UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 - Q

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

        EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006.

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 filero Accelerated filerþNon-accelerated filero

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

7,135,120 shares outstanding as of August 4, 2006

Summit Financial Group, Inc. and Subsidiaries

Table of Contents

			Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Consolidated balance sheets June 30, 2006 (unaudited), December 31, 2005, and June 30, 2005 (unaudited)	4
		Consolidated statements of income for the three months and six months ended June 30, 2006 and 2005 (unaudited)	5
		Consolidated statements of shareholders’ equity for the six months ended June 30, 2006 and 2005 (unaudited)	6
		Consolidated statements of cash flows for the six months ended June 30, 2006 and 2005 (unaudited)	7-8
		Notes to consolidated financial statements (unaudited)	9-22
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	23-35
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34
	Item 4.	Controls and Procedures	35

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Summit Financial Group, Inc. and Subsidiaries

Table of Contents

PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings		36
	Item 1A.	Risk Factors		36
	Item 2.	Changes in Securities and Use of Proceeds		None
	Item 3.	Defaults upon Senior Securities		None
	Item 4.	Submission of Matters to a Vote of Security Holders		37
	Item 5.	Other Information		37-39
	Item 6.	Exhibits
		Exhibit 3.2                       By-laws of Summit Financial Group Inc., as last amended and restated August 8, 2006
		Exhibit 11.	Statement re: Computation of Earnings per Share - Information contained in Note 2 to the Consolidated Financial Statements on page 9 of this Quarterly Report is incorporated herein by reference.
		Exhibit 31.1	Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer
		Exhibit 31.2	Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer
		Exhibit 32.1	Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer
		Exhibit 32.2	Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer
SIGNATURES				40

3

Summit Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets (unaudited)

	June 30,			December 31,			June 30,
	2006			2005			2005
	(unaudited)			(*)			(unaudited)
ASSETS
Cash and due from banks	$	12,529,955		$	22,535,761		$	16,944,283
Interest bearing deposits with other banks		123,007			1,536,506			2,341,860
Federal funds sold		1,590,000			3,650,000			-
Securities available for sale		238,381,668			223,772,298			209,561,053
Loans held for sale		9,702,114			16,584,990			17,073,628
Loans, net		866,680,077			793,766,837			659,792,179
Property held for sale		358,287			378,287			906,334
Premises and equipment, net		23,553,482			23,089,412			20,514,791
Accrued interest receivable		5,024,931			4,835,763			3,940,495
Intangible assets		3,272,097			3,347,672			3,423,248
Other assets		18,432,692			16,034,499			11,989,316
Total assets	$	1,179,648,310		$	1,109,532,025		$	946,487,187
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest bearing	$	66,070,752		$	62,631,410		$	63,207,232
Interest bearing		695,491,425			611,269,308			501,960,173
Total deposits		761,562,177			673,900,718			565,167,405
Short-term borrowings		164,185,071			182,028,113			127,973,843
Long-term borrowings		147,578,964			150,911,835			165,455,406
Subordinated debentures owed to unconsolidated subsidiary trusts		19,589,000			19,589,000			11,341,000
Other liabilities		10,174,068			9,299,134			6,711,767
Total liabilities		1,103,089,280			1,035,728,800			876,649,421
Commitments and Contingencies
Shareholders' Equity
Common stock and related surplus, $2.50 par value;
authorized 20,000,000 shares, issued and outstanding
2005 - 7,135,120 shares; issued December 2005 - 7,126,220
shares; issued June 2005 - 7,123,820 shares		18,913,551			18,856,774			18,724,826
Retained earnings		60,678,420			56,214,807			51,639,709
Accumulated other comprehensive income		(3,032,941	)		(1,268,356	)		(526,769	)
Total shareholders' equity		76,559,030			73,803,225			69,837,766
Total liabilities and shareholders' equity	$	1,179,648,310		$	1,109,532,025		$	946,487,187

(*) - December 31, 2005 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				Six Months Ended
	June 30,		June 30,		June 30,			June 30,
	2006		2005		2006			2005
Interest income
Interest and fees on loans
Taxable	$	16,685,053	$	11,097,070	$	32,077,234		$	20,998,414
Tax-exempt		101,903		108,117		201,648			216,513
Interest and dividends on securities
Taxable		2,249,793		1,748,650		4,384,670			3,478,365
Tax-exempt		537,145		542,397		1,048,910			1,070,999
Interest on interest bearing deposits with other banks		4,080		22,970		20,537			45,538
Interest on Federal funds sold		8,467		4,843		16,235			7,276
Total interest income		19,586,441		13,524,047		37,749,234			25,817,105
Interest expense
Interest on deposits		6,407,742		2,926,400		11,560,934			5,443,073
Interest on short-term borrowings		1,830,754		1,055,296		3,794,743			1,809,323
Interest on long-term borrowings and subordinated debentures		2,517,516		1,938,679		4,931,985			3,806,009
Total interest expense		10,756,012		5,920,375		20,287,662			11,058,405
Net interest income		8,830,429		7,603,672		17,461,572			14,758,700
Provision for loan losses		480,000		425,000		875,000			755,000
Net interest income after provision for loan losses		8,350,429		7,178,672		16,586,572			14,003,700
Other income
Insurance commissions		246,897		235,126		476,963			383,165
Service fees		725,443		651,148		1,356,333			1,197,707
Mortgage origination revenue		5,945,390		7,112,749		12,529,303			12,968,898
Securities gains (losses)		-		5,351		-			5,351
Gain (loss) on sale of assets		-		1,250		(3,875	)		(1,075	)
Other		136,252		209,645		282,531			328,677
Total other income		7,053,982		8,215,269		14,641,255			14,882,723
Other expense
Salaries and employee benefits		4,854,615		5,394,241		10,012,647			9,936,451
Net occupancy expense		570,389		462,805		1,141,116			891,958
Equipment expense		575,507		483,172		1,095,366			976,194
Supplies		254,631		181,410		459,781			339,135
Professional fees		489,312		241,757		774,353			468,683
Postage		1,749,576		1,458,091		3,541,050			3,025,215
Advertising		1,313,834		1,221,812		2,653,149			2,546,852
Amortization of intangibles		37,788		37,788		75,576			75,576
Other		1,725,226		1,393,999		3,335,807			2,670,108
Total other expense		11,570,878		10,875,075		23,088,845			20,930,172
Income before income taxes		3,833,533		4,518,866		8,138,982			7,956,251
Income tax expense		1,199,900		1,402,627		2,533,750			2,429,107
Net income	$	2,633,633	$	3,116,239	$	5,605,232		$	5,527,144
Basic earnings per common share	$	0.37	$	0.44	$	0.79		$	0.78
Diluted earnings per common share	$	0.37	$	0.43	$	0.78		$	0.77
Average common shares outstanding
Basic		7,135,107		7,081,044		7,131,611			7,060,529
Diluted		7,193,407		7,205,377		7,193,199			7,206,181
Dividends per common share	$	0.16	$	0.14	$	0.16		$	0.14

See Notes to Consolidated Financial Statements

5

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited)

