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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark one)

|x | ANNUAL   REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|- | ------------------------------------------------------------------------------------------
|  |                                                                                           
|  | For the fiscal year ended December   31, 2004                                             
|  |                                                                                           
|o | TRANSITION   REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  |                                                                                           
|  | For the transition period from   __________ to _________                                  

Commission File Number   0-24958

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

|West   Virginia                                                  |  | 55-0732247                            
|---------------------------------------------------------------- |  | --------------------------------------
|(State or   Other Jurisdiction of Incorporation or Organization) |  | (I.R.S.   Employer Identification No.)
|                                                                 |  |                                       
|111   East Washington Street   PO Box 906, Charles Town WV       |  | 25414-0906                            
|(Address   of Principal Executive Offices)                       |  | (Zip Code)                            

|Registrants telephone number,   including area code   304-725-8431
|-------------------------------------------------------------------
|                                                                   
|Securities registered pursuant to   Section 12(b) of the Act:      

|Title of   Each Class |  | Name of   Each Exchange    on Which Registered
|--------------------- |  | ----------------------------------------------
|                      |  |                                               
|NONE                  |  |                                               
|                      |  |                                               
|                      |  |                                               
|                      |  |                                               

Securities registered pursuant to Section 12(g) of the Act:

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

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past the 90 days.

Yes
x     No  
o

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes
o     No  
x

State the aggregate market value of the voting and  non-voting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrants most recently completed second fiscal quarter.   $38,098,342 as of June 30, 2004

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Indicate by check mark whether the registrant has filed all documents and reports required by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes
o     No  
o   Not Applicable   
x

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

Indicate the number of shares outstanding of each of the registrants classes of common stock, as of the latest practicable date.

1,696,561 as of March 2, 2005

DOCUMENTS INCORPORATED BY REFERENCE

The following lists the document that is incorporated by reference in the Form 10-K Annual Report, and the Parts and Items of the Form 10-K into which the document is incorporated.

|Document                                                                                             |  | Part of   the Form 10-K Into Which   the Document is Incorporated
|---------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------
|                                                                                                     |  |                                                                  
|Portions of Potomac Bancshares, Inc.s Proxy Statement   for the 2005 Annual Meeting of Shareholders |  | Part III, Items 10, 11, 12, 13 and 14                            

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Potomac Bancshares, Inc. Annual Report on Form 10-K For the Year Ended December 31, 2004

|PART I   |     |                                                                                                               
|-------- | --- | --------------------------------------------------------------------------------------------------------------
|         |     |                                                                                                               
|Item     | 1.  | Business                                                                                                      
|Item     | 2.  | Properties                                                                                                    
|Item     | 3.  | Legal Proceedings                                                                                             
|Item     | 4.  | Submission of Matters to a Vote of   Security Holders                                                         
|         |     |                                                                                                               
|PART II  |     |                                                                                                               
|         |     |                                                                                                               
|Item     | 5.  | Market for Registrants Common   Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|Item     | 6.  | Selected Financial Data                                                                                       
|Item     | 7.  | Managements Discussion and   Analysis of Financial Condition and Results of Operations                       
|Item     | 7A. | Quantitative and Qualitative   Disclosures About Market Risk                                                  
|Item     | 8.  | Financial Statements and Supplementary   Data                                                                 
|Item     | 9.  | Changes In and Disagreements with   Accountants on Accounting and Financial Disclosure                        
|Item     | 9A. | Controls and Procedures                                                                                       
|Item     | 9B. | Other Information                                                                                             
|         |     |                                                                                                               
|PART III |     |                                                                                                               
|         |     |                                                                                                               
|Item     | 10. | Directors and Executive Officers   of the Registrant                                                          
|Item     | 11. | Executive Compensation                                                                                        
|Item     | 12. | Security Ownership of Certain   Beneficial Owners and Management and Related Stockholder Matters              
|Item     | 13. | Certain Relationships and Related   Transactions                                                              
|Item     | 14. | Principal Accountant Fees and Services                                                                        
|         |     |                                                                                                               
|PART IV  |     |                                                                                                               
|         |     |                                                                                                               
|Item     | 15. | Exhibits and Financial Statements   Schedules                                                                 

FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 evidences Congress determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management.  This Annual Report on Form 10-K, including the Presidents letter and the Managements Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty.  Forward-looking statements are easily identified by the use of words such as could, anticipate, estimate, believe, and similar words that refer to a future outlook.  To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the companys actual results and
experiences to differ materially from the anticipated results or other expectations expressed in the companys forward-looking statements.

The risks and uncertainties that may affect the operations, performance, development and results of the companys business include, but are not limited to, the growth of the economy, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, Congressional legislation and similar matters.  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.



PART I

|Item  1. | Business.
|-------- | ---------

History and Operations

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

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

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

The bank provides individuals, businesses and local governments with a broad range of banking services. These services include

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

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

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

Underwriting standards for all lending include

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

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

1



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

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

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

Approximately 87% of the banks loans are secured by real estate.  These loans had an average delinquency rate of .50% and a loss rate of 0% during 2004.  The average delinquency rate and loss rate are based on comparisons to 2004 average total loans.

As of December 31, 2004, aggregate dollar amounts (in thousands) in loan categories secured by real estate are as follows:

| |  |  | Construction and land development | $ | 28 929  |  | 
| |  | - | --------------------------------- | - | ------- |  | 
| |  |  | Secured by farmland               |   | 3 986   |  | 
| |  |  | Secured by 1-4 family residential |   | 79 800  |  | 
| |  |  | Other real estate                 |   | 42 759  |  | 
| |  |   |                                   |   |         |  | 
| |  |   |                                   | $ | 155 474 |  | 
| |  |   |                                   |   |         |  | 

Commercial loans not secured by real estate with an aggregate balance of $5.95 million at December 31, 2004 make up approximately 3.3% of the total loan portfolio.  The banks loan policy for commercial loans including those commercial loans secured by real estate is to

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

Average delinquency for commercial loans not secured by real estate was .12% and the loss rate was 0% during 2004.

Retail loans to individuals for personal expenditures are approximately 9.7% of the banks total loans at December 31, 2004.  The aggregate balance of these loans was $17.35 million at December 31, 2004.  The majority of these loans are installment loans with the remainder made as term loans.

There is some risk in every retail loan transaction.  The bank accepts moderate levels of risk while minimizing retail loan losses through careful investigation into the character of each borrower, determining the source of repayment before closing each loan, collateralizing most loans, exercising care in documentation procedures, administering an aggressive retail loan collection program, and following the retail loan policies.  Loans to individuals for personal expenditures had an average delinquency rate of .15% and a loss rate of .03% in 2004 (based on comparisons to 2004 average total loans).

All other loans total $236 thousand (less than 1% of total loans) at December 31, 2004.  These loans had a 0% average delinquency rate and a 0% average loss rate in 2004 compared to 2004 average total loans.

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

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

2



According to the policy, funds in excess of those invested in federal funds sold and securities purchased under agreements to resell are to be invested in U.S. Treasury bills, notes or bonds, obligations of U.S. Government agencies and obligations of political subdivisions of the State of West Virginia with a rating of not less than A+.

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

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

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

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

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

Competition

As of March 3, 2005, there were 65 bank holding companies (including multi-bank and one bank holding companies) operating in the State of West Virginia.  These holding companies are headquartered in various West Virginia cities and control banks throughout the State of West Virginia, including banks that compete with the bank in its market area.

The banks market area is generally defined as Jefferson County and Berkeley County, West Virginia.  As of June 30, 2004, there were six banks in Jefferson County with 13 banking offices.  The total deposits of these commercial banks as of June 30, 2004 were $576.6 million, and the bank ranked number one in total deposits with $171.4 million or 29.7% of the total deposits in the market at that time.  The bank has two branch offices in Berkeley County at this time.  Opening in July 2001 and June 2003, these branches have 2.5% of the market share of deposits in Berkeley County where there are eight banks with 29 banking offices.

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

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

3



Employees

Potomac currently has no employees.

As of March 7, 2005, the bank had 83 full-time employees and 21 part-time employees.

Supervision and Regulation

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

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

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

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

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

Depository Institution Subsidiaries.  The bank is subject to FDIC deposit insurance assessments.  As of January 1, 2005, FDIC set the Financing Corporation (FICO) Bank Insurance Fund (BIF) premium for the bank at the annual rate of 1.440 basis points or .0001440 times the total deposits of the bank.  This premium is not tied to the banks risk classification.  The rate of the premium based on the banks risk classification is at 0.00%.  It is possible that BIF insurance assessments will be changed, and it is also possible that there may be a special additional assessment.  A large special assessment could have an adverse impact on Potomacs results of operations.

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

4



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

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

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

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

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

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

5



As of December 31, 2004, Potomac had capital in excess of all applicable requirements as shown below:

|                                                    |  | Actual           |         | Required |   | Excess |  
|--------------------------------------------------- |  | ---------------- | ------- | -------- | - | ------ | -
|                                                    |  |                  |         |          |   |        |  
|                                                    |  | (in   thousands) |        
|Tier 1 capital:                                     |  |                  |         |          |   |        |  
|Common   stock                                      |  | $                | 1,800   |          |   |        |  
|Surplus                                             |  |                  | 4,200   |          |   |        |  
|Retained   earnings                                 |  |                  | 18,631  |          |   |        |  
|                                                    |  |                  |         |          |   |        |  
|                                                    |  |                  | 24,631  |          |   |        |  
|Less   cost of shares acquired for the treasury     |  |                  | 1,850   |          |   |        |  
|                                                    |  |                  |         |          |   |        |  
|Total tier 1 capital                                |  | $                | 22,781  |          | $ | 6,857  |  
|                                                    |  |                  |         |          |   |        |  
|Tier 2 capital:                                     |  |                  |         |          |   |        |  
|Allowance   for loan losses (1)                     |  |                  | 1,966   |          |   |        |  
|                                                    |  |                  |         |          |   |        |  
|Total risk-based capital                            |  | $                | 24,747  |          | $ | 13,715 |  
|                                                    |  |                  |         |          |   |        |  
|Risk-weighted assets                                |  | $                | 171,432 |          |   |        |  
|                                                    |  |                  |         |          |   |        |  
|Tier 1 capital                                      |  | $                | 22,781  |          | $ | 9,641  |  
|                                                    |  |                  |         |          |   |        |  
|Average total assets                                |  | $                | 241,027 |          |   |        |  
|                                                    |  |                  |         |          |   |        |  
|Capital ratios:                                     |  |                  |         |          |   |        |  
|Tier   1 risk-based capital ratio                   |  |                  | 13.29   | %        |   | 4.00   | %
|Total   risk-based capital ratio                    |  |                  | 14.44   | %        |   | 8.00   | %
|Tier   1 capital to average total assets (leverage) |  |                  | 9.45    | %        |   | 4.00   | %

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

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

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

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

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

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

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

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

6



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

Available
Information.  The company files annual, quarterly and current reports,
proxy statements and other information with the SEC.  The companys
SEC filings are filed electronically and are available to the public through the
Internet at the SECs website at http://www.sec.gov.  In addition, any document filed by
the company with the SEC can be read and copied at the SECs public
reference facilities at 450 Fifth Street, NW, Washington, DC  20549. 
Copies of documents can be obtained at prescribed rates by writing to the Public
Reference Section of the SEC at 450 Fifth Street, NW, Washington, DC 
20549.  The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330.  Copies of documents
can also be obtained free of charge by any shareholder by writing to Gayle
Marshall Johnson, Vice President and Chief Financial Officer, Potomac
Bancshares, Inc., PO Box 906, Charles Town, WV  25414.

|Item  2. | Properties.
|-------- | -----------

Potomac currently has no property.

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

The main office property is located at 111 East Washington Street, Charles Town, West Virginia.  This property consists of two separate two story buildings located side by side with adjoining corridors.  During 2000, the construction of the newer of these two buildings was completed.  The first floor of the new building houses the Trust and Financial Services Division. The second floor of the new building houses certain administrative and loan offices.  Both of these floors open into the older bank premises. The basement of the new building is currently being remodeled for use as offices and a board/conference room.  Record storage formerly kept in the basement is now held offsite.

The older premise, constructed in 1967, was renovated at the same time the new building was constructed.  The renovation includes all new lighting, new ceilings, new floor and wall coverings as well as some minor structural changes for more efficient operations.

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

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

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

7



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

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

|Item  3. | Legal   Proceedings.
|-------- | --------------------

Currently Potomac is involved in no legal proceedings.

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

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

Not Applicable.

PART II

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

The following information reflects comparative per share data for the periods indicated for Potomac common stock for (a) trading values, and (b) dividends.  This information has been restated to reflect a 200% stock dividend declared on February 11, 2003.  As of March 2, 2005, there were approximately 1,100 shareholders.

Potomacs common stock is not traded on any stock exchange or over the counter.  Potomac (symbol PTBS.OB) is on the OTC Bulletin Board, a network available to brokers.  Scott and Stringfellow, Inc., Koonce Securities Inc. and Ferris, Baker Watts, Inc. are market makers for Potomac common stock.  A market maker is one who makes a market for a particular stock.  Information about sales (but not necessarily all sales) of Potomac common stock is available on the Internet through many of the stock information services using Potomacs symbol.  Shares of Potomac common stock are occasionally bought and sold by private individuals, firms or corporations, and, in many instances, Potomac does not have knowledge of the purchase price or the terms of the purchase.  The trading values for 2003 and 2004 are based on information available is a result of our participation on the
Bulletin Board described above and information gathered on the Internet.  No attempt was made by Potomac to verify or determine the accuracy of the representations made to Potomac or gathered on the Internet.

|     |  |  |                |  | Price   Range |       |                                   |  
|---- |  |  | -------------- |  | ------------- | ----- | --------------------------------- | -
|     |  |  |                |  |               |       | Cash   Dividends   Paid per Share |  
|     |  |  |                |  | High          |       | Low                               |  
|     |  |  |                |  |               |       |                                   |  
|2003 |  |  | First Quarter  |  | $             | 19.00 |                                   | $
|     |  |  | Second Quarter |  |               | 20.00 |                                   |  
|     |  |  | Third Quarter  |  |               | 25.00 |                                   |  
|     |  |  | Fourth Quarter |  |               | 23.75 |                                   |  
|2004 |  |  | First Quarter  |  | $             | 23.75 |                                   | $
|     |  |  | Second Quarter |  |               | 24.25 |                                   |  
|     |  |  | Third Quarter  |  |               | 25.25 |                                   |  
|     |  |  | Fourth Quarter |  |               | 28.00 |                                   |  

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

8



ISSUER PURCHASES OF EQUITY SECURITIES

|Period                           |  | (a
)
Total   Number of   Shares
Purchased |      | (b)   Average   Price Paid
Per Share |  | (c)   Total Number   of Shares   Purchased as   Part of Publicly   Announced
Programs |  | (d)   Maximum Number   of Shares that May   Yet be Purchased
Under the   Program |  
|-------------------------------- |  | ----------------------------------------- | ---- | ------------------------------------ |  | ------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------- | -
|                                 |  |                                           |      |                                      |  |                                                                                       |  |                                                                                  |  
|October 1 through October 31     |  |                                           | NONE |                                      |  |                                                                                      |  |                                                                                  | 
|November 1 through November   30 |  |                                           | NONE |                                      |  |                                                                                      |  |                                                                                  | 
|December 1 through December   31 |  |                                           | NONE |                                      |  |                                                                                      |  |                                                                                  | 

On February 12, 2002, the companys Board of Directors originally authorized the repurchase program.  The program authorized the repurchase of up to 10% of the companys stock over the next twelve months.  The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent.  The program has been extended on annual basis.

