U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (Mark One) XX Quarterly report under Section 13 or 15(d) of the Securities - ---- Exchange Act of 1934 For quarterly period ended March 31, 1999 -------------------------- Transition report under Section 13 or 15(d) of the Exchange Act - ---- For the transition period from to Commission file number 0-24958 Potomac Bancshares, Inc. (Exact Name of Small Business Issuer as Specified in Its Charter) West Virginia 55-0732247 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification Number) 111 East Washington Street, Charles Town WV 25414-1071 (Address of Principal Executive Offices) (Zip Code) 304-725-8431 (Issuer's Telephone Number, Including Area Code) NO CHANGE (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes XXX No -------- -------- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes No Not applicable --------- --------- APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 600,000 shares Transitional Small Business Disclosure Format (check one): Yes No XXX --------- ---------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements POTOMAC BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS (000 OMITTED) (Unaudited) March 31 December 31 1999 1998 ---------------- --------------- Assets: Cash and due from banks $ 5 178 $ 4 646 Securities (fair value: March 31, 1999, $50,499; December 31, 1998, $50,530) 50 306 50 208 Securities purchased under agreements to resell and federal funds sold 11 430 13 483 Loans 78 304 77 807 Less reserve for loan losses (1 131) (1 140) ----------- ------------ Net loans 77 173 76 667 Bank premises and equipment, net 1 179 1 224 Accrued interest receivable 1 204 1 168 Other assets 698 708 ----------- ------------ Total Assets $ 147 168 $ 148 104 =========== ============ Liabilities and Stockholders' Equity: Liabilities: Non-interest bearing deposits $ 15 917 $ 17 422 Interest bearing deposits 113 201 113 244 ----------- ------------ Total Deposits 129 118 130 666 Accrued interest payable 330 350 Other liabilities 1 170 892 ----------- ------------ Total Liabilities $ 130 618 $ 131 908 ----------- ------------ Stockholders' Equity: Common stock par value $1.00 per share (5,000,000 shares authorized, 600,000 shares issued and outstanding) $ 600 $ 600 Surplus 5 400 5 400 Accumulated other comprehensive income 31 105 Undivided profits 10 519 10 091 ----------- ------------ Total Stockholders' Equity 16 550 16 196 ----------- ------------ Total Liabilities and Stockholders' Equity $ 147 168 $ 148 104 =========== ============ See Accompanying Notes to Consolidated Financial Statements POTOMAC BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME (000 omitted except for per share data) (Unaudited) For the Three Months Ended March 31 ------------------------------- 1999 1998 -------------- --------------- Interest Income: Interest and fees on loans $ 1 650 $ 1 768 Interest on investment securities Taxable 364 400 Interest and dividends on securities available for sale Taxable 324 186 Dividends 7 6 Interest on securities purchased under agreements to resell and federal funds sold 120 99 ---------- ---------- Total Interest Income $ 2 465 $ 2 459 Interest Expense: Interest on deposits $ 1 074 $ 1 028 Interest on federal funds purchased -- -- ---------- ---------- Total Interest Expense $ 1 074 $ 1 028 ---------- ---------- Net Interest Income $ 1 391 $ 1 431 Provision for Loan Losses -- -- ---------- ---------- Net Interest Income after Provision for Loan Losses $ 1 391 $ 1 431 ---------- ---------- Other Income: Commissions and fees from fiduciary activities $ 193 $ 143 Service charges on deposit accounts 84 93 Fees for other customer services 39 37 Other operating income 60 8 ---------- ---------- Total Other Income $ 376 $ 281 ---------- ---------- Other Expenses: Salaries and employee benefits $ 634 $ 650 Net occupancy expense of premises 48 45 Furniture and equipment expenses 102 84 Other operating expenses 306 240 ---------- ---------- Total Other Expenses $ 1 090 $ 1 019 ---------- ---------- Income before Income Tax Expense $ 677 $ 693 Income Tax Expense 249 258 ---------- ---------- Net Income $ 428 $ 435 ========== ========== Earnings Per Share, basic and diluted $ .71 $ .73 ========== ========== See Accompanying Notes to Consolidated Financial Statements POTOMAC BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998 (000 Omitted) (Unaudited) Accumulated Other Common Capital Undivided Comprehensive Comprehensive Stock Surplus Profits Income Income Total ------- --------- --------- ------------- --------------- ---------- Balances, December 31, 1998 $ 600 $ 5 400 $ 10 091 $ 105 $ 16 196 Comprehensive income Net income -- -- 428 -- $ 428 428 Other comprehensive income net of tax, unrealized holding (losses) arising during the period -- -- -- (74) (74) (74) -------- Comprehensive income $ 354 ======== ------- -------- --------- ------- Balances, March 31, 1999 $ 600 $ 5 400 $ 10 519 $ 31 $ 16 550 ======= ======== ========= ======= ======== Balances, December 31, 