-----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, HY4fvSe2uedT6k1K+86//1ifZweAtO1zt8f3zM2WB8RYDQquwC841VjFdXqZ71G7 Z4T3895Yi0zbPRLZ34O7Yw== 0001021408-02-004319.txt : 20020415 0001021408-02-004319.hdr.sgml : 20020415 ACCESSION NUMBER: 0001021408-02-004319 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020328 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: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-24958 FILM NUMBER: 02591956 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 10-K 1 d10k.txt POTOMAC BANCSHARES, INC. 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 For the fiscal year ended December 31, 2001 ___ Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 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 _____ ----- 2 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 --- State issuer's revenues for its most recent fiscal year. $12,313,495 ----------- 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. $21,424,371 ----------- 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 2001 Annual Part II, Items 6 and 7 Report to Shareholders for the year ended December 31, 2001 Portions of Potomac Bancshares, Inc.'s Proxy Statement for Part III, Items 9, 10, 11 and 12 the 2002 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. ("Potomac") to be formed on March 2, 1994, as a single-bank holding company. To date, Potomac's only activities have involved the acquisition of the Bank. Potomac 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 that formed and opened for business in 1871. The bank's deposits are insured by the Federal Deposit Insurance Corporation. The bank is engaged in general banking business primarily in Jefferson County and Berkeley County, West Virginia. The bank also provides services to Washington County and Frederick County, Maryland and Loudoun County, Frederick County and Clarke County, Virginia. The main office is in Charles Town, West Virginia at 111 East Washington Street, with branch offices in . Harpers Ferry, West Virginia, . Kearneysville, West Virginia and . Martinsburg, West Virginia. The bank provides consumers, businesses, and governments with a broad range of banking services. These services include . lines of credit, . home equity lines of credit, . commercial, agricultural, real estate, installment loans, . checking, savings, NOW, money market accounts, . certificates of deposit, and . individual retirement accounts. Automated teller machines are located at each of the four offices. Touchline 24 is an interactive voice response system available at 1-304-728-2424 that provides certain services to customers on a twenty-four hour basis. Bill paying and certain other banking services are available online through any touch tone telephone and/or the World Wide Web. 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, secured by collateral being purchased or secured by other collateral. Underwriting standards for 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. 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, . to purchase owner occupied one to four family residential property, . for lines of credit and . for home equity loans. Approximately 76% of the bank's loans are secured by real estate. These loans had an average delinquency rate of .62% and a loss rate of .01% during 2001. The average delinquency rate and loss rate is based on comparisons to 2001 average total loans. 4 As of December 31, 2001, aggregate dollar amounts in loan categories secured by real estate are as follows: Construction and land development $ 530,000 Secured by farmland 1,801,165 Secured by 1-4 family residential 56,283,230 Other 19,275,005 ------------- $ 77,889,400 ============= Loans to individuals for personal expenditures are approximately 21% of the bank's total loans at December 31, 2001. The aggregate balance of these loans was $21,213,959 at December 31, 2001. The majority of these loans are installment loans with the remainder made as term loans. 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 .22% and a loss rate of .11% in 2001 (based on comparisons to 2001 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, a loan officer must review the loan before a renewal can be approved. The average delinquency rate was -0-% and the loss rate was .01% for term loans compared to average total loans in 2001. The remaining aggregate dollar amount of the bank's loans is $3,286,309 at December 31, 2001. The amount includes: (1) Dealer wholesale loans with generally no delinquencies or losses $ 978,351 (2) Term loans for business and commercial purposes 1,974,102 (3) Industrial revenue bond loans secured by real estate 56,550 (4) Term loans for agricultural purposes 46,020 (5) Other loans 231,286
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 federal funds sold and 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 federal funds sold and 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. 5 Deposit Activities. The bank offers noninterest-bearing checking accounts, interest-bearing NOW accounts and interest-bearing 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. To open a deposit account, the depositor must meet the following requirements: . present a valid identification, . have a 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. Competition - ----------- As of March 7, 2002, there were 62 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 that compete with the bank in its market area. The bank's market area is generally defined as Jefferson County and Berkeley County, West Virginia. The following data has not been updated since Berkeley County became part of the bank's primary market area. As of June 30, 2001, there were six banks in Jefferson County with 14 banking offices. The total deposits of those commercial banks as of June 2001 were $477,886,000 and the bank ranked number one with $131,144,000 or 27.44% 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 has been increased competition for West Virginia banks, including the bank. 6 Employees - --------- Potomac currently has no employees. As of March 22, 2002, the bank had 79 full-time employees and 15 part-time employees. Supervision and Regulation - -------------------------- Introduction. Potomac 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 Potomac to secure the prior approval of the Board of Governors before Potomac 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. As a bank holding company, Potomac 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 Potomac 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. Potomac's 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. Potomac 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. Potomac is also subject to regulation and supervision by the Commissioner. Potomac 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 25% 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, 2002, FDIC set the Financing Corporation (FICO) Bank Insurance Fund (BIF) premium for the bank at the annual rate of 1.820 basis points or .0001820 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 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 Potomac's results of operations. 7 Capital Requirements. The Federal Reserve Board has issued risk-based capital guidelines for bank holding companies, such as Potomac. 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. 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. 8 As of December 31, 2001, Potomac had capital in excess of all applicable requirements as shown below:
Actual Required Excess --------------- --------------- ------------ (Amounts in thousands) Tier 1 capital: Common stock $ 600 Surplus 5,400 Retained earnings 13,208 --------- Total tier 1 capital $ 19,208 $ 3,862 $ 15,346 Tier 2 capital: Allowance for loan losses (1) 1,209 --------- Total risk-based capital $ 20,417 $ 7,724 $ 12,693 ========= ======= ========= Risk-weighted assets $ 96,545 ========= Tier 1 capital $ 19,208 $ 5,099 $ 14,109 ========= ======= ========= Average total assets $ 169,982 ========= Capital ratios: Tier 1 risk-based capital ratio 19.90% 4.00% 15.90% Total risk-based capital ratio 21.15% 8.00% 13.15% Tier 1 capital to average total assets (leverage) 11.30% 4.00% 7.30%
(1) Limited to 1.25% of gross risk-weighted assets. Gramm-Leach-Bliley Act of 1999. On November 4, 1999, Congress adopted the Gramm-Leach-Bliley Act of 1999. This Act, also known as the Financial Modernization Law, repealed a number of federal limitations on the powers of banks and bank holding companies originally adopted in the 1930's. Under the Act, banks, insurance companies, securities firms and other service providers may now affiliate. In addition to broadening the powers of banks, the Act created a new form of entity, called a financial holding company, which may engage in any activity that is financial in nature or incidental or complimentary to financial activities. The Federal Reserve Board provides the principal regulatory supervision of financial services permitted under the Act. However, the Securities and Exchange Commission and state insurance and securities regulators also assume substantial supervisory powers and responsibilities. The Act addresses a variety of other matters, including customer privacy issues. The obtaining of certain types of information by false or fraudulent pretenses is a crime. Banks and other financial institutions must notify their customers about their policies on sharing information with certain third parties. In some instances, customers may refuse to permit their information to be shared. The Act also requires disclosures of certain automatic teller machine fees and contains certain amendments to the federal Community Reinvestment Act. Permitted Non-Banking Activities. Under the Gramm-Leach-Bliley Act, bank holding companies may become financial holding companies and engage in certain non-banking activities. Potomac has not yet filed to become a financial holding company and presently does not engage in, nor does it have any immediate plans to engage in, any such non-banking activities. A notice of proposed non-banking activities must be furnished to the Federal Reserve and the Banking Board before Potomac engages in such activities, and an application must be made to the Federal Reserve and Banking Board concerning acquisitions by Potomac 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 that 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 Potomac or the bank. 9 Item 2. Description of Property. Potomac currently has no property. The bank owns the land and buildings of the main office and the branch office facilities in Harpers Ferry and Kearneysville. 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 adjoining corridors. During 2000 the construction of the newer of these two buildings was completed. The first floor of the new building houses the Trust and Financial Services Division. The second floor of the new building houses certain administrative and loan offices. Both of these floors open into the older bank premises. The basement of the new building is used for record storage. The older premises, constructed in 1967, was renovated at the same time the new building was constructed. The renovation includes all new lighting, new ceilings, new floor and wall coverings as well as some minor structural changes for more efficient operations. The Harpers Ferry branch office is located at 1318 Washington Street, Bolivar, West Virginia. The office is a one story brick building constructed in 1975. There is another building on this property which existed at the time of the bank's purchase. This building is rented to others by the bank. The branch facility in Kearneysville, West Virginia 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. The bank leases the facilities housing the branch office in Martinsburg, West Virginia. The three year lease expires in February, 2004. Renewals are an option. This branch opened for business in July, 2001. The bank has an option to buy property in Hedgesville, West Virginia. If purchased, a fourth full service branch will be constructed on the sight. 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 Potomac 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 Potomac common stock for (a) trading values, and (b) dividends. As of March 15, 2002, there were approximately 1,100 shareholders. 10 Potomac Common Stock is not traded on any stock exchange or over the counter. Potomac (symbol PTBS) is now on the OTC 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 common stock. A market maker is one who makes a market for a particular stock. Information about sales (but not necessarily all sales) of Potomac common stock is available on the Internet through many of the stock information services using Potomac's symbol. Shares of Potomac common stock are occasionally bought and sold by private individuals, firms or corporations, and, in many instances, Potomac does not have knowledge of the purchase price or the terms of the purchase. The trading values for 2000 and 2001 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 Potomac to verify or determine the accuracy of the representations made to Potomac or gathered on the Internet.
Price Range Cash Dividends* High Low Paid per Share 2000 First Quarter $ 33.500 $ 28.250 $ N/A Second Quarter 30.000 26.125 .50 Third Quarter 28.500 24.000 N/A Fourth Quarter 28.000 22.000 .75 2001 First Quarter $ 28.750 $ 25.000 $ N/A Second Quarter 33.500 25.250 .50 Third Quarter 34.500 32.000 N/A Fourth Quarter 38.500 33.000 .85
* Dividends have been declared traditionally by Potomac on a semi-annual basis. The primary source of funds for dividends paid by Potomac 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 Potomac anticipates that the dividends paid by Potomac 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 4-11 of the Annual Report to Shareholders for the year ended December 31, 2001, is incorporated herein by reference. Item 7. Financial Statements. The information contained on pages 13-31 of the Annual Report to Shareholders for the year ended December 31, 2001, 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 5-6 and 13 of the Proxy Statement dated March 29, 2002, for the April 23, 2002 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. 11 The Executive Officers are as follows:
Name Position Since Age Principal Occupation - ----------------------- --------------- --- -------------------- Robert F. Baronner, Jr. President & CEO 43 Employed by bank as of 1/1/01 as President 2001 & CEO; former Senior Credit Officer BB&T Northern West Virginia May 2000 - December 2000; former Executive Vice President One Valley Bank East September 1997 - April 2000; Senior Vice President Commercial Lending Division One Valley Bank East April 1994 - September 1997. William R. Harner Sr. Vice President, 61 Employed at bank since 1967; Sr. Vice Secretary & Treasurer President & Cashier since 1988. 1994 Gayle Marshall Johnson Vice President & Chief 52 Employed with the bank 1977-1985 as as Financial Officer internal auditor. Rejoined bank in 1988 1994 as Financial Officer. Vice President & Financial Officer of bank since 1990. Donald S. Smith Vice President & 73 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 29, 2002, for the April 23, 2002 Annual Meeting under the captions "Executive Compensation," "Employment Agreement," and "Compensation of Directors" is incorporated herein by reference. Item 11. Security Ownership of Certain Beneficial Owners and Management. The information contained on pages 6-8 of the Proxy Statement dated March 29, 2002, for the April 23, 2002 Annual Meeting under the captions "Principal Holders of Voting Securities" and "Ownership of Securities by Nominees, Directors and Officers" is incorporated herein by reference. Item 12. Certain Relationships and Related Transactions. The information contained on page 12 of the Proxy Statement dated March 29, 2002, for the April 23, 2002 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) 2.1 Agreement 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. 12 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. 10.2 Employment Agreement 13 2001 Annual Report to Shareholders 21 Subsidiaries of the Registrant 99 Proxy Statement for the 2002 Annual Meeting for Potomac (b) No Form 8-K reports were filed during the last quarter of 2001. 13 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/ Robert F. Baronner, Jr. March 22, 2002 ------------------------------------------------ --- Robert F. Baronner, Jr. President & Chief Executive Officer By /s/ L. Gayle Marshall Johnson March 22, 2002 ------------------------------------------------ --- L. Gayle Marshall Johnson Vice President & Chief Financial 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/ J. Scott Boyd March 22, 2002 ------------------------------------------------ --- J. Scott Boyd, Director By /s/ John P. Burns, Jr. March 22, 2002 ------------------------------------------------ --- John P. Burns, Jr., Director By /s/ Robert W. Butler March 22, 2002 ------------------------------------------------ --- Robert W. Butler, Director By /s/ Guy Gareth Chicchirichi March 22, 2002 ------------------------------------------------ --- Guy Gareth Chicchirichi, Director By /s/ Thomas C. G. Coyle March 22, 2002 ----------------------------------------------- --- Thomas C. G. Coyle, Director 14 Signature & Title Date - ----------------- ---- By /s/ William R. Harner March 22, 2002 ---------------------------------------------------- --- William R. Harner, Director, Sr. Vice President, Secretary & Treasurer By /s/ E. William Johnson March 22, 2002 ---------------------------------------------------- --- E. William Johnson, Director By /s/ John C. Skinner, Jr. March 22, 2002 ---------------------------------------------------- --- John C. Skinner, Jr., Director By /s/ Donald S. Smith March 22, 2002 ---------------------------------------------------- --- Donald S. Smith, Director EX-10.2 3 dex102.txt EMPLOYMENT AGREEMENT Exhibit 10.2 EMPLOYMENT AGREEMENT This Agreement made between ROBERT F. BARONNER, JR., herein referred to as Employee, and BANK OF CHARLES TOWN, whose principal place of business is located in Charles Town, Jefferson County, West Virginia, herein referred to as Employer, and POTOMAC BANKSHARES, INC., the corporate parent of Employer ("BANKSHARES"). RECITALS WHEREAS Employer is engaged in the business of banking, in Charles Town, Jefferson County, West Virginia; WHEREAS Employee has been engaged in and has had a great deal of experience in the business of banking; WHEREAS Employee is willing to be employed by Employer, and Employer is willing to employ Employee, on the terms, covenants and conditions hereinafter set forth; and WHEREAS Employer deems it in its best interests to secure the continued services, and ensure the undivided dedication and objectivity of Employee, in the future and in the event of any threat or occurrence of or negotiation or other action that could lead to, or create the possibility of, a Change in Control, as defined in this Agreement; NOW, THEREFORE: For the reasons set forth above, and in consideration of the mutual promises and agreements hereinafter set forth, employer and employee agree as follows: 1 SECTION ONE DEFINITIONS 1. Definitions. As used in this Agreement, the following terms shall have ----------- the respective meanings set forth below (a) "Board" means the Board of Directors of the Employer. (b) "Cause" means (i) the willful and continued failure of Employee to perform substantially his duties with the Employer (other than any such failure resulting from Employee's incapacity due to physical or mental illness or any such failure subsequent to Employee being delivered a Notice of Termination without Cause by the Employer or delivering a Notice of Termination for Good Reason to the Employer) after a written demand for substantial performance is delivered to Employee by the Board which specifically identifies the manner in which the Board believes that Employee has not substantially performed Employee's duties, (ii) the willful engaging by Employee in illegal conduct or gross misconduct which is directly demonstrably and materially injurious to the Employer or its affiliates or (iii) the Employee's conviction of, or plea of guilty of nolo contendere to, a felony involving moral turpitude. For purposes --------------- of this paragraph (b) no act or failure to act by Employee shall be considered "willful" unless done or omitted to be done by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Employer or its affiliates. The unwillingness of Employee to accept any condition or event which would constitute Good Reason under Section 2 1(f) may not be considered by the Board to be a failure to perform or misconduct by Employee. Notwithstanding the foregoing, Employee shall not be deemed to have been terminated for Cause for purposes of this Agreement unless and until there shall have been delivered