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POTOMAC BANCSHARES INC - Quarter Report: 2006 June (Form 10-Q)

Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q

 


 

(Mark one)

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

 

For the quarterly period ended June 30, 2006

 

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

 

For the transition period from              to             

 

Commission File Number 0-24958

 


 

POTOMAC BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 


 

West Virginia   55-0732247

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

111 East Washington Street    
PO Box 906, Charles Town WV   25414-0906
(Address of Principal Executive Offices)   (Zip Code)

 

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

 


 

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

 

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

 

Large Accelerated Filer  ¨    Accelerated Filer  ¨    Non-Accelerated Filer  x

 

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

 

APPLICABLE ONLY TO CORPORATE REGISTRANTS

 

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

 

3,454,250 as of August 4, 2006

 



Table of Contents

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

FORM 10-Q

June 30, 2006

 

INDEX

 

          PAGE

PART I.

  

FINANCIAL INFORMATION

    

Item 1.

  

Financial Statements.

    
    

Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005 (Audited)

   3
    

Consolidated Statements of Income (Unaudited) for the Three Months Ended June 30, 2006 and 2005 and for the Six Months Ended June 30, 2006 and 2005

   4
    

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Six Months Ended June 30, 2006 and 2005

   5
    

Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2006 and 2005

   6
    

Notes to Consolidated Financial Statements June 30, 2006 (Unaudited) and December 31, 2005 (Audited)

   7 - 11

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

   11 - 15

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk.

   15

Item 4.

  

Controls and Procedures.

   15

Part II.

  

OTHER INFORMATION

    

Item 1.

  

Legal Proceedings.

   15

Item 1A.

  

Risk Factors.

   15

Item 2.

  

Unregistered Sale of Equity Securities and Use of Proceeds.

   16

Item 4.

  

Submission of Matters to a Vote of Security Holders.

   16

Item 5.

  

Other Information.

   17

Item 6.

  

Exhibits.

   17

Signatures

   18

 

FORWARD-LOOKING STATEMENTS

 

The Private Securities Litigation Reform Act of 1995 evidences Congress’ determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. “Forward-looking statements” are easily identified by the use of words such “could,” “anticipate,” “estimate,” “believe,” and similar words that refer to a future outlook. To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the company’s forward-looking statements.

 

The risks and uncertainties that may affect the operations, performance, development and results of the company’s business include, but are not limited to, the growth of the economy, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, Congressional legislation and similar matters. We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by the named risk factors and unanticipated future events. Actual results, accordingly, may differ materially from management expectations.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     (Unaudited)
June 30
2006


    December 31
2005


 

Assets:

                

Cash and due from banks

   $ 5 973     $ 7 607  

Interest-bearing deposits in financial institutions

     461       508  

Securities purchased under agreements to resell and federal funds sold

     292       357  

Securities available for sale, at fair value

     50 446       46 951  

Loans held for sale

     689       —    

Loans, net of allowance for loan losses of $2,221 and $2,161 respectively

     220 217       208 274  

Bank premises and equipment, net

     6 536       6 045  

Accrued interest receivable

     1 241       1 152  

Other assets

     6 735       6 433  
    


 


Total Assets

   $ 292 590     $ 277 327  
    


 


Liabilities and Stockholders’ Equity:

                

Liabilities:

                

Deposits

                

Noninterest-bearing deposits

   $ 33 564     $ 32 614  

Interest-bearing deposits

     212 500       197 266  
    


 


Total Deposits

     246 064       229 880  

Accrued interest payable

     400       331  

Securities sold under agreements to repurchase and federal funds purchased

     11 890       19 557  

Federal Home Loan Bank advances

     6 815       1 005  

Other liabilities

     970       1 522  

Commitments and contingent liabilities

     —         —    
    


 


Total Liabilities

   $ 266 139     $ 252 295  
    


 


Stockholders’ Equity:

                

Common stock, $1 per share par value; 5,000,000 shares authorized; issued, 2006, 3,671,691 shares; 2005, 3,600,000 shares

   $ 3 672     $ 3 600  

Surplus

     3 634       2 400  

Undivided profits

     21 430       21 158  

Accumulated other comprehensive (loss), net

     (435 )     (276 )
    


