UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549____________

FORM 10-K

ANNUAL REPORTPURSUANT TO SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark one)

XXX
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the fiscal year ended December 31, 2005____
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934For the transition period from __________ to __________


Commission File Number 0-24958

POTOMAC BANCSHARES, INC.(Exact Name of Registrant as Specified in Its Charter)

|West Virginia                                               |                     | 55-0732247         
|----------------------------------------------------------- | ------------------- | -------------------
|(State or Other Jurisdiction of                             |                     | (I.R.S. Employer   
|Incorporation or Organization)                              |                     | Identification No.)
|                                                           
|111 East Washington Street                                  |                     |                    
|PO Box 906, Charles Town WV                                 |                     | 25414-0906         
|(Address of Principal Executive Offices)                    |                     | (Zip Code)         
|                                                           
|Registrant's telephone number, including area code          |                     | 304-725-8431       
|                                                           
|Securities registered pursuant to Section 12(b) of the Act: |                     |                    
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|                                                            | Title of Each Class |                    
|                                                           
|NONE                                                        |                     |                    
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Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $1.00 Par Value(Title of Class)

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|Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.               
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|                                                                                                                                      
|Yes                                                                                                                                   
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|Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.          
|                                                                                                                                      
|Yes                                                                                                                                   
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|Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
|Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such         
|reports), and (2) has been subject to such filing requirements for past the 90 days.                                                  
|                                                                                                                                      
|YesXX                                                                                                                                 
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|Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and      
|will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference 
|in Part III of this Form 10-K or any amendment to this Form 10-K.                                                                     
|                                                                                                                                      
|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                                                                                                               
|                                                                                                                                      
|Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                      
|                                                                                                                                      
|Yes                                                                                                                                   
|                                                                                                                                      
|State the aggregate market value of the voting and non-voting common equity held by nonaffiliates computed by reference to the        
|price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business     
|day of the registrants most recently completed second fiscal quarter.                                                                
|                                                                                                                                      
|APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY                                                                                 
|PROCEEDINGS DURING THE PRECEDING FIVE YEARS                                                                                           
|                                                                                                                                      
|Indicate by check mark whether the registrant has filed all documents and reports required by Section 12, 13 or 15(d) of the          
|Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.                       
|                                                                                                                                      
|Yes                                                                                                                                   
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|(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.     
|3,393,122 as of March 3, 2006                                                                                                         
|                                                                                                                                      
|DOCUMENTS INCORPORATED BY REFERENCE                                                                                                   
|                                                                                                                                      
|The following lists the document that is incorporated by reference in the Form 10-K Annual Report, and the Parts and Items of the     
|Form 10-K into which the document is incorporated.                                                                                    
|                                                                                                                                      
|                                                                                                                                      
|                                                                                                                                      
|Portions of Potomac Bancshares, Inc.s Proxy Statement for                                                                            
|the 2006 Annual Meeting of Shareholders                                                                                               

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Potomac Bancshares, Inc.Annual Report on Form 10-KFor the Year Ended December 31, 2005

|PART I   |   
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|        
|Item     | 1 
|Item     | 1 
|Item     | 2 
|Item     | 3 
|Item     | 4 
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|PART II  |   
|        
|Item     | 5 
|         |   
|Item     | 6 
|Item     | 7 
|Item     | 7 
|Item     | 8 
|Item     | 9 
|Item     | 9 
|Item     | 9 
|        
|PART III |   
|        
|Item     | 10
|Item     | 11
|Item     | 12
|Item     | 13
|Item     | 14
|        
|PART IV  |   
|        
|Item     | 15

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 Annual Report on Form 10-K, including the Presidents letter and the 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 this 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.

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PART I

Item 1. Business.

History and Operations

The Board of Directors of Bank of Charles Town (the "bank") caused Potomac Bancshares, Inc. ("Potomac") to be formed on March 2, 1994, as a single-bank holding company. To date, Potomac's only activities have involved the acquisition of the bank. Potomac acquired all of the shares of the banks common stock on July 29, 1994.

Bank of Charles Town is a West Virginia state-chartered bank that formed and opened for business in 1871. The Federal Deposit Insurance Corporation insures the banks deposits. The bank engages in general banking business primarily in Jefferson County and Berkeley County, West Virginia. The bank also provides services to Washington County and Frederick County, Maryland and Loudoun County, Frederick County and Clarke County, Virginia. In 2005 the bank opened a loan production office in Winchester, Virginia. The main office is in Charles Town, West Virginia at 111 East Washington Street, with branch offices in

- Harpers Ferry, West Virginia,
- Kearneysville, West Virginia,
- Martinsburg, West Virginia and
- Hedgesville, West Virginia.

- Commercial credit lines, equipment loans, construction financing,
- Real estate loans, secondary market and adjustable rate mortgages,
- Retail loan products including home equity lines of credit,
- Checking and savings accounts for businesses and individuals and
- Certificates of deposit and individual retirement accounts.

Automated teller machines located at each of the five offices and Touchline 24, an interactive voice response system available at 1-304-728-2424; provide certain services to customers on a twenty-four hour basis. The bank initiated the formation of an ATM network with two banks in the community to provide customers of all three banks 17 ATM locations in the eastern panhandle of West Virginia. Bill paying and certain other banking services are available through the Internet. The trust and financial services department provides financial management, investment and trust services. BCT Investments provides financial management, investment and brokerage services.

Lending Activities. The bank offers a variety of loans for consumer and commercial purposes. The majority of these loans are secured.

Underwriting standards for all lending include

- Sound credit analysis,
- Proper documentation according to the bank's loan policy standards,
- Avoidance of loan concentrations to a single industry or with a single class of collateral,
- Diligent maintenance of past due and nonaccrual loans and
- A risk grading system that assists us in managing deteriorating credit on a proactive basis.

The lending policies of the bank address the importance of a diversified portfolio and of a balance between maximum yield and minimum risk. It is the banks policy to avoid concentrations of loans such as loans to one industry, loans to one borrower or guarantor or loans secured by similar collateral.

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The bank's loan policy designates particular loan-to-value limits for real estate loans in accordance with recommendations in Section 304 of the Federal Deposit Insurance Corporation Improvement Act of 1991. As stated in the loan policy, there may be certain lending situations not subject to these loan-to-value limits and from time to time the senior management of the bank may permit exceptions to the established limits. Any exceptions are sufficiently documented.

Loans secured by real estate are made to individuals and businesses for

- The purchase of raw land and land development,
- Commercial, multi-family and other non-residential construction,
- Purchase of improved property,
- Purchase of owner occupied one to four family residential property,
- Lines of credit and
- Home equity loans.

Approximately 90% of the bank's loans are secured by real estate. These loans had an average delinquency rate of .51% and a loss rate of 0% during 2005. The average delinquency rate and loss rate are based on comparisons to 2005 average total loans.

As of December 31, 2005, aggregate dollar amounts (in thousands) in loan categories secured by real estate are as follows:



| | · | Construction and land development  | $ | 41 174 
| | - | ---------------------------------- | - | -------
| | · | Secured by farmland                |   | 2 381  
| | · | Secured by 1-4 family residential  |   | 98 408 
| | · | Secured by multifamily residential |   | 3 486  
| | · | Secured by nonfarm nonresidential  |   | 43 019 
| |   |                                    |   |        
| |   |                                    | $ | 188 468

Commercial loans not secured by real estate with an aggregate balance of $6 million at December 31, 2005 make up approximately 2.9% of the total loan portfolio. The banks loan policy for commercial loans including those commercial loans secured by real estate is to

- Grant loans on a sound and collectible basis,
- Invest the banks funds profitably for the benefit of shareholders and the protection of depositors and
- Serve the legitimate credit needs of the community in which the bank is located.

Average delinquency for commercial loans not secured by real estate was less than 1% and the loss rate was .02% during 2005.

Retail loans to individuals for personal expenditures are approximately 7.4% of the bank's total loans at December 31, 2005. The aggregate balance of these loans was $15.5 million at December 31, 2005. The majority of these loans are installment loans with the remainder made as term loans.

There is some risk in every retail loan transaction. The bank accepts moderate levels of risk while minimizing retail loan losses through careful investigation into the character of each borrower, determining the source of repayment before closing each loan, collateralizing most loans, exercising care in documentation procedures, administering an aggressive retail loan collection program, and following the retail loan policies. Loans to individuals for personal expenditures had an average delinquency rate of .08% and a loss rate of .05% in 2005 (based on comparisons to 2005 average total loans).

All other loans total $372 thousand (less than 1% of total loans) at December 31, 2005. These loans had a 0% average delinquency rate and a 0% average loss rate in 2005 compared to 2005 average total loans.

Investment Activities. The bank's investment policy governs its investment activities.

The policy states that excess daily funds are to be invested in federal funds sold and securities purchased under agreements to resell. The daily funds are used to cover deposit draw downs by customers, to fund loan commitments and to help maintain the bank's asset/liability mix.

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According to the policy, funds in excess of those invested in federal funds sold and securities purchased under agreements to resell are to be invested in (1) U.S. Treasury bills, notes or bonds, (2) obligations of U.S. Government agencies or (3) obligations of the State of West Virginia and political subdivisions thereof with a rating of not less than AAA or fully insured bonds.

The policy governs various other factors including maturities, the closeness of purchase price to par, amounts that may be purchased and percentages of the various types of investments that may be held.

Deposit Activities. The bank offers noninterest-bearing and interest-bearing checking accounts and statement savings accounts. The bank offers automatically renewable certificates of deposit in various terms from 91 days to five years. Individual retirement accounts in the form of certificates of deposit are also available.

To open a deposit account, the depositor must meet the following requirements for low risk individuals:

- Present a valid identification,
- Have a social security number,
- Must be a U.S. citizen or possess evidence of legal alien status, and
- Must be at least 18 years of age or share account with a person at least 18 years of age.

Depositors who are considered medium or high risk (i.e. out-of-state drivers license and/or resident), additional verification requirements apply. Management believes that the bank fully complies with the Patriot Act.

Competition

As of March 3, 2006, there were 65 bank holding companies (including multi-bank and one bank holding companies) operating in the State of West Virginia. These holding companies are headquartered in various West Virginia cities and control banks throughout the State of West Virginia, including banks that compete with the bank in its market area.

The bank's market area is generally defined as Jefferson County and Berkeley County, West Virginia. As of June 30, 2005, there were six banks in Jefferson County with 13 banking offices. The total deposits of these commercial banks as of June 30, 2005 were $641.4 million, and the bank ranked number one in total deposits with $187.2 million or 29.2% of the total deposits in the market at that time. The bank has two branch offices in Berkeley County at this time. Opening in July 2001 and June 2003, these branches have 2.9% of the market share of deposits in Berkeley County where there are eight banks with 28 banking offices.

For most of the services that the bank performs, there is also competition from financial institutions other than commercial banks. For instance, credit unions, some insurance companies, and issuers of commercial paper and money market funds actively compete for funds and for various types of loans. In addition, personal and corporate trust and investment counseling services are offered by insurance companies, investment counseling firms and other business firms and individuals. Due to the geographic location of the bank's primary market area, the existence of larger financial institutions in Maryland, Virginia and Washington, D.C. influences the competition in the market area. In addition, larger regional and national corporations continue to be increasingly visible in offering a broad range of financial services to all types of commercial and consumer customers. The principal competitive factors in the markets for deposits and loans are
interest rates, either paid or charged. The chartering of numerous new banks in West Virginia and the opening of numerous federally chartered savings and loan associations has increased competition for the bank. The 1986 legislation passed by the West Virginia Legislature allowing statewide branch banking provided increased opportunities for the bank, but it also increased competition for the bank in its service area. With the beginning of reciprocal interstate banking in 1988, bank holding companies (such as Potomac Bancshares, Inc.) also face additional competition in efforts to acquire other subsidiaries throughout West Virginia.

In 1994, Congress passed the Riegle-Neal Interstate Banking and Branching Efficiency Act. Under this Act, bank holding companies are permitted to acquire banks located in states other than the bank holding companys home state without regard to whether the transaction is permitted under state law. Commencing on June 1, 1997, the Act allowed national banks and state banks with different home states to merge across state lines, unless the home state of a participating bank enacted legislation prior to May 31, 1997, that expressly prohibits interstate mergers. Additionally, the Act allows banks to branch across state lines, unless the state where the new branch will be located enacted legislation restricting or prohibitingdenovointerstate branching on or before May 31, 1997. West Virginia adopted
legislation, effective May 31, 1997, that allowed for interstate branch banking by merger across state lines and allowed fordenovobranching and branching by purchase and assumption on a reciprocal basis with the home state of the bank in question. The effect of this legislation has been increased competition for West Virginia banks, including the bank.

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Employees

Potomac currently has no employees.

As of March 6, 2006, the bank had 93 full-time employees and 16 part-time employees.

Supervision and Regulation

Introduction. Potomac is a bank holding company within the provisions of the Bank Holding Company Act of 1956, is registered as such, and is subject to supervision by the Board of Governors of the Federal Reserve System ("Board of Governors"). The Bank Holding Company Act requires Potomac to secure the prior approval of the Board of Governors before Potomac acquires ownership or control of more than five percent (5%) of the voting shares or substantially all of the assets of any institution, including another bank.

As a bank holding company, Potomac is required to file with the Board of Governors annual reports and such additional information as the Board of Governors may require pursuant to the Bank Holding Company Act. The Board of Governors may also make examinations of Potomac and its banking subsidiaries. Furthermore, under Section 106 of the 1970 Amendments to the Bank Holding Company Act and the regulations of the Board of Governors, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or any provision of credit, sale or lease of property or furnishing of services.

Potomacs depository institution subsidiaries are subject to affiliate transaction restrictions under federal law that limit the transfer of funds by the subsidiary banks to their respective parents and any nonbanking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases. Such transfers by any subsidiary bank to its parent corporation or any nonbanking subsidiary are limited in an amount to 10% of the institution's capital and surplus and, with respect to such parent and all such nonbanking subsidiaries, to an aggregate of 20% of any such institution's capital and surplus.

Potomac is required to register annually with the Commissioner of Banking of West Virginia ("Commissioner") and to pay a registration fee to the Commissioner based on the total amount of bank deposits in banks with respect to which it is a bank holding company. Although legislation allows the Commissioner to prescribe the registration fee, it limits the fee to ten dollars per million dollars of deposits rounded off to the nearest million dollars. Potomac is also subject to regulation and supervision by the Commissioner.

Potomac is required to secure the approval of the West Virginia Board of Banking before acquiring ownership or control of more than five percent of the voting shares or substantially all of the assets of any institution, including another bank. West Virginia banking law prohibits any West Virginia or non-West Virginia bank or bank holding company from acquiring shares of a bank if the acquisition would cause the combined deposits of all banks in the State of West Virginia, with respect to which it is a bank holding company, to exceed 25% of the total deposits of all depository institutions in the State of West Virginia.

Depository Institution Subsidiaries. The bank is subject to FDIC deposit insurance assessments. As of January 1, 2006, the FDIC set the Financing Corporation (FICO) Bank Insurance Fund (BIF) premium for the bank at the annual rate of 1.320 basis points or .0001320 times the total deposits of the bank. This premium is not tied to the bank's risk classification. The rate of the premium based on the bank's risk classification is at 0.00% . It is possible that BIF insurance assessments will be changed, and it is also possible that there may be a special additional assessment. A large special assessment could have an adverse impact on Potomacs results of operations.

Capital Requirements. The Federal Reserve Board has issued risk-based capital guidelines for bank holding companies, such as Potomac. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. Under the guidelines and related policies, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and leverage ratio test on a consolidated basis. The risk-based ratio is determined by allocating assets and specified off-balance sheet commitments into four weighted categories, with higher levels of capital being required for categories perceived as representing greater risk. The leverage ratio is
determined by relating core capital (as described below) to total assets adjusted as specified in the guidelines. The bank is subject to substantially similar capital requirements adopted by applicable regulatory agencies.

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Generally, under the applicable guidelines, the financial institution's capital is divided into two tiers. "Tier 1", or core capital, includes common equity, noncumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts or consolidated subsidiaries, less goodwill. Bank holding companies, however, may include cumulative perpetual preferred stock in their Tier 1 capital, up to a limit of 25% of such Tier 1 capital. "Tier 2", or supplementary capital, includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan losses, subject to certain limitations, less required deductions. "Total capital" is the sum of Tier 1 and Tier 2 capital.

