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, 1998.
Commission file number 0-18543
CHESAPEAKE FINANCIAL SHARES, INC.
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Virginia 54-1210845
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
19 N. Main St., Kilmarnock, VA 22482
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(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 $16,601,324.
As of March 2, 1999 the aggregate market value of Common Stock of
Chesapeake Financial Shares, Inc. held by nonaffiliates was
approximately $8,430,535 based upon the average sales price per share
known to management during January and February 1999.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of March 1, 1999.
Class Outstanding at March 1, 1999
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Common Stock, $5.00 par value 1,237,439
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference and the Part of
the Form 10-KSB into which the document is incorporated. (1)Portions
of the Annual Report to Shareholders for the year ended December 31,
1998 are incorporated into Part II, Items 5 through 7 of this Form
10-KSB.
(2)Portions of the definitive proxy statement for the 1999
Annual Meeting of Stockholders are incorporated into Part III, Items
9 through 12 of this Form 10-KSB.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT YES__ NO X
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CHESAPEAKE FINANCIAL SHARES, INC.
FORM 10-KSB
INDEX
PART I
Page
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Item 1.Description of Business............................................ 3
Statistical Information................................................... 12-23
Item 2.Description of Property............................................. 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.......................................................... 25
Item 10. Executive Compensation.............................................. 25
Item 11. Security Ownership of Certain Beneficial Owners and
Management.......................................................... 25
Item 12. Certain Relationships and Related Transactions...................... 25
Item 13. Exhibits and Reports on Form 8-K.................................... 26
Signatures .................................................................. 27
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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 Financial Group, Inc.,
Chesapeake Mortgage Company, Inc. (Inactive), Chesapeake Insurance Agency, Inc.,
t/a Chesapeake Investment Services, and CNB Properties, Inc.
On December 31, 1998, the Company and its subsidiaries had 101 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. Other products
include Touch Tone Teller and Touch Tone Loan 24 hour access services and
annuity and brokerage 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 10.9%, 14.7%, and 8.9% for each of the years
1998, 1997 and 1996, respectively. At December 31, 1998, total loans amounted to
$109.4 million, a 7.1% increase from $102.1 million in total loans at December
31, 1997, which was a 12.9% increase from the previous year-end total of $90.4
million at December 31, 1996. Growth in total deposits has followed a similar
pattern with increases of 7.5%, 15.6%, and 11.6% during 1996, 1997 and 1998,
respectively.
The Bank operates ten banking offices and thirteen ATMs. The Bank
expanded its market area to the James City County/Williamsburg area in May 1995
with the opening of its James City County Winn-Dixie office. In May 1996, the
Bank opened its Five Forks/Williamsburg Office. The third full service banking
facility in Williamsburg opened in June 1998 on Lafayette Street, near Merchant
Square. This branch functions as a regional office and houses Chesapeake
Financial Group, Inc. and Chesapeake Investment Services.
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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.
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 - James City County/Williamsburg -
Hampton triangle has provided additional commercial and residential business
activity which diversifies revenue sources.
With the exception of the Bank's Westminster Canterbury Office, the
Gloucester Winn-Dixie Office, the James City County Winn-Dixie Office, and the
Five Forks Office, the Bank's Main Office and branch offices are held in fee,
free of any encumbrances. 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.
<TABLE>
<CAPTION>
The Bank's branch offices are located as follows:
<S> <C> <C> <C>
Gloucester Winn-Dixie Office Hayes Office Lively Office
Route 17 Route 17 Lively
The Shoppes at Gloucester Hayes Shopping Center
Gloucester Hayes
Rappahannock Westminster Kilmarnock Office Mathews Office
Canterbury Office 97 North Main Street Mathews Courthouse
Irvington Kilmarnock Mathews
Irvington Office James City County Five Forks Office
Irvington Winn-Dixie Office Rt5 & Ironbound Rd
Williamsburg Williamsburg
</TABLE>
Lafayette Street Financial Center
1229 Lafayette Street
Williamsburg
The Company acquired a 2.647 acre commercial property (formerly the
Colonial Store complex) on School Street in Kilmarnock on January 2, 1998. The
long term debt is secured by this property. The building is approximately 27,000
square feet. Just over one half of the space is rented to three tenants, Advance
Auto, deMedici's Fine Italian Restaurante, and Rappahannock General Hospital.
The remaining space is being 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 space at 19 N. Main Street is leased under
an agreement that expires on April 1, 2002 and has a five year renewal.
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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 COMPANIES
Chesapeake Financial Group, Inc. ("CFG") was incorporated August 31,
1998 and opened for business at year end. CFG has established unique
partnerships with premier investment managers to offer superior portfolio
management coupled with highly customized service to high net worth individuals
and institutions.
Chesapeake Insurance Agency, Inc., formerly T/A Chesapeake Title
Company, (the "Title Company"), which is a wholly-owned subsidiary of the Bank,
completed its ninth year of operations as a title company in 1995. The Title
Company has also had the operations area consolidated with the Bank and provides
referrals to other companies for title insurance services. Chesapeake Insurance
Agency, Inc is now T/A Chesapeake Investment Services ("CIS") and offers annuity
products (fixed and variable), mutual funds and discount brokerage products. The
Bank, the Trust Department, CIS, and CFG combine to offer services for every
financial need.
OTHER ENTITIES
CNB Properties, Inc. was formed September 23, 1991, to provide a
corporate vehicle to buy and hold properties (such as foreclosures) on a
temporary basis. There has never been more than one property held at any point
in time and never more than several months.
LENDING ACTIVITIES
The Company provides a wide range of commercial, real estate, and
consumer loan services through the Bank.
REAL ESTATE LENDING. The Bank's second largest loan category is its real
estate loan portfolio, (both mortgage and construction lending) which amounted
to $38.5 million at December 31, 1998, or 34.5% of the Bank's 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.
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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, 1998, 46.7% 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. 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.
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 (a 31.4% increase over 1997 and an
11.8% increase in 1997 over 1996) 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 $21.4
million at December 31, 1998, or 19.2% 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, 1998, only 0.31% 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, 1998, the Bank's commercial loan portfolio amounted to
$49.1 million, or 44.1% of its total loan portfolio. See Note 3 to the Financial
Statements for
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a breakdown of the major loan classifications. Of the $49.1 million of
commercial loans at December 31, 1998, 64.7% of such loans either matured or
were subject to repricing within one year. (see Table 4 at page 16).
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, 1998, 94.6% of the
commercial loans were secured by some form of collateral and 0.45% of the Bank's
commercial loan portfolio was 30 days or more delinquent. See Table 6 at page 18
showing the amount of commercial loans charged off during 1998 and 1997.
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.
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 Company 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 it is 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 judgment 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, 1998, 1997, and 1996.
LONG-TERM DEBT
See Note 5 to the Financial Statements for information concerning term
loan agreements of the Company.
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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 regional banking
institutions, including First Virginia Bank, Wachovia Bank, SunTrust Bank,
NationsBank, and First Union. 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 in recent years 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.
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-Neal Interstate Banking and Branching Efficiency Act of 1994
authorizes 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
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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.
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 the "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, 1998 were 11.3% and 12.6%, 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, 1998, was 8.4%, which is above the minimum
requirements. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to
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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 from any loans or extensions of credit permitted by such
exceptions.
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, 1998, the Bank could have paid additional dividends to the
Company of approximately $1.9 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 federal law, 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
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is subject to insurance assessments imposed by the FDIC. The FDIC has
implemented a risk-based deposit insurance assessment system under which the
assessment rate for an insured institutions may vary according to regulatory
capital levels of the institution and other factors (including supervisory
evaluations). Depository institutions insured by the BIF that are "well
capitalized," are required to pay only the statutory minimum assessment of
$2,000 annually for deposit insurance, while all other banks are required to pay
premiums ranging from .03% to .27% of domestic deposits. These rate schedules
are subject to future adjustments by the FDIC. In addition, the FDIC has
authority to impose special assessments from time to time. However, because the
legislation enacted in 1996 requires that both Savings Association Insurance
Fund insured and BIF-insured deposits pay a pro rata portion of the interest due
on the obligations issued by the Financing Corporation, the FDIC is assessing
BIF-insured deposits an additional 1.30 basis points per $100 of deposits to
cover those obligations.
OTHER SAFETY AND SOUNDNESS REGULATIONS. 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 funds 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 its subsidiary depository institutions and to commit resources to
support such institutions in circumstances where it might not do so otherwise.
In addition, the "cross-guarantee" provisions of Federal law require insured
depository institutions under common control to reimburse the FDIC for any loss
suffered or reasonably anticipated by the 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 provision
if it determines that a waiver is in the best interests of the BIF. The FDIC's
claim for reimbursement is superior to claims of shareholders 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 institution.
The Federal banking agencies also have broad powers under current Federal
law to take prompt corrective action to resolve problems of insured depository
institutions. The FDIA requires that the federal banking agencies establish five
capital levels for insured depository institutions - "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized,"
and "critically undercapitalized." It also requires or permits such agencies to
take certain supervisory actions should an insured institution's capital level
fall. For example, an "adequately capitalized" institution is restricted from
accepting brokered deposits. An "undercapitalized" or "significantly
undercapitalized" institution must develop a capital restoration plan and is
subject to a number of mandatory and discretionary supervisory actions. These
powers and authorities are in addition to the traditional powers of the Federal
banking agencies to deal with undercapitalized institutions.
Federal regulatory authorities also have broad enforcement powers over the
Company and the Bank, including the power to impose fines and other civil and
criminal penalties, and to appoint a receiver in order
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to conserve the assets of any such institution for the benefit of depositors and
other creditors.
OTHER
Please see the "Year 2000 Readiness Disclosure" at page 33 of the
Company's Annual Report to Shareholder's.
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, State Corporation Commission,
Commonwealth of Virginia. In December of 1997 the Company satisfactorily
completed a Transfer Agent Examination and the Bank satisfactorily completed a
Phase I and Phase II Year 2000 Examination, all 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.
12
<PAGE>
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, 1998 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
13
<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.
Year Ended December 31,
1998 1997
---- ----
Annual Annual
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
(Dollars in Thousands)
Assets:
Securities:
Taxable $34,234 $1,886 5.51% $26,383 $1,636 6.20%
Tax-exempt(1) 11,749 605 7.80 11,211 589 7.96%
------ ------ -------- -----
Total securities 45,983 2,491 6.10 37,594 2,225 6.72%
Loans (net of unearned income):
Taxable(2) 103,215 9,962 9.65 94,841 8,872 9.35%
Tax-exempt 2,567 205 12.10 2,174 166 11.57%
------ ------ -------- -----
Total loans 105,782 10,167 9.71 97,015 9,038 9.40%
Federal funds sold and
repurchase agreements 1,702 89 5.23 1,050 58 5.52%
Interest-bearing deposits
in other banks 346 16 4.62 586 40 6.83%
------ --- ----- ----- ------ ------
Total earning asset
153,813 12,763 8.57% 136,245 11,361 8.62%
Less: allowance for loan
losses (1,806) (1,678)
Total nonearning assets 19,261 14,381
------- -------
Total assets $171,268 $148,948
-------- --------
14
<PAGE>
TABLE 1 (CONT.)
