UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997.
Commission file number 0-18543
CHESAPEAKE FINANCIAL SHARES, INC.
Virginia 54-1210845
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
1 N. Main St., Kilmarnock, VA 22482
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (804)-435-1181
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock ($5.00 par value)
(Title of Class)
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No________
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State Issuer's Revenues for its most recent fiscal year $14,343,120.
As of March 2, 1998 the aggregate market value of Common Stock of Chesapeake
Financial Shares, Inc. held by nonaffiliates was approximately $8,672,042 based
upon the sales price per share known to management on that date.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of March 2, 1998.
Class Outstanding at March 2, 1998
----- ----------------------------
Common Stock, $5.00 par value 1,010,103
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its
Annual Meeting of Shareholders to be held on April 3, 1998 are
incorporated by reference into Part III of this Form 10-KSB.
Portions of the registrant's 1997 Annual Report to Shareholders are
incorporated by reference into Part II of this Form 10-KSB.
Transitional Small Business Disclosure Format (check one): Yes No X.
CHESAPEAKE FINANCIAL SHARES, INC.
FORM 10-KSB
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INDEX
PART I
Page
Item 1. Description of Business............................ 3-11
Statistical Information............................ 12-24
Item 2. Description of Properties.......................... 24
Item 3. Legal Proceedings.................................. 24
Item 4. Submission of Matters to a Vote of Security Holders 24
PART II
Item 5. Market for Common Equity and Related Stockholder
Matters............................................ 25
Item 6. Management's Discussion and Analysis or Plan of
Operation.......................................... 25
Item 7. Financial Statements............................... 25
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......... 25
PART III
Item 9. Directors, Executive Officers, Promoters and Control
Persons, Compliance with Section 16(a) of the
Exchange Act................................. 26
Item 10. Executive Compensation............................. 26
Item 11. Security Ownership of Certain Beneficial Owners and
Management......................................... 26
Item 12. Certain Relationships and Related Transactions..... 26
Item 13. Exhibits and Reports on Form 8-K................... 27
Signatures ................................................. 31
EXHIBIT A Financial Reports
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PART I
Item 1. Description of Business
The Company
Chesapeake Financial Shares, Inc. (the "Company") is an independent,
community owned one-bank holding company based in Kilmarnock, Virginia. The
Company was incorporated under the laws of the Commonwealth of Virginia in 1982
in connection with the reorganization of Chesapeake Bank (the "Bank", organized
in 1900) into a one-bank holding company structure. Today the Company conducts
substantially all of its business activities through the wholly-owned subsidiary
- - the Bank. Additionally, the Company operates Chesapeake Mortgage Company,
Inc., Chesapeake Insurance Agency, Inc., t/a Chesapeake Investment Services, and
CNB Properties, Inc.
On December 31, 1997, the Company and its subsidiaries had 92 full-time
equivalent employees.
The Bank
The Bank is a full-service commercial bank incorporated under the laws
of the Commonwealth of Virginia and traces its origins back to 1900. The current
Bank was formed by the merger on April 27, 1968 of Chesapeake Banking Company,
headquartered in Lively, Virginia, and Lancaster National Bank, headquartered in
Irvington, Virginia. Lancaster National Bank was originally chartered on April
14, 1900, and Chesapeake Banking Company was organized on October 15, 1920. The
Bank (formerly Chesapeake National Bank) converted from a national to a state
chartered bank on June 27,1995.
The Bank has grown to provide a full range of banking and related
financial services, including checking, savings, certificates of deposit and
other depository services, commercial, residential real estate and consumer loan
services, safekeeping services and trust and estate services. The Bank is a
member of the Federal Reserve System and its deposits are insured by the Bank
Insurance Fund of the Federal Deposit Insurance Corporation.
Total assets have increased 14.7%, 8.9%, and 5.5% for each of the years
1997, 1996, and 1995, respectively. Total loans increased to $102.2 or 12.9% at
December 31, 1997, to $90.4 million or 11.6% at December 31, 1996, and to $81.0
million or 8.3% at December 31, 1995. Growth in total deposits has followed a
similar pattern with increases of 15.6%, 7.5%, and 5.7%. The James City County
Winn-Dixie Office was opened in May of 1995. The Five Forks/Williamsburg Office
was opened in May of 1996. The Bank operates nine banking offices and thirteen
ATMs.
The Bank expanded its market area to James City County in the spring of
1995. The second full service banking facility was opened at Route 5 and
Ironbound Road, southwest of Williamsburg. This branch has complimented the
Winn-Dixie branch and ATM facilities currently in the county. The third
Williamsburg office will open in May of 1998 at Lafayette Street, near
Merchant's Square. This will be a regional office that will also provide office
space for Chesapeake Investment Services.
The Bank's existing market area covers most of the area north of the
Rappahannock River and south of the Potomac River known as the "Northern Neck",
the area bounded on the south by the York River and on the north by the
Rappahannock River, known as the "Middle Peninsula", and the Williamsburg area
north of the James River.
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The Bank's current market area is largely rural. The principal business
activities are primarily related to the small commercial enterprises and
residential real estate due to the area's popularity as a retirement and summer
home location. The growth of the York County - Williamsburg - Hampton triangle
has provided additional commercial and residential business activity which
diversifies revenue sources.
The Westminster Canterbury Office is leased under an agreement that
expires May 31, 2000. The Gloucester and the James City County branches occupy
facilities rented from Winn-Dixie Raleigh. The initial Gloucester lease on the
premises expires in October of 1999, and the James City lease expires May of
2000. Both Winn-Dixie contracts have two five year renewals. The Five Forks
Office lease expires December 31, 2000 with three five year renewals. The Bank's
Main Office and other branch offices are held in fee, free of any encumbrances
The Bank's branch offices are located as follows:
Gloucester Winn-Dixie Office Hayes Office Lively Office
Route 17 Route 17 Lively, Virginia
The Shoppes at Gloucester Hayes Shopping Center
Gloucester, Virginia Hayes, Virginia
Rappahannock Westminster Kilmarnock Office Mathews Office
Canterbury Office 97 North Main Street Mathews Courthouse
Irvington, Virginia Kilmarnock, Virginia Mathews, Virginia
Irvington Office James City County Five Forks Office
Irvington, Virginia Winn-Dixie Office Rt5 & Ironbound Rd
Williamsburg, Virginia Williamsburg, Va.
The Company operates a separate office for its Loan Administration
Department at 19 North Main Street, Kilmarnock, Virginia. This office is leased
under an agreement that expires on April 1, 2002 and has a five year renewal.
The Company has an operations center at 1 North Main Street in Kilmarnock, which
it owns in fee and is unencumbered.
The Company acquired a 2.647 acre commercial property (formerly the
Colonial Store complex) located on School Street in Kilmarnock on January 2,
1998. The building is approximately 27,000 square feet. Just over one half of
the space is rented to three tenants, Advance Auto, deMedici Italian Restaurant,
and Rappahannock General Hospital. The remaining space will be used by the
Administrative Support, Operations, and Loan Processing Center. The vacated
space will be sold (1 North Main Street) or sub-let (19 North Main Street).
The Mortgage Company
Chesapeake Mortgage Company, Inc. (the "Mortgage Company"), which is a
wholly-owned subsidiary of the Company, completed its ninth year of operations
in 1994. The Mortgage Company operations area was consolidated with the Bank's
loan operations/underwriting area at the end of 1995. This resulted in improved
customer service while reducing over all costs. The Bank offers the same
permanent fixed and adjustable rate home mortgage loans as the Mortgage Company.
The Bank also solicits customers in the counties of Lancaster, Northumberland,
Gloucester, Mathews, Middlesex, York and the James City County/Williamsburg
area. The Bank and the Mortgage Company comply with the guidelines of the
Federal Home Loan Mortgage Corporation, and all loans are sold in the secondary
market within fifteen to sixty days after the loan closing date.
See "Lending Activities" below for further information on the mortgage
lending services offered by the Bank.
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The Investment Company
Chesapeake Insurance Agency, Inc., formerly T/A Chesapeake Title
Company, (the "Title Company"), which is a wholly-owned subsidiary of the Bank,
completed its eleventh year of operations in 1997. The Title Company has also
had its operations consolidated with the Bank and provides referrals to other
companies for title insurance services. The Company is now T/A Chesapeake
Investment Services and offers annuity products (fixed and variable), mutual
funds and discount brokerage products.
Lending Activities
The Company provides a wide range of commercial, real estate, and
consumer loan services.
Real Estate Lending. The Company's real estate loan portfolio (both
mortgage and construction lending) continues to be its largest loan category as
it amounted to $41.8 million at December 31, 1997, or 40.3% of its total loan
portfolio. The Bank offers permanent fixed and adjustable rate first mortgage
loans on one-to-four family residential properties. Most of the long-term fixed
rate mortgages and the adjustable rate mortgages are underwritten and documented
in accordance with the guidelines of the Federal Home Loan Mortgage Corporation
and are sold in the secondary market within fifteen to sixty days after the loan
closing date.
The Bank emphasizes the origination of adjustable rate mortgages in
order to increase the proportion of the Company's total loan portfolio with more
frequent repricing. At December 31, 1997, 47.0% of the mortgage portfolio was
subject to repricing or maturing within twelve months.
The relative customer demand for adjustable-rate and fixed-rate
residential mortgage loans has varied considerably, depending on such factors as
the level of interest rates and expectations regarding future interest rates and
the supply of new housing units placed on the market in the Company's trade
area. At December 31, 1997, the mortgage portfolio amounted to $38.9 million, or
37.5% of total loans.
As part of its residential lending program, the Bank offers
construction loans with 80% loan-to-value ratios to qualified builders and
individuals. Construction loans generally have terms of up to twelve months and
interest rates which generally are fixed commitments. Loan proceeds are
disbursed in increments as construction progresses and as inspections warrant.
In addition to builders' projects, the Bank finances the construction of
individual, owner-occupied houses where qualified contractors are involved.
Construction loans are structured either to be converted to permanent loans at
the end of the construction phase or to be paid off upon receiving financing
from another financial institution.
Construction loans afford the Bank the opportunity to charge higher
loan origination fees, to increase the frequency of repricing of its loan
portfolio and to earn yields higher than those obtainable on adjustable-rate
loans secured by existing one-to-four family residential properties. These
higher yields reflect the higher risks associated with construction lending,
principally the difficulty in evaluating accurately the total funds required to
complete a project and the post-completion value of the project. As a result,
the Bank places a strong emphasis upon the borrower's ability to repay principal
and interest.
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Consumer Lending. As the competitive and regulatory environments have
changed, the Company has sought to expand its retail banking services to
complement the range of traditional consumer services already offered. The Bank
has maintained emphasis on consumer loans (11.8% increase in 1997 over 1996 and
11.8% increase in 1996 over 1995) because of their attractive yields and
repricing characteristics. The Bank currently originates a variety of consumer
loans, including lines of credit secured by owner-occupied real estate, real
estate equity loans, boat loans, loans secured by deposits, unsecured loans and
automobile loans. The Bank's consumer loan portfolio was approximately $16.3
million at December 31, 1997, or 15.7% of its total loan portfolio.
Consumer loans generally are considered to entail greater risk than
residential mortgage loans secured by first liens on owner-occupied properties.
The Bank's underwriting and screening processes have been designed to reduce
this risk and have, to date, limited the Bank's consumer delinquency rate to
levels below industry averages. At December 31, 1997, 0.39% of the Bank's
consumer loan portfolio was 30 days or more delinquent.
Commercial Lending. Commercial lending activities to the Bank's
commercial, industrial, agricultural, and governmental customers include the
making of asset-based and other secured loans, making unsecured loans, and
offering demand and term loans. Management believes commercial loans offer the
potential for better yields and repricing characteristics than most other types
of loans. At December 31, 1997, the Bank's commercial loan portfolio amounted to
$40.9 million, or 39.4% of its total loan portfolio. See Note 3 to the Financial
Statements for a breakdown of the major loan classifications. Of the $40.9
million of commercial loans at December 31, 1997, 73.5% of such loans either
matured or were subject to repricing within one year. (see Table 4 at page 18).
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his employment and other
income, commercial loans generally involve more risk. Commercial loans typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of its business and are generally secured by business assets, such as
accounts receivable, equipment, and inventory. As a result, the availability of
funds for the repayment of commercial loans may be substantially dependent on
the success of the business itself. At December 31, 1997, 90.5% of the
commercial loans were secured by some form of collateral and 1.14% of the Bank's
commercial loan portfolio was 30 days or more delinquent. See Table 6 at page 20
showing the amount of commercial loans charged off during 1997 and 1996.
The Company adopted FASB No. 114, "Accounting by Creditors for
Impairment of a Loan". This statement has been amended by FASB No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures". Statement 114, as amended, requires that the impairment of loans
that have been separately identified for evaluation is to be measured based on
present value of expected future cash flows or, alternatively, the observable
market price of the loans or the fair value of the collateral. However, for
those loans that are collateral dependent (that is, if repayment of those loans
is expected to be provided solely by the underlying collateral) and for which
management has determined foreclosure is probable, the measure of impairment of
those loans is to be based on the fair value of the collateral. Statement 114,
as amended, also requires certain disclosures about investments in impaired
loans and the allowance for credit losses and interest income recognized on
loans.
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The Company considers all consumer installment loans and residential
mortgage loans to be homogeneous loans. These loans are not subject to
impairment under FASB 114. A loan is considered impaired when it is probable
that the Corporation will be unable to collect all principal and interest
amounts according to the contractual terms of the loan agreement. Factors
involved in determining impairment include, but are not limited to, expected
future cash flows, financial condition of the borrower, and the current economic
conditions. A performing loan may be considered impaired, if the factors above
indicate a need for impairment. A loan on nonaccrual status may not be
considered impaired, if in the process of collection or there is an
insignificant shortfall in payment. An insignificant delay of less than 30 days
or a shortfall of 5% of the required principal and interest payment generally
does not indicate an impairment situation, if in management's judgement the loan
will be paid in full. Loans that meet the regulatory definitions of doubtful or
loss generally qualifies as an impaired loan under FASB 114. Charge-offs for
impaired loans occur when the loan, or portion of the loan is determined to be
uncollectible, as is the case for all loans. The Company had no loans subject to
FASB 114 at December 31, 1997, 1996, and 1995.
Long-Term Debt
See Note 6 to the Financial Statements for information concerning past
term loan agreements of the Company. The existing line of credit agreement
mentioned in Note 6 requires the Bank, among other things, to maintain its
reserve for loan losses and certain minimum capital ratios as required by the
Company's regulators.
There is no line of credit balance outstanding at December 31, 1997.
To secure this indebtedness of the Company to The Community Banker's
Bank, the Company pledged its entire stock ownership interest in the Bank to The
Community Banker's Bank. So long as no event of default shall occur under the
loan agreement and related documents, the Company will be entitled to continue
to receive all cash distributions and dividends with respect to the pledged
shares and to vote such shares, and otherwise to have all rights as owner of the
pledged shares, except the right to transfer or encumber such shares.
Competition
The Bank is subject to intense competition from various financial
institutions and other companies or firms that offer financial services. In its
market area, the Bank is and will be competing with several statewide banking
institutions, including First Virginia Bank, Crestar Bank, NationsBank and First
Union National Bank. The Bank competes for deposits with other commercial banks,
savings and loan associations, credit unions and with issuers of commercial
paper and securities, such as money market and mutual funds. In making loans,
the Bank competes with other commercial banks, savings and loan associations,
consumer finance companies, credit unions, leasing companies and other lenders.
Federal and state legislative changes since 1982 have significantly increased
competition among financial institutions, and current trends towards further
deregulation may be expected to increase such competition even further. Many of
the financial organizations in competition with the Company have greater
financial resources than the Company and are able to offer similar services at
varying costs with greater loan capacities.
