U. S. Securities and Exchange Commission
Washington, D. C. 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15 (d)
of The Securities Exchange Act of 1934
For the Quarterly period Ended September 30, 1998
Commission file Number 000-24933
Heritage Bancorp, Inc.
(Exact Name of Registrant As Specified In Its Charter)
VIRGINIA 54-1914902
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation of Organization) Identification No.)
1313 Dolley Madison Blvd., McLean, Va. 22101
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER
703-356-6060
N/A
(Former Name, Former Address and Former Year,
If Changed Since Last Report)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS
FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF
EXCHANGE ACT DURING THE PRECEDING 12
MONTHS (OF SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE
PAST 90 DAYS.
YES x NO
----- -----
COMMON SHARES OUTSTANDING AS OF October 9, 1998: 2,294,617
<PAGE>
INDEX
THE HERITAGE BANK
Part 1 Financial Information Page
Item 1 Financial Statements
Balance Sheets
September 30, 1998 and December 31, 1997 3
Statement of income
Three months ended September 30, 1998 and 1997 4
Nine months ended September 30, 1998 and 1997 5
Statement of Stockholders Equity
Nine months ended September 30, 1998 and 1997 6
Statement of Cash Flows
Nine months ended September 30, 1998 and 1997 7
Notes to Financial Statements 8
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of operation 9
and Selected Financial Data
Part II. Other Information: 17
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon /Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
<PAGE>
<TABLE>
ITEM I.
Part I. Financial Information
THE HERITAGE BANK
STATEMENT OF CONDITION
(in thousands, unaudited)
<CAPTION>
ASSETS SEPT. 30,1998 DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
Cash and due from banks $ 1,517 $ 1,987
Federal Funds Sold 4,250 7,600
Total Cash and Due From Banks 5,767 9,587
Securities available for sale 20,967 11,794
Securities held to maturity 0 250
Loans, Net 27,056 22,756
Premises and Equipment, Net 346 379
Other Real Estate Owned 263 263
Accrued Int and other Assets 795 $ 421
TOTAL ASSETS $55,194 $ 45,450
LIABILITIES
Noninterest bearing deposits $ 10,366 $ 11,856
Interest bearing deposits 33,787 28,748
TOTAL DEPOSITS 44,153 40,604
Repurchase agreements 1,922 0
Other liabilities 118 116
TOTAL LIABILITIES 46,193 40,720
CAPITAL
Common Stock 2,295 1,490
Surplus 6,530 3,327
Undivided profits 57 -105
Accumulated other comprehensive
income net 119 18
TOTAL CAPITAL 9,001 4,730
TOTAL CAPITAL AND LIABILITIES $ 55,194 $ 45,450
Notes to financial statements are an
integral part of these statements.
3
<PAGE>
THE HERITAGE BANK
STATEMENTS OF OPERATION
Third Quarter Ending September 30, 1998
<CAPTION>
INTEREST INCOME 3rd Quarter 1998 3rd quarter 1997
---------------- ----------------
Loans $ 616,000 $ 564,000
Securities 315,000 197,000
Federal Funds Sold 74,000 51,000
----------- -----------
Total interest income $ 1,005,000 $ 812,000
INTEREST EXPENSE
Interest checking deposit 34,000 27,000
Other time deposit 232,000 210,000
Cert.of deposit $100,000 or more 57,000 36,000
Repurchase agreements 17,000 3,000
----------- -----------
Total interest expense 340,000 276,000
Net interest income 665,000 536,000
Provision for loan losses 98,000 (7)
----------- -----------
Net interest income after
provision for loan losses 567,000 543,000
OTHER INCOME
Service charges on deposit accounts 27,000 21,000
Other operating income, net 8,000 8,000
Gain or loss on sale of securities 0 0
----------- -----------
Total other income 35,000 29,000
OTHER EXPENSES
Salaries and employee benefits 267,000 229,000
Occupancy expense 71,000 55,000
Equipment expense 19,000 24,000
Other operating expenses 283,000 159,000
----------- -----------
Total other expenses 640,000 467,000
Income before income taxes (38,000) 105,000
Income tax 1,000 1,000
----------- -----------
NET INCOME $ (39,000) $ 104,000
=========== ===========
Basic income per share $ (0.02) $ 0.08
Diluted income per share $ (0.02) $ 0.08
Weighted avg shares outstanding 2,294,617 1,249,634
Notes to financial statements are an integral part of these statements.
