POTOMAC BANCSHARES INC
PART II  Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.       The following information reflects comparative per share data for the periods indicated for Potomac common stock for (a) trading values, and (b) dividends. This information has been restated to reflect a 100% stock dividend declared on February 8, 2005. As of March 2, 2006, there were approximately 1,100 shareholders.       Trading of Potomac Bancshares, Inc. common stock is not extensive and cannot be described as a public trading market. Potomac Bancshares, Inc. is on the OTC Bulletin Board Market. To gather information about securities in this market, use the suffix .OB after its symbol. Potomac’s symbol is PTBS.OB. Scott and Stringfellow, Inc., Koonce Securities Inc. and Ferris, Baker Watts, Inc. are market makers for Potomac’s stock. Market makers are firms that maintain a firm bid and ask price for a given number of shares at a given point in time in a given security by standing ready to buy or sell at publicly quoted prices. Information about sales of Potomac’s stock is available on the Internet through many of the stock information services using Potomac’s symbol. Shares of Potomac common stock are occasionally bought and sold by private individuals, firms or corporations, and, in most instances, Potomac does not have knowledge of the purchase price or the terms of the purchase. The trading values for 2004 and 2005 are based on information available through the Internet. No attempt was made by Potomac to verify or determine the accuracy of the representations made to Potomac or gathered on the Internet.            Price Range   Cash Dividends         High   Low   Paid per Share       2004  First Quarter    $  11.88   $  11.28   $  .0700        Second Quarter      12.13      11.23      .0725       Third Quarter      12.63      11.75      .0750       Fourth Quarter      14.00      12.00      .0775         2005  First Quarter   $  21.00   $  13.38   $  .0800       Second Quarter      18.85      15.35      .0825       Third Quarter      18.00      16.10      .0850       Fourth Quarter      17.75      16.60      .0875          The primary source of funds for dividends paid by Potomac is the dividend income received from the bank. The bank's ability to pay dividends is subject to restrictions under federal and state law, and under certain cases, approval by the FDIC and the Commissioner could be required. Management of Potomac anticipates that the dividends paid by Potomac will likely be similar to those paid in the past, but dividends will only be paid when and as declared by the board of directors.  ISSUER PURCHASES OF EQUITY SECURITIES                 (c) Total Number                   of Shares           (a) Total       Purchased as   (d) Maximum Number       Number of   (b) Average   Part of Publicly   of Shares that May       Shares    Price Paid    Announced    Yet be Purchased   Period   Purchased    Per Share   Programs    Under the Program       October 1 through October 31   NONE    --     --    153 122       November 1 through November 30   NONE    --     --    153 122       December 1 through December 31   NONE    --      --   153 122         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 annual basis.  11
2005    2004    2003    2002    2001       (Dollars in Thousands Except Per Share Data)   Summary of Operations                                                    Interest income    $  15 424      $  12 008      $  10 786      $ 11 279      $  10 956          Interest expense       4 135         2 409         2 235         2 823         3 758          Net interest income       11 289         9 599         8 551         8 456         7 198          Provision for loan losses       330         289         147         423         221          Net interest income after provision                                                       for loan losses       10 959         9 310         8 404         8 033         6 977          Noninterest income       3 185         3 158         2 844         2 097         1 358          Noninterest expense       8 460         7 668         7 142         6 263         5 160          Income before income taxes       5 684         4 800         4 106         3 867         3 175          Income tax expense       2 020         1 710         1 432         1 408         1 166              Net income    $  3 664      $  3 090      $  2 674      $  2 459      $  2 009          Per Share Data **                                                    Net income, basic    $  1.08      $  .91      $  .77      $  .69      $  .56          Net income, diluted       1.07         .91         .77         .69         .56          Cash dividends declared       .34         .30         .27         .24         .23          Book value at period end       7.38         6.71         6.27         5.98         5.40          Weighted-average shares outstanding, basic       3 393 122         3 395 464         3 500 140         3 582 054         3 600 000          Weighted-average shares outstanding, diluted       3 409 351         3 397 936         3 500 140         3 582 054         3 600 000          Average Balance Sheet Summary                                                    Assets    $  264 314      $   226 052      $  197 052      $  181 741      $  158 385          Loans       196 478         155 546         125 407         109 461         93 816          Securities       47 183         46 701         47 087         50 454         41 870          Deposits       217 307         190 153         163 328         153 148         135 658          Stockholders’ equity       23 822         22 045         21 274         20 542         18 812          Performance Ratios                                                    Return on average assets       1.39  %      1.37  %      1.36  %       1.35  %      1.27  %       Return on average equity       15.38  %       14.02  %      12.57  %       11.97  %       10.68  %       Dividend payout ratio       31.48  %       32.97  %      35.06  %       34.78  %       41.07  %       Capital Ratios                                                    Leverage ratio       9.18  %      9.45  %      10.20  %      10.77  %       11.30  %        Risk-based capital ratios                                                       Tier 1 capital       12.68  %      13.29  %      14.67  %      18.34  %       19.90  %              Total capital       13.76  %       14.44  %      15.89  %      19.60  %       21.15  %      **       All figures have been restated to reflect a 100% stock dividend declared on February 8, 2005 and a 200% stock dividend declared on February 11, 2003.   12
2005  2004   2003        Average   Income/   Average         Average  Income/   Average        Average   Income/   Average        Balances        Expense       Yield/Rate   Balances         Expense      Yield/Rate    Balances        Expense       Yield/Rate       (in thousands)   (in thousands)   (in thousands)   ASSETS                                                      Loans                                                         Taxable    $  195 357      $  13 635   6.98  %   $   154 486      $  10 283   6.66  %   $  123 701   $  8 745   7.07  %      Tax exempt       1 121          106   9.46  %     1 060        114   10.75  %     1 706       157   9.20  %          Total loans       196 478         13 741   6.99  %     155 546        10 397   6.68  %     125 407      8 902   7.10  %   Taxable securities       45 721         1 516   3.32  %    46 473       1 575   3.39  %    47 087      1 828   3.88  %   Nontaxable securities       1 462         79   5.40  %    228       11   4.82  %    - -      - -    - -      Securities purchased under                                                          agreements to resell and                                                          federal funds sold       1 164         43   3.69  %    3 457       39   1.13  %    4 533      44   .97  %   Other earning assets        3 278         108   3.29  %     1 069        29   2.71  %     2 015       65   3.23  %          Total earning assets       248 103      $  15 487   6.24  %     206 773      $  12 051   5.83  %      179 042   $  10 839   6.05  %       Allowance for loan losses       (2 077  )                (1 842  )               (1 710               Cash and due from banks       7 704                   10 888                 9 789               Premises and equipment, net       5 975                   5 163                 4 868               Other assets      4 609                    5 070                  5 063                      Total assets    $  264 314                  $  226 052                $  197 052                   LIABILITIES AND                                                          STOCKHOLDERS’ EQUITY                                                       Deposits                                                          Savings and interest-                                                              bearing demand deposits    $  119 998      $  1 333   1.11  %   $  104 182      $  442   .42  %   $  92 951   $  462   .50  %      Time deposits       63 661        2 107   3.31  %     55 961        1 649   2.96  %     47 991       1 497   3.12  %          Total interest-                                                                  bearing deposits       183 659         3 440   1.87  %     160 143       2 091   1.31  %     140 942      1 959   1.39  %       Securities sold under agreements                                                          to repurchase and federal                                                          funds purchased       16 557         516   3.12  %    10 777       232   2.15  %    8 549      172   2.01  %   Advances from FHLB        4 937         179   3.63  %     1 584       86   5.43  %      1 878      104   5.54  %          Total interest                                                                  bearing liabilities        205 153      $  4 135   2.02  %     172 504      $  2 409   1.40  %      151 369   $  2 235   1.48  %       Noninterest-bearing demand                                                          deposits       33 648                   30 010                 22 386               Other liabilities       1 691                   1 493                 2 023               Stockholders’ equity        23 822                    22 045                  21 274                      Total liabilities and                                                                  stockholders’ equity    $  264 314                  $  226 052                $  197 052                   Net interest income            $  11 352              $  9 642           $  8 604            Net interest spread                   4.22  %              4.43  %             4.57  %   Interest expense as a                                                          percent of average earning assets               1.67  %              1.16  %             1.25  %           Net interest margin                   4.58  %              4.66  %             4.81  %    13   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS  CRITICAL ACCOUNTING POLICIES  GENERAL       The company’s financial statements are prepared in accordance with U. S. generally accepted accounting principles. 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, U. S. generally accepted accounting principles may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.  ALLOWANCE FOR LOAN LOSSES       The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that estimated losses be accrued when they are probable of occurring and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.       The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. 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.  GENERAL       By viewing the company results of operations and financial position over the past five years as shown in the Selected Consolidated Financial Data schedule, successful accomplishment of a number of the long term goals of management is evident. Management wishes to grow the company by increasing loans and deposits and increasing earnings on a regular basis so that we are providing the best service possible to our customers as well as increasing the value of our shareholders’ investments. Regular earnings increases allow us to build our capital and pay increased dividends to our shareholders. Increasing capital in turn provides the basis for continued expansion of the company and the ability to keep up with the ever changing and improving computer technology. Meeting the constant computer technology challenge is one of the most expensive costs of doing business after costs of real estate and human resources.       The continuing increase of regulation in the banking industry with the associated costs is a concern of management. At least the cost of initial compliance with Sarbanes-Oxley Act of 2002 has been spread out over several years now, with the delay of the bank’s initial implementation date to December 31, 2007. Compliance costs add additional pressure for management to find ways to increase income.       The major source of income for the company is interest income earned on loans and investments that, of course, is dependent on current market conditions, so in addition to increasing income in these areas, management has concentrated on finding additional types of noninterest income. During the past several years the introduction of an overdraft protection plan has provided a generous increase to noninterest income, though in 2005 the income from this product has leveled off. There is some concern that future regulation may diminish earnings on this product, which would have an adverse affect on the earnings of the company.  14        The company has added to tax exempt loan income and the tax exempt income of bank owned life insurance policies by adding municipal securities to the investment portfolio. These items reduce the income tax expense for the company as well as produce income.       The company continues to seek ways to reduce expenses in addition to ways to increase income. Several of the suggestions that were a result of the efficiency consultant studies during 2004 have been put into practice and have either increased income or reduced expenses.   Utilization of personnel to full potential has allowed the company to continue to grow but to maintain a much slower growth in numbers of employees.  Reclassification of deposit balances so that a lower required balance may be kept at the Federal Reserve has allowed the company to invest the relocated funds in income producing loans or to borrow funds at a lower level.  Increases in certain service charges have increased noninterest income.  Outsourcing of official checks has provided time for deposit operations personnel to perform other duties and has provided interest income earned on the outstanding balance of these checks.         The bank has been monitoring it’s efficiency through the calculation of the efficiency ratio each month and that ratio declined throughout 2005.       Management is unaware of any trends, events or uncertainties that would have a material effect on liquidity, capital resources or operations. There are no current recommendations by regulatory authorities that, if they were to be implemented, would have a material effect on the company.       The following table sets forth selected quarterly results (with dollars in thousands) of the company for 2005 and 2004.         2005    2004       Three Months Ended   Three Months Ended       Dec 31     Sept 30    June 30    Mar 31    Dec 31    Sept 30      June 30      Mar 31  Interest income    $  4 247     $  4 053   $  3 716   $  3 408   $  3 287   $  3 096      $  2 890   $  2 735   Interest expense       1 301        1 140     915      779       682      620         571       536   Net interest income        2 946        2 913      2 801      2 629      2 605      2 476         2 319      2 199   Provision for loan losses       19        134      113       64       25       131          98      35   Net interest income after                                                                    provision for loan losses       2 927        2 779      2 688      2 565      2 580      2 345         2 221      2 164  Noninterest income       913        955      913      773      843      832         773      736   Gain (loss) sale of securities, net       (369  )      - -      - -      - -      - -      (28  )       2      - -   Noninterest expense       2 261         2 188       2 041      1 970       2 131       1 969          1 756       1 812   Income before income taxes       1 210        1 546      1 560      1 368      1 292       1 180         1 240      1 088   Income tax expense        411       572       558      479       467       432         433       378       Net income    $  799    $  974   $  1 002   $  889   $  825   $  748      $  807   $  710       Earnings per share, basic    $  .23      $  .29   $  .30   $  .26    $  .24   $  .22      $  .24   $  .21   Earnings per share, diluted    $  .23      $  .29   $  .29   $  .26   $  .24   $  .22      $  .24   $  .21    NET INTEREST INCOME       During 2005, growth in the loan portfolio of 18% and the consistent increase in loan rates have played an important part in the 18% increase in net interest income in 2005 compared to 2004. Income on securities increased slightly in 2005 compared to 2004 and other interest and dividends increased due to interest earned on balances held at Travelers Express for funding of the bank’s official checks. 