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 operating segments, Summit Community Bank ("Summit Community"), and Summit Insurance Services, LLC for the periods indicated. See Note 14 of the accompanying consolidated financial statements for our segment information. This discussion and analysis should be read in conjunction with our 2011 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.

Interest earning assets declined by 2.80% for the first three months in 2012 compared to the same period of 2011 while our net interest earnings on a tax equivalent basis increased 0.61%. Our tax equivalent net interest margin increased 9 basis points. Historically high levels of nonaccrual loans continue to negatively impact our net interest earnings while our reduced cost of interest bearing funds continues to positively impact our net interest earnings.

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 by segment follows:


                                             Three Months Ended March 31,
        Dollars in thousands                  2012                   2011
        Community banking                $         2,007         $        (598 )
        Insurance                                    102                   120
        Parent and other                            (605 )                 156
        Consolidated net income (loss)   $         1,504         $        (322 )

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.

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

Our most significant accounting policies are presented in the notes to the consolidated financial statements of our 2011 Annual Report on Form 10-K. These policies, along with the other disclosures presented in the 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, the valuation of goodwill, fair value measurements and deferred tax assets 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.

Allowance for Loan Losses: 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 8 to the consolidated financial statements of our 2011 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 2011 Annual Report on Form 10-K.

Goodwill: Goodwill is subject to a two-step impairment test by reporting unit at least annually to determine whether write-downs of the recorded balances are necessary. During the third quarter, we completed the required annual impairment test for 2011 for each of our reporting units, community banking and insurance services. The first step (Step 1) of impairment testing requires a comparison of each reporting unit's fair value to its carrying value to identify potential impairment. If the fair value equals or exceeds the related unit's carrying value, no write-down of recorded goodwill is necessary. If the fair value is less than the carrying value, an expense may be required on our books to write down the goodwill to the proper carrying value. The second step (Step 2) of impairment testing is necessary only if the reporting unit does not pass Step
1. Step 2 compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill for the reporting unit. The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination.

The fair value, carrying amount and allocated goodwill with regard to each of our reporting units as of September 30, 2011 (date of our most recent goodwill impairment test) were as follows:

           (in thousands)        Community Banking      Insurance Services

           Fair value           $           164,235     $             6,929
           Carrying amount                  132,845                   6,414
           Allocated goodwill                 1,488                   4,710

Neither of our reporting units failed Step 1 of the goodwill impairment tests conducted as of September 30, 2011. For purposes of these goodwill impairment tests, the following methodologies were utilized and key assumptions were made in determining the fair value of each reporting unit:

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

Community Banking - We performed an internal valuation utilizing the income approach to determine the fair value of our Community Banking reporting unit. The income approach was based on discounted cash flows derived from assumptions of balances sheet and income statement activity based upon an internally developed forecast considering several long-term key business drivers such as anticipated loan and deposit growth. The long term growth rate used in determining the terminal value was estimated at 3.5%, and a discount rate of 11% based upon the Capital Asset Pricing Model was applied to the Bank's estimated future cash flow streams.

Insurance Services - We performed an internal valuation, which was verified by a third party firm, utilizing the income approach to determine the fair value of our Insurance Services reporting unit. This methodology consisted of discounting the expected future cash flows of this unit based upon a forecast of its operations considering long-term key business drivers such as anticipated commission revenue growth. The long term growth rate used in determining the terminal value was estimated at 2.5%, and a discount rate of 11% was applied to the Insurance Services unit's estimated future cash flows.

We cannot assure you that future goodwill impairment tests will not result in a charge to earnings. See Note 11 of the consolidated financial statements of our Annual Report on Form 10-K for further discussion of our intangible assets, which include goodwill.

Fair Value Measurements: ASC Topic 820 Fair Value Measurements and Disclosures provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Based on the observability of the inputs used in the valuation techniques, we classify our financial assets and liabilities measured and disclosed at fair value in accordance with the three-level hierarchy (e.g., Level 1, Level 2 and Level 3) established under ASC Topic 820. Fair value determination in accordance with this guidance requires that we make a number of significant judgments. In determining the fair value of financial instruments, we use market prices of the same or similar instruments whenever such prices are available. We do not use prices involving distressed sellers in determining fair value. If observable market prices are unavailable or impracticable to obtain, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques incorporate our assessments regarding assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risks inherent in a particular valuation technique and the risk of nonperformance.

Fair value is used on a recurring basis for certain assets and liabilities in which fair value is the primary basis of accounting. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes in accordance with ASC Topic 825 Financial Instruments.

Deferred Income Tax Assets: At March 31, 2012, we had net deferred tax assets of $12.0 million. Based on our ability to offset the net deferred tax asset against taxable income in carryback years and expected future taxable income in carryforward years, there was no impairment of the deferred tax asset at March 31, 2012. All available evidence, both positive and negative, was considered to determine whether, based on the weight of that evidence, impairment should be recognized. However, our forecast process includes judgmental and quantitative elements that may be subject to significant change. If our forecast of taxable income within the carryback/carryforward periods available under applicable law is not sufficient to cover the amount of net deferred tax assets, such assets may become impaired.

