SUMMIT FINANCIAL GROUP INC - 10-Q Quarterly Report

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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 March 31, 2004.

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) 530-7233
(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 |X| No |_|

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|

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

Common Stock, $2.50 par value
3,510,620 shares outstanding as of May 10, 2004

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

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated balance sheets
March 31, 2004 (unaudited), December 31, 2003, and March 31, 2003.....4

Consolidated statements of income
for the three months ended March 31, 2004
and 2003 (unaudited)..................................................5

Consolidated statements of shareholders' equity
for the three months ended
March 31, 2004 and 2003 (unaudited)...................................6

Consolidated statements of cash flows
for the three months ended
March 31, 2004 and 2003 (unaudited).................................7-8

Notes to consolidated financial statements (unaudited).............9-21

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................22-30

Item 3. Quantitative and Qualitative Disclosures about Market Risk...........29
Item 4. Controls and Procedures..............................................30

2

PART II. OTHER INFORMATION

Item 1. Legal Proceedings..................................................31

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..............None

Item 5. Other Information................................................None

Item 6. Exhibits and Reports on Form 8-K

Exhibits

Exhibit 10. Amended and Restated Summit Financial Group, Inc. 1998
Officer Stock Option Plan

Exhibit 11. Statement re: Computation of Earnings per
Share - Information contained in Note 2 to the
Consolidated Financial Statements on page 8 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

Reports on Form 8-K.................................................31

SIGNATURES....................................................................32

3

Summit Financial Group, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
Consolidated Balance Sheets

March 31, December 31, March 31,
2004 2003 2003
(unaudited) (*) (unaudited)
------------- ------------- -------------
ASSETS

Cash and due from banks $ 9,584,246 $ 14,412,120 $ 11,816,307
Interest bearing deposits with other banks 3,223,383 3,141,092 3,820,145
Federal funds sold 1,048,000 244,000 51,223
Securities available for sale 215,732,183 235,409,228 231,559,929
Loans held for sale 9,595,896 6,352,836 2,083,065
Loans, net 532,854,898 498,340,211 433,937,306
Property held for sale, net 475,000 480,000 1,393,798
Premises and equipment, net 19,458,692 17,846,269 11,285,970
Accrued interest receivable 3,771,963 3,778,139 4,115,519
Goodwill 2,088,030 1,488,030 1,488,030
Other intangible assets 1,524,158 1,561,946 1,675,310
Other assets 9,760,944 8,411,333 7,665,365
------------- ------------- -------------
Total assets $ 809,117,393 $ 791,465,204 $ 710,891,967
============= ============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest bearing $ 48,916,332 $ 51,004,403 $ 44,806,740
Interest bearing 481,421,526 460,797,017 424,035,131
------------- ------------- -------------
Total deposits 530,337,858 511,801,420 468,841,871
------------- ------------- -------------
Short-term borrowings 42,546,950 49,714,246 28,029,455
Long-term borrowings 158,266,552 164,646,208 152,713,067
Subordinated debentures owed to unconsolidated subsidiary trust 11,341,000 3,609,000 3,609,000
Other liabilities 5,951,531 4,506,787 4,319,571
------------- ------------- -------------
Total liabilities 748,443,891 734,277,661 657,512,964
------------- ------------- -------------

Commitments and Contingencies

Shareholders' Equity
Preferred stock, $1.00 par value; authorized
250,000 shares; no shares issued - - -
Common stock, $2.50 par value; authorized
5,000,000 shares; issued 2004 - 3,568,560 shares ;
December 2003 - 3,566,960 shares; March 2003 - 3,562,260 shares 8,921,400 8,917,400 8,905,650
Capital surplus 3,858,849 3,845,906 3,811,531
Retained earnings 45,878,181 43,427,000 38,590,570
Less cost of shares acquired for the treasury,
57,940 shares (627,659) (627,659) (627,659)
Accumulated other comprehensive income 2,642,731 1,624,896 2,698,911
------------- ------------- -------------
Total shareholders' equity 60,673,502 57,187,543 53,379,003
------------- ------------- -------------

Total liabilities and shareholders' equity $ 809,117,393 $ 791,465,204 $ 710,891,967
============= ============= =============

(*) - December 31, 2003 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
----------------------------
March 31, March 31,
2004 2003
------------ ------------

Interest income
Interest and fees on loans
Taxable $ 8,216,886 $ 7,412,062
Tax-exempt 97,292 83,668
Interest and dividends on securities
Taxable 1,974,939 2,115,315
Tax-exempt 551,562 474,714
Interest on interest bearing deposits with other banks 31,180 35,509
Interest on Federal funds sold 921 9,760
------------ ------------
Total interest income 10,872,780 10,131,028
------------ ------------
Interest expense
Interest on deposits 2,414,093 2,625,468
Interest on short-term borrowings 171,909 80,196
Interest on long-term borrowings and subordinated debentures 1,685,420 1,756,993
------------ ------------
Total interest expense 4,271,422 4,462,657
------------ ------------
Net interest income 6,601,358 5,668,371
Provision for loan losses 232,500 217,500
------------ ------------
Net interest income after provision for loan losses 6,368,858 5,450,871
------------ ------------
Other income
Insurance commissions 23,096 20,232
Service fees 509,409 339,387
Mortgage origination revenue 4,319,358 139,000
Securities gains (losses) 19,928 40,892
Gain (loss) on sale of assets (1,615) (19,558)
Other 72,255 53,430
------------ ------------
Total other income 4,942,431 573,383
------------ ------------
Other expense
Salaries and employee benefits 3,685,959 1,918,620
Net occupancy expense 303,888 194,741
Equipment expense 429,027 300,245
Supplies 140,362 105,924
Professional fees 170,646 128,754
Postage 1,352,973 51,784
Advertising 961,636 49,051
Amortization of intangibles 37,788 37,788
Other 756,579 553,485
------------ ------------
Total other expense 7,838,858 3,340,392
------------ ------------
Income before income taxes 3,472,431 2,683,862
Income tax expense 1,021,250 819,875
------------ ------------
Net income $ 2,451,181 $ 1,863,987
============ ============

