Edgar Filing: SUMMIT BANCSHARES INC /TX/

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the quarterly period ended September 30, 2006 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 0-11986

SUMMIT BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Texas		75-1694807

(State of Incorporation)		(I.R.S. Employer Identification No.)

3880 Hulen St., Fort Worth, Texas 76107

(Address of principal executive offices)

(817) 336-6817

(Registrant’s telephone number, including area code)

No Change

(Former name, former address and former fiscal year if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x

No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o

No x

The number of shares of common stock, $1.25 par value, of the issuer outstanding at October 31, 2006 was 12,711,872 shares.

SUMMIT BANCSHARES, INC.

INDEX

			Page No.

PART I - FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Consolidated Balance Sheets at September 30, 2006 and 2005 and at December 31, 2005	3

		Consolidated Statements of Income for the Nine Months Ended September 30, 2006 and 2005 and for the Year Ended December 31, 2005	4

		Consolidated Statements of Income for the Three Months Ended September 30, 2006 and 2005	5

		Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2006 and 2005 and for the Year Ended December 31, 2005	6

		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005 and for the Year Ended December 31, 2005	7

		Notes to Consolidated Financial Statements for the Nine Months Ended September 30, 2006 and 2005 and for the Year Ended December 31, 2005	8-21

	The September 30, 2006 and 2005 financial statements included herein are unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management of the registrant, necessary to a fair statement of the results for the interim periods. The financial statements for the year ended December 31, 2005 included herein are headed “unaudited.” These financial statements were reported as “audited” in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission but are required to be reflected herein as unaudited because of the absence of an independent auditor’s report.

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22-33

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	33

	Item 4.	Controls and Procedures	33

PART II - OTHER INFORMATION

	Item 1.	Legal Proceedings	34

	Item 1 A.	Risk Factors	34-35

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35

	Item 3.	Defaults Upon Senior Securities	35

	Item 4.	Submission of Matters to a Vote of Security Holders	35

	Item 5.	Other Information	35

	Item 6.	Exhibits	35-36

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	(Unaudited) September 30,						(Unaudited) December 31, 2005

	2006			2005

	(In Thousands)
*ASSETS*
CASH AND DUE FROM BANKS – NOTE 1	$	29,837		$	34,967		$	32,558
INTEREST-BEARING DEPOSITS		1,015			-0-			892
FEDERAL FUNDS SOLD		-0-			15,671			-0-
INVESTMENT SECURITIES – NOTE 3
Securities Available-for-Sale, at fair value		251,153			236,544			256,842
LOANS – NOTES 4, 15 AND 21
Loans, Net of Unearned Income		857,840			754,153			774,886
Allowance for Loan Losses		(10,399	)		(11,131	)		(11,208	)

LOANS, NET		847,441			743,022			763,678

PREMISES AND EQUIPMENT – NOTE 5		16,613			15,620			16,515
GOODWILL – NOTE 6		9,060			9,060			9,060
OTHER INTANGIBLE ASSETS, NET – NOTE 6		1,936			2,276			2,191
ACCRUED INCOME RECEIVABLE		7,264			5,651			6,273
OTHER REAL ESTATE – NOTE 7		-0-			-0-			-0-
OTHER ASSETS		12,994			11,450			11,726

TOTAL ASSETS	$	1,177,313		$	1,074,261		$	1,099,735

*LIABILITIES AND SHAREHOLDERS’ EQUITY*
DEPOSITS – NOTE 8
Noninterest-Bearing Demand	$	270,863		$	258,644		$	263,027
Interest-Bearing		657,935			607,384			615,749

TOTAL DEPOSITS		928,798			866,028			878,776
SHORT TERM BORROWINGS – NOTE 9		141,370			111,370			121,859
NOTE PAYABLE – NOTE 10		-0-			150			-0-
JUNIOR SUBORDINATED DEFERRABLE DEBENTURES – NOTE 11		12,372			12,372			12,372
ACCRUED INTEREST PAYABLE		1,773			900			1,014
OTHER LIABILITIES		4,233			3,714			4,381

TOTAL LIABILITIES		1,088,546			994,534			1,018,402

COMMITMENTS AND CONTINGENCIES – NOTES 16, 18, 20 AND 22
SHAREHOLDERS’ EQUITY – NOTES 17, 19 AND 23
Common Stock - $1.25 Par Value; 20,000,000 shares authorized; 12,600,722, 12,430,116 and 12,443,518 shares issued and outstanding at September 30, 2006 and 2005 and at December 31, 2005, respectively		15,751			15,538			15,554
Capital Surplus		9,628			8,082			8,170
Retained Earnings		66,804			58,362			60,964
Accumulated Other Comprehensive Income – Unrealized Loss on Available-for-Sale Investment Securities, Net of Tax Benefit		(3,416	)		(2,236	)		(3,349	)
Treasury Stock at Cost (988 and 300 shares at September 30, 2005 and December 31, 2005, respectively)		-0-			(19	)		(6	)

TOTAL SHAREHOLDERS’ EQUITY		88,767			79,727			81,333

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,177,313		$	1,074,261		$	1,099,735

The accompanying Notes should be read with these financial statements.

SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

	(Unaudited) For the Nine Months Ended September 30,					(Unaudited) Year Ended December 31, 2005

	2006		2005

	(In Thousands, Except Per Share Data)
INTEREST INCOME
Interest and Fees on Loans	$	48,827	$	36,905		$	51,064
Interest and Dividends on Investment Securities:
Taxable		7,084		5,912			8,281
Exempt from Federal Income Taxes		370		228			324
Interest on Federal Funds Sold and Interest-Bearing Deposits		56		182			292

TOTAL INTEREST INCOME		56,337		43,227			59,961

INTEREST EXPENSE
Interest on Deposits		13,208		8,169			11,663
Interest on Short Term Borrowings		4,860		2,313			3,317
Interest on Note Payable		1		55			57
Interest on Junior Subordinated Deferrable Debentures		701		522			731

TOTAL INTEREST EXPENSE		18,770		11,059			15,768

NET INTEREST INCOME		37,567		32,168			44,193
LESS: PROVISION FOR LOAN LOSSES – NOTE 4		3,515		765			1,105

NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		34,052		31,403			43,088

NON-INTEREST INCOME
Service Charges and Fees on Deposits		2,968		2,964			3,938
Other Income		3,202		3,127			4,066

TOTAL NON-INTEREST INCOME		6,170		6,091			8,004

NON-INTEREST EXPENSE
Salaries and Employee Benefits - NOTE 18		14,731		13,296			18,277
Occupancy Expense - Net		2,456		1,988			2,834
Furniture and Equipment Expense		1,887		1,756			2,341
Other Real Estate Owned Expense - Net		-0-		(11	)		(11	)
Intangible Asset Amortization		255		246			334
Other Expense – NOTE 13		6,048		5,172			6,883

TOTAL NON-INTEREST EXPENSE		25,377		22,447			30,658

INCOME BEFORE INCOME TAXES		14,845		15,047			20,434
APPLICABLE INCOME TAXES – NOTE 14		5,306		5,387			7,258

NET INCOME	$	9,539	$	9,660		$	13,176

NET INCOME PER SHARE – NOTE 19
Basic	$	0.76	$	0.78		$	1.06
Diluted		0.75		0.76			1.04

The accompanying Notes should be read with these financial statements.

SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

	(Unaudited) For the Three Months Ended September 30,

	2006		2005

	(In Thousands, Except Per Share Data)
INTEREST INCOME
Interest and Fees on Loans	$	17,308	$	13,203
Interest and Dividends on Investment Securities:
Taxable		2,389		2,072
Exempt from Federal Income Taxes		138		86
Interest on Federal Funds Sold and Interest-Bearing Deposits		24		115

TOTAL INTEREST INCOME		19,859		15,476

INTEREST EXPENSE
Interest on Deposits		5,002		3,185
Interest on Short Term Borrowings		1,764		878
Interest on Note Payable		-0-		12
Interest on Junior Subordinated Deferrable Debentures		249		188

TOTAL INTEREST EXPENSE		7,015		4,263

NET INTEREST INCOME		12,844		11,213
LESS: PROVISION FOR LOAN LOSSES – NOTE 4		415		315

NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		12,429		10,898

NON-INTEREST INCOME
Service Charges and Fees on Deposits		1,046		992
Other Income		1,055		1,184

TOTAL NON-INTEREST INCOME		2,101		2,176

NON-INTEREST EXPENSE
Salaries and Employee Benefits - NOTE 18		4,895		4,579
Occupancy Expense - Net		847		724
Furniture and Equipment Expense		648		587
Other Real Estate Owned Expense - Net		-0-		-0-
Intangible Asset Amortization		85		82
Other Expense – NOTE 13		2,482		1,665

TOTAL NON-INTEREST EXPENSE		8,957		7,637

INCOME BEFORE INCOME TAXES		5,573		5,437
APPLICABLE INCOME TAXES – NOTE 14		1,983		1,981

NET INCOME	$	3,590	$	3,456

NET INCOME PER SHARE - NOTE 19
Basic	$	0.28	$	0.28
Diluted		0.28		0.27

The accompanying Notes should be read with these financial statements.

SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
AND FOR THE YEAR ENDED DECEMBER 31, 2005
(Unaudited)

												Accumulated Other Comprehensive Income - Net Unrealized Loss on Investment Securities


																		Total Share-Holders’ Equity
	Common Stock						Capital Surplus		Retained Earnings						Treasury Stock

	Shares			Amount

	(Dollars in Thousands, Except Per Share Data)
Balance at December 31, 2004		12,359,232		$	15,449		$	7,705	$	51,810		$	(474	)	$	-0-		$	74,490
Stock Options Exercised		100,184			126			377											503
Purchases of Stock Held in Treasury																(561	)		(561	)
Retirement of Stock Held in Treasury		(29,300	)		(37	)				(505	)					542			-0-
Cash Dividend - $.21 Per Share										(2,603	)								(2,603	)
Net Income for the Nine Months Ended September 30, 2005										9,660									9,660
Securities Available- for-Sale Adjustment													(1,762	)					(1,762	)

Total Comprehensive Income – NOTE 26																			7,898

Balance at September 30, 2005		12,430,116			15,538			8,082		58,362			(2,236	)		(19	)		79,727
Stock Options Exercised		15,840			19			88											107
Purchases of Stock Held in Treasury																(33	)		(33	)
Retirement of Stock Held in Treasury		(2,438	)		(3	)				(43	)					46			-0-
Cash Dividend - $.07 Per Share										(871	)								(871	)
Net Income for the Three Months Ended December 31, 2005										3,516									3,516
Securities Available- for-Sale Adjustment													(1,113	)					(1,113	)

Total Comprehensive Income – NOTE 26																			2,403

Balance at December 31, 2005		12,443,518			15,554			8,170		60,964			(3,349	)		(6	)		81,333
Stock Options Exercised		196,704			246			1,330											1,576
Stock-Based Compensation Expense								128											128
Purchases of Stock Held in Treasury																(733	)		(733	)
Retirement of Stock Held in Treasury		(39,500	)		(49	)				(690	)					739			-0-
Cash Dividend - $.24 Per Share										(3,009	)								(3,009	)
Net Income for the Nine Months Ended September 30, 2006										9,539									9,539
Securities Available- for-Sale Adjustment													(67	)					(67	)

Total Comprehensive Income – NOTE 26																			9,472

Balance at September 30, 2006		12,600,722		$	15,751		$	9,628	$	66,804		$	(3,416	)	$	-0-		$	88,767

The accompanying Notes should be read with these financial statements.

SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
AND FOR THE YEAR ENDED DECEMBER 31, 2005

	(Unaudited) For the Nine Months Ended September 30,						(Unaudited) Year Ended December 31, 2005

	2006			2005

	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	9,539		$	9,660		$	13,176

Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Stock-Based Compensation Expense		128			-0-			-0-
Depreciation and Amortization		1,494			1,430			1,946
Net Premium Amortization of Investment Securities		669			1,044			1,309
Amortization of Intangible Assets		255			246			334
Provision for Loan Losses		3,515			765			1,105
Deferred Income Taxes Expense (Benefit)		122			(502	)		(533	)
Net Gain From Sale of Other Real Estate & Repossessed Assets		(8	)		-0-			(19	)
Net (Gain) Loss From (Sale) Disposal of Premises and Equipment		11			(247	)		(247	)
Net Increase in Accrued Income and Other Assets		(1,436	)		(1,421	)		(1,322	)
Net Increase in Accrued Expenses and Other Liabilities		611			345			1,126

Total Adjustments		5,361			1,660			3,699

NET CASH PROVIDED BY OPERATING ACTIVITIES		14,900			11,320			16,875

CASH FLOWS FROM INVESTING ACTIVITIES:
Net Increase in Interest Bearing Deposits		(123	)		-0-			(522	)
Net (Increase) Decrease in Federal Funds Sold		-0-			(10,651	)		4,650
Proceeds from Matured and Prepaid Investment Securities
· Available-for-Sale		251,754			356,758			524,266
Proceeds from Sales and Redemptions of Investment Securities		-0-			-0-			700
Purchase of Investment Securities
· Available-for-Sale		(248,497	)		(373,447	)		(563,976	)
Net Assets Acquired in the Purchase of Dignum Financial		-0-			(976	)		(1,043	)
Loans Originated and Principal Repayments, Net		(87,544	)		(51,534	)		(72,857	)
Recoveries of Loans Previously Charged-Off		266			435			458
Proceeds from Sale of Premises and Equipment		46			339			338
Proceeds from Sale of Other Real Estate & Repossessed Assets		764			-0-			67
Purchases of Premises and Equipment		(1,654	)		(1,397	)		(2,808	)

NET CASH USED BY INVESTING ACTIVITIES		(84,988	)		(80,473	)		(110,727	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase in Demand Deposits, Savings Accounts and Interest-Bearing Transaction Accounts		6,122			37,647			48,070
Net Increase in Certificates of Deposit		43,900			36,117			38,442
Net Increase in Short Term Borrowings		19,511			7,398			17,887
Repayment of Note Payable		-0-			(1,600	)		(1,750	)
Payments of Cash Dividends		(3,009	)		(2,603	)		(3,474	)
Proceeds from Stock Options Exercised		1,576			503			610
Purchases of Treasury Stock		(733	)		(561	)		(594	)

NET CASH PROVIDED BY FINANCING ACTIVITIES		67,367			76,901			99,191

NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS		(2,721	)		7,748			5,339
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD		32,558			27,219			27,219

CASH AND DUE FROM BANKS AT END OF PERIOD	$	29,837		$	34,967		$	32,558

SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES:
Interest Paid	$	18,011		$	10,760		$	15,355
Income Taxes Paid		5,283			5,549			7,476
Other Real Estate and Other Assets Acquired in Settlement of Loans		721			-0-			461

The accompanying Notes should be read with these financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMIT BANCSHARES, INC. AND SUBSIDIARIES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
AND FOR THE YEAR ENDED DECEMBER 31, 2005 (UNAUDITED)

NOTE 1 - Summary of Significant Accounting and Reporting Policies

The accounting and reporting policies of Summit Bancshares, Inc. are in accordance with accounting principles generally accepted in the United States of America and the prevailing practices within the banking industry. A summary of the more significant policies follows:

Basis of Presentation and Principles of Consolidation

The consolidated financial statements of Summit Bancshares, Inc. (hereinafter, collectively with its subsidiaries, the “Corporation”), include its accounts and its direct and indirect wholly-owned subsidiaries, Summit Delaware Financial Corporation, Summit Bank, National Association (the “Bank”) and SIA Insurance Agency, Inc. (“SIA”). All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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 periods. Actual results could differ materially from those estimates.

Cash and Due From Banks

The Bank is required to maintain certain noninterest-bearing cash balances at the Federal Reserve Bank based on its level of deposits. During the first nine months of 2006, the average cash balance maintained at the Federal Reserve Bank was $2,631,000. Compensating balances held at correspondent banks, to minimize service charges, averaged approximately $24,961,000 during the same period.

Investment Securities

The Corporation has adopted Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). At the date of purchase, the Corporation is required to classify debt and equity securities into one of three categories: held-to-maturity, trading or available-for-sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities are classified as held-to-maturity and measured at amortized cost in the financial statements only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Investments not classified as either held-to-maturity or trading are classified as available-for-sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, in a separate component of shareholders’ equity until realized.

The Corporation has the ability and intent to hold to maturity its investment securities classified as held-to-maturity; accordingly, no adjustment has been made for the excess, if any, of amortized cost over market. In determining the investment category classifications at the time of purchase of securities, management considers its asset/liability strategy, changes in interest rates and prepayment risk, the need to increase capital and other factors. Under certain circumstances (including the deterioration of the issuer’s creditworthiness, a change in tax law, or statutory or regulatory requirements), the Corporation may change the investment security classification. In the periods reported for 2006 and 2005, the Corporation held no securities that would have been classified as trading securities.

All investment securities are adjusted for amortization of premiums and accretion of discounts. Amortization of premiums and accretion of discounts are recorded to income over the contractual maturity or estimated life of the individual investment on the level yield method. Gain or loss on sale of investments is based upon the specific identification method and the gain or loss is recorded in non-interest income. Income earned on the Corporation’s investments in securities issued by state and political subdivisions is not taxable.

Loans and Allowance for Loan Losses

Loans are stated at the principal amount outstanding less unearned discount, deferred fees and the allowance for loan losses. Unearned discount on installment loans is recognized as income over the terms of the loans by a method approximating the interest method. Interest income on all other loans is recognized based upon the principal amounts outstanding, the simple interest method. Loan origination fee income, net of direct loan origination costs, is deferred and amortized over the life of the related loan. The accrual of interest on a loan is discontinued when, in the opinion of management, there is doubt about the ability of the borrower to pay interest or principal. Interest previously earned, but uncollected on such loans, is written off. After loans are placed on non-accrual all payments received are applied to principal and no interest income is recorded until the loan is returned to accrual status or the principal balance has been reduced to zero.

NOTE 1 - Summary of Significant Accounting and Reporting Policies (cont’d.)

The Corporation has adopted Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by Statement of Financial Accounting Standards No. 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure.” Under this standard, the allowance for loan losses related to loans that are identified for evaluation in accordance with Statement No. 114 (impaired loans) is based on discounted cash flows using the loan’s initial effective rate or the fair value of the collateral for certain collateral dependent loans.

The allowance for loan losses is comprised of amounts charged against income in the form of a provision for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected. In these situations, a valuation allowance is recorded when the carrying amount of the loan exceeds the discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Income on impaired loans is recognized based on the collectibility of the principal amount. Adjustments to the allowance for loan losses will be reported in the period such adjustments become known or are reasonably estimable.

The amount maintained in the allowance reflects management’s continuing assessment of the potential losses inherent in its loan portfolio based on its evaluation of a number of factors, including the Bank’s loss experience in relation to outstanding loans and the existing level of the allowance, prevailing and prospective economic conditions, and management’s continuing review of the discounted cash flow values of impaired loans and its evaluation of the quality of the loan portfolio. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely.

The evaluation of the adequacy of loan collateral is often based upon estimates and appraisals. Because of changing economic conditions, the valuations determined from such estimates and appraisals may also change. Accordingly, the Corporation may ultimately incur losses which vary materially from management’s current estimates.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation expense is computed on the straight-line method based upon the estimated useful lives of the assets ranging from three to forty years. Maintenance and repairs are charged to non-interest expense. Renewals and betterments are added to the asset accounts and depreciated over the periods benefited. Depreciable assets sold or retired are removed from the asset and related accumulated depreciation accounts and any gain or loss is reflected in the income and expense accounts.

Other Real Estate

Other real estate is foreclosed property held pending disposition and is valued at the lower of its fair value or the recorded investment in the related loan. At foreclosure, if the fair value, less estimated costs to sell, of the real estate acquired is less than the Corporation’s recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Any subsequent reduction in value is recognized by a charge to income. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in non-interest expense.

Federal Income Taxes

The Corporation joins with its subsidiaries in filing a consolidated federal income tax return. The subsidiaries pay to the parent a charge equivalent to their current federal income tax based on the separate taxable income of the subsidiaries.

The Corporation and the subsidiaries maintain their records for financial reporting and income tax reporting purposes on the accrual basis of accounting. Deferred income taxes are provided in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Deferred income taxes are provided for accumulated temporary differences due to basic differences for assets and liabilities for financial reporting and income tax purposes.

Realization of net deferred tax assets is dependent on generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax assets will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced.

Cash and Cash Equivalents

For the purpose of presentation in the Statements of Cash Flows, cash and cash equivalents include cash on hand, clearings and exchanges, and balances due from correspondent banks.

Reclassification

Certain reclassifications have been made to the 2005 financial statements to conform to the 2006 presentation.

NOTE 1 - Summary of Significant Accounting Policies (cont’d.)

Earnings Per Common and Common Equivalent Shares

Statement of Financial Accounting Standards No. 128 (“SFAS 128”), “Earnings Per Share,” requires presentation of basic and diluted earnings per share. Basic earnings per share has been computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Net income per common share for all periods presented has been calculated in accordance with SFAS 128. Outstanding stock options issued by the Corporation represent the only dilutive effect reflected in diluted weighted average shares.

Stock-Based Compensation

On January 1, 2006, the Corporation changed its accounting policy related to stock-based compensation in connection with the adoption of Statement of Financial Accounting Standards (SFAS) No. 123, “Share-Based Payment (Revised 2004).” See Note 12 – Stock-Based Compensation for additional information.

Advertising Costs

Advertising costs are expensed as incurred.

Comprehensive Income

Comprehensive income includes all changes in shareholders’ equity during a period, except those resulting from investments by and distributions to owners and treasury stock transactions. Besides net income, the other component of the Corporation’s comprehensive income is the after tax effect of changes in the fair value of securities available-for-sale. Comprehensive income for the periods ended September 30, 2006 and 2005 and for the year ended December 31, 2005 is reported in Note 26, “Comprehensive Income.”

Audited Financial Statements

The consolidated balance sheet as of December 31, 2005, and the consolidated statements of income, changes in shareholders’ equity and cash flows for the year ended December 31, 2005 are headed “unaudited” in these financial statements. These statements were reported as “audited” in our Annual Report of Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission but are required to be reflected in these statements as unaudited because of the absence of an independent auditor’s report.

NOTE 2 – Mergers and Acquisitions

On July 2, 2006, the Corporation and Cullen/Frost Bankers, Inc., a Texas corporation (“Cullen/Frost”), entered into an Agreement and Plan of Merger (the “Agreement”) pursuant to which the Corporation will merge with and into Cullen/Frost. Under the terms of the Agreement, the Corporation’s shareholders will have the right, subject to pro-ration, to elect to receive cash, shares of Cullen/Frost common stock or a combination thereof having a value equal to $11.50 plus 0.2933 Cullen/Frost shares. The total consideration consists of approximately $143.4 million in cash and approximately 3.84 million shares of Cullen/Frost common stock (assuming the treasury stock method of accounting for options before giving effect to any exercises of outstanding options). The transaction is subject to customary closing conditions, including the receipt of regulatory approvals and approval of the shareholders of the Corporation. As of the date this report is filed all regulatory approvals have been received as well as shareholder approval. The merger is currently expected to be completed in the fourth quarter of 2006, although delays could occur.

The foregoing summary of the Agreement is not complete and is qualified in its entirety by reference to the complete text of such document, which is filed as Exhibit 2.1 to the Report on Form 8-K filed with the Securities and Exchange Commission on July 3, 2006 and which is incorporated herein by reference.

On March 21, 2005, the Corporation acquired Dignum Financial Services (“DFS”) for a purchase price of approximately $1.0 million. DFS was a proprietorship engaged in financial planning and management services. Of the purchase price, $0.5 million is subject to the earnings performance of Summit Financial Partners (formerly DFS), a division of the Bank.

NOTE 3 - Investment Securities

A summary of amortized cost and estimated fair values of investment securities as of September 30, 2006 is as follows (in thousands):

	September 30, 2006

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Investment Securities - Available-for-Sale
U.S. Government Agencies and Corporations	$	170,969		27	$	(3,004	)	$	167,992
U.S. Government Agency Mortgage Backed Securities		64,269		71		(1,918	)		62,422
Obligations of States and Political Subdivisions		15,055		7		(258	)		14,804
Community Reinvestment Act Investment Fund		3,025		-0-		(101	)		2,924
Other Securities		3,011		-0-		-0-			3,011

Total Available-for-Sale Securities	$	256,329	$	105	$	(5,281	)	$	251,153

All investment securities are carried on the consolidated balance sheet as of September 30, 2006 at fair value. The net unrealized loss of $5,176,000 is included in the Available-for-Sale Investment Securities balance. The unrealized loss, net of tax benefit, is included in Shareholders’ Equity.

