POTOMAC BANCSHARES INC - Quarter Report: 2011 March (Form 10-Q)

potomac_10q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________

FORM 10-Q

(Mark one)

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

	For the quarterly period ended March 31, 2011

	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	(I.R.S. Employer
Incorporation or Organization)	Identification No.)

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

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

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes XX No ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ___ No ___

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

Large Accelerated Filer _____ Accelerated Filer ___ Non-Accelerated Filer ___ Smaller Reporting Company XX

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ___ No XX

APPLICABLE ONLY TO CORPORATE REGISTRANTS

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
3,390,178 as of May 7, 2011

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
March 31, 2011

INDEX

PART I.	FINANCIAL INFORMATION	PAGE

Item 1.	Financial Statements.

	Consolidated Balance Sheets as of March 31, 2011 (Unaudited) and December 31, 2010 (Audited)	3

	Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2011 and 2010	4

	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months Ended March 31, 2011 and 2010	5

	Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2011 and 2010	6

	Notes to Consolidated Financial Statements (Unaudited)	7 - 21

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	22 - 26

Item 4.	Controls and Procedures.	26

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings.	26

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	27

Item 4.	(Removed and Reserved).	27

Item 5.	Other Information.	27

Item 6.	Exhibits.	27

Signatures		28

FORWARD-LOOKING STATEMENTS

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

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

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

	(Unaudited)
	March 31			December 31
	2011			2010
Assets:
Cash and due from banks	$	2 181		$	2 185
Interest-bearing deposits in other financial institutions		19 095			7 995
Federal funds sold		2 725			2 725
Securities available for sale, at fair value		52 795			42 690
Loans held for sale		- -			76
Loans, net of allowance for loan losses of $4,845 and
$5,012, respectively		207 671			214 238
Premises and equipment, net		8 157			8 270
Other real estate owned, net of valuation allowance of
$95 and $95, respectively		6 980			6 563
Accrued interest receivable		1 012			960
Federal Home Loan Bank of Pittsburgh stock		726			765
Other assets		10 903			11 142

Total Assets	$	312 245		$	297 609

Liabilities and Stockholders’ Equity:
Liabilities:
Deposits
Noninterest-bearing	$	26 941		$	26 695
Interest-bearing		245 535			230 727
Total Deposits		272 476			257 422
Securities sold under agreements to repurchase		7 015			7 382
Federal Home Loan Bank advances		2 421			2 717
Accrued interest payable		360			361
Other liabilities		2 851			2 951
Total Liabilities	$	285 123		$	270 833

Stockholders’ Equity:
Common stock, $1 per share par value; 5,000,000 shares
authorized; 3,671,691 shares issued and outstanding	$	3 672		$	3 672
Surplus		3 936			3 932
Undivided profits		23 948			23 725
Accumulated other comprehensive (loss), net		(1 568	)		(1 687	)
	$	29 988		$	29 642

Less cost of shares acquired for the treasury, 281,513 shares		2 866			2 866

Total Stockholders’ Equity	$	27 122		$	26 776

Total Liabilities and Stockholders’ Equity	$	312 245		$	297 609

See Notes to Consolidated Financial Statements.

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(Unaudited)

	For the Three Months
	Ended March 31
	2011			2010
Interest and Dividend Income:
Interest and fees on loans	$	2 993		$	3 277
Interest on securities available for sale - taxable		168			196
Interest on securities available for sale - nontaxable		54			49
Interest on federal funds sold		1			1
Other interest and dividends		8			3
Total Interest and Dividend Income	$	3 224		$	3 526

Interest Expense:
Interest on deposits	$	895		$	1 078
Interest on securities sold under agreements to repurchase		19			20
Federal Home Loan Bank advances		11			46
Total Interest Expense	$	925		$	1 144

Net Interest Income	$	2 299		$	2 382

Provision for Loan Losses		423			310

Net Interest Income after Provision for Loan Losses	$	1 876		$	2 072

Noninterest Income:
Trust and financial services	$	221		$	210
Service charges on deposit accounts		429			436
(Loss) gain on sale of other real estate		(27	)		112
Visa/MC fees		174			151
Cash surrender value of life insurance		57			59
Other operating income		94			84
Total Noninterest Income	$	948		$	1 052

Noninterest Expenses:
Salaries and employee benefits	$	1 236		$	1 260
Net occupancy expense of premises		171			190
Furniture and equipment expenses		200			210
Communications		47			45
FDIC assessment		153			120
Foreclosed property expense		113			181
ATM and check card expenses		71			64
Online banking expense		59			17
Other operating expenses		475			422
Total Noninterest Expenses	$	2 525		$	2 509
Income before Income Tax Expense	$	299		$	615
Income Tax Expense		42			193

Net Income	$	257		$	422

Earnings Per Share, basic and diluted	$	.08		$	.12

See Notes to Consolidated Financial Statements.

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(in thousands, except share and per share data)
(Unaudited)

											Accumulated
											Other
	Common				Undivided			Treasury			Comprehensive				Comprehensive
	Stock		Surplus		Profits			Stock			(Loss)				Income				Total
Balances, December 31, 2009	$	3 672	$	3 898	$	21 931		$	(2 866	)		$	(1 063	)					$	25 572

Comprehensive income
Net income		- -		- -		422			- -				- -			$	422			422
Other comprehensive (loss):
unrealized holding (losses)
arising during the period
(net of tax, $28)		- -		- -		- -			- -				(54	)			(54	)		(54	)
Total comprehensive income																$	368

Stock-based compensation expense		- -		8		- -			- -				- -							8

Balances, March 31, 2010	$	3 672	$	3 906	$	22 353		$	(2 866	)		$	(1 117	)					$	25 948

Balances, December 31, 2010	$	3 672	$	3 932	$	23 725		$	(2 866	)		$	(1 687	)					$	26 776

Comprehensive income
Net income		- -		- -		257			- -				- -			$	257			257
Other comprehensive income:
unrealized holding gains
arising during the period
(net of tax, $61)		- -		- -		- -			- -				119				119			119
Total comprehensive income																$	376

Stock-based compensation expense		- -		4		- -			- -				- -							4

Cash dividends ($.01 per share)		- -		- -		(34	)		- -				- -							(34	)

Balances, March 31, 2011	$	3 672	$	3 936	$	23 948		$	(2 866	)		$	(1 568	)					$	27 122

See Notes to Consolidated Financial Statements.