Financial institutions are required to maintain a risk-based ratio of 8%, of which 4% must be Tier 1 capital. The appropriate regulatory authority may set higher capital requirements when an institution's particular circumstances warrant.

Financial institutions that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating, are required to maintain a minimum leverage ratio of 3%. Financial institutions not meeting these criteria are required to maintain a leverage ratio which exceeds 3% by a cushion of at least 100 to 200 basis points, and, therefore, the ratio of Tier 1 capital to total assets should not be less than 4%.

The guidelines also provide that financial institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the Federal Reserve Board's guidelines indicate that the Federal Reserve Board will continue to consider a "tangible Tier 1 leverage ratio" in evaluating proposals for expansion or new activities. The tangible Tier 1 leverage is the ratio of an institution's Tier 1 capital, less all intangibles, to total assets, less all intangibles.

Failure to meet applicable capital guidelines could subject the financial institution to a variety of enforcement remedies available to the federal regulatory authorities, including limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital and the termination of deposit insurance by the FDIC, as well as to the measures described in the "Federal Deposit Insurance Corporation Improvement Act of 1991" as applicable to undercapitalized institutions.

The Federal Reserve Board, as well as the FDIC, has adopted changes to their risk-based and leverage ratio requirements that require that all intangible assets, with certain exceptions, be deducted from Tier 1 capital. Under the Federal Reserve Board's rules, the only types of intangible assets that may be included in (i.e., not deducted from) a bank holding company's capital are readily marketable purchased mortgage servicing rights ("PMSRs") and purchased credit card relationships ("PCCRs"), provided that, in the aggregate, that the total amount of PMSRs and PCCRs included in capital does not exceed 50% of Tier 1 capital. PCCRs are subject to a separate limit of 25% of Tier 1 capital. The amount of PMSRs and PCCRs that a bank holding company may include in its capital is limited to the lesser of (i) 90% of such assets' fair market value (as determined under the guidelines), or (ii) 100% of such assets' book value, each determined
quarterly. Identifiable intangible assets (i.e., intangible assets other than goodwill) other than PMSRs and PCCRs, including core deposit intangibles, acquired on or before February 19, 1992 (the date the Federal Reserve Board issued its original proposal for public comment), generally will not be deducted from capital for supervisory purposes, although they will continue to be deducted for purposes of evaluating applications filed by bank holding companies.

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As of December 31, 2005, Potomac had capital in excess of all applicable requirements as shown below:

Actual

Required

Excess(in thousands)Tier 1 capital:Common stock


$
3,600Surplus



2,400Retained earnings



21,15827,158Less cost of shares acquired for the treasury



1,850Total tier 1 capital


$
25,308



$
7,984



$
17,324Tier 2 capital:Allowance for loan losses (1)



2,161Total risk-based capital


$
27,469



$
15,968



$
11,501Risk-weighted assets


$
199,602Tier 1 capital


$
25,308



$
11,030



$
14,278Average total assets


$
275,742Capital ratios:Tier 1 risk-based capital ratio



12.68%




4.00%




8.68%Total risk-based capital ratio



13.76%




8.00%




5.76%Tier 1 capital to average total assets (leverage)



9.18%




4.00%




5.18%(1) Limited to 1.25% of gross risk-weighted assets.


Gramm-Leach-Bliley Act of 1999.On November 4, 1999, Congress adopted the Gramm-Leach-Bliley Act of 1999. This Act, also known as the Financial Modernization Law, repealed a number of federal limitations on the powers of banks and bank holding companies originally adopted in the 1930s. Under the Act, banks, insurance companies, securities firms and other service providers may now affiliate. In addition to broadening the powers of banks, the Act created a new form of entity, called a financial holding company, which may engage in any activity that is financial in nature or incidental or complimentary to financial activities.

The Federal Reserve Board provides the principal regulatory supervision of financial services permitted under the Act. However, the Securities and Exchange Commission and state insurance and securities regulators also assume substantial supervisory powers and responsibilities.

The Act addresses a variety of other matters, including customer privacy issues. The obtaining of certain types of information by false or fraudulent pretenses is a crime. Banks and other financial institutions must notify their customers about their policies on sharing information with certain third parties. In some instances, customers may refuse to permit their information to be shared. The Act also requires disclosures of certain automatic teller machine fees and contains certain amendments to the federal Community Reinvestment Act.

Permitted Non-Banking Activities. Under the Gramm-Leach-Bliley Act, bank holding companies may become financial holding companies and engage in certain non-banking activities. Potomac has not yet filed to become a financial holding company and presently does not engage in, nor does it have any immediate plans to engage in, any such non-banking activities.

A notice of proposed non-banking activities must be furnished to the Federal Reserve and the Banking Board before Potomac engages in such activities, and an application must be made to the Federal Reserve and Banking Board concerning acquisitions by Potomac of corporations engaging in those activities. In addition, the Federal Reserve may, by order issued on a case-by-case basis, approve additional non-banking activities.

The Bank. The bank is a state-chartered bank that is not a member of the Federal Reserve System and is subject to regulation and supervision by the FDIC and the Commissioner.

Compliance with Environmental Laws. The costs and effects of compliance with federal, state and local environmental laws will not have a material effect or impact on Potomac or the bank.

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International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (USA Patriot Act). TheInternational Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (the Patriot Act) was adopted in response to the September 11, 2001 terrorist attacks. The Patriot Act provides law enforcement with greater powers to investigate terrorism and prevent future terrorist acts. Among the broad-reading provisions contained in the Patriot Act are several designed to deter terrorists ability to launder money in the United States and provide law enforcement with additional powers to investigate how terrorists and terrorist organizations are financed. The Patriot Act creates additional requirements for banks, which were already subject to similar regulations. The Patriot Act authorizes the Secretary of the Treasury
to require financial institutions to take certain special measures when the Secretary suspects that certain transactions or accounts are related to money laundering. These special measures may be ordered when the Secretary suspects that a jurisdiction outside of the United States, a financial institution operating outside of the United States, a class of transactions involving a jurisdiction outside of the United States or certain types of accounts are of primary money laundering concern. The special measures include the following: (a) require financial institutions to keep records and report on the transactions or accounts at issue; (b) require financial institutions to obtain and retain information related to the beneficial ownership of any account opened or maintained by foreign persons; (c) require financial institutions to identify each customer who is permitted to use a payable-through or correspondent account and obtain certain information from each customer permitted to
use the account; and (d) prohibit or impose conditions on the opening or maintaining of correspondent or payable-through accounts.

Sarbanes-Oxley Act of 2002.On July 30, 2002, the Senate and the House of Representatives of the United States enacted the Sarbanes-Oxley Act of 2002, a law that addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information.

Effective August 29, 2002, as directed by Section 302(a) of Sarbanes-Oxley, Potomacs chief executive officer and chief financial officer are each required to certify that Potomacs Quarterly and Annual Reports do not contain any untrue statement of a material fact. The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of Potomacs internal controls; they have made certain disclosures to Potomacs auditors and the audit committee of the Board of Directors about Potomacs internal controls; and they have included information in Potomacs Quarterly and Annual Reports about their evaluation and whether there have been significant changes in Potomacs internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation. Effective in
2007, Section 404 of Sarbanes-Oxley will become applicable to Potomac.

Available Information.The company files annual, quarterly and current reports, proxy statements and other information with the SEC. The companys SEC filings are filed electronically and are available to the public through the Internet at the SECs website athttp://www.sec.gov. In addition, any document filed by the company with the SEC can be read and copied at the SECs public reference facilities at 100 F Street, NE, Washington, DC 20549. Copies of documents can be obtained at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Copies of documents can also be obtained free of charge by any
shareholder by writing to Gayle Marshall Johnson, Vice President and Chief Financial Officer, Potomac Bancshares, Inc., PO Box 906, Charles Town, WV 25414.

Item 1A. Risk Factors.

Due to Increased Competition, the Company May Not Be Able to Attract and Retain Banking Customers At Current Levels.

If, due to competition from competitors in the companys market area of Jefferson and Berkeley Counties, West Virginia, the company is unable to attract new and retain current customers, loan and deposit growth could decrease causing the companys results of operations and financial condition to be negatively impacted. The company faces competition from the following:

- local, regional and national banks;
- savings and loans;
- internet banks;
- credit unions;
- insurance companies;
- finance companies; and
- brokerage firms serving the companys market areas.

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Because of the banks geographic location, the existence of larger financial institutions in Maryland, Virginia and Washington, DC influences the competition in the banks market area.

The Companys Lending Limit May Prevent It from Making Large Loans.

In the future, the company may not be able to attract larger volume customers because the size of loans that the company can offer to potential customers is less than the size of the loans that many of the companys larger competitors can offer. Accordingly, the company may lose customers seeking large loans to regional and national banks. We anticipate that our lending limit will continue to increase proportionately with the companys growth in earnings; however, the company may not be able to successfully attract or maintain larger customers.

It should also be noted that the company may choose with its larger volume customers to participate or syndicate that portion of a loan that exceeds its legal lending limit. This may be done from time to time to retain that customers primary relationship within the bank.

Certain Loans That the Bank Makes Are Riskier than Loans for Real Estate Lending.

The bank makes loans that involve a greater degree of risk than loans involving residential real estate lending. Commercial business loans may involve greater risks than other types of lending although the banks commercial loans are generally real estate secured. Only a small portion of the banks commercial loans are secured by collateral other than real estate. Consumer loans may involve greater risk because adverse changes in borrowers incomes and employment after funding of the loans may impact their abilities to repay the loans.

The Company Is Subject to Interest Rate Risk.

Aside from credit risk, the most significant risk resulting from the companys normal course of business, extending loans and accepting deposits, is interest rate risk. If market interest rate fluctuations cause the companys cost of funds to increase faster than the yield of its interest-earning assets, then its net interest income will be reduced. The companys results of operations depend to a large extent on the level of net interest income, which is the difference between income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Interest rates are highly sensitive to many factors that are beyond the companys control, including general economic conditions and the policies of various governmental and regulatory authorities.

The Company May Not Be Able to Retain Key Members of Management.

The departure of one or more of the companys officers or other key personnel could adversely affect the companys operations and financial position. The companys management makes most decisions that involve the companys operations. The key personnel have all been with the company since 2001. They include Robert F. Baronner, Jr., David W. Irvin and Gayle Marshall Johnson.

An Economic Slowdown in the Companys Market Area Could Hurt Our Business.

Because we focus our business in Jefferson and Berkeley Counties, West Virginia, an economic slowdown in these areas could hurt our business. An economic slowdown could have the following consequences:

- Loan delinquencies may increase;
- Problem assets and foreclosures may increase;
- Demand for the products and services of the company may decline; and
- Collateral (including real estate) for loans made by the company may decline in value, in turn reducingcustomers borrowing power and making existing loans less secure.



8



---

The Company and the Bank are Extensively Regulated.

The operations of the company are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on them. Policies adopted or required by these governmental authorities can affect the companys business operations and the availability, growth and distribution of the companys investments, borrowings and deposits. Proposals to change the laws governing financial institutions are frequently raised in Congress and before bank regulatory authorities. Changes in applicable laws or policies could materially affect the companys business, and the likelihood of any major changes in the future and their effects are impossible to determine.

The Companys Allowance for Loan Losses May Not Be Sufficient.

In the future, the company could experience negative credit quality trends that could head to a deterioration of asset quality. Such deterioration could require the company to incur loan charge-offs in the future and incur additional loan loss provision, both of which would have the effect of decreasing earnings. The company maintains an allowance for possible loan losses, which is a reserve established through a provision for possible loan losses charged to expense that represents managements best estimate of probable losses that have been incurred within the existing portfolio of loans. Any increases in the allowance for possible loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the companys financial condition and results of operation.

A Shareholder May Have Difficulty Selling Shares.

Because a very limited public market exists for the holding companys common stock, a shareholder may have difficulty selling his or her shares in the secondary market. We cannot predict when, if ever, we could meet the listing qualifications of the NASDAQ Stock Markets National Market Tier or any exchange. We cannot assure you that there will be a more active public market for the shares in the near future.

Shares of the Companys Common Stock Are Not FDIC Insured.

Neither the Federal Deposit Insurance Corporation nor any other governmental agency insures the shares of the companys common stock. Therefore, the value of your shares in the company will be based on their market value and may decline.

Customers May Default on the Repayment of Loans.

The banks customers may default on the repayment of loans, which may negatively impact the companys earnings due to loss of principal and interest income. Increased operating expenses may result from the allocation of management time and resources to the collection and work-out of the loan. Collection efforts may or may not be successful causing the company to write off the loan or repossess the collateral securing the loan which may or may not exceed the balance of the loan.

The Companys Controls and Procedures May Fail or Be Circumvented.

Management regularly reviews and updates the companys internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, no matter how well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the companys controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the companys business, results of operations and financial conditions.

9

---

Item 2. Properties.

Potomac currently has no property.

The bank owns the land and buildings of the main office and the branch office facilities in Harpers Ferry, Kearneysville, and Hedgesville. The bank owns the branch office facility in Martinsburg and the land is leased through February 2008 when the bank will purchase the land at a predetermined price. The bank also owns a lot at the corner of Route 340 and Washington Street in Bolivar that may be used for future expansion.

The main office property is located at 111 East Washington Street, Charles Town, West Virginia. This property consists of two separate two story buildings located side by side with adjoining corridors. During 2000, the construction of the newer of these two buildings was completed. The first floor of the new building houses the Trust and Financial Services Division. The second floor of the new building houses certain administrative and loan offices. Both of these floors open into the older bank premises. The older premise, constructed in 1967, was renovated at the same time the new building was constructed. The renovation includes all new lighting, new ceilings, new floor and wall coverings as well as some minor structural changes for more efficient operations.

In October 2005 to provide additional office and storage areas, the bank leased space in Burr Industrial Park in Kearneysville, West Virginia. The leased space houses the Finance Department and provides record storage facilities for the bank.

The Harpers Ferry branch office is located at 1366 W. Washington Street, Bolivar, West Virginia. The office is a one story brick building constructed in 1975 and renovated in 2005. There is another building on this property that existed at the time of the bank's purchase. This separate building is rented to an outside party by the bank.

The branch facility at 5480 Charles Town Road, Kearneysville, West Virginia was erected in 1985. This one story brick building opened for business in April of 1985. During 1993, an addition was constructed, doubling the size of this facility. These facilities are currently being renovated.

The branch facility at 119 Cowardly Lion Drive, Hedgesville, West Virginia was erected in 2003. This one story brick building opened for business in June of 2003.

The branch office at 9738 Tuscarora Pike in Martinsburg, West Virginia (which opened for business in July 2001) is now located in a building owned by the bank. The construction of the one story brick facility was started in 2004 and completed in January 2005. The amended lease for this property expires in February 2008 when the bank will purchase the land at a predetermined price.

The bank is leasing offices in Winchester, Virginia, to house a loan production office that opened in late 2005.

There are no encumbrances on any of these properties, except the lease on the Martinsburg property. In the opinion of management, these properties are adequately covered by insurance.

Item 3. Legal Proceedings.

Currently Potomac is involved in no legal proceedings.

The bank is involved in various legal proceedings arising in the normal course of business, and in the opinion of the bank, the ultimate resolution of these proceedings will not have a material effect on the financial position or operations of the bank.

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

Not Applicable.

10

---

PART II

Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The following information reflects comparative per share data for the periods indicated for Potomac common stock for (a) trading values, and (b) dividends. This information has been restated to reflect a 100% stock dividend declared on February 8, 2005. As of March 2, 2006, there were approximately 1,100 shareholders.

