UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark one)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2007
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-24958
POTOMAC BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
| West Virginia | 55-0732247 | |
| (State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
| 111 East Washington Street PO Box 906, Charles Town WV |
25414-0906 | |
| (Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code 304-725-8431
Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
3,410,000 as of August 10, 2007
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
June 30, 2007
INDEX
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 evidences Congress’ determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. “Forward-looking statements” are easily identified by the use of words such 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 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, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, Congressional legislation and similar matters as well as the occurrence of the events described in the “Risk Factors” section of the December 31, 2006 Form 10-K. 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
| Item 1. | Financial Statements |
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
| (Unaudited) | ||||||||
| June 30 2007 |
December 31 2006 |
|||||||
| Assets: |
||||||||
| Cash and due from banks |
$ | 7 806 | $ | 6 214 | ||||
| Interest-bearing deposits in financial institutions |
167 | 367 | ||||||
| Securities purchased under agreements to resell and federal funds sold |
3 402 | 345 | ||||||
| Securities available for sale, at fair value |
42 105 | 42 706 | ||||||
| Loans held for sale |
465 | 405 | ||||||
| Loans, net of allowance for loan losses of $2,406 and $2,423 respectively |
223 397 | 227 646 | ||||||
| Premises and equipment, net |
6 306 | 6 421 | ||||||
| Accrued interest receivable |
1 420 | 1 431 | ||||||
| Other assets |
7 655 | 7 214 | ||||||
| Total Assets |
$ | 292 723 | $ | 292 749 | ||||
| Liabilities and Stockholders’ Equity: |
||||||||
| Liabilities: |
||||||||
| Deposits |
||||||||
| Noninterest-bearing deposits |
$ | 29 721 | $ | 29 873 | ||||
| Interest-bearing deposits |
221 596 | 221 905 | ||||||
| Total Deposits |
251 317 | 251 778 | ||||||
| Accrued interest payable |
614 | 672 | ||||||
| Securities sold under agreements to repurchase and federal funds purchased |
10 321 | 10 526 | ||||||
| Federal Home Loan Bank advances |
419 | 620 | ||||||
| Other liabilities |
1 999 | 2 436 | ||||||
| Total Liabilities |
$ | 264 670 | $ | 266 032 | ||||
| Stockholders’ Equity: |
||||||||
| Common stock, $1 per share par value; 5,000,000 shares authorized; 3,671,691 shares issued |
$ | 3 672 | $ | 3 672 | ||||
| Surplus |
3 762 | 3 661 | ||||||
| Undivided profits |
24 030 | 22 677 | ||||||
| Accumulated other comprehensive (loss) |
(1 132 | ) | (1 014 | ) | ||||
| $ | 30 332 | $ | 28 996 | |||||
| Less cost of shares acquired for the treasury, 238,108 shares |
2 279 | 2 279 | ||||||
| Total Stockholders’ Equity |
$ | 28 053 | $ | 26 717 | ||||
| Total Liabilities and Stockholders’ Equity |
$ | 292 723 | $ | 292 749 | ||||
See Notes to Consolidated Financial Statements.
3
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
(Unaudited)
| For the Three Months Ended June 30 |
For the Six Months Ended June 30 | |||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||
| Interest and Dividend Income: |
||||||||||||
| Interest and fees on loans |
$ | 4 315 | $ | 4 131 | $ | 8 599 | $ | 7 979 | ||||
| Interest on securities available for sale—taxable |
495 | 533 | 982 | 1 017 | ||||||||
| Interest on securities available for sale—nontaxable |
19 | 13 | 35 | 26 | ||||||||
| Interest on securities purchased under agreement to resell and federal funds sold |
131 | 26 | 257 | 33 | ||||||||
| Other interest and dividends |
54 | 53 | 97 | 88 | ||||||||
