As filed with the Securities and Exchange Commission on June 1, 2000.
Registration No. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM S-4
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
CARDINAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
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Virginia 6022 54-1874630
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
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10555 Main Street, Suite 500
Fairfax, VA 22030
(703) 279-5060
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
L. Burwell Gunn, Jr.
10555 Main Street, Suite 500
Fairfax, VA 22030
(703) 279-5052
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent For Service)
Copies of Communications to:
Wayne A. Whitham, Jr., Esq. Richard A. Schaberg, Esq.
Williams, Mullen, Clark & Dobbins Thacher Proffitt & Wood
1021 East Cary Street 1700 Pennsylvania Avenue, N.W.
Richmond, VA 23219 Washington, DC 20006
(804) 783-6473 (202) 626-5630
Fax: (804) 783-6507 Fax: (202) 626-1930
Approximate date of commencement of proposed sale to the public: As soon as
practicable following the effectiveness of this Registration Statement.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
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CALCULATION OF REGISTRATION FEE
================================= ================== ======================= ==================== ==================
Proposed Maximum Proposed Maximum
Title Of Each Class Of Amount To Be Offering Price Aggregate Amount of
Securities To Be Registered Registered (1) Per Unit (2) Offering Price (2) Registration Fee
--------------------------------- ------------------ ----------------------- -------------------- ------------------
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Preferred Stock, $1.00 par value 1,376,770 N/A N/A $1,184
================================= ================== ======================= ==================== ==================
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(1) Based upon an assumed number of shares that may be issued in the merger
described in this Registration Statement. The assumed number is based upon
the maximum number of shares of common stock of Heritage Bancorp, Inc. that
may be outstanding immediately prior to the merger.
(2) Reflects the market price of Heritage Bancorp, Inc.'s common stock to be
exchanged for Cardinal preferred stock in connection with the merger,
computed in accordance with Rule 457(c) and Rule 457(f) under the
Securities Act of 1933, as amended, based upon the average of the high and
low sales price of Heritage Bancorp, Inc. common stock as reported on The
Nasdaq SmallCap Market on May 24, 2000, less the cash to be received in the
merger ($11,365,468 - $6,883,851). The proposed maximum aggregate offering
price is estimated solely to determine the registration fee.
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 5(a) of the
Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
================================================================================
<PAGE>
MERGER PROPOSED - YOUR VOTE IS VERY IMPORTANT
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
The Boards of Directors of Cardinal Financial Corporation and Heritage
Bancorp, Inc. have agreed to merge the two companies. After the merger, Cardinal
will own four banks with total assets of almost $180 million and seven branch
offices in northern Virginia.
If shareholders of both companies approve the merger, Heritage will
merge into Cardinal Merger Corp., a wholly-owned subsidiary of Cardinal.
Heritage's bank subsidiary will change its name to Cardinal Bank - Potomac and
operate as a separate subsidiary of Cardinal Merger Corp.. Heritage shareholders
will receive $6.00 in cash or shares of preferred stock with a per share value
of approximately $6.00 and a 7.25% annual dividend for each share of Heritage
common stock that they own. Cardinal has applied to list the preferred stock on
the Nasdaq SmallCap Market. Cardinal shareholders will continue to hold their
existing shares of Cardinal common stock after the merger.
We cannot complete the merger unless shareholders of Heritage approve
the merger agreement and the shareholders of Cardinal approve the issuance of
preferred stock to the shareholders of Heritage and the election of three
Heritage directors to the Cardinal board.
We have each scheduled meetings for our shareholders to vote on the
merger. Whether or not you plan to attend your shareholder meeting, please take
the time to vote by completing and mailing the enclosed proxy card to us. If
your shares are held in "street name," you must instruct your broker on how to
vote your shares.
The dates, times and places of the meetings are as follows:
For Cardinal shareholders:
________ __, _____, ______ _.m.
____________________
____________________
For Heritage shareholders:
________ __, ______, _____ _. m.
____________________
____________________
The document accompanying this letter contains additional information
regarding the merger agreement, the proposed merger and the two companies. We
encourage you to read this entire document carefully.
We strongly support this merger and appreciate your prompt attention to
this very important matter.
_______________________________
L. Burwell Gunn, Jr.
President and Chief Executive Officer
Cardinal Financial Corporation
_______________________________
Terrie G. Spiro
President and Chief Executive Officer
Heritage Bancorp, Inc.
[END OF TWO-COLUMN FORMAT]
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this document. Any representation to the contrary is a
criminal offense. The securities offered hereby are not savings accounts,
deposits or other obligations of a bank or savings association and are not
insured by the Federal Deposit Insurance Corporation or any other government
agency.
The date of this joint proxy statement/prospectus is ________ _, 2000 and it is
first being mailed to shareholders on or about ________ __, 2000.
<PAGE>
Cardinal Financial Corporation
10555 Main Street, Suite 500
Fairfax, VA 22030
Notice of Special Meeting of Shareholders
to be held on ________ __, 2000
A special meeting of shareholders of Cardinal Financial Corporation
will be held on ________ __, 2000, at ________, _.m., at
_____________________________, ______________, ________________, __________, for
the following purposes:
(1) To approve the issuance of shares of Cardinal preferred stock
under the Amended and Restated Agreement and Plan of
Reorganization dated June __, 2000 by and between Heritage
Bancorp, Inc., Cardinal Merger Corp. and Cardinal, which
provides for Heritage to be merged with and into Cardinal
Merger Corp.;
(2) To elect three of Heritage's directors to serve on Cardinal's
board of directors; and
(3) To transact such other business as may properly come before
the special meeting or any adjournment or postponement of the
meeting.
The Cardinal board of directors recommends a vote in favor of issuing
shares of Cardinal preferred stock to Heritage shareholders in the merger and
electing three Heritage directors to the Cardinal board.
Only holders of record of Cardinal common stock as of the close of
business on ________ __, 2000, are entitled to notice of and to vote at the
special meeting and any adjournments or postponements of the meeting.
To ensure that your shares are voted at the special meeting, please
sign, date and promptly mail the accompanying proxy card in the enclosed
envelope. Any shareholder of record present at this meeting or at any
adjournments or postponements of the meeting may revoke his or her proxy and
vote personally on each matter brought before the meeting. You may revoke your
proxy at any time before it is voted.
Remember, if your shares are held in the name of a broker, only your
broker can vote your shares and only after receiving your instructions. Please
contact the person responsible for your account and instruct him/her to execute
a proxy card on your behalf. You should also sign, date and mail your proxy at
your earliest convenience.
Please review the joint proxy statement/prospectus accompanying this
notice for more complete information regarding the matter proposed for your
consideration at the special meeting.
By Order of the Board of Directors
Nancy K. Falck
Corporate Secretary
Fairfax, Virginia
________ __, 2000
Whether or not you plan to attend the meeting in person, we urge you to
date, sign and return promptly the enclosed proxy in the accompanying envelope.
You may revoke your proxy at any time before it is voted in the manner provided
in the accompanying joint proxy statement/prospectus.
<PAGE>
Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, VA 22101
Notice of Special Meeting of Shareholders
to be held on ________ __, 2000
A special meeting of shareholders of Heritage Bancorp, Inc. will be
held at ________ __.m. on ________ __, 2000 at
__________________________________________________, _________, Virginia _______,
to consider the following matters:
(1) To approve the Amended and Restated Agreement and Plan of
Reorganization dated June __, 2000 by and between Heritage,
Cardinal Merger Corp. and Cardinal Financial Corporation which
provides for Heritage to be merged with and into Cardinal
Merger Corp.; and
(2) Any other business properly brought before the special meeting
or any adjournment or postponement thereof.
Your board of directors recommends a vote in favor of the merger
agreement.
Only Heritage shareholders of record at the close of business on
________ __, 2000 are entitled to notice of, and to vote at, this special
meeting and any adjournments or postponements thereof.
Each Heritage shareholder has the right to dissent from the merger and
seek an appraisal of the fair market value of his or her shares, provided the
proper procedures are followed. These procedures are described in the joint
proxy statement/prospectus.
To ensure that your shares are voted at the special meeting, please
sign, date and promptly mail the accompanying proxy card in the enclosed
envelope. Any shareholder of record present at this meeting or at any
adjournments or postponements of the meeting may revoke his or her proxy and
vote personally on each matter brought before the meeting. You may revoke your
proxy at any time before it is voted.
Remember, if your shares are held in the name of a broker, only your
broker can vote your shares and only after receiving your instructions. Please
contact the person responsible for your account and instruct him/her to execute
a proxy card on your behalf. You should also sign, date and mail your proxy at
your earliest convenience.
Please review the joint proxy statement/prospectus accompanying this
notice for more complete information regarding the matter proposed for your
consideration at the special meeting.
By Order of the Board of Directors
Janet A. Valentine
Corporate Secretary
McLean, Virginia
________ __, 2000
Regardless of whether you plan to attend the special meeting in person,
you are urged to vote promptly by dating, signing and returning the enclosed
proxy in the accompanying envelope. You may revoke your proxy at any time before
it is voted in the manner provided in the accompanying joint proxy
statement/prospectus.
<PAGE>
TABLE OF CONTENTS
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Page
CHAPTER I
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QUESTIONS AND ANSWERS ABOUT THE MERGER.................................................................. I-1
WHO CAN HELP ANSWER YOUR QUESTIONS...................................................................... I-4
SUMMARY................................................................................................. I-5
The Companies...................................................................................... I-5
The Meetings....................................................................................... I-5
Votes Required..................................................................................... I-6
Record Date; Voting Power.......................................................................... I-6
The Merger......................................................................................... I-6
Recommendations.................................................................................... I-6
Reasons for the Merger............................................................................. I-7
Opinion of Financial Advisors...................................................................... I-7
Appraisal Rights................................................................................... I-8
Comparison of Shareholder Rights................................................................... I-8
Comparative Per Share Market Price Information..................................................... I-8
Share Ownership of Management...................................................................... I-8
Benefits to Management in the Merger............................................................... I-8
Transaction Structure.............................................................................. I-9
The Heritage Bank.................................................................................. I-9
Conditions that Must Be Satisfied for the Merger to Occur.......................................... I-9
Termination of the Merger Agreement................................................................ I-10
Effective Date Expected: Third Quarter of 2000..................................................... I-10
Selected Historical Financial Data................................................................. I-11
Selected Unaudited Pro Forma Combined Financial Data............................................... I-12
Consolidated Ratios of Earnings to Fixed Charges and Preferred Stock Dividends..................... I-12
RISK FACTORS THAT YOU SHOULD CONSIDER................................................................... I-13
Cardinal has not been profitable since it began banking operations in 1998 and does not
expect to be profitable in the near future........................................................ I-13
If Cardinal's bank subsidiaries do not become profitable, it may not be able to pay
dividends on its preferred stock.................................................................. I-13
Cardinal and Heritage may not successfully integrate their respective business operations.......... I-13
THE MERGER.............................................................................................. I-14
Background......................................................................................... I-14
Cardinal's Reasons for the Merger.................................................................. I-15
Heritage's Reasons for the Merger.................................................................. I-16
Financial Board....................................................................................
Accounting Treatment............................................................................... I-17
Material Federal Income Tax Consequences of the Merger............................................. I-17
Appraisal Rights................................................................................... I-19
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION..................................................... I-21
OPINION OF HERITAGE'S FINANCIAL ADVISOR................................................................. I-28
OPINION OF CARDINAL'S FINANCIAL ADVISOR................................................................. I-31
INTERESTS OF CERTAIN PERSONS IN THE MERGER.............................................................. I-36
TERMS OF THE MERGER AGREEMENT........................................................................... I-37
Merger Consideration............................................................................... I-37
Representations and Warranties; Conditions to the Merger........................................... I-37
Regulatory Approvals............................................................................... I-38
Business Pending the Merger........................................................................ I-38
<PAGE>
Page
No Solicitation; Board Action...................................................................... I-39
Effective Date..................................................................................... I-39
Surrender of Stock Certificates.................................................................... I-39
Conversion of Stock Options........................................................................ I-40
Waiver and Amendment............................................................................... I-40
Termination........................................................................................ I-40
Resales of Cardinal Preferred Stock................................................................ I-41
Expenses of the Merger and Termination Fee......................................................... I-41
MARKET PRICES AND DIVIDENDS............................................................................. I-41
Market Prices...................................................................................... I-41
Dividends.......................................................................................... I-43
CHAPTER II
INFORMATION ABOUT THE SPECIAL MEETINGS AND VOTING
General........................................................................................... II-1
Cardinal Meeting.................................................................................. II-1
Heritage Meeting.................................................................................. II-2
CHAPTER III
DESCRIPTION OF CARDINAL
BUSINESS............................................................................................... III-1
MANAGEMENT'S DISCUSSION AND ANALYSIS................................................................... III-13
CHAPTER IV
DESCRIPTION OF HERITAGE
BUSINESS................................................................................................ IV-1
MANAGEMENT'S DISCUSSION AND ANALYSIS.................................................................... IV-14
CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors................................................................................. V-1
Executive Officers Who Are Not Directors............................................................... V-3
Security Ownership of Management....................................................................... V-4
Security Ownership of Certain Beneficial Owners........................................................ V-6
Executive Compensation................................................................................. V-6
Stock Options.......................................................................................... V-7
Directors' Fees........................................................................................ V-9
Compensation and Other Employment Arrangements......................................................... V-9
Transactions with Management........................................................................... V-10
<PAGE>
Page
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF CARDINAL CAPITAL STOCK.................................................................. VI-1
COMPARATIVE RIGHTS OF SHAREHOLDERS..................................................................... VI-4
General........................................................................................... VI-4
Authorized Capital................................................................................ VI-4
Amendment of Articles of Incorporation or Bylaws.................................................. VI-5
Mergers, Consolidations and Sales of Assets....................................................... VI-6
Size and Classification of Board of Directors..................................................... VI-6
Vacancies and Removal of Directors................................................................ VI-7
Director Liability and Indemnification............................................................ VI-7
Special Meetings of Shareholders.................................................................. VI-9
Shareholder Nominations and Proposals............................................................. VI-9
Shareholder Voting Rights in General.............................................................. VI-11
State Anti-Takeover Statutes...................................................................... VI-11
SHAREHOLDER PROPOSALS.................................................................................. VI-13
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS.............................................. VI-13
EXPERTS................................................................................................ VI-14
LEGAL OPINIONS......................................................................................... VI-14
WHERE YOU CAN FIND MORE INFORMATION.................................................................... VI-14
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<PAGE>
APPENDICES
----------
General
-------
A Amended and Restated Agreement and Plan of Reorganization between Heritage
Bancorp, Inc., Cardinal Merger Corp. and Cardinal Financial Corporation,
dated June __, 2000.
Cardinal Financial Corporation
------------------------------
B Cardinal Financial Corporation Financial Statements (including the audited
December 31, 1999 financial statements and the unaudited March 31, 2000
financial statements)
C Opinion of Scott & Stringfellow, Inc.
Heritage Bancorp, Inc.
----------------------
D Heritage Bancorp, Inc. Financial Statements (including the audited December
31, 1999 financial statements and the unaudited March 31, 2000 financial
statements)
E Opinion of Ferris, Baker Watts, Incorporated
F Excerpts from the Virginia Stock Corporation Act relating to dissenting
shareholders
<PAGE>
CHAPTER I
QUESTIONS AND ANSWERS ABOUT THE MERGER
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
Q: Why is Heritage merging with Cardinal?
A: Both the Heritage board of directors and the Cardinal board of directors
believe the merger is in the best interests of their respective companies and
will provide significant benefits to their shareholders, customers and
employees. The merger will enable Cardinal, a new bank holding company just
completing its start-up phase, to become profitable sooner. Heritage will become
part of a community banking company with more capital, products and geographic
scope. The boards believe the merger will create a company with enhanced
financial performance which will be better positioned to compete in the rapidly
changing and consolidating financial services industry in Virginia.
To review the background and reasons for the merger in greater detail, see pages
I-14 through I-17.
Q: What will I receive in the merger?
A: CARDINAL SHAREHOLDERS:
Each share of Cardinal common stock held by a Cardinal shareholder will continue
to represent one share of Cardinal common stock following the merger.
FOR EXAMPLE:
o If you own 100 shares of Cardinal common stock, after the merger those shares
will continue to represent 100 shares of Cardinal common stock.
HERITAGE SHAREHOLDERS:
Each Heritage shareholder can elect to receive either $6.00 in cash or 1.2
shares of Cardinal's 7.25% Cumulative Convertible Preferred Stock, Series A, for
each share of Heritage common stock. Cardinal will not issue fractional shares
of preferred stock in the merger. Instead, a Heritage shareholder who elects to
receive Cardinal preferred stock will receive a cash payment based on the $5.00
liquidation value of the Cardinal preferred stock for any fractional shares.
FOR EXAMPLE:
o If you own 100 shares of Heritage common stock and receive all cash in the
merger, you will receive $600 in cash.
o If you own 100 shares of Heritage common stock and receive all Cardinal
preferred stock, after the merger you will receive 120 shares of Cardinal
preferred stock, with a value of approximately $600.
Q. What are the key attributes of the Cardinal preferred stock?
A:
o If Cardinal ever liquidates, each share of preferred stock will be entitled
to a $5.00 payment before any distribution to holders of Cardinal common
stock.
o Each share will be entitled to cumulative annual dividend of $0.3625, or
7.25% of the $5.00 liquidation amount, before any dividend is paid on any
Cardinal common stock.
o A holder of Cardinal preferred stock will have the right to convert each
share into _____ shares of Cardinal common stock at any time.
o If Cardinal's common stock trades at a price above $_______ for 20
consecutive days beginning at least 42 months after the merger closes, each
share of Cardinal preferred stock will automatically convert into Cardinal
common stock.
o Cardinal preferred stock will not have the right to vote for directors, but
will have the right to vote on mergers and similar transactions that affect
the Cardinal preferred stock.
I-1
<PAGE>
o Generally, the Cardinal preferred stock cannot be redeemed by Cardinal for 20
years.
Q. How will a Heritage shareholder elect cash or Cardinal preferred stock?
A: Cardinal will mail an election form to Heritage shareholders no more than
10 days after the Heritage special meeting. If you want to receive any Cardinal
preferred stock, you will need to complete the form and return it to Cardinal.
You may elect to receive all cash, all Cardinal preferred stock or any
combination of cash and Cardinal preferred stock. If you do not complete and
return the form, you will be treated as if you elected to receive all cash.
Q. If I am a Heritage shareholder, will I receive exactly what I elect?
A: Not necessarily. The merger agreement provides that total consideration
given to Heritage shareholders will be 50% cash and 50% Cardinal preferred
stock. This means that if holders of more than 50% of Heritage common stock
elect to receive Cardinal preferred stock, the amount of Cardinal preferred
stock given to each will be reduced and cash will be substituted. Reductions
will be proportional.
FOR EXAMPLE:
o You own 100 shares of Heritage common stock and elect to receive no cash and
all Cardinal preferred stock. If holders of 75% of the Heritage common stock
elect to receive Cardinal preferred stock, instead of receiving 120 shares of
Cardinal preferred stock, you will receive 80 shares of Cardinal preferred
stock and $200 in cash.
o You own 100 shares of Heritage common stock and elect to receive no cash and
all Cardinal preferred stock. If holders of 60% of Heritage common stock
elect to receive Cardinal preferred stock, instead of receiving 120 shares of
Cardinal preferred stock, you will receive 100 shares of Cardinal preferred
stock and $100 in cash.
o You own 100 shares of Heritage common stock and elect to receive $120 in cash
and 96 shares of Cardinal preferred stock. If holders of 75% of the Heritage
common stock elect to receive Cardinal preferred stock, you will receive 64
shares of Cardinal preferred stock and $280 in cash.
Likewise, if holders of more than 50% of the Heritage common stock elect to
receive cash and exercise dissenters' rights, the cash payments made to each
Heritage shareholder will be reduced and Cardinal preferred stock will be
substituted. Reductions will be proportional.
FOR EXAMPLE:
o You own 100 shares of Heritage common stock and elect to receive all cash. If
holders of 75% of the Heritage common stock elect to receive cash, instead of
receiving $600 in cash, you will receive $400 in cash and 40 shares of
Cardinal preferred stock.
o You own 100 shares of Heritage common stock and elect to receive $300 in cash
and 60 shares of Cardinal preferred stock. If holders of 75% of the Heritage
common stock elect to receive cash, instead of receiving $300 in cash and 60
shares of Cardinal preferred stock, you will receive $200 in cash and 80
shares of Cardinal preferred stock.
o You own 100 shares of Heritage common stock and elect to receive $120 in cash
and 96 shares of Cardinal preferred stock. If holders of 75% of the Heritage
common stock elect to receive cash, you will receive $80 in cash and 104
shares of Cardinal preferred stock.
Q: Will Cardinal pay dividends after the merger?
A: CARDINAL SHAREHOLDERS:
Because it is a new bank holding company, without a history of profitable
operations, Cardinal has paid no dividends on its common stock. Cardinal does
not expect to pay dividends on its common stock for the next several years.
I-2
<PAGE>
A: HERITAGE SHAREHOLDERS:
Heritage shareholders who receive shares of Cardinal preferred stock will be
entitled to annual dividends of 7.25% of the $5.00 per share liquidation value
of the preferred stock, or $0.3625 per share per year. The dividends will be
cumulative, which means that no dividends may be paid on Cardinal common stock
unless all dividends accrued on the Cardinal preferred stock have been paid.
The Cardinal board will use its discretion to decide whether and when to declare
dividends and in what amount, and it will consider all relevant factors in doing
so.
Q: When is the merger expected to be completed?
A: We are working to complete the merger during the third quarter of 2000.
Because the merger is subject, however, to regulatory approval, we cannot
predict the exact timing.
Q: What are the tax consequences of the merger to me?
A: HERITAGE SHAREHOLDERS:
We expect that the exchange of Heritage shares for Cardinal preferred stock
generally will be tax-free to Heritage shareholders for U.S. federal income tax
purposes. A Heritage shareholder who has a gain will have to pay taxes on cash
received up to the amount of the gain. To review the tax consequences to
Heritage shareholders in greater detail, see page I-17. Your tax consequences
may depend on your personal situation. You should consult your tax advisor for a
full understanding of the tax consequences of the merger to you.
CARDINAL SHAREHOLDERS:
The merger will have no tax consequences to Cardinal shareholders.
Q: What am I being asked to vote upon?
A: HERITAGE SHAREHOLDERS:
You are being asked to approve the merger agreement. Approval of the proposal
requires the vote of a majority of the shares of Heritage common stock that vote
on the merger.
CARDINAL SHAREHOLDERS:
You are being asked to approve the issuance of Cardinal preferred stock to
Heritage shareholders in the merger. You also are being asked to elect three
directors of Heritage to the Cardinal board of directors. Approval of each
proposal requires the affirmative vote of over 50% of the shares that vote at
the Cardinal meeting.
Q: What should I do now?
A: Just indicate on your proxy card how you want to vote, and sign and mail it
in the enclosed envelope as soon as possible, so that your shares will be
represented at your meeting.
If you sign and send in your proxy and do not indicate how you want to vote,
your proxy will be voted in favor of the proposal presented to you.
Q. Can I change my vote?
A: Yes. You can change your vote by submitting a later signed proxy or by
attending the special meeting and voting in person.
You may attend your shareholders' meeting and vote your shares in person, rather
than voting by proxy. In addition, you may withdraw your proxy up to and
including the day of your shareholders' meeting by following the directions on
pages II-1 through II-4 and either change your vote or attend your shareholders'
meeting and vote in person.
Q: If my shares are held in "street name" by my broker, will my broker vote my
shares for me?
A: No. Your broker will vote your shares of Heritage common stock or Cardinal
common stock only if you provide instructions on how to vote. You should
instruct your broker how to vote your shares, following the directions your
broker provides. If you do not provide instructions to your broker, your shares
will not be voted.
Q: Should I send in my stock certificates now?
I-3
<PAGE>
A: No. If you are a Heritage shareholder, after the merger is completed we
will send you written instructions for exchanging your Heritage common stock
certificates for cash and Cardinal preferred stock certificates.
If you are a Cardinal shareholder, the merger will not require you to take any
action regarding your Cardinal common stock certificates.
Q. May I dissent from the merger and seek an appraisal of the fair value of my
shares?
A: Yes. If you are a Heritage shareholder and you choose to dissent from the
merger, you are entitled to appraisal of your shares of Heritage common stock
under Virginia law. To exercise your appraisal rights you must strictly comply
with the procedures in Article 15 of Title 13.1 of the Virginia Stock
Corporation Act. If you do not strictly comply with these procedures you will
lose your appraisal rights. We have attached a copy of the relevant portions of
the Virginia Stock Corporation Act for dissenting shareholders as Appendix F of
this joint proxy statement/prospectus. See also "Appraisal Rights" on page I-19.
If you seek appraisal rights, the appraised value of your shares may be more or
less than the consideration to be paid by Cardinal in the merger.
Cardinal shareholders do not have appraisal rights under Virginia law in
connection with the merger.
[END OF TWO-COLUMN FORMAT]
WHO CAN HELP ANSWER YOUR QUESTIONS
If you want additional copies of this document, or if you want to ask
any questions about the merger, you should contact:
If you are a Cardinal shareholder:
L. Burwell Gunn, Jr.
President and Chief Executive Officer
Cardinal Financial Corporation
10555 Main Street, Suite 500
Fairfax, VA 22030
(703) 279-5060
If you are a Heritage shareholder:
Terrie G. Spiro
President and Chief Executive Officer
Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, VA 22101-3926
(703) 873-0320
I-4
<PAGE>
SUMMARY
This summary highlights selected information from this document and may
not contain all the information that is important to you. For a more complete
understanding of the merger and for a more complete description of the legal
terms of the merger, you should read this entire document carefully, as well as
the additional documents to which we refer you, including the merger agreement.
See "Where You Can Find More Information" on page VI-14. Each item in this
summary refers to the page where the subject is discussed in more detail.
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
The Companies (pages III-1 and IV-1)
Cardinal Financial Corporation
10555 Main Street, Suite 500
Fairfax, VA 22030
(703) 279-5060
Cardinal is a Virginia bank holding company that was incorporated in
1997. Cardinal owns three banks, headquartered in northern Virginia, which
opened in 1998 and 1999. Each of Cardinal's bank subsidiaries is a national bank
with deposits insured by the Federal Deposit Insurance Corporation. On March 31,
2000, Cardinal had total assets of $115.9 million, total deposits of $80.0
million, total loans of $81.4 million and shareholders' equity of $29.7 million.
Cardinal has not yet completed the start-up phase of its business plan. Its
oldest bank, which opened in June 1998, is barely two years old. Its second and
third banks have been open for less than one year each. Cardinal, as it
anticipated, sustained losses in 1998 and 1999. Cardinal also will report a net
loss in 2000. Cardinal expects that the merger will advance the time when
Cardinal becomes profitable.
Cardinal's common stock is listed and traded on The Nasdaq SmallCap
Market under the symbol "CFNL."
Cardinal has applied for the Cardinal preferred stock to be listed on
The Nasdaq SmallCap Market.
Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, VA 22101-3926
(703) 356-6610
Heritage is a Virginia bank holding company chartered in 1998. The
Heritage Bank, its bank subsidiary, is a Virginia commercial bank founded in
1987 and is a member of the Federal Reserve System. Its deposits are insured by
the Federal Deposit Insurance Corporation. Heritage's headquarters are in
McLean, Virginia. In addition to its main office, Heritage operates two branch
offices, opened in 1999 and May 2000, extending operations into the neighboring
areas of Loudoun County, Virginia and Tysons Corner, Virginia . On March 31,
2000, Heritage had total assets of $64.4 million, total deposits of $48.0
million, total loans of $36.0 million, and shareholders' equity of $8.6 million.
Heritage's common stock is listed and traded on The Nasdaq SmallCap
Market under the symbol "HBVA."
The Meetings (pages II-1 and II-2)
CARDINAL. The Cardinal meeting will be held at
___________________________, Virginia, at____ _.m., local time, on ________ __,
2000. At the Cardinal meeting, Cardinal shareholders will be asked to consider
and vote to authorize the issuance of Cardinal preferred stock to Heritage
shareholders in the merger. Cardinal shareholders also will be asked to elect
three of Heritage's directors to Cardinal's board of directors. These
individuals will become
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<PAGE>
directors of Cardinal only if the merger is completed.
HERITAGE. The Heritage meeting will be held at
________________________,Virginia, at _____ _.m., local time, on ________
__,2000. At the Heritage meeting, Heritage shareholders will be asked to
consider and vote upon a proposal to approve the merger agreement.
Votes Required (pages II-1 and II-2)
CARDINAL. Approval by the Cardinal shareholders of the issuance of
Cardinal preferred stock and election of three Heritage directors to the
Cardinal board will require the affirmative vote of holders of a majority of the
shares of Cardinal common stock voted at the Cardinal meeting.
HERITAGE. Approval by the Heritage shareholders of the merger
agreement will require the affirmative vote of a majority of the shares of
Heritage common stock that vote on the merger.
Record Date; Voting Power (pages II-1 and II-2)
CARDINAL. You are entitled to vote at the Cardinal meeting if you
owned shares on ________ __, 2000, the Cardinal record date. On that date, there
were _________ issued and outstanding shares of Cardinal common stock held by
approximately _____ holders of record. Cardinal shareholders are entitled to one
vote per share on any matter that may properly come before the Cardinal meeting.
HERITAGE. You are entitled to vote at the Heritage meeting if you
owned shares on ________ __, 2000, the Heritage record date. On that date, there
were _________ issued and outstanding shares of Heritage common stock held by
approximately _____ holders of record. Heritage shareholders are entitled to one
vote per share on any matter that may properly come before the Heritage meeting.
The Merger (page I-14)
The merger agreement provides that each share of Heritage common stock
will be converted into 1.2 shares of Cardinal preferred stock or $6.00 in cash
on the effective date of the merger. Half of the total consideration will be
cash and half will be Cardinal preferred stock. Accordingly, the 2,294,617
shares of Heritage common stock outstanding on May 24, 2000 will be converted
into $6.88 million in cash and approximately 1,376,770 shares of Cardinal
preferred stock. Fractional shares of Cardinal preferred stock will not be
issued, and Heritage shareholders will receive cash payment, without interest,
for the value of any fraction of a share of Cardinal preferred stock that they
would otherwise be entitled to receive, based upon the $5.00 liquidation value
per share of Cardinal preferred stock.
Each Heritage shareholder can elect to receive either $6.00 in cash or
1.2 shares of Cardinal's 7.25% Cumulative Convertible Preferred Stock, Series A,
for each share of Heritage common stock.
The merger agreement provides that total consideration given to
Heritage shareholders will be 50% cash and 50% Cardinal preferred stock. This
means that if holders of more than 50% of Heritage common stock elect to receive
Cardinal preferred stock, the amount of Cardinal preferred stock given to each
will be reduced and cash will be substituted. Reductions will be proportional.
Furthermore, if holders of more than 50% of Heritage common stock elect
to receive cash in the merger, the amount of cash given to each will be reduced
and shares of preferred stock will be substituted. Reductions will be
proportional.
Recommendations (pages I-15 through I-17)
The Cardinal board of directors and the Heritage board of directors
have each unanimously approved and adopted the merger agreement. The Heritage
board recommends a vote "FOR" approval of the merger agreement. The Cardinal
board recommends a vote "FOR"
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<PAGE>
the approval of issuing Cardinal preferred stock to Heritage shareholders in the
merger and "FOR" the election of three Heritage directors to the Cardinal board.
You also should refer to the board's reasons for the merger in determining
whether to approve and adopt the merger agreement on pages I-15 through I-17.
Reasons for the Merger (pages I-15 through I-17)
The Cardinal board and Heritage board each carefully considered the
merger decision. Each board had several reasons for approving the merger.
CARDINAL:
o By merging with Heritage, Cardinal will avoid the additional start-up
losses that would result from opening a fourth subsidiary bank. Heritage's
bank subsidiary already is profitable. Cardinal plans to increase its
profitability by substituting higher yielding loans for lower yielding
securities.
o The merger with Heritage will expand Cardinal's presence in Fairfax County,
a growing region of Virginia, and afford new expansion opportunities into
adjacent areas such as Loudoun County.
o The merger will allow Cardinal to spread administrative and operational
costs over a larger asset base and to realize a limited amount of direct
cost savings.
o The compatibility of Heritage and Cardinal, including community bank
operating philosophies and similarity of products and customer orientation.
HERITAGE:
o The terms of the merger agreement, including the per share value that
Heritage shareholders will receive, the ability to elect cash or Cardinal
preferred stock and the provisions that will put three Heritage directors
on the Cardinal board.
o The compatibility of Heritage's and Cardinal's community bank operating
philosophies and the similarity of products and customer orientation.
o An association with Cardinal will result in Heritage's participation in a
banking organization with seven offices in northern Virginia. The resulting
geographic diversification and economies of scale would enable Heritage to
compete more effectively in the financial services industry of the future.
o The representation of Ferris, Baker Watts, Incorporated to the board that
the merger consideration is fair from a financial point of view to the
Heritage shareholders.
o The expectation that the receipt of Cardinal preferred stock in the merger
will be tax-free for federal income tax purposes to Heritage and its
shareholders.
Opinion of Financial Advisors (pages I-28 and I-31)
At the April 17, 2000, meeting of the Heritage board, Ferris, Baker
Watts, Incorporated, financial advisor to Heritage, gave its opinion to the
Heritage board that as of that date, the merger was fair to the Heritage
shareholders from a financial point of view. Ferris, Baker Watts subsequently
confirmed its April 17, 2000 opinion by delivery to the Heritage board of a
written opinion dated as of the date of this document. A copy of the fairness
opinion, setting forth the information reviewed, assumptions made and matters
considered, is attached to this document as Appendix E. Heritage shareholders
should read the fairness opinion of Ferris, Baker Watts in its entirety.
Scott & Stringfellow, Inc., financial advisor to Cardinal, gave its
oral opinion to the Cardinal board that the merger is fair to Cardinal's
shareholders from a financial point of view. Scott & Stringfellow, Inc.
subsequently confirmed its opinion by delivery to the Cardinal board of a
written opinion dated as of the date of
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<PAGE>
this document. A copy of the opinion setting forth the information reviewed,
assumptions made and matters considered, is attached to this document as
Appendix C. Cardinal's shareholders should read the fairness opinion of Scott &
Stringfellow, Inc. in its entirety.
Appraisal Rights (page I-19)
Under Virginia law, a Heritage shareholder has the right to an
appraisal of the fair value of his or her shares in connection with the merger.
Cardinal shareholders do not have appraisal rights.
Cardinal to Use Purchase Accounting Treatment (page I-17)
We expect that the merger will be accounted for as a purchase.
Comparison of Shareholder Rights (page VI-4)
Both Cardinal and Heritage are corporations subject to the provisions
of the Virginia State Corporation Act. Heritage's shareholder's rights are
presently governed by Heritage's articles of incorporation and bylaws. Upon
consummation of the merger, Heritage's shareholders will become shareholders of
Cardinal and Heritage's shareholders' rights will be governed by the articles of
incorporation and bylaws of Cardinal.
There are material differences between the rights of a Heritage
shareholder under Heritage's articles of incorporation and bylaws and the rights
of a Cardinal shareholder under the articles of incorporation and bylaws of
Cardinal which are disclosed in the section "Comparative Rights of Shareholders"
on page VI-__.
Comparative Per Share Market Price Information (page I-41)
Heritage common stock is traded on The Nasdaq SmallCap Market under the
symbol "HBVA." On April 17, 2000, the last full trading day before the merger
was publicly announced, Heritage's common stock closed at $3.75.
No Cardinal preferred stock has been issued and Cardinal cannot predict
the price at which it will trade after the merger.
Cardinal common stock is traded on The Nasdaq SmallCap Market under the
symbol "CFNL." On April 17, 2000, the last full trading day before Heritage and
Cardinal issued a joint press release announcing the merger, Cardinal common
stock closed at $4.63. On ________ __, 2000, Cardinal common stock closed at
$_____.
Share Ownership of Management (pages V-4)
On the Cardinal record date, the executive officers and directors of
Cardinal, including their affiliates, had voting power with respect to an
aggregate of 604,449 shares of Cardinal common stock, or approximately 14.1% of
the shares of Cardinal common stock then outstanding.
On the Heritage record date, the executive officers and directors of
Heritage, including their affiliates, had voting power with respect to an
aggregate of 679,422 shares of Heritage common stock, or approximately 22.9% of
the shares of Heritage common stock then outstanding.
We expect that the directors and executive officers of Cardinal and
Heritage will vote their shares of Cardinal common stock "FOR" the approval of
the issuance of Cardinal preferred stock to Heritage shareholders and the
election of three Heritage directors to the Cardinal board and their shares of
Heritage common stock "FOR" the approval of the merger agreement.
Benefits to Management in the Merger (page I-36)
When considering the recommendation of the Heritage board, you should
be aware that some Heritage directors and officers have
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<PAGE>
interests in the merger that differ from the interests of other Heritage
shareholders. Three directors of Heritage, Harold E. Lieding, George P. Shafran
and Kevin B. Tighe, will become directors of Cardinal. Each Cardinal director
receives an option each year to purchase 2,000 shares of Cardinal common stock.
Options are granted at or above market value at the time of grant and have a ten
year term. Cardinal directors do not receive cash fees.
Messrs. Lieding, Tighe and Shafran, Phillip F. Herrick and Terrie G.
Spiro, President and Chief Executive Officer of Heritage and The Heritage Bank,
will continue as directors of The Heritage Bank after the merger. The Heritage
Bank will be changing its name to Cardinal Bank - Potomac. Jones V. Isaac, a
director of Cardinal, and up to seven additional individuals will be appointed
to the board of Cardinal Bank - Potomac by Cardinal. Directors fees to Messrs.
Lieding, Tighe, Shafran and Herrick will not be reduced as a result of the
merger. Currently, as directors of The Heritage Bank, they receive $500 per
month and $100 per committee meeting, with an annual maximum amount of $700 for
committee meeting attendance. In addition, members of the executive committee
receive an additional $250 per month. Ms. Spiro is not compensated for serving
as a director of The Heritage Bank.
Options to purchase a total of 30,500 shares of common stock of
Heritage at $5.00 per share were granted to the current directors on May 24,
2000. These grants represent the annual option awards for fiscal year 2000,
which were scheduled to be made at the end of this year. These grants were made
as follows: directors with 1-2 years of service were granted options for 2,000
shares; directors with 2-3 years of service were granted options for 3,500
shares; directors with over 4 years of service were granted options for 5,000
shares; and the chairman and vice chairman of the board each were granted an
option for 5,000 shares.
Heritage, with the concurrence of Cardinal, may agree to provide
certain key employees of The Heritage Bank with "stay bonuses" in the form of
cash payments and options for Heritage common stock as an inducement to these
employees to continue their services through or following the closing of the
merger. These cash payments are not expected to exceed $65,000 in the aggregate
and the option grants are not expected to exceed options for more than 10,000
shares.
Also, all outstanding options for shares of common stock of Heritage
issued to employees and directors of Heritage or The Heritage Bank under
Heritage's stock option plans will be converted as of the close of the merger to
options for common stock of Cardinal having equivalent values.
Within two days after the Heritage shareholders approve the merger, Ms.
Spiro will receive a lump sum payment of approximately $360,000 in satisfaction
of Heritage's obligations to pay change of control benefits under her employment
contract with Heritage.
The Heritage board was aware of these and other interests and
considered them before approving and adopting the merger agreement.
Transaction Structure
Heritage will merge into Cardinal Merger Corp., a wholly owned
subsidiary of Cardinal. Cardinal Merger Corp. was formed solely to facilitate
the merger. It has minimal assets and no liabilities.
The Heritage Bank
The Heritage Bank is Heritage's bank subsidiary. After the merger, it
will continue to operate as a separate bank, but will change its name to
Cardinal Bank - Potomac.
Conditions that Must Be Satisfied for the Merger to Occur (page I-37)
The following conditions must be met for us to complete the merger:
o approval by Cardinal shareholders of the issuance of Cardinal preferred
stock to
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<PAGE>
Heritage shareholders and election of three Heritage directors to the
Cardinal board;
o approval by Heritage shareholders of the merger agreement;
o the continuing effectiveness of Cardinal's registration statement filed
with the Securities and Exchange Commission;
o receipt of an opinion of Cardinal's counsel that the merger will be treated
for U.S. federal income tax purposes as a reorganization within the meaning
of Section 368 of the Internal Revenue Code of 1986, as amended.
We cannot complete the merger unless we obtain the approval of the
Board of Governors of the Federal Reserve System and the Virginia State
Corporation Commission. On ________ __, 2000, Cardinal filed applications with
the Federal Reserve Board and the Virginia State Corporation Commission. The
applications include a request for The Heritage Bank to pay a $3.0 million
dividend to Cardinal on the effective date. While we cannot predict whether or
when we will obtain all required regulatory approvals, we see no reason why the
approvals will not be obtained in a timely manner.
Unless prohibited by law, either Heritage or Cardinal could elect to
waive a condition that has not been satisfied and complete the merger anyway.
Termination of the Merger Agreement (page I-40)
We can mutually agree to terminate the merger agreement at any time
without completing the merger. Either company may also terminate the merger
agreement if:
o the merger is not completed on or before December 31, 2000;
o any event occurs which renders impossible, in a material way, the
satisfaction by one company of one or more of the conditions described
above, unless the other company waives such satisfaction; or
o other conditions to the closing of the merger have not been satisfied.
Effective Date Expected: Third Quarter of 2000 (page I-39)
The merger will become effective at the date and time stated on the
certificate of merger issued by the Virginia State Corporation Commission. We
anticipate the merger will take place in the third quarter of 2000.
[END OF TWO-COLUMN FORMAT]
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<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
We are providing the following information to help you analyze the
financial aspects of the merger. We derived this information from audited
financial statements for 1997 through 1999 and unaudited financial statements
for the three months ended March 31, 2000 and 1999. This information is only a
summary, and you should read it in conjunction with the information about
Cardinal that begins on page III-1, Cardinal's historical financial statements
in Appendix B, the information about Heritage that begins on page IV-1, and
Heritage's historical financial statements in Appendix D. You should not rely on
the three-month information as being indicative of results expected for the
entire year.
CARDINAL - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
2000 1999 1999 1998 1997
---------------------------------- -----------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $1,153 $607 $3,025 $1,216 $4
Net income (loss) (942) (824) (4,039) (1,696) (145)
Diluted net income per share (0.22) (0.19) (0.95) (0.64) (0.12)
Cash dividends per share -- -- -- -- --
Book value per share 7.01 8.02 7.25 8.19 7.28
Total assets 115,925 60,342 97,033 57,295 8,796
Shareholders' equity 29,730 34,020 30,745 34,728 8,551
</TABLE>
HERITAGE - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
2000 1999 1999 1998 1997
---------------------------------- -----------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $744 $739 $2,942 $2,494 $2,146
Net income 25 177 182 133 571
Diluted net income per share 0.01 0.08 0.08 0.07 0.44
Cash dividends per share -- -- -- -- --
Book value per share 3.73 3.94 3.75 3.89 3.18
Total assets 64,421 61,050 59,939 64,776 45,450
Shareholders' equity 8,568 9,031 8,598 8,928 4,730
</TABLE>
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<PAGE>
SELECTED UNAUDITED PRO FORMA COMBINED FINANCIAL DATA
The following table sets forth certain unaudited pro forma combined
financial data for Cardinal giving effect to the merger accounted for as a
purchase. This information should be read in conjunction with the historical
financial statements of Cardinal and Heritage, including respective notes to the
financial statements, appearing elsewhere in this joint proxy
statement/prospectus. See "Unaudited Pro Forma Condensed Financial Information"
on page I-21. The pro forma financial data may not be indicative of the results
that actually would have occurred had the merger been consummated on the dates
indicated or that may be obtained in the future.
As of and for the
--------------------------------------------
Three Months Ended Year Ended
March 31, December 31,
2000 1999
--------------------- ----------------------
(in thousands, except per share data)
Net interest income $ 1,805 $ 5,686
Net income (loss) (1,120) (4,536)
Diluted net income per common share (0.29) (1.19)
Cash dividends per common share -- --
Book value per common share 7.11 7.35
Total assets 178,839 N/A
Shareholders' equity 37,066 N/A
CONSOLIDATED RATIOS OF EARNINGS TO FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
The following table sets forth for Cardinal the consolidated ratios of
earnings to fixed charges and preferred stock dividends for the periods
indicated. Earnings represent income before income taxes plus fixed charges.
Fixed charges, excluding interest on deposits, represent interest expense on
borrowings and dividends paid on Cardinal preferred stock. Fixed charges,
including interest on deposits, represent all interest expense and dividends
paid on Cardinal preferred stock.
<TABLE>
<CAPTION>
Historical Pro Forma (Unaudited)
----------------------------------- --------------------------------------
Three Months Ended Year Ended
Year Ended December 31, March 31, December 31,
----------------------------------- ------------------ ---------------------
1999 1998 1997 2000 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Including interest on deposits (2.10x) (3.99x) (47.33x) 0.02x (0.51x)
Excluding interest on deposits (40.21x) (847.00x) (47.33x) (3.68x) (6.24x)
</TABLE>
The above ratios for the years ended December 31, 1999 and 1998
indicate that earnings were inadequate to cover fixed charges in the amount of
$4.0 million and $1.7 million, respectively.
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<PAGE>
RISK FACTORS THAT YOU SHOULD CONSIDER
In addition to the other information contained in this joint proxy
statement/prospectus, you should consider the following material risk factors
carefully before deciding how to vote at the special meeting. Please see
specifically the additional information in the "Cautionary Statement Concerning
Forward-Looking Statements" section on page VI-14.
Cardinal has not been profitable since it began banking operations in 1998 and
does not expect to be profitable in the near future.
Cardinal was incorporated in Virginia in 1997 and its first banking
subsidiary opened for business in June 1998. Three additional subsidiaries began
operations over the next two years. For the years ended December 31, 1999 and
1998, Cardinal had net losses of $4.0 million and $1.7 million, respectively.
Although the principal goal of Cardinal's business strategy is profitability,
Cardinal has not achieved this profitability to date and cannot assure its
future profitability.
Cardinal's management expects that the merger of Cardinal and Heritage
will accelerate the achievement of this future profitability. For the years
ended December 31, 1999 and 1998, Heritage had net income of $182,000 and
$133,000, respectively. Neither Cardinal nor Heritage, however, are able to make
any assurances as to the future profitability of The Heritage Bank.
If Cardinal's bank subsidiaries do not become profitable, it may not be able to
pay dividends on its preferred stock.
The Heritage Bank has filed a regulatory application for permission to
pay a $3.0 million dividend to Cardinal on the effective date of the merger. The
merger will not be completed unless The Heritage Bank receives regulatory
approval for the dividend. An important purpose of that dividend will be to
provide Cardinal with the cash that it will need to pay holding company level
expenses and to pay dividends on the Cardinal preferred stock. Those dividends
will total approximately $499,000 per year. Except for the $3.0 million dividend
to be received from The Heritage Bank, Cardinal does not expect to receive
dividends from its subsidiary banks in the near term. Without regulatory
approval, a Cardinal bank subsidiary cannot pay dividends to Cardinal until it
has recovered all of its start-up losses.
After 2003, Cardinal expects that it will need dividends from its bank
subsidiaries to continue to pay dividends on the Cardinal preferred stock. While
Cardinal expects that its bank subsidiaries will be able to pay dividends to
Cardinal sufficient to continue the preferred stock dividend, it cannot
guarantee that any dividend payments to Cardinal will be made. If Cardinal's
bank subsidiaries cannot pay dividends to Cardinal sufficient to cover
Cardinal's operating expenses and the preferred stock dividend, Cardinal would
attempt to raise cash by borrowing money or selling common stock. If it could
not borrow or sell common stock, it would suspend payment of the dividend on the
Cardinal preferred stock.
If Cardinal suspends the preferred stock dividend, it also could not
pay dividends on its common stock.
Cardinal and Heritage may not successfully integrate their respective business
operations.
Integrating the business operations of Cardinal and Heritage after the
merger may be difficult and time consuming. If we are unable to integrate our
businesses successfully, this could hurt our business and operating results.
Successful integration of Heritage's operations will depend on Cardinal's
ability to consolidate operations, systems and procedures to eliminate
redundancies and costs. Cardinal may encounter difficulties in the integration
process, such as the loss of key employees and customers, the disruption of
ongoing businesses or possible inconsistencies in standards, controls,
procedures and policies.
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<PAGE>
THE MERGER
The following is a summary description of the material terms of the
merger, and is qualified in its entirety by reference to the merger agreement,
which is attached as Appendix A to this joint proxy statement/prospectus. All
holders of Cardinal and Heritage common stock are urged to read the merger
agreement in its entirety.
Background
General. Cardinal and Heritage operate community banks in
geographically close, but separate markets in northern Virginia. Heritage's
subsidiary, The Heritage Bank operates two banking offices that serve
predominantly affluent urban markets in McLean and Sterling, Virginia. Heritage
opened a third banking office in Tyson's Corner, Virginia in May, 2000. Cardinal
operates three bank subsidiaries that serve predominantly urban markets in
Manassas, Reston and the Dulles Corridor and Fairfax, Virginia and had planned
to open a fourth located in Alexandria, Virginia. Cardinal also owns and
operates an investment subsidiary, Cardinal Wealth Services, Inc. Cardinal has
decided to suspend its charter application for Cardinal Bank -
Alexandria/Arlington, N.A. pending the merger with Heritage. Once the merger is
complete, The Heritage Bank will change its name to Cardinal Bank - Potomac and
will become the fourth Cardinal Bank and will operate the branch office that
Cardinal planned the Alexandria bank would have occupied. There are no
overlapping branch facilities. Heritage offers Cardinal a stable core business;
a cost of funds lower than Cardinal's; access to attractive markets adjacent to
Cardinal's; the opportunity for cross sales of products and services of Cardinal
Wealth Services, Inc.; and the liquidity and capital to diversify and serve
customers with higher borrowing needs. Cardinal offers Heritage systems, product
and consolidated operational support and access to rapidly growing markets with
strong loan demand. Each of Cardinal and Heritage offer to the other greater
diversification of assets and deposits, depth of management and greater
opportunity to enhance revenue and realize economies of scale.
In December 1999, Mr. Gunn from Cardinal met with Ms. Spiro from
Heritage to discuss the concept of a merger. The December 1999 discussions were
informal and preliminary. Discussions included the advantages of combining
entities and the practical difficulties of remaining independent and continuing
to be able to compete with large statewide and regional bank holding companies,
including challenges presented by increasing technology costs and costs
associated with offering non-deposit products and services. Heritage had planned
to make significant investments in systems and products in the year 2000. As a
new entity, Cardinal had already completed its investment in state of the art
products and systems. Cardinal engaged Scott & Stringfellow and Heritage engaged
Ferris, Baker Watts to prepare a financial analysis of possible combination. In
January 2000, Messrs. Gunn, and Rust and Ms. Spiro and Messrs. Lieding and
Shafran continued discussions that included possible board of directors
composition, management structure, products, strategic alignment of branches,
computer systems and growth plans. A number of negotiating sessions took place
between the parties over the course of the next several months with
representatives of Scott & Stringfellow and Ferris, Baker Watts along with
counsel for both entities attending. The meetings consisted of discussions of
financial analyses of Cardinal and Heritage, as combined. The boards of the
respective institutions met on several occasions during this time period to
discuss and amend various terms including the exchange ratio, the preferred
dividend, the change of control provisions of Ms. Spiro's contract and other
costs, terms and conditions. Discussions continued into April of 2000 as the
main issue centered around the pricing of the transaction and on several
occasions talks were suspended and it appeared unlikely that the parties would
be able to agree on final terms of an affiliation in a time frame consistent
with Cardinal's need for a decision on opening its approved, but not yet
chartered Alexandria affiliate bank.
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<PAGE>
In mid-April 2000 however, Cardinal represented by Messrs. Gunn and
Rust and Heritage represented by Ms. Spiro and Messrs. Lieding and Shafran
reached agreement, subject to their respective boards' approval, on the
structure of the merger and on all key issues involving management and board
representation. The Cardinal board met on Friday April 14th and offered Heritage
the terms so agreed to. The Heritage board met on Monday the 17th of April and
approved the offer and executed the merger agreement.
Cardinal and Heritage subsequently agreed to revise the terms of the
merger so that Heritage would merge with a subsidiary of Cardinal that was
created only for that purpose. The reason that the parties agreed to this
restructuring was to be sure that Cardinal shareholders would not have
dissenters' rights. If the parties had provided Cardinal's shareholders with
dissenters' rights and if there were a substantial number of dissenting Cardinal
shareholders, cash payments to those shareholders could have adversely affected
the regulatory approvals sought by Cardinal and Heritage in connection with the
merger and thus the consummation of the merger. On June __, 2000, the Cardinal
board and the Heritage board executed an amended and restated merger agreement
that reflects this restructuring.
Cardinal's Reasons for the Merger
In deciding to enter into the merger agreement, the Cardinal board
considered a number of factors. The Cardinal board did not assign any relative
or specific weights to the factors considered. The principal factors that led
the Cardinal board to approve the merger were:
Earnings. Cardinal's strategy of forming separate community banks in
northern Virginia has involved start-up losses for Cardinal and each of its
three subsidiary banks. Cardinal projected that the fourth proposed Cardinal
Bank - Alexandria/Arlington, N.A. would experience a first year loss of
approximately $1.1million. In contrast, The Heritage Bank is profitable. By
combining Cardinal's proposed Alexandria/Arlington operations with Heritage's
existing operations, Cardinal expects to avoid additional start-up losses and
reach profitability sooner than would without the merger.
Liquidity and Loan Demand. Cardinal believes that its strong loan
growth will not slow in the immediate future. Due to Cardinal's higher cost of
funds, it can profitably employ the available liquidity at Heritage. As of March
31, 2000, Cardinal's loan to deposit ratio was 101.8% compared to Heritage's
loan to deposit ratio of 75.0%. From March 31, 1999 to March 31, 2000,
Cardinal's total assets have increased from $60.3 million to $115.9 million
(92.2%), deposits increased from $25.9 million to $80.0 million (208.9%) and net
loans increased from $21.8 million to $80.6 million (270.3%). In the same
period, Heritage's total assets increased by 5.5% and deposits decreased by
5.1%, while net loans increased by 24.4%. Heritage's strength has been its
stable deposit base while Cardinal's strength has been its strong loan
generation. Heritage has approximately $23.8 million in securities that can be
reinvested in higher yielding loans.
Operating Efficiencies. Cardinal operates its bank and non-bank
subsidiaries through a consolidated back office. Cardinal anticipates that the
addition of Heritage will provide opportunities for increased operating
efficiency as The Heritage Bank's back office is consolidated into Cardinal's.
The consolidation with Cardinal will eliminate the need for Heritage to upgrade
its internal systems at significant cost, compared to a less costly expansion of
Cardinal's system.
Local Autonomy. The Heritage Bank will continue to operate with a large
degree of autonomy, under a board of directors comprised of current directors of
Cardinal, Cardinal's proposed Alexandria affiliate bank directors and five
directors of The Heritage Bank.
Cardinal considered other material factors including: the consideration
offered for Heritage common stock; the market value of Cardinal common stock;
the dividend to be paid on the Cardinal preferred stock; the financial condition
and history of performance of Cardinal and Heritage; diversification of risk
associated with ownership of an institution with a broader geographic market
area; the well capitalized position and earnings of Heritage; and the
compatibility of the managements of the two organizations. The Cardinal board
believes that the addition of the resources it will provide to Heritage will
enable the new Cardinal Bank formed out of Heritage to provide a wider and
improved array of financial services to consumers and businesses and to achieve
added flexibility in dealing with the changing competitive environment in their
market areas.
I-15
<PAGE>
The Cardinal board has concluded that the terms of the merger
agreement, which were determined on the basis of arms-length negotiations, are
fair to Cardinal shareholders. As explained below, this conclusion is supported
by the opinion of an independent financial advisor. In establishing the merger
consideration, the Cardinal board also considered the merger consideration in
relation to the market value of Cardinal common stock and Heritage common stock;
information concerning the financial condition, results of operations and the
prospects of Cardinal and Heritage; and the tax-free nature of the merger to the
shareholders of Heritage to the extent they receive Cardinal preferred stock in
exchange for their shares of Heritage common stock.
Following the effective date, Messrs. Lieding, Herrick, Tighe, Shafran,
Gunn, Rust, Isaac, Tech, Lockwood, Kell, Anderson, DeCarlo and Broadwater and
Ms. Spiro are expected to serve as directors of Cardinal Bank-Potomac.
The board of directors of Cardinal believes that the merger is in the
best interests of Cardinal and its shareholders. The Cardinal directors have all
committed to vote shares under their control in favor of the merger to the
extent of their fiduciary ability. The Cardinal directors unanimously recommend
that Cardinal shareholders vote "FOR" the approval of the issuance of Cardinal
preferred stock to Heritage shareholders and "FOR" the election of three
Heritage directors to the Cardinal board of directors.
Heritage's Reasons for the Merger
The terms of the merger agreement, including the merger consideration
of $6.00 per share of Heritage common stock to be paid in a combination of
preferred stock and cash, were the result of an arms length negotiation between
Heritage and Cardinal. Heritage consulted with its special legal counsel,
Thacher Proffitt & Wood, and its financial advisor, Ferris, Baker Watts during
the negotiations. The Heritage board considered various factors in determining
that the merger was fair and in the best interests of Heritage and its
shareholders. The Heritage board did not assign any specific weights to the
factors considered. In considering the factors described below, individual
members of the Heritage board may have given different weights to different
factors. Among other things, the Heritage board considered:
o the premium presented by the consideration offered to Heritage's
shareholders in relation to the current trading price of Heritage's
common stock;
o favorable terms of the preferred stock as it relates to dividend
and conversion features;
o the fact that Heritage will be combining with a Virginia-based
holding company and that The Heritage Bank will remain a subsidiary
of Cardinal, with a name change to denote its location;
o the probable impact of the merger on the customers and the
communities served by Heritage and Cardinal and Cardinal's
willingness to retain Heritage's employees and provide certain
benefits to these employees;
o the fact that Heritage will appoint three directors to serve on
Cardinal's board and five directors to serve on the board of The
Heritage Bank following the consummation of the merger;
o the potential for expansion of products and services that may be
offered to the customers of Cardinal and Heritage, on a combined
basis;
I-16
<PAGE>
o the increasingly competitive environment in which financial
institutions operate and the uncertain economic regulatory and
legal environment affecting financial institutions such as
Heritage;
o the increasing consolidation of financial institutions which has
resulted in fewer potential acquirors for Heritage;
o the potential for greater liquidity and potential market
appreciation for Cardinal's common stock, as compared to Heritage's
common stock;
o the large and growing investment in technology that is needed to
compete with larger banks; and
o the opinion of Ferris, Baker Watts that the merger consideration is
fair from a financial point of view to Heritage's shareholders.
Accounting Treatment
The merger will be accounted for by Cardinal as a purchase. Under the
purchase method, the assets and liabilities of Heritage will be recorded on the
books of Cardinal at their respective fair values as of the effective date of
the merger. The excess of value of consideration paid by Cardinal over the fair
value of Heritage's specifically identifiable tangible and intangible assets
acquired less liabilities assumed is considered goodwill, which is expected to
be amortized over 15 years. Cardinal's consolidated results of operations will
include the results of Heritage after the effective date of the merger.
Material Federal Income Tax Consequences of the Merger
The following is a discussion of all material federal income tax
consequences of the merger under the Internal Revenue Code of 1986, as amended,
to Heritage shareholders. The discussion does not deal with all aspects of
federal taxation that may be relevant to particular Heritage shareholders.
Certain tax consequences of the merger may vary depending upon the particular
circumstances of each Heritage shareholder and other factors.
You are urged to consult with your tax advisor to determine the
particular tax consequences of the merger to you.
This summary is based on current law and the advice of Williams,
Mullen, Clark & Dobbins, legal counsel to Cardinal. The advice in this summary
assumes that Heritage shareholders hold their shares as capital assets and is
based on, among other things, certain customary assumptions and representations
relating to certain facts and circumstances of, and the intentions of the
parties to the merger. Neither Cardinal nor Heritage has requested a ruling from
the Internal Revenue Service in connection with the merger. To meet a condition
to consummation of the merger, Cardinal and Heritage will receive from Williams,
Mullen, Clark & Dobbins an opinion as to certain federal income tax consequences
of the merger. This opinion is not binding on the Internal Revenue Service.
In the opinion of Williams, Mullen, Clark & Dobbins the merger will
constitute a tax-free reorganization under Section 368(a) of the Internal
Revenue Code, if consummated in the manner set forth in the merger agreement.
Accordingly, among other things, in the opinion of such counsel:
I-17
<PAGE>
o The merger will constitute a reorganization within the meaning of
Section 368(a) of the Internal Revenue Code;
o No gain or loss will be recognized by Cardinal or Heritage as a
result of the merger;
o No gain or loss will be recognized by a Heritage shareholder who
receives solely Cardinal preferred stock in exchange for all of
such shareholder's shares of Heritage common stock (except to the
extent such a shareholder receives cash in lieu of a fractional
share interest in Cardinal preferred stock). The aggregate tax
basis of the Cardinal preferred stock received by such shareholder
will be the same as the aggregate tax basis of the Heritage common
stock surrendered in exchange therefor, reduced by any amount
allocable to a fractional share interest of Cardinal preferred
stock received will include the holding period of the share of
Heritage common stock exchanged therefor.
o A Heritage shareholder who received both Cardinal preferred stock
and cash in exchange for all of such shareholder's shares of
Heritage common stock will recognize capital gain, but not loss, to
the extent of the less of:
(i) the excess of (A) the sum of the fair market value of the
Cardinal preferred stock and the amount of cash received by
such shareholder over (B) the shareholder's aggregate tax
basis for the shares of Heritage common stock exchanged
therefor; and
(ii) the amount of cash received by such shareholder.
Any such gain will be long-term capital gain if such shares of
Heritage common stock were held for more than one year. The
aggregate tax basis of the Cardinal preferred stock received by
such shareholder will equal such shareholder's aggregate tax basis
of the Heritage common stock surrendered in exchange therefor,
reduced by any amount allocable to a fractional share interest of
Cardinal preferred stock for which cash is received and by the
amount of other cash received, and increased by the amount of any
gain recognized, by such shareholder in the merger. Such
shareholder's holding period of each share of Cardinal preferred
stock received will include the holding period of the share of
Heritage common stock exchanged therefor.
o A Heritage shareholder who receives solely cash in exchange for all
such shareholder's shares of Heritage common stock will recognize
capital gain or capital loss in an amount equal to the difference
between the amount of cash received and the shareholder's aggregate
tax basis for such shares of Heritage common stock, which gain or
loss will be long-term capital gain or loss if such shares of
Heritage common stock were held for more than one year.
o In certain limited situations, the receipt of cash in the merger,
or a sale or redemption of Cardinal preferred stock received in the
merger by a shareholder who owns shares of Heritage common stock at
the effective time, may be treated as a dividend and taxed as
ordinary income. Heritage shareholders should consult their tax
advisors as to the possibility that all or a portion of any cash
received in exchange for their shares of Heritage common stock, or
that a sale or redemption of the Cardinal preferred stock received
in the merger, will be treated as a dividend.
I-18
<PAGE>
o Based upon the current ruling position of the IRS, a Heritage
shareholder who received cash in lieu of a fractional share
interest will be treated as having received such fractional share
pursuant to the merger and then as having exchanged such fractional
share for cash in a redemption by Cardinal subject to Section 302
of the Code. Such a deed redemption will be treated as a sale of
the fractional share, provided that it is not "essentially
equivalent to a dividend." A Heritage shareholder will generally
recognize capital gain or loss on such a deemed redemption of the
fractional share in an amount determined by the excess of the
amount of cash received therefor and the shareholder's tax basis in
the fractional share. Any such capital gain or loss will be
long-term capital gain or loss if the Heritage common stock
exchanged was held for more than one year.
Appraisal Rights
General. Shareholders of a corporation that is proposing to merge or
consolidate with another entity are sometimes entitled under relevant state laws
to appraisal or dissenters' rights in connection with the proposed transaction
depending on the circumstances. This right generally confers on shareholders who
oppose a merger or the consideration to be received in a merger the right to
receive, in lieu of the consideration being offered in the merger, the fair
value for their shares as provided for in the statute.
Cardinal shareholders do not have dissenters' appraisal rights in
connection with the merger under Virginia law. Heritage shareholders, however,
are entitled to dissenters' appraisal rights in connection with the merger under
Virginia law.
Any shareholder of Heritage common stock who objects to the merger and
who complies with provisions of Article 15 of Title 13.1 of the Virginia SCA
("Article 15") may demand the right to receive a cash payment, if the merger is
consummated, for the fair value of his or her stock immediately before the
merger effective date, exclusive of any appreciation or depreciation in
anticipation of the merger unless such exclusion would be inequitable. In order
to receive payment, a dissenting shareholder must deliver to Heritage prior to
the Heritage special meeting a written notice of intent to demand payment for
his or her shares if the merger is consummated and must not vote his or her
shares in favor of the merger. The intent to demand payment should be addressed
to Janet A. Valentine, Secretary, Heritage Bancorp, Inc., 1313 Dolley Madison
Boulevard, McLean, Virginia 22101.
A shareholder of record of Heritage common stock may assert dissenters'
rights as to fewer than all the shares registered in his or her name only if the
shareholder dissents with respect to all shares beneficially owned by any one
person and notifies Heritage in writing of the name and address of each person
on whose behalf he or she asserts dissenters' rights. The rights of such a
partial dissenter are determined as if the shares to which he or she dissents
and his or her other shares were registered in the names of different
shareholders. A beneficial shareholder of Heritage common stock may assert
dissenters' rights as to shares held on his or her behalf by a shareholder of
record only if the individual (i) submits to Heritage the record shareholder's
written consent to the dissent not later than the time when the beneficial
shareholder asserts dissenters' rights, and (ii) dissents with respect to all
shares of which he or she is the beneficial shareholder or over which he or she
has power to direct the vote.
Within 10 days after the effective date of the merger, Cardinal is
required to deliver a notice in writing to each dissenting shareholder who has
filed an intent to demand payment and who has not voted such shares in favor of
the merger. The notice will (i) state where the payment demand must be sent and
where and when stock certificates shall be deposited; (ii) supply a form for
demanding payment; (iii) set a date by which Cardinal must receive the payment
demand; and (iv) be accompanied by a copy of Article 15. A dissenting
shareholder who is sent a dissenter's notice must submit the payment demand and
deposit his or her stock certificates in accordance with the terms of, and
within the time frames set forth
I-19
<PAGE>
in, the dissenter's notice. As a part of the payment demand, the dissenting
shareholder must certify whether he or she acquired beneficial ownership of the
shares before or after the date of the first public announcement of the terms of
the proposed merger, which was April 18, 2000. Cardinal will specify the
announcement date in the dissenter's notice.
Except with respect to shares acquired after the announcement date,
Cardinal will pay a dissenting shareholder the amount Cardinal estimates to be
the fair value of his or her shares, plus accrued interest. This payment will be
made within 30 days of receipt of the dissenting shareholder's payment demand.
The payment will be accompanied by (i) Cardinal's balance sheet as of the end of
the fiscal year ending not more than 16 months before the effective date of the
corporate action creating the dissenter's right, an income statement for that
year, a statement of changes in shareholders' equity for that year, and the
latest available interim financial statements; (ii) an explanation of how
Cardinal estimated the fair value of the shares and how the interest was
calculated; (iii) a statement of the dissenter's right to demand payment under
Article 15; and (iv) a copy of Article 15. As to shares acquired after the
announcement date, Cardinal is only obligated to estimate the fair value of the
shares, plus accrued interest, and to offer to pay this amount to the dissenting
shareholder conditioned upon the dissenting shareholder's agreement to accept it
in full satisfaction of his or her claim.
If a dissenting shareholder believes that the amount paid or offered by
Cardinal is less than the fair value of his or her shares, or that the interest
due is incorrectly calculated, that dissenting shareholder may notify Cardinal
of his or her own estimate of the fair value of his or her shares and amount of
interest due and demand payment of such estimate (less any amount already
received by the dissenting shareholder). The dissenting shareholder must notify
Cardinal of the estimate and demand within 30 days after the date Cardinal makes
or offers to make payment to the dissenting shareholder.
Within 60 days after receiving the estimate and demand, Cardinal must
either commence a proceeding in the appropriate circuit court to determine the
fair value of the dissenting shareholder's shares and accrued interest, or
Cardinal must pay each dissenting shareholder whose demand remains unsettled the
amount demanded. If a proceeding is commenced, the court must determine all
costs of the proceeding and must assess those costs against Cardinal, except
that the court may assess costs against all or some of the dissenting
shareholders to the extent the court finds that the dissenting shareholders did
not act in good faith in demanding payment of the dissenting shareholder's
estimates.
The foregoing discussion is a summary of the material provisions of
Article 15. Shareholders are strongly encouraged to review carefully the full
text of Article 15, which is included as Appendix F to this joint proxy
statement/prospectus. The provisions of Article 15 are technical and complex,
and a shareholder failing to comply strictly with them may forfeit his or her
dissenting rights. Any shareholder who intends to dissent from the merger should
review the text of those provisions carefully and also should consult with his
or her attorney. No further notice of the events giving rise to dissenters'
rights or any steps associated therewith will be furnished Heritage shareholders
except as indicated above or otherwise required by law.
Any dissenting shareholder who perfects his or her right to be paid the
fair value of his or her shares will recognize gain or loss, if any, for federal
income tax purposes upon the receipt of cash for his or her shares. The amount
of gain or loss and its character as ordinary or capital gain or loss will be
determined in accordance with applicable provisions of the Internal Revenue
Code. See "- Federal Income Tax Matters."
I-20
<PAGE>
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION
The following unaudited pro forma condensed financial statements have
been prepared on a consolidated basis based upon the historical financial
statements of Cardinal and Heritage. The pro forma combined information gives
effect to the merger, accounted for as a purchase, and is based on the issuance
of 1,376,770 shares of Cardinal preferred stock and the payment of $6,883,851 in
cash in the merger, which in turn is based on the number of shares of Heritage
common stock outstanding at May 17, 2000. Accordingly, the assets and
liabilities of Heritage have been recorded on Cardinal's books at their fair
market value and Heritage's capital accounts have been eliminated. The amount by
which the sum of the cash paid by Cardinal and the fair value of the Cardinal
preferred stock issued in the merger exceeds the net fair value of Heritage's
assets and liabilities has been allocated to goodwill.
The pro forma statement of condition combines the balance sheet of
Cardinal and Heritage as of March 31, 2000. The pro forma statements of
operations for the three months ended March 31, 2000 and for the year ended
December 31, 1999 combine the results of operations of Cardinal and Heritage for
the respective periods. The pro forma statement of condition and statement of
operations for the three months ended March 31, 2000 are based on unaudited
financial statements, and the pro forma statement of operations for the year
ended December 31, 1999 is based on audited financial statements, all of which
are included elsewhere in this joint proxy statement/prospectus.
The pro forma financial statements should be read in conjunction with
the historical financial statements and the related notes of Cardinal in
Appendix B and of Heritage in Appendix D. There are no adjustments necessary to
the historical results of operations as a result of these transactions. The pro
forma combined financial position and results of operations are not necessarily
indicative of the results which would actually have been attained if the
Heritage merger had occurred in the past or which may be attained in the future.
The pro forma combined condensed financial statements also do not take
into account the following items which will impact the financial condition,
results of operations and reported per share amounts of Cardinal.
o Losses from March 31, 2000 to the actual closing date of the
transaction.
o Estimated expense savings to be derived from, among other things,
the termination of certain Heritage executive officers, elimination
of duplicate backroom operations and conversion to Cardinal's data
processing system.
o Expected revenue enhancements from selling Heritage's investment
securities and investing the funds in higher yielding loans
receivable.
I-21
<PAGE>
CARDINAL AND HERITAGE
PRO FORMA COMBINED CONDENSED STATEMENT OF CONDITION
MARCH 31, 2000
(Unaudited)
<TABLE>
<CAPTION>
Pro Forma
Cardinal Heritage Adjustments Combined
------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Assets
Cash and due from banks $ 4,180 $ 2,990 (1,375) (A) $ 5,795
Federal funds sold 20,378 -- (6,884) (C) 13,494
Investment securities, available-for-sale 4,620 23,764 -- 28,384
Loans receivable, net 80,575 35,649 (414) (C) 115,810
Premises and equipment, net 4,476 872 -- 5,348
Goodwill -- -- 7,166 (C) 7,166
Other assets 1,696 1,146 -- 2,842
------------------------------------------------------------------------------
Total assets $ 115,925 $ 64,421 (1,507) $ 178,839
==============================================================================
Liabilities and Stockholders' Equity
Liabilities:
Deposits 80,010 48,033 (75) (C) 127,968
Borrowings 6,000 7,603 -- 13,603
Other liabilities 185 217 -- 402
------------------------------------------------------------------------------
Total liabilities 86,195 55,853 (75) 141,973
------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock -- -- 6,884 (B) 6,884
Common stock 4,243 2,295 (2,295) (B) 4,243
Additional paid in capital 32,498 6,530 (6,078) (B) 32,950
Retained earnings (6,823) 235 (435) (B) (7,023)
Accumulated other comprehensive income (loss) (188) (492) 492 (B) (188)
------------------------------------------------------------------------------
Total stockholders' equity 29,730 8,568 (1,432) 36,866
------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 115,925 $ 64,421 $ (1,507) $ 178,839
==============================================================================
</TABLE>
I-22
<PAGE>
CARDINAL AND HERITAGE
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THREE MONTHS ENDED MARCH 31, 2000
(Unaudited)
<TABLE>
<CAPTION>
Pro Forma
Cardinal Heritage Adjustments Combined
------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Interest income:
Loans $ 1,529 $ 725 35 (D) $ 2,289
Federal funds sold 287 7 (108) (D) 186
Investment securities 88 386 -- 474
------------------------------------------------------------------------------------
Total interest income 1,904 1,118 (73) 2,949
------------------------------------------------------------------------------------
Interest expense:
Deposits 655 330 19 (D) 1,004
Borrowings 96 44 -- 140
------------------------------------------------------------------------------------
Total interest expense 751 374 19 1,144
------------------------------------------------------------------------------------
Net interest income 1,153 744 (92) 1,805
Provision for loan losses 143 (28) -- 115
------------------------------------------------------------------------------------
Net interest income after provision for
loan losses 1,010 772 (92) 1,690
------------------------------------------------------------------------------------
Non-interest income:
Service charges 84 46 -- 130
Investment fee income 313 -- -- 313
Other 27 (13) -- 14
------------------------------------------------------------------------------------
Total non-interest income 424 33 -- 457
------------------------------------------------------------------------------------
Non-interest expense:
Salary and benefits 1,363 319 -- 1,682
Occupancy 221 105 -- 326
Professional fees 102 62 -- 164
Depreciation 129 64 -- 193
Amortization of Goodwill -- -- 119 (D) 119
Other 561 218 -- 779
------------------------------------------------------------------------------------
Total non-interest expense 2,376 768 119 3,263
------------------------------------------------------------------------------------
Income (loss) before income taxes (942) 37 (211) (1,116)
Provision for income taxes -- 12 (12) (D) --
------------------------------------------------------------------------------------
Net income (loss) $ (942) $ 25 (199) $ (1,116)
====================================================================================
Dividend to preferred stockholders -- -- 125 (E) 125
Net income (loss) to
common stockholders $ (942) $ 25 (324) $ (1,241)
====================================================================================
Earnings per common share:
Basic $ (0.22) $ 0.01 (E) $ (0.29)
Diluted $ (0.22) $ 0.01 (E) $ (0.29)
Weighted average shares outstanding:
Basic 4,242,634 2,294,617 (E) 4,242,634
Diluted 4,242,634 2,296,405 (E) 4,242,634
</TABLE>
I-23
<PAGE>
CARDINAL AND HERITAGE
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR YEAR ENDED DECEMBER 31, 1999
(Unaudited)
<TABLE>
<CAPTION>
Pro Forma
Cardinal Heritage Adjustments Combined
-------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Interest income:
Loans $ 2,661 $ 2,690 138 (D) $ 5,489
Federal funds sold 1,234 277 (344) (D) 1,167
Investment securities 435 1,414 -- 1,849
-------------------------------------------------------------------------------------
Total interest income 4,330 4,381 (206) 8,505
-------------------------------------------------------------------------------------
Interest expense:
Deposits 1,207 1,342 75 (D) 2,624
Borrowings 98 97 -- 195
-------------------------------------------------------------------------------------
Total interest expense 1,305 1,439 75 2,819
-------------------------------------------------------------------------------------
Net interest income 3,025 2,942 (281) 5,686
Provision for loan losses 514 -- -- 514
-------------------------------------------------------------------------------------
Net interest income after provision for
loan losses 2,511 2,942 (281) 5,172
-------------------------------------------------------------------------------------
Non-interest income:
Service charges 268 164 -- 432
Investment fee income 1,018 -- -- 1,018
Other 35 58 -- 93
-------------------------------------------------------------------------------------
Total non-interest income 1,321 222 -- 1,543
-------------------------------------------------------------------------------------
Non-interest expense:
Salary and benefits 4,277 1,472 -- 5,749
Occupancy 812 328 -- 1,140
Professional fees 495 176 -- 671
Depreciation 356 146 -- 502
Amortization of Goodwill -- -- 478 (D) 478
Other 1,931 767 -- 2,698
-------------------------------------------------------------------------------------
Total non-interest expense 7,871 2,889 478 11,238
-------------------------------------------------------------------------------------
Income (loss) before income taxes (4,039) 275 (759) (4,523)
Provision for income taxes -- 93 (93) (D) -
-------------------------------------------------------------------------------------
Net income (loss) $ (4,039) $ 182 (666) $ (4,523)
=====================================================================================
Dividend to Preferred stockholders -- -- 499 (E) 499
Net income (loss) to common
stockholders $ (4,039) $ 182 (1,165) $ (5,022)
=====================================================================================
Earnings per common share:
Basic $ (0.95) $ 0.08 (E) $ (1.18)
Diluted $ (0.95) $ 0.08 (E) $ (1.18)
Weighted average shares outstanding:
Basic 4,240,819 2,294,617 (E) 4,240,819
Diluted 4,240,819 2,301,548 (E) 4,240,819
</TABLE>
I-24
<PAGE>
Notes to Pro Forma Combined Financial Information
The merger will be accounted for by Cardinal using the purchase method
of accounting in accordance with Accounting Principles Board Opinion ("APB") No.
