10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 0-24958

POTOMAC BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)

West Virginia	55-0732247
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
111 East Washington Street PO Box 906, Charles Town WV	25414-0906
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code 304-725-8431

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

Large Accelerated Filer     ¨	Accelerated Filer                    ¨
Non-Accelerated Filer       ¨	Smaller Reporting Company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE REGISTRANTS

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

3,390,178 as of August 7, 2010

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

FORM 10-Q

June 30, 2010

INDEX

		PAGE
PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements.	3
	Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and December 31, 2009 (Audited)	3
	Consolidated Statements of Operations (Unaudited) for the Three Months Ended June 30, 2010 and 2009 and for the Six Months ended June 30, 2010 and 2009	4
	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Six Months Ended June 30, 2010 and 2009	5
	Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2010 and 2009	6
	Notes to Consolidated Financial Statements June 30, 2010 (Unaudited) and December 31, 2009 (Audited)	7 - 16
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	16 - 20
Item 4.	Controls and Procedures.	21
Part II.	OTHER INFORMATION	21
Item 1.	Legal Proceedings.	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	21
Item 4.	(Removed and Reserved).	21
Item 5.	Other Information.	21
Item 6.	Exhibits.	22
Signatures		23

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 Form 10-Q, including 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,” “confident,” 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 experiences 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, unemployment, pricing in the real estate market, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, the current economic environment posing significant challenges and affecting our financial condition and results of operations, the possibility of future FDIC assessments, Congressional legislation and similar matters (including changes as a result of rules and regulations adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act). We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by unanticipated future events. Actual results, accordingly, may differ materially from management expectations.

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(Unaudited)

	June 30			December 31
	2010			2009
Assets:
Cash and due from banks	$	13,278		$	6,620
Interest-bearing deposits in other financial institutions		—			53
Federal funds sold		1,875			5,950
Securities available for sale, at fair value		39,680			34,313
Loans held for sale		—			97
Loans, net of allowance for loan losses of $5,577 and $5,718, respectively		221,460			228,993
Premises and equipment, net		8,485			8,726
Other real estate owned, net of valuation allowance of $258 and $303, respectively		6,647			5,632
Accrued interest receivable		991			952
Federal Home Loan Bank of Pittsburgh stock		805			805
Other assets		10,703			11,048
Total Assets	$	303,924		$	303,189
Liabilities and Stockholders’ Equity:
Liabilities:
Deposits
Noninterest-bearing	$	27,650		$	27,953
Interest-bearing		235,427			236,514
Total Deposits		263,077			264,467
Securities sold under agreements to repurchase		7,609			7,340
Federal Home Loan Bank advances		3,307			3,856
Accrued interest payable		393			405
Other liabilities		3,011			1,549
Total Liabilities	$	277,397		$	277,617
Stockholders’ Equity:
Common stock, $1 per share par value; 5,000,000 shares authorized; 3,671,691 shares issued and outstanding	$	3,672		$	3,672
Surplus		3,915			3,898
Undivided profits		22,791			21,931
Accumulated other comprehensive (loss), net		(985	)		(1,063	)
	$	29,393		$	28,438
Less cost of shares acquired for the treasury, 281,513 shares		2,866			2,866
Total Stockholders’ Equity	$	26,527		$	25,572
Total Liabilities and Stockholders’ Equity	$	303,924		$	303,189

See Notes to Consolidated Financial Statements.

3

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(Unaudited)

	For the Three  Months Ended June 30					For the Six Months Ended June 30
	2010		2009			2010		2009
Interest and Dividend Income:
Interest and fees on loans	$	3,269	$	3,509		$	6,546	$	7,031
Interest on securities available for sale – taxable		216		254			412		497
Interest on securities available for sale – nontaxable		49		37			98		71
Interest on federal funds sold		1		1			2		3
Other interest and dividends		4		4			7		13
Total Interest and Dividend Income	$	3,539	$	3,805		$	7,065	$	7,615
Interest Expense:
Interest on deposits	$	1,023	$	1,210		$	2,101	$	2,503
Interest on securities sold under agreements to repurchase and federal funds purchased		20		38			40		76
Federal Home Loan Bank advances		15		52			61		106
Total Interest Expense	$	1,058	$	1,300		$	2,202	$	2,685
Net Interest Income	$	2,481	$	2,505		$	4,863	$	4,930
Provision for Loan Losses		461		1,560			771		3,137
Net Interest Income after Provision for Loan Losses	$	2,020	$	945		$	4,092	$	1,793
Noninterest Income:
Trust and financial services	$	227	$	189		$	437	$	364
Service charges on deposit accounts		478		539			914		1,034
Fee income on secondary market loans		18		56			24		108
Gain (loss) on sale of other real estate		30		(18	)		142		36
Visa/MC Fees		178		140			329		267
Cash surrender value of life insurance		59		60			118		118
Other operating income		103		81			181		142
Total Noninterest Income	$	1,093	$	1,047		$	2,145	$	2,069
Noninterest Expenses:
Salaries and employee benefits	$	1,142	$	1,293		$	2,402	$	2,544
Net occupancy expense of premises		144		141			334		273
Furniture and equipment expenses		227		247			437		467
Impairment loss on CFSI stock		—		—			—		117
FDIC assessment		154		190			274		234
Printing, stationery and supplies		67		45			102		120
ATM and check card expenses		71		89			135		184
Foreclosed property expense		110		539			291		718
Other operating expenses		546		590			995		1,103
Total Noninterest Expenses	$	2,461	$	3,134		$	4,970	$	5,760
Income (Loss) before Income Tax Expense (Benefit)	$	652	$	(1,142	)	$	1,267	$	(1,898	)
Income Tax Expense (Benefit)		214		(508	)		407		(846	)
Net Income (Loss)	$	438	$	(634	)	$	860	$	(1,052	)
Earnings (Loss) Per Share, basic and diluted	$	.13	$	(.19	)	$	.25	$	(.31	)

See Notes to Consolidated Financial Statements.