Basic earnings per common share $ 0.70 $ 0.53
============ ============
Diluted earnings per common share $ 0.69 $ 0.53
============ ============

Average common shares outstanding
Basic 3,510,063 3,503,930
============ ============
Diluted 3,553,392 3,529,886
============ ============

Dividends per common share $ - $ -
============ ============

See Notes to Consolidated Financial Statements

5

Summit Financial Group, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity (unaudited)

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

Balance, December 31, 2003 $ 8,917,400 $ 3,845,906 $ 43,427,000 $ (627,659) $ 1,624,896 $ 57,187,543

Three Months Ended March 31, 2004
Comprehensive income:
Net income - - 2,451,181 - - 2,451,181
Other comprehensive income,
net of deferred taxes
of $623,834:
Net unrealized gain on
securities of $1,030,190, net
of reclassification adjustment
for gains included in net
income of $12,355 - - - - 1,017,835 1,017,835
------------
Total comprehensive income 3,469,016
------------
Exercise of stock options 4,000 12,943 - - - 16,943
----------- ----------- ------------ ----------- ----------- ------------

Balance, March 31, 2004 $ 8,921,400 $ 3,858,849 $ 45,878,181 $ (627,659) $ 2,642,731 $ 60,673,502
=========== =========== ============ ========== =========== ============

Balance, December 31, 2002 $ 8,904,150 $ 3,805,891 $ 36,726,583 $ (619,711) $ 3,262,883 $ 52,079,796
Three Months Ended March 31, 2003
Comprehensive income:
Net income - - 1,863,987 - - 1,863,987
Other comprehensive income,
net of deferred tax benefit
of ($345,660):
Net unrealized (loss) on
securities of ($589,325), net
of reclassification adjustment
for gains included in net
income of $25,353 - - - - (563,972) (563,972)
---------
Total comprehensive income - - - - - 1,300,015
---------
Exercise of stock options 1,500 5,640 - - - 7,140
Purchase of treasury shares - - - (7,948) - (7,948)
----------- ----------- ------------ ----------- ----------- ------------

Balance, March 31, 2003 $ 8,905,650 $ 3,811,531 $ 38,590,570 $ (627,659) $ 2,698,911 $ 53,379,003
=========== =========== ============ ========== =========== ============

See Notes to Consolidated Financial Statements

6

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

Three Months Ended
----------------------------
March 31, March 31,
2004 2003
------------ ------------

Cash Flows from Operating Activities
Net income $ 2,451,181 $ 1,863,987
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation 341,131 252,433
Provision for loan losses 232,500 217,500
Deferred income tax (benefit) (145,250) (68,000)
Loans originated for sale (44,941,003) (7,644,790)
Proceeds from loans sold 41,697,943 6,468,625
Securities (gains) (19,928) (40,892)
Loss on disposal of other assets 1,615 19,558
Amortization of securities premiums, net 142,402 306,650
Amortization of goodwill and purchase accounting
adjustments, net 43,086 43,086
(Increase) decrease in accrued interest receivable 6,176 (70,804)
(Increase) in other assets (1,014,566) (663,774)
Increase in other liabilities 1,444,744 919,631
------------ ------------
Net cash provided by operating activities 240,031 1,603,210
------------ ------------
Cash Flows from Investing Activities
Net (increase) decrease in interest bearing deposits with other banks (82,292) (1,634,776)
Proceeds from maturities and calls of securities available for sale 6,439,500 11,995,000
Proceeds from sales of securities available for sale 28,823,935 1,394,555
Principal payments received on securities available for sale 11,622,069 21,629,654
Purchases of securities available for sale (25,715,293) (55,146,213)
Net (increase) decrease in Federal funds sold (804,000) 3,338,912
Net loans made to customers (34,762,187) (20,533,164)
Purchases of premises and equipment (1,706,885) (298,488)
Proceeds from sales of other assets 21,000 1,023,695
Net cash paid in acquisition of Sager Insurance Agency (850,000) -
------------ ------------
Net cash provided by (used in) investing activities (17,014,153) (38,230,825)
------------ ------------
Cash Flows from Financing Activities
Net increase (decrease) in demand deposit, NOW and
savings accounts 6,266,654 (2,388,533)
Net increase in time deposits 12,269,784 12,620,347
Net increase (decrease) in short-term borrowings (7,167,296) 7,838,352
Proceeds from long-term borrowings 7,763,250 19,250,000
Repayment of long-term borrowings (7,203,087) (345,747)
Exercise of stock options 16,943 7,140
Purchase of treasury stock - (7,948)
------------ ------------
Net cash provided by financing activities 11,946,248 36,973,611
------------ ------------
Increase (decrease) in cash and due from banks (4,827,874) 345,996
Cash and due from banks:
Beginning 14,412,120 11,470,311
------------ ------------
Ending $ 9,584,246 $ 11,816,307
============ ============

(Continued)

See Notes to Consolidated Financial Statements

7

Summit Financial Group, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
Consolidated Statments of Cash Flows - continued (unaudited)

Three Months Ended
----------------------------
March 31, March 31,
2004 2003
------------ ------------

Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest $ 4,385,047 $ 4,508,920
============ ============
Income taxes $ 25,000 $ -
============ ============

Supplemental Schedule of Noncash Investing and Financing Activities
Other assets acquired in settlement of loans $ 14,000 $ 622,441
============ ============

Acquisition of Sager Insurance Agency:
Net cash and cash equivalents paid in acquisition of Sager Insurance
Agency $ 850,000 $ -
============ ============
Fair value of assets acquired (principally building and land) $ 250,000 $ -
============ ============
Goodwill 600,000 -
------------ ------------
$ 850,000 $ -
============ ============

See Notes to Consolidated Financial Statements

8

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

Note 1. Basis of Presentation

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

The presentation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that effect 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 three months ended March 31, 2004 are not
necessarily indicative of the results to be expected for the full year. The
consolidated financial statements and notes included herein should be read in
conjunction with our 2003 audited financial statements and Annual Report on Form
10-K. Certain accounts in the consolidated financial statements for December 31,
2003 and March 31, 2003, as previously presented, have been reclassified to
conform to current year classifications.

