Exhibit 13



cover page



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CONTENTS



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|Presidents Report                                                                   
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|Description of Business                                                              
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|Board of Directors                                                                   
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|Selected Consolidated Financial Data                                                 
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|Managements Discussion and Analysis of Financial Condition and Results of Operations
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|Independent Auditors Report                                                         
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|Consolidated Financial Statements                                                    
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|Consolidated Balance Sheets                                                          
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|Consolidated Statements of Income                                                    
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|Consolidated Statements of Changes in Stockholders Equity                           
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|Consolidated Statements of Cash Flows                                                
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|Notes to Consolidated Financial Statements                                           
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|Officers                                                                             
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|Annual Report on Form 10-KSB                                                         
|                                                                                     
|General Information                                                                  



FORWARD LOOKING STATEMENTS



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



The risks and uncertainties that may affect the operations, performance, development and results of the corporations business include, but are not limited to, the growth of the economy, interest rate movements, the impact of
competitive products, services and pricing, customer business requirements, Congressional legislation and similar matters. We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by
the named risk factors and unanticipated future events. Actual results, accordingly, may differ materially from management expectations.



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THE
PRESIDENTS REPORT TO OUR SHAREHOLDERS



Dear Shareholder,



For the year
ended December 31, 2002, Potomac Bancshares, Inc. had record earnings of $2.46 million, an increase of 22% over the previous year. This translated into an improvement in earnings per share from $3.35 to $4.12. Return on assets and return on equity
were 1.35% and 11.97% respectively. The market price for Potomac Bancshares stock also improved from $35.25 on December 31, 2001 to $45.00 on December 31, 2002, an increase of 28%. We feel this is quite an accomplishment in a year when the
Standard and Poors 500 Index was down 23%.



Improvement in earnings was achieved through loan and fee income growth as well as through aggressive reductions in funding costs. Average loans outstanding grew from $93.8 million to $109.4 million, an improvement of 17%.
Non-interest income increased from $1.36 million to $2.1 million an improvement of 54%. This was primarily a result of increases in deposit account fees and commercial and secondary market loan fees. In 2002, interest rates on deposits and loans
decreased significantly. However, our net interest margin improved from 4.89% in 2001 to 5.02 % in 2002. During 2003, we expect our net interest margin to decline as our loan portfolio continues to reprice. To counterbalance for this loss in margin,
one of our primary goals in 2003 is to accelerate loan portfolio growth in primarily floating rate assets. As interest rates eventually increase, we anticipate this will have a favorable impact on net interest margin.



To achieve growth in our loan portfolio, it is critical that
we continue to grow sources of low cost funding. Average deposits including our commercial cash management account, grew from $137.7 million in 2001 to $157.3 million in 2002, an increase of 14%. A loan to deposit ratio of 72% affords us the room to
grow the loan portfolio without negatively impacting the banks liquidity.



Credit quality for the bank overall has been very good. The average delinquency for the year was .75% of the outstanding portfolio. Net loan charge-offs for the year were .09% of the total portfolio
which compares very favorably to our peers. The majority of our charge-offs were concentrated in our retail lending area which includes a small indirect automobile portfolio. In 2003, we are revamping our retail credit approval systems and
aggressively shrinking the indirect auto portfolio. We managed to grow our loan loss reserve by $240 thousand and ended the year with a respectable 1.40% reserve as a percentage of loans outstanding.



In 2003, we will complete two projects that will set the
course of our growth in the years to come. First, we expect to open our new Hedgesville office in late May. Although this additional infrastructure may negatively affect earnings initially, we feel we have the right location and personnel to provide
long term growth in earnings and assets for the bank. And second, our computer conversion to the Jack Henry 20/20 system will be completed in early July at a cost of approximately $1.0 million. This state of the art computer system will
allow us to offer the products and timely service demanded by todays consumer. It will also serve to make us more efficient and permit us to continue our growth without adding significant staffing.



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For our
stockholders, a 200 % stock dividend was paid to all shareholders of record on February 15, 2003. The purpose of this dividend is to make our stock more affordable thereby improving the liquidity of your Potomac Bancshares investment. We also
decided to begin paying quarterly dividends starting March 1, 2003.



Since 1871 your bank has been an integral part of this community. During that time, the depositors, borrowers, shareholders, employees and members of the Board of Directors have all been members of the community. This
consistent and deep community involvement is a significant reason for the past success of the bank. We take pride in our history of honorable and profitable service to all of our stakeholders and we will continue that tradition in the years ahead.



We continue to make the changes necessary to
keep us competitive and independent. We hope you are pleased with your investment in our company and we also appreciate your support!



Sincerely



|/s/    ROBERT F. BARONNER,
JR.           
|-----------------------------------------
|Robert F. Baronner, Jr. President and CEO



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DESCRIPTION
OF BUSINESS



Potomac Bancshares, Inc., a
one-bank holding company, and subsidiary, Bank of Charles Town (BCT), are engaged in general banking business serving primarily Berkeley County and Jefferson County, West Virginia. The corporation also provides services to Washington County and
Frederick County, Maryland and Loudoun County, Frederick County, and Clarke County, Virginia. The main office is in Charles Town with branch offices in Harpers Ferry, Kearneysville and Martinsburg.



The corporation provides consumers, businesses, and
governments with a broad range of banking services including lines of credit, home equity lines of credit, commercial, agricultural, real estate, and installment loans, checking, savings and NOW accounts, certificates of deposit, and individual
retirement accounts. Automated teller machines located at each of the four offices and Touchline 24, an interactive voice response system available at 1-304-728-2424, provide certain services to customers on a twenty-four hour basis. Bill paying and
certain other banking services are available online through any touch tone telephone and/or the World Wide Web. 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



|                                                            
|------------------------------------------------------------
|Robert F. Baronner, Jr. President & CEO Bank of Charles Town
|                                                            
|J. Scott Boyd President Jefferson Pharmacy, Inc.            
|                                                            
|John P. Burns, Jr. Partner Burns Farm                       
|                                                            
|                                                            



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SELECTED
CONSOLIDATED FINANCIAL DATA



(Dollars in
Thousands Except Per Share Data)



|                                                                  |  | 2002 |         |   | 2001 |   |         | 2000 |  |   | 1999    |   |  | 1998 |        
|----------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | -------
|Summary of Operations                                             |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Interest income                                                   |  | $    | 11 279  |   |      | $ | 10 956  |      |  | $ | 10 328  |   |  | $    | 10 009 
|Interest expense                                                  |  |      | 2 823   |   |      |   | 3 758   |      |  |   | 3 968   |   |  |      | 4 191  
|                                                                  |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Net interest income                                               |  |      | 8 456   |   |      |   | 7 198   |      |  |   | 6 360   |   |  |      | 5 818  
|Provision for (recovery of) loan losses                           |  |      | 423     |   |      |   | 221     |      |  |   | (70     | ) |  |      | 125    
|                                                                  |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Net interest income after provision for (recovery of) loan losses |  |      | 8 033   |   |      |   | 6 977   |      |  |   | 6 430   |   |  |      | 5 693  
|Noninterest income                                                |  |      | 2 096   |   |      |   | 1 358   |      |  |   | 1 148   |   |  |      | 1 170  
|Noninterest expense                                               |  |      | 6 262   |   |      |   | 5 160   |      |  |   | 4 711   |   |  |      | 4 423  
|                                                                  |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Income before income taxes                                        |  |      | 3 867   |   |      |   | 3 175   |      |  |   | 2 867   |   |  |      | 2 440  
|Income tax expense                                                |  |      | 1 408   |   |      |   | 1 166   |      |  |   | 1 053   |   |  |      | 897    
|                                                                  |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Net income                                                        |  | $    | 2 459   |   |      | $ | 2 009   |      |  | $ | 1 814   |   |  | $    | 1 543  
|                                                                  |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Per Share Data                                                    |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Net income, basic and diluted                                     |  | $    | 4.12    |   |      | $ | 3.35    |      |  | $ | 3.02    |   |  | $    | 2.57   
|Cash dividends declared                                           |  |      | 1.45    |   |      |   | 1.35    |      |  |   | 1.25    |   |  |      | 1.15   
|Book value at period end                                          |  |      | 35.89   |   |      |   | 32.36   |      |  |   | 29.94   |   |  |      | 27.81  
|Weighted-average shares outstanding                               |  |      | 597 009 |   |      |   | 600 000 |      |  |   | 600 000 |   |  |      | 600 000
|Average Balance Sheet Summary                                     |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Assets                                                            |  | $    | 181 741 |   |      | $ | 158 385 |      |  | $ | 145 339 |   |  | $    | 147 612
|Loans                                                             |  |      | 109 461 |   |      |   | 93 816  |      |  |   | 81 755  |   |  |      | 78 710 
|Securities                                                        |  |      | 50 454  |   |      |   | 41 870  |      |  |   | 44 935  |   |  |      | 48 865 
|Deposits                                                          |  |      | 153 148 |   |      |   | 135 658 |      |  |   | 126 617 |   |  |      | 129 711
|Stockholders equity                                              |  |      | 20 542  |   |      |   | 18 812  |      |  |   | 17 345  |   |  |      | 16 539 
|Performance Ratios                                                |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Return on average assets                                          |  |      | 1.35    | % |      |   | 1.27    | %    |  |   | 1.25    | % |  |      | 1.05   
|Return on average equity                                          |  |      | 11.97   | % |      |   | 10.68   | %    |  |   | 10.46   | % |  |      | 9.33   
|Dividend payout ratio                                             |  |      | 35.19   | % |      |   | 40.30   | %    |  |   | 41.39   | % |  |      | 44.75  
|Capital Ratios                                                    |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Leverage ratio                                                    |  |      | 10.77   | % |      |   | 11.30   | %    |  |   | 12.32   | % |  |      | 11.55  
|Risk-based capital ratios                                         |  |      |         |   |      |   |         |      |  |   |         |   |  |      |        
|Tier 1 capital                                                    |  |      | 18.34   | % |      |   | 19.90   | %    |  |   | 22.70   | % |  |      | 23.19  
|Total capital                                                     |  |      | 19.60   | % |      |   | 21.15   | %    |  |   | 23.95   | % |  |      | 24.45  



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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.



