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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NUMBER 0-15059
HERITAGE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
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ILLINOIS 36-3139645
(State or other jurisdiction of (I.R.S. employer identification No.)
incorporation or organization)
17500 SOUTH OAK PARK AVENUE 60477
TINLEY PARK, ILLINOIS (Zip code)
(Address of principal executive offices)
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(708) 532-8000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON SHARES, $.625 PAR VALUE PER SHARE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of 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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of February 14, 1997, 8,078,921 common shares, $.625 par value, were
outstanding, and the aggregate market value of common shares (based on the last
sale price of the registrant's common shares on February 14, 1997) held by
non-affiliates was approximately $148,800,000. See "Item 5. Market for
Registrant's Common Shares and Related Shareholder Matters".
DOCUMENTS INCORPORATED BY REFERENCE
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DOCUMENT INTO FORM 10-K PART:
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Portions of the Proxy Statement for 1997 Annual
Meeting of Shareholders to be held on April 22, 1997 III
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HERITAGE FINANCIAL SERVICES, INC.
FORM 10-K TABLE OF CONTENTS
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PART I
Item 1 Business.................................................... 3
Item 2 Properties.................................................. 10
Item 3 Legal Proceedings........................................... 11
Item 4 Submission of Matters to a Vote of Security Holders......... 11
PART II
Item 5 Market for Registrant's Common Shares and Related
Shareholder Matters......................................... 13
Item 6 Selected Financial Data..................................... 14
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 8 Financial Statements and Supplementary Data................. 34
Item 9 Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 58
PART
III
Item 10 Directors and Executive Officers of the Registrant.......... 58
Item 11 Executive Compensation...................................... 58
Item 12 Security Ownership of Certain Beneficial Owners and
Management.................................................. 58
Item 13 Certain Relationships and Related Transactions.............. 58
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 58
SIGNATURES............................................................... 59
Exhibit Index............................................... 60
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PART I
ITEM 1. BUSINESS
REGISTRANT
The registrant, Heritage Financial Services, Inc., is an Illinois
corporation which was incorporated on July 2, 1984, and a multi-bank holding
company which is subject to the federal Bank Holding Company Act of 1956, as
amended. On July 2, 1984, its predecessor by merger, County Bankshares, Inc., a
Delaware corporation incorporated September 8, 1981, was merged into the
registrant in order to reincorporate in Illinois. The stockholders of the
predecessor thereby automatically became the shareholders of the registrant.
Unless the context otherwise requires, as used hereafter the "Company" refers to
Heritage Financial Services, Inc., its predecessor, County Bankshares, Inc. and
its subsidiaries.
The Company was organized for the purpose of becoming a multi-bank holding
company by acquiring and operating Illinois commercial banks. The Company's
current subsidiaries are Heritage Bank, First National Bank of Lockport and
Heritage Trust Company which operate from fifteen banking offices located in
southwest suburban Chicago. See "Subsidiaries" below.
The Company derives substantially all its income from its principal
subsidiary, Heritage Bank. The Company's primary source of cash is dividends
from Heritage Bank. The amount of dividends paid by Heritage Bank is determined
in relation to its earnings and capital position and the cash requirements of
the Company. Also see "Supervision and Regulation -- Dividends" below.
Financial information relating to the Company only is set forth in "Note 14
- -- Condensed Financial Statements -- Parent Company" of the Notes to
Consolidated Financial Statements included under Item 8 of this document.
SUBSIDIARIES
Prior to October, 1991, the Company owned and operated four bank
subsidiaries: Heritage Bank and Trust Company, Blue Island, Illinois, Heritage
Bank of Oak Lawn, Oak Lawn, Illinois, Heritage Bank Crestwood, Crestwood,
Illinois and Heritage Bank Tinley Park, Tinley Park, Illinois. In October, 1991,
the four bank subsidiaries were merged into one bank, now known as Heritage Bank
("Heritage Bank" or the "Bank").
On January 10, 1992, the Company acquired all of the issued and outstanding
common stock of 1st Heritage Bank, Country Club Hills, Illinois, for $6.9
million in cash. In October, 1992, 1st Heritage Bank was merged into the Bank
and is operated as a branch. On December 11, 1992, the Bank purchased the
banking facility and assumed approximately $6 million of deposit liabilities of
First Chicago Bank for Savings, Frankfort, Illinois. The Frankfort banking
office is also operated as a branch. On December 18, 1992, the Company acquired
all of the issued and outstanding common stock of Alsip Bank and Trust, Alsip,
Illinois, for approximately $8 million in cash. In April, 1993, Alsip Bank and
Trust was merged into the Bank and is operated as a branch.
On July 8, 1994, the Company acquired all of the issued and outstanding
common stock of Midlothian State Bank, Midlothian, Illinois, for $16.5 million
in cash. Midlothian State Bank was merged into the Bank in October, 1994, and
its banking facilities are operated as branches of the Bank.
On February 2, 1996, the Company acquired all of the issued and outstanding
common stock of the First National Bank of Lockport ("Lockport"), Lockport,
Illinois, for $16.8 million in cash. At the date of acquisition the bank had
total assets of $102 million. In April, 1996, the banking assets and liabilities
of Lockport were transferred to Heritage Bank under a purchase and assumption
transaction, and its banking office is operated as a branch. Lockport continues
to operate as a national bank conducting a trust business. In 1996 Lockport was
authorized by bank and insurance regulators to act as an insurance agent or
broker. Beginning in 1997 Lockport will begin to offer insurance products
through its Heritage Insurance Services division.
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The Company also owns and operates Heritage Trust Company, an Illinois
trust company, located in Tinley Park, Illinois.
DESCRIPTION OF BUSINESS
General
The Company conducts a full service banking business through the Bank,
Lockport and Heritage Trust Company. The Bank offers a complete range of
financial products and services to individuals, businesses and municipal
customers. These products and services include checking, savings, NOW and money
market accounts and certificates of deposit; commercial, real estate and
consumer loans; mutual funds, annuities and discount brokerage; corporate cash
management services, debit cards, safe deposit and night depository facilities;
and other services tailored to customer needs. Automated teller machines
("ATMs"), which provide 24-hour banking services to customers, are installed at
all branches and four off site locations. The Bank is a member of the "Cash
Station" and "CIRRUS/National" systems of ATMs which operate a substantial
number of ATMs in the Chicago metropolitan area.
The Bank also offers electronic banking services to commercial and retail
customers. The Bank's Business Express software allows commercial and municipal
customers to access accounts and initiate a number of transactions via on-line
personal computers. Heritage's Phone Banker is an automated telephone system
which provides customers access to account balance and transaction information
and interest rates on most retail loan and deposit products. In 1996, an
automated loan application feature was added to the Phone Banker system which
allows customers to apply for a number of retail loan products.
Heritage Trust Company offers a number of fiduciary, custodial and
investment management services to individuals, corporations and municipalities
at all of the Bank's locations. It also administers (as trustee and in other
fiduciary and representative capacities) pension, profit sharing, 401K and other
employee benefit plans, and personal trusts and estates. Lockport offers and
services personal trust accounts.
Lending
The Bank concentrates its lending activities in the following areas:
commercial and industrial and commercial real estate loans, residential real
estate loans and home equity loans and lines of credit. It maintains
comprehensive underwriting and credit policies which cover all aspects of
commercial and retail lending. The Bank conducts substantially all of its
lending activities in the southwest suburbs of Chicago and, to a lesser extent
the Chicago metropolitan area.
For over 25 years, the Bank's primary organizational emphasis has been
commercial lending. At December 31, 1996, approximately 48% of the Bank's loan
portfolio was comprised of commercial and industrial loans, commercial real
estate loans and construction loans. Commercial loans are provided on either a
secured or unsecured basis to corporations, partnerships and individuals for
working capital, business acquisitions, equipment purchases, plant expansion and
commercial/industrial real estate financing. The Bank's lending limit to a
single borrower exceeds $10 million, sufficient to satisfy the credit needs of
most of the businesses located in its market area.
A majority of the commercial portfolio represents loans to small to
mid-size companies in businesses such as light manufacturing, wholesale,
distribution and other service industries. The Company believes the commercial
loan portfolio is well diversified by industry. The Bank has no energy or
agricultural loans, loans to foreign countries or loans which would be
classified as highly leveraged transactions.
In recent years the Bank has expanded its marketing and origination
activities for consumer loans to supplement the growth of the loan portfolio,
attract new retail customers and increase the number of relationships with
existing customers. At December 31, 1996, residential real estate loans and home
equity loans comprised 50% of the loan portfolio. Residential real estate loans
represent single-family, first mortgages secured by properties primarily located
in southwest suburban Chicago. Home equity loans represent second mortgages
secured by residential real estate properties located in Cook County and the
adjacent collar
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counties. In addition to originating residential loans for its portfolio, the
Bank originates home loans for sale to secondary market investors.
Market Information and Community Banking
The Company's primary market area is southwest suburban Cook County, and to
a lesser extent adjacent Will County, Illinois. For many years there has been
significant economic and population growth in the outlying areas of southwest
Cook County and in parts of Will County. The market for banking and financial
services may be characterized as competitive due to the number of financial
institutions located in the area.
The Company's banking offices are located in rapidly growing residential
areas as well as in stable neighborhoods of established suburbs. The general
profile of retail banking customers consists of blue and white collar workers
with excellent savings habits. A combination of retail, commercial and municipal
customers provide the Company with stable sources of core deposits to fund its
loans and investments.
The market area has a diverse economic base including manufacturing
businesses, service industries, wholesalers and distributors. This diversity has
contributed to the stability and success of the Company's lending business when
compared to other areas of the country which, from time to time, have
experienced economic declines. Real estate property values in the Chicago
metropolitan area have generally been stable over the past five years.
The Company attributes its success in part to its community banking
philosophy. This philosophy is based on the perception of the ongoing need for
conveniently located financial institutions that offer a full range of products
and services at competitive prices. The community banking approach also embodies
a high level of personalized quality service and a commitment to local
communities. Community banking, combined with commercial and retail lending
expertise, has allowed the Company to grow within the southwest metropolitan
Chicago area and has contributed to the Company's overall profitability.
Neither the Company nor any of its subsidiaries is dependent for a material
part of its business upon a single customer, or very few customers, the loss of
any one of which would have a materially adverse effect on the Company. The
Bank's customers are not concentrated in any one industry, and many of them do
business on a national basis, reducing the lending risk associated with
downturns in particular industries or geographic areas.
Acquisitions and Expansion
In 1981, a strategic decision was made to form a holding company and expand
operations through acquisitions. Since then, the Company has purchased Crestwood
Bank in 1983, Heritage Bank of Oak Lawn in 1984, Bremen Bank and Trust in 1986,
1st Heritage Bank and Alsip Bank and Trust in 1992, Midlothian State Bank in
1994 and the First National Bank of Lockport in 1996. With the acquisition of
these banks, the Company expanded its network for gathering stable deposits and
reinforced its presence in the southwest metropolitan Chicago market. The
Company intends to continue to seek acquisitions in its existing or adjoining
market areas, to the extent suitable candidates may be identified. However,
there is no assurance that any further acquisitions will be made.
As an additional means of entering new markets or increasing market share,
the Company has also grown through the development or acquisition of
strategically positioned branches. In 1989, two branch offices were opened in
Cook County and one branch was opened in adjacent Will County. In 1992, Heritage
Bank purchased the branch facility and deposits of First Chicago Bank for
Savings, located in Will County. In 1995 a branch office was opened in Monee,
located in Will County. In 1997 the Company plans to open at least two branch
offices in adjacent markets. Management believes that branch expansion has and
will continue to strengthen its current market position and will enhance the
future growth of loans and retail core deposits.
Competition
The Company encounters significant competition in all of its activities. It
competes for commercial and individual deposits, loans and trust business with
local and regional banks, savings and loan associations,
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savings banks and other financial institutions, including mortgage banking
companies, finance companies and credit unions. The Company faces additional
competition in attracting deposits from money market funds, mutual funds and
other investment funds. In addition, a number of large national companies,
including manufacturers, insurance companies and brokerage firms have expanded
in the area of financial services, have substantially greater financial
resources than the Company and compete with the Company for loans and deposits.
To compete in the banking and financial services industry, the Company is
committed to delivering high quality financial products in a professional manner
at a competitive price. The Company believes that competition for its products
and services is based principally on location, convenience, service and price.
The price factors primarily relate to interest rates and fees charged on loans,
interest rates paid on deposits and service charges on deposits. While the
pricing of products and services is an important element in competing for
customers, the Company also believes that the delivery of quality service as
well as convenience will continue to be at least as important in retaining and
expanding its customer base. See "Description of Business -- Market Information
and Community Banking" above.
SUPERVISION AND REGULATION
General
Bank holding companies and banks are extensively regulated under federal
and state laws and regulations. As a result, the business, financial condition
and prospects of the Company and its subsidiaries can be affected not only by
management decisions and general economic conditions, but also by applicable
statutes and regulations and other regulatory pronouncements and policies
adopted by regulatory agencies with authority over the Company and its
subsidiaries. The effect of such statutes, regulations and other pronouncements
and policies can be significant, cannot be predicted and can change over time.
The federal and state laws and regulations generally applicable to
financial institutions regulate, among other things, the scope of business,
investments, reserves against deposits, capital levels relative to operations,
lending activities and practices, the nature and amount of and collateral for
loans, the establishment of branches and mergers and acquisitions. Finally, the
system of supervision and regulation applicable to the Company and its
subsidiaries is intended to protect the deposit insurance systems, the Bank's
depositors, and the public, rather than the Company's shareholders.
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
registered as such with the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board"). Under the Bank Holding Company Act, and the
regulations promulgated thereunder, the Company is required to file annual and
quarterly reports of its operations and such additional information as the
Federal Reserve Board may require. It is also subject to examination by the
Federal Reserve Board which has jurisdiction to regulate the terms of certain
debt issues of the Company and the authority to impose capital and reserve
requirements.
The Bank is a state bank chartered under the Illinois Banking Act. It is
subject to regulation and examination by the Illinois Office of Banks and Real
Estate and by the Federal Deposit Insurance Corporation ("FDIC") under the
provisions of the Federal Deposit Insurance Act. Lockport is a national bank
that is subject to regulation and examination by the Office of the Comptroller
of the Currency ("OCC") and the FDIC. Heritage Trust Company is an Illinois
chartered trust company subject to regulation and examination by the Illinois
Office of Banks and Real Estate.
The Bank and Lockport are also subject to certain restrictions under the
Federal Reserve Act and the Federal Deposit Insurance Act on loans and
extensions of credit to the Company or its subsidiaries, investments in the
stock or other securities of the Company or its other subsidiaries, or advances
to any borrower collateralized by such stock or other securities.
References under this "Supervision and Regulation" heading to applicable
statutes or regulations are brief summaries of portions thereof which do not
purport to be complete and which are qualified in their entirety by reference to
those statutes and regulations.
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Recent Legislation
In recent years Congress has enacted significant legislation which has
changed the statutory requirements affecting bank holding companies and banks
and broadened the regulatory powers of the federal regulatory agencies. To a
great extent, these changes have resulted from the enactment of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FIRREA, among other things, significantly increased the enforcement powers
of federal regulatory agencies, substantially changed the federal deposit
insurance system and provided that all commonly controlled FDIC insured
depository institutions may be held liable for any loss incurred by the FDIC
resulting from a failure of, or any assistance given by the FDIC to, any of such
commonly controlled institutions.
FDICIA revised sections of the Federal Deposit Insurance Act affecting bank
regulation, deposit insurance and provisions for funding the Bank Insurance Fund
("BIF"). FDICIA also contained, among other things, several supervisory reforms,
including required annual regulatory examinations of depository institutions,
annual independent audits and related management reports on internal controls;
the adoption of safety and soundness standards on matters such as loan
underwriting and documentation, and compensation and other employee benefits;
the establishment of a risk-based deposit insurance system; and mandated
consumer protection disclosures with respect to deposit accounts.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996
("Economic Growth Act") which was signed into law on September 30, 1996 provides
for the recapitalization of the Savings Association Insurance Fund ("SAIF").
Among other things, this legislation also provides for expedited application
procedures for nonbanking activities by well capitalized and well managed bank
holding companies, contains reforms to the Fair Credit Reporting Act, and
provides other forms of regulatory relief to the financial services industry.
See "Supervision and Regulation -- Deposit Insurance" below.
Deposit Insurance
As an FDIC-insured institution, the Bank is required to pay deposit
insurance premiums to the FDIC. Pursuant to FDICIA, the FDIC adopted a
risk-based insurance premium system effective January 1, 1994. Under the
risk-based system, each insured depository institution is placed into one of
nine risk categories and assessed insurance premiums based on its level of
capital and supervisory evaluation. Financial institutions classified as
"well-capitalized" (as defined) pay the lowest premium, while institutions that
are less than adequately capitalized pay the highest premium. On a semi-annual
basis, the FDIC assigns a risk classification and assessment rate for all
institutions.
FDICIA required the FDIC to establish assessment rates at levels which
would restore the BIF to a mandated reserve ratio of 1.25% of insured deposits.
In 1995 the FDIC determined that the BIF had reached the required ratio.
Effective June 1, 1995, the FDIC reduced the premium assessment range, and the
Bank's assessment rate was lowered from .23% of deposits to .04% of deposits. In
1996 the FDIC reduced the Bank's assessment rate for both semi-annual periods
from .04% of deposits to zero. As of December 31, 1996, the FDIC continued to
categorize the Bank as a "well capitalized" institution and assigned a zero
assessment rate for the semi-annual period ending June 30, 1997. There are no
assurances, however, that future assessment rates will remain at that level. See
"Supervision and Regulation -- Capital Adequacy " below.
The Economic Growth Act, among other things, authorized the FDIC to
recapitalize the SAIF by imposing a special assessment on institutions holding
SAIF deposits. Under the Act, members of the BIF and SAIF will be jointly
responsible for servicing a portion of interest on Financing Corporation
("FICO") bonds that were issued by the government to pay for the thrift cleanup
in the late 1980's. Beginning January 1, 1997, the Company will begin paying
FICO assessments at the rate of .013% of BIF deposits.
Capital Adequacy
Under the regulatory framework of the Federal Deposit Insurance Act, as
amended by FDICIA, the Federal Reserve and the FDIC adopted risk-based capital
guidelines and ratio requirements for bank holding
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companies and banks. The risk-based capital guidelines are intended to provide a
fair and consistent framework for comparing capital positions of all banking
institutions. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, financial institutions must meet specific capital
guidelines that involve quantitative measures of the bank's assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting
practices. A bank's capital amounts and classification are also subject to
qualitative judgments by regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier I capital (as defined in the regulations) to risk-weighted assets (as
defined), and Tier I capital (as defined) to average assets (as defined). If the
capital of a bank holding company falls below minimum guidelines, it may, among
other things, be denied the approval to acquire or establish additional banks or
non-bank businesses. The failure of a bank to meet minimum capital requirements
can initiate certain mandatory-and possibly discretionary-actions by regulators
that, if undertaken, could have a direct material effect on a bank's financial
statements.
At December 31, 1996, the capital ratios of the Company and the Bank
exceeded the thresholds required to meet the "well capitalized" capital
category. For additional information on the capital requirements and ratios of
the Company and the Bank, see "Note 15 -- Regulatory Restrictions and Capital
Adequacy" of the Notes to Consolidated Financial Statements included under Item
8 of this document.
Under FDICIA, banking agencies were required to revise their capital
standards to take into account interest rate risk exposure. In August, 1995, the
agencies issued a proposed policy statement that established a proposed
supervisory framework to measure and monitor the level of interest rate risk at
individual banks. The framework would facilitate the agencies' assessment of a
bank's risk exposure and capital adequacy. The regulators anticipated that the
proposed framework would provide a basis for issuance of a rule establishing an
explicit minimum capital requirement for interest rate risk.
In July, 1996, the agencies issued a new policy statement providing
financial institutions with guidance on interest rate risk principles and
management practices. Such principles and practices effectively established
standards which will be used by the agencies in evaluating a bank's interest
rate risk management and exposure and the adequacy of its capital in light of
its interest rate risk profile. Under the policy statement, the agencies also
elected not to pursue a standardized measure and explicit capital charge. At
this time, the Company cannot predict what impact the new supervisory approach
will have on its future capital requirements. While the Company believes that
its interest rate risk management process is adequate and its interest rate risk
exposure is not significant, the results of the FDIC's evaluation could be
different and may be a basis for requiring the Bank to maintain additional
capital. For additional information on the Company's interest rate risk and
management practices, see "Interest Rate Risk" in Management's Discussion and
Analysis of Financial Condition and Results of Operations included under Item 7
of this document.
