Prepared by R.R. Donnelley Financial -- Form 10QSB dated June 30, 2002
Table of Contents
 
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-QSB
 
x
 
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
    
 
SECURITIES EXCHANGE ACT OF 1934
 
    
 
For the quarterly period ended June 30, 2002
 
¨
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
    
 
EXCHANGE ACT
 
    
 
For the transition period from                      to                     
 
Commission file number 0-18543
 
 
CHESAPEAKE FINANCIAL SHARES, INC.
(Exact name of registrant as specified in its charter)
 
Virginia
  
54-1210845
(State or other jurisdiction
of incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
97 N. Main St., Kilmarnock, VA
  
22482
(Address of principal executive offices)
  
(Zip Code)
 
(804) 435-1181
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 12, 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x   No  ¨
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of August 1, 2002.
 
Class
   
Outstanding at August 1, 2002
Common Stock, voting, $5.00 par value
   
1,284,198
Common Stock, non-voting, $5.00 par value
   
              0
 

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
FORM 10-QSB
 
INDEX
 
 
    
Page
PART I—FINANCIAL INFORMATION
     
  
1-8
  
1-2
  
3
  
4
  
5
  
6
  
7
  
8
  
9-14
PART II—OTHER INFORMATION
     
  
15
  
15
  
15
  
15
  
15
  
16
  
17
  
18

Table of Contents
 
PART I.
 
Item 1— Financial Information
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED BALANCE SHEETS
 
    
June 30,
2002
     
December 31,
2001
  
    
(Unaudited)
         
ASSETS
                  
Cash and due from banks
   
$
12,868,586
 
   
$
12,298,550
 
Federal funds sold
   
 
0
 
   
 
7,674,000
 
Securities available for sale
U.S. Government agencies (book value of $24,234,601-2002 and $17,700,819-2001)
   
 
24,566,526
 
   
 
17,965,367
 
Obligations of state and political subdivisions (book value of $16,612,883-2002 and $15,151,912-2001)
   
 
16,791,925
 
   
 
15,655,638
 
Other Securities (book value $1,535,451-2002 and $2,480,027-2001
   
 
2,581,673
 
   
 
2,499,350
 
Loans
   
 
183,860,931
 
   
 
169,015,349
 
Less: Allowance for loan loss
   
 
(2,802,001
)
   
 
(2,540,577
)
    
  
Net loans
   
 
181,058,930
 
   
 
166,474,772
 
Bank premises and equipment, net
   
 
7,236,930
 
   
 
6,985,214
 
Accrued interest receivable
   
 
1,310,738
 
   
 
1,288,705
 
Business Manager Assets
   
 
14,001,408
 
   
 
10,882,704
 
Other assets
   
 
5,717,917
 
   
 
3,279,369
 
    
  
Total assets
   
$
266,134,633
 
   
$
245,003,669
 
    
  
 
See accompanying notes to consolidated financial statements.

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED BALANCE SHEETS
 
    
June 30, 2002
   
December 31, 2001
    
(Unaudited)
     
LIABILITIES AND SHAREHOLDERS’ EQUITY
              
Deposits
              
Noninterest bearing deposits
   
$
38,545,950
   
$
33,592,404
Savings and interest bearing deposits
   
 
88,429,434
   
 
83,345,883
Certificates of deposit
   
 
103,174,868
   
 
94,879,030
    
  
Total deposits
   
 
230,150,252
   
 
211,817,317
Federal funds purchased and FHLB advances
   
 
10,986,749
   
 
10,000,000
Accrued interest payable
   
 
225,029
   
 
255,482
Other liabilities
   
 
1,542,097
   
 
1,564,010
Note payable
   
 
776,376
   
 
791,922
    
  
Total liabilities
   
 
243,680,503
   
 
224,428,731
Commitments and contingent liabilities
              
Shareholders’ equity
              
Preferred stock, par value $1 per share; authorized 50,000 shares; none outstanding
   
 
0
   
 
0
Common stock, voting, par value $5
   
 
6,420,990
   
 
6,276,900
Common stock, non-voting
   
 
0
   
 
0
   
voting
  
non-voting
        
   
6/30/02
  
12/31/01
  
6/30/02
  
12/31/01
        
Shares auth.
  
