Exhibit 13

Potomac Bancshares, Inc. cover page

1

CONTENTS

President’s Report	3
Description of Business	4
Board of Directors	4
Selected Consolidated Financial Data	5
Management’s Discussion and Analysis of Financial Condition and Results of Operations	6-14
Independent Auditor’s Report	15
Consolidated Financial Statements
Consolidated Balance Sheets	16
Consolidated Statements of Income	17
Consolidated Statements of Changes in Stockholders’ Equity	18
Consolidated Statements of Cash Flows	19
Notes to Consolidated Financial Statements	20-35
Annual Report on Form 10-KSB	36
General Information	36

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. “Forward-looking statements are easily identified by the use of words such as “could,” “anticipate,” “estimate,” “believe,” and similar words that refer to a future outlook. To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the company’s forward-looking statements.

The risks and uncertainties that may affect the operations, performance, development and results of the company’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. We caution readers of this report 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.

2

Area left blank for President’s Report

3

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 company 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, Martinsburg and Hedgesville.

The company provides individuals, businesses, and local governments with a broad range of banking services including commercial credit lines, real estate loans, equipment loans, secondary and adjustable rate mortgages and retail loan products, checking and savings accounts, certificates of deposit, and individual retirement accounts. Automated teller machines located at each of the five 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 through the Internet. 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. President & CEO Bank of Charles Town	Margaret Cogswell Executive Director Hospice of the Panhandle	Barbara H. Pichot Partner CoxHollida LLP
J. Scott Boyd President Jefferson Pharmacy, Inc.	Thomas C. G. Coyle Retired Owner-Operator Riddleberger’s Store	John C. Skinner Jr. Owner Nichols & Skinner, L.C.
John P. Burns, Jr. Partner Burns Farm	William R. Harner Retired Senior Vice President & Cashier Bank of Charles Town	Donald S. Smith Retired President Bank of Charles Town
Guy Gareth Chicchirichi Executive Manager Guy’s Buick-Pontiac-Oldsmobile-GMC Truck, Inc.	E. William Johnson Professor of Economics Shepherd College	C. Larry Togans Retired U.S. Geological Survey

4

SELECTED CONSOLIDATED FINANCIAL DATA

(Dollars in Thousands Except Per Share Data)

	2003			2002			2001			2000			1999
Summary of Operations
Interest income	$	10,786		$	11,279		$	10,956		$	10,328		$	10,009
Interest expense		2,235			2,823			3,758			3,968			4,191
Net interest income		8,551			8,456			7,198			6,360			5,818
Provision for (recovery of) loan losses		148			423			221			(70	)		125
Net interest income after provision for (recovery of) loan losses		8,403			8,033			6,977			6,430			5,693
Noninterest income		2,844			2,096			1,358			1,148			1,170
Noninterest expense		7,141			6,262			5,160			4,711			4,423
Income before income taxes		4,106			3,867			3,175			2,867			2,440
Income tax expense		1,432			1,408			1,166			1,053			897
Net income	$	2,674		$	2,459		$	2,009		$	1,814		$	1,543
Per Share Data **
Net income, basic and diluted	$	1.53		$	1.37		$	1.12		$	1.01		$	.86
Cash dividends declared		.54			.48			.45			.42			.38
Book value at period end		12.53			11.96			10.79			9.98			9.27
Weighted-average shares outstanding		1,750,070			1,791,027			1,800,000			1,800,000			1,800,000
Average Balance Sheet Summary
Assets	$	197,052		$	181,741		$	158,385		$	145,339		$	147,612
Loans		125,407			109,461			93,816			81,755			78,710
Securities		47,087			50,454			41,870			44,935			48,865
Deposits		163,328			153,148			135,658			126,617			129,711
Stockholders’ equity		21,274			20,542			18,812			17,345			16,539
Performance Ratios
Return on average assets		1.36	%		1.35	%		1.27	%		1.25	%		1.05	%
Return on average equity		12.57	%		11.97	%		10.68	%		10.46	%		9.33	%
Dividend payout ratio		35.29	%		35.04	%		40.18	%		41.58	%		44.19	%
Capital Ratios
Leverage ratio		10.20	%		10.77	%		11.30	%		12.32	%		11.55	%
Risk-based capital ratios
Tier 1 capital		14.67	%		18.34	%		19.90	%		22.70	%		23.19	%
Total capital		15.89	%		19.60	%		21.15	%		23.95	%		24.45	%

** All figures have been restated to reflect a 200% stock dividend declared on February 11, 2003.

5

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.

	2003							2002							2001
	Average Balances			Income/ Expense		Average Yield/Rate		Average Balances			Income/ Expense		Average Yield/Rate		Average Balances			Income Expense		Average Yield/Rate
ASSETS
Loans
Taxable	$	123,701,192		$	8,745,268	7.07	%	$	107,619,793		$	8,556,920	7.95	%	$	92,434,336		$	8,070,799	8.73	%
Tax exempt		1,705,694			156,334	9.17	%		1,841,205			159,231	8.65	%		1,381,761			137,003	9.92	%
Total loans		125,406,886			8,901,602	7.10	%		109,460,998			8,716,151	7.96	%		93,816,097			8,207,802	8.75	%
Taxable securities		47,086,793			1,828,230	3.88	%		50,454,026			2,444,342	4.84	%		41,870,474			2,318,806	5.54	%
Securities purchased under agreements to resell and federal funds sold		4,533,462			44,348	.98	%		6,402,575			90,452	1.41	%		10,366,914			393,154	3.79	%
Other earning assets		2,014,531			64,847	3.22	%		3,300,322			82,074	2.49	%		2,113,431			82,289	3.89	%
Total earning assets		179,041,672		$	10,839,027	6.05	%		169,617,921		$	11,333,019	6.68	%		148,166,916		$	11,002,051	7.43	%
Allowance for loan losses		(1,709,640	)						(1,528,580	)						(1,287,062	)
Cash and due from banks		9,788,819							8,015,469							6,352,987
Premises and equipment, net		4,868,176							3,660,177							3,278,950
Other assets		5,063,309							1,976,220							1,872,882
Total assets	$	197,052,336						$	181,741,207						$	158,384,673
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Savings and interest-bearing demand deposits	$	92,950,732		$	461,726	.50	%	$	86,844,968		$	852,591	.98	%	$	73,730,903		$	1,461,562	1.98	%
Time deposits		47,991,306			1,497,233	3.12	%		45,911,558			1,750,221	3.81	%		42,830,718			2,198,395	5.13	%
Total interest-bearing deposits		140,942,038			1,958,959	1.39	%		132,756,526			2,602,812	1.96	%		116,561,621			3,659,957	3.14	%
Securities sold under agreements to repurchase and federal funds purchased		8,549,015			171,458	2.01	%		4,196,410			98,536	2.35	%		1,093,284			31,160	2.85	%
Advances from FHLB		1,878,255			104,349	5.56	%		2,196,854			121,834	5.55	%		1,304,876			66,663	5.12	%
Total interest bearing liabilities		151,369,308		$	2,234,766	1.48	%		139,149,790		$	2,823,182	2.03	%		118,959,781		$	3,757,780	3.16	%
Noninterest-bearing demand deposits		22,385,873							20,391,089							19,096,124
Other liabilities		2,022,763							1,658,519							1,516,895
Stockholders’ equity		21,274,392							20,541,809							18,811,873
Total liabilities and stockholders’ equity	$	197,052,336						$	181,741,207						$	158,384,673
Net interest income				$	8,604,261						$	8,509,837						$	7,244,271
Net interest spread						4.57	%						4.65	%						4.27	%
Interest expense as a percent of average earning assets						1.25	%						1.66	%						2.54	%
Net interest margin						4.81	%						5.02	%						4.89	%

6

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

GENERAL

The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that estimated losses be accrued when they are probable of occurring and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

Our allowance for loan losses has two basic components: the formula allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in the formula allowance.