Included in the Other Securities category at September 30, 2006 is $2,095,000 of Federal Home Loan Bank Stock and $800,000 of Federal Reserve Stock which are classified as restricted investment securities, carried at cost, and evaluated for impairment. No impairment losses were recorded as of September 30, 2006. The Bank was required at September 30, 2006 to have stock holdings of Federal Home Loan Bank Stock equal to .08% of the Bank’s total assets as of the previous quarter end plus 4.10% of its outstanding advances from the Federal Home Loan Bank (“FHLB”). The Bank is also required to have stock holdings of Federal Reserve Stock equal to 6% of its Capital Stock and Surplus.

A summary of amortized cost and estimated fair values of investment securities as of September 30, 2005 is as follows (in thousands):

	September 30, 2005

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Investment Securities - Available-for-Sale
U.S. Government Agencies and Corporations	$	167,840	$	19	$	(2,360	)	$	165,499
U.S. Government Agency Mortgage Backed Securities		53,068		20		(1,074	)		52,014
Obligations of States and Political Subdivisions		10,673		69		(68	)		10,674
Community Reinvestment Act Investment Fund		3,025		5		-0-			3,030
Other Securities		5,327		-0-		-0-			5,327

Total Available-for-Sale Securities	$	239,933	$	113	$	(3,502	)	$	236,544

All investment securities were carried on the consolidated balance sheet as of September 30, 2005 at fair value. The net unrealized loss of $3,389,000 was included in the Available-for-Sale Investment Securities balance. The unrealized loss, net of tax benefit, was included in Shareholders’ Equity.

Included in the Other Securities category at September 30, 2005 was $4,450,000 of Federal Home Loan Bank Stock and $800,000 of Federal Reserve Stock which were classified as restricted investment securities, carried at cost, and evaluated for impairment. No impairment losses were recorded as of September 30, 2005. The Bank was required at September 30, 2005 to have stock holdings of Federal Home Loan Bank Stock equal to .14% of the Bank’s total assets as of the previous year end plus 4.25% of its outstanding advancements from the FHLB. The Bank was also required to have stock holdings of Federal Reserve Stock equal to 6% of its Capital Stock and Surplus.

NOTE 4 - Loans and Allowance for Loan Losses

The book values of loans by major type follow (in thousands):

	September 30,						December 31, 2005

	2006			2005

Commercial and Industrial	$	310,236		$	270,807		$	277,827
Real Estate Mortgage - Commercial		281,107			244,966			260,736
Real Estate Mortgage - Residential		93,764			89,487			91,183
Real Estate - Construction		135,992			109,431			106,227
Loans to Individuals		36,741			39,462			38,913

		857,840			754,153			774,886
Allowance for Loan Losses		(10,399	)		(11,131	)		(11,208	)

Loans - Net	$	847,441		$	743,022		$	763,678

Loans are net of unearned income of $1,059,000 and $945,000 at September 30, 2006 and 2005, respectively, and $1,101,000 at December 31, 2005.

Transactions in the allowance for loan losses are summarized as follows (in thousands):

	Nine Months Ended September 30,						Year Ended December 31, 2005

	2006			2005

Balance, Beginning of Period	$	11,208		$	10,187		$	10,187
Provisions, Charged to Income		3,515			765			1,105
Loans Charged-Off		(4,590	)		(256	)		(542	)
Recoveries of Loans Previously
Charged-Off		266			435			458

Net Loans (Charged-Off) Recovered		(4,324	)		179			(84	)

Balance, End of Period	$	10,399		$	11,131		$	11,208

The provisions for loan losses charged to operating expenses during the nine months ended September 30, 2006 and September 30, 2005 of $3,515,000 and $765,000, respectively, were considered adequate to maintain the allowance in accordance with the policy discussed in Note 1. For the year ended December 31, 2005, a provision of $1,105,000 was recorded.

At September 30, 2006, the recorded investment in loans that are considered to be impaired under Statement of Financial Accounting Standards No. 114 was $8,213,000 (of which $8,213,000 were on non-accrual status). The related allowance for loan losses for these loans was $1,506,000. The average recorded investment in impaired loans during the nine months ended September 30, 2006 was approximately $12,875,000. For this period, the Corporation recognized interest income of $40,000 on these impaired loans.

NOTE 5 - Premises and Equipment

The investment in premises and equipment stated at cost and net of accumulated amortization and depreciation is as follows (in thousands):

	September 30,				December 31 2005

	2006		2005

Land	$	3,302	$	3,296	$	3,296
Buildings and Improvements		13,436		12,519		12,957
Furniture & Equipment		13,042		11,208		12,104

Total Cost		29,780		27,023		28,357
Less: Accumulated Amortization and Depreciation		13,167		11,403		11,842

Net Book Value	$	16,613	$	15,620	$	16,515

NOTE 6 – Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations under the purchase method of accounting. The Corporation has adopted Financial Accounting Standards Board Statement No. 142 (FAS 142), “Goodwill and Other Intangible Assets.” FAS 142 eliminates amortization of goodwill associated with business combinations completed after September 30, 2001. Goodwill is periodically assessed for impairment when events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. The Corporation bases its evaluation on such impairment factors as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present.

On May 3, 2004, the Corporation completed its merger with ANB Financial Corporation and its wholly-owned subsidiary, Arlington National Bank of Arlington, Texas (“collectively “ANB”). A premium of $10.7 million was paid in connection with the acquisition of ANB, $2.7 million of which was identified as core deposit intangibles. The remaining $8.0 million has been recorded as goodwill. In accordance with FAS 142, the goodwill will not be amortized. The core deposit intangibles are being amortized using a straight line method over their estimated useful life of 8 years. Amortization expense on the core deposit intangibles was $246,000, $328,000 and $246,000 for the nine months ended September 30, 2006, the year ended December 31, 2005 and the nine months ended September 30, 2005, respectively.

On March 21, 2005, the Corporation completed the acquisition of DFS. Goodwill of $1.0 million was recorded in connection with the acquisition.

As of September 30, 2006, the Corporation had other intangible assets with a net book value of $32,000. Amortization expense of $6,000 and $9,000 has been recorded on the other intangible assets for the year ended December 31, 2005 and for the nine months ended September 30, 2006, respectively.

NOTE 7 - Other Real Estate

The carrying value of other real estate is as follows (in thousands):

	September 30,				December 31, 2005

	2006		2005

Other Real Estate	$	-0-	$	-0-	$	-0-

There were no direct write-downs of other real estate charged to income for the nine months ended September 30, 2006 or September 30, 2005. There were also no direct write-downs of other real estate charged to income for the year ended December 31, 2005.

NOTE 8 – Deposits

The book values of deposits by major type follow (in thousands):

	September 30,
					December 31 2005
	2006		2005		December 31 2005

Noninterest-Bearing Demand Deposits	$	270,863	$	258,644	$	263,027
Interest-Bearing Deposits:
Interest-Bearing Transaction
Accounts and Money Market Accounts		261,596		241,251		268,116
Savings		161,268		177,287		156,462
Certificates of Deposits under $100,000 and IRA’s		97,177		85,765		88,273
Certificates of Deposits of $100,000 or more		130,844		100,031		99,848
Other		7,050		3,050		3,050

Total		657,935		607,384		615,749

Total Deposits	$	928,798	$	866,028	$	878,776

NOTE 9 - Short Term Borrowings

Securities sold under repurchase agreements generally represent borrowings with maturities ranging from one to thirty days. Information relating to these and other borrowings is summarized as follows (in thousands):

	Nine Months Ended September 30,						Year Ended December 31, 2005

	2006			2005

Securities Sold Under Repurchase Agreements:
Average Balance	$	107,218		$	44,332		$	50,825
Period-End Balance		121,370			51,370			61,559
Maximum Month-End Balance During Period		127,628			51,370			67,494
Interest Rate:
Average		4.23	%		2.40	%		2.72	%
Period-End		4.59			3.04			3.65
Federal Home Loan Bank Advances:
Average Balance	$	41,099		$	63,663		$	61,808
Period-End Balance		20,000			60,000			55,000
Maximum Month-End Balance During Period		25,000			70,000			70,000
Interest Rate:
Average		3.91	%		3.00	%		3.10	%
Period-End		3.92			3.49			3.44
Federal Funds Purchased:
Average Balance	$	1,254		$	444		$	534
Period-End Balance		-0-			-0-			5,300
Maximum Month-End Balance During Period		7,944			-0-			5,300
Interest Rate:
Average		5.43	%		2.95	%		3.54	%
Period-End		-0-			-0-			4.33

The Corporation has available a line of credit with the FHLB of Dallas which allows it to borrow on a collateralized basis at a fixed term. The borrowings are collateralized by a blanket floating lien on certain real estate loans, the FHLB capital stock owned by the Corporation and any funds on deposit with FHLB. At September 30, 2006, the Corporation had $20.0 million of borrowings outstanding under the line of credit at an average rate of 4.10%, $5.0 million of which matures in 2006 and the remaining $15.0 million of which matures in 2007. For the nine months ended September 30, 2006, the Corporation had average borrowings under the line of credit of $41.0 million. For the nine months ended September 30, 2005, the Corporation had average borrowings of $63.7 million. At December 31, 2005, $55.0 million of borrowings were outstanding at an average rate of 3.44%. For the year ended December 31, 2005, the Corporation had average borrowings of $61.8 million.

NOTE 10 – Note Payable

On September 15, 2005, the Corporation obtained a line of credit from a bank under which the Corporation may borrow $10,000,000 at a floating rate (three month LIBOR plus margin of 2.00%). The line of credit is secured by stock of the Bank. The original maturity date of the line of credit was extended from September 15, 2006 to December 8, 2006, whereupon, if balances are outstanding, the line converts to a term note having a five year term. The Corporation will not pay a fee for any unused portion of the line. As of September 30, 2006, there were no borrowings under this line.

NOTE 11 - Junior Subordinated Deferrable Debentures

On May 3, 2004, the Corporation formed SBI Trust and SBI Trust subsequently issued $12.0 million of floating rate (three month LIBOR plus a margin of 2.65%) Capital Securities (the “Trust Capital Securities”). Concurrent with the issuance of the Trust Capital Securities, SBI Trust issued trust common securities to the Corporation in the aggregate liquidation value of $372,000. The proceeds of the issuance of the Trust Capital Securities and trust common securities were invested in the Corporation’s Floating Rate Junior Subordinated Deferrable Debentures (the “Deferrable Debentures”), which mature on July 7, 2034 and have a call feature that permits the Corporation to redeem any or all of the securities after July 7, 2009. The interest rate on the Deferrable Debentures at September 30, 2006 and December 31, 2005 was 7.72% and 6.80%, respectively. The Deferrable Debentures, which are the only assets of SBI Trust, are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture dated May 3, 2004) of the Corporation.

NOTE 12 - Stock -Based Compensation

Prior to January 1, 2006, the Corporation accounted for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees” and related Interpretations. Accordingly no compensation expense was recognized for stock option plans because the exercise prices of stock options equaled or exceeded the market prices of the underlying stock on the dates of the grants. However, stock-based compensation has been included in pro forma disclosures in the financial statement footnotes in prior periods.

Effective January 1, 2006, the Corporation adopted the fair value recognition provisions of SFAS No. 123R, “Share-Based Payment” using a modified version of prospective application. Under this method, compensation expense will be recorded for all awards granted after the date of adoption and for the unvested portion of previously granted awards that were outstanding as of the beginning of the period of adoption.

For the nine months ended September 30, 2006, stock-based compensation expense was $128,000. The following table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of SFAS 123R to stock based compensation (in thousands, except for per share data):

	Nine Months Ended September 30, 2005			Year Ended December 31, 2005

Net Income, as Reported	$	9,660		$	13,176
Deduct: Total stock-based compensation expense
determined under fair value based method
for all awards, net of related tax effects		(196	)		(241	)

Pro Forma Net Income	$	9,464		$	12,935

Earnings Per Share:
Basic - as Reported	$	0.78		$	1.06
Basic - Pro Forma		0.76			1.04
Diluted - as Reported		0.76			1.04
Diluted - Pro Forma		0.74			1.02

NOTE 13 - Other Non-Interest Expense

The significant components of other non-interest expense are as follows (in thousands):

	Nine Months Ended September 30,				Year Ended December 31 2005

	2006		2005

Business Development	$	845	$	795	$	1,097
Legal and Professional Fees		1,061		975		1,304
Data and Item Processing		553		474		821
Printing and Supplies		349		359		475
Regulatory Fees and Assessments		262		239		325
Other		2,978		2,330		2,861

Total	$	6,048	$	5,172	$	6,883

NOTE 14 - Income Taxes

Federal income taxes included in the consolidated balance sheets were as follows (in thousands):

	September 30,					December 31, 2005

	2006		2005

Current Tax Asset (Liability)	$	68	$	(82	)	$	(56	)
Net Deferred Tax Asset		4,932		4,416			5,020

Total Included in Other Assets	$	5,000	$	4,334		$	4,964

The net deferred tax asset at September 30, 2006 of $4,932,000 included $1,760,000, a deferred tax asset related to unrealized losses on Available-for-Sale Securities.