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES
Year Ended December 31,
1998 1997
---- ----
Annual Annual
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
(Dollars in Thousands)
Liabilities and Shareholder's Equity:
Interest-bearing deposits:
Checking $27,170 $ 728 2.68% $21,022 $ 508 2.42%
Regular savings 12,305 332 2.70 11,437 308 2.69
Money market savings
6,189 178 2.88 5,980 174 2.91
Certificates of deposit:
$100,000 and over 16,908 897 5.31 15,131 851 5.62
Under $100,000 70,205 3,932 5.60 63,236 3,504 5.54
------ ------ ---- ------ ----- ----
Total interest-bearing
deposits 132,777 6,067 4.57 116,806 5,345 4.58
Federal funds purchased
and securities sold under
agreements to repurchase
648 36 5.56 849 51 6.01
Other borrowing 884 49 5.54 216 11 5.09
----- --- ---- ----- --- ----
Total interest-bearing
liabilities 134,309 6,152 4.58% 117,871 5,407 4.59%
Noninterest bearing liabilities:
Demand deposits 21,141 16,612
Other liabilities 1,462 1,599
------ -----
Total liabilities 156,912 136,082
Shareholders' equity 14,355 12,866
Total liabilities and share-
holders' equity $171,267 $148,948
Net interest income/yield $6,611 4.57% $5,954 4.65%
Interest rate spread 3.99% 4.03%
1) Yields are reported on a taxable equivalent basis assuming a federal tax rate
of 34%.
2) Includes non-accrual loans.
15
<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.
Year Ended December 31,
1998 vs.1997 1997 vs. 1996
Increase (Decrease) Increase (Decrease)
Due to Changes in:(1) Due to Changes in:(2)
--------------------- ---------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
Earning Assets:
Securities:
Taxable $ 399 $(149) $ 250 $ 88 $ 82 $ 170
Tax-exempt 28 (12) 16 56 19 75
Loans
Taxable 799 291 1,090 1,032 (88) 944
Tax-exempt 31 8 (39) (32) 23 (9)
Federal funds sold
and repurchase
agreements 34 (3) 31 16 2 18
Interest-bearing deposits
in other banks (13) (11) (24) 8 13 21
------ ----- ------ ----- ---- ------
Total earning
assets $1,278 $124 $1,402 $1,168 $ 51 $1,219
------ ---- ------ ------ ---- ------
Interest-Bearing Liabilities:
Interest checking $ 161 $ 59 $ 220 $ 12 $ (7) $ 5
Regular savings 23 1 24 10 (1) 9
Money market savings 6 (2) 4 (21) (4) (25)
Time deposits:
CDS $100,000 or more 87 (41) 46 62 8 70
CDS Other 390 38 428 561 21 582
------ ---- ---- ------ ---- ----
Total interest-bearing
deposits 667 55 722 624 17 641
Federal funds purchased
and securities sold
under agreements to
repurchase (11) (4) (15) 22 4 26
Other borrowing 37 1 38 (6) (9) (15)
--- ---- --- --- --- ----
Total interest-bearing
liabilities $ 693 $ 52 $ 745 $ 640 $ 12 $ 652
----- ----- ------ ----- ----- -----
Change in net interest
income: $ 585 $ 72 $ 657 $ 528 $ 39 $ 567
----- ---- ----- ----- ---- -----
(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 combine 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.
16
<PAGE>
TABLE 3
SECURITIES HELD FOR RESALE AND INVESTMENT
MATURITY DISTRIBUTION AND AVERAGE YIELD
December 31,
1998 1997
Book Value: (In thousands)
U.S. Government securities. . . . . . . . . $29,046 $31,186
State and political subdivisions. . . . . . 12,330 11,473
Other securities. . . . . . . . . . . . . 835 743
Total securities $42,211 $43,402
Maturities of Securities Held at December 31, 1998
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 $5,973 $20,958 $1,615 $ - $28,546
Market value 5,963 20,664 1,573 - 28,200
Weighted average yield(1) 4.72% 4.62% 5.16% -% 4.62%
U.S. Treasury Securities:
Book value 500 - - - 500
Market value 501 - - - 501
Weighted average yield(1) 5.22% 0% -% -% 5.22%
State and Political Subdivisions:
Book value - 203 2,165 9,962 12,330
Market value - 209 2,268 10,456 12,933
Weighted average yield(1) -% 7.42%- 7.91% 8.02% 7.99%
Other Securities:
Book Value - - - 835 835
Market Value - - - 841 841
Weighted Average Yield(1) -% -% -% 6.26% 6.26%
Total Securities:
Book value $6,473 $21,161 $3,780 $10,797 $42,211
Market value 6,464 20,873 3,841 11,297 42,475
Weighted average yield(1) 4.76% 4.64% 6.73% 7.88% 5.76%
(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, 1998.
17
<PAGE>
TABLE 4
LOAN PORTFOLIO AND MATURITY SCHEDULE OF SELECTED LOANS
AS OF DECEMBER 31, 1998
For the table and accompanying notes addressing the loan portfolio, see
"Note 3. Loans" on page 14 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, 1998 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 $5,649 $26,096 $ 6,242 $ 8,894 $3,104 $ 0
Real estate-construction 5,166 0 111 0 191 0
Real estate mortgage 467 12,316 953 17,749 1,518 0
Consumer installment 6,125 1,132 9,250 510 4,361 0
------ ------- ------ ------ ------ ----
Total $17,407 $39,544 $16,556 $27,153 $9,174 $ 0
------- ------- ------- ------- ------ ------
18
<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,
-----------
(Thousands)
1998 1997
Nonaccrual loans(1) $ 202 $ 581
Restructured loans 0 0
Foreclosed properties 185 245
----- -----
Total nonperforming assets $ 387 $ 826
------- -----
Loans past due 90+ days and
accruing interest $ 4 $ 14
Reserve for loan losses
to period end loans 1.8% 1.7%
Reserve for loan losses to
nonaccrual loans 999.7% 299.5%
Nonperforming assets to
period-end loans and
foreclosed properties (2) 0.35% .80%
Net charge-offs (recoveries)
to average loans 0.32% (0.01%)
(1)There were no troubled debt restructurings in 1998 or 1997. The Bank expects
to charge off $585,705 in problem loans (fully reserved at December 31, 1998).
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 29 of the 1998 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, 1998, performing loans totaling approximately $4.5 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, consumer, hospitality, and the
retail sectors.
19
<PAGE>
20
<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,
-----------------------
1998 1997
----- ----
(Dollars in thousands)
Reserve, beginning of period $1,740 $1,653
Loans charged off:
Commercial (330) (29)
Real estate construction 0 0
Real estate mortgage (0) (3)
Consumer (25) (10)
------- --------
Total loans charged off (355) (42)
-------- ------
Recoveries of loans previously charged off:
Commercial 0 35
Real estate - construction 0 0
Real estate - mortgage 7 0
Consumer 12 19
----- ---
Total recoveries 19 54
------- -------
Net loans (charged off) recovered
(336) 12
Provision for (recovery off) loan losses
620 75
--- -----
Balance, end of period $2,024 $1,740
------ ------
Net charge-offs (recoveries) to average loans
(0.32%) (0.01%)
21
<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.
1998 1997
Percent of loans Percent of loans
in each category in each category
Amount to Total Loans Amount to Total Loans
------ -------------- ------ ---------------
(dollars in thousands)
Commercial $1,233 44.1% $ 366 39.3%
Real estate - construction 0 4.9 0 2.8
Real estate - mortgage 463 29.6 1,154 37.5
Consumer 299 19.2 220 15.7
Other 29 0.8 0 0.4
Participations 0 1.4 0 4.3
----- ------ ----- ----
Total $2,024 100.0% $1,740 100.0%
------ ------ ------ -----
TABLE 8
DEPOSITS
The average balance and rates for certain categories of deposits for the
last two years are shown in the following table:
Year ended December 31,
-----------------------
1998 1997
---- ----
Average Average Average Average
Balance Rate Balance Rate
------- ------- -------- -------
(dollars in thousands)
Non-interest bearing demand deposits
$ 21,141 $ 16,612
-------- --------
Interest bearing deposits:
Interest checking 27,170 2.68% 21,022 2.42%
Regular savings 12,305 2.70 11,437 2.69
Money market savings 6,189 2.88 5,980 2.91
Time deposits:
Certificates of deposit $100,000 or more
16,908 5.31 15,131 5.62
Other certificates of deposit
70,205 5.60 63,236 5.54
-------- --------
Total interest bearing deposits
132,777 4.57 116,806 4.58
-------- --------
Total deposits $153,918 3.94% $133,418 4.01%
-------- --------
Maturities of time certificates of deposits of $100,000 or more
outstanding at December 31, 1998 were (dollars in thousands):
1998
----
3 months or less $ 6,073
3 - 6 months 3,144
6 - 12 months 4,763
Over 12 months 1,528
-------
Total $15,508
22
<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,
----------------------
1998 1997
---- -----
Return on average assets 0.81% 1.18%
Return on average equity 9.62% 13.61%
Dividend payout ratio 24.69% 16.21%
Average equity to average assets 8.39% 8.63%
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 1998 and 1997 are presented below:
Year ended December 31,
-----------------------
(Dollars in Thousands)
1998 1997
---- ----
Average daily amount outstanding $ 648 $1,065
Average interest rate 5.56% 5.52%
Maximum outstanding at any month end $3,500 $3,300
Balance at end of period $ 0 $1,250
23
<PAGE>
<TABLE>
<CAPTION>
TABLE 11
INTEREST SENSITIVITY ANALYSIS
December 31, 1998
-----------------
Within 90-365 1 to 5 Over
90 Days Days Years 5 Years Total
-------- ---- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Earnings Assets:
Loans (2) $ 21,127 $ 37,535 $ 43,610 $ 9,174 $111,446
Securities & Time
Deposits with
other banks 3,510 6,912 15,895 16,158 42,475
Federal funds sold
and other short-
term investments 7,000 - - - 7,000
-------- --------- --------- -------- -------
Total interest
earning assets
$ 31,637 $ 44,447 $ 59,505 $25,332 $160,921
-------- -------- -------- ------- --------
Interest-Bearing
Liabilities:
Interest checking,
savings and money
market savings(3) $ 3,165 $ 7,210 $ 45,343 $ 0 $ 55,718
Certificates of
deposit:
$100,000 and over 5,553 6,715 3,421 - 15,507
Under $100,000 14,073 39,349 18,706 - 69,583
Federal funds
purchased and
securities sold
under agreements
to repurchase 0 - - - 0
Other borrowing 6 21 123 725 875
--------- ----- ------ ----- ------
Total interest-
bearing liabilities $24,330 $ 56,218 $ 60,410 $ 725 $141,683
------ ------ ------ ------ -------
Period gap $ 7,307 $(11,771) $ (905) $24,607 $ 19,238
Cumulative gap $ (4,464) $ (5,369) $19,238
Ratio of cumulative
gap to total
earning assets(4) 4.54% -2.77% -3.34% 12.30%
</TABLE>
(1) The repricing dates may differ from maturity dates for certain assets due to
prepayment assumptions.
