# Potomac Bancshares Inc: Form 10-Q for the period ended Jun 30, 2010

- Company: [Potomac Bancshares Inc](/companies/ptbs.md) (CIK 925173)
- Form: 10-Q
- Filed: 2010-08-16
- Accepted by EDGAR: Aug 16, 2010, 13:25 ET
- Period: 2010-06-30
- Accession: 0001193125-10-189901
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/925173/000119312510189901/d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/925173/000119312510189901/

## Management's discussion and analysis

As filed, 16,452 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: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) 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 outlook for the economy continues to be somewhat of a moving target. Each day seems to bring economic news that contradicts the news of the previous day. Management keeps abreast of the latest economic data and how it might affect our local economy. The overall view is still that the economic recovery will be slow and, at times, painful.

The strategies adopted by management and the board of directors and discussed in the March 31, 2010 Form 10-Q are producing the intended results. We are once again increasing capital and income. Although gross income is lower than the previous year we have increased net income through cost cutting measures such as lowering interest rates on deposits and encouraging employees to cut costs whenever reasonably possible. This strategy has produced three consecutive quarters of net income and each quarter has been slightly more profitable than the previous quarter.

Total assets have increased $.7 million or .2% from the December 2009 total of $303.2 million to $303.9 million at June 30, 2010. Cash and due from banks increased $6.7 million from December 31, 2009 and $5.6 million from March 31, 2010. Cash and due from banks increased because of liquidity needs and the added fact of keeping funds at the Federal Reserve. Currently the Federal Reserve is paying slightly higher rates than our correspondents are paying for federal funds. Federal funds sold decreased $4.1 million from December 31, 2009 compared to June 30, 2010. Securities have increased $5.4 million from December 31, 2009 and have decreased $3.5 million from March 31, 2010. Securities have been somewhat volatile due to the call of many higher yielding securities and the timing of replacing the called securities. Loans have decreased $7.5 million since December 31, 2009 and $5.6 million since March 31, 2010. The decrease in loans has been a combination of payoffs and defaults. Other real estate owned has increased $1.0 million from December 31, 2009 and $0.8 million from March 31, 2010. Other real estate owned has increased due to continuing defaults by customers on residential and commercial properties as well as the continued slow pace of the real estate market.

Total deposits have decreased $.4 million or .5% at June 30, 2010 compared to December 31, 2009. Noninterest-bearing deposits have decreased 1.1% and interest-bearing deposits have decreased 0.5% during the first six months of 2010. Overall, core deposits actually increased slightly. The largest contributor to the decrease in total deposits was the maturity of $1.5 million in brokered deposits.

The June 30, 2010 annualized return (loss) on average assets is .56% compared to (.74)% at December 31, 2009. At June 30, 2010 the annualized return (loss) on average equity is 6.56 % compared to (8.53)% at December 31, 2009. The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.99% at June 30, 2010 compared to 8.75% at December 31, 2009. The Tier 1 capital to total risk weighted assets ratio is 12.37% at June 30, 2010 compared to 11.65% at December 31, 2009. The total capital to risk weighted assets ratio is 13.64% at June 30, 2010 compared to 12.92% at December 31, 2009. All capital ratios are within the regulatory guidelines for “well capitalized”.

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 monthly basis for all loans and information on commercial loans graded below a certain level and 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.

|  | June 30 2010 | December 31 2009 | June 30 2009 |
| --- | ---: | ---: | ---: |
| Balance at beginning of period | $5,718 | $4,079 | $4,079 |
| Charge-offs: |  |  |  |
| Commercial, financial and agricultural | — | 23 | 23 |
| Real estate – construction | 406 | 3,957 | 2,945 |
| Real estate – mortgage | 487 | 920 | 376 |
| Consumer | 141 | 383 | 180 |
| Total charge-offs | 1,034 | 5,283 | 3,524 |
| Recoveries: |  |  |  |
| Commercial, financial and agricultural | — | 5 | 5 |
| Real estate – construction | — | — | — |
| Real estate – mortgage | 8 | 2 | 2 |
| Consumer | 114 | 225 | 120 |
| Total recoveries | 122 | 232 | 127 |
| Net charge-offs | 912 | 5,051 | 3,397 |
| Provision charged to operations | 771 | 6,690 | 3,137 |
| Balance at end of period | $5,577 | $5,718 | $3,819 |
| Ratio of net charge-offs during the period to average loans outstanding during the period | .40% | 2.11% | 1.39% |

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.

Following is a table showing the risk elements in the loan portfolio with amounts in thousands.

|  | June 30 2010 | December 31 2009 | June 30 2009 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $3,094 | $3,819 | $2,707 |
| Restructured loans | — | — | — |
| Foreclosed properties | 6,647 | 5,632 | 5,566 |
| Total nonperforming assets | $9,741 | $9,451 | $8,273 |
| Loans past due 90 days accruing interest | $— | $— | $558 |
| Allowance for loan losses to period end loans | 2.46% | 2.44% | 1.61% |
| Nonperforming assets to period end loans and foreclosed properties | 4.17% | 3.93% | 3.41% |

At June 30, 2010, other potential problem loans total $6.4 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.