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Supervision and Regulation
Bank holding companies and banks are extensively regulated under both
federal and state law. The following description briefly discusses certain
provisions of federal and state laws and certain regulations and proposed
regulations and the potential impact of such provisions on the Company and the
Bank.
Bank Holding Companies. As a bank holding company registered under The
Bank Holding Company Act of 1956 (the "BHCA"), the Company is subject to
regulation by the Federal Reserve Board. The Federal Reserve Board has
jurisdiction under the BHCA to approve any bank or nonbank acquisition, merger
or consolidation proposed by a bank holding company. The BHCA generally limits
the activities of a bank holding company and its subsidiaries to that of
banking, managing or controlling banks, or any other activity which is so
closely related to banking or to managing or controlling banks as to be a proper
incident thereto.
The Riegle-Neil Interstate Banking and Branching Efficiency Act of 1994
authorizes the Federal Reserve the Federal Reserve Board to permit adequately
capitalized and adequately managed bank holding companies to acquire all or
substantially all of the assets of an out-of-state bank or bank holding company,
subject to certain conditions, including nationwide and state concentration
limits. Effective June 1, 1997, banks also are able to branch across state lines
(unless state law would permit such interstate branching at an earlier date),
provided certain conditions are met, including that applicable state law must
expressly permit such interstate branching. Virginia has adopted legislation
that permits branching across state lines effective July 1, 1995, provided there
is reciprocity with the state in which the out-of-state bank is based.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by federal law
and regulatory policy that are designed to reduce potential loss exposure to the
depositors of such depository institutions and to the FDIC insurance fund in the
event the depository institution becomes in danger of default or is in default.
For example, under a policy of the Federal Reserve Board with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to is subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such policy. In addition, the "cross guarantee" provision of
federal law requires insured depository institutions under common control to
reimburse the FDIC for any loss suffered or reasonably anticipated by either the
Savings Association Insurance Fund ("SAIF") or the Bank Insurance Fund ("BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
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The Federal Deposit Insurance Act ("FDIA") also provides that amounts
received from the liquidation or other resolution of any insured depository
institution by any receiver must be distributed (after payment of secured
claims) to pay the deposit liabilities of the institution prior to payment of
any other general or unsecured senior liability, subordinated liability, general
creditor or stockholder. This provision would give depositors a preference over
general and subordinated creditors and stockholders in the event a receiver is
appointed to distribute the assets of the Bank.
The Company is registered under the bank holding company laws of
Virginia. Accordingly, the Company and the Bank are subject to regulation and
supervision by the State Corporation Commission of Virginia (the "SCC").
Capital Requirements. The Federal Reserve Board, the Office of the
Comptroller of the Currency (the "OCC") and the FDIC have issued substantially
similar risk-based and leverage capital guidelines applicable to United States
banking organizations. In addition, those regulatory agencies may from time to
time require that banking organization maintain capital above the minimum levels
because of its financial condition or actual or anticipated growth. Under the
risk- based capital requirements of these federal bank regulatory agencies, the
Company and the Bank are required to maintain a minimum ratio of total capital
to risk-weighted assets of at least 8%. At least, half of the total capital is
required to be "Tier 1 capital", which consists principally of common and
certain qualifying preferred shareholders' equity, less certain intangibles and
other adjustments. The remainder ("Tier 2 capital") consists of a limited amount
of subordinated and other qualifying debt (including certain hybrid capital
instruments) and a limited amount of the general loan loss allowance. The Tier 1
and total capital to risk-weighted asset ratios of the Company as of December
31, 1997 were 12.2% and 13.5%, respectively, exceeding the minimums required.
In addition, each of the federal regulatory agencies has established a
minimum leverage capital ratio (Tier 1 capital to average tangible assets).
These guidelines provide for a minimum ratio of 3% for banks and bank holding
companies that meet certain specified criteria, including that they have the
highest regulatory examination rating and are not contemplating significant
growth or expansion. All other institutions are expected to maintain a leverage
ratio of at least 100 to 200 basis points above the minimum. The leverage ratio
of the Company as of December 31, 1997, was 8.5%, which is above the minimum
requirements . The guidelines also provide that banking organizations
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.
Limits on Dividends and Other Payments. The Company is a legal entity
separate and distinct from its subsidiary institutions. Substantially all of the
revenues of the Company result from dividends paid to it by the Bank. There are
various legal limitations applicable to the payment of dividends to Company as
well as the payment of dividends by Company to its respective shareholders.
Under federal law, the Bank may not, subject to certain limited
exceptions, make loans or extensions of credit to, or investments in the
securities of, the Company or take securities of the Company as collateral for
loans to any borrower. The Bank is also subject to collateral security
requirements for any loans or extensions of credit permitted by such exceptions.
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The Bank is subject to various statutory restrictions on its ability to
pay dividends to the Company. Under the current supervisory practices of the
Bank's regulatory agencies, prior approval from those agencies is required if
cash dividends declared in any given year exceed net income for that year plus
retained earnings of the two preceding years. Under these supervisory practices,
at December 31, 1997, the Bank could have paid additional dividends to the
Company of approximately $1.5 million, without obtaining prior regulatory
approval. The payment of dividends by the Bank or the Company may also be
limited by other factors, such as requirements to maintain capital above
regulatory guidelines. Bank regulatory agencies have authority to prohibit the
Bank or the Company from engaging in an unsafe or unsound practice in conducting
their business. The payment of dividends, depending upon the financial condition
of the Bank, or the Company, could be deemed to constitute such an unsafe and
unsound practice. .
Under the FDIA, insured depository institutions such as the Bank are
prohibited from making capital distributions, including the payment of
dividends, if, after making such distribution, the institution would become
"undercapitalized" (as such term is used in the statute). Based on the Bank's
current financial condition, the Company does not expect that this provision
will have any impact on its ability to obtain dividends from the Bank.
The Bank. The Bank is supervised and regularly examined by the Federal
Reserve Board and the SCC. The various laws and regulations administered by the
regulatory agencies affect corporate practices, such as payment of dividends,
incurring debt and acquisition of financial institutions and other companies,
and affect business practices, such as payment of interest of deposits, the
charging of interest on loans, types of business conducted and locations of
offices.
The Bank is also subject to the requirements of the Community
Reinvestment Act (the "CRA"). The CRA imposes on financial institutions an
affirmative and ongoing obligation to meet the credit needs of the local
communities, including low and moderate income neighborhoods, consistent with
the safe and sound operation of those institutions. Each financial institution's
efforts in meeting community credit needs currently are evaluated as part of the
examination process pursuant to twelve assessment factors. These factors also
are considered in evaluating mergers, acquisitions and applications to open a
branch or facility.
As an institution with deposits insured by the BIF, the Bank also is
subject to insurance assessments imposed by the FDIC. Because the SAIF was
recently recapitalized through a special assessment, the FDIC has implemented a
risk-based assessment schedule for both BIF insured and SAIF insured deposits,
imposing assessments ranging from zero (or a $2,000 minimum) to 0.27% of an
institution's average assessment base. The actual assessment to be paid is based
on whether the institution is considered "well capitalized", "adequately
capitalized" or "undercapitalized", as such terms have been defined in
applicable federal regulations, and whether such institution is considered by
its supervisory agency to be financially sound or to have supervisory concerns.
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Other Safety and Soundness Regulations. The federal banking agencies
have broad powers under current federal law to take prompt corrective action to
resolve problems of insured depository institutions. The extent of these powers
depends upon whether the institutions in question are "well capitalized,"
adequately capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized," all such terms are defined under uniform
regulations defining such capital levels issued by each of the federal banking
agencies.
Current federal law also requires each of the federal banking agencies
to develop regulations addressing certain safety and soundness standards for
insured depository institutions and depository institution holding companies,
including operational and managerial standards, asset quality, earnings and
stock valuation standards, as well as compensation standards (but not dollar
levels of compensation). Each of the federal banking agencies have issued a
joint notice of proposed rulemaking, which requested comment on the
implementation of these standards. The proposed rule sets forth general
operational and managerial standards in the areas of internal controls,
information systems and internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth and compensation, fees and
benefits. The proposal contemplates that each federal agency would determine
compliance with these standards throughout the examination process, and if
necessary to correct weaknesses, require an institution to file a written safety
and soundness compliance plan. The Company has not yet determined the effect
that the proposed rule would have on its operations if it is enacted
substantially as proposed.
Other
The Bank utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems and software
include a mainframe processing system licensed to the Bank by an outside vendor
and various purchased software packages which are run on in-house computer
networks. In 1997, the Bank initiated a review and assessment of all hardware
and software to confirm that it will function properly in the year 2000. The
Bank's mainframe hardware and banking software are currently Year 2000
compliant. The majority of the other vendors have been contacted and have
indicated that their hardware and/or software will be Year 2000 compliant.
Testing will be performed on all systems and hardware for compliance. While
there may be some additional expenses incurred during the next two years, Year
2000 compliance is not expected to have a material effect on the Company's
consolidated financial statements.
During the first quarter of 1997, the Bank satisfactorily completed a
Consumer Compliance Examination and a Community Reinvestment Act Examination
performed by the Federal Reserve Bank of Richmond. As of June 9, 1997, the Bank
and the company satisfactorily completed a Safety and Soundness Examination
performed by the Bureau of Financial Institutions of the SCC. In December of
1997 the Company satisfactorily completed a Transfer Agent Examination and a
Year 2000 Examination, both performed by the Federal Reserve Bank of Richmond.
As a result of these examinations management is not aware of any current
recommendations of the regulatory authorities which, if they were implemented,
would have a material effect on liquidity, capital resources or operations of
the Company.
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Item 1. Statistical Information
The following statistical information is furnished pursuant to the
requirements of Guide 3 (Statistical Disclosure by Bank Holding Companies)
promulgated under the Securities Act of 1933.
INDEX
Page
TABLE 1. Average Balance Sheets, Net Interest Income, and Rates..13-14
TABLE 2 . Analysis of Change in Net Interest Income............... 15
TABLE 3. Types of Investment Securities.......................... 16
TABLE 4. Maturity Schedule of Selected Loans as of Dec. 31, 1997. 17
TABLE 5 . Risk Elements........................................... 18
TABLE 6. Summary of Reserve for Loan Losses...................... 19
TABLE 7. Allocation of the Reserve for Loan Losses............... 20
TABLE 8. Deposits................................................ 20
TABLE 9. Return on Equity and Assets............................. 21
TABLE 10. Short Term Borrowing.................................... 21
TABLE 11. Interest Sensitivity Analysis........................... 22
TABLE 12. Analysis of Capital..................................... 23
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<PAGE>
TABLE 1
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES
The following table depicts interest income on earnings assets and
related average yields as well as interest expense on interest-bearing
liabilities and related average rates paid for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1996
---- ----
Annual Annual
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ----- ------ ------- ------
(Dollars in Thousands)
<S> <C>
Assets:
Securities:
Taxable $26,969 $1,676 6.21% $24,881 $1,466 5.89%
Tax-exempt(1) 11,211 589 7.96 10,101 514 7.38%
------ ------ ------ -----
Total securities 38,180 2,265 6.73 34,982 1,980 6.32%
Loans (net of
unearned income):
Taxable(2) 94,841 8,872 9.35 83,935 7,929 9.45%
Tax-exempt 2,174 166 11.57 2,669 175 9.51%
------ ------ ------ -----
Total loans 97,015 9,038 9.40 86,604 8,104 9.45%
Federal funds sold and
repurchase agreements 1,050 58 5.52 750 40 5.33%
Interest-bearing deposits
in other banks -- -- -- 396 18 4.55%
------ ----- ----- ----- ------ ------
Total earning asset
136,245 11,361 8.62% 122,732 10,142 8.55%
Less: allowance for loan
losses (1,678) (1,587)
Total nonearning assets 14,381 12,231
Total assets $148,948 $133,376
-------- --------
</TABLE>
13
<PAGE>
TABLE 1 (cont.)
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1996
---- ----
Annual Annual
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ------ ------- ------- -------
(Dollars in Thousands)
<S> <C>
Liabilities and Shareholder's Equity:
Interest-bearing deposits:
Checking 21,022 508 2.42% $ 20,552 $ 503 2.45%
Regular savings 11,437 308 2.69 11,064 299 2.70
Money market savings 5,980 174 2.91 6,692 199 2.97
Certificates of deposit:
$100,000 and over 15,131 851 5.62 14,022 781 5.57
Under $100,000 63,236 3,504 5.54 53,049 2,922 5.51
------ ------ ---- ------ ----- ----
Total interest-bearing
deposits 116,806 5,345 4.58 105,379 4,704 4.46
Federal funds purchased
and securities sold under
agreements to repurchase 849 51 6.04 452 25 5.53
Other borrowing 216 11 5.17 286 26 9.09
----- --- ---- --- ----
Total interest-bearing
liabilities 117,871 5,407 4.59% 106,117 4,755 4.48%
Noninterest bearing liabilities:
Demand deposits 16,612 14,362
Other liabilities 1,599 1,471
-------- -------
Total liabilities 136,082 121,950
Shareholders' equity 12,866 11,426
Total liabilities and share-
holders' equity $148,948 $133,376
Net interest income/yield 5,954 4.65% $5,387 4.68%
Interest rate spread 4.03% 4.07%
</TABLE>
1) Yields are reported on a taxable equivalent basis assuming a federal tax rate
of 34%.
2) Includes non-accrual loans.
14
<PAGE>
TABLE 2
VOLUME AND RATE ANALYSIS (1)
The following table analyzes changes in net interest income
attributable to changes in the volume of interest-bearing assets and liabilities
compared to changes in interest rates. Nonaccruing loans are included in average
loans outstanding.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 vs.1996 1996 vs. 1995
Increase (Decrease) Increase (Decrease)
Due to Changes in:(1) Due to Changes in:(2)
--------------------- ---------------------
Volume Rate Total Volume Rate Total
(In thousands)
<S> <C>
Earning Assets:
Securities:
Taxable $ 127 $ 83 $ 210 $(269) $ 30 $(239)
Tax-exempt 56 19 75 185 (14) 171
Loans
Taxable 1,032 (89) 943 730 (25) 705
Tax-exempt (32) 23 (9) 4 38 42
Federal funds sold
and repurchase
agreements 16 2 18 (59) (3) (62)
Interest-bearing deposits
in other banks (18) 0 (18) (28) (3) (31)
------ ---- ------- ----- ---- -----
Total earning
assets $1,181 $ 38 $1,219 $ 563 $ 23 $586
------ ---- ------ ----- ---- -----
Interest-Bearing Liabilities:
Interest checking $ 12 $ (7) $ 5 $ 30 $(41) $(11)
Regular savings 10 (1) 9 5 (4) 1
Money market savings (21) (4) (25) (42) 1 (41)
Time deposits:
CDS $100,000 or more 62 8 70 444 (283) 161
CDS Other 561 21 582 (118) 223 105
----- ---- ---- ----- ---- -----
Total interest-bearing
deposits 624 17 641 319 (104) 215
Federal funds purchased
and securities sold
under agreements to
repurchase 22 4 26 4 (3) 1
Other borrowing (6) (9) (15) (17) (1) (18)
---- ---- ---- ---- ---- ----
Total interest-bearing
liabilities $ 640 $ 12 $ 652 $ 306 $(108) $198
---- ---- ----- ---- ----- -----
Change in net interest
income: $ 528 $ 39 $ 567 $257 $ 131 $388
----- ---- ----- ---- ------ ----
</TABLE>
(1) The change in interest due to both rate and volume has been allocated to
change due to volume and change due to rate in proportion to the relationship of
the absolute dollar amounts of the change in each.
