1

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                  FORM 10-KSB

(Mark one)

XXX      Annual Report Under Section 13 or 15(d)of the Securities
---      Exchange Act of 1934 (Fee required)

         For the fiscal year ended December 31, 1996

         Transition report under Section 13 or 15(d) of the Securities  Exchange
---      Act of 1934 (No fee required)

         For the transition period from_____________ to _____________

         Commission File No. 0-24958

                            Potomac Bancshares, Inc.
                 (Name of Small Business Issuer 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)

                                  304-725-8431
                (Issuer's Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Exchange Act:

                                                   Name of Each Exchange
      Title of Each Class                           on Which Registered
      -------------------                          ---------------------

-------------------------------               --------------------------------

-------------------------------               --------------------------------

         Securities registered under Section 12(g) of the Exchange Act:

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


<PAGE>

                                                                               2


Check whether the issuer:  (l) filed all reports required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 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 90 days.

Yes   XXX     No
      ---        ---

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB.   XX
                                       ----

State issuer's revenues for its most recent fiscal year.
                                  $10,074,770

State the  aggregate  market  value of the voting  stock held by  non-affiliates
computed by reference  to the price at which the stock was sold,  or the average
bid and asked  prices of such stock,  as of a specified  date within the past 60
days. $16,724,160

                   ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
                           DURING THE PAST FIVE YEARS

Check  whether the issuer has filed all  documents  and  reports  required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the  distribution  of
securities under a plan confirmed by a court.

Yes           No            Not Applicable   XXX
    -----        -----                      -----

                    APPLICABLE ONLY TO CORPORATE REGISTRANTS

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
                                    600,000

Transitional Small Business Disclosure Format (check one):

Yes           No   XXX
    -----         -----

                      DOCUMENTS INCORPORATED BY REFERENCE

Annual  Report to  security-holders  for fiscal year ended  December 31, 1996 is
incorporated by reference into Part II.

Proxy  Statement for annual meeting April 22, 1997, is incorporated by reference
into Part III.


<PAGE>


                                                                               3

PART I

Item 1.  Description of Business.

History and Operations

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

             Bank of Charles Town is a West Virginia  state-chartered bank which
formed and opened for business in 1871.  The Bank's  deposits are insured by the
Federal Deposit Insurance Corporation.  Engaged in general banking business with
the primary market area being Jefferson County,  the Bank also provides services
to Washington County and Frederick County,  Maryland;  Loudoun County and Clarke
County,  Virginia;  and Berkeley  County,  West Virginia.  The main office is in
Charles  Town at 111 East  Washington  Street,  with  branch  offices in Harpers
Ferry, West Virginia and Kearneysville, West Virginia.

             The Bank provides  consumers,  businesses,  and governments  with a
broad range of banking services, including personal lines of credit, home equity
lines of credit, commercial,  agricultural,  real estate, and installment loans;
checking, savings, NOW, and money market accounts,  certificates of deposit, and
individual retirement accounts. Automated teller machines are located at each of
the three offices to provide 24 hour service.  The trust and financial  services
department provides financial management, investment and trust services.

             Lending  Activities.  The Bank offers  installment,  term, and real
estate loans for consumer,  business and commercial purposes. These loans can be
unsecured or secured by collateral being purchased or other collateral.

             Underwriting  standards  covering all lending  include sound credit
analysis,  proper  documentation  according  to the  Bank's  loan  documentation
checklist,  promotion of profitable customer relationships with cross-selling of
bank services,  avoidance of loan  concentrations to a single industry or with a
single class of collateral,  and diligent maintenance of past due and nonaccrual
loans at a minimum.

             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.



<PAGE>


                                                                               4

             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
Board  of  Directors  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, for land development, for commercial, multi-family
and other non-residential  construction,  to purchase improved property,  and to
purchase owner occupied one to four family residential property. Lines of credit
and home equity loans are available.

             Approximately  72% of the Bank's  loans are secured by real estate.
These  loans had an  average  delinquency  rate of 1.56% and a loss rate of .00%
during 1996. These rates are based on comparisons to 1996 average total loans.

             As  of  December  31,  1996,   aggregate  dollar  amounts  in  loan
categories secured by real estate are as follows:

             Construction and land development              $   759,619
             Secured by farmland                              1,501,527
             Secured by 1-4 family residential               38,220,730
             Other                                           12,124,747
                                                            -----------
                                                            $52,606,623
                                                            ===========

             Loans to individuals for personal  expenditures  are  approximately
25% of the Bank's  total loans at December 31, 1996.  The  aggregate  balance of
these  loans  was  $18,654,695  at  December  31.  The  majority  of  these  are
installment loans with the remainder made as term loans.

             The Bank's loan policy states that evaluation of  applications  for
installment loans will consider place and length of residence,  place and length
of employment,  and credit history. Although these are considered,  verification
of employment is usually not done,  since it is recognized that unless immediate
decisions on  applications  can be made, a lender may be unable to secure a fair
share of loan business  since instant  credit is available  from many sources in
the market place. This may make installment  lending more risky than real estate
lending; however,  installment loans had an average delinquency rate of .37% and
a loss rate of .13% in 1996 (based on  comparisons to 1996 average total loans).
This  delinquency  rate for installment  loans is lower than the comparable rate
for real estate loans.

             The Bank's policy for evaluating term loans involves  consideration
of credit history and current  financial  statements if loan is a certain amount
and unsecured. If loans are not paid at original scheduled maturity, information
must be reviewed by a loan officer for a renewal.  The average  delinquency rate
was .21% and loss rate was 0.00% compared to average total loans in 1996.


<PAGE>


                                                                               5


             The  remaining  aggregate  dollar  amount  of the  Bank's  loans is
$2,264,022 at December 31. The amount includes:

         (1)  Dealer wholesale loans with generally
              no delinquencies or losses                    $  707,309

         (2)  Term loans for business and commercial
              purposes                                       1,149,910

         (3)  Industrial revenue bond loans secured
              by real estate                                   149,605

         (4)  Term loans for agricultural
              purposes                                         229,022

         (5)  Other loans                                       28,176

             Investment Activities.  The Bank's investment activities
are governed by its investment policy.

             The policy  states  that  excess  daily funds are to be invested in
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.

             According  to the  policy,  funds in  excess of those  invested  in
securities  purchased  under  agreements  to resell are to be  invested  in U.S.
Treasury  bills,  notes  or  bonds,  obligations  of U.S.  Government  agencies,
obligations  of  political  subdivisions  of the State of West  Virginia  with a
rating of not less than AAA and, with prior  approval of the Board of Directors,
bank qualified local  industrial  revenue bonds to be carried in the Bank's loan
portfolio.

             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 checking
accounts and interest bearing NOW accounts and money market  accounts.  Passbook
and  statement  savings  accounts and  Christmas  Club  accounts are  available.
Certificates  of deposit are offered in various terms from 91 days to four years
and may be automatically renewed if the depositor wishes.  Individual retirement
accounts in the form of certificates of deposit are also available.


<PAGE>


                                                                               6

             Prior to opening any deposit account  particular  requirements must
be met by the  depositor  including  presentation  of valid  identification  and
social  security  number,  must  not be on  record  with  Chex  Systems  (credit
reporting  agency),  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.

Competition

             As of  December  31,  1996,  there were 54 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 which compete with the Bank in its market area.

             The Bank's  market area is generally  defined as Jefferson  County,
West  Virginia.  As of June 30, 1996,  there were six banks in Jefferson  County
with 14 banking  offices.  The total  deposits of those  commercial  banks as of
June, 1996, were  $375,146,000 and the Bank ranked number one with  $109,364,000
or 29.2% of the total deposits in the market.

             For most of the  services  which the Bank  performs,  there is also
competition  from  financial  institutions  other  than  commercial  banks.  For
instance,  credit unions 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,  which are not subject to the State's  branch  banking laws,  have
increased  competition  for the Bank.  The 1986  legislation  passed by the West
Virginia  Legislature  allowing  state-wide  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.



<PAGE>


                                                                               7

             In 1994,  Congress  passed the Riegle-Neal  Interstate  Banking and
Branching  Efficiency  Act.  Under this Act,  absent  action to opt out or limit
interstate branching by the West Virginia Legislature, interstate branch banking
may occur after June 1, 1997. States are permitted to opt into interstate branch
banking prior to June 1, 1997, may opt out of interstate branch banking prior to
that  date,  may  allow  only  acquisition  of  branches,  may opt  into de novo
interstate  branch  banking or may allow the  acquisition  of a branch of a bank
without acquiring the bank itself. In 1996, the West Virginia  Legislature opted
into  interstate  branch  banking,  effective  May 31, 1997.  The effect of this
legislation  will likely be  increased  competition  with West  Virginia  banks,
including the Bank.

Employees

             Bancshares currently has no employees.

             As of January 31, 1997,  the Bank had 79 full-time  employees and 8
part-time employees.


Supervision and Regulation

             Introduction.  Bancshares  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 Bancshares
to  secure  the  prior  approval  of the Board of  Governors  before  Bancshares
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,  Bancshares 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 Bancshares 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.



<PAGE>


                                                                               8

             Bancshares'  depository  institution  subsidiaries  are  subject to
affiliate transaction restrictions under federal law which 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.

             Bancshares 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.
Bancshares is also subject to regulation and supervision by the Commissioner.

             Bancshares  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
20% of the total  deposits of all depository  institutions  in the State of West
Virginia.

             Depository  Institution  Subsidiaries.  Bank  is  subject  to  FDIC
deposit  insurance  assessments.  As of January 1, 1997,  FDIC set the Financing
Corporation  (FICO) Bank Insurance Fund (BIF) premium for the Bank at the annual
rate of 1.296  basis  points or .0001296  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 still  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 Bancshares' results of operations.

             Capital   requirements.   The  Federal  Reserve  Board  has  issued
risk-based capital  guidelines for bank holding  companies,  such as Bancshares.
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


<PAGE>


                                                                               9

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.  Bank
is subject to substantially  similar capital  requirements adopted by applicable
regulatory agencies.

             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.



<PAGE>


                                                                              10

             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 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.

             As of December  31, 1996,  Bancshares  had capital in excess of all
applicable requirements as shown below:

                                       Actual        Required        Excess
Tier 1 capital:                     ------------    ----------    -----------
  Common stock                      $    600,000
  Surplus                              5,400,000
  Retained earnings                    8,260,037
                                    ------------
Total tier 1 capital                $ 14,260,037    $2,457,173    $11,802,864
Tier 2 capital:
  Allowance for loan losses (1)          772,445
                                    ------------

Total risk-based capital            $ 15,032,482    $4,914,345    $10,118,137
                                    ============    ==========    ===========

Risk-weighted assets                $ 61,429,313
                                    ============

Tier 1 capital                      $ 14,260,037    $3,741,411    $10,518,626
                                    ============    ==========    ===========

Average total assets                $124,713,706
                                    ============
Capital ratios:
  Tier 1 risk-based capital ratio          23.21%        4.00%         19.21%
  Total risk-based capital ratio           24.47%        8.00%         16.47%
  Tier 1 capital to average total
    assets (leverage)                      11.43%        4.00%          7.43%


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


<PAGE>


                                                                              11


             Permitted Non-Banking Activities.  The Federal Reserve permits bank
holding companies to engage in non-banking activities closely related to banking
or managing or controlling banks.  Bancshares  presently does not engage in, nor
does it have any immediate plans to engage in, any  non-banking  activities bank
holding companies are permitted to perform.

             A notice of proposed  non-banking  activities  must be furnished to
the Federal  Reserve and the Banking  Board  before  Bancshares  engages in such
activities,  and an application  must be made to the Federal Reserve and Banking
Board  concerning  acquisitions by Bancshares 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 which 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 Bancshares or The Bank.

Item 2.  Description of Property.

             Bancshares currently has no property.

             The Bank owns the land and  buildings  of the main  office  and two
branch office facilities.

             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 an adjoining  corridor.  The older of these
two  buildings  houses the Bank's Trust and Financial  Services  Division on its
first floor and the second  floor is used for storage.  The Trust and  Financial
Services area was remodeled in 1982.  The newer  building  houses the commercial
bank  operations,  using  the  majority  of both  floors of the  building.  This
building was  constructed  in 1967.  Two adjoining  sections of property at this
location were purchased in 1986 and 1988 to meet additional parking needs.

             The Bank sold the property formerly housing the Charles Town Lodge,
Loyal Order of Moose, Inc., during 1996 for $220,000.  This property,  used only
as a storage facility, was no longer needed.

             One branch office is located at 1318  Washington  Street,  Bolivar,
West Virginia.  The office is a one story brick building constructed in 1975. On
this  property  is  another  building  which  existed  at the time of the Bank's
purchase. This is rented to others by the Bank.


<PAGE>


                                                                              12

             In  addition,  the  Bank  owns  property  in  Kearneysville,   West
Virginia,  on which a second branch facility 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.

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


Item 3.  Legal Proceedings.

             Currently Bancshares 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.


PART II

Item 5.  Market for Common Equity and Related Stockholder Matters.

             The following  information  reflects comparative per share data for
the periods  indicated for Bancshares  Common Stock for (a) trading values,  and
(b) dividends. As of March 21, 1997, there were approximately 850 shareholders.

             Bancshares Common Stock is not traded on any stock exchange or over
the counter.  Shares of Bancshares Common Stock are occasionally bought and sold
by  private  individuals,  firms  or  corporations,   and,  in  many  instances,
Bancshares  does not have  knowledge of the  purchase  price or the terms of the
purchase.  The following  information  relating to trading values for Bancshares
Common Stock is based upon  information  furnished to  Bancshares by one or more
parties  involved in purchases or sales of Bancshares  Common Stock. The trading
values shown below are based on arms-length  transactions between  shareholders.
NO ATTEMPT WAS MADE BY  BANCSHARES  TO VERIFY OR  DETERMINE  THE ACCURACY OF THE
REPRESENTATIONS MADE TO BANCSHARES.