|                                                                           |  | 2002             |              |   | 2001            |  
|-------------------------------------------------------------------------- |  | ---------------- | ------------ | - | --------------- | -
|                                                                           |  | Average Balances |              |   | Income/ Expense |  
|ASSETS                                                                     |  |                  |              |   |                 |  
|Loans                                                                      |  |                  |              |   |                 |  
|Taxable                                                                    |  |                  | $107 619 793 |   |                 | $
|Tax exempt                                                                 |  |                  | 1 841 205    |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total loans                                                                |  |                  | 109 460 998  |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Taxable securities                                                         |  |                  | 50 454 026   |   |                 |  
|Securities purchased under agreements to resell and federal funds sold     |  |                  | 6 402 575    |   |                 |  
|Other earning assets                                                       |  |                  | 3 300 322    |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total earning assets                                                       |  |                  | 169 617 921  |   |                 | $
|                                                                           |  |                  |              |   |                 |  
|Allowance for loan losses                                                  |  |                  | (1 528 580   | ) |                 |  
|Cash and due from banks                                                    |  |                  | 8 015 469    |   |                 |  
|Premises and equipment, net                                                |  |                  | 3 660 177    |   |                 |  
|Other assets                                                               |  |                  | 1 976 220    |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total assets                                                               |  | $                | 181 741 207  |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                       |  |                  |              |   |                 |  
|Deposits                                                                   |  |                  |              |   |                 |  
|Savings and interest  bearing demand deposits                             |  | $                | 86 844 968   |   |                 | $
|Time deposits                                                              |  |                  | 45 911 558   |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total interest  bearing deposits                                          |  |                  | 132 756 526  |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Securities sold under agreements to repurchase and federal funds
purchased |  |                  | 4 196 410    |   |                 |  
|Advances from FHLB                                                         |  |                  | 2 196 854    |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total interest bearing liabilities                                         |  |                  | 139 149 790  |   |                 | $
|                                                                           |  |                  |              |   |                 |  
|Noninterest-bearing demand deposits                                        |  |                  | 20 391 089   |   |                 |  
|Other liabilities                                                          |  |                  | 1 658 519    |   |                 |  
|Stockholders equity                                                       |  |                  | 20 541 809   |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Total liabilities and stockholders equity                                 |  | $                | 181 741 207  |   |                 |  
|                                                                           |  |                  |              |   |                 |  
|Net interest income                                                        |  |                  |              |   |                 | $
|                                                                           |  |                  |              |   |                 |  
|Net interest spread                                                        |  |                  |              |   |                 |  
|Interest expense as a percent of average earning assets                    |  |                  |              |   |                 |  
|Net interest margin                                                        |  |                  |              |   |                 |  



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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS



CRITICAL ACCOUNTING POLICIES



GENERAL



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



ALLOWANCE FOR LOAN LOSSES



The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two
basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires
that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.



Our allowance for loan losses has two basic components: the
formula allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and,
as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The unallocated allowance captures losses that are
attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in the formula allowance.



GENERAL



Total assets increased $19.8 million or 11.4% in 2002 compared to 2001. Increases included loans 14.3% or $14.7 million, securities 4.1%
or $2 million and premises and equipment 31.5% or $1.1 million. This asset growth is offset on the liability side with growth in deposits of $15.3 million or 10.4% and in the daily cash management accounts (securities sold under agreements to
repurchase) of $3.2 million or 106.9%. The growth of loans and deposits indicates the bank is providing service and products that customers like and want. Increase in premises and equipment is due to the construction of a new branch in Hedgesville,
WV and a core computer conversion in process with new products from Jack Henry and Associates. Both of these projects will enable us to continue to service our customers conveniently and efficiently.



The increase in net income of $450 thousand or 22.4% in 2002
compared to 2001 primarily results from decreased interest expense and increased noninterest income as well as an increase in interest income.



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



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NET INTEREST INCOME



Net interest income increased 17.5% in 2002
compared to 2001 as a result of both increased interest income and decreased interest expense. Interest income increased $300 thousand, or 3.0% in 2002 when compared to 2001. Interest and fees on loans increased 6.1% in 2002 compared to 2001 due
almost entirely to increased volume of the loan portfolio from $102 million at December 31, 2001 to $117 million at December 31, 2002. The average rate of the taxable portion of the portfolio dropped to 7.95% in 2002 from 8.73% in 2001. An
experienced and aggressive lending staff has continued to grow the loan portfolio during 2002.



Interest income on securities held to maturity and securities available for sale increased 5.4% in 2002 compared to 2001. The increase resulted from volume growth even though there was a decrease in
average rate in 2002 to 4.84% compared to 5.54% in 2001. Interest income from securities purchased under agreements to resell and federal funds sold decreased in 2002 compared to 2001 due to decreased rates and decreased volumes.



Other earning assets added over $80,000 of income during 2002.
These assets included an average balance of $2.2 million in the Federal Home Loan Bank interest-bearing demand deposit account, Federal Home Loan Bank stock with an average balance of $554 thousand and loans held for sale with an average balance of
$554 thousand.



Interest expense decreased 24.9%
or $935 thousand in 2002 compared to 2001. Reduced interest rates were responsible for the decrease in interest expense since the volume of total deposits increased $15.3 million in 2002 compared to 2001. The average rate on interest-bearing
deposits dropped to 1.96% in 2002 compared to 3.14% in 2001.



In 2002, the average yield for earning assets was 6.68% compared to 7.43% in 2001. The average rate paid on all interest bearing liabilities was 2.03% in 2002 compared to 3.16% in 2001. The net interest spread (difference between
yield on earning assets and rate paid on interest-bearing liabilities) increased in 2002 to 4.65% from 4.27% in 2001. The net interest margin (total interest income less total interest expense divided by average earning assets) increased in 2002 to
5.02% from 4.89% in 2001. The reason the net interest spread and net interest margin continued to increase in 2002 is that the reduction in rates has a slower penetration in the loan and securities portfolios than in the deposit portfolio. Almost
two thirds of the deposits reprice immediately after rates change while only a quarter to a third of the loans and securities reprice within the first three months after rates change.



SCHEDULE 2  VOLUME AND RATE ANALYSIS



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



|                                                                           |  | 2002 Compared to 2001    |           |   | 2001 Compared to 2000 |  
|-------------------------------------------------------------------------- |  | ------------------------ | --------- | - | --------------------- | -
|                                                                           |  | Change in Income/Expense |           |   | Volume Effect         |  
|INTEREST INCOME                                                            |  |                          |           |   |                       |  
|Taxable loans                                                              |  | $                        | 486 121   |   |                       | $
|Tax exempt loans                                                           |  |                          | 22 228    |   |                       |  
|Taxable securities                                                         |  |                          | 125 536   |   |                       |  
|Securities purchased under agreements to resell and federal funds sold     |  |                          | (302 702  | ) |                       |  
|Other earning assets                                                       |  |                          | (215      | ) |                       |  
|                                                                           |  |                          |           |   |                       |  
|TOTAL                                                                      |  | $                        | 330 968   |   |                       | $
|                                                                           |  |                          |           |   |                       |  
|INTEREST EXPENSE                                                           |  |                          |           |   |                       |  
|Savings and interest-bearing demand deposits                               |  | $                        | (608 971  | ) |                       | $
|Time deposits                                                              |  |                          | (448 174  | ) |                       |  
|Securities sold under agreements to repurchase and federal funds
purchased |  |                          | 67 376    |   |                       |  
|Advances from FHLB                                                         |  |                          | 55 171    |   |                       |  
|                                                                           |  |                          |           |   |                       |  
|TOTAL                                                                      |  | $                        | (934 598  | ) |                       | $
|                                                                           |  |                          |           |   |                       |  
|NET INTEREST INCOME                                                        |  | $                        | 1 265 566 |   |                       | $
|                                                                           |  |                          |           |   |                       |  



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NONINTEREST INCOME AND
EXPENSE



Noninterest income increased
54.4% in 2002 compared to 2001. The Trust and Financial Services income decreased 9.1% in 2002 compared with 2001, a reflection of fewer estate appointments and decreased market values of accounts (fees are based on account market values). Service
charges on deposit accounts increased 136.4% in 2002 compared to 2001 due to the increased volume of overdraft charges in conjunction with the overdraft protection program begun late in 2001. Other customer service fees increased 25.2% in 2002
compared to 2001. These included volume increases for installment loan insurance commissions, credit and debit card fees, and merchant discount and cash advance fees. Fees associated with sale of loans in the secondary market increased 101.0% in
2002 compared to 2001 due to doubling the dollar volume of loans completed in 2002 compared to 2001.



Noninterest expense increased 21.4% in 2002 compared to 2001. Salaries and employee benefits increased 12.0% in 2002 compared to 2001. An
increase of 10.9% in salaries, wages and related taxes in 2002 compared to 2001 included annual increases and incentives for officers and employees as well as some staffing additions by the bank in 2002. There were also increases in group insurance,
pension and 401k expenses during 2002. Furniture and equipment expense increased 40.8% due to equipment replacement for maintenance of the banks high information technology standards which includes various conversion details prior to the core
conversion to Jack Henry products in March 2003. Advertising and marketing expenses increased in 2002 by 20.6% compared to 2001 showing the banks continual effort to communicate product and service information to the public. Stationery and
supplies expense increased 52.4% in 2002 compared to 2001 and postage expense increased 36.7% in 2002 compared to 2001. Increases in both of these areas are due to a combination of growth and communications with our customers regarding changes
necessary and related to our computer conversion. Other operating expenses increased 43.0% in 2002 compared to 2001. Training and study expenses increased in 2002 in an ongoing effort to keep employees well informed and up to date in their
particular job areas and due to training directly related to the computer conversion. West Virginia Business Franchise tax expense increased in 2002 due to growth in the banks capital. Correspondent bank fees increased due to decreased rates
being paid on balances we kept with the various institutions.



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, 2002.



|                                                                       |  | Mature or Reprice  
|---------------------------------------------------------------------- |  | -------------------
|                                                                       |  | Within Three Months
|Interest Earning Assets:                                               |  |                    
|Fixed rate loans                                                       |  | $                  
|Floating rate loans                                                    |  |                    
|Securities                                                             |  |                    
|Securities purchased under agreements to resell and federal funds sold |  |                    
|Other earning assets                                                   |  |                    
|                                                                       |  |                    
|Total                                                                  |  | $                  
|                                                                       |  |                    
|Interest-Bearing Liabilities:                                          |  |                    
|Time deposits $100,000 and over                                        |  | $                  
|Other time deposits                                                    |  |                    
|Money market accounts                                                  |  |                    
|NOW accounts                                                           |  |                    
|Savings accounts                                                       |  |                    
|Securities sold under agreements to repurchase                         |  |                    
|Federal Home Loan Bank advances                                        |  |                    
|                                                                       |  |                    
|Total                                                                  |  | $                  
|                                                                       |  |                    
|Rate Sensitivity Gap                                                   |  | $                  
|                                                                       |  |                    
|Cumulative Gap                                                         |  | $                  
|                                                                       |  |                    



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INTEREST RATE
SENSITIVITY (Continued)



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



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



During the first twelve months shown in the schedule on page 8, the corporation is liability sensitive and
after that time period the corporation is asset sensitive. During January, February and March of 2003, $25 million more liabilities reprice or mature than assets. During April through December of 2003, $16 million more assets reprice or mature than
liabilities. The net effect for 2003 is that almost $10 million more liabilities reprice than assets. Therefore, the corporation will be impacted favorably if interest rates continue to decline and unfavorably if interest rates rise.