| Total Interest and Dividend Income |
$ | 5 014 | $ | 4 756 | $ | 9 970 | $ | 9 143 | ||||
| Interest Expense: |
||||||||||||
| Interest on deposits |
$ | 1 869 | $ | 1 460 | $ | 3 892 | $ | 2 677 | ||||
| Interest on securities sold under agreements to repurchase and federal funds purchased |
104 | 135 | 205 | 293 | ||||||||
| Federal Home Loan Bank advances |
7 | 16 | 15 | 59 | ||||||||
| Total Interest Expense |
$ | 1 980 | $ | 1 611 | $ | 4 112 | $ | 3 029 | ||||
| Net Interest Income |
$ | 3 034 | $ | 3 145 | $ | 5 858 | $ | 6 114 | ||||
| Provision for Loan Losses |
— | 75 | — | 75 | ||||||||
| Net Interest Income after Provision for Loan Losses |
$ | 3 034 | $ | 3 070 | $ | 5 858 | $ | 6 039 | ||||
| Noninterest Income: |
||||||||||||
| Trust and financial services |
$ | 267 | $ | 356 | $ | 526 | $ | 594 | ||||
| Service charges on deposit accounts |
505 | 444 | 950 | 838 | ||||||||
| BCT Visa/MC Fees |
115 | 90 | 212 | 169 | ||||||||
| Other operating income |
201 | 181 | 349 | 316 | ||||||||
| Total Noninterest Income |
$ | 1 088 | $ | 1 071 | 2 037 | 1 917 | ||||||
| Noninterest Expenses: |
||||||||||||
| Salaries and employee benefits |
$ | 1 188 | $ | 1 300 | $ | 2 463 | $ | 2 630 | ||||
| Net occupancy expense of premises |
135 | 129 | 276 | 273 | ||||||||
| Furniture and equipment expenses |
231 | 223 | 461 | 433 | ||||||||
| Advertising and marketing |
47 | 79 | 113 | 151 | ||||||||
| Miscellaneous expense |
152 | 19 | 155 | 56 | ||||||||
| ATM and check card expenses |
95 | 82 | 181 | 152 | ||||||||
| Other operating expenses |
545 | 503 | 1 048 | 983 | ||||||||
| Total Noninterest Expenses |
$ | 2 393 | $ | 2 335 | $ | 4 697 | $ | 4 678 | ||||
| Income before Income Tax Expense |
$ | 1 729 | $ | 1 806 | $ | 3 198 | $ | 3 278 | ||||
| Income Tax Expense |
626 | 620 | 1 150 | 1 154 | ||||||||
| Net Income |
$ | 1 103 | $ | 1 186 | $ | 2 048 | $ | 2 124 | ||||
| Earnings Per Share, basic |
$ | .32 | $ | .34 | $ | .60 | .61 | |||||
| Earnings Per Share, diluted |
$ | .32 | $ | .34 | $ | .59 | .61 | |||||
See Notes to Consolidated Financial Statements.
4
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(in thousands except per share data)
(Unaudited)
| Common Stock |
Surplus | Undivided Profits |
Treasury Stock |
Accumulated Other Comprehensive (Loss) |
Comprehensive Income |
Total | ||||||||||||||||||||
| Balances, December 31, 2005 |
$ | 3 600 | $ | 2 400 | $ | 21 158 | $ | (1 850 | ) | $ | (276 | ) | $ | 25 032 | ||||||||||||
| Comprehensive income |
||||||||||||||||||||||||||
| Net income |
— | — | 2 124 | — | — | $ | 2 124 | 2 124 | ||||||||||||||||||
| Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $82) |
— | — | — | — | (159 | ) | (159 | ) | (159 | ) | ||||||||||||||||
| Total comprehensive income |
$ | 1 965 | ||||||||||||||||||||||||
| 2% stock dividend |
72 | 1 149 | (1 221 | ) | — | — | — | |||||||||||||||||||
| Stock compensation expense |
— | 85 | — | — | — | 85 | ||||||||||||||||||||
| Cash dividends ($.18 per share) |
— | — | (631 | ) | — | — | (631 | ) | ||||||||||||||||||
| Balances, June 30, 2006 |
$ | 3 672 | $ | 3 634 | $ | 21 430 | $ | (1 850 | ) | $ | (435 | ) | $ | 26 451 | ||||||||||||
| Balances, December 31, 2006 |
$ | 3 672 | $ | 3 661 | $ | 22 677 | $ | (2 279 | ) | $ | (1 014 | ) | $ | 26 717 | ||||||||||||
| Comprehensive income |
||||||||||||||||||||||||||
| Net income |
— | — | 2 048 | — | — | $ | 2 048 | 2 048 | ||||||||||||||||||
| Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $61) |
— | — | — | — | (118 | ) | (118 | ) | (118 | ) | ||||||||||||||||
| Total comprehensive income |
$ | 1 930 | ||||||||||||||||||||||||
| Stock compensation expense |
— | 101 | — | — | — | 101 | ||||||||||||||||||||
| Cash dividends ($.20 per share) |
— | — | (695 | ) | — | — | (695 | ) | ||||||||||||||||||
| Balances, June 30, 2007 |
$ | 3 672 | $ | 3 762 | $ | 24 030 | $ | (2 279 | ) | $ | (1 132 | ) | $ | 28 053 | ||||||||||||
See Notes to Consolidated Financial Statements.