Note 2. Significant New Accounting Pronouncements

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

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

9

Note 3. Earnings per Share

The computations of basic and diluted earnings per share follow:

Three Months Ended March 31,
-----------------------------
2004 2003
----------- -----------
Numerator:
Net Income $ 2,451,181 $ 1,863,987
=========== ===========

Denominator:
Denominator for basic earnings
per share - weighted average
common shares outstanding 3,510,063 3,503,930

Effect of dilutive securities:
Stock options 43,329 25,956
----------- -----------

Denominator for diluted earnings
per share - weighted average
common shares outstanding and
assumed conversions 3,553,392 3,529,886
=========== ==========

Basic earnings per share $ 0.70 $ 0.53
=========== ==========

Diluted earnings per share $ 0.69 $ 0.53
=========== ==========

10

Note 4. Securities

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

March 31, 2004
---------------------------------------------------------
Amortized Unrealized Estimated
---------------------------
Cost Gains Losses Fair Value
------------ ------------ ------------ ------------

Available for Sale
Taxable:
U. S. Government agencies
and corporations $ 17,794,757 $ 479,850 $ - $ 18,274,607
Mortgage-backed securities 117,221,262 1,572,589 194,851 118,599,000
State and political subdivisions 3,748,011 28,149 - 3,776,160
Corporate debt securities 12,601,813 623,458 - 13,225,271
Federal Reserve Bank stock 436,000 - - 436,000
Federal Home Loan Bank stock 10,499,000 - - 10,499,000
Other equity securities 175,535 - - 175,535
------------ ------------ ------------ ------------
Total taxable 162,476,378 2,704,046 194,851 164,985,573
------------ ------------ ------------ ------------
Tax-exempt:
State and political subdivisions 41,561,208 2,173,834 20,029 43,715,013
Federal Reserve Bank stock 8,400 - - 8,400
Other equity securities 7,509,726 9,873 496,402 7,023,197
------------ ------------ ------------ ------------
Total tax-exempt 49,079,334 2,183,707 516,431 50,746,610
------------ ------------ ------------ ------------
Total $211,555,712 $ 4,887,753 $ 711,282 $215,732,183
============ ============ ============ ============

December 31, 2003
---------------------------------------------------------
Amortized Unrealized Estimated
---------------------------
Cost Gains Losses Fair Value
------------ --------------------------- ------------

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

11

March 31, 2003
---------------------------------------------------------
Amortized Unrealized Estimated
---------------------------
Cost Gains Losses Fair Value
------------ --------------------------- ------------

Available for Sale
Taxable:
U. S. Government agencies
and corporations $ 26,769,001 $ 943,685 $ - $ 27,712,686
Mortgage-backed securities 115,746,226 1,679,106 555,378 116,869,954
State and political subdivisions 5,119,239 40,581 - 5,159,820
Corporate debt securities 29,416,044 1,176,470 24,326 30,568,188
Federal Reserve Bank stock 418,000 - - 418,000
Federal Home Loan Bank stock 9,051,100 - - 9,051,100
Other equity securities 102,452 - - 102,452
------------ ------------ ------------ ------------
Total taxable 186,622,062 3,839,842 579,704 189,882,200
------------ ------------ ------------ ------------
Tax-exempt:
State and political subdivisions 34,103,877 1,074,465 15,749 35,162,593
Federal Reserve Bank stock 8,400 - - 8,400
Other equity securities 6,561,822 89,577 144,663 6,506,736
------------ ------------ ------------ ------------
Total tax-exempt 40,674,099 1,164,042 160,412 41,677,729
------------ ------------ ------------ ------------
Total $227,296,161 $ 5,003,884 $ 740,116 $231,559,929
============ ============ ============ ============

The maturites, amortized cost and estimated fair values of securities at March
31, 2004, are summarized as follows:

Available for Sale
--------------------------------
Amortized Estimated
Cost Fair Value
------------- -------------
Due in one year or less $ 52,706,917 $ 53,218,315
Due from one to five years 77,062,641 78,631,941
Due from five to ten years 32,523,438 33,606,150
Due after ten years 30,634,055 32,133,644
Equity securities 18,628,661 18,142,133
------------- -------------
$ 211,555,712 $ 215,732,183
============= =============

12

Note 5. Loans

Loans are summarized as follows:

March 31, December 31, March 31,
2004 2003 2003
------------ ------------ ------------
Commerical $ 47,178,262 $ 46,860,481 $ 38,837,124
Commercial real estate 235,565,159 209,391,036 182,146,228
Real estate - construction 2,697,409 2,368,552 3,980,003
Real estate - mortgage 203,224,889 196,134,926 168,273,675
Consumer 41,059,663 41,112,132 39,628,271
Other 8,968,088 8,223,033 6,041,761
------------ ------------ ------------
Total loans 538,693,470 504,090,160 438,907,062
Less unearned income 1,117,909 1,069,324 841,220
------------ ------------ ------------
Total loans net of unearned income 537,575,561 503,020,836 438,065,842
Less allowance for loan losses 4,720,663 4,680,625 4,128,536
------------ ------------ ------------
Loans, net $532,854,898 $498,340,211 $433,937,306
============ ============ ============