(2) Includes 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 5.7% 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.
24
<PAGE>
TABLE 12
ANALYSIS OF CAPITAL *
December 31,
1998 1997
---- ----
(thousands)
Tier 1 Capital:
Common stock $ 6,148 $ 5,054
Additional paid in capital 524 484
Retained earnings 8,082 8,064
Less: Goodwill 0 0
------ -------
Total Tier 1 capital $ 14,754 $ 13,602
Tier 2 Capital:
Allowance for loan losses 1,633 1,392
Allowable long-term debt 0 0
----- -----
Total Tier 2 Capital 1,633 1,392
Total risk-based capital $ 16,387 $ 14,999
-------- ------
Risk weighted assets $130,167 $111,196
Capital Ratios:
Tier 1 risk-based capital ratio 11.3% 12.2%
Total risk-based capital ratio 12.6 13.5
Tier 1 capital to average
adjusted total assets 8.4 8.5
* See the captioned "Note 17 Regulatory Matters" which is included in Exhibit A
at page 22, The Annual Report to Shareholders was filed with the Commission on
or about March 10, 1999.
25
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The Company owns one property at December 31, 1998 which was purchased
on January 2, 1998 that is described in PART I, Item 1, The Bank, however, owns
and leases properties as also described in Item 1 of this report.
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, 1998.
26
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
This information is included in the 1998 Annual Report to Shareholders
at page 32 in the section captioned, "Dividend and Market Information".
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This information is included in the 1998 Annual Report to Shareholders
at pages 28-33.
ITEM 7. FINANCIAL STATEMENTS
This information is included in the 1998 Annual Report to Shareholders
at pages 2-27.
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.
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
Proxy Statement for the 1999 Annual Meeting of Shareholders at pages 2 through 4
and page 6 thereof.
ITEM 10. EXECUTIVE COMPENSATION
This information is incorporated herein by reference from the Company's
Proxy Statement for the 1999 Annual Meeting of Shareholders at pages 4 through 6
thereof.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated herein by reference from the Company's
Proxy Statement for the 1999 Annual Meeting of Shareholders at pages 2 and 3
thereof.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated herein by reference from the Company's
Proxy Statement for the 1999 Annual Meeting of Shareholders at page 7 thereof.
27
<PAGE>
28
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index:
#3(i) Articles of Incorporation and (ii) 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.
#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 Ownership 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
10.8 Ted M. Kattmann Employment Agreement filed herewith
10.9 John H. Hunt, II Employment Agreement filed herewith
#13 Annual Report to Security Holders is filed herewith
#21 Subsidiaries of the Registrant is filed herewith.
#22 None
(b) Reports on Form 8-K. No reports were filed by the registrant
during the fourth quarter of 1998.
28
<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 29, 1999 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 29, 1999
----------------------
Douglas D. Monroe, Jr.
Chairman of the Board and
Chief Executive Officer
/s/ T. Nash Broaddus March 29, 1999
--------------------------
T. Nash Broaddus, Director
/s/ Thomas B. Denegre, Jr. March 29, 1999
----------------------
Thomas B. Denegre, Jr., Director
/s/ Eugene S. Hudnall March 29, 1999
---------------------------
Eugene S. Hudnall, Director
/s/ Katherine W. Monroe March 29, 1999
-----------------------------
Katherine W. Monroe, Director
/s/ Robert S. Scheu March 29, 1999
-----------------------------
Robert S. Scheu, Director
/s/ William F. Shumadine, Jr. March 29, 1999
-----------------------------
William F. Shumadine, Jr., Director
/s/ Robert L. Stephens March 29, 1999
-----------------------------
Robert L. Stephens, Director
29
<PAGE>
EXHIBIT #13
[INSERT 1998 ANNUAL REPORT HERE]
EXHIBIT #21
SUBSIDIARIES OF THE REGISTRANT
Chesapeake Bank
Chesapeake Mortgage Company
Chesapeake Investment Services
CNB Properties, Inc.
Chesapeake Financial Group, Inc.
30
CHESAPEAKE FINANCIAL SHARES, INC.
1998
ANNUAL
REPORT
<PAGE>
(CHESAPEAKE FINANCIAL SHARES, INC. 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.
(CHESAPEAKE BANK LOGO)
(CHESAPEAKE (CHESAPEAKE
FINANCIAL GROUP LOGO) INVESTMENT SERVICES LOGO)
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Highlights for 1998
- --------------------------------------------------------------------------
Year ended December 31, 1998
Earnings
Net Income $ 1,388,733
Per Share 1.07
At Year End
Assets $ 181,861,275
Deposits 164,639,201
Loans - Net 109,422,041
Securities 42,474,916
Shareholders' Equity 14,928,406
Book Value Per Share 12.14
Number of Shareholders 451
CONTENTS
Chairman's Letter to Shareholders ............................................ 1
Selected Financial Information ............................................... 2
Financial Statements ......................................................... 3
Notes to Financial Statements ................................................10
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 ...................................................34
<PAGE>
(CHESAPEAKE FINANCIAL SHARES, INC. LOGO)
Dear Shareholder:
What an unusual year! The headlines for 1998 include Monica Lewinsky, a
special prosecutor, impeachment of the President by the House of
Representatives, the first loss of Congressional seats in a general election by
a party not occupying the White House (probably because of lack of agenda and
lack of leadership by the Republicans), Senator John Glenn returning into space
at age 77, wrestler Jesse "the Body" Ventura being elected governor of
Minnesota, and resignation of Newt Gingrich, Republican Speaker of the House. On
the lighter side!--the comeback of heroes with baseball's Mark McGwire and Sammy
Sosa record home run slugfest of 70 and 66 respectively for the season, along
with 15 year old Tara Lipinski, the youngest skater to ever win an Olympic gold
medal. During the year we lost entertainer turned Congressman Sonny Bono, comic
Flip Wilson (Geraldine), Olympic track star Florence Griffith Joyner, Senator
Barry Goldwater, Gene Autry and Roy Rogers, George Wallace, and finally,
singer/entertainer extraordinaire, Frank Sinatra.
In August Jeffrey M. Szyperski was elected a Director and President of
Chesapeake Bank. Chesapeake Bank will operate under his overall direction
including strategic planning with special emphasis on overall growth, earnings,
community service, and planning for the Year 2000. Marshall N. Warner, Executive
Vice President, moved to Williamsburg to head all customer services on the
Peninsula including business development, lending, sales of annuities and mutual
funds, and most recently to help guide the new affiliate, Chesapeake Financial
Group.
For the second consecutive year, Chesapeake Financial Shares declared and
paid a 20% stock dividend and maintained its quarterly dividend payout of $.08
per share or $.28 per share for 1998, up 20.0%.
Earnings for the year of $1.07 were recorded by Chesapeake for 1998.
Initially earnings of approximately $1.49 per share were written down by two
major non-recurring events. As reported earlier in 1998, the company wrote off
$297,000 based on a series of disputed international electronic transactions
involving Visa. Secondly, $410,000 was added to the allowance for loan loss
provisions to provide for a specific loan which was classified as "doubtful."
Chesapeake's loan quality remained extremely strong as 30 day and over past due
loans were .7% of total loans, the lowest in the company's history, coupled with
a strong loan loss provision of 1.8% of loans. Loan volume ended the year at
$111,436,000, the highest in the company's history, along with total assets of
$181,861,000, also a record. These numbers represent increases of 7.32% and
10.6% respectively.
Managed trust assets continued to climb to new record levels as clients
took advantage of investment management services. The outreach program to
clients in the Northern Neck, Middle Peninsula, and Williamsburg/James City
County areas continued to produce very positive results.
Chesapeake Financial Group, a subsidiary of Chesapeake Financial Shares,
was incorporated in the early summer and opened for business on December 1.
After establishing unique partnerships with premier investment managers, CFG
offers superior portfolio management coupled with highly customized service to
high net worth individuals and institutions.
In response to Chesapeake's enthusiastic acceptance on the Peninsula, the
Lafayette Street Financial Center was opened off of Richmond Road. The
renovation was completed, and on June 19 Chesapeake Financial Shares opened the
financial center housing a Chesapeake Bank office, mortgage loan office, trust
services, Chesapeake Investment Services, and Chesapeake Financial Group.
As announced in 1997, approximately 30,000 square feet of space in the
School Street business center complex in Kilmarnock was purchased. The area
occupied formerly by the Colonial Store was renovated. Data Processing, Loan
Administration, and Operational Support moved into the new modern quarters on
October 5.
Specific details on the financial achievements of Chesapeake Financial
Shares are contained within the confines of this report. Please pay particular
attention to management's discussion and analysis of its operations. The
company's annual meeting will be held at 4:00 p.m. on Friday, April 2, 1999 at
Rappahannock Westminster-Canterbury in Irvington. Please try to attend.
Yours sincerely,
/s/ Douglas D. Monroe, Jr.
-----------------------------------------------
Douglas D. Monroe, Jr.