1998 $ 600 $ 5 400 $ 9 292 $ 6 $ 15 298 Comprehensive income Net income -- -- 435 -- $ 435 435 Other comprehensive income net of tax, unrealized holding (losses) arising during the period -- -- -- 3 3 3 -------- Comprehensive income $ 438 ======== ------- -------- --------- ------- -------- Balances, March 31, 1999 $ 600 $ 5 400 $ 9 727 $ 9 $ 15 736 ======= ======== ========= ======= ======== See Accompanying Notes to Consolidated Financial Statements POTOMAC BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (000 Omitted) (Unaudited) For the Three Months Ended -------------------------------------- March 31 March 31 1999 1998 -------------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 428 $ 435 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses -- -- Depreciation 62 46 Amortization 9 3 Discount accretion and premium amortization on securities, net 10 1 Gain on sale of real estate (54) -- (Increase) in accrued interest receivable (36) (71) (Increase) decrease in other assets 11 (50) (Decrease) in accrued interest payable (20) (2) Increase in other liabilities 278 232 ----------- --------- Net cash provided by operating activities $ 688 $ 594 ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturity of investment securities $ -- $ 1 000 Proceeds from maturity of securities available for sale 3 000 1 000 Purchase of investment securities -- (6 009) Purchase of securities available for sale (3 221) -- Net (increase) in loans (587) (49) Purchases of bank premises and equipment (17) (45) Proceeds from sale of real estate 163 -- ----------- --------- Net cash (used in) investing activities $ (662) $ (4 103) ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in demand deposits, NOW accounts and savings accounts $ (1 405) $ 4 062 Net increase (decrease) in certificates of deposit (142) 1 265 ----------- --------- Net cash provided by (used in) financing activities $ (1 547) $ 5 327 ----------- --------- Increase (decrease) in cash and cash equivalents $ (1 521) $ 1 818 CASH AND CASH EQUIVALENTS Beginning 18 129 13 118 ----------- --------- Ending $ 16 608 $ 14 936 =========== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest $ 1 095 $ 1 030 =========== ========= Income taxes $ -- $ 7 =========== ========= SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES Other real estate acquired in settlement of loans $ 125 $ -- =========== ========= Loans made on sale of real estate $ 191 $ -- =========== ========= Unrealized gain (loss) on securities available for sale $ (113) $ 5 =========== ========= See Accompanying Notes to Consolidated Financial Statements POTOMAC BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 (UNAUDITED) AND DECEMBER 31, 1998 1. In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of March 31, 1999, and December 31, 1998, and the results of operations and cash flows for the three months ended March 31, 1999 and 1998. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 1998. The results of operations for the three month periods ended March 31, 1999 and 1998, are not necessarily indicative of the results to be expected for the full year. 2. Securities held to maturity as of March 31, 1999 and December 31, 1998 are summarized below: (000 Omitted) March 31, 1999 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ------------- -------------- -------------- Securities held to maturity: U.S. Treasury securities $ 8 013 $ 60 $ -- $ 8 073 Obligations of U.S. Government agencies 17 009 132 -- 17 141 --------- --------- -------- --------- $ 25 022 $ 192 $ -- $ 25 214 ========= ========= ======== ========= (000 Omitted) December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ------------- -------------- -------------- Securities held to maturity: U.S. Treasury securities $ 17 009 $ 229 $ -- $ 17 238 Obligations of U.S. Government agencies 8 021 92 -- 8 113 --------- --------- -------- --------- $ 25 030 $ 321 $ -- $ 25 351 ========= ========= ======== ========= Securities available for sale as of March 31, 1999 and December 31, 1998 are summarized below: (000 Omitted) March 31, 1999 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ------------- -------------- -------------- Securities available for sale: U.S. Treasury securities $ 2 000 $ 26 $ -- $ 2 026 Obligations of U.S. Government agencies 22 788 21 -- 22 809 Federal Home Loan Bank stock 450 -- -- 450 --------- --------- -------- --------- $ 25 238 $ 47 $ -- $ 25 285 ========= ========= ======== ========= (000 Omitted) December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ------------- -------------- -------------- Securities held to maturity: U.S. Treasury securities $ 5 000 $ 43 $ -- $ 5 043 Obligations of U.S. Government agencies 19 570 140 (24) 19 686 Federal Home Loan Bank stock 450 -- -- 450 --------- --------- -------- --------- $ 25 020 $ 183 $ (24) $ 25 179 ========= ========= ======== ========= 3. The consolidated loan portfolio, stated at face amount, is composed of the following: (000 Omitted) March 31 December 31 1998 1998 ----------- --------------- Real