15        The loan portfolio grew 28% during 2004, but with little increase in rates there was only a 12% increase in net interest income in 2004 compared to 2003. Other factors affecting 2004 net interest income compared to 2003 were a decrease in the income on securities due to decreased rates and only an 8% increase in interest expense even though we had deposit growth as well as some increase in rates on deposits.       Interest expense increased 72% in 2005 compared to 2004 due in large part to increased interest rates. Increased borrowings have also contributed to increased interest expense in 2005 compared to 2004.       During the last quarter of 2005, management has seen some leveling off of loan growth but are hopeful that spring will bring some growth back into the loan market. There has been growth in loans in the Berkeley County offices and a loan production office was opened in Winchester, Virginia in late 2005. Management is optimistic this will help sustain the bank’s loan growth.       By reviewing the volume and rate analysis schedule below, the affects of changes in volumes and rates of the various other assets and liabilities on net interest income can be seen.  VOLUME AND RATE ANALYSIS       This schedule analyzes the change in net interest income attributable to changes in volume of the various portfolios and changes in interest rates. The change due to both rate and volume variances has been allocated between rate and volume based on the percentage relationship of such variances to each other. Income and rates on tax exempt loans and securities are computed on a tax equivalent basis using a federal tax rate of 34%. Nonaccruing loans are included in average loans outstanding.         2005 Compared to 2004     2004 Compared to 2003          (in thousands)         (in thousands)             Change in                  Change in                       Income/   Volume   Rate   Income/   Volume  Rate       Expense    Effect    Effect    Expense   Effect   Effect  INTEREST INCOME                                                        Taxable loans    $  3 352      $  2 837      $  515      $  1 538     $  2 005      $  (467  )        Tax exempt loans     (8  )       8         (16  )       (43  )       (77  )       34           Taxable securities     (59  )       (25  )       (34  )       (253  )       (25  )       (228  )        Nontaxable securities     68         67         1         11         11         - -           Securities purchased under                                                            agreements to resell                                                            and federal funds sold     4         (2  )       6         (5  )       (16  )       11           Other earning assets      79          72          7         (36  )        (27  )        (9  )                       TOTAL    $  3 436      $  2 957      $  479      $  1 212      $  1 871      $  (659  )        INTEREST EXPENSE                                                      Savings and interest-bearing                                                            demand deposits    $  891      $  75      $  816      $  (20  )    $  62      $  (82  )        Time deposits     458         246         212         152         226         (74  )        Securities sold under agreements                                                            to repurchase and federal                                                            funds purchased     284         154         130         60         47         13           Advances from FHLB      93         111         (18  )        (18  )       (16  )        (2  )                       TOTAL    $  1 726      $  586      $  1 140      $  174      $  319      $  (145  )       NET INTEREST INCOME    $  1 710      $  2 371      $  (661  )    $  1 038      $  1 552      $  (514  )    16   NONINTEREST INCOME AND EXPENSE       The major income producer for 2005 noninterest income, as in 2004 and 2003, continues to be the fees generated through the bank’s overdraft protection plan available for customers. These fees are included in the service charges on deposit accounts category which totaled $1.6 million in 2005, $1.5 million in 2004 and $1.2 million in 2003. Trust and financial services is the next largest contributor to the 2005 noninterest income figure with a 19% increase in income compared to 2004. Trust income was boosted in 2005 and 2004 by the accrual of fees for settlement of several large estates. One of these fees was totally accrued in August of 2005 and the second will be totally accrued in March of 2006. There are other estate fees being accrued but these two were significantly larger than most fees the bank has earned. Estate settlement fees are one area of income that is not particularly consistent from year to year. In comparing 2003 trust income with 2004 and 2005, the estate fees were a major difference. The financial services area is also continuing to benefit from the growth of BCT Investments that offers brokerage services in addition to other financial services. The vision for BCT Investments was to reach customers with smaller amounts available for investment than were being handled through the regular trust services. The vision has come to productive fruition in providing a needed customer service as well as providing additional noninterest income.       As the bank customer base continues to expand, the growth has a positive affect on various components of noninterest income in addition to the overdraft protection plan mentioned above. It provides for increases in other service charges such as stop payments, sales of cashiers checks and money orders, wire transfer fees, debit, ATM and charge card transaction fees.       Fees on sales of loans in the secondary market are a source of noninterest income that varies with the market conditions. Our income from this source was $187 thousand in 2005, $157 thousand in 2004 and $360 thousand in 2003.       During the fourth quarter, the company’s net income was negatively affected by the one time sale of approximately $14 million in Federal agency securities that had an average coupon yield of 2.6% . The gross loss on this sale was $369 thousand with an after tax net income affect of $243 thousand. The proceeds of this sale were reinvested in Federal agency securities with an average coupon yield of 4.9% which going forward, will favorably impact income.       Salaries and employee benefits of $4.5 million are about 53% of the total noninterest expense for 2005. This percentage was about the same in 2004. Even though the bank has grown during the past few years, full utilization of personnel has allowed the bank to hold down salaries and benefit costs by holding down the increase in personnel. During 2006 management expects these costs to increase since personnel additions in a number of areas have been made. The finance and audit areas have each added a full time person to handle continuing growth in the bank as well as continuing increase in regulatory requirements. Additional personnel have also been added in the loan area and branch administration area to handle the continuing growth.       Expenses related to premises have increased 8% in 2005 compared to 2004. These costs include new branch facilities, refurbished branch facilities, additional leased facilities, increased utility costs due to increased facilities and increased property taxes due to new facilities.       Other noninterest expense is the total of approximately 60 separate expense accounts. The total for this category increased 15% or $182 thousand in 2005 compared to 2004 and 20% or $207 thousand in 2004 compared to 2003. There is no significant change in any one account for either of these time period comparisons. Most of the increases are due to the growth in the bank’s customer base and growth in facilities.  17   INTEREST RATE SENSITIVITY      The table below shows the opportunities the company will have to reprice interest earning assets and interest-bearing liabilities as of December 31, 2005 (in thousands).         Mature or Reprice            WithinThree Months    After ThreeMonths ButWithinTwelve Months   After OneYear But Within Five Years   AfterFive Years          Nonsensitive  Interest Earning Assets:                                            Loans    $  74 180      $ 15 446      $  58 551   $  62 258   $  - -      Securities       - -         15 435         30 390      1 126      - -      Securities purchased under                                               agreements to resell and                                               federal funds sold       357         - -         - -      - -      - -      Other earning assets       508         - -         - -      - -      - -                Total    $  75 045      $  30 881      $  88 941   $  63 384   $  - -       Interest-Bearing Liabilities:                                             Time deposits                                                $100,000 and over    $  4 828      $  2 435      $  8 909   $  - -   $  - -      Other time deposits       14 999         8 985         28 598      - -      - -      Gold and Platinum accounts                                                (NOW accounts)       57 885         - -         - -       - -     44 256      Savings accounts       - -         - -         - -       - -      26 371      Securities sold under agreements to                                                repurchase and federal funds                                                purchased       19 557         - -         - -       - -      - -      Federal Home Loan Bank                                                advances       - -         - -         1 005      - -      - -                 Total    $  97 269      $  11 420      $  38 512   $  - -   $  70 627     Rate Sensitivity Gap    $  (22 224  )   $  19 461      $  50 429   $  63 384            Cumulative Gap    $  (22 224  )   $  (2 763  )   $ 47 666   $  111 050                 The matching of the maturities or repricing opportunities of interest earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring an institution’s interest rate sensitivity gap. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that period. The interest rate sensitivity gap is the difference between the amount of interest earning assets that will mature or reprice within a specific time period and the amount of interest-bearing liabilities that will mature or reprice within the same time period.       A gap is considered negative when the amount of liabilities maturing or repricing in a specific period exceeds the amount of assets maturing or repricing in the same period. An even match between assets and liabilities in each time frame is the safest position especially in times of rapidly rising or declining rates. During other times, the even match is not as critical. The advantages or disadvantages of positive and negative gaps depend totally on the direction in which interest rates are moving. An asset sensitive institution’s net interest margin and net interest income generally will be impacted favorably by rising interest rates, while that of a liability sensitive institution generally will be impacted favorably by declining interest rates.       During the first twelve months shown in the schedule above, the company is liability sensitive, and after that time period the company is asset sensitive. During January, February and March of 2006, $22 million more liabilities may reprice or will mature than assets. During April through December of 2006, $19 million more assets may reprice or will mature than liabilities. The total effect for 2006 is that $2.7 million more liabilities may reprice or mature than assets. Over the year this is minimal sensitivity in comparison to the total of all assets and liabilities repricing and maturing. During the 2006 time period the company should be only slightly impacted by either rising or falling interest rates.  18   LOAN PORTFOLIO       Loans at December 31 (in thousands) for each of the five years in the period ended 2005.         2005    2004    2003    2002   2001   Commercial, financial and agricultural    $  6 046   $  5 949   $  6 217   $  3 696   $  2 999   Mortgage loans on real estate:                                        Construction and land development       41 174      28 929    14 071    2 211    530          Secured by farm land       2 381      3 986    3 711    1 821    1 801          Secured by 1-4 family residential       98 408      79 800    62 693    63 239    56 283          Secured by multifamily residential       3 486      3 088    1 635    2 623    1 453          Secured by nonfarm nonresidential       43 019      39 671    33 317    23 528    17 822   Consumer loans       15 549      17 346    17 697    19 198    21 214   All other loans       372     236     717     730     288       $  210 435   $  179 005   $  140 058   $  117 046   $  102 390         An experienced and aggressive loan production staff continues to grow the loan portfolio. Loan production for residential mortgages continues to increase the bank’s portfolio of loans secured by 1-4 family residential property. Commercial lending continues to be a prime part of the loan portfolio showing in the construction and land development and nonfarm nonresidential categories. The majority of the loan portfolio is secured by real estate and delinquencies are being kept to a minimum.       There were no categories of loans that exceeded 10% of outstanding loans at December 31, 2005 that were not disclosed in the table above.  REMAINING MATURITIES (in thousands) OF SELECTED LOANS         Commercial,             Financial and  Real Estate-   At December 31, 2005     Agricultural  Construction   Loans maturing within one year       $ 1 419    $  20 859     Variable rate loans due after one year       1 362      16 864     Fixed rate loans due after one year through five years       3 075      3 402     Fixed rate loans due after five years        190        49                 Total maturities      $ 6 046      $ 41 174      ALLOWANCE FOR LOAN LOSSES      The table shown below is an analysis of the company’s allowance for loan losses. Historically, net charge-offs (loans charged off as uncollectible less any amounts recovered on these loans) for the company have been very low when compared with the size of the total loan portfolio. Management continually monitors the loan portfolio with quarterly procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Based on experience, the loan policies and the current monitoring program, management believes the allowance for loan losses is adequate.         2005     2004     2003     2002    2001        (in thousands)         Balance at beginning of period      $ 1 966       $  1 724        $ 1 642      $  1 402      $  1 268      Charge-offs:                                          Commercial, financial and agricultural      30       - -         - -       - -       12           Real estate – construction      - -       - -         - -       - -       - -           Real estate – mortgage      - -       - -         - -       - -       7           Consumer       218         202           191         287         103                  Total charge-offs       248         202            191         287         122      Recoveries:                                          Commercial, financial and agricultural      - -       - -         - -       - -       1           Real estate – construction      - -       - -         - -       - -       - -           Real estate – mortgage      - -       - -         8       1       - -           Consumer        113         155           118        103         34                Total recoveries        113         155           126         104         35      Net charge-offs      135       47         65       183       87      Additions charged to operations        330        289            147         423         221          Balance at end of period      $ 2 161       $  1 966        $ 1 724      $  1 642      $  1 402      Ratio of net charge-offs during the period                                          to average loans outstanding during the period      0.07%      0.03%        0.05%      0.17%      0.09%     19   ALLOCATION OF ALLOWANCE FOR LOAN LOSSES       The following table shows an allocation of the allowance among loan categories based upon analysis of the loan portfolio’s composition, historical loan loss experience, and other factors, and the ratio of the related outstanding loan balances to total loans.         