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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 – Q

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

For the quarterly period ended March 31, 2005.

or

     
o   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
(State or other jurisdiction of
incorporation or organization)
  55-0672148
(IRS Employer
Identification No.)
     
300 North Main Street
Moorefield, West Virginia

(Address of principal executive offices)
  26836
(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 an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

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
7,039,840 shares outstanding as of May 6, 2005

 
 

 


Summit Financial Group, Inc. and Subsidiaries


Table of Contents
                 
            Page
PART I.   FINANCIAL INFORMATION        
 
               
  Item 1.   Financial Statements        
 
               
      Consolidated balance sheets March 31, 2005 (unaudited), December 31, 2004, and March 31, 2004 (unaudited)     4  
 
               
      Consolidated statements of income for the three months ended March 31, 2005 and 2004 (unaudited)     5  
 
               
      Consolidated statements of shareholders’ equity for the three months ended March 31, 2005 and 2004 (unaudited)     6  
 
               
      Consolidated statements of cash flows for the three months ended March 31, 2005 and 2004 (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     23-34  
 
               
  Item 3.   Quantitative and Qualitative Disclosures about Market Risk     33  
 
               
  Item 4.   Controls and Procedures     34  
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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Table of Contents
             
  OTHER INFORMATION        
 
           
  Item 1. Legal Proceedings     35  
 
           
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   None
 
           
  Item 3 . Defaults upon Senior Securities   None
 
           
  Item 4. Submission of Matters to a Vote of Security Holders   None
 
           
  Item 5. Other Information   None
 
           
  Item 6. Exhibits        
 
           
                      Exhibits        
                 
  Exhibit 11.   Statement re: Computation of Earnings per Share – Information contained in Note 3 to the Consolidated Financial Statements on page 10 of this Quarterly Report is incorporated herein by reference.        
 
               
  Exhibit 31.1   Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer        
 
               
  Exhibit 31.2   Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer        
 
               
  Exhibit 32.1   Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer        
 
               
  Exhibit 32.2   Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer        
 
               
SIGNATURES     36  

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Consolidated Balance Sheets
                         
    March 31,     December 31,     March 31,  
    2005     2004     2004  
    (unaudited)     (*)     (unaudited)  
ASSETS
                       
Cash and due from banks
  $ 13,243,838     $ 19,416,219     $ 9,584,246  
Interest bearing deposits with other banks
    2,161,772       2,338,698       3,223,383  
Federal funds sold
    1,615,000       48,000       1,048,000  
Securities available for sale
    209,223,443       211,361,504       215,732,183  
Loans held for sale
    15,766,266       14,273,916       9,595,896  
Loans, net
    623,862,573       602,727,975       532,854,898  
Property held for sale
    593,137       593,137       475,000  
Premises and equipment, net
    20,690,209       20,776,007       19,458,692  
Accrued interest receivable
    3,942,548       3,651,907       3,771,963  
Intangible assets
    3,461,036       3,498,824       3,612,188  
Other assets
    12,703,790       10,802,330       9,760,944  
 
                 
Total assets
  $ 907,263,612     $ 889,488,517     $ 809,117,393  
 
                 
 
                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                       
Liabilities
                       
Deposits
                       
Non interest bearing
  $ 57,008,292     $ 55,401,552     $ 48,916,332  
Interest bearing
    480,403,692       469,212,146       481,421,526  
 
                 
Total deposits
    537,411,984       524,613,698       530,337,858  
 
                 
Short-term borrowings
    129,696,988       120,629,214       42,546,950  
Long-term borrowings
    154,042,527       160,860,182       158,266,552  
Subordinated debentures owed to unconsolidated subsidiary trusts
    11,341,000       11,341,000       11,341,000  
Other liabilities
    8,371,156       6,336,402       5,951,531  
 
                 
Total liabilities
    840,863,655       823,780,496       748,443,891  
 
                 
 
                       
Commitments and Contingencies
                       
 
                       
Shareholders’ Equity
                       
Preferred stock and related surplus, $1.00 par value; authorized 250,000 shares, issued 2005 and December 2004 - 33,400 shares
    1,158,471       1,158,471        
Common stock and realted surplus, $2.50 par value; authorized 20,000,000 shares, issued 2005 -7,039,840 shares ; December 2004 - 7,155,420 shares; March 2004 - 7,137,120 shares
    17,501,134       18,123,492       12,780,249  
Retained earnings
    49,519,803       47,108,898       45,878,181  
Less cost of shares acquired for the treasury - 2004 - 115,880 shares
          (627,659 )     (627,659 )
Accumulated other comprehensive income
    (1,779,451 )     (55,181 )     2,642,731  
 
                 
Total shareholders’ equity
    66,399,957       65,708,021       60,673,502  
 
                 
 
                       
Total liabilities and shareholders’ equity
  $ 907,263,612     $ 889,488,517     $ 809,117,393  
 
                 


    (*) - December 31, 2004 financial information has been extracted from audited consolidated financial statements

See Notes to Consolidated Financial Statements

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Consolidated Statements of Income (unaudited)
                 
    Three Months Ended  
    March 31,     March 31,  
    2005     2004  
Interest income
               
Interest and fees on loans
               
Taxable
  $ 9,901,344     $ 8,216,886  
Tax-exempt
    108,396       97,292  
Interest and dividends on securities
               
Taxable
    1,729,715       1,974,939  
Tax-exempt
    528,602       551,562  
Interest on interest bearing deposits with other banks
    22,568       31,180  
Interest on Federal funds sold
    2,433       921  
 
           
Total interest income
    12,293,058       10,872,780  
 
           
Interest expense
               
Interest on deposits
    2,516,673       2,414,093  
Interest on short-term borrowings
    754,027       171,909  
Interest on long-term borrowings and subordinated debentures
    1,867,330       1,685,420  
 
           
Total interest expense
    5,138,030       4,271,422  
 
           
Net interest income
    7,155,028       6,601,358  
Provision for loan losses
    330,000       232,500  
 
           
Net interest income after provision for loan losses
    6,825,028       6,368,858  
 
           
Other income
               
Insurance commissions
    148,039       23,096  
Service fees
    546,559       509,409  
Mortgage origination revenue
    5,856,149       4,319,358  
Securities gains (losses)
          19,928  
Gain (loss) on sale of assets
    (2,325 )     (1,615 )
Other
    119,032       72,255  
 