2,000,000
  
2,000,000
  
635,000
  
635,000
        
Shares o/s
  
1,284,198
  
1,255,398
  
           0
  
           0
        
Paid in capital
   
 
310,383
   
 
229,948
Accumulated other comprehensive income
   
 
1,027,745
   
 
514,534
Retained earnings
   
 
14,695,012
   
 
13,553,466
    
  
Total shareholders’ equity
   
 
22,454,130
   
 
20,574,938
    
  
Total liabilities and Shareholders’ equity
   
$
266,134,633
   
$
245,003,669
    
  
 
See accompanying notes to consolidated financial statements.

2

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED STATEMENTS OF EARNINGS
 
    
Three Months Ended
June 30,
    
2002
   
2001
    
(Unaudited)
Interest Income
              
Interest and fees on loans
   
$
3,346,313
   
$
3,722,515
Interest on federal funds sold
   
 
33,818
   
 
29,523
Interest on time deposits with banks
   
 
2,327
   
 
6,631
Interest on U.S. Agency Obligations
   
 
360,075
   
 
329,195
Interest on obligations of state and political subs
   
 
226,557
   
 
217,297
    
  
Total interest income
   
 
3,969,090
   
 
4,305,161
Interest Expense
              
Interest on savings and interest bearing deposits
   
 
297,689
   
 
417,238
Interest on certificates of deposit
   
 
936,747
   
 
1,469,741
Interest on federal funds purchased
   
 
57,822
   
 
100,633
Other interest expense
   
 
10,747
   
 
11,165
    
  
Total interest expense
   
 
1,303,005
   
 
1,998,777
    
  
Net interest income
   
 
2,666,085
   
 
2,306,384
Provision for loan losses
   
 
254,501
   
 
127,666
    
  
Net interest income after provision for loan losses
   
 
2,411,584
   
 
2,178,718
    
  
Noninterest Income
              
Income from fiduciary activities
   
 
255,287
   
 
255,035
Service charges on deposit accounts
   
 
237,363
   
 
216,975
Securities gains (losses)—net
   
 
70
   
 
0
Merchant card income
   
 
294,697
   
 
230,834
ATM income
   
 
84,149
   
 
69,358
Cash Management income
   
 
655,428
   
 
453,325
Other income
   
 
231,233
   
 
171,321
    
  
Total noninterest income
   
 
1,758,227
   
 
1,396,848
    
  
Noninterest Expense
              
Salaries
   
 
1,123,927
   
 
1,084,657
Employee benefits
   
 
183,971
   
 
178,615
Occupancy expenses
   
 
409,877
   
 
473,343
Merchant card expense
   
 
265,992
   
 
225,936
ATM expense
   
 
70,329
   
 
59,269
Cash management expense
   
 
306,101
   
 
138,310
Other expenses
   
 
716,663
   
 
527,606
    
  
Total noninterest expense
   
 
3,076,860
   
 
2,687,736
    
  
Income before income taxes
   
 
1,092,951
   
 
887,830
Income taxes
   
 
320,195
   
 
244,879
    
  
Net income
   
$
772,756
   
$
642,951
    
  
Earnings per share, basic
   
$
0.60
   
$
0.52
Earnings per share, assuming dilution
   
$
0.59
   
$
0.51
Dividends per share
   
$
0.12
   
$
0.11
 
See accompanying notes to consolidated financial statements.

