870		—		—		—		—			—			(495,170	)		(495,170	)
Total comprehensive income																	7,756,092
Exercise of stock options		—		13,875		51,174		—			—			—			65,049
Issuance of preferred shares		33,400		—		1,125,071		—			—			—			1,158,471
Cash dividends declared ($.25 per share)		—		—		—		(877,754	)		—			—			(877,754	)
Balance, September 30, 2004	$	33,400	$	8,931,275	$	5,022,151	$	50,800,508		$	(627,659	)	$	1,129,726		$	65,289,401
Balance, December 31, 2002	$	—	$	8,904,150	$	3,805,891	$	36,726,583		$	(619,711	)	$	3,262,883		$	52,079,796
Nine Months Ended September 30, 2003
Comprehensive income:
Net income		—		—		—		5,715,578			—			—			5,715,578
Other comprehensive income, net of deferred taxes of ($978,686):
Net unrealized (loss) on securities of ($1,530,830), net of reclassification adjustment for gains included in net income of $65,974		—		—		—		—			—			(1,596,804	)		(1,596,804	)
Total comprehensive income																	4,118,774
Exercise of stock options		—		2,750		9,015		—			—			—			11,765
Purchase of treasury shares		—		—		—		—			(7,948	)		—			(7,948	)
Cash dividends declared ($.20 per share)		—		—		—		(700,863	)		—			—			(700,863	)
Balance, September 30, 2003	$	—	$	8,906,900	$	3,814,906	$	41,741,298		$	(627,659	)	$	1,666,079		$	55,501,524

See Notes to Consolidated Financial Statements

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Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

	Nine Months Ended
	September 30,			September 30,
	2004			2003
Cash Flows from Operating Activities
Net income	$	8,251,262		$	5,715,578
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation		1,101,384			767,878
Provision for loan losses		757,500			682,500
Deferred income tax (benefit)		(435,650	)		(238,050	)
Loans originated for sale		(195,059,386	)		(30,712,570	)
Proceeds from loans sold		189,315,573			30,910,070
Securities (gains)		(1,403	)		(106,410	)
Loss on disposal of other assets		30,739			(2,747	)
Amortization of securities premiums, net		636,999			1,110,682
Amortization of goodwill and purchase accounting adjustments, net		134,253			128,160
Increase in accrued interest receivable		15,730			461,141
(Increase) in other assets		(805,846	)		(545,021	)
Increase (decrease) in other liabilities		551,543			310,704
Net cash provided by operating activities		4,492,698			8,481,915
Cash Flows from Investing Activities
Net (increase) in interest bearing deposits with other banks		(22,623	)		(1,496,049	)
Proceeds from maturities and calls of securities available for sale		21,021,403			23,361,500
Proceeds from sales of securities available for sale		46,731,835			6,485,830
Principal payments received on securities available for sale		28,521,445			77,349,314
Purchases of securities available for sale		(71,980,456	)		(121,902,748	)
Net decrease in Federal funds sold		243,000			3,291,135
Net loans made to customers		(88,980,707	)		(61,006,768	)
Purchases of premises and equipment		(3,720,962	)		(4,694,493	)
Proceeds from sales of other assets		283,250			2,021,251
Net cash paid in acquisition of Sager Insurance Agency		(850,000	)		—
Net cash (used in) investing activities		(68,753,815	)		(76,591,028	)
Cash Flows from Financing Activities
Net increase (decrease) in demand deposit, NOW and savings accounts		15,115,420			3,283,990
Net increase in time deposits		8,904,869			13,085,239
Net increase in short-term borrowings		27,804,177			20,857,942
Proceeds from long-term borrowings		21,585,000			40,000,000
Repayment of long-term borrowings		(18,940,033	)		(8,520,523	)
Exercise of stock options		65,049			11,765
Dividends paid		(877,754	)		(700,863	)
Purchase of treasury stock		—			(7,948	)
Net proceeds from issuance of trust preferred securities		7,406,250			—
Net proceeds from issuance of preferred stock		1,158,471			—
Net cash provided by financing activities		62,221,449			68,009,602
Increase (decrease) in cash and due from banks		(2,039,668	)		(99,511	)
Cash and due from banks:
Beginning		14,412,120			11,470,311
Ending	$	12,372,452		$	11,370,800

(Continued)

See Notes to Consolidated Financial Statements

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Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows — continued (unaudited)

	Nine Months Ended
	September 30,		September 30,
	2004		2003
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	13,221,052	$	13,250,968
Income taxes	$	4,065,534	$	2,420,000
Supplemental Schedule of Noncash Investing and Financing Activities
Other assets acquired in settlement of loans	$	354,756	$	787,871
Acquisition of Sager Insurance Agency:
Net cash and cash equivalents paid in acquisition of Sager Insurance Agency	$	850,000	$	—
Fair value of assets acquired (principally building and land)	$	250,000	$	—
Goodwill		600,000		—
	$	850,000	$	—
Noncash investment in unconsolidated subsidiary trust	$	232,000	$	—

See Notes to Consolidated Financial Statements

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Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

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

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

The results of operations for the nine months ended September 30, 2004 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 2003 audited financial statements and Annual Report on Form 10-K. Certain accounts in the consolidated financial statements for December 31, 2003 and September 30, 2003, as previously presented, have been reclassified to conform to current year classifications.

