UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
Quarterly Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1997
Commission File Number 0-15059
HERITAGE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Illinois 36-3139645
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
17500 South Oak Park Avenue
Tinley Park, Illinois 60477
(Address of principal executive offices) (Zip code)
(708) 532-8000
(Registrant's telephone number, including area code)
Former name, former address and former fiscal year, if changed from last
report: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the last practicable date:
Class Outstanding at November 10, 1997
Common Shares, no par value 12,005,813
<TABLE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
<CAPTION>
September 30 December 31
1997 1996
------------ -----------
<S> <C> <C>
ASSETS
Cash and due from banks $36,524 $43,830
Federal funds sold and interest-bearing deposits - -
------- -------
Total cash and cash equivalents 36,524 43,830
Securities:
Held-to-maturity (market value: $121,450 in
1997 and $117,046 in 1996) 118,654 115,913
Available-for-sale, at market 395,613 392,754
Trading, at market 350 262
------- -------
Total securities 514,617 508,929
Loans, net of unearned income 697,395 639,004
Less: allowance for loan losses (9,761) (9,407)
------- -------
Net loans 687,634 629,597
Premises and equipment 19,567 18,786
Goodwill and core deposit intangibles 16,695 18,196
Other assets 9,666 9,682
------- -------
TOTAL ASSETS $1,284,703 $1,229,020
LIABILITIES
Demand deposits 170,063 185,705
NOW and money market accounts 231,958 190,955
Savings deposits 191,774 203,483
Time deposits 512,660 473,160
------- -------
Total deposits $1,106,455 $1,053,303
Federal funds purchased - 13,000
Securities sold under agreements to repurchase 52,641 40,706
Notes payable - 7,000
Other liabilities 9,579 9,324
------- -------
TOTAL LIABILITIES $1,168,675 $1,123,333
------- -------
SHAREHOLDERS' EQUITY
Preferred shares - no par value; shares authorized: - -
12,000,000; shares issued: none
Common shares - no par value in 1997, $.625
par value in 1996; shares authorized:
16,000,000; shares issued: 12,128,313
in 1997 and 11,946,464 in 1996 - 4,979
Surplus 23,564 17,634
Retained earnings 90,613 83,374
Net unrealized gains (losses) on securities,
net of tax 3,963 1,525
Treasury stock, at cost (117,500 shares in 1997
and 129,038 shares in 1996) (2,112) (1,825)
------- -------
TOTAL SHAREHOLDERS' EQUITY 116,028 105,687
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS'EQUITY $1,284,703 $1,229,020
======= =======
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands except per share data)
(unaudited)
<CAPTION>
Nine Months Ended
September 30,
-----------------
1997 1996
------- -------
<S> <C> <C>
INTEREST INCOME
Loans, including fees $42,841 $39,437
Securities:
Taxable 18,905 17,648
Exempt from federal income taxes 5,735 4,617
Federal funds sold and interest-bearing
deposits 211 581
------- -------
TOTAL INTEREST INCOME 67,692 62,283
------- -------
INTEREST EXPENSE
Deposits 29,901 26,891
Short-term borrowings 1,451 1,302
Notes payable 141 482
------- -------
TOTAL INTEREST EXPENSE 31,493 28,675
------- -------
NET INTEREST INCOME 36,199 33,608
Provision for loan losses 450 300
------- -------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 35,749 33,308
------- -------
OTHER INCOME
Service charges on deposit accounts 3,846 3,281
Income for trust services 626 592
Investment product fees 960 890
Other operating income 1,295 856
Securities gains 150 88
------- -------
TOTAL OTHER INCOME 6,877 5,707
------- -------
OTHER EXPENSE
Salaries and employee benefits 12,820 12,577
Net occupancy expense 2,418 2,327
Equipment expense 1,284 1,259
Data processing expense 896 838
Amortization of intangible assets 1,501 1,668
Other operating expenses 4,585 4,145
------- -------
TOTAL OTHER EXPENSE 23,504 22,814
------- -------
INCOME BEFORE INCOME TAXES 19,122 16,201
Income tax expense 6,041 5,098
------- -------
NET INCOME $13,081 $11,103
======= =======
NET INCOME PER COMMON SHARE
Primary $1.05 $.89
Fully diluted $1.05 $.89
Weighted average common and common equivalent
shares outstanding:
Primary 12,464,272 12,501,120
Fully diluted 12,492,407 12,522,639
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands except per share data)
(unaudited)
<CAPTION>
Three Months Ended
September 30,
------------------
1997 1996
------- -------
<S> <C> <C>
INTEREST INCOME
Loans, including fees $14,721 $13,243
Securities:
Taxable 6,179 6,111
Exempt from federal income taxes 2,049 1,594
Federal funds sold and interest-bearing
deposits 127 231
------- -------
TOTAL INTEREST INCOME 23,076 21,179
------- -------
INTEREST EXPENSE
Deposits 10,429 9,248
Short-term borrowings 481 402
Notes payable 7 158
------- -------
TOTAL INTEREST EXPENSE 10,917 9,808
------- -------
NET INTEREST INCOME 12,159 11,371
Provision for loan losses 150 100