4
<PAGE>
THE HERITAGE BANK
STATEMENTS OF OPERATION
Nine Months Ending September 30, 1998
<CAPTION>
INTEREST INCOME SEPT. 30, 1998 SEPT 30, 1997
Loans $1,746,000 $1,737,000
Securities 801,000 599,000
Federal Funds Sold 212,000 97,000
---------- -----------
Total interest income $2,759,000 $ 2,433,000
INTEREST EXPENSE
Interest checking deposits 98,000 84,000
Other time deposit 652,000 632,000
Cert. of deposit $100,000 or more 147,000 109,000
Repurchase agreements 24,000 4,000
---------- -----------
Total interest expense 921,000 829,000
Net interest income 1,838,000 1,604,000
Provision for loan losses 102,000 0
---------- -----------
Net interest income after
provision for loan losses 1,736,000 1,604,000
OTHER INCOME
Service charges on deposit accounts 80,000 67,000
Other operating income, net 23,000 29,000
Gain or loss on sale of securities (1,000) 0
---------- -----------
Total other income 102,000 96,000
OTHER EXPENSES
Salaries and employee benefits 792,000 708,000
Occupancy expense 158,000 161,000
Equipment expense 53,000 67,000
Other operating expenses 670,000 451,000
---------- -----------
Total other expenses 1,673,000 1,387,000
Income before income taxes 165 000 313,000
Income tax 3,000 8,000
---------- -----------
NET INCOME $162,000 $ 305,000
========== ===========
Basic income per share $ 0.09 $0.24
Diluted income per share $ 0.08 $0.24
Weighted average shares outstanding basic. 1,890,666 1,249,634
Weighted average shares outstanding, assuming
dilution. 1,894,639 1,263,988
Notes to financial statements are an integral part of these statements
5
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THE HERITAGE BANK
Statement of Change in Stockholder's Equity
For Nine Months Ended Sept. 30, 1998 and Sept. 30 1997
(Dollars in Thousands,unaudited)
<CAPTION>
Accumulated
other
Comprehensive etained comprehensive Capital
Total income arnings income Common stock surplus
----- ------ ------- ------ ------------ -------
Balances January 1 1997
$ 3,543 $ (676) $ 2 $ 1,250 $ 2,967
Comprehensive income
Net income 305 $305 305 - - -
Other comprehensive income net of tax - - - - - -
Unrealized gain(loss) on securities available for
sale 38 38 - 38 - -
Unrealized holding gain(loss) arising during period - - - - - -
Less reclassification adjustment - - - - - -
Other comprehensive income, net of tax 38 38 - 38 - -
------- ----- ------ --- ------- -------
Total comprehensive income 343 $343 - $ - -
======= ===== ======= ==== ======= =======
Balances Sept. 30, 1997 $3,886 $ (371) $ 40 $ 1,250 $ 2,967
======= ======= ==== ======= =======
Balances January 1 1998
$ 4,730 $ (105) $18 $ 1,490 $ 3,327
Comprehensive income
Net income 162 $162 162 - - -
Other comprehensive income net of tax - - - - - -
Unrealized gain(loss) on securities available for 157 157 - 157 - -
sale
Unrealized holding gain(loss) arising during period 1 1 - 1 - -
Less reclassification adjustment 57 57 - 57 - -
------- ----- ------ --- ------- -------
Other comprehensive income, net of tax 101 101 - 101 - -
Total comprehensive income $ 263 $263 - -
======= ==== ======= ==== ======= =======
Issuance of common stock $ 4,108 - - $ 805 $ 3,303
------- ----- ------ --- ------- -------
Balances June 30, 1998 $ 9,001 $ 57 $119 $ 2,295 $ 6,530
======= ======= ==== ======= =======
6
<PAGE>
THE HERITAGE BANK
Statement of Cash Flows
(In Thousands of Dollars)
<CAPTION>
Sept. 30 1998 Sept. 30 1997
------------- -------------
Cash Flows From Operating Activities
Net income $ 162 $ 305
Adjustments to reconcile net income(loss) to net
cash provided by (used in) operating activities
Provision for loan losses 102 0
Depreciation and amortization 35 30
Gain on sale of available-for-sale investments (1) 0
Amortization of investment security
premiums, net of discount 26 24
(Increase)decrease in accrued interest and
other assets (446) (5)
(Increase)Decrease in accrued interest and other
liabilities 2 (30)
-------- --------
Net cash provided by(used in) operating activities $ (120) $ 324
-------- --------
Cash Flows From Investing Activities
Maturities of securities available-for-sale $ 7,000 $ 750
Maturities of securities held-to-maturity 250 0
Purchases of securities available-for-sale (16,524) (5,010)
Proceeds from sale of securities available-for-sale 499 4,500
Increase(decrease) in loans (4,402) 1,567
Purchase of premises and equipment (2) (73)
-------- --------
Net cash provided by (used in) investing activities $(13,179) $ 1,734
-------- --------
Cash Flows From Financing Activities
(decrease) in non interest-bearing deposits $ (1,490) $ 684
Increase(Decrease)in certif of deposits and savings 5,039 (3,408)
Increase in securities sold under repurchase agreement 1,922 586
Issuance of common stock 4,008 --
-------- --------
Net cash provided by (used in) financing activities $ 9,479 $ (2,138)
-------- --------
Net change in cash and cash equivalents (3,820) $ (80)
Cash and cash equivalents, beginning of year 9,587 6,679
-------- --------
Cash and cash equivalents, end of period $ 5,767 $ 6,599
======== ========
</TABLE>
7
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<TABLE>
THE HERITAGE BANK
NOTES TO UNAUDITED FINANCIAL STATEMENTS
(1) Basis of Presentation
The financial statements included herein have been prepared by the Bank
without audit. In the opinion of management, the quarterly unaudited financial
statements include all adjustments, consisting of normal recurring accruals,
necessary for a fair presentation of the financial position and results of
operations at and for the periods presented. The Bank believes that the
disclosures are adequate to make the information presented not misleading,
however, the results for the periods presented are not necessarily indicative of
results to be expected for the entire year.