The components of income tax expense were as follows (in thousands):

	Nine Months Ended September 30,						Year Ended December 31, 2005

	2006			2005

Federal Income Tax Expense:
Current	$	5,184		$	5,889		$	7,791
Deferred (Benefit)		122			(502	)		(533	)

Total Federal Income Tax Expense	$	5,306		$	5,387		$	7,258

Effective Tax Rates		35.7	%		35.8	%		35.0	%

The reasons for the difference between income tax expense and the amount computed by applying the statutory federal income tax rate to operating earnings are as follows (in thousands):

	Nine Months Ended September 30,						Year Ended December 31, 2005

	2006			2005

Federal Income Taxes at Statutory Rate of 35.0%	$	5,195		$	5,267		$	7,152
Effect of Tax Exempt Interest Income		(122	)		(77	)		(108	)
Non-deductible Expenses		227			167			228
Other		6			30			(14	)

Income Taxes Per Income Statement	$	5,306		$	5,387		$	7,258

NOTE 14 - Income Taxes (cont’d.)

Deferred income tax expense (benefit) results from differences between amounts of assets and liabilities as measured for income tax return and financial reporting purposes. The significant components of federal deferred tax assets and liabilities are in the following table (in thousands):

	September 30,				December 31, 2005

	2006		2005

Federal Deferred Tax Assets:
Allowance for Loan Losses	$	3,639	$	3,896	$	3,923
Interest on Non-accrual Loans		250		142		135
Unrealized Losses on Available-for-Sale Securities		1,760		1,152		1,725
Deferred Compensation		865		719		747
Net Operating Loss Carryover		71		116		105
Other		4		40		48

Gross Federal Deferred Tax Assets		6,589		6,065		6,683

Federal Deferred Tax Liabilities:
Depreciation and Amortization		1,297		1,414		1,385
Accretion		202		79		113
Other		158		156		165

Gross Federal Deferred Tax Liabilities		1,657		1,649		1,663

Net Deferred Tax Asset	$	4,932	$	4,416	$	5,020

NOTE 15 - Related Party Transactions

The Bank has made loan transactions in the ordinary course of business with certain of its and the Corporation’s officers, directors and their affiliates. All loans included in such transactions are made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other unrelated persons and all such loans are current as to principal and interest payments. Total loans outstanding to such related parties amounted to approximately $6,843,000 at September 30, 2006 and $9,356,000 at December 31, 2005 and $11,410,000 at September 30, 2005.

NOTE 16 - Commitments and Contingent Liabilities

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as guarantees and commitments to extend credit, which are not reflected in the financial statements. No losses are anticipated as a result of these transactions. Commitments are most frequently extended for real estate, commercial and industrial loans.

At September 30, 2006, outstanding documentary and standby letters of credit totaled $9,117,000 and commitments to extend credit totaled $238,095,000.

In addition, the Corporation leases certain office facilities under operating leases. Rent expense for all operating leases totaled $1,041,000 and $947,000 for the nine months ended September 30, 2006 and 2005, respectively, and $1,305,000 for the year ended December 31, 2005.

NOTE 17 - Stock Option Plans

On April 18, 2006, the shareholders of the Corporation approved the 2006 Long-Term Incentive Plan of the Corporation (the “2006 Plan”). The 2006 Plan replaced the 1997 Stock Option Plan and is intended to enable the Corporation to remain competitive and innovative in its ability to attract, motivate, reward and retain the services of key employees. The 2006 Plan provides for the granting of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights, and other awards which may be paid in cash or stock. The 2006 Plan is expected to provide flexibility to the Corporation’s compensation methods in order to adapt the compensation of key employees to a changing business environment, after giving due consideration to competitive conditions and the impact of federal tax laws. Subject to certain adjustments, the number of the Corporation’s shares of common stock that may be issued pursuant to awards under the 2006 Plan is 1,250,000 shares, less the total number of shares of common stock issued pursuant to the 2006 Plan or issuable upon the exercise of awards granted under the 1997 Stock Option Plan. No more options may be granted under the 1993 Stock Option Plan or the 1997 Stock Option Plan of the Corporation, each of which has terminated. Each award granted under the 1997 Stock Option Plan is now subject to the 2006 Plan. The stock options granted under the 2006 Plan will generally be exercisable for ten years from the date of grant and generally vest ratably over a five year period. Options have been granted at prices which will not be less than 100-110% of the fair market value of the underlying common stock at the date of grant.

NOTE 17 - Stock Option Plans (cont’d.)

The following is a summary of transactions during the periods presented:

	Shares Under Option Plans

	Nine Months Ended September 30, 2006			Year Ended December 31, 2005

Outstanding, Beginning of Period		616,354			679,578
Additional Options Granted During the Period		11,500			55,200
Forfeited During the Period		(11,300	)		(2,400	)
Exercised During the Period		(196,704	)		(116,024	)

Outstanding, End of Period		419,850			616,354

Options outstanding at September 30, 2006 have exercise prices between $5.19 to $18.75 per share with a weighted average exercise price of $10.95 and 356,330 shares exercisable. At September 30, 2006, there remained 798,545 shares reserved for future grants of options under the 2006 Plan. See Note 12 “Stock –Based Compensation” for information regarding the dilutive impact of these stock options.

NOTE 18 - Employee Benefit Plans

401(k) Plan

The Corporation implemented a 401(k) plan in December 1997 covering substantially all employees. The Corporation made no contribution to this plan in 1998 or 1999. Beginning in 2000, the Corporation made matching contributions, not to exceed 6% of the employee’s annual compensation, to the participants’ deferrals of compensation up to 100% of the employee contributions.

The amount expensed in support of the plan was $510,000 and $451,000 during the first nine months of 2006 and 2005, respectively, and $592,000 for the year 2005.

Supplemental Executive Retirement Plan

In 2002, the Corporation established a Supplemental Executive Retirement Plan (the “Retirement Plan”) to provide key employees with retirement, death or disability benefits. For currently employed employees, the Retirement Plan replaces the previous Management Security Plan. The Retirement Plan is a defined contribution plan and the expense charged to earnings relating to the Retirement Plan was $397,000 and $312,000 for the first nine months of 2006 and 2005, respectively, and $458,000 for the year 2005.

Employment Contracts

The Chief Executive Officer of the Corporation has entered into a severance agreement with the Corporation providing for salary and fringe benefits in the event of termination for other than cause and under certain changes in control.

Other Post Retirement Benefits

The Corporation provides certain health care benefits for certain retired employees who bear all costs of these benefits. These benefits are covered under the Consolidated Omnibus Budget Reconciliation Act.

Compensated Absences

Employees of the Corporation are entitled to paid vacation, paid sick days and other personal days off, depending on job classification, length of service and other factors. It is impracticable to estimate the amount of compensation for future absences, and accordingly, no liability has been recorded in the accompanying financial statements. The Corporation’s policy is to recognize the costs of compensated absences when actually paid to employees.

Other Employment Letter Agreements

In conjunction with the merger agreement, Cullen/Frost entered into employment letters with certain Summit executives. Under the employment letters, each of the executives will be employed by Cullen/Frost through at least the second anniversary of the completion of the merger, unless earlier terminated pursuant to the terms of the letter agreements. The executives who entered into the letter agreements, also entered into a Confidential Information, Non-Solicitation and Noncompetition Agreement (referred to herein as the “non-compete agreement”) with Cullen/Frost and Summit, which became effective as of the date the merger agreement was signed. Under the non-compete agreement the executives agreed to keep confidential information confidential and not to compete with the business of Cullen/Frost and its affiliates in Tarrant County, Texas.

NOTE 19 - Earnings per Share

The following data shows the amounts used in computing earnings per share (“EPS”) and the weighted average number of shares of dilutive potential common stock (dollars in thousands):

	Nine Months Ended September 30,				Year Ended December 31, 2005

	2006		2005

Net income	$	9,539	$	9,660	$	13,176

Weighted average number of common shares used in Basic EPS		12,532,768		12,405,183		12,414,366
Effect of dilutive stock options		267,044		300,294		295,957

Weighted number of common shares and dilutive potential common stock used in Diluted EPS		12,799,812		12,705,477		12,710,323

The incremental shares for the assumed exercise of the outstanding options were determined by application of the treasury stock method.

NOTE 20 - Financial Instruments with Off-Balance Sheet Risk

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments, standby letters of credit and documentary letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.

The Corporation’s exposure to credit loss in the event of non-performance by the other party of these loan commitments and letters of credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The total contractual amounts of financial instruments with off-balance sheet risk are as follows (in thousands):

	September 30,

	2006		2005

Financial Instruments Whose Contract Amounts Represent Credit Risk:
Loan Commitments Including Unfunded Lines of Credit	$	238,095	$	189,257
Letters of Credit		9,117		5,112

Loan commitments are agreements to lend to a customer as long as there is no customer 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. Letters of credit are conditional commitments by the Corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Since many of the loan commitments and letters of credit may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Corporation evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, owner-occupied real estate and income-producing commercial properties.

The Corporation originates real estate, commercial and consumer loans primarily to customers in the Tarrant County area. Although the Corporation has a diversified loan portfolio, a substantial portion of its customers’ ability to honor their contracts is dependent upon the local economy and the real estate market.

The Corporation maintains funds on deposit at correspondent banks which at times exceed the federally insured limits. Management of the Corporation monitors the balance in these accounts and periodically assesses the financial condition of correspondent banks.

NOTE 21 - Concentrations of Credit Risk

The Bank makes commercial, consumer and real estate loans in its direct market which is defined as Fort Worth and its surrounding area. The Board of Directors of the Bank monitors concentrations of credit by purpose, collateral and industry at least quarterly. Certain limitations for concentration are set by the Board of Directors of the Bank. Additional loans in excess of these limits must have prior approval of the Bank’s directors’ loan committee. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ abilities to honor their contracts is dependent upon the strength of the local and state economy.

NOTE 22 - Litigation

The Corporation is involved in legal actions arising in the ordinary course of business. It is the opinion of management, after reviewing such actions with outside legal counsel, that the settlement of these matters will not materially affect the Corporation’s financial position.

NOTE 23 - Stock Repurchase Plan

On April 18, 2006, the Board of Directors of the Corporation approved a stock purchase plan (the “2006 Stock Purchase Plan”) authorizing management to purchase up to 623,675 shares of the Corporation’s common stock on behalf of the Corporation over the twelve-month period beginning April 19, 2006 and ending on April 18, 2007, including in open market transactions, privately negotiated transactions or other transactions in accordance with all applicable state and federal laws and regulations. In the quarter ended September 30, 2006, no shares were purchased by the Corporation pursuant to the 2006 Stock Purchase Plan in privately negotiated transactions.

The Corporation’s ability to purchase shares of the Corporation’s common stock is subject to various banking laws, regulations and policies as well as rules and regulations of the Securities and Exchange Commission.

NOTE 24 - Subsequent Events

On October 5, 2006, the Company filed a Form 8-K Report with the Securities and Exchange Commission reporting a loan charge-off recovery of $3.0 million was recorded resulting from a cash payment of $4.5 million on the credit. This payment satisfies the full obligation of the borrower with the exception of an $183,000 secured note. It is anticipated that the recovery will result in a reduction in the provision for loan losses for the year of 2006 that is to be recorded in the fourth quarter.

On October 18, 2006, the Board of Directors of the Corporation approved a quarterly dividend of $.08 per share to be paid on November 15, 2006 to shareholders of record on November 1, 2006.

NOTE 25 - Fair Values of Financial Instruments

The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:

	Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and due from banks and federal funds sold approximate those assets’ fair values.

	Investment securities (including mortgage backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

	Loans: For variable rate loans, fair values are based on carrying values. The fair values for fixed rate loans such as mortgage loans (e.g., one-to-four family residential) and installment loans are estimated using discounted cash flow analysis. The carrying amount of accrued interest receivable approximates its fair value.

	Deposit liabilities: The fair value disclosed for interest-bearing and noninterest-bearing demand deposits, passbook savings, and certain types of money market accounts are, by definition, equal to the amount payable on demand at the reporting date or their carrying amounts. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

	Short term borrowings: The carrying amounts of borrowings under repurchase agreements, Federal Home Loan Bank advances and Federal Funds Purchased approximate their fair values.