(2) The combined effect of changes in both volume and rate which cannot be
separately identified has been allocated proportionately to the change due to
volume and change due to rate.
15
<PAGE>
TABLE 3
SECURITIES HELD FOR RESALE AND INVESTMENT
MATURITY DISTRIBUTION AND AVERAGE YIELD
December 31,
------------
1997 1996
---- ----
Book Value: (In thousands)
U.S. Government securities.................$31,186 $26,547
State and political subdivisions........... 11,473 10,540
Other securities........................... 743 711
-------- -------
Total securities $43,402 $37,798
Expected maturities of Securities Held at December 31, 1997
Over Ten
One One Five Years and
Year to Five to Ten Equity
or Less Years Years Securities Total
------- ------- ------ ---------- ------
(Dollars in thousands)
U.S. Agency Securities:
Book value $4,087 $ 7,298 $3,670 $14,428 $29,483
Market value 4,057 7,270 3,673 14,540 29,540
Weighted average yield(1) 5.59% 6.76% 6.95% 8.13% 7.34%
U.S. Treasury Securities:
Book value 1,197 506 - - 1,703
Market value 1,195 504 - - 1,699
Weighted average yield(1) 5.27% 5.23% -% -% 5.26%
State and Political Subdivisions:
Book value 261 - 910 10,302 11,473
Market value 261 - 933 10,731 11,925
Weighted average yield(1) 6.61% - 7.97% 8.27% 8.21%
Other Securities:
Book Value - - - 743 743
Market Value - - - 743 743
Weighted Average Yield(1) -% -% -% 4.50% 4.50%
Total Securities:
Book value $5,545 $ 7,804 $4,580 $25,473 $43,402
Market value 5,513 7,774 4,606 26,014 43,907
Weighted average yield(1) 5.57% 6.35% 7.16% 8.19% 7.44%
(1) Yields on tax-exempt securities have been computed on a tax-equivalent
basis.
The Bank held no issues that exceeded 10% of Shareholder's Equity at December
31, 1997.
16
<PAGE>
TABLE 4
LOAN PORTFOLIO AND MATURITY SCHEDULE OF SELECTED LOANS
AS OF DECEMBER 31, 1997
For the table and accompanying notes addressing the loan portfolio, see
"Note 3. Loans" on page 13 of the Annual Report to Shareholders which is
incorporated by reference herein (attached as Exhibit 13 to this Form 10-KSB).
The maturity distribution and rate sensitivity of certain categories of
loans as of December 31, 1997 is presented below.
Management considers the liquidity of the Company to be adequate.
Sufficient assets are maintained on a short-term basis to meet the liquidity
demands anticipated by management. In addition, secondary sources are available
through the use of borrowed funds. See Table 10 at page 18.
1 Year or Less 1-5 Years Over 5 Years
-------------- --------- ------------
Fixed Variable Fixed Variable Fixed Variable
Rate Rate Rate Rate Rate Rate
----- -------- ----- -------- ----- --------
(Dollars in thousands)
Commercial and other $2,696 $27,335 $ 4,412 $ 5,850 $ 562 $ 0
Real estate-construction 2,900 0 0 0 0 0
Real estate mortgage 1,625 15,151 852 20,090 1,228 0
Consumer installment 4,594 1,107 6,706 702 3,158 0
------ ------- ------ ------ ------ ----
Total $12,115 $43,593 $11,970 $26,642 $4,648 $ 0
------- ------- ------- ------- ------ ------
17
<PAGE>
TABLE 5
RISK ELEMENTS
Risk elements associated with the loan portfolio are presented below.
The Company places a loan on nonaccrual status when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of principal and interest
is doubtful. The Company's policy is to place loans on nonaccrual status if
principal or interest is past due for 90 days or more unless the debt is both
well secured and in the process of being collected.
December 31,
-----------
1997 1996
---- ----
(Thousands)
Nonaccrual loans(1) $ 581 $ 143
Restructured loans 0 0
Foreclosed properties 245 245
Total nonperforming assets $ 826 $ 388
------- -----
Loans past due 90+ days and
accruing interest $ 14 $ 8
Reserve for loan losses
to period end loans 1.7% 1.8%
Reserve for loan losses to
nonaccrual loans 299.5% 1,156.3%
Nonperforming assets to
period-end loans and
foreclosed properties (2) 0.79% .42%
Net charge-offs (recoveries)
to average loans (0.01%) (0.05%)
(1)There were no troubled debt restructurings in 1997 or 1996. The Bank expects
to charge off $86,481 in problem loans (fully reserved at December 31, 1997).
These loans present potential risk of non-payment and are not included in the
numbers above. The Bank expects to collect all other payments due. See the
discussion on page 28 of the 1997 Annual Report to Shareholders and Note 3 to
the Financial Statements contained therein for additional information on the
risk elements associated with the loan portfolio.
(2)As of December 31, 1997, performing loans totaling approximately $5.2 million
were identified as potential problem loans through internal loan review systems
and procedures. The Bank has specifically reserved for potential losses in these
loans as of year end.
Loan Concentrations: The Bank has no concentration of credit that
exceeds 10% of gross loans, except real estate and consumer.
18
<PAGE>
TABLE 6
SUMMARY OF RESERVE FOR LOAN LOSS
The following table shows the Company's loan loss and recovery
experience for the past two years.
The Company tries to maintain a reserve for loan loss that represents
an estimate of all losses estimated in the Bank's loan portfolio. To achieve
this goal, the loan loss provision must be sufficient to cover charged-off loans
plus growth in the loan portfolio. The loan loss provision is a charge against
earnings necessary to maintain the reserve for loan losses at management's
targeted level. In considering the provision for loan loss, an evaluation of the
loan portfolio is conducted. Loans in non-accrual status and loans past due over
ninety days are considered in this evaluation as well as other loans the Company
feels may be a potential loss. The status of non-accrual and past due loans
varies from quarter to quarter based on seasonality and cash flow of customers.
Year ended December 31,
-----------------------
1997 1996
---- ----
(Dollars in thousands)
Reserve, beginning of period $1,653 $1,463
Loans charged off:
Commercial (29) (92)
Real estate construction 0 0
Real estate mortgage (3) 0
Consumer (10) (65)
------ -----
Total loans charged off (42) (157)
------- -----
Recoveries of loans previously charged off:
Commercial 35 180
Real estate - construction 0 0
Real estate - mortgage 0 0
Consumer 19 17
------- -----
Total recoveries 54 197
------- -----
Net loans (charged off) recovered
12 40
Provision for (recovery off) loan losses
75 150
------- ------
Balance, end of period $1,740 $1,653
------- ------
Net charge-offs (recoveries) to average loans
(0.01%) (0.17%)
19
<PAGE>
TABLE 7
ALLOCATION OF THE RESERVE FOR LOAN LOSSES
The following table provides a breakdown of the allowance for loan
losses by major categories of the Company's loan portfolio. See Note 3 to the
Financial Statements for the amount of loans in each category.
1997 1996
Percent of loans Percent of loans
in each category in each category
Amount to Total Loans Amount to Total Loans
------ -------------- ------ ----------------
(dollars in thousands)
Commercial $ 366 39.3% $ 344 36.1%
Real estate - construction 0 2.8 0 3.4
Real estate - mortgage 1,154 37.5 1,107 41.6
Consumer 220 15.7 202 15.8
Other 0 0.4 0 0.5
Participations 0 4.3 0 2.6
----- ------ ----- ----
Total $1,740 100.0% $1,653 100.0%
------ ------ ------ -----
TABLE 8
DEPOSITS
The average balance and rates for certain categories of deposits for
the last two years are shown in the following table:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996
---- ----
Average Average Average Average
Balance Rate Balance Rate
------- ------- ------- -------
(dollars in thousands)
<S> <C>
Non-interest bearing demand deposits
$ 16,612 $ 14,362
-------- --------
Interest bearing deposits:
Interest checking 21,022 2.42% 20,552 2.45%
Regular savings 11,437 2.69 11,064 2.70
Money market saving 5,980 2.91 6,692 2.97
Time deposits:
Certificates of deposit $100,000 or more
15,131 5.62 14,022 5.57
Other certificates of deposit
63,236 5.54 55,049 5.51
------- ------
Total interest bearing deposits
116,806 4.58 105,379 4.46
-------- -------
Total deposits $133,418 4.01% $119,741 3.93%
-------- --------
</TABLE>
Maturities of time certificates of deposits of $100,000 or more
outstanding at December 31, 1997 were (dollars in thousands):
1997
3 months or less $ 5,547
3 - 6 months 2,245
6 - 12 months 4,472
Over 12 months 3,425
-------
Total $15,689
20
<PAGE>
TABLE 9
RETURN ON EQUITY AND ASSETS
The ratio of net income to average total assets and average
shareholders' equity and certain other ratios for the periods indicated are as
follows:
Year ended December 31,
----------------------
1997 1996
---- ----
Return on average assets 1.18% 1.18%
Return on average equity 13.61% 13.78%
Dividend payout ratio 16.21% 15.53%
Average equity to average assets 8.63% 8.57%
TABLE 10
SHORT TERM BORROWING
The Bank periodically borrows funds through federal funds from its
correspondent banks, through securities sold under agreements to repurchase, and
through the discount window at the Federal Reserve Bank of Richmond. The
borrowings mature daily for cash flow requirements. The borrowed amounts and
their corresponding rates during 1997 and 1996 are presented below:
Year ended December 31,
-----------------------
(Dollars in Thousands)
1997 1996
---- ----
Average daily amount outstanding $1,065 $ 452
Average interest rate 5.86% 5.53%
Maximum outstanding at any month end $3,300 $2,400
Balance at end of period $1,250 $2,000
21
<PAGE>
TABLE 11
INTEREST SENSITIVITY ANALYSIS
December 31, 1997
-----------------
Within 90-365 1 to 5 Over
90 Days Days Years 5 Years Total
-------- ------ ------ ------- -----
(dollars in thousands)
Earnings Assets:
Loans (2) $ 27,782 $ 32,906 $ 37,960 $ 4,649 $103,297
Securities & Time
Deposits with
other banks 1,800 8,366 16,706 17,036 43,908
Federal funds sold
and other short-
term investments 1,900 - - - 1,900
-------- --------- ------- ------- -------
Total interest
earning assets
$ 31,482 $ 41,272 $ 54,666 $21,685 $149,105
-------- -------- -------- ------- --------
Interest-Bearing
Liabilities:
Interest checking,
savings and money
market savings(3) $ 2,280 $ 5,319 $ 32,847 $ 0 $ 40,448
Certificates of
deposit:
$100,000 and over 5,553 6,715 3,421 - 15,689
Under $100,000 14,073 39,349 18,706 - 72,128
Federal funds
purchased and
securities sold
under agreements
to repurchase 1,250 - - - 1,250
--------- ------- ------ ------- -------
Total interest-
bearing liabilities $23,156 $ 51,383 $ 54,974 $ 0 $129,513
------ -------- -------- ------- -------
Period gap $ 8,326 $(10,111) $ (308) $21,685 $ 19,592
Cumulative gap $ (1,785) $ (2,093) $19,592
Ratio of cumulative
gap to total
earning assets(4) 5.58% -1.20% -1.40% 13.14%
(1) The repricing dates may differ from maturity dates for certain assets due to
prepayment assumptions.
(2) Excludes nonaccrual loans.
(3) The Bank's Asset Liability Management Committee has found that interest
bearing checking accounts and regular saving accounts are generally not
sensitive to changes in interest rates. However, current interest rate levels
have warranted placing approximately 5.6% of these balances in the 90 day
category.
(4) The Bank's Asset Liability Management Committee monitors interest rate risk
using gap analysis and rate shock - market value - duration analysis using
regulatory guidelines. The relative risk to earnings based on the gaps in the
table above are considered reasonable by management and is within limits
established by the Board of Directors.
22
<PAGE>
TABLE 12
ANALYSIS OF CAPITAL *
December 31,
1997 1996
---- ----
(thousands)
Tier 1 Capital:
Common stock $ 5,054 $ 4,198
Additional paid in capital 484 468
Retained earnings 8,064 7,343
Less: Goodwill 0 (84)
-------- --------
Total Tier 1 capital $ 13,602 $11,925
Tier 2 Capital:
Allowance for loan losses 1,397 1,196
Allowable long-term debt 0 0
-------- --------
Total Tier 2 Capital 1,397 1,196
Total risk-based capital $ 14,999 $13,121
-------- --------
Risk weighted assets $111,196 $95,348
Capital Ratios:
Tier 1 risk-based capital ratio 12.2% 12.5%
Total risk-based capital ratio 13.5 13.7
Tier 1 capital to average
adjusted total assets 8.5 8.5
* See the captioned "Note 19 Regulatory Matters" which is included in Exhibit A
at page 23, The Annual Report to Shareholders was filed with the Commission on
or about March 11, 1997.
23
<PAGE>
Accounting Rule Changes
In June 1996, the FASB issued FASB No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities". This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. Those
standards are based on consistent application of a financial components approach
that focuses on control of the affected asset or liability that it controls or
surrenders. This Statement is effective for transfers and servicing of financial
assets and extinguishments of liabilities occurring after December 31, 1996, and
is to be applied prospectively.
In October 1996, the FASB issued FASB Statement No. 127, which deferred
for one year paragraphs 9-12 (Accounting for Transfers and Servicing of
Financial Assets) under FASB No. 125 for securities lending, repurchase
agreements, dollar rolls, and other secured transactions. The FASB also agreed
to defer for one year paragraph 15 (Secured Borrowings and Collateral) under
FASB No 125 for all transactions.
During June 1997, the FASB issued FASB No. 130, "Reporting
Comprehensive Income". This pronouncement established standards for reporting
and display of comprehensive income and its components (revenues, expenses,
gains, and losses) in a full set of general purpose financial statements. FASB
No. 130 is effective for financial statements beginning after December 15, 1997.
Additionally during June of 1997, the FASB issued FASB No. 131,
"Disclosures About Segments of an Enterprise and Related Information". FASB No.
131 establishes standards for the way that public enterprises report information
about operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement becomes effective for financial statements for periods
beginning after December 31, 1997.
ITEM 2. Description of Properties
The Company owns no properties at December 31, 1997; however, its
subsidiary, the Bank owns and leases properties as described in PART 1, Item 1
of this report. The Company purchased a property on January 2, 1998 that is
described in PART I, Item 1, The Bank.
ITEM 3. Legal Proceedings
The Bank is currently not involved in any material legal proceeding
other than ordinary litigation incidental to its business.
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during
the quarter ended December 31, 1997.
24
<PAGE>
PART II
ITEM 5. Market for the Common Equity and Related Shareholder Matters
This information is included in the 1997 Annual Report to Shareholders
at pages 30-31 in the section captioned, "Dividend and Market Information".
ITEM 6. Management's Discussion and Analysis or Plan of Operations
This information is included in the 1997 Annual Report to Shareholders
at pages 28-32.
ITEM 7. Financial Statements
The financial statements, together with the report thereon of Yount,
Hyde and Barbour, P.C. dated January 8, 1998, are attached hereto as exhibit A.
ITEM 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There have been no disagreements between the Company and its
independent accountants for the past two years.
25
<PAGE>
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act
This information is incorporated herein by reference from the Company's
1998 Proxy Statement at pages 2 through 4 and page 8 thereof attached hereto as
exhibit B.
ITEM 10. Executive Compensation
This information is incorporated herein by reference from the 1998
Proxy Statement at pages 4 through 8 thereof attached hereto as exhibit B.
ITEM 11. Security Ownership of Certain Beneficial Owners and Management
This information is incorporated herein by reference from the 1998
Proxy Statement at pages 2 through 4 thereof attached hereto as exhibit B.
