-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WhU+VnoAudsNI357k5LHup+TgGD6/u8Oe6QotAL0pd3XRTmU905+zIpaDy4NC8VH ZAIeisuwHXkUafYM9belrQ== 0000950168-99-000979.txt : 19990331 0000950168-99-000979.hdr.sgml : 19990331 ACCESSION NUMBER: 0000950168-99-000979 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: POTOMAC BANCSHARES INC CENTRAL INDEX KEY: 0000925173 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 550732247 STATE OF INCORPORATION: WV FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-24958 FILM NUMBER: 99579035 BUSINESS ADDRESS: STREET 1: 111 EAST WASHINGTON ST CITY: CHARLES TOWN STATE: WV ZIP: 25414 BUSINESS PHONE: 3047258431 MAIL ADDRESS: STREET 1: P O BOX 906 CITY: CHARLES TOWN STATE: WV ZIP: 25414 10KSB 1 POTOMAC BANCSHARES, INC. 10-KSB 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark one) [XXX] Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee required) For the fiscal year ended December 31, 1998 [ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required) For the transition period from ___________ to ___________ Commission File No. 0-24958 Potomac Bancshares, Inc. (Name of Small Business Issuer in Its Charter) West Virginia 55-0732247 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 111 East Washington Street PO Box 906, Charles Town WV 25414-0906 (Address of Principal Executive Offices) (Zip Code) 304-725-8431 (Issuer's Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Exchange Act: Name of Each Exchange Title of Each Class on Which Registered ------------------- --------------------- NONE --------------------------- --------------------------- --------------------------- --------------------------- Securities registered under Section 12(g) of the Exchange Act: Common Stock, $1.00 Par Value (Title of Class) Check whether the issuer: (l) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days. Yes [XXX] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [XX] 2 State issuer's revenues for its most recent fiscal year. $11,180,990 State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within the past 60 days. $21,427,060 ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS Check whether the issuer has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] Not Applicable [XXX] APPLICABLE ONLY TO CORPORATE REGISTRANTS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. 600,000 Transitional Small Business Disclosure Format (check one): Yes [ ] No [XXX] DOCUMENTS INCORPORATED BY REFERENCE The following lists the documents which are incorporated by reference in the Form 10-KSB Annual Report, and the Parts and Items of the Form 10-KSB into which the documents are incorporated. Part of the Form 10-KSB Into Which Document the Document is Incorporated -------- ---------------------------- Portions of Potomac Bancshares, Inc.'s Part II, Items 6 and 7 1998 Annual Report to Shareholders for the year ended December 31, 1998 Portions of Potomac Bancshares, Inc.'s Part III, Items 9, Proxy Statement for 10, 11 and 12 the 1999 Annual Meeting of Shareholders PART I ITEM 1. DESCRIPTION OF BUSINESS. History and Operations The Board of Directors of Bank of Charles Town (the "Bank") caused Potomac Bancshares, Inc. ("Bancshares") to be formed on March 2, 1994, as a single-bank holding company. To date, Bancshares' only activities have involved the acquisition of the Bank. Bancshares acquired all of the shares of common stock of the Bank on July 29, 1994. 3 Bank of Charles Town is a West Virginia state-chartered bank which formed and opened for business in 1871. The Bank's deposits are insured by the Federal Deposit Insurance Corporation. Engaged in general banking business with the primary market area being Jefferson County, West Virginia, the Bank also provides services to Washington County and Frederick County, Maryland; Loudoun County and Clarke County, Virginia; and Berkeley County, West Virginia. The main office is in Charles Town at 111 East Washington Street, with branch offices in Harpers Ferry, West Virginia and Kearneysville, West Virginia. The Bank provides consumers, businesses, and governments with a broad range of banking services, including lines of credit, home equity lines of credit, commercial, agricultural, real estate, and installment loans, checking, savings, NOW, and money market accounts, certificates of deposit, and individual retirement accounts. Automated teller machines located at each of the three offices and Touchline 24, an interactive voice response system available at 1-304-728-2424, provide certain services to customers on a twenty-four hour basis. Bill paying and certain other banking services are available online through a personal computer and/or the World Wide Web. These same bill paying and banking services are also available using a special telephone. The trust and financial services department provides financial management, investment and trust services. LENDING ACTIVITIES. The Bank offers installment, term, and real estate loans for consumer, business and commercial purposes. These loans can be unsecured or secured by collateral being purchased or other collateral. Underwriting standards covering all lending include sound credit analysis, proper documentation according to the Bank's loan documentation checklist, promotion of profitable customer relationships with cross-selling of bank services, avoidance of loan concentrations to a single industry or with a single class of collateral, and diligent maintenance of past due and nonaccrual loans at a minimum. The Bank's loan policy designates particular loan-to-value limits for real estate loans in accordance with recommendations in Section 304 of the Federal Deposit Insurance Corporation Improvement Act of 1991. As stated in the loan policy, there may be certain lending situations not subject to these loan-to-value limits and from time to time the Board of Directors may permit exceptions to the established limits. Any exceptions are sufficiently documented. Loans secured by real estate are made to individuals and businesses for the purchase of raw land, for land development, for commercial, multi-family and other non-residential construction, to purchase improved property, and to purchase owner occupied one to four family residential property. Lines of credit and home equity loans are available. Approximately 74% of the Bank's loans are secured by real estate. These loans had an average delinquency rate of 2.76% and a loss rate of .00% during 1998. These rates are based on comparisons to 1998 average total loans. As of December 31, 1998, aggregate dollar amounts in loan categories secured by real estate are as follows: Construction and land development $ 651,848 Secured by farmland 1,394,201 Secured by 1-4 family residential 42,541,181 Other 12,623,662 ---------- $57,210,892 ========== Loans to individuals for personal expenditures are approximately 23% of the Bank's total loans at December 31, 1998. The aggregate balance of these loans was $17,738,039 at December 31, 1998. The majority of these are installment loans with the remainder made as term loans. 4 The Bank's loan policy states that evaluation of applications for installment loans will consider place and length of residence, place and length of employment, and credit history. Although these are considered, verification of employment is usually not done, since it is recognized that unless immediate decisions on applications can be made, a lender may be unable to secure a fair share of loan business since instant credit is available from many sources in the market place. This may make installment lending more risky than real estate lending; however, installment loans had an average delinquency rate of .31% and a loss rate of .19% in 1998 (based on comparisons to 1998 average total loans). This delinquency rate for installment loans is lower than the comparable rate for real estate loans. The Bank's policy for evaluating term loans involves consideration of credit history and current financial statements if the loan is of a certain amount and is unsecured. If loans are not paid at original scheduled maturity, information must be reviewed by a loan officer for a renewal. The average delinquency rate was .13% and the loss rate was .02% compared to average total loans in 1998. The remaining aggregate dollar amount of the Bank's loans is $2,857,605 at December 31, 1998. The amount includes: (1) Dealer wholesale loans with generally no delinquencies or losses $1,201,858 (2) Term loans for business and commercial purposes 985,613 (3) Industrial revenue bond loans secured by real estate 85,817 (4) Term loans for agricultural purposes 246,100 (5) Other loans 338,217 INVESTMENT ACTIVITIES. The Bank's investment activities are governed by its investment policy. The policy states that excess daily funds are to be invested in securities purchased under agreements to resell. The daily funds are used to cover deposit draw downs by customers, to fund loan commitments, and to help maintain the Bank's asset/liability mix. According to the policy, funds in excess of those invested in securities purchased under agreements to resell are to be invested in U.S. Treasury bills, notes or bonds, obligations of U.S. Government agencies, obligations of political subdivisions of the State of West Virginia with a rating of not less than AAA and, with prior approval of the Board of Directors, bank qualified local industrial revenue bonds to be carried in the Bank's loan portfolio. The policy governs various other factors including maturities, the closeness of purchase price to par, amounts that may be purchased, and percentages of the various types of investments that may be held. DEPOSIT ACTIVITIES. The Bank offers noninterest bearing checking accounts and interest bearing NOW accounts and money market accounts. Passbook and statement savings accounts and Christmas Club accounts are available. Certificates of deposit are offered in various terms from 91 days to four years and may be automatically renewed if the depositor wishes. Individual retirement accounts in the form of certificates of deposit are also available. Prior to opening any deposit account particular requirements must be met by the depositor including presentation of valid identification and social security number, must not be on record with Chex Systems (credit reporting agency), must be a U.S. citizen or possess evidence of legal alien status, and must be at least 18 years of age or share account with a person at least 18 years of age. 5 Competition As of March 5, 1999, there were 52 bank holding companies (including multi-bank and one bank holding companies) operating in the State of West Virginia. These holding companies are headquartered in various West Virginia cities and control banks throughout the State of West Virginia, including banks which compete with the Bank in its market area. The Bank's market area is generally defined as Jefferson County, West Virginia. As of June 30, 1998, there were six banks in Jefferson County with 17 banking offices. The total deposits of those commercial banks as of June, 1998, were $456,515,000 and the Bank ranked number one with $121,756,000 or 26.7% of the total deposits in the market. For most of the services which the Bank performs, there is also competition from financial institutions other than commercial banks. For instance, credit unions and issuers of commercial paper and money market funds actively compete for funds and for various types of loans. In addition, personal and corporate trust and investment counseling services are offered by insurance companies, investment counseling firms and other business firms and individuals. Due to the geographic location of the Bank's primary market area, the existence of larger financial institutions in Maryland, Virginia and Washington, D.C. influences the competition in the market area. In addition larger regional and national corporations continue to be increasingly visible in offering a broad range of financial services to all types of commercial and consumer customers. The principal competitive factors in the markets for deposits and loans are interest rates, either paid or charged. The chartering of numerous new banks in West Virginia and the opening of numerous federally chartered savings and loan associations have increased competition for the Bank. The 1986 legislation passed by the West Virginia Legislature allowing state-wide branch banking provided increased opportunities for the Bank, but it also increased competition for the Bank in its service area. With the beginning of reciprocal interstate banking in 1988, bank holding companies (such as Potomac Bancshares, Inc.) also face additional competition in efforts to acquire other subsidiaries throughout West Virginia. In 1994, Congress passed the Riegle-Neal Interstate Banking and Branching Efficiency Act. Under this Act, bank holding companies are permitted to acquire banks located in states other than the bank holding company's home state without regard to whether the transaction is permitted under state law. Commencing on June 1, 1997, the Act allows national banks and state banks with different home states to merge across state lines, unless the home state of a participating bank enacted legislation prior to May 31, 1997, that expressly prohibits interstate mergers. Additionally, the Act allows banks to branch across state lines, unless the state where the new branch will be located enacted legislation restricting or prohibiting de novo interstate branching on or before May 31, 1997. West Virginia adopted legislation, effective May 31, 1997, that allows for interstate branch banking by merger across state lines and allows for de novo branching and branching by purchase and assumption on a reciprocal basis with the home state of the bank in question. The effect of this legislation will likely be increased competition with West Virginia banks, including the Bank. Employees Bancshares currently has no employees. As of January 31, 1999, the Bank had 77 full-time employees and 13 part-time employees. Supervision and Regulation INTRODUCTION. Bancshares is a bank holding company within the provisions of the Bank Holding Company Act of 1956, is registered as such, and is subject to supervision by the Board of Governors of the Federal Reserve System ("Board of Governors"). The Bank Holding Company Act requires Bancshares to secure the prior approval of the Board of Governors before Bancshares acquires ownership or control of more than five percent (5%) of the voting shares or substantially all of the assets of any institution, including another bank. 6 As a bank holding company, Bancshares is required to file with the Board of Governors annual reports and such additional information as the Board of Governors may require pursuant to the Bank Holding Company Act. The Board of Governors may also make examinations of Bancshares and its banking subsidiaries. Furthermore, under Section 106 of the 1970 Amendments to the Bank Holding Company Act and the regulations of the Board of Governors, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or any provision of credit, sale or lease of property or furnishing of services. Bancshares' depository institution subsidiaries are subject to affiliate transaction restrictions under federal law which limit the transfer of funds by the subsidiary banks to their respective parents and any nonbanking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases. Such transfers by any subsidiary bank to its parent corporation or any nonbanking subsidiary are limited in an amount to 10% of the institution's capital and surplus and, with respect to such parent and all such nonbanking subsidiaries, to an aggregate of 20% of any such institution's capital and surplus. Bancshares is required to register annually with the Commissioner of Banking of West Virginia ("Commissioner") and to pay a registration fee to the Commissioner based on the total amount of bank deposits in banks with respect to which it is a bank holding company. Although legislation allows the Commissioner to prescribe the registration fee, it limits the fee to ten dollars per million dollars of deposits rounded off to the nearest million dollars. Bancshares is also subject to regulation and supervision by the Commissioner. Bancshares is required to secure the approval of the West Virginia Board of Banking before acquiring ownership or control of more than five percent of the voting shares or substantially all of the assets of any institution, including another bank. West Virginia banking law prohibits any West Virginia or non-West Virginia bank or bank holding company from acquiring shares of a bank if the acquisition would cause the combined deposits of all banks in the State of West Virginia, with respect to which it is a bank holding company, to exceed 20% of the total deposits of all depository institutions in the State of West Virginia. DEPOSITORY INSTITUTION SUBSIDIARIES. Bank is subject to FDIC deposit insurance assessments. As of January 1, 1998, FDIC set the Financing Corporation (FICO) Bank Insurance Fund (BIF) premium for the Bank at the annual rate of 1.195 basis points or .0001195 times the total deposits of the Bank. This premium is not tied to the Bank's risk classification. The rate of the premium based on the Bank's risk classification is still at 0.00%. It is possible that BIF insurance assessments will be changed, and it is also possible that there may be a special additional assessment. A large special assessment could have an adverse impact on Bancshares' results of operations. CAPITAL REQUIREMENTS. The Federal Reserve Board has issued risk-based capital guidelines for bank holding companies, such as Bancshares. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. Under the guidelines and related policies, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and leverage ratio test on a consolidated basis. The risk-based ratio is determined by allocating assets and specified off-balance sheet commitments into four weighted categories, with higher levels of capital being required for categories perceived as representing greater risk. The leverage ratio is determined by relating core capital (as described below) to total assets adjusted as specified in the guidelines. Bank is subject to substantially similar capital requirements adopted by applicable regulatory agencies. Generally, under the applicable guidelines, the financial institution's capital is divided into two tiers. "Tier 1", or core capital, includes common equity, noncumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts or consolidated subsidiaries, less goodwill. Bank holding companies, however, may include cumulative perpetual preferred stock in their Tier 1 capital, up to a limit of 25% of such Tier 1 capital. "Tier 2", or supplementary capital, includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan losses, subject to certain limitations, less required deductions. "Total capital" is the sum of Tier 1 and Tier 2 capital. 7 Financial institutions are required to maintain a risk-based ratio of 8%, of which 4% must be Tier 1 capital. The appropriate regulatory authority may set higher capital requirements when an institution's particular circumstances warrant. Financial institutions that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating, are required to maintain a minimum leverage ratio of 3%. Financial institutions not meeting these criteria are required to maintain a leverage ratio which exceeds 3% by a cushion of at least 100 to 200 basis points, and, therefore, the ratio of Tier 1 capital to total assets should not be less than 4%. The guidelines also provide that financial institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the Federal Reserve Board's guidelines indicate that the Federal Reserve Board will continue to consider a "tangible Tier 1 leverage ratio" in evaluating proposals for expansion or new activities. The tangible Tier 1 leverage is the ratio of an institution's Tier 1 capital, less all intangibles, to total assets, less all intangibles. Failure to meet applicable capital guidelines could subject the financial institution to a variety of enforcement remedies available to the federal regulatory authorities, including limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital and the termination of deposit insurance by the FDIC, as well as to the measures described in the "Federal Deposit Insurance Corporation Improvement Act of 1991" as applicable to undercapitalized institutions. The Federal Reserve Board, as well as the FDIC, has adopted changes to their risk-based and leverage ratio requirements that require that all intangible assets, with certain exceptions, be deducted from Tier 1 capital. Under the Federal Reserve Board's rules, the only types of intangible assets that may be included in (i.e., not deducted from) a bank holding company's capital are readily marketable purchased mortgage servicing rights ("PMSRs") and purchased credit card relationships ("PCCRs"), provided that, in the aggregate, that total amount of PMSRs and PCCRs included in capital does not exceed 50% of Tier 1 capital. PCCRs are subject to a separate limit of 25% of Tier 1 capital. The amount of PMSRs and PCCRs that a bank holding company may include in its capital is limited to the lesser of (i) 90% of such assets' fair market value (as determined under the guidelines), or (ii) 100% of such assets' book value, each determined quarterly. Identifiable intangible assets (i.e., intangible assets other than goodwill) other than PMSRs and PCCRs, including core deposit intangibles, acquired on or before February 19, 1992 (the date the Federal Reserve Board issued its original proposal for public comment), generally will not be deducted from capital for supervisory purposes, although they will continue to be deducted for purposes of evaluating applications filed by bank holding companies. As of December 31, 1998, Bancshares had capital in excess of all applicable requirements as shown below:
Actual Required Excess ------ -------- ------ Tier 1 capital: Common stock $ 600,000 Surplus 5,400,000 Retained earnings 10,090,870 ------------ Total tier 1 capital $ 16,090,870 $ 2,843,486 $ 13,247,384 Tier 2 capital: Allowance for loan losses (1) 891,693 Total risk-based capital $ 16,982,563 $ 5,686,972 $ 11,295,591 ============ ============== ============== Risk-weighted assets $ 71,087,152 ============ Tier 1 capital $ 16,090,870 $ 4,330,639 $ 11,760,231 ============ ============== ============== Average total assets $144,354,648 ============
8
Actual Required Excess ------ -------- ------ Capital ratios: Tier 1 risk-based capital ratio 22.64% 4.00% 18.64% Total risk-based capital ratio 23.89% 8.00% 15.89% Tier 1 capital to average total assets (leverage) 11.15% 4.00% 7.15%
(1) Limited to 1.25% of gross risk-weighted assets. PERMITTED NON-BANKING ACTIVITIES. The Federal Reserve permits bank holding companies to engage in non-banking activities closely related to banking or managing or controlling banks. Bancshares presently does not engage in, nor does it have any immediate plans to engage in, any non-banking activities bank holding companies are permitted to perform. A notice of proposed non-banking activities must be furnished to the Federal Reserve and the Banking Board before Bancshares engages in such activities, and an application must be made to the Federal Reserve and Banking Board concerning acquisitions by Bancshares of corporations engaging in those activities. In addition, the Federal Reserve may, by order issued on a case-by-case basis, approve additional non-banking activities. THE BANK. The Bank is a state-chartered bank which is not a member of the Federal Reserve system and is subject to regulation and supervision by the FDIC and the Commissioner. COMPLIANCE WITH ENVIRONMENTAL LAWS. The costs and effects of compliance with federal, state and local environmental laws will not have a material effect or impact on Bancshares or the Bank. ITEM 2. DESCRIPTION OF PROPERTY. Bancshares currently has no property. The Bank owns the land and buildings of the main office and two branch office facilities. Main office property is located at 111 East Washington Street, Charles Town, West Virginia. This property consists of two separate two story buildings located side by side with an adjoining corridor. The older of these two buildings houses the Bank's Trust and Financial Services Division on its first floor and the second floor is used for storage. The Trust and Financial Services area was remodeled in 1982. The newer building houses the commercial bank operations, using the majority of both floors of the building. This building was constructed in 1967. Two adjoining sections of property at this location were purchased in 1986 and 1988 to meet additional parking needs. The schematic design has been completed for a major building and renovation project approved by the Board. The design and development stage is now underway. The project will include demolition of the older building now housing Trust and Financial Services and construction of a new building on the same location. This new building will house Trust, some of the commercial operations, and provide storage. The project will also include redecoration of the main office building originally constructed in 1967. The total estimated cost is $1,800,000 and completion is expected within a year and a half of the start date. The Bank sold the property formerly housing the Charles Town Lodge, Loyal Order of Moose, Inc., during 1996 for $220,000. This property, used only as a storage facility, was no longer needed. One branch office is located at 1318 Washington Street, Bolivar, West Virginia. The office is a one story brick building constructed in 1975. On this property is another building which existed at the time of the Bank's purchase. This is rented to others by the Bank. 9 In addition, the Bank owns property in Kearneysville, West Virginia, on which a second branch facility was erected in 1985. This one story brick building opened for business in April of 1985. During 1993, an addition was constructed, doubling the size of this facility. There are no encumbrances on any of these properties. In the opinion of management, these properties are adequately covered by insurance. ITEM 3. LEGAL PROCEEDINGS. Currently Bancshares is involved in no legal proceedings. The Bank is involved in various legal proceedings arising in the normal course of business, and in the opinion of the Bank, the ultimate resolution of these proceedings will not have a material effect on the financial position or operations of the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not Applicable. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The following information reflects comparative per share data for the periods indicated for Bancshares Common Stock for (a) trading values, and (b) dividends. As of March 1, 1999, there were approximately 830 shareholders. Bancshares Common Stock is not traded on any stock exchange or over the counter. Bancshares (symbol PTBS) is now on the Bulletin Board, a network available to brokers. Scott and Stringfellow, a regional securities firm with an office in Winchester, Virginia, is a market maker for Bancshares Common Stock. A market maker is one who makes a market for a particular stock. Information about sales (but not necessarily all sales) of Bancshares Common Stock is available on the Internet through many of the stock information services using Bancshares's symbol. Shares of Bancshares Common Stock are occasionally bought and sold by private individuals, firms or corporations, and, in many instances, Bancshares does not have knowledge of the purchase price or the terms of the purchase. The following information relating to trading values for Bancshares Common Stock in 1997 is based upon information furnished to Bancshares by one or more parties involved in purchases or sales of Bancshares Common Stock. The trading values shown below are based on arms-length transactions between shareholders. The trading values for 1998 are based on information available as a result of our participation on the Bulletin Board described above and information gathered on the Internet. NO ATTEMPT WAS MADE BY BANCSHARES TO VERIFY OR DETERMINE THE ACCURACY OF THE REPRESENTATIONS MADE TO BANCSHARES OR GATHERED ON THE INTERNET.