           
Total other income
    6,667,454       4,942,431  
 
           
Other expense
               
Salaries and employee benefits
    4,542,210       3,685,959  
Net occupancy expense
    429,153       303,888  
Equipment expense
    493,022       429,027  
Supplies
    91,990       140,362  
Professional fees
    226,926       170,646  
Postage
    1,567,124       1,352,973  
Advertising
    1,325,040       961,636  
Amortization of intangibles
    37,788       37,788  
Other
    1,341,844       756,579  
 
           
Total other expense
    10,055,097       7,838,858  
 
           
Income before income taxes
    3,437,385       3,472,431  
Income tax expense
    1,026,480       1,021,250  
 
           
Net income
  $ 2,410,905     $ 2,451,181  
 
           
 
Basic earnings per common share
  $ 0.34     $ 0.35  
 
           
Diluted earnings per common share
  $ 0.34     $ 0.35  
 
           
 
Average common shares outstanding
               
Basic
    7,039,783       7,020,126  
 
           
Diluted
    7,171,099       7,084,970  
 
           
 
Dividends per common share
  $     $  
 
           

See Notes to Consolidated Financial Statements

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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, 2004
  $ 1,158,471     $ 18,123,492     $ 47,108,898     $ (627,659 )   $ (55,181 )   $ 65,708,021  
 
                                               
Three Months Ended March 31, 2005
                                               
Comprehensive income:
                                               
Net income
                2,410,905                   2,410,905  
Other comprehensive income, net of deferred tax benefit of ($1,056,811):
                                               
Net unrealized (loss) on securities of ($1,724,270)
                            (1,724,270 )     (1,724,270 )
 
                                             
Total comprehensive income
                                            686,635  
 
                                             
Exercise of stock options
          5,301                         5,301  
Cancellation of treasury shares
          (627,659 )           627,659              
 
                                   
 
Balance, March 31, 2005
  $ 1,158,471     $ 17,501,134     $ 49,519,803     $     $ (1,779,451 )   $ 66,399,957  
 
                                   
 
                                               
Balance, December 31, 2003
  $     $ 17,862,255     $ 38,328,051     $ (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 (loss) 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
          16,943                         16,943  
 
                                   
 
                                               
Balance, March 31, 2004
  $     $ 17,879,198     $ 40,779,232     $ (627,659 )   $ 2,642,731     $ 60,673,502  
 
                                   

See Notes to Consolidated Financial Statements

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Consolidated Statements of Cash Flows (unaudited)
                 
    Three Months Ended  
    March 31,     March 31,  
    2005     2004  
Cash Flows from Operating Activities
               
Net income
  $ 2,410,905     $ 2,451,181  
Adjustments to reconcile net earnings to net cash provided by operating activities:
               
Depreciation
    415,827       341,131  
Provision for loan losses
    330,000       232,500  
Deferred income tax (benefit)
    (129,320 )     (145,250 )
Loans originated for sale
    (68,939,267 )     (44,941,003 )
Principal payments on and proceeds from loans sold
    69,752,985       43,376,927  
(Gains) on loans sold
    (2,306,068 )     (1,678,984 )
Securities (gains)
          (19,928 )
Loss on disposal of other assets
    2,324       1,615  
Amortization of securities premiums, net
    192,265       142,402  
Amortization of goodwill and purchase accounting adjustments, net
    40,671       43,086  
(Increase)decrease in accrued interest receivable
    (290,642 )     6,176  
(Increase) in other assets
    (678,286 )     (1,014,566 )
Increase in other liabilities
    1,010,150       1,444,744  
 
           
Net cash provided by operating activities
    1,811,544       240,031  
 
           
Cash Flows from Investing Activities
               
Net (increase) decrease in interest bearing deposits with other banks
    176,926       (82,292 )
Proceeds from maturities and calls of securities available for sale
    2,957,625       6,439,500  
Proceeds from sales of securities available for sale
    2,321,100       28,823,935  
Principal payments received on securities available for sale
    7,331,803       11,622,069  
Purchases of securities available for sale
    (13,401,766 )     (25,715,293 )
Net (increase)decrease in Federal funds sold
    (1,567,000 )     (804,000 )
Net loans made to customers
    (21,479,998 )     (34,762,187 )
Purchases of premises and equipment
    (330,029 )     (1,706,885 )
Proceeds from sales of other assets
    52,700       21,000  
Net cash paid in acquisition of Sager Insurance Agency
          (850,000 )
 
           
Net cash (used in) investing activities
    (23,938,639 )     (17,014,153 )
 
           
Cash Flows from Financing Activities
               
Net increase (decrease) in demand deposit, NOW and savings accounts
    13,971,073       6,266,654  
Net increase (decrease) in time deposits
    (1,172,786 )     12,269,784  
Net increase (decrease) in short-term borrowings
    9,067,774       (7,167,296 )
Proceeds from long-term borrowings
    718,000       7,763,250  
Repayment of long-term borrowings
    (6,634,648 )     (7,203,087 )
Exercise of stock options
    5,301       16,943  
 
           
Net cash provided by financing activities
    15,954,714       11,946,248  
 
           
Increase (decrease) in cash and due from banks
    (6,172,381 )     (4,827,874 )
Cash and due from banks:
               
Beginning
    19,416,219       14,412,120  
 
           
Ending
  $ 13,243,838     $ 9,584,246  
 
           

(Continued)

See Notes to Consolidated Financial Statements

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Consolidated Statements of Cash Flows — continued (unaudited)
                 
    Three Months Ended  
    March 31,     March 31,  
    2005     2004  
 
               
Supplemental Disclosures of Cash Flow Information
               
Cash payments for:
               
Interest
  $ 4,994,309     $ 4,385,047  
 
           
Income taxes
  $     $ 25,000  
 
           
 
               
Supplemental Schedule of Noncash Investing and Financing Activities
               
Other assets acquired in settlement of loans
  $ 15,400     $ 14,000  
 
           
 
               
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

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Notes to Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

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

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

The results of operations for the three months ended March 31, 2005 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 2004 audited financial statements and Annual Report on Form 10-K. Certain accounts in the consolidated financial statements for December 31, 2004 and March 31, 2004, as previously presented, have been reclassified to conform to current year classifications.