													Accumulated
	Preferred			Common									Other			Total
	Stock and			Stock and									Compre-			Share-
	Related			Related			Retained			Treasury			hensive			holders'
	Surplus			Surplus			Earnings			Stock			Income			Equity
Balance, December 31, 2005	$	-		$	18,856,774		$	56,214,807		$	-		$	(1,268,356	)	$	73,803,225
Six Months Ended June 30, 2006
Comprehensive income:
Net income		-			-			5,605,232			-			-			5,605,232
Other comprehensive income,
net of deferred tax benefit
of ($909,029):
Net unrealized (loss) on
securities of ($1,764,585), net
of reclassification adjustment
for gains included in net
income of $0		-			-			-			-			(1,764,585	)		(1,764,585	)
Total comprehensive income																	3,840,647
Exercise of stock options		-			56,777			-			-			-			56,777
Cash dividends declared
($.16 per share)		-			-			(1,141,619	)		-			-			(1,141,619	)
Balance, June 30, 2006	$	-		$	18,913,551		$	60,678,420		$	-		$	(3,032,941	)	$	76,559,030
Balance, December 31, 2004	$	1,158,471		$	18,123,492		$	47,108,898		$	(627,659	)	$	(55,181	)	$	65,708,021
Six Months Ended June 30, 2005
Comprehensive income:
Net income		-			-			5,527,144			-			-			5,527,144
Other comprehensive income,
net of deferred tax benefit
of ($289,038):
Net unrealized (loss) on
securities of ($474,906), net
of reclassification adjustment
for gains included in net
income of $3,318		-			-			-			-			(471,588	)		(471,588	)
Total comprehensive income																	5,055,556
Exercise of stock options		-			70,522			-			-			-			70,522
Conversion of preferred shares		(1,158,471	)		1,158,471			-			-			-			-
Retirement of treasury shares					(627,659	)					627,659						-
Cash dividends declared
($.14 per share)		-			-			(996,333	)		-			-			(996,333	)
Balance, June 30, 2005	$	-		$	18,724,826		$	51,639,709		$	-		$	(526,769	)	$	69,837,766

See Notes to Consolidated Financial Statements

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Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

	Six Months Ended
	June 30,			June 30,
	2006			2005
Cash Flows from Operating Activities
Net income	$	5,605,232		$	5,527,144
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation		852,664			836,948
Provision for loan losses		875,000			755,000
Stock compensation expense		13,234			-
Deferred income tax (benefit)		(191,900	)		(204,943	)
Loans originated for sale		(140,305,196	)		(152,552,850	)
Proceeds from loans sold		152,289,872			155,121,968
(Gain) on sales of loans held for sale		(5,101,800	)		(5,368,830	)
Securities (gains)		-			(5,351	)
Loss on disposal of premises, equipment and other assets		3,875			1,075
Amortization of securities premiums, net		101,307			367,041
Amortization of goodwill and purchase accounting
adjustments, net		81,341			81,342
Increase (decrease) in accrued interest receivable		(189,168	)		(288,589	)
(Increase) in other assets		(271,306	)		(830,844	)
Increase in other liabilities		130,771			451,055
Net cash provided by (used in) operating activities		13,893,926			3,890,166
Cash Flows from Investing Activities
Net (increase)decrease in interest bearing deposits
with other banks		1,413,499			(3,162	)
Proceeds from maturities and calls of securities available for sale		3,500,308			6,612,889
Proceeds from sales of securities available for sale		8,622,800			6,150,328
Principal payments received on securities available for sale		11,953,673			16,928,228
Purchases of securities available for sale		(41,578,640	)		(28,991,673	)
Net decrease in Federal funds sold		2,060,000			48,000
Net loans made to customers		(73,831,916	)		(58,165,343	)
Purchases of premises and equipment		(1,316,734	)		(575,734	)
Proceeds from sales of premises, equipment and other assets		25,645			62,950
Purchase of life insurance contracts		(880,000	)		-
Net cash provided by (used in) investing activities		(90,031,365	)		(57,933,517	)
Cash Flows from Financing Activities
Net increase in demand deposit, NOW and
savings accounts		11,137,632			28,055,605
Net increase in time deposits		76,599,152			12,405,833
Net increase(decrease) in short-term borrowings		(17,843,042	)		7,344,629
Proceeds from long-term borrowings		17,801,000			26,718,000
Repayment of long-term borrowings		(20,465,034	)		(22,026,841	)
Exercise of stock options		43,544			70,522
Dividends paid		(1,141,619	)		(996,333	)
Net cash provided by financing activities		66,131,633			51,571,415
Increase (decrease) in cash and due from banks		(10,005,806	)		(2,471,936	)
Cash and due from banks:
Beginning		22,535,761			19,416,219
Ending	$	12,529,955		$	16,944,283
(Continued)

See Notes to Consolidated Financial Statements

7

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

	Six Months Ended
	June 30,		June 30,
	2006		2005
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	19,832,325	$	10,447,430
Income taxes	$	2,641,000	$	1,600,000
Supplemental Schedule of Noncash Investing and Financing Activities
Other assets acquired in settlement of loans	$	43,676	$	346,139

See Notes to Consolidated Financial Statements

8

Summit Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (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 six months ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year. The consolidated financial statements and notes included herein should be read in conjunction with our 2005 audited financial statements and Annual Report on Form 10-K. Certain accounts in the consolidated financial statements for December 31, 2005 and June 30, 2005, as previously presented, have been reclassified to conform to current year classifications.

Note 2. Earnings per Share

The computations of basic and diluted earnings per share follow:

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Numerator:
Net Income	$	2,633,633	$	3,116,239	$	5,605,232	$	5,527,144
Denominator:
Denominator for basic earnings
per share - weighted average
common shares outstanding		7,135,107		7,081,044		7,131,611		7,060,529
Effect of dilutive securities:
Convertible preferred stock		-		37,144		-		56,872
Stock options		58,300		87,189		61,588		88,780
		58,300		124,333		61,588		145,652
Denominator for diluted earnings
per share - weighted average
common shares outstanding and
assumed conversions		7,193,407		7,205,377		7,193,199		7,206,181
Basic earnings per share	$	0.37	$	0.44	$	0.79	$	0.78
Diluted earnings per share	$	0.37	$	0.43	$	0.78	$	0.77

9

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 3. Securities

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at June 30, 2006 and December 31, 2005, and June 30, 2005 are summarized as follows:

	June 30, 2006
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies
and corporations	$	40,447,891	$	2,357	$	829,676	$	39,620,572
Mortgage-backed securities		131,993,225		35,295		4,693,034		127,335,486
State and political subdivisions		3,758,832		-		37,100		3,721,732
Corporate debt securities		2,537,384		14,637		4,840		2,547,181
Federal Reserve Bank stock		639,000		-		-		639,000
Federal Home Loan Bank stock		15,769,300		-		-		15,769,300
Other equity securities		150,410		-		-		150,410
Total taxable		195,296,042		52,289		5,564,650		189,783,681
Tax-exempt:
State and political subdivisions		41,911,326		644,454		334,506		42,221,274
Other equity securities		5,976,665		429,969		29,921		6,376,713
Total tax-exempt		47,887,991		1,074,423		364,427		48,597,987
Total	$	243,184,033	$	1,126,712	$	5,929,077	$	238,381,668