Note 6. Allowance for Loan Losses

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

Three Months Ended Year Ended
March 31, December 31,
-----------------------
2004 2003 2003
---------- ---------- ----------
Balance, beginning of period $4,680,624 $4,052,949 $4,053,131
Losses:
Commercial 136,765 - 1,308
Commercial real estate 6,862 96,640 96,640
Real estate - mortgage - 33,653 59,952
Consumer 42,657 35,118 178,305
Other 71,694 7,642 72,539
---------- ---------- ----------
Total 257,978 173,053 408,744
---------- ---------- ----------
Recoveries:
Commercial 184 954 1,805
Commercial real estate 6,000 - 2,602
Real estate - mortgage 9,413 300 413
Consumer 31,658 22,513 78,515
Other 18,262 7,373 37,903
---------- ---------- ----------
Total 65,517 31,140 121,238
---------- ---------- ----------
Net losses 192,461 141,913 287,506
Provision for loan losses 232,500 217,500 915,000
---------- ---------- ----------
Balance, end of period $4,720,663 $4,128,536 $4,680,625
========== ========== ==========

13

Note 7. Goodwill and Other Intangible Assets

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

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

Balance, March 31, 2004 $ 1,488,030 $ - $ 600,000 $ 2,088,030
====================================================

Unidentifiable Intangible Assets
-------------------------------------------
March 31, December 31, March 31,
2004 2003 2003
-------------------------------------------
Unidentifiable intangible assets
Gross carrying amount $ 2,267,323 $ 2,267,323 $ 2,267,323
Less: accumulated amortization 743,165 705,377 592,013
-------------------------------------------
Net carrying amount $ 1,524,158 $ 1,561,946 $ 1,675,310
===========================================

We recorded amortization expense of $38,000 for the quarter ended March 31, 2004
relative to our unidentifiable intangible assets. Annual amortization is
expected to be approximately $151,000 for each of the years ending 2004 through
2008.

Note 8. Deposits

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

March 31, December 31, March 31,
2004 2003 2003
------------ ------------ ------------
Interest bearing demand deposits $119,924,697 $112,670,844 $ 97,850,089
Savings deposits 48,497,876 47,397,004 47,751,642
Certificates of deposit 286,663,692 274,543,713 253,475,978
Individual retirement accounts 26,335,261 26,185,456 24,957,422
------------ ------------ ------------
Total $481,421,526 $460,797,017 $424,035,131
============ ============ ============

14

The following is a summary of the maturity distribution of certificates of
deposit and Individual Retirement Accounts in denominations of $100,000 or more
as of March 31, 2004:

Amount Percent
------------- -------
Three months or less $ 12,929,152 11.3%
Three through six months 16,352,946 14.2%
Six through twelve months 41,248,532 35.9%
Over twelve months 44,315,920 38.6%
------------- -----
Total $ 114,846,550 100.0%
============= =====

A summary of the scheduled maturities for all time deposits as of March 31, 2004
is as follows:

Nine month period ending December 31, 2004 $ 161,051,833
Year ending December 31, 2005 97,704,980
Year ending December 31, 2006 20,936,842
Year ending December 31, 2007 15,523,127
Year ending December 31, 2008 14,085,668
Thereafter 3,696,503
-------------
$ 312,998,953
=============

Note 9. Borrowed Funds

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

Quarter Ended March 31, 2004
---------------------------------------------
Federal Funds Federal
Purchased Home
and Loan Bank
Lines of Repurchase Short-term
Credit Agreements Advances
------------ ------------ ------------

Balance at March 31 $ - $ 10,125,050 $ 32,421,900
Average balance outstanding for the quarter 1,694,341 9,973,395 42,532,134
Maximum balance outstanding at
any month end during quarter 945,000 10,524,126 52,721,900
Weighted average interest rate for the quarter 2.16% 1.50% 1.18%
Weighted average interest rate for balances
outstanding at March 31 - 1.53% 1.26%

15

Year Ended December 31, 2003
---------------------------------------------
Federal Funds Federal
Purchased Home
and Loan Bank
Lines of Repurchase Short-term
Credit Agreements Advances
------------ ------------ ------------

Balance at December 31 $ 39,285,100 $ 10,429,146 $ -
Average balance outstanding for the year 22,177,797 8,419,384 1,191,013
Maximum balance outstanding at
any month end 39,285,100 10,429,146 6,851,000
Weighted average interest rate for the year 1.27% 1.55% 2.37%
Weighted average interest rate for balances
outstanding at December 31 1.07% 1.59% -

Quarter Ended March 31, 2003
---------------------------------------------
Federal Funds Federal
Purchased Home
and Loan Bank
Lines of Repurchase Short-term
Credit Agreements Advances
------------ ------------ ------------

Balance at March 31 $ 490,000 $ 8,979,955 $ 18,559,500
Average balance outstanding for the quarter 338,300 8,385,866 12,645,338
Maximum balance outstanding at
any month end during quarter 490,000 8,979,955 18,559,500
Weighted average interest rate for the quarter 2.32% 1.56% 1.44%
Weighted average interest rate for balances
outstanding at March 31 2.99% 1.59% 1.48%

Long-term borrowings: Our long-term borrowings of $158,266,552, $164,646,208 and
$152,713,067 at March 31, 2004, December 31, 2003, and March 31, 2003
respectively, consisted primarily of advances from the Federal Home Loan Bank
("FHLB").

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

The average interest rate paid on long-term borrowings for the three month
period ended March 31, 2003 was 4.04% compared to 4.96% for the first three
months of 2003.

Subordinated Debentures: We have two statutory business trusts that were formed
for the purpose of issuing corporation obligated mandatorily redeemable
securities (the "capital securities") to third party investors and investing the
proceeds from the sale of the capital securities in our junior subordinated
debentures (the "debentures"). The debentures held by the trusts are their sole
assets. Our subordinated debentures totaled $11,341,000 at March 31, 2004, and
$3,609,000 at both December 31, 2003 and March 31, 2003.