2005    2004      2003      2002    2001       Allowance(inthousands)  % Loans inCategory toTotal Loans  Allowance(inthousands)  % Loans inCategory toTotal Loans  Allowance(inthousands)  % Loans inCategory toTotal Loans  Allowance(inthousands)  % Loans inCategory toTotal Loans  Allowance(inthousands)  % Loans inCategory toTotal Loans     Commercial,                                  financial and                                   agricultural $ 94  2.87 %  $ 81  3.32%   $ 62   4.44 %  $ 37  3.16%   $    15  2.92 %  Mortgage loans on                                  real estate:                                  Construction                                        and land                                        developmen  538  19.57 %   166  16.16%    141   10.05 %   22  1.89%        3  .52 %     Secured by farm                                        land  17  1.13 %   29  2.23%    37   2.65 %   2  1.56%        9  1.76 %     Secured by 1-4                                        family                                        residential  696  46.76 %   458  44.58%    272   44.76 %   293  54.03%     316  54.97 %     Secured by multi-                                        family                                        residential  25  1.66 %   24  1.73%    20   1.17 %   22  2.24%       18  1.42 %     Secured by nonfarm                                      nonresidential  477  20.44 %   341  22.16%    330   23.79 %   298  20.10%     232  17.41 %  Consumer loans  261  7.39 %   591  9.69%    536   12.63 %   424  16.40%     120  20.72 %  All other loans  2  .18 %   3  .13%    6   .51 %   5     .62%         1  .28 %  Unallocated   51  - -     273  - -         320   - -     539  - -              688    - -        $ 2 161  100.00 %   $ 1 966  100.00 %   $ 1 724  100.00 %   $ 1 642  100.00 %    $ 1 402    100.00 %    RISK ELEMENTS IN THE LOAN PORTFOLIO          2005    2004    2003    2002    2001        (in thousands)       Nonaccrual loans    $  122   $  - -   $   251   $  - -   $  9   Restructured loans       - -      - -      - -      - -      - -   Foreclosed properties       - -      - -      - -      - -      - -       Total nonperforming assets    $   122   $  - -   $   251   $  - -   $  9       Loans past due 90 days                                 accruing interest    $   65   $  - -   $   153   $  41   $  29       Allowance for loan losses                                 to period end loans       1.03%      1.10%      1.23%      1.40%      1.37%       Nonperforming assets to                                 period end loans and                                 foreclosed properties       .06%     - -      .18%      - -      .01%         Loans are placed on nonaccrual status when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.       There were no impaired loans at December 31, 2005 and 2004.       At December 31, 2005, other potential problem loans totaled $1.8 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.  20   SECURITIES PORTFOLIO       In accordance with Financial Accounting Standards Board Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the company records securities being held to maturity at amortized cost and securities available for sale at fair value. The effect of unrealized gains and losses, net of tax effects, is recognized in stockholders’ equity.      The schedule below summarizes the book value of the portfolio by maturity classifications and shows the weighted average yield in each group.         2005   Weighted   2004     Weighted    2003   Weighted       Carrying Value    Average  Carrying Value     Average  Carrying Value   Average        (in thousands)     Yield      (in thousands)    Yield       (in thousands)    Yield       Securities held to maturity                                                Obligations of U.S. Government agencies:                                                     Maturing within one year     $  - -   - -     $  - -     - -      $  6 002    5.02%              Maturing after one year but                                                          within five years        - -   - -         - -     - -         - -    - -                          Total securities held to maturity     $  - -        $  - -          $  6 002           Securities available for sale                                               Obligations of U.S. Government agencies:                                                     Maturing within one year     $  15 435    3.82%      $  9 042     4.12%      $  5 132    4.73%              Maturing after one year but                                                           within five years        30 243    4.10%         36 982     3.32%        33 293    3.47%        Municipal obligations:                                                     Maturing within one year        - -    - -         - -      - -         - -    - -              Maturing after on year but                                                           within five years        147    3.75%         529     3.57%         - -    - -              Maturing after five years       1 126    3.87%         786     3.70%         - -    - -                          Total securities available for sale     $  46 951         $  47 339          $  38 425          Total securities     $  46 951          $  47 339          $  44 427       DEPOSITS       Deposit growth of 15% in 2005 and our business sweep accounts were still not able to keep pace with the loan growth during the year. Periodically we have continued to depend on alternative methods of funding. We have seen additional deposit growth through our Berkeley County branch offices and anticipate continued growth in those areas. As of June 2004, the bank had almost 2.5% of the market share of deposits in Berkeley County and as of June 2005, we have approximately 2.9% of that market. Jefferson County deposit market share continues at about 29%.  Schedule of Average Deposits and Average Rates Paid            Year Ended December 31               2005       2004       2003          Average    Average    Average    Average    Average    Average       Balance     Rate    Balance    Rate     Balance    Rate        Noninterest-bearing demand deposits    $  33 648         $  30 010        $  22 386                 Interest-bearing demand deposits     93 563     1.27%        82 426   .46%        71 462      .56%          Savings deposits     26 435     .56%        21 756   .29%       21 489      .30%         Time deposits      63 661     3.31%         55 961   2.96%         47 991      3.12%              Total interest-bearing deposits      183 659     1.87%         160 143   1.31%       140 942      1.39%                            Total deposits    $  217 307         $  190 153       $  163 328         21        At December 31, 2005 time deposits of $100 thousand or more were 7.03% of total deposits compared with 6.58% at December 31, 2005. Maturities of time deposits of $100 thousand or more (in thousands) at December 31, 2005 are as follows:     Within three months   $  736   Over three through six months      1 343   Over six months through twelve months      1 091   Over twelve months      13 002       Total   $  16 172    ANALYSIS OF CAPITAL       The adequacy of the company’s capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the company’s asset and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.       The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The company had a ratio of total capital to risk-weighted assets of 13.76% and a ratio of Tier 1 capital to risk-weighted assets of 12.68 % at December 31, 2005. These two ratios have decreased in large part due to the asset growth during 2005. Even with the reductions in these ratios, both exceed the capital requirements adopted by the federal regulatory agencies.        (In thousands)      2005     2004     2003   Tier 1 capital:                          Common stock   $  3 600     $  1 800     $  1 800       Surplus      2 400        4 200        4 200       Retained earnings      21 158        18 631        16 543         27 158        24 631        22 543       Less cost of shares acquired for the treasury      1 850        1 850        1 709       Total tier 1 capital   $  25 308     $  22 781     $  20 834   Tier 2 capital:                          Allowance for loan losses (1)      2 161        1 966        1 724       Total risk-based capital   $  27 469     $  24 747     $  22 558       Risk-weighted assets   $  199 602     $  171 432     $  141 978       Capital ratios:                          Tier 1 risk-based capital ratio      12.68%          13.29%         14.67%         Total risk-based capital ratio      13.76%          14.44%         15.89%         Leverage ratio        9.18%        9.45%        10.20%         (1) Limited to 1.25% of gross risk-weighted assets.                       22   LIQUIDITY       Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. This could also be termed the management of the cash flows of an organization. Liquid assets include cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s liquidity during 2005 is detailed in the statement of cash flows included in the financial statements.       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 reduces net income but does not require a cash outlay. During 2005 net income as adjusted has provided cash of $4.3 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 investments. In addition, the principal portion of loan payments and payoffs and investment maturities provide cash flow. Purchases of bank premises and equipment are an investing activity. As mentioned in the deposit discussion above, we have taken advantage of our borrowing capabilities for additional funding since deposit growth was not sufficient to cover our needs. The net amount of cash used in investing activities in 2005 is $32.8 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 to shareholders, 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 provided by financing activities in 2005 is $24.8 million.       At December 31, 2005, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $57.7 million.       Borrowing capabilities provide additional liquidity. The subsidiary bank maintains a federal funds line of $7 million with one financial institution and a federal funds line of $4 million with a second financial institution. The subsidiary bank is also a member of the Federal Home Loan Bank of Pittsburgh and has short and/or long-term borrowing capabilities of approximately $102.7 million. In June 2001, the subsidiary bank borrowed $2.5 million amortized over seven years from the Federal Home Loan Bank. The subsidiary bank has a Repo Plus account with the FHLB with a current credit line of $20 million that can be renewed on an annual basis.       Financial Instruments With Off-Balance-Sheet Risk. The company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the company has in particular classes of financial instruments.       The company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.       A summary of the contract or notional amount of the company’s exposure to off-balance-sheet risk as of December 31, 2005 and 2004 is as follows:         2005  2004  Financial instruments whose contract              amounts represent credit risk:                   Commitments to extend credit  $ 63 747  $ 58 477  Standby letters of credit     5 265     2 996   23        Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.      Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers. The majority of these lines of credit is collateralized and usually contains a specified maturity date and may not be drawn upon to the extent to which the company is committed.      Standby letters of credit are conditional commitments issued by the company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The company generally holds collateral supporting those commitments if deemed necessary.      At December 31, 2005, the company had rate lock commitments to originate mortgage loans amounting to $1 million. The company has entered into corresponding mandatory commitments, on a best-efforts basis, to sell these loans. These commitments to sell loans are designed to eliminate the company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.      Short-Term Borrowings. At December 31, 2005, short-term borrowings consist of securities sold under agreements to repurchase that are secured transactions with customers. These borrowings generally mature the day following the day sold. The total of short-term borrowings were $19.6 million on December 31, 2005 and $22.6 million on December 31, 2004. The short-term borrowings at December 31, 2004 included securities sold under agreements to repurchase that were secured transactions with customers, securities sold under agreements to repurchase through the Federal Home Loan Bank and federal funds purchased through The Bankers Bank and Mercantile Safe Deposit and Trust Company.      The table below presents selected information on these short-term borrowings:      December 31     2005    2004  Balance outstanding at year end $  19 557     $ 22 577    Maximum balance at any month-end during the year $ 27 467    $ 22 577    Average balance for the year $ 20 307    $ 10 818    Weighted average rate for the year   3.10%     2.19%    Weighted average rate at year end   3.63%      2.55%   Estimated fair value $ 19 557    $ 22 577          Contractual Obligations. The table below presents the contractual obligations of the company as of December 31, 2005:      Payments (in thousands) Due By Period       Total   Lessthan 1Year   Over 1Yearthrough3 Years   Over 3Yearsthrough5 Years     Long-Term Debt Obligations  $ 1 005   $ 386    $ 619     $ - -
Interest rate risk is monitored through the use of three complimentary modeling tools: static gap analysis, earnings simulation modeling and economic value simulation (net present value estimation). Each of these models measure changes in a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap which measures aggregate repricing values is less utilized since it does not effectively measure the investment options risk impact on the company and is not addressed here. But earnings simulation and economic value models which more effectively measure the cash flow impacts are utilized by management on a regular basis and are explained below.  Earnings Simulation Analysis       Management uses simulation analysis to measure the sensitivity of net income to change in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.       Assumptions used in this model, including loan and deposit growth rates, are derived from seasonal trends, economic forecasts and management’s outlook, as are the assumptions used to project yields and rates for new loans and deposits. Maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of repayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios.       The most likely scenario represents the rate environment as management forecasts it to occur. From this base, rate shocks in 100 basis point increments are applied to see the impact on the company’s earnings. The following table represents the interest rate sensitivity on net income (fully tax equivalent basis) for the company using different rate scenarios as of December 31, 2005:           % Change in   Change in Yield Curve    Net Income   +   200 basis points       +   6.5  %      +   100 basis points       +   3.3  %       Most likely       0       -   100 basis points       -   3.0  %     -   200 basis points       -   6.5  %     Economic Value Simulation       Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation.       The following chart reflects the change in net market value over different rate environments as of December 31, 2005:           Change in Economic Value of Equity   Change in Yield Curve    (dollars in thousands)     +   200 basis points      $  -   4,163       +   100 basis points       -   2,079        Most likely          0      -   100 basis points       +   1,364      -   200 basis points       +   1,994      25