 


     $ 28 301     $ 26 882  

Less cost of shares acquired for the treasury, 2006, 211,015 shares; 2005, 206,878 shares

     1 850       1 850  
    


 


Total Stockholders’ Equity

   $ 26 451     $ 25 032  
    


 


Total Liabilities and Stockholders’ Equity

   $ 292 590     $ 277 327  
    


 


 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(in thousands except per share data)

(Unaudited)

 

     For the Three Months
Ended June 30


   For the Six Months
Ended June 30


     2006

   2005

   2006

   2005

Interest and Dividend Income:

                           

Interest and fees on loans

   $ 4 131    $ 3 311    $ 7 979    $ 6 325

Interest on securities available for sale - taxable

     533      366      1 017      735

Interest on securities available for sale – nontaxable

     13      13      26      26

Interest on securities purchased under agreements to resell and federal funds sold

     26      2      33      5

Other interest and dividends

     53      24      88      33
    

  

  

  

Total Interest and Dividend Income

   $ 4 756    $ 3 716    $ 9 143    $ 7 124
    

  

  

  

Interest Expense:

                           

Interest on deposits

   $ 1 460    $ 757    $ 2 677    $ 1 366

Interest on securities sold under agreements to repurchase and federal funds purchased

     135      108      293      207

Federal Home Loan Bank advances

     16      50      59      121
    

  

  

  

Total Interest Expense

   $ 1 611    $ 915    $ 3 029    $ 1 694
    

  

  

  

Net Interest Income

   $ 3 145    $ 2 801    $ 6 114    $ 5 430

Provision for Loan Losses

     75      113      75      177
    

  

  

  

Net Interest Income after Provision for Loan Losses

   $ 3 070    $ 2 688    $ 6 039    $ 5 253
    

  

  

  

Noninterest Income:

                           

Trust and financial services

   $ 356    $ 250    $ 594    $ 474

Service charges on deposit accounts

     444      409      838      752

BCT Visa/MC Fees

     90      66      169      123

Other operating income

     181      188      316      337
    

  

  

  

Total Noninterest Income

   $ 1 071    $ 913      1 917    $ 1 686
    

  

  

  

Noninterest Expenses:

                           

Salaries and employee benefits

   $ 1 300    $ 1 056    $ 2 630    $ 2 110

Net occupancy expense of premises

     129      111      273      224

Furniture and equipment expenses

     223      241      433      466

Advertising and marketing

     79      72      151      118

Auditing and accounting expense

     19      62      56      106

ATM and check card expenses

     82      63      152      118

Other operating expenses

     503      436      983      869
    

  

  

  

Total Noninterest Expenses

   $ 2 335    $ 2 041    $ 4 678    $ 4 011
    

  

  

  

Income before Income Tax Expense

   $ 1 806    $ 1 560    $ 3 278    $ 2 928

Income Tax Expense

     620      558      1 154      1 037
    

  

  

  

Net Income

   $ 1 186    $ 1 002    $ 2 124    $ 1 891
    

  

  

  

Earnings Per Share, basic

   $ .34    $ .30    $ .61    $ .56
    

  

  

  

Earnings Per Share, diluted

   $ .34    $ .29    $ .61    $ .55
    

  

  

  

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005

(in thousands)

(Unaudited)

 

     Common
Stock


   Surplus

    Undivided
Profits


    Treasury
Stock


    Accumulated
Other
Comprehensive
(Loss)


    Comprehensive
Income


    Total

 

Balances, December 31, 2004

   $ 1 800    $ 4 200     $ 18 631     $ (1 850 )   $ (25 )           $ 22 756  

Comprehensive income

                                                       

Net income

     —        —         1 891       —         —       $ 1 891       1 891  

Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $144)

     —        —         —         —         (280 )     (280 )     (280 )
                                           


       

Total comprehensive income

                                          $ 1 611          
                                           


       

Cash dividends ($.17 per share)

     —        —         (551 )     —         —                 (551 )

Stock split in the form of a 100% stock dividend

     1 800      (1 800 )     —         —         —                 —    
    

  


 


 


 


         