Note 2. Significant New Accounting Pronouncements

Variable interest entities:In December 2003 the Financial Accounting Standards Board (FASB) issued revised Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46-R”). In accordance with FIN 46-R, business enterprises that represent the primary beneficiary of another entity by retaining a controlling interest in that entity’s assets, liabilities and results of operations must consolidate that entity in its financial statements. Prior to the issuance of FIN 46-R, consolidation generally occurred when an enterprise controlled another entity through voting interests. If applicable, transition rules allow the restatement of financial statements or prospective application with a cumulative effect adjustment. We have determined that the provisions of FIN 46-R require deconsolidation of subsidiary trusts which issued guaranteed preferred beneficial interests in subordinated debentures (Trust Preferred Securities). Prior to the adoption of FIN 46-R, we consolidated the trust and the balance sheet included the guaranteed beneficial interests in the subordinated debentures of the trust. Upon adoption of FIN 46-R at December 31, 2003, the trust has been deconsolidated and the junior subordinated debentures of the Company owned by the trust are being disclosed. The Trust Preferred Securities continue to qualify as Tier 1 capital for regulatory purposes. The banking regulatory agencies have not issued any guidance which would change the regulatory capital treatment for the Trust Preferred Securities based on the adoption of FIN 46-R. The adoption of the provisions of FIN 46-R has had no material impact on our results of operations, financial condition, or liquidity. See Note 9 of our Notes to Consolidated Financial Statements for a discussion of our subordinated debentures.

Loan commitments:During 2003, we adopted the provisions of Statement of Financial Accounting Standards No. 149 (“SFAS 149”), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 requires that commitments to make mortgage loans should be accounted for as derivatives if the loans are to be held for sale, because the commitment represents a written option and accordingly is recorded at the fair value of the option liability. The adoption of SFAS 149 did not have a material impact on our results of operations, financial position, or liquidity.

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Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 3. Earnings per Share

The computations of basic and diluted earnings per share follow:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Numerator:
Net Income	$	3,126,018	$	1,843,157	$	8,251,262	$	5,715,578
Denominator:
Denominator for basic earnings per share — weighted average common shares outstanding		3,513,086		3,504,820		3,511,317		3,504,373
Effect of dilutive securities:
Convertible preferred stock		37,730		—		18,865		—
Stock options		55,474		49,880		51,581		45,615
		93,204		49,880		70,446		45,615
Denominator for diluted earnings per share — weighted average common shares outstanding and assumed conversions		3,606,290		3,554,700		3,581,763		3,549,988
Basic earnings per share	$	0.89	$	0.53	$	2.35	$	1.63
Diluted earnings per share	$	0.87	$	0.52	$	2.30	$	1.61

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Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 4. Securities

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September 30, 2004 and December 31, 2003, and September 30, 2003 are summarized as follows:

	September 30, 2004
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies and corporations	$	17,742,890	$	269,508	$	22,231	$	17,990,167
Mortgage-backed securities		119,555,229		820,559		510,271		119,865,517
State and political subdivisions		3,746,155		15,130		—		3,761,285
Corporate debt securities		5,000,672		256,419		—		5,257,091
Federal Reserve Bank stock		526,000		—		—		526,000
Federal Home Loan Bank stock		12,453,200		—		—		12,453,200
Other equity securities		175,535		—		—		175,535
Total taxable		159,199,681		1,361,616		532,502		160,028,795
Tax-exempt:
State and political subdivisions		41,219,731		1,691,544		7,788		42,903,487
Federal Reserve Bank stock		8,400		—		—		8,400
Other equity securities		7,490,763		—		729,186		6,761,577
Total tax-exempt		48,718,894		1,691,544		736,974		49,673,464
Total	$	207,918,575	$	3,053,160	$	1,269,476	$	209,702,259

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Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	December 31, 2003
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies and corporations	$	21,323,741	$	556,785	$	37,831	$	21,842,695
Mortgage-backed securities		132,030,288		959,890		532,445		132,457,733
State and political subdivisions		4,008,910		24,685		—		4,033,595
Corporate debt securities		16,516,090		774,306		—		17,290,396
Federal Reserve Bank stock		436,000		—		—		436,000
Federal Home Loan Bank stock		10,319,400		—		—		10,319,400
Other equity securities		175,535		—		—		175,535
Total taxable		184,809,964		2,315,666		570,276		186,555,354
Tax-exempt:
State and political subdivisions		40,510,819		1,448,023		31,757		41,927,085
Federal Reserve Bank stock		8,400		—		—		8,400
Other equity securities		7,519,216		—		600,827		6,918,389
Total tax-exempt		48,038,435		1,448,023		632,584		48,853,874
Total	$	232,848,399	$	3,763,689	$	1,202,860	$	235,409,228

	September 30, 2003
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies and corporations	$	29,190,922	$	674,663	$	25,599	$	29,839,986
Mortgage-backed securities		113,335,764		924,851		854,787		113,405,828
State and political subdivisions		4,602,024		32,371		—		4,634,395
Corporate debt securities		20,796,792		1,063,383		—		21,860,175
Federal Reserve Bank stock		436,000		—		—		436,000
Federal Home Loan Bank stock		10,257,400		—		—		10,257,400
Other equity securities		175,535		—		—		175,535
Total taxable		178,794,437		2,695,268		880,386		180,609,319
Tax-exempt:
State and political subdivisions		34,805,206		1,238,243		51,308		35,992,141
Federal Reserve Bank stock		8,400		—		—		8,400
Other equity securities		7,528,703		—		532,019		6,996,684
Total tax-exempt		42,342,309		1,238,243		583,327		42,997,225
Total	$	221,136,746	$	3,933,511	$	1,463,713	$	223,606,544

12

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

The maturities, amortized cost and estimated fair values of securities at September 30, 2004, are summarized as follows:

	Available for Sale
	Amortized		Estimated
	Cost		Fair Value
Due in one year or less	$	43,781,230	$	43,996,489
Due from one to five years		88,195,718		88,702,186
Due from five to ten years		25,155,519		25,756,396
Due after ten years		30,132,210		31,322,476
Equity securities		20,653,898		19,924,712
	$	207,918,575	$	209,702,259

Note 5. Loans

Loans are summarized as follows:

	September 30,		December 31,		September 30,
	2004		2003		2003
Commercial	$	49,630,140	$	46,860,481	$	43,887,181
Commercial real estate		271,096,757		209,391,036		201,011,465
Real estate — construction		3,351,168		2,368,552		4,042,282
Real estate — mortgage		218,117,609		196,134,926		183,141,730
Consumer		40,558,484		41,112,132		40,846,458
Other		9,784,308		8,223,033		6,330,576
Total loans		592,538,466		504,090,160		479,259,692
Less unearned fees and interest		1,199,675		1,069,324		995,948
Total loans net of unearned fees and interest		591,338,791		503,020,836		478,263,744
Less allowance for loan losses		5,138,121		4,680,625		4,484,263
Loans, net	$	586,200,670	$	498,340,211	$	473,779,481

Note 6. Allowance for Loan Losses

An analysis of the allowance for loan losses for the nine month periods ended September 30, 2004 and 2003, and for the year ended December 31, 2003 is as follows:

13

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Nine Months Ended
	September 30,				Year Ended December 31,
	2004		2003		2003
Balance, beginning of period	$	4,680,625	$	4,053,131	$	4,053,131
Losses:
Commercial		118,635		1,308		1,308
Commercial real estate		6,862		96,640		96,640
Real estate — mortgage		5,199		59,952		59,952
Consumer		163,304		150,378		178,305
Other		235,373		42,333		72,539
Total		529,373		350,611		408,744
Recoveries:
Commercial		184		1,583		1,805
Commercial real estate		21,301		—		2,602
Real estate — mortgage		9,413		300		413
Consumer		77,683		65,638		78,515
Other		120,788		31,722		37,903
Total		229,369		99,243		121,238
Net losses		300,004		251,368		287,506
Provision for loan losses		757,500		682,500		915,000
Balance, end of period	$	5,138,121	$	4,484,263	$	4,680,625

Note 7. Goodwill and Other Intangible Assets

The following tables present our goodwill at September 30, 2004 and other intangible assets at September 30, 2004, December 31, 2003, and September 30, 2003. There was no goodwill activity during 2003.

	Goodwill Activity by Operating Segment
	Community		Mortgage		Parent and
	Banking		Banking		Other		Total
Balance, January 1, 2004	$	1,488,030	$	—	$	—	$	1,488,030
Acquired goodwill, net		—		—		600,000		600,000
Balance, September 30, 2004	$	1,488,030	$	—	$	600,000	$	2,088,030

	Unidentifiable Intangible Assets
	September 30,		December 31,		September 30,
	2004		2003		2003
Unidentifiable intangible assets
Gross carrying amount	$	2,267,323	$	2,267,323	$	2,267,323
Less: accumulated amortization		818,740		705,377		667,589
Net carrying amount	$	1,448,583	$	1,561,946	$	1,599,734

14

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

We recorded amortization expense of approximately $113,000 for the nine months ended September 30, 2004 relative to our unidentifiable intangible assets. Annual amortization is expected to be approximately $151,000 for each of the years ending 2004 through 2008.

Note 8. Deposits

The following is a summary of interest bearing deposits by type as of September 30, 2004 and 2003 and December 31, 2003:

	September 30,		December 31,		September 30,
	2004		2003		2003
Interest bearing demand deposits	$	123,686,663	$	112,670,844	$	101,739,751
Savings deposits		51,616,243		47,397,004		47,306,731
Certificates of deposit		283,649,197		274,543,713		252,405,795
Individual retirement accounts		25,984,840		26,185,456		26,467,797
Total	$	484,936,943	$	460,797,017	$	427,920,074

The following is a summary of the maturity distribution of certificates of deposit and Individual Retirement Accounts in denominations of $100,000 or more as of September 30, 2004:

	Amount		Percent
Three months or less	$	24,886,451		21.0	%
Three through six months		21,748,115		18.3	%
Six through twelve months		27,091,593		22.8	%
Over twelve months		44,919,794		37.9	%
Total	$	118,645,953		100.0	%

A summary of the scheduled maturities for all time deposits as of September 30, 2004 is as follows:

Three month period ending December 31, 2004	$	71,534,779
Year Ending December 31, 2005		153,835,371
Year Ending December 31, 2006		42,865,655
Year Ending December 31, 2007		16,843,610
Year Ending December 31, 2008		15,542,605
Thereafter		9,012,017
	$	309,634,037

15

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 9. Borrowed Funds

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

	Nine Months Ended September 30, 2004
	Federal Funds						Federal
	Purchased						Home
	and						Loan Bank
	Lines of			Repurchase			Short-term
	Credit			Agreements			Advances
Balance at September 30	$	127,000		$	10,289,823		$	67,101,600
Average balance outstanding for the period		1,166,283			9,651,655			52,308,195
Maximum balance outstanding at any month end during period		1,173,000			10,524,126			67,101,600
Weighted average interest rate for the period		1.99	%		1.52	%		1.44	%
Weighted average interest rate for balances outstanding at September 30		2.29	%		1.64	%		2.03	%