(2) Accounting Policies
The interim financial information should be read in conjunction with the
Bank's 1997 Annual Report on Form 10-K-A. Management is required to make
estimates and assumptions that affect amounts reported in the financial
statements. Actual results could differ significantly from estimates.
(3) 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 shareholders.
<CAPTION>
1998 1997
----------------------------- ----------------------------
Per Share Per Share
Shares Amount Shares Amount
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Basic earnings
per share 1 890 666 $ .09 1 249 634 $ .24
============= =============
Effect of dilutive
securities:
Stock options 3,973 197
Warrants 0 14,157
------------ ------------
Diluted earnings
per share 1,894,639 $ .08 1 263 988 $ .24
============ ============= ============ =============
</TABLE>
Options on 30,625 shares of common stock were not included in computing diluted
EPS in 1997, because their effects were antidilutive.
(4) Holding Company Formation
On October 1, 1998, the Bank became a wholly-owned subsidiary of
Heritage Bancorp, Inc., a newly formed stock holding company, pursuant to an
agreement and plan of reorganization approved by the Bank's shareholders on
August 26, 1998. Upon completion of the reorganization, holders of the Bank's
common stock became holders of Heritage Bancorp, Inc. common stock in a share
for share exchange. The common stock of Heritage Bancorp, Inc. will continue to
trade on the Nasdaq SmallCap Market under the symbol "HBVA."
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
The following discussion and analysis of financial condition and
results of operations, unless otherwise disclosed, presented in this quarterly
report on Form 10-QSB represents the activities of the Bank for the quarter
ended September 30, 1998, and should be read in conjunction with the financial
statements of the Bank included in this Form 10-QSB.
Heritage Bancorp, Inc. (the "Company"), a Virginia corporation, is the
holding company for The Heritage Bank (the "Bank"), a Virginia chartered
commercial bank. On October 1, 1998, the Company acquired all of the capital
stock of the Bank and shareholders of the Bank became shareholders of the
Company in a share for share exchange pursuant to a plan of reorganization
approved by the Bank's shareholders on August 26, 1998, whereby the Bank became
the wholly-owned subsidiary of the Company (the "Reorganization"). The Company's
sole business activity is ownership of the Bank. The Company's common stock
trades on the Nasdaq SmallCap Market under the symbol "HBVA".
The Bank is the only independent financial institution headquartered in
McLean, Virginia. Established in 1987, the 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 Bank is a
well-capitalized, profitable community bank dedicated to financing small
business and consumer needs in its market area. The Bank also is committed to
providing personalized "hometown" quality service to its customers by tailoring
its products and services to appeal to its local market. The Bank currently
operates one full-service office and engages in a broad range of lending and
deposit services aimed at individual and commercial customers in the McLean area
of Fairfax County, Virginia.
The business of the 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. The Bank's commercial
activities include providing checking accounts, money market accounts and
certificates of deposit to small and medium sized businesses. The 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 Bank's products include checking accounts, NOW
accounts, savings accounts, certificates of deposit, installment accounts,
construction and other personal loans, home improvement loans, automobile and
other consumer financing.
On May 18, 1998, the Bank closed a secondary offering of 805,000 shares
of its common stock, par value $1.00 per share (the "Offering"), at $5.50 per
share, raising $4.4 million in gross proceeds. After offering expenses and
underwriting commissions , the Bank netted $4,117,575 in new capital from the
offering.
9
<PAGE>
<TABLE>
The selected financial ratios and other data of the Bank set forth
below is derived in part from, and should be read in conjunction with, the
Unaudited Financial Statements of the Bank and Notes thereto presented elsewhere
in this report.