to him a copy of a resolution, duly adopted by a vote of a majority of the entire Board at a meeting of the Board called and held (after reasonable notice to Employee and an opportunity for Employee and his counsel to be heard before the Board). The Employer must notify Employee of an event constituting Cause within ninety (90) days following its knowledge of its existence or such event shall not constitute Cause under this Agreement. (c) "Change in Control" means the occurrence of any one of the following events: (i) individuals who, on January 1, 2001, constitute the Board (the "Incumbent Directors") cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to January 1, 2001, whose election or nomination for election was approved by a vote of at least two-thirds (2/3) of the Incumbent Directors then on the Board (either by a specific vote or by approval of the proxy statement of the Employer in which such person is named as a nominee for director, without objection to such nomination) shall be an Incumbent Director; provided, however, that no -------- ------- individual elected or nominated as a director of the Employer initially as a result of an actual or threatened election contest with respect to directors 3 or any other actual or threatened solicitation of proxies or consents by or on behalf of any person other than the Board shall be deemed to an Incumbent Director; (ii) any "person" (as such term is defined in Section 3(a)(9) of the Securities Exchange Act of 1934 (the "Exchange Act") and as used in Sections 13(d)(3) and 14 (d)(2) of the Exchange Act) is or becomes a "beneficial owner" (as defined in Rule 13d-3 under the Exchange act), directly or indirectly, of securities of the Employer representing 50% or more of the combined voting power of the Employer's then outstanding securities eligible to vote for the election of the Board (the "Employer Voting Securities"); provided, however, that the -------- ------- event described in this paragraph (i) shall not be deemed to be a Change of Control by virtue of any of the following acquisitions: (A) by the Employer or any Subsidiary, (B) by any employee benefit plan sponsored or maintained by the Employer or any Subsidiary, (C) by any underwriter temporarily holding securities pursuant to an offering of such securities, (D) pursuant to a Non-Control Transaction (as defined in paragraph (iii), (E) pursuant to any acquisition by Employee or any group of persons including Employee (or any entity controlled by Employee or any group of persons including Employee); or (F) a transaction (other than one described in (iii) below) in which Employer Voting Securities are acquired from the Employer, if a majority of the Incumbent Directors then on the Board approve a resolution providing expressly that the acquisition pursuant to this clause 4 (F) does not constitute a Change in Control under this paragraph (i); (iii) the consummation of a merger, consolidation, statutory share exchange or similar form of corporate transaction involving the Employer or any of its Subsidiaries that requires the approval of the Employer's stockholders, whether for such transaction or the issuance of securities in the transaction (a "Business Combination"), unless immediately following such Business Combination: (A) more than 60% of the total voting power of (x) the corporation resulting from such Business Combination (the "Surviving Corporation"), or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of 100% of the voting securities eligible to elect directors of the Surviving Corporation (the "Parent Corporation"), is represented by Employer Voting Securities that were outstanding immediately prior to such Business Combination (or, if applicable, shares into which such Employer Voting Securities were converted pursuant to such Business Combination), and such voting power among the holders thereof is in substantially the same proportion as the voting power of such Employer Voting Securities among the holders thereof immediately prior to the Business Combination, (B) no person (other than any employee benefit plan sponsored or maintained by the Surviving Corporation or the Parent Corporation), is or becomes the 5 beneficial owner, directly or indirectly, of 50% or more of the total voting power of the outstanding voting securities eligible to elect directors or the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) and (C) at least a majority of the members of the board of directors of the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) following the consummation of the Business Combination were Incumbent Directors at the time of the Board's approval of the execution of the initial agreement providing for such Business Combination (any Business Combination which satisfies all of the criteria specified in (A), (B) and (C) above shall be deemed to be a "Non-Control Transaction"); or (iv) the stockholders of the Employer approve a plan of complete liquidation or dissolution of the Employer or a sale or disposition of all or substantially all of the Employer's assets. Notwithstanding the foregoing, a Change in Control of the Employer shall not be deemed to occur solely because any person acquires beneficial ownership of more than 50% of the Employer Voting Securities as a result of the acquisition of Employer Voting Securities by the Employer which reduces the number of Employer Voting Securities outstanding; provided, that if after such -------- ---- acquisition by the Employer such person becomes the beneficial owner of additional Employer Voting Securities that increases the percentage of outstanding Employer Voting Securities beneficially owned by such person, a Change in Control of the Employer shall 6 then occur. (d) "Date of Termination" means (i) the effective date on which Employee's employment by the Employer terminates as specified in a prior written notice by the Employer or Employee, as the case may be, to the other, delivered pursuant to Section 10 or (II) if Employee's employment by the Employer terminates by reason of death, the date of death of Employee. (e) "Disability" means Employee's total and permanent disability as defined by the Employer's long-term disability plan (as in existence immediately prior to the Change in Control, or if none is in existence, the most recent such plan). (f) "Good Reason" means, without Employee's express written consent, the occurrence of any of the following events after a Change in Control: (1) (A) any change in the duties or responsibilities (including reporting responsibilities) of Employee that is inconsistent in any material and adverse respect with Employee's position(s), duties, responsibilities or status with the Employer immediately prior to such Change in Control (including any material and adverse diminution of such duties or responsibilities); provided, -------- however that Good Reason shall not be deemed to occur upon a change in duties or responsibilities that is solely and directly a result of the Employer no longer being a publicly traded entity and does not involve any other event set forth in this paragraph (f) or (B) a material and adverse change in Employee's 7 titles or offices (including, if applicable, membership on the Board) with the Employer as in effect immediately prior to such Change in Control; (2) a reduction by the Employer in Employee's rate of annual base salary or annual target bonus opportunity (including any adverse change in the formula for such annual bonus target) as in effect immediately prior to such Change in Control or as the same may be increased from time to time thereafter; (3) any requirement of the Employer that Employee (i) be based anywhere more than fifty (50) miles from the facility where Employee is located at the time of such Change in Control or (ii) travel on Employer business to an extent substantially greater than the travel obligations of Employee immediately prior to such Change in Control; (4) the failure of the Employer to (A) continue in effect any employee benefit plan, compensation plan, welfare benefit plan or material fringe benefit plan in which the Employee is participating immediately prior to such Change in Control or the taking of any action by the Employer which would adversely affect Employee's participation in or reduce Employee's benefits under any such plan, unless Employee is permitted to participate in other plans providing Employee with substantially equivalent benefits in the aggregate (at substantially equivalent cost with respect to welfare benefit plans), or (B) provide Employee with paid vacation in accordance with the most favorable vacation policies of the 8 Employer and its affiliated companies as in effect for Employee immediately prior to such Change in Control, including the crediting of all service for which Employee had been credited under such vacation policies prior to the Change in Control; or (5) the failure of the Employer to obtain the assumption agreement from any successor as contemplated in Section 8(b). Notwithstanding the foregoing, an isolated and inadvertent action taken in good faith and which is remedied by the Employer within ten (10) days after receipt of notice thereof given by Employee shall not constitute Good Reason. Employee must notify Employer of any event constituting Good Reason within ninety (90) days following his knowledge of its existence or such event shall not constitute Good Reason under this Agreement. Employee's termination of employment under this Agreement for Good Reason shall in no event impair Employee's ability to receive benefits under any retirement-based plans or programs for which Employee is otherwise eligible as of Employee's Date of Termination. (g) "Nonqualifying Termination" means a termination of Employee's employment (1) by the Employer for Cause, (2) by Employee for any reason other than Good Reason (including Retirement if Good Reason does not exist at such time), (3) as a result of Employee's death, or (4) as a result of Disability. (h) "Qualifying Termination" means any termination of Employee's employment that is not a Nonqualifying Termination. (i) "Retirement" means termination of employment by Employee 9 in accordance with the Employer's retirement plan generally applicable to salaried employees (as in existence immediately prior to the Change in Control), or in accordance with any retirement arrangement established with respect to Employee with Employee's written consent. (j) "Subsidiary" means any corporation or other entity in which the Employer or Potomac Bankshares has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then outstanding securities of such corporation or other entity entitled to vote generally in the election of directors. (k) "Termination Period" means the period of time beginning with a Change in Control and ending two (2) years following such Change in Control. Notwithstanding anything in this Agreement to the contrary, if (i) Employee's employment is terminated prior to a Change in Control for reasons that would have constituted a Qualifying Termination if they had occurred following a Change in Control and (ii) Employee reasonably demonstrates that such termination (or Good Reason event) was at the request or suggestion of a third party who had indicated an intention or taken steps reasonably calculated to effect a Change in Control then for purposes of this Agreement (and notwithstanding whether a Change in Control occurs), the date immediately prior to the date of such termination of employment or event constituting Good Reason shall be treated as a Change in Control. 10 SECTION TWO EMPLOYMENT Employer and Potomac Bankshares hereby employ, engage, and hire Employee as President and Chief Executive Officer of Potomac Bankshares, Inc. and The Bank of Charles Town, and as member of the Board of Directors of same, and employee hereby accepts and agrees to such hiring, engagement, and employment, subject to the general supervision and pursuant to the orders, advice, and direction of the Board of Directors of Employer and Potomac Bankshares. Employee shall perform such other duties as are customarily performed by one holding such position in other, same, or similar businesses or enterprises as that engaged in by Employer, and shall also additionally render such other and related services and duties as may be assigned to him from time to time by Employer. SECTION THREE BEST EFFORTS OF EMPLOYEE Employee agrees that he will at all times faithfully, industriously, and to the best of his ability, experience, and talents, perform all of the duties that may be required of and from him pursuant to the terms of this Agreement, to the reasonable satisfaction of employer. SECTION FOUR TERM OF EMPLOYMENT The term of this agreement shall be a period of one (1) year, commencing January 1, 2001, and terminating December 31, 2001, subject, however, to prior termination only as herein provided. At 11 the expiration date of December 31, 2001, this agreement shall be considered renewed for regular periods of one year, provided neither party submits a notice of termination pursuant to Section 17. SECTION FIVE COMPENSATION OF EMPLOYEE Employer shall pay employee, and employee shall accept from employer, as Employee's base salary, compensation at the rate of One Hundred Ten Thousand Dollars ($110,000.00) per annum, payable using the normal pay periods of employees of Employer while this agreement shall be in force. Additionally, Employee shall receive an annual Directors' fee in an amount equal to the fee paid to other directors of employer, and paid at the normal pay period for said directors. Employer shall maintain the premium payments for medical coverage for employee, at least at the same level of coverage as that offered to other employees of the Employer. Employer shall reimburse employee for all reasonable and necessary expenses incurred by Employee while tending to the business of the Employer, including but not limited to travel, customer development and entertainment, and professional development expenses. Employer shall maintain the monthly full-family dues payment for Employee at Cress Creek Country Club. SECTION SIX 12 CHANGE IN CONTROL 1. Obligation of Employee. In the event of a tender or exchange offer, ---------------------- proxy contest, or the execution of any agreement which, if consummated, would constitute a Change in Control, Employee agrees not to voluntarily leave the employ of the Employer, other than as a result of Disability, Retirement (following age sixty (60)) or an event which would constitute Good Reason if a Change in Control had occurred, until the Change in Control occurs or, if earlier, such tender or exchange offer, proxy contest, or agreement is terminated or abandoned; provided, however, that such obligation shall not -------- ------- extend for a period exceeding one hundred and eighty (180) days from the initial event resulting in the obligation under this Section 2. 2. Payments Upon Termination of Employment. --------------------------------------- (a) If during the Termination Period the employment of Employee shall terminate, other than by reason of a Nonqualifying Termination, then the Employer shall pay to Employee (or Employee's beneficiary or estate) within ten (10) days following the Date of Termination, as compensation for services rendered to the Employer: (1) a lump-sum cash amount equal to the sum of (A) Employee's unpaid base salary from the Employer and its affiliate companies through the Date of Termination (without taking into account any reduction of base salary constituting Good Reason), (B) any bonus payments which have become payable, to the extent not theretofore 13 paid, and (C) any compensation previously deferred by Employee other than pursuant to a tax-qualified plan (together with any interest thereon) and any unpaid accrued vacation, each to the extent not theretofore paid; (2) to the extent not paid under the terms of the Employer's annual incentive compensation plan, a lump-sum cash amount equal to the target award for the Employee under such annual incentive compensation plan for the fiscal year in which his Date of Termination occurs, reduced pro rata for that portion of the fiscal year not completed as of the end of the month in which such Date of Termination occurs; and (3) a lump-sum cash amount equal to the sum of (A) twice the Employee's annual rate of base salary from the Employer and its affiliated companies in effect immediately prior to the Date of Termination (not taking into account any reductions which would constitute Good Reason) plus (B) the average annualized bonus earned by the Employee from the Employer (or its Subsidiaries) during the three fiscal years (or shorter annualized period if Employee had not been employed for the full three-year period) ending immediately prior to the year of the Change in Control. (b) If during the Termination Period the employment of Employee shall terminate, other than by reason of a Nonqualifying Termination, then for a period of eighteen (18) months following the Date of Termination, the Employer shall provide Employee (and Employee's dependents, if applicable) with the same level of 14 medical, dental, accident, disability, and life insurance benefits upon substantially the same terms and conditions (including contributions required from Employee to receive such benefits) as existed immediately prior to Employee's Date of Termination (or, if more favorable to Employee, as such benefits and terms and conditions existed immediately prior to the Change in Control); provided, that, if Employee cannot continue to participate in the -------- ---- Employer plans providing such benefits, the Employer shall otherwise provide such benefits on the same after-tax basis as if continued participation had been permitted. Notwithstanding the foregoing, if Employee becomes reemployed with another employer and is eligible to receive welfare benefits from such employer, the welfare benefits described herein shall be secondary to such benefits during the period of Employee's eligibility, but only to the extent that the Employer reimburses Employee for any increased cost and provides any additional benefits necessary to give Employee the benefits promised hereunder. (c) Any amount of severance paid pursuant to this Section 6 shall offset any other amount of severance to be received by Employee upon termination of employment of Employee under any other severance plan or policy of the Employer, including any employment agreement. (d) If during the Termination Period the employment of Employee shall terminate by reason of a Nonqualifying Termination, then the Employer shall pay to Employee within ten (10) days 15 following the Date of Termination a lump sum cash amount equal to the sum of (i) Employee's unpaid base salary from the Employer through the Date of Termination, (ii) any bonus payments which have become payable, to the extent not theretofore paid, and (iii) any compensation previously deferred by Employee other than pursuant to a tax-qualified plan (together with any interest thereon) and any unpaid accrued vacation, each to the extent not theretofore paid. 3. Withholding Taxes. The Employer may withhold from all payments due to ----------------- the Employee (or his beneficiary or estate) hereunder all taxes which, by applicable federal, state, local or other law, the Employer is required to withhold therefrom. 4. Limitations on Payments by the Employer. --------------------------------------- (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment, award, benefit or distribution (or any acceleration of any payment, award, benefit or distribution) by the Employer (or any of its affiliate entities) or any entity which effectuates a Change in Control (or any of its affiliated entities) to or for the benefit of Employee (whether pursuant to the terms of this Agreement of otherwise) (the "Payments") would be subject to the excise tax (the "Excise Tax") under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), then the amounts payable to Employee under this Agreement shall be reduced (reducing first the payments under Section 3(a)(ii), unless an alternative method of reduction is elected by Employee) to the maximum amount 16 as will result in no portion of the Payments being subject to such excise tax (the "Safe Harbor Cap"). For purposes of reducing the Payments to the Safe Harbor Cap, only amounts payable under this Agreement (and not other Payments) shall be reduced, unless consented to by Employee. (b) All determinations required to be made under this Section 5 shall be made by the public accounting firm that is retained by the Employer and Potomac Bankshares as of the date immediately prior to the Change in Control (the "Accounting Firm"). In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control (or if the Accounting Firm fails to make the Determination), Employee may appoint another nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). If payments are reduced to the Safe Harbor Cap, the Accounting Firm shall provide a reasonable opinion to Employee that he is not required to report any Excise Tax on his federal income tax return. All fees, costs and expenses (including, but not limited to, the costs of retaining experts) of the Accounting Firm shall be borne by the Employer. The determination by the Accounting Firm shall be binding upon the Employer and Employee (except as provided in Subsection (c) below). (c) If it is established pursuant to a final determination of a court or an Internal Revenue Service (the "IRS") proceeding which 17 has been finally and conclusively resolved, that Payments have been made to, or provided for the benefit of, Employee by the Employer, which are in excess of the limitations provided in this Section 5 (hereinafter referred to as an "Excess Payment"), such Excess Payment shall be deemed for all purposes to be a loan to Employee made on the date Employee received the Excess Payment and Employee shall repay the Excess Payment to the Employer on demand, together with interest on the Excess Payment at the applicable federal rate (as defined in Section 1274(d) of the Code) from the date of Employee's receipt of such Excess Payment until the date of such repayments. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the determination, it is possible that Payments which will not have been made by the Employer should have been made (an "Underpayment"), consistent with the calculations required to be made under this Section 5. In the event that it is determined (1) by the Accounting Firm, the Employer (which shall include the position taken by the Employer, or together with its consolidated group, on its federal income tax return) or the IRS or (2) pursuant to a determination by a court, that an Underpayment has occurred, the Employer shall pay an amount equal to such Underpayment to Employee within ten (10) days of such determination together with interest on such amount at the applicable federal rate from the date such amount would have been paid to Employee until the date of payment. 18 SECTION SEVEN SUCCESSORS; BINDING AGREEMENT (a) This Agreement shall not be terminated by any Business Combination. In the event of any such Business Combination, the provisions of this Agreement shall be binding upon the Surviving Corporation, and such Surviving Corporation shall be treated as the Employer hereunder. (b) The Employer agrees that in connection with any Business Combination, it will cause any successor entity to the Employer unconditionally to assume, by written instrument delivered to Employee (or his beneficiary or estate), all of the obligations of the Employer hereunder. Failure of the Employer to obtain such assumption prior to the effectiveness of any such Business Combination that constitutes a Change in Control shall constitute Good Reason hereunder and shall entitle Employee to compensation and other benefits from the Employer in the same amount and on the same terms as Employee would be entitled hereunder if Employee's employment were terminated following a Change in Control other than by reason of a Nonqualifying Termination. For purposes of implementing the foregoing, the date on which any such Business Combination becomes effective shall be deemed the date Good Reason occurs, and shall be the Date of Termination if requested by Employee. (c) This Agreement shall inure to the benefit of and be enforceable by Employee's personal or legal representatives, 19 executors, administrators, successors, heirs, distributees, devisees and legatees. If Employee shall die following the Date of Termination while any amounts would be payable to Employee hereunder had Employee continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to such person or persons appointed in writing by Employee to receive such amounts or, if no person is so appointed, to Employee's estate. SECTION EIGHT NOTICE (a) For purposes of this Agreement, all notices and other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given when delivered or five (5) days after deposit in the United States mail, certified and return receipt requested, postage prepaid, addressed as follows: If to the Employee: Robert F. Baronner, Jr. 2060 Fox Chase Drive Martinsburg, WV 25401 20 If to the Employer or Potomac Bankshares: Bank of Charles Town Potomac Bankshares, Inc. P. O. Box 906 Charles Town, WV 254l4 Attention: John C. Skinner, Jr. or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address be effective only upon receipt. (b) A written notice of Employee's Date of Termination by the Employer or Employee, as the case may be, to the other, shall (i) indicate the specific termination provision in this Agreement relied upon, and (ii) to the extent applicable, set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Employee's employment under the provision so indicated. SECTION NINE FULL SETTLEMENT; RESOLUTION OF DISPUTES The Employer's obligation to make any payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Employer may have against Employee or others. In no event shall Employee be obligated to seek other employment or take other action by way of mitigation of the amounts payable to Employee under any of the provisions of this Agreement and, except as provided in Section 21 3(b) hereof, such amounts shall not be reduced whether or not Employee obtains other employment. SECTION TEN EMPLOYMENT WITH SUBSIDIARIES Employment with the Employer for purposed of this Agreement shall include employment with any Subsidiary. SECTION ELEVEN GOVERNING LAW; VALIDITY The interpretation, construction and performance of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of West Virginia without regard to the principle of conflicts of laws. the invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which other provisions shall remain in full force and effect. SECTION TWELVE COUNTERPARTS This Agreement may be executed in counterparts, each of which shall be deemed to be an original and all of which together shall constitute one and the same instrument. SECTION THIRTEEN OTHER EMPLOYMENT Employee shall devote all of his time, attention, knowledge, and skills solely to the business and interest of employer, and 22 employer shall be entitled to all of the benefits, profits or other issues arising from or incident to all work, services, and advice of employee, and employee shall not, during the term hereof, be interested directly or indirectly, in any manner, as partner, officer, director, stockholder, advisor, employee or in any other capacity in any other business similar to employer's business or any allied trade; provided, however, that nothing herein contained shall be deemed to prevent or limit the right of employee to invest any of his surplus funds in the capital stock or other securities of any corporation whose stock or securities are publicly owned or are regularly traded on any public exchange, nor shall anything herein contained be deemed to prevent employee from investing or limit employee's right to invest his surplus funds in real estate, or to engage in any other activity which does not interfere or otherwise conflict with Employee's obligations to Employer under this Agreement, all subject to the restrictions and limitations imposed by Federal and State banking laws on officers and directors of banks and bank holding companies. SECTION FOURTEEN AGREEMENTS OUTSIDE OF CONTRACT This contract contains the complete agreement concerning the employment arrangement between the parties and shall, as of the effective date hereof, supersede all other agreements between the parties. The parties stipulate that neither of them has made any representation with respect to the subject matter of this agreement 23 or any representations including the execution and delivery hereof except such representations as are specifically set forth herein and each of the parties hereto acknowledges that he or it has relied on its own judgment in entering into this agreement. The parties hereto further acknowledge that any payments or representations that may have heretofore been made by either of them to the other are of no effect and that neither of them has relied thereon in connection with his or its dealings with the other. SECTION FIFTEEN MODIFICATION OF CONTRACT No waiver or modification of this agreement or of any covenant, condition, or limitation herein contained shall be valid unless in writing and duly executed by the party to be charged therewith and no evidence of any waiver or modification shall be offered or received in evidence of any proceeding, arbitration, or litigation between the parties hereto arising out of or affecting this agreement, or the rights or obligations of the parties hereunder, unless such waiver or modification is in writing, duly executed as aforesaid, and the parties further agree that the provisions of this section may not be waived except as herein set forth. SECTION SIXTEEN TERMINATION This agreement may be terminated by either party on thirty 24 (30) days' written notice to the other. Such notice also applies to Employer's determination not to renew this Agreement. Except as set forth in Section 6 hereof, Employer shall terminate this Agreement, or fail to renew same for any reason other than Cause as defined in Section 1, employee shall be entitled to compensation for one full year from termination, as set forth in Section 5, and Employee shall, for a period of twelve (12) months from termination, continue to provide to Employee and Employee's dependents, if applicable, with the same level of medical, dental, disability and life insurance benefits upon substantially the same terms and conditions (including contributions required from Employee to receive such benefits) as existed immediately prior to the termination, provided that, if Employee cannot continue to participate in the -------- ---- Employer plans providing such benefits, the Employer shall otherwise provide such benefits on the same after-tax basis as if continued participation had been permitted. Notwithstanding the foregoing, if Employee becomes re-employed with another employer and is eligible to receive welfare benefits from such employer, the welfare benefits described herein shall be secondary to such benefits during the period of Employee's eligibility, but only to the extent that the Employer reimburses Employee for any increased cost and provides any additional benefits necessary to give Employee the benefits promised hereunder. Employee may withhold required taxes from all payments due to Employee hereunder. In the event of termination for Cause, 25 Employer thereon may terminate employment without notice and with pay only to the date of such termination. It is further agreed that any breach or evasion of any of the terms of this contract by either party hereto will result in immediate and irreparable injury to the other party and will authorize recourse to injunction and/or specific performance as well as to all other legal or equitable remedies to which such injured party may be entitled hereunder. SECTION SEVENTEEN SEVERABILITY All agreements and covenants contained herein are severable, and in the event any of them, with the exception of those contained in Sections One and Four hereof, shall be held to be invalid by any competent court, this contract shall be interpreted as if such invalid agreements or covenants were not contained herein. In witness whereof, the parties have executed this agreement at Charles Town, West Virginia, on July 10, 2001. ------------- BANK OF CHARLES TOWN /s/ John C. Skinner, Jr. ------------------------ By: John C. Skinner, Jr. for the Board of Directors POTOMAC BANKSHARES, INC. /s/ John C. Skinner, Jr. ------------------------ By: John C. Skinner, Jr. for the Board of Directors /s/ Robert F. Baronner, Jr. --------------------------- ROBERT F. BARONNER, JR. 26 STATE OF WEST VIRGINIA, COUNTY OF Jefferson, TO-WIT: --------- Taken, subscribed and sworn to by John C. Skinner, Jr., for the Board of Directors of Bank of Charles Town, before me, a Notary Public, this 12 day of -- July, 2001. - ---- /s/ Virginia Mae Longerbeam --------------------------- Notary Public My commission expires: May 7, 2006 - --------------------- STATE OF WEST VIRGINIA, COUNTY OF Jefferson, TO-WIT: --------- Taken, subscribed and sworn to by John C. Skinner, Jr., for the Board of Directors of Potomac Bankshares, Inc., before me, a Notary Public, this 12/th/ ------ day of July, 2001. ---- /s/ Virginia Mae Longerbeam --------------------------- Notary Public My commission expires: May 7, 2006 - ----------- 27 STATE OF WEST VIRGINIA, COUNTY OF Jefferson, TO-WIT: --------- Taken, subscribed and sworn to by Robert F. Baronner, Jr., before me, a Notary Public, this 12/th/ day of July, 2001. ------ ---- /s/ Virginia Mae Longerbeam ------------------------------- Notary Public My commission expires: May 7, 2006 - ----------- 28 EX-13 4 dex13.txt ANNUAL REPORT Exhibit 13 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....................................................4-11 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......................................................18-31 Trust and Financial Services................................................................................32 Officers....................................................................................................33 Annual Report on Form 10-KSB................................................................................34 General Information.........................................................................................34
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, 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. THE PRESIDENT'S REPORT TO OUR SHAREHOLDERS The officers and directors of Potomac Bancshares, Inc. are pleased to present to you a summary of the past year's results for the holding company and its subsidiary, Bank of Charles Town. For 2001, the Corporation had record earnings of $2.01 million, an increase of 10.7% over the previous year. Net income per share increased from $3.02 to $3.35. Return on Assets and Return on Equity, key ratios that investors frequently use to gauge banks, were favorably impacted, improving to 1.27% and 10.68% respectively. These gradual improvements in our financial performance during the year appear to have helped the market price for Potomac Bancshares Stock. On December 31, 2001, our stock closed at $35.25 per share compared to $24.625 on December 31, 2000, an increase of 43% in market value in 12 months. There are a number of reasons for the improvement in income, including loan growth, fee income improvement, and disciplined margin management. Average loans grew from $81,755 million in 2000 to $93,816 million in 2001, an overall increase of 14.8%. The bulk of the portfolio growth came in the latter part of the year with total loans outstanding at year-end topping $100 million, net of reserve. With the increase in loan activity came a corresponding improvement in noninterest income, up 18.3% over the previous year. This was primarily driven by commercial loan fees and secondary mortgage market income. In a year where interest rates sharply declined, our net interest margin improved from 4.67% to 4.89%. This was accomplished through a combination of changing the mix of our loan portfolio, doing more higher yielding business loans, and aggressively reducing our funding costs as interest rates declined during 2001. Last year we wrote that there was an industry trend toward loan demand outpacing deposit growth. Although we had a great year with loan growth, surprisingly, we had very good year with deposit growth as well. Average deposits grew from $126.6 million in 2000 to $135.7 million in 2001, an increase of 7.2%. Like our loan portfolio, we saw the bulk of this growth occurring in the latter part of the year. Deposit balances at year-end, including our commercial cash management account, were $149.8 million. In conjunction with this growth, our credit quality continued to be very good. Average delinquency for the year (accounts more than 30 days past due) was less than 1% of the outstanding portfolio. Charged off loans, net of recoveries, were less than .10% of the outstanding portfolio. We added an additional $220 thousand to our loan loss reserve to keep pace with our growth and historical loss record. Our loan reserve as a percentage of outstanding loans is a respectable 1.37%. The employees of Potomac Bancshares' subsidiary, Bank of Charles Town, are very pleased with the year's results. However, we also recognize that we cannot "rest on our laurels" and be satisfied with the status quo. We operate in a competitive environment that demands continual self-evaluation and improvement. Keeping this in mind, we will embark this year on a number of changes designed to keep the bank profitable and growing. First, we will invest in new technology that will help us improve efficiency and allow us to service our customer base better. Secondly, we will continue to train our employees to deliver nothing less but the best in customer sales and service. And third, we will build upon our the number of locations and banking services available to our customers by continuing to expand our market presence throughout the Eastern Panhandle. We believe we "have a good thing going" and invite you as both a shareholder and customer to spread the word. We continually change to improve shareholder value and we appreciate your support! /s/ Robert F. Baronner, Jr. - -------------------------- Robert F. Baronner, Jr. President and CEO ~1~ ================================================================================ DESCRIPTION OF BUSINESS Potomac Bancshares, Inc., a one-bank holding company, and Subsidiary, Bank of Charles Town (BCT), are engaged in general banking business serving primarily Berkeley County and Jefferson County, West Virginia. The Corporation also provides services to Washington County and Frederick County, Maryland and Loudoun County, Frederick County, and Clarke County, Virginia. The main office is in Charles Town with branch offices in Harpers Ferry, Kearneysville and Martinsburg. 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 four 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 any touch tone telephone and/or the World Wide Web. 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 Robert F. Baronner, Jr. Robert W. Butler E. William Johnson President & CEO Farmer-Orchardist Professor of Economics Bank of Charles Town Warm Spring Orchard & Farm Shepherd College J. Scott Boyd Guy Gareth Chicchirichi John C. Skinner, Jr. President Executive Manager Owner Jefferson Pharmacy, Inc. Guy's Buick-Pontiac-Oldsmobile- Nichols & Skinner, L.C. GMC Truck, Inc. John P. Burns, Jr. Thomas C. G. Coyle Donald S.Smith Partner Retired Owner-Operator Retired President Burns Farm Riddleberger's Store Bank of Charles Town William R. Harner Senior Vice President & Cashier Bank of Charles Town
~2~ ================================================================================ SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in Thousands Except Per Share Data)
2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- Summary of Operations Interest income $ 10,956 $ 10,328 $ 10,009 $ 10,055 $ 9,563 Interest expense 3,758 3,968 4,191 4,401 3,710 -------- -------- -------- -------- -------- Net interest income 7,198 6,360 5,818 5,654 5,853 Provision for (recovery of) loan losses 221 (70) 125 125 127 -------- -------- -------- -------- -------- Net interest income after provision for (recovery of) loan losses 6,977 6,430 5,693 5,529 5,726 Noninterest income 1,358 1,148 1,170 1,126 1,128 Noninterest expense 5,160 4,711 4,423 4,297 4,127 -------- -------- -------- -------- -------- Income before income taxes 3,175 2,867 2,440 2,358 2,727 Income tax expense 1,166 1,053 897 869 1,005 -------- -------- -------- -------- -------- Net income $ 2,009 $ 1,814 $ 1,543 $ 1,489 $ 1,722 ======== ======== ======== ======== ======== Per Share Data Net income, basic and diluted $ 3.35 $ 3.02 $ 2.57 $ 2.48 $ 2.87 Cash dividends declared 1.35 1.25 1.15 1.15 1.15 Book value at period end 32.36 29.94 27.81 26.99 25.50 Average shares outstanding 600,000 600,000 600,000 600,000 600,000 Average Balance Sheet Summary Assets $158,385 $145,339 $147,612 $138,698 $126,474 Loans 93,816 81,755 78,710 78,552 76,866 Securities 41,870 44,935 48,865 44,752 40,178 Deposits 135,658 126,617 129,711 121,612 110,291 Shareholders' equity 18,812 17,345 16,539 15,862 14,870 Performance Ratios Return on average assets 1.27% 1.25% 1.05% 1.07% 1.36% Return on average equity 10.68% 10.46% 9.33% 9.39% 11.58% Dividend payout ratio 40.30% 41.39% 44.75% 46.37% 40.07% Capital Ratios Leverage ratio 11.30% 12.32% 11.55% 11.15% 11.83% Risk-based capital ratios Tier 1 capital 19.90% 22.70% 23.19% 22.64% 23.15% Total capital 21.15% 23.95% 24.45% 23.89% 24.41%
~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.
