UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
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) |
(IRS employer identification number) |
111 East Washington Street
PO Box 906
Charles Town WV 25414
(Address of principal executive offices) (zip code)
304-725-8431
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x
As of November 5, 2004, Potomac Bancshares, Inc. had 1,696,561 shares of common stock outstanding.
FORM 10-Q
September 30, 2004
INDEX
| PAGE | ||||
| PART I. |
||||
| Item 1. |
||||
| Consolidated Balance Sheets as of September 30, 2004 (Unaudited) and December 31, 2003 (Audited) |
3 | |||
| 4 | ||||
| 5 | ||||
| 6 | ||||
| 7 – 10 | ||||
| Item 2. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
10 | ||
| Item 3. |
14 | |||
| Item 4. |
15 | |||
| Part II. |
||||
| Item 1. |
15 | |||
| Item 2. |
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. |
15 | ||
| Item 5. |
16 | |||
| Item 6. |
16 | |||
| Signatures | 17 | |||
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,” 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.
2
CONSOLIDATED BALANCE SHEETS
(000 OMITTED)
| (Unaudited) September 30 |
December 31 2003 | |||||
| Assets: |
||||||
| Cash and due from banks |
$ | 11 301 | $ | 102 98 | ||
| Interest-bearing deposits in financial institutions |
82 | 336 | ||||
| Securities purchased under agreements to resell and federal funds sold |
495 | 2 390 | ||||
| Securities held to maturity (fair value $6,039 at December 31, 2003) |
— | 6 001 | ||||
| Securities available for sale, at fair value |
46 867 | 38 425 | ||||
| Loans held for sale |
494 | 564 | ||||
| Loans, net of allowance for loan losses of $1,948 and $1,724 respectively |
163 072 | 138 334 | ||||
| Bank premises and equipment, net |
5 269 | 4 992 | ||||
| Accrued interest receivable |
914 | 909 | ||||
| Other assets |
4 737 | 4 394 | ||||
| Total Assets |
$ | 233 231 | $ | 206 643 | ||
| Liabilities and Stockholders’ Equity: |
||||||
| Liabilities: |
||||||
| Deposits |
||||||
| Noninterest-bearing deposits |
$ | 32 858 | $ | 25 396 | ||
| Interest-bearing deposits |
165 615 | 147 860 | ||||
| Total Deposits |
198 473 | 173 256 | ||||
| Accrued interest payable |
189 | 128 | ||||
| Securities sold under agreements to repurchase and federal funds purchased |
9 650 | 9 199 | ||||
| Federal Home Loan Bank advances |
1 458 | 1 715 | ||||
| Other liabilities |
1 074 | 1 013 | ||||
| Total Liabilities |
$ | 210 844 | $ | 185 311 | ||
| Stockholders’ Equity: |
||||||
| Common stock, $1 per share par value; 5,000,000 shares authorized; 1,800,000 shares issued |
$ | 1 800 | $ | 1 800 | ||
| Surplus |
4 200 | 4 200 | ||||
| Undivided profits |
18 070 | 16 543 | ||||
| Accumulated other comprehensive income, net |
168 | 498 | ||||
| $ | 24 238 | $ | 23 041 | |||
| Less cost of shares acquired for the treasury, 2004, 103,439 shares; 2003, 97,329 shares |
1 851 | 1 709 | ||||
| Total Stockholders’ Equity |
$ | 22 387 | $ | 21 332 | ||
| Total Liabilities and Stockholders’ Equity |
$ | 233 231 | $ | 206 643 | ||
See Notes to Consolidated Financial Statements.
