# Potomac Bancshares Inc: Form 10-Q for the period ended Mar 31, 2009

- Company: [Potomac Bancshares Inc](/companies/ptbs.md) (CIK 925173)
- Form: 10-Q
- Filed: 2009-05-15
- Accepted by EDGAR: May 15, 2009, 11:18 ET
- Period: 2009-03-31
- Accession: 0001193125-09-112554
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/925173/000119312509112554/d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/925173/000119312509112554/

## Management's discussion and analysis

As filed, 19,061 characters.

CRITICAL ACCOUNTING POLICIES

General

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

Allowance for Loan Losses

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

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful or substandard. 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.

FINANCIAL OVERVIEW

The bank continues to operate on the assumption that 2009 will be as challenging as 2008. Although there are glimpses of hope that the economy is reaching a “bottom”, management believes recovery will be a slow process compared to the period of economic growth experienced during the first five years of the current decade. For the most part, we face the same issues as in 2008 with varying degrees of change. Liquidity, tightening credit and the local housing market continue to be key issues for the bank’s decision makers.

Fortunately, the liquidity of the bank has not been an issue outside of the need to monitor the bank’s level of liquidity. The asset liability committee monitors liquidity on a quarterly basis and management has developed a tool to monitor liquidity on a weekly basis to avoid any concerns that may arise during the interim. Although the level has fluctuated, management is confident our liquidity level is adequate to meet the needs of our customers. The Smart checking account (an account that pays a higher rate of interest if certain electronic usage criteria are met) and an overall return to savings in the general customer base have provided an increase in deposits for the current quarter. In addition, management has made a conscious effort to become more liquid in response to the current economy. We are keeping more cash in accounts at our correspondent banks and in order to keep our investments in the bond market as liquid as possible, we have encouraged our municipal customers to allow the bank to use alternative methods (as allowable by law) to collateralize their deposits rather than pledging investments.

To date, the bank’s ability to borrow has not been affected by the tightening credit market. We test credit lines quarterly to insure that our ability to borrow remains at an adequate level. As part of a risk management strategy, management is investigating additional options for borrowing in the future. Although we do not foresee exhausting our current sources of funding, management believes it is important to have additional options should one or more of our current sources of funding have issues that would reduce or eliminate our ability to borrow through no fault of the bank.

Although the housing industry continues to play a large part in the bank’s commercial lending, lenders have made efforts to expand the commercial customer base outside of construction lending. Our affiliation with BlueRidge Bank in Frederick, MD has provided some additional resources and continues to be a pipeline to a market in which we do not have a branch location. There is also hope that the housing market will stabilize sooner than previously expected. However, bank management remains cautiously optimistic and is keenly aware that recovery in this sector will be a slow process and will not return to the levels experienced in 2000 through 2005 for some time to come.

Total assets have increased $10.4 million or 3.5% from the December 2008 total of $300.4 million to $310.8 million at March 31, 2009. Federal funds sold increased approximately $2.7 million as a result of deposit growth. Cash and due from banks increased approximately $5.3 million. Securities have increased approximately $4.9 million. The increases to cash and due from banks and securities had to do with timing and liquidity planning. Cash is being kept in checking accounts with correspondents that participate in the temporary liquidity guarantee program as these funds are guaranteed versus investing in overnight funds that are not guaranteed. The security increase was the result of replacing securities in the first quarter of 2009 that had matured or been called in 2008.

Total deposits have increased $9.9 million or 3.9% at March 31, 2009 compared to December 31, 2008. Noninterest-bearing deposits have decreased 1.3% and interest-bearing deposits have increased 4.5% during the first quarter of 2009. Some of the increase in interest bearing deposits can be attributed to the new Smart checking accounts introduced in December 2008. The purchase of an additional $2.1 million in brokered CDs and small increases in other interest bearing accounts make up the rest of the increase in interest bearing deposits.

The March 31, 2009 annualized (loss) return on average assets is (.55) % compared to .61% at December 31, 2008. At March 31, 2009 the annualized (loss) return on average equity is (6.02) % compared to 6.18% at December 31, 2008. The Tier 1 capital to average assets ratio (leverage capital ratio) is 9.54% at March 31, 2009 compared to 9.85% at December 31, 2008. The Tier 1 capital to total risk weighted assets ratio is 12.01% at March 31, 2009 compared to 12.37% at December 31, 2008. The total capital to risk weighted assets ratio is 13.27% at March 31, 2009 compared to 13.63% at December 31, 2008. All capital ratios are within the regulatory guidelines.