2001 2000 ------------------------------------------ ---------------------------------------- Average Income/ Average Average Income/ Average Balances Expense Yield/Rate Balances Expense Yield/Rate ------------- ------------ ----------- ------------- ----------- ---------- ASSETS Loans Taxable $ 92,434 336 $ 8,070,799 8.73% $ 81,440,912 $ 7,109,661 8.73% Tax exempt 1,381,761 137,003 9.92% 313,769 29,502 9.40% ------------- ------------ ------------- ----------- Total loans 93,816,097 8,207,802 8.75% 81,754,681 7,139,163 8.73% ------------- ------------ ------------- ----------- Taxable securities 41,870,474 2,318,806 5.54% 44,935,292 2,645,904 5.89% Securities purchased under agreements to resell and federal funds sold 10,366,914 393,154 3.79% 9,161,133 522,368 5.70% Other earning assets 2,113,431 82,289 3.89% 448,471 31,220 6.96% ------------- ------------ ------------- ----------- Total earning assets 148,166,916 $ 11,002,051 7.43% 136,299,577 $10,338,655 7.59% ------------- ------------- Allowance for loan losses (1,287,062) (1,262,222) Cash and due from banks 6,352,987 5,376,831 Premises and equipment, net 3,278,950 2,845,680 Other assets 1,872,882 2,079,473 ------------- ------------- Total assets $ 158,384,673 $ 145,339,339 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Savings and interest- bearing demand deposits $ 73,730,903 $ 1,461,562 1.98% $ 69,628,442 $ 1,968,321 2.83% Time deposits 42,830,718 2,198,395 5.13% 39,760,157 1,999,184 5.03% ------------- ------------ ------------- ----------- Total interest- bearing deposits 116,561,621 3,659,957 3.14% 109,388,599 3,967,505 3.63% ------------- ------------ ------------- ----------- Securities sold under agreements to repurchase and federal funds purchased 1,093,284 31,160 2.85% 8,197 584 7.12% Advances from FHLB 1,304,876 66,663 5.12% 0 0 ------------- ------------ ------------- ----------- Total interest bearing liabilities 118,959,781 $ 3,757,780 3.16% 109,396,796 $ 3,968,089 3.63% ------------- ------------ ------------- ----------- Noninterest-bearing demand deposits 19,096,124 17,227,906 Other liabilities 1,516,895 1,369,983 Stockholders' equity 18,811,873 17,344,654 ------------- ------------- Total liabilities and stockholders' equity $ 158,384,673 $ 145,339,339 ============= ============= Net interest income $ 7,244,271 $ 6,370,566 ============ =========== Net interest spread 4.27% 3.96% Interest expense as a percent of average earning 2.54% 2.91% assets Net interest margin 4.89% 4.67%
~4~ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL - ------- Total assets increased over $24,000,000 or 16.8% in 2001 compared to 2000. Loans increased 21.4% or $17,800,000 in 2001 compared to 2000. Investment securities increased 37.7% or $13,600,000 in 2001 over balances at December 31, 2000. The daily investments consisting of securities purchased under agreements to resell and federal funds sold decreased in 2001 compared to 2000 by $13.400,000. Cash and due from banks increased $3,200,000 and interest-bearing balances in financial institutions increased $2,500,000. The increase in net income of $195,000 or 10.7% in 2001 compared to 2000 results from increased interest income, decreased interest expense and increased noninterest income. Management is unaware of any trends, events or uncertainties that would have a 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 - ------------------- Net interest income increased 13.2% in 2001 compared to 2000 due to increased interest income and decreased interest expense. Interest income increased $600,000 or 6.1% in 2001 when compared to 2000. Interest and fees on loans increased 14.5% in 2001 compared to 2001 due almost entirely to increased volume of the loan portfolio from $84,446,835 at December 31, 2000 to $102,389,668 at December 31, 2001. The average rate of the taxable portion of the portfolio remained the same in 2001 as in 2000. An experienced commercial lender added to the staff early in 2001 played a large part in increasing the loan volume during 2001. Interest income on securities held to maturity and securities available for sale decreased 12.4% in 2001 compared to 2000. This decrease resulted from a decreased average rate in 2001 even though there was an increase in volume. Interest income from securities purchased under agreements to resell and federal funds sold also decreased in 2001 compared to 2000 as a result of decreased rates and decreased volumes. Other earning assets added over $80,000 of income during 2001. These assets included an average balance of $1,435,282 in the Federal Home Loan Bank interest-bearing demand deposit account, Federal Home Loan Bank stock with an average balance of $461,215 and loans held for sale with an average balance of $216,934. Interest expense decreased 5.3% or $210,000 in 2001 compared to 2000. Decreased rates were responsible for the majority of decrease in interest expense even though total deposits increased $17,900,000 in 2001 compared to 2000. Over 93% of this increase was in interest-bearing deposits. In 2001, the average yield for earning assets was 7.43% compared to 7.59% in 2000. The average rate paid on all interest bearing liabilities was 3.16% in 2001 compared to 3.63% in 2000. The net interest spread (difference between yield on earning assets and rate paid on interest-bearing liabilities) increased in 2001 to 4.27% from 3.96% in 2000. The net interest margin (total interest income less total interest expense divided by average earning assets) increased in 2001 to 4.89% from 4.67% in 2000. ~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.
2001 Compared to 2000 2000 Compared to 1999 --------------------------------------- ------------------------------------- Change in Volume Rate Change in Volume Rate Income/Expense Effect Effect Income/Expense Effect Effect -------------- ---------- --------- -------------- --------- -------- INTEREST INCOME Taxable loans $ 961,138 $ 961,138 $ -- $ 444,777 $ 262,349 $182,428 Tax exempt loans 107,501 105,782 1,719 1,320 (499) 1,819 Taxable securities (327,098) (174,803) (152,295) (105,069) (249,145) 144,076 Securities purchased under agreements to resell and federal funds sold (129,214) 83,586 (212,800) (20,709) (143,696) 122,987 Other earning assets 51,069 57,955 (6,886) -- -- -- --------- ---------- --------- --------- --------- -------- TOTAL $ 663,396 $1,033,658 $(370,262) $ 320,319 $(130,991) $451,310 --------- ---------- --------- --------- --------- -------- INTEREST EXPENSE Savings and interest-bearing demand deposits $(506,759) $ 123,669 $(630,428) $ (50,399) $ (36,363) $(14,036) Time deposits 199,211 158,427 40,784 (172,759) (134,657) (38,102) Securities sold under agreements to repurchase and federal funds purchased 30,576 30,715 (139) 584 584 -- Advances from FHLB 66,663 66,663 -- -- -- -- --------- ---------- --------- --------- --------- -------- TOTAL $(210,309) $ 379,474 $(589,783) $(222,574) $(170,436) $(52,138) --------- ---------- --------- --------- --------- -------- NET INTEREST INCOME $ 873,705 $ 654,184 $ 219,521 $ 542,893 $ 39,445 $503,448 ========= ========== ========= ========= ========= ========
NONINTEREST INCOME AND EXPENSE - ------------------------------ Noninterest income increased 18.3% in 2001 compared to 2000. The Trust and Financial Services income decreased 6.7% in 2001 compared with 2000, a reflection of no new estate appointments. Service charges on deposit accounts increased 25% in 2001 compared to 2000 due to a 100% increase in overdraft charges as a result of the overdraft protection program begun late in 2001. Other customer service fees increased 42.1% in 2001 compared to 2000. These included volume increases for installment loan insurance commissions and credit and debit card fees. Non customer ATM surcharges increased due to increased rates. Fees associated with sale of loans in the secondary market increased noninterest income $87,382 in 2001 compared to 2000 when the Bank had no secondary market program. Noninterest expense increased 9.5% in 2001 compared to 2000. Salaries and employee benefits increased 9.9% in 2001 compared to 2000. An increase of 13.3% in salaries, wages and related taxes in 2001 compared to 2000 included annual increases for officers and employees as well as major staffing changes and additions incorporated by the Bank in 2001. Occupancy expense of premises increased 40.1% in 2001 compared to 2000. This included increased depreciation expense for the renovation and building program completed in 2000 and leasehold improvements for the new Martinsburg branch; increased rent and utility expense due to the Martinsburg branch; and increased building maintenance expense for major landscaping improvements for all Bank locations. Furniture and equipment expense increased 17.1% for the building and renovation project completed in 2000 as well as for continual equipment replacement for maintenance of the Bank's high information technology standards. Advertising and marketing expenses increased in 2001 by 49% compared to 2000 due to upgraded standards and creation of consistent branding. ~6~ 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, 2001.
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 $ 10,911,325 $ 22,864,100 $51,997,367 $ 6,852,055 $ -- Floating rate loans 9,764,821 -- -- -- -- Securities 3,259,725 10,045,170 36,393,296 -- -- Securities purchased under agreements to resell and federal funds sold 3,911,812 -- -- -- -- Other earning assets 2,466,314 -- -- -- 465,500 ------------ ------------ ----------- ----------- ----------- Total $ 30,313,997 $ 32,909,270 $88,390,663 $ 6,852,055 $ 465,500 ------------ ------------ ----------- ----------- ----------- Interest-Bearing Liabilities: Time deposits $100,000 and over $ 1,495,553 $ 3,258,146 $ 2,546,266 $ -- $ -- Other time deposits 8,655,745 17,203,833 12,311,503 -- -- Money market accounts 6,049,079 -- -- -- -- NOW accounts 38,235,706 -- -- -- 19,486,436 Savings accounts -- -- -- -- 17,040,431 Securities sold under agreements to repurchase 2,949,056 -- -- -- -- Federal Home Loan Bank advances 75,765 233,644 1,422,657 619,492 -- ------------ ------------ ----------- ----------- ----------- Total $ 57,460,904 $ 20,695,623 $16,280,426 $ 619,492 $36,526,867 ------------ ------------ ----------- ----------- ----------- Rate Sensitivity Gap $(27,146,907) $ 12,213,647 $72,110,237 $ 6,232,563 ------------ ------------ ----------- ----------- Cumulative Gap $(27,146,907) $(14,933,260) $57,176,977 $63,409,540 ============ ============ =========== ===========
The matching of the maturities or repricing opportunities of interest earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring an institution's interest rate sensitivity gap. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that period. The interest rate sensitivity gap is the difference between the amount of interest earning assets that will mature or reprice within a specific time period and the amount of interest-bearing liabilities that will mature or reprice within the same time period. A gap is considered negative when the amount of liabilities maturing or repricing in a specific period exceeds the amount of assets maturing or repricing in the same period. 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. During the first twelve months shown in the schedule above, the Corporation is liability sensitive and after that time period the Corporation is asset sensitive. During January, February and March of 2002, $27,000,000 more liabilities reprice or mature than assets. During April through December of 2002, $12,000,000 more assets reprice or mature than liabilities. The net effect for 2002 is that almost $15,000,000 more liabilities reprice than assets. This is advantageous to the Corporation because it allows older assets that were incurred at higher than current rates to remain on the books while interest rates being paid on deposit and other liabilities are changing to the current lower rates. Similar to the situation displayed in the schedule for 2002 and beyond, during 2001 the Corporation experienced the rather rapid decrease of deposit rates which lowered interest expense while maintaining longer term assets with higher rates on the books which helped maintain interest income at higher levels. ~7~ LOAN PORTFOLIO - -------------- Loans at December 31, 2001and 2000 are summarized below: 2001 2000 ------------ ----------- Commercial, financial and agricultural $ 2,998,473 $ 2,235,977 Mortgage loans on real estate: Construction and land development 530,000 14,000 Secured by farm land 1,801,165 2,762,776 Secured by 1-4 family residential 56,283,230 45,055,946 Other real estate 19,275,005 12,150,047 Consumer loans 21,213,959 22,022,827 All other loans 287,836 205,262 ------------ ----------- $102,389,668 $84,446,835 ============ =========== Loans have increased 21.2% in 2001 over 2000 when comparing year end totals without reducing the portfolio numbers by the allowance for loan losses. The addition of an experienced commercial lender to the staff has played a great part in this growth that has affected most loan categories. Significant increases include 34.1% in commercial, financial and agricultural loans; 3685.7% in real estate construction and land development loans; 24.9% in real estate loans secured by 1-4 family residential properties, and 58.6% in other real estate loans. There were no categories of loans that exceeded 10% of outstanding loans at December 31, 2001 which were not disclosed in the table above. REMAINING MATURITIES OF SELECTED LOANS Commercial, Financial and Real Estate- Agricultural Construction ------------- ------------- Within one year $ 1,791,210 $ -- Variable rate 580,719 -- Fixed rate, over one through five years 626,544 530,000 ------------ ------------ Total maturities $ 2,998,473 $ 530,000 ============ ============ 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 allowance for loan losses is adequate.