GENERAL

Total assets increased $13.8 million or 7.1% in 2003 compared to 2002. Increases included growth in loans of 19.7% or $23 million and additions to premises and equipment of 12.0% or $.5 million. Increases in premises and equipment included completion of two major projects begun in 2002: the new branch office facility in Hedgesville, WV and the computer conversion to the Jack Henry & Associates products. The other assets category increased due to the purchase of $3,000,000 of bank owned life insurance at the beginning of 2003. Both securities categories decreased as of December 31, 2003 compared to December 31, 2002. The 14.1% or $7.3 million decrease in the securities portfolio was utilized as part of the increase in loans.

Growth on the liability side of the balance sheet was in deposit increases of $11.1 million or 6.8% and in daily cash management account increases (securities sold under agreements to repurchase) of $3.1 million of 50.7%.

This balance sheet growth is indicative of the bank’s continuing ability to attract and maintain a solid customer base.

The increase in net income of $214 thousand or 8.7% in 2003 compared to 2002 results from decreased interest expense, increased noninterest income and reduced additions to the provision for loan losses.

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 that, if they were to be implemented, would have a material effect on the company.

7

The following table sets forth selected quarterly results (with dollars in thousands) of the company for 2003 and 2002.

	2003								2002
	Three Months Ended								Three Months Ended
	Dec 31		Sept 30		June 30		Mar 31		Dec 31		Sept 30		June 30		Mar 31
Interest income	$	2,769	$	2,684	$	2,675	$	2,658	$	2,755	$	2,903	$	2,844	$	2,777
Interest expense		532		532		583		588		678		719		703		723
Net interest income		2,237		2,152		2,092		2,070		2,077		2,184		2,141		2,054
Provision for loan losses		—		64		27		57		130		94		109		90
Net interest income after provision for loan losses		2,237		2,088		2,065		2,013		1,947		2,090		2,032		1,964
Noninterest income		727		744		687		686		579		526		512		479
Noninterest expense		1,875		1,785		1,794		1,687		1,868		1,468		1,558		1,368
Income before income taxes		1,089		1,047		958		1,012		658		1,148		986		1,075
Income tax expense		383		361		339		349		264		407		351		386
Net income	$	706	$	686	$	619	$	663	$	394	$	741	$	635	$	689
Earnings per share, basic and diluted	$	.41	$	.40	$	.35	$	.37	$	.23	$	.41	$	.35	$	.38

NET INTEREST INCOME

Net interest income increased 1.1% in 2003 compared to 2002 resulting from a decrease of over 20% or $588 thousand in interest expense in 2003 compared to 2002. Interest income decreased as well by $493 thousand or 4.4% in 2003 when compared to 2002.

The only 2.2% increase in interest and fees on loans in 2003 compared to 2002 was due to the lower interest rates and would have been even less if the volume of the loan portfolio had not increased from $117 million at December 31, 2002 to $140 million at December 31, 2003. The average rate of the taxable portion of the portfolio dropped to 7.07% in 2003 from 7.95% in 2002. The average rate on tax exempt loans increased in 2003 to 9.17% on a tax equivalent basis from 8.65% in 2002. However, tax exempt loans are only a little over 1% of the total loan portfolio. During the past several years efforts of the bank’s loan personnel have been successful in increasing the number of floating rate loans. In times of lower interest rates this will reduce our income but the floating rates position the bank well as rates increase.

Interest income on securities held to maturity and securities available for sale decreased 25.2% in 2003 compared to 2002 primarily due to the decreased interest rates and to a lesser degree the decrease in size of the security portfolio. Interest income from securities purchased under agreements to resell and federal funds sold also decreased in 2003 compared to 2002 due about equally to decreased rates and decreased volume. During 2003 and 2002, interest income from securities purchased under agreements to resell and federal funds sold have made up less than 1% of the total interest income of the bank. Management has made a conscious effort to keep less funds in daily investments that pay lower rates than investments in loans and securities.

Reduced interest rates were almost entirely responsible for the decrease in interest expense in 2003 compared to 2002 since the volume of interest-bearing deposits increased $7.3 million in 2003 compared to 2002. The average rate on interest-bearing deposits dropped to 1.39% in 2003 compared to 1.96% in 2002.

In 2003, the average yield for earning assets was 6.05% compared to 6.68% in 2002. Although offering rates on loans have not changed much during the past several years, the bank had many higher rate loans that reached maturity or repricing dates during 2003 and so have repriced or new loans were made at the lower rates. The average rate paid on all interest-bearing liabilities was 1.48% in 2003 compared to 2.03% in 2002.

The net interest spread (difference between yield on earning assets and rate paid on interest-bearing liabilities) decreased in 2003 to 4.57% from 4.65% in 2002. The net interest margin (total interest income less total interest expense divided by average earning assets) also decreased in 2003 to 4.81% from 5.02% in 2002. Net interest spread and net interest margin decreased in 2003 since the reduction in rates has finally penetrated the loan and securities portfolios. Additionally, some time deposit rates have been increased to attract funds to support the expanding loan portfolio.

8

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.

	2003 Compared to 2002									2002 Compared to 2001
	Change in Income/Expense			Volume Effect			Rate Effect			Change in Income/Expense			Volume Effect			Rate Effect
INTEREST INCOME
Taxable loans	$	188,348		$	726,569		$	(538,221	)	$	486,121		$	1,065,725		$	(579,604	)
Tax exempt loans		(2,897	)		(15,813	)		12,916			22,228			36,154			(13,926	)
Taxable securities		(616,112	)		(155,114	)		(460,998	)		125,536			327,216			(201,680	)
Securities purchased under agreements to resell and federal funds sold		(46,104	)		(22,549	)		(23,555	)		(302,702	)		(114,566	)		(188,136	)
Other earning assets		(17,227	)		(69,610	)		52,383			(215	)		599			(814	)
TOTAL	$	(493,992	)	$	463,483		$	(957,475	)	$	330,968		$	1,315,128		$	(984,160	)
INTEREST EXPENSE
Savings and interest-bearing demand deposits	$	(390,865	)	$	65,509		$	(456,374	)	$	(608,971	)	$	331,045		$	(940,016	)
Time deposits		(252,988	)		84,387			(337,375	)		(448,174	)		173,900			(622,074	)
Securities sold under agreements to repurchase and federal funds purchased		72,922			84,743			(11,821	)		67,376			71,815			(4,439	)
Advances from FHLB		(17,485	)		(17,705	)		220			55,171			49,134			6,037
TOTAL	$	(588,416	)	$	216,934		$	(805,350	)	$	(934,598	)	$	625,894		$	(1,560,492	)
NET INTEREST INCOME	$	94,424		$	246,549		$	(152,125	)	$	1,265,566		$	689,234		$	576,332

NONINTEREST INCOME AND EXPENSE

Noninterest income increased 35.6% or $747 thousand in 2003 compared to 2002. Trust and financial services income increased 20.7% or $96 thousand in 2003 compared with 2002 including growth in the income of BCT Investments as well as the original trust department. Service charges on deposit accounts increased 8.5% or $95 thousand in 2003 compared to 2002 due to increased volume during the year which included the opening of the branch office in Hedgesville and increases in the fees themselves as of August 1, 2003. Gains associated with sale of loans in the secondary market increased 104.9% or $184 thousand in 2003 compared to 2002 with the continuation of refinancing frenzy during the early part of 2003. However, there was a slow down in the refinancing during the latter part of 2003, and management expects the income in this market to decrease slightly in 2004. The purchase of bank owned life insurance provided income of $165 thousand through the increase in cash surrender values of the policies. Other significant additions to noninterest income for 2003 were gains on sales of securities of $99 thousand and an income increase of $42 thousand in credit and debit card fees.