	Year Ended December 31, 2003
	Federal Funds						Federal
	Purchased						Home
	and						Loan Bank
	Lines of			Repurchase			Short-term
	Credit			Agreements			Advances
Balance at December 31	$	—		$	10,429,146		$	39,285,100
Average balance outstanding for the year		1,191,013			8,419,384			22,177,797
Maximum balance outstanding at any month end during year		6,851,000			10,429,146			39,285,100
Weighted average interest rate for the year		2.37	%		1.55	%		1.27	%
Weighted average interest rate for balances outstanding at December 31		—			1.59	%		1.07	%

16

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Nine Months Ended September 30, 2003
	Federal Funds						Federal
	Purchased						Home
	and						Loan Bank
	Lines of			Repurchase			Short-term
	Credit			Agreements			Advances
Balance at September 30	$	500,000		$	8,799,845		$	31,749,200
Average balance outstanding for the period		968,949			8,365,447			17,019,751
Maximum balance outstanding at any month end during period		6,851,000			9,002,590			31,749,200
Weighted average interest rate for the period		3.50	%		1.62	%		1.28	%
Weighted average interest rate for balances outstanding at September 30		2.61	%		1.55	%		1.33	%

Long-term borrowings:Our long-term borrowings of $166,992,593, $164,646,208 and $165,526,033 at September 30, 2004, December 31, 2003, and September 30, 2003 respectively, consisted primarily of advances from the Federal Home Loan Bank (“FHLB”).

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

The average interest rate paid on long-term borrowings for the nine month period ended September 30, 2004 was 4.02% compared to 4.63% for the first nine months of 2003.

Subordinated Debentures: We have two 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 $11,341,000 at September 30, 2004, and $3,609,000 at both December 31, 2003 and September 30, 2003.

In October 2002, we sponsored SFG Capital Trust I, and in March 2004, we sponsored SFG Capital Trust II, of which 100% of the common equity of both trusts 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. 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 and 3 month LIBOR plus 280 basis points for SFG Capital Trust II, 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 and SFG Capital Trust II are first redeemable by us in November 2007 and March 2009, respectively.

In fourth quarter 2003, as a result of applying the provisions of FIN 46-R, which governs when an equity interest should be consolidated, we were required to deconsolidate SFG Capital Trust I from our financial statements. The deconsolidation of the net assets and results of operations of the trust had virtually no impact on our financial statements or liquidity position, since we continue to be obligated to repay the debentures held by the trust and guarantee repayment of the capital securities issued by the trust. The consolidated debt obligation related to the trust increased from $3,500,000 to $3,609,000 upon deconsolidation with the difference representing our common

17

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

ownership interest in the trust. The accompanying financial statements reflect the deconsolidation for all periods presented.

The capital securities held by SFG Capital Trust I and SFG Capital Trust II qualify as Tier 1 capital under Federal Reserve Board guidelines. As a result of the issuance of FIN 46-R, the Federal Reserve Board is currently evaluating whether deconsolidation of the trust will affect the qualification of the capital securities as Tier 1 capital.

A summary of the maturities of all long-term borrowings and subordinated debentures for the next five years and thereafter is as follows:

Year Ending
December 31,	Amount
2004	$	7,378,992
2005		28,793,780
2006		17,028,624
2007		14,554,208
2008		14,344,851
Thereafter		96,233,138
	$	178,333,593

Note 10. Stock Option Plan

In accordance with Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation, we have elected to follow Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees,and related interpretations in accounting for our employee stock options.

The Officer Stock Option Plan, which provides for the granting of stock options for up to 480,000 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. Accordingly, no compensation expense is recognized for options granted under the Plan.

The following pro forma disclosures present for the quarters ended and nine months ended September 30, 2004 and 2003, 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).

18

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Quarter Ended September 30,						Nine Months Ended September 30,
(in thousands, except per share data)	2004			2003			2004			2003
Net income:
As reported	$	3,126		$	1,843		$	8,251		$	5,716
Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(23	)		(9	)		(80	)		(27	)
Pro forma	$	3,103		$	1,834		$	8,171		$	5,689
Basic earnings per share:
As reported	$	0.89		$	0.53		$	2.35		$	1.63
Pro forma	$	0.88		$	0.52		$	2.33		$	1.62
Diluted earnings per share:
As reported	$	0.87		$	0.52		$	2.30		$	1.61
Pro forma	$	0.86		$	0.52		$	2.28		$	1.60

For purposes of computing the above pro forma amounts, we estimated the fair value of the options at the date of grant using a Black-Scholes option pricing model using the following weighted-average assumptions for grants during the first nine months of 2004: risk free interest rate of 2.96%; dividend yield of 1.21%; volatility factor of the expected market price of our common stock of 22; and an expected option life of 5 years. The weighted-average grant date fair value of the options granted was $7.68. There were no option grants during the first nine months of 2003. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.

Note 11. Issuance of Preferred Stock

On April 23, 2004, the Board of Directors approved an amendment to our Articles of Incorporation establishing the Rockingham National Bank Series Convertible Preferred Stock (“Preferred Stock”) and authorizing up to 40,000 shares of its issuance. On May 17, 2004, we completed the sale of 33,400 shares of Preferred Stock in a private placement. The Preferred Stock was sold to potential investors that we believed would be beneficial to the development and support of the Rockingham National Bank, a division of Summit’s subsidiary, Shenandoah Valley National Bank, and to the outside directors of Shenandoah Valley National Bank. The offering price for each share of the Preferred Stock was the mean of the closing prices of Summit’s common stock reported on the last five (5) business days on which the stock traded prior to and inclusive of May 10, 2004, which was $35.28 per share, and aggregate offering proceeds were $1,158,471, net of related issuance costs. The shares of Preferred Stock will convert automatically into a maximum of 41,750 shares of our common stock on May 15, 2005 based on the total loans and deposits of the Rockingham National Bank division of Shenandoah Valley National Bank on that date.