4

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

(in thousands, except share and per share data)

(Unaudited)

	Common Stock		Surplus		Undivided Profits			Treasury Stock			Accumulated Other Comprehensive (Loss)			Comprehensive Income/(Loss)			Total
Balances, December 31, 2008	$	3,672	$	3,851	$	25,070		$	(2,837	)	$	(1,952	)				$	27,804
Comprehensive (loss)
Net (loss)		—		—		(1,052	)		—			—		$	(1,052	)		(1,052	)
Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $59)		—		—		—			—			(115	)		(115	)		(115	)
Total comprehensive (loss)														$	(1,167	)
Purchase of treasury shares: 3,427 shares		—		—		—			(29	)		—						(29	)
Stock-based compensation expense		—		24		—			—			—						24
Cash dividends ($.24 per share)		—		—		(797	)		—			—						(797	)
Balances, June 30, 2009	$	3,672	$	3,875	$	23,221		$	(2,866	)	$	(2,067	)				$	25,835
Balances, December 31, 2009	$	3,672	$	3,898	$	21,931		$	(2,866	)	$	(1,063	)				$	25,572
Comprehensive income
Net income		—		—		860			—			—		$	860			860
Other comprehensive income: unrealized holding gains arising during the period (net of tax, ($40)		—		—		—			—			78			78			78
Total comprehensive income														$	938
Stock-based compensation expense		—		17		—			—			—						17
Balances, June 30, 2010	$	3,672	$	3,915	$	22,791		$	(2,866	)	$	(985	)				$	26,527

See Notes to Consolidated Financial Statement

5

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	For the Six Months Ended
	June 30 2010			June 30 2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	860		$	(1,052	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Provision for loan losses		771			3,137
Depreciation		282			272
Valuation allowance for other real estate		16			—
Discount accretion and premium amortization on securities, net		82			61
Gain on sale of other real estate		(142	)		(36	)
Loss on disposal of fixed assets		2			5
Stock compensation expense		17			24
Proceeds from sale of loans		1,091			4,932
Origination of loans for sale		(994	)		(5,603	)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable		(39	)		109
Decrease (increase) in other assets		303			(132	)
Decrease in accrued interest payable		(12	)		(7	)
Increase (decrease) in other liabilities		1,462			(1,896	)
Net cash provided by (used in) operating activities	$	3,699		$	(186	)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available for sale	$	—		$	4,500
Proceeds from call of securities available for sale		19,545			8,000
Purchase of securities available for sale		(24,875	)		(23,487	)
Net decrease (increase) in loans		4,520			(196	)
Purchases of premises and equipment		(42	)		(1,026	)
Proceeds from sale of other real estate		1,353			2,426
Net cash provided by (used in) investing activities	$	501		$	(9,783	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (decrease) increase in noninterest-bearing deposits	$	(303	)	$	2,198
Net (decrease) increase in interest-bearing deposits		(1,087	)		4,328
Net purchase of securities sold under agreements to repurchase and federal funds purchased		269			1,503
Net repayment of Federal Home Loan Bank advances		(549	)		(455	)
Purchase of treasury shares		—			(29	)
Cash dividends		—			(797	)
Net cash (used in) provided by financing activities	$	(1,670	)	$	6,748
Increase (decrease) in cash and cash equivalents	$	2,530		$	(3,221	)
CASH AND CASH EQUIVALENTS
Beginning		12,623			8,349
Ending	$	15,153		$	5,128
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	2,214		$	2,692
Income taxes	$	—		$	41
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Unrealized gain (loss) on securities available for sale	$	118		$	(174	)
Loans transferred to other real estate owned	$	2,226		$	6,013
Loans made on sale of other real estate	$	298		$	448

See Notes to Consolidated Financial Statements.

6

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009

1. In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of June 30, 2010 and December 31, 2009, the results of operations for the three months and six months ended June 30, 2010 and 2009, and cash flows and statements of changes in stockholders’ equity for the six months ended June 30, 2010 and 2009. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 2009. The results of operations for the three month and six month periods ended June 30, 2010 and 2009 are not necessarily indicative of the results to be expected for the full year.

The consolidated financial statements of Potomac Bancshares, Inc. (the “company”) and its wholly-owned subsidiary, Bank of Charles Town (the “bank”), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation.

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

In preparing these financial statements the company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

2. Stock-Based Compensation

The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003, which authorized up to 183,600 shares of common stock to be used in the granting of incentive options to employees and directors. On April 24, 2007, the stockholders approved an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first and only stock incentive plan adopted by the company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Options granted under the plan may be subject to a graded vesting schedule.

Incremental stock-based compensation expense recognized for the six month periods ending June 30, 2010 and 2009 was $17 thousand and $24 thousand, respectively.

Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first six months of 2010 and 2009.

Stock option plan activity for the six months ended June 30, 2010 is summarized below:

	Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Options outstanding, January 1, 2010	126,224	$	14.75
Granted	—		—
Exercised	—		—
Canceled or expired	—		—
Options outstanding, June 30, 2010	126,224		14.75	5	$	—
Options exercisable, June 30, 2010	113,399		14.59	5	$	—

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2010. The amount changes based on changes in the market value of the company’s stock.

As of June 30, 2010 there was $33 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining five year average service period.

7

3. Securities

The amortized cost and fair value of securities available for sale as of June 30, 2010 and December 31, 2009 (in thousands) are as follows:

	June 30, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Obligations of U. S. Government agencies	$	33,153	$	328	$	(1	)	$	33,480
State and municipal obligations		5,043		76		(19	)		5,100
Equity securities		1,100		—		—			1,100
	$	39,296	$	404	$	(20	)	$	39,680
	December 31, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Obligations of U. S. Government agencies	$	28,159	$	279	$	(15	)	$	28,423
State and municipal obligations		4,789		56		(55	)		4,790
Equity securities		1,100		—		—			1,100
	$	34,048	$	335	$	(70	)	$	34,313

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 5 accounts in the consolidated portfolio that have losses at June 30, 2010. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at June 30, 2010 and no impairment has been recognized.

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 June 30, 2010 and December 31, 2009 (in thousands).

	June 30, 2010
	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	$	1,017	$	(1	)	$	—	$	—	$	1,017	$	(1	)
State and municipal obligations		1,951		(19	)		—		—		1,951		(19	)
Total	$	2,968	$	(20	)	$	—	$	—	$	2,968	$	(20	)

8

3. Securities (Continued)

	December 31, 2009
	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	$	4,987	$	(15	)	$	—	$	—	$	4,987	$	(15	)
State and municipal obligations		2,746		(55	)		—		—		2,746		(55	)
Total	$	7,733	$	(70	)	$	—	$	—	$	7,733	$	(70	)

The company investment in Federal Home loan Bank (“FHLB”) stock totaled $805 thousand at June 30, 2010. FHLB stock is generally viewed as a long term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLBs temporary suspension of repurchases of excess capital stock in 2009, the company does not consider this investment to be other-than-temporarily impaired at June 30, 2010 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.