SELECTED FINANCIAL DATA
For the Nine Months Ended For the Nine Months Ended
Sept. 30, 1998 Sept. 30, 1997
(Dollars in thousands)
(Unaudited)
<S> <C> <C>
Summary of operating results:
Total interest income.............................. $2,759 $2,433
Total interest expense............................. 921 829
------ ------
Net interest income................................ $1,838 $1,604
Provision for (recovery of) loan losses............ 102 0
Net interest income after provision for (recovery
of) loan losses............................... $1,736 $1,604
Other income....................................... 102 96
Other expenses..................................... 1,673 1,387
------ ------
Income (loss) before taxes......................... 165 313
Income tax expense (benefit)(1).................... 3 8
Net income (loss).................................. $ 162 $ 305
====== ======
Per share:
Basic earnings (loss) per share.................... $ 0.09 $ 0.24
Diluted earnings (loss) per share.................. 0.08 0.24
Cash dividend declared............................. - -
Book value at period end........................... 3.92 3.11
Common shares outstanding.......................... 2,294,617 1,249,634
Balance sheet data (at period end): Sept. 30, 1998 December 31, 1997
- --------------- -----------------
Loans, net of unearned interest.................... $27,626 $23,391
Allowance for loan loss............................ 570 634
Total assets....................................... 55,194 45,450
Total deposits..................................... 44,153 40,604
Total stockholders' equity......................... 9,001 4,730
Performance and asset quality ratios:
Return on average total assets (3)................. 0.43% 1.33%
Return on average stockholders' equity..........(3) 3.12 15.24
Average stockholders' equity to average total assets 13.86 8.74
Non-accrual and past due loans to total loans...... 5.27 .98
Allowance for loan losses to total loans........... 2.06 2.71
Net yield.......................................... 3.87 4.29
Net interest margin(2)............................. 5.15 5.25
</TABLE>
(1) At December 31, 1997, the Bank had available approximately $387,000 of an
operating loss carryforward which could be offset against future income.
(2) Net interest margin is calculated as net interest income divided by average
earning assets and represents the Bank's net yield on its earning assets.
(3) Annualized for the nine months ended September 30, 1998.
10
<PAGE>
Comparison of Financial Condition at September 30, 1998 and December 31, 1997
Total assets increased $9.7 million, or 21.4%, from $45.5 million at
December 31, 1997 to $55.2 million at September 30 1998. This increase in assets
is due in part to the receipt by the Bank of $4.l million in net proceeds from
the Offering which closed on May 18, 1998. The proceeds of the Offering were
invested in U.S. agency securities. In addition, net loans increased by $4.3
million. Federal funds sold decreased $3.4 million from $7.6 million at December
31, 1997 to $4.2 million at September 30, 1998. This decrease primarily is due
to use of these funds to purchase U. S. Agencies Bonds.
Securities available for sale increased $9.2 million, or 77.8%, from
$11.8 million at December 31, 1997 to $20.9 million at September 30, 1998. The
increase was caused by the investment by the Bank of the net proceeds of the
Offering and the decrease in the fed funds sold in the bond portfolio.
Net loans increased $4.3 million, or 18.9%, from $22.8 million at
December 31, 1997 to $27.1 million at September 30, 1998. This increase was
primarily due to the increased marketing of the Bank's loan products. Also, the
proceeds from the offering increased the Bank's legal lending limit by 86%, thus
allowing loan originations to increase.
Total deposits increased $3.5 million, or 8.7%, from $40.6 million at
December 31, 1997 to $44.1 million at September 30, 1998. This increase was
caused by an increase in attorney's escrow account balances and an increase of
$1.8 million of certificates of deposit of $100,000 and over. Of these deposits,
$40.0 million were core deposits which the Bank uses to originate loans.
Repurchase agreements at September 30,1998 totaled $1,922,000, as
compared to no repurchase agreements at December 31, 1997. The Bank utilizes
repurchase agreements to fund customer sweep accounts.
11
<PAGE>
Comparison of Operating Results for the Three Months Ended September 30, 1998
and 1997
Net income. The Bank incurred a net loss for the three months ended
September 30, 1998 of $39 000, or $(0.02) basic and diluted earnings per share,
compared to net income of $104,000, or $0.08 basic and diluted earnings per
share, for the three months ended September 30, 1997. This $143,000 decrease was
due primarily to an increase in the provision for loan losses of $98,000, an
increase in legal fees of 105,000 and an increase in salaries and benefits of
$40,000, which was partially offset by an increase in net interest income before
provision of loan losses of $129,000.
Interest Income. Total interest income for the three months ended
September 30, 1998 was $1,005,000, as compared to $812,000 for the three months
ended September 30, 1997, representing an increase of $193,000, or 23.8%. This
increase was due primarily to the increase in the bond portfolio and interest on
Fed Funds sold.