Dividends
The Company has paid a cash dividend every quarter since it became a bank
holding company in 1982. The Company's shareholders are entitled to receive such
dividends as are declared by the Board of Directors, which considers payment of
dividends quarterly. The dividend policy of the Company is designed to balance
the shareholder interest in current return with the need to retain adequate
capital to support future asset growth. While the Company anticipates paying
quarterly cash dividends in the future, the timing and amount of dividends will
depend upon the earnings, capital requirements and financial condition of the
Company as well as general economic conditions and other relevant factors
affecting the Company. The ability of the Company to pay dividends is dependent
upon its 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 regulatory authorities. At December 31, 1996, the amount of undistributed
earnings of the Bank available for payment of dividends within such limitations
is more than adequate to fund dividends paid by the Company. For further
information on the Bank's capital and dividend restrictions, see "Note 15 --
Regulatory Restrictions and Capital Adequacy" of the Notes to Consolidated
Financial Statements included under Item 8 of this document.
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Acquisitions and Expansion
The Bank Holding Company Act requires the Company to obtain the prior
approval of the Federal Reserve Board before merging with or consolidating into
another bank holding company, acquiring substantially all the assets of any bank
or bank holding company or acquiring direct or indirect ownership or control of
more than 5% of the voting shares of any bank or bank holding company. In its
approval process, the Federal Reserve Board is required to weigh the expected
benefit to the public, such as greater convenience and increased competition,
against the risks of possible adverse effects, such as undue concentration of
resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board also gives consideration to the
Bank's compliance with the Community Reinvestment Act, including the rating
assigned by the FDIC. The Community Reinvestment Act obligates each financial
institution to address the credit needs of its entire community, including low-
and moderate-income areas. See "Supervision and Regulation -- Community
Reinvestment" below.
The Bank Holding Company Act also prohibits the Company, with certain
exceptions, from acquiring direct or indirect ownership or control of more than
5% of the voting shares of any company which is not a bank and from engaging in
any business other than that of banking, managing and controlling banks or
furnishing services to banks and their subsidiaries. The Company, however, may
engage in, and may own shares of companies engaged in, certain businesses
determined by the Federal Reserve Board to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. The Bank
Holding Company Act does not place territorial restrictions on the activities of
non-bank subsidiaries of bank holding companies.
The enactment of FIRREA in 1989 amended the Bank Holding Company Act by
permitting bank holding companies to acquire and operate savings and loan
associations or purchase branch deposits of a thrift (subject to certain
limitations). In 1989, the Illinois Bank Holding Company Act of 1957, as amended
(the "Illinois Act"), and the Illinois Banking Act were also amended to reflect
a series of thrift recovery amendments ("Thrift Amendments"). The Thrift
Amendments were designed to permit an Illinois bank, subject to certain
limitations, to acquire branches of failed, failing or undercapitalized thrifts
and operate them as branches of a bank. The enactment of FIRREA and Thrift
Amendments expanded the options of the Company to grow through acquisition of
thrifts or branches of thrifts.
For many years, banks in Illinois were restricted as to the number and
geographic location of branches which they could establish. In June, 1993,
Illinois law was amended to eliminate all branching restrictions. Accordingly,
banks located in Illinois are permitted to establish branches anywhere in
Illinois without regard to the location of other banks' main offices or the
number of branches previously established. See "Description of Business --
Acquisitions and Expansion" above.
On September 29, 1994, the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 ("IBBA") was signed into law. In general, IBBA permits
bank holding companies that are adequately capitalized and adequately managed to
acquire banks located in any other state after September 29, 1995, subject to
certain conditions, including limitations on the aggregate amount of deposits
that may be held by the acquiring holding company and all of its insured
depository institution affiliates. IBBA also allows interstate branching and
merging of existing banks beginning June 1, 1997. States may elect to prohibit
interstate branching and merger transactions if they enact legislation after
September 29, 1994, and before June 1, 1997. This state "opt out" provision does
not apply to bank holding company acquisitions. The State of Illinois has
enacted legislation opting in IBBA effective June 1, 1997.
Community Reinvestment
On April 19, 1995, federal banking agencies adopted a new rule amending the
Community Reinvestment Act ("CRA"). The new CRA rule became effective July 1,
1995 under a phased-in implementation schedule. Beginning January 1, 1996,
financial institutions are required to collect and periodically report certain
information on loans. Effective July 1, 1997, all institutions will be evaluated
under the new CRA performance tests which will include the following: (1) the
lending test, which will evaluate an institution's record of helping to meet its
assessment area's credit needs through its lending activities by evaluating home
mortgage,
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small business and community development lending; (2) an investment test, which
will evaluate a financial institution's record of meeting assessment area credit
needs through qualified investments within its assessment area; and (3) a
service test, by which the FDIC will analyze the availability and effectiveness
of a financial institution's system for delivering retail banking services and
the extent and innovativeness of its community development services. The FDIC
will assign a rating of outstanding, satisfactory, needs to improve or
substantial noncompliance, depending upon an institution's performance under
each of the tests. Regulatory agencies will take into account a financial
institution's rating when considering its application for approval of mergers,
acquisitions and relocations of main or branch offices and may deny an
application based on an unsatisfactory CRA rating.
Monetary/Fiscal Policies and Economic Conditions
The earnings of bank holding companies and their subsidiary banks are
affected by general economic conditions and also by the monetary and fiscal
policies of governmental authorities, including, in particular, those of the
Federal Reserve Board which influences conditions in the money and capital
markets through, among other means, open market operations in U.S. Government
securities, varying the discount rate on bank borrowings and setting reserve
requirements against bank deposits. Such operations and policies are designed to
affect interest rates and the growth in bank credit, investments and deposits.
The monetary and fiscal policies of the Federal Reserve Board have affected
the operating results of all commercial banks in the past and are expected to do
so in the future. The Company cannot predict the nature or the extent of any
effect which economic conditions or fiscal or monetary policies may have on its
business and earnings.
Securities Laws
The Company is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934 (the "1934 Act"). These requirements include the
obligation to file with the Securities and Exchange Commission annual, quarterly
and other reports. In addition, the Company is subject to the proxy rules
promulgated pursuant to the 1934 Act, and its directors, officers and principal
shareholders are subject to the "short swing profits" and reporting provisions
of Sections 16(a) and 16(b) of the 1934 Act.
EMPLOYEES
As of December 31, 1996, the Company and its subsidiaries had approximately
446 full-time equivalent employees. The Company and its subsidiaries provide a
variety of employment benefits, and management of the Company considers its
employee relations to be excellent.
MISCELLANEOUS
The Company's subsidiaries utilize the name "Heritage", including use
pursuant to license agreement. Other financial institutions not part of the
Company also use the name "Heritage".
ITEM 2. PROPERTIES
At December 31, 1996, the Company had 15 banking locations, of which 12
were owned and three were leased. The Bank also leases certain space which
houses its operations center. Of the total banking locations, 11 are located in
southwest suburban Cook County and four are located in adjacent Will County. All
bank-owned properties are free-standing buildings that provide adequate customer
parking and drive-up facilities. The leased banking facilities are located in or
near retail shopping centers, and most maintain drive-up facilities. All of
these offices are considered by management to be well maintained and adequate
for the purpose intended. See "Note 6 -- Premises and Equipment" of the Notes to
Consolidated Financial Statements included under Item 8 of this document for
further information on properties.
10
<PAGE> 11
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in certain claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material adverse effect on the consolidated financial
condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information about each of the
Company's executive officers:
<TABLE>
<CAPTION>
NAME AGE POSITIONS WITH THE COMPANY AND SUBSIDIARIES
---- --- -------------------------------------------
<S> <C> <C>
Richard T. Wojcik.................... 58 Chairman of the Board and Chief Executive Officer of the
Company, Heritage Bank, First National Bank of Lockport
and Heritage Trust Company and President of Heritage
Trust Company
Frederick J. Sampias................. 49 President and a Director of the Company, Heritage Bank
and First National Bank of Lockport and Vice Chairman of
Heritage Trust Company
Ronald P. Groebe..................... 57 Senior Executive Vice President, Secretary and a
Director of the Company, Heritage Bank and First
National Bank of Lockport and Secretary and a Director
of Heritage Trust Company
Ramesh L. Ajwani..................... 50 Executive Vice President of Heritage Bank
John E. Barry........................ 52 Executive Vice President of Heritage Bank and a Director
of Heritage Trust Company
Paul A. Eckroth...................... 39 Executive Vice President of the Company and Heritage
Bank, Treasurer of the Company and Vice President and
Controller of the First National Bank of Lockport
Susan G. Peterson.................... 47 Executive Vice President of Heritage Bank and a Director
of Heritage Trust Company
Albert A. Stroka..................... 54 Executive Vice President and General Counsel of Heritage
Bank
</TABLE>
Mr. Wojcik has been Chairman of the Board and Chief Executive Officer of
the Company and Heritage Bank and Chairman of the Board and President of
Heritage Trust Company for more than the past five years. Mr. Wojcik currently
serves as Chairman of the Board and a Director of the First National Bank of
Lockport and served in such positions for Heritage Bank Country Club Hills from
January 1992 until that bank's merger into Heritage Bank in October 1992,
Heritage Bank Alsip from December 1992 until that bank's merger into Heritage
Bank in April 1993 and Heritage Bank Midlothian from July 1994 until that bank's
merger into Heritage Bank in October 1994.
Mr. Sampias has been President and a Director of the Company and Heritage
Bank and Vice Chairman and a Director of Heritage Trust Company for more than
the past five years. Mr. Sampias currently serves as President and a Director of
the First National Bank of Lockport and served in such positions for Heritage
Bank Country Club Hills from January 1992 until that bank's merger into Heritage
Bank in October 1992, Heritage Bank Alsip from December 1992 until that bank's
merger into Heritage Bank in April 1993 and Heritage Bank Midlothian from July
1994 until that bank's merger into Heritage Bank in October 1994.
Mr. Groebe has been a Director of the Company, Heritage Bank and Heritage
Trust Company for more than the past five years. He has been the Senior
Executive Vice President of the Company and Heritage Bank
11
<PAGE> 12
since April 1993 and prior to that was Executive Vice President of the Company
and Heritage Bank for more than five years. Mr. Groebe served as Executive Vice
President, Secretary and a Director of Heritage Bank Country Club Hills from
January 1992 until that bank's merger into Heritage Bank in October 1992 and
Heritage Bank Alsip from December 1992 until that bank's merger into Heritage
Bank in April 1993. He currently serves as Senior Executive Vice President,
Secretary and a Director of the First National Bank of Lockport and served in
such positions for Heritage Bank Midlothian from July 1994 until that bank's
merger into Heritage Bank in October 1994.
Mr. Ajwani has been an Executive Vice President of Heritage Bank for more
than the past five years. He has also served as a Vice President of the Company
from January 1988 until April 1991 when he became a Senior Vice President. He
served in that capacity until April 1992.
Mr. Barry has been an Executive Vice President of Heritage Bank and a
Director of Heritage Trust Company for more than the past five years.
Mr. Eckroth has been Treasurer of the Company for more than the past five
years. He became Executive Vice President of the Company in April 1993 and prior
to that was Senior Vice President. Mr. Eckroth became Executive Vice President
of Heritage Bank in June 1993. Prior to that he was Senior Vice President of
Heritage Bank since October 1991. Mr. Eckroth currently serves as Vice President
and Controller of the First National Bank of Lockport. He served as Controller
of Heritage Bank Country Club Hills from January 1992 until that bank's merger
into Heritage Bank in October 1992 and of Heritage Bank Alsip from December 1992
until that bank's merger into Heritage Bank in April 1993. He also served as
Executive Vice President and Treasurer of Heritage Bank Midlothian from July
1994 until that bank's merger into Heritage Bank in October 1994.
Ms. Peterson has been an Executive Vice President of Heritage Bank since
June 1993. Prior to that she was Senior Vice President of Heritage Bank
beginning in January 1992. Ms. Peterson joined the Company as Vice President in
August 1987 and served in that capacity until April 1992. She became a Director
of Heritage Trust Company in January 1993.
Mr. Stroka has been an Executive Vice President and General Counsel of
Heritage Bank since June 1993. Prior to that he was Senior Vice President and
General Counsel of Heritage Bank since October 1991.
12
<PAGE> 13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS
For purposes of the calculation of aggregate market value of the common
shares held by nonaffiliates of the Company as set forth on the cover page of
this report, the Company did not consider the Banc Funds or Carl C. Greer to be
affiliates. Conversely, for purposes of such calculation, 446,333 shares (as of
December 31, 1996) which may be voted by certain officers of the Company as
trustees of a profit sharing trust for the Company and subsidiaries were
included in the shares considered held by affiliates.
The Company's common shares are traded on the NASDAQ National Market tier
of the NASDAQ Stock Market under the symbol HERS. Stock price quotations can be
found in the Wall Street Journal and other major daily newspapers. At December
31, 1996, there were approximately 770 holders of record of the Company's
shares.
The following sets forth the dividends paid, common share prices and number
of shares traded during each quarter of 1996 and 1995, as reported by NASDAQ:
<TABLE>
<CAPTION>
MARKET PRICE RANGE NUMBER
DIVIDENDS -------------------------- OF SHARES
PAID HIGH LOW CLOSE TRADED
--------- ---- --- ----- ---------
<S> <C> <C> <C> <C> <C>
1996
4th Quarter..................................... $.13 $22.00 $20.75 $21.25 268,706
3rd Quarter..................................... .13 21.75 20.75 21.00 295,218
2nd Quarter..................................... .13 21.75 18.50 21.75 278,320
1st Quarter..................................... .13 19.25 18.25 18.25 164,329
1995
4th Quarter..................................... $.11 $19.50 $18.75 $19.25 114,564
3rd Quarter..................................... .11 19.50 17.25 19.00 488,171
2nd Quarter..................................... .11 18.00 16.50 17.25 128,609
1st Quarter..................................... .11 17.50 15.75 17.25 289,042
</TABLE>
The Company's shareholders are entitled to receive such dividends as are
declared by the board of directors, which considers payment of dividends
quarterly. Dividends are declared and paid quarterly in accordance with annual
dividend policies established by the board of directors. The ability of the
Company to pay dividends, as well as fund its operations and service debt, is
dependent upon receipt of dividends from Heritage Bank ("Bank"). Regulatory
authorities limit the amount of dividends which can be paid by the Bank without
prior approval from such authorities. At December 31, 1996, the amount of
undistributed earnings of the Bank available for payment of dividends within
such limitations is more than adequate to fund the anticipated cash requirements
of the Company. For a further discussion of the Bank's dividend restrictions and
capital requirements see "Note 15 -- Regulatory Restrictions and Capital
Adequacy" of the Notes to Consolidated Financial Statements included under Item
8 of this document.
On January 14, 1997, the board of directors increased the annual dividend
rate to 60 cents per share and declared a quarterly cash dividend of 15 cents
per share payable February 11, 1997 to shareholders of record on January 30,
1997. While the Company anticipates paying quarterly dividends of 15 cents per
share in the future, there can be no assurance that any such dividends will be
paid by the Company or that such dividends will not be reduced or eliminated in
the future. The timing and amount of dividends will depend upon the earnings,
capital requirements and financial condition of the Company as well as general
economic conditions and other relevant factors affecting the Company. Also see
"Supervision and Regulation -- Dividends" included under Item 1 of this
document.
13
<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA
The following sets forth a five year comparison of selected financial data.
The financial data reflects the balances and results of operations of
acquisitions which occurred in 1996 and 1994. The acquisitions were accounted
for using the purchase method.
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (in thousands)
Interest income.............................. $83,824 $73,860 $60,158 $55,259 $55,463
Interest expense............................. 38,606 33,364 22,116 21,122 25,155
------- ------- ------- ------- -------
Net interest income....................... 45,218 40,496 38,042 34,137 30,308
Provision for loan losses.................... 400 200 90 500 650
Other income................................. 7,724 6,971 6,487 6,101 5,234
Other expense................................ 30,801 27,670 26,218 24,220 21,910
------- ------- ------- ------- -------
Income before income taxes................ 21,741 19,597 18,221 15,518 12,982
Income tax expense........................... 6,903 6,303 5,804 4,493 3,364
------- ------- ------- ------- -------
Net income................................ $14,838 $13,294 $12,417 $11,025 $ 9,618
======= ======= ======= ======= =======
PER COMMON SHARE DATA
Fully diluted net income..................... $ 1.78 $ 1.60 $ 1.50 $ 1.34 $ 1.18
Cash dividends............................... .52 .44 .36 .32 .30
Book value at year end....................... 13.41 12.19 10.50 9.57 8.48
Market price at year end..................... 21.25 19.25 16.50 16.00 13.25
FINANCIAL RATIOS
Net interest margin (TE)..................... 4.43% 4.58% 4.90% 4.82% 4.82%
Return on average assets..................... 1.25% 1.31% 1.39% 1.33% 1.30%
Return on average shareholders' equity....... 15.00% 15.10% 15.81% 15.77% 15.48%
Dividend payout ratio........................ 27.80% 26.27% 22.93% 22.73% 24.44%
Average equity to average assets............. 8.34% 8.65% 8.78% 8.45% 8.37%
Tier 1 capital to total assets............... 7.19% 7.75% 7.41% 7.87% 7.48%
Total capital to risk-adjusted assets........ 14.00% 14.66% 13.73% 14.45% 12.86%
LOAN QUALITY
Net charge-offs (recoveries) to average
loans..................................... .11% .08% (.03)% .13% (.09)%
Allowance for loan losses to loans........... 1.47% 1.49% 1.66% 1.68% 1.70%
Nonperforming loans to loans................. .66% .85% 1.04% 1.03% 1.48%
Nonperforming assets to loans plus OREO...... .75% .98% 1.15% 1.15% 1.61%
YEAR END BALANCES (in millions)
Total assets................................. $1,229 $1,066 $953 $834 $824
Net loans.................................... 630 561 516 448 448
Total deposits............................... 1,053 915 824 727 729
Total shareholders' equity................... 106 97 83 75 66
AVERAGE BALANCES (in millions)
Total assets................................. $1,187 $1,018 $895 $827 $742
Total loans.................................. 616 545 489 454 421
Total deposits............................... 1,021 877 776 724 649
Total shareholders' equity................... 99 88 79 70 62
</TABLE>
14
<PAGE> 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Heritage Financial Services, Inc. and subsidiaries (the "Company") for the
years ended December 31, 1996, 1995 and 1994. This discussion and analysis
should be read in conjunction with the consolidated financial statements,
related notes and selected financial data appearing elsewhere in this report.
On February 2, 1996, the Company acquired all of the common stock of the
First National Bank of Lockport ("Lockport") for $16.8 million in cash. At the
date of acquisition Lockport had total assets of $104 million. 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.
On July 8, 1994, the Company acquired all of the common stock of Midlothian
State Bank ("Midlothian") for $16.5 million in cash. At the date of acquisition
Midlothian had total assets of $116 million. The acquisition was accounted for
as a purchase and, accordingly, Midlothian's results of operations have been
included in the consolidated statements of income since the acquisition date.
OVERVIEW
In 1996 the Company achieved record net income and earnings per share. For
the year, net income was $14.8 million, up 12% from $13.3 million in 1995. In
1995 net income increased 7% from $12.4 million in 1994. Fully diluted earnings
per share were $1.78 compared with $1.60 in 1995 and $1.50 in 1994. The
Company's return on average assets in 1996 was 1.25%, compared to 1.31% in 1995
and 1.39% in 1994. The return on average equity was 15.00% in 1996 compared to
15.10% in 1995 and 15.81% in 1994.
The growth in earnings in 1996 was principally due to increases in net
interest income and other operating income. The improvement in net interest
income was attributable to the growth in the volumes of earning assets and
interest-bearing liabilities, primarily reflecting the acquisition of Lockport
during the year. A decline in the net interest spread partially offset the
positive impact of volume growth. The growth in other operating income primarily
reflected increases in deposit service charges and investment product fee
income. A decrease in FDIC deposit insurance premiums also contributed to the
increase in net income for the year.
In 1995 the growth in net interest income and a reduction in FDIC deposit
insurance premiums were the major factors contributing to the increase in net
income. The improvement in net interest income was attributable to increases in
the volumes of earning assets and interest-bearing liabilities, reflecting
strong internal growth during the year. In 1995 a decline in the net interest
spread partially offset the positive impact of volume growth.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The largest source of operating revenue for the Company is net interest
income. Net interest income represents the difference between total interest
income earned on earning assets and total interest expense paid on
interest-bearing liabilities. The amount of interest income is dependent upon
many factors including the volume and mix of earning assets, the general level
of interest rates and the dynamics of changes in interest rates. The cost of
funds necessary to support earning assets varies with the volume and mix of
interest-bearing liabilities and the rates paid to attract and retain such
funds.
For purposes of this discussion and analysis, the interest earned on
tax-exempt assets is adjusted to an amount comparable to interest subject to
normal income taxes. The adjustment is referred to as the tax equivalent ("TE")
adjustment.