Price Range Cash Dividends * High Low Paid per Share 1997 First Quarter $30.000 $29.000 $ N/A Second Quarter 32.000 30.000 .45 Third Quarter 32.000 30.000 N/A Fourth Quarter 32.000 30.000 .70 1998 First Quarter $38.000 $34.875 $ N/A Second Quarter 42.000 32.500 .50 Third Quarter 46.000 41.000 N/A Fourth Quarter 41.000 40.000 .65
* Dividends have been declared traditionally by Bancshares on a semi-annual basis. 10 The primary source of funds for dividends paid by Bancshares is the dividend income received from the Bank. The Bank's ability to pay dividends is subject to restrictions under federal and state law, and under certain cases, approval by the FDIC and Commissioner could be required. Management of Bancshares anticipates that the dividends paid by Bancshares will likely be similar to those paid in the past, but dividends will only be paid when and as declared by the Board of Directors. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information contained on pages 4-12 of the Annual Report to Shareholders for the year ended December 31, 1998, is incorporated herein by reference. ITEM 7. FINANCIAL STATEMENTS. The information contained on pages 13-30 of the Annual Report to Shareholders for the year ended December 31, 1998, is incorporated herein by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. The information contained on pages 4-6 and 13 of the Proxy Statement dated March 30, 1999, for the April 27, 1999 Annual Meeting under the captions "Management Nominees to the Board of Potomac," "Directors Continuing to Serve Unexpired Terms," and "Section 16(a) Beneficial Ownership Reporting Compliance" is incorporated herein by reference. The Executive Officers are as follows:
Name Position Since Age Principal Occupation ---- -------------- --- -------------------- Charles W. LeMaster President & CEO 57 Employed at Bank since 1983; 1994 President & CEO since 1991. William R. Harner Sr. Vice President, 58 Employed at Bank since 1967; Sr. Vice Secretary & Treasurer President & Cashier since 1988. 1994 Gayle Marshall Johnson Vice President & Chief 49 Employed with the Bank 1977-1985 as Financial Officer as internal auditor. Rejoined Bank in 1988 1994 as Financial Officer. Vice President & Financial Officer of Bank since 1990. Donald S. Smith Vice President & 70 Employed at Bank 1947 to 1991; President Assistant Secretary 1979 to 1991 (retired). 1994
ITEM 10. EXECUTIVE COMPENSATION. The information contained on pages 8-9 and 12 of the Proxy Statement dated March 30, 1999, for the April 27, 1999 Annual Meeting under the captions "Executive Compensation" and "Compensation of Directors" is incorporated herein by reference. 11 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information contained on pages 6-8 of the Proxy Statement dated March 30, 1999, for the April 27, 1999 Annual Meeting under the captions "Principal Holders of Voting Securities" and "Ownership of Securities by Nominees, Directors and Officer" is incorporated herein by reference. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information contained on page 12 of the Proxy Statement dated March 30, 1999, for the April 27, 1999 Annual Meeting under the caption "Certain Transactions with Directors, Officers and Their Associates" is incorporated herein by reference. ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K. (a) 2.1Agreement and Plan of Merger dated March 8, 1994, by and between Potomac Bancshares, Inc., and Bank of Charles Town filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994: Registration no. 33-80092. 3.1 Articles of Incorporation of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994: Registration no. 33-80092. 3.2 Amendments to Articles of Incorporation of Potomac Bancshares, Inc. adopted by shareholders on April 25, 1995 and filed with the West Virginia Secretary of State on May 23, 1995, and incorporated by reference from Potomac's Form 10-KSB for the year ended December 31, 1995 and filed with the Securities and Exchange Commission, file no. 0-24958. 3.3 Bylaws of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994: Registration no. 33-80092. 3.4 Amended and Restated Bylaws of Potomac Bancshares, Inc. adopted by shareholders April 25, 1995 and incorporated by reference from Potomac's Form 10-KSB for the year ended December 31, 1995 and filed with the Securities and Exchange Commission, file no. 0-24958. 13 1998 Annual Report to Shareholders 21 Subsidiaries of the Registrant 27 Financial Data Schedule 99 Proxy Statement for the 1999 Annual Meeting for Potomac (b) No reports on Form 8-K were filed during the last quarter of the period covered by this report. 12 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. POTOMAC BANCSHARES, INC. By /s/ Charles W. LeMaster March 30, 1999 ----------------------------------------------- -- Charles W. LeMaster President & Chief Executive Officer By /s/ L. Gayle Marshall Johnson March 30, 1999 ----------------------------------------------- -- L. Gayle Marshall Johnson Vice President & Chief Financial Officer & Chief Accounting Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature & Title Date - ----------------- ---- By /s/ John P. Burns, Jr. March 30, 1999 ------------------------------------------------- -- John P. Burns, Jr., Director By /s/ Robert W. Butler March 30, 1999 ------------------------------------------------- -- Robert W. Butler, Director By /s/ Guy Gary Chicchirichi March 30, 1999 -------------------------------------------------- -- Guy Gary Chicchirichi, Director By /s/ Thomas C. G. Coyle March 30, 1999 -------------------------------------------------- -- Thomas C. G. Coyle, Director By /s/ Francis M. Frye March 30, 1999 -------------------------------------------------- -- Francis M. Frye, Director 13 Signature & Title Date - ----------------- ---- By /s/ William R. Harner March 30, 1999 -------------------------------------------------- -- William R. Harner, Director, Sr. Vice President, Secretary & Treasurer By /s/ E. William Johnson March 30, 1999 -------------------------------------------------- -- E. William Johnson, Director By /s/ Charles W. LeMaster March 30, 1999 -------------------------------------------------- -- Charles W. LeMaster, Director, President, Chief Executive Officer By /s/ Minnie R. Mentzer March 30, 1999 -------------------------------------------------- -- Minnie R. Mentzer, Director By March 30, 1999 -------------------------------------------------- -- James E. Senseney, Director By /s/ John C. Skinner, Jr. March 30, 1999 -------------------------------------------------- -- John C. Skinner, Jr., Director By /s/ Donald S. Smith March 30, 1999 -------------------------------------------------- -- Donald S. Smith, Director EX-13 2 EXHIBIT 13 -- 1998 ANNUAL REPORT COVER PAGE CONTENTS President's Report.............................................................1 Description of Business........................................................2 Board of Directors.............................................................2 Selected Consolidated Financial Data...........................................3 Management's Discussion and Analysis of Financial Condition and Results of Operations.......................4-12 Independent Auditor's Report..................................................13 Consolidated Financial Statements Consolidated Balance Sheets...........................................14 Consolidated Statements of Income.....................................15 Consolidated Statements of Changes in Stockholders' Equity............16 Consolidated Statements of Cash Flows.................................17 Notes to Consolidated Financial Statements.........................18-30 Trust and Financial Services..................................................31 Officers and Staff............................................................32 Annual Report on Form 10-KSB..................................................33 General Information...........................................................33 FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 evidences Congress' determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Annual Report, including the President's Letter and the Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the Corporation notes that a variety of factors could cause the Corporation's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Corporation's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Corporation's business include, but are not limited to, the growth of the economy, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, the impact, if any, of Year 2000 computer problems, Congressional legislation and similar matters. Readers of this report are cautioned not to place undue reliance on forward-looking statements which are subject to influence by the named risk factors and unanticipated future events. Actual results, accordingly, may differ materially from management expectations. PRESIDENT'S REPORT On behalf of the Board of Directors, Officers and Staff, we are pleased to submit this Annual Report for your holding company, Potomac Bancshares, Inc., for the year ended December 31, 1998. During the year we experienced growth in assets of over $17,000,000 with the major portion reflected in deposit growth. Net profit after taxes for 1998 totaled $1,489,129 or $2.48 per share. Even though net income was down from the previous year, cash dividends paid to stockholders were $1.15 per share, same as were paid in 1997, and totaled $690,000. For some time now you have heard a constant media blitz regarding Y2K. A committee comprised of members of the Board and Staff has been working diligently for the past year and will continue to do so for the balance of 1999 to prepare for this millennium conversion. Your Board has been working on its building project and has completed the schematic design. We are now progressing into the design and development stage. This venture will involve the area now being utilized for the Trust Department offices and storage area, along with a redecorating project for the main office building. This should all be well on its way by mid-year 1999. The success enjoyed by this corporation would not be possible without the dedication from members of the staff, nor could it progress without the commitment of the members of the Board. Everyone's loyalty is greatly appreciated, as is that of our stockholders and customers. Sincerely, Charles W. LeMaster President and CEO -1- DESCRIPTION OF BUSINESS Potomac Bancshares, Inc., a one-bank holding company, and Subsidiary, Bank of Charles Town, are engaged in general banking business with the primary market area being Jefferson County, West Virginia. However, the Corporation also provides services to Washington County and Frederick County, Maryland; Loudoun County and Clarke County, Virginia; and Berkeley County, West Virginia. The main office is in Charles Town with branch offices in Harpers Ferry and Kearneysville. The Corporation provides consumers, businesses, and governments with a broad range of banking services including lines of credit, home equity lines of credit, commercial, agricultural, real estate, and installment loans, checking, savings, NOW, and money market accounts, certificates of deposit, and individual retirement accounts. Automated teller machines located at each of the three offices and Touchline 24, an interactive voice response system available at 1-304-728-2424, provide certain services to customers on a twenty-four hour basis. Bill paying and certain other banking services are available online through a personal computer and/or the World Wide Web. These same bill paying and banking services are also available using a special telephone. The trust and financial services department provides financial management, investment and trust services. Bank of Charles Town is a West Virginia state chartered bank which formed and opened for business in 1871. The Bank's deposits are insured by Federal Deposit Insurance Corporation. BOARD OF DIRECTORS POTOMAC BANCSHARES, INC. AND BANK OF CHARLES TOWN
JOHN P. BURNS, JR. FRANCIS M. FRYE MINNIE R. MENTZER Partner Retired President Retired President Burns Farm Ranson Real Estate Myers Coal Company, Inc. ROBERT W. BUTLER WILLIAM R. HARNER JAMES E. SENSENEY Farmer-Orchardist Senior Vice President Retired Owner-Operator Warm Spring Orchard & Farm & Cashier J.E. Senseney & Sons, Inc. Bank of Charles Town GUY GARY CHICCHIRICHI E. WILLIAM JOHNSON JOHN C. SKINNER, JR. General Manager Professor of Economics Owner Guy's Buick-Pontiac-Oldsmobile- Shepherd College Nichols & Skinner, L.C. GMC Truck, Inc. THOMAS C. G. COYLE CHARLES W. LEMASTER DONALD S. SMITH Retired Owner-Operator President Retired President Riddleberger's Store Bank of Charles Town Bank of Charles Town
-2- SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in Thousands Except Per Share Data)
1998 1997 1996 1995 1994 --------- --------- --------- --------- -------- Summary of Operations Interest income $ 10 055 $ 9 563 $ 9 086 $ 8 747 $ 8 979 Interest expense 4 401 3 710 3 623 3 591 3 509 --------- --------- --------- --------- --------- Net interest income 5 654 5 853 5 463 5 156 5 470 Provision for loan losses 125 127 100 125 125 --------- --------- --------- --------- --------- Net interest income after provision for loan losses 5 529 5 726 5 363 5 031 5 345 Non-interest income 1 126 1 128 989 906 939 Non-interest expense 4 297 4 127 4 114 4 078 4 211 --------- --------- --------- --------- --------- Income before income taxes 2 358 2 727 2 238 1 859 2 073 Income tax expense 869 1 005 831 674 742 --------- --------- --------- --------- --------- Net income $ 1 489 $ 1 722 $ 1 407 $ 1 185 $ 1 331 ========= ========= ========= ========= ========= Per Share Data Net income, basic and diluted $ 2.48 $ 2.87 $ 2.35 $ 1.98 $ 2.22 Cash dividends declared 1.15 1.15 .95 .85 .85 Book value at period end 26.99 25.50 23.70 22.37 21.19 Average shares outstanding 600 000 600 000 600 000 600 000 600 000 Average Balance Sheet Summary Assets $ 138 698 $ 126 474 $ 124 267 $ 121 638 $ 128 993 Loans 78 552 76 866 73 817 72 440 68 558 Securities 45 190 40 576 36 972 37 682 52 288 Deposits 121 612 110 291 109 709 107 826 115 907 Shareholders' equity 15 862 14 870 13 806 13 052 12 393 Performance Ratios Return on average assets 1.07% 1.36% 1.13% .97% 1.03% Return on average equity 9.39% 11.58% 10.19% 9.08% 10.74% Dividend payout ratio 46.37% 40.07% 40.43% 43.93% 38.29% Capital Ratios Leverage ratio 11.15% 11.83% 11.43% 10.83% 9.61% Risk-based capital ratios Tier 1 capital 22.64% 23.15% 23.21% 20.73% 20.74% Total capital 23.89% 24.41% 24.47% 21.98% 21.99%
-3- SCHEDULE 1 - AVERAGE BALANCES, INCOME/EXPENSE AND AVERAGE YIELD/RATE This schedule is a comparison of interest earning assets and interest bearing liabilities showing average yields or rates derived from average balances and actual income and expenses. Income and rates on tax exempt loans are computed on a tax equivalent basis using a federal tax rate of 34%. Loans placed on nonaccrual status are reflected in the balances.