16 and Statement of Financial Accounting Standards ("SFAS" No. 72). Under this
method, the aggregate cost of the merger will be allocated to assets acquired
and liabilities assumed based on their estimated fair values as of the closing
date. For purposes of pro forma presentation, estimates of the fair values of
Heritage's assets and liabilities as of March 31, 2000, have been combined with
the book values of Cardinal's assets and liabilities as of March 31, 2000.
(A) As part of the transaction, Cardinal expects to incur, on a pre-tax
basis, $375,000 in transaction costs, primarily for professional
expenses, including financial advisory, legal and accounting fees.
Additionally, it is estimated that Heritage will incur, on a pre-tax
basis, $800,000 in transaction costs, including financial advisory,
legal, accounting and contract termination costs. Cardinal also expects
to incur nonrecurring charges of $200,000 as a result of the merger
during the 12 months after its closing. These charges are included in
the pro forma combined condensed statement of condition, but are not
considered in the pro forma combined condensed statement of operations.
(B) As stated in the merger agreement, Cardinal will issue 1,376,770 shares
of 7.25% cumulative, convertible preferred stock valued at $5 per share
and cash of $6,884,000 to Heritage's shareholders. Cardinal will issue
Cardinal stock options for vested Heritage stock options with terms
based on the merger consideration.
The following table details the adjustments to stockholders' equity
based on the assumed purchase price:
<TABLE>
<CAPTION>
Accumulated
Other
Preferred Common Paid-In Retained Comprehensive
Stock Stock Capital Earnings Income
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Elimination of Heritage's stockholders' equity - (2,295) (6,530) (235) 492
Issuance of Cardinal stock options for
Heritage carryover stock options - - 452 - -
Issuance of Cardinal convertible preferred stock 6,884 - - - -
Nonrecurring charges subsequent to merger - - - (200) -
-------------------------------------------------------------
Total pro forma adjustment 6,884 (2,295) (6,078) (435) 492
</TABLE>
(C) The purchase price is allocated to identifiable tangible and intangible
assets at their fair values. Although not included here, a core deposit
intangible is expected to be identified. Any portion of the purchase
price that cannot be assigned to specifically identifiable tangible and
intangible assets acquired less liabilities assumed is considered
goodwill, which is expected to be amortized over 15 years.
The following table provides a reconciliation of the excess cost of the
merger to Cardinal over the fair value of net assets acquired from
Heritage (in thousands):
I-25
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Cash to be paid by Cardinal $ 6,884
Value of preferred stock to be issued by Cardinal 6,884
Fair value of 138,420 Cardinal stock options issued for Heritage carryover options 452
Cardinal transaction costs 375
---------------
14,595
Less:
Stockholders' equity of Heritage 8,568
Fair value adjustments, net (339)
Heritage transaction costs (800)
---------------
Cost in excess of fair value of net assets acquired $ 7,166
===============
</TABLE>
The fair value adjustments as of March 31, 2000 were calculated for
loans receivable and deposits. Loans receivable were decreased by
approximately $414,000, while deposits were decreased by $75,000. The
fair values ultimately recorded by Cardinal may be materially different
from the values indicated due to (a) changes in future interest rates
and economic conditions beyond the control of management, (b) changes
in the composition of Heritage's assets and liabilities, and (c)
refinements to the underlying assumptions made by Cardinal.
(D) The purchase accounting adjustments, including the recording of
goodwill have the following impact on the unaudited pro forma combined
condensed statements of operations:
Interest income on loans receivable in the unaudited pro forma combined
condensed statements of operations for the three months ended March 31,
2000, and the year ended December 31, 1999, is increased by $35,000 and
$138,000, respectively, reflecting the amortization of the discount
calculated on loans receivable using the level yield method over the
estimated life of 36 months.
Interest income on federal funds sold in the unaudited pro forma
combined condensed statements of operations for the three months ended
March 31, 2000, and the year ended December 31, 1999, is decreased by
$108,000 and $344,000, respectively, reflecting the decrease in federal
funds sold due to the pay out of $6,884,000 in cash to Heritage
shareholders.
Interest expense on deposits in the unaudited pro forma combined
condensed statements of operations for the three months ended March 31,
2000, and the year ended December 31, 1999, is increased by $19,000 and
$75,000, respectively, to reflect amortization of the discount on
certificates of deposit using the level yield method over the estimated
life of 12 months.
Goodwill amortization expense in the unaudited pro forma combined
condensed statements of operations for the three months ended March 31,
2000, and the year ended December 31, 1999, reflects $119,000 and
$478,000, respectively, of goodwill amortization on a straight line
basis over 15 years.
Provision for income taxes in the unaudited pro forma combined
condensed statements of operations for the three months ended March 31,
2000, and the year ended December 31, 1999, is decreased by $12,000 and
$93,000, respectively, to reduce the historical income tax expense due
to pro forma net losses.
I-26
<PAGE>
(E) Basic and diluted earnings per share in the pro forma combined
condensed statements of operations were computed by dividing pro forma
net loss less dividends to preferred stockholders by the pro forma
total average shares outstanding of Cardinal's common stock for the
period and the elimination of Heritage's average shares outstanding.
Conversion of Cardinal's preferred stock and options results in
antidilution and therefore was excluded.
I-27
<PAGE>
OPINION OF HERITAGE'S FINANCIAL ADVISOR
Heritage retained Ferris, Baker Watts, Incorporated, to act as its sole
financial advisor in connection with the merger and related matters. As part of
its engagement, Ferris, Baker Watts agreed, if requested by Heritage, to render
an opinion with respect to the fairness, from a financial point of view, to the
holders of Heritage common stock, of the merger consideration of either
preferred shares of Cardinal; cash; or a combination of preferred shares and
cash. Heritage selected Ferris, Baker Watts because Ferris, Baker Watts is a
nationally recognized investment-banking firm with substantial experience in
transactions similar to the merger and is familiar with Heritage and its
business. As part of its investment banking business, Ferris, Baker Watts is
continually engaged in the valuation of businesses and their securities in
connection with mergers and acquisitions.
On April 17, 2000, Ferris, Baker Watts delivered to the Heritage board
its written opinion, that the merger consideration was fair to Heritage
shareholders, from a financial point of view, as of the date of such opinion.
Ferris, Baker Watts has also delivered to the Heritage board a written opinion
as of the date of this document, which is substantially similar to the opinion
delivered on April 17, 2000. No limitations were imposed by Heritage on Ferris,
Baker Watts with respect to the investigations made or the procedures followed
in rendering its opinion.
The full text of the Ferris, Baker Watts opinion, which sets forth the
assumptions made, matters considered and extent of review by Ferris, Baker
Watts, is attached as Appendix E to this document and is incorporated herein by
reference. It should be read carefully and in its entirety in conjunction with
this document. The following summary of the Ferris, Baker Watts opinion is
qualified in its entirety by reference to the full text of the opinion. The
Ferris, Baker Watts opinion is addressed to the Heritage board and does not
constitute a recommendation to any shareholder of Heritage as to how such
shareholder should vote at the Heritage special meeting described in this
document.
Ferris, Baker Watts, in connection with rendering its opinion:
o reviewed the proposed transaction;
o reviewed the draft Agreement and Plan of Reorganization;
o reviewed selected public and internal information of Heritage;
o interviewed management of Heritage;
o utilized its own independent research; and
o utilized its expertise in merger, acquisition and divestiture
transactions and valuations.
The written opinions provided by Ferris, Baker Watts to Heritage were
necessarily based upon economic, monetary, financial market, and other relevant
conditions as of the dates thereof.
In connection with its review and arriving at its opinion, Ferris,
Baker Watts relied upon the accuracy and completeness of the financial
information and other pertinent information provided by Heritage to Ferris,
Baker Watts for purposes of rendering its opinion. Ferris, Baker Watts did not
assume any obligation to independently verify any of the provided information as
being complete and accurate in all material respects. With regard to the
financial forecasts established and developed for Heritage with the input of
management, Ferris, Baker Watts assumed that this material had been reasonably
prepared on bases reflecting the best available estimates and judgments of
Heritage as to the future performance of Heritage and that the projections
provided a reasonable basis upon which Ferris, Baker Watts could formulate its
opinion. Heritage does not publicly disclose such internal management
projections of the type utilized by Ferris, Baker Watts in connection with
Ferris, Baker Watts' role as financial advisor to Heritage with respect to
review of the merger. Therefore, such projections cannot be assumed to have been
prepared with a view toward public disclosure. The projections were based upon
numerous variables
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and assumptions that are inherently uncertain, including, among others, factors
relative to the general economic and competitive conditions facing Heritage and
Cardinal. Accordingly, actual results could vary significantly from those set
forth in the respective projections.
Furthermore, Ferris, Baker Watts assumed that the merger will be
consummated in accordance with the terms set forth in the plan of
reorganization, without any waiver of any material terms or conditions by
Heritage, and that obtaining the necessary regulatory approvals for the merger
will not have an adverse effect on either separate institution or the combined
entity. Moreover, in each analysis that involves per share data for Heritage,
Ferris, Baker Watts adjusted the data to reflect full dilution.
In connection with rendering its opinion to the Heritage board, Ferris,
Baker Watts performed a variety of financial and comparative analyses, which are
briefly summarized below. This summary of analyses does not purport to be a
complete description of the analyses performed by Ferris, Baker Watts. Moreover,
Ferris, Baker Watts believes that these analyses must be considered as a whole
and that selecting portions of these analyses and the factors considered by it,
without considering all of the analyses and factors, could create an incomplete
understanding of the scope of the process underlying the analyses and, more
importantly, the opinion derived from them. The preparation of a financial
advisor's opinion is a complex process involving subjective judgments and is not
necessarily susceptible to partial analyses or a summary description of the
analyses. In its full analysis, Ferris, Baker Watts also included assumptions
with respect to general economic, financial market, and other financial
conditions. Furthermore, Ferris, Baker Watts drew from its past experience in
similar transactions, as well as its experience in the valuation of securities
and its general knowledge of the banking industry as a whole. Any estimates in
Ferris, Baker Watts' analyses were not necessarily indicative of future results
or values, which may significantly diverge favorably or adversely from the
estimates. Estimates of company valuations do not purport to be appraisals nor
do they necessarily reflect the prices at which companies or their respective
securities actually may be sold. None of the analyses performed by Ferris, Baker
Watts were assigned a greater significance by Ferris, Baker Watts than any other
in deriving its opinion.
Transaction Summary. In its fairness opinion, Ferris, Baker Watts
stated that the consideration to be paid by Cardinal is at a premium to the
values determined through the discounted cash flow analysis and the comparable
company analysis. In addition, the opinion stated that the merger consideration
compares favorably to the premiums paid in comparable transactions, and finally,
the transaction value is in the upper range of the control premium study.
Finally, Ferris, Baker Watts stated that the transaction allows Heritage to
compete as part of a larger organization with attractive growth rates,
addressing some of the non-price financial issues that were considered during
the sale process. The analyses used by Ferris, Baker Watts to determine whether
the merger consideration is fair from a financial point of view to Heritage's
shareholders are described in more detail below.
Discounted Cash Flow Analysis. Ferris, Baker Watts performed a
discounted cash flow analysis with regard to Heritage on a stand-alone basis.
This analysis utilized projections derived from assumptions provided by
management and included loan growth of 50% in the first year, with slower growth
provided in the out years, and deposit growth of 60% in the first year, also
slowing in following years. These assumptions resulted in a return on average
assets of 0.42% and return on average equity of 5.63% by fiscal 2003. The
resulting per share value was $1.29 per share. This analysis is not necessarily
indicative of actual values or actual future results and does not purport to
reflect the prices at which any securities may trade at the present or at any
time in the future. Ferris, Baker Watts noted that the accuracy of this method
of valuation depends largely on the integrity of the projections.
Comparable Sale Transactions. Ferris, Baker Watts reviewed and examined
publicly available records for sale transactions in the banking industry.
Ferris, Baker Watts reviewed 10 transactions that
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have been announced since January 1, 1999, whose target banks were located in
the eastern portion of the United States and whose asset size was under $125
million.
The following table represents a summary analysis based on the
announced transaction values.
Average Median Heritage/Cardinal
------- ------ -----------------
Price/Deposits 25.06% 24.21% 28.69%
Price/Book Value 234.07% 224.80% 160.13%
P/E 27.33x 27.02x 75.65x
Price/Assets 21.83% 20.93% 22.87%
Comparable Bank Analysis. Ferris, Baker Watts reviewed and compared
Heritage multiples pricing to multiples of 18 publicly traded banks based in
Maryland, Virginia, West Virginia and North Carolina that had total assets of
less than $100 million. These banks are listed below:
AmericasBank Corp. First Western Bank
Bank of Ashville Gateway Bank & Trust
BOC Financial Corp. Heritage Bankshares, Incorporated
Cardinal Financial Corporation Metro-County Bank of Virginia, Inc.
Carolina Bank Patapsco Bancorp, Inc.
CNB Holdings, Inc. Rowan Bancorp, Inc.
Easton Bancorp, Incorporated Surrey Bank & Trust
First Commerce Bank United Financial Banking Companies, Inc.
First Gaston Bank of North Carolina Virginia National Bank
The table below compares the premium to be received in the merger by
the Heritage shareholders to comparable company valuations.
Consideration Offered $6.00
Implied Value Per Share
-----------------------
Discounted Cash Flow Analysis $1.29
Comparable Company Analysis:
Price/Book $3.93
Price/Tangible Book $3.96
Price/Earnings $0.99
Closing Bid Price (as of April 10, 2000) $3.06
Control Premium. Ferris, Baker Watts also reviewed the Control Premium
Study, which is published quarterly by Hoilihan Lokey Howard & Zukin, Inc. which
analyzes stock prices of target companies prior to takeover announcement dates.
Market data for the fourth quarter of 1999 for banking and credit agencies
indicated that the median premium paid was 24.4% and the average premium paid
was 29.1%. The premiums ranges from 0.9% to 81.6%. The $6.00 transaction value
represents a 95.9% premium to the $3.063 closing bid price of Heritage's common
stock as of April 10, 2000.
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In connection with its opinion dated as of the date of this joint proxy
statement/prospectus, Ferris, Baker Watts performed procedures to update, as
necessary, certain of the analyses described above, as it deemed appropriate.
As described above, Ferris, Baker Watts' fairness opinion to Heritage's
board of directors was among many factors taken into consideration by Heritage's
board in making its determination to approve the agreement and plan of
reorganization.
OPINION OF CARDINAL'S FINANCIAL ADVISOR
Pursuant to an engagement letter dated as of April 14, 2000, Cardinal
retained Scott & Stringfellow as its financial advisor in connection with
Cardinal's consideration of a possible business combination with Heritage. In
connection therewith, the Cardinal board requested Scott & Stringfellow to
render its opinion as to the fairness, from a financial point of view, of the
transaction to the holders of Cardinal common stock. Scott & Stringfellow
delivered to Cardinal's board its oral opinion prior to April 14, 2000 that as
of such date, the transaction was fair, from a financial point of view, to the
holders of shares of Cardinal common stock. Scott & Stringfellow has reconfirmed
its opinion by delivering a written opinion to the Cardinal board, dated the
date of this joint proxy statement/prospectus, to the effect that, as of the
date of the opinion, the transaction was fair to the holders of shares of
Cardinal common stock from a financial point of view. Scott & Stringfellow is a
regional investment banking firm and was selected by Cardinal based on the
firm's reputation and experience in investment banking, its extensive experience
and knowledge of the Virginia banking market, its recognized expertise in the
valuation of commercial banking businesses and because of its familiarity with,
and prior work for Cardinal. Scott & Stringfellow, through its investment
banking business and specifically through its Financial Institutions Group,
specializes in commercial banking institutions and is continually engaged in the
valuation of such businesses and their securities in connection with mergers and
acquisitions, negotiated underwritings, competitive biddings and other corporate
transactions.
The full text of Scott & Stringfellow's opinion, dated the date of this
joint proxy statement/prospectus, which sets forth the assumptions made,
procedures followed, matters considered and limits on the review undertaken, is
attached as Appendix C to this joint proxy statement/prospectus. The description
of the Scott & Stringfellow opinion set forth below is qualified in its entirety
by reference to Appendix C. The Scott & Stringfellow opinion is provided for the
information of Cardinal shareholders because it was provided to the Cardinal
board in connection with its consideration of the merger.
In developing its opinion, Scott & Stringfellow reviewed and analyzed:
o the merger agreement;
o this joint proxy statement/prospectus;
o Cardinal's audited financial statements for the three years ended
December 31, 1999;
o Cardinal's unaudited financial statements for the three months
ended March 31, 2000 and 1999, and other internal information
relating to Cardinal prepared by Cardinal's management;
o information regarding the trading market for Cardinal common stock
and Heritage common stock and the price ranges within which the
respective stocks have traded;
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o the relationship of prices paid to relevant financial data such as
net worth, earnings, deposits and assets in certain bank and bank
holding company mergers and acquisitions in recent years;
o Heritage's annual reports to shareholders and its audited financial
statements for the three years ended December 31, 1999;
o Heritage's unaudited financial statements for the three months
ended March 31, 2000 and 1999 and other internal information
relating to Heritage prepared by Heritage's management; and
o Conducted such other studies, analysis and investigations
particularly of the banking industry, and considered such other
information as it deemed appropriate, the material portion of which
is described below.
o Scott & Stringfellow also took into account its assessment of
general economic, market and financial conditions and its
experience in other transactions, as well as its experience in
securities valuations and knowledge of the commercial banking
industry generally.
o Scott & Stringfellow also discussed with members of Cardinal's and
Heritage's management past and current business operations, the
background of the merger, the reasons and basis for the merger,
results of regulatory examinations, and the business and future
prospects of Cardinal and Heritage individually and as a combined
entity, as well as other matters relevant to its inquiry.
Scott & Stringfellow relied without independent verification upon the
accuracy and completeness of all of the financial and other information reviewed
by it and discussed with it for purposes of its opinion. With respect to
financial forecasts reviewed by Scott & Stringfellow in rendering its opinion,
Scott & Stringfellow assumed that such financial forecasts were reasonably
prepared on the basis reflecting the best currently available estimates and
judgment of the managements of Cardinal and Heritage as to the future financial
performance of Cardinal and Heritage, respectively. Scott & Stringfellow did not
make an independent evaluation or appraisal of the assets or liabilities of
Cardinal and Heritage nor was it furnished with any such appraisal.
In connection with rendering its opinion, Scott & Stringfellow
performed a variety of financial analyses. Scott & Stringfellow evaluated the
financial terms of the transaction using standard valuation methods, including
comparable acquisition analysis, contribution analysis, present value analysis,
among others. The following is a summary of the material analyses presented by
Scott & Stringfellow to the Cardinal board of directors in connection with its
fairness opinion.
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Summary of Proposal. Scott & Stringfellow reviewed the terms of the
proposed transaction, including the aggregate transaction value. Heritage
shareholders will be able to elect to receive $6.00 in cash or 1.2 shares of
convertible preferred stock or a combination of cash and stock for each share of
Heritage common stock, resulting in an implied total transaction value of
approximately $13.8 million. Scott & Stringfellow calculated the premium over
the closing price of Heritage's common stock on April 17, 2000, price to book,
price to tangible book, price to deposits, price to assets, and implied core
deposit premium (defined as the transaction value minus the tangible book value
divided by core deposits) for Heritage based on such implied total transaction
value. This analysis yielded a premium over the closing price of Heritage's
common stock on April 17, 2000 of 60.00%, a price to book value multiple of
1.61x, a price to tangible book value multiple of 1.61x, price to deposits of
28.66%, price to assets of 21.37%, and an implied core deposit premium of
12.01%.
Comparable Acquisition Analysis. Scott & Stringfellow reviewed 16
acquisitions announced from January 1, 1997 to April 18, 2000 involving
commercial banking institutions based in Virginia with less than $1.0 billion in
assets ("Virginia Acquisitions") and 18 acquisitions announced from April 18,
1999 to April 18, 2000 involving commercial banking institutions nationwide with
assets between $50.0 million and $100.0 million and a return on average assets
of less than 1.0% ("Recent Peer Acquisitions"). Scott & Stringfellow compared
the average price to book value, price to tangible book value, price to
deposits, price to assets, and the implied core deposit premium, for such
Virginia Acquisitions and Recent Peer Acquisitions to the proposed merger at
announcement.
<TABLE>
<CAPTION>
Cardinal/ Virginia Recent Peer
Heritage Acquisitions Acquisitions
----------- -------------- --------------
<S> <C> <C> <C>
Deal Price/Book Value 1.61x 2.49x 2.17x
Deal Price/Tangible Book 1.61x 2.52x 2.18x
Deal Price/Deposits 28.66% 30.55% 20.66%
Deal Price/Assets 21.37% 26.26% 17.79%
Tangible Book Premium/Core Deposits 12.01% 21.01% 12.93%
</TABLE>
Contribution Analysis. Scott & Stringfellow reviewed the relative
contributions of, among other things, last twelve months net interest income,
last twelve months net income, estimated 2000 net income, total assets, total
loans, total deposits, total equity and market capitalization to be made by
Cardinal and Heritage to the combined institution based on data at and for the
twelve months ended March 31, 2000. Scott & Stringfellow compared such
contributions to the consideration to be received by Heritage shareholders.
Based upon the terms of the proposed transaction and the assumption that
Cardinal's stock price is $5.00 for the purpose of calculating the common
equivalent shares of the convertible preferred stock, Heritage shareholders
shall receive approximately 20.0% of the fully converted shares of the combined
institution and approximately $6.9 million in cash.
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Cardinal Heritage
Contribution Contribution
-------------- --------------
Last 12 Months Net Interest Income 54.9% 45.1%
Last 12 Months Net Income 0.0% 100.0%
Estimated 2000 Net Income 0.0% 100.0%
Total Assets 64.3% 35.7%
Total Loans 69.3% 30.7%
Total Deposits 62.5% 37.5%
Total Equity 77.6% 22.4%
Market Capitalization 71.1% 28.9%
Present Value Analysis. Scott & Stringfellow performed an analysis to
determine a range of present values of Heritage common stock assuming Heritage
is merged with Cardinal. This range was determined by adding (1) the present
value of the estimated future cash flows that Heritage could generate and (2)
the present value of the "terminal value" of Heritage common stock at the end of
year 10 following the transaction. For years 1 through 3 following the
transaction, Scott & Stringfellow relied upon Cardinal's financial projections,
which Scott & Stringfellow viewed as reasonable. The cash flow projections for
years 4 through 10 were grown using an annual earnings growth rate of 8%. The
"terminal value" of Heritage's common stock at the end of the period was
determined by applying a range of price-to-earnings multiples (11.0x to 15.0x)
to year 10 projected earnings. The cash flows and terminal values were
discounted to present value using discount rates of 15% to 19%, which Scott &
Stringfellow viewed as the appropriate discount rate range for a commercial bank
with Heritage's risk characteristics. Based upon the above assumptions, the
synergistic value of Heritage common stock ranged from $14.8 million to $22.1
million.
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($ in 000s)
Discount Rate
------------------------------------------------------------
Terminal
P/E 15.0% 16.0% 17.0% 18.0% 19.0%
----------------------------------------------------------------------------
------------
11.0x $18,943 $17,773 $16,698 $15,707 $14,795
------------
12.0x $19,733 $18,498 $17,363 $16,318 $15,356
13.0x $20,523 $19,223 $18,028 $16,929 $15,917
14.0x $21,313 $19,947 $18,693 $17,540 $16,479
------------
15.0x $22,104 $20,672 $19,358 $18,151 $17,040
------------
Other Analyses. Scott & Stringfellow also reviewed, among other things,
selective investment research reports on, and earnings estimates for, Cardinal
and Heritage and analyzed available information regarding the ownership of
Heritage common stock. In addition, Scott & Stringfellow prepared an overview of
Heritage's business, prepared a summary of the historical financial performance
of Heritage, summarized Heritage's financial goals and objectives, and, based on
publicly available information, analyzed Heritage's deposit market share and
branch presence.
In connection with its opinion dated as of the date of this joint proxy
statement/prospectus, Scott & Stringfellow performed procedures to update, as
necessary, certain of the analyses described above and reviewed the assumptions
on which such analyses described above were based and the factors considered in
connection therewith.
The summary set forth above includes all the material factors
considered by Scott & Stringfellow in developing its opinion. The preparation of
a fairness opinion involves various determinations as to the most appropriate
and relevant methods of financial analysis and the application of these methods
to the particular circumstances and, therefor, such an opinion is not readily
susceptible to summary description. Accordingly, notwithstanding the separate
factors discussed above, Scott & Stringfellow believes that its analyses must be
considered as a whole and that selecting portions of its analysis and of the
factors considered by it, without considering all analyses and factors, could
create an incomplete view of the evaluation process underlying its opinion. As a
whole, these various analyses contributed to Scott & Stringfellow's opinion that
the transaction is fair from a financial point of view to Cardinal's
shareholders.
Pursuant to an engagement letter dated April 14, 2000 between Cardinal
and Scott & Stringfellow, in exchange for its services, Cardinal has agreed to
pay Scott & Stringfellow a transaction fee of $25,000, as a non-refundable
retainer, plus one and one half percent (1.5%) of the aggregate value of the
transaction up to $175,000 which is payable and contingent upon the consummation
of the merger. In the past, Scott & Stringfellow has provided investment banking
services to Cardinal for which services Scott & Stringfellow received customary
fees. In the ordinary course of its business, Scott & Stringfellow may actively
trade the equity securities of Cardinal for its own account or the account of
its customers, and, accordingly, may at any time hold a long or short position
in such securities.
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INTERESTS OF CERTAIN PERSONS IN THE MERGER
Certain members of Heritage's management, as well as certain members of
the Heritage board of directors, have interests in the merger in addition to
their interests as shareholders of Heritage. These interests are described
below. In each case, the Heritage board was aware of these potential interests,
and considered them, among other matters, in approving the merger agreement and
the transactions contemplated by it.
Indemnification. Cardinal has generally agreed to indemnify the
officers and directors of Heritage to the same extent and on the same conditions
as they are entitled to from Heritage before the merger. Cardinal also has
agreed to provide directors' and officers' liability insurance for the present
officers and directors of Heritage comparable to the coverage currently provided
by Heritage before the merger for three years following the effective date of
the merger.
Directors of Heritage. Three Heritage directors (Messrs. Lieding,
Shafran and Tighe) will serve on the Cardinal board and will receive the same
compensation as current Cardinal board members. Cardinal directors do not
receive any cash fees. Each Cardinal director is granted an option to purchase
2,000 shares of Cardinal common stock each year. Options are granted at or above
market value at the time of grant and have a ten year term.
In addition, five current members of The Heritage Bank's board, Messrs.
Lieding, Tighe, Shafran and Herrick and Ms. Spiro, will continue to serve as
directors of The Heritage Bank, which will change its name to Cardinal Bank -
Potomac. They will receive fees of $500 per month and $100 per committee
meeting. In addition, members of the executive committee receive an additional
$250 per month. These fees will not be reduced following the merger. Ms. Spiro
is not compensated for serving as a director of The Heritage Bank.
Options for a total of 30,500 shares of common stock of Heritage were
granted to the current outside directors on May 24, 2000. These grants represent
the annual option awards for fiscal year 2000, which were scheduled to be made
at the end of this year. These grants were made as follows: directors with 1-2
years of service were granted options for 2,000 shares; directors with 2-3 years
of service were granted options for 3,500 shares; directors with over 4 years of
service were granted options for 5,000 shares; and the chairman and vice
chairman of the board each were granted an option for 5,000 shares.
Stay Bonuses. Heritage, with the concurrence of Cardinal, may agree to
provide certain key employees of The Heritage Bank with "stay bonuses" in the
form of cash payments and options for Heritage common stock as an inducement to
these employees to continue their services through or following the closing of
the merger. These cash payments are not expected to exceed $65,000 in the
aggregate and the option grants are not expected to exceed options for more than
10,000 shares.
Conversion of Stock Options. All outstanding options for shares of
common stock of Heritage issued to employees and directors of Heritage or The
Heritage Bank under Heritage's stock option plans will be converted as of the
close of the merger to options for common stock of Cardinal having equivalent
values.
Employment Arrangement. Within two days after Heritage's shareholders
approve the merger, Ms. Spiro will receive a lump sum payment of approximately
$360,000 in satisfaction of all of Heritage's obligations to pay change of
control benefits under her contract with Heritage.
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Employee and Benefit Plans. Cardinal will coordinate the participation
of Heritage's employees in its employee benefit plans and programs. Cardinal
will treat the service of a Heritage employee with Heritage as service with
Cardinal for purposes of all employee benefit plans and programs.
TERMS OF THE MERGER AGREEMENT
The following is a summary description of the material aspects of the
merger agreement. This description does not purport to be complete and is
qualified in its entirety by reference to Appendix A that contains the full
merger agreement. We urge you to read Appendix A in its entirety.
Merger Consideration
The total consideration received by holders of Heritage common stock
will consist of approximately 1,376,770 shares of Cardinal preferred stock and
$6,883,851 in cash. Each Heritage shareholder can elect to receive all cash, all
Cardinal preferred stock or any combination of cash and Cardinal preferred
stock. A Heritage shareholder who beneficially owns Heritage common stock in
more than one account or capacity may direct how cash and shares of Cardinal
preferred stock will be allocated among such accounts. If, however, Heritage
shareholders elect to receive more than $6,883,851 in cash, the amount of cash
paid to each Heritage shareholder who elects to receive cash will be reduced so
that the total amount of cash paid will be $6,883,851. Reductions will be
proportional, based on the amount of cash each Heritage shareholder elects.
Conversely, if Heritage shareholders elect to receive more than 1,376,770 shares
of Cardinal preferred stock, the number of shares of Cardinal preferred stock
received by each Heritage shareholder who elects to receive Cardinal preferred
stock will be reduced so that the number of shares of Cardinal preferred stock
actually issued will be 1,376,770. Reductions will be proportional.
Representations and Warranties; Conditions to the Merger
The merger agreement contains representations and warranties by
Cardinal and Heritage, including representations and warranties with respect to
their individual organizations, authorizations to enter into the merger
agreement, capitalization, financial statements and pending and threatened
litigation. These representations and warranties, except as otherwise provided
in the merger agreement, will not survive the effective date of the merger.
The obligations of Cardinal and Heritage to consummate the merger are
subject to the following conditions, among others:
o approval of the merger agreement by the requisite shareholder vote
of the Heritage shareholders;
o approval by the Cardinal shareholders of the issuance of Cardinal
preferred stock in the merger;
o the election of three Heritage directors to the Cardinal board of
directors;
o receipt of all necessary regulatory approvals not conditioned or
restricted in a manner that, in the judgment of the boards of
directors of Cardinal or Heritage, materially adversely affects the
economic or business benefits of the merger so as to render
inadvisable or unduly burdensome consummation of the merger;
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o the absence of certain actual or threatened proceedings before a
court or other governmental body relating to the merger;
o the receipt of an opinion of counsel as to certain federal income
tax consequences of the merger;
o performance by the other company of its obligations under the
merger agreement;
o the accuracy, in all material respects, of the representations and
warranties of the other company contained in the merger agreement;
o the receipt of certain opinions and certificates from the other
company;
o the receipt by Cardinal of a final fairness opinion from Scott &
Stringfellow; and
o the receipt by Heritage of a final fairness opinion from Ferris,
Baker Watts.
Regulatory Approvals
As indicated above, the merger is conditioned on the prior approval of
the merger by the Board of Governors of the Federal Reserve System and the
Virginia State Corporation Commission. The applications to the Federal Reserve
and the State Corporation Commission will include a request for The Heritage
Bank to pay a $3.0 million dividend to Cardinal on the effective date. On
________ __, 2000, applications were filed with the Federal Reserve and the
State Corporation Commission. The applications were accepted but no approvals
have been obtained. While we cannot predict whether or when we will obtain all
required regulatory approvals, we see no reason why the approvals will not be
obtained in a timely manner. However, there can be no assurance that the
necessary approvals will be obtained, or that any approval will not be
conditioned in a manner which makes consummation of the merger, in the judgment
of the board of directors of Cardinal or Heritage, inadvisable or unduly
burdensome.
Business Pending the Merger
Until the effective date of the merger, each of Cardinal and Heritage
has agreed that it will operate its business substantially as presently
operated, in the ordinary course of business, and will use its best efforts to
preserve intact its relationships with persons having business dealings with it.
In addition, until the effective date, Heritage and Cardinal each has agreed not
to take, without Cardinal's consent, certain specific actions in connection with
the ongoing operation of its business. Specifically, neither Cardinal nor
Heritage may:
o declare or pay dividends on its capital stock;
o enter into any merger, consolidation or business combination (other
than the merger with Cardinal) or any acquisition or disposition of
a material amount of assets or securities or solicit proposals in
respect thereof otherwise than in the ordinary course of business;
o amend its charter or bylaws (except as may be required by the
merger agreement with Cardinal);
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o issue any capital stock, except upon exercise of rights, warrants
or options issued pursuant to existing employee benefits plans,
programs or arrangements or effect any stock split or otherwise
change its capitalization;
o purchase or redeem any of its capital stock; or
o make any change in the compensation or title of any employees,
other than as permitted by current employment practices in the
ordinary course of business.
No Solicitation; Board Action
Heritage has agreed not to (i) encourage, solicit or initiate
discussions or negotiations with any person other than Cardinal concerning any
merger, share exchange, sale of substantial assets, tender offer, sale of shares
of capital stock or similar transaction involving Heritage, (ii) enter into any
agreement with any third party providing for a business combination transaction,
equity investment or sale of a significant amount of assets, or (iii) furnish
any information to any other person relating to or in support of such
transaction.
Heritage also agreed that it will promptly communicate to Cardinal the
terms of any proposal which it may receive in respect to any of the foregoing
transactions.
Effective Date
If the merger agreement is approved by the Heritage shareholders and
the issuance of preferred stock is approved by the Cardinal shareholders, all
required governmental and other consents are obtained and the other conditions
to the merger are satisfied or waived, the merger will be consummated and made
effective on the date and at the time indicated on the certificate of merger
issued by the Virginia State Corporation Commission pursuant to the Virginia
Stock Corporation Act. See "Terms of the Merger Agreement - Representations and
Warranties; Conditions to the Merger" on page I-37.
It is anticipated that the effective date of the merger will occur in
the third quarter of 2000.
Surrender of Stock Certificates
As soon as practicable after the effective date of the merger, Cardinal
will cause American Stock Transfer & Trust Company, its exchange agent, to mail
to each Heritage shareholder a letter of transmittal and instructions for use to
surrender the certificates representing shares of Heritage common stock in
exchange for certificates representing shares of Cardinal preferred stock and/or
cash.
Heritage shareholders should not send in their certificates until they
receive such instructions.
Promptly after surrender of one or more certificates for Heritage
common stock, together with a properly completed letter of transmittal, you will
receive a certificate or certificates representing the number of shares of
Cardinal preferred stock to which you are entitled and/or a check for the amount
payable in cash. Lost, stolen, mutilated or destroyed certificates will be
treated in accordance with the existing procedures of Cardinal.
The merger agreement provides, however, that no dividend or
distribution payable to the holders of record of Cardinal preferred stock at or
as of any time after the effective date of the merger will be paid
I-39
<PAGE>
to the holder of any Heritage certificate until such holder physically
surrenders such certificate, promptly after which time all such dividends or
distributions will be paid, without interest.
Cardinal shareholders should not send in their certificates.
Conversion of Stock Options
All outstanding options for shares of common stock of Heritage issued
under Heritage's stock option plans will be converted as of the close of the
merger to options for common stock of Cardinal. Converted options will continue
to be subject to the same terms and conditions as such options were subject
under Heritage's stock option plans prior to the closing, except that the number
of shares of Cardinal common stock subject to the converted options and the
exercise price for the Cardinal shares will be adjusted as follows: the number
of shares of Heritage stock subject to the option prior to the closing will be
multiplied by the Option Conversion Ratio and the exercise price of the option
prior to the closing will be divided by the Option Conversion Ratio. The "Option
Conversion Ratio" means the fraction determined by dividing $6.00 by the average
last sales price of Cardinal common stock for the twenty trading day period
ending on the closing of the merger.
Waiver and Amendment
At any time on or before the effective date of the merger, any term or
condition of the merger may be waived by the party which is entitled to the
benefits thereof and without shareholder approval. The merger agreement may be
amended at any time before the merger by agreement of the parties whether before
or after the shareholder meetings. Any material change in a material term of the
merger agreement would require a resolicitation of Heritage's and Cardinal's
shareholders. Such a material change would include, but not be limited to, a
decrease in the merger consideration or a change in the tax consequences to
Heritage's shareholders.
Termination
The merger agreement may be terminated by Cardinal or Heritage, whether
before or after the approval of the merger by the shareholders of Heritage:
o by mutual consent of Heritage and Cardinal;
o unilaterally by Heritage or Cardinal, if the merger has not
occurred on or before December 31, 2000;
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<PAGE>
o unilaterally by Heritage or Cardinal if the satisfaction in any
material respect of one or more conditions to the obligation of
that party is rendered impossible of satisfaction;
o by Cardinal, if Heritage receives a subsequent offer from a third
party and the Heritage board does not confirm in writing that the
Heritage board will continue to support the merger with Cardinal;
or
o by Heritage, if before the effective date, Cardinal enters into an
agreement for the sale of merger of Cardinal with a party other
than Heritage.
In the event of termination, the merger agreement shall become null and void,
except that certain provisions relating to expenses and confidentiality of
information exchanged between the parties shall survive any such termination.
Resales of Cardinal Preferred Stock
All shares of Cardinal preferred stock received by Heritage
shareholders in connection with the merger will be freely transferable, except
that Cardinal preferred stock received by persons who are deemed to be
"affiliates" of Heritage for purposes of Rule 145 under the Securities Act of
1933, as amended. To the best knowledge of Heritage and Cardinal, the only
persons who may be deemed to be affiliates of Heritage subject to these
limitations are the directors and executive officers of Heritage.
Expenses of the Merger and Termination Fee
In general, whether or not the merger is consummated, Heritage and
Cardinal will pay their own expenses incident to preparing, entering into and
carrying out the merger agreement, and preparing and filing the registration
statement of which this joint proxy statement/prospectus is a part.
If either party willfully and materially breaches the merger agreement,
that party must pay the costs associated with this transaction incurred by the
non-breaching party. If Cardinal terminates the merger because Heritage received
an offer from a third party and the Heritage board did not continue to support
the merger, Heritage will pay Cardinal's expenses. Any liability incurred to the
other party under this section cannot exceed $200,000. If the merger agreement
is terminated because Heritage shareholders did not approve the merger agreement
or Cardinal shareholders did not approve the issuance of preferred stock in the
merger, then the party whose shareholders failed to grant such approval will pay
50% of the costs and expenses of the other party, except that such reimbursement
will not exceed a total of $200,000.
MARKET PRICES AND DIVIDENDS
Market Prices
There is no established market for Cardinal preferred stock and there
can be no assurance that any market for Cardinal preferred stock will develop
following the merger, or if any such market develops, the prices at which
Cardinal preferred stock may trade. Each share of Cardinal preferred stock is
convertible into ____ shares of Cardinal common stock. Cardinal has applied to
list the Cardinal preferred stock on The Nasdaq SmallCap Market.
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Cardinal common stock is listed and traded on The Nasdaq SmallCap
Market under the symbol "CFNL." On the record date, there were _____ shares
outstanding, which were held by approximately _____ holders of record.
Heritage common stock is listed and traded on The Nasdaq SmallCap
Market under the symbol "HBVA." On the record date, there were _____ shares
outstanding, which were held by approximately _____ holders of record.
The following tables sets forth the high, low, and closing sales prices
of the Cardinal common stock and Heritage common stock as reported by The Nasdaq
SmallCap Market for the periods listed.
Cardinal
<TABLE>
<CAPTION>
--------------------------------------- ------------ ------------ ------------
High Low Closing
--------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
2000
--------------------------------------- ------------ ------------ ------------
2nd Quarter (through May 17, 2000) 6.00 4.50 5.00
--------------------------------------- ------------ ------------ ------------
1st Quarter 5.88 4.25 4.50
--------------------------------------- ------------ ------------ ------------
--------------------------------------- ------------ ------------ ------------
1999
--------------------------------------- ------------ ------------ ------------
4th Quarter 7.38 5.50 5.63
--------------------------------------- ------------ ------------ ------------
3rd Quarter 7.88 6.25 6.63
--------------------------------------- ------------ ------------ ------------
2nd Quarter 8.63 6.75 7.25
--------------------------------------- ------------ ------------ ------------
1st Quarter 7.00 6.25 7.00
--------------------------------------- ------------ ------------ ------------
--------------------------------------- ------------ ------------ ------------
1998
--------------------------------------- ------------ ------------ ------------
4th Quarter 8.13 6.13 6.38
--------------------------------------- ------------ ------------ ------------
3rd Quarter 10.63 7.25 7.88
--------------------------------------- ------------ ------------ ------------
Heritage
--------------------------------------- ------------ ------------ ------------
High Low Closing
--------------------------------------- ------------ ------------ ------------
2000
--------------------------------------- ------------ ------------ ------------
2nd Quarter (through May 17, 2000) 5.06 3.06 4.9375
--------------------------------------- ------------ ------------ ------------
1st Quarter 4.03 3.250 3.250
--------------------------------------- ------------ ------------ ------------
--------------------------------------- ------------ ------------ ------------
1999
--------------------------------------- ------------ ------------ ------------
4th Quarter 4.625 3.625 3.6875
--------------------------------------- ------------ ------------ ------------
3rd Quarter 4.125 3.875 4.00
--------------------------------------- ------------ ------------ ------------
2nd Quarter 4.56 3.875 3.825
--------------------------------------- ------------ ------------ ------------
1st Quarter 4.75 3.50 4.5625
--------------------------------------- ------------ ------------ ------------
--------------------------------------- ------------ ------------ ------------
1998
--------------------------------------- ------------ ------------ ------------
4th Quarter 4.75 3.625 3.75
--------------------------------------- ------------ ------------ ------------
3rd Quarter 5.50 3.75 3.9375
--------------------------------------- ------------ ------------ ------------
2nd Quarter 6.125 4.75 5.500
--------------------------------------- ------------ ------------ ------------
1st Quarter 4.875 4.00 4.625
--------------------------------------- ------------ ------------ ------------
</TABLE>
The closing price of Cardinal common stock on The Nasdaq SmallCap
Market on April 17, 2000, the last full trading day preceding the public
announcement of the proposed merger, was $4.63 per share.
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<PAGE>
The closing price of Cardinal common stock on The Nasdaq SmallCap Market on
________ __, 2000, the latest practicable date before the date of this joint
proxy statement/prospectus was $_____ per share.
Dividends
Neither Cardinal nor Heritage has paid any dividends on its common
stock. Each share of Cardinal preferred stock is entitled to a dividend of
$0.3625 per year.
No dividends can be declared or paid on Cardinal common stock unless
full dividends on Cardinal preferred stock to be received by holders of Heritage
common stock upon consummation of the merger have been paid for all past
dividend periods and a sum sufficient for the full dividends due on the next
payment date has been set aside for the payment of such dividends.
For federal income tax purposes, a distribution is taxed as a dividend
to the extent that the distribution is paid out of current or accumulated
earnings and profits. To the extent that the amount of such distribution exceeds
current and accumulated earnings and profits, the amount of such excess
allocable to any shareholder is deemed for federal income tax purposes to be
first a nontaxable return of capital reducing such shareholder's tax basis in
his or her stock and, to the extent such non-dividend distributions exceed the
shareholder's tax basis, such distributions are treated as a taxable capital
gain. Cardinal had no accumulated earnings and profits for federal income tax
purposes through December 31, 1999. No predictions can be made as to the amount
of current and accumulated earnings and profits for 2000 or subsequent years.
Certain state law restrictions are imposed on distributions of
dividends to shareholders of Cardinal. Cardinal shareholders are entitled to
receive dividends as declared by the Cardinal board of directors. However, no
such distribution may be made if, after giving effect to the distribution, it
would not be able to pay its debts as they become due in the usual course of
business or its total assets would be less than its total liabilities. There are
similar restrictions with respect to stock repurchases and redemptions.
Banks have limitations imposed upon all "capital distributions,"
including cash dividends, payments to repurchase or otherwise acquire its
shares, payments to shareholders of another institution in a cash-out merger,
and other distributions charged against capital. As of March 31, 2000,
Cardinal's bank subsidiaries did not have the capacity to pay dividends to its
sole shareholder, Cardinal, and The Heritage Bank had the capacity to pay
$235,000 in total dividends to its sole shareholder, Heritage.
Similarly, Cardinal's bank subsidiaries and The Heritage Bank each are
subject to legal limitations on 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). Prior regulatory
approval is required if the total of all dividends declared in any calendar year
will exceed the sum of the bank's net profits for that year and its retained net
profits for the preceding two calendar years. Federal law also generally
prohibits a depository institution from making any capital distribution
(including payment of a dividend or payment of a management fee to its holding
company) if the depository institution would thereafter fail to maintain capital
above regulatory minimums. Furthermore, because Cardinal's bank subsidiaries
have only been recently formed and Office of the Comptroller of the Currency
regulations specifically prohibit a national bank from declaring a dividend in
excess of its undivided profits, each of Cardinal's bank subsidiaries must
recover any start-up losses before it may pay a dividend to Cardinal.
Federal bank regulators are also authorized to limit the payment of
dividends if such payment may be deemed to constitute an unsafe or unsound
practice. In addition, under Virginia law no dividend
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<PAGE>
may be declared or paid that would impair a Virginia chartered bank's paid-in
capital. The Virginia State Corporation Commission has general authority to
prohibit payment of dividends by a Virginia chartered bank if it determines that
the limitation is in the public interest and is necessary to ensure the bank's
financial soundness.
Following the consummation of the merger, most of the revenues of
Cardinal and Cardinal's ability to pay dividends to its shareholders will depend
on dividends paid to it by Cardinal Bank and Heritage. Based on the current
financial condition of Cardinal Bank and Heritage, Cardinal expects that the
above-described provisions will have no impact on Cardinal's ability to obtain
dividends from Cardinal Bank and Heritage or on Cardinal's ability to pay
dividends to its shareholders.
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<PAGE>
CHAPTER II
INFORMATION ABOUT THE SPECIAL MEETINGS AND VOTING
General
We are furnishing this document in connection with the solicitation of
proxies by the board of directors of Cardinal for use at the special meeting of
Cardinal shareholders including any adjournments or postponements of the
meeting, to be held on ________ __, 2000 , and by the board of directors of
Heritage for use at the special meeting of Heritage shareholders including any
adjournments or postponements of the meeting, to be held on ________ __, 2000,
at the times and places set forth in the accompanying notices.
Cardinal Meeting
General. The Cardinal meeting will be held on ________ __, 2000 at 2:00
p.m., local time, at ______________________________________________, Virginia.
At the Cardinal meeting, holders of Cardinal common stock will be asked to
consider and vote upon a proposal to approve the issuance of shares of Cardinal
preferred stock under the merger agreement, elect three of Heritage's directors
to the Cardinal board and to transact such other business as may properly come
before the special meeting or any adjournment or postponement of the meeting.
Record Date; Voting Power. Only holders of record of shares of Cardinal
common stock at the close of business on ________ __, 2000 are entitled to
notice of and to vote at the Cardinal meeting. On such date, there were
__________ issued and outstanding shares of Cardinal common stock held by
approximately _____ holders of record. Holders of record of Cardinal common
stock on the Cardinal record date are entitled to one vote per share on any
matter that may properly come before the Cardinal meeting. Brokers who hold
shares of Cardinal common stock as nominees will not have discretionary
authority to vote such shares in favor of the issuance of preferred stock in the
merger and the election of the three Heritage directors to the Cardinal board in
the absence of instructions from the beneficial owners. Any shares of Cardinal
common stock for which a broker has submitted an executed proxy but for which
the beneficial owner has not given instructions on voting to such broker are
referred to as "broker non-votes."
Vote Required. The approval of the issuance of preferred stock and
election of Heritage directors to the Cardinal board at the Cardinal meeting
requires a greater number of votes cast in favor of each matter than the number
of votes opposing such matter, provided the total number of votes cast
represents a majority of the issued and outstanding shares of Cardinal common
stock.
Broker non-votes and abstentions will be counted for purposes of
establishing the presence of a quorum at the Cardinal meeting. Abstentions and
broker non-votes will not, however, be deemed to have been cast either "for" or
"against" the proposal for approval of the issuance of preferred stock and the
election of three Heritage directors to the Cardinal board considered at the
meeting. Since approval of each proposal requires the affirmative vote of a
majority of the issued and outstanding shares of Cardinal common stock voting in
person or by proxy at the Cardinal meeting, abstentions and broker non-votes,
will have the effect of a vote against the issuance of preferred stock and the
election of directors. The Cardinal board urges Cardinal shareholders to
complete, date and sign the accompanying proxy and return it promptly in the
enclosed, postage-paid envelope.
On the Cardinal record date, the executive officers and directors of
Cardinal, including their affiliates, had voting power with respect to an
aggregate of __________ shares of Cardinal common stock
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<PAGE>
or approximately _____% of the shares of Cardinal common stock then outstanding.
We expect that such directors and officers will vote all of such shares in favor
of the approval of the issuance of preferred stock.
Recommendation of the Cardinal Board. The Cardinal board has
unanimously approved and adopted the merger agreement and the transactions
contemplated by it, including the merger. The Cardinal board believes that the
merger agreement and the transactions contemplated thereby, including the
merger, are fair to and in the best interests of Cardinal and the Cardinal
shareholders and recommends that the Cardinal shareholders vote "FOR" the
approval of the issuance of Cardinal preferred stock in the merger and "FOR" the
election of three Heritage directors to the Cardinal board of directors. See
"The Merger - Cardinal's Reasons for the Merger" on page I-15.
Solicitation and Revocation of Proxies. A form of proxy is enclosed
with this document. All shares of Cardinal common stock represented by properly
executed proxies will, unless such proxies have been previously revoked, be
voted in accordance with the instructions indicated on such proxies. If no
instructions are indicated, such shares will be voted "FOR" the approval of the
issuance of preferred stock in the merger, "FOR" the election of three Heritage
directors to the Cardinal board of directors and in the discretion of the proxy
holder as to any other matter which may properly come before the Cardinal
special meeting.
Each holder of Cardinal common stock is requested to complete, date and
sign the accompanying proxy and return it promptly to Cardinal in the enclosed,
postage-paid envelope.
Any Cardinal shareholder that has previously delivered a properly
executed proxy may revoke such proxy at any time before it is voted. A proxy may
be revoked either by (i) filing with the secretary of Cardinal prior to the
Cardinal meeting, at Cardinal's principal executive offices, a written
revocation of such proxy or a duly executed proxy bearing a later date or (ii)
attending the Cardinal special meeting and voting in person. Presence at the
Cardinal meeting will not revoke a shareholder's proxy unless such shareholder
votes in person.
The cost of soliciting proxies will be borne by Cardinal. Proxies may
be solicited by personal interview, mail or telephone. In addition, Cardinal may
reimburse brokerage firms and other persons representing beneficial owners of
shares of Cardinal common stock for their expenses in forwarding solicitation
materials to beneficial owners. Proxies may also be solicited by certain of
Cardinal's executive officers, directors and regular employees, without
additional compensation, personally or by telephone or facsimile transmission.
Other Matters. Cardinal is unaware of any matter to be presented at the
Cardinal special meeting other than the proposal to approve the issuance of
preferred stock. If other matters are properly presented at the Cardinal
meeting, the persons named in the enclosed form of proxy will have authority to
vote all properly executed proxies in accordance with their judgment on any such
matter, including any proposal to adjourn or postpone the Cardinal meeting,
provided that no proxy that has been designated to vote against approval of the
issuance of preferred stock will be voted in favor of any proposal to adjourn or
postpone the Cardinal meeting for the purpose of soliciting additional proxies
to approve the issuance of Cardinal preferred stock.
Heritage Meeting
General. The Heritage meeting will be held on ________ __, 2000 at
______ _.m., local time, at ____________________________________________,
Virginia. At the Heritage meeting, holders of Heritage common stock will be
asked to consider and vote upon a proposal to approve the merger
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<PAGE>
agreement. Heritage shareholders may also be asked to vote upon a proposal to
adjourn or postpone the Heritage meeting for the purpose of, among other things,
allowing additional time for the solicitation of proxies from Heritage
shareholders to approve the merger agreement.
Record Date; Voting Power. Only holders of record of shares of Heritage
common stock at the close of business on ________ __, 2000 are entitled to
notice of and to vote at the Heritage meeting. As of such date, there were
_________ issued and outstanding shares of Heritage common stock held by
approximately _____ holders of record. Holders of record of Heritage common
stock on the Heritage record date are entitled to one vote per share on any
matter that may properly come before the Heritage meeting. Brokers who hold
shares of Heritage common stock as nominees will not have discretionary
authority to vote such shares in the absence of instructions from the beneficial
owners. Any such shares of Heritage common stock for which a broker has
submitted an executed proxy but for which the beneficial owner has not given
instructions on voting to such broker are referred to as "broker non-votes."
Vote Required. The approval of the merger agreement at the Heritage
meeting requires the affirmative vote of a majority of the shares of Heritage
stock present and voted at the Heritage meeting. The presence in person or by
proxy of the holders of a majority of the shares of Heritage common stock
outstanding on the Heritage record date will constitute a quorum for the
transaction of business at the Heritage meeting. Abstentions and broker
non-votes will be counted for purposes of establishing the presence of a quorum
at the Heritage meeting. Broker non-votes and abstentions will have no effect on
the proposal to approve the merger agreement because approval of the Heritage
transaction only requires a majority of the votes cast at the Heritage meeting.
On the Heritage record date, the executive officers and directors of
Heritage, including their affiliates, had voting power with respect to an
aggregate of ________ shares of Heritage common stock or approximately ______%
of the shares of Heritage common stock then outstanding. We currently expect
that such directors and officers will vote all of such shares in favor of the
proposal to approve the merger agreement.
Recommendation of the Heritage Board. The Heritage board has
unanimously approved and adopted the merger agreement. The Heritage board
believes that the merger is fair to and in the best interests of Heritage and
the Heritage shareholders and recommends that the Heritage shareholders vote
"FOR" approval of the merger agreement and the transactions contemplated by it.
See "The Merger - Heritage's Reasons for the Merger" on page I-16.
Solicitation and Revocation of Proxies. A form of proxy is enclosed
with this document. All shares of Heritage common stock represented by properly
executed proxies will, unless such proxies have been previously revoked, be
voted in accordance with the instructions indicated on such proxies. If no
instructions are indicated, such shares will be voted "FOR" approval of the
merger agreement and in the discretion of the proxy holder as to any other
matter which may properly come before the Heritage special meeting.
Each holder of Heritage common stock is requested to vote by
completing, dating and signing the accompanying proxy card and returning it
promptly to Heritage in the enclosed, postage-paid envelope. Heritage
shareholders should not send stock certificates with their proxy cards.
Any Heritage shareholder that has previously delivered a properly
executed proxy may revoke such proxy at any time before it is voted. A proxy may
be revoked either by (i) filing with the secretary of Heritage prior to the
Heritage meeting, at Heritage's principal executive offices, either a written
revocation of such proxy or a duly executed proxy bearing a later date or (ii)
attending the Heritage
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<PAGE>
special meeting and voting in person. Presence at the Heritage special meeting
will not revoke a shareholder's proxy unless such shareholder votes in person.
The cost of soliciting proxies will be borne by Heritage. Proxies may
be solicited by personal interview, mail or telephone. In addition, Heritage may
reimburse brokerage firms and other persons representing beneficial owners of
shares of Heritage common stock for their expenses in forwarding solicitation
materials to beneficial owners. Proxies may also be solicited by certain of
Heritage's executive officers, directors and regular employees, without
additional compensation, personally or by telephone or facsimile transmission.
Other Matters. Heritage is unaware of any matter to be presented at the
Heritage special meeting other than the proposal to approve the merger
agreement. If other matters are properly presented at the Heritage meeting, the
persons named in the enclosed form of proxy will have authority to vote all
properly executed proxies in accordance with their judgment on any such matter,
including any proposal to adjourn or postpone the Heritage meeting, provided
that no proxy that has been designated to vote against approval of the merger
agreement will be voted in favor of any proposal to adjourn or postpone the
Heritage meeting for the purpose of soliciting additional proxies to approve the
merger agreement.
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<PAGE>
CHAPTER III
DESCRIPTION OF CARDINAL
BUSINESS
General
Cardinal is a bank holding company that was incorporated under Virginia
law in 1997. Cardinal's three bank subsidiaries (collectively, the "banks") are
the following:
o Cardinal Bank, N.A., which is based in Fairfax, Virginia and began
operations on June 8, 1998;
o Cardinal Bank - Manassas/Prince William, N.A., which is based in
Manassas, Virginia and began operations on July 26, 1999; and
o Cardinal Bank - Dulles, N.A., which is based in Reston, Virginia
and began operations on August 2, 1999.
Cardinal also has an investment advisory subsidiary, Cardinal Wealth Services,
Inc., which began operations on February 1, 1999.
Through its bank subsidiaries, Cardinal pursues a community banking
strategy by offering a broad range of banking products to individuals,
professionals and small to medium-sized businesses, with an emphasis on
personalized service and local decision-making authority. Management's expansion
strategy to date has included attracting experienced local management teams, who
have significant decision-making authority at the local bank level, and local
independent boards of directors consisting of individuals with strong community
affiliations and extensive business backgrounds and business development
potential in the identified markets. Each management team operates in a manner
that provides responsive, personalized services. Cardinal provides credit
policies and procedures as well as centralized back office functions to provide
corporate, technological and marketing support to the banks.
Cardinal's principal executive offices are located at 10555 Main
Street, Suite 500, Fairfax, Virginia 22030, and its telephone number is (703)
934-9200. Cardinal also maintains a web site at www.cardinalbank.com.
Business Development
Background. Cardinal was formed in late 1997, principally in response
to perceived opportunities resulting from the takeovers of several
Virginia-based banks by regional bank holding companies. Since January 1, 1997,
numerous community banks headquartered in northern Virginia have been acquired.
Collectively, these banks had deposits of approximately $1.0 billion. Moreover,
in 1997 and 1998, four statewide banks with substantial northern Virginia
operations -- Crestar Bank, Central Fidelity National Bank, Signet Bank, N.A.
and Jefferson National Bank -- were acquired by large out-of-state bank holding
companies.
In Cardinal's market area, bank consolidations have been accompanied by
the dissolution of local boards of directors and relocation or termination of
management and customer service professionals. Cardinal believes that local
industry consolidation has disrupted customer relationships as the larger
regional financial institutions increasingly focus on larger corporate
customers, standardized loan and deposit products and other services. Generally,
these products and services are offered through less personalized delivery
systems, which has created the demand for high quality, personalized services to
small and medium-sized businesses and professionals. In addition, consolidation
in the local market has
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created opportunities to attract experienced bankers. Bank acquisitions have
dislocated experienced and talented management personnel due to the elimination
of redundant functions and the drive to achieve cost savings. Additionally,
uncertainty over possible future acquisitions has helped enable Cardinal to
attract officers from other banks that have not been acquired. As a result of
these factors, management believes that Cardinal has taken advantage of a rare
opportunity to attract its targeted banking customers and experienced management
personnel within Cardinal's identified markets.
Initial Capitalization of Cardinal. Cardinal funded its start-up and
organizational costs through a private offering of 1,409,509 shares of its
common stock in the fourth quarter of 1997 and the first quarter of 1998. The
total proceeds to Cardinal in the private offering were $10.6 million, of which
$8.0 million were used to capitalize Cardinal Bank, N.A., in June 1998. In
addition, Cardinal raised additional capital for general corporate purposes,
including the capitalization of Cardinal Wealth Services, Inc. and the three
additional banks, and to support the growth of assets and deposits through a
public offering of 2,830,000 shares of common stock in the third quarter of
1998. The total proceeds to Cardinal in the public offering were $26.0 million,
after deducting underwriting discounts and expenses.
Experienced Board and Management. Cardinal's board of directors
consists of 11 individuals, seven of whom formerly were founding directors of
First Patriot Bankshares Corporation, the holding company for Patriot National
Bank, headquartered in Reston, Virginia. First Patriot was organized in 1990 and
was acquired in 1997 by an out-of-state bank holding company. John H. Rust, Jr.,
Cardinal's Chairman, served as Chairman of First Patriot. Directors of Cardinal
who were former First Patriot directors include the chairs of First Patriot's
loan, audit, strategic planning, compensation and marketing committees. Until he
joined Cardinal in late 1997, L. Burwell Gunn, Jr., Cardinal's President and
Chief Executive Officer, served as Executive Vice President and Commercial
Division head for the Greater Washington Region for Crestar Bank. The last 13
years of Mr. Gunn's 25 year career with Crestar all involved service in the
northern Virginia area. Each of Cardinal's eight other executive officers has
extensive banking experience in northern Virginia.
Decentralized Operating Strategy. The foundation of Cardinal's strategy
is to operate a multi-community bank organization that emphasizes
decision-making at the local bank level combined with strong corporate,
technological, marketing, financial and managerial support. Cardinal's operating
model is for each bank to operate with local management and boards of directors
consisting of individuals with extensive knowledge of the local community and
the authority to make credit decisions. Cardinal believes that this operating
strategy enables the Banks to attract customers who wish to conduct their
business with a locally owned and managed institution with strong ties and an
active commitment to the community.
Centralized Corporate Support. Cardinal provides oversight and various
services to its banks, including technology, finance and accounting, human
resources, credit administration, internal audit, compliance, loan review,
marketing, retail administration, administrative support, policies and
procedures, product development and item processing. By providing such services
and oversight, Cardinal expects not only to achieve monetary savings, compared
to its costs if the banks were individually responsible for such functions, but
also expects to achieve a uniformity of operations and service that will be
associated with the "Cardinal" name in Cardinal's northern Virginia markets. The
banks' principal focus is to generate deposits and loans. This corporate support
system will enable Cardinal to achieve administrative economies of scale while
capitalizing on the responsiveness to client needs of its decentralized
community bank network. With the support from its significant investment in
infrastructure, particularly a management information system that links Cardinal
to its banks and facilitates data processing, compliance, and reporting
requirements, Cardinal believes that it has the operational and administrative
capacity to accommodate its banks and effectively manage Cardinal's growth for
the foreseeable future.
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Growth Strategy
Cardinal intends to focus on the growth of its banks. Each bank's
growth is expected to come from within its primary service area through loan and
deposit business. Cardinal focuses on acquiring market share, particularly from
large bank holding companies, by emphasizing local management and
decision-making and through delivering personalized services to business
customers and individuals. Specifically, Cardinal's competitive strategy
consists of approving loan requests quickly with a local loan committee,
operating with flexible, but prudent, lending policies, personalizing service by
establishing a long-term banking relationship with the customer, and maintaining
the requisite personnel to ensure a high level of service. While Cardinal does
not currently intend to actively search for expansion opportunities beyond its
designated markets, Cardinal may consider opportunities that arise from time to
time, which could occur through acquisitions of existing institutions or
branches.
Cardinal believes that a management team that is familiar with the
needs of its community can provide higher quality personalized service to its
customers. The local management team of each bank has a significant amount of
decision-making authority and is accessible to its customers. As a result of the
consolidation trend in the northern Virginia area, Cardinal's management
believes that there are significant opportunities to attract experienced bank
managers who would like to join an institution promoting a community banking
concept.
As it anticipated the opening of its subsidiary banks, Cardinal
established through its first subsidiary, Cardinal Bank, N.A., loan production
offices in Manassas, the Reston area of Fairfax County, and Alexandria in order
to establish customer relationships, brand awareness and a pipeline of loan
business. Each loan production office was staffed by personnel now employed by
the bank that opened in that location.
Each bank has a local board of directors that is comprised of prominent
members of the community, including business leaders and professionals. These
directors not only operate the banks, but also act as ambassadors of their
respective banks within the community and are expected to promote the business
development of each bank. The directors and officers of Cardinal and the
directors of the banks are active in the civic, charitable and social
organizations located in the local communities. It is anticipated that members
of the local management teams will hold leadership positions in a number of
community organizations and continue to volunteer for other positions in the
future.
Cardinal believes that each bank's ability to compete with other
financial institutions in its respective market area will be enhanced by its
posture as a locally managed bank with a broad base of local ownership. The
directors of each of the banks, most of whom reside or work in the market area
in which their respective banks will operate, own a significant amount of common
stock. Cardinal believes that local ownership of common stock is a highly
effective means of attracting customers and fostering loyalty to the banks.
Market Areas
Cardinal's targeted market includes areas in and around Fairfax County,
Virginia, including the independent cities of Fairfax and Alexandria, as well as
Arlington, Manassas, and Prince William and Loudoun Counties. Interstates 95,
495, and 66 all pass through the market area and provide efficient access to
other regions of the state. Prominent local newspapers, the Washington Post and
Washington Times, and a number of radio and television stations provide diverse
media outlets. The broad exposure of television, print media and radio offer
several opportunities to explore effective advertising and public relations
avenues for Cardinal.
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Cardinal has established banking operations in four locations in the
broad target market, each of which represents a separate market. These distinct,
but contiguous markets are: (1) the city of Fairfax and central Fairfax County;
(2) the city of Manassas and Prince William County; (3) the city of Alexandria
and Arlington County; and (4) the Reston and Herndon areas (of western Fairfax
County) and Loudoun County. As of 1997, Fairfax County, the city of Fairfax,
Prince William County, the city of Manassas, Arlington County, the city of
Alexandria and Loudoun County each ranked in the top ten for Virginia in median
household income, and collectively the population of the area represented 24.4%
of the state's total population. Northern Virginia continues to provide more
than half of all the jobs created in the state and outstrips the state in most
other measures of growth. In 1999, the number of jobs in northern Virginia
increased by 41,110, as compared to a state-wide increase of 64,137.
The Banks
The bank subsidiaries of Cardinal engage in the commercial banking
business in their respective communities. Cardinal believes that there is a
demand for, and that the northern Virginia communities described above will
support, new locally operated community banks. Although Cardinal could have
obtained a banking presence in the identified markets by opening branch offices
of Cardinal Bank, N.A. management of Cardinal believes that separate banks with
their own local boards of directors and banking practices, tailored to the local
market, is a preferable approach. Each bank provides personalized banking
services, with emphasis on the financial needs and objectives of individuals,
professionals and small to medium-sized businesses. Additionally, substantially
all credit and related decisions are made by the banks' local management and
board of directors, thereby facilitating prompt response.
The principal business of each bank is to accept deposits from the
public and to make loans and other investments. The principal sources of funds
for each bank's loans and investments are demand, time, savings and other
deposits, repayment of loans, and borrowings. In addition, a portion of the net
proceeds of the 1998 public offering, after having been contributed to the
capital of each bank, were used by each bank to fund loans. The principal source
of income for each bank is interest collected on loans. The principal expenses
of each bank are interest paid on savings and other deposits, employee
compensation, office expenses, and other overhead expenses. The banks do not
currently offer trust or fiduciary services.
Cardinal is committed to providing high quality banking products and
services to its banks' customers and has made a significant investment in its
advanced automated operating accounting system, which supports virtually every
banking function. The system provides the technology that fully automates the
branches, processes bank transactions, mortgages, loans and electronic banking,
conducts database and direct response marketing, provides cash management
solutions, streamlined reporting and reconciliation support as well as sales
support.
With this investment in technology, Cardinal offers Internet-based
delivery products for both consumers and commercial customers. Customers can
open accounts, apply for loans, check balances, check account history, transfer
funds, download images of checks, pay bills, download active statements into
QuickenTM or Microsoft MoneyTM, use interactive calculators and transmit e-mail
with Cardinal over the Internet. The Internet provides an inexpensive way for
Cardinal to expand its geographic borders and branch activities while providing
the kind of services one would expect from the larger banks.
Cardinal also offers customers the convenience of digital imaged checks
that make it easy to reconcile statements, organize and store account
information while streamlining the back office. Every item is imaged and
available for inspection. Among the many features, check imaging allows for
instant statement reconstruction for research, which can be faxed or e-mailed
directly to a customer's personal computer.
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Customers
Management believes that the recent bank consolidation within northern
Virginia provides a significant opportunity to build a successful,
locally-oriented franchise. Management of Cardinal also believes that many of
the larger financial institutions do not emphasize a high level of personalized
service to the small and medium-sized commercial, professional or individual
retail customers. Cardinal focuses its marketing efforts on attracting small and
medium-sized businesses and professionals, such as physicians, accountants and
attorneys. Because Cardinal focuses on businesses and professionals, the
majority of its loan portfolio is in the commercial area with an emphasis placed
on originating sound, profitable commercial and industrial loans secured by real
estate, accounts receivable, inventory, property, plant and equipment.
Although Cardinal expects to concentrate its lending to commercial
businesses, Cardinal attracts a significant amount of professional and consumer
business. Many of its customers are the principals of the small and medium-sized
businesses for whom the banks provide banking services. Management emphasizes
"relationship banking" in order that each customer can identify and establish a
comfort level with bank officers who come to understand their customers'
business and financial needs in depth. Management intends to develop its retail
business with individuals who appreciate a higher level of personal service,
contact with their lending officer and responsive decision-making. It is
expected that most of Cardinal's business will be further developed through its
lending officers and local boards of directors and by pursuing an aggressive
strategy of making calls on customers throughout the market area.
Banking Products and Services
Cardinal offers a broad array of banking products and services to its
customers. These products and services are set forth below.
Loans. Through each of its subsidiary banks, Cardinal offers a wide
range of short to long-term commercial and consumer loans, which are described
in further detail below. Cardinal has established pre-determined percentage
levels as targets for the division of Cardinal's loan portfolio across the
various categories of loans. Commercial loans, real estate-commercial loans,
real estate-construction loans, real estate-residential loans, home equity
loans, and consumer loans account for approximately 33%, 29%, 1%, 17%, 6% and
14%, respectively, of its loan portfolio. Cardinal believes that this division
reflects the current credit demands of its markets and provides a sufficient
amount of diversification to avoid over-reliance on one category. Cardinal may
adjust these levels from time to time as the credit demands of the community
change and as each bank's business evolves.
Credit Policies. With respect to each bank's loan portfolio, Cardinal
oversees credit operations while still granting local authority to each bank.
Cardinal's chief credit officer is primarily responsible for maintaining a
quality loan portfolio and developing a strong credit culture throughout the
entire organization. The chief credit officer is responsible for developing and
updating the credit policies and procedures for the organization. The board of
directors of a bank subsidiary may make exceptions to these credit policies and
procedures as appropriate, but any such exception must be documented and made
for sound business reasons.
Credit quality is controlled by the chief credit officer through
compliance with Cardinal's credit policies and procedures. Cardinal's
risk-decision process is actively managed in a disciplined fashion to maintain
an acceptable risk profile characterized by soundness, diversity, quality,
prudence, balance and accountability. Cardinal's credit approval process
consists of specific authorities granted to the lending officers. Loans
exceeding a particular lending officer's level of authority are reviewed and
considered for
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approval by an officers' loan committee and, then, a bank's board of directors.
In addition, the chief credit officer works closely with each lending officer at
the bank level to ensure that the business being solicited is of the quality and
structure that fits Cardinal's desired risk profile.
Under its credit policies, Cardinal generally limits the concentration
of credit risk by a particular bank in any loan or group of loans to 30% of that
bank's capital. Such concentration limit pertains to any group of borrowers
related as to the source of repayment or any one specific industry. Furthermore,
each bank has established limits on the total amount of that bank's outstanding
loans to one borrower, all of which are set below legal lending limits. Any loan
that a bank proposes to make that will exceed such established limits requires
the prior approval of Cardinal's board of directors.
Commercial Loans. Cardinal makes commercial loans to qualified
businesses in its market area. Cardinal's commercial lending consists primarily
of commercial and industrial loans for the financing of accounts receivable,
inventory, property, plant and equipment. Cardinal also offers Small Business
Administration guaranteed loans and asset-based lending arrangements to certain
of its customers.
Commercial business loans generally have a higher degree of risk than
residential mortgage loans, but have commensurately higher yields. Residential
mortgage loans generally are made on the basis of the borrower's ability to make
repayment from his or her employment and other income and are secured by real
estate whose value tends to be easily ascertainable. In contrast, commercial
business loans typically are made on the basis of the borrower's ability to make
repayment from cash flow from its business and are secured by business assets,
such as commercial real estate, accounts receivable, equipment and inventory. As
a result, the availability of funds for the repayment of commercial business
loans may be substantially dependent on the success of the business itself.
Further, the collateral for commercial business loans may depreciate over time
and cannot be appraised with as much precision as residential real estate.
To manage these risks, Cardinal's policy is to secure commercial loans
with both the assets of the borrowing business and other additional collateral
and guarantees that may be available. In addition, Cardinal actively monitors
certain measures of the borrower, including advance rate, cash flow, collateral
value and other appropriate credit factors.
Commercial Mortgage Loans. Cardinal also originates commercial mortgage
loans. These loans are primarily secured by various types of commercial real
estate, including office, retail, warehouse, industrial and other
non-residential types of properties and are made to the owner and/or occupiers
of such property. These loans have maturities generally ranging from one to 10
years.
Commercial mortgage lending entails significant additional risk,
compared with residential mortgage lending. Commercial mortgage loans typically
involve larger loan balances concentrated with single borrowers or groups of
related borrowers. Additionally, the payment experience on loans secured by
income producing properties is typically dependent on the successful operation
of a business or a real estate project and thus may be subject, to a greater
extent, to adverse conditions in the real estate market or in the economy
generally. Cardinal's commercial real estate loan underwriting criteria require
an examination of debt service coverage ratios, the borrower's creditworthiness
and prior credit history and reputation, and Cardinal generally requires
personal guarantees or endorsements of borrowers. Cardinal also carefully
considers the location of the security property.
Loan-to-value ratios for commercial mortgage loans generally do not
exceed 75%. Loan-to-value ratios up to 85% are permitted if the borrower has
unusually strong general liquidity, net worth and cash flow, and loan-to-value
ratios up to 90% are permitted if an Small Business Administration guaranty has
been obtained.
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Residential Mortgage Loans. Cardinal's residential mortgage loans
consist of residential first and second mortgage loans, residential construction
loans and home equity lines of credit and term loans secured by first and second
mortgages on the residences of borrowers for home improvements, education and
other personal expenditures. Cardinal makes mortgage loans with a variety of
terms, including fixed and floating or variable rates and a variety of
maturities. Maturities for construction loans generally range from six to 12
months for residential property and from 12 to 18 months for non-residential and
multi-family properties.
Residential mortgage loans generally are made on the basis of the
borrower's ability to make repayment from his or her employment and other income
and are secured by real estate whose value tends to be easily ascertainable.
These loans are made consistent with Cardinal's appraisal policy and real estate
lending policy, which detail maximum loan-to-value ratios and maturities. Loans
for owner-occupied property generally are made with a loan-to-value ratio of up
to 80% for first liens and 75% for junior liens. Higher loan-to-value ratios may
be allowed based on the borrower's unusually strong general liquidity, net worth
and cash flow. Loan-to-value ratios for home equity lines of credit generally do
not exceed 75%. If the loan-to-value ratio exceeds 90% for residential mortgage
loans, Cardinal has determined that it is an unusually strong credit.
Construction lending entails significant additional risks, compared
with residential mortgage lending. Construction loans often involve larger loan
balances concentrated with single borrowers or groups of related borrowers.
Construction loans also involve additional risks attributable to the fact that
loan funds are advanced upon the security of property under construction, which
is of uncertain value prior to the completion of construction. Thus, it is more
difficult to evaluate accurately the total loan funds required to complete a
project and related loan-to-value ratios. To minimize the risks associated with
construction lending, Cardinal limits loan-to-value ratios for residential
property to 85% and for non-residential property and multi-family properties to
80%, in addition to its usual credit analysis of its borrowers.
Management expects that the loan-to-value ratios described above will
be sufficient to compensate for fluctuations in the real estate market to
minimize the risk of loss.
Consumer Loans. Cardinal's consumer loans consist primarily of
installment loans to individuals for personal, family and household purposes.
The specific types of consumer loans made by Cardinal include home improvement
loans, debt consolidation loans and general consumer lending.
Consumer loans may entail greater risk than residential mortgage loans
do, particularly in the case of consumer loans that are unsecured, such as lines
of credit, or secured by rapidly depreciable assets such as automobiles. In such
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount that can be recovered on
such loans. A loan may also give rise to claims and defenses by a consumer loan
borrower against an assignee of such loan, such as Cardinal, and a borrower may
be able to assert against such assignee claims and defenses that it has against
the seller of the underlying collateral.
Cardinal's policy for consumer loans is to accept moderate risk while
minimizing losses, primarily through a careful analysis of the borrower. In
evaluating consumer loans, Cardinal requires its
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lending officers to review the borrower's level and stability of income, past
credit history and the impact of these factors on the ability of the borrower to
repay the loan in a timely manner. In addition, Cardinal requires that its
banking officers maintain an appropriate margin between the loan amount and
collateral value. Many of Cardinal's consumer loans are made to the principals
of the small and medium-sized businesses for whom the banks provide banking
services.
In the fourth quarter of 1999, Cardinal purchased a $7.8 million
installment loan portfolio. While Cardinal does not have any current plans to
purchase additional loan portfolios, Cardinal may consider opportunities that
arise from time to time with respect to portfolios that meet established
underwriting criteria.
Credit Card and Other Loans. Cardinal also issues credit cards to
certain of its customers. In determining to whom it will issue credit cards,
Cardinal evaluates the borrower's level and stability of income, past credit
history and other factors. Finally, Cardinal makes additional loans that are not
classified in one of the above categories. In making such loans, Cardinal
attempts to ensure that the borrower meets Cardinal's credit quality standards.
Deposits. Management offers a broad range of interest-bearing and
noninterest-bearing deposit accounts, including commercial and retail checking
accounts, money market accounts, individual retirement accounts, regular
interest-bearing savings accounts and certificates of deposit with a range of
maturity date options. The primary sources of deposits are small and
medium-sized businesses and individuals within an identified market. In each
identified market, senior management has the authority to set rates within
specified parameters in order to remain competitive with other financial
institutions. All deposits are insured by the Federal Deposit Insurance
Corporation up to the maximum amount permitted by law. Cardinal implements a
service charge fee schedule, which is competitive with other financial
institutions in a subsidiary bank's market area, covering such matters as
maintenance fees on checking accounts, per item processing fees on checking
accounts, returned check charges and other similar fees.
Specialized Consumer Services. Management offers specialized products
and services to its customers, such as travelers checks and safe deposit
services.
Courier Services. Cardinal offers courier services to its business
customers. Courier services permit Cardinal to provide the convenience and
personalized service that its customers require by scheduling pick-ups of
deposits.