9



|Item  6. | Selected Financial Data.
|-------- | ------------------------

|                                               |  | 2004                                           |           | 2003 |   | 2002      |   | 2001 |           | 2000 |  
|---------------------------------------------- |  | ---------------------------------------------- | --------- | ---- | - | --------- | - | ---- | --------- | ---- | -
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|                                               |  | (Dollars   in Thousands Except Per Share Data) |          
|Summary of Operations                          |  |                                                |           |      |   |           |   |      |           |      |  
|Interest income                                |  | $                                              | 12 008    |      | $ | 10 786    |   | $    | 11 279    |      | $
|Interest expense                               |  |                                                | 2 409     |      |   | 2 235     |   |      | 2 823     |      |  
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|Net interest income                            |  |                                                | 9 599     |      |   | 8 551     |   |      | 8 456     |      |  
|Provision for (recovery   of) loan losses      |  |                                                | 289       |      |   | 147       |   |      | 423       |      |  
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|Net interest income   after provision          |  |                                                |           |      |   |           |   |      |           |      |  
|for (recovery of) loan   losses                |  |                                                | 9 310     |      |   | 8 404     |   |      | 8 033     |      |  
|Noninterest income                             |  |                                                | 3 158     |      |   | 2 844     |   |      | 2 097     |      |  
|Noninterest expense                            |  |                                                | 7 668     |      |   | 7 142     |   |      | 6 263     |      |  
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|Income before income   taxes                   |  |                                                | 4 800     |      |   | 4 106     |   |      | 3 867     |      |  
|Income tax expense                             |  |                                                | 1 710     |      |   | 1 432     |   |      | 1 408     |      |  
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|Net income                                     |  | $                                              | 3 090     |      | $ | 2 674     |   | $    | 2 459     |      | $
|                                               |  |                                                |           |      |   |           |   |      |           |      |  
|Per Share Data **                              |  |                                                |           |      |   |           |   |      |           |      |  
|Net income, basic and   diluted                |  | $                                              | 1.82      |      | $ | 1.53      |   | $    | 1.37      |      | $
|Cash dividends declared                        |  |                                                | .59       |      |   | .54       |   |      | .48       |      |  
|Book value at period   end                     |  |                                                | 13.41     |      |   | 12.53     |   |      | 11.96     |      |  
|Weighted-average shares   outstanding, basic   |  |                                                | 1 697 732 |      |   | 1 750 070 |   |      | 1 791 027 |      |  
|Weighted-average shares   outstanding, diluted |  |                                                | 1 698 968 |      |   | 1 750 070 |   |      | 1 791 027 |      |  
|Average Balance Sheet Summary                  |  |                                                |           |      |   |           |   |      |           |      |  
|Assets                                         |  | $                                              | 226 052   |      | $ | 197 052   |   | $    | 181 741   |      | $
|Loans                                          |  |                                                | 155 546   |      |   | 125 407   |   |      | 109 461   |      |  
|Securities                                     |  |                                                | 46 701    |      |   | 47 087    |   |      | 50 454    |      |  
|Deposits                                       |  |                                                | 190 153   |      |   | 163 328   |   |      | 153 148   |      |  
|Stockholders equity                           |  |                                                | 22 045    |      |   | 21 274    |   |      | 20 542    |      |  
|Performance Ratios                             |  |                                                |           |      |   |           |   |      |           |      |  
|Return on average   assets                     |  |                                                | 1.37      | %    |   | 1.36      | % |      | 1.35      | %    |  
|Return on average   equity                     |  |                                                | 14.02     | %    |   | 12.57     | % |      | 11.97     | %    |  
|Dividend payout ratio                          |  |                                                | 32.42     | %    |   | 35.29     | % |      | 35.04     | %    |  
|Capital Ratios                                 |  |                                                |           |      |   |           |   |      |           |      |  
|Leverage ratio                                 |  |                                                | 9.45      | %    |   | 10.20     | % |      | 10.77     | %    |  
|Risk-based capital   ratios                    |  |                                                |           |      |   |           |   |      |           |      |  
|Tier 1 capital                                 |  |                                                | 13.29     | %    |   | 14.67     | % |      | 18.34     | %    |  
|Total capital                                  |  |                                                | 14.44     | %    |   | 15.89     | % |      | 19.60     | %    |  

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

10



|Item  7. | Managements   Discussion and Analysis of Financial Condition and Results of Operations.
|-------- | ----------------------------------------------------------------------------------------

AVERAGE BALANCES, INCOME/EXPENSE AND AVERAGE YIELD/RATE

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

|                                                                             |  | 2004               |           | 2003              |   | 2002                 | 
|---------------------------------------------------------------------------- |  | ------------------ | --------- | ----------------- | - | -------------------- | 
|                                                                             |  |                    |           |                   |   |                      | 
|                                                                             |  | Average   Balances |           | Income/   Expense |   | Average   Yield/Rate | 
|                                                                             |  |                    |           |                   |   |                      | 
|                                                                             |  | (in   thousands
)  |           | (in   thousands
) |   | (in   thousands
)    | 
|ASSETS                                                                       |  |                    |           |                   |   |                      | 
|Loans                                                                        |  |                    |           |                   |   |                      | 
|Taxable                                                                      |  | $                  | 154   486 |                   | $ | 10   283             | 
|Tax   exempt                                                                 |  |                    | 1   060   |                   |   | 114                  | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total   loans                                                                |  |                    | 155   546 |                   |   | 10   397             | 
|                                                                             |  |                    |           |                   |   |                      | 
|Taxable securities                                                           |  |                    | 46   473  |                   |   | 1   575              | 
|Nontaxable securities                                                        |  |                    | 228       |                   |   | 11                   | 
|Securities purchased under   agreements to resell and federal funds sold     |  |                    | 3   457   |                   |   | 39                   | 
|Other earning assets                                                         |  |                    | 1   069   |                   |   | 29                   | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total earning assets                                                         |  |                    | 206 773   |                   | $ | 12 051               | 
|                                                                             |  |                    |           |                   |   |                      | 
|Allowance for loan losses                                                    |  |                    | (1   842  | )                 |   |                      | 
|Cash and due from banks                                                      |  |                    | 10   888  |                   |   |                      | 
|Premises and equipment, net                                                  |  |                    | 5   163   |                   |   |                      | 
|Other assets                                                                 |  |                    | 5   070   |                   |   |                      | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total   assets                                                               |  | $                  | 226   052 |                   |   |                      | 
|                                                                             |  |                    |           |                   |   |                      | 
|LIABILITIES AND   STOCKHOLDERS EQUITY                                       |  |                    |           |                   |   |                      | 
|Deposits                                                                     |  |                    |           |                   |   |                      | 
|Savings   and interest- bearing demand deposits                              |  | $                  | 104   182 |                   | $ | 442                  | 
|Time   deposits                                                              |  |                    | 55   961  |                   |   | 1   649              | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total   interest- bearing deposits                                           |  |                    | 160   143 |                   |   | 2   091              | 
|                                                                             |  |                    |           |                   |   |                      | 
|Securities sold under   agreements to repurchase and federal funds purchased |  |                    | 10   777  |                   |   | 232                  | 
|Advances from FHLB                                                           |  |                    | 1   584   |                   |   | 86                   | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total interest bearing liabilities                                           |  |                    | 172 504   |                   | $ | 2 409                | 
|                                                                             |  |                    |           |                   |   |                      | 
|Noninterest-bearing demand   deposits                                        |  |                    | 30   010  |                   |   |                      | 
|Other liabilities                                                            |  |                    | 1   493   |                   |   |                      | 
|Stockholders equity                                                         |  |                    | 22   045  |                   |   |                      | 
|                                                                             |  |                    |           |                   |   |                      | 
|Total   liabilities and stockholders equity                                 |  | $                  | 226   052 |                   |   |                      | 
|                                                                             |  |                    |           |                   |   |                      | 
|Net   interest income                                                        |  |                    |           |                   | $ | 9 642                | 
|                                                                             |  |                    |           |                   |   |                      | 
|Net   interest spread                                                        |  |                    |           |                   |   |                      | 
|Interest   expense as a percent of average earning assets                    |  |                    |           |                   |   |                      | 
|Net   interest margin                                                        |  |                    |           |                   |   |                      | 

11



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

CRITICAL ACCOUNTING POLICIES

GENERAL

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

ALLOWANCE FOR LOAN LOSSES

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

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

GENERAL

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

The continuing increase of regulation in the banking industry is a concern of management.  The cost of compliance with Sarbanes-Oxley Act of 2002 is expected to reach $250 thousand annually.  This adds additional pressure to find ways to increase income.

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

12



The company is seeking ways to reduce expenses in addition to ways to increase income.  During 2004 we contracted consultants to perform efficiency testing and examination of company operations.  Numerous suggestions came as a result of the consultants studies.  The suggestions included

| |  |  |  | Utilization of personnel to full potential allowing   the company to decrease numbers of employees in several areas.  Decreases in personnel will occur through   attrition not in terminations.                 
| |  |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |  | Reclassification of deposit balances so that a lower   required balance may be kept at the Federal Reserve.  This will allow the company to invest the   relocated funds in income producing loans or securities.
| |  |  |  | Increasing certain service charges while maintaining   a competitive position.                                                                                                                                   
| |  |  |  | Ways for more efficient use of cash.                                                                                                                                                                             
| |  |  |  | Outsourcing of official checks which frees time for   deposit operations personnel and provides a small amount of income earned on   the outstanding balance of these checks.                                    

The company has added tax exempt income in addition to tax exempt loan income with the January 2003 purchase of $3 million in bank owned life insurance policies.  This reduces the income tax expense for the company.

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

The following table sets forth selected quarterly results (with dollars in thousands) of the company for 2004 and 2003.



|                                                      |  | 2004   Three Months Ended |       | 2003   Three Months Ended |  
|----------------------------------------------------- |  | ------------------------- | ----- | ------------------------- | -
|                                                      |  |                           |       |                           |  
|                                                      |  | Dec 31                    |       | Sept 30                   |  
|                                                      |  |                           |       |                           |  
|Interest income                                       |  | $                         | 3 287 |                           | $
|Interest expense                                      |  |                           | 682   |                           |  
|                                                      |  |                           |       |                           |  
|Net interest income                                   |  |                           | 2 605 |                           |  
|Provision for loan losses                             |  |                           | 25    |                           |  
|                                                      |  |                           |       |                           |  
|Net interest income after   provision for loan losses |  |                           | 2 580 |                           |  
|Noninterest income                                    |  |                           | 843   |                           |  
|Noninterest expense                                   |  |                           | 2 131 |                           |  
|                                                      |  |                           |       |                           |  
|Income before income taxes                            |  |                           | 1 292 |                           |  
|Income tax expense                                    |  |                           | 467   |                           |  
|                                                      |  |                           |       |                           |  
|Net income                                            |  | $                         | 825   |                           | $
|                                                      |  |                           |       |                           |  
|Earnings per share, basic and   diluted               |  | $                         | .48   |                           | $
|                                                      |  |                           |       |                           |  

NET INTEREST INCOME

Growth in the loan portfolio of 28% during 2004 was the single most significant factor in the 12% increase in net interest income for 2004 compared to 2003.  The continuing affects of lower rates of the past few years diminished this increase in interest and fees somewhat.  Other factors affecting 2004 net interest income compared to 2003 were a decrease in the income on securities due to decreased rates and only an 8% increase in interest expense even though we had deposit growth as well as some increase in rates on deposits.

13



Net interest income in 2003 increased only 1% over 2002.  Total interest and dividend income actually decreased 4.4% in 2003 compared to 2002.  Interest and fees on loans increased only 2% in 2003 compared to 2002 due to decreased rates even though there was loan growth of almost 20%.  Income on securities decreased 25% in 2003 compared to 2002 due to lower rates and a decrease in volume.  Interest expense decreased 21% in 2003 compared to 2002 due almost entirely to decreased rates.

Management anticipates that the growth in loans and deposits that we have seen in the past several years will continue in future years as we continue to gain market share in the Berkeley County area as well as areas in Virginia.

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

VOLUME AND RATE ANALYSIS

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

|                                                                             |  | 2004   Compared to 2003   (in thousands) |       | 2003   Compared to 2002   (in thousands) |  
|---------------------------------------------------------------------------- |  | ---------------------------------------- | ----- | ---------------------------------------- | -
|                                                                             |  |                                          |       |                                          |  
|                                                                             |  | Change in   Income/   Expense            |       | Change in   Volume   Effect              |  
|                                                                             |  |                                          |       |                                          |  
|INTEREST INCOME                                                              |  |                                          |       |                                          |  
|Taxable loans                                                                |  | $                                        | 1 538 |                                          | $
|Tax exempt loans                                                             |  |                                          | (43   | )                                        |  
|Taxable securities                                                           |  |                                          | (253  | )                                        |  
|Nontaxable securities                                                        |  |                                          | 11    |                                          |  
|Securities purchased   under agreements to resell and federal funds sold     |  |                                          | (5    | )                                        |  
|Other earning assets                                                         |  |                                          | (36   | )                                        |  
|                                                                             |  |                                          |       |                                          |  
|TOTAL                                                                        |  | $                                        | 1 212 |                                          | $
|                                                                             |  |                                          |       |                                          |  
|INTEREST EXPENSE                                                             |  |                                          |       |                                          |  
|Savings and   interest-bearing demand deposits                               |  | $                                        | (20   | )                                        | $
|Time deposits                                                                |  |                                          | 152   |                                          |  
|Securities sold under   agreements to repurchase and federal funds purchased |  |                                          | 60    |                                          |  
|Advances from FHLB                                                           |  |                                          | (18   | )                                        |  
|                                                                             |  |                                          |       |                                          |  
|TOTAL                                                                        |  | $                                        | 174   |                                          | $
|                                                                             |  |                                          |       |                                          |  
|NET INTEREST INCOME                                                          |  | $                                        | 1 038 |                                          | $
|                                                                             |  |                                          |       |                                          |  

14



NONINTEREST INCOME AND EXPENSE

The major income producer for 2004 noninterest income, as in 2003 and 2002, continues to be the banks overdraft protection plan available for customers.  These fees are included in the service charges on deposit accounts category which totaled $1.5 million in 2004, $1.2 million in 2003 and $1.1 million in 2002.  Trust and financial services is the next largest contributor to the 2004 noninterest income figure with a 47% increase in income compared to 2003.  Trust income has increased in 2004 partially due to accrual of fees for settlement of several large estates.  Estate settlement fees are one area of income that is not particularly consistent from year to year.  The financial services area is also continuing to benefit from the growth of BCT Investments that offers brokerage services in addition to other financial services.  The vision for BCT Investments was to
reach customers with smaller amounts available for investment than were being handled through the regular trust services.  The vision has come to productive fruition in providing a needed customer service as well as providing additional noninterest income.  Trust and financial services income increased 21% in 2003 compared to 2002 due in large part to the first full year of income through BCT Investments.