ITEM 12. Certain Relationships and Related Transactions
This information is incorporated herein by reference from the 1998
Proxy Statement at page 7 thereof. See for further information Note 12 to the
Financial statements at page 20 of the Company's 1997 Consolidated Financial
Report attached hereto as exhibit A.
26
<PAGE>
ITEM 13. Exhibits and Reports on Form 8-K
(a) Exhibit Index:
#2 Not Applicable.
#3 (I)(ii)Articles of Incorporation and Bylaws. Incorporated by
reference to Exhibits 3.1 and 3.2 of previously filed
Registration Statement on Form S-18, Registration No. 33-27825,
dated May 15, 1989, as amended.
#4 Not Applicable
#9 Not Applicable
#10 Material Contracts. Exhibits 10.1 - 10.6 are incorporated by
reference to Exhibit 10 to previously filed Registration
Statement on Form S-18, Registration No. 33-27825, dated May 15,
1989, as amended.
10.1 Employee Stock Option Plan
10.2 Douglas D. Monroe, Jr. Deferred Compensation Agreement
10.3 Thomas B. Denegre, Jr. Deferred Compensation Agreement
10.4 Rappahannock Westminster Canterbury Lease Agreement
10.5 Main Street, Kilmarnock Lease Agreement
10.6 IBM Credit Corporation Equipment Leasing Agreement
10.7 Virginia Bankers Bank Term Loan Agreement incorporated
by reference to the Company's SEC 10-Q filing for March
31, 1993, Exhibit 10.2
10.8 Ted M. Kattmann Employment Agreement filed herewith
10.9 John H. Hunt, II Employment Agreement filed herewith
#11 Not Applicable
#12 Not Applicable
#13 Annual Report to Security Holders is filed herewith
#16 Not Applicable
#18 Not Applicable
#21 Subsidiaries of the Registrant is filed herewith.
#22 None
#23 Attached
#24 Not Applicable
#27 Not Applicable
#28 Not Applicable
#99 Not Applicable
(b) Reports on Form 8-K. No reports were filed by the registrant during
the fourth quarter of 1997.
27
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto, duly authorized.
CHESAPEAKE FINANCIAL SHARES, INC.
Date: March 13, 1998 By /s/ Douglas D. Monroe, Jr.
Douglas D. Monroe, Jr.
Chairman of the Board and
Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Douglas D. Monroe, Jr. March 13, 1998
----------------------
Douglas D. Monroe, Jr.
Chairman of the Board and
Chief Executive Officer
/s/ T. Nash Broaddus March 13, 1998
----------------
T. Nash Broaddus, Director
/s/ Thomas B. Denegre, Jr. March 13, 1998
----------------------
Thomas B. Denegre, Jr., Director
/s/ Eugene S. Hudnall March 13, 1998
-----------------
Eugene S. Hudnall, Director
/s Katherine W. Monroe March 13, 1998
-------------------
Katherine W. Monroe, Director
/s/ Robert S. Scheu March 13, 1998
----------------
Robert S. Scheu, Director
/s/ William F. Shumadine, Jr. March 13, 1998
-------------------------
William F. Shumadine, Jr., Director
/s/ Robert L. Stephens March 13, 1998
------------------
Robert L. Stephens, Director
28
[TO COME]
[TO COME]
[LOGO]
MISSION STATEMENT
Chesapeake Financial Shares, Inc. is an independent,
community-oriented, one-bank holding company serving
a market between the Potomac and James rivers.
Each staff and board member is part of a team that is
committed to innovation and to maintaining excellence in
customer service that creates growing and
rewarding returns to its clients, employees,
community, and shareholders.
[LOGO] [LOGO]
<PAGE>
Chesapeake Financial Shares, Inc.
Highlights for 1997
- -------------------------------------------------------------------------------
Year ended December 31, 1997
Earnings
Net Income $ 1,750,509
Per Share 1.68
At Year End
Assets $ 163,915,653
Deposits 147,519,068
Loans - Net 102,099,056
Securities 43,907,871
Shareholders' Equity 13,914,675
Book Value Per Share 13.76
Number of Shareholders 463
Contents
- -------------------------------------------------------------------------------
Chairman's Letter to Shareholders......................... 1
Selected Financial Information............................ 2
Financial Statements...................................... 3
Note to Financial Statements.............................. 9
Independent Auditor's Report.............................. 27
Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 28
Chesapeake Financial Shares, Inc.
Directors and Subsidiaries................................ 33
<PAGE>
[LOGO]
Dear Shareholder:
The past year was accented by losses more than gains. The deaths of Mother
Teresa and Princess Diana led the headlines. We lost Charles Kuralt, Jimmy
Stewart, Jacques Cousteau, John Denver, William Brennan, Ben Hogan, Eddie
Arcaro, Robert Mitchem, and Deng Xiaoping, to name a few. Iraq's Saddam Hussein
again confronted the UN inspector teams; the President's and Vice President's
fund-raising practices were investigated; Mike Tyson bit Evander Holyfield's ear
during their heavyweight fight; the Mars Pathfinder explored the Red Planet; and
after 156 years of British colonial rule, Hong Kong sovereignty reverted to
China. In Virginia the most significant events occurred in November as the
Republicans swept the three seats of Governor, Lieutenant Governor, and Attorney
General in the Statewide election, the first time in more than 100 years.
After adjusting for a 20% stock dividend, record earnings of $1.68 per
share were recorded by Chesapeake for 1997 versus $1.52 per share for 1996, an
increase of 10.53%. Dividend pay-outs of $.28 per share were up 16.7% with total
record earnings of $1,750,509, an 11.11% increase. Return on beginning equity
was 14.57% versus 14.26% for 1996.
The economy in Chesapeake's market area generally remains strong with
aggressive expansion in the Williamsburg/James City County area. Overall spots
of concern showed in the Nation's economy as illustrated by the 1.3 million
bankruptcies filed during the year, the highest ever, however, in general
business was brisk, and the Nation's population was comfortable and optimistic.
Chesapeake Bank's loan quality remained extremely strong as 30-day and over past
due loans were 1.15% of total loans, and the loan loss reserve was maintained at
1.68% of net loans.
Managed trust assets continued upward to new record levels as clients
continued to switch to Chesapeake to take advantage of the investment management
services. A new Trust Officer was added to the staff to be assigned to the
Williamsburg/James City County area early in 1998. The outreach program to
clients in the community begun several years ago continues to produce very
positive results.
In an effort to expand Chesapeake's presence on the Peninsula in
Williamsburg and James City County, property on Lafayette Street just off of the
Richmond Road in Williamsburg was purchased. The existing building is being
renovated, and Chesapeake Bank has received permission to open a third office on
the Peninsula. Opening date is anticipated for late spring.
CFS also contracted to purchase approximately 30,000 square feet of space
in the School Street business center complex in Kilmarnock. The space formerly
occupied by the Colonial store will be renovated, and Operations, Support, Data
Processing, and Loan Administration Departments will move to this location.
Space will continue to be leased to Advance Auto Parts and de' Medici. The
renovation and move will be completed early in the third quarter.
During the past year Chesapeake introduced Chesapeake Investment Services
offering investment reviews, annuities, mutual funds, stock and bond discount
brokerage, and holding customers' investment portfolios. Each financial center
(bank branch) is able to offer investment services directly or by appointment.
Specific details on the financial achievements of Chesapeake Financial
Shares for 1997 are contained in this report as required by the Securities and
Exchange Commission and other regulatory bodies. I hope that you will read the
report with particular interest in management's discussion and analysis of the
financial condition and the results of operations.
Sincerely,
Douglas D. Monroe, Jr.
Chairman of the Board & Chief Executive Officer
1
<PAGE>
Chesapeake Financial Shares, Inc.
Selected Financial Information
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------------------------------------------------------------------
(Dollars in thousands except ratios and per share amounts)
<S> <C>
RESULTS OF OPERATIONS
Interest income $ 11,361 $ 10,142 $ 9,556 $ 8,668 $ 8,423
Interest expense 5,407 4,755 4,556 3,770 3,827
--------- --------- ---------- ---------- ---------
Net interest income 5,954 5,387 5,000 4,898 4,596
Provision for loan losses 75 150 84 (96) 300
--------- --------- ---------- ---------- ---------
Net interest income after
provision for loan losses 5,879 5,237 4,916 4,994 4,296
Other operating income 2,982 2,559 2,120 1,626 2,362
Other operating expenses 6,556 5,720 5,351 5,167 5,190
--------- --------- ---------- ---------- ---------
Income before tax 2,305 2,076 1,685 1,453 1,468
Income tax expense 554 501 420 418 471
--------- --------- ---------- ---------- ---------
Net income $ 1,751 $ 1,575 $ 1,265 $ 1,035 $ 997
========== ========= ========== ========== =========
FINANCIAL CONDITION
Total assets $ 163,916 $ 142,876 $ 131,258 $ 124,439 $ 120,846
Total deposits 147,519 127,630 118,687 112,295 109,309
Net loans 102,099 90,426 80,991 74,804 67,880
Note payable and
subordinated debentures 0 0 388 538 888
Shareholders' Equity 13,915 12,009 11,048 9,793 9,210
Average assets 148,948 133,376 127,230 122,642 120,222
Average shareholders' equity 12,866 11,426 10,421 9,502 8,908
KEY FINANCIAL RATIOS
Return on average assets 1.18% 1.18% 0.99% 0.84% 0.83%
Return on average equity 13.61% 13.78% 12.14% 10.89% 11.19%
Dividends paid as a percent
of net income 16.21% 15.53% 16.97% 17.68% 16.55%
PER SHARE DATA
Net income, assuming dilution $ 1.68 $ 1.52 $ 1.22 $ .99 $ 0.96
Cash dividends declared $ 0.28 $ .24 $ 0.21 $ 0.18 $ 0.16
Book value $ 13.76 $ 11.92 $ 10.77 $ 9.40 $ 8.84
</TABLE>
2
<PAGE>
1997 Annual Report
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------
<S> <C>
Assets
Cash and due from banks $ 5,123,586 $ 5,896,836
Federal funds sold 1,900,000 --
Securities, at approximate market value (Note 2) 43,907,871 37,682,482
Loans, net (Notes 3 and 12) 102,099,056 90,425,824
Premises and equipment, net (Note 4) 3,448,318 3,284,063
Accrued interest receivable 1,300,062 1,088,201
Intangible assets, net (Note 5) -- 84,000
Other assets (Note 7) 6,136,760 4,414,212
--------------- ------------
Total assets $ 163,915,653 $142,875,618
=============== ============
Liabilities and Shareholders' Equity
Deposits:
Demand accounts $ 19,255,328 $ 16,646,453
Savings and interest bearing demand deposits 40,445,981 37,273,969
Certificates of deposit:
Denominations less than $100,000 72,128,426 57,952,834
Denominations of $100,000 or more 15,689,333 15,756,309
--------------- ------------
Total deposits $ 147,519,068 $127,629,565
Short-term borrowings 1,250,000 2,000,000
Accrued interest payable 334,763 272,546
Other liabilities (Note 8) 897,147 964,536
Commitments and contingent liabilities
(Notes 11 and 15) -- --
--------------- ------------
Total liabilities $ 150,000,978 $130,866,647
--------------- ------------
Shareholders' equity: (Note 10)
Preferred stock, par value $1 per share;
authorized 50,000 shares; no shares outstanding $ -- $ --
Common stock, voting, par value $5 per share;
authorized 2,000,000 shares; issued and
outstanding 1,010,888 in 1997 and 839,687
in 1996 5,054,440 4,198,435
Common stock, nonvoting, par value $5 per share;
authorized 635,000 shares; no shares outstanding -- --
Paid-in capital 484,348 468,493
Retained earnings (Note 19) 8,047,310 7,418,259
Unrealized gain (loss) on securities available
for sale, net 328,577 (76,216)
--------------- ------------
Total shareholders' equity $ 13,914,675 $ 12,008,971
--------------- ------------
Total liabilities and shareholders' equity $ 163,915,653 $142,875,618
=============== ============
See Notes to Consolidated Financial Statements.
<PAGE>
3
Chesapeake Financial Shares, Inc.
Consolidated Statements of Income
Years Ended December 31, 1997, 1996 and 1995
</TABLE>
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------------
<S> <C>
Interest Income
Interest and fees on loans $ 9,038,054 $ 8,103,829 $ 7,357,399
Interest on Federal funds sold 58,076 40,281 102,481
Interest on time deposits with banks -- 18,431 48,996
Interest on investment securities
Taxable -- -- 1,412,518
Nontaxable -- -- 193,552
Interest on securities available for sale
Taxable 1,636,219 1,428,063 260,175
Nontaxable 589,059 514,213 149,158
Dividends 40,060 37,118 31,964
----------- ----------- -----------
Total interest income $11,361,468 $10,141,935 $ 9,556,243
----------- ----------- -----------
Interest Expense
Savings and interest bearing accounts $ 990,450 $ 1,001,072 $ 1,051,747
Certificates of deposit
Denominations less than $100,000 3,503,931 2,922,308 2,816,698
Denominations of $100,000 or more 850,604 780,509 619,895
Short-term borrowings 62,454 24,764 23,706
Long-term debt -- 26,026 44,379
----------- ----------- -----------
Total interest expense $ 5,407,439 $ 4,754,679 $ 4,556,425
----------- ----------- -----------
Net interest income $ 5,954,029 $ 5,387,256 $ 4,999,818
Provision for loan losses (Note 3) 75,000 150,000 84,000
----------- ----------- -----------
Net interest income after provision
for loan losses $ 5,879,029 $ 5,237,256 $ 4,915,818
----------- ----------- -----------
Noninterest Income
Trust income $ 923,483 $ 818,888 $ 728,851
Service charges 527,107 499,705 506,125
Net gain (loss) on other real estate owned -- 12,788 (26,740)
(Loss) on securities available for sale (2,365) (1,593) (6,384)
Other income (Note 13) 1,533,427 1,229,708 918,337
----------- ----------- -----------
Total noninterest income $ 2,981,652 $ 2,559,496 $ 2,120,189
----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
1997 Annual Report
Consolidated Statements of Income (Continued)
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------------
<S> <C>
Noninterest Expenses
Salaries and benefits $3,079,538 $2,840,262 $2,705,334
Occupancy expenses 1,365,534 1,210,534 935,022
Other expenses (Note 13) 2,110,722 1,669,517 1,711,252
---------- ---------- ----------
Total noninterest expenses $6,555,794 $5,720,313 $5,351,608
---------- ----------
Income before income taxes $2,304,887 $2,076,439 $1,684,399
Income tax expense (Note 7) 554,378 501,303 419,697
---------- ---------- ----------
Net income $1,750,509 $1,575,136 $1,264,702
========== ========== ==========
Earnings per share, basic (Note 14) $ 1.74 $ 1.55 $ 1.22
========== ========== ==========
Earnings per share, assuming dilution (Note 14) $ 1.68 $ 1.52 $ 1.22
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
Chesapeake Financial Shares, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------------
<S> <C>
Cash Flows from Operating Activities
Net income $ 1,750,509 $ 1,575,136 $ 1,264,702
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 575,598 472,537 335,557
Provision for loan losses 75,000 150,000 84,000
Deferred income tax expense (benefit) 1,681 (66,298) 8,826
Amortization of premiums, net 217,385 251,642 258,648
Net loss on sale of bank premises 28,806 523 653
Loss on securities available for sale 2,365 1,593 6,384
Net (gain) loss on other real estate
owned -- (12,788) 26,740
Issuance of common stock for services 54,175 37,380 33,420
Changes in other assets and liabilities:
(Increase) decrease in accrued interest
receivable (211,861) (3,399) 39,537
(Increase) in other assets (1,940,419) (404,721) (2,046,451)
Increase in accrued interest payable 62,217 16,512 61,134
Increase (decrease) in other liabilities (67,389) 200,752 (134,028)
------------- ------------- -------------
Net cash provided by (used in)
operating activities $ 548,067 $ 2,218,869 $ (60,878)
------------- ------------- -------------
Cash Flows from Investing Activities
Net decrease in time deposits with banks $ -- $ 450,375 $ 984,555
Purchase of investment securities -- -- (264,215)
Proceeds from sale and call of investment
securities -- -- 250,000
Proceeds from maturities of investment
securities -- -- 1,945,000
Purchases of securities available for sale (18,499,317) (18,784,158) (6,938,447)
Proceeds from sales and calls of securities
available for sale 7,217,090 9,216,346 4,487,354
Proceeds from maturities of securities
available for sale 5,458,072 8,501,663 2,650,000
Origination of loans available for sale (4,251,450) (3,635,002) (4,145,550)
Proceeds from sale of loans available
for sale 4,033,450 3,635,002 4,145,550
Proceeds from sale of other real estate -- 35,905 --
Proceeds from sale of bank premises -- 600 --
Net (increase) in loans (11,530,232) (9,563,173) (6,314,258)
Other capital expenditures (684,660) (1,029,587) (674,111)
------------- ------------- -------------
Net cash (used in)
investing activities $(18,257,047) $(11,172,029) $ (3,874,122)
See Notes to Consolidated Financial Statements.