	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

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Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	June 30, 2005
	Amortized		Unrealized				Estimated
	Cost		Gains		Losses		Fair Value
Available for Sale
Taxable:
U. S. Government agencies
and corporations	$	23,671,763	$	103,167	$	79,949	$	23,694,981
Mortgage-backed securities		115,010,307		329,697		1,128,262		114,211,742
State and political subdivisions		3,743,273		3,507		-		3,746,780
Corporate debt securities		4,048,118		89,976		-		4,138,094
Federal Reserve Bank stock		451,500		-		-		451,500
Federal Home Loan Bank stock		15,551,400		-		-		15,551,400
Other equity securities		175,535		-		-		175,535
Total taxable		162,651,896		526,347		1,208,211		161,970,032
Tax-exempt:
State and political subdivisions		40,266,955		1,559,877		15,344		41,811,488
Other equity securities		7,480,557		-		1,701,024		5,779,533
Total tax-exempt		47,747,512		1,559,877		1,716,368		47,591,021
Total	$	210,399,408	$	2,086,224	$	2,924,579	$	209,561,053

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

	Available for Sale
	Amortized		Estimated
	Cost		Fair Value
Due in one year or less	$	48,330,932	$	47,151,587
Due from one to five years		109,068,697		105,447,399
Due from five to ten years		34,096,433		33,572,390
Due after ten years		29,152,596		29,274,869
Equity securities		22,535,375		22,935,423
	$	243,184,033	$	238,381,668

11

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 4. Loans

Loans are summarized as follows:

	June 30,		December 31,
	2006		2005
Commercial	$	64,341,549	$	63,205,991
Commercial real estate		296,680,636		266,228,999
Construction and development		181,999,992		141,206,211
Residential real estate		288,990,666		285,596,743
Consumer		37,040,264		36,863,170
Other		6,187,640		8,597,768
Total loans		875,240,747		801,698,882
Less unearned income		1,766,864		1,780,315
Total loans net of unearned income		873,473,883		799,918,567
Less allowance for loan losses		6,793,806		6,151,730
Loans, net	$	866,680,077	$	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 six month periods ended June 30, 2006 and 2005, and for the year ended December 31, 2005 is as follows:

	Six Months Ended				Year Ended
	June 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		18,891		-		-
Real estate - mortgage		95,586		50,200		204,926
Consumer		81,036		89,123		173,020
Other		201,981		123,350		364,311
Total		429,238		282,432		778,066
Recoveries:
Commercial		1,025		-		6,495
Commercial real estate		36,910		12,577		41,228
Real estate - mortgage		6,518		-		42
Consumer		25,625		32,793		55,700
Other		126,236		106,068		273,645
Total		196,314		151,438		377,110
Net losses		232,924		130,994		400,956
Provision for loan losses		875,000		755,000		1,479,400
Balance, end of period	$	6,793,806	$	5,697,292	$	6,151,730

12

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 6. Goodwill and Other Intangible Assets

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

	Goodwill Activity by Operating Segment
	Community		Mortgage		Parent and
	Banking		Banking		Other		Total
Balance, January 1, 2006	$	1,488,030	$	-	$	600,000	$	2,088,030
Acquired goodwill, net		-		-		-		-
Balance, June 30, 2006	$	1,488,030	$	-	$	600,000	$	2,088,030

	Unidentifiable Intangible Assets
	June 30,		December 31,		June 30,
	2006		2005		2005
Unidentifiable intangible assets
Gross carrying amount	$	2,267,323	$	2,267,323	$	2,267,323
Less: accumulated amortization		1,083,256		1,007,681		932,105
Net carrying amount	$	1,184,067	$	1,259,642	$	1,335,218

We recorded amortization expense of approximately $76,000 for the six months ended June 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 June 30, 2006 and 2005 and December 31, 2005:

	June 30,		December 31,		June 30,
	2006		2005		2005
Interest bearing demand deposits	$	214,279,129	$	200,637,520	$	145,625,507
Savings deposits		38,737,221		44,680,540		47,407,305
Retail time deposits		251,643,514		237,262,760		231,775,092
Brokered time deposits		190,831,561		128,688,488		77,152,269
Total	$	695,491,425	$	611,269,308	$	501,960,173

13

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

	Amount		Percent
Three months or less	$	32,455,607		12.6	%
Three through six months		27,795,236		10.8	%
Six through twelve months		79,850,643		31.0	%
Over twelve months		117,079,576		45.5	%
Total	$	257,181,062		100.0	%

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

Six month period ending December 31, 2006	$	131,296,676
Year Ending December 31, 2007		194,552,711
Year Ending December 31, 2008		63,042,550
Year Ending December 31, 2009		28,257,149
Year Ending December 31, 2010		22,831,646
Thereafter		2,494,343
	$	442,475,075

Note 8. Borrowed Funds

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

	Six Months Ended June 30, 2006
							Federal Funds
							Purchased
	Short-term						and
	FHLB			Repurchase			Lines of
	Advances			Agreements			Credit
Balance at June 30	$	157,796,000		$	5,749,071		$	640,000
Average balance outstanding for the period		151,198,679			6,333,903			832,271
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		4.82	%		3.92	%		7.03	%
Weighted average interest rate for balances
outstanding at June 30		5.36	%		4.17	%		7.75	%

14

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

	Six Months Ended June 30, 2005
							Federal Funds
							Purchased
	Short-term						and
	FHLB			Repurchase			Lines of
	Advances			Agreements			Credit
Balance at June 30	$	115,906,600		$	8,671,743		$	3,395,500
Average balance outstanding for the period		114,955,701			10,248,299			802,124
Maximum balance outstanding at
any month end during period		126,336,000			10,881,188			3,395,500
Weighted average interest rate for the period		2.93	%		2.07	%		4.50	%
Weighted average interest rate for balances
outstanding at June 30		3.52	%		2.42	%		4.08	%

Long-term borrowings: Our long-term borrowings of $147,578,964, $150,911,835 and $165,455,406 at June 30, 2006, December 31, 2005, and June 30, 2005 respectively, consisted primarily of advances from the Federal Home Loan Bank (“FHLB”).

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

The average interest rate paid on long-term borrowings for the six month period ended June 30, 2006 was 5.19% compared to 4.41% for the first six months of 2005.

Subordinated Debentures:We have three statutory business trusts that were formed for the purpose of issuing mandatorily redeemable securities (the “capital securities”) for which we are obligated to third party investors and investing the proceeds from the sale of the capital securities in our junior subordinated debentures (the “debentures”). The debentures held by the trusts are their sole assets. Our subordinated debentures totaled $19,589,000 at June 30, 2006 and December 31, 2005, and $11,341,000 June 30, 2005.

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

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.