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

Fees on sales of loans in the secondary market is a source of noninterest income that varies with the market conditions.  Our income from this source was $157 thousand in 2004, $360 thousand in 2003 and $176 thousand in 2002.

Salaries and employee benefits of $4.1 million are slightly over half of the total noninterest expense for 2004.  This percentage of salaries and benefits to total noninterest expense has decreased over the last three years which indicates better utilization of personnel even with significant growth in the banks asset base during the same time period.  Expenses related to premises, furniture and equipment of $1.3 million are 17% of total noninterest expense in 2004.  These expenses have increased in the past two years with the opening of the two branch offices in Berkeley County and our extensive modernization of computer technology.

When examining the noninterest expense portion of the income statements, you will see the increase in other professional fees in 2004 compared to 2003 and 2002.  This is primarily due to the consultants fee paid for the efficiency studies that were described earlier in this narrative.

Other operating expenses is the total of approximately 40 separate expense accounts.  The total for this category increased 20% or $200 thousand in 2004 compared to 2003 and 5% or $50 thousand in 2003 compared to 2002.  There is no significant change in any one account for either of these time period comparisons.  Most of the increases are due to the growth in the banks customer base and growth in facilities.

15



INTEREST RATE SENSITIVITY

The table below shows the opportunities the company will have to reprice interest earning assets and interest-bearing liabilities as of December 31, 2004 (in thousands).

|                                                                             |  | Mature or   Reprice   |        
|---------------------------------------------------------------------------- |  | --------------------- | -------
|                                                                             |  |                       |        
|                                                                             |  | Within   Three Months |        
|                                                                             |  |                       |        
|Interest Earning Assets:                                                     |  |                       |        
|Loans                                                                        |  | $                     | 65 526 
|Securities                                                                   |  |                       | 3 014  
|Securities purchased   under agreements to resell and federal funds sold     |  |                       | 6      
|Other earning assets                                                         |  |                       | 794    
|                                                                             |  |                       |        
|Total                                                                        |  | $                     | 69 340 
|                                                                             |  |                       |        
|Interest-Bearing Liabilities:                                                |  |                       |        
|Time deposits $100,000   and over                                            |  | $                     | 1 606  
|Other time deposits                                                          |  |                       | 6 305  
|Gold and Platinum   accounts (NOW accounts)                                  |  |                       | 62 520 
|Savings accounts                                                             |  |                       |       
|Securities sold under   agreements to repurchase and federal funds purchased |  |                       | 17 577 
|Federal Home Loan Bank   advances                                            |  |                       |       
|                                                                             |  |                       |        
|Total                                                                        |  | $                     | 88 008 
|                                                                             |  |                       |        
|Rate Sensitivity Gap                                                         |  | $                     | (18 668
|                                                                             |  |                       |        
|Cumulative Gap                                                               |  | $                     | (18 668
|                                                                             |  |                       |        
|                                                                             |  |                       |        

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

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

During the first twelve months shown in the schedule above, the company is liability sensitive, and after that time period the company is asset sensitive.  During January, February and March of 2005, $18.7 million more liabilities may reprice or will mature than assets.  During April through December of 2005, $5.8 million more liabilities may reprice or will mature than assets.  The total effect for 2005 is that $24.5 million more liabilities may reprice or mature than assets.  Therefore, the company will be impacted favorably if interest rates continue to decline and unfavorably if interest rates rise.

16



LOAN PORTFOLIO

Loans at December 31 (in thousands) for each of the five years in the period ended 2004.

|                                       |  | 2004 |         | 2003 |   | 2002    |  | 2001 |         | 2000 |  
|-------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | -
|                                       |  |      |         |      |   |         |  |      |         |      |  
|Commercial, financial and agricultural |  | $    | 5 949   |      | $ | 6 217   |  | $    | 3 696   |      | $
|Mortgage loans on real estate:         |  |      |         |      |   |         |  |      |         |      |  
|Construction and land   development    |  |      | 28 929  |      |   | 14 071  |  |      | 2 211   |      |  
|Secured by farm land                   |  |      | 3 986   |      |   | 3 711   |  |      | 1 821   |      |  
|Secured by 1-4 family   residential    |  |      | 79 800  |      |   | 62 693  |  |      | 63 239  |      |  
|Other real estate                      |  |      | 42 759  |      |   | 34 952  |  |      | 26 151  |      |  
|Consumer loans                         |  |      | 17 346  |      |   | 17 697  |  |      | 19 198  |      |  
|All other loans                        |  |      | 236     |      |   | 717     |  |      | 730     |      |  
|                                       |  |      |         |      |   |         |  |      |         |      |  
|                                       |  | $    | 179 005 |      | $ | 140 058 |  | $    | 117 046 |      | $
|                                       |  |      |         |      |   |         |  |      |         |      |  

An experienced and aggressive loan production staff continue to grow the loan portfolio.  Even though the loan production for secondary market sales decreased in 2004 compared to 2003, 2004 loan production for residential mortgages has increased the banks portfolio of loans secured by 1-4 family residential property.  Commercial lending continues to be a prime part of the loan portfolio showing in the construction and land development and other real estate categories.  The majority of the loan portfolio is well secured and delinquencies are being kept to a minimum.

There were no categories of loans that exceeded 10% of outstanding loans at December 31, 2004 that were not disclosed in the table above.

REMAINING MATURITIES (in thousands) OF SELECTED LOANS

|At December 31, 2004                                     |  | Commercial,   Financial and   Agricultural |       | Real   Estate-   Construction |  
|-------------------------------------------------------- |  | ------------------------------------------ | ----- | ----------------------------- | -
|                                                         |  |                                            |       |                               |  
|Loans maturing within one year                           |  | $                                          | 1 326 |                               | $
|Variable rate loans due after one year                   |  |                                            | 1 709 |                               |  
|Fixed rate loans due after one year through five   years |  |                                            | 2 914 |                               |  
|Fixed rate loans due after five years                    |  |                                            |      |                               |  
|                                                         |  |                                            |       |                               |  
|Total maturities                                         |  | $                                          | 5 949 |                               | $
|                                                         |  |                                            |       |                               |  

ALLOWANCE FOR LOAN LOSSES

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

|                                                                                            |  | 2004             |       | 2003 |   | 2002  |   | 2001 |       | 2000 |  
|------------------------------------------------------------------------------------------- |  | ---------------- | ----- | ---- | - | ----- | - | ---- | ----- | ---- | -
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|                                                                                            |  | (in   thousands) |      
|Balance at beginning of period                                                              |  | $                | 1 724 |      | $ | 1 642 |   | $    | 1 402 |      | $
|Charge-offs:                                                                                |  |                  |       |      |   |       |   |      |       |      |  
|Commercial, financial   and agricultural                                                    |  |                  |      |      |   |      |   |      |      |      |  
|Real estate    construction                                                                |  |                  |      |      |   |      |   |      |      |      |  
|Real estate  mortgage                                                                      |  |                  |      |      |   |      |   |      |      |      |  
|Consumer                                                                                    |  |                  | 202   |      |   | 191   |   |      | 287   |      |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Total charge-offs                                                                           |  |                  | 202   |      |   | 191   |   |      | 287   |      |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Recoveries:                                                                                 |  |                  |       |      |   |       |   |      |       |      |  
|Commercial, financial   and agricultural                                                    |  |                  |      |      |   |      |   |      |      |      |  
|Real estate    construction                                                                |  |                  |      |      |   |      |   |      |      |      |  
|Real estate  mortgage                                                                      |  |                  |      |      |   | 8     |   |      | 1     |      |  
|Consumer                                                                                    |  |                  | 155   |      |   | 118   |   |      | 103   |      |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Total recoveries                                                                            |  |                  | 155   |      |   | 126   |   |      | 104   |      |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Net charge-offs                                                                             |  |                  | 47    |      |   | 65    |   |      | 183   |      |  
|Additions charged to operations                                                             |  |                  | 289   |      |   | 147   |   |      | 423   |      |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Balance at end of period                                                                    |  | $                | 1 966 |      | $ | 1 724 |   | $    | 1 642 |      | $
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  
|Ratio of net charge-offs during the period to   average loans outstanding during the period |  |                  | 0.03  | %    |   | 0.05  | % |      | 0.17  | %    |  
|                                                                                            |  |                  |       |      |   |       |   |      |       |      |  

17



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.

|                                         |  | 2004                         |         | 2003                                   |  | 2002                         |   | 2001                                   |         | 2000                         | 
|---------------------------------------- |  | ---------------------------- | ------- | -------------------------------------- |  | ---------------------------- | - | -------------------------------------- | ------- | ---------------------------- | 
|                                         |  |                              |         |                                        |  |                              |   |                                        |         |                              | 
|                                         |  | Allowance   (in   thousands) |         | % Loans in   Category to   Total Loans |  | Allowance   (in   thousands) |   | % Loans in   Category to   Total Loans |         | Allowance   (in   thousands) | 
|                                         |  |                              |         |                                        |  |                              |   |                                        |         |                              | 
|Commercial, financial and   agricultural |  | $                            | 81      |                                        |  | 3.32                         | % | $                                      | 62      |                              | 
|Mortgage loans on real   estate:         |  |                              |         |                                        |  |                              |   |                                        |         |                              | 
|Construction   and land development      |  |                              | 166     |                                        |  | 16.16                        | % |                                        | 141     |                              | 
|Secured   by farm land                   |  |                              | 29      |                                        |  | 2.23                         | % |                                        | 37      |                              | 
|Secured   by 1-4 family residential      |  |                              | 458     |                                        |  | 44.58                        | % |                                        | 272     |                              | 
|Other   real estate                      |  |                              | 365     |                                        |  | 23.89                        | % |                                        | 350     |                              | 
|Consumer loans                           |  |                              | 591     |                                        |  | 9.69                         | % |                                        | 536     |                              | 
|All other loans                          |  |                              | 3       |                                        |  | .13                          | % |                                        | 6       |                              | 
|Unallocated                              |  |                              | 273     |                                        |  |                             |   |                                        | 320     |                              | 
|                                         |  |                              |         |                                        |  |                              |   |                                        |         |                              | 
|                                         |  | $                            | 1   966 |                                        |  | 100.00                       | % | $                                      | 1   724 |                              | 
|                                         |  |                              |         |                                        |  |                              |   |                                        |         |                              | 

RISK ELEMENTS IN THE LOAN PORTFOLIO

|                                                                     |  | 2004             |      | 2003 |   | 2002 |   | 2001 |      | 2000 |  
|-------------------------------------------------------------------- |  | ---------------- | ---- | ---- | - | ---- | - | ---- | ---- | ---- | -
|                                                                     |  |                  |      |      |   |      |   |      |      |      |  
|                                                                     |  | (in   thousands) |     
|Nonaccrual loans                                                     |  | $                |     |      | $ | 251  |   | $    |     |      | $
|Restructured loans                                                   |  |                  |     |      |   |     |   |      |     |      |  
|Foreclosed properties                                                |  |                  |     |      |   |     |   |      |     |      |  
|                                                                     |  |                  |      |      |   |      |   |      |      |      |  
|Total nonperforming   assets                                         |  | $                |     |      | $ | 251  |   | $    |     |      | $
|                                                                     |  |                  |      |      |   |      |   |      |      |      |  
|Loans past due 90 days accruing interest                             |  | $                |     |      | $ | 153  |   | $    | 41   |      | $
|                                                                     |  |                  |      |      |   |      |   |      |      |      |  
|Allowance for loan losses to period end loans                        |  |                  | 1.10 | %    |   | 1.23 | % |      | 1.40 | %    |  
|Nonperforming assets to period end loans and   foreclosed properties |  |                  |     |      |   | .18  | % |      |     |      |  

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

Impaired loans excluded from nonperforming assets amounted to $341 thousand at December 31, 2003.  There were no impaired loans at December 31, 2004.

At December 31, 2004, other potential problem loans totaled $843 thousand.  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.

18



SECURITIES PORTFOLIO

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

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

|                                                |  | 2004   Carrying Value   (in thousands) |        | Weighted   Average   Yield |  | 2003   Carrying Value   (in thousands) |   | Weighted   Average   Yield |        | 2002   Carrying Value   (in thousands) |  | Weighted   Average   Yield |  
|----------------------------------------------- |  | -------------------------------------- | ------ | -------------------------- |  | -------------------------------------- | - | -------------------------- | ------ | -------------------------------------- |  | -------------------------- | -
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Securities held to maturity                     |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Obligations of U.S.   Government agencies:      |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Maturing within one   year                      |  | $                                      |       |                            |  |                                       |   | $                          | 6 002  |                                        |  | 5.02                       | %
|Maturing after one year   but within five years |  |                                        |       |                            |  |                                       |   |                            |       |                                        |  |                           |  
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Total securities held   to maturity             |  | $                                      |       |                            |  |                                        |   | $                          | 6 002  |                                        |  |                            |  
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Securities available for sale                   |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Obligations of U.S.   Government agencies:      |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Maturing within one   year                      |  | $                                      | 9 042  |                            |  | 4.12                                   | % | $                          | 5 132  |                                        |  | 4.73                       | %
|Maturing after one year   but within five years |  |                                        | 36 982 |                            |  | 3.32                                   | % |                            | 33 293 |                                        |  | 3.47                       | %
|Municipal obligations:                          |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Maturing within one   year                      |  |                                        |       |                            |  |                                       |   |                            |       |                                        |  |                           |  
|Maturing after one year   but within five years |  |                                        | 529    |                            |  | 3.57                                   | % |                            |       |                                        |  |                           |  
|Maturing after five   years                     |  |                                        | 786    |                            |  | 3.70                                   | % |                            |       |                                        |  |                           |  
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Total securities   available for sale           |  | $                                      | 47 339 |                            |  |                                        |   | $                          | 38 425 |                                        |  |                            |  
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  
|Total securities                                |  | $                                      | 47 339 |                            |  |                                        |   | $                          | 44 427 |                                        |  |                            |  
|                                                |  |                                        |        |                            |  |                                        |   |                            |        |                                        |  |                            |  

DEPOSITS

Deposit growth has been strong especially in the noninterest bearing accounts which provide an inexpensive source of funding.  However, deposit growth including the securities sold with agreements to repurchase of our business sweep accounts did not keep up with the loan growth during 2004.  We have had to depend on alternative methods of funding.  We are anticipating additional deposit growth through our Berkeley County branch offices.  The new full service branch office opened in January 2005 in Martinsburg and we continue to work in the area of our Hedgesville office.  As of June 2003, the bank had less than 1% of the market share of deposits in Berkeley County.  As of June 2004, we have almost 2.5% of the market share.

