SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ x ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2000
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number: 000-24933
HERITAGE BANCORP, INC.
(Name of Small Business Issue in its Charter)
VIRGINIA 54-1914902
------------------------------------ ------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
Of Incorporation or Organization)
1313 DOLLEY MADISON BLVD., MCLEAN, VIRGINIA 22101
(Address of Principal Executive Offices)
(703) 356-6060
(Issuer's Telephone Number, Including Area Code)
--------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
If Changed Since Last Report)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X . No ___.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of June 30, 2000.
Common stock, $1 par value--2,294,617 shares outstanding
--------------------------------------------------------------------------------
<PAGE>
INDEX
Part I. Financial Information
Page No.
Item 1. Financial Statements
Consolidated Balance Sheets--
June 30, 2000 and December 31, 1999 3
Consolidated Statements of Income--
Three and six months ended June 30, 2000 and 1999 4
Consolidated Statements of Stockholders' Equity--
Six months ended June 30, 2000 and 1999 5
Consolidated Statements of Cash Flows--
Six months ended June 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7 - 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 14
Part II. Other Information: 14 - 15
Item 1. Legal Proceedings
Item 2. Changes in Securities
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>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
<TABLE>
<CAPTION>
(Unaudited) (Audited)
June 30, December 31,
ASSETS: 2000 1999
---------------- ------------
<S> <C> <C>
Cash and due from banks $ 3,362 $ 2,667
Securities available for sale (at market value) 23,688 24,054
Loans, net 36,901 31,268
Premises and equipment 912 849
Other assets 1,213 1,101
------------ ------------
Total assets $ 66,076 $ 59,939
========== ==========
LIABILITIES:
Deposits
Non-interest bearing $ 13,736 $ 13,708
Interest-bearing 37,248 34,285
---------- ---------
Total deposits 50,984 47,993
Short-term debt 6,309 3,001
Other liabilities 315 347
------------ -----------
Total liabilities 57,608 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 146 210
Accumulated other comprehensive
income (loss), net (503) (437)
---------- ------------
Total stockholders' equity 8,468 8,598
---------- -----------
Total liabilities and
stockholders' equity $ 66,076 $ 59,939
========= =========
</TABLE>
Notes to financial statements are an integral part of these statements.
3
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30,
------- --------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
---- ------ ---- ------
INTEREST INCOME:
Loans and fees $ 791 $ 692 $ 1,516 $ 1,391
Federal funds sold 9 64 16 145
Investment securities 392 356 778 675
------- ------- -------- -------
Total interest income 1,192 1,112 2,310 2,211
INTEREST EXPENSE:
Interest on deposits 371 343 701 691
Interest on federal funds purchased
and other borrowings 59 23 103 35
------- ------ --------- -------
Total interest expense 430 366 804 726
------ ----- --------- ------
Net interest income 762 746 1,506 1,485
PROVISION FOR LOAN
AND LEASE LOSSES (64) 6 (92) 13
-------- ------ ---------- -------
Net interest income after 826 740 1,598 1,472
provision for loan losses
OTHER INCOME:
Service charges & fees 40 37 86 71
Securities gains (losses) 0 1 (13) 1
--------- ------- ----------- -----------
Total other income 40 38 73 72
OTHER EXPENSES:
Salaries & employee benefits 342 354 661 649
Occupancy expenses 119 85 224 162
Furniture & equipment expenses 60 21 124 35
Other operating expenses 479 289 759 473
------- -------- --------- --------
Total other expenses 1,000 749 1,768 1,319
------- -------- --------- --------
Income (loss) before income taxes (134) 29 (97) 225
Applicable income taxes (benefit) (45) 14 (33) 33
--------- ---------- ---------- --------
Net income (loss) $ (89) $ 15 $ (64) $ 192
======== ========= ========= ======
EARNINGS PER SHARE, BASIC $ (0.04) $ 0.01 $ (0.03) $ 0.08
======== ========= ========= ======
EARNINGS PER SHARE, ASSUMING
DILUTION $ (0.04) $ 0.01 $ (0.03) $ 0.08
======== ========= ========= ======
</TABLE>
Notes to financial statements are an integral part of these statements.