	The estimated fair values of the Corporation’s financial instruments are as follows (in thousands):

NOTE 25 - Fair Values of Financial Instruments (cont’d)

	September 30,

	2006						2005

	Carrying Amount			Fair Value			Carrying Amount			Fair Value

Financial Assets:
Cash and due from banks	$	29,837		$	29,837		$	34,967		$	34,967
Federal funds sold and interest bearing deposits		1,015			1,015			15,671			15,671
Investment securities		251,153			251,153			236,544			236,544
Loans		857,840			846,505			754,153			735,864
Allowance for loan losses		(10,399	)		(10,399	)		(11,131	)		(11,131	)
Financial Liabilities:
Deposits		928,798			931,508			866,028			866,701
Short term borrowings		141,370			141,184			111,370			111,224
Off-balance Sheet Financial Instruments:
Loan commitments					238,095						189,257
Letters of credit					9,117						5,112

NOTE 26 - Comprehensive Income

The Corporation has adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 130 “Reporting Comprehensive Income”. This standard requires an entity to report and display comprehensive income and its components. Comprehensive income is as follows (in thousands):

	Nine Months Ended September 30,						Year Ended December 31, 2005

	2006			2005

Net Income	$	9,539		$	9,660		$	13,176
Other Comprehensive Income:
Change in unrealized loss on securities available-for-sale, net of tax benefit		(67	)		(1,762	)		(2,875	)

Comprehensive Income	$	9,472		$	7,898		$	10,301

NOTE 27 – Dividends from Subsidiaries

The primary source of funds for the Corporation is cash dividends received from the Bank. The amount of dividends that the Bank may pay in any one year, without the approval of the Comptroller of the Currency, is the sum of the retained net profits for the preceding two years plus its total of the retained net profits for the current year. Under this formula, as defined, as of September 30, 2006, the Bank can legally initiate dividend payments of $19,510,000 for the remainder of 2006. The Bank is also restricted from paying dividends that would cause the Bank to be under-capitalized.

Internal dividend policies limit dividends paid by the Bank if its equity capital falls below certain minimum levels as determined by the Bank’s Board of Directors.

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements, accompanying notes and selected financial data appearing elsewhere in this Quarterly Report on Form 10-Q and in our most recent Annual Report on Form 10-K and may contain certain forward-looking statements that are based on current management expectations. Generally, verbs in the future tense and the words “believe,” “expect,” “anticipate,” “estimate,” “intends,” “opinion,” “potential” and similar expressions identify forward-looking statements. Examples of this forward-looking information can be found in, but are not limited to, the expected effects of accounting pronouncements and government regulation applicable to our operations, the discussion of allowance for loan losses, and quantitative and qualitative disclosure about market risk. Our actual results could differ materially from the forward-looking statements and management expectations. Further information concerning our business, including additional risk factors and uncertainties that could cause actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q, is set forth below under the heading “Risk Factors.” These risk factors and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The forward-looking statements contained herein speak only as of the date of this Quarterly Report on Form 10-Q and, except as may be required by applicable law and regulation, we do not undertake, and specifically disclaim any obligation to, publicly update or revise such statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Except as the context otherwise requires, references herein to “the Corporation,” “we,” “us,” or “our” refer to Summit Bancshares, Inc. and its consolidated subsidiaries.

Overview

Our business has been conducted primarily through our wholly-owned subsidiaries, Summit Bank, National Association (the “Bank”) and Summit Delaware Financial Corporation. The Bank currently operates its branch offices in twelve locations in Tarrant County, Texas.

Our results of operations are primarily dependent on net interest income, which is the difference between the income earned on our loans and investment portfolios and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by our allowance for loan losses, investment activities, loan servicing fees and other fees. Our non-interest expense principally consists of salary and benefits, occupancy and equipment expense, business development costs, professional fees, data processing expense and other expenses.

Net income for the third quarter of 2006 was $3,590,000, which represented an increase of $134,000, or 3.9%, compared to $3,456,000 for the third quarter of 2005. On a weighted average share basis, net income for the third quarter of 2006 was $0.28 per diluted share as compared to $0.27 per diluted share for the third quarter of 2005, an increase of 3.7%. The increase in net income for the third quarter of 2006 reflected an increase in net interest income (tax equivalent) of $1,659,000, or 14.7%, over the third quarter of 2005. Net income for the first nine months of 2006 was $9,539,000, which represented a decrease of $121,000, or 1.3%, compared to net income of $9,660,000 for the first nine months of 2005. On a weighted average share basis, net income for the first nine months of 2006 was $0.75 per diluted share, which represented a decrease of 1.3% from $0.76 per diluted share for the first nine months of 2005. The decrease in earnings during the first nine months of 2006 compared to the first nine months of 2005 was primarily due to an increase of $2,750,000 in the provision for loan losses. The increase in the provision for loan losses reflected a higher level of charge offs and an increase in loan volume.

Total loans were $858.0 million at September 30, 2006, which represented an increase of $104.0 million, or 13.7%, from the amount reported as of September 30, 2005 and an increase of $83.0 million, or 10.7% over total loans at December 31, 2005. Total deposits at September 30, 2006 of $928.8 million increased $62.8 million, or 7.2%, from $866.0 million at September 30, 2005 and increased $50.0 million, or 5.7%, from $878.8 million at December 31, 2005. Compared to the third quarter of 2005, we experienced growth in every category of deposits during the third quarter of 2006. Shareholders’ equity was $88.8 million at September 30, 2006, an increase of $9.1 million, or 11.4%, compared to shareholders’ equity of $79.7 million at September 30, 2005. See the Statement of Changes in Shareholders’ Equity for a detail of the changes.

The following table shows selected performance ratios for the first nine months of 2006 and 2005 that management believes to be key indicators of our performance:

	September 30, 2006			September 30, 2005

Annualized Return on Average Assets (ROAA)		1.12	%		1.27	%
Annualized Return on Average Shareholders’ Equity (ROAE)		15.08			16.75
Shareholders’ Equity to Assets - Average		7.42			7.61
Dividend Payout Ratio		31.54			26.95
Net Interest Margin (tax equivalent)		4.72			4.54
Efficiency Ratio		57.76			58.49
Net Income Per Share - Diluted	$	0.75		$	0.76

The return on average assets ratio is calculated by dividing annualized net income by average total assets for the period. Our return on average assets ratio was 1.12% for the first nine months of 2006. Our return on average assets for the first nine months of 2006 was negatively affected by the level of the provision for loan losses.

The return on average shareholders’ equity ratio is calculated by dividing annualized net income by average shareholders’ equity for the period. Our return on average shareholders’ equity ratio was 15.08% in the first nine months of 2006.

The shareholders’ equity to assets ratio is calculated by dividing average shareholders’ equity by average total assets for the period. Our shareholders’ equity to assets ratio was 7.42% in the first nine months of 2006.

The dividend payout ratio is determined by dividing the total dividends paid by net income for the period. Our dividend payout ratio was 31.54 % in the first nine months of 2006.

Net interest margin is calculated by dividing annualized net interest income on a tax equivalent basis by average total earning assets. Our net interest margin was 4.72% in the first nine months of 2006.

The efficiency ratio is calculated by dividing non-interest expenses by the sum of total non-interest income and tax equivalent interest income for the period. Our efficiency ratio was 57.76% in the first nine months of 2006 and provides a measure of the extent to which our revenues are absorbed by our non-interest expenses.

Summary of Earning Assets and Interest-Bearing Liabilities

The following schedule presents average balance sheets that highlight earning assets and interest-bearing liabilities and their related rates earned and paid for the third quarters of 2006 and 2005 (rates on tax equivalent basis):

	Three Months Ended September 30,

	2006								2005

	Average Balances			Interest		Average Yield/Rate			Average Balances			Interest		Average Yield/Rate

	(Dollars in Thousands)
Earning Assets:
Federal Funds Sold & Interest Bearing Deposits	$	1,875		$	24		4.87	%	$	13,294		$	114		3.40	%
Investment Securities (Taxable)		227,135			2,389		4.21	%		216,541			2,073		3.83	%
Investment Securities (Tax-exempt)		15,293			213		5.57	%		9,900			133		5.37	%
Loans, Net of Unearned Discount⁽¹⁾		843,458			17,308		8.14	%		735,109			13,203		7.13	%

Total Earning Assets		1,087,761			19,934		7.27	%		974,844			15,523		6.32	%

Non-interest Earning Assets:
Cash and Due From Banks		34,114								30,876
Other Assets		49,588								43,824
Allowance for Loan Losses		(10,184	)							(10,916	)

Total Assets	$	1,161,279							$	1,038,628

Interest-Bearing Liabilities:
Interest-Bearing Transaction Accounts and Money Market Funds	$	255,760			1,475		2.29	%	$	232,640			886		1.51	%
Savings		163,024			1,198		2.92	%		173,539			866		1.98	%
Certificates of Deposit under $100,000 and IRA’s		96,505			965		3.97	%		82,786			614		2.94	%
Certificates of Deposit $100,000 or more		124,301			1,291		4.12	%		98,670			794		3.19	%
Other Time		5,680			74		5.17	%		2,755			25		3.60	%
Other Borrowings		161,058			2,012		4.96	%		121,435			1,078		3.52	%

Total Interest-Bearing Liabilities		806,328			7,015		3.45	%		711,825			4,263		2.38	%

Non-interest Bearing Liabilities:
Demand Deposits		261,768								242,849
Other Liabilities		6,320								4,901
Shareholders’ Equity		86,863								79,053

Total Liabilities and Shareholders’ Equity	$	1,161,279							$	1,038,628

Net Interest Income and Margin (Tax-equivalent Basis)⁽²⁾				$	12,919		4.71	%				$	11,260		4.58	%

(1) Loan interest income includes fees and loan volumes include loans on non-accrual. The loan fees include loan origination fees which are considered adjustments to interest income. These fees aggregated $490,000 and $427,000 at September 30, 2006 and 2005, respectively.

(2) Presented on tax equivalent basis using a federal income tax rate of 35% for 2006 and 2005.

The following schedule presents average balance sheets that highlight earning assets and interest-bearing liabilities and their related rates earned and paid for the first nine months of 2006 and 2005 (rates on tax equivalent basis):

	Nine Months Ended September 30,

	2006								2005

	Average Balances			Interest		Average Yield/Rate			Average Balances			Interest		Average Yield/Rate

	(Dollars in Thousands)
Earning Assets:
Federal Funds Sold & Interest Bearing Deposits	$	1,548		$	56		4.87	%	$	7,823		$	181		3.09	%
Investment Securities (Taxable)		232,074			7,084		4.07	%		212,369			5,913		3.71	%
Investment Securities (Tax-exempt)		13,917			569		5.45	%		8,796			349		5.29	%
Loans, Net of Unearned Discount⁽¹⁾		822,546			48,827		7.94	%		721,952			36,905		6.83	%

Total Earning Assets		1,070,085			56,536		7.06	%		950,940			43,348		6.09	%

Non-interest Earning Assets:
Cash and Due From Banks		32,633								30,361
Other Assets		48,262								42,663
Allowance for Loan Losses		(11,763	)							(10,644	)

Total Assets	$	1,139,217							$	1,013,320

Interest-Bearing Liabilities:
Interest-Bearing Transaction Accounts and Money Market Funds	$	259,503			4,041		2.08	%	$	233,203			2,400		1.38	%
Savings		155,337			3,032		2.61	%		168,002			2,206		1.76	%
Certificates of Deposit under $100,000 and IRA’s		93,154			2,571		3.69	%		78,341			1,585		2.70	%
Certificates of Deposit $100,000 or more		116,450			3,361		3.86	%		89,253			1,951		2.92	%
Other Time		5,687			204		4.80	%		1,028			27		3.51	%
Other Borrowings		161,960			5,561		4.59	%		126,073			2,890		3.06	%

Total Interest-Bearing Liabilities		792,091			18,770		3.17	%		695,900			11,059		2.12	%

Non-interest Bearing Liabilities:
Demand Deposits		257,008								235,896
Other Liabilities		5,571								4,435
Shareholders’ Equity		84,547								77,089

Total Liabilities and Shareholders’ Equity	$	1,139,217							$	1,013,320

Net Interest Income and Margin (Tax-equivalent Basis)⁽²⁾				$	37,766		4.72	%				$	32,289		4.54	%

(1) Loan interest income includes fees and loan volumes include loans on non-accrual. The loan fees include loan origination fees which are considered adjustments to interest income. These fees aggregated $1,454,000 and $1,263,000 at September 30, 2006 and 2005, respectively.