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

Year Ending
December 31,	Amount
2006	$	19,494,542
2007		23,318,204
2008		24,585,851
2009		3,911,094
2010		52,050,871
Thereafter		43,807,402
	$	167,167,964

Note 9. Stock Option Plan

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

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

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

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 Six Months
	Ended June 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 six months of 2006 or 2005. Therefore, the factors for June 30, 2006 and June 30, 2005 are consistent with amounts reported in our 2005 Annual Report and 2004 Annual Report, respectively.

During first six months of 2006, we recognized $13,234 of compensation expense for share-based payment arrangements in our income statement, with a deferred tax asset of $5,000. At June 30, 2006, we had approximately $31,000 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 six months ended June 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.

17

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	Quarter Ended			Six MonthsEnded
(in thousands, except per share data)	June 30, 2005
Net income:
As reported	$	3,116		$	5,527
Deduct total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects		(36	)		(76	)
Pro forma	$	3,080		$	5,451
Basic earnings per share:
As reported	$	0.44		$	0.78
Pro forma	$	0.43		$	0.77
Diluted earnings per share:
As reported	$	0.43		$	0.77
Pro forma	$	0.43		$	0.76

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

	For the Six Months Ended
	June 30, 2006					June 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		(7,460	)		9.45
Forfeited		-			-		-			-
Outstanding, June 30		352,840		$	17.73		276,640		$	15.24

Other information regarding options outstanding and exercisable at June 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		6.42		1,588		78,600	$	5.30		1,465
6.01 - 10.00		33,640		9.49		9.54		484		19,240		9.49		278
10.01 - 17.50		3,500		17.43		7.67		57		3,500		17.43		23
17.51 - 20.00		51,800		17.79		10.47		698		20,600		17.79		127
20.01 - 25.93		178,500		25.19		9.07		-		178,500		25.19		-
		352,840		17.73				2,827		300,440		18.38		1,893

18

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

Note 10. Commitments and Contingencies

Off-Balance Sheet Arrangements

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

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

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

	June 30,
	2006
Commitments to extend credit:
Revolving home equity and
credit card lines	$	32,410,329
Construction loans		91,704,660
Other loans		37,552,776
Standby letters of credit		10,688,250
Total	$	172,356,015

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

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

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

Note 11. Restrictions on Capital

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

Quantitative measures established by regulation to ensure capital adequacy require us and each of our subsidiaries to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). We believe, as of June 30, 2006, that we and each of our subsidiaries met all capital adequacy requirements to which they were subject.

19

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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.

(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 June 30, 2006
Total Capital (to risk weighted assets)
Summit	$	102,289		11.3	%	$	72,328		8.0	%	$	90,409		10.0	%
Summit Community		57,432		10.8	%		42,621		8.0	%		53,276		10.0	%
Shenandoah		39,553		10.9	%		29,021		8.0	%		36,277		10.0	%
Tier I Capital (to risk weighted assets)
Summit		95,317		10.5	%		36,164		4.0	%		54,246		6.0	%
Summit Community		53,056		10.0	%		21,310		4.0	%		31,966		6.0	%
Shenandoah		36,957		10.2	%		14,511		4.0	%		21,766		6.0	%
Tier I Capital (to average assets)
Summit		95,317		8.2	%		34,754		3.0	%		57,924		5.0	%
Summit Community		53,056		7.4	%		21,628		3.0	%		36,046		5.0	%
Shenandoah		36,957		8.7	%		12,792		3.0	%		21,320		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)

Note 12. Segment Information

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

	For the Quarter Ended June 30, 2006
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	19,399		$	412		$	-		$	11		$	(235	)	$	19,587
Interest expense		10,347			234			-			410			(235	)		10,756
Net interest income		9,052			178			-			(399	)		-			8,831
Provision for loan losses		330			150			-			-			-			480
Net interest income after provision
for loan losses		8,722			28			-			(399	)		-			8,351
Noninterest income		923			5,945			186			1,465			(1,465	)		7,054
Noninterest expense		5,153			5,974			179			1,730			(1,465	)		11,571
Income before income taxes		4,492			(1	)		7			(664	)		-			3,834
Income taxes		1,462			7			-			(269	)		-			1,200
Net income	$	3,030		$	(8	)	$	7		$	(395	)	$	-		$	2,634
Intersegment revenue (expense)	$	(1,148	)	$	(309	)	$	(8	)	$	1,465		$	-		$	-
Average assets	$	1,150,170		$	17,998		$	1,041		$	99,375		$	(106,829	)	$	1,161,755

	For the Quarter Ended June 30, 2005
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	13,328		$	485		$	-		$	6		$	(295	)	$	13,524
Interest expense		5,725			294			-			196			(295	)		5,920
Net interest income		7,603			191			-			(190	)		-			7,604
Provision for loan losses		345			80			-			-			-			425
Net interest income after provision
for loan losses		7,258			111			-			(190	)		-			7,179
Noninterest income		905			7,113			197			1,183			(1,183	)		8,215
Noninterest expense		4,374			6,055			135			1,494			(1,183	)		10,875
Income before income taxes		3,789			1,169			62			(501	)		-			4,519
Income taxes		1,221			414			26			(258	)		-			1,403
Net income	$	2,568		$	755		$	36		$	(243	)	$	-		$	3,116
Intersegment revenue (expense)	$	(820	)	$	(355	)	$	(8	)	$	1,183		$	-		$	-
Average assets	$	921,770		$	23,838		$	1,008		$	81,095		$	(95,937	)	$	931,774

21

Summit Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

	For the Six Months Ended June 30, 2006
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	37,298		$	974		$	-		$	23		$	(546	)	$	37,749
Interest expense		19,509			545			-			779			(546	)		20,287
Net interest income		17,789			429			-			(756	)		-			17,462
Provision for loan losses		655			220			-			-			-			875
Net interest income after provision
for loan losses		17,134			209			-			(756	)		-			16,587
Noninterest income		1,733			12,529			379			2,963			(2,963	)		14,641
Noninterest expense		10,145			12,206			354			3,347			(2,963	)		23,089
Income before income taxes		8,722			532			25			(1,140	)		-			8,139
Income taxes		2,776			208			8			(458	)		-			2,534
Net income	$	5,946		$	324		$	17		$	(682	)	$	-		$	5,605
Intersegment revenue (expense)	$	(2,251	)	$	(695	)	$	(17	)	$	2,963		$	-		$	-
Average assets	$	1,133,212		$	20,286		$	1,019		$	98,270		$	(108,322	)	$	1,144,465

	For the Six Months Ended June 30, 2005
	Community			Mortgage			Insurance			Parent and
Dollars in thousands	Banking			Banking			Services			Other			Eliminations			Total
Condensed Statements of Income
Interest income	$	25,532		$	788		$	-		$	12		$	(515	)	$	25,817
Interest expense		10,695			513			-			365			(515	)		11,058
Net interest income		14,837			275			-			(353	)		-			14,759
Provision for loan losses		675			80			-			-			-			755
Net interest income after provision
for loan losses		14,162			195			-			(353	)		-			14,004
Noninterest income		1,593			12,969			319			2,360			(2,359	)		14,882
Noninterest expense		8,571			11,652			269			2,797			(2,359	)		20,930
Income before income taxes		7,184			1,512			50			(790	)		-			7,956
Income taxes		2,250			530			21			(372	)		-			2,429
Net income	$	4,934		$	982		$	29		$	(418	)	$	-		$	5,527
Intersegment revenue (expense)	$	(1,726	)	$	(618	)	$	(15	)	$	2,359		$	-		$	-
Average assets	$	902,753		$	21,625		$	996		$	79,703		$	(92,887	)	$	912,190

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

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

Although we believe the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. Factors that might cause such a difference include changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking laws and regulations; changes in tax laws; the impact of technological advances; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national and local economy.