1998 1997 ------------------------------------ -------------------------------------- Average Income/ Average Average Income/ Average Balances Expense Yield/Rate Balances Expense Yield/Rate ASSETS Loans Taxable $78 215 073 $6 967 855 8.91% $76 726 418 $7 008 657 9.13% Tax exempt 336 999 32 076 9.52% 139 322 15 492 11.12% ---------- ---------- ----------- ---------- Total loans 78 552 072 6 999 931 8.91% 76 865 740 7 024 149 9.14% ---------- ---------- ----------- ---------- Taxable securities 45 190 167 2 610 758 5.78% 40 576 196 2 344 806 5.78% Securities purchased under agreements to resell and federal funds sold 7 796 026 455 539 5.84% 3 755 616 198 926 5.30% ---------- ---------- ----------- ---------- TOTAL EARNING ASSETS 131 538 265 $10 066 228 7.65% 121 197 552 $ 9 567 881 7.89% ----------- =========== ----------- =========== Reserve for loan losses (1 137 864) (1 160 396) Cash and due from banks 5 322 429 3 613 704 Bank premises/equipment, net 1 212 223 1 204 798 Other assets 1 763 203 1 617 882 ------------ ------------ Total assets $138 698 256 $126 473 540 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Savings and interest bearing demand deposits $64 410 847 $2 047 815 3.18% $ 55 365 510 $1 451 731 2.62% Time deposits 42 083 997 2 353 117 5.59% 40 929 846 2 241 745 5.48% ----------- ---------- ----------- ---------- Total interest bearing deposits 106 494 844 4 400 932 4.13% 96 295 356 3 693 476 3.84% ----------- ---------- ----------- ---------- Federal funds purchased and securities sold under agreements to repurchase - - - - - - 269 471 16 219 6.02% ----------- ---------- ----------- ---------- TOTAL INTEREST BEARING LIABILITIES 106 494 844 $ 4 400 932 4.13% 96 564 827 $ 3 709 695 3.84% ----------- =========== ---------- =========== Noninterest bearing demand deposits 15 117 247 13 995 920 Other liabilities 1 223 874 1 042 649 Stockholders' equity 15 862 291 14 870 144 ------------ ----------- Total liabilities and stockholders' equity $138 698 256 $ 126 473 ============ =========== 540 NET INTEREST SPREAD 3.52% 4.05% INTEREST EXPENSE AS A PERCENT OF AVERAGE EARNING ASSETS 3.35% 3.06% NET INTEREST MARGIN 4.31% 4.84%
-4- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Total assets increased over 13% in 1998 compared to 1997. This $17,500,000 increase included growth of $13,000,000 in the securities portfolio and a $5,000,000 increase in the daily investment vehicles of securities purchased under agreements to resell and federal funds sold. The increased assets were offset by deposit growth. Management is unaware of any trends, events or uncertainties that would have material effect on liquidity, capital resources or operations. There are no current recommendations by regulatory authorities which if they were to be implemented would have a material effect on the Corporation. NET INTEREST INCOME In 1998 net interest income decreased 3% when compared to 1997. The majority of the increase is due to increases in deposit volume and deposit rates. A 5% increase in interest income brought the 1998 total to $10,055,322 compared to $9,562,614 in 1997. Although the year end balance for total loans in 1998 was slightly less than the 1997 balance, the average balance of total loans in 1998 increased about $1,700,000 compared to the average balance in 1997. Interest and fees on loans remained basically the same in 1998 showing only a slight increase compared to 1997. The decrease in average yield on loans offset the increase in average volume for the year. No particular category of loans showed a significant increase or decrease in volume. Interest income on investment securities and securities available for sale increased 11% in 1998 compared to 1997. This increase is due to increased volumes of securities since the average rate remained the same in 1997 and 1998. Income on securities purchased under agreements to resell and federal funds sold increased 129% in 1998 compared to 1997. Most of this increase is due to increased volumes although there was an increase in the average rate to 5.84% in 1998 compared to 5.30% in 1997. The increase in interest expense to $4,400,932 in 1998 compared to $3,709,695 in 1997 is the major cause of decreased net income for 1998 compared to 1997. The majority of this increase is in the expense for savings and interest bearing demand deposits with a smaller expense increase in time deposits. The savings and interest bearing demand deposits increase is due to the increase in volume and rate of the Select Checking balances. Select Checking accounts are NOW accounts that earn a higher rate of interest for balances of $5,000 or more. Increase in time deposit expense is due to an increase in average volume of $1,000,000 and an increase in average rate of .11%. Total deposits increased $16,500,000 in 1998 compared to 1997. This increase is due to the increase in the Select Checking balances as described above. Continuing to compare 1998 year end balances with 1997 year end balances, non interest bearing demand deposits increased $2,500,000 in 1998, money market deposits decreased $5,000,000 in 1998, savings decreased $1,500,000 in 1998, and certificates of deposits increased $2,000,000 in 1998. The decreases in money market and savings deposits can also be attributed to the availability of the Select Checking accounts. In 1998, the average yield for earning assets was 7.65%, a decrease of .24% when compared to 1997. The lower yield is due to the decreased loan yields during 1998 compared to 1997, since the yields on securities remained the same and yields on securities purchased under agreements to resell and federal funds sold increased during 1998. The average rate paid on all interest bearing liabilities was 4.13% in 1998 compared to 3.84% in 1997. The net interest spread decreased .53% to 3.52% compared to 4.05% in 1997, and the net interest margin decreased the same .53% to 4.31% in 1998 compared to 4.84% in 1997. As the narrative above describes, the major reason for decreased interest income, reduced interest spread and reduced interest margin is the increased balances in the Select Checking Accounts which pay a higher rate of interest and minimal increase in income to compensate for this increase in expense. -5- SCHEDULE 2 - VOLUME AND RATE ANALYSIS This schedule analyzes the change in net interest income attributable to changes in volume of the various portfolios and changes in interest rates. The change due to both rate and volume variances has been allocated between rate and volume based on the percentage relationship of such variances to each other. Income and rates on tax exempt loans are computed on a tax equivalent basis using a federal tax rate of 34%. Nonaccruing loans are included in average loans outstanding.
1998 Compared to 1997 1997 Compared to 1996 ---------------------------------------- -------------------------------------- Change in Volume Rate Change in Volume Rate Income/Expense Effect Effect Income/Expense Effect Effect -------------- ------ ------ -------------- ------ ------ INTEREST INCOME Taxable loans $ (40 802) $ 168 640 $ (209 442) $ 280 573 $ 295 395 $ (14 822) Tax exempt loans 16 584 18 455 (1 871) (17 344) (17 197) (147) Taxable securities 265 952 265 952 - - 445 650 195 697 249 953 Securities purchased under agreements to resell 256 613 234 413 22 200 (238 108) (240 612) 2 504 ---------- --------- ----------- --------- ---------- --------- TOTAL $ 498 347 $ 687 460 $ (189 113) $ 470 771 $ 233 283 $ 237 488 ---------- --------- ----------- --------- ---------- --------- INTEREST EXPENSE Savings and interest bearing demand deposits $596 084 $ 258 237 $ 337 847 $ 30 717 $ (11 232) $ 41 949 Time deposits 111 372 65 059 46 313 39 516 51 374 (11 858) Federal funds purchased and securities sold under agreements to repurchase (16 219) (16 219) - - 16 219 16 219 - - ---------- --------- ----------- --------- ---------- --------- TOTAL $ 691 237 $ 307 077 $ 384 160 $ 86 452 $ 56 361 $ 30 091 ---------- --------- ----------- --------- ---------- --------- NET INTEREST INCOME $ (192 890) $ 380 383 $(573 273) $ 384 319 $ 176 922 $ 207 397 ========== ========= =========== ========= ========== =========
NONINTEREST INCOME AND EXPENSE Noninterest income (other income) decreased slightly in 1998 compared to 1997. This included a 6% increase in income from the Trust and Financial Services Department in 1998 compared to 1997 which was offset by decreased income from service charges on deposit accounts, specifically in the return check charge category, and decreased other operating income which is a combination of numerous categories. Noninterest expense (other expense) increased 4% in 1998 compared to 1997. Included in this is a 6% increase in salaries and employee benefits in 1998 compared to 1997 and a 4% increase in furniture and equipment expenses in 1998 compared to 1997. The bulk of the furniture and equipment expense was the purchase of new computer equipment to prepare for the year 2000. There was also a decrease in net occupancy expense of premises of 5% in 1998 compared to 1997. YEAR 2000 The "Year 2000 Problem" exists because computers and computer programs were written using only a two digit field for the year rather than a four digit field. As we move into the Year 2000 and continue to use "00" for the date, many computers, computer programs, and any equipment using date sensitive microchips may not recognize "00" as the Year 2000, but may "think" it is the year 1900. For many businesses and industries, this misconception may cause problems. Hence, the challenge facing the world has been to prepare for the Year 2000 by ensuring that all equipment is appropriately date sensitive to the four digit date 2000 and beyond. The Subsidiary Bank depends heavily on computer processing in connection with its business activities. Failure of its computer systems could have a significant impact on its operations. During 1997 the Subsidiary Bank began preparing to meet the challenge by sending letters to third party vendors and suppliers requesting written documentation regarding their planning, renovation, and testing of computer systems and software and other equipment containing embedded microchips to ensure Year 2000 compliance. Vendors contacted included all parties that supplied service that the Subsidiary Bank believed could be affected by embedded microchips, such as electric, water, computer hardware and software providers. In January 1998, the Subsidiary Bank's Board of Directors approved the appointment of a Year 2000 Committee composed of directors, officers and staff. The Committee has written a Year 2000 Plan that was approved by the Board of Directors which details steps to be taken for Year 2000 compliance. -6- The Plan includes the following phases of procedure: awareness, assessment, renovation, validation and implementation. The AWARENESS PHASE was educating all personnel within the organization including directors, officers and staff so that everyone understood the definition of the problem. All personnel also needed to understand that the Corporation was seriously undertaking the challenge to complete all the remaining phases of the Plan in a timely manner. The ASSESSMENT PHASE included identifying all systems and equipment that would be affected by the problem. The RENOVATION PHASE included performing repairs, upgrades and/or replacements of all computer systems and equipment containing embedded microchips that were identified in the assessment phase as needing renovation. The VALIDATION PHASE includes testing of all systems and equipment. The IMPLEMENTATION PHASE occurs when all previous phases are complete and all systems have been certified as Year 2000 compliant. The status of these phases as of December 31, 1998 is listed below: Awareness Complete Assessment Complete Renovation Substantially Complete. Remaining renovation includes replacement of optical disk storage system hardware and software, five personal computers, one server and hub, and one printer. Expected completion May 31, 1999. Validation Progressing on schedule. Mission critical systems expected to be substantially complete by March 31, 1999. Remaining validation expected to be substantially complete within guidelines of the Federal Financial Institutions Examination Council (FFIEC), whose completion deadline is June 30, 1999. Implementation Progressing on schedule. As renovation and validation phases progress so does completion of this phase. Expected completion will be within FFIEC guidelines. The Subsidiary Bank does not maintain a formal budget. Therefore, expenses related to the Year 2000 are reviewed and approved by the Board of Directors on an as needed basis. As of December 31, 1998, actual costs were $187,025. Most of the costs were for computers and related equipment. There have also been expenditures for testing of our major software vendors. It is estimated that the total costs for the Year 2000 will not exceed $350,000, assuming that the Subsidiary Bank has identified the most significant Year 2000 issues. These costs do not include the costs of personnel who have performed Year 2000 functions in addition to their regular responsibilities during this time of preparation. The Subsidiary Bank has continued to communicate with third party vendors and suppliers to update documentation from them in regard to their Year 2000 readiness. The majority of these vendors and suppliers have stated that they have successfully completed their renovations and testing. Questionnaires were mailed to significant loan customers (limited to commercial purpose loans) to determine the effectiveness of their Year 2000 preparation including anticipated problems and proposed solutions. Written responses were requested with approximately 69% responding as of mid-March 1999. Response and no response customers are being evaluated (95% evaluated to date) by loan personnel, and additions to the reserve for loan losses will be made if necessary. At this time, the Subsidiary Bank does not expect any of these loan customer Year 2000 situations to have an adverse material impact on Bank operations. The aggregate balances (including available but not outstanding amounts on lines of credit) of the loan customers questioned represent approximately 27% of the Bank's total loan portfolio. In the near future, questionnaires will be sent to significant deposit customers and responses will be evaluated. The aggregate balances of the deposit customers who will be questioned represent 2% of the total deposit portfolio. The Year 2000 Committee has identified customer awareness as an important part of Year 2000 preparation. We have a Customer Awareness Policy and have mailed several communications to customers regarding Year 2000 plans. It is necessary that all customers understand that the Subsidiary Bank's deposits are insured by the Federal Deposit Insurance Corporation. The Year 2000 Committee has written a Year 2000 Contingency Plan which has been approved by the Board of Directors. Many issues were discussed during the development and planning for business resumption and remediation contingency plans. Responsibility and reporting structure have been designated. Critical personnel have been designated to be available as needed. Special staffing and hours have been approved as needed. Core business processes were identified. Event timelines were designated including critical testing dates. Numerous failure scenarios were discussed including power outages from complete to localized, telecommunications outages, water outages, various hardware and software failures, and lack of vendor supplies. Considerations were given to the following factors during the planning process: estimated costs, feasibility, functionality, and appropriateness. The most likely worst-case scenario would be a localized disruption or failure of power and/or telecommunications, although the Subsidiary Bank has no reason to conclude that these events will happen. If these events did occur, the Subsidiary Bank would implement its contingency plan. It is important for customers to understand that if a contingency plan is implemented there may be some customer inconvenience since service levels may not be at peak. -7- Finally, we must admit that even after detailed preparation as described above, there are no guarantees that the assumptions, estimates, tests and validation will be as we expect. The Corporation is still dependent on third party vendors and suppliers for a large part of our business operation. If events are not as the Corporation and our vendors expect, the Subsidiary Bank's business, results of operations and financial position could be materially adversely affected. INTEREST RATE SENSITIVITY The table below shows the opportunities the Corporation will have to reprice interest earning assets and interest bearing liabilities as of December 31, 1998. Nonaccrual loans are excluded from these balances.
Mature or Reprice After Three Months But After One Year Within Within But Within After Three Months Twelve Months Five Years Five Years Nonsensitive Interest Earning Assets: Fixed rate loans $ 8 214 733 $21 503 255 $41 111 453 $ 2 559 819 $ - - Floating rate loans 4 417 276 - - - - - - - - Securities 3 000 937 10 571 656 36 185 768 - - 449 700 Securities purchased under agreements to resell and federal funds sold 13 483 258 - - - - - - - - ----------- ----------- ---------- ----------- ----------- Total $29 116 204 $32 074 911 $77 297 221 $ 2 559 819 $ 449 700 ----------- ----------- ----------- ----------- ----------- Interest Bearing Liabilities: Time deposits $100,000 and over $ 779 128 $ 1 643 375 $2 587 927 $ - - $ - - Other time deposits 6 601 677 19 591 090 11 532 077 - - - - Money market accounts 7 292 223 - - - - - - - - NOW accounts 29 111 469 - - - - - - 16 810 385 Savings accounts - - - - - - - - 17 294 315 ----------- ----------- ---------- ----------- ----------- Total $43 784 497 $21 234 465 $14 120 004 $ - - $ 34 104 700 ----------- ----------- ----------- ----------- ------------ Rate Sensitivity Gap $(14 668 293) $10 840 446 $63 177 217 $ 2 559 819 ------------ ----------- ----------- ----------- Cumulative Gap $(14 668 293) $(3 827 847) $59 349 370 $ 61 909 189 ============ =========== =========== ============
At December 31, 1998, the Corporation showed negative cumulative gaps in the first two time frames with the remaining time frames showing positive gaps. The increase in the negative gap in the first time frame when comparing to December 31, 1997 is due to the increase in Select Checking account balances (Select Checking is a form of NOW account). The Select Checking pays a higher rate of interest on balances of $5,000 or more and were started in August of 1997 because competition was increasing with similar types of accounts. While serving the customer well, these accounts are not favorable to the Corporation's liability sensitive position. The Corporation's Asset Liability Committee recommended that the APY (annual percentage yield) on these Select Checking accounts be gradually reduced until the balances stopped increasing. However, to date this strategy which was accepted by the Board of Directors has not been successful. The increase in Select Checking accounts is basically the only change in the Corporation's balance sheet during 1998 and therefore the major cause of the increased liability sensitive positions in the first two time frames. The Committee explored several other options during the year to decrease liability sensitivity, but the consensus of opinion was not to adopt any of the suggested strategies. As stated in previous years, an even match between assets and liabilities in each time frame is the safest position especially in times of rapidly rising or declining rates. During other times, the even match is not as critical. The advantages or disadvantages of positive and negative gaps depend totally on the direction in which interest rates are moving. An asset sensitive institution's net interest margin and net interest income generally will be impacted favorably by rising interest rates, while that of a liability sensitive institution generally will be impacted favorably by declining interest rates. -8- LOAN PORTFOLIO Loans at December 31, 1998 and 1997 are summarized below: 1998 1997 ----------- ----------- Commercial, financial and agricultural $ 2 433 571 $2 314 804 Real estate: Construction and land development 651 848 393 187 Secured by farm land 1 394 201 1 717 930 Secured by 1-4 family residential 42 541 181 43 282 898 Other real estate 12 623 662 12 496 739 Consumer 17 738 039 17 705 824 All other 424 034 301 580 ----------- ---------- $ 77 806 536 $78 212 962 ============ =========== Loans have decreased slightly when comparing year end totals for 1998 and 1997, while the average balance for total loans has increased approximately $1,700,000 in 1998 compared to 1997. There are no significant differences between categories in the loan portfolios when comparing 1998 to 1997. There were no categories of loans that exceeded 10% of outstanding loans at December 31, 1998 which were not disclosed in the table above. REMAINING MATURITIES OF SELECTED LOANS Commercial, Financial and Real Estate- Agricultural Construction Within one year $ 2 050 883 $ 109 436 Variable rate 248 030 48 000 Fixed rate, over one through five years 134 658 494 412 ---------- ---------- Total maturities $ 2 433 571 $ 651 848 =========== ========== ALLOWANCE FOR LOAN LOSSES The table shown below is an analysis of the Corporation's allowance for loan losses. Historically, net charge-offs (loans charged off as uncollectible less any amounts recovered on these loans) for the Corporation have been very low when compared with the size of the total loan portfolio. Management continually monitors the loan portfolio with quarterly procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Based on experience, the loan policies and the current monitoring program, management believes the loan loss reserve is adequate.