19

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 12. Stock Split

On October 29, 2004, our Board of Directors authorized a 2-for-1 split of our common stock to be effected in the form of a 100% stock dividend that will be distributed on December 15, 2004 to shareholders of record as of December 1, 2004.

Note 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.

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 September 30, 2004, 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”), Capital State Bank, Inc.’s (“Capital State”) and Shenandoah Valley National Bank’s (“Shenandoah”) are presented in the following table.

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 September 30, 2004
Total Capital (to risk weighted assets)
Summit	$	76,371		12.4	%	$	49,455		8.0	%	$	61,819		10.0	%
Summit Community		31,168		11.1	%		22,541		8.0	%		28,176		10.0	%
Capital State		14,339		11.2	%		10,223		8.0	%		12,779		10.0	%
Shenandoah		22,520		11.2	%		16,015		8.0	%		20,019		10.0	%
Tier I Capital (to risk weighted assets)
Summit		71,233		11.5	%		24,728		4.0	%		37,091		6.0	%
Summit Community		28,727		10.2	%		11,271		4.0	%		16,906		6.0	%
Capital State		13,110		10.3	%		5,111		4.0	%		7,667		6.0	%
Shenandoah		21,052		10.5	%		8,008		4.0	%		12,011		6.0	%
Tier I Capital (to average assets)
Summit		71,233		8.3	%		25,619		3.0	%		42,698		5.0	%
Summit Community		28,727		7.2	%		11,970		3.0	%		19,951		5.0	%
Capital State		13,110		7.1	%		5,502		3.0	%		9,170		5.0	%
Shenandoah		21,052		8.1	%		7,815		3.0	%		13,026		5.0	%
As of December 31, 2003
Total Capital (to risk weighted assets)
Summit	$	60,092		11.0	%		43,678		8.0	%		54,598		10.0	%
Summit Community		28,449		10.9	%		20,791		8.0	%		25,989		10.0	%
Capital State		12,843		10.7	%		9,621		8.0	%		12,026		10.0	%
Shenandoah		16,650		10.4	%		12,780		8.0	%		15,975		10.0	%
Tier I Capital (to risk weighted assets)
Summit		55,411		10.1	%		21,839		4.0	%		32,759		6.0	%
Summit Community		26,032		10.0	%		10,396		4.0	%		15,593		6.0	%
Capital State		11,830		9.8	%		4,810		4.0	%		7,216		6.0	%
Shenandoah		15,399		9.6	%		6,390		4.0	%		9,585		6.0	%
Tier I Capital (to average assets)
Summit		55,411		7.3	%		22,692		3.0	%		37,820		5.0	%
Summit Community		26,032		7.0	%		11,184		3.0	%		18,639		5.0	%
Capital State		11,830		7.0	%		5,064		3.0	%		8,440		5.0	%
Shenandoah		15,399		7.1	%		6,472		3.0	%		10,786		5.0	%

Note 14. Segment Information

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

21

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	For the Quarter Ended September 30, 2004
	Community		Mortgage		Parent and
Dollars in thousands	Banking		Banking		Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	11,399	$	421	$	5		$	(191	)	$	11,634
Interest expense		4,436		189		139			(191	)		4,573
Net interest income		6,963		232		(134	)		—			7,061
Provision for loan losses		293		—		—			—			293
Net interest income after provision for loan losses		6,670		232		(134	)		—			6,768
Noninterest income		700		7,732		1,147			(1,034	)		8,545
Noninterest expense		3,880		6,585		1,336			(1,034	)		10,767
Income before income taxes		3,490		1,379		(323	)		—			4,546
Income taxes		1,064		479		(123	)		—			1,420
Net income	$	2,426	$	900	$	(200	)	$	—		$	3,126
Average assets	$	846,824	$	20,185	$	75,311		$	(67,515	)	$	874,805

	For the Quarter Ended September 30, 2003
	Community		Mortgage			Parent and
Dollars in thousands	Banking		Banking			Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	10,298	$	—		$	2		$	(6	)	$	10,294
Interest expense		4,292		—			66			(6	)		4,352
Net interest income		6,006		—			(64	)		—			5,942
Provision for loan losses		232		—			—			—			232
Net interest income after provision for loan losses		5,774		—			(64	)		—			5,710
Noninterest income		599		211			844			(844	)		810
Noninterest expense		3,390		331			920			(844	)		3,797
Income before income taxes		2,983		(120	)		(140	)		—			2,723
Income taxes		938		(41	)		(17	)		—			880
Net income	$	2,045	$	(79	)	$	(123	)	$	—		$	1,843
Average assets	$	719,738	$	3,994		$	60,940		$	(58,962	)	$	725,710

22

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	For the Nine Months Ended September 30, 2004
	Community		Mortgage		Parent and
Dollars in thousands	Banking		Banking		Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	33,095	$	930	$	11		$	(437	)	$	33,599
Interest expense		12,790		432		353			(437	)		13,138
Net interest income		20,305		498		(342	)		—			20,461
Provision for loan losses		758		—		—			—			758
Net interest income after provision for loan losses		19,547		498		(342	)		—			19,703
Noninterest income		2,065		18,664		3,032			(2,842	)		20,919
Noninterest expense		11,299		16,600		3,718			(2,842	)		28,775
Income before income taxes		10,313		2,562		(1,028	)		—			11,847
Income taxes		3,114		885		(403	)		—			3,596
Net income	$	7,199	$	1,677	$	(625	)	$	—		$	8,251
Average assets	$	805,533	$	15,376	$	72,352		$	(64,724	)	$	828,537