16

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

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

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

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

Year Ending
December 31, Amount
- -----------------------------------------
2004 $ 17,615,937
2005 21,885,818
2006 11,686,368
2007 5,519,208
2008 14,344,851
Thereafter 98,555,370
- -----------------------------------------
Total $ 169,607,552
=========================================

Note 10. Stock Option Plan

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

The Officer Stock Option Plan, which provides for the granting of stock options
for up to 480,000 shares of common stock to our key officers, was adopted in
1998 and expires in 2008. Each option granted under the plan vests according to
a schedule designated at the grant date and shall have a term of no more than 10
years following the vesting date. Also, the option price per share shall not be
less than the fair market value of our common stock on the date of grant.
Accordingly, no compensation expense is recognized for options granted under the
Plan.

17

The following pro forma disclosures present for the quarters ended March 31,
2004 and 2003, our reported net income and basic and diluted earnings per share
had we recognized compensation expense for our Officer Stock Option Plan based
on the grant date fair values of the options (the fair value method described in
Statement of Financial Accounting Standards No. 123).

Quarter Ended March 31,
-----------------------
(in thousands, except per share data) 2004 2003
-------- --------

Net income:
As reported $ 2,451 $ 1,864

Deduct total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects (34) (10)
------- -------
Pro forma $ 2,417 $ 1,854
======= =======
Basic earnings per share:
As reported $ 0.70 $ 0.53
======= =======
Pro forma $ 0.69 $ 0.53
======= =======
Diluted earnings per share:
As reported $ 0.69 $ 0.53
======= =======
Pro forma $ 0.68 $ 0.53
======= =======

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

Note 11. Acquisitions

On March 1, 2004, we acquired Sager Insurance Agency located in Moorefield, West
Virginia. This acquisition had no material impact on our results of operations,
financial condition, or liquidity.

Note 12. 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.

18

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 March 31, 2004, that we and each of our subsidiaries
met all capital adequacy requirements to which they were subject.

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

Our actual capital amounts and ratios as well as our subsidiaries', Summit
Community Bank's ("Summit Community"), Capital State Bank, Inc.'s ("Capital
State") and Shenandoah Valley National Bank's ("Shenandoah") are presented in
the following table.

19

(Dollars in thousands)
To be Well Capitalized
Minimum Required under Prompt Corrective
Actual Regulatory Capital Action Provisions
-------------------- --------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- -------- -----

As of March 31, 2004
Total Capital (to risk weighted assets)
Summit $ 69,652 12.1% $ 46,174 8.0% $ 57,717 10.0%
Summit Community 29,842 11.1% 21,442 8.0% 26,802 10.0%
Capital State 13,360 10.9% 9,806 8.0% 12,257 10.0%
Shenandoah 18,056 10.2% 14,185 8.0% 17,731 10.0%
Tier I Capital (to risk weighted assets)
Summit 64,931 11.2% 23,087 4.0% 34,630 6.0%
Summit Community 27,511 10.3% 10,721 4.0% 16,081 6.0%
Capital State 12,279 10.0% 4,903 4.0% 7,354 6.0%
Shenandoah 16,747 9.4% 7,092 4.0% 10,639 6.0%
Tier I Capital (to average assets)
Summit 64,931 8.2% 23,802 3.0% 39,671 5.0%
Summit Community 27,511 7.1% 11,609 3.0% 19,348 5.0%
Capital State 12,279 7.1% 5,199 3.0% 8,666 5.0%
Shenandoah 16,747 7.3% 6,838 3.0% 11,396 5.0%

As of December 31, 2003
Total Capital (to risk weighted assets)
Summit $ 60,092 11.0% 43,678 8.0% 54,598 10.0%
Summit Community 28,449 10.9% 20,791 8.0% 25,989 10.0%
Capital State 12,843 10.7% 9,621 8.0% 12,026 10.0%
Shenandoah 16,650 10.4% 12,780 8.0% 15,975 10.0%
Tier I Capital (to risk weighted assets)
Summit 55,411 10.1% 21,839 4.0% 32,759 6.0%
Summit Community 26,032 10.0% 10,396 4.0% 15,593 6.0%
Capital State 11,830 9.8% 4,810 4.0% 7,216 6.0%
Shenandoah 15,399 9.6% 6,390 4.0% 9,585 6.0%
Tier I Capital (to average assets)
Summit 55,411 7.3% 22,692 3.0% 37,820 5.0%
Summit Community 26,032 7.0% 11,184 3.0% 18,639 5.0%
Capital State 11,830 7.0% 5,064 3.0% 8,440 5.0%
Shenandoah 15,399 7.1% 6,472 3.0% 10,786 5.0%

Note 13. 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 mortgage origination facilities that originate and sell mortgage
products. Information for each of our segments is included below:

20

For the Quarter Ended March 31, 2004
-------------------------------------------------------
Community Mortgage Parent and
Dollars in thousands Banking Banking Other Eliminations Total
- ---------------------------------------------------------------------------------------------------

Condensed Statements of Income
Interest income $ 10,755 $ 207 $ 3 $ (92) $ 10,873
Interest expense 4,169 89 105 (92) 4,271
-------- -------- -------- -------- --------
Net interest income 6,586 118 (102) - 6,602
Provision for loan losses 233 - - - 233
-------- -------- -------- -------- --------
Net interest income after provision
for loan losses 6,353 118 (102) - 6,369
-------- -------- -------- -------- --------
Noninterest income 624 4,318 888 (888) 4,942
Noninterest expense 3,600 4,062 1,065 (888) 7,839
-------- -------- -------- -------- --------
Income before income taxes 3,377 374 (279) - 3,472
Income taxes 999 130 (108) - 1,021
-------- -------- -------- -------- --------
Net income $ 2,378 $ 244 $ (171) $ - $ 2,451
======== ======== ======== ======== ========