LOAN PORTFOLIO



Loans at December 31, 2002 and 2001 are summarized below:



|                                       |  | 2002 |             | 2001
|-------------------------------------- |  | ---- | ----------- | ----
|Commercial, financial and agricultural |  | $    | 3 695 732   |     
|Mortgage loans on real estate:         |  |      |             |     
|Construction and land development      |  |      | 2 210 582   |     
|Secured by farm land                   |  |      | 1 821 345   |     
|Secured by 1-4 family residential      |  |      | 63 239 443  |     
|Other real estate                      |  |      | 26 151 183  |     
|Consumer loans                         |  |      | 19 197 747  |     
|All other loans                        |  |      | 729 717     |     
|                                       |  |      |             |     
|                                       |  | $    | 117 045 749 |     
|                                       |  |      |             |     



Loans
have increased 14.3% in 2002 over 2001 when comparing year end totals without reducing the portfolio numbers by the allowance for loan losses. An experienced staff has enabled a continual growth in loans. Particular areas of growth to note include
23.3% in commercial, financial and agricultural loans; 317.1% in real estate construction and land development loans; 12.4% in real estate loans secured by 1-4 family residential properties, and 35.7% in other real estate loans.



There were no categories of loans that exceeded 10% of
outstanding loans at December 31, 2002 which were not disclosed in the table above.



REMAINING MATURITIES OF SELECTED LOANS





|                                        |  | Commercial, Financial and Agricultural |           | Real Estate- Construction
|--------------------------------------- |  | -------------------------------------- | --------- | -------------------------
|Within one year                         |  | $                                      | 1 622 367 |                          
|Variable rate                           |  |                                        | 1 315 219 |                          
|Fixed rate, over one through five years |  |                                        | 758 146   |                          
|                                        |  |                                        |           |                          
|Total maturities                        |  | $                                      | 3 695 732 |                          
|                                        |  |                                        |           |                          



---



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 continually monitors the loan portfolio with quarterly procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Based on experience, the loan policies and the current monitoring
program, management believes the allowance for loan losses is adequate.



|                                                                                                       |  | 2002 |           |   | 2001 |   |           | 2000 | 
|------------------------------------------------------------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | ---- | 
|Balance at beginning of period                                                                         |  | $    | 1 402 247 |   |      | $ | 1 268 235 |      | 
|Charge-offs:                                                                                           |  |      |           |   |      |   |           |      | 
|Commercial, financial and agricultural                                                                 |  |      |          |   |      |   | 12 456    |      | 
|Real estate  construction                                                                             |  |      |          |   |      |   |          |      | 
|Real estate  mortgage                                                                                 |  |      |          |   |      |   | 6 658     |      | 
|Consumer                                                                                               |  |      | 287 133   |   |      |   | 102 574   |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Total charge-offs                                                                                      |  |      | 287 133   |   |      |   | 121 688   |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Recoveries:                                                                                            |  |      |           |   |      |   |           |      | 
|Commercial, financial and agricultural                                                                 |  |      |          |   |      |   | 667       |      | 
|Real estate  construction                                                                             |  |      |          |   |      |   |          |      | 
|Real estate  mortgage                                                                                 |  |      | 398       |   |      |   | 492       |      | 
|Consumer                                                                                               |  |      | 103 307   |   |      |   | 33 966    |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Total recoveries                                                                                       |  |      | 103 705   |   |      |   | 35 125    |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Net charge-offs (recoveries)                                                                           |  |      | 183 428   |   |      |   | 86 563    |      | 
|Additions charged (credited) to operations                                                             |  |      | 423 000   |   |      |   | 220 575   |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Balance at end of period                                                                               |  | $    | 1 641 819 |   |      | $ | 1 402 247 |      | 
|                                                                                                       |  |      |           |   |      |   |           |      | 
|Ratio of net charge-offs (recoveries) during the period to average loans outstanding
during the period |  |      | 0.17      | % |      |   | 0.09      | %    | 
|                                                                                                       |  |      |           |   |      |   |           |      | 



As shown
in the schedule above, net charge-offs increased in 2002 when compared to 2001. The loan portion of net charge-offs is $98,485, which is .09% of average loans outstanding during the period. This loan portion remains consistent with the 2001 level
for loan net charge-offs that was also .09% of average outstanding loans. The remaining net charge-offs of $84,943 (.08% of average loans outstanding during the period) are for deposit accounts and are related to our overdraft protection program
started in December 2001. Deposit account charge-offs in previous years were minimal and were not accounted for with a reserve account.



ALLOCATION OF ALLOWANCE FOR LOAN LOSSES



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



|                                       |  | 2002      |           |                                                  | 2001   |  
|-------------------------------------- |  | --------- | --------- | ------------------------------------------------ | ------ | -
|                                       |  | Allowance |           | Percent of Loans in Each Category to Total Loans |        |  
|Commercial, financial and agricultural |  | $         | 36 957    |                                                  | 3.16   | %
|Mortgage loans on real estate:         |  |           |           |                                                  |        |  
|Construction and land development      |  |           | 22 106    |                                                  | 1.89   | %
|Secured by farm land                   |  |           | 1 821     |                                                  | 1.56   | %
|Secured by 1-4 family residential      |  |           | 293 367   |                                                  | 54.03  | %
|Other real estate                      |  |           | 619 405   |                                                  | 22.34  | %
|Consumer loans                         |  |           | 124 360   |                                                  | 16.40  | %
|All other loans                        |  |           | 5 030     |                                                  | 62     | %
|Unallocated                            |  |           | 538 773   |                                                  |       |  
|                                       |  |           |           |                                                  |        |  
|                                       |  | $         | 1 641 819 |                                                  | 100.00 | %
|                                       |  |           |           |                                                  |        |  



---



RISK ELEMENTS IN THE LOAN
PORTFOLIO



|                                                                   |  | 2002 |        |   | 2001 |   |        | 2000 | 
|------------------------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- | 
|Nonaccrual loans                                                   |  | $    |       |   |      | $ | 9 060  |      | 
|Restructured loans                                                 |  |      |       |   |      |   |       |      | 
|Foreclosed properties                                              |  |      |       |   |      |   |       |      | 
|                                                                   |  |      |        |   |      |   |        |      | 
|Total nonperforming assets                                         |  | $    |       |   |      | $ | 9 060  |      | 
|                                                                   |  |      |        |   |      |   |        |      | 
|Loans past due 90 days accruing interest                           |  | $    | 41 161 |   |      | $ | 29 293 |      | 
|                                                                   |  |      |        |   |      |   |        |      | 
|Allowance for loan losses to period end loans                      |  |      | 1.40   | % |      |   | 1.37   | %    | 
|Nonperforming assets to period end loans and foreclosed properties |  |      | .00    | % |      |   | .01    | %    | 



Loans
are placed on nonaccrual status when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of
further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.



There were no impaired loans at December 31, 2002 and 2001.



There were no nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2002
and 2000. Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2001 totaled $9,060 in 2001.



At December 31, 2002, other potential problem loans totaled $799,740. 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 Financial Accounting Standards Board Statement 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, is recognized in stockholders equity.



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



|                                              |  | 2002 Book Value |            | Weighted Average Yield |      |   | 2001 Book Value |   | Weighted Average Yield | 
|--------------------------------------------- |  | --------------- | ---------- | ---------------------- | ---- | - | --------------- | - | ---------------------- | 
|Securities held to maturity                   |  |                 |            |                        |      |   |                 |   |                        | 
|Obligations of U.S. Government agencies:      |  |                 |            |                        |      |   |                 |   |                        | 
|Maturing within one year                      |  | $               | 2 998 336  |                        | 7.08 | % |                 | $ | 6 970 170              | 
|Maturing after one year but within five years |  |                 | 6 014 853  |                        | 5.25 | % |                 |   | 12 020 204             | 
|                                              |  |                 |            |                        |      |   |                 |   |                        | 
|Total securities held to maturity             |  | $               | 9 013 189  |                        |      |   |                 | $ | 18 990 374             | 
|                                              |  |                 |            |                        |      |   |                 |   |                        | 
|Securities available for sale                 |  |                 |            |                        |      |   |                 |   |                        | 
|Obligations of U.S. Government agencies:      |  |                 |            |                        |      |   |                 |   |                        | 
|Maturing within one year                      |  | $               | 7 116 270  |                        | 4.23 | % |                 | $ | 6 334 725              | 
|Maturing after one year but within five years |  |                 | 35 611 850 |                        | 4.45 | % |                 |   | 24 373 092             | 
|                                              |  |                 |            |                        |      |   |                 |   |                        | 
|Total securities available for sale           |  | $               | 42 728 120 |                        |      |   |                 | $ | 30 707 817             | 
|                                              |  |                 |            |                        |      |   |                 |   |                        | 
|Total securities                              |  | $               | 51 741 309 |                        |      |   |                 | $ | 49 698 191             | 
|                                              |  |                 |            |                        |      |   |                 |   |                        | 



---



DEPOSITS



When comparing the 2002 and 2001 year end
balances, total deposits increased $15.3 million or 10.4% in 2002. Interest- bearing deposits increased $14.3 million or 11.3%, and noninterest-bearing deposits increased $1 million or 4.7%. Growth in deposits has continued during 2002 for a number
of reasons including that Bank of Charles Town remains one of only a few banks in the service area with no monthly maintenance fees on deposit accounts. An increasing customer base in Berkeley County, WV due to our Martinsburg branch that opened in
July of 2001 also added to this growth. For the second year money market accounts showed a decrease in balance when comparing balances at December 31, 2002 and 2001. Most customers are choosing our Select Checking account, a form of NOW account that
earns a higher rate of interest on balances of $5 thousand or more. This account is more flexible because there are no activity limitations as the money market account has. Based on these trends of account choices by the customer, beginning in 2003
the bank is no longer offering money market accounts and later in 2003 all existing money market accounts will be changed to Select Checking accounts. Select Checking account balances increased $9.6 million when comparing balances at December 31,
2002 with balances at December 31, 2001. NOW account balances increased $3.1 million when comparing December 31, 2002 balances to balances at December 31, 2001.



The average yield on savings and interest bearing demand deposits decreased to .98% at December 31, 2002 as
compared to 1.98% at December 31, 2001. The average yield on time deposits decreased in 2002 to 3.81% compared to 5.13% at December 31, 2001.



At December 31, 2002, time deposits of $100 thousand or more were 5.43% of total deposits compared with 4.97% at December 31, 2001.
Maturities of time deposits of $100 thousand or more at December 31, 2002 are as follows:



|Within three months                   |  | $ | 1 929 694
|------------------------------------- |  | - | ---------
|Over three through six months         |  |   | 305 496  
|Over six months through twelve months |  |   | 751 753  
|Over twelve months                    |  |   | 5 817 421
|                                      |  |   |          
|Total                                 |  | $ | 8 804 364
|                                      |  |   |          



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 consistency with regulatory requirements and industry standards.
Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.