Telephone and Internet Banking. Cardinal believes that there is a
strong demand within its market for telephone banking and internet banking. Both
services allow both commercial and retail customers to access detailed account
information and execute a wide variety of the banking transactions referred to
above. Management believes that these services are particularly attractive for
its customers, as it enables them to conduct their banking business and monitor
their bank accounts from remote locations. Telephone and internet banking
assists the banks in attracting and retaining customers and encourages its
customers to maintain their total banking relationships with Cardinal.
Automatic Teller Machines ("ATMs"). Cardinal has an ATM at each office
of each bank. Management makes other financial institutions' ATMs available to
its customers and offers customers a certain number of free ATM transactions per
month.
Other Products and Services. Cardinal evaluates other services such as
trust services, insurance, mortgage services and other permissible activities.
Management expects to introduce these services as they become economically
viable.
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Brokerage and Investment Advisory Services
Through Cardinal Wealth Services, Inc., Cardinal provides financial and
estate planning services. Cardinal Wealth Services, Inc. has formed a strategic
alliance with LM Financial Partners, Inc., a wholly owned subsidiary of Legg
Mason Inc. Through this alliance, Cardinal's financial advisors can offer its
customers an extensive range of financial products and services, including
estate planning, qualified retirement plans, mutual funds, annuities, life
insurance, fixed income securities and equity research and recommendations.
Competition
Banks generally compete with other financial institutions through the
selection of banking products and services offered, the pricing of services, the
level of service provided, the convenience and availability of services, and the
degree of expertise and the personal manner in which services are offered.
Virginia law permits statewide branching by banks. Consequently, commercial
banking in Virginia is highly competitive. Many large banking organizations,
several of which are controlled by out-of-state holding companies, currently
operate in Cardinal's targeted market areas. In addition, competition between
commercial banks and thrift institutions (savings institutions and credit
unions) has intensified significantly by the elimination of many previous
distinctions between the various types of financial institutions and the
expanded powers and increased activity of thrift institutions in areas of
banking that previously had been the sole domain of commercial banks. Recent
legislation, together with other regulatory changes by the primary regulators of
the various financial institutions, has resulted in the almost total elimination
of practical distinctions between a commercial bank and a thrift institution.
Consequently, competition among financial institutions of all types is largely
unlimited with respect to legal ability and authority to provide most financial
services. Furthermore, out-of-state banks not previously allowed to operate in
Virginia are allowed to commence operations and compete in Cardinal's targeted
market areas.
Cardinal faces competition from other banks, as well as thrift
institutions, consumer finance companies, insurance companies and other
institutions in Cardinal's markets. Some of these competitors are not subject to
the same degree of regulation and restriction imposed upon Cardinal. Many of
these competitors also have broader geographic markets and substantially greater
resources and lending limits than Cardinal's subsidiary banks and offer certain
services such as trust banking that the banks are not expected to provide in the
near term. In addition, many of these competitors have numerous branch offices
located throughout the extended market areas of the banks that may provide these
competitors with an advantage in geographic convenience that Cardinal does not
have at present. Some competitors may also be in a position to make more
effective use of media advertising, support services, and electronic technology
than Cardinal.
Employees
At March 31, 2000, Cardinal had 88 full time employees, none of whom
are represented by a union or covered by a collective bargaining agreement.
Management considers employee relations to be good.
Government Supervision and Regulation
The following discussion is a summary of the principal laws and
regulations that comprise the regulatory framework applicable to Cardinal and
each of its bank subsidiaries. Other laws and regulations that govern various
aspects of the operations of banks and bank holding companies are not described
in this section, although violations of such laws and regulations could result
in supervisory enforcement
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action against Cardinal or its bank subsidiaries. The following descriptions
summarize the material terms of the principal laws and regulations and are
qualified in their entirety by reference to applicable laws and regulations.
General. As a bank holding company, Cardinal is subject to regulation
under the Bank Holding Company Act of 1956, as amended, and the examination and
reporting requirements of the Board of Governors of the Federal Reserve System.
Under the Bank Holding Company Act, a bank holding company may not directly or
indirectly acquire ownership or control of more than 5% of the voting shares or
substantially all of the assets of any additional bank or merge or consolidate
with another bank holding company without the prior approval of the Federal
Reserve. The Bank Holding Company Act also generally limits the activities of a
bank holding company to that of banking, managing or controlling banks, or any
other activity which is determined to be so closely related to banking or to
managing or controlling banks that an exception is allowed for those activities.
As national banks, Cardinal's subsidiaries are subject to regulation,
supervision and examination by the Office of the Comptroller of the Currency.
The banks also are subject to regulation, supervision and examination by the
FDIC. Federal law also governs the activities in which the Banks may engage and
the investments that they may make and limits the aggregate amount of loans that
may be granted to one borrower to 15% of a bank's capital and surplus. Various
consumer and compliance laws and regulations also affect the banks' operations.
The activities permissible to bank holding companies and their
affiliates were substantially expanded by the Gramm-Leach-Bliley Act, which the
President signed on November 12, 1999. Gramm-Leach-Bliley repeals the
anti-affiliation provisions of the Glass-Steagall Act to permit the common
ownership of commercial banks, investment banks and insurance companies. Under
Gramm-Leach-Bliley, a bank holding company can elect to be treated as a
financial holding company. A financial holding company may engage in any
activity and acquire and retain any company that the Federal Reserve determines
to be financial in nature. A financial holding company also may engage in any
activity that is complementary to a financial activity and does not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally. The Federal Reserve must consult with the Secretary
of the Treasury in determining whether an activity is financial in nature or
incidental to a financial activity.
The earnings of Cardinal's bank subsidiaries, and therefore the
earnings of Cardinal, are affected by general economic conditions, management
policies and the legislative and governmental actions of various regulatory
authorities, including those referred to above.
The OCC conducts regular examinations of Cardinal's bank subsidiaries
and reviews such matters as the adequacy of loan loss reserves, quality of loans
and investments, management practices, compliance with laws, and other aspects
of their operations. In addition to these regular examinations, the banks must
furnish the OCC with periodic reports containing a full and accurate statement
of its affairs. Supervision, regulation and examination of banks by these
agencies are intended primarily for the protection of depositors rather than
shareholders.
Insurance of Accounts, Assessments and Regulation by the FDIC. The
deposits of the Banks are insured by the FDIC up to the limits set forth under
applicable law. The deposits of the Banks are subject to the deposit insurance
assessments of the Bank Insurance Fund of the FDIC.
The FDIC has implemented a risk-based deposit insurance assessment
system under which the assessment rate for an insured institution may vary
according to regulatory capital levels of the institution and other factors
(including supervisory evaluations). Depository institutions insured by the Bank
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Insurance Fund 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 .30% 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.
The FDIC is authorized to prohibit any BIF-insured institution from
engaging in any activity that the FDIC determines by regulation or order to pose
a serious threat to the respective insurance fund. Also, the FDIC may initiate
enforcement actions against banks, after first giving the institution's primary
regulatory authority an opportunity to take such action. The FDIC may terminate
the deposit insurance of any depository institution if it determines, after a
hearing, that the institution has engaged or is engaging in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations, or has
violated any applicable law, regulation, order or any condition imposed in
writing by the FDIC. It also may suspend deposit insurance temporarily during
the hearing process for the permanent termination of insurance, if the
institution has no tangible capital. If deposit insurance is terminated, the
deposits at the institution at the time of termination, less subsequent
withdrawals, shall continue to be insured for a period from six months to two
years, as determined by the FDIC. Management is not aware of any existing
circumstances that could result in termination of any bank's deposit insurance.
Capital. The OCC and the Federal Reserve have issued risk-based and
leverage capital guidelines applicable to banking organizations that they
supervise. Under the risk-based capital requirements, Cardinal and its banks are
each generally required to maintain a minimum ratio of total capital to
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) of 8%. At least half of the total capital is to be
composed of common equity, retained earnings and qualifying perpetual preferred
stock, less certain intangibles ("Tier 1 capital"). The remainder may consist of
certain subordinated debt, certain hybrid capital instruments and other
qualifying preferred stock and a limited amount of the loan loss allowance
("Tier 2 capital" and, together with Tier 1 capital, "total capital").
In addition, each of the federal banking regulatory agencies has
established minimum leverage capital ratio requirements for banking
organizations. These requirements provide for a minimum leverage ratio of Tier 1
capital to adjusted average quarterly assets equal to 3% for bank holding
companies that are rated a composite "1" and 4% for all other bank holding
companies. Bank holding companies are expected to maintain higher than minimum
capital ratios if they have supervisory, financial, operational or managerial
weaknesses, or if they are anticipating or experiencing significant growth.
The risk-based capital standards of the OCC and the Federal Reserve
explicitly identify concentrations of credit risk and the risk arising from
non-traditional activities, as well as an institution's ability to manage these
risks, as important factors to be taken into account by the agency in assessing
an institution's overall capital adequacy. The capital guidelines also provide
that an institution's exposure to a decline in the economic value of its capital
due to changes in interest rates be considered by the agency as a factor in
evaluating a bank's capital adequacy. The OCC and the Federal Reserve also have
recently issued additional capital guidelines for bank holding companies that
engage in certain trading activities.
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 that the
depository institution becomes in danger of default or is in default. For
example, under a policy of the Federal Reserve with respect to bank
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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 Federal Deposit Insurance Act 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
Cardinal and its banks, including the power to impose fines and other civil and
criminal penalties, and to appoint a receiver in order to conserve the assets of
any such institution for the benefit of depositors and other creditors.
Payment of Dividends. Cardinal is a legal entity separate and distinct
from its banks. Virtually all of the revenues of Cardinal will result from
dividends paid to Cardinal by its banks. Under OCC regulations, a national bank
may not declare a dividend in excess of its undivided profits, which means that
each bank must recover any start-up losses before it may pay a dividend to
Cardinal. Additionally, a national bank may not declare a dividend if the total
amount of all dividends, including the proposed dividend, declared by the
national bank in any calendar year exceeds the total of the national bank's
retained net income of that year to date, combined with its retained net income
of the two preceding years, unless the dividend is approved by the OCC. A
national bank may not declare or pay any dividend if, after making the dividend,
the national bank would be "undercapitalized," as defined in regulations of the
OCC. Cardinal is subject to state laws that limit the amount of dividends it can
pay. In addition, Cardinal is subject to various general regulatory policies
relating to the payment of dividends, including requirements to maintain
adequate capital above regulatory minimums. The Federal Reserve has indicated
that banking organizations should generally pay dividends only if (1) the
organization's net income available to common shareholders over the past year
has been sufficient to fund fully the dividends and (2) the prospective rate of
earnings retention appears consistent with the organization's capital needs,
asset quality and overall financial condition. These laws, regulations or
policies will materially impact the ability of Cardinal's banks and, therefore,
Cardinal to pay dividends in the early years of operations.
Community Reinvestment. The requirements of the Community Reinvestment
Act are applicable to the Banks. The Community Reinvestment Act imposes on
financial institutions an affirmative and ongoing obligation to meet the credit
needs of their local communities, including low and moderate income
neighborhoods, consistent with the safe and sound operation of those
institutions. A financial institution's efforts in meeting community credit
needs currently are evaluated as part of the examination
III-12
<PAGE>
process pursuant to twelve assessment factors. These factors also are considered
in evaluating mergers, acquisitions and applications to open a branch or
facility.
Interstate Banking and Branching. Current federal law authorizes
interstate acquisitions of banks and bank holding companies without geographic
limitation. Effective June 1, 1997, a bank headquartered in one state is able to
merge with a bank headquartered in another state, as long as neither of the
states has opted out of such interstate merger authority prior to such date.
States are authorized to enact laws permitting such interstate bank merger
transactions prior to June 1, 1997, as well as authorizing a bank to establish
"de novo" interstate branches. Virginia enacted early "opt in" laws, permitting
interstate bank merger transactions. Once a bank has established branches in a
state through an interstate merger transaction, the bank may establish and
acquire additional branches at any location in the state where a bank
headquartered in that state could have established or acquired branches under
applicable federal or state law.
Economic and Monetary Polices. The operations of Cardinal are affected
not only by general economic conditions, but also by the economic and monetary
policies of various regulatory authorities. In particular, the Federal Reserve
regulates money, credit and interest rates in order to influence general
economic conditions. These policies have a significant influence on overall
growth and distribution of loans, investments and deposits and affect interest
rates charged on loans or paid for time and savings deposits. Federal Reserve
monetary policies have had a significant effect on the operating results of
commercial banks in the past and are expected to continue to do so in the
future.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
General
Cardinal is the holding company for three bank subsidiaries and one
non-bank subsidiary. Cardinal began operations November 24, 1997 and opened its
first bank subsidiary, Cardinal Bank, N.A., on June 8, 1998. Following its
private offering in December 1997 that generated $10.6 million in capital,
Cardinal raised an additional $26.0 million in an initial public offering of
2,830,000 shares in July 1998. In February 1999, Cardinal Wealth Services, Inc.
began operations as Cardinal's nonbank investment subsidiary. Through a
strategic alliance with LM Financial Partners, Inc., a wholly-owned subsidiary
of Legg Mason, Inc., Cardinal Wealth Services, Inc. can offer an extensive range
of financial products and services. In July 1999, Cardinal's second bank
subsidiary, Cardinal Bank -Manassas/Prince William, N.A. began operations.
Cardinal Bank - Dulles, N.A., the third banking subsidiary, began operations in
August 1999.
The following presents management's discussion and analysis of the
consolidated financial condition and results of operation of Cardinal for the
three months ended March 31, 2000 and the years ended December 31, 1999 and
1998. The discussion should be read in conjunction with the accompanying
consolidated financial statements.
III-13
<PAGE>
March 31, 2000 compared to December 31, 1999
Financial Condition
Total assets of Cardinal were $115.9 million at March 31, 2000 compared
to $97.0 million at December 31, 1999. This represents an increase of $18.9
million or 19.5% and is due to increased deposit and loan generation. Gross
loans increased $13.3 million to $81.4 million at March 31, 2000 from $68.2
million at December 31, 1999 (see Table 1 for loan portfolio details). Total
deposits increased $20.1 million to $80.0 million at March 31, 2000 compared to
$59.9 million at December 31, 1999. Total cash and cash equivalents increased to
$24.6 million at March 31, 2000 from $19.0 million at December 31, 1999.
Investment securities available-for-sale and other investments declined $174
thousand to $5.6 million at March 31, 2000 from $5.8 million at December 31,
1999 (see Table 2 for details of the investment securities available-for-sale
portfolio). The increase in loans of $13.3 million was funded primarily through
increased deposits. Shareholders' equity at March 31, 2000 was $29.7 million
compared to $30.7 million at December 31, 1999. Book value per share on March
31, 2000 was $7.01 compared to $7.25 on December 31, 1999.
Results of Operations
Net loss for the three months ended March 31, 2000 was $942 thousand or
$0.22 per share compared to a net loss of $824 thousand or $0.19 per share for
the three months ended March 31, 1999. The increase in the net loss reflects the
expenses associated with the operation of two additional bank subsidiaries that
opened in the third quarter of 1999. Return on average assets and return on
average equity for the three months ended March 31, 2000 were -3.53% and
-12.39%, respectively. For the three months ended March 31, 1999, return on
average assets and return on average equity were -5.76% and -9.70%,
respectively.
Net interest income is Cardinal's primary source of revenue and
represents the difference between interest and fees earned on interest-bearing
assets and the interest paid on deposits and other interest-bearing liabilities.
Net interest income for the three months ended March 31, 2000 was $1.15 million
compared to $607 thousand for the three months ended March 31, 1999.
Cardinal's net interest margin for the three months ended March 31, 2000
was 4.93% compared to 4.54% for the three months ended March 31, 1999. The 41
basis point increase in the margin can be attributed to a change in asset mix as
loans represented a higher percentage of interest-earning assets at March 31,
2000 than at March 31, 1999. Table 3 presents an analysis of average earning
assets, interest-bearing liabilities and demand deposits with the related
components of interest income and interest expense.
The provision for loan losses for the three months ended March 31, 2000
was $143 thousand compared to $68 thousand for the three months ended March 31,
1999. The increase is due to the increased loan balances. The allowance for loan
losses at March 31, 2000 was $869 thousand compared to $726 thousand at December
31, 1999. The ratio of the allowance for loan losses to gross loans at March 31,
2000 was 1.07% compared to a ratio of 1.07% at December 31, 1999. In the fourth
quarter of 1999, Cardinal purchased a $7.8 million installment loan portfolio.
This transaction was structured in such a way that the seller absorbs losses up
to 115 basis points of the outstanding balances. Consequently, Cardinal does not
expect losses in this portfolio and did not add to its allowance for loan losses
when this transaction was recorded. The second factor to be considered is
Cardinal's Business Manager receivable financing product. Under this product,
advances to customers are collateralized by customer receivables and a
restricted deposit account equal to at least 10% of the amount borrowed. As a
III-14
<PAGE>
result, Cardinal does not expect losses on those transactions and therefore has
not added to its allowance for loan losses. Table 4 reflects the components of
the allowance for loan losses and calculates the loan loss ratio two ways:
first, with total gross loans, and second, with total gross loans less purchased
loans and the Business Manager receivables.
Non-interest income for the three months ended March 31, 2000 was $424
thousand compared to $45 thousand for the three months ended March 31, 1999. The
significant increase in non-interest income was due to investment fees generated
by Cardinal's non-bank subsidiary, Cardinal Wealth Services, Inc. This
subsidiary opened in February, 1999 and had minimal fee income for the three
months ended March 31, 1999.
Non-interest expense for the three months ended March 31, 2000 totaled
$2.38 million compared to $1.41 million for the three months ended March 31,
1999. The increases in expenses were due to the opening of two bank subsidiaries
in the third quarter of 1999 and the resulting increase in personnel. Total
employees increased to 88 as of March 31, 2000 from 45 as of March 31, 1999.
Non-personnel related expenses associated with the operation of the new bank
subsidiaries increased as well.
Business Segment Operations
Cardinal provides a diversified selection of banking and non-banking
financial services and products through its subsidiaries. Management operates
and reports the results of the Company's operations through two business
segments- commercial banking and investment advisory services.
Commercial Banking. The commercial banking segment provides
comprehensive banking services to small businesses and individuals through
multiple delivery channels. Through three banking subsidiaries, services include
commercial and consumer lending, deposit products, direct banking via the
internet and telephone and the funding of small business receivables through the
Business Manager product.
For the three months ended March 31, 2000, the commercial banking
segment had a net loss of $457 thousand compared to a net loss of $441 thousand
for the three months ended March 31, 1999. As of March 31, 2000 total assets
were $107.0 million, total loans were $81.4 million and deposits were $80.0
million. As of March 31, 1999, total assets were $32.1 million, total loans were
$22.0 million and deposits were $25.9 million.
Investment Advisory Services. The investment advisory services segment
provides financial and estate planning services utilizing a host of products
provided through a strategic alliance with Legg Mason Financial Partners, a
wholly-owned subsidiary of Legg Mason, Inc. Operations for this segment began
February 1, 1999.
For the three months ended March 31, 2000, the investment advisory
services segment had a net loss of $155 thousand. As of March 31, 2000 total
assets were $213 thousand and total assets under management were $72.6 million.
For the three months ended March 31, 1999 the net loss was $194 thousand. As of
March 31, 1999, total assets were $189 thousand and total assets under
management were $22.6 million.
III-15
<PAGE>
Capital Resources
Shareholders' equity at March 31, 2000 was $29.7 million compared to
$30.7 million at December 31, 1999. The reduction in equity reflects the net
loss recorded for the quarter ended March 31, 2000. At March 31, 2000 Cardinal's
tier 1 and total risk-based capital ratios were 30.9% and 31.8%, respectively.
At December 31, 1999 Cardinal's tier 1 and total risk-based capital ratios were
37.9% and 38.8%, respectively. The decline in Cardinal's capital ratios is due
to the increase in total assets as well as the absorption of operating losses.
Table 5 reflects the components of regulatory capital. Cardinal continues to
maintain a capital structure that places it well above minimum regulatory
requirements.
Liquidity
Liquidity provides Cardinal with the ability to meet normal deposit
withdrawals while also providing for the credit needs of customers. At March 31,
2000, cash and cash equivalents and securities available for sale totaled $29.2
million or 25% of total assets compared to $23.8 million or 25% of total assets
at December 31, 1999. Management is committed to maintaining liquidity at a
level sufficient to protect depositors, provide for reasonable growth, and fully
comply with all regulatory requirements.
Interest Rate Sensitivity
An important element of asset/liability management is the monitoring of
Cardinal's sensitivity to interest rate movements. In order to measure the
effect of interest rates on Cardinal's net interest income, management takes
into consideration the expected cash flows from the loan and securities
portfolios and the expected magnitude of the repricing of specific asset and
liability categories. Management evaluates interest sensitivity risk and then
formulates guidelines to manage this risk based upon its outlook regarding the
economy, forecasted interest rate movements and other business factors.
Management's goal is to maximize and stabilize the net interest margin by
limiting exposure to interest rate changes.
The data in Table 7 reflects re-pricing or expected maturities of
various assets and liabilities as of March 31, 2000. This "gap" analysis
represents the difference between interest sensitive assets and liabilities in a
specific time interval. Interest sensitivity gap analysis presents a position
that existed at one particular point in time, and assumes that assets and
liabilities with similar re-pricing characteristics will re-price at the same
time and to the same degree.
1999 Compared to 1998
Earnings Summary
The net loss for the year ended December 31, 1999 was $4.0 million or
$0.95 per diluted share, compared to a net loss of $1.7 million, or $0.64 per
diluted share, for the year ended December 31, 1998. The increase in the net
loss in 1999 compared to 1998 was primarily due to increased non-interest
expenses associated with the opening of three subsidiaries. Two bank
subsidiaries, Cardinal Bank - Manassas/Prince William, N.A., and Cardinal Bank -
Dulles, N.A., opened in the third quarter of 1999 and one non-bank subsidiary,
Cardinal Wealth Services, Inc., opened in the first quarter of 1999.
These operating results represent a return on average shareholders'
equity of -12.26% for the year ended December 31, 1999 compared to -7.45% for
the year ended December 31, 1998. Return on average assets for the year ended
December 31, 1999 was -5.61% compared to -5.37% in 1998.
III-16
<PAGE>
Financial Condition Summary
Total assets were $97.0 million at December 31, 1999, an increase of
$39.7 million, or 69.4%, compared with December 31, 1998. Loans, net of unearned
income, increased $51.8 million in 1999 to $68.2 million. This increase can be
attributed to strong results from Cardinal Bank, N.A. as well as the activity
associated with two new banking subsidiaries that opened in the third quarter of
1999. Cash and cash equivalents declined $6.3 million and investment securities
available-for-sale declined $8.7 million in 1999 compared to 1998. These
declines can be attributed to funding increased loan growth.
Total deposits grew $38.0 million to $59.9 million in 1999 from $21.9
million at year-end 1998 due again to having multiple banks operating for part
of 1999 versus only one operating in 1998. Non- interest-bearing deposits
increased $7.3 million or 144.5% and interest-bearing deposits increased $30.7
million or 182.6%. Cardinal's short-term borrowings were $6.0 million at
December 31, 1999. There were no borrowings at December 31, 1998. The short-term
borrowings are Federal Home Loan Bank advances and were utilized for loan growth
and other operating purposes.
Shareholders' equity decreased $4.0 million or 11.5% from December 31,
1998 to December 31, 1999. Operating losses for the year ended December 31, 1999
caused the decline. At December 31, 1999 Cardinal's regulatory capital levels
exceeded those established for well-capitalized institutions.
Net Interest Income and Net Interest Margin
The fundamental source of Cardinal's revenue, net interest income, is
defined as the difference between income on earning assets and the cost of funds
supporting those assets. The significant categories of earning assets are loans
and investment securities, while deposits and Federal Home Loan Bank advances
represent interest bearing liabilities. The level of net interest income is
impacted primarily by variations in the volume and mix of these assets and
liabilities, as well as changes in interest rates when compared to previous
periods of operation. Net interest income for 1999 was $3.02 million, 148.7%
higher than the prior year. The growth in net interest income was due to the
increase in average interest-earning assets of 144.9% which was the result of
three bank subsidiaries operating in 1999 compared to only one operating in
1998. The net interest margin increased to 4.75% in 1999 compared to 4.66% in
1998. The average rate on earning assets increased 79 basis points to 6.57% and
the average rate on interest-bearing liabilities decreased 42 basis points to
4.27%. Table 1 reflects the components of interest income and interest expense
and their applicable yields and costs.
Provision and Allowance for Loan Losses
Management's policy is to maintain the allowance for loan losses at a
level sufficient to absorb the estimated losses inherent in the loan portfolio.
Both the amount of the provision and the level of the allowance for loan losses
are impacted by many factors, including general economic conditions, actual and
expected credit losses, loan performance measures, historical trends and
specific conditions of the individual borrower. Due to the relatively short
credit history of its subsidiaries Cardinal Bank, N.A. (18 months of operation),
Cardinal Bank - Manassas/Prince William, N.A. (five months) and Cardinal Bank -
Dulles, N.A. (five months) management is currently providing for loan losses at
a rate of 1.25% which approximates its peer group average.
The ratio of the allowance for losses to gross loans at December 31,
1999 was 1.07% compared to 1.30% at December 31, 1998. While the calculated
reserve ratio reflects a 23 basis point decline there are two factors that need
to be taken into account in order to better understand Cardinal's level of loan
loss coverage. In the fourth quarter of 1999, Cardinal purchased a $7.8 million
installment loan portfolio. This transaction was structured in such a way that
the seller absorbs losses up to 115 basis points of the
III-17
<PAGE>
outstanding balances. Consequently, Cardinal does not expect losses on this
portfolio and did not add to its allowance for loan losses when this transaction
was recorded. The second factor to be considered is Cardinal's Business Manager
product. Under this product, advances to customers are collateralized by
customer receivables and a restricted deposit account equal to at least 10% of
the amount borrowed.
As a result, Cardinal does not expect losses on those transactions and
therefore has not added to its allowance for loan losses. Table 2 reflects the
components of the allowance for loan losses and calculates the loan loss ratio
two ways: first, with total gross loans, and second, with total gross loans less
purchased loans and the Business Manager receivables.
Non-Interest Income
Non-interest income is an important factor in Cardinal's operating
results. Management continues to evaluate and identify new sources of
non-interest income as well as enhance existing ones. Non-interest income
increased to $1.3 million in 1999 from $34 thousand in 1998. The significant
increase in non-interest income for 1999 was due to $1.0 million of investment
fee income generated by Cardinal Wealth Services, Inc. which began operations on
February 1, 1999. Other non-interest income includes loan and deposit service
charges, which increased to $268 thousand in 1999 from $20 thousand in 1998.
Table 3 reflects the components of non-interest income for 1999 and 1998.
Non-Interest Expense
Non-interest expense was $7.9 million in 1999 compared to $2.7 million
in 1998. The significant increase in expense can be attributed to the opening of
two bank subsidiaries and one non-bank subsidiary during 1999. Total personnel
expense increased to $4.3 million from $1.4 million in 1998 as a result of the
staffing of the above mentioned subsidiaries. Increases in depreciation,
occupancy and other operating expenses are also associated with start-up
subsidiary operations. Footnote 17 of the Consolidated Financial Statements
provides additional details of non-interest expense.
Income Taxes
Cardinal has not incurred income tax liability due to the recognition
of net losses in 1999, 1998 and 1997. The ability to utilize net operating loss
carryforwards will be dependent on Cardinal's ability to generate future
earnings. Footnote 8 of the Consolidated Financial Statements provides
additional information with respect to the deferred tax accounts and the net
operating loss carryforward.
Liquidity
The objective of liquidity management is to ensure the continuous
availability of funds to meet the demands of depositors, investors and
borrowers. Stable core deposits and a strong capital position are the components
of a solid foundation for Cardinal's liquidity position. In addition, the
availability of the investment portfolio and access to regional and national
wholesale funding sources including fed funds purchased, negotiable certificates
of deposits, securities sold under agreements to repurchase, and Federal Home
Loan Bank advances enhances Cardinal's liquidity. Cash flows from operations,
such as loan payments and pay-offs are also a significant source of liquidity.
Cardinal has a contingency plan that provides for continued monitoring of
liquidity needs and available sources of liquidity. Management believes Cardinal
has the ability to meet its liquidity needs.
III-18
<PAGE>
Capital Resources
Capital adequacy is an important measure of financial stability and
performance. Management's objectives are to maintain a level of capitalization
that is sufficient to sustain asset growth and promote depositor and investor
confidence.
Regulatory agencies measure capital adequacy utilizing a formula that
takes into account the individual risk profiles of financial institutions. The
guidelines define capital as either Tier 1 (primarily common shareholders'
equity, defined to include certain debt obligations) and Tier 2 (to include
certain other debt obligations and a portion of the allowance for loan losses
and 45% of unrealized gains in equity securities).
At December 31, 1999, shareholders' equity was $30.7 million compared
to $34.7 million at December 31, 1998. The decline in shareholders' equity is
attributable to the net loss incurred in 1999. Footnote 9 of the Consolidated
Financial Statements shows the minimum capital requirements and Cardinal's
capital position as of December 31, 1999 and 1998. Cardinal's regulatory capital
levels exceed those established for well-capitalized institutions.
Lending
Cardinal has comprehensive policies and procedures which cover both
commercial and consumer loan origination and management of credit risk. Loans
are underwritten in a manner that focuses on the borrowers' ability to repay.
Cardinal's goal is not to avoid risk, but to manage it and to include credit
risk as part of the pricing decision for each product.
Total loans, net of fees and premiums and discounts, increased to $68.2
million as of December 31, 1999 compared to $16.3 million as of December 31,
1998. The increase is the result of a full years operation of Cardinal Bank,
N.A. in addition to the activity of Cardinal Bank - Manassas/Prince William,
N.A., and Cardinal Bank - Dulles, N.A., both of which opened in the third
quarter of 1999. There were no non-performing loans at December 31, 1999 and
1998.
Cardinal's loan portfolio consists of commercial short-term lines of
credit, term loans, mortgage financing and construction loan funds that are used
by the borrower to build or develop real estate properties. The consumer
portfolio includes residential real estate mortgages, bankcard, home equity
lines and installment loans. Table 4 reflects the components of the loan
portfolio as of December 31, 1999 and 1998. Table 5 reflects the allocation of
the allowance for loan loss by loan category.
Securities Available-for-Sale
The investment securities portfolio of Cardinal is used as a source of
income and liquidity. The portfolio has declined to $4.8 million as of December
31, 1999 from $13.5 million as of December 31, 1998. The decline reflects
liquidity needs associated with funding the loan growth experienced in 1999.
Table 6 reflects the composition of the investment portfolio as of December 31,
1999 and 1998.
Interest Rate Sensitivity
The most important element of asset/liability management is the
monitoring of Cardinal's sensitivity to interest rate movements. The income
stream of Cardinal is subject to risk resulting from interest rate fluctuations
to the extent there is a difference between the amount of Cardinal's interest
earning assets and the amount of interest bearing liabilities that are prepaid,
mature or reprice in specified periods. Cardinal's goal is to maximize net
interest income with acceptable levels of risk to changes in
III-19
<PAGE>
interest rates. Management seeks to meet this goal by influencing the maturity
and re-pricing characteristics of the various lending and deposit taking lines
of business and by managing discretionary balance sheet asset and liability
portfolios.
One of the ways Cardinal identifies and manages its interest rate risk
is through an analysis of the relationship between interest-earning assets and
interest-bearing liabilities to measure the impact that future changes in
interest rates will have on net interest income. The difference between rate
sensitive assets and rate sensitive liabilities for specified periods of time is
known as the "GAP." The data in Table 7 reflects re-pricing or expected
maturities of various assets and liabilities at December 31, 1999. Interest
sensitivity gap analysis presents a position that existed at one particular
point in time and assumes that assets and liabilities with similar
characteristics will re-price at the same time and to the same degree. As shown
in the table, Cardinal was liability sensitive (excess of liabilities over
assets) in the three month to one year horizon. Management has included
estimates in the table with respect to certain deposit balances of Cardinal
Bank, N.A. that reflect the fact that not all of these deposits re-price on a
contractual basis. Deposit balances for Cardinal Bank - Manassas/Prince William,
N.A. and Cardinal Bank - Dulles, N.A. have not been adjusted due to the lack of
historical data. The result of these adjustments was to reduce the negative gap
in the three-month to one-year period to that reflected in the table.
1998 Compared to 1997
The comparison of operating results between 1998 and 1997 should be
read in the context of the start-up nature of Cardinal. The holding company
began operations on November 24, 1997 and its first bank subsidiary began
operations on June 8, 1998.
Consolidated net loss for 1998 was $1.7 million or $0.64 per diluted
share compared to a net loss of $145 thousand or $0.12 per diluted share in
1997. Net interest income was $1.2 million in 1998 compared to $4 thousand in
1997. Non-interest income totaled $34 thousand in 1998 compared to none recorded
in 1997. Total non-interest expense increased in 1998 to $2.7 million from $149
thousand in 1997.
Total assets increased to $57.3 million in 1998 compared to $8.8
million in 1997. The increase was due to Cardinal's initial public offering
which generated net proceeds of $26.0 million, and an increase of $21.9 million
in deposit balances. Total loans were $16.3 million at December 31, 1998
compared to zero at December 31, 1997. The remaining sources of funds were
invested into government agency securities totaling $13.7 million and fed funds
sold which increased $20.1 million to $24.3 million at December 31, 1998.
Year 2000
Cardinal successfully completed the transition to the year 2000 with no
impact to Cardinal's financial condition. Cardinal is not aware of any
significant third party relationships which were negatively impacted by the year
2000 transition. The cost of year 2000 readiness was minimal to Cardinal due to
its recent formation and the ability to incorporate year 2000 ready systems and
vendors at its inception.
III-20
<PAGE>
Table 1
Cardinal Financial Corporation and Subsidiaries
Rate and Volume Analysis
For the three months ended March 31, 2000 and 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
Variance
Average Volume Average Rate Interest Increase Attributable to
2000 1999 2000 1999 2000 1999 (Decrease) Rate Volume
-------------------------- -------------------- -------------------- -----------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Loans:
$ 23,652 $ 6,445 8.79% 8.32% Commercial $ 520 $ 134 $ 386 $ 28 $ 358
22,935 3,587 8.34% 8.48% Real estate - commercial 478 76 402 (8) 410
1,022 526 10.57% 7.60% Real estate - construction 27 10 17 8 9
12,955 5,668 7.60% 7.27% Real estate - residential 246 103 143 11 132
4,258 1,211 8.17% 6.28% Home equity lines 87 19 68 20 48
9,288 588 7.41% 8.84% Consumer 172 13 159 (33) 192
------------------------------------------------------------------------------------------------------------------------------------
74,110 18,025 8.26% 7.88% Total loans 1,530 355 1,175 26 1,149
4,700 9,238 6.13% 5.54% Investment Securities - AFS 72 128 (56) 7 (63)
1,016 225 5.91% 5.33% Other Investments 15 3 12 1 11
18,147 26,898 6.33% 4.77% Federal Funds Sold 287 321 (34) 70 (104)
------------------------------------------------------------------------------------------------------------------------------------
$ 97,973 $ 54,386 7.77% 5.94% Total interest-earning assets $ 1,904 $ 807 $ 1,097 $ 104 $ 993
====================================================================================================================================
Interest Expense
$ 3,306 $ 1,912 2.31% 2.10% Interest Checking $ 19 $ 10 $ 9 $ 2 $ 7
10,884 4,299 3.54% 4.11% Money Markets 96 44 52 (15) 67
624 111 3.21% 3.61% Statement Savings 5 1 4 (1) 5
38,169 12,078 5.62% 4.82% Certificates of Deposit 535 145 390 77 313
------------------------------------------------------------------------------------------------------------------------------------
52,983 18,400 4.96% 4.36% Total deposits 655 200 455 63 392
6,000 - 6.42% 0.00% Borrowings 96 - 96 96 -
------------------------------------------------------------------------------------------------------------------------------------
$ 58,983 $ 18,400 5.11% 4.36% Total interest-bearing liabilities $ 751 $ 200 $ 551 $ 159 392
====================================================================================================================================
46,871 38,898 Other Sources
------------------------------------------------------------------------------------------------------------------------------------
105,854 57,298 2.84% 1.40% Total Sources of Funds 751 200 551 159 392
------------------------------------------------------------------------------------------------------------------------------------
$ 38,990 $ 35,986 4.93% 4.54% Net Interest Margin $ 1,153 $ 607 $ 546 $ (55) $ 601
====================================================================================================================================
</TABLE>
No tax equivalent adjustment made to the above table.
III-21
<PAGE>
Table 1 (continued)
Cardinal Financial Corporation and Subsidiaries
Rate and Volume Analysis
For the Years Ended December 31, 1999 and 1998
(Dollars in thousands)
<TABLE>
<CAPTION>
Variance
Average Volume Average Rate Interest Increase Attributable to
1999 1998 1999 1998 1999 1998 (Decrease) Rate Volume
---------------------- --------------------- --------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Loans:
$ 11,087 $ 529 7.58% 10.01% Commercial $ 840 $ 53 $ 787 $ (270) $ 1,057
9,718 287 8.13% 8.01% Real estate - commercial 790 23 767 12 755
719 63 9.32% 7.89% Real estate - construction 67 5 62 10 52
8,089 768 7.76% 7.42% Real estate - residential 628 57 571 28 543
2,340 155 7.17% 10.36% Home equity lines 168 16 152 (74) 226
1,724 168 9.75% 13.73% Consumer 168 23 145 (69) 214
------------------------------------------------------------------------------------------------------------------------------------
33,677 1,970 7.90% 8.99% Total loans 2,661 177 2,484 (363) 2,847
6,960 5,484 5.83% 5.62% Investment Securities - AFS 406 308 98 15 83
504 133 5.74% 5.97% Other Investments 29 8 21 (1) 22
- 764 0.00% 4.17% Money Market Accounts - 32 (32) - (32)
24,804 18,574 4.97% 5.55% Federal Funds Sold 1,234 1,031 203 (143) 346
------------------------------------------------------------------------------------------------------------------------------------
$ 65,945 $ 26,925 6.57% 5.78% Total interest-earning assets $ 4,330 $ 1,556 $ 2,774 $ (492) $ 3,266
====================================================================================================================================
Interest Expense
2,436 535 2.01% 2.06% Interest Checking 49 11 38 (1) 39
7,168 2,316 3.68% 3.71% Money Markets 264 86 178 (2) 180
239 62 2.93% 3.23% Statement Savings 7 2 5 (1) 6
18,980 4,336 4.67% 5.54% Certificates of Deposit 887 240 647 (164) 811
------------------------------------------------------------------------------------------------------------------------------------
28,823 7,249 4.19% 4.68% Total deposits 1,207 339 868 (168) 1,036
1,773 - 5.53% 0.00% Borrowings 98 1 97 97 -
------------------------------------------------------------------------------------------------------------------------------------
30,596 7,249 4.27% 4.69% Total interest-bearing liabilities 1,305 340 965 (71) 1,036
====================================================================================================================================
41,151 23,045 Other Sources
------------------------------------------------------------------------------------------------------------------------------------
71,747 30,294 1.82% 1.12% Total Sources of Funds 1,305 340 965 (71) 1,036
------------------------------------------------------------------------------------------------------------------------------------
$ 35,349 $ 19,676 4.75% 4.66% Net Interest Margin $ 3,025 $ 1,216 $ 1,809 $ (421) $ 2,230
====================================================================================================================================
</TABLE>
No tax equivalent adjustment made to the above table.
III-22
<PAGE>
Table 2
Cardinal Financial Corporation and Subsidiaries
Allowance for Loan Losses
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
----------------------------- -----------------------------
2000 1999 1999 1998
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Beginning balance $ 726 $ 212 $ 212 $ -
Provision for loan losses 143 68 514 212
Loans charged off:
Commercial - - - -
Real estate - commercial - - - -
Real estate - construction - - - -
Real estate - residential - - - -
Home equity lines - - - -
Consumer - - - -
-----------------------------------------------------------------------------------------------------------
Total loans charged off - - - -
Recoveries:
Commercial - - - -
Real estate - commercial - - - -
Real estate - construction - - - -
Real estate - residential - - - -
Home equity lines - - - -
Consumer - - - -
-----------------------------------------------------------------------------------------------------------
Total recoveries - - - -
Net charge-offs - - - -
Balance at end of period $ 869 $ 280 $ 726 $ 212
===========================================================================================================
</TABLE>
<TABLE>
<CAPTION>
March 31, March 31, December 31, December 31,
Loans: 2000 1999 1999 1998
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Balance at period end $ 81,444 $ 21,760 $ 68,147 $ 16,343
Allowance for loan losses to
Period end loans 1.07% 1.29% 1.07% 1.30%
Less: Business Manager $ 2,196 $ 107 $ 1,522 $ -
Less: Purchased Loans 7,331 - 7,687 -
------------- ------------- ------------- --------------
Adjusted Loan Balance $ 71,917 $ 21,653 $ 58,938 $ 16,343
Allowance for loan losses to
Period end adjusted loans 1.21% 1.30% 1.23% 1.30%
</TABLE>
III-23
<PAGE>
Table 3
Cardinal Financial Corporation and Subsidiaries
Non-interest Income
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
------------------------------------ ------------------------------------
2000 1999 1999 1998
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 20,401 $ 5,087 $ 41,612 $ 3,388
Loan service charges 63,104 19,200 226,211 16,145
Investment fee income 313,326 1,278 1,017,924 --
Gain on sale of investment securities -- 11,203 4,207 8,760
Other income 26,848 8,455 30,531 5,744
----------------- ----------------- ----------------- -----------------
$ 423,679 $ 45,223 $ 1,320,485 $ 34,037
================= ================= ================= =================
</TABLE>
III-24
<PAGE>
Table 4
Cardinal Financial Corporation and Subsidiaries
Loans
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, March 31,
2000 1999
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
Commercial $ 24,977 30.68% $ 6,855 31.07%
Real estate - commercial 27,032 33.20% 6,237 28.27%
Real estate - construction 756 0.93% 829 3.76%
Real estate - residential 14,283 17.54% 5,598 25.38%
Home equity lines 4,902 6.02% 1,527 6.92%
Consumer 9,465 11.63% 1,014 4.60%
---------------------------- -----------------------------
Gross loans $ 81,415 100.00% $ 22,060 100.00%
Less: unearned income, net (29) 19
Less: allowance for loan loss 869 281
-------------- ---------------
Total loans, net $ 80,575 $ 21,760
============== ===============
</TABLE>
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
Commercial $ 22,558 33.10% $ 5,138 31.43%
Real estate - commercial 19,780 29.03% 3,507 21.46%
Real estate - construction 870 1.28% 760 4.65%
Real estate - residential 11,851 17.39% 5,529 33.83%
Home equity lines 3,777 5.54% 1,040 6.37%
Consumer 9,311 13.66% 369 2.26%
---------------------------- -----------------------------
Gross loans $ 68,147 100.00% $ 16,343 100.00%
Less: unearned income, net (20) 16
Less: allowance for loan loss 726 212
-------------- ---------------
Total loans, net $ 67,441 $ 16,115
============== ===============
</TABLE>
III-25
<PAGE>
Table 5
Cardinal Financial Corporation and Subsidiaries
Allocation of the Allowance for Loan Losses
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, March 31,
2000 1999
----------------------- -----------------------
<S> <C> <C> <C> <C>
Commercial $ 300 34.52% $ 79 28.11%
Real estate - commercial 259 29.80% 71 25.27%
Real estate - construction 10 1.15% 9 3.20%
Real estate - residential 137 15.77% 64 22.78%
Home equity lines 47 5.41% 17 6.05%
Consumer 26 2.99% 11 3.91%
Unallocated 90 10.36% 30 10.68%
----------------------- -----------------------
Total allowance for loan losses $ 869 100.00% $ 281 100.00%
======================= =======================
</TABLE>
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
----------------------- -----------------------
<S> <C> <C> <C> <C>
Commercial $ 241 33.20% $ 59 27.83%
Real estate - commercial 211 29.06% 40 18.87%
Real estate - construction 9 1.24% 9 4.25%
Real estate - residential 126 17.36% 64 30.19%
Home equity lines 40 5.51% 12 5.66%
Consumer 24 3.31% 4 1.89%
Unallocated 75 10.32% 24 11.31%
----------------------- -----------------------
Total allowance for loan losses $ 726 100.00% $ 212 100.00%
======================= =======================
</TABLE>
III-26
<PAGE>
Table 6
Cardinal Financial Corporation and Subsidiaries
Investment Securities - Available-for-Sale
As of March 31, 2000 and 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
Amortized Fair Unrealized Average
As of March 31, 2000 Par Value Cost Value Gain/(Loss) Yield
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Government Agencies and Enterprises
One to five years $ 3,000 $ 3,000 $ 2,920 $ (80) 5.90%
After ten years 500 498 440 (58) 6.26%
---------------------------------------------------------------------------------------------------------------------------
Total U.S. Government Agencies 3,500 3,498 3,360 (138) 5.95%
---------------------------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities
Five to ten years 1,305 1,310 1,260 (50) 5.96%
---------------------------------------------------------------------------------------------------------------------------
Total Mortgage-Backed Securities 1,305 1,310 1,260 (50) 5.96%
---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale $4,805 $ 4,808 $ 4,620 $ (188) 5.93%
As of March 31, 1999
U.S. Government Agencies and Enterprises
Within one year $ 2,000 $ 2,000 $ 1,997 $ (3) 5.31%
One to five years 3,000 3,002 2,987 (15) 5.76%
After ten years 500 499 494 (5) 6.26%
---------------------------------------------------------------------------------------------------------------------------
Total U.S. Government Agencies 5,500 5,501 5,478 (23) 5.64%
---------------------------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities
Within one year 777 778 778 -- 5.44%
One to five years 796 809 812 3 5.53%
Five to ten years 858 862 852 (10) 5.92%
---------------------------------------------------------------------------------------------------------------------------
Total Mortgage-Backed Securities 2,431 2,449 2,442 (7) 5.64%
---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale $ 7,931 $ 7,950 $ 7,920 $ (30) 5.64%
</TABLE>
III-27
<PAGE>
Table 6 (continued)
Cardinal Financial Corporation and Subsidiaries
Investment Securities - Available-for-Sale
As of December 31, 1999 and 1998
(Dollars in thousands)
<TABLE>
<CAPTION>
Amortized Fair Unrealized Average
As of December 31, 1999 Par Value Cost Value Gain/(Loss) Yield
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Government Agencies and Enterprises
Within one year $ 2,000 2,000 1,948 (52) 5.99%
One to five years 1,000 1,000 979 (21) 5.74%
After ten years 500 499 445 (54) 6.26%
---------------------------------------------------------------------------------------------------------------------------
Total U.S. Government Agencies $ 3,500 3,499 3,372 (127) 5.95%
---------------------------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities
Within one year 305 305 304 (1) 5.63%
One to five years 367 368 368 - 5.92%
Five to ten years 803 806 763 (43) 5.93%
---------------------------------------------------------------------------------------------------------------------------
Total Mortgage-Backed Securities $ 1,475 1,479 1,435 (44) 5.87%
---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale $ 4,975 4,978 4,807 (171) 5.93%
Amortized Fair Unrealized Average
As of December 31, 1998 Par Value Cost Value Gain/(Loss) Yield
----------------------------------------------------------------
U.S. Government Agencies and Enterprises
Within one year $ 300 300 300 - 5.28%
One to five years 9,000 9,002 9,005 3 5.79%
Five to ten years 500 501 502 1 5.79%
After ten years 500 499 499 - 6.26%
---------------------------------------------------------------------------------------------------------------------------
Total U.S. Government Agencies $ 10,300 10,302 10,306 4 5.78%
---------------------------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities
Within one year - - - - -
One to five years 437 441 440 (1) 5.43%
Five to ten years 460 460 460 - 5.27%
After ten years 2,278 2,271 2,271 - 5.87%
---------------------------------------------------------------------------------------------------------------------------
Total Mortgage-Backed Securities $ 3,175 3,172 3,171 (1) 5.52%
---------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Available-for-Sale $ 13,475 13,474 13,477 3 5.65%
</TABLE>
III-28
<PAGE>
Table 7
Cardinal Financial Corporation and Subsidiaries
Interest Rate Sensitivity Gap Analysis
As of March 31, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
1-90 91-180 181-365 1-5 Over 5
Days Days Days Years Years TOTAL
----------------------------------------------------------------------
ASSETS
<S> <C> <C> <C> <C> <C> <C>
Investment securities
U.S. Government agency securities $ - $ - $ - $ 2,920 $ 440 $ 3,360
Mortgage-backed securities - - - - 1,260 1,260
----------------------------------------------------------------------
Total investment securities - - - 2,920 1,700 4,620
----------------------------------------------------------------------
Federal funds sold 20,378 - - - - 20,378
----------------------------------------------------------------------
Loans
Commercial -fixed 2,757 454 945 6,142 1,554 11,852
Commercial - variable 12,497 280 597 17,271 9,541 40,186
Real estate - construction fixed - - - - 151 151
Real estate - construction variable 605 - - - - 605
Real estate - residential fixed 13 14 30 1,911 463 2,431
Real estate - residential variable 341 44 90 8,690 2,687 11,852
Home equity lines 4,676 118 108 - - 4,902
Consumer - fixed 149 76 191 1,018 7,364 8,798
Consumer - variable 667 - - - - 667
----------------------------------------------------------------------
Loans receivable, net of fees 21,705 986 1,961 35,032 21,760 81,444
----------------------------------------------------------------------
Total Earning Assets 42,083 986 1,961 37,952 23,460 $ 106,442
----------------------------------------------------------------------
Cumulative Rate Sensitive Assets $ 42,083 $ 43,069 $ 45,030 $ 82,982 $ 106,442
----------------------------------------------------------------------
Liabilities and Shareholders' Equity
Deposits
Demand deposits $ 18,533 $ 590 $ 590 $ 590 $ 2,361 $ 22,664
Interest checking 2,752 710 237 237 - 3,936
Statement savings 548 54 54 95 - 751
Money market accounts 7,454 2,033 678 678 - 10,843
Certificates of deposit - fixed 4,062 4,036 4,471 9,566 111 22,246
Certificates of deposit - no penalty 2,649 2,007 5,372 9,542 - 19,570
----------------------------------------------------------------------
Total Deposits 35,998 9,430 11,402 20,708 2,472 80,010
----------------------------------------------------------------------
Borrowings - short term 4,000 - 2,000 - - 6,000
----------------------------------------------------------------------
Total Interest Bearing Liabilities 39,998 9,430 13,402 20,708 2,472 $ 86,010
----------------------------------------------------------------------
Cumulative Rate Sensitive Liabilities $ 39,998 $ 49,428 $ 62,830 $ 83,538 $ 86,010
----------------------------------------------------------------------
Gap $ 2,085 $ (8,444) $(11,441) $ 17,244 $ 20,988
Cumulative Gap 2,085 (6,359) (17,800) (556) 20,432
Gap/ Total Assets 1.80% -7.28% -9.87% 14.88% 18.10%
Cumulative Gap/ Total Assets 1.80% -5.49% -15.35% -0.48% 17.63%
Rate Sensitive Assets/ Rate Sensitive 1.05x 0.10x 0.15x 1.83x 9.49x
Liabilities
Cumulative Rate Sensitive Assets/
Cumulative Rate Sensitive Liabilities 1.05x 0.87x 0.72x 0.99x 1.24x
</TABLE>
III-29
<PAGE>
Table 7 (continued)
Cardinal Financial Corporation and Subsidiaries
Interest Rate Sensitivity Gap Analysis
As of December 31, 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
1-90 91-180 181-365 1-5 Over 5
Days Days Days Years Years TOTAL
----------------------------------------------------------------------
ASSETS
<S> <C> <C> <C> <C> <C> <C>
Investment securities
U.S. Government agency securities $ 1,462 $ 486 $ - $ 980 $ 445 $ 3,373
Mortgage-backed securities 89 215 - 367 763 1,434
----------------------------------------------------------------------
Total investment securities 1,551 701 - 1,347 1,208 4,807
----------------------------------------------------------------------
Federal funds sold 13,025 - - - - 13,025
----------------------------------------------------------------------
Loans
Commercial -fixed 546 1,112 1,140 3,851 412 7,061
Commercial - variable 11,838 529 565 19,514 2,831 35,277
Real estate - construction fixed - - - - - -
Real estate - construction variable 870 - - - - 870
Real estate - residential fixed 10 12 23 1,482 61 1,588
Real estate - residential variable 280 39 81 9,025 838 10,263
Home equity lines 3,691 86 - - - 3,777
Consumer - fixed 207 52 104 676 7,693 8,732
Consumer - variable 442 3 6 128 - 579
----------------------------------------------------------------------
Loans receivable, net of fees 17,884 1,833 1,919 34,676 11,835 68,147
----------------------------------------------------------------------
Total Earning Assets 32,460 2,534 1,919 36,023 13,043 $ 85,979
----------------------------------------------------------------------
Cumulative Rate Sensitive Assets $ 32,460 $ 34,994 $ 36,913 $ 72,936 $ 85,979
----------------------------------------------------------------------
Liabilities and Shareholders' Equity
Deposits
Demand deposits $ 9,971 $ 337 $ 337 $ 337 $ 1,348 $ 12,330
Interest checking 2,607 770 257 257 - 3,891
Statement savings 317 43 43 76 - 479
Money market accounts 7,660 2,016 672 672 - 11,020
Certificates of deposit - fixed 558 3,860 5,560 5,404 539 15,921
Certificates of deposit - no penalty 4,141 1,895 1,793 8,403 - 16,232
----------------------------------------------------------------------
Total Deposits 25,254 8,921 8,662 15,149 1,887 59,873
----------------------------------------------------------------------
Borrowings - short term - 4,000 2,000 - - 6,000
----------------------------------------------------------------------
Total Interest Bearing Liabilities 25,254 12,921 10,662 15,149 1,887 $ 65,873
----------------------------------------------------------------------
Cumulative Rate Sensitive Liabilities $ 25,254 $ 38,175 $ 48,837 $ 63,986 $ 65,873
----------------------------------------------------------------------
Gap $ 7,206 $(10,387) $ (8,743) $ 20,874 $ 11,156
Cumulative Gap 7,206 (3,181) (11,924) 8,950 20,106
Gap/ Total Assets 7.43% -10.70% -9.01% 21.51% 11.50%
Cumulative Gap/ Total Assets 7.43% -3.28% -12.29% 9.22% 20,72%
Rate Sensitive Assets/ Rate Sensitive 1.29x 0.20x 0.18x 2.38x 6.91x
Liabilities
Cumulative Rate Sensitive Assets/
Cumulative Rate Sensitive Liabilities 1.29x 0.92x 0.76x 1.14x 1.31x
</TABLE>
III-30
<PAGE>
CHAPTER IV
DESCRIPTION OF HERITAGE
BUSINESS
General
Heritage, a Virginia corporation, is the holding company for The
Heritage Bank, a Virginia chartered commercial bank. On October 1, 1998,
Heritage acquired all of the capital stock of The Heritage Bank and the
shareholders of The Heritage Bank became shareholders of Heritage in a share for
share exchange under a plan of reorganization approved by The Heritage Bank's
shareholders on August 26, 1998, whereby The Heritage Bank became the
wholly-owned subsidiary of Heritage (the "Reorganization"). Heritage's sole
business activity is ownership of The Heritage Bank. Heritage's common stock
trades on The Nasdaq SmallCap Market under the symbol "HBVA." At March 31, 2000,
Heritage had total assets of $64.4 million, total deposits of $48.0 million and
total stockholders' equity of $8.6 million. Net income for the quarter ended
March 31, 2000 was $25,000, a decrease of $152,000 from net income of $177,000
for the comparable period in 1999. Basic earnings per share for the quarter
ended March 31, 2000 were $0.01 ($0.01 per share, assuming dilution), down from
$0.08 per share ($0.08 per share, assuming dilution) for the quarter ended March
31, 1999. Unless otherwise disclosed, the information presented in this joint
proxy statement/prospectus represents the activity of The Heritage Bank for the
period prior to October 1, 1998 and the activity of Heritage consolidated
thereafter. Unless the context otherwise requires, all references to The
Heritage Bank or Heritage include Heritage and The Heritage Bank on a
consolidated basis.
The Heritage Bank is the only independent financial institution
headquartered in McLean, Virginia. Established in 1987, The Heritage Bank
operated as a wholly-owned subsidiary of Heritage Bankshares, Inc. (formerly
Independent Banks of Virginia, Inc.), until 1992 when it became an independent
bank. The Heritage Bank is a well-capitalized, profitable community bank
dedicated to financing small business and consumer needs in its market area and
providing personalized "hometown" quality service to its customers by tailoring
its products and services to appeal to a local market. The Heritage Bank
currently operates two full-service offices in McLean and Sterling, Virginia and
engages in a broad range of lending and deposit services aimed at individual and
commercial customers in Fairfax and Loudoun Counties, Virginia. A third branch
in Tysons Corner, Virginia opened May 15, 2000. The Heritage Bank closed its
secondary offering of common stock in which it sold 805,000 shares of common
stock to the public at a per share price of $5.50, resulting in the raising of
net proceeds to The Heritage Bank of approximately $4.1 million in May 1998.
The business of The Heritage Bank consists of attracting deposits from
the general public and using these funds to originate various types of
individual and commercial loans primarily in the McLean area, as well as in
Fairfax and Loudoun counties. The Heritage Bank's commercial activities include
providing checking accounts, money market accounts and certificates of deposit
to small and medium-sized businesses. The Heritage Bank also provides credit
services, such as lines of credit, term loans, construction loans, and letters
of credit, as well as real estate loans and other forms of collateralized
financing. The Heritage Bank's personal services include checking accounts, NOW
accounts, savings accounts, certificates of deposit, installment loans,
construction and other personal loans, home improvement loans, automobile and
other consumer financing.
The Heritage Bank's profitability depends primarily on its net interest
income, the difference between the interest income it earns on its loans and
investment portfolio and its cost of funds, which consists mainly of interest
paid on deposits. Net interest income is affected by the relative amounts of
interest-earning assets and interest-bearing liabilities and the interest rates
earned or paid on these
IV-1
<PAGE>
balances. When interest-earning assets approximate or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income.
The Heritage Bank's profitability is also affected by the level of
other non-interest income and operating expenses. Other income consists
primarily of service fees, loan servicing and other loan fees and gains on sales
of investment securities. Operating expenses consist of salaries and benefits,
occupancy-related expenses, and other general operating expenses.
The operations of The Heritage Bank, and banking institutions in
general, are significantly influenced by general economic conditions and related
monetary and fiscal policies of financial institutions' regulatory agencies.
Deposit flows and the cost of funds are influenced by interest rates on
competing investments and general market rates of interest. Lending activities
are affected by the demand for financing real estate and other types of loans,
which in turn are affected by the interest rates at which such financing may be
offered, strength of the economy and other factors affecting loan demand and the
availability of funds.
Asset/Liability Management
A principal operating objective of The Heritage Bank is to produce
stable earnings by achieving a favorable interest rate spread that can be
sustained during fluctuations in prevailing interest rates. Since The Heritage
Bank's principal interest-earning assets have longer terms to maturity than its
primary source of funds, i.e., deposit liabilities, increases in general
interest rates will generally result in an increase in The Heritage Bank's cost
of funds before the yield on its asset portfolio adjusts upward. The Heritage
Bank has sought to reduce its exposure to adverse changes in interest rates by
attempting to achieve a closer match between the periods in which its
interest-bearing liabilities and interest-earning assets can be expected to
reprice through the origination of adjustable-rate mortgages and loans with
shorter terms and the purchase of other shorter term interest-earning assets.
The term "interest rate sensitivity" refers to those assets and
liabilities which mature and reprice periodically in response to fluctuations in
market rates and yields. As noted above, one of the principal goals of The
Heritage Bank's asset/liability program is to maintain and match the interest
rate sensitivity characteristics of the asset and liability portfolios.
In order to properly manage interest rate risk, The Heritage Bank's
board of directors has established an Asset/Liability Management Committee made
up of members of management and outside directors to monitor the difference
between The Heritage Bank's maturing and repricing assets and liabilities and to
develop and implement strategies to decrease the "negative gap" between the two.
The primary responsibilities of the committee are to assess The Heritage Bank's
asset/liability mix, recommend strategies to the board that will enhance income
while managing The Heritage Bank's vulnerability to changes in interest rates
and report to the board the results of the strategies used.
Credit Policies
The Heritage Bank utilizes written policies and procedures to enhance
management of credit risk. The loan portfolio is managed under a
specifically-defined credit process. This process includes formulation of
portfolio management strategy, guidelines for underwriting standards and risk
assessment, procedures for ongoing identification and management of credit
deterioration, and regular portfolio reviews to estimate loss exposure and
ascertain compliance with The Heritage Bank's policies. Lending authority is
granted to individual lending officers with the current highest limit being
$150,000 for secured and $25,000 for unsecured loans. Any two officers acting
together may approve a loan up to the amount of the lower lending authority of
the two officers. An Officers' Loan Committee comprised of six
IV-2
<PAGE>
officers is authorized to approve credit of up to $400,000 for secured loans and
$200,000 for unsecured loans. Approval of such credits requires a majority vote
of the Officers' Loan Committee. The directors' Loan Committee is authorized to
approve loans up to the legal lending limit of The Heritage Bank.
The Heritage Bank's management generally requires that secured loans
have a loan-to-value ratio of 80% or less. Management believes that when a
borrower has significant equity in the assets securing the loan, the borrower is
less likely to default on the outstanding loan balance.
A major element of credit risk management is diversification. The
Heritage Bank's objective is to maintain a diverse loan portfolio to minimize
the impact of any single event or set of circumstances. Concentration parameters
are based on factors of individual risk, policy constraints, economic
conditions, collateral and product type.
Lending activities include a variety of consumer, real estate and
commercial loans with a strong emphasis on serving the needs of customers within
The Heritage Bank's market territory. Consumer loans are made primarily on a
secured basis in the form of installment obligations or personal lines of
credit. The focus of real estate lending is commercial mortgages, but also
includes home improvement loans, construction lending and home equity lines of
credit. Commercial lending is provided to businesses seeking credit for working
capital and the purchase of equipment and facilities. The principal lending
activity of The Heritage Bank is concentrated in mortgage loans secured by
commercial real estate, usually consisting of commercial and warehouse
facilities in The Heritage Bank's market area.
Market Area
The Heritage Bank currently has three offices serving the McLean area
of Fairfax County, Virginia; Sterling, Virginia, which primarily serves Loudoun
County, Virginia; and Tysons Corner, Virginia. From these offices, The Heritage
Bank serves its customers, many of whom own businesses or reside in the
McLean/Great Falls area of Northern Virginia, which is located eight miles west
of Washington, DC. The remainder of The Heritage Bank's customers reside
primarily in other communities in Fairfax, Arlington and Loudoun counties.
McLean resides in the northernmost part of Fairfax County, Virginia, by
most measures, the wealthiest county in Virginia. Fairfax County's labor force
of 523,863 ranks 11th out of the 20 largest U.S. cities and ninth in number of
residents that can be employed. The employment industries with the largest share
of the Fairfax County market are services with 40% of the market and trade with
23% of that market. Both of these areas contain customers that fit well into the
small to medium sized businesses The Heritage Bank serves. Fairfax County is
also home to many information technology firms including UUNet and PSINet. It is
estimated that nearly one-half of all international Internet traffic flows
through one of the Fairfax-based access providers.
McLean is home to the Central Intelligence Agency, McLean's largest
employer, and the Federal Home Loan Mortgage Corporation. The Heritage Bank
provides financial services to the many professional service firms, including
lawyers, accountants, consultants and engineers. Fairfax County also includes
the Tysons Corner area, an office and commercial district that is home to a
significant number of high-technology employers. Major employers in Tysons
Corner include INOVA Health Systems, EDS, SAIC and AT&T. Tysons Corner is also
home to two major shopping centers and several major hotels. The Heritage Bank's
projected new branch will service this area.
With the opening of the Sterling branch, The Heritage Bank has expanded
its market area to include a significant portion of Loudoun County, one of the
fastest growing counties in the United States. According to Loudoun county's
Department of Economic Development in January 2000, the county has
IV-3
<PAGE>
one of the fastest growing populations and employment bases in the country with
the average income per household of $93,769. This area is experiencing
significant economic growth as a result of the expansion of the Dulles
International Airport technology corridor and the influx of "high-tech"
companies from Fairfax County. The Loudoun County market is predominately
residential with a healthy mix of retail, service activities and light industry.
The Sterling branch is located in the CountrySide Shopping and
Professional Center, a 350,000 square foot retail/professional/medical campus
near the entrance to the 2,500 unit CountrySide residential community that is
home to over 12,000 persons. The Heritage Bank believes that development now
taking place along the Route 7 and Route 28 corridors, coupled with the rapid
population growth in eastern Loudoun County, will provide The Heritage Bank with
the opportunity to expand its consumer and small business services.
Competition
The Heritage Bank operates in the highly competitive environment of
Fairfax County, as well as in Loudoun County, Virginia. It competes for deposits
and loans with commercial banks, savings and loans, credit unions and other
financial institutions, including non-bank competitors such as loan companies,
insurance companies and large securities firms. Many of these organizations
possess substantially greater financial and technical resources than The
Heritage Bank.
In Fairfax County, The Heritage Bank commands 0.39% of the market,
according to the most recent survey of deposits by the Federal Deposit Insurance
Corporation. Seventeen banks with 31 branches operate in the greater McLean area
and 17 of these branches are located in proximity to The Heritage Bank in the
McLean Central Business District.
The market is mature and the growth of deposits and loan demand has
slowed in recent years. While it can produce stable earnings from its operations
in the McLean office, The Heritage Bank believes the future growth of The
Heritage Bank will be in expansion to other parts of Northern Virginia.
There are numerous commercial banks located in Loudoun County. A number
of mortgage companies along with several non-bank financial institutions also
compete in the area. All are full-service banks and provide a wide array of bank
products and services like The Heritage Bank. The Heritage Bank believes that it
will enjoy a competitive advantage due to its local community bank orientation
and reputation for providing personalized service to its customers.
With the opening of the Sterling branch in April 1999 and the Tysons
Corner branch in May 2000, The Heritage Bank increased its deposit base, which
in turn increased the funds available for loans and other profitable
opportunities for The Heritage Bank. While The Heritage Bank will continue to
experience a competitive environment in Fairfax and Loudoun counties, there
still exist opportunities to establish new branches in those areas where
significant population increases and economic growth are occurring.
Employees
At March 31, 2000, The Heritage Bank had 30 full-time equivalent
employees. None of its employees is represented by any collective bargaining
unit. The Heritage Bank considers relations with its employees to be good.
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Federal Taxation
General. The following is intended only as a discussion of material
federal income tax matters and does not purport to be a comprehensive
description of the federal income tax rules applicable to The Heritage Bank or
Heritage. For federal income tax purposes, Heritage and The Heritage Bank, as
members of the same affiliated group, file consolidated income tax returns on a
December 31 fiscal year basis using the accrual method of accounting and are
subject to federal income taxation in the same manner as other corporations.
Distributions. To the extent that The Heritage Bank makes "non-dividend
distributions" to Heritage, such distributions will be considered to have been
made from The Heritage Bank's "base year reserve," and then from The Heritage
Bank's supplemental reserve for losses on loans, to the extent thereof, and an
amount based on the amount distributed (but not in excess of the amount of such
reserves) will be included in The Heritage Bank's income. Non-dividend
distributions include distributions in excess of The Heritage Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of The Heritage Bank's current or accumulated
earnings and profits will not be so included in The Heritage Bank's income.
The amount of additional taxable income created from a non-dividend
distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, if The Heritage Bank
makes a non-dividend distribution to Heritage, approximately one and one-half
times the amount of such distribution (but not in excess of the amount of such
reserves) would be includible in income, assuming a 34% federal corporate income
tax rate. The Heritage Bank does not intend to pay dividends that would result
in a recapture of any portion of its bad debt reserves.
Corporate Alternative Minimum Tax. The Code imposes a tax on
alternative minimum taxable income at a rate of 20%. Only 90% of alternative
minimum taxable income can be offset by net operating loss carryovers of which
The Heritage Bank currently has none. Alternative minimum taxable income is also
adjusted by determining the tax treatment of certain items in a manner that
negates the deferral of income resulting from the regular tax treatment of those
items. Heritage and The Heritage Bank have not been subject to the alternative
minimum tax during the past five years.
Elimination of Dividends; Dividends Received Deduction. Heritage may
exclude from its income 100% of dividends received from The Heritage Bank as a
member of the same affiliated group of corporations.
State Taxation
The Heritage Bank is exempt from paying state income tax to the
Commonwealth of Virginia. Under Virginia law, however, banks must pay a
franchise tax at the rate of $1 on each $100 of net capital as defined under
Virginia law. For additional information regarding taxation, see Note 8 of the
Notes to Financial Statements.
Regulation and Supervision
The Heritage Bank is extensively regulated under both federal and state
law. The following is a brief summary of certain statutes, rules and regulations
affecting Heritage and The Heritage Bank. This summary is qualified in its
entirety by reference to the particular statutory and regulatory provisions
referred to below and is not intended to be an exhaustive description of the
statutes or regulations applicable to The Heritage Bank's business.
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Financial Services Modernization Legislation
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Financial Services Modernization Act of 1999, federal
legislation intended to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers.
Bank holding companies will be permitted to engage in a wider variety
of financial activities than permitted under prior law, particularly with
respect to insurance and securities activities. In addition, in a change from
prior law, bank holding companies will be in a position to be owned, controlled
or acquired by any company engaged in financially-related activities.
Heritage does not believe that the Act will have a material adverse
effect on its operations in the near-term. However, to the extent that it
permits banks, securities firms and insurance companies to affiliate, the
financial services industry may experience further consolidation. This could
result in a growing number of larger financial institutions that offer a wider
variety of financial services than Heritage currently offers and that can
aggressively compete in the markets that it currently serves.
Regulation of The Heritage Bank
The Heritage Bank is regulated and supervised by the Virginia State
Corporation Commission. In addition, as a state member bank, The Heritage Bank
is regulated and supervised by the Federal Reserve, which serves as its primary
federal regulator, and is subject to certain regulations promulgated by the
FDIC. The Virginia State Corporation Commission and the Federal Reserve conduct
regular examinations of The Heritage Bank, reviewing the adequacy of its loan
loss reserves, the quality of its loans and investments, the propriety of
management practices, compliance with laws and regulations, and other aspects of
The Heritage Bank's operations. In addition to these regular examinations, The
Heritage Bank must furnish to the Federal Reserve semi-annual reports containing
detailed financial statements and schedules.
Federal and Virginia banking laws and regulations govern all areas of
the operations of The Heritage Bank, including reserves, loans, mortgages,
capital, issuance of securities, payment of dividends and establishment of
branches. Federal and state bank regulatory agencies also have the general
authority to limit the dividends paid by insured banks. See "--Limits on
Dividends and Other Payments." As its primary federal regulator, the Federal
Reserve has authority to impose penalties, initiate civil and administrative
actions and take other steps intended to prevent The Heritage Bank from engaging
in unsafe or unsound practices. In this regard, the Federal Reserve has adopted
capital adequacy requirements applicable to state member banks such as The
Heritage Bank. See "--Capital Requirements."
Transactions with Affiliates and Insiders of The Heritage Bank.
Transactions between an insured bank, such as The Heritage Bank, and any of its
affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An
affiliate of a bank is any company or entity which controls, is controlled by or
is under common control with The Heritage Bank. Generally, Sections 23A and 23B
(i) limit the extent to which The Heritage Bank or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to 10% of
such institution's capital stock and surplus, and limit all such transactions
with all affiliates to an amount equal to 20% of such capital stock and surplus
and (ii) require that all such transactions be on terms that are consistent with
safe and sound banking practices. In addition, any purchase of assets or
services by a bank from an affiliate must be on terms that are substantially the
same, or at least as favorable, to the institution as those that would be
provided to a non-affiliate. The term
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"covered transaction" includes the making of loans, purchase of assets, issuance
of guarantees and similar other types of transactions. Further, most loans by a
bank to its affiliate must be supported by collateral in amounts ranging from
100 to 130 percent of the loan amounts.
Banks are also subject to the restrictions contained in Section 22(h)
of the Federal Reserve Act and the Federal Reserve Board's Regulation O
thereunder on loans to executive officers, directors and principal shareholders.
Under Section 22(h), loans to a director, an executive officer or a greater than
10% shareholder of a bank as well as certain affiliated interests of any of the
foregoing, may not exceed, together with all other outstanding loans to such
person and affiliated interests, the loans-to-one-borrower limit applicable to
national banks (generally 15% of the institution's unimpaired capital and
surplus), and all loans to all such persons in the aggregate may not exceed the
institution's unimpaired capital and unimpaired surplus. Regulation O also
prohibits the making of loans in an amount greater than $25,000, or 5% of
capital and surplus but in any event over $500,000, to directors, executive
officers and greater than 10% shareholders of a bank, and their respective
affiliate, unless such loans are approved in advance by a majority of the board
of directors of The Heritage Bank with any "interested" director not
participating in the voting. Further, Regulation O requires that loans to
directors, executive officers and principal shareholders be made on terms
substantially the same as those that are offered in comparable transactions to
other persons. Regulation O also prohibits a depository institution from paying
the overdrafts over $1,000 of any of its executive officers or directors unless
they are paid pursuant to written pre-authorized extension of credit or transfer
of funds plans.
Community Reinvestment. Under the Community Reinvestment Act, any
insured depository institution, including The Heritage Bank, has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. The Community Reinvestment Act does not establish specific
lending requirements or programs for financial institutions, nor does it limit
an institution's discretion to develop the types of products and services that
it believes are best suited to its particular community. The Community
Reinvestment Act requires the Federal Reserve, in connection with its
examination of a state member bank, to assess the depository institution's
record of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications by such institution, including
applications for additional branches and acquisitions.
Among other things, the current Community Reinvestment Act regulations
replace the prior process-based assessment factors with a new evaluation system
that rates an institution based on its actual performance in meeting community
needs. In particular, the current evaluation system focuses on three tests:
o a lending test, to evaluate the institution's record of making
loans in its service areas;
o an investment test, to evaluate the institution's record of
investing in community development projects, affordable housing,
and programs benefiting low or moderate income individuals and
businesses; and
o a service test, to evaluate the institution's delivery of services
through its branches, ATMs and other offices.
The Community Reinvestment Act requires the Federal Reserve to provide
a written evaluation of an institution's Community Reinvestment Act performance
utilizing a four-tiered descriptive rating system and requires public disclosure
of an institution's Community Reinvestment Act rating. The Heritage Bank
received a "satisfactory" rating in its last Community Reinvestment Act
examination conducted by the Federal Reserve.
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Safety and Soundness Standards. Pursuant to the requirements of FDIC
Improvement Act, as amended by the Riegle Community Development and Regulatory
Improvement Act of 1994, each federal banking agency, including the Federal
Reserve, has adopted guidelines establishing general standards relating to
internal controls, information and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, asset quality,
earnings, and compensation, fees and benefits. In general, the guidelines
require, among other things, appropriate systems and practices to identify and
manage the risks and exposures specified in the guidelines. The guidelines
prohibit excessive compensation as an unsafe and unsound practice and describe
compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director, or principal shareholder.
Uniform Real Estate Lending Standards. Under the FDIC Improvement Act,
the federal banking agencies adopted uniform regulations prescribing standards
for extensions of credit that are secured by liens on interests in real estate
or made for the purpose of financing the construction of a building or other
improvements to real estate. Under the joint regulations adopted by the federal
banking agencies, all insured depository institutions must adopt and maintain
written policies that establish appropriate limits and standards for extensions
of credit that are secured by liens or interests in real estate or are made for
the purpose of financing permanent improvements to real estate. These policies
must establish loan portfolio diversification standards, prudent underwriting
standards, including loan-to-value limits, that are clear and measurable, loan
administration procedures, and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies that have been adopted
by the federal bank regulators.
The Interagency Guidelines, among other things, require a depository
institution to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits:
o for loans secured by raw land, the supervisory loan-to-value limit
is 65% of the value of the collateral;
o for land development loans, or loans for the purpose of improving
unimproved property prior to the erection of structures, the
supervisory limit is 75%;
o for loans for the construction of commercial, multi-family or other
non-residential property, the supervisory limit is 80%;
o for loans for the construction of one- to four-family properties,
the supervisory limit is 85%; and
o for loans secured by other improved property, for example,
farmland, completed commercial property and other income-producing
property including non-owner occupied, one- to four-family
property, the limit is 85%.
Although no supervisory loan-to-value limit has been established for
owner-occupied, one to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
Deposit Insurance. Pursuant to FDIC Improvement Act, the FDIC
established a system for setting deposit insurance premiums based upon the risks
a particular bank or savings association posed to
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its deposit insurance funds. Under the risk-based deposit insurance assessment
system, the FDIC assigns an institution to one of three capital categories based
on the institution's financial information, as of the reporting period ending
six months before the assessment period. The three capital categories are (1)
well capitalized, (2) adequately capitalized and (3) undercapitalized. The FDIC
also assigns an institution to one of three supervisory subcategories within
each capital group. With respect to the capital ratios, institutions are
classified as well capitalized, adequately capitalized or undercapitalized using
ratios that are substantially similar to the prompt corrective action capital
ratios discussed below. The FDIC also assigns an institution to supervisory
subgroup based on a supervisory evaluation provided to the FDIC by the
institution's primary federal regulator and information that the FDIC determines
to be relevant to the institution's financial condition and the risk posed to
the deposit insurance funds, which may include information provided by the
institution's state supervisor.
An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Under the final risk-based
assessment system, there are nine assessment risk classifications, or
combinations of capital groups and supervisory subgroups, to which different
assessment rates are applied. Assessment rates for deposit insurance currently
range from 0 basis points to 27 basis points. The capital and supervisory
subgroup to which an institution is assigned by the FDIC is confidential and may
not be disclosed.
A bank's rate of deposit insurance assessments will depend upon the
category and subcategory to which The Heritage Bank is assigned by the FDIC. Any
increase in insurance assessments could have an adverse effect on the earnings
of insured institutions, including The Heritage Bank.
Under the Deposit Insurance Funds Act of 1996 the assessment base for
the payments on the bonds issued in the late 1980's by the Financing Corporation
to recapitalize the now defunct Federal Savings and Loan Insurance Corporation
was expanded to include, beginning January 1, 1997, the deposits of institutions
insured by Bank Insurance Fund. Until December 31, 1999, or such earlier date on
which the last savings association ceases to exist, the rate of assessment for
Bank Insurance Fund-assessable deposits will be one-fifth of the rate imposed on
deposits insured by the Savings Association Insurance Fund. The annual rate of
assessments for the payments on the Financing Corporation bonds for the
quarterly period beginning on January 1, 1999 was 0.0122% for Bank Insurance
Fund-assessable deposits and 0.0610% for Savings Association Insurance
Fund-assessable deposits.