------- -------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 12,009 11,271
------- -------
OTHER INCOME
Service charges on deposit accounts 1,350 1,249
Income for trust services 216 199
Investment product fees 260 279
Other operating income 466 286
Securities gains 50 76
------- -------
TOTAL OTHER INCOME 2,342 2,089
------- -------
OTHER EXPENSE
Salaries and employee benefits 4,204 4,142
Net occupancy expense 750 875
Equipment expense 464 441
Data processing expense 301 257
Amortization of intangible assets 505 581
Other operating expenses 1,575 1,403
------- -------
TOTAL OTHER EXPENSE 7,799 7,699
------- -------
INCOME BEFORE INCOME TAXES 6,552 5,661
Income tax expense 2,054 1,804
------- -------
NET INCOME $4,498 $3,857
======= =======
NET INCOME PER COMMON SHARE
Primary $.36 $.31
Fully diluted $.36 $.31
Weighted average common and common equivalent
shares outstanding:
Primary 12,444,821 12,481,709
Fully diluted 12,448,358 12,481,709
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<CAPTION>
Nine Months Ended
September 30,
-------------
1997 1996
----- -----
<S> <C> <C>
OPERATING ACTIVITIES
Net income $13,081 $11,103
Adjustments to reconcile net income to net cash
provided by operating activities:
Discount accretion on securities (1,423) (1,070)
Deferred loan fee accretion (292) (357)
Provision for loan losses 450 300
Securities gains (150) (88)
Depreciation and amortization 1,391 1,294
Deferred income taxes (391) (491)
Net amortization of purchase accounting
adjustments 1,829 2,063
Increase in accrued interest income (1,181) (1,502)
Increase in accrued interest expense (81) 101
Other, net 435 430
------ ------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 13,668 11,783
------ ------
INVESTING ACTIVITIES
Securities held-to-maturity:
Proceeds from maturities, repayments
and calls 4,614 3,053
Purchases (6,782) (21,000)
Securities available-for-sale:
Proceeds from maturities, repayments
and calls 49,559 69,668
Proceeds from sales 57,490 14,773
Purchases (104,986) (99,582)
Purchase of trading security - (250)
Net increase in loans (59,100) (25,376)
Purchases of premises and equipment (2,251) (1,910)
Proceeds from sales of other real estate
owned 695 905
Purchase price of acquired bank net of cash
and cash equivalents - (7,798)
------ ------
NET CASH USED IN INVESTING ACTIVITIES (60,761) (67,517)
------ ------
FINANCING ACTIVITIES
Net increase in deposits 53,217 38,864
Decrease in federal funds purchased (13,000) 16,500
Net increase (decrease) in securities sold
under agreements to repurchase 11,935 (1,061)
Proceeds from notes payable - 14,000
Principal payments on notes payable (7,000) (5,000)
Proceeds from stock option exercises 376 148
Dividends paid (3,629) (3,110)
Purchases of common stock (2,112) (1,470)
------ ------
NET CASH PROVIDED FROM FINANCING
ACTIVITIES 39,787 58,871
------ ------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (7,306) 3,137
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD 43,830 49,879
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $36,524 $53,016
====== ======
SUPPLEMENTAL DISCLOSURES:
Interest paid $31,639 $28,656
Income taxes paid 6,215 4,935
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The unaudited consolidated financial statements include the
accounts of Heritage Financial Services, Inc. and its subsidiaries (the
"Company"). In the opinion of management, all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation
of the financial position, results of operations and cash flows for the
interim periods have been made. Certain amounts reported in prior
periods have been reclassified for presentation or comparative purposes.
The results of operations for the three and nine months ended September
30, 1997 are not necessarily indicative of the results to be expected
for the entire fiscal year.
The unaudited interim financial statements have been prepared in
conformity with generally accepted accounting principles and reporting
practices. Certain information in footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles and industry reporting practices has been
condensed or omitted pursuant to rules and regulations of the Securities
and Exchange Commission, although the Company believes the disclosures
are adequate to make the information not misleading. These financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's 1996 Form 10-K.
EARNINGS PER SHARE
Primary and fully diluted earnings per common share for the three
and nine months ended September 30, 1997 and 1996 are computed by
dividing net income by the weighted average number of common shares
outstanding and common equivalent shares, assumed to be issued under the
Company's stock option plan. Common share equivalents attributable to
stock options are computed based on the treasury stock method. Average
common and common equivalent shares have been adjusted to reflect the
Company's 1997 three-for-two stock split.