OVERVIEW

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

Strong growth in our interest earning assets resulted in an increase of 17.41%, or $2,681,000, in our net interest earnings on a tax equivalent basis for the first six months in 2006 compared to the same period of 2005. Our mortgage banking segment contributed $324,000 to our first six months 2006 earnings compared to $982,000 for the comparable period of 2005, as we experienced a sharp decline in mortgage loan originations during second quarter 2006.

CRITICAL ACCOUNTING POLICIES

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

Our most significant accounting policies are presented in Note 1 to the consolidated financial statements of our 2005 Annual Report on Form 10-K. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

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 2005 Annual Report on Form 10-K describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses is included in the Asset Quality section of the financial review of the 2005 Annual Report on Form 10-K.

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

BUSINESS SEGMENT RESULTS

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

	For the Quarter Ended						For the Six Months Ended
	June 30,						June 30,
in thousands	2006			2005			2006			2005
Community Banking	$	3,030		$	2,568		$	5,946		$	4,934
Mortgage Banking		(8	)		755			324			982
Parent and Other		(388	)		(207	)		(665	)		(389	)
Consolidated net income	$	2,634		$	3,116		$	5,605		$	5,527

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 income for the six months ended June 30, 2006 grew 1.41% to $5,605,000, or $0.78 per diluted share as compared to $5,527,000, or $0.77 per diluted share for the six months ended June 30, 2005. For the quarter ended June 30, 2006, net income declined 15.47% to $2,634,000 from the $3,116,000 net income for the second quarter 2005. Returns on average equity and assets for the first six months of 2005 were 14.53% and 0.98%, respectively, compared with 16.41% and 1.21% for the same period of 2005.

Net Interest Income

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

Our net interest income on a fully tax-equivalent basis totaled $18,084,000 for the six months period ended June 30, 2006 compared to $15,403,000 for the same period of 2005, representing an increase of $2,681,000 or 17.41%. This increase resulted from growth in interest earning assets, primarily loans, which served to more than offset the 126 basis points increase in the cost of interest bearing liabilities during the same period. Average interest earning assets grew 25.91% from $863,634,000 during the first six months of 2005 to $1,087,366,000 for the first six months of 2006. Average interest bearing liabilities grew 27.12% from $780,807,000 at June 30, 2005 to $992,532,000 at June 30, 2006 at an average yield for the first six months of 2006 of 4.12% compared to 2.86% for the same period of 2005.

Our net yield on interest earning assets decreased to 3.35% for the six month period ended June 30, 2006, compared to 3.60% for the same period in 2005. On a quarterly basis, our net interest margin declined to 3.32% at June 30, 2006, from 3.39% for the quarter ended March 31, 2006. The positive impact to net interest income of our growth in interest earning assets was somewhat offset by lower net interest margin due to increased cost of interest bearing liabilities, which tend to move more proportionately with rate increases by the Fed. The yields on earning assets increased only 94 basis points, while the cost of our interest bearing funds increased by 126 basis points.

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

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
(Dollars in thousands)
	For the Six Months Ended
	June 30, 2006								June 30, 2005
	Average			Earnings/		Yield/			Average			Earnings/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest earning assets
Loans, net of unearned income
Taxable	$	844,093		$	32,077		7.66	%	$	641,631		$	20,998		6.60	%
Tax-exempt (1)		8,242			305		7.46	%		9,041			328		7.32	%
Securities
Taxable		188,414			4,385		4.69	%		162,072			3,478		4.33	%
Tax-exempt (1)		44,988			1,568		7.03	%		48,102			1,604		6.72	%
Federal funds sold and interest
bearing deposits with other banks		1,629			37		4.58	%		2,788			53		3.83	%
Total interest earning assets		1,087,366			38,372		7.12	%		863,634			26,461		6.18	%
Noninterest earning assets
Cash & due from banks		14,259								15,294
Premises and equipment		23,475								20,714
Other assets		25,890								17,883
Allowance for loan losses		(6,525	)							(5,335	)
Total assets	$	1,144,465							$	912,190
Interest bearing liabilities
Interest bearing demand deposits	$	209,565		$	3,366		3.24	%	$	134,987		$	1,025		1.53	%
Savings deposits		40,209			147		0.74	%		49,954			158		0.64	%
Time deposits		402,422			8,048		4.03	%		302,046			4,260		2.84	%
Short-term borrowings		158,365			3,795		4.83	%		126,006			1,809		2.90	%
Long-term borrowings
and capital trust securities		181,971			4,932		5.47	%		167,814			3,806		4.57	%
Total interest bearing liabilities		992,532			20,288		4.12	%		780,807			11,058		2.86	%
Noninterest bearing liabilities
and shareholders' equity
Demand deposits		64,906								57,610
Other liabilities		9,850								6,393
Shareholders' equity		77,177								67,380
Total liabilities and
shareholders' equity	$	1,144,465							$	912,190
Net interest earnings				$	18,084							$	15,403
Net yield on interest earning assets							3.35	%							3.60	%

(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 $622,000 and $644,000 for the periods ended

       June 30, 2006 and 2005, 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 Six Months Ended
	June 30, 2006 versus June 30, 2005
	Increase (Decrease)
	Due to Change in:
	Volume			Rate			Net
Interest earned on:
Loans
Taxable	$	7,333		$	3,746		$	11,079
Tax-exempt		(29	)		6			(23	)
Securities
Taxable		596			311			907
Tax-exempt		(107	)		71			(36	)
Federal funds sold and interest
bearing deposits with other banks		(25	)		9			(16	)
Total interest earned on
interest earning assets		7,768			4,143			11,911
Interest paid on:
Interest bearing demand
deposits		775			1,566			2,341
Savings deposits		(34	)		23			(11	)
Time deposits		1,678			2,110			3,788
Short-term borrowings		551			1,435			1,986
Long-term borrowings and capital
trust securities		340			786			1,126
Total interest paid on
interest bearing liabilities		3,310			5,920			9,230
Net interest income	$	4,458		$	(1,777	)	$	2,681

Noninterest Income

Total noninterest income decreased to $7,054,000 for the second quarter of 2006, compared to $8,215,000 for the same period of 2005 due to a sharp decline in mortgage origination revenue. Mortgage origination revenue declined to $5,945,000 for the second quarter of 2006, compared to $7,113,000 for the same period of 2005. This revenue includes mortgage loan origination and sales activity conducted through Summit Mortgage. Further detail regarding noninterest income is reflected in the following table. Also, refer to Note 12 of the accompanying consolidated financial statements for our segment information.