Noninterest expenses increased 14.0% or $879 thousand in 2003 compared to 2002. Salaries and employee benefits increased 12.3% or $434 thousand in 2003 compared to 2002. An increase of 7.2% in salaries, wages and related taxes in 2003 compared to 2002 included annual increases and incentives for officers and employees and staffing additions particularly with the new branch office in Hedgesville. The expense of group insurance provided for the employees by the bank increased 22.4% or $83 thousand in 2003 compared to 2002 as a result of the continual rise of health care costs. Pension expenses tripled from $64 thousand in 2002 to $192 thousand in 2003 due to decreased market value of pension fund assets resulting from lower interest rates during the past several years. Furniture and equipment expense increased 36.4% or $238 thousand with the completion of the core conversion to Jack Henry products in March 2003 and regularly scheduled equipment replacement to maintain the bank’s high information technology standards. Advertising and marketing expenses increased in 2003 by 13.7% or $28 thousand compared to 2002, and communications increased in 2003 by 24.2% or $28 thousand compared to 2002. Increases in both of these areas are due to growth of the company and the bank’s continual effort to communicate with our customers and the public regarding product and service information. Postage expense decreased 7.9% or $11 thousand in 2003 compared to 2002 due to completion of conversion communications with our customers as well as a savings through the use of check imaging for customer statements rather than the bulky return of checks themselves. ATM and check card expenses significantly increased 49.1% or $54 thousand due primarily to the volume increases.

9

INTEREST RATE SENSITIVITY

The table below shows the opportunities the company will have to reprice interest earning assets and interest-bearing liabilities as of December 31, 2003.

	Mature or Reprice
	Within Three Months			After Three Months But Within Twelve Months			After One Year But Within Five Years		After Five Years		Nonsensitive
Interest Earning Assets:
Loans	$	26,931,872		$	18,451,981		$	60,184,401	$	34,489,570	$	—
Securities		6,001,584			5,132,337			33,292,344		—		—
Securities purchased under agreements to resell and federal funds sold		2,390,020			—			—		—		—
Other earning assets		335,615			—			—		—		554,500
Total	$	35,659,091		$	23,584,318		$	93,476,745	$	34,489,570	$	554,500
Interest-Bearing Liabilities:
Time deposits $100,000 and over	$	1,687,234		$	5,332,693		$	5,443,933	$	—	$	—
Other time deposits		8,554,668			17,075,015			12,865,092		—		—
Gold and Platinum accounts (NOW accounts)		55,374,953			—			—		—		22,295,123
Savings accounts		—			—			—		—		19,231,712
Securities sold under agreements to repurchase		9,199,345			—			—		—		—
Federal Home Loan Bank advances		84,571			260,798			1,369,885		—		—
Total	$	74,900,771		$	22,668,506		$	19,678,910	$	—	$	41,526,835
Rate Sensitivity Gap	$	(39,241,680	)	$	915,812		$	73,797,835	$	34,489,570
Cumulative Gap	$	(39,241,680	)	$	(38,325,868	)	$	35,471,967	$	69,961,537

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 company is liability sensitive and after that time period the company is asset sensitive. During January, February and March of 2004, $39 million more liabilities may reprice or will mature than assets. During April through December of 2004, $1 million more assets may reprice or will mature than liabilities. The net effect for 2004 is that $38 million more liabilities may reprice or mature than assets. Therefore, the company will be impacted favorably if interest rates continue to decline and unfavorably if interest rates rise.

10

LOAN PORTFOLIO

Loans at December 31, 2003 and 2002 are summarized below:

	2003		2002		2001		2000		1999
Commercial, financial and agricultural	$	17,906,329	$	3,695,732	$	2,998,473	$	2,235,977	$	2,823,556
Mortgage loans on real estate:
Construction and land development		13,956,590		2,210,582		530,000		14,000		31,000
Secured by farm land		3,711,332		1,821,345		1,801,165		2,762,776		2,604,920
Secured by 1-4 family residential		60,903,351		63,239,443		56,283,230		45,055,946		43,798,037
Other real estate		25,313,790		26,151,183		19,275,005		12,150,047		11,859,376
Consumer loans		17,549,454		19,197,747		21,213,959		22,022,827		16,879,468
All other loans		716,978		729,717		287,836		205,262		333,695
	$	140,057,824	$	117,045,749	$	102,389,668	$	84,446,835	$	78,330,052

Loans have increased 19.7% in 2003 over 2002 when comparing year-end totals without reducing the portfolio numbers by the allowance for loan losses. An experienced and aggressive loan production staff has enabled the bank to continue to grow the loan portfolio. Particular areas of growth during 2003 were in commercial loans and in real estate construction and land development loans. As loans increase in these two areas, management is being diligent to assure that risk is minimal. After considerable growth in 2002 in loans secured by 1-4 family residential property and other real estate loans, the December 31, 2003 totals are slightly less than at December 31, 2002. Refinancing of residential property slowed in the latter part of 2003 and the winter weather during November and December added to the slowdown in loan production.

There were no categories of loans that exceeded 10% of outstanding loans at December 31, 2003 that were not disclosed in the table above.

REMAINING MATURITIES OF SELECTED LOANS

At December 31, 2003	Commercial, Financial and Agricultural		Real Estate- Construction
Loans maturing within one year	$	2,063,107	$	7,815,691
Variable rate loans due after one year		9,549,427		2,930,884
Fixed rate loans due after one year through five years		3,336,822		2,372,620
Fixed rate loans due after five years		2,956,973		837,395
Total maturities	$	17,906,329	$	13,956,590

ALLOWANCE FOR LOAN LOSSES

The table shown below is an analysis of the company’s allowance for loan losses. Historically, net charge-offs (loans charged off as uncollectible less any amounts recovered on these loans) for the company 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.

	2003			2002			2001			2000			1999
Balance at beginning of period	$	1,641,819		$	1,402,247		$	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		191,644			287,133			102,574			105,677			62,510
Total charge-offs		191,644			287,133			121,688			105,677			89,364
Recoveries:
Commercial, financial and agricultural		—			—			667			—			—
Real estate – construction		—			—			—			—			—
Real estate – mortgage		8,216			398			492			201,284			17,000
Consumer		117,733			103,307			33,966			24,709			25,283
Total recoveries		125,949			103,705			35,125			225,993			42,283
Net charge-offs		65,695			183,428			86,563			(120,316	)		47,081
Additions charged to operations		147,500			423,000			220,575			(70,000	)		125,000
Balance at end of period	$	1,723,624		$	1,641,819		$	1,402,247		$	1,268,235		$	1,217,919
Ratio of net charge-offs during the period to average loans outstanding during the period		0.05	%		0.17	%		0.09	%		0.15	%		0.06	%

11

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.

	2003				2002				2001				2000				1999
	Allowance		% Loans in Category to Total Loans		Allowance		% Loans in Category to Total Loans		Allowance		% Loans in Category to Total Loans		Allowance		% Loans in Category to Total Loans		Allowance		% Loans in Category to Total Loans
Commercial, financial and agricultural	$	179,063	12.78	%	$	36,957	3.16	%	$	14,992	2.92	%	$	46,934	2.65	%	$	14,118	3.61	%
Mortgage loans on real estate:
Construction and land development		139,566	9.96	%		22,106	1.89	%		2,650	.52	%		70	.02	%		155	.04	%
Secured by farm land		37,113	2.65	%		1,821	1.56	%		9,006	1.76	%		13,814	3.27	%		13,025	3.32	%
Secured by 1-4 family residential		254,295	43.50	%		293,367	54.03	%		315,375	54.97	%		268,879	53.35	%		265,168	55.91	%
Other real estate		253,138	18.07	%		319,405	22.34	%		250,993	18.83	%		365,623	14.39	%		246,681	15.14	%
Consumer loans		534,790	12.53	%		424,360	16.40	%		119,331	20.72	%		119,779	26.08	%		93,869	21.55	%
All other loans		6,381	.51	%		5,030	.62	%		1,439	.28	%		1,026	.24	%		1,668	.43	%
Unallocated		319,278	—			538,773	—			688,461	—			452,110	—			583,235	—
	$	1,723,624	100.00	%	$	1,641,819	100.00	%	$	1,402,247	100.00	%	$	1,268,235	100.00	%	$	1,217,919	100.00	%

RISK ELEMENTS IN THE LOAN PORTFOLIO

	2003			2002			2001			2000			1999
Nonaccrual loans	$	250,946		$	—		$	9,060		$	—		$	112,844
Restructured loans		—			—			—			—			—
Foreclosed properties		—			—			—			12,647			201,429
Total nonperforming assets	$	250,946		$	—		$	9,060		$	12,647		$	314,273
Loans past due 90 days accruing interest	$	153,293		$	41,161		$	29,293		$	790,349		$	559,924
Allowance for loan losses to period end loans		1.23	%		1.40	%		1.37	%		1.50	%		1.55	%
Nonperforming assets to period end loans and foreclosed properties		.18	%		.00	%		.01	%		.01	%		.07	%

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 $340,752 at December 31, 2003. There were no impaired loans at December 31, 2002 or 2001.

Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2003 and 2001 totaled $250,946 and $9,060, respectively. There were no nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2002.

At December 31, 2003, other potential problem loans totaled $770,923. 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.

12

SECURITIES PORTFOLIO

In accordance with Financial Accounting Standards Board Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the company 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 schedule below summarizes the book value of the portfolio by maturity classifications and shows the weighted average yield in each group.

	2003 Carrying Value		Weighted Average Yield		2002 Carrying Value		Weighted Average Yield		2001 Carrying Value		Weighted Average Yield
Securities held to maturity
Obligations of U.S. Government agencies:
Maturing within one year	$	6,001,584	5.02	%	$	2,998,336	7.08	%	$	6,970,170	6.18	%
Maturing after one year but within five years		—	—			6,014,853	5.25	%	$	12,020,204	5.67	%
Total securities held to maturity	$	6,001,584			$	9,013,189			$	18,990,374
Securities available for sale
Obligations of U.S. Government agencies:
Maturing within one year	$	5,132,337	4.73	%	$	7,116,270	4.23	%	$	6,334,725	5.50	%
Maturing after one year but within five years		33,292,344	3.47	%		35,611,850	4.45	%		24,373,092	4.74	%
Total securities available for sale	$	38,424,681			$	42,728,120			$	30,707,817
Total securities	$	44,426,265			$	51,741,309			$	49,698,191

DEPOSITS

When comparing the 2003 and 2002 year end balances, total deposits increased $11.1 million or 6.8% in 2003. Interest- bearing deposits increased $7.3 million or 5.2% and noninterest-bearing deposits increased $3.8 million or 17.7%. Deposit growth has continued during 2003 for a number of reasons including Bank of Charles Town remaining one of few area banks with no monthly maintenance fees on deposit accounts. Our customer base continues to expand in Berkeley County, West Virginia with the opening of the branch office in Hedgesville in June 2003 in addition to our Martinsburg branch office that opened in July 2001. All checking accounts have now been renamed Silver (noninterest-bearing), Gold (a NOW account) and Platinum (a NOW account that pays a higher rate of interest of balances of $5,000 or more) and various services are packaged with each account type. The bulk of the growth in interest-bearing accounts has been in the certificate of deposit accounts with some growth in the Platinum accounts.

Schedule of Average Deposits and Average Rates Paid

	Year Ended December 31
	2003				2002				2001
	Average Balance		Average Rate		Average Balance		Average Rate		Average Balance		Average Rate
Noninterest-bearing demand deposits	$	22,385,873			$	20,391,089			$	19,096,124
Interest-bearing demand deposits		71,461,468	.56	%		62,936,496	1.20	%		49,488,124	2.19	%
Savings deposits		21,489,264	.30	%		23,908,472	.41	%		24,242,779	1.55	%
Time deposits		47,991,306	3.12	%		45,911,558	3.81	%		42,830,718	5.13	%
Total interest-bearing deposits		140,942,038	1.39	%		132,756,526	1.96	%		116,561,621	3.14	%
Total deposits	$	163,327,911			$	153,147,615			$	135,657,745

At December 31, 2003 time deposits of $100 thousand or more were 7.19% of total deposits compared with 5.43% at December 31, 2002. Maturities of time deposits of $100 thousand or more at December 31, 2003 are as follows:

Within three months	$	1,687,234
Over three through six months		1,356,073
Over six months through twelve months		3,976,620
Over twelve months		5,443,933
Total	$	12,463,860

13

ANALYSIS OF CAPITAL

The adequacy of the company’s capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the company’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.

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 company had a ratio of total capital to risk-weighted assets of 15.89% and a ratio of Tier 1 capital to risk-weighted assets of 14.67 % at December 31, 2003. These two ratios have decreased because of the use of capital to repurchase shares of Potomac stock for the treasury and because of the asset growth during 2003. Even with these reductions in these ratios, both exceed the capital requirements adopted by the federal regulatory agencies.

	(In thousands)
	2003			2002			2001
Tier 1 capital:
Common stock	$	1,800		$	600		$	600
Surplus		4,200			5,400			5,400
Retained earnings		16,543			14,801			13,208
		22,543			20,801			19,208
Less cost of shares acquired for the treasury		1,709			248			—
Total tier 1 capital	$	20,834		$	20,553		$	19,208
Tier 2 capital:
Allowance for loan losses (1)		1,724			1,403			1,209
Total risk-based capital	$	22,558		$	21,956		$	20,417
Risk-weighted assets	$	141,978		$	112,038		$	96,545
Capital ratios:
Tier 1 risk-based capital ratio		14.67	%		18.34	%		19.90	%
Total risk-based capital ratio		15.89	%		19.60	%		21.15	%
Leverage ratio		10.20	%		10.77	%		11.30	%

(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 company’s liquidity during 2003 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 during included maturity, call or sale 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 company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the company’s overall liquidity is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

At December 31, 2003, 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 $43,967,531.

Borrowing capabilities provide additional liquidity. The subsidiary bank maintains a federal funds line of $7 million with another financial institution. 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 $64,695,000. In June 2001, the subsidiary bank borrowed $2.5 million amortized over seven years from the Federal Home Loan Bank.

14

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, 2003 and 2002, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the years ended December 31, 2003, 2002 and 2001. These financial statements are the responsibility of the company’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, 2003 and 2002, and the results of their operations and their cash flows for the years ended December 31, 2003, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America.

Winchester, Virginia

February 5, 2004

15

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002

	2003		2002
ASSETS
Cash and due from banks	$	10,298,159	$	11,243,060
Interest-bearing deposits in financial institutions		335,615		1,969,773
Securities purchased under agreements to resell and federal funds sold		2,390,020		3,915,285
Securities held to maturity (fair value $6,039,375 in 2003 and $9,313,460 in 2002)		6,001,584		9,013,189
Securities available for sale, at fair value		38,424,681		42,728,120
Loans held for sale		564,213		1,923,694
Loans, net of allowance for loan losses of $1,723,624 in 2003 and $1,641,819 in 2002		138,334,200		115,403,930
Premises and equipment, net		4,991,513		4,456,560
Accrued interest receivable		908,983		1,064,815
Other assets		4,393,614		1,158,487
Total Assets	$	206,642,582	$	192,876,913
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits
Noninterest-bearing	$	25,395,596	$	21,573,475
Interest-bearing		147,860,423		140,606,257
Total Deposits	$	173,256,019	$	162,179,732
Accrued interest payable		127,809		160,263
Securities sold under agreements to repurchase		9,199,345		6,102,441
Federal Home Loan Bank advances		1,715,254		2,042,149
Other liabilities		1,012,450		1,079,932
Commitments and contingent liabilities		—		—
Total Liabilities	$	185,310,877	$	171,564,517
STOCKHOLDERS’ EQUITY
Common stock, $1 per share par value; 5,000,000 shares authorized; issued, 2003, 1,800,000 shares; 2002, 600,000 shares	$	1,800,000	$	600,000
Surplus		4,200,000		5,400,000
Undivided profits		16,543,225		14,801,225
Accumulated other comprehensive income		497,607		758,816
	$	23,040,832	$	21,560,041
Less cost of shares acquired for the treasury, 2003, 97,329 shares; 2002, 6,110 shares		1,709,127		247,645
Total Stockholders’ Equity	$	21,331,705	$	21,312,396
Total Liabilities and Stockholders’ Equity	$	206,642,582	$	192,876,913

See Notes to Consolidated Financial Statements.