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

	For the Three Months Ended
	March 31			March 31
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	257		$	422
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses		423			310
Depreciation		125			143
Discount accretion and premium amortization on securities, net		75			44
Loss (gain) on sale of other real estate		27			(112	)
Stock-based compensation expense		4			8
Proceeds from sale of loans		314			209
Origination of loans for sale		(238	)		(566	)
Changes in assets and liabilities:
Increase in accrued interest receivable		(52	)		(180	)
Decrease in other assets		217			11
Decrease in accrued interest payable		(1	)		(7	)
Decrease in other liabilities		(100	)		(214	)
Net cash provided by operating activities	$	1 051		$	68

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available for sale	$	2 000		$	- -
Proceeds from call of securities available for sale		3 000			7 000
Purchase of securities available for sale		(15 000	)		(16 029	)
Net decrease in loans		5 230			683
Purchases of premises and equipment		(12	)		(10	)
Proceeds from sale of other real estate		470			909
Net cash used in investing activities	$	(4 312	)	$	(7 447	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in noninterest-bearing deposits	$	246		$	1 089
Net increase in interest-bearing deposits		14 808			6 129
Net (repayment) proceeds of securities sold under agreements to repurchase		(367	)		1 427
Net repayment of Federal Home Loan Bank advances		(296	)		(256	)
Cash dividends		(34	)		- -
Net cash provided by financing activities	$	14 357		$	8 389

Increase in cash and cash equivalents	$	11 096		$	1 010

CASH AND CASH EQUIVALENTS
Beginning		12 905			12 623

Ending	$	24 001		$	13 633

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	926		$	1 151

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES
Unrealized gain (loss) on securities available for sale	$	180		$	(82	)
Loans transferred to other real estate owned	$	914		$	970
Loans made on sale of other real estate owned	$	20		$	230

See Notes to Consolidated Financial Statements.

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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, 2011 and December 31, 2010, and the results of operations, cash flows and statements of changes in stockholders’ equity for the three months ended March 31, 2011 and 2010. 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, 2010. The results of operations for the three month periods ended March 31, 2011 and 2010 are not necessarily indicative of the results to be expected for the full year.

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

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

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

2.	Stock-Based Compensation

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

	Incremental stock-based compensation expense recognized for the three month periods ending March 31, 2011 and 2010 was $4 thousand and $8 thousand, respectively.

	Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first quarters of 2011 and 2010.

	Stock option plan activity for the three months ended March 31, 2011 is summarized below:

				Weighted
				Average
		Weighted		Remaining
		Average		Contractual	Aggregate
		Exercise		Life	Intrinsic
	Shares	Price		(in years)	Value
Options outstanding, January 1, 2011	120 974	$	14.76
Granted	- -		- -
Exercised	- -		- -
Canceled or expired	- -		- -
Options outstanding, March 31, 2011	120 974		14.76	4	$	- -
Options exercisable, March 31, 2011	116 896		14.73	4	$	- -

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2011. The aggregate intrinsic values change based on changes in the market value of the company’s stock.

As of March 31, 2011 there was $12 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining requisite service period.

3.	Securities

	The amortized cost and fair value of securities available for sale as of March 31, 2011 and December 31, 2010 (in thousands) are as follows:

	March 31, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
Obligations of U. S. Government agencies	$	46 134	$	243	$	(145	)	$	46 232
State and municipal obligations		5 537		88		(31	)		5 594
Equity securities		1 099		- -		(130	)		969
	$	52 770	$	331	$	(306	)	$	52 795

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
Obligations of U. S. Government agencies	$	36 207	$	241	$	(160	)	$	36 288
State and municipal obligations		5 537		71		(84	)		5 524
Equity securities		1 100		- -		(222	)		878
	$	42 844	$	312	$	(466	)	$	42 690

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 13 accounts in the consolidated portfolio that have losses at March 31, 2011. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at March 31, 2011 and no impairment has been recognized.

There are two equity security investments in the company’s portfolio with losses at March 31, 2011. Because the company has the ability and intent to hold these equity investments until the investments recover their unrealized losses, the company considers these investments to be temporarily impaired at March 31, 2011 and is recognizing no impairment. These are community bank stock related holdings.

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 March 31, 2011 and December 31, 2010 (in thousands).

	March 31, 2011
	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	$	9 914	$	(132	)	$	1 098	$	(13	)	$	11 012	$	(145	)
State and municipal obligations		865		(31	)		- -		- -			865		(31	)
Equity securities		969		(130	)		- -		- -			969		(130	)
Total	$	11 748	$	(293	)	$	1 098	$	(13	)	$	12 846	$	(306	)

3. Securities (Continued)

	December 31, 2010
	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	$	9 899	$	(147	)	$	1 108	$	(13	)	$	11 007	$	(160	)
State and municipal obligations		1 912		(84	)		- -		- -			1 912		(84	)
Equity securities		878		(222	)		- -		- -			878		(222	)
Total	$	12 689	$	(453	)	$	1 108	$	(13	)	$	13 797	$	(466	)

	The company’s investment in Federal Home Loan Bank (FHLB) stock totaled $726 thousand at March 31, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess capital stock on a regular basis, the company does not consider this investment to be other-than-temporarily impaired at March 31, 2011 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.