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 June 30,				For the Six Months Ended June 30,
	2006		2005		2006		2005
Insurance commissions	$	247	$	235	$	477	$	383
Service fees		726		651		1,356		1,198
Mortgage origination revenue		5,945		7,113		12,529		12,969
Securities gains (losses)		-		5		-		5
Other		136		211		279		327
Total	$	7,054	$	8,215	$	14,641	$	14,882

Insurance commissions: These commissions increased 5.1% for second quarter 2006 over second quarter 2005 and 24.5% for the six months ended June 30, 2006 compared to the same period of 2005 primarily due to Summit Insurance Services, LLC, which offers both commercial and personal lines of insurance.

Service fees: Total service fees increased 11.5% for the second quarter of 2006 compared to the same period of 2005 and 13.2% for the first six months of 2006 compared to the same period of 2005. These increases were 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 June 30,				For the Six Months Ended June 30,
Dollars in thousands	2006		2005		2006		2005
Loans originated
1st mortgage
Amount	$	13,665	$	10,484	$	24,764	$	24,794
Number		68		57		132		136
2nd mortgage
Amount	$	53,465	$	73,132	$	115,333	$	127,751
Number		1,154		1,521		2,476		2,750
Total
Amount	$	67,130	$	83,616	$	140,097	$	152,545
Number		1,222		1,578		2,608		2,886
Loans sold
Amount	$	69,315	$	81,422	$	145,690	$	148,183
Number		1,304		1,549		2,725		2,844

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

Mortgage Origination Revenue
	For the Quarter Ended				For the Six Months Ended
	June 30,				June 30,
Dollars in thousands	2006		2005		2006		2005
Origination fees, net	$	3,580	$	4,050	$	7,427	$	7,600
Gains		2,365		3,063		5,102		5,369
Total	$	5,945	$	7,113	$	12,529	$	12,969

Loan originations in the second quarter of 2006 were $67.1 million, a decline of 8.0 percent from the linked quarter and 19.7 percent from the prior-year second quarter. We believe that several 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.

In addition, Summit Mortgage suspended its direct mailings during the second quarter of 2006, to residents of Indiana, Illinois and Wisconsin, one of its strongest performing markets. Mailings were also briefly suspended in all other states, from late May until early June, 2006. Suspension of these mailings enabled Summit Mortgage to assess several recent federal court decisions concerning the Fair Credit Reporting Act (FCRA), a federal law which prescribes the legal requirements its prescreened offers of credit must meet, and two lawsuits which were filed against the company. Management believes, based on advice from legal counsel, that its mailings fully complied with all applicable legal requirements, including those of the FCRA. Summit Mortgage has also developed a new uniform mailer that it believes complies with the evolving standards in all jurisdictions where it does business.  While initial response to the revised mailer was poor, recent indications are that its response rate has improved significantly following further modification. However, even with improving response rates, due to the length of this business segment’s production-sales cycle, management reasonably expects this business segment’s third quarter 2006 results to be equally as or more unprofitable than second quarter 2006.

Other: Other income decreased 35.5% for the second quarter of 2006 and 14.7% for the six months ended June 30, 2006 compared to the same respective periods of 2005. Our increase in debit card and ATM income due to increased card usage by customers was more than offset by decreases in both financial services revenue and derivative income.

Noninterest Expense

Total noninterest expense increased approximately $2,159,000, or 10.3% to $23,089,000 during the first six months of 2006 as compared to the same period in 2005 and $696,000 or 6.4% for second quarter 2006 compared to second quarter 2005. The primary factors contributing to 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. Table III below shows the breakdown of these increases by segment. Also, refer to Note 12 of the accompanying consolidated financial statements for our segment information.

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 June 30,									For the Six Months Ended June 30,
			Change									Change
Community Banking and Other	2006		$		%			2005		2006		$			%			2005
Salaries and employee benefits	$	3,049	$	319		11.7	%	$	2,730	$	6,104	$	860			16.4	%	$	5,244
Net occupancy expense		390		49		14.4	%		341		791		137			20.9	%		654
Equipment expense		496		59		13.5	%		437		946		62			7.0	%		884
Supplies		222		41		22.7	%		181		388		49			14.5	%		339
Professional fees		245		82		50.3	%		163		452		112			32.9	%		340
Postage		60		19		46.3	%		41		115		10			9.5	%		105
Advertising		151		18		13.5	%		133		200		(5	)		-2.4	%		205
Amortization of intangibles		38		-		0.0	%		38		76		-			0.0	%		76
Other		946		190		25.1	%		756		1,811		380			26.6	%		1,431
Total	$	5,597	$	777		16.1	%	$	4,820	$	10,883	$	1,605			17.3	%	$	9,278

			Change										Change
Mortgage Banking	2006		$			%			2005		2006		$			%			2005
Salaries and employee benefits	$	1,806	$	(858	)		-32.2	%	$	2,664	$	3,908	$	(784	)		-16.7	%	$	4,692
Net occupancy expense		180		58			47.5	%		122		350		112			47.1	%		238
Equipment expense		79		33			71.7	%		46		150		58			63.0	%		92
Supplies		33		1			3.1	%		32		72		21			41.2	%		51
Professional fees		244		165			208.9	%		79		322		193			149.6	%		129
Postage		1,690		273			19.3	%		1,417		3,426		506			17.3	%		2,920
Advertising		1,163		74			6.8	%		1,089		2,453		111			4.7	%		2,342
Other		779		173			28.5	%		606		1,525		337			28.4	%		1,188
Total	$	5,974	$	(81	)		-1.3	%	$	6,055	$	12,206	$	554			4.8	%	$	11,652

			Change										Change
Consolidated	2006					$%			2005		2006				$%			2005
Salaries and employee benefits	$	4,855	$	(539	)		-10.0	%	$	5,394	$	10,012	$	76		0.8	%	$	9,936
Net occupancy expense		570		107			23.1	%		463		1,141		249		27.9	%		892
Equipment expense		575		92			19.0	%		483		1,096		120		12.3	%		976
Supplies		255		42			19.7	%		213		460		70		17.9	%		390
Professional fees		489		247			102.1	%		242		774		305		65.0	%		469
Postage		1,750		292			20.0	%		1,458		3,541		516		17.1	%		3,025
Advertising		1,314		92			7.5	%		1,222		2,653		106		4.2	%		2,547
Amortization of intangibles		38		-			0.0	%		38		76		-		0.0	%		76
Other		1,725		363			26.7	%		1,362		3,336		717		27.4	%		2,619
Total	$	11,571	$	696			6.4	%	$	10,875	$	23,089	$	2,159		10.3	%	$	20,930

Community Banking, Parent and Other Segments

Total noninterest expense for our community banking segment, parent, and other increased $777,000, or 16.1% for the second quarter of 2006, compared to the same period of 2005 and $1,605,000, or 17.3% for the six months ended June 30, 2006 versus the same period of 2005. The major factors contributing to these increases follow.

30

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Salaries and employee benefits: Salaries and employee benefits expense increased 11.7% and 16.4% for the quarter ended June 30, 2006 and the six months ended June 30, 2006, respectively, 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 25.1% for second quarter 2006 compared to second quarter 2005, and 26.6% for the six months ended June 30, 2006 compared to the same period of 2005. These increases include $60,000 of losses in fraudulent checks.