	For the Nine Months Ended September 30, 2003
	Community		Mortgage		Parent and
Dollars in thousands	Banking		Banking		Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	30,603	$	—	$	6		$	(15	)	$	30,594
Interest expense		13,125		—		172			(15	)		13,282
Net interest income		17,478		—		(166	)		—			17,312
Provision for loan losses		683		—		—			—			683
Net interest income after provision for loan losses		16,795		—		(166	)		—			16,629
Noninterest income		1,666		534		2,444			(2,464	)		2,180
Noninterest expense		9,810		498		2,732			(2,464	)		10,576
Income before income taxes		8,651		36		(454	)		—			8,233
Income taxes		2,640		12		(135	)		—			2,517
Net income	$	6,011	$	24	$	(319	)	$	—		$	5,716
Average assets	$	703,576	$	3,280	$	58,786		$	(56,918	)	$	708,724

23

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The following discussion and analysis focuses on significant changes in our financial condition and results of operations of Summit Financial Group, Inc. (“Company” or “Summit”) and our wholly owned subsidiaries, Summit Community Bank (“Summit Community”), Capital State Bank, Inc. (“Capital State”),Shenandoah Valley National Bank (“Shenandoah”), Summit Financial, LLC (“SFLLC”), and Summit Insurance Services, LLC for the periods indicated. This discussion and analysis should be read in conjunction with our 2003 audited financial statements and Annual Report on Form 10-K.

The Private Securities Litigation Act of 1995 indicates that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by us. 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 variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in those forward-looking statements.

OVERVIEW AND 4TH QUARTER 2004 EARNINGS

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

Strong growth in our interest earning assets resulted in an increase of 18.18%, or $3,298,000, in our net interest earnings on a tax equivalent basis for the first nine months in 2004 compared to the same period of 2003. Further, our mortgage banking segment, SFLLC, which began operations during third quarter 2003, contributed $1,684,000 to our first nine months 2004 earnings. Although we have experienced strong earnings momentum from SFLLC, there can be no assurances that SFLLC will continue to perform at this level in the near-term. Earnings derived from SFLLC in the short-term are expected to be tempered by seasonal factors, an overall slowing of consumer mortgage refinancings, and the intense competition that exists in the mortgage lending industry. Accordingly, we anticipate a reduction in the earnings contributed by SFLLC in fourth quarter of 2004, and we expect our consolidated diluted earnings per share for the fourth quarter 2004 to range between $0.65 and $0.70, less than an analyst’s most recent published estimate of $0.77 for the same period.

During the first quarter of 2004, we acquired an insurance agency located in Moorefield, West Virginia. This acquisition had no material impact on our results of operations, financial condition, or liquidity.

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 2003 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.

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

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 2003 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 2003 Annual Report on Form 10-K.

With the adoption of SFAS No. 142 on January 1, 2002, we discontinued the amortization of goodwill resulting from acquisitions. Goodwill is now subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. A fair value is determined based on at least one of three various market valuation methodologies. If the fair value equals or exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value is less than the book value, an expense may be required on our books to write down the goodwill to the proper carrying value. During the third quarter, we completed the required annual impairment test for 2004 and determined that no impairment write-offs were necessary. We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Notes 1 and 7 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 14 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 (loss) by segment follows:

	For the Quarter Ended						For the Nine Months Ended
	September 30,						September 30,
in thousands	2004			2003			2004			2003
Community Banking	$	2,426		$	2,045		$	7,199		$	6,011
Mortgage Banking		900			(79	)		1,677			24
Parent and Other		(200	)		(123	)		(625	)		(319	)
Consolidated net income	$	3,126		$	1,843		$	8,251		$	5,716

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

Earnings Summary

Net income for the quarter ended September 30, 2004 grew 69.61% to $3,126,000, or $0.87 per diluted share as compared to $1,843,000, or $0.52 per diluted share for the quarter ended September 30, 2003. Returns on average equity and assets for the first nine months of 2004 were 18.31% and 1.33%, respectively, compared with 14.06% and 1.08% for the same period of 2003.

Net Interest Income

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

Our net interest income on a fully tax-equivalent basis totaled $21,443,000 for the nine months period ended September 30, 2004 compared to $18,145,000 for the same period of 2003, representing an increase of $3,298,000 or 18.18%. This increase resulted from growth in interest earning assets, primarily loans, which served to more than offset the 36 basis points decline in the yield on interest earning assets during the same period. Average interest earning assets grew 16.7% from $670,907,000 during the first nine months of 2003 to $782,780,000 for the first nine months of 2004. Average interest bearing liabilities grew 17.6% from $604,149,000 at September 30, 2003 to $710,441,000 at September 30, 2004, at an average yield for the first nine months of 2004 of 2.47% compared to 2.93% for the same period of 2003.

Our net yield on interest earning assets increased to 3.65% for the nine month period ended September 30, 2004, compared to 3.61% for the same period in 2003. The yields on taxable loans declined 60 basis points during the period ended September 30, 2004, and during the same period, our cost of interest bearing funds also decreased by 46 basis points. Consistent with the experience of many other financial institutions, this margin compression is the result of earning assets repricing at historically low yields, while at the same time, we have limited ability to decrease correspondingly the rates paid on interest bearing liabilities. Further contributing to this situation are historically high prepayments of loans and mortgage-backed securities which necessitate the reinvestment of significant cash flows at rates well below each respective portfolio’s overall yield.