3
CONSOLIDATED STATEMENTS OF INCOME
(000 omitted except for per share data)
(Unaudited)
| For the Three Months Ended September 30 |
For the Nine Months Ended September 30 | |||||||||||||
| 2004 |
2003 |
2004 |
2003 | |||||||||||
| Interest and Dividend Income: |
||||||||||||||
| Interest and fees on loans |
$ | 2 688 | $ | 2 242 | $ | 7 486 | $ | 6 548 | ||||||
| Interest on securities held to maturity - taxable |
— | 75 | 35 | 284 | ||||||||||
| Interest on securities available for sale - taxable |
402 | 357 | 1 163 | 1 133 | ||||||||||
| Interest on secuirities available for sale – nontaxable |
2 | — | 2 | — | ||||||||||
| Interest on securities purchased under agreements to resell and federal funds sold |
2 | 7 | 29 | 36 | ||||||||||
| Other interest and dividends |
2 | 3 | 6 | 16 | ||||||||||
| Total Interest and Dividend Income |
$ | 3 096 | $ | 2 684 | $ | 8 721 | $ | 8 017 | ||||||
| Interest Expense: |
||||||||||||||
| Interest on deposits |
$ | 539 | $ | 464 | $ | 1 510 | $ | 1 498 | ||||||
| Interest on securities sold under agreements to repurchase and federal funds purchased |
60 | 42 | 151 | 125 | ||||||||||
| Federal Home Loan Bank advances |
21 | 26 | 66 | 80 | ||||||||||
| Total Interest Expense |
$ | 620 | $ | 532 | $ | 1 727 | $ | 1 703 | ||||||
| Net Interest Income |
$ | 2 476 | $ | 2 152 | $ | 6 994 | $ | 6 314 | ||||||
| Provision for Loan Losses |
131 | 64 | 264 | 148 | ||||||||||
| Net Interest Income after Provision for Loan Losses |
$ | 2 345 | $ | 2 088 | $ | 6 730 | $ | 6 166 | ||||||
| Noninterest Income: |
||||||||||||||
| Trust and financial services |
$ | 211 | $ | 135 | $ | 610 | $ | 393 | ||||||
| Service charges on deposit accounts |
389 | 316 | 1 114 | 863 | ||||||||||
| BCT Visa/MC Fees |
48 | 28 | 126 | 78 | ||||||||||
| Gain (loss) on sale of securities available for sale |
(28 | ) | 19 | (26 | ) | 99 | ||||||||
| Net gain on sale of loans |
46 | 98 | 119 | 318 | ||||||||||
| Cash surrender value of life insurance |
36 | 43 | 105 | 123 | ||||||||||
| Other operating income |
102 | 105 | 267 | 243 | ||||||||||
| Total Noninterest Income |
$ | 804 | $ | 744 | $ | 2 315 | $ | 2 117 | ||||||
| Noninterest Expenses: |
||||||||||||||
| Salaries and employee benefits |
$ | 1 044 | $ | 951 | $ | 2 996 | $ | 2 910 | ||||||
| Net occupancy expense of premises |
103 | 85 | 300 | 286 | ||||||||||
| Furniture and equipment expenses |
229 | 262 | 642 | 667 | ||||||||||
| Stationery and supplies |
31 | 42 | 94 | 136 | ||||||||||
| Communications |
37 | 37 | 111 | 104 | ||||||||||
| Legal and professional |
68 | 23 | 126 | 63 | ||||||||||
| Postage |
37 | 35 | 112 | 105 | ||||||||||
| Advertising and marketing |
65 | 56 | 147 | 162 | ||||||||||
| ATM and check card expenses |
51 | 44 | 143 | 122 | ||||||||||
| Other operating expenses |
304 | 250 | 866 | 711 | ||||||||||
| Total Noninterest Expenses |
$ | 1 969 | $ | 1 785 | $ | 5 537 | $ | 5 266 | ||||||
| Income before Income Tax Expense |
$ | 1180 | $ | 1 047 | $ | 3 508 | $ | 3 017 | ||||||
| Income Tax Expense |
432 | 361 | 1 243 | 1 049 | ||||||||||
| Net Income |
$ | 748 | $ | 686 | $ | 2 265 | $ | 1 968 | ||||||
| Earnings Per Share, basic and diluted |
$ | .44 | $ | .40 | $ | 1.33 | $ | 1.11 | ||||||
See Notes to Consolidated Financial Statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(000 Omitted)
(Unaudited)
| Common Stock |
Surplus |
Undivided Profits |
Treasury Stock |
Accumulated Other Comprehensive Income (Loss) |
Comprehensive Income |
Total |
|||||||||||||||||||||
| Balances, December 31, 2002 |
$ | 600 | $ | 5 400 | $ | 14 801 | $ | (248 | ) | $ | 759 | $ | 21 312 | ||||||||||||||
| Comprehensive income |
|||||||||||||||||||||||||||
| Net income |
— | — | 1 968 | — | — | $ | 1 968 | 1 968 | |||||||||||||||||||
| Other comprehensive income: |
|||||||||||||||||||||||||||
| unrealized holding (losses) arising during the period (net of tax, $116) |
— | — | — | — | (227 | ) | (227 | ) | (227 | ) | |||||||||||||||||
| Reclassification for gains included in net income (net of tax, $34) |
— | — | — | — | (65 | ) | (65 | ) | (65 | ) | |||||||||||||||||
| Total comprehensive income |