Under the Federal Deposit Insurance Act, the FDIC may terminate the
insurance of an institution's deposits upon a finding that the institution has
engaged in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, rule, order
or condition imposed by the FDIC. The management of The Heritage Bank does not
know of any practice, condition or violation that might lead to termination of
deposit insurance.
Capital Requirements
The FDIC Act of 1991 requires the Federal Reserve to take "prompt
corrective action" with respect to any insured depository institution which does
not meet specified minimum capital requirements. The applicable regulations
establish five capital levels, ranging from "well-capitalized" to "critically
undercapitalized," and require or permit the Federal Reserve to take supervisory
action in certain circumstances. Under these regulations, an insured depository
institution is considered well-capitalized if it has a total risk-based capital
ratio of 10.0% or greater, a tier 1 risk-based capital ratio of 6.0% or greater,
and a leverage ratio of 5.0% or greater, and it is not subject to an order,
written agreement, capital directive or prompt corrective action directive to
meet and maintain a specific capital level for any capital measure. An insured
depository institution is considered adequately capitalized if it has a total
risk-based capital ratio of 8.0% or greater, a tier I risk-based capital ratio
and leverage ratio of
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4.0% or greater (or a leverage ratio of 3.0% or greater if the institution is
rated composite 1 in its most recent report of examination, subject to
appropriate federal banking agency guidelines), and the institution does not
meet the definition of an undercapitalized institution. An insured depository
institution is considered undercapitalized if it has a total risk-based capital
ratio that is less than 8.0%, a tier 1 risk-based capital ratio that is less
than 4.0%, or a leverage ratio that is less than 4.0%. A significantly
undercapitalized institution is one which has a total risk-based capital ratio
that is less than 6.0%, a tier 1 risk-based capital ratio that is less than
3.0%, or a leverage ratio that is less than 3.0%. A critically undercapitalized
institution is one which has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. As of March 31, 2000, The Heritage Bank was
classified as well-capitalized. The Heritage Bank's tier 1 and total risk-based
capital ratios as of March 31, 2000 were 18.3% and 19.1%, respectively.
The severity of action authorized or required to be taken under prompt
corrective action regulations increases as a bank's capital deteriorates within
the three undercapitalized categories. All banks are prohibited from paying
dividends or other capital distributions or paying management fees to any
controlling person, if, following such distribution, The Heritage Bank will be
undercapitalized. The Federal Reserve is authorized by this legislation and
under Regulation H (which regulates state member banks) to take various
enforcement actions against any undercapitalized insured depository institution
and any insured depository institution that fails to submit an acceptable
capital restoration plan or fails to implement a plan accepted by the Federal
Reserve. These powers include, among other things, requiring the institution to
be recapitalized, prohibiting asset growth, restricting interest rates paid,
requiring prior approval of capital distributions by any bank holding company
which controls the institution, requiring divestiture by the institution of its
subsidiaries or by the holding company of the institution itself, requiring new
election of directors, and requiring the dismissal of directors and officers.
With certain exceptions, insured depository institutions will be
prohibited from making capital distributions or paying management fees if the
payment of such distributions or fees will cause them to become
undercapitalized. Furthermore, undercapitalized insured depository institutions
will be required to file capital restoration plans with the Federal Reserve.
Undercapitalized insured depository institutions also will be subject to
restrictions on growth, acquisitions, branching and engaging in new lines of
business unless they have an approved capital plan that permits otherwise. The
Federal Reserve also may, among other things, require an undercapitalized
insured depository institution to issue shares or obligations, which could be
voting stock, to recapitalize the institution or, under certain circumstances,
to divest itself of any subsidiary.
Significantly and critically undercapitalized insured depository
institutions may be subject to more extensive control and supervision. The
Federal Reserve may prohibit any such institutions from, among other things,
entering into any material transaction not in the ordinary course of business,
amending their articles of incorporation or bylaws, or engaging in certain
transactions with affiliates. In addition, critically undercapitalized
institutions generally will be prohibited from making payments of principal or
interest on outstanding subordinated debt. Within 90 days of an insured
depository institution becoming critically undercapitalized, the Federal Reserve
must appoint a receiver or conservator unless certain findings are made with
respect to the prospect for the institution's continued viability. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Analysis of Financial Condition - Capital Requirements" for more
information about The Heritage Bank's capital ratios and applicable minimum
ratios.
Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994, the Federal Reserve may approve bank holding company acquisitions of
banks in other states, subject to certain aging and deposit concentration
limits. As of June 1, 1997, banks in one state may merge with banks in another
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state, unless the other state has chosen not to implement this section of the
Riegle Act. These mergers are also subject to similar aging and deposit
concentration limits.
Virginia "opted-in" to the provisions of the Riegle Act. Since July 1,
1995, an out-of-state bank that did not already maintain a branch in Virginia
was permitted to establish and maintain a de novo branch in Virginia, or acquire
a branch in Virginia, if the laws of the home state of the out-of-state bank
permit Virginia banks to engage in the same activities in that state under
substantially the same terms as permitted by Virginia. Also, Virginia banks may
merge with out-of-state banks, and an out-of-state bank resulting from such an
interstate merger transaction may maintain and operate the branches in Virginia
of a merged Virginia bank, if the laws of the home state of the out-of-state
bank involved in the interstate merger transaction permit interstate merger.
Federal Reserve System
Under Federal Reserve Board regulations, The Heritage Bank is required
to maintain non-interest-earning reserves against its transaction accounts. The
Federal Reserve Board regulations generally require that reserves of 3% must be
maintained against aggregate transaction accounts of $44.3 million or less,
subject to adjustment by the Federal Reserve Board, and an initial reserve of
$1.3 million plus 10%, subject to adjustment by the Federal Reserve Board
between 8% and 14%, against that portion of total transaction accounts in excess
of $44.3 million. The first $5.0 million of otherwise reservable balances,
subject to adjustments by the Federal Reserve Board, are exempted from the
reserve requirements. The Heritage Bank is in compliance with these
requirements. Because required reserves must be maintained in the form of either
vault cash, a non-interest-bearing account at a Federal Reserve bank or a
pass-through account as defined by the Federal Reserve Board, the effect of this
reserve requirement is to reduce The Heritage Bank's interest-earning assets.
Effect of Economic Environment
The policies of regulatory authorities, including the monetary policy
of the Federal Reserve, have a significant effect on the operating results of
banks and their subsidiaries. Among the means available to the Federal Reserve
to affect the money supply are open market operations in U.S. government
securities, changes in the discount rate on member bank borrowings, and changes
in reserve requirements against member bank deposits. These means are used in
varying combinations to influence overall growth and distribution of bank loans,
investments and deposits, and their use may affect interest rates charged on
loans or paid for deposits.
Federal Reserve monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and income of The Heritage Bank cannot be
predicted.
Regulation of Holding Company
Federal Regulation. Heritage is a bank holding company. Bank holding
companies are subject to examination, regulation and periodic reporting under
Bank Holding Company Act, as administered by the Federal Reserve Board. The
Federal Reserve Board has adopted capital adequacy guidelines for bank holding
companies on a consolidated basis. As of March 31, 2000, Heritage's total
capital and tier 1 capital ratios exceeded these minimum capital requirements.
Regulations of the Federal Reserve Board provide that a bank holding
company must serve as a source of strength to any of its subsidiary banks and
must not conduct its activities in an unsafe or
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unsound manner. Under the prompt corrective action provisions of the FDIC
Improvement Act, a bank holding company parent of an undercapitalized subsidiary
bank would be directed to guarantee, within limitations, the capital restoration
plan that is required of such an undercapitalized bank. See "- Federal Banking
Regulation - Prompt Corrective Action" above. If the undercapitalized bank fails
to file an acceptable capital restoration plan or fails to implement an accepted
plan, the Federal Reserve Board may prohibit the bank holding company parent of
the undercapitalized bank from paying any dividend or making any other form of
capital distribution without the prior approval of the Federal Reserve Board.
As a bank holding company, Heritage is required to obtain the prior
approval of the Federal Reserve Board to acquire all, or substantially all, of
the assets of any bank or bank holding company. Prior Federal Reserve Board
approval will be required for Heritage to acquire direct or indirect ownership
or control of any voting securities of any bank or bank holding company if,
after giving effect to such acquisition, it would, directly or indirectly, own
or control more than 5% of any class of voting shares of such bank or bank
holding company.
A bank holding company is required to give the Federal Reserve Board
prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, will be equal to 10% or more of Heritage's
consolidated net worth. The Federal Reserve Board may disapprove such a purchase
or redemption if it determines that the proposal would constitute an unsafe and
unsound practice, or would violate any law, regulation, Federal Reserve Board
order or directive, or any condition imposed by, or written agreement with, the
Federal Reserve Board. Such notice and approval is not required for a bank
holding company that would be treated as "well capitalized" under applicable
regulations of the Federal Reserve Board, that has received a composite "1" or
"2" rating at its most recent bank holding company inspection by the Federal
Reserve Board, and that is not the subject of any unresolved supervisory issues.
In addition, a bank holding company which does not qualify as a
financial holding company under the Bank Holding Company Act is generally
prohibited from engaging in, or acquiring direct or indirect control of any
company engaged in non-banking activities. One of the principal exceptions to
this prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be
permissible. Some of the principal activities that the Federal Reserve Board has
determined by regulation to be so closely related to banking as to be
permissible are:
o making or servicing loans;
o performing certain data processing services;
o providing discount brokerage services;
o acting as fiduciary, investment or financial advisor;
o leasing personal or real property;
o making investments in corporations or projects designed primarily
to promote community welfare; and
o acquiring a savings and loan association.
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Bank holding companies that do qualify as a financial holding company
may engage in activities that are financial in nature or incident to activities
which are financial in nature. Bank holding companies may qualify to become a
financial holding company if:
o each of its depository institution subsidiaries is "well
capitalized";
o each of its depository institution subsidiaries is "well managed";
o each of its depository institution subsidiaries has at least a
"satisfactory" Community Reinvestment Act rating at its most recent
examination; and
o the bank holding company has filed a certification with the Federal
Reserve Board that it elects to become a financial holding company.
Under the Federal Deposit Insurance Act, depository institutions are
liable to the FDIC for losses suffered or anticipated by the FDIC in connection
with the default of a commonly controlled depository institution or any
assistance provided by the FDIC to such an institution in danger of default.
This law would potentially be applicable to Heritage if it ever acquired as a
separate subsidiary a depository institution in addition to The Heritage Bank.
Federal Securities Laws
Heritage's common stock is registered with the Securities and Exchange
Commission under Section 12(g) of the Securities Exchange Act of 1934. Heritage
is subject to the information, proxy solicitation, insider trading restrictions
and other requirements under the Securities Exchange Act of 1934.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is intended to assist readers in understanding
and evaluating the financial condition and results of operations of Heritage and
The Heritage Bank. This review should be read in conjunction with the audited
financial statements and accompanying notes. This analysis provides an overview
of the significant changes that occurred during the periods presented.
Results of Operations
The Heritage Bank's operating results depend primarily upon its net
interest income, the difference between the interest earned on its
interest-bearing assets (loans and investment securities) and the interest paid
on interest-bearing liabilities (deposits and securities sold under agreement to
repurchase). Operating results are significantly affected by provisions for loan
losses, other income and operating expenses. Each of these factors is
significantly affected not only by The Heritage Bank's policies, to varying
degrees, but general economic and competitive conditions and by policies of
state and federal regulatory authorities.
Comparison of Financial Condition at March 31, 2000 and December 31, 1999
As of March 31, 2000 Heritage's total assets were $64.4 million as
compared to $59.9 million as of December 31, 1999, which represents an increase
of 7.5%. The 2000 increase in total assets of $4.5 million was primarily due to
the increased loan production. Total loans increased by 13.7% or $4.4 million to
$36.0 million at March 31, 2000 from $31.7 million at December 31, 1999.
Total deposits increased $40,000 to $48.0 million at March 31, 2000 as
compared to $47.9 million at December 31, 1999. Repurchase agreements at March
31, 2000 were $7.6 million or 153.3% greater than the December 31, 1999 balance
of $3.0 million. The Heritage Bank temporarily funded loans with a repurchase
agreement with another bank using its investment securities as collateral. At
March 31, 2000, the total of The Heritage Bank's repurchase agreements with
another bank was $4.5 million. Customer related repurchase agreements totaled
$3.1 million and $3.0 million at March 31, 2000 and December 31, 1999,
respectively.
Federal funds sold and cash and due from banks represent Heritage's
cash and cash equivalents. Federal funds sold and cash and cash due from banks
at March 31, 2000 totaled $3.0 million compared to $2.7 million at December 31,
1999, representing an increase of $323,000, or 12.1%. The Heritage Bank had no
balances in federal funds sold at March 31, 2000 and December 31, 1999. The
increase in due from banks was attributable to usual fluctuations in clearing
balances at the Federal Reserve Bank.
Securities available for sale decreased $290,000 or 1.2% to $23.8
million at March 31, 2000 from $24.1 million at December 31, 1999. The net
$290,000 decrease was primarily due to the sale of two securities for liquidity
in January and the purchase of one additional floating rate security to increase
the yield on earning assets.
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Comparison of Financial Condition at December 31, 1999 and 1998
As of December 31, 1999, Heritage's total assets were $59.9 million, as
compared to $64.8 million at December 31, 1998, which represents a decrease of
$4.9 million, or 7.5%. The 1999 decline in total assets was primarily due to the
loss of funds provided by a one time $8.0 million deposit into attorneys escrow
accounts at the end of fiscal 1998. These funds were withdrawn the first week of
January 1999 in the normal course of business, decreasing total deposits. Total
deposits decreased by $5.4 million to $48.0 million at December 31, 1999, as
compared to $53.4 million at December 31, 1998. Adjusting for the $8.0 million
in escrow deposits, total assets at December 31, 1999 increased $3.1 million
over December 31, 1998 and total deposits increased $2.6 at December 31, 1999 as
compared to December 31, 1998.
Securities sold under agreements to repurchase at December 31, 1999
were $3.0 million or 31.2% greater than the December 31, 1998 balance of $2.3
million. The Heritage Bank increased the offering of repurchase agreements for
customers with larger short term funds in fiscal 1999. Federal funds sold and
cash and due from banks represent Heritage's cash and cash equivalents. Federal
funds sold and cash and cash due from banks at December 31, 1999 totaled $2.7
million, compared to $14.4 million at December 31,1998, representing a decrease
of $11.7 million, or 81.4%. Federal funds sold represented $8.6 million of the
decrease with cash and due from banks decreasing $3.2 million. Increased loan
production and the decrease of deposits in January 1999 was the primary cause
for the decrease in federal funds sold.
Securities available for sale increased $4.2 million, or 21.3%, to
$24.1 million at December 31, 1999 from $19.8 million at December 31, 1998. This
investment in securities was made to increase the yield on earning assets as
compared to the lower yield of federal funds sold.
Net loans were $31.3 million at December 31, 1999 as compared to $29.2
million at December 31, 1998. This net increase of $2.1 million, or 7.2%, was
primarily due to the change in lending officers prior to year end and the new
customer relationships developed by the new lending officers. Stockholders'
equity at December 31, 1999 was $8.6 million, as compared to $8.9 million at
December 31, 1998, representing a decrease of $330,000, or 3.7%. This decline
was primarily due to an increase in the unrealized loss net of income taxes on
the available for sale security portfolio due to market declines.
Heritage's return on average assets was 0.30% and its return on average
equity was 2.06% in fiscal year 1999. The Heritage Bank's return on average
assets was 0.26% and its return on average equity was 1.79% in fiscal year 1998.
The Heritage Bank is required to meet certain capital requirements as
established by the Federal Reserve Board. At December 31, 1999 and 1998, The
Heritage Bank met all capital adequacy requirements to which it was subject.
Results of Operations For The Three Months Ended March 31, 2000 and 1999
Net income. Heritage reported net income for the three months ended
March 31, 2000 of $25,000 or $.01 basic and diluted earnings per share as
compared to the $177,000 net income or $.08 basic and diluted earnings per share
for the same period of 1999. Net income decreased $152,000 from March 31, 1999
as compared to the same period of 2000. This decrease was primarily due to
increased operational and facility costs due to the Sterling branch which opened
in April of 1999 and additional space rented for operational expansion at the
main office address in McLean in March of 1999.
Net-interest income. Net interest income is the difference between
interest earned on loans, investment securities and short-term investments, and
the interest paid on deposits and repurchase
IV-15
<PAGE>
agreements. Factors affecting net interest income include interest rates earned
on loans and investments and those paid on deposits and repurchase agreements,
the mix and volume of earning assets and interest bearing liabilities and the
level of non-earning assets and non-interest bearing liabilities. Net interest
income for the quarter ended March 31, 2000 increased $5,000 or .7% over the
same quarter of 1999.
Non-interest income. During the three-month period ended March 31, 2000
non-interest income decreased $1,000 over the same period of 1999. A loss on
sale of securities of $13,000 in January 2000 was partially offset by increases
in overdraft and return check charges, and other commission fees such as ATM
fees and merchant discount fees. The securities were sold to provide some
liquidity for loan funding.
Non-interest expense. In the first quarter of 2000 non-interest
expenses increased $198,000 or 34.7% over the same period of 1999 due to
increased operational and facility costs due to the Sterling branch which opened
in April of 1999 and additional space rented for operational expansion at the
main office address in March of 1999. These increased leases raised occupancy
expense by $53,000 for the three months ended March 31, 2000 as compared to the
same period of 1999. Additional salaries of $41,000 due to increase employees at
the Sterling branch also contributed to the increased non-interest expenses for
the quarter.
Provision for loan losses. In view of the loan growth for the first
three months of 1999 and the fact that there was no deterioration in The
Heritage Bank's loan portfolio, a provision of $7,000 was made for loan losses
in the first quarter of 1999. The allowance for loan losses at March 31, 1999
was 1.33% of outstanding loans. In view of the improvement in The Heritage
Bank's loan portfolio, an analysis of the reserve for loan losses indicated that
the reserves were greater than required. Management determined that a reserve of
1.10% would be an acceptable level. A credit of $28,000 was made to the
provision to reduce the reserve balance at March 31, 2000. The level of the
allowance for loan losses is based upon management's review of the loan
portfolio and includes the present and prospective financial condition of
borrowers, consideration of actual loan loss experience and projected economic
conditions in general and for The Heritage Bank's service areas in particular.
Management believes that the provision for loan losses and the allowance for
loan losses are reasonable and adequate to cover any known losses and any losses
reasonably expected in the existing loan portfolio. While management estimates
loan losses using the best available information, such as independent appraisals
on collateral, no assurance can be given that future additions to the allowance
will not be necessary based on changes in economic and real estate market
conditions, further information obtained regarding known problem loans,
identification of additional problem loans and other factors, both within and
outside management's control.
Income Taxes. Heritage recognized a net income tax expense of $12,000
in the first quarter of 2000, as compared to $19,000 in the same period of 1999.
A net operating loss carryforward of Heritage became completely utilized for
accounting purposes in 1999.
Results of Operations For The Years Ended December 31, 1999 and 1998
Net Income. Net income for the year ended December 31, 1999 was
$182,000, an increase of 36.4% from $133,000 for the same period of 1998. Net
income per basic and diluted share increased 14.3% to $.08 from $.07 for the
same period of 1998. The increase in net income for the year ended December 31,
1999 as compared to the same period of 1998 was primarily the result of
increases in net interest, which were partially offset by increases in
non-interest expenses. In addition, the allowance for loan losses was considered
adequate without additional provision expense for 1999, due to an improvement in
the quality of the loan portfolio as compared to year end 1998. In 1998, the net
operating loss carryforward was fully utilized. This change in tax status
created a $133,000 variance in tax expense.
IV-16
<PAGE>
Net income before taxes for the year ended December 31, 1999 increased 195.7% to
$275,000 as compared to $93,000 for the same period of 1998.
Interest Income. Interest income totaled $4.4 million for the year
ended December 31, 1999, an increase of $615,000, or 16.3%, from $3.8 million
for the year ended December 31, 1998. The increase in interest income was
primarily due to a $304,000 increase in interest on increased loan balances and
an increase of $296,000 on securities available for sale.
Interest Expense. Total interest expense increased $167,000, or 13.1%,
from $1.3 million for the year ended December 31, 1998 to $1.4 million for the
year ended December 31, 1999. Increased interest expense was due to a shift from
balances in non-interest deposits to interest bearing deposits and securities
sold under agreements to repurchase.
Net Interest Income. Net interest income is the difference between
interest earned on loans, investment securities and short term investments, and
the interest paid on deposits and repurchase agreements. Factors affecting net
interest income include interest rates earned on loans and investments and those
paid on deposits and repurchase agreements, the mix and volume of earning assets
and interest bearing liabilities and the level of non-earning assets and
non-interest bearing liabilities. Net interest income for the year ended
December 31, 1999 increased $448,000, or 18.0%, from $2.5 million for the year
ended December 31, 1998 to $2.9 million for the year ended December 31, 1999.
The increase in net interest income is primarily due to the growth in the loan
portfolio.
Non-interest income. During the year ended December 31, 1999,
non-interest income increased $85,000 over the same period in 1998. This
increase resulted from increased overdraft and return check charges, loan
service fees and other commission fees such as ATM fees and merchant discount
fees. The Heritage Bank also had a gain on the sale of other real estate of
$57,000 in fiscal 1999, a nonrecurring item.
Non-interest Expense. During the year ended December 31, 1999,
non-interest expenses increased $468,000, or 19.3%, over the same period of
1998. This increase was partially due to increased operational and facility
costs of the Sterling branch that opened in April 1999 and additional space
rented for operational expansion at the main office address in McLean during
1999. These increased leases raised occupancy and equipment expense by $196,000
for the year ended December 31, 1999, as compared to fiscal 1998. Salaries and
employee benefits expense increased by $398,000, from $1.1 million for the year
ended December 31, 1998 to $1.5 million for the year ended December 31, 1999.
This increase is due, in part, to the increase in employees at the Sterling
branch. Incentive bonuses of $52,000 were also paid to employees during the year
ended December 31, 1999. Salaries and benefits increased partially due to
$15,000 in severance pay to bank employees during 1999. Other expenses decreased
by $126,000, or 11.8%, from $1.1 million for the year ended December 31, 1998 to
$943,000 for the year ended December 31, 1999. This decrease is due primarily to
a decrease in professional fees, which was partially offset by an increase in
business development fees paid in connection with a possible branch location in
Great Falls, Virginia. Other expenses were also affected by $42,000 of non-loan
charge-offs, of which a large part was the payment due under the terms of a
lawsuit settled in March 1999.
Provision for Loan Losses. In view of the loan balances for 1999, and
the improvement in The Heritage Bank's loan portfolio, no provision was made for
loan losses in the year ended December 31, 1999. A provision of $117,000 was
made for loan losses in the year ended December 31, 1998 to return the reserve
for loan losses to an acceptable level. The reserve had been reduced due to a
charge resulting from the settlement of a lawsuit. The allowance for loan losses
at December 31, 1999 was 1.33% of outstanding loans. At December 31, 1998, the
allowance for loan losses was 1.45% of outstanding loans.
IV-17
<PAGE>
The level of the allowance for loan losses is based upon management's review of
the loan portfolio and includes the present and prospective financial condition
of borrowers, consideration of actual loan loss experience and projected
economic conditions in general and for The Heritage Bank's service areas in
particular. Management believes that the provision for loan losses and the
allowance for loan losses are reasonable and adequate to cover any known losses
and any losses reasonably expected in the existing loan portfolio. While
management estimates loan losses using the best available information, such as
independent appraisals on collateral, no assurance can be given that future
additions to the allowance will not be necessary. Additions may be necessary
based on changes in economic and real estate market condition, further
information obtained regarding known problem loans, identification of additional
problem loans and other factors, both within and outside management's control.
Income Taxes. Heritage recognized a net income tax expense of $93,000
for the year ended December 31, 1999, as compared to a tax benefit of $41,000
for the year ended December 31, 1998. This increase in income tax expense for
the year ended December 31, 1999 is primarily due to the fact that a net
operating loss carryforward of Heritage became completely utilized for
accounting purposes by January 1, 1999.
Results of Operations For The Years Ended December 31, 1998 and 1997
Net Income. Net income for the year ended December 31, 1998 decreased
$437,000 to $133,000, or $0.07 basic earnings per share ($0.07 per share,
assuming dilution), from net income of $570,000, or $0.45 basic earnings per
share ($0.44 per share, assuming dilution) for the year ended December 31, 1997.
The decrease in net income was primarily due to loan loss from a bankruptcy
during the third quarter totaling $141,456, an increase in stockholder expenses
of $89,944 incurred in connection with the formation of the holding company, an
increase in legal fees of $175,000 incurred in defending lawsuits and the
$25,000 settlement of a lawsuit plus a $25,000 loss due to a robbery. The
expenses associated with the formation of the holding company, the opening of
the Sterling branch in Sterling, Virginia, and the legal fees incurred in
connection with the settlement of a lawsuit are nonrecurring items and are not
expected to have an impact on the long-term profitability of The Heritage Bank.
Interest Income. The major component of The Heritage Bank's net
earnings is net interest income, which is the excess of interest income on
interest-earning assets over the interest expense on interest-bearing
liabilities. Net interest income is affected by changes in volume resulting from
growth and alterations of the balance sheet composition as well as fluctuations
in interest rates ("interest rate spread") and maturities of sources and uses of
funds. The Heritage Bank's management seeks to maximize net interest income by
managing the balance sheet and determining the optimal product mix with respect
to yields on assets and costs of funds in light of projected economic
conditions, while maintaining an acceptable level of risk.
Interest income totaled $3.7 million for the year ended December 31,
1998, an increase of $509,000 or 15.6% from $3.2 million from the year ended
December 31, 1997. The increase in interest income was due to a $108,000
increase in interest on federal funds sold and an increase of $302,000 on
securities available for sale. Loan interest income also increased by $99,000.
The increase in interest on securities available for sale was the result of The
Heritage Bank investing the funds received from the sale of stock in the
offering in investment bonds. The increase in federal funds sold interest was
the result of the increase in deposits. The increase in interest income on loans
was the result of an increase in the loan portfolio, due to the ability of The
Heritage Bank to increase its legal lending limit as a result of proceeds
received in the offering and favorable interest rates in fiscal 1998.
Interest Expense. Total interest expense increased $162,000, or 14.6%,
from $1.1 million for the year ended December 31, 1997 to $1.3 million for the
year ended December 31, 1998. This increase was
IV-18
<PAGE>
primarily due to the $3.1 million increase in the average balance of
interest-bearing liabilities from $30.2 million for the year ended December 31,
1997 to $33.3 million for the year ended December 31, 1998.
Net Interest Income. Net interest income increased by $349,000, or
16.3%, from $2.1 million for the year ended December 31, 1997 to $2.5 million
for the year ended December 31, 1998.
The Heritage Bank's net interest margin (net interest income expressed
as a percentage of total average interest-earning assets) decreased to 5.09% for
the year ended December 31, 1998 compared to 5.25% for the year ended December
31, 1997. The Heritage Bank's interest spread (the average yield earned on
interest-earning assets less the average rate incurred on interest-bearing
liabilities) was 3.87% and 4.29% for the years ended December 31, 1998 and 1997,
respectively.
Provision for Loan Losses. The provision for loan losses for the year
ended December 31, 1998 was $117,000 as compared to $3,825 for the year ended
December 31, 1997. This increase was necessary due to a loss on a loan in
connection with a bankruptcy and the need to replenish some of the reserves
used.
Management believes that the provision for loan losses and the
allowance for loan losses are reasonable and adequate to cover any known losses
and any losses reasonably expected in the loan portfolio. While management
estimates loan losses using the best available information, no assurance can be
made that future additions to the allowance will not be necessary.
Non-interest Income. Non-interest income consists primarily of service
charges and fees associated with The Heritage Bank's loan and savings accounts
and gains on the sale of securities. Non-interest income for the year ended
December 31, 1998 was $137,000, representing a decrease of $44,000 from the
non-interest income of $181,000 for the year ended December 31, 1997. This
decrease was caused primarily by a $47,000 decrease in gains on the sale of
government securities.
Non-interest Expense. Non-interest expense consists primarily of
operating expenses for compensation and related benefits, occupancy, federal
insurance premiums and operating assessments, and equipment expenses.
Non-interest expense increased $585,000, or 31.9%, from $1.8 million
for the year ended December 31, 1997 to $2.4 million for the year ended December
31, 1998. This increase was due in part to an increase in salaries and employee
benefits expense of $121,000 or 12.7% from $953,000 for the year ended December
31, 1997 to $1,074,000 for the year ended December 31, 1998. Other operating
expenses increased by $489,000 or 84.3% from $580,000 to $1,069,000 for the
years ended December 31, 1997 and 1998, respectively. This increase was due to
settlement of a lawsuit of $108,800, loss on a bankruptcy of $141,456, legal
fees of $175,732 incurred in defending a lawsuit, expenses associated with the
formation of the holding company of $89,944 and the $25,000 loss in a robbery.
Income Taxes. The Heritage Bank had an income tax benefit of $41,000
for the year ended December 31, 1998 compared to a benefit of $85,000 in 1997.
At December 31, 1998, The Heritage Bank had effectively used all of its
operating loss carryforwards. The Heritage Bank expects to have tax expense for
the fiscal year 1999.
IV-19
<PAGE>
Performance Ratios and Per Share Data
The table below presents per share data regarding Heritage and The
Heritage Bank, as well as performance and asset quality ratios for the time
periods indicated.
Selected Financial Data
(Dollars in thousands, except for per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31, Years Ended December 31,
-------------------------- --------------------------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
PER SHARE DATA
Net income, basic $ 0.01 $ 0.08 $ 0.08 $ 0.07 $ 0.45 $ 0.32 $ 0.15
Net income, diluted 0.01 0.08 0.08 0.07 0.44 0.32 0.15
Cash dividends -- -- -- -- -- -- --
Dividend payout ratio -- -- -- -- -- -- --
Book value at period end $ 3.73 $ 3.94 $ 3.75 $ 3.89 $ 3.18 $ 2.84 2.52
Common shares outstanding 2,294,617 2,294,617 2,294,617 2,294,617 1,489,636 1,249,634 1,249,634
PERFORMANCE AND ASSET
QUALITY RATIOS
Return on average assets (1) 0.16% 1.18% 0.30% 0.26% 1.33% 0.87% 0.46%
Return on average equity (1) 1.17% 7.86% 2.06% 1.79% 15.24% 12.05% 5.89%
Average stockholders'
equity to average total assets 14.06% 15.07% 14.49% 14.47% 8.74% 7.19% 7.74%
Non-accrual and past due
loans to total loans 0.00% 0.46% 0.00% 1.35% 0.98% 1.85% 2.93%
Allowance for loan losses
to total loans 1.10% 1.44% 1.33% 1.45% 2.71% 2.45% 2.81%
Net yield 4.13% 4.06% 4.07% 3.87% 4.29% 3.69% 3.96%
Net interest margin (2) 5.20% 5.20% 5.16% 5.09% 5.25% 4.54% 4.93%
</TABLE>
(1) Annualized for the three months ended March 31, 2000 and March 31, 1999.
(2) Net interest margin is calculated as net interest income divided by average
earning assets and represents Heritage's net yield on its earning assets.
IV-20
<PAGE>
Average Balances, Interest and Average Yields
The following table sets forth information relating to The Heritage
Bank's average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated and the average yields
earned and rates paid for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average daily balances of assets
and liabilities, respectively, for the periods presented.
Average Balances, Interest Income and Expenses
and Average Yields and Rates
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------------------------------------
2000 1999
--------------------------------- ----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans receivable(1) $ 32,932 $ 725 8.81% $ 29,231 $ 699 9.57%
Investment securities, taxable 23,772 386 6.50% 20,708 319 6.16%
Federal funds sold 508 7 5.51% 6,891 81 4.70%
---------- ----------- ----------- ----------
Total earning assets 57,212 1,118 7.82% 56,830 1,099 7.74%
---------- ----------- ----------- ----------
NON-EARNING ASSETS:
Cash and due from banks 2,373 1,862
Other assets 1,469 1,089
---------- -----------
Total non-earning assets 3,842 2,951
---------- -----------
Total assets $ 61,054 $ 59,781
========== ===========
INTEREST-BEARING LIABILITIES:
Deposits:
Interest-bearing demand (NOW)
deposits $ 7,402 $ 33 1.78% $ 6,725 $ 36 2.14%
Money market deposits 10,122 79 3.12% 11,978 90 3.00%
Savings deposits 3,168 23 2.90% 3,268 22 2.69%
Time deposits 15,623 195 4.99% 15,664 200 5.11%
Repurchase agreements 3,351 33 3.94% 1,505 12 3.19%
Federal Funds purchased 847 11 5.19% - - 0.00%
---------- ----------- ----------- ----------
Total interest-bearing
Liabilities 40,513 374 3.69% 39,140 360 3.68%
---------- ----------- ----------- ----------
NON-INTEREST-BEARING LIABILITIES:
Demand deposits 11,781 11,490
Other liabilities 177 142
---------- -----------
Total non-interest-bearing
liabilities 11,958 11,632
---------- -----------
Stockholders' equity 8,583 9,009
---------- -----------
Total liabilities and
stockholders' equity $ 61,054 $ 59,781
========== ===========
Interest spread 4.13% 4.06%
Net interest margin $ 744 5.20% $ 739 5.20%
=========== ==========
</TABLE>
IV-21
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997
------------------------------ ------------------------------- -------------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
--------- ---------- --------- ---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans receivable(1) $ 29,383 $ 2,690 9.15% $ 25,978 $ 2,386 9.18% $ 24,533 $ 2,286 9.32%
Investment securities, taxable 22,583 1,414 6.26 18,208 1,118 6.14 13,432 816 6.08
Federal funds sold 5,523 277 5.02 4,830 262 5.42 2,867 154 5.37
--------- ---------- ---------- --------- --------- ----------
Total earning assets 57,489 4,381 7.62 49,016 3,766 7.68 40,832 3,256 7.97
--------- ---------- ---------- --------- --------- ----------
NON-EARNING ASSETS:
Cash and due from banks 2,141 1,691 1,649
Other assets 1,329 802 414
--------- ---------- ---------
Total non-earning assets 3,470 2,493 2,063
--------- ---------- ---------
Total assets $ 60,959 $ 51,509 $ 42,895
========= ========== =========
INTEREST-BEARING LIABILITIES:
Deposits:
Interest-bearing demand (NOW)
deposits $ 7,387 $ 130 1.76% $ 5,696 $ 133 2.33% $ 5,073 $ 113 2.23%
Money market deposits 11,808 350 2.96 10,875 363 3.34 10,377 331 3.19
Savings deposits 3,250 90 2.77 3,298 97 2.94 3,369 99 2.94
Time deposits 15,373 772 5.02 12,424 640 5.15 11,196 561 5.01
Repurchase agreements 2,675 97 3.63 1,069 39 3.65 159 7 4.40
--------- ---------- ---------- --------- --------- ----------
Total interest-bearing
liabilities 40,493 1,439 3.55 33,362 1,272 3.81 30,174 1,111 3.68
--------- ---------- ---------- --------- --------- ----------
NON-INTEREST-BEARING LIABILITIES:
Demand deposits 11,522 10,546 8,829
Other liabilities 114 149 145
--------- ---------- ---------
Total non-interest-bearing
liabilities 11,636 10,695 8,974
--------- ---------- ---------
Stockholders' equity 8,830 7,452 3,747
--------- ---------- ---------
Total liabilities and
stockholders' equity $ 60,959 $ 51,509 $ 42,895
========= ========== =========
Interest spread 4.07% 3.87% 4.29%
Net interest margin $ 2,942 5.12% $ 2,494 5.09% $ 2,145 5.25%
========== ========= ==========
</TABLE>
------------------
(1) Non-accrual loan balances are included in the calculation of average
balances.
IV-22
<PAGE>
Rate/Volume Analysis
The following table sets forth certain information regarding changes in
interest income and interest expense of The Heritage Bank for the periods
indicated. For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to: (i) changes in
volume (changes in volume multiplied by old rate); and (ii) changes in rates
(change in rate multiplied by old volume). Changes in rate-volume (changes in
rate multiplied by the changes in volume) are allocated between changes in rate
and changes in volume.
Rate and Volume Analysis
(Dollars in thousands)
Three Months Ended
March 31, 2000
Compared To
March 31, 1999
Increase (Decrease) Due To
---------------------------------------
Rate Volume Total
----------- ------------ ------------
INTEREST EARNED ON:
Loans receivable, net $ $ $ 26
(44) 70
Investment securities, taxable 18 49 67
Federal funds sold 17 (91) (74)
----------- ------------ ------------
Total interest income (9) 28 19
----------- ------------ ------------
INTEREST PAID ON:
Interest-bearing (NOW) deposits (7) 4 (3)
Money market deposits 4 (15) (11)
Savings deposits 2 (1) 1
Time deposits (4) (1) (5)
Securities sold under agreement to
repurchase 3 18 21
Federal funds purchased -- 11 11
----------- ------------ ------------
Total interest expense (2) (16) 14
----------- ------------ ------------
Net interest income $ (7) $ 12 $ 5
=========== ============ ============
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1999 December 31, 1998
Compared To Compared To
December 31, 1998 December 31, 1997
Increase (Decrease) Due To Increase (Decrease) Due To
------------------------------------- ---------------------------------------
Rate Volume Total Rate Volume Total
----------- ----------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNED ON:
Loans receivable, net $ 29 $ 275 $ 304 $ (34) $ 134 $ 100
Investment securities, taxable 22 274 296 8 294 302
Federal funds sold (16) 31 15 1 107 108
----------- ----------- ----------- ------------ ----------- ------------
Total interest income 35 580 615 (25) 535 510
----------- ----------- ----------- ------------ ----------- ------------
INTEREST PAID ON:
Interest-bearing (NOW) deposits 14 (17) (3) 5 15 20
Money market deposits (53) 40 (13) 16 17 33
Savings deposits (6) (1) (7) -- (2) (2)
Time deposits (16) 148 132 15 63 78
Securities sold under agreement to
repurchase -- 58 58 -- 32 32
----------- ----------- ----------- ------------ ----------- ------------
Total interest expense (61) 228 167 36 125 161
----------- ----------- ----------- ------------ ----------- ------------
Net interest income $ 96 $ 352 $ 448 $ (61) $ 410 $ 349
=========== =========== =========== ============ =========== ============
</TABLE>
IV-23
<PAGE>
Interest Rate Sensitivity
An important element of both earnings performance and liquidity is
management of interest rate sensitivity. Interest rate sensitivity reflects the
potential effect on net interest income of a movement in interest rates. The
difference between The Heritage Bank's interest-sensitive assets and
interest-sensitive liabilities for a specified time frame is referred to as
"gap." A financial institution is considered to be asset-sensitive, or having a
positive gap, when the amount of its earning assets maturing or repricing within
a given time period exceeds the amount of its interest-bearing liabilities also
maturing or repricing within that time period. Conversely, a financial
institution is considered to be liability-sensitive, or have a negative gap,
when the amount of its interest-bearing liabilities maturing or repricing within
a given period exceeds the amount of earning assets also maturing or repricing
within that time period. During a period of rising interest rates, a positive
gap would tend to increase net interest income, while a negative gap would tend
to have an adverse effect on net interest income. During a period of falling
interest rates, a positive gap would tend to have an adverse effect on net
interest income, while a negative gap would tend to increase net interest
income.
The Heritage Bank evaluates interest sensitivity risk and then
formulates guidelines regarding asset generation and pricing, funding sources
and pricing, and off-balance sheet commitments in order to decrease sensitivity
risk. These guidelines are based upon management's outlook regarding future
interest rate movements, the state of the regional and national economy and
other financial and business risk factors. The Heritage Bank uses a static gap
model and a computer simulation to measure the effect on net interest income of
various interest rate scenarios over selected time periods. The gap can be
managed by repricing assets or liabilities, selling investments available for
sale, replacing an asset or liability prior to maturity or adjusting the
interest rate during the life of an asset or liability. Matching the amount of
assets and liabilities repricing during the same time interval helps to reduce
the risk and minimize the impact on net interest income in periods of rising or
falling interest rates.
As of March 31, 2000, The Heritage Bank's static one-year cumulative
gap to total interest-sensitive assets position was a negative 31.0% and The
Heritage Bank was, therefore, in an asset-sensitive position. It is The Heritage
Bank's goal to control the mix and rate sensitivity of assets and liabilities
such that the revolving gap (the gap is less than one year) will not exceed 10%
(positive or negative) of assets.
The following table illustrates the interest sensitivity gap position
of The Heritage Bank as of March 31, 2000 (focusing only on repricing schedules,
not fixed versus variable rates). This table presents a position as of a
particular day, which position changes continually and is not necessarily
indicative of The Heritage Bank's position at any other time.
IV-24
<PAGE>
Interest Sensitivity Analysis
March 31, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
MATURING OR REPRICING IN:
--------------------------------------------------------------------------
3 MONTHS 4-12 1 TO 5 MORE THAN
OR LESS MONTHS YEARS 5 YEARS TOTAL
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
INTEREST-SENSITIVE ASSETS:
Federal funds sold $ - $ - $ - $ - $ -
Loans (1) 11,147 5,326 12,990 6,582 36,045
Securities 999 508 21,047 1,210 23,764
-------------- -------------- -------------- -------------- --------------
Total interest-sensitive assets $ 12,146 $ 5,834 $ 34,037 $ 7,792 $ 59,809
============== ============== ============== ============== ==============
INTEREST-SENSITIVE LIABILITIES:
Certificates of deposit > $100,000 $ 1,122 $ 1,513 $ 3,928 $ 692 $ 7,255
Certificates of deposit < $100,000 9,279 3,182 3,076 245 15,782
Super NOW accounts/Money Market deposit 13,844 - - - 13,844
Federal funds purchased and securities
sold 7,603 - - - 7,603
under agreement to repurchase
-------------- -------------- -------------- -------------- --------------
Total interest-sensitive $ 31,848 $ 4,695 $ 7,004 $ 937 $ 44,484
liabilities
============== ============== ============== ============== ==============
Period gap $ (19,702) $ 1,139 $ 27,033 $ 6,855 $ 15,325
Cumulative gap $ (19,702) $ (18,563) $ 8,470 $ 15,325
Ratio of cumulative interest-
sensitive liabilities to
interest-sensitive
assets 262.2% 203.1% 83.7% 74.4%
============== ============== ============== ==============
</TABLE>
(1) Excludes non-accrual loans.
(2) Non-certificate deposit accounts are shown as repricing within the three
month or less time frame, although The Heritage Bank believes, based on
historical experience, that such deposits are less interest sensitive.
Analysis of Financial Condition
Loan Portfolio
The loan portfolio is the largest category of The Heritage Bank's
earning assets and is comprised of commercial real estate loans, commercial
loans, home equity loans, construction loans, consumer loans and participation
loans with other financial institutions. The primary markets in which The
Heritage Bank makes loans include Fairfax and Loudoun Counties, Virginia. The
mix of the loan portfolio is weighted toward loans secured by real estate and
commercial loans. In management's opinion, there are no significant
concentrations of credit with particular borrowers engaged in similar
activities.
Net loans consist of total loans minus the allowance for loan losses,
unearned discount. The Heritage Bank's net loans at March 31, 2000 were $35.6
million, representing a 14.0% increase over net loans of $31.3 million at
December 31, 1999. Loan volume increased in 1999 and the first quarter of 2000
due to The Heritage Bank's ability to make larger loans as a result of the
increase in The Heritage Bank's legal lending limit from the offering. Gross
loans increased 7.1% in 1999 from a balance of $29.2
IV-25
<PAGE>
million at December 31, 1998. The average balance of total loans as a percentage
of average earning assets was 57.6% for March 31, 2000, up from 51.1% for
December 31,1999. The average balance of total loans as a percentage of average
earnings assets was 53.0% for 1998.
In the normal course of business, The Heritage Bank makes various
commitments to meet the financing needs of its customers and incurs certain
contingent liabilities, including standby letters of credit and commitments to
extend credit. At March 31, 2000, commitments for standby letters of credit
totaled $73,300 and commitments to extend credit totaled $10.0 million.
Commitments for standby letters of credit totaled $92,300 and $182,000 for the
years ended December 31, 1999 and 1998, respectively. Commitments to extend
credit totaled $10.6 million and $8.7 million for the years ended December 31,
1999 and 1998.
The following table summarizes the composition of The Heritage Bank's
loan portfolio at the periods indicated:
Loan Portfolio
(Dollars in thousands)
March 31,
---------------------------------------
2000 1999
---------- ----------
Amount Percent Amount Percent
---------- -------- ---------- --------
Real estate:
Construction $ 1,696 4.7% $ 438 1.5%
Residential (1-4) 10,541 29.2% 10,377 35.7%
Commercial 16,680 46.3% 12,676 43.6%
Commercial 4,475 12.4% 2,294 7.9%
Agricultural 966 2.7% 987 3.4%
Consumer 1,331 3.7% 1,681 5.8%
All other 356 1.0% 630 2.1%
---------- ----------
Loan, gross 36,045 100.0% 29,083 100.0%
---------- ----------
Less: allowance for
loan losses (396) (418)
---------- ----------
Loans, net $ 35,649 $ 28,665
========== ==========
IV-26
<PAGE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
---------- --------- ---------- --------- ---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Mortgage $ 24,653 77.8% $ 24,077 81.3% $ 17,532 75.0% $ 19,524 77.5% $ 18,735 76.9%
Construction 1,157 3.6 441 1.5 448 1.9 633 2.5 147 0.6
Commercial 4,372 13.8 3,789 12.8 4,191 17.9 4,210 16.7 4,526 18.6
Consumer 1,507 4.8 1,306 4.4 1,219 5.2 835 3.3 938 3.9
---------- ---------- ---------- ---------- ----------
Loan, gross 31,689 100.0% 29,610 100.0% 23,390 100.0% 25,202 100.0% 24,346 100.0%
---------- ---------- ---------- ---------- ----------
Less: allowance for
loan losses (421) (429) (634) (617) (685)
---------- ---------- ---------- ---------- ----------
Loans, net $ 31,268 $ 29,181 $ 22,756 $ 24,585 $ 23,661
========== ========== ========== ========== ==========
</TABLE>
The following table sets forth certain information with respect to The
Heritage Bank's non-accrual, restructured and past due loans, as well as
foreclosed assets, for the periods indicated.
Non-Performing Assets
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Month Ended March 31, Years Ended December 31,
-----------------------------------------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Non-accrual loans -- $ 3 -- $ 395 $ 222 $ 465 $ 445
Real estate owned -- 263 -- 263 263 263 300
------------- ------------- --------- ---------- ---------- ---------- ----------
Total non-performing loans -- 266 -- 658 485 728 745
============= ============= ========= ========== ========== ========== ==========
Loans past due 90 or more days accruing -- 14 -- -- 7 -- 268
interest
Non-performing loans to total loans, at 0.0% 0.0% 0.0% 1.3% 0.9% 1.8% 1.8%
period end
Non-performing assets to period end 0.0% 0.4% 0.0% 1.0% 1.1% 1.6% 1.6%
assets
Non-performing assets: total loans
and other real estate owned 0.0% 0.9% 0.0% 2.2% 2.1% 2.9% 3.0%
</TABLE>
The amount of interest on non-accrual loans which would have been
recorded as income under the original terms of such loans was approximately $0,
$26,800 and $34,300 for the years ended December 31, 1999, 1998 and 1997,
respectively. There were no nonaccrual loans at March 31, 2000. Loans are placed
on non-accrual when a loan is specifically determined to be impaired or when
principal or interest is delinquent for 90 days or more.
In addition to the nonaccrual loans, past due loans, and other real
estate owned listed above, loans totaling $1.2 million or 3.4% of total loans at
March 31, 2000 were either internally classified or specially mentioned, require
more than normal attention, and are potential problem loans. These potential
problem loans represent a decrease from $1.7 million of potential problem loans,
or 5.4% of total loans, at December 31, 1999. The decrease is related primarily
to The Heritage Bank's efforts to improve loan quality.
Loan Maturity
The following table shows the contractual maturity at March 31, 2000.
The table reflects the entire unpaid principal balance in the maturity period
that includes the final loan payment date and, accordingly, does not give effect
to periodic principal repayments or possible prepayments.
IV-27
<PAGE>
Maturity and Rate Sensitivity of Loans
(Dollars in thousands)
<TABLE>
<CAPTION>
At March 31, 2000
-----------------------------------------------------------------------
Over One Year
One Year Through Five Years Over Five Years
Or Less Fixed Rate Floating Rate Fixed Rate Floating Rate
------------- ------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Commercial $ 1,495 $ 2,934 $ -- $ 46 $ --
Real Estate-construction $ 1,696 -- -- -- --
</TABLE>
Allowance For Loan Losses
In originating loans, The Heritage Bank recognizes that credit losses
will be experienced and the risk of loss will vary with, among other things,
general economic conditions, the type of loan being made, the creditworthiness
of the borrower over the term of the loan and, in the case of a collateralized
loan, the quality of the collateral for such loan. The Heritage Bank maintains
an allowance for loan losses based upon, among other things, such factors as
changes in the character and size of the loan portfolio and related loan loss
experience, a review and examination of overall loan quality which includes the
assessment of problem loans, the amount of non-performing assets, regulatory
policies, generally accepted accounting principles, general economic conditions,
and other factors related to the collectibility of loans in The Heritage Bank's
portfolios. In addition to unallocated allowances, specific allowances are
provided for individual loans when ultimate collection is considered
questionable by management after reviewing the current status of loans which are
contractually past due and after considering the net realizable value of any
collateral for the loan.
Management actively monitors The Heritage Bank's asset quality in a
continuing effort to identify potential loans that would be charged against the
allowance for loan losses and to provide specific loss allowances when
necessary. The Heritage Bank employs an outside consultant to provide the loan
review function. Although management believes it uses the best information
available to make determinations with respect to the allowance for loan losses,
future adjustments may be necessary if economic conditions differ from the
assumptions used in making the initial determinations. The Heritage Bank's
allowance for loan losses was $396,000, or 1.10% of total loans, as of March 31,
2000 and $429,000, or 1.45% of total loans, as of December 31, 1998.
Management believes the allowance is adequate to absorb losses inherent
in the loan portfolio. The Heritage Bank expects to grow its loan portfolio and
believes it will add to the reserves in the allowance for loan losses to mirror
the growth in the loan portfolio.
In view of The Heritage Bank's plans for expansion and possible loan
growth, management will continue to closely monitor the performance of its
portfolio and make additional provisions as necessary. The Heritage Bank does
not presently anticipate that such provisions will have a material adverse
impact on The Heritage Bank's results of operations in future periods.
IV-28
<PAGE>
An analysis of the allowance for loan losses, including charge-off
activity, is presented below:
Allowance For Loan Losses
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31, Years Ended December 31,
---------------------- ----------------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
ALLOWANCE FOR LOAN LOSSES:
Balance at beginning of year $ 421 $ 429 $ 429 $ 634 $ 617 $ 685 $ 1,164
CHARGE-OFFS:
Commercial -- 20 20 332 8 70 360
Real estate -- -- -- -- 50 34 158
Consumer -- -- -- 7 3 5 2
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total loans charged off -- 20 20 339 61 109 520
---------- ---------- ---------- ---------- ---------- ---------- ----------
RECOVERIES:
Commercial -- -- 6 13 60 15 32
Real estate -- -- 3 -- 14 26 96
Consumer 3 2 3 4 -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total recoveries 3 2 12 17 74 41 128
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net charge-offs (recoveries) (3) 18 8 322 (13) 68 392
---------- ---------- ---------- ---------- ---------- ---------- ----------
Provision for (recovery of)
loan losses (28) 7 -- 117 4 -- (87)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at end of year $ 396 $ 418 $ 421 $ 429 $ 634 $ 617 $ 685
========== ========== ========== ========== ========== ========== ==========
Ratio of net charge-offs
(recoveries) to average loans
outstanding (0.01%) 0.06% 0.03% 1.24% (0.05%) 0.28% 1.49%
Ratio of allowance for loan
losses to loans at period-end 1.10% 1.44% 1.33% 1.45% 2.71% 2.45% 2.81%
</TABLE>
A breakdown of the allowance for loan losses is provided in the
following table. However, The Heritage Bank's management does not believe that
the allowance for loan losses can be allocated by category with a degree of
precision that would be useful to investors. Because all of these factors are
subject to change, the allocation of loan losses in the following table is not
necessarily predictive of future loan losses in the indicated categories. See
Note 1 of the notes to the financial statements for further information
regarding the classification of loan losses.
Allocation of Allowance For Loan Losses
(Dollars in thousands)
March 31,
-----------------------------------------------
2000 1999
-----------------------------------------------
Amount Percent (1) Amount Percent (1)
-----------------------------------------------
Commercial $ 49 12.4% $ 33 7.9%
Real Estate
Mortgage and
Construction 328 82.8% 352 84.2%
Consumer and other 19 4.8% 33 7.9%
---------- ----------
Total Allowance for
Loan Losses $ 396 $ 418
========== ==========
IV-29
<PAGE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------------
Amount Percent (1) Amount Percent (1) Amount Percent (1) Amount Percent (1) Amount Percent (1)
-------- ----------- -------- ----------- -------- ----------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $ 60 14.3% $ 82 12.8% $ 109 17.9% $ 105 16.7% $ 88 18.6%
Real Estate
Mortgage and
Construction 351 83.3% 334 82.8% 502 76.9% 492 80.0% 560 77.5%
Consumer 10 2.4% 13 4.4% 23 5.2% 20 3.3% 37 3.9%
-------- -------- -------- -------- --------
Total Allowance for
Loan Losses $ 421 $ 429 $ 634 $ 617 $ 685
======== ======== ======== ======== ========
</TABLE>
-----------
(1) Represents percentage of loans in each category to total loans.
Investment Activities
The Heritage Bank is required to maintain an amount of liquid assets
appropriate to its level of net savings withdrawals and current borrowings. It
has generally been The Heritage Bank's policy to maintain a liquidity portfolio
in excess of regulatory requirements. At March 31, 2000, The Heritage Bank's
liquidity ratio was 41.7%. Liquidity levels may be increased or decreased
depending upon the yields on investment alternatives, management's judgment as
to the attractiveness of the yields then available in relation to other
opportunities, management's expectations of the level of yield that will be
available in the future and management's projections as to the short-term demand
for funds to be used in The Heritage Bank's loan origination and other
activities.
Interest income from investments in various types of liquid assets
provides a significant source of revenue for The Heritage Bank. The Heritage
Bank invests in U.S. Treasury and federal agency securities, bank certificates
of deposits, equity securities, corporate debt securities, taxable municipals
and overnight federal funds. The balance of investment securities maintained by
The Heritage Bank in excess of regulatory requirements reflects management's
historical objective of maintaining liquidity at a level that assures the
availability of adequate funds, taking into account anticipated cash flows and
available sources of credit, for meeting withdrawal requests and loan
commitments and making other investments. See "Liquidity and Capital Resources."
The Heritage Bank purchases securities through a primary dealer of U.S.
government obligations or such other securities dealers authorized by the board
of directors and requires that the securities be delivered to a safekeeping
agent before the funds are transferred to the broker or dealer. The Heritage
Bank purchases investment securities pursuant to an investment policy
established by the board of directors.
Investment securities are recorded on the books of The Heritage Bank in
accordance with generally accepted accounting principles. The Heritage Bank does
not purchase investment securities for trading. Effective January 1, 1994, The
Heritage Bank implemented SFAS No. 115. Available- for-sale securities are
reported at fair value with unrealized gains or losses reported as a separate
component of net worth, net of tax effects. Held-to-maturity securities are
carried at amortized cost. Substantially all purchases of investment securities
conform to The Heritage Bank's interest rate risk policy.
IV-30
<PAGE>
The following table summarizes the carrying value of securities for the
dates indicated:
Securities Portfolio
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
------------------------------ ---------------------------------------------
2000 1999 1999 1998 1997
-------------- -------------- -------------- -------------- --------------
AVAILABLE FOR SALE:
<S> <C> <C> <C> <C> <C>
U.S. treasury and other government agencies $ 22,387 $ 20,837 $ 22,273 $ 17,333 $ 9,828
State, county and municipal 508 1,655 1,007 1,685 1,854
Other 869 265 775 806 112
-------------- -------------- -------------- -------------- --------------
Total available for sale 23,764 22,757 24,055 19,824 11,794
-------------- -------------- -------------- -------------- --------------
HELD TO MATURITY:
-------------- -------------- -------------- -------------- --------------
U.S. treasury and other government agencies -- -- -- -- 250
-------------- -------------- -------------- -------------- --------------
Total held to maturity -- -- -- -- 250
-------------- -------------- -------------- -------------- --------------
Total securities $ 23,764 $ 22,757 $ 24,055 $ 19,824 $ 12,044
============== ============== ============== ============== ==============
</TABLE>
The following table sets forth the maturity distribution and weighted
average yields of the investment portfolio at March 31, 2000. The weighted
average yields are calculated on the basis of the book value of' the investment
portfolio and on the interest income of investments adjusted for amortization of
premium and accretion of discount.
Investment Portfolio - Maturity and Yields
(Dollars in thousands)
<TABLE>
<CAPTION>
1 Year 5 Years After
1 Year or Less To 5 Years To 10 Years 10 Years
-------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
MATURITY DISTRIBUTION:
U.S. Agency Issues $ 999 $ 20,440 $ 942 $ --
Municipal Issues 508 -- -- --
Other Corp Securities -- 608 -- --
Federal Reserve Bank Stock -- -- -- 265
-------------- ------------- ------------- -------------
Total Maturity Distribution $ 1,507 $ 21,048 $ 942 $ 265
-------------- ------------- ------------- -------------
WEIGHTED AVERAGE YIELD:
U.S. Agency Issues 8.77% 6.21% 6.02% --
Municipal Issues 6.34% -- -- --
Other Corp Securities -- 5.98% -- --
Federal Reserve Bank Stock -- -- -- 6.00%
Total Portfolio Weighted Average Yield 7.95% 6.20% 6.02% 6.00%
</TABLE>
IV-31
<PAGE>
Deposits
The Heritage Bank primarily uses deposits to fund its loans and
investment portfolio. The Heritage Bank offers a variety of deposit accounts to
individuals and small to medium-sized businesses. Deposit accounts include
checking, savings, escrow accounts, money market and certificates of deposit.
Certificates of deposit in amounts of $100,000 or more totaled $7.3 million at
March 31, 2000 and $4.7 million at December 31, 1999. Many of these deposits are
from long-standing customers and, therefore, are believed by The Heritage Bank's
management to be as stable as, and for all practical purposes, no more rate
sensitive than, core deposits.
The following table details the average amount of, and the average rate
paid on, the following primary deposit categories for the periods indicated:
Average Deposits and Average Rates Paid
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------------------------------
2000 1999
------------------------- --------------------------
Average Average Average Average
Interest-bearing deposits: Balance Rate Balance Rate
------------- ---------- ------------- -----------
<S> <C> <C> <C> <C>
NOW accounts $ 7,402 1.78% $ 6,725 2.14%
Money market savings 10,122 3.12% 11,978 3.00%
Regular savings 3,168 2.90% 3,268 2.69%
Certificates of deposit 15,623 4.99% 15,664 5.11%
------------- -------------
Total interest-bearing deposits 36,315 3.63% 37,635 3.70%
Non-interest-bearing deposits 11,781 11,490
------------- -------------
Total deposits $ 48,096 $ 49,125
============= =============
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------------------------
1999 1998 1997
-------------------------- --------------------------- -----------------------------
Average Average Average Average Average Average
Interest-bearing deposits: Balance Rate Balance Rate Balance Rate
------------ ------------ ------------- ------------ --------------- ------------
<S> <C> <C> <C> <C> <C> <C>
NOW accounts $ 7,387 1.76% $ 5,696 2.33% $ 5,073 2.23%
Money market savings 11,808 2.96 10,875 3.34 10,377 3.19
Regular savings 3,250 2.77 3,298 2.94 3,369 2.94
Certificates of deposit 15,373 5.02 12,424 5.14 11,196 5.01
------------ ------------- ---------------
Total interest-bearing deposits $ 37,818 3.55% $ 32,293 3.82% $ 30,015 3.68%
Non-interest-bearing deposits 11,522 10,546 8,829
------------ ------------- ---------------
Total deposits $ 49,340 $ 42,839 $ 38,844
============ ============= ===============
</TABLE>
IV-32
<PAGE>
The following is a summary of the maturity distribution of certificates
of deposit in amounts of $100,000 or more as of March 31, 2000:
Maturities of Certificates of Deposit of $100,000 or More
Maturity Period Amount Percent
----------------------------------------- -------------- -------------
3 months or less $ 1,122 15.4%
Over 3 months to 6 months 1,124 15.5%
Over 6 months to 12 months 389 5.4%
Over 12 months 4,620 63.7%
-------------- -------------
Total $7,255 100.0%
============== =============
Short-Term Borrowings
The Heritage Bank occasionally finds it necessary to purchase funds on
a short-term basis due to fluctuations in loan and deposit levels. The Heritage
Bank has several arrangements under which it may purchase funds. For the periods
ended December 31, 1999 and 1998, the expense for federal funds purchased
totaled approximately $0 and $7,000, respectively. For the three month period
ended March 31, 2000, interest expense for these arrangements was $11,000.
Capital Requirements
The determination of capital adequacy depends upon a number of factors,
such as asset quality, liquidity, earnings, growth trends and economic
conditions. The Heritage Bank seeks to maintain a strong capital base to support
its growth and expansion plans, provide stability to current operations and
promote public confidence in The Heritage Bank.
Management believes that The Heritage Bank's capital position, as of
December 31, 1999, exceeds all regulatory minimums. The federal banking
regulators have defined three tests for assessing the capital strength and
adequacy of banks, based on two definitions of capital. "Tier 1 Capital" is
defined as a combination of common and qualifying preferred stockholders' equity
less goodwill. "Tier 2 Capital" is defined as qualifying subordinated debt and a
portion of the allowance for loan losses. "Total Capital" is defined as Tier 1
Capital plus Tier 2 Capital. Three risk-based capital ratios are computed using
the above capital definitions, total assets and risk-weighted assets and are
measured against regulatory minimums to ascertain adequacy. All assets and
off-balance sheet risk items are grouped into categories according to degree of
risk and assigned a risk weighing and the resulting total is risk-weighted
assets. "Tier 1 Risk-based Capital" is Tier 1 Capital divided by risk-weighted
assets. "Total Risk-based Capital" is Total Capital divided by risk-weighted
assets. The Leverage Ratio is Tier 1 Capital divided by total average assets.
See "Supervision and Regulation--Capital Requirements."
The following table shows The Heritage Bank's capital ratios and the
minimum ratios currently required by the Federal Reserve to be well-capitalized:
Capital Ratios
<TABLE>
<CAPTION>
March 31, December 31,
--------------------------- ---------------------------------------- Regulatory
2000 1999 1999 1998 1997 Minimum
------------- ------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Tier 1 Risk-based Capital 18.3% 24.9% 23.3% 24.5% 17.4% 4.0%
Total Risk-based Capital 19.1% 26.1% 24.4 25.7 18.6 8.0
Leverage ratio 14.8% 15.0% 14.7 17.2 11.0 4.0
</TABLE>
IV-33
<PAGE>
Liquidity And Capital Resources
Liquidity is a measure of The Heritage Bank's ability to generate
sufficient cash to meet present and future financial obligations in a timely
manner through either the sale or maturity of existing assets or the acquisition
of additional funds through liability management. These obligations include the
credit needs of customers, funding deposit withdrawals, and the day-to-day
operations of The Heritage Bank. Liquid assets include cash, interest-bearing
deposits with banks, federal funds sold, and certain investment securities. As a
result of The Heritage Bank's management of liquid assets and the ability to
generate liquidity through liability funding, management believes that The
Heritage Bank maintains overall liquidity sufficient to satisfy its depositors'
requirements and meet its customers' credit needs.
As of March 31, 2000, cash, federal funds sold, held-to-maturity
investment securities maturing within one year and available-for-sale securities
represented 47.90% of deposits and other liabilities compared to 52.05% at
December 31, 1999 and 61.23% at December 31, 1998. See "-- Interest
Sensitivity." At March 31, 2000, based upon The Heritage Bank's investment
policy, approximately 100% of total investment securities were available for
sale, and were primarily invested in U.S. Treasury and agency securities. See
"-- Investment Activities." Asset liquidity is also provided by managing loan
maturities. At March 31, 2000, approximately 45.7% or $16.5 million of loans
would mature or reprice within a one-year period.
The following table summarizes The Heritage Bank's liquid assets for
the periods indicated:
Summary of Liquid Assets
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
------------------------- ----------------------------------------
2000 1999 1999 1998 1997
----------- ----------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Cash and due from banks $ 2,990 $ 1,870 $ 2,667 $ 5,824 $ 1,987
Federal funds sold -- 6,000 -- 8,550 7,600
Available-for-sale securities, at fair value 23,764 22,757 24,055 19,824 11,794
----------- ----------- ----------- ------------ -------------
Total liquid assets $ 26,754 $ 30,627 $ 26,722 $ 34,198 $ 21,381
=========== =========== =========== ============ =============
Deposits and other liabilities $ 55,853 $ 52,019 $ 51,341 $ 55,848 $ 40,719
Ratio of liquid assets to deposits and other liabilities 47.90% 58.88% 52.05% 61.23% 52.51%
</TABLE>
Impact of Inflation, Changing Prices and Monetary Policies
The financial statements and related financial data concerning The
Heritage Bank presented in this document have been prepared in accordance with
generally accepted accounting principles, which require the measurement of
financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. The primary effect of inflation on the operations of The Heritage
Bank is reflected in increased operating costs. Unlike industrial companies,
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, changes in interest rates have a more
significant effect on the performance of a financial institution than do the
effects of changes in the general rate of inflation and changes in prices.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services. Interest rates are highly
sensitive to many factors which are beyond the control of The Heritage Bank,
including the influence of domestic and foreign economic conditions and the
IV-34
<PAGE>
monetary and fiscal policies of the U.S. government and federal agencies,
particularly the Federal Reserve.
The Federal Reserve implements national monetary policies such as
seeking to curb inflation and combat recession by its open market operations in
U.S. government securities, control of the discount rate applicable to borrowing
by banks, and establishment of reserve requirements against bank deposits. The
actions of the Federal Reserve in these areas influence the growth of bank
loans, investments and deposits, and affect the interest rates charged on loans
and paid on deposits. The nature, timing and impact of any future changes in
federal monetary and fiscal policies on The Heritage Bank and its results of
operations are not predictable.
Accounting Matters
In June 1998, the FASB issued Statement No. 133 "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 2000. The statement permits early adoption as
of the beginning of any fiscal quarter after its issuance. This statement
establishes accounting and reporting standards for derivative instruments and
hedging activities, including certain derivative instruments embedded in other
contracts, and requires that an entity recognize all derivatives as assets or
liabilities in the balance sheet and measure them at fair value. Because
Heritage does not use these derivative instruments and strategies, management
does not expect the adoption of this statement to have any effect on earnings or
financial position.
IV-35
<PAGE>
CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors
The Cardinal board of directors currently is comprised of ten members.
The board of directors is divided into three classes, two of which consists of
three members and one of which has four members. These directors serve, and will
continue to serve following the merger, for the terms of their respective
classes, which expire in 2000, 2001 and 2002.
The merger agreement requires that Cardinal increase the size of the
board to 13 members and appoint three current directors of Heritage to become
directors of Cardinal.
The following table sets forth the composition of the board of
directors following the merger.
<TABLE>
<CAPTION>
Class A Class B Class C
(Term Expiring in 2001) (Term Expiring in 2002) (Term Expiring in 2003)
<S> <C> <C>
Wayne W. Broadwater Nancy K. Falck Robert M. Barlow
Harvey W. Huntzinger L. Burwell Gunn, Jr. Anne B. Hazel
John H. Rust, Jr. Jones V. Isaac James D. Russo
Harold E. Lieding* J. Hamilton Lambert George P. Shafran*
Kevin B. Tighe*
</TABLE>
______________
* Heritage director
The following information sets forth as of May 24, 2000 the names,
ages, principal occupations and business experience for the past five years for
incumbent directors and the three Heritage directors who will become Cardinal
directors following the merger.
Directors Serving
for Terms Expiring in 2001
Wayne W. Broadwater, 76, has been a director of Cardinal since 1997.
Mr. Broadwater served as President and CEO of Shipmates, Ltd., a chain
of tool and equipment rental and sales companies that he founded in
1972, until its sale in 1997.
Harvey W. Huntzinger, 73, has been a director of Cardinal since 1997.
Mr. Huntzinger is a founder of National Systems Management Corporation,
a service company organized in 1972, and was its President and CEO
until his retirement in 1998.
John H. Rust, Jr., 52, has been Chairman of the Board of Cardinal since 1997.
Mr. Rust is an attorney with the law firm of Wilkes Artis in Fairfax,
Virginia. He had previously been of counsel in the law firm of
McCandlish and Lillard. Mr. Rust is a member of the Virginia House of
Delegates.
V-1
<PAGE>
Harold E. Lieding, 63, has been a director of The Heritage Bank since 1990 and a
director of Heritage since 1998.
Mr. Lieding is a senior partner in the law firm of Lieding and
Anderson, P.C., in McLean Virginia, and has practiced law in McLean
since 1970. He is a member of the Fairfax Bar Association and the
McLean Bar Association. Mr. Lieding is the Chairman of the Board of
Heritage and The Heritage Bank.
Directors Serving
for Terms Expiring in 2002
Nancy K. Falck, 70, has been a director of Cardinal since 1997.
Ms. Falck has been Secretary of Cardinal since 1998. She is active in
community affairs and is past President of the Board of Directors of
the Family Respite Center (a day program that helps people with
Alzheimer's disease) and is a Commissioner on the Fairfax Area Council
on Aging.
L. Burwell Gunn, Jr., 55, has been a director of Cardinal since 1997.
Mr. Gunn has been President and Chief Executive Officer of Cardinal and
President of Cardinal Bank, N.A., a subsidiary of Cardinal, since 1997.
Prior to 1997, he was Executive Vice President and Commercial Division
Head of the Greater Washington Region of Crestar Bank, where he worked
in various positions for 25 years.
Jones V. Isaac, 68, has been a director of Cardinal since 1997.
Mr. Isaac is President of Isaac Enterprises, Inc., a service oriented
firm located in Potomac, Maryland. Prior to 1995, Mr. Isaac was the
Administrator of Finance and Administration for the Construction
Specifications Institute, where he had been employed since 1967.
J. Hamilton Lambert, 59, has been a director of Cardinal since 1999.
Mr. Lambert is President of J. Hamilton Lambert and Associates, a
consulting firm based in Leesburg, Virginia. He served as County
Executive of Fairfax County from August 1980 to December 1990.
Kevin B. Tighe, 55, has been a director of The Heritage Bank since 1994 and a
director of Heritage since 1998.
Mr. Tighe is a senior partner in the law firm of Tighe, Patton,
Tabackman and Babbin in Washington, D.C. Mr. Tighe is also the owner
and Chairman of the Board of Directors of the McLean Racquet and Health
Club in McLean, Virginia.
Directors Serving
for Terms Expiring in 2003
Robert M. Barlow, 70, has been a director of Cardinal since 1997.
Mr. Barlow was the founder and principal shareholder of a group of
companies engaged in construction, manufacturing and real estate in
northern Virginia for 38 years. In 1995, he sold those ventures and is
now retired.
Anne B. Hazel, 60, has been a director of Cardinal since 1997.
Ms. Hazel serves as a Director of the Corcoran Museum of Art,
Washington, D.C., the Florida House, Washington, D.C., the Morikani
Museum and Japanese Gardens Foundation, Delray Beach, Florida and the
Concert Hall at Mizner Park, Boca Raton, Florida.
V-2
<PAGE>
James D. Russo, 53, has been a director of Cardinal since 1997.
Mr. Russo is the Senior Vice President, Chief Financial Officer and
Treasurer of Shire Laboratories, Inc., a pharmaceutical research and
development company in Rockville, Maryland.
George P. Shafran, 72, has been a director of The Heritage Bank and Heritage
since 1998.
Mr. Shafran is a business consultant to a number of varied clients. He
is also involved in several partnerships and is the chairman of the AAA
MidAtlantic Advisory Board. He is president of Geo. P. Shafran &
Associates, Inc., a consulting firm in McLean, Virginia. Mr. Shafran
serves as Vice Chairman of Heritage and has served as Vice Chairman of
the Board of Directors of The Heritage Bank since August 1998.
Executive Officers Who Are Not Directors
Edgar M. Andrews, III, 53, has been Executive Vice President of
Cardinal and head of Cardinal's Alexandria loan production office since 1998.
Most recently, Mr. Andrews was President and Chief Executive Officer of the
Civil War Trust, a 501(c)(3) non-profit organization that he helped organize in
1992. Prior to 1992, Mr. Andrews held several senior management positions with
financial institutions in Cardinal's market area.
Christopher W. Bergstrom, 40, has been President of Cardinal Bank -
Manassas/Prince William, N.A., a subsidiary of Cardinal, since 1999 and
Executive Vice President and Commercial Lending Officer of Cardinal since 1998.
Prior to 1998, Mr. Bergstrom was employed with Crestar Bank, where he served in
a variety of retail and commercial functions.
Joseph L. Borrelli, 52, has been Executive Vice President and Chief
Financial Officer of Cardinal since 1998. Prior to 1998, Mr. Borrelli served as
the Regional Finance Manager for the greater Washington Region for Crestar Bank.
Carl E. Dodson, 45, was Senior Vice President and Chief Credit Officer
of Cardinal from May 1998 until March 1999 and has served as Executive Vice
President since March 1999. From 1997 to 1998, Mr. Dodson was Chief Financial
Officer of C.C. Pace Resources, Inc., an engineering company in Fairfax,
Virginia. Prior to 1997, he was the senior commercial lending officer of Palmer
National Bank ("Palmer") in Washington, D.C. and, following Palmer's sale to
George Mason Bank ("George Mason") in 1996, Senior Vice President of Credit
Administration of George Mason.
Thomas C. Kane, 38, has been President of Cardinal Wealth Services,
Inc., a wholly-owned subsidiary of Cardinal that offers full service investment
management products, since December 1998. Prior to that time, Mr. Kane was
Senior Vice President and Division Manager, Retail Securities & Personal Trust &
Investment Management Sales for Crestar Bank in its Greater Washington Region.
F. Kevin Reynolds, 40, has been President of Cardinal Bank, N.A. since
1999 and Executive Vice President and Senior Lending Officer of Cardinal since
1998. Prior to 1998, Mr. Reynolds was the senior lending officer responsible for
all facets of the commercial lending business of George Mason and helped create
George Mason's commercial lending group.
Eleanor D. Schmidt, 39, has been Executive Vice President and Retail
Banking Head of Cardinal since March 1999. From January 1998 until March 1999
she was a Senior Vice President with the same responsibility. Prior to 1998, Ms.
Schmidt was employed with NationsBank, where she managed multiple branches in
the Fairfax area serving a large and diverse deposit and loan base.
V-3
<PAGE>
Greg D. Wheeless, 38, has been President of Cardinal Bank - Dulles,
N.A., a subsidiary of Cardinal, since 1999 and Executive Vice President of
Cardinal since 1998. Prior to 1998, Mr. Wheeless was employed with Crestar Bank,
which he joined in 1989 as Vice President, Commercial Lender, and where he
served most recently as Senior Vice President and Northern Virginia Middle
Market Manager.
Security Ownership of Management
The following table sets forth, based on information as of May 1, 2000,
the beneficial ownership of Cardinal common stock and the beneficial ownership
of Heritage common stock by each director of Cardinal and Heritage, by each
person named in the "Summary Compensation Table" on page V-6 and by all
directors and executive officers of each of Cardinal and Heritage as a group.
V-4
<PAGE>
<TABLE>
<CAPTION>
Cardinal Common Stock Heritage Common Stock
--------------------- ---------------------
Number Percent Number Percent
of Shares (1) of Class (%) of Shares (1) of Class (%)
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Cardinal:
Robert M. Barlow 100,900 2.4 -- --
Christopher W. Bergstrom 15,407 * -- --
Joseph L. Borrelli 12,674 * -- --
Wayne W. Broadwater 31,000 * -- --
Nancy K. Falck 63,336 1.5 -- --
L. Burwell Gunn 21,548 * -- --
Anne B. Hazel 17,334 * -- --
Harvey W. Huntzinger 90,500 2.1 -- --
Jones V. Isaac 47,400 1.1 -- --
J. Hamilton Lambert 13,000 * 4,000 *
Dale B. Peck 26,667 * -- --
F. Kevin Reynolds 16,080 * -- --
James D. Russo 63,600 1.5 -- --
John H. Rust, Jr. 40,158 * -- --
Greg D. Wheeless 991 * -- --
All current Cardinal directors
and executive officers as a
group (19 persons) 604,449 14.1 4,000 *
Heritage Directors:
George K. Degnon -- -- 27,100 1.2
Philip F. Herrick, Jr. -- -- 136,058 5.9
Ronald W. Kosh -- -- 10,900 *
Harold E. Lieding -- -- 368,993 16.0
Stanley I. Richards -- -- 18,102 *
Terrie G. Spiro -- -- 45,000 1.9
Kevin P. Tighe -- -- 11,000 *
George P. Shafran -- -- 50,269 2.1
All current Heritage directors
and executive officers as a
group (10 persons)
-- -- 679,422 22.9
</TABLE>
________________
* Percentage of ownership is less than one percent of the shares of
outstanding common stock of Cardinal or Heritage, respectively.
(1) Amounts include beneficial ownership of shares of common stock, if any,
held in the name of the spouse, minor children or other relatives of a
director living in such person's home, as well as shares, if any, held in
the name of another person under an arrangement whereby the director or
executive officer can vest title in himself at once or at some future time.
Amounts also include beneficial ownership of shares of common stock
issuable upon the exercise of stock options exercisable within 60 days of
May 1, 2000.
V-5
<PAGE>
Security Ownership of Certain Beneficial Owners
The following table sets forth, to the knowledge of Cardinal and
Heritage and based on information as of May 1, 2000, the beneficial ownership of
each person who owns more than five percent of the outstanding shares of
Heritage common stock. No person is known to be the beneficial owner of more
than five percent of the outstanding shares of Cardinal common stock.