<PAGE>


                                                                              13



                            Price Range (1)       Cash Dividends (2)
                           High          Low      Paid per Share

1995     First Quarter    $30.00       $30.00          $ N/A
         Second Quarter    30.00        30.00            .35
         Third Quarter     35.00        28.00            N/A
         Fourth Quarter    30.00        30.00            .50

1996     First Quarter    $30.00       $25.00          $ N/A
         Second Quarter    30.00        27.00            .35
         Third Quarter     30.00        27.00            N/A
         Fourth Quarter    31.00        28.00            .60

(1) See the description of "Trading Value" in the preceding paragraph.
(2) Dividends have been declared traditionally by Bancshares on a semi-annual
    basis.

             The primary source of funds for dividends paid by Bancshares 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  Commissioner  could  be  required.  Management  of
Bancshares  anticipates  that the dividends  paid by  Bancshares  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.


Item 6.  Management's Discussion and Analysis of Financial
             Condition and Results of Operations.

             Pages 4-11 of the Annual Report to Shareholders  for the year ended
December 31, 1996, are incorporated by reference for this item 6.


Item 7.  Financial Statements.

             Pages 13-29 of the Annual Report to Shareholders for the year ended
December 31, 1996, are incorporated by reference for this item 7.


Item 8.  Changes In and Disagreements with Accountants on
             Accounting and Financial Disclosure.

             Not Applicable.




<PAGE>


                                                                              14

PART III

Item 9.  Directors, Executive Officers, Promoters and Control
             Persons; Compliance with Section 16(a) of the Exchange
             Act.

             Pages 2-5 of the Proxy  Statement  dated  March 28,  1997,  for the
April 22, 1997 Annual Meeting are incorporated by reference for this item 9.

The Executive Officers are as follows:

         Name                Position Since        Age    Principal Occupation
-----------------------   ---------------------   -----   --------------------
Charles W. LeMaster       President & CEO           55    Employed at Bank
                          1994                            since 1983; President
                                                          & CEO since 1991.

William R. Harner         Sr. Vice President,       56    Employed at Bank
                          Secretary & Treasurer           since 1967; Sr. Vice
                          1994                            President & Cashier
                                                          since 1988.

Gayle Marshall Johnson    Vice President & Chief    47    Employed with the
                          Financial Officer               Bank 1977-1985 as
                          1994                            internal auditor.
                                                          Rejoined Bank in 1988
                                                          as Financial Officer.
                                                          Vice President &
                                                          Financial Officer of
                                                          Bank since 1990.

Donald S. Smith           Vice President &          68    Employed at Bank 1947
                          Assistant Secretary             to 1991; President
                          1994                            1979 to 1991
                                                          (retired).


Item 10. Executive Compensation.

             Pages 7-9 of the Proxy  Statement  dated  March 28,  1997,  for the
April 22, 1997 Annual Meeting are incorporated by reference for this item 10.


Item 11. Security Ownership of Certain Beneficial Owners and
             Management.

             Pages 5-7 of the Proxy  Statement  dated  March 28,  1997,  for the
April 22, 1997 Annual Meeting are incorporated by reference for this item 11.




<PAGE>


                                                                              15

Item 12. Certain Relationships and Related Transactions.

             Page 11 of the Proxy  Statement dated March 28, 1997, for the April
22, 1997 Annual Meeting is incorporated by reference for this item 12.

Item 13. Exhibits List and Reports on Form 8-K.

                     1.1        Pages 4-11 and 14-29 of Bancshares' 1996 Annual
Report to Shareholders are incorporated herein by reference.

             (a) 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 April 25, 1995 and recorded by
West  Virginia  Secretary  of State May 23, 1995 filed with the  Securities  and
Exchange Commission with 1995 Form 10-KSB.

                     3.3       Bylaws 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.

                     3.4        Amended and Restated Bylaws of Potomac
Bancshares, Inc. adopted by shareholders April 25, 1995 filed with
the Securities and Exchange Commission with 1995 Form 10-KSB.

                     21         Subsidiaries of the Registrant

             (b) No reports on Form 8-K were  filed  during the last  quarter of
the period covered by this report.



<PAGE>



                                   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/ Charles W. LeMaster                       March  25, 1997
   ----------------------------------------
   Charles W. LeMaster
   President & Chief Executive Officer



By /s/ L. Gayle Marshall Johnson                 March  25, 1997
   ----------------------------------------
   L. Gayle Marshall Johnson
   Vice President & Chief Financial Officer
   & Chief Accounting 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
-----------------                                ----
   /s/ John P. Burns, Jr.
By ________________________________
   John P. Burns, Jr., Director                  March  25, 1997


   /s/ Robert W. Butler
By ________________________________
   Robert W. Butler, Director                    March  25, 1997

   /s/ Guy Gary Chicchirichi
By ________________________________
   Guy Gary Chicchirichi, Director               March  25, 1997

   /s/ Thomas C. G. Coyle
By ________________________________
   Thomas C. G. Coyle, Director                  March  25, 1997


   /s/ Francis M. Frye
By ________________________________
   Francis M. Frye, Director                     March  25, 1997





<PAGE>



Signature & Title                                Date
-----------------                                ----
   /s/ William R. Harner
By ________________________________
   William R. Harner, Director,                  March  25, 1997
   Sr. Vice President, Secretary &
   Treasurer

   /s/ E. William Johnson
By ________________________________
   E. William Johnson, Director                  March  25, 1997

   /s/ Charles W. LeMaster
By ________________________________
   Charles W. LeMaster, Director,                March  25, 1997
   President, Chief Executive Officer

   /s/ Minnie R. Mentzer
By ________________________________
   Minnie R. Mentzer, Director                   March  25, 1997

   /s/ James E. Senseney
By ________________________________
   James E. Senseney, Director                   March  25, 1997

   /s/ John C. Skinner, Jr.
By ________________________________
   John C. Skinner, Jr., Director                March  25, 1997


   /s/ Donald S. Smith
By ________________________________
   Donald S. Smith, Director                     March  25, 1997


<PAGE>



                        [GRAPHIC FRAMED BORDER OMITTED]

                            Potomac Bancshares, Inc.
                               1996 Annual Report

                               [GRAPHIC OMITTED]


                   Connected To Our Community Through Service



                              Bank of Charles Town
       Member FDIC o Wholly-owned Subsidiary of Potomac Bancshares, Inc.




<PAGE>


                          ANNUAL REPORT ON FORM 10-KSB


         A copy of the  Corporation's  1996  annual  report  on Form  10-KSB  to
Securities and Exchange  Commission may be obtained  without charge upon written
request by any stockholder to:

                               Gayle Marshall Johnson
                               Vice President and Chief Financial Officer
                               Potomac Bancshares, Inc.
                               111 East Washington Street
                               PO Box 906
                               Charles Town West Virginia 25414-0906



                              GENERAL INFORMATION


COMMON STOCK PRICES AND DIVIDENDS

         Trading of Potomac  Bancshares,  Inc. common stock is not extensive and
cannot be described as a public trading  market.  A market of the  Corporation's
stock and quotations are not listed in any publication of national  circulation.
As of December 31, 1996, there were 600,000 common shares outstanding with these
being held by approximately 850 shareholders.

         The per share sale prices of and dividends on the  Corporation's  stock
over the last two years,  based solely on  transactions of which the Corporation
is aware, are listed below.

                                  High             Low            Dividends
     1995
     First Quarter              $30.00           $30.00             $ N/A
     Second Quarter              30.00            30.00              0.35
     Third Quarter               35.00            28.00               N/A
     Fourth Quarter              30.00            30.00              0.50

     1996
     First Quarter               30.00            25.00               N/A
     Second Quarter              30.00            27.00              0.35
     Third Quarter               30.00            27.00               N/A
     Fourth Quarter              31.00            28.00              0.60


         Common stock  dividends  are paid on a  semi-annual  basis.  Management
intends to continue to recommend dividends to be paid as profits and maintenance
of satisfactory equity capital allow.

STOCK TRANSFER AGENT
                           American Stock Transfer
                              & Trust Company
                           40 Wall Street
                           New York NY  10005
                           (212) 936-5100


ANNUAL MEETING

         The annual  meeting of  stockholders  will be held at the Bavarian Inn,
Shepherdstown,  Jefferson  County,  West Virginia,  on Tuesday,  April 22, 1997,
beginning at 10:00 a.m.


<PAGE>


                                    CONTENTS

<TABLE>
<S> <C>
Annual Report on Form 10-KSB...................................................Inside Front Cover
General Information............................................................Inside Front Cover
President's Report..............................................................................1
Description of Business.........................................................................2
Board of Directors..............................................................................2
Selected Consolidated Financial Data............................................................3
Management's Discussion and Analysis of
         Financial Condition and Results of Operations.......................................4-11
Independent Auditor's Report...................................................................13
Consolidated Financial Statements
         Consolidated Balance Sheets...........................................................14
         Consolidated Statements of Income.....................................................15
         Consolidated Statements of Changes in Stockholders' Equity............................16
         Consolidated Statements of Cash Flows.................................................17
         Notes to Consolidated Financial Statements.........................................18-29
Trust and Financial Services...................................................................30
Officers and Staff..............................................................Inside Back Cover
</TABLE>


<PAGE>

                               PRESIDENT'S REPORT


              On behalf of the Board of  Directors,  Officers and Staff,  we are
pleased to submit our  Annual  Report of the  operations  and  condition  of our
holding company, Potomac Bancshares, Inc. for the year ended December 31, 1996.

              Our net income totaled  $1,407,434 for the year 1996 and showed an
increase of $222,306 over 1995. The earnings per share were $2.35 and benefitted
the  shareholders  who received a dividend of $.95 per share  during 1996.  This
1996  net  income  reversed  the  previous  two  years'   declining  trend.  The
Corporation maintains a very strong capital to average assets ratio of 11.43% as
of year  end.  Also,  you will  note  that  Reserve  for Loan  Losses  increased
significantly.  This is attributed  to our continued  effort to collect on loans
previously  classified  as losses.  The loan loss  allowance  is  sufficient  to
support any loans that may become troublesome.

              Your  Corporation  continues  to  support  the  community  and its
surrounding  market area by providing  the services that  customers  expect from
their financial  institution.  In January, we instituted Saturday lobby hours at
the main office.  This has been well received and is a complete success.  We are
working on other services  which will be in place in the near future.  The first
of these,  available this spring,  is Touchline 24, our automated voice response
system which will allow our customers to access information about their accounts
24 hours a day.

              I want to  thank  our  Officers  and  Staff  for  their  continued
service,  trust and  dedication  to our  customers,  and our Directors for their
invaluable  support  and  guidance.  As always,  we solicit  the  support of our
shareholders to refer customers to the Bank to ensure our growth and success.

                                       Sincerely,




                                       Charles W. LeMaster
                                       President & CEO





                                      -1-


<PAGE>



                            DESCRIPTION OF BUSINESS


          Potomac Bancshares,  Inc., a one-bank holding company, and Subsidiary,
Bank of Charles Town, are engaged in general  banking  business with the primary
market area being  Jefferson  County.  However,  the  Corporation  also provides
services to Washington County and Frederick County, Maryland; Loudoun County and
Clarke County,  Virginia; and Berkeley County, West Virginia. The main office is
in Charles Town with branch offices in Harpers Ferry and Kearneysville.

          The Corporation provides consumers, businesses, and governments with a
broad range of banking services, including personal lines of credit, home equity
lines of credit, commercial,  agricultural,  real estate, and installment loans;
checking, savings, NOW, and money market accounts,  certificates of deposit, and
individual retirement accounts. Automated teller machines are located at each of
the three offices to provide  twenty-four hour service.  The trust and financial
services  department  provides  financial   management,   investment  and  trust
services.

          Bank of Charles Town is a West  Virginia  state  chartered  bank which
formed and opened for  business  in 1871.  The Bank's  deposits  are  insured by
Federal Deposit Insurance Corporation.



                               BOARD OF DIRECTORS

               Potomac Bancshares, Inc. and Bank of Charles Town

<TABLE>
<S> <C>
John P. Burns, Jr.                 Francis M. Frye            Minnie R. Mentzer
Partner                            Retired President          Retired President
Burns Farm                         Ranson Real Estate         Myers Coal Company, Inc.

Robert W. Butler                   William R. Harner          James E. Senseney
Farmer-Orchardist                  Senior Vice President      Retired Owner-Operator
Warm Spring Orchard & Farm          & Cashier                 J. E. Senseney & Sons, Inc.
                                   Bank of Charles Town

Guy Gary Chicchirichi              E. William Johnson         John C. Skinner, Jr.
General Manager                    Professor of Economics     Owner
Guy's Buick-Pontiac-Oldsmobile-    Shepherd College           Nichols and Skinner, L.C.
  GMC Truck, Inc.

Thomas C. G. Coyle                 Charles W. LeMaster        Donald S. Smith
Retired Owner-Operator             President                  Retired President
Riddleberger's Store               Bank of Charles Town       Bank of Charles Town
</TABLE>


                                      -2-


<PAGE>



                      SELECTED CONSOLIDATED FINANCIAL DATA
                  (Dollars in Thousands Except Per Share Data)

<TABLE>
<CAPTION>
                                                   1996          1995           1994          1993          1992
                                                ----------    ----------     ----------    ----------    ----------
<S> <C>
Summary of Operations

  Interest income                                $   9 086     $   8 747      $   8 979     $   9 809     $  10 448
  Interest expense                                   3 623         3 591          3 509         3 971         4 667
                                                ----------    ----------     ----------    ----------    ----------
  Net interest income                                5 463         5 156          5 470         5 838         5 781
  Provision for loan losses                            100           125            125           297           565
                                               -----------   -----------    -----------   -----------   -----------
  Net interest income after provision
    for loan losses                                  5 363         5 031          5 345         5 541         5 216
  Non-interest income                                  989           906            939         1 036           836
  Non-interest expense                               4 114         4 078          4 211         4 054         3 780
                                                ----------    ----------     ----------    ----------    ----------
  Income before income taxes                         2 238         1 859          2 073         2 523         2 272
  Income tax expense                                   831           674            742           894           798
                                               -----------   -----------    -----------   -----------   -----------

  Net income                                    $    1 407    $    1 185     $    1 331    $    1 629    $    1 474
                                                ==========    ==========     ==========    ==========    ==========


Per Share Data

  Net income                                   $      2.35   $      1.98     $     2.22    $     2.72    $     2.46
  Cash dividends declared                              .95           .85            .85          1.00           .85
  Book value at period end                           23.70         22.37          21.19         19.88         18.16
  Average shares outstanding                       600 000       600 000        600 000       600 000       600 000


Average Balance Sheet Summary

  Assets                                         $ 124 267     $ 121 638      $ 128 993     $ 126 000     $ 120 770
  Loans                                             73 817        72 440         68 558        69 672        70 703
  Securities                                        36 972        37 682         52 288        48 530        42 311
  Deposits                                         109 709       107 826        115 907       113 885       109 725
  Shareholders' equity                              13 806        13 052         12 393        11 419        10 462


Performance Ratios

  Return on average assets                           1.13%          .97%          1.03%         1.29%         1.22%
  Return on average equity                          10.19%         9.08%         10.74%        14.27%        14.09%
  Dividend payout ratio                             40.43%        42.93%         38.29%        36.76%        34.55%


Capital Ratios

  Leverage ratio                                    11.43%        10.83%          9.61%         9.06%         8.66%
  Risk-based capital ratios
    Tier 1 capital                                  23.21%        20.73%         20.74%        19.76%        17.89%
    Total capital                                   24.47%        21.98%         21.99%        21.02%        19.15%
</TABLE>




                                      -3-


<PAGE>



SCHEDULE 1 - 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
are computed on a tax  equivalent  basis using a federal tax rate of 34%.  Loans
placed on nonaccrual status are reflected in the balances.