16

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2003, 2002 and 2001

	2003		2002		2001
Interest and Dividend Income:
Interest and fees on loans	$	8,848,449	$	8,662,013	$	8,161,221
Interest on securities held to maturity - taxable		359,636		953,715		1,132,929
Interest on securities available for sale - taxable		1,468,594		1,490,627		1,185,877
Interest on securities purchased under agreements to resell and federal funds sold		44,348		90,452		393,154
Other interest and dividends		64,847		82,074		82,289
Total Interest and Dividend Income	$	10,785,874	$	11,278,881	$	10,955,470
Interest Expense:
Interest on deposits	$	1,958,959	$	2,602,812	$	3,659,957
Interest on securities sold under agreements to repurchase		171,458		98,536		31,160
Federal Home Loan Bank advances		104,349		121,834		66,663
Total Interest Expense	$	2,234,766	$	2,823,182	$	3,757,780
Net Interest Income	$	8,551,108	$	8,455,699	$	7,197,690
Provision for Loan Losses		147,500		423,000		220,575
Net Interest Income after Provision for Loan Losses	$	8,403,608	$	8,032,699	$	6,977,115
Noninterest Income:
Trust and financial services	$	560,693	$	464,633	$	510,933
Service charges on deposit accounts		1,217,020		1,121,826		474,556
Net gain on sale of loans		359,840		175,645		87,382
Cash surrender value of life insurance		165,495		—		—
Gain on sale of securities available for sale		99,087		—		—
Other operating income		441,749		334,550		285,154
Total Noninterest Income	$	2,843,884	$	2,096,654	$	1,358,025
Noninterest Expenses:
Salaries and employee benefits	$	3,954,725	$	3,520,647	$	3,143,150
Net occupancy expense of premises		378,562		324,661		296,740
Furniture and equipment expenses		891,177		653,302		464,058
Advertising and marketing		228,705		201,201		166,780
Stationery and supplies		190,124		190,788		125,173
Postage		132,313		143,587		105,042
Communications		144,216		116,160		95,730
ATM and check card expense		164,175		110,098		91,361
Other operating expenses		1,057,809		1,002,019		672,106
Total Noninterest Expenses	$	7,141,806	$	6,262,463	$	5,160,140
Income before Income Tax Expense	$	4,105,686	$	3,866,890	$	3,175,000
Income Tax Expense		1,432,018		1,407,720		1,165,733
Net Income	$	2,673,668	$	2,459,170	$	2,009,267
Earnings Per Share, basic and diluted	$	1.53	$	1.37	$	1.12

See Notes to Consolidated Financial Statements.

17

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years Ended December 31, 2003, 2002 and 2001

	Common Stock		Surplus			Undivided Profits			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Comprehensive Income			Total
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 ($.45 per share)		—		—			(810,000	)		—			—						(810,000	)
Balances, December 31, 2001	$	600,000	$	5,400,000		$	13,207,472		$	—		$	209,062					$	19,416,534
Comprehensive income Net income – 2002		—		—			2,459,170			—			—		$	2,459,170			2,459,170
Other comprehensive income:
Unrealized holding gains arising during the period (net of tax, $372,679)		—		—			—			—			723,436			723,436			723,436
Minimum pension liability adjustment (net of tax, $89,473)		—		—			—			—			(173,682	)		(173,682	)		(173,682	)
Total comprehensive income															$	3,008,924
Cash dividends – 2002 ($.48 per share)		—		—			(865,417	)		—			—						(865,417	)
Purchase of common stock for the treasury		—		—			—			(247,645	)		—						(247,645	)
Balances, December 31, 2002	$	600,000	$	5,400,000		$	14,801,225		$	(247,645	)	$	758,816					$	21,312,396
Comprehensive income
Net income – 2003		—		—			2,673,668			—			—		$	2,673,668			2,673,668
Other comprehensive income:
Unrealized holding (losses) arising during the period (net of tax, ($257,725))		—		—			—			—			(500,288	)		(500,288	)		(500,288	)
Add: reclassification for gains included in net income (net of tax, $33,690)		—		—			—			—			65,397			65,397			65,397
Minimum pension liability adjustment (net of tax, $89,473)		—		—			—			—			173,682			173,682			173,682
Total comprehensive income															$	2,412,459
Stock split in the form of a 200% stock dividend		1,200,000		(1,200,000	)		—			—			—						—
Cash dividends – 2003 ($.54 per share)		—		—			(931,668	)		—			—						(931,668	)
Purchase of common stock for the treasury		—		—			—			(1,461,482	)		—						(1,461,482	)
Balances, December 31, 2003	$	1,800,000	$	4,200,000		$	16,543,225		$	(1,709,127	)	$	497,607					$	21,331,705

See Notes to Consolidated Financial Statements.

18

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2003, 2002 and 2001

	2003			2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	2,673,668		$	2,459,170		$	2,009,267
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		147,500			423,000			220,575
Depreciation		623,154			417,120			288,464
Deferred tax expense (benefit)		20,060			1,517			(98,262	)
Discount (accretion) and premium amortization on securities, net		153,505			74,352			(14,578	)
(Gain) on sale of other real estate		—			—			(2,468	)
(Gain) on sale of securities available for sale		(99,087	)		—			—
Proceeds from sale of loans		21,104,470			10,417,951			4,652,242
Origination of loans for sale		(19,744,989	)		(11,426,069	)		(5,567,818	)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable		155,832			79,652			(93,250	)
(Increase) decrease in other assets		(3,120,624	)		(214,413	)		31,788
(Decrease) in accrued interest payable		(32,454	)		(63,189	)		(79,232	)
Increase (decrease) in other liabilities		195,672			(440,486	)		247,211
Net cash provided by operating activities	$	2,076,707		$	1,728,605		$	1,593,939
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities held to maturity	$	3,000,000		$	10,000,000		$	8,000,000
Proceeds from maturity of securities available for sale		7,000,000			9,250,000			12,000,000
Proceeds from sale of securities available for sale		8,117,925			—			—
Proceeds from call of securities available for sale		3,000,000			—			—
Purchases of securities held to maturity		—			—			(9,035,270	)
Purchases of securities available for sale		(14,516,225	)		(20,271,354	)		(24,174,178	)
Net (increase) in loans		(23,077,770	)		(14,839,508	)		(18,029,396	)
Purchases of premises and equipment		(1,158,107	)		(1,485,648	)		(499,381	)
Proceeds from sale of other real estate		—			—			15,115
Net cash (used in) investing activities	$	(17,634,177	)	$	(17,346,510	)	$	(31,723,110	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in noninterest-bearing deposits	$	3,822,121		$	961,940		$	1,188,875
Net increase in interest-bearing deposits		7,254,166			14,323,558			16,760,417
Net proceeds in securities sold under agreements to repurchase		3,096,904			3,153,385			2,949,056
Net proceeds (repayment) of Federal Home Loan Bank advances		(326,895	)		(309,409	)		2,351,558
Purchase of treasury shares		(1,461,482	)		(247,645	)		—
Cash dividends		(931,668	)		(865,417	)		(810,000	)
Net cash provided by financing activities	$	11,453,146		$	17,016,412		$	22,439,906
Increase (decrease) in cash and cash equivalents	$	(4,104,324	)		1,398,507		$	(7,689,265	)
CASH AND CASH EQUIVALENTS
Beginning		17,128,118			15,729,611			23,418,876
Ending	$	13,023,794		$	17,128,118		$	15,729,611
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	2,267,220		$	2,886,371		$	3,837,012
Income taxes	$	1,208,522		$	1,702,789		$	1,123,613
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Unrealized gain (loss) on securities available for sale	$	(658,926	)	$	1,096,115		$	384,120
Minimum pension liability adjustment	$	(263,155	)	$	263,155		$	—

See Notes to Consolidated Financial Statements.

19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Banking Activities and Significant Accounting Policies

Potomac Bancshares, Inc. and subsidiary (the company) grant commercial, financial, agricultural, residential and consumer loans to customers, primarily in Berkeley County and Jefferson County, West Virginia. The company’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 collateralized 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 company 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 company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of the company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions of the company’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. Consumer 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.