Schedule of Average Deposits and Average Rates Paid

|                                    |  | Year Ended   December 31 |        
|----------------------------------- |  | ------------------------ | -------
|                                    |  |                          |        
|                                    |  | 2004                     |        
|                                    |  |                          |        
|                                    |  | Average   Balance        |        
|                                    |  |                          |        
|Noninterest-bearing demand deposits |  | $                        | 30 010 
|                                    |  |                          |        
|Interest-bearing demand deposits    |  |                          | 82 426 
|Savings deposits                    |  |                          | 21 756 
|Time deposits                       |  |                          | 55 961 
|                                    |  |                          |        
|Total interest-bearing deposits     |  |                          | 160 143
|                                    |  |                          |        
|Total deposits                      |  | $                        | 190 153
|                                    |  |                          |        

19



At December 31, 2004 time deposits of $100 thousand or more were 6.58% of total deposits compared with 7.19% at December 31, 2003.  Maturities of time deposits of $100 thousand or more (in thousands) at December 31, 2004 are as follows:

|Within three months                   |  | $ | 1 606  | 
|------------------------------------- |  | - | ------ | 
|Over three through six months         |  |   | 798    | 
|Over six months through twelve months |  |   | 2 850  | 
|Over twelve months                    |  |   | 7 945  | 
|                                      |  |   |        | 
|Total                                 |  | $ | 13 199 | 
|                                      |  |   |        | 

ANALYSIS OF CPITAL

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

The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation 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 company had a ratio of total capital to risk-weighted assets of 14.44% and a ratio of Tier 1 capital to risk-weighted assets of 13.29 % at December 31, 2004.  These two ratios have decreased because of the use of capital to repurchase shares of Potomac stock for the treasury and
because of the asset growth during 2004.  Even with the reductions in these ratios, both exceed the capital requirements adopted by the federal regulatory agencies.

|                                                |  | (In   thousands) |        
|----------------------------------------------- |  | ---------------- | -------
|                                                |  |                  |        
|                                                |  | 2004             |        
|                                                |  |                  |        
|Tier 1 capital:                                 |  |                  |        
|Common stock                                    |  | $                | 1 800  
|Surplus                                         |  |                  | 4 200  
|Retained earnings                               |  |                  | 18 631 
|                                                |  |                  |        
|                                                |  |                  | 24 631 
|Less cost of shares   acquired for the treasury |  |                  | 1 850  
|                                                |  |                  |        
|Total tier 1 capital                            |  | $                | 22 781 
|Tier 2 capital:                                 |  |                  |        
|Allowance for loan   losses (1)                 |  |                  | 1 966  
|                                                |  |                  |        
|Total risk-based capital                        |  | $                | 24 747 
|                                                |  |                  |        
|Risk-weighted assets                            |  | $                | 171 432
|                                                |  |                  |        
|Capital ratios:                                 |  |                  |        
|Tier 1 risk-based   capital ratio               |  |                  | 13.29  
|Total risk-based   capital ratio                |  |                  | 14.44  
|Leverage ratio                                  |  |                  | 9.45   

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

20



LIQUIDITY

Liquidity represents an institutions ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management.  This could also be termed the management of the cash flows of an organization.  Liquid assets include cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year.  The companys liquidity during 2004 is detailed in the statement of cash flows included in the financial statements.

Operating Activities.  The companys net income provides cash from the banks operating activities.  The net income figure is adjusted for certain noncash transactions such as depreciation expense that reduces net income but does not require a cash outlay.  During 2004 net income as adjusted has provided cash of $4.2 million.  Interest income earned on loans and investments is the companys major income source.

Investing Activities.  Customer deposits and company borrowings provide the funds used to invest in loans and securities investments.  In addition, principal portion of loan payments and payoffs and investment maturities provide cash flow.  Purchases of bank premises and equipment are an investing activity.  As mentioned in the deposit discussion above, we have taken advantage of our borrowing capabilities for additional funding since deposit growth was not sufficient to cover our needs.  The net amount of cash used in investing activities in 2004 is $44.2 million.

Financing Activities.  Customer deposits and company borrowings provide the financing for the investing activities as stated above.  If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities.  Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds.  Financing activities also include payment of dividends to shareholders, purchase of shares of the companys common stock for the treasury and repayment of any borrowed or purchased funds.  The net amount of cash provided by financing activities in 2004 is $39.2 million.

At December 31, 2004, 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 $49.877 million.

Borrowing capabilities provide additional liquidity.  The subsidiary bank maintains a federal funds line of $7 million with one financial institution and a federal funds line of $4 million with a second financial institution.  The subsidiary bank is also a member of the Federal Home Loan Bank of Pittsburgh and has short and/or long-term borrowing capabilities of approximately $100.026 million.  In June 2001, the subsidiary bank borrowed $2.5 million amortized over seven years from the Federal Home Loan Bank.  In December 2004, the subsidiary bank opened a Repo Plus account with the FHLB with a current credit line of $20 million.  This line has a maturity date one year from the date opened.

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

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

A summary of the contract or notional amount of the companys exposure to off-balance-sheet risk as of December 31, 2004 and 2003, is as follows:

|                                                                      |  | 2004 |        | 2003 |  
|--------------------------------------------------------------------- |  | ---- | ------ | ---- | -
|                                                                      |  |      |        |      |  
|                                                                      |  |      |        |      |  
|Financial instruments whose contract amounts   represent credit risk: |  |      |        |      |  
|Commitments to extend   credit                                        |  | $    | 58 477 |      | $
|Standby letters of   credit                                           |  |      | 2 996  |      |  

21



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

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

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

At December 31, 2004, the company had rate lock commitments to originate mortgage loans amounting to $1.1 million and loans held for sale of $148 thousand.  The company has entered into corresponding mandatory commitments, on a best-efforts basis, to sell these loans.  These commitments to sell loans are designed to eliminate the companys exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

Short-Term Borrowings.Short-term borrowings consist of securities sold under agreements to repurchase and federal funds purchased.  A portion of the securities sold under agreements to repurchase are secured transactions with customers and some are through the Federal Home Loan Bank of Pittsburgh.  Federal funds are purchased through The Bankers Bank and Mercantile Safe Deposit and Trust Company.  These borrowings generally mature the day following the day sold.  Balances of these borrowings were $22.6 million on December 31, 2004 and $9.1 million on December 31, 2003.

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

|                                                 |  | December   31 |       
|------------------------------------------------ |  | ------------- | ------
|                                                 |  |               |       
|                                                 |  | 2004          |       
|                                                 |  |               |       
|Balance outstanding at year end                  |  | $             | 22 577
|Maximum balance at any month-end during the year |  | $             | 22 577
|Average balance for the year                     |  | $             | 10 818
|Weighted average rate for the year               |  |               | 2.19  
|Weighted average rate at year end                |  |               | 2.55  
|Estimated fair value                             |  | $             | 22 577

Contractual Obligations.  The table below presents the contractual obligations of the company as of December 31, 2004:

|                           |  | Payments   (in thousands) Due By Period |      
|-------------------------- |  | --------------------------------------- | -----
|                           |  |                                         |      
|                           |  | Total                                   |      
|                           |  |                                         |      
|Long-Term Debt Obligations |  | $                                       | 1 370
|                           |  |                                         |      

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

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

22



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

Earnings Simulation Analysis

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

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

The most likely scenario represents the rate environment as management forecasts it to occur.  From this base, rate shocks in 100 basis point increments are applied to see the impact on the companys earnings.  The following table represents the interest rate sensitivity on net income (fully tax equivalent basis) for the company using different rate scenarios as of December 31, 2004:

|Change in   Yield Curve |  | % Change   in   Net Income
|----------------------- |  | --------------------------
|                        |  |                           
|+ 200 basis points      |  | +  5.6%                   
|+ 100 basis points      |  | +  2.9%                   
|Most   likely           |  | 0                         
|- 100 basis points      |  | -  3.1%                   
|- 200 basis points      |  | -  6.4%                   

Economic Value Simulation

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

The following chart reflects the change in net market value over different rate environments as of December 31, 2004:

|Change in   Yield Curve |  | Change in   Economic Value of Equity   (dollars in thousands)
|----------------------- |  | -------------------------------------------------------------
|                        |  |                                                              
|+ 200 basis points      |  | $  -  2,023                                                  
|+ 100 basis points      |  | - 1,032                                                      
|Most   likely           |  | 0                                                            
|- 100 basis points      |  | +  484                                                       
|- 200 basis points      |  | +  344                                                       

23



|Item   8. | Financial   Statements and Supplementary Data.
|--------- | ----------------------------------------------

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated balance sheets of Potomac Bancshares, Inc. and Subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders equity and cash flows for each of the three years ended December 31, 2004.  These financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years ended December 31, 2004, in conformity with U. S. generally accepted accounting principles.

Message

Winchester, Virginia January 27, 2005

24



POTOMAC BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2004 and 2003 (in thousands)

|                                                                                             |  | 2004 |         | 2003 |  
|-------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | -
|                                                                                             |  |      |         |      |  
|ASSETS                                                                                       |  |      |         |      |  
|Cash and due from banks                                                                      |  | $    | 11 371  |      | $
|Interest-bearing deposits in financial institutions                                          |  |      | 794     |      |  
|Securities purchased under agreements to resell and   federal funds sold                     |  |      | 6       |      |  
|Securities held to maturity (fair value $6,039 in   2003)                                    |  |      |        |      |  
|Securities available for sale, at fair value                                                 |  |      | 47 339  |      |  
|Loans held for sale                                                                          |  |      | 148     |      |  
|Loans, net of allowance for loan losses of $1,966 in   2004 and $1,724 in 2003               |  |      | 177 039 |      |  
|Premises and equipment, net                                                                  |  |      | 5 787   |      |  
|Accrued interest receivable                                                                  |  |      | 913     |      |  
|Other assets                                                                                 |  |      | 5 139   |      |  
|                                                                                             |  |      |         |      |  
|Total Assets                                                                                 |  | $    | 248 536 |      | $
|                                                                                             |  |      |         |      |  
|LIABILITIES AND   STOCKHOLDERS EQUITY                                                       |  |      |         |      |  
|LIABILITIES                                                                                  |  |      |         |      |  
|Deposits                                                                                     |  |      |         |      |  
|Noninterest-bearing                                                                          |  | $    | 34 236  |      | $
|Interest-bearing                                                                             |  |      | 166 315 |      |  
|                                                                                             |  |      |         |      |  
|Total Deposits                                                                               |  | $    | 200 551 |      | $
|Accrued interest   payable                                                                   |  |      | 180     |      |  
|Securities sold under   agreements to repurchase and federal funds purchased                 |  |      | 17 577  |      |  
|Federal Home Loan Bank   advances                                                            |  |      | 6 370   |      |  
|Other liabilities                                                                            |  |      | 1 102   |      |  
|Commitments and   contingent liabilities                                                     |  |      |        |      |  
|                                                                                             |  |      |         |      |  
|Total Liabilities                                                                            |  | $    | 225 780 |      | $
|                                                                                             |  |      |         |      |  
|STOCKHOLDERS EQUITY                                                                         |  |      |         |      |  
|Common stock, $1 per   share par value; 5,000,000 shares authorized; issued 1,800,000 shares |  | $    | 1 800   |      | $
|Surplus                                                                                      |  |      | 4 200   |      |  
|Undivided profits                                                                            |  |      | 18 631  |      |  
|Accumulated other   comprehensive income (loss)                                              |  |      | (25     | )    |  
|                                                                                             |  |      |         |      |  
|                                                                                             |  | $    | 24 606  |      | $
|Less cost of shares   acquired for the treasury, 2004, 103,439 shares; 2003, 97,329 shares   |  |      | 1 850   |      |  
|                                                                                             |  |      |         |      |  
|Total Stockholders   Equity                                                                 |  | $    | 22 756  |      | $
|                                                                                             |  |      |         |      |  
|Total Liabilities and   Stockholders Equity                                                 |  | $    | 248 536 |      | $
|                                                                                             |  |      |         |      |  

See Notes to Consolidated Financial Statements.

25



POTOMAC BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2004, 2003 and 2002 (in thousands, except per share data)

|                                                                                     |  | 2004 |        | 2003 |   | 2002   | 
|------------------------------------------------------------------------------------ |  | ---- | ------ | ---- | - | ------ | 
|                                                                                     |  |      |        |      |   |        | 
|Interest and Dividend Income:                                                        |  |      |        |      |   |        | 
|Interest and fees on   loans                                                         |  | $    | 10 358 |      | $ | 8 848  | 
|Interest on securities   held to maturity - taxable                                  |  |      | 35     |      |   | 360    | 
|Interest on securities   available for sale - taxable                                |  |      | 1 540  |      |   | 1 469  | 
|Interest on securities   available for sale  nontaxable                             |  |      | 7      |      |   |       | 
|Interest on securities   purchased under agreements to resell and federal funds sold |  |      | 39     |      |   | 44     | 
|Other interest and   dividends                                                       |  |      | 29     |      |   | 65     | 
|                                                                                     |  |      |        |      |   |        | 
|Total Interest and   Dividend Income                                                 |  | $    | 12 008 |      | $ | 10 786 | 
|                                                                                     |  |      |        |      |   |        | 
|Interest Expense:                                                                    |  |      |        |      |   |        | 
|Interest on deposits                                                                 |  | $    | 2 091  |      | $ | 1 959  | 
|Interest on securities   sold under agreements to repurchase                         |  |      | 232    |      |   | 172    | 
|Federal Home Loan Bank   advances                                                    |  |      | 86     |      |   | 104    | 
|                                                                                     |  |      |        |      |   |        | 
|Total Interest Expense                                                               |  | $    | 2 409  |      | $ | 2 235  | 
|                                                                                     |  |      |        |      |   |        | 
|Net Interest Income                                                                  |  | $    | 9 599  |      | $ | 8 551  | 
|Provision for Loan Losses                                                            |  |      | 289    |      |   | 147    | 
|                                                                                     |  |      |        |      |   |        | 
|Net Interest Income   after Provision for Loan Losses                                |  | $    | 9 310  |      | $ | 8 404  | 
|                                                                                     |  |      |        |      |   |        | 
|Noninterest Income:                                                                  |  |      |        |      |   |        | 
|Trust and financial   services                                                       |  | $    | 826    |      | $ | 561    | 
|Service charges on   deposit accounts                                                |  |      | 1 512  |      |   | 1 217  | 
|Visa/MC Fees                                                                         |  |      | 180    |      |   | 107    | 
|Net gain on sale of   loans                                                          |  |      | 157    |      |   | 360    | 
|Cash surrender value of   life insurance                                             |  |      | 141    |      |   | 165    | 
|Gain (loss) on sale of   securities available for sale                               |  |      | (26    | )    |   | 99     | 
|Other operating income                                                               |  |      | 368    |      |   | 335    | 
|                                                                                     |  |      |        |      |   |        | 
|Total Noninterest   Income                                                           |  | $    | 3 158  |      | $ | 2 844  | 
|                                                                                     |  |      |        |      |   |        | 
|Noninterest Expenses:                                                                |  |      |        |      |   |        | 
|Salaries and employee   benefits                                                     |  | $    | 4 076  |      | $ | 3 955  | 
|Net occupancy expense   of premises                                                  |  |      | 399    |      |   | 378    | 
|Furniture and equipment   expenses                                                   |  |      | 881    |      |   | 892    | 
|Advertising and   marketing                                                          |  |      | 222    |      |   | 229    | 
|Stationery and supplies                                                              |  |      | 156    |      |   | 190    | 
|Postage                                                                              |  |      | 157    |      |   | 132    | 
|Communications                                                                       |  |      | 150    |      |   | 144    | 
|Other professional fees                                                              |  |      | 203    |      |   | 37     | 
|ATM and check card   expense                                                         |  |      | 196    |      |   | 164    | 
|Other operating   expenses                                                           |  |      | 1 228  |      |   | 1 021  | 
|                                                                                     |  |      |        |      |   |        | 
|Total Noninterest   Expenses                                                         |  | $    | 7 668  |      | $ | 7 142  | 
|                                                                                     |  |      |        |      |   |        | 
|Income before Income   Tax Expense                                                   |  | $    | 4 800  |      | $ | 4 106  | 
|Income Tax Expense                                                                   |  |      | 1 710  |      |   | 1 432  | 
|                                                                                     |  |      |        |      |   |        | 
|Net Income                                                                           |  | $    | 3 090  |      | $ | 2 674  | 
|                                                                                     |  |      |        |      |   |        | 
|Earnings Per Share, basic and diluted                                                |  | $    | 1.82   |      | $ | 1.53   | 
|                                                                                     |  |      |        |      |   |        | 

See Notes to Consolidated Financial Statements.