The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation have adopted capital guidelines to
supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of
qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The corporation had
a ratio of total capital to risk-weighted assets of 19.60% and a ratio of Tier 1 capital to risk-weighted assets of 18.34% at December 31, 2002. Both of these exceed the capital requirements adopted by the federal regulatory agencies.



---



ANALYSIS OF CAPITAL
(Continued)



|                                              |  | 2002 |         |   | 2001 |  
|--------------------------------------------- |  | ---- | ------- | - | ---- | -
|Tier 1 capital:                               |  |      |         |   |      |  
|Common stock                                  |  | $    | 600     |   |      | $
|Surplus                                       |  |      | 5 400   |   |      |  
|Retained earnings                             |  |      | 14 801  |   |      |  
|                                              |  |      |         |   |      |  
|                                              |  |      | 20 801  |   |      |  
|Less cost of shares acquired for the treasury |  |      | 248     |   |      |  
|                                              |  |      |         |   |      |  
|Total tier 1 capital                          |  | $    | 20 553  |   |      | $
|Tier 2 capital:                               |  |      |         |   |      |  
|Allowance for loan losses (1)                 |  |      | 1 403   |   |      |  
|                                              |  |      |         |   |      |  
|Total risk-based capital                      |  | $    | 21 956  |   |      | $
|                                              |  |      |         |   |      |  
|Risk-weighted assets                          |  | $    | 112 038 |   |      | $
|                                              |  |      |         |   |      |  
|Capital ratios:                               |  |      |         |   |      |  
|Tier 1 risk-based capital ratio               |  |      | 18.34   | % |      |  
|Total risk-based capital ratio                |  |      | 19.60   | % |      |  
|Leverage ratio                                |  |      | 10.77   | % |      |  



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



LIQUIDITY



Liquidity represents an institutions ability to meet present and future financial obligations through either the sale or maturity of
existing assets or the acquisition of additional funds through liability management. This could also be termed the management of the cash flows of an organization. Liquid assets include cash and due from banks, interest-bearing deposits in financial
institutions, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The corporations liquidity during 2002 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 and payments on and maturities of loans.
Cash flows from financing activities include increases in any deposit accounts, proceeds from securities sold under agreements to repurchase and proceeds from borrowed funds. 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s overall liquidity is sufficient to satisfy its depositors requirements and to meet its customers credit needs.



At December 31, 2002, cash and due from banks,
interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $40,455,495.



Borrowing capabilities provide additional liquidity. The subsidiary bank maintains a federal funds line of $4
million with another financial institution. The subsidiary bank is also a member of the Federal Home Loan Bank of Pittsburgh and has short and/or long-term borrowing capabilities of approximately $64,127,000. In June 2001, the subsidiary bank
borrowed $2.5 million amortized over seven years from the Federal Home Loan Bank.



---



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, 2002 and 2001,
and the related consolidated statements of income, changes in stockholders equity and cash flows for the years ended December 31, 2002, 2001 and 2000. 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 auditing standards generally accepted in the United States of America. 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, 2002 and 2001, and the results of their operations and their cash flows for the years ended December 31, 2002,
2001 and 2000, in conformity with accounting principles generally accepted in the United States of America.



Yount, Hyde & Barlour, P.C.





Winchester, Virginia

February 5, 2003



---



CONSOLIDATED
BALANCE SHEETS

December 31, 2002 and 2001



|                                                                                         |  | 2002 |             | 2001
|---------------------------------------------------------------------------------------- |  | ---- | ----------- | ----
|ASSETS                                                                                   |  |      |             |     
|Cash and due from banks                                                                  |  | $    | 11 243 060  |     
|Interest-bearing deposits in financial institutions                                      |  |      | 1 969 773   |     
|Securities purchased under agreements to resell and federal funds sold                   |  |      | 3 915 285   |     
|Securities held to maturity (fair value $9,313,460 in 2002 and $19,613,951 in
2001)      |  |      | 9 013 189   |     
|Securities available for sale, at fair value                                             |  |      | 42 728 120  |     
|Loans held for sale                                                                      |  |      | 1 923 694   |     
|Loans, net of allowance for loan losses of $1,641,819 in 2002 and $1,402,247 in
2001     |  |      | 115 403 930 |     
|Premises and equipment, net                                                              |  |      | 4 456 560   |     
|Accrued interest receivable                                                              |  |      | 1 064 815   |     
|Other assets                                                                             |  |      | 1 158 487   |     
|                                                                                         |  |      |             |     
|Total Assets                                                                             |  | $    | 192 876 913 |     
|                                                                                         |  |      |             |     
|LIABILITIES AND STOCKHOLDERS EQUITY                                                     |  |      |             |     
|LIABILITIES                                                                              |  |      |             |     
|Deposits                                                                                 |  |      |             |     
|Noninterest-bearing                                                                      |  | $    | 21 573 475  |     
|Interest-bearing                                                                         |  |      | 140 606 257 |     
|                                                                                         |  |      |             |     
|Total Deposits                                                                           |  | $    | 162 179 732 |     
|Accrued interest payable                                                                 |  |      | 160 263     |     
|Securities sold under agreements to repurchase                                           |  |      | 6 102 441   |     
|Federal Home Loan Bank advances                                                          |  |      | 2 042 149   |     
|Other liabilities                                                                        |  |      | 1 079 932   |     
|Commitments and contingent liabilities                                                   |  |      |            |     
|                                                                                         |  |      |             |     
|Total Liabilities                                                                        |  | $    | 171 564 517 |     
|                                                                                         |  |      |             |     
|STOCKHOLDERS EQUITY                                                                     |  |      |             |     
|Common stock, $1 per share par value; 5,000,000 shares authorized; 600,000 shares
issued |  | $    | 600 000     |     
|Surplus                                                                                  |  |      | 5 400 000   |     
|Undivided profits                                                                        |  |      | 14 801 225  |     
|Accumulated other comprehensive income                                                   |  |      | 758 816     |     
|                                                                                         |  |      |             |     
|                                                                                         |  | $    | 21 560 041  |     
|Less cost of shares acquired for the treasury, 2002, 6,110 shares                        |  |      | 247 645     |     
|                                                                                         |  |      |             |     
|Total Stockholders Equity                                                               |  | $    | 21 312 396  |     
|                                                                                         |  |      |             |     
|Total Liabilities and Stockholders Equity                                               |  | $    | 192 876 913 |     
|                                                                                         |  |      |             |     



See Notes
to Consolidated Financial Statements.



---



CONSOLIDATED
STATEMENTS OF INCOME

Years Ended December 31, 2002, 2001 and 2000



|                                                                                   |  | 2002 |            | 2001 |   | 2000       | 
|---------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | 
|Interest and Dividend Income:                                                      |  |      |            |      |   |            | 
|Interest and fees on loans                                                         |  | $    | 8 662 013  |      | $ | 8 161 221  | 
|Interest on securities held to maturity  taxable                                  |  |      | 953 715    |      |   | 1 132 929  | 
|Interest on securities available for sale  taxable                                |  |      | 1 490 627  |      |   | 1 185 877  | 
|Interest on securities purchased under agreements to resell and federal funds
sold |  |      | 90 452     |      |   | 393 154    | 
|Other interest and dividends                                                       |  |      | 82 074     |      |   | 82 289     | 
|                                                                                   |  |      |            |      |   |            | 
|Total Interest and Dividend Income                                                 |  | $    | 11 278 881 |      | $ | 10 955 470 | 
|                                                                                   |  |      |            |      |   |            | 
|Interest Expense:                                                                  |  |      |            |      |   |            | 
|Interest on deposits                                                               |  | $    | 2 602 812  |      | $ | 3 659 957  | 
|Interest on securities sold under agreements to repurchase                         |  |      | 98 536     |      |   | 31 160     | 
|Federal Home Loan Bank advances                                                    |  |      | 121 834    |      |   | 66 663     | 
|                                                                                   |  |      |            |      |   |            | 
|Total Interest Expense                                                             |  | $    | 2 823 182  |      | $ | 3 757 780  | 
|                                                                                   |  |      |            |      |   |            | 
|Net Interest Income                                                                |  | $    | 8 455 699  |      | $ | 7 197 690  | 
|Provision for (Recovery of) Loan Losses                                            |  |      | 423 000    |      |   | 220 575    | 
|                                                                                   |  |      |            |      |   |            | 
|Net Interest Income after Provision for (Recovery of) Loan Losses                  |  | $    | 8 032 699  |      | $ | 6 977 115  | 
|                                                                                   |  |      |            |      |   |            | 
|Noninterest Income:                                                                |  |      |            |      |   |            | 
|Trust and financial services                                                       |  | $    | 464 633    |      | $ | 510 933    | 
|Service charges on deposit accounts                                                |  |      | 1 121 826  |      |   | 474 556    | 
|Fees for other customer services                                                   |  |      | 280 741    |      |   | 224 239    | 
|Net gain on sale of loans                                                          |  |      | 175 645    |      |   | 87 382     | 
|Other operating income                                                             |  |      | 53 809     |      |   | 60 915     | 
|                                                                                   |  |      |            |      |   |            | 
|Total Noninterest Income                                                           |  | $    | 2 096 654  |      | $ | 1 358 025  | 
|                                                                                   |  |      |            |      |   |            | 
|Noninterest Expenses:                                                              |  |      |            |      |   |            | 
|Salaries and employee benefits                                                     |  | $    | 3 520 647  |      | $ | 3 143 150  | 
|Net occupancy expense of premises                                                  |  |      | 324 661    |      |   | 296 740    | 
|Furniture and equipment expenses                                                   |  |      | 653 302    |      |   | 464 058    | 
|Advertising and marketing                                                          |  |      | 201 201    |      |   | 166 780    | 
|Stationery and supplies                                                            |  |      | 190 788    |      |   | 125 173    | 
|Postage                                                                            |  |      | 143 587    |      |   | 105 042    | 
|Other operating expenses                                                           |  |      | 1 228 277  |      |   | 859 197    | 
|                                                                                   |  |      |            |      |   |            | 
|Total Noninterest Expenses                                                         |  | $    | 6 262 463  |      | $ | 5 160 140  | 
|                                                                                   |  |      |            |      |   |            | 
|Income before Income Tax Expense                                                   |  | $    | 3 866 890  |      | $ | 3 175 000  | 
|Income Tax Expense                                                                 |  |      | 1 407 720  |      |   | 1 165 733  | 
|                                                                                   |  |      |            |      |   |            | 
|Net Income                                                                         |  | $    | 2 459 170  |      | $ | 2 009 267  | 
|                                                                                   |  |      |            |      |   |            | 
|Earnings Per Share, basic and diluted                                              |  | $    | 4.12       |      | $ | 3.35       | 
|                                                                                   |  |      |            |      |   |            | 



See Notes
to Consolidated Financial Statements.