<TABLE>
<CAPTION>
                                                      1996                                              1995
                                  ----------------------------------------------   -----------------------------------------------
                                      Average            Income/       Average          Average          Income/         Average
                                     Balances            Expense     Yield/Rate        Balances          Expense        Yield/Rate
                                  -------------    -------------     ----------    ---------------    -------------     ----------
<S> <C>
ASSETS
Loans
   Taxable                         $ 73 523 500      $ 6 728 084        9.15%         $ 71 946 058      $ 6 532 422        9.08%
   Tax exempt                           293 422           32 836       11.19%              494 410           55 664       11.26%
                                  -------------    -------------                     -------------    -------------
      Total loans                    73 816 922        6 760 920        9.16%           72 440 468        6 588 086        9.09%
                                  -------------      -----------                     -------------      -----------
Taxable securities                   36 971 951        1 899 156        5.14%           37 681 579        1 800 761        4.78%
Securities purchased under
   agreements to resell               8 292 896          437 034        5.27%            6 471 547          376 939        5.82%
                                  -------------     ------------                     -------------     ------------

      Total earning assets          119 081 769      $ 9 097 110       7.64%           116 593 594      $ 8 765 786        7.52%
                                   ------------      ===========                      ------------      ===========

Reserve for loan losses                (986 515)                                          (990 939)
Cash and due from banks               3 475 732                                          3 284 283
Bank premises/equipment,
   net                                1 384 312                                          1 506 591
Other assets                          1 311 661                                          1 244 417
                                   ------------                                      -------------

      Total assets                 $124 266 959                                       $121 637 946
                                   ============                                       ============

LIABILITIES AND
   STOCKHOLDERS' EQUITY
Deposits
   NOW accounts                    $ 15 862 099      $   320 545       2.02%          $ 14 760 237      $   328 734       2.23%
   Money market accounts             16 319 705          409 080       2.51%            19 164 626          523 534       2.73%
   Savings deposits                  23 654 570          691 389       2.92%            23 913 028          853 301       3.57%
   Certificates of deposit           39 986 622        2 202 229       5.51%            36 924 593        1 880 834       5.09%
                                   ------------      -----------                      ------------      -----------
      Total interest
         bearing deposits            95 822 996      $ 3 623 243       3.78%            94 762 484      $ 3 586 403       3.78%
                                   ------------      -----------                      ------------      -----------

Federal funds purchased                     - -              - -         - -                65 470            4 008       6.12%
                                   ------------      -----------                      ------------      -----------
      Total interest
         bearing liabilities         95 822 996      $ 3 623 243       3.78%            94 827 954      $ 3 590 411       3.79%
                                   ------------      -----------                      ============      ===========       =====

Noninterest bearing demand
   deposits                          13 886 051                                         13 063 373
Other liabilities                       751 824                                            694 215
Stockholders' equity                 13 806 088                                         13 052 404
                                   ------------                                      -------------
      Total liabilities and
         stockholders' equity      $124 266 959                                       $121 637 946
                                   ============                                       ============


Net interest spread                                                    3.86%                                              3.73%
Interest expense as a
   percent of average earning assets                                   3.04%                                              3.08%

Net interest margin                                                    4.60%                                              4.44%
</TABLE>

                                      -4-


<PAGE>



               MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                      CONDITION AND RESULTS OF OPERATIONS



GENERAL

         Net  income in 1996 of  $1,407,434  is 19%  greater  than net income of
$1,185,128  in 1995.  Total  assets  decreased  slightly  to  $123,779,866  from
$124,043,150 when comparing the 1996 year end to the 1995 year end.

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



NET INTEREST INCOME

         Net  interest  income  increased to  $5,462,702  in 1996 as compared to
$5,156,449 in 1995. This is an increase of 6% due to a combination of changes in
rates and volumes in loans, securities and deposits.

         A 4% increase in interest  income  brought the total to $9,085,945  for
1996 compared to $8,746,860 in 1995.

         The  average  balance  of total  loans  increased  for the year and the
average rate on loans increased as well. The 3% increase in interest and fees on
loans from  $6,569,160  in 1995 to  $6,749,755 in 1996 was due more to increased
volumes in loans rather than increased  rates.  Year end balances of residential
real  estate  loans and home  equity  loans  have each  increased  approximately
$1,000,000 in 1996 compared to 1995.

         Income on  investment  securities,  securities  available  for sale and
securities purchased under agreements to resell increased 7% in 1996 compared to
1995. The increase in interest  income for investment  securities and securities
available  for  sale was due  more to  increased  rates  since  average  volumes
actually  decreased.   Increased  volume  caused  the  increase  in  income  for
securities  purchased under agreements to resell since rates actually  decreased
for these investments.

         Interest  expense  increased  slightly under 1.0% in 1996 to $3,623,243
compared to $3,590,411 in 1995.  This slight increase was due to various changes
in rates and volumes within the deposit structure.

         Comparing year end balances, total deposits have decreased in 1996 to
 $108,512,469 compared to $109,789,474 in 1995. However, the average balance for
 total deposits shows an increase in 1996 to $109,709,047 compared to
 $107,825,857 in 1995.  The average  balance for total interest  bearing
 deposits also shows an increase in 1996 to  $95,822,996  compared to
 $94,762,484  in 1995.  Average rates for NOW, money market and savings
 accounts  decreased  significantly in 1996 compared to 1995, while the average
 rate for certificate of deposits increased significantly in 1996 compared to
 1995. Even with the varying directions of these rate changes for the deposit
 accounts the average rate of interest for all deposits  remained the same at
 3.78% in 1996 as in 1995.

         The  average  rate for the Bank's  total  earnings  assets was 7.64% in
1996,  an increase of .12% over the average  rate of 7.52% in 1995.  The average
rate for total  interest  bearing  liabilities  decreased  .01% to 3.78% in 1996
compared to 3.79% in 1995.  The  interest  spread in 1996 was 3.86%  compared to
3.73% in 1995.  The net interest  margin was 4.60% in 1996  compared to 4.44% in
1995.


SCHEDULE 2 - VOLUME AND RATE ANALYSIS

         This  schedule at the top of page 6 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 are computed on a
tax  equivalent  basis  using a federal tax rate of 34%.  Nonaccruing  loans are
included in average loans outstanding.

                                      -5-


<PAGE>



<TABLE>
<CAPTION>
                                                 1996 Compared to 1995                             1995 Compared to 1994
                                    ------------------------------------------------   -------------------------------------------
                                       Change in          Volume         Rate            Change in        Volume           Rate
                                    Income/Expense        Effect         Effect        Income/Expense      Effect         Effect
                                    --------------      -----------   ------------     --------------   ------------   -----------
<S> <C>
INTEREST INCOME
   Taxable loans                     $    195 662        $  144 762    $    50 900     $    389 022     $   371 275    $    17 747
   Tax exempt loans                       (22 828)          (22 484)          (344)         (22 697)        (23 388)           691
   Taxable securities                      98 395           (32 807)       131 202         (871 503)       (707 156)      (164 347)
   Securities purchased under
      agreements to resell                 60 095            90 475        (30 380)         264 854         201 818         63 036
                                     ------------        ----------    -----------     ------------     ------------   -----------
         TOTAL                       $    331 324        $  179 946    $   151 378     $   (240 324)    $  (157 451)   $   (82 873)
                                     ------------        ----------    -----------     ------------     ------------   -----------

INTEREST EXPENSE
   NOW accounts                      $     (8 189)       $   31 323    $   (39 512)    $    (34 393)    $     (3 427)  $   (30 966)
   Money market accounts                 (114 454)          (74 183)       (40 271)        (147 529)        (156 958)        9 429
   Savings deposits                      (161 912)           (9 073)      (152 839)        (133 439)        (106 192)      (27 247)
   Certificates of deposit                321 395           161 098        160 297          392 221           24 520       367 701
   Federal funds purchased                 (4 008)           (4 008)            --            4 008            4 008            --
                                     ------------        ----------    ------------    ------------     ------------   -----------
         TOTAL                       $     32 832        $  105 157    $    (72 325)   $     80 868     $   (238 049)  $   318 917
                                     ------------        ----------    ------------    ------------     ------------   -----------

NET INTEREST INCOME                  $    298 492        $   74 789    $   223 703     $   (321 192)    $     80 598   $  (401 790)
                                     ============        ==========    ===========     ============     ============   ===========
</TABLE>



NONINTEREST INCOME AND EXPENSE

         Noninterest  income  (other  income)  increased  9% to $988,825 in 1996
compared to $905,571 in 1995. The  significant  change was in service charges on
deposit  accounts  which  increased  32% due to  increased  rates and  increased
numbers of charges.

         Noninterest expense (other expenses) increased only slightly under 1.0%
in 1996  compared to 1995 due in great part to the  diligence  of  officers  and
staff. Expense reductions showed in deposit insurance,  stationery and supplies,
and ATM expenses. There were slight increases in salaries and employee benefits,
in directors  fees due to  increased  number of payments  rather than  increased
fees, and in other operating  expenses which included a net loss on sale of real
estate of $94,972.



INTEREST RATE SENSITIVITY

         The table below shows the  opportunities  the Corporation  will have to
reprice interest earning assets and interest bearing  liabilities as of December
31, 1996. Nonaccrual loans are excluded from these balances.

<TABLE>
<CAPTION>
                                                                         Mature or Reprice
                                    ------------------------------------------------------------------------------------
                                                         After Three
                                                         Months But        After One Year
                                       Within              Within            But Within        After
                                    Three Months        Twelve Months        Five Years      Five Years     Nonsensitive
                                    ------------        -------------      --------------   ------------    ------------
<S> <C>
Interest Earning Assets:
   Fixed rate loans                 $ 11 040 981        $ 19 499 396        $ 38 134 893    $    335 891    $        - -
   Floating rate loans                 4 229 029                 - -                 - -             - -             - -
   Securities                          3 999 535          12 007 549          23 939 625             - -         386 800
   Securities purchased under
      agreements to resell             4 800 000                 - -                 - -             - -             - -
                                    ------------        ------------        ------------    ------------    ------------
        Total                       $ 24 069 545        $ 31 506 945        $ 62 074 518    $    335 891    $    386 800
                                    ------------        ------------        ------------    ------------    ------------

Interest Bearing Liabilities:
   Certificates of deposit
      $100,000 and over             $  1 448 539        $  1 588 254        $  1 031 041    $        - -    $         - -
   Other certificates of deposit       7 737 645          17 359 598          10 227 475             - -              - -
   Money market accounts              15 223 554                 - -                 - -             - -              - -
   NOW accounts                              - -                 - -                 - -             - -       16 748 803
   Savings accounts                          - -                 - -                 - -             - -       23 111 062
                                    ------------        ------------        ------------    ------------    -------------
        Total                       $ 24 409 738        $ 18 947 852        $ 11 258 516    $        - -    $  39 859 865
                                    ------------        ------------        ------------    ------------    -------------

Rate Sensitivity Gap                $   (340 193)       $ 12 559 093        $ 50 816 002    $    335 891
                                    ------------        ------------        ------------    ------------

Cumulative Gap                      $   (340 193)       $ 12 218 900        $ 63 034 902    $ 63 370 793
                                    ============        ============        ============    ============
</TABLE>

                                      -6-


<PAGE>



        As of December 31, 1996 the  Corporation is almost evenly matched in the
first time frame,  showing  only a slight  negative  gap.  Even  matches are the
safest  positions  in the  times of  rapidly  rising  or  declining  rates.  The
remaining  time frames are  positively  gapped.  In the second  time frame,  the
cumulative gap is narrower than in 1995. The continued increase of floating rate
loans in 1996 and  movement  of fixed  rate  repricing  into the  first two time
frames has helped to narrow the gap in these time frames. The cumulative gaps in
the third and fourth time frames are only slightly higher than in 1995.

        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.



LOAN PORTFOLIO

        Loans at December 31, 1996 and 1995 are summarized below:

                                                      1996            1995
                                                  ------------    ------------

        Commercial, financial and agricultural   $ 2 086 241     $ 3 033 160
        Real estate:
           Construction and land development         759 619       1 052 659
           Secured by farm land                    1 501 527       1 207 714
           Secured by 1-4 family residential      38 220 730      36 586 317
           Other real estate                      12 124 747      12 295 313
        Consumer                                  18 654 695      18 998 386
        All other                                    177 781         477 625
                                                 -----------     -----------
                                                 $73 525 340     $73 651 174
                                                 ===========     ===========


        Loans have  decreased  $125,834 when comparing year end totals for 1996
and 1995,  while  the  average  balance  for total  loans  increased  in 1996 to
$73,816,922  compared to  $72,440,468  in 1995.  The most notable  change was an
increase of $1,634,413 in residential  real estate which included an increase of
$995,360 in home equity loans.

        There were no  categories  of loans that  exceeded  10% of  outstanding
loans at December 31, 1996 which were not disclosed in the table above.