Mortgage Banking Segment

Total noninterest expense for our mortgage banking segment decreased 1.3% for the second quarter of 2006 over the same period of 2005. These expenses increased $554,000 or 4.8% for the six months ended June 30, 2006 compared to the same period of 2005.

Salaries and employee benefits: The decrease of $858,000 in salaries and employee benefits for the quarter ended June 30, 2006 and $784,000 for the six months ended June 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 47.5% for the second quarter 2006 compared to the same period of 2005 and 47.1% for the first six 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 208.9% for the second quarter 2006, compared to the second quarter 2005, and 149.6% for the six months ended June 30, 2006 compared to the same period of 2005. This increase is primarily attributable to increased legal expenses arising from legal compliance reviews and litigation defense.

Postage: The increase in postage expense of $273,000 and $506,000 for the quarter and six months ended June 30, 2006, respectively, was the result of 1) a 10% increase in the number of direct mail pieces mailed and 2) a rate increase by the US Postal Service.

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 an $875,000 provision for loan losses for the first six months of 2006, compared to $755,000 for the same period in 2005. Net loan charge offs for the first six months of 2006 were $233,000, as compared to $131,000 over the same period of 2005. At June 30, 2006, the allowance for loan losses totaled $6,794,000 or 0.77% of loans, both portfolio and held for sale, net of unearned income, compared to $6,152,000 or 0.75% at December 31, 2005. Our asset quality remains sound. As illustrated in Table IV below, our non-performing assets and loans past due 90 days or more and still accruing interest have decreased during the past 12 months, and still remain at a historically moderate level.

31

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Table IV - Summary of Past Due Loans and Non-Performing Assets
(Dollars in thousands)
	June 30,						December 31,
	2006			2005			2005
Accruing loans past due 90 days or more	$	290		$	536		$	799
Nonperforming assets:
Nonaccrual loans		1,303			375			750
Nonaccrual securities		-			326			-
Foreclosed properties		358			906			378
Repossessed assets		15			43			17
Total	$	1,966		$	2,186		$	1,944
Total nonperforming loans as a
percentage of total loans		0.18	%		0.13	%		0.19	%
Total nonperforming assets as a
percentage of total assets		0.17	%		0.23	%		0.18	%

FINANCIAL CONDITION

Our total assets were $1,179,648,000 at June 30, 2006, compared to $1,109,532,000 at December 31, 2005, representing a 6.3% increase. Table V below serves to illustrate significant changes in our financial position between December 31, 2005 and June 30, 2006.

Table V - Summary of Significant Changes in Financial Position
(Dollars in thousands)
	Balance								Balance
	December 31,		Increase (Decrease)						June 30,
	2005		Amount			Percentage			2006
Assets
Securities available for sale	$	223,772		14,610			6.5	%	$	238,382
Loans, net of unearned income		799,919		73,555			9.2	%		873,474
Liabilities
Deposits	$	673,901	$	87,661			13.0	%	$	761,562
Short-term borrowings		182,028		(17,843	)		-9.8	%		164,185
Long-term borrowings
and subordinated debentures		170,501		(3,333	)		-2.0	%		167,168

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

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

32

Summit Financial Group, Inc. and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and

Results of Operations

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 $184 million, or 15.6% of total assets at June 30, 2006 versus $125 million, or 11.3% of total assets at December 31, 2005.

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

CAPITAL RESOURCES

One of our continuous goals is maintenance of a strong capital position. Through management of our capital resources, we seek to provide an attractive financial return to our shareholders while retaining sufficient capital to support future growth. Shareholders’ equity at June 30, 2006 totaled $76,559,000 compared to $73,803,000 at December 31, 2005.

During second quarter 2006, our Board of Directors declared and paid the first half 2006 cash dividend of $0.16 per share compared to $0.14 paid for the first half of 2005. The first half 2006 dividend totaled $1,141,619, representing a 14.58% increase over the $996,333 paid during the first half 2005.

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

On August 8, 2006, theBoard 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. 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. All shares acquired under the plan will be retired. Management believes, depending on market and business conditions, the stock repurchase plan should enhance the value of its common stock for the benefit of the Company’s shareholders and have no material adverse impact on our capital resources.

CONTRACTUAL CASH OBLIGATIONS

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

	Long		Capital
	Term		Trust		Operating
	Debt		Securities		Leases
2006	$	19,494,542	$	-	$	542,192
2007		23,318,204		-		1,030,983
2008		24,585,851		-		982,772
2009		3,911,094		-		431,349
2010		52,050,871		-		116,263
Thereafter		24,218,402		19,589,000		257,140
Total	$	147,578,964	$	19,589,000	$	3,360,699

33

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 June 30, 2006 are presented in the following table.

	June 30,
	2006
Commitments to extend credit:
Revolving home equity and
credit card lines	$	32,410,329
Construction loans		91,704,660
Other loans		37,552,776
Standby letters of credit		10,688,250
Total	$	172,356,015

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

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

34

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 June 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)		1.50	%		2.50	%
Down 200, steepening yield curve (2)		2.46	%		8.20	%
Up 100 (1)		-0.88	%		1.56	%
Up 200 (1)		-2.80	%		-4.20	%

     1) assumes a parallel shift in the yield curve

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

                                                                                 term rates decline by 50 basis points

CONTROLS AND PROCEDURES

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

35

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

 

Item 1. Legal Proceedings

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

On December 26, 2003, two of our subsidiaries, Summit Financial, LLC and Shenandoah Valley National Bank, and various employees of Summit Financial, LLC were served with a Petition for Temporary Injunction and a Bill of Complaint filed in the Circuit Court of Fairfax County, Virginia by Corinthian Mortgage Corporation.  The filings allege various claims against Summit Financial, LLC and Shenandoah Valley National Bank arising out of the hiring of former employees of Corinthian Mortgage Corporation 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 employment with Summit Financial, LLC. Summit Financial, LLC now operates as Summit Mortgage, a division of Shenandoah Valley National Bank.

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

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

We, aAfter consultation with legal counsel, we believe that Corinthian’s claims made in its 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.

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 claims 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 requests statutory damages. Theseis cases areis a purported class actions. Presently, we do not have final information as to the size of the alleged classes. Responsive pleadings have been filed, and discovery is in the initial stageswill be initiated shortly. We will continue to evaluate the claims in these lawsuits and intend to vigorously defend against it them. Management, at the present time, is unable to estimate the impact, if any, an adverse decision may have on our results of operations or financial condition.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

36

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

Item 4. Submission of Matters to a Vote of Security Holders

On May 18, 2006, we held our Annual Meeting of Shareholders, and the shareholders took the following actions:

1.   Elected as directors the following individuals to three year terms:

	For	Withheld
James M. Cookman	5,671,413	62,809
Thomas J. Hawse, III	5,693,296	40,926
Gary L. Hinkle	5,693,765	40,457
Gerald W. Huffman	5,693,765	40,457
H. Charles Maddy, III	5,662,127	72,095

The following directors’ terms of office continued after the 2006 annual shareholders’ meeting: Frank A. Baer, III, Oscar M. Bean, Dewey F. Bensenhaver, John W. Crites, Patrick N. Frye, James Paul Geary, Phoebe F. Heishman, Duke A. McDaniel, Ronald F. Miller, G. R. Ours, Jr., and Charles S. Piccirillo.