5
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
| For the Six Months Ended | ||||||||
| June 2007 | June 2006 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income |
$ | 2 048 | $ | 2 124 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
| Provision for loan losses |
— | 75 | ||||||
| Depreciation |
282 | 280 | ||||||
| Discount accretion and premium amortization on securities, net |
(48 | ) | (53 | ) | ||||
| Stock compensation expense |
101 | 85 | ||||||
| Proceeds from sale of loans |
5 205 | 3 840 | ||||||
| Origination of loans for sale |
(5 265 | ) | (4 529 | ) | ||||
| Changes in assets and liabilities: |
||||||||
| Decrease (increase) in accrued interest receivable |
11 | (89 | ) | |||||
| (Increase) in other assets |
(306 | ) | (220 | ) | ||||
| (Decrease) increase in accrued interest payable |
(58 | ) | 69 | |||||
| (Decrease) in other liabilities |
(437 | ) | (552 | ) | ||||
| Net cash provided by operating activities |
$ | 1 533 | $ | 1 030 | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Proceeds from maturity of securities available for sale |
$ | 9 800 | $ | 5 500 | ||||
| Proceeds from call of securities available for sale |
5 035 | — | ||||||
| Purchase of securities available for sale |
(14 363 | ) | (9 183 | ) | ||||
| Net decrease (increase) in loans |
4 174 | (12 018 | ) | |||||
| Purchases of premises and equipment |
(168 | ) | (771 | ) | ||||
| Net cash provided by (used in) investing activities |
$ | 4 478 | $ | (16 472 | ) | |||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Net (decrease) increase in noninterest-bearing deposits |
$ | (152 | ) | $ | 950 | |||
| Net (decrease) increase in interest-bearing deposits |
(309 | ) | 15 234 | |||||
| Net (repayment) of securities sold under agreements to repurchase and federal funds sold |
(205 | ) | (7 667 | ) | ||||
| Net (repayment) proceeds of Federal Home Loan Bank advances |
(201 | ) | 5 810 | |||||
| Cash dividends |
(695 | ) | (631 | ) | ||||
| Net cash (used in) provided by financing activities |
$ | (1 562 | ) | $ | 13 696 | |||
| Increase (decrease) in cash and cash equivalents |
$ | 4 449 | $ | (1 746 | ) | |||
| CASH AND CASH EQUIVALENTS |
||||||||
| Beginning |
6 926 | 8 472 | ||||||
| Ending |
$ | 11 375 | $ | 6 726 | ||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
||||||||
| Cash payments for: |
||||||||
| Interest |
$ | 4 171 | $ | 2 960 | ||||
| Income taxes |
$ | 1 377 | $ | 1 522 | ||||
| SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES |
||||||||
| Unrealized (loss) on securities available for sale |
$ | (179 | ) | $ | (241 | ) | ||
See Notes to Consolidated Financial Statements.
6
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007 (UNAUDITED) AND DECEMBER 31, 2006
| 1. | In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of June 30, 2007, and December 31, 2006, the results of operations for the three months and six months ended June 30, 2007 and 2006, and cash flows and statements of changes in stockholders’ equity for the six months ended June 30, 2007 and 2006. 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, 2006. The results of operations for the three month and six month periods ended June 30, 2007 and 2006 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 183,600 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. On April 24, 2007 the shareholders authorized an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. 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 36,723 options in the first quarter of 2007 and 45,889 options in the first quarter of 2006. Options granted under the plan may be subject to a graded vesting schedule. |
In December 2004, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment” (SFAS 123R). SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant and eliminates the choice to account for employee stock options under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). The company adopted SFAS 123R effective January 1, 2006 using the modified prospective method and as such, results for prior periods have not been restated. Prior to January 1, 2006, no compensation expense was recognized for stock option grants as all such grants had an exercise price not less than fair market value on the date of grant.
Incremental stock-based compensation expense recognized for the six month period ending June 30, 2007 was $101 thousand. Although the stock-based compensation expense reduced net income, it had no impact on basic and diluted earnings per share at June 30, 2007.
Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. The weighted average estimated fair value of stock options granted in the six months ended June 30, 2007 and 2006 was $3.76 and $3.88, respectively. Fair value is estimated using the Black-Scholes option-pricing model with the following assumptions for grants during 2007 and 2006: option term until exercise 10 years, expected volatility of 19.56% and 17.86%, risk-free interest rates of 4.66% and 4.43%, and expected dividend yields of 2.74% and 2.66%, respectively.
7
Stock option plan activity for the six months ended June 30, 2007 is summarized below:
| Shares (in thousands) |
Weighted Average Exercise Price |
Weighted Average Remaining Contractual Life (in years) |
Aggregate Intrinsic Value (in thousands) | |||||||
| (dollars in thousands, except per share amounts) | ||||||||||
| Options outstanding, January 1 |
116 | $ | 14 | |||||||
| Granted |
37 | 16 | ||||||||
| Exercised |
— | — | ||||||||
| Canceled or expired |
— | — | ||||||||
| Options outstanding, June 30 |
153 | 15 | 8 | $ | 968 | |||||
| Options exercisable, June 30 |
84 | 14 | 8 | $ | 643 | |||||
As of June 30, 2007 there was $211 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining requisite service period.
| 3. | On March 14, 2006 the Board of Directors of Potomac Bancshares, Inc. declared a 2% stock dividend payable on June 1, 2006. Shares issued increased from 3,600,000 to 3,671,691. All per share information for all periods presented has been restated to reflect this dividend. |
| 4. | The amortized cost and fair value of securities available for sale as of June 30, 2007 and December 31, 2006 (in thousands) are as follows: |
| June 30, 2007 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 40 457 | $ | — | $ | (359 | ) | $ | 40 098 | ||||
| State and municipal obligations |
2 057 | — | (50 | ) | 2 007 | ||||||||
| $ | 42 514 | $ | — | $ | (409 | ) | $ | 42 105 | |||||
| December 31, 2006 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 41 213 | $ | 16 | $ | (242 | ) | $ | 40 987 | ||||
| State and municipal obligations |
1 725 | 3 | (9 | ) | 1 719 | ||||||||
| $ | 42 938 | $ | 19 | $ | (251 | ) | $ | 42 706 | |||||
The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. The primary cause of impairments is the decline in the prices of the bonds as rates have risen. There are approximately 33 accounts in the consolidated portfolio that have losses at June 30, 2007. These securities have not suffered credit deterioration and the company has the ability and intent to hold these issues to maturity; therefore, the gross unrealized losses are considered temporary as of June 30, 2007.
The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of June 30, 2007 and December 31, 2006 (in thousands).
8
| June 30, 2007 | |||||||||||||||||||||
| Less than 12 months | More than 12 months | Total | |||||||||||||||||||
| Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
||||||||||||||||
| Obligations of U.S. Government agencies |
$ | 20 313 | $ | (170 | ) | $ | 17 786 | $ | (189 | ) | $ | 38 099 | $ | (359 | ) | ||||||
| State and municipal obligations |
1 287 | (33 | ) | 720 | (17 | ) | 2 007 | (50 | ) | ||||||||||||
| Total |
$ | 21 600 | $ | (203 | ) | $ | 18 506 | $ | (206 | ) | $ | 40 106 | $ | (409 | ) | ||||||
| December 31, 2006 | |||||||||||||||||||||
| Less than 12 months | More than 12 months | Total | |||||||||||||||||||
| Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
||||||||||||||||
| Obligations of U.S. Government agencies |
$ | 6 753 | $ | (11 | ) | $ | 20 733 | $ | (231 | ) | $ | 27 486 | $ | (242 | ) | ||||||
| State and municipal obligations |
— | — | 731 | (9 | ) | 731 | (9 | ) | |||||||||||||
| Total |
$ | 6 753 | $ | (11 | ) | $ | 21 464 | $ | (240 | ) | $ | 28 217 | $ | (251 | ) | ||||||
| 5. | The loan portfolio, stated at face amount, is composed of the following: |
| June 30 2007 |
December 31 2006 | |||||
| (in thousands) | ||||||
| Mortgage loans on real estate: |
||||||
| Construction, land development and other land |
$ | 53 717 | $ | 53 801 | ||
| Secured by farmland |
1 715 | 1 557 | ||||
| Secured by 1-4 family residential |
99 440 | 103 983 | ||||
| Secured by multifamily residential |
3 684 | 3 733 | ||||
| Secured by nonfarm nonresidential |
47 324 | 46 367 | ||||
| Commercial and industrial loans (except those secured by real estate) |
4 599 | 4 247 | ||||
| Consumer loans |
15 107 | 16 089 | ||||
| All other loans |
217 | 292 | ||||
| Total loans |
$ | 225 803 | $ | 230 069 | ||