Note 2. Significant New Accounting Pronouncements

Stock-based compensation: In December 2004, the Financial Accounting Standards Board (FASB) issued revised statement 123, Share-Based Payment (Revised 2004). SFAS 123R establishes accounting requirements for share-based compensation to employees. SFAS 123R eliminates our ability to account for stock-based compensation using APB 25 effective July 1, 2005 for all equity awards granted after the effective date. SFAS 123R requires us to recognize compensation expense based on the estimated number of stock awards expected to actually vest, exclusive of the awards expected to be forfeited. On April 14, 2005, the SEC announced an amendment to the compliance dates of SFAS 123R, delaying our required implementation until January 1, 2006. The adoption of this standard is not expected to have a material impact on our financial condition, results of operations, or liquidity.

Other than temporary impairment: In March 2004, the Financial Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) released Issue 03-01, Meaning of Other Than Temporary Impairment, which addressed other-than-temporary impairment for certain debt and equity investments. The recognition and measurement requirements of Issue 03-01, and other disclosure requirements not already implemented, were effective for periods beginning after June 15, 2004. In September 2004, the FASB staff issued FASB Staff Position (FSP) EITF 03-1-1, which delayed the effective date for certain measurement and recognition guidance contained in Issue 03-01. The FSP requires the application of pre-existing other-than-temporary guidance during the period of delay until a final consensus is reached.

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Notes to Consolidated Financial Statements (unaudited)

Note 3. Earnings per Share

The computations of basic and diluted earnings per share follow:

                 
    Three Months Ended March 31,  
    2005     2004  
Numerator:
               
Net Income
  $ 2,410,905     $ 2,451,181  
 
           
 
               
Denominator:
               
Denominator for basic earnings per share - weighted average common shares outstanding
    7,039,784       7,020,126  
 
               
Effect of dilutive securities:
               
Convertible preferred stock
    39,445        
Stock options
    91,870       64,844  
 
           
 
    131,315       64,844  
 
           
 
               
Denominator for diluted earnings per share - weighted average common shares outstanding and assumed conversions
    7,171,099       7,084,970  
 
           
 
               
Basic earnings per share
  $ 0.34     $ 0.35  
 
           
 
               
Diluted earnings per share
  $ 0.34     $ 0.35  
 
           

Note 4. Securities

The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at March 31, 2005 and December 31, 2004, and March 31, 2004 are summarized as follows:

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Notes to Consolidated Financial Statements (unaudited)
                                 
    March 31, 2005  
    Amortized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
Available for Sale
                               
Taxable:
                               
U. S. Government agencies and corporations
  $ 23,773,908     $ 78,764     $ 282,784     $ 23,569,888  
Mortgage-backed securities
    116,243,844       243,813       2,550,706       113,936,951  
State and political subdivisions
    3,744,254       3,876             3,748,130  
Corporate debt securities
    5,000,123       106,583       461       5,106,245  
Federal Reserve Bank stock
    436,500                   436,500  
Federal Home Loan Bank stock
    14,289,100                   14,289,100  
Other equity securities
    175,535                   175,535  
 
                       
Total taxable
    163,663,264       433,036       2,833,951       161,262,349  
 
                       
Tax-exempt:
                               
State and political subdivisions
    40,915,050       1,135,196       116,551       41,933,695  
Other equity securities
    7,481,530             1,454,131       6,027,399  
 
                       
Total tax-exempt
    48,396,580       1,135,196       1,570,682       47,961,094  
 
                       
Total
  $ 212,059,844     $ 1,568,232     $ 4,404,633     $ 209,223,443  
 
                       
                                 
    December 31, 2004  
    Amortized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
 
                               
Available for Sale
                               
Taxable:
                               
U. S. Government agencies and corporations
  $ 21,429,728     $ 154,012     $ 37,242     $ 21,546,498  
Mortgage-backed securities
    118,872,576       513,765       1,029,288       118,357,053  
State and political subdivisions
    3,745,196       8,954             3,754,150  
Corporate debt securities
    5,000,328       180,939             5,181,267  
Federal Reserve Bank stock
    436,500                   436,500  
Federal Home Loan Bank stock
    13,843,100                   13,843,100  
Other equity securities
    175,535                   175,535  
 
                       
Total taxable
    163,502,963       857,670       1,066,530       163,294,103  
 
                       
 
                               
Tax-exempt:
                               
State and political subdivisions
    40,475,405       1,508,540       24,043       41,959,902  
Other equity securities
    7,482,503             1,375,004       6,107,499  
 
                       
Total tax-exempt
    47,957,908       1,508,540       1,399,047       48,067,401  
 
                       
Total
  $ 211,460,871     $ 2,366,210     $ 2,465,577     $ 211,361,504  
 
                       

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Notes to Consolidated Financial Statements (unaudited)
                                 
    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  
 
                       

The maturities, amortized cost and estimated fair values of securities at March 31, 2005, are summarized as follows:

                 
    Available for Sale  
    Amortized     Estimated  
    Cost     Fair Value  
 
               
Due in one year or less
  $ 44,188,709     $ 43,703,594  
Due from one to five years
    89,796,220       88,175,397  
Due from five to ten years
    24,613,788       24,626,734  
Due after ten years
    31,078,463       31,789,184  
Equity securities
    22,382,665       20,928,534  
 
           
 
  $ 212,059,845     $ 209,223,443  
 
           

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Notes to Consolidated Financial Statements (unaudited)

Note 5. Loans

Loans are summarized as follows:

                         
    March 31,     December 31,     March 31,  
    2005     2004     2004  
Commerical
  $ 56,393,600     $ 53,225,840     $ 47,178,262  
Commercial real estate
    296,910,832       279,631,237       235,565,159  
Real estate - construction
    3,805,511       3,916,361       2,697,409  
Real estate - mortgage
    226,866,186       223,689,617       203,224,889  
Consumer
    37,066,130       38,947,775       41,059,663  
Other
    9,458,326       9,604,693       8,968,088  
 
                 
Total loans
    630,500,585       609,015,523       538,693,470  
Less unearned fees and interest
    1,322,218       1,214,262       1,117,909  
 
                 
Total loans net of unearned fees and interest
    629,178,367       607,801,261       537,575,561  
Less allowance for loan losses
    5,315,794       5,073,286       4,720,663  
 
                 
Loans, net
  $ 623,862,573     $ 602,727,975     $ 532,854,898  
 
                 