---



CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

Years Ended December 31, 2002, 2001 and 2000



|                                                                          |  | Common Stock |         | Surplus |   | Undivided Profits |  |   | Treasury Stock |   |  | Accumulated Other Comprehensive Income (Loss) |          |   | Comprehensive Income |   |          | Total | 
|------------------------------------------------------------------------- |  | ------------ | ------- | ------- | - | ----------------- |  | - | -------------- | - |  | --------------------------------------------- | -------- | - | -------------------- | - | -------- | ----- | 
|Balances, December 31, 1999                                               |  | $            | 600 000 |         | $ | 5 400 000         |  | $ | 10 943 890     |   |  | $                                             |         |   |                      | $ | (256 213 | )     | 
|Comprehensive income                                                      |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Net income  2000                                                         |  |              |        |         |   |                  |  |   | 1 814 315      |   |  |                                               |         |   |                      |   |         |       | 
|Other comprehensive income:                                               |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Unrealized holding gains arising during the period (net of tax,
$109,086) |  |              |        |         |   |                  |  |   |               |   |  |                                               |         |   |                      |   | 211 756  |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Total comprehensive income                                                |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Cash dividends  2000 ($1.25 per share)                                   |  |              |        |         |   |                  |  |   | (750 000       | ) |  |                                               |         |   |                      |   |         |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Balances, December 31, 2000                                               |  | $            | 600 000 |         | $ | 5 400 000         |  | $ | 12 008 205     |   |  | $                                             |         |   |                      | $ | (44 457  | )     | 
|Comprehensive income                                                      |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Net income  2001                                                         |  |              |        |         |   |                  |  |   | 2 009 267      |   |  |                                               |         |   |                      |   |         |       | 
|Other comprehensive income:                                               |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Unrealized holding gains arising during the period (net of tax,
$130,601) |  |              |        |         |   |                  |  |   |               |   |  |                                               |         |   |                      |   | 253 519  |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Total comprehensive income                                                |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Cash dividends  2001 ($1.35 per share)                                   |  |              |        |         |   |                  |  |   | (810 000       | ) |  |                                               |         |   |                      |   |         |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Balances, December 31, 2001                                               |  | $            | 600 000 |         | $ | 5 400 000         |  | $ | 13 207 472     |   |  | $                                             |         |   |                      | $ | 209 062  |       | 
|Comprehensive income                                                      |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Net income  2002                                                         |  |              |        |         |   |                  |  |   | 2 459 170      |   |  |                                               |         |   |                      |   |         |       | 
|Other comprehensive income:                                               |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Unrealized holding gains arising during the period (net of tax,
$372,679) |  |              |        |         |   |                  |  |   |               |   |  |                                               |         |   |                      |   | 723 436  |       | 
|Minimum pension liability adjustment (net of tax, $89,473)                |  |              |        |         |   |                  |  |   |               |   |  |                                               |         |   |                      |   | (173 682 | )     | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Total comprehensive income                                                |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Cash dividends  2002 ($1.45 per share)                                   |  |              |        |         |   |                  |  |   | (865 417       | ) |  |                                               |         |   |                      |   |         |       | 
|Purchase of common stock for the treasury                                 |  |              |        |         |   |                  |  |   |               |   |  |                                               | (247 645 | ) |                      |   |         |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 
|Balances, December 31, 2002                                               |  | $            | 600 000 |         | $ | 5 400 000         |  | $ | 14 801 225     |   |  | $                                             | (247 645 | ) |                      | $ | 758 816  |       | 
|                                                                          |  |              |         |         |   |                   |  |   |                |   |  |                                               |          |   |                      |   |          |       | 





See Notes to Consolidated Financial Statements.





---



CONSOLIDATED
STATEMENTS OF CASH FLOWS

Years Ended December 31, 2002, 2001 and 2000



|                                                                                  |  | 2002 |             |   | 2001 |   |             | 2000 | 
|--------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                              |  |      |             |   |      |   |             |      | 
|Net income                                                                        |  | $    | 2 459 170   |   |      | $ | 2 009 267   |      | 
|Adjustments to reconcile net income to net cash provided by operating
activities: |  |      |             |   |      |   |             |      | 
|Provision for (recovery of) loan losses                                           |  |      | 423 000     |   |      |   | 220 575     |      | 
|Depreciation                                                                      |  |      | 417 120     |   |      |   | 288 464     |      | 
|Deferred tax expense (benefit)                                                    |  |      | 1 517       |   |      |   | (98 262     | )    | 
|Discount (accretion) and premium amortization on securities, net                  |  |      | 74 352      |   |      |   | (14 578     | )    | 
|(Gain) on sale of other real estate                                               |  |      |            |   |      |   | (2 468      | )    | 
|(Gain) on sale and disposal of premises and equipment                             |  |      |            |   |      |   |            |      | 
|Proceeds from sale of loans                                                       |  |      | 10 417 951  |   |      |   | 4 652 242   |      | 
|Origination of loans for sale                                                     |  |      | (11 426 069 | ) |      |   | (5 567 818  | )    | 
|Changes in assets and liabilities:                                                |  |      |             |   |      |   |             |      | 
|(Increase) decrease in accrued interest receivable                                |  |      | 79 652      |   |      |   | (93 250     | )    | 
|(Increase) decrease in other assets                                               |  |      | (214 413    | ) |      |   | 31 788      |      | 
|(Decrease) in accrued interest payable                                            |  |      | (63 189     | ) |      |   | (79 232     | )    | 
|Increase (decrease) in other liabilities                                          |  |      | (440 486    | ) |      |   | 247 211     |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Net cash provided by operating activities                                         |  | $    | 1 728 605   |   |      | $ | 1 593 939   |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|CASH FLOWS FROM INVESTING ACTIVITIES                                              |  |      |             |   |      |   |             |      | 
|Proceeds from maturity of securities held to maturity                             |  | $    | 10 000 000  |   |      | $ | 8 000 000   |      | 
|Proceeds from maturity of securities available for sale                           |  |      | 9 250 000   |   |      |   | 12 000 000  |      | 
|Purchases of securities held to maturity                                          |  |      |            |   |      |   | (9 035 270  | )    | 
|Purchases of securities available for sale                                        |  |      | (20 271 354 | ) |      |   | (24 174 178 | )    | 
|Net (increase) in loans                                                           |  |      | (14 839 508 | ) |      |   | (18 029 396 | )    | 
|Purchases of premises and equipment                                               |  |      | (1 485 648  | ) |      |   | (499 381    | )    | 
|Proceeds from sale of equipment                                                   |  |      |            |   |      |   |            |      | 
|Proceeds from sale of other real estate                                           |  |      |            |   |      |   | 15 115      |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Net cash (used in) investing activities                                           |  | $    | (17 346 510 | ) |      | $ | (31 723 110 | )    | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |      |             |   |      |   |             |      | 
|Net increase in noninterest-bearing deposits                                      |  | $    | 961 940     |   |      | $ | 1 188 875   |      | 
|Net increase (decrease) in interest-bearing deposits                              |  |      | 14 323 558  |   |      |   | 16 760 417  |      | 
|Net proceeds in securities sold under agreements to repurchase                    |  |      | 3 153 385   |   |      |   | 2 949 056   |      | 
|Net proceeds (repayment) of Federal Home Loan Bank advances                       |  |      | (309 409    | ) |      |   | 2 351 558   |      | 
|Purchase of treasury shares                                                       |  |      | (247 645    | ) |      |   |            |      | 
|Cash dividends                                                                    |  |      | (865 417    | ) |      |   | (810 000    | )    | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Net cash provided by financing activities                                         |  | $    | 17 016 412  |   |      | $ | 22 439 906  |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Increase (decrease) in cash and cash equivalents                                  |  | $    | 1 398 507   |   |      |   | (7 689 265  | )    | 
|CASH AND CASH EQUIVALENTS                                                         |  |      |             |   |      |   |             |      | 
|Beginning                                                                         |  |      | 15 729 611  |   |      |   | 23 418 876  |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Ending                                                                            |  | $    | 17 128 118  |   |      | $ | 15 729 611  |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                 |  |      |             |   |      |   |             |      | 
|Cash payments for:                                                                |  |      |             |   |      |   |             |      | 
|Interest                                                                          |  | $    | 2 886 371   |   |      | $ | 3 837 012   |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Income taxes                                                                      |  | $    | 1 702 789   |   |      | $ | 1 123 613   |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES           |  |      |             |   |      |   |             |      | 
|Other real estate acquired in settlement of loans                                 |  | $    |            |   |      | $ |            |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Loans originated upon sale of real estate                                         |  | $    |            |   |      | $ |            |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Unrealized gain on securities available for sale                                  |  | $    | 1 096 115   |   |      | $ | 384 120     |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 
|Minimum pension liability adjustment                                              |  | $    | 263 155     |   |      | $ |            |      | 
|                                                                                  |  |      |             |   |      |   |             |      | 



See Notes
to Consolidated Financial Statements.



---



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 Berkeley County and Jefferson County, West Virginia. The corporations market area also includes Washington County and Frederick County, Maryland and Frederick County, Loudoun County and
Clarke County, Virginia. The loan portfolio is well diversified and loans generally are collateralized 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 accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a summary of the more significant policies.



Principles of Consolidation



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.



Interest-bearing Deposits in Financial Institutions



Interest-bearing deposits in financial
institutions mature within one year and are carried at cost.



Securities



Debt securities that
management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable
fair values, are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.



Purchased premiums and discounts are recognized in interest
income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized
losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.



Loans



The corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented
by mortgage loans. The ability of the corporations debtors to honor their contracts is dependent upon the real estate and general economic conditions of the corporations market area.



Loans that management has the intent and ability to hold for
the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses. Interest income is accrued on the unpaid principal balance.



The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Installment loans are typically charged off not later than 180 days past due. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is considered doubtful.



All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.



Allowance for Loan Losses



The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are
credited to the allowance.



---



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



Allowance for Loan Losses (Continued)



The allowance for loan losses is evaluated on a regular basis by management and is based upon
managements periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any
underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.



A loan is considered impaired when, based on current
information and events, it is probable that the corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining
impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as
impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the
present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent.



Large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. Accordingly, the corporation does not separately identify individual consumer and residential loans for impairment disclosures.



Loans Held for Sale



Loans originated and intended for sale in the secondary market are carried at the lower of cost or market determined in the aggregate.



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



Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of the loan balance or
the fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.
Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.



Employee Benefit Plans



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.



The corporation sponsors a postretirement life insurance plan
covering retirees with 25 years of service over the age of 60 and a health care plan for all retirees and three 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.



The corporation sponsors a 401(k) profit sharing plan available to fulltime employees meeting certain age
and service requirements. Under this plan the employer may make a discretionary matching contribution each plan year and may also make other discretionary contributions to the plan.



---



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



Earnings Per Share



Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares
outstanding during the period. The weighted-average number of common shares outstanding was 597,009, 600,000 and 600,000 at December 31, 2002, 2001 and 2000. Diluted earnings per share reflects additional common shares that would have been
outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. The corporation had no potential common stock as of December 31, 2002, 2001, and 2000.