20

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 company 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 company 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. Estimated useful lives range from five to forty years for premises and improvements and five to twenty-five years for furniture and equipment.

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 company has a noncontributory, defined benefit pension plan covering employees meeting certain age and service requirements. The company computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Board Statement No. 87, “Employers’ Accounting for Pensions.”

The company 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 one current employee that have met certain eligibility requirements. The company 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.”

The company sponsors 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.

21

Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued)

Stock Split

On February 11, 2003, the Board of Directors declared a stock split in the form of a 200% stock dividend. Shares increased from 600,000 to 1,800,000.

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. The weighted-average number of common shares outstanding was 1,750,070, 1,791,027 and 1,800,000 at December 31, 2003, 2002 and 2001. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. The company had no potential common stock as of December 31, 2003, 2002, and 2001. All amounts have been retroactively restated for the stock split.

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 company 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 company 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 and minimum pension liability adjustment, 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.

Stock Incentive Plan

The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003 which authorized up to 90,000 shares to be granted. No shares were granted in 2003.

Reclassifications

Certain reclassifications have been made to prior period amounts to conform to the current year presentation.

22

Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued)

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” which amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation and revised disclosure requirements. The provisions of the Statement were effective December 31, 2002. The company established a plan in 2003. No shares have been granted as of December 31, 2003. Management currently intends to continue to account for stock-based compensation under the intrinsic value method set forth in Accounting Principles Board (“APB”) Opinion 25 and related interpretations. For this reason, the transition guidance of SFAS No. 148 does not have an impact on the company’s consolidated financial position or consolidated results of operations.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition requirements of the Interpretation were effective beginning January 1, 2003. The initial adoption of the Interpretation did not materially affect the company, and management does not anticipate that the recognition requirements of this Interpretation will have a materially adverse impact on either the company’s consolidated financial position or consolidated results of operations in the future.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This Interpretation provides guidance with respect to the identification of variable interest entities and when the assets, liabilities, noncontrolling interests, and results of operations of a variable interest entity need to be included in a company’s consolidated financial statements. The Interpretation requires consolidation by business enterprises of variable interest entities in cases where (a) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, or (b) in cases where the equity investors lack one or more of the essential characteristics of a controlling financial interest, which include the ability to make decisions about the entity’s activities through voting rights, the obligations to absorb the expected losses of the entity if they occur, or the right to receive the expected residual returns of the entity if they occur. The implementation of FIN 46 did not have a significant impact on either the company’s consolidated financial position or consolidated results of operations. Interpretive guidance relating to FIN 46 is continuing to evolve and the company’s management will continue to assess various aspects of consolidations and variable interest entity accounting as additional guidance becomes available.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003 and is not expected to have an impact on the company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. Adoption of the Statement did not result in an impact on the company’s consolidated financial statements.

23

Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued)

Recent Accounting Pronouncements (Continued)

In November 2003, the FASB’s Emerging Issues Task Force (EITF) reached a consensus on a new disclosure requirement related to unrealized losses on investment securities. The new disclosure requires a table of securities which have unrealized losses as of the reporting date. The table must distinguish between those securities which have been in a continuous unrealized loss position for twelve months or more and those securities which have been in a continuous unrealized loss position for less than twelve months. The table is to include the aggregate unrealized losses of securities whose fair values are below book values as of the reporting date, and the aggregate fair value of securities whose fair values are below book values as of the reporting date. In addition to the quantitative disclosure, FASB requires a narrative discussion that provides sufficient information to allow financial statement users to understand the quantitative disclosures and the information that was considered in determining whether impairment was not other-than-temporary. The new disclosure requirements apply to fiscal years ending after December 15, 2003. The company has included the required disclosures in their consolidated financial statements.

In December 2003, the FASB issued a revised version of SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits an amendment of FASB Statements No. 87, 88 and 106.” This Statement revises employers’ disclosures about pension plans and other postretirement benefits. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, No. 88, and No. 106. This Statement retains the disclosure requirements contained in the original FASB Statement No. 132, which it replaces. However, it requires additional disclosures to those in the original Statement 132 about the assets, obligations, cash flows, and net periodic benefit costs of defined benefit pension plans and other defined benefit postretirement plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. The disclosures for earlier annual periods presented for comparative purposes are required to be restated for (a) the percentages of each major category of plan assets held, (b) the accumulated benefit obligation, and (c) the assumptions used in the accounting for the plans. This Statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim-period disclosures required by this Statement are effective for interim periods beginning after December 15, 2003. The company has included the required disclosures in its consolidated financial statements.

Note 2. Securities

The amortized cost and fair value of securities being held to maturity as of December 31, 2003 and 2002, are as follows:

	2003
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Fair Value
Obligations of U.S. Government agencies	$	6,001,584	$	37,791	$	—	$	6,039,375
	2002
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Fair Value
Obligations of U.S. Government agencies	$	9,013,189	$	300,271	$	—	$	9,313,460

The amortized cost and fair value of the securities being held to maturity as of December 31, 2003, by contractual maturity, are shown below:

	Amortized Cost		Fair Value
Due in one year or less	$	6,001,584	$	6,039,375

24

Note 2. Securities (Continued)

The amortized cost and fair value of securities available for sale as of December 31, 2003 and 2002 are as follows:

	2003
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Obligations of U.S. Government agencies	$	37,670,732	$	822,146	$	(68,197	)	$	38,424,681

	2002
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Fair Value
Obligations of U.S. Government agencies	$	41,315,245	$	1,412,875	$	—	$	42,728,120

The amortized cost and fair value of the securities available for sale as of December 31, 2003, by contractual maturity, are shown below:

	Amortized Cost		Fair Value
Due in one year or less	$	5,014,426	$	5,132,337
Due after one year through five years		32,656,306		33,292,344
	$	37,670,732	$	38,424,681

Proceeds from sales of securities available for sale were $8,117,925 during 2003. Gross gains of $99,087 were realized on those sales. There were no sales of securities during 2002 and 2001.

The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. The primary cause of impairments is the decline in the prices of the bonds as rates have risen. There are approximately 4 accounts in the consolidated portfolio that have losses. These securities have not suffered credit deterioration and the company has the ability to hold these issues to maturity; therefore, the gross unrealized losses are considered temporary as of December 31, 2003.

The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of December 31, 2003.

	Less than 12 months					More than 12 months				Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
Obligations of U.S. Government agencies	$	8,445,781	$	(68,197	)	$	—	$	—	$	8,445,781	$	(68,197	)

Securities with a carrying value of $27,333,119 and $23,600,125 at December 31, 2003 and 2002, were pledged to secure public funds and other balances as required by law.

25

Note 3. Loans and Related Party Transactions

The loan portfolio is composed of the following:

	December 31
	2003		2002
Mortgage loans on real estate:
Construction and land development	$	13,956,590	$	2,210,582
Secured by farm land		3,711,332		1,821,345
Secured by 1-4 family residential		60,903,351		63,239,443
Other real estate		25,313,790		26,151,183
Loans to farmers (except those secured by real estate)		257,000		248,494
Commercial loans (except those secured by real estate)		17,649,329		3,447,238
Consumer loans		17,549,454		19,197,747
All other loans		716,978		729,717
Total loans	$	140,057,824	$	117,045,749
Less: allowance for loan losses		1,723,624		1,641,819
	$	138,334,200	$	115,403,930

At December 31, 2003 and 2002, overdraft demand deposits reclassified to loans totaled $126,684 and $113,408, respectively.

The Securities and Exchange Commission requires disclosure of loans which exceed $60,000 to executive officers and directors of the company 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, 2003 and 2002, these loans totaled $876,995 and $869,861 respectively. During 2003, total principal additions were $213,910 and total principal payments were $206,776.