4. Loans

The loan portfolio, stated at face amount, is composed of the following:

	June 30, 2010		December 31, 2009
	(in thousands)
Mortgage loans on real estate:
Construction, land development and other land loans	$	29,573	$	38,083
Secured by farmland		871		1,419
Secured by 1-4 family residential		98,283		102,290
Secured by multifamily residential		2,037		2,070
Secured by nonfarm nonresidential		80,119		71,916
Commercial and industrial loans (except those secured by real estate)		7,531		9,700
Consumer loans		7,703		9,011
All other loans		920		222
Total loans	$	227,037	$	234,711
Less: allowance for loan losses		5,577		5,718
	$	221,460	$	228,993

5. Allowance for Loan Losses

The following is a summary of transactions (in thousands) in the allowance for loan losses:

	June 30, 2010			December 31, 2009			June 30, 2009
Balance at beginning of period	$	5,718		$	4,079		$	4,079
Provision charged to operating expense		771			6,690			3,137
Recoveries added to the allowance		122			232			127
Loan losses charged to the allowance		(1,034	)		(5,283	)		(3,524	)
Balance at end of period	$	5,577		$	5,718		$	3,819

9

5. Allowance for Loan Losses (Continued)

The following is a summary of information pertaining to impaired loans at June 30, 2010 and December 31, 2009 (in thousands):

	June 30, 2010		December 31, 2009
Impaired loans without a valuation allowance	$	11,284	$	12,397
Impaired loans with a valuation allowance		14,145		14,985
Total impaired loans	$	25,429	$	27,382
Valuation allowance related to impaired loans	$	3,556	$	3,799
Total nonaccrual loans	$	3,094	$	3,819
Average investment in impaired loans	$	22,222	$	16,262
Interest income recognized on impaired loans	$	617	$	1,233
Interest income recognized on a cash basis on impaired loans	$	0	$	68

No additional funds are committed to be advanced in connection with impaired loans.

Impaired loans are evaluated in relation to the ability of the customer to meet the agreed upon terms of the loan and are evaluated by the value of collateral pledged to secure the loan. Impaired loans without a valuation allowance have sufficient collateral value to cover the outstanding balance of the loan.

Total nonaccrual loans as reported in the above table include impaired and non-impaired loans. Nonaccrual loans excluded from the above impaired loan disclosure at June 30, 2010 and December 31, 2009 totaled $1.1 million and $1.3 million, respectively. If interest had been accrued on the nonaccrual loans excluded from the impaired loan disclosure, such income would have approximated $34 thousand for the first half of 2010 and $58 thousand in 2009.

6. Employee Benefit Plans

Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below:

	Pension Benefits						Other Postretirement Benefits
	Six Months Ended						Six Months Ended
	June 30 2010			June 30 2009			June 30 2010		June 30 2009
	(in thousands)						(in thousands)
Components of Net Periodic Benefit Cost
Service cost	$	—		$	151		$	6	$	6
Interest cost		207			205			17		15
Expected return on plan assets		(230	)		(157	)		—		—
Amortization of net obligation at transition		—			—			9		9
Recognized net actuarial loss		48			36			—		—
Net periodic benefit cost	$	25		$	235		$	32	$	30

The company’s defined benefit pension plan was frozen as of October 31, 2009. Benefits of all existing participants stopped accruing and no new participants could be admitted to the plan after that date. The results of the freeze can be seen in the changes in service cost and net periodic benefit cost of the pension plan between the periods ending June 30, 2009 and June 30, 2010.

10

6. Employee Benefit Plans (continued)

Employer Contribution

The company anticipates the 2010 contribution for the pension plan will approximate $345 thousand. The company has made payments of $316 thousand as of June 30, 2010. The company has made payments of $10 thousand for the other postretirement benefit plans for the first six months of 2010 and anticipates remaining payments for 2010 to total $12 thousand.

7. Weighted Average Number of Shares Outstanding and Earnings Per Share

The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential diluted common stock had no effect on June 30, 2010 and June 30, 2009 earnings per share.

	Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
	Average Shares	Per Share Amount		Average Shares	Per Share Amount
Basic earnings per share	3,390,178	$	.25	3,390,860	$	(.31	)
Effect of dilutive securities:
Stock options	—			—
Diluted earnings per share	3,390,178	$	.25	3,390,860	$	(.31	)

For the six months ended June 30, 2010, stock options representing 126,224 shares and for the six months ended June 30, 2009, stock options representing 131,474 shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.

8. Recent Accounting Pronouncements

In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”, was adopted into Codification in December 2009 through the issuance of Accounting Standards Update (“ASU”) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

In June 2009, the FASB issued new guidance relating to the variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”, was adopted into Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 is effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-04, “Accounting for Various Topics – Technical Corrections to SEC Paragraphs”. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements – subsequent events, use of residual method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

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8. Recent Accounting Pronouncements (Continued)

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

In February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 is effective immediately. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning after December 15, 2010. The company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.

9. Fair Value Measurements

Determination of Fair Value

The company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

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9. Fair Value Measurements (Continued)

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

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

Cash and Short-Term Investments

The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

Securities

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

Loans

For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.

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 fixed rate 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 and federal funds purchased 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.

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9. Fair Value Measurements (Continued)

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 June 30, 2010 and December 31, 2009, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.

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

	June 30, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(in thousands)				(in thousands)
Financial assets:
Cash	$	13,278	$	13,278	$	6,673	$	6,673
Federal funds sold		1,875		1,875		5,950		5,950
Securities available for sale		39,680		39,680		34,313		34,313
Loans, net		221,460		219,010		228,993		236,838
Loans held for sale		—		—		97		97
Accrued interest receivable		991		991		952		952
Financial liabilities:
Deposits		263,077		263,181		264,467		260,915
Securities sold under agreements to repurchase		7,609		7,609		7,340		7,340
FHLB advances		3,307		3,318		3,856		4,012
Accrued interest payable		393		393		405		405

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following describes the valuation techniques used by the company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

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9. Fair Value Measurements (Continued)

The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009:

			Fair Value Measurements at June 30, 2010 Using
Description	Balance as of June 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities	$	39,680	$	—	$	39,680	$	—
			Fair Value Measurements at December 31, 2009 Using
Description	Balance as of December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities	$	34,313	$	—	$	34,313	$	—

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended June 30, 2010 and December 31, 2009. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of operations.

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell.

15

9. Fair Value Measurements (Continued)

The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of June 30, 2010 and December 31, 2009.