$ | 1 676 | |||||||||||||||||||||||||
| Stock split in the form of a 200% stock dividend |
1 200 | (1 200 | ) | — | — | — | — | ||||||||||||||||||||
| Cash dividends ($.26 per share) |
— | — | (698 | ) | — | — | (698 | ) | |||||||||||||||||||
| Purchase of treasury shares: |
|||||||||||||||||||||||||||
| 78,999 shares |
— | — | — | (1 461 | ) | — | (1 461 | ) | |||||||||||||||||||
| Balances, September 30, 2003 |
$ | 1 800 | $ | 4 200 | $ | 16 071 | $ | (1 709 | ) | $ | 467 | $ | 20 829 | ||||||||||||||
| Balances, December 31, 2003 |
$ | 1 800 | $ | 4 200 | $ | 16 543 | $ | (1 709 | ) | $ | 498 | $ | 21 332 | ||||||||||||||
| Comprehensive income |
|||||||||||||||||||||||||||
| Net income |
— | — | 2 265 | — | — | $ | 2 265 | 2 265 | |||||||||||||||||||
| Other comprehensive income: |
|||||||||||||||||||||||||||
| unrealized holding (losses) arising during the period (net of tax, $179) |
— | — | (347 | ) | (347 | ) | (347 | ) | |||||||||||||||||||
| Reclassification for (losses) included in net income (net of tax, $9) |
— | — | — | — | 17 | 17 | 17 | ||||||||||||||||||||
| Total comprehensive income |
$ | 1 935 | |||||||||||||||||||||||||
| Cash dividends ($.44 per share) |
— | — | (738 | ) | — | — | (738 | ) | |||||||||||||||||||
| Purchase of treasury shares: |
|||||||||||||||||||||||||||
| 6,110 shares |
— | — | — | (142 | ) | — | (142 | ) | |||||||||||||||||||
| Balances, September 30, 2004 |
$ | 1 800 | $ | 4 200 | $ | 18 070 | $ | (1 851 | ) | $ | 168 | $ | 22 387 | ||||||||||||||
See Notes to Consolidated Financial Statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000 Omitted)
(Unaudited)
| For the Nine Months Ended |
||||||||
| September 30 2004 |
September 30 2003 |
|||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income |
$ | 2 265 | $ | 1 968 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
| Provision for loan losses |
264 | 148 | ||||||
| Depreciation |
447 | 463 | ||||||
| Discount accretion and premium amortization on securities, net |
78 | 126 | ||||||
| (Gain) loss on sale of securities available for sale |
26 | (99 | ) | |||||
| Proceeds from sale of loans |
6 536 | 18 400 | ||||||
| Origination of loans for sale |
(6 466 | ) | (17 109 | ) | ||||
| Changes in assets and liabilities: |
||||||||
| (Increase) decrease in accrued interest receivable |
(5 | ) | 185 | |||||
| (Increase) in other assets |
(173 | ) | (3 131 | ) | ||||
| Increase (decrease) in accrued interest payable |
61 | (38 | ) | |||||
| Increase in other liabilities |
61 | 180 | ||||||
| Net cash provided by operating activities |
$ | 3 094 | $ | 1 093 | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Proceeds from maturity of securities held to maturity |
$ | 6 000 | $ | 3 000 | ||||
| Proceeds from maturity of securities available for sale |
1 000 | 7 000 | ||||||
| Proceeds from sale of securities available for sale |
8 974 | 8 118 | ||||||
| Proceeds from call of securities available for sale |
5 000 | — | ||||||
| Purchase of securities available for sale |
(24 019 | ) | (11 517 | ) | ||||
| Net (increase) in loans |
(25 002 | ) | (14 082 | ) | ||||
| Purchases of bank premises and equipment |
(724 | ) | (1 013 | ) | ||||
| Net cash (used in) investing activities |
$ | (28 771 | ) | $ | (8 494 | ) | ||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Net increase in noninterest-bearing deposits |
$ | 7 462 | $ | 1 858 | ||||
| Net increase in interest-bearing deposits |
17 755 | 1 178 | ||||||
| Net proceeds in securities sold under agreements to repurchase |
451 | 2 501 | ||||||
| Repayment of Federal Home Loan Bank advances |
(257 | ) | (243 | ) | ||||
| Purchase of treasury shares |
(142 | ) | (1 461 | ) | ||||
| Cash dividends |
(738 | ) | (698 | ) | ||||
| Net cash provided by financing activities |
$ | 24 531 | $ | 3 135 | ||||
| Decrease in cash and cash equivalents |
$ | (1 146 | ) | $ | (4 266 | ) | ||
| CASH AND CASH EQUIVALENTS |
||||||||
| Beginning |
13 024 | 17 128 | ||||||
| Ending |
$ | 11 878 | $ | 12 862 | ||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
||||||||
| Cash payments for: |
||||||||
| Interest |
$ | 1 666 | $ | 1 741 | ||||