Average assets $790,721 $ 9,417 $ 68,282 $(71,397) $797,023
======== ======== ======== ======== ========

For the Quarter Ended March 31, 2003
---------------------------------------------------------
Community Mortgage Parent and
Dollars in thousands Banking Banking Other Eliminations Total
- ----------------------------------------------------------------------------------------------------

Condensed Statements of Income
Interest income $ 10,134 $ - $ 2 $ (6) $ 10,130
Interest expense 4,413 - 54 (6) 4,461
-------- -------- -------- -------- --------
Net interest income 5,721 - (52) - 5,669
Provision for loan losses 218 - - - 218
-------- -------- -------- -------- --------
Net interest income after provision
for loan losses 5,503 - (52) - 5,451
-------- -------- -------- -------- --------
Noninterest income 454 139 782 (802) 573
Noninterest expense 3,167 83 892 (802) 3,340
-------- -------- -------- -------- --------
Income before income taxes 2,790 56 (162) - 2,684
Income taxes 854 19 (53) - 820
-------- -------- -------- -------- --------
Net income $ 1,936 $ 37 $ (109) $ - $ 1,864
======== ======== ======== ======== ========

Average assets $683,562 $ 2,278 $ 55,725 $(55,256) $686,309
======== ======== ======== ======== ========

21

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

INTRODUCTION

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

The Private Securities Litigation Act of 1995 indicates that the disclosure of
forward-looking information is desirable for investors and encourages such
disclosure by providing a safe harbor for forward-looking statements by us. Our
following discussion and analysis of financial condition and results of
operations contains certain forward-looking statements that involve risk and
uncertainty. In order to comply with the terms of the safe harbor, we note that
a variety of factors could cause our actual results and experience to differ
materially from the anticipated results or other expectations expressed in those
forward-looking statements.

OVERVIEW

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 16.5%,
or $979,000, in our net interest earnings on a tax equivalent basis in first
quarter 2004 compared to the same period of 2003. Further, our mortgage banking
segment, SFLLC, which began operations during third quarter 2003, contributed
$244,000 to our first quarter 2004 earnings. During the first quarter of 2004,
we acquired an insurance agency located in Moorefield, West Virginia. This
acquisition had no material impact on our results of operations, financial
condition, or liquidity.

CRITICAL ACCOUNTING POLICIES

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

Our most significant accounting policies are presented in Note 1 to the
consolidated financial statements of our 2003 Annual Report on Form 10-K. These
policies, along with the disclosures presented in the other financial statement
notes and in this financial review, provide information on how significant
assets and liabilities are valued in the financial statements and how those
values are determined.

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

22

The allowance for loan losses represents our estimate of probable credit losses
inherent in the loan portfolio. Determining the amount of the allowance for loan
losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type on
our consolidated balance sheet. To the extent actual outcomes differ from our
estimates, additional provisions for loan losses may be required that would
negatively impact earnings in future periods. Note 1 to the consolidated
financial statements of our 2003 Annual Report on Form 10-K describes the
methodology used to determine the allowance for loan losses and a discussion of
the factors driving changes in the amount of the allowance for loan losses is
included in the Asset Quality section of the financial review of the 2003 Annual
Report on Form 10-K.

With the adoption of SFAS No. 142 on January 1, 2002, we discontinued the
amortization of goodwill resulting from acquisitions. Goodwill is now subject to
impairment testing at least annually to determine whether write-downs of the
recorded balances are necessary. A fair value is determined based on at least
one of three various market valuation methodologies. If the fair value equals or
exceeds the book value, no write-down of recorded goodwill is necessary. If the
fair value is less than the book value, an expense may be required on our books
to write down the goodwill to the proper carrying value. During the third
quarter, we will complete the required annual impairment test for 2004. We
cannot assure you that future goodwill impairment tests will not result in a
charge to earnings. See Notes 1 and 9 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 13 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
March 31,
(in thousands) 2004 2003
--------------------------------
ommunity banking $ 2,378 $ 1,936
Mortgage banking 244 37
Parent and other (171) (109)
--------------------------------
Consolidated net income $ 2,451 $ 1,864
================================

RESULTS OF OPERATIONS

Earnings Summary

Net income for the quarter ended March 31, 2004 grew 31.5% to $2,451,000, or
$0.69 per diluted share as compared to $1,864,000, or $0.53 per diluted share
for the quarter ended March 31, 2003. Returns on average equity and assets for
the first quarter of 2004 were 16.77% and 1.23%, respectively, compared with
14.33% and 1.09% for the same period of 2003.

23

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 $6,925,000 for
the three month period ended March 31, 2004 compared to $5,946,000 for the same
period of 2003, representing an increase of $979,000 or 16.5%. This increase
resulted from growth in interest earning assets, primarily loans, which served
to more than offset the 47 basis points decline in the yield on average interest
earning assets during the same period. Average interest earning assets grew
16.1% from $649,572,000 during the first quarter of 2003 to $753,894,000 for the
first quarter of 2004. Average interest bearing liabilities grew 17.0% from
$584,923,000 at March 31, 2003 to $684,309,000 at March 31, 2004, at an average
yield for the first three months of 2004 of 2.50% compared to 3.05% for the same
period of 2003.

Our net yield on interest earning assets increased to 3.67% for the three month
period ended March 31, 2004, compared to 3.66% for the same period in 2003. The
yields on taxable securities and loans declined 27 and 71 basis points,
respectively, during the period ended March 31, 2004, and during the same
period, our cost of interest bearing funds also decreased by 55 basis points.
Consistent with the experience of many other financial institutions, this margin
compression is the result of earning assets repricing at historically low
yields, while at the same time, we have limited ability to decrease
correspondingly the rates paid on interest bearing liabilities. Further
contributing to this situation are historically high prepayments of loans and
mortgage-backed securities which necessitate the reinvestment of significant
cash flows at rates well below each respective portfolio's overall yield.