Trading of Potomac Bancshares, Inc. common stock is not extensive and cannot be described as a public trading market. Potomac Bancshares, Inc. is on the OTC Bulletin Board Market. To gather information about securities in this market, use the suffix .OB after its symbol. Potomacs symbol is PTBS.OB. Scott and Stringfellow, Inc., Koonce Securities Inc. and Ferris, Baker Watts, Inc. are market makers for Potomacs stock. Market makers are firms that maintain a firm bid and ask price for a given number of shares at a given point in time in a given security by standing ready to buy or sell at publicly quoted prices. Information about sales of Potomacs stock is available on the Internet through many of the stock information services using Potomacs symbol. Shares of Potomac common stock are occasionally bought and sold by private individuals, firms or corporations, and, in most instances, Potomac
does not have knowledge of the purchase price or the terms of the purchase.The trading values for 2004 and 2005 are based on information available through the Internet.No attempt was made by Potomac to verify or determine the accuracy of the representations made to Potomac or gathered on the Internet.

Price Range

Cash DividendsHigh

Low

Paid per Share2004
First Quarter

$
11.88

$
11.28

$
.0700Second Quarter


12.13


11.23


.0725Third Quarter


12.63


11.75


.0750Fourth Quarter


14.00


12.00


.07752005
First Quarter

$
21.00

$
13.38

$
.0800Second Quarter


18.85


15.35


.0825Third Quarter


18.00


16.10


.0850Fourth Quarter


17.75


16.60


.0875


The primary source of funds for dividends paid by Potomac is the dividend income received from the bank. The bank's ability to pay dividends is subject to restrictions under federal and state law, and under certain cases, approval by the FDIC and the Commissioner could be required. Management of Potomac anticipates that the dividends paid by Potomac will likely be similar to those paid in the past, but dividends will only be paid when and as declared by the board of directors.

ISSUER PURCHASES OF EQUITY SECURITIES

(c) Total Numberof Shares(a) Total



Purchased as

(d) Maximum NumberNumber of

(b) Average

Part of Publicly

of Shares that MayShares

Price Paid

Announced

Yet be PurchasedPeriod

Purchased

Per Share

Programs

Under the ProgramOctober 1 through October 31

NONE

--

--

153 122November 1 through November 30

NONE

--

--

153 122December 1 through December 31

NONE

--

--

153 122


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.

11

---

Item 6. Selected Financial Data.

2005

2004

2003

2002

2001(Dollars in Thousands Except Per Share Data)Summary of OperationsInterest income

$
15 424


$
12 008


$
10 786


$
11 279


$
10 956Interest expense


4 135



2 409



2 235



2 823



3 758Net interest income


11 289



9 599



8 551



8 456



7 198Provision for loan losses


330



289



147



423



221Net interest income after provisionfor loan losses


10 959



9 310



8 404



8 033



6 977Noninterest income


3 185



3 158



2 844



2 097



1 358Noninterest expense


8 460



7 668



7 142



6 263



5 160Income before income taxes


5 684



4 800



4 106



3 867



3 175Income tax expense


2 020



1 710



1 432



1 408



1 166Net income

$
3 664


$
3 090


$
2 674


$
2 459


$
2 009Per Share Data **Net income, basic

$
1.08


$
.91


$
.77


$
.69


$
.56Net income, diluted


1.07



.91



.77



.69



.56Cash dividends declared


.34



.30



.27



.24



.23Book value at period end


7.38



6.71



6.27



5.98



5.40Weighted-average shares outstanding, basic


3 393 122



3 395 464



3 500 140



3 582 054



3 600 000Weighted-average shares outstanding, diluted


3 409 351



3 397 936



3 500 140



3 582 054



3 600 000Average Balance Sheet SummaryAssets

$
264 314


$
226 052


$
197 052


$
181 741


$
158 385Loans


196 478



155 546



125 407



109 461



93 816Securities


47 183



46 701



47 087



50 454



41 870Deposits


217 307



190 153



163 328



153 148



135 658Stockholders equity


23 822



22 045



21 274



20 542



18 812Performance RatiosReturn on average assets


1.39
%


1.37
%


1.36
%


1.35
%


1.27
%Return on average equity


15.38
%


14.02
%


12.57
%


11.97
%


10.68
%Dividend payout ratio


31.48
%


32.97
%


35.06
%


34.78
%


41.07
%Capital RatiosLeverage ratio


9.18
%


9.45
%


10.20
%


10.77
%


11.30
%Risk-based capital ratiosTier 1 capital


12.68
%


13.29
%


14.67
%


18.34
%


19.90
%Total capital


13.76
%


14.44
%


15.89
%


19.60
%


21.15
%


|** | All figures have been restated to reflect a 100% stock dividend declared on February 8, 2005 and a 200% stock dividend declared on February 11, 2003.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------

12

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

AVERAGE BALANCES, INCOME/EXPENSE AND AVERAGE YIELD/RATE

This schedule is a comparison of interest earning assets and interest-bearing liabilities showing average yields or rates derived from average balances and actual income and expenses. Income and rates on tax exempt loans and securities are computed on a tax equivalent basis using a federal tax rate of 34%. Loans placed on nonaccrual status are reflected in the balances.

2005

2004

2003Average

Income/

Average

Average

Income/

Average

Average

Income/

AverageBalances

Expense

Yield/Rate

Balances

Expense

Yield/Rate

Balances

Expense

Yield/Rate(in thousands)

(in thousands)

(in thousands)ASSETSLoansTaxable

$
195 357


$
13 635

6.98
%

$
154 486


$
10 283

6.66
%

$
123 701

$
8 745

7.07
%Tax exempt


1 121



106

9.46
%


1 060



114

10.75
%


1 706


157

9.20
%Total loans


196 478



13 741

6.99
%


155 546



10 397

6.68
%


125 407


8 902

7.10
%Taxable securities


45 721



1 516

3.32
%


46 473



1 575

3.39
%


47 087


1 828

3.88
%Nontaxable securities


1 462



79

5.40
%


228



11

4.82
%


- -


- -

- -Securities purchased underagreements to resell andfederal funds sold


1 164



43

3.69
%


3 457



39

1.13
%


4 533


44

.97
%Other earning assets


3 278



108

3.29
%


1 069



29

2.71
%


2 015


65

3.23
%Total earning assets


248 103


$
15 487

6.24
%


206 773


$
12 051

5.83
%


179 042

$
10 839

6.05
%Allowance for loan losses


(2 077
)








(1 842
)








(1 710Cash and due from banks


7 704









10 888









9 789Premises and equipment, net


5 975









5 163









4 868Other assets


4 609









5 070









5 063Total assets

$
264 314








$
226 052








$
197 052LIABILITIES ANDSTOCKHOLDERS EQUITYDepositsSavings and interest-bearing demand deposits

$
119 998


$
1 333

1.11
%

$
104 182


$
442

.42
%

$
92 951

$
462

.50
%Time deposits


63 661



2 107

3.31
%


55 961



1 649

2.96
%


47 991


1 497

3.12
%Total interest-bearing deposits


183 659



3 440

1.87
%


160 143



2 091

1.31
%


140 942


1 959

1.39
%Securities sold under agreementsto repurchase and federalfunds purchased


16 557



516

3.12
%


10 777



232

2.15
%


8 549


172

2.01
%Advances from FHLB


4 937



179

3.63
%


1 584



86

5.43
%


1 878


104

5.54
%Total interestbearing liabilities


205 153


$
4 135

2.02
%


172 504


$
2 409

1.40
%


151 369

$
2 235

1.48
%Noninterest-bearing demanddeposits


33 648









30 010









22 386Other liabilities


1 691









1 493









2 023Stockholders equity


23 822









22 045









21 274Total liabilities andstockholders equity

$
264 314








$
226 052








$
197 052Net interest income





$
11 352








$
9 642







$
8 604Net interest spread








4.22
%








4.43
%







4.57
%Interest expense as apercent of average earning assets






1.67
%








1.16
%







1.25
%Net interest margin








4.58
%








4.66
%







4.81
%


13

---

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

GENERAL

The companys financial statements are prepared in accordance with U. S. generally accepted accounting principles. 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, U. S. generally accepted accounting principles 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 estimated losses be accrued when they are probable of occurring 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.

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

GENERAL

By viewing the company results of operations and financial position over the past five years as shown in the Selected Consolidated Financial Data schedule, successful accomplishment of a number of the long term goals of management is evident. Management wishes to grow the company by increasing loans and deposits and increasing earnings on a regular basis so that we are providing the best service possible to our customers as well as increasing the value of our shareholders investments. Regular earnings increases allow us to build our capital and pay increased dividends to our shareholders. Increasing capital in turn provides the basis for continued expansion of the company and the ability to keep up with the ever changing and improving computer technology. Meeting the constant computer technology challenge is one of the most expensive costs of doing business after costs of real estate and human resources.

The continuing increase of regulation in the banking industry with the associated costs is a concern of management. At least the cost of initial compliance with Sarbanes-Oxley Act of 2002 has been spread out over several years now, with the delay of the banks initial implementation date to December 31, 2007. Compliance costs add additional pressure for management to find ways to increase income.

The major source of income for the company is interest income earned on loans and investments that, of course, is dependent on current market conditions, so in addition to increasing income in these areas, management has concentrated on finding additional types of noninterest income. During the past several years the introduction of an overdraft protection plan has provided a generous increase to noninterest income, though in 2005 the income from this product has leveled off. There is some concern that future regulation may diminish earnings on this product, which would have an adverse affect on the earnings of the company.

14

---

The company has added to tax exempt loan income and the tax exempt income of bank owned life insurance policies by adding municipal securities to the investment portfolio. These items reduce the income tax expense for the company as well as produce income.

The company continues to seek ways to reduce expenses in addition to ways to increase income. Several of the suggestions that were a result of the efficiency consultant studies during 2004 have been put into practice and have either increased income or reduced expenses.

- Utilization of personnel to full potential has allowed the company to continue to grow but to maintain a much slower growth in numbers of employees.
- Reclassification of deposit balances so that a lower required balance may be kept at the Federal Reserve has allowed the company to invest the relocated funds in income producing loans or to borrow funds at a lower level.
- Increases in certain service charges have increased noninterest income.
- Outsourcing of official checks has provided time for deposit operations personnel to perform other duties and has provided interest income earned on the outstanding balance of these checks.

The bank has been monitoring its efficiency through the calculation of the efficiency ratio each month and that ratio declined throughout 2005.

Management is unaware of any trends, events or uncertainties that would have a material effect on liquidity, capital resources or operations. There are no current recommendations by regulatory authorities that, if they were to be implemented, would have a material effect on the company.

The following table sets forth selected quarterly results (with dollars in thousands) of the company for 2005 and 2004.

2005

2004Three Months Ended

Three Months EndedDec 31


Sept 30

June 30

Mar 31

Dec 31

Sept 30


June 30

Mar 31Interest income

$
4 247


$
4 053

$
3 716

$
3 408

$
3 287

$
3 096


$
2 890

$
2 735Interest expense


1 301



1 140


915


779


682


620



571


536Net interest income


2 946



2 913


2 801


2 629


2 605


2 476



2 319


2 199Provision for loan losses


19



134


113


64


25


131



98


35Net interest income afterprovision for loan losses


2 927



2 779


2 688


2 565


2 580


2 345



2 221


2 164Noninterest income


913



955


913


773


843


832



773


736Gain (loss) sale of securities, net


(369
)


- -


- -


- -


- -


(28
)


2


- -Noninterest expense


2 261



2 188


2 041


1 970


2 131


1 969



1 756


1 812Income before income taxes


1 210



1 546


1 560


1 368


1 292


1 180



1 240


1 088Income tax expense


411



572


558


479


467


432



433


378Net income

$
799


$
974

$
1 002

$
889

$
825

$
748


$
807

$
710Earnings per share, basic

$
.23


$
.29

$
.30

$
.26

$
.24

$
.22


$
.24

$
.21Earnings per share, diluted

$
.23


$
.29

$
.29

$
.26

$
.24

$
.22


$
.24

$
.21


NET INTEREST INCOME

During 2005, growth in the loan portfolio of 18% and the consistent increase in loan rates have played an important part in the 18% increase in net interest income in 2005 compared to 2004. Income on securities increased slightly in 2005 compared to 2004 and other interest and dividends increased due to interest earned on balances held at Travelers Express for funding of the banks official checks.

15

---

The loan portfolio grew 28% during 2004, but with little increase in rates there was only a 12% increase in net interest income in 2004 compared to 2003. Other factors affecting 2004 net interest income compared to 2003 were a decrease in the income on securities due to decreased rates and only an 8% increase in interest expense even though we had deposit growth as well as some increase in rates on deposits.

Interest expense increased 72% in 2005 compared to 2004 due in large part to increased interest rates. Increased borrowings have also contributed to increased interest expense in 2005 compared to 2004.

During the last quarter of 2005, management has seen some leveling off of loan growth but are hopeful that spring will bring some growth back into the loan market. There has been growth in loans in the Berkeley County offices and a loan production office was opened in Winchester, Virginia in late 2005. Management is optimistic this will help sustain the banks loan growth.

By reviewing the volume and rate analysis schedule below, the affects of changes in volumes and rates of the various other assets and liabilities on net interest income can be seen.

VOLUME AND RATE ANALYSIS

This schedule analyzes the change in net interest income attributable to changes in volume of the various portfolios and changes in interest rates. The change due to both rate and volume variances has been allocated between rate and volume based on the percentage relationship of such variances to each other. Income and rates on tax exempt loans and securities are computed on a tax equivalent basis using a federal tax rate of 34%. Nonaccruing loans are included in average loans outstanding.

2005 Compared to 2004

2004 Compared to 2003(in thousands)

(in thousands)Change in







Change inIncome/

Volume

Rate

Income/

Volume

RateExpense

Effect

Effect

Expense

Effect

EffectINTEREST INCOMETaxable loans

$
3 352


$
2 837


$
515


$
1 538


$
2 005


$
(467
)Tax exempt loans


(8
)


8



(16
)


(43
)


(77
)


34Taxable securities


(59
)


(25
)


(34
)


(253
)


(25
)


(228
)Nontaxable securities


68



67



1



11



11



- -Securities purchased underagreements to reselland federal funds sold


4



(2
)


6



(5
)


(16
)


11Other earning assets


79



72



7



(36
)


(27
)


(9
)TOTAL

$
3 436


$
2 957


$
479


$
1 212


$
1 871


$
(659
)INTEREST EXPENSESavings and interest-bearingdemand deposits

$
891


$
75


$
816


$
(20
)

$
62


$
(82
)Time deposits


458



246



212



152



226



(74
)Securities sold under agreementsto repurchase and federalfunds purchased


284



154



130



60



47



13Advances from FHLB


93



111



(18
)


(18
)


(16
)


(2
)TOTAL

$
1 726


$
586


$
1 140


$
174


$
319


$
(145
)NET INTEREST INCOME

$
1 710


$
2 371


$
(661
)

$
1 038


$
1 552


$
(514
)


16

---

NONINTEREST INCOME AND EXPENSE

The major income producer for 2005 noninterest income, as in 2004 and 2003, continues to be the fees generated through the banks overdraft protection plan available for customers. These fees are included in the service charges on deposit accounts category which totaled $1.6 million in 2005, $1.5 million in 2004 and $1.2 million in 2003. Trust and financial services is the next largest contributor to the 2005 noninterest income figure with a 19% increase in income compared to 2004.Trust income was boosted in 2005 and 2004 by the accrual of fees for settlement of several large estates. One of these fees was totally accrued in August of 2005 and the second will be totally accrued in March of 2006. There are other estate fees being accrued but these two were significantly larger than most fees the bank has earned. Estate settlement fees are one area
of income that is not particularly consistent from year to year. In comparing 2003 trust income with 2004 and 2005, the estate fees were a major difference. The financial services area is also continuing to benefit from the growth of BCT Investments that offers brokerage services in addition to other financial services. The vision for BCT Investments was to reach customers with smaller amounts available for investment than were being handled through the regular trust services. The vision has come to productive fruition in providing a needed customer service as well as providing additional noninterest income.

As the bank customer base continues to expand, the growth has a positive affect on various components of noninterest income in addition to the overdraft protection plan mentioned above. It provides for increases in other service charges such as stop payments, sales of cashiers checks and money orders, wire transfer fees, debit, ATM and charge card transaction fees.

Fees on sales of loans in the secondary market are a source of noninterest income that varies with the market conditions. Our income from this source was $187 thousand in 2005, $157 thousand in 2004 and $360 thousand in 2003.