1998 1997 1996 ----------- ----------- ----------- Balance at beginning of period $ 1 138 747 $1 138 747 $ 899 245 Charge-offs: Commercial, financial and agricultural - - - - - - Real estate - construction - - - - - - Real estate - mortgage - - - - - - Consumer 166 722 175 828 98 124 ----------- ----------- ----------- Total charge-offs 166 722 175 828 98 124 ----------- ----------- ----------- Recoveries: Commercial, financial and agricultural - - - - - - Real estate - construction - - - - - - Real estate - mortgage - - - - 186 534 Consumer 42 730 48 420 51 092 ----------- ----------- ----------- Total recoveries 42 730 48 420 237 626 ----------- ----------- ----------- Net charge-offs (recoveries) 123 992 127 408 (139 502) Additions charged to operations 125 245 127 408 100 000 ----------- ----------- ----------- Balance at end of period $ 1 140 000 $ 1 138 747 $ 1 138 747 =========== =========== =========== Ratio of net charge-offs (recoveries) during the period to average loans outstanding during the period 0.16% 0.17% (0.19)% ==== ==== =====
-9- ALLOCATION OF RESERVE FOR LOAN LOSSES The following table shows an allocation of the reserve among loan categories based upon analysis of the loan portfolio's composition, historical loan loss experience, and other factors, and the ratio of the related outstanding loan balances to total loans. This analysis is recorded each quarter with monitoring procedures where all loans are examined and problem loans and potentially problem loans are highlighted for continued observance.
1998 1997 ------------------------------ ------------------------------ Percent of Loans Percent of Loans in Each Category in Each Category Reserve to Total Loans Reserve to Total Loans --------- ---------------- --------- ---------------- Commercial, financial and agricultural $ 12 168 3.13% $ 11 575 2.95% Real estate mortgage: Construction and land development 52 759 .84% 51 466 .50% Secured by farm land 6 971 1.79% 35 679 2.20% Secured by 1-4 family residential 294 588 54.68% 272 837 55.34% Other real estate 288 405 16.22% 210 719 15.98% Consumer 103 769 22.80% 100 671 22.64% All other 2 120 .54% 1 506 .39% Unallocated 379 220 - - 454 294 - - --------- ------ --------- ------ $1 140 000 100.00% $1 138 747 100.00% ========== ====== ========== ====== RISK ELEMENTS IN THE LOAN PORTFOLIO 1998 1997 1996 --------- --------- --------- Nonaccrual loans $ - - $ 285 150 $ 285 150 Restructured loans - - - - - - Foreclosed properties 55 425 100 005 - - --------- --------- --------- Total nonperforming assets $ 55 425 $ 385 155 $ 285 150 ========= ========= ========= Loans past due 90 days accruing interest $ 596 877 $ 19 923 $ 48 663 ========= ========= ========= Reserve for loan losses to period end loans 1.47% 1.46% 1.55% Nonperforming assets to period end loans and foreclosed properties .07% .49% .39%
Loans are placed on nonaccrual status when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Impaired loans excluded from nonperforming assets amounted to $397,986 at December 31, 1998 and 1997. At December 31, 1998, other potential problem loans totaled $100,079. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis. Management has allocated a portion of the allowance for these loans according to the review of the potential loss in each loan situation. SECURITIES PORTFOLIO In accordance with FASB No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Corporation records securities being held to maturity at amortized cost and securities available for sale at fair value. The effect of unrealized gains and losses, net of tax effects, is recognized in stockholders' equity. The Corporation does not have any derivative financial instruments. -10- The schedule below summarizes the book value of the portfolio by maturity classifications and shows the weighted average yield in each group.
Weighted Weighted 1998 Average 1997 Average Book Value Yield Book Value Yield Securities held to maturity U.S. Treasury securities and securities of U.S. Government agencies: Maturing within one year $10 018 466 5.84% $ 9 995 556 5.98% Maturing after one year but within five years 15 010 863 5.79% 14 044 650 5.90% ----------- ----------- Total securities held to maturity $ 25 029 329 $24 040 206 ============ =========== Securities available for sale U.S. Treasury securities and securities of U.S. government agencies: Maturing within one year $3 554 127 5.01% $ 3 000 000 6.09% Maturing after one year but within five years 21 174 905 5.43% 10 002 502 5.66% Equity securities 449 700 - - 401 600 - - ----------- ----------- Total securities available for sale $ 25 178 732 $13 404 102 ============ =========== Total securities $ 50 208 061 $37 444 308 ============ ===========
DEPOSITS When comparing the 1998 and 1997 year end balances, total deposits increased over $16,400,000 or 14.44% in 1998. Noninterest bearing demand deposits increased over $2,400,000 or 16.04%. Time deposits increased almost $2,000,000 or 4.88%. The most significant change in deposits was in the savings and interest bearing demand category which increased over $12,000,000 or 20.69%. The Select Checking balances (a form of NOW account that pays a higher interest rate on balances of $5,000 or more) increased over $18,000,000. Approximately $5,000,000 moved from Money Market accounts to Select Checking. Balances of NOW accounts and savings accounts remained basically the same when comparing year end balances of 1998 and 1997. The average yield on savings and interest bearing demand deposits increased from 2.62% at year end 1997 to 3.18% at December 31, 1998. This increase is due to the higher rates paid on Select Checking balances during 1998. The average yield on time deposits increased slightly in 1998 to 5.59% compared to 5.48% in 1997. At December 31, 1998, time deposits of $100,000 or more were 3.8% of total deposits compared with 4.0% at December 31, 1997. Maturities of time deposits of $100,000 or more at December 31, 1998 are as follows: Within three months $ 779 128 Over three through six months 528 599 Over six months through twelve months 1 114 776 Over twelve months 2 587 927 ---------- Total $5 010 430 ========== ANALYSIS OF CAPITAL The adequacy of the Corporation's capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Corporation's asset and liability levels and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. -11- The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The Corporation had a ratio of total capital to risk-weighted assets of 23.89% at December 31, 1998 and a ratio of Tier 1 capital to risk-weighted assets of 22.64%. Both of these exceed the capital requirements adopted by the federal regulatory agencies. 1998 1997 ------------ ------------ Tier 1 capital: Common stock $ 600 000 $ 600 000 Surplus 5 400 000 5 400 000 Retained earnings 10 090 870 9 291 741 ------------ ------------ Total tier 1 capital $16 090 870 $15 291 741 Tier 2 capital: Allowance for loan losses (1) 891 693 829 378 ------------ ------------ Total risk-based capital $ 16 982 563 $ 16 121 119 ============ ============ Risk-weighted assets $ 71 087 152 $ 66 040 845 ============ ============ Capital ratios: Tier 1 risk-based capital ratio 22.64% 23.15% Total risk-based capital ratio 23.89% 24.41% Leverage ratio 11.15% 11.83% (1) Limited to 1.25% of gross risk-weighted assets. LIQUIDITY Liquidity represents an institution's ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. This could also be termed the management of the cash flows of an organization. Liquid assets include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The Corporation's liquidity during 1998 (aside from borrowing capabilities) is detailed in the statement of cash flows included in the financial statements. Operating cash flows are derived from net income adjusted for items that do not involve cash. Cash flows from investing activities include maturity of securities and payments on and maturities of loans. Cash flows from financing activities include increases in any deposit accounts. As a result of the Corporation's management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Corporation's overall liquidity is sufficient to satisfy its depositors' requirements and to meet its customers' credit needs. At December 31, 1998, cash and due from banks, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $50,785,000. Borrowing capabilities provide additional liquidity. The Subsidiary Bank maintains a federal funds line of $5,000,000 with NationsBank, N.A. The Subsidiary Bank is also a member of the Federal Home Loan Bank of Pittsburgh and has short and/or long-term borrowing capabilities of approximately $45,000,000. The Subsidiary Bank did not use either of these sources during 1998. ACCOUNTING RULE CHANGES In June 1998, FASB issued FAS 133, "Accounting for Derivative Instruments and Hedging Activities." FAS 133 establishes accounting and reporting standards for derivative financial instruments and other similar financial instruments and for hedging activities. The standard also allows securities classified as held-to-maturity to be transferred to the available-for-sale category at the date of initial application of this standard. FAS 133 is effective for all fiscal years beginning after June 15, 1999. Management is currently reviewing this statement to determine the impact, if any, it will have since the Corporation currently has no derivative instruments. -12- INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders Potomac Bancshares, Inc. and Subsidiary Charles Town, West Virginia We have audited the accompanying consolidated balance sheets of Potomac Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years ended December 31, 1998, 1997 and 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Potomac Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years ended December 31, 1998, 1997 and 1996, in conformity with generally accepted accounting principles. Winchester, Virginia January 29, 1999 -13- CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
1998 1997 -------------- ------------- ASSETS Cash and due from banks $ 4 646 475 $ 4 517 965 Securities purchased under agreements to resell and federal funds sold 13 483 258 8 600 000 Securities (fair value: 1998, $50,530,066; 1997, $37,507,918) 50 208 061 37 444 308 Loans 77 806 536 78 212 962 Reserve for loan losses (1 140 000) (1 138 747) -------------- ------------- Net loans 76 666 536 77 074 215 Premises and equipment, net 1 223 979 1 201 550 Accrued interest receivable 1 167 699 1 008 357 Other assets 707 556 710 133 -------------- ------------- Total Assets $ 148 103 564 $ 130 556 528 ============== ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Noninterest bearing demand deposits $ 17 421 542 $ 15 013 619 Savings and interest bearing demand deposits 70 508 392 58 419 752 Time deposits 42 735 274 40 748 551 -------------- ------------- Total Deposits $ 130 665 208 $ 114 181 922 Accrued interest payable 350 258 342 503 Other liabilities 891 942 734 152 Commitments and contingent liabilities - - - - -------------- ------------- Total Liabilities $ 131 907 408 $ 115 258 577 -------------- ------------- STOCKHOLDERS' EQUITY Common stock, $1 per share par value; 5,000,000 shares authorized; 600,000 shares issued and outstanding $ 600 000 $ 600 000 Surplus 5 400 000 5 400 000 Undivided profits 10 090 870 9 291 741 Accumulated other comprehensive income 105 286 6 210 -------------- ------------- Total Stockholders' Equity $ 16 196 156 $ 15 297 951 -------------- ------------- Total Liabilities and Stockholders' Equity $ 148 103 564 $ 130 556 528 ============== =============
See Notes to Consolidated Financial Statements. -14- CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------- ------------ ------------ Interest Income: Interest and fees on loans $ 6 989 025 $ 7 018 882 $ 6 749 755 Interest on investment securities Taxable 1 702 127 1 628 597 1 213 709 Interest and dividends on securities available for sale Taxable 881 103 691 203 661 125 Dividends 27 528 25 006 24 322 Interest on securities purchased under agreements to resell and federal funds sold 455 539 198 926 437 034 ------------- ------------ ------------ Total Interest Income $ 10 055 322 $ 9 562 614 $ 9 085 945 ------------- ------------ ------------ Interest Expense: Interest on deposits $ 4 400 932 $ 3 693 476 $ 3 623 243 Interest on federal funds purchased and securities sold under agreements to repurchase - - 16 219 - - ------------- ------------ ------------ Total Interest Expense $ 4 400 932 $ 3 709 695 $ 3 623 243 ------------- ------------ ------------ Net Interest Income $ 5 654 390 $ 5 852 919 $ 5 462 702 Provision for Loan Losses 125 245 127 408 100 000 ------------- ------------ ------------ Net Interest Income after Provision for Loan Losses $ 5 529 145 $ 5 725 511 $ 5 362 702 ------------- ------------ ------------ Other Income: Trust and financial services $ 555 101 $ 522 023 $ 460 053 Service charges on deposit accounts 378 523 403 006 318 062 Fees for other customer services 161 298 162 423 181 980 Other operating income 30 746 40 933 28 730 ------------- ------------ ------------ Total Other Income $ 1 125 668 $ 1 128 385 $ 988 825 ------------- ------------ ------------ Other Expenses: Salaries and employee benefits $ 2 627 960 $ 2 473 151 $ 2 468 762 Net occupancy expense of premises 183 917 194 426 203 033 Furniture and equipment expenses 361 798 348 798 300 211 Stationery and supplies 104 927 109 472 106 810 Directors fees 103 630 102 330 105 700 ATM expenses 72 078 75 766 105 445 Other operating expenses 842 650 822 628 823 555 ------------- ------------ ------------ Total Other Expenses $ 4 296 960 $ 4 126 571 $ 4 113 516 ------------- ------------ ------------ Income before Income Tax Expense $ 2 357 853 $ 2 727 325 $ 2 238 011 Income Tax Expense 868 724 1 005 621 830 577 ------------- ------------ ------------ Net Income $ 1 489 129 $ 1 721 704 $ 1 407 434 ============= ============ ============ Earnings Per Share, basic and diluted $ 2.48 $ 2.87 $ 2.35 ============= ============ ============
See Notes to Consolidated Financial Statements. -15- CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Accumulated Other Common Undivided Comprehensive Comprehensive Stock Surplus Profits Income Income Total -------- ---------- ---------- ------------- ------------- ----------- Balances, December 31, 1995 $600 000 $5 400 000 $7 422 603 $- - $13 422 603 Comprehensive income Net income - 1996 - - - - 1 407 434 - - $1 407 434 1 407 434 Other comprehensive income net of tax, unrealized holding (losses) arising during the period (net of tax, $21,018) - - - - - - (40 800) (40 800) (40 800) ---------- Comprehensive income $1 366 634 ========== Cash dividends - 1996 ($.95 per share) - - - - (570 000) - - (570 000) -------- ---------- ---------- -------- ------------ Balances, December 31, 1996 $600 000 $5 400 000 $8 260 037 $(40 800) $ 14 219 237 Comprehensive income Net income - 1997 - - - - 1 721 704 - - $1 721 704 1 721 704 Other comprehensive income net of tax, unrealized holding gains arising during the period (net of tax, $24,217) - - - - - - 47 010 47 010 47 010 ---------- Comprehensive income $1 768 714 ========== Cash dividends - 1997 ($1.15 per share) - - - - (690 000) - - (690 000) -------- ---------- ---------- -------- ------------ Balances, December 31, 1997 $600 000 $5 400 000 $9 291 741 $6 210 $ 15 297 951 Comprehensive income Net income - 1998 - - - - 1 489 129 - - $1 489 129 1 489 129 Other comprehensive income net of tax, unrealized holding gains arising during the period (net of tax, $51,039) - - - - - - 99 076 99 076 99 076 ---------- Comprehensive income $1 588 205 ========== Cash dividends - 1998 ($1.15 per share) - - - - (690 000) - - (690 000) -------- ---------- ---------- -------- ------------ Balances, December 31, 1998 $600 000 $5 400 000 $10 090 870 $105 286 $ 16 196 156 ======== ========== =========== ======== ============
See Notes to Consolidated Financial Statements. -16- CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1 489 129 $ 1 721 704 $ 1 407 434 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 125 245 127 408 100 000 Depreciation 212 287 208 809 181 424 Amortization 12 282 12 282 12 282 Deferred income tax (credits) (43 592) (40 759) (88 111) Discount accretion and premium amortization on securities, net 19 416 28 853 27 060 Loss on sale of real estate 9 579 - - 94 972 Changes in assets and liabilities: (Increase) decrease in accrued interest receivable (159 342) 12 859 (243 706) (Increase) decrease in other assets (61 732) (19 025) 15 002 Increase (decrease) in accrued interest payable 7 755 16 459 (20 196) Increase in other liabilities 157 790 8 837 237 283 ------------ ----------- ----------- Net cash provided by operating activities $ 1 768 817 $ 2 077 427 $ 1 723 444 ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturity of investment securities $ 10 000 000 $ 8 000 000 $18 000 000 Proceeds from maturity of securities available for sale 3 000 000 8 000 000 - - Purchases of investment securities (11 014 326) (6 049 375) (17 996 884) Purchases of securities available for sale (14 618 728) (7 019 050) (14 071 795) Net (increase) decrease in loans 226 428 (4 915 035) 265 336 Purchases of premises and equipment (234 716) (155 966) (318 897) Proceeds from sale of real estate 91 007 - - 350 000 ------------ ----------- ----------- Net cash (used in) investing activities $(12 550 335) $(2 139 426) $(13 772 240) ------------ ----------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase in noninterest bearing demand deposits $ 2 407 923 $ 977 121 $ 188 872 Net increase (decrease) in savings and interest bearing demand deposits 12 088 640 3 336 332 (1 407 379) Net increase (decrease) in time deposits 1 986 723 1 356 000 (58 498) Cash dividends (690 000) (690 000) (570 000) ------------ ------------- ------------ Net cash provided by (used in) financing activities $15 793 286 $ 4 979 453 $ (1 847 005) ------------ ------------- ------------ Increase (decrease) in cash and cash equivalents $ 5 011 768 $ 4 917 454 $(13 895 801) CASH AND CASH EQUIVALENTS Beginning 13 117 965 8 200 511 22 096 312 ------------ ------------- ------------ Ending $ 18 129 733 $ 13 117 965 $ 8 200 511 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 4 393 177 $ 3 693 236 $ 3 643 439 ============ =========== =========== Income taxes $902 011 $ 1 202 017 $ 806 431 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES Other real estate acquired in settlement of loans $ 110 006 $ 100 005 $ - - ============ =========== =========== Loans made on sale of real estate $ 54 000 $ - - $ 291 000 ============ =========== =========== Unrealized gain (loss) on securities available for sale $ 150 115 $ 71 227 $ (61 818) ============ =========== ===========