POTOMAC BANCSHARES, INC. AND SUBSIDIARY   CONSOLIDATED BALANCE SHEETS   December 31, 2005 and 2004   (in thousands)              2005    2004                  ASSETS                       Cash and due from banks   $   7 607     $   11 371      Interest-bearing deposits in financial institutions      508         794      Securities purchased under agreements to resell                        and federal funds sold      357         6      Securities available for sale, at fair value      46 951         47 339      Loans held for sale      - -         148      Loans, net of allowance for loan losses of $2,161                        in 2005 and $1,966 in 2004      208 274         177 039      Premises and equipment, net      6 045         5 787      Accrued interest receivable      1 152         913      Other assets      6 433         5 139                         Total Assets   $   277 327      $   248 536                             LIABILITIES AND STOCKHOLDERS’ EQUITY                       LIABILITIES                        Deposits                              Noninterest-bearing   $   32 614      $   34 236                 Interest-bearing      197 266         166 315                     Total Deposits   $ 229 880     $   200 551           Accrued interest payable      331         180           Securities sold under agreements to repurchase and federal                              funds purchased      19 557         17 577           Federal Home Loan Bank advances      1 005         6 370           Other liabilities      1 522         1 102           Commitments and contingent liabilities      - -         - -                     Total Liabilities   $   252 295      $   225 780          STOCKHOLDERS’ EQUITY                        Common stock, $1 per share par value; 5,000,000 shares                              authorized; issued, 2005, 3,600,000 shares; 2004, 1,800,000 shares   $   3 600      $   1 800           Surplus      2 400         4 200           Undivided profits      21 158         18 631           Accumulated other comprehensive (loss)      (276  )       (25  )       $   26 882      $   24 606                     Less cost of shares acquired for the treasury, 2005,                                       206,878 shares; 2004, 103,439 shares       1 850         1 850                     Total Stockholders’ Equity   $   25 032      $   22 756                         Total Liabilities and Stockholders’ Equity   $   277 327      $   248 536              See Notes to Consolidated Financial Statements.                    27     POTOMAC BANCSHARES, INC. AND SUBSIDIARY   CONSOLIDATED STATEMENTS OF INCOME   Years Ended December 31, 2005, 2004 and 2003   (in thousands, except per share data)          2005    2004    2003   Interest and Dividend Income:                            Interest and fees on loans   $   13 705     $   10 358     $   8 848      Interest on securities held to maturity - taxable      - -        35        360      Interest on securities available for sale - taxable      1 516        1 540        1 469      Interest on securities available for sale – nontaxable      52        7        - -      Interest on securities purchased under agreements                              to resell and federal funds sold      43        39        44      Other interest and dividends      108        29        65               Total Interest and Dividend Income   $   15 424     $   12 008     $   10 786       Interest Expense:                           Interest on deposits   $   3 440     $   2 091    $   1 959      Interest on securities sold under agreements to repurchase                              and federal funds purchased      516        232        172      Federal Home Loan Bank advances      179        86        104               Total Interest Expense   $   4 135     $   2 409     $   2 235                   Net Interest Income   $ 11 289     $   9 599     $   8 551       Provision for Loan Losses      330        289       147                   Net Interest Income after Provision                                       for Loan Losses   $ 10 959    $   9 310     $   8 404       Noninterest Income:                           Trust and financial services   $   986     $   826     $   561      Service charges on deposit accounts      1 582        1 512        1 217      Visa/MC Fees      274        180        107      Net gain on sale of loans      187        157        360      Cash surrender value of life insurance      131        141        165      Gain (loss) on sale of securities available for sale      (369  )      (26  )      99      Other operating income      394        368        335               Total Noninterest Income   $   3 185     $   3 158     $   2 844       Noninterest Expenses:                           Salaries and employee benefits   $   4 518     $   4 076     $   3 955      Net occupancy expense of premises      507        399        378      Furniture and equipment expenses      875        881        892      Advertising and marketing      281        222        229      Stationery and supplies      171       156        190      Postage      149        157        132      Communications      153        150        144      Other professional fees      144        203        37      ATM and check card expense      252        196        164      Other operating expenses      1 410        1 228        1 021               Total Noninterest Expenses   $   8 460     $   7 668     $   7 142               Income before Income Tax Expense   $   5 684     $   4 800     $   4 106   Income Tax Expense      2 020        1 710        1 432                   Net Income   $   3 664     $   3 090     $   2 674       Earnings Per Share, basic   $   1.08     $   .91     $   .77   Earnings Per Share, diluted   $   1.07     $   .91     $   .77       See Notes to Consolidated Financial Statements.                         28     POTOMAC BANCSHARES, INC. AND SUBSIDIARY   CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY   Years Ended December 31, 2005, 2004 and 2003   (in thousands, except per share data)                                 Accumulated                                                Other                     Common        Undivided   Treasury  Comprehensive  Comprehensive             Stock   Surplus  Profits  Stock  Income (Loss)   Income  Total  Balances, December 31, 2002   $   600    $  5 400      $  14 801      $   (248  )      $   759             $   21 312            Comprehensive income                                                            Net income – 2003      - -    - -       2 674         - -          - -       $   2 674         2 674            Other comprehensive income:                                                                Unrealized holding (losses)                                                                   arising during the period                                                                   (net of tax, $190)      - -    - -       - -         - -          (370  )       (370  )       (370  )             Reclassification for (gains)                                                                   included in net income                                                                   (net of tax, $34)      - -    - -       - -         - -          (65  )       (65  )       (65  )             Minimum pension liability                                                                   adjustment (net of tax, $89)     - -    - -       - -         - -          174         174         174            Total comprehensive income                                       $   2 413                 Stock split in the form of a                                                             200% stock dividend      1 200    (1 200  )     - -         - -          - -                 - -         Cash dividends – 2003                                                             ($.27 per share)      - -    - -       (932  )       - -          - -                 (932  )       Purchase of treasury shares:                                                             78,999 shares      - -     - -        - -         (1 461  )         - -                 (1 461  )    Balances, December 31, 2003   $   1 800   $  4 200      $  16 543      $   (1 709  )     $   498              $   21 332             Comprehensive income                                                             Net income – 2004      - -    - -       3 090         - -          - -      $   3 090         3 090            Other comprehensive income:                                                                Unrealized holding (losses)                                                                   arising during the period                                                                   (net of tax, $277)      - -    - -       - -         - -          (540  )       (540  )       (540  )             Reclassification for losses                                                                   included in net income                                                                   (net of tax, $9)      - -    - -       - -         - -          17         17         17            Total comprehensive income                                       $   2 567                 Cash dividends – 2004                                                             ($.30 per share)      - -    - -       (1 002  )       - -          - -                 (1 002  )       Purchase of treasury shares:                                                             6,110 shares      - -    - -        - -         (141  )        - -                 (141  )    Balances, December 31, 2004   $   1 800   $  4 200      $  18 631      $   (1 850  )     $   (25  )            $   22 756             Comprehensive income                                                             Net income – 2005      - -    - -       3 664         - -          - -      $   3 664         3 664            Other comprehensive income:                                                                Unrealized holding (losses)                                                                   arising during the period                                                                   (net of tax, $255)      - -    - -       - -         - -          (495  )       (495  )       (495  )             Reclassification for losses                                                                   included in net income                                                                   (net of tax, $125)      - -    - -       - -         - -          244         244         244            Total comprehensive income                                       $   3 413                 Stock split in the form of a                                                             100% stock dividend      1 800    (1 800  )     - -         - -          - -                 - -         Cash dividends – 2005                                                             ($.34 per share)      - -     - -        (1 137  )       - -          - -                 (1 137  )    Balances, December 31, 2005   $   3 600   $  2 400      $  21 158      $   (1 850  )     $   (276  )            $   25 032          See Notes to Consolidated Financial Statements.                             29     POTOMAC BANCSHARES, INC. AND SUBSIDIARY   CONSOLIDATED STATEMENTS OF CASH FLOWS   Years Ended December 31, 2005, 2004 and 2003   (in thousands)          2005   2004    2003   CASH FLOWS FROM OPERATING ACTIVITIES                               Net income   $   3 664      $   3 090      $  2 674           Adjustments to reconcile net income to net cash                                   provided by operating activities:                                        Provision for loan losses      330         289       147                     Depreciation      578         605       623                     Deferred tax expense (benefit)      (41  )       (32  )     20                     Premium amortization on securities, net      69         101       154                     (Gain) loss on sale of securities available for sale      369         26       (99  )                   Proceeds from sale of loans      10 260         8 749       21 104                     Origination of loans for sale      (10 112  )       (8 333  )     (19 745  )                   Changes in assets and liabilities:                                             (Increase) decrease in accrued interest receivable      (239  )       (4  )     156                          (Increase) in other assets      (1 123  )       (444  )     (3 121  )                       Increase (decrease) in accrued interest payable      151         52       (32  )                        Increase in other liabilities      420         89        196                               Net cash provided by operating activities   $   4 326      $   4 188      $  2 077          CASH FLOWS FROM INVESTING ACTIVITIES                              Proceeds from maturity of securities held to maturity   $   - -      $   6 000      $  3 000           Proceeds from maturity of securities available for sale      9 000         2 000       7 000           Proceeds from sale of securities available for sale      13 900         8 974       8 118           Proceeds from call of securities available for sale      - -         5 000       3 000           Purchases of securities available for sale      (23 331  )       (25 805  )     (14 516  )         Net (increase) in loans      (31 565  )       (38 994  )     (23 078  )         Purchases of premises and equipment      (836  )       (1 401  )      (1 158  )                             Net cash (used in) investing activities   $   (32 832  )    $   (44 226  )    $   (17 634  )        CASH FLOWS FROM FINANCING ACTIVITIES                              Net increase (decrease) in noninterest-bearing deposits   $   (1 622  )    $   8 840      $  3 822           Net increase in interest-bearing deposits      30 951         18 455       7 254           Net proceeds in securities sold under agreements to repurchase                                   and federal funds purchased      1 980         8 378       3 097           Net proceeds (repayment) of Federal Home Loan Bank advances      (5 365  )       4 655       (327  )         Purchase of treasury shares      - -         (141  )     (1 461  )         Cash dividends      (1 137  )       (1 002  )      (932  )                             Net cash provided by financing activities   $   24 807      $   39 185      $  11 453                                   (Decrease) in cash and cash equivalents   $   (3 699  )    $   (853  )     (4 104  )        CASH AND CASH EQUIVALENTS                              Beginning      12 171         13 024        17 128           Ending   $   8 472      $   12 171      $  13 024          SUPPLEMENTAL DISCLOSURES OF CASH                              FLOW INFORMATION                                   Cash payments for:                                        Interest   $   3 984      $   2 357      $  2 267                     Income taxes   $   1 519      $   1 677      $  1 209          SUPPLEMENTAL DISCLOSURES OF NON-CASH                              INVESTING AND FINANCING ACTIVITIES                                   Unrealized (loss) on securities available for sale   $   (381  )    $   (791  )    $  (659  )              Minimum pension liability adjustment   $   - -      $   - -      $  (263  )        See Notes to Consolidated Financial Statements.               30   POTOMAC BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   Note 1.      Nature of Banking Activities and Significant Accounting Policies           Potomac Bancshares, Inc. and Subsidiary (the company) grant commercial, financial, agricultural, residential and consumer loans to customers, primarily in Berkeley County and Jefferson County, West Virginia. The company’s market area also includes Washington County and Frederick County, Maryland and Frederick County, Loudoun County and Clarke County, Virginia. The loan portfolio is well diversified and loans generally are collateralized by assets of the customers. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers.           The accounting and reporting policies of the company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a summary of the more significant policies.                  Principles of Consolidation              The consolidated financial statements of Potomac Bancshares, Inc. and its wholly-owned subsidiary, Bank of Charles Town (the bank), include the accounts of both companies. All material intercompany balances and transactions have been eliminated in consolidation.               Interest-bearing Deposits in Financial Institutions            Interest-bearing deposits in financial institutions mature within one year and are carried at cost.                Securities              Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (l) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.                Loans                        The company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is comprised of loans secured by real estate. The ability of the company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions of the company’s market area.Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses. Interest income is accrued on the unpaid principal balance. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.    31      Note 1.      Nature of Banking Activities and Significant Accounting Policies (Continued)            Loans (Continued)                All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.               Allowance for Loan Losses              The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. 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.A loan is considered impaired when, based on current information and events, it is probable that the company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the company does not separately identify individual consumer and residential loans for impairment disclosures.                                         Loans Held for Sale                                    Loans originated and intended for sale in the secondary market are carried at the lower of cost or market determined in the aggregate. The company does not retain mortgage servicing rights on loans held for sale.    32      Note 1.       Nature of Banking Activities and Significant Accounting Policies (Continued)                Rate Lock Commitments                       The company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates.                Premises and Equipment               Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily on the straight-line and declining-balance methods. Estimated useful lives range from five to forty years for premises and improvements and five to twenty-five years for furniture and equipment. Maintenance and repairs of property and equipment are charged to operations and major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts and gain or loss is included in operations.                Other Real Estate               Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of the loan balance or the fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.                Employee Benefit Plans               The company has a noncontributory, defined benefit pension plan covering employees meeting certain age and service requirements. The company computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Board Statement No. 87, “Employers’ Accounting for Pensions.” The company sponsors a postretirement life insurance plan covering retirees with 25 years of service over the age of 60 and a health care plan for all retirees and one current employee that have met certain eligibility requirements. The company computes the net periodic postretirement benefit cost of the plan in accordance with Financial Accounting Standards Board Statement No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.”The company sponsors a 401(k) retirement savings plan available to fulltime employees meeting certain age and service requirements. Under this plan the employer may make a discretionary matching contribution each plan year and may also make other discretionary contributions to the plan.                