During the fourth quarter, the companys net income was negatively affected by the one time sale of approximately $14 million in Federal agency securities that had an average coupon yield of 2.6% . The gross loss on this sale was $369 thousand with an after tax net income affect of $243 thousand. The proceeds of this sale were reinvested in Federal agency securities with an average coupon yield of 4.9% which going forward, will favorably impact income.

Salaries and employee benefits of $4.5 million are about 53% of the total noninterest expense for 2005. This percentage was about the same in 2004. Even though the bank has grown during the past few years, full utilization of personnel has allowed the bank to hold down salaries and benefit costs by holding down the increase in personnel. During 2006 management expects these costs to increase since personnel additions in a number of areas have been made. The finance and audit areas have each added a full time person to handle continuing growth in the bank as well as continuing increase in regulatory requirements. Additional personnel have also been added in the loan area and branch administration area to handle the continuing growth.

Expenses related to premises have increased 8% in 2005 compared to 2004. These costs include new branch facilities, refurbished branch facilities, additional leased facilities, increased utility costs due to increased facilities and increased property taxes due to new facilities.

Other noninterest expense is the total of approximately 60 separate expense accounts. The total for this category increased 15% or $182 thousand in 2005 compared to 2004 and 20% or $207 thousand in 2004 compared to 2003. There is no significant change in any one account for either of these time period comparisons. Most of the increases are due to the growth in the banks customer base and growth in facilities.

17

---

INTEREST RATE SENSITIVITY

The table below shows the opportunities the company will have to reprice interest earning assets and interest-bearing liabilities as of December 31, 2005 (in thousands).

Mature or RepriceWithinThree Months

After ThreeMonths ButWithinTwelve Months

After OneYearBut Within Five Years

AfterFive Years

NonsensitiveInterest Earning Assets:Loans

$
74 180


$
15 446


$
58 551

$
62 258

$
- -Securities


- -



15 435



30 390


1 126


- -Securities purchased underagreements to resell andfederal funds sold


357



- -



- -


- -


- -Other earning assets


508



- -



- -


- -


- -Total

$
75 045


$
30 881


$
88 941

$
63 384

$
- -Interest-Bearing Liabilities:Time deposits$100,000 and over

$
4 828


$
2 435


$
8 909

$
- -

$
- -Other time deposits


14 999



8 985



28 598


- -


- -Gold and Platinum accounts(NOW accounts)


57 885



- -



- -


- -


44 256Savings accounts


- -



- -



- -


- -


26 371Securities sold under agreements torepurchase and federal fundspurchased


19 557



- -



- -


- -


- -Federal Home Loan Bankadvances


- -



- -



1 005


- -


- -Total

$
97 269


$
11 420


$
38 512

$
- -

$
70 627Rate Sensitivity Gap

$
(22 224
)

$
19 461


$
50 429

$
63 384Cumulative Gap

$
(22 224
)

$
(2 763
)

$
47 666

$
111 050


The matching of the maturities or repricing opportunities of interest earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring an institutions interest rate sensitivity gap. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that period. The interest rate sensitivity gap is the difference between the amount of interest earning assets that will mature or reprice within a specific time period and the amount of interest-bearing liabilities that will mature or reprice within the same time period.

A gap is considered negative when the amount of liabilities maturing or repricing in a specific period exceeds the amount of assets maturing or repricing in the same period. An even match between assets and liabilities in each time frame is the safest position especially in times of rapidly rising or declining rates. During other times, the even match is not as critical. The advantages or disadvantages of positive and negative gaps depend totally on the direction in which interest rates are moving. An asset sensitive institutions net interest margin and net interest income generally will be impacted favorably by rising interest rates, while that of a liability sensitive institution generally will be impacted favorably by declining interest rates.

During the first twelve months shown in the schedule above, the company is liability sensitive, and after that time period the company is asset sensitive. During January, February and March of 2006, $22 million more liabilities may reprice or will mature than assets. During April through December of 2006, $19 million more assets may reprice or will mature than liabilities. The total effect for 2006 is that $2.7 million more liabilities may reprice or mature than assets. Over the year this is minimal sensitivity in comparison to the total of all assets and liabilities repricing and maturing. During the 2006 time period the company should be only slightly impacted by either rising or falling interest rates.

18

---

LOAN PORTFOLIO

2005

2004

2003

2002

2001Commercial, financial and agricultural

$
6 046

$
5 949

$
6 217

$
3 696

$
2 999Mortgage loans on real estate:Construction and land development


41 174


28 929


14 071


2 211


530Secured by farm land


2 381


3 986


3 711


1 821


1 801Secured by 1-4 family residential


98 408


79 800


62 693


63 239


56 283Secured by multifamily residential


3 486


3 088


1 635


2 623


1 453Secured by nonfarm nonresidential


43 019


39 671


33 317


23 528


17 822Consumer loans


15 549


17 346


17 697


19 198


21 214All other loans


372


236


717


730


288$
210 435

$
179 005

$
140 058

$
117 046

$
102 390


An experienced and aggressive loan production staff continues to grow the loan portfolio. Loan production for residential mortgages continues to increase the banks portfolio of loans secured by 1-4 family residential property. Commercial lending continues to be a prime part of the loan portfolio showing in the construction and land development and nonfarm nonresidential categories. The majority of the loan portfolio is secured by real estate and delinquencies are being kept to a minimum.

There were no categories of loans that exceeded 10% of outstanding loans at December 31, 2005 that were not disclosed in the table above.

REMAINING MATURITIES (in thousands) OF SELECTED LOANS

Commercial,Financial and

Real Estate-At December 31, 2005

Agricultural

ConstructionLoans maturing within one year


$
1 419


$
20 859Variable rate loans due after one year


1 362



16 864Fixed rate loans due after one year through five years


3 075



3 402Fixed rate loans due after five years



190




49Total maturities


$
6 046



$
41 174


ALLOWANCE FOR LOAN LOSSES The table shown below is an analysis of the companys allowance for loan losses. Historically, net charge-offs (loans charged off as uncollectible less any amounts recovered on these loans) for the company have been very low when compared with the size of the total loan portfolio. Management continually monitors the loan portfolio with quarterly procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Based on experience, the loan policies and the current monitoring program, management believes the allowance for loan losses is adequate.

2005

2004

2003

2002

2001(in thousands)Balance at beginning of period


$
1 966


$
1 724



$
1 642


$
1 402


$
1 268Charge-offs:Commercial, financial and agricultural



30



- -



- -



- -



12Real estate  construction



- -



- -



- -



- -



- -Real estate  mortgage



- -



- -



- -



- -



7Consumer



218



202




191



287



103Total charge-offs



248



202




191



287



122Recoveries:Commercial, financial and agricultural



- -



- -



- -



- -



1Real estate  construction



- -



- -



- -



- -



- -Real estate  mortgage



- -



- -



8



1



- -Consumer



113



155




118



103



34Total recoveries



113



155




126



104



35Net charge-offs



135



47



65



183



87Additions charged to operations



330



289




147



423



221Balance at end of period


$
2 161


$
1 966



$
1 724


$
1 642


$
1 402Ratio of net charge-offs during the periodto average loans outstanding during the period



0.07%



0.03%



0.05%



0.17%



0.09%


19

---

ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

The following table shows an allocation of the allowance among loan categories based upon analysis of the loan portfolios composition, historical loan loss experience, and other factors, and the ratio of the related outstanding loan balances to total loans.

2005

2004

2003

2002

2001Allowance(inthousands)

% Loans inCategory toTotal Loans

Allowance(inthousands)

% Loans inCategory toTotal Loans

Allowance(inthousands)

% Loans inCategory toTotal Loans

Allowance(inthousands)

% Loans inCategory toTotal Loans

Allowance(inthousands)

% Loans inCategory toTotal LoansCommercial,financial andagricultural
$
94

2.87
%

$
81

3.32%


$
62

4.44
%

$
37

3.16%


$
15

2.92
%Mortgage loans onreal estate:Constructionand landdevelopmen

538

19.57
%


166

16.16%



141

10.05
%


22

1.89%



3

.52
%Secured by farmland

17

1.13
%


29

2.23%



37

2.65
%


2

1.56%



9

1.76
%Secured by 1-4familyresidential

696

46.76
%


458

44.58%



272

44.76
%


293

54.03%



316

54.97
%Secured by multi-familyresidential

25

1.66
%


24

1.73%



20

1.17
%


22

2.24%



18

1.42
%Secured by nonfarmnonresidential

477

20.44
%


341

22.16%



330

23.79
%


298

20.10%



232

17.41
%Consumer loans

261

7.39
%


591

9.69%



536

12.63
%


424

16.40%



120

20.72
%All other loans

2

.18
%


3

.13%



6

.51
%


5

.62%



1

.28
%Unallocated

51

- -



273

- -



320

- -



539

- -




688


- -$
2 161

100.00
%

$
1 966

100.00
%

$
1 724

100.00
%

$
1 642

100.00
%


$
1 402


100.00
%


RISK ELEMENTS IN THE LOAN PORTFOLIO

2005

2004

2003

2002

2001(in thousands)Nonaccrual loans

$
122

$
- -

$
251

$
- -

$
9Restructured loans


- -


- -


- -


- -


- -Foreclosed properties


- -


- -


- -


- -


- -Total nonperforming assets

$
122

$
- -

$
251

$
- -

$
9Loans past due 90 daysaccruing interest

$
65

$
- -

$
153

$
41

$
29Allowance for loan lossesto period end loans


1.03%


1.10%


1.23%


1.40%


1.37%Nonperforming assets toperiod end loans andforeclosed properties


.06%


- -


.18%


- -


.01%


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.

There were no impaired loans at December 31, 2005 and 2004.

At December 31, 2005, other potential problem loans totaled $1.8 million. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis.

20

---

SECURITIES PORTFOLIO

In accordance with Financial Accounting Standards Board Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, the company records securities being held to maturity at amortized cost and securities available for sale at fair value. The effect of unrealized gains and losses, net of tax effects, is recognized in stockholders equity.

The schedule below summarizes the book value of the portfolio by maturity classifications and shows the weighted average yield in each group.

2005

Weighted

2004

Weighted

2003

WeightedCarrying Value

Average

Carrying Value

Average

Carrying Value

Average(in thousands)

Yield

(in thousands)

Yield

(in thousands)

YieldSecurities held to maturityObligations of U.S. Government agencies:Maturing within one year


$
- -


- -


$
- -



- -


$
6 002


5.02%Maturing after one year butwithin five years



- -


- -



- -



- -



- -


- -Total securities held to maturity


$
- -





$
- -






$
6 002Securities available for saleObligations of U.S. Government agencies:Maturing within one year


$
15 435


3.82%


$
9 042



4.12%


$
5 132


4.73%Maturing after one year butwithin five years



30 243


4.10%



36 982



3.32%



33 293


3.47%Municipal obligations:Maturing within one year



- -


- -



- -



- -



- -


- -Maturing after on year butwithin five years



147


3.75%



529



3.57%



- -


- -Maturing after five years



1 126


3.87%



786



3.70%



- -


- -Total securities available for sale


$
46 951





$
47 339






$
38 425Total securities


$
46 951





$
47 339






$
44 427


DEPOSITS

Deposit growth of 15% in 2005 and our business sweep accounts were still not able to keep pace with the loan growth during the year. Periodically we have continued to depend on alternative methods of funding. We have seen additional deposit growth through our Berkeley County branch offices and anticipate continued growth in those areas. As of June 2004, the bank had almost 2.5% of the market share of deposits in Berkeley County and as of June 2005, we have approximately 2.9% of that market. Jefferson County deposit market share continues at about 29%.

Schedule of Average Deposits and Average Rates Paid

Year Ended December 312005

2004

2003Average

Average

Average

Average

Average

AverageBalance

Rate

Balance

Rate

Balance

RateNoninterest-bearing demand deposits

$
33 648



$
30 010



$
22 386Interest-bearing demand deposits


93 563

1.27%



82 426

.46%



71 462

.56%Savings deposits


26 435

.56%



21 756

.29%



21 489

.30%Time deposits


63 661

3.31%



55 961

2.96%



47 991

3.12%Total interest-bearing deposits


183 659

1.87%



160 143

1.31%



140 942

1.39%Total deposits

$
217 307



$
190 153



$
163 328


21

---

At December 31, 2005 time deposits of $100 thousand or more were 7.03% of total deposits compared with 6.58% at December 31, 2005. Maturities of time deposits of $100 thousand or more (in thousands) at December 31, 2005 are as follows:

Within three months
$
736Over three through six months

1 343Over six months through twelve months

1 091Over twelve months

13 002Total
$
16 172


ANALYSIS OF CAPITAL

The adequacy of the companys capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the companys asset and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.

The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The company had a ratio of total capital to risk-weighted assets of 13.76% and a ratio of Tier 1 capital to risk-weighted assets of 12.68 % at December 31, 2005. These two ratios have decreased in large part due to the asset growth during 2005. Even with the reductions in these ratios, both exceed the capital
requirements adopted by the federal regulatory agencies.

(In thousands)2005

2004

2003Tier 1 capital:Common stock
$
3 600

$
1 800

$
1 800Surplus

2 400


4 200


4 200Retained earnings

21 158


18 631


16 54327 158


24 631


22 543Less cost of shares acquired for the treasury

1 850


1 850


1 709Total tier 1 capital
$
25 308

$
22 781

$
20 834Tier 2 capital:Allowance for loan losses (1)

2 161


1 966


1 724Total risk-based capital
$
27 469

$
24 747

$
22 558Risk-weighted assets
$
199 602

$
171 432

$
141 978Capital ratios:Tier 1 risk-based capital ratio

12.68%



13.29%



14.67%Total risk-based capital ratio

13.76%



14.44%



15.89%Leverage ratio

9.18%



9.45%



10.20%(1) Limited to 1.25% of gross risk-weighted assets.


22

---

LIQUIDITY

Liquidity represents an institutions ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. This could also be termed the management of the cash flows of an organization. Liquid assets include cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The companys liquidity during 2005 is detailed in the statement of cash flows included in the financial statements.

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. During 2005 net income as adjusted has provided cash of $4.3 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 investment maturities provide cash flow. Purchases of bank premises and equipment are an investing activity. As mentioned in the deposit discussion above, we have taken advantage of our borrowing capabilities for additional funding since deposit growth was not sufficient to cover our needs. The net amount of cash used in investing activities in 2005 is $32.8 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 to shareholders, 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 2005 is $24.8 million.

At December 31, 2005, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $57.7 million.

Borrowing capabilities provide additional liquidity. The subsidiary bank maintains a federal funds line of $7 million with one financial institution and a federal funds line of $4 million with a second financial institution. The subsidiary bank is also a member of the Federal Home Loan Bank of Pittsburgh and has short and/or long-term borrowing capabilities of approximately $102.7 million. In June 2001, the subsidiary bank borrowed $2.5 million amortized over seven years from the Federal Home Loan Bank. The subsidiary bank has a Repo Plus account with the FHLB with a current credit line of $20 million that can be renewed on an annual basis.

Financial Instruments With Off-Balance-Sheet Risk.The company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the company has in particular classes of financial instruments.

The companys exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

A summary of the contract or notional amount of the companys exposure to off-balance-sheet risk as of December 31, 2005 and 2004 is as follows:

2005

2004Financial instruments whose contractamounts represent credit risk:Commitments to extend credit

$
63 747

$
58 477Standby letters of credit


5 265


2 996


23

---

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The company evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company upon extension of credit, is based on managements credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.

Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers. The majority of these lines of credit is collateralized and usually contains a specified maturity date and may not be drawn upon to the extent to which the company is committed.

Standby letters of credit are conditional commitments issued by the company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The company generally holds collateral supporting those commitments if deemed necessary.

At December 31, 2005, the company had rate lock commitments to originate mortgage loans amounting to $1 million. The company has entered into corresponding mandatory commitments, on a best-efforts basis, to sell these loans. These commitments to sell loans are designed to eliminate the companys exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

Short-Term Borrowings. At December 31, 2005, short-term borrowings consist of securities sold under agreements to repurchase that are secured transactions with customers. These borrowings generally mature the day following the day sold. The total of short-term borrowings were $19.6 million on December 31, 2005 and $22.6 million on December 31, 2004. The short-term borrowings at December 31, 2004 included securities sold under agreements to repurchase that were secured transactions with customers, securities sold under agreements to repurchase through the Federal Home Loan Bank and federal funds purchased through The Bankers Bank and Mercantile Safe Deposit and Trust Company.