| Less: allowance for loan losses |
2 406 | 2 423 | ||||
| $ | 223 397 | $ | 227 646 | |||
| 6. | The following is a summary of transactions (in thousands) in the allowance for loan losses: |
| June 30 2007 |
June 30 2006 |
|||||||
| Balance at beginning of period |
$ | 2 423 | $ | 2 161 | ||||
| Provision charged to operating expense |
— | 75 | ||||||
| Recoveries added to the allowance |
89 | 62 | ||||||
| Loan losses charged to the allowance |
(106 | ) | (77 | ) | ||||
| Balance at end of period |
$ | 2 406 | $ | 2 221 | ||||
9
| 7. | There were no impaired loans at June 30, 2007 and at December 31, 2006. There were no nonaccrual loans at June 30, 2007 and $144 thousand in nonaccrual loans at December 31, 2006. |
| 8. | Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below: |
| Pension Benefits | Postretirement Benefits | ||||||||||||||
| Six Months Ended | Six Months Ended | ||||||||||||||
| June 30 2007 |
June 30 2006 |
June 30 2007 |
June 30 2006 |
||||||||||||
| (in thousands) | (in thousands) | ||||||||||||||
| Components of Net Periodic Benefit Cost |
|||||||||||||||
| Service cost |
$ | 137 | $ | 113 | $ | 5 | $ | 4 | |||||||
| Interest cost |
162 | 157 | 15 | 15 | |||||||||||
| Expected return on plan assets |
(166 | ) | (157 | ) | — | — | |||||||||
| Amortization of net obligation (asset) at transition |
— | (8 | ) | 9 | 9 | ||||||||||
| Recognized net actuarial (gain)loss |
18 | 14 | — | (1 | ) | ||||||||||
| Net periodic benefit cost |
$ | 151 | $ | 119 | $ | 29 | $ | 27 | |||||||
Employer Contribution
Through the six months ended June 30, 2007, the company has contributed $485,000 to the pension plan. The company has made payments of $10,404 for the postretirement benefits plan for the first six months of 2007 and anticipates remaining payments for 2007 to total $12,536.
| 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 available to shareholders.
| Six Months Ended June 30, 2007 |
Six Months Ended June 30, 2006 | |||||||||
| Average Shares | Per Share Amount | Average Shares | Per Share Amount | |||||||
| Basic earnings per share |
3 433 583 | $ | .60 | 3 460 676 | $ | .61 | ||||
| Effect of dilutive securities: |
||||||||||
| Stock options |
9 043 | 17 840 | ||||||||
| Diluted earnings per share |
3 442 626 | $ | .59 | 3 478 516 | $ | .61 | ||||
As of June 30, 2007 stock options representing 79,960 shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.
Average shares outstanding for all periods presented have been restated to reflect the 2% stock dividend discussed in Note 3.
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| 10. | Recent Accounting Pronouncements |
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but may change current practice for some entities. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The company does not expect the implementation of SFAS 157 to have a material impact on its consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses in earnings on items for which the fair value option has been elected at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The company is in the process of evaluating the impact SFAS 159 may have on its consolidated financial statements.
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
CRITICAL ACCOUNTING POLICIES
General
The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and can be estimated; and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
Our allowance for loan losses has two basic components: the formula allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in the formula allowance.
FINANCIAL OVERVIEW
The bank is currently experiencing a decrease in loan demand. This trend has affected our deposit strategy. We had been offering CD specials to increase deposits. The bank is no longer offering these specials in an attempt to keep expenses under control until loan demand begins to increase. We anticipate loan demand will begin to pick up in the first six months of 2008. The effect on the balance sheet and income statement are outlined below.
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Total assets are basically unchanged from the December 2006 total of $292.7 million with a decrease of $26 thousand or .01%. Since loan demand has been low the excess deposits have been invested in federal funds sold. The choice to invest in federal funds sold is driven by two factors. Federal funds sold are currently competitive with other investment options and they provide better liquidity than other investment options.