Balances, June 30, 2005

   $ 3 600    $ 2 400     $ 19 971     $ (1 850 )   $ (305 )           $ 23 816  
    

  


 


 


 


         


Balances, December 31, 2005

   $ 3 600    $ 2 400     $ 21 158     $ (1 850 )   $ (276 )           $ 25 032  

Comprehensive income

                                                       

Net income

     —        —         2 124       —         —       $ 2 124       2 124  

Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $82)

     —        —         —         —         (159 )     (159 )     (159 )
                                           


       

Total comprehensive income

                                          $ 1 965          
                                           


       

2% stock dividend

     72      1 149       (1 221 )     —         —                 —    

Stock compensation expense

     —        85       —         —         —                 85  

Cash dividends ($.18 per share)

     —        —         (631 )     —         —                 (631 )
    

  


 


 


 


         


Balances, June 30, 2006

   $ 3 672    $ 3 634     $ 21 430     $ (1 850 )   $ (435 )           $ 26 451  
    

  


 


 


 


         


 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     For the Six Months Ended

 
    

June

2006


   

June

2005


 

CASH FLOWS FROM OPERATING ACTIVITIES

                

Net income

   $ 2 124     $ 1 891  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Provision for loan losses

     75       177  

Depreciation

     280       319  

Discount accretion and premium amortization on securities, net

     (53 )     46  

Stock compensation expense

     85       —    

Proceeds from sale of loans

     3 840       3 928  

Origination of loans for sale

     (4 529 )     (4 899 )

Changes in assets and liabilities:

                

(Increase) in accrued interest receivable

     (89 )     (72 )

(Increase) in other assets

     (220 )     (1 322 )

Increase in accrued interest payable

     69       63  

(Decrease) in other liabilities

     (552 )     (86 )
    


 


Net cash provided by operating activities

   $ 1 030     $ 45  
    


 


CASH FLOWS FROM INVESTING ACTIVITIES

                

Proceeds from maturity of securities available for sale

   $ 5 500     $ 4 000  

Proceeds from sale of securities available for sale

     —         300  

Purchase of securities available for sale

     (9 183 )     (4 470 )

Net (increase) in loans

     (12 018 )     (20 489 )

Purchases of bank premises and equipment

     (771 )     (559 )
    


 


Net cash (used in) investing activities

   $ (16 472 )   $ (21 218 )
    


 


CASH FLOWS FROM FINANCING ACTIVITIES

                

Net increase in noninterest-bearing deposits

   $ 950     $ 3 506  

Net increase in interest-bearing deposits

     15 234       8 691  

Net (repayment) of securities sold under agreements to repurchase and federal funds sold

     (7 667 )     (2 535 )

Net proceeds of Federal Home Loan Bank advances

     5 810       5 170  

Cash dividends

     (631 )     (551 )
    


 


Net cash provided by financing activities

   $ 13 696     $ 14 281  
    


 


Decrease in cash and cash equivalents

   $ (1 746 )   $ (6 892 )

CASH AND CASH EQUIVALENTS

                

Beginning

     8 472       12 171  
    


 


Ending

   $ 6 726     $ 5 279  
    


 


SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

                

Cash payments for:

                

Interest

   $ 2 960     $ 1 630  
    


 


Income taxes

   $ 1 522     $ 854  
    


 


SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

                

Unrealized (loss) on securities available for sale

   $ (241 )   $ (424 )
    


 


 

See Notes to Consolidated Financial Statements.

 

6


Table of Contents

POTOMAC BANCSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005

 

1. In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of June 30, 2006, and December 31, 2005, the results of operations for the three months and six months ended June 30, 2006 and 2005, and cash flows and statements of changes in stockholders’ equity for the six months ended June 30, 2006 and 2005. 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, 2005. The results of operations for the three month and six month periods ended June 30, 2006 and 2005, are not necessarily indicative of the results to be expected for the full year.

 

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

 

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

 

2. The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003 which authorized up to 180,000 shares 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. The company granted 45,893 options in the first quarter of 2006 and 45,882 options in the first quarter of 2005. No options were granted in 2003. Options granted under the plan may be subject to a graded vesting schedule.