Interest Expense. Total interest expense increased from $276,000 for
the three months ended September 30, 1997 to $340,000 for the three months ended
September 30, 1998, representing an increase of $64,000, or 23.2%. This increase
was due primarily to the increase in deposits.
Net Interest Income. Net interest income is the difference between
interest earned on loans, investments, securities and short term investments and
interest paid on deposits. Factors affecting net interest income include
interest rates earned on loans and investments and those paid on deposits, the
mix and volume of earning assets and interest bearing liabilities and the level
or non-earning assets and non-interest bearing liabilities. The 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.
Net interest income increased in the three months ended September 30,
1998 by $129,000, or 24.1%, from $536,000 for the three months ended September
30, 1997 to $665,000 for the three months ended September 30, 1998. This
increase was due primarily to an increase in interest income on the bond
investment portfolio. The bond portfolio increased due to the investment by the
Bank of the net proceeds of the Offering which occurred in May, 1998.
Provision for Loan Losses. The provision for loan losses for the three
months ended September 30, 1998 was $98,000, as compared to $.00 for the same
period in the prior year, representing a $98,000 increase. This increase was
caused primarily by the settlement of the Wills case. See part II, Item 1 for a
discussion of the Wills case.
The level of the allowance for loan losses is based upon management's
ongoing 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 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
12
<PAGE>
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, regulatory examinations and other factors, both within
and outside of management's control.
Other income. Total other income consists primarily of service charges
and fees associated with the Bank's loan and savings accounts. Total other
income increased $6,000 from $29,000 for the three months ended September 30,
1997 to $35,000 for the three months ended September 30, 1998. This was caused
by an increase in service charges on deposit accounts.
Other expense. Other expense consists primarily of operating expenses
for compensation and related benefits, occupancy, federal insurance premiums and
operating assessments and data processing charges. Total other expense increased
by $173,000, or 37.0%, from $467,000 for the three months ended September 30,
1997 to $640,000 for the three months ended September 30, 1998. This increase
was due, in part, to a $105,000 increase in legal fees in connection with the
Reorganization, a non-recurring item. The increase is also due, in part, to
costs associated with the Year 2000 expenses and increases in salaries and
benefits.
Income Tax Expense. The Bank had a tax liability of $1,000 for the
three months ended September 30, 1998 and 1997. At December 31, 1997, the Bank
had operating loss carryforwards of approximately $387,000 that may be offset
against future taxable income. The Bank expects to use its net operating loss
carryforward in its entirety by the end of fiscal year 1998.
13
<PAGE>
Comparison of Operating Results for the Nine Months Ended September 30, 1998
and 1997
Net income. Net income for the nine months ended September 30, 1998
was $162,000 and $305,000 for the nine months ended September 30, 1997. For the
nine months ended September 30, 1997 basic earnings per share and diluted
earnings per share was $0.24 per share, as compared to basic earnings per share
of $0.09 and diluted earnings per share of $0.08 for the nine months ended
September 30, 1998. Net income decreased primarily due to an increase of
$105,000 in legal fees, a $84,000 increase in salaries and benefits and a
$35,000 increase in stockholder expense.
Interest Income. Total interest income for the nine months ended
September 30, 1998 was $2.7 million, as compared to $2.4 million for the nine
months ended September 30, 1997, representing an increase of $326,000, or 13.4%.
This increase was due primarily to the increase in Bond portfolio and fed funds
sold.
Interest Expense. Total interest expense increased from $829,000 for
the nine months ended June 30, 1997 compared to $921,000 for the nine months
ended September 30, 1998, representing a increase of $92,000, or 11.1%. This
increase was due to the growth in deposits.
Net Interest Income. Net interest income is the difference between
interest earned on loans, investments, securities and short term investments and
interest paid on deposits. Factors affecting net interest income include
interest rates earned on loans and investments and those paid on deposits, the
mix and volume of earning assets and interest bearing liabilities and the level
or non-earning assets and non-interest bearing liabilities. The 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.
Net interest income increased for the nine months ended September 30,
1998 by $234,000, or 14.6%, from $1.6 million for the nine months ended
September 30, 1997 to $1.8 million for the nine months ended September 30, 1998.
This increase was due primarily to an increase in interest income on the bond
investment portfolio. The bond portfolio increased due to the investment by the
Bank of the net proceeds of the Offering which occurred in May, 1998.
Provision for Loan Losses. The provision for loan losses for the nine
months ended September 30, 1998 was $102,000, as compared to $ 0 for the same
period in the prior year, representing a $102,000 increase. This increased was
caused by a the settlement of the Wills suit which resulted in a charge to
reserve for loan losses.