Chairman of the Board & Chief Executive Officer
- --------------------------------------------------------------------------------
1
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Selected Financial Information
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
-------------------------------------------------------------
(Dollars in thousands except ratios and per share amounts)
Results of Operations
Interest income $ 12,763 $ 11,361 $ 10,142 $ 9,556 $ 8,668
Interest expense 6,153 5,407 4,755 4,556 3,770
--------- --------- --------- --------- ---------
Net interest income 6,610 5,954 5,387 5,000 4,898
Provision for loan losses 620 75 150 84 (96)
--------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 5,990 5,879 5,237 4,916 4,994
Noninterest income 3,838 2,982 2,559 2,120 1,626
Noninterest expenses 8,104 6,556 5,720 5,351 5,167
--------- --------- --------- --------- ---------
Income before tax 1,724 2,305 2,076 1,685 1,453
Income tax expense 335 554 501 420 418
--------- --------- --------- --------- ---------
Net income $ 1,389 $ 1,751 $ 1,575 $ 1,265 $ 1,035
========= ========= ========= ========= =========
Financial Condition
Total assets $ 181,861 $ 163,916 $ 142,876 $ 131,258 $ 124,439
Total deposits 164,639 147,519 127,630 118,687 112,295
Net loans 109,422 102,099 90,426 80,991 74,804
Note payable and
subordinated debentures 0 0 0 388 538
Shareholders' Equity 14,928 13,915 12,009 11,048 9,793
Average assets 171,987 148,948 133,376 127,230 122,642
Average shareholders' equity 14,429 12,866 11,426 10,421 9,502
Key Financial Ratios
Return on average assets 0.81% 1.18% 1.18% 0.99% 0.84%
Return on average equity 9.62% 13.61% 13.78% 12.14% 10.89%
Dividends paid as a percent
of net income 24.69% 16.21% 15.53% 16.97% 17.68%
Per Share Data
Net income, assuming dilution $ 1.07 $ 1.40 $ 1.27 $ 1.02 $ .83
Cash dividends declared $ .28 $ 0.23 $ .20 $ 0.18 $ 0.15
Book value $ 12.14 $ 11.49 $ 9.93 $ 8.98 $ 7.83
</TABLE>
- --------------------------------------------------------------------------------
2
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
Assets ---------------------------------
Cash and due from banks $ 5,937,686 $ 5,123,586
Federal funds sold 7,000,000 1,900,000
Securities, at approximate market value 42,474,916 43,907,871
Loans, net 109,422,041 102,099,056
Premises and equipment, net 5,247,605 3,448,318
Accrued interest receivable 1,346,616 1,300,062
Other assets 10,432,411 6,136,760
------------ ------------
Total assets $181,861,275 $163,915,653
============ ============
Liabilities and Shareholders' Equity
Deposits:
Demand accounts $ 23,830,189 $ 19,255,328
Savings and interest bearing demand deposits 55,718,469 40,445,981
Certificates of deposit
Denominations less than $100,000 69,582,581 72,128,426
Denominations of $100,000 or more 15,507,962 15,689,333
------------ ------------
Total deposits $164,639,201 $147,519,068
Short-term borrowings -- 1,250,000
Accrued interest payable 303,269 334,763
Other liabilities 1,115,825 897,147
Long-term debt 874,574 --
Commitments and contingent liabilities -- --
------------ ------------
Total liabilities $166,932,869 $150,000,978
------------ ------------
Shareholders' equity:
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
1,229,599 in 1998 and 1,010,888 in 1997 6,147,995 5,054,440
Common stock, nonvoting, par value $5 per share;
authorized 635,000 shares; no shares outstanding -- --
Paid-in capital 523,795 484,348
Retained earnings 8,082,349 8,047,310
Accumulated other comprehensive income 174,267 328,577
------------ ------------
Total shareholders' equity $ 14,928,406 $ 13,914,675
------------ ------------
Total liabilities and shareholders' equity $181,861,275 $163,915,653
============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
3
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Consolidated Statements of Income
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
--------------------------------------------
Interest Income
Interest and fees on loans $ 10,167,293 $ 9,038,054 $ 8,103,829
Interest on federal funds sold 88,899 58,076 40,281
Interest on time deposits with banks -- -- 18,431
Interest on securities available for sale
Taxable 1,854,898 1,636,219 1,428,063
Nontaxable 604,730 589,059 514,213
Dividends 47,049 40,060 37,118
------------ ------------ ------------
Total interest income $ 12,762,869 $ 11,361,468 $ 10,141,935
------------ ------------ ------------
Interest Expense
Savings and interest bearing accounts $ 1,237,949 $ 990,450 $ 1,001,072
Certificates of deposit
Denominations less than $100,000 3,932,247 3,503,931 2,922,308
Denominations of $100,000 or more 896,847 850,604 780,509
Short-term borrowings 36,630 62,454 24,764
Long-term debt 48,865 -- 26,026
------------ ------------ ------------
Total interest expense $ 6,152,538 $ 5,407,439 $ 4,754,679
------------ ------------ ------------
Net interest income $ 6,610,331 $ 5,954,029 $ 5,387,256
Provision for loan losses 620,000 75,000 150,000
------------ ------------ ------------
Net interest income after provision
for loan losses $ 5,990,331 $ 5,879,029 $ 5,237,256
------------ ------------ ------------
Noninterest Income
Trust income $ 1,042,136 $ 923,483 $ 818,888
Service charges 531,227 527,107 499,705
Net gain (loss) on other real estate owned (59,500) -- 12,788
(Loss) on securities available for sale -- (2,365) (1,593)
Other income 2,324,592 1,533,427 1,229,708
------------ ------------ ------------
Total noninterest income $ 3,838,455 $ 2,981,652 $ 2,559,496
------------ ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
4
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Consolidated Statements of Income (Continued)
Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996
------------------------------------
Noninterest Expenses
Salaries and benefits $3,529,694 $3,079,538 $2,840,262
Occupancy expenses 1,625,083 1,365,534 1,210,534
Other expenses 2,949,648 2,110,722 1,669,517
---------- ---------- ----------
Total noninterest expenses $8,104,425 $6,555,794 $5,720,313
---------- ---------- ----------
Income before income taxes $1,724,361 $2,304,887 $2,076,439
Income tax expense 335,628 554,378 501,303
---------- ---------- ----------
Net income $1,388,733 $1,750,509 $1,575,136
========== ========== ==========
Earnings per share, basic $ 1.13 $ 1.45 $ 1.29
========== ========== ==========
Earnings per share, assuming dilution $ 1.07 $ 1.40 $ 1.27
========== ========== ==========
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
5
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
---------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 1,388,733 $ 1,750,509 $ 1,575,136
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 657,339 575,598 472,537
Provision for loan losses 620,000 75,000 150,000
Deferred income tax expense (benefit) (302,046) 1,681 (66,298)
Amortization of premiums, net 738,887 217,385 251,642
Net loss on sale of bank premises -- 28,806 523
Loss on securities available for sale -- 2,365 1,593
Net (gain) loss on other real estate owned 59,500 -- (12,788)
Origination of loans available for sale (7,881,750) (4,251,450) (3,635,002)
Proceeds from sale of loans available for sale 8,005,750 4,033,450 3,635,002
Issuance of common stock for services 62,000 54,175 37,380
Changes in other assets and liabilities:
(Increase) in accrued interest receivable (46,554) (211,861) (3,399)
(Increase) decrease in other assets (937,928) (52,695) 47,067
Increase (decrease) in accrued interest
payable (31,494) 62,217 16,512
Increase (decrease) in other liabilities 218,678 (67,389) 200,752
-------------- ------------ ------------
Net cash provided by
operating activities $ 2,551,115 $ 2,217,791 $ 2,670,657
-------------- ------------ ------------
Cash Flows from Investing Activities
Net decrease in time deposits with banks $ -- $ -- $ 450,375
Purchases of securities available for sale (19,242,766) (18,499,317) (18,784,158)
Proceeds from sales and calls of securities
available for sale 970,207 7,217,090 9,216,346
Proceeds from maturities of securities
available for sale 18,725,164 5,458,072 8,501,663
Proceeds from sale of other real estate -- -- 35,905
Proceeds from sale of bank premises -- -- 600
Net (increase) in loans (8,066,985) (11,530,232) (9,563,173)
Net (increase) in cash management accounts (3,028,024) (1,887,724) (451,788)
Other capital expenditures (2,456,626) (684,660) (1,029,587)
-------------- ------------ ------------
Net cash (used in) investing activities $ (13,099,030) $(19,926,771) $(11,623,817)
-------------- ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
6
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
--------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of long-term debt $ 900,000 $ -- $ --
Net increase (decrease) in short-term borrowings (1,250,000) (750,000) 1,885,000
Net increase in demand accounts, interest-
bearing demand accounts and savings accounts 19,847,349 5,780,887 2,402,429
Net increase (decrease) in certificates of deposits (2,727,216) 14,108,616 6,539,824
Net proceeds from issuance of common stock 123,175 15,914 41,825
Acquisition of common stock (62,943) (36,754) (293,631)
Cash dividends (342,924) (282,933) (244,585)
Curtailment of long-term debt (25,426) -- (387,500)
------------ ------------ ------------
Net cash provided by financing
activities $ 16,462,015 $ 18,835,730 $ 9,943,362
------------ ------------ ------------
Net increase in cash and federal
funds sold $ 5,914,100 $ 1,126,750 $ 990,202
Cash and federal funds sold at beginning of year 7,023,586 5,896,836 4,906,634
------------ ------------ ------------
Cash and federal funds sold at end of year $ 12,937,686 $ 7,023,586 $ 5,896,836
============ ============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest $ 6,184,032 $ 5,345,222 $ 4,738,167
============ ============ ============
Income taxes $ 594,326 $ 479,719 $ 531,684
============ ============ ============
Supplemental Schedule of Noncash Investing and
Financing Activities
Sale of other real estate by issuance
of new loans $ -- $ -- $ 30,000
============ ============ ============
Unrealized gain (loss) on securities
available for sale $ (241,463) $ 613,324 $ (234,964)
============ ============ ============
Common stock issued for services $ 62,000 $ 54,175 $ 37,380
============ ============ ============
Common stock dividend $ 1,010,770 $ 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, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common Accumulated Other
Stock, Paid-In Retained Comprehensive Comprehensive
Voting Capital Earnings Income Income Total
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $ 4,275,685 $ 605,669 $ 6,087,708 $ 78,860
$ 11,047,922
Comprehensive income:
Net income -- -- 1,575,136 -- $ 1,575,136 1,575,136
Other comprehensive income:
Unrealized losses on securities
available for sale:
Unrealized holding losses
arising during the
period, net of deferred
income taxes of $80,430 -- -- -- -- (156,127) --
Add: reclassification
adjustment, net of
income taxes of $542 -- -- -- -- 1,051 --
------------
Other comprehensive income,
net of tax -- -- -- (155,076) $ (155,076) (155,076)
------------
Total comprehensive income -- -- -- -- $ 1,420,060 --
============
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 ($.20 per share) -- -- (244,585) -- (244,585)
------------ ---------- ------------ ---------- ------------
Balance, December 31, 1996 $ 4,198,435 $ 468,493 $ 7,418,259 $ (76,216) $ 12,008,971
Comprehensive income:
Net income -- -- 1,750,509 -- $ 1,750,509 1,750,509
Other comprehensive income:
Unrealized gains on securities
available for sale:
Unrealized holding gains
arising during the period,
net of deferred income
taxes of $207,727 -- -- -- -- 403,232 --
Add: reclassification
adjustment, net of
income taxes of $804 -- -- -- -- 1,561 --
------------
Other comprehensive income,
net of tax -- -- -- 404,793 $ 404,793 404,793
------------
Total comprehensive income -- -- -- -- $ 2,155,302 --
============
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 ($.23 per share) -- -- (282,933) -- (282,933)
Stock dividend 838,525 -- (838,525) -- --
---------- ---------- ----------- -------------
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>
1998 Annual Report
- --------------------------------------------------------------------------------
Consolidated Statements of Changes in Shareholders' Equity (Continued) Years
Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common Accumulated Other
Stock, Paid-In Retained Comprehensive Comprehensive
Voting Capital Earnings Income Income Total
-----------------------------------------------------------------------------------------
Balance, December 31, 1997
<S> <C> <C> <C> <C> <C>
(forwarded) $ 5,054,440 $ 484,348 $ 8,047,310 $ 328,577 $ 13,914,675
Comprehensive income:
Net income -- -- 1,388,733 -- $ 1,388,733 1,388,733
Other comprehensive income:
Unrealized holding losses on
securities available for sale,
net of deferred income
taxes of $79,493 -- -- -- (154,310) (154,310) (154,310)
------------
Total comprehensive income -- -- -- -- $ 1,234,423 --
============
Exercise of stock options 79,260 43,915 -- -- 123,175
Issuance of common stock
for services 18,950 43,050 -- -- 62,000
Acquisition of common stock (15,425) (47,518) -- -- (62,943)
Cash dividends ($.28 per share) -- -- (342,924) -- (342,924)
Stock dividend 1,010,770 -- (1,010,770) -- --
------------ ---------- ----------- ------------ ------------
Balance, December 31, 1998 $ 6,147,995 $ 523,795 $ 8,082,349 $ 174,267 $ 14,928,406
============ ========== =========== ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
9
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
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 Financial Group, 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 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, 1998 or 1997.