4
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the six months ended June 30, 2000 and 1999
(in thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Other
Common Retained Comprehensive Comprehensive
Stock Surplus Earnings Income(loss) Income (loss) Total
----- ------- -------- ------------ ------------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 $ 2,295 $ 6,530 $ 28 $ 75 $8,928
Comprehensive income:
Net income - - 192 - $ 192 192
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(124) - - - (314) (314) (314)
-----
Other comprehensive income, net of tax - - - - -
----------
Total comprehensive income - - - - $ (122) -
------- -------- ------- ------ ============ -------
Balance, June 30, 1999 $2,295 $ 6,530 $ 220 $ ( 239) $8,806
====== ======= ========= ======= ======
Balance, January 1, 2000 $ 2,295 $ 6,530 $ 210 $ (437) $8,598
Comprehensive income:
Net income (loss) - - (64) - $ (64) (64)
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(34) - - - (66) (66) (66)
----
Other comprehensive income, net of tax - - - - - -
----------
Total comprehensive income - - - - $ (130) -
------- -------- -------- ------ ============= -------
Balance, June 30, 2000 $2,295 $ 6,530 $ 146 $ (503) $8,468
====== ======= ========= ======= ======
</TABLE>
Notes to financial statements are an integral part of these statements.
5
<PAGE>
HERITAGE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
2000 1999
----- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ (64) $ 192
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 50 33
Provision for loan losses (92) 13
Amortization of premiums, net 9 15
(Gain) loss on sale of securities available for sale 13 (1)
Changes in assets and liabilities:
Decrease (increase) in other assets (43) 36
(Decrease) in other liabilities (32) (26)
---------- ------------
Net cash (used in ) operating activities (159) 262
--------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans (5,540) (366)
Purchase of securities available for sale (813) (11,552)
Proceeds from sales of securities available for sale 987 646
Proceeds from calls and maturities of securities available for sale 73 7,249
Purchase of premises and equipment (152) (496)
----------- -----------
Net cash used in investing activities (5,445) (4,519)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in deposits 2,991 (4,571)
Net increase in short-term borrowings 3,308 308
----------- ------------
Net cash provided by financing activities 6,299 (4,263)
----------- -----------
Net increase (decrease) in cash and cash equivalents 695 (8,520)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 2,667 14,375
---------- ----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 3,362 $ 5,855
========= ==========
Supplemental disclosures of cash flow information Cash payments for:
Interest on deposits $ 700 $ 690
Income taxes $ - $ -
Supplemental schedule of non-cash investing activities
Unrealized gain (loss) on securities available for sale $ (761) $ (363)
</TABLE>
Notes to financial statements are an integral part of these statements.
6
<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 June 30, 2000 and December 31, 1999, and the results of
operations and cash flows for the six months ended June 30, 2000 and 1999.
The results of operations for the six months ended June 30, 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>
June 30, 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 $ 23,074 $ - $ (763) $ 22,311
Obligations of states & political subdivisions 510 - (2) 508
Corporate debt obligations 500 4 - 504
Other securities 100 - - 100
Federal reserve stock 265 - - 265
--------- --------- ---------- ---------
$ 24,449 $ 4 $ (765) $ 23,688
======== ======== ======= ========
Securities available for sale at December 31, 1999 consist of the following:
December 31, 1999
--------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(in thousands of dollars) Cost Gains Losses Value
----------------------------------------------------
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
========= ========== ======= ========
Six Months Ended
(in thousands of dollars)
June 30,
2000 1999
--------- -------
Gross proceeds from sales of securities 987 646
========= =======
Gross gains on sale of securities - 1
Gross losses on sale of securities 13 -
--------- -------
Net securities gains/losses 13 1
========= =======
</TABLE>
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(unaudited)
3. LOANS
Major classifications of loans are as follows:
(in thousands of dollars)
June 30, December 31,
2000 1999
--------- ------------
Commercial $ 5,894 $ 3,665
Real estate:
Construction 1,838 1,157
Residential (1-4 family) 11,214 10,475
Commercial 15,331 13,088
Agricultural 962 972
Consumer 1,262 1,507
All other Loans 729 825
---------- ----------
37,230 31,689
Less allowance for loan losses (329) (421)
---------- ----------
$ 36,901 $31,268
========= =======
The following schedule summarizes the changes in the allowance for loan and
lease losses:
Six Months Six Months
Ending Ending December 31,
June 30, 2000 June 30, 1999 1999
(in thousands of dollars) --------- --------- ----------
Balance, beginning $ 421 $ 429 $ 429
Provision charged against income (92) 13 -
Recoveries 5 9 12
Loans charged off 5 20 20
-------- -------- --------
Balance, ending $ 329 $ 431 $ 421
======= ======== ========
There were no nonperforming assets on June 30, 2000 or on December 31, 1999.