Stock Splits               On February 8, 2005 the Board of Directors declared a stock split in the form of a 100% stock dividend. Shares increased from 1,800,000 to 3,600,000. On February 11, 2003 the Board of Directors declared a stock split in the form of a 200% stock dividend.     33      Note 1.      Nature of Banking Activities and Significant Accounting Policies (Continued)                Earnings Per Share                        Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the company relate solely to outstanding stock options and are determined using the treasury method. All amounts have been retroactively restated for the stock splits.                Income Taxes             Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary difference between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.                Cash and Cash Equivalents             For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell and federal funds sold. Generally, securities purchased under agreements to resell and federal funds sold are purchased and sold for one-day periods.                Trust Division             Securities and other property held by the Trust Division in a fiduciary or agency capacity are not assets of the company and are not included in the accompanying financial statements.                Use of Estimates             In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate and deferred tax assets.                Advertising             The company follows the policy of charging the costs of advertising to expense as incurred.               Comprehensive Income             Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and minimum pension liability adjustment, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.                Stock-Based Compensation Plan             The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003 which authorized up to 180,000 shares (shares restated to reflect 100% stock dividend declared February 8, 2005) of common stock to be used in the granting of incentive options to employees and directors. This is the first 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.     34      Note 1.      Nature of Banking Activities and Significant Accounting Policies (Continued)                Stock-Based Compensation Plan (Continued)                        The company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under the plan have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.          For the Years Ended      December 31    December 31      2005   2004     (dollars in thousands, except per share amounts)                                        Net income, as reported    $   3 664       $   3 090                                               Total stock-based compensation expense determined                                                           under fair value based method for all awards       (55  )        (32  )                                                   Pro forma net income    $   3 609       $   3 058                                                Earnings per share:                                                                    Basic – as reported    $   1.08       $   .91                                                 Basic – pro forma    $   1.06       $   .90                                                 Diluted – as reported    $   1.07       $   .91                                                 Diluted – pro forma    $   1.06       $   .90                              Reclassifications                       Certain reclassifications have been made to prior period amounts to conform to the current year presentation.             Recent Accounting Pronouncements               In November 2005, FASB Staff Position (FSP) 115-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” was issued. The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. The FSP applies to investments in debt and equity securities and cost-method investments. The application guidance within the FSP includes items to consider in determining whether an investment is impaired, in evaluating if an impairment is other than temporary and recognizing impairment losses equal to the difference between the investment’s cost and its fair value when an impairment is determined. The FSP is required for all reporting periods beginning after December 15, 2005. Earlier application is permitted. The company does not anticipate the amendment will have a material effect on its financial statements.     35      Note 1.      Nature of Banking Activities and Significant Accounting Policies (Continued)                Recent Accounting Pronouncements (Continued)                        In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement No. 154, (“SFAS No. 154”) “Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” The new standard changes the requirements for the accounting for and reporting of a change in accounting principle. Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The company does not anticipate this revision will have a material effect on its financial statements. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (Revised 2004) (SFAS No. 123R) “Share-Based Payment”, which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Share-based compensation arrangements include share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123R requires all share-based payments to employees to be valued using a fair value method on the date of grant and expensed based on that fair value over the applicable vesting period. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows” requiring the benefits of tax deductions in excess of recognized compensation cost be reported as financing instead of operating cash flows. The Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses the SEC’s views regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. Additionally, SAB No. 107 provides guidance related to share-based payment transactions for public companies. The company will be required to apply SFAS No. 123R as of the annual reporting period that begins after September 15, 2005. The company does not anticipate this revision will have a material effect on its financial statements. In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans purchased by the company or acquired in business combinations. SOP 03-3 does not apply to loans originated by the company. The company adopted the provisions of SOP 03-3 effective January 1, 2005. The initial implementation had no material effect on the company’s financial statements.     36      Note 2.       Securities            There were no securities held to maturity as of December 31, 2005 and 2004.The amortized cost and fair value of securities available for sale as of December 31, 2005 and 2004 (in thousands) are as follows:          2005              Gross   Gross           Amortized        Unrealized        Unrealized        Fair      Cost   Gains   (Losses)   Value                               Obligations of U.S. Government agencies     $  45 897       $   6        $   (396  )    $    45 507                           State and municipal obligations      1 473        - -        (29  )      1 444       $  47 370     $   6     $   (425  )    $   46 951          2004             Gross  Gross           Amortized   Unrealized   Unrealized   Fair      Cost   Gains   (Losses)    Value                               Obligations of U.S. Government agencies    $  46 069     $   238     $   (283  )    $   46 024                           State and municipal obligations      1 307        8        - -        1 315       $  47 376    $   246     $   (283  )    $   47 339                       The amortized cost and fair value of the securities available for sale as of December 31, 2005 (in thousands), by contractual maturity, are shown below:          Amortized   Fair       Cost        Value                                 Due in one year or less     $  15 493        $    15 435                               Due after one year through five years                                   30 726          30 390                              Due after five years      1 151       1 126         $  47 370     $    46 951                        Proceeds from sales of securities available for sale were $13.9 million during 2005, $9.0 million during 2004 and $8.0 million during 2003. Gross losses of $369 thousand were realized on sales in 2005. Gross losses of $30 thousand and gross gains of $4 thousand were realized on sales in 2004. Gross losses of $29 thousand and gross gains of $128 thousand were realized on sales in 2003. The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. The primary cause of impairments is the decline in the prices of the bonds as rates have risen. There are approximately 30 accounts in the consolidated portfolio that have losses. These securities have not suffered credit deterioration and the company has the ability and intent to hold these issues to maturity; therefore, the gross unrealized losses are considered temporary as of December 31, 2005. The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of December 31, 2005 and 2004 (in thousands).     37      Note 2.      Securities (Continued)       December 31, 2005      Less than 12 months     More than 12 months    Total               Gross             Gross            Gross               Unrealized             Unrealized            Unrealized       Fair Value      Losses       Fair Value    Losses       Fair Value       Losses                               Obligations of U.S.                                                                                           Government agencies    $  20 278       $  (105  )      $  13 717       $  (291  )      $  33 995       $   (396  )                            State and municipal obligations      1 444         (29  )         - -        - -          1 444         (29  )        $  21 722       $  (134  )      $     13 717      $  (291  )      $  35 439      $   (425  )                   December 31, 2004      Less than 12 months    More than 12 months    Total                Gross           Gross             Gross              Unrealized           Unrealized               Unrealized        Fair Value     Losses     Fair Value    Losses   Fair Value    Losses                           Obligations of U.S.                                                                                         Government agencies    $  28 750       $  (241  )      $  2 470      $  (42  )       $  31 220       $   (283  )           Securities with a carrying value of $41.8 million and $28.2 million at December 31, 2005 and 2004 were pledged to secure public funds and other balances as required by law.        Note 3.      Loans and Related Party TransactionsThe loan portfolio is composed of the following:         December 31      2005   2004      (in thousands)   Mortgage loans on real estate:                       Construction and land development   $  41 174    $  28 929        Secured by farm land    2 381     3 986        Secured by 1-4 family residential    98 408     79 800        Secured by multifamily residential    3 486     3 088        Secured by nonfarm nonresidential    43 019     39 671   Commercial loans (except those secured                  by real estate)    6 046     5 949  Consumer loans    15 549     17 346   All other loans     372      236        Total loans   $  210 435    $  179 005             Less: allowance for loan losses     2 161      1 966      $   208 274    $   177 039                       At December 31, 2005 and 2004, overdraft demand deposits reclassified to loans totaled $129 thousand and $120 thousand, respectively. The Securities and Exchange Commission requires disclosure of loans which exceed $60,000 to executive officers and directors of the company or to their associates. Such loans were made on substantially the same terms as those prevailing for comparable transactions with similar risks. At December 31, 2005 and 2004, these loans totaled $1.6 million and $1.1 million respectively. During 2005, total principal additions were $766 thousand and total principal payments were $257 thousand.     38      Note 4.       Allowance for Loan Losses                      The following is a summary of transactions in the allowance for loan losses for 2005, 2004 and 2003 (in thousands):                                   2005     2004     2003                             Balances at beginning of year   $   1 966      $   1 724      $  1 642                                    Provision charged to operating expense    330        289         147                                   Recoveries added to the allowance     113        155         126                                     Loan losses charged to the allowance     (248  )      (202  )        (191 )                        Balances at end of year   $  2 161      $  1 966      $  1 724                          There were no impaired loans at December 31, 2005 and 2004.         Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2005 totaled $122 thousand. If interest had been accrued, such income would have approximated $3 thousand in 2005. There were no nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2004.      Note 5.       Premises and Equipment, Net                      Premises and equipment consists of the following:                                      December 31                 2005    2004                  (in thousands)                                        Premises and improvements   $ 5 978     $ 5 195                                  Furniture and equipment      5 304     4 503                                  Construction in progress      - -      749               $ 11 282     $ 10 447                                  Less accumulated depreciation      5 237      4 660               $ 6 045     $ 5 787                       Depreciation included in operating expense for 2005, 2004 and 2003 was $578 thousand, $605 thousand and $623 thousand respectively.      Note 6. Deposits        The aggregate amount of time deposits with a balance of $100,000 or more was $16.2 million and $13.2 million at December 31, 2005 and 2004, respectively.         At December 31, 2005, the scheduled maturities of all time deposits (in thousands) are as follows:    2006     $ 16 504     2007      24 543     2008      10 090      2009     12 071     2010       5 546         $ 68 754      39      Note 7.       Borrowings        Short-term borrowings may consist of securities sold under agreements to repurchase and federal funds purchased. At December 31, 2005 short-term borrowings totaled $19.6 million in securities sold under agreements to repurchase through secured transactions with customers.         At December 31, 2004, short-term borrowings totaled $22.6 million which included $11.8 million in securities sold under agreements to repurchase with customers, $5 million through the Repo Plus account at the Federal Home Loan Bank and $5.8 million in federal funds purchased through The Bankers Bank.         In June 2001, the bank incurred fixed rate long term debt consisting of a Federal Home Loan Bank seven year loan with an original balance of $2.5 million and monthly payments of interest and principal with an interest rate of 5.51% . The loan is secured by capital stock, deposits, mortgage collateral and securities collateral of the bank.         Principal payments on the note are due as follows:      2006    $   386     2007      407     2008       212         $   1 005         The balance of this loan at December 31, 2004 was $1,370.       The company has unused lines of credit with the Federal Home Loan Bank and other financial institutions totaling approximately $113.7 million at December 31, 2005.     Note 8.       Employee Benefit Plans        The company sponsors a 401(k) retirement savings plan available to full-time employees meeting certain age and service requirements. Employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. Entry dates are January 1, April 1, July 1 and October 1. Employees can make a salary deferral election authorizing the employer to withhold up to the amount allowed by law each calendar year. The employer may make a discretionary matching contribution each plan year. The employer may also make other discretionary contributions to the plan. The company made 401(k) matching contributions of $50 thousand, $49 thousand and $44 thousand in 2005, 2004 and 2003, respectively.         The company sponsors a noncontributory, defined benefit pension plan covering full-time employees over 21 years of age upon completion of one year of service. Benefits are based on average compensation for the five consecutive full calendar years of service which produces the highest average. The company computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Statement No. 87, “Employers’ Accounting for Pensions.”         