See part II, item 1 for a discussion of the Wills suit.
The level of the allowance is based upon management's ongoing 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 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, regulatory
examinations and other factors, both within and outside of management's control.
The ratio of the allowance for loan losses to total loans was 2.06% at September
30, 1998, as compared to 2.71% for the year ended December 31, 1997.
14
<PAGE>
Other income. Total other income consists primarily of service charges
and fees associated with the Bank's loan and savings accounts. Total other
income increased $6,000 from $96,000 for the nine months ended September 30,
1997 to $102,000 for the nine months ended September 30, 1998. This increase was
caused by a increase in service charges on deposit accounts.
Other expense. Other expense consists primarily of operating expenses
for compensation and related benefits, occupancy, federal insurance premiums and
operating assessments and data processing charges. Total other expense increased
by $286,000, or 20.6%, from $1,387,000 for the nine months ended September 30,
1997 to $1,673,000 million for the nine months ended September 30, 1998. This
increase was due to a $105,000 increase in legal fees due to the litigation and
settlement of the Wills case and the formation of the Bank's holding company,
$84,000 increase in salaries and benifits, an increse in stockholder expense of
$35,000 and a loss of $25,000 from a robbery at the Bank which occurred in May,
1998. The increase also was due, in part, to a $14,000 expense associated with
Year 2000 compliance.
Income Tax Expense. The Bank had a tax liability of $3,000 for the
nine months ended September 30, 1998, as compared to $8,000 for the nine months
ended September 30, 1997. At December 31, 1997, the Bank had operating loss
carryforwards of approximately $387,000 that may be offset against future
taxable income. The Bank expects to use its net operating loss carryforward in
its entirety by the end of fiscal year 1998.
Liquidity and Capital Resources
Liquidity is a measure of the 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
Bank. Liquid assets include cash, interest-bearing deposits with banks, federal
funds sold, and certain investment securities. As a result of the Bank's
management of liquid assets and the ability to generate liquidity through
liability funding, management believes that the Bank maintains overall liquidity
sufficient to satisfy its depositors' requirements and meet its customers'
credit needs. The levels of the Bank's liquid assets are dependent on the Bank's
operating, financing and investing activities during any given period.
Management believes it will have adequate resources to fund all commitments on a
short-term and long-term basis in accordance with its business strategy.
As of September 30, 1998, cash, federal funds sold, held-to-maturity
investment securities maturing within one year and available-for-sale securities
represented 57.87% of deposits and other liabilities, compared to 52.51% at
December 31, 1997.
Management continuously reviews the capital position of the Bank to
insure compliance with minimum regulatory requirements, as well as exploring
ways to increase capital either by retained earnings or other means.
Banks are required to maintain minimum risk-based capital ratios. These
ratios compare capital, as defined by the risk-based regulations, to assets
adjusted for their relative risk as defined by the regulations. Guidelines
require banks to have a minimum Tier 1 capital ratio, as defined by the
regulators, of 4.00% and a minimum Tier 2 capital ratio of 8.00%, and a minimum
4.00% leverage capital ratio. On September 30, 1998, the Bank's Tier 1 capital
ratio was 26.52%, Tier 2 capital ratio was 27.77% and leverage ratio was 16.09%.
At September 30 1998, the Bank exceeded all of its regulatory capital
requirements.
15
<PAGE>
<TABLE>
At September 30, 1998, the total stockholders' equity of The Heritage
Bank was $9.0 million, and the ratio of average stockholders' equity to average
total assets was 13.86%, as compared to 8.74% on December 31, 1998.
Year 2000 Issues
The "Year 2000 Problem" centers on the inability of computer systems to
recognize the Year 2000. Many existing computer programs and systems were
originally programmed with six digit dates that provided only two digits to
identify the calendar year in the date field, without considering the upcoming
change in the century. With the impending millennium, these programs and
computers will recognize "00" as the year 1900 rather than the Year 2000. Like
most financial service providers, the Bank may be significantly affected by the
Year 2000 Problem due to the nature of financial information. Furthermore, if
computer systems are not adequately changed to identify the Year 2000, many
computer applications could fail or create erroneous results.
In addition, noninformation technology systems, such as telephones,
copies and elevators may contain embedded technology which controls its
operations and which may be affected by the Year 2000 Problem. Thus, even
noninformation technology systems may affect the normal operations of the
Company upon the arrival of the Year 2000.