3

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED STATEMENTS OF EARNINGS
    
Six Months Ended
June 30,
  
    
2002
     
2001
  
    
(Unaudited)
  
Interest Income
                  
Interest and fees on loans
   
$
6,596,528
 
   
$
7,411,679
 
Interest on federal funds sold
   
 
86,296
 
   
 
30,017
 
Interest on time deposits with banks
   
 
4,075
 
   
 
14,263
 
Interest on U.S. Agency Obligations
   
 
650,066
 
   
 
684,048
 
Interest on obligations of state and political subs
   
 
447,390
 
   
 
453,860
 
    
  
Total interest income
   
 
7,784,355
 
   
 
8,593,867
 
Interest Expense
                  
Interest on savings and interest bearing deposits
   
 
633,326
 
   
 
910,506
 
Interest on certificates of deposit
   
 
1,916,684
 
   
 
2,998,548
 
Interest on federal funds purchased
   
 
119,375
 
   
 
228,113
 
Other interest expense
   
 
21,601
 
   
 
22,431
 
    
  
Total interest expense
   
 
2,690,986
 
   
 
4,159,598
 
    
  
Net interest income
   
 
5,093,369
 
   
 
4,434,269
 
Provision for loan losses
   
 
454,500
 
   
 
322,666
 
    
  
Net interest income after provision for loan losses
   
 
4,638,869
 
   
 
4,111,603
 
    
  
Noninterest Income
                  
Income from fiduciary activities
   
 
496,219
 
   
 
474,704
 
Service charges on deposit accounts
   
 
431,031
 
   
 
414,200
 
Security gains (losses)—net-
   
 
(2,335
)
   
 
(1,625
)
Merchant card income
   
 
511,434
 
   
 
425,778
 
ATM income
   
 
152,126
 
   
 
124,744
 
Cash Management income
   
 
1,239,210
 
   
 
890,046
 
Other income
   
 
396,972
 
   
 
321,387
 
    
  
Total noninterest income
   
 
3,224,657
 
   
 
2,649,234
 
    
  
Noninterest Expense
                  
Salaries
   
 
2,155,175
 
   
 
1,975,509
 
Employee benefits
   
 
421,779
 
   
 
395,905
 
Occupancy expenses
   
 
915,896
 
   
 
856,888
 
Merchant card expense
   
 
446,040
 
   
 
387,047
 
ATM expense
   
 
141,604
 
   
 
117,644
 
Cash management expense
   
 
403,351
 
   
 
285,762
 
Other expenses
   
 
1,378,597
 
   
 
1,036,161
 
    
  
Total noninterest expense
   
 
5,862,442
 
   
 
5,054,916
 
    
  
Income before income taxes
   
 
2,001,084
 
   
 
1,705,921
 
Income taxes
   
 
554,096
 
   
 
441,066
 
    
  
Net income
   
$
1,446,988
 
   
$
1,264,855
 
    
  
Earnings per share, basic
   
$
1.14
 
   
$
1.02
 
Earnings per share, assuming dilution
   
$
1.12
 
   
$
1.00
 
Dividends per share
   
$
0.24
 
   
$
0.22
 
 
See accompanying notes to consolidated financial statements.

4

Table of Contents
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
    
Six Months Ended June 30,
  
    
2002
     
2001
  
    
(Unaudited)
         
Cash flows from operating activities:
                  
Net income
   
$
1,446,988
 
   
$
1,264,855
 
Adjustments to reconcile net income to net cash provided by (used for) operating activities:
                  
Depreciation and amortization
   
 
589,954
 
   
 
498,581
 
Provision for loan losses
   
 
454,500
 
   
 
322,666
 
Provision for cash management account losses
   
 
180,000
 
   
 
120,000
 
(Accretion) of discount and amortization of premiums, net
   
 
217,051
 
   
 
150,374
 
Net loss on sale of securities
   
 
2,335
 
   
 
1,625
 
Changes in assets and liabilities:
                  
Decrease (increase) in accrued interest receivable
   
 
(22,033
)
   
 
48,595
 
Decrease (increase) in other assets
   
 
(2,702,930
)
   
 
118,009
 
Increase (decrease) in accrued interest payable
   
 
(30,453
)
   
 
(76,040
)
Increase (decrease) in other liabilities
   
 
(21,913
)
   
 
412,517
 
    
  
Net cash provided by (used for) operating activities
   
 
113,499
 
   
 