Note 6. Allowance for Loan Losses

An analysis of the allowance for loan losses for the three month periods ended March 31, 2005 and 2004, and for the year ended December 31, 2004 is as follows:

                         
    Three Months Ended   Year Ended  
    March 31,   December 31,  
    2005     2004     2004  
Balance, beginning of period
  $ 5,073,286     $ 4,680,625     $ 4,680,625  
Losses:
                       
Commercial
    19,759       136,766       141,815  
Commercial real estate
          6,862       335,777  
Real estate - mortgage
    50,200             5,199  
Consumer
    32,427       42,657       208,391  
Other
    54,731       71,694       285,671  
 
                 
Total
    157,117       257,979       976,853  
 
                 
Recoveries:
                       
Commercial
          184       18,702  
Commercial real estate
    6,577       6,000       27,302  
Real estate - mortgage
          9,413       9,413  
Consumer
    17,979       31,658       109,211  
Other
    45,069       18,262       154,886  
 
                 
Total
    69,625       65,517       319,514  
 
                 
Net losses
    87,492       192,462       657,339  
Provision for loan losses
    330,000       232,500       1,050,000  
 
                 
Balance, end of period
  $ 5,315,794     $ 4,720,663     $ 5,073,286  
 
                 

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Notes to Consolidated Financial Statements (unaudited)

Note 7. Goodwill and Other Intangible Assets

The following tables present our goodwill at March 31, 2005 and other intangible assets at March 31, 2005, December 31, 2004, and March 31, 2004.

                                 
    Goodwill Activity by Operating Segment  
    Community     Mortgage     Parent and        
    Banking     Banking     Other     Total  
     
Balance, January 1, 2005
  $ 1,488,030     $     $ 600,000     $ 2,088,030  
Acquired goodwill, net
                       
     
 
                               
Balance, March 31, 2005
  $ 1,488,030     $     $ 600,000     $ 2,088,030  
     
                         
    Unidentifiable Intangible Assets  
    March 31,     December 31,     March 31,  
    2005     2004     2004  
     
Unidentifiable intangible assets
                       
Gross carrying amount
  $ 2,267,323     $ 2,267,323     $ 2,267,323  
Less: accumulated amortization
    894,317       856,529       743,165  
     
Net carrying amount
  $ 1,373,006     $ 1,410,794     $ 1,524,158  
     

We recorded amortization expense of approximately $38,000 for the three months ended March 31, 2005 relative to our unidentifiable intangible assets. Annual amortization is expected to be approximately $151,000 for each of the years ending 2005 through 2009.

Note 8. Deposits

The following is a summary of interest bearing deposits by type as of March 31, 2005 and 2004 and December 31, 2004:

                         
    March 31,     December 31,     March 31,  
    2005     2004     2004  
Interest bearing demand deposits
  $ 134,500,291     $ 122,355,331     $ 119,924,697  
Savings deposits
    50,646,930       50,427,556       48,497,876  
Certificates of deposit
    269,845,854       271,130,829       286,663,692  
Individual retirement accounts
    25,410,617       25,298,430       26,335,261  
 
                 
Total
  $ 480,403,692     $ 469,212,146     $ 481,421,526  
 
                 

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Notes to Consolidated Financial Statements (unaudited)

Included in certificates of deposit are brokered certificates of deposit, which totaled $54,716,000, $53,268,000, and $43,639,000 at March 31, 2005, December 31, 2004, and March 31, 2004, respectively. Brokered deposits represent certificates of deposit acquired through a third party. 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, 2005:

                 
    Amount     Percent  
Three months or less
  $ 14,623,687       12.1 %
Three through six months
    16,562,102       13.7 %
Six through twelve months
    37,643,519       31.1 %
Over twelve months
    52,031,166       43.1 %
 
           
Total
  $ 120,860,474       100.0 %
 
           

A summary of the scheduled maturities for all time deposits as of March 31, 2005 is as follows:

         
Nine month period ending December 31, 2005
  $ 131,191,114  
Year Ending December 31, 2006
    87,511,711  
Year Ending December 31, 2007
    39,242,536  
Year Ending December 31, 2008
    17,368,583  
Year Ending December 31, 2009
    14,671,601  
Thereafter
    5,270,926  
 
     
 
  $ 295,256,471  
 
     

Note 9. Borrowed Funds

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

                         
    Quarter Ended March 31, 2005  
                    Federal Funds  
    Short-term             Purchased  
    FHLB     Repurchase     and Lines  
    Advances     Agreements     of Credit  
Balance at March 31
  $ 118,115,800     $ 10,881,188     $ 700,000  
Average balance outstanding for the period
    105,859,989       10,561,099       506,293  
Maximum balance outstanding at any month end during period
    118,115,800       10,881,188       700,000  
Weighted average interest rate for the period
    2.65 %     1.88 %     2.88 %
Weighted average interest rate for balances outstanding at March 31
    2.91 %     2.13 %     5.00 %

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Notes to Consolidated Financial Statements (unaudited)
                         
    Year Ended December 31, 2004  
                    Federal Funds  
    Short-term             Purchased  
    FHLB     Repurchase     and Lines  
    Advances     Agreements     of Credit  
Balance at December 31
  $ 109,798,900     $ 10,830,314     $  
Average balance outstanding for the year
    59,498,008       9,739,367       1,076,402  
Maximum balance outstanding at any month end during year
    109,798,900       11,098,557       1,173,000  
Weighted average interest rate for the year
    1.72 %     1.59 %     2.11 %
Weighted average interest rate for balances outstanding at December 31
    2.31 %     1.85 %      
                         
    Quarter Ended March 31, 2004  
                    Federal Funds  
    Short-term             Purchased  
    FHLB     Repurchase     and Lines  
    Advances     Agreements     of Credit  
Balance at March 31
  $ 32,421,900     $ 10,125,050     $  
Average balance outstanding for the quarter
    42,532,134       9,973,395       1,694,341  
Maximum balance outstanding at any month end during quarter
    52,721,900       10,524,126       945,000  
Weighted average interest rate for the quarter
    1.18 %     1.50 %     2.16 %
Weighted average interest rate for balances outstanding at March 31
    1.26 %     1.53 %      

Long-term borrowings: Our long-term borrowings of $154,042,527, $160,860,182 and $158,266,552 at March 31, 2005, December 31, 2004, and March 31, 2004 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, 2005 was 4.27% compared to 4.04% for the first three months of 2004.