Income Taxes



Deferred income tax assets and liabilities are determined
using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary difference between the book and tax bases of the various balance sheet assets and liabilities and
gives current recognition to changes in tax rates and laws.



Cash and Cash Equivalents



For
purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell and federal funds sold. Generally,
securities purchased under agreements to resell and federal funds sold 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.



Use of Estimates



In preparing
consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term
relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate and deferred tax assets.



Advertising



The corporation follows the policy of charging the costs of advertising to expense as incurred.



Comprehensive Income



Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and minimum pension liability adjustment, are reported as a
separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.



Recent Accounting Pronouncements



In December, 2001, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 01-6,
Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others,to reconcile and conform the accounting and financial reporting provisions established by various AICPA industry
audit guides. This Statement is effective for annual and interim financial statements issued for fiscal years beginning after December 15, 2001, and did not have a material impact on the corporations consolidated financial statements.



---



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



Recent Accounting Pronouncements (Continued)



On March 13, 2002, the Financial Accounting Standard Board determined that commitments for the origination
of mortgage loans that will be held for sale must be accounted for as derivatives instruments, effective for fiscal quarters beginning after April 10, 2002. The corporation enters into commitments to originate loans whereby the interest rate on the
loan is determined prior to funding. Such rate lock commitments on mortgage loans to be sold in the secondary market are considered derivatives. Accordingly, these commitments including any fees received from the potential borrower are recorded at
fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments
also considers the difference between current levels of interest rates and the committed rates. The cumulative effect of adopting Statement No. 133 for rate lock commitments as of December 31, 2002, was not material. The corporation originally
adopted Statement No. 133, Accounting for Derivative Instruments and Hedging Activitieson January 1, 2001.



In April 2002, the Financial Accounting Standards Board issued Statement 145, Rescission of FASB No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections.The amendment to Statement 13 eliminates an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The
provisions of this Statement related to the rescission of Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions of this Statement related to Statement 13 are effective for transactions occurring after May 15,
2002, with early application encouraged.



In
June 2002, the Financial Accounting Standards Board issued Statement 146, Accounting for Costs Associated with Exit or Disposal Activities.This Statement requires recognition of a liability, when incurred, for costs associated with an exit
or disposal activity. The liability should be measured at fair value. The provisions of the Statement are effective for exit or disposal activities initiated after December 31, 2002.



Effective January 1, 2002, the corporation adopted Financial Accounting Standards Board Statement No. 142,
Goodwill and Other Intangible Assets.Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value based test. Additionally,
Statement 142 requires that acquired intangible assets (such as core deposit intangibles) be separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over their estimated useful life.
Branch acquisition transactions were outside the scope of the Statement and therefore any intangible asset arising from such transactions remained subject to amortization over their estimated useful life.



In October 2002, the Financial Accounting Standards Board
issued Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement amends previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations,and Statement No. 142 to branch acquisitions if such transactions meet the definition of a business combination. The provisions of the Statement do not apply to transactions between two
or more mutual enterprises. In addition, the Statement amends Statement No. 144, Accounting for the Impairment of Long-Lived Assets,to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are
subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and measurement provisions required for other long-lived assets held and used.



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



Recent Accounting Pronouncements (Continued)



The Financial Accounting Standards Board issued Statement No. 148, Accounting for Stock-Based Compensation
 Transition and Disclosure, an amendment of Statement No. 123,in December 2002. The Statement amends Statement No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, the Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. Finally, this Statement amends APB Opinion No. 28, Interim Financial Reporting,to require disclosure about the effects of stock options in interim financial
information. The amendments to Statement No. 123 are effective for financial statements for fiscal years ending after December 15, 2002. The amendments to APB No. 28 are effective for financial reports containing condensed financial statements for
interim periods beginning after December 15, 2002. Early application is encouraged for both amendments.



The adoption of Statement No. 142, 145, 146, 147 and 148 did not have a material impact on the corporations consolidated financial
statements.



Reclassifications



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



|Note 2. |  | Securities
|------- |  | ----------



The amortized cost and fair value of securities being held to maturity as of December 31, 2002 and 2001, are as follows:





|                                        |  | 2002          
|--------------------------------------- |  | --------------
|                                        |  | Amortized Cost
|Obligations of U.S. Government agencies |  | $             
|                                        |  |               





|                                        |  | 2001          
|--------------------------------------- |  | --------------
|                                        |  | Amortized Cost
|Obligations of U.S. Government agencies |  | $             
|                                        |  |               



The
amortized cost and fair value of the securities being held to maturity as of December 31, 2002, by contractual maturity, are shown below:



|                                      |  | Amortized Cost |           | Fair Value
|------------------------------------- |  | -------------- | --------- | ----------
|Due in one year or less               |  | $              | 2 998 336 |           
|Due after one year through five years |  |                | 6 014 853 |           
|                                      |  |                |           |           
|                                      |  | $              | 9 013 189 |           
|                                      |  |                |           |           



The
amortized cost and fair value of securities available for sale as of December 31, 2002 and 2001 are as follows:



|                                        |  | 2002          
|--------------------------------------- |  | --------------
|                                        |  | Amortized Cost
|Obligations of U.S. Government agencies |  | $             
|                                        |  |               



---

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



|                                        |  | 2002          
|--------------------------------------- |  | --------------
|                                        |  | Amortized Cost
|Obligations of U.S. Government agencies |  | $             
|                                        |  |               



The
amortized cost and fair value of the securities available for sale as of December 31, 2002, by contractual maturity, are shown below:



|                                      |  | Amortized Cost |            | Fair Value
|------------------------------------- |  | -------------- | ---------- | ----------
|Due in one year or less               |  | $              | 7 028 614  |           
|Due after one year through five years |  |                | 34 286 631 |           
|                                      |  |                |            |           
|                                      |  | $              | 41 315 245 |           
|                                      |  |                |            |           



There
were no sales of securities during 2002, 2001 and 2000.



Securities with a carrying value of $23,600,125 and $14,217,554 at December 31, 2002 and 2001, 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:



|                                                       |  | December 31
|------------------------------------------------------ |  | -----------
|                                                       |  | 2002       
|Mortgage loans on real estate:                         |  |            
|Construction and land development                      |  | $          
|Secured by farm land                                   |  |            
|Secured by 1-4 family residential                      |  |            
|Other real estate                                      |  |            
|Loans to farmers (except those secured by real estate) |  |            
|Commercial loans (except those secured by real estate) |  |            
|Consumer loans                                         |  |            
|All other loans                                        |  |            
|                                                       |  |            
|Total loans                                            |  | $          
|Less: allowance for loan losses                        |  |            
|                                                       |  |            
|                                                       |  | $          
|                                                       |  |            



At
December 31, 2002 and 2001, overdraft demand deposits reclassified to loans totaled $113,408 and $125,443, respectively.



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 risks. At December 31, 2002 and 2001, these loans totaled $869,861 and $979,348 respectively.
During 2002, total principal additions were $145,246 and total principal payments were $254,733.



---

|Note 4. |  | Allowance for Loan Losses
|------- |  | -------------------------



The following is a summary of transactions in the allowance for loan losses for 2002, 2001 and 2000:



|                                                  |  | 2002 |           |   | 2001 |   |           | 2000 | 
|------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- | 
|Balances at beginning of year                     |  | $    | 1 402 247 |   |      | $ | 1 268 235 |      | 
|Provision charged (credited) to operating expense |  |      | 423 000   |   |      |   | 220 575   |      | 
|Recoveries added to the allowance                 |  |      | 103 705   |   |      |   | 35 125    |      | 
|Loan losses charged to the allowance              |  |      | (287 133  | ) |      |   | (121 688  | )    | 
|                                                  |  |      |           |   |      |   |           |      | 
|Balances at end of year                           |  | $    | 1 641 819 |   |      | $ | 1 402 247 |      | 
|                                                  |  |      |           |   |      |   |           |      | 





There were no impaired loans at December 31, 2002 and 2001.





There were no nonaccrual loans
excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2002 and 2000. Nonaccrual loans excluded from impaired loan disclosure under SFAS No. 114 at December 31, 2001 amounted to $9,060. If interest on this loan had been accrued,
such income would have approximated $497 in 2001.



|Note 5. |  | Premises and Equipment, Net
|------- |  | ---------------------------



Premises and equipment consists of the following:





|                              |  | December 31
|----------------------------- |  | -----------
|                              |  | 2002       
|Premises                      |  | $          
|Furniture and equipment       |  |            
|                              |  |            
|                              |  | $          
|Less accumulated depreciation |  |            
|                              |  |            
|                              |  | $          
|                              |  |            



Depreciation included in operating expense for 2002, 2001 and 2000, was $417,120, $228,464 and $236,554 respectively.



|Note 6. |  | Deposits
|------- |  | --------



The aggregate amount of time deposits with a balance of $100,000 or more was $8,804,364 and $7,299,965 at December 31, 2002 and 2001,
respectively.



At December 31, 2002, the
scheduled maturities of all time deposits are as follows:



|2003 |  | $ | 22 150 892
|---- |  | - | ----------
|2004 |  |   | 15 331 658
|2005 |  |   | 7 525 719 
|2006 |  |   | 1 687 484 
|2007 |  |   | 194 641   
|     |  |   |           
|     |  | $ | 46 890 394
|     |  |   |           



---

|Note 7. |  | Borrowings
|------- |  | ----------



Short-term borrowings consist of securities sold under agreements to repurchase which are secured transactions with customers and
generally mature the day following the date sold.



In June 2001, the bank incurred fixed rate long term debt consisting of a Federal Home Loan Bank seven year loan with an original balance of $2,500,000 and monthly payments of interest and principal with an interest rate of 5.51%.
The loan is secured by capital stock, deposits, mortgage collateral and securities collateral of the bank.



Principal payments on the note are due as follows:



|2003 |  | $ | 326 895  
|---- |  | - | ---------
|2004 |  |   | 345 369  
|2005 |  |   | 364 886  
|2006 |  |   | 385 507  
|2007 |  |   | 407 293  
|2008 |  |   | 212 199  
|     |  |   |          
|     |  | $ | 2 042 149
|     |  |   |          



The
corporation has unused lines of credit with the Federal Home Loan Bank and other financial institutions totaling approximately $68,127,000 at December 31, 2002.



|Note 8. |  | Employee Benefit Plans
|------- |  | ----------------------



The corporation sponsors a noncontributory, defined benefit pension plan covering full-time employees over 21 years of age upon completion
of one year of service. Benefits are based on average compensation for the five consecutive full calendar years of service which produce the highest average. The corporation computes the net periodic pension cost of the plan in accordance with
Financial Accounting Standards Statement No. 87, Employers Accounting for Pensions.



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 three 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. The corporation
accounts for its share of the costs of those benefits in accordance with Financial Accounting Standards Statement No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions. Under that Statement, the
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.