| Income taxes |
$ | 1 176 | $ | 878 | ||||
| SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES |
||||||||
| Unrealized (loss) on securities available for sale |
$ | (500 | ) | $ | (442 | ) | ||
See Notes to Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 (UNAUDITED) AND DECEMBER 31, 2003
| 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 September 30, 2004, and December 31, 2003, the results of operations for the three months and nine months ended September 30, 2004 and 2003, and cash flows and statements of changes in stockholders’ equity for the nine months ended September 30, 2004 and 2003. 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, 2003. The results of operations for the three month and nine month periods ended September 30, 2004 and 2003, 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 90,000 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 17,994 options in the first quarter of 2004. There were no options granted in 2003. Options granted under the plan may be subject to a graded vesting schedule. |
The company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under the plan have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.
| For the Nine Months Ended | |||||||
| September 30 2004 |
September 30 2003 | ||||||
| (dollars in thousands, except per share amounts) | |||||||
| Net income, as reported |
$ | 2 265 | $ | 1 968 | |||
| Total stock-based compensation expense determined under fair value based method for all awards |
(30 | ) | — | ||||
| Pro forma net income |
$ | 2 235 | $ | 1 968 | |||
| Earnings per share: |
|||||||
| Basic – as reported |
$ | 1.33 | $ | 1.11 | |||
| Basic – pro forma |
$ | 1.32 | $ | 1.11 | |||
| Diluted – as reported |
$ | 1.33 | $ | 1.11 | |||
| Diluted – pro forma |
$ | 1.32 | $ | 1.11 | |||
| 3. | On February 11, 2003 the Board of Directors of Potomac Bancshares, Inc. declared a stock split in the form of a 200% stock dividend payable on March 1, 2003. Shares issued increased from 600,000 to 1,800,000. |
7
| 4. | The amortized cost and fair value of securities available for sale as of September 30, 2004 and December 31, 2003 are as follows: |
| (000 Omitted) September 30, 2004 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 46 092 | $ | 392 | $ | (146 | ) | $ | 46 338 | ||||
| Obligations of states and political subdivisions |
521 | 8 | — | 529 | |||||||||
| $ | 46 613 | $ | 400 | $ | (146 | ) | $ | 46 867 | |||||
| (000 Omitted) December 31, 2003 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 37 671 | $ | 822 | $ | (68 | ) | $ | 38 425 | ||||
| 5. | The loan portfolio, stated at face amount, is composed of the following: |
| (000 Omitted) | ||||||
| September 30 2004 |
December 31 2003 | |||||
| Mortgage loans on real estate: |
||||||
| Construction, land development and other land |
$ | 20 013 | $ | 13 957 | ||
| Secured by farmland |
2 694 | 3 711 | ||||
| Secured by 1-4 family residential |
73 299 | 60 904 | ||||
| Other real estate |
37 924 | 25 314 | ||||
| Loans to farmers (except those secured by real estate) |
232 | 257 | ||||
| Commercial and industrial loans (except those secured by real estate) |
14 400 | 17 649 | ||||
| Consumer loans |
16 303 | 17 549 | ||||
| All other loans |
155 | 717 | ||||
| Total loans |
$ | 165 020 | $ | 140 058 | ||
| Less: allowance for loan losses |
1 948 | 1 724 | ||||
| $ | 163 072 | $ | 138 334 | |||
| 6. | The following is a summary of transactions in the allowance for loan losses: |
| (000 Omitted) |
||||||||
| September 30 2004 |
December 31 2003 |
|||||||
| Balance at beginning of period |
$ | 1 724 | $ | 1 642 | ||||
| Provision charged to operating expense |
264 | 148 | ||||||
| Recoveries added to the allowance |
87 | 126 | ||||||
| Loan losses charged to the allowance |
(127 | ) | (192 | ) | ||||
| Balance at end of period |
$ | 1 948 | $ | 1 724 | ||||
8
| 7. | There were no impaired loans at September 30, 2004. At December 31, 2003 impaired loans were $340,752. |
There were no nonaccrual loans excluded from impaired loan disclosures under FASB 114 at September 30, 2004. At December 31, 2003 nonaccrual loans were $250,946.