NEW ACCOUNTING PRONOUNCEMENTS
As of January 1, 1997, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") 125, "Accounting
for Transfers of Financial Assets, Servicing Rights, and Extinguishment
of Liabilities". SFAS 125 sets forth accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities. The standards are based on consistent application of a
financial-components approach that focuses on control. Under the
approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. In
December, 1996, the Financial Accounting Standards Board ("FASB") issued
SFAS 127, "Deferral of the Effective Date of Certain Provisions of SFAS
125". SFAS 127 defers the effective date of certain provisions of SFAS
125 for one year. The adoption of SFAS 125 did not have a material
effect on the Company's financial condition or results of operations.
In February, 1997, the FASB issued SFAS 128, "Earnings Per Share",
which becomes effective for the 1997 Annual Report to Shareholders.
Early application of the new standard is not permitted, however,
restatement of all prior period information is required. The new
standard replaces primary earnings per share ("EPS") with earnings per
common share ("basic EPS"). Basic EPS is computed by dividing net income
by the weighted average number of common shares outstanding for the
period. The standard also requires presentation of EPS assuming
dilution. This is computed similarly to the fully diluted EPS that is
now required.
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
If SFAS 128 was adopted in 1997, basic EPS for the third quarter
would have been $.37 and EPS assuming dilution would have been $.36.
Year-to-date, basic EPS for the first nine months of 1997 would have been
$1.08 and EPS assuming dilution would have been $1.05. Similarly, basic
EPS for the 1996 third quarter would have been $.32 and EPS assuming
dilution would have been $.31. Year-to-date, basic EPS for the first nine
months of 1996 would have been $.93 and EPS assuming dilution would have
been $.89.
<TABLE>
LOANS
The following table summarizes loan balances by category (in
thousands):
<CAPTION>
September 30 December 31
1997 1996
--------- ---------
<S> <C> <C>
Commercial and industrial $166,601 $143,811
Commercial real estate 143,472 148,798
Construction 16,118 13,515
Residential real estate 268,936 239,380
Home equity 95,526 85,113
Other consumer 8,047 10,192
--------- ---------
Gross loans 698,700 640,809
Less: unearned income (1,305) (1,805)
--------- ---------
Total $697,395 $639,004
========= =========
</TABLE>
COMMON SHARES
On May 14, 1997, the Board of Directors of Heritage Financial
Services, Inc. declared a three-for-two stock split, payable June 13,
1997, to shareholders of record at the close of business on May 27,
1997. The Board of Directors also voted to eliminate the par value of
common shares. As a result of the stock split, shareholders of record
as of May 27, 1997, received one additional common share for every two
shares owned. Shareholders entitled to fractional shares received cash
in lieu of fractional shares. Per share information included in the
consolidated financial statements has been adjusted to reflect the
split.
In June, 1996, the Company's Board of Directors approved a stock
repurchase program which authorized the repurchase of up to 325,000
common shares to be used for the issuance of shares under the Company's
stock option plan. In May, 1997, the Board of Directors authorized the
repurchase of an additional 68,850 shares as a result of the Company's
1997 three-for-two stock split. The shares were authorized to be
repurchased from time to time in the open market or in private
transactions. During the nine month period ended September 30, 1997, on
a split adjusted basis, 200,001 common shares were repurchased at a cost
of $3,335,031 and 213,452 treasury shares were reissued upon the
exercise of stock options. At September 30, 1997, the Company had
156,549 common shares remaining to be repurchased under the stock
repurchase program.
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
STOCK OPTIONS
<TABLE>
A summary of stock option activity for the nine months ended
September 30, 1997 is presented below (shares in thousands):
<CAPTION>
Weighted
Option Average
Shares Price
------ ------
<S> <C> <C>
Balance, December 31, 1996 1,022 $5.82
Granted - -
Exercised (389) $4.11
Forfeited - -
------ ------
Balance, September 30, 1997 633 $6.87
====== ======
</TABLE>
<TABLE>
A summary of outstanding and exercisable stock options at
September 30, 1997 is presented below (shares in thousands):
<CAPTION>
Outstanding Options Exercisable Options
-------------------- -------------
Weighted Average Weighted
Option Average Remaining Option Average
Shares Price Life Shares Price
<S> <C> <C> <C> <C> <C>
Exercise Price Ranges ----- ----- ------- ----- -----
$4.73 - $7.08 448 $5.59 2.8 yrs 448 $5.59
$9.00 - $11.00 185 $9.97 5.8 yrs 158 $9.81
----- -----
Total 633 606
===== =====
</TABLE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
The following represents management's analysis of the Company's
results of operations for the three and nine month periods ended
September 30, 1997 and 1996 and its consolidated financial condition at
September 30, 1997 as compared to December 31, 1996. This discussion
should be read in conjunction with the consolidated financial statements
and notes thereto appearing elsewhere in this Form 10-Q.