See Notes to Consolidated Financial Statements. -17- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Banking Activities and Significant Accounting Policies Potomac Bancshares, Inc. and Subsidiary (the Corporation) grant commercial, financial, agricultural, residential and consumer loans to customers, primarily in Jefferson County, West Virginia. The Corporation's market area also includes Washington County and Frederick County, Maryland; Loudoun County and Clarke County, Virginia; and Berkeley County, West Virginia. The loan portfolio is well diversified and loans generally are collaterized by assets of the customers. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers. The accounting and reporting policies of the Corporation conform to generally accepted accounting principles and to general practices within the banking industry. The following is a summary of the more significant policies. Principles of Consolidation The consolidated financial statements of Potomac Bancshares, Inc. and its wholly-owned subsidiary, Bank of Charles Town (the Bank), include the accounts of both companies. All material intercompany balances and transactions have been eliminated in consolidation. Securities Investments are classified in three categories and accounted for as follows: a. Securities Held to Maturity Securities classified as held to maturity are those debt securities the Corporation has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. b. Securities Available for Sale Securities classified as available for sale are those debt and equity securities that the Corporation intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Corporation's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value. Unrealized gains or losses are reported as a separate component of other comprehensive income, net of tax. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. c. Trading Securities Trading securities, which are generally held for the short term in anticipation of market gains, are carried at fair value. Realized and unrealized gains and losses on trading account assets are included in interest income on trading account securities. The Corporation had no trading securities at December 31, 1998 and 1997. Loans Loans are stated at the amount of unpaid principal reduced by a reserve for possible loan losses. Interest income on loans is computed on the loan balance outstanding. Loans are charged off when in the opinion of management, they are deemed to be uncollectible after taking into consideration such factors as the current financial condition of the customer and the underlying collateral and guarantees. The Corporation has adopted Financial Accounting Standards Statement No. 114, "Accounting by Creditors for Impairment of a Loan." This Statement has been amended by FASB Statement No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." Statement 114, as amended, requires that the impairment of loans that have been separately identified for evaluation is to be measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment of those loans is to be based on the fair value of the collateral. Statement 114, as amended, also requires certain disclosures about investments in impaired loans and the reserve for loan losses and interest income recognized on loans. -18- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) The Corporation considers all consumer installment loans and residential mortgage loans to be homogeneous loans. These loans are not subject to impairment under FASB 114. A loan is considered impaired when it is probable that the Corporation will be unable to collect all principal and interest amounts according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and the current economic conditions. A performing loan may be considered impaired if the factors above indicate a need for impairment. A loan on nonaccrual status may not be impaired if in the process of collection or there is an insignificant shortfall in payment. An insignificant delay of less than 30 days or a shortfall of less than 5% of the required principal and interest payment generally does not indicate an impairment situation, if in management's judgment the loan will be paid in full. Loans that meet the regulatory definitions of doubtful or loss generally qualify as an impaired loan under FASB 114. Charge-offs for impaired loans occur when the loan, or portion of the loan is determined to be uncollectible, as is the case for all loans. Loans are placed on nonaccrual status when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Reserve for Loan Losses The reserve for loan losses is maintained at a level which, in management's judgement, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the reserve is based on management's evaluation of the collectibility of the loan portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Reserves for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The reserve is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the reserves relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related reserve may change in the near term. For federal income tax purposes, the Corporation deducts the maximum amount allowable under current income tax regulations. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily on the straight-line and declining-balance methods. Maintenance and repairs of property and equipment are charged to operations and major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts and gain or loss is included in operations. Other Real Estate Real estate acquired by foreclosure is carried at the lower of cost or fair market value, adjusted for anticipated selling expenses. Employee Benefit Plans The Corporation has a noncontributory, defined benefit pension plan covering employees meeting certain age and service requirements. The Corporation computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Board Statement No. 87, "Employers' Accounting for Pensions." The Corporation sponsors a postretirement life insurance plan covering retirees with 25 years of service over the age of 60 and health care plan for all retirees and five current employees that have met certain eligibility requirements. The Corporation computes the net periodic postretirement benefit cost of the plan in accordance with Financial Accounting Standards Board Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." In 1998, the Corporation adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This pronouncement does not change the measurement or recognition of amounts recognized in the Corporation's financial statements applicable to its defined benefit and postretirement plans. Statement No. 132 revises the existing disclosure requirements by standardizing the disclosure requirements for pensions requiring certain additional information on changes in the benefit obligations and fair values of plan assets, and eliminating certain disclosures. -19- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Earnings Per Share In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share." Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. The Corporation had no potential common stock as of December 31, 1998, 1997 and 1996. Income Taxes Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss carryforwards, and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, securities purchased under agreements to resell and federal funds sold. Generally, securities purchased under agreements to resell and federal funds sold are purchased and sold for one-day periods. Trust Division Securities and other property held by the Trust Division in a fiduciary or agency capacity are not assets of the Corporation and are not included in the accompanying financial statements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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 period. Actual results could differ from those estimates. Advertising The Corporation follows the policy of charging the costs of advertising to expense as incurred. Comprehensive Income As of January 1, 1998, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this statement had no impact on the Corporation's net income or stockholders' equity. The Statement requires other comprehensive income to include unrealized gains and losses on investments in securities classified as available for sale, which prior to adoption were reported separately in stockholders' equity. Financial statements for prior years have been reclassified to conform to the requirements of Statement No. 130. Note 2. Securities The amortized cost and fair value of securities being held to maturity as of December 31, 1998 and 1997, are as follows:
1998 ----------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- --------- ----------- U.S. Treasury securities $17 008 734 $ 229 475 $ - - $17 238 209 Obligations of U.S. Government agencies 8 020 595 92 530 - - 8 113 125 ----------- ---------- --------- ----------- $25 029 329 $ 322 005 $ - - $25 351 334 =========== ========== ========= ===========
-20- Note 2. Securities (Continued)
1997 ----------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- --------- ----------- U.S. Treasury securities $12 045 427 $ 32 708 $ (1 570) $12 076 565 Obligations of U.S. Government agencies 11 994 779 32 472 - - 12 027 251 ----------- ---------- --------- ----------- $24 040 206 $ 65 180 $ (1 570) $24 103 816 =========== ========== ========= =========== The amortized cost and fair value of the securities being held to maturity as of December 31, 1998, by contractual maturity, are shown below: Amortized Fair Cost Value ----------- ----------- Due in one year or less $10 018 466 $10 104 375 Due after one year through five years 15 010 863 15 246 959 ----------- ----------- $25 029 329 $25 351 334 =========== =========== There were no sales of securities being held to maturity during 1998, 1997 and 1996. Securities being held to maturity with a carrying value of $6,024,899 and $7,013,601 at December 31, 1998 and 1997, were pledged to secure public funds and other balances as required by law. The amortized cost and fair value of securities available for sale as of December 31, 1998 and 1997 are as follows: 1998 ----------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- --------- ----------- U.S. Treasury securities $ 4 999 573 $ 43 239 $ - - $ 5 042 812 Obligations of U.S. Government agencies 19 569 935 140 337 (24 052) 19 686 220 Federal Home Loan Bank stock 449 700 - - - - 449 700 ----------- ---------- --------- ----------- $25 019 208 $ 183 576 $ (24 052) $25 178 732 =========== ========== ========= =========== 1997 ----------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- --------- ----------- U.S. Treasury securities $ 7 988 435 $ 25 941 $ (19 687) $ 7 994 689 Obligations of U.S. Government agencies 5 004 655 4 408 (1 250) 5 007 813 Federal Home Loan Bank stock 401 600 - - - - 401 600 $13 394 690 $ 30 349 $ (20 937) $13 404 102 =========== ========== ========= =========== The amortized cost and fair value of the securities available for sale as of December 31, 1998, by contractual maturity, are shown below: Amortized Fair Cost Value ----------- ----------- Due in one year or less $ 3 552 553 $ 3 554 127 Due after one year through five years 21 016 955 21 174 905 Other 449 700 449 700 ----------- ----------- $25 019 208 $25 178 732 =========== ===========
There were no sales of securities available for sale during 1998, 1997 and 1996. Securities available for sale with a carrying value of $2,005,174 and $1,988,991 at December 31, 1998 and 1997, were pledged to secure public funds and other balances as required by law. -21- Note 3. Loans and Related Party Transactions The loan portfolio is composed of the following:
December 31 ------------------------- 1998 1997 ----------- ----------- Real estate loans: Construction and land development $ 651 848 $ 393 187 Secured by farm land 1 394 201 1 717 930 Secured by 1-4 family residential 42 541 181 43 282 898 Other real estate loans 12 623 662 12 496 739 Loans to farmers (except those secured by real estate) 246 100 269 682 Commercial and industrial loans (except those secured by real estate) 2 187 471 2 045 122 Loans to individuals for personal expenditures 17 738 039 17 705 824 All other loans 424 034 301 580 ----------- ----------- $77 806 536 $78 212 962 =========== =========== The Securities and Exchange Commission requires disclosure of loans which exceed $60,000 to executive officers and directors of the Corporation or to their associates. Such loans were made on substantially the same terms as those prevailing for comparable transactions with similar risks. At December 31, 1998 and 1997, these loans totaled $214,881 and $674,248 respectively. During 1998, total principal additions were $279,722 and total principal payments were $739,089. Note 4. Reserve for Loan Losses The following is a summary of transactions in the reserve for loan losses for 1998, 1997 and 1996: 1998 1997 1996 ---------- ---------- ---------- Balances at beginning of year $1 138 747 $1 138 747 $ 899 245 Provision charged to operating expense 125 245 127 408 100 000 Recoveries added to the reserve 42 730 48 420 237 626 Loan losses charged to the reserve (166 722) (175 828) (98 124) ---------- ---------- ---------- Balances at end of year $1 140 000 $1 138 747 $1 138 747 ========== ========== ========== Information about impaired loans as of and for the years ended December 31, 1998 and 1997 are as follows: 1998 1997 ---------- ---------- Impaired loans for which a reserve has been provided $ 397 986 $ 397 986 Impaired loans for which no reserve has been provided - - - - Total impaired loans $ 397 986 $ 397 986 ========== ========== Reserve provided for impaired loans, included in the reserve for loan losses $198 993 $ 198 993 ========== ========== 1998 1997 1996 ---------- ---------- ---------- Average balance in impaired loans $397 986 $ 399 178 $ 472 292 ========== ========== ========== Interest income recognized $ 34 062 $ 34 271 $ 36 125 ========== ========== ==========
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 amounted to $-0- at December 31, 1998 and $285,150 at December 31, 1997. If interest on these loans had been accrued, such income would have approximated $-0- in 1998 and $29,267 in 1997. -22- Note 5. Premises and Equipment, Net Premises and equipment consists of the following: December 31 ------------------------- 1998 1997 ---------- ----------- Premises $1 851 509 $ 1 813 763 Furniture and equipment 2 458 650 2 262 136 ---------- ----------- $4 310 159 $ 4 075 899 Less accumulated depreciation 3 086 180 2 874 349 $1 223 979 $ 1 201 550 ========== =========== Depreciation included in operating expense for 1998, 1997 and 1996, was $212,287, $208,809 and $181,424 respectively. Note 6. Deposits The aggregate amount of time deposits with a balance of $100,000 or more was $5,010,430 and $4,513,606 at December 31, 1998 and 1997, respectively. At December 31, 1998, the scheduled maturities of all time deposits are as follows: 1999 $28 614 874 2000 10 222 428 2001 2 567 506 2002 1 328 466 2003 and thereafter 2 000 ----------- $42 735 274 =========== Note 7. Employee Benefit Plans The Corporation sponsors a noncontributory, defined benefit pension plan covering full-time employees over 21 years of age upon completion of one year of service. Benefits are based on average compensation for the five consecutive full calendar years of service which produce the highest average. The Corporation computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Board Statement No. 87, "Employers' Accounting for Pensions." The Corporation sponsors a postretirement life insurance plan covering retirees with 25 years of service over the age of 60 and health care plan for all retirees and five current employees that have met certain eligibility requirements. The plan is contributory for future retirees, with retiree contributions that are currently set at 20% of the required premium. Effective January 1, 1995, the Corporation adopted Financial Accounting Standards Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," to account for its share of the costs of those benefits. Under that Statement, the Corporation's share of the estimated costs that will be paid after retirement is generally being accrued by charges to expense over the employees' active service periods to the dates they are fully eligible for benefits, except that the Corporation's unfunded cost that existed at January 1, 1995 is being accrued primarily in a straight-line manner that will result in its full accrual by December 31, 2014. -23- Note 7. Employee Benefit Plans (Continued) Information about the plans follow:
Pension Benefits Postretirement Benefits ----------------------------- ------------------------- 1998 1997 1998 1997 ---------- ---------- ---------- --------- Change in Benefit Obligation: Benefit obligation, beginning $3 339 744 $2 866 017 $ 463 642 $ 422 021 Service cost 156 373 129 289 7 904 7 249 Interest cost 262 650 220 359 38 337 34 342 Actuarial loss 337 654 183 315 52 976 21 871 Benefits paid (119 720) (98 157) (28 014) (21 841) Change in discount rate 152 549 38 921 - - - - ---------- ---------- ---------- --------- Benefit obligation, ending $4 129 250 $3 339 744 $ 534 845 $ 463 642 ---------- ---------- ---------- --------- Change in Plan Assets: Fair value of plan assets, beginning $3 337 355 $ 2 888 800 $ - - $ - - Actual return on plan assets 199 055 546 712 - - - - Employer contributions - - - - 28 014 21 841 Benefits paid (119 720) (98 157) (28 014) (21 841) ---------- ---------- ---------- --------- Fair value of plan assets, ending $3 416 690 $ 3 337 355 $ - - $ - - ---------- ---------- ---------- --------- Funded status $(712 560) $ (2 389) $ (534 845) $(463 642) Unrecognized net (gain) loss 197 926 (372 224) 17 979 (6 950) Accumulated premium payments for retirees - - - - 94 851 66 837 Unrecognized net obligation (asset) at transition (137 245) (157 547) 278 588 295 851 Unrecognized prior service cost 1 335 1 490 - - - - ---------- ---------- ---------- --------- Accrued benefit cost included in other liabilities $(650 544) $ (530 670) $(143 427) $(107 904) ========= ========= ========= ========= Pension Benefits Postretirement Benefits ---------------------------------- ------------------------------ 1998 1997 1996 1998 1997 1996 --------- --------- -------- -------- -------- --------- Components of Net Periodic Benefit Cost: Service cost $156 373 $ 129 289 $ 133 596 $ 7 904 $ 7 249 $ 6 025 Interest cost 262 650 220 359 200 942 38 337 34 342 38 479 Expected return on plan assets (279 002) (241 937) (217 359) - - - - - - Amortization of prior service cost 155 155 155 - - - - - - Amortization of net obligation at transition (20 302) (20 302) (20 302) 17 296 17 568 19 670 --------- --------- -------- -------- -------- --------- Net periodic benefit cost $ 119 874 $ 87 564 $ 97 032 $ 63 537 $ 59 159 $ 64 174 ========= ========= ======== ======== ======== ========= Weighted-Average Assumptions: Discount rate 7.00% 7.25% 7.75% 8.00% 8.00% 8.00% Expected return on plan assets 8.50% 8.50% 8.50% - - - - - - Rate of compensation increase 5.00% 5.00% 6.00% - - - - - - For measurement purposes, a 10% annual rate of increase in per capita health care costs of covered benefits was assumed for 1998, 1997 and 1996, with such annual rate of increase gradually declining to 5% in 2013. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1% change in assumed health care cost trend rates would have the following effects: 1% Increase 1% Decrease ----------- ----------- Effect on the health care component of the accumulated postretirement benefit obligation $ 33 619 $ (29 555) Effect on total of service and interest cost components of net periodic postretirement health care benefit cost 3 340 (3 610)
-24- Note 8. Income Taxes Net deferred tax assets consist of the following components as of December 31, 1998 and 1997: 1998 1997 ---------- ----------- Deferred tax assets: Reserve for loan losses $ 232 271 $ 231 845 Accrued pension expense 221 185 180 428 Accrued postretirement benefits 48 765 36 687 Nonaccrual interest - - 10 880 ---------- ----------- $ 502 221 $ 459 840 ---------- ----------- Deferred tax liabilities: Premises $ 25 800 $ 27 012 Securities available for sale 54 239 3 199 $ 80 039 $ 30 211 ---------- ----------- Net deferred tax assets $ 422 182 $ 429 629 ========== =========== The provision for income taxes charged to operations for the years ended December 31, 1998, 1997 and 1996 consists of the following:
1998 1997 1996 ---------- ----------- ----------- Current tax expense $ 912 317 $ 1 046 380 $ 918 688 Deferred tax expense (benefit) (43 593) (40 759) (88 111) ---------- ----------- ----------- $ 868 724 $ 1 005 621 $ 830 577 ========== =========== =========== The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the years ended December 31, 1998, 1997 and 1996 due to the following: 1998 1997 1996 ---------- ----------- ----------- Computed "expected" tax expense $ 801 670 $ 927 291 $ 760 924 Increase (decrease) in income taxes resulting from: Tax exempt interest income (4 627) (3 353) (6 809) State income taxes, net of federal income tax benefit 69 385 79 092 74 544 Other 2 296 2 591 1 918 ---------- ----------- ----------- $ 868 724 $ 1 005 621 $ 830 577 ========== =========== ===========
Note 9. Commitments and Contingent Liabilities In the normal course of business, there are outstanding, various commitments and contingent liabilities which are not reflected in the accompanying financial statements. The Corporation does not anticipate losses as a result of these transactions. See Note 11 with respect to financial instruments with off-balance-sheet risk. The Corporation has approximately $2,303,481 in deposits in another financial institution in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 1998. The Corporation must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final bi-weekly reporting periods which included December 31, 1998 and 1997, the aggregate amounts of daily average required balances were approximately $2,484,000 and $990,000, respectively. The Corporation is conducting a comprehensive review of its computer systems to identify the systems that could be affected by the Year 2000 Issue, and is developing a remediation plan to resolve the Issue. The Issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Corporation is heavily dependent on computer processing in the conduct of its business activities. Failure of these systems could have a significant impact on the Corporation's operations. -25- Note 10. Retained Earnings Transfers of funds from the banking subsidiary to the parent corporation in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities. As of December 31, 1998, the aggregate amount of unrestricted funds which could be transferred from the banking subsidiary to the parent corporation, without prior regulatory approval, totaled $2,723,034 or 16.8% of the consolidated net assets. Note 11. 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. Those financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional 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. A summary of the contract or notional amount of the Corporation's exposure to off-balance-sheet risk as of December 31, 1998 and 1997, is as follows:
1998 1997 ----------- ---------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $12 225 851 $8 538 048 Standby letters of credit 3 900 144 639
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do 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 and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation holds real estate as collateral supporting those commitments for which collateral is deemed necessary. No collateral was held for commitments as of December 31, 1998. Note 12. Disclosures About Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Short-Term Investments For those short-term instruments, the carrying amount is a reasonable estimate of fair value. Securities For securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. Loans For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered. -26- Note 12. Disclosures About Fair Value of Financial Instruments (Continued) Deposit Liabilities The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Off-Balance Sheet Financial Instruments The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At December 31, 1998 and 1997, the difference between the carrying amounts and fair values of loan commitments and standby-letters of credit were immaterial. The estimated fair values of the Corporation's financial instruments are as follows:
1998 1997 ----------------------- ----------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- (in thousands) (in thousands) Financial assets: Cash $ 4 646 $ 4 646 $ 4 518 $ 4 518 Securities purchased under agreements to resell and federal funds sold 13 483 13 483 8 600 8 600 Securities 50 208 50 530 37 444 37 508 Loans 76 667 74 280 77 074 77 039 -------- -------- -------- -------- Total financial assets $145 004 $142 939 $ 127 636 $ 127 665 ======== ======== ========== ========== Financial liabilities: Deposits $130 665 $130 925 $ 114 182 $ 114 069 ======== ======== ========== ==========
Note 13. Regulatory Matters The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 1998, that the Corporation meets all capital adequacy requirements to which it is subject. As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation and the Federal Reserve Bank categorized the Corporation as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Corporation must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. -27- Note 13. Regulatory Matters (Continued) The Corporation's actual capital amounts and ratios are also presented in the table.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------- ------------------ ----------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (Amount in Thousands) As of December 31, 1998: Total capital (to risk-weighted assets): Consolidated $16 983 23.89% =>$5 687 => 8.0% N/A Bank of Charles Town $16 940 23.84% =>$5 685 => 8.0% =>$7 107 =>10.0% Tier 1 capital (to risk-weighted assets): Consolidated $16 091 22.64% =>$2 843 => 4.0% N/A Bank of Charles Town $16 048 22.58% =>$2 843 => 4.0% =>$4 264 => 6.0% Tier 1 capital (to average assets): Consolidated $16 091 11.15% =>$5 774 => 4.0% N/A Bank of Charles Town $16 048 11.12% =>$5 773 => 4.0% =>$7 217 => 5.0% As of December 31, 1997: Total capital (to risk-weighted assets): Consolidated $16 121 24.41% =>$5 283 => 8.0% N/A Bank of Charles Town $16 074 24.35% =>$5 281 => 8.0% =>$6 601 =>10.0% Tier 1 capital (to risk-weighted assets): Consolidated $15 292 23.15% =>$2 642 => 4.0% N/A Bank of Charles Town $15 245 23.09% =>$2 640 => 4.0% =>$3 961 => 6.0% Tier 1 capital (to average assets): Consolidated $15 292 11.83% =>$5 169 => 4.0% N/A Bank of Charles Town $15 245 11.80% =>$5 168 => 4.0% =>$6 460 => 5.0%
-28- Note 14. Parent Corporation Only Financial Statements POTOMAC BANCSHARES, INC. (Parent Corporation Only) Balance Sheets December 31, 1998 and 1997
1998 1997 ------------ ------------ ASSETS Cash $ 26 587 $ 20 705 Investment in subsidiary 16 153 510 15 250 816 Organization costs, net of accumulated amortization 7 165 19 447 Other assets 13 890 11 979 ----------- ----------- Total Assets $16 201 152 $15 302 947 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES, other $ 4 996 $ 4 996 ----------- ----------- STOCKHOLDERS' EQUITY Common stock $ 600 000 $ 600 000 Surplus 5 400 000 5 400 000 Undivided profits 10 090 870 9 291 741 Accumulated other comprehensive income 105 286 6 210 ----------- ----------- Total Stockholders' Equity $16 196 156 $15 297 951 ----------- ----------- Total Liabilities and Stockholders' Equity $16 201 152 $15 302 947 =========== =========== POTOMAC BANCSHARES, INC. (Parent Corporation Only) Statements of Income Years Ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------ ------------ ------------ Income Dividends from subsidiary $ 715 000 $ 690 000 $ 570 000 Expenses Amortization $ 12 282 $ 12 282 $ 12 282 Transfer agent expense 7 887 7 592 7 563 Legal and professional 4 634 2 831 2 575 Other operating expenses 18 394 14 710 13 858 ----------- ----------- ----------- Total Expenses $ 43 197 $ 37 415 $ 36 278 ----------- ----------- ----------- Income before Income Tax (Benefit) and Equity in Undistributed Income of Subsidiary $ 671 803 $ 652 585 $ 533 722 Income Tax (Benefit) (13 708) (11 797) (11 618) ----------- ----------- ----------- Income before Equity in Undistributed Income of Subsidiary $ 685 511 $ 664 382 $ 545 340 Equity in Undistributed Income of Subsidiary 803 618 1 057 322 862 094 ----------- ----------- ----------- Net Income $ 1 489 129 $ 1 721 704 $ 1 407 434 =========== =========== ===========
-29- Note 14. Parent Corporation Only Financial Statements (Continued) POTOMAC BANCSHARES, INC. (Parent Corporation Only) Statements of Cash Flows Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1 489 129 $ 1 721 704 $ 1 407 434 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed (income) of subsidiary (803 618) (1 057 322) (862 094) Amortization 12 282 12 282 12 282 (Increase) decrease in other assets (1 911) (180) 9 575 Increase in other liabilities - - - - 255 ----------- ----------- ----------- Net cash provided by operating activities $ 695 882 $ 676 484 $ 567 452 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Cash dividends $ (690 000) $ (690 000) $ (570 000) ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents $ 5 882 $ (13 516) $ (2 548) CASH AND CASH EQUIVALENTS Beginning 20 705 34 221 36 769 ----------- ----------- ----------- Ending $ 26 587 $ 20 705 $ 34 221 =========== =========== ===========
-30- TRUST AND FINANCIAL SERVICES Your trust department realized record income and asset balances in 1998! Trust assets as of December 31, 1998 totaled $90,189,000, an increase of $7,017,000 (8.44%) over December 31, 1997 footings of $83,172,000. Trust fees in 1998 totaled $555,101, an increase of $33,078 (6.34%) compared to $522,023 in 1997. The question of Y2K preparedness is a concern to all businesses and individuals as we approach the year 2000. The department administers its accounting system through the TRUST-RITE software system, developed and supported by one of the country's leading fiduciary correspondents, Northern Trust Company. The software has been verified for Y2K compliance by Northern and independent third party proxy testing. In 1999, the department will be moving to a temporary office at 202 West Washington Street during the renovation and construction of the new bank quarters at the Citizens Building. The temporary location will provide convenient access to customers visiting the main bank and trust department. We will enjoy greeting you in our relocated office over the next several months! The department continues to provide emphasis on personal trust service, specifically addressing the investment, financial management, third party "bill-paying", and estate settlement needs of our customers. Our dedication to the delivery of community bank service and our response to the financial and estate planning needs of our clients will continue to be the foundation of our fiduciary service. Robert L. Hersey Vice President and Trust Officer STATEMENT OF CONDITION DECEMBER 31, 1998 (unaudited) ASSETS Discretionary assets: Bank Deposits: Bank of Charles Town $ 259 000 Other Banks 215 000 United States Treasury and Agency Obligations 6 751 000 State, County, and Municipal Obligations 1 149 000 Short Term Interest Bearing Funds 6 720 000 Other Short Term Obligations 115 000 Notes and Bonds 6 076 000 Common and Preferred Stocks 37 563 000 Real Estate Mortgages 301 000 Real Estate 495 000 Miscellaneous Assets 5 000 ----------- Total Discretionary Assets $59 649 000 ----------- Non-Discretionary Assets $30 540 000 ----------- Total Assets $90 189 000 =========== ACCOUNTS Personal Trusts 154 $56 938 000 Estates and Other Court Accounts 35 6 999 000 Employee Benefit Accounts 25 5 082 000 Agencies and Other 78 21 170 000 --- ----------- Total Accounts 292 $90 189 000 === =========== -31- POTOMAC BANCSHARES, INC. Charles W. LeMaster, President & CEO William R. Harner, Sr. Vice President, Secretary & Treasurer L. Gayle Marshall Johnson, Vice President & Chief Financial Officer Donald S. Smith, Vice President & Assistant Secretary Susan S. Myers, Assistant Vice President & Auditor BANK OF CHARLES TOWN MORTGAGE AND COMMERCIAL LOAN DEPARTMENT Thomas F. Chambers Vice President H. William Easter, Jr. Assistant Vice President Cynthia A. Light Assistant Cashier Patricia A. Ott INSTALLMENT LOAN DEPARTMENT Donna J. Burns Vice President Richard B. Breeden Assistant Vice President & Security Officer Janice B. Davis Assistant Cashier Victoria B. Burns Kimberly K. DeSarno Timothy F. Hitrick Deborah A. Ring Linda A. Stewart TELLER DEPARTMENT Carolyn N. O'Brien Assistant Cashier & Head Teller Kyle S. Carter Jennifer A. Casale Lisa R. Cook-Bork Cathryn M. DeRonda Cathy Jo Fraley Sharon L. Hardy Melissa A. Harrison John N. Haymaker Christopher J. Lancaster Cindy L. Magaha C. Lane McCarron Kendra L. Nichols Consuelo L. Shanton Roxann L. Shives Michelle N. Slusher Jeanette Staubs Misty D. Staubs Suzanne N. Taylor Terrie C. Thomas Linda L. Whittington ADMINISTRATION Charles W. LeMaster President William R. Harner Sr. Vice President & Cashier L. Gayle Marshall Johnson, CPA Vice President & Financial Officer Susan S. Myers, CPA Assistant Vice President & Auditor Diane C. Bogden Personnel Officer William H. Chesley, Jr. Marketing Officer Shelly D. Dodson Tammy L. Miller BOOKKEEPING DEPARTMENT Doris V. Loudan Assistant Cashier & Head Bookkeeper Patricia L. Clay Marcia S. Lerch Elizabeth W. Park John N. Poole Penny J. Sebastian Karen A. Staubs Stephanie N. Tennant Peggy C. Turner KEARNEYSVILLE BRANCH C. Kenneth Nicewarner, Jr. Assistant Vice President & Branch Manager Nancy L. Baker Assistant Cashier & Assistant Branch Manager Rebecca E. Black Mary L. Bowers Stephanie L. DiGennaro-Dailey Carolyn A. Dunn Erin L. Guarino Joshua E. Higdon Jennifer L. Hockensmith Tina D. Holbrook Tammy E. Hough April D. Myers COURIER Benjamin T. Breeden MAINTENANCE DEPARTMENT Paula M. Fraley Paul D. Staubs E. Geraldine White TRUST AND FINANCIAL SERVICES Robert L. Hersey Vice President & Trust Officer David S. (Joe) Smith Trust Officer Deanna D. Greenfield Michelle S. Griffith Sheila R. Miller K. Renee Queen Holly A. Stevens CERTIFICATES OF DEPOSIT DEPARTMENT Judith A. Edwards DATA PROCESSING DEPARTMENT Richard M. Crea Assistant Cashier & Data Processing Manager Amy L. Brill Nancy L. Harrison Robert F. Spring, Jr. HARPERS FERRY BRANCH Wayne C. Welty Assistant Vice President & Branch Manager Shelly L. Holmes Assistant Cashier & Assistant Branch Manager Misty N. Ashbaugh Melissa D. Castle Jennifer E. Chand Barbara J. Dupuy Karen S. James M. Jacqueline Propst W. Ann Wilt Charles W. Wyndham, Jr. -32- ANNUAL REPORT ON FORM 10-KSB A copy of the Corporation's 1998 annual report of Form 10-KSB filed with Securities and Exchange Commission may be obtained without charge upon written request by any stockholder to: Gayle Marshall Johnson Vice President and Chief Financial Officer Potomac Bancshares, Inc. 111 East Washington Street PO Box 906 Charles Town, West Virginia 25414-0906 GENERAL INFORMATION COMMON STOCK PRICES AND DIVIDENDS Trading of Potomac Bancshares, Inc. common stock is not extensive, is infrequent and cannot be described as a public trading market. Potomac Bancshares, Inc. (symbol PTBS) is now on the Bulletin Board, a network available to brokers. Scott and Stringfellow, a regional securities firm with an office in Winchester, Virginia, is a market maker for Potomac's stock. A market maker is one who makes a market for a particular stock. Information about sales (but not necessarily all sales) of Potomac's stock are available on the Internet through many of the stock information services using Potomac's symbol. As of December 31, 1998, there were 600,000 common shares outstanding held by approximately 830 shareholders. The per share sale prices of the Corporation's stock for 1997 listed below are based solely on transactions of which the Corporation is aware. The per share sale prices for 1998 are based on information available as a result of our participation on the Bulletin Board described above and information gathered on the Internet. The dividends for 1997 and 1998 are also listed. High Low Dividends 1997 ---- First Quarter $ 30.000 $ 29.000 $ N/A Second Quarter 32.000 30.000 0.45 Third Quarter 32.000 30.000 N/A Fourth Quarter 32.000 30.000 0.70 1998 ---- First Quarter $ 38.000 $ 34.875 $ N/A Second Quarter 42.000 32.500 0.50 Third Quarter 46.000 41.000 N/A Fourth Quarter 41.000 40.000 0.65 Common stock dividends are paid on a semi-annual basis. Management intends to continue to recommend dividends to be paid as profits and maintenance of satisfactory equity capital allow. STOCK TRANSFER AGENT American Stock Transfer & Trust Company 40 Wall Street New York NY 10005 (212) 936-5100 ANNUAL MEETING The annual meeting of stockholders will be held at the Bavarian Inn, Shepherdstown, Jefferson County, West Virginia, on Tuesday, April 27, 1999, beginning at 10:30 a.m. -33- EX-21 3 EXHIBIT 21 -- SUBSIDIARIES OF THE REGISTRANT Exhibit 21 Subsidiaries of the Registrant Wholly-owned subsidiary: Bank of Charles Town 111 East Washington Street PO Box 906 Charles Town WV 25414-0906 EX-27 4 EXHIBIT 27 -- FINANCIAL DATA SCHEDULE