(2) Presented on tax equivalent basis using a federal income tax rate of 35% for 2006 and 2005.

Net Interest Income

The net interest margin was 4.71% for the third quarter of 2006, which represented an increase of 13 basis points from the third quarter of 2005. This increase in net interest margin reflected a 95 basis point increase in yield on earning assets from the third quarter of 2005 to the third quarter of 2006, which was partially offset by a 107 basis point increase in rates paid on interest-bearing liabilities from the third quarter of 2005 to the third quarter of 2006. The increase in the net interest margin also reflected the impact of our non-interest bearing funding sources, primarily demand deposits and shareholders’ equity. Average demand deposits were $261.8 million in the third quarter of 2006, an increase of $19.0 million, or 7.8%, over the third quarter of 2005.

Net interest income (tax equivalent) for the third quarter of 2006 was $12,919,000, which represented an increase of $1,659,000, or 14.7%, compared to the third quarter of 2005. In the third quarter of 2006, tax equivalent interest income increased $4,411,000, or 28.4%, while interest expense increased $2,752,000, or 64.6%, compared to the third quarter of 2005. The increase in net interest income resulted from a 11.6% growth in average earning assets for the third quarter of 2006 compared to the third quarter of 2005, along with a 166 basis point increase in market interest rates (as measured by the prime rate as published in the Wall Street Journal) from September 2005 through September 2006.

The net interest margin was 4.72% for the nine months ended September 30, 2006 which represented a 18 basis point increase over the net interest margin of 4.54% for the nine months ended September 30, 2005. The increase in net interest margin reflected a 97 basis point increase in yield on earning assets from the first nine months of 2005 to the first nine months of 2006, which was partially offset by a 105 basis point increase in rates paid on interest-bearing liabilities from the first nine months of 2005 to the first nine months of 2006. The increase in net interest margin also reflected an increase in the volume of loans, up $100.6 million, or 13.9%, over the first nine months of 2005 and increases in non-interest bearing funding sources, such as demand deposits and shareholders’ equity. Average demand deposits were $257.0 million in the first nine months of 2006, an increase of $21.1 million, or 8.9%, over the first nine months of 2005.

Net interest income (tax equivalent) for the first nine months of 2006 was $37,766,000, which represented an increase of $5,477,000, or 17.0%, compared to the first nine months of 2005. In the first nine months of 2006, tax equivalent interest income increased $13,188,000, or 30.4%, while interest expense increased $7,711,000, or 69.7% compared to the first nine months of 2005. The increase in net interest income reflected a 12.5% increase in average earning assets for the first nine months of 2006 compared to the first nine months of 2005 and the higher interest rate environment.

In the event that our average loans continue to increase and we are unable to fund such growth solely through the generation of additional deposits, we may be required to obtain additional funding from secondary sources, such as the Federal Home Loan Bank, Federal Funds purchased, or brokered deposits, which could have a negative impact on our net interest margin. We may experience a slower growth in our net interest margin during the remainder of 2006 if we are required to obtain additional funding from secondary sources, but should benefit as our investment portfolio and maturing fixed rate loans reprice at higher rates. Because of the composition of our balance sheet and our emphasis on commercial lending, we are market interest rate sensitive and expect to benefit from any market interest rate increases, assuming that interest rates on deposits and borrowings do not increase significantly faster than interest rates on earning assets.

The table below analyzes the increase in net interest income on a fully tax equivalent basis for the three month periods ended September 30, 2006 and 2005. Non-accruing loans have been included in assets for these computations, thereby reducing yields on total loans. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.


	ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in Thousands)

	3rd Qtr. 2006 vs. 3rd Qtr. 2005 Increase (Decrease) Due to Changes in:									3rd Qtr. 2005 vs. 3rd Qtr. 2004 Increase (Decrease) Due to Changes in:

	Volume			Rate			Total			Volume			Rate		Total

Interest Earning Assets:
Federal Funds Sold & Interest Bearing Deposits	$	(106	)	$	16		$	(90	)	$	(10	)	$	74	$	64
Investment Securities		156			240			396			84			69		153
Loans, Net of Unearned Discount		1,946			2,159			4,105			852			2,054		2,906

Total Interest Income		1,996			2,415			4,411			926			2,197		3,123

Interest-Bearing Liabilities:
Deposits		368			1,450			1,818			209			980		1,189
Other Borrowings		(71	)		1,005			934			15			526		541

Total Interest Expense		297			2,455			2,752			224			1,506		1,730

Net Interest Income	$	1,699		$	(40	)	$	1,659		$	702		$	691	$	1,393

Non-Interest Income

The major component of non-interest income is various charges and fees that we earn on deposit accounts and related services. The following table reflects the changes in non-interest income during the periods presented (dollars in thousands):

	Three Months Ended September 30,							Nine Months Ended September 30,

	2006		2005		% Change			2006		2005		% Change

Service Charges on Deposit Accounts	$	1,046	$	992		5.4	%	$	2,968	$	2,904		2.2	%
Non-recurring Income		-0-		315		(100.0	)		-0-		449		(100.0	)
Gain on Sale of Student Loans		25		25		-0-			229		263		(12.9	)
Other Non-interest Income		1,030		844		22.0			2,973		2,475		20.1

Total Non-interest Income	$	2,101	$	2,176		(3.4	)%	$	6,170	$	6,091		1.3	%

Non-interest income was $2.1 million for the third quarter of 2006, a decrease of $75,000, or 3.4%, over the third quarter of 2005. Non-interest income was $6.2 million for the nine months ended September 30, 2006, an increase of $79,000, or 1.3%, over the nine months ended September 30, 2005.

In the third quarter of 2006 compared to the third quarter of 2005, there were positive increases in service charges on deposits, investment service fees, mortgage origination fees and debit card fees.

Non-recurring non-interest income for the first nine months of 2005 includes a gain of $247,000 on the sale of land carried in Premises and Equipment in the third quarter of 2005 that was previously held for future bank expansion. The other component of non-recurring income for the first nine months of 2005 resulted from extraordinary payments of $202,000 received from Pulse EFT as a participant in that ATM network.

The increase in other non-interest income in the third quarter and first nine months of 2006, as compared to the same periods last year, is largely due to increases in investment services fees, mortgage loan origination fees, debit card income and insurance commissions.

Non-interest Expense

Non-interest expense includes all expenses other than interest expense, the provision for loan losses and income tax expense. The following table summarizes the changes in non-interest expense during the periods presented (dollars in thousands):

	Three Months Ended September 30,							Nine Months Ended September 30,

	2006		2005		% Change			2006		2005			% Change

Salaries & Employee Benefits	$	4,895	$	4,579		6.9	%	$	14,731	$	13,296			10.8	%
Occupancy Expense - Net		847		724		17.0			2,456		1,988			23.5
Furniture and Equipment Expense		648		587		10.4			1,887		1,756			7.5
Other Real Estate and Foreclosed
Asset Expense - Net		-0-		-0-		-0-			-0-		(11	)		(100.0	)
Intangible Asset Amortization		85		82		3.7			255		246			3.7
Other Expenses:
Business Development		269		236		14.0			845		795			6.3
Insurance - Other		63		72		(12.5	)		212		167			26.9
Legal & Professional Fees		443		282		57.1			1,061		975			8.8
Data & Item Processing		191		173		10.4			553		474			16.7
Franchise Taxes		18		38		(52.6	)		55		82			(32.9	)
Postage & Courier		139		108		28.7			401		342			17.3
Printing & Supplies		96		141		(31.9	)		349		359			(2.8	)
Regulatory Fees & Assessments		87		76		14.5			262		239			9.6
Other Operating Expenses		1,176		539		118.2			2,310		1,739			32.8

Total Other Expenses		2,482		1,665		49.1			6,048		5,172			16.9

Total Non-interest Expense	$	8,957	$	7,637		17.3	%	$	25,377	$	22,447			13.1	%

Total non-interest expense increased 17.3% in the third quarter of 2006 over the third quarter of 2005. As a percent of average assets, non-interest expense was 3.06% in the third quarter of 2006 (annualized) compared with 2.92% in the same period last year. Total non-interest expense for the first nine months of 2006 was 13.1% higher than the first nine months of last year. The higher levels of non-interest expense for third quarter of 2006 and for the nine months ended September 30, 2006 were largely the result of increases in salaries and benefits and occupancy expense.

The “efficiency ratio” (non-interest expenses divided by total non-interest income plus net interest income) was 59.63% for the third quarter of 2006 compared to 56.84% for the third quarter of 2005.

The increases in salaries and benefits during the third quarter of 2006 and the first nine months of 2006 compared to the same periods in 2005 were due to salary merit increases, increases in the cost of employee benefit programs, expenses associated with Summit Financial Partners and the recognition of expense related to employee stock options. Effective January 1, 2006, the Corporation adopted the fair value recognition provisions of SFAS No. 123R, “Share-Based Payment” using a modified version of prospective application. Under this method, compensation expense will be recorded for all awards granted after the date of adoption and for the unvested portion of previously granted awards that were outstanding as of the beginning of the period of adoption. For the three month and nine month periods ended September 30, 2006, stock-based compensation expense was $26,000 and $128,000, respectively. For periods prior to January 1, 2006, stock based compensation has been included in pro forma disclosures in the financial statement footnotes.

The higher levels of occupancy expense for the third quarter and first nine months of 2006 compared to the same periods of 2005 year were due to several factors, including increases in rent expense, utilities and ad valorem taxes. Also contributing to the increase in occupancy expense was the loss of tenant rents at a bank-owned facility beginning in September 2005.

The increases in insurance expense during the first nine months of 2006 were largely attributable to higher costs of blanket bond and directors and officers liability policies.

The increases in data and item processing expense during the third quarter and first nine months of 2006 were largely attributable to higher costs related to the Corporation’s internet banking product.

Included in the third quarter 2006 total non-interest expense was the expense impact of a $524,000 check fraud loss representing approximately 40% of the increase for the quarter. Also, in the third quarter of 2006, there was a 68% increase in legal and professional fees compared to the third quarter of 2005. A portion of this increase is attributable to legal and consulting fees incurred in connection with collection efforts related to a problem credit that was reported in January 2006.

Allowance for Loan Losses and Non-Performing Assets

The allowance for loan losses was $10,399,000, or 1.21% of total loans, as of September 30, 2006 compared to $11,131,000, or 1.48% of total loans, as of September 30, 2005. The provision for loan losses was $3,515,000 for the first nine months of 2006 compared with $765,000 for the same period last year. For the nine months ended September 30, 2006 and 2005, net charge-offs (recoveries) were 0.05% and (0.02)% of average loans, respectively, not annualized.

Transactions in the provision for loan losses are summarized as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,

	2006			2005			2006			2005

Balance, Beginning of Period	$	9,958		$	10,798		$	11,208		$	10,187
Provisions, Charged to Income		415			315			3,515			765
Loans Charged-Off		(22	)		(25	)		(4,590	)		(256	)
Recoveries of Loans Previously Charged-Off		48			43			266			435

Net Loans (Charged-Off) Recovered		26			18			(4,324	)		179

Balance, End of Period	$	10,399		$	11,131		$	10,399		$	11,131

The increase in the provision for loan losses for the quarter and nine month period ended September 30, 2006 reflected an increase in charge offs, a higher level of non-accrual loans and the increase in loan volume. Net loans recovered were $26,000 for the third quarter of 2006 compared with net recoveries of $18,000 for the same period last year. Non-accrual loans were $9.3 million at September 30, 2006, an increase of $4.3 million, or 86.2%, from September 30, 2005, and an increase of $6.3 million, or 210.0%, from December 31, 2005.

We reported in a filing on Form 8-K in February 2006 that our largest classified borrower had experienced further deterioration in its financial condition and had requested a standstill agreement until September 30, 2006. All loans to this borrower were placed on non-accrual status in February 2006 with an agreement, subject to an infusion of a specified amount of capital and certain other conditions, to defer all payments of principal and interest from this borrower until September 30, 2006. Also in February 2006, an outside investor contributed to the borrower the specified amount of additional capital in the form of debt subordinated to the Corporation’s loans. Subsequent to placing the loans to this borrower on non-accrual, the outstanding principal balance was reduced to $6.9 million as of June 30, 2006 prior to any charge-offs. Based on our evaluation of collateral value, the borrower’s financial prospects and other considerations, we recorded a charge-off of $4.3 million on these credits as of June 30, 2006. Our exposure on these credits was thereby reduced to approximately $2.6 million. On October 5, 2006, the Company filed a Form 8-K Report with the Securities and Exchange Commission reporting a $3.0 million loan charge-off recovery resulting from a cash payment of $4.5 million on the problem credit. This payment satisfied the full obligation of the borrower with the exception of an $183,000 secured note. It is anticipated that the recovery will result in a reduction in the provision for loan losses in the fourth quarter of 2006.