On February 2, 1996, the Company acquired all of the common shares
of the First National Bank of Lockport ("Lockport") for $16.8 million in
cash. The acquisition was accounted for as a purchase and, accordingly,
the results of operations of Lockport have been included in the
consolidated statement of income from the date of acquisition.
ANALYSIS OF INCOME STATEMENTS
SUMMARY OF OPERATIONS
Net income in the third quarter of 1997 increased to $4,498,000, up
17% from $3,857,000 earned in the same quarter of 1996. On a fully
diluted basis, earnings per share for the quarterly period increased to
36 cents per share, up 16% compared to 31 cents per share earned in the
third quarter of 1996. For the nine months ended September 30, 1997,
net income was $13,081,000, up 18% compared to $11,103,000 in the same
period of 1996. Earnings per share for the nine month period were
$1.05, up 18% compared to 89 cents in the 1996 period.
Higher earnings in the three and nine month periods were
principally due to increases in net interest income and other operating
income. Growth in year-to-date earnings was also positively affected by
a pre-tax recovery of $160,000 of interest income on a nonaccrual loan
and the reimbursement of $150,000 of legal costs related to litigation
settled in 1996. These adjustments were recognized in the 1997
first quarter. The Company also recognized net securities gains of
$150,000 in the first nine months of 1997.
NET INTEREST INCOME
<TABLE>
The following table sets forth the average balances, tax equivalent
yields and effective rates for the major categories of earning asset and
interest-bearing liabilities for the three and nine months ended
September 30, 1997 and 1996 (in thousands):
<CAPTION>
Three Months Ended September 30,
--------------------------------
1997 1996
---------- ---------
Average Average
Balance Rate Balance Rate
---------- ---- --------- ----
<S> <C> <C> <C> <C>
Loans $687,282 8.54% $620,881 8.54%
Securities 504,871 7.33 484,171 7.04
Short-term investments 9,292 5.38 17,717 5.19
---------- ---- ---------- ----
Total earning assets $1,201,445 8.01% $1,122,769 7.84%
========== ---- ========== -----
Time deposits $498,958 5.56% $459,609 5.42%
NOW and money market
accounts 233,191 3.53 190,644 3.17
Savings deposits 195,125 2.78 211,634 2.76
Short-term borrowings 53,378 3.58 48,651 3.30
Notes payable 407 6.82 9,439 6.66
---------- ---- --------- ----
Total interest-bearing
liabilities $981,059 4.41% $919,977 4.24%
========== ---- ========= ----
Net interest spread 3.60% 3.60%
Impact of non-interest bearing funds 0.81% 0.76%
---- ----
Net yield on interest earning assets 4.41% 4.36%
==== ====
Nine Months Ended September 30,
-------------------------------
1997 1996
---------- --------
Average Average
Balance Rate Balance Rate
------- ---- ------- ----
<S> <C> <C> <C> <C>
Loans $668,228 8.62% $611,550 8.67%
Securities 504,037 7.36 468,725 7.05
Short-term investments 5,251 5.37 14,855 5.23
---------- ---- ---------- ----
Total earning assets $1,177,516 8.06% $1,095,130 7.93%
========== ---- ========== ----
Time deposits $490,211 5.51% $436,107 5.47%
NOW and money market
accounts 217,741 3.43 190,626 3.19
Savings deposits 198,698 2.76 215,046 2.79
Short-term borrowings 52,886 3.67 49,070 3.55
Notes payable 2,868 6.57 9,932 6.48
---------- ---- -------- ----
Total interest-bearing
liabilities $962,404 4.38% $900,781 4.25%
=========== ---- ======== ----
Net interest spread 3.68% 3.68%
Impact of non-interest bearing funds 0.81% 0.75%
---- -----
Net yield on interest earning assets 4.49% 4.43%
==== ====
</TABLE>
On a tax equivalent basis, net interest income for the third
quarter of 1997 was $13,344,000, an increase of $1,029,000 or 8%
compared with the 1996 third quarter. For the nine months ended
September 30, 1997, net interest income increased $3,174,000 or 9%
compared to 1996. The growth in net interest income for the three and
nine month periods was primarily due to increases in the volume of
average earning assets. The growth in average earning assets primarily
resulted from strong internal deposit growth over the past twelve
months.
Average loans for the first nine months of 1997 were $668 million,
an increase of $57 million or 9% compared to the same period in 1996.
The increase was primarily in commercial and industrial loans and
residential real estate loans. Average securities increased $35 million
or 8% compared to the 1996 nine month period. The Company continues to
purchase fixed-rate intermediate-term mortgage-backed securities and
longer-term bank-qualified tax-exempt securities.