The table below presents selected information on these short-term borrowings:

December 312005

2004Balance outstanding at year end
$
19 557


$
22 577Maximum balance at any month-end during the year
$
27 467


$
22 577Average balance for the year
$
20 307


$
10 818Weighted average rate for the year

3.10%



2.19%Weighted average rate at year end

3.63%



2.55%Estimated fair value
$
19 557


$
22 577


Contractual Obligations. The table below presents the contractual obligations of the company as of December 31, 2005:

Payments (in thousands) Due By PeriodTotal

Lessthan 1Year

Over 1Yearthrough3 Years

Over 3Yearsthrough5 YearsLong-Term Debt Obligations

$
1 005


$
386



$
619



$
- -


Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The companys market risk is composed primarily of interest rate risk. The companys Asset and Liability Management Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. The Board of Directors reviews and approves the guidelines established by ALCO.

24

---

Interest rate risk is monitored through the use of three complimentary modeling tools: static gap analysis, earnings simulation modeling and economic value simulation (net present value estimation). Each of these models measure changes in a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap which measures aggregate repricing values is less utilized since it does not effectively measure the investment options risk impact on the company and is not addressed here. But earnings simulation and economic value models which more effectively measure the cash flow impacts are utilized by management on a regular basis
and are explained below.

Earnings Simulation Analysis

Management uses simulation analysis to measure the sensitivity of net income to change in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.

Assumptions used in this model, including loan and deposit growth rates, are derived from seasonal trends, economic forecasts and managements outlook, as are the assumptions used to project yields and rates for new loans and deposits. Maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of repayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios.

The most likely scenario represents the rate environment as management forecasts it to occur. From this base, rate shocks in 100 basis point increments are applied to see the impact on the companys earnings. The following table represents the interest rate sensitivity on net income (fully tax equivalent basis) for the company using different rate scenarios as of December 31, 2005:

% Change inChange in Yield Curve

Net Income+
200 basis points

+
6.5
%+
100 basis points

+
3.3
%Most likely


0-
100 basis points

-
3.0
%-
200 basis points

-
6.5
%


Economic Value Simulation

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation.

The following chart reflects the change in net market value over different rate environments as of December 31, 2005:

Change in Economic Value of EquityChange in Yield Curve

(dollars in thousands)+
200 basis points


$  -
4,163+
100 basis points


-
2,079Most likely



0-
100 basis points


+
1,364-
200 basis points


+
1,994


25

---

Item 8. Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders Potomac Bancshares, Inc. and Subsidiary Charles Town, West Virginia



We have audited the accompanying consolidated balance sheets of Potomac Bancshares, Inc. and Subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders equity and cash flows for each of the three years ended December 31, 2005. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Potomac Bancshares, Inc. and Subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years ended December 31, 2005, in conformity with U.S. generally accounting principles.

Winchester, Virginia February 3, 2006

26

---

|POTOMAC BANCSHARES, INC. AND SUBSIDIARY                           
|------------------------------------------------------------------
|CONSOLIDATED BALANCE SHEETS                                       
|December 31, 2005 and 2004                                        
|(in thousands)                                                    
|                                                                  
|                                                                  
|                                                                  
|ASSETS                                                            
|                                                                  
|Cash and due from banks                                           
|Interest-bearing deposits in financial institutions               
|Securities purchased under agreements to resell                   
|and federal funds sold                                            
|Securities available for sale, at fair value                      
|Loans held for sale                                               
|Loans, net of allowance for loan losses of $2,161                 
|in 2005 and $1,966 in 2004                                        
|Premises and equipment, net                                       
|Accrued interest receivable                                       
|Other assets                                                      
|                                                                  
|Total Assets                                                      
|                                                                  
|                                                                  
|LIABILITIES AND STOCKHOLDERS EQUITY                              
|                                                                  
|LIABILITIES                                                       
|Deposits                                                          
|Noninterest-bearing                                               
|Interest-bearing                                                  
|Total Deposits                                                    
|Accrued interest payable                                          
|Securities sold under agreements to repurchase and federal        
|funds purchased                                                   
|Federal Home Loan Bank advances                                   
|Other liabilities                                                 
|Commitments and contingent liabilities                            
|Total Liabilities                                                 
|                                                                  
|STOCKHOLDERS EQUITY                                              
|Common stock, $1 per share par value; 5,000,000 shares            
|authorized; issued, 2005, 3,600,000 shares; 2004, 1,800,000 shares
|Surplus                                                           
|Undivided profits                                                 
|Accumulated other comprehensive (loss)                            
|                                                                  
|Less cost of shares acquired for the treasury, 2005,              
|206,878 shares; 2004, 103,439 shares                              
|Total Stockholders Equity                                        
|                                                                  
|Total Liabilities and Stockholders Equity                        
|                                                                  
|                                                                  
|See Notes to Consolidated Financial Statements.                   

27

---

|POTOMAC BANCSHARES, INC. AND SUBSIDIARY                   
|----------------------------------------------------------
|CONSOLIDATED STATEMENTS OF INCOME                         
|Years Ended December 31, 2005, 2004 and 2003              
|(in thousands, except per share data)                     
|                                                          
|                                                          
|Interest and Dividend Income:                             
|Interest and fees on loans                                
|Interest on securities held to maturity - taxable         
|Interest on securities available for sale - taxable       
|Interest on securities available for sale  nontaxable    
|Interest on securities purchased under agreements         
|to resell and federal funds sold                          
|Other interest and dividends                              
|Total Interest and Dividend Income                        
|                                                          
|Interest Expense:                                         
|Interest on deposits                                      
|Interest on securities sold under agreements to repurchase
|and federal funds purchased                               
|Federal Home Loan Bank advances                           
|Total Interest Expense                                    
|                                                          
|Net Interest Income                                       
|                                                          
|Provision for Loan Losses                                 
|                                                          
|Net Interest Income after Provision                       
|for Loan Losses                                           
|                                                          
|Noninterest Income:                                       
|Trust and financial services                              
|Service charges on deposit accounts                       
|Visa/MC Fees                                              
|Net gain on sale of loans                                 
|Cash surrender value of life insurance                    
|Gain (loss) on sale of securities available for sale      
|Other operating income                                    
|Total Noninterest Income                                  
|                                                          
|Noninterest Expenses:                                     
|Salaries and employee benefits                            
|Net occupancy expense of premises                         
|Furniture and equipment expenses                          
|Advertising and marketing                                 
|Stationery and supplies                                   
|Postage                                                   
|Communications                                            
|Other professional fees                                   
|ATM and check card expense                                
|Other operating expenses                                  
|Total Noninterest Expenses                                
|Income before Income Tax Expense                          
|Income Tax Expense                                        
|                                                          
|Net Income                                                
|                                                          
|Earnings Per Share, basic                                 
|Earnings Per Share, diluted                               
|                                                          
|See Notes to Consolidated Financial Statements.           

28

---

|POTOMAC BANCSHARES, INC. AND SUBSIDIARY                   
|----------------------------------------------------------
|CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
|Years Ended December 31, 2005, 2004 and 2003              
|(in thousands, except per share data)                     
|                                                          
|                                                          
|                                                          
|                                                          
|Balances, December 31, 2002                               
|                                                          
|Comprehensive income                                      
|Net income  2003                                         
|Other comprehensive income:                               
|Unrealized holding (losses)                               
|arising during the period                                 
|(net of tax, $190)                                        
|Reclassification for (gains)                              
|included in net income                                    
|(net of tax, $34)                                         
|Minimum pension liability                                 
|adjustment (net of tax, $89)                              
|Total comprehensive income                                
|Stock split in the form of a                              
|200% stock dividend                                       
|Cash dividends  2003                                     
|($.27 per share)                                          
|Purchase of treasury shares:                              
|78,999 shares                                             
|Balances, December 31, 2003                               
|                                                          
|Comprehensive income                                      
|Net income  2004                                         
|Other comprehensive income:                               
|Unrealized holding (losses)                               
|arising during the period                                 
|(net of tax, $277)                                        
|Reclassification for losses                               
|included in net income                                    
|(net of tax, $9)                                          
|Total comprehensive income                                
|Cash dividends  2004                                     
|($.30 per share)                                          
|Purchase of treasury shares:                              
|6,110 shares                                              
|Balances, December 31, 2004                               
|                                                          
|Comprehensive income                                      
|Net income  2005                                         
|Other comprehensive income:                               
|Unrealized holding (losses)                               
|arising during the period                                 
|(net of tax, $255)                                        
|Reclassification for losses                               
|included in net income                                    
|(net of tax, $125)                                        
|Total comprehensive income                                
|Stock split in the form of a                              
|100% stock dividend                                       
|Cash dividends  2005                                     
|($.34 per share)                                          
|Balances, December 31, 2005                               
|                                                          
|See Notes to Consolidated Financial Statements.           

29

---

|POTOMAC BANCSHARES, INC. AND SUBSIDIARY                       
|--------------------------------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS                         
|Years Ended December 31, 2005, 2004 and 2003                  
|(in thousands)                                                
|                                                              
|                                                              
|CASH FLOWS FROM OPERATING ACTIVITIES                          
|Net income                                                    
|Adjustments to reconcile net income to net cash               
|provided by operating activities:                             
|Provision for loan losses                                     
|Depreciation                                                  
|Deferred tax expense (benefit)                                
|Premium amortization on securities, net                       
|(Gain) loss on sale of securities available for sale          
|Proceeds from sale of loans                                   
|Origination of loans for sale                                 
|Changes in assets and liabilities:                            
|(Increase) decrease in accrued interest receivable            
|(Increase) in other assets                                    
|Increase (decrease) in accrued interest payable               
|Increase in other liabilities                                 
|Net cash provided by operating activities                     
|                                                              
|CASH FLOWS FROM INVESTING ACTIVITIES                          
|Proceeds from maturity of securities held to maturity         
|Proceeds from maturity of securities available for sale       
|Proceeds from sale of securities available for sale           
|Proceeds from call of securities available for sale           
|Purchases of securities available for sale                    
|Net (increase) in loans                                       
|Purchases of premises and equipment                           
|Net cash (used in) investing activities                       
|                                                              
|CASH FLOWS FROM FINANCING ACTIVITIES                          
|Net increase (decrease) in noninterest-bearing deposits       
|Net increase in interest-bearing deposits                     
|Net proceeds in securities sold under agreements to repurchase
|and federal funds purchased                                   
|Net proceeds (repayment) of Federal Home Loan Bank advances   
|Purchase of treasury shares                                   
|Cash dividends                                                
|Net cash provided by financing activities                     
|                                                              
|(Decrease) in cash and cash equivalents                       
|                                                              
|CASH AND CASH EQUIVALENTS                                     
|Beginning                                                     
|Ending                                                        
|                                                              
|SUPPLEMENTAL DISCLOSURES OF CASH                              
|FLOW INFORMATION                                              
|Cash payments for:                                            
|Interest                                                      
|Income taxes                                                  
|                                                              
|SUPPLEMENTAL DISCLOSURES OF NON-CASH                          
|INVESTING AND FINANCING ACTIVITIES                            
|Unrealized (loss) on securities available for sale            
|Minimum pension liability adjustment                          
|                                                              
|See Notes to Consolidated Financial Statements.               

30

---

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

|Note 1. | Nature of Banking Activities and Significant Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       
|        | Potomac Bancshares, Inc. and Subsidiary (the company) grant commercial, financial, agricultural, residential andconsumer loans to customers, primarily in Berkeley County and Jefferson County, West Virginia. The companys market area also includes Washington County and Frederick County, Maryland and Frederick County, LoudounCounty and Clarke County, Virginia. The loan portfolio is well diversified and loans generally are collateralizedby assets of the customers. The loans are expected to be repaid from cash flows or proceeds from the sale ofselected assets of the borrowers.
|       
|        | The accounting and reporting policies of the company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a summary of the more significant policies.                                                                                                                                                                                                                                                                                                                                        
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | Principles of Consolidation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|       
|        | Interest-bearing Deposits in Financial Institutions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|       
|        | Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|       
|        | Loans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|       
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

31

---

|Note 1. | Nature of Banking Activities and Significant Accounting Policies (Continued)
|------- | ----------------------------------------------------------------------------
|       
|        | Loans (Continued)                                                           
|       
|        |                                                                             
|       
|        | Allowance for Loan Losses                                                   
|       
|        |                                                                             
|        |                                                                             
|        | Loans Held for Sale                                                         
|       
|        |                                                                             

32

---

|Note 1. | Nature of Banking Activities and Significant Accounting Policies (Continued)
|------- | ----------------------------------------------------------------------------
|       
|        | Rate Lock Commitments                                                       
|       
|        |                                                                             
|       
|        | Premises and Equipment                                                      
|       
|        |                                                                             
|       
|        | Other Real Estate                                                           
|       
|        |                                                                             
|       
|        | Employee Benefit Plans                                                      
|       
|        |                                                                             
|       
|        | Stock Splits                                                                
|       
|        |                                                                             

33

---

|Note 1. | Nature of Banking Activities and Significant Accounting Policies (Continued)
|------- | ----------------------------------------------------------------------------
|       
|        | Earnings Per Share                                                          
|       
|        |                                                                             
|       
|        | Income Taxes                                                                
|       
|        |                                                                             
|       
|        | Cash and Cash Equivalents                                                   
|       
|        |                                                                             
|       
|        | Trust Division                                                              
|       
|        |                                                                             
|       
|        | Use of Estimates                                                            
|       
|        |                                                                             
|       
|        | Advertising                                                                 
|       
|        |                                                                             
|       
|        | Comprehensive Income                                                        
|       
|        |                                                                             
|       
|        | Stock-Based Compensation Plan                                               
|       
|        |                                                                             

34

---

|Note 1. | Nature of Banking Activities and Significant Accounting Policies (Continued)
|------- | ----------------------------------------------------------------------------
|       
|        | Stock-Based Compensation Plan (Continued)                                   
|       
|        |                                                                             

|                                                  | For the Years Ended                             
|------------------------------------------------- | ------------------------------------------------
|                                                  | December 31                                     
|                                                  | 2005                                            
|                                                  | (dollars in thousands, except per share amounts)
|                                                 
|Net income, as reported                           |                                                 
|                                                 
|Total stock-based compensation expense determined |                                                 
|under fair value based method for all awards      |                                                 
|                                                 
|Pro forma net income                              |                                                 
|                                                 
|Earnings per share:                               |                                                 
|                                                 
|Basic  as reported                               |                                                 
|Basic  pro forma                                 |                                                 
|Diluted  as reported                             |                                                 
|Diluted  pro forma                               |                                                 

| | Reclassifications               
| | --------------------------------
| |                                 
| |                                 
|
| | Recent Accounting Pronouncements
|
| |                                 

35

---

|Note 1. | Nature of Banking Activities and Significant Accounting Policies (Continued)
|------- | ----------------------------------------------------------------------------
|       
|        | Recent Accounting Pronouncements (Continued)                                
|       
|        |                                                                             

36

---

|Note 2. | Securities                                                                                                                                                                                                   
|------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                                                                                                              
|        | There were no securities held to maturity as of December 31, 2005 and 2004.The amortized cost and fair value of securities available for sale as of December 31, 2005 and 2004 (in thousands) are as follows:

|                                        | 2005     
|--------------------------------------- | ---------
|                                        |          
|                                        | Amortized
|                                        | Cost     
|                                       
|Obligations of U.S. Government agencies |          
|State and municipal obligations         |          
|                                        |          
|                                       
|                                        | 2004     
|                                        |          
|                                        | Amortized
|                                        | Cost     
|                                       
|Obligations of U.S. Government agencies |          
|State and municipal obligations         |          
|                                        |          

| | The amortized cost and fair value of the securities available for sale as of December 31, 2005 (in thousands), by contractual maturity, are shown below:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      | Amortized |   | Fair   | 
|------------------------------------- | --------- | - | ------ | 
|                                      | Cost      |   | Value  | 
|                                     
|Due in one year or less               |           | $ | 15 493 | 
|Due after one year through five years |           |   | 30 726 | 
|Due after five years                  |           |   | 1 151  | 
|                                      |           | $ | 47 370 | 

| | Proceeds from sales of securities available for sale were $13.9 million during 2005, $9.0 million during 2004 and $8.0 million during 2003. Gross losses of $369 thousand were realized on sales in 2005. Gross losses of $30 thousand and gross gains of $4 thousand were realized on sales in 2004. Gross losses of $29 thousand and gross gains of $128 thousand were realized on sales in 2003. 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 30 accounts in the consolidated portfolio that have losses. These securities have not suffered credit deterioration and the company has the ability and intent to hold these issues to maturity; therefore, the gross unrealized losses are considered temporary as of December 31, 2005. 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 December 31, 2005 and 2004 (in thousands).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37