The Bank recently hired an outside consultant to assess the impact of
the Year 2000 Problem on the Bank. Because the Bank outsources its data
processing and item processing operations, a significant component of the Year
2000 plan is working with external vendors to test and certify their systems as
Year 2000 compliant. The Bank's external vendors have surveyed their programs to
inventory the necessary changes and have begun correcting the applicable
computer programs and replacing equipment so that the Bank's information systems
will be Year 2000 compliant prior to the end of 1998. This will enable the Bank
to devote substantial time to the testing of the upgraded systems prior to the
arrival of the millennium in order to comply with all applicable regulations.
The Company's timetable for working on the Year 2000 Problem is divided
into the following five phases:
<CAPTION>
Phase Description Status
- ----- ----------- ------
<S> <C> <C>
1. Awareness Define the problem. Completed 11/1/97.
2. Assessment Identify all systems and criticality of systems. Completed 6/1/98
3. Renovation Program enhancements, hardware and software upgrades, 95% complete
system replacements, and vendor certifications. 9/30/98
4. Validation Test and verify system changes. 75% complete
9/30/98
5. Implementation Components certified as Year 2000 compliant and moved 75% complete
to production. 9/30/98
</TABLE>
The Bank has a contingency plan to keep the bank in operation in the
event that some Y2K problems have been overlooked and system malfunctions occur
at the turn of the century. This plan was developed by the Bank's outside
consultant with the help of Bank management.
16
<PAGE>
The Company currently estimates its total direct and indirect cost will
be $35,000. The costs of the project and the date on which the Bank plans to
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ materially from those plans. In
addition, there can be no guarantee that the systems of other companies on which
the Bank's systems rely will be timely converted, or that a failure to convert
by another company, or a conversion that is incompatible with the Bank's
systems, would not have a material adverse effect on the Bank.
Provision for Loan Losses
For the nine months ended September 30, 1998 the provision for loan
losses was $102,000, a $102,000 increase compared to the $ 0 allowance for loan
losses recorded in the first nine months of 1997. This increase was caused by a
charge to reserve for loan loss on the settlement of the Wills suit. To bring
the reserve for loss back up to acceptable level the Bank made a charge to
earnings of $98,000 in the month of September 1998.
An analysis of the allowance for loan losses is as follows:
Loan Loss Reserve
Balance, December 31, 1997 $634,000
Provision for Loan Losses 102,000
Charge-offs (177,000)
Recoveries 11,000
Balance, September 30, 1998 570,000
The level of the allowance is based upon management's ongoing 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 Bank's service areas in particular.
Potential Problem Loans
At September 30, 1998, in addition to $838,000 of loans on either
non-accrual status or loans past due 90 days or more and still accruing, the
Bank had approximately 3.69% of the loan portfolio in loans which were either
internally classified or specially mentioned and require more than normal
attention and are potential problem loans. The Bank has considered these loans
in establishing the level of the allowance for loan losses. As of September 30,
1997, $990,000 of loans were either on a non-accrual status or loans past due 90
days or more and still accruing. In addition to these loans, 4.0% of the loan
portfolio was either internally classified or specially mentioned and required
more than normal attention and considered potential problems loans.
17
<PAGE>
Part II OTHER INFORMATION
Item 1. Legal Proceedings
On July 24, 1998, in the case or Wills v. The Heritage Bank, the United
States Bankruptcy Court for the Eastern District of Virginia, Alexandria
Division, granted plaintiff's motion for partial summary judgment ruling against
the Bank. The Court ruled that the Bank violated an automatic stay imposed by
the United States Bankruptcy Code (the "Code") by collecting interest payments
on a note payable by plaintiff to the Bank and in selling stock pledged as
collateral to secure such note. The Bank received the interest payments in 1990
and the stock was sold in 1993.
The total amount of the judgment is $108,382 plus attorney's fees in an
amount to be determined at a later date. This sum represents payments received
by the Bank in excess of sums due it under the plaintiffs Plan of
Reorganization. The Bank is entitled to recover the sum of $11,810 from
plaintiff for sums due the Bank under plaintiff's Plan of Reorganization upon
payment of the judgment. Plaintiff's request for punitive damages in the sum of
$105,000 was denied on the summary judgment motion, but remains pending for
adjudication. An additional claim by the plaintiff, in the aggregate amount of
$326,437, is vigorously disputed by the Bank and would have been the subject of
a summary judgment motion by the Bank provided that all matters were not
otherwise resolved.
The Bank settled all outstanding judgments and claims on this suit on
August 21, 1998 for $131,190.00.
Heritage Bank is a defendant in a case pending in the United States
District Court for the Eastern District of Virginia styled Travelers Property
Casualty Corporation v. The Heritage Bank and Crestar Bank, Case Number 98-496A.
Travelers seeks judgment against Heritage Bank and Crestar Bank for losses
sustained by its insured on an employee check embezzlement and forgery scheme
for checks deposited at Heritage Bank and paid by Crestar Bank. The total loss
claimed is $396,123.79, plus interest, attorney's fees, and costs. Heritage Bank
obtained summary judgment in the amount of $30,529.77 for checks barred by the
statute of limitations. Trial in this matter is set for December 8, 1998.