15
<PAGE> 16
The Company's average balances, interest income and expense and rates
earned or paid for major balance sheet categories are set forth in the following
table (in thousands):
TABLE 1 DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST, RATES AND NET YIELDS
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------- ---------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold and
interest-bearing
deposits................ $ 13,254 $ 694 5.24% $ 40,761 $ 2,378 5.83% $ 45,147 $ 1,926 4.27%
Taxable securities........ 360,553 24,001 6.66 287,951 18,881 6.56 233,642 12,844 5.50
Non-taxable
securities(1)........... 113,935 9,572 8.40 72,482 6,838 9.43 63,178 6,443 10.20
---------- ------- ---------- ------- -------- -------
Total securities........ 474,488 33,573 7.08 360,433 25,719 7.14 296,820 19,287 6.50
Loans(2):
Commercial and
industrial(1)......... 151,658 13,783 9.09 136,339 13,057 9.58 132,852 11,136 8.38
Real estate(1).......... 371,717 31,180 8.39 318,413 27,380 8.60 281,981 24,231 8.59
Consumer................ 92,399 8,289 8.97 89,986 8,122 9.03 74,465 6,240 8.38
---------- ------- ---------- ------- -------- -------
Total loans........... 615,774 53,252 8.65 544,738 48,559 8.91 489,298 41,607 8.50
---------- ------- ---------- ------- -------- -------
Total earning
assets.............. 1,103,516 87,519 7.93 945,932 76,656 8.10 831,265 62,820 7.56
------- ------- -------
Cash and due from banks... 41,728 37,149 35,156
Other assets(3)........... 41,258 34,990 28,491
---------- ---------- --------
Total assets.......... $1,186,502 $1,018,071 $894,912
========== ========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts............ $ 75,685 $ 1,662 2.20% $ 76,245 $ 1,631 2.14% $ 74,294 $ 1,596 2.15%
Money market accounts... 115,762 4,453 3.85 85,096 3,421 4.02 70,289 2,029 2.89
Savings deposits........ 212,312 5,908 2.78 209,799 6,256 2.98 235,481 6,623 2.81
Time deposits........... 445,055 24,304 5.46 361,911 20,208 5.58 261,382 10,961 4.19
---------- ------- ---------- ------- -------- -------
Total interest-bearing
deposits............ 848,814 36,327 4.28 733,051 31,516 4.30 641,446 21,209 3.31
Short-term borrowings..... 47,489 1,675 3.53 41,749 1,661 3.98 30,284 710 2.34
Notes payable............. 9,315 604 6.48 2,689 187 6.95 3,130 197 6.29
---------- ------- ---------- ------- -------- -------
Total interest-bearing
liabilities......... 905,618 38,606 4.26 777,489 33,364 4.29 674,860 22,116 3.28
------- ------- -------
Demand deposits........... 172,447 144,388 134,286
Other liabilities......... 9,497 8,175 7,234
Shareholders' equity...... 98,940 88,019 78,532
---------- ---------- --------
Total liabilities and
shareholders'
equity.............. $1,186,502 $1,018,071 $894,912
========== ========== ========
Net interest income... $48,913 $43,292 $40,704
======= ======= =======
Net interest spread....... 3.67% 3.81% 4.28%
Impact of non-interest
bearing funds........... .76% .77% .62%
---- ---- -----
Net yield on interest
earning assets.......... 4.43% 4.58% 4.90%
==== ==== =====
</TABLE>
- -------------------------
(1) Interest income and rates are presented on a tax equivalent basis, assuming
a federal income tax rate of 35%.
(2) Includes fees on loans of $1,305 in 1996, $1,187 in 1995 and $1,090 in 1994.
(3) For presentation purposes in this table, other assets includes nonaccrual
loans, the allowance for loan losses and the net unrealized gain (loss) on
securities available-for-sale.
16
<PAGE> 17
Changes in net interest income may also be analyzed by segregating the
volume and rate components of interest income and interest expense. The
following table summarizes the approximate relative contribution of changes in
average volume and interest rates to changes in net interest income (TE) for the
past two years (in thousands):
TABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE(1)
<TABLE>
<CAPTION>
1996 COMPARED TO 1995 1995 COMPARED TO 1994
----------------------------- ----------------------------
CHANGE IN CHANGE IN
INTEREST DUE TO INTEREST DUE TO
------------------ TOTAL ----------------- TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
------ ---- ------ ------ ---- ------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Federal funds sold and
interest-bearing deposits....... $(1,462) $ (221) $(1,683) $ (202) $ 654 $ 452
Taxable securities................. 4,696 425 5,121 3,270 2,767 6,037
Non-taxable securities(2).......... 3,552 (819) 2,733 901 (506) 395
------- ------- ------- ------ ------- -------
Total securities.............. 8,248 (394) 7,854 4,171 2,261 6,432
------- ------- ------- ------ ------- -------
Loans:
Commercial and industrial(2).... 1,416 (689) 727 299 1,622 1,921
Real estate(2).................. 4,329 (530) 3,799 3,035 114 3,149
Consumer........................ 217 (50) 167 1,374 508 1,882
------- ------- ------- ------ ------- -------
Total loans................... 5,962 (1,269) 4,693 4,708 2,244 6,952
------- ------- ------- ------ ------- -------
Total interest income......... 12,748 (1,884) 10,864 8,677 5,159 13,836
------- ------- ------- ------ ------- -------
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits:
NOW accounts.................... (12) 43 31 42 (7) 35
Money market accounts........... 1,185 (153) 1,032 486 906 1,392
Savings deposits................ 74 (422) (348) (750) 383 (367)
Time deposits................... 4,546 (450) 4,096 4,990 4,257 9,247
------- ------- ------- ------ ------- -------
Total interest-bearing
deposits................... 5,793 (982) 4,811 4,768 5,539 10,307
Short-term borrowings.............. 214 (199) 15 335 616 951
Notes payable...................... 430 (13) 417 (29) 19 (10)
------- ------- ------- ------ ------- -------
Total interest expense........ 6,437 (1,194) 5,243 5,074 6,174 11,248
------- ------- ------- ------ ------- -------
Net interest income........... $ 6,311 $ (690) $ 5,621 $3,603 $(1,015) $ 2,588
======= ======= ======= ====== ======= =======
</TABLE>
- -------------------------
(1) The change in interest due to both rate and volume has been allocated to
rate and volume changes in proportion to the relationship of the absolute
dollar amount of the change in each.
(2) Interest income is presented on a tax equivalent basis assuming a federal
income tax rate of 35%.
On a tax equivalent basis, net interest income increased $5.6 million, or
13% in 1996, compared to an increase of $2.6 million, or 6% in 1995. As set
forth in Table 2, the improvement in net interest income in both years was due
to increases in the volume of earning assets and interest-bearing liabilities,
partially offset by the effect of changes in interest rates.
In 1996 average earning assets increased by $158 million, or 17%, and
average interest-bearing liabilities increased $128 million, or 16%, compared
with 1995 (Table 1). The higher volumes of earning assets and interest-bearing
liabilities in 1996 primarily resulted from the acquisition of Lockport coupled
with strong deposit growth during the year. In 1995 average earning assets
increased by $115 million, or 14%, and average interest-bearing liabilities
increased $103 million, or 15%, compared with 1994. Growth in the volume of
earning assets and interest-bearing liabilities in 1995 was due primarily to
internal deposit growth. As a percentage of average earning assets, the level of
average interest-bearing liabilities was 82.1% in 1996 compared to 82.2% in 1995
and 81.2% in 1994.
17
<PAGE> 18
As a percentage of average earning assets, average loans decreased from
58.9% in 1994 to 55.8% in 1996 whereas average securities increased from 35.7%
in 1994 to 43.0% in 1996. The decrease in average loans in both years primarily
reflects a relatively faster rate of growth in deposits versus loans in both
1996 and 1995. A majority of excess deposit funds not used to support loan
growth were invested in securities. In 1996 the mix of average earning assets
was also affected by Lockport which contributed a relatively greater proportion
of securities compared to loans.
The composition or mix of interest-bearing liabilities also changed in 1996
and 1995. As a percentage of average interest-bearing liabilities, average time
deposits increased from 38.7% in 1994 to 49.1% in 1996 while average savings
deposits decreased from 34.9% in 1994 to 23.4% in 1996. The change in funding
sources was primarily due to higher levels of short-term interest rates in 1996
and 1995 compared to 1994. The overall rise in market rates caused the Company,
as well as other financial institutions, to raise rates paid on time deposits.
As a result, the interest rate differential between savings and time deposits
widened, and customers opted to shift funds from savings to time deposits. The
wider interest rate differential also influenced the mix of new deposit growth.
A majority of the Company's growth in total deposits in 1996 and 1995 was in the
time deposit category. The growth resulted from a combination of higher rates
offered on time deposits and premium-rate time deposit promotions.
On a tax equivalent basis, the net interest spread decreased to 3.67% in
1996 compared to 3.81% in 1995. The change in the net interest spread reflected
a decrease of .17% in the yield on average earning assets while the rate paid on
interest-bearing liabilities declined by only .03%. The decline in the yield on
earning assets primarily resulted from the change in the mix of earning assets
discussed above and generally lower rates earned on new volumes of earning
assets and rate sensitive assets, such as prime-based floating rate loans and
federal funds sold. The cost of interest-bearing liabilities declined slightly
as short-term market interest rates remained relatively stable throughout 1996
compared to 1995.
In 1995 the tax equivalent net interest spread decreased to 3.81% compared
to 4.28% in 1994. The change in the net interest spread reflected an increase of
.54% in the yield on average earning assets that was more than offset by an
increase of 1.01% in the rate paid on interest-bearing liabilities. The increase
in the yield on earning assets primarily reflected higher rates earned on new
loans and securities and rate sensitive assets, such as federal funds sold,
adjustable-rate securities and prime-based floating rate loans. The increase in
the rate paid on interest-bearing liabilities was primarily due to higher
interest rates paid on time deposits, money market accounts and short-term
borrowings. Changes in the deposit mix and premium rates paid on short-term time
deposit promotions also contributed to the increase in funding costs in 1995.
A factor contributing to lower net interest spreads in 1996 and 1995 has
been the flattening of the treasury yield curve. This trend is primarily
attributable to the market's expectation of moderate economic growth with
relatively low rates of inflation. The monetary policies and actions of the
Federal Reserve Board have also influenced the shape of the yield curve. In
general, a flatter yield curve reduces the interest spreads earned on new loans
and securities compared to the cost of funds. Throughout 1995 the yield curve
flattened as the spreads between long-term and short-term market interest rates
compressed. In first half of 1996 the yield curve steepened as intermediate and
long-term market interest rates increased while short-term interest rates
remained relatively unchanged. In the second half of 1996 the yield curve began
to flatten as spreads between long-term and short-term market interest rates
narrowed. The Company cannot predict whether recent changes in the yield curve
will continue or be sustained. However, changes in the slope of the yield curve
will continue to impact the spread earned on average earning assets. The mix of
earning assets and funding sources will also impact future net interest spreads.
PROVISION FOR LOAN LOSSES
The provision for loan losses in 1996 was $400,000 compared to $200,000 in
1995 and $90,000 in 1994. The increase in provisions in 1996 and 1995 primarily
resulted from higher net charge-offs in each year. The provisions in both years
were also influenced by the improvement in asset quality and reductions in
potential risks associated with impaired loans. For further information on the
Company's nonperforming loans, impaired
18
<PAGE> 19
loans and loss experience, see the "Nonperforming Assets", "Impaired Loans" and
"Allowance for Loan Losses" sections below.
OTHER INCOME
An important source of the Company's revenue is derived from other income.
The following table sets forth the major components of other income for the last
three years (in thousands):
TABLE 3 OTHER INCOME
<TABLE>
<CAPTION>
$ CHANGE
FROM PRIOR
YEAR
-------------
1996 1995 1994 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Service charges on deposits........................... $4,477 $4,097 $3,832 $ 380 $265
Income for trust services............................. 784 737 707 47 30
Investment product fees............................... 1,134 909 939 225 (30)
Other operating income................................ 1,209 1,005 997 204 8
Securities gains...................................... 120 223 12 (103) 211
------ ------ ------ ----- ----
Total other income............................... $7,724 $6,971 $6,487 $ 753 $484
====== ====== ====== ===== ====
</TABLE>
Service charges on deposits, the primary component of other income,
increased 9% in 1996 and 7% in 1995. The increase in service charge income in
1996 was due in part to the additional fee income of Lockport and a change in
service charge pricing methods. In 1995 the increase in income was primarily due
to the additional fee income of Midlothian. While the Company has historically
experienced increases in deposit service charges, the growth has been tempered
by the introduction of new retail products, such as free checking accounts.
These products have been offered in response to similar products offered by
local financial institutions and non-bank competitors. In the future the
introduction of similar products and customer cost preferences may limit the
growth in service charge revenue.
Income from trust services increased 6% in 1996 and 4% in 1995. The growth
in trust revenue in 1996 was primarily attributable to the trust accounts
acquired from Lockport. In 1995 the increase reflected continued growth of
employee benefit plans and other asset management accounts serviced by Heritage
Trust Company. At December 31, 1996, total customer trust assets were
approximately $183 million, up $31 million from year-end 1995.
Income from investment product fees is derived from sales of third-party
mutual funds and annuities through arrangements with licensed broker-dealers. In
1996 the Company expanded the annuity and mutual fund product selections. The
growth in investment product income was in part due to the increased product
offerings combined with greater customer demand. In 1995 fees declined 3%
reflecting a lower volume of product sales.
Net securities gains in 1996 were $120,000 compared to net gains of
$223,000 in 1995 and $12,000 in 1994. In 1996 the Company sold $18 million of
REMIC securities and $20 million of adjustable-rate mortgage pools which,
collectively, resulted in a net loss of $58,000. The proceeds from these sales
were reinvested in longer-term, fixed rate CMOs and REMICs. In 1996 the Company
also recognized a gain of $135,000 on the payoff of a nonaccrual tax-exempt
obligation and gross gains of $30,000 from calls of municipal securities. In
1995 the Company sold $8 million of adjustable-rate mortgage pools for gains of
$177,000 and realized gains of $46,000 from calls of municipal securities. In
1994 securities gains were limited to calls of municipal securities.
OTHER EXPENSE
The major categories of other expense include salaries and employee
benefits, occupancy and equipment expenses and other operating expenses
associated with the day-to-day operations of the Company. In general, the
increases in most expense categories in 1996 and 1995 were attributable to the
Lockport and Midlothian
19
<PAGE> 20
acquisitions. However, the growth of operating expenses has been contained due
in part to the realization of certain economies of scale from the acquisitions,
efficient staffing and management's ongoing efforts to reduce costs through
investments in technology and competitive bidding.
Operating expense levels of financial institutions are often measured using
the efficiency ratio (operating expense divided by the sum of taxable equivalent
net interest income plus other income, excluding securities transactions). The
ratio reflects on average how much an institution spends to generate each dollar
of revenue. The Company's efficiency ratio was 54.5% in 1996 compared to 55.3%
in 1995 and 55.6% in 1994. The improvement in the efficiency ratio in 1996 was
primarily due to higher revenue growth combined with relatively lower operating
expenses.
The following table sets forth the major components of other expense for
the last three years (in thousands):
TABLE 4 OTHER EXPENSE
<TABLE>
<CAPTION>
$ CHANGE
FROM PRIOR YEAR
------------------
1996 1995 1994 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Salaries and employee benefits............ $16,645 $15,146 $14,373 $1,499 $ 773
Net occupancy expense..................... 3,107 2,618 2,395 489 223
Equipment expense......................... 1,697 1,569 1,550 128 19
Data processing expense................... 1,105 817 750 288 67
Federal deposit insurance premiums........ 53 958 1,683 (905) (725)
Amortization of intangible assets......... 2,251 1,613 1,374 638 239
Stationery and supplies................... 766 700 616 66 84
Legal and professional fees............... 633 681 561 (48) 120
Marketing and promotion................... 679 528 389 151 139
Other operating expenses.................. 3,865 3,040 2,527 825 513
------- ------- ------- ------ ------
Total other expense..................... $30,801 $27,670 $26,218 $3,131 $1,452
======= ======= ======= ====== ======
</TABLE>
Salaries and employee benefits, the largest component of other expense,
increased 10% in 1996 compared to 5% in 1995. The increases in both years were
primarily attributable to the additional salary expense from acquisitions and
annual merit increases paid to employees. In 1996 higher expenses were also due
to an increase in profit sharing expense and incentive compensation. In 1995 the
growth in expense was partially offset by a decrease in profit sharing expense.
At December 31, 1996, the number of full-time equivalent ("FTE") employees
totaled 446 compared to 434 and 440 at December 31, 1995 and 1994, respectively.
The increase in the number of FTE employees in 1996 was primarily due to the
additional employees of Lockport.
Occupancy expense increased 19% in 1996 and 9% in 1995. The increase in
1996 expense was largely due to higher real estate taxes, reflecting sharp
increases in property valuations which were reassessed in 1996. A majority of
the bank's real estate properties are reassessed by taxing authorities every
three years. The additional costs of the Monee branch, which opened in August
1995, higher utility costs and the additional expenses of bank acquisitions also
contributed to the growth in occupancy expense in 1996 and 1995.
For many years the Company has continued to expand and upgrade computer,
data processing and communications equipment to improve productivity, increase
operating efficiencies and enhance customer sales and service. In 1996 data
processing expense increased 35% compared to an increase of 9% in 1995 and
equipment expense increased 8% compared to a 1% growth in 1995. Higher data
processing and equipment expenses were due primarily to the upgrade of teller
platform systems, the upgrade of bank-wide telephone systems and the purchase of
approximately $1 million of new personal computers. The growth in data
processing expense in both years also reflects the additional costs to process
the activity of acquired banks and general price increases in third-party data
processing services. In 1997 the Company expects to install a new retail banking
platform system.
20
<PAGE> 21
The significant decline in deposit insurance expense in 1996 and 1995 was
due to a reduction in the Bank Insurance Fund ("BIF") assessment rates.
Effective June 1, 1995, the FDIC reduced the Bank's assessment rate from .23% of
deposits to .04% of deposits. In 1996 the FDIC reduced the Bank's assessment
rate for both semi-annual periods from .04% of deposits to zero. In December,
1996, the FDIC set the Company's BIF assessment rate for the semi-annual
assessment period ending June 30, 1997, at zero. There are no assurances,
however, that future assessment rates will remain at that level. On September
30, 1996, the Economic Growth and Regulatory Paperwork Reduction Act of 1996
("Economic Growth Act") was signed into law which, among other things,
authorized the FDIC to recapitalize the Savings Association Insurance Fund
("SAIF") by imposing a special assessment on institutions holding SAIF deposits.
Under the Economic Growth Act, members of the BIF and SAIF will be jointly
responsible to service a portion of interest on Financing Corporation ("FICO")
bonds that were issued by the government to pay for the thrift cleanup in the
late 1980's. Beginning January 1, 1997, the Company will begin paying FICO
assessments at the rate of .013% of BIF deposits.
The increases in the amortization of intangible assets in 1996 and 1995
resulted from the acquisitions of Lockport and Midlothian, respectively. Higher
marketing and promotion expenses in 1996 and 1995 were primarily attributable to
increased advertising and direct mail costs associated with loan and deposit
promotions. The increase in other operating expenses in 1996 reflects a charge
of approximately $300,000 to settle a lawsuit filed by Federal Insurance Company
in May, 1995. Higher operating expenses in 1996 also resulted from increased
loan servicing costs and ATM processing fees. The growth in other operating
expenses in 1995 was primarily due to increases in loan servicing and OREO
expenses, communication and postage expenses and employee training costs.
INCOME TAXES
Income tax expense increased $600,000 in 1996 and $499,000 in 1995. The
Company's effective tax rate (income tax expense divided by income before taxes)
was 31.7% in 1996, 32.2% in 1995 and 31.9% in 1994. Higher income tax expense in
both years was principally due to the increases in pre-tax earnings. The
decrease in the effective tax rate in 1996 was primarily due to an increase in
the amount of tax-exempt income earned on state and municipal securities.
ANALYSIS OF BALANCE SHEETS
LOANS
The loan portfolio is the largest category of the Company's earning assets.