The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Management monitors the loan portfolio on a continual basis with procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Written reports are prepared on a quarterly basis for all loans and information on commercial loans graded below a certain level are reported to the Board of Directors on a monthly basis. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.

| Balance at beginning of period Charge-offs: | March 31 2009 $4 079 | December 31 2008 $2 779 | March 31 2008 $2 779 |
| --- | ---: | ---: | ---: |
| Commercial, financial and agricultural | — | 21 | — |
| Real estate – construction | 662 | 269 | 21 |
| Real estate – mortgage | 107 | 1 102 | — |
| Consumer | 90 | 441 | 80 |
| Total charge-offs | 859 | 1 833 | 101 |
| Recoveries: |  |  |  |
| Commercial, financial and agricultural | 5 | — | — |
| Real estate – construction | — | — | — |
| Real estate – mortgage | 1 | 17 | — |
| Consumer | 75 | 182 | 52 |
| Total recoveries | 81 | 199 | 52 |
| Net charge-offs | 778 | 1 634 | 49 |
| Provision charged to operations | 1 577 | 2 934 | 153 |
| Balance at end of period | $4 878 | $4 079 | $2 883 |
| Ratio of net charge-offs during the period to average loans outstanding during the period | .32% | .70% | .02% |

Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The majority of the current nonaccrual loans as shown in the chart below are in the process of collection. Management expects the collateral securing the loans will be liquidated in the second or third quarter of 2009. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

| Nonaccrual loans | March 31, 2009 $2 771 | March 31, 2008 $4 052 |
| --- | ---: | ---: |
| Restructured loans | — | — |
| Foreclosed properties | 1 689 | 46 |
| Total nonperforming assets | $4 460 | $4 098 |
| Loans past due 90 days accruing interest | $250 | $26 |
| Allowance for loan losses to period end loans | 1.99% | 1.27% |
| Nonperforming assets to period end loans and foreclosed properties | 1.81% | 1.81% |

15

At March 31, 2009, other potential problem loans total $7.6 million. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis. As a result of the regular loan reviews management has decided to increase its loan loss reserve. This is reflected in the allowance for loan loss to period end loans ratio for the March quarter. The increase over the previous year represents management’s assessment of the bank’s loan portfolio that has been affected by the poor economic conditions. As stated earlier, the decline in the housing industry has affected the bank. Most of the loans foreclosed upon or currently in nonaccrual status are related to the housing industry. They include loans to consumers who can no longer afford to make their mortgage payments and commercial clients who have housing projects in various stages of completion that are not selling or cannot be completed due to lack of cash and/or borrowing capacity.

The details of the income statements for the three months ended March 31, 2009 and 2008 are highlighted below.

- Net income in 2009 is 146.9% less than 2008 net income. The greatest factors contributing to this reduction are the additions to the provision for loan losses, expenses related to foreclosed properties and the decrease in interest rates.
- At March 31, 2009, total interest and dividend income is down 18.4% compared to March 31, 2008 due to decreased interest rates and no dividends paid on stock holdings in the first quarter of 2009.
- At March 31, 2009, interest expense was 27.4% below 2008 expense for the same time period. The decrease in expense is due to the decrease in interest rates and the lower overall amount of purchased federal funds.
- Net interest income through March 31, 2009 has decreased 12.3% compared to March 31, 2008. Interest income and expense are somewhat skewed by our agreement with BlueRidge Bank during the first quarter of 2008. Both income and expense amounts for 2008 are slightly higher due to loan and deposit amounts that were eventually returned to BlueRidge Bank later in 2008 as a result of their chartering. Other contributing factors include the decrease in interest rates and interest expense on a new loan received from FHLB in September 2008.
- Net interest margin at March 31, 2009 is 3.52%, down from the December 31, 2008 figure of 3.84% and March 31, 2008 figure of 3.82%. During the first three months of 2009, the overall average rate on loans dropped from 6.5% at December 31, 2008 to 5.8% at March 31, 2009. The overall rate on loans at March 31, 2008 was 6.95%. During this same period the overall average rate being paid on deposits decreased to 2.3% from 2.7% at December 31, 2008 and 3.07% at March 31, 2008.