26



POTOMAC BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY Years Ended December 31, 2004, 2003 and 2002 (in thousands, except per share data)

|                                                                           |  | Common   Stock |         | Surplus |   | Undivided   Profits |   | Treasury   Stock |          | Accumulated   Other   Comprehensive   Income (Loss) |   | Comprehensive   Income |   | Total |     
|-------------------------------------------------------------------------- |  | -------------- | ------- | ------- | - | ------------------- | - | ---------------- | -------- | --------------------------------------------------- | - | ---------------------- | - | ----- | ----
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Balances, December 31, 2001                                                |  | $              | 600     |         | $ | 5   400             |   | $                | 13   207 |                                                     | $ |                       |   | $     | 209 
|Comprehensive   income                                                     |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Net   income  2002                                                        |  |                |        |         |   |                    |   |                  | 2   459  |                                                     |   |                       |   |       |    
|Other   comprehensive income:                                              |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Unrealized   holding gains arising during the period (net of tax, $373)    |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | 724 
|Minimum   pension liability adjustment (net of tax, $89)                   |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | (174
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Total   comprehensive income                                               |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Cash   dividends  2002 ($.48 per share)                                   |  |                |        |         |   |                    |   |                  | (865     | )                                                   |   |                       |   |       |    
|Purchase   of treasury shares:                                             |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|18,330   shares                                                            |  |                |        |         |   |                    |   |                  |         |                                                     |   | (248                   | ) |       |    
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Balances, December 31, 2002                                                |  | $              | 600     |         | $ | 5   400             |   | $                | 14   801 |                                                     | $ | (248                   | ) | $     | 759 
|Comprehensive   income                                                     |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Net   income  2003                                                        |  |                |        |         |   |                    |   |                  | 2   674  |                                                     |   |                       |   |       |    
|Other   comprehensive income:                                              |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Unrealized   holding (losses) arising during the period (net of tax, $190) |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | (370
|Reclassification   for (gains) included in net income (net of tax, $34)    |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | (65 
|Minimum   pension liability adjustment (net of tax, $89)                   |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | 174 
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Total   comprehensive income                                               |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Stock   split in the form of a 200% stock dividend                         |  |                | 1   200 |         |   | (1   200            | ) |                  |         |                                                     |   |                       |   |       |    
|Cash   dividends  2003 ($.54 per share)                                   |  |                |        |         |   |                    |   |                  | (932     | )                                                   |   |                       |   |       |    
|Purchase   of treasury shares:                                             |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|78,999   shares                                                            |  |                |        |         |   |                    |   |                  |         |                                                     |   | (1   461               | ) |       |    
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Balances, December 31, 2003                                                |  | $              | 1   800 |         | $ | 4   200             |   | $                | 16   543 |                                                     | $ | (1   709               | ) | $     | 498 
|Comprehensive   income                                                     |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Net   income  2004                                                        |  |                |        |         |   |                    |   |                  | 3   090  |                                                     |   |                       |   |       |    
|Other   comprehensive income:                                              |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Unrealized   holding (losses) arising during the period (net of tax, $277) |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | (540
|Reclassification   for losses included in net income (net of tax, $9)      |  |                |        |         |   |                    |   |                  |         |                                                     |   |                       |   |       | 17  
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Total   comprehensive income                                               |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Cash   dividends  2004 ($.59 per share)                                   |  |                |        |         |   |                    |   |                  | (1   002 | )                                                   |   |                       |   |       |    
|Purchase   of treasury shares:                                             |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|6,110   shares                                                             |  |                |        |         |   |                    |   |                  |         |                                                     |   | (141                   | ) |       |    
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     
|Balances, December 31, 2004                                                |  | $              | 1   800 |         | $ | 4   200             |   | $                | 18   631 |                                                     | $ | (1   850               | ) | $     | (25 
|                                                                           |  |                |         |         |   |                     |   |                  |          |                                                     |   |                        |   |       |     

See Notes to Consolidated Financial Statements.

27



POTOMAC BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31, 2004, 2003 and 2002(in thousands)

|                                                                                               |  | 2004 |           | 2003 |   | 2002      |  
|---------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | --------- | -
|                                                                                               |  |      |           |      |   |           |  
|CASH FLOWS FROM OPERATING   ACTIVITIES                                                         |  |      |           |      |   |           |  
|Net   income                                                                                   |  | $    | 3   090   |      | $ | 2   674   |  
|Adjustments   to reconcile net income to net cash provided by operating activities:            |  |      |           |      |   |           |  
|Provision   for loan losses                                                                    |  |      | 289       |      |   | 147       |  
|Depreciation                                                                                   |  |      | 605       |      |   | 623       |  
|Deferred   tax expense (benefit)                                                               |  |      | (32       | )    |   | 20        |  
|Premium   amortization on securities, net                                                      |  |      | 101       |      |   | 154       |  
|(Gain)   loss on sale of securities available for sale                                         |  |      | 26        |      |   | (99       | )
|Proceeds   from sale of loans                                                                  |  |      | 8   749   |      |   | 21   104  |  
|Origination   of loans for sale                                                                |  |      | (8   333  | )    |   | (19   745 | )
|Changes   in assets and liabilities:                                                           |  |      |           |      |   |           |  
|(Increase)   decrease in accrued interest receivable                                           |  |      | (4        | )    |   | 156       |  
|(Increase)   in other assets                                                                   |  |      | (444      | )    |   | (3   121  | )
|Increase   (decrease) in accrued interest payable                                              |  |      | 52        |      |   | (32       | )
|Increase   (decrease) in other liabilities                                                     |  |      | 89        |      |   | 196       |  
|                                                                                               |  |      |           |      |   |           |  
|Net   cash provided by operating activities                                                    |  | $    | 4   188   |      | $ | 2   077   |  
|                                                                                               |  |      |           |      |   |           |  
|CASH FLOWS FROM INVESTING   ACTIVITIES                                                         |  |      |           |      |   |           |  
|Proceeds   from maturity of securities held to maturity                                        |  | $    | 6   000   |      | $ | 3   000   |  
|Proceeds   from maturity of securities available for sale                                      |  |      | 2   000   |      |   | 7   000   |  
|Proceeds   from sale of securities available for sale                                          |  |      | 8   974   |      |   | 8   118   |  
|Proceeds   from call of securities available for sale                                          |  |      | 5   000   |      |   | 3   000   |  
|Purchases   of securities available for sale                                                   |  |      | (25   805 | )    |   | (14   516 | )
|Net   (increase) in loans                                                                      |  |      | (38   994 | )    |   | (23   078 | )
|Purchases   of premises and equipment                                                          |  |      | (1   401  | )    |   | (1   158  | )
|                                                                                               |  |      |           |      |   |           |  
|Net   cash (used in) investing activities                                                      |  | $    | (44   226 | )    | $ | (17   634 | )
|                                                                                               |  |      |           |      |   |           |  
|CASH FLOWS FROM FINANCING   ACTIVITIES                                                         |  |      |           |      |   |           |  
|Net   increase in noninterest-bearing deposits                                                 |  | $    | 8   840   |      | $ | 3   822   |  
|Net   increase in interest-bearing deposits                                                    |  |      | 18   455  |      |   | 7   254   |  
|Net   proceeds in securities sold under agreements to repurchase and federal funds   purchased |  |      | 8   378   |      |   | 3   097   |  
|Net   proceeds (repayment) of Federal Home Loan Bank advances                                  |  |      | 4   655   |      |   | (327      | )
|Purchase   of treasury shares                                                                  |  |      | (141      | )    |   | (1   461  | )
|Cash   dividends                                                                               |  |      | (1   002  | )    |   | (932      | )
|                                                                                               |  |      |           |      |   |           |  
|Net   cash provided by financing activities                                                    |  | $    | 39   185  |      | $ | 11   453  |  
|                                                                                               |  |      |           |      |   |           |  
|Increase   (decrease) in cash and cash equivalents                                             |  | $    | (853      | )    |   | (4   104  | )
|CASH AND CASH EQUIVALENTS                                                                      |  |      |           |      |   |           |  
|Beginning                                                                                      |  |      | 13   024  |      |   | 17   128  |  
|                                                                                               |  |      |           |      |   |           |  
|Ending                                                                                         |  | $    | 12   171  |      | $ | 13   024  |  
|                                                                                               |  |      |           |      |   |           |  
|SUPPLEMENTAL DISCLOSURES OF   CASH FLOW INFORMATION                                            |  |      |           |      |   |           |  
|Cash   payments for:                                                                           |  |      |           |      |   |           |  
|Interest                                                                                       |  | $    | 2   357   |      | $ | 2   267   |  
|                                                                                               |  |      |           |      |   |           |  
|Income   taxes                                                                                 |  | $    | 1   677   |      | $ | 1   209   |  
|                                                                                               |  |      |           |      |   |           |  
|SUPPLEMENTAL DISCLOSURES OF   NON-CASH INVESTING AND FINANCING ACTIVITIES                      |  |      |           |      |   |           |  
|Unrealized   gain (loss) on securities available for sale                                      |  | $    | (791      | )    | $ | (659      | )
|                                                                                               |  |      |           |      |   |           |  
|Minimum   pension liability adjustment                                                         |  | $    |          |      | $ | (263      | )
|                                                                                               |  |      |           |      |   |           |  

See Notes to Consolidated Financial Statements.

28



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

|Note   1. | Nature of Banking Activities and Significant   Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          | Potomac Bancshares, Inc. and Subsidiary (the   company) grant commercial, financial, agricultural, residential and consumer   loans to customers, primarily in Berkeley County and Jefferson County, West   Virginia.  The companys market area   also includes Washington County and Frederick County, Maryland and Frederick   County, 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 company   conform to accounting principles generally accepted in the United States of   America and to general practices within the banking industry.  The following is a summary of the more   significant policies.                                                                                                                                                                                                                                                                                                                                                        
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

29



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

30





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

| |  | Premises and Equipment
| |  | ----------------------
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  | Other Real Estate     
| |  |                       
| |  |                       
| |  |                       
| |  | Employee Benefit Plans
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  |                       
| |  | Stock Split           
| |  |                       
| |  |                       

31



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

32



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

|                                                                                                 |  | For the   Years Ended                              |      
|------------------------------------------------------------------------------------------------ |  | -------------------------------------------------- | -----
|                                                                                                 |  |                                                    |      
|                                                                                                 |  | December   31   2004                               |      
|                                                                                                 |  |                                                    |      
|                                                                                                 |  | (dollars in   thousands, except per share amounts) |      
|Net income, as reported                                                                          |  | $                                                  | 3 090
|Total stock-based   compensation expense determined under fair value based method for all awards |  |                                                    | (32  
|                                                                                                 |  |                                                    |      
|Pro forma net income                                                                             |  | $                                                  | 3 058
|                                                                                                 |  |                                                    |      
|Earnings per share:                                                                              |  |                                                    |      
|Basic  as reported                                                                              |  | $                                                  | 1.82 
|                                                                                                 |  |                                                    |      
|Basic  pro forma                                                                                |  | $                                                  | 1.80 
|                                                                                                 |  |                                                    |      
|Diluted  as reported                                                                            |  | $                                                  | 1.82 
|                                                                                                 |  |                                                    |      
|Diluted  pro forma                                                                              |  | $                                                  | 1.80 
|                                                                                                 |  |                                                    |      

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

33



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

34



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

35



|Note   2. | Securities                                                                                                                                                                                             
|--------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                        
|          | There were no securities held to maturity as of   December 31, 2004.  The amortized cost   and fair value of securities being held to maturity as of December 31, 2003   (in thousands) are as follows:

|                                        |  | 2003             |      
|--------------------------------------- |  | ---------------- | -----
|                                        |  |                  |      
|                                        |  | Amortized   Cost |      
|                                        |  |                  |      
|Obligations of U.S. Government agencies |  | $                | 6 002
|                                        |  |                  |      

| | The amortized cost and fair value of securities   available for sale as of December 31, 2004 and 2003 (in thousands) are as   follows:
| | --------------------------------------------------------------------------------------------------------------------------------------

|                                        |  | 2004             |       
|--------------------------------------- |  | ---------------- | ------
|                                        |  |                  |       
|                                        |  | Amortized   Cost |       
|                                        |  |                  |       
|Obligations of U.S. Government agencies |  | $                | 46 069
|State and municipal obligations         |  |                  | 1 307 
|                                        |  |                  |       
|                                        |  | $                | 47 376
|                                        |  |                  |       

|                                        |  | 2003             |       
|--------------------------------------- |  | ---------------- | ------
|                                        |  |                  |       
|                                        |  | Amortized   Cost |       
|                                        |  |                  |       
|Obligations of U.S. Government agencies |  | $                | 37 671
|                                        |  |                  |       

| | The amortized cost and fair value of the securities   available for sale as of December 31, 2004 (in thousands), by contractual   maturity, are shown below:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      |  | Amortized   Cost |        | Fair   Value |  
|------------------------------------- |  | ---------------- | ------ | ------------ | -
|                                      |  |                  |        |              |  
|Due in one year or less               |  | $                | 9 019  |              | $
|Due after one year through five years |  |                  | 37 575 |              |  
|Due after five years                  |  |                  | 782    |              |  
|                                      |  |                  |        |              |  
|                                      |  | $                | 47 376 |              | $
|                                      |  |                  |        |              |  

| | Proceeds from sales of securities available for sale   were $9.0 million during 2004 and $8.1 million during 2003.  Net losses of $26 thousand were realized   on sales in 2004 and gross gains of $99 thousand were realized on sales in   2003.  There were no sales of   securities during 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | The primary purpose of the investment portfolio is   to generate income and meet liquidity needs of the company through readily   saleable financial instruments.  The   portfolio is made up of fixed rate bonds, whose prices move inversely with   rates.  At the end of any accounting   period, the investment portfolio has unrealized gains and losses.  The company monitors the portfolio which   is subject to liquidity needs, market rate changes and credit risk changes to   see if adjustments are needed.  The   primary concern in a loss situation is the credit quality of the business behind   the instrument.  The primary cause of   impairments is the decline in the prices of the bonds as rates have   risen.  There are approximately 20   accounts in the consolidated portfolio that have losses.  These securities have not suffered credit   deterioration and the company has the ability and intent to hold these issues   to maturity;
therefore, the gross unrealized losses are considered temporary   as of December 31, 2004.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | The following table summarizes the fair value and   gross unrealized losses for securities aggregated by investment category and   length of time that individual securities have been in a continuous gross   unrealized loss position as of December 31, 2004 and 2003 (in thousands).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