The corporation sponsors a 401(k) profit sharing plan available to fulltime employees meeting certain age and
service requirements. Employees become eligible to participate in the plan upon reaching age 21 and completing one year of service. Entry dates are January 1, April 1, July 1 and October 1. Employees can make a salary deferral election authorizing
the employer to withhold up to the amount allowed by law each calendar year. The employer may make a discretionary matching contribution each plan year. The employer may also make other discretionary contributions to the plan. The corporation made
401(k) matching contributions of $30,302 and $17,011 in 2002 and 2001, respectively.



---

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



Information about the plans follow:



|                                                   |  | Pension Benefits |            |   | Postretirement Benefits |  
|-------------------------------------------------- |  | ---------------- | ---------- | - | ----------------------- | -
|                                                   |  | 2002             |            |   | 2001                    |  
|Change in Benefit Obligation:                      |  |                  |            |   |                         |  
|Benefit obligation, beginning                      |  | $                | 4 117 159  |   |                         | $
|Service cost                                       |  |                  | 112 001    |   |                         |  
|Interest cost                                      |  |                  | 293 612    |   |                         |  
|Actuarial (gain) loss                              |  |                  | 6 843      |   |                         |  
|Benefits paid                                      |  |                  | (127 273   | ) |                         |  
|Change in discount rates                           |  |                  | 98 664     |   |                         |  
|                                                   |  |                  |            |   |                         |  
|Benefit obligation, ending                         |  | $                | 4 501 006  |   |                         | $
|                                                   |  |                  |            |   |                         |  
|Change in Plan Assets:                             |  |                  |            |   |                         |  
|Fair value of plan assets, beginning               |  | $                | 3 407 698  |   |                         | $
|Actual return on plan assets                       |  |                  | (432 486   | ) |                         |  
|Employer contributions                             |  |                  | 174 692    |   |                         |  
|Benefits paid                                      |  |                  | (127 273   | ) |                         |  
|                                                   |  |                  |            |   |                         |  
|Fair value of plan assets, ending                  |  | $                | 3 022 631  |   |                         | $
|                                                   |  |                  |            |   |                         |  
|Funded status                                      |  | $                | (1 478 375 | ) |                         | $
|Unrecognized net (gain) loss                       |  |                  | 964 911    |   |                         |  
|Unrecognized net obligation (asset) at transition  |  |                  | (56 037    | ) |                         |  
|Unrecognized prior service cost                    |  |                  | 716        |   |                         |  
|Minimum liability adjustment                       |  |                  | (263 155   | ) |                         |  
|                                                   |  |                  |            |   |                         |  
|Accrued benefit cost included in other liabilities |  | $                | (831 940   | ) |                         | $
|                                                   |  |                  |            |   |                         |  



|                                             |  | Pension Benefits |          |   | Postretirement Benefits |  
|-------------------------------------------- |  | ---------------- | -------- | - | ----------------------- | -
|                                             |  | 2002             |          |   | 2001                    |  
|Components of Net Periodic Benefit Cost:     |  |                  |          |   |                         |  
|Service cost                                 |  | $                | 112 001  |   |                         | $
|Interest cost                                |  |                  | 293 612  |   |                         |  
|Expected return on plan assets               |  |                  | (321 263 | ) |                         |  
|Amortization of net (gain) loss              |  |                  |         |   |                         |  
|Amortization of prior service cost           |  |                  | 155      |   |                         |  
|Amortization of net obligation at transition |  |                  | (20 302  | ) |                         |  
|                                             |  |                  |          |   |                         |  
|Net periodic benefit cost                    |  | $                | 64 203   |   |                         | $
|                                             |  |                  |          |   |                         |  
|Weighted-Average Assumptions:                |  |                  |          |   |                         |  
|Discount rate                                |  |                  | 7.00     | % |                         |  
|Expected return on plan assets               |  |                  | 8.50     | % |                         |  
|Rate of compensation increase                |  |                  | 4.00     | % |                         |  



For
measurement purposes, an 8.64% annual rate of increase in per capita health care costs of covered benefits was assumed for 2002, a 9% increase was assumed for 2001 and a 10% increase was assumed for 2000, with such annual rate of increase gradually
declining to 5% in 2013.



Assumed health care
cost trend rates have a significant effect on the amounts reported for the health care plans. A 1% change in assumed health care cost trend rates would have the following effects:



|                                                                                                                |  | 1% Increase |        | 1% Decrease |  
|--------------------------------------------------------------------------------------------------------------- |  | ----------- | ------ | ----------- | -
|Effect on the health care component of the accumulated postretirement benefit
obligation                        |  | $           | 19 672 |             | $
|Effect on total of service and interest cost components of net periodic postretirement
health care benefit cost |  |             | 1 287  |             |  



---

|Note 9. |  | Income Taxes
|------- |  | ------------



Net deferred tax assets consist of the following components as of December 31, 2002 and 2001:



|                                     |  | 2002 |         | 2001
|------------------------------------ |  | ---- | ------- | ----
|Deferred tax assets:                 |  |      |         |     
|Reserve for loan losses              |  | $    | 403 230 |     
|Accrued pension expense              |  |      | 193 387 |     
|Minimum pension liability adjustment |  |      | 89 473  |     
|Accrued postretirement benefits      |  |      | 103 617 |     
|Nonaccrual interest                  |  |      |        |     
|                                     |  |      |         |     
|                                     |  | $    | 789 707 |     
|                                     |  |      |         |     
|Deferred tax liabilities:            |  |      |         |     
|Depreciation                         |  | $    | 74 134  |     
|Securities available for sale        |  |      | 480 378 |     
|                                     |  |      |         |     
|                                     |  | $    | 554 512 |     
|                                     |  |      |         |     
|Net deferred tax assets              |  | $    | 235 195 |     
|                                     |  |      |         |     



The
provision for income taxes charged to operations for the years ended December 31, 2002, 2001 and 2000 consists of the following:



|                               |  | 2002 |           | 2001 |   |           | 2000
|------------------------------ |  | ---- | --------- | ---- | - | --------- | ----
|Current tax expense            |  | $    | 1 406 203 |      | $ | 1 263 995 |     
|Deferred tax expense (benefit) |  |      | 1 517     |      |   | (98 262   | )   
|                               |  |      |           |      |   |           |     
|                               |  | $    | 1 407 720 |      | $ | 1 165 733 |     
|                               |  |      |           |      |   |           |     



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, 2002, 2001 and 2000 due to the following:



|                                                      |  | 2002 |           |   | 2001 |   |           | 2000 | 
|----------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- | 
|Computed expected tax expense                       |  | $    | 1 314 743 |   |      | $ | 1 079 500 |      | 
|Increase (decrease) in income taxes resulting from:   |  |      |           |   |      |   |           |      | 
|Tax exempt interest income                            |  |      | (33 793   | ) |      |   | (28 503   | )    | 
|State income taxes, net of federal income tax benefit |  |      | 123 186   |   |      |   | 114 303   |      | 
|Other                                                 |  |      | 3 584     |   |      |   | 433       |      | 
|                                                      |  |      |           |   |      |   |           |      | 
|                                                      |  | $    | 1 407 720 |   |      | $ | 1 165 733 |      | 
|                                                      |  |      |           |   |      |   |           |      | 



|Note 10. |  | 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 12 with respect to financial instruments with off-balance-sheet risk.



The corporation has approximately $2,535,677 in deposits in
other financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2002.



The corporation must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final
bi-weekly reporting periods which included December 31, 2002 and 2001, the aggregate amounts of daily average required balances were approximately $5,980,000 and $4,422,000, respectively.



|Note 11. |  | 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, 2002, the aggregate amount of unrestricted funds which could be transferred from the banking subsidiary to the parent corporation, without prior regulatory approval, totaled $3,632,689
or 17.0% of the consolidated net assets.



---



|Note 12. |  | Financial Instruments With Off-Balance-Sheet Risk
|-------- |  | -------------------------------------------------



The corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in
the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the 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 instruments 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, 2002 and 2001, is as follows:



|                                                                    |  | 2002 |            | 2001
|------------------------------------------------------------------- |  | ---- | ---------- | ----
|Financial instruments whose contract amounts represent credit risk: |  |      |            |     
|Commitments to extend credit                                        |  | $    | 19 990 685 |     
|Standby letters of credit                                           |  |      | 1 638 028  |     



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.



Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers.
These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the extent to which the corporation is committed.



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 generally holds collateral supporting those commitments if deemed necessary.



At December 31, 2002, the corporation had rate lock commitments to originate mortgage loans amounting to
$1,748,520 and loans held for sale of $1,923,694. The corporation has entered into corresponding mandatory commitments, on a best-efforts basis, to sell these loans. These commitments to sell loans are designed to eliminate the corporations
exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.



|Note 13. |  | Fair Value of Financial Instruments and Interest Rate Risk
|-------- |  | ----------------------------------------------------------



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.



Loans Held for Sale

The carrying amount of loans held for sale approximates fair value.



---



|Note 13. |  | Fair Value of Financial Instruments and Interest Rate Risk (Continued)
|-------- |  | ----------------------------------------------------------------------



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.



Short-term Borrowings

The carrying amounts of borrowings under repurchase
agreements approximate fair value.



FHLB Advances

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



Accrued Interest

The carrying amounts of accrued interest approximate fair
value.



Off-Balance Sheet Financial Instruments

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



At December 31, 2002 and 2001, the carrying amounts of loan
commitments and standby-letters of credit approximated fair value.



The estimated fair values of the corporations financial instruments are as follows:



|                                                                       |  | 2002            |         | 2001          
|---------------------------------------------------------------------- |  | --------------- | ------- | --------------
|                                                                       |  | Carrying Amount |         | Fair Value    
|                                                                       |  | (in thousands)  |         | (in thousands)
|Financial assets:                                                      |  |                 |         |               
|Cash                                                                   |  | $               | 13 213  |               
|Securities purchased under agreements to resell and federal funds sold |  |                 | 3 915   |               
|Securities held to maturity                                            |  |                 | 9 013   |               
|Securities available for sale                                          |  |                 | 42 728  |               
|Loans, net                                                             |  |                 | 115 404 |               
|Loans held for sale                                                    |  |                 | 1 924   |               
|Accrued interest receivable                                            |  |                 | 1 065   |               
|Financial liabilities:                                                 |  |                 |         |               
|Deposits                                                               |  |                 | 162 180 |               
|Repurchase agreements                                                  |  |                 | 6 102   |               
|FHLB advances                                                          |  |                 | 2 042   |               
|Accrued interest payable                                               |  |                 | 160     |               



The
corporation assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the corporations financial instruments will change when interest rate levels
change and that change may be either favorable or unfavorable to the corporation. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate
obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate
environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in
securities with terms that mitigate the corporations overall interest rate risk.