 

In December 2004, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment” (SFAS 123R). SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant and eliminates the choice to account for employee stock options under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). The company adopted SFAS 123R effective January 1, 2006 using the modified prospective method and as such, results for prior periods have not been restated. Prior to January 1, 2006, no compensation expense was recognized for stock option grants as all such grants had an exercise price not less than fair market value on the date of grant.

 

As a result of adopting SFAS 123R on January 1, 2006, incremental stock-based compensation expense recognized for the six month period ending June 30, 2006 was $85 thousand ($58 thousand after tax), which impacted basic and diluted earnings per share by $.02 for the six months ended June 30, 2006.

 

The following illustrates the effect on net income and earnings per share if the company had applied the fair value method of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Bases compensation”, prior to January 1, 2006:

 

    

For the Six

Months Ended

June 30

2005


 
     (dollars in thousands
except per share amounts)
 

Net income, as reported

   $ 1 891  

Less: pro forma stock option compensation expense, net of tax

     (42 )
    


Pro forma net income

   $ 1 849  
    


Earnings per share:

        

Basic – as reported

   $ .56  
    


Basic – pro forma

   $ .54  
    


Diluted – as reported

   $ .55  
    


Diluted – pro forma

   $ .54  
    


 

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Table of Contents

Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. The weighted average estimated fair value of stock options granted in the six months ended June 30, 2006 and 2005 was $3.88 and $2.91, respectively. Fair value is estimated using the Black-Scholes option-pricing model with the following assumptions for grants during 2006 and 2005: option term until exercise 10 years, expected volatility of 17.86% and 19.46%, risk-free interest rates of 4.43% and 4.26%, and expected dividend yields of 2.66% and 3.15%, respectively.

 

Stock option plan activity for the six months ended June 30, 2006 is summarized below:

 

     Shares
(in thousands)


   Weighted
Average
Exercise
Price


   Weighted
Average
Remaining
Contractual
Life
(in years)


   Value of
Unexercised
In-The-
Money
Options


     (dollars in thousands, except per share amounts)

Options outstanding, January 1

   75    $ 13            

Granted

   46      17            

Exercised

   —        —              

Canceled or expired

   —        —              
    
                  

Options outstanding, June 30

   121      14    9    $ 953
    
                  

Options exercisable, June 30

   56      14    8    $ 506
    
                  

 

As of June 30, 2006 there was $197 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining requisite service period.

 

3. On March 14, 2006 the Board of Directors of Potomac Bancshares, Inc. declared a 2% stock dividend payable on June 1, 2006. Shares issued increased from 3,600,000 to 3,671,691. All per share information for all periods presented has been restated to reflect this dividend.

 

On January 11, 2005 the Board of Directors of Potomac Bancshares, Inc. declared a stock split in the form of a 100% stock dividend payable on March 15, 2005. Shares issued increased from 1,800,000 to 3,600,000. All per share information has been restated for the stock split.

 

4. The amortized cost and fair value of securities available for sale as of June 30, 2006 and December 31, 2005 (in thousands) are as follows:

 

     June 30, 2006

     Amortized
Cost


   Gross
Unrealized
Gains


   Gross
Unrealized
(Losses)


    Fair
Value


Obligations of U. S. Government agencies

   $ 49 634    $ —      $ (629 )   $ 49 005

State and municipal obligations

     1 471      —        (30 )     1 441
    

  

  


 

     $ 51 105    $ —      $ (659 )   $ 50 446
    

  

  


 

     December 31, 2005

     Amortized
Cost


   Gross
Unrealized
Gains


   Gross
Unrealized
(Losses)


    Fair
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
    

  

  


 

 

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Table of Contents

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 34 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 June 30, 2006.

 

The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of June 30, 2006 and December 31, 2005 (in thousands).