The increase in average earning assets was primarily funded by
growth in average time deposits and money market accounts, which
increased $54 million and $25 million, respectively, year-over-year. The
growth in time deposits primarily resulted from a combination of time
deposit promotions and generally higher interest rates offered on time
deposits compared to other interest-bearing deposit products. The growth
in money market accounts was primarily due to the promotion of the
Company's Premier Money Market Account in the 1997 second quarter.
On a tax equivalent basis, the annualized net interest spread in
the third quarter was 3.60%, the same as that earned in the third
quarter of 1996. For the first nine months of 1997, the net interest
spread was 3.68%, also equaling the net interest spread in the year ago
period. On a year-to-date basis, the Company's yield on earning assets
and rate paid on interest-bearing liabilities each increased by .13%.
The increase in the yield on earning assets was primarily due to the
increase in the yield on securities, reflecting higher rates earned on
new purchases and the sale and reinvestment of lower-yielding securities.
The increase in the rate paid on interest-bearing liabilities was
primarily due to the change in deposit mix, with most growth coming in
time deposits and money market accounts.
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The allowance for loan losses is an amount which is available to
absorb potential credit losses. The allowance is comprised of both
specific and general valuation allowances and is maintained at a level
management believes to be adequate to provide for known and potential
risks inherent in the Company's loan portfolio. Management assesses the
adequacy of the allowance for loan losses on a quarterly basis.
Management's evaluation of the adequacy of the allowance considers such
factors as prior loss experience, loan portfolio growth, loan
delinquency levels and trends, and reviews of impaired loans and the
value of underlying collateral securing these loans. A provision for
loan losses is charged to income to increase the allowance to a level
deemed to be adequate, but not excessive, based on management's
evaluation. When a loan or a part thereof is considered by management
to be uncollectible, a charge is made against the allowance. Recoveries
of loans previously charged off are credited back to the allowance.
<TABLE>
The changes in the allowance for loan losses for the three and nine
months ended September 30, 1997 and 1996 were as follows (in thousands):
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------ -----------
1997 1996 1997 1996
----- ----- ----- -----
<S> <C> <C> <C> <C>
Balance at beginning of period $9,538 $9,456 $9,407 $8,477
Allowance of acquired bank - - - 1,179
Provision for loan losses 150 100 450 300
Loan charge-offs (3) (95) (379) (584)
Loan recoveries 76 68 283 157
----- ----- ----- -----
Balance at end of period $9,761 $9,529 $9,761 $9,529
====== ===== ===== =====
Net charge-offs to average loans (04)% .02% .02% .09%
Allowance for loan losses to loans 1.40% 1.51% 1.40% 1.51%
Allowance for loan losses to
nonperforming loans 362% 241% 362% 241%
</TABLE>
Higher provisions for loan losses were recorded for the three and
nine month periods of 1997 primarily due to the growth in the Company's
loan portfolio. The provisions were also influenced by the improvement
in asset quality since year-end 1996. For further information on the
Company's nonperforming loans and impaired loans, see the "Asset Quality"
section below.
<TABLE>
The following table sets forth an allocation of the allowance for
loan losses and the percent of loans in each category to total loans
outstanding for the periods and categories shown (in thousands):
<CAPTION>
September 30, 1997 December 31,1996
----------- -----------
Amount % Amount %
------- --- ------- ---
<S> <C> <C> <C> <C>
Commercial and industrial $2,311 24 $2,157 23
Commercial real estate 4,050 21 4,200 23
Construction - 2 - 2
Residential real estate 2,500 38 2,250 37
Home equity and other consumer 900 15 800 15
------------ ------------
Total $9,761 100 $9,407 100
============= ============
</TABLE>
Changes in the allocation of the allowance to individual loan
categories since December 31, 1996 were primarily the result of loan
portfolio growth and changes in management's risk assessment and
assignment of unallocated reserves. Notwithstanding management's
allocation of the allowance, the entire allowance for loan losses is
available to absorb losses in any particular category of loans.