The following table summarizes the composition of the loan portfolio for the
last five years (in thousands):
TABLE 5 COMPOSITION OF LOANS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---------------- ---------------- ---------------- ---------------- ----------------
% OF % OF % OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and
industrial......... $143,811 23% $130,508 23% $124,351 24% $127,499 28% $133,198 29%
Commercial real
estate............. 148,798 23 145,080 25 142,833 27 138,471 30 126,353 28
Construction......... 13,515 2 8,645 2 6,096 1 5,055 1 8,004 2
Residential real
estate............. 239,380 37 200,323 35 162,246 31 133,178 29 137,431 30
Home equity.......... 85,113 13 73,525 13 72,394 13 33,132 7 29,908 6
Other consumer....... 10,192 2 13,782 2 20,078 4 19,824 5 21,466 5
-------- --- -------- --- -------- --- -------- --- -------- ---
Total............ $640,809 100% $571,863 100% $527,998 100% $457,159 100% $456,360 100%
======== === ======== === ======== === ======== === ======== ===
</TABLE>
21
<PAGE> 22
The Company's primary organizational emphasis is commercial lending. A
majority of the commercial loan portfolio represents loans to small and mid-size
companies in businesses such as light manufacturing, wholesale, distribution and
other service operations. Commercial and industrial loans consist primarily of
secured loans made for business working capital and purchases of inventory and
equipment. Commercial real estate loans generally represent intermediate-term
mortgages (five to fifteen years) made to finance owner-occupied property, plant
expansion or the acquisition of income-producing property. While most of the
Company's commercial borrowers operate in the southwest suburbs of Chicago, a
number of these customers conduct business nationally.
Combined, commercial and industrial, commercial real estate and
construction loans increased $22 million or 8% in 1996 compared to an increase
of $11 million or 4% in 1995. The Company continues to actively pursue
commercial borrowers within the markets it serves. However, increased
competition and aggressive pricing by both bank and non-bank competitors has
tempered the growth of commercial loans over the past several years.
The maturity distribution and interest rate sensitivity of commercial and
industrial, commercial real estate and construction loans at December 31, 1996
are set forth below (in thousands):
TABLE 6 LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
MATURITY(1)
---------------------------------------------------
WITHIN AFTER
1 YEAR(2) 1-5 YEARS 5 YEARS TOTAL
--------- --------- ------- -----
<S> <C> <C> <C> <C>
Commercial and industrial........................ $ 93,225 $ 43,203 $ 7,383 $143,811
Commercial real estate........................... 30,294 97,726 20,778 148,798
Construction..................................... 13,515 -- -- 13,515
-------- -------- ------- --------
Total....................................... $137,034 $140,929 $28,161 $306,124
======== ======== ======= ========
Fixed rate loans................................. $ 51,050 $124,265 $23,849 $199,164
Variable rate loans.............................. 85,984 16,664 4,312 106,960
-------- -------- ------- --------
Total....................................... $137,034 $140,929 $28,161 $306,124
======== ======== ======= ========
</TABLE>
- -------------------------
(1) Based on scheduled principal repayments.
(2) Includes demand loans, past due loans and overdrafts.
Residential real estate loans primarily represent single-family, first
mortgages with intermediate terms secured by properties primarily located in the
Company's general market area. In 1996 this portfolio increased $39 million or
19% compared to $38 million or 23% in 1995. The Company continues to grow the
residential real estate portfolio based on its asset/liability mix and interest
rate sensitivity position. A majority of the new loans originated in 1996 and
1995 were 15-year conventional loans and 30-year bi-weekly loans.
Home equity loans represent second mortgages secured by residential real
estate properties primarily located in Cook County and the adjacent collar
counties. At December 31, 1996, approximately $21 million, or 25%, of home
equity loans are floating rate advances under equity lines of credit. The
remaining balance of the portfolio consists of fixed-rate installment loans with
terms of five to 15 years.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, loans where scheduled
payments are 90 days or more past due and other real estate owned. The Company
places loans on nonaccrual status when management believes, after considering
the borrower's financial condition and other relevant factors, that future
collection of principal or interest in accordance with contractual terms may be
doubtful. Loans 90 days or more past due are transferred to nonaccrual status
unless they are well secured and in the process of collection. Other real estate
owned includes properties acquired through foreclosure or deed in lieu of
foreclosure. The properties are recorded at the lower of the book value of the
loan or fair value, less estimated costs to sell.
22
<PAGE> 23
The following table sets forth the aggregate amount of the Company's
nonperforming assets for the last five years (in thousands):
TABLE 7 NONPERFORMING ASSETS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Nonaccrual loans............................... $3,421 $3,919 $4,272 $4,299 $5,999
Loans past due 90 days or more................. 783 938 1,201 409 731
------ ------ ------ ------ ------
Total nonperforming loans................. 4,204 4,857 5,473 4,708 6,730
Other real estate owned........................ 618 760 563 524 602
------ ------ ------ ------ ------
Total nonperforming assets................ $4,822 $5,617 $6,036 $5,232 $7,332
====== ====== ====== ====== ======
Restructured loans............................. -- -- $ 582 -- --
====== ====== ====== ====== ======
Nonperforming loans to loans................... .66% .85% 1.04% 1.03% 1.48%
Nonperforming assets to loans plus OREO........ .75% .98% 1.15% 1.15% 1.61%
</TABLE>
The largest nonperforming loan at December 31, 1996 is a nonaccrual loan in
the amount of $536,000. The loan is secured by construction equipment, accounts
receivable and business assets. While the borrower continues to make payments,
the ultimate collectibility of all principal and interest is uncertain. The
second largest nonperforming loan is a loan secured by residential real estate
lots in the amount of $450,000. The borrower continues to attempt to sell the
lots and proceeds from sales are partially applied to the nonaccrual loan
balance. The composition of the remaining nonperforming loans primarily consists
of loans secured by local commercial real estate or residential real estate of
which no single loan exceeds $350,000. Other real estate owned primarily
consists of residential real estate. At December 31, 1996, the largest OREO
property was a residential property with a carrying value of $284,000.
In addition to the loans classified as nonperforming at December 31, 1996
other loans with a total principal balance of approximately $2.4 million were
identified by management to be possible problem loans. While these borrowers are
in compliance with present repayment terms, their financial conditions have
caused management to believe that their loans may result in classification as
past due or nonaccrual loans at some future time. These loans have been
considered in the recognition and evaluation of impaired loans described below.
IMPAIRED LOANS
In 1995 the Company adopted the provisions of SFAS 114, "Accounting by
Creditors for Impairment of a Loan" as amended by SFAS 118, "Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures". Under
the Company's credit policy, all loans, except for home equity loans and other
consumer loans, are subject to impairment recognition on a quarterly basis. A
loan is considered impaired when it is probable that all principal and interest
due under the contractual terms of a loan will not be collected. The Company
generally considers most loans 90 days or more past due and all nonaccrual loans
to be impaired. Loan impairment is measured based on the present value of
expected future cash flows or the fair value of collateral if the loan is
collateral dependent. If the fair value of an impaired loan is less than its
recorded investment, a specific valuation allowance is allocated to the loan.
Interest income on impaired loans, other than nonaccrual loans, is recorded on
an accrual basis.
23
<PAGE> 24
The following table sets forth the recorded investment in impaired loans
and the related valuation allowance for each loan category as of December 31,
1996 and 1995 (in thousands):
TABLE 8 IMPAIRED LOANS
<TABLE>
<CAPTION>
AMOUNT OF IMPAIRED LOANS
-----------------------------------
NO VALUATION VALUATION AMOUNT OF
ALLOWANCE ALLOWANCE VALUATION
REQUIRED REQUIRED TOTAL ALLOWANCE
------------ --------- ----- ---------
<S> <C> <C> <C> <C>
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
====== ====== ====== ====
DECEMBER 31, 1995
Commercial and industrial.......................... $ 271 $ 796 $1,067 $285
Commercial real estate............................. 3,312 1,410 4,722 486
Residential real estate............................ 1,104 134 1,238 51
------ ------ ------ ----
Total impaired loans............................ $4,687 $2,340 $7,027 $822
====== ====== ====== ====
</TABLE>
Of the total amount of impaired loans, $1,827,000 were measured using the
present value of expected future cash flows and $1,779,000 were measured based
on the fair value of collateral. The average recorded investment in impaired
loans for the years ended December 31, 1996 and 1995, were $5,855,000 and
$7,357,000, respectively. Interest income recognized on impaired loans totaled
$236,000 in 1996 and $311,000 in 1995.
The amount of impaired loans is not directly comparable with the amount of
nonperforming loans previously disclosed in Table 7. The primary differences
between nonperforming loans and impaired loans are: i.) all loan categories are
considered in determining nonperforming loans while impaired loan recognition is
limited to commercial and industrial loans, commercial real estate loans and
residential real estate loans; and ii.) impaired loan recognition considers not
only loans 90 days or more past due and nonaccrual loans but also may include
possible problem loans other than delinquent loans. Included in the total
balance of impaired loans at December 31, 1996 were nonaccrual loans of
$2,951,000. At December 31, 1995 the balance of impaired loans included
nonaccrual loans of $3,423,000 and loans 90 days or more past due of $334,000.
ALLOWANCE 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.
24
<PAGE> 25
The following table summarizes the changes in the allowance for loan losses
for the last five years (in thousands):
TABLE 9 ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning of period............ $ 8,477 $ 8,720 $ 7,655 $ 7,755 $ 5,127
Allowance of acquired banks............... 1,179 -- 850 -- 1,598
-------- -------- -------- -------- --------
Provision for loan losses................. 400 200 90 500 650
-------- -------- -------- -------- --------
Loans charged off:
Commercial and industrial............... 112 348 100 571 444
Commercial real estate.................. 565 351 182 310 129
Construction............................ -- -- -- -- --
Residential real estate................. 164 61 127 96 229
Home equity............................. 37 52 23 18 11
Other consumer.......................... 47 53 108 112 182
-------- -------- -------- -------- --------
Total charge-offs.................... 925 865 540 1,107 995
-------- -------- -------- -------- --------
Recoveries on loans previously charged
off:
Commercial and industrial............... 96 234 97 379 321
Commercial real estate.................. 121 36 477 35 903
Construction............................ -- -- -- -- --
Residential real estate................. 27 111 43 32 55
Home equity............................. -- -- -- -- --
Other consumer.......................... 32 41 48 61 96
-------- -------- -------- -------- --------
Total recoveries..................... 276 422 665 507 1,375
-------- -------- -------- -------- --------
Net charge-offs (recoveries)......... 649 443 (125) 600 (380)
-------- -------- -------- -------- --------
Balance at end of period.................. $ 9,407 $ 8,477 $ 8,720 $ 7,655 $ 7,755
======== ======== ======== ======== ========
Specific valuation reserves for impaired
loans................................... $ 541 $ 822
======== ========
Average loans............................. $615,774 $544,738 $489,298 $453,673 $420,826
======== ======== ======== ======== ========
Net charge-offs (recoveries) to average
loans................................... .11% .08% (.03)% .13% (.09)%
Allowance for loan losses to loans........ 1.47% 1.49% 1.66% 1.68% 1.70%
Allowance for loan losses to nonperforming
loans................................... 224% 175% 159% 163% 115%
</TABLE>
For many years the Company has minimized credit risk by adhering to sound
underwriting and credit review policies. These policies are reviewed at least
annually, and changes are approved by the board of directors. Senior management
is actively involved in business development efforts and the maintenance and
monitoring of credit underwriting and approval. Loans and lines of credit over
$2 million are reviewed and approved by the executive committee of the Bank's
board of directors. The Company's loan review system and controls are designed
to identify, monitor and address asset quality problems in an accurate and
timely manner. The Bank's loan review committee meets monthly to assess
delinquent and problem loans and develop collection strategies to minimize
potential loan losses. The board of directors also review the status of problem
loans monthly. In addition to internal policies and controls, regulatory
authorities and the Company's independent auditors periodically review asset
quality and the overall adequacy of the allowance for loan losses as integral
parts of their examinations.
The Company recorded slightly higher loan loss provisions in 1996 and 1995
primarily due to higher net charge-offs in each year. While the amount of net
charge-offs increased in 1996 and 1995, they were still relatively low when
compared to the overall growth in the loan portfolio and prior loss experience.
The provisions in both years were also influenced by the improvement in the
Company's asset quality and reductions in potential risks associated with
impaired loans. The loan loss provisions in 1994 and 1992 were
25
<PAGE> 26
influenced by large recoveries of previously charged-off commercial real estate
loans. Excluding the large recoveries, the Company's net charge-off ratios would
have been .06% in 1994 and .12% in 1992.
At December 31, 1996, the allowance for loan losses as a percentage of
loans was 1.47% compared to 1.49% at year-end 1995. The decrease in the level of
the allowance was primarily due to higher net charge-offs and the growth in the
loan portfolio. As a percentage of nonperforming loans, the allowance increased
to 224% at December 31, 1996 compared to 175% at December 31, 1995. The increase
in the allowance coverage of nonperforming loans was primarily due to the
addition of Lockport's allowance for loan losses in 1996.
The following table sets forth an allocation of the Company's allowance for
loan losses for the last five years (in thousands):
TABLE 10 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES(1)
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial and industrial...................... $2,157 $2,077 $2,570 $2,905 $3,105
Commercial real estate......................... 4,200 4,100 4,500 3,300 3,000
Construction................................... -- -- -- -- --
Residential real estate........................ 2,250 1,550 1,100 1,100 1,300
Home equity and other consumer................. 800 750 550 350 350
------ ------ ------ ------ ------
Total........................................ $9,407 $8,477 $8,720 $7,655 $7,755
====== ====== ====== ====== ======
</TABLE>
- -------------------------
(1) See Table 5 for the percentage of each loan category to total loans.
Changes in the allocation of the allowance to individual loan categories at
December 31, 1996 and 1995 were primarily the result of loan portfolio growth
and changes in management's risk assessment and assignment of unallocated
reserves. In 1995 the change in the allocation reflected the adoption of the
impaired loan accounting standard. Notwithstanding management's allocation of
the allowance, the entire allowance for loan losses is available to absorb
losses in any particular category of loans. The increase in general valuation
reserves in 1996 compared to 1995 primarily reflects the addition of Lockport's
allowance for loan losses.
SECURITIES
The Company's overall investment goal is to maximize earnings while
maintaining liquidity in securities having minimal credit risk. The types and
maturities of securities purchased are primarily based on the Company's current
and projected liquidity and interest rate sensitivity positions.
26
<PAGE> 27
The following table sets forth the year-end carrying value of securities
for the last three years (in thousands):
TABLE 11 COMPOSITION OF SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
% OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
By Type:
Mortgage-backed securities:
REMICs and CMOs..................... $166,709 33% $121,695 29% $ 67,361 22%
Pass-through obligations and
pools............................. 92,353 18 61,359 15 52,338 17
Adjustable-rate mortgage pools...... 68,065 13 93,198 22 86,541 28
State and municipal securities......... 128,367 25 97,807 24 60,190 20
Asset-backed securities................ 33,533 7 34,511 8 31,278 10
Other securities....................... 19,902 4 7,045 2 10,580 3
-------- --- -------- --- -------- ---
Total............................. $508,929 100% $415,615 100% $308,288 100%
======== === ======== === ======== ===
By Classification:
Available-for-sale..................... $392,754 77% $318,159 77% $ 71,478 23%
Held-to-maturity....................... 115,913 23 97,456 23 236,810 77
Trading................................ 262 -- -- -- -- --
-------- --- -------- --- -------- ---
Total............................. $508,929 100% $415,615 100% $308,288 100%
======== === ======== === ======== ===
</TABLE>
Mortgage-backed securities primarily consist of mortgage pass-through
securities directly or implicitly backed by the full faith and credit of the
United States government. A majority of mortgage-backed securities represent
investments in fixed-rate, current pay tranches of real estate mortgage
investment conduits ("REMICs") and collateralized mortgage obligations ("CMOs").
Mortgage-backed securities are acquired based on their relative yield advantage
over other investment alternatives with similar maturity characteristics.
Acquisitions of these securities involve a thorough analysis of their estimated
prepayment speeds and yield performance with movements in market interest rates
of plus or minus 300 basis points. Asset-backed securities generally represent
interests in pools of short-term loans or receivables, such as auto, home equity
and credit card loans. All asset-backed securities are AAA rated bonds.
In 1996 and 1995 the Company increased its investments in fixed-rate,
intermediate-term mortgage-backed securities having average lives ranging from
three to ten years. Fixed-rate mortgage-backed securities comprised 51% of total
securities at December 31, 1996, compared to 44% in 1995 and 39% in 1994. The
Company also increased its holdings of longer-term bank-qualified tax-exempt
securities. The maturities of these securities primarily range from seven to 15
years. Cash flows from payments and sales of adjustable-rate mortgage ("ARM")
pools were used to partially fund the growth of mortgage-backed and municipal
securities.
In 1994 the Company adopted SFAS 115, "Accounting for Certain Investments
in Debt and Equity Securities". SFAS 115 requires that all debt and equity
securities be classified as held-to-maturity, available-for-sale or trading.
Securities which the Company has the ability and intent to hold to maturity are
classified as held-to-maturity and are carried at cost. Securities that may be
sold as part of the Company's management of interest rate risk, liquidity, or in
response to or in anticipation of changes in interest rates and prepayment risk,
or for other similar factors, are classified as available-for-sale.
On November 15, 1995, the Financial Accounting Standards Board ("FASB")
issued a Special Report on the implementation of SFAS 115, "Accounting for
Certain Investments in Debt and Equity Securities". As part of the application
of the Special Report, companies were allowed a one-time opportunity to
reclassify securities, including securities classified as held-to-maturity. In
accordance with the Special Report, the
27
<PAGE> 28
Company transferred all of its taxable securities classified as held-to-maturity
at December 31, 1995 to available-for-sale. At the date of transfer, the
securities had an approximate market value of $207,000,000 and an unrealized
gain of $1,928,000.
At December 31, 1996, concentrations of securities of a single issuer
consisted of investments in tax-exempt obligations issued by the Village of
Alsip. The amortized cost and market value of these securities were $8,440,000
and $8,835,000, respectively. In addition to securities, the Company has granted
tax-exempt loans to the Village of Alsip which totaled $4,527,000 at December
31, 1996. All securities and loans are secured by the general taxing authority
of the Village of Alsip except for $370,000 in securities which are secured
solely by revenue from certain real estate taxes. Some loans are further secured
by real estate or other marketable collateral. The Company has no other
securities of any one issuer, excluding mortgage-backed securities, that exceed
10% of shareholders' equity.
The maturities and weighted average yields of securities as of December 31,
1996, are presented in the following table. The amounts and yields of fixed-rate
mortgage-backed securities and asset-backed securities are presented based on
current estimated principal cash flows of each security. The amount and yield of
ARM securities are presented in the "Within 1 Year" maturity period since these
securities reprice at least annually. Yields on state and municipal securities
are stated on a tax equivalent basis assuming a federal income tax rate of 35%
(in thousands):
TABLE 12 SECURITIES MATURITIES AND YIELDS
<TABLE>
<CAPTION>
MATURING
--------------------------------------------------------------------------------------------------
WITHIN 1 YEAR 1-5 YEARS 5-10 YEARS AFTER 10 YEARS
----------------- ----------------- ---------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL
------ ----- ------ ----- ------ ----- ------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
HELD-TO-MATURITY
State and municipal
securities....... $ 10,783 9.64% $ 30,587 8.91% $68,615 7.79% $ 5,928 10.07% $115,913
======== ==== ======== ==== ======= ==== ======= ===== ========
AVAILABLE-FOR-SALE
Mortgage-backed
securities:
REMICs and
CMOs.......... $ 25,557 6.74% $108,511 7.11% $15,035 7.00% $17,606 7.04% $166,709
Pass-through
obligations
and pools..... 16,242 6.98% 52,777 7.09% 7,526 7.04% 15,808 7.10% 92,353
Adjustable-rate
mortgage
pools......... 68,065 6.65% -- -- -- -- -- -- 68,065
Asset-backed
securities....... 9,888 6.82% 21,830 7.01% 1,815 6.95% -- -- 33,533
State and municipal
securities....... -- -- 3,573 8.11% 5,348 8.06% 3,533 8.59% 12,454
Other securities... 13,840 5.80% 5,800 5.31% -- -- -- -- 19,640
-------- -------- ------- ------- --------
Total............ $133,592 6.63% $192,491 7.06% $29,724 7.20% $36,947 7.21% $392,754
======== ==== ======== ==== ======= ==== ======= ===== ========
</TABLE>
DEPOSITS
Funding of earning assets is substantially provided by a combination of
consumer, commercial and public fund deposits. The Company continues to focus
its marketing strategies and emphasis on retail core deposits, the major
component of funding sources. The Company offers a number of different products
which are priced competitively within the markets it serves. These products,
including promotions, are designed to attract new customers, retain existing
customers and create opportunities to offer other bank products or services.
While
28
<PAGE> 29
the market and pricing for deposit funds is very competitive, the Company
believes that personalized, quality service is also an important element in
retaining core deposit customers.