<TABLE>
<CAPTION>
Cardinal Common Stock Heritage Common Stock
--------------------- ---------------------
Number Percent Number Percent
of Shares (1) of Class (%) of Shares (1) of Class (%)
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Philip F. Herrick, Jr. -- -- 136,058 5.9
c/o Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, Virginia 22101
Harold E. Lieding -- -- 368,993 16.0
c/o Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, Virginia 22101
</TABLE>
___________________
(1) Amounts include beneficial ownership of shares of common stock, if any,
held in the name of the spouse, minor children or other relatives of a
director living in such person's home, as well as shares, if any, held in
the name of another person under an arrangement whereby the director or
executive officer can vest title in himself at once or at some future time.
Amounts also include beneficial ownership of shares of common stock
issuable upon the exercise of stock options exercisable within 60 days of
May 1, 2000.
Executive Compensation
The following table shows, for the fiscal years ended December 31,
1999, 1998 and 1997, the cash compensation paid by Cardinal and its
subsidiaries, as well as certain other compensation paid or accrued for those
years, to each of the named executive officers in all capacities in which they
served:
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long Term Compensation
------------------- ----------------------
Securities
Name and Other Annual Underlying All Other
Principal Position Year Salary ($) Bonus ($) Compensation ($) Options (#)(1) Compensation ($)(2)
------------------ ---- ---------- --------- ---------------- -------------- -------------------
<S> <C> <C> <C> <C> <C>
L. Burwell Gunn, Jr. 1999 159,497 42,325 * 14,750 12,959
President and Chief 1998 150,000 50,000 * 1,250 5,247
Executive Officer 1997 27,174 25,000 * - 981
F. Kevin Reynolds 1999 104,587 26,000 * 3,131 3,685
President, Cardinal Bank, 1998(3) 98,640 30,000 * - 545
N.A.
V-6
<PAGE>
Annual Compensation Long Term Compensation
------------------- ----------------------
Securities
Name and Other Annual Underlying All Other
Principal Position Year Salary ($) Bonus ($) Compensation ($) Options (#)(1) Compensation ($)(2)
------------------ ---- ---------- --------- ---------------- -------------- -------------------
Christopher W. Bergstrom 1999 105,504 23,000 * 3,131 8,060
President, Cardinal Bank - 1998(4) 70,189 30,000 * - 3,405
Manassas/Prince William,
N.A.
Joseph L. Borrelli 1999 103,846 20,000 * 2,818 8,565
Executive Vice President 1998(5) 90,670 27,000 * - 3,544
and Chief Financial
Officer
Greg D. Wheeless, 1999 103,726 18,540 * 2,159 7,301
President, Cardinal Bank - 1998(6) 30,006 13,000 * - -
Dulles, N.A.
</TABLE>
_______________
* All benefits that might be considered of a personal nature did not exceed
the lesser of $50,000 or 10% of total annual salary and bonus.
(1) Amounts disclosed include 750 shares of Cardinal common stock for the year
ended December 31, 1999 and 1,250 shares of common stock for the year ended
December 31, 1998 that underlie options granted to Mr. Gunn in his capacity
as a director of Cardinal.
(2) Amounts presented represent (i) gross value of payments made by Cardinal
pursuant to life insurance agreements between Cardinal and the named
executive officers and (ii) total contributions to Cardinal's 401(k) plan
on behalf of each of the named executive officers to match pre-tax elective
deferral contributions (which are included under the "Salary" column) made
by each to such plan. The 1997 amount reflects COBRA payments to Mr. Gunn's
former employer to continue insurance benefits.
(3) Mr. Reynolds' employment with Cardinal commenced on January 19, 1998.
(4) Mr. Bergstrom's employment with Cardinal commenced on April 6, 1998.
(5) Mr. Borrelli's employment with Cardinal commenced on January 1, 1998.
(6) Mr. Wheeless' employment with Cardinal commenced on August 31, 1998.
Stock Options
The following table sets forth for the year ended December 31, 1999,
the grants of stock options to the named executive officers.
V-7
<PAGE>
Option Grants In Last Fiscal Year
<TABLE>
<CAPTION>
Percent of Total
Number of Options Granted
Securities Underlying to Employees in Exercise or Base
Name Options Granted (1) Fiscal Year (%)(2) Price ($/Share) (3) Expiration Date
---- ------------------- ------------------ ------------------- ---------------
<S> <C> <C> <C> <C>
L. Burwell Gunn, Jr. 14,750 11.5 7.50 January 1, 2009
F. Kevin Reynolds 3,131 2.4 6.38 January 1, 2009
Christopher W. Bergstrom 3,131 2.4 6.38 January 1, 2009
Joseph L. Borrelli 2,818 2.2 6.38 January 1, 2009
Greg D. Wheeless 2,159 1.7 6.38 January 1, 2009
</TABLE>
__________________
(1) Amounts disclosed include 750 shares of Cardinal common stock that underlie
options granted to Mr. Gunn in his capacity as a director of Cardinal.
(2) Options to purchase a total of 127,929 shares of Cardinal common stock were
granted to employees during the year ended December 31, 1999.
(3) Stock options were awarded at or above the fair market value of the shares
of Cardinal common stock at the date of award.
The following table sets forth the amount and value of stock options
held by the named executive officers as of December 31, 1999.
Fiscal Year End Option Values
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options at In-the-Money Options
Fiscal Year End at Fiscal Year End ($)(2)
--------------- -------------------------
Name Exercisable(1) Unexercisable Exercisable Unexercisable
---- -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
L. Burwell Gunn, Jr. 2,000 14,000 -- --
F. Kevin Reynolds -- 3,131 -- --
Christopher W. Bergstrom -- 3,131 -- --
Joseph L. Borrelli -- 2,818 -- --
Greg D. Wheeless -- 2,159 -- --
</TABLE>
_____________________
(1) Amounts disclosed represent shares of Cardinal common stock that underlie
options granted to Mr. Gunn in his capacity as a director of Cardinal.
(2) The value of in-the-money options at fiscal year end is calculated by
determining the difference between the closing price of a share of Cardinal
common stock as reported on The Nasdaq SmallCap Market on December 31, 1999
and the exercise price of the options. No options disclosed in the table
were in-the-money as of December 31, 1999.
V-8
<PAGE>
Directors' Fees
Directors of Cardinal do not receive any cash compensation. In lieu of
cash fees for service on the board of directors, each director of Cardinal is
granted annually options to purchase 2,000 shares of Cardinal common stock. Such
options are granted with an exercise price at or above the fair market value of
the Cardinal common stock and expire ten years from the date of grant.
Compensation and Other Employment Arrangements
On September 30, 1997, Mr. Gunn entered into an employment contract to
serve as President and Chief Executive Officer of Cardinal and to perform such
services and duties as each entity's board of directors may designate. Under the
contract, Mr. Gunn is entitled to an annual base salary of $150,000. Any
increases in base salary are at the discretion of the boards of directors. In
addition, Mr. Gunn earned a bonus in 1997 of $25,000 in connection with the
completion of various aspects of the organization of Cardinal and Cardinal Bank,
N.A., and may be entitled to up to an additional $50,000 in connection with the
first year of operations of Cardinal and Cardinal Bank, N.A. and up to $50,000
per year for future performance.
The contract is for a term of three years and may be extended for at
least two additional years. Mr. Gunn serves at the pleasure of Cardinal's board
of directors. If, during the term of the contract, Mr. Gunn's employment is
terminated without cause, Mr. Gunn will be entitled to a severance payment equal
to his annual base salary at that time. The contract also provides for certain
non-competition covenants for a period of one year following Mr. Gunn's
termination.
During each year under his three-year employment contract, Mr. Gunn
will be granted an option to purchase 14,000 shares of Cardinal common stock at
$7.50 per share, or such number of shares as may be determined by the board of
directors in its discretion. The grant of any option for any particular year,
however, shall be conditioned on Cardinal's financial performance exceeding
certain amounts budgeted for that year.
Each of F. Kevin Reynolds, Christopher W. Bergstrom, Joseph L. Borrelli
and Greg D. Wheeless have also entered into employment agreements with Cardinal.
Mr. Reynolds' agreement, which is dated as of February 12, 1999, provides for
his service as Executive Vice President of Cardinal and President and Chief
Executive Officer of Cardinal Bank, N.A. Mr. Bergstrom's agreement, which is
dated as of December 17, 1998, provides for his service as Executive Vice
President of Cardinal and President and Chief Executive Officer of Cardinal Bank
- Manassas/Prince William Bank, N.A. Mr. Borrelli's agreement, which is dated as
of February 17, 1999, provides for his service as Executive Vice President and
Chief Financial Officer of Cardinal. Mr. Wheeless' agreement, which is dated as
of August 31, 1998, provides for his service as Executive Vice President of
Cardinal and President and Chief Executive Officer of Cardinal Bank - Dulles,
N.A.
Each of the agreements for Messrs. Reynolds, Bergstrom, Borrelli and
Wheeless provide for annual base salaries of $100,000 and includes annual
increases at the discretion of the board of directors and cash bonuses up to 30%
of the salary based on the attainment of certain performance objectives by the
individual. The agreements also include stock option grants up to 20% of salary
based on the attainment of such objectives. Such grants are awarded with an
option exercise price equal to the fair market value of shares of Common Stock
at the date of grant, and the options vest and become exercisable in equal
installments over a three-year period from the date of grant. Each of these
agreements is for a term that expires in 2001 and may be renewed for an
additional two-year period.
V-9
<PAGE>
Transactions with Management
Some of the directors and officers of Cardinal are at present, as in
the past, customers of Cardinal and, Cardinal has had, and expects to have in
the future, banking transactions in the ordinary course of its business with
directors, officers, principal shareholders and their associates, on
substantially the same terms, including interest rates and collateral on loans,
as those prevailing at the same time for comparable transactions with others.
These transactions do not involve more than the normal risk of collectibility or
present other unfavorable features. The aggregate outstanding balance of loans
to directors, executive officers and their associates, as a group, at December
31, 1999 totaled approximately $2.9 million, or 9.4% of Cardinal's equity
capital at that date.
Any future transactions between Cardinal and its officers and
directors, as well as transactions with any person who acquires five percent or
more of Cardinal's voting stock will be on substantially the same terms,
including interest rates and security for loans, as those prevailing at the time
for comparable transactions with others.
There are no legal proceedings to which any director, officer,
principal shareholder or associate is a party that would be material and adverse
to Cardinal.
V-10
<PAGE>
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF CARDINAL CAPITAL STOCK
Cardinal is authorized to issue up to 50,000,000 shares of common stock
and 10,000,000 shares of preferred stock. The board of directors is authorized
to issue the preferred stock in one or more series and, subject to certain
restrictions imposed by state and federal law, to fix the number and designation
of shares, rate of dividends, redemption terms (including purchase and sinking
fund provisions), conversion rights, liquidation amounts, voting rights, and any
other lawful rights, preferences and limitations of each such series.
The Cardinal Preferred Stock
Cardinal has designated the shares of preferred stock to be issued in
the merger as the 7.25% Cumulative Convertible Preferred Stock, Series A.
Dividends
Dividends on the preferred stock accrue each calendar quarter at an
annual rate of $0.3625 per share. Dividends are cumulative and are payable
quarterly if, as and when declared by the board of directors from funds legally
available therefor on the last day of each calendar quarter, commencing on the
last day of the calendar quarter in which Cardinal and Heritage merge. For a
description of limits on the declaration and payment of dividends and of certain
tax effects of dividend payments by Cardinal, see "Market Prices and Dividends
-- Dividends" on page I-43.
Unless dividends accrued on all outstanding shares of each series of
preferred stock for all past dividend periods have been declared and paid, or
declared and a sum sufficient for the payment thereof set apart, and full
dividends (to the extent that the amount has become determinable) on all
outstanding shares of such stock due on the respective following payment dates
have been declared and a sum sufficient for payment set part, then:
o no dividend (other than a dividend payable solely in common stock) may be
declared or paid upon, or any sum set part for the payment of dividends on
any shares of common stock;
o no other distribution may be made upon any shares of common stock;
o no shares of common stock may be purchased, redeemed or otherwise acquired
for value by Cardinal or by any subsidiary; and
o no monies may be paid into or set part or made available for a sinking or
other like fund for the purchase, redemption or other acquisition for value
of any shares of common stock by Cardinal or any subsidiary.
VI-1
<PAGE>
Conversion to Common Stock
Each share of preferred stock is convertible, at the option of the
holder, at any time, into shares of Cardinal common stock. The number of shares
of common stock into which each share of preferred stock will be convertible
shall be equal to the number arrived at by dividing $5.00, without any payment
or adjustment for dividends accrued, by the conversion price per share of the
common stock. The conversion price shall initially be $_______ per share, which
means that each share of preferred stock initially will be convertible into
_____ shares of Cardinal common stock. If any fractional interest in a share of
Cardinal common stock would be deliverable upon conversion, the number of shares
of common stock deliverable will be rounded up to the nearest full share.
The conversion rate is subject to adjustment in certain events,
including the issuance of Cardinal capital stock as a stock dividend;
combinations and subdivisions of the common stock; the issuance after the date
hereof securities convertible into or exchangeable for common stock or warrants,
rights or options to acquire common stock (except pursuant to employee benefit
plans) at less than the then current market price of the common stock; certain
distributions of debt securities or assets (other than cash dividends) of
Cardinal; and certain reclassifications of the common stock. Upon conversion of
any preferred stock, a payment shall be made for all dividends declared and
unpaid on such shares up to the dividend date immediately preceding surrender of
the shares for conversion. No payment or adjustment will be made for any
dividends accrued but undeclared as of such date.
In case of any consolidation or merger to which Cardinal is a party but
not the surviving corporation, or in case of any sale or conveyance to another
corporation of the property of Cardinal as an entirety or substantially as an
entirety, each holder of shares of preferred stock will thereafter have the
right to convert the shares into (and any successor corporation shall expressly
assume the obligation to deliver) the kind and amount of shares of stock and
other securities and property receivable upon such consolidation, merger, sale
or conveyance by a holder of the number of shares of common stock into which the
preferred stock was convertible immediately prior to such consolidation, merger,
sale or conveyance.
The election to convert shares of preferred stock into common stock can
be made by delivering written notice of election to convert to Cardinal's
transfer agent, accompanied by the certificates for any preferred stock being
converted.
If, for 20 consecutive trading days beginning on or after the end of
the 42nd calendar month following the effective date of the merger of Cardinal
and Heritage, the last sale price of Cardinal common stock as reported by NASDAQ
or its successor exceeds 1.30 times the conversion price, each share of
preferred stock will automatically convert into Cardinal common stock.
Liquidation Preference
In the event of an involuntary liquidation, dissolution or winding-up
of Cardinal, the holders of the preferred stock will be entitled to receive,
before any distribution or payment is made upon any shares of stock of Cardinal
ranking junior to the preferred stock, $5.00 per share in cash, together with an
amount in cash equal to all accrued and unpaid dividends thereon on the date of
distribution or payment. In the event of a voluntary liquidation, dissolution or
winding-up of the affairs of Cardinal, the holders of the preferred stock will
be entitled, before any distribution or payment upon any shares of common stock
of Cardinal, to a liquidation preference equal to the then applicable redemption
price per share as described below plus accrued dividends to the date of
distribution. If, upon any liquidation, dissolution or winding-up, the assets of
Cardinal distributable among the holders of the preferred stock in respect of
the
VI-2
<PAGE>
liquidation, are insufficient to permit payment in full to such holders of the
amounts to which they are respectively entitled, the assets will then be
distributed among such holders on a pro rata basis.
A voluntary sale, lease, exchange or transfer of all or any part of
Cardinal property or assets, the consolidation or merger of Cardinal into or
with one or more corporations, or a redemption of Cardinal capital stock shall
not be deemed a liquidation, dissolution or winding-up of Cardinal.
Redemption
Cardinal generally may not redeem the preferred stock for a period of
20 years from the date of issue. However, if a merger is approved by holders of
Cardinal common stock and disapproved by holders of the preferred stock,
Cardinal may redeem the preferred stock at any time after the vote is taken. If
the redemption is less than 42 months from the date of the merger, Cardinal must
also pay the amount of dividends that would accrue from the redemption date to
the end of the 42nd month after the merger closes.
If less than all of the outstanding shares of preferred stock are to be
redeemed, Cardinal will select those to be redeemed pro rata, by lot or in such
other equitable manner as the board of directors may determine. There is no
mandatory redemption or sinking fund obligation with respect to the preferred
stock.
Notice of redemption will be mailed at least 30 days but not more than
60 days before the redemption date to each holder of record of preferred stock
to be redeemed at the address shown on Cardinal books. On and after the earlier
of the date that the redemption price is paid or the date that such price is
deposited in trust for the benefit of the holders of the shares to be redeemed,
all rights of the holders of such preferred stock shall terminate except the
right to convert or to receive the redemption price. The right of conversion
with respect to such shares shall cease and terminate at the close of business
five days prior to the date fixed for such redemption.
Voting Rights
Except as expressly provided by applicable law, the holders of the
preferred stock are not entitled to receive notice of, or to participate in, or
to vote on any matter at any meeting of the Cardinal shareholders.
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The Common Stock
Holders of Cardinal common stock are entitled to one vote for each
share held of record on all matters voted on by shareholders. The shares of
common stock do not have cumulative voting rights, which means that the holders
of more than 50% of the shares of common stock voting for the election of
directors can elect all of the directors, in which event the holders of the
remaining shares of common stock will not be able to elect any director. Subject
to the prior rights of the holders of preferred stock and any class or series of
stock of Cardinal ranking on a parity with the preferred stock in respect of
payment of dividends, holders of common stock are entitled to receive dividends
when, as and if declared by the board of directors out of funds legally
available for the payment of dividends. Upon any liquidation, dissolution or
winding-up of the affairs of Cardinal, holders of common stock are entitled to
receive pro rata all of the assets of Cardinal available for distribution to
shareholders after payment of the liquidation preference of any preferred stock
and any class or series of stock of Cardinal ranking on a parity with the
preferred stock in respect of liquidation outstanding at the time. Holders of
common stock have no subscription, redemption, sinking fund, conversion or
preemptive rights. The outstanding shares of common stock are fully paid and
nonassessable.
COMPARATIVE RIGHTS OF SHAREHOLDERS
General
Cardinal and Heritage are corporations subject to the provisions of the
Virginia Stock Corporation Act. Rights as a shareholder of Heritage are governed
by the Heritage articles of incorporation and bylaws and by the Virginia Stock
Corporation Act. Upon consummation of the merger, Heritage shareholders will
become shareholders of Cardinal, and as such shareholder rights will then be
governed by the articles of incorporation of Cardinal, the Cardinal bylaws and
by the Virginia Stock Corporation Act.
The following is a summary of the material differences in the rights of
shareholders of Heritage and Cardinal. This summary is qualified in its entirety
by reference to the articles of incorporation and bylaws of Cardinal and
Heritage and to the Virginia Stock Corporation Act.
Authorized Capital
Heritage. The Heritage Articles authorize the issuance of up to
10,000,000 shares of Heritage common stock, without par value, of which
2,294,617 shares were issued and outstanding as of May 24, 2000. Heritage is not
authorized to issue preferred stock.
Cardinal. The Cardinal Articles authorize the issuance of up to
50,000,000 shares of Cardinal common stock, par value $1.00 per share, of which
4,245,759 shares were issued and outstanding as of May 1, 2000, and 10,000,000
shares of preferred stock, $1.00 par value, of which no shares are issued and
outstanding.
Cardinal's Articles authorize the Cardinal board, without shareholder
approval, to fix the preferences and relative rights of the preferred stock,
within certain limitations, and to establish series of such preferred stock and
determine the variations, such as in dividends, voting rights, redemption price
and conditions, and conversion features, between each series. Although series
may have different features, all series shall rank on a parity as to dividends
and assets with all other series according to the respective dividend rates and
amounts distributable upon any voluntary or involuntary liquidation of the
corporation fixed for each such series and without preference or priority of any
series over any other series. All shares of preferred stock within a series
shall be identical, and all shares of preferred stock
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shall be preferred over common stock as to both dividends and amounts
distributable upon any voluntary or involuntary liquidation of the corporation.
If any additional shares of preferred stock are issued, the rights of holders of
Cardinal common stock would be subject to the rights and preferences conferred
to holders of such preferred stock.
The authority to create and issue separate classes and series of
preferred stock allows a corporation greater flexibility in structuring
financings and acquisitions. While such issuances could, under certain
circumstances, be considered to have the effect of making a change in control
more difficult, any issuance of such stock would be subject to applicable law,
including, without limitation, the duty of the Cardinal board to exercise its
good faith business judgment in the best interests of Cardinal and its
shareholders. Under Cardinal's Articles, the Cardinal board would be authorized
to issue a series of preferred stock with more than one vote, less than one
vote, no vote or one vote per share.
Cardinal's ability to pay dividends is limited by restrictions imposed
by the Virginia Stock Corporation Act on Virginia corporations. In general,
dividends paid by a Virginia corporation may be paid only if, after giving
effect to the distribution, (i) the corporation is still able to pay its debts
as they become due in the usual course of business, or (ii) the corporation's
total assets are greater than or equal to the sum of its total liabilities plus
(unless the corporation's articles permit otherwise) the amount that would be
needed, if the corporation were to be dissolved at the time of the distribution,
to satisfy the preferential rights, upon the dissolution, of shareholders whose
preferential rights are superior to those receiving the distribution.
Dividends on the Cardinal preferred stock are cumulative, which means
that no dividends may be declared or paid on the common stock unless all
dividends accrued on the preferred stock have been paid, or declared and a sum
sufficient for the payment thereof set apart for such payment.
Amendment of Articles of Incorporation or Bylaws
The Virginia Stock Corporation Act provides that an amendment to a
corporation's articles of incorporation must be approved by each voting group
entitled to vote on the proposed amendment. Under Virginia law, an amendment to
the corporation's articles of incorporation must be approved by more than
two-thirds of all votes entitled to be cast by that voting group. However, the
corporation's articles of incorporation may require a greater vote or a lesser
vote, which may not be not less than a majority, by each voting group entitled
to vote on the transaction. A corporation's board of directors may require a
greater vote.
Heritage. The Heritage Articles provide that amendments to the Heritage
Articles must be approved by two-thirds of all votes entitled to be cast by each
voting class; however, the Heritage Articles further provide that the Heritage
board, at its sole discretion, may decrease the required vote to not less than a
majority of all the votes cast by each voting class.
The Heritage Bylaws provide that the Heritage Bylaws may be amended,
repealed or altered by a majority vote of the full board of directors at any
regular or special meeting. The Heritage Bylaws also permit the shareholders to
change, repeal or prescribe new bylaws and to prescribe that any bylaws made by
them shall not be altered or repealed by the board.
Cardinal. As noted above, amendments to the articles of incorporation
of Virginia corporations, such as Cardinal, can be submitted to the shareholders
for a vote only by the board of directors. Additionally, Virginia law provides,
as a general rule, that an amendment to the articles of incorporation must be
approved by each voting group entitled to vote on the proposed amendment by more
than two-thirds of all votes entitled to be cast by such voting group. However,
Virginia law also permits the
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articles of incorporation to provide for a greater or lesser vote. Cardinal's
Articles contain such a provision. Cardinal's Articles provide that amendments
must be approved by a majority of the votes entitled to be cast by each voting
group entitled to vote and, unless such action is approved by at least
two-thirds of the directors, by holders of at least two-thirds of the issued and
outstanding shares of Cardinal common stock.
Cardinal's Bylaws generally may be amended by either the board of
directors or the shareholders by a majority vote.
Mergers, Consolidations and Sales of Assets
Heritage. The Heritage Articles provide that a merger, share exchange,
or direct or indirect sale, lease, exchange or other disposition of all or
substantially all of the property of Heritage must be approved by two-thirds of
the issued and outstanding shares of each voting class. However, the Heritage
Articles further provide that the Heritage board, at its sole discretion, may
decrease the required vote to not less than a majority of all the votes cast by
each voting class.
Cardinal. Cardinal's Articles provide that a plan of merger or share
exchange, or direct or indirect sale, lease, exchange or other disposition of
all or substantially all of the property of Cardinal not in the ordinary course
of business may be approved by the same vote that is required in order to amend
the articles of incorporation. Additionally, consistent with Virginia law, the
Cardinal board may condition its submission of such plan of merger or share
exchange or such a sale or disposition of assets to the shareholders on any
basis, including the requirement of a greater vote than the required vote
described above.
A proposed merger, share exchange or sale of substantially all assets
of Cardinal that is favored by two-thirds of the directors could be adopted as
long as a majority (rather than two-thirds) of the outstanding shares entitled
to vote in each voting group entitled to vote are voted in favor of the proposed
action. In addition to requiring the affirmative vote of a majority of the
shares entitled to vote in each voting group entitled to vote, Cardinal's
Articles would require that, unless a proposed action is approved by at least
two-thirds of the directors, holders of at least two-thirds of the issued and
outstanding shares of Cardinal common stock must vote in favor of the proposed
action.
As with amendments to the articles of incorporation, however, if at
least two-thirds of the directors of Cardinal do not approve such corporate
action upon which shareholders are voting, the additional requirement would
permit a minority of the holders of Cardinal common stock to defeat the proposed
action.
Size and Classification of Board of Directors
Heritage. The Heritage Articles provide that the initial number of
directors is nine, and the Heritage Bylaws provide that the board of directors
will not consist of less than five or more than nine individuals. The Heritage
Articles provide for the division of the directors into three classes, as nearly
equal in number as possible. The first Class A directors' initial terms expire
at the first annual meeting of shareholder after their election. The first Class
B directors' terms expire at the second annual meeting of shareholders after
their election. The first Class C directors' initial terms expire at the third
annual meeting of shareholders after their election. Upon expiration of the
initial terms, successor directors are elected for three-year terms and continue
to hold office until their respective successors are elected and qualify, unless
the director dies, resigns, retires, becomes disqualified, is removed from
office, or leaves due to another cause. At least three directors must be elected
at each annual meeting.
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The Heritage Articles further provide that in the event of an increase
or decrease in the number of directors within the range permitted by the
Heritage Bylaws, all classes of directors shall be increased or decreased as
equally as may be practicable. No decrease in the number of directors
constituting the Heritage board shall shorten the term of any incumbent
director.
Cardinal. Cardinal's Articles and Bylaws contain similar provisions to
that of Heritage, except that its board of directors shall consist of nine
individuals.
A classified board of directors makes it more difficult for
shareholders, including those holding a majority of shares, to force an
immediate change in the composition of a majority of the board of directors,
even when the reason for a proposed removal is poor performance. Since the terms
of only approximately one-third of Cardinal's directors expire each year, it
requires at least two annual elections for the shareholders to change a
majority, whereas a majority of a non-classified board may be changed in one
year.
Vacancies and Removal of Directors
Heritage. The Heritage Articles provide that directors may be removed
only for good cause shown. Under the Heritage Bylaws, a vacancy on the board of
directors, however occurring, may be filled by a majority vote of the remaining
directors, although the remaining directors may be less than a quorum.
Cardinal. The Cardinal Articles contain similar provisions to that of
Heritage with respect to the filling of vacancies on the board of directors.
Cardinal's Articles allow removal of a director from office only for cause, and
only by the affirmative vote of at least two-thirds of the votes cast by each
class of Cardinal voting stock then outstanding at a meeting called for that
purpose. Such a meeting could be the annual shareholder meeting or a special
shareholder meeting, although only the president, the chairman of the board, or
the board itself has a right to call a special shareholder meeting.
The provisions of Cardinal's Articles relating to the removal of
directors and the filling of vacancies would preclude a holder of a majority of
the voting stock from removing incumbent directors and simultaneously gaining
control of the board of directors by filling the vacancies so created with its
own nominees. Accordingly, except with the concurrence of a majority of the
directors remaining in office, persons seeking representation either by
enlarging the board of directors or by filling the newly created directorships
with their own nominees would be unsuccessful.
Director Liability and Indemnification
The Virginia Stock Corporation Act provides that in any proceeding
brought by or in the right of a corporation or brought by or on behalf of
shareholders of the corporation, the damages assessed against an officer or
director arising out of a single transaction, occurrence or course of conduct
may not exceed the lesser of (1) the monetary amount, including the elimination
of liability, specified in the articles of incorporation or, if approved by the
shareholders, in the bylaws as a limitation on or elimination of the liability
of the officer or director; or (2) the greater of (a) $100,000 or (b) the amount
of cash compensation received by the officer or director from the corporation
during the twelve months immediately preceding the act or omission for which
liability was imposed. The liability of an officer or director is not limited
under the Virginia Stock Corporation Act or a corporation's articles of
incorporation and bylaws if the officer or director engaged in willful
misconduct or a knowing violation of the criminal law or of any federal or state
securities law.
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In addition, the Virginia Stock Corporation Act permits a Virginia
corporation to indemnify any director or officer for reasonable expenses
incurred in any legal proceeding in advance of final disposition of the
proceeding, if the director or officer furnishes the corporation a written
statement of his or her good faith belief that he or she has conducted himself
or herself in good faith and that he or she believed that his or her conduct was
in the best interests of the corporation, and a determination is made by the
board of directors that such standard has been met. In a proceeding by or in the
right of the corporation, no indemnification shall be made in respect of any
matter as to which an officer or director is adjudged to be liable to the
corporation, unless the court in which the proceeding took place determines
that, despite such liability, such person is reasonably entitled to
indemnification in view of all the relevant circumstances. In any other
proceeding, no indemnification shall be made if the director or officer is
adjudged liable to the corporation on the basis that personal benefit was
improperly received by him or her. Corporations are given the power to make any
other or further indemnity, including advancement of expenses, to any director
or officer that may be authorized by the articles of incorporation or any bylaw
made by the shareholders, or by any resolution adopted, before or after the
event, by the shareholders, except an indemnity against willful misconduct or a
knowing violation of the criminal law. Unless limited by its articles of
incorporation, indemnification of a director or officer is mandatory when he or
she entirely prevails in the defense of any proceeding to which he or she is a
party because he or she is or was a director or officer.
Heritage. The Heritage Articles provide that, to the fullest extent
that Virginia permits the limitation or elimination of liability of directors or
officers, a director or officer shall not be liable to Heritage or its
shareholders for monetary damages. To the fullest extent permitted by Virginia
law, the Heritage Bylaws require Heritage to indemnify any director or officer
of Heritage who is made a party to any proceeding against any liability incurred
in the proceeding, because he or she was or is a director or officer of Heritage
or because he or she served at the request of Heritage as a director, trustee,
partner or officer of another corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise. Under the Heritage Bylaws,
"proceeding" is broadly defined to include pending, threatened or completed
actions of all types, and includes actions by or in the right of Heritage.
Similarly, "liability" is defined to include, not only judgments, but also
settlements, penalties, fines, and certain excise taxes. The Heritage Bylaws
also provide that the Heritage board may, upon majority vote of a quorum, but is
not obligated to, indemnify its other employees or agents and any person by
reason of the fact that he or she was serving at the request of Heritage as an
employee or agent of another corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise. The indemnification provisions of the
Heritage Bylaws also permit Heritage to pay reasonable expenses, including
counsel fees, incurred by a director or officer of Heritage in a proceeding in
advance of the final disposition of any such proceeding, provided that the
indemnified person (i) provides Heritage with a written statement of his or her
good faith belief that he or she met the statutory standard of conduct and (ii)
undertakes to repay Heritage if it is ultimately determined that such person was
not entitled to indemnification. Determination of eligibility for
indemnification and of meeting the requisite standard of conduct shall be made
by the Heritage board of directors by a majority vote of a disinterested quorum,
or by the majority vote of disinterested shareholders, or by special legal
counsel appointed by the board of directors. At this time, Virginia law does not
permit indemnification against willful misconduct or a knowing violation of the
criminal law.
Cardinal. Cardinal's Articles provide that, to the full extent that
Virginia permits the limitation or elimination of liability of directors or
officers, a director of officer shall not be liable to Cardinal or its
shareholders for monetary damages. Cardinal's Articles permit, but do not
require, it to indemnify, to the fullest extent permitted by Virginia law, any
person who is made a party to any proceeding because he or she was or is a
director, officer, employee or agent of Cardinal against any liability,
including reasonable expenses and legal fees, incurred in the proceeding. Under
Cardinal's articles of incorporation, "proceeding" is broadly defined to include
pending, threatened or completed actions of all types. Cardinal shall be
required to indemnify a person in connection with a proceeding initiated by such
person
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only if the proceeding was authorized by the Cardinal board. "Liability" is
defined to include, not only judgments, but also settlements, penalties, fines
and certain excise taxes. Cardinal may also indemnify any person who is or was
serving at the written request of Cardinal as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust, enterprise or
nonprofit entity, including service with respect to employee benefit plans, to
the full extent provided by Virginia law. The indemnification so provided by
Cardinal will be reduced by the amount of indemnification received from the
other entity.
The indemnification provisions also require Cardinal to pay reasonable
expenses incurred by a director or officer of Cardinal in a proceeding in
advance of the final disposition of any such proceeding, provided that the
indemnified person undertakes to repay Cardinal if it is ultimately determined
that such person was not entitled to indemnification. At this time, Virginia law
does not permit indemnification against willful misconduct or a knowing
violation of the criminal law. If a claim for indemnification or payment of
expenses is not paid within 60 days after the claim is received by Cardinal, the
claimant may bring suit to recover the unpaid claim. The indemnification
provided under the Cardinal Articles also applies to a director, officer,
employee or agent of a constituent corporation acquired through a consolidation
or merger.
The rights of indemnification provided in Cardinal's Articles are not
exclusive of any other rights which may be available under any insurance or
other agreement, by vote of shareholders or disinterested directors or
otherwise. In addition, the Cardinal Articles authorize Cardinal to maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of Cardinal, whether or not Cardinal would have the power to provide
indemnification to such person. The rights of indemnification provided to
directors of Cardinal could reduce the likelihood of shareholder derivative
actions and may discourage other third party claims against the directors, even
if such actions otherwise would be beneficial to shareholders of Cardinal.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling
Cardinal pursuant to the foregoing provisions, Cardinal has been informed that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is
therefore unenforceable.
Special Meetings of Shareholders
Heritage. The Heritage Bylaws provide that special meetings of
shareholders may be held on the call of the chairman of the board, the president
or a majority of the board, which means that the shareholders of Heritage do not
have the right to call special meetings.
Cardinal. Cardinal's Bylaws provide that special meetings of
shareholders may be held whenever called by the president, chairman of the board
of directors or by the board of directors, itself, which means that the
shareholders of Cardinal do not have the right to call special meetings. The
inability of shareholders to call a special meeting could affect changes in
control of Cardinal by delaying the presentation to shareholders of proposals
relating to, or facilitating, such a change in control until the annual meeting.
Shareholder Nominations and Proposals
Heritage. Under the Heritage Bylaws, notice of a director nomination or
a proposal from a shareholder must be received by Heritage not less than 60 nor
more than 90 days prior to the scheduled annual meeting of shareholders,
provided in each case that if fewer than 70 days' notice of the meeting or
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prior public disclosure of the date of the meeting is given to shareholders,
such notice from the shareholder shall be received not later than the close of
the 10th day following the earlier of the day on which notice of the meeting was
mailed to shareholders or public disclosure of the date of the meeting was
given.
The Heritage Bylaws require that the shareholder's notice of nomination
set forth as to each nominee (i) the name, age, business address and residence
address of such nominee, (ii) the principal occupation or employment of such
nominee, (iii) the class and number of shares of Heritage common stock which are
owned of record and beneficially by such nominee, and (iv) any other information
relating to such nominee that is required under federal securities laws to be
disclosed in solicitations of proxies for the election of directors, or is
otherwise required (including, without limitation, such nominee's written
consent to being named in a proxy statement as nominee and to serving as a
director if elected). The Heritage Bylaws further require that the shareholder's
notice set forth as to the shareholder giving the notice (i) the name and
address of such shareholder and of any other Heritage shareholder known to
support such nominee, and (ii) the class and amount of record and beneficial
ownership of Heritage capital stock by the nominating shareholder and the
supporting shareholder.
The Heritage Bylaws require that the notice relating to a shareholder
proposal contain (i) a brief description of the shareholder proposal and the
reason for conducting such business at the annual meeting, (ii) the name and
record address of the shareholder proposing such business and of any other
shareholder who is known to support such proposal, and (iii) the class and
number of shares of Heritage which are beneficially owned by the shareholder
making the proposal and by the other supporting shareholder(s), and (iv) any
material interest (financial or otherwise) of such shareholder in the proposal.
If the information supplied by a shareholder is deficient in any
material aspect or if the foregoing procedure is not followed, the chairman of
the annual meeting may announce to the meeting that such shareholder's
nomination or proposal should not be brought before the annual meeting and that
such nominee shall not be eligible for election as a director of Heritage of
such business is not properly brought before the meeting.
Cardinal. Under Cardinal's Bylaws, notice of a proposed nomination or a
shareholder proposal meeting certain specified requirements must be received by
Cardinal not less than 60 nor more than 90 days prior to any meeting of
shareholders called for the election of directors, provided in each case that if
fewer than 70 days' notice of the meeting is given to shareholders, such written
notice shall be received not later than the close of the 10th day following the
earlier of the day on which notice of the meeting was mailed to shareholders or
public disclosure of the date of the meeting was given.
Cardinal's Bylaws require that the shareholder's notice of nomination
set forth as to each nominee (i) the name, age, business address and residence
address of such nominee, (ii) the principal occupation or employment of such
nominee, (iii) the class and number of shares of Cardinal which are beneficially
owned by such nominee, and (iv) any other information relating to such nominee
that is required under federal securities laws to be disclosed in solicitations
of proxies for the election of directors, or is otherwise required (including,
without limitation, such nominee's written consent to being named in a proxy
statement as nominee and to serving as a director if elected). Cardinal's Bylaws
further require that the shareholder's notice set forth as to the shareholder
giving the notice (i) the name and address of such shareholder and of any other
shareholder known to support such nominee, and (ii) the class and amount of
record and beneficial ownership of Cardinal capital stock by the nominating
shareholder and the supporting shareholder(s).
Cardinal's Bylaws require that the notice relating to a shareholder
proposal contain (i) a brief description of the shareholder proposal and the
reason for conducting such business at the annual meeting,
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(ii) the name and record address of the shareholder proposing such business and
of any other shareholder who is known to support such proposal, and (iii) the
class and number of shares of Cardinal which are beneficially owned by the
shareholder making the proposal and by the other supporting shareholder(s), and
(iv) any material interest (financial or otherwise) of such shareholder in the
proposal.
If the information supplied by a shareholder is deficient in any
material aspect or if the foregoing procedure is not followed, the chairman of
the annual meeting may announce to the meeting that such shareholder's
nomination or purpose should not be brought before the annual meeting and that
such nominee shall not be eligible for election as a director of Cardinal or
such business is not properly brought before the meeting.
Shareholder Voting Rights in General
The Virginia Stock Corporation Act generally provides that shareholders
do not have cumulative voting rights unless those rights are provided in the
corporation's articles of incorporation. The Virginia Stock Corporation Act also
specifies additional voting requirements for Affiliated Transactions which are
discussed below under "State Anti-Takeover Statutes."
Heritage. The Heritage Articles do provide shareholders cumulative
voting rights for the election of directors, provided that the shareholder gives
notice of his or her intent to cumulate votes to the secretary of Heritage 60
days before the date established in the Heritage Bylaws for the annual meeting
or no later than 10 days following the mailing of the notice of a special
meeting.
The Heritage Articles eliminate the pre-emptive right of shareholders
to subscribe for and purchase unissued shares of Heritage common stock.
Cardinal. Cardinal's Articles do not provide shareholders cumulative
rights for the election of directors. Therefore, the holders of a majority of
the shares voted in the election of directors can elect all of the directors
then standing for election. The holders of Cardinal common stock are entitled to
one vote per share on all matters submitted to a vote of shareholders. Except to
the extent to which the board of directors shall have specified voting power
with respect to any other class of stock and except as otherwise provided by
law, the exclusive voting power shall be vested in the holders of Cardinal
common stock.
The Cardinal Articles eliminate the pre-emptive right of shareholders
to subscribe for and purchase any shares of any class of Cardinal stock or other
securities, or any other options, warrants, or rights to purchase.
State Anti-Takeover Statutes
The Virginia Stock Corporation Act restricts transactions between a
corporation and its affiliates and potential acquirors. The summary below is
necessarily general and is not intended to be a complete description of all the
features and consequences of those provisions, and is qualified in its entirety
by reference to the statutory provisions contained in the Virginia Stock
Corporation Act. Because both Heritage and Cardinal are Virginia corporations,
the provisions of the Virginia Stock Corporation Act described below apply to
Heritage and Cardinal and will continue to apply to Cardinal after the merger.
Affiliated Transactions. The Virginia Stock Corporation Act contains
provisions governing "Affiliated Transactions," found at Sections 13.1-725 -
727.1 of the Virginia Stock Corporation Act. Affiliated Transactions include
certain mergers and share exchanges, certain material dispositions of corporate
assets not in the ordinary course of business, any dissolution of a corporation
proposed by or on
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behalf of an interested shareholder, as defined below, and reclassifications,
including reverse stock splits, recapitalizations or mergers of a corporation
with its subsidiaries, or distributions or other transactions which have the
effect of increasing the percentage of voting shares beneficially owned by an
interested shareholder by more than five percent. For purposes of the Virginia
Stock Corporation Act, an interested shareholder is defined as any beneficial
owner of more than 10% of any class of the voting securities of a Virginia
corporation.
Subject to certain exceptions discussed below, the provisions governing
affiliated transactions require that, for three years following the date upon
which any shareholder becomes an interested shareholder, any affiliated
transaction must be approved by the affirmative vote of holders of two-thirds of
the outstanding shares of the corporation entitled to vote, other than the
shares beneficially owned by the interested shareholder, and by a majority (but
not less than two) of the disinterested directors, as defined below. A
disinterested director is defined in the Virginia Stock Corporation Act as a
member of a corporation's board of directors who (i) was a member before the
later of January 1, 1988 or the date on which an interested shareholder became
an interested shareholder and (ii) was recommended for election by, or was
elected to fill a vacancy and received the affirmative vote of, a majority of
the disinterested directors then on the corporation's board of directors. At the
expiration of the three year period after a shareholder becomes an interested
shareholder, these provisions require approval of the affiliated transaction by
the affirmative vote of the holders of two-thirds of the outstanding shares of
the corporation entitled to vote, other than those beneficially owned by the
interested shareholder.
The principal exceptions to the special voting requirement apply to
affiliated transactions occurring after the three year period has expired and
require either that the transaction be approved by a majority of the
corporation's disinterested directors or that the transaction satisfy certain
fair price requirements of the statute. In general, the fair price requirements
provide that the shareholders must receive the higher of: the highest per share
price for their shares as was paid by the interested shareholder for his, her or
its shares, or the fair market value of the shares. The fair price requirements
also require that, during the three years preceding the announcement of the
proposed affiliated transaction, all required dividends have been paid and no
special financial accommodations have been accorded the interested shareholder,
unless approved by a majority of the disinterested directors.
None of the foregoing limitations and special voting requirements
applies to a transaction with an interested shareholder who has been an
interested shareholder continuously since the effective date of the statute
(January 26, 1988) or who became an interested shareholder by gift or
inheritance from such a person or whose acquisition of shares making such person
an interested shareholder was approved by a majority of the disinterested
directors of the corporation.
These provisions were designed to deter certain takeovers of Virginia
corporations. In addition, the Virginia Stock Corporation Act provides that by
affirmative vote of a majority of the voting shares other than shares owned by
any interested shareholder, a corporation may adopt by meeting certain voting
requirements, an amendment to its articles of incorporation or bylaws providing
that the affiliated transactions provisions shall not apply to the corporation.
Neither Heritage nor Cardinal has adopted such an amendment. Currently, no
shareholder of Cardinal owns or controls 10% or more of Cardinal common stock,
and there are no interested shareholders of Cardinal as defined by the Virginia
Stock Corporation Act.
Control Share Acquisitions. The Virginia Control Share Acquisitions
statute, found at Sections 13.1-728.1 - 728.8 of the Virginia Stock Corporation
Act, also is designed to afford shareholders of a public company incorporated in
Virginia protection against certain types of non-negotiated acquisitions in
which a person, entity or group seeks to gain voting control of that
corporation. With certain enumerated exceptions, the statute applies to
acquisitions of shares of a corporation which would result in an
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acquiring person's ownership of the corporation's shares entitled to vote in the
election of directors falling within any one of the following ranges: 20% to
33-1/3%, 33-1/3% to 50% or 50% or more. Shares that are the subject of a control
share acquisition will not be entitled to voting rights unless the holders of a
majority of the disinterested shares vote at an annual or special meeting of
shareholders of the corporation to accord the control shares with voting rights.
Disinterested shares do not include shares owned by the acquiring person or by
officers and inside directors of the target company. Under certain
circumstances, the statute permits an acquiring person to call a special
shareholders' meeting for the purpose of considering granting voting rights to
the holders of the control shares. As a condition to having this matter
considered at either an annual or special meeting, the acquiring person must
provide shareholders with detailed disclosures about his or her identity, the
method and financing of the control share acquisition and any plans to engage in
certain transactions with, or to make fundamental changes to, the corporation,
its management or business. Under certain circumstances, the statute grants
dissenters' rights to shareholders who vote against granting voting rights to
the control shares. The Virginia Control Share Acquisitions Statute also enables
a corporation to make provisions for redemption of control shares with no voting
rights. A corporation may opt-out of the statute, which Heritage has not done,
by so providing in its articles of incorporation or bylaws. Cardinal, however,
has opted out of the statute by so providing in its Bylaws. Among the
acquisitions specifically excluded from the statute are acquisitions which are a
part of certain negotiated transactions to which the corporation is a party and
which, in the case of mergers or share exchanges, have been approved by the
corporation's shareholders under other provisions of the Virginia Stock
Corporation Act.
SHAREHOLDER PROPOSALS
Heritage
Heritage will hold its 2000 annual meeting of shareholders only if the
merger is not consummated. In order to be eligible for inclusion in Heritage's
proxy materials for the 2000 annual meeting, if held, any Heritage shareholder
proposal to take action at such meeting must have been received at Heritage's
executive offices at 1313 Dolley Madison Boulevard, McLean, Virginia 22101-3926,
no later than __________, 2000. Any such proposals shall be subject to the
requirements of the proxy rules adopted under the Securities Exchange Act of
1934, Virginia law and Heritage's articles of incorporation and bylaws.
Cardinal
Cardinal expects to hold its next annual meeting of shareholders in
________, 2000. Under the rules of the Securities and Exchange Commission,
proposals of Cardinal shareholders intended to be presented at that meeting must
have been received by Cardinal at its principal executive offices no later than
__________, 2000, to be included in the proxy statement for the meeting. Any
such proposals shall be subject to the requirements of the proxy rules adopted
under the Securities Exchange Act of 1934, Virginia law and Cardinal's articles
of incorporation and bylaws.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This joint proxy statement/prospectus, including information included
or incorporated by reference herein, contains certain forward-looking statements
with respect to the financial condition, results of operations, plans,
objectives, future performance and businesses of each of Cardinal and Heritage.
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:
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o competitive pressure from banks and other financial service
providers increases significantly;
o changes in the interest rate environment reduce margins;
o general economic conditions, either nationally or regionally, are
less favorable than expected, resulting in, among other things, a
deterioration in credit quality;
o changes occur in the regulatory environment;
o changes occur in business conditions and inflation; and
o changes occur in the securities markets.
EXPERTS
The financial statements of Cardinal as of December 31, 1999 and 1998
and for each of the years then ended have been included herein and in the
registration statement in reliance upon the report of KPMG LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
The financial statements of Heritage as of December 31, 1999 and 1998
and for each of the years ended December 31, 1999, 1998 and 1997 have been
included herein and in the registration statement in reliance upon the report of
Yount, Hyde & Barbour, P.C., independent certified public accountants, appearing
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
LEGAL OPINIONS
The validity of the shares of Cardinal common stock offered hereby is
being passed upon for Cardinal by Williams, Mullen, Clark & Dobbins, Richmond,
Virginia. Williams, Mullen, Clark & Dobbins will deliver an opinion to Cardinal
and Heritage concerning certain federal income tax consequences of the merger.
See "The Merger - Material Federal Income Tax Consequences of the Merger" on
page I-17.
Certain matters relating to the merger will be passed upon for Heritage
by Thacher Proffitt & Wood, Washington, D.C.
WHERE YOU CAN FIND MORE INFORMATION
Cardinal and Heritage file annual, quarterly and current reports, proxy
statements and other information with the Securities and Exchange Commission.
You may read and copy any document that Cardinal and Heritage file at the
Securities and Exchange Commission's public reference room facility located at
450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's regional offices
at 7 World Trade Center, 13th Floor, Suite 1300, New York, New York 10048 and
Suite 1400, Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661.
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference room. The SEC maintains an Internet site at www.sec.gov that contains
reports, proxy and information statements and other information regarding
issuers, including Cardinal, that file documents with the SEC electronically
through the SEC's electronic data gathering, analysis and retrieval system known
as EDGAR. Cardinal's and Heritage's reports, proxy and information statements
may also be reviewed at the offices of the National Association of Securities
Dealers, Inc., 1735 K Street, N.W., Washington D.C. 20006.
This joint proxy statement/prospectus is part of a registration
statement filed by and constitutes a prospectus of Cardinal in addition to being
a joint proxy statement of Cardinal and Heritage for their special meetings.
Because the rules and regulations of the SEC allow the omission of certain
portions of
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the registration statement from this document, this joint proxy
statement/prospectus does not contain all the information contained in the
registration statement. You may review the registration statement and the
exhibits filed with the registration statement for further information. The
registration statement and its exhibits may be inspected at the public reference
facilities of the SEC at the addresses mentioned above.
Cardinal also maintains an Internet site at www.cardinalbank.com, which
contains information relating to Cardinal and its business.
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<PAGE>
Appendix A
AMENDED AND RESTATED
AGREEMENT AND PLAN OF REORGANIZATION
BETWEEN
HERITAGE BANCORP, INC.,
CARDINAL FINANCIAL CORPORATION
AND
CARDINAL MERGER CORP.
_________________________
June __, 2000
<PAGE>
TABLE OF CONTENTS
ARTICLE 1
The Reorganization and Related Matters
<TABLE>
<CAPTION>
Page
----
<S> <C>
1.1 The Reorganization................................................... 1
1.2 Management of CFC ................................................... 1
1.3 The Closing and Effective Date....................................... 2
1.4 Definitions.......................................................... 2
ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of HBI Stock.............................................. 3
2.2 Exchange and Payment Procedures...................................... 4
2.3 No Fractional Shares................................................. 5
2.4 Dividends............................................................ 5
2.5 Rights of Dissenting Shareholders.................................... 5
ARTICLE 3
Representations and Warranties
3.1 Representations and Warranties of HBI ............................... 5
(a) Organization, Standing and Power............................ 5
(b) Authority................................................... 6
(c) Capital Structure........................................... 6
(d) Ownership of the HBI Subsidiaries; Capital Structure
of the HBI Subsidiaries; and Organization of the HBI
Subsidiaries................................................ 6
(e) Financial Statements........................................ 7
(f) Absence of Undisclosed Liabilities.......................... 8
(g) Legal Proceedings; Compliance with Laws..................... 8
(h) Regulatory Approvals........................................ 8
(i) Labor Relations............................................. 8
(j) Tax Matters................................................. 8
(k) Property.................................................... 9
(l) Reports..................................................... 9
(m) Employee Benefit Plans...................................... 9
(n) Investment Securities....................................... 10
(o) Certain Contracts........................................... 10
(p) Insurance................................................... 11
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(q) Loans, OREO and Allowance for Loan Losses................... 11
(r) Absence of Material Changes and Events...................... 12
(s) Statements True and Correct................................. 12
(t) Brokers and Finders......................................... 12
(u) Administration of Trust Accounts............................ 12
(v) Environmental Matters....................................... 13
3.2 Representations and Warranties of CFC ............................... 15
(a) Organization, Standing and Power............................ 15
(b) Authority................................................... 15
(c) Capital Structure........................................... 16
(d) Ownership of the CFC Subsidiaries; Capital Structure
of the CFC Subsidiaries; and Organization of the CFC
Subsidiaries................................................ 16
(e) Financial Statements........................................ 16
(f) Absence of Undisclosed Liabilities.......................... 17
(g) Legal Proceedings; Compliance with Laws..................... 17
(h) Regulatory Approvals........................................ 17
(i) Labor Relations............................................. 18
(j) Tax Matters................................................. 18
(k) Property.................................................... 18
(l) Reports..................................................... 18
(m) Employee Benefit Plans...................................... 19
(n) Investment Securities....................................... 19
(o) Certain Contracts........................................... 19
(p) Insurance................................................... 20
(q) Loans, OREO and Allowance for Loan Losses................... 20
(r) Absence of Material Changes and Events...................... 21
(s) Statements True and Correct................................. 21
(t) Brokers and Finders......................................... 22
(u) Administration of Trust Accounts............................ 22
(v) Environmental Matters....................................... 22
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties..................................... 23
4.2 Confidentiality...................................................... 24
4.3 Registration Statement, Proxy Statement and Shareholder Approval..... 24
4.4 Operation of the Business of HBI and CFC ............................ 25
4.5 Dividends............................................................ 27
4.6 No Solicitation...................................................... 27
4.7 Regulatory Filings................................................... 27
4.8 Public Announcements................................................. 27
4.9 Notice of Breach..................................................... 27
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<PAGE>
4.10 Reorganization Consummation................................................................. 27
4.11 Adjustments................................................................................. 28
4.12 Certain Payments............................................................................ 28
ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options................................................................. 28
5.2 Benefit Plans............................................................................... 29
5.3 Indemnification............................................................................. 29
5.4 Agreement with Terrie G. Spiro.............................................................. 30
5.5 Data Processing............................................................................. 30
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to Each Party's Obligations to Effect the Reorganization......................... 30
(a) Shareholder Approvals.............................................................. 30
(b) Regulatory Approvals............................................................... 30
(c) Registration Statement............................................................. 30
(d) Tax Opinion........................................................................ 31
(e) Opinions of Counsel................................................................ 31
(f) Legal Proceedings.................................................................. 31
6.2 Conditions to Obligations of CFC ........................................................... 31
(a) Representations and Warranties..................................................... 31
(b) Performance of Obligations......................................................... 31
(c) Affiliate Letters.................................................................. 31
(d) Investment Banking Letter.......................................................... 32
6.3 Conditions to Obligations of HBI .......................................................... 32
(a) Representations and Warranties..................................................... 32
(b) Performance of Obligations......................................................... 32
(c) Investment Banking Letter.......................................................... 32
ARTICLE 7
Termination
7.1 Termination................................................................................. 32
7.2 Effect of Termination....................................................................... 33
7.3 Non-Survival of Representations, Warranties and Covenants................................... 33
7.4 Expenses.................................................................................... 33
iv
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ARTICLE 8
General Provisions
8.1 Entire Agreement............................................................................ 34
8.2 Waiver and Amendment........................................................................ 34
8.3 Descriptive Headings........................................................................ 34
8.4 Governing Law............................................................................... 34
8.5 Notices..................................................................................... 34
8.6 Counterparts................................................................................ 35
8.7 Severability................................................................................ 35
8.8 Subsidiaries................................................................................ 36
</TABLE>
Exhibit A - Plan of Merger between Heritage Bancorp, Inc. and Cardinal Merger
Corp.
Exhibit B - Articles of Amendment to the Articles of Incorporation of Cardinal
Financial Corporation
Exhibit C - Amendment to the Bylaws of Cardinal Financial Corporation
Exhibit D - Agreement among Terrie G. Spiro, Cardinal Financial Corporation,
Heritage Bancorp, Inc. and The Heritage Bank.
v
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AMENDED AND RESTATED
AGREEMENT AND PLAN OF REORGANIZATION
THIS AMENDED AND RESTATED AGREEMENT AND PLAN OF REORGANIZATION (the
"Agreement") is made and entered into as of June __, 2000 by and between
Heritage Bancorp, Inc., a Virginia corporation with its principal office located
in McLean, Virginia ("HBI"), Cardinal Financial Corporation, a Virginia
corporation with its principal office located in Fairfax, Virginia ("CFC"), and
Cardinal Merger Corp., a Virginia corporation and wholly-owned subsidiary of CFC
("CMC"), and amends and restates the Agreement and Plan of Reorganization (the
"Original Agreement") dated as of April 17, 2000 by and between HBI and CFC.
WITNESSETH:
WHEREAS, HBI and CFC desire to combine their respective businesses; and
WHEREAS, pursuant to the Original Agreement, HBI and CFC agreed to the
affiliation of their two companies through a merger under Virginia law, in which
HBI would merge with and into CFC; and
WHEREAS, HBI and CFC now desire, pursuant to Section 8.2 of the
Original Agreement, to amend and restate the Original Agreement in order to
agree to the affiliation of their two companies through a merger under Virginia
law, in which HBI will merge with and into CMC and the shareholders of HBI will
become preferred shareholders of CFC, all as more specifically provided in this
Agreement and the Plan of Merger in the form attached hereto as Exhibit A (the
"Plan"); and
WHEREAS, the respective Boards of Directors of HBI and CFC have
resolved that the transactions described herein are in the best interests of the
parties and their respective shareholders and have authorized and approved the
execution and delivery of this Agreement.
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements set forth herein, the parties hereby agree as follows:
ARTICLE 1
The Reorganization and Related Matters
1.1 The Reorganization. Subject to the terms and conditions of
this Agreement, at the Effective Date as defined in Section 1.3 hereof, HBI will
be merged with and into CMC (the "Reorganization"). The separate corporate
existence of HBI thereupon shall cease, and CMC will be the surviving
corporation.
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1.2 Management of CFC. (a) On the Effective Date, CFC shall
increase the size of its Board of Directors by three (3) members. Harold E.
Lieding, George P. Shafran and Kevin B. Tighe shall be appointed to fill the
vacancies so created. Mr. Lieding shall become a member of the class of
Directors whose terms expire in 2001 and Messrs. Tighe and Shafran shall become
members of the classes of Directors whose terms expire in 2002 and 2003,
respectively. At the Effective Date, Section 2.3 of the Bylaws of CFC shall be
amended to read as set forth in Exhibit C hereto.
(b) On or after the Effective Date, The Heritage Bank, a
wholly owned subsidiary of HBI, will change its name to "Cardinal Bank", with an
appropriate modifier to denote its location. Messrs. Lieding, Tighe, Shafran and
Philip F. Herrick and Terrie G. Spiro shall continue as Directors, together with
Jones V. Isaac and up to seven additional individuals who will be appointed by
CFC. Fees to Directors of The Heritage Bank will not be reduced as a result of
the Reorganization.
1.3 The Closing and Effective Date. The closing of the
transactions contemplated by this Agreement and the Plan shall take place at the
offices of Williams, Mullen, Clark & Dobbins, 1021 East Cary Street, Richmond,
Virginia or at such other place as may be mutually agreed upon by the parties.
The Reorganization shall become effective on the date shown on the Certificate
of Merger issued by the State Corporation Commission of Virginia the ("SCC")
effecting the Reorganization (the "Effective Date"). Unless otherwise agreed
upon in writing by the chief executive officers of CFC and HBI, subject to the
conditions to the obligations of the parties to effect the Reorganization as set
forth in Article 6, the parties shall cause the Effective Date to occur on or
before the first day of the second month following the month in which the
conditions set forth in Sections 6.1(a) and 6.1(b) are satisfied. All documents
required by the terms of this Agreement to be delivered at or prior to
consummation of the Reorganization will be exchanged by the parties at the
closing of the Reorganization (the "Reorganization Closing"), which shall be
held on or before the Effective Date. Prior to the Reorganization Closing, CMC
and HBI shall execute and deliver to the SCC Articles of Merger containing the
Plan in substantially the form of Exhibit A hereto.
1.4 Definitions. Any term defined anywhere in this Agreement shall
have the meaning ascribed to it for all purposes of this Agreement (unless
expressly noted to the contrary). In addition:
(a) "Effective Time" means the time of day on the
Effective Date that the Reorganization is effective.
(b) the term "knowledge" when used with respect to a
party shall mean the knowledge, after due inquiry, of any "Executive Officer" of
such party, as such term is defined in Regulation O, (12 C.F.R. 215);
(c) the term "Material Adverse Effect", when applied to a
party, shall mean an event, occurrence or circumstance (including without
limitation (i) the making of any provisions for possible loan and lease losses,
write-downs or other real estate and taxes and (ii) any breach of a
representation or warranty by such party) which (a) has or is reasonably likely
to have a material adverse effect on the financial position, results of
operations or business of the party and its subsidiaries, taken as a whole, or
(b) would materially impair the party's ability to perform its
2
<PAGE>
obligations under this Agreement or the consummation of the Reorganization and
the other transactions contemplated by this Agreement; provided, however, that
solely for purposes of measuring whether an event, occurrence or circumstance
has a material adverse effect on such party's results of operations, the term
"results of operations" shall mean net interest income plus non-interest income
(less securities gains) less gross expenses; and provided further, that material
adverse effect and material impairment shall not be deemed to include the impact
of (i) changes in banking and similar laws of general applicability or
interpretations thereof by courts or governmental authorities, (ii) changes in
generally accepted accounting principles or regulatory accounting requirements
applicable to banks and bank holding companies generally, and (iii) the
Reorganization on the operating performance of the parties to this Agreement;
and
(d) the term "Previously Disclosed" by a party shall mean
information set forth in a written disclosure letter that is delivered by that
party to the other party prior to or contemporaneously with the execution of
this Agreement and specifically designated as information "Previously Disclosed"
pursuant to this Agreement.
(e) "Series A Preferred Stock" means a share of the 7.25%
Cumulative Convertible Preferred Stock, Series A of CFC, par value $1.00 per
share, which shall have the rights and preferences set forth in the form of
articles of amendment to the articles of incorporation of CFC that are set forth
in Exhibit B hereto. The initial conversion price to be set forth in Section
4(a) of such articles of amendment shall be equal to 1.30 multiplied by the
average of the last sale price of Cardinal Common Stock for the fifteen (15)
business day period that ends seven (7) business days prior to the date that the
Proxy Statement (as hereafter defined) is first mailed to shareholders of HBI or
CFC.
ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of HBI Stock. (a) At the Effective Date, by virtue
of the Reorganization and without any action on the part of the holders thereof,
each share of common stock, par value $1.00 per share, of HBI ("HBI Common
Stock") issued and outstanding immediately prior to the Effective Date shall
cease to be outstanding and (other than dissenting shares) shall be converted
into and exchanged either for $6.00 in cash or 1.2 shares of Series A Preferred
Stock and cash for fractional shares. Each holder of shares of HBI Common Stock
shall thereafter cease to have any rights with respect to such HBI Common Stock,
except the consideration described in Sections 2.1 and 2.3 upon the surrender of
such certificate in accordance with Section 2.2.
The form of consideration into which each individual shareholder's
shares of HBI Common Stock will be converted will be determined in the manner
described in Sections 2.1(b) and 2.1(c).
(b) By written notice to CFC in the manner described below, each
HBI shareholder may elect the form of consideration (shares of Series A
Preferred Stock or cash) into which his or her shares of HBI Common Stock will
be converted on the Effective Date; provided that despite such elections,
shareholders of HBI may be required to receive a different amount of cash or
shares of Series A Preferred Stock in the event of a proration pursuant to
Section 2.1(c). Within
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<PAGE>
ten (10) days following approval of this Agreement and the Plan by HBI's
shareholders, HBI will mail written instructions to each of its shareholders for
making the election, together with a form (a "Notice of Election") which each
shareholder shall be required to use to make such election. HBI's notice shall
specify a date by which a shareholder's election must be made (the "Election
Date," which shall be twenty (20) days following the date the instructions and
Notice of Election form are first distributed to HBI's shareholders). The
instructions and Notice of Election distributed to HBI's shareholders shall be
provided by and in a form satisfactory to CFC and HBI.
In order to make an effective election, a shareholder must deliver to
CFC a properly completed Notice of Election on or before the close of its
business on the Election Date in accordance with CFC's instructions. Each
shareholder may elect any combination of cash and Series A Preferred Stock. Any
shareholder who does not make an election or whose Notice of Election is not
timely received by CFC or otherwise is not made in accordance with CFC's
instructions will be deemed to have elected that each share of the shareholder's
HBI Common Stock be converted into the right to receive $6.00 in cash.
(c) Notwithstanding anything contained herein to the contrary, in
no event shall cash be paid (whether pursuant to shareholders' elections to
receive cash, proration or exercise of dissenters' rights) for more or less than
50% of the total outstanding shares of HBI Common Stock.
(i) If the aggregate number of shares of HBI Common Stock
held by the HBI shareholders who dissent and by HBI shareholders who
effectively elect (and who are deemed to have elected) as provided
above to receive cash is more than 50% of the total outstanding shares
of HBI Common Stock then, in the case of each shareholder who has
effectively elected to receive cash for any or all of his or her shares
of HBI Common Stock, CFC will reduce (by the same percentage for each
such shareholder and by rounding to the nearest full share) the number
of shares of HBI Common Stock held by such shareholders for which cash
will be paid, such that the aggregate number of shares of HBI Common
Stock for which cash will be paid is as nearly equal as possible to 50%
of the total outstanding shares of HBI Common Stock and each share held
by each such shareholder for which cash will not be paid will be
converted into 1.2 shares of Series A Preferred Stock.
(ii) If the aggregate number of shares of HBI Common Stock
held by the HBI shareholders who dissent and by HBI shareholders who
effectively elect (and who are deemed to have elected) as provided
above to receive cash is less than 50% of the total outstanding shares
of HBI Common Stock, then, in the case of each shareholder who
effectively has elected to receive Series A Preferred Stock for any or
all of his or her shares of HBI Common Stock, CFC will reduce (by the
same percentage for each such shareholder and by rounding to the
nearest full share) the number of shares of HBI Common Stock that will
be converted into Series A Preferred Stock such that the aggregate
number of shares of HBI Common Stock to be converted into Series A
Preferred Stock is as nearly equal as possible to 50% of the total
outstanding shares of HBI Common Stock and each share held by each such
shareholder which will not be converted into Series A Preferred Stock
will be converted into $6.00 in cash.
4
<PAGE>
(iii) A shareholder who beneficially owns HBI Common Stock
in more than one account or capacity may direct how cash and shares of
Series A Preferred Stock will be allocated among such accounts.
2.2 Exchange and Payment Procedures. Following the Effective Date,
certificates representing shares of HBI Common Stock outstanding at the
Effective Time (herein sometimes referred to as "Old Certificates") shall
evidence only the right of the registered holder thereof to receive, and may be
exchanged for, the form of consideration into which each individual
shareholder's shares of HBI Common Stock have been converted as determined by
and based on the shareholder's election in the manner described in Sections
2.1(b) and 2.1(c).
As promptly as practicable following the Effective Date, CFC shall send
or cause to be sent to each former shareholder of HBI of record immediately
prior to the Effective Date written instructions and transmittal materials (a
"Transmittal Letter") for use in surrendering Old Certificates to American Stock
Transfer & Trust Company ("the Transfer Agent"). Upon the proper surrender and
delivery to the Transfer Agent (in accordance with CFC's instructions, and
accompanied by a properly completed Transmittal Letter) by a former shareholder
of HBI of his or her Old Certificate(s), and in exchange therefor, the Transfer
Agent shall, (i) in the case of a shareholder whose HBI Common Stock has been
converted into Series A Preferred Stock, issue, register and deliver to the
shareholder a certificate evidencing the number of shares of Series A Preferred
Stock to which the shareholder is entitled and/or (ii) in the case of a
shareholder whose HBI Common Stock has been converted into the right to receive
cash, issue and deliver to the shareholder a check in the amount of cash to
which the shareholder is entitled.
Following the Effective Time there shall be no further transfers of HBI
Common Stock on the stock transfer books of HBI or the registration of any
transfer of an Old Certificate by any holder thereof, and the surrender of each
Old Certificate as provided herein must be made by or on behalf of its holder of
record at the Effective Date.
2.3 No Fractional Shares. No certificates or scrip for fractional
shares of Series A Preferred Stock will be issued. In lieu thereof, CFC will pay
the value of such fractional shares in cash on the basis of $5.00 per share of
Series A Preferred Stock.
2.4 Dividends. No dividend or other distribution payable to the
holders of record of Series A Preferred Stock at or as of any time after the
Effective Date shall be paid to the holder of any certificate representing
shares of HBI Common Stock issued and outstanding at the Effective Date until
such holder physically surrenders such certificate for exchange as provided in
Section 2.2 of this Agreement, promptly after which time all such dividends or
distributions shall be paid (without interest).
2.5 Rights of Dissenting Shareholders. Shareholders of HBI will be
entitled to the rights and remedies set forth in sections 13.1-729 through
13.1-741 of the Virginia Stock Corporation Act.
5
<PAGE>
ARTICLE 3
Representation and Warranties
3.1 Representations and Warranties of HBI. HBI represents and
warrants to CFC as follows:
(a) Organization, Standing and Power. HBI is a
corporation duly organized, validly existing and in good standing under the laws
of Virginia. It has all requisite corporate power and authority to carry on its
business as now being conducted and to own and operate its assets, properties
and business, and HBI has the corporate power and authority to execute and
deliver this Agreement and perform the respective terms of this Agreement and
Plan. HBI is duly registered as a bank holding company under the Bank Holding
Company Act of 1956. The Heritage Bank, a wholly owned subsidiary of HBI, is a
Virginia corporation and a Virginia state bank, duly organized, validly existing
and in good standing under the laws of Virginia, is in compliance in all
material respects with all rules and regulations promulgated by any relevant
regulatory authority, and it has all requisite corporate power and authority to
carry on a commercial banking business as now being conducted and to own and
operate its assets, properties and business.
(b) Authority. (1) The execution and delivery of this
Agreement and the Plan and the consummation of the Reorganization have been duly
and validly authorized by all necessary corporate action on the part of HBI,
except the approval of shareholders. The HBI Board has taken action sufficient
to permit this Agreement and the Plan to be approved and adopted by a majority
of the votes cast on this Agreement and the Plan at the HBI Shareholders'
Meeting (as hereinafter defined). The Agreement represents the legal, valid, and
binding obligation of HBI, enforceable against HBI in accordance with its terms
(except in all such cases as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally and except that the availability of
the equitable remedy of specific performance or injunctive relief is subject to
the discretion of the court before which any proceeding may be brought).
(2) Neither the execution and delivery of the Agreement,
the consummation of the transactions contemplated therein, nor the compliance by
HBI with any of the provisions thereof will (i) conflict with or result in a
breach of any provision of the Articles of Incorporation or Bylaws of HBI, (ii)
except as Previously Disclosed, constitute or result in the breach of any term,
condition or provision of, or constitute default under, or give rise to any
right of termination, cancellation or acceleration with respect to, or result in
the creation of any lien, charge or encumbrance upon, any property or assets of
the HBI Companies (as hereafter defined) pursuant to (A) any note, bond,
mortgage, indenture, or (B) any material license, agreement, lease or other
instrument or obligation, to which any of the HBI Companies is a party or by
which any of them or any of their properties or assets may be bound, or (iii)
subject to the receipt of the requisite approvals referred to in Section 4.7,
violate any order, writ, injunction, decree, statute, rule or regulation
applicable to any of the HBI Companies or any of their properties or assets.
(c) Capital Structure. The authorized capital stock of
HBI consists of: 10,000,000 shares of HBI Common Stock, of which 2,294,617
shares are issued and outstanding,
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fully paid and nonassessable, not subject to shareholder preemptive rights, and
not issued in violation of any agreement to which HBI is a party or otherwise
bound, or of any registration or qualification provisions of any federal or
state securities laws. Except as Previously Disclosed, there are no outstanding
understandings or commitments of any character pursuant to which HBI and any of
the HBI Companies could be required or expected to issue shares of capital
stock.
(d) Ownership of the HBI Subsidiaries; Capital Structure
of HBI Subsidiaries; and Organization of the HBI Subsidiaries. (1) HBI does not
own, directly or indirectly, 5% or more of the outstanding capital stock or
other voting securities of any corporation, bank or other organization actively
engaged in business except as Previously Disclosed (collectively the "HBI"
Subsidiaries" and each individually an "HBI Subsidiary" and, together with HBI,
the "HBI Companies"). The outstanding shares of capital stock of each HBI
Subsidiary have been duly authorized and are validly issued, and are fully paid
and nonassessable and all such shares are directly or indirectly owned by HBI
free and clear of all liens, claims and encumbrances. No rights are authorized,
issued or outstanding with respect to the capital stock of any HBI Subsidiary
and there are no agreements, understandings or commitments relating to the right
of HBI to vote or to dispose of said shares. None of the shares of capital stock
of any HBI Subsidiary has been issued in violation of the preemptive rights of
any person or of any state or federal securities law.
(2) Each HBI Subsidiary is a duly organized corporation,
validly existing and in good standing under applicable laws. Each HBI Subsidiary
(i) has full corporate power and authority to own, lease and operate its
properties and to carry on its business as now conducted except where the
absence of such power or authority would not have a Material Adverse Effect on
the financial condition, results of operations or business of HBI on a
consolidated basis, and (ii) is duly qualified to do business in the states of
the United States and foreign jurisdictions where its ownership or leasing of
property or the conduct of its business requires such qualification and where
failure to so qualify would have a material adverse effect on the financial
condition, results of operations or business of HBI on a consolidated basis.
Each HBI Subsidiary has all federal, state, local and foreign governmental
authorizations and licenses necessary for it to own or lease its properties and
assets and to carry on its business as it is now being conducted, except where
failure to obtain such authorization or license would not have a material
adverse effect on the business of such HBI Subsidiary.
(e) Financial Statements. HBI's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1999, and all other documents
filed or to be filed subsequent to December 31, 1999 under Sections 13(a),
13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended (together
with the rules and regulations thereunder, the "Exchange Act"), in the form
filed with the United States Securities and Exchange Commission (the "SEC") (in
each such case, the "HBI Financial Statements") did not and will not contain any
untrue statement of a material fact or omit to state a material fact required to
be stated therein or necessary to make the statements made therein, in light of
the circumstances under which they were made, not misleading; and each of the
balance sheets in or incorporated by reference into the HBI Financial Statements
(including the related notes and schedules thereto) fairly presents and will
fairly present the financial position of the entity or entities to which it
relates as of its date and each of the statements of income and changes in
stockholders' equity and cash flows or equivalent statements in the HBI
Financial Statements (including any related notes and schedules thereto) fairly
presents and will fairly present the results of operations, changes in
stockholders' equity
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and changes in cash flows, as the case may be, of the entity or entities to
which it relates for the periods set forth therein, in each case in accordance
with generally accepted accounting principles consistently applied to banks and
bank holding companies during the periods involved, except as may be noted
therein, subject to normal and recurring year-end audit adjustments in the case
of unaudited statements.
(f) Absence of Undisclosed Liabilities. At December 31,
1999, none of the HBI Companies had any obligation or liability (contingent or
otherwise) of any nature which were not reflected in the HBI Financial
Statements, except for those which in the aggregate are immaterial or have been
Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of HBI's management, threatened or probable of
assertion against any of the HBI Companies, or against any property, asset,
interest or right of any of them, that are reasonably expected to have, either
individually or in the aggregate, a material adverse effect on the financial
condition of HBI on a consolidated basis or that are reasonably expected to
threaten or impede the consummation of the transactions contemplated by this
Agreement. None of the HBI Companies is a party to any agreement or instrument
or subject to any judgment, order, writ, injunction, decree or rule that might
reasonably be expected to have a material adverse effect on the condition
(financial or otherwise), business or prospects of HBI on a consolidated basis.
Except as Previously Disclosed, as of the date of this Agreement, none of the
HBI Companies nor any of their properties is a party to or is subject to any
order, decree, agreement, memorandum of understanding or similar arrangement
with, or a commitment letter or similar submission to, any federal or state
governmental agency or authority charged with the supervision or regulation of
depository institutions or mortgage lenders or engaged in the insurance of
deposits which restricts or purports to restrict in any material respect the
conduct of the business of it or any of its subsidiaries or properties, or in
any manner relates to the capital, liquidity, credit policies or management of
it; and except as Previously Disclosed, none of the HBI Companies has been
advised by any such regulatory authority that such authority is contemplating
issuing or requesting (or is considering the appropriateness of issuing or
requesting) any such order, decree, agreement, memorandum of understanding,
commitment letter or similar submission. To the best knowledge of HBI, the HBI
Companies have complied in all material respects with all laws, ordinances,
requirements, regulations or orders applicable to its business (including
environmental laws, ordinances, requirements, regulations or orders).
(h) Regulatory Approvals. HBI knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b).
(i) Labor Relations. None of the HBI Companies is a party
to, or is bound by any collective bargaining agreement, contract or other
agreement or understanding with a labor union or labor organization, nor is it
the subject of a proceeding asserting that it has committed an unfair labor
practice (within the meaning of the National Labor Relations Act) or seeking to
compel it to bargain with any labor organization as to wages and conditions of
employment, nor is there any strike or other labor dispute involving it, pending
or, to the best of its knowledge, threatened, nor is it aware of any activity
involving its employees seeking to certify a collective bargaining unit or
engaging in any other organizational activity.
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(j) Tax Matters. The HBI Companies have filed all
federal, state, and local tax returns and reports required to be filed, and all
taxes shown by such returns to be due and payable have been paid or are
reflected as a liability in the HBI Financial Statements or are being contested
in good faith and have been Previously Disclosed. Except to the extent that
liabilities therefor are specifically reflected in the HBI Financial Statements,
there are no federal, state or local tax liabilities of the HBI Companies other
than liabilities that have arisen since December 31, 1999, all of which have
been properly accrued or otherwise provided for on the books and records of the
HBI Companies. Except as Previously Disclosed, no tax return or report of any of
the HBI Companies is under examination by any taxing authority or the subject of
any administrative or judicial proceeding, and no unpaid tax deficiency has been
asserted against any of the HBI Companies by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the HBI Financial Statements, all of the HBI Companies have good and marketable
title free and clear of all material liens, encumbrances, charges, defaults or
equities of whatever character to all of the material properties and assets,
tangible or intangible, reflected in the HBI Financial Statements as being owned
by the HBI Companies as of the dates thereof. To the best knowledge of HBI, all
buildings, and all fixtures, equipment, and other property and assets which are
material to its business on a consolidated basis, held under leases or subleases
by the HBI Companies are held under valid instruments enforceable in accordance
with their respective terms, subject to bankruptcy, insolvency, reorganization,
moratorium and similar laws. The buildings, structures, and appurtenances owned,
leased, or occupied by the HBI Companies are, to the best knowledge of HBI, in
good operating condition, in a state of good maintenance and repair and (i)
comply with applicable zoning and other municipal laws and regulations, and (ii)
there are no latent defects therein.