We anticipate modest growth in our net interest income to continue over the near term as the growth in the volume of interest earning 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.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

Table I — Average Balance Sheet and Net Interest Income Analysis
(Dollars in thousands)

	For the Nine Months Ended
	September 30, 2004								September 30, 2003
	Average			Earnings/		Yield/			Average			Earnings/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest earning assets
Loans, net of unearned income
Taxable	$	554,819		$	26,069		6.26	%	$	443,628		$	22,827		6.86	%
Tax-exempt (1)		8,628			489		7.56	%		5,931			367		8.25	%
Securities
Taxable		167,446			5,459		4.35	%		174,554			5,949		4.54	%
Tax-exempt (1)		48,344			2,468		6.81	%		40,934			2,151		7.01	%
Federal funds sold and interest bearing deposits with other banks		3,543			97		3.65	%		5,860			133		3.03	%
Total interest earning assets		782,780			34,582		5.89	%		670,907			31,427		6.25	%
Noninterest earning assets
Cash & due from banks		13,269								8,645
Premises and equipment		19,803								13,091
Other assets		17,577								20,321
Allowance for loan losses		(4,892	)							(4,240	)
Total assets	$	828,537							$	708,724
Interest bearing liabilities		��
Interest bearing demand deposits	$	119,403		$	841		0.94	%	$	97,891		$	590		0.80	%
Savings deposits		49,234			174		0.47	%		46,821			202		0.58	%
Time deposits		307,334			6,240		2.71	%		278,648			6,816		3.26	%
Short-term borrowings		63,120			692		1.46	%		26,407			286		1.44	%
Long-term borrowings and capital trust securities		171,350			5,192		4.04	%		154,382			5,388		4.65	%
Total interest bearing liabilities		710,441			13,139		2.47	%		604,149			13,282		2.93	%
Noninterest bearing liabilities and shareholders’ equity
Demand deposits		52,631								45,394
Other liabilities		5,372								4,965
Shareholders’ equity		60,093								54,216
Total liabilities and shareholders’ equity	$	828,537							$	708,724
Net interest earnings				$	21,443							$	18,145
Net yield on interest earning assets							3.65	%							3.61	%

(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 $983,000 and $833,000 for the periods ended September 30, 2004 and 2003, respectively.

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Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Table II — Changes in Interest Margin Attributable to Rate and Volume
(Dollars in thousands)

	For the Nine Months Ended
	September 30, 2004 versus September 30, 2003
	Increase (Decrease)
	Due to Change in:
	Volume			Rate			Net
Interest earned on:
Loans
Taxable	$	5,352		$	(2,110	)	$	3,242
Tax-exempt		155			(33	)		122
Securities
Taxable		(237	)		(253	)		(490	)
Tax-exempt		379			(62	)		317
Federal funds sold and interest bearing deposits with other banks		(60	)		24			(36	)
Total interest earned on interest earning assets		5,589			(2,434	)		3,155
Interest paid on:
Interest bearing demand deposits		142			109			251
Savings deposits		10			(38	)		(28	)
Time deposits		657			(1,233	)		(576	)
Short-term borrowings		403			3			406
Long-term borrowings and capital trust securities		557			(753	)		(196	)
Total interest paid on interest bearing liabilities		1,769			(1,912	)		(143	)
Net interest income	$	3,820		$	(522	)	$	3,298

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 $758,000 provision for loan losses for the first nine months of 2004, compared to $683,000 for the same period in 2003. Net loan charge offs for the first nine months of 2004 were $300,000, as compared to $251,000 over the same period of 2003. At September 30, 2004, the allowance for loan losses totaled $5,138,000 or 0.87% of loans, net of unearned income, compared to $4,681,000 or 0.93% of loans, net of unearned income at December 31, 2003.

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Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our asset quality remains sound. As illustrated in Table III below, our non-performing assets and loans past due 90 days or more and still accruing interest have increased during the past 12 months, but still remain at a historically moderate level.

Table III — Summary of Past Due Loans and Non-Performing Assets
(Dollars in thousands)

	September 30,						December 31,
	2004			2003			2003
Accruing loans past due 90 days or more	$	457		$	259		$	342
Nonperforming assets:
Nonaccrual loans		1,008			345			1,014
Nonaccrual securities		363			399			396
Foreclosed properties		756			560			497
Repossessed assets		53			11			—
Total	$	2,637		$	1,574		$	2,249
Total nonperforming loans as a percentage of total loans		0.39	%		0.25	%		0.27	%
Total nonperforming assets as a percentage of total assets		0.31	%		0.21	%		0.28	%

Noninterest Income

On the strength of mortgage origination revenue, total noninterest income increased to $8,544,000 for the third quarter of 2004, compared to $810,000 for the same period of 2003. Mortgage origination revenue grew to $7,732,000 for the third quarter of 2004, compared to $211,000 for the same period of 2003. This increase was due to the organization of SFLLC during the third quarter of 2003. This revenue includes mortgage loan origination and sales activity conducted through SFLLC. Refer to Note 14 of the accompanying consolidated financial statements for our segment information.

Total noninterest income was $20,919,000 for the first nine months of 2004, compared to $2,180,000 in the same period of 2003. Mortgage origination revenue was $18,666,000 for the first nine months of 2004, compared to $534,000 for the same period of 2003.

Noninterest Expense

Total noninterest expense increased approximately $18,199,000, or 172.1% to $28,775,000 during the first nine months of 2004 as compared to the same period in 2003. The primary factor contributing to growth in noninterest expense was an increase in salaries and employee benefits expense due to the staffing requirements of SFLLC. Two other major contributors to the increase in total noninterest expense for the nine months ended September 30, 2004 were advertising and postage expense. These increased expenses resulted from SFLLC’s direct mail program utilized to obtain customers. Refer to Note 14 of the accompanying consolidated financial statements for our segment information.