---

|Note 2. | Securities (Continued)
|------- | ----------------------

|                                | December 31, 2005  
|------------------------------- | -------------------
|                                | Less than 12 months
|                                |                    
|                                |                    
|                                | Fair Value         
|                               
|Obligations of U.S.             |                    
|Government agencies             |                    
|State and municipal obligations |                    
|                                |                    
|                               
|                               
|                               
|                                | December 31, 2004  
|                                | Less than 12 months
|                                |                    
|                                |                    
|                                | Fair Value         
|Obligations of U.S.             |                    
|Government agencies             |                    

|        | Securities with a carrying value of $41.8 million and $28.2 million at December 31, 2005 and 2004 were pledged to secure public funds and other balances as required by law.
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       
|Note 3. | Loans and Related Party TransactionsThe loan portfolio is composed of the following:                                                                                        

December 312005

2004(in thousands)Mortgage loans on real estate:Construction and land development
$
41 174

$
28 929Secured by farm land

2 381


3 986Secured by 1-4 family residential

98 408


79 800Secured by multifamily residential

3 486


3 088Secured by nonfarm nonresidential

43 019


39 671Commercial loans (except those securedby real estate)

6 046


5 949Consumer loans

15 549


17 346All other loans

372


236Total loans
$
210 435

$
179 005Less: allowance for loan losses

2 161


1 966$
208 274

$
177 039


| | At December 31, 2005 and 2004, overdraft demand deposits reclassified to loans totaled $129 thousand and $120 thousand, respectively.The Securities and Exchange Commission requires disclosure of loans which exceed $60,000 to executive officers and directors of the company or to their associates. Such loans were made on substantially the same terms as those prevailing for comparable transactions with similar risks. At December 31, 2005 and 2004, these loans totaled $1.6 million and $1.1 million respectively.During 2005, total principal additions were $766 thousand and total principal payments were $257 thousand.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

38

---

|Note 4. | Allowance for Loan Losses                                                                                          
|------- | -------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                    
|        | The following is a summary of transactions in the allowance for loan losses for 2005, 2004 and 2003 (in thousands):
|       
|       
|       
|       
|       
|       

|
|
|
|
|
|
|
|
|
|
|
|

| | There were no impaired loans at December 31, 2005 and 2004.                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                             
| | Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2005 totaled $122 thousand. If interest had been accrued, such income would have approximated $3 thousand in 2005. There were no nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2004.

|Note5. | Premises and Equipment, Net                      
|------ | -------------------------------------------------
|       |                                                  
|       | Premises and equipment consists of the following:
|       |                                                  
|      
|      
|      
|      
|      
|      

| | 
| | 
| | 
| | 
| | 
| | 
| | 
| | 
| | 
| | 
| | 
| | 

|       | Depreciation included in operating expense for 2005, 2004 and 2003 was $578 thousand, $605 thousand and $623 thousand respectively.                      
|------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|       |                                                                                                                                                          
|Note6. | Deposits                                                                                                                                                 
|       |                                                                                                                                                          
|       | The aggregate amount of time deposits with a balance of $100,000 or more was $16.2 million and $13.2 million at December 31, 2005 and 2004, respectively.
|       |                                                                                                                                                          
|       | At December 31, 2005, the scheduled maturities of all time deposits (in thousands) are as follows:                                                       

|2006 |  | $ | 16 504 | 
|---- |  | - | ------ | 
|2007 |  |   | 24 543 | 
|2008 |  |   | 10 090 | 
|2009 |  |   | 12 071 | 
|2010 |  |   | 5 546  | 
|     |  | $ | 68 754 | 

39

---

|Note 7. | Borrowings                                                                                                                                                                                                                                                                                                                                          
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                                                                                                                                                                                                                                                     
|        | Short-term borrowings may consist of securities sold under agreements to repurchase and federal funds purchased. At December 31, 2005 short-term borrowings totaled $19.6 million in securities sold under agreements to repurchase through secured transactions with customers.                                                                    
|        |                                                                                                                                                                                                                                                                                                                                                     
|        | At December 31, 2004, short-term borrowings totaled $22.6 million which included $11.8 million in securities sold under agreements to repurchase with customers, $5 million through the Repo Plus account at the Federal Home Loan Bank and $5.8 million in federal funds purchased through The Bankers Bank.                                       
|        |                                                                                                                                                                                                                                                                                                                                                     
|        | In June 2001, the bank incurred fixed rate long term debt consisting of a Federal Home Loan Bank seven year loan with an original balance of $2.5 million and monthly payments of interest and principal with an interest rate of 5.51% . The loan is secured by capital stock, deposits, mortgage collateral and securities collateral of the bank.
|        |                                                                                                                                                                                                                                                                                                                                                     
|        | Principal payments on the note are due as follows:                                                                                                                                                                                                                                                                                                  

|2006 |  | $ | 386   | 
|---- |  | - | ----- | 
|2007 |  |   | 407   | 
|2008 |  |   | 212   | 
|     |  | $ | 1 005 | 

| | The balance of this loan at December 31, 2004 was $1,370.                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                    
| | The company has unused lines of credit with the Federal Home Loan Bank and other financial institutions totaling approximately $113.7 million at December 31, 2005.

|Note 8. | Employee Benefit Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | The company sponsors a 401(k) retirement savings plan available to full-time employees meeting certain age and service requirements. Employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. Entry dates are January 1, April 1, July 1 and October 1. Employees can make a salary deferral election authorizing the employer to withhold up to the amount allowed by law each calendar year. The employer may make a discretionary matching contribution each plan year. The employer may also make other discretionary contributions to the plan. The company made 401(k) matching contributions of $50 thousand, $49 thousand and $44 thousand in 2005, 2004 and 2003, respectively.                                                                                                                                                                                                                                                                                               
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | The company sponsors a noncontributory, defined benefit pension plan covering full-time employees over 21 years of age upon completion of one year of service. Benefits are based on average compensation for the five consecutive full calendar years of service which produces the highest average. The company computes the net periodic pension cost of the plan in accordance with Financial Accounting Standards Statement No. 87, Employers Accounting for Pensions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | The company sponsors a postretirement life insurance plan covering retirees with 25 years of service over the age of 60 and health care plan for all current retirees and one current employee that have met certain eligibility requirements. The plan is contributory for the future retiree, with retiree contributions that are currently set at 20% of the required premium. The company accounts for its share of the costs of those benefits in accordance with Financial Accounting Standards Statement No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions. Under that Statement, the companys share of the estimated costs that will be paid after retirement is generally being accrued by charges to expense over the employees active service periods to the dates they are fully eligible for benefits, except that the companys unfunded cost that existed at January 1, 1995 is being accrued primarily in a straight-line manner that will
result in its full accrual by December 31, 2014.

40

---

|Note 8. | Employee Benefit Plans (Continued)
|------- | ----------------------------------

| | Information about the plans follows:                                                                                                                   |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | ------------------------------------------------------------------------------------------------------------------------------------------------------ | ---- | ---------------- | ---- |  | ----------------------- | -------------- | ---- |  | - | ---- | - |  | - | ---- | -
| |                                                                                                                                                        |      | Pension Benefits |      |  | Postretirement Benefits |               
| |                                                                                                                                                        | 2005 |                  | 2004 |  | 2005                    |                | 2004 | 
| |                                                                                                                                                        |      | (in thousands)   |      |  |                         | (in thousands) |     
| | Change in Benefit Obligation:                                                                                                                          |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | Benefit obligation, beginning                                                                                                                          | $    | 4 923            |      |  | $                       | 4 070          |      |  | $ | 467  |   |  | $ | 441  |  
| | Service cost                                                                                                                                           |      | 226              |      |  |                         | 238            |      |  |   | 7    |   |  |   | 6    |  
| | Interest cost                                                                                                                                          |      | 314              |      |  |                         | 259            |      |  |   | 30   |   |  |   | 29   |  
| | Change in assumptions                                                                                                                                  |      | - -              |      |  |                         | - -            |      |  |   | - -  |   |  |   | 14   |  
| | Actuarial loss                                                                                                                                         |      | 222              |      |  |                         | 533            |      |  |   | 39   |   |  |   | - -  |  
| | Benefits paid                                                                                                                                          |      | (195             | )    |  |                         | (177           | )    |  |   | (26  | ) |  |   | (23  | )
| | Benefit obligation, ending                                                                                                                             | $    | 5 490            |      |  | $                       | 4 923          |      |  | $ | 517  |   |  | $ | 467  |  
| |                                                                                                                                                       
| | Change in Plan Assets:                                                                                                                                 |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | Fair value of plan assets, beginning                                                                                                                   | $    | 3 708            |      |  | $                       | 3 357          |      |  | $ | - -  |   |  | $ | - -  |  
| | Actual return on plan assets                                                                                                                           |      | 237              |      |  |                         | 272            |      |  |   | - -  |   |  |   | - -  |  
| | Employer contributions                                                                                                                                 |      | 347              |      |  |                         | 256            |      |  |   | 26   |   |  |   | 23   |  
| | Benefits paid                                                                                                                                          |      | (195             | )    |  |                         | (177           | )    |  |   | (26  | ) |  |   | (23  | )
| | Fair value of plan assets, ending                                                                                                                      | $    | 4 097            |      |  | $                       | 3 708          |      |  | $ | - -  |   |  | $ | - -  |  
| |                                                                                                                                                       
| | Funded status                                                                                                                                          | $    | (1 393           | )    |  | $                       | (1 215         | )    |  | $ | (517 | ) |  | $ | (467 | )
| | Unrecognized net (gain) loss                                                                                                                           |      | 1 075            |      |  |                         | 803            |      |  |   | (27  | ) |  |   | (68  | )
| | Unrecognized net obligation                                                                                                                            |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | (asset) at transition                                                                                                                                  |      | - -              |      |  |                         | (15            | )    |  |   | 157  |   |  |   | 174  |  
| | Unrecognized prior service cost                                                                                                                        |      | - -              |      |  |                         | - -            |      |  |   | - -  |   |  |   | - -  |  
| | Accrued benefit cost included                                                                                                                          |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | in other liabilities                                                                                                                                   | $    | (318             | )    |  | $                       | (427           | )    |  | $ | (387 | ) |  | $ | (361 | )
| |                                                                                                                                                        |      |                  |      |  |                         |                |      |  |   |      |   |  |   |      |  
| | The accumulated benefit obligation for the defined benefit pension plan was $4.3 million and $3.9 million at December 31, 2005 and 2004, respectively.

| |                                                                           | Pension Benefits |       |   | Postretirement Benefits
| | ------------------------------------------------------------------------- | ---------------- | ----- | - | -----------------------
| |                                                                           | 2005             |       |   | 2004                   
| | Components of Net Periodic Benefit Cost:                                  |                  |       |   |                        
| | Service cost                                                              | $                | 226   |   |                        
| | Interest cost                                                             |                  | 314   |   |                        
| | Expected return on plan assets                                            |                  | (314  | ) |                        
| | Amortization of net (gain)                                                |                  | - - - |   |                        
| | Amortization of prior service cost                                        |                  | - -   |   |                        
| | Amortization of net obligation                                            |                  |       |   |                        
| | (asset) at transition                                                     |                  | (15   | ) |                        
| | Recognized actuarial (gain) loss                                          |                  | 27    |   |                        
| | Net periodic benefit cost                                                 | $                | 238   |   |                        
| |                                                                          
| |                                                                          
| | Weighted-average assumptions used to determine net periodic benefit cost: |                  |       |   |                        
| | Discount rate                                                             | 6.50%            |       |   | 6.50%                  
| | Expected return on plan assets                                            | 8.50%            |       |   | 8.50%                  
| | Rate of compensation increase                                             | 4.00%            |       |   | 4.00%                  
| |                                                                          
| | Weighted-average assumptions used to determine benefit obligations:       |                  |       |   |                        
| | Discount rate                                                             | 6.50%            |       |   | 6.50%                  
| | Rate of compensation increase                                             | 4.00%            |       |   | 4.00%                  

41

---

|Note8. | Employee Benefit Plans (Continued)
|------ | ----------------------------------
|       |                                   
|       | Long-Term Rate of Return          
|       |                                   
|       |                                   
|       |                                   
|       |                                   
|       |                                   
|       | Asset Allocation                  
|       |                                   
|       |                                   

|                  |  | Plan Assets at October 31 |  |     
|----------------- |  | ------------------------- |  | ----
|                  |  | 2005                      |  | 2004
|Asset Category    |  |                           |  |     
|Equities          |  | 61%                       |  | 56% 
|Fixed income/cash |  | 39%                       |  | 44% 
|                  | 
|Total             |  | 100%                      |  | 100%

| |  | The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 60% equities and 40% fixed income/cash. The trust fund allocation is reviewed on a quarterly basis and rebalanced back to the original weighting if the actual weighting varies by at least 5% from the target allocation. The investment manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the plans investment strategy. The investment manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | It is the responsibility of the trustee to administer the investments of the trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the trust.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          





42

---

|Note8. | Employee Benefit Plans (Continued)
|------ | ----------------------------------
|       |                                   
|       | Cash Flow                         

| |  | The company expects to contribute $295 thousand to its pension plan in 2005 and $26 thousand to its postretirement plan in 2005.
| |  | --------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                 
| |  | The following benefit payments, which reflect future service, are expected to be paid:                                          

Pension Benefits

Other Benefits(in thousands)2006

$
218

$
322007


213


342008


251


362009


260


372010


255


392011-2015


1 773


200


For measurement purposes, an 8.50% annual rate of increase in per capita health care costs of covered benefits was assumed for 2005 and 2004, and an 8.64% increase was assumed for 2003, with such annual rate of increase gradually declining to 5% in 2013.Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1% change in assumed health care cost trend rates would have the following effects:




| |                                                            | 1% Increase    |    | 1% Decrease
| | ---------------------------------------------------------- | -------------- | -- | -----------
| |                                                            | (in thousands)
| | Effect on the health care component of the accumulated     |                |    |            
| | postretirement benefit obligation                          | $              | 20 |            
| | Effect on total of service and interest cost components of |                |    |            
| | net periodic postretirement health care benefit cost       |                | 2  |            

|Note 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 stockholders.
|        |                                                                                                                                                                                                                                                                                    
|       
|       

| |                                | December 31, 2005 |  | December 31, 2004 |      | December 31, 2003
| | ------------------------------ | ----------------- |  | ----------------- | ---- | -----------------
| |                                | Average           |  | Per Share         |      | Average          
| |                                | Shares            |  | Amount            |      | Shares           
| |                               
| | Basic earnings per share       | 3 393 122         |  | $                 | 1.08 |                  
| |                               
| | Effect of dilutive securities: |                   |  |                   |      |                  
| | Stock options                  | 16 229            |  |                   |      | 2 472            
| |                               
| | Diluted earnings per share     | 3 409 351         |  | $                 | 1.07 |                  
| |                                |                   |  |                   |      |                  

|
|
|
|
|
|

43

---

|        
|--------
|        
|        
|Note 10.
|        
|        
|        

2005
    
    2004Weighted Average
    
    
    
    Weighted AverageShares
    
    Exercise Price
    
    Shares
    
    Exercise PriceOutstanding at
      beginning of year
    
    33
      988
    
    $
    11.28
    
    
    -
    -
    
    
    $
    -
      -Granted
    
    44
      982
    
    
    14.00
    
    
    35 988
    
    
    
    11.28Exercised
    
    -
      -
    
    
    -
      -
    
    
    - -
    
    
    