In March 2006, we placed loans to a second borrower on non-accrual based on deterioration in that borrower’s financial condition. The loans to the second borrower had a combined balance of approximately $2.1 million as of June 30, 2006.

As of September 30, 2006, the allowance for loan losses as a percentage of non-accrual loans was 111.9% compared with 373.6% as of December 31, 2005. Total non-performing assets as a percentage of loans and foreclosed assets was 1.08% at September 30, 2006 compared with 0.39% as of December 31, 2005.

The following table summarizes the non-performing assets as of the end of the last five quarters (dollars in thousands):

	September 30, 2006			June 30, 2006			March 31, 2006			December 31, 2005			September 30, 2005

Non-Accrual Loans	$	9,289		$	6,058		$	11,164		$	3,000		$	4,989
Renegotiated Loans		-0-			-0-			-0-			-0-			-0-
Other Real Estate Owned and Other Foreclosed Assets		-0-			-0-			387			-0-			-0-

Total Non-Performing Assets	$	9,289		$	6,058		$	11,551		$	3,000		$	4,989

As a Percent of:
Total Assets		0.79	%		0.52	%		1.03	%		0.27	%		0.46	%
Total Loans and Other Real Estate/ Foreclosed Assets		1.08	%		0.72	%		1.43	%		0.39	%		0.66	%
Loans Past Due 90 days or More and Still Accruing	$	636		$	-0-		$	-0-		$	-0-		$	2,178

As of September 30, 2006, non-accrual loans were comprised of $5,382,000 in commercial loans, $3,819,000 in real estate mortgage loans and $88,000 in consumer loans.

The following table summarizes the relationship between non-performing loans, criticized loans and the allowance for loan losses (dollars in thousands):

	September 30, 2006			June 30, 2006			March 31, 2006			December 31, 2005			September 30, 2005

Non-Performing Loans	$	9,289		$	6,058		$	11,164		$	3,000		$	4,989
Criticized Loans		32,808			31,620			30,732			35,161			39,450
Allowance for Loan Losses		10,399			9,958			13,092			11,208			11,131
Allowance for Loan Losses as a Percent of:
Non-Performing Loans		112	%		164	%		117	%		374	%		223	%
Criticized Loans		32	%		31	%		43	%		32	%		28	%

Loans are graded on a system similar to that used by the banking industry regulators. The first level of criticized loans is “Other Assets Especially Mentioned” (OAEM). These loans are fundamentally sound but have potential weaknesses which may, if not corrected, weaken the asset or inadequately protect the bank’s credit position at some future date. The second level is “Substandard,” which are loans inadequately protected by current sound net worth, paying capacity or pledged collateral of the borrower. The last level of criticized loans, before they are charged-off, is “Doubtful.” Doubtful loans are considered to have inherent weaknesses because collection or liquidation in full is highly questionable. In addition to the above grading system, the Corporation maintains a separate

“watch list” which further aids the Corporation in monitoring loan quality. Watch list loans show warning elements where the present status portrays one or more deficiencies that require attention in the short run or where pertinent ratios of the account have weakened to a point where more frequent monitoring is warranted. The Corporation remains diligent in its efforts to identify any loan that might reflect weakness of the borrower as soon as possible. Management is not aware of any potential loan problems that have not been disclosed to which serious doubt exists as to the ability of the borrower to substantially comply with the present repayment terms.

Total criticized loans were $32.8 million at September 30, 2006, a decrease of $2.4 million and $6.6 million from the levels of December 31, 2005 and September 30, 2005, respectively. The loan charge-off previously discussed materially contributed to the decrease in criticized loans. Criticized loans as a percentage of total loans were 3.8%, 4.5% and 5.2% as of September 30, 2006, December 31, 2005 and September 30, 2005, respectively.

Interest Rate Sensitivity

Interest rate sensitivity is the relationship between changes in market interest rates and net interest income due to the repricing characteristics of assets and liabilities.

The following table, commonly referred to as a “static GAP report”, indicates the interest rate sensitivity position at September 30, 2006 and may not be reflective of positions in subsequent periods (dollars in thousands):

													Repriced After 1 Year or Non-interest Sensitive
	Matures or Reprices within:									Total Rate Sensitive One Year or Less

	30 Days or Less			31-180 Days			181 to One Year								Total

Earning Assets:
Loans	$	385,963		$	60,320		$	63,421		$	509,704		$	348,136	$	857,840
Investment Securities		14,395			54,058			27,381			95,834			155,319		251,153
Federal Funds Sold and Interest Bearing Deposits		1,015			-0-			-0-			1,015			-0-		1,015

Total Earning Assets		401,373			114,378			90,802			606,553			503,455		1,110,008

Interest Bearing Liabilities:
Interest-Bearing Transaction Accounts and Savings		422,864			-0-			-0-			422,864			-0-		422,864
Certificates of Deposit under $100,000 and IRA’s		11,038			31,158			29,813			72,009			25,168		97,177
Certificates of Deposit $100,000 or More		15,508			42,832			46,498			104,838			33,056		137,894
Borrowings		121,370			5,000			15,000			141,370			-0-		141,370

Total Interest Bearing Liabilities		570,780			78,990			91,311			741,081			58,224		799,305

Interest Sensitivity Gap	$	(169,407	)	$	35,388		$	(509	)	$	(134,528	)	$	445,231	$	310,703

Cumulative Gap	$	(169,407	)	$	(134,019	)	$	(134,528	)

Periodic Gap to Total Assets		(14.39	)%		3.01	%		(0.04	)%
Cumulative Gap to Total Assets		(14.39	)%		(11.38	)%		(11.42	)%

The preceding static GAP report reflects a cumulative liability sensitive position during the one year horizon. An inherent weakness of this report is that it ignores the relative volatility any one category may have in relation to other categories or market rates in general. For instance, the rate paid on NOW accounts typically moves slower than the three month T-Bill. Management attempts to capture this relative volatility by utilizing a simulation model with a “beta factor” adjustment which estimates the volatility of rate sensitive assets and/or liabilities in relation to other market rates.

Beta factors are an estimation of the long term, multiple interest rate environment relation between an individual account and market rates in general. For instance, NOW, savings and money market accounts, which are repriceable within 30 days, will have considerably lower beta factors than variable rate loans and most investment categories. Taking this into consideration, it is quite possible for a bank with a negative cumulative GAP to total asset ratio to have a positive “beta adjusted” GAP risk position. As a result of applying the beta factors established by management to the earning assets and interest bearing liabilities in the static gap report via a simulation model, the negative cumulative GAP to total assets ratio at one year of (11.42%) was reversed to a positive 16.65% “beta adjusted” GAP position. Management feels that the “beta adjusted” GAP risk technique more accurately reflects the Corporation’s GAP position.

Capital

At September 30, 2006, shareholders’ equity totaled $88.8 million, an increase of $7.4 million, or 9.1%, compared to December 31, 2005, and an increase of $9.0 million, or 11.3%, compared to September 30, 2005. This increase reflects the increase in retained earnings which was partially offset by the payment of dividends, the increase in the unrealized loss on available-for-sale investment securities and the impact of the purchase of treasury stock. The unrealized loss, net of tax benefit, on available-for-sale investment securities increased $67,000 in the nine months ended September 30, 2006.

We and the Bank are subject to capital adequacy guidelines established by the Federal Reserve Board and other regulatory authorities. The table below illustrates the Bank’s and our compliance with the capital adequacy guidelines as of September 30, 2006 and 2005 (dollars in thousands):

	September 30, 2006						September 30, 2005

	The Consolidated Corporation			Summit Bank, N.A.			The Consolidated Corporation			Summit Bank, N.A.

Total Assets	$	1,177,313		$	1,178,730		$	1,074,261		$	1,073,868
Risk Weighted Assets		884,807			884,781			801,549			801,532
Equity Capital (Tier 1)		93,120			92,378			82,627			82,632
Qualifying Allowance for Loan Losses		10,399			10,399			10,037			10,033

Total Capital	$	103,519		$	102,777		$	92,664		$	92,665

Leverage Ratio		8.25	%		8.03	%		8.04	%		8.05	%
Risk Capital Ratio:
Tier I Capital		10.52	%		10.44	%		10.31	%		10.31	%
Total Capital		11.70			11.62			11.56			11.56

As of September 30, 2006, the Bank exceeded the risk-based capital and leverage requirements set by regulatory authorities and satisfied the criteria for classification as a “well capitalized” institution under the rules of the Federal Deposit Insurance Corporation Improvement Act of 1991.

Liquidity

Our primary “internal” sources of liquidity consist of the federal funds that we sell and our portfolio of marketable investment securities, particularly those with shorter maturities. Federal funds sold and investment securities maturing within 90 days represented $28.8 million, or 2.45%, of total assets as of September 30, 2006. Additionally, our ability to sell loan participations, purchase federal funds and obtain advances from the Federal Home Loan Bank serve as secondary sources of liquidity. The Bank has approved federal funds lines at other banks.

Our liquidity is enhanced by the fact that 85.2% of our total deposits at September 30, 2006 were “core” deposits. Core deposits are defined as total deposits less public funds, brokered deposits and certificates of deposit greater than $100,000. Core deposits are generally more stable (i.e., less likely to be withdrawn) than other deposits. Additionally interest-bearing core deposits may have lower interest rates than other interest-bearing deposits. Our loan to deposit ratio averaged 92.7% for the nine month period ended September 30, 2006.

In the event that our average loans continue to grow during 2006 and we are unable to fund any such growth solely through the generation of additional deposits, we may be required to obtain funding from secondary sources, including purchasing federal funds, obtaining advances from the Federal Home Loan Bank or other secondary sources. In such an event, our business, results of operations and financial condition could be negatively impacted.

Our income, which provides funds for the payment of dividends to our shareholders and for other corporate purposes, is derived from our investment in the Bank.

On May 3, 2004, the Corporation formed SBI Trust and SBI Trust subsequently issued $12.0 million of floating rate (three month LIBOR plus a margin of 2.65%) Capital Securities (the “Trust Capital Securities”). Concurrent with the issuance of the Trust Capital Securities, SBI Trust issued trust common securities to the Corporation in the aggregate liquidation value of $372,000. The proceeds of the issuance of the Trust Capital Securities and trust common securities were invested in the Corporation’s Floating Rate Junior Subordinated Deferrable Debentures (the “Deferrable Debentures”), which mature on July 7, 2034 and have a call feature that permits the Corporation to redeem any or all of the securities after July 7, 2009. The interest rate on the Deferrable Debentures at September 30, 2006 was 8.16%. The Deferrable Debentures, which are the only asset of SBI Trust, are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture dated May 3, 2004) of the Corporation.

On September 15, 2005, we obtained a line of credit from a bank under which we may borrow $10,000,000 at a floating rate (three month LIBOR plus a margin of 2.00%). The line of credit is secured by stock of the Bank. The original maturity date of the line of credit was extended from September 15, 2006 to December 8, 2006, whereupon, if balances are outstanding, the line converts to a term note having a five year term. The Corporation will not pay a fee for any unused portion of this line. At September 30, 2006, there were no amounts outstanding under the line. The purpose of the line is to provide an additional liquidity source.

Off-Balance-Sheet Arrangements, Commitments, Guarantees and Contractual Obligations

Except as set forth herein, during the nine months ended September 30, 2006, there have been no material changes outside the ordinary course of the Corporation’s business in the contractual obligations specified in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance-Sheet Arrangements, Commitments, Guarantees and Contractual Obligations” in our Annual Report on Form 10-K for the year ended December 31, 2005.

At September 30, 2006, outstanding documentary and standby letters of credit totaled $9,117,000 and commitments to extend credit totaled $238,095,000. Documentary and standby letters of credit and commitments to extend credit totaled $6,637,000 and $227,031,000 at December 31, 2005. The increase in commitments to extend credit reflects the continued demand for credit facilities in our market.