Subordinated Debentures: We have two statutory business trusts that were formed for the purpose of issuing mandatorily redeemable securities (the “capital securities”) for which we are obligated to third party investors and investing the proceeds from the sale of the capital securities in our junior subordinated debentures (the “debentures”). The debentures held by the trusts are their sole assets. Our subordinated debentures totaled $11,341,000 at March 31, 2005, December 31, 2004 and March 31, 2004.

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

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Notes to Consolidated Financial Statements (unaudited)

$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  
2005
  $ 22,111,289  
2006
    16,948,442  
2007
    15,272,204  
2008
    16,085,851  
2009
    2,110,094  
Thereafter
    92,855,647  
 
     
 
  $ 165,383,527  
 
     

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 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. Accordingly, no compensation expense is recognized for options granted under the Plan.

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Notes to Consolidated Financial Statements (unaudited)

The following pro forma disclosures present for the quarters ended March 31, 2005 and 2004, 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)   2005     2004  
 
               
Net income:
               
As reported
  $ 2,411     $ 2,451  
 
               
Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
    (41 )     (34 )
 
           
Pro forma
  $ 2,370     $ 2,417  
 
           
 
               
Basic earnings per share:
               
As reported
  $ 0.34     $ 0.35  
 
           
Pro forma
  $ 0.33     $ 0.34  
 
           
 
               
Diluted earnings per share:
               
As reported
  $ 0.34     $ 0.35  
 
           
Pro forma
  $ 0.33     $ 0.34  
 
           

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. There were no option grants during the first quarter of 2005. 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. 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. T he 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.

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Notes to Consolidated Financial Statements (unaudited)

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

         
    March 31,  
    2005  
 
Commitments to extend credit:
       
Revolving home equity and credit card lines
  $ 25,409,078  
Construction loans
    83,609,825  
Other loans
    34,360,841  
Standby letters of credit
    4,866,840  
 
Total
  $ 148,246,584  
 

     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 12. Issuance of Preferred Stock

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

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Notes to Consolidated Financial Statements (unaudited)

Note 13. Restrictions on Capital

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

Quantitative measures established by regulation to ensure capital adequacy require us and each of our subsidiaries to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). We believe, as of March 31, 2005, that we and each of our subsidiaries met all capital adequacy requirements to which they were subject.

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

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

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Notes to Consolidated Financial Statements (unaudited)
                                                 
                                    To be Well Capitalized  
                    Minimum Required     under Prompt Corrective  
    Actual     Regulatory Capital     Action Provisions  
(Dollars in thousands)   Amount     Ratio     Amount     Ratio     Amount     Ratio  
As of March 31, 2005
                                               
 
                                               
Total Capital (to risk weighted assets)
                                               
Summit
  $ 79,578       11.9 %   $ 53,548       8.0 %   $ 66,935       10.0 %
Summit Community
    47,563       10.9 %     34,950       8.0 %     43,688       10.0 %
Shenandoah
    24,656       11.0 %     17,940       8.0 %     22,425       10.0 %
Tier I Capital (to risk weighted assets)
                                               
Summit
  $ 74,263       11.1 %   $ 26,774       4.0 %   $ 40,161       6.0 %
Summit Community
    43,932       10.1 %     17,475       4.0 %     26,213       6.0 %
Shenandoah
    22,972       10.2 %     8,970       4.0 %     13,455       6.0 %
Tier I Capital (to average assets)
                                               
Summit
  $ 74,263       8.4 %   $ 26,661       3.0 %   $ 44,435       5.0 %
Summit Community
    43,932       7.4 %     17,931       3.0 %     29,885       5.0 %
Shenandoah
    22,972       8.2 %     8,451       3.0 %     14,085       5.0 %
 
                                               
As of December 31, 2004
                                               
Total Capital (to risk weighted assets)
                                               
Summit
  $ 77,301       11.9 %     51,863       8.0 %     64,829       10.0 %
Summit Community
    45,672       10.8 %     33,817       8.0 %     42,271       10.0 %
Shenandoah
    23,253       10.7 %     17,440       8.0 %     21,800       10.0 %
Tier I Capital (to risk weighted assets)
                                               
Summit
    72,228       11.1 %     25,932       4.0 %     38,897       6.0 %
Summit Community
    42,165       10.0 %     16,908       4.0 %     25,363       6.0 %
Shenandoah
    21,687       9.9 %     8,720       4.0 %     13,080       6.0 %
Tier I Capital (to average assets)
                                               
Summit
    72,228       8.3 %     26,256       3.0 %     43,761       5.0 %
Summit Community
    42,165       7.1 %     17,739       3.0 %     29,565       5.0 %
Shenandoah
    21,687       8.0 %     8,128       3.0 %     13,546       5.0 %

Note 14. Segment Information

We operate two major 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:

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Notes to Consolidated Financial Statements (unaudited)
                                                 
    For the Quarter Ended March 31, 2005  
    Community     Mortgage     Insurance     Parent and              
Dollars in thousands   Banking     Banking     Services     Other     Eliminations     Total  
 
Condensed Statements of Income
                                               
Interest income
  $ 12,204     $ 302     $     $ 7     $ (220 )   $ 12,293  
Interest expense
    4,971       218             169       (220 )     5,138  
 
                                   
Net interest income
    7,233       84             (162 )           7,155  
Provision for loan losses
    330                               330  
 
                                   
Net interest income after provision for loan losses
    6,903       84             (162 )           6,825  
 
                                   
Noninterest income
    689       5,856       122       1,176       (1,176 )     6,667  
Noninterest expense
    4,198       5,597       134       1,302       (1,176 )     10,055  
 
                                   
Income before income taxes
    3,394       343       (12 )     (288 )           3,437  
Income taxes
    1,028       117       (5 )     (114 )           1,026  
 
                                   
Net income
  $ 2,366     $ 226     $ (7 )   $ (174 )   $     $ 2,411  
 
                                   
Intersegment revenue (expense)
  $ (906,060 )   $ (262,540 )   $ (7,500 )   $ 1,176,100     $     $  
 
                                   
Average assets
  $ 866,756     $ 19,386     $ 983     $ 78,370     $ (73,334 )   $ 892,161  
 
                                   
                                                 
    For the Quarter Ended March 31, 2004  
    Community     Mortgage     Insurance     Parent and              
Dollars in thousands   Banking     Banking     Services     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       7       1,058       (888 )     7,839  
 
                                   
Income before income taxes
    3,377       374       (7 )     (272 )           3,472  
Income taxes
    999       130       (2 )     (106 )           1,021  
 
                                   
Net income
  $ 2,378     $ 244     $ (5 )   $ (166 )   $     $ 2,451  
 
                                   
Intersegment revenue (expense)
  $ (759,493 )   $ (128,957 )   $     $ 888,450     $     $  
 
                                   
Average assets
  $ 790,425     $ 9,417     $ 296     $ 68,282     $ (71,397 )   $ 797,023  
 
                                   

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

FORWARD LOOKING STATEMENTS

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 2004 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.