2001 2000 1999 ------------ ------------ ------------- Balance at beginning of period $ 1,268,235 $ 1,217,919 $ 1,140,000 Charge-offs: Commercial, financial and agricultural 12,456 -- -- Real estate - construction -- -- -- Real estate - mortgage 6,658 -- 26,854 Consumer 102,574 105,677 62,510 ------------ ------------ ------------- Total charge-offs 121,688 105,677 89,364 ------------ ------------ ------------- Recoveries: Commercial, financial and agricultural 667 -- -- Real estate - construction -- -- -- Real estate - mortgage 492 201,284 17,000 Consumer 33,966 24,709 25,283 ------------ ------------ ------------- Total recoveries 35,125 225,993 42,283 ------------ ------------ ------------- Net charge-offs (recoveries) 86,563 (120,316) 47,081 Additions charged (credited) to operations 220,575 (70,000) 125,000 ------------ ------------ ------------- Balance at end of period $ 1,402,247 $ 1,268,235 $ 1,217,919 ============ ============ ============= Ratio of net charge-offs (recoveries) during the period to average loans outstanding during the period 0.09% (0.15)% 0.06% ============ ============ =============
~8~ ALLOCATION OF ALLOWANCE FOR LOAN LOSSES The following table shows an allocation of the allowance 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.
2001 2000 -------------------------------- ------------------------------- Percent of Loans Percent of Loans in Each Category in Each Category Allowance to Total Loans Allowance to Total Loans ----------- ---------------- ----------- ----------------- Commercial, financial and agricultural $ 14,992 2.92% $ 46,934 2.65% Mortgage loans on real estate: Construction and land development 2,650 .52% 70 .02% Secured by farm land 9,006 1.76% 13,814 3.27% Secured by 1-4 family residential 315,375 54.97% 268,879 53.35% Other real estate 250,993 18.83% 365,623 14.39% Consumer loans 119,331 20.72% 119,779 26.08% All other loans 1,439 .28% 1,026 .24% Unallocated 688,461 -- 452,110 -- ----------- ------ ----------- ------ $ 1,402,247 100.00% $ 1,268,235 100.00% =========== ====== =========== ======
RISK ELEMENTS IN THE LOAN PORTFOLIO
2001 2000 1999 ----------- ----------- ----------- Nonaccrual loans $ 9,060 $ -- $ 112,844 Restructured loans -- -- -- Foreclosed properties -- 12,647 201,429 ----------- ----------- ----------- Total nonperforming assets $ 9,060 $ 12,647 $ 314,273 =========== =========== =========== Loans past due 90 days accruing interest $ 29,293 $ 790,349 $ 559,924 =========== =========== =========== Allowance for loan losses to period end loans 1.37% 1.50% 1.55% Nonperforming assets to period end loans and foreclosed properties .01% .01% .40%
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 $-0- and $725,040 at December 31, 2001 and 2000. Nonaccrual loans not classified as impaired totaled $9,060 in 2001 and $-0- in 2000. At December 31, 2001, other potential problem loans totaled $5,927. 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 Financial Accounting Standards Board Statement 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. ~9~ The schedule below summarizes the book value of the portfolio by maturity classifications and shows the weighted average yield in each group.
Weighted Weighted 2001 Average 2000 Average Book Value Yield Book Value Yield ------------- -------- -------------- -------- Securities held to maturity Obligations of U.S. Government agencies: Maturing within one year $ 6,970,170 6.18% $ 8,004,061 5.66% Maturing after one year but within five years 12,020,204 5.67% 9,923,700 6.89% ------------- -------------- Total securities held to maturity $ 18,990,374 $ 17,927,761 ============= ============== Securities available for sale Obligations of U.S. Government agencies: Maturing within one year $ 6,334,725 5.50% $ 11,932,860 5.17% Maturing after one year but within five years 24,373,092 4.74% 6,229,425 5.77% ------------- -------------- Total securities available for sale $ 30,707,817 $ 18,162,285 ============= ============== Total securities $ 49,698,191 $ 36,090,046 ============= ==============
DEPOSITS - -------- When comparing the 2001 and 2000 year end balances, total deposits increased $17,900,000 or 13.9% in 2001. Interest- bearing deposits increased $16,800,000 or 15.3%, and noninterest-bearing deposits increased $1,200,000 or 6.1%. Money market accounts were the only category of deposits that showed a decreased balance when comparing December 31, 2001 to December 31, 2000. The average yield on savings and interest bearing demand deposits decreased to 1.98% at December 31, 2001 as compared to 2.83% at December 31, 2000. The average yield on time deposits increased in 2001 to 5.13% compared to 5.03% at December 31, 2000. At December 31, 2001, time deposits of $100,000 or more were 4.97% of total deposits compared with 4.25% at December 31, 2000. Maturities of time deposits of $100,000 or more at December 31, 2001 are as follows: Within three months $ 1,495,553 Over three through six months 859,633 Over six months through twelve months 2,398,513 Over twelve months 2,546,266 ------------ Total $ 7,299,965 ============ 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. ~10~ 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 21.15% and a ratio of Tier 1 capital to risk-weighted assets of 19.90% at December 31, 2001. Both of these exceed the capital requirements adopted by the federal regulatory agencies. 2001 2000 --------- ---------- Tier 1 capital: Common stock $ 600 $ 600 Surplus 5,400 5,400 Retained earnings 13,208 12,008 --------- ---------- Total tier 1 capital $ 19,208 $ 18,008 Tier 2 capital: Allowance for loan losses (1) 1,209 995 --------- ---------- Total risk-based capital $ 20,417 $ 19,003 ========= ========== Risk-weighted assets $ 96,545 $ 79,347 ========= ========== Capital ratios: Tier 1 risk-based capital ratio 19.90% 22.70% Total risk-based capital ratio 21.15% 23.95% Leverage ratio 11.30% 12.32% (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, interest-bearing deposits in financial institutions, 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 2001 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, proceeds from securities sold under agreements to repurchase and proceeds from borrowed funds. 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, 2001, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $49,327,269. Borrowing capabilities provide additional liquidity. The Subsidiary Bank maintains a federal funds line of $7,000,000 with Bank of America. 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 $50,906,000. The Subsidiary Bank borrowed $2,500,000 amortized over seven years from the Federal Home Loan Bank in June 2001. ~11~ This page is intentionally left blank. ~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, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years ended December 31, 2001, 2000 and 1999. 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 auditing standards generally accepted in the United States of America. 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, 2001 and 2000, and the results of their operations and their cash flows for the years ended December 31, 2001, 2000 and 1999, in conformity with accounting principles generally accepted in the United States of America. /s/ YOUNT, HYDE & BARBOUR, P.C. Winchester, Virginia February 6, 2002 ~13~ CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000
2001 2000 ------------ ------------ ASSETS Cash and due from banks $ 9,351,485 $ 6,052,922 Interest-bearing deposits in financial institutions 2,466,314 -- Securities purchased under agreements to resell and federal funds sold 3,911,812 17,365,954 Securities held to maturity (fair value $19,613,951 in 2001 and $18,104,620 in 2000) 18,990,374 17,927,761 Securities available for sale, at fair value 30,707,817 18,162,285 Loans held for sale 915,576 -- Loans, net of allowance for loan losses of $1,402,247 in 2001 and $1,268,235 in 2000 100,987,421 83,178,600 Other real estate owned -- 12,647 Premises and equipment, net 3,388,033 3,177,115 Accrued interest receivable 1,144,467 1,051,217 Other assets 1,228,798 1,292,925 ------------ ------------ Total Assets $173,092,097 $148,221,426 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Noninterest-bearing $ 20,611,535 $ 19,422,660 Interest-bearing 126,282,699 109,522,282 ------------ ------------ Total Deposits $146,894,234 $128,944,942 Accrued interest payable 223,452 302,684 Securities sold under agreements to repurchase 2,949,056 -- Federal Home Loan Bank advances 2,351,558 -- Other liabilities 1,257,263 1,010,052 Commitments and contingent liabilities -- -- ------------ ------------ Total Liabilities $153,675,563 $130,257,678 ------------ ------------ 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 13,207,472 12,008,205 Accumulated other comprehensive income (loss) 209,062 (44,457) ------------ ------------ Total Stockholders' Equity $ 19,416,534 $ 17,963,748 ------------ ------------ Total Liabilities and Stockholders' Equity $173,092,097 $148,221,426 ============ ============
See Notes to Consolidated Financial Statements. ~14~ CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 ----------- ----------- ----------- Interest and Dividend Income: Interest and fees on loans $ 8,161,221 $ 7,129,132 $ 6,683,484 Interest on securities held to maturity - taxable 1,132,929 1,276,315 1,358,213 Interest on securities available for sale - taxable 1,185,877 1,369,589 1,394,466 Interest on securities purchased under agreements to resell and federal funds sold 393,154 522,368 543,077 Other interest and dividends 82,289 31,220 29,514 ----------- ----------- ----------- Total Interest and Dividend Income $10,955,470 $10,328,624 $10,008,754 ----------- ----------- ----------- Interest Expense: Interest on deposits $ 3,659,957 $ 3,967,505 $ 4,190,663 Interest on securities sold under agreements to repurchase and federal funds purchased 31,160 584 -- Federal Home Loan Bank advances 66,663 -- -- ----------- ----------- ----------- Total Interest Expense $ 3,757,780 $ 3,968,089 $ 4,190,663 ----------- ----------- ----------- Net Interest Income $ 7,197,690 $ 6,360,535 $ 5,818,091 Provision for (Recovery of) Loan Losses 220,575 (70,000) 125,000 ----------- ----------- ----------- Net Interest Income after Provision for (Recovery of) Loan Losses $ 6,977,115 $ 6,430,535 $ 5,693,091 ----------- ----------- ----------- Noninterest Income: Trust and financial services $ 510,933 $ 547,727 $ 592,182 Service charges on deposit accounts 474,556 379,763 348,992 Fees for other customer services 224,239 156,910 168,810 Net gain on sale of loans 87,382 -- -- Other operating income 60,915 63,500 59,924 ----------- ----------- ----------- Total Noninterest Income $ 1,358,025 $ 1,147,900 $ 1,169,908 ----------- ----------- ----------- Noninterest Expenses: Salaries and employee benefits $ 3,143,150 $ 2,860,274 $ 2,601,097 Net occupancy expense of premises 296,740 211,838 204,076 Furniture and equipment expenses 464,058 396,045 377,852 Advertising and marketing 166,780 111,936 119,056 Stationery and supplies 125,173 111,389 123,573 Other operating expenses 964,239 1,019,479 997,215 ----------- ----------- ----------- Total Noninterest Expenses $ 5,160,140 $ 4,710,961 $ 4,422,869 ----------- ----------- ----------- Income before Income Tax Expense $ 3,175,000 $ 2,867,474 $ 2,440,130 Income Tax Expense 1,165,733 1,053,159 897,110 ----------- ----------- ----------- Net Income $ 2,009,267 $ 1,814,315 $ 1,543,020 =========== =========== =========== Earnings Per Share, basic and diluted $ 3.35 $ 3.02 $ 2.57 =========== =========== =========== See Notes to Consolidated Financial Statements.