2,861,182
 
    
  
Cash flows from investing activities:
                  
Purchases of securities available for sale
   
 
(14,237,399
)
   
 
(994,798
)
Proceeds from sale or call of securities available for sale
   
 
673,524
 
   
 
1,038,375
 
Proceeds from maturities of securities available for sale
   
 
6,302,313
 
   
 
2,664,709
 
Origination of loans available for sale
   
 
(11,586,015
)
   
 
(5,032,900
)
Proceeds from sale of loans available for sale
   
 
11,586,015
 
   
 
5,032,900
 
Net (increase) decrease in loans outstanding
   
 
(15,038,658
)
   
 
(5,518,691
)
Net (increase) decrease in business manager assets
   
 
(3,298,704
)
   
 
(1,175,245
)
Other capital expenditures
   
 
(841,670
)
   
 
(197,307
)
    
  
Net cash provided by (used for) investing activities
   
 
(26,440,594
)
   
 
(4,182,957
)
    
  
Cash flows from financing activities:
                  
Net increase (decrease) in demand accounts, interest bearing demand deposit accounts and savings deposits
   
 
10,037,097
 
   
 
9,496,986
 
Net increase (decrease) in certificates of deposit
   
 
8,295,838
 
   
 
(1,372,760
)
Net increase (decrease) in federal funds purchased
   
 
986,749
 
   
 
500,000
 
Cash dividends
   
 
(305,442
)
   
 
(272,989
)
Proceeds from issuance of voting common stock
   
 
224,435
 
   
 
119,000
 
Acquisition of voting common stock
   
 
0
 
   
 
(9,150
)
Curtailment of long-term borrowings
   
 
(15,546
)
   
 
(14,716
)
    
  
Net cash provided by (used for) financing activities
   
 
19,223,131
 
   
 
8,446,371
 
    
  
Net (decrease) increase in cash and federal funds sold
   
 
(7,103,964
)
   
 
7,124,596
 
Cash and federal funds sold at beginning of period
   
 
19,972,550
 
   
 
8,965,457
 
    
  
Cash and federal funds sold at end of period
   
$
12,868,586
 
   
$
16,090,053
 
    
  
 
 
See accompanying notes to consolidated financial statements.
 

5

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER’S EQUITY
Six Months Ended June 30, 2001
(unaudited)
 
    
Total
     
Comprehensive Income
   
Retained
Earnings
     
Accumulated
Other
Comprehensive
Income
   
Common
Stock
     
Additional
Paid-In
Capital
  
Beginning balance
   
$
18,330,317
 
          
$
11,473,316
 
   
$
554,280
   
$
6,149,200
 
   
$
153,521
 
Comprehensive Income:
                                                  
Net Income
   
 
1,264,855
 
   
$
1,264,855
   
 
1,264,855
 
                         
Other comprehensive income, net of tax:
                                                  
Unrealized gain on securities available for sale, net of deferred taxes of $88,568
   
 
171,927
 
   
 
171,927
            
 
171,927
                  
Add: reclassification adjustment, net of income taxes of $552
   
 
1,073
 
   
 
1,073
            
 
1,073
                  
    
  
           
                 
Total comprehensive income, net of tax:
            
$
1,437,855
                                  
             
                                 
Acquisition of common stock
   
 
(9,150
)
                          
 
(3,000
)
   
 
(6,150
)
Issuance of common stock
   
 
119,000
 
                          
 
93,600
 
   
 
25,400
 
Dividends declared
   
 
(272,989
)
          
 
(272,989
)
                   
 
0
 
    
         
  
  
  
Ending balance
   
$
19,605,033
 
          
$
12,465,182
 
   
$
727,280
   
$
6,239,800
 
   
$
172,771
 
    
         
  
  
  

6

Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER’S EQUITY
Six Months Ended June 30, 2002
(Unaudited)
 