36



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

|                                        |  | December   31, 2004   |       
|--------------------------------------- |  | --------------------- | ------
|                                        |  |                       |       
|                                        |  | Less than   12 months |       
|                                        |  |                       |       
|                                        |  | Fair Value            |       
|                                        |  |                       |       
|Obligations of U.S. Government agencies |  | $                     | 28 750
|                                        |  |                       |       

|                                        |  | December   31, 2004   |      
|--------------------------------------- |  | --------------------- | -----
|                                        |  |                       |      
|                                        |  | Less than   12 months |      
|                                        |  |                       |      
|                                        |  | Fair Value            |      
|                                        |  |                       |      
|Obligations of U.S. Government agencies |  | $                     | 8 446
|                                        |  |                       |      

|          | Securities with a carrying value of $28.2 million   and $27.3 million at December 31, 2004 and 2003 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    |        
|-------------------------------------------------------- |  | ---------------- | -------
|                                                         |  |                  |        
|                                                         |  | 2004             |        
|                                                         |  |                  |        
|                                                         |  | (in   thousands) |        
|Mortgage loans on real estate:                           |  |                  |        
|Construction and land   development                      |  | $                | 28 929 
|Secured by farm land                                     |  |                  | 3 986  
|Secured by 1-4 family   residential                      |  |                  | 79 800 
|Other real estate                                        |  |                  | 42 759 
|Loans to farmers (except those secured by real   estate) |  |                  |       
|Commercial loans (except those secured by real   estate) |  |                  | 5 949  
|Consumer loans                                           |  |                  | 17 346 
|All other loans                                          |  |                  | 236    
|                                                         |  |                  |        
|Total loans                                              |  | $                | 179 005
|Less: allowance for   loan losses                        |  |                  | 1 966  
|                                                         |  |                  |        
|                                                         |  | $                | 177 039
|                                                         |  |                  |        

| | At December 31, 2004 and 2003, overdraft demand   deposits reclassified to loans totaled $120 thousand and $126 thousand,   respectively.                                                                                                                                                                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | The Securities and Exchange Commission requires   disclosure of loans which exceed $60,000 to executive officers and directors   of the company or to their associates.    Such loans were made on substantially the same terms as those   prevailing for comparable transactions with similar risks.  At December 31, 2004 and 2003, these loans   totaled $1.1 million and $877 thousand respectively.  During 2004, total principal additions   were $594 thousand and total principal payments were $404 thousand.

37



|Note   4. | Allowance for Loan Losses                                                                                            
|--------- | ---------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                      
|          | The following is a summary of transactions in the   allowance for loan losses for 2004, 2003 and 2002 (in thousands):

|                                         |  | 2004 |       | 2003 |   | 2002  |  
|---------------------------------------- |  | ---- | ----- | ---- | - | ----- | -
|                                         |  |      |       |      |   |       |  
|Balances at beginning of year            |  | $    | 1 724 |      | $ | 1 642 |  
|Provision charged to   operating expense |  |      | 289   |      |   | 147   |  
|Recoveries added to the   allowance      |  |      | 155   |      |   | 126   |  
|Loan losses charged to   the allowance   |  |      | (202  | )    |   | (191  | )
|                                         |  |      |       |      |   |       |  
|Balances at end of year                  |  | $    | 1 966 |      | $ | 1 724 |  
|                                         |  |      |       |      |   |       |  

| | Information about impaired loans as of and for the   years ended December 31, 2004 and 2003 (in thousands) is as follows:
| | -------------------------------------------------------------------------------------------------------------------------

|                                                                                   |  | 2004 |   | 2003 |  
|---------------------------------------------------------------------------------- |  | ---- | - | ---- | -
|                                                                                   |  |      |   |      |  
|Impaired loans for which an allowance has been   provided                          |  | $    |  |      | $
|Impaired loans for which no allowance has been   provided                          |  |      |  |      |  
|                                                                                   |  |      |   |      |  
|Total impaired loans                                                               |  | $    |  |      | $
|                                                                                   |  |      |   |      |  
|Allowance provided for impaired loans, included in   the allowance for loan losses |  | $    |  |      | $
|                                                                                   |  |      |   |      |  

|                                  |  | 2004 |    | 2003 |  
|--------------------------------- |  | ---- | -- | ---- | -
|                                  |  |      |    |      |  
|Average balance in impaired loans |  | $    | 85 |      | $
|                                  |  |      |    |      |  
|Interest income recognized        |  | $    |   |      | $
|                                  |  |      |    |      |  

|          | Nonaccrual loans excluded from impaired loan   disclosure under SFAS No. 114 at December 31, 2003 totaled $250   thousand.  If interest on these loans   had been accrued, such income would have approximated $18 thousand in   2003.  There were no nonaccrual loans   excluded from impaired loan disclosure under SFAS No. 114 at December 31,   2004.
|--------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                           
|Note   5. | Premises and Equipment, Net                                                                                                                                                                                                                                                                                                                               
|          |                                                                                                                                                                                                                                                                                                                                                           
|          | Premises and equipment consists of the following:                                                                                                                                                                                                                                                                                                         

|                              |  | December   31    |       
|----------------------------- |  | ---------------- | ------
|                              |  |                  |       
|                              |  | 2004             |       
|                              |  |                  |       
|                              |  | (in   thousands) |       
|Premises and improvements     |  |                  | 5 195 
|Furniture and equipment       |  |                  | 4 503 
|Construction in progress      |  |                  | 749   
|                              |  |                  |       
|                              |  |                  | 10 447
|Less accumulated depreciation |  |                  | 4 660 
|                              |  |                  |       
|                              |  |                  | 5 787 
|                              |  |                  |       

| | Depreciation included in operating expense for 2004,   2003 and 2002 was $605 thousand, $623 thousand and $417 thousand respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------

38



|Note   6. | Deposits                                                                                                                                                     
|--------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                              
|          | The aggregate amount of time deposits with a balance   of $100,000 or more was $13.2 million and $12.5 million at December 31, 2004   and 2003, respectively.
|          |                                                                                                                                                              
|          | At December 31, 2004, the scheduled maturities of   all time deposits (in thousands) are as follows:                                                         

|2005 |  | $ | 23 479 | 
|---- |  | - | ------ | 
|2006 |  |   | 6 958  | 
|2007 |  |   | 15 087 | 
|2008 |  |   | 7 926  | 
|2009 |  |   | 2 708  | 
|     |  |   |        | 
|     |  | $ | 56 158 | 
|     |  |   |        | 

|Note   7. | Borrowings                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | Short-term borrowings consist of securities sold   under agreements to repurchase and federal funds purchased.  A portion of the securities sold under   agreements to repurchase are secured transactions with customers and some are   through a Repo Plus account with the Federal Home Loan Bank.  Federal funds purchased are through The   Bankers Bank and Mercantile Safe Deposit and Trust Company.  These borrowings generally mature the day   following the date sold.
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | The bank had $5.83 million in federal funds   purchased outstanding with The Bankers Bank at December 31, 2004.  These funds reprice daily and all or part   of the principal may be repaid at any time but must be repaid within 14   business days.  The interest rate on   these funds was 2.70% on December 31, 2004.                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | The bank had $11.7 million in securities sold under   agreements to repurchase through secured transactions with customers.                                                                                                                                                                                                                                                                                                                                                       
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | The bank had a $5 million short-term advance through   the Repo Plus account with the Federal Home Loan Bank outstanding as of   December 31, 2004.  This account   matures one year from the date of opening, advances reprice daily and all or   part of the principal may be paid back at any time.  The interest rate on this advance was 2.24% on December 31,   2004.                                                                                                       
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | In June 2001, the bank incurred fixed rate long term   debt consisting of a Federal Home Loan Bank seven year loan with an original   balance of $2.5 million and monthly payments of interest and principal with   an interest rate of 5.51%.  The loan   is secured by capital stock, deposits, mortgage collateral and securities   collateral of the bank.                                                                                                                    
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|          | Principal payments on the note are due as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                

|2005 |  | $ | 365   | 
|---- |  | - | ----- | 
|2006 |  |   | 386   | 
|2007 |  |   | 407   | 
|2008 |  |   | 212   | 
|     |  |   |       | 
|     |  | $ | 1 370 | 
|     |  |   |       | 

| | The company has unused lines of credit with the   Federal Home Loan Bank and other financial institutions totaling   approximately $105.2 million at December 31, 2004.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

39



|Note   8. | Employee Benefit Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|          | The company sponsors a 401(k) retirement savings   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 company made 401(k)   matching contributions of $49 thousand, $44 thousand and  $30 thousand in 2004, 2003 and 2002,   respectively.                                                                                                                                                                                                                                                                                 
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|          | The company sponsors a noncontributory, defined   benefit pension plan covering full-time employees over 21 years of age upon   completion of one year of service.    Benefits are based on average compensation for the five consecutive   full calendar years of service which produce the highest average.  The company computes the net periodic   pension cost of the plan in accordance with Financial Accounting Standards   Statement No. 87, Employers Accounting for Pensions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|          | The company sponsors a postretirement life insurance   plan covering retirees with 25 years of service over the age of 60 and health   care plan for all retirees and one current employee 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 company accounts for its share of the costs of those   benefits in accordance with Financial Accounting Standards Statement No. 106,   Employers Accounting for Postretirement Benefits Other Than Pensions.  Under that Statement, the companys share of the   estimated costs that will be paid after retirement is generally being accrued   by charges to expense over the employees active service periods to the dates   they are fully eligible for benefits, except that the companys unfunded cost   that existed at January 1, 1995 is being accrued primarily in a straight-line   manner that will result in its full accrual by December 31, 2014.
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|          | Information about the plans follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|                                                     |  | Pension   Benefits |        | Postretirement   Benefits |  
|---------------------------------------------------- |  | ------------------ | ------ | ------------------------- | -
|                                                     |  |                    |        |                           |  
|                                                     |  | 2004               |        | 2003                      |  
|                                                     |  |                    |        |                           |  
|                                                     |  | (in   thousands)   |        | (in   thousands)          |  
|Change in Benefit Obligation:                        |  |                    |        |                           |  
|Benefit obligation,   beginning                      |  | $                  | 4 070  |                           | $
|Service cost                                         |  |                    | 238    |                           |  
|Interest cost                                        |  |                    | 259    |                           |  
|Change in assumptions                                |  |                    |       |                           |  
|Actuarial (gain) loss                                |  |                    | 533    |                           |  
|Benefits paid                                        |  |                    | (177   | )                         |  
|                                                     |  |                    |        |                           |  
|Benefit obligation,   ending                         |  | $                  | 4 923  |                           | $
|                                                     |  |                    |        |                           |  
|Change in Plan Assets:                               |  |                    |        |                           |  
|Fair value of plan   assets, beginning               |  | $                  | 3 357  |                           | $
|Actual return on plan   assets                       |  |                    | 272    |                           |  
|Employer contributions                               |  |                    | 256    |                           |  
|Benefits paid                                        |  |                    | (177   | )                         |  
|                                                     |  |                    |        |                           |  
|Fair value of plan   assets, ending                  |  | $                  | 3 708  |                           | $
|                                                     |  |                    |        |                           |  
|Funded status                                        |  | $                  | (1 215 | )                         |  
|Unrecognized net (gain)   loss                       |  |                    | 803    |                           |  
|Unrecognized net   obligation (asset) at transition  |  |                    | (15    | )                         |  
|Unrecognized prior   service cost                    |  |                    |       |                           |  
|                                                     |  |                    |        |                           |  
|Accrued benefit cost   included in other liabilities |  | $                  | (427   | )                         | $
|                                                     |  |                    |        |                           |  

| | The accumulated benefit obligation for the defined   benefit pension plan was $3.9 million and $3.4 million at December 31, 2004   and 2003, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

40



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

|                                                                            |  | Pension   Benefits |      | Postretirement   Benefits |  
|--------------------------------------------------------------------------- |  | ------------------ | ---- | ------------------------- | -
|                                                                            |  |                    |      |                           |  
|                                                                            |  | 2004               |      | 2003                      |  
|                                                                            |  |                    |      |                           |  
|Components of Net Periodic Benefit Cost:                                    |  |                    |      |                           |  
|Service cost                                                                |  | $                  | 238  |                           | $
|Interest cost                                                               |  |                    | 259  |                           |  
|Expected return on plan   assets                                            |  |                    | (316 | )                         |  
|Amortization of net   (gain) loss                                           |  |                    |     |                           |  
|Amortization of prior   service cost                                        |  |                    |     |                           |  
|Amortization of net   obligation at transition                              |  |                    | (20  | )                         |  
|Recognized actuarial   loss                                                 |  |                    |     |                           |  
|                                                                            |  |                    |      |                           |  
|Net periodic benefit   cost                                                 |  | $                  | 161  |                           | $
|                                                                            |  |                    |      |                           |  
|Weighted-average assumptions used to determine net   periodic benefit cost: |  |                    |      |                           |  
|Discount rate                                                               |  |                    | 6.50 | %                         |  
|Expected return on plan   assets                                            |  |                    | 8.50 | %                         |  
|Rate of compensation   increase                                             |  |                    | 4.00 | %                         |  
|Weighted-average assumptions used to determine   benefit obligations:       |  |                    |      |                           |  
|Discount rate                                                               |  |                    | 6.50 | %                         |  
|Rate of compensation   increase                                             |  |                    | 4.00 | %                         |  

| | Long-Term Rate of Return
| | ------------------------
| |                         
| |                         
| |                         
| |                         
| |                         
| | Asset Allocation        
| |                         
| |                         