4.	Loans

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

	March 31		December 31
	2011		2010
	(in thousands)
Commercial – non real estate
Commercial and industrial	$	7 274	$	7 920
Commercial real estate
Owner occupied		64 133		67 517
Non-owner occupied		13 245		12 098
Construction
Residential		5 874		5 922
Commercial		16 944		18 252
Real Estate
Farmland		741		792
Residential
Revolving open end		5 834		5 975
1 to 4 family – first liens		79 825		82 691
1 to 4 family – junior liens		8 634		8 871
5 or more family		3 167		1 976
Consumer loans
Titled vehicles		3 280		3 713
Deposit accounts		866		737
All other consumer loans		2 305		2 350
All other loans		394		436
Total loans	$	212 516	$	219 250
Less: allowance for loan losses		4 845		5 012

	$	207 671	$	214 238

5.	Allowance for Loan Losses

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

	March			December			March
	2011			2010			2010
Balance at beginning of period	$	5 012		$	5 718		$	5 718

Provision charged to operating expense		423			1 599			310
Recoveries added to the allowance		52			321			71
Loan losses charged to the allowance		(642	)		(2 626	)		(792	)

Balance at end of period	$	4 845		$	5 012		$	5 307

Allowance for Loan Losses – By Segment
March 31, 2011
(in thousands)

							Commercial												All
	Farmland			Commercial			Real Estate			Construction			Consumer			Residential			Other		Unallocated		Total
Beginning balance	$	166		$	239		$	859		$	2 022		$	20		$	1 691		$	1	$	14	$	5 012
Charge-offs		- -			- -			(59	)		(57	)		(45	)		(481	)		- -		- -		(642	)
Recoveries		- -			5			6			5			34			2			- -		- -		52
Provision		(155	)		(39	)		5			(424	)		11			922			- -		103		423

Ending balance	$	11		$	205		$	811		$	1 546		$	20		$	2 134		$	1	$	117	$	4 845

Individually evaluated
for impairment	$	0		$	186		$	478		$	1 308		$	- -		$	836		$	- -	$	- -	$	2 808
Collectively evaluated
for impairment		11			19			333			238			20			1 298			1		117		2 037

Financing receivables:
Ending balance	$	741		$	7 274		$	77 378		$	22 818		$	6 451		$	97 460		$	394	$	- -	$	212 516

Ending balance:
Individually evaluated
for impairment	$	0		$	353		$	8 903		$	8 352		$	- -		$	4 521		$	- -	$	- -	$	22 129
Collectively evaluated
for impairment		741			6 921			68 475			14 466		6 451				92 939		394			- -		190 387

Allowance for Loan Losses – By Segment
December 31, 2010
(in thousands)

					Commercial								All
	Farmland		Commercial		Real Estate		Construction		Consumer		Residential		Other		Unallocated		Total
Ending balance	$	166	$	239	$	859	$	2 022	$	20	$	1 691	$	1	$	14	$	5 012

Individually evaluated
for impairment	$	161	$	217	$	528	$	1 812	$	- -	$	429	$	- -	$	- -	$	3 147
Collectively evaluated
for impairment		5		22		331		210		20		1 262		1		14		1 865

Financing receivables:
Ending balance	$	792	$	7 920	$	79 615	$	24 174	$	6 800	$	99 513	$	436	$	- -	$	219 250

Ending balance:
Individually evaluated
for impairment	$	539	$	367	$	9 398	$	11 484	$	- -	$	2 874	$	- -	$	- -	$	24 662
Collectively evaluated
for impairment		253		7 553		70 217		12 690	6 800			96 639	436			- -		194 588

5. Allowance for Loan Losses (Continued)

Credit Quality Information – By Class
March 31, 2011
(in thousands)

			Special		Sub-
Internal Risk Rating Grades	Pass		Mention		Standard		Doubtful		Loss
Commercial – non real estate
Commercial and industrial	$	6 753	$	168	$	- -	$	261	$	92
Commercial real estate
Owner occupied		51 101		4 242		2 917		5 873		- -
Non-owner occupied		7 230		5 901		- -		114		- -
Construction
Residential		2 006		1 380		510		1 951		27
Commercial		9 452		3 932		1 974		1 466		120
Real estate
Farmland		741		- -		- -		- -		- -
Consumer
Titled vehicles		N/A		N/A		N/A		N/A		N/A
Deposit accounts		N/A		N/A		N/A		N/A		N/A
All other		N/A		N/A		N/A		N/A		N/A
Residential
Revolving open end		N/A		300		N/A		24		N/A
1-4 family – first liens		N/A		3 378		1 162		2 249		569
1-4 family – junior liens		N/A		100		- -		174		42
5 or more family		N/A		305		- -		- -		- -

Totals	$	77 283	$	19 706	$	6 563	$	12 112	$	850

As a matter of practice, we do not risk rate consumer or residential mortgage loans. Any of these loans listed in the risk rating table above are associated with commercial loans that have been risk rated as per our policy. Once a loan is designated as a loss, it will usually be cleared from the loan portfolio within 90 days.