The following table summarizes the composition of major deposit categories
for the last three years (in thousands):
TABLE 13 COMPOSITION OF DEPOSITS
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------------------------------------------
1996 1995 1994
------------------- ----------------- -----------------
% OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Demand deposits........................... $ 185,705 18% $161,400 18% $143,378 17%
NOW and money market accounts............. 190,955 18 175,407 19 145,543 18
Savings deposits.......................... 203,483 19 201,542 22 232,100 28
Time deposits............................. 473,160 45 376,943 41 302,569 37
---------- --- -------- --- -------- ---
Total deposits....................... $1,053,303 100% $915,292 100% $823,590 100%
========== === ======== === ======== ===
</TABLE>
At December 31, 1996, total deposits increased $138 million or 15% compared
to year-end 1995. The increase primarily resulted from the acquisition of
Lockport and strong deposit growth. At December 31, 1995, total deposits
increased $92 million or 11% compared to year-end 1994. Approximately $50
million of the growth resulted from a seven month, premium-rate certificate of
deposit promotion offered in early 1995.
As previously discussed in the analysis of net interest income, the
composition of deposits has changed primarily due to higher levels of short-term
interest rates in 1996 and 1995. During these years a majority of the Company's
growth in total deposits was in the time deposit category. The growth resulted
from a combination of higher rates offered on time deposits and premium-rate
time deposit promotions. The growth also reflects the shift of funds from
savings deposits as a result of the widening of the interest rate differential
between savings and time deposits. While it has been the Company's experience
that savings deposits are relatively insensitive to changes in interest rates,
the Company believes that further shifting of savings may occur based on the
current level of interest rates offered on time deposits. The potential shift of
savings has been considered and incorporated in the Company's asset/liability
analysis and measurement of interest rate risk.
The following table sets forth the maturity distribution of time deposits
of $100,000 or more for the past three years (in thousands):
TABLE 14 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
3 months or less............................................ $ 45,330 $35,001 $34,765
Over 3 months but within 6 months........................... 22,190 19,967 12,779
Over 6 months but within 12 months.......................... 23,873 14,663 8,094
Over 12 months.............................................. 15,980 12,687 21,102
-------- ------- -------
Total..................................................... $107,373 $82,318 $76,740
======== ======= =======
</TABLE>
29
<PAGE> 30
SHORT-TERM BORROWINGS
Short-term borrowings consist of securities sold under agreements to
repurchase, federal funds purchased and notes payable. Information relating to
short-term borrowings for the last three years is presented below (in
thousands):
TABLE 15 SHORT-TERM BORROWINGS
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
At December 31:
Securities sold under agreements to repurchase............ $40,706 $47,002 $33,018
Federal funds purchased................................... 13,000 -- --
Notes payable............................................. 7,000 -- 6,500
------- ------- -------
Total.................................................. $60,706 $47,002 $39,518
======= ======= =======
Average interest rate.................................. 3.24% 3.88% 3.98%
Maximum Outstanding at Any Month-end During the Year:
Securities sold under agreements to repurchase............ $50,790 $51,553 $34,184
Federal funds purchased................................... 16,500 -- --
Notes payable............................................. 14,000 5,000 8,000
------- ------- -------
Total.................................................. $81,290 $56,553 $42,184
======= ======= =======
Averages for the Year:
Securities sold under agreements to repurchase............ $45,846 $41,749 $30,284
Federal funds purchased................................... 1,643 -- --
Notes payable............................................. 9,315 2,689 3,130
------- ------- -------
Total.................................................. $56,804 $44,438 $33,414
======= ======= =======
Average interest rate.................................. 4.01% 4.16% 2.71%
</TABLE>
Securities sold under agreements to repurchase primarily represent
borrowings originated as part of cash management services offered to corporate
customers. Borrowings that mature in one business day totaled $38 million at
December 31, 1996. The remaining balance of securities sold under agreements to
repurchase represents term repurchase agreements issued to customers that mature
within 90 to 360 days. Federal funds purchased represent temporary over night
borrowings from correspondent banks.
Notes payable represent borrowings by the Company to partially fund bank
acquisitions. For more information on acquisitions and borrowings, see "Note 2
- -- Acquisitions" and "Note 7 -- Notes Payable" of the Notes to Consolidated
Financial Statements included under Item 8 of this document.
INTEREST RATE RISK
The Company seeks to maximize its net interest margin within an acceptable
level of interest rate risk. Interest rate risk can be defined as the amount of
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities.
In the banking industry, a traditional measurement of interest rate
sensitivity is known as "gap" analysis, which measures the cumulative
differences between the amounts of assets and liabilities maturing or repricing
30
<PAGE> 31
at various time intervals. The following table sets forth the Company's interest
rate repricing gaps for selected maturity periods at December 31, 1996 (in
thousands):
TABLE 16 GAP TABLE
<TABLE>
<CAPTION>
RATE SENSITIVE PERIOD
---------------------------------------------------------
1-90 91-365 1-2 OVER
DAYS DAYS YEARS 2 YEARS TOTAL
---- ------ ----- ------- -----
<S> <C> <C> <C> <C> <C>
Earning assets:
Loans
Fixed-rate....................... $ 21,166 $ 51,543 $ 57,747 $368,351 $ 498,807
Variable-rate.................... 130,358 3,261 2,000 4,578 140,197
Securities
Fixed-rate(1).................... 17,739 53,911 64,401 300,152 436,203
Variable-rate.................... 27,022 45,704 -- -- 72,726
--------- --------- --------- -------- ----------
Total earning assets............. 196,285 154,419 124,148 673,081 1,147,933
--------- --------- --------- -------- ----------
Interest-bearing liabilities:
Time deposits....................... 136,692 247,731 60,335 28,402 473,160
NOW and money market deposits(2).... 112,852 -- -- 78,103 190,955
Savings deposits(2)................. 6,000 18,000 20,000 159,483 203,483
Short-term borrowings............... 53,706 -- -- -- 53,706
Notes payable....................... 7,000 -- -- -- 7,000
--------- --------- --------- -------- ----------
Total interest-bearing
liabilities.................... 316,250 265,731 80,335 265,988 928,304
--------- --------- --------- -------- ----------
Incremental asset (liability) gap... $(119,965) $(111,312) $ 43,813 $407,093 $ 219,629
========= ========= ========= ======== ==========
Cumulative asset (liability) gap.... $(119,965) $(231,277) $(187,464) $219,629
========= ========= ========= ========
</TABLE>
- -------------------------
(1) Maturity volumes of mortgage-backed and asset-backed securities are
presented based on current estimated cash flows.
(2) Historically the Company's NOW accounts and savings deposits have been
relatively insensitive to interest rate changes. However, the Company
considers a portion of savings deposits to be rate sensitive based on
historical growth trends and management's expectations.
While the gap analysis provides an indication of interest rate sensitivity,
experience has shown that it does not fully capture the true dynamics of
interest rate changes. Essentially, the analysis presents only a static
measurement of asset and liability volumes based on contractual maturity, cash
flow estimates or repricing opportunity. It fails to reflect the differences in
the timing and degree of repricing of assets and liabilities due to interest
rate changes. In analyzing interest rate sensitivity, management considers these
differences and incorporates other assumptions and factors, such as balance
sheet growth and prepayments, to better measure interest rate risk.
A principal objective of the Company's asset/liability management effort is
to balance the various factors that generate interest rate risk, thereby
maintaining the interest rate sensitivity of the Company within acceptable risk
levels. To measure its interest rate sensitivity position, the Company utilizes
a simulation model that facilitates the forecasting of net interest income under
a variety of interest rate and growth scenarios. Simulation modeling is
performed over time horizons of one and two years. To manage interest rate risk,
the Company assesses its current risk position in light of interest rate
forecasts and develops and implements specific lending, funding and investment
strategies. Strategies are monitored and evaluated to determine if they achieve
the desired risk reduction objectives. The Company may also use derivative
financial instruments, including interest rate swaps, caps, floors, futures and
options, to manage interest rate risk. To date such instruments have not been
utilized.
The Company's asset/liability policy has established guidelines that limit
to 5% the amount of forecasted net interest income at risk over a twelve month
period, assuming a 300 basis point fluctuation in market interest rates. If the
projected change in net interest income is greater than 5%, management is
required to develop strategies to reduce this risk. At December 31, 1996, the
Company's forecast of interest rate risk indicated that its sensitivity to
changes in interest rates in a one-year period was less than 5%.
31
<PAGE> 32
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. Liquidity needs of Heritage Bank 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 1996 the
Bank's average amount of federal funds sold was $13 million. At year-end
however, the Bank purchased $13 million of federal funds to meet temporary
funding needs. The Bank may purchase up to $40 million under informal federal
funds lines with correspondent banks. For the three and twelve months ended
December 31, 1996, the aggregate principal payments received on mortgage-backed
and asset-backed securities totaled approximately $18 million and $75 million,
respectively. At December 31, 1996, the Bank has $19 million of securities
having contractual maturities of one year or less and expects to receive
approximately $68 million of payments on mortgage-backed and asset-backed
securities over the next twelve months. The cash flow projections of mortgage-
backed and asset-backed securities are based on the 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
$139 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
Heritage Bank. Regulatory authorities limit the amount of dividends which can be
paid by Heritage Bank without prior approval from such authorities. At December
31, 1996, the amount of undistributed earnings of Heritage Bank available for
payment of dividends within such limitations is sufficient to fund the
anticipated cash requirements of HFS. For a further discussion of Heritage
Bank's capital requirements and dividend restrictions, see "Note 15 --
Regulatory Restrictions and Capital Adequacy" of the Notes to Consolidated
Financial Statements included under Item 8 of this document.
CAPITAL
At December 31, 1996 total shareholders' equity increased to $105.7
million, up $8.9 million or 9% from December 31, 1995. In 1995 shareholders'
equity increased $13.7 million or 16% compared with year-end 1994. The growth in
equity primarily reflects the retention of current year earnings, less dividends
paid and changes in the composition and market values of securities
available-for-sale. In 1996 the change in shareholders' equity also reflects the
purchase of treasury stock.
In 1996 the Company paid dividends of 52 cents per share, an increase of
18% over the 1995 annual dividend rate. On January 14, 1997, the board of
directors increased the annual dividend rate 15% to 60 cents per share, payable
quarterly at the rate of 15 cents per share. The dividend policy of the Company
is designed to balance the shareholder interest in current return with the need
to retain adequate capital to support future asset growth.
The capital ratios of the Company and Heritage Bank are presently in excess
of the requirements necessary to meet the "well capitalized" capital category
established by bank regulators. For a further discussion of capital
requirements, see "Note 15 -- Regulatory Restrictions and Capital Adequacy" of
the Notes to Consolidated Financial Statements included under Item 8 of this
document.
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. The
shares may be repurchased from time to time in the open market or in private
transactions. In 1996 the Company repurchased 87,300 common shares at a cost of
$1,852,000 and reissued 1,275 treasury shares upon the exercise of stock
options. 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.
32
<PAGE> 33
NEW ACCOUNTING PRONOUNCEMENTS
In 1997 the Company will adopt 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, 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. Management believes that the impact of the adoption of SFAS 125 will not
have a material effect on the Company's financial condition or results of
operations.
33
<PAGE> 34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 43,830 $ 44,268
Federal funds sold and interest-bearing deposits............ -- 5,611
---------- ----------
Total cash and cash equivalents...................... 43,830 49,879
Securities:
Held-to-maturity (market value: $117,046 in 1996 and
$99,306 in 1995)....................................... 115,913 97,456
Available-for-sale, at market............................. 392,754 318,159
Trading, at market........................................ 262 --
---------- ----------
Total securities..................................... 508,929 415,615
Loans, net of unearned income............................... 639,004 569,494
Less: allowance for loan losses........................... (9,407) (8,477)
---------- ----------
Net loans............................................ 629,597 561,017
Premises and equipment...................................... 18,786 16,304
Goodwill and core deposit intangibles....................... 18,196 13,554
Other assets................................................ 9,682 9,999
---------- ----------
TOTAL ASSETS......................................... $1,229,020 $1,066,368
========== ==========
LIABILITIES
Demand deposits............................................. $ 185,705 $ 161,400
NOW and money market accounts............................... 190,955 175,407
Savings deposits............................................ 203,483 201,542
Time deposits............................................... 473,160 376,943
---------- ----------
Total deposits....................................... 1,053,303 915,292
Federal funds purchased..................................... 13,000 --
Securities sold under agreements to repurchase.............. 40,706 47,002
Notes payable............................................... 7,000 --
Other liabilities........................................... 9,324 7,291
---------- ----------
TOTAL LIABILITIES.................................... 1,123,333 969,585
---------- ----------
SHAREHOLDERS' EQUITY
Preferred shares -- no par value; shares authorized:
12,000,000; shares issued: none........................... -- --
Common shares -- $.625 par value; shares authorized:
16,000,000; shares issued: 7,967,032 in 1996 and 7,939,359
in 1995................................................... 4,979 4,962
Surplus..................................................... 17,634 17,499
Retained earnings........................................... 83,374 72,681
Net unrealized gains on securities, net of tax.............. 1,525 1,641
Treasury stock, at cost (86,025 shares in 1996)............. (1,825) --
---------- ----------
TOTAL SHAREHOLDERS' EQUITY........................... 105,687 96,783
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........... $1,229,020 $1,066,368
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 35
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees................................... $52,907 $48,156 $41,200
Securities:
Taxable.............................................. 24,001 18,881 13,151
Exempt from federal income taxes..................... 6,222 4,445 3,881
Federal funds sold and interest-bearing deposits........ 694 2,378 1,926
TOTAL INTEREST INCOME................................ 83,824 73,860 60,158
INTEREST EXPENSE
Deposits................................................ 36,327 31,516 21,209
Short-term borrowings................................... 1,675 1,661 710
Notes payable........................................... 604 187 197
TOTAL INTEREST EXPENSE............................... 38,606 33,364 22,116
NET INTEREST INCOME.................................. 45,218 40,496 38,042
Provision for loan losses................................. 400 200 90
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES............................................. 44,818 40,296 37,952
OTHER INCOME
Service charges on deposit accounts..................... 4,477 4,097 3,832
Income for trust services............................... 784 737 707
Investment product fees................................. 1,134 909 939
Other operating income.................................. 1,209 1,005 997
Securities gains........................................ 120 223 12
TOTAL OTHER INCOME................................... 7,724 6,971 6,487
OTHER EXPENSE
Salaries and employee benefits.......................... 16,645 15,146 14,373
Net occupancy expense................................... 3,107 2,618 2,395
Equipment expense....................................... 1,697 1,569 1,550
Federal deposit insurance premiums...................... 53 958 1,683
Data processing expense................................. 1,105 817 750
Amortization of intangible assets....................... 2,251 1,613 1,374
Other operating expenses................................ 5,943 4,949 4,093
TOTAL OTHER EXPENSE.................................. 30,801 27,670 26,218
INCOME BEFORE INCOME TAXES........................... 21,741 19,597 18,221
Income tax expense........................................ 6,903 6,303 5,804
NET INCOME........................................... $14,838 $13,294 $12,417
NET INCOME PER COMMON SHARE:
Primary................................................. $1.78 $1.60 $1.50
Fully diluted........................................... $1.78 $1.60 $1.50
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES
OUTSTANDING:
Primary................................................. 8,324,556 8,309,004 8,284,833
Fully diluted........................................... 8,338,309 8,330,164 8,287,851
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE> 36
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NET
UNREALIZED
GAINS
PREFERRED COMMON RETAINED (LOSSES) TREASURY
SHARES SHARES SURPLUS EARNINGS ON SECURITIES STOCK TOTAL
--------- ------ ------- -------- ------------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1994........... -- $4,896 $16,746 $53,309 $ 74,951
Adoption of SFAS No. 115, net of
related taxes of $124......... -- -- -- -- $ 187 187
Net income....................... -- -- -- 12,417 -- 12,417
Cash dividends ($.36 per
share)........................ -- -- -- (2,847) -- (2,847)
Common shares issued upon
exercise of stock options..... -- 51 639 -- -- 690
Change in net unrealized gains
(losses) on securities, net of
related taxes of $(1,508)..... -- -- -- -- (2,287) (2,287)
------ ------ ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 1994......... -- 4,947 17,385 62,879 (2,100) 83,111
Net income....................... -- -- -- 13,294 -- 13,294
Cash dividends ($.44 per
share)........................ -- -- -- (3,492) -- (3,492)
Common shares issued upon
exercise of stock options..... -- 15 114 -- -- 129
Change in net unrealized gains
(losses) on securities, net of
related taxes of $2,468....... -- -- -- -- 3,741 3,741
------ ------ ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 1995......... -- 4,962 17,499 72,681 1,641 96,783
Net income....................... -- -- -- 14,838 -- 14,838
Cash dividends ($.52 per
share)........................ -- -- -- (4,125) -- (4,125)
Common shares issued upon
exercise of stock options..... -- 17 135 -- -- 152
Change in net unrealized gains
(losses) on securities, net of
related taxes of $(76)........ -- -- -- -- (116) (116)
Purchases of common stock........ -- -- -- -- -- (1,852) (1,852)
Treasury stock reissued upon
exercise of stock options..... -- -- -- (20) -- 27 7
------ ------ ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 1996......... -- $4,979 $17,634 $83,374 $ 1,525 $(1,825) $105,687
====== ====== ======= ======= ======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE> 37
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................................ $ 14,838 $ 13,294 $ 12,417
Adjustments to reconcile net income to net cash provided
by operating activities:
Discount accretion on securities..................... (1,473) (978) (843)
Deferred loan fee accretion.......................... (452) (311) (325)
Provision for loan losses............................ 400 200 90
Securities gains..................................... (120) (223) (12)
Depreciation and amortization........................ 1,740 1,690 1,634
Deferred income taxes................................ (346) (464) (659)
Net amortization of purchase accounting
adjustments.......................................... 2,818 2,085 1,751
(Increase) decrease in accrued interest income....... (270) (1,249) 400
Increase in accrued interest expense................. 115 703 365
Other, net........................................... 849 (459) 87
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES.......... 18,099 14,288 14,905
-------- -------- --------
INVESTING ACTIVITIES
Securities held-to-maturity:
Proceeds from maturities, repayments and calls.......... 9,894 51,333 44,407
Purchases............................................... (25,635) (114,787) (70,754)
Securities available-for-sale:
Proceeds from maturities, repayments and calls.......... 88,142 14,391 43,875
Proceeds from sales..................................... 38,093 7,962 4,920
Purchases............................................... (150,994) (58,834) (14,556)
Purchase of trading security.............................. (250) -- --
Net (increase) decrease in loans.......................... (35,308) (45,985) 3,107
Purchases of premises and equipment....................... (2,180) (1,288) (1,255)
Proceeds from the sale of premises and equipment.......... 20 29 249
Proceeds from sales of other real estate owned............ 945 645 617
Purchase price of acquired bank net of cash and cash
equivalents............................................. (7,798) -- (11,509)
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES.............. (85,071) (146,534) (899)
-------- -------- --------
FINANCING ACTIVITIES
Net increase (decrease) in deposits....................... 56,946 91,848 (2,811)
Net federal funds purchased............................... 13,000 -- --
Net increase (decrease) in securities sold under
agreements to repurchase................................ (10,205) 13,984 7,114
Proceeds from notes payable............................... 14,000 -- 8,000
Principal payments on notes payable....................... (7,000) (6,500) (1,500)
Proceeds from stock option exercises...................... 159 129 690
Dividends paid............................................ (4,125) (3,492) (2,847)
Purchases of common stock................................. (1,852) -- --
-------- -------- --------
NET CASH PROVIDED FROM FINANCING ACTIVITIES........ 60,923 95,969 8,646
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (6,049) (36,277) 22,652
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 49,879 86,156 63,504
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 43,830 $ 49,879 $ 86,156
======== ======== ========
SUPPLEMENTAL DISCLOSURES:
Interest paid............................................. $ 38,595 $ 32,807 $ 21,546
Income taxes paid......................................... 6,825 7,005 6,469
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Securities transferred from held-to-maturity to
available-for-sale...................................... $ -- $205,290 $ --
Loans transferred to other real estate owned.............. 901 735 534
Loans made in connection with the disposition of other
real estate owned....................................... 370 -- 1,634
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE> 38
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and conform to prevailing practices
within the banking industry. The significant accounting and reporting policies
of Heritage Financial Services, Inc. and subsidiaries are as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Heritage
Financial Services, Inc. and its wholly-owned subsidiaries, Heritage Bank, First
National Bank of Lockport and Heritage Trust Company (collectively, the
"Company"). Significant intercompany accounts and transactions are eliminated in
consolidation. Certain amounts in the 1995 and 1994 consolidated financial
statements have been reclassified to conform to the 1996 presentation.