~15~ CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2001, 2000 and 1999
Accumulated Other Common Undivided Comprehensive Comprehensive Stock Surplus Profits Income (Loss) Income Total -------- ---------- ----------- ------------- ------------- ----------- Balances, December 31, 1998 $600,000 $5,400,000 $10,090,870 $ 105,286 $16,196,156 Comprehensive income Net income - 1999 -- -- 1,543,020 -- $1,543,020 1,543,020 Other comprehensive income, unrealized holding (losses) arising during the period (net of tax, $186,227) -- -- -- (361,499) (361,499) (361,499) ---------- Total comprehensive income $1,181,521 ========== Cash dividends - 1999 ($1.15 per share) -- -- (690,000) -- (690,000) -------- ---------- ----------- --------- ----------- Balances, December 31, 1999 $600,000 $5,400,000 $10,943,890 $(256,213) $16,687,677 Comprehensive income Net income - 2000 -- -- 1,814,315 -- $1,814,315 1,814,315 Other comprehensive income, unrealized holding gains arising during the period (net of tax, $109,086) -- -- -- 211,756 211,756 211,756 ---------- Total comprehensive income $2,026,071 ========== Cash dividends - 2000 ($1.25 per share) -- -- (750,000) -- (750,000) -------- ---------- ----------- --------- ----------- Balances, December 31, 2000 $600,000 $5,400,000 $12,008,205 $ (44,457) $17,963,748 Comprehensive income Net income - 2001 -- -- 2,009,267 -- $2,009,267 2,009,267 Other comprehensive income, unrealized holding gains arising during the period (net of tax, $130,601) -- -- -- 253,519 253,519 253,519 ---------- Total comprehensive income $2,262,786 ========== Cash dividends - 2001 ($1.35 per share) -- -- (810,000) -- (810,000) -------- ---------- ----------- --------- ----------- Balances, December 31, 2001 $600,000 $5,400,000 $13,207,472 $ 209,062 $19,416,534 ======== ========== =========== ========= ===========
See Notes to Consolidated Financial Statements. ~16~ CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 ------------ ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,009,267 $ 1,814,315 $ 1,543,020 Adjustments to reconcile net income to net cash provided by operating activities: Provision for (recovery of) loan losses 220,575 (70,000) 125,000 Depreciation 288,464 236,554 202,873 Amortization -- -- 7,165 Deferred tax expense (benefit) (98,262) 32,870 (85,804) Discount (accretion) and premium amortization on securities, net (14,578) (40,428) 26,060 (Gain) on sale of other real estate (2,468) (12,220) (58,796) (Gain) loss on sale and disposal of premises and equipment -- (5,684) 41,903 Changes in assets and liabilities: (Increase) decrease in accrued interest receivable (93,250) 60,741 55,741 (Increase) decrease in other assets 31,788 (181,807) 113,621 Proceeds from sale of loans 4,652,242 -- -- Origination of loans for sale (5,567,818) -- -- (Decrease) in accrued interest payable (79,232) (5,101) (42,473) Increase (decrease) in other liabilities 247,211 (24,013) 142,123 ------------ ----------- ----------- Net cash provided by operating activities $ 1,593,939 $ 1,805,227 $ 2,070,433 ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturity of securities held to maturity $ 8,000,000 $ 7,000,000 $10,000,000 Proceeds from maturity of securities available for sale 12,000,000 9,000,000 3,550,000 Purchases of securities held to maturity (9,035,270) (9,889,898) -- Purchases of securities available for sale (24,174,178) -- (6,204,302) Net (increase) in loans (18,029,396) (6,009,114) (864,271) Purchases of premises and equipment (499,381) (1,271,019) (1,186,174) Proceeds from sale of equipment -- 5,684 22,727 Proceeds from sale of other real estate 15,115 213,649 206,467 ------------ ----------- ----------- Net cash provided by (used in) investing activities $(31,723,110) $ (950,698) $ 5,524,447 ------------ ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in noninterest-bearing deposits $ 1,188,875 $ 3,388,526 $(1,387,408) Net increase (decrease) in interest-bearing deposits 16,760,417 (1,128,107) (2,593,277) Net proceeds in securities sold under agreements to repurchase 2,949,056 -- -- Net proceeds in Federal Home Loan Bank advances 2,351,558 -- -- Cash dividends (810,000) (750,000) (690,000) ------------ ----------- ----------- Net cash provided by (used in) financing activities $ 22,439,906 $ 1,510,419 $(4,670,685) ------------ ----------- ----------- Increase (decrease) in cash and cash equivalents $ (7,689,265) $ 2,364,948 $ 2,924,195 CASH AND CASH EQUIVALENTS Beginning 23,418,876 21,053,928 18,129,733 ------------ ----------- ----------- Ending $ 15,729,611 $23,418,876 $21,053,928 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 3,837,012 $ 3,973,190 $ 4,233,136 ============ =========== =========== Income taxes $ 1,123,613 $ 1,088,541 $ 949,882 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES Other real estate acquired in settlement of loans $ -- $ 12,647 $ 293,674 ============ =========== =========== Loans originated upon sale of real estate $ -- $ 105,000 $ 249,000 ============ =========== =========== Unrealized gain (loss) on securities available for sale $ 384,120 $ 320,842 $ (547,726) ============ =========== ===========
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 Berkeley County and Jefferson County, West Virginia. The Corporation's market area also includes Washington County and Frederick County, Maryland and Frederick County, Loudoun County and Clarke County, 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 accounting principles generally accepted in the United States of America 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. Interest-bearing Deposits in Financial Institutions Interest-bearing deposits in financial institutions mature within one year and are carried at cost. Securities Debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as "available for sale" and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchased premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Loans The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of the Corporation's debtors to honor their contracts is dependent upon the real estate and general economic conditions of the Corporation's market area. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses. Interest income is accrued on the unpaid principal balance. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Installment loans are typically charged off not later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. ~18~ Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Allowance for Loan Losses (Continued) The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures. Loans Held for Sale Loans originated and intended for sale in the secondary market are carried at the lower of cost or market determined in the aggregate. 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 Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of the loan balance or the fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. 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 a health care plan for all retirees and four 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." During 2001, the Corporation established a 401(k) profit sharing plan available to fulltime employees meeting certain age and service requirements. Under this plan the employer may make a discretionary matching contribution each plan year and may also make other discretionary contributions to the plan. ~19~ Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Earnings Per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilative potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. The Corporation had no potential common stock as of December 31, 2001, 2000, and 1999. Income Taxes Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary difference between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits in financial institutions, 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 In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate and deferred tax assets. Advertising The Corporation follows the policy of charging the costs of advertising to expense as incurred. Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which will potentially impact the accounting for goodwill and other intangible assets. Statement 141 eliminates the pooling method of accounting for business combinations and requires that intangible assets that meet certain criteria be reported separately from goodwill. The Statement also requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. The Corporation does not have any goodwill and intangible assets. Therefore, the adoption of these standards will not have an impact on the financial statements. ~20~ Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Recent Accounting Pronouncements (Continued) In June 2001, the Financial Accounting Standards Board issued Statement 143, Accounting for Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated retirement costs. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Statement is not expected to have a material effect on the Corporation's financial statements. In August 2001, the Financial Accounting Standards Board issued Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2001. The Statement is not expected to have a material effect on the Corporation's financial statements. Reclassifications Certain reclassifications have been made to prior period amounts to conform to the current year presentation. Note 2. Securities The amortized cost and fair value of securities being held to maturity as of December 31, 2001 and 2000, are as follows:
2001 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- ---------- ------------ Obligations of U.S. Government agencies $18,990,374 $ 623,577 $ -- $ 19,613,951 =========== ========== ========== ============
2000 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- ---------- ------------ Obligations of U.S. Government agencies $17,927,761 $ 186,630 $ (9,771) $ 18,104,620 =========== ========== ========== ============
The amortized cost and fair value of the securities being held to maturity as of December 31, 2001, by contractual maturity, are shown below: Amortized Fair Cost Value ----------- ----------- Due in one year or less $ 6,970,170 $ 7,221,590 Due after one year through five years 12,020,204 12,392,361 ----------- ----------- $18,990,374 $19,613,951 =========== =========== The amortized cost and fair value of securities available for sale as of December 31, 2001 and 2000 are as follows:
2001 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- ---------- ------------ Obligations of U.S. Government agencies $30,391,057 $ 378,095 $ (61,335) $ 30,707,817 =========== ========== ========== ============
~21~ Note 2. Securities (Continued)
2000 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ---------- ---------- ----------- Obligations of U.S. Government agencies $18,229,644 $15,020 $(82,379) $18,162,285 =========== ======= ======== ===========
The amortized cost and fair value of the securities available for sale as of December 31, 2001, by contractual maturity, are shown below: Amortized Fair Cost Value ------------ ------------- Due in one year or less $ 6,245,282 $ 63,34,725 Due after one year through five years 24,145,775 243,73,092 ------------ ------------- $ 30,391,057 $ 307,07,817 ============ ============= There were no sales of securities during 2001, 2000 and 1999. Securities with a carrying value of $14,217,554 and $9,947,074 at December 31, 2001 and 2000, were pledged to secure public funds and other balances as required by law. Note 3. Loans and Related Party Transactions The loan portfolio is composed of the following: December 31 -------------------------- 2001 2000 ------------ ----------- Mortgage loans on real estate: Construction and land development $ 530,000 $ 14,000 Secured by farm land 1,801,165 2,762,776 Secured by 1-4 family residential 56,283,230 45,055,946 Other real estate 19,275,005 12,150,047 Loans to farmers (except those secured by real estate) 46,020 208,688 Commercial loans (except those secured by real estate) 2,952,453 2,027,289 Consumer loans 21,213,959 22,022,827 All other loans 287,836 205,262 ------------ ----------- Total loans $102,389,668 $84,446,835 Less: allowance for loan losses 1,402,247 1,268,235 ------------ ----------- $100,987,421 $83,178,600 ============ =========== 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, 2001 and 2000, these loans totaled $979,348 and $1,048,250 respectively. During 2001, total principal additions were $430,563 and total principal payments were $499,465. ~22~ Note 4. Allowance for Loan Losses The following is a summary of transactions in the allowance for loan losses for 2001, 2000 and 1999:
2001 2000 1999 ----------- ----------- ----------- Balances at beginning of year $ 1,268,235 $ 1,217,919 $ 1,140,000 Provision charged (credited) to operating expense 220,575 (70,000) 125,000 Recoveries added to the allowance 35,125 225,993 42,283 Loan losses charged to the allowance (121,688) (105,677) (89,364) ----------- ----------- ----------- Balances at end of year $ 1,402,247 $ 1,268,235 $1,217,919 =========== =========== ===========
Information about impaired loans as of and for the years ended December 31, 2001, 2000 and 1999 are as follows: 2001 2000 ---- -------- Impaired loans for which an allowance has been provided $-- $725,040 Impaired loans for which no allowance has been provided -- -- --- -------- Total impaired loans $-- $725,040 === ======== Allowance provided for impaired loans, included in the allowance for loan losses $-- $217,512 === ======== 2001 2000 1999 ------- -------- -------- Average balance in impaired loans $14,185 $239,140 $372,633 ======= ======== ======== Interest income recognized $ 666 $ 18,443 $ 21,994 ======= ======== ======== No additional funds are committed to be advanced in connection with impaired loans. Nonaccrual loans excluded from disclosure under FASB 114 amounted to $9,060 at December 31, 2001. If interest on this loan had been accrued, such income would have approximated $497 in 2001. There were no nonaccrual loans excluded from disclosure under FASB 114 at December 31, 2000. Note 5. Premises and Equipment, Net Premises and equipment consists of the following: December 31 ----------------------- 2001 2000 ---------- ---------- Premises $3,893,695 $3,596,546 Furniture and equipment 2,958,031 2,758,250 ---------- ---------- $6,851,726 $6,354,796 Less accumulated depreciation 3,463,693 3,177,681 ---------- ---------- $3,388,033 $3,177,115 ========== ========== Depreciation included in operating expense for 2001, 2000 and 1999, was $288,464, $236,554 and $202,873 respectively. ~23~ Note 6. Deposits The aggregate amount of time deposits with a balance of $100,000 or more was $7,299,965 and $5,481,447 at December 31, 2001 and 2000, respectively. At December 31, 2001, the scheduled maturities of all time deposits are as follows: 2002 $ 30,613,277 2003 6,941,136 2004 6,787,131 2005 1,129,502 ------------- $ 45,471,046 ============= Note 7. Borrowings Short-term borrowings consist of securities sold under agreements to repurchase which are secured transactions with customers and generally mature the day following the date sold. In June 2001, the Bank incurred fixed rate long term debt consisting of a Federal Home Loan Bank seven year loan with an original balance of $2,500,000 and monthly payments of interest and principal with an interest rate of 5.51%. The loan is secured by capital stock, deposits, mortgage collateral and securities collateral of the Bank. Principal payments on the note are due as follows: 2002 $ 309,409 2003 326,895 2004 345,369 2005 364,886 2006 385,507 2007 407,293 2008 212,199 ---------- $2,351,558 ========== The Corporation has unused lines of credit with the Federal Home Loan Bank and other financial institutions totaling approximately $57,906,000 at December 31, 2001. Note 8. 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 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. The Corporation accounts for its share of the costs of those benefits in accordance with Financial Accounting Standards Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." 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. During 2001, the Corporation established a 401(k) profit sharing plan available to fulltime employees meeting certain age and service requirements. Employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. Entry dates are January 1, April 1, July 1 and October 1. Employees can make a salary deferral election authorizing the employer to withhold up to the amount allowed by law each calendar year. The employer may make a discretionary matching contribution each plan year. The employer may also make other discretionary contributions to the plan. During 2001, the Corporation made 401(k) matching contributions of $17,011. ~24~ Note 8. Employee Benefit Plans (Continued) Information about the plans follow:
Pension Benefits Postretirement Benefits ------------------------------------- ------------------------------------ 2001 2000 1999 2001 2000 1999 ---------- ---------- ---------- --------- ---------- --------- Change in Benefit Obligation: Benefit obligation, beginning $3,838,228 $3,736,742 $4,129,250 $ 601,062 $ 574,797 $ 534,845 Service cost 106,081 133,682 161,271 5,482 9,219 8,536 Interest cost 282,256 289,811 274,718 38,252 45,160 42,787 Actuarial (gain) loss (247,400) (182,204) (144,079) (55,207) -- 13,855 Benefits paid (120,116) (139,803) (117,991) (27,428) (28,114) (25,226) Change in discount rates 258,110 -- (566,427) -- -- -- ---------- ---------- ---------- --------- ---------- --------- Benefit obligation, ending $4,117,159 $3,838,228 $3,736,742 $ 562,161 $ 601,062 $ 574,797 ---------- ---------- ---------- --------- ---------- --------- Change in Plan Assets: Fair value of plan assets, beginning $3,769,264 $3,531,914 $3,416,690 $ -- $ -- $ -- Actual return on plan assets (241,450) 208,776 175,266 -- -- -- Employer contributions -- 168,377 57,949 27,428 28,114 5,226 Benefits paid (120,116) (139,803) (117,991) (27,428) (28,114) (25,226) ---------- ---------- ---------- --------- ---------- --------- Fair value of plan assets, ending $3 407,698 $3,769,264 $3 531,914 $ -- $ -- $ -- ---------- ---------- ---------- --------- ---------- --------- Funded status $ (709,461) $ (68,964) $ (204,828) $(562,161) $ (601,062) $(574,797) Unrecognized net (gain) loss 105,655 (491,923) (402,581) 60,624 126,685 126,685 Unrecognized net obligation (asset) at transition (76,339) (96,641) (116,943) 226,352 243,764 261,176 Unrecognized prior service cost 870 1,025 1,180 -- -- -- ---------- ---------- ---------- --------- ---------- --------- Accrued benefit cost included in other liabilities $ (679,275) $ (656,503) $ (723,172) $(275,185) $ (230,613) $(186,936) ========== ========== ========== ========= ========== =========
Pension Benefits Postretirement Benefits ------------------------------------- ------------------------------------ 2001 2000 1999 2001 2000 1999 ---------- ---------- ---------- --------- ---------- --------- Components of Net Periodic Benefit Cost: Service cost $ 106,081 $ 133,682 $ 161,271 $ 5,482 $ 9,219 $ 8,536 Interest cost 282,256 289,811 274,718 38,252 45,160 42,787 Expected return on plan assets (345,418) (301,638) (285,265) -- -- -- Amortization of net (gain) loss -- -- -- 10,854 -- -- Amortization of prior service cost 155 155 155 -- -- -- Amortization of net obligation at transition (20,302) (20,302) (20,302) 17,412 17,412 17,412 ---------- ---------- ---------- --------- ---------- ---------- Net periodic benefit cost $ 22,772 $ 101,708 $ 130,577 $ 72,000 $ 71,791 $ 68,735 ========== ========== ========== ========= ========== ========= Weighted-Average Assumptions: Discount rate 7.25% 8.00% 8.00% 7.00% 8.00% 8.00% Expected return on plan assets 8.50% 8.50% 8.50% -- -- -- Rate of compensation increase 4.25% 5.00% 5.00% 3.00% -- --
For measurement purposes, a 9% annual rate of increase in per capita health care costs of covered benefits was assumed for 2001 and a 10% increase was assumed for 2000 and 1999, 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 $ 33,783 $ (28,493) Effect on total of service and interest cost components of net periodic postretirement health care benefit cost 2,365 (1,994)
~25~ Note 9. Income Taxes Net deferred tax assets consist of the following components as of December 31, 2001 and 2000: 2001 2000 -------- -------- Deferred tax assets: Reserve for loan losses $309,958 $234,963 Accrued pension expense 230,954 223,211 Accrued postretirement benefits 94,416 78,409 Nonaccrual interest 169 -- Securities available for sale -- 22,902 -------- -------- $635,497 $559,485 -------- -------- Deferred tax liabilities: Depreciation $ 7,881 $ 7,228 Securities available for sale 107,698 -- -------- -------- $115,579 $ 7,228 -------- -------- Net deferred tax assets $519,918 $552,257 ======== ======== The provision for income taxes charged to operations for the years ended December 31, 2001, 2000 and 1999 consists of the following: 2001 2000 1999 ---------- ---------- -------- Current tax expense $1,263,995 $1,020,289 $982,914 Deferred tax expense (benefit) (98,262) 32,870 (85,804) ---------- ---------- -------- $1,165,733 $1,053,159 $897,110 ========== ========== ======== 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, 2001, 2000 and 1999 due to the following:
2001 2000 1999 ---------- ---------- -------- Computed "expected" tax expense $1,079,500 $ 974,941 $829,644 Increase (decrease) in income taxes resulting from: Tax exempt interest income (28,503) (6,041) (6,324) State income taxes, net of federal income tax benefit 114,303 78,435 73,767 Other 433 5,824 23 ---------- ---------- -------- $1,165,733 $1,053,159 $897,110 ========== ========== ========
Note 10. 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 12 with respect to financial instruments with off-balance-sheet risk. The Corporation has approximately $6,175,928 in deposits in other financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2001. 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, 2001 and 2000, the aggregate amounts of daily average required balances were approximately $4,422,000 and $3,147,000, respectively. Note 11. 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, 2001, the aggregate amount of unrestricted funds which could be transferred from the banking subsidiary to the parent corporation, without prior regulatory approval, totaled $3,134,480 or 16.1% of the consolidated net assets. ~26~ Note 12. 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 instruments 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, 2001 and 2000, is as follows: 2001 2000 ----------- ---------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $16,796,262 $9,225,661 Standby letters of credit 712,458 266,251 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. Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the extent to which the Corporation is committed. 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 generally holds collateral supporting those commitments if deemed necessary. Note 13. Fair Value of Financial Instruments and Interest Rate Risk 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. Loans Held for Sale The carrying amount of loans held for sale approximates fair value. ~27~ Note 13. Fair Value of Financial Instruments and Interest Rate Risk (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. Short-term Borrowings The carrying amounts of borrowings under repurchase agreements approximate fair value. FHLB Advances The fair values of the Corporation's FHLB advances are estimated using discounted cash flow analysis based on the Corporation's incremental borrowing rates for similar types of borrowing arrangements. Accrued Interest The carrying amounts of accrued interest approximates fair value. 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, 2001 and 2000, the carrying amounts of loan commitments and standby-letters of credit approximated fair value. The estimated fair values of the Corporation's financial instruments are as follows: 2001 2000 -------------------- ------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- (in thousands) (in thousands) Financial assets: Cash $ 11,818 $ 11,818 $ 6,053 $ 6,053 Securities purchased under agreements to resell and federal funds sold 3,912 3,912 17,366 17,366 Securities held to maturity 18,990 19,614 17,928 18,105 Securities available for sale 30,708 30,708 18,162 18,162 Loans, net 100,987 99,348 83,179 78,083 Loans held for sale 916 916 -- -- Accrued interest receivable 1,144 1,144 1,051 1,051 Financial liabilities: Deposits 146,894 147,542 128,945 128,792 Repurchase agreements 2,949 2,949 -- -- FHLB advances 2,352 2,228 -- -- Accrued interest payable 223 223 303 303 The Corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Corporation's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Corporation's overall interest rate risk ~28~ Note 14. Regulatory Matters The Corporation (on a consolidated basis) and the Bank are 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 and Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank 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 (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001 and 2000, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2001, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution 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. The Corporation's and the Bank's actual capital amounts and ratios are also presented in the table.