There were no loans past due 90 days or more and still accruing on June 30, 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>
June 30, 2000 June 30, 1999
------------- -------------
Per Share Per Share
Shares Amount Shares Amount
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Basic Earnings Per Share 2,294,617 $ (0.03) 2,294,617 $ .08
Effect of dilutive securities:
Nonemployee directors' stock options 10,000 10,000
Employee incentive stock options 21,544 44,050
----------- -----------
Diluted Earnings Per Share 2,424,907 $ (0.03) 2,348,667 $ .08
========= -------- ========= =======
</TABLE>
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(unaudited)
5. CAPITAL REQUIREMENTS
A comparison of the Company's capital as of June 30, 2000 with the minimum
requirements is presented below:
Minimum
Actual Requirements
------ ------------
Tier I risk-based capital 22.41% 4.00 %
Total risk-based capital 23.23% 8.00 %
Leverage ratio 14.29% 4.00 %
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
FORWARD-LOOKING STATEMENTS
Certain information contained in this discussion may include
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements are generally identified by phrases
such as "the Company expects," "the Company believes" or words of similar
import. Such forward-looking statements involve known and unknown risks
including, but not limited to, changes in general economic and business
conditions, interest rate fluctuations, competition within and from outside the
banking industry, new products and services in the banking industry, risk
inherent in making loans such as repayment risks and fluctuating collateral
values, problems with technology utilized by the Company, changing trends in
customer profiles and changes in laws and regulations applicable to the Company.
Although the Company believes that its expectations with respect to the
forward-looking statements are based upon reliable assumptions within the bounds
of its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements.
GENERAL
The following presents management's discussion and analysis of the
consolidated financial condition and results of operations of Heritage Bancorp,
Inc. (the "Company") as of the dates and for the periods indicated. This
discussion should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto, and other financial data appearing
elsewhere in this report. The Company is the parent bank holding company for The
Heritage Bank (the "Bank"). The Bank is a Virginia chartered bank headquartered
in McLean, Virginia that currently operates three full-service offices and
engages in a broad range of lending and deposit services aimed at individual and
small to medium-sized business customers in their respective market areas.
PROPOSED MERGER
The Boards of Directors of Cardinal Financial Corporation and Heritage
Bancorp, Inc. have agreed to merge the two companies pursuant to an amended and
restated agreement and plan of reorganization, dated June 19, 2000. After the
merger, Cardinal Financial Corporation will own four banks with expected total
assets of approximately $180,000,000 and seven branch offices in northern
Virginia.
The shareholders of both corporations approved the proposed merger at
special meetings of shareholders of both corporations on July 25, 2000. If
regulatory approvals received, the Bank will become a subsidiary of Cardinal
Financial Corporation and most likely change its name to Cardinal Bank -
Potomac. The Company's shareholders will receive $6.00 in cash, shares of
preferred stock with a per share value of approximately $6.00 per share or a
combination of both for each share of Heritage common stock that they own.
Cardinal Financial Corporation has applied to list the preferred stock on the
Nasdaq SmallCap Market.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2000 AND DECEMBER 31, 1999.
As of June 30, 2000 the Company's total assets were $66,076,000 as
compared to $59,939,000 as of December 31, 1999, which represents an increase of
10.2%. The 2000 increase in total assets of $6,137,000 was primarily due to the
increased loan production efforts. Total loans increased by 17.5% or $5,541,000
to $37,230,000 at June 30, 2000 from $31,689,000 at December 31, 1999.