As interest margins remain narrow, we continue to seek other business opportunities which earn non interest income. Our mortgage banking segment contributed $226,000 to our first three months 2005 earnings. During the first quarter of 2004, we acquired an insurance agency located in Moorefield, West Virginia. This acquisition has 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 2004 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.

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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 2004 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 2004 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 2005. We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Notes 1 and 7 of the consolidated financial statements of our Annual Report on Form 10-K for further discussion of our intangible assets, which include goodwill.

BUSINESS SEGMENT RESULTS

We are organized and managed along two major business segments, as described in Note 14 of the accompanying consolidated financial statements. The results of each business segment are intended to reflect each segment as if it were a stand alone business. Net income (loss) by segment follows:

                 
    For the Quarter Ended  
    March 31,  
in thousands   2005     2004  
 
Community Banking
  $ 2,366     $ 2,378  
Mortgage Banking
    226       244  
Parent and Other
    (181 )     (171 )
     
Consolidated net income
  $ 2,411     $ 2,451  
     

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

RESULTS OF OPERATIONS

Earnings Summary

Net income for the quarter ended March 31, 2005 was relatively unchanged at $2,411,000, or $0.34 per diluted share as compared to $2,451,000, or $0.35 per diluted share for the quarter ended March 31, 2004. Returns on average equity and assets for the first three months of 2005 were 14.53% and 1.08%, respectively, compared with 16.77% and 1.23% for the same period of 2004.

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. We seek to maximize our net interest income through management of our balance sheet components. This is accomplished by determining the optimal product mix with respect to yields on assets and costs of funds in light of projected economic conditions, while maintaining portfolio risk at an acceptable level.

Our net interest income on a fully tax-equivalent basis totaled $7,476,000 for the three month period ended March 31, 2005 compared to $6,924,000 for the same period of 2004, representing an increase of $552,000 or 7.97%. This increase resulted from substantial growth in interest earning assets, primarily loans, which served to more than offset the 23 basis points increase in the cost of funds during the same period. Average interest earning assets grew 12.17% from $753,894,000 during the first three months of 2004 to $845,667,000 for the first three months of 2005. Average interest bearing liabilities grew 11.69% from $684,309,000 at March 31, 2004 to $764,336,000 at March 31, 2005, at an average yield for the first three months of 2005 of 2.73% compared to 2.50% for the same period of 2004.

Our net yield on interest earning assets decreased to 3.59% for the three month period ended March 31, 2005, compared to 3.67% for the same period in 2004. The yields on earning assets increased only 11 basis points, while our total cost of funds increased 23 basis points. Despite the increases in rates by the Fed over the past year, assets that repriced during the first quarter of 2005 typically repriced downward, while at the same time, our cost of short term borrowings moved more proportionately with the rate increases.

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 decline in our yield on earning assets. However, if market interest rates were to rise significantly over the next year, the spread between interest earning assets and interest bearing liabilities could decline more, such that its impact could not be offset by growth in earning assets. See the “Market Risk Management” section for further discussion of the impact changes in market interest rates could have on us. Further analysis of our yields on interest earning assets and interest bearing liabilities are presented in Tables I and II below.

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

Table I - Average Distribution Of Assets, Liabilities And Shareholders’

   Equity, Interest Earnings & Expenses, and Average Yield/Rate
                                                 
    For the Quarter Ended  
    March 31, 2005     March 31, 2004  
    AVERAGE     EARNINGS/     YIELD/     AVERAGE     EARNINGS/     YIELD/  
(In thousands of dollars)   BALANCES     EXPENSE     RATE     BALANCES     EXPENSE     RATE  
     
ASSETS
                                               
Interest earning assets
                                               
Loans, net of unearned interest
                                               
Taxable
  $ 623,652     $ 9,902       6.44 %   $ 522,007     $ 8,217       6.30 %
Tax-exempt (1)
    9,108       164       7.30 %     7,630       147       7.71 %
Securities
                                               
Taxable
    162,314       1,729       4.32 %     172,397       1,975       4.58 %
Tax-exempt (1)
    47,876       793       6.72 %     48,288       825       6.83 %
Interest bearing deposits other banks and Federal funds sold
    2,717       26       3.88 %     3,572       31       3.47 %
 
                                   
Total interest earning assets
    845,667       12,614       6.05 %     753,894       11,195       5.94 %
 
                                           
 
                                               
Noninterest earning assets
                                               
Cash & due from banks
    14,513                       9,965                  
Premises & equipment
    20,740                       18,777                  
Other assets
    16,442                       19,161                  
Allowance for loan losses
    (5,201 )                     (4,774 )                
 
                                           
Total assets
  $ 892,161                     $ 797,023                  
 
                                           
 
                                               
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                               
 
                                               
Liabilities
                                               
Interest bearing liabilities
                                               
Interest bearing demand deposits
  $ 127,994     $ 425       1.35 %   $ 115,233     $ 253       0.88 %
Savings deposits
    50,727       79       0.63 %     48,053       56       0.47 %
Time deposits
    298,514       2,013       2.73 %     301,375       2,105       2.79 %
Short-term borrowings
    116,898       754       2.62 %     54,183       172       1.27 %
Long-term borrowings and subordinated debentures
    170,203       1,867       4.45 %     165,465       1,685       4.07 %
         
 
    764,336       5,138       2.73 %     684,309       4,271       2.50 %
Noninterest bearing liabilities
                                               
Demand deposits
    56,130                       48,394                  
Other liabilities
    5,316                       5,847                  
 
                                           
Total liabilities
    825,782                       738,550                  
 
                                               
Shareholders’ equity
    66,379                       58,473                  
 
                                           
Total liabilities and shareholders’ equity
  $ 892,161                     $ 797,023                  
 
                                           
 
                                               
NET INTEREST EARNINGS
          $ 7,476                     $ 6,924          
 
                                           
NET INTEREST YIELD ON EARNING ASSETS
                    3.59 %                     3.67 %
 
                                           


(1)   - Interest income on tax-exempt loans and 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 $321,000 and $322,000 for the quarters ended March 31, 2005 and 2004, respectively.