Minimum To Be Well Minimum Capitalized Capital Prompt Corrective Actual Requirement Action Provisions --------------- -------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------ ----- -------- ------ (Amount in Thousands) As of December 31, 2001: Total capital (to risk-weighted assets): Consolidated $20,417 21.15% $7,724 8.0% N/A N/A Bank of Charles Town $20,392 21.12% $7,723 8.0% $9,654 10.0% Tier 1 capital (to risk-weighted assets): Consolidated $19,208 19.90% $3,862 4.0% N/A N/A Bank of Charles Town $19,183 19.87% $3,861 4.0% $5,792 6.0% Tier 1 capital (to average assets): Consolidated $19,208 11.30% $6,803 4.0% N/A N/A Bank of Charles Town $19,183 11.28% $6,803 4.0% $8,503 5.0% As of December 31, 2000: Total capital (to risk-weighted assets): Consolidated $19,003 23.95% $6,348 8.0% N/A N/A Bank of Charles Town $18,956 23.89% $6,347 8.0% $7,934 10.0% Tier 1 capital (to risk-weighted assets): Consolidated $18,008 22.70% $3,174 4.0% N/A N/A Bank of Charles Town $17,961 22.64% $3,174 4.0% $4,760 6.0% Tier 1 capital (to average assets): Consolidated $18,008 12.32% $5,849 4.0% N/A N/A Bank of Charles Town $17,961 12.28% $5,849 4.0% $7,311 5.0%
~29~ Note 15. Parent Corporation Only Financial Statements POTOMAC BANCSHARES, INC. (Parent Corporation Only) Balance Sheets December 31, 2001 and 2000 2001 2000 ----------- ----------- ASSETS Cash $ 19,802 $ 43,216 Investment in subsidiary 19,391,766 17,916,484 Other assets 9,962 9,044 ----------- ----------- Total Assets $19,421 530 $17,968,744 =========== =========== 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 13,207,472 12,008,205 Accumulated other comprehensive income (loss) 209,062 (44,457) ----------- ----------- Total Stockholders' Equity $19,416,534 $17,963,748 ----------- ----------- Total Liabilities and Stockholders' Equity $19,421,530 $17,968,744 =========== =========== POTOMAC BANCSHARES, INC. (Parent Corporation Only) Statements of Income Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 ---------- ---------- ---------- Income Dividends from subsidiary $ 810,000 $ 750,000 $ 740,000 Expenses Amortization $ -- $ -- $ 7,165 Transfer agent expense 7,000 6,000 6,375 Legal and professional 4,433 4,410 3,675 Other operating expenses 20,844 19,761 17,546 ---------- ---------- ---------- Total Expenses $ 32,277 $ 30,171 $ 34,761 ---------- ---------- ---------- Income before Income Tax (Benefit) and Equity in Undistributed Income of Subsidiary $ 777,723 $ 719,829 $ 705,239 Income Tax (Benefit) (9,781) (8,862) (10,688) ---------- ---------- ---------- Income before Equity in Undistributed Income of Subsidiary $ 787,504 $ 728,691 $ 715,927 Equity in Undistributed Income of Subsidiary 1,221,763 1,085,624 827,093 ---------- ---------- ---------- Net Income $2,009,267 $1,814,315 $1,543,020 ========== ========== ==========
~30~ Note 15. Parent Corporation Only Financial Statements (Continued) POTOMAC BANCSHARES, INC. (Parent Corporation Only) Statements of Cash Flows Years Ended December 31, 2001 2000 and 1999
2001 2000 1999 ----------- ----------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,009,267 $ 1,814,315 $1,543,020 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed (income) of subsidiary (1,221,763) (1,085,624) (827,093) Amortization -- -- 7,165 (Increase) decrease in other assets (918) 1,826 3,020 ----------- ----------- --------- Net cash provided by operating activities $ 786,586 $ 730,517 $ 726,112 ----------- ----------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Cash dividends $ (810,000) $ (750,000) $ (690,000) ----------- ----------- ---------- Increase (decrease) in cash and cash equivalents $ (23,414) $ (19,483) $ 36,112 CASH AND CASH EQUIVALENTS Beginning 43,216 62,699 26,587 ----------- ----------- ---------- Ending $ 19,802 $ 43,216 $ 62,699 =========== =========== ==========
~31~ TRUST AND FINANCIAL SERVICES Trust fees in year 2001 totaled $510,933, compared to $547,727 in 2000. Your Bank's net trust income in 2001 equaled 15.3% of gross fees, down from 16.4% in 2000, but still ahead of the 12.5% benchmark for our peer group. In 2001 estate fees totaled $44,300 as compared to $101,000 in 2000, a reflection of no new estate appointments. Trust revenue continues to reflect the department's emphasis on personal account relationships, with approximately 92% of income derived from grantor trusts, testamentary trusts, and personal agency accounts. Trust assets as of December 31, 2001, totaled $89,087,000, compared to December 31, 2000 footings of $83,852,000. The net increase (6.24%) in fiduciary assets was the result of opening 19 new accounts with $13,067,000 in assets, and the closing of 17 accounts (including four estates) totaling $3,873,000 in asset value. As we continue our mission to provide eminent personal trust services, the department anticipates an increasing emphasis on mutual-fund account relationships for moderately-sized deposit accounts (through our Federated Investors program) and the development of annuity products. 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 hallmark of our fiduciary service. /s/ Robert L. Hersey -------------------------------- Robert L. Hersey Vice President and Trust Officer STATEMENT OF CONDITION December 31, 2001 (unaudited) ASSETS - ------ Discretionary assets: Bank Deposits: Non-Interest Bearing $ 12,000 Interest Bearing 456,000 United States Treasury and Agency Obligations 7,675,000 State, County, and Municipal Obligations 800,000 Short Term Interest Bearing Funds 3,938,000 Other Short Term Obligations 108,000 Notes and Bonds 9,022,000 Common and Preferred Stocks 28,594,000 Real Estate Mortgages 146,000 Real Estate 77,000 Miscellaneous Assets 2,000 ----------- Total Discretionary Assets $55,830,000 ----------- Non-Discretionary Assets $38,257,000 ----------- Total Assets $89,087,000 =========== ACCOUNTS - -------- Personal Trusts 133 $51,152,000 Estates and Other Court Accounts 23 3,873,000 Employee Benefit Accounts 26 4,194,000 Agencies and Other 81 29,868,000 --- ----------- Total Accounts 263 $89,087,000 === =========== ~32~ ================================================================================ POTOMAC BANCSHARES, INC. Robert F. Baronner, Jr. President & CEO William R. Harner Senior Vice President, Secretary & Treasurer 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 Robert F. Baronner, Jr. President & CEO William R. Harner Senior Vice President & Cashier David W. Irvin Senior Vice President & Commercial Loan Division Manager Robert L. Hersey Vice President & Trust Officer Donna J. Burns Vice President L. Gayle Marshall Johnson Vice President & Financial Officer Pamela T. Hinkle Vice President & Mortgage Loan Officer Karen S. Hensell Vice President & Commercial Loan Officer Charles K. Nicewarner, Jr. Vice President & Charles Town Branch Office Manager Susan S. Myers Vice President & Auditor Richard Crea Vice President of Information Technology ~33~ ================================================================================ ANNUAL REPORT ON FORM 10-KSB A copy of the Corporation's 2001 annual report on 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 and cannot be described as a public trading market. Potomac Bancshares, Inc. (symbol PTBS) is 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 is available on the Internet through many of the stock information services using Potomac's symbol. As of December 31, 2001, there were 600,000 common shares outstanding held by approximately 1,100 shareholders. The per share sale prices of the Corporation's stock for 2000 and 2001 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 2000 and 2001 are also listed. High Low Dividends 2000 - ---- First Quarter $ 33.500 $ 28.250 $ N/A Second Quarter 30.000 26.125 0.50 Third Quarter 28.500 24.000 N/A Fourth Quarter 28.000 22.000 0.75 2001 - ---- First Quarter $28.750 $ 25.000 $ N/A Second Quarter 33.500 25.250 0.50 Third Quarter 34.500 32.000 N/A Fourth Quarter 38.500 33.000 0.85 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 59 Maiden Lane New York NY 10038 (212) 936-5100 ANNUAL MEETING - -------------- The annual meeting of stockholders will be held at the Clairon Hotel & Conference Center, Shepherdstown, Jefferson County, West Virginia, on Tuesday, April 23, 2002, beginning at 10:30 a.m. ~34~ EX-21 5 dex21.txt 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-99 6 dex99.txt NOTICE & PROXY STATEMENT Exhibit 99 POTOMAC BANCSHARES, INC. Charles Town, West Virginia -------------------------------------------------- NOTICE OF REGULAR ANNUAL MEETING OF SHAREHOLDERS To be held April 23, 2002 -------------------------------------------------- To the Shareholders: The Regular Annual Meeting of Shareholders of Potomac Bancshares, Inc. ("Potomac"), will be held at Clarion Hotel and Conference Center, Shepherdstown, West Virginia, at 10:30 a.m. on April 23, 2002, 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 2002. 3. Any other business that may properly be brought before the meeting or any adjournment thereof. Only those shareholders of record at the close of business on March 15, 2002, shall be entitled to notice of the meeting and to vote at the meeting. By Order of the Board of Directors Robert F. Baronner, Jr., President & CEO 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 29, 2002 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 23, 2002 Potomac Bancshares, Inc. is furnishing this statement in connection with its solicitation of proxies for use at the Annual Meeting of Shareholders of Potomac Bancshares, Inc. to be held on April 23, 2002, at the time and for the purposes set forth in the accompanying Notice of Regular Annual Meeting of Shareholders. Solicitation of Proxies Potomac's management, at the direction of Potomac's board of directors, is making this proxy solicitation. These proxies enable shareholders to vote on all matters 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 by: . by notifying Potomac in person, . by giving written notice to Potomac of the revocation of the proxy, . by submitting to Potomac a subsequently-dated proxy, or . by attending the meeting and withdrawing the proxy before it is voted at the meeting. Potomac will pay the expenses of this proxy solicitation. 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 Under Potomac's bylaws, the board of directors has fixed March 15, 2002, as the record date for determining the shareholders entitled to notice of, and to vote at, the meeting or any adjournment thereof. Only shareholders of record at the close of business on that date are entitled to notice of and to vote at the annual 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 1,100 shareholders of record. ~1~ PURPOSES OF MEETING 1. ELECTION OF DIRECTORS General Potomac's bylaws currently provide for a classified board of directors. There are three classes with each being elected for a three year term. There are presently 10 directors on the board, four of whom are nominees for election at the 2002 Annual Meeting. Three of the nominees are non-employee directors. Potomac's Bylaws provide that in the election of directors, 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 his 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 example, if you own five shares and there are four nominees for director, you have a cumulative total of 20 votes. You may choose to vote all 20 votes for one nominee. Or, you may allocate 10 votes for one nominee and 10 votes for another nominee. Or you may choose any other allocation over all or part of the four nominees. If you vote your shares cumulatively by proxy, you must indicate how you wish to divide your cumulative total. Otherwise, the proxies will vote the cumulative total evenly or in a manner to elect as many of Potomac's nominees as possible. 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. Potomac's bylaws provide that nominations for election to the board of directors, other than those made by or on behalf of Potomac's existing management, 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: . name and address of proposed nominee(s); . principal occupation of nominee(s); . total shares to be voted for each nominee; . name and address of notifying shareholder; and . 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 on pages 4 and 5 of this proxy statement contains background information on each director nominee. ~2~ Committees of the Board Potomac's board of directors has a standing Audit Committee. Other 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 Bank of Charles Town. 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/Investment Management Committee, Audit Committee, Community Reinvestment Act Committee, Personnel Committee, Trust Committee, Trust Investment Review Committee and Executive Committee. The Asset/Liability/Investment Management Committee consists of seven members: Robert F. Baronner, Jr., Guy Gareth Chicchirichi, William R. Harner, E. William Johnson, Gayle Marshall Johnson, J.P. Burns, Jr. and David S. Smith. This committee is comprised of board members and officers whose responsibilities are to manage the balance sheet of the bank by maximizing and maintaining the spread between interest earned and interest paid while assuming acceptable business risks and ensuring adequate liquidity. The committee recommends investment policies to the board and reviews investments as necessary. This committee held four meetings during 2001. The Audit Committee consists of five members: Robert F. Baronner, Jr. (ex-officio), J. Scott Boyd, Guy Gareth Chicchirichi, E. William Johnson and Donald S. Smith. The Audit Committee is appointed and approved by the boards of Potomac and the bank. The committee is to assist these boards in monitoring (1) the integrity of the financial statements of the Corporation, (2) the compliance by the Corporation with legal and regulatory requirements and (3) the independence of the Corporation's internal and external auditors. During 2001 the Audit Committee held five meetings. The Community Reinvestment Act (CRA) Committee consists of six members: Robert F. Baronner, Jr., Donna J. Burns, Robert W. Butler, Thomas C. G. Coyle, Marcia Lerch and Susan Myers. The CRA 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 two meetings in 2001. The Personnel Committee consists of seven members: Robert F. Baronner, Jr., J. Scott Boyd, Guy Gareth Chicchirichi, Thomas C.G. Coyle, Tammy Miller, John C. Skinner, Jr. and Donald S. Smith. The 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 one meeting in 2001. The executive officer who serves on this committee did not make recommendations or participate in meetings relating to his own salary. See "Salary and Personnel Committee Report on Executive Compensation." The Trust Committee consists of six members: Robert F. Baronner, Jr., John P. Burns, Jr., Robert W. Butler, Thomas C.G. Coyle, Robert L. Hersey 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 seven regular meetings in 2001. ~3~ The Trust Investment Review Committee, consisting of two trust officers, the President & CEO, and one director (Robert L. Hersey, David S. Smith, Robert F. Baronner, Jr. 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 12 meetings during 2001. The Executive Committee consists of seven members: Robert F. Baronner, Jr., J. Scott Boyd, J.P. Burns, Jr., William R. Harner, E. William Johnson, John C. Skinner, Jr. and Donald S. Smith. This committee meets on an as needed basis to review and approve loans that exceed the CEO's lending authority. This committee held four meetings in 2001. 