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, 1998 or 1997.
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.
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.
- --------------------------------------------------------------------------------
10
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
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,
1998 and 1997.
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 $185,000 and $245,000
of foreclosed properties in other assets at December 31, 1998 and 1997. No real
estate was acquired in settlement of loans during 1998 and 1997.
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.
- --------------------------------------------------------------------------------
11
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
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.
Comprehensive Income
As of January 1, 1998, CFS adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this statement had no impact on the
Corporation's net income or shareholders' equity. SFAS No. 130 requires other
comprehensive income to include unrealized gains and losses on investments in
securities classified as available for sale in accordance with SFAS No. 115,
foreign currency translation adjustments, and minimum pension liability
adjustments, which prior to adoption were reported separately in shareholders'
equity. The December 31, 1997 and December 31, 1996 financial statements have
been reclassified to conform to the requirements of SFAS No. 130.
Defined Benefit Plan
In 1998, CFS adopted Statement of Financial Accounting Standards No. 132,
"Employers' Disclosures About Pensions and Other Postretirement Benefits." This
pronouncement does not change the measurement or recognition of amounts
recognized in CFS's financial statements applicable to its defined benefit plan.
Statement No. 132 revises the existing disclosure requirements by standardizing
the disclosure requirements for pensions requiring certain additional
information on changes in the benefit obligations and fair values of plan
assets, and eliminating certain disclosures.
- --------------------------------------------------------------------------------
12
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 2. Securities
Amortized cost and fair values of securities available for sale as of
December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 500,187 $ 1,219 $ -- $ 501,406
U.S. Government agencies 28,546,182 38,175 (384,326) 28,200,031
Securities of state and
political subdivisions 12,329,706 602,780 (57) 12,932,429
Other 834,800 6,250 -- 841,050
------------ ------------ ------------ ------------
Total $ 42,210,875 $ 648,424 $ (384,383) $ 42,474,916
============ ============ ============ ============
1997
----------------------------------------------------------
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>
The amortized cost and fair value of securities available for sale as of
December 31, 1998, 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.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
-----------------------------------
<S> <C> <C>
Due in one year or less $ 3,160,167 $ 3,151,364
Due after one year through five years 18,921,397 18,788,151
Due after five years through ten years 6,676,325 6,560,277
Due after ten years 12,618,186 13,134,074
Other 834,800 841,050
------------- -------------
Total $ 42,210,875 $ 42,474,916
============= =============
</TABLE>
Proceeds from sales and calls of securities available for sale during
1998, 1997 and 1996 were $970,207, $7,217,090 and $9,216,346, respectively.
There were no realized gains or losses on sales and calls of securities during
1998. Gross gains of $22,319 and $37,526 and gross losses of $24,684 and $39,119
were realized on sales and calls of securities in 1997 and 1996, respectively.
The amortized cost of securities pledged to secure public deposits,
borrowings from the Federal Reserve Bank and fiduciary powers amounted to
$7,214,920 and $7,991,890, at December 31, 1998 and 1997, respectively.
13
- --------------------------------------------------------------------------------
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 3. Loans
Major classifications of loans are summarized as follows:
December 31,
-------------------------------
1998 1997
-------------------------------
Commercial $ 49,058,143 $ 43,370,353
Real estate-mortgage 33,003,161 38,945,983
Real estate-construction 5,468,068 2,900,402
Consumer 21,378,419 16,267,812
Participations with other banks 1,610,393 1,945,360
Other 927,609 409,225
------------ ------------
Loans, gross $111,445,793 $103,839,121
Less reserve for loan losses 2,023,752 1,740,065
------------ ------------
Loans, net $109,422,041 $102,099,056
============ ============
Participations with other banks are secured by residential property.
Nonaccrual loans excluded from impaired loan disclosure under FASB No. 114
amounted to $202,434 and $581,048 at December 31, 1998 and 1997, respectively.
If interest on these loans had been accrued, such income would have approximated
$11,502 and $37,604 at December 31, 1998 and 1997, respectively.
Changes in the reserve for loan losses are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
<S> <C> <C> <C>
1998 1997 1996
-------------------------------------------------
Balance at beginning of year $ 1,740,065 $ 1,652,844 $ 1,463,181
Provision for loan losses 620,000 75,000 150,000
Loans charged off (355,637) (41,956) (157,448)
Recoveries on loans
previously charged off 19,324 54,177 197,111
----------- ------------ -----------
Balance at end of year $ 2,023,752 $ 1,740,065 $ 1,652,844
=========== ============ ===========
</TABLE>
Note 4. Premises and Equipment
Major classifications of premises and equipment are summarized as follows:
December 31,
------------------------------------
1998 1997
------------------------------------
Land $ 762,335 $ 553,135
Buildings 3,795,886 2,432,575
Furniture, fixtures and improvements 1,001,452 819,849
Mechanical equipment 3,246,239 2,648,085
Leasehold improvements 762,001 759,033
------------- -------------
$ 9,567,913 $ 7,212,677
Less accumulated depreciation 4,320,308 3,764,359
------------- -------------
$ 5,247,605 $ 3,448,318
============= =============
For the years ended December 31, 1998, 1997 and 1996, depreciation expense
was $657,339, $491,598 and $388,537, respectively.
- --------------------------------------------------------------------------------
14
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 5. Note Payable
The Bank has unsecured lines of credit with correspondent banks totaling
$10,300,000 available for overnight borrowing. The Bank also has a line of
credit secured by mortgage loans totaling $13,000,000 available for long or
short-term borrowing. There were no amounts drawn on these lines of credit at
December 31, 1998.
CFS's fixed-rate long-term debt of $874,574 at December 31, 1998 matures
through 2018. The long-term debt is secured by a deed of trust on property
located in Lancaster County, Virginia. Aggregate maturities during the next five
years are: 1999, $24,566; 2000, $28,246; 2001, $29,840; 2002, $31,523; and 2003,
$33,301.
Note 6. Income Taxes
Net deferred tax assets consist of the following components as of December
31, 1998 and 1997:
1998 1997
-----------------------------------
Deferred tax assets:
Reserve for loan losses $ 615,878 $ 389,778
Deferred compensation 130,108 110,071
Accrued pension expense 106,686 82,452
Intangible assets 56,439 80,489
Other 51,144 20,373
----------- ------------
$ 960,255 $ 683,163
=========== ============
Deferred tax liabilities:
Securities available for sale $ 89,774 $ 160,134
Accumulated discount accretion 4,576 2,948
Premises and equipment 154,619 181,201
----------- ------------
$ 248,969 $ 344,283
----------- ------------
$ 711,286 $ 338,880
=========== ============
The provision for income taxes charged to operations for the years ended
December 31, 1998, 1997 and 1996, consists of the following:
1998 1997 1996
--------------------------------------------
Current tax expense $ 637,674 $ 552,697 $ 567,601
Deferred tax expense (benefit) (302,046) 1,681 (66,298)
----------- ---------- ----------
$ 335,628 $ 554,378 $ 501,303
=========== ========== ==========
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, 1998, 1997 and 1996, due to the following:
1998 1997 1996
----------------------------------------
Computed "expected" tax expense $ 586,283 $ 783,662 $ 705,989
Increase (decrease) in income taxes
resulting from:
Tax exempt interest income (242,660) (204,598) (203,087)
Other (7,995) (24,686) (1,599)
---------- ---------- ---------
$ 335,628 $ 554,378 $ 501,303
========== ========== =========
15
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 7. 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 tables provide a reconciliation of the changes in the plan's
benefit obligations and fair value of assets over the two-year period ending
December 31, 1998 and 1997, computed as of October 1, 1998 and 1997,
respectively:
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
-----------------------------------
Change in Benefit Obligation
Benefit obligation, beginning $ 1,577,250 $ 1,311,102
Service cost 121,141 105,702
Interest cost 117,913 97,952
Actuarial loss 132,795 81,391
Benefits paid (756,407) (18,897)
------------- --------------
Benefit obligation, ending $ 1,192,692 $ 1,577,250
============= ==============
Change in Plan Assets
Fair value of plan assets, beginning $ 1,770,008 $ 1,255,666
Actual return on plan assets (5,716) 287,179
Employer contributions -- 246,060
Benefits paid (756,407) (18,897)
------------- --------------
Fair value of plan assets, ending $ 1,007,885 $ 1,770,008
============= ==============
Funded Status
Unrecognized net actual gain $ (184,807) $ 192,758
Unrecognized net obligation at transition (207,851) (520,835)
Unrecognized prior service cost 44,764 48,834
Accrued benefit cost included in other liabilities 34,113 36,737
------------- --------------
$ (313,781) $ (242,506)
============= ==============
The following table provides the components of net periodic benefit cost
for the plans for the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996
-----------------------------------------------------
Components of Net Periodic Benefit Cost
Service cost $ 121,141 $ 105,702 $ 102,467
Interest cost 117,913 97,952 88,547
Expected return on plan assets (158,844) (112,553) (91,671)
Amortization of prior service cost 2,624 2,624 2,624
Amortization of net obligation at transition 4,070 4,070 4,070
Recognized net actuarial (loss) (15,629) (14,119) (12,684)
------------- ------------ ------------
Net periodic benefit cost $ 71,275 $ 83,676 $ 93,353
============= ============ ============
</TABLE>
The assumptions used in the measurement of the Company's benefit obligation are
shown in the following table:
1998 1997 1996
------------------------------
Weighted-Average Assumptions
Discount rate 7.50% 7.50% 7.50%
Expected return on plan assets 9.00% 9.00% 9.00%
Rate of compensation increase 5.00% 6.00% 6.00%
- --------------------------------------------------------------------------------
16
<PAGE>
1998 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 $19,993, $20,000 and $19,992 in
1998, 1997 and 1996, 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 $28,916, $25,590 and $20,381
for 1998, 1997 and 1996.
Note 8. Stock Option Plan
CFS had a stock option plan in which options for 172,800 shares of voting
common stock and 112,500 shares of nonvoting common stock were 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 owned more than 10% of the
stock of CFS, the option price was at least 110% of the fair market value on the
date of grant. Such options were generally not exercisable until after three
years from the date of issuance and required 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.