    -
      -Forfeited
    
    (4 600
    )
    
    12.82
    
    
    (2 000
    )
    
    
    11.28Outstanding at
      end of year
    
    74 370
    
    $
    12.83
    
    
    33 988
    
    
    $
    11.28Weighted average
      fair valueof options
      granted
    
    
    $
    2.91
    
    
    
    
    
    
    $2.62


|
|
|
|
|
|
|

| |          |  | Options Outstanding |                 | Options Exercisable
| | -------- |  | ------------------- | --------------- | -------------------
| |          |  |                     | Weighted        |                    
| |          |  |                     | Average         | Weighted           
| |          |  |                     | Remaining       | Average            
| | Exercise |  | Number              | Contractual     | Exercise           
| | Price    |  | Outstanding         | Life (in years) | Price              
|
| | $11.28   |  |                     | 31 988          |                    
| | 14.00    |  |                     | 42 382          |                    
| |          |  |                     | 74 370          |                    

44

---

|        
|--------
|        
|        
|Note 11.
|        
|        
|        

| |                                 |                | 2005 |   | 2004 |    
| | ------------------------------- | -------------- | ---- | - | ---- | ---
| |                                 | (in thousands) |     
| | Deferred tax assets:            |                |      |   |     
| | Reserve for loan losses         |                |      | $ | 580  |    
| | Accrued pension expense         |                | 89   |   |      | 151
| | Accrued postretirement benefits |                | 132  |   |      | 123
| | Nonaccrual interest             |                | 1    |   |      | - -
| | Securities available for sale   |                |      |   | 142  |    
| |                                 |                |      | $ | 944  |    
| | Deferred tax liabilities:       |                |      |   |     
| | Depreciation                    |                |      | $ | 123  |    
| |                                
| | Net deferred tax assets         |                |      | $ | 821  |    

|
|
|
|
|
|

| |                                |                | 2005 |   | 2004  |   |  | 2003
| | ------------------------------ | -------------- | ---- | - | ----- | - |  | ----
| |                                | (in thousands)
| |                                |                |      |   |      
| | Current tax expense            |                |      | $ | 2 061 |   |  | $   
| | Deferred tax expense (benefit) |                |      |   | (41   | ) |  |     
| |                                |                |      | $ | 2 020 |   |  | $   
|
|
|
|
|
|

|
|
|
|
|
|

| |                                                       |                | 2005 |   | 2004  |   |  | 2003
| | ----------------------------------------------------- | -------------- | ---- | - | ----- | - |  | ----
| |                                                       | (in thousands)
| |                                                       |                |      |   |      
| | Computed expected tax expense                       |                |      | $ | 1 933 |   |  | $   
| | Increase (decrease) in income taxes resulting from:   |                |      |   |       |   |  |     
| | Tax exempt interest income                            |                |      |   | (86   | ) |  |     
| | State income taxes, net of federal income tax benefit |                |      |   | 173   |   |  |     
| | Other                                                 |                |      |   | - -   |   |  |     
| |                                                       |                |      | $ | 2 020 |   |  | $   
|
|
|
|
|
|

|        
|--------
|        
|        
|Note 12.
|        
|        
|        
|        
|        
|        
|        
|        
|        

45

---

|        
|--------
|        
|        
|Note 13.
|        
|        
|        
|Note 14.
|        
|        
|        
|        
|        
|        
|        

2005

2004Financial instruments whose contractamounts represent credit risk:Commitments to extend credit

$
63 747

$ 58 477Standby letters of credit


5 265

2 996




|
|
|
|
|
|
|
|
|
|
|
|
|
|
|



46

---

|        
|--------
|        
|        
|Note 15.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        



47

---

|        
|--------
|        
|        
|Note 15.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        

| |                               |  | 2005           |       | 2004          
| | ----------------------------- |  | -------------- | ----- | --------------
| |                               |  | Carrying       |       | Fair          
| |                               |  | Amount         |       | Value         
| |                               |  | (in thousands) |       | (in thousands)
| | Financial assets:             |  |                |       |               
| | Cash                          |  | $              | 8 115 |               
| | Securities purchased under    |  |                |       |               
| | agreements to resell and      |  |                |       |               
| | federal funds sold            |  | 357            |       | 357           
| | Securities available for sale |  | 46 951         |       | 46 951        
| | Loans, net                    |  | 208 274        |       | 206 838       
| | Loans held for sale           |  | - -            |       | - -           
| | Accrued interest receivable   |  | 1 152          |       | 1 152         
| |                              
| | Financial liabilities:        |  |                |       |               
| | Deposits                      |  | 229 880        |       | 229 941       
| | Repurchase agreements         |  | 19 557         |       | 19 557        
| | FHLB advances                 |  | 1 005          |       | 1 005         
| | Accrued interest payable      |  | 331            |       | 331           

|        
|--------
|        
|        
|        
|        
|Note 16.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        



48

---

|        
|--------
|        
|        
|Note 16.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        

| |                                  |  |        |        |             |        |                   |   |                   |  | Minimum   
| | -------------------------------- |  | ------ | ------ | ----------- | ------ | ----------------- | - | ----------------- |  | ----------
| |                                  |  |        |        |             |        |                   |   |                   |  | To Be Well
| |                                  |  |        |        |             |        | Minimum           |   | Capitalized Under
| |                                  |  |        |        |             |        | Capital           |   | Prompt Corrective
| |                                  |  | Actual |        | Requirement |        | Action Provisions
| |                                  |  | Amount |        | Ratio       |        | Amount            |   | Ratio             |  | Amount    
| |                                  |  |        |        |             |        | (in thousands)    |   |                   |  |           
| | As of December 31, 2005:         |  |        |        |             |        |                   |   |                   |  |           
| | Total capital (to risk-weighted  |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 27 469 |             | 13.76% |                   | $ | 15 968            |  | 8.0%      
| | Bank of Charles Town             |  | $      | 27 148 |             | 13.62% |                   | $ | 15 946            |  | 8.0%      
| | Tier 1 capital (to risk-weighted |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 25 308 |             | 12.68% |                   | $ | 7 984             |  | 4.0%      
| | Bank of Charles Town             |  | $      | 24 987 |             | 12.54% |                   | $ | 7 973             |  | 4.0%      
| | Tier 1 capital (to average       |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 25 308 |             | 9.18%  |                   | $ | 11 030            |  | 4.0%      
| | Bank of Charles Town             |  | $      | 24 987 |             | 9.07%  |                   | $ | 11 019            |  | 4.0%      
| |                                 
| |                                 
| | As of December 31, 2004:         |  |        |        |             |        |                   |   |                   |  |           
| | Total capital (to risk-weighted  |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 24 747 |             | 14.44% |                   | $ | 13 715            |  | 8.0%      
| | Bank of Charles Town             |  | $      | 24 713 |             | 14.42% |                   | $ | 13 712            |  | 8.0%      
| | Tier 1 capital (to risk-weighted |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 22 781 |             | 13.29% |                   | $ | 6 857             |  | 4.0%      
| | Bank of Charles Town             |  | $      | 22 747 |             | 13.27% |                   | $ | 6 856             |  | 4.0%      
| | Tier 1 capital (to average       |  |        |        |             |        |                   |   |                   |  |           
| | assets):                         |  |        |        |             |        |                   |   |                   |  |           
| | Consolidated                     |  | $      | 22 781 |             | 9.45%  |                   | $ | 9 641             |  | 4.0%      
| | Bank of Charles Town             |  | $      | 22 747 |             | 9.44%  |                   | $ | 9 640             |  | 4.0%      

49

---

|        
|--------
|        
|        
|Note 17.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        

POTOMAC BANCSHARES, INC.(Parent Company Only)Balance SheetsDecember 31, 2005 and 2004

| |                                               |  | 2005   |        |   | 2004   |       
| | --------------------------------------------- |  | ------ | ------ | - | ------ | ------
| | ASSETS                                        |  |        |        |   |        |       
| |                                              
| | Cash                                          |  | $      | 40     |   |        | $     
| | Investment in subsidiary                      |  | 24 711 |        |   | 22 722 |       
| | Other assets                                  |  | 281    |        |   | 30     |       
| |                                              
| | Total Assets                                  |  | $      | 25 032 |   |        | $     
| |                                              
| | LIABILITIES AND STOCKHOLDERS EQUITY          |  |        |        |   |        |       
| |                                              
| | LIABILITIES, other                            |  | $      | - -    |   |        | $     
| |                                              
| | STOCKHOLDERS EQUITY                          |  |        |        |   |        |       
| | Common stock                                  |  | $      | 3 600  |   |        | $     
| | Surplus                                       |  |        | 2 400  |   |        | 4 200 
| | Undivided profits                             |  |        | 21 158 |   |        | 18 631
| | Accumulated other comprehensive (loss)        |  |        | (276   | ) |        | (25   
| |                                               |  | $      | 26 882 |   |        | $     
| | Less cost of shares acquired for the treasury |  |        | 1 850  |   |        | 1 850 
| | Total Stockholders Equity                    |  | $      | 25 032 |   |        | $     
| |                                              
| | Total Liabilities and Stockholders Equity    |  | $      | 25 032 |   |        | $     

POTOMAC BANCSHARES, INC.(Parent Company Only)Statements of IncomeYears Ended December 31, 2005, 2004 and 2003

| |                                              |  | 2005  |       |  | 2004  |   |       | 2003 |  
| | -------------------------------------------- |  | ----- | ----- |  | ----- | - | ----- | ---- | -
| | Income                                       |  |       |       |  |       |   |       |      |  
| | Dividends from subsidiary                    |  | $     | 1 487 |  |       | $ | 1 193 |      |  
| |                                             
| | Expenses                                     |  |       |       |  |       |   |       |      |  
| | Other professional fees                      |  | 34    |       |  | 37    |   |       | 19   |  
| | Other operating expenses                     |  | 60    |       |  | 54    |   |       | 56   |  
| | Total Expenses                               |  | $     | 94    |  |       | $ | 91    |      |  
| |                                             
| | Income before Income Tax (Benefit) and       |  |       |       |  |       |   |       |      |  
| | Equity in Undistributed Income of            |  |       |       |  |       |   |       |      |  
| | Subsidiary                                   |  | $     | 1 393 |  |       | $ | 1 102 |      |  
| |                                             
| | Income Tax (Benefit)                         |  | (31   | )     |  | (30   | ) |       | (25  | )
| |                                             
| | Income before Equity in Undistributed        |  |       |       |  |       |   |       |      |  
| | Income of Subsidiary                         |  | $     | 1 424 |  |       | $ | 1 132 |      |  
| |                                             
| | Equity in Undistributed Income of Subsidiary |  | 2 240 |       |  | 1 958 |   |       | 281  |  
| |                                             
| | Net Income                                   |  | $     | 3 664 |  |       | $ | 3 090 |      |  



50

---

|        
|--------
|        
|        
|Note 17.
|        
|        
|        
|        
|        
|        
|        
|        
|        
|        

POTOMAC BANCSHARES, INC.(Parent Company Only)Statements of Cash FlowsYears Ended December 31, 2005, 2004 and 2003

| |                                                 |  | 2005   |        |   | 2004   |   |        |   | 2003   |  
| | ----------------------------------------------- |  | ------ | ------ | - | ------ | - | ------ | - | ------ | -
| | CASH FLOWS FROM OPERATING ACTIVITIES            |  |        |        |   |        |   |        |   |        |  
| | Net income                                      |  | $      | 3 664  |   |        | $ | 3 090  |   |        | $
| | Adjustments to reconcile net income to net cash |  |        |        |   |        |   |        |   |        |  
| | provided by operating activities:               |  |        |        |   |        |   |        |   |        |  
| | Equity in undistributed (income) of             |  |        |        |   |        |   |        |   |        |  
| | subsidiary                                      |  | (2 240 | )      |   | (1 958 | ) |        |   | (281   | )
| | (Increase) in other assets                      |  | (251   | )      |   | (5     | ) |        |   | (11    | )
| | (Decrease) in other liabilities                 |  | (3     | )      |   | - -    |   |        |   | (2     | )
| |                                                
| | Net cash provided by operating                  |  |        |        |   |        |   |        |   |        |  
| | activities                                      |  | $      | 1 170  |   |        | $ | 1 127  |   |        | $
| |                                                
| | CASH FLOWS FROM FINANCING ACTIVITIES            |  |        |        |   |        |   |        |   |        |  
| | Cash dividends                                  |  | $      | (1 137 | ) |        | $ | (1 002 | ) |        | $
| | Purchase of treasury shares                     |  | - -    |        |   | (141   | ) |        |   | (1 461 | )
| |                                                
| | Net cash (used in) financing activities         |  | $      | (1 137 | ) |        | $ | (1 143 | ) |        | $
| |                                                
| | Increase (decrease) in cash and cash            |  |        |        |   |        |   |        |   |        |  
| | equivalents                                     |  | $      | 33     |   |        | $ | (16    | ) |        | $
| | CASH AND CASH EQUIVALENTS                       |  |        |        |   |        |   |        |   |        |  
| | Beginning                                       |  | 7      |        |   | 23     |   |        |   | 36     |  
| |                                                
| | Ending                                          |  | $      | 40     |   |        | $ | 7      |   |        | $

51

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Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.

Not Applicable.

Item 9A. Controls and Procedures.

The companys chief executive officer and chief financial officer, based on their evaluation as of the date of this report of the companys disclosure controls and procedures (as defined in Rule 13(a)-14(e) of the Securities Exchange Act of 1934), have concluded that the companys disclosure controls and procedures are adequate and effective for purposes of Rule 13(a)-14(c) and timely, alerting them to material information relating to the company required to be included in the companys filings with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

There were no significant changes in the companys internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

Item 9B. Other Information.

None.

PART III

Item 10. Directors and Executive Officers of the Registrant.

The information contained on pages 7-9 of the Proxy Statement dated March 24, 2006, for the April 25, 2006 Annual Meeting under the captions Management Nominees to the Board of Potomac and Directors Continuing to Serve Unexpired Terms, and page 16 under the caption Section 16(a) Beneficial Ownership Reporting Compliance is incorporated herein by reference.

The Executive Officers are as follows:

|Name                    |  | Position Since             |  | Age |  | Principal Occupation                                  
|----------------------- |  | -------------------------- |  | --- |  | ------------------------------------------------------
|                       
|Robert F. Baronner, Jr. |  | President & CEO            |  | 47  |  | Employed by bank as of 1/1/01 as President and CEO.   
|                        |  | 2001                       |  |     |  |                                                       
|                       
|David W. Irvin          |  | Sr. Vice President         |  | 42  |  | Employed at bank from 2001 to present as Commercial   
|                        |  | 2004                       |  |     |  | Loan Division Manager; former Senior Vice President - 
|                        |  |                            |  |     |  | Commercial Lending BB&T 2000-2001.                    
|                       
|Gayle Marshall Johnson  |  | Sr. Vice President & Chief |  | 56  |  | Employed with the bank 1977-1985 and 1988-present;    
|                        |  | Financial Officer          |  |     |  | Vice President and Chief Financial Officer since 1990.
|                        |  | 1994                       |  |     |  | Sr. Vice President since 2005.                        
|                       
|Donald S. Smith         |  | Vice President &           |  | 77  |  | Employed at bank 1947 to 1991; President 1979 to 1991 
|                        |  | Assistant Secretary        |  |     |  | (retired).                                            
|                        |  | 1994                       |  |     |  |                                                       

The bank has adopted a Code of Ethics that applies to all employees, including Potomacs and the banks chief executive officer and chief financial officer and other senior officers. Additionally, there is a Code of Ethics for Senior Financial Officers which applies to Potomacs and the banks chief executive officer and chief financial officer. These Codes of Ethics are attached to this document as Exhibits 14.1 and 14.2. If we make any substantive amendments to this code or grant any waiver from a provision of the code to our chief executive officer or chief financial officer, we will disclose the amendment or waiver in a report on Form 8-K.

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Item 11. Executive Compensation.

The information contained on pages 10-12 and 14 of the Proxy Statement dated March 24, 2006, for the April 25, 2006 Annual Meeting under the captions Executive Compensation, Employee Benefit Plans, Employment Agreement, and Compensation of Directors is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information contained on pages 9-10 of the Proxy Statement dated March 24, 2006, for the April 25, 2006 Annual Meeting under the caption Ownership of Securities by Nominees, Directors and Officers is incorporated herein by reference.