			Carrying Value at June 30, 2010
Description	Balance as of June 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Input (Level 2)		Significant Unobservable Input (Level 3)
Assets
Impaired Loans	$	10,589	$	—	$	9,783	$	806
OREO		6,647		—		6,647		—
			Carrying Value at December 31, 2009
Description	Balance as of December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Input (Level 2)		Significant Unobservable Input (Level 3)
Assets
Impaired Loans	$	11,186	$	—	$	3,311	$	7,875
OREO		5,632		—		5,632		—

Item 2. 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: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) 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.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects that margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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FINANCIAL OVERVIEW

The outlook for the economy continues to be somewhat of a moving target. Each day seems to bring economic news that contradicts the news of the previous day. Management keeps abreast of the latest economic data and how it might affect our local economy. The overall view is still that the economic recovery will be slow and, at times, painful.

The strategies adopted by management and the board of directors and discussed in the March 31, 2010 Form 10-Q are producing the intended results. We are once again increasing capital and income. Although gross income is lower than the previous year we have increased net income through cost cutting measures such as lowering interest rates on deposits and encouraging employees to cut costs whenever reasonably possible. This strategy has produced three consecutive quarters of net income and each quarter has been slightly more profitable than the previous quarter.

Total assets have increased $.7 million or .2% from the December 2009 total of $303.2 million to $303.9 million at June 30, 2010. Cash and due from banks increased $6.7 million from December 31, 2009 and $5.6 million from March 31, 2010. Cash and due from banks increased because of liquidity needs and the added fact of keeping funds at the Federal Reserve. Currently the Federal Reserve is paying slightly higher rates than our correspondents are paying for federal funds. Federal funds sold decreased $4.1 million from December 31, 2009 compared to June 30, 2010. Securities have increased $5.4 million from December 31, 2009 and have decreased $3.5 million from March 31, 2010. Securities have been somewhat volatile due to the call of many higher yielding securities and the timing of replacing the called securities. Loans have decreased $7.5 million since December 31, 2009 and $5.6 million since March 31, 2010. The decrease in loans has been a combination of payoffs and defaults. Other real estate owned has increased $1.0 million from December 31, 2009 and $0.8 million from March 31, 2010. Other real estate owned has increased due to continuing defaults by customers on residential and commercial properties as well as the continued slow pace of the real estate market.

Total deposits have decreased $.4 million or .5% at June 30, 2010 compared to December 31, 2009. Noninterest-bearing deposits have decreased 1.1% and interest-bearing deposits have decreased 0.5% during the first six months of 2010. Overall, core deposits actually increased slightly. The largest contributor to the decrease in total deposits was the maturity of $1.5 million in brokered deposits.

The June 30, 2010 annualized return (loss) on average assets is .56% compared to (.74)% at December 31, 2009. At June 30, 2010 the annualized return (loss) on average equity is 6.56 % compared to (8.53)% at December 31, 2009. The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.99% at June 30, 2010 compared to 8.75% at December 31, 2009. The Tier 1 capital to total risk weighted assets ratio is 12.37% at June 30, 2010 compared to 11.65% at December 31, 2009. The total capital to risk weighted assets ratio is 13.64% at June 30, 2010 compared to 12.92% at December 31, 2009. All capital ratios are within the regulatory guidelines for “well capitalized”.

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The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Management monitors the loan portfolio on a continual basis with procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Written reports are prepared on a monthly basis for all loans and information on commercial loans graded below a certain level and are reported to the Board of Directors on a monthly basis. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.

	June 30 2010			December 31 2009			June 30 2009
Balance at beginning of period	$	5,718		$	4,079		$	4,079
Charge-offs:
Commercial, financial and agricultural		—			23			23
Real estate – construction		406			3,957			2,945
Real estate – mortgage		487			920			376
Consumer		141			383			180
Total charge-offs		1,034			5,283			3,524
Recoveries:
Commercial, financial and agricultural		—			5			5
Real estate – construction		—			—			—
Real estate – mortgage		8			2			2
Consumer		114			225			120
Total recoveries		122			232			127
Net charge-offs		912			5,051			3,397
Provision charged to operations		771			6,690			3,137
Balance at end of period	$	5,577		$	5,718		$	3,819
Ratio of net charge-offs during the period to average loans outstanding during the period		.40	%		2.11	%		1.39	%

Loans are placed on nonaccrual status 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. The majority of the current nonaccrual loans as shown in the chart below are in the process of collection.

Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

	June 30 2010			December 31 2009			June 30 2009
Nonaccrual loans	$	3,094		$	3,819		$	2,707
Restructured loans		—			—			—
Foreclosed properties		6,647			5,632			5,566
Total nonperforming assets	$	9,741		$	9,451		$	8,273
Loans past due 90 days accruing interest	$	—		$	—		$	558
Allowance for loan losses to period end loans		2.46	%		2.44	%		1.61	%
Nonperforming assets to period end loans and foreclosed properties		4.17	%		3.93	%		3.41	%

At June 30, 2010, other potential problem loans total $6.4 million. 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.

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The details of the income statements for the six months ended June 30, 2010 and 2009 are highlighted below.

• Net income in 2010 is $860 thousand compared to the net loss in 2009 of $1.1 million. The greatest factors contributing to this increase are the decrease in interest rates on deposits, an overall decrease in most expense categories and a large decrease in the provision for loan losses.

• At June 30, 2010, total interest and dividend income is down 7.2% compared to June 30, 2009 due to decreased interest rates on a reduced loan portfolio and the replacement of called securities with lower yielding securities.

• At June 30, 2010, interest expense was 18.0% below 2009 expense for the same time period. The decrease in expense is due to the decrease in interest rates including the FHLB advance that was refinanced at the end of the first quarter of 2010.

• Net interest margin at June 30, 2010 is 3.53%, equal to the December 31, 2009 figure of 3.53% and down slightly from the June 30, 2009 figure of 3.55%. During the first six months of 2010, the overall average rate on loans dropped slightly from 5.78% at December 31, 2009 to 5.73% at June 30, 2010. The overall rate on loans at June 30, 2009 was 5.83%. During this same period the overall average rate being paid on deposits decreased to 1.77% from 2.03% at December 31, 2009 and 2.16% at June 30, 2009.

Noninterest income increased 3.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some significant income items are listed here.

• Income from fiduciary activities has increased 20.1% in 2010 over the same period in 2009. Both trust and investment income has increased over 2009. The majority of the increase in trust income was the closing of estates where the fees were greater than the original accruals for the income. When an estate account is established the trust department creates an estimate of expected fee income from the account. A monthly accrual is booked based on the estimate. When the estate closes the income is adjusted for the difference between the estimate and the actual fee earned.