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

41



|Note   8. | Employee Benefit Plans (Continued)
|--------- | ----------------------------------
|          |                                   
|          | Asset Allocation (Continued)      
|          |                                   
|          |                                   
|          |                                   
|          |                                   
|          | Cash Flow                         
|          |                                   
|          |                                   
|          |                                   
|          |                                   

|          |  | Pension   Benefits |       | Other   Benefits |                 
|--------- |  | ------------------ | ----- | ---------------- | ----------------
|          |  |                    |       |                  |                 
|          |  |                    |       |                  | (in   thousands)
|2005      |  | $                  | 293   |                  | $               
|2006      |  |                    | 491   |                  |                 
|2007      |  |                    | 633   |                  |                 
|2008      |  |                    | 364   |                  |                 
|2009      |  |                    | 472   |                  |                 
|2010-2014 |  |                    | 1 781 |                  |                 

| |  | For measurement purposes, an 8.50% annual rate of   increase in per capita health care costs of covered benefits was assumed for   2004, a 8.64% increase was assumed for 2003 and a 9% increase was assumed for   2002, with such annual rate of increase gradually declining to 5% in 2013.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                                                                                                                                                                              
| |  | Assumed health care cost trend rates have a   significant effect on the amounts reported for the health care plans.  A 1% change in assumed health care cost   trend rates would have the following effects:                                                                                 

|                                                                                                                  |  | 1%   Increase    |    | 1%   Decrease |  
|----------------------------------------------------------------------------------------------------------------- |  | ---------------- | -- | ------------- | -
|                                                                                                                  |  |                  |    |               |  
|                                                                                                                  |  | (in   thousands) |   
|Effect on the health care component of the   accumulated postretirement benefit obligation                        |  | $                | 16 |               | $
|Effect on total of service and interest cost components   of net periodic postretirement health care benefit cost |  |                  | 1  |               |  

42



|Note   9. | Weighted Average Number of Shares Outstanding and   Earnings Per Share                                                                                                                                                                                                                    
|--------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                           
|          | The following shows the weighted average number of   shares used in computing earnings per share and the effect on weighted   average number of shares of diluted potential common stock.  Potential diluted common stock had no   effect on earnings per share available to shareholders.

|                               |  | December   31, 2004 |           | December   31, 2003 |   | December   31, 2002 | 
|------------------------------ |  | ------------------- | --------- | ------------------- | - | ------------------- | 
|                               |  |                     |           |                     |   |                     | 
|                               |  | Average   Shares    |           | Per Share   Amount  |   | Average   Shares    | 
|                               |  |                     |           |                     |   |                     | 
|Basic earnings per share       |  |                     | 1 697 732 |                     | $ | 1.82                | 
|Effect of dilutive securities: |  |                     |           |                     |   |                     | 
|Stock options                  |  |                     | 1 236     |                     |   |                     | 
|Diluted earnings per share     |  |                     | 1 698 968 |                     | $ | 1.82                | 

|           | Shares outstanding have been restated to reflect the   200% stock dividend in 2003.                                                                                                                                                                                                                                                            
|---------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           |                                                                                                                                                                                                                                                                                                                                                
|Note   10. | Stock-Based Compensation                                                                                                                                                                                                                                                                                                                       
|           |                                                                                                                                                                                                                                                                                                                                                
|           | During 2003, the company adopted an incentive stock   plan which allows key employees and directors to increase their personal   financial interest in the company.    This plan permits the issuance of incentive stock options and   non-qualified stock options.  The plan   authorizes the issuance of up to 90,000 shares of common stock.

|                                               |  | 2004   |       
|---------------------------------------------- |  | ------ | ------
|                                               |  |        |       
|                                               |  | Shares |       
|                                               |  |        |       
|Outstanding at beginning of year               |  |        |      
|Granted                                        |  |        | 17 994
|Exercised                                      |  |        |      
|Forfeited                                      |  |        | (1 000
|                                               |  |        |       
|Outstanding at end of year                     |  |        | 16 994
|                                               |  |        |       
|Weighted average fair value of options granted |  | $      | 5.23  
|                                               |  |        |       

| | The exercise price of stock options granted under   this plan, both incentive and non-qualified, cannot be less than the fair   market value of the common stock on the date that the option is granted.  The maximum term for an option granted   under this plan is ten years and options granted may be subject to a vesting   schedule.  The non-qualified options   granted during 2004 are exercisable immediately.  The incentive options granted during 2004 are subject to a five   year vesting period whereby the grantees are entitled to exercise one fifth   of the options on the anniversary of the grant date over the next five   years.  In determining the pro forma   amounts below, the value of each grant is estimated at the grant date using   the Black-Scholes option-pricing model with the following weighted-average   assumptions for grants during 2004, dividend rate of 3.39%, risk-free   interest rate of 4.42%, expected life of 10 years, and expected
volatility of   23.47%.  The following table   summarizes options outstanding at December 31, 2004:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                 |  | Options   Outstanding |        | Options   Exercisable                                          | 
|---------------- |  | --------------------- | ------ | -------------------------------------------------------------- | 
|                 |  |                       |        |                                                                | 
|Exercise   Price |  | Number   Outstanding  |        | Weighted   Average   Remaining   Contractual   Life (in years) | 
|                 |  |                       |        |                                                                | 
|$22.55           |  |                       | 16 994 |                                                                | 

43





|Note   11. | Income Taxes                                                                                   
|---------- | -----------------------------------------------------------------------------------------------
|           |                                                                                                
|           | Net deferred tax assets consist of the following   components as of December 31, 2004 and 2003:

|                                  |  | 2004             |     | 2003 |  
|--------------------------------- |  | ---------------- | --- | ---- | -
|                                  |  |                  |     |      |  
|                                  |  | (in   thousands) |    
|Deferred tax assets:              |  |                  |     |      |  
|Reserve for loan losses           |  | $                | 513 |      | $
|Accrued pension expense           |  |                  | 151 |      |  
|Accrued postretirement   benefits |  |                  | 123 |      |  
|Nonaccrual interest               |  |                  |    |      |  
|Securities available   for sale   |  |                  | 13  |      |  
|                                  |  |                  |     |      |  
|                                  |  | $                | 800 |      | $
|                                  |  |                  |     |      |  
|Deferred tax liabilities:         |  |                  |     |      |  
|Depreciation                      |  | $                | 149 |      | $
|Securities available   for sale   |  |                  |    |      |  
|                                  |  |                  |     |      |  
|                                  |  | $                | 149 |      | $
|                                  |  |                  |     |      |  
|Net deferred tax assets           |  | $                | 651 |      | $
|                                  |  |                  |     |      |  

| | The provision for income taxes charged to operations   for the years ended December 31, 2004, 2003 and 2002 consists of the   following:
| | ----------------------------------------------------------------------------------------------------------------------------------------

|                               |  | 2004             |       | 2003 |   | 2002  | 
|------------------------------ |  | ---------------- | ----- | ---- | - | ----- | 
|                               |  |                  |       |      |   |       | 
|                               |  | (in   thousands) |      
|Current tax expense            |  | $                | 1 742 |      | $ | 1 412 | 
|Deferred tax expense (benefit) |  |                  | (32   | )    |   | 20    | 
|                               |  |                  |       |      |   |       | 
|                               |  | $                | 1 710 |      | $ | 1 432 | 
|                               |  |                  |       |      |   |       | 

| | 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, 2004, 2003 and 2002 due to the   following:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                        |  | 2004 |        | 2003 |   | 2002  |  
|------------------------------------------------------- |  | ---- | ------ | ---- | - | ----- | -
|                                                        |  |      |        |      |   |       |  
|Computed expected tax expense                         |  | $    | 1 632  |      | $ | 1 396 |  
|Increase (decrease) in income taxes resulting from:     |  |      |        |      |   |       |  
|Tax exempt interest   income                            |  |      | (75    | )    |   | (90   | )
|State income taxes, net   of federal income tax benefit |  |      | 149    |      |   | 122   |  
|Other                                                   |  |      | 4      |      |   | 4     |  
|                                                        |  |      |        |      |   |       |  
|                                                        |  | $    | $1 710 |      | $ | 1 432 |  
|                                                        |  |      |        |      |   |       |  

|Note   12. | 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 company does not anticipate losses as a result of these   transactions.                                                                                 
|           |                                                                                                                                                                                                                                                                                                                                            
|           | See Note 14 with respect to financial instruments   with off-balance-sheet risk.                                                                                                                                                                                                                                                           
|           |                                                                                                                                                                                                                                                                                                                                            
|           | The company has approximately $794 thousand in   deposits in other financial institutions in excess of amounts insured by the   Federal Deposit Insurance Corporation (FDIC) at December 31, 2004.                                                                                                                                         
|           |                                                                                                                                                                                                                                                                                                                                            
|           | The company 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, 2004 and 2003, the aggregate amounts of daily   average required balances were approximately $7.1 million and $6.6 million,   respectively.

44



|Note   13. | Retained Earnings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|---------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|           | Transfers of funds from the banking subsidiary to   the parent company in the form of loans, advances and cash dividends are   restricted by federal and state regulatory authorities.  As of December 31, 2004, the aggregate   amount of unrestricted funds which could be transferred from the banking   subsidiary to the parent company, without prior regulatory approval, totaled   $3.6 million or 15.7% of the consolidated net assets.                                                                                                                                       
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Note   14. | Financial Instruments With Off-Balance-Sheet Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|           | The company is a party to financial instruments with   off-balance-sheet risk in the normal course of business to meet the financing   needs of its customers.  Those   financial instruments include commitments to extend credit and standby   letters of credit.  Those instruments   involve, to varying degrees, elements of credit and interest rate risk in   excess of the amount recognized in the balance sheet.  The contract or notional amounts of those   instruments reflect the extent of involvement the company has in particular   classes of financial instruments.
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|           | The companys exposure to credit loss in the event   of nonperformance by the other party to the financial instruments for   commitments to extend credit and standby letters of credit is represented by   the contractual notional amount of those instruments.  The company uses the same credit policies   in making commitments and conditional obligations as it does for   on-balance-sheet instruments.                                                                                                                                                                        
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|           | A summary of the contract or notional amount of the   companys exposure to off-balance-sheet risk as of December 31, 2004 and 2003   (in thousands) is as follows:                                                                                                                                                                                                                                                                                                                                                                                                                    

|                                                                      |  | 2004 |        | 2003 |  
|--------------------------------------------------------------------- |  | ---- | ------ | ---- | -
|                                                                      |  |      |        |      |  
|Financial instruments whose contract amounts   represent credit risk: |  |      |        |      |  
|Commitments to extend   credit                                        |  | $    | 58 477 |      | $
|Standby letters of   credit                                           |  |      | 2 996  |      |  

| | Commitments to extend credit are agreements to lend   to a customer as long as there is no violation of any condition established   in the contract.  Commitments   generally have fixed expiration dates or other termination clauses and may   require payment of a fee.  Since many   of the commitments are expected to expire without being drawn upon, the total   commitment amounts do not necessarily represent future cash   requirements.  The company evaluates   each customers credit worthiness on a case-by-case basis.  The amount of collateral obtained, if   deemed necessary by the company upon extension of credit, is based on   managements credit evaluation of the counterparty.  Collateral held varies but may include accounts receivable,   inventory, property and equipment, and income-producing commercial   properties.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Unfunded commitments under commercial lines of   credit are commitments for possible future extensions of credit to existing   customers.  The majority of these   lines of credit are collateralized and usually contain a specified maturity   date and may not be drawn upon to the extent to which the company is   committed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | Standby letters of credit are conditional   commitments issued by the company to guarantee the performance of a customer   to a third party.  Those guarantees   are primarily issued to support public and private borrowing arrangements,   including commercial paper, bond financing, and similar transactions.  The credit risk involved in issuing   letters of credit is essentially the same as that involved in extending loan   facilities to customers.  The company   generally holds collateral supporting those commitments if deemed necessary.                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | At December 31, 2004, the company had rate lock   commitments to originate mortgage loans amounting to $1.1 million and loans   held for sale of $148 thousand.  The   company has entered into corresponding mandatory commitments, on a best-efforts   basis, to sell these loans.  These   commitments to sell loans are designed to eliminate the companys exposure to   fluctuations in interest rates in connection with rate lock commitments and   loans held for sale.                                                                                                                                                                                                                                                                                                                                                                             

45



|Note   15. | 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:
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          
|           |                                                                                                                                                                          

46







|Note     15. | Fair Value of Financial Instruments and Interest   Rate Risk (Continued)
|------------ | ------------------------------------------------------------------------

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

|                                                                         |  | 2004              |         | 2003             |  
|------------------------------------------------------------------------ |  | ----------------- | ------- | ---------------- | -
|                                                                         |  |                   |         |                  |  
|                                                                         |  | Carrying   Amount |         | Fair   Value     |  
|                                                                         |  |                   |         |                  |  
|                                                                         |  | (in   thousands)  |         | (in   thousands) |  
|Financial assets:                                                        |  |                   |         |                  |  
|Cash                                                                     |  | $                 | 12 165  |                  | $
|Securities purchased   under agreements to resell and federal funds sold |  |                   | 6       |                  |  
|Securities held to   maturity                                            |  |                   |        |                  |  
|Securities available   for sale                                          |  |                   | 47 339  |                  |  
|Loans, net                                                               |  |                   | 177 039 |                  |  
|Loans held for sale                                                      |  |                   | 148     |                  |  
|Accrued interest   receivable                                            |  |                   | 913     |                  |  
|Financial liabilities:                                                   |  |                   |         |                  |  
|Deposits                                                                 |  |                   | 200 551 |                  |  
|Repurchase agreements                                                    |  |                   | 17 577  |                  |  
|FHLB advances                                                            |  |                   | 6 370   |                  |  
|Accrued interest   payable                                               |  |                   | 180     |                  |  

|             | The company 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 companys financial   instruments will change when interest rate levels change and that change may   be either favorable or unfavorable to the company.  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   companys overall interest rate risk.
|------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Note     16. | Regulatory Matters                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|             | The company (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 companys and banks financial   statements.  Under capital adequacy   guidelines and the regulatory framework for prompt corrective action, the   company 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 company 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,   2004 and 2003, that the company and the bank meet all capital adequacy   requirements to which they are subject.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

47



|Note     16. | Regulatory Matters (Continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|             | As of December 31, 2004, 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 company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                                                                           |  
|                                            |  |                  |        |                                 |  |                                                                                  |  
|                                            |  | (in   thousands) |       
|As of December 31, 2004:                    |  |                  |        |                                 |  |                                                                                  |  
|Total capital (to   risk-weighted assets):  |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 24 747 |                                 |  | 14.44                                                                            | %
|Bank of Charles Town                        |  | $                | 24 713 |                                 |  | 14.42                                                                            | %
|Tier 1 capital (to   risk-weighted assets): |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 22 781 |                                 |  | 13.29                                                                            | %
|Bank of Charles Town                        |  | $                | 22 747 |                                 |  | 13.27                                                                            | %
|Tier 1 capital (to   average assets):       |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 22 781 |                                 |  | 9.45                                                                             | %
|Bank of Charles Town                        |  | $                | 22 747 |                                 |  | 9.44                                                                             | %
|As of December 31, 2003:                    |  |                  |        |                                 |  |                                                                                  |  
|Total capital (to   risk-weighted assets):  |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 22 558 |                                 |  | 15.89                                                                            | %
|Bank of Charles Town                        |  | $                | 22 513 |                                 |  | 15.86                                                                            | %
|Tier 1 capital (to   risk-weighted assets): |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 20 834 |                                 |  | 14.67                                                                            | %
|Bank of Charles Town                        |  | $                | 20 789 |                                 |  | 14.64                                                                            | %
|Tier 1 capital (to   average assets):       |  |                  |        |                                 |  |                                                                                  |  
|Consolidated                                |  | $                | 20 834 |                                 |  | 10.20                                                                            | %
|Bank of Charles Town                        |  | $                | 20 789 |                                 |  | 10.18                                                                            | %