RESULTS OF OPERATIONS

Earnings Summary

Net income applicable to common shares for the three months ended March 31, 2012 increased to $1,504,000, or $0.18 per diluted share as compared to a net loss of $322,000 or $0.04 per diluted share for the same period of 2011. Earnings were negatively impacted for all periods by continued high provisions for loan losses due to our continued increased nonperforming loans, write-downs of foreclosed properties to their estimated fair values,

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

and other-than-temporary impairment of securities. The provision for loan losses was $2.0 million and $3.0 million for the three months ended March 31, 2012 and 2011, respectively. Included in earnings for the three months ended March 31, 2012 was $1.2 million of realized securities gains, $1.9 million of charges resulting from the write down of a portion of our foreclosed properties to fair value and $229,000 in other than temporary impairment charges on securities. Returns on average equity and assets for the first three months of 2012 were 7.13% and 0.47%, respectively, compared with (1.14%) and (0.07%) for the same period of 2011.

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 $10,430,000 for the three months ended March 31, 2012 compared to $10,367,000 for the same period of 2011, representing an increase of $63,000 or 0.61%. While our earnings on interest earning assets decreased, this decrease was more than offset by a reduction in the volume of interest bearing liabilities and a reduction in the cost of interest bearing liabilities (see Table II). Average interest earning assets decreased 2.80% from $1,350,338,000 during the first three months of 2011 to $1,312,524,000 for the first three months of 2012. Average interest bearing liabilities declined 4.03% from $1,294,179,000 at March 31, 2011 to $1,242,036,000 at March 31, 2012, at an average yield for the first three months of 2012 of 2.20% compared to 2.54% for the same period of 2011.

Our consolidated net interest margin increased to 3.20% for the three months ended March 31 2012, compared to 3.11% for the same period in 2011. The margin continues to be affected by elevated levels of nonaccruing loans. The present continued low interest rate environment has served to positively impact our net interest margin due to our liability sensitive balance sheet. For the three months ended March 31, 2012 compared to March 31, 2011, the yields on earning assets decreased 28 basis points, while the cost of our interest bearing funds decreased by 34 basis points.

Assuming no significant change in market interest rates, we anticipate a relatively stable net interest margin in the near term as we do not expect interest rates to rise in the near future, we do not expect significant growth in our interest earning assets, nor do we expect our nonperforming asset balances to decline significantly in the near future. We continue to monitor the net interest margin through net interest income simulation to minimize the potential for any significant negative impact. 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.

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


Table I - Average Balance Sheet and Net Interest Income Analysis
 Dollars in thousands
                                                  For the Three Months Ended
                                      March 31, 2012                        March 31, 2011
                            Average        Earnings/     Yield/      Average      Earnings/   Yield/
                            Balance         Expense       Rate       Balance       Expense     Rate
 Interest earning
assets
   Loans, net of
unearned income (1)
     Taxable                 $973,862        $14,279       5.90%    $1,001,347      $15,083    6.11%
     Tax-exempt (2)             7,248            130       7.21%         4,940           98    8.05%
   Securities
     Taxable                  234,973          1,697       2.90%       269,858        2,609    3.92%
     Tax-exempt (2)            71,559          1,092       6.14%        37,827          658    7.05%
   Federal funds sold
and interest
     bearing deposits
with other banks               24,882             11       0.18%        36,366           17    0.19%
    Total interest
   earning assets           1,312,524         17,209       5.27%     1,350,338       18,465    5.55%

 Noninterest earning
assets
   Cash & due from
banks                           4,073                                    4,036
   Premises and
equipment                      21,978                                   22,977
   Other assets               122,188                                  113,000
   Allowance for loan
losses                       (18,251)                                 (18,116)
     Total assets          $1,442,512                               $1,472,235

 Interest bearing
liabilities
   Interest bearing
demand deposits              $160,147            $82       0.21%      $148,263         $100    0.27%
   Savings deposits           211,783            381       0.72%       197,638          501    1.03%
   Time deposits              550,689          3,250       2.37%       623,318        4,142    2.69%
   Short-term
borrowings                     14,390              7       0.20%         1,734            1    0.23%
   Long-term
borrowings
    and capital trust
securities                    305,027          3,059       4.03%       323,226        3,354    4.21%
    Total interest
 bearing liabilities        1,242,036          6,779       2.20%     1,294,179        8,098    2.54%

 Noninterest bearing
liabilities
   and shareholders'
equity
   Demand deposits             87,000                                   78,023
   Other liabilities            8,850                                    9,634
   Total liabilities        1,337,886                                1,381,836

   Shareholders'
equity - preferred              9,326                                    3,519
   Shareholders'
equity - common                95,300                                   86,880
  Total liabilities
         and
     shareholders'
       equity              $1,442,512                               $1,472,235
 Net interest
earnings                                     $10,430                                $10,367
 Net yield on
interest earning
assets                                                     3.20%                               3.11%

(1) For purposes of this table, nonaccrual loans are included in average loan balances.