Credit Quality Information – By Class (Continued)
March 31, 2011
(in thousands)

Non Risk Rated Loans	Performing		Nonperforming
Consumer – non real estate
Titled vehicles	$	3 273	$	7
Deposit accounts		866		- -
All other		2 301		4
Residential
Revolving open end		5 497		13
1-4 family – first liens		72 065		402
1-4 Family – junior liens		8 308		10
5 or more family		2 862		- -
All other		394		- -
Totals	$	95 566	$	436

5. Allowance for Loan Losses (Continued)

Credit Quality Information – By Class
December 31, 2010
(in thousands)

			Special		Sub-
Internal Risk Rating Grades	Pass		Mention		Standard		Doubtful		Loss
Commercial – non real estate
Commercial and industrial	$	7 371	$	180	$	95	$	106	$	166
Commercial real estate
Owner occupied		53 078		5 041		3 829		5 375		194
Non-owner occupied		11 470		628		- -		- -		- -
Construction
Residential		282		489		4 005		1 095		51
Commercial		10 348		2 789		3 575		1 363		- -
Real estate
Farmland		253		- -		- -		539		- -
Consumer
Titled vehicles		N/A		N/A		N/A		N/A		N/A
Deposit accounts		N/A		N/A		N/A		N/A		N/A
All other		N/A		N/A		N/A		N/A		N/A
Residential
Revolving open end		N/A		N/A		N/A		N/A		N/A
1-4 family – first liens		N/A		3 234		956		1 434		242
1-4 family – junior liens		N/A		187		42		175		25
5 or more family		N/A		308		- -		- -		- -

Totals	$	82 802	$	12 856	$	12 502	$	10 087	$	678

Credit Quality Information – By Class (Continued)
December 31, 2010
(in thousands)

Non Risk Rated Loans	Performing		Nonperforming
Consumer – non real estate
Titled vehicles	$	3 705	$	8
Deposit accounts		737		- -
All other		2 345		7
Residential
Revolving open end		5 962		13
1-4 family – first liens		75 901		1 101
1-4 Family – junior liens		8 442		- -
5 or more family		1 668		- -
All other		436		- -
Totals	$	99 196	$	1 129

5. Allowance for Loan Losses (Continued)

Impaired Loans – By Class
March 31, 2011
(in thousands)

With no related allowance:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	187	$	167	$	N/A	$	84	$	1
Commercial real estate
Owner occupied		4 285		4 260		N/A		3 678		215
Non-owner occupied		- -		- -		N/A		15		- -
Construction
Residential		876		866		N/A		1 479		35
Commercial		2 322		2 311		N/A		3 213		128
Real estate
Farmland		- -		- -		N/A		- -		- -
Residential
Revolving open end		302		300		N/A		60		15
1 to 4 family –first liens		772		769		N/A		1 179		17
1 to 4 family – junior liens		175		174		N/A		158		5
5 or more family		- -		- -		N/A		- -		- -
Consumer
Titled vehicles		- -		- -		N/A		- -		- -
Deposit accounts		- -		- -		N/A		- -		- -
All other consumer		- -		- -		N/A		- -		- -
All other		- -		- -		N/A		- -		- -

With an allowance recorded:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	187	$	186	$	186	$	292	$	7
Commercial real estate
Owner occupied		4 572		4 529		401		5 017		332
Non-owner occupied		114		114		77		23		- -
Construction
Residential		1 649		1 622		672		3 031		171
Commercial		3 596		3 553		636		3 453		177
Real estate
Farmland		- -		- -		- -		431		- -
Residential
Revolving open end		28		24		24		5		- -
1 to 4 family – first liens		3 244		3 212		770		1 680		143
1 to 4 family – junior liens		43		42		42		164		- -
5 or more family		- -		- -		- -		- -		- -
Consumer
Titled vehicles		- -		- -		- -		- -		- -
Deposit accounts		- -		- -		- -		- -		- -
All other consumer		- -		- -		- -		- -		- -
All other		- -		- -		- -		- -		- -

Totals:
Commercial – non real estate	$	374	$	353	$	186	$	376	$	8
Commercial real estate		8 972		8 903		478		8 733		547
Construction		8 443		8 352		1 308		11 176		511
Real estate –farmland		- -		- -		- -		431		- -
Residential		4 564		4 521		836		3 246		180
Consumer		- -		- -		- -		- -		- -
All other		- -		- -		- -		- -		- -
	$	22 353	$	22 129	$	2 808	$	23 962	$	1 246

5. Allowance for Loan Losses (Continued)

Impaired Loans – By Class
December 31, 2010
(in thousands)

With no related allowance:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	117	$	95	$	N/A	$	53	$	- -
Commercial real estate
Owner occupied		4 206		4 256		N/A		3 591		158
Non-owner occupied		75		- -		N/A		15		- -
Construction
Residential		1 188		1 183		N/A		1 769		52
Commercial		2 641		2 631		N/A		3 655		112
Real estate
Farmland		- -		- -		N/A		- -		- -
Residential
Revolving open end		- -		- -		N/A		- -		- -
1 to 4 family –first liens		1 259		1 242		N/A		1 351		15
1 to 4 family – junior liens		175		175		N/A		142		3
5 or more family		- -		- -		N/A		- -		- -
Consumer
Titled vehicles		- -		- -		N/A		- -		- -
Deposit accounts		- -		- -		N/A		- -		- -
All other consumer		- -		- -		N/A		- -		- -
All other		- -		- -		N/A		- -		- -