6
<PAGE>
1997 Annual Report
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31, 1997, 1996 and 1995
</TABLE>
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------------------------
<S> <C>
Cash Flows from Financing Activities
Net increase (decrease) in short-term
borrowings $ (750,000) $1,885,000 $ (605,000)
Net increase (decrease) in demand
accounts, interest bearing demand
accounts and savings accounts 5,780,887 2,402,429 (3,419,149)
Net increase in certificates of deposits 14,108,616 6,539,824 9,811,362
Net proceeds from issuance of
common stock 15,914 41,825 --
Acquisition of common stock (36,754) (293,631) (167,630)
Cash dividends (282,933) (244,585) (214,646)
Curtailment of note payable -- (387,500) (150,000)
------------- ----------- -----------
Net cash provided by
financing activities $ 18,835,730 $9,943,362 $ 5,254,937
------------- ----------- -----------
Net increase in cash
and Federal funds sold $ 1,126,750 $ 990,202 $ 1,319,937
Cash and Federal funds sold at beginning
of year 5,896,836 4,906,634 3,586,697
------------- ----------- -----------
Cash and Federal funds sold at end of year $ 7,023,586 $5,896,836 $ 4,906,634
============= =========== ===========
Supplemental Disclosures of Cash Flow
Information:
Cash paid during the year for:
Interest $ 5,345,222 $4,738,167 $ 4,495,292
============= =========== ===========
Income taxes $ 479,719 $ 531,684 $ 534,398
============= =========== ===========
Supplemental Schedule of Noncash
Investing and Financing Activities
Other real estate acquired in settlement
of loans $ -- $ -- $ 43,655
============= =========== ===========
Sale of other real estate by issuance
of new loans $ -- $ 30,000 $ --
============= =========== ===========
Unrealized gain (loss) on securities
available for sale $ 613,324 $ (234,964) $ 513,386
============= =========== ===========
Common stock issued for services $ 54,175 $ 37,380 $ 33,420
============= =========== ===========
Common stock dividend $ 838,525 $ -- $ --
============= =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
7
<PAGE>
Chesapeake Financial Shares, Inc.
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unrealized
Gain (Loss)
Common Common on Securities
Stock, Stock, Paid-In Retained Available
Voting Nonvoting Capital Earnings for Sale, Net Total
--------------------------------------------------------------------------------------------
<S> <C>
Balance, December 31, 1994 $4,306,915 $ 33,750 $ 674,899 $ 5,037,652 $ (259,974) $ 9,793,242
Net income -- -- -- 1,264,702 -- 1,264,702
Issuance of common stock for
services 16,710 -- 16,710 -- -- 33,420
Acquisition of common stock (47,940) (33,750) (85,940) -- -- (167,630)
Cash dividends ($.21 per share) -- -- -- (214,646) -- (214,646)
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $174,552 -- -- -- -- 338,834 338,834
---------- ---------- ---------- ----------- ------------ -----------
Balance, December 31, 1995 $4,275,685 $ -- $ 605,669 $ 6,087,708 $ 78,860 $11,047,922
Net income -- -- -- 1,575,136 -- 1,575,136
Exercise of stock options 20,375 -- 21,450 -- -- 41,825
Issuance of common stock
for services 15,575 -- 21,805 -- -- 37,380
Acquisition of common stock (113,200) -- (180,431) -- -- (293,631)
Cash dividends ($.24 per share) -- -- -- (244,585) -- (244,585)
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $79,888 -- -- -- -- (155,076) (155,076)
----------- ----------- ----------- ----------- ------------- -----------
Balance, December 31, 1996 $4,198,435 $ -- $ 468,493 $ 7,418,259 $ (76,216) $12,008,971
Net income -- -- -- 1,750,509 -- 1,750,509
Sale of common stock 2,500 -- 4,664 -- -- 7,164
Exercise of stock options 5,000 -- 3,750 -- -- 8,750
Issuance of common stock
for services 21,670 -- 32,505 -- -- 54,175
Acquisition of common stock (11,690) -- (25,064) -- -- (36,754)
Cash dividends ($.28 per share) -- -- -- (282,933) -- (282,933)
Stock dividend 838,525 -- -- (838,525) -- --
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $208,531 -- -- -- -- 404,793 404,793
----------- ----------- ----------- ----------- ------------ ------------
Balance, December 31, 1997 $5,054,440 $ -- $ 484,348 $ 8,047,310 $ 328,577 $13,914,675
=========== =========== =========== =========== ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
8
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
Chesapeake Financial Shares, Inc. ("CFS") owns 100% of Chesapeake Bank
(the "Bank"). Two additional subsidiaries, Chesapeake Mortgage Company, Inc.
and Chesapeake Insurance Agency, Inc. T/A Chesapeake Investment Services
are wholly-owned subsidiaries of CFS and the Bank, respectively. The
consolidated financial statements include the accounts of CFS and its
wholly-owned subsidiaries. All significant intercompany accounts have been
eliminated.
The accounting and reporting policies of CFS are in accordance with
generally accepted accounting principles and conform to general practices within
the banking industry. The more significant of these policies are summarized
below.
Securities
Investments in equity securities that have readily determinable fair values
and for all investments in debt securities are classified in three categories
based on management's intent and accounted for as follows:
a. Securities Held to Maturity
Securities classified as held to maturity are those debt securities the
Corporation has both the intent and ability to hold to maturity regardless
of changes in market conditions, liquidity needs or changes in general
economic conditions. These securities are carried at cost adjusted for
amortization of premium and accretion of discount, computed by the interest
method over their contractual lives. The Corporation held no assets
classified as held to maturity at December 31, 1997 or 1996.
b. Securities Available for Sale
Securities classified as available for sale are those debt and equity
securities that the Corporation intends to hold for an indefinite period of
time, but not necessarily to maturity. Any decision to sell a security
classified as available for sale would be based on various factors,
including significant movements in interest rates, changes in the maturity
mix of the Corporation's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. Securities
available for sale are carried at fair value. Unrealized gains or losses
are reported as increases or decreases in shareholders' equity, net of the
related deferred tax effect. Realized gains or losses, determined on the
basis of the amortized cost of specific securities sold, are included in
earnings.
c. Trading Securities
Trading securities, which are generally held for the short term in
anticipation of market gains, are carried at fair value. Realized and
unrealized gains and losses on trading account assets are included in
interest income on trading account securities. The Corporation held no
assets classified as trading securities at December 31, 1997 or 1996.
Derivatives
The Corporation has no securities defined as derivatives by FASB No.
119, "Disclosures for Derivative Financial Instruments."
Loans
Loans are stated at face value, net of unearned discount and the reserve
for loan losses. Interest is computed by methods which result in level rates of
return on principal. Nonrefundable loan fees and direct loan origination costs
are recognized in operations when received and incurred, respectively. The
impact of this methodology is not significantly different from recognizing the
net of these fees and costs over the contractual life of the related loan.
9
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
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. Any unpaid interest previously accrued on those loans is reversed
from income. Interest income generally is not recognized on specific impaired
loans unless the likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the loan principal balance.
Interest income on other nonaccrual loans is recognized only to the extent of
interest payments received.
Mortgage loans held for resale are stated at the lower of cost or market on
an individual loan basis. Loan discounts and origination fees received on loans
held for resale are deferred until the related loans are sold to third party
investors. Gains are recognized at the time of sale.
The impairment of loans that have been separately identified for evaluation
is measured based on the present value of expected future cash flows or,
alternatively, the observable market price of the loans or the fair value of the
collateral. However, for those loans that are collateral dependent (that is, if
repayment of those loans is expected to be provided solely by the underlying
collateral) and for which management has determined foreclosure is probable, the
measure of impairment of those loans is to be based on the fair value of the
collateral. The Corporation had no loans subject to FASB No. 114 at December 31,
1997 and 1996.
Reserve for Loan Losses
The reserve for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the reserve is based on management's evaluation of the
collectibility of the loan portfolio, including the nature of the portfolio,
credit concentrations, trends in historical loss experience, specific impaired
loans, and economic conditions. Reserves for impaired loans are generally
determined based on collateral values or the present value of estimated cash
flows. The reserve is increased by a provision for loan losses, which is charged
to expense and reduced by charge-offs, net of recoveries. Changes in the reserve
relating to impaired loans are charged or credited to the provision for loan
losses. Because of uncertainties inherent in the estimation process,
management's estimate of credit losses inherent in the loan portfolio and the
related reserve may change in the near term.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using both straight-line and accelerated methods over
the assets' estimated useful lives. Estimated useful lives range from 10 to 39
years for buildings and 3 to 7 years for furniture, fixtures and equipment.
Foreclosed Properties
Foreclosed properties are recorded at the lower of the outstanding loan
balance at the time of foreclosure or the estimated fair value less estimated
costs to sell. At foreclosure any excess of loan balance over the fair value of
the property is charged to the reserve for loan losses. Such carrying value is
periodically reevaluated and written down if there is an indicated decline in
fair value. Costs to bring a property to salable condition are capitalized up to
the fair value of the property while costs to maintain a property in salable
condition are expensed as incurred. The Bank has included $245,000 of foreclosed
properties in other assets at December 31, 1997 and 1996. No real estate was
acquired in settlement of loans during 1997 and 1996.
Intangible Assets
The franchise asset was amortized on an accelerated basis over a ten year
period, which is the estimated life of the acquired customer base.
10
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
Trust Department Assets
Securities and other property held by the Trust Department in a fiduciary
or agency capacity are not assets of the Corporation and are not included in the
accompanying consolidated financial statements.
Income Taxes
Deferred taxes are provided on a liability method whereby deferred tax
assets are recognized for deductible temporary differences, operating loss
carryforwards, and tax credit carryforwards. Deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.
Statement of Cash Flows
For purposes of the statement of cash flows, CFS considers cash equivalents
to include cash on hand, amounts due from banks and Federal funds sold.
Advertising Costs
CFS follows the policy of charging the production costs of advertising to
expense as incurred.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Earnings Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share." Statement 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the statement 128 requirements.
11
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
NOTE 2. SECURITIES
Amortized cost and fair values of securities available for sale as of
December 31, 1997 and 1996, are as follows:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------
<S> <C>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
U.S. Treasury securities $ 1,702,928 $ 516 $ (4,787) $ 1,698,657
U.S. Government agencies 29,482,679 130,705 (73,037) 29,540,347
Securities of state and
political subdivisions 11,473,361 452,106 -- 11,925,467
Other 743,400 -- -- 743,400
----------- --------- -------- -----------
Total $43,402,368 $ 583,327 $ (77,824) $43,907,871
=========== ========= ========= ===========
</TABLE>
<TABLE>
<CAPTION>
1996
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
<S> <C>
U.S. Treasury securities $ 3,058,460 $ 3,180 $ (19,171) $ 3,042,469
U.S. Government agencies 23,488,966 47,414 (136,337) 23,400,043
Securities of state and
political subdivisions 10,539,035 44,924 (55,489) 10,528,470
Other 711,500 -- -- 711,500
----------- ---------- --------- -----------
Total $37,797,961 $ 95,518 $(210,997) $37,682,482
=========== ========== ========= ===========
</TABLE>
The amortized cost and fair value of securities available for sale as of
December 31, 1997, by contractual maturity are shown below. Expected maturities
may differ from contractual maturities because issuers may have the right to
call or prepay obligations without any penalties.
Amortized Fair
Cost Value
---------------------------------
Due in one year or less $ 3,880,365 $ 3,871,605
Due after one year through five years 1,916,274 1,907,418
Due after five years through ten years 4,835,419 4,872,026
Due after ten years 32,026,910 32,513,422
Other 743,400 743,400
-------------- --------------
Total $ 43,402,368 $ 43,907,871
============== ==============
There were no sales and calls of securities being held to maturity during
1997 and 1996. Proceeds from sales and calls of securities being held to
maturity during 1995 were $250,000. There were no gross gains or losses realized
on the sales and calls during 1995.
Proceeds from sales and calls of securities available for sale during 1997,
1996 and 1995 were $7,217,090, $9,216,346 and $4,487,354, respectively. Gross
gains of $22,319, $37,526 and $10,967 and gross losses of $24,684, $39,119 and
$17,351 were realized on those sales and calls, respectively.
As allowed by the Question and Answer Guide to FASB No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" issued in November of
1995, debt securities with an amortized cost of $28,960,443 were transferred
from held-to-maturity to available-for-sale on December 1, 1995. The securities
had an unrealized gain of approximately $39,700.
12
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
The amortized cost of securities pledged to secure public deposits,
borrowings from the Federal Reserve Bank and fiduciary powers amounted to
$7,991,890 and $8,538,977, at December 31, 1997 and 1996, respectively.
NOTE 3. LOANS
Major classifications of loans are summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------
1997 1996
--------------------------------------------------
<S> <C>
Commercial $ 40,854,618 $ 33,256,921
Real estate - mortgage 38,945,983 38,333,737
Real estate - construction 2,900,402 3,109,470
Consumer 16,267,812 14,554,795
Participations with other banks 4,461,081 2,429,715
Other 409,225 394,030
--------------- --------------
$ 103,839,121 $ 92,078,668
Less, reserve for loan losses 1,740,065 1,652,844
--------------- --------------
$ 102,099,056 $ 90,425,824
=============== ==============
</TABLE>
Participations with other banks are secured by commercial real estate.
Nonaccrual loans excluded from impaired loan disclosure under FASB No. 114
amounted to $581,048 and $142,944 at December 31, 1997 and 1996, respectively.
If interest on these loans had been accrued, such income would have approximated
$37,604 and $5,313 at December 31, 1997 and 1996, respectively.
Changes in the reserve for loan losses are as follows:
Years Ended December 31,
-------------------------------------------
1997 1996 1995
--------------------------------------------
Balance at beginning of year $1,652,844 $1,463,181 $1,370,598
Provision for loan losses 75,000 150,000 84,000
Loans charged off (41,956) (157,448) (27,530)
Recoveries on loans
previously charged-off 54,178 197,111 36,113
---------- ---------- ----------
Balance at end of year $1,740,066 $1,652,844 $1,463,181
========== ========== ==========
13
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
NOTE 4. PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
December 31,
------------------------------
1997 1996
------------------------------
Land $ 553,135 $ 428,135
Buildings 2,432,575 2,232,418
Furniture, fixtures and improvements 819,849 813,391
Mechanical equipment 2,648,085 2,401,214
Leasehold improvements 759,033 759,033
------------- ------------
$ 7,212,677 $ 6,634,191
Less accumulated depreciation 3,764,359 3,350,128
------------- ------------
$ 3,448,318 $ 3,284,063
============= ============
For the years ended December 31, 1997, 1996 and 1995, depreciation
expense was $491,598, $388,537 and $251,557, respectively.