A summary of the status of the expired plan at December 31, 1998, 1997 and
1996 and the changes during the years ended on those dates is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
----------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------------------------------------------------------------------------------------
Outstanding at beginning
of year 89,460 $ 7.66 90,900 $ 7.02 96,768 $ 7.02
Options exercised (16,452) 7.49 (1,440) 6.08 (5,868) 7.13
-------- ------- -------
Outstanding at end of year 73,008 6.92 89,460 7.66 90,900 7.02
======== ======= =======
Options exercisable,
end of year 73,008 64,260 41,220
</TABLE>
- --------------------------------------------------------------------------------
17
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
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 64,800 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, 1998, 1997 and
1996 and the changes during the years ended on those dates are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
-------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------------------------------------------------------------------------
Outstanding at beginning
of year 25,920 $ 9.77 13,680 $ 9.41 -- $ --
Options granted 12,000 17.07 12,240 10.16 13,680 9.41
------ ------ ------
Outstanding at end of year 37,920 12.08 25,920 9.77 13,680 9.41
====== ====== ======
Options exercisable, end
of year -- -- --
Options available for grant,
end of year 26,880 38,880 51,120
The status of the options outstanding at December 31, 1998 is as follows:
Options Outstanding Options Exercisable
---------------------------------- -----------------------------
Weighted Weighted
Remaining Range of Average Average
Contractual Exercise Number Exercise Number Exercise
Life Price Outstanding Price Exercisable Price
- ----------------------------------------------------------------------------------------------------------------------------------
0.3 $6.68 to 6.94 19,728 $ 6.83 19,728 6.83
1.3 $6.94 to 7.64 12,960 7.41 12,960 7.41
2.3 $6.08 to 6.85 16,560 6.18 16,560 6.18
3.3 $6.94 to 7.64 23,760 7.26 23,760 7.26
4.3 $9.03 to 18.33 16,560 10.96 -- --
5.3 $9.93 to 16.67 13,320 10.69 -- --
6.3 $16.67 8,040 16.67 -- --
</TABLE>
CFS applies APB Opinion 25 in accounting for its stock option plans,
accordingly no compensation expense has been recognized for 1998, 1997 and 1996.
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.
- --------------------------------------------------------------------------------
18
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 9. Shareholders' Equity
During 1998, 1997 and 1996, CFS issued 3,790 shares, 4,334 shares and
3,115 shares, respectively, of common stock to its Directors for partial
compensation.
Note 10. Commitments and contingencies
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, 1998 are as follows:
Year Ending
December 31,
-----------------------
1999 $ 95,664
2000 63,264
2001 15,864
2002 7,088
2003 2,700
Rent expense under operating leases aggregated $142,610, $129,130 and
$129,707 for the years ended December 31, 1998, 1997 and 1996, respectively.
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, 1998 and 1997, the aggregate amounts of daily
average required balances were approximately $2,492,000 and $1,206,000 for both
periods.
CFS utilizes and is dependent upon data processing systems and software,
generally referred to as Information Technology or IT, to conduct its business.
The IT systems include a mainframe processing system licensed to the Bank by an
outside vendor and various purchased software packages which are run on in-house
computers and computer networks. Non-IT systems include most other equipment and
machinery, such as elevators and thermostats, that may have microcontrollers.
In 1997, the Company initiated a review and assessment of all IT and
non-IT systems to confirm that they will function properly in the year 2000. The
Bank has successfully completed three reviews by regulatory authorities
assessing progress toward year 2000 compliance. While management believes that
it is taking the necessary steps to resolve its year 2000 issues in a timely
manner, there can be no assurances that there will be no year 2000 problems. At
present, management does not expect that any such problems will have a material
adverse effect on its business.
Note 11. Related Party Transactions
Officers, Directors and their affiliates had borrowings of $5,967,946 and
$5,679,221 at December 31, 1998 and 1997, respectively, with the Bank.
Changes in borrowings during 1998 were as follows:
Balance, December 31, 1997 $5,679,221
Additions 791,599
Payments (502,874)
----------
Balance, December 31, 1998 $5,967,946
==========
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.
- --------------------------------------------------------------------------------
19
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 12. Other Income and Expenses
The principal components of "Other Income" in the consolidated statements
of income are:
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------------------------------------------
<S> <C> <C> <C>
Cash management fees and discount $ 954,505 $ 598,003 $ 381,985
FHLMC servicing fee income 118,601 121,534 130,871
Merchant discount 656,190 369,441 204,438
ATM fee income 181,960 199,329 149,241
Other (includes no items in
excess of 1% of total revenue) 413,336 245,120 363,173
-------------- ------------- -------------
$ 2,324,592 $ 1,533,427 $ 1,229,708
============== ============= =============
</TABLE>
The principal components of "Other Expenses" in the consolidated
statements of income are:
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------------------------------------------
<S> <C> <C> <C>
Advertising $ 225,829 $ 211,136 $ 135,468
Merchant card 668,407 368,320 211,815
Cash management royalties 189,887 138,615 91,386
Check card losses 297,102 -- --
Other (includes no items in
excess of 1% of total revenue) 1,568,423 1,392,651 1,230,848
-------------- ------------- -------------
$ 2,949,648 $ 2,110,722 $ 1,669,517
============== ============= =============
</TABLE>
Note 13. 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 did not have a significant impact on
net income. The number of shares used in the calculations for 1997 and 1996
reflect a 20% stock dividend paid on October 15, 1997 and a 20% stock dividend
paid on October 15, 1998.
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------------------------
<S> <C> <C> <C>
Weighted average number
of common shares, basic 1,224,531 1,208,310 1,218,444
Effect of dilutive stock options 68,078 43,159 24,901
---------- ---------- ----------
Weighted number of common shares
and dilutive potential common stock
used in diluted EPS 1,292,609 1,251,469 1,243,345
========= ========= =========
</TABLE>
Note 14. Time Deposits
Remaining maturities on certificates of deposit are as follows:
1999 $ 65,691,040
2000 10,977,518
2001 4,553,109
2002 128,953
2003 and thereafter 3,739,923
---------------
$ 85,090,543
===============
- --------------------------------------------------------------------------------
20
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 15. 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, 1998, the Corporation's total commitments to extend
credit and standby letters of credit were $27,300,202 and $1,063,440,
respectively. 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. 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 counterparty. 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, Williamsburg 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.
The Corporation maintains its cash accounts in several correspondent
banks. The total amount by which cash on deposit in those banks exceeds the
federally insured limits is approximately $96,166 at December 31, 1998.
Note 16. 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.
- --------------------------------------------------------------------------------
21
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
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 counterparties at the reporting date.
At December 31, 1998 and 1997, the carrying amounts and fair values of
loan commitments and stand-by letters of credit were deemed immaterial.
The estimated fair values of CFS's financial instruments are as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------- ---------------------------------------
Carrying Fair Carrying Fair
(In Thousands) Amount Value Amount Value
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and short-term
investments $ 12,938 $ 12,938 $ 7,024 $ 7,024
Securities 42,475 42,475 43,908 43,908
Loans 109,422 110,071 102,099 102,044
---------- ------------ ----------- ------------
Total financial assets $ 164,835 $ 165,484 $ 153,031 $ 152,976
========== ============ =========== ============
Financial liabilities:
Deposits $ 164,639 $ 165,008 $ 147,519 $ 148,174
Short-term borrowings -- -- 1,250 1,250
Long-term debt 875 601 -- --
---------- ------------ ----------- ------------
Total financial liabilities $ 165,514 $ 165,609 $ 148,769 $ 149,424
========== ============ =========== ============
</TABLE>
Note 17. 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, 1998, that the Corporation meets all capital
adequacy requirements to which it is subject.
- --------------------------------------------------------------------------------
22
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
As of December 31, 1998, 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.
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 in Thousands) Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 16,387 12.6% (> or =)$10,413 (> or =) 8.0% N/A
Chesapeake Bank $ 15,436 12.0% (> or =)$10,340 (> or =) 8.0% (> or =)$12,924 (> or =) 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 14,754 11.3% (> or =)$ 5,207 (> or =) 4.0% N/A
Chesapeake Bank $ 13,820 10.7% (> or =)$ 5,170 (> or =) 4.0% (> or =)$ 7,755 (> or =) 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 14,754 8.4% (> or =)$ 7,029 (> or =)4.0% N/A
Chesapeake Bank $ 13,820 7.9% (> or =)$ 6,966 (> or =) 4.0% (> or =)$ 8,707 (> or =) 5.0%
As of December 31, 1997:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 14,999 13.5% (> or =)$ 8,903 (> or =) 8.0% N/A
Chesapeake Bank $ 13,057 11.8% (> or =)$ 8,879 (> or =) 8.0% (> or =)$11,098 (> or =) 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 13,602 12.2% (> or =)$ 4,452 (> or =) 4.0% N/A
Chesapeake Bank $ 11,665 10.5% (> or =)$ 4,440 (> or =) 4.0% (> or =)$ 6,659 (> or =) 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 13,602 8.5% (> or =)$ 6,392 (> or =) 4.0% N/A
Chesapeake Bank $ 11,665 7.4% (> or =)$ 6,317 (> or =) 4.0% (> or =) $7,896 (> or =) 5.0%
</TABLE>
- --------------------------------------------------------------------------------
23
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 18. 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 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. As of December 31, 1998, the amount available for payment of additional
dividends without prior regulatory approval from the Bank to the parent company
is $1,851,278 or 12.4% of consolidated net assets.
Balance Sheets (Condensed)
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------
1998 1997
--------------------------------------------------
<S> <C> <C>
Assets
Cash $ 408,701 $ 366,397
Securities 550,052 1,534,706
Investment in subsidiaries 13,982,051 11,987,491
Premises and equipment, net 860,377 --
Other assets 30,132 36,081
--------------- ---------------
Total assets $ 15,831,313 $ 13,924,675
=============== ===============
Liabilities and Shareholders' Equity
Long-term debt $ 874,574 $ --
Other liabilities 28,333 10,000
Shareholders' equity 14,928,406 13,914,675
--------------- ---------------
Total liabilities and shareholders' equity $ 15,831,313 $ 13,924,675
=============== ===============
</TABLE>
- --------------------------------------------------------------------------------
24
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Statements of Income (Condensed)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------
<S> <C> <C> <C>
Income - Dividends - Bank $ 325,000 $ 930,000 $ 1,800,000
Other 151,088 87,830 21,858
-------------- ------------- -------------
Total income $ 476,088 $ 1,017,830 $ 1,821,858
-------------- ------------- -------------
Expenses - Interest expense $ 48,865 $ -- $ 26,026
Other expenses 206,692 144,747 103,912
-------------- ------------- -------------
Total expenses $ 255,557 $ 144,747 $ 129,938
-------------- ------------- -------------
Income before income taxes and
equity in undistributed earnings
of subsidiaries $ 220,531 $ 873,083 $ 1,691,920
Allocated income tax benefit 30,856 25,552 21,158
-------------- ------------- -------------
Income before equity in
undistributed earnings of subsidiaries $ 251,387 $ 898,635 $ 1,713,078
Equity (deficit) in undistributed
earnings of subsidiaries 1,137,346 851,874 (137,942)
-------------- ------------- -------------
Net income $ 1,388,733 $ 1,750,509 $ 1,575,136
============== ============= =============
</TABLE>
- --------------------------------------------------------------------------------
25
<PAGE>
Chesapeake Financial Shares, Inc.