estate loans: Construction and land development $ 157 $ 652 Secured by farmland 1 974 1 394 Secured by 1-4 family residential 44 083 42 541 Other real estate loans 12 077 12 624 Loans to farmers (except those secured by real estate) 438 246 Commercial and industrial loans (except those secured by real estate) 2 133 2 188 Loans to individuals for personal expenditures 17 105 17 738 All other loans 337 424 --------- --------- Total loans $ 78 304 $ 77 807 ========= ========= 4. The following is a summary of transactions in the reserve for loan losses: (000 Omitted) March 31 December 31 1999 1998 ----------------- -------------- Balance at beginning of period $ 1 140 $ 1 139 Provision charged to operating expense -- 125 Recoveries added to the reserve 5 43 Loan losses charged to the reserve (14) (167) --------- --------- Balance at end of period $ 1 131 $ 1 140 ========= ========= 5. Information about impaired loans as of March 31, 1999 and December 31, 1998 is as follows: (000 Omitted) ----------------------------------- March 31 December 31 1999 1998 -------------- -------------- Impaired loans for which a reserve has been provided $ 398 $ 398 Impaired loans for which no reserve has been provided -- -- -------- -------- Total impaired loans $ 398 $ 398 ======== ======== Reserve provided for impaired loans, included in the reserve for loan losses $ 199 $ 199 ======== ======== Average balance in impaired loans $ 398 $ 398 ======== ======== Interest income recognized $ 9 $ 34 ======== ======== Nonaccrual loans excluded from impaired loan disclosures under FASB 114 amounted to $-0- at March 31, 1999 and $285,150 at December 31, 1998. If interest on these loans had been accrued, such income would have been $-0- for the first three months of 1999 and $29,267 in 1998. 6. The "Year 200 Problem" exists because computers and computer programs were written using only a two digit field for the year rather than a four digit field. As we move into the Year 2000 and continue to use "00" for the date, many computers, computer programs, and any equipment using date sensitive microchips may not recognize "00" as the Year 2000, but may "think" it is the year 1900. For many businesses and industries, this misconception may cause problems. Hence, the challenge facing the world has been to prepare for the Year 2000 by ensuring that all equipment is appropriately date sensitive to the four digit date 2000 and beyond. The Subsidiary Bank depends heavily on computer processing in connection with its business activities. Failure of its computer systems could have a significant impact on its operations. During 1997 the Subsidiary Bank began preparing to meet the challenge by sending letters to third party vendors and suppliers requesting written documentation regarding their planning, renovation, and testing of computer systems and software and other equipment containing embedded microchips to ensure Year 2000 compliance. Vendors contacted included all parties that supplied service that the Subsidiary Bank believed could be affected by embedded microchips, such as electric, water, computer hardware and software providers. In January 1998, the Subsidiary Bank's Board of Directors approved the appointment of a Year 2000 Committee composed of directors, officers and staff. The Committee has written a Year 2000 Plan that was approved by the Board of Directors which details steps to be taken for Year 2000 compliance. The Plan includes the following phases of procedure: awareness, assessment, renovation, validation and implementation. The awareness phase was educating all personnel within the organization including directors, officers and staff so that everyone understood the definition of the problem. All personnel also needed to understand that the Corporation was seriously undertaking the challenge to complete all the remaining phases of the Plan in a timely manner. The assessment phase included identifying all systems and equipment that would be affected by the problem. The renovation phase included performing repairs, upgrades and/or replacements of all computer systems and equipment containing embedded microchips that were identified in the assessment phase as needing renovation. The validation phase includes testing of all systems and equipment. The implementation phase occurs when all previous phases are complete and all systems have been certified as Year 2000 compliant. The status of these phases as of March 31, 1999 is listed below: Awareness Complete Assessment Complete Renovation Substantially Complete. Remaining renovation includes replacement of optical disk storage system hardware and software, two personal computers, one server and hub. Expected completion June 30, 1999. Validation Progressing on schedule. Remaining validation expected to be substantially complete within guidelines of the Federal Financial Institutions Examination Council (FFIEC), whose completion deadline is June 30, 1999. Implementation Progressing on schedule. As renovation and validation phases progress so