9 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 4,646,475 113,243,666 13,483,258 0 25,178,732 25,029,329 25,351,334 77,806,536 1,140,000 148,103,564 130,665,208 0 1,242,200 0 0 0 600,000 15,596,156 148,103,564 6,989,025 2,610,758 455,539 10,055,322 4,400,932 4,400,932 5,654,390 125,245 0 4,296,960 2,357,853 1,489,129 0 0 1,489,129 2.48 2.48 7.65 0 596,877 0 100,079 1,138,747 166,722 42,730 1,140,000 1,140,000 0 0
EX-99 5 EXHIBIT 99 -- PROXY STATEMENT POTOMAC BANCSHARES, INC. Charles Town, West Virginia ------------------------------------------------ NOTICE OF REGULAR ANNUAL MEETING OF SHAREHOLDERS TO BE HELD APRIL 27, 1999 ------------------------------------------------ To the Shareholders: The Regular Annual Meeting of Shareholders of Potomac Bancshares, Inc. ("Potomac"), will be held at Bavarian Inn, Shepherdstown, West Virginia, at 10:30 a.m. on April 27, 1999, for the purposes of considering and voting upon proposals: 1. To elect a class of Directors for a term of three years. 2. To ratify the selection by the Board of Directors of Yount, Hyde & Barbour, P.C., as independent Certified Public Accountants for the year 1999. 3. Any other business which may properly be brought before the meeting or any adjournment thereof. Only those shareholders of record at the close of business on March 19, 1999, shall be entitled to notice of the meeting and to vote at the meeting. By Order of the Board of Directors Charles W. LeMaster, President PLEASE SIGN AND RETURN THE ENCLOSED PROXY AS PROMPTLY AS POSSIBLE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON. IF YOU DO ATTEND THE MEETING, YOU HAVE THE OPTION TO WITHDRAW YOUR PROXY. March 30, 1999 POTOMAC BANCSHARES, INC. 111 EAST WASHINGTON STREET P.O. BOX 906 CHARLES TOWN, WEST VIRGINIA (304) 725-8431 PROXY STATEMENT ANNUAL MEETING OF SHAREHOLDERS - APRIL 27, 1999 This statement is furnished in connection with the solicitation of proxies for use at the Annual Meeting of Shareholders of Potomac Bancshares, Inc. ("Potomac") to be held on April 27, 1999, at the time and for the purposes set forth in the accompanying Notice of Regular Annual Meeting of Shareholders. SOLICITATION OF PROXIES The solicitation of proxies is made by management at the direction of the Board of Directors of Potomac. These proxies enable shareholders to vote on all matters which are scheduled to come before the meeting. If the enclosed proxy is signed and returned, it will be voted as directed; or if not directed, the proxy will be voted "FOR" all of the various proposals to be submitted to the vote of shareholders described in the enclosed Notice of Regular Annual Meeting and this Proxy Statement. A shareholder executing the proxy may revoke it at any time before it is voted: (i) by notifying Potomac in person, (ii) by giving written notice to Potomac of the revocation of the proxy, (iii) by submitting to Potomac a subsequently-dated proxy, or (iv) by attending the meeting and withdrawing the proxy before it is voted at the meeting. The expenses of the solicitation of proxies will be paid by Potomac. In addition to this solicitation by mail, officers and regular employees of Potomac and Bank of Charles Town may, to a limited extent, solicit proxies personally or by telephone or telegraph, although no person will be engaged specifically for that purpose. ELIGIBILITY OF STOCK FOR VOTING PURPOSES Pursuant to the Bylaws of Potomac, the Board of Directors has fixed March 19, 1999, as the record date for the purpose of determining the shareholders entitled to notice of, and to vote at, the meeting or any adjournment thereof, and only shareholders of record at the close of business on that date are entitled to such notice and to vote at such meeting or any adjournment thereof. As of the record date for the Annual Meeting, 600,000 shares of the capital stock of Potomac were issued and outstanding and entitled to vote. The principal holders of Potomac Common Stock are discussed under the section of this Proxy Statement entitled, "Principal Holders of Voting Securities". As of the record date, Potomac had a total of approximately 830 shareholders. PURPOSES OF MEETING 1. ELECTION OF DIRECTORS GENERAL The Bylaws of Potomac currently provide for a classified Board of Directors. There are three classes with each being elected for a three year term. There are presently twelve Directors on the Board, four of whom are nominees for election at the 1999 Annual Meeting. All of the four nominees are non-employee Directors. The Bylaws of Potomac provide that in the election of Directors of Potomac each shareholder will have the right to vote the number of shares owned by that shareholder for as many persons as there are Directors to be elected, or to cumulate such shares and give one candidate as many votes as the number of Directors multiplied by the number of shares owned shall equal, or to distribute them on the same principle among as many candidates as the shareholder sees fit. For all other purposes, each share is entitled to one vote. If any shares are voted cumulatively for the election of Directors, the Proxies, unless otherwise directed, shall have full discretion and authority to cumulate their votes and vote for less than all such nominees. The Bylaws of Potomac provide that nominations for election to the Board of Directors, other than those made by or on behalf of the existing management of Potomac, must be made by a shareholder in writing delivered or mailed to the President not less than 14 days nor more than 50 days prior to the meeting called for the election of Directors; provided, however, that if less than 21 days' notice of the meeting is given to shareholders, the nominations must be mailed or delivered to the President not later than the close of business on the 7th day following the day on which the notice of meeting was mailed. The notice of nomination must contain the following information, to the extent known: (a) name and address of proposed nominee(s); (b) principal occupation of nominee(s); (c) total shares to be voted for each nominee; (d) name and address of notifying shareholder; and (e) number of shares owned by notifying shareholder. Nominations not made in accordance with these requirements may be disregarded by the Chairman of the meeting and in such case the votes cast for each such nominee will likewise be disregarded. The table set forth on pages 4 and 5 of this Proxy Statement contains background information on each director nominee. COMMITTEES OF THE BOARD The Board of Directors of Potomac, as such, has no standing committees, and the functions of Board committees have been carried out by the Board of Directors as a whole or through committees of the Board of Directors of the Bank. While there is no such requirement, the Board of Directors of the Bank and Potomac are, and have at all times been, identical. The Bank has a standing Asset/Liability Management Committee, Audit Committee, Building/Site Committee, Community Reinvestment Act/Fair Lending Committee, Investment Committee, Salary and Personnel Committee, Steering Committee, Trust Committee and Trust Investment Review Committee. A Year 2000 Committee was appointed in 1998 and will continue to serve as long as necessary to meet Year 2000 challenges. 2 The Asset/Liability Management Committee consists of eight members: Donna J. Burns, Thomas F. Chambers, Thomas C.G. Coyle, William R. Harner, E. William Johnson, Gayle Marshall Johnson, Charles W. LeMaster and Donald S. Smith. This Committee is comprised of Board members and senior officers whose responsibilities are to manage the balance sheet of the Bank to maximize and maintain the spread between interest earned and interest paid while assuming acceptable business risks and ensuring adequate liquidity. This Committee held three meetings during 1998. The Audit Committee consists of five members: Guy Gary Chicchirichi, Francis M. Frye, E. William Johnson, Minnie R. Mentzer and Donald S. Smith. The purpose of the Audit Committee is to meet with the internal auditor to discuss and review audit procedures and results. The auditing department consists of one full-time employee with the responsibility to administer internal audit procedures on a regular basis. During 1998, the Audit Committee held three meetings. The Building/Site Committee consists of eight members: John P. Burns, Jr., Robert W. Butler, Thomas C.G. Coyle, Francis M. Frye, William R. Harner, Charles W. LeMaster, John C. Skinner, Jr. and Donald S. Smith. The Building/Site Committee is charged with making recommendations and decisions regarding proper repair and maintenance of the Bank's real property. The Committee held two meetings in 1998. The Community Reinvestment Act (CRA)/Fair Lending Committee consists of eight members: Donna J. Burns, John P. Burns, Jr., Thomas F. Chambers, William H. Chesley, Jr., Guy Gary Chicchirichi, William R. Harner, E. William Johnson and Charles W. LeMaster. The CRA/Fair Lending Committee is responsible for recommending to the Board of Directors policies that address fair lending concerns and the requirements of the CRA. Fair lending concerns are directed at preventing lending practices that discriminate either overtly or that have the effect of discrimination. The Community Reinvestment Act requires that banks meet the credit needs of their communities, including those of low and moderate income borrowers. This Committee held no meetings in 1998. The Investment Committee consists of seven members: John P. Burns, Jr., Guy Gary Chicchirichi, William R. Harner, E. William Johnson, Charles W. LeMaster, Minnie R. Mentzer and Donald S. Smith. The Investment Committee recommends investment policies to the Board and reviews investments as necessary. On most occasions the entire Board acts as the Committee. The Investment Committee held no meetings in 1998. The Salary and Personnel Committee consists of seven members: Guy Gary Chicchirichi, Thomas C.G. Coyle, Francis M. Frye, William R. Harner, Charles W. LeMaster, Minnie R. Mentzer and Donald S. Smith. The Salary and Personnel Committee's responsibilities include evaluating staff performance and requirements, reviewing salaries, and making necessary recommendations to the Board regarding these responsibilities. The Committee held ten meetings in 1998. Neither of the executive officers who serve on this Committee makes recommendations or participates in meetings relating to his own salary. See "Salary and Personnel Committee Report on Executive Compensation." The Steering Committee consists of thirteen members: Donna J. Burns, John P. Burns, Jr., Robert W. Butler, Thomas F. Chambers, Francis M. Frye, William R. Harner, Robert L. Hersey, Gayle Marshall Johnson, Charles W. LeMaster, Minnie R. Mentzer, James E. Senseney, John C. Skinner, Jr. and Donald S. Smith. The Steering Committee held no meetings in 1998. This Committee reviews and evaluates operating procedures, interest rates charged on loans and interest rates being paid on deposits. 3 The Trust Committee consists of six members: Robert W. Butler, Thomas C.G. Coyle, Robert L. Hersey, Charles W. LeMaster, James E. Senseney and John C. Skinner, Jr. The Trust Committee is responsible for the general supervision of the fiduciary activities performed by the Trust and Financial Services Division in order to ensure proper administration of all aspects of the Bank's fiduciary business. It sets forth prudent policies and guidelines under which the department can fulfill its fiduciary responsibilities in a timely and efficient manner and meet state and federal regulatory requirements. The Committee makes periodic reports to the Board of Directors and oversees the activities of the Trust Investment Review Committee. The Trust Committee held fifteen regular meetings in 1998. The Trust Investment Review Committee, consisting of two trust officers and one director (Robert L. Hersey, David S. Smith and Robert W. Butler), meets regularly to review investments in trust accounts and to determine that these investments remain within the guidelines of the account. This Committee held ten meetings during 1998. The Year 2000 Committee consists of fifteen members: Donna J. Burns, John P. Burns, Jr., Thomas F. Chambers, Thomas C.G. Coyle, Richard Crea, Judy Edwards, William R. Harner, Robert L. Hersey, Gayle Marshall Johnson, Doris Loudan, Susan Myers, Kenny Nicewarner, Carolyn O'Brien and Wayne C. Welty. The Year 2000 Committee was appointed by the Board in January 1998 to coordinate and guide the Bank in its preparation to meet the challenge of Year 2000 by ensuring that all equipment is appropriately date sensitive to the four digit date of 2000 and beyond. This Committee held fourteen meetings in 1998. Neither Potomac nor the Bank has a nominating committee. Rather, the Board of Directors of each selects nominees to fill vacancies on the Board. The Board of Directors of Potomac met for four regular quarterly meetings in 1998. The Board of Directors of the Bank holds regular weekly meetings each Tuesday and special meetings from time to time as required. During 1998, the Bank Board held 52 regular meetings and one special meeting. During the year, each of the Directors, except Guy Gary Chicchirichi and John C. Skinner, Jr., attended at least 75% of all meetings of the Boards of Potomac and the Bank and all Committees of the Board of the Bank on which they served. MANAGEMENT NOMINEES TO THE BOARD OF POTOMAC The management nominees for the Board of Directors are:
SERVED AS FAMILY DIRECTOR RELATION- YEAR OF SHIP WITH IN WHICH POTOMAC OTHER TERM PRINCIPAL OCCUPATION OR NOMINEES AGE SINCE NOMINEES EXPIRES EMPLOYMENT LAST FIVE YEARS Robert W. Butler 75 1994 None 2002 Owner of Warm Spring Farm & Orchard, Jefferson County, West Virginia; retired from Stauffer Chemical Company Guy Gary Chicchirichi 57 1994 None 2002 Secretary/Treasurer - Guy's Buick-Pontiac- Oldsmobile-GMC Truck, Inc., Jefferson County, West Virginia; charter member of Charles Town Rotary Club
4
SERVED AS FAMILY DIRECTOR RELATION- YEAR OF SHIP WITH IN WHICH NOMINEES POTOMAC OTHER TERM PRINCIPAL OCCUPATION OR (CONTINUED) AGE SINCE NOMINEES EXPIRES EMPLOYMENT LAST FIVE YEARS Thomas C.G. Coyle 70 1994 None 2002 Retired owner/operator of Riddleberger's Store, Jefferson County, West Virginia; Trustee and active Elder - Charles Town Presbyterian Church; Director - Edge Hill Cemetery. Francis M. Frye 72 1994 None 2002 Retired owner/operator of Ranson Real Estate Company, Jefferson County, West Virginia. DIRECTORS CONTINUING TO SERVE UNEXPIRED TERMS SERVED AS FAMILY DIRECTOR RELATION- YEAR OF SHIP WITH IN WHICH POTOMAC OTHER TERM PRINCIPAL OCCUPATION OR DIRECTORS AGE SINCE NOMINEES EXPIRES EMPLOYMENT LAST FIVE YEARS John P. Burns, Jr. 57 1994 None 2001 Owner/operator of a beef & grain farm in Jefferson County, West Virginia; President - Jefferson County Fair Association; Director - Valley Farm Credit. William R. Harner 58 1994 None 2000 Employed at Bank since 1967; Sr. Vice President & Cashier since 1988; Sr. Vice President and Secretary of Potomac since 1994. E. William Johnson 54 1994 None 2000 Chair - Division of Business and Social Sciences and Professor - Shepherd College, Jefferson County, West Virginia; Director - Jefferson Memorial Hospital. Charles W. LeMaster 57 1994 None 2001 Employed at Bank since 1983; President & CEO since 1991; former member of Jefferson County Board of Education; President and CEO of Potomac since 1994. Minnie R. Mentzer 82 1994 None 2001 Retired owner of Myers Coal Company; President - Jefferson County Youth Board; former member of Citizens Advisory Committee for Jefferson County, West Virginia. James E. Senseney 85 1994 None 2001 Retired from J.E. Senseney & Sons, Inc. (Western Auto Franchisee), Jefferson County, West Virginia. John C. Skinner, Jr. 57 1994 None 2000 Attorney, owner of Nichols & Skinner, L.C., Jefferson County, West Virginia; Bank attorney since 1986; Potomac attorney since 1994.