Note 4. Allowance for Loan Losses

The following is a summary of transactions in the allowance for loan losses for 2003, 2002 and 2001:

	2003			2002			2001
Balances at beginning of year	$	1,641,819		$	1,402,247		$	1,268,235
Provision charged to operating expense		147,500			423,000			220,575
Recoveries added to the allowance		125,949			103,705			35,125
Loan losses charged to the allowance		(191,644	)		(287,133	)		(121,688	)
Balances at end of year	$	1,723,624		$	1,641,819		$	1,402,247

Information about impaired loans as of and for the years ended December 31, 2003 and 2002 is as follows:

	2003		2002
Impaired loans for which an allowance has been provided	$	340,752	$	—
Impaired loans for which no allowance has been provided		—		—
Total impaired loans	$	340,752	$	—
Allowance provided for impaired loans, included in the allowance for loan losses	$	60,752	$	—
	2003		2002
Average balance in impaired loans	$	68,319	$	—
Interest income recognized	$	36,013	$	—

Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2003 and 2001 totaled $250,946 and $9,060, respectively. If interest on these loans had been accrued, such income would have approximated $18,390 in 2003 and $497 in 2001. There were no nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2002.

26

Note 5. Premises and Equipment, Net

Premises and equipment consists of the following:

	December 31
	2003		2002
Premises and improvements	$	4,883,577	$	4,278,073
Furniture and equipment		4,538,879		3,986,277
	$	9,422,456	$	8,264,350
Less accumulated depreciation		4,430,943		3,807,790
	$	4,991,513	$	4,456,560

Depreciation included in operating expense for 2003, 2002 and 2001, was $623,154, $417,120 and $228,464 respectively.

Note 6. Deposits

The aggregate amount of time deposits with a balance of $100,000 or more was $12,463,860 and $8,804,364 at December 31, 2003 and 2002, respectively.

At December 31, 2003, the scheduled maturities of all time deposits are as follows:

2004	$	32,649,610
2005		10,077,662
2006		4,076,691
2007		1,019,172
2008		3,135,500
	$	50,958,635

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:

2004	$	345,369
2005		364,886
2006		385,507
2007		407,293
2008		212,199
	$	1,715,254

The company has unused lines of credit with the Federal Home Loan Bank and other financial institutions totaling approximately $71,695,000 at December 31, 2003.

Note 8. Employee Benefit Plans

The company 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 company computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Statement No. 87, “Employers’ Accounting for Pensions.”

27

Note 8. Employee Benefit Plans (Continued)

The company 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 one current employee 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 company 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 company’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 company’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.

The company sponsors 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. The company made 401(k) matching contributions of $44,659, $30,302 and $17,011 in 2003, 2002 and 2001, respectively.

Information about the plans follow:

	Pension Benefits						Postretirement Benefits
	2003			2002			2003			2002
Change in Benefit Obligation:
Benefit obligation, beginning	$	4,501,006		$	4,117,159		$	487,761		$	562,161
Service cost		160,276			112,001			5,780			5,806
Interest cost		310,616			293,612			31,258			38,012
Actuarial (gain) loss		(760,263	)		105,507			(59,144	)		(86,390	)
Benefits paid		(141,581	)		(127,273	)		(24,263	)		(31,828	)
Benefit obligation, ending	$	4,070,054		$	4,501,006		$	441,392		$	487,761
Change in Plan Assets:
Fair value of plan assets, beginning	$	3,022,631		$	3,407,698		$	—		$	—
Actual return on plan assets		257,223			(432,486	)		—			—
Employer contributions		218,425			174,692			24,263			31,828
Benefits paid		(141,581	)		(127,273	)		(24,263	)		(31,828	)
Fair value of plan assets, ending	$	3,356,698		$	3,022,631		$	—		$	—
Funded status	$	(713,356	)		(1,478,375	)	$	(441,392	)	$	(487,761	)
Unrecognized net (gain) loss		226,184			964,911			(84,850	)		(25,933	)
Unrecognized net obligation (asset) at transition		(35,735	)		(56,037	)		191,528			208,940
Unrecognized prior service cost		560			716			—			—
Minimum liability adjustment		—			(263,155	)		—			—
Accrued benefit cost included in other liabilities	$	(522,347	)	$	(831,940	)	$	(334,714	)	$	(304,754	)

The accumulated benefit obligation for the defined benefit pension plan was $3,383,520 and $3,854,571 at December 31, 2003 and 2002, respectively.

	Pension Benefits									Postretirement Benefits
	2003			2002			2001			2003			2002		2001
Components of Net Periodic Benefit Cost:
Service cost	$	160,276		$	112,001		$	106,081		$	5,780		$	5,806	$	5,482
Interest cost		310,616			293,612			282,256			31,258			38,012		38,252
Expected return on plan assets		(312,182	)		(321,263	)		(345,418	)		—			—		—
Amortization of net (gain) loss		—			—			—			(227	)		167		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
Recognized actuarial loss		33,423			—			—			—			—		—
Net periodic benefit cost	$	171,986		$	64,203		$	22,772		$	54,223		$	61,397	$	72,000

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Note 8. Employee Benefit Plans (Continued)

Weighted-Average Assumptions:
Discount rate	7.00	%	7.00	%	7.25	%	6.75	%	7.00	%	7.00	%
Expected return on plan assets	8.50	%	8.50	%	8.50	%	—		—		—
Rate of compensation increase	4.00	%	4.00	%	4.25	%	3.00	%	3.00	%	3.00	%

Long-Term Rate of Return

The plan sponsor selects the expected long-term rate-of-return-on-assets assumption in consultation with their investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period, with higher significance placed on current forecasts of future long-term economic conditions.

Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).

Asset Allocation

The pension plan’s weighted-average asset allocations at October 31, 2003 and 2002, by asset category are as follows:

	Plan Assets at October 31
	2003		2002
Asset Category
Equities	63	%	63	%
Fixed income/cash	37	%	37	%
Total	100	%	100	%

The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 60% equities and 40% fixed income/cash. The investment manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the plan’s investment strategy. The investment manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.

It is the responsibility of the trustee to administer the investments of the trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the trust.

The company expects to contribute $218,425 to its pension plan in 2004.

For measurement purposes, an 8.64% annual rate of increase in per capita health care costs of covered benefits was assumed for 2003, a 9% increase was assumed for 2002 and a 10% increase was assumed for 2001, 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	$	17,900	$	(16,000	)
Effect on total of service and interest cost components of net periodic postretirement health care benefit cost		1,175		(1,100	)

The company expects to contribute $49,911 to its post retirement plan in 2004.

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Note 9. Income Taxes

Net deferred tax assets consist of the following components as of December 31, 2003 and 2002:

	2003		2002
Deferred tax assets:
Reserve for loan losses	$	431,044	$	403,230
Accrued pension expense		184,432		193,387
Minimum pension liability adjustment		—		89,473
Accrued postretirement benefits		113,779		103,617
Nonaccrual interest		6,252		—
	$	735,507	$	789,707
Deferred tax liabilities:
Depreciation	$	129,468	$	74,134
Securities available for sale		256,343		480,378
	$	385,811	$	554,512
Net deferred tax assets	$	349,696	$	235,195

The provision for income taxes charged to operations for the years ended December 31, 2003, 2002 and 2001 consists of the following:

	2003		2002		2001
Current tax expense	$	1,411,958	$	1,406,203	$	1,263,995
Deferred tax expense (benefit)		20,060		1,517		(98,262	)
	$	1,432,018	$	1,407,720	$	1,165,733

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, 2003, 2002 and 2001 due to the following:

	2003			2002			2001
Computed “expected” tax expense	$	1,395,933		$	1,314,743		$	1,079,500
Increase (decrease) in income taxes resulting from:
Tax exempt interest income		(90,033	)		(33,793	)		(28,503	)
State income taxes, net of federal income tax benefit		121,925			123,186			114,303
Other		4,193			3,584			433
	$	1,432,018		$	1,407,720		$	1,165,733

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 company does not anticipate losses as a result of these transactions.

See Note 12 with respect to financial instruments with off-balance-sheet risk.

The company has approximately $700,420 in deposits in other financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2003.

The company 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, 2003 and 2002, the aggregate amounts of daily average required balances were approximately $6,633,000 and $5,980,000, respectively.