Heritage Bank has advised its financial institution bond carrier of this claim.
The Bank's insurance carrier has notified the Bank that the Bank's insurance
policy will cover a fraudulent endorsement loss above the policy's $25,000
deductible.
Heritage Bank is a defendant in a suit styled Brault & Associates,
Ltd., et al. v. The Heritage Bank, At Law Number 174525 pending in the Circuit
Court of Fairfax County Virginia. The Bank is being sued for trover and
conversion, breach of fiduciary duty, defamation, and breach of contract,
arising out of a loan relationship with plaintiffs. Plaintiff seeks compensatory
damages of $80,000.00 on the trover and conversion count, $80,000.00 in
compensatory damages on the breach of duty count, $50,000.00 on the defamation
count, and $50,000.00 on the breach of contract count. Plaintiff also seeks
punitive damages of $350,000.00 on each count plus interest and costs. The
matter has been tendered to Heritage Bank's insurance carrier who is defending
the Bank under a reservation of rights.
18
<PAGE>
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of matters to a Vote of Security Holders
The Bank held its Annual Meeting of Shareholders ("Meeting") on August
26, 1998. All of the proposals submitted to the shareholders at the Meeting were
approved. The proposals submitted to shareholders and the tabulation of votes
for each proposal is as follows:
1. Election of nine candidates to the Board of Directors, each to serve
for a one-year term expiring in 1999.
The number of votes cast with respect to this matter was as follows:
Nominee For Withheld Broker Non-Votes
------- --- -------- ----------------
George K. Degnon 2,006,706 13,859 0
Philip F. Herrick, Jr. 1,981,762 38,803 0
Henry E. Hudson 2,003,803 16,762 0
Ronald W. Kosh 1,996,635 23,930 0
Harold E. Lieding 1,976,599 46,966 0
Stanley I. Richards 2,006,806 13,759 0
John T. Rohrback 1,984,638 35,927 0
George P. Shafran 1,996,838 23,727 0
Kevin P. Tighe 2,003,317 17,248 0
2. Ratification of the appointment of Yount, Hyde & Barbour, P.C. to as
independent auditors for fiscal year ending December 31, 1998.
The number of votes cast with respect to this matter was as follows:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
1,997,754 10,682 11,949 0
3. Approval of the 1998 The Heritage Bank Stock Option Plan.
The number of votes cast with respect to this matter was as follows:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
1,502,082 70,039 23,074 425,370
19
<PAGE>
4. Approval of the 1998 The Heritage Bank Outside Directors Stock Option
Plan.
The number of votes cast with respect to this matter was as follows:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
1,446,460 133,141 15,594 425,370
5. Approval of the Agreement and Plan of Reorganization
The number of votes cast with respect to this matter was as follows:
For Against Abstained Broker Non-Votes
--- ------- --------- ----------------
1,540,698 47,381 5,558 426,928
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.1-Financial Data Schedule* *Filed in electronic format only.
(b) Reports on Form 8-K
None
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
THE HERITAGE BANK
(Registrant)
Date: November 10, 1998 /s/ William B. Sutphin
-----------------------------------
William B. Sutphin
Senior V. P. and Cashier
21
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheets and the statements of income of Heritage Bancorp,
Inc. and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,517,000
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4,250,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 20,967,000
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 27,056,000
<ALLOWANCE> 570,000
<TOTAL-ASSETS> 55,194,000
<DEPOSITS> 44,153,000
<SHORT-TERM> 1,922,000
<LIABILITIES-OTHER> 118,000
<LONG-TERM> 0
0
0
<COMMON> 2,295,000
<OTHER-SE> 6,706,000
<TOTAL-LIABILITIES-AND-EQUITY> 55,194,000
<INTEREST-LOAN> 616,000
<INTEREST-INVEST> 315,000
<INTEREST-OTHER> 74,000
<INTEREST-TOTAL> 1,005,000
<INTEREST-DEPOSIT> 323,000
<INTEREST-EXPENSE> 340,000
<INTEREST-INCOME-NET> 665,000
<LOAN-LOSSES> 98,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 640,000
<INCOME-PRETAX> (38,000)
<INCOME-PRE-EXTRAORDINARY> (38,000)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (39,000)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> (0.02)
<YIELD-ACTUAL> 3.87
<LOANS-NON> 838,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,019,000
<ALLOWANCE-OPEN> 634,000
<CHARGE-OFFS> 177,000
<RECOVERIES> 11,000
<ALLOWANCE-CLOSE> 570,000
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