NOTE 5. INTANGIBLE ASSETS
Intangible assets consist of the following:
December 31,
---------------------------
1997 1996
---------------------------
Franchise asset associated with customer
deposits assumed, net of accumulated
amortization of $1,200,000 and $1,116,000,
respectively $ -- $ 84,000
---------- ----------
For the years ended December 31, 1997, 1996 and 1995 amortization expense
was $84,000, respectively.
NOTE 6. NOTE PAYABLE
CFS has available a $2,000,000 line of credit with the Community Bankers'
Bank. The line of credit bears interest at The Wall Street Journal prime rate
and is secured by all issued and outstanding shares of capital stock of
Chesapeake Bank. The loan agreement also contains certain covenants including
restrictions on changes in control of CFS and the Bank, redemption of stock,
payment of dividends, and capital expenditures. CFS was in compliance with all
of the covenants at December 31, 1997. There was no amount drawn on this line of
credit at December 31, 1997.
The Bank has unsecured lines of credit with correspondent banks totalling
$6,500,000 available for overnight borrowing. The Bank also has a line of credit
secured by mortgage loans totalling $13,000,000 available for long or short-term
borrowing. There were no amounts drawn on these lines of credit at December 31,
1997.
14
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
NOTE 7. INCOME TAXES
Net deferred tax assets consist of the following components as of December
31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
-----------------------------------
<S> <C>
Deferred tax assets:
Reserve for loan losses $ 389,778 $ 356,629
Deferred compensation 110,071 101,642
Accrued pension expense 82,452 105,056
Intangible asset 80,489 84,568
Securities available for sale -- 39,262
Other 20,373 19,146
------------ -----------
$ 683,163 $ 706,303
------------ -----------
Deferred tax liabilities:
Securities available for sale $ 160,134 $ --
Accumulated discount accretion 2,948 1,009
Premises and equipment 181,201 165,338
------------ -----------
$ 344,283 $ 166,347
------------ -----------
$ 338,880 $ 539,956
============ ===========
</TABLE>
The provision for income taxes charged to operations for the years ended
December 31, 1997, 1996 and 1995, consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------
<S> <C>
Current tax expense $ 552,697 $ 567,601 $ 410,871
Deferred tax expense (benefit) 1,681 (66,298) 8,826
--------- --------- -----------
$ 554,378 $ 501,303 $ 419,697
========= ========= ===========
</TABLE>
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, 1997, 1996 and 1995, due to the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------
<S> <C>
Computed "expected" tax expense $ 783,662 $ 705,989 $ 572,696
Increase (decrease) in income taxes
resulting from:
Tax exempt interest income (204,598) (203,087) (137,588)
Other (24,686) (1,599) (15,411)
--------- --------- ---------
$ 554,378 $ 501,303 $ 419,697
========= ========= =========
</TABLE>
15
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
NOTE 8. EMPLOYEE BENEFIT PLANS
Pension Plan
The Corporation has a noncontributory, defined benefit pension plan for all
full-time employees over 21 years of age. Benefits are generally based upon
years of service and the employees' compensation. The Corporation funds pension
costs in accordance with the funding provisions of the Employee Retirement
Income Security Act.
The following table sets forth the plan's funded status and amounts
recognized as of December 31, 1997 and 1996, computed as of October 1, 1997 and
1996, respectively:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996
-----------------------------------
<S> <C>
Accumulated benefit obligation, including vested
benefits of $1,032,458 and $842,198 in 1997
and 1996, respectively $ 1,065,889 $ 871,146
=========== =============
Projected benefit obligation for service
rendered to date $(1,577,250) $ (1,311,102)
Plan assets at fair value 1,770,008 1,255,666
----------- -------------
Funded status $ 192,758 $ (55,436)
Unrecognized net obligation 48,834 52,904
Unrecognized prior service cost 36,737 39,361
Unrecognized net gain (520,835) (441,719)
----------- -------------
Accrued pension liability at October 1 $ (242,506) $ (404,890)
Contribution made in fourth quarter -- 95,902
----------- -------------
Accrued pension liability at December 31 $ (242,506) $ (308,988)
=========== ==============
</TABLE>
Net pension costs for 1997, 1996 and 1995 include the following:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------
1997 1996 1995
------------------------------------------------
<S> <C>
Service cost-benefits earned during
the period $121,141 $102,467 $90,630
Interest costs on projected benefit
obligation 117,913 88,547 78,506
Actual return on plan assets (158,844) (91,671) (78,656)
Net amortization (8,935) (5,990) (2,423)
---------- -------- -------
Net periodic pension cost $ 71,275 $ 93,353 $88,057
========== ========= =======
</TABLE>
The discount rate and rate of increase in future compensation levels used
in determining the actuarial present value of the projected benefit obligation
were 7.5% and 5.0%, respectively, for the year ended December 31, 1997. The
discount rate and rate of increase in future compensation levels were 7.5% and
6.0%, respectively, for the years ended December 31, 1996 and 1995. The expected
long-term rate of return on plan assets was 9.0% for all years presented.
16
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
Deferred Compensation Agreements
The Bank and CFS have deferred compensation agreements providing for
monthly payments to an officer of each company commencing at retirement. The
liabilities under these agreements are being accrued over the officers'
remaining periods of employment such that the then present value of the monthly
payments will have been accrued by retirement date. CFS funds the deferred
compensation commitments through life insurance policies on the officers. One of
the officers is currently retired and receiving benefits under this plan.
Employee Stock Ownership Plan
Generally, full-time employees who have completed one calendar year of
service are eligible. Contributions each year are at the discretion of the Board
of Directors, within certain limitations prescribed by Federal tax regulations.
Compensation expense related to the plan was $20,000, $19,992 and $10,000 in
1997, 1996 and 1995, respectively. An employee's proportional ownership in the
plan assets vests on an increasing scale over 7 years, or sooner under certain
circumstances. The plan intends to invest contributions received in shares of
CFS common stock.
401-K Plan
CFS has adopted a contributory 401-k plan which covers substantially all
employees. Total expense related to the plan was $25,590, $20,381 and $20,687
for 1997, 1996 and 1995.
NOTE 9. STOCK OPTION PLAN
CFS had a stock option plan in which options for 144,000 shares of voting
common stock and 112,500 shares of nonvoting common stock are reserved for
issuance. The stock option plan required that options be granted at an exercise
price equal to at least 100% of the fair market value of the common stock on the
date of grant; however, for those individuals who own more than 10% of the stock
of CFS, the option price must be at least 110% of the fair market value on the
date of grant. Such options are generally not exercisable until after three
years from the date of issuance and require continuous employment during the
period prior to exercise. This plan expired in 1995. Options previously granted
may be exercised by the participants until the options expire, which is ten
years after the date of the original option grant.
17
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
A summary of the status of the expired plan at December 31, 1997, 1996
and 1995 and the changes during the years ended on those dates is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------------------------------------------------------------------------------------
<S> <C>
Outstanding at
beginning of year 75,750 $ 8.42 80,640 $ 8.43 59,640 $ 8.33
Options granted -- -- -- -- 21,000 8.69
Options exercised (1,200) 7.29 (4,890) 8.55 -- --
Options forfeited -- -- -- -- -- --
------ ------- ------ ------ ------- -------
Outstanding at
end of year 74,550 9.19 75,750 8.42 80,640 8.43
====== ======= ====== ====== ======= =======
Options exercisable,
end of year 53,550 34,350 39,240
Options available for
grant, end of year -- -- --
</TABLE>
In 1996, CFS adopted an incentive stock plan under which options may be
granted to certain key employees for purchase of CFS's common stock. The
effective date of the plan was April 5, 1996 with an expiration date of March
31, 2006. The plan reserves for issuance 54,000 shares of CFS's voting common
stock. The stock option plan requires that options be granted at an exercise
price equal to at least 100% of the fair market value of the common stock on the
date of the grant; however for those individuals who own more than 10% of the
stock of CFS, the option price must be at least 110% of the fair market value on
the date of grant. Such options are generally not exercisable until three years
from the date of issuance and require continuous employment during the period
prior to exercise. The options will expire in no more than ten years after the
date of grant.
A summary of the status of the 1996 plan at December 31, 1997 and 1996
and the changes during the years ended on those dates are as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------- -----------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
----------------------------------------------------------------------------
<S> <C>
Outstanding at beginning
of year 12,600 $ 11.25 -- $ --
Options granted 10,200 12.20 12,600 11.25
Options exercised -- -- -- --
Options forfeited -- -- -- --
------ ---------- ------ --------
Outstanding at end of year 22,800 11.67 12,600 11.25
====== =========== ====== ========
Options exercisable, end of year -- --
Options available for grant,
end of year 31,200 41,400
</TABLE>
18
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
The status of the options outstanding at December 31, 1997 is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- ------------------------
Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- --------------------------------------------------------------------------------------------------------------
<S> <C>
$8.33 to $9.17 19,950 1.3 $ 8.78 19,950 $ 8.78
$8.33 to $9.17 12,600 2.3 8.81 12,600 8.81
$8.22 1,800 3.3 8.22 1,800 8.22
$10.83 to $11.92 12,600 5.3 11.25 -- --
$7.29 to $11.92 29,400 6.3 9.17 19,200 7.57
$8.33 to $9.17 21,000 7.3 8.69 -- --
</TABLE>
CFS applies APB Opinion 25 in accounting for its stock option plans,
accordingly no compensation expense has been recognized for 1997, 1996 and 1995.
Had compensation cost been determined on the basis of fair value pursuant to
FASB Statement No. 123, there would not have been a significant impact on net
income or earnings per share.
NOTE 10. SHAREHOLDERS' EQUITY
During 1997, 1996 and 1995, CFS issued 4,334 shares, 3,115 shares and 3,342
shares, respectively, of common stock to its Directors for partial
compensation.
The voting and nonvoting common stock have equal dividend and participation
rights.
NOTE 11. COMMITMENTS
CFS leases certain facilities and equipment under operating leases which
expire at various dates through 2000. These leases generally contain renewal
options and require CFS to pay taxes, insurance, maintenance and other expenses
in addition to the minimum normal rentals.
Minimum rental payments under these operating lease agreements as of
December 31, 1997 are as follows:
Year Ending
December 31,
- ------------------------------------
1998 $ 101,064
1999 101,064
2000 63,264
2001 15,864
2002 7,088
Rent expense under operating leases aggregated $129,130, $129,707 and
$85,879 for the years ended December 31, 1997, 1996 and 1995, respectively.
CFS has entered into a contract totalling $502,500 for renovations to an
existing branch facility acquired in 1997. The renovations will be completed and
the branch will open in 1998.
19
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
As a member of the Federal Reserve System, the Bank is required to maintain
certain average reserve balances. For the final weekly reporting period in the
years ended December 31, 1997 and 1996, the aggregate amounts of daily average
required balances were approximately $196,000 for both periods.
NOTE 12. RELATED PARTY TRANSACTIONS
Officers, Directors and their affiliates had borrowings of $5,679,221
and $5,071,174 at December 31, 1997 and 1996, respectively, with the Bank.
Changes in borrowings during 1997 were as follows:
Balance, December 31, 1996 $ 5,071,174
Additions 1,686,849
Payments (1,078,802)
-------------
Balance, December 31, 1997 $ 5,679,221
=============
These transactions occurred in the ordinary course of business on
substantially the same terms as those prevailing at the time for comparable
transactions with unrelated persons.
NOTE 13. OTHER INCOME AND EXPENSES
The principal components of "Other Income" in the consolidated statements
of income are:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------
<S> <C>
Cash Management fees and discount $ 598,003 $ 381,985 $ 258,870
FHLMC servicing fee income 121,534 130,871 131,328
Merchant discount 369,441 204,438 150,843
ATM fee income 199,329 149,241 77,281
Other (includes no items in
excess of 1% of total revenue) 245,120 363,173 300,015
----------- ------------ -----------
$ 1,533,427 $ 1,229,708 $ 918,337
=========== ============ ===========
</TABLE>
The principal components of "Other Expenses" in the consolidated statements
of income are:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------------
<S> <C>
Advertising $ 211,136 $ 135,468 $ 127,757
Deposit insurance 15,253 2,000 131,568
Merchant card 368,320 211,815 144,786
Professional 87,380 83,925 126,575
Other (includes no items in
excess of 1% of total revenue) 1,428,633 1,236,309 1,180,566
------------ ------------ ------------
$ 2,110,722 $ 1,669,517 $ 1,711,252
============ ============ ============
</TABLE>
20
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
NOTE 14. EARNINGS PER SHARE
The following data shows the amounts used in computing earnings per share
and the effect on the weighted average number of shares of dilutive potential
common stock. The potential common stock will not have a significant impact on
net income. The number of shares used in the calculations for 1996 and 1995
reflect a 20% stock dividend paid on October 15, 1997.
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------------------
<S> <C>
Weighted average number
of common shares, basic 1,006,925 1,015,370 1,031,434
Effect of dilutive stock options 35,966 20,751 1,114
---------- --------- ---------
Weighted number of common shares
and dilutive potential common stock
used in diluted EPS 1,042,891 1,036,121 1,032,548
========= ========= =========
</TABLE>
NOTE 15. SUBSEQUENT EVENT
On January 2, 1998, CFS acquired real estate to be used for an operations
center. The total purchase price was $900,000 and is to be paid under a
promissory note payable bearing interest at 5.5%. The note is payable in monthly
principal and interest payments of $6,191 through January 2018.
NOTE 16. TIME DEPOSITS
Remaining maturities on certificates of deposit are as follows:
1998 $ 65,744,789
1999 and later years 22,072,970
---------------
$ 87,817,759
===============
NOTE 17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the balance sheet. The contract amounts of those instruments reflect the extent
of involvement the Corporation has in particular classes of financial
instruments.
The Corporation's exposure to credit loss in the event of nonperformance by
the other party to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contractual amounts of those
instruments. The Corporation uses the same credit policies in making commitments
and conditional obligations as they do for on-balance-sheet instruments.
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. Standby
letters of credit are conditional commitments issued by the Corporation to
guarantee the performance of a customer to a third party. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. At December 31, 1997, the Corporation's total commitments to extend
credit and standby letters of credit were $14,923,489 and $1,079,950,
respectively. At December 31, 1996, the Corporation's total commitments to
extend credit and standby letters of credit were $15,140,458 and $3,000,
respectively.
21
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
The Corporation evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Corporation upon extension of credit, is based on management's credit
evaluation of the counter-party. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment, and income-producing
commercial properties. Since most of the letters of credit are expected to
expire without being drawn upon, they do not necessarily represent future cash
requirements.
The Corporation grants commercial, real estate and consumer loans to
customers primarily in the Northern Neck, Middle Peninsula, and James City
County areas of Virginia. Although the Corporation has a diversified loan
portfolio, the ability of debtors to honor their contracts is highly dependent
upon the real estate development market in this area.
NOTE 18. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Cash and Short-Term Investments
For those short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Securities
For securities held for investment purposes, fair values are based on
quoted market prices or dealer quotes.
Loan Receivables
For certain homogeneous categories of loans, such as some residential
mortgages, and other consumer loans, fair value is estimated using the quoted
market prices for securities backed by similar loans, adjusted for differences
in loan characteristics. The fair value of other types of loans is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities.
Deposit Liabilities
The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposits of similar remaining maturities.