Total deposits increased $2,991,000 to $50,984,000 at June 30, 2000 as
compared to $47,993,000 at December 31, 1999. The largest deposit increases were
in certificates of deposits and interest bearing demand accounts. Repurchase
agreements at June 30, 2000 were $3,174,000 or $173,000 greater than the
December 31, 1999 balance of $3,001,000. The Bank also had $3,135,000 in federal
funds purchased at June 30, 2000 compared to none at December 31, 1999.
10
<PAGE>
Federal funds sold and cash and due from banks represent the Company's
cash and cash equivalents. Federal funds sold and cash and cash due from banks
at June 30, 2000 totaled $3,362,000 compared to $2,667,000 at December 31, 1999,
representing an increase of $695,000, or 26.1%. The increase in due from banks
was attributable to usual fluctuations in clearing balances at the Federal
Reserve Bank.
Securities available for sale decreased $366,000 or 1.5% to $23,688,000
at June 30, 2000 from $24,054,000 at December 31, 1999. The net 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.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 AND 1999.
Net income. The Company reported a net loss for the three months ended
June 30, 2000 of $89,000 or $(0.04) basic and diluted earnings per share as
compared to the $15,000 net income or $.01 basic and diluted earnings per share
for the same period of 1999. This decrease was primarily due to the $189,000 in
merger related expenses. Prior to these merger expenses, the Bank had net income
for the three months ended June 30, 2000 of $100,000. The increase in net income
without the pre-merger expenses as compared to the same period of 1999 was
primarily comprised of a credit to provision for loan losses of $64,000 due to
the continued improvement in quality of the loan portfolio, and increased net
interest income of $16,000.
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, repurchase agreements and other short-term
borrowings. 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 June 30, 2000 increased $16,000 or 2.1% over the
same quarter of 1999.
Non-interest income. During the three-month period ended June 30, 2000
non-interest income increased $2,000 over the same period of 1999. The increase
is primarily due to increased volume of fees on deposit accounts.
Non-interest expense. In the second quarter of 2000 non-interest
expenses increased $251,000 or 33.5% over the same period of 1999 due to
increased occupancy and equipment costs and operating expenses. Occupancy and
equipment costs increased due to the Tysons branch, which opened May of 2000,
and the Sterling branch, which opened in April of 1999. These additional leases
raised occupancy expense by $34,000 for the three months ended June 30, 2000 as
compared to the same period of 1999. Additional equipment expenses increased by
$39,000 for the three-month period ended June 30, 2000 as compared to the same
period of 1999. During this same period operation expenses increased by $190,000
as compared to the same period of 1999. This increase was primarily comprised of
the $189,000 in merger related expenses.
Provision for loan losses. In view of the loan growth for the second
quarter of 1999 and the fact that there was no deterioration in the Bank's loan
portfolio, a provision of $6,000 was made for loan losses in the first quarter
of 1999. The allowance for loan losses at June 30, 1999 was 1.44% of outstanding
loans. In view of the improvement in the 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 .88% would be an acceptable
level. A credit of $64,000 for the second quarter was made to the provision to
reduce the reserve balance at June 30, 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 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.
11
<PAGE>
Income Taxes. The Company recognized a net income tax credit of $45,000
in the second quarter of 2000, as compared to an expense of $14,000 in the same
period of 1999. A net operating loss carryforward of the Company became
completely utilized for accounting purposes in 1999.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999.
Net income. The Company reported a net loss for the six months ended
June 30, 2000 of $64,000 or $(0.03) basic and diluted earnings per share as
compared to the $192,000 net income or $.01 basic and diluted earnings per share
for the same period of 1999. This $256,000 decrease was primarily due to the
$189,000 in merger related expenses. Prior to these merger expenses the Bank had
net income for the six months ended June 30, 2000 of $125,000. The decrease in
net income without merger expenses as compared to the same period of 1999 was
primarily comprised of increased occupancy and equipment costs and operational
expenses.
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 six-month period
ended June 30, 2000 increased $21,000 or 1.4% over the same quarter of 1999.