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 and three special meetings in 2001. The board of directors of the bank held regular weekly meetings each Tuesday in January and February of 2001 and meetings the second and fourth Tuesdays of March through December 2001. Special meetings are held from time to time as required. During 2001, the bank board held 29 regular meetings. During the year, each of the directors attended at least 75% of all meetings of the boards of Potomac and the bank and all committees of the boards on which they served. Audit Committee Report The Audit Committee's Report to the Shareholders which follows was approved and adopted by the committee on March 5, 2002, and by the board of directors on March 12, 2002. The members of the Audit Committee are all independent directors. The Audit Committee oversees Potomac's financial reporting process on behalf of the board of directors. Management has the primary responsibility for the financial statements and the reporting process including the systems of internal controls. The Audit Committee has reviewed and discussed the audited financial statements with management, discussed with the independent auditor the matters required by SAS 61, received communications from the independent auditor as to their independence, and discussed independence with the auditor. Based on its review and discussions with management and the independent auditor, the Audit Committee recommended to the board of directors that the audited financial statements be included in the Form 10-KSB filed by the Corporation. The Audit Committee and the board of directors have adopted a written charter for the Audit Committee. A copy of that charter is attached to this proxy statement as Attachment A. The following fees were paid to Yount, Hyde & Barbour, P.C., Potomac Bancshares, Inc.'s Certified Public Accountants, for services provided to the Corporation for the fiscal year ending December 31, 2001. Audit Fees $47,388 All Other Fees $ 3,800 Financial Information Systems Design and Implementation Fees $ 0 ~4~ Audit fees are fees billed for the audit of the Corporation's financial statements and for the required quarterly reviews of those statements. All other fees include payment for any other types of services provided. The Audit Committee of the board believes that the non-audit services provided by Yount, Hyde & Barbour are compatible with maintaining the auditor's independence. E. William Johnson, Chairman J. Scott Boyd Guy Gareth Chicchirichi Donald S. Smith 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 F. Baronner, Jr. 43 2001 None 2005 Employed by bank as of 1/1/01 as President & CEO; former Senior Credit Officer BB&T Northern West Virginia May 2000 - December 2000; former Executive Vice President One Valley Bank East September 1997 - April 2000; Senior Vice President Commercial Lending Division One Valley Bank East April 1994 - September 1997. Robert W. Butler 78 1994 None 2005 Retired owner of Warm Spring Farm & Orchard, Jefferson County, West Virginia; retired from Stauffer Chemical Company. Guy Gareth Chicchirichi 60 1994 None 2005 Executive Manager; Secretary/Treasurer - Guy's Buick-Pontiac-Oldsmobile-GMC Truck, Inc., Jefferson County, West Virginia; charter member of Charles Town Rotary Club. Thomas C.G. Coyle 73 1994 None 2005 Retired owner/operator of Riddleberger's Store, Jefferson County, West Virginia; Trustee and Elder - Charles Town Presbyterian Church; Director - Edge Hill Cemetery.
~5~ 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 J. Scott Boyd 45 1999 None 2004 Pharmacist and President of Jefferson Pharmacy, Inc. in Jefferson County, West Virginia since 1982; President and Chairman of Board of Directors of In Home Medications West Virginia, Inc. John P. Burns, Jr. 60 1994 None 2004 Owner/operator of a beef and grain farm in Jefferson County, West Virginia; President - Jefferson County Fair Association; Director - Valley Farm Credit. William R. Harner 61 1994 None 2003 Employed at Bank since 1967; Sr. Vice President & Cashier since 1988; Sr. Vice President and Secretary of Potomac since 1994. E. William Johnson 57 1994 None 2003 Chair - Division of Business and Social Sciences and Professor - Shepherd College, Jefferson County, West Virginia. John C. Skinner, Jr. 60 1994 None 2003 Attorney, owner of Nichols & Skinner, L.C., Jefferson County, West Virginia; Bank attorney since 1986; Potomac attorney since 1994. Donald S. Smith 73 1994 None 2003 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's common stock as of March 7, 2002. Name of Amount and Nature of Beneficial Owner Beneficial Ownership Percent of Common Stock Virginia F. Burns 44,480 shares; Direct 7.4133 Rt 2 Box 132 Charles Town WV 25414-9632 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 7, 2002, on which date 600,000 shares were outstanding. ~6~ Amount and Nature of Nominees Beneficial Ownership Percent of Common Stock Robert F. Baronner, Jr. 320 shares (1,3)* .0533 PO Box 906 150 shares (2,4)* .0250 Charles Town, WV 25414-0906 79 shares (5)* .0132 Robert W. Butler 2,330 shares (1,3)* .3883 635 S Samuel Street 96 shares (2,4)* .0160 Charles Town WV 25414-1141 1,450 shares (5)* .2417 Guy Gareth Chicchirichi 1,800 shares (1,3)* .3000 RR 6 Box 38 Charles Town WV 25414-9704 Thomas C.G. Coyle 1,426 shares (1,3)* .2377 808 High Street 1,941 shares (5)* .3235 Charles Town WV 25414 Amount and Nature of Directors (Non-Nominees) Beneficial Ownership Percent of Common Stock J. Scott Boyd 50 shares (1,3)* .0083 201 S Preston Street 100 shares (2,4)* .0167 Ranson WV 25438 John P. Burns, Jr. 100 shares (1,3)* .0167 12 Burns Farm Lane 2,445 shares (2,4)* .4075 Charles Town WV 25414 12 shares (5)* .0020 William R. Harner 50 shares (1,3)* .0083 PO Box 906 1,350 shares (2,4)* .2250 Charles Town WV 25414-0906 E. William Johnson 325 shares (1,3)* .0542 Division of Business and Social Sciences 275 shares (2,4)* .0458 Shepherd College Shepherdstown WV 25443 John C. Skinner, Jr. 1,858 shares (1,3)* .3097 PO Box 487 1,946 shares (2,4)* .3243 Charles Town WV 25414 1,878 shares (5)* .3130 Donald S. Smith 2,400 shares (1,3)* .4000 PO Box 264 3,500 shares (5)* .5833 Charles Town WV 25414-0264 ~7~ Amount and Nature of Officers (Non-Nominees) Beneficial Ownership Percent of Common Stock Gayle Marshall Johnson 408 shares (1,3)* .0680 PO Box 906 100 shares (2,4)* .0167 Charles Town WV 25414-906 All nominees, directors & principal 11,067 shares (1,3)* 1.8445 officers as a group 6,462 shares (2,4)* 1.0770 (11 persons) 8,860 shares (5)* 1.4767 ------------- ------ Total 26,389 shares 4.3982 ============= ====== - ---------- * 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 2001. 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, 2001, 2000 and 1999 of the chief executive officer. Neither Potomac nor the bank has any stock option plans, employee stock ownership plans or other employee benefit plans except for the pension plan and 401(k) 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 (#) ($) ($) - ---------------------------------------------------------------------------------------------------------- Robert F. Baronner, Jr. 2001 107,224 17,200 9,175 N/A N/A N/A 0 President and CEO William R. Harner 2001 76,794 N/A 9,175 N/A N/A N/A 0 Sr. Vice President & Cashier 2000 73,726 N/A 8,875 N/A N/A N/A 0 1999 69,132 N/A 7,800 N/A N/A N/A 0 Charles W. LeMaster* 2000 60,154 N/A 4,325 N/A N/A N/A 0 1999 77,751 N/A 7,800 N/A N/A N/A 0
- ---------- * During 2000, Mr. LeMaster resigned his position with Potomac and with the bank. William R. Harner was appointed as Acting CEO during the search for a new chief executive. Robert F. Baronner, Jr. became President, CEO and director of Potomac and the bank as of January 1, 2001. ** During 2001, the Corporation established a 401(k) profit sharing plan available initially to all fulltime employees. After initiation of the plan, employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. ~8~ Employee Benefit Plans Potomac sponsors a noncontributory, defined benefit pension 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. PENSION PLAN TABLE Years of Service Average ------------------------------------------------------- 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 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, 2001, 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 Robert F. Baronner, Jr. 1 year $ -0-* William R. Harner 34 years $32,892 During 2001, the Corporation established a 401(k) profit sharing plan available initially to all fulltime employees. After initiation of the plan, employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. Employees can make a salary deferral election authorizing the employer to withhold up to the amount allowed by law each calendar year. The employer may make a discretionary matching contribution each plan year. The employer may also make other discretionary contributions to the plan. *Mr. Baronner completed one year of service as of December 31, 2001 and became eligible to participate in the defined benefit pension plan after that date. There is no projected annual pension for him at this time since he just became eligible to participate. ~9~ Personnel Committee Report on Executive Compensation The Personnel Committee is comprised of seven members: Robert F. Baronner, Jr. (ex-officio), J. Scott Boyd, Guy Gareth Chicchirichi, Thomas C.G. Coyle, Tammy Miller (Human Resources Director), John C. Skinner, Jr. and Donald S. Smith. The 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 2001 compensation levels. The bank's Chief Executive Officer and the Senior Vice President and Cashier 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, Jefferson Security Bank, City National Bank and BB&T. Compensation levels for executives of the bank are competitive when compared to these institutions. Compensation for the Chief Executive Officer is determined in essentially the same way as for other executives. The Chief Executive Officer's salary and bonus is tied to performance goals of the bank and the bank's profitability for the prior fiscal year. Robert F. Baronner, Jr. served on the committee and was the bank's Chief Executive Officer; however, he did not make any recommendations relating to his salary and was not present at Committee meetings when his compensation was being discussed. The Senior Vice President and Cashier's compensation is not tied to any performance goals of the bank and he does not serve on the committee Potomac currently has an employment agreement with Robert F. Baronner, Jr., President and CEO. The agreement provides for one year's severance to include salary and benefits if Mr. Baronner's employment is terminated (other than for cause). 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. In addition, in 2001 Mr. Baronner had the opportunity to earn up to 20% of his base salary in bonus. This incentive program was based on a number of factors including average market price per share, net income per share, loan and deposit growth, the bank's efficiency ratio, credit quality, and trust department income. During 2001, Mr. Baronner earned $17,200 out a possible bonus of $22,000. The details have not been completed for a 2002 performance bonus. The 2001 base salary figure in the employment agreement was set after discussions with a professional executive recruiter as well as research regarding market rates for similar positions for candidates with equivalent education and experience. The salary is set each year as the agreement renews. 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: Robert F. Baronner, Jr. (ex-officio) J. Scott Boyd Guy Gareth Chicchirichi Thomas C.G. Coyle John C. Skinner, Jr. 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, 2001, 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. COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG POTOMAC BANCSHARES, INC., MEDIA GENERAL INDEX AND SIC CODE INDEX [GRAPH APPEARS HERE]
---------------------------FISCAL YEAR ENDING-------------------------------- COMPANY/INDEX/MARKET 12/31/1996 12/31/1997 12/31/1998 12/31/1999 12/29/2000 12/31/2001 POTOMAC BANCSHARES, INC. 100.00 118.54 156.18 129.88 101.28 150.91 Bank Holding Companies 100.00 139.79 182.58 219.86 113.71 165.52 Media General Index 100.00 129.85 158.74 193.64 174.80 154.77
ASSUMES $100 INVESTED ON JAN. 01, 1997 ASSUMES DIVIDEND REINVESTED FISCAL YEAR ENDING DEC. 31, 2001 ~11~ Employment Agreement Potomac and the bank have an employment agreement with Robert F. Baronner, Jr., President and Chief Executive Officer of Potomac and the bank. The agreement is for a one-year term, with additional renewals for one year each, unless terminated by one of the parties. The agreement provides for an annual salary of $110,000 (in the base year 2001), plus director's fees. The Personnel Committee set the annual salary at $125,000 for 2002. The subsequent annual salaries will be set each year as the agreement renews. Under the agreement, if Mr. Baronner's employment is terminated (other than for cause), he is entitled to one year's salary and benefits. In the event of an actual or constructive termination of Mr. Baronner's employment after a change in control of Potomac or the bank, Mr. Baronner would receive two years' compensation and benefits for 18 months. Compensation of Directors Directors of Potomac were not compensated for their services as directors for 2001. Directors of the bank were compensated at the rate of $175 for each regular board meeting attended in January and February and $350 for each regular meeting attended from March through December. Directors 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 2001 and will perform similar services in 2002. 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 2001 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. J. Scott Boyd, Thomas C.G. Coyle, William R. Harner, John C. Skinner, Jr. and Donald S. Smith, directors of the bank and Potomac, have been indebted to the bank during 2001 in an amount in excess of $60,000. In the opinion of Potomac and the bank, these loans were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and do not involve more than the normal risk of collectability or present other unfavorable features. 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 2002. 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. ~12~ 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 2001 Annual Report on Form 10-KSB will be provided without charge. 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, 2000, all Section 16(a) filing requirements applicable to its officers, directors and persons owning more than ten percent were complied with. OTHER MATTERS If any of the nominees for election as directors should be unable to serve as a director 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. ~13~ Shareholder Proposals for 2003 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 28, 2002, to have it considered for inclusion in the proxy statement of the annual meeting in 2003. Robert F. Baronner, Jr. President and CEO Charles Town, West Virginia March 29, 2002 ~14~ -----END PRIVACY-ENHANCED MESSAGE-----