Off-Balance Sheet Financial Instruments
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair value of
letters of credit is based on fees currently charged for similar agreements or
on the estimated cost to terminate them or otherwise settle the obligations with
the counter-parties at the reporting date.
At December 31, 1997 and 1996, the carrying amounts and fair values of loan
commitments and standby letters of credit were deemed immaterial.
22
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
The estimated fair values of CFS's financial instruments are as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------ -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-----------------------------------------------------
(In Thousands) (In Thousands)
<S> <C>
Financial assets:
Cash and short-term
investments $ 7,024 $ 7,024 $ 5,897 $ 5,897
Securities 43,908 43,908 37,682 37,682
Loans 103,839 102,044 92,079 91,905
Less: reserve for loan losses (1,740) -- (1,653) --
-------- ---------- ------- ---------
Total financial assets $153,031 $ 152,976 $134,005 $ 135,484
======== ========== ======== =========
Financial liabilities:
Deposits $147,519 $ 148,174 $127,629 $ 127,816
Short-term borrowings 1,250 1,250 2,000 2,000
-------- ---------- -------- ---------
Total financial liabilities $148,769 $ 149,424 $129,629 $ 129,816
======== ========== ======== =========
</TABLE>
NOTE 19. REGULATORY MATTERS
The Corporation is subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - possibly additional discretionary
- - actions by regulators that, if undertaken, could have a direct material effect
on the Corporation's financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Corporation must meet
specific capital guidelines that involve quantitative measures of the
Corporation's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Corporation's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes, as of December 31, 1997, that the Corporation meets all capital
adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from the Federal
Reserve Bank categorized the Corporation as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Corporation must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
23
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
The Corporation's actual capital amounts and ratios are also presented in
the table.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------ ----------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------------
(Amount in Thousands)
<S> <C>
As of December 31, 1997:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 14,999 13.5% > $8,903 > 8.0% N/A
Chesapeake Bank $ 13,057 11.8% > $8,879 > 8.0% > $11,098 > 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 13,602 12.2% > $4,452 > 4.0% N/A
Chesapeake Bank $ 11,665 10.5% > $4,440 > 4.0% > $6,659 > 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 13,602 8.5% > $6,392 > 4.0% N/A
Chesapeake Bank $ 11,665 7.4% > $6,317 > 4.0% > $7,896 > 5.0%
As of December 31, 1996:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 13,121 13.7% > $7,656 > 8.0% N/A
Chesapeake Bank $ 11,925 12.5% > $7,612 > 8.0% > $9,515 > 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 11,925 12.5% > $3,828 > 4.0% N/A
Chesapeake Bank $ 10,729 11.3% > $3,806 > 4.0% > $5,709 > 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 11,925 8.5% > $5,590 > 4.0% N/A
Chesapeake Bank $ 10,729 7.7% > $5,556 > 4.0% > $6,945 > 5.0%
</TABLE>
NOTE 20. PARENT COMPANY FINANCIAL STATEMENTS
The following parent company accounting policies should be read in
conjunction with the related condensed balance sheets, statements of income, and
statements of cash flows.
Investments in subsidiaries are accounted for using the equity method of
accounting. The parent company and its subsidiaries file a consolidated U.S.
Federal income tax return. The subsidiaries' individual tax provisions and
liabilities are stated as if they filed separate returns and any benefits or
detriments of filing the consolidated tax return are absorbed by the parent
company.
The parent company's principal assets are its investments in its
wholly-owned subsidiaries. Dividends from the Bank are the primary source of
funds for the parent company. The payment of dividends by the Bank is restricted
by various statutory limitations. Banking regulations also prohibit extensions
of credit by the Bank to the parent company unless appropriately secured by
assets. The amount available for payment of additional dividends without prior
regulatory approval in 1996 from the Bank to the parent company is $1,508,084 or
10.8% of consolidated net assets.
24
<PAGE>
1997 Annual Report
Notes to Consolidated Financial Statements
BALANCE SHEETS (CONDENSED)
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1997 1996
----------------------------------------
<S> <C>
Assets
Cash $ 366,397 $ 198,629
Securities 1,534,706 1,000,839
Investment in subsidiaries 11,987,491 10,767,716
Other assets 36,081 45,787
------------- ---------------
Total assets $ 13,924,675 $ 12,012,971
============= ===============
Liabilities and Shareholders' Equity
Other liabilities $ 10,000 $ 4,000
Shareholders' equity 13,914,675 12,008,971
------------- --------------
Total liabilities and shareholders' equity $ 13,924,675 $ 12,012,971
============= ==============
</TABLE>
STATEMENTS OF INCOME (CONDENSED)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------
1997 1996 1995
---------------------------------------------------------
<S> <C>
Income - Dividends - Bank $ 930,000 $1,800,000 $ 600,000
Dividends - Mortgage Co. -- -- 3,632
Other 87,830 21,858 19,947
----------- ---------- -----------
Total income $ 1,017,830 $1,821,858 $ 623,579
Expenses - Interest expense $ -- $ 26,026 $ 44,379
Other expenses 144,747 103,912 133,023
----------- ----------- -----------
Total expenses $ 144,747 $ 129,938 $ 177,402
----------- ----------- -----------
Income before income taxes and
equity in undistributed earnings
of subsidiaries $ 873,083 $1,691,920 $ 446,177
Allocated income tax benefit 25,552 21,158 24,373
Income before equity in undistri- ----------- ----------- -----------
buted earnings of subsidiaries $ 898,635 $1,713,078 $ 470,550
Equity (deficit) in undistributed
earnings of subsidiaries 851,874 (137,942) 794,152
----------- ----------- -----------
Net income $ 1,750,509 $1,575,136 $ 1,264,702
=========== =========== ===========
</TABLE>
25
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
STATEMENTS OF CASH FLOWS (CONDENSED)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1997 1996 1995
------------------------------------------------------
<S> <C>
Cash Flows from Operating Activities
Net income $1,750,509 $1,575,136 $1,264,702
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity (deficit) in undistributed
earnings of subsidiaries (851,874) 137,942 (794,152)
Issuance of common stock for services 54,175 37,380 33,420
Amortization of premium (2,960) 144 2,435
Changes in other assets and liabilities:
(Increase) decrease in other assets (10,025) (10,847) 21,682
Increase (decrease) in other liabilities 6,000 (9,624) 1,090
---------- ---------- -----------
Net cash provided by
operating activities $ 945,825 $1,730,131 $ 529,177
---------- ---------- ----------
Cash Flows from Investing Activities
Purchase of investment securities $ (574,284) $ (907,718) $ --
Proceeds from maturities of
investment securities 100,000 200,625 --
---------- ---------- ----------
Net cash (used in)
investing activities $ (474,284) $ (707,093) $ --
---------- ----------- ----------
Cash Flows from Financing Activities
Dividends paid $ (282,933) $ (244,585) $ (214,646)
Curtailment of note payable -- (387,500) (150,000)
Acquisitions of common stock (36,754) (293,631) (167,630)
Net proceeds from issuance of common stock 15,914 41,825 --
---------- ---------- ----------
Net cash (used in)
financing activities $ (303,773) $ (883,891) $ (532,276)
---------- ---------- ----------
Net increase (decrease) in cash $ 167,768 $ 139,147 $ (3,099)
Cash at beginning of year 198,629 59,482 62,581
---------- ---------- ----------
Cash at end of year $ 366,397 $ 198,629 $ 59,482
========== ========== ============
</TABLE>
26
<PAGE>
1997 Annual Report
[LOGO]
Yount, Hyde & Barbour, P.C.
Certified Public Accountants
and Consultants
Independent Auditor's Report
To the Boards of Directors and Shareholders
Chesapeake Financial Shares, Inc. and Subsidiaries
Kilmarnock, Virginia
We have audited the accompanying consolidated balance sheets of Chesapeake
Financial Shares, Inc. and Subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flows for the years ended December 31, 1997, 1996 and 1995. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chesapeake
Financial Shares, Inc. and Subsidiaries as of December 31, 1997 and 1996, and
the results of its operations and its cash flows for the years ended December
31, 1997, 1996 and 1995, in conformity with generally accepted accounting
principles.
Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 8, 1998
27
<PAGE>
Chesapeake Financial Shares, Inc.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion is intended to assist the reader in understanding
and evaluating Chesapeake's consolidated financial condition and results of
operations. This discussion should be read in conjunction with the company's
audited consolidated financial statements, the accompanying notes, the Letter to
Shareholders, and other information contained elsewhere in this annual report.
There was a stock split effective in the form of a 20% stock dividend, paid on
October 15, 1997. All per share information has been adjusted accordingly. This
analysis attempts to identify trends and material changes which occurred during
the periods presented.
FINANCIAL CONDITION
On December 31, 1997, the Company had total assets of $163.9 million,
representing a 14.7% increase over the December 31, 1996 balance of $142.9
million, following an increase of 12.7% from December 31, 1995. Loan growth has
been strong during the last four years due to the demand in the Northern Neck,
the Middle Peninsula, and the Company's expansion into the James City
County/Williamsburg area. The Company will open the third office in Williamsburg
in the late spring of 1998.
Summary of Results of Operations
Record earnings for 1997 of $1,750,509 or $1.68 (fully diluted) compared to
$1,575,136 or $1.52 per share in 1996 completes the third continuous year of
double digit earnings growth. The 11.1% increase in net income resulted from a
12.3% increase or $641,773 in net interest income after provision for loan
losses. Noninterest income increased to $2,981,652 in 1997, up 16.5% over the
1996 level of $2,559,496. All noninterest income items were up for 1997, except
other income and FHLMC servicing fee income. Cash Management fee (see note 13)
income was up 56.6% or $216,018, Merchant Card income was up 80.7% or $165,003,
Trust income was up 12.8% or $104,595, and ATM income was up 33.6% or $50,088.
Other income was down 32.5% or $118,053 due to a one time recovery in 1996.
FHLMC servicing income is down 7.13% or $9,337 from 1996. Total noninterest
expenses for 1997 were $6,555,794, up 14.6% over 1996 totals of $5,720,313.
Earnings for 1996 of $1,575,136 or $1.52 compared to $1,264,702 or $1.22
per share in 1995 highlighted an outstanding year of accomplishment and change
for Chesapeake Financial Shares, Inc. The 24.6% increase in net income resulted
from a 20.7% increase in noninterest income, an increase of 6.5% in net interest
income after provision for loan losses, and holding noninterest expense to a
6.9% increase. Noninterest income increased to $2,559,496 in 1996, up 20.7% over
the 1995 level of $2,120,189. Most noninterest income items were up for 1996,
with Trust income up 12.4%, Cash Management (see note 13) income up 47.6%, and
ATM income up 93.1%. Net interest income increased to $5,387,256 in 1996, up
7.7% over the 1995 level of $4,999,818. Total noninterest expenses for 1996 were
$5,720,313, up only 6.9% over 1995 totals of $5,351,608.
Chesapeake Financial Shares' recorded earnings for 1995 of $1,264,702 or
$1.22 per share compared to $1,035,116 or $0.99 per share in 1994. The 22.2%
increase in net income resulted from increases in noninterest income,
controlling expenses, and maintaining net interest income. Total noninterest
income increased to $2,120,189 in 1995, up 30.4% over the 1994 level of
$1,625,999. All noninterest income items were up for 1995, with trust income up
3.7%, service charge income up 25.5%, and other income up 84.4%. Total
noninterest expenses for 1995 were $5,351,608, up only 3.6% over 1994 totals of
$5,167,469. Net interest income increased to $4,999,818 in 1995, up 2.1% over
the 1994 level of $4,897,451.
Assets: Loan Portfolio
The net loan portfolio (net of unearned discounts and reserve for loan
loss) totaled $102.1, $90.4, and $80.9 million for 1997, 1996, and 1995,
respectively, representing an increase of 12.9% for 1997 from 1996, 11.6% for
1996 from 1995, and 8.3% for 1995 from 1994. All loan categories except real
estate -- construction were up during 1996. Commercial loans increased 22.9% or
$7.6 million for 1997 over 1996 levels of $33.3 million. Participations with
other banks increased $2.0 million or 83.6% and consumer loans increased 11.8%
or $1.7 million during 1997. Real estate -- mortgage loans increased 1.6% or
$612,246 while real estate -- construction was down 6.7% or $209,068.
28
<PAGE>
1997 Annual Report
On December 31, 1997, the loan portfolio consisted of 40.3% of single
family residential and residential construction loans and 39.3% of commercial
loans. The commercial loans consist principally of business loans such as
retail, hospitality, service and professional, marine industry, and commercial
real estate loans where real estate is the primary collateral, plus a very small
portion of agriculture loans. Management attempts to reduce the Bank's exposure
to the risks of the local real estate market by limiting the aggregate size of
its commercial portfolio and by primarily making such loans directly to the
business occupants. The Bank has historically engaged in limited mortgage
lending secured by multi family and agricultural properties. At year end,
residential real estate construction accounted for 2.8% of total loans
outstanding. The Bank's consumer installment portfolio remains its third largest
major loan category.
Consistent with its focus on providing community based financial services,
Chesapeake Bank generally does not make loans outside its principal market
regions. By policy it does not originate or purchase highly leveraged loans or
loans to foreign entities or individuals.
Total nonperforming assets consist of nonaccrual loans, restructured loans,
repossessed and foreclosed properties. Nonperforming assets were $791,344 at
December 31, 1997, representing no substantial change from $395,944 from
December 31, 1996. Past due loans were 1.13% of total loans at December 31,
1997.
Asset Quality-Provision/Reserve for Loan Losses
The provision for loan losses is a charge against earnings necessary to
maintain the reserve for loan losses at a level consistent with management's
evaluation of the credit quality and the level of risk in the loan portfolio.
The 1997 provision of $75,000 brought the reserve for loan losses to
$1,740,065 or 1.68% of gross loans. There was a provision of $150,000 in 1996
compared to the 1995 provision of $84,000. Management and the Board of Directors
believe the total reserve at year end was adequate relative to current levels of
risk in the portfolio. Continued loan growth may warrant additional provisions
in the future. The reserve for loan losses as a percent of gross loans less
unearned discounts was 1.7% on December 31, 1997, 1.8% on December 31, 1996 and
1.8% on December 31, 1995.
Loan charge offs totaled $41,956 in 1997, $157,448 in 1996, and $27,530 in
1995. Recoveries for the same periods were $54,178, $197,111, and $36,113,
respectively. Management does not expect to have similar recovery experience in
1998.
The Bank maintains a reserve for loan loss which management believes
represents a conservative estimate of potential losses in the Bank's loan
portfolio. To achieve this goal, the loan loss provision must be sufficient to
cover loans charged off plus the growth (if any) in the loan portfolio. In
determining the adequacy of the reserve for loan losses, management uses a
methodology which specifically identifies and reserves for higher risk loans. A
general reserve is established for non-specifically reserved loans. Loans in a
nonaccrual status and over ninety days past due are considered in this
evaluation as well as other loans which may be potential problem loans. The
status of nonaccrual and past due loans varies from quarter to quarter based on
seasonality, local economic conditions, and cash flow of customers.
Management has periodically contracted outside professionals to perform an
independent loan quality review to enhance the internal loan review process. A
review was performed in late 1997 and the results were consistent with those of
the internal loan review officer and management's reserve analysis process. The
maintenance of high loan quality objectives has been key to the Company's
current levels of performance.
Investment Securities
At year end, total securities and time deposits with other banks were $43.9
million, up 16.5% from the $37.7 million on December 31, 1996, which compared to
$37.1 million on December 31, 1995. Investment portfolio liquidity and deposit
growth provided funding for the increases in the loan portfolio.