ASSET QUALITY
NONPERFORMING ASSETS
<TABLE>
The following table sets forth the Company's nonperforming assets
and asset quality ratios (in thousands):
<CAPTION>
September 30, December 31,
1997 1996
-------- --------
<S> <C> <C>
Nonaccrual loans $1,671 $3,421
Loans past due 90 days or more 1,026 783
-------- --------
Total nonperforming loans 2,697 4,204
Other real estate owned 599 618
-------- --------
Total nonperforming assets $3,296 $4,822
======== ========
Restructured loans $140 -
======== ========
Nonperforming loans to loans 0.39% 0.66%
Nonperforming assets to loans plus 0.47% 0.75%
</TABLE>
IMPAIRED LOANS
<TABLE>
The following table sets forth the recorded investment in impaired
loans and the related valuation allowance for each loan category (in
thousands):
<CAPTION>
Amount of Impaired Loans
------------------------
No Valuation Valuation Amount of
Allowance Allowance Valuation
Required Required Total Allowance
-------- -------- ------ ------
<S> <C> <C> <C> <C>
September 30, 1997
Commercial and industrial $220 $310 $530 $104
Commercial real estate 1,018 616 1,634 77
Residential real estate 459 608 1,067 74
-------- -------- ------ ------
Total impaired loans $1,697 $1,534 $3,231 $255
======== ======== ====== ======
December 31, 1996
Commercial and industrial $137 $646 $783 $275
Commercial real estate 816 955 1,771 200
Residential real estate 812 240 1,052 66
-------- -------- ------ ------
Total impaired loans $1,765 $1,841 $3,606 $541
======== ======== ====== ======
</TABLE>
The average recorded investment in impaired loans for the nine
months ended September 30, 1997 was approximately $2,986,000. Interest
income recognized on impaired loans for the first nine months of 1997
totaled $89,000 compared to $223,000 in the same period a year ago.
Included in the balance of impaired loans at September 30, 1997, were
$442,000 of loans 90 days or more past due and $1,186,000 of nonaccrual
loans.
OTHER INCOME
Other income, excluding securities transactions, for the three
months ended September 30, 1997 increased $279,000 or 14% compared to
the same period in 1996. On a year-to-date basis, other income, excluding
securities transactions, increased $1,108,000 or 20% compared to the
nine month period in 1996.
Year-to-date, service charges on deposits increased $565,000 or 17%
in 1997 compared to the same period in 1996. The increase was
principally due to changes in overdraft service charge methods. Other
operating income increased $439,000 or 51% in the first nine months of
1997 primarily due to ATM surcharge fees which were established in
December, 1996.
In the 1997 third quarter, the Company recognized net securities
gains of $50,000 compared to gains of $76,000 in the third quarter in
1996. For the nine months ended September 30, 1997, net securities
gains of $150,000 were recognized compared to net securities gains of
$88,000 in the same period of 1996. In 1997, the Company recognized net
gains of $62,000 on the sale of $58 million of fixed-rate and
adjustable-rate securities. The proceeds of these sales were primarily
reinvested in longer-term, fixed rate mortgage-backed securities and
tax-exempt securities. The balance of net securities gains recognized in
1997 reflected a market value adjustment of an investment security
classified as trading.
OTHER EXPENSE
Other expense in the 1997 third quarter increased $100,000 or 1%
compared to the same period in 1996. For the nine months ended
September 30, 1997, other expense increased $690,000 or 3% compared to
the same period a year ago. The year-to-date growth in other expense was
primarily attributable to increases in salaries and benefits and other
operating expenses.
Salaries and employee benefits, the largest component of other
expense, increased $243,000 or 2% for the first nine months of 1997
compared to the same period a year ago. The increase primarily
reflected normal salary increases and higher incentive compensation
expense. A reduction in staffing levels from the year ago period
partially limited the growth in salaries and employee benefits. At
September 30, 1997, the number of full-time equivalent employees totaled
440 compared to 451 at September 30, 1996.
Other operating expenses increased $440,000 or 11% in 1997 compared
with the 1996 nine month period. The increase primarily resulted from
increases in FDIC insurance premiums, ATM processing costs, postage
expense, professional fees and advertising and promotional costs.
Partially offsetting the increase in other operating expenses was the
reimbursement of $150,000 of legal costs related to litigation settled
in 1996.
The Company utilizes and is dependent upon data processing systems
and software to conduct its business. The data processing systems and
software include those developed and maintained by the Company's
third-party data processing vendor and purchased PC software which is run on
in-house computer networks. In 1997, the Company initiated a review and
assessment of all hardware and PC software to confirm that it will function
properly in the year 2000. To date, those vendors which have been
contacted and have responded indicate that their hardware or software is
or will be Year 2000 compliant by the end of 1998. The Company's
third-party data processor, however, has indicated that the Company will
have to convert to new software applications in 1998 to be Year 2000
compliant. In light of this, the Company is currently reviewing other
data processing vendor systems and applications and may elect to convert
to a new processor if deemed appropriate. The Company is in the
preliminary stages of evaluating its data processing options and expects
to make a decision sometime prior to the end of the 1998 first quarter.
Although final cost estimates have yet to be determined, it is
anticipated that data processing expenses will increase in 1998 due to
one-time conversion costs. These expenses are not expected to have a
material impact on the Company's results of operations.
INCOME TAXES
Income tax expense for the nine months ended September 30, 1997
increased $943,000 compared to the same period in 1996. The Company's
effective tax rate (income tax expense divided by net income before
taxes) increased slightly to 31.6% in 1997 compared to 31.5% in the same
period a year ago. The increase in income tax expense in 1997 was
primarily due to an increase in pre-tax earnings.