REMAINING MATURITIES OF SELECTED LOANS


                                           Commercial,
                                         Financial and        Real Estate-
                                          Agricultural       Construction
                                         -------------       ------------
        Within one year                    $ 1 748 848        $   677 619
        Variable rate                              - -             82 000
        Fixed rate:
           Over one through five years         317 393                - -
           After five years                     20 000                - -
                                           -----------        -----------
             Total                             337 393                - -
                                           -----------        -----------

             Total maturities              $ 2 086 241        $   759 619
                                           ===========        ===========

                                      -7-



<PAGE>



ALLOWANCE FOR LOAN LOSSES

         The table shown below is an analysis of the Corporation's allowance for
loan losses.  Historically,  net charge-offs (loans charged off as uncollectible
less any amounts  recovered on these loans) for the  Corporation  have been very
low when compared with the size of the total loan portfolio. Management monitors
the loan portfolio on a quarterly  basis with  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 loan loss reserve is adequate.

<TABLE>
<CAPTION>
                                                            1996                 1995                1994
                                                       ---------------      ---------------     ------------
<S> <C>
         Balance at beginning of period                  $   899 245           $  988 524         $1 040 000
         Charge-offs:
            Commercial, financial and agricultural               - -                  - -                - -
            Real estate - construction                           - -                  - -                - -
            Real estate - mortgage                               - -              148 246            136 084
            Consumer                                          98 124              116 005            106 874
                                                         -----------           ----------         ----------
                Total charge-offs                             98 124              264 251            242 958
                                                         -----------           ----------         ----------
         Recoveries:
            Commercial, financial and agricultural               - -                  - -                - -
            Real estate - construction                           - -                  - -                - -
            Real estate - mortgage                           186 534                  - -             29 683
            Consumer                                          51 092               49 972             36 799
                                                         -----------           ----------         ----------
                Total recoveries                             237 626               49 972             66 482
                                                         -----------           ----------         ----------
         Net charge-offs (recoveries)                       (139 502)             214 279            176 476
         Additions charged to operations                     100 000              125 000            125 000
                                                         -----------           ----------         ----------
         Balance at end of period                        $ 1 138 747           $  899 245         $  988 524
                                                         ===========           ==========         ==========

         Ratio of net charge-offs (recoveries)
            during the period to average loans
             outstanding during the period                 (0.1890)%              0.2958%            0.2574%
                                                           ========               =======            =======
</TABLE>


ALLOCATION OF RESERVE FOR LOAN LOSSES

          The  following  table shows an  allocation  of the reserve  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. This analysis is recorded each quarter
with  monitoring  procedures  where all loans are examined and problem loans and
potentially problem loans are highlighted for continued observance.

<TABLE>
<CAPTION>
                                                              1996                                   1995
                                                 --------------------------------       --------------------------------
                                                                    Percent of                             Percent of
                                                                  Loans in Each                          Loans in Each
                                                                   Category to                            Category to
                                                   Reserve         Total Loans            Reserve         Total Loans
                                                 -----------      -------------         -----------      -------------
<S> <C>
         Commercial, financial and agricultural  $    10 431           2.84%            $    15 785          4.12%
         Real estate mortgage:
           Construction and land development          53 298           1.04%                 54 763          1.43%
           Secured by farm land                       34 597           2.04%                 33 128          1.64%
           Secured by 1-4 family residential         267 587          51.98%                326 307         49.67%
           Other real estate                         213 675          16.49%                230 294         16.69%
         Consumer                                    129 255          25.37%                123 202         25.80%
         All other                                       889            .24%                  2 389           .65%
         Unallocated                                 429 015           - -                  113 377           - -
                                                 -----------      ----------             ----------      --------
                                                  $1 138 747         100.00%             $  899 245        100.00%
                                                  ==========         =======             ==========        =======
</TABLE>

                                      -8-


<PAGE>


RISK ELEMENTS IN THE LOAN PORTFOLIO


<TABLE>
<CAPTION>
                                                           1996               1995               1994
                                                        ----------         ----------         ----------
<S> <C>
         Nonaccrual loans                                $ 285 150          $ 485 150          $     - -
         Restructured loans                                    - -                - -                - -
         Foreclosed properties                                 - -                - -                - -
                                                        ----------         ----------         ----------
             Total nonperforming assets                  $ 285 150          $ 485 150         $      - -
                                                        ==========         ==========         ==========

         Loans past due 90 days accruing interest        $     - -          $     - -         $  439 076
                                                        ==========         ==========         ==========

         Reserve for loan losses to period end loans         1.55%              1.22%              1.41%
         Nonperforming assets to period end loans and
           foreclosed properties                              .39%               .66%               .00%
</TABLE>

         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.

         Impaired loans excluded from nonperforming  assets amounted to $407,422
and $417,228 at December 31, 1996 and 1995, respectively.

         At December 31, 1996,  other potential  problem loans totaled  $59,462.
Loans are viewed as  potential  problem  loans  according to the ability of such
borrowers to comply with  current  repayment  terms.  These loans are subject to
constant management attention,  and their status is reviewed on a regular basis.
Management has allocated a portion of the allowance for these loans according to
the review of the potential loss in each loan situation.



SECURITIES PORTFOLIO

         In accordance with FASB No. 115, "Accounting for Certain Investments in
Debt and Equity  Securities," the Corporation  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,  are  recognized in
stockholders'  equity.  The Corporation  does not have any derivative  financial
instruments.

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

<TABLE>
<CAPTION>
                                                                            Weighted                             Weighted
                                                          1996               Average            1995              Average
                                                       Book Value             Yield          Book Value            Yield

<S> <C>
Securities held to maturity
   U.S. Treasury securities and securities
     of U.S. Government agencies:
       Maturing within one year                       $ 7 993 959              5.33%         $17 999 931           4.37%
       Maturing after one year but
         within five years                             18 003 062              5.92%           7 985 877           5.33%
                                                      -----------                            -----------
           Total securities held to maturity          $25 997 021                            $25 985 808
                                                      ===========                            ===========

Securities available for sale
   U.S. Treasury securities and securities
     of U.S. government agencies:
       Maturing within one year                       $ 8 013 125               5.14%        $       - -            - -
       Maturing after one year but
         within five years                              5 936 563               5.55%                - -            - -
   Equity securities                                      386 800                - -             367 900            - -
                                                      -----------                            -----------
           Total securities available for sale        $14 336 488                            $   367 900
                                                      ===========                            ===========

           Total securities                           $40 333 509                            $26 353 708
                                                      ===========                            ===========
</TABLE>

                                      -9-


<PAGE>



DEPOSITS

          Detail of average  deposit  information  using  average  balances  and
average  rates is found in  Schedule 1 on page 4. The 1996  average  balance for
certificates  is  approximately  $3,000,000  higher than the 1995  balance  even
though the year end  balances  are  similar.  The 1996  average  balance for NOW
accounts shows a slightly  greater than $1,000,000  increase over 1995. The only
notable change in the comparison of year end deposit structure in 1996 with 1995
is the reduction of money market  deposits by about  $2,000,000.  This reduction
also shows in comparing the average balance for 1996 and 1995.

          At December 31, 1996, certificates of deposit of $100,000 or more were
3.7% of total  deposits  compared with 4.3% at December 31, 1995.  Maturities of
certificates of deposit of $100,000 or more at December 31, 1996 are as follows:

               Within three months                     $1 448 538
               Over three through six months              812 049
               Over six months through twelve months      776 205
               Over twelve months                       1 031 041
                                                       ----------

                  Total                                $4 067 833
                                                       ==========



ANALYSIS OF CAPITAL

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

          The Federal  Reserve,  the Comptroller of the Currency and the Federal
Deposit Insurance  Corporation have adopted capital guidelines to supplement the
existing definitions of capital for regulatory purposes and to establish minimum
capital   standards.   Specifically,   the  guidelines   categorize  assets  and
off-balance sheet items into four risk-weighted categories. The minimum ratio of
qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0%
must be Tier 1 capital,  composed  of common  equity,  retained  earnings  and a
limited amount of perpetual  preferred  stock,  less certain goodwill items. The
Corporation  had a ratio of total capital to  risk-weighted  assets of 24.47% at
December  31,  1996 and a ratio of Tier 1  capital  to  risk-weighted  assets of
23.21%.  Both of these  exceed the capital  requirements  adopted by the federal
regulatory agencies.

                                                 1996                  1995
                                             ------------          ------------
         Tier 1 capital:
            Common stock                      $   600 000           $   600 000
            Surplus                             5 400 000             5 400 000
            Retained earnings                   8 260 037             7 422 603
                                              -----------           -----------
         Total tier 1 capital                 $14 260 037           $13 422 603
         Tier 2 capital:
            Allowance for loans losses (1)        772 445               810 495
                                              -----------           -----------

         Total risk-based capital             $15 032 482           $14 233 098
                                              ===========           ===========

         Risk-weighted assets                 $61 429 313           $64 750 821
                                              ===========           ===========

         Capital ratios:
            Tier 1 risk-based capital ratio      23.21%                20.73%
            Total risk-based capital ratio       24.47%                21.98%
            Leverage ratio                       11.43%                10.83%

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


                                      -10-


<PAGE>


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, securities purchased under agreements to
resell, securities available for sale, and loans and investments maturing within
one  year.  The  Corporation's  liquidity  during  1996  (aside  from  borrowing
capabilities)  is  detailed  in the  statement  of cash  flows  included  in the
financial statements.  Operating cash flows are derived from net income adjusted
for items that do not involve cash. Cash flows from investing activities include
maturity of  securities,  payments on and  maturities of loans and proceeds from
sales of real estate and equipment. Cash flows from financing activities include
increases in any deposit accounts.  As a result of the Corporation's  management
of liquid  assets  and the  ability  to  generate  liquidity  through  liability
funding,  management  believes that the Corporation  maintains overall liquidity
sufficient to satisfy its  depositors'  requirements  and to meet its customers'
credit needs.

          At December 31, 1996,  cash and due from banks,  securities  purchased
under agreements to resell,  and loans and investments  maturing within one year
were $58,977,001.

          Borrowing  capabilities provide additional  liquidity.  The Subsidiary
Bank  maintains a federal funds line of $5,000,000  with  NationsBank,  N.A. 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  $39,000,000.
The Subsidiary Bank did not use either of these sources during 1996.



ACCOUNTING RULE CHANGES

           FASB  Statement No. 125,  "Accounting  for Transfers and Servicing of
Financial Assets and  Extinguishments of Liabilities",  was issued in June, 1996
and  establishes,  among other things,  new criteria for  determining  whether a
transfer of financial assets in exchange for cash or other consideration  should
be accounted for as a sale or as a pledge of collateral in a secured  borrowing.
Statement  125  also   establishes  new  accounting   requirements  for  pledged
collateral.  As  issued,  Statement  125 is  effective  for  all  transfers  and
servicing of financial assets and extinguishments of liabilities occurring after
December 1996.

           FASB Statement No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125", defers for one year the effective date
(a) of paragraph 15 of Statement 125 and (b) for repurchase agreement,
dollar-roll, securities lending, or similar transactions, of paragraph 9-12 and
237(b) of Statement 125.

           The effects of these  Statements  on the  Corporation's  consolidated
financial statements are not expected to be material.

                                      -11-


<PAGE>


                               [GRAPHIC OMITTED]


                                      -12-


<PAGE>

                          INDEPENDENT AUDITOR'S REPORT




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,  1996 and 1995,  and the
related consolidated  statements of income,  changes in stockholders' equity and
cash flows for the years ended December 31, 1996, 1995 and 1994. These financial
statements  are  the  responsibility  of  the  Corporation's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

       We conducted our audits in accordance  with generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
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,  1996 and 1995,  and the
results of its  operations  and its cash flows for the years ended  December 31,
1996,  1995  and  1994,  in  conformity  with  generally   accepted   accounting
principles.

       As discussed in Note 1 and Note 12, the Corporation changed its method of
accounting  for  certain  benefits  provided  for  retired  employees  to  adopt
provisions of Statement of Financial  Accounting  Standards No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions," in 1995.



YOUNT, HYDE & BARBOUR, P.C.

Winchester, Virginia
February 5, 1997

                                      -13-


<PAGE>

                          CONSOLIDATED BALANCE SHEETS
                           December 31, 1996 and 1995





<TABLE>
<CAPTION>
          ASSETS                                                           1996                   1995
                                                                      ---------------        --------------
<S> <C>
Cash and due from banks (Note 9)                                        $  3 400 511          $  3 396 312
Securities (fair value:  1996, $40,330,863; 1995,
   $26,307,412) (Note 2)                                                  40 333 509            26 353 708
Securities purchased under agreements to resell                            4 800 000            18 700 000
Loans (Note 3)                                                            73 525 340            73 651 174
   Reserve for loan losses (Note 4)                                       (1 138 747)             (899 245)
                                                                        ------------          ------------
          Net loans                                                       72 386 593            72 751 929
Premises and equipment, net (Note 5)                                       1 254 393             1 444 027
Accrued interest receivable                                                1 021 216               777 510
Other assets                                                                 583 644               619 664
                                                                        ------------          ------------

          Total Assets                                                  $123 779 866          $124 043 150
                                                                        ============          ============



          LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES
   Deposits (Note 6):
     Noninterest bearing                                                $ 14 036 498          $ 13 847 626
     Interest bearing                                                     94 475 971            95 941 848
                                                                        ------------          ------------
          Total Deposits                                                $108 512 469          $109 789 474
   Accrued interest payable                                                  326 044               346 240
   Other liabilities                                                         722 116               484 833
   Commitments and contingent liabilities (Notes 9 and 11)                       - -                   - -
                                                                        ------------          ------------
          Total Liabilities                                             $109 560 629          $110 620 547
                                                                        ------------          ------------

STOCKHOLDERS' EQUITY
   Common stock, $1 per share par value; 5,000,000 shares
     authorized; 600,000 shares issued and outstanding (Note 1)         $    600 000          $    600 000
   Surplus                                                                 5 400 000             5 400 000
   Undivided profits (Note 10)                                             8 260 037             7 422 603
   Unrealized gain (loss) on securities available for sale, net              (40 800)                  - -
                                                                        ------------          ------------
          Total Stockholders' Equity                                    $ 14 219 237          $ 13 422 603
                                                                        ------------          ------------

          Total Liabilities and Stockholders' Equity                    $123 779 866          $124 043 150
                                                                        ============          ============
</TABLE>


See Notes to Consolidated Financial Statements.