All of the Company's securities are classified as securities available for
sale. Securities may be classified as investment securities when management has
the intent and the Company has the ability at the time of purchase to hold
29
<PAGE>
Chesapeake Financial Shares, Inc.
the securities to maturity. Investment securities are carried at cost adjusted
for amortization of premiums and accretion of discounts. Securities available
for sale include securities that may be sold in response to changes in market
interest rates, changes in the securities prepayment risk, increases in loan
demand, general liquidity needs and other similar factors. Securities available
for sale are carried at fair market value.
At December 31, 1997, securities available for sale totaled $43.9 million
and at December 31, 1996 the total was $37.7 million. Fair market value of the
portfolio at December 31, 1997 exceeded book value by $328,577 net of the tax
effect. At December 31, 1996 the book value of the portfolio exceeded fair
market value by $76,216 net of the tax effect. Debt securities with an amortized
cost of $29.0 million were transferred from held-to-maturity to
available-for-sale on December 1, 1995 (see Note 2). The reclassification of
securities for 1995 had no effect on the Company's financial condition or
results of operations as the aggregate market value of the portfolio exceeded
its book value by $78,860, also net of the tax effect. The original
reclassification in 1994 warranted a capital reserve at December 31, 1994 for
unrealized losses on securities available for sale of $259,974. This is within
risk limits monitored by the Board and the asset/liability management committee.
The securities portfolio increased 16.5% or $6.2 million in 1997 and
increased less than 1% in 1996 over 1995. U. S. Government Agencies increased
26.2 or $6.1 million during 1997. Investments in state and political
subdivisions increased 13.3% or $1.4 million during 1997. Investments in U.S.
Treasury issues decreased $1.3 million or 44.2% from 1996, which had a decrease
of $1.5 million, or 33.6% from 1995. Management has increased the investment in
securities of state and political subdivisions including some local
municipalities to utilize the tax free income. Management has also changed the
investment strategy to increase the mortgage-backed securities portfolio. This
strategy has increased current income and has improved the total return of the
overall portfolio without assuming amounts of risk greater than limits
established and monitored by the Board of Directors.
Liabilities: Deposits
Deposits totaled $147.5, $127.6, and $118.7 million for 1997, 1996, and
1995, respectively, representing an increase of 15.6% for 1997 from 1996, and an
increase of 7.5% for 1996 from 1995. The composition of deposits continued to
change this year with changing interest rates. There was a 19.1% increase in
certificates of deposit. Noninterest bearing deposits increased to $19.3 million
or 15.7% from $16.6 million on December 31, 1996. Savings balances increased
during the year by 8.5% or $3.2 million to $40.4 million.
Shareholders' Equity
Future growth and expansion of the Company is dictated by the ability to
generate capital which is generated principally by the earnings of the Bank. As
of December 31, 1997, the Company's primary capital to asset ratio was 9.3%. The
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
established a capital based supervisory system for all insured depository
institutions including state chartered, Federal Reserve member banks. Under this
new requirement, the Bank continues to be certified as a "well capitalized"
institution, which is the highest level of this ranking.
Federal regulators adopted 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%. For Chesapeake, Tier 1 capital is composed of common equity and
retained earnings less certain intangible items. Tier 1 capital to risk weighted
assets and Tier 1 capital to average assets (called leveraged capital) must be
4%.
On December 31, 1997, the Company had ratios of Tier 1 risk based capital
to risk weighted assets of 12.2%, total risk based capital to risk weighted
assets of 13.5%, and Tier 1 leverage capital of 8.5%. At December 31, 1996,
these ratios were 12.5%, 13.7% and 8.5%, respectively.
The adequacy of the Company's capital is reviewed by management on an
ongoing basis with reference to the size, composition and quality of the
company's asset and liability levels and consistent with regulatory requirements
and industry standards. Management seeks to maintain a capital structure that
assures an adequate level to support anticipated asset growth and absorb
potential losses.
Dividend and Market Information
The Company raised its dividend to $.28 per share in 1997, an increase of
$.04 over 1996. This increase followed another $.03 per share dividend increase
from $.21 in 1995 to $.24 in 1996.
30
<PAGE>
1997 Annual Report
Trades in the Company's common stock have occurred infrequently on a local
basis and generally involve a relatively small number of shares. Based on
information made available to them, management believes that the selling price
for the Company's common stock ranged during 1995 from $8.13 to $9.17; during
1996, from $10.63 to $12.71; and during 1997, from $12.71 to $20.00. Such
transactions may not be representative of all transactions during the indicated
periods or of the fair value of the stock at the time of such transactions due
to the infrequency of trades and the limited market for the stock. At December
31, 1997, there were 1,010,888 shares of Company stock outstanding held by
approximately 463 holders of record.
Liquidity, Interest Rate Sensitivity, and Inflation
The objectives of the Company's liquidity management policy include
providing adequate funds to meet the needs of depositors and borrowers at all
times, as well as providing funds to meet the basic needs for ongoing operations
of the Company, to allow funding of longer-term investment opportunities and
regulatory requirements. Sufficient assets are maintained on a short-term basis
to meet the liquidity demands anticipated by management.
The most immediate and efficient source of liquidity is the Bank's pool of
short-term investments. The Bank's primary sources of liquidity continue to be
Federal funds sold, time deposits with banks, and securities maturing or
repricing within one year. On December 31, 1997, approximately 26.4% of the
total invested portfolio dollars mature within one year as compared to 9.0% on
December 31, 1996. The Bank's loan portfolio is also liquid with 57.6% of all
loan dollars maturing or repricing within one year. This loan liquidity ratio
was 58.3% on December 31, 1996. Management considers the Company's liquidity to
be adequate. Other sources of liquidity include repayment of loans, the sale of
loans, and proceeds from the sale of repossessed assets and Other Real Estate
Owned. The sale of loans through the secondary market operation enhances this
liquidity position by providing both fixed and adjustable rate long-term
mortgage options to our client base. Mortgage loans held for resale are stated
at the lower of cost or market (or contract value), however, due to the quick
turnover of these assets, seldom do the loans represent more than 1% of total
assets.
Bank management maintains overnight borrowing relationships with
correspondent banks for up to $6,500,000, unsecured. The Bank has other
borrowing relationships for up to $13,000,000, secured. The Company also has an
unused revolving line of credit for $2,000,000.
As of December 31, 1997, the Bank had $249,300 in repossessed assets and
Other Real Estate Owned. These assets are being aggressively marketed for sale
and represent a near term secondary source of liquidity. The Bank expects to
realize full book value for these assets.
Since the assets and liabilities of a bank are primarily monetary in nature
(payable in fixed, determinable amounts), the performance of a bank is affected
more by changes in interest rates than by inflation. Interest rates generally
increase as the rate of inflation increases, but the magnitude of the change in
rates may not be the same.
While the effect of inflation is normally not as significant as is its
influence on those businesses which have large investments in plant and
inventories, it does have an effect. There are normally corresponding increases
in the money supply, and banks will normally experience above average growth in
assets, loans and deposits. Also, general increases in the prices of goods and
services will result in increased operating expenses.
Net Interest Income
The principal source of earnings for Chesapeake is net interest income. Net
interest income is the difference between interest and fees generated by earning
assets and interest expense paid to fund those assets. As such, net interest
income represents the gross profit from the Bank's lending, investment, and
funding activities.
A large number of variables interact to affect net interest income.
Included are variables such as changes in the mix and volume of earning assets
and interest bearing liabilities, market interest rates, and the statutory
Federal tax rate. It is management's ongoing policy to maximize net interest
income through the development of balance sheet and pricing strategies while
maintaining appropriate risk levels as set by the Board of Directors.
Net interest income totaled $5.9, $5.4, and $5.0 million for 1997, 1996,
and 1995, respectively, representing an increase of 10.5% for 1997 over 1996,
7.7% for 1996 over 1995, and 2.1% for 1995 over 1994. Loan demand was strong
31
<PAGE>
Chesapeake Financial Shares, Inc.
again this year with total net loans up 12.9% or $11.7 million for 1997 over
1996. Total interest expense was $5.4, $4.8, and $4.6 million for 1997, 1996 and
1995, respectively. On a tax equivalent annualized basis, the net interest
margin was 4.6%, 4.6% and 4.4% for 1997, 1996 and 1995, respectively.
Noninterest Income
For the year ended December 31, 1997, noninterest income was $3.0 million,
a 16.6% increase over the 1996 amount of $2.6 million, which was a 20.7%
increase over the 1995 amount of $2.1 million. The increase in 1997 was due to a
56.6% or $216,018 increase in our Cash Management service, and an increase of
$165,003 or 80.7% in Merchant Card income. Trust income was also up 12.8% or
$104,595, and ATM income was up 33.6% or $50,088. Service Charge income was up
5.5% or $27,402 from the same period in 1996. All other operating income items
increased for the year excluding the effect of the one-time recovery in 1996.
Merchant Card, ATM, and Cash Management income was up due to product
promotions, including incentives and aggressive pricing. We expect our market
share to continue to grow in these product areas. The Company continuously seeks
additional sources of noninterest income.
Noninterest Expenses
Total noninterest expenses increased 14.6% or $835,481 in 1997 over 1996.
In 1996, total operating expenses increased 6.9% over 1995 and increased 3.6% in
1995 over 1994. The 1997 increase was due primarily to a 26.4% or $441,205
increase in other expenses related to a $148,283 increase or 162.3% in Cash
Management expenses, $156,505 or 74.0% increase in Merchant Card expenses, a
$75,668 or 55.9% increase in advertising, and a $75,087 or 34.0% increase in ATM
expenses. The Bank now operates nine banking offices. Our ATM network was
reduced from seventeen to fourteen sites during the year. The ATM computer
processing function was moved in-house from a third party servicer. This has
reduced operating costs during the last quarter of the year and should make the
ATM function profitable for 1998.
Salaries and benefits were up 8.4%, or $239,276, over 1996 levels of
$2,840,262. This increase was due to additional staffing, incentives, and cost
of living increases. Total occupancy expenses increased 12.8% or $155,000
compared to 1996 which was up 29.5% or $275,512 from the 1995 level of $935,022.
The FDIC insurance assessment was up 662.7% or $13,253 for 1997 over 1996,
compared to a decrease of 98.5% for 1996 over 1995. The assessment was at the
lowest rate available for 1997, 1996, and 1995 as a result of the Bank's "well
capitalized" status with Federal Deposit Insurance Corporation. Professional
fees and expenses were up only 4.1% or $3,455 for 1997 over 1996, compared to an
decrease of 33.7% or $42,650 for 1996 over 1995. The primary reason for the
decrease in 1996 was related to a comprehensive technology review and mainframe
software selection and implementation process that took place in 1995. This
culminated in a February 1996 banking software conversion.
The rate of increase in noninterest expense is not expected to continue.
There were several one-time expenses in 1997 related to the ATM processing
conversion, combining several local area networks, and upgrading personal
computer systems.
Services available to our customer base have been enhanced or added
including Touch Tone Loan (a computerized telephone based loan application
product), Touch Tone Teller (24 hour banking that now includes loan payments)
and the 24 Hour ATM network. Additionally, mutual funds, fixed and variable
annuities, and enhanced estate planning are available through Chesapeake
Investment Services and the Trust Department.
32
<PAGE>
[LOGO]
Chesapeake Financial Shares, Inc. - Directors
- -------------------------------------------------------------------------------
<TABLE>
<S> <C>
Douglas D. Monroe, Jr. T. Nash Broaddus Thomas B. Denegre, Jr.
Chairman of the Board Chairman of the Board Retired Vice Chairman &
Chief Executive Officer Prodesco, Inc. Senior Trust Officer
Textile Manufacturer Chesapeake Bank
Eugene S. Hudnall, Jr. Robert S. Scheu William F. Shumadine, Jr.
President, Noblett, Inc. Retired CEO Senior Vice President
Retailer Marine Midland Trust Lowe, Brockenbrough & Tattersall, Inc.
Company of Western New York Registered Investment Advisor
Robert L. Stephens Katherine W. Monroe
Owner Shareholder
The Tides Inn, Inc.
Resort Operations
</TABLE>
Chesapeake Bank - Directors
- ------------------------------------------------------------------------------
<TABLE>
<S> <C>
Rexford F. Beckwith, III James M. Holmes, Jr. L. Frank Phillips, Jr.
President President, Administrator President
Rappahannock Westminster-Canterbury Rappahannock General Hospital L. F. Phillips & Son Oil Co., Inc.
Charles C. Chase, II Eugene S. Hudnall, Jr. Albert C. Pollard
President, Rappahannock President President
Seafood Company, Inc. Noblett, Inc. Pollard Properties, Inc.
James F. Chase, Jr. Douglas D. Monroe, Jr. Robert L. Stephens
Farmer Chairman and President Owner
Chesapeake Bank The Tides Inn, Inc.
C. Irwin Clark, III Harvey B. Morgan Harry M. Ward
Chairman of the Board Pharmacist and Legislator Superintendent of Schools
Hubbard Insurance Agency, Inc. Mathews County
</TABLE>
Chesapeake Bank - Officers
- ------------------------------------------------------------------------------
<TABLE>
<S> <C>
Douglas D. Monroe, Jr. Ray H. Hargett Linda J. Bisulca Carlie H. Gill
Jeffrey M. Szyperski Betty Sue Spence Shirley M. Daniel Kathleen S. Banks
Marshall N. Warner Jean H. Harper Bert H. Heath, Jr. Doris C. Bussells
John H. Hunt, II Paul L. Wegkamp, Jr. John N. Chappell Patricia R. Lewis
Ted M. Kattmann Dianne D. Hall Brenda S. Cornell Pattie G. R. Matthews
Larry T. Lawrence Suzanne D. Keyser Heidi L. Wilkins Ann Marie Pruitt
John K. O'Shaughnessy Cecelia G. Klink Julie A. Williams
</TABLE>
Chesapeake Insurance Agency, Inc.
and Chesapeake Mortgage Company, Inc. - Directors
- -------------------------------------------------------------------------------
Douglas D. Monroe, Jr. Eugene S. Hudnall, Jr. Katherine W. Monroe
Robert L. Stephens Ray H. Hargett T. Nash Broaddus
Chesapeake Bank Business Advisory Committees
- -----------------------------------------------------------------------------
Middle Peninsula Peninsula
Alvin L. Newton Henry S. Branscome Vernon M. Geddy, III
L. Frank Phillips, Jr. John D. Briggs Bruce P. Robertson
William J. Pointer Patrick G. Duffeler Thomas G. Tingle
33
EXHIBIT #21
SUBSIDIARIES OF THE REGISTRANT
Chesapeake Bank
Chesapeake Mortgage Company
Chesapeake Investment Services
CNB Properties, Inc.
29
<PAGE>
EXHIBIT #21
CONSENT OF CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the use of our report dated January 8, 1998 in
this Annual Report on Form 10KSB relating to the Consolidated Financial
Statements of Chesapeake Financial Shares, Inc. and subsidiaries, appearing
under Item 7., Financial Statements, including, without limitation, the
incorporation by reference in the Prospectuses constituting part of the
Registration Statements on Form S-18 (#33- 27825) of Chesapeake Financial
Shares, Inc.
/s/
Yount, Hyde & Barbour, P.C.
March 13, 1998
Winchester, Virginia
30
[TO COME]
EXHIBIT A
CHESAPEAKE FINANCIAL SHARES, INC.
AND SUBSIDIARIES
Kilmarnock, Virginia
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 1997
EXHIBIT B
CHESAPEAKE FINANCIAL SHARES, INC.
AND SUBSIDIARIES
Kilmarnock, Virginia
REGISTRANT'S DEFINITIVE PROXY STATEMENT
DATED MARCH 10, 1998
31
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
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5,054,440
0
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</TABLE>