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Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations

FINANCIAL CONDITION

Our total assets were $862,246,000 at September 30, 2004, compared to $791,465,000 at December 31, 2003, representing an 8.9% increase. Table IV below serves to illustrate significant changes in our financial position between December 31, 2003 and September 30, 2004.

Table IV — Summary of Significant Changes in Financial Position
(Dollars in thousands)

	Balance December 31,		Increase (Decrease)						Balance September 30,
	2003		Amount			Percentage			2004
Assets
Securities available for sale		235,409		(25,707	)		-10.9	%		209,702
Loans, net of unearned income		504,693		93,605			18.5	%		598,298
Liabilities
Interest bearing deposits	$	460,797	$	24,140			5.2	%	$	484,937
Short-term borrowings		49,714		27,804			55.9	%		77,518
Long-term borrowings		168,255		10,079			6.0	%		178,334

Loan growth during the first nine months of 2004, occurring principally in the commercial and real estate portfolios, was funded primarily by both long-term and short-term borrowings from the FHLB.

Refer to Notes 4, 5, 8, and 9 of the notes to the accompanying consolidated financial statements for additional information with regard to changes in the composition of our securities, loans, deposits and borrowings between September 30, 2004 and December 31, 2003.

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 $112 million, or 13.0% of total assets at September 30, 2004 versus $115 million, or 14.7% of total assets at December 31, 2003.

Our liquidity position is monitored continuously to ensure that day-to-day as well as anticipated funding needs are met. We are not aware of any trends, commitments, events or uncertainties that have resulted in or are reasonably likely to result in a material change to our liquidity.

CAPITAL RESOURCES

One of our continuous goals is maintenance of a strong capital position. Through management of our capital resources, we seek to provide an attractive financial return to our shareholders while retaining sufficient capital to support future growth. Shareholders’ equity at September 30, 2004 totaled $65,289,000 compared to $57,188,000 at December 31, 2003, representing an increase of 14.2%.

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Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Refer to Note 13 of the notes to the accompanying consolidated financial statements for information regarding regulatory restrictions on our capital as well as our subsidiaries’ capital.

CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations. The following table summarizes our contractual cash obligations at September 30, 2004.

	Long
	Term		Subordinated
	Debt		Debentures
2004	$	7,378,992	$	—
2005		28,793,780		—
2006		17,028,624		—
2007		14,554,208		—
2008		14,344,851		—
Thereafter		84,892,138		11,341,000
Total	$	166,992,593	$	11,341,000

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, 2004 are presented in the following table.

	September 30,
	2004
Commitments to extend credit:
Revolving home equity and credit card lines	$	23,678,939
Construction loans		52,910,895
Other loans		28,507,982
Standby letters of credit		4,909,491
Total	$	110,007,307

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

Several techniques are available to monitor and control the level of interest rate risk. We primarily use earnings simulations modeling to monitor interest rate risk. The earnings simulation model forecasts the effects on net interest income under a variety of interest rate scenarios that incorporate changes in the absolute level of interest rates and changes in the shape of the yield curve. Each increase or decrease in interest rates is assumed to take place over the next 12 months, and then remain stable. Assumptions used to project yields and rates for new loans and deposits are derived from historical analysis. Securities portfolio maturities and prepayments are reinvested in like instruments. Mortgage loan prepayment assumptions are developed from industry estimates of prepayment speeds. Noncontractual deposit repricings are modeled on historical patterns.

The following table shows our projected earnings sensitivity as of September 30, 2004 which is well within our ALCO policy limit of +/- 10%:

Change in	Percentage
Interest Rates	Change in Net
(basis points)	Interest Income
Down 100		-2.10	%
Up 100		0.58	%
Up 200		0.75	%

CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, have conducted as of September 30, 2004, 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, 2004 were effective. There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting

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Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

Item 1. Legal Proceedings

We are involved in various pending legal actions, all of which are regarded as litigation arising in the ordinary course of business and are not expected to have a materially adverse effect on our business or financial condition.

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 and the alleged use of trade secrets. The individual defendants have also been sued based on allegations arising out of their former employment relationship with Corinthian Mortgage and their current employment with Summit Financial, LLC.

The plaintiff seeks damages in the amount proven at trial on each claim and punitive damages in the amount of $350,000 on each claim. Plaintiff also seeks permanent and temporary injunctive relief prohibiting the alleged use of trade secrets by Summit Financial and the alleged solicitation of Corinthian’s employees.

On January 22, 2004, we successfully defeated the Petition for Temporary Injunction brought against us by Corinthian Mortgage Corporation. The Circuit Court of Fairfax County, Virginia denied Corinthian’s petition.

We, after consultation with legal counsel, believe that Corinthian’s claims made in its recent lawsuit arising out of the hiring of former employees of Corinthian Mortgage Corporation and the alleged use of trade secrets are without foundation and that meritorious defenses exist as to all the claims. We will continue to evaluate the claims in the Corinthian lawsuit and intend to vigorously defend against them. We believe that the lawsuit is without merit and will have no material adverse effect on us. 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.

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SIGNATURES

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

SUMMIT FINANCIAL GROUP, INC.
(registrant)
By:	/s/ H. Charles Maddy, III
H. Charles Maddy, III,
President and Chief Executive Officer
By:	/s/ Robert S. Tissue
Robert S. Tissue,
Senior Vice President and Chief Financial Officer

Date: November 12, 2004

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