---



|Note 14. |  | Regulatory Matters
|-------- |  | ------------------



The corporation (on a consolidated basis) and the bank are 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
and banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the corporation and bank must meet specific capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other
factors. Prompt corrective action provisions are not applicable to bank holding companies.



Quantitative measures established by regulation to ensure capital adequacy require the corporation and the bank 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 (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002 and 2001, that the corporation and the bank meet all
capital adequacy requirements to which they are subject.



As of December 31, 2002, the most recent notification from the Federal Deposit Insurance Corporation categorized the bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well
capitalized, an institution 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 and the banks actual capital amounts and ratios are also presented in the table.



|                                          |  | Actual                |        |       | Minimum Capital Requirement |   |        | Minimum To Be Well Capitalized Under Prompt Corrective Action
Provisions |      
|----------------------------------------- |  | --------------------- | ------ | ----- | --------------------------- | - | ------ | ------------------------------------------------------------------------ | -----
|                                          |  | Amount                |        | Ratio |                             |   | Amount |                                                                          | Ratio
|                                          |  | (Amount in Thousands) |       
|As of December 31, 2002:                  |  |                       |        |       |                             |   |        |                                                                          |      
|Total capital (to risk-weighted assets):  |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 21 956 |       | 19.60                       | % |        | $                                                                        | 8 963
|Bank of Charles Town                      |  | $                     | 21 911 |       | 19.56                       | % |        | $                                                                        | 8 962
|Tier 1 capital (to risk-weighted assets): |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 20 553 |       | 18.34                       | % |        | $                                                                        | 4 482
|Bank of Charles Town                      |  | $                     | 20 508 |       | 18.31                       | % |        | $                                                                        | 4 481
|Tier 1 capital (to average assets):       |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 20 553 |       | 10.77                       | % |        | $                                                                        | 7 636
|Bank of Charles Town                      |  | $                     | 20 508 |       | 10.74                       | % |        | $                                                                        | 7 635
|As of December 31, 2001:                  |  |                       |        |       |                             |   |        |                                                                          |      
|Total capital (to risk-weighted assets):  |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 20 417 |       | 21.15                       | % |        | $                                                                        | 7 724
|Bank of Charles Town                      |  | $                     | 20 392 |       | 21.12                       | % |        | $                                                                        | 7 723
|Tier 1 capital (to risk-weighted assets): |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 19 208 |       | 19.90                       | % |        | $                                                                        | 3 862
|Bank of Charles Town                      |  | $                     | 19 183 |       | 19.87                       | % |        | $                                                                        | 3 861
|Tier 1 capital (to average assets):       |  |                       |        |       |                             |   |        |                                                                          |      
|Consolidated                              |  | $                     | 19 208 |       | 11.30                       | % |        | $                                                                        | 6 803
|Bank of Charles Town                      |  | $                     | 19 183 |       | 11.28                       | % |        | $                                                                        | 6 803



---



|Note 15. |  | Parent Corporation Only Financial Statements
|-------- |  | --------------------------------------------



POTOMAC BANCSHARES, INC.

(Parent Corporation Only)

Balance Sheets

December 31, 2002 and 2001



|                                              |  | 2002 |            | 2001
|--------------------------------------------- |  | ---- | ---------- | ----
|ASSETS                                        |  |      |            |     
|Cash                                          |  | $    | 36 549     |     
|Investment in subsidiary                      |  |      | 21 266 822 |     
|Other assets                                  |  |      | 14 021     |     
|                                              |  |      |            |     
|Total Assets                                  |  | $    | 21 317 392 |     
|                                              |  |      |            |     
|LIABILITIES AND STOCKHOLDERS EQUITY          |  |      |            |     
|LIABILITIES, other                            |  | $    | 4 996      |     
|                                              |  |      |            |     
|STOCKHOLDERS EQUITY                          |  |      |            |     
|Common stock                                  |  | $    | 600 000    |     
|Surplus                                       |  |      | 5 400 000  |     
|Undivided profits                             |  |      | 14 801 225 |     
|Accumulated other comprehensive income        |  |      | 758 816    |     
|                                              |  |      |            |     
|                                              |  | $    | 21 560 041 |     
|Less cost of shares acquired for the treasury |  |      | 247 645    |     
|                                              |  |      |            |     
|Total Stockholders Equity                    |  | $    | 21 312 396 |     
|                                              |  |      |            |     
|Total Liabilities and Stockholders Equity    |  | $    | 21 317 392 |     
|                                              |  |      |            |     



POTOMAC
BANCSHARES, INC.

(Parent Corporation Only)

Statements of Income

Years Ended December 31, 2002, 2001 and 2000



|                                                                                    |  | 2002 |           |   | 2001 |   |           | 2000 | 
|----------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- | 
|Income                                                                              |  |      |           |   |      |   |           |      | 
|Dividends from subsidiary                                                           |  | $    | 1 163 062 |   |      | $ | 810 000   |      | 
|Expenses                                                                            |  |      |           |   |      |   |           |      | 
|Transfer agent expense                                                              |  | $    | 9 000     |   |      | $ | 7 000     |      | 
|Legal and professional                                                              |  |      | 12 315    |   |      |   | 4 433     |      | 
|Other operating expenses                                                            |  |      | 21 718    |   |      |   | 20 844    |      | 
|                                                                                    |  |      |           |   |      |   |           |      | 
|Total Expenses                                                                      |  | $    | 43 033    |   |      | $ | 32 277    |      | 
|                                                                                    |  |      |           |   |      |   |           |      | 
|Income before Income Tax (Benefit) and Equity in Undistributed Income of
Subsidiary |  | $    | 1 120 029 |   |      | $ | 777 723   |      | 
|Income Tax (Benefit)                                                                |  |      | (13 839   | ) |      |   | (9 781    | )    | 
|                                                                                    |  |      |           |   |      |   |           |      | 
|Income before Equity in Undistributed Income of Subsidiary                          |  | $    | 1 133 868 |   |      | $ | 787 504   |      | 
|Equity in Undistributed Income of Subsidiary                                        |  |      | 1 325 302 |   |      |   | 1 221 763 |      | 
|                                                                                    |  |      |           |   |      |   |           |      | 
|Net Income                                                                          |  | $    | 2 459 170 |   |      | $ | 2 009 267 |      | 
|                                                                                    |  |      |           |   |      |   |           |      | 



---



|Note 15. |  | Parent Corporation Only Financial Statements (Continued)
|-------- |  | --------------------------------------------------------



POTOMAC BANCSHARES, INC.

(Parent Corporation Only)

Statements of Cash Flows

Years Ended December 31, 2002, 2001 and 2000



|                                                                                  |  | 2002 |            |   | 2001 |   |            | 2000 | 
|--------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                              |  |      |            |   |      |   |            |      | 
|Net income                                                                        |  | $    | 2 459 170  |   |      | $ | 2 009 267  |      | 
|Adjustments to reconcile net income to net cash provided by operating
activities: |  |      |            |   |      |   |            |      | 
|Equity in undistributed (income) of subsidiary                                    |  |      | (1 325 302 | ) |      |   | (1 221 763 | )    | 
|(Increase) decrease in other assets                                               |  |      | (4 059     | ) |      |   | (918       | )    | 
|                                                                                  |  |      |            |   |      |   |            |      | 
|Net cash provided by operating activities                                         |  | $    | 1 129 809  |   |      | $ | 786 586    |      | 
|                                                                                  |  |      |            |   |      |   |            |      | 
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |      |            |   |      |   |            |      | 
|Cash dividends                                                                    |  | $    | (1 113 062 | ) |      | $ | (810 000   | )    | 
|                                                                                  |  |      |            |   |      |   |            |      | 
|Increase (decrease) in cash and cash equivalents                                  |  | $    | 16 747     |   |      | $ | (23 414    | )    | 
|CASH AND CASH EQUIVALENTS                                                         |  |      |            |   |      |   |            |      | 
|Beginning                                                                         |  |      | 19 802     |   |      |   | 43 216     |      | 
|                                                                                  |  |      |            |   |      |   |            |      | 
|Ending                                                                            |  | $    | 36 549     |   |      | $ | 19 802     |      | 
|                                                                                  |  |      |            |   |      |   |            |      | 



---



POTOMAC
BANCSHARES, INC.



|                       
|-----------------------
|Robert F. Baronner, Jr.
|                       
|William R. Harner      
|                       
|Gayle Marshall Johnson 
|                       
|Donald S. Smith        
|                       
|Susan S. Myers         



BANK
OF CHARLES TOWN



|                          
|--------------------------
|Robert F. Baronner, Jr.   
|                          
|William R. Harner         
|                          
|David W. Irvin            
|                          
|Donna J. Burns            
|                          
|Richard Crea              
|                          
|Karen S. Hensell          
|                          
|Robert L. Hersey          
|                          
|Gayle Marshall Johnson    
|                          
|Susan S. Myers            
|                          
|Charles K. Nicewarner, Jr.
|                          
|David S. (Joe) Smith      
|                          
|Linda G. Wasilius         



---



ANNUAL
REPORT ON FORM 10-KSB



A copy of the
corporations 2002 annual report on Form 10-KSB filed with 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. Potomac Bancshares, Inc. (symbol PTBS) is on the Bulletin Board, a network available to brokers. Scott and
Stringfellow, a regional securities firm with an office in Winchester, Virginia, is a market maker for Potomacs stock. A market maker is one who makes a market for a particular stock. Information about sales (but not necessarily all sales) of
Potomacs stock is available on the Internet through many of the stock information services using Potomacs symbol. As of December 31, 2002, there were 593,890 common shares outstanding held by approximately 1,100 shareholders.



The per share sale prices of the
corporations stock for 2001 and 2002 are based on information available as a result of our participation on the Bulletin Board described above and information gathered on the Internet. The dividends for 2001 and 2002 are also listed.



|               |  | High |        | Low |   | Dividends
|-------------- |  | ---- | ------ | --- | - | ---------
|2001           |  |      |        |     |   |          
|First Quarter  |  | $    | 28.750 |     | $ | 25.000   
|Second Quarter |  |      | 33.500 |     |   | 25.250   
|Third Quarter  |  |      | 34.500 |     |   | 32.000   
|Fourth Quarter |  |      | 38.500 |     |   | 33.000   
|2002           |  |      |        |     |   |          
|First Quarter  |  | $    | 38.350 |     | $ | 35.250   
|Second Quarter |  |      | 41.000 |     |   | 36.500   
|Third Quarter  |  |      | 42.500 |     |   | 40.100   
|Fourth Quarter |  |      | 46.500 |     |   | 41.750   



Beginning in 2003 common stock dividends are paid on a quarterly basis. Historically, the corporation has paid dividends 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 59 Maiden Lane New York NY 10038 (212) 936-5100
| |  | ---------------------------------------------------------------------------------------



ANNUAL MEETING



The
annual meeting of stockholders will be held at the Clarion Hotel & Conference Center, Shepherdstown, Jefferson County, West Virginia, on Tuesday, April 22, 2003, beginning at 10:30 a.m.