• Gains on the sale of other real estate have increased 294% over the 2009 amount. This increase is due to more properties being sold in 2010. Another factor is the continuing stabilization of the housing market which has slightly increased real estate values, although not to pre-recession levels.

• Visa and MasterCard fees have increased 23.2% over 2009. The increase is still due to the continued popularity of the Smart Checking account which requires twelve debit card transactions each statement cycle to earn the higher interest rate.

• Other income has increased 27.5% over the same period in 2009. The increase is due to increases in a number of other income categories.

• Service charges on deposit accounts have decreased 11.6% in 2010 from 2009. The bulk of this change is decrease in income from overdraft fees and return check charges. It appears that customers are paying more attention to their spending and incurring fewer fees. These fees may decrease even more based on proposed legislation that would affect the amount the bank can charge customers for these fees.

• Fee income on secondary loans has decreased 77.8% as of June 30, 2010 compared to June 30, 2009. Although the housing market is showing some stabilization, it has not resulted in an increase in mortgage activity.

Noninterest expense decreased about 13.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some details are listed below.

• The FDIC assessment has increased 17.1%. This is the result of increases in the calculation of the assessment. The FDIC was forced to increase the assessment to recoup the costs of the many bank failures in the past few years.

• Occupancy expense has increased 22.3 % over 2009. A significant factor in the increase is the depreciation of the costs of the Smith Building addition and second floor renovations, all at the main office. These projects were not complete as of June 30, 2009.

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• Printing, stationery and supplies expense decreased 15%. This is due to management emphasis on cutting costs. There are many more expense categories that have decreased, to a lesser extent, for the same reason. This expense category increased 91.4% in the quarter ended June 30, 2010 over the quarter ended March 31, 2010. The increase is the result of expenses related to notifying customers of the legislation requiring customers to opt in to the overdraft protection feature on deposit accounts.

• ATM and check card expenses have decreased 26.6% in the first six months of 2010 compared to the same time period in 2009. The expense in 2009 included the cost of reissuing quantities of cards that were compromised due to the nationwide “Heartland payment systems” fraud. The expense is down in 2010 based on not having that additional expense.

• Foreclosed property expenses are 59.5% lower as of June 2010 compared to June 2009. The number of new foreclosures has decreased. In addition, the foreclosures have required less expense to prepare them for sale.

• Other noninterest expenses have decreased 9.8% at June 30, 2010 compared to June 30, 2009. There are few significant changes, but slight decreases in many expenses. Most of the decreases are due to the aforementioned management emphasis on controlling costs. The few significant changes are detailed below.

• External audit expense decreased 56.5% in 2010 compared to 2009. The majority of the decrease is due to the cost of an out-sourced loan review in 2009. The review will not be performed in 2010.

• Legal fees have increased 48.5% over the same period in 2009. The increase is due to more legal fees related to foreclosure and bankruptcy proceedings during the first half of 2010 as compared to the same period in 2009.

LIQUIDITY

Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2010.

Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions, such as depreciation expense, that reduce net income but do not require a cash outlay. Through June 30, 2010 net income as adjusted has provided cash of $3.7 million. Interest income earned on loans and investments is the company’s major income source.

Investing Activities. Customer deposits and company borrowings provide the funds used to invest in loans and securities. In addition, the principal portion of loan payments and loan payoffs and funds from maturing investments provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash provided by investing activities through June 30, 2010 is $.5 million.

Financing Activities. Customer deposits and company borrowings provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends, purchase of shares of the company’s common stock for the treasury and repayment of any borrowed or purchased funds. The net amount of cash used in financing activities as of June 30, 2010 is $1.7 million.

Borrowing capabilities provide additional liquidity. The bank has unused credit lines in the approximate amount of $16 million at multiple institutions including the Federal Home Loan Bank of Pittsburgh.

OFF BALANCE SHEET ARRANGEMENTS

No material changes to off balance sheet arrangement have occurred since the filing of the 2009 Form 10-K.

20

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance.

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

ISSUER PURCHASES OF EQUITY SECURITIES

Period	(a) Total Number of Shares Purchased	(b) Average Price Paid Per Share	(c) Total Number of Shares Purchased as Part of Publicly Announced Programs	(d) Maximum Number of Shares that May Yet be Purchased Under the Program
April 1 through April 30	NONE	—	283 553	62 515
May 1 through May 31	NONE	—	283 553	62 515
June 1 through June 30	NONE	—	283 553	62 515

On February 12, 2002, the company’s board of directors originally authorized the repurchase program. The program authorized the repurchase of up to 10% of the company’s stock over the next twelve months. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent. The program has been extended on an annual basis at Potomac’s reorganization meeting.

Item 4. (Removed and Reserved).

Item 5. Other Information

(b) There have been changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors. The details of the change were provided on Form 8-K filing on June 25, 2010. A complete copy of the amended and restated bylaws are included in Exhibit 3.2 in this Form 10-Q.

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Item 6. Exhibits

3.2	Amended and restated bylaws of Potomac Bancshares, Inc.
31.1	Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
31.2	Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
32	Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002)

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	POTOMAC BANCSHARES, INC.
Date: August 16, 2010	/s/ Robert F. Baronner, Jr.
	Robert F. Baronner, Jr.
	President & CEO
Date: August 16, 2010	/s/ Gayle Marshall Johnson
	Gayle Marshall Johnson
	Sr. Vice President and Chief Financial Officer

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EX-3.2

Exhibit 3.2

AMENDED AND RESTATED

BYLAWS

OF

POTOMAC BANCSHARES, INC.

ARTICLE I. OFFICES

The principal offices of the Corporation shall be located in the City of Charles Town, County of Jefferson, State of West Virginia. The Corporation may have such other offices, either within or without the State of West Virginia, as the Board of Directors may designate or as the business of the Corporation may require from time to time.

ARTICLE II. SHAREHOLDERS

1. Annual Meeting. The annual meeting of the shareholders shall be held on the third Tuesday in the month of May of each year, between the hours of 9:30 a.m., and 4:00 p.m., local time, or at such other time on such other day as shall be fixed by the Board of Directors. If the day fixed for the annual meeting shall be a legal holiday in the State of the principal office of the Corporation, such meeting shall be held on the next succeeding business day. At an annual meeting of the shareholders only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (b) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (c) otherwise properly brought before the meeting by a shareholder. For business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a shareholder’s notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than 40 days prior to the meeting; provided, however, that in the event that less than 50 days’ notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by the shareholder to be timely must be so received not later than the close of business on the 8th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A shareholder’s notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation’s books, of the shareholder proposing such business, (c) the class and number of shares of the Corporation which are beneficially owned by the shareholder, and (d) any material interest of the shareholder in such business. Notwithstanding anything in the Bylaws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 1. The Chairman of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section 1, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted.