The details of the income statements for the six months ended June 30, 2010 and 2009 are highlighted below.

- Net income in 2010 is $860 thousand compared to the net loss in 2009 of $1.1 million. The greatest factors contributing to this increase are the decrease in interest rates on deposits, an overall decrease in most expense categories and a large decrease in the provision for loan losses.
- At June 30, 2010, total interest and dividend income is down 7.2% compared to June 30, 2009 due to decreased interest rates on a reduced loan portfolio and the replacement of called securities with lower yielding securities.
- At June 30, 2010, interest expense was 18.0% below 2009 expense for the same time period. The decrease in expense is due to the decrease in interest rates including the FHLB advance that was refinanced at the end of the first quarter of 2010.
- Net interest margin at June 30, 2010 is 3.53%, equal to the December 31, 2009 figure of 3.53% and down slightly from the June 30, 2009 figure of 3.55%. During the first six months of 2010, the overall average rate on loans dropped slightly from 5.78% at December 31, 2009 to 5.73% at June 30, 2010. The overall rate on loans at June 30, 2009 was 5.83%. During this same period the overall average rate being paid on deposits decreased to 1.77% from 2.03% at December 31, 2009 and 2.16% at June 30, 2009.

Noninterest income increased 3.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some significant income items are listed here.

- Income from fiduciary activities has increased 20.1% in 2010 over the same period in 2009. Both trust and investment income has increased over 2009. The majority of the increase in trust income was the closing of estates where the fees were greater than the original accruals for the income. When an estate account is established the trust department creates an estimate of expected fee income from the account. A monthly accrual is booked based on the estimate. When the estate closes the income is adjusted for the difference between the estimate and the actual fee earned.
- Gains on the sale of other real estate have increased 294% over the 2009 amount. This increase is due to more properties being sold in 2010. Another factor is the continuing stabilization of the housing market which has slightly increased real estate values, although not to pre-recession levels.
- Visa and MasterCard fees have increased 23.2% over 2009. The increase is still due to the continued popularity of the Smart Checking account which requires twelve debit card transactions each statement cycle to earn the higher interest rate.
- Other income has increased 27.5% over the same period in 2009. The increase is due to increases in a number of other income categories.
- Service charges on deposit accounts have decreased 11.6% in 2010 from 2009. 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. These fees may decrease even more based on proposed legislation that would affect the amount the bank can charge customers for these fees.
- Fee income on secondary loans has decreased 77.8% as of June 30, 2010 compared to June 30, 2009. Although the housing market is showing some stabilization, it has not resulted in an increase in mortgage activity.

Noninterest expense decreased about 13.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some details are listed below.

- The FDIC assessment has increased 17.1%. This is the result of increases in the calculation of the assessment. The FDIC was forced to increase the assessment to recoup the costs of the many bank failures in the past few years.
- Occupancy expense has increased 22.3 % over 2009. A significant factor in the increase is the depreciation of the costs of the Smith Building addition and second floor renovations, all at the main office. These projects were not complete as of June 30, 2009.
- Printing, stationery and supplies expense decreased 15%. This is due to management emphasis on cutting costs. There are many more expense categories that have decreased, to a lesser extent, for the same reason. This expense category increased 91.4% in the quarter ended June 30, 2010 over the quarter ended March 31, 2010. The increase is the result of expenses related to notifying customers of the legislation requiring customers to opt in to the overdraft protection feature on deposit accounts.
- ATM and check card expenses have decreased 26.6% in the first six months of 2010 compared to the same time period in 2009. The expense in 2009 included the cost of reissuing quantities of cards that were compromised due to the nationwide “Heartland payment systems” fraud. The expense is down in 2010 based on not having that additional expense.
- Foreclosed property expenses are 59.5% lower as of June 2010 compared to June 2009. The number of new foreclosures has decreased. In addition, the foreclosures have required less expense to prepare them for sale.
- Other noninterest expenses have decreased 9.8% at June 30, 2010 compared to June 30, 2009. There are few significant changes, but slight decreases in many expenses. Most of the decreases are due to the aforementioned management emphasis on controlling costs. The few significant changes are detailed below.
- External audit expense decreased 56.5% in 2010 compared to 2009. The majority of the decrease is due to the cost of an out-sourced loan review in 2009. The review will not be performed in 2010.
- Legal fees have increased 48.5% over the same period in 2009. The increase is due to more legal fees related to foreclosure and bankruptcy proceedings during the first half of 2010 as compared to the same period in 2009.

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, 2010.

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 June 30, 2010 net income as adjusted has provided cash of $3.7 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 provided by investing activities through June 30, 2010 is $.5 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 used in financing activities as of June 30, 2010 is $1.7 million.

Borrowing capabilities provide additional liquidity. The bank has unused credit lines in the approximate amount of $16 million at multiple institutions including the Federal Home Loan Bank of Pittsburgh.

OFF BALANCE SHEET ARRANGEMENTS

No material changes to off balance sheet arrangement have occurred since the filing of the 2009 Form 10-K.

## 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 Aug 16, 2010.
Source: SEC EDGAR, the filing index for accession 0001193125-10-189901. Last ingested by Listed: Oct 24, 2026, 15:00 ET. No prices; not investment advice.