                                      -14-


<PAGE>



                       CONSOLIDATED STATEMENTS OF INCOME
                  Years Ended December 31, 1996, 1995 and 1994

<TABLE>
<CAPTION>
                                                      1996           1995           1994
                                                   ----------     ----------     ----------
<S> <C>
Interest Income:
  Interest and fees on loans                       $6 749 755     $6 569 160     $6 195 118
  Interest on investment securities
      Taxable                                       1 213 709      1 594 544      1 919 333
  Interest and dividends on securities
    available for sale
      Taxable                                         661 125        181 570        728 953
      Dividends                                        24 322         24 647         23 978
  Interest on securities purchased under
    agreements to resell                              437 034        376 939        112 085
                                                   ----------     ----------     ----------

          Total Interest Income                    $9 085 945     $8 746 860     $8 979 467
                                                   ----------     ----------     ----------

Interest Expense:
  Interest on deposits (Note 6)                    $3 623 243     $3 586 403     $3 509 543
  Interest on federal funds purchased                     - -          4 008            - -
                                                   ----------     ----------     ----------

          Total Interest Expense                   $3 623 243     $3 590 411     $3 509 543
                                                   ----------     ----------     ----------

          Net Interest Income                      $5 462 702     $5 156 449     $5 469 924

Provision for Loan Losses (Note 4)                    100 000        125 000        125 000
                                                   ----------     ----------     ----------

          Net Interest Income after
                 Provision for Loan Losses         $5 362 702     $5 031 449     $5 344 924
                                                   ----------     ----------     ----------

Other Income:
  Trust and financial services                     $  460 053     $  446 000     $  425 993
  Service charges on deposit accounts                 318 062        240 529        240 162
  Fees for other customer services                    181 980        192 857        218 844
  Other operating income                               28 730         26 185         53 633
                                                   ----------     ----------     ----------

          Total Other Income                       $  988 825     $  905 571     $  938 632
                                                   ----------     ----------     ----------

Other Expenses:
  Salaries and employee benefits (Notes 7 and 12)  $2 468 762     $2 370 054     $2 343 443
  Net occupancy expense of premises                   203 033        213 891        211 705
  Furniture and equipment expenses                    300 211        283 546        322 112
  Deposit insurance                                     2 000        128 478        261 671
  Stationery and supplies                             106 810        108 279        107 936
  Directors fees                                      105 700         98 910        121 055
  ATM expenses                                        105 445        108 645         98 901
  Other operating expenses                            821 555        766 047        744 138
                                                   ----------     ----------     ----------

          Total Other Expenses                     $4 113 516     $4 077 850     $4 210 961
                                                   ----------     ----------     ----------

          Income before Income Tax Expense         $2 238 011     $1 859 170     $2 072 595

Income Tax Expense (Note 8)                           830 577        674 042        741 627
                                                   ----------     ----------     ----------

          Net Income                               $1 407 434     $1 185 128     $1 330 968
                                                   ==========     ==========     ==========

Earnings Per Share, net income                     $     2.35     $     1.98     $     2.22
                                                   ==========     ==========     ==========
</TABLE>

See Notes to Consolidated Financial Statements.

                                      -15-


<PAGE>



           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                  Years Ended December 31, 1996, 1995 and 1994

<TABLE>
<CAPTION>
                                                                                            Unrealized
                                                                                          Gain (Loss) on
                                                                                            Securities
                                           Common                          Undivided       Available for
                                            Stock          Surplus          Profits          Sale, Net           Total
                                         -----------     -----------     -------------    --------------     -------------
<S> <C>
Balances, December 31, 1993                $600 000       $5 400 000       $5 926 507        $    - -         $11 926 507
   Net income - 1994                            - -              - -        1 330 968             - -           1 330 968
   Cash dividends - 1994
     ($.85 per share)                           - -              - -         (510 000)            - -            (510 000)
   Net unrealized gain (loss) on
     securities available for sale,
     net of deferred income taxes
     of $16,095                                 - -              - -              - -         (31 242)            (31 242)
                                           --------       ----------       ----------        --------         -----------
Balances, December 31, 1994                $600 000       $5 400 000       $6 747 475        $(31 242)        $12 716 233
   Net income - 1995                            - -              - -        1 185 128             - -           1 185 128
   Cash dividends - 1995
     ($.85 per share)                           - -              - -         (510 000)            - -            (510 000)
   Change in net unrealized gain
     (loss) on securities available
     for sale, net of deferred
     income taxes of $16,095                    - -              - -              - -          31 242              31 242
                                           --------       ----------       ----------        --------         -----------
Balances, December 31, 1995                $600 000       $5 400 000       $7 422 603        $    - -         $13 422 603
  Net income - 1996                             - -              - -        1 407 434             - -           1 407 434
  Cash dividends - 1996
    ($.95 per share)                            - -              - -         (570 000)            - -            (570 000)
  Change in net unrealized gain
     (loss) on securities available
     for sale, net of deferred
     income taxes of $21,018                    - -              - -              - -         (40 800)            (40 800)
                                           --------       ----------       ----------        --------         -----------

Balances, December 31, 1996                $600 000       $5 400 000       $8 260 037        $(40 800)        $14 219 237
                                           ========       ==========       ==========        ========         ===========
</TABLE>


See Notes to Consolidated Financial Statements.


                                      -16-


<PAGE>



                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  Years Ended December 31, 1996, 1995 and 1994

<TABLE>
<CAPTION>
                                                                        1996                 1995                   1994
                                                                   --------------       --------------         --------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net income                                                       $  1 407 434          $ 1 185 128            $ 1 330 968
   Adjustments to reconcile net income to net cash
     provided by operating activities:
       Provision for loan losses                                         100 000              125 000                125 000
       Depreciation                                                      181 424              170 739                218 066
       Amortization                                                       12 282               12 282                  5 118
     Deferred income taxes (credits)                                     (88 111)              32 425                (13 285)
     Discount accretion and premium amortization
       on securities, net                                                 27 060                2 699                 56 964
     Loss on sale of equipment                                               - -                  - -                 23 465
     (Gain) loss on sale of real estate                                   94 972                  - -                (27 300)
     Changes in assets and liabilities:
       (Increase) decrease in accrued interest receivable               (243 706)             205 896                166 207
       (Increase) decrease in other assets                                15 002              (81 153)                47 433
       Increase (decrease) in accrued interest payable                   (20 196)              22 514                (29 767)
       Increase in other liabilities                                     237 283               70 045                 66 551
                                                                    ------------          -----------            -----------
         Net cash provided by operating activities                  $  1 723 444          $ 1 745 575            $ 1 969 420
                                                                    ------------          -----------            -----------

CASH FLOWS FROM INVESTING ACTIVITIES
   Proceeds from maturity of investment securities                  $ 18 000 000          $12 000 000            $10 000 000
   Proceeds from maturity of securities available for sale                   - -            6 019 900              7 000 000
   Purchases of investment securities                                (17 996 884)                 - -             (8 983 808)
   Purchases of securities available for sale                        (14 071 795)                 - -               (997 812)
   Net (increase) decrease in loans                                      265 336           (3 803 937)            (1 766 380)
   Purchases of premises and equipment                                  (318 897)             (45 330)              (106 220)
   Proceeds from sale of real estate                                     350 000                  - -                327 500
   Proceeds from sale of equipment                                           - -                  - -                 40 825
                                                                    ------------          -----------            -----------
         Net cash provided by (used in) investing activities        $(13 772 240)         $14 170 633            $ 5 514 105
                                                                    ------------          -----------            -----------

CASH FLOWS FROM FINANCING ACTIVITIES
   Net (decrease) in demand deposits, NOW accounts
     and savings accounts                                           $ (1 218 507)         $(5 428 878)           $(2 188 166)
   Net increase (decrease) in certificates of deposit                    (58 498)           5 994 395             (5 207 449)
   Cash dividends                                                       (570 000)            (510 000)              (510 000)
                                                                    ------------          -----------            -----------
            Net cash provided by (used in) financing activities     $ (1 847 005)         $    55 517            $(7 905 615)
                                                                    ------------          -----------            -----------

            Increase (decrease) in cash and cash equivalents        $(13 895 801)         $15 971 725            $  (422 090)

CASH AND CASH EQUIVALENTS
   Beginning                                                          22 096 312            6 124 587              6 546 677
                                                                    ------------          -----------            -----------

   Ending                                                           $  8 200 511          $22 096 312            $ 6 124 587
                                                                    ============          ===========            ===========

SUPPLEMENTAL DISCLOSURES OF CASH
   FLOW INFORMATION
     Cash payments for:
       Interest                                                     $  3 643 439          $ 3 567 897            $ 3 539 310
                                                                    ============          ===========            ===========

       Income taxes                                                 $    806 431          $   532 749            $   807 942
                                                                    ============          ===========            ===========

SUPPLEMENTAL DISCLOSURES OF NON-CASH
   INVESTING AND FINANCING ACTIVITIES
     Other real estate acquired in settlement of loans              $        - -          $   108 000            $   300 200
                                                                    ============          ===========            ===========

     Other assets acquired in settlement of loans                   $        - -          $       - -            $    64 290
                                                                    ============          ===========            ===========

     Loans made on sale of real estate                              $    291 000          $       - -            $       - -
                                                                    ============          ===========            ===========

     Unrealized gain (loss) on securities available for sale        $    (61 818)         $    47 337            $   (47 337)
                                                                    ============          ===========            ===========
</TABLE>

See Notes to Consolidated Financial Statements.


                                      -17-


<PAGE>



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1.  Nature of Banking Activities and Significant Accounting Policies

         Potomac  Bancshares,   Inc.  and  Subsidiary  (the  Corporation)  grant
         commercial, financial, agricultural,  residential and consumer loans to
         customers,   primarily  in  Jefferson   County,   West  Virginia.   The
         Corporation's market area also includes Washington County and Frederick
         County,  Maryland;  Loudoun  County and Clarke  County,  Virginia;  and
         Berkeley County, West Virginia.  The loan portfolio is well diversified
         and loans generally are  collaterized  by assets of the customers.  The
         loans are  expected to be repaid  from cash flows or proceeds  from the
         sale of selected assets of the borrowers.

         The accounting  and reporting  policies of the  Corporation  conform to
         generally  accepted  accounting  principles  and to  general  practices
         within the banking  industry.  The  following  is a summary of the more
         significant policies.

           Principles of Consolidation

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

           Securities

             Investments are classified in three categories and accounted for as
             follows:

             a.   Securities Held to Maturity

                  Securities  classified  as held to  maturity  are  those  debt
                  securities the  Corporation has both the intent and ability to
                  hold to maturity  regardless of changes in market  conditions,
                  liquidity  needs or changes in  general  economic  conditions.
                  These securities are carried at cost adjusted for amortization
                  of premium and accretion of discount, computed by the interest
                  method over their contractual lives.

             b.   Securities Available for Sale

                  Securities classified as available for sale are those debt and
                  equity securities that the Corporation  intends to hold for an
                  indefinite  period of time,  but not  necessarily to maturity.
                  Any decision to sell a security  classified  as available  for
                  sale would be based on various factors,  including significant
                  movements  in interest  rates,  changes in the maturity mix of
                  the  Corporation's  assets and  liabilities,  liquidity needs,
                  regulatory capital considerations,  and other similar factors.
                  Securities  available  for sale  are  carried  at fair  value.
                  Unrealized  gains or  losses  are  reported  as  increases  or
                  decreases in stockholders' equity, net of the related deferred
                  tax effect. Realized gains or losses,  determined on the basis
                  of the cost of  specific  securities  sold,  are  included  in
                  earnings.

             c.   Trading Securities

                  Trading  securities,  which are  generally  held for the short
                  term in  anticipation  of market  gains,  are  carried at fair
                  value.  Realized  and  unrealized  gains and losses on trading
                  account  assets are  included  in  interest  income on trading
                  account securities.  The Corporation had no trading securities
                  at December 31, 1996 and 1995.

           Loans

             Loans are  stated at the  amount of unpaid  principal  reduced by a
             reserve  for  possible  loan  losses.  Interest  income on loans is
             computed  on the loan  balance  outstanding.  Loans are charged off
             when  in  the  opinion  of  management,   they  are  deemed  to  be
             uncollectible  after taking into  consideration such factors as the
             current  financial  condition of the  customer  and the  underlying
             collateral and guarantees.

             On January 1, 1995, the Corporation  adopted  Financial  Accounting
             Standards   Statement  No.  114,   "Accounting   by  Creditors  for
             Impairment  of a Loan."  This  Statement  has been  amended by FASB
             Statement No. 118,  "Accounting  by Creditors  for  Impairment of a
             Loan - Income  Recognition  and  Disclosures."  Statement  114,  as
             amended,  requires  that the  impairment  of loans  that  have been
             separately identified for evaluation is to be measured based on the
             present value of expected future cash flows or, alternatively,  the
             observable  market  price of the  loans  or the  fair  value of the
             collateral.  However, for those loans that are collateral dependent
             (that is, if  repayment  of those  loans is expected to be provided
             solely by the underlying  collateral) and for which  management has
             determined  foreclosure  is probable,  the measure of impairment of
             those  loans is to be based  on the fair  value of the  collateral.
             Statement 114, as amended,  also requires certain disclosures about
             investments  in impaired  loans and the allowance for credit losses
             and interest income recognized on loans.

             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.

                                      -18-


<PAGE>



Note 1.  Nature of Banking Activities and Significant Accounting Policies
         (Continued)

           Reserve for Loan Losses

             The reserve  for loan losses is  maintained  at a level  which,  in
             management's   judgement,  is  adequate  to  absorb  credit  losses
             inherent in the loan portfolio.  The amount of the reserve is based
             on  management's  evaluation  of the  collectibility  of  the  loan
             portfolio,   credit  concentrations,   trends  in  historical  loss
             experience,  specific  impaired  loans,  and  economic  conditions.
             Reserves  for  impaired  loans are  generally  determined  based on
             collateral values or the present value of estimated cash flows. The
             reserve is  increased  by a  provision  for loan  losses,  which is
             charged to expense and reduced by  charge-offs,  net of recoveries.
             Changes in the reserves  relating to impaired  loans are charged or
             credited to the provision for loan losses. Because of uncertainties
             inherent in the estimation process, management's estimate of credit
             losses  inherent in the loan portfolio and the related  reserve may
             change in the near term.