Non-interest income. During the six-month period ended June 30, 2000
non-interest income increased $1,000 over the same period of 1999. A loss on
sale of securities of $13,000 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 six months of 2000 non-interest
expenses increased $449,000 or 34.0% over the same period of 1999. Merger
expenses represent $189,000 of this increase. Occupancy and equipment costs and
operational expenses increased due to the Tysons branch which opened May of
2000, 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 additional leases raised occupancy expense by $62,000 for the six months
ended June 30, 2000 as compared to the same period of 1999. Equipment expenses
increased by $89,000 primarily due to the additional facilities, and partially
due to the Company's upgrade of its computer systems. Data processing increased
by $37,000 during this six month period as compared to the same period of 1999
and marketing and business development increased by $37,000.
Provision for loan losses. In view of the loan growth for the first six
months of 1999 and the fact that there was no deterioration in the Bank's loan
portfolio, a provision of $13,000 was made for loan losses in the first half of
1999. The allowance for loan losses at June 30, 1999 was 1.44% of outstanding
loans. In view of the improvement in the 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 .88% would be an acceptable
level. A credit of $92,000 for the first half of 2000 was made to the provision
to reduce the reserve balance at June 30, 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 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. The Company recognized a net income tax credit of $33,000
in the first half of 2000, as compared to an expense of $33,000 in the same
period of 1999. A net operating loss carryforward of the Company became
completely utilized for accounting purposes in 1999.
12
<PAGE>
LOAN QUALITY
The Bank attempts to manage the risk characteristics of its loan
portfolio through various control processes, such as credit evaluation of
borrowers, establishment of lending limits and application of lending
procedures, including the holding of adequate collateral and the maintenance of
compensating balances. However, the Bank seeks to rely primarily on the cash
flow of its borrowers as the principal source of repayment. Although credit
policies are designed to minimize risk, management recognizes that loan losses
will occur and that the amount of these losses will fluctuate depending on the
risk characteristics of the loan portfolio, as well as general and regional
economic conditions.
The allowance for loan losses represents a reserve for potential losses
in the loan portfolio. The adequacy of the allowance for loan losses is
evaluated periodically based on a review of all significant loans, with a
particular emphasis on non-accruing, past due and other loans that management
believes require special attention. As of June 30, 2000, the Company had no
loans in non-accrual or 90 days past due as compared to $129,000 in non-accrual
or 90 days past due as of June 30, 1999.
For significant problem loans, management's review consists of
evaluation of the financial strengths of the borrower, the related collateral,
and the effects of economic conditions. Specific reserves against the remaining
loan portfolio are based on analysis of historical loan loss ratios, loan
charge-offs, delinquency trends, and previous collection experience, along with
an assessment of the effects of external economic conditions.
As of June 30, 2000, the allowance for loan losses was .88% of
outstanding loans, which was a decrease from the June 30, 1999 percentage of
1.44%. Management's judgment as to the level of future losses on existing loans
is based on management's internal review of the loan portfolio, including an
analysis of the borrowers' current financial position, the consideration of
current and anticipated economic conditions and their potential effects on
specific borrowers, an evaluation of the existing relationships among loans,
potential loan losses, and the present level of the loan loss allowance; and
results of examinations by independent consultants. In determining the
collectibility of certain loans, management also considers the fair value of any
underlying collateral. However, management's determination of the appropriate
allowance level is based upon a number of assumptions about future events, which
are believed to be reasonable, but which may or may not prove valid. Thus, there
can be no assurance that charge-offs in future periods will not exceed the
allowance for loan loss or that additional increases in the loan loss allowance
will not be required.
CAPITAL RESOURCES
Stockholders' equity was $8,468,000 as of June 30, 2000 as compared to
$8,598,000 as of December 31, 1999. The $130,000 decrease, or 1.5%, was
partially due to a $66,000 increase in the unrealized loss on investment
securities available-for-sale and the year to date net loss of $64,000. No
dividends have been declared by the Company since its inception. In addition, no
options under the Stock Option Plan have been exercised during 2000.