            2. Ratified Arnett & Foster, PLLC, to serve as our independent registered public accounting firm for the year ending December 31, 2006.

ForAgainstAbstentions

5,699,418                    12,680    22,124

Item 5. Other Information

On August 9, 2006, the Board of Directors of Summit Financial Group, Inc. (the “Company”) adopted amendments to the Company’s Bylaws to bring the Company’s Bylaws into compliance with the West Virginia Business Corporation Act, which was amended in 2002. A description of the provisions that were adopted or changed by amendment is set forth below. In addition, a complete copy of the Company’s Amended and Restated Bylaws is filed as Exhibit 3.2 and incorporated herein by reference.

Article / Section	Revisions
Article II Section 1	Changed the date of the annual meeting of shareholders from the third Tuesday of April at noon to the third Thursday of May at 1:00 p.m.
Article II                                 Section 2	This section previously required the president to call a special meeting of the shareholders at the request of the holders of not less than 10% of all of the outstanding shares of the corporation entitled to vote at the meeting. The method for determining the minimum number of shareholders that could request a special meeting and the method for making the request were revised. This section now requires the president to call a special meeting if the holders of at least 10% of all of the votes entitled to be cast on an issue to be considered at the proposed special meeting sign, date and deliver to the corporation one or more written demands for the meeting describing the purpose or purposes for which it shall be held.

37

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

Article / Section	Revisions
Article II           Section 5	The ability of the corporation to close the stock transfer books for purposes of determining shareholders entitled to notice of or to vote at a meeting or to receive dividends was deleted. The ability of the Board of Directors to fix a record date was retained and the language relating to the fixing of a record date was changed to (i) increase the period of time that the record date may be set in advance of the meeting from not more than 50 days before the meeting to not more than 70 days before the meeting and (ii) provide that a record date is effective for any adjournment of a meeting unless the Board of Directors fixes a new record date, which is required if the meeting is adjourned to a date more than 120 days after the date of the original meeting.
Article II Section 6	Added the requirement that the list of shareholders be available for inspection by shareholders during the meeting for which the list was prepared.
Article II Section 7	The method for determining a quorum was changed from the majority of outstanding shares of the corporation entitled to vote to a majority of the votes entitled to be cast on a matter. In addition, a provision was added to clarify that any business may be transacted at an adjourned meeting at which a quorum is present unless a new record date is set or must be set for the adjourned meeting.
Article II Section 10	This section was revised to incorporate the provisions in the West Virginia Code dealing with the corporation’s acceptance of votes where the name signed on the vote does not correspond to the name of the shareholder. This section now reads as follows: “If the name signed on a vote, consent, waiver or proxy does not correspond to the name of a shareholder, the corporation is entitled to accept such vote, consent, waiver or proxy and give it effect as the act of the shareholder if: (a) the shareholder is an entity and the name signed purports to be that of an officer or agent of the entity; (b) the name signed purports to be that of an administrator, executor, guardian or conservator representing the shareholder and, if the corporation requests, evidence of this status acceptable to the corporation has been presented; (c) the name signed purports to be that of a receiver or trustee in bankruptcy of the shareholder and, if the corporation requests, evidence of this status acceptable to the corporation has been presented; (d) the name signed purports to be that of a pledgee, beneficial owner or attorney-in-fact of the shareholder and, if the corporation requests, evidence acceptable to the corporation of the signatory’s authority to sign for the shareholder has been presented; and (e) two or more persons are shareholders as co-tenants or fiduciaries and the name signed purports to be the name of at least one of the co-tenants or fiduciaries and the person signing appears to be acting on behalf of all co-tenants or fiduciaries. The corporation may reject a vote, consent, waiver or proxy if the secretary or other officer authorized to tabulate votes, acting in good faith, has reasonable basis for doubt as to the validity of the signature or the signatory’s authority to sign for the shareholder.”
Article III Section 3	The requirement that a regular meeting of the Board of Directors be held immediately after and at the same place as the annual meeting of shareholders was deleted. Language was added to permit the Board of Directors to set the date of regular meetings by resolution.
Article III Section 4	The number of directors required to call a special meeting of the Board of Directors was changed from 4 directors to fifty percent of the directors.

38

Summit Financial Group, Inc. and Subsidiaries

Part II. Other Information

Article / Section	Revisions
Article III Section 5	The references to notice of a special meeting of the Board of Directors by telegram was deleted and replaced with notice by electronic transmission. The requirement that the notice set forth the nature of the business intended to be transacted in the case of amending the bylaws or authorizing the sale of all or substantially all of the assets of the corporation was deleted.
Article III Section 7	The required vote of the directors to authorize (i) mergers and closures of banks and branches, (ii) amendments to the Articles of Incorporation or Bylaws of the corporation, or (iii) the adoption of any agreement or plan to merge, consolidate, liquidate, dissolve or sell shares of stock or the sale, lease or exchange of all or substantially all of the assets of the corporation was changed from three-fourths of the directors to two-thirds of the directors. In addition, the three-fourths required vote to change Potomac Valley Bank’s name was deleted.
Article III Section 7	The following provision was added delegating the authority of the Board of Directors to the Executive Committee: “The Executive Committee shall have the authority to act on behalf of the Board of Directors and in the name of and on behalf of the corporation, to the fullest extent permitted by law and the corporation’s Articles of Incorporation and these Bylaws.”
Article III Section 8	Language was added to clarify that vacancies in the Board of Directors are not required to be filled but may be filled by the Board of Directors and that the purpose of the meeting need not be specified if the purpose of the meeting is to fill a vacancy.
Article III Section 10	Deleted the ability of a director to dissent to action taken at the meeting by forwarding his dissent by registered mail to the secretary of the corporation after the adjournment of the meeting.
Article IV Section 1	Deleted the prohibition against an individual serving as both the president and the secretary of the corporation.
Article IV Section 9	Added the phrase “as permitted by law” to limit the power of committees created by the Board of Directors.
Article V Section 1	Deleted the requirement that a construction contract had to be approved by the unanimous vote of the directors and added the requirement that a construction contract involving an amount greater than the amount authorized by the corporation’s Capital Expenditure and Purchasing Policy has to be approved by the directors. This revision conformed the bylaw provision to the corporation’s Capital Expenditure and Purchasing Policy.

39

SIGNATURES

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

	SUMMIT FINANCIAL GROUP, INC.
	(registrant)
	By:	/s/ H. Charles Maddy, III
	H. Charles Maddy, III,
	President and Chief Executive Officer
	By:	/s/ Robert S. Tissue
	Robert S. Tissue,
	Senior Vice President and Chief Financial Officer
	By:	/s/ Julie R. Cook
	Julie R. Cook,
	Vice President and Chief Accounting Officer
Date: August 8, 2006

            40