             For  federal  income tax  purposes,  the  Corporation  deducts  the
             maximum amount allowable under current income tax regulations.

           Premises and Equipment

             Premises  and  equipment  are  stated  at  cost  less   accumulated
             depreciation.   Depreciation   is   computed   primarily   on   the
             straight-line and declining-balance methods.

             Maintenance  and repairs of property and  equipment  are charged to
             operations and major improvements are capitalized. Upon retirement,
             sale or other  disposition of property and equipment,  the cost and
             accumulated  depreciation are eliminated from the accounts and gain
             or loss is included in operations.

           Other Real Estate

             Real estate acquired by foreclosure is carried at the lower of cost
             or fair market value, adjusted for anticipated selling expenses.

           Pension Plan

             The Corporation has a noncontributory, defined benefit pension plan
             covering employees meeting certain age and service requirements.
             The Corporation computes the net periodic pension cost of the plan
             in accordance with Financial Accounting Standards Board Statement
             No. 87, "Employers' Accounting for Pensions."

           Earnings and Dividends Per Share

             Earnings and  dividends  per share of common stock are based on the
             weighted average number of shares outstanding during each year.

           Income Taxes

             Deferred taxes are provided on a liability  method whereby deferred
             tax assets are  recognized for  deductible  temporary  differences,
             operating  loss  carryforwards,   and  tax  credit   carryforwards.
             Deferred  tax  liabilities  are  recognized  for taxable  temporary
             differences.  Temporary  differences  are  differences  between the
             reported  amounts  of assets and  liabilities  and their tax bases.
             Deferred tax assets are reduced by a valuation  allowance  when, in
             the  opinion of  management,  it is more  likely than not that some
             portion or all of the  deferred  tax assets  will not be  realized.
             Deferred tax assets and liabilities are adjusted for the effects of
             changes in tax laws and rates on the date of enactment.

           Cash and Cash Equivalents

             For purposes of  reporting  cash flows,  cash and cash  equivalents
             include  cash on  hand,  amounts  due  from  banks  and  securities
             purchased  under  agreements  to  resell.   Generally,   securities
             purchased  under  agreements  to resell are  purchased and sold for
             one-day periods.

           Trust Division

             Securities  and  other  property  held by the Trust  Division  in a
             fiduciary or agency  capacity are not assets of the Corporation and
             are not included in the accompanying financial statements.

           Postretirement Benefits

             The  Corporation  sponsors a  postretirement  life  insurance  plan
             covering  retirees  with 25 years of service over the age of 60 and
             health care plan for all  retirees and six current  employees  that
             have met certain eligibility requirements. The Corporation computes
             the  net  periodic  postretirement  benefit  cost  of the  plan  in
             accordance with Financial  Accounting Standards Board Statement No.
             106, "Employers' Accounting for Postretirement Benefits Other Than
             Pensions."

                                      -19-


<PAGE>



Note 1.  Nature of Banking Activities and Significant Accounting Policies
         (Continued)

           Use of Estimates

             The   preparation  of  financial   statements  in  conformity  with
             generally accepted  accounting  principles  requires  management to
             make estimates and assumptions  that affect the reported amounts of
             assets and  liabilities  and  disclosure of  contingent  assets and
             liabilities  at  the  date  of the  financial  statements  and  the
             reported  amounts of revenues  and  expenses  during the  reporting
             period. Actual results could differ from those estimates.



Note 2.  Securities

         The amortized cost and fair value of securities  being held to maturity
as of December 31, 1996 and 1995, are as follows:

<TABLE>
<CAPTION>
                                                                                1996
                                                    ---------------------------------------------------------------
                                                                       Gross            Gross
                                                     Amortized       Unrealized       Unrealized            Fair
                                                        Cost           Gains           (Losses)            Value
                                                    -----------      ----------       ----------        -----------
<S> <C>
         U.S. Treasury securities                   $14 005 278        $24 951        $ (42 416)        $13 987 813
         Obligations of U.S. Government agencies     11 991 743         20 692           (5 873)         12 006 562
                                                    -----------      ----------       ----------        -----------
                                                    $25 997 021        $45 643        $ (48 289)        $25 994 375
                                                    ===========      ==========       ==========        ===========
</TABLE>

<TABLE>
<CAPTION>
                                                                              1995
                                                    ---------------------------------------------------------------
                                                                       Gross            Gross
                                                     Amortized       Unrealized       Unrealized            Fair
                                                        Cost           Gains           (Losses)             Value
                                                    -----------      ----------       ----------        -----------
<S> <C>
         U.S. Treasury securities                   $15 986 120        $63 651        $ (41 334)        $16 008 437
         Obligations of U.S. Government agencies      9 999 688            625          (69 238)          9 931 075
                                                    -----------      ----------       ----------        -----------
                                                    $25 985 808        $64 276        $(110 572)        $25 939 512
                                                    ===========      ==========       ==========        ===========
</TABLE>


         The  amortized  cost and fair  value of the  securities  being  held to
         maturity as of December 31, 1996, by  contractual  maturity,  are shown
         below:
                                                   Amortized          Fair
                                                      Cost           Value
                                                  -----------      -----------
         Due in one year or less                  $ 7 993 959      $ 8 007 931
         Due after one year through five years     18 003 062       17 986 444
                                                  -----------      -----------
                                                  $25 997 021      $25 994 375
                                                  ===========      ===========


         There were no sales of securities  being held to maturity  during 1996,
         1995 and 1994.

         Securities being held to maturity with a carrying value of $6,988,229
         and $8,987,672 at December  31, 1996 and 1995, were pledged to secure
         public funds and other balances as required by law.

         The amortized  cost and fair value of securities  available for sale as
         of December 31, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
                                                                                  1996
                                                   ------------------------------------------------------------------
                                                                        Gross            Gross
                                                    Amortized         Unrealized       Unrealized            Fair
                                                       Cost             Gains           (Losses)             Value
                                                   -----------        ----------       ----------         -----------
<S> <C>
             U.S. Treasury securities              $14 011 506         $ 12 389         $(74 207)         $13 949 688
             Federal Home Loan Bank stock              386 800              - -              - -              386 800
                                                   -----------        ----------       ----------         -----------
                                                   $14 398 306         $ 12 389         $(74 207)         $14 336 488
                                                   ===========        ==========       ==========         ===========
</TABLE>


<TABLE>
<CAPTION>
                                                                                  1995
                                                   ------------------------------------------------------------------
                                                                        Gross            Gross
                                                    Amortized         Unrealized       Unrealized            Fair
                                                       Cost             Gains           (Losses)             Value
                                                   -----------        ----------       -----------        -----------
<S> <C>
             Federal Home Loan Bank stock          $   367 900         $    - -         $    - -          $   367 900
                                                   ===========        ==========       ===========        ===========
</TABLE>

                                      -20-


<PAGE>



Note 2.  Securities (Continued)

         The amortized cost and fair value of the securities  available for sale
         as of December 31, 1996, by contractual maturity, are shown below:
<TABLE>
<CAPTION>

                                                          Amortized         Fair
                                                             Cost           Value
                                                          -----------    -----------
<S> <C>
                   Due in one year or less                $ 8 032 958    $ 8 013 125
                   Due after one year through five years    5 978 548      5 936 563
                   Other                                      386 800        386 800
                                                          -----------    -----------
                                                          $14 398 306    $14 336 488
                                                          ===========    ===========
</TABLE>

         There were no sales of securities available for sale during 1996, 1995
         and 1994.

         Securities  available for sale with a carrying  value of $1,986,250 and
         $-0- at of December 31, 1996 and 1995,  were  pledged to secure  public
         funds and other balances as required by law.



Note 3.  Loans and Related Party Transactions

         The loan portfolio is composed of the following:

<TABLE>
<CAPTION>
                                                                       December 31
                                                            -----------------------------------
                                                                 1996                  1995
                                                            --------------        -------------
<S> <C>
           Real estate loans:
              Construction and land development              $   759 619            $ 1 052 659
              Secured by farm land                             1 501 527              1 207 714
              Secured by 1-4 family residential               38 220 730             36 586 317
              Other real estate loans                         12 124 747             12 295 313
            Loans to farmers (except those secured by
              real estate)                                       229 022                650 275
            Commercial and industrial loans (except those
              secured by real estate)                          1 857 219              2 382 885
            Loans to individuals for personal expenditures    18 654 695             18 998 386
            All other loans                                      177 781                477 625
                                                             -----------            -----------
                                                             $73 525 340            $73 651 174
                                                             ===========            ===========
</TABLE>

         The Securities  and Exchange  Commission  requires  disclosure of loans
         which  exceed  $60,000  to  executive  officers  and  directors  of the
         Corporation   or  to  their   associates.   Such  loans  were  made  on
         substantially  the  same  terms  as  those  prevailing  for  comparable
         transactions  with similar risk.  At December 31, 1996 and 1995,  these
         loans totaled  $265,715 and $355,806  respectively.  During 1996, total
         principal  additions  were $96,700 and total  principal  payments  were
         $186,791.



Note 4.  Reserve for Loan Losses

         The  following  is a summary of  transactions  in the  reserve for loan
losses for 1996, 1995 and 1994:

<TABLE>
<CAPTION>
                                                        1996              1995               1994
                                                    ------------      ------------       ------------
<S> <C>
           Balance at beginning of year              $  899 245         $ 988 524         $1 040 000
           Provision charged to operating expense       100 000           125 000            125 000
           Recoveries added to the reserve              237 626            49 972             66 482
           Loan losses charged to the reserve           (98 124)         (264 251)          (242 958)
                                                     ----------         ---------         ----------
           Balance at end of year                    $1 138 747         $ 899 245         $  988 524
                                                     ==========         =========         ==========
</TABLE>

                                      -21-


<PAGE>



Note 4.  Reserve for Loan Losses (Continued)

         Information about impaired loans as of and for the years ended December
31, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
                                                                      1996            1995
                                                                  -----------     ------------
<S> <C>
           Impaired loans for which a reserve has been provided     $407 422        $617 228
           Impaired loans for which no reserve has been provided         - -             - -
                                                                    --------        --------
             Total impaired loans                                   $407 422        $617 228
                                                                    ========        ========

           Reserve provided for impaired loans, included in the
              reserve for loan losses                               $203 711        $268 614

           Average balance in impaired loans                        $472 292        $522 457

           Interest income recognized                               $ 36 125        $ 44 107
</TABLE>


         Nonaccrual  loans excluded from impaired loan disclosure under FASB 114
         amounted  to $285,150  at  December  31, 1996 and 1995.  If interest on
         these  loans had been  accrued,  such  income  would have  approximated
         $28,494 in 1996 and $8,820 in 1995.



Note 5.  Premises and Equipment, Net

         Premises and equipment consists of the following:


                                                  December 31
                                           ---------------------------
                                               1996           1995
                                           ------------   ------------

           Premises                         $1 811 852     $2 146 531
           Furniture and equipment           2 111 224      1 952 876
                                            ----------     ----------
                                            $3 923 076     $4 099 407
           Less accumulated depreciation     2 668 683      2 655 380
                                            ----------     ----------
                                            $1 254 393     $1 444 027
                                            ==========     ==========


         Depreciation included in operating expense for 1996, 1995 and 1994, was
$181,424, $170,739 and $218,066, respectively.



Note 6.  Deposits

         Deposits outstanding at December  31, 1996, 1995 and 1994, and the
         related interest expense for the years then ended are summarized as
         follows:

<TABLE>
<CAPTION>
                                              1996                          1995                           1994
                                    -------------------------     -------------------------      --------------------------
                                       Amount        Expense         Amount        Expense          Amount         Expense
                                    ------------   ----------     ------------   ----------      ------------    ----------
<S> <C>
         Noninterest bearing        $ 14 036 498   $      - -     $ 13 847 626   $      - -      $ 13 295 845    $      - -
                                    ------------   ----------     ------------    ---------      ------------    ----------
         Interest bearing:
           NOW accounts             $ 16 748 803   $  320 545     $ 15 996 973   $  328 734      $ 14 875 986    $  363 127
           Money market accounts      15 223 555      409 080       17 182 177      523 534        21 271 806       671 063
           Savings deposits           23 111 062      691 389       23 311 649      853 301        26 323 667       986 740
           Certificates of deposit:
            Less than $100,000        35 324 718    1 932 641       34 757 455    1 643 457        30 265 501     1 303 414
            $100,000 and more          4 067 833      269 588        4 693 594      237 377         3 191 152       185 199
                                    ------------   ----------     ------------   ----------      ------------    ----------

              Total interest
                bearing             $ 94 475 971   $3 623 243     $ 95 941 848   $3 586 403      $ 95 928 112    $3 509 543
                                    ------------   ----------     ------------   ----------      ------------   ------------

              Total deposits        $108 512 469   $3 623 243     $109 789 474   $3 586 403      $109 223 957    $3 509 543
                                    ============   ==========     ============   ==========      ============    ==========
</TABLE>

                                      -22-


<PAGE>



Note 7.  Defined Benefit Pension Plan

         The amount  charged  to  expense  for the  Corporation's  pension  plan
         totaled  $97,032,  $93,508 and $93,106 for the years ended December 31,
         1996, 1995 and 1994,  respectively.  The components of the pension cost
         charged  against  expense  for  1996,  1995 and 1994  consisted  of the
         following:

<TABLE>
<CAPTION>
                                                                    1996          1995          1994
                                                                 ----------    ----------   -----------
<S> <C>
               Service cost                                       $133 596     $ 114 859    $ 120 976
               Interest cost on projected benefit obligation       200 942       182 585      179 141
               Actual return on plan assets                       (217 359)     (183 789)    (186 864)
               Net amortization and deferral                       (20 147)      (20 147)     (20 147)
                                                                 ----------    -----------  -----------
                                                                  $ 97 032     $  93 508    $  93 106
                                                                 ==========    ===========  ===========
</TABLE>

         The following table sets forth the plan's funded status as of October
         31, 1996 and 1995 and the amount recognized in the accompanying balance
         sheets as of December 31, 1996 and 1995.