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

24

Table I - Average Balance Sheet and Net Interest Income Analysis
(Dollars in thousands)
For the Quarter Ended
---------------------------------------------------------------------
March 31, 2004 March 31, 2003
------------------------------- ----------------------------------
Average Earnings/ Yield/ Average Earnings/ Yield/
Balance Expense Rate Balance Expense Rate
--------- ------- ------ --------- ------- ------

Interest earning assets
Loans, net of unearned income
Taxable $ 522,007 $ 8,217 6.30% $ 422,953 $ 7,412 7.01%
Tax-exempt (1) 7,630 147 7.71% 6,208 127 8.18%
Securities
Taxable 172,397 1,975 4.58% 174,478 2,114 4.85%
Tax-exempt (1) 48,288 825 6.83% 39,209 710 7.24%
Federal funds sold and interest
bearing deposits with other banks 3,572 32 3.58% 6,724 45 2.68%
--------- ------- ----- --------- ------- -----
Total interest earning assets 753,894 11,196 5.94% 649,572 10,408 6.41%
------- ----- ------- -----
Noninterest earning assets
Cash & due from banks 9,965 8,168
Premises and equipment 18,777 12,765
Other assets 19,161 19,895
Allowance for loan losses (4,774) (4,091)
--------- ---------
Total assets $ 797,023 $ 686,309
========= =========

Interest bearing liabilities
Interest bearing demand deposits $ 115,233 $ 253 0.88% $ 99,283 $ 229 0.92%
Savings deposits 48,053 56 0.47% 46,098 73 0.63%
Time deposits 301,375 2,105 2.79% 273,566 2,323 3.40%
Short-term borrowings 54,183 172 1.27% 21,337 80 1.50%
Long-term borrowings
and capital trust securities 165,465 1,685 4.07% 144,639 1,757 4.86%
--------- ------- ----- --------- -------- -----
Total interest bearing liabilities 684,309 4,271 2.50% 584,923 4,462 3.05%
------- ----- -------- -----
Noninterest bearing liabilities
and shareholders' equity
Demand deposits 48,394 44,217
Other liabilities 5,847 5,152
Shareholders' equity 58,473 52,017
--------- ---------
Total liabilities and
shareholders' equity $ 797,023 $ 686,309
========= =========

Net interest earnings $ 6,925 $ 5,946
======= =======
Net yield on interest earning assets 3.67% 3.66%
===== =====

(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 $322,000, and
$277,000 for the quarters ended March 31, 2004 and 2003, respectively.

25

Table II - Changes in Interest Margin Attributable to Rate and Volume
(Dollars in thousands)
For the Quarter Ended
March 31, 2004 versus March 31, 2003
------------------------------------
Increase (Decrease)
Due to Change in:
------------------------------------
Volume Rate Net
--------- -------- -------
Interest earned on:
Loans
Taxable $ 1,613 $ (808) $ 805
Tax-exempt 28 (8) 20
Securities
Taxable (25) (114) (139)
Tax-exempt 157 (42) 115
Federal funds sold and interest
bearing deposits with other banks (25) 12 (13)
------- ------- -------
Total interest earned on
interest earning assets 1,748 (960) 788
------- ------- -------

Interest paid on:
Interest bearing demand
deposits 36 (12) 24
Savings deposits 3 (20) (17)
Time deposits 221 (439) (218)
Short-term borrowings 106 (14) 92
Long-term borrowings and
subordinated debentures 234 (306) (72)
------- ------- -------
Total interest paid on
interest bearing liabilities 600 (791) (191)
------- ------- -------

Net interest income $ 1,148 $ (169) $ 979
======= ======= =======

Credit Experience

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

We recorded a $233,000 provision for loan losses for the first three months of
2004, compared to $218,000 for the same period in 2003. Net loan charge offs for
the first quarter of 2004 were $192,000, as compared to $142,000 over the same
period of 2003. At March 31, 2004, the allowance for loan losses totaled
$4,721,000 or 0.88% of loans, net of unearned income, compared to $4,681,000 or
0.93% of loans, net of unearned income at December 31, 2003.

26

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

(Dollars in thousands)
March 31, December 31,
--------------------
2004 2003 2003
------- ----- -------
Accruing loans past due 90 days or more $ 233 $ 247 $ 342
Nonperforming assets:
Nonaccrual loans 1,215 468 1,014
Nonaccrual securities 389 412 396
Foreclosed properties 475 677 497
Repossessed assets 14 19 -
------- ------- -------
Total $ 2,326 $ 1,823 $ 2,249
Total nonperforming loans as a ======= ======= =======

percentage of total loans 0.36% 0.33% 0.27%
==== ==== ====
Total nonperforming assets as a
percentage of total assets 0.29% 0.26% 0.28%
==== ==== ====

Noninterest Income

On the strength of mortgage origination revenue, total noninterest income
increased to $4,942,000 in the first quarter of 2004, compared to $573,000 in
the same period of 2003. Mortgage origination revenue grew to $4,319,000 for the
first quarter of 2004, compared to $139,000 for the same period of 2003. This
increase was due to the organization of SFLLC during the third quarter of 2003.
This revenue includes mortgage loan origination and sales activity conducted
through SFLLC. Refer to Note 13 of the accompanying consolidated financial
statements for our segment information.