    
Total
     
Comprehensive
Income
   
Retained
Earnings
     
Comprehensive Income
   
Accumulated
Other Common Stock
   
Additional Paid-In Capital
Beginning balance
   
$
20,574,938
 
          
$
13,553,466
 
   
$
514,534
   
$
6,276,990
   
$
229,948
Comprehensive Income:
                                              
Net Income
   
 
1,446,988
 
   
$
1,446,988
   
 
1,446,988
 
                     
Other comprehensive income, net of tax:
                                              
Unrealized gain on securities available for sale, net of deferred taxes of $263,588
   
 
511,670
 
   
 
511,670
            
 
511,670
              
Add: reclassification adjustment, net of income taxes of $794
   
 
1,541
 
   
 
1,541
            
 
1,541
              
    
  
           
             
Total comprehensive income, net of tax:
            
$
1,960,199
                              
             
                             
Issuance of common stock
   
 
224,435
 
                          
 
144,000
   
 
80,435
Dividends declared
   
 
(305,442
)
          
 
(305,442
)
                 
 
0
    
         
  
  
  
Ending balance
   
$
22,454,130
 
          
$
14,695,012
 
   
$
1,027,745
   
$
6,420,990
   
$
310,383
    
         
  
  
  

7

Table of Contents
CHESAPEAKE FINANCIAL SHARES, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  Chesapeake Financial Shares, Inc. (“CFS) is a Virginia based financial services holding company which traces its roots to a national bank founded in Irvington, Virginia in 1900. The Company has two operating subsidiaries, Chesapeake Bank (the “Bank”), which constitutes the majority of its business activity, and Chesapeake Investment Group, Inc., an entity that has as its subsidiaries, Chesapeake Financial Group, Inc., Chesapeake Insurance Agency, Inc., d/b/a Chesapeake Investment Services, and Chesapeake Trust Company, Inc. Chesapeake Bank also is the 100% owner of CNB Properties, Inc. The consolidated financial statements include the accounts of CFS and its wholly owned subsidiaries. All significant intercompany accounts have been eliminated.
 
2.  The accounting and reporting policies of the registrant conform to accounting principles generally accepted in the United States of America and to the general practices within the banking industry. The interim financial statements have not been audited; however, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial statements have been included.
 
The results of operations for the three and six months ended June 30, 2002 are not necessarily indicative of the results expected for the full year. These financial statements should be read in conjunction with the financial statements and the footnotes included in the registrant’s 2001 Annual Report to Shareholders.
 
3.  The following data shows the amounts used in computing earnings per share and the effect on the weighted average number of shares of potential dilutive common stock. The potential common stock will not have a significant impact on net income.
 
    
June 30,
2002
   
June 30, 2001
Weighted average number of common shares, basic
   
1,271,230
   
1,237,720
Effect of dilutive stock options
   
21,780
   
25,204
    
  
Weighted number of common shares and dilutive potential common stock used in diluted EPS
   
1,293,010
   
1,262,924
    
  
 

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Table of Contents
 
Item 2— Financial Information
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(Unaudited)
 
A.  Critical Accounting Policies
 
The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements, selected financial data appearing elsewhere within this report, and management’s discussion and analysis are, to a large degree, dependent upon Chesapeake Financial Shares’ accounting policies. The selection and application of these policies involve judgments, estimates and uncertainties that are susceptible to change.
 
Presented below are discussions of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of Chesapeake’s finanancial condition and results of operations. These Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial conditions or results of operations is a reasonable likelihood.
 
Allowance for Loan Loss—Chesapeake Bank’s management maintains an allowance for loan loss that they feel represents a conservative estimate of potential losses in the Bank’s loan portfolio. The methodology incorporates subjective factors into the evaluation of the adequacy of the ALLL such as:
 
The effect of volume and trends in delinquencies and nonaccrual loans.
 
The effect of trends in portfolio volume, maturity, and composition.
 
An estimate of loss on all significant loans and assessment of underwriting and lending policies and procedures including those for charge off, collection and recovery.
 
Experience, ability and depth of lending management and staff.
 
The effect of national and local economic conditions and downturns in specific industries.
 