NATURE OF OPERATIONS
The Company is a multi-bank holding company which provides a full range of
banking and trust services to individuals and business customers located in the
southwest metropolitan Chicago market. The Company's primary business is the
extension of credit to commercial, real estate and consumer loan customers in
its market area. Funding of the Company's assets is substantially provided by a
combination of consumer, commercial and public fund deposits. The Company
encounters significant competition for loans and deposits from other financial
institutions and non-bank companies. The Company is regulated by federal and
state banking agencies and undergoes periodic examinations by those agencies.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements, as well as the reported amounts of income and expenses during the
reported periods. Actual results could differ from those estimates.
STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows in the Statements of Cash Flows, cash
and cash equivalents include cash and due from banks, federal funds sold and
interest-bearing deposits at other institutions. Generally, federal funds are
sold for one-day periods and interest-bearing deposits generally mature in 90
days or less. Included in the 1994 and 1996 Statements of Cash Flows are the
purchase price of acquisitions, net of cash and cash equivalents acquired.
SECURITIES
Securities which the Company has the ability and intent to hold to maturity
are classified as held-to-maturity and are carried at amortized cost. Securities
that may be sold as part of the Company's management of interest rate risk,
liquidity, or in response to or in anticipation of changes in interest rates and
prepayment risk, or for other similar factors, are classified as
available-for-sale. Securities available-for-sale are carried at their estimated
market values and net unrealized gains and losses, net of tax, are reported as a
separate category of shareholders' equity. Premiums and discounts on securities
held-to-maturity and securities available-for-sale are amortized in a manner
that approximates the level yield method. Trading securities are carried at
market value and changes in fair value are recorded as securities gains or
losses. Realized gains and losses on securities sold are computed based on the
adjusted cost of the specific securities sold.
38
<PAGE> 39
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On November 15, 1995, the Financial Accounting Standards Board ("FASB")
issued a Special Report on the implementation of Statement of Financial
Accounting Standards No. ("SFAS") 115, "Accounting for Certain Investments in
Debt and Equity Securities". As part of the application of the Special Report,
companies were allowed a one-time opportunity to reclassify securities,
including securities classified as held-to-maturity. In accordance with the
Special Report, the Company transferred all of its taxable securities classified
as held-to-maturity at December 31, 1995 to available-for-sale. At the date of
transfer, the securities had an approximate market value of $207,000,000 and an
unrealized gain of $1,928,000.
LOANS
Interest income on nondiscounted loans is recognized based upon the
principal amount outstanding during the period. Interest income on discounted
loans is recognized based on methods that approximate a level yield. The accrual
of interest income is discontinued when management believes, after considering
the borrower's financial condition and other relevant factors, that future
collection of principal or interest in accordance with contractual terms may be
doubtful. Loans 90 days or more past due are transferred to nonaccrual status
unless they are well secured and in the process of collection. When a loan is
placed on nonaccrual status, interest previously accrued is reversed and charged
against current year income. Interest income on nonaccrual loans is recognized
on a cash basis. Certain loan origination fees in excess of incremental direct
costs are deferred and recognized over the term of the loan using the level
yield method.
ALLOWANCE 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.
Effective January 1, 1995, the Company adopted the provisions of SFAS 114,
"Accounting by Creditors for Impairment of a Loan" as amended by SFAS 118,
"Accounting by Creditors for Impairment of a Loan -- Income Recognition and
Disclosures". Under the Company's credit policy, all loans, except for home
equity loans and other consumer loans, are subject to impairment recognition on
a quarterly basis. A loan is considered impaired when it is probable that all
principal and interest due under the contractual terms of a loan will not be
collected. The Company generally considers most loans 90 days or more past due
and all nonaccrual loans to be impaired. Loan impairment is measured based on
the present value of expected future cash flows or the fair value of collateral
if the loan is collateral dependent. If the fair value of an impaired loan is
less than its recorded investment, a specific valuation allowance is allocated
to the loan. Interest income on impaired loans, other than nonaccrual loans, is
recorded on an accrual basis.
MORTGAGE SERVICING RIGHTS
Effective January 1, 1996, the Company adopted the provisions of SFAS 122,
"Accounting for Mortgage Servicing Rights". SFAS 122 provides guidance on the
accounting for mortgage servicing rights and the evaluation and recognition of
impairment of mortgage servicing rights. The provisions of SFAS 122 do not
currently impact the Company since it sells mortgage loans to investors on a
servicing released basis.
39
<PAGE> 40
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
A derivative financial instrument is a futures, forward, swap, or option
contract, or other financial instrument with similar characteristics. At
December 31, 1996 and 1995, the Company's derivative financial instruments were
limited to fixed-rate and variable-rate loan commitments.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation and amortization have been computed principally
using the straight-line method. Rates of depreciation are generally based on the
following useful lives: building -- 40 to 50 years; building improvements,
furniture and equipment -- 3 to 15 years.
OTHER REAL ESTATE OWNED
Other real estate owned represents properties acquired through foreclosure
or deed in lieu of foreclosure. These properties are recorded at the lower of
the book value of the loan or fair value, less estimated costs to sell. The
excess, if any, of the loan amount over fair value is charged to the allowance
for loan losses. Subsequent declines in the fair value of other real estate
owned, along with related operating expenses, are charged to other operating
expenses.
INTANGIBLE ASSETS
The net assets of subsidiaries acquired in purchase transactions have been
recorded at fair value at the acquisition date. The values of the acquired
deposit base intangibles recognized in purchase transactions are being amortized
on a straight-line basis over periods ranging from 5 to 8 years. Goodwill,
representing the cost in excess of the fair value of net assets acquired, is
being amortized on a straight-tine basis over periods ranging from 15 to 25
years. Management reviews intangible assets for possible impairment if there is
a significant event that detrimentally affects operations. Impairment is
measured by comparing the carrying amount of intangibles to the current and
estimated future net income of businesses acquired.
Effective January 1, 1996, the Company adopted the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". SFAS 121 requires that long-lived assets and certain identifiable
intangibles that are used in operations be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of assets
might not be recoverable. The adoption of SFAS 121 did not effect the Company's
financial condition or results of operations.
STOCK OPTIONS
Effective January 1, 1996, the Company adopted SFAS 123, "Accounting for
Stock-Based Compensation". SFAS 123 encourages, but does not require, companies
to recognize compensation expense for grants of stock, stock options and other
equity instruments based on the fair value of those instruments. The Company has
elected to continue to account for employee stock compensation plans under APB
Opinion 25 and related Interpretations.
INCOME TAXES
The Company files consolidated federal and state income tax returns.
Accordingly, no income tax is applicable to the dividends received by Heritage
Financial Services, Inc. from its subsidiaries. Deferred tax assets and
liabilities are recorded based on the expected tax effect of future taxable
income or deductions resulting from differences in the financial statement and
tax bases of assets and liabilities and the expected tax effect of carryforwards
for tax purposes.
40
<PAGE> 41
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EARNINGS PER SHARE
Primary and fully diluted earnings per common share 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 plans. Common share equivalents attributable to stock options are
computed based on the treasury stock method.
NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 1997, the Company will adopt 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 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. Management believes that the impact of the
adoption of SFAS 125 will not have a material effect on the Company's financial
condition or results of operations.
NOTE 2 -- ACQUISITIONS
On February 2, 1996, the Company acquired all of the common shares of the
First National Bank of Lockport ("Lockport") for $16,820,000 in cash. The
acquisition was funded with cash and borrowings of $14,000,000 under a revolving
line of credit facility. 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. In connection
with the acquisition, the Company acquired assets with an aggregate fair value
of $104,375,000 and assumed deposits and other liabilities of $87,555,000.
On July 8, 1994, the Company acquired all of the common stock of Midlothian
State Bank for $16,545,000 in cash. The acquisition was funded with cash and
borrowings of $8,000,000 under a revolving line of credit facility. The
acquisition was accounted for as a purchase and, accordingly, the results of
operations of Midlothian State Bank were included in the consolidated statement
of income from the date of acquisition. In connection with the acquisition, the
Company acquired assets with an aggregate fair value of $116,140,000 and assumed
deposits and other liabilities of $99,668,000.
NOTE 3 -- SECURITIES
The amortized cost and estimated market values of securities
held-to-maturity are as follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
State and municipal obligations................... $115,913 $1,986 $ (853) $117,046
======== ====== ======= ========
DECEMBER 31, 1995
State and municipal obligations................... $ 97,456 $2,184 $ (334) $ 99,306
======== ====== ======= ========
</TABLE>
41
<PAGE> 42
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The amortized cost and estimated market values of securities
available-for-sale are as follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
Mortgage-backed securities:
REMICs and CMOs................................ $166,171 $1,410 $ (872) $166,709
Adjustable rate mortgage pools................. 66,623 1,484 (42) 68,065
Pass-through obligations and pools............. 91,700 973 (320) 92,353
Asset-backed securities........................... 33,554 212 (233) 33,533
U.S. Treasury and governmental agencies........... 14,791 27 (91) 14,727
State and municipal obligations................... 12,471 2 (19) 12,454
Other securities.................................. 4,912 2 (1) 4,913
-------- ------ ------- --------
Total.......................................... $390,222 $4,110 $(1,578) $392,754
======== ====== ======= ========
DECEMBER 31, 1995
Mortgage-backed securities:
REMICs and CMOs................................ $120,858 $1,471 $ (634) $121,695
Adjustable rate mortgage pools................. 92,041 1,318 (161) 93,198
Pass-through obligations and pools............. 60,788 994 (423) 61,359
Asset-backed securities........................... 34,445 253 (187) 34,511
U.S. Treasury and governmental agencies........... 2,002 9 -- 2,011
State and municipal obligations................... 270 81 -- 351
Other securities.................................. 5,030 4 -- 5,034
-------- ------ ------- --------
Total.......................................... $315,434 $4,130 $(1,405) $318,159
======== ====== ======= ========
</TABLE>
Securities with carrying values of $162,920,000 and $141,153,000 at
December 31, 1996 and 1995, respectively, were pledged principally to secure
public fund deposits and securities sold under agreements to repurchase.
Proceeds from sales of securities available-for-sale were $38,093,000 in
1996, $7,962,000 in 1995 and $4,920,000 in 1994. In 1996 gross gains from sales
were $63,000 and gross losses were $121,000. In 1995 gross gains from sales were
$177,000. In 1994 no gains or losses were recognized on securities sales since
the amortized cost of the securities equaled the market value at the time of
sale. In 1996 a gain of $135,000 was recognized on the payoff of a tax-exempt
obligation that was in default and carried on nonaccrual status. In 1996 calls
of securities resulted in gross gains of $30,000. In 1995 calls of securities
resulted in gross gains of $47,000 and gross losses of $1,000. In 1994 calls of
securities resulted in gross gains of $12,000. Income tax expense recognized on
net securities gains was $51,000 in 1996, $93,000 in 1995 and $5,000 in 1994.
The following table summarizes the contractual maturities of securities
held-to-maturity and available-for-sale at December 31, 1996. Expected
maturities may differ from contractual maturities because certain issuers have
the right to call or prepay these obligations without penalties. The stated
maturities of mortgage-backed
42
<PAGE> 43
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and asset-backed securities are presented in total since the principal cash
flows of these securities are not received at a single maturity date (in
thousands):
<TABLE>
<CAPTION>
AMORTIZED MARKET
COST VALUE
--------- ------
<S> <C> <C>
HELD-TO-MATURITY:
Due in one year or less................................... $ 10,243 $ 10,336
Due after one year through five years..................... 27,997 28,368
Due after five years through ten years.................... 71,845 72,147
Due after ten years....................................... 5,828 6,195
-------- --------
Total held-to-maturity................................. $115,913 $117,046
======== ========
AVAILABLE-FOR-SALE:
Due in one year or less................................... $ 13,513 $ 13,488
Due after one year through five years..................... 5,824 5,787
Due after five years through ten years.................... 366 365
Due after ten years....................................... 12,471 12,454
-------- --------
Subtotal............................................... 32,174 32,094
Mortgage-backed securities................................ 324,494 327,127
Asset-backed securities................................... 33,554 33,533
-------- --------
Total available-for-sale............................... $390,222 $392,754
======== ========
</TABLE>
NOTE 4 -- LOANS
The following table summarizes loan balances by category as of December 31,
1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Commercial and industrial................................... $143,811 $130,508
Commercial real estate...................................... 148,798 145,080
Construction................................................ 13,515 8,645
Residential real estate..................................... 239,380 200,323
Home equity................................................. 85,113 73,525
Other consumer.............................................. 10,192 13,782
-------- --------
Gross loans............................................... 640,809 571,863
Less: unearned income....................................... (1,805) (2,369)
-------- --------
Loans, net of unearned income............................. $639,004 $569,494
======== ========
</TABLE>
Loans on which the accrual of interest has been discontinued amounted to
$3,421,000 and $3,919,000 at December 31, 1996 and 1995, respectively. If
interest on those loans had been accrued at their original terms, such income
would approximate $170,000 in 1996 and $197,000 in 1995. The amount of interest
accrued on these loans and included in interest income was $76,000 in 1996 and
$71,000 in 1995. There were no restructured loans at December 31, 1996 and 1995.
Real estate loans with carrying values of $10,686,000 and $12,863,000 at
December 31, 1996 and 1995, respectively, were pledged to secure public fund
deposits.
Certain directors and executive officers of the Company and companies with
which they are affiliated have obtained loans from the Bank on various
occasions. All loans and loan commitments have been made in the ordinary course
of business and on substantially the same terms, including interest rates and
collateral, as
43
<PAGE> 44
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
those prevailing at the time for comparable transactions with unrelated persons.
The aggregate balance of these loans was $9,056,000 at December 31, 1996 and
$10,134,000 at December 31, 1995. During 1996, $2,375,000 of new loans were made
and repayments were $3,453,000.
NOTE 5 -- ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The changes in the allowance for loan losses for the years ended December
31, 1996, 1995 and 1994 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year.................................. $8,477 $8,720 $7,655
Allowance of acquired bank................................ 1,179 -- 850
Provision for loan losses................................. 400 200 90
Loan charge-offs.......................................... (925) (865) (540)
Loan recoveries........................................... 276 422 665
------ ------ ------
Balance, end of year........................................ $9,407 $8,477 $8,720
====== ====== ======
</TABLE>
The following table sets forth the recorded investment in impaired loans
and the related valuation allowance for each loan category as of December 31,
1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
AMOUNT OF IMPAIRED LOANS
---------------------------------------
NO VALUATION VALUATION AMOUNT OF
ALLOWANCE ALLOWANCE VALUATION
REQUIRED REQUIRED TOTAL ALLOWANCE
------------ --------- ----- ---------
<S> <C> <C> <C> <C>
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
====== ====== ====== ====
DECEMBER 31, 1995
Commercial and industrial...................... $ 271 $ 796 $1,067 $285
Commercial real estate......................... 3,312 1,410 4,722 486
Residential real estate........................ 1,104 134 1,238 51
------ ------ ------ ----
Total impaired loans........................ $4,687 $2,340 $7,027 $822
====== ====== ====== ====
</TABLE>
The average recorded investment in impaired loans for the years ended
December 31, 1996 and 1995, were $5,855,000 and $7,357,000, respectively.
Interest income recognized on impaired loans totaled $236,000 in 1996 and
$311,000 in 1995. Included in the total balance of impaired loans at December
31, 1996 and 1995, were nonaccrual loans of $2,951,000 and $3,423,000,
respectively. Of the total amount of impaired loans at December 31, 1996,
$1,827,000 were measured using the present value of expected future cash flows
and $1,779,000 were measured based on the fair value of collateral.
44
<PAGE> 45
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 -- PREMISES AND EQUIPMENT
The following is a summary of the Company's premises and equipment as of
December 31, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Land........................................................ $ 5,245 $ 4,613
Buildings and improvements.................................. 18,324 15,957
Furniture and equipment..................................... 15,583 14,401
-------- --------
Total cost............................................. 39,152 34,971
Less: accumulated depreciation and amortization............. (20,366) (18,667)
-------- --------
Premises and equipment, net............................ $ 18,786 $ 16,304
======== ========
</TABLE>
The Company leases certain banking facilities under noncancelable operating
leases which expire on various dates from 1997 through 2000. The leases contain
renewal options for varying terms expiring between 2001 through 2007 and require
the payment of property taxes, insurance and related expenses. The Company also
leases certain equipment under cancelable and noncancelable leases with terms of
up to three years. Total rent expense under operating leases amounted to
$270,000 in 1996, $234,000 in 1995 and $224,000 in 1994. Aggregate amounts of
minimum rental commitments under noncancelable operating leases are $397,000 and
for each of the years subsequent to December 31, 1996, are $141,000 (1997),
$141,000 (1998), $80,000 (1999), and $35,000 (2000).
NOTE 7 -- NOTES PAYABLE
Notes payable represent borrowings under a $20 million unsecured revolving
line of credit. The borrowings are structured as revolving notes and bear
interest at either prime floating or may, at the Company's option, be fixed at
1% above the London Interbank Offered Rate (LIBOR) for periods up to one year.
Periodic interest payments are required on revolving notes. On January 1, 1998,
the unpaid principal balance of the revolving notes will convert into a term
loan. The Company is required to make quarterly principal reductions beginning
January 1, 1998. The weighted average interest rate of notes payable at December
31, 1996 was 6.59%.
NOTE 8 -- COMMON AND PREFERRED SHARES
In 1987 shareholders authorized 12,000,000 no par value preferred shares.
The preferred shares may be issued in one or more series by the Board of
Directors, which has been given the authority to establish or change the number
of shares of each series, fix the designation and relative powers, preferences
and rights and restrictions. At December 31, 1996 and 1995 there were no
preferred shares issued.
In March, 1993, the Company filed a Registration Statement on Form S-8
registering 959,000 common shares for issuance pursuant to the Company's stock
option plans. Common shares issued pursuant to the exercise of stock options
totaled 27,673 in 1996, 23,387 in 1995 and 81,700 in 1994.
On June 19, 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. The shares will be repurchased from time to time in the open market or in
private transactions. In 1996 the Company repurchased 87,300 common shares at a
cost of $1,852,000 and reissued 1,275 treasury shares upon the exercise of stock
options.
45
<PAGE> 46
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 -- STOCK OPTION PLANS
In April, 1991, shareholders approved the 1990 Executive Equity Incentive
Plan ("the Plan") which provides for the grant to certain officers and key
employees of the Company of incentive and non-qualified stock options, tandem
stock appreciation rights, stand-alone stock appreciation rights and limited
stock appreciation rights, with respect to not more than 450,000 common shares.
The Plan replaced the 1987 Stock Option Plan ("Prior Plan") for grants of stock
options after September, 1990. The Prior Plan provided for options of up to
750,000 common shares. Options outstanding under the Prior Plan retain the terms
as set forth at the time such options were granted. The Plan and the Prior Plan
("Option Plans") are administered by a Committee of the Board of Directors.
The exercise prices of stock options granted under Option Plans were equal
to the market prices on the dates of grant, and each such option has a maximum
duration of ten years. Each option generally becomes exercisable in up to four
annual installments, commencing one year from the date of grant.
A summary of the Company's stock options for the years ended December 31,
1996 and 1995 is presented below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------ ------------------
WEIGHTED WEIGHTED
OPTION AVERAGE OPTION AVERAGE
SHARES PRICE SHARES PRICE
------ -------- ------ --------
<S> <C> <C> <C> <C>
Balance, beginning of period................................ 710 $8.60 723 $ 8.39
Granted................................................... -- -- 10 $16.50
Exercised................................................. (29) $5.55 (23) $ 5.55
Forfeited................................................. -- -- -- --
--- ---
Balance, end of period...................................... 681 $8.73 710 $ 8.60
=== ===
</TABLE>
For options granted in 1995, the compensation cost as determined under SFAS
123 (based on the fair value of options at the grant date) was not material.
A summary of the Company's outstanding and exercisable options at December
31, 1996 is presented below (in thousands):
<TABLE>
<CAPTION>
EXERCISABLE
OUTSTANDING OPTIONS OPTIONS
------------------------------- ------------------
WEIGHTED AVERAGE WEIGHTED
OPTION AVERAGE REMAINING OPTION AVERAGE
SHARES PRICE LIFE SHARES PRICE
------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C>
Exercise Price Ranges:
$5.55 - $7.20................................... 425 $ 6.31 1.6 yrs 425 $ 6.31
$10.125 - $16.50................................ 256 $12.74 5.4 yrs 204 $12.02
--- ---
Total........................................ 681 629
=== ===
</TABLE>
NOTE 10 -- PROFIT SHARING PLAN
The Company and its subsidiaries have a noncontributory profit sharing plan
which covers substantially all employees who meet certain age and employment
requirements. The contribution to the plan is made in accordance with a
resolution passed by the Board of Directors. Charges to expense with respect to
the plan for the years ended December 31, 1996, 1995 and 1994 amounted to
$1,184,000, $940,000 and $1,211,000, respectively.