| 8. | Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below: |
| Pension Benefits |
Postretirement Benefits | |||||||||||||
| Nine Months Ended |
Nine Months Ended | |||||||||||||
| Sept 30 2004 |
Sept 30 2003 |
Sept 30 2004 |
Sept 30 2003 | |||||||||||
| (in thousands) | (in thousands) | |||||||||||||
| Components of Net Periodic Benefit Cost |
||||||||||||||
| Service cost |
$ | 120 | $ | 120 | $ | 4 | $ | 4 | ||||||
| Interest cost |
233 | 233 | 24 | 24 | ||||||||||
| Expected return on plan assets |
(234 | ) | (234 | ) | — | — | ||||||||
| Amortization of net obligation at transition |
(15 | ) | (15 | ) | 13 | 13 | ||||||||
| Recognized net actuarial loss |
25 | 25 | — | — | ||||||||||
| Net periodic benefit cost |
$ | 129 | $ | 129 | $ | 41 | $ | 41 | ||||||
Employer Contribution
Through the nine months ended September 30, 2004, the company has contributed $255,754 to the pension plan, which is the entire contribution for 2004. The company has made payments of $17,361 for the postretirement benefits plan for the first nine months of 2004.
| 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.
| Nine Months Ended September 30, 2004 |
Nine Months Ended September 30, 2003 | |||||||||
| Unaudited |
Average Shares |
Per Share Amount |
Average Shares |
Per Share Amount | ||||||
| Basic earnings per share |
1 698 125 | $ | 1.33 | 1 766 044 | $ | 1.11 | ||||
| Effect of dilutive securities: |
||||||||||
| Stock options |
933 | — | ||||||||
| Diluted earnings per share |
1 699 058 | $ | 1.33 | 1 766 044 | $ | 1.11 | ||||
Shares outstanding have been restated to reflect the 200% stock dividend discussed in Note 3.
9
| 8. | Recent Accounting Pronouncements |
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments” (“SAB 105”). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments (“IRLC”), subject to SFAS No. 149 and Derivative Implementation Group Issue C13, “Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133.” Furthermore, SAB 105 disallows the inclusion of the values of a servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The Company has adopted the provisions of SAB 105. Since the provisions of SAB 105 affect only the timing of the recognition of mortgage banking income, management does not anticipate that this guidance will have a material adverse effect on either the Company’s consolidated financial position or consolidated results of operations.
Emerging Issues Task Force Issue No. 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”) was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of “other –than-temporarily impaired” and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”) and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the ability and intent to hold investments in instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired.
On September 30, 2004, the Financial Accounting Standards Board decided to delay the effective date for the measurement and recognition guidance contained in Issue 03-1. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure guidance in Issue 03-1 was not delayed.
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 estimatable 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.
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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.
FINANCIAL OVERVIEW
Bank of Charles Town is the wholly owned subsidiary of Potomac Bancshares, Inc. The bank is an independent commercial institution whose primary goal is to provide the best loan and deposit services to customers in the bank’s market area while providing acceptable return on the investments of Potomac’s shareholders.
Since December 31, 2003 assets have continued to grow and total $233 million at September 30, 2004. Loans are the major factor in this planned growth and expansion of Bank of Charles Town. Management has concentrated on the hiring and retention of loan originators who are capable of capturing a substantial portion of the loan growth in the bank’s major market areas of Jefferson and Berkeley Counties in West Virginia.