Subsequent to September 30, 1997, the Company received a refund of
state income taxes as a result of an amendment to a prior year income
tax return. As a result of the refund, the Company has amended other
state income tax returns and has paid taxes due with such returns. In
the 1997 fourth quarter, the Company will recognize a $379,000 after tax
benefit reflecting the net tax refund and interest earned thereon.
ANALYSIS OF BALANCE SHEETS
ASSETS
Total assets at September 30, 1997 were $1.285 billion, an increase
of $56 million compared to December 31, 1996. Changes in total assets
since December 31, 1996 primarily reflected increases of $58 million in
net loans and $6 million in securities. During 1997, the Company
continued to experience increased loan demand in most loan categories as
market interest rates remained generally stable. For the nine month
period, residential real estate loans increased $30 million, commercial
and industrial loans increased $23 million and home equity loans
increased $10 million.
LIABILITIES
The Company's funding sources, consisting of deposits and short-term
borrowings, increased $52 million since December 31, 1996. Changes in
funding sources since year-end primarily reflect increases of $41 million
in NOW and money market accounts, $40 million in time deposits and $12
million in securities sold under agreements to repurchase. Partially
offsetting the growth in those categories were decreases of $16 million
in demand deposits, $12 million in savings deposits and $13 million in
federal funds purchased. The growth in NOW and money market accounts
was primarily due to the promotion of the Company's Premier Money Market
Account in the 1997 second quarter. The increase in time deposits
primarily resulted from a combination of time deposit promotions and
generally higher interest rates offered on time deposits compared to
other interest-bearing deposit products.
CAPITAL
At September 30, 1997, total shareholders' equity increased to $116
million, up $10 million from December 31, 1996. The growth in equity
reflected the retention of current year earnings, less dividends paid
and the cost of treasury stock purchased, plus the proceeds from the
exercise of stock options. The change in equity also reflected a
$2,438,000 increase in the market value of securities available-for-sale.
The capital ratios of the Company and Heritage Bank (the "Bank") are
presently in excess of the requirements necessary to meet the "well
capitalized" capital category established by banking regulators. The
capital ratios of the Company and the Bank at September 30, 1997 and the
minimum capital ratios for "well capitalized" financial institutions are
as follows:
<TABLE>
<CAPTION>
Minimum
Well
Capitalized Company Heritage
Ratio Consolidated Bank
<S> <C> <C> <C>
Tier I capital to average assets > 5.00% 7.56% 7.15%
-
Tier I capital to risk weighted assets > 6.00% 13.20% 12.89%
-
Total capital to risk weighted assets > 10.00% 14.45% 14.15%
-
</TABLE>
On May 14, 1997, the Board of Directors of Heritage Financial
Services, Inc. declared a three-for-two stock split, payable June 13,
1997, to shareholders of record at the close of business on May 27,
1997. The Board of Directors also voted to eliminate the par value of
common shares. As a result of the stock split, shareholders of record
as of May 27, 1997, received one additional common share for every two
shares owned. Shareholders entitled to fractional shares received cash
in lieu of fractional shares. Per share information included in the
financial statements has been adjusted to reflect the split.
In June, 1996, the Company's Board of Directors approved a stock
repurchase program which authorized the repurchase of up to 325,000
common shares to be used for the issuance of shares under the Company's
stock option plan. In May, 1997, the Board of Directors authorized the
repurchase of an additional 68,850 shares as a result of the Company's
1997 three-for-two stock split. The shares were authorized to be
repurchased from time to time in the open market or in private
transactions. During the nine month period ended September 30, 1997, on
a split adjusted basis, 200,001 common shares were repurchased at a cost
of $3,335,031 and 213,452 treasury shares were reissued upon the
exercise of stock options. At September 30, 1997, the Company had
156,549 common shares remaining to be repurchased under the stock
repurchase program.
Presently the Company has no other commitments for material capital
expenditures. Management believes that the Company has sufficient
financing options available to fund commitments that may arise in the
future.
LIQUIDITY
Liquidity management in banking involves the ability to generate
funds to support asset growth and meet cash flow requirements of
customers and other obligations. The Bank's immediate liquidity needs
have historically been met by daily investments in federal funds sold,
monthly cash flows from mortgage-backed and asset-backed securities and
maturities of other securities. In 1997, the Bank's average amount of
federal funds sold was $5 million. At quarter-end however, the Bank
neither sold nor purchased federal funds. When necessary, the Bank may
purchase up to $55 million under informal federal funds lines with
correspondent banks. For the three and twelve months ended September
30, 1997, the aggregate principal payments received on mortgage-backed
and asset-backed securities totaled approximately $12 million and $59
million, respectively. At September 30, 1997, the Bank had $17 million
of securities having contractual maturities of one year or less and
expects to receive approximately $54 million of payments on
mortgage-backed and asset-backed securities over the next twelve months.