46
<PAGE> 47
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 -- INCOME TAXES
The components of income tax expense (benefit) for the years ended December
31, 1996, 1995 and 1994 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Current:
Federal................................................... $5,644 $5,370 $5,078
State..................................................... 1,605 1,397 1,385
------ ------ ------
Total current.......................................... 7,249 6,767 6,463
------ ------ ------
Deferred:
Federal................................................... (338) (439) (598)
State..................................................... (8) (25) (61)
------ ------ ------
Total deferred......................................... (346) (464) (659)
------ ------ ------
Total income tax expense $6,903 $6,303 $5,804
====== ====== ======
</TABLE>
A reconciliation of the federal statutory tax rate to the Company's
effective tax rate for the years ended December 31, 1996, 1995 and 1994 is as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Federal income tax at statutory rate........................ 35.0% 35.0% 35.0%
State income tax, net of federal income tax benefit......... 4.7 4.6 4.8
Amortization of goodwill.................................... 1.8 1.5 1.3
Tax-exempt interest income, less disallowed interest
expense................................................... (9.7) (8.3) (8.8)
Other, net.................................................. (.1) (.6) (.4)
---- ---- ----
Actual effective income tax rate....................... 31.7% 32.2% 31.9%
==== ==== ====
</TABLE>
The tax effects of temporary differences which comprise the significant
portions of the Company's deferred tax assets and deferred tax liabilities as of
December 31, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses................................. $ 3,690 $ 3,283
Loan fees................................................. 288 438
State net operating loss carryforward..................... 232 273
Compensation expense...................................... 594 513
Other..................................................... 123 251
------- -------
4,927 4,758
------- -------
Deferred tax liabilities:
Purchase accounting adjustments........................... (3,607) (2,259)
Net unrealized gains on securities........................ (1,008) (1,084)
Depreciation.............................................. (85) (50)
Other..................................................... (6) (1)
------- -------
(4,706) (3,394)
------- -------
Net deferred tax assets................................ $ 221 $ 1,364
======= =======
</TABLE>
47
<PAGE> 48
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
No valuation allowances were established at December 31, 1996 and 1995. In
1996 the change in net deferred taxes reflected $1,530,000 of net deferred tax
liabilities from the Lockport acquisition. State net operating loss
carryforwards at December 31, 1996 expire under current law as follows:
$1,178,000 in 2002, $1,596,000 in 2003, $815,000 in 2004, $806,000 in 2005 and
$488,000 in 2006.
NOTE 12 -- COMMITMENTS AND CONTINGENT LIABILITIES
Credit
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include lines of credit, letters of credit and other
commitments to extend credit. Each of these instruments involves, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets. The Company uses the same credit
policies and requires similar collateral in approving lines of credit and
commitments and issuing letters of credit as it does in making loans. The
exposure to credit losses on financial instruments is represented by the
contractual amount of these instruments; however, the Company does not
anticipate any losses from these instruments.
The off-balance sheet financial instruments whose contract amounts
represent credit risk at December 31, 1996 and 1995 are as follows (in
thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Commitments to extend credit:
Unused lines of credit:
Commercial and other................................... $ 66,994 $ 59,571
Home equity............................................ 19,808 17,010
Commitments to originate credit........................... 29,019 31,445
-------- --------
Total............................................. $115,821 $108,026
======== ========
Letters of credit........................................... $ 9,199 $ 6,555
======== ========
</TABLE>
Lines of credit are agreements by which the Bank agrees to provide a
borrowing accommodation up to a stated amount as long as there is no violation
of any condition established in the loan agreement. The borrower may
periodically reduce or retire amounts drawn under a line and subsequently redraw
these amounts. Lines of credit generally have fixed expiration dates or other
termination clauses and may require payment of a fee.
Commitments to originate credit represent approved commercial and real
estate loans which generally are expected to be funded within ninety days.
Letters of credit are conditional commitments issued by the Company to
guarantee the financial performance of customers to third parties. Letters of
credit are primarily issued to facilitate trade or support borrowing
arrangements and generally expire in one year or less. The credit risk involved
in issuing letters of credit is essentially the same as that involved in
extending credit facilities to customers.
Concentrations of Credit Risks
In addition to financial instruments with off-balance sheet risk, the
Company, to a certain extent, is exposed to varying risks associated with
concentrations of credit. Concentrations of credit risk generally exist if an
individual or number of counterparties are engaged in similar activities and
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by economic or other
conditions.
48
<PAGE> 49
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1996, approximately 64% of the securities portfolio is
comprised of mortgage-backed securities which consist of pass-through securities
directly or implicitly backed by the full faith and credit of the United States
government. Concentrations of securities of a single issuer consisted of
investments in tax-exempt obligations issued by the Village of Alsip. At
December 31, 1996, the amortized cost and market value of Village of Alsip
securities were $8,440,000 and $8,835,000, respectively. In addition to
securities, the Company has granted tax-exempt loans to the Village of Alsip
which totaled $4,527,000 at December 31, 1996. All securities and loans are
secured by the general taxing authority of the respective issuer except for
$370,000 in securities which are secured solely by revenue from certain real
estate taxes. Some loans are further secured by real estate or other marketable
collateral.
The Company conducts substantially all of its lending activities in the
southwest suburbs of Chicago and, to a lesser extent, the Chicago metropolitan
area. Loans granted to businesses are primarily secured by business assets,
owner-occupied real estate or personal assets of commercial borrowers. Loans to
individuals are primarily secured by automobiles, residential real estate or
other personal assets. Since the Company's borrowers and its loan collateral
have geographic concentration in the Chicago metropolitan area, the Company
could have exposure to a decline in the local economy and real estate market.
However, management believes that the diversity of its customer base and local
economy, its knowledge of the local market, and its proximity to customers
limits the risk of exposure to adverse economic conditions.
Litigation
The Company is a defendant in certain claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material adverse effect on the consolidated financial
condition of the Company.
NOTE 13 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
As a financial institution, most of the Company's assets and liabilities
are considered financial instruments. However, many of the Company's financial
instruments lack an available trading market as characterized by a willing buyer
and willing seller engaging in an exchange transaction.
49
<PAGE> 50
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Presented below are the carrying amounts and estimated fair values of the
Company's financial instruments as of December 31, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents......................... $ 43,830 $ 43,830 $ 49,879 $ 49,879
Securities:
Held-to-maturity............................... 115,913 117,046 97,456 99,306
Available-for-sale............................. 392,754 392,754 318,159 318,159
Trading 262 262 -- --
Loans, net........................................ 629,597 636,671 561,017 568,682
Interest receivable............................... 7,419 7,419 6,587 6,587
Financial Liabilities:
Demand deposits................................... 185,705 185,705 161,400 161,400
NOW, money market and savings deposits............ 394,438 394,438 376,949 376,949
Time deposits..................................... 473,160 473,184 376,943 377,287
Federal funds purchased........................... 13,000 13,000 -- --
Securities sold under agreements to repurchase.... 40,706 40,706 47,002 47,002
Notes payable..................................... 7,000 7,000 -- --
Interest payable.................................. 3,410 3,410 2,796 2,796
</TABLE>
The estimated fair values of financial instruments have been determined by
the Company using available market information and appropriate valuation
methodologies. However, considerable judgment was used by the Company in
interpreting market data to develop the estimates of fair value. In addition,
significant estimations and present value calculations were used by the Company
for purposes of this disclosure. Accordingly, the estimates presented herein are
not necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and estimation
methodologies may have a material effect on the estimated fair value amounts.
The Company has used an entry-value market perspective as a basis of
estimating the fair value of most financial instruments. For purposes of fair
value disclosures the carrying values of cash and cash equivalents, accrued
interest receivable, demand deposits, NOW accounts, money market accounts,
savings deposits, federal funds purchased, securities sold under agreements to
repurchase, notes payable and interest payable are assumed to approximate fair
value since these assets and liabilities have no stated maturity or are
relatively short-term financial instruments.
Securities have been valued using quoted market prices, dealer quotes or
prices from independent pricing services that specialize in matrix pricing and
modeling techniques.
Net loans with stated maturities have been valued using present value
discounted cash flow techniques. The discount rates used to calculate the fair
values of loans were the applicable risk-adjusted spreads to the US Treasury
curve to approximate current entry-value interest rates applicable to each
category. No adjustment was made to the entry-value interest rates for changes
in credit of performing loans for which there are no known credit concerns. The
Company believes that the risk factor embedded in the entry-value interest rates
results in a fair valuation of such loans on an entry-value basis. It is assumed
that the fair value of floating rate loans approximates the recorded book value.
For real estate loans, contractual cash flows were adjusted for anticipated
prepayments. For loans delinquent ninety days or more and nonaccrual loans, fair
value is assumed to equal the recorded book value less specific reserves which
have been allocated to these financial instruments.
50
<PAGE> 51
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Time deposits with stated maturities have been valued using present value
discounted cash flow techniques. The discount rates used to calculate the fair
value of time deposits were the market rates currently offered for deposits of
similar remaining maturities.
There is no material difference between the contract amount and the
estimated fair value of off-balance sheet items which are primarily comprised of
unfunded loan commitments which are either floating-rate or generally funded
within ninety days.
NOTE 14 -- CONDENSED FINANCIAL STATEMENTS -- PARENT COMPANY
The following presents the condensed Balance Sheets as of December 31, 1996
and 1995, and Statements of Income and Statements of Cash Flows for each of the
three years ended December 31, 1996, for Heritage Financial Services, Inc. (in
thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
BALANCE SHEETS
Cash........................................................ $ 2,678 $ 636
Trading securities.......................................... 262 --
Investment in bank subsidiary............................... 108,629 94,878
Investment in non-bank subsidiary........................... 1,761 1,588
Other assets................................................ 153 187
-------- -------
Total assets......................................... $113,483 $97,289
======== =======
Notes payable............................................... $ 7,000 $ --
Other liabilities........................................... 796 506
Shareholders' equity........................................ 105,687 96,783
-------- -------
Total liabilities and shareholders' equity........... $113,483 $97,289
======== =======
</TABLE>
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
STATEMENTS OF INCOME
Income:
Dividends from bank subsidiary............................ $18,500 $10,500 $13,000
Other income.............................................. 71 40 24
------- ------- -------
Total income......................................... 18,571 10,540 13,024
------- ------- -------
Expenses:
Interest on notes payable................................. 604 187 197
Salaries and employee benefits............................ 564 559 464
Other expenses............................................ 429 320 368
------- ------- -------
Total expenses....................................... 1,597 1,066 1,029
------- ------- -------
Income before income taxes and equity in undistributed
earnings of subsidiaries.................................. 16,974 9,474 11,995
Income tax benefit.......................................... (634) (460) (395)
Equity in undistributed earnings of subsidiaries............ (2,770) 3,360 27
------- ------- -------
Net income........................................... $14,838 $13,294 $12,417
======= ======= =======
</TABLE>
51
<PAGE> 52
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
STATEMENTS OF CASH FLOWS
Operating Activities:
Net income................................................ $ 14,838 $13,294 $ 12,417
Adjustments to reconcile net income to cash provided by
operating activities:
Equity in undistributed earnings of subsidiaries..... 2,770 (3,360) (27)
Depreciation and amortization........................ -- -- 2
Increase (decrease) in accrued expenses.............. 316 (48) 98
Other, net........................................... 6 (94) 70
-------- ------- --------
Net cash provided by operating activities.............. 17,930 9,792 12,560
-------- ------- --------
Investing Activities:
Acquisition of bank subsidiary............................ (16,820) -- (16,545)
Purchase of trading security.............................. (250) -- --
-------- ------- --------
Net cash used in investing activities.................. (17,070) -- (16,545)
-------- ------- --------
Financing Activities:
Proceeds from notes payable............................... 14,000 -- 8,000
Principal payments on notes payable....................... (7,000) (6,500) (1,500)
Proceeds from stock option exercises...................... 159 129 690
Dividends paid............................................ (4,125) (3,492) (2,847)
Purchases of common stock................................. (1,852) -- --
-------- ------- --------
Net cash provided by (used in) financing activities.... 1,182 (9,863) 4,343
-------- ------- --------
Net increase (decrease) in cash............................. 2,042 (71) 358
Cash at beginning of year................................... 636 707 349
-------- ------- --------
Cash at end of year......................................... $ 2,678 $ 636 $ 707
======== ======= ========
Supplemental disclosures:
Interest paid............................................. $ 582 $284 $100
Income tax benefit received............................... 634 460 395
</TABLE>
NOTE 15 -- REGULATORY RESTRICTIONS AND CAPITAL ADEQUACY
Heritage Bank ("the Bank") is required to maintain vault cash and
non-interest-bearing balances with the Federal Reserve Bank to satisfy reserve
requirements. The average reserve requirement balances for the years ended
December 31, 1996 and 1995 were $15,126,000 and $15,353,000, respectively.
The Bank is subject to various capital requirements administered by its
principal regulatory agency. Failure to meet minimum capital requirements can
initiate certain mandatory-and possibly additional discretionary-actions by
regulators that, if undertaken could have a direct material effect on the Bank's
and consolidated financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier I capital (as defined in the regulations) to risk-weighted assets (as
defined), and Tier I capital (as defined) to average assets (as defined). The
following
52
<PAGE> 53
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
table sets forth the actual and required regulatory capital amounts and ratios
of the Company and the Bank as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
TO BE WELL
MINIMUM FOR CAPITALIZED UNDER
CAPITAL ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
--------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1996
Tier I Capital to Average Assets
Consolidated........................ $85,757 7.19% >= $47,723 4.00%
Bank................................ 87,537 7.36% >= 47,558 4.00% >= $59,448 5.00%
Tier I Capital to Risk Weighted Assets
Consolidated........................ 85,757 12.74% >= 26,915 4.00%
Bank................................ 87,537 13.03% >= 26,874 4.00% >= 40,311 6.00%
Total Capital to Risk Weighted Assets
Consolidated........................ 94,183 14.00% >= 53,830 8.00%
Bank................................ 95,948 14.28% >= 53,748 8.00% >= 67,185 10.00%
DECEMBER 31, 1995
Tier I Capital to Average Assets
Consolidated........................ $81,356 7.75% >= $41,982 4.00%
Bank................................ 78,572 7.51% >= 41,833 4.00% >= $52,292 5.00%
Tier I Capital to Risk Weighted Assets
Consolidated........................ 81,356 13.41% >= 24,269 4.00%
Bank................................ 78,572 12.95% >= 24,277 4.00% >= 36,415 6.00%
Total Capital to Risk Weighted Assets
Consolidated........................ 88,954 14.66% >= 48,539 8.00%
Bank................................ 86,169 14.20% >= 48,554 8.00% >= 60,692 10.00%
</TABLE>
Management believes that the Company and the Bank meet all capital adequacy
requirements as of December 31, 1996. The most recent notification from the
FDIC, dated December 31, 1996, categorized the Bank as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Bank must maintain minimum Tier 1 and Total risk-based
capital ratios and Tier 1 leverage ratios as set forth in the table above. Since
December 31, 1996, there are no conditions or events that management believes
have changed the Bank's capital category.
Regulatory authorities limit the amount of dividends which can be paid by
Heritage Bank to Heritage Financial Services, Inc. without prior approval from
such authorities. At December 31, 1996, $27,614,000 of undistributed earnings of
the Bank were available for payment of dividends to Heritage Financial Services,
Inc. without prior regulatory approval.
53
<PAGE> 54
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
The following sets forth condensed quarterly results of operations for 1996
and 1995 (in thousands, except per share data):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
1996
Interest income.................................... $20,089 $21,015 $21,179 $21,541
Interest expense................................... 9,347 9,520 9,808 9,931
------- ------- ------- -------
Net interest income.............................. 10,742 11,495 11,371 11,610
Provision for loan losses.......................... 100 100 100 100
Other income....................................... 1,682 1,936 2,089 2,017
Other expense...................................... 7,364 7,751 7,699 7,987
Income tax expense................................. 1,483 1,811 1,804 1,805
------- ------- ------- -------
Net income....................................... $ 3,477 $ 3,769 $ 3,857 $ 3,735
======= ======= ======= =======
Net income per common share:
Primary.......................................... $.42 $.45 $.46 $.45
Fully diluted.................................... $.42 $.45 $.46 $.45
1995
Interest income.................................... $17,141 $18,377 $19,114 $19,228
Interest expense................................... 7,165 8,397 8,906 8,896
------- ------- ------- -------
Net interest income.............................. 9,976 9,980 10,208 10,332
Provision for loan losses.......................... 50 50 50 50
Other income....................................... 1,731 1,808 1,695 1,737
Other expense...................................... 7,096 7,058 6,678 6,838
Income tax expense................................. 1,500 1,465 1,730 1,608
------- ------- ------- -------
Net income....................................... $ 3,061 $ 3,215 $ 3,445 $ 3,573
======= ======= ======= =======
Net income per common share:
Primary.......................................... $.37 $.39 $.41 $.43
Fully diluted.................................... $.37 $.39 $.41 $.43
</TABLE>
54
<PAGE> 55
MANAGEMENT'S REPORT
Management of Heritage Financial Services, Inc. and subsidiaries (the
Company) has prepared and is responsible for the integrity and fairness of the
financial statements and other financial information included in this annual
report. The financial statements are prepared in accordance with generally
accepted accounting principles and, when appropriate, include amounts based on
management's estimates and judgment.
To meet its responsibility both for the integrity and fairness of these
financial statements and information, management maintains accounting systems
and related internal accounting controls. These systems and controls provide for
an appropriate division of responsibility and are designed to provide reasonable
assurance that transactions are properly authorized and recorded, that assets
are safeguarded and financial records are reliably maintained.
The Company monitors the effectiveness and compliance of its internal
control systems through a continuous program of internal audits. Management has
reviewed the recommendations of its internal auditors and Arthur Andersen LLP,
independent auditors, and has responded in an appropriate, cost-effective
manner.
The Audit Committee of the Board of Directors, composed of three outside
directors, meets periodically with the Company's internal auditors and the
independent auditors to review matters relative to financial reporting, internal
accounting controls and the scope and results of audits. In addition, reports of
examination conducted by federal and state regulatory agencies are reviewed by
management and the Board of Directors.
RICHARD T. WOJCIK PAUL A. ECKROTH
Chairman and CEO Executive Vice President and Treasurer
55
<PAGE> 56
INDEPENDENT AUDITORS' REPORT
To the Shareholders of
Heritage Financial Services, Inc.:
We have audited the accompanying consolidated balance sheets of Heritage
Financial Services, Inc. and subsidiaries as of December 31, 1996 and 1995 and
the related consolidated statements of income, changes in shareholders' equity
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Heritage
Financial Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and
the results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 17, 1997
56
<PAGE> 57
INDEPENDENT AUDITORS' REPORT
To the Shareholders of
Heritage Financial Services, Inc.:
We have audited the accompanying consolidated statements of income, changes
in shareholders' equity and cash flows of Heritage Financial Services, Inc. and
subsidiaries for the year ended December 31, 1994. These financial statements
are the responsibility of the management of Heritage Financial Services, Inc.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the results of operations and cash flows of Heritage
Financial Services, Inc. and subsidiaries for the year ended December 31, 1994
in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Chicago, Illinois
January 19, 1995
57
<PAGE> 58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The disclosure called for by paragraph (a) of Regulation S-K Item 304, has
been previously reported (on Form 8-K dated February 15, 1995) as that term is
defined in Rule 12b-2 under the Exchange Act. As a result, pursuant to the
Instructions to Item 304 such disclosure need not be provided here.
PART III
ITEMS 10, 11, 12 AND 13
The Company has filed a definitive proxy statement with the Securities and
Exchange Commission pursuant to Regulation 14A under the 1934 Act not later than
120 days after the close of the Company's fiscal year ended December 31, 1996.
Accordingly, pursuant to General Instruction G(3), the information called for by
Part III of Form 10-K (except for the Section "Executive Officers of the
Registrant" included in Part I hereof) has been omitted and is incorporated
herein by reference from the proxy statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) -- Financial Statements and Financial Statement Schedules
The following consolidated financial statements and financial statement
schedules of the registrant are filed as a part of this document under Item 8.
Financial Statements and Supplementary Data:
Consolidated Balance Sheets -- December 31, 1996 and 1995
Consolidated Statements of Income -- For the Years Ended December 31,
1996, 1995 and 1994
Consolidated Statements of Changes in Shareholders' Equity -- For the
Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows -- For the Years Ended December
31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements -- For the Years Ended
December 31, 1996, 1995 and 1994
Quarterly Financial Data
(a)(3) -- Exhibits
(a)(3) -- The exhibits required by Item 601 of Regulation S-K and filed
herewith are listed in the Exhibit Index which follows the Signature Page and
immediately precedes the exhibits filed. The management contracts and
compensatory plans and arrangements which are required to be filed are listed in
the Exhibit Index as Exhibit Numbers 10(a) - 10(i) inclusive.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed by the registrant during the
quarter ended December 31, 1996.