 

     June 30, 2006

 
     Less than 12 months

    More than 12 months

    Total

 
     Fair Value

   Gross
Unrealized
Losses


    Fair Value

   Gross
Unrealized
Losses


    Fair Value

   Gross
Unrealized
Losses


 

Obligations of U.S. Government agencies

   $ 34 853    $ (278 )   $ 14 152    $ (351 )   $ 49 005    $ (629 )

State and municipal obligations

     337      (6 )     1 104      (24 )     1 441      (30 )
    

  


 

  


 

  


Total

   $ 35 190    $ (284 )   $ 15 256    $ (375 )   $ 50 446    $ (659 )
    

  


 

  


 

  


     December 31, 2005

 
     Less than 12 months

    More than 12 months

    Total

 
     Fair Value

   Gross
Unrealized
Losses


    Fair Value

   Gross
Unrealized
Losses


    Fair Value

   Gross
Unrealized
Losses


 

Obligations of U.S. Government agencies

   $ 20 278    $ (105 )   $ 13 717    $ (291 )   $ 33 995    $ (396 )

State and municipal obligations

     1 444      (29 )     —        —         1 444      (29 )
    

  


 

  


 

  


Total

   $ 21 722    $ (134 )   $ 13 717    $ (291 )   $ 35 439    $ (425 )
    

  


 

  


 

  


 

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

 

     June 30
2006


   December 31
2005


     (in thousands)

Mortgage loans on real estate:

             

Construction, land development and other land

   $ 50 775    $ 41 174

Secured by farmland

     2 691      2 381

Secured by 1-4 family residential

     100 785      98 408

Secured by multifamily residential

     3 088      3 486

Secured by nonfarm nonresidential

     42 581      43 019

Commercial and industrial loans (except those secured by real estate)

     5 406      6 046

Consumer loans

     16 705      15 549

All other loans

     407      372
    

  

Total loans

   $ 222 438    $ 210 435

Less: allowance for loan losses

     2 221      2 161
    

  

     $ 220 217    $ 208 274
    

  

 

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

 

     June 30
2006


    June 30
2005


 

Balance at beginning of period

   $ 2 161     $ 1 966  

Provision charged to operating expense

     75       177  

Recoveries added to the allowance

     62       59  

Loan losses charged to the allowance

     (77 )     (110 )
    


 


Balance at end of period

   $ 2 221     $ 2 092  
    


 


 

7. There were no impaired loans at June 30, 2006 and at December 31, 2005. Nonaccrual loans amounted to $130 thousand and $122 thousand at June 30, 2006 and December 31, 2005, respectively

 

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

 

     Pension Benefits

    Postretirement Benefits

 
     Six Months Ended

    Six Months Ended

 
     June 30
2006


    June 30
2005


    June 30
2006


    June 30
2005


 
     (in thousands)     (in thousands)  

Components of Net Periodic Benefit Cost

                                

Service cost

   $ 113     $ 119     $ 4     $ 3  

Interest cost

     157       130       15       15  

Expected return on plan assets

     (157 )     (158 )     —         —    

Amortization of net (gain) loss

     —         —         —         (2 )

Amortization of net obligation at transition

     (8 )     (10 )     9       9  

Recognized net actuarial loss

     14       —         (1 )     —    
    


 


 


 


Net periodic benefit cost

   $ 119     $ 81     $ 27     $ 25  
    


 


 


 


 

Employer Contribution

 

Through the six months ended June 30, 2006, the company has contributed $299,229 to the pension plan. This total includes $297,248, the entire contribution for 2006 and $1,981, an additional payment for 2005. The company has made payments of $12,266 for the postretirement benefits plan for the first six months of 2006 and anticipates remaining payments for 2006 to total $17,587.

 

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 shareholders.

 

    

Six Months Ended

June 30, 2006


  

Six Months Ended

June 30, 2005


     Average Shares

   Per Share Amount

   Average Shares

   Per Share Amount

Basic earnings per share

   3 460 676    $ .61    3 393 122    $ .56

Effect of dilutive securities: Stock options

   17 840           14 341       

Diluted earnings per share

   3 478 516    $ .61    3 407 463    $ .55

 

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As of June 30, 2006 stock options representing 45,893 shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.

 

Shares outstanding have been restated to reflect the 2% stock dividend discussed in Note 3.

 

10. Recent Accounting Pronouncements

 

In March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets an amendment of FASB Statement 140” (Statement 156). Statement 156 amends Statement 140 with respect to separately recognized servicing assets and liabilities. Statement 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract and requires all servicing assets and liabilities to be initially measured at fair value, if practicable. Statement 156 also permits entities to subsequently measure servicing assets and liabilities using an amortization method or fair value measurement method. Under the amortization method, servicing assets and liabilities are amortized in proportion to and over the estimated period of servicing. Under the fair value measurement method, servicing assets are measured at fair value at each reporting date and changes in fair value are reported in net income for the period the change occurs.