Concentrations of credit that might affect loss experience across one or more components of the portfolio.
 
The results of any independent reviews of the portfolio.
 
The lookback period for losses and recoveries was changed in 2001 from a 24-month history to a 15-month history in order to arrive at more accurate historical factors which reflect the effects of current economic conditions on the loan portfolio.

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Table of Contents
 
CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(Unaudited)
 
B.  Summary—liquidity and capital resources
 
Sufficient short-term assets are maintained at Chesapeake Financial Shares to meet cash needs anticipated by management. Management’s primary sources of liquidity continue to be federal funds sold, short term borrowings from Federal Home Loan Bank Atlanta, securities maturing within one year, and principal payments from mortgage securities. The repayment and sale of loans also provides liquidity. The total of federal funds sold, securities maturing within one year, and estimated principal payments on mortgage-backed securities within one year at June 30, 2002 was approximately $8,786,000, compared to $11,595,000 one year ago and $15,205,000 at December 31, 2001.
 
The liquidity ratio at June 30, 2002 was 19.9%, compared with 19.7% one year ago. This ratio is arrived at by dividing net liquid assets (sum of total Cash and Due from Banks, including Federal Reserve, unpledged and over pledged portions of Investment Securities at market value, and federal funds sold less reserves required at the Federal Reserve Bank) by net liabilities (total liabilities excluding valuation reserves and capital). Management has found in the past that 18% represents a sufficient level of liquidity to meet cash needs. Lower asset liquidity ratios have been expected as management has positioned the Company to be more liability liquid to meet the demand for changing needs for deposit and loan funding.
 
Management believes capital is adequate to meet current needs. Unencumbered capital (total capital net of accumulated other comprehensive income less intangibles plus reserves) as a percent of total adjusted assets (total assets net of accumulated other comprehensive income less intangibles plus reserves) was 9.0% at June 30, 2002 and 9.2% at December 31, 2001, for CFS.
 
Chesapeake Financial Shares and Chesapeake Bank must have a ratio of Tier 1 capital (common equity, retained earnings less certain goodwill) to risk-adjusted assets of at least 4.0%. Minimums for total risk based and tier one leverage are 8% and 4%, respectively. At June 30, 2002 and December 31, 2001 the consolidated ratio of Tier 1 risk-based capital to risk-adjusted assets was 9.8% and 9.4%, respectively. Total risked based capital to risk weighted assets was 11.1% and 10.6% at June 30, 2002 and December 31, 2001, respectively. Tier one leverage capital was 8.2% and 7.7% at June 30, 2002 and December 31, 2001, respectively.

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CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
(UNAUDITED)
 
C.  Results of operations:
 
Earnings Summary:
 
Net income was $1,446,988 for the six months ended June 30, 2002, compared with income of $1,264,855 for the same period in 2001. On a fully diluted per share basis, the net income was $1.12 for the first six months of 2002. Fully diluted earnings per share for the first six months of 2001 were $1.00. Net interest income before provision increased $659,100 or 14.9% and noninterest income increased $575,423 or 21.7%. The Company experienced a net increase in noninterest expense (which includes other expense) of $807,526 or 16.0%.
 
Net Interest Income:
 
Chesapeake Financial Shares’ results of operation are significantly affected by its ability to manage effectively the interest rate sensitivity and maturity of its interest-earning assets and interest-bearing liabilities. At June 30, 2002, the Company’s interest-earning assets exceeded its interest-bearing liabilities by approximately $34.5 million, compared with $35.5 million excess one year ago.
 
Net interest margins are 4.75% at June 30, 2002 compared to 4.53% at June 30, 2001. Margins had narrowed during the later part of 1998 and the first half of 1999 due to falling rates and the resulting compression of spreads as deposit rates hit floors. Margins have generally improved since the spreads were most narrow for Chesapeake in 2000. In the falling rate environment and steepening of the yield curve in 2001, management expected margins to improve slightly with higher priced deposits maturing in this lower rate environment. This has been somewhat offset by loans and investments repricing in the lower rate environment as well. The Bank’s sustained margin levels of 4.5% to 4.7% have been 30 basis points better than several Virginia community banks.
 