The company sponsors a postretirement life insurance plan covering retirees with 25 years of service over the age of 60 and health care plan for all current retirees and one current employee that have met certain eligibility requirements. The plan is contributory for the future retiree, with retiree contributions that are currently set at 20% of the required premium. The company accounts for its share of the costs of those benefits in accordance with Financial Accounting Standards Statement No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” Under that Statement, the company’s share of the estimated costs that will be paid after retirement is generally being accrued by charges to expense over the employees’ active service periods to the dates they are fully eligible for benefits, except that the company’s unfunded cost that existed at January 1, 1995 is being accrued primarily in a straight-line manner that will result in its full accrual by December 31, 2014.    40      Note 8.     Employee Benefit Plans (Continued)                       Information about the plans follows:                                Pension Benefits       Postretirement Benefits         2005           2004     2005       2004         (in thousands)      (in thousands)     Change in Benefit Obligation:                                Benefit obligation, beginning  $  4 923        $  4 070     $ 467    $  441          Service cost    226       238      7      6          Interest cost    314      259      30      29          Change in assumptions    - -      - -       - -      14          Actuarial loss    222      533      39      - -          Benefits paid    (195 )     (177 )       (26 )     (23 )        Benefit obligation, ending  $  5 490     $  4 923     $ 517    $  467         Change in Plan Assets:                                Fair value of plan assets, beginning  $  3 708    $  3 357     $ - -    $  - -          Actual return on plan assets    237      272      - -      - -          Employer contributions    347      256      26      23          Benefits paid     (195 )       (177 )         (26 )     (23 )        Fair value of plan assets, ending  $  4 097    $  3 708     $ - -    $  - -              Funded status  $  (1 393 )    $  (1 215 )    $ (517 )   $  (467 )        Unrecognized net (gain) loss    1 075      803      (27 )     (68 )        Unrecognized net obligation                                        (asset) at transition    - -      (15 )     157      174          Unrecognized prior service cost    - -      - -          - -        - -          Accrued benefit cost included                                             in other liabilities  $  (318 )   $  (427 )    $ (387 )   $  (361 )                        The accumulated benefit obligation for the defined benefit pension plan was $4.3 million and $3.9 million at December 31, 2005 and 2004, respectively.                 Pension Benefits      Postretirement Benefits                     2005    2004       2003       2005      2004    2003                  Components of Net Periodic Benefit Cost:                                        Service cost  $  226     $ 238     $  160       $  7      $  6  $  6        Interest cost    314    259      311       30      29    30         Expected return on plan assets    (314 )   (316 )     (312 )      - -       - -    - -        Amortization of net (gain)    - - -    - -      - -      - -      - -    - -        Amortization of prior service cost    - -    - -       - -       - -      - -      - -        Amortization of net obligation                                               (asset) at transition    (15 )   (20 )      (20 )     17       18    18        Recognized actuarial (gain) loss     27    - -      33       (2 )    (3 )   - -        Net periodic benefit cost  $  238    $ 161    $  172    $  52    $  50  $  54           Weighted-average assumptions used to determine net periodic benefit cost:                        Discount rate  6.50%    6.50%   7.00%      6.50%   6.75%  7.00%        Expected return on plan assets  8.50%    8.50%   8.50%      - -      - -   - -        Rate of compensation increase  4.00%    4.00%   4.00%      3.00%    3.00%  3.00%       Weighted-average assumptions used to determine benefit obligations:                          Discount rate  6.50%    6.50%           6.00%    6.50%            Rate of compensation increase  4.00%    4.00%           3.00%    3.00%       41      Note 8.       Employee Benefit Plans (Continued)         Long-Term Rate of Return               The plan sponsor selects the expected long-term rate-of-return-on-assets assumption in consultation with their investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period, with higher significance placed on current forecasts of future long-term economic conditions.          Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).         Asset Allocation          The pension plan’s weighted-average asset allocations at October 31, 2005 and 2004, by asset category are as follows:             Plan Assets at October 31            2005    2004       Asset Category                                            Equities    61%    56%                                     Fixed income/cash    39%    44%                                             Total    100%    100%                                             The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 60% equities and 40% fixed income/cash. The trust fund allocation is reviewed on a quarterly basis and rebalanced back to the original weighting if the actual weighting varies by at least 5% from the target allocation. The investment manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the plan’s investment strategy. The investment manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.           It is the responsibility of the trustee to administer the investments of the trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the trust.        42     Note 8.       Employee Benefit Plans (Continued)           Cash Flow              The company expects to contribute $295 thousand to its pension plan in 2005 and $26 thousand to its postretirement plan in 2005.         The following benefit payments, which reflect future service, are expected to be paid:             Pension Benefits      Other Benefits                (in thousands)        2006               $      218              $     32   2007            213          34   2008            251          36   2009            260          37   2010            255          39   2011-2015         1 773        200               For measurement purposes, an 8.50% annual rate of increase in per capita health care costs of covered benefits was assumed for 2005 and 2004, and an 8.64% increase was assumed for 2003, with such annual rate of increase gradually declining to 5% in 2013.         Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1% change in assumed health care cost trend rates would have the following effects:           1% Increase    1% Decrease       (in thousands)    Effect on the health care component of the accumulated               postretirement benefit obligation   $     20     $  (17)     Effect on total of service and interest cost components of               net periodic postretirement health care benefit cost      2       (1)       Note 9.       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 earnings per share available to stockholders.                                       December 31, 2005    December 31, 2004    December 31, 2003        Average    Per Share       Average    Per Share        Average    Per Share        Shares     Amount    Shares    Amount    Shares    Amount          Basic earnings per share   3 393 122       $  1.08    3 395 464    $   .91    3 500 140     $   .77          Effect of dilutive securities:                                   Stock options        16 229       2 472           - -                 Diluted earnings per share   3 409 351     $  1.07  3 397 936    $   .91    3 500 140    $   .77                                                 Shares outstanding have been restated to reflect the 100% stock dividend in 2005 and the 200% stock dividend in 2003.     43            Note 10.        Stock-Based Compensation         During 2003, the company adopted an incentive stock plan which allows key employees and directors to increase their personal financial interest in the company. This plan permits the issuance of incentive stock options and non-qualified stock options. The plan authorizes the issuance of up to 180,000 shares (shares restated to reflect the 100% stock dividend declared February 8, 2005) of common stock.               2005        2004               Weighted Average      Weighted Average         Shares     Exercise Price     Shares    Exercise Price           Outstanding at       beginning of year     33       988     $       11.28          -     -    $     -       -     Granted    44       982        14.00      35 988        11.28     Exercised    -       -        -       -      - -          -       -      Forfeited    (4 600  )      12.82       (2 000 )      11.28          Outstanding at       end of year    74 370     $       12.83         33 988    $  11.28          Weighted average       fair value                         of options       granted       $ 2.91               $2.62                                 Shares have been restated to reflect the 100% stock dividend in 2005.         The exercise price of stock options granted under this plan, both incentive and non-qualified, cannot be less than the fair market value of the common stock on the date that the option is granted. The maximum term for an option granted under this plan is ten years and options granted may be subject to a vesting schedule. The non-qualified options granted are exercisable immediately. The incentive options granted are subject to a five year vesting period whereby the grantees are entitled to exercise one fifth of the options on the anniversary of the grant date over the next five years. In determining the pro forma amounts below, the value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants during 2005 and 2004, dividend rates of 3.15% and 3.39%, risk-free interest rates of 4.26% and 4.42%, expected life of 10 years, and expected volatility of 19.46% and 23.47%. The following table summarizes options outstanding at December 31, 2005:             Options Outstanding           Options Exercisable             Weighted                                          Average   Weighted       Weighted            Remaining   Average       Average     Exercise    Number   Contractual   Exercise    Number   Exercise     Price    Outstanding   Life (in years)   Price    Exercisable   Price          $11.28       31 988   8.0   $11.28        19 988   $11.28     14.00       42 382   9.0     14.00       20 462     14.00            74 370             40 450        44            Note 11. Income Taxes       Net deferred tax assets consist of the following components as of December 31, 2005 and 2004:            2005         2004                 (in thousands)            Deferred tax assets:                          Reserve for loan losses       $    580     $  513           Accrued pension expense    89      151           Accrued postretirement benefits    132        123                                        Nonaccrual interest    1       - -          Securities available for sale        142       13            $  944     $  800      Deferred tax liabilities:                   Depreciation       $  123     $  149                        Net deferred tax assets        $  821     $  651                               The provision for income taxes charged to operations for the years ended December 31, 2005, 2004 and 2003 consists of the following:            2005          2004      2003                         (in thousands)                                                                 Current tax expense       $    2 061      $ 1 742      $  1 412     Deferred tax expense (benefit)         (41 )       (32 )                  20           $ 2 020        $  1 710     $ 1 432                                        The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the years ended December 31, 2005, 2004 and 2003 due to the following:             2005          2004      2003                         (in thousands)                                                            Computed “expected” tax expense       $    1 933      $ 1 632      $   1 396         Increase (decrease) in income taxes resulting from:                       Tax exempt interest income        (86  )      (75 )                 (90)         State income taxes, net of federal income tax benefit      173        149        122         Other     - -     4           4      $ 2 020    $ 1 710    $ 1 432                      Note 12.       Commitments and Contingent Liabilities         In the normal course of business, there are outstanding, various commitments and contingent liabilities which are not reflected in the accompanying financial statements. The company does not anticipate losses as a result of these transactions.         See Note 14 with respect to financial instruments with off-balance-sheet risk.         The company has approximately $508 thousand in deposits in other financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2005.          The company must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final bi-weekly reporting periods which included December 31, 2005 and 2004, the aggregate amounts of daily average required balances were approximately $300 thousand and $7.1 million, respectively.     45             Note 13.       Retained Earnings        Transfers of funds from the banking subsidiary to the parent company in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities. As of December 31, 2005, the aggregate amount of unrestricted funds which could be transferred from the banking subsidiary to the parent company, without prior regulatory approval, totaled $4.5 million or 17.9% of the consolidated net assets.        Note 14. Financial Instruments With Off-Balance-Sheet Risk         The company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the company has in particular classes of financial instruments.         The company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.         A summary of the contract or notional amount of the company’s exposure to off-balance-sheet risk as of December 31, 2005 and 2004 (in thousands) is as follows:            2005    2004    Financial instruments whose contract             amounts represent credit risk:                           Commitments to extend credit      $ 63 747    $ 58 477    Standby letters of credit       5 265   2 996                                     Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.                        Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers. The majority of these lines of credit is collateralized and usually contains a specified maturity date and may not be drawn upon to the extent to which the company is committed.          Standby letters of credit are conditional commitments issued by the company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The company generally holds collateral supporting those commitments if deemed necessary.          At December 31, 2005, the company had rate lock commitments to originate mortgage loans amounting to $1 million and no loans held for sale. The company enters into corresponding mandatory commitments, on a best-efforts basis, to sell loans that are held for sale. These commitments to sell loans are designed to eliminate the company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.             46            Note 15.       Fair Value of Financial Instruments and Interest Rate Risk          The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:                                    Cash and Short-Term Investments              For those short-term instruments, the carrying amount is a reasonable estimate of fair value.             Securities               For securities held for investment purposes, fair values are based on quoted market prices or dealer quotes.              Loans                  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.               Loans Held for Sale      The carrying amount of loans held for sale approximates fair value.              Deposit Liabilities     The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.             Short-term Borrowings      The carrying amounts of borrowings under repurchase agreements approximate fair value.             FHLB Advances     The fair values of the company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.              Accrued Interest     The carrying amounts of accrued interest approximate fair value.            Off-Balance Sheet Financial Instruments         The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.           At December 31, 2005 and 2004, the fair value of loan commitments and standby-letters of credit was immaterial.        47            Note 15.       Fair Value of Financial Instruments and Interest Rate Risk (Continued)                      The estimated fair values of the company’s financial instruments are as follows:                            2005       2004             Carrying     Fair    Carrying     Fair          Amount    Value    Amount     Value         (in thousands)     (in thousands)     Financial assets:                          Cash     $  8 115    $   8 115    $  12 165    $   12 165         Securities purchased under                                 agreements to resell and                                federal funds sold    357     357    6     6           Securities available for sale    46 951     46 951    47 339     47 339          Loans, net    208 274     206 838    177 039     176 203          Loans held for sale    - -     - -    148     148          Accrued interest receivable    1 152     1 152    913     913          Financial liabilities:                          Deposits    229 880     229 941    200 551     200 558          Repurchase agreements    19 557     19 557    17 577     17 577          FHLB advances    1 005     1 005    6 370     6 370          Accrued interest payable    331     331    180     180                The company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the company's overall interest rate risk.                     