(l) Reports. Since January 1, 1996, the HBI Companies
have filed all reports and statements, together with any amendments required to
be made with respect thereto, that were required to be filed with the SEC, the
Federal Reserve, the SCC, and any other governmental or regulatory authority or
agency having jurisdiction over their operations, and such reports were prepared
in all material respects in accordance with the applicable statutes, regulations
and instructions in existence as of the date of filing of such reports.
(m) Employee Benefit Plans. (1) HBI will deliver for
CFC's review, as soon as practicable, true and complete copies of all material
pension, retirement, profit-sharing, deferred compensation, stock option, bonus,
vacation or other material incentive plans or agreements, all material medical,
dental or other health plans, all life insurance plans and all other material
employee benefit plans or fringe benefit plans, including, without limitation,
all "employee benefit plans" as that term is defined in Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), currently
adopted, maintained by, sponsored in whole or in part by, or contributed to by
HBI for the benefit of employees, retirees or other beneficiaries eligible to
participate (collectively, the "HBI Benefit Plans"). Any of the HBI Benefit
Plans which is an "employee pension benefit plan," as that term is defined in
Section 3(2) of ERISA, is referred to herein as a "HBI ERISA Plan." No HBI
Benefit Plan is or has been a multi-employer plan within the meaning of Section
3(37) of ERISA.
(2) Except as Previously Disclosed, all HBI Benefit Plans
are in compliance
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with the applicable terms of ERISA and the Internal Revenue Code of 1986, as
amended (the "IRC") and any other applicable laws, rules and regulations the
breach or violation of which could result in a material liability to HBI on a
consolidated basis.
(3) No HBI ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which any
of the HBI Companies has sold securities subject to an obligation to repurchase,
none of the investment securities reflected in the HBI Financial Statements is
subject to any restriction, contractual, statutory, or otherwise, which would
impair materially the ability of the holder of such investment to dispose freely
of any such investment at any time. With respect to any agreements pursuant to
which any of the HBI Companies has purchased securities subject to any agreement
to resell, it has a valid, perfected first lien or security interest in the
government securities or other collateral securing such agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, neither HBI nor any HBI Subsidiary is a party to, or is bound by, (i)
any material agreement, arrangement or commitment, (ii) any agreement, indenture
or other instrument relating to the borrowing of money by HBI or any HBI
Subsidiary or the guarantee by HBI or any HBI Subsidiary of any such obligation,
(iii) any agreement, arrangement or commitment relating to the employment of a
consultant or the employment, election, retention in office or severance of any
present or former director or officer, (iv) any agreement to make loans or for
the provision, purchase or sale of goods, services or property between HBI or
any HBI Subsidiary and any director or officer of HBI or any HBI Subsidiary, or
any member of the immediate family or affiliate of any of the foregoing, or (v)
any agreement between HBI or any HBI Subsidiary and any 5% or more shareholder
of HBI; in each case other than agreements entered into in the ordinary course
of the banking business of HBI or a HBI Subsidiary consistent with past
practice.
(2) Neither HBI or any HBI Subsidiary, nor to the
knowledge of HBI, the other party thereto, is in default under any material
agreement, commitment, arrangement, lease, insurance policy or other instrument
whether entered into in the ordinary course of business or otherwise, nor has
there occurred any event that, with the lapse of time or giving of notice or
both, would constitute such a default, other than defaults of loan agreements by
borrowers from HBI or a HBI Subsidiary in the ordinary course of its business.
(3) Since December 31, 1999, neither HBI nor any HBI
Subsidiary has incurred or paid any obligation or liability that would be
material to HBI, except obligations incurred or paid in connection with
transactions in the ordinary course of business of HBI or an HBI Subsidiary
consistent with its practice and, except as Previously Disclosed, from December
31, 1999 to the date hereof, neither HBI nor any HBI Subsidiary has taken any
action that, if taken after the date hereof, would breach any of the covenants
contained in Section 4.4 hereof.
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(p) Insurance. A complete list of all policies or binders
of fire, liability, product liability, workmen's compensation, vehicular and
other insurance held by or on behalf of the HBI Companies has previously been
furnished to CFC and all such policies or binders are valid and enforceable in
accordance with their terms, are in full force and effect, and insure against
risks and liabilities to the extent and in the manner customary for the industry
and are deemed appropriate and sufficient by HBI. The HBI Companies are not in
default with respect to any provision contained in any such policy or binder and
have not failed to give any notice or present any claim under any such policy or
binder in due and timely fashion. None of the HBI Companies has received notice
of cancellation or non-renewal of any such policy or binder. None of the HBI
Companies has knowledge of any inaccuracy in any application for such policies
or binders, any failure to pay premiums when due or any similar state of facts
or the occurrence of any event that is reasonably likely to form the basis for
any material claim against it not fully covered (except to the extent of any
applicable deductible) by the policies or binders referred to above. None of the
HBI Companies has received notice from any of its insurance carriers that any
insurance premiums will be increased materially in the future or that any such
insurance coverage will not be available in the future on substantially the same
terms as now in effect.
(q) Loans, OREO, and Allowance for Loan Losses. (1)
Except as Previously Disclosed, and except for matters which individually or in
the aggregate, do not materially adversely affect the Reorganization or the
financial condition of HBI, to HBI's best knowledge each loan reflected as an
asset in the HBI Financial Statements (i) is evidenced by notes, agreements, or
other evidences of indebtedness which are true, genuine and what they purport to
be, (ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
terms, subject to bankruptcy, insolvency, and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles. All loans and extensions of credit which are subject to regulation
of the Federal Reserve which have been made by HBI and the HBI Subsidiaries
comply therewith.
(2) The classification on the books and records of HBI
and each HBI Subsidiary of loans and/or non-performing assets as nonaccrual,
troubled debt restructuring, OREO or other similar classification, complies in
all material respects with generally accepted accounting principles and
applicable regulatory accounting principles.
(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the HBI Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and neither HBI nor any HBI
Subsidiary has received any notice of denial of any such claim.
(4) HBI and each HBI Subsidiary are in possession of all
of the OREO or, if any of the OREO remains occupied by the mortgagor, eviction
or summary proceedings have been commenced or rental arrangements providing for
market rental rates have been agreed upon and HBI and/or each HBI Subsidiary are
diligently pursuing such eviction of summary proceedings or such rental
arrangements. Except as Previously Disclosed, no legal proceeding or quasi-legal
proceeding is pending or, to the knowledge of HBI and each HBI Subsidiary,
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threatened concerning any OREO or any servicing activity or omission to provide
a servicing activity with respect to any of the OREO.
(5) Except as Previously Disclosed, all loans made by any
of the HBI Companies to facilitate the disposition of OREO are performing in
accordance with their terms.
(6) The allowance for possible loan losses shown on the
HBI Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of HBI as of dates subsequent to the execution of
this Agreement will be, in each case as of the dates thereof, adequate in all
material respects to provide for possible losses, net of recoveries relating to
loans previously charged off, on loans outstanding (including accrued interest
receivable) of the HBI Companies and other extensions of credit (including
letters of credit and commitments to make loans or extend credit) by HBI.
(r) Absence of Material Changes and Events. Except as
Previously Disclosed, since December 31, 1999, there has not been any material
adverse change in the condition (financial or otherwise), aggregate assets or
liabilities, cash flow, earnings or business of the HBI Companies on a
consolidated basis, and each of the HBI Companies has conducted its business
only in the ordinary course consistent with past practice.
(s) Statements True and Correct. None of the information
supplied or to be supplied by HBI for inclusion in the registration statement,
the Proxy Statement (as hereafter defined) or any other document to be filed
with the SEC or any other regulatory authority in connection with the
transactions contemplated hereby, will, at the respective time such documents
are filed, and, in the case of the registration statement, when it becomes
effective and with respect to the Proxy Statement, when first mailed to CFC
shareholders, be false or misleading with respect to any material fact or omit
to state any material fact necessary in order to make the statements therein not
misleading, or, in the case of the Proxy Statement or any supplement thereto, at
the time of the CFC Shareholders' Meeting, be false or misleading with respect
to any material fact or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the solicitation of any
proxy for the CFC Shareholders' Meeting. All documents that HBI is responsible
for filing with the SEC or any other regulatory authority in connection with the
transactions contemplated, hereby will comply as to form in all material
respects with the provisions of applicable law, including applicable provisions
of federal and state securities law.
(t) Brokers and Finders. Neither HBI nor any HBI
Subsidiary, nor any of their respective officers, directors or employees, has
employed any broker, finder or financial advisor or incurred any liability for
any fees or commissions in connection with the transactions contemplated herein,
except for Ferris, Baker Watts, Incorporated.
(u) Administration of Trust Accounts. HBI and HBI
Subsidiaries have properly administered, in all respects material and which
could reasonably be expected to be material to the business, operations or
financial condition of HBI and HBI Subsidiaries, taken as a whole, all accounts
for which they act as fiduciaries including but not limited to accounts for
which they serve as trustees, agents, custodians, personal representatives,
guardians, conservators or investment advisors, in accordance with the terms of
the governing documents and applicable state and federal law and regulation and
common law. Neither HBI nor a HBI
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Subsidiary, nor any director, officer or employee of HBI or a HBI Subsidiary has
committed any breach of trust with respect to any such fiduciary account which
is material to or could reasonably be expected to be material to the business,
operations or financial condition of HBI, or a HBI Subsidiary, taken as a whole,
and the accountings for each such fiduciary account are true and correct in all
material respects and accurately reflect the assets of such fiduciary account in
all material respects.
(v) Environmental Matters. (1) Except as Previously
Disclosed, to the best of HBI's knowledge, neither HBI nor any HBI Subsidiary
owns or leases any properties affected by toxic waste, radon gas or other
hazardous conditions or constructed in part with the use of asbestos. Each of
HBI and the HBI Subsidiaries is in substantial compliance with all Environmental
Laws applicable to real or personal properties in which it has a direct fee
ownership or, with respect to a direct interest as lessee, applicable to the
leasehold premises or, to the best knowledge of HBI and the HBI Subsidiaries,
the premises on which the leasehold is situated. Neither HBI nor any HBI
Subsidiary has received any Communication (as hereafter defined) alleging that
HBI or such HBI Subsidiary is not in such compliance and, to the best knowledge
of HBI and the HBI Subsidiaries, there are no present circumstances (including
Environmental Laws (as hereafter defined) that have been adopted but are not yet
effective) that would prevent or interfere with the continuation of such
compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on HBI and the HBI
Subsidiaries of any liability arising under any Environmental Laws pending or,
to the best knowledge of HBI and the HBI Subsidiaries, threatened against (A)
HBI or any HBI Subsidiary, (B) any person or entity whose liability for any
Environmental Claim, HBI or any HBI Subsidiary has or may have retained or
assumed either contractually or by operation of law, or (C) any real or personal
property which HBI or any HBI Subsidiary owns or leases, or has been or is
judged to have managed or to have supervised or participated in the management
of, which liability might have a material adverse effect on the business,
financial condition or results of operations of HBI. HBI and the HBI
Subsidiaries are not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
(3) To the best knowledge of HBI and the HBI
Subsidiaries, there are no legal, administrative, arbitral or other proceedings,
or Environmental Claims or other claims, causes of action or governmental
investigations of any nature, seeking to impose, or that could result in the
imposition, on HBI or any HBI Subsidiary of any liability arising under any
Environmental Laws pending or threatened against any real or personal property
in which HBI or any HBI Subsidiary holds a security interest in connection with
a loan or a loan participation which liability might have a Material Adverse
Effect on the business, financial condition or results of operations of HBI. HBI
and the HBI Subsidiaries are not subject to any agreement, order, judgment,
decree or memorandum by or with any court, governmental authority, regulatory
agency or third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by HBI or any HBI Subsidiary, other than OREO, HBI has made available
to CFC copies of any environmental audits, analyses and surveys that have been
prepared relating to such properties. With respect to all OREO held by HBI or
any HBI Subsidiary and all real or personal property
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which HBI or any HBI Subsidiary has been or is judged to have managed or to have
supervised or participated in the management of, HBI has made available to CFC
the information relating to such OREO available to HBI. HBI and the HBI
Subsidiaries are in compliance in all material respects with all recommendations
contained in any environmental audits, analyses and surveys relating to any of
the properties, real or personal, described in this subsection (4).
(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern (as hereafter defined), that could reasonably form the basis of any
Environmental Claim or other claim or action or governmental investigation that
could result in the imposition of any liability arising under any Environmental
Laws currently in effect or adopted but not yet effective against HBI or any HBI
Subsidiary or against any person or entity whose liability for any Environmental
Claim HBI or any HBI Subsidiary has or may have retained or assumed either
contractually or by operation of law.
(6) For the purpose of this Agreement, the following
terms shall have the following meanings:
(i) "Communication" means a communication which is of a
substantive nature and which is made (A) in writing to HBI or any HBI Subsidiary
on the one hand or to CFC or any CFC Subsidiary on the other hand, or (B) orally
to a senior officer of HBI or any HBI Subsidiary or of CFC or any CFC
Subsidiary, whether from a governmental authority or a third party.
(ii) "Environmental Claim" means any Communication from
any governmental authority or third party alleging potential liability
(including, without limitation, potential liability for investigatory costs,
cleanup costs, governmental response costs, natural resources damages, property
damages, personal injuries, or penalties) arising out of, based on or resulting
from the presence, or release into the environment, of any Material of
Environmental Concern (as hereafter defined).
(iii) "Environmental Laws" means all applicable federal,
state and local laws and regulations, including the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended, that relate to
pollution or protection of human health or the environment (including, without
limitation, ambient air, surface water, ground water, land surface or subsurface
strata). This definition includes, without limitation, laws and regulations
relating to emissions, discharges, releases or threatened releases of Materials
of Environmental Concern, or otherwise relating to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling of
Materials of Environmental Concern.
(iv) "Materials of Environmental Concern" means
pollutants, contaminants, wastes, toxic substances, petroleum and petroleum
products and any other materials regulated under Environmental Laws.
3.2 Representations and Warranties of CFC. CFC represents and
warrants to HBI as follows:
(a) Organization, Standing and Power. CFC is a
corporation duly
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organized, validly existing and in good standing under the laws of Virginia. It
has all requisite corporate power and authority to carry on its business as now
being conducted and to own and operate its assets, properties and business, and
CFC has the corporate power and authority to execute and deliver this Agreement
and perform the respective terms of this Agreement and the Plan. CFC is duly
registered as a bank holding company under the Bank Holding Company Act of 1956.
Cardinal Bank, N.A., Cardinal Bank - Manassas/Prince William, N.A. and Cardinal
Bank - Dulles, N.A., each, is a wholly owned subsidiary of CFC and a national
banking association validly existing and in good standing under the laws of the
United States, is in compliance in all material respects with all rules and
regulations promulgated by any relevant regulatory authority, and it has all
requisite corporate power and authority to carry on a commercial banking
business as now being conducted and to own and operate its assets, properties
and business.
(b) Authority. (1) The execution and delivery of this
Agreement and the Plan and the consummation of the Reorganization have been duly
and validly authorized by all necessary corporate action on the part of CFC,
except the approval of shareholders. The Agreement represents the legal, valid,
and binding obligation of CFC, enforceable against CFC in accordance with its
terms (except in all such cases as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally and except that the availability of
the equitable remedy of specific performance or injunctive relief is subject to
the discretion of the court before which any proceeding may be brought).
(2) Neither the execution and delivery of the Agreement,
the consummation of the transactions contemplated therein, nor the compliance by
CFC with any of the provisions thereof will (i) conflict with or result in a
breach of any provision of the Articles of Incorporation or Bylaws of CFC, (ii)
except as Previously Disclosed, constitute or result in the breach of any term,
condition or provision of, or constitute default under, or give rise to any
right of termination, cancellation or acceleration with respect to, or result in
the creation of any lien, charge or encumbrance upon, any property or assets of
the CFC Companies pursuant to (A) any note, bond, mortgage, indenture, or (B)
any material license, agreement, lease or other instrument or obligation, to
which any of the CFC Companies is a party or by which any of them or any of
their properties or assets may be bound, or (iii) subject to the receipt of the
requisite approvals referred to in Section 4.7, violate any order, writ,
injunction, decree, statute, rule or regulation applicable to any of the CFC
Companies or any of their properties or assets.
(c) Capital Structure. The authorized capital stock of
CFC consists of: 50,000,000 shares of common stock, par value $1.00 per share
("CFC Common Stock), of which 4,242,634 shares are issued and outstanding, fully
paid and nonassessable, not subject to shareholder preemptive rights, and not
issued in violation of any agreement to which CFC is a party or otherwise bound,
or of any registration or qualification provisions of any federal or state
securities laws; and 10,000,000 shares of preferred stock, par value $1.00 per
share, of which none are issued and outstanding. The shares of Series A
Preferred Stock to be issued in exchange for shares of HBI Common Stock upon
consummation of the Reorganization will have been duly authorized and, when
issued in accordance with the terms of this Agreement, will be validly issued,
fully paid and nonassessable and subject to no preemptive rights. Except as
Previously Disclosed, there are no outstanding understandings or commitments of
any character pursuant to which CFC and any of the CFC Companies could be
required or expected to issue
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shares of capital stock.
(d) Ownership of the CFC Subsidiaries; Capital Structure
of the CFC Subsidiaries; and Organization of the CFC Subsidiaries. (1) CFC does
not own, directly or indirectly, 5% or more of the outstanding capital stock or
other voting securities of any corporation, bank or other organization actively
engaged in business except as Previously Disclosed (collectively the "CFC"
Subsidiaries" and each individually a "CFC Subsidiary" and, together with CFC,
the "CFC Companies"). The outstanding shares of capital stock of each CFC
Subsidiary have been duly authorized and are validly issued, and are fully paid
and nonassessable and all such shares are directly or indirectly owned by CFC
free and clear of all liens, claims and encumbrances. No rights are authorized,
issued or outstanding with respect to the capital stock of any CFC Subsidiary
and there are no agreements, understandings or commitments relating to the right
of CFC to vote or to dispose of said shares. None of the shares of capital stock
of any CFC Subsidiary has been issued in violation of the preemptive rights of
any person or of any state or federal securities law.
(2) Each CFC Subsidiary is a duly organized corporation,
validly existing and in good standing under applicable laws. Each CFC Subsidiary
(i) has full corporate power and authority to own, lease and operate its
properties and to carry on its business as now conducted except where the
absence of such power or authority would not have a material adverse effect on
the financial condition, results of operations or business of CFC on a
consolidated basis, and (ii) is duly qualified to do business in the states of
the United States and foreign jurisdictions where its ownership or leasing of
property or the conduct of its business requires such qualification and where
failure to so qualify would have a material adverse effect on the financial
condition, results of operations or business of CFC on a consolidated basis.
Each CFC Subsidiary has all federal, state, local and foreign governmental
authorizations and licenses necessary for it to own or lease its properties and
assets and to carry on its business as it is now being conducted, except where
failure to obtain such authorization or license would not have a Material
Adverse Effect on the business of such CFC Subsidiary.
(e) Financial Statements. CFC's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1999, and all other documents
filed or to be filed subsequent to December 31, 1999 under Sections 13(a),
13(c), 14 or 15(d) of the Exchange Act, in the form filed with the SEC (in each
such case, the "CFC Financial Statements") did not and will not contain any
untrue statement of a material fact or omit to state a material fact required to
be stated therein or necessary to make the statements made therein, in light of
the circumstances under which they were made, not misleading; and each of the
balance sheets in or incorporated by reference into the CFC Financial Statements
(including the related notes and schedules thereto) fairly presents and will
fairly present the financial position of the entity or entities to which it
relates as of its date and each of the statements of income and changes in
stockholders' equity and cash flows or equivalent statements in the CFC
Financial Statements (including any related notes and schedules thereto) fairly
presents and will fairly present the results of operations, changes in
stockholders' equity and changes in cash flows, as the case may be, of the
entity or entities to which it relates for the periods set forth therein, in
each case in accordance with generally accepted accounting principles
consistently applied to banks and bank holding companies during the periods
involved, except as may be noted therein, subject to normal and recurring
year-end audit adjustments in the case of unaudited statements.
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(f) Absence of Undisclosed Liabilities. At December 31,
1999, none of the CFC Companies had any obligation or liability (contingent or
otherwise) of any nature which were not reflected in the CFC Financial
Statements, except for those which in the aggregate are immaterial or have been
Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of CFC's management, threatened or probable of
assertion against any of the CFC Companies, or against any property, asset,
interest or right of any of them, that are reasonably expected to have, either
individually or in the aggregate, a material adverse effect on the financial
condition of CFC on a consolidated basis or that are reasonably expected to
threaten or impede the consummation of the transactions contemplated by this
Agreement. None of the CFC Companies is a party to any agreement or instrument
or subject to any judgment, order, writ, injunction, decree or rule that might
reasonably be expected to have a material adverse effect on the condition
(financial or otherwise), business or prospects of CFC on a consolidated basis.
Except as Previously Disclosed, as of the date of this Agreement, none of the
CFC Companies nor any of their properties is a party to or is subject to any
order, decree, agreement, memorandum of understanding or similar arrangement
with, or a commitment letter or similar submission to, any federal or state
governmental agency or authority charged with the supervision or regulation of
depository institutions or mortgage lenders or engaged in the insurance of
deposits which restricts or purports to restrict in any material respect the
conduct of the business of it or any of its subsidiaries or properties, or in
any manner relates to the capital, liquidity, credit policies or management of
it; and except as Previously Disclosed, none of the CFC Companies has been
advised by any such regulatory authority that such authority is contemplating
issuing or requesting (or is considering the appropriateness of issuing or
requesting) any such order, decree, agreement, memorandum of understanding,
commitment letter or similar submission. To the best knowledge of CFC, the CFC
Companies have complied in all material respects with all laws, ordinances,
requirements, regulations or orders applicable to its business (including
environmental laws, ordinances, requirements, regulations or orders).
(h) Regulatory Approvals. CFC knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b). CFC has funds sufficient to enable it to pay the cash component of the
merger consideration and, provided it receives the dividend described in Section
4.7, will have sufficient sources of funds to pay the dividend obligation on the
Series A Preferred Stock without seeking funding from third parties. CFC
believes that it can satisfy all capital and other regulatory requirements
referred to Section 6.1(b).
(i) Labor Relations. None of the CFC Companies is a party
to, or is bound by any collective bargaining agreement, contract or other
agreement or understanding with a labor union or labor organization, nor is it
the subject of a proceeding asserting that it has committed an unfair labor
practice (within the meaning of the National Labor Relations Act) or seeking to
compel it to bargain with any labor organization as to wages and conditions of
employment, nor is there any strike or other labor dispute involving it, pending
or, to the best of its knowledge, threatened, nor is it aware of any activity
involving its employees seeking to certify a collective bargaining unit or
engaging in any other organizational activity.
(j) Tax Matters. The CFC Companies have filed all
federal, state, and local
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tax returns and reports required to be filed, and all taxes shown by such
returns to be due and payable have been paid or are reflected as a liability in
the CFC Financial Statements or are being contested in good faith and have been
Previously Disclosed. Except to the extent that liabilities therefor are
specifically reflected in the CFC Financial Statements, there are no federal,
state or local tax liabilities of the CFC Companies other than liabilities that
have arisen since December 31, 1999, all of which have been properly accrued or
otherwise provided for on the books and records of the CFC Companies. Except as
Previously Disclosed, no tax return or report of any of the CFC Companies is
under examination by any taxing authority or the subject of any administrative
or judicial proceeding, and no unpaid tax deficiency has been asserted against
any of the CFC Companies by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the CFC Financial Statements, all of the CFC Companies have good and marketable
title free and clear of all material liens, encumbrances, charges, defaults or
equities of whatever character to all of the material properties and assets,
tangible or intangible, reflected in the CFC Financial Statements as being owned
by the CFC Companies as of the dates thereof. To the best knowledge of CFC, all
buildings, and all fixtures, equipment, and other property and assets which are
material to its business on a consolidated basis, held under leases or subleases
by the CFC Companies are held under valid instruments enforceable in accordance
with their respective terms, subject to bankruptcy, insolvency, reorganization,
moratorium and similar laws. The buildings, structures, and appurtenances owned,
leased, or occupied by the CFC Companies are, to the best knowledge of CFC, in
good operating condition, in a state of good maintenance and repair and (i)
comply with applicable zoning and other municipal laws and regulations, and (ii)
there are no latent defects therein.
(l) Reports. Since January 1, 1996, the CFC Companies
have filed all reports and statements, together with any amendments required to
be made with respect thereto, that were required to be filed with the SEC, the
Federal Reserve, the SCC, and any other governmental or regulatory authority or
agency having jurisdiction over their operations, and such reports were prepared
in all material respects in accordance with the applicable statutes, regulations
and instructions in existence as of the date of filing of such reports.
(m) Employee Benefit Plans. (1) CFC will deliver for
HBI's review, as soon as practicable, true and complete copies of all material
pension, retirement, profit-sharing, deferred compensation, stock option, bonus,
vacation or other material incentive plans or agreements, all material medical,
dental or other health plans, all life insurance plans and all other material
employee benefit plans or fringe benefit plans, including, without limitation,
all "employee benefit plans" as that term is defined in Section 3(3) of ERISA,
currently adopted, maintained by, sponsored in whole or in part by, or
contributed to by CFC for the benefit of employees, retirees or other
beneficiaries eligible to participate (collectively, the "CFC Benefit Plans").
Any of the CFC Benefit Plans which is an "employee pension benefit plan," as
that term is defined in Section 3(2) of ERISA, is referred to herein as a "CFC
ERISA Plan." No CFC Benefit Plan is or has been a multi-employer plan within the
meaning of Section 3(37) of ERISA.
(2) Except as Previously Disclosed, all CFC Benefit Plans
are in compliance with the applicable terms of ERISA and the IRC and any other
applicable laws, rules and regulations the breach or violation of which could
result in a material liability to CFC on a
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consolidated basis.
(3) No CFC ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which any
of the CFC Companies has sold securities subject to an obligation to repurchase,
none of the investment securities reflected in the CFC Financial Statements is
subject to any restriction, contractual, statutory, or otherwise, which would
impair materially the ability of the holder of such investment to dispose freely
of any such investment at any time. With respect to any agreements pursuant to
which any of the CFC Companies has purchased securities subject to any agreement
to resell, it has a valid, perfected first lien or security interest in the
government securities or other collateral securing such agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, neither CFC nor any CFC subsidiary is a party to, or is bound by, (i)
any material agreement, arrangement or commitment, (ii) any agreement, indenture
or other instrument relating to the borrowing of money by CFC or any CFC
Subsidiary or the guarantee by CFC or any CFC Subsidiary of any such obligation,
(iii) any agreement, arrangement or commitment relating to the employment of a
consultant or the employment, election, retention in office or severance of any
present or former director or officer, (iv) any agreement to make loans or for
the provision, purchase or sale of goods, services or property between CFC or
any CFC Subsidiary and any director or officer of CFC or any CFC Subsidiary, or
any member of the immediate family or affiliate of any of the foregoing, or (v)
any agreement between CFC or any CFC Subsidiary and any 5% or more shareholder
of CFC; in each case other than agreements entered into in the ordinary course
of the banking business of CFC or a CFC Subsidiary consistent with past
practice.
(2) Neither CFC or any CFC Subsidiary, nor to the
knowledge of CFC, the other party thereto, is in default under any material
agreement, commitment, arrangement, lease, insurance policy or other instrument
whether entered into in the ordinary course of business or otherwise, nor has
there occurred any event that, with the lapse of time or giving of notice or
both, would constitute such a default, other than defaults of loan agreements by
borrowers from CFC or a CFC Subsidiary in the ordinary course of its business.
(3) Since December 31, 1999 neither CFC nor any CFC
Subsidiary has incurred or paid any obligation or liability that would be
material to CFC, except obligations incurred or paid in connection with
transactions in the ordinary course of business of CFC or a CFC Subsidiary
consistent with its practice and, except as Previous Disclosed, from December
31, 1999 to the date hereof, neither CFC nor any CFC Subsidiary has taken any
action that, if taken after the date hereof, would breach any of the covenants
contained in Section 4.4 hereof.
(p) Insurance. A complete list of all policies or binders
of fire, liability, product liability, workmen's compensation, vehicular and
other insurance held by or on behalf of
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the CFC Companies has previously been furnished to HBI and all such policies or
binders are valid and enforceable in accordance with their terms, are in full
force and effect, and insure against risks and liabilities to the extent and in
the manner customary for the industry and are deemed appropriate and sufficient
by CFC . The CFC Companies are not in default with respect to any provision
contained in any such policy or binder and have not failed to give any notice or
present any claim under any such policy or binder in due and timely fashion.
None of the CFC Companies has received notice of cancellation or non-renewal of
any such policy or binder. None of the CFC Companies has knowledge of any
inaccuracy in any application for such policies or binders, any failure to pay
premiums when due or any similar state of facts or the occurrence of any event
that is reasonably likely to form the basis for any material claim against it
not fully covered (except to the extent of any applicable deductible) by the
policies or binders referred to above. None of the CFC Companies has received
notice from any of its insurance carriers that any insurance premiums will be
increased materially in the future or that any such insurance coverage will not
be available in the future on substantially the same terms as now in effect.
(q) Loans, OREO, and Allowance for Loan Losses. (1)
Except as Previously Disclosed, and except for matters which individually or in
the aggregate, do not materially adversely affect the Reorganization or the
financial condition of CFC, to CFC's best knowledge each loan reflected as an
asset in the CFC Financial Statements (i) is evidenced by notes, agreements, or
other evidences of indebtedness which are true, genuine and what they purport to
be, (ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
terms, subject to bankruptcy, insolvency, and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles. All loans and extensions of credit which are subject to regulation
of the Federal Reserve which have been made by CFC and the CFC Subsidiaries
comply therewith.
(2) The classification on the books and records of CFC
and each CFC Subsidiary of loans and/or non-performing assets as nonaccrual,
troubled debt restructuring, OREO or other similar classification, complies in
all material respects with generally accepted accounting principles and
applicable regulatory accounting principles.
(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the CFC Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and neither CFC nor any CFC
Subsidiary has been received any notice of denial of any such claim.
(4) CFC and each CFC Subsidiary are in possession of all
of the OREO or, if any of the OREO remains occupied by the mortgagor, eviction
or summary proceedings have been commenced or rental arrangements providing for
market rental rates have been agreed upon and CFC and/or each CFC Subsidiary are
diligently pursuing such eviction of summary proceedings or such rental
arrangements. Except as Previously Disclosed, no legal proceeding or quasi-legal
proceeding is pending or, to the knowledge of CFC and each CFC Subsidiary,
threatened concerning any OREO or any servicing activity or omission to provide
a servicing activity with respect to any of the OREO.
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(5) Except as Previously Disclosed, all loans made by any
of the CFC Companies to facilitate the disposition of OREO are performing in
accordance with their terms.
(6) The allowance for possible loan losses shown on the
CFC Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of CFC as of dates subsequent to the execution of
this Agreement will be, in each case as of the dates thereof, adequate in all
material respects to provide for possible losses, net of recoveries relating to
loans previously charged off, on loans outstanding (including accrued interest
receivable) of the CFC Companies and other extensions of credit (including
letters of credit and commitments to make loans or extend credit) by CFC.
(r) Absence of Material Changes and Events. Except as
Previously Disclosed, since December 31, 1999, there has not been any material
adverse change in the condition (financial or otherwise), aggregate assets or
liabilities, cash flow, earnings or business or CFC Companies on a consolidated
basis, and each of the CFC Companies has conducted its business only in the
ordinary course consistent with past practice.
(s) Statements True and Correct. None of the information
supplied or to be supplied by CFC for inclusion in the registration statement,
the Proxy Statement or any other document to be filed with the SEC or any other
regulatory authority in connection with the transactions contemplated hereby,
will, at the respective time such documents are filed, and, in the case of the
registration statement, when it becomes effective and with respect to the Proxy
Statement, when first mailed to HBI shareholders, be false or misleading with
respect to any material fact or omit to state any material fact necessary in
order to make the statements therein not misleading, or, in the case of the
Proxy Statement or any supplement thereto, at the time of the HBI Shareholders'
Meeting, be false or misleading with respect to any material fact or omit to
state any material fact necessary to correct any statement in any earlier
communication with respect to the solicitation of any proxy for the HBI
Shareholders' Meeting. All documents that CFC is responsible for filing with the
SEC or any other regulatory authority in connection with the transactions
contemplated, hereby will comply as to form in all material respects with the
provisions of applicable law, including applicable provisions of federal and
state securities law.
(t) Brokers and Finders. Neither CFC nor any CFC
Subsidiary, nor any of their respective officers, directors or employees, has
employed any broker, finder or financial advisor or incurred any liability for
any fees or commissions in connection with the transactions contemplated herein,
except for the Scott & Stringfellow, Inc.
(u) Administration of Trust Accounts. CFC and CFC
Subsidiaries have properly administered, in all respects material and which
could reasonably be expected to be material to the business, operations or
financial condition of CFC and CFC Subsidiaries, taken as a whole, all accounts
for which they act as fiduciaries including but not limited to accounts for
which they serve as trustees, agents, custodians, personal representatives,
guardians, conservators or investment advisors, in accordance with the terms of
the governing documents and applicable state and federal law and regulation and
common law. Neither CFC nor a CFC Subsidiary, nor any director, officer or
employee of CFC or a CFC Subsidiary has committed any breach of trust with
respect to any such fiduciary account which is material to or could reasonably
be expected to be material to the business, operations or financial condition of
CFC,
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or a CFC Subsidiary, taken as a whole, and the accountings for each such
fiduciary account are true and correct in all material respects and accurately
reflect the assets of such fiduciary account in all material respects.
(v) Environmental Matters. (1) Except as Previously
Disclosed, to the best of CFC's knowledge, neither CFC nor any CFC Subsidiary
owns or leases any properties affected by toxic waste, radon gas or other
hazardous conditions or constructed in part with the use of asbestos. Each of
CFC and the CFC Subsidiaries is in substantial compliance with all Environmental
Laws applicable to real or personal properties in which it has a direct fee
ownership or, with respect to a direct interest as lessee, applicable to the
leasehold premises or, to the best knowledge of CFC and the CFC Subsidiaries,
the premises on which the leasehold is situated. Neither CFC nor any CFC
Subsidiary has received any Communication alleging that CFC or such CFC
Subsidiary is not in such compliance and, to the best knowledge of CFC and the
CFC Subsidiaries, there are no present circumstances (including Environmental
Laws that have been adopted but are not yet effective) that would prevent or
interfere with the continuation of such compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on CFC and the CFC
Subsidiaries of any liability arising under any Environmental Laws pending or,
to the best knowledge of CFC and the CFC Subsidiaries, threatened against (A)
CFC or any CFC Subsidiary, (B) any person or entity whose liability for any
Environmental Claim, CFC or any CFC Subsidiary has or may have retained or
assumed either contractually or by operation of law, or (C) any real or personal
property which CFC or any CFC Subsidiary owns or leases, or has been or is
judged to have managed or to have supervised or participated in the management
of, which liability might have a material adverse effect on the business,
financial condition or results of operations of CFC. CFC and the CFC
Subsidiaries are not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
(3) To the best knowledge of CFC and the CFC
Subsidiaries, there are no legal, administrative, arbitral or other proceedings,
or Environmental Claims or other claims, causes of action or governmental
investigations of any nature, seeking to impose, or that could result in the
imposition, on CFC or any CFC Subsidiary of any liability arising under any
Environmental Laws pending or threatened against any real or personal property
in which CFC or any CFC Subsidiary holds a security interest in connection with
a loan or a loan participation which liability might have a material adverse
effect on the business, financial condition or results of operations of CFC. CFC
and the CFC Subsidiaries are not subject to any agreement, order, judgment,
decree or memorandum by or with any court, governmental authority, regulatory
agency or third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by CFC or any CFC Subsidiary, other than OREO, CFC has made available
to HBI copies of any environmental audits, analyses and surveys that have been
prepared relating to such properties. With respect to all OREO held by CFC or
any CFC Subsidiary and all real or personal property which CFC or any CFC
Subsidiary has been or is judged to have managed or to have supervised or
participated in the management of, CFC has made available to HBI the information
relating to such OREO available to CFC. CFC and the CFC Subsidiaries are in
compliance in all material
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respects with all recommendations contained in any environmental audits,
analyses and surveys relating to any of the properties, real or personal,
described in this subsection (4).
(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern, that could reasonably form the basis of any Environmental Claim or
other claim or action or governmental investigation that could result in the
imposition of any liability arising under any Environmental Laws currently in
effect or adopted but not yet effective against CFC or any CFC Subsidiary or
against any person or entity whose liability for any Environmental Claim CFC or
any CFC Subsidiary has or may have retained or assumed either contractually or
by operation of law.
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties. HBI will keep CFC, and CFC
will keep HBI advised of all material developments relevant to their respective
businesses prior to consummation of the Reorganization. Prior to the Effective
Date, CFC, on the one hand, and HBI on the other, agree to give to the other
party reasonable access to all the premises and books and records (including tax
returns filed and those in preparation) of it and its subsidiaries and to cause
its officers to furnish the other with such financial and operating data and
other information with respect to the business and properties as the other shall
from time to time request for the purposes of verifying the warranties and
representations set forth herein; provided, however, that any such investigation
shall be conducted in such manner as not to interfere unreasonably with the
operation of the respective business of the other. CFC will designate an
individual as the transition officer for the Reorganization. The transition
officer will be an officer of CFC. HBI will provide office facilities and such
support as necessary to enable him to perform his duties. The transition
officer's duties will include (i)supervising the data processing conversion
described in Section 5.5, (ii) meeting with employees of The Heritage Bank to
familiarize them with CFC's business practices and programs and to prepare
employees for any changes that may result from the Reorganization; and (iii)
attending such meetings he deems necessary in order to gain a thorough
understanding of HBI and The Heritage Bank. The transition officer shall be
given the same reports on operations of The Heritage Bank that are given to the
President of HBI. The transition officer will have no direct contact or any
opportunities to meet with the customers of The Heritage Bank without the
written consent of HBI.
4.2 Confidentiality. Between the date of this Agreement and the
Effective Date, CFC and HBI each will maintain in confidence, and cause its
directors, officers, employees, agents and advisors to maintain in confidence,
and not use to the detriment of the other party, any written, oral or other
information obtained in confidence from the other party or a third party in
connection with this Agreement or the transactions contemplated hereby unless
such information is already known to such party or to others not bound by a duty
of confidentiality or unless such information becomes publicly available through
no fault of such party, unless use of such information is necessary or
appropriate in making any filing or obtaining any consent or approval required
for the consummation of the transactions contemplated hereby or unless the
furnishing or use of such information is required by or necessary or appropriate
in connection
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with legal proceedings. If the Reorganization is not consummated, each party
will return or destroy as much of such written information as may reasonably be
requested.
4.3 Registration Statement, Proxy Statement and Shareholder
Approval. The Board of Directors of HBI and the Board of Directors of CFC each
will duly call and will hold a meeting of shareholders as soon as practicable
for the purpose of approving the Reorganization or, in the case of CFC,
obtaining such shareholder approvals as are necessary for CFC to consummate the
Reorganization and perform its obligations under this Agreement (the "HBI
Shareholders' Meeting" and the "CFC Shareholders' Meeting", respectively).
Subject to the fiduciary duties of the Board of Directors of HBI and of CFC
(each as advised in writing by its counsel), HBI and CFC each shall use its best
efforts to solicit and obtain votes of the holders of its Common Stock in favor
of the matters presented for a vote at the HBI Shareholders' Meeting and the CFC
Shareholders' Meeting and will comply with the provisions in its Articles of
Incorporation and Bylaws relating to the call and holding of a meeting of
shareholders for such purpose. HBI will not take any action that would increase
the vote required, as described in Section 3.1(b), to approve and adopt this
Agreement and the Plan. Each member of the Boards of Directors of HBI and CFC
shall vote all shares of HBI Common Stock and CFC Common Stock under his or her
control (and not held in a fiduciary capacity) in favor of the matters presented
for a vote at the HBI Shareholders' Meeting and the CFC Shareholders' Meeting.
Without the consent of CFC and HBI, neither CFC nor HBI nor any of their
respective directors shall bid for or purchase or sell or offer to sell any
shares of CFC Common Stock during the period of twenty (20) business days that
ends seven (7) business days before the date that the Proxy Statement (as
hereafter defined) is first mailed to shareholders of HBI or CFC.
HBI and CFC each shall, at the other's request, recess or adjourn the
meeting if such recess or adjournment is deemed by the other to be necessary or
desirable. CFC and HBI will prepare jointly the proxy statement/prospectus to be
used in connection with the HBI Shareholders' Meeting and the CFC Shareholders'
Meeting (the "Proxy Statement"). Within forty-five (45) days of the date hereof,
CFC will prepare and file with the SEC the registration statement, of which such
Proxy Statement shall be a part and will use its best efforts to have the
registration statement declared effective as promptly as possible, under federal
law and the laws of any states in which the Reorganization is not an exempt
transaction.
When the registration statement or any post-effective amendment or
supplement thereto shall become effective, and at all times subsequent to such
effectiveness, up to and including the date of the meeting, such registration
statement and all amendments or supplements thereto, with respect to all
information set forth therein furnished or to be furnished by HBI relating to
the HBI Companies and by CFC relating to the CFC Companies, (i) will comply in
all material respects with the provisions of the Securities Act of 1933 and any
other applicable statutory or regulatory requirements, including applicable
state blue-sky and securities laws, and (ii) will not contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein or necessary to make the statements contained therein not
misleading; provided, however, in no event shall any party hereto be liable for
any untrue statement of a material fact or omission to state a material fact in
the registration statement made in reliance upon, and in conformity with,
written information concerning another party furnished by such other party
specifically for use in the registration statement.
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<PAGE>
CFC will use its best efforts to cause the Series A Preferred Stock to
be listed on the Nasdaq SmallCap Market. CFC will register Series A Preferred
stock under the Exchange Act and, once registered, will not take action to
terminate such registration. CFC shall use its reasonable best efforts to cause
KPMG LLP, its independent public accounting firm to deliver to HBI and HBI shall
use its reasonable best efforts to cause Yount, Hyde & Barbour, PC, its
independent public accounting firm to deliver to CFC and to its officers and
directors who sign the registration statement, a "comfort letter" or "agreed
upon procedures letter" in form customarily issued by such accountants at such
time in transactions of this type dated (a) the date of the mailing of the Proxy
Statement for the CFC Shareholders' Meeting and the date of mailing of the Proxy
Statement for the HBI Shareholders' Meeting, respectively, and (b) a date not
earlier than fourteen (14) days preceding the date of the Reorganization
Closing.
4.4 Operation of the Business of HBI and CFC. HBI and CFC each
agrees that from the date hereof to the Effective Date it will operate its
business substantially as presently operated and only in the ordinary course,
and, consistent with such operation, it will use its best efforts to preserve
intact its relationships with persons having business dealings with it. Without
limiting the generality of the foregoing, HBI and CFC each agrees that it will
not, without the prior written consent of the other:
(a) Except as Previously Disclosed, make any change in
its authorized capital stock, or issue or sell any additional shares of,
securities convertible into or exchangeable for, or options, warrants or rights
to purchase, its capital stock, nor shall it purchase, redeem or otherwise
acquire any of its outstanding shares of capital stock, provided that CFC and
HBI each may issue shares of common stock pursuant to options granted or issued
prior to the date hereof;
(b) Except as Previously Disclosed, voluntarily make any
changes in the composition of its officers, directors or other key management
personnel;
(c) Except as Previously Disclosed, make any change in
the compensation or title of any officer, director or key management employee or
make any change in the compensation or title of any other employee, other than
permitted by current employment policies in the ordinary course of business, any
of which changes shall be reported promptly to the other party;
(d) Except as Previously Disclosed, enter into any bonus,
incentive compensation, stock option, deferred compensation, profit sharing,
thrift, retirement, pension, group insurance or other benefit plan or any
employment or consulting agreement;
(e) Incur any obligation or liability (whether absolute
or contingent, excluding suits instituted against it), make any pledge, or
encumber any of its assets, nor dispose of any of its assets in any other
manner, except in the ordinary course of its business and for adequate value, or
as otherwise specifically permitted in this Agreement;
(f) Except as permitted by Section 4.4(a) hereof, issue
or contract to issue any shares of its Common Stock, options for shares of its
Common Stock, or securities exchangeable for or convertible into such shares;
(g) Knowingly waive any right of substantial value;
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(h) Enter into material transactions otherwise than in
the ordinary course of its business, including any equity investment that
exceeds $100,000;
(i) Take any action with respect to accounting methods,
principles or practices, other than changes required by applicable law or
generally accepted accounting principles or regulatory accounting as concurred
in by its independent public accounts; or make any tax election or settle or
compromise any federal, state, local or foreign tax liability;
(j) Change in any material respect its loan policies,
except as required by regulatory authorities;
(k) Alter, amend or repeal its Bylaws or Articles of
Incorporation; or
(l) Propose or take any other action which would make any
representation or warranty in Section 3.1 or Section 3.2 hereof untrue.
4.5 Dividends. CFC and HBI each agree not to pay any cash
dividends from the date of this Agreement through the Effective Date.
4.6 No Solicitation. Unless and until this Agreement shall have
been terminated pursuant to its terms, neither HBI nor any of its officers,
directors, representatives or agents shall, directly or indirectly, (i)
encourage, solicit or initiate discussions or negotiations with any person other
than CFC concerning any merger, share exchange, sale of substantial assets,
tender offer, sale of shares of capital stock or similar transaction involving
HBI, (ii) enter into any agreement with any third party providing for a business
combination transaction, equity investment or sale of a significant amount of
assets, or (iii) furnish any information to any other person relating to or in
support of such transaction. HBI will promptly communicate to CFC the terms of
any proposal which it may receive in respect to any of the foregoing
transactions. Unless and until the Effective Date or until this Agreement shall
have been terminated pursuant to its terms, neither CFC nor any of its officers,
directors, representatives or agents shall enter into any agreement or letter of
intent that provides for the acquisition by CFC of substantially all of the
assets or voting stock of a third party.
4.7 Regulatory Filings. CFC and HBI shall prepare jointly all
regulatory filings required to consummate the transactions contemplated by the
Agreement and the Plan and submit the filings for approval with the Federal
Reserve Board and the SCC, and any other governing regulatory authority, as soon
as practicable after the date hereof. The applications of CFC to the Federal
Reserve and SCC shall include a request for permission for The Heritage Bank to
pay a dividend of $3.0 million on the Effective Date. CFC and HBI shall use
their best efforts to obtain approvals of such filings.
4.8 Public Announcements. Each party will consult with the other
before issuing any press release or otherwise making any public statements with
respect to the Reorganization and shall not issue any such press release or make
any such public statement prior to such consultations except as may be required
by law.
4.9 Notice of Breach. CFC and HBI will give written notice to the
other promptly
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<PAGE>
upon becoming aware of the impending or threatened occurrence of any event which
would cause or constitute a breach of any of the representations, warranties or
covenants made to the other party in this Agreement and will use its best
efforts to prevent or promptly remedy the same.
4.10 Reorganization Consummation. Subject to the terms and
conditions of this Agreement, each party shall use its best efforts in good
faith to take, or cause to be taken, all actions, and to do or cause to be done
all things necessary, proper or desirable, or advisable under applicable laws,
as promptly as practicable so as to permit consummation of the Reorganization at
the earliest possible date, consistent with Section 1.3 herein, and to otherwise
enable consummation of the transactions contemplated hereby and shall cooperate
fully with the other parties hereto to that end, and each of HBI and CFC shall
use, and shall cause each of their respective subsidiaries to use, its best
efforts to obtain all consents (governmental or other) necessary or desirable
for the consummation of the transactions contemplated by this Agreement.
4.11 Adjustments.
(a) HBI and CFC shall consult and cooperate with each
other with respect to determining the amount and the timing for recognizing for
financial accounting purposes the expenses of the Reorganization and the
restructuring charges related to or to be incurred in connection with the
Reorganization, provided that any such accounting shall be in accordance with
generally accepted accounting principles.
(b) At the request of CFC, HBI shall sell investment
securities in order to conform its securities portfolio to the amounts, types
and maturities that CFC deems advisable. At the request of CFC, HBI shall
promptly establish and take such reserves and accruals as CFC shall request in
order to conform on a mutually satisfactory basis, HBI's loan, accrual and
reserve policies to CFC's policies. It is the objective of CFC and HBI that such
reserves, accruals and charges be taken on or before the Effective Date.
However, no such securities sales and no such reserves and
accruals shall be deemed to have a Material Adverse Effect on HBI, and HBI shall
not be obligated to take any such action pursuant to this Section 4.11(b) unless
and until (i) all conditions to the obligations of HBI and CFC to consummate the
Reorganization set forth in Sections 6.1 through 6.3 have been waived or
satisfied by the appropriate party, and (ii) such reserves, accruals and charges
conform with generally accepted accounting principles, applicable laws,
regulations, and the requirements of governmental entities.
4.12 Certain Payments. Notwithstanding Section 4.4, HBI, in
consultation and concurrence with CFC, may agree to pay bonuses and/or grant
stock options to key employees who are not to be offered continued employment by
CFC or who determine not to continue employment with CFC to induce such
employees to remain employees of HBI until the Effective Date, or such date
after the Effective Date that is necessary to protect the parties' business
interests. Unless CFC consents, such payments will not exceed $50,000 in the
aggregate and options will not be granted on more than 8,000 shares of HBI
Common Stock.
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ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options. (a) On the Effective Date, all
rights with respect to HBI Common Stock pursuant to stock options ("HBI
Options") granted by HBI under an HBI stock option plan which are outstanding on
the Effective Date, whether or not they are exercisable, shall be converted into
and become rights with respect to CFC Common Stock, and CFC shall assume each
HBI Option in accordance with the terms of the stock option plan under which it
was issued and the stock option agreement, including amounts vested and any
vesting schedule, by which it is evidenced. From the Effective Date forward, (i)
each HBI Option assumed by CFC may be excised solely for shares of CFC Common
Stock, (ii) the number of shares of CFC Common Stock subject to each HBI Option
shall be equal to the number of shares of HBI Common Stock subject to such
option immediately prior to the Effective Date multiplied by Option Conversion
Ratio (as hereafter defined) and (iii) the per share exercise price under each
such HBI Option shall be adjusted by dividing the per share exercise price under
each such option by Option Conversion Ratio and rounding down to the nearest
cent; provided, however, that the terms of each HBI Option shall, in accordance
with its terms, be subject to further adjustment as appropriate to reflect any
stock split, stock dividend, recapitalization or other similar transaction after
the Effective Date. It is intended that the foregoing assumption shall be
undertaken in a manner that will not constitute a "modification" as defined in
Section 424 of the IRC, as to any stock option which is an "incentive stock
option." The "Option Conversion Ratio" shall mean the fraction, the numerator of
which is $6.00 and the denominator of which is equal to the average last sale
price of CFC Common Stock for the twenty (20) trading day period ending on the
Effective Date.
5.2 Benefit Plans. (a) Upon consummation of the Reorganization,
employees of HBI shall be entitled to participate in CFC pension, benefit,
health and similar plans on the same terms and conditions as employees of CFC
and its subsidiaries, without waiting periods or exceptions for pre-existing
conditions and giving effect to years of service with HBI as if such service
were with CFC. CFC also shall cause HBI to honor in accordance with their terms
as in effect on the date hereof (or as amended after the date hereof with the
prior written consent of CFC), all employment, severance, consulting and other
compensation contracts and agreements Previously Disclosed and executed in
writing by HBI on the one hand and any individual current or former director,
officer or employee thereof on the other hand, copies of which have previously
been delivered by HBI to CFC. Employees of HBI shall receive credit under CFC's
group health plans for all deductibles and co-payments made by such employees
under the group health plans maintained by HBI prior to the Effective Date.
(b) For a period of six months following the Effective Date, CFC
agrees not to amend or terminate HBI's current severance policy and agrees that
any employee of HBI whose employment is terminated within six months of the
Effective Date for reasons other than cause shall be entitled to severance
benefits in the amounts determined in accordance with such severance policy. For
the purpose of this provision, "cause" shall mean personal dishonesty,
incompetence, intentional failure to perform stated duties, willful misconduct,
breach of fiduciary duty involving personal profit, conviction of a felony, or
willful violation of any law, rule or regulation (other than traffic violations
or similar offenses).
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5.3 Indemnification. CFC agrees that following the Effective Date,
it shall indemnify and hold harmless any person who has rights to
indemnification from HBI, to the same extent and on the same conditions as such
person is entitled to indemnification pursuant to Virginia law and HBI's
Articles of Incorporation or Bylaws, as in effect on the date of this Agreement,
to the extent legally permitted to do so, with respect to matters occurring on
or prior to the Effective Date. CFC further agrees that any such person who has
rights to indemnification pursuant to this Section 5.3 is expressly made a third
party beneficiary of this Section 5.3 and may directly, in such person's
personal capacity, enforce such rights through an action at law or in equity or
through any other manner or means of redress allowable under Virginia law to the
same extent as if such person were a party hereto. Without limiting the
foregoing, in any case in which corporate approval may be required to effectuate
any indemnification, CFC shall direct, at the election of the party to be
indemnified, that the determination of permissibility of indemnification shall
be made by independent counsel mutually agreed upon between CFC and the
indemnified party. CFC shall apply to its directors and officers liability
insurance carrier for coverage for persons who are currently covered by such
insurance of HBI and shall purchase and maintain such insurance for three years
after the Effective Date for coverage not to exceed $15,000 per year for such
individuals.
5.4 Agreement with Terrie G. Spiro. Notwithstanding Section 4.4,
an agreement with Terrie G. Spiro in the form of Exhibit D hereto has been
executed by The Heritage Bank, HBI, CFC, and such parties will take all steps
necessary and desirable to perform such agreement.
5.5 Data Processing. CFC and HBI agree to use their best efforts
to take all steps necessary, including HBI's notification to its outside data
processing service provider of its intent to terminate its data processing
contract, to coordinate and effect, no later than five business days following
the Effective Date of the Merger, the transition of the data processing systems
of HBI and The Heritage Bank to those of CFC. The termination by HBI of its data
processing contract as provided in this paragraph shall not constitute a breach
of any warranty, representation or covenant contained in this Agreement.
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to Each Party's Obligations to Effect the
Reorganization. The respective obligations of each of CFC and HBI to effect the
Reorganization and the other transactions contemplated by this Agreement shall
be subject to the fulfillment or waiver at or prior to the Effective Date of the
following conditions:
(a) Shareholder Approvals. Shareholders of HBI and CFC
shall have approved all matters relating to this Agreement and the
Reorganization required to be approved by such shareholders in accordance with
Virginia law and the requirements of The Nasdaq Stock Market, including, but not
limited to the election of HBI Directors to the Cardinal Board of Directors in
accordance with Section 1.2(a).
(b) Regulatory Approvals. This Agreement and the Plan
(including permission for The Heritage Bank to pay a $3.0 million dividend on
the Effective Date) shall
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have been approved by the Federal Reserve, the SCC, and any other regulatory
authority whose approval is required for consummation of the transactions
contemplated hereby, and such approvals shall not have imposed any condition or
requirement which would so materially adversely impact the economic or business
benefits of the transactions contemplated by this Agreement as to render
inadvisable the consummation of the Reorganization in the reasonable opinion of
the Board of Directors of CFC or HBI.
(c) Registration Statement. The registration statement
shall have been declared effective and shall not be subject to a stop order or
any threatened stop order.
(d) Tax Opinion. CFC and HBI shall have received an
opinion of Williams, Mullen, Clark & Dobbins, or other counsel reasonably
satisfactory to CFC and HBI, to the effect that the Reorganization will
constitute a reorganization within the meaning of Section 368 of the IRC and
that no gain or loss will be recognized by the shareholders of HBI to the extent
they receive Series A Preferred Stock in exchange for their HBI Common Stock in
the Reorganization. Such opinion shall be reasonably satisfactory to each of the
parties and counsel to HBI.
(e) Opinions of Counsel. HBI shall have delivered to CFC
and CFC shall have delivered to HBI opinions of counsel, dated as of the
Effective Date, as to such matters as they may each reasonably request with
respect to the transactions contemplated by this Agreement and in a form
reasonably acceptable to each of them.
(f) Legal Proceedings. Neither CFC nor HBI shall be
subject to any order, decree or injunction of a court or agency of competent
jurisdiction which enjoins or prohibits the consummation of the Reorganization.
(g) Articles of Amendment. The Articles of Amendment in
the form attached hereto shall have been filed with the SCC, reflecting an
effective date prior to date of the Reorganization closing.
6.2 Conditions to Obligations of CFC. The obligations of CFC to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of HBI shall be true and correct
as of the date of the Original Agreement and upon the Effective Date with the
same effect as though all such representations and warranties had been made on
the Effective Date, except (i) for any such representations and warranties made
as of a specified date, which shall be true and correct as of such date, (ii) as
expressly contemplated by this Agreement, or (iii) for representations and
warranties the inaccuracies of which relate to matters that, individually or in
the aggregate, do not materially adversely affect the Reorganization and the
other transactions contemplated by this Agreement and CFC shall have received a
certificate or certificates signed by the Chief Executive Officer and Chief
Financial Officer of HBI dated the Effective Date, to such effect.
(b) Performance of Obligations. HBI shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective
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Date, and CFC shall have received a certificate signed by the Chief Executive
Officer of HBI to that effect.
(c) Affiliate Letters. Each shareholder of HBI who may be
deemed by counsel for CFC to be an "affiliate" of HBI within the meaning of Rule
145 under the Securities Act of 1933 shall have executed and delivered a
commitment and undertaking to the effect that (1) such shareholder will dispose
of the shares of Series A Preferred Stock received by him or her in connection
with the Reorganization only in accordance with the provisions of paragraph (d)
of Rule 145; (2) such shareholders will not dispose of any such shares until CFC
has received an opinion of counsel acceptable to it that such proposed
disposition will not violate the provisions of any applicable securities laws;
and (3) the certificates representing said shares may bear a conspicuous legend
referring to the forgoing restrictions.
(d) Investment Banking Letter. CFC shall have received a
written opinion in form and substance satisfactory to CFC from Scott &
Stringfellow, Inc. addressed to CFC and dated the date the Proxy Statement is
mailed to shareholders of CFC, to the effect that the terms of the
Reorganization, are fair, from a financial point of view, to CFC.
6.3 Conditions to Obligations of HBI. The obligations of HBI to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of CFC shall be true and correct
as of the date of the Original Agreement and upon the Effective Date with the
same effect as though all such representations and warranties had been made on
the Effective date, except (i) for any such representations and warranties made
as of a specified date, which shall be true and correct as of such date, (ii) as
expressly contemplated by this Agreement, or (iii) for representations and
warranties the inaccuracies of which relate to matters that, individually or in
the aggregate, do not materially adversely affect the Reorganization and the
other transactions contemplated by this Agreement and HBI shall have received a
certificate or certificates signed by the Chief Executive Officer and Chief
Financial Officer of CFC dated the Effective Date, to such effect.
(b) Performance of Obligations. CFC shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective Date, and HBI shall have received a
certificate signed by Chief Executive Officer of CFC to that effect.
(c) Investment Banking Letter. HBI shall have received a
written opinion in form and substance satisfactory to HBI from Ferris, Baker
Watts, Incorporated addressed to HBI and dated the date the Proxy Statement is
mailed to shareholders of HBI, to the effect that the terms of the
Reorganization, are fair, from a financial point of view, to HBI.
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ARTICLE 7
Termination
7.1 Termination. Notwithstanding any other provision of this
Agreement, and notwithstanding the approval of this Agreement and the Plan by
the shareholders of CFC and HBI, this Agreement may be terminated and the
Reorganization abandoned at any time prior to the Effective Date:
(a) By the mutual consent of the Board of Directors of
each of CFC and HBI;
(b) By the respective Boards of Directors of CFC or HBI
if the conditions set forth in Section 6.1 have not been met or waived by CFC
and HBI;
(c) By the Board of Directors of CFC if the conditions
set forth in Section 6.2 have not been met or waived by CFC;
(d) By the Board of Directors of HBI if the conditions
set forth in Section 6.3 have not been met or waived by HBI;
(e) By the respective Boards of Directors CFC or HBI if
the Reorganization is not consummated by December 31, 2000;
(f) By the Board of Directors of CFC if the Board of
Directors of HBI receives a subsequent offer to acquire HBI and does not within
fourteen (14) days after receipt of such subsequent offer confirm in writing to
CFC that each member of the Board of Directors of HBI supports the
Reorganization, will vote his shares of HBI Common Stock in favor of the
Reorganization, and will recommend to the shareholders of HBI that they approve
the Reorganization; or
(g) By the Board of Directors of HBI if, before the
Effective Date, CFC shall enter into any agreement or letter of intent providing
for the direct or indirect acquisition of substantially all of the assets and
liabilities or voting stock of CFC.
7.2 Effect of Termination. In the event of the termination and
abandonment of this agreement and the Reorganization pursuant to Section 7.1,
this Agreement shall become void and have no effect, except that (i) the last
sentence of Section 4.2 and all of Sections 4.8 and 7.4 shall survive any such
termination and abandonment and (ii) no party shall be relieved or released from
any liability arising out of an intentional breach of any provision of this
Agreement.
7.3 Non-Survival of Representations, Warranties and Covenants.
Except for Sections 1.2(a), 1.4, 2.1, 2.2, 2.3, 2.4, 5.1, 5.2, 5.3 and 7.4 of
this Agreement, none of the respective representations and warranties,
obligations, covenants and agreements of the parties shall survive the Effective
Date, provided that no such representations, warranties, obligations, covenants
and agreements shall be deemed to be terminated or extinguished so as to deprive
CFC or HBI (or any director, officer, or controlling person thereof) of any
defense in law or equity which otherwise would be available against the claims
of any person, including without
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limitation any shareholder or former shareholder of either CFC or HBI.
7.4 Expenses. The parties provide for the payment of expenses as
follows:
(a) Except as provided in Section 7.4(b) or in Section
7.4(c), each of the parties shall bear and pay all costs and expenses incurred
by it or on its behalf in connection with the transactions contemplated herein,
including fees and expenses of its own consultants, investment bankers,
accountants and counsel.
(b) If for any reason the Reorganization is not approved
by the shareholders of either party, it shall bear and pay 50% of the costs and
expenses incurred by the other with respect to the accountants, counsel,
printers and persons involved in the transactions contemplated by this
Agreement, including the preparation of the registration statement and the Proxy
Statement.
(c) If this Agreement is terminated by CFC pursuant to
Section 7.1(f), then HBI shall pay all of the costs and expenses incurred by CFC
relating to the Reorganization including, fees and expenses of consultants,
investment bankers, accountants, counsel, printers and persons involved in the
transactions contemplated by this Agreement, including the preparation of the
registration statement and the Proxy Statement.
(d) Any liability to the other incurred by HBI or CFC
pursuant to this Section 7.4 shall not exceed a total of $200,000.
(e) Final settlement with respect to the payment of such
fees and expenses by the parties shall be made within thirty (30) days after the
termination of this Agreement.
ARTICLE 8
General Provisions
8.1 Entire Agreement. This Agreement contains the entire agreement
among CFC and HBI with respect to the Reorganization and the related
transactions and supersedes all prior arrangements or understandings with
respect thereto.
8.2 Waiver and Amendment. Any term or provision of this Agreement
may be waived in writing at any time by the party which is, or whose
shareholders are, entitled to the benefits thereof, and this Agreement may be
amended or supplemented by written instructions duly executed by the parties
hereto at any time, whether before or after the meetings of HBI and CFC
shareholders referred to in Section 6.1(a) hereof, except statutory requirements
and requisite approvals of shareholders and regulatory authorities.
8.3 Descriptive Headings. Descriptive headings are for convenience
only and shall not control or affect the meaning and construction of any
provisions of this Agreement.
8.4 Governing Law. Except as required otherwise or otherwise
indicated herein, this Agreement shall be construed and enforced according to
the laws of the Commonwealth of Virginia.
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8.5 Notices. All notices or other communications which are
required or permitted hereunder shall be in writing and sufficient if delivered
personally or sent by registered or certified mail, postage prepaid, addressed
as follows:
If to CFC:
L. Burwell Gunn, President
Cardinal Financial Corporation
10555 Main Street, Suite 500
P. O. Box 1147
Fairfax, Virginia 22030
(Tel. 703- 279-5060)
Copy to:
Wayne A. Whitham, Jr.
Williams, Mullen, Clark & Dobbins
1021 East Cary Street
P.O. Box 1320
Richmond, Virginia 23210-1320
(Tel. 804-783-6473)
If to HBI :
Terrie G. Spiro, President
and Harold E. Lieding, Chairman of the Board
Heritage Bancorp, Inc.
1313 Dolley Madison Boulevard
McLean, Virginia 22101-7207 (Tel. 703-873-0320)
Copy to:
Richard A. Schaberg
Thacher Proffitt & Wood
1700 Pennsylvania Avenue, N.W.
Washington, DC 20006
(Tel. 202-626-5630)
8.6 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original, but such counterparts together
shall constitute one and the same agreement.
8.7 Severability. In the event any provisions of this Agreement
shall be held invalid or unenforceable by any court of competent jurisdiction,
such holding shall not invalidate or render unenforceable any other provisions
hereof. Any provision of this Agreement held invalid or unenforceable only in
part or degree shall remain in full force and effect to the extent not held
invalid or unenforceable. Further, the parties agree that a court of competent
jurisdiction may reform any provision of this Agreement held invalid or
unenforceable so as to reflect the intended agreement of the parties hereto.
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8.8 Subsidiaries. All representations, warranties, and covenants
herein, where pertinent, include and shall apply to the wholly owned
subsidiaries belonging to the party making such representations, warranties, and
covenants.
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be executed in counterparts by their duly authorized officers and
their corporate seals to be affixed hereto, all as of the dates first written
above.
CARDINAL FINANCIAL CORPORATION
By:
-------------------------------------
L. Burwell Gunn, Jr.
President and Chief Executive Officer
ATTEST:
---------------------------------
Secretary
CARDINAL MERGER CORP.
By:
-------------------------------------
L. Burwell Gunn, Jr.
President and Chief Executive Officer
ATTEST:
---------------------------------
Secretary
HERITAGE BANCORP, INC.
By:
-------------------------------------
Terrie G. Spiro
President and Chief Executive Officer
ATTEST:
---------------------------------
Secretary
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HERITAGE BANCORP, INC.
BOARD OF DIRECTORS
Each of the undersigned members of the Board of Directors of Heritage
Bancorp, Inc. agrees to be bound by his or her personal obligations as provided
in Section 4.3 and 4.6 of this Agreement.
-------------------------------- --------------------------------
Harold E. Lieding Terrie G. Spiro
-------------------------------- --------------------------------
George K. Degnon Kevin P. Tighe
-------------------------------- --------------------------------
Philip F. Herrick, Jr. Stanley I. Richards
-------------------------------- --------------------------------
George P. Shafran Ronald W. Kosh
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CARDINAL FINANCIAL CORPORATION
BOARD OF DIRECTORS
Each of the undersigned members of the Board of Directors of Cardinal
Financial Corporation agrees to be bound by his or her personal obligations as
provided in Section 4.3 and 4.6 of this Agreement.
-------------------------------- --------------------------------
Robert M. Barlow Wayne W. Broadwater
-------------------------------- --------------------------------
Nancy K. Falck L. Burwell Gunn, Jr.
-------------------------------- --------------------------------
Anne B. Hazel Harvey W. Huntzinger
-------------------------------- --------------------------------
Jones V. Isaac Dale B. Peck
-------------------------------- --------------------------------
James D. Russo John S. Rust, Jr.
--------------------------------
J. Hamilton Lambert
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EXHIBIT A
to the
Agreement and Plan
of Reorganization
PLAN OF MERGER
BETWEEN
HERITAGE BANCORP, INC.
AND
CARDINAL MERGER CORP.
Pursuant to this Plan of Merger ("Plan of Merger"), Heritage Bancorp,
Inc. ("HBI"), a Virginia corporation, shall merge with and into Cardinal Merger
Corp. ("CMC"), a Virginia corporation and wholly-owned subsidiary of Cardinal
Financial Corporation ("CFC"), a Virginia corporation, in a merger under Section
13.1-716 of the Virginia Stock Corporation Act.
ARTICLE 1
Terms of the Merger
Subject to the terms and conditions of the Amended and Restated
Agreement and Plan of Reorganization, dated as of June __, 2000 between HBI, CFC
and CMC (the "Agreement"), at the Effective Date, HBI shall merge with and into
CMC, which shall be the surviving corporation. Each outstanding share of common
stock of HBI shall be converted into and exchanged for cash and shares of the
preferred stock of CFC in accordance with Section 2.1 of this Plan of Merger and
Section 13.1-716 of the Virginia Stock Corporation Act (the "Merger"). At the
Effective Date, the Merger shall have the effect as provided in Section 13.1-721
of the Virginia Stock Corporation Act. Unless otherwise specified herein,
capitalized terms in this Plan of Merger shall have the same meaning as in the
Agreement.
ARTICLE 2
Manner of Converting Shares
2.1 Conversion of Shares.
(a) Conversion of HBI Stock. At the Effective Date, by virtue of
the Merger and without any action on the part of the holders thereof, each share
of common stock, par value $1.00 per share, of HBI ("HBI Common Stock") issued
and outstanding immediately prior to the Effective Date shall cease to be
outstanding and (other than dissenting shares) shall be converted into and
exchanged either for $6.00 in cash or 1.2 shares of 7.25% Cumulative Convertible
Preferred Stock, Series A of CFC ("Series A Preferred Stock") and cash for
fractional shares. Each holder of shares of HBI Common Stock shall thereafter
cease to have any rights with
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respect to such HBI Common Stock, except the consideration described in Sections
2.1 and 2.4 upon the surrender of such certificate in accordance with Section
2.2.
The form of consideration into which each individual shareholder's
shares of HBI Common Stock will be converted will be determined in the manner
described in Sections 2.1(b) and 2.1(c).
(b) Election of Consideration. By written notice to CFC in the
manner described below, each HBI shareholder may elect the form of consideration
(shares of Series A Preferred Stock or cash) into which his or her shares of HBI
Common Stock will be converted on the Effective Date; provided that despite such
elections, shareholders of HBI may be required to receive a different amount of
cash or shares of Series A Preferred Stock in the event of a proration pursuant
to Section 2.1(c). Within ten (10) days following approval of this Agreement and
the Plan of Merger by HBI's shareholders, HBI will mail written instructions to
each of its shareholders for making the election, together with a form (a
"Notice of Election") which each shareholder shall be required to use to make
such election. HBI's notice shall specify a date by which a shareholder's
election must be made (the "Election Date," which shall be twenty (20) days
following the date the instructions and Notice of Election form are first
distributed to HBI's shareholders). The instructions and Notice of Election
distributed to HBI's shareholders shall be provided by and in a form
satisfactory to CFC and HBI.
In order to make an effective election, a shareholder must deliver to
CFC a properly completed Notice of Election on or before the close of its
business on the Election Date in accordance with CFC's instructions. Each
shareholder may elect any combination of cash and Series A Preferred Stock. Any
shareholder who does not make an election or whose Notice of Election is not
timely received by CFC or otherwise is not made in accordance with CFC's
instructions will be deemed to have elected that each share of the shareholder's
HBI Common Stock be converted into the right to receive $6.00 in cash.
(c) Limit on Election; Proration of Cash and Series A Preferred
Stock. Notwithstanding anything contained herein to the contrary, in no event
shall cash be paid (whether pursuant to shareholders' elections to receive cash,
proration or exercise of dissenters' rights) for more or less than 50% of the
total outstanding shares of HBI Common Stock.
(i) If the aggregate number of shares of HBI Common Stock
held by the HBI shareholders who dissent and by HBI shareholders who
effectively elect (and who are deemed to have elected) as provided
above to receive cash is more than 50% of the total outstanding shares
of HBI Common Stock then, in the case of each shareholder who has
effectively elected to receive cash for any or all of his or her shares
of HBI Common Stock, CFC will reduce (by the same percentage for each
such shareholder and by rounding to the nearest full share) the number
of shares of HBI Common Stock held by such shareholders for which cash
will be paid, such that the aggregate number of shares of HBI Common
Stock for which cash will be paid is as nearly equal as possible to 50%
of the total outstanding shares of HBI Common Stock and each share held
by each such shareholder for which cash will not be paid will be
converted into 1.2 shares of Series A Preferred Stock.
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(ii) If the aggregate number of shares of HBI Common Stock
held by the HBI shareholders who dissent and by HBI shareholders who
effectively elect (and who are deemed to have elected) as provided
above to receive cash is less than 50% of the total outstanding shares
of HBI Common Stock, then, in the case of each shareholder who
effectively has elected to receive Series A Preferred Stock for any or
all of his or her shares of HBI Common Stock, CFC will reduce (by the
same percentage for each such shareholder and by rounding to the
nearest full share) the number of shares of HBI Common Stock that will
be converted into Series A Preferred Stock such that the aggregate
number of shares of HBI Common Stock to be converted into Series A
Preferred Stock is as nearly equal as possible to 50% of the total
outstanding shares of HBI Common Stock and each share held by each such
shareholder which will not be converted into Series A Preferred Stock
will be converted into $6.00 in cash.
(iii) A shareholder who beneficially owns HBI Common Stock
in more than one account or capacity may direct how cash and shares of
Series A Preferred Stock will be allocated among such accounts.
2.2 Exchange and Payment Procedures. Following the Effective Date,
certificates representing shares of HBI Common Stock outstanding at the
Effective Time (herein sometimes referred to as "Old Certificates") shall
evidence only the right of the registered holder thereof to receive, and may be
exchanged for, the form of consideration into which each individual
shareholder's shares of HBI Common Stock have been converted as determined by
and based on the shareholder's election in the manner described in Sections
2.1(b) and 2.1(c).
As promptly as practicable following the Effective Date, CMC shall send
or cause to be sent to each former shareholder of the HBI of record immediately
prior to the Effective Date written instructions and transmittal materials (a
"Transmittal Letter") for use in surrendering Old Certificates to American Stock
Transfer & Trust Company ("the Transfer Agent"). Upon the proper surrender and
delivery to the Transfer Agent (in accordance with CFC's instructions, and
accompanied by a properly completed Transmittal Letter) by a former shareholder
of the HBI of his or her Old Certificate(s), and in exchange therefor, the
Transfer Agent shall, (i) in the case of a shareholder whose HBI Common Stock
has been converted into Series A Preferred Stock, issue, register and deliver to
the shareholder a certificate evidencing the number of shares of Series A
Preferred Stock to which the shareholder is entitled and/or (ii) in the case of
a shareholder whose HBI Common Stock has been converted into the right to
receive cash, issue and deliver to the shareholder a check in the amount of cash
to which the shareholder is entitled.
Following the Effective Time there shall be no further transfers of HBI
Common Stock on the stock transfer books of the HBI or the registration of any
transfer of an Old Certificate by any holder thereof, and the surrender of each
Old Certificate as provided herein must be made by or on behalf of its holder of
record at the Effective Date.
2.3 Conversion of Stock Options. On the Effective Date, all rights
with respect to HBI Common Stock pursuant to stock options ("HBI Options")
granted by HBI under a HBI stock option plan which are outstanding on the
Effective Date, whether or not then exercisable, shall be converted into and
become rights with respect to CFC Common Stock, and CFC shall
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assume each HBI Option in accordance with the terms of the stock option plan
under which it was issued and the stock option agreement, including amounts
vested and any vesting schedule by which it is evidenced. From the Effective
Date forward, (i) each HBI Option assumed by CFC may be exercised solely for
shares of CFC Common Stock, (ii) the number of shares of CFC Common Stock
subject to each HBI Option shall be equal to the number of shares of HBI Common
Stock subject to such option immediately prior to the Effective Date multiplied
by the Option Conversion Ratio and (iii) the per share exercise price under each
such HBI Option shall be adjusted by dividing the per share exercise price under
each such option by the Option Conversion Ratio and rounding down to the nearest
cent; provided, however, that the terms of each HBI Option shall, in accordance
with its terms, be subject to further adjustment as appropriate to reflect any
stock split, stock dividend, recapitalization or other similar transaction after
the Effective Date. It is intended that the forgoing assumption shall be
undertaken in a manner that will not constitute a "modification" as defined in
Section 425 of the Internal Revenue Code of 1986, as to any stock option which
is an "incentive stock option." The "Option Conversion Ratio" shall mean the
fraction, the numerator of which is $6.00 and the denominator of which is equal
to the average last sale price of CFC Common Stock for the twenty (20) trading
day period ending on the Effective Date.
2.4 No Fractional Shares. No certificates or scrip for fractional
shares of Series A Preferred Stock will be issued. In lieu thereof, CFC will pay
the value of such fractional shares in cash on the basis of $5.00 per share of
Series A Preferred Stock.
2.5 Dividends. No dividend or other distribution payable to the
holders of record of CFC Common Stock at or as of any time after the Effective
Date shall be paid to the holder of any certificate representing shares of HBI
Common Stock issued and outstanding immediately prior to the Effective Date
until such holder physically surrenders such certificate for exchange as
provided in Section 2.3, promptly after which time all such dividends or
distributions shall be paid by CFC (without interest).
2.6 Rights of Dissenting Shareholders. Shareholders of HBI and CFC
will be entitled to the dissenters' rights and remedies set forth in sections
13.1-729 through 13.1-741 of the Virginia Stock Corporation Act.
ARTICLE 3
Termination
This Plan of Merger may be terminated at any time prior to the
Effective Date by the parties hereto as provided in Article 7 of the Amended and
Restated Agreement and Plan of Reorganization, dated as of June __, 2000,
between the parties.
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ARTICLE 4
Name, Charter and Bylaws
At the Effective Date, the name, Charter of HBI and bylaws of HBI shall
be the name, Charter and bylaws of CMC.
CARDINAL FINANCIAL CORPORATION
By:__________________________________
L. Burwell, Gunn, Jr., President and Chief
Executive Officer
CARDINAL MERGER CORP.
By:__________________________________
L. Burwell, Gunn, Jr., President and Chief
Executive Officer
HERITAGE BANCORP, INC.