<TABLE>
<CAPTION>
                                                                       1996           1995
                                                                   -----------    -----------
<S> <C>
               Actuarial present value of benefit obligations:
                 Vested benefits                                   $ 1 921 000    $ 1 849 000
                                                                   ===========    ===========

                 Accumulated benefits                              $ 2 072 000    $ 1 978 000
                                                                   ===========    ===========

               Projected benefits                                  $(2 866 017)   $(2 733 720)
               Plan assets at fair value                             2 888 800      2 601 639
                                                                   -----------    -----------
               Funded status                                       $    22 783    $  (132 081)
               Unrecognized net (gain)                                (289 685)       (17 642)
               Unrecognized net (asset)                               (177 849)      (198 151)
               Unrecognized prior service cost                           1 645          1 800
                                                                   -----------    -----------

                 Liability on balance sheet                        $  (443 106)   $  (346 074)
                                                                   ===========    ===========
</TABLE>

         The  weighted  average  discount  rate and rate of  increase  in future
         compensation  levels used in determining the actuarial present value of
         the benefit  obligations  were 7.75% and 6.0% at October 31, 1996.  The
         expected long-term rate of return on plan assets was 8.5%.



Note 8.  Income Taxes

         Net  deferred  tax assets  consist of the  following  components  as of
December 31, 1996 and 1995:


                                                      1996           1995
                                                   ----------     ----------
              Deferred tax assets:
                Reserve for loan losses             $ 231 845      $ 197 844
                Accrued pension expense               150 656        117 665
                Securities available for sale          21 018            - -
                Accrued postretirement benefits        23 999          9 988
                Nonaccrual interest                    12 687          4 741
                                                   ----------     ----------
                                                    $ 440 205      $ 330 238
                                                    ---------      ---------
              Deferred tax liabilities:
                Premises                            $  25 932      $  24 670
                Other                                   1 186          1 610
                                                   ----------     ----------
                                                    $  27 118      $  26 280
                                                    ---------      ---------

                      Net deferred tax assets       $ 413 087      $ 303 958
                                                    =========      =========


         The  provision  for income taxes  charged to  operations  for the years
         ended December 31, 1996, 1995 and 1994 consists of the following:

<TABLE>
<CAPTION>
                                                      1996           1995            1994
                                                   ----------     ----------      ----------
<S> <C>
              Current tax expense                   $ 918 688      $ 641 617       $ 754 912
              Deferred tax expense (benefit)          (88 111)        32 425         (13 285)
                                                   ----------     ----------      ----------
                                                    $ 830 577      $ 674 042       $ 741 627
                                                   ==========     ==========      ==========
</TABLE>

                                      -23-


<PAGE>



Note 8.  Income Taxes (Continued)

         The  income  tax  provision  differs  from the  amount  of  income  tax
         determined  by  applying  the U.S.  federal  income  tax rate to pretax
         income for the years ended December 31, 1996,  1995 and 1994 due to the
         following:

<TABLE>
<CAPTION>
                                                                       1996              1995             1994
                                                                    ----------        ----------       ----------
<S> <C>
           Computed "expected" tax expense                           $760 924          $632 118         $704 682
           Increase (decrease) in income taxes resulting from:
             Tax exempt interest income                                (6 809)          (11 544)         (16 371)
             State income taxes, net of federal income tax benefit     74 544            51 461           51 574
             Other                                                      1 918             2 007            1 742
                                                                    ----------        ----------       ----------
                                                                     $830 577          $674 042         $741 627
                                                                    ==========        ==========       ==========
</TABLE>


Note 9.  Commitments and Contingent Liabilities

         In the  normal  course  of  business,  there  are  outstanding  various
         commitments and contingent liabilities,  which are not reflected in the
         accompanying financial statements.  The Corporation does not anticipate
         losses as a result of these transactions.

         See   Note   11   with   respect   to   financial    instruments   with
         off-balance-sheet risk.

         The  Corporation  has  approximately  $1,200,230 in deposits in another
         financial  institution  in excess of  amounts  insured  by the  Federal
         Deposit Insurance Corporation (FDIC) at December 31, 1996.



Note 10. Retained Earnings

         Transfers  of  funds  from  the  banking   subsidiary   to  the  parent
         corporation  in the form of  loans,  advances  and cash  dividends  are
         restricted by federal and state regulatory authorities.  As of December
         31, 1996,  the aggregate  amount of  unrestricted  funds which could be
         transferred  from the  banking  subsidiary  to the parent  corporation,
         without prior regulatory  approval,  totaled $2,410,776 or 17.0% of the
         consolidated net assets.



Note 11. Financial Instruments With Off-Balance-Sheet Risk

         The    Corporation   is   party   to   financial    instruments    with
         off-balance-sheet  risk in the normal  course of  business  to meet the
         financing needs of its customers.  These 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 Corporation has in particular  classes of
         financial instruments.

         The   Corporation's   exposure   to   credit   loss  in  the  event  of
         nonperformance  by the  other  party to the  financial  instrument  for
         commitments  to  extend  credit  and  standby   letters  of  credit  is
         represented by the contractual  notional  amount of those  instruments.
         The Corporation 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  Corporation's
         exposure to off-balance-sheet risk as of December 31, 1996 and 1995, is
         as follows:
                                                        1996         1995
                                                     ----------   ----------
             Financial instruments whose contract
               amounts represent credit risk:
                   Commitments to extend credit      $9 234 952   $7 707 163
                   Standby letters of credit            145 777      184 080


         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  Corporation   evaluates  each  customer's   credit
         worthiness on a case-by-case basis. The amount of collateral  obtained,
         if deemed  necessary by the  Corporation  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.


                                      -24-


<PAGE>



Note 11.  Financial Instruments With Off-Balance-Sheet Risk (Continued)

          Standby  letters of credit are conditional  commitments  issued by the
          Corporation  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  Corporation  holds real
          estate as collateral supporting those commitments for which collateral
          is deemed  necessary.  No collateral  was held for  commitments  as of
          December 31, 1996.



Note 12.  Postretirement Benefits

          The Corporation sponsors a postretirement life insurance plan covering
          retirees  with 25 years of service  over the age of 60 and health care
          plan for all retirees and six current  employees that have met certain
          eligibility   requirements.   The  plan  is  contributory  for  future
          retirees,  with retiree contributions that are currently set at 20% of
          the  required  premium.  Effective  January 1, 1995,  the  Corporation
          adopted Financial  Accounting Standards Statement No. 106, "Employers'
          Accounting  for  Postretirement  Benefits  Other  Than  Pensions,"  to
          account  for its  share of the  costs of those  benefits.  Under  that
          Statement, the Corporation'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  Corporation'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.  Prior to 1995, the Corporation  expensed its share of costs
          as they were paid.

          Net  periodic  postretirement  benefit  cost  included  the  following
          components for the years ended December 31, 1996 and 1995:

<TABLE>
<CAPTION>
                                                          1996                   1995
                                                    -----------------      -----------------
                                                    Medical    Life        Medical     Life
                                                    -------   -------      -------   -------
<S> <C>
            Service cost benefits attributable to
              service during the year               $ 2 237   $ 3 788      $ 1 641   $ 4 163
            Interest on accumulated postretirement
              benefit obligation                     23 824    14 655       18 333     9 860
            Amortization of transition obligation    12 298     7 372       11 458     5 954
                                                    -------   -------      -------   -------

                                                    $38 359   $25 815      $31 432   $19 977
                                                    =======   =======      =======   =======
</TABLE>


          Postretirement benefit cost recognized in 1994 under the Corporation's
prior accounting policy was $21,480.

          The following  table sets forth the plan's  funded  status  reconciled
          with the obligation  recognized in the accompanying  balance sheets at
          December 31, 1996 and 1995:

<TABLE>
<CAPTION>
                                                                    1996                         1995
                                                           ----------------------      -----------------------
                                                             Medical       Life          Medical        Life
                                                           ---------    ---------      ---------     ---------
<S> <C>
               Accumulated postretirement
                  benefit obligation:
                    Retirees                               $ 213 057    $  77 934      $ 206 424     $  78 294
                    Other fully eligible participants         72 733       24 101         42 711        22 661
                    Other active participants                    - -       34 196            - -        32 150
                                                           ---------    ---------      ---------     ---------

                                                           $ 285 790    $ 136 231      $ 249 135     $ 133 105
                                                           =========    =========      =========     =========
               Plan assets:
                  Accumulated postretirement benefit
                    obligation in excess of plan assets    $ 285 790    $ 136 231      $ 249 135     $ 133 105
                  Unrecognized transition obligation         206 245)    (107 174)      (217 703)     (113 128)
                  Net amortization and deferral              (10 114)      16 735            - -           - -
                  Accumulated premium payments for retirees  (31 485)     (13 152)       (15 622)       (6 410)
                                                           ---------    ---------      ---------     ---------

                     Obligation included on balance sheet  $  37 946    $  32 640     $   15 810     $  13 567
                                                           =========    =========     ==========     =========
</TABLE>


          For measurement  purposes, a 10 percent annual rate of increase in per
          capita health care costs of covered  benefits was assumed for 1996 and
          1995,  with such  annual  rate of increase  gradually  declining  to 5
          percent  in 2011.  If  assumed  health  care  cost  trend  rates  were
          increased  by  1  percentage  point  in  each  year,  the  accumulated
          postretirement  benefit  obligation  at  December  31,  1996  would be
          increased  by $35,064 and the  aggregate  of the service and  interest
          cost  components of net periodic  postretirement  benefit cost for the
          year ended December 31, 1996 would be increased by $3,261.

          The weighted  average discount rate used in estimating the accumulated
          postretirement benefit obligation was 8%.

                                      -25-


<PAGE>



Note 13.  Disclosures About Fair Value of Financial Instruments

          The following  methods and assumptions  were used to estimate the fair
          value  of  each  class  of  financial  instruments  for  which  it  is
          practicable to estimate that value:

            Cash and Short-Term Investments

               For  those  short-term  instruments,  the  carrying  amount  is a
               reasonable estimate of fair value.

            Securities

               For  securities  held for  investment  purposes,  fair values are
               based on quoted market prices or dealer quotes.

            Loans

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

            Deposit Liabilities

               The fair value of demand deposits,  savings accounts, and certain
               money  market  deposits  is the  amount  payable on demand at the
               reporting date. The fair value of fixed-maturity  certificates of
               deposit  is  estimated  using the  rates  currently  offered  for
               deposits of similar remaining maturities.

            Off-Balance Sheet Financial Instruments

               The  fair  value  of  commitments  is  estimated  using  the fees
               currently charged to enter into similar  agreements,  taking into
               account the  remaining  terms of the  agreements  and the present
               creditworthiness  of  the  counterparties.  For  fixed-rate  loan
               commitments,  fair value also  considers the  difference  between
               current  levels of interest  rates and the committed  rates.  The
               fair  value of  letters  of  credit  is  based on fees  currently
               charged  for  similar  agreements  or on the  estimated  cost  to
               terminate  them or  otherwise  settle  the  obligations  with the
               counterparties at the reporting date.

            At December 31, 1996 and 1995, the carrying  amounts and fair values
            of loan commitments and standby-letters of credit were immaterial.

            The estimated fair values of the Corporation's financial instruments
are as follows:

<TABLE>
<CAPTION>
                                                        1996                          1995
                                               ----------------------       -----------------------
                                               Carrying        Fair         Carrying         Fair
                                                Amount         Value          Amount         Value
                                               --------      --------       --------       --------
                                                   (in thousands)                (in thousands)
<S> <C>
            Financial assets:
               Cash                            $  3 401      $  3 401       $  3 396       $  3 396
               Securities purchased under
                 agreements to resell             4 800         4 800         18 700         18 700
               Securities                        40 334        40 331         26 354         26 307
               Loans                             73 525        72 103         73 651         68 970
               Less:  reserve for loan losses    (1 139)          - -           (899)           - -
                                               --------      --------       --------       --------
                    Total financial assets     $120 921      $120 635       $121 202       $117 373
                                               ========      ========       ========       ========

            Financial liabilities:
               Deposits                        $108 512      $108 479       $109 789       $109 855
                                               ========      ========       ========       ========
</TABLE>



Note 14.  Derivative Financial Instruments

          In October, 1994, Statement of Financial Accounting Standards No. 119,
          "Disclosure about Derivative  Financial  Instruments and Fair Value of
          Financial  Instruments"  was issued.  The  Statement is effective  for
          financial statements issued for fiscal years ending after December 15,
          1994.  It  requires  various  disclosures  for  derivative   financial
          instruments which are futures,  forward,  swap, or option contract, or
          other  financial   instruments  with  similar   characteristics.   The
          Corporation  does not have any  derivative  financial  instruments  as
          defined under this Statement.


                                      -26-


<PAGE>



Note 15.  Regulatory Matters

          The Corporation is subject to various regulatory capital  requirements
          administered by the federal banking agencies.  Failure to meet minimum
          capital   requirements  can  initiate  certain  mandatory  -  possibly
          additional  discretionary - actions by regulators that, if undertaken,
          could have a direct  material  effect on the  Corporation's  financial
          statements.  Under  capital  adequacy  guidelines  and the  regulatory
          framework for prompt  corrective  action,  the  Corporation  must meet
          specific capital guidelines that involve quantitative  measures of the
          Corporation's  assets,  liabilities,  and certain  off-  balance-sheet
          items  as  calculated  under  regulatory  accounting  practices.   The
          Corporation's  capital amounts and  classification are also subject to
          qualitative  judgments  by  the  regulators  about  components,   risk
          weightings, and other factors.

          Quantitative  measures  established  by regulation  to ensure  capital
          adequacy  require  the  Corporation  to maintain  minimum  amounts and
          ratios (set forth in the table  below) of total and Tier 1 capital (as
          defined in the  regulations) to  risk-weighted  assets,  and of Tier 1
          capital to average  assets.  Management  believes,  as of December 31,
          1996, that the Corporation meets all capital adequacy  requirements to
          which it is subject.

          As of December 31, 1996, the most recent notification from the Federal
          Deposit  Insurance  Corporation  categorized  the  Corporation as well
          capitalized  under the  regulatory  framework  for  prompt  corrective
          action.  To be categorized as well  capitalized,  the Corporation must
          maintain  minimum  total  risk-based,  Tier 1  risk-based,  and Tier 1
          leverage ratios as set forth in the table.  There are no conditions or
          events since that notification  that management  believes have changed
          the institution's category.