Note 16.       Regulatory Matters          The company (on a consolidated basis) and the bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the company’s and bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the company and bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.         Quantitative measures established by regulation to ensure capital adequacy require the company and the bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005 and 2004, that the company and the bank meet all capital adequacy requirements to which they are subject.                     48             Note 16.       Regulatory Matters (Continued)                      As of December 31, 2005, the most recent notification from the Federal Deposit Insurance Corporation categorized the bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.        The company’s and the bank’s actual capital amounts and ratios are also presented in the table.                                                      Minimum                    To Be Well              Minimum   Capitalized Under              Capital    Prompt Corrective        Actual   Requirement    Action Provisions        Amount    Ratio   Amount    Ratio   Amount    Ratio               (in thousands)         As of December 31, 2005:                             Total capital (to risk-weighted                                       assets):                                             Consolidated     $     27 469   13.76%  $   15 968   8.0%   N/A    N/A                         Bank of Charles Town     $   27 148   13.62%  $   15 946   8.0%    $  19 932   10.0%         Tier 1 capital (to risk-weighted                                     assets):                                            Consolidated     $   25 308   12.68%   $  7 984   4.0%   N/A     N/A                         Bank of Charles Town     $   24 987   12.54%   $   7 973   4.0%   $   11 959   6.0%         Tier 1 capital (to average                                    assets):                                            Consolidated     $   25 308   9.18%   $   11 030   4.0%   N/A    N/A                         Bank of Charles Town     $   24 987   9.07%   $   11 019   4.0%  $   13 773   5.0%              As of December 31, 2004:                            Total capital (to risk-weighted                                    assets):                                            Consolidated     $   24 747   14.44%   $  13 715   8.0%   N/A    N/A                         Bank of Charles Town     $   24 713   14.42%   $   13 712   8.0%   $   17 140   10.0%         Tier 1 capital (to risk-weighted                                    assets):                                            Consolidated     $  22 781   13.29%   $   6 857   4.0%   N/A    N/A                         Bank of Charles Town     $  22 747   13.27%   $   6 856   4.0%   $   10 284   6.0%         Tier 1 capital (to average                                    assets):                                            Consolidated     $   22 781   9.45%   $   9 641   4.0%   N/A    N/A%                         Bank of Charles Town     $   22 747   9.44%   $   9 640   4.0%   $   12 050   5.0%   49            Note 17.       Parent Company Only Financial Statements                         POTOMAC BANCSHARES, INC.(Parent Company Only)Balance SheetsDecember 31, 2005 and 2004                            2005        2004       ASSETS                            Cash      $  40       $    7           Investment in subsidiary      24 711        22 722            Other assets      281        30                                 Total Assets      $  25 032       $  22 759          LIABILITIES AND STOCKHOLDERS’ EQUITY                        LIABILITIES, other      $  - -       $  3           STOCKHOLDERS’ EQUITY                        Common stock      $  3 600       $ 1 800           Surplus        2 400       4 200            Undivided profits        21 158       18 631            Accumulated other comprehensive (loss)        (276 )    (25  )           $ 26 882       $  24 606                           Less cost of shares acquired for the treasury        1 850       1 850                            Total Stockholders’ Equity      $  25 032       $  22 756                                Total Liabilities and Stockholders’ Equity      $ 25 032       $  22 759     POTOMAC BANCSHARES, INC.(Parent Company Only)Statements of IncomeYears Ended December 31, 2005, 2004 and 2003                            2005      2004      2003       Income                           Dividends from subsidiary      $    1 487      $  1 193     $ 2 443           Expenses                          Other professional fees      34      37      19            Other operating expenses      60      54      56                            Total Expenses      $   94     $  91     $ 75                                Income before Income Tax (Benefit) and                                                   Equity in Undistributed Income of                                                    Subsidiary      $  1 393     $  1 102     $  2 368           Income Tax (Benefit)      (31  )    (30  )    (25  )                               Income before Equity in Undistributed                                                   Income of Subsidiary      $  1 424     $  1 132     $ 2 393           Equity in Undistributed Income of Subsidiary      2 240      1 958      281                                Net Income      $  3 664     $  3 090     $ 2 674             50            Note 17.       Parent Company Only Financial Statements (Continued)                      POTOMAC BANCSHARES, INC.(Parent Company Only)Statements of Cash FlowsYears Ended December 31, 2005, 2004 and 2003                            2005      2004          2003        CASH FLOWS FROM OPERATING ACTIVITIES                               Net income      $  3 664      $  3 090      $   2 674           Adjustments to reconcile net income to net cash                         provided by operating activities:                                             Equity in undistributed (income) of                                                      subsidiary      (2 240  )    (1 958  )       (281  )                          (Increase) in other assets      (251  )     (5  )       (11  )                          (Decrease) in other liabilities      (3  )    - -         (2  )                                       Net cash provided by operating                                                              activities     $  1 170     $  1 127     $   2 380            CASH FLOWS FROM FINANCING ACTIVITIES                              Cash dividends      $  (1 137 )    $ (1 002 )    $   (932  )          Purchase of treasury shares      - -      (141  )       (1 461  )                                       Net cash (used in) financing activities      $  (1 137 )    $  (1 143 )    $   (2 393  )                                       Increase (decrease) in cash and cash                         equivalents      $  33     $ (16 )    $   (13  )     CASH AND CASH EQUIVALENTS                              Beginning      7      23         36                 Ending      $  40     $  7     $   23       51
Name    Position Since    Age    Principal Occupation        Robert F. Baronner, Jr.    President & CEO    47    Employed by bank as of 1/1/01 as President and CEO.        2001                 David W. Irvin    Sr. Vice President    42    Employed at bank from 2001 to present as Commercial        2004        Loan Division Manager; former Senior Vice President -                Commercial Lending BB&T 2000-2001.        Gayle Marshall Johnson    Sr. Vice President & Chief    56    Employed with the bank 1977-1985 and 1988-present;           Financial Officer        Vice President and Chief Financial Officer since 1990.        1994        Sr. Vice President since 2005.        Donald S. Smith    Vice President &    77    Employed at bank 1947 to 1991; President 1979 to 1991        Assistant Secretary        (retired).        1994                  The bank has adopted a Code of Ethics that applies to all employees, including Potomac’s and the bank’s chief executive officer and chief financial officer and other senior officers. Additionally, there is a Code of Ethics for Senior Financial Officers which applies to Potomac’s and the bank’s chief executive officer and chief financial officer. These Codes of Ethics are attached to this document as Exhibits 14.1 and 14.2. If we make any substantive amendments to this code or grant any waiver from a provision of the code to our chief executive officer or chief financial officer, we will disclose the amendment or waiver in a report on Form 8-K.  52
Number of securities         Number of securities        remaining available for         to be issued    Weighted-average    future issuance under          upon exercise of    exercise price of    equity compensation plans           outstanding options,    outstanding options,    (excluding securities     Plan category    warrants and rights     warrants and rights        reflected in column (a))          2003 Stock Incentive Plan                 approved by shareholders                 May 13, 2003        74 370          $12.83       105 630
53
(a)        (1)     Financial Statements. Reference is made to Part II, Item 8 of this Annual Report on Form 10-K.         (2)     Financial Statement Schedules. These schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.         (3)   Exhibits. See below.                                       2.1     Agreement and Plan of Merger dated March 8, 1994, by and between Potomac Bancshares, Inc., and Bank of Charles Town filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.                                         3.1     Articles of Incorporation of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.                                       3.2     Amendments to Articles of Incorporation of Potomac Bancshares, Inc. adopted by shareholders on April 25, 1995 and filed with the West Virginia Secretary of State on May 23, 1995, and incorporated by reference from Potomac’s Form 10-KSB for the year ended December 31, 1995 and filed with the Securities and Exchange Commission, File No. 0-24958.                                       3.3     Amended and Restated Bylaws of Potomac Bancshares, Inc. adopted by shareholders April 25, 1995 and incorporated by reference from Potomac’s Form 10-KSB for the year ended December 31, 1995, and filed with the Securities and Exchange Commission, File No. 0-24958.                                       10.1     2003 Stock Incentive Plan adopted by the Potomac Board February 20, 2003 and approved by the Company’s shareholders on May 13, 2003 and incorporated by reference from Potomac’s Form 10-KSB for the year ended December 31, 2003 and filed with the Securities and Exchange Commission, File No. 0-24958.                                       10.2     Employment Agreement of Mr. Robert F. Baronner, Jr., filed with and incorporated by reference from Form 10-KSB for the year ended December 31, 2001, and filed with the Securities and Exchange Commission, File No. 0-24958.                                       14.1     Code of Ethics (for all employees)                                       14.2     Code of Ethics for Senior Financial Officers                                       21      Subsidiaries of the Registrant                                       23.1     Consent of Independent Accountants                                       31.1     Rule 13a-15(e)/15d-15(e) Certification of Chief Executive Officer                                       31.2     Rule 13a-15(e)/15d-15(e) Certification of Chief Financial Officer                                      32.1     Section 1350 Certification of Chief Executive Officer                                       32.2     Section 1350 Certification of Chief Financial Officer                                       99.1     Proxy Statement for the 2006 Annual Meeting for Potomac, portions are incorporated by reference in Form 10-K Annual Report*                                                                   * Filed herewith.     54    SIGNATURES  In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  POTOMAC BANCSHARES, INC.   By   /s/ Robert F. Baronner, Jr.   March 24, 2006   Robert F. Baronner, Jr.       President & Chief Executive Officer                     By  /s/ Gayle Marshall Johnson  March 24, 2006   Gayle Marshall Johnson       Sr. Vice President & Chief Financial Officer      In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.    Signature & Title  Date       By  /s/ J. Scott Boyd   March 24, 2006   J. Scott Boyd, Director               By  /s/ John P. Burns, Jr.  March 24, 2006   John P. Burns, Jr., Director                By  /s/ Guy Gareth Chicchirichi  March 24, 2006   Guy Gareth Chicchirichi, Director                By  /s/ Margaret Cogswell  March 24, 2006   Margaret Cogswell, Director                By  /s/ Thomas C. G. Coyle  March 24, 2006   Thomas C. G. Coyle, Director                By  /s/ William R. Harner  March 24, 2006   William R. Harner, Director and Secretary       55       Signature & Title   Date       By   /s/ E. William Johnson   March 24, 2006   E. William Johnson, Director                By  /s/ Barbara H. Pichot   March 24, 2006   Barbara H. Pichot, Director                By  /s/ John C. Skinner, Jr.  March 24, 2006   John C. Skinner, Jr., Director                By  /s/ Donald S. Smith   March 24, 2006   Donald S. Smith, Director                By  /s/ C. Larry Togans   March 24, 2006   C. Larry Togans, Director       56    Exhibit 14.1  CODE OF ETHICS  The bank’s reputation for honesty and integrity is determined by the personal reputations of our individual staff members. To protect this reputation and to warrant our customers’ trust, each of us must strive to avoid situations that might cause a conflict of interest among the bank, its customers, its suppliers, and ourselves. The following principles have been established as the bank’s code of ethics. Any exceptions to these policies must be approved in writing.  Conflict of Interest  It is the policy of the bank that all staff members conduct their business affairs in such a manner and with such ethics and integrity that no conflict of interest, real or implied, could exist. Complying with Laws, Regulations, Policies and Procedures  All directors, officers and employees of Potomac Bancshares, Inc. are expected to understand, respect, and comply with all of the laws, regulations, policies and procedures that apply to them in their position with Potomac and Bank of Charles Town (collectively, the “company”). Employees are responsible for talking to their manager or compliance officer to determine which laws, regulations, and policies apply to their position and what training is necessary to understand and comply with them.  Extension of Credit to Relatives and Business Associates  No employees shall make or approve loans to any bank, partnership, estate, trust, association, or other entity or person in which the employee has an interest directly or indirectly (whether as a director, officer, shareholder, manager, lender, joint venture, or other otherwise controlling investor), or in which a relative has such an interest or business associate. Any such request for credit extension is to be referred to another bank officer with no connection or affiliation to the potential borrower. All transactions are to be arm’s-length transactions.  Employee Indebtedness  Borrowing by an employee from an individual or business customer of the bank should be avoided (unless the customer is a recognized lending institution). The approval or denial of such a request imposes a wrongful burden on the customer and can impair the judgment of the employee when making business decisions involving the customer.  Executive officers of the bank are reminded of the reporting requirements of Regulation O. If you are unclear about these requirements, please contact the president.  Personal Finances  Because of our position of trust in the community, personal finances should be managed with prudence. Personal financial affairs should be conducted in such a manner as to be above regulatory or auditing criticisms or concerns. Officers should discuss any financial emergency with the president. Employees may discuss any financial emergency with the human resources department.  57    All employees should assume the position of a regular customer when handling their personal bank business. All transactions should be handled in the normal over-the-counter procedure. No employees will be permitted to transact their own or a relative’s bank business. Avoid direct or indirect financial interest with competitors, customers, and suppliers.  