Deposit growth has also continued since December 31, 2003, and as of September 30, 2004 total $198 million. Deposits provide major funding for the loan and investment activities of the bank. About half of the bank’s investments are held for liquidity purposes. The remainder are used to retain, collateralize and protect a portion of the bank’s larger depositors.
Several performance measures commonly used in the banking industry are followed closely by Bank of Charles Town management to track the bank’s performance in comparison with itself and with peer groups. Return on average assets (ROA) is the ratio of net income to average total assets. As of September 30, 2004, the bank’s ROA was 1.37%. Return on average equity (ROE) is the ratio of net income to average total stockholders’ equity. The bank’s ROE at September 30, 2004 was 13.82%. The leverage capital ratio is the ratio of total stockholders’ equity to total assets. The bank’s leverage capital ratio is 9.55% at September 30, 2004. To be considered a well-capitalized bank by the Federal Deposit Insurance Corporation regulators, the leverage capital ratio must be at least 5%.
The following table is an analysis of the company’s allowance for loan losses. 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. The loan policy regarding the grading and review system has recently been revised to enhance procedures for our growing portfolio of commercial loans as well as to update procedures for all other loans. Written reports are prepared on a quarterly basis for all loans. Information on commercial loans graded below a certain level is 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.
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| (000 Omitted) September 30, 2004 |
||||
| Balance at beginning of period |
$ | 1 724 | ||
| Charge-offs: |
||||
| Commercial, financial and agricultural |
— | |||
| Real estate – construction |
— | |||
| Real estate – mortgage |
3 | |||
| Consumer |
124 | |||
| Total charge-offs |
127 | |||
| Recoveries: |
||||
| Commercial, financial and agricultural |
— | |||
| Real estate – construction |
— | |||
| Real estate – mortgage |
— | |||
| Consumer |
87 | |||
| Total recoveries |
87 | |||
| Net charge-offs |
40 | |||
| Additions charged to operations |
264 | |||
| Balance at end of period |
$ | 1 948 | ||
| Ratio of net charge-offs during the period to average loans outstanding during the period |
.026 | % | ||
Loans are placed on nonaccrual status when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Following is a table showing the risk elements in the loan portfolio.
| (000 Omitted) September 30, 2004 |
||||
| Nonaccrual loans |
$ | — | ||
| Restructured loans |
— | |||
| Foreclosed properties |
— | |||
| Total nonperforming assets |
$ | — | ||
| Loans past due 90 days accruing interest |
$ | 40 | ||
| Allowance for loan losses to period end loans |
1.18 | % | ||
| Nonperforming assets to period end loans and foreclosed properties |
— | |||
At September 30, 2004, other potential problem loans (excluding impaired loans) totalled $682,570. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis. Management has allocated a portion of the allowance for these loans.
The comparison of the income statements for the three months ended September 30, 2004 and 2003 and for the nine months ended September 30, 2004 and 2003 shows similar differences between 2004 and 2003. Through June 30, total interest and dividend income increased due to loan fee income. The interest and dividend income increase during the third quarter was due to the prime rate increases. While income on the securities portfolio is down 15% at September 30, 2004 compared to September 30, 2003 due to lower interest rates, total interest and dividend income in 2004 is above 2003 levels due to performance of the loan portfolio. At the end of the first nine months of 2004, interest expense is at about the same level for the same time period in 2003. Net interest income has increased 11% in 2004 compared to 2003 with the increase in interest and dividend income and the same level of interest expense.
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Noninterest income increased 9% for the nine months ended September 30, 2004 compared to September 30, 2003. Particular accounts to note are listed below.
| • | Significant income growth has occurred in trust and financial services due primarily to fee accruals on several large estates as well as the addition of brokerage fees and commissions from BCT Investments. |
| • | Service charges on deposit accounts and credit and debit card fees have increased due to fee increases effective August 1, 2003 and the growth in the deposit account base. |
| • | Fees from production of secondary market loans are down since secondary market rates have increased. |
| • | Income from the increase in cash surrender value of life insurance has decreased 14.6% as of September 30, 2004 compared to September 30, 2003 due to decreased rates on one of our three policies. |
Other operating income has increased 10% as of September 30, 2004 compared to September 30, 2003. The most significant increase in this category is in the other fee income account due to fee increases effective August 1, 2003 and growth in the bank’s customer base.