Under the Federal Reserve's capital regulations, for as long as the
Company's assets are under $150 million, the Company's capital ratios are
reviewed on a bank-only basis. The Bank exceeded its capital adequacy
requirements as of June 30, 2000 and December 31, 1999. The Company continually
monitors its capital adequacy ratios to assure that the Bank remains within the
guidelines.
13
<PAGE>
LIQUIDITY AND INTEREST RATE SENSITIVITY
The primary objective of asset/liability management is to ensure the
steady growth of the Company's primary earnings component, net interest income.
Net interest income can fluctuate with significant interest rate movements. To
lessen the impact of these rate swings, management endeavors to structure the
balance sheet so that repricing opportunities exist for both assets and
liabilities in roughly equivalent amounts at approximately the same time
intervals. Imbalances in these repricing opportunities at any point in time
constitute interest rate sensitivity.
The measurement of the Company's interest rate sensitivity, or "gap,"
is one of the principal techniques used in asset/liability management.
Interest-sensitive gap is the dollar difference between assets and liabilities
that are subject to interest-rate repricing within a given time period,
including both floating rate or adjustable rate instruments and instruments
which are approaching maturity.
In theory, maintaining a nominal level of interest rate sensitivity can
diminish interest rate risk. In practice, this is made difficult by a number of
factors, including cyclical variations in loan demand, different impacts on
interest-sensitive assets and liabilities when interest rates change, and the
availability of funding sources. Accordingly, the Company undertakes to manage
the interest-rate sensitivity gap by adjusting the maturity of and establishing
rate prices on the earning asset portfolio and certain interest-bearing
liabilities to keep it in line with management's expectations relative to market
interest rates. Management generally attempts to maintain a balance between
rate-sensitive assets and liabilities as the exposure period is lengthened to
minimize the overall interest rate risk to the Company.
The Bank's Executive Committee that oversees the asset/liability
management function meets periodically to monitor and manage the structure of
the balance sheet, control interest rate exposure, and evaluate pricing
strategies for the Company. The asset mix of the balance sheet is continually
evaluated in terms of several variables: yield, credit quality, and appropriate
funding sources and liquidity. Management of the liability mix of the balance
sheet focuses on expanding the various funding sources.
Securities maintained in the available-for-sale portfolio may be sold
prior to maturity in order to provide the Company and the Bank with increased
liquidity. Available-for-sale investment securities totaled $23,688,000 and
$24,054,000 as of June 30, 2000 and December 31, 1999, respectively.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - Definitive Merger Agreement
On July 25, 2000, the Company's shareholders approved the Amended and
Restated Agreement and Plan of Reorganization dated June 19, 2000 providing for
the merger of the Company with Cardinal Financial Corporation ("Cardinal"), a
bank holding company headquartered in Fairfax, Virginia. Under the terms of the
merger agreement, Cardinal will issue a combination of cash and shares of
convertible preferred stock to the Company's stockholders in exchange for all of
the shares of the Company's common stock.
The Company's stockholders will be able to elect to receive $6.00 in
cash, 1.2 shares of convertible preferred stock, or a combination of both for
each share of the Company's common stock, subject to certain adjustments to
permit Cardinal to issue an equal amount of cash and convertible preferred
stock. The preferred stock will have a
14
<PAGE>
liquidation value of $5.00 and the right to dividend payments at the rate of
7.25% per annum. Each share of preferred stock will also be convertible into
shares of Cardinal's common stock at any time at the option of its holder.
It is expected that The Heritage Bank will be renamed "Cardinal Bank -
Potomac" and become a subsidiary of Cardinal, the surviving company in the
merger. Following the merger, three members of the Company's Board of Directors
will join Cardinal's Board. Subject to certain conditions including receipt of
regulatory approval, the closing of the merger is anticipated to occur in the
third quarter of 2000. The merger will be accounted for under the purchase
method.
Item 6. Exhibits and reports on Form 8-K
a) Exhibits
27 Financial Data Schedule (filed electronically only)
b) Form 8-K - None
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2000 BY /s/ Terrie G. Spiro
-------------------------------
President & CEO
Date: August 14, 2000 BY /s/ Janet A. Valentine
----------------------------------
Exec. Vice President
& Chief Financial Officer
16