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

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

                         
    For the Quarter Ended  
    March 31, 2005 versus March 31, 2004  
    Increase (Decrease)  
    Due to Change in:  
    Volume     Rate     Net  
Interest earned on:
                       
Loans
                       
Taxable
  $ 1,509     $ 176     $ 1,685  
Tax-exempt
    377       (360 )     17  
Securities
                       
Taxable
    (124 )     (122 )     (246 )
Tax-exempt
    (11 )     (21 )     (32 )
Federal funds sold and interest bearing deposits with other banks
    (151 )     146       (5 )
 
                 
Total interest earned on interest earning assets
    1,600       (181 )     1,419  
 
                 
 
                       
Interest paid on:
                       
Interest bearing demand deposits
    30       142       172  
Savings deposits
    3       20       23  
Time deposits
    (28 )     (64 )     (92 )
Short-term borrowings
    304       278       582  
Long-term borrowings and subordinated debentures
    43       139       182  
 
                 
Total interest paid on interest bearing liabilities
    352       515       867  
 
                 
 
                       
Net interest income
  $ 1,248     $ (696 )   $ 552  
 
                 

Noninterest Income

On the strength of mortgage origination revenue, total noninterest income increased to $6,667,000 for the first quarter of 2005, compared to $4,942,000 for the same period of 2004. Further detail regarding noninterest income is reflected in the following table. Also, refer to Note 14 of the accompanying consolidated financial statements for our segment information.

Noninterest Income
Dollars in thousands

                 
    For the Quarter Ended March 31,  
    2005     2004  
     
Insurance commissions
  $ 148     $ 23  
Service fees
    546       509  
Mortgage origination revenue
    5,856       4,319  
Securities gains (losses)
          20  
Other
    117       71  
     
Total
  $ 6,667     $ 4,942  
     

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Insurance commissions: These commissions increased 543% over 2004 primarily due to Summit Insurance Services, LLC, which offers both commercial and personal lines of insurance.

Service fees: Total service fees increased 7.3% for the first quarter of 2005 compared to the same period of 2004. This increase was primarily attributable to an increase in overdraft and nonsufficient funds (NSF) fees due to increased overdrafts by customers.

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

                 
    For the Quarter Ended March 31,  
Dollars in thousands   2005     2004  
 
Loans originated
               
Amount
  $ 68,929     $ 44,935  
Number
    1,308       931  
 
               
Loans sold
               
Amount
  $ 66,761     $ 41,376  
Number
    1,295       861  

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:

Mortgage origination revenue

                 
    For the Quarter Ended  
    March 31,  
Dollars in thousands   2005     2004  
 
Origination fees, net
  $ 3,550     $ 2,640  
Gains
    2,306       1,679  
     
 
               
Total
  $ 5,856     $ 4,319  
     

Although mortgage origination revenue increased for the first quarter of 2005, profitability was impacted by the continued change in the mix of loans originated. During first quarter 2005, 18.0% of the total dollar amount of loan originations were first mortgage loans as compared to 9.9% during the first quarter of 2004. Sales of first mortgage loans typically result in smaller margins than sales of second mortgage loans.

Other: Other income increased 64.8% for the first quarter of 2005 compared to 2004. This increase was primarily attributable to an increase in financial services revenue.

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

Noninterest Expense

Total noninterest expense increased approximately $2,216,000, or 28.3% to $10,055,000 during the first three months of 2005 as compared to the same period in 2004. Table III below shows the breakdown of these increases by segment. Also, refer to Note 14 of the accompanying consolidated financial statements for our segment information.

Table III - Noninterest Expense
Dollars in thousands

                                 
            Change        
    2005     $     %     2004  
     
Community Banking and Other
                               
Salaries and employee benefits
  $ 2,514     $ 334       15.3 %   $ 2,180  
Net occupancy expense
    313       41       15.1 %     272  
Equipment expense
    448       65       17.0 %     383  
Supplies
    73       (41 )     -36.0 %     114  
Professional fees
    176       71       67.6 %     105  
Postage
    64       13       25.5 %     51  
Advertising
    72       18       33.3 %     54  
Amortization of intangibles
    38             0.0 %     38  
Other
    760       180       31.0 %     580  
     
Total
  $ 4,458     $ 681       18.0 %   $ 3,777  
     
                                 
            Change        
    2005     $     %     2004  
     
Mortgage Banking
                               
Salaries and employee benefits
  $ 2,028     $ 522       34.7 %   $ 1,506  
Net occupancy expense
    116       84       262.5 %     32  
Equipment expense
    45       (1 )     -2.2 %     46  
Supplies
    19       (7 )     -26.9 %     26  
Professional fees
    51       (14 )     -21.5 %     65  
Postage
    1,503       201       15.4 %     1,302  
Advertising
    1,253       345       38.0 %     908  
Other
    582       405       228.8 %     177  
     
Total
  $ 5,597     $ 1,535       37.8 %   $ 4,062  
     
                                 
            Change        
    2005     $     %     2004  
     
Consolidated
                               
Salaries and employee benefits
  $ 4,542     $ 856       23.2 %   $ 3,686  
Net occupancy expense
    429       125       41.1 %     304  
Equipment expense
    493       64       14.9 %     429  
Supplies
    92       (48 )     -34.3 %     140  
Professional fees
    227       57       33.5 %     170  
Postage
    1,567       214       15.8 %     1,353  
Advertising
    1,325       363       37.7 %     962  
Amortization of intangibles
    38             0.0 %     38  
Other
    1,342       585       77.3 %     757  
     
Total
  $ 10,055     $ 2,216       28.3 %   $ 7,839  
     

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

Community Banking, Parent and Other Segments

Total noninterest expense for our community banking segment, parent, and other increased $681,000, or 18.0% for the first quarter of 2005, compared to the same period of 2004. The major factors contributing to these increases follow.