Noninterest expense increased 5% for the nine months ended September 30, 2004 compared to the same period in 2003. Significant items to note are listed below.
| • | Group insurance expense is $40,000 less in 2004 than in 2003. During the first quarter of 2003 fees were being paid to our previous group insurance vendor in addition to paying the expense of our current vendor. |
| • | 401(k) expense in the first nine months of 2004 is more than the same time period in 2003 due to increase in the number of participants and increased contributions by the participants which in turn increases the employer expense. The increase in 401(k) expense is a positive position since management believes the plan is an incentive for good employees to remain at Bank of Charles Town. |
| • | Stationery and supplies expense has decreased 31% at September 30, 2004 compared to September 30, 2003 due to fewer mass mailings and completion of the computer conversion which had created some extra expense. |
| • | Advertising and marketing expenses have decreased in 2004 compared to 2003 as a result of intentional spending reductions. |
| • | ATM and check card expenses have increased in the first nine months of 2004 compared to the same time period in 2003 primarily due to growth in the deposit account base. |
| • | Increase in legal and professional fees due to payments to an outside firm who is currently doing bank wide operational efficiency and economical studies. |
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Other operating expenses have increased 22% at September 30, 2004 compared to September 30, 2003. Significant increases in this category include the following.
| • | Contributions have increased as a result of spreading the expense throughout the year rather than making all expenditures at year end. |
| • | Fees for the overdraft protection program have increased due to deposit growth and a fee increase effective August 1, 2003. |
| • | Directors and committee fees have increased beginning in the second quarter with the election of two new directors in March 2004. |
| • | In the trust department area a fee collected in a prior period in error was refunded with interest during the second quarter of 2004. |
| • | Home equity closing costs have increased due to increased loan volume. |
| • | Online banking expense is more than 2003 due to paying the remainder of a previous maintenance contract after we had begun using Jack Henry & Associates and paying for JHA maintenance. |
| • | Incurrence of two new expense items: outsourcing of investment review of certain trust department accounts and the outsourcing of the internal audit function. |
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 the transactions of this liquidity since January 1, 2004.
Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions such as depreciation expense that reduces net income but does not require a cash outlay. Through September 30, 2004 net income as adjusted has provided cash of $4,270 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, principal portion of loan payments and payoffs and investment maturities provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash used in investing activities in 2004 through September 30 is $28,771 thousand.
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 2004 through September 30 is $24,531 thousand.
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 to the quantitative and qualitative disclosures made in the second quarter 10Q.
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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.
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. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
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 |
3,854 | $ | 22.90 | 101,183 | 78,817 | ||||
| February 1 through February 29 |
NONE | — | — | — | |||||
| March 1 through March 31 |
NONE | — | — | — | |||||
| April 1 through April 30 |
NONE | — | — | — | |||||
| May 1 through May 31 |
NONE | — | — | — | |||||
| June 1 through June 30 |
2,256 | $ | 23.50 | 103,439 | 76,561 | ||||
| July 1 through July 31 |
NONE | — | — | — | |||||
| August 1 through August 31 |
NONE | — | — | — | |||||
| September 1 through September 30 |
NONE | — | — | — | |||||
| Total |
6,110 | ||||||||
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.
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| (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. |
| 2. | Plan of acquisition, reorganization, arrangement, liquidation or succession. | |
| Not applicable | ||
| 4. | Instruments defining the rights of security holders, including indentures. | |
| Not applicable | ||
| 10. | Material contracts. | |
| Not applicable | ||
| 11. | Statement re: computation of per share earnings. | |
| Not applicable | ||
| 15. | Letter on unaudited interim financial information. | |
| Not applicable | ||
| 18. | Letter on change in accounting principles. | |
| Not applicable | ||
| 19. | Reports furnished to security holders. | |
| Not applicable | ||
| 22. | Published report regarding matters submitted to vote of security holders. | |
| Not applicable | ||
| 23. | Consent of experts and counsel. | |
| Not applicable | ||
| 24. | Power of attorney. | |
| Not applicable | ||
| 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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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 November 12, 2004 | /s/ Robert F. Baronner, Jr. | |
| Robert F. Baronner, Jr. | ||
| President & CEO | ||
| Date November 12, 2004 | /s/ Gayle Marshall Johnson | |
| Gayle Marshall Johnson | ||
| Vice President and Chief Financial Officer | ||
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