With an allowance recorded:
							Average		Interest
	Unpaid		Recorded		Related		Recorded		Income
	Principal		Investment		Allowance		Investment		Recognized
Commercial – non real estate
Commercial and industrial	$	274	$	272	$	217	$	355	$	6
Commercial real estate
Owner occupied		5 201		5 142		528		4 972		272
Non-owner occupied		- -		- -		- -		- -		- -
Construction
Residential		2 786		2 767		600		3 910		175
Commercial		4 924		4 903		1 212		3 242		216
Real estate
Farmland		549		539		161		547		- -
Residential
Revolving open end		- -		- -		- -		- -		- -
1 to 4 family – first liens		1 412		1 390		362		1 186		56
1 to 4 family – junior liens		71		67		67		220		- -
5 or more family		- -		- -		- -		- -		- -
Consumer
Titled vehicles		- -		- -		- -		- -		- -
Deposit accounts		- -		- -		- -		- -		- -
All other consumer		- -		- -		- -		4		- -
All other		- -		- -		- -		- -		- -

Totals:
Commercial – non real estate	$	391	$	367	$	217	$	408	$	6
Commercial real estate		9 482		9 398		528		8 578		430
Construction		11 539		11 484		1 812		12 576		555
Real estate –farmland		549		539		161		547		- -
Residential		2 917		2 874		429		2 899		74
Consumer		- -		- -		- -		4		- -
All other		- -		- -		- -		- -		- -
	$	24 878	$	24 662	$	3 147	$	25 012	$	1 065

5.	Allowance for Loan Losses (Continued)

	Recorded reserves for impaired loans total $2.8 million compared to total nonaccrual loans of $2.7 million. There are loans with impairment that are not on nonaccrual status because payments on these loans are current. These loans are kept under constant scrutiny by the loan officers and credit administration.

Nonaccrual and Past Due Loans – By Class
March 31, 2011
(in thousands)

													90 Days
	30-59		60-89		90 Days								Past Due
	Days		Days		or more		Total				Total		Still		Non-
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing		Accrual
Commercial – non real estate
Commercial and industrial	$	26	$	92	$	1	$	119	$	7 155	$	7 274	$	- -	$	93
Commercial real estate
Owner Occupied		644		- -		- -		644		63 489		64 133		- -		- -
Non owner occupied		- -		- -		- -		- -		13 245		13 245		- -		- -
Construction
Residential		1 340		- -		374		1 714		4 160		5 874		- -		401
Commercial		464		477		321		1 262		15 682		16 944		- -		798
Real Estate
Farmland		- -		- -		- -		- -		741		741		- -		- -
Residential
Revolving open end		- -		- -		- -		- -		5 834		5 834		- -		37
1 to 4 family – first liens		3 361		220		705		4 566		75 259		79 825		276		1 282
1 to 4 family – junior liens		118		43		52		213		8 421		8 634		- -		52
5 or more family		- -		- -		- -		- -		3 167		3 167		- -		- -
Consumer
Titled Vehicles		3		- -		- -		3		3 277		3 280		- -		7
Deposit Accounts		- -		- -		- -		- -		866		866		- -		- -
All other consumer		20		- -		3		23		2 282		2 305		- -		4
All Other		- -		- -		- -		- -		394		394		- -		- -
Totals	$	5 976	$	832	$	1 460	$	8 544	$	203 972	$	212 516	$	276	$	2 674

Percentage to Total Loans		2.81%		0.39%		0.69%		4.02%		95.98%				.13%		1.26%

Nonaccrual and Past Due Loans – By Class
December 31, 2010
(in thousands)

													90 Days
	30-59		60-89		90 Days								Past Due
	Days		Days		or more		Total				Total		Still		Non-
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing		Accrual
Commercial – non real estate
Commercial and industrial	$	80	$	92	$	2	$	174	$	7 746	$	7 920	$	- -	$	97
Commercial real estate
Owner Occupied		612		- -		- -		612		66 905		67 517		- -		- -
Non owner occupied		194		- -		- -		194		11 904		12 098		- -		- -
Construction
Residential		238		- -		- -		238		5 684		5 922		- -		- -
Commercial		115		- -		285		400		17 852		18 252		- -		405
Real Estate
Farmland		- -		- -		539		539		253		792		- -		539
Residential
Revolving open end		- -		- -		- -		- -		5 975		5 975		- -		38
1 to 4 family – first liens		2 269		416		881		3 566		79 125		82 691		- -		1 099
1 to 4 family – junior liens		135		19		- -		154		8 717		8 871		- -		42
5 or more family		- -		- -		- -		- -		1 976		1 976		- -		- -
Consumer
Titled Vehicles		37		2		- -		39		4 310		4 349		- -		8
Deposit Accounts		11		- -		- -		11		774		785		- -		- -
All other consumer		3		- -		5		8		1 658		1 666		- -		5
All Other		- -		- -		- -		- -		436		436		- -		- -
Totals	$	3 694	$	529	$	1 712	$	5 935	$	213 315	$	219 250	$	- -	$	2 233

Percentage to Total Loans		1.69%		0.24%		0.78%		2.71%		97.29%				- -%		1.02%

5.	Allowance for Loan Losses (Continued)

	The past due policy of the bank is to report all classes of loans past due in the following categories:

30 to 59 days past due (principal or interest) still accruing interest
60 to 89 days past due (principal or interest) still accruing interest
90 days or more past due (principal or interest) still accruing interest
Nonaccrual status.

6.	Employee Benefit Plans

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

	Pension Benefits						Other Postretirement Benefits
	Three Months Ended						Three Months Ended
	March 31			March 31			March 31		March 31
	2011			2010			2011		2010
	(in thousands)						(in thousands)
Components of Net Periodic Benefit Cost
Service cost	$	- -		$	- -		$	3	$	3
Interest cost		100			103			9		9
Expected return on plan assets		(119	)		(115	)		- -		- -
Amortization of net obligation at transition		- -			- -			5		4
Recognized net actuarial loss		38			24			- -		- -

Net periodic benefit cost	$	19		$	12		$	17	$	16

	Employer Contribution

	The company anticipates the 2011 contribution for the pension plan will approximate $10 thousand. The company has made payments of $10 thousand as of March 31, 2011. The company has made payments of $5 thousand for the other postretirement benefit plans for the first three months of 2011 and anticipates remaining payments for 2011 to total $15 thousand.