5
SERVED AS FAMILY DIRECTOR RELATION- YEAR OF SHIP WITH IN WHICH DIRECTORS POTOMAC OTHER TERM PRINCIPAL OCCUPATION OR (CONTINUED) AGE SINCE NOMINEES EXPIRES EMPLOYMENT LAST FIVE YEARS Donald S. Smith 70 1994 None 2000 Employed at Bank 1947 to 1991; President 1978 to 1991 (retired); Vice President and Assistant Secretary of Potomac since 1994. PRINCIPAL HOLDERS OF VOTING SECURITIES The following shareholder beneficially owns more than 5% of Potomac Common Stock as of March 1, 1999: NAME OF AMOUNT AND NATURE OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF COMMON STOCK Virginia F. Burns Rt 2 Box 132 Charles Town WV 25414-9632 44,480 shares; Direct 7.4133 OWNERSHIP OF SECURITIES BY NOMINEES, DIRECTORS AND OFFICERS The following table shows the amount of Potomac's outstanding Common Stock beneficially owned by nominees, directors and principal officers of Potomac individually and as a group. The information is furnished as of March 1, 1999, on which date 600,000 shares were outstanding. AMOUNT AND NATURE OF NOMINEES BENEFICIAL OWNERSHIP PERCENT OF COMMON STOCK Robert W. Butler 2,310 shares(1,3)* .3850 635 S Samuel Street 96 shares(2,4)* .0160 Charles Town WV 25414-1141 1,416 shares (5)* .2360 Guy Gary Chicchirichi 1,550 shares(1,3)* .2583 Rt 1 Box 38 Charles Town WV 25414-9704 Thomas C.G. Coyle 784 shares(1,3)* .1307 Rt 3 Box 252 1,641 shares (5)* .2735 Kearneysville WV 25430-9439 Francis M. Frye 1,000 shares(1,3)* .1667 400 Forrest Avenue 1,873 shares(2,4)* .3122 Charles Town WV 25414-1408
6
AMOUNT AND NATURE OF DIRECTORS (NON-NOMINEES) BENEFICIAL OWNERSHIP PERCENT OF COMMON STOCK John P. Burns, Jr. 100 shares(1,3)* .0167 Rt 1 Box 296 1,645 shares(2,4)* .2742 Charles Town WV 25414-9769 12 shares (5)* .0020 William R. Harner 50 shares(1,3)* .0083 141 Tuscawilla Hills 1,350 shares(2,4)* .2250 Charles Town WV 25414-3535 E. William Johnson 325 shares(1,3)* .0542 869 Deer Mountain Estates 50 shares(2,4)* .0083 Harpers Ferry WV 25425 Charles W. LeMaster 3,805 shares(1,3)* .6342 PO Box 207 1,000 shares(2,4)* .1667 Shepherdstown WV 25443-0207 Minnie R. Mentzer 4,326 shares(1,3)* .7210 PO Box 84 Harpers Ferry WV 25425-0084 James E. Senseney 8,000 shares(1,3)* 1.3333 117 Eastland Drive 1,720 shares(2,4)* .2867 Charles Town WV 25414-9718 96 shares (5)* .0160 John C. Skinner, Jr. 936 shares(1,3)* .1560 PO Box 133 1,946 shares(2,4)* .3243 Charles Town WV 25414-0133 1,014 shares (5)* .1690 Donald S. Smith 2,400 shares(1,3)* .4000 PO Box 264 3,500 shares (5)* .5833 Charles Town WV 25414-0264 AMOUNT AND NATURE OF OFFICERS (NON-NOMINEES) BENEFICIAL OWNERSHIP PERCENT OF COMMON STOCK Gayle Marshall Johnson 408 shares(1,3)* .0680 PO Box 1028 100 shares(2,4)* .0167 Charles Town WV 25414-7028
7
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP PERCENT OF COMMON STOCK All nominees, Directors & principal 25,994 shares(1,3)* 4.3324 officers as a group 9,780 shares(2,4)* 1.6300 (13 persons) 7,679 shares (5)* 1.2798 ------------- ------ Total 43,453 shares 7.2422 ============= ======
- -------------------------------------------------------------------------------- * 1 indicates sole voting power, 2 indicates shared voting power, 3 indicates sole investment power, 4 indicates shared investment power, 5 indicates indirect ownership by spouse or minor child. EXECUTIVE COMPENSATION Potomac's officers did not receive compensation as such during 1998. The following table sets forth the annual and long-term compensation for services in all capacities to the Bank for the fiscal years ended December 31, 1998, 1997 and 1996 of the chief executive officer. No officer had total annual salary and bonus exceeding $100,000. Neither Potomac nor the Bank has any stock option plans, employee stock ownership plans or other employee benefit plans except for the pension plan described in this Proxy Statement. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ------------------------------------------------ ANNUAL COMPENSATION AWARDS PAYOUTS ------------------------- ------------------------- -------------------- OTHER SECURITIES ALL ANNUAL RESTRICTED UNDER- OTHER COMPEN- STOCK LYING LTIP COMPEN- NAME AND SALARY BONUS SATION AWARD(S) OPTIONS/ PAYOUTS SATION PRINCIPAL POSITION YEAR ($) ($) ($) ($) SARS (#) ($) ($) Charles W. LeMaster 1998 84,282 N/A 0 N/A N/A N/A 0 President and CEO 1997 79,822 N/A 0 N/A N/A N/A 0 1996 76,366 N/A 0 N/A N/A N/A 0
8 PENSION PLAN TABLE
YEARS OF SERVICE ------------------------------------------------------------------------------- REMUNERATION 5 10 15 20 25 30 ------------------------------------------------------------------------------- $10,000 $ 760 $ 1,520 $ 2,280 $ 3,040 $ 3,800 $ 3,800 15,000 1,260 2,520 3,780 5,040 6,300 6,300 20,000 1,760 3,520 5,280 7,040 8,800 8,800 25,000 2,260 4,520 6,780 9,040 11,300 11,300 30,000 2,760 5,520 8,280 11,040 13,800 13,800 40,000 3,760 7,520 11,280 15,040 18,800 18,800 50,000 4,760 9,520 14,280 19,040 23,800 23,800 60,000 5,760 11,520 17,280 23,040 28,800 28,800 70,000 6,760 13,520 20,280 27,040 33,800 33,800 80,000 7,760 15,520 23,280 31,040 38,800 38,800
The Bank's retirement plan is The West Virginia Bankers' Association Retirement Plan for Employees of Member Banks. This is a defined benefit plan under which benefits are determined based on an employee's average annual compensation for any five consecutive full calendar years of service which produce the highest average. An employee is any person (but not including a person acting only as a director) who is regularly employed on a full-time basis. An employee becomes eligible to participate in the plan upon completion of at least one year of service and attainment of age 21. Normal retirement is at age 65 with the accrued monthly benefit determined on actual date of retirement. An employee may take early retirement from age 60 and the accrued monthly benefit as of the normal retirement date is actuarially reduced. There is no reduction if an employee is 62 years of age and has 30 years service. Compensation covered by the pension plan is based upon total pay. Effective for plan years beginning after December 31, 1993, the Internal Revenue Code (the Code) prohibits compensation in excess of $150,000 (as indexed) to be taken into account in determining one's pension benefit. As of December 31, 1998, the current credited years of service and projected estimated annual benefit under the pension plan (assuming that he continues employment, the plan is not terminated or amended, current compensation increases under the plan's assumptions and that the maximum compensation allowed under the Code does not exceed $150,000) for the following officer is: NAME CURRENT SERVICE PROJECTED ANNUAL PENSION Charles W. LeMaster 23 years $33,480 9 SALARY AND PERSONNEL COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Salary and Personnel Committee is comprised of seven members: Guy Gary Chicchirichi, Thomas C.G. Coyle, Francis M. Frye, William R. Harner, Charles W. LeMaster, Minnie R. Mentzer and Donald S. Smith. The Salary and Personnel Committee reviews and recommends to the board changes to the compensation levels of all executive officers of the Bank. The Committee seeks to attract and retain highly capable and well-qualified executives and to compensate executives at levels commensurate with their amount of service to the Bank. The Committee met once to review and approve the Bank's 1998 compensation levels. The Bank's Chief Executive Officer and the Senior Vice President review each executive officer's compensation and make recommendations to the Committee. The Committee reviews these recommendations and independently evaluates each executive's job performance and contribution to the Bank. The Committee also considers the inflation rate and the compensation levels of executive officers holding similar positions with the Bank's competitors. For instance, the Committee compares the compensation levels of its executive officers with the levels, when known, of such institutions as United National Bank, F&M Blakeley, Jefferson Security Bank, Blue Ridge Bank and One Valley Bank of Martinsburg. Compensation levels for executives of the Bank are competitive when compared to these institutions. Compensation for the Chief Executive Officer and the Senior Vice President is determined in essentially the same way as for other executives. Although the Chief Executive Officer's compensation is not tied to any performance goals of the Bank, the Committee does consider the Bank's profitability for the prior fiscal years. Charles W. LeMaster serves on the Committee and is the Bank's Chief Executive Officer; however, he does not make any recommendations relating to his salary and is not present at Committee meetings when his compensation is being discussed. The Senior Vice President's compensation also is not tied to any performance goals of the Bank. William R. Harner serves on the Committee and is Senior Vice President of the Bank; however, he does not make any recommendations relating to his salary and is not present at Committee meetings when his compensation is being discussed. Neither Potomac nor Bank of Charles Town currently has any employment agreements with any employees. The Internal Revenue Code disallows deductions of compensation exceeding $1,000,000 for certain executive compensation. The Committee has not adopted a policy in this regard because none of the Bank's executives received compensation approaching the $1,000,000 level. This report should not be deemed incorporated by reference by any general statement incorporating by reference this Proxy Statement into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that Potomac specifically incorporates this report by reference, and shall not otherwise be filed under such Acts. This report is submitted by: Guy Gary Chicchirichi Thomas C.G. Coyle Francis M. Frye William R. Harner Charles W. LeMaster Minnie R. Mentzer Donald S. Smith 10 PERFORMANCE GRAPH The following graph compares the yearly percentage change in Potomac's (and prior to Potomac's formation, the Bank's) cumulative total shareholder return on Common Stock for the five-year period ending December 31, 1998, with the cumulative total return of the Media General Index (SIC Code Index 6712 - Bank Holding Companies). Shareholders may obtain a copy of the index by calling Media General Financial Services, Inc. at telephone number (800) 446-7922. There is no assurance that Potomac's stock performance will continue in the future with the same or similar trends as depicted in the graph. The information used to determine Potomac's cumulative total shareholder return on its Common Stock is based upon information furnished to Potomac or the Bank by one or more parties involved in purchases or sales of Potomac's (and prior to its formation, the Bank's) Common Stock. NO ATTEMPT WAS MADE BY POTOMAC OR THE BANK TO VERIFY OR DETERMINE THE ACCURACY OF THE REPRESENTATIONS MADE TO POTOMAC OR THE BANK. The graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Proxy Statement into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that Potomac specifically incorporates this graph by reference, and shall not otherwise be filed under such Acts. [graph appears here] COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG POTOMAC BANCSHARES, INC., MEDIA GENERAL INDEX AND SIC CODE INDEX
FISCAL YEAR ENDING --------------------------------------------------------------------------- COMPANY/INDEX/MARKET 12/31/1993 12/30/1994 12/29/1995 12/31/1996 12/31/1997 12/31/1998 - -------------------- ---------- ---------- ---------- ---------- ---------- ---------- POTOMAC BANCSHARES, INC. 100.00 129.66 134.91 130.17 154.30 203.30 Bank Holding Companies 100.00 108.84 161.89 233.99 327.08 427.22 Media General Index 100.00 99.17 128.58 155.28 201.64 246.49
ASSUMES $100 INVESTED ON JAN. 01, 1994 ASSUMES DIVIDEND REINVESTED FISCAL YEAR ENDING DEC. 31, 1998 11 COMPENSATION OF DIRECTORS Directors of Potomac were not compensated as such during 1998. Directors of the Bank are compensated at the rate of $150 for each regular and special board meeting attended. They are additionally compensated $85 for each committee meeting attended. Directors who are operating officers of the Bank are not compensated for Committee meetings attended. CERTAIN TRANSACTIONS WITH DIRECTORS, OFFICERS AND THEIR ASSOCIATES Potomac and the Bank have had, and expect to have in the future, transactions in the ordinary course of business with Directors, officers, principal shareholders and their associates. All of these transactions remain on substantially the same terms, including interest rates, collateral and repayment terms on the extension of credit, as those prevailing at the same time for comparable transactions with unaffiliated persons, and in the opinion of management of Potomac and the Bank, did not involve more than the normal risk of collectibility or present other unfavorable features. Nichols and Skinner, L.C., a law firm in which Director John C. Skinner, Jr. is a shareholder, performed legal services for the Bank and Potomac in 1998 and will perform similar services in 1999. On the basis of information provided by Mr. Skinner, it is believed that less than five percent of the gross revenues of this law firm in 1998 resulted from payment for legal services by Potomac and the Bank. In the opinion of Potomac and the Bank, the transactions with Nichols and Skinner, L.C., were on terms as favorable to Potomac and the Bank as they would have been with third parties not otherwise affiliated with Potomac or the Bank. 2. RATIFICATION OF SELECTION OF AUDITORS The Board of Directors has selected the firm of Yount, Hyde & Barbour, P.C. to serve as independent auditors for Potomac for the calendar year 1999. Although the selection of auditors does not require shareholder ratification, the Board of Directors has directed that the appointment of Yount, Hyde & Barbour, P.C. be submitted to the shareholders for ratification. If the shareholders do not ratify the appointment of Yount, Hyde & Barbour, P.C., the Board will consider the appointment of other auditors. Potomac is advised that no member of this accounting firm has any direct or indirect material interest in Potomac, or any of its subsidiaries. A representative of Yount, Hyde & Barbour, P.C., will be present at the Annual Meeting to respond to appropriate questions and to make a statement if he so desires. The enclosed proxy will be voted "FOR" the ratification of the selection of Yount, Hyde & Barbour, P.C., unless otherwise directed. The affirmative vote of a majority of the shares of Potomac's Common Stock represented at the Annual Meeting of Shareholders is required to ratify the appointment of Yount, Hyde & Barbour, P.C. FORM 10-KSB ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION Upon written request by any shareholder to Gayle Marshall Johnson, Vice President and Chief Financial Officer, Potomac Bancshares, Inc., 111 East Washington Street, PO Box 906, Charles Town, West Virginia 25414-0906, a copy of Potomac's 1998 Annual Report on Form 10-KSB will be provided without charge. 12 SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires Potomac's Directors and executive officers, and persons who own more than ten percent of a registered class of Potomac's equity securities, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of Potomac. Officers, Directors and shareholders owning more than ten percent are required by SEC regulation to furnish Potomac with copies of all Section 16(a) forms which they file. To Potomac's knowledge, based solely upon review of the copies of such reports furnished to Potomac and written representations that no other reports were required, during the two fiscal years ended December 31, 1998, all Section 16(a) filing requirements applicable to its officers, Directors and persons owning more than ten percent were complied with. OTHER INFORMATION If any of the nominees for election as Directors should be unable to serve as Directors by reason of death or other unexpected occurrence, a proxy will be voted for a substitute nominee or nominees designated by the Board of Potomac unless the Board of Directors adopts a resolution pursuant to the Bylaws reducing the number of Directors. The Board of Directors is unaware of any other matters to be considered at the meeting but, if any other matters properly come before the meeting, persons named in the proxy will vote such proxy in accordance with their judgment on such matters. SHAREHOLDER PROPOSAL FOR 2000 Any shareholder who wishes to have a proposal placed before the next Annual Meeting of Shareholders must submit the proposal to William R. Harner, Senior Vice President and Secretary of Potomac, at its executive offices, no later than November 30, 1999, to have it considered for inclusion in the proxy statement of the Annual Meeting in 2000. Charles W. LeMaster President Charles Town, West Virginia March 30, 1999 POTOMAC BANCSHARES, INC. 111 EAST WASHINGTON STREET, PO BOX 906, CHARLES TOWN WV 25414-0906 PROXY FOR ANNUAL MEETING OF SHAREHOLDERS April 27, 1999 KNOW ALL PERSONS BY THESE PRESENTS, That the undersigned shareholder(s) of Potomac Bancshares, Inc. ("Potomac"), Charles Town, West Virginia, does (do) hereby nominate, constitute and appoint Donald S. Smith and Thomas C.G. Coyle, or any one of them, with full power to act alone as my (our) true and lawful attorney(s) will full power of substitution for me (us) in my (our) name, place and stead to vote all the Common Stock of Potomac, standing in my (our) name on its books at the close of business on March 19, 1999, at the Annual Meeting of Shareholders of Potomac Bancshares, Inc., called for and to be held at the Bavarian Inn and Lodge, Shepherdstown, West Virginia, on April 27, 1999, at 10:30 a.m., and at any and all adjournments of said meeting, with all the powers the undersigned would possess if personally present, as follows: 1. Election of Directors. For the election of the four persons listed below for a three year term: Robert W. Butler Thomas C. G. Coyle Guy Gary Chicchirichi Francis M. Frye [ ] FOR ALL OF THE ABOVE LISTED NOMINEES [ ] DO NOT VOTE FOR ANY OF THE ABOVE LISTED NOMINEES [ ] FOR ALL OF THE NOMINEES LISTED ABOVE EXCEPT THOSE FOR WHOM I CHOSE TO WITHHOLD TO VOTE FOR AS LISTED BELOW: ------------------------------------------------------------ 2. A proposal to ratify the appointment by the Board of Directors of Yount, Hyde & Barbour, P.C., as independent Certified Public Accountants for the year 1998. [ ] FOR [ ] AGAINST [ ] ABSTAIN 3. Any other business which may be brought before the meeting or any adjournment thereof. Unless otherwise specified on this Proxy, the shares represented by this Proxy will be voted "FOR" the propositions listed above the described more fully in this Proxy Statement of Potomac Bancshares, Inc., distributed in connection with this Annual Meeting. If any shares are voted cumulatively for the election of Directors, the Proxies, unless otherwise directed, shall have full discretion and authority to cumulate their votes and vote for less than all such nominees. If any other business is presented at said meeting, this Proxy shall be voted in accordance with recommendations of management. The Board of Directors recommends a vote "FOR" the listed propositions. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS AND MAY BE REVOKED PRIOR TO ITS EXERCISE. Dated: ________________________________ _______________________________________ _______________________________________ (Signature(s) of Shareholder(s)) When signing as attorney, executor, administrator, trustee or guardian, please give full title. If more than one trustee, all should sign. All joint owners must sign. -----END PRIVACY-ENHANCED MESSAGE-----