Total deposits have decreased $.5 million or .2% at June 30, 2007 compared to December 31, 2006. The decrease in noninterest-bearing deposits is .5% at June 30, 2007 compared to December 31, 2006. Interest-bearing deposits have decreased .1% during the same time period. The bank initiated the use of brokered CDs approximately two years ago. We currently buy brokered CDs directly and participate in the CDARS program. The bank is not renewing brokered CDs because of the decrease in loan demand and to reduce the interest expense incurred for these deposits. In addition, core CDs and deposits in the CDARS program have increased because of the CD specials offered in the past and higher rates paid on CDARS deposits.
The June 30, 2007 annualized return on average assets is 1.36% compared to 1.39% at December 31, 2006. At June 30, 2007 the annualized return on average equity is 14.81% compared to 15.15% at December 31, 2006. The leverage capital (equity to assets) ratio is 9.68% at June 30, 2007 compared to 9.34% at December 31, 2006. The Tier 1 capital (equity to total risk weighted assets) ratio is 13.32% at June 30, 2007 compared to 12.71% at December 31, 2006. The total capital (total equity to risk weighted assets) ratio is 14.42% at June 30, 2007 compared to 13.82% at December 31, 2006.
The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Net charge-offs for the company have been very low when compared with the size of the total loan portfolio. Management monitors the loan portfolio continuously with procedures that allow for problem loans and potential problem loans to be highlighted and watched. Written reports are prepared on a quarterly basis for all loans and information on commercial loans graded below a certain level are reported to the Board of Directors on a monthly basis. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.
| June 30, 2007 | June 30, 2006 | |||||||
| Balance at beginning of period |
$ | 2423 | $ | 2161 | ||||
| Charge-offs: |
||||||||
| Commercial, financial and agricultural |
— | — | ||||||
| Real estate – construction |
— | — | ||||||
| Real estate – mortgage |
30 | — | ||||||
| Consumer |
76 | 77 | ||||||
| Total charge-offs |
106 | 77 | ||||||
| Recoveries: |
||||||||
| Commercial, financial and agricultural |
30 | — | ||||||
| Real estate – construction |
— | — | ||||||
| Real estate – mortgage |
— | — | ||||||
| Consumer |
59 | 62 | ||||||
| Total recoveries |
89 | 62 | ||||||
| Net charge-offs |
17 | 15 | ||||||
| Additions charged to operations |
— | 75 | ||||||
| Balance at end of period |
$ | 2 406 | $ | 2 221 | ||||
| Ratio of net charge-offs during the period to average loans outstanding during the period |
.007 | % | .007 | % | ||||
Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.
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| June 30, 2007 | June 30, 2006 | |||||||
| Nonaccrual loans |
$ | — | $ | 130 | ||||
| Restructured loans |
— | — | ||||||
| Foreclosed properties |
75 | — | ||||||
| Total nonperforming assets |
$ | 75 | $ | 130 | ||||
| Loans past due 90 days accruing interest |
$ | 13 | $ | — | ||||
| Allowance for loan losses to period end loans |
1.07 | % | 1.00 | % | ||||
| Nonperforming assets to period end loans and foreclosed properties |
.03 | % | .06 | % | ||||
At June 30, 2007, other potential problem loans (excluding impaired loans) totaled $1.7 million. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis. A portion of the allowance for loan losses is specifically allocated for these loans as a group at a rate that reflects the potential problems these loans may present.
The details of the income statements for the three months and six months ended June 30, 2007 and 2006 are highlighted below.
| • | Net income is down 7% for the June quarter of 2007 compared to the same quarter in 2006. The 2007 year to date decrease in net income is 3.6% compared to the same period in 2006. |
| • | At June 30, 2007 total interest and dividend income has increased 5.4% and 9% over 2006 for the quarter and year to date periods, respectively. |
| • | Income on federal funds sold increased greatly because of the increase in volume and in interest rates. Management temporarily invested higher than normal amounts in federal funds because of the competitive rate compared to alternative types of investments. Federal funds also provided additional liquidity versus those alternative investments. It was anticipated that loan demand would pick up before now and the additional liquidity would have been helpful. |
| • | Interest expense continues to increase. At June 30, 2007 interest expense was 22.9% above 2006 expense for the quarter and showed an increase of 35.8% for 2007 year to date compared to 2006. The increase in expense is due to higher interest rates being paid to retain deposits and attract additional deposit growth. As interest rates have leveled off and deposits have decreased slightly, the increase in this expense has been reduced. |
| • | Net interest income through June 30, 2007 has decreased 4.2% compared to June 30, 2006. Although both loan and deposit balances have shown decreases, the deposits have decreased less than loans, contributing to the decrease in net interest income. |
| • | Net interest margin at June 30, 2007 is 4.15%, down from the December 31, 2006 figure of 4.45%. During the first six months of 2007, the overall average rate on loans matched the 7.57% overall average rate on loans at December 31, 2006. During the first six months of 2007 the overall average rate being paid on deposits increased to 3.41% from 2.92% for 2006. |
| • | There have been no additions to the provision for loan losses during 2007 since loans have decreased and loan quality remains good. |
Noninterest income increased 6.3% for the six months ended June 20, 2007 compared to June 30, 2006 year to date. Some significant income items are listed here.