There has been reasonable growth in deposits in all trade areas of the bank and total deposits increased 8.7% since December 31, 2001 and 13.8% from one year ago. Noninterest bearing deposits and savings and interest bearing deposits are up 25.8% and 24.6%, respectively, over the same time last year. Total certificates of deposit have increased 2.6% from one year ago, and are up 8.7% from December 31, 2001. Deposits have been easier to obtain with the instability of the equity markets and the bank had a promotion for noninterest bearing deposits during the second quarter. The bank also relocated the Gloucester Winn-Dixie office to a new building in January, which has created substantial deposit growth in that market.

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CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION
(Unaudited)
 
Provision for Loan Losses:
 
The loan loss provision is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management’s evaluation of the credit quality and risk adverseness of the portfolio. Management makes a quarterly evaluation as to the adequacy of the current loan loss allowance. Management’s detailed analysis as of June 30, 2002 supports the adequacy of the current loan loss level of $2.8 million.
 
The loan loss allowance was 1.5% of gross loans as of June 30, 2002 and December 31, 2001.
 
Noninterest Income:
 
Noninterest income is up 21.7% or $575,423 from the same period last year. Chesapeake Bank’s Cash Management product generated $1,239,210 in gross revenue for the first six months ended June 30, 2002, compared to the same period last year of $890,046. Managed assets in the Cash Management program were $14,633,255 at June 30, 2002, and $10,714,619 at June 30, 2001. Merchant Card income was up 20.1%, or $85,656, from one year ago due to an increased client base.
 
The Other Income category was $396,972, up 23.5%, or $75,585 from one year ago.

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CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION
(Unaudited)
 
Noninterest Expenses:
 
Employee salary expense amounted to $2,155,175 and $1,975,509 for the six months ended June 30, 2002 and 2001, respectively. Benefits expense is up 6.5% or $25,874 from June 30, 2001. These increases are directly related to new hires and increases for existing staff. Other expenses were up $342,436 or 33.0% from the same period one year ago due to general increases in business activity.
 
Cash management expense was $403,351 for the six months ended June 30, 2002, up 41.1% from the same period one year ago. This increase is mainly due to increased business activity.

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CHESAPEAKE FINANCIAL SHARES, INC.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION
(Unaudited)
 
Assets and Loans:
 
At June 30, 2002, Chesapeake Financial Shares had total assets of $ 266.1 million, up 8.6% from $245.0 million at December 31, 2001 and up 13.5% from $234.4 million of one year ago. Management has budgeted for a 10.6% growth in total assets for 2002.
 
Total loans (gross) at June 30, 2002 were $183.9 million, representing an increase of 8.8% from December 31, 2001, when loans were $169.0 million. Chesapeake Bank’s loan quality is good as the following table shows. Management is confident that no serious delinquency trends are developing.
 
    
6/30/02
   
12/31/01
Nonaccrual loans
   
$
42,517
   
$
822,264
90 days past due
   
 
480,655
   
 
21,551
Restructured loans
   
 
0
   
 
0
    
  
Totals
   
$
523,172
   
$
843,815
Impaired loans with a valuation allowance
   
$
268,906
   
$
552,104
Valuation allowance related to impaired loans
   
$
219,928
   
$
350,000
 
Management is also confident there will be no significant loss incurred as the Bank is well secured on these assets.
 
Charged off loans through June 30, 2002, amounted to $200,166 and charged off loans through June 30, 2001, were $13,572. Recoveries through June 30, 2002 were $7,090 as compared to $1,474 as of June 30, 2001.
 
Concentrations of credit in loans are compiled quarterly by management and reviewed with the Board of Director’s Loan Review Committee. There have been no material changes in the concentrations of credit within the past three months that would warrant above average additions to the allowance. The Bank’s only concentrations of credit greater than 60% of capital are individual consumer (224% of capital) and residential real estate (65% of total capital). Bank management feels that the current levels are consistent with the objectives of the Bank and do not represent unwarranted risk.
 