 

Adoption of Statement 156 is required as of the beginning of fiscal years beginning subsequent to September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements.

 

The company does not expect the adoption of Statement 156 at the beginning of 2007 to have a material impact.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

CRITICAL ACCOUNTING POLICIES

 

General

 

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

 

Allowance for Loan Losses

 

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

 

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

 

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FINANCIAL OVERVIEW

 

Total assets have increased $15.3 million or 5.5% from the December 2005 total of $277.3 million to $292.6 million at June 30, 2006. An increase in loans and securities available for sale of $11.9 million and $3.5 million, respectively, combined with a decrease in cash and due from banks makes up the majority of the change on the asset side of the balance sheet.

 

Total deposits have increased $16.2 million or 7.0% at June 30, 2006 compared to December 31, 2005. The increase in noninterest-bearing deposits is 2.9% at June 30, 2006 compared to December 31, 2005. Interest-bearing deposits have increased 7.7% during this time period. In order to retain and grow our deposit base we have been doing some negotiating and some matching of rates. Also, in 2006 we have begun participating in the Certificate of Deposit Account Registry Service (CDARS). During the second quarter of 2006 we have an additional $3 million in brokered certificates through this program compared to no CDARS deposits at December 31, 20005.

 

The June 30, 2006 annualized return on average assets is 1.50% compared to 1.39% at December 31, 2005. At June 30, 2006 the annualized return on average equity is 16.37% compared to 15.38% at December 31, 2005. The leverage capital (equity to assets) ratio is 9.04% at June 30, 2006 compared to 9.18% at December 31, 2005.

 

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

 

     June 30, 2006

    June 30, 2005

 

Balance at beginning of period

   $ 2 161     $ 1 966  

Charge-offs:

                

Commercial, financial and agricultural

     —         1  

Real estate – construction

     —         —    

Real estate – mortgage

     —         —    

Consumer

     77       109  
    


 


Total charge-offs

     77       110  
    


 


Recoveries:

                

Commercial, financial and agricultural

     —         —    

Real estate – construction

     —         —    

Real estate – mortgage

     —         —    

Consumer

     62       59  
    


 


Total recoveries

     62       59  
    


 


Net charge-offs

     15       51  

Additions charged to operations

     75       177  
    


 


Balance at end of period

   $ 2 221     $ 2 092  
    


 


Ratio of net charge-offs during the period to average loans outstanding during the period

     .007 %     .026 %
    


 


 

Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

 

     June 30, 2006

    June 30, 2005

 

Nonaccrual loans

   $ 130     $ —    

Restructured loans

     —         —    

Foreclosed properties

     —         —    
    


 


Total nonperforming assets

   $ 130     $ —    
    


 


Loans past due 90 days accruing interest

   $ —       $ 81  
    


 


Allowance for loan losses to period end loans

     1.00 %     1.05 %
    


 


Nonperforming assets to period end loans and foreclosed properties

     .06 %     —    
    


 


 

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Table of Contents

At June 30, 2006, other potential problem loans (excluding impaired 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. A portion of the allowance for loan losses is specifically allocated for these loans as a group at a rate that reflects the potential problems these loans may present.

 

The comparison of the income statements for the three months ended June 30, 2006 and 2005 and for the six months ended June 30, 2006 and 2005 shows similar differences between 2006 and 2005. Some of the details are highlighted below.

 

    Net income for the six month period ending June 30, 2006 is 12.3% greater than 2005 net income.

 

    For the six month period ending June 30, 2006 total interest and dividend income is up 28.3% compared to June 30, 2005 due to loan growth and some increase in interest rates.

 

    The income on the securities portfolio for the six months ended June 30, 2006 is 37.0% greater than for the same time period in 2005.

 

    Other interest income has increased for the three and six month periods ending June 30, 2006 due to increased interest rates on deposits in other institutions and on federal funds sold.