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

	The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential diluted common stock had no effect on March 31, 2011 and March 31, 2010 earnings per share.

	Three Months Ended			Three Months Ended
	March 31, 2011			March 31, 2010

	Average Shares	Per Share Amount		Average Shares	Per Share Amount
Basic earnings per share	3 390 178	$	.08	3 390 178	$	.12
Effect of dilutive securities:
Stock options	- -			- -

Diluted earnings per share	3 390 178	$	.08	3 390 178	$	.12

For the quarter ended March 31, 2011, stock options representing 120,974 average shares, and for the quarter ended March 31, 2010, stock options representing 126,224 average shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.

8.	Recent Accounting Pronouncements

	In January 2010, the Financial Accounting Standards Board (FASB) issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

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

	The Securities Exchange Commission (SEC) has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting”, which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.

	In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.

	In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The company is currently assessing the impact that ASU 2011-02 will have on its consolidated financial statements.

9.	Fair Value Measurements

	Determination of Fair Value

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

9.	Fair Value Measurements (Continued)

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

	Fair Value Hierarchy

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

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

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

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

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

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

	Cash and Short-Term Investments

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

	Securities

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

	Loans

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

	FHLB Stock

	The carrying amounts of FHLB stock approximate fair value based on redemption provisions of the FHLB.

9.	Fair Value Measurements (Continued)

	Bank Owned Life Insurance (BOLI)

	The carrying amounts of BOLI approximate 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 fixed rate certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

	Short-Term Borrowings

	The carrying amounts of borrowings under repurchase agreements and federal funds purchased approximate fair value.

	FHLB Advances

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

	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 March 31, 2011 and December 31, 2010, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.

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

	March 31, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(in thousands)				(in thousands)
Financial assets:
Cash	$	21 276	$	21 276	$	10 180	$	10 180
Federal funds sold		2 725		2 725		2 725		2 725
Securities available for sale		52 795		52 795		42 690		42 690
Loans, net		207 671		205 312		214 238		212 200
Loans held for sale		- -		- -		76		76
FHLB stock		726		726		765		765
BOLI		6 454		6 454		6 397		6 397
Accrued interest receivable		1 012		1 012		960		960

Financial liabilities:
Deposits		272 476		273 651		257 422		258 240
Securities sold under
agreements to repurchase		7 015		7 015		7 382		7 382
FHLB advances		2 421		2 437		2 717		2 734
Accrued interest payable		360		360		361		361

9.	Fair Value Measurements (Continued)

	Assets and Liabilities Measured at Fair Value on a Recurring Basis

	The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010:

			Fair Value Measurements at March 31, 2011 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	March 31		Assets		Inputs		Inputs
Description	2011		(Level 1)		(Level 2)		(Level 3)
Available for sale debt securities
U.S. Government agency securities	$	46 232	$	- -	$	46 232	$	- -
State and municipal securities		5 594		- -		5 594		- -

Total available for sale debt securities	$	51 826	$	- -	$	51 826	$	- -

Available for sale equity securities
Financial services industry	$	969	$	- -	$	969	$	- -

Total available for sale securities	$	52 795	$	- -	$	52 795	$	- -

			Fair Value Measurements at December 31, 2010 Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	December 31		Assets		Inputs		Inputs
Description	2010		(Level 1)		(Level 2)		(Level 3)
Available for sale debt securities
U.S. Government agency securities	$	36 288	$	- -	$	36 288	$	- -
State and municipal securities		5 524		- -		5 524		- -

Total available for sale debt securities	$	41 812	$	- -	$	41 812	$	- -

Available for sale equity securities
Financial services industry	$	878	$	- -	$	878	$	- -

Total available for sale securities	$	42 690	$	- -	$	42 690	$	- -

	Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

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

9.	Fair Value Measurements (Continued)

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

	Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one- to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended March 31, 2011 and December 31, 2010. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of income.

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

	Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3.

	The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of March 31, 2011 and December 31, 2010.

Carrying Value at March 31, 2011

Quoted Prices

in Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Balance as of

Assets

Input

Description

March 31, 2011

(Level 1)

(Level 2)

(Level 3)

Assets

Impaired Loans

10 474

- -

10 374

100

OREO

6 980

- -

6 980

- -

Carrying Value at December 31, 2010

Quoted Prices

in Active

Significant

Markets for

Other

Significant

Identical

Observable

Unobservable

Balance as of

Assets

Input

Description

December 31, 2010

(Level 1)

(Level 2)

(Level 3)

Assets

Impaired Loans

11 933

- -

10 593

1 340

OREO

6 563

- -

6 563

- -

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

CRITICAL ACCOUNTING POLICIES

General

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

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

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

FINANCIAL OVERVIEW

If the first quarter is any indication, 2011 is shaping up to be a challenging year for the industry and the bank. Lenders are finding loan demand to be somewhat stagnant. Interest bearing deposits have had unexpected growth which has had a negative impact on earnings. Management has counteracted the trend by substantially lowering deposit rates and modifying terms of the Smart Checking account. The excess funds have been predominantly put into investment securities in an attempt to improve returns until loan demand improves.

On a more positive note, there are some indications of potential growth. Several commercial projects are under way within our primary banking area. This brings the potential for job creation and an improving overall local economy. We are very hopeful that the start of growth will continue toward a more “normal” local economy in the near future. Growth in deposits has increased liquidity and put us in a great position to meet loan demand when it begins to increase.