| • | Trust and financial services income decreased for the quarter ending and the year to date ending June 30, 2007 compared to the same periods in 2006 by 25% and 11.5%, respectively. The principal reason is that two large estates closed in May of 2006 which gave trust and financial services a boost in income in 2006. |
| • | Service charges on deposit accounts have increased 13.7% in 2007 over 2006 year to date. Increased volumes of overdraft and returned check charges are responsible for the majority of this increase. Fees for customer use of foreign ATMs have decreased during the same period. |
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| • | Credit and debit card fees have increased 25.4% at June 30, 2007 compared to the same year to date period in 2006. The increase is due to increased usage and continued concentration on sale of cards by bank personnel. |
| • | Net gain on sale of loans has increased 45.3% at June 30, 2007 compared to the same time period in 2006. Secondary market loan business picked up in the fourth quarter of 2006 and has continued to remain steady. The increase is due to the current market for fixed rate loans and a trained mortgage lending staff. |
| • | Cash surrender value of life insurance has increased 23.3% in 2007 over the same period in 2006 due to increased interest rates on some policies and a small additional purchase in September of 2006. |
Noninterest expense increased only 2.5 % for the three months ended June 30, 2007 compared to the same period in 2006 and under 1% for the year to date period ended June 30, 2007 compared to 2006. Some details are listed below.
| • | Salaries and employee benefits for the first six months of 2007 have decreased 6.4% compared to the first six months of 2006 and have decreased 8.6% for the quarter ended June 30, 2007 compared to the same period in 2006. The largest contributors to this reduction are FASB 91 salary deferrals and a decrease in group insurance costs which also offset increases in salaries and wages, stock compensation expense, pension expense and 401(k) expense. |
| • | Occupancy and furniture and equipment expense has increased 4.4% in 2007 compared to 2006. As the bank continues to grow so does the space and equipment needed to respond to the growth. Facilities are continually being updated and, as has been the case for a number of years, the bank’s continual attention to staying on the cutting edge of technology comes at considerable cost. |
| • | Advertising and marketing expenses have decreased 25.2% in 2007 compared to 2006. As the new marketing program has evolved the bank has been able to reduce costs through collaboration with our outside marketing agency. |
| • | ATM and check card expenses have increased 19.1% in the first six months of 2007 compared to the same time period in 2006 due to increased usage and concentrated sales efforts of the bank staff to market this product. |
| • | Other noninterest expenses have increased at June 30, 2007 compared to June 30, 2006. Significant details in this category include the following. |
| • | Printing, stationery and supplies expense is 20.6% greater in 2007 than in 2006. The increase is due in part to increased costs related to deposit account supplies such as statements and printed checks since deposit accounts have increased in 2007 compared to 2006. There have also been some procedural changes that have required reprinting of forms and numerous notifications to inform and educate customers regarding the rampant fraudulent schemes occurring in the marketplace today. |
| • | Legal fees and miscellaneous expenses have increased due to a one time expense in settlement of litigation associated with customer fraud. |
| • | Home equity closing costs are down 21.0% in 2007 compared to 2006 due to a slowdown in the housing market and home values dropping or not escalating as quickly as before. |
| • | Other professional fees have decreased 16.1% in 2007 compared to 2006 partially due to a fee in 2006 paid to an employment consulting company in relation to hiring their client. |
| • | Officers and directors liability and errors and omissions liability insurance increased due to updating policy parameters as part of an annual review and due to the current environment. |
| • | The period after signing the initial contract with our overdraft protection vendor in which we paid a portion of our increased fees to them has ended so the bank will no longer have that expense. |
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| • | The bank’s charge-offs for ATM fraud and other check fraud schemes have almost doubled year to date at June 30, 2007 compared to 2006 for the same period. |
LIQUIDITY
Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2007.
Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions, such as depreciation expense, that reduce net income but do not require a cash outlay. Through June 30, 2007 net income as adjusted has provided cash of $1.5 million. Interest income earned on loans and investments is the company’s major income source.