58
<PAGE> 59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Heritage Financial Services, Inc. has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized,
on this the 5th day of March, 1997.
HERITAGE FINANCIAL SERVICES, INC.
(Registrant)
by /s/ Richard T. Wojcik
------------------------------------
Richard T. Wojcik
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 5th day of March, 1997 by the following
persons on behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE AND TITLE SIGNATURE AND TITLE
------------------- -------------------
<S> <C> <C>
by /s/ Richard T. Wojcik by /s/ Lael W. Mathis*
---------------------------------------- ----------------------------------------
Richard T. Wojcik, Chairman of the Board Lael W. Mathis, Director
(Principal Executive Officer) and
Director
by /s/ Frederick J. Sampias by /s/ Jack Payan*
---------------------------------------- ----------------------------------------
Frederick J. Sampias, President and Jack Payan, Director
Director
by /s/ Paul A. Eckroth by /s/ Arthur E. Sieloff*
---------------------------------------- ----------------------------------------
Paul A. Eckroth, Executive Vice Arthur E. Sieloff, Director
President and Treasurer (Principal
Financial and Accounting Officer)
by by /s/ John L. Sterling*
---------------------------------------- ----------------------------------------
John J. Gallagher, Director John L. Sterling, Director
by /s/ Ronald P. Groebe by
---------------------------------------- ----------------------------------------
Ronald P. Groebe, Director Chester Stranczek, Director
by /s/ Arthur G. Tichenor*
----------------------------------------
Arthur G. Tichenor, Director
by /s/ Dominick J. Velo*
----------------------------------------
Dominick J. Velo, Director
*Signed by /s/ Frederick J. Sampias
-------------------------------
Frederick J. Sampias
Attorney-in-Fact
</TABLE>
59
<PAGE> 60
HERITAGE FINANCIAL SERVICES, INC.
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION AND PAGE OR INCORPORATION REFERENCE
- ------- -----------------------------------------------
<C> <S>
2(a) Merger Agreement dated as of April 25, 1994, by and between
Midlothian State Bank and Heritage Bank Midlothian and
joined in by Heritage Financial Services, Inc. (incorporated
by reference to the Registrant's Current Report on Form 8-K
dated July 8, 1994).
2(b) Supplemental Agreement dated as of April 25, 1994, by and
among Ollie J. Yates, Eugene J. Winston, Peter J. Feil,
Joseph Krol and Henry J. Milen ("Sellers"), Midlothian State
Bank and Heritage Financial Services, Inc. (incorporated by
reference to the Registrant's Current Report on Form 8-K
dated July 8, 1994).
2(c) Stock Purchase Agreement dated September 28, 1995, by and
among Heritage Financial Services, Inc., Old Kent Financial
Corporation and Old Kent-Illinois, Inc. and List of exhibits
thereto (incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1995).
3(a) Articles of Incorporation of the Registrant (incorporated by
reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1994).
3(b) By-laws of the Registrant (incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1994).
4(a) Articles of Incorporation (See Exhibit 3(a) above).
4(b) Specimen Common Share Certificate (incorporated by reference
to the Registrant's Registration Statement (No. 33-8693) on
Form S-1, effective October 14, 1986, File No. 0-15059).
4(c) By-laws (See Exhibit 3(b) above).
9(a) Voting Trust Agreement dated as of December 31, 1985 among
Carl C. Greer as voting trustee and individually; James A.
Henshall, Jr., Herbert A. Vance, Jr., Melinda Martin Vance,
Joyce Martin Brown, and Eloise W. Martin, all individually;
trustees of the testamentary trusts created under the Will
of Harold T. Martin, Deceased; and certain corporations and
Amendment dated as of September 10, 1986 (incorporated by
reference to the Registrant's Registration Statement (No.
33-8693) on Form S-1, effective October 14, 1986, File No.
0-15059).
9(b) Extension of Voting Trust Agreement dated as of December 31,
1985 (incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995).
10(a) 1987 Stock Option Plan, including Amendment (incorporated by
reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1987).
10(b) 1990 Executive Equity Incentive Plan (incorporated by
reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1990).
10(c) Indemnification Agreement dated June 12, 1990 between the
Registrant and Ronald P. Groebe (incorporated by reference
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1990) and Schedule of Indemnification
Agreements executed by other Directors of the Registrant
(incorporated by reference to the Registrant's Annual Report
on form 10-K for the year ended December 31, 1994).
10(d) Amended and Restated Employment Agreement dated as of
January 19, 1995 between the Registrant and Ronald P. Groebe
and Schedule of Employment Agreements executed by Richard T.
Wojcik, Frederick J. Sampias and Paul A. Eckroth
(incorporated by reference to the Registrant's Annual Report
on form 10-K for the year ended December 31, 1994).
</TABLE>
60
<PAGE> 61
HERITAGE FINANCIAL SERVICES, INC.
EXHIBIT INDEX (CONTINUED)
(Pursuant to Item 601 of Regulation S-K)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION AND PAGE OR INCORPORATION REFERENCE
- ------- -----------------------------------------------
<C> <S>
10(e) (i) Agreement to Substitute Deferred Compensation Trust and
(ii) Deferred Compensation Trust Under Heritage Financial
Services Plan(s), each dated as of January 19, 1995 between
the Registrant and Dominick J. Velo as Trustee (incorporated
by reference to the Registrant's Annual Report on form 10-K
for the year ended December 31, 1994).
10(f) Amendment #1 to 1995 Deferred Compensation Trust, dated as
of November 19, 1996, between the Registrant and Dominick J.
Velo as Trustee (filed herewith).
10(g) Amended and Restated Employment Termination Benefits
Agreement dated as of January 19, 1995 between the
Registrant and John E. Barry (incorporated by reference to
the Registrant's Annual Report on form 10-K for the year
ended December 31, 1994).
10(h) Amended and Restated Limited Employment Termination Benefits
Agreement dated as of January 19, 1995 between the
Registrant and Ramesh L. Ajwani and Schedule of Amended and
Restated Limited Employment Termination Benefits Agreements
between the Registrant and Each of Susan G. Peterson and
Albert A. Stroka (incorporated by reference to the
Registrant's Annual Report on form 10-K for the year ended
December 31, 1994).
10(i) Amendment #1 to Amended and Restated Limited Employment
Termination Benefits Agreement, dated as of November 19,
1996, between the Registrant and Ramesh L. Ajwani and
Schedule of Amendment #1s to Amended and Restated Limited
Employment Termination Benefits Agreements between the
Registrant and each of Susan G. Peterson and Albert A.
Stroka (filed herewith).
11 Statement Re Computation of Per Share Earnings (filed
herewith).
21 Subsidiaries of Registrant (filed herewith).
23(a) Consent of Arthur Andersen LLP (filed herewith).
23(b) Consent of Deloitte & Touche LLP (filed herewith).
24 Power of Attorney (filed herewith).
27 Financial Data Schedule (filed herewith).
</TABLE>
- -------------------------
Heritage Financial Services, Inc. will furnish those of the above exhibits which
are filed herewith to requesting security holders.
61
<PAGE> 1
EXHIBIT 10(f)
HERITAGE FINANCIAL SERVICES, INC.
AMENDMENT #1 TO 1995 DEFERRED COMPENSATION TRUST
THIS AMENDMENT #1 ("Amendment") to Trust Agreement dated January 19, 1995
(the "Agreement") is made as of the 19th day of November, 1996, by Heritage
Financial Services, Inc., an Illinois corporation ("Heritage"), and Dominick J.
Velo, as trustee (the "Trustee").
WITNESSETH THAT:
WHEREAS, as of January 19, 1995, Heritage established certain benefits
under the Employment Agreements of Richard T. Wojcik, Frederick J. Sampias,
Ronald P. Groebe and Paul A. Eckroth and under the Employment Termination
Benefits Agreements of Ramesh L. Ajwani, John E. Barry, Susan G. Peterson and
Albert A. Stroka, which benefits were to become payable in the event of
termination of employment by Heritage after a change of control, and the
totality of such benefits for each one of those eight named individuals were
described in the Agreement as a "Plan" and collectively as the "Plans".
WHEREAS, as of January 19, 1995, Heritage and the Trustee entered into the
Agreement and thereby established a trust for the purpose of providing a method
for the orderly funding and payment of benefits payable under the Plans.
WHEREAS, since the establishment of the Plans and the aforesaid trust, the
Employment Termination Benefits Agreements of Ramesh L. Ajwani, Susan G.
Peterson and Albert A. Stroka have been amended.
WHEREAS, as a result of the foregoing, it is desirable to amend the
Agreement.
NOW, THEREFORE, in consideration of the mutual undertakings of the parties
hereto, IT IS AGREED by Heritage and the Trustee, that the Agreement shall be
and hereby is amended as follows:
Appendix A to the Agreement is hereby amended to read in its entirety as
set forth on the Appendix A which is attached to, and made a part of, this
Amendment.
IN WITNESS WHEREOF, Heritage and the Trustee have caused this Amendment to
be executed on their behalf as of the Amendment date indicated above.
HERITAGE FINANCIAL
SERVICES, INC.
By /s/ Frederick J. Sampias /s/ Dominick J. Velo , Trustee
------------------------ -----------------------------------
Its President Dominick J. Velo, Trustee
<PAGE> 2
APPENDIX A--HERITAGE FINANCIAL SERVICES, INC. TRUST UNDER PLAN(S)
Individual Name of "Plan"
- -------------------- ----------------
Richard T. Wojcik Amended and Restated Employment Agreement of Richard T.
Wojcik dated as of January 19, 1995, including
particularly Sections 6, 7 and 8.(1)
Frederick J. Sampias Amended and Restated Employment Agreement of Frederick J.
Sampias dated as of January 19, 1995, including
particularly Sections 6, 7 and 8.(1)
Ronald P. Groebe Amended and Restated Employment Agreement of Ronald P.
Groebe dated as of January 19, 1995, including
particularly Sections 6, 7 and 8.(1)
Paul A. Eckroth Amended and Restated Employment Agreement of Paul A.
Eckroth dated as of January 19, 1995, including
particularly Sections 6, 7, and 8.(1)
John E. Barry Amended and Restated Employment Termination Benefits
Agreement of John E. Barry dated as of January 19, 1995,
including particularly Sections 2, 3, 4 and 5.(1)
Ramesh L. Ajwani Amended and Restated Limited Employment Termination
Benefits Agreement of Ramesh L. Ajwani dated as of
January 19, 1995 (2), including particularly Sections 2,
3, 4 and 5.(1)
Susan G. Peterson Amended and Restated Limited Employment Termination
Benefits Agreement of Susan G. Peterson dated as of
January 19, 1995 (2), including particularly Sections 2,
3, 4 and 5.(1)
Albert A. Stroka Amended and Restated Limited Employment Termination
Benefits Agreement of Albert A. Stroka dated as of
January 19, 1995 (2), including particularly Sections 2,
3, 4 and 5.(1)
__________________
(1) and those Sections and provisions which are related to the listed Sections.
(2) and amended as of November 19, 1996.
<PAGE> 1
EXHIBIT 10(i)
AMENDMENT #1 TO AMENDED AND RESTATED LIMITED
EMPLOYMENT TERMINATION BENEFITS AGREEMENT
THIS AMENDMENT #1 ("Amendment") to Amended and Restated Limited Employment
Termination Benefits Agreement dated as of January 19, 1995 (the "Agreement")
is made as of the 19th day of November, 1996, by Heritage Financial Services,
Inc., an Illinois corporation (the "Company"), and Ramesh L. Ajwani
(Employee).
Preliminary Recitals
1. Since Employee and the Company entered into the Agreement, the Company
has determined that, as an incentive to retain the services of Employee, it is
desirable to amend the Agreement to increase from six months to one year the
period during which Employee would receive compensation benefits payable in the
event of termination after a change in control of the Company.
2. Employee is willing to continue to serve the Company in consideration
of such enhancement in benefits.
3. This Amendment amends the Agreement as of the date of effectiveness
hereof.
NOW, THEREFORE, in consideration of the mutual undertakings of the parties
hereto and Employee's continued employment by the Company, the Company and
Employee AGREE as follows:
1. Preamble; Preliminary Recitals. The preamble and preliminary recitals
set forth above are hereby incorporated in and made a part of this Amendment.
2. Amendment. Subsections 4 (a) and (b) of the Agreement are hereby
amended to read in their entirety as follows (bold face):
<PAGE> 2
4. PAYMENTS AFTER TERMINATION UPON A CHANGE OF CONTROL.
(a) UPON AND AFTER A CHANGE OF CONTROL EMPLOYMENT TERMINATION THE COMPANY
SHALL:
(i) PAY EMPLOYEE (AT TIMES CONSISTENT WITH THE COMPANY'S PAYROLL
PRACTICES) FOR A PERIOD OF ONE (1) YEAR FROM THE DATE OF THE CHANGE OF
CONTROL EMPLOYMENT TERMINATION (THE "PAYMENT PERIOD"), COMPENSATION AT
AN ANNUAL RATE EQUAL TO EMPLOYEE'S BASE AMOUNT (AS HEREINAFTER
DEFINED); AND
(ii) THROUGHOUT THE PAYMENT PERIOD INCLUDE EMPLOYEE AS A
PARTICIPANT (AT THE COMPANY'S EXPENSE) IN ALL EMPLOYEE GROUP
HEALTH/MEDICAL PLANS.
(b) FOR THE PURPOSE OF THIS AGREEMENT, EMPLOYEE'S "BASE AMOUNT" SHALL
INCLUDE ALL AMOUNTS COMPRISING HIS THEN CURRENT COMPENSATION, INCLUDING,
WITHOUT LIMITATION, ALL SALARY AND INCENTIVE. NOTWITHSTANDING THE PRECEDING
PROVISIONS OF THIS SECTION 4, IF IT CAN BE CLEARLY SHOWN THAT THE PAYMENTS TO
BE MADE PURSUANT TO THIS SECTION 4 WOULD CAUSE THE IMPOSITION OF A PARACHUTE
PAYMENT EXCISE TAX ON EMPLOYEE (PURSUANT TO INTERNAL REVENUE CODE SECTION 4999
OR A SUCCESSOR SECTION), THE PAYMENTS TO BE MADE PURSUANT TO THIS SECTION 4
SHALL BE REDUCED TO THE EXTENT NECESSARY TO ELIMINATE SUCH PARACHUTE PAYMENT
EXCISE TAX TREATMENT.
IN WITNESS WHEREOF, the parties have entered into this Amendment as of the
Amendment date indicated above.
HERITAGE FINANCIAL SERVICES, INC.
/s/ Ramesh L. Ajwani By: /s/ Frederick J. Sampias
- ----------------------- ------------------------
Ramesh L. Ajwani Frederick J. Sampias
Employee President
2
<PAGE> 3
ATTACHMENT TO EXHIBIT 10(i)
SCHEDULE OF AMENDMENT #1S TO AMENDED AND RESTATED
LIMITED EMPLOYMENT TERMINATION BENEFITS AGREEMENTS
(OMITTED DOCUMENTS)
The Amendment #1s, dated as of November 19, 1996, to the Amended and
Restated Limited Employment Termination Benefits Agreements dated as of January
19, 1995 between the Registrant and each of Susan G. Peterson and Albert A.
Stroka are not filed herewith pursuant to Regulation S-K 601 Instruction 2.
The Amendment #1s to Amended and Restated Limited Employment Termination
Benefits Agreements with Ms. Peterson and Mr. Stroka are identical to the
Amendment #1 between the Registrant and Ramesh L. Ajwani filed herewith as an
Exhibit to the Report on Form 10-K.
<PAGE> 1
EXHIBIT 11
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
The calculation of the Registrant's primary and fully diluted earnings per
share required by Item 601(b)(11) of Regulation S-K is presented below (dollars
in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
PRIMARY
Net income................................................ $14,838 $13,294 $12,417
======= ======= =======
Average common shares outstanding......................... 7,932 7,937 7,901
Common stock equivalents -- net effect of the assumed
exercise of stock options -- based on the treasury
stock method using average market price................ 393 372 384
------- ------- -------
Average primary shares outstanding..................... 8,325 8,309 8,285
======= ======= =======
Primary earnings per share............................. $1.78 $1.60 $1.50
======= ======= =======
FULLY DILUTED
Net income................................................ $14,838 $13,294 $12,417
======= ======= =======
Average common shares outstanding......................... 7,932 7,937 7,901
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..................... 406 393 387
------- ------- -------
Average fully diluted shares outstanding............... 8,338 8,330 8,288
======= ======= =======
Fully diluted earnings per share....................... $1.78 $1.60 $1.50
======= ======= =======
</TABLE>
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES
The following are wholly owned subsidiaries of the Registrant:
1. Heritage Bank
2. First National Bank of Lockport*
3. Heritage Trust Company
- ------
* Except for directors' qualifying shares.
<PAGE> 1
EXHIBIT 23(a)
CONSENT OF ARTHUR ANDERSEN LLP
We consent to the incorporation by reference in the Registration Statement
No. 33-59924 of Heritage Financial Services, Inc. on Form S-8 of our report
dated January 17, 1997, appearing in this Annual Report on Form 10-K of Heritage
Financial Services, Inc. for the year ended December 31, 1996.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 5, 1997
<PAGE> 1
EXHIBIT 23(b)
CONSENT OF DELOITTE & TOUCHE LLP
We consent to the incorporation by reference in the Registration Statement
No. 33-59924 of Heritage Financial Services, Inc. on Form S-8 of our report
dated January 19, 1995, appearing in this Annual Report on Form 10-K of Heritage
Financial Services, Inc. for the year ended December 31, 1996.
DELOITTE & TOUCHE LLP
Chicago, Illinois
March 5, 1997
<PAGE> 1
Exhibit 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Richard T. Wojcik, Frederick J. Sampias
and Ronald P. Groebe, or any of them, the undersigned's true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
to act for the undersigned and in the undersigned's name, place and stead, in
any and all capabilities, to sign the Annual Report on Form 10-K of HERITAGE
FINANCIAL SERVICES, INC. for the fiscal year ended December 31, 1996 and any
and all amendments thereto and to file the same, with all exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent, full power and
authority to do and perform each and every act and thing requisite or necessary
to be done in and about the premises, as fully to all intents and purposes as
the undersigned might or could do in person, hereby ratifying and confirming
all that said attorney-in-fact and agent, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Dated February 18, 1997
/s/ Lael W. Mathis
- ----------------------- ---------------------
John J. Gallagher Lael W. Mathis
/s/ Jack Payan /s/ Arthur E. Sieloff
- ----------------------- ---------------------
Jack Payan Arthur E. Sieloff
/s/ John L. Sterling
- ----------------------- ---------------------
John L. Sterling Chester Stranczek
/s/ Arthur G. Tichenor /s/ Dominick J. Velo
- ----------------------- ---------------------
Arthur G. Tichenor Dominick J. Velo
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-END> DEC-31-1996 DEC-31-1996
<CASH> 43621 43621
<INT-BEARING-DEPOSITS> 209 209
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 262 262
<INVESTMENTS-HELD-FOR-SALE> 392754 392754
<INVESTMENTS-CARRYING> 115913 115913
<INVESTMENTS-MARKET> 117046 117046
<LOANS> 639004 639004
<ALLOWANCE> 9407 9407
<TOTAL-ASSETS> 1229020 1229020
<DEPOSITS> 1053303 1053303
<SHORT-TERM> 60706 60706
<LIABILITIES-OTHER> 9324 9324
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 4979 4979
<OTHER-SE> 100708 100708
<TOTAL-LIABILITIES-AND-EQUITY> 1229020 1229020
<INTEREST-LOAN> 13470 52907
<INTEREST-INVEST> 7958 30223
<INTEREST-OTHER> 113 694
<INTEREST-TOTAL> 21541 83824
<INTEREST-DEPOSIT> 9436 36327
<INTEREST-EXPENSE> 9931 38606
<INTEREST-INCOME-NET> 11610 45218
<LOAN-LOSSES> 100 400
<SECURITIES-GAINS> 32 120
<EXPENSE-OTHER> 7987 30801
<INCOME-PRETAX> 5540 21741
<INCOME-PRE-EXTRAORDINARY> 5540 21741
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 3735 14838
<EPS-PRIMARY> .45 1.78
<EPS-DILUTED> .45 1.78
<YIELD-ACTUAL> 4.43 4.43
<LOANS-NON> 3421 3421
<LOANS-PAST> 783 783
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 9529 8477
<CHARGE-OFFS> 341 925
<RECOVERIES> 119 276
<ALLOWANCE-CLOSE> 9407 9407
<ALLOWANCE-DOMESTIC> 9407 9407
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