Notes to Consolidated Financial Statements
Statements of Cash Flows (Condensed)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 1,388,733 $ 1,750,509 $ 1,575,136
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation 39,623 -- --
Equity (deficit) in undistributed earnings
of subsidiaries (1,137,346) (851,874) 137,942
Issuance of common stock for services 62,000 54,175 37,380
Amortization of premium (3,742) (2,960) 144
Changes in other assets and liabilities:
(Increase) decrease in other assets 12,133 (10,025) (10,847)
Increase (decrease) in other liabilities 18,333 6,000 (9,624)
-------------- ------------- --------------
Net cash provided by operating
activities $ 379,734 $ 945,825 $ 1,730,131
-------------- ------------- --------------
Cash Flows from Investing Activities
Purchase of investment securities $ -- $ (574,284) $ (907,718)
Proceeds from maturities of
investment securities -- 100,000 200,625
Purchases of premises and equipment (900,000) -- --
Investment in subsidiary (29,312) -- --
-------------- ------------- --------------
Net cash (used in) investing
activities $ (929,312) $ (474,284) $ (707,093)
-------------- ------------- --------------
Cash Flows from Financing Activities
Dividends paid $ (342,924) $ (282,933) $ (244,585)
Proceeds from issuance of long-term debt 900,000 -- --
Curtailment of note payable (25,426) -- (387,500)
Acquisitions of common stock (62,943) (36,754) (293,631)
Net proceeds from issuance of common stock 123,175 15,914 41,825
-------------- ------------- --------------
Net cash provided by (used in)
financing activities $ 591,882 $ (303,773) $ (883,891)
-------------- ------------- --------------
Net increase in cash $ 42,304 $ 167,768 $ 139,147
Cash at beginning of year 366,397 198,629 59,482
-------------- ------------- --------------
Cash at end of year $ 408,701 $ 366,397 $ 198,629
============== ============= ==============
Supplemental Disclosure of Noncash Investing
Activities, contribution of securities to capital
of a subsidiary bank $ 970,207 $ -- $ --
============== ============= ==============
</TABLE>
- --------------------------------------------------------------------------------
26
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
(YHB 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, 1998 and 1997, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flows for the years ended December 31, 1998, 1997 and 1996. 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, 1998 and 1997, and
the results of its operations and its cash flows for the years ended December
31, 1998, 1997 and 1996, in conformity with generally accepted accounting
principles.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 15, 1999
- --------------------------------------------------------------------------------
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 Financial'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 were 20% stock splits effective October 15, 1997, and October 15,
1998. All per share information has been adjusted accordingly.
Financial Condition
On December 31, 1998, Chesapeake Financial Shares, Inc. (CFS) had total
assets of $181.9 million, representing a 10.9% increase over the December 31,
1997 balance of $163.9 million, which followed an increase of 10.8% from total
assets of $142.9 on December 31, 1996. The Company had gross total loans of
$111.4 million, total deposits of $164.6 million and total shareholder's equity
of $14.4 million on December 31, 1998. The return on average equity in 1998 was
9.6% and return on average assets was 0.81% compared to 13.6% and 1.18%,
respectively, in 1997 (see "Summary of Results of Operations").
In June of 1998, CFS opened a new regional office in Williamsburg and in
October, consolidated the two operation support areas in a newly remodeled
Operations Center in Kilmarnock. The Bank now operates ten banking offices. At
year end, the Company opened Chesapeake Financial Group, Inc., a wholly owned
subsidiary of the Company offering comprehensive, individualized, portfolio
management services. New interest bearing products were introduced through the
Bank to fulfill customer needs for the new millennium and CFS initiated programs
to ensure compliance with Year 2000 standards by June of 1999. Simultaneously
with the Year 2000 effort, management built a technology infrastructure to
position the Company to maintain and further develop the competitive advantage
available to a community bank.
Loan growth reached record highs during 1998 and the average annual loan
growth rate for the last five years has exceeded 10.0%. Asset quality was
maintained during this growth period with past due loans at record lows and the
reserve for loan loss remained at adequate levels. The Bank maintained its "well
capitalized" status, the highest ranking available from the Federal Deposit
Insurance Corporation.
Summary of Results of Operations
Earnings for 1998 were $1,388,733 or $1.07 per share (fully diluted)
compared to $1,750,509 or $1.40 per share in 1997, a decrease of 23.6% or
$361,776. The results of operations would have exceeded the prior year's
performance except for two non-recurring events. The Company wrote off $297,102
or $0.15 per share, based on a series of disputed international electronic
transactions involving VISA International. The Company also added $410,000 or
$0.21 per share, to the provision for loan losses to provide for a specific
loan, which was classified as "doubtful." Precautions were taken to prevent the
recurrence of these two unique events.
Net interest income during 1998 increased $656,302 or 11.0% over the
$5,954.029 reported in 1997. Noninterest income increased to $3,838,455 in 1998,
up 28.7% over the 1997 level of $2,981,652. All noninterest income items
exceeded 1997 results, except for ATM fee income and FHLMC servicing fee income.
Cash management fee income was up 59.6% or $356,502, merchant card income was up
77.6% or $286,749 and trust fee income was up 12.9% or $118,653. Other
noninterest income was up 68.8% or $168,216, due in part to increased fee income
from annuity sales and other nondeposit investment products. FHLMC servicing
income was down 2.4% or $2,933 from 1997. Total noninterest expenses for 1998
were $8,104,425, up 23.6% over the 1997 total of $6,555,794.
Earnings for 1997 of $1,750,509 or $1.40 (fully diluted) compared to
$1,575,136 or $1.27 per share in 1996 completed a three year string of double
digit earnings growth. The 11.1% increase in net income resulted primarily from
a 10.5% increase or $566,773 in net interest income. 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 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 $50,087. Other income was down 32.5% or
$118,053 due to a one time recovery in 1996. FHLMC servicing income was down
7.13% or $9,337 from 1996. Total noninterest expenses for 1997 were $6,555,794,
up 14.6% over the 1996 total of $5,720,313.
- --------------------------------------------------------------------------------
28
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
In 1996 earnings were $1,575,136 or $1.27 compared to $1,264,702 or $1.02
per share in 1995. 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.
Most noninterest income items were up for 1996, with trust income up 12.4%, cash
management income up 47.6%, and ATM income up 160.7%. Net interest income
increased to $5,387,256 in 1996, up 7.7% over the 1995 level of $4,999,818.
Assets: Loan Portfolio
The net loan portfolio totaled $109.4, $102.1, and $90.4 million for 1998,
1997, and 1996, respectively, representing an increase of 7.2% for 1998 from
1997, 12.9% for 1997 from 1996, and 11.6% for 1996 from 1995. All loan
categories except real estate - mortgage and participations were up during 1998.
Consumer loans increased 31.4% or $5.1 million for 1998 over 1997 levels of
$16.3 million. Participations with other banks decreased $0.3 million or 17.2%
and real estate construction loans increased 88.5% or $2.6 million during 1998.
Real estate - mortgage loans were down 15.3% or $5.9 million. The real estate -
mortgage totals are not indicative of the volume of loans processed during the
year. Over $35.7 million in real estate related loans were closed. Of this total
$27.0 million were sold in the secondary market. Commercial loans increased
13.1% or $5.7 million.
On December 31, 1998, the loan portfolio consisted of 44.0% of commercial
loans and 34.5% of single family residential and residential construction 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 4.9% 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,
the 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 $747,916
at December 31, 1998, representing no substantial change from $791,344 million
from December 31, 1997. Past due loans were 0.7% of total loans at December 31,
1998, the lowest in the Bank's recent history.
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 risk adverseness of the loan portfolio.
The 1998 provision of $620,000 brought the net reserve for loan losses to
$2,023,752 or 1.82% of gross loans. There was a provision of $75,000 in 1997
compared to the 1996 provision of $150,000. Management and the Board of
Directors believe that 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 1.82% on December 31, 1998, 1.72% in
1997 and 1.80% in 1996. Loan charge offs totaled $335,637 in 1998, $41,956 in
1997, and $157,448 in 1996. Recoveries for the same periods were $19,324,
$54,177, and $197,111, respectively.
The Bank maintains a reserve for loan loss which management believes
represents a conservative estimate of potential losses inherent 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 of 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 a potential loss. The status of
nonaccrual and past due loans varies from quarter to quarter based on
seasonality, local economic conditions, and cash flow of customers.
- --------------------------------------------------------------------------------
29
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
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. Management intends to schedule a similar review
33 during 1999.
Investment Securities
- ---------------------
At year end, total securities and time deposits with other banks were
$42.5 million, down 3.3% from the $43.9 million on December 31, 1997, which was
up 16.5% from $37.7 million on December 31, 1996. 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 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, 1998, securities available for sale totaled $42.5 million
and at December 31, 1997 the total was $43.9 million. Fair market value of the
portfolio exceeded book value by $174,267 and $328,577, net of the tax effect,
at December 31, 1998 and 1997, respectively. This is within risk limits
established by the Board and the Asset/Liability Management Committee.
The securities portfolio decreased 3.3% or $1.4 million in 1998, following
an increase of 16.5% or $6.2 million in 1997 over 1996. U. S. Government
Agencies decreased 4.5% or $1.3 million during 1998. Investments in state and
political subdivisions increased 8.4% or $1.0 million during 1998. Investments
in U.S. Treasury issues decreased $1.2 million or 70.5% from 1997, which
decreased $1.3 million, or 44.2% from 1996. Management increased the investment
in securities of state and political subdivisions to utilize the tax free
income. Management has also changed the investment strategy to increase the
mortgage-backed securities portfolio. This long term strategy is expected to
increase current income and improve the total return of the overall portfolio
without assuming amounts of risk greater than limits established and monitored
by the Board.
Liabilities: Deposits
- ----------------------
Deposits totaled $164.6, $147.5, and $127.6 million for 1998, 1997, and
1996, respectively, representing an increase of 11.6% for 1998 from 1997 and an
increase of 15.6% for 1997 from 1996. There was a 3.1% decrease in certificates
of deposit. Noninterest bearing deposits increased to $4.6 million or 23.8% from
$19.3 million on December 31, 1997 and savings balances increased during 1998 by
37.8% or $15.3 million to $55.7 million. This is a reverse of the prior year's
reported results when most deposit growth resulted in increases in certificates
of deposit. Marketing and sales efforts have focused on growing these deposit
categories and that strategy will be continued.
Shareholders' Equity
- --------------------
Future growth and expansion of the Company is dictated by the ability to
produce capital, which is generated principally by the earnings of the Bank. As
of December 31, 1998, the Company's primary capital to asset ratio was 9.2%. 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 also have 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. Tier 1 capital to risk weighted assets and Tier 1
capital to average assets (called leveraged capital) must be 4%. On December 31,
1998, the Company had ratios of Tier 1 risk based capital to risk weighted
assets of 11.3%, total risk based capital to risk weighted assets of 12.6%, and
Tier 1 leverage capital of 8.4%. At December 31, 1997, these ratios were 12.2%,
13.5% and 8.5%, respectively, well above the regulatory minimums and exceed the
minimums for the "well capitalized" designation.
- --------------------------------------------------------------------------------
30
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
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 $0.28 per share in 1998, an increase of
$0.05 over 1997. This increase followed another $0.03 per share dividend
increase from $0.20 in 1996 to $0.23 in 1997.