Section 2. Special Meetings. Special meetings of the shareholders, for any purpose or purposes, may be called by the Chairman of the Board, if any, President, Secretary, or by the Board of Directors, and shall be called by the President at the request of the holders of not less than two-tenths of all outstanding shares of the Corporation entitled to vote at the meeting.

Section 3. Place of Meeting. The Board of Directors may designate any place, either within or without the State of West Virginia, as the place of meeting for any annual meeting or for any special meeting called by the Board of Directors. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the principal office of the Corporation.

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Section 4. Notice of Meeting. Written notice stating the place, day and hour of the meeting and, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than fifty days before the date of the meeting, either personally or by mail, by or at the direction of the Chairman of the Board, President, Secretary or the officer or other persons calling the meeting, to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the stock transfer books of the Corporation, with postage thereon prepaid.

Section 5. Closing of Transfer Books or Fixing of Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the Board of Directors of the Corporation may provide that the stock transfer books shall be closed for a stated period but not to exceed, in any case, fifty (50) days. If the stock transfer books shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such book shall be closed for at least ten (10) days immediately preceding such meeting. In lieu of closing the stock transfer books, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case not to be more than seventy (70) days and, in the case of a meeting of shareholders, not less than ten (10) days prior to the date on which the particular action, requiring such determination of shareholders, is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this section, such determination shall apply to any adjournment thereof.

Section 6. Voting Record. The officer or agent having charge of the stock transfer books for shares of the Corporation shall make a complete record of the shareholders entitled to vote at each meeting of shareholders or any adjournment thereof, arranged in alphabetical order, with the address of and the number of shares held by each. Such record shall be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting for the purposes thereof.

Section 7. Quorum. A majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. If less than a majority of the outstanding shares are represented at a meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally noticed. The shareholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum.

Section 8. Proxies. At all meetings of shareholders, a shareholder may vote in person or by proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact. Such proxy shall be filed with the Secretary of the Corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy.

Section 9. Voting of Shares. Subject to the provisions of Section 12 of this Article II, each outstanding share entitled to vote shall be entitled to one (1) vote upon each matter submitted to a vote at a meeting of shareholders.

Section 10. Voting of Shares by Certain Holders. Shares standing in the name of another corporation may be voted by such officer, agent or proxy as the bylaws of such corporation may prescribe, or, in the absence of such provision, as the Board of Directors of such other corporation may determine.

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Shares held by an administrator, executor, guardian, committee, curator, or conservator may be voted by him, either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a trustee may be voted by him, either in person or by proxy, but no trustee shall be entitled to vote shares held by him without a transfer of such shares into his name.

Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority so to do be contained in an appropriate order of the court by which such receiver was appointed.

A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred.

Neither treasury shares of its own stock held by the Corporation, nor shares held by another corporation if a majority of the shares entitled to vote for the election of directors of such other corporation are held by the Corporation, shall be voted at any meeting or counted in determining the total number of outstanding shares at any given time for purposes of any meeting.

Section 11. Informal Action by Shareholders. Any action required or permitted to be taken at a meeting of the shareholders may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the shareholders entitled to vote with respect to the subject matter thereof.

ARTICLE III. BOARD OF DIRECTORS

Section 1. General Powers. The business and affairs of the Corporation shall be managed by its Board of Directors.

Section 2. Number, election and terms; nominations. The number of the directors of the Corporation shall be fixed from time to time by resolution of the Board of Directors but shall not be less than five nor more than 25. The directors, other than those who may be elected by the holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation, shall be classified, with respect to the time for which they severally hold office, into three classes, as nearly equal in number as possible, as determined by the Board of Directors of the Corporation, one class to be originally elected for a term expiring at the annual meeting of stockholders to be held in 1996, another class to be originally elected for a term expiring at the annual meeting of shareholders to be held in 1997, and another class to be originally elected for a term expiring at the annual meeting of shareholders to be held in 1998, with each class to hold office until its successor is elected and qualified. At each annual meeting of the shareholders of the Corporation, the successors of the class of directors whose term expires at that meeting shall be elected to hold office for a term expiring at the annual meeting of shareholders held in the third year following the year of their election. Directors need not be residents of the State of West Virginia but shall be shareholders of the Corporation. Members of the Board of Directors of the Corporation may serve until they attain the age of 72 years, and thereafter may serve only until the next annual meeting or other meeting in which directors are elected. Nominations for election to the Board of Directors other than those made by or on behalf of the existing management of the Corporation, shall be made by a shareholder in writing delivered or mailed to the President not less than fourteen days nor more than fifty days prior to the meeting called for the election of directors; provided, however, that if less than twenty-one days’ notice of the meeting is given to shareholders, the nominations shall be mailed or delivered to the President not later than the close of business on the seventh day following the day on which the notice of meeting was mailed. The notice of nomination shall include: (a) name and address of proposed nominee(s); (b) principal occupation of nominee(s); (c) total shares to be voted for each nominee; (d) name and address of notifying shareholder; and (e) number of shares owned by notifying shareholder. Nominations not made in accordance with these requirements may be disregarded by the Chairman of the meeting and in such case the votes cast for each such nominee shall likewise be disregarded.

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Section 3. Regular Meetings. A regular meeting of the Board of Directors shall be held without other notice than this bylaw immediately after, and at the same place as, the annual meeting of shareholders. The Board of Directors may provide, by resolution, the time and place, either within or without the State of West Virginia, for the holding of additional regular meetings without other notice than such resolution.

Section 4. Special Meetings. Special meetings of the Board of Directors may be called by or at the request of the Chairman of the Board, if any, the President or any two (2) directors. The person or persons authorized to call special meetings of the Board of Directors may fix any place, either within or without the State of West Virginia, as the place for holding any special meeting of the Board of Directors called by them.

Section 5. Notice. Notice of any special meeting shall be given at least three (3) days previously thereto by written notice delivered personally or mailed to each director at his business address, or by telegram. If mailed at least five (5) days prior to the date of meeting, such notice shall be deemed to be delivered when deposited in the United States mail, so addressed, with postage thereon prepaid. If notice be given by telegram, such notice shall be deemed to be delivered when the telegram is delivered to the telegraph company. Any director may waive notice of any meeting. The attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting, except as otherwise provided by statute.