Related Party Transactions

Merger

On July 2, 2006, the Corporation and Cullen/Frost Bankers, Inc., a Texas corporation (“Cullen/Frost”), entered into an Agreement and Plan of Merger (the “Agreement”) pursuant to which the Corporation will merge with and into Cullen/Frost. Under the terms of the Agreement, the Corporation’s shareholders will have the right, subject to pro-ration, to elect to receive cash, shares of Cullen/Frost common stock or a combination thereof having a value equal to $11.50 plus 0.2933 Cullen/Frost shares. The total consideration consists of approximately $143.4 million in cash and approximately 3.84 million shares of Cullen/Frost common stock (assuming the treasury stock method of accounting for options before giving effect to any exercises of outstanding options). The transaction is subject to customary closing conditions, including the receipt of regulatory approvals and approval of the shareholders of the Corporation. The merger is currently expected to be completed in the fourth quarter of 2006, although delays could occur.

Subsequent Events

On October 18, 2006, the Board of Directors of the Corporation approved a quarterly dividend of $.08 per share to be paid on November 15, 2006 to shareholders of record on November 1, 2006.

Critical Accounting Policies

Our accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. We have identified our policy with respect to allowance for loan losses as critical because it requires management to make particularly difficult, subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. We, in consultation with our Audit Committee of the Board of Directors, have reviewed and approved this critical accounting policy, which is further described under the caption “Loan and Allowance for Loan Losses” in Note 1 (“Summary of Significant Accounting Policies”) to the Financial Statements.

These evaluations are inherently subjective because, even though they are based on objective data, it is management’s interpretation of that data that determines the amount of the appropriate allowance. Therefore, from time to time (but at least quarterly), management reviews the actual performance and write-off history of the loan portfolio and compares that to previously determined allowance coverage percentages. In this manner, management evaluates the impact the previously mentioned variables may have had on the loan portfolio to determine which changes, if any, should be made to the assumptions and analyses. Recent analysis has indicated that projections of estimated losses inherent in the loan portfolio have approximated actual write-off experience during the current economic environment.

Actual results could differ materially from estimates as a result of changes in economic or market conditions and other factors. Changes in our evaluations and the assumptions underlying these evaluations could result in a material change in the allowance. While we believe that the allowance for loan losses has been established and maintained at levels adequate to reflect the risks inherent in the loan portfolio, future increases may be necessary if economic or market conditions and other factors differ substantially from the conditions that existed at the time of the initial determination.

The Corporation adopted FAS No. 123R, “Share-Based Payments,” effective January 1, 2006, utilizing the “modified prospective” method as described in the standard. Under the “modified prospective” method, compensation cost is recognized for all share-based payments granted after the effective date and for all unvested awards granted prior to the effective date. Prior to adoption, the Corporation accounted for stock-based compensation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Corporation recognized $128,000 in total stock-based compensation expense during the first nine months of 2006.

There have been no significant changes in critical accounting policies or management estimates since the year ended December 31, 2005 other than the adoption of FAS No. 123R as described above. A comprehensive discussion of the Company’s critical accounting policies and management estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Item 3 – Quantitative and Qualitative Disclosure about Market Risk

There were no material changes in market risks faced by the Corporation from December 31, 2005 to September 30, 2006. For more information regarding quantitative and qualitative disclosures about market risk, please refer to the Corporation’s Annual Report on Form 10-K as of and for the year ended December 31, 2005, and in particular, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity and Liquidity.”

Item 4 – Controls and Procedures

The Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the Corporation’s principal executive officer and principal financial officer have concluded that the Corporation’s disclosure controls and procedures were effective as of the end of the period covered by this report.

There was no change in the Corporation’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Corporation’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings

	Not applicable

Item 1A.	Risk Factors

Risks Associated with our Pending Merger with Cullen/Frost Bancshares, Inc. (‘Cullen/Frost”)

Failure to complete the pending merger with Cullen/Frost could materially and adversely affect our stock price and our results of operations.

On July 2, 2006, we entered into an Agreement and Plan of Merger with Cullen/Frost whereby we would merge with and into Cullen/Frost. Completion of the merger is subject to certain conditions, including approval by our holders of common stock, regulatory approvals, and various other closing conditions. We cannot assure you that these conditions will be met or waived, that the necessary approvals will be obtained or that we will be able to successfully consummate the merger as currently contemplated under the merger agreement or at all. If the merger is not completed:

	•	the market price of our common stock may decline to the extent that the current market price includes a market assumption that the merger will be completed;

	•	we will remain liable for significant transaction costs, including legal, accounting, financial advisory and other costs related to the merger, and may not receive any termination fee from Cullen/Frost;

	•	the inability to retain employees in the interim period may be significant and we may find it difficult to continue as a stand-alone entity; and

	•	we may experience a negative reaction to the termination of the merger from our customers, employees or affiliates which may adversely impact our future results of operations as a stand-alone entity.

The occurrence of any of these events individually or in combination could have a material adverse effect on our financial condition, results of operations and our stock price. In addition, if the merger agreement is terminated and our board of directors seeks another merger or business combination, we may not be able to find a party willing to pay a price equal to or more attractive than the price Cullen/Frost has agreed to pay.

Fluctuations in market prices of Cullen/Frost common stock will affect the value that our shareholders receive for their shares of our common stock.

Upon completion of the merger, shares of our common stock (other than any dissenting shares) will be converted into shares of Cullen/Frost common stock and cash. While the merger consideration has been generally structured to provide that our shareholders will receive, for each of their shares of common stock , 0.2933 shares of Cullen/Frost common stock and $11.50 in cash, in the event the average share price of Cullen/Frost common stock during the 15 consecutive trading days ending on and including the date of receipt of the last requisite regulatory approval falls below $45.95, Cullen/Frost has the discretion, but not the obligation, to increase either the exchange ratio with respect to the number of shares of Cullen/Frost common stock that our shareholders will receive, the per share cash consideration or a combination of both. Because the price of Cullen/Frost common stock will fluctuate prior to the merger, Cullen/Frost cannot assure our shareholders of the market value or number of the shares of Cullen/Frost common stock or of the amount of cash that they will receive in the merger.

The price of Cullen/Frost common stock may vary from its price on the date the proxy statement/prospectus is sent to our shareholders, the date of our special meeting of shareholders and the date for determining the average trading price discussed elsewhere. Stock price fluctuations may result from a variety of factors, some of which are beyond the control of Cullen/Frost, including, among other things, changes in Cullen/Frost’s businesses, operations and prospects, regulatory considerations and general market and economic conditions. Because the date the merger is to be completed will be later than the date of the special meeting, the price of the Cullen/Frost common stock on the date of the special meeting may not be indicative of its price on the date the merger is to be completed.

If the price of Cullen/Frost common stock falls and the decrease exceeds certain pre-agreed levels, and if Cullen/Frost does not elect to alter the exchange ratio to provide more shares and/or alter the amount of the per share cash consideration to provide more cash, we have the right to terminate the merger agreement and the merger will not occur.

Cullen/Frost may have difficulty combining our operations with its own operations or realizing the anticipated benefits of the merger.

Because the markets and industries in which we and Cullen/Frost operate are highly competitive, and due to the inherent uncertainties associated with the integration of acquired companies, Cullen/Frost may not be able to integrate our operations without encountering difficulties, including, without limitation, the loss of key employees and customers, the disruption of their respective ongoing businesses and possible inconsistencies in standards, controls and procedures. We expect the merger to result in certain benefits for the combined company, such as cost savings and other financial and operational benefits. We cannot assure you, however, when, if ever, or to the extent to which the combined company will be able to realize these benefits. Difficulties associated with integrating the two companies could have a material adverse effect on the combined company and the market price of the Cullen/Frost common stock.

Except as set forth herein, there have been no material changes from the risk factors previously disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005 in response to Item 1A. to Part I of Form 10-K.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

The Corporation’s ability to purchase shares of the Corporation’s common stock is subject to various banking law regulations and policies as well as rules and regulations of the Securities and Exchange Commission.

In the quarter ended September 30, 2006, no shares were purchased by the Corporation pursuant to the 2006 Stock Purchase Plan. No information is required to be furnished by Item 703 of Regulation S-K for any other purchase made in the quarter covered by this report.

Item 3.

Defaults Upon Senior Securities

Not applicable

Item 4.

Submission of Matters to a Vote of Security Holders

Not applicable

Item 5.

Other Information

Not applicable

Item 6.

Exhibits

	2.1	Agreement and Plan of Merger by and between the Corporation and Cullen/Frost Bankers, Inc dated July 2, 2006 (incorporated herein by reference to Exhibit 2.1 to the Corporation’s Current Report on Form 8-K dated July 2, 2006 and filed on July 3, 2006)

	3.1	Restated Articles of Incorporation of the Corporation (incorporated herein by Reference to Exhibit 3(a) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 1998)

	3.2	Amended and Restated Bylaws of the Corporation (incorporated herein by reference to Exhibit 3(b) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002)

	3.3	Amendment to the Amended and Restated Bylaws of the Corporation adopted by resolution of the Board of Directors of the Corporation (incorporated herein by reference to Exhibit 99.1 to the Corporation’s Current Report on Form 8-K filed February 22, 2005)

	4.1	Rights Agreement, dated April 17, 1990, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 1 to the Corporation’s Current Report on Form 8-K dated April 18, 1990 filed on April 24, 1990)

	4.2	Amendment No. 1 to the Rights Agreement, effective as of April 16, 2000, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 4(b) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000)

	4.3	Junior Subordinated Debt Securities Indenture Agreement dated May 3, 2004 (incorporated herein by reference to Exhibit 4(a) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004)

	4.4	Junior Subordinated Debt Securities Due 2034 (incorporated herein by reference to Exhibit 4(b) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004)

	4.5	Loan Agreement dated September 15, 2005 between the Corporation and Frost National Bank (incorporated herein by reference to Exhibit 10 to the Corporation’s Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2005)

	4.6	Amendment No. 1 to the Rights Agreement, effective as of July 2, 2006, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 4.1 to the Corporation’s Current Report on Form 8-K dated July 2, 2006 filed on July 3, 2006)

	11	Computation of Earnings Per Common Share

	31.1	Certification of Principal Executive Officer of Summit Bancshares, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

	31.2	Certification of Principal Financial Officer of Summit Bancshares, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

	32.1	Certification of Principal Executive Officer of Summit Bancshares, Inc. pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	32.2	Certification of Principal Financial Officer of Summit Bancshares, Inc. pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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 BANCSHARES, INC.
	Registrant


Date: November 8, 2006	By:	/s/ Philip E. Norwood

		Philip E. Norwood, Chairman, President
		and Chief Executive Officer

Date: November 8, 2006	By:	/s/ Bob G. Scott

		Bob G. Scott, Executive Vice President
		and Chief Operating Officer
		(Chief Financial Officer)

EXHIBIT INDEX

Exhibit		Description

2.1		Agreement and Plan of Merger by and between the Corporation and Cullen/Frost Bankers, Inc dated July 2, 2006 (incorporated herein by reference to Exhibit 2.1 to the Corporation’s Current Report on Form 8-K dated July 2, 2006 filed on July 3, 2006)

3.1		Restated Articles of Incorporation of the Corporation (incorporated herein by Reference to Exhibit 3(a) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 1998)

3.2		Amended and Restated Bylaws of the Corporation (incorporated herein by reference to Exhibit 3(b) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002)

3.3		Amendment to the Amended and Restated Bylaws of the Corporation adopted by resolution of the Board Directors of the Corporation (incorporated herein by reference to Exhibit 99.1 to the Corporation’s Current Report on Form 8-K filed February 22, 2005)

4.1		Rights Agreement, dated April 17, 1990, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 1 to the Corporation’s Current Report on Form 8-K dated April 18, 1990 filed on April 24, 1990)

4.2		Amendment No. 1 to Rights Agreement, effective as of April 16, 2000, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 4(b) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000)

4.3		Junior Subordinated Debt Securities Indenture Agreement dated May 3, 2004 (incorporated herein by reference to Exhibit 4(a) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004)

4.4		Junior Subordinated Debt Securities Due 2034 (incorporated herein by reference to Exhibit 4(b) to the Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004)

4.5		Loan Agreement dated September 15, 2005 between the Corporation and Frost National Bank (incorporated herein by reference to Exhibit 10 to the Corporation’s Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2005)

4.6		Amendment No. 1 to the Rights Agreement, effective as of July 2, 2006, by and between the Corporation and Summit Bancservices, Inc. (incorporated herein by reference to Exhibit 4.1 to the Corporation’s Current Report on Form 8-K dated July 2, 2006 filed on July 3, 2006)

11		Computation of Earnings Per Common Share

31.1		Certification of Principal Executive Officer of Summit Bancshares, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of Principal Financial Officer of Summit Bancshares, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of Principal Executive Officer of Summit Bancshares, Inc. pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Principal Financial Officer of Summit Bancshares, Inc. pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.