 

    Interest expense continues to increase. For the six month period ending June 30, 2006 interest expense was 78.8% above 2005 expense for the same time period. The increase is a combination of growth in deposits and higher interest rates being paid to retain deposits and attract additional deposits.

 

    Net interest income through June 30, 2006 is 12.6% greater than at June 30, 2005.

 

    Net interest margin at June 30, 2006 is 4.63%, up slightly from the December 31, 2005 figure of 4.58%. During the first six months of 2006, the overall average rate on loans has increased to 7.54% compared to 6.99% at December 31, 2005. During this same period the overall average rate being paid on deposits also increased to 2.63% compared to 1.87% at December 31, 2005.

 

Noninterest income increased 13.7% for the six months ended June 30, 2006 compared to June 30, 2005. Some significant income items are listed here.

 

    Trust and financial services income increased 25.3% at June 30, 2006 compared to June 30, 2005. The two large estate fees that had been accruing were paid and the payments exceeded accruals due to sale of land at higher prices than originally estimated. Income from BCT Investments continues to increase.

 

    Service charges on deposit accounts have increased 11.4% in 2006 over 2005 and have now slightly exceeded budget as of June 30, 2006.

 

    Credit and debit card fees have increased 37.4% at June 30, 2006 compared to the same time in 2005 due to the growth in the deposit account base and concentrated sale of cards by bank personnel.

 

    Other noninterest income has decreased 6.23% as of June 30, 2006 compared to June 30, 2005. Significant factors include decreases in insurance commissions, in net gains on sale of loans, in income from cash surrender value of life insurance and in online banking fee income. There were increases in penalties on the early payoff of home equity loans, penalties on early withdrawal of certificates of deposit, letter of credit fee income and moderate increases in the other noninterest income items. A number of these factors can be traced to the effects of increasing interest rates.

 

Noninterest expense increased 16.6% for the six months ended June 30, 2006 compared to the same period in 2005. Some details of this increase are listed below.

 

    Salaries and employee benefits for the first six months of 2006 are 24.7% more than for the first six months of 2005 due to annual salary increases and related benefit cost increases and increase in staffing.

 

    Occupancy expense has increased 21.9% in 2006 compared to 2005. As the bank continues to grow so does the space needed to respond to the growth. Facilities have been remodeled and several additional office spaces have been leased.

 

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Table of Contents
    Advertising and marketing expenses have increased 27.5% in 2006 compared to 2005 due to continual efforts to grow the bank’s customer base by keeping Bank of Charles Town in the public “eye” as well as to keep customers informed. These efforts include a new advertising program in 2006 that is providing a new look to bank brochures and media advertising. The bank is proactive in providing information to our customers to educate them about the increasing fraudulent schemes and scams in the market place today.

 

    Auditing and accounting expenses have decreased 47.3% in 2006 compared to 2005. The delay in the required compliance with Sarbanes-Oxley and bringing the internal audit function “in house” are the major factors in the decrease.

 

    ATM and check card expenses have increased 28.8% in the first six months of 2006 compared to the same time period in 2005 due to growth in the deposit account base, concentrated sales efforts of the bank staff to market this product and costs of scheduled replacement of customer cards.

 

    Other noninterest expenses have increased 13.1% at June 30, 2006 compared to June 30, 2005. Significant details in this category include the following:

 

    Printing, stationery and supplies expense is 26.0% greater in 2006 than in 2005 because of continually growing customer base and required additional statements, statement stuffers and other similar items.

 

    Home equity closing costs are up 42.5% in 2006 compared to 2005 due to increased loans being made.

 

    Online banking expense has increased 38.7% in 2006 compared to 2005 due to increased number of online banking customers and the offering of free bill paying services.

 

    Other professional fees have increased 31.1% in 2006 compared to 2005. The increase is due to a fee paid to a recruiting firm for personnel and to fees paid in outsourcing advertising.

 

    Training and study expense through June 2006 has increased 89.9% over the June 2005 amount. Growth in staff and continued emphasis by management to have a well trained staff have contributed to this increase.

 

    Correspondent bank fees have increased 38.2 % in 2006 over 2005. Federal reserve service fees are included in this account and these have increased at least for the present due to the company’s partial implementation of Check 21. We expect this to decrease as full implementation by the company occurs as well as full implementation by all financial institutions.