Note 11. Retained Earnings

Transfers of funds from the banking subsidiary to the parent company in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities. As of December 31, 2003, the aggregate amount of unrestricted funds which could be transferred from the banking subsidiary to the parent company, without prior regulatory approval, totaled $2,827,868 or 13.3% of the consolidated net assets.

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Note 12. Financial Instruments With Off-Balance-Sheet Risk

The company 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 company has in particular classes of financial instruments.

The company’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 company 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 company’s exposure to off-balance-sheet risk as of December 31, 2003 and 2002, is as follows:

	2003		2002
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit	$	24,847,726	$	19,990,685
Standby letters of credit		5,006,967		1,638,028

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 company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company 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 company is committed.

Standby letters of credit are conditional commitments issued by the company 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 company generally holds collateral supporting those commitments if deemed necessary.

At December 31, 2003, the company had rate lock commitments to originate mortgage loans amounting to $976,088 and loans held for sale of $564,213. The company has entered into corresponding mandatory commitments, on a best-efforts basis, to sell these loans. These commitments to sell loans are designed to eliminate the company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

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.

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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 company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest

The carrying amounts of accrued interest approximate 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, 2003 and 2002, the fair value of loan commitments and standby-letters of credit was immaterial.

The estimated fair values of the company’s financial instruments are as follows:

	2003				2002
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(in thousands)				(in thousands)
Financial assets:
Cash	$	10,634	$	10,634	$	13,213	$	13,213
Securities purchased under agreements to resell and federal funds sold		2,390		2,390		3,915		3,915
Securities held to maturity		6,002		6,039		9,013		9,313
Securities available for sale		38,425		38,425		42,728		42,728
Loans, net		138,334		140,427		115,404		114,516
Loans held for sale		564		564		1,924		1,924
Accrued interest receivable		909		909		1,065		1,065
Financial liabilities:
Deposits		173,256		173,279		162,180		162,332
Repurchase agreements		9,199		9,199		6,102		6,102
FHLB advances		1,715		1,715		2,042		2,170
Accrued interest payable		128		128		160		160

The company 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 company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the company. 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 company’s overall interest rate risk.

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Note 14. Regulatory Matters

The company (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 company’s and bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the company 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 company 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, 2003 and 2002, that the company and the bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2003, 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 company’s and the bank’s actual capital amounts and ratios are also presented in the table.

	Actual				Minimum Capital Requirement				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Amount in Thousands)
As of December 31, 2003:
Total capital (to risk-weighted assets):
Consolidated	$	22,558	15.89	%	$	11,358	8.0	%		N/A	N/A
Bank of Charles Town	$	22,513	15.86	%	$	11,356	8.0	%	$	14,195	10.0	%
Tier 1 capital (to risk-weighted assets):
Consolidated	$	20,834	14.67	%	$	5,679	4.0	%		N/A	N/A
Bank of Charles Town	$	20,789	14.64	%	$	5,678	4.0	%	$	8,517	6.0	%
Tier 1 capital (to average assets):
Consolidated	$	20,834	10.20	%	$	8,171	4.0	%		N/A	N/A
Bank of Charles Town	$	20,789	10.18	%	$	8,170	4.0	%	$	10,213	5.0	%
As of December 31, 2002:
Total capital (to risk-weighted assets):
Consolidated	$	21,956	19.60	%	$	8,963	8.0	%		N/A	N/A
Bank of Charles Town	$	21,911	19.56	%	$	8,962	8.0	%	$	11,203	10.0	%
Tier 1 capital (to risk-weighted assets):
Consolidated	$	20,553	18.34	%	$	4,482	4.0	%		N/A	N/A
Bank of Charles Town	$	20,508	18.31	%	$	4,481	4.0	%	$	6,722	6.0	%
Tier 1 capital (to average assets):
Consolidated	$	20,553	10.77	%	$	7,636	4.0	%		N/A	N/A
Bank of Charles Town	$	20,508	10.74	%	$	7,635	4.0	%	$	9,543	5.0	%

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Note 15. Parent Company Only Financial Statements

POTOMAC BANCSHARES, INC.

(Parent Company Only)

Balance Sheets

December 31, 2003 and 2002

	2003		2002
ASSETS
Cash	$	23,140	$	36 549
Investment in subsidiary		21,286,416		21,266,822
Other assets		24,907		14,021
Total Assets	$	21,334,463	$	21,317,392
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES, other	$	2,758	$	4,996
STOCKHOLDERS’ EQUITY
Common stock	$	1,800,000	$	600,000
Surplus		4,200,000		5,400,000
Undivided profits		16,543,225		14,801,225
Accumulated other comprehensive income		497,607		758,816
	$	23,040,832	$	21,560,041
Less cost of shares acquired for the treasury		1,709,127		247,645
Total Stockholders’ Equity	$	21,331,705	$	21,312,396
Total Liabilities and Stockholders’ Equity	$	21,334,463	$	21,317,392

POTOMAC BANCSHARES, INC.

(Parent Company Only)

Statements of Income

Years Ended December 31, 2003, 2002 and 2001

	2003			2002			2001
Income
Dividends from subsidiary	$	2,443,150		$	1,163,062		$	810,000
Expenses
Legal and professional		33,243			12,315			4,433
Other operating expenses		41,767			30,718			27,844
Total Expenses	$	75,010		$	43,033		$	32,277
Income before Income Tax (Benefit) and Equity in Undistributed Income of Subsidiary	$	2,368,140		$	1,120,029		$	777,723
Income Tax (Benefit)		(24,725	)		(13,839	)		(9,781	)
Income before Equity in Undistributed Income of Subsidiary	$	2,392,865		$	1,133,868		$	787,504
Equity in Undistributed Income of Subsidiary		280,803			1,325,302			1,221,763
Net Income	$	2,673,668		$	2,459,170		$	2,009,267

34

Note 15. Parent Company Only Financial Statements (Continued)

POTOMAC BANCSHARES, INC.

(Parent Company Only)

Statements of Cash Flows

Years Ended December 31, 2003, 2002 and 2001

	2003			2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	2,673,668		$	2,459,170		$	2,009,267
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed (income) of subsidiary		(280,803	)		(1,325,302	)		(1,221,763	)
(Increase) in other assets		(10,886	)		(4,059	)		(918	)
(Decrease) in other liabilities		(2,238	)		—			—
Net cash provided by operating activities	$	2,379,741		$	1,129,809		$	786,586
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends	$	(931,668	)	$	(865,417	)	$	(810,000	)
Purchase of treasury shares		(1,461,482	)		(247,645	)		—
Net cash (used in) financing activities	$	(2,393,150	)	$	(1,113,062	)	$	(810,000	)
Increase (decrease) in cash and cash equivalents	$	(13,409	)	$	16,747		$	(23,414	)
CASH AND CASH EQUIVALENTS
Beginning		36,549			19,802			43,216
Ending	$	23,140		$	36,549		$	19,802

35

ANNUAL REPORT ON FORM 10-KSB

A copy of the company’s 2003 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 & Stringfellow, Inc., Koonce Securities Inc. and Ferris, Baker Watts, Inc. are market makers 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, 2003, there were 1,702,671 common shares outstanding held by approximately 1,100 shareholders.

The per share sale prices of the company’s stock for 2002 and 2003 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 2002 and 2003 are also listed.

	High		Low		Dividends
2002
First Quarter	$	12.78	$	11.75	$	N/A
Second Quarter		13.67		12.17		0.23
Third Quarter		14.17		13.37		N/A
Fourth Quarter		15.50		13.92		0.25
2003
First Quarter	$	19.00	$	15.50	$	0.1300
Second Quarter		20.00		18.30		0.1325
Third Quarter		25.00		19.00		0.1350
Fourth Quarter		23.75		22.10		0.1375

Beginning in 2003 common stock dividends are paid on a quarterly basis. Prices and dividends in the above schedule have been restated to reflect a 200% stock dividend declared on February 11, 2003. Prior to 2003 the company had paid dividends 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 Clarion Hotel & Conference Center, Shepherdstown, Jefferson County, West Virginia, on Tuesday, April 27, 2004, beginning at 10:30 a.m.

36