48



|Note     17. | Parent Company Only Financial Statements
|------------ | ----------------------------------------

POTOMAC BANCSHARES, INC. (Parent Company Only) Balance Sheets December 31, 2004 and 2003

|                                                |  | 2004 |        | 2003 |  
|----------------------------------------------- |  | ---- | ------ | ---- | -
|                                                |  |      |        |      |  
|ASSETS                                          |  |      |        |      |  
|Cash                                            |  | $    | 7      |      | $
|Investment in   subsidiary                      |  |      | 22 722 |      |  
|Other assets                                    |  |      | 30     |      |  
|                                                |  |      |        |      |  
|Total Assets                                    |  | $    | 22 759 |      | $
|                                                |  |      |        |      |  
|LIABILITIES AND STOCKHOLDERS EQUITY            |  |      |        |      |  
|LIABILITIES, other                              |  | $    | 3      |      | $
|                                                |  |      |        |      |  
|STOCKHOLDERS EQUITY                            |  |      |        |      |  
|Common stock                                    |  | $    | 1 800  |      | $
|Surplus                                         |  |      | 4 200  |      |  
|Undivided profits                               |  |      | 18 631 |      |  
|Accumulated other   comprehensive income (loss) |  |      | (25    | )    |  
|                                                |  |      |        |      |  
|                                                |  | $    | 24 606 |      | $
|Less cost of shares   acquired for the treasury |  |      | 1 850  |      |  
|                                                |  |      |        |      |  
|Total Stockholders   Equity                    |  | $    | 22 756 |      | $
|                                                |  |      |        |      |  
|Total Liabilities and   Stockholders Equity    |  | $    | 22 759 |      | $
|                                                |  |      |        |      |  

POTOMAC BANCSHARES, INC. (Parent Company Only) Statements of Income Years Ended December 31, 2004, 2003 and 2002

|                                                                                      |  | 2004 |       | 2003 |   | 2002  |  
|------------------------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- | -
|                                                                                      |  |      |       |      |   |       |  
|Income                                                                                |  |      |       |      |   |       |  
|Dividends from   subsidiary                                                           |  | $    | 1 193 |      | $ | 2 443 |  
|Expenses                                                                              |  |      |       |      |   |       |  
|Other professional fees                                                               |  |      | 37    |      |   | 19    |  
|Other operating   expenses                                                            |  |      | 54    |      |   | 56    |  
|                                                                                      |  |      |       |      |   |       |  
|Total Expenses                                                                        |  | $    | 91    |      | $ | 75    |  
|                                                                                      |  |      |       |      |   |       |  
|Income before Income   Tax (Benefit) and Equity in Undistributed Income of Subsidiary |  | $    | 1 102 |      | $ | 2 368 |  
|Income Tax (Benefit)                                                                  |  |      | (30   | )    |   | (25   | )
|                                                                                      |  |      |       |      |   |       |  
|Income before Equity in   Undistributed Income of Subsidiary                          |  | $    | 1 132 |      | $ | 2 393 |  
|Equity in Undistributed Income of Subsidiary                                          |  |      | 1 958 |      |   | 281   |  
|                                                                                      |  |      |       |      |   |       |  
|Net Income                                                                            |  | $    | 3 090 |      | $ | 2 674 |  
|                                                                                      |  |      |       |      |   |       |  

49



|Note     17. | Parent Company Only Financial Statements (Continued)
|------------ | ----------------------------------------------------

POTOMAC BANCSHARES, INC. (Parent Company Only) Statements of Cash Flows Years Ended December 31, 2004, 2003 and 2002

|                                                                                    |  | 2004 |        | 2003 |   | 2002   |  
|----------------------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ------ | -
|                                                                                    |  |      |        |      |   |        |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                |  |      |        |      |   |        |  
|Net income                                                                          |  | $    | 3 090  |      | $ | 2 674  |  
|Adjustments to   reconcile net income to net cash provided by operating activities: |  |      |        |      |   |        |  
|Equity in undistributed   (income) of subsidiary                                    |  |      | (1 958 | )    |   | (281   | )
|(Increase) in other   assets                                                        |  |      | (5     | )    |   | (11    | )
|(Decrease) in other   liabilities                                                   |  |      |       |      |   | (2     | )
|                                                                                    |  |      |        |      |   |        |  
|Net cash provided by   operating activities                                         |  | $    | 1 127  |      | $ | 2 380  |  
|                                                                                    |  |      |        |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                |  |      |        |      |   |        |  
|Cash dividends                                                                      |  | $    | (1 002 | )    | $ | (932   | )
|Purchase of treasury   shares                                                       |  |      | (141   | )    |   | (1 461 | )
|                                                                                    |  |      |        |      |   |        |  
|Net cash (used in)   financing activities                                           |  | $    | (1 143 | )    | $ | (2 393 | )
|                                                                                    |  |      |        |      |   |        |  
|Increase (decrease) in   cash and cash equivalents                                  |  | $    | (16    | )    | $ | (13    | )
|CASH AND CASH EQUIVALENTS                                                           |  |      |        |      |   |        |  
|Beginning                                                                           |  |      | 23     |      |   | 36     |  
|                                                                                    |  |      |        |      |   |        |  
|Ending                                                                              |  | $    | 7      |      | $ | 23     |  
|                                                                                    |  |      |        |      |   |        |  

50



|Item   9.  | Changes In and Disagreements with   Accountants on Accounting and Financial Disclosure.
|---------- | ---------------------------------------------------------------------------------------
|           |                                                                                        
|           | Not Applicable.                                                                        
|           |                                                                                        
|Item   9A. | Controls and Procedures.                                                               

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

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

|Item   9B. | Other Information.
|---------- | ------------------
|           |                   
|           | None.             

PART III

|Item   10. | Directors and Executive Officers of   the Registrant.
|---------- | -----------------------------------------------------

The information contained on pages 7-9 of the Proxy Statement dated March 30, 2005, for the April 26, 2005 Annual Meeting under the captions Management Nominees to the Board of Potomac and Directors Continuing to Serve Unexpired Terms, and page 16 under the caption Section 16(a) Beneficial Ownership Reporting Compliance is incorporated herein by reference.

The Executive Officers are as follows:

|Name                    |  | Position   Since                                  |  | Age |  | Principal   Occupation                                                                                                                                                                                                          
|----------------------- |  | ------------------------------------------------- |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                        |  |                                                   |  |     |  |                                                                                                                                                                                                                                 
|Robert F. Baronner, Jr. |  | President & CEO   2001                            |  | 46  |  | Employed by bank as of   1/1/01 as President and CEO; former    Senior Credit Officer BB&T Northern WestVirginia May 2000    December 2000; former Executive Vice President One Valley Bank East September   1997 - April 2000.
|David W. Irvin          |  | Sr. Vice President   2004                         |  | 41  |  | Employed at bank from 2001   to present as Commercial Loan Division Manager; former Senior Vice President   - Commercial Lending BB&T 2000-2001.                                                                                
|                        |  |                                                   |  |     |  |                                                                                                                                                                                                                                 
|Gayle Marshall Johnson  |  | Vice President & Chief   Financial Officer   1994 |  | 55  |  | Employed with the bank   1977-1985 and 1988-present; Vice President and Chief Financial Officer since   1990.                                                                                                                   
|Donald S. Smith         |  | Vice President &   Assistant Secretary   1994     |  | 76  |  | Employed at bank 1947 to   1991; President 1979 to 1991(retired).                                                                                                                                                               

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

51



|Item   11. | Executive Compensation.
|---------- | -----------------------

The information contained on pages 10-12 and 14-15 of the Proxy Statement dated March 30, 2005, for the April 26, 2005 Annual Meeting under the captions Executive Compensation, Employee Benefit Plans, Employment Agreement, and Compensation of Directors is incorporated herein by reference.

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

The information contained on pages 9-10 of the Proxy Statement dated March 30, 2005, for the April 26, 2005 Annual Meeting under the caption Ownership of Securities by Nominees, Directors and Officers is incorporated herein by reference.

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

|Plan   category                                                   |  | Number of   securities   to be issued   upon exercise of   outstanding options,   warrants and rights |        | Weighted-average   exercise price of   outstanding options,   warrants and rights |   | Number of   securities   remaining available for   future issuance under   equity compensation plans   (excluding securities   reflected in column (a)) | 
|----------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------- | ------ | --------------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|                                                                  |  |                                                                                                       |        |                                                                                   |   |                                                                                                                                                         | 
|2003 Stock Incentive Plan approved by shareholders   May 13, 2003 |  |                                                                                                       | 16 994 |                                                                                   | $ | 22.55                                                                                                                                                   | 
|                                                                  |  |                                                                                                       |        |                                                                                   |   |                                                                                                                                                         | 

|Item   13. | Certain Relationships and Related   Transactions.
|---------- | -------------------------------------------------

The information contained on page 15 of the Proxy Statement dated March 30, 2005, for the April 26, 2005 Annual Meeting under the caption Certain Transactions with Directors, Officers and Their Associates is incorporated herein by reference.

|Item   14. | Principal Accountant Fees and   Services.
|---------- | -----------------------------------------

The information contained on pages 6-7 of the Proxy Statement dated March 30, 2005, for the April 26, 2005 Annual Meeting under the caption Audit Committee Report is incorporated herein by reference.

52



|Item   15. | Exhibits and Financial Statement   Schedules.
|---------- | ---------------------------------------------

| | (a) | (1)     Financial   Statements.  Reference is made to   Part II, Item 8 of this Annual Report on Form 10-K.                                                                                                       
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                   
| |     | (2)     Financial   Statement Schedules.  These   schedules are omitted as the required information is inapplicable or the   information is presented in the consolidated financial statements or related   notes.
| |     |                                                                                                                                                                                                                   
| |     | (3)     Exhibits.  See below.                                                                                                                                                                                     

2.1     Agreement and Plan of Merger dated March 8, 1994, by and between Potomac Bancshares, Inc., and Bank of Charles Town filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.

3.1     Articles of Incorporation of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.

3.2     Amendments to Articles of Incorporation of Potomac Bancshares, Inc. adopted by shareholders on April 25, 1995 and filed with the West Virginia Secretary of State on May 23, 1995, and incorporated by reference from Potomacs Form 10-KSB for the year ended December 31, 1995 and filed with the Securities and Exchange Commission, File No. 0-24958.

3.3     Bylaws of Potomac Bancshares, Inc. filed with and incorporated by reference from the Registration on Form S-4 filed with the Securities and Exchange Commission on June 10, 1994, Registration No. 33-80092.

3.4     Amended and Restated Bylaws of Potomac Bancshares, Inc. adopted by shareholders April 25, 1995 and incorporated by reference from Potomacs Form 10-KSB for the year ended December 31, 1995, and filed with the Securities and Exchange Commission, File No. 0-24958.

10.1     2003 Stock Incentive Plan adopted by the Potomac Board February 20, 2003 and approved by the Companys shareholders on May 13, 2003.

10.2     Employment Agreement of Mr. Robert F. Baronner, Jr., filed with and incorporated by reference from Form 10-KSB for the year ended December 31, 2001, and filed with the Securities and Exchange Commission, File No. 0-24958.

14.1     Code of Ethics (for all employees)

14.2     Code of Ethics for Senior Financial Officers

21        Subsidiaries of the Registrant

23.1     Consent of Independent Accountants

31.1     Rule 13a-15(e)/15d-15(e) Certification of Chief Executive Officer

31.2     Rule 13a-15(e)/15d-15(e) Certification of Chief Financial Officer

32.1     Section 1350 Certification of Chief Executive Officer

32.2     Section 1350 Certification of Chief Financial Officer

99.1     Proxy Statement for the 2005 Annual Meeting for Potomac, portions are incorporated by reference in Form 10-K Annual Report*

*          Filed herewith.

53



SIGNATURES

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

POTOMAC BANCSHARES, INC.

|By |  | /s/   ROBERT F. BARONNER, JR.              |  | March 30, 2005 | 
|-- |  | ------------------------------------------ |  | -------------- | 
|   |  |                                            |  |                | 
|   |  | Robert F.   Baronner, Jr.                  |  |                | 
|   |  | President   & Chief Executive Officer      |  |                | 
|   |  |                                            |  |                | 
|By |  | /s/   GAYLE MARSHALL JOHNSON               |  | March 30, 2005 | 
|   |  |                                            |  |                | 
|   |  | Gayle   Marshall Johnson                   |  |                | 
|   |  | Vice   President & Chief Financial Officer |  |                | 

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

|   |  | Signature   & Title                         |  | Date           | 
|-- |  | ------------------------------------------- |  | -------------- | 
|   |  |                                             |  |                | 
|By |  | /s/ J. SCOTT BOYD                           |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | J. Scott Boyd, Director                     |  |                | 
|   |  |                                             |  |                | 
|By |  | /s/ JOHN P. BURNS, JR.                      |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | John P.   Burns, Jr., Director              |  |                | 
|   |  |                                             |  |                | 
|By |  | /s/ GUY GARETH CHICCHIRICHI                 |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | Guy Gareth   Chicchirichi, Director         |  |                | 
|   |  |                                             |  |                | 
|By |  | /s/ MARGARET COGSWELL                       |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | Margaret   Cogswell, Director               |  |                | 
|   |  |                                             |  |                | 
|By |  | /s/ THOMAS C. G. COYLE                      |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | Thomas C.   G. Coyle, Director              |  |                | 
|   |  |                                             |  |                | 
|By |  | /s/ WILLIAM R. HARNER                       |  | March 30, 2005 | 
|   |  |                                             |  |                | 
|   |  | William R.   Harner, Director and Secretary |  |                | 

54



|   |  | Signature   & Title              |  | Date           | 
|-- |  | -------------------------------- |  | -------------- | 
|   |  |                                  |  |                | 
|By |  | /s/ E. WILLIAM JOHNSON           |  | March 30, 2005 | 
|   |  |                                  |  |                | 
|   |  | E. William   Johnson, Director   |  |                | 
|   |  |                                  |  |                | 
|By |  | /s/ BARBARA H. PICHOT            |  | March 30, 2005 | 
|   |  |                                  |  |                | 
|   |  | Barbara H.   Pichot, Director    |  |                | 
|   |  |                                  |  |                | 
|By |  | /s/ JOHN C. SKINNER, JR.         |  | March 30, 2005 | 
|   |  |                                  |  |                | 
|   |  | John C.   Skinner, Jr., Director |  |                | 
|   |  |                                  |  |                | 
|By |  | /s/ DONALD S. SMITH              |  | March 30, 2005 | 
|   |  |                                  |  |                | 
|   |  | Donald S.   Smith, Director      |  |                | 
|   |  |                                  |  |                | 
|By |  | /s/ C. LARRY TOGANS              |  | March 30, 2005 | 
|   |  |                                  |  |                | 
|   |  | C. Larry   Togans, Director      |  |                | 

55