 

    Contributions have increased 92.9% in 2006 compared to 2005. This increase is due in large part to the timing of payment of the contributions.

 

    Dues and memberships expense show an increase of 53.1% which is due in large part to the timing of the payment of the expenses.

 

    Other taxes which includes a local business and occupation tax, sales tax and purchaser’s use tax has increased 33.4%. The local tax is based on gross income and the company’s gross income continues to grow so the taxes will increase. Business growth also requires more items that are taxable so sales and purchaser’s use taxes can be expected to increase.

 

LIQUIDITY

 

Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2006.

 

Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions, such as depreciation expense, that reduce net income but do not require a cash outlay. Through June 30, 2006 net income as adjusted has provided cash of $945 thousand. 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 funds from maturing investments provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash used in investing activities through June 30, 2006 is $16.5 million.

 

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Table of Contents

Financing Activities. Customer deposits and company borrowings provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends, purchase of shares of the company’s common stock for the treasury and repayment of any borrowed or purchased funds. The net amount of cash provided by financing activities in 2006 through June 30 is $13.8 million.

 

The company has additional funding sources in the Federal Home Loan Bank, The Bankers Bank and Mercantile-Safe Deposit and Trust Company. Liquidity of the company is adequate to meet present and future financial obligations.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

There have been no significant changes during the first six months of 2006 to the quantitative and qualitative disclosures about market risk as discussed in the annual report of Form 10-K as of December 31, 2005.

 

Item 4. Controls and Procedures

 

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

 

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

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

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

 

Item 1A. Risk Factors.

 

There have been no significant changes during the first six months of 2006 to the risk factors as discussed in the annual report on Form 10-K as of December 31, 2005.

 

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Table of Contents

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

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period


   (a) Total
Number of
Shares
Purchased


   (b) Average
Price Paid
Per Share


   (c) Total Number
of Shares
Purchased as
Part of Publicly
Announced
Programs


   (d) Maximum Number
of Shares that May
Yet be Purchased
Under the Program


January 1 through
     January 31

   NONE    —      —      —  

February 1 through
     February 28

   NONE    —      —      —  

March 1 through
     March 31

   NONE    —      —      —  

April 1 through
     April 30

   NONE    —      —      —  

May 1 through
     May 31

   NONE    —      —      —  

June 1 through
     June 30

   NONE    —      —      —  

 

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

 

Item 4. Submission of Matters to a Vote of Security Holders.

 

The annual meeting of security-holders was held on April 25, 2006 and the following matters were submitted to the security-holders for a vote:

 

  1. To elect a class of directors for a term of three years.

 

  2. To ratify the selection by the board of directors of Yount, Hyde & Barbour, P.C., as independent Certified Public Accountants for the year 2005.

 

  3. To approve any other business which may properly be brought before the meeting or any adjournment thereof.

 

Results of the voting in regard to the above listed matters were as follows:

 

     Votes For

   Votes
Against


   Votes
Withheld


   Total

1.      William R. Harner

   2,160,072    None    111,420    2,271,492

E. William Johnson

   2,208,472    None    63,020    2,271,492

John C. Skinner, Jr.

   2,164,164    None    107,328    2,271,492

Donald S. Smith

   2,162,532    None    108,960    2,271,492
     Votes For

   Votes
Against


   Abstentions

   Total

2.      Ratification of accountants

   2,238,368    None    33,124    2,271,492

 

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Table of Contents

Item 5. Other Information

 

  (b) There have been no changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors since the registrant last provided disclosure in response to Item 7(d)(2)(ii)(G) of Schedule 14A.

 

Item 6. Exhibits

 

  31.1 Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002)

 

  31.2 Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002)

 

  32 Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002)

 

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Table of Contents

SIGNATURES

 

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

 

    POTOMAC BANCSHARES, INC.
Date August 11, 2006  

/s/ Robert F. Baronner, Jr.


    Robert F. Baronner, Jr.
    President & CEO
Date August 11, 2006  

/s/ Gayle Marshall Johnson


    Gayle Marshall Johnson
    Sr.Vice President and Chief Financial Officer

 

18