The cash flow projections for mortgage-backed and asset-backed securities
are based on consensus prepayment estimates of securities brokers.
Other sources of potential liquidity include the sale of securities
classified as available-for-sale and advances under a $143 million credit
facility with the Federal Home Loan Bank.
For the parent company, Heritage Financial Services, Inc.("HFS"),
liquidity means having cash available to pay shareholder dividends, to
service debt and to fund operating expenses. The ability of HFS to pay
dividends, as well as fund its operations and service debt, is dependent
upon receipt of dividends from the Bank. Regulatory authorities
limit the amount of dividends which can be paid by the Bank without
prior approval from such authorities. At September 30, 1997, the amount
of undistributed earnings of the Bank available for the payment of
dividends within such limitations is sufficient to fund the anticipated
cash requirements of HFS.
PART II-OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 4 - Specimen Common Share Certificate (incorporated by
reference to the Registrants Quarterly Report on Form 10-Q for the period
ended June 30, 1997).
(b) Exhibit 11 - Statement Re Computation of Per Share Earnings
(included at page 17).
(c) Exhibit 27 - Financial Data Schedule.
(d) There were no reports on Form 8-K filed by the registrant during
the quarter ending September 30, 1997.
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.
HERITAGE FINANCIAL SERVICES, INC.
(Registrant)
Date: November 14, 1997 by /s/ Frederick J. Sampias
Frederick J. Sampias
President
(Duly Authorized Officer)
Date: November 14, 1997 by /s/ Paul A. Eckroth
Paul A. Eckroth
Executive Vice President and Treasurer
(Principal Financial and Chief Accounting
Officer)
Exhibit 11 - Statement Re: Computation of Per Share Earnings
<TABLE>
Presented below is the calculation of the Registrant's primary and
fully diluted earnings per share required by Item 601(b)(11) of
Regulation S-K (dollars in thousands, except per share data):
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
------- ------ ------- -------
<S> <C> <C> <C> <C>
Primary
Net income $4,498 $3,857 $13,081 $11,103
====== ====== ======= =======
Average common shares
outstanding 12,032 11,880 12,066 11,920
Common stock equivalents - net effect of the
assumed exercise of stock options -- based
on the treasury stock method using average
market price 413 602 398 581
------ ------ ------ ------
Average primary shares
outstanding 12,445 12,482 12,464 12,501
====== ====== ====== ======
Primary earnings per share $0.36 $0.31 $1.05 $0.89
====== ===== ====== ======
Fully Diluted
Net income $4,498 $3,857 $13,081 $11,103
====== ====== ======= =======
Average common shares
outstanding 12,032 11,880 12,066 11,920
Common stock equivalents - net effect of the
assumed exercise of stock options -- based
on the treasury stock method using average
market price or year-end market price,
whichever was higher 416 602 426 603
------ ------ ------ ------
Average fully diluted shares
outstanding 12,448 12,482 12,492 12,523
====== ====== ====== ======
Fully diluted earnings
per share $0.36 $0.31 $1.05 $0.89
====== ====== ====== ======
Share data has been adjusted for a three-for-two stock split paid in
June, 1997.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 36524
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 350
<INVESTMENTS-HELD-FOR-SALE> 395613
<INVESTMENTS-CARRYING> 118654
<INVESTMENTS-MARKET> 121450
<LOANS> 697395
<ALLOWANCE> 9761
<TOTAL-ASSETS> 1284703
<DEPOSITS> 1106455
<SHORT-TERM> 52641
<LIABILITIES-OTHER> 9579
<LONG-TERM> 0
0
0
<COMMON> 0
<OTHER-SE> 116028
<TOTAL-LIABILITIES-AND-EQUITY> 1284703
<INTEREST-LOAN> 14721
<INTEREST-INVEST> 8228
<INTEREST-OTHER> 127
<INTEREST-TOTAL> 23076
<INTEREST-DEPOSIT> 10429
<INTEREST-EXPENSE> 10917
<INTEREST-INCOME-NET> 12159
<LOAN-LOSSES> 150
<SECURITIES-GAINS> 50
<EXPENSE-OTHER> 7799
<INCOME-PRETAX> 6552
<INCOME-PRE-EXTRAORDINARY> 6552
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4498
<EPS-PRIMARY> .36
<EPS-DILUTED> .36
<YIELD-ACTUAL> 4.41
<LOANS-NON> 1671
<LOANS-PAST> 1026
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 9538
<CHARGE-OFFS> 3
<RECOVERIES> 76
<ALLOWANCE-CLOSE> 9761
<ALLOWANCE-DOMESTIC> 9761
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>