does completion of this phase. Expected completion will be within FFIEC guidelines. The Subsidiary Bank does not maintain a formal budget. Therefore, expenses related to the Year 2000 are reviewed and approved by the Board of Directors on an as needed basis. As of March 31, 1999, actual costs were $187,632. Most of the costs were for computers and related equipment. There have also been expenditures for testing of our major software vendors. It is estimated that the total costs for the Year 2000 will not exceed $350,000, assuming that the Subsidiary Bank has identified the most significant Year 2000 issues. These costs do not include the costs of personnel who have performed Year 2000 functions in addition to their regular responsibilities during this time of preparation. The Subsidiary Bank has continued to communicate with third party vendors and suppliers to update documentation from them in regard to their Year 2000 readiness. The majority of these vendors and suppliers have stated that they have successfully completed their renovations and testing. Questionnaires were mailed to significant loan customers (limited to commercial purpose loans) to determine the effectiveness of their Year 2000 preparation including anticipated problems and proposed solutions. Written responses were requested with approximately 69% responding as of mid-March 1999. Response and no response customers are being evaluated (95% evaluated to date) by loan personnel, and additions to the reserve for loan losses will be made if necessary. At this time, the Subsidiary Bank does not expect any of these loan customer Year 2000 situations to have an adverse material impact on Bank operations. The aggregate balances (including available and outstanding amounts on lines of credit) of the loan customers questioned represent approximately 27% of the Bank's total loan portfolio. Questionnaires have been sent to significant deposit customers and responses will be evaluated upon receipt. The aggregate balances of the deposit customers who will be questioned represent 2% of the total deposit portfolio. The Year 2000 Committee has identified customer awareness as an important part of Year 2000 preparation. We have a Customer Awareness Policy and have mailed several communications to customers regarding Year 2000 plans. It is necessary that all customers understand that the Subsidiary Bank's deposits are insured by the Federal Deposit Insurance Corporation. We anticipate more communications with the customers beginning in the near future. The Year 2000 Committee has written a Year 2000 Contingency Plan which has been approved by the Board of Directors. Many issues were discussed during the development and planning for business resumption and remediation contingency plans. Responsibility and reporting structure have been designated. Critical personnel have been designated to be available as needed. Special staffing and hours have been approved as needed. Core business processes were identified. Event timelines were designated including critical testing dates. Numerous failure scenarios were discussed including power outages from complete to localized, telecommunications outages, water outages, various hardware and software failures, and lack of vendor supplies. Considerations were given to the following factors during the planning process: estimated costs, feasibility, functionality, and appropriateness. The most likely worst-case scenario would be a localized disruption or failure of power and/or telecommunications, although the Subsidiary Bank has no reason to conclude that these events will happen. If these events did occur, the Subsidiary Bank would implement its contingency plan. It is important for customers to understand that if a contingency plan is implemented there may be some customer inconvenience since service levels may not be at peak. Finally, we must admit that even after detailed preparation as described above, there are no guarantees that the assumptions, estimates, tests, and validation will be as we expect. The Corporation is still dependent on third party vendors and suppliers for a large part of our business operations. If events are not as the Corporation and our vendors expect, the Subsidiary Bank's business, results of operations and financial position could be materially adversely affected. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Between December 31, 1998 and March 31, 1999, total assets have decreased slightly. The March 31 annualized return on average assets is 1.16% compared to 1.07% at December 31. At March 31 the annualized return on average equity is 10.46% compared to 9.39% at December 31. The leverage capital (equity to assets) ratio is 11.25% at March 31 compared to 11.15% at December 31. The table shown below is an analysis of the Corporation's reserve for loan losses. Net charge-offs for the Corporation have been very low when compared with the size of the total loan portfolio. Management monitors the loan portfolio on a quarterly basis with the procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Based on experience, the loan policies and the current monitoring program, management believes the loan loss reserve is adequate. (000 Omitted) March 31, 1999 -------------- Balance at beginning of period $ 1 140 Charge-offs: Commercial, financial and agricultural -- Real estate - construction -- Real estate - mortgage -- Consumer 14 ------- Total charge-offs 14 Recoveries: Commercial, financial and agricultural -- Real estate - construction -- Real estate - mortgage -- Consumer 5 ------- Total recoveries 5 ------- Net charge-offs 9 Additions charged to operations -- ------- Balance at end of period $ 1 131 ======= Ratio of net charge-offs during the period to average loans outstanding during the period .0115% ======= 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. Following is a table showing the risk elements in the loan portfolio. (000 Omitted) March 31, 1999 Nonaccrual loans $ 144 Restructured loans -- Foreclosed properties 76 ------ Total nonperforming assets $ 220 ====== Loans past due 90 days accruing interest $ 161 ====== Reserve for loan losses to period end loans 1.44% ====== Nonperforming assets to period end loans and foreclosed properties .281% ====== At March 31, 1999, other potential problem loans totalled $24,305. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis. Management has allocated a portion of the reserve for these loans according to the review of the potential loss in each loan situation. Total deposits have decreased $1,500,000 as of March 31, 1999 compared with December 31, 1998. Non-interest bearing demand deposits have decreased about $1,400,000. Balances of other types of accounts have changed some between the account types. The comparison of the income statements for the three months ended March 31, 1999 and 1998 shows a decrease of 2% in net income in 1999. Net interest income decreased 3%, interest income increased less than 1%, and interest expense increased 5%. The increase in interest expense as of March 31, 1999 compared with March 31, 1998, is due to the increase in deposits overall of which a significant portion went to Select Checking as well as the movement of funds into Select Checking from existing deposit accounts paying a lower interest rate. Noninterest income increased 34% as of March 31, 1999 compared to March 31, 1998. There was an increase in income from fiduciary activities and a gain on sale of foreclosed real estate. Noninterest expense increased almost 7%. This included an increase in furniture and equipment expenses due to replacement of equipment for Year 2000 compliance as well as a combination of increases and decreases in numerous other operating expenses. Two particular operating expenses with changes are the legal and professional fees increase compared to 1998 because of a reimbursement received in 1998 for legal expenses on a foreclosure that actually reduced 1998 expenses and the increase in West Virginia business franchise tax because of a change in the taxing of financial institutions. Liquid assets of the Corporation include cash and due from banks, securities purchased under agreements to resell, securities available for sale, and loans and investments maturing within one year. The Corporation's statement of cash flows details this liquidity. Net income after certain adjustments for noncash transactions provided cash from operating activities. Funds from maturity of investment securities were used to fund investing activities. Financing activities used funds total deposits decreased. Cash and cash equivalents decreased during this period, but liquidity of the Corporation is more than adequate to meet present and future financial obligations. PART II. OTHER INFORMATION Item 1. Legal Proceedings. There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the Company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: 2. Plan of acquisition, reorganization, arrangement, liquidation or succession. Not applicable 4. Instruments defining the rights of security holders, including indentures. Not applicable 10. Material contracts. Not applicable 11. Statement re: computation of per share earnings. Not applicable 15. Letter on unaudited interim financial information. Not applicable 18. Letter on change in accounting principles. Not applicable 19. Reports furnished to security holders. Not applicable 22. Published report regarding matters submitted to vote of security holders. Not applicable 23. Consent of experts and counsel. Not applicable 24. Power of attorney. Not applicable 27. Financial Data Schedule. 99. Additional exhibits. Not applicable (b) Reports on Form 8-K: NONE SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. POTOMAC BANCSHARES, INC. Date May 11, 1999 /s/ Charles W. LeMaster ________________ ____________________________________ Charles W. LeMaster, President & CEO Date May 11, 1999 /s/ L. Gayle Marshall Johnson ________________ ____________________________________ L. Gayle Marshall Johnson, Vice President and Chief Financial Officer