Securities authorized for issuance under Potomacs 2003 Stock Incentive Plan are listed below:

| |                           |  |                      |        |                      |  | Number of securities     
| | ------------------------- |  | -------------------- | ------ | -------------------- |  | -------------------------
| |                           |  | Number of securities |        |                      |  | remaining available for  
| |                           |  | to be issued         |        | Weighted-average     |  | future issuance under    
| |                           |  | upon exercise of     |        | exercise price of    |  | equity compensation plans
| |                           |  | outstanding options, |        | outstanding options, |  | (excluding securities    
| | Plan category             |  | warrants and rights  |        | warrants and rights  |  | reflected in column (a)) 
| |                          
| | 2003 Stock Incentive Plan |  |                      |        |                      |  |                          
| | approved by shareholders  |  |                      |        |                      |  |                          
| | May 13, 2003              |  |                      | 74 370 |                      |  |                          

Item 13. Certain Relationships and Related Transactions.

The information contained on page 15 of the Proxy Statement dated March 24, 2006, for the April 25, 2006 Annual Meeting under the caption Certain Transactions with Directors, Officers and Their Associates is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services.

The information contained on pages 6-7 of the Proxy Statement dated March 24, 2006, for the April 25, 2006 Annual Meeting under the caption Audit Committee Report is incorporated herein by reference.

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Item 15. Exhibits and Financial Statement Schedules.

|                                                                                                                                                                                                                                                                                                                                                                  | (a) |  | (1)Financial Statements. Reference is made to Part II, Item 8 of this Annual Report on Form 10-K.                                                                                                        
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                  |     |  | (2)     Financial Statement Schedules. These schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
|                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                  |     |  | (3)   Exhibits. See below.                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                 
|2.1     Agreement and Plan of Merger dated March 8, 1994, by and between Potomac Bancshares, Inc., and Bank of Charles Town filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.                                                            
|                                                                                                                                                                                                                                                                                                                                                                 
|3.1     Articles of Incorporation of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                 
|3.2     Amendments to Articles of Incorporation of Potomac Bancshares, Inc. adopted by shareholders on April 25, 1995 and filed with the West Virginia Secretary of State on May 23, 1995, and incorporated by reference from Potomacs Form 10-KSB for the year ended December 31, 1995 and filed with the Securities and Exchange Commission, File No. 0-24958.
|                                                                                                                                                                                                                                                                                                                                                                 
|3.3     Amended and Restated Bylaws of Potomac Bancshares, Inc. adopted by shareholders April 25, 1995 and incorporated by reference from Potomacs Form 10-KSB for the year ended December 31, 1995, and filed with the Securities and Exchange Commission, File No. 0-24958.                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                 
|10.1     2003 Stock Incentive Plan adopted by the Potomac Board February 20, 2003 and approved by the Companys shareholders on May 13, 2003 and incorporated by reference from Potomacs Form 10-KSB for the year ended December 31, 2003 and filed with the Securities and Exchange Commission, File No. 0-24958.                                              
|                                                                                                                                                                                                                                                                                                                                                                 
|10.2     Employment Agreement of Mr. Robert F. Baronner, Jr., filed with and incorporated by reference from Form 10-KSB for the year ended December 31, 2001, and filed with the Securities and Exchange Commission, File No. 0-24958.                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                 
|14.1     Code of Ethics (for all employees)                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                 
|14.2     Code of Ethics for Senior Financial Officers                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                 
|21      Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                 
|23.1     Consent of Independent Accountants                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                 
|31.1     Rule 13a-15(e)/15d-15(e) Certification of Chief Executive Officer                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                 
|31.2     Rule 13a-15(e)/15d-15(e) Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                 
|32.1     Section 1350 Certification of Chief Executive Officer                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                 
|32.2     Section 1350 Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                 
|99.1     Proxy Statement for the 2006 Annual Meeting for Potomac, portions are incorporated by reference in Form 10-K Annual Report*                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                 
|* Filed herewith.                                                                                                                                                                                                                                                                                                                                                

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

POTOMAC BANCSHARES, INC.

|By | /s/ Robert F. Baronner, Jr.                  |  | March 24, 2006
|-- | -------------------------------------------- |  | --------------
|   | Robert F. Baronner, Jr.                      |  |               
|   | President & Chief Executive Officer          |  |               
|   |                                             
|   |                                             
|   |                                             
|By | /s/ Gayle Marshall Johnson                   |  | March 24, 2006
|   | Gayle Marshall Johnson                       |  |               
|   | Sr. Vice President & Chief Financial Officer |  |               

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

|Signature & Title |                                           | Date
|----------------- | ----------------------------------------- | ----
|                  |                                          
|By                | /s/ J. Scott Boyd                         |     
|                  | J. Scott Boyd, Director                   |     
|                  |                                          
|                  |                                          
|By                | /s/ John P. Burns, Jr.                    |     
|                  | John P. Burns, Jr., Director              |     
|                  |                                          
|                  |                                          
|By                | /s/ Guy Gareth Chicchirichi               |     
|                  | Guy Gareth Chicchirichi, Director         |     
|                  |                                          
|                  |                                          
|By                | /s/ Margaret Cogswell                     |     
|                  | Margaret Cogswell, Director               |     
|                  |                                          
|                  |                                          
|By                | /s/ Thomas C. G. Coyle                    |     
|                  | Thomas C. G. Coyle, Director              |     
|                  |                                          
|                  |                                          
|By                | /s/ William R. Harner                     |     
|                  | William R. Harner, Director and Secretary |     

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|Signature & Title |                                | Date
|----------------- | ------------------------------ | ----
|                  |                               
|By                | /s/ E. William Johnson         |     
|                  | E. William Johnson, Director   |     
|                  |                               
|                  |                               
|By                | /s/ Barbara H. Pichot          |     
|                  | Barbara H. Pichot, Director    |     
|                  |                               
|                  |                               
|By                | /s/ John C. Skinner, Jr.       |     
|                  | John C. Skinner, Jr., Director |     
|                  |                               
|                  |                               
|By                | /s/ Donald S. Smith            |     
|                  | Donald S. Smith, Director      |     
|                  |                               
|                  |                               
|By                | /s/ C. Larry Togans            |     
|                  | C. Larry Togans, Director      |     

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Exhibit 14.1

CODE OF ETHICS

The banks reputation for honesty and integrity is determined by the personal reputations of our individual staff members. To protect this reputation and to warrant our customers trust, each of us must strive to avoid situations that might cause a conflict of interest among the bank, its customers, its suppliers, and ourselves. The following principles have been established as the banks code of ethics. Any exceptions to these policies must be approved in writing.

Conflict of Interest

It is the policy of the bank that all staff members conduct their business affairs in such a manner and with such ethics and integrity that no conflict of interest, real or implied, could exist.

Complying with Laws, Regulations, Policies and Procedures

All directors, officers and employees of Potomac Bancshares, Inc. are expected to understand, respect, and comply with all of the laws, regulations, policies and procedures that apply to them in their position with Potomac and Bank of Charles Town (collectively, the company). Employees are responsible for talking to their manager or compliance officer to determine which laws, regulations, and policies apply to their position and what training is necessary to understand and comply with them.

Extension of Credit to Relatives and Business Associates

No employees shall make or approve loans to any bank, partnership, estate, trust, association, or other entity or person in which the employee has an interest directly or indirectly (whether as a director, officer, shareholder, manager, lender, joint venture, or other otherwise controlling investor), or in which a relative has such an interest or business associate. Any such request for credit extension is to be referred to another bank officer with no connection or affiliation to the potential borrower. All transactions are to be arms-length transactions.

Employee Indebtedness

Borrowing by an employee from an individual or business customer of the bank should be avoided (unless the customer is a recognized lending institution). The approval or denial of such a request imposes a wrongful burden on the customer and can impair the judgment of the employee when making business decisions involving the customer.

Executive officers of the bank are reminded of the reporting requirements of Regulation O. If you are unclear about these requirements, please contact the president.

Personal Finances

Because of our position of trust in the community, personal finances should be managed with prudence. Personal financial affairs should be conducted in such a manner as to be above regulatory or auditing criticisms or concerns. Officers should discuss any financial emergency with the president. Employees may discuss any financial emergency with the human resources department.

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All employees should assume the position of a regular customer when handling their personal bank business. All transactions should be handled in the normal over-the-counter procedure. No employees will be permitted to transact their own or a relatives bank business. Avoid direct or indirect financial interest with competitors, customers, and suppliers.

Outside Employment

The bank does not wish to control the personal affairs of employees, nor will it attempt to regulate the use of their time outside their employment with us. However, the bank does not look with favor upon a full-time employee working elsewhere if such outside employment in any way affects the individuals work, fellow employees, or the bank. Of particular concern and requiring the presidents approval are jobs working for a competitor, supplier, or customer. Engaging in self-employment that in any way competes with the bank is prohibited.

Gifts and Fees

Employees and their families (as well as their agents or attorneys) are not to solicit or accept a personal benefit from any customer, vendor, individual, or organization seeking to do business with the bank. A personal benefit is any type of gift, gratuity, loan, fee, compensation, or anything of monetary value. Any deviation from the above must be specifically approved in writing by the president. The bank does recognize that situations may arise when it would be appropriate for a staff member to accept the benefit of a gift. Such situations include:

| |  | Gifts of nominal value (not in excess of $50.00) given at Christmas or other holidays or special occasions that represent expressions of friendship.                                                                                                      
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                           
| |  | Reasonable entertainment such as luncheon, dinner, or business meetings with present or prospective customers and suppliers, when the return of the expenditure on a comparable basis is likely to occur and is properly chargeable as a business expense.
| |   |                                                                                                                                                                                                                                                           
| |  | Gifts or bequests based strictly on a family relationship.                                                                                                                                                                                                

Political Contributions and Activities

Individual participation in political and civic activities is encouraged, including the making of personal contributions to political candidates or activities. The bank, or anyone acting on its behalf, is prohibited from making an expenditure or contribution either directly or indirectly in connection with an election to political office.

Therefore, the bank will not make political contributions to individual candidates or political parties. Employees who wish to donate money or services to a candidate or party may do so as individuals, and not as representatives of the bank. To avoid any interpretation of bank sponsorship or endorsement, neither the banks name nor its address should be used. Do not use the bank name in or associated with any political advertisements or literature.

Public Company Reporting

As a public company, it is of critical importance that the public filings with the Securities Exchange Commission be accurate and timely. Depending upon their position with the company, an employee, officer or director may be called upon to provide necessary information to assurethat the companys public reports are complete, fair and understandable. The company expects employees, officers and directors to take this responsibility very seriously and to provide prompt, accurate answers to inquiries related to the companys public disclosure requirements.

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Financial Statements and Other Records

All of the companys books, records, accounts and financial statements (1) must be maintained in reasonable detail, must appropriately reflect the companys transactions and must conform both to applicable legal requirements and (2) the companys systems of internal control. Unrecorded or off the books funds or assets should not be maintained unless permitted by applicable law or regulation.

Records should always be retained or destroyed according to the companys record retention policies.

Accounting Complaints

Potomac Bancshares, Inc.s policy is to comply with all applicable financial reporting and accounting regulations. If any director, officer or employee of the company has unresolved concerns or complaints regarding questionable accounting or auditing matters of the company, then he or she should follow the provisions contained in Potomacs Whistleblower Policy.

Business Conduct

In the conduct of the banks business, no bribe, kickback, or similar remuneration or consideration of any kind is to be given or offered to any individual or organization. The activities of the bank must always be in full compliance with all applicable laws and regulations. The bank expects its staff to comply fully with the letter, spirit, and intent of all laws and regulations.

It is the policy of the bank to comply fully with the anti-bribery provisions. It is a criminal offense for any U.S. enterprise to offer a bribe to an official, political party, party official, or candidate for political office for the purpose of obtaining, retaining, or directing business to any person, regardless of whether that person is the one making the bribe. A bribe may take the form of an offer, payment, promise to pay, or authorization of the payment of any money or anything of value.

Customer Referral

Bank employees may be requested by bank customers and the general public to provide a referral to professional services, such as attorneys, securities brokers, certified public accountants, insurance agents, and real estate agents. Employees shall, when approved by management, recommend several qualified sources from which the customer can select. Bank employees should not make any adverse or negative comments regarding any outside professional. If an employee cannot give a positive recommendation regarding the outside professional, the employee should indicate to the customer that the employee has no recommendation to give regarding the particular professional. If you do make a positive referral, it should be limited to a statement that you have heard good comments regarding the professional but you or the bank cannot make any specific referrals or endorsements. The employee should exercise extreme care not to make any statement that could subject either the
employee or the bank, or both, to an action for libel or slander.

In several instances, discussions with customers may lead to a request that the employee give an opinion or statement about the legality of a particular transaction. Employees are not qualified to give legal advice. The bank also does not engage in the business of giving investment or tax advice. These are areas that are best left to the professional in that particular field. Extreme care must be exercised in discussions with customers, and nothing should be said that could be construed as the giving of legal advice or tax advice. Investment advice is only to be given by BCT Investments or the BCT Trust Department.

Employee Purchases Of Bank Stock

In an effort to prevent conflicts of interests only or violations of SEC regulations, purchases or sales of Potomac Bancshares, Inc. stock are to be made through a registered securities broker/dealer. If you have any questions consult your supervisor.

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Fiduciary Appointment

Without specific approval, employees are not to act as agent or deputy in any signing capacity on any account (except for members of their families) held in the bank. Further, employees may not act as executor, administrator, trustee, guardian, custodian, or in any fiduciary capacity without authority granted by the bank. This would normally be granted only to act for spouse, mother, father, brother, sister, son, daughter, or dependent.

There may be instances whereby a bank employee is requested to accept an appointment as a fiduciary or co-fiduciary (personal representative, trustee, administrator, guardian, executor, or custodian) with the bank, another person, or a firm or corporation. Except where the request is for a member of the immediate family, all employees must obtain prior approval of the banks board of directors before acceptance of the positions. Employees are reminded to consult senior management because federal or state regulations govern the acceptance of fees as a fiduciary.

Confidential Information

All of our records are confidential and may not be copied or disclosed without authorization from management. Never discuss customer affairs, accounts, files, or printed material, except on a need-to-know basis with other employees. Confidential information includes all personnel and payroll records, information about our customers, and anything else about the way we operate.On a periodic basis, the bank is examined. The reports that examiners furnish must remain the property of the regulatory agency and are strictly confidential. Information contained in the reports is privileged information and should not be communicated to anyone not officially connected with the bank.

The bank respects the right of employees to privacy in matters that have no relation to their employment. Matters of a personal nature concerning fellow employees should be treated with the utmost confidentiality.

Financial information regarding the bank is not to be released to any person unless it has been published in reports to shareholders or otherwise made available to the public in agreement with applicable disclosure regulations currently in effect. Any questions regarding disclosures of confidential financial information should be reviewed with the president and legal counsel prior to disclosure.

Confidential information obtained as a result of comments made within our bank should not be used for private interests.

Reporting Illegal or Unethical Behavior

If you suspect or know of violations of this Code or illegal or unethical business or workplace conduct by employees, officers or directors, you have an obligation to contact either their supervisor or superiors or the appropriate contact in Potomac or Bank of Charles Towns department. If the individual to whom such information is conveyed is not responsive, or if there is reason to believe that reporting to such individual is inappropriate in particular cases, then the employee, officer or director may contact the chairman of the Audit Committee.Such communications will be kept confidential to the extent feasible. If concerns or complaints require confidentiality, then this confidentiality will be protected to the extent feasible, subject to applicable law.

Non-Retaliation

The company prohibits retaliation of any kind against individuals who have made good faith reports of complaints or violations of this Code or other known or suspected illegal or unethical conduct.

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Amendment, Modification and Waiver

This Code may be amended or modified by the Board of Directors of Potomac. Waivers of this Code may only be granted on the recommendation to the Board of Directors or Committee of the board with specific delegated authority. Waivers that will be disclosed to shareholders are required by the Securities Exchange Act of 1934 and the rules thereof.

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