Noninterest Expense

Total noninterest expense increased approximately $4,498,000, or 134.70% to
$7,839,000 during the first quarter of 2004 as compared to the same period in
2003. The primary factor contributing to growth in noninterest expense was an
increase in salaries and employee benefits expense due to the staffing
requirements of SFLLC. Two other major contributors to the increase in total
noninterest expense for the quarter ended March 31, 2004 were advertising and
postage expense. These increased expenses resulted from SFLLC's direct mail
program utilized to obtain customers. Refer to Note 13 of the accompanying
consolidated financial statements for our segment information.

FINANCIAL CONDITION

Our total assets were $809,117,000 at March 31, 2004, compared to $791,465,000
at December 31, 2003, representing a 2.23% increase. Table IV below serves to
illustrate significant changes in our financial position between December 31,
2003 and March 31, 2004.

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

Balance Balance
December 31, Increase (Decrease) March 31,
----------------------
2003 Amount Percentage 2004
--------- -------- ---------- ---------

Assets
Federal funds sold $ 244 $ 804 329.5% $ 1,048
Securities available for sale 235,409 (19,677) -8.4% 215,732
Loans, net of unearned income 504,693 37,758 7.5% 542,451

Liabilities
Interest bearing deposits $ 460,797 $ 20,625 4.5% $ 481,422
Short-term borrowings 49,714 (7,167) -14.4% 42,547
Long-term borrowings and
subordinated debentures 168,255 1,353 0.8% 169,608

Loan growth during the first three months of 2004, occurring principally in the
commercial and real estate portfolios, was funded primarily by deposit growth.

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

LIQUIDITY

Liquidity reflects our ability to ensure the availability of adequate funds to
meet loan commitments and deposit withdrawals, as well as provide for other
transactional requirements. Liquidity is provided primarily by funds invested in
cash and due from banks, Federal funds sold, non-pledged securities, and
available lines of credit with the FHLB, the total of which approximated $112
million, or 13.8% of total assets at March 31, 2004 versus $115 million, or
14.7% of total assets at December 31, 2003.

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

CAPITAL RESOURCES

One of our continuous goals is maintenance of a strong capital position. Through
management of our capital resources, we seek to provide an attractive financial
return to our shareholders while retaining sufficient capital to support future
growth. Shareholders' equity at March 31, 2004 totaled $60,674,000 compared to
$57,188,000 at December 31, 2003, representing an increase of 6.10%.

Refer to Note 9 of the notes to the accompanying consolidated financial
statements for a discussion of our subordinated debentures which currently
qualify as Tier I capital, and Note 12 of the notes to the accompanying
consolidated financial statements for information regarding regulatory
restrictions on our capital as well as our subsidiaries' capital.

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CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations. The
following table summarizes our contractual cash obligations at March 31, 2004.

Long
Term Subordinated
Debt Debentures
- --------------------------------------------------------------
2004 $ 17,615,937 $ -
2005 21,885,818 -
2006 11,686,368 -
2007 5,519,208 -
2008 14,344,851 -
Thereafter 87,214,370 11,341,000
- --------------------------------------------------------------
Total $ 158,266,552 $ 11,341,000
==============================================================

OFF-BALANCE SHEET ARRANGEMENTS

We are involved with some off-balance sheet arrangements that have or are
reasonably likely to have an effect on our financial condition, liquidity, or
capital. These arrangements at March 31, 2004 are presented in the following
table.

March 31,
2004
--------------------------------------------
Commitments to extend credit:
Revolving home equity and
credit card lines $ 22,640,577
Construction loans 38,437,882
Other loans 21,389,660
Standby letters of credit 4,652,571
--------------------------------------------
Total $ 87,120,690
============================================

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.

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Some amount of interest rate risk is inherent and appropriate to the banking
business. Our net income is affected by changes in the absolute level of
interest rates. Our interest rate risk position is liability sensitive; that is,
liabilities are likely to reprice faster than assets, resulting in a decrease in
net income in a rising rate environment. Conversely, net income should increase
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, assuming a static balance sheet with a similar mix of assets and
liabilities, 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. Assumptions used to project yields and rates for new loans and deposits
are derived from historical analysis. Securities portfolio maturities and
prepayments are reinvested in like instruments. Mortgage loan prepayment
assumptions are developed from industry estimates of prepayment speeds.
Noncontractual deposit repricings are modeled on historical patterns.

The following table shows our projected earnings sensitivity as of March 31,
2004 which is well within our ALCO policy limit of +/- 10%:

Change in Percentage
Interest Rates Change in Net
(basis points) Interest Income
-----------------------------------------
Down 100 1.23%
Up 100 -0.34%
Up 200 -0.75%

CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial
Officer, have conducted as of March 31, 2004, an evaluation of the effectiveness
of disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the disclosure controls and procedures as of March 31,
2004 were effective. There were no changes in our internal control over
financial reporting that occurred during the quarter ended March 31, 2004 that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.

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Summit Financial Group, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
Part II. Other Information

Item 1. Legal Proceedings

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

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

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

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

We, after consultation with legal counsel, believe that Corinthian's claims made
in its recent lawsuit arising out of the hiring of former employees of
Corinthian Mortgage Corporation and the alleged use of trade secrets are without
foundation and that meritorious defenses exist as to all the claims. We will
continue to evaluate the claims in the Corinthian lawsuit and intend to
vigorously defend against them. We believe that the lawsuit is without merit and
will have no material adverse effect on us. Management, at the present time, is
unable to estimate the impact, if any, an adverse decision may have on our
results of operations or financial condition.

Item 6. Reports on Form 8-K

On January 22, 2004, we announced our fourth quarter and year ended December 31,
2003 earnings. We further announced that Corinthian Mortgage Corporation's
petition for temporary injunction against Summit Financial, LLC and Shenandoah
Valley National Bank, subsidiaries of Summit Financial Group, Inc., was denied.

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SIGNATURES

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

SUMMIT FINANCIAL GROUP, INC.
(registrant)

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

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

Date: May 14, 2004

32