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 1997 from $10.59 to $16.67, and during
1998, from $16.67 to $22.91. Such transactions may not be representative of all
transactions during the indicated periods 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, 1998, there were 1,229,599 shares of
Company's common stock outstanding held by approximately 451 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, and 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 other banks, and securities maturing or
repricing within one year. On December 31, 1998, approximately 36.2% of the
total invested portfolio dollars mature within one year as compared to 26.4% on
December 31, 1997. The Bank's loan portfolio enhances the liquidity position
with 50.9% of all loan dollars maturing or repricing within one year. This loan
liquidity ratio was 57.6% on December 31, 1998. 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 turning of these
assets, seldom do these loans represent more than 1% of total assets.
Bank management maintains overnight borrowing relationships with
correspondent banks for up to $10,300,000, unsecured. The Bank has other
borrowing relationships for up to $13,000,000, secured.
As of December 31, 1998, the Bank had $185,000 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 that 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.
- --------------------------------------------------------------------------------
31
<PAGE>
Chesapeake Financial Shares, Inc.
- --------------------------------------------------------------------------------
Net Interest Income
- -------------------
The principal source of earnings for CFS 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.
Net interest income totaled $6.6, $6.0, and $5.4 million for 1998, 1997,
and 1996, respectively, representing an increase of 11.0% for 1998 over 1997,
10.5% for 1997 over 1996, and 7.7% for 1996 over 1995. Loan demand was strong
again this year with gross total loans up 7.3% or $7.6 million for 1998 over
1997. Total interest expense was $6.2, $5.4, and $4.8 million for 1998, 1997 and
1996, respectively. On a tax equivalent annualized basis, the net interest
margin was 4.5%, 4.6% and 4.6% for 1998, 1997 and 1996, respectively.
Noninterest Income
- ------------------
For the year ended December 31, 1998, noninterest income was $3.8 million,
a 28.7% increase over the 1997 amount of $3.0 million, which was a 16.5%
increase over the 1996 amount of $2.6 million. The increase in 1998 was due to a
59.6% or $356,502 increase in our cash management service, and an increase of
$286,749 or 77.6% in merchant card income. Trust income was also up 12.9% or
$118,653, and ATM income was down 8.7% or $17,369. Other income was up 68.6% or
$168,216 from the same period in 1997.
Merchant card 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 23.6% or $1,548,631 in 1998 over
1997. In 1997, total noninterest expenses increased 14.6% over 1996 and
increased 6.9% in 1996 over 1995. The 1998 increase was due primarily to a 39.7%
or $838,926 increase in other expenses. The principal components of other
expenses include: merchant card expenses which were up 81.5% or $300,087, over
the 1997 amount of $368,320; the check card loss of $297,102; miscellaneous
expenses which were up 12.6% or $175,772 over the 1997 amount of $1,392,651;
cash management expenses which were up 37.0% or $51,272 over the 1997 amount of
$138,615; and advertising expenses which were up 7.0% or $14,693 over the 1997
amount of $211,136.
Salaries and benefits were up 14.6%, or $450,156, over 1997 levels of
$3,079,538. This increase was due to additional staffing for the Williamsburg
office opened in June, performance incentives, and cost of living increases.
Total occupancy expenses increased 19.0% or $259,549 compared to 1997, which was
up 12.8%, or $155,000 from the 1996 level of $1,210,534.
Chesapeake Financial Shares, Inc. chartered Chesapeake Financial Group,
Inc. (CFG) in August of 1998. CFG has established unique partnerships with
premier investment managers to offer high net worth individuals and institutions
superior portfolio management coupled with highly customized service.
Other accomplishments in 1998 include the opening of the Lafayette Street
Financial Services Center in Williamsburg and the move of two support groups
into a single Operations Center on School Street in Kilmarnock. These two events
were significant additions to job descriptions of the employees involved, during
a year of unprecedented loan growth. The staff also finished an upgrade of the
entire technology backbone of the Company and a complete review of hardware and
software for Year 2000 compliance. Two new products were introduced, Business
Cash Management for the commercial customer and ChesVest Preferred for the
consumer.
- --------------------------------------------------------------------------------
32
<PAGE>
1998 Annual Report
- --------------------------------------------------------------------------------
Year 2000 Readiness Disclosure
- ------------------------------
Chesapeake Financial Shares, Inc. utilizes and is dependent upon data
processing systems and software, generally referred to as Information Technology
or IT, to conduct its business. The IT systems include a mainframe processing
system licensed to the Bank by an outside vendor and various purchased software
packages which are run on in-house computers and computer networks. Non-IT
systems include most other equipment and machinery, such as elevators and
thermostats, that may have microcontrollers.
Many currently installed IT systems are programmed to assume that the
century portion of a date was "19" to conserve the use of storage and memory.
This assumption resulted in the use of two digits (rather than four) to define
the applicable year. Accordingly, computer systems that rely on two digits to
define an applicable year may recognize a date using "00" as the year 1900,
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process or transmit data or engage in normal
business activities.
In 1997, the Company initiated a review and assessment of all IT and
non-IT systems to confirm that they will function properly in the Year 2000. The
Bank successfully completed three reviews by regulatory authorities assessing
progress toward Year 2000 compliance. To date, the incremental costs of the
Company's Year 2000 remediation program have been approximately $65,000.
Approximately 20% of these costs were incurred in 1997 and approximately 80%
were incurred in 1998. The Company estimates that expenditures in 1999 will
total $ 25,000 and are expected to relate primarily to testing, contingency
planning and internal certification.
For computer systems that it has determined to be most critical, CFS
expects to complete development, test, and adopt business contingency plans by
June 30, 1999. These plans will conform to recently issued guidance from the
FFIEC on business contingency planning for Year 2000 readiness. Contingency
plans will include, among other actions, manual workarounds and identification
of resource requirements and alternative solutions for resuming critical
business processes in the event of a Year 2000 related failure. While management
believes that it is taking the necessary steps to resolve its Year 2000 issues
in a timely manner, there can be no guarantees that there will be no Year 2000
problems. At present, management does not expect that any such problems will
have a material adverse effect on its business.
Forward-Looking Statements:
- ---------------------------
The foregoing discussion may contain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act with respect to the
plans, objectives, future performance and business of the Company. These
forward-looking statements involve certain risks and uncertainties. Factors that
may cause actual results to differ materially from those contemplated by such
forward-looking statements include, among others, the following possibilities:
(1) competitive pressure in the banking industry increases significantly; (2)
changes in the interest rate environment reduce margins; (3) general economic
conditions, either nationally or regionally, are less favorable than expected,
resulting in, among other things, a deterioration in credit quality; (4) changes
occur in the regulatory environment; (5) changes occur in business conditions,
impacting, among others, the Company's customers and vendors; and (6) changes
occur in the securities market.
- --------------------------------------------------------------------------------
33
<PAGE>
(CHESAPEAKE FINANCIAL SHARES, INC. LOGO)
Chesapeake Financial Shares, Inc. - Directors
- --------------------------------------------------------------------------------
Douglas D. Monroe, Jr.
Chairman of the Board
Chief Executive Officer
Eugene S. Hudnall, Jr.
Chairman, Noblett, Inc.
Retailer
Robert L. Stephens
Owner
The Tides Inn, Inc.
Resort Operations
T. Nash Broaddus
Chairman of the Board
Prodesco, Inc.
Textile Manufacturer
Robert S. Scheu
Retired CEO
Marine Midland Trust
Company of Western New York
Katherine W. Monroe
Shareholder
Thomas B. Denegre, Jr.
Retired Vice Chairman &
Senior Trust Officer
Chesapeake Bank
William F. Shumadine, Jr.
Senior Vice President
Lowe, Brockenbrough & Co.
Registered Investment Advisor
Chesapeake Bank - Directors
- --------------------------------------------------------------------------------
Rexford F. Beckwith, III
President
Rappahannock Westminster-Canterbury
Charles C. Chase, II
President, Rappahannock
Seafood Company, Inc.
James F. Chase, Jr.
Farmer
C. Irwin Clark, III
Chairman of the Board
Hubbard Insurance Agency, Inc.
James M. Holmes, Jr.
President, Administrator
Rappahannock General Hospital
Eugene S. Hudnall, Jr.
Chairman
Noblett, Inc.
Douglas D. Monroe, Jr.
Chairman and CEO
Chesapeake Bank
Harvey B. Morgan
Pharmacist and Legislator
L. Frank Phillips, Jr.
President
L. F. Phillips & Son Oil Co., Inc.
Albert C. Pollard
President
Pollard Properties, Inc.
Robert L. Stephens
Owner
The Tides Inn, Inc.
Jeffrey M. Szyperski
President
Chesapeake Bank
Harry M. Ward
Superintendent of Schools
Mathews County
Chesapeake Bank - Officers
- --------------------------------------------------------------------------------
Douglas D. Monroe, Jr.
Jeffrey M. Szyperski
Marshall N. Warner
John H. Hunt, II
Ted M. Kattmann
Larry T. Lawrence
John K. O'Shaughnessy
Ray H. Hargett
Betty Sue Spence
Jean H. Harper
Paul L. Wegkamp, Jr.
Dianne D. Hall
Tony K. Griggs
Suzanne D. Keyser
Cecelia G. Klink
Linda J. Bisulca
Bert H. Heath, Jr.
Brenda S. Sims
Heidi L. Wilkins
Julie A. Williams
Carlie H. Gill
Kathleen S. Banks
Doris C. Bussells
Patricia R. Lewis
Pattie G. R. Matthews
Ann Marie Pruitt
Carol C. Rakes
Becky A. Foster
Chesapeake Insurance Agency, Inc. and Chesapeake Mortgage Company, Inc. -
Directors
- --------------------------------------------------------------------------------
Douglas D. Monroe, Jr.
Robert L. Stephens
Eugene S. Hudnall, Jr.
Katherine W. Monroe
T. Nash Broaddus
Chesapeake Financial Group, Inc. - Directors
- --------------------------------------------------------------------------------
Douglas D. Monroe, Jr.
Robert L. Stephens
T. Nash Broaddus
Robert S. Scheu
William F. Shumadine, Jr.
Chesapeake Bank Business Advisory Committees
- --------------------------------------------------------------------------------
Middle Peninsula
Alvin L. Newton
L. Frank Phillips, Jr.
William J. Pointer
Peninsula
Henry S. Branscome
John D. Briggs
Patrick G. Duffeler
Vernon M. Geddy, III
Bruce P. Robertson
Thomas G. Tingle
Northern Neck/Mathews
Elwood G. Everington
Hank J. George
Weldon M. Howard
B.H.B. Hubbard, III
Leland T. James
John C. Miller
F. Stuart Painter
Harry Lee Self
Donald E. Smiley
R. Lee Stephens, Jr.
Robert J. Stewart, Jr.
Norman R. Tingle, Jr.
<PAGE>
(CHESAPEAKE FINANCIAL SHARES, INC. LOGO)
P.O. Box 1419
Kilmarnock, VA 22482
804-435-1181
www.chesbank.com
Ticker Symbol CPKF
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