Total assets have increased $14.6 million or 4.9% from the December 31, 2010 total of $297.6 million to $312.2 million at March 31, 2011. Interest bearing deposits in other financial institutions increased approximately $11.1 million. Securities have increased approximately $10.1 million. The increase in cash is primarily due to an increase in deposits. The security increase was the result of replacing securities that had matured or been called in the first quarter of 2011 and adding additional securities to provide a return on the excess funds currently on deposit. Loans have decreased approximately $6.5 million from the December 31, 2010 total of $214.2 million to $207.7 million at March 31, 2011. The loan decrease can be attributed to minimal loan demand, the pay down of existing loans, loan charge-offs and the transfer of loans to OREO.

Total deposits have increased $15.1 million or 5.9% at March 31, 2011 compared to December 31, 2010. Noninterest-bearing deposits have increased 0.9% and interest-bearing deposits have increased 6.4% during the first quarter of 2011. The increase in deposits is the result of a combination of circumstances including, management believes, customers saving more. Other liabilities decreased 3.39%.

The March 31, 2011 annualized return on average assets is .34% compared to .59% at December 31, 2010. At March 31, 2011 the annualized return on average equity is 3.79% compared to 6.70% at December 31, 2010. The Tier 1 capital to average assets ratio (leverage capital ratio) is 9.02% at March 31, 2011 compared to 9.36% at December 31, 2010. The Tier 1 capital to total risk weighted assets ratio is 12.88% at March 31, 2011 compared to 12.97% at December 31, 2010. The total capital to risk weighted assets ratio is 14.14% at March 31, 2011 compared to 14.24% at December 31, 2010. All capital ratios are within the regulatory guidelines.

					Minimum
					Capital
	Actual				Requirement
	Amount		Ratio		Amount		Ratio
Total capital to risk weighted assets	$	30 086	14.14	%	$	17 022	8.00%
Tier 1 capital to risk weighted assets	$	27 400	12.88	%	$	8 511	4.00%
Tier 1 capital to average assets	$	27 400	9.02	%	$	12 152	4.00%

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

	March 31		December 31		March 31
	2011		2010		2010
Balance at beginning of period	$	5 012	$	5 718	$	5 718
Charge-offs:
Commercial, financial and agricultural		- -		313		- -
Real estate – construction		57		775		346
Real estate – mortgage		540		1 245		357
Consumer		45		293		89
Total charge-offs		642		2 626		792
Recoveries:
Commercial, financial and agricultural		5		25		- -
Real estate – construction		5		- -		- -
Real estate – mortgage		9		95		6
Consumer		33		201		65
Total recoveries		52		321		71
Net charge-offs		590		2 305		721
Provision charged to operations		423		1 599		310
Balance at end of period	$	4 845	$	5 012	$	5 307

Ratio of net charge-offs during the period to average
loans outstanding during the period		.27%		1.01%		.31%

As a result of the regular loan reviews by management, the reserve decreased when comparing data as of March 31, 2011 to March 31, 2010. This is reflected in the allowance for loan loss to period end loans ratios for these same quarter ends. The decrease over the previous year represents management’s assessment of the bank’s loan portfolio that has been affected by the poor economic conditions. Most of the loans foreclosed upon or currently in nonaccrual status are related to the real estate industry. In comparing data for the loan loss reserve for the March 31, 2011 quarter end to December 31, 2010 information, the reserve has decreased. This represents the gradual improvement in the status of problem assets as management continues to review these assets on a regular basis.

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

	March 31			December 31			March 31
	2011			2010			2010
Nonaccrual loans	$	2 674		$	2 233		$	3 177
Restructured loans		- -			- -			- -
Foreclosed properties		6 980			6 563			5 805
Total nonperforming assets	$	9 654		$	8 796		$	8 982

Loans past due 90 days accruing interest	$	276		$	- -		$	- -
Allowance for loan losses to period end loans		2.28	%		2.29	%		2.28	%
Nonperforming assets to period end loans and
foreclosed properties		4.40	%		3.90	%		3.77	%

At March 31, 2011, other potential problem loans total $2.3 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.

The details of the income statements for the three months ended March 31, 2011 and 2010 are highlighted below.

Ø Net income in 2011 is 39.1% less than the 2010 net income. This is predominantly the result of changes in the loan and deposit portfolios. The loan portfolio has decreased and the total deposits, including interest bearing deposits, have increased.

Ø At March 31, 2011, total interest and dividend income is down 8.6% compared to March 31, 2010. Although loan yields have remained relatively stable over the past year, the loan portfolio has decreased. The reduction in income is created by the smaller amount of loans from which to collect interest.

Ø At March 31, 2011, interest expense was 19.1% below 2010 expense for the same time period. The decrease in expense is primarily due to a reduction in interest rates since interest bearing deposit balances actually increased. The lower overall average balance in daily cash management accounts and a lower balance on the FHLB advance due to the continued pay down of the advance contributed to the decrease in interest expense.

Ø Net interest margin at March 31, 2011 is 3.44%, down from the December 31, 2010 figure of 3.56% and March 31, 2010 figure of 3.47%. During the first three months of 2011, the overall average rate on loans dropped slightly from 5.70% at December 31, 2010 to 5.64% at March 31, 2011. The overall rate on loans at March 31, 2010 was 5.74%. During this same period the overall average rate being paid on deposits decreased to 1.53% from 1.68% at December 31, 2010 and 1.81% at March 31, 2010.

Noninterest income decreased 9.9% for the three months ended March 31, 2011 compared to March 31, 2010. Some significant income items are listed here.