By:________________________________
Terrie G. Spiro, President and Chief
Executive Officer
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EXHIBIT B
to the Agreement and
Plan of Reorganization
ARTICLES OF AMENDMENT
TO THE
ARTICLES OF INCORPORATION
OF
CARDINAL FINANCIAL CORPORATION
A. The name of the Corporation is Cardinal Financial Corporation.
B. The following resolution, setting forth the designation and
the number of shares of a series of Preferred Stock ($1.00 par value) of the
Corporation and the relative rights and preferences thereof, was duly adopted by
the Board of Directors of the Corporation at a meeting held on _______ __, 2000:
RESOLVED, that ___________ authorized but unissued shares of this
Corporation's Preferred Stock ($1.00 par value) are hereby designated as a
series of Preferred Stock called the 7.25% Cumulative Convertible Preferred
Stock, Series A (the "Series A Preferred Stock"), with the following voting
powers, rights and preferences:
1. Dividends.
(a) The holders of the outstanding shares of Series A
Preferred Stock shall be entitled to receive, if, when and as declared by the
Board of Directors of the Corporation, out of any funds legally available
therefor, cash dividends at the rate and payable on the dates hereinafter set
forth. The rate of dividends payable on the Series A Preferred Stock shall be
$.3625 per share per annum and no more. Dividends shall be payable in equal
quarterly installments on the last day of March, June, September and December of
each year, commencing on the last day of the calendar quarter in which the
Corporation and Heritage Bancorp, Inc. merge. Dividends shall be cumulative and
accrue on the Series A Preferred Stock from and after the date of issuance
thereof. Dividends payable on the last day of the calendar quarter in which the
Corporation and Heritage Bancorp, Inc. merge or on any other date which is not
the last day of March, June, September or December shall be calculated on the
basis of a 360 day year and the actual number of days elapsed.
(b) No dividend whatsoever shall be declared or paid
upon, or any sum set apart for the payment of dividends upon any shares of
Parity Stock for any dividend period unless a like proportionate dividend for
the same dividend period (in proportion to the respective
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annual dividend rates per share set forth in the Articles of Incorporation or
the respective Articles of Amendment) shall have been declared and paid upon, or
declared and a sufficient sum set apart for the payment of such dividend upon,
all shares of Series A Preferred Stock outstanding.
(c) Unless Dividends Accrued on all outstanding shares of
Series A Preferred Stock and any outstanding shares of Parity Stock due for all
past dividend periods shall have been declared and paid, or declared and a sum
sufficient for the payment thereof set apart, and full dividends (to the extent
that the amount thereof shall have become determinable) on all outstanding
shares of such stock due on the respective next following payment dates shall
have been declare and a sum sufficient for the payment thereof set apart then
(i) no dividend (other than a dividend payable solely in Common Stock) shall be
declared or paid upon, or any sum set apart for the payment of dividends on any
shares of Junior Stock; (ii) no other distribution shall be made upon any shares
of Junior Stock; (iii) no shares of Junior Stock shall be purchased, redeemed or
otherwise acquired for value by the Corporation or by any Subsidiary; and (iv)
no monies shall be paid into or set apart or made available for a sinking or
other like fund for the purchase, redemption or other acquisition for value of
any shares of Junior Stock by the Corporation or any Subsidiary.
2. Voting Rights.
The holders of the outstanding shares of Series A Preferred
Stock shall not be entitled to receive notice of, or to participate in, or to
vote on any matter at any meeting of the stockholders of the Corporation, except
to the extent that such holders are afforded a vote by the laws of the
Commonwealth of Virginia in existence at the time any matter requiring such vote
shall arise.
3. Liquidation.
In the event of liquidation, dissolution or winding up of the
affairs of the Corporation, the holders of shares of Series A Preferred Stock
then outstanding shall be entitled to be paid in cash out of the net assets of
the Corporation, including its capital, a liquidation price of $5.00 per share,
plus Dividends Accrued to the date of payment, and no more, before any
distribution or payment shall be made to the holders of shares of Junior Stock
and after payment to the holders of the outstanding shares of Series A Preferred
Stock and to the holders of shares of other classes and series of Parity Stock
of the amounts to which they are respectively entitled, the balance of such
assets, if any, shall be paid to the holders of the Junior Stock according to
their respective rights. For the purposes of the preceding sentence, neither the
consolidation of the Corporation with nor the merger of the Corporation into any
other corporation nor the sale, lease or other disposition of all or
substantially all of the Corporation's properties and assets shall, without
further corporate action, be deemed a liquidation, dissolution or winding up of
the affairs of the Corporation. In case the net assets of the Corporation are
insufficient to pay the holders of the outstanding shares of Series A Preferred
Stock and other series of Parity Stock the full preferential amounts to which
they are respectively entitled, the entire net assets of the Corporation shall
be distributed ratably to the holders of the outstanding shares of Series A
Preferred Stock and other series of Parity Stock in proportion to the full
preferential amounts to which they are respectively entitled.
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4. Conversion.
(a) Each holder of any outstanding shares of Series A
Preferred Stock shall have the right, at any time, to convert any of such shares
into Common Stock of the Corporation. Furthermore, as to any shares of Series A
Preferred Stock called for redemption, each such holder shall have the right at
any time prior to the close of business on the fifth full business day preceding
the date fixed for redemption (unless default shall be made by the Corporation
in the payment of the redemption price in which case such right of conversion
shall continue without interruption), to convert any of such shares into shares
of Common Stock of the Corporation. The number of shares of Common Stock into
which each share of Series A Preferred Stock shall be convertible shall be equal
to the number arrived at by dividing $5.00, without any payment or adjustment
for Dividends Accrued, by the conversion price per share of the Common Stock
fixed or determined as hereinafter provided. Such conversion price shall
initially be $____ per share, subject to the adjustments hereinafter provided
(such price as adjusted at any time being hereinafter called the "Conversion
Price").
(b) The holder of any outstanding shares of Series A
Preferred Stock may exercise the conversion right provided in Paragraph (a)
above as to all or any portion of the shares that he holds by delivering to the
Corporation during regular business hours, at the principal office of the
Corporation's transfer agent or such other place as may be designated in writing
by the Corporation, the certificate or certificates for the shares to be
converted, duly endorsed or assigned in blank or endorsed or assigned to the
Corporation (if required by it), accompanied by written notice stating that the
holder elects to convert such shares and stating the name or names (with address
and applicable social security number or other tax identification number) in
which the certificate or certificates or shares of Common Stock are to be
issued. Conversion shall be deemed to have been effected on the date (the
Conversion Date) when such delivery is made. As promptly as practicable
thereafter the Corporation shall issue and deliver to or upon the written order
of such holder, at such office or other place designated by the Corporation, a
certificate or certificates for the number of full shares of Common Stock to
which he is entitled and a payment in cash of any dividends declared and unpaid
with respect to the shares of Series A Preferred Stock so surrendered up to the
dividend date that immediately precedes the Conversion Date. The person in whose
name the certificate or certificates for shares of Common Stock are to be issued
shall be deemed to have become a stockholder of record on the Conversion Date,
unless the transfer books of the Corporation are closed on that date, in which
event he shall be deemed to have become a stockholder of record on the next
succeeding date on which the transfer books are open; but the Conversion Price
shall be that in effect on the Conversion Date, unless the Conversion Date falls
after the date that the Corporation mails a notice of redemption under Section
5(c) and before the date fixed for redemption, in which case the Conversion
Price shall be that in effect on the date that such notice of redemption is
mailed.
(c) If, for twenty (20) consecutive trading days
beginning on or after the end of the forty second (42nd) calendar month
following the effective date of the merger of the Corporation and Heritage
Bancorp, Inc., the last sale price of the Common Stock exceeds 1.30 multiplied
by the Conversion Price, then, effective at 5:00 p.m. on the last day in such
twenty
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(20) day period, (y) all outstanding shares of Series A Preferred Stock shall
automatically convert into and become shares of Common Stock, as if each holder
of Series A Preferred Stock exercised the conversion right provided in Section
4(a) and (z) all shares of Series A Preferred Stock, whether or not the
certificates therefore shall have been surrendered for cancellation, shall be
deemed no longer to be outstanding for any purpose and all rights with respect
to such shares shall thereupon cease and determine, except the right to receive
certificates for shares of the Corporation's Common Stock upon surrender of
certificates for shares of Series A Preferred Stock the same manner described in
Section 4(b). Promptly following a conversion of shares of Series A Preferred
Stock pursuant to this Section 4(c) the Corporation shall give written notice of
such conversion by first class mail, postage prepaid to the holders of Series A
Preferred Stock at the last addresses shown by the Corporation's stock transfer
records. No delay or imperfection in such notice will affect the automatic
conversion of Series A Preferred Stock into shares of Common Stock pursuant to
this Section 4(c). For purposes of this Section 4(c) and Section 4(f), the last
sale price of the Corporation's Common Stock shall be deemed to be the last sale
price reported by NASDAQ or its successor, but if the Common Stock is listed on
a national stock exchange, the last sale price on any date shall be deemed to be
the last sale price on the exchange on which it generally has the highest
trading volume.
(d) The Corporation shall not issue any fraction of a
share upon conversion of shares of the Series A Preferred Stock. If more than
one share of the Series A Preferred Stock shall be surrendered for conversion at
any time by the same holder, the number of full shares of Common Stock issuable
upon conversion thereof shall be computed on the basis of the total number of
the shares of Series A Preferred Stock so surrendered. If any fractional
interest in a share of Common Stock would be deliverable upon conversion, the
number of shares of Common Stock deliverable shall be rounded up to the nearest
full share.
(e) The issuance of Common Stock on conversion of
outstanding shares of Series A Preferred Stock shall be made by the Corporation
without charge for expenses or for any tax in respect of the issuance of such
Common Stock, but the Corporation shall not be required to pay any tax or
expense which may be payable in respect of any transfer involved in the issuance
and delivery of shares of Common Stock in any name other than that of the holder
of record on the books of the Corporation of the outstanding shares of Series A
Preferred Stock converted, and the Corporation shall not be required to issue or
deliver any certificate for shares of Common Stock unless and until the person
requesting the issuance shall have paid to the Corporation the amount of such
tax or shall have established to the satisfaction of the Corporation that such
tax has been paid.
(f) The Conversion Price shall be subject to the
following adjustments:
(i) Whenever the Corporation shall (A) pay a
dividend on its outstanding shares of Common Stock in shares of its Common Stock
or subdivide or otherwise split its outstanding shares of Common Stock, or (B)
combine its outstanding shares of Common Stock into a smaller number of shares,
the Conversion Price in effect at the effective date of the happening of such
event shall be adjusted so that the holders of the Series A Preferred Stock,
upon conversion of all thereof immediately following such event, would be
entitled to
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receive the same aggregate number of shares of Common Stock as they would have
been entitled to receive immediately following such event if such shares of
Series A Preferred Stock had been converted immediately prior to such event, or
if there is a record date in respect of such event, immediately prior to such
record date.
(ii) In case the Corporation, after the date of
this resolution, shall issue rights, warrants or options to subscribe for or
purchase shares of Common Stock, or securities convertible into or exchangeable
for shares of Common Stock, at a price per share less than the lesser of the
Conversion Price or Current Market Value (as hereinafter defined) per share of
Common Stock and if such rights, warrants, options or securities are
exercisable, convertible or exchangeable for a period of more than thirty (30)
days after the date of their issuance, the Conversion Price shall be adjusted so
that the same shall equal the price determined by multiplying the Conversion
Price in effect immediately prior to the issuance of such rights, warrants,
options or securities by a fraction, the numerator of which shall be the number
of shares of Common Stock outstanding at the close of business on the date of
issuance of such rights, warrants, options or securities plus the number of
shares which the aggregate exercise price of the shares of Common Stock called
for by all such rights, warrants, options or securities (excluding any
theretofore exercised, converted or exchanged) would purchase at such Current
Market Value and the denominator of which shall be the number of shares of
Common Stock outstanding at the close of business on the date of issuance of
such rights, warrants, options or securities plus the number of additional
shares of Common Stock called for by all such rights, warrants, options or
securities (excluding any theretofore exercised, converted or exchanged). Such
adjustment shall be made on the date that such rights, warrants or options are
issued. For the purposes of this Section 4(f), the "Current Market Value" per
share of Common Stock on any date shall be deemed to be the average of the last
sale price on each of the twenty (20) consecutive trading days commencing forty
(40) trading days before such date. A trading day, for the purpose of this
resolution, is a day on which securities are traded on the Nasdaq Stock Market
or, if the Common Stock is then listed on any national stock exchange, on such
exchange.
(iii) Whenever the Corporation shall make a
distribution to holders of Common Stock of evidences of its indebtedness or
assets (excluding dividends and distributions paid in cash out of funds
available for dividends in accordance with applicable law), the Conversion Price
immediately prior to such distribution shall be adjusted by multiplying such
Conversion Price by a fraction, (y) the numerator of which shall be the
denominator, hereinbelow described, less the fair value (as conclusively
determined in good faith by the Board of Directors of the Corporation) at the
time of such distribution of that portion of the evidences of indebtedness or
assets distributed which is applicable to one share of Common Stock, and (z) the
denominator of which shall be the Current Market Value per share of Common Stock
on the next full business day after the record date fixed for the determination
of the holders of the Common Stock entitled to such distribution. Such
adjustment shall be retroactively effective as of immediately after such record
date.
(g) Notwithstanding any of the foregoing provisions of
this Section 4, no adjustment of the Conversion Price shall be made if the
Corporation shall issue rights, warrants or options to purchase Common Stock, or
issue Common Stock, pursuant to one or more stock purchase plans, stock option
plans, stock purchase contracts, incentive compensation plans, or
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other remuneration plans for employees (including officers) or any shareholder
rights plan of the Corporation or its Subsidiaries adopted or approved by the
Board of Directors of the Corporation before or after the adoption of this
resolution.
(h) In any case in which this Section 4 provides that an
adjustment of the Conversion Price shall become effective retroactively
immediately after a record date for an event, the Company may defer until the
occurrence of such event issuing to the holder of any shares of Series A
Preferred Stock converted after such record date and before the occurrence of
such event that number of shares of Common Stock issuable upon such conversion
that shall be in addition to the number of shares of Common Stock which were
issuable upon such conversion immediately before the adjustment in the
conversion price required in respect of such event.
(i) Anything in this Section 4 to the contrary
notwithstanding, no adjustment in the Conversion Price shall be required unless
such adjustment would require an increase or decrease of at least $.25 in such
price; provided, however, that any adjustments which by reason of this paragraph
(h) are not required to be made shall be carried forward and taken into account
in making subsequent adjustments. All calculations under this Section 4 shall be
made to the nearest cent.
(j) Whenever the Conversion Price and subsequent changes
to be made therein are adjusted pursuant to this Section 4, the Corporation
shall (i) promptly place on file at its principal office and at the office of
each transfer agent for the Series A Preferred Stock, if any, a statement,
signed by the Chairman or President of the Corporation and by its Treasurer,
showing in detail the facts requiring such adjustment and a computation of the
adjusted Conversion Price, and shall make such statement available for
inspection by shareholders of the Corporation, and (ii) cause a notice to be
mailed to each holder of record of the outstanding shares of Series A Preferred
Stock stating that such adjustment has been made and setting forth the adjusted
Conversion Price. Unless the change in the Conversion Price is caused as a
result of action described in subparagraph (i) of paragraph (e) of this Section
4, it shall be accompanied by a letter from the Corporation's independent public
accountants stating that the change has been made in accordance with the
provisions of this resolution.
(k) In the event of any merger, share exchange or similar
transaction to which the Corporation is a party, except (i) a merger in which
the Corporation is the surviving corporation or (ii) a share exchange in which
the Corporation's shares are issued to shareholders of another corporation, the
plan of merger, plan of share exchange or comparable document shall provide that
each share of Series A Preferred Stock then outstanding shall be converted into
or exchanged for the kind and amount of stock, other securities and property
receivable upon such merger, share exchange or similar transaction by a holder
of the number of shares of Common Stock of the Corporation into which such share
of Series A Preferred Stock might have been converted immediately prior thereto.
(l) Shares of Common Stock issued on conversion of shares
of Series A Preferred Stock shall be issued as fully paid shares and shall be
nonassessable by the Corporation. The Corporation shall, at all times, reserve
and keep available for the purpose of effecting the conversion of the
outstanding shares of Series A Preferred Stock such number of its
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duly authorized shares of Common Stock as shall be sufficient to effect the
conversion of all outstanding shares of Series A Preferred Stock.
(m) Shares of Series A Preferred Stock converted as
provided herein shall not thereafter be reissued as shares of Series A Preferred
Stock, but, upon issuance by the State Corporation Commission of Virginia or any
successor thereof of a certificate of reduction or document of similar effect,
such shares shall become authorized and unissued shares of Preferred Stock which
may be designated as shares of any other series. No additional shares of
Preferred Stock, however, may be classified as Series A Preferred Stock.
5. Redemption.
(a) The Corporation may, at its option at any time after
December 31, 2020 and from time to time thereafter, redeem all or any portion of
the outstanding shares of Series A Preferred Stock at a redemption price of
$5.00 per share, plus in each case Dividends Accrued to the date fixed for
redemption. Additionally and at the same redemption price, the Corporation may
redeem all or any portion of the Series A Preferred Stock after a merger, share
exchange or similar transaction to which the Corporation is a party is approved
by the holders of the Common Stock and not approved by holders of the Series A
Preferred Stock; provided such transaction is submitted to the holders of the
Series A Preferred Stock on terms that are in accordance with Section 4(k); and,
provided further, that no redemption may occur and no redemption notice may be
sent before the end of the forty second (42nd) month following the effective
date of the merger of the Corporation and Heritage Bancorp, Inc. unless such
notice states that the redemption price will be $5.00 per share, plus Dividends
Accrued to the date fixed for redemption, plus an amount equal to all dividends
that would accrue if the Series A Preferred Stock remained outstanding until the
end of the forty second (42nd) month following the effective date of the merger
of the Corporation and Heritage Bancorp, Inc. and no later.
(b) In case less than all of the outstanding shares of
Series A Preferred Stock are to be redeemed, not more than 60 days prior to the
date fixed for redemption the Corporation shall select the shares to be redeemed
by prorating the total number of shares to be so redeemed among all holders
thereof in proportion, as nearly as may be, to the number of shares registered
in their respective names, by lot or in such other equitable manner as the Board
of Directors may determine. The Corporation in its discretion may determine the
particular certificates (if there are more than one) representing shares
registered in the name of a holder which are to be redeemed.
(c) Not less than thirty (30) nor more than sixty (60)
days prior to the date fixed for any redemption pursuant to paragraph (a) of
this Section 5, notice of redemption shall be given by first class mail, postage
prepaid, to the holders of record of the outstanding shares of Series A
Preferred Stock to be redeemed at their last addresses as shown by the
Corporation's stock transfer records. The notice of redemption shall set forth
the number of shares to be redeemed, the date fixed for redemption, the
applicable redemption price (including the amount of Dividends Accrued to the
date fixed for redemption), and the place or places where certificates
representing shares to be redeemed may be surrendered. In case less than all
B-7
<PAGE>
outstanding shares are to be redeemed, the notice of redemption shall also set
forth the numbers of the certificates representing shares to be redeemed and, in
case less than all shares represented by any such certificate are to be
redeemed, the number of shares represented by such certificate to be redeemed.
(d) When a notice of redemption of any outstanding shares
of Series A Preferred Stock shall have been duly mailed as hereinabove provided,
on or before the date fixed for redemption the Corporation shall deposit in cash
funds sufficient to pay the redemption price (including Dividends Accrued to the
date fixed for redemption) of such shares in trust for the benefit of the
holders of the shares to be redeemed with any bank or trust company in the City
of Richmond, State of Virginia, having capital and surplus aggregating at least
$50,000,000 as of the date of its most recent report of financial condition and
named in such notice, to be applied to the redemption of the shares so called
for redemption against surrender of the certificates representing shares so
redeemed for cancellation. Except as set forth in Section 4(a), from and after
the time of such deposit all shares for the redemption of which such deposits
shall have been so made shall, whether or not the certificates therefor shall
have been surrendered for cancellation, be deemed no longer to be outstanding
for any purpose and all rights with respect to such shares shall thereupon cease
and determine except the right to receive payment of the redemption price
(including Dividends Accrued to the date fixed for redemption), but without
interest. Any interest accrued on such funds shall be paid to the Corporation
from time to time.
(e) The Corporation shall also have the right to acquire
outstanding shares of Series A Preferred Stock otherwise than by redemption,
pursuant to this Section 5, from time to time, for such consideration as may be
acceptable to the holders thereof; provided, however, that if all Dividends
Accrued on all outstanding shares of Series A Preferred Stock shall not have
been declared and paid or declared and a sum sufficient for the payment thereof
set apart neither the Corporation nor any Subsidiary shall so acquire any shares
of such series except in accordance with a purchase offer made on the same terms
to all the holders of the outstanding shares of Series A Preferred Stock.
(f) Shares of Series A Preferred Stock redeemed or
otherwise acquired by the Corporation shall not thereafter be disposed of as
shares of Series A Preferred Stock, but, upon issuance by the State Corporation
Commission of Virginia or successor thereof of a Certificate of Reduction or
document of similar effect, such shares shall become authorized and unissued
shares of Preferred Stock which may be designated as shares of any other series.
No additional shares of preferred stock, however, may be classified as Series A
Preferred Stock.
6. Definitions
For the purposes of this resolution, the following terms shall
have the following meanings:
"Capital Stock" means the Capital Stock of any class or series
(however designated) of the Corporation.
B-8
<PAGE>
"Common Stock" means the Common Stock of the Corporation
($1.00 par value) as constituted on the date of this Resolution, or shares of
any other class of Capital Stock into which such Common Stock is reclassified
after such date.
"Dividends Accrued" means an amount equal to the sum of all
dividends required to be paid on the shares of Series A Preferred Stock from the
date of issue of the shares of Series A Preferred Stock to the date to which the
determination is to be made, whether or not such amount or any part thereof
shall have been declared as dividends and whether there shall be or have been
any funds out of which such dividends might legally be paid, less the amount of
dividends declared and paid and, if any dividends have been declared and set
apart for payment but not paid, the amount so set apart for the payment of such
dividends. Accrued Dividends for any period less than a full calendar quarter
shall be calculated on the basis of the actual number of days elapsed over a
360-day year.
"Junior Stock" means any Capital Stock ranking as to dividends
and as to rights in liquidation, dissolution or winding up of the affairs of the
Corporation junior to the Series A Preferred Stock.
"Parity Stock" means shares of any series of the Corporation's
Preferred Stock and any shares of Capital Stock ranking as to dividends and/or
as to the rights in liquidation, dissolution or winding up of the affairs of the
Corporation equally with the Series A Preferred Stock.
"Prior Stock" means any Capital Stock ranking as to dividends
or as to rights in liquidation, dissolution or winding up of the affairs of the
Corporation prior to the Series A Preferred Stock.
"Subsidiary" means any corporation, a majority of the
outstanding voting stock of which is owned, directly or indirectly, by the
Corporation or by the Corporation and one or more Subsidiaries.
CARDINAL FINANCIAL CORPORATION
By:___________________________________
President
By:___________________________________
Secretary
B-9
<PAGE>
[This page intentionally left blank]
<PAGE>
EXHIBIT C
to the Agreement and
Plan of Reorganization
Section 2.3. Election of Directors. The Directors shall be elected at
the annual meeting of shareholders, and shall hold their offices until their
successors are elected in accordance with the Articles of Incorporation.
Nominations for the election of Directors shall be given in the manner provided
in Section 2.5. At the annual meeting of shareholders in 2001, Harold E.
Lieding, or an individual designated by Directors who formerly were directors of
Heritage Bancorp, Inc., shall be nominated for election to a three-year term. At
the annual meeting of shareholders in 2002, Kevin B. Tighe, or an individual
designed by Directors who formerly were directors of Heritage Bancorp, Inc.,
shall be nominated for election to a three-year term. At the annual meeting of
shareholders in 2003, George P. Shafran or an individual designated by Directors
who were formerly directors of Heritage Bancorp, Inc. shall be nominated for
election to a three-year term. If the seat held by any of Messrs. Lieding, Tighe
or Shafran becomes vacant, the Board shall appoint a successor chosen by the
Directors who formerly were directors of Heritage Bancorp, Inc. Prior to the
annual meeting of shareholders in 2003, this Section 2.3 may be amended only by
the unanimous vote of the entire Board of Directors.
C-1
<PAGE>
EXHIBIT D
to the Agreement and
Plan of Reorganization
AGREEMENT
THIS AGREEMENT is made by and among Cardinal Financial Corporation
("Cardinal"), Heritage Bancorp, Inc. ("Heritage"), Heritage Bank (the "Bank")
and Terrie G. Spiro ("Spiro") this ___ day of April, 2000.
RECITALS
1. Spiro is the President and Chief Executive Officer of Heritage
and its wholly-owned subsidiary, the Bank.
2. Spiro, Bank and Heritage are parties to an employment
agreement, dated October 1, 1999 (the "Employment Agreement").
3. Cardinal and Heritage have entered into an Agreement and Plan
of Reorganization of even date herewith ("Merger Agreement"), which provides for
the merger of Heritage with and into Cardinal (the "Merger").
4. Cardinal, Heritage, the Bank and Spiro desire to enter into
this agreement in order to clearly define Spiro's rights and Cardinal's ,
Heritage's and the Bank's obligations under the Employment Agreement if the
Merger is consummated.
NOW, THEREFORE, in consideration of the premises, the mutual promises
contained herein and other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereby agree as
follows:
1. Effectiveness. This Agreement shall be effective
immediately, provided that in the event that (i) the Merger Agreement terminates
prior to the vote of the Heritage
D-1
<PAGE>
stockholders with respect to the Merger or (ii) the stockholders of Heritage
fail to approve the Merger, then this Agreement shall be null and void ab
initio.
2. Payment. Heritage agrees to pay Spiro $360,000, less
the amount attributable to the acceleration of Spiro's Anniversary Options (as
defined in Section 3.5 of the Employment Agreement) that constitutes a parachute
payment under Section 280G of the Internal Revenue Code of 1986, as amended
("Section 280G"), less one dollar ($1.00), no later than two days following the
date on which the stockholders of Heritage approve the Merger (the "Approval
Date"). Cardinal unconditionally guarantees Heritage's full and prompt payment
of the amounts set forth in this Section 2. Spiro will forfeit all rights to
payment under this Agreement and Section 5.2 of the Employment Agreement if she
terminates her employment voluntarily and without "Just Cause" (as defined in
the Employment Agreement) before the Approval Date.
3. Continuation of Employment. From and after the
Approval Date, Spiro will be an at will employee of Heritage and the Bank. Spiro
agrees that she will not resign until the earlier of (i) September 30, 2000 or
(ii) the effective date of the Merger. Spiro's employment after the Approval
Date shall be governed by the terms of the Employment Agreement, except that,
after the payment referred to in Section 2 above, Sections 4 and 5 thereof shall
no longer be applicable and have no further force or effect.
4. Stock Options. In accordance with Section 5.1 of the
Merger Agreement, all options to purchase Heritage common stock that have been
granted to Spiro heretofore will vest and become options to purchase Cardinal
common stock and will be exercisable in accordance with the terms of the stock
option plan and stock option agreements under which such options were granted.
The number of additional options that may be awarded to Spiro as a
D-2
<PAGE>
"Long Term Performance Bonus" under Section 3.3 of the Employment Agreement
shall be calculated as if the fair market value of the underlying shares is
equal to the "conversion price," as defined in Section 4(a) of Annex I to
Exhibit A of the Merger Agreement.
5. No Other Parachute Benefits. Upon payment by
Heritage, the cash payment to be made to Spiro under Section 2 of this Agreement
and the stock options described in Section 4 of this Agreement will be in lieu
of all other rights to money, benefits or any other thing of value from
Cardinal, Heritage or Heritage Bank to which Spiro otherwise might be entitled
and that would be considered a "parachute payment" under Section 280G, all of
which Spiro waives.
6. Nondisclosure and Nonsolicitation. (a) Spiro,
Heritage, the Bank and Cardinal agree that upon the termination of Spiro's
employment and thereafter, Section 6.1 of the Employment Agreement will remain
in full force and effect. Upon the termination of Spiro's employment, Section
6.2 of the Employment Agreement shall no longer be applicable and have no
further force or effect with respect to her employment.
(b) From the date of this Agreement and for six months
after the termination of Spiro's employment for any reason, Spiro will not,
directly or indirectly, on behalf of Spiro or any other person or entity,
solicit or induce, or attempt to solicit or induce, any person employed by the
Bank on the date of this Agreement or immediately prior to Spiro's termination,
to terminate his or her relationship with the Bank and/or to enter into an
employment or agency relationship with Spiro or with any other person or entity
with whom Spiro is affiliated.
(c) From the date of this Agreement and for six months
after the termination of Spiro's employment for any reason, Spiro will not
directly or indirectly provide Competitive Services (as defined below) to any
Customer (as defined below), directly or indirectly, on behalf
D-3
<PAGE>
of Spiro or any other person or entity, solicit or divert away or attempt to
solicit or divert away any Customer of the Bank for the purpose of selling or
providing Competitive Services, provided the Bank is then still engaged in the
sale or provision of Competitive Services to such Customer.
For purposes of this Agreement, the term "Customer" means any
individual or entity to whom or to which the Bank provided Competitive Services
between March 31, 1999 and the termination of Spiro's employment with the Bank.
For purposes of this Agreement, "Competitive Services" means
the banking services of the type that the Bank provides as of the date of this
Agreement.
(d) Spiro agrees that the covenants in this Section 6 are
reasonably necessary to protect the legitimate interests of the Bank, are
reasonable in scope and time and are necessary to protect the Bank and do not
interfere with the interests of the public. Spiro further agrees that the
descriptions of the covenants contained in this Section 6 are sufficiently
accurate and definite to inform Spiro of the scope of the covenants. Finally,
Spiro agrees that the consideration set forth in the Merger Agreement and in
this Agreement is full, fair and adequate to support Spiro's obligations
hereunder and the Bank's rights hereunder before and after the termination of
Spiro's employment. Spiro acknowledges that in the event Spiro's employment is
terminated for any reason, Spiro will be able to earn a livelihood without
violating such covenants. The parties intend that the covenants contained in
this Section 6 to be completely severable and independent, and any invalidity or
unenforceability of any one or more such covenants will not render invalid or
unenforceable any one or more of the other covenants. The parties further agree
that, if the scope or enforceability of a covenant contained in this Section 6
is in any way disputed at any time, a court or other trier of fact may modify
and reform such provision to substitute such other terms as are reasonable to
protect the Corporation's legitimate business interests.
D-4
<PAGE>
The parties hereto agree that in the event of any breach by
Spiro of any of the provisions of Section 6 that monetary damages alone will not
adequately compensate the Bank for its losses and, therefore, that it shall be
entitled to any and all legal or equitable relief available to it, specifically
including, but not limited to, injunctive relief.
7. Benefit of Counsel. Spiro acknowledges that she is
entering into this agreement freely and voluntarily and on the advice of her
counsel.
8. Fees of Spiro's counsel. Upon execution of this
Agreement, Cardinal agrees to reimburse Spiro $7,500.00 for the fees and
expenses of her counsel in connection with the negotiation and execution of this
Agreement.
9. Assumption. This Agreement satisfies the requirements
of Section 7.1 of the Employment Agreement.
_____________________________(SEAL)
Terrie G. Spiro
CARDINAL FINANCIAL CORPORATION
By:__________________________(SEAL)
Its: President
HERITAGE BANCORP, INC.
By:__________________________(SEAL)
Its: Chairman
HERITAGE BANK
By:__________________________(SEAL)
Its: Chairman
D-5
<PAGE>
Appendix B
CARDINAL FINANCIAL CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report B-2
Consolidated Financial Statements
Statements of Condition as of December 31, 1999 and 1998 B-3
Statements of Operations for the years ended December 31, 1999 and 1998 B-4
Statements of Comprehensive Income (Loss) for the years ended December 31,
1999 and 1998 B-5
Statements of Changes in Shareholders' Equity for the years ended December 31,
1999 and 1998 B-6
Statements of Cash Flows for the years ended December 31, 1999 and 1998 B-7
Notes to Consolidated Financial Statements B-8 - B-22
Consolidated Interim Financial Statements
Statements of Condition as of March 31, 2000 and December 31, 1999 B-24
Statements of Operations for the three months ended March 30, 2000 and 1999 B-25
Statements of Comprehensive Income (Loss) for the three months ended March 31,
2000 and 1999 B-26
Statements of Changes in Shareholders' Equity for the three months ended March
31, 2000 B-27
Statements of Cash Flows for the three months ended March 31, 2000 and 1999 B-28
Notes to Consolidated Interim Financial Statements B-29 - B-31
</TABLE>
<PAGE>
Independent Auditors' Report
The Board of Directors and Shareholders
Cardinal Financial Corporation and subsidiaries:
We have audited the accompanying consolidated statements of condition of
Cardinal Financial Corporation and subsidiaries (the Company) as of December 31,
1999 and 1998, and the related consolidated statements of operations,
comprehensive income (loss), changes in shareholders' equity, and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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 Cardinal Financial
Corporation and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
/s/ KPMG LLP
McLean, Virginia
January 20, 2000
B-2
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition
December 31, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
Assets 1999 1998
----------------- -----------------
<S> <C> <C>
Cash & due from banks $ 6,018 $ 1,073
Federal funds sold 13,025 24,277
----------------- -----------------
Total cash and cash equivalents 19,043 25,350
Investment securities available-for-sale (Note 3) 4,807 13,477
Other investments (Note 3) 1,015 220
Loans receivable, net of fees (Note 4) 68,167 16,327
Allowance for loan losses (Note 4) (726) (212)
----------------- -----------------
67,441 16,115
Premises and equipment, net (Note 5) 4,203 1,829
Accrued interest and other assets 524 304
----------------- -----------------
Total assets $ 97,033 $ 57,295
================= =================
Liabilities and Shareholders' Equity
Deposits (Note 6) $ 59,873 $ 21,867
Borrowings (Note 7) 6,000 --
Accrued interest and other liabilities 415 700
----------------- -----------------
Total liabilities 66,288 22,567
Common stock, $1 par value, 50,000,000 shares authorized,
shares outstanding 4,242,634 in 1999 and 4,239,509 in 1998 4,243 4,240
Additional paid in capital 32,496 32,327
Accumulated deficit (5,881) (1,842)
Accumulated other comprehensive income (loss) (113) 3
----------------- -----------------
Total shareholders' equity 30,745 34,728
----------------- -----------------
Total liabilities and shareholders' equity $ 97,033 $ 57,295
================= =================
See accompanying notes to consolidated financial statements.
</TABLE>
B-3
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Interest income:
Loans receivable $ 2,660,851 $ 178,697
Federal funds sold 1,234,273 1,061,815
Investment securities 405,604 308,131
Other investments 28,902 7,928
----------------- -----------------
Total interest income 4,329,630 1,556,571
Interest expense:
Deposits (Note 6) 1,206,882 338,608
Borrowings 98,036 1,616
----------------- -----------------
Total interest expense 1,304,918 340,224
----------------- -----------------
Net interest income 3,024,712 1,216,347
Provision for loan losses (Note 4) 513,847 212,460
----------------- -----------------
Net interest income after provision for loan losses 2,510,865 1,003,887
Non-interest income:
Service charges on deposit accounts 41,612 3,388
Loan service charges 226,211 16,145
Investment fee income 1,017,924 --
Gains from sale of securities 4,207 8,760
Other income 30,531 5,744
----------------- -----------------
Total non-interest income 1,320,485 34,037
Non-interest expense:
Salary and benefits 4,277,231 1,401,117
Occupancy 811,578 151,583
Professional fees 494,472 463,497
Depreciation 356,435 106,653
Other operating expenses (Note 17) 1,930,353 611,419
----------------- -----------------
Total non-interest expense 7,870,069 2,734,269
----------------- -----------------
Net loss before income taxes (4,038,719) (1,696,345)
Provision for income taxes (Note 8) -- --
----------------- -----------------
Net loss $ (4,038,719) $ (1,696,345)
================= =================
Basic and diluted loss per share $ (0.95) $ (0.64)
================= =================
Weighted-average shares outstanding 4,240,819 2,646,036
================= =================
See accompanying notes to consolidated financial statements.
</TABLE>
B-4
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
Years ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Net loss $ (4,038,719) $ (1,696,345)
Other comprehensive income (loss):
Unrealized holding gain (loss) on available-for-sale
investment securities, net of tax (115,491) 2,605
----------------- -----------------
Comprehensive loss $ (4,154,210) $ (1,693,740)
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
B-5
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 1999 and 1998
(In thousands, except per share data)
<TABLE>
<CAPTION>
Accumulated
Additional Other Uncollected
Common Paid-in Accumulated Comprehensive Subscription
Shares Stock Capital Deficit Income (Loss) Receivable Total
--------- ---------- ------------ ----------- -------------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 1,175 $ 1,175 $ 7,621 $ (145) $ -- $ (100) $ 8,551
Issuance of 235 shares of common stock
at $7.50 per share, net of costs 235 235 1,525 -- -- -- 1,760
Issuance of 2,830 shares of common stock
at $10.00 per share, net of costs 2,830 2,830 23,181 -- -- -- 26,011
Payment of subscription receivable -- -- -- -- -- 100 100
Change in unrealized holding gain (loss) on
investment securities available-for-sale -- -- -- -- 3 -- 3
Net loss -- -- -- (1,697) -- -- (1,697)
--------- ---------- ------------ ----------- -------------- ------------ ---------
Balance, December 31, 1998 4,240 4,240 32,327 (1,842) 3 -- 34,728
Issuance of stock awards 3 3 19 -- -- -- 22
Reversal of accrued cost related to public
offering -- -- 138 -- -- -- 138
Accrual of stock award -- -- 12 -- -- -- 12
Change in unrealized holding gain (loss) on
investment securities available-for-sale,
net of tax -- -- -- -- (116) -- (116)
Net loss -- -- -- (4,039) -- -- (4,039)
--------- ---------- ------------ ----------- -------------- ------------ ---------
Balance, December 31, 1999 4,243 $ 4,243 $ 32,496 $ (5,881) $ (113) $ -- $ 30,745
========= ========== ============ =========== ============== ============ =========
</TABLE>
See accompanying notes to consolidated financial statements.
B-6
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $ (4,039) $ (1,697)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 356 107
Amortization of premium 13 --
Provision for loan losses 514 212
Gain on sale of securities (4) (9)
Increase in accrued interest and other assets (220) (301)
Increase (decrease) in accrued interest and other liabilities (227) 640
Non-cash charges for issuance of stock award 22 --
Compensation related to stock awards 12 --
----------------- -----------------
Net cash used in operating activities (3,573) (1,048)
----------------- -----------------
Cash flows from investing activities:
Purchase of premises and equipment (2,730) (1,936)
Proceeds from sale of securities 7,722 3,460
Purchase of securities (850) (17,379)
Redemptions of available-for-sale 820 234
Net increase in loan portfolio (51,840) (16,327)
----------------- -----------------
Net cash used in investing activities (46,878) (31,948)
----------------- -----------------
Cash flows from financing activities:
Net increase in deposits 38,006 21,867
Proceeds from stock issuance, net -- 27,871
Decrease in subscription receivables -- 4,510
Proceeds (repayment) of short-term borrowings 6,000 (185)
Reversal of accrued costs related to public offering 138 --
----------------- -----------------
Net cash provided by financing activities 44,144 54,063
----------------- -----------------
Net increase (decrease) in cash and cash equivalents (6,307) 21,067
Cash and cash equivalents at beginning of period 25,350 4,283
----------------- -----------------
Cash and cash equivalents at end of period $ 19,043 $ 25,350
================= =================
Supplemental disclosure of cash flow information
Cash paid during period for interest: $ 1,259 $ 341
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
B-7
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
(1) Organization
Cardinal Financial Corporation (the "Company") was incorporated November
24, 1997 under the laws of the Commonwealth of Virginia as a holding
company whose activities consist of investment in its wholly-owned
subsidiaries. In addition to Cardinal Bank, N.A. which began operations
in 1998, the Company opened the following three subsidiaries in 1999,
Cardinal Wealth Services, Inc. an investment subsidiary (as of February
1, 1999), Cardinal Bank - Manassas/Prince William, N.A. (as of July 26,
1999), and Cardinal Bank - Dulles, N.A. (as of August 2, 1999).
(2) Summary of Significant Accounting Policies
(a) 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 and disclosures of contingent assets and
contingent liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
(c) Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of
cash flows, the Company has defined cash and cash equivalents as
those amounts included in cash, due from banks, and Federal funds
sold.
(d) Investment Securities
The Company classifies its debt and marketable equity securities
in one of two categories: available-for-sale or held-to-maturity.
Held-to-maturity securities are those securities for which the
Company has the ability and intent to hold until maturity. All
other securities not classified as trading or held-to-maturity are
classified as available-for-sale.
Available-for-sale securities are recorded at fair value.
Unrealized holding gains and losses, net of tax, on
available-for-sale securities are reported in other comprehensive
income (loss).
Gains and losses on the sale of securities are determined using
the specific identification method. Declines in the fair value of
individual held-to-maturity and available-for-sale securities
below their cost that are deemed other than temporary are charged
to earnings as realized losses, resulting in the establishment of
a new cost basis for the security.
B-8
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Premiums and discounts are recognized in interest income using the
effective interest method over the period to maturity. Prepayment
of the mortgages securing the collateralized mortgage obligations
may affect the maturity date and yield to maturity. The Company
uses actual principal prepayment experience and estimates of
future principal prepayments in calculating the yield necessary to
apply the effective interest method.
(e) Loans Receivable
Loans receivable that management has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are
reported at their outstanding principal balance adjusted for any
charge-offs, and net of the allowance for loan losses and any
deferred fees or costs on originated loans.
Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the
related loan.
Loans are placed in nonaccrual status when they are past-due 90
days as to either principal or interest or when, in the opinion of
management, the collection of principal and interest is in doubt.
A loan remains in nonaccrual status until the loan is current as
to payment of both principal and interest or past-due less than 90
days, and the borrower demonstrates the ability to pay and remain
current. Loans are charged-off when a loan or a portion thereof is
considered uncollectible.
The Company determines and recognizes impairment of certain loans
when based on current information and events, it is probable that
the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. A loan is not
considered impaired during a period of delay in payment if the
Company expects to collect all amounts due, including past-due
interest. An impaired loan is measured at the present value of its
expected future cash flows discounted at the loan's effective
interest rate, or at the loan's observable market price or fair
value of the collateral if the loan is collateral dependent. As of
December 31, 1999 and 1998, the Company had no impaired loans.
The allowance for loan losses is increased by provisions for loan
losses and decreased by charge-offs (net of recoveries).
Management's periodic evaluation of the adequacy of the allowance
is based on the Bank's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may
affect the borrower's ability to repay, the estimated value of any
underlying collateral, and current economic conditions. In
addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company
to recognize additions to the allowance based on their judgments
about information available to them at the time of their
examination. Management believes that the current allowance for
loan losses is adequate to absorb losses that are inherent in the
current loan portfolio.
(f) Premises and Equipment
Land is carried at cost. Premises, furniture, equipment, and
leasehold improvements are carried at cost, less accumulated
depreciation and amortization. Depreciation of premises, furniture
and equipment is computed using the straight-line method over
their estimated
B-9
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
useful lives from 3 to 10 years. Amortization of leasehold
improvements is computed using the straight-line method over the
useful lives of the improvements or the lease term, whichever is
shorter.
(g) Investment Fee Income
Investment fee income represents commissions paid by customers of
Cardinal Wealth Services, Inc. for investment transactions. Fees
are recognized into income when received.
(h) Income Taxes
Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for
income taxes.
(i) Net Income Per Share
Basic and diluted loss per common share is computed by dividing
net loss by the weighted average number of shares of common stock
outstanding during the periods. Common stock equivalents
outstanding at December 31, 1999 and 1998 were antidilutive and
consequently not included in the EPS calculation.
(j) Stock Option Plan
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations, in accounting for its fixed plan stock options.
As such, compensation expense is recorded only if the current
market price of the underlying stock exceeded the exercise price
on the date of grant.
(k) New Accounting Standards
In June 1998, the Financial Accounting Standards Board (FASB)
issued Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities, effective for fiscal years beginning after
June 15, 1999. Statement No. 133 established accounting and
reporting standards for derivative instruments and hedging
activities and requires that the Company recognize all derivatives
as assets or liabilities on the balance sheet at fair market
value. In June 1999, the FASB issued Statement No. 137, which
deferred the implementation of Statement No. 133 to fiscal years
beginning after June 15, 2000. As of December 31, 1999 and 1998,
the Company had no derivative instruments or hedging activities
and therefore does not expect Statement No. 133 to have any
material impact on the Company's financial position or results of
operations.
(l) Reclassifications
Certain amounts for 1998 have been reclassified to conform to the
presentation for 1999.
B-10
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
(3) Investment Securities and Other Investments
The fair value and amortized cost of available-for-sale securities as of
December 31, 1999 and 1998 are shown below.
<TABLE>
<CAPTION>
1999
-------------------------------------
Fair Amortized
(In thousands) value cost
----------------- -----------------
<S> <C> <C>
Obligations of U.S. government-sponsored
agencies and enterprises $ 3,373 $ 3,499
Mortgage - backed securities 1,434 1,479
----------------- -----------------
Total $ 4,807 $ 4,978
================= =================
1998
-------------------------------------
Fair Amortized
(In thousands) value cost
----------------- -----------------
Obligations of U.S. government-sponsored
agencies and enterprises $ 10,306 $ 10,302
Mortgage - backed securities 3,171 3,172
----------------- -----------------
Total $ 13,477 $ 13,474
================= =================
</TABLE>
The fair value and amortized cost of available-for-sale securities by
contractual maturity at December 31, 1999 is shown below. Expected
maturities may differ from contractual maturities because many issuers
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
1999
-------------------------------------
Fair Amortized
(In thousands) value cost
----------------- -----------------
<S> <C> <C>
Maturing within 1 year $ 2,252 $ 2,305
After 1 year but within 5 years 1,347 1,368
After 5 years but within 10 years 763 806
After 10 years 445 499
Marketable equity securities
----------------- -----------------
Total $ 4,807 $ 4,978
================= =================
</TABLE>
Gross realized gains and gross realized losses on sales of
available-for-sale securities were $13,532 and $9,325, respectively, in
1999 and $12,996 and $4,236, respectively, in 1998. Gross unrealized
holding losses in the available-for-sale securities at December 31, 1999
and 1998 were $171,348 and $13,348, respectively, while gross unrealized
holding gains were $309 and $15,953, respectively.
Other investments include $585 thousand of Federal Reserve Bank stock,
$346 thousand of Federal Home Loan Bank stock, $63 thousand of Community
Bankers' Bank stock and $21 thousand in
B-11
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
other investments. As members of the Federal Reserve Bank of Richmond and
Federal Home Loan Bank of Atlanta, the Company's banking subsidiaries are
required to hold stock in these entities. Stock membership in Community
Bankers' Bank allows the Company to participate in loan purchases or
sales including participations. These stocks are carried at cost since no
active trading markets exist.
Securities available-for-sale that were pledged to secure short-term
borrowings had fair values of $2,834,867 at December 31, 1999. There were
no pledged investment securities as of December 31, 1998.
(4) Loans Receivable
The loan portfolio at December 31, 1999 and 1998 consists of the
following:
<TABLE>
<CAPTION>
(In thousands) 1999 1998
----------------- ------------------
<S> <C> <C>
Commercial $ 22,558 $ 5,138
Real estate - commercial 19,780 3,507
Real estate - construction 870 760
Real estate - residential 11,851 5,529
Home equity lines 3,777 1,040
Consumer 9,311 369
----------------- ------------------
68,147 16,343
Net deferred loan fees, premiums and discounts 20 (16)
----------------- ------------------
Loans receivable, net of fees 68,167 16,327
Allowance for loan losses (726) (212)
----------------- ------------------
Loans receivable, net of fees and allowance $ 67,441 $ 16,115
================= ==================
</TABLE>
Most of the Company's loans, commitments and standby letters of credit
have been granted to customers located in the Washington, D.C.
metropolitan area. The concentrations of credit by type of loan are set
forth above. Cardinal Bank, N.A., Cardinal Bank-Manassas/Prince William,
N.A. and Cardinal Bank-Dulles, N.A., as a matter of regulatory
restriction, do not extend credit, net of participated amounts, to any
single borrower or group of related borrowers in excess of $855,000,
$1,004,000, and $975,000, respectively.
An analysis of the change in the allowance for loan losses follows:
<TABLE>
<CAPTION>
(In thousands) 1999 1998
---------------- ----------------
<S> <C> <C>
Balance, beginning of year $ 212 $ --
Provision for loan losses 514 212
Loans charged off -- --
Recoveries -- --
---------------- ----------------
Balance, end of year $ 726 $ 212
================ ================
</TABLE>
B-12
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
There were no impaired or nonaccrual loans at December 31, 1999 and 1998,
or during the years then ended.
(5) Premises and Equipment
Components of premises and equipment included in the consolidated
statements of condition at December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
----------------- ------------------
<S> <C> <C>
Land $ 197 $ 20
Building 789 --
Furniture and equipment 2,413 1,334
Leasehold improvements 1,267 582
----------------- ------------------
Total cost 4,666 1,936
Less accumulated depreciation and amortization 463 107
----------------- ------------------
Premises and equipment, net $ 4,203 $ 1,829
================= ==================
</TABLE>
The Company has entered into leases for office space over various terms
beginning January 1998. The leases are subject to annual increases as
well as allocations of real estate taxes and certain operating expenses.
Minimum future rental payments under the noncancelable operating leases,
as of December 31, 1999 for each of the next five years and in the
aggregate, are as follows:
Year ending December 31, Amount
-----------------
2000 $ 720,177
2001 741,075
2002 762,288
2003 784,139
2004 489,774
Thereafter 2,997,433
-----------------
$ 6,494,886
=================
The total rent expense was $742,179 and $71,687 in 1999 and 1998,
respectively.
(6) Deposits
Deposits consist of the following at December 31, 1999 and 1998:
B-13
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
<TABLE>
<CAPTION>
(In thousands) 1999 1998
----------------- -----------------
<S> <C> <C>
Demand deposits $ 12,330 $ 5,044
Interest checking 3,891 1,746
Money market and statement savings 11,499 3,471
Certificates of deposit 32,153 11,606
----------------- -----------------
$ 59,873 $ 21,867
================= =================
</TABLE>
Interest expense by deposit categories is as follows:
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Interest checking $ 48,527 $ 11,088
Money market and statement savings 271,140 87,832
Certificates of deposit 887,215 239,688
----------------- -----------------
$ 1,206,882 $ 338,608
================= =================
</TABLE>
The aggregate amount of time deposits, each with a minimum denomination
of $100,000 was $22,290,439 and $1,056,580 in 1999 and 1998,
respectively.
At December 31, 1999, the scheduled maturities of CDs are as follows:
(In thousands)
2000 $ 11,906
2001 17,195
2002 1,851
2003 299
2004 and thereafter 902
-----------------
$ 32,153
=================
(7) Borrowings
The Company has obtained advances from the Federal Home Loan Bank of
Atlanta in the amount of $6.0 million in 1999. The Company had no
advances in 1998. As of December 31, 1999, the Company had the following
advances outstanding:
<TABLE>
<CAPTION>
Amount
Advance Date Interest Rate Term of Advance Date Due Outstanding
----------------------- --------------------- ------------------------- --------------- -----------------
<S> <C> <C> <C> <C>
12/09/99 6.15% 6 months 06/09/00 $ 3,000,000
12/21/99 6.35% 6 months 06/21/00 1,000,000
12/23/99 6.53% 12 months 12/26/00 2,000,000
-----------------
$ 6,000,000
=================
</TABLE>
B-14
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Total interest expense for the year ended December 31, 1999 was $97,775.
(8) Income Taxes
The Company and its subsidiaries file consolidated tax returns on a
calendar-year basis. The Company had no provision for current and
deferred income taxes for the years ended December 31, 1999 and 1998,
respectively.
The provision for income taxes is reconciled to the amount computed by
applying the federal corporate tax rate to income before taxes and is as
follows:
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Income tax (benefit) at federal corporate rate $ (1,373,165) $ (576,757)
Nondeductible expenses 18,363 1,870
Change in valuation allowance 1,354,802 574,887
----------------- -----------------
$ -- $ --
================= =================
</TABLE>
The tax benefits of temporary differences between the financial reporting
basis and income tax basis of assets and liabilities relate to the
following:
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Deferred tax assets:
Bad debts $ 223,126 $ 64,465
Organization and other costs 71,438 18,730
Net operating loss carryforwards 1,765,588 538,901
Unrealized (gains) losses on investments available-for-sale 58,153 (886)
Other 6,890 567
----------------- -----------------
Total gross deferred assets 2,125,195 621,777
Less valuation allowance (2,026,756) (612,915)
----------------- -----------------
Net deferred tax assets 98,439 8,862
----------------- -----------------
Deferred tax liabilities:
Prepaid expenses (6,960) (8,862)
Depreciation (91,479) --
----------------- -----------------
Total gross deferred tax liabilities $ -- $ --
================= =================
</TABLE>
Deferred income taxes reflect temporary differences in the recognition of
revenue and expenses for tax reporting and financial statement purposes,
principally because certain items, such as depreciation and amortization
are recognized in different periods for financial reporting and tax
return purposes. A valuation allowance in the amount of $2,026,756 at
December 31, 1999 and $612,915 at December 31, 1998 has been established
for deferred tax assets as realization is dependent upon generating
future taxable income.
B-15
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
The Company has net operating loss carryforwards of approximately
$5,192,906 at December 31, 1999 which are available to offset future
taxable income. There are no annual limitations on utilization of the net
operating loss carryforwards.
(9) Regulatory Matters
The Company's banking subsidiaries ("the Banks"), as national banks, are
subject to the dividend restrictions set forth by the Comptroller of the
Currency. Under such restrictions, the Banks may not, without the prior
approval of the Comptroller of the Currency, declare dividends in excess
of the sum of the current year's earnings (as defined) plus the retained
earnings (as defined) from the prior two years. At December 31, 1999,
there were no earnings against which dividends could be paid.
The Banks are required to maintain a minimum average reserve balance with
the Federal Reserve Bank. The average amount of the required reserve was
$150,000 for 1999. As members of the Federal Reserve Bank system, the
Banks are required to subscribe to shares of $100 par value Federal
Reserve Bank stock equal to 6 percent of the Bank's capital and surplus.
The Banks are required to pay for one-half of the subscription. The
remaining amount is subject to call when deemed necessary by the Board of
Governors of the Federal Reserve.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires the regulators to stratify institutions into five
quality tiers based upon their relative capital strengths and to increase
progressively the degree of regulation over the weaker institutions,
limits the pass through deposit insurance treatment of certain types of
accounts, adopts a "truth in savings" program, calls for the adoption of
risk-based premiums on deposit insurance and requires the Banks to
observe insider credit underwriting products no less strict than those
applied to comparable noninsider transactions.
At December 31, 1999, the Company and its subsidiary banks met all
regulatory capital requirements. The key measures of capital are: (1)
total capital (Tier I capital plus the allowance for loan losses up to
certain limitations) as a percent of total risk-weighted assets, (2) Tier
I capital (as defined) as a percent of total risk-weighted assets (as
defined), and (3) Tier I capital (as defined) as a percent of total
assets (as defined).
B-16
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
<TABLE>
<CAPTION>
As of December 31, 1999 To Be Well
(in thousands) Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ----------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Total capital to risk weighted assets $ 31,585 38.75% $ 6,521 >= 8.00% $ 8,151 >= 10.00%
Tier I capital to risk weighted assets 30,858 37.86% 3,261 >= 4.00% 4,891 >= 6.00%
Tier I capital to average assets 30,858 32.55% 3,881 >= 4.00% 4,852 >= 5.00%
As of December 31, 1998 To Be Well
(in thousands) Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ----------- ----------- ---------- ---------- -----------
Total capital to risk weighted assets $ 34,938 147.80% $ 1,892 >= 8.00% $ 2,365 >= 10.00%
Tier I capital to risk weighted assets 34,725 146.90% 946 >= 4.00% 1,419 >= 6.00%
Tier I capital to average assets 34,725 60.20% 2,292 >= 4.00% 2,865 >= 5.00%
</TABLE>
(10) Related-Party Transactions
Officers, directors, employees and their related business interests are
loan customers in the ordinary course of business. In management's
opinion, these loans are made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable loans with other persons and do not involve more than normal
risk of collectibility or present other unfavorable features.
Analysis of activity for loans to related parties is as follows:
<TABLE>
<CAPTION>
(In thousands) 1999 1998
----------------- -----------------
<S> <C> <C>
Balance, beginning of year $ 996 $ --
New loans 2,336 999
Loans paid off or paid down (456) (3)
----------------- -----------------
Balance, end of year $ 2,876 $ 996
================= =================
</TABLE>
(11) Earnings Per Share
The following discloses the calculation of basic and diluted earnings per
share. Because the Company has net losses due to the start-up nature of
the organization, stock options issued have an anti-dilutive effect on
the earnings per share calculation.
B-17
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Net loss $ (4,038,719) $ (1,696,345)
Weighted average shares for basic and diluted 4,240,819 2,646,036
Basic earnings (loss) per share $ (0.95) $ (0.64)
Diluted earnings (loss) per share $ (0.95) $ (0.64)
</TABLE>
(12) Employee Benefit Plan
The Company established a 401(k) plan in January 1998 for all eligible
employees. The Company began to match a portion of employee contributions
beginning January 1, 1999. The Company's match was $60,513 in 1999.
(13) Director and Employee Stock Compensation Plan
In 1998, the Company adopted a stock option plan (the "Plan") pursuant to
which the Company may grant stock options to members of its holding
company and subsidiaries' Board of Directors. The Company has granted
options to purchase up to 178,151 shares of common stock as of December
31, 1999.
The Company also granted stock awards to an employee. The stock awards
vest ratably over a three year period and are contingent upon continued
employment of the individual and other factors as set forth in the
agreement. As of December 31, 1999, the Company recognized $12,000 in
compensation expense related to the stock awards.
Stock options are granted with an exercise price equal to the stock's
fair market value at the date of grant. Director stock options have
10-year terms and vest and become fully exercisable immediately. Employee
stock options have 10-year terms and vest and become fully exercisable
after three years.
B-18
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Stock option activity during the periods indicated is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Shares Price
----------------- ----------------
<S> <C> <C>
Balance at December 31, 1997 -- $ --
Granted 13,750 6.75
Exercised -- --
Forfeited -- --
Expired -- --
----------------- ----------------
Balance at December 31, 1998 13,750 6.75
Granted 164,841 6.84
Exercised -- --
Forfeited 440 --
Expired -- --
----------------- ----------------
Balance at December 31, 1999 178,151 $ 6.84
================= ================
</TABLE>
At December 31, 1999, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $6.38 - $7.50 and
9.2 years, respectively. All outstanding director options are exercisable
at December 31, 1999.
At December 31, 1999, there were 221,849 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock
options granted during 1999 was $2.74 on the date of grant using the
Black Scholes option-pricing model (using an expected volatility over the
expected life of the options of 37.5 percent) with the following
weighted-average assumptions: expected dividend yield 0.00 percent,
risk-free interest rate of 4.94 percent, and an expected life of 10
years.
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized for its stock
options. Had the Company determined compensation cost based on the fair
value at the grant date for its stock options under SFAS No. 123, the
Company's net loss would have been increased to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Net loss:
As reported $ (4,038,719) $ (1,696,345)
Pro forma (4,490,383) (1,751,758)
Loss per share:
As reported $ (0.95) $ (0.64)
Pro forma (1.06) (0.66)
</TABLE>
B-19
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
(14) Segment Reporting
The Company operates and reports in two business segments, commercial
banking and investment advisory services. The commercial banking segment
includes both commercial and consumer lending and provides customers such
products as commercial loans, real estate loans, other business financing
and consumer loans. In addition, this segment also provides customers
with several choices of deposit products including demand deposit
accounts, savings accounts and certificates of deposit. The investment
advisory services segment provides advisory services to businesses and
individuals including financial planning and retirement/estate planning.
Information about reportable segments, and reconciliation of such
information to the consolidated financial statements as of and for the
year ended December 31, 1999 follows:
<TABLE>
<CAPTION>
Commercial Investment Intersegment
Banking Advisory Other Elimination Consolidated
------------------ ------------ ------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Net interest income $ 2,136,974 $ -- $ 887,738 $ -- $ 3,024,712
Provision for loan losses 513,847 -- -- -- 513,847
Non-interest income 310,441 1,017,924 -- (7,880) 1,320,485
Non-interest expense 4,240,540 1,612,411 2,017,118 -- 7,870,069
Net income (loss) (2,306,972) (594,487) (1,129,380) (7,880) (4,038,719)
Total assets $ 91,628,884 $ 792,792 $ 31,056,219 $ (26,444,928) $ 97,032,967
----------------- ------------ ------------- ---------------- ---------------
</TABLE>
The Company does not have operating segments other than those reported.
Parent Company financial information is included in the Other category
and represents the overhead function rather than an operating segment.
Comparable information for December 31, 1998 is not shown as the Company
had one operating segment and one subsidiary, Cardinal Bank, N.A. The
investment advisory segment began operations in February 1999.
(15) Financial Instruments with Off Balance Sheet Risk
The Company 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 and financial guarantees.
Commitments to extend credit are agreements to lend to a customer so long
as there is no violation of any condition established in the contract.
Commitments usually have fixed expiration dates up to one year or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of the contractual obligations by a
customer to a third party. The majority of these guarantees extend until
satisfactory completion of the customer's contractual obligations. All
standby letters of credit outstanding at December 31, 1999 are
collateralized.
B-20
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Those instruments represent obligations of the Company to extend credit
or guarantee borrowings, therefore, they are not recorded on the
consolidated statements of financial condition. The rates and terms of
these instruments are competitive with others in the market in which the
Company operates. Almost all of these instruments as of December 31, 1999
have floating rates, therefore significantly mitigating the market risk.
Those instruments may involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
statements of financial condition. Credit risk is defined as the
possibility of sustaining a loss because the other parties to a financial
instrument fail to perform in accordance with the terms of the contract.
The Company's maximum exposure to credit loss under standby letters of
credit and commitments to extend credit is represented by the contractual
amounts of those instruments.
<TABLE>
<CAPTION>
<S> <C>
(In thousands)
Financial instruments whose contract amounts represent potential
credit risk:
Commitments to extend credit $ 19,411
Standby letters of credit 916
==============
</TABLE>
The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. The
Company evaluates each customer's creditworthiness on a case-by-case
basis and requires collateral to support financial instruments when
deemed necessary. The amount of collateral obtained upon extension of
credit is based on management's evaluation of the counterparty.
Collateral held varies but may include deposits held by the Company,
marketable securities, accounts receivable, inventory, property, plant
and equipment, and income-producing commercial properties.
(16) Disclosures of Fair Value of Financial Instruments
The assumptions used and the estimates disclosed represent management's
best judgment of appropriate valuation methods. These estimates are based
on pertinent information available to management as of December 31, 1999.
In certain cases, fair values are not subject to precise quantification
or verification and may change as economic and market factors, and
management's evaluation of those factors change.
Although management uses its best judgment in estimating the fair value
of these financial instruments, there are inherent limitations in any
estimation technique. Therefore, these fair value estimates are not
necessarily indicative of the amounts that the Company would realize in a
market transaction. Because of the wide range of valuation techniques and
the numerous estimates which must be made, it may be difficult to make
reasonable comparisons of the Company's fair value information to that of
other financial institutions. It is important that the many uncertainties
discussed above be considered when using the estimated fair value
disclosures and to realize that because of these uncertainties, the
aggregate fair value amount should in no way be construed as
representative of the underlying value of the Company.
B-21
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Fair Value of Financial Instruments
The following summarizes the significant methodologies and assumptions
used in estimating the fair values presented in the accompanying table.
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents is used as a reasonable
estimate of fair value.
Investment Securities and Other Investments
Fair values for investment securities are based on quoted market prices
or prices quoted for similar financial instruments. Fair value for other
investments is estimated as their cost since no active trading markets
exist.
Loans Receivable
In order to determine the fair market value for loans, the loan portfolio
was segmented based on loan type, credit quality and maturities. For
certain variable rate loans with no significant credit concerns and
frequent repricings, estimated fair values are based on current carrying
amounts. The fair values of other loans are estimated using discounted
cash flow analyses, using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality.
Deposits
The fair values disclosed for demand deposits are, by definition, equal
to the amount payable on demand at the reporting date (that is, their
carrying amounts.) The carrying amounts of variable rate, fixed-term
money market accounts and certificates of deposit (CDs) approximate their
fair value at the reporting date. Fair values for fixed-rate CDs are
estimated using a discounted cash flow calculation that applies interest
rates currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
Commitments
The fair value of these financial instruments is based on the credit
quality and relationship, fees, interest rates, probability of funding,
compensating balance and other convenants or requirements. These
commitments generally have fixed expiration dates expiring within one
year. Many commitments are expected to, and typically do, expire without
being drawn upon. The rates and terms of these instruments are
competitive with others in the market in which the Company operates. The
carrying amounts are reasonable estimates of the fair value of these
financial instruments. The carrying amounts of these instruments are zero
at December 31, 1999.
Accrued Interest
The carrying amounts of accrued interest approximate their fair values.
B-22
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
Fair Value of Financial Instruments as of December 31, 1999
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------
Carrying Estimated
(In thousands) Amount Fair Value
----------------- -----------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 19,043 $ 19,043
Investment securities and other investments 5,822 5,822
Loans receivable 68,147 67,622
Accrued interest receivable 351 351
Financial liabilities:
Demand deposits $ 12,330 $ 12,330
Interest checking 3,891 3,891
Money market and statement savings 11,499 11,499
Certificates of deposit 32,153 32,124
Accrued interest payable 48 48
</TABLE>
(17) Other Operating Expenses
Other operating expenses for December 31, 1999 and 1998 include the
following:
<TABLE>
<CAPTION>
1999 1998
----------------- -----------------
<S> <C> <C>
Data processing $ 353,498 $ 104,067
Stationary and supplies 322,586 133,821
Brokerage clearing 197,822 -
Advertising and marketing 175,100 82,069
Telecommunications 163,481 36,591
Bank operations 125,541 38,216
Premises and equipment 103,739 6,047
Other taxes 94,670 11,225
Insurance 85,182 36,719
Travel and entertainment 79,128 54,031
Dues and membership 57,959 42,708
Miscellaneous 171,647 65,925
----------------- -----------------
$ 1,930,353 $ 611,419
================= =================
</TABLE>
B-23
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition
As of March 31, 2000 and December 31, 1999
(In thousands, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
Assets 2000 1999
----------------- -----------------
<S> <C> <C>
Cash & due from banks $ 4,180 $ 6,018
Federal funds sold 20,378 13,025
----------------- -----------------
Total cash and cash equivalents 24,558 19,043
Investment securities available-for-sale 4,620 4,807
Other investments 1,028 1,015
Loans receivable, net of fees 81,444 68,167
Allowance for loan losses (869) (726)
----------------- -----------------
80,575 67,441
Premises and equipment, net 4,476 4,203
Accrued interest and other assets 668 524
----------------- -----------------
Total assets $ 115,925 $ 97,033
================= =================
Liabilities and Shareholders' Equity
Deposits $ 80,010 $ 59,873
Borrowings 6,000 6,000
Accrued interest and other liabilities 185 415
----------------- -----------------
Total liabilities 86,195 66,288
Common stock, $1 par value, 50,000,000 shares authorized,
shares outstanding 4,242,634 in 2000 and 1999 4,243 4,243
Additional paid in capital 32,498 32,496
Accumulated deficit (6,823) (5,881)
Accumulated other comprehensive income (loss) (188) (113)
----------------- -----------------
Total shareholders' equity 29,730 30,745
----------------- -----------------
Total liabilities and shareholders' equity $ 115,925 $ 97,033
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
B-24
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended March 31, 2000 and 1999
(Unaudited)
<TABLE>
<CAPTION>
2000 1999
----------------- -----------------
<S> <C> <C>
Interest income:
Loans receivable $ 1,528,938 $ 354,895
Federal funds sold 287,204 320,801
Investment securities available-for-sale 72,202 127,914
Other investments 15,480 3,293
----------------- -----------------
Total interest income 1,903,824 806,903
Interest expense:
Deposits 654,516 199,510
Borrowings 96,214 --
----------------- -----------------
Total interest expense 750,730 199,510
----------------- -----------------
Net interest income 1,153,094 607,393
Provision for loan losses 143,091 68,125
----------------- -----------------
Net interest income after provision for loan losses 1,010,003 539,268
Non-interest income:
Service charges on deposit accounts 20,401 5,087
Loan service charges 63,104 19,198
Investment fee income 313,326 1,278
Gains from sale of securities -- 11,203
Other income 26,848 8,457
----------------- -----------------
Total non-interest income 423,679 45,223
Non-interest expense:
Salary and benefits 1,362,859 761,618
Occupancy 221,508 215,228
Professional fees 101,554 117,007
Depreciation 128,500 59,945
Other operating expenses 561,421 255,010
----------------- -----------------
Total non-interest expense 2,375,842 1,408,808
----------------- -----------------
Net loss before income taxes (942,160) (824,317)
Provision for income taxes -- --
----------------- -----------------
Net loss $ (942,160) $ (824,317)
================= =================
Basic and diluted loss per share $ (0.22) $ (0.19)
================= =================
Weighted-average shares outstanding 4,242,634 4,239,509
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
B-25
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
For the three months ended March 31, 2000 and 1999
(Unaudited)
<TABLE>
<CAPTION>
2000 1999
----------------- -----------------
<S> <C> <C>
Net loss $ (942,160) $ (824,317)
Other comprehensive income (loss):
Unrealized holding loss on investment securities
available-for-sale (75,179) (21,633)
----------------- -----------------
Comprehensive loss $ (1,017,339) $ (845,950)
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
B-26
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
Three months ended March 31, 2000 and 1999
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Accumulated Comprehensive
Shares Stock Capital Deficit Income (Loss) Total
------ ----- ------- ------- ------------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 4,240 $ 4,240 $ 32,327 $ (1,842) $ 3 $ 34,728
Change in unrealized holding loss on
investment securities available-for-sale,
net of tax -- -- -- -- (22) (22)
Reversal of Expense Accrual from
Public Offering -- -- 138 -- -- 138
Net loss -- -- -- (824) -- (824)
-------- -------- -------- -------- -------- --------
Balance, March 31, 1999 4,240 $ 4,240 $ 32,465 $ (2,666) $ (19) $ 34,020
==================================================================================================================================
Balance, January 1, 2000 4,243 $ 4,243 $ 32,496 $ (5,881) $ (113) $ 30,745
Accrual of stock award -- -- 2 -- -- 2
Change in unrealized holding loss on
investment securities available-for-sale -- -- -- -- (75) (75)
Net loss -- -- -- (942) -- (942)
-------- -------- -------- -------- -------- --------
Balance, March 31, 2000 4,243 $ 4,243 $ 32,498 $ (6,823) $ (188) $ 29,730
==================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
B-27
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31, 2000 and 1999
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
2000 1999
-------- --------
Cash flows from operating activities:
<S> <C> <C>
Net loss $ (942) $ (824)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 129 60
Provision for loan losses 143 68
Gain on sale of investment securities available-for-sale -- (11)
Increase in accrued interest and other assets (144) (36)
Decrease in accrued interest and other liabilities (288) (310)
Compensation related to stock awards 2 --
-------- --------
Net cash used in operating activities (1,100) (1,053)
-------- --------
Cash flows from investing activities:
Purchase of premises and equipment (402) (588)
Proceeds from sale of securities 6 1,984
Purchase of securities (18) (15)
Redemptions of investment securities-available-for-sale 169 3,562
Net increase in loan portfolio (13,277) (5,714)
-------- --------
Net cash used in investing activities (13,522) (771)
-------- --------
Cash flows from financing activities:
Net increase in deposits 20,137 4,065
Reversal of accrued costs related to public offering -- 138
-------- --------
Net cash provided by financing activities 20,137 4,203
-------- --------
Net increase in cash and cash equivalents 5,515 2,379
Cash and cash equivalents at beginning of period 19,043 25,350
-------- --------
Cash and cash equivalents at end of period $ 24,558 $ 27,729
======== ========
Supplemental disclosure of cash flow information
Cash paid during period for interest: $ 760 $ 200
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
B-28
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 2000
(Unaudited)
Note 1
Organization
Cardinal Financial Corporation (the "Company") was incorporated November 24,
1997 under the laws of the Commonwealth of Virginia as a holding company whose
activities consist of investment in its wholly owned subsidiaries, Cardinal
Bank, N.A., Cardinal Wealth Services, Inc., Cardinal Bank - Manassas/Prince
William, N.A. and Cardinal Bank - Dulles, N.A.
Basis of Presentation
In the opinion of management, the accompanying condensed consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. However, all adjustments that are,
in the opinion of management, necessary for a fair presentation have been
included. The results of operations for the three months ended March 31, 2000
are not necessarily indicative of the results to be expected for the full year
ending December 31, 2000. The unaudited interim financial statements should be
read in conjunction with the audited financial statements and notes to financial
statements that are presented in the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1999.
Note 2
Segment Disclosures
The Company operates and reports in two business segments, commercial banking
and investment advisory services. The commercial banking segment includes both
commercial and consumer lending and provides customers such products as term
loans, real estate loans, other business financing and installment loans. In
addition, this segment also provides customers with several choices of deposit
products including demand deposit accounts, savings accounts and certificates of
deposit. The investment advisory services segment provides advisory services to
businesses and individuals including financial planning and retirement/estate
planning.
Information about reportable segments, and reconciliation of such information to
the consolidated financial statements as of and for the quarter to date ended
March 31, 2000 and 1999 follows:
B-29
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 2000
(Unaudited)
For the Three Months Ended March 31, 2000 (in dollars):
<TABLE>
<CAPTION>
Commercial Investment Intersegment
Banking Advisory Elimination Other Consolidated
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest income 993,606 - - 159,488 1,153,094
Provision for loan losses 143,091 - - - 143,091
Non-interest income 106,020 313,326 (3,553) 7,886 423,679
Non-interest expense 1,413,143 467,949 (3,553) 498,303 2,375,842
----------- ------- ----------- ---------- -----------
Net income (loss) (456,608) (154,623) - (330,929) (942,160)
=========== ======= =========== ==========
Total Assets 106,990,578 212,631 (21,178,772) 29,900,182 115,924,619
</TABLE>
For the Three Months Ended March 31, 1999 (in dollars):
<TABLE>
<CAPTION>
Commercial Investment Intersegment
Banking Advisory Elimination Other Consolidated
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest income 280,407 - - 326,986 607,393
Provision for loan losses 68,125 - - - 68,125
Non-interest income 43,945 1,278 - - 45,223
Non-interest expense 697,587 195,001 - 516,220 1,408,808
---------- ------- ----------- ---------- ----------
Net income (loss) (441,360) (193,723) - (189,234) (824,317)
========== ======= ========== ========== ==========
Total Assets 32,129,128 188,565 (6,553,889) 34,578,494 60,342,298
</TABLE>
The Company does not have operating segments other than those reported. Parent
Company financial information is included in the Other category above and
represents the overhead function rather than an operating segment.
Note 3
Earnings Per Share
The following discloses the calculation of basic and diluted earnings per share
as of March 31, 2000 and 1999. Because the Company has net losses due to the
start-up nature of the organization, stock options issued have an anti-dilutive
effect on the earnings per share calculation.
B-30
<PAGE>
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 2000
(Unaudited)
2000 1999
---- ----
Net loss $ (942,160) $ (824,317)
Weighted average shares for basic and diluted 4,242,634 4,239,509
Basic and diluted loss per share $ (.22) $ (.19)
Note 4
Subsequent Events
On April 17, 2000, the Company entered into a definitive agreement to acquire
the Heritage Bancorp, Inc. Under the terms of the agreement, the Company will
issue a combination of cash and shares of convertible preferred stock to the
shareholders of Heritage in exchange for all of the shares of Heritage's common
stock. Heritage's shareholders will be able to elect to receive $6.00 in cash or
1.2 shares of convertible preferred stock for each share of Heritage stock,
subject to certain adjustments to permit the Company to issue an equal amount of
cash and convertible preferred stock. The completion of the acquisition is
subject to shareholder and regulatory approval, which is expected in the third
quarter of 2000.
B-31
<PAGE>
Appendix C
[LETTERHEAD OF SCOTT & STRINGFELLOW, INC.]
May __, 2000
Board of Directors
Cardinal Bankshares Corporation
10555 Main Street
Fairfax, VA 22030
Dear Madams and Gentlemen:
You have asked us to render our opinion relating to the fairness, from a
financial point of view, to the shareholders of Cardinal Financial Corporation
("Cardinal") of the terms of an Agreement and Plan of Reorganization between
Cardinal and Heritage Bancorp, Inc. dated April 17, 2000 (the "Merger
Agreement") pursuant to which Heritage will be merged with and into Cardinal
(the "Merger") and further provides that each share of common stock, par value
$1.00 per share, of Heritage issued and outstanding shall be converted into or
exchanged either for $6.00 in cash or 1.2 shares of Cardinal 7.25% Cumulative
Convertible Preferred Stock, Series A (the "Consideration"). Scott &
Stringfellow further understands that in no event shall cash be more or less
than 50% of the total Consideration.
Scott & Stringfellow, as a customary part of its investment banking
business, is engaged in the valuation of financial institutions and their
securities in connection with mergers and acquisitions, negotiated
underwritings, private placements, and valuations for estate, corporate and
other purposes. We have acted as financial advisor to the Board of Directors of
Cardinal in connection with the transaction described above. We are familiar
with Cardinal, having acted as its financial advisor in the past and have
provided certain investment banking services from time to time.
In developing our opinion, we have, among other things, reviewed and
analyzed: (1) the Merger Agreement; (2) the joint Proxy Statement; (3)
Cardinal's audited financial statements for the three years ended December 31,
1999; (4) Cardinal's unaudited financial statements for the three months ended
March 31, 2000 and 1999, and other internal information relating to Cardinal
prepared by Cardinal's management; (5) information regarding the trading market
for the common stocks of Cardinal and Heritage and the price ranges within which
the respective stocks have traded; (6) the relationship of prices paid to
relevant financial data such as net worth, earnings, assets and deposits in
certain bank and bank holding company mergers and acquisitions in recent years;
(7) Heritage's annual reports to shareholders and its financial statements for
the three years ended December 31, 1999; (8) Heritage's unaudited financial
statements for the three months ended March 31, 2000 and 1999, and certain other
internal information relating to Heritage prepared by Heritage's management. We
have discussed with members of management of Cardinal and Heritage the
background of the Merger, the reasons and basis for the Merger and the business
and future prospects of Cardinal and Heritage individually and as a combined
entity. Finally, we have conducted such other studies, analyses and
investigations, particularly of the banking industry, and considered such other
information as we have deemed appropriate.