The Bank currently has no assets carried as Other Real Estate Owned (OREO) nor any repossessed assets.
 
Deposits:
 
Deposits were $ 230.2 million at June 30, 2002 and $211.8 million at December 31, 2001. Deposits were $202.2 million at June 30, 2001. The Bank’s mix of deposit dollars has changed from June 30, 2001 with net increases in all categories. It is management’s opinion that this trend will continue in the current interest rate environment.

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PART II.
 
Item l—Other Information
 
Chesapeake Financial Shares, Inc.
 
Legal Proceedings
 
None to report
 
Item 2—Other Information
 
Chesapeake Financial Shares, Inc.
 
Changes in Securities
 
None to report.
 
Item 3—Other Information
 
Chesapeake Financial Shares, Inc.
 
Default Upon Senior Securities
 
None to report.
 
Item 4—Other Information
 
Chesapeake Financial Shares, Inc.
 
Submission of Matters to a Vote of Security Holders
 
Chesapeake Financial Shares’ annual meeting of shareholders was held on Friday, April 5, 2002 in Irvington, Virginia. We have previously forwarded to the Commission copies of the letter to shareholders, the notice of the meeting, the proxy statement, and the proxy. Over 87% of the shareholders were represented at the meeting in person or by proxy with over 87% voting in favor of the proposals submitted.
 
Item 5—Other Information
 
Chesapeake Financial Shares, Inc.
 
Other Information
 
During the fourth quarter of 2000, the Company satisfactorily completed a Combined Safety and Soundness Examination performed by the Federal Reserve Bank of Richmond. As of December 2000, the Bank and the Company satisfactorily completed Transfer Agent Examination, also performed by the Federal Reserve Bank. Chesapeake completed a Combined Safety and Soundness Examination performed by the Virginia State Corporation Commission, Bureau of Financial Institutions, during the first quarter of 2002. 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 Bank or Holding Company.

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Item 6—Other Information
 
Chesapeake Financial Shares, Inc.
 
Exhibits and Reports on Form 8-K
 
(Unaudited)
 
(a)  Exhibit 2     
  
Plan of acquisition, reorganization, arrangement, liquidation or succession
   
N/A
Exhibit 3(i) 
  
Articles of Incorporation
   
N/A(1)
3(ii)
  
By-laws
     
Exhibit 4     
  
Instruments defining the rights of security holders, including indentures
   
N/A(1)
Exhibit 10   
  
Material contracts
   
N/A(1)
Exhibit 11   
  
Statement re: computation of earnings per share
   
See Part 1, Item 1, Note 3 of this Form 10-QSB
Exhibit 15   
  
Letter re: unaudited interim financial information
   
N/A
Exhibit 18   
  
Letter re: change in accounting principles
   
N/A
Exhibit 19   
  
Report furnished to security holders
   
N/A
Exhibit 22   
  
Published report regarding matters submitted to vote of security holders
   
Previously Filed
Exhibit 23   
  
Consents of experts and counsel
   
N/A
Exhibit 24   
  
Power of attorney
   
N/A
Exhibit 27   
  
Financial data schedule
   
N/A
Exhibit 99   
  
Certification of CEO and CFO
   
Attached
 
(b)  No filings were made on Form 8-K for the period.
(1)
 
Incorporated by reference to previously filed Registration Statement on Form S-18, Registration No: 33-27825, dated May 15, 1989, as amended.

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CHESAPEAKE FINANCIAL SHARES, INC.
 
SIGNATURES
 
Pursuant to the requirements 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.
(Registrant)
By:
  
/s/    DOUGLAS D. MONROE, JR.        
   
Douglas D. Monroe, Jr.
Chairman and Chief Executive Officer
 
Date: 08/08/02
 
By:
  
/s/    JOHN H. HUNT, II        
   
John H. Hunt, II
Secretary and Chief Financial Officer
 
Date: 08/08/02

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