          The Corporation's actual capital amounts and ratios are also presented
in the table.

<TABLE>
<CAPTION>
                                                                                                To Be Well
                                                                                             Capitalized Under
                                                                     For Capital             Prompt Corrective
                                               Actual             Adequacy Purposes          Action Provisions
                                         ------------------      --------------------       --------------------
                                          Amount     Ratio        Amount       Ratio         Amount       Ratio
                                         -------    -------      --------     -------       --------     -------
                                                                (Amount in Thousands)
<S> <C>
          As of December 31, 1996:
            Total capital (to risk-
              weighted assets):
               Consolidated              $15 032     24.47%       >$4 914       >8.0%                N/A
                                                                  -             -
               Bank of Charles Town      $14 959     24.37%       >$4 911       >8.0%        >$6 139      >10.0%
                                                                  -             -            -            -
            Tier 1 capital (to risk-
              weighted assets):
               Consolidated              $14 260     23.21%       >$2 457       >4.0%                N/A
                                                                  -             -
               Bank of Charles Town      $14 187     23.11%       >$2 455       >4.0%        >$3 683       >6.0%
                                                                  -             -            -             -
            Tier 1 capital (to
              average assets):
               Consolidated              $14 260     11.43%       >$4 989       >4.0%                N/A
                                                                  -             -
               Bank of Charles Town      $14 187     11.38%       >$4 987       >4.0%        >$6 234       >5.0%
                                                                  -             -            -             -
</TABLE>


<TABLE>
<CAPTION>
                                                                                                To Be Well
                                                                                             Capitalized Under
                                                                     For Capital             Prompt Corrective
                                               Actual             Adequacy Purposes          Action Provisions
                                         ------------------      --------------------       --------------------
                                          Amount     Ratio        Amount       Ratio         Amount       Ratio
                                         -------    -------      --------     -------       --------     -------
                                                                (Amount in Thousands)
<S> <C>
          As of December 31, 1995:
            Total capital (to risk-
              weighted assets):
               Consolidated              $14 233     21.98%       >$5 180       >8.0%                N/A
                                                                  -             -
               Bank of Charles Town      $14 135     21.84%       >$5 177       >8.0%        >$6 472      >10.0%
                                                                  -             -            -            -
            Tier 1 capital (to risk-
              weighted assets):
               Consolidated              $13 423     20.73%       >$2 590       >4.0%                N/A
                                                                  -             -
               Bank of Charles Town      $13 325     20.59%       >$2 589       >4.0%        >$3 883       >6.0%
                                                                  -             -            -             -
            Tier 1 capital (to
              average assets):
               Consolidated              $13 423     10.83%       >$4 957       >4.0%                N/A
                                                                  -             -
               Bank of Charles Town      $13 325     10.76%       >$4 954       >4.0%        >$6 193       >5.0%
                                                                  -             -            -             -
</TABLE>


                                      -27-


<PAGE>



Note 16.  Parent Corporation Only Financial Statements

                            POTOMAC BANCSHARES, INC.
                           (Parent Corporation Only)
                                 Balance Sheets
                           December 31, 1996 and 1995


<TABLE>
<CAPTION>
        ASSETS                                                      1996              1995
                                                                 -----------      -----------
<S> <C>
          Cash                                                   $    34 221      $    36 769
          Investment in subsidiary                                14 146 483       13 325 189
          Organization costs, net of accumulated amortization         31 729           44 012
          Other assets                                                11 800           21 374
                                                                 -----------      -----------

             Total Assets                                        $14 224 233      $13 427 344
                                                                 ===========      ===========


        LIABILITIES AND STOCKHOLDERS' EQUITY

        LIABILITIES
          Other liabilities                                      $     4 996      $     4 741
                                                                 -----------      -----------

        STOCKHOLDERS' EQUITY
          Common stock                                           $   600 000      $   600 000
          Surplus                                                  5 400 000        5 400 000
          Undivided profits                                        8 260 037        7 422 603
          Unrealized gain (loss) on securities available
            for sale, net                                            (40 800)             - -
                                                                 -----------      -----------
             Total Stockholders' Equity                          $14 219 237      $13 422 603
                                                                 -----------      -----------

             Total Liabilities and Stockholders' Equity          $14 224 233      $13 427 344
                                                                 ===========      ===========
</TABLE>



                            POTOMAC BANCSHARES, INC.
                           (Parent Corporation Only)
                              Statements of Income
                  Years Ended December 31, 1996, 1995 and 1994


<TABLE>
<CAPTION>
                                                                     1996           1995           1994
                                                                  ----------     ----------     ----------
<S> <C>
        Income
          Dividends from subsidiary                               $  570 000     $  576 000     $  437 000
                                                                  ----------     ----------     ----------

        Expenses
          Amortization                                            $   12 282     $   12 282     $    5 118
          Transfer agent expense                                       7 563         21 553          1 315
          Legal and professional fees                                  2 575         13 582            - -
          Other operating expenses                                    13 858         15 219            - -
                                                                  ----------     ----------     ----------
             Total Expenses                                       $   36 278     $   62 636     $    6 433
                                                                  ----------     ----------     ----------

             Income before Taxes and Equity in Undistributed
               Income of Subsidiary                               $  533 722     $  513 364     $  430 567

        Income Tax (Benefit)                                         (11 618)       (21 296)        (2 187)
                                                                  ----------     ----------     ----------

             Income before Equity in Undistributed Income
               of Subsidiary                                      $  545 340     $  534 660     $  432 754

        Equity in Undistributed Income of Subsidiary                 862 094        650 468        898 214
                                                                  ----------     ----------     ----------

             Net Income                                           $1 407 434     $1 185 128     $1 330 968
                                                                  ==========     ==========     ==========
</TABLE>

                                      -28-


<PAGE>



Note 16. Parent Corporation Only Financial Statements (Continued)

                            POTOMAC BANCSHARES, INC.
                           (Parent Corporation Only)
                            Statements of Cash Flows
                  Years Ended December 31, 1996, 1995 and 1994


<TABLE>
<CAPTION>
                                                                          1996           1995            1994
                                                                       ----------     ----------      ----------
<S> <C>
         CASH FLOWS FROM OPERATING ACTIVITIES
            Net income                                                 $1 407 434     $1 185 128      $1 330 968
            Adjustments to reconcile net income to net cash
              provided by operating activities:
                 Equity in undistributed (income) of subsidiary          (862 094)      (650 468)       (898 214)
                 Amortization                                              12 282         12 282           5 118
                 (Increase) decrease in other assets                        9 575        (19 187)       (123 599)
                 Increase in other liabilities                                255          3 789             952
                                                                       ----------     ----------      ----------

                    Net cash provided by operating activities          $  567 452     $  531 544      $  315 225
                                                                       ----------     ----------      ----------

         CASH FLOWS FROM FINANCING ACTIVITIES,
            cash dividends                                             $ (570 000)    $ (510 000)     $ (300 000)
                                                                       ----------     ----------      ----------

                    Net cash (used in) financing activities            $ (570 000)    $ (510 000)     $ (300 000)
                                                                       ----------     ----------      ----------

                    Increase (decrease) in cash and cash equivalents   $   (2 548)    $   21 544      $   15 225

         CASH AND CASH EQUIVALENTS
            Beginning                                                      36 769         15 225             - -
                                                                       ----------     ----------      ----------

            Ending                                                     $   34 221     $   36 769      $   15 225
                                                                       ==========     ==========      ==========
</TABLE>

                                      -29-


<PAGE>


                          TRUST AND FINANCIAL SERVICES


         1996 was a year of account  restructuring  for your Trust and Financial
Services  Department.  Distributions  from 32 closed  trust and estate  accounts
totaled  $2,130,000  (average $66,562) in assets,  and approximately  $57,000 in
fees.  Of the closed  accounts,  19 were under  $25,000 in assets and  generated
under  $5,000 in total  fees,  and four were  estates  generating  approximately
$47,000 in fees.  During 1996, 15 new trust,  agency,  and estate accounts added
over  $2,400,000 to department  assets (average  $160,000),  and over $90,000 to
income. Of the new accounts,  six were estates generating  approximately $65,000
in fees.

         Trust assets as of December 31, 1996, totaled $71,868,000,  an increase
of $3,989,000 (5.8%) over December 31, 1995 footings of $67,879,000.  Trust fees
in 1996 totaled $460,053, compared to $446,000 in 1995.

         The Trust  Referral  Plan was adopted in the fall of 1996 as a means of
developing new trust accounts and cross selling bank services. The plan provides
financial  incentives  for  employees  providing  referral of fiduciary  account
prospects to the  department.  In addition,  the  department is  implementing  a
direct mail newsletter program to promote trust services.

         The  department's  dedication to the delivery of community bank service
and our response to customer  financial and estate  planning needs will continue
to be the mission of our fiduciary service.




                                              Robert L. Hersey
                                              Vice President & Trust Officer



                             STATEMENT OF CONDITION
                               December 31, 1996
                                  (unaudited)

      ASSETS
      Discretionary assets:
          Bank Deposits:       Bank of Charles Town             $    94 000
                               Other Banks                          125 000
      United States Treasury and Agency Obligations               7 089 000
      State, County, and Municipal Obligations                    1 527 000
      Short Term Interest Bearing Funds                           4 820 000
      Other Short Term Obligations                                   44 000
      Notes and Bonds                                             4 775 000
      Common and Preferred Stocks                                27 930 000
      Real Estate Mortgages                                       1 590 000
      Real Estate                                                 1 260 000
      Miscellaneous Assets                                           27 000
                                                                -----------
          Total Discretionary Assets                            $49 281 000
                                                                -----------

      Non-Discretionary Assets                                  $22 587 000
                                                                -----------

                               Total Assets                     $71 868 000
                                                                ===========

      ACCOUNTS
      Personal Trusts                                   177     $47 474 000
      Estates and Other Court Accounts                   37       4 170 000
      Employee Benefit Accounts                          27       3 892 000
      Agencies and Other                                 72      16 332 000
                                                       ----     -----------

                               Total Accounts           313     $71 868 000
                                                       ====     ===========


                                      -30-


<PAGE>


                            POTOMAC BANCSHARES, INC.

                      Charles W. LeMaster, President & CEO
          William R. Harner, Sr. Vice President, Secretary & Treasurer
      L. Gayle Marshall Johnson, Vice President & Chief Financial Officer
             Donald S. Smith, Vice President & Assistant Secretary
                            Susan S. Myers, Auditor


                              BANK OF CHARLES TOWN

<TABLE>
<S> <C>
                                             Administration                     Maintenance Department

                                           Charles W. LeMaster                      Paula M. Fraley
      Mortgage and Commercial                   President                           Paul D. Staubs
          Loan Department                                                         E. Geraldine White
                                            William R. Harner
        Thomas F. Chambers            Sr. Vice President & Cashier
          Vice President                                                     Trust and Financial Services
                                     L. Gayle Marshall Johnson, CPA
      H. William Easter, Jr.       Vice President & Financial Officer              Robert L. Hersey
     Assistant Vice President                                               Vice President & Trust Officer
                                             Diane C. Allen
         Cynthia A. Light                   Personnel Officer                      Betty A. Braxton
         Assistant Cashier                                                           Trust Officer
                                           Susan S. Myers, CPA
         Carolyn A. Galli                        Auditor                         David S. (Joe) Smith
          Patricia A. Ott                                                            Trust Officer
          Lisa O. Weiant                 Pamela W. Stevens, CPA
                                           Compliance Officer                       Tina D. Carroll
                                                                                  Rebecca J. Johnson
    Installment Loan Department          William H. Chesley, Jr.                    K. Renee Queen
                                            Marketing Officer                       Deanna D. Shade
        Fonnie R. Crawford                                                         Deborah A. Watts
          Vice President                    Shelly D. Dodson
                                             Tammy L. Miller
        Richard B. Breeden                                                         Teller Department
    Assistant Vice President &
         Security Officer                 Kearneysville Branch                    Carolyn N. O'Brien
                                                                            Assistant Cashier & Head Teller
          Donna J. Burns               C. Kenneth Nicewarner, Jr.
         Assistant Cashier             Assistant Vice President &                Malissia A. Aronowitz
                                             Branch Manager                         Michael W. Boyd
         Victoria B. Burns                                                           Amy L. Brill
          Janice B. Davis                    Nancy L. Baker                        Jennifer L. Burch
        Kimberly K. DeSarno           Assistant Cashier & Assistant                Melissa D. Castle
         Timothy F. Hitrik                   Branch Manager                        Shirley G. Dutrow
         Linda A. Stewart                                                            Lisa M. Gray
                                             Mary L. Bowers                       Melissa A. Harrison
                                      Stephanie L. Digennaro-Dailey                 Brian T. Moler
      Certificates of Deposit                Carolyn A. Dunn                        Stacy L. Mumaw
            Department                       Erin L. Guarino                       Kendra L. Nichols
                                         Jennifer L. Hockensmith                 M. Jacqueline Propst
         Judith A. Edwards                   Tammy E. Hough                         Jeanette Staubs
         Erin E. Harrison                   Lisa M. Sherrard                     Linda L. Whittington
                                          Robert F. Spring Jr.

    Data Processing Department                                                   Harpers Ferry Branch
                                         Bookkeeping Department
         Kelly J. Bechdel                                                           Wayne C. Welty
    Assistant Vice President &              Clara K. Carroll                  Assistant Vice President &
      Data Processing Manager               Assistant Cashier                       Branch Manager

         Roberta J. Burke                   Rebecca E. Black                       Bernice H. Snyder
          Doris V. Loudan                   Cathy J. Chambers                Assistant Cashier & Assistant
          Lori L. Orlando                   Connie R. Craigo                        Branch Manager
                                            Nancy L. Harrison
                                             Marcia S. Lerch                      Michele R. Carroll
              Courier                        April D. Myers                      Margaret A. Courtney
                                            Elizabeth W. Park                      Shelly L. Holmes
                                             Deborah A. Ring                        Karen S. James
        Benjamin T. Breeden                  Karen A. Staubs                      Jennifer L. Manuel
                                             Peggy C. Turner                       Deborah L. Roper
                                            Rebekah L. Turner                       Paula A. Wolfe
                                            Tricia M. Viands                    Charles W. Wyndham, Jr.
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