<PAGE>
In conducting our review and arriving at our opinion, we have relied
upon and assumed the accuracy and completeness of the information furnished to
us by or on behalf of Cardinal and Heritage. We have not attempted independently
to verify such information, nor have we made any independent appraisal of the
assets of Cardinal or Heritage. With respect to the information relating to the
prospects of Cardinal and Heritage, we have assumed that such information
reflects the best currently available judgments and estimates of the managements
of Cardinal and Heritage as to the likely future financial performances of their
respective companies and of the combined entity. We have taken into account our
assessment of general economic, financial market and industry conditions as they
exist and can be evaluated as of the date hereof, as well as our experience in
business valuation in general. We have also assumed that, in the course of
obtaining regulatory and third party consents for the Merger and the
transactions contemplated by the Merger Agreement, no restriction will be
imposed that will have a material adverse effect on the future results of
operations or financial condition of Cardinal or Heritage.
Our advisory services and opinion expressed herein were prepared for
the use of the Board of Directors of Cardinal and do not constitute a
recommendation to the Cardinal shareholders as to how they should vote at the
shareholders' meeting in connection with the Merger. We hereby consent, however,
to the inclusion of this opinion as an exhibit to the proxy statement
distributed in connection with the Merger.
On the basis of our analyses and review and in reliance on the accuracy
and completeness of the information furnished to us and subject to the
conditions and assumptions noted above, it is our opinion that, as of the date
hereof, the terms of the Merger Agreement are fair from a financial point of
view to the shareholders of Cardinal Common Stock.
Very truly yours,
SCOTT & STRINGFELLOW, INC.
By:
----------------------------
Gary S. Penrose
Managing Director
Financial Institutions Group
<PAGE>
Appendix D
HERITAGE BANCORP, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Independent Auditor's Report D-2
Consolidated Financial Statements
Statements of Condition as of December 31, 1999 and 1998 D-3
Statements of Operations for the years ended December 31, 1999, 1998 and 1997 D-4
Statements of Changes in Stockholders' Equity for the years ended December 31,
1999, 1998 and 1997 D-5
Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 D-6
Notes to Consolidated Financial Statements D-8 - D-28
Consolidated Interim Financial Statements
Balance Sheets as of March 31, 2000 and December 31, 1999 D-29
Statements of Income for the three months ended March 30, 2000 and 1999 D-30
Statements of Stockholders' Equity for the three months ended March 31, 2000 D-31
Statements of Cash Flows for the three months ended March 31, 2000 and 1999 D-32
Notes to Consolidated Interim Financial Statements D-33 - D-35
</TABLE>
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Heritage Bancorp, Inc. and Subsidiary
McLean, Virginia
We have audited the accompanying consolidated statements of condition of
Heritage Bancorp, Inc. and Subsidiary as of December 31, 1999 and 1998, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the three years then ended. These financial statements are
the responsibility of the Company'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 Heritage
Bancorp, Inc. and Subsidiary as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for the three years then ended, in
conformity with generally accepted accounting principles.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
February 4, 2000
D-2
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CONDITION
December 31, 1999 and 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
------------ ------------
<S> <C> <C>
Cash and due from banks $ 2,667,443 $ 5,824,649
Federal funds sold -- 8,550,000
------------ ------------
Total cash and cash equivalents $ 2,667,443 $ 14,374,649
Securities available for sale, at approximate market value 24,054,515 19,823,754
Loans, net of allowance for loan losses of $420,940 in 1999
and $429,059 in 1998 31,268,232 29,181,039
Premises and equipment, net 848,995 376,453
Accrued interest receivable 535,571 459,340
Other real estate owned -- 263,199
Other assets 564,657 297,160
------------ ------------
Total assets $ 59,939,413 $ 64,775,594
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing deposits $ 13,707,792 $ 17,385,307
Interest-bearing deposits 34,284,891 36,056,672
------------ ------------
Total deposits $ 47,992,683 $ 53,441,979
Accrued interest and other liabilities 347,527 119,170
Securities sold under agreement to repurchase 3,001,225 2,286,781
Commitments and contingent liabilities -- --
------------ ------------
Total liabilities $ 51,341,435 $ 55,847,930
============ ============
STOCKHOLDERS' EQUITY
Common stock, $1 par value; authorized 10,000,000
shares; issued and outstanding 2,294,617 shares $ 2,294,617 $ 2,294,617
Capital surplus 6,529,539 6,529,539
Retained earnings 210,534 28,549
Accumulated other comprehensive income (loss) (436,712) 74,959
------------ ------------
Total stockholders' equity $ 8,597,978 $ 8,927,664
------------ ------------
Total liabilities and stockholders' equity $ 59,939,413 $ 64,775,594
============ ============
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
D-3
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees $ 2,689,853 $ 2,386,091 $ 2,285,986
Securities 1,413,942 1,117,858 816,256
Federal funds sold 277,106 262,053 154,066
----------- ----------- -----------
Total interest income $ 4,380,901 $ 3,766,002 $ 3,256,308
----------- ----------- -----------
INTEREST EXPENSE
Deposits $ 1,342,470 $ 1,233,550 $ 1,103,974
Securities sold under agreement to repurchase 96,794 38,859 6,797
----------- ----------- -----------
Total interest expense $ 1,439,264 $ 1,272,409 $ 1,110,771
----------- ----------- -----------
Net interest income $ 2,941,637 $ 2,493,593 $ 2,145,537
Provision for loan losses -- 117,000 3,825
----------- ----------- -----------
Net interest income after
provision for loan losses $ 2,941,637 $ 2,376,593 $ 2,141,712
----------- ----------- -----------
OTHER INCOME
Service charges on deposit accounts $ 116,343 $ 122,684 $ 112,039
Other operating income, net 47,835 15,477 21,233
Gain (loss) on sale of securities 1,468 (781) 47,261
Gain on sale of other real estate 56,611 -- --
----------- ----------- -----------
Total other income $ 222,257 $ 137,380 $ 180,533
----------- ----------- -----------
OTHER EXPENSES
Salaries and employee benefits $ 1,472,136 $ 1,074,228 $ 953,246
Occupancy expense 328,105 204,669 215,204
Equipment expense 146,172 73,667 88,275
Other operating expenses 942,821 1,068,643 579,961
----------- ----------- -----------
Total other expenses $ 2,889,234 $ 2,421,207 $ 1,836,686
----------- ----------- -----------
Income before income taxes $ 274,660 $ 92,766 $ 485,559
Income tax expense (benefit) 92,675 (40,639) (85,297)
----------- ----------- -----------
Net income $ 181,985 $ 133,405 $ 570,856
=========== =========== ===========
EARNINGS PER SHARE, BASIC $ 0.08 $ 0.07 $ 0.45
=========== =========== ===========
EARNINGS PER SHARE, ASSUMING DILUTION $ 0.08 $ 0.07 $ 0.44
=========== =========== ===========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
D-4
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON CAPITAL RETAINED COMPREHENSIVE COMPREHENSIVE
STOCK SURPLUS EARNINGS INCOME (LOSS) INCOME (LOSS) TOTAL
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 $ 1,249,634 $ 2,967,448 $ (675,712) $ 1,464 $ 3,542,834
Net income -- -- 570,856 -- $ 570,856 570,856
Other comprehensive income,
net of tax:
Unrealized holding gains on
securities available for sale
arising during period,
net of tax of $25,401 -- -- -- -- $ 47,845 --
Less reclassification adjustment,
net of tax of $16,068 -- -- -- -- (31,192) --
-----------
Other comprehensive income -- -- -- 16,653 $ 16,653 16,653
-----------
Comprehensive income -- -- -- -- $ 587,509 --
-----------
Warrants exercised 240,002 360,003 -- -- 600,005
----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 $ 1,489,636 $ 3,327,451 $ (104,856) $ 18,117 $ 4,730,348
Net income -- -- 133,405 -- $ 133,405 133,405
-----------
Other comprehensive income,
net of tax:
Unrealized holding gains on
securities available for sale
arising during period,
net of tax of $29,016 -- -- -- -- $ 56,327 --
Add reclassification adjustment,
net of tax of $266 -- -- -- -- 515 --
-----------
Other comprehensive income -- -- -- 56,842 $ 56,842 56,842
-----------
Comprehensive income -- -- -- -- $ 190,247 --
-----------
Stock options exercised 2,700 7,120 -- -- 9,820
Repurchase of stock in odd lot tender (2,719) (12,236) -- -- (14,955)
Issuance of common stock 805,000 3,207,204 -- -- 4,012,204
----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 $ 2,294,617 $ 6,529,539 $ 28,549 $ 74,959 $ 8,927,664
Net income -- -- 181,985 -- $ 181,985 181,985
-----------
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale
arising during period,
net of tax of $263,089 -- -- -- -- $ (510,702) --
Less reclassification adjustment,
net of tax of $499 -- -- -- -- (969) --
-----------
Other comprehensive income (loss) -- -- -- (511,671) $ (511,671) (511,671)
-----------
Comprehensive income (loss) -- -- -- -- $ (329,686) --
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1999 $ 2,294,617 $ 6,529,539 $ 210,534 $ (436,712) $ 8,597,978
----------- ----------- ----------- ----------- -----------
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
D-5
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 181,985 $ 133,405 $ 570,856
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses -- 117,000 3,825
(Gain) loss on sale of securities (1,486) 781 (47,261)
(Gain) on sale of fixed assets (200) -- --
(Gain) on sale of other real estate (56,611) -- --
Depreciation and amortization 81,460 50,958 67,733
Deferred tax (benefit) expense 72,362 (45,239) (85,297)
Amortization of investment security premiums,
net of discounts 22,442 37,438 13,845
(Increase) decrease in accrued interest and other assets (152,502) (319,486) 64,677
Increase (decrease) in accrued interest and other liabilities 228,357 5,412 (30,169)
------------ ------------ ------------
Net cash provided by (used in) operating activities $ 375,807 $ (19,731) $ 558,209
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities and calls of securities available for sale $ 9,250,000 $ 9,195,000 $ 1,800,000
Purchase of securities available for sale (14,923,462) (17,676,403) (9,236,816)
Maturities of securities held to maturity -- 250,000 250,000
Proceeds from sale of securities available for sale 646,486 499,219 8,984,402
Net (increase) decrease in loans (2,087,193) (6,543,481) 1,825,409
Purchase of premises and equipment (554,002) (48,472) (90,920)
Proceeds from sale of equipment 200 -- --
Proceeds from sale of other real estate owned 319,810 -- --
------------ ------------ ------------
Net cash provided by (used in) investing activities $ (7,348,161) $(14,324,137) $ 3,532,075
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in demand deposits, NOW accounts
and savings deposits $ (3,677,515) $ 8,639,394 $ 550,791
Increase (decrease) in certificates of deposit (1,771,781) 4,198,750 (2,333,488)
Proceeds from stock warrants exercised -- -- 600,005
Proceeds from sale of common stock -- 4,022,024 --
Repurchase of common stock -- (14,955) --
Increase in securities sold under agreement to repurchase 714,444 2,286,781 --
------------ ------------ ------------
Net cash provided by (used in) financing activities $ (4,734,852) $ 19,131,994 $ (1,182,692)
------------ ------------ ------------
Net change in cash and cash equivalents $(11,707,206) $ 4,788,126 $ 2,907,592
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 14,374,649 9,586,523 6,678,931
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 2,667,443 $ 14,374,649 $ 9,586,523
============ ============ ============
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
D-6
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ -----------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 1,437,740 $ 1,269,516 $ 1,113,620
=========== ============ ===========
Income taxes $ 40,500 $ -- $ 9,187
=========== ============ ===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES,
unrealized gain (loss) on securities available for sale $ (775,258) $ 86,124 $ 25,986
=========== ============ ===========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
D-7
<PAGE>
HERITAGE BANCORP, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 1. NATURE OF BANKING ACTIVITIES AND SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Heritage Bancorp, Inc. (Company) is a bank holding company organized
under Virginia law in July, 1998. During 1998, the Company acquired
The Heritage Bank through a share exchange in which the stockholders
of The Heritage Bank received one share of the Company for each share
of The Heritage Bank. The exchange was a tax-free transaction for
federal income tax purposes. The merger was accounted for on the same
basis as a pooling-of-interests. Financial statements for the prior
years, have been retroactively adjusted for the exchange as if it
occurred on January 1, 1997.
The Company's wholly-owned subsidiary, The Heritage Bank (Bank) was
incorporated under Virginia law in 1987. It operated as a wholly-owned
subsidiary of Heritage Bankshares, Inc. until September 1, 1992, when
it became independent. The Bank is a state chartered member of the
Federal Reserve System with deposits insured by the Federal Deposit
Insurance Corporation (FDIC) and is headquartered in McLean, Virginia.
During 1999, the Bank opened its first branch office in Sterling,
Virginia.
BUSINESS
Heritage Bancorp, Inc. is a bank holding company that provides a
variety of banking services to individuals and businesses. Its primary
deposit products are demand and savings deposits and certificates of
deposit. Its primary lending products are commercial business and real
estate mortgage loans. The loans are expected to be repaid from cash
flow or proceeds from the sale of selected assets of the borrowers.
PRINCIPLES OF CONSOLIDATION
The accounting and reporting policies of Heritage Bancorp, Inc. and
subsidiary conform to generally accepted accounting principles and
general practices within the banking industry. The following is a
description of the more significant of those policies:
SECURITIES
Debt securities that management has the positive intent and
ability to hold to maturity are classified as "held to maturity"
and recorded at amortized cost. Securities not classified as held
to maturity, including equity securities with readily
determinable fair values, are classified as "available for sale"
and recorded at fair value, with unrealized gains and losses
excluded from earnings and reported in other comprehensive
income.
Purchased premiums and discounts are recognized in interest
income using the interest method over the terms of the
securities. Declines in the fair value of held to maturity and
available for sale securities below their cost that are deemed to
be other than temporary are reflected in earnings as realized
losses. Gains and losses on the sale of securities are recorded
on the trade date and are determined using the specific
identification method.
D-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
LOANS
The Company grants mortgage, commercial and consumer loans to
customers. A substantial portion of the loan portfolio is
represented by residential and commercial real estate loans. The
ability of the Company's debtors to honor their contracts is
dependent upon the real estate and general economic conditions of
the Company's market area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are
reported at their outstanding unpaid principal balances adjusted
for the allowance for loan losses and any deferred fees or costs
on originated loans. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain
origination costs, are deferred and recognized as an adjustment
of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent unless
the credit is well-secured and in process of collection.
Installment loans are typically charged off no later than 180
days past due. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or
interest is considered doubtful.
All interest accrued but not collected for loans that are placed
on nonaccrual or charged-off is reversed against interest income.
The interest on these loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all principal and
interest amounts contracturally due are brought current and
future payments are reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses
charged to earnings. Loan losses are charged against the
allowance when management believes the uncollectibility of a loan
balance is confirmed. Subsequent recoveries, if any, are credited
to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the
collectibility of the loans in light of historical experience,
the nature and volume of the loan portfolio, adverse situations
that may affect the borrower's ability to repay, estimated value
of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information
becomes available.
A loan is considered impaired when, based on current information
and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due
according to the contractural terms of the loan agreement.
Factors considered by management in determining impairment
include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment
shortfalls
D-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including
the length of the delay, the reasons for the delay, the
borrower's prior payment record, and the amount of the shortfall
in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction
loans by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's
obtainable market price, or the fair value of the collateral if
the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. Accordingly, the Company
does not separately identify individual consumer and residential
loans for impairment disclosures.
BANK PREMISES AND EQUIPMENT
Land is carried at cost. Buildings and equipment are carried at
cost, less accumulated depreciation computed on the straight-line
method over the estimated useful lives of the assets.
INCOME TAXES
Deferred income tax assets and liabilities are determined using
the balance sheet method. Under this method, the net deferred tax
asset or liability is determined based on the tax effects of the
temporary differences between the book and tax bases of the
various balance sheet assets and liabilities and gives current
recognition to changes in tax rates and laws.
EARNINGS PER SHARE
Basic earnings per share represents income available to common
stockholders divided by the weighted-average number of common
shares outstanding during the period. Diluted earnings per share
reflects additional common shares that would have been
outstanding if dilutive potential common shares had been issued,
as well as any adjustment to income that would result from the
assumed issuance. Potential common shares that may be issued by
the Company relate solely to outstanding stock options, and are
determined using the treasury method.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents
include cash and balances due from banks and federal funds sold.
OTHER REAL ESTATE
Assets acquired through, or in lieu of, loan foreclosure are held
for sale and are initially recorded at fair value at the date of
foreclosure, establishing a new cost basis. Subsequent to
foreclosure, valuations are periodically performed by management
and the assets are carried at the lower of carrying amount or
fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in
net expenses from foreclosed assets.
D-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
USE OF ESTIMATES
In preparing consolidated financial statements in conformity with
generally accepted accounting principles, management is required
to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the balance
sheet and the reported amounts of revenues and expenses during
the reported period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible
to significant change in the near term relate to the
determination of the allowance for loan losses, and the valuation
of foreclosed real estate and deferred tax assets.
ADVERTISING
The Company follows the policy of charging the costs of
advertising to expense as incurred. The amount of advertising
included in expense for December 31, 1999, 1998 and 1997 was
$37,231, $31,482 and $20,394, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which is required
to be adopted in years beginning after June 15, 2000. The
statement permits early adoption as of the beginning of any
fiscal quarter after its issuance. This Statement establishes
accounting and reporting standards for derivative instruments and
hedging activities, including certain derivative instruments
embedded in other contracts, and requires that an entity
recognize all derivatives as assets or liabilities in the balance
sheet and measure them at fair value. Because the Company does
not use these derivative instruments and strategies, management
does not expect the adoption of this Statement to have any effect
on earnings or financial position.
NOTE 2. CASH AND DUE FROM BANKS
The Bank is required to maintain reserve balances with the Federal
Reserve Bank. For the final weekly reporting period in the years ended
December 31, 1999 and 1998, the aggregate amounts of daily average
required balances were approximately $469,000 and $391,000,
respectively.
D-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 3. SECURITIES
The amortized cost, with gross unrealized gains and losses, follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities Available for Sale
U.S. Government agencies $22,916,301 $ -- $ (643,120) $22,273,181
Obligations of states and
political subdivisions 1,009,856 -- (3,378) 1,006,478
Corporate 525,343 -- (15,187) 510,156
Other 264,700 -- -- 264,700
----------- ----- ----------- -----------
Total $24,716,200 $ -- $ (661,685) $24,054,515
=========== ===== =========== ===========
<CAPTION>
DECEMBER 31, 1998
-------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Securities Available for Sale
U.S. Treasury securities $ 3,021,530 $ 29,721 $ -- $ 3,051,251
U.S. Government agencies 14,769,231 57,082 (2,344) 14,823,969
Obligations of states and
political subdivisions 1,654,720 29,114 -- 1,683,834
Corporate
Other 264,700 -- -- 264,700
----------- ----------- ----------- -----------
Total $19,710,181 $ 115,917 $ (2,344) $19,823,754
=========== =========== =========== ===========
</TABLE>
The amortized cost and fair value of securities by contractural
maturity follows:
<TABLE>
<CAPTION>
1999
AMORTIZED FAIR
COST VALUE
----------- -----------
<S> <C> <C>
Due in one year or less $ 510,000 $ 508,477
Due from one year to five years 22,565,980 21,961,130
Due from five years to ten years 1,000,000 944,688
Due after ten years 375,520 375,520
Federal Reserve stock 264,700 264,700
----------- -----------
Total $24,716,200 $24,054,515
=========== ===========
</TABLE>
D-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
Proceeds from sale of securities available for sale during 1999, 1998
and 1997 were $646,486 $449,219 and $8,984,402. Gross gains on those
sales during 1999, 1998 and 1997 were $1,468, $0 and $47,261. Gross
losses on those sales were $0, $781 and $0 during 1999, 1998 and 1997,
respectively.
Securities having a book value of approximately $5,496,544 and
$3,792,558 at December 31, 1999 and 1998, were pledged to secure
public deposits, letters of credit, and customer repurchase
agreements.
NOTE 4. LOANS
A summary of the balances of loans follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
(in thousands)
<S> <C> <C>
Real estate:
Residential $ 10,475 $ 11,168
Commercial 13,088 11,791
Farmland 972 992
Construction 1,157 441
Commercial 3,665 3,279
Consumer 1,507 1,306
All other loans 825 633
-------- --------
$ 31,689 $ 29,610
Less: allowance for loan losses (421) (429)
-------- --------
Loans, net $ 31,268 $ 29,181
======== ========
</TABLE>
Analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
1999 1998 1997
----- ----- -----
(in thousands)
<S> <C> <C> <C>
Balance, beginning of year $ 429 $ 634 $ 617
Provision for loan losses -- 117 4
Loans charged-off (20) (339) (61)
Recoveries 12 17 74
----- ----- -----
Balance at end of year $ 421 $ 429 $ 634
===== ===== =====
</TABLE>
D-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
Information about impaired loans is as follows:
<TABLE>
<CAPTION>
1999 1998
------- --------
<S> <C> <C>
Impaired loans for which an allowance
has been provided $ -- $ 29,370
Impaired loans for which no allowance
has been provided -- --
------- --------
Total impaired loans $ -- $ 29,370
------- --------
Allowance provided for impaired loans,
included in the allowance for loan
losses $ -- $ 11,405
------- --------
<CAPTION>
1999 1998 1997
------- --------- ---------
<S> <C> <C> <C>
Average balance in impaired loans $ 2,719 $ 176,334 $ 378,901
------- --------- ---------
Interest income recognized $ 524 $ 23,605 $ 26,858
------- --------- ---------
</TABLE>
There were no nonaccrual loans excluded from impaired loan disclosure
at December 31, 1999. Nonaccrual loans excluded from impaired loan
disclosure under FASB 114 amounted to $365,670 at December 31, 1998.
If interest on these loans had been accrued, such income would have
approximated $26,836.
NOTE 5. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to
principal officers and directors and their affiliates amounting to
$306,496 at December 31, 1999 and $279,384 at December 31, 1998.
During the year ended December 31, 1999, total principal additions
were $150,500 and total principal payments were $123,388.
D-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 6. PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and
equipment follows:
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Land $ 245,000 $ 245,000
Land improvements 41,964 31,885
Leasehold improvements 242,997 147,647
Equipment, furniture and fixtures 459,268 354,200
--------- ---------
$ 989,229 $ 778,732
Less accumulated depreciation
and amortization (140,234) (402,279)
--------- ---------
$ 848,995 $ 376,453
========= =========
</TABLE>
Depreciation and amortization charged to operations totaled $81,460,
$50,958 and $67,733 in 1999, 1998 and 1997, respectively.
NOTE 7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase, which are classified
as secured borrowings, generally mature within one to four days from
the transaction date. Securities sold under agreements to repurchase
are reflected at the amount of cash received in connection with the
transaction. The Company may be required to provide additional
collateral based on the fair value of the underlying securities.
D-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 8. INCOME TAXES
The components of the net deferred tax assets, included in other
assets, are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
DEFERRED TAX ASSETS:
Net operating loss carryforwards $ -- $ 47,105
Alternative minimum tax credits -- 6,652
Unrealized loss on securities available for sale 224,973 --
Accumulated depreciation 24,794 28,160
Allowance for loan losses 32,448 32,448
Organization costs 15,286 19,362
Other -- 11,163
-------- --------
Gross deferred tax asset $297,501 $144,890
======== ========
DEFERRED TAX LIABILITIES, unrealized gain
on securities available for sale $ -- $ 38,615
-------- --------
Net deferred tax assets $297,501 $106,275
-------- --------
</TABLE>
Allocation of federal income taxes between current and deferred
portions is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
Current $ 165,498 $ 4,600 $ --
Deferred (72,823) 40,058 161,717
Change in valuation allowance -- (85,297) (247,014)
--------- --------- ---------
$ 92,675 $ (40,639) $ (85,297)
========= ========= =========
</TABLE>
The reasons for the difference between the statutory federal income
tax rate and the effective tax rates are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Tax expense at statutory rate $ 93,384 $ 31,540 $ 165,090
Change in valuation allowance -- (85,297) (247,014)
Other, net (709) 13,118 (3,373)
--------- --------- ---------
$ 92,675 $ (40,639) $ (85,297)
========= ========= =========
</TABLE>
D-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 9. DEPOSITS
The aggregate amount of time deposits, in denominations of $100,000 or
more at December 31, 1999 and 1998 was $4,738,768 and $6,339,277,
respectively.
At December 31, 1999, the scheduled maturities of time deposits are as
follows:
2000 $ 9,095,970
2001 4,932,561
2002 1,368,049
------------
$ 15,396,580
============
NOTE 10. OTHER OPERATING EXPENSES
The components of other operating expenses consisted of the following
for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Data processing $ 126,762 $ 99,589 $ 78,702
Professional fees 175,555 374,229 115,024
Stationary and supplies 85,693 70,172 61,957
Postage 38,461 33,235 36,899
Stockholder expense 49,329 77,524 18,116
Bank franchise tax 59,556 27,597 27,366
Business development 84,533 31,482 20,794
Other (includes no items in excess of
1% of total revenue) 322,932 354,815 221,103
---------- ---------- ----------
$ 942,821 $1,068,643 $ 579,961
========== ========== ==========
</TABLE>
D-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 11. EARNINGS PER SHARE
The following shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number
of shares of diluted potential common stock. Potential dilutive common
stock had no effect on income available to common stockholders.
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------- ---------------------------- -----------------------------
PER SHARE PER SHARE PER SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ------------ --------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings
per share 2,294,617 $ 0.08 1,890,666 $ 0.07 1,271,176 $ 0.45
============ ============ =============
Effect of dilutive
securities:
Stock options 6,931 5,585 1,307
Warrants -- -- 22,726
Diluted earnings
per share 2,301,548 $ 0.08 1,896,251 $ 0.07 1,295,209 $ 0.44
============ ============ =============
</TABLE>
NOTE 12. COMMITMENTS AND CONTINGENCIES
The Company leases its main office and operations center in McLean and
its branch office in Sterling. The McLean lease contains three, five
year renewal periods and expires in 2008. The Sterling lease has a
term of ten years with one five year renewal option. The Sterling
lease expires in 2009. Total rent expense was $310,910, $191,272 and
$194,945 for 1999, 1998 and 1997, respectively, and was included in
occupancy expense.
The following is a schedule, by year, of future minimum lease payments
required under the long-term noncancelable lease agreements.
2000 $ 336,892
2001 350,194
2002 364,325
2003 374,705
2004 385,959
Due thereafter 1,355,997
----------
$3,168,072
==========
The Company entered into a long-term lease for its Tyson's branch on
March 16, 2000, which is subject to regulatory approval. The lease
expires March 31, 2006 and has annual base rent of $111,078 with 3%
yearly increases.
D-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
In the normal course of business there are outstanding various
commitments and contingent liabilities, which are not reflected in the
accompanying consolidated financial statements. Management does not
anticipate any material losses as a result of these transactions.
See Note 15 with respect to financial instruments with
off-balance-sheet risk.
NOTE 13. STOCK-BASED COMPENSATION
In 1998, the stockholders approved an employee incentive stock option
plan. The option price for shares granted under this plan shall be
determined by a Committee of the Company's Board of Directors, but in
no event shall the option price be less than the fair market value of
the Company's stock at the time of grant. The term of each option
granted under the plan is ten years, unless the optionee has been
discharged from his or her employment by the Company for cause in
which case the option must be exercised no later than six months
following the date of discharge. The maximum aggregate number of
shares which may be optioned and sold under the plan is 75,000 shares.
As of December 31, 1999, 29,480 options were outstanding under this
plan.
In 1992, the Company adopted a nonqualified stock option plan which
full-time employees and part-time employees working at least 25 hours
per week were eligible to receive options to acquire Common Stock.
Options expire ten years after the date of grant. There are 18,125
options outstanding under this plan as of December 31, 1999.
Grants under the above plans are accounted for following APB Opinion
No. 25 and related interpretations. Accordingly, no compensation cost
has been recognized for grants under the stock option plans. No
employee stock options were granted during 1997 and 1996. Had
compensation cost for the employee stock-based compensation plan been
determined based on the grant date fair values of awards (the method
described in FASB Statement No. 123), reported net income and earnings
per common share would have been reduced to the pro forma amounts
shown below for 1999:
<TABLE>
<S> <C>
Net income:
As reported $ 181,985
Pro forma $ 139,600
Basic earnings per share:
As reported $ .08
Pro forma $ .06
Diluted earnings per share:
As reported $ .08
Pro forma $ .06
</TABLE>
The fair value of each grant is estimated at the grant date using the
Black-Scholes option-pricing model. The following weighted average
assumptions for grants in 1999 were used: price volatility of 20.9%;
risk-free interest rate of 6.5%; dividend rate of 0.00% and expected
life of 10 years.
D-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
The status of the Option Plans during 1999, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
January 1 29,550 $ 3.45 27,375 $ 3.43 30,675 $ 3.51
Granted 24,500 3.97 8,925 3.875 -- --
Exercised -- -- (2,700) 3.64 -- --
Canceled (6,445) 3.96 (4,050) 4.13 (3,300) 4.20
------ ------ ------
Outstanding at
December 31 47,605 $ 3.65 29,550 $ 3.45 27,375 $ 3.43
------ ------ ------
Exercisable at
end of year 47,605 29,550 27,375
====== ====== ======
Weighted-average
fair value per
option of options
granted during
the year $ 2 $ 2 $ --
====== ====== =====
</TABLE>
The Status of the options outstanding at December 31, 1999 is as
follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE
EXERCISE AND CONTRACTUAL EXERCISE
PRICE EXERCISABLE LIFE PRICE
------------- ----------- ----------- --------
<S> <C> <C> <C>
$3.10 - $3.15 18,125 0.75 years 3.14
$3.875 12,480 9.35 3.875
$4.00 16,000 9.75 4.00
$4.25 1,000 9.75 4.25
------
47,605 6.22 3.65
======
</TABLE>
D-20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 14. DIRECTOR COMPENSATION PLAN
In 1998, the stockholders approved a stock option plan for outside
directors of the Company. The option price for shares to be issued
upon exercise of any option granted under this plan shall be
determined by a Committee of the Company's Board of Directors, but in
no event shall the option price be less than the fair market value of
the Company's stock at the time of grant. The term of each option
granted under this plan shall be ten years from the date of grant. If
a director resigns or is removed from the Board, all of the Director's
stock options must be exercised within sixty days of his or her
departure from the Board. The maximum aggregate number of shares which
may be optioned and sold under the plan is 75,000 shares. As of
December 31, 1999, 28,500 options were outstanding under this plan.
On March 26, 1997, the Board of Directors granted stock options to
those members serving on the Bank's Board of Directors, who were not
employees or officers of the Bank, to acquire common stock at an
exercise price of $2.86. The options expire ten years after the grant
date, unless the Director ceases to be a member of the Bank's Board of
Directors, in which case the options expire sixty days following such
date. As of December 31, 1999, there were 10,000 options outstanding.
The status of the Option Plan during 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- ------------------------ -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January 1 26,000 $ 3.48 10,000 $ 2.86 -- $ --
Granted 14,000 4.00 16,000 3.875 10,000 2.86
Forfeited (1,500) 3.875 -- -- -- --
------ ------ ------
Outstanding at December 31 38,500 $ 3.66 26,000 $ 3.48 10,000 $ 2.86
====== ====== ======
</TABLE>
The status of the options outstanding as of December 31, 1999 is as
follows:
<TABLE>
<CAPTION>
WEIGHTED NUMBER
AVERAGE OUTSTANDING REMAINING
EXERCISE AND CONTRACTUAL
PRICE EXERCISABLE LIFE
------- ----------- ---------
<S> <C> <C>
$ 2.860 10,000 7.25 years
3.875 14,500 8.75
4.000 14,000 10
------
$ 3.660 38,500 8.81
======
</TABLE>
D-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is party to credit related 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. Such
commitments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the
consolidated balance sheets.
The Company's exposure to credit loss is represented by the
contractural amount of these commitments. The Company uses the same
credit policies in making commitments as it does for on-balance-sheet
instruments.
At December 31, 1999 and 1998, the following financial instruments
were outstanding whose contract amounts represent credit risk:
<TABLE>
<CAPTION>
1999 1998
---------------- --------------
<S> <C> <C>
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $ 10,594,692 $ 8,708,866
Standby letters of credit $ 92,333 $ 181,900
</TABLE>
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. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's credit worthiness
on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on
management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property and
equipment, and income-producing commercial properties.
Unfunded commitments under commercial lines of credit, revolving
credit lines and overdraft protection agreements are commitments for
possible future extensions of credit to existing customers. These
lines of credit may be uncollateralized and usually do not contain a
specified maturity date and may not be drawn upon to the total extent
to which the Company is committed.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing,
and similar transactions. The credit risk involved in issuing letters
of credit is essentially the same as that involved in extending loan
facilities to customers. The Company holds cash and marketable
securities supporting those commitments for which collateral is deemed
necessary.
The Company maintains several cash accounts in other commercial banks.
The amount on deposit with correspondent institutions at December 31,
1999, exceeded the insurance limits of the Federal Deposit Insurance
Corporation by $490,963.
D-22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 16. RESTRICTIONS ON TRANSFERS TO PARENT
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company.
The total amount of dividends, which may be paid at any date is
generally limited to the retained earnings of the Bank, and loans or
advances are limited to 10 percent of the Bank's capital stock and
surplus on a secured basis. As of December 31, 1999, the aggregate
amount of unrestricted funds, which could be transferred from the
banking subsidiary to the Parent Company without prior regulatory
approval totaled $1,025,519 or 11.93% of the consolidated net assets.
NOTE 17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS
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 variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on
carrying values. Fair values for certain mortgage loans (e.g.,
one-to-four family residential), and other consumer loans are
based on quoted market prices of similar loans sold in
conjunction with securitization transactions, adjusted for
differences in loan characteristics. Fair values for other loans
(e.g., commercial real estate and investment property mortgage
loans, commercial and industrial loans) are estimated using
discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of
similar credit quality. Fair values for non-performing loans are
estimated using discounted cash flow analyses or underlying
collateral values, where applicable.
DEPOSITS
The fair values disclosed for demand deposits (e.g., interest and
non-interest checking, statement savings, and certain types of
money market accounts) are, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying
amounts). The carrying amounts of variable-rate, fixed-term money
market accounts and certificates of deposit approximate their
fair values at the reporting date. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash
flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
D-23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
ACCRUED INTEREST
The carrying amounts of accrued interest approximate fair value.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Commitments to extend credit were evaluated and fair value was
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. The fair value of standby 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. The
carrying amount of treasury, tax and loan deposits approximates
the fair value.
The carrying amounts and fair values of financial instruments as
of December 31, 1999 are presented below:
<TABLE>
<CAPTION>
1999 1998
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ----- -------- -----
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 2,667 $ 2,667 $ 5,825 $ 5,825
Federal funds sold and securities
purchased under agreement to resell -- -- 8,550 8,550
Securities 24,055 24,055 19,824 19,824
Loans, net 31,268 31,113 29,181 29,539
Accrued interest receivable 536 536 459 459
Financial liabilities:
Deposits $47,993 $47,918 $53,442 $53,684
Securities sold under agreement
to repurchase 3,001 3,001 2,287 2,287
Accrued interest payable 53 53 55 55
</TABLE>
D-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 18. CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to
various regulatory capital requirements administered by the Federal
banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct
material effect on the Company's and Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Prompt corrective action provisions are not applicable to bank holding
companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank 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 (as defined)
and of Tier 1 capital (as defined) to average assets (as defined).
Management believes, as of December 31, 1999 and 1998, that the
Company and the Bank met all capital adequacy requirements to which
they are subject.
As of December 31, 1999, the most recent notification from the Federal
Reserve Bank categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized
as well capitalized, an institution 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.
D-25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
The Company and Subsidiary's actual capital amounts and ratios are
also presented in the table. No amount was deducted from capital for
interest-rate risk.
<TABLE>
<CAPTION>
MINIMUM
TO BE WELL
CAPITALIZED UNDER
MINIMUM CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
------ ----------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(Amount in Thousands)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total Capital (to Risk
Weighted Assets)
Consolidated $ 9,456 24.5% greater than greater than N/A
or equal to $ 3,088 or equal to 8.0%
The Heritage Bank $ 9,456 24.5% greater than greater than greater than greater than
or equal to $ 3,088 or equal to 8.0% or equal to $ 3,860 or equal to 10.0%
Tier 1 Capital (to Risk
Weighted Assets)
Consolidated $ 9,035 23.4% greater than greater than N/A
or equal to $ 1,544 or equal to 4.0%
The Heritage Bank $ 9,035 23.4% greater than greater than greater than greater than
or equal to $ 1,544 or equal to 4.0% or equal to $ 2,316 or equal to 6.0%
Tier 1 Capital (to
Average Assets)
Consolidated $ 9,035 14.7% greater than greater than N/A
or equal to $ 2,453 or equal to 4.0%
The Heritage Bank $ 9,035 14.7% greater than greater than greater than greater than
or equal to $ 2,453 or equal to 4.0% or equal to $ 3,066 or equal to 5.0%
As of December 31, 1998:
Total Capital (to Risk
Weighted Assets)
Consolidated $ 9,282 25.7% greater than greater than N/A
or equal to $ 2,886 or equal to 8.0%
The Heritage Bank $ 9,282 25.7% greater than greater than greater than greater than
or equal to $ 2,886 or equal to 8.0% or equal to $ 3,607 or equal to 10.0%
Tier 1 Capital (to Risk
Weighted Assets)
Consolidated $ 8,853 24.5% greater than greater than N/A
or equal to $ 1,443 or equal to 4.0%
The Heritage Bank $ 8,853 24.5% greater than greater than greater than greater than
or equal to $ 1,443 or equal to 4.0% or equal to $ 2,164 or equal to 6.0%
Tier 1 Capital (to
Average Assets)
Consolidated $ 8,853 17.2% greater than greater than N/A
or equal to $ 2,060 or equal to 4.0%
The Heritage Bank $ 8,853 17.2% greater than greater than greater than greater than
or equal to $ 2,060 or equal to 4.0% or equal to $ 2,575 or equal to 5.0%
</TABLE>
NOTE 19. COMMON STOCK
On May 18, 1998, the Company completed a secondary stock offering in
which it sold 805,000 shares of common stock at a price of $5.50 per
share. Net proceeds for the Company were $4,012,204 after deducting
underwriting commissions of $309,925 and direct offering costs of
$105,371. On June 8, 1998, the Company used part of the new capital to
complete an odd-lot tender offer, purchasing 2,719 shares at $5.50 per
share for a total cost of $14,955.
D-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE 20. PARENT COMPANY ONLY FINANCIAL STATEMENTS
HERITAGE BANCORP, INC.
(Parent Company Only)
BALANCE SHEETS
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
----------- -----------
ASSETS
<S> <C> <C>
Investment in subsidiary, at cost, plus
equity in undistributed net income $ 8,737,251 $ 9,017,608
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES, due to subsidiary $ 139,273 $ 89,944
----------- -----------
STOCKHOLDERS' EQUITY
Common stock $ 2,294,617 $ 2,294,617
Surplus 6,529,539 6,529,539
Retained earnings 210,534 28,549
Accumulated other comprehensive income (436,712) 74,959
----------- -----------
Total stockholders' equity $ 8,597,978 $ 8,927,664
----------- -----------
Total liabilities and stockholders' equity $ 8,737,251 $ 9,017,608
=========== ===========
</TABLE>
D-27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
HERITAGE BANCORP, INC.
(Parent Company Only)
STATEMENTS OF INCOME
For the Years Ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
INCOME
Equity in undistributed net income of subsidiary $231,314 $223,349
-------- --------
EXPENSES
Organization costs $ -- $ 89,944
Stockholder expense 49,329 --
-------- --------
Total expenses $ 49,329 $ 89,944
-------- --------
Net income $181,985 $133,405
======== ========
</TABLE>
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 181,985 $ 133,405
Adjustments to reconcile net income to
net cash provided by operating activities,
increase in due to subsidiary 49,329 89,944
Undistributed earnings of subsidiary (181,985) (223,349)
--------- ---------
Net cash provided by operating activities $ 49,329 $ --
CASH AND CASH EQUIVALENTS, beginning of year -- --
--------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 49,329 $ --
========= =========
</TABLE>
D-28
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
<TABLE>
<CAPTION>
(Unaudited) (Audited)
March 31, December 31,
ASSETS: 2000 1999
----------- ------------
<S> <C> <C>
Cash and due from banks $ 2,990 $ 2,667
Securities available for sale (at market value) 23,764 24,054
Federal funds sold 0 0
Loans, net 35,649 31,268
Premises and equipment 872 849
Other assets 1,146 1,101
------- -------
Total assets $64,421 $59,939
======= =======
LIABILITIES:
Deposits
Non-interest bearing $11,152 $13,708
Interest-bearing 36,881 34,285
------- -------
Total deposits 48,033 47,993
Short-term debt 7,603 3,001
Other liabilities 217 347
------- -------
Total liabilities 55,853 51,341
------- -------
STOCKHOLDERS' EQUITY:
Common stock; $1 par value per share;
authorized 10,000,000 shares; issued and
outstanding 2,294,617 shares 2,295 2,295
Surplus 6,530 6,530
Undivided profits 235 210
Accumulated other comprehensive
income (loss), net (492) (437)
------- -------
Total stockholders' equity 8,568 8,598
------- -------
Total liabilities and
stockholders' equity $64,421 $59,939
======= =======
</TABLE>
Notes to financial statements are an integral part of these statements.
D-29
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands of dollars)
(unaudited)
Three Months Ended
------------------
March 31,
---------
2000 1999
------- -------
INTEREST INCOME:
Loans and fees $ 725 $ 699
Federal funds sold 7 81
Investment securities 386 319
------- -------
Total interest income 1,118 1,099
INTEREST EXPENSE:
Interest on deposits 330 348
Interest on federal funds purchased
and other borrowings 44 12
------- -------
Total interest expense 374 360
------- -------
Net interest income 744 739
PROVISION FOR LOAN
AND LEASE LOSSES (28) 7
------- -------
Net interest income after
provision for loan losses 772 732
OTHER INCOME:
Service charges & fees 46 34
Securities gains (losses) (13) --
------- -------
Total other income 33 34
OTHER EXPENSES:
Salaries & employee benefits 319 295
Occupancy expenses 105 52
Furniture & equipment expenses 64 39
Other operating expenses 280 184
------- -------
Total other expenses 768 570
------- -------
Income before income taxes 37 196
Applicable income taxes 12 19
------- -------
Net income $ 25 $ 177
======= =======
EARNINGS PER SHARE, BASIC $ .01 $ .08
======= =======
EARNINGS PER SHARE, ASSUMING
DILUTION $ .01 $ .08
======= =======
Notes to financial statements are an integral part of these statements.
D-30
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the three months ended March 31, 2000
(in thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Other
Common Retained Comprehensive Comprehensive
Stock Surplus Earnings Income Income Total
----- ------- -------- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 $ 2,295 $ 6,530 $ 28 $ 75 $8,928
Comprehensive income:
Net income -- -- 177 -- $ 177 177
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(39) -- -- -- (74) (74) (74)
--
Other comprehensive income, net of tax -- -- -- -- --
Total comprehensive income -- -- -- -- $ 103
====== ======= ===== ====== ======= ======
Balance, March 31, 1999 $2,295 $ 6,530 $ 205 $ 1 $9,031
====== ======= ===== ====== ======
Balance, January 1, 2000 $ 2,295 $ 6,530 $ 210 $ (437) $8,598
Comprehensive income:
Net income -- -- 25 -- $ 25 25
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(28- -- -- -- (55) (55) (55)
Other comprehensive income, net of tax -- -- -- -- --
Total comprehensive income -- -- -- -- $ (30)
====== ======= ====== ======= ======= ======
Balance, March 31, 2000 $2,295 $ 6,530 $ 235 $ (492) $8,568
====== ======= ====== ======= ======
</TABLE>
Notes to financial statements are an integral part of these statements.
D-31
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------
March 31,
------------------
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 25 $ 177
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 24 12
Provision for loan losses (28) 7
Amortization of premiums, net 2 9
Loss on sale of securities available for sale 13 --
Changes in assets and liabilities:
(Increase) in other assets (17) (259)
(Decrease) in other liabilities (130) --
-------- --------
Net cash provided by operating activities (111) (54)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans (4,353) 523
Purchase of securities available for sale (813) (7,055)
Proceeds from sales of securities available for sale 987 --
Proceeds from calls and maturities of securities available for sale 18 4,000
Purchase of premises and equipment (47) (90)
-------- --------
Net cash (used in) investing activities (4,208) (2,622)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in deposits 40 (2,820)
Net increase (decrease) in short-term borrowings 4,602 (1,009)
-------- --------
Net Cash provided by financing activities 4,642 (3,829)
-------- --------
Net increase (decrease) in cash and cash equivalents 323 (6,505)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 2,667 14,375
-------- --------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 2,990 $ 7,870
======== ========
Supplemental disclosures of cash flow information
Cash payments for:
Interest on deposits $ 369 $ 344
Income taxes $ -- $ --
Supplemental schedule of non-cash investing activities
Unrealized gain (loss) on securities available for sale $ (83) $ (74)
</TABLE>
Notes to financial statements are an integral part of these statements.
D-32
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. GENERAL
The consolidated statements include the accounts of Heritage Bancorp,
Inc. (the "Company") and its subsidiary, The Heritage Bank (the "Bank").
All significant intercompany balances and transactions have been
eliminated. In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments (consisting of
only normal recurring accruals) necessary to present fairly the financial
positions as of March 31, 2000 and December 31, 1999, and the results of
operations and cash flows for the three months ended March 31, 2000 and
1999.
The results of operations for the three months ended March 31, 2000 and
1999 are not necessarily indicative of the results to be expected for the
full year.
2. INVESTMENT SECURITIES
Amortized cost and carrying amount (estimated fair value) of securities
available for sale are summarized as follows:
<TABLE>
<CAPTION>
March 31, 2000
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands of dollars) Cost Gains Losses Value
---------------------------------------------------
<S> <C> <C> <C> <C>
US government agencies & corporations $ 23,110 $ -- $ 723 $ 22,387
Obligations of states & political subdivisions 510 -- 2 508
Corporate debt obligations 523 -- 19 504
Other securities 100 -- -- 100
Federal reserve stock 265 -- -- 265
-------- -------- ------- --------
$ 24,508 $ -- $ 744 $ 23,764
======== ======== ======= ========
Securities available for sale at December 31, 1999 consist of the following:
<CAPTION>
December 31, 1999
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands of dollars) Cost Gains Losses Value
---------------------------------------------------
<S> <C> <C> <C> <C>
US government & federal agencies $ 22,916 $ -- $ (643) $ 22,273
Obligations of states & political subdivisions 1,010 -- (4) 1,006
Corporate debt obligations 525 -- (15) 510
Federal reserve stock 265 -- -- 265
-------- -------- ------- --------
$ 24,716 $ -- $ (662) $ 24,054
======== ======== ======= ========
<CAPTION>
Three Months Ended
(in thousands of dollars) March 31,
---------
2000 1999
---- ----
<S> <C> <C>
Gross proceeds from sales of securities 987 --
====== =====
Gross gains on sale of securities -- --
Gross losses on sale of securities 13 --
------ -----
Net securities gains (losses) 13 --
====== ======
</TABLE>
D-33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(unaudited)
3. LOANS
Major classifications of loans are as follows:
(in thousands of dollars) March 31, December 31,
2000 1999
--------- ------------
Commercial $ 4,475 $ 3,665
Real estate:
Construction 1,696 1,157
Residential (1-4 family) 10,541 10,475
Commercial 16,680 13,088
Agricultural 966 972
Consumer 1,331 1,507
All other Loans 356 825
-------- --------
36,045 31,689
Less allowance for loan losses (396) (421)
-------- --------
$ 35,649 $ 31,268
======== ========
The following schedule summarizes the changes in the allowance for loan and
lease losses:
Three Months Three Months
Ending Ending December 31,
(in thousands of dollars) March 31, 2000 March 31, 1999 1999
-------------- -------------- ----
Balance, beginning $ 421 $ 429 $ 429
Provision charged against income (28) 7 --
Recoveries 3 2 12
Loans charged off -- 20 20
----- ----- -----
Balance, ending $ 396 $ 418 $ 421
===== ===== =====
There were no nonperforming assets on March 31, 2000 or on December 31, 1999.
There were no loans past due 90 days or more and still accruing on March 31,
2000 or on December 31, 1999.
4. EARNINGS PER SHARE
The following shows the weighted average number of shares used in computing
earnings per share and the effect on weighted average number of shares of
diluted potential common stock income available to common shareholders.
<TABLE>
<CAPTION>
March 31, 2000 March 31, 1999
-------------- --------------
Per Share Per Share
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Basic Earnings Per Share 2,294,617 $ .01 2,294,617 $ .08
Effect of dilutive securities:
Nonemployee directors' stock options 1,200 24,500
Employee incentive stock options 588 31,050
--------- ---------
Diluted Earnings Per Share 2,296,405 $ .01 2,350,167 $ .08
========= ======= ========= =======
</TABLE>
D-34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(unaudited)
5. CAPITAL REQUIREMENTS
A comparison of the Company's capital as of March 31, 2000 with the minimum
requirements is presented below:
Minimum
Actual Requirements
------ ------------
Tier I risk-based capital 18.34% 4.00%
Total risk-based capital 19.14% 8.00%
Leverage ratio 14.84% 4.00%
D-35
<PAGE>
Appendix E
[LETTERHEAD OF FERRIS, BAKER WATTS, INCORPORATED]
__, 2000
The Board of Directors
Heritage Bancorp, Inc.
1313 Dolly Madison Blvd.
McLean, VA 22101
Members of the Board:
Heritage Bancorp, Inc. ("Heritage" or the "Company") has requested a
review of the proposed transaction (the "Transaction") involving the acquisition
of Heritage by Cardinal Financial Corporation ("Cardinal") in a cash and
preferred stock for stock merger. Specifically, you have requested a review of
the financial consideration to be offered to the Company's stockholders as
consideration for their shares in the Transaction.
Pursuant to the Transaction, all outstanding shares of the Company
shall be exchanged for either preferred shares in Cardinal; cash; or a
combination of preferred shares and cash. The resulting value of the Company's
stock is $6.00 per share.
In connection with the opinion, we have reviewed, among other things,
(i) the proposed Transaction, (ii) the original letter of intent, as well as
subsequent revisions to the above mentioned letter, (iii) the Agreement and Plan
of Merger, as amended (iv) historical operating results of Heritage, (v)
internally prepared projections for fiscal year 2000. We have held discussions
with the members of the management of the Company regarding the past and current
business operations as well as the future prospects of the Company. We have
reviewed industry specific data regarding the valuation of publicly traded
companies in the banking industry as well as other such information as we
considered appropriate.
Ferris, Baker Watts, Incorporated as part of its investment banking
business, is regularly involved in the valuation of businesses and their
securities in connection with mergers and acquisitions, negotiated
underwritings, competitive biddings, secondary distributions of listed and
unlisted securities, private placements and valuations for corporate and other
purposes. Ferris, Baker Watts, Incorporated is a full service brokerage firm and
periodically prepares research reports on the banking industry. In addition,
through its normal course of business, its clients, its officers or its
employees, may have a position in the common stock of the Company and Cardinal.
We have acted as financial advisor to the Company in connection with the
proposed Transaction and will receive a fee for our services which is contingent
upon the
<PAGE>
consummation of the Proposed Transaction. In addition, the Company has agreed to
indemnify us for certain liabilities arising out of the rendering of this
opinion.
In rendering our opinion, we have assumed and relied upon the accuracy
and completeness of all financial and other information reviewed by us for
purposes of this opinion whether publicly available or provided to us by the
Company or representatives of the Company and we have not assumed any
responsibility for independent verification of such information. We express no
opinion as to the consideration to be received by holders of shares who may
perfect dissenters' statutory fair appraisal remedies, if available. Based upon
the foregoing and based upon other such matters that we considered relevant, it
is our opinion that the consideration to be received by the stockholders of the
Company as a result of the Transaction is fair from a financial point of view as
of the date hereof.
Our opinion is necessarily based upon economic, market and other
conditions as in effect on, and the information made available to us, as of the
date hereof. Our opinion is directed to the Board of Directors of the Company
and does not constitute a recommendation to any stockholder of the Company as to
how the stockholder should vote at the stockholders' meeting held in connection
with the Transaction. It is understood that subsequent developments may affect
the conclusions reached in this opinion and that we do not have any obligation
to update, revise or reaffirm this opinion.
Very truly yours,
Ferris, Baker Watts, Incorporated
<PAGE>
Appendix F
Code of Virginia (1950), as amended
Title 13.1
Chapter 9
Article 15.
Dissenters' Rights.
ss. 13.1-729. Definitions.
In this article:
"Corporation" means the issuer of the shares held by a
dissenter before the corporate action, except that (i) with respect to
a merger, "corporation" means the surviving domestic or foreign
corporation or limited liability company by merger of that issuer, and
(ii) with respect to a share exchange, "corporation" means the
acquiring corporation by share exchange, rather than the issuer, if the
plan of share exchange places the responsibility for dissenters' rights
on the acquiring corporation.
"Dissenter" means a shareholder who is entitled to dissent
from corporate action under ss. 13.1-730 and who exercises that right
when and in the manner required by ss.ss. 13.1-732 through 13.1-739.
"Fair value," with respect to a dissenter's shares, means the
value of the shares immediately before the effectuation of the
corporate action to which the dissenter objects, excluding any
appreciation or depreciation in anticipation of the corporate action
unless exclusion would be inequitable.
"Interest" means interest from the effective date of the
corporate action until the date of payment, at the average rate
currently paid by the corporation on its principal bank loans or, if
none, at a rate that is fair and equitable under all the circumstances.
"Record shareholder" means the person in whose name shares are
registered in the records of a corporation or the beneficial owner of
shares to the extent of the rights granted by a nominee certificate on
file with a corporation.
"Beneficial shareholder" means the person who is a beneficial
owner of shares held by a nominee as the record shareholder.
"Shareholder" means the record shareholder or the beneficial
shareholder.
ss. 13.1-730 Right to dissent.
A. A shareholder is entitled to dissent from, and obtain payment
of the fair value of his shares in the event of, any of the following corporate
actions:
F-1
<PAGE>
1. Consummation of a plan of merger to which the
corporation is a party (i) if shareholder approval is required for the
merger by ss. 13.1-718 or the articles of incorporation and the
shareholder is entitled to vote on the merger or (ii) if the
corporation is a subsidiary that is merged with its parent under ss.
13.1-719;
2. Consummation of a plan of share exchange to which the
corporation is a party as the corporation whose shares will be
acquired, if the shareholder is entitled to vote on the plan;
3. Consummation of a sale or exchange of all, or
substantially all, of the property of the corporation if the
shareholder was entitled to vote on the sale or exchange or if the sale
or exchange was in furtherance of a dissolution on which the
shareholder was entitled to vote, provided that such dissenter's rights
shall not apply in the case of (i) a sale or exchange pursuant to court
order, or (ii) a sale for cash pursuant to a plan by which all or
substantially all of the net proceeds of the sale will be distributed
to the shareholders within one year after the date of sale;
4. Any corporate action taken pursuant to a shareholder
vote to the extent the articles of incorporation, bylaws, or a
resolution of the board of directors provides that voting or nonvoting
shareholders are entitled to dissent and obtain payment for their
shares.
B. A shareholder entitled to dissent and obtain payment for his
shares under this article may not challenge the corporate action creating his
entitlement unless the action is unlawful or fraudulent with respect to the
shareholder or the corporation.
C. Notwithstanding any other provision of this article, with
respect to a plan of merger or share exchange or a sale or exchange of property
there shall be no right of dissent in favor of holders of shares of any class or
series which, at the record date fixed to determine the shareholders entitled to
receive notice of and to vote at the meeting at which the plan of merger or
share exchange or the sale or exchange of property is to be acted on, were (i)
listed on a national securities exchange or on the National Association of
Securities Dealers Automated Quotation System (NASDAQ) or (ii) held by at least
2,000 record shareholders, unless in either case:
1. The articles of incorporation of the corporation
issuing such shares provide otherwise;
2. In the case of a plan of merger or share exchange,
the holders of the class or series are required under the plan of
merger or share exchange to accept for such shares anything except:
a. Cash;
b. Shares or membership interests, or shares or
membership interests and cash in lieu of fractional shares (i)
of the surviving or acquiring corporation or limited liability
company or (ii) of any other corporation or limited liability
company which, at the record date fixed to determine the
shareholders entitled to receive notice of and to vote at the
meeting at which the plan of merger or share exchange is to be
acted on, were either listed subject to notice of issuance on
a national securities exchange or held of record by at least
2,000 record shareholders or members; or
F-2
<PAGE>
c. A combination of cash and shares or
membership interests as set forth in subdivisions 2 a and 2 b
of this subsection; or
3. The transaction to be voted on is an "affiliated
transaction" and is not approved by a majority of "disinterested
directors" as such terms are defined inss.13.1-725.
D. The right of a dissenting shareholder to obtain payment of the
fair value of his shares shall terminate upon the occurrence of any one of the
following events:
1. The proposed corporate action is abandoned or
rescinded;
2. A court having jurisdiction permanently enjoins or
sets aside the corporate action; or
3. His demand for payment is withdrawn with the written
consent of the corporation.
E. Notwithstanding any other provision of this article, no
shareholder of a corporation located in a county having a county manager form of
government and which is exempt from income taxation under ss. 501 (c) or ss. 528
of the Internal Revenue Code and no part of whose income inures or may inure to
the benefit of any private share holder or individual shall be entitled to
dissent and obtain payment for his shares under this article.
ss. 13.1-731. Dissent by nominees and beneficial owners.
A. A record shareholder may assert dissenters' rights as to fewer
than all the shares registered in his name only if he dissents with respect to
all shares beneficially owned by any one person and notifies the corporation in
writing of the name and address of each person on whose behalf he asserts
dissenters' rights. The rights of a partial dissenter under this subsection are
determined as if the shares as to which he dissents and his other shares were
registered in the names of different shareholders.
B. A beneficial shareholder may assert dissenters' rights as to
shares held on his behalf only if:
1. He submits to the corporation the record
shareholder's written consent to the dissent not later than the time
the beneficial shareholder asserts dissenters' rights; and
2. He does so with respect to all shares of which he is
the beneficial shareholder or over which he has power to direct the
vote.
ss. 13.1-732. Notice of dissenters' rights.
A. If proposed corporate action creating dissenters' rights under
ss. 13.1-730 is submitted to a vote at a shareholders' meeting, the meeting
notice shall state that shareholders are or may be entitled to assert
dissenters' rights under this article and be accompanied by a copy of this
article.
B. If corporate action creating dissenters' rights under ss.
13.1-730 is taken without a vote of shareholders, the corporation, during the
ten-day period after the effectuation of such corporate action,
F-3
<PAGE>
shall notify in writing all record shareholders entitled to assert dissenters'
rights that the action was taken and send them the dissenters' notice described
in ss. 13.1-734.
ss. 13.1-733. Notice of intent to demand payment.
A. If proposed corporate action creating dissenters' rights under
ss. 13.1-730 is submitted to a vote at a shareholders' meeting, a shareholder
who wishes to assert dissenters' rights (i) shall deliver to the corporation
before the vote is taken written notice of his intent to demand payment for his
shares if the proposed action is effectuated and (ii) shall not vote such shares
in favor of the proposed action.
B. A shareholder who does not satisfy the requirements of
subsection A of this section is not entitled to payment for his shares under
this article.
ss. 13.1-734. Dissenters' notice.
A. If proposed corporate action creating dissenters' rights under
ss. 13.1-730 is authorized at a shareholders' meeting, the corporation, during
the ten-day period after the effectuation of such corporate action, shall
deliver a dissenters' notice in writing to all shareholders who satisfied the
requirements of ss. 13.1-733.
B. The dissenters' notice shall:
1. State where the payment demand shall be sent and
where and when certificates for certificated shares shall be deposited;
2. Inform holders of uncertificated shares to what
extent transfer of the shares will be restricted after the payment
demand is received;
3. Supply a form for demanding payment that includes the
date of the first announcement to news media or to shareholders of the
terms of the proposed corporate action and requires that the person
asserting dissenters' rights certify whether or not he acquired
beneficial ownership of the shares before or after that date;
4. Set a date by which the corporation must receive the
payment demand, which date may not be fewer than thirty nor more than
sixty days after the date of delivery of the dissenters' notice; and
5. Be accompanied by a copy of this article.
ss. 13.1-735. Duty to demand payment.
A. A shareholder sent a dissenters' notice described in ss.
13.1-734 shall demand payment, certify that he acquired beneficial ownership of
the shares before or after the date required to be set forth in the dissenters'
notice pursuant to subdivision 3 of subsection B of ss. 13.1-734, and, in the
case of certificated shares, deposit his certificates in accordance with the
terms of the notice.
F-4
<PAGE>
B. The shareholder who deposits his shares pursuant to subsection
A of this section retains all other rights of a shareholder except to the extent
that these rights are canceled or modified by the taking of the proposed
corporate action.
C. A shareholder who does not demand payment and deposits his
share certificates where required, each by the date set in the dissenters'
notice, is not entitled to payment for his shares under this article.
ss. 13.1-736. Share restrictions.
A. The corporation may restrict the transfer of uncertificated
shares from the date the demand for their payment is received.
B. The person for whom dissenters' rights are asserted as to
uncertificated shares retains all other rights of a shareholder except to the
extent that these rights are canceled or modified by the taking of the proposed
corporate action.
ss. 13.1-737. Payment.
A. Except as provided in ss. 13.1-738, within thirty days after
receipt of a payment demand made pursuant to ss. 13.1-735, the corporation shall
pay the dissenter the amount the corporation estimates to be the fair value of
his shares, plus accrued interest. The obligation of the corporation under this
paragraph may be enforced (i) by the circuit court in the city or county where
the corporation's principal office is located, or, if none in this Commonwealth,
where its registered office is located or (ii) at the election of any dissenter
residing or having its principal office in the Commonwealth, by the circuit
court in the city or county where the dissenter resides or has its principal
office. The court shall dispose of the complaint on an expedited basis.
B. The payment shall be accompanied by:
1. The corporation's balance sheet as of the end of a
fiscal year ending not more than sixteen months before the effective
date of the corporate action creating dissenters' rights, an income
statement for that year, a statement of changes in shareholders' equity
for that year, and the latest available interim financial statements,
if any;
2. An explanation of how the corporation estimated the
fair value of the shares and of how the interest was calculated;
3. A statement of the dissenters' right to demand
payment under ss. 13.1-739; and
4. A copy of this article.
ss. 13.1-738. After-acquired shares.
A. A corporation may elect to withhold payment required by ss. 13.1-737
from a dissenter unless he was the beneficial owner of the shares on the date of
the first publication by news media or the
F-5
<PAGE>
first announcement to shareholders generally, whichever is earlier, of the terms
of the proposed corporate action, as set forth in the dissenters' notice.
B. To the extent the corporation elects to withhold payment under
subsection A of this section, after taking the proposed corporate action, it
shall estimate the fair value of the shares, plus accrued interest, and shall
offer to pay this amount to each dissenter who agrees to accept it in full
satisfaction of his demand. The corporation shall send with its offer an
explanation of how it estimated the fair value of the shares and of how the
interest was calculated, and a statement of the dissenter's right to demand
payment under ss. 13.1-739.
ss.13.1-739. Procedure if shareholder dissatisfied with payment or offer.
A. A dissenter may notify the corporation in writing of his own
estimate of the fair value of his shares and amount of interest due, and demand
payment of his estimate (less any payment under ss. 13.1-737), or reject the
corporation's offer under ss. 13.1-738 and demand payment of the fair value of
his shares and interest due, if the dissenter believes that the amount paid
under ss. 13.1-737 or offered under ss. 13.1-738 is less than the fair value of
his shares or that the interest due is incorrectly calculated.
B. A dissenter waives his right to demand payment under this
section unless he notifies the corporation of his demand in writing under
subsection A of this section within thirty days after the corporation made or
offered payment for his shares.
ss. 13.1-740. Court action.
A. If a demand for payment under ss. 13.1-739 remains unsettled,
the corporation shall commence a proceeding within sixty days after receiving
the payment demand and petition the circuit court in the city or county
described in subsection B of this section to determine the fair value of the
shares and accrued interest. If the corporation does not commence the proceeding
within the sixty-day period, it shall pay each dissenter whose demand remains
unsettled the amount demanded.
B. The corporation shall commence the proceeding in the city or
county where its principal office is located, or, if none in this Commonwealth,
where its registered office is located. If the corporation is a foreign
corporation without a registered office in this Commonwealth, it shall commence
the proceeding in the city or county in this Commonwealth where the registered
office of the domestic corporation merged with or whose shares were acquired by
the foreign corporation was located.
C. The corporation shall make all dissenters, whether or not
residents of this Commonwealth, whose demands remain unsettled parties to the
proceeding as in an action against their shares and all parties shall be served
with a copy of the petition. Nonresidents may be served by registered or
certified mail or by publication as provided by law.
D. The corporation may join as a party to the proceeding any
shareholder who claims to be a dissenter but who has not, in the opinion of the
corporation, complied with the provisions of this article. If the court
determines that such shareholder has not complied with the provisions of this
article, he shall be dismissed as a party.
F-6
<PAGE>
E. The jurisdiction of the court in which the proceeding is
commenced under subsection B of this section is plenary and exclusive. The court
may appoint one or more persons as appraisers to receive evidence and recommend
a decision on the question of fair value. The appraisers have the powers
described in the order appointing them, or in any amendment to it. The
dissenters are entitled to the same discovery rights as parties in other civil
proceedings.
F. Each dissenter made a party to the proceeding is entitled to
judgment (i) for the amount, if any, by which the court finds the fair value of
his shares, plus interest, exceeds the amount paid by the corporation or (ii)
for the fair value, plus accrued interest, of his after-acquired shares for
which the corporation elected to withhold payment under ss. 13.1-738.
ss.13.1-741. Court costs and counsel fees.
A. The court in an appraisal proceeding commenced under ss.
13.1-740 shall determine all costs of the proceeding, including the reasonable
compensation and expenses of appraisers appointed by the court. The court shall
assess the costs against the corporation, except that the court may assess costs
against all or some of the dissenters, in amounts the court finds equitable, to
the extent the court finds the dissenters did not act in good faith in demanding
payment under ss. 13.1-739.
B. The court may also assess the reasonable fees and expenses of
experts, excluding those of counsel, for the respective parties, in amounts the
court finds equitable:
1. Against the corporation and in favor of any or all
dissenters if the court finds the corporation did not substantially
comply with the requirements ofss.ss.13.1-732 through 13.1-739; or
2. Against either the corporation or a dissenter, in
favor of any other party, if the court finds that the party against
whom the fees and expenses are assessed did not act in good faith with
respect to the rights provided by this article.
C. If the court finds that the services of counsel for any
dissenter were of substantial benefit to other dissenters similarly situated,
the court may award to these counsel reasonable fees to be paid out of the
amounts awarded the dissenters who were benefited.
D. In a proceeding commenced under subsection A of ss. 13.1-737
the court shall assess the costs against the corporation, except that the court
may assess costs against all or some of the dissenters who are parties to the
proceeding, in amounts the court finds equitable, to the extent the court finds
that such parties did not act in good faith in instituting the proceeding.
F-7
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 20. Indemnification of Directors and Officers.
Article 10 of Chapter 9 of Title 13.1 of the Code of Virginia permits a
Virginia corporation to indemnify any director or officer for reasonable
expenses incurred in any legal proceeding in advance of final disposition of the
proceeding, if the director or officer furnishes the corporation a written
statement of his good faith belief that he has met the standard of conduct
prescribed by the Code, and a determination is made by the board of directors
that such standard has been met. In a proceeding by or in the right of the
corporation, no indemnification shall be made in respect of any matter as to
which an officer or director is adjudged to be liable to the corporation, unless
the court in which the proceeding took place determines that, despite such
liability, such person is reasonably entitled to indemnification in view of all
the relevant circumstances. In any other proceeding, no indemnification shall be
made if the director or officer is adjudged liable to the corporation on the
basis that personal benefit was improperly received by him. Corporations are
given the power to make any other or further indemnity, including advancement of
expenses, to any director or officer that may be authorized by the articles of
incorporation or any bylaw made by the shareholders, or any resolution adopted,
before or after the event, by the shareholders, except an indemnity against
willful misconduct or a knowing violation of the criminal law. Unless limited by
its articles of incorporation, indemnification of a director or officer is
mandatory when he entirely prevails in the defense of any proceeding to which he
is a party because he is or was a director or officer.
The Articles of Incorporation of the undersigned Registrant contain
provisions indemnifying the directors and officers of the Registrant to the full
extent permitted by Virginia law. In addition, the Articles of Incorporation
eliminate the personal liability of the Registrant's directors and officers to
the Registrant or its shareholders for monetary damages to the full extent
permitted by Virginia law.
Item 21. Exhibits and Financial Statement Schedules.
(a) Exhibits:
The following exhibits are filed on behalf of the Registrant as part of
this Registration Statement:
Exhibit No. Document
----------- --------
2.1 Amended and Restated Agreement and Plan of
Reorganization between Heritage Bancorp, Inc. and
Cardinal Financial Corporation and Cardinal Merger
Corp., dated as of June __, 2000, filed as Appendix A to
the Joint Proxy Statement/Prospectus included in this
Registration Statement.*
3.1 Articles of Incorporation of Cardinal Financial
Corporation, attached as Exhibit 3.1 to the Registration
Statement on Form SB-2, Registration No. 333-52279,
filed with the Commission on May 8, 1998 (the "Form
SB-2"), incorporated herein by reference.
3.2 Bylaws of Cardinal Financial Corporation, attached as
Exhibit 3.2 to the Form SB-2, incorporated herein by
reference.
II-1
<PAGE>
4 Form of Stock Certificate, attached as Exhibit 4 to the
Form SB-2, incorporated herein by reference.
5 Legal opinion of Williams, Mullen, Clark & Dobbins.*
8 Form of tax opinion of Williams, Mullen, Clark &
Dobbins.*
10.1 Employment Agreement, dated as of September 30, 1997,
between Commercial Fidelity Financial Partnership
(predecessor to Cardinal Financial Corporation) and L.
Burwell Gunn, Jr., attached as Exhibit 10 to the Form
SB-2, incorporated herein by reference.
10.2 Employment Agreement, dated as of October 13, 1998,
between Cardinal Financial Corporation and Thomas C.
Kane, attached as Exhibit 10.2 to the Company's Annual
Report on Form 10-KSB for the year ended December 31,
1998 (the "1998 Form 10-KSB"), incorporated herein by
reference.
10.3 Employment Agreement, dated as of December 17, 1998,
between Cardinal Financial Corporation and Edgar M.
Andrews, III, attached as Exhibit 10.3 to the 1998 Form
10-KSB, incorporated herein by reference.
10.4 Employment Agreement, dated as of December 17, 1998,
between Cardinal Financial Corporation and Christopher
W. Bergstrom, attached as Exhibit 10.4 to the 1998 Form
10-KSB, incorporated herein by reference.
10.5 Employment Agreement, dated as of February 17, 1999,
between Cardinal Financial Corporation and Joseph L.
Borrelli, attached as Exhibit 10.5 to the 1998 Form
10-KSB, incorporated herein by reference.
10.6 Employment Agreement, dated as of February 12, 1999,
between Cardinal Financial Corporation and F. Kevin
Reynolds, attached as Exhibit 10.6 to the 1998 Form
10-KSB, incorporated herein by reference.
10.7 Employment Agreement, dated as of August 31, 1998,
between Cardinal Financial Corporation and Greg D.
Wheeless, attached as Exhibit 10.7 to the 1998 Form
10-KSB, incorporated herein by reference.
21 Subsidiaries of the Registrant.*
23.1 Consent of Williams, Mullen, Clark & Dobbins (included
in Exhibit 5).
23.2 Consent of KPMG LLP.*
23.3 Consent of Yount, Hyde & Barbour, P.C.*
23.4 Consent of Scott & Stringfellow, Inc.*
24 Powers of attorney (included on signature page).
II-2
<PAGE>
99.1 Form of Proxy of Cardinal Financial Corporation.*
99.2 Form of Proxy of Heritage Bancorp, Inc.*
______________
* Filed herewith.
(b) Financial Statement Schedules
Not applicable.
(c) Reports, Opinions or Appraisals.
Not applicable.
Item 22. Undertakings
(a) Undertakings Required by Item 512 of Regulation S-B.
The small business issuer will:
(1) File, during any period in which it offers or sells
securities, a post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3)
of the Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental
change in the information in the registration
statement; and
(iii) Include any additional or changed material
information on the plan of distribution;
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering;
(3) File a post-effective amendment to remove from registration
any of the securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the small business issuer pursuant to the foregoing provisions, or
otherwise, the small business issuer has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable.
(b) The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Item 4, 10(b), 11, or 13 of this form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
II-3
<PAGE>
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request.
(c) The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the County of Fairfax,
Commonwealth of Virginia, on June 1, 2000.
CARDINAL FINANCIAL CORPORATION
Date: June 1, 2000 By: /s/ L. Burwell Gunn, Jr.
------------------------------------
L. Burwell Gunn, Jr.
President and Chief Executive Officer
POWER OF ATTORNEY
Each of the undersigned hereby appoints L. Burwell Gunn, Jr. and John
H. Rust, Jr., each of whom may act individually, as attorneys-in-fact and agents
for the undersigned, with full power of substitution, for and in the name, place
and stead of the undersigned, to sign and file with the Securities and Exchange
Commission under the Securities Act of 1933, as amended, any and all amendments
(including post-effective amendments) to this Registration Statement, with any
schedules or exhibits thereto, and any and all supplements or other documents to
be filed with the Securities and Exchange Commission pertaining to the
registration of securities covered hereby, with full power and authority to do
and perform any and all acts and things as may be necessary or desirable in
furtherance of such registration.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ L. Burwell Gunn, Jr. President and Chief Executive June 1, 2000
------------------------------------------- Officer and Director
L. Burwell Gunn, Jr. (Principal Executive Officer)
/s/ Joseph L. Borrelli Chief Financial Officer June 1, 2000
------------------------------------------- (Principal Financial and
Joseph L. Borrelli Accounting Officer)
/s/ Robert M. Barlow Director May 31, 2000
-------------------------------------------
Robert M. Barlow
/s/ Wayne W. Broadwater Director June 1, 2000
-------------------------------------------
Wayne W. Broadwater
<PAGE>
Signature Title Date
--------- ----- ----
Director ______ __, 2000
-------------------------------------------
Nancy K. Falck
/s/ Anne B. Hazel Director June 1, 2000
-------------------------------------------
Anne B. Hazel
/s/ Harvey W. Huntzinger Director May 31, 2000
-------------------------------------------
Harvey W. Huntzinger
/s/ Jones V. Isaac Director May 31, 2000
-------------------------------------------
Jones V. Isaac
/s/ J. Hamilton Lambert Director June 1, 2000
-------------------------------------------
J. Hamilton Lambert
/s/ Dale B. Peck Director May 31, 2000
-------------------------------------------
Dale B. Peck
/s/ James D. Russo Director June 1, 2000
-------------------------------------------
James D. Russo
Director ________ __, 2000
-------------------------------------------
John H. Rust, Jr.
</TABLE>
<PAGE>
EXHIBIT INDEX
-------------
Exhibit No. Document
----------- --------
2.1 Amended and Restated Agreement and Plan of Reorganization
between Heritage Bancorp, Inc. and Cardinal Financial
Corporation and Cardinal Merger Corp., dated as of June __,
2000, filed as Appendix A to the Joint Proxy
Statement/Prospectus included in this Registration Statement.*
3.1 Articles of Incorporation of Cardinal Financial Corporation,
attached as Exhibit 3.1 to the Registration Statement on Form
SB-2, Registration No. 333-52279, filed with the Commission on
May 8, 1998 (the "Form SB-2"), incorporated herein by reference.
3.2 Bylaws of Cardinal Financial Corporation, attached as Exhibit
3.2 to the Form SB-2, incorporated herein by reference.
4 Form of Stock Certificate, attached as Exhibit 4 to the Form
SB-2, incorporated herein by reference.
5 Legal opinion of Williams, Mullen, Clark & Dobbins.*
8 Form of tax opinion of Williams, Mullen, Clark & Dobbins.*
10.1 Employment Agreement, dated as of September 30, 1997, between
Commercial Fidelity Financial Partnership (predecessor to
Cardinal Financial Corporation) and L. Burwell Gunn, Jr.,
attached as Exhibit 10 to the Form SB-2, incorporated herein by
reference.
10.2 Employment Agreement, dated as of October 13, 1998, between
Cardinal Financial Corporation and Thomas C. Kane, attached as
Exhibit 10.2 to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1998 (the "1998 Form 10-KSB"),
incorporated herein by reference.
10.3 Employment Agreement, dated as of December 17, 1998, between
Cardinal Financial Corporation and Edgar M. Andrews, III,
attached as Exhibit 10.3 to the 1998 Form 10-KSB, incorporated
herein by reference.
10.4 Employment Agreement, dated as of December 17, 1998, between
Cardinal Financial Corporation and Christopher W. Bergstrom,
attached as Exhibit 10.4 to the 1998 Form 10-KSB, incorporated
herein by reference.
10.5 Employment Agreement, dated as of February 17, 1999, between
Cardinal Financial Corporation and Joseph L. Borrelli, attached
as Exhibit 10.5 to the 1998 Form 10-KSB, incorporated herein by
reference.
10.6 Employment Agreement, dated as of February 12, 1999, between
Cardinal Financial Corporation and F. Kevin Reynolds, attached
as Exhibit 10.6 to the 1998 Form 10-KSB, incorporated herein by
reference.
<PAGE>
10.7 Employment Agreement, dated as of August 31, 1998, between
Cardinal Financial Corporation and Greg D. Wheeless, attached as
Exhibit 10.7 to the 1998 Form 10-KSB, incorporated herein by
reference.
21 Subsidiaries of the Registrant.*
23.1 Consent of Williams, Mullen, Clark & Dobbins (included in
Exhibit 5).
23.2 Consent of KPMG LLP.*
23.3 Consent of Yount, Hyde & Barbour, P.C.*
23.4 Consent of Scott & Stringfellow, Inc.*
24 Powers of attorney (included on signature page).
99.1 Form of Proxy of Cardinal Financial Corporation.*
99.2 Form of Proxy of Heritage Bancorp, Inc.*
_______________
* Filed herewith.