Investing Activities. Customer deposits and company borrowings provide the funds used to invest in loans and securities investments. In addition, the principal portion of loan payments and payoffs and funds from maturing investments provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash provided by investing activities through June 30, 2007 is $4.5 million.
Financing Activities. Customer deposits and company borrowings provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends, 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 used in financing activities in 2007 through June 30 is $1.5 million.
The company has additional funding sources in the Federal Home Loan Bank, The Bankers Bank and Mercantile-Safe Deposit and Trust Company. Liquidity of the company is adequate to meet present and future financial obligations.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
There have been no significant changes during the first six months of 2007 to the quantitative and qualitative disclosures about market risk as discussed in the annual report on Form 10-K as of December 31, 2006.
| 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.
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| Item 1. | Legal Proceedings. |
There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance.
| Item 1A. | Risk Factors. |
There have been no significant changes during the first six months of 2007 to the risk factors as discussed in the annual report on Form 10-K as of December 31, 2006.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
ISSUER PURCHASES OF EQUITY SECURITIES
| Period |
(a) Total Number of Shares Purchased |
(b) Average Price Paid Per Share |
(c) Total Number of Shares Purchased as Part of Publicly Announced Programs |
(d) Maximum Number of Shares that May Yet be Purchased Under the Program | ||||
| January 1 through |
||||||||
| January 31 |
NONE | — | — | 107 960 | ||||
| February 1 through |
||||||||
| February 28 |
NONE | — | — | 107 960 | ||||
| March 1 through |
||||||||
| March 31 |
NONE | — | — | 107 960 | ||||
| April 1 through |
||||||||
| April 30 |
NONE | — | — | 107 960 | ||||
| May 1 through |
||||||||
| May 31 |
NONE | — | — | 107 960 | ||||
| June 1 through |
||||||||
| June 30 |
NONE | — | — | 107 960 | ||||
On February 12, 2002, the company’s board of directors originally authorized the repurchase program. The program authorized the repurchase of up to 10% of the company’s stock over the next twelve months. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent. The program has been extended on an annual basis.
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| Item 4. | Submission of Matters to a Vote of Security Holders. |
The annual meeting of security-holders was held on April 24, 2007 and the following matters were submitted to the security-holders for a vote:
| 1. | To elect a class of directors for a term of three years. |
| 2. | To ratify the selection by the board of directors of Yount, Hyde & Barbour, P.C., as registered independent accountants for the year 2007. |
| 3. | To approve an amendment to the Potomac Bancshares, Inc. 2003 Stock Incentive Plan to provide for an increase from 183,600 to 433,600 shares of Common Stock to be available for the Plan. |
| 4. | To approve any other business which may properly be brought before the meeting or any adjournment thereof. |
Results of the voting in regard to the above listed matters were as follows:
| Votes For | Votes Against |
Votes Withheld |
Total | |||||||
| 1. | J. Scott Boyd |
2,389,570 | None | 39,909 | 2,429,479 | |||||
| John P. Burns, Jr. |
2,389,240 | None | 40,239 | 2,429,479 | ||||||
| Barbara H. Pichot |
2,389,417 | None | 40,062 | 2,429,479 | ||||||
| C. Larry Togans |
2,389,179 | None | 40,300 | 2,429,479 | ||||||
| Votes For |
Votes Against |
Abstentions |
Total | |||||||
| 2. | Ratification of accountants |
2,426,873 | None | 2,606 | 2,429,479 | |||||
| Votes For | Against | Abstentions | Total | |||||||
| 3. | Approval of the amendment to the Stock Incentive Plan |
1,484,497 | 288,961 | 50,324 | 1,823,782 | |||||
| Item 5. | Other Information |
| (b) | There have been no changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors since the registrant last provided disclosure in response to Item 7(d)(2)(ii)(G) of Schedule 14A. |
| Item 6. | Exhibits |
| 31.1 | Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002) |
| 31.2 | Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002) |
| 32 | Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002) |
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In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| POTOMAC BANCSHARES, INC. | ||||
| Date August 10, 2007 |
/s/ Robert F. Baronner, Jr. | |||
| Robert F. Baronner, Jr. | ||||
| President & CEO | ||||
| Date August 10, 2007 |
/s/ Gayle Marshall Johnson | |||
| Gayle Marshall Johnson | ||||
| Sr.Vice President and Chief Financial Officer | ||||
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