Ø At March 31, 2011 there is an overall loss on sale of OREO compared to an overall gain at March 31, 2010. This results in a decrease of 124.1% in the gain or loss on sale of OREO account.

Ø Visa and Mastercard fees have increased 15.2%. The increase is believed to be an overall increase in consumer spending and the likelihood that consumers continue to get more comfortable with using credit/debit cards versus cash.

Ø Other non interest income has decreased 11.9%. The significant factor contributing to this drop is the reduction in rental income on other real estate. Two properties, a home and set of storage units, that were being rented during the first quarter of 2010 were sold later in 2010 reducing rental income.

Noninterest expense increased about .64% for the three months ended March 31, 2011 compared to the same period in 2010. Some details are listed below.

Ø Occupancy expense has decreased 10.0%. The biggest contributing factor was the 47.1% decrease in grounds maintenance during the first quarter of 2011. Normally grounds maintenance is higher during this time period due to the extra expense associated with winter weather. The 2011 winter was somewhat mild compared to the record snowfall of February 2010, thus the costs associated with handling the weather was reduced.

Ø Foreclosed property expense has decreased 37.6% compared to the first quarter of 2010. The decrease is two fold. The latest properties foreclosed upon have been in better shape and/or a finished product. Many of the properties in the other real estate portfolio are land with no structures to maintain or improve for selling purposes.

Ø ATM and check card expenses have increased 10.9% in the first three months of 2011 compared to the same time period in 2010. The increase is due to increased usage by customers.

Ø The FDIC assessment has increased 27.5% in the first quarter of 2011 as compared to the same quarter in 2010. The increase is due to the increase in deposits.

Ø Other noninterest expenses have increased 12.6% at March 31, 2011 compared to March 31, 2010. The significant contributing factors are outlined below.

Other professional fees increased due to timing differences of bill payments and to the use of a consultant to assess the Small Business Lending Fund program.
Postage has increased primarily due to the timing differences of payments.
Printing, stationery and supplies expense increased 18.6%. The increase is due to timing differences of payments and to some additional costs related to the outsourced printing of statements.

LIQUIDITY

Liquidity is a measure of the Bank’s ability to respond to sudden changes in funding needs or funding sources. Examples of sudden changes could involve a sudden increase in loan demand, a funding need, or it might involve a large decrease in deposited funds, a funding source. The role of cash management is to manage assets and liabilities so that the Bank can respond to such fluctuations in sources and uses of cash. Management spends much of its time assessing our liquidity position.

Management is informed of the liquidity information via reports and committee discussion. The president is provided a weekly “dashboard” report of our liquidity information. The Asset/Liability Committee reviews and discusses our liquidity position on a quarterly basis. The committee has set a benchmark minimum liquidity ratio of 15%. Management has recently worked on a strategy to free up some pledged assets for liquidity purposes.

Public funds are required to have collateral pledged against their balances above the FDIC insurance limits. Generally the bank has pledged securities or obtained letters of credit from the Federal Home Loan Bank of Pittsburgh to cover public funds. Two additional strategies to cover these funds are being considered. In the case of public funds in the form of CDs, the bank plans to aid customers in utilizing the CDARS network to insure their funds. We are also exploring the use of the Insured Cash Sweep (ICS) product to secure public funds. Both of the programs provide complete coverage through FDIC insurance. Most importantly, the securities that had been pledged against the public funds can be used as a source of cash if the need would arise. The securities are effectively converted from a non liquid asset to a liquid asset.

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, 2011.

Operating Activities. The company’s net income usually 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 2011, the net income as adjusted has provided cash of $1.0 million. Interest income earned on loans and investment securities is the company’s major income source.

Investing Activities. Customer core deposits and company noncore funding provide the funds used to invest in loans and investment securities. In addition, the principal portion of loan payments, loan payoffs and maturity of investment securities provide cash flow. Purchases of bank premises and equipment are an investing activity. As mentioned in the section on deposits, we have taken advantage of our noncore funding capabilities since deposit growth is not always sufficient. The net amount of cash used in investing activities in 2011 is $4.3 million.

		Financing Activities. Customer core deposits and company noncore funding 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 noncore funding. The net amount of cash provided by financing activities in 2010 is $14.4 million. At March 31, 2011, 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 $51.6 million. Noncore funding capabilities, including borrowing, provide additional liquidity. The subsidiary bank maintains a federal funds line with one financial institution and is a member of the Federal Home Loan Bank of Pittsburgh. In March 2010, the subsidiary bank modified a $3 million borrowing amortizing over three years from the Federal Home Loan Bank. In July 2009 the subsidiary bank secured a credit line with the Federal Reserve discount window. At March 31, 2011, the subsidiary bank has total credit available through these institutions of approximately $28.4 million. ANALYSIS OF CAPITAL The adequacy of the company’s capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the company’s asset and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The company had a ratio of total capital to risk-weighted assets of 14.14% and a ratio of tier 1 capital to risk-weighted assets of 12.88% at March 31, 2011. Both ratios exceed the capital requirements adopted by the federal regulatory agencies.

Item 4. Controls and Procedures

		Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

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

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

ISSUER PURCHASES OF EQUITY SECURITIES

			(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
January 1 through
January 31	NONE	- -	283 553	62 515
February 1 through
February 28	NONE	- -	283 553	62 515
March 1 through
March 31	NONE	- -	283 553	62 515

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

Item 4. (Removed and Reserved)

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)

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 16, 2011	/s/ Robert F. Baronner, Jr.
		Robert F. Baronner, Jr.
		President & CEO

Date:	May 16, 2011	/s/ Gayle Marshall Johnson
		Gayle Marshall Johnson
		Sr. Vice President and Chief Financial Officer