Salaries and employee benefits: Salaries and employee benefits expense increased 15.3% for the quarter ended March 31, 2005 due to additional staffing requirements needed as a result of our growth, including opening a new community banking office in Harrisonburg, Virginia in late 2004, and staffing Summit Insurance Services, LLC. In the December-January timeframe, we added three seasoned lenders who will become increasingly productive over the remainder of the year. Also included in this increase are general merit raises.

Professional fees: The 67.6% increase in professional fees is primarily attributable to two items: 1) costs incurred in connection with implementing and complying with Sarbanes Oxley, and 2) fees in connection with the hiring of employees for the newly opened community banking office in Harrisonburg, Virginia.

Other: Other expenses increased $180,000 or 31.0% for the first quarter of 2005 compared to the first quarter of 2004. This increase includes the initial listing fee for NASDAQ.

Mortgage Banking Segment

Total noninterest expense for our mortgage banking segment increased 37.8% for the first quarter of 2005 over the same period of 2004. This increase is a result of the 40.5% increase in the number of loan originations for 2005, as these expenses are directly tied to loan originations.

Salaries and employee benefits: The increase of $522,000 in salaries and employee benefits reflects the additional staffing requirements needed as a result of increased production.

Net occupancy expense: Net occupancy expense increased $84,000 or 262.5% for the first quarter of 2005 due to the relocation of our Summit Mortgage headquarters in mid-2004, to support our growth in staffing needs.

Postage and Advertising expense: Postage expense and advertising expense, combined, increased 24.71% from 2004 to 2005. This increase reflects the costs incurred with the direct mail method of obtaining customers.

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 $330,000 provision for loan losses for the first three months of 2005, compared to $233,000 for the same period in 2004. Net loan charge offs for the first three months of 2005 were $87,000, as compared to $192,000 over the same period of 2004. At March 31, 2005, the allowance for loan losses totaled $5,316,000 or 0.84% of loans, net of unearned income, compared to $5,073,000 or 0.83% of loans, net of unearned income at December 31, 2004.

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

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

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

                         
    March 31,     December 31,  
    2005     2004     2004  
Accruing loans past due 90 days or more
  $ 423     $ 233     $ 140  
Nonperforming assets:
                       
Nonaccrual loans
    413       1,215       532  
Nonaccrual securities
    334       389       349  
Foreclosed properties
    593       475       593  
Repossessed assets
    15       14       53  
 
                 
Total
  $ 1,778     $ 2,326     $ 1,667  
 
                 
Total nonperforming loans as a percentage of total loans
    0.13 %     0.27 %     0.11 %
 
                 
Total nonperforming assets as a percentage of total assets
    0.20 %     0.29 %     0.19 %
 
                 

FINANCIAL CONDITION

Our total assets were $907,264,000 at March 31, 2005, compared to $889,489,000 at December 31, 2004, representing a 2.0% increase. Table IV below serves to illustrate significant changes in our financial position between December 31, 2004 and March 31, 2005.

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

                                 
    Balance                     Balance  
    December 31,     Increase (Decrease)     March 31,  
    2004     Amount     Percentage     2005  
Assets
                               
Securities available for sale
  $ 211,361     $ (2,138 )     -1.0 %   $ 209,223  
Loans, net of unearned income
    622,075       22,869       3.7 %     644,944  
 
                               
Liabilities
                               
Interest bearing deposits
  $ 469,212     $ 11,192       2.4 %   $ 480,404  
Short-term borrowings
    120,629       9,068       7.5 %     129,697  
Long-term borrowings and subordinated debentures
    172,201       (6,817 )     -4.0 %     165,384  

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

Loan growth during the first three months of 2005, occurring principally in the commercial and real estate portfolios, was funded primarily by short-term borrowings from the FHLB.

Refer to Notes 4, 5, 8, and 9 of the notes to the accompanying consolidated financial statements for additional information with regard to changes in the composition of our securities, loans, deposits and borrowings between March 31, 2005 and December 31, 2004.

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 $121 million, or 13.3% of total assets at March 31, 2005 versus $88 million, or 9.9% of total assets at December 31, 2004.

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, 2005 totaled $66,400,000 compared to $65,708,000 at December 31, 2004.

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

CONTRACTUAL CASH OBLIGATIONS

During our normal course of business, we incur contractual cash obligations. The following table summarizes our contractual cash obligations at March 31, 2005.

                         
    Long              
    Term     Subordinated     Operating  
    Debt     Debentures     Leases  
 
2004
  $ 22,111,289     $     $ 661,316  
2005
    16,948,442             917,999  
2006
    15,272,204             877,659  
2007
    16,085,851             851,534  
2008
    2,110,094             428,100  
Thereafter
    81,514,647       11,341,000       384,340  
 
Total
  $ 154,042,527     $ 11,341,000     $ 4,120,948  
 

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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 March 31, 2005 are presented in the following table.

         
    March 31,  
    2005  
 
Commitments to extend credit:
       
Revolving home equity and credit card lines
  $ 25,409,078  
Construction loans
    83,609,825  
Other loans
    34,360,841  
Standby letters of credit
    4,866,840  
 
Total
  $ 148,246,584  
 

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 well matched in year one, with asset sensitivity over the longer period. That is, over the long term, assets are likely to reprice faster than liabilities, resulting in an increase in net income in a rising rate environment. Our net income would decline 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.

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

The following table shows our projected earnings sensitivity as of March 31, 2005 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 100
    -0.09 %     -2.44 %
Up 100
    -0.15 %     1.12 %
Up 200
    -0.67 %     0.93 %

CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, have conducted as of March 31, 2005, 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, 2005 were effective. There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting

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Part II. Other Information

Item 1. Legal Proceedings

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

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

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

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

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

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  SUMMIT FINANCIAL GROUP, INC.
(registrant)
 
 
  By:   /s/ H. Charles Maddy, III    
    H. Charles Maddy, III,   
    President and Chief Executive Officer   
 
         
     
  By:   /s/ Robert S. Tissue    
    Robert S. Tissue,   
    Senior Vice President and Chief Financial Officer   
 
         
     
  By:   /s/ Julie R. Cook    
    Julie R. Cook,   
    Vice President and Chief Accounting Officer   
 

Date: May 6, 2005

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