(2) - Interest income on tax-exempt securities and loans has been adjusted assuming an effective tax rate of 34% for all periods presented. The tax equivalent adjustment resulted in an increase in interest income of $412,000 and $265,000 for the periods ended March 31, 2012 and March 31 2011, respectively.

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


Table II - Changes in Interest Margin Attributable to Rate and Volume

                                                       For the Three Months Ended
                                                  March 31, 2012 versus March 31, 2011
                                                  Increase (Decrease) Due to Change in:
In thousands                                    Volume               Rate             Net
Interest earned on:
Loans
 Taxable                                     $       (355 )      $       (449 )    $    (804 )
 Tax-exempt                                            43                 (11 )           32
Securities
 Taxable                                             (303 )              (609 )         (912 )
 Tax-exempt                                           528                 (94 )          434
Federal funds sold and interest
 bearing deposits with other banks                     (5 )                (1 )           (6 )
Total interest earned on
 interest earning assets                              (92 )            (1,164 )       (1,256 )

Interest paid on:
Interest bearing demand
 deposits                                               8                 (26 )          (18 )
Savings deposits                                       35                (155 )         (120 )
Time deposits                                        (441 )              (451 )         (892 )
Short-term borrowings                                   6                   -              6
Long-term borrowings and capital
  trust securities                                   (170 )              (125 )         (295 )
 Total interest paid on
  interest bearing liabilities                       (562 )              (757 )       (1,319 )

           Net interest income               $        470        $       (407 )    $      63

Noninterest Income

Total noninterest income increased to $1,703,000 for the first three months of
2012, compared to a loss of $482,000 for the same period of 2011, with
other-than-temporary impairment charges on securities and writedowns of
foreclosed properties to their estimated fair value being the primary negative
components. Further detail regarding noninterest income is reflected in the
following table.


Table III - Noninterest Income
                                                   For the Quarter Ended March 31,
Dollars in thousands                                 2012                  2011
Insurance commissions                           $         1,158       $         1,242
Service fees                                              1,014                   888
Realized securities gains (losses)                        1,165                 1,628
Other-than-temporary impairment of securities              (229 )              (1,228 )
Gain (loss) on sale of assets                               (77 )                  71
Bank owned life insurance income                            275                   130
Writedown of foreclosed properties                       (1,912 )              (3,443 )
Other                                                       309                   230
                    Total                       $         1,703       $          (482 )

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

Other-than-temporary impairment of securities: During the first three months of 2012, we recorded non-cash other-than temporary impairment charges of $229,000 related to certain residential mortgage-backed securities which we continue to own.

Writedown of foreclosed properties: During the first three months of 2012, we recorded $1,912,000 in charges to writedown certain OREO properties to fair value less estimated costs to sell as part of our normal, ongoing re-appraisal process. Continued volatility in the real estate markets could result in further writedowns of these properties in the foreseeable future.

Noninterest Expense

Total noninterest expense increased approximately 6.1% for the three months ended March 31, 2012, as compared to the same period in 2011. While professional fees, primarily related to complex collection issues relative to our problem assets, continue to increase, FDIC premiums are lower in 2012 due to our lower deposit base and a change in the assessment base used in calculating FDIC premiums that became effective during second quarter 2011. Other expenses are higher in 2012 due to the refund during first quarter 2011 of Virginia business franchise taxes paid or accrued for due to an allowable credit for property taxes paid on foreclosed properties in Virginia being an allowable offset to taxable capital for business franchise tax calculation purposes. Table IV below shows the breakdown of the changes.

Table IV - Noninterest Expense
                                                       For the Quarter Ended March 31,
                                                                     Change
Dollars in thousands                               2012           $           %         2011
  Salaries, commissions, and employee benefits   $   3,901     $  (71 )      -1.8 %   $ 3,972
  Net occupancy expense                                479        (30 )      -5.9 %       509
  Equipment expense                                    594         14         2.4 %       580
  Professional fees                                    304        108        55.1 %       196
  Amortization of intangibles                           88          -         0.0 %        88
  FDIC premiums                                        522       (171 )     -24.7 %       693
  OREO expense                                         374        (60 )     -13.8 %       434
  Other                                              1,277        643       101.4 %       634
                    Total                        $   7,539     $  433         6.1 %   $ 7,106

Credit Experience

Due to continued recessionary economic conditions, borrowers have in many cases been unable to refinance their loans to a range of factors including declining property values and elevated unemployment levels. As a result, we have experienced higher delinquencies and nonperforming assets, particularly with regard to our construction & development , residential real estate, and commercial real estate loan portfolios. It is not known when the housing market will stabilize. Management anticipates loan delinquencies will remain higher than historical levels in the near term, and we anticipate that nonperforming assets will remain elevated for the foreseeable future.

The provision for loan losses represents charges to earnings necessary to maintain an adequate allowance for probable credit losses inherent in the loan portfolio. 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 $2,001,000 and $3,000,000 provisions for loan losses for the first three months of 2012 and 2011, respectively. This decline is a result of lower levels of specific reserves, based upon the fair value of collateral method in measuring impairment, necessary on newly identified impaired loans at March 31, 2012 compared to March 31, 2011.

. . .