Noninterest income decreased 2.7% for the three months ended March 31, 2009 compared to March 31, 2008. Some significant income items are listed here.

- Service charges on deposit accounts have decreased 11.6% in 2009 over 2008. The bulk of this change is decrease in income from overdraft fees and return check charges. It appears that customers are paying more attention to their spending and incurring fewer fees.
- Income from fiduciary activities has decreased 28.6% in 2009 over the same period in 2008. The majority of this decrease was due to a personnel change in the investment department which caused sales to be reduced significantly during the transition period.

Income decreases for the two items described directly above were offset by increases in secondary market fee income and a current gain on sale of other real estate compared to a loss at March 31, 2008.

- Fee income from secondary market loans have increased 100% on the strength of refinancing and a buyer’s market for those that can afford to participate.

Noninterest expense increased about 15.0% for the three months ended March 31, 2009 compared to the same period in 2008. Some details are listed below.

- Salaries and employee benefits for the first three months of 2009 have decreased 5.2% compared to the first three months of 2008. Some employees have not been replaced due to economic conditions and current staffing needs.
- Occupancy expense has decreased 10.2 % due to a reduction in repairs and maintenance expense and rent expense. Rent expense decreased when, in 2008, the bank exercised its lease purchase option on the land on which our Martinsburg branch is located and closed our loan production office in Winchester, Virginia.
- Advertising and marketing expenses have decreased 29.6% in 2009 compared to 2008. The conscious effort to reduce costs and the use of internal software to provide more cost effective advertising have contributed to this reduction in expense.
- Printing, stationery and supplies expense increased 59.6%. This is due in part to a billing for the printing of marketing materials for the launch of the Smart checking account.
- ATM and check card expenses have increased 28.4% in the first three months of 2009 compared to the same time period in 2008. The increase can be attributed to more use, in general, and more usage as one of the conditions of earning higher interest on Smart checking balances as well as the cost of reissue of quantities of cards that were compromised due to the nationwide “Heartland payment systems” fraud.
- Foreclosed property expenses are significantly higher in March 2009 compared to March 2008 as foreclosures increased throughout the remainder of 2008 and are continuing in 2009. The rate of foreclosure of privately owned residential properties has slowed during the first quarter of 2009. However, we are starting to see commercial property foreclosures increase during the current quarter.
- CFSI is the parent of Silverton Bank, N.A. Silverton was closed by the OCC on Friday, May 1, 2009. The FDIC has been named receiver. Silverton Bridge Bank, N.A. has been chartered by the OCC and controlled by the FDIC in order to liquidate the failed bank in orderly fashion. Management of Potomac believed it was prudent under these circumstances to write off the investment in CFSI as an impairment loss.
- Other noninterest expenses have increased 24.3% at March 31, 2009 compared to March 31, 2008. There are few significant changes, but slight increases in many expenses. The few significant changes are detailed below.
- External audit expense increased 29.4% in 2009 compared to 2008. The increase is due to increases in audit fees, an increase in areas needing specific audits on an annual basis, as well as timing of audit billings.
- Other professional fees increased 25.6% in 2009 compared to 2008. The increase is due to payments for updated appraisals on property collateralizing loans. After March 31, 2009, these charges were reclassified to another general ledger account.
- Postage expense has decreased 18. 6% compared to the first quarter of 2008. The increased use of E-statements by customers has contributed to this decrease as well as the timing of payments.

LIQUIDITY

Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2009.

Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions, such as depreciation expense, that reduce net income but do not require a cash outlay. Through March 31, 2009 net income as adjusted has used cash of $0.1 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. In addition, the principal portion of loan payments and loan payoffs and funds from maturing investments provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash used in investing activities through March 31, 2009 is $4.8 million.

Financing Activities. Customer deposits and company borrowings provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends, 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 as of March 31, 2009 is $12.2 million.

Borrowing capabilities provide additional liquidity. The bank has unused credit lines in the approximate amount of $130 million at multiple institutions including the Federal Home Loan Bank of Pittsburgh.

## Controls and procedures

As filed, 1,024 characters.

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Filed May 15, 2009.
Source: SEC EDGAR, the filing index for accession 0001193125-09-112554. Last ingested by Listed: Oct 24, 2026, 15:00 ET. No prices; not investment advice.