Section 6. Quorum. A majority of the number of directors fixed by Section 2 of this Article III shall constitute a quorum for the transaction of business at any meeting of the Board of Directors, but if less than such majority is present at a meeting a majority of the directors present may adjourn the meeting from time to time without further notice.

Section 7. Manner of Acting. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors.

Section 8. Action Without a Meeting. Any action required or permitted to be taken by the Board of Directors at a meeting may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the directors.

Section 9. Newly created directorships and vacancies. Newly-created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors resulting from death, resignation, disqualification, removal or other cause shall be filled by the affirmative vote of a majority of the remaining Directors then in office, even though less than a quorum of the Board of Directors. Any director elected in accordance with the preceding sentence to fill a vacancy resulting from the death, resignation, disqualification, removal or other cause shall hold office for the remainder of the full term of the class of directors in which the vacancy occurred and until such director’s successor shall have been elected and qualified, and any director elected in accordance with the preceding sentence by reason of an increase in the number of directors shall hold office only until the next election of directors by shareholders and until his successor shall have been elected and qualified. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director.

Section 10. Compensation. By resolution of the Board of Directors, each director may be paid his expenses, if any, of attendance at each meeting of the Board of Directors, or committee thereof, and may be paid a stated salary as director or a fixed sum for attendance at each meeting of the Board of Directors or committee thereof or both. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor.

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Section 11. Presumption of Assent. A director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the Secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action.

Section 12. Telephone Conference. Members of the Board of Directors or any committee thereof may participate in a meeting of the Board or such committee by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other at the same time and participation by such means shall constitute presence in person at the meeting.

Section 13. Confidentiality. All of the proceedings and business transacted by the Board of Directors of the Corporation shall be confidential, except as among the Directors. Any violation or breach of this confidentiality by any Director shall be grounds for his removal and replacement by a majority vote of the Board of Directors.

Section 14. Conflicts of Interest; Voting. Any Director having a personal interest in any question or issue before the Board of Directors shall advise the Board of his interest, give his personal information on the question or issue, and then withdraw pending a discussion and determination of that question or issue. Otherwise, no Director shall refrain from voting or withdraw while business is pending at any meeting, unless he is excused by a majority vote of Directors in attendance at the meeting. In all matters requiring action by the Board of Directors, a simple majority vote of those present at a meeting shall prevail, unless otherwise required by law.

Section 15. Removal. Any director may be removed from office, with or without cause and only by the affirmative vote of the holders of 80% of the combined voting power of the then outstanding shares of stock entitled to vote generally in the election of directors, voting together as a single class.

ARTICLE IV. OFFICERS

Section 1. Number. The officers of the Corporation shall be a President, one or more Vice Presidents (the number thereof to be determined by the Board of Directors), a Secretary, and a Treasurer, each of whom shall be elected by the Board of Directors. A Chairman of the Board of Directors and such other officers and assistant officers as may be deemed necessary may be elected or appointed by the Board of Directors. Any two or more offices may be held by the same person, except the offices of President and Secretary. The President and the Chairman of the Board, if any, shall be elected from the membership of the Board of Directors.

Section 2. Election and Term of Office. The officers of the Corporation to be elected by the Board of Directors shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of the shareholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as conveniently may be. Each officer shall hold office until his successor shall have been duly elected and shall have qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided.

Section 3. Removal. Any officer or agent may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of an officer or agent shall not of itself create contract rights.

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Section 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the Board of Directors for the unexpired portion of the term.

Section 5. Chairman of the Board and President. The Chairman of the Board or the President, as the Board of Directors may from time to time determine, shall be the principal executive officer of the Corporation. The principal executive officer of the Corporation shall in general supervise and control all of the business and affairs of the Corporation, subject to the control of the Board of Directors. He shall, when present, preside at all meetings of the shareholders. Whether the Chairman of the Board or the President be designated as the principal executive officer of the Corporation the other shall, in the absence or incapacity of the principal executive officer or by his authority may, exercise any of the powers of the principal executive officer. The Chairman of the Board or the President may sign deeds, mortgages, bonds, contracts, or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and executing thereof shall be expressly delegated by the Board or by these bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed. The Chairman of the Board and the President shall each, in general, perform all duties incident to their respective offices and shall perform such other duties as may be prescribed by the Board of Directors from time to time.

Section 6. The Vice Presidents. In the absence of the Chairman of the Board and President or in the event of their death, inability or refusal to act, the Vice President (or in the event there be more than one Vice President, the Vice Presidents in the order designated at the time of their election, or in the absence of any designation, then in the order of their election) shall perform the duties of the Chairman of the Board and President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the Chairman of the Board and President. Any Vice President may sign, with the Secretary or an Assistant Secretary, certificates for shares of the Corporation; and shall perform such other duties as from time to time may be assigned to him by the principal executive officer of the Corporation, the bylaws or the Board of Directors.

Section 7. The Secretary. The Secretary shall: (a) keep the minutes of the proceedings of the shareholders and of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation and see that the seal of the Corporation is affixed to all documents the execution of which on behalf of the Corporation under its seal is duly authorized; (d) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such shareholder; (e) sign with the President, or a Vice President, certificates for shares of the Corporation, the issuance of which shall have been authorized by resolution of the Board of Directors; (f) have general charge of the stock transfer books of the Corporation; and (g) in general perform all duties incident to the office of Secretary and such other duties as from time to time may be assigned to him by the principal executive officer of the Corporation, the bylaws or by the Board of Directors.

Section 8. The Treasurer. The Treasurer shall: (a) have charge and custody of and be responsible for all funds and securities of the Corporation; (b) receive and give receipts for moneys due and payable to the Corporation from any source whatsoever, and deposit all such moneys in the name of the Corporation in such banks, trust companies or other depositaries as shall be selected in accordance with the provisions of Article V of these bylaws; and (c) in general perform all of the duties incident to the office of Treasurer and such other duties as from time to time may be assigned to him by the principal executive officer of the Corporation, the bylaws or by the Board of Directors. If required by the Board of Directors, the Treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the Board of Directors shall determine.

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Section 9. Assistant Secretaries and Assistant Treasurers. The Assistant Secretaries, when authorized by the Board of Directors, may sign with the President or a Vice President certificates for shares of the Corporation the issuance of which shall have been authorized by a resolution of the Board of Directors. The Assistant Treasurers shall respectively, if required by the Board of Directors, give bonds for the faithful discharge of their duties in such sums and with such sureties as the Board of Directors shall determine. The Assistant Secretaries and Assistant Treasurers, in general, shall perform such duties as shall be assigned to them by the Secretary or the Treasurer, respectively, or by the principal executive officer of the Corporation, the bylaws or by the Board of Directors.