Outside Employment  The bank does not wish to control the personal affairs of employees, nor will it attempt to regulate the use of their time outside their employment with us. However, the bank does not look with favor upon a full-time employee working elsewhere if such outside employment in any way affects the individual’s work, fellow employees, or the bank. Of particular concern and requiring the president’s approval are jobs working for a competitor, supplier, or customer. Engaging in self-employment that in any way competes with the bank is prohibited.  Gifts and Fees  Employees and their families (as well as their agents or attorneys) are not to solicit or accept a personal benefit from any customer, vendor, individual, or organization seeking to do business with the bank. A personal benefit is any type of gift, gratuity, loan, fee, compensation, or anything of monetary value. Any deviation from the above must be specifically approved in writing by the president. The bank does recognize that situations may arise when it would be appropriate for a staff member to accept the benefit of a gift. Such situations include:               •   Gifts of nominal value (not in excess of $50.00) given at Christmas or other holidays or special occasions that represent expressions of friendship.                     •   Reasonable entertainment such as luncheon, dinner, or business meetings with present or prospective customers and suppliers, when the return of the expenditure on a comparable basis is likely to occur and is properly chargeable as a business expense.                    •       Gifts or bequests based strictly on a family relationship.    Political Contributions and Activities  Individual participation in political and civic activities is encouraged, including the making of personal contributions to political candidates or activities. The bank, or anyone acting on its behalf, is prohibited from making an expenditure or contribution either directly or indirectly in connection with an election to political office.  Therefore, the bank will not make political contributions to individual candidates or political parties. Employees who wish to donate money or services to a candidate or party may do so as individuals, and not as representatives of the bank. To avoid any interpretation of bank sponsorship or endorsement, neither the bank’s name nor its address should be used. Do not use the bank name in or associated with any political advertisements or literature.  Public Company Reporting  As a public company, it is of critical importance that the public filings with the Securities Exchange Commission be accurate and timely. Depending upon their position with the company, an employee, officer or director may be called upon to provide necessary information to assure that the company’s public reports are complete, fair and understandable. The company expects employees, officers and directors to take this responsibility very seriously and to provide prompt, accurate answers to inquiries related to the company’s public disclosure requirements.  58    Financial Statements and Other Records  All of the company’s books, records, accounts and financial statements (1) must be maintained in reasonable detail, must appropriately reflect the company’s transactions and must conform both to applicable legal requirements and (2) the company’s systems of internal control. Unrecorded or “off the books” funds or assets should not be maintained unless permitted by applicable law or regulation.  Records should always be retained or destroyed according to the company’s record retention policies.  Accounting Complaints  Potomac Bancshares, Inc.’s policy is to comply with all applicable financial reporting and accounting regulations. If any director, officer or employee of the company has unresolved concerns or complaints regarding questionable accounting or auditing matters of the company, then he or she should follow the provisions contained in Potomac’s Whistleblower Policy.  Business Conduct  In the conduct of the bank’s business, no bribe, kickback, or similar remuneration or consideration of any kind is to be given or offered to any individual or organization. The activities of the bank must always be in full compliance with all applicable laws and regulations. The bank expects its staff to comply fully with the letter, spirit, and intent of all laws and regulations.  It is the policy of the bank to comply fully with the anti-bribery provisions. It is a criminal offense for any U.S. enterprise to offer a bribe to an official, political party, party official, or candidate for political office for the purpose of obtaining, retaining, or directing business to any person, regardless of whether that person is the one making the bribe. A bribe may take the form of an offer, payment, promise to pay, or authorization of the payment of any money or anything of value.  Customer Referral  Bank employees may be requested by bank customers and the general public to provide a referral to professional services, such as attorneys, securities brokers, certified public accountants, insurance agents, and real estate agents. Employees shall, when approved by management, recommend several qualified sources from which the customer can select. Bank employees should not make any adverse or negative comments regarding any outside professional. If an employee cannot give a positive recommendation regarding the outside professional, the employee should indicate to the customer that the employee has no recommendation to give regarding the particular professional. If you do make a positive referral, it should be limited to a statement that you have heard good comments regarding the professional but you or the bank cannot make any specific referrals or endorsements. The employee should exercise extreme care not to make any statement that could subject either the employee or the bank, or both, to an action for libel or slander.  In several instances, discussions with customers may lead to a request that the employee give an opinion or statement about the legality of a particular transaction. Employees are not qualified to give legal advice. The bank also does not engage in the business of giving investment or tax advice. These are areas that are best left to the professional in that particular field. Extreme care must be exercised in discussions with customers, and nothing should be said that could be construed as the giving of legal advice or tax advice. Investment advice is only to be given by BCT Investments or the BCT Trust Department.  Employee Purchases Of Bank Stock  In an effort to prevent conflicts of interests only or violations of SEC regulations, purchases or sales of Potomac Bancshares, Inc. stock are to be made through a registered securities broker/dealer. If you have any questions consult your supervisor.  59    Fiduciary Appointment  Without specific approval, employees are not to act as agent or deputy in any signing capacity on any account (except for members of their families) held in the bank. Further, employees may not act as executor, administrator, trustee, guardian, custodian, or in any fiduciary capacity without authority granted by the bank. This would normally be granted only to act for spouse, mother, father, brother, sister, son, daughter, or dependent.  There may be instances whereby a bank employee is requested to accept an appointment as a fiduciary or co-fiduciary (personal representative, trustee, administrator, guardian, executor, or custodian) with the bank, another person, or a firm or corporation. Except where the request is for a member of the immediate family, all employees must obtain prior approval of the bank’s board of directors before acceptance of the positions. Employees are reminded to consult senior management because federal or state regulations govern the acceptance of fees as a fiduciary.  Confidential Information  All of our records are confidential and may not be copied or disclosed without authorization from management. Never discuss customer affairs, accounts, files, or printed material, except on a need-to-know basis with other employees. Confidential information includes all personnel and payroll records, information about our customers, and anything else about the way we operate.On a periodic basis, the bank is examined. The reports that examiners furnish must remain the property of the regulatory agency and are strictly confidential. Information contained in the reports is privileged information and should not be communicated to anyone not officially connected with the bank.  The bank respects the right of employees to privacy in matters that have no relation to their employment. Matters of a personal nature concerning fellow employees should be treated with the utmost confidentiality.  Financial information regarding the bank is not to be released to any person unless it has been published in reports to shareholders or otherwise made available to the public in agreement with applicable disclosure regulations currently in effect. Any questions regarding disclosures of confidential financial information should be reviewed with the president and legal counsel prior to disclosure.  Confidential information obtained as a result of comments made within our bank should not be used for private interests.  Reporting Illegal or Unethical Behavior  If you suspect or know of violations of this Code or illegal or unethical business or workplace conduct by employees, officers or directors, you have an obligation to contact either their supervisor or superiors or the appropriate contact in Potomac or Bank of Charles Town’s department. If the individual to whom such information is conveyed is not responsive, or if there is reason to believe that reporting to such individual is inappropriate in particular cases, then the employee, officer or director may contact the chairman of the Audit Committee.Such communications will be kept confidential to the extent feasible. If concerns or complaints require confidentiality, then this confidentiality will be protected to the extent feasible, subject to applicable law.  Non-Retaliation  The company prohibits retaliation of any kind against individuals who have made good faith reports of complaints or violations of this Code or other known or suspected illegal or unethical conduct.  60    Amendment, Modification and Waiver  This Code may be amended or modified by the Board of Directors of Potomac. Waivers of this Code may only be granted on the recommendation to the Board of Directors or Committee of the board with specific delegated authority. Waivers that will be disclosed to shareholders are required by the Securities Exchange Act of 1934 and the rules thereof.  61        GRAPHIC 2 potomac_10k3x2x1.jpg GRAPHIC  begin 644 potomac_10k3x2x1.jpg M_]C_X``02D9)1@`!`0```0`!``#_VP!#``$!`0$!`0$!`0$!`0$!`0$!`0$! 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Its purpose is to promote honest and ethical conduct and compliance with all applicable laws, rules and regulations, particularly as related to the maintenance of the Company’s financial records and the preparation of financial statements filed with the Securities and Exchange Commission. The provisions of this Code of Ethics for Senior Financial Officers supplement, but do not replace, the Code of Ethics applicable to all employees.               1.           Each Senior       Financial Officer shall carry out his or her responsibilities honestly and       with integrity, maintaining and promoting high standards of ethical       conduct, while exercising at all times their best independent       judgment.                2.             Senior Financial       Officers are responsible for full, fair, accurate, timely and       understandable disclosure in the periodic reports required to be filed by       the Company with the Securities and Exchange Commission. Accordingly, it       is the responsibility of each Senior Financial Officer promptly to bring       to the attention of the Audit Committee any material information of which       he or she may become aware that affects the disclosures made by the       Company in its public filings or otherwise assist the appropriate members       of senior management in fulfilling their responsibilities as specified in       the Company’s policies related to financial reporting and disclosure, and       internal controls.                3.             Each Senior       Financial Officer shall promptly bring to the attention of the Audit       Committee any information he or she may have concerning (a) significant       deficiencies in the design or operation of internal controls which could       adversely affect the Company’s ability to record, process, summarize and       report financial data or (b) any fraud, whether or not material, that       involves senior management or other employees who have a significant role       in the Company’s financial reporting, disclosure or internal       controls.                4.             Each Senior       Financial Officer shall promptly bring to the attention of the Audit       Committee any information he or she may have concerning any actual or       apparent conflicts of interest between personal and professional       relationships, involving senior management or other employees who have a       significant role in the Company’s financial reporting, disclosures or       internal controls.                5.             Each Senior       Financial Officer shall promptly bring to the attention of the Audit       Committee any information he or she may have concerning evidence of a       material violation of the securities or other laws, rules or regulations       applicable to the Company and the operation of its business, by the       company or any agent thereof.                6.             The Board of       Directors shall determine, or designate appropriate persons to determine,       appropriate actions to be taken in the event of violations of this Code of       Ethics for Senior Financial Officers. Such actions shall be reasonably       designed to deter wrongdoing and to promote accountability for adherence       to this Code of Ethics for Senior Financial Officers. 62        EX-21 4 ex21.htm SUBSIDIARIES OF THE REGISTRANT       Exhibit 21  Subsidiaries of the Registrant   Wholly-owned       subsidiary:   Bank of Charles     Town      111 East Washington       Street     PO Box 906      Charles Town WV       25414-0906 63        EX-23.1 5 ex23-1.htm CONSENTS OF EXPERTS AND COUNSEL       Exhibit 23.1  Consent of Independent Registered Public Accounting Firm  We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-113479) and in the related Prospectus, of our report, dated February 3, 2006, relating to the consolidated financial statements of Potomac Bancshares, Inc. included in the Annual Report on Form 10-K for the year ended December 31, 2005.  /s/ Yount, Hyde & Barbour, P.C. Winchester, VirginiaMarch 24, 2006  64        EX-31.1 6 ex31-1.htm RULE 13A-14(A)/15D-14(A) CERTIFICATIONS       Exhibit 31.1  CERTIFICATION UNDER EXCHANGE ACT RULE 13a-15ANDSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002  I, Robert F. Baronner, Jr., Chief Executive Officer, certify that:                    1.     I have reviewed this annual report on Form       10-K 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 annual 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)     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                      c)     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 March 24, 2006   /s/ Robert F. Baronner, Jr.             Robert F. Baronner,       Jr.           Chief Executive       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.  65        EX-31.2 7 ex31-2.htm RULE 13A-14(A)/15D-14(A) CERTIFICATIONS      Exhibit 31.2  CERTIFICATION UNDER EXCHANGE ACT RULE 13A-15ANDSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002  I, Gayle Marshall Johnson, Chief Financial Officer, certify that:               1.     I have reviewed this annual report on Form 10-K 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 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 annual 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)     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                   c)     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 March 24, 2006   /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.  66        EX-32.1 8 ex32-1.htm SECTION 1350 CERTIFICATIONS       Exhibit 32.1  CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002  In connection with the Annual Report of Potomac Bancshares, Inc. (the “company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert F. Baronner, Jr., President and Chief Executive Officer of the company, certify, pursuant to18 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       result of operations of the company.            /s/ Robert F. Baronner, Jr.          Robert F. Baronner,       Jr.      President and Chief       Executive Officer      March 24,       2006     67        EX-32.2 9 ex32-2.htm SECTION 1350 CERTIFICATIONS       Exhibit 32.2  CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002  In connection with the Annual Report of Potomac Bancshares, Inc. (the “company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gayle Marshall Johnson, Vice President and 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       result of operations of the company.            /s/ Gayle Marshall Johnson          Gayle Marshall       Johnson      Sr. Vice President and       Chief Financial Officer      March 24,       2006     68        -----END PRIVACY-ENHANCED MESSAGE-----