Section 10. Officers’ Salaries. The salaries of the officers shall be fixed from time to time by the Board of Directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the Corporation.

ARTICLE V. CONTRACTS, LOANS, CHECKS AND DEPOSITS

Section 1. Contracts. The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances.

Section 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances. The Board of Directors may encumber and mortgage real estate and pledge, encumber and mortgage stocks, bonds and other securities and other personal property of all types, tangible and intangible, and convey any such property in trust to secure the payment of corporate obligations.

Section 3. Checks, Drafts, etc. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors.

Section 4. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositaries as the Board of Directors may select.

ARTICLE VI. CERTIFICATES FOR SHARES AND THEIR TRANSFER

Section 1. Certificates for Shares. Certificates representing shares of the Corporation shall be in such form as shall be determined by the Board of Directors. Such certificates shall be signed by the President or a Vice President and by the Secretary or an Assistant Secretary and sealed with the Corporate Seal or a facsimile thereof. The signatures of such officers upon a certificate may be facsimiles if the certificate is manually signed on behalf of a transfer agent or a registrar, other than the Corporation itself or one of its employees. Each certificate for shares shall be consecutively numbered or otherwise identified. The name and address of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the stock transfer books of the Corporation. All certificates surrendered to the Corporation for transfer shall be cancelled and no new certificate shall be issued until the former certificate for a like number of shares shall have been surrendered and cancelled, except that in case of a lost, destroyed or mutilated certificate a new one may be issued therefor upon such terms and indemnity to the Corporation as the Board of Directors may prescribe.

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Section 2. Transfer of Shares. Transfer of shares of the Corporation shall be made only on the stock transfer books of the Corporation by the holder of record thereof or by his legal representative, who shall furnish proper evidence of authority to transfer, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary of the Corporation, and on surrender for cancellation of the certificate for such shares. The person in whose name shares stand on the books of the Corporation shall be deemed by the Corporation to be the owner thereof for all purposes.

Section 3. Lost Certificates. Any person claiming a certificate of shares to be lost or destroyed shall make an affidavit or affirmation of that fact, and if requested to do so by the Board of Directors of the Corporation shall advertise such fact in such manner as the Board of Directors may require, and shall give the Corporation a bond of indemnity in such sum as the Board of Directors may direct, but not less than double the value of shares represented by such certificate, in form satisfactory to the Board of Directors and with or without sureties as the Board of Directors may prescribe; whereupon the President and the Secretary may cause to be issued a new certificate of the same tenor and for the same number of shares as the one alleged to have been lost or destroyed, but always subject to the approval of the Board of Directors.

Section 4. Stock Transfer Books. The stock transfer books of the Corporation shall be kept in the principal office of the Corporation and shares shall be transferred under such regulations as may be prescribed by the Board of Directors.

ARTICLE VII. FISCAL YEAR

The fiscal year of the Corporation may be fixed and may be changed from time to time by resolution of the Board of Directors. Until the Board of Directors has acted to fix such fiscal year, the fiscal year of the Corporation shall begin on the first day of January and end on the thirty-first day of December in each year.

ARTICLE VIII. DIVIDENDS

The Board of Directors may, from time to time, declare and the Corporation may pay dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and its Articles of Incorporation.

ARTICLE IX. CORPORATE SEAL

The Board of Directors shall provide a corporate seal which shall be circular in form and shall have inscribed thereon the name of the Corporation and the state of incorporation and the words “Corporate Seal”.

ARTICLE X. WAIVER OF NOTICE

Whenever any notice is required to be given to any shareholder or director of the Corporation under the provisions of these bylaws or under the provisions of the Articles of Incorporation or by law, a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice.

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ARTICLE XI. AMENDMENTS

Subject to the provisions of the Articles of Incorporation, these Bylaws may be altered, amended or repealed at any regular meeting of the shareholders (or at any special meeting thereof duly called for that purpose) by a majority vote of the shares represented and entitled to vote at such meeting; provided that in the notice of such meeting notice of such purpose shall be given. Subject to the laws of the State of West Virginia, the Articles of Incorporation and these Bylaws, the Board of Directors may by majority vote of those present at any meeting at which a quorum is present amend these Bylaws, or enact such other bylaws as in their judgment may be advisable for the regulation of the conduct of the affairs of the Corporation; provided, however, that, without the affirmative vote of two-thirds of all members of the Board, the Board may not amend the Bylaws to (i) change the principal office of the Corporation, (ii) change the number of directors, or (iii) make a substantial change in the duties of the Chairman of the Board and the President.

ARTICLE XII. VOTING SHARES OF OTHER CORPORATIONS

Unless otherwise ordered by the Board of Directors, shares in other corporations held by this Corporation may be voted by the Chairman of the Board or the President of this Corporation.

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EX-31.1

Exhibit 31.1

CERTIFICATION UNDER EXCHANGE ACT RULE 13a-14

AND

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Robert F. Baronner, Jr., Chief Executive Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Potomac Bancshares, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting or cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for internal purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 16, 2010	/s/ Robert F. Baronner, Jr.
	Robert F. Baronner, Jr.
	President and CEO

A signed original of this written statement required by Section 302 of the Sarbanes-Oxley Act of 2002 has been provided to Potomac Bancshares, Inc. and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.

EX-31.2

Exhibit 31.2

CERTIFICATION UNDER EXCHANGE ACT RULE 13a-14

AND

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Gayle Marshall Johnson, Chief Financial Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Potomac Bancshares, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting or cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for internal purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 16, 2010	/s/ Gayle Marshall Johnson
	Gayle Marshall Johnson
	Chief Financial Officer

A signed original of this written statement required by Section 302 of the Sarbanes-Oxley Act of 2002 has been provided to Potomac Bancshares, Inc. and will be retained and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32

Exhibit 32

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Potomac Bancshares, Inc. (the “company”) on Form 10-Q for the period ending June 30, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert F. Baronner, Jr., Chief Executive Officer of the company, and I, Gayle Marshall Johnson, Chief Financial Officer of the company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the company.

/s/ Robert F. Baronner, Jr.

Robert F. Baronner, Jr.

Chief Executive Officer

August 16, 2010

/s/ Gayle Marshall Johnson

Gayle Marshall Johnson

Chief Financial Officer

August 16, 2010