UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
Quarterly Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 1998
Commission File Number 0-15059
HERITAGE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Illinois 36-3139645
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
17500 South Oak Park Avenue
Tinley Park, Illinois 60477
(Address of principal executive offices) (Zip code)
(708) 532-8000
(Registrant's telephone number, including area code)
Former name, former address and former fiscal year, if changed from
last report: NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirement for the
past 90 days. Yes/X/ No
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Class Outstanding at May 11, 1998
Common Shares, no par value 12,545,924
<TABLE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
<CAPTION>
March 31, December 31,
1998 1997
ASSETS ------- -------
<S> <C> <C>
Cash and due from banks $35,088 $48,214
Federal funds sold and interest-bearing deposits 43,255 2,864
------- -------
Total cash and cash equivalents 78,343 51,078
Securities:
Held-to-maturity (market value: $114,923 in
1998 and $116,544 in 1997) 111,393 113,101
Available-for-sale, at market 380,516 407,087
Trading, at market 471 450
------- -------
Total securities 492,380 520,638
Loans, net of unearned income 718,533 711,541
Less: allowance for loan losses (9,801) (9,621)
------- -------
Net loans 708,732 701,920
Premises and equipment 19,352 19,585
Goodwill and core deposit intangibles 15,767 16,190
Other assets 10,519 9,910
------- -------
TOTAL ASSETS $1,325,093 $1,319,321
========= =========
LIABILITIES
Demand deposits 178,528 186,358
NOW and money market accounts 260,938 262,679
Savings deposits 190,895 189,128
Time deposits 504,048 501,466
------- -------
Total deposits 1,134,409 1,139,631
Securities sold under agreements to repurchase 52,442 45,569
Other liabilities 12,364 11,915
------- -------
TOTAL LIABILITIES 1,199,215 1,197,115
------- -------
SHAREHOLDERS' EQUITY
Preferred shares - no par value; shares authorized
12,000,000; shares issued: none - -
Common shares - no par value; shares authorized:
16,000,000; shares issued: 12,145,528 in 1998
and 12,128,313 in 1997 - -
Surplus 24,260 24,181
Retained earnings 96,130 93,346
Accumulated other comprehensive income 5,579 5,367
Treasury stock, at cost (5,000 shares in 1998
and 37,911 shares in 1997 (91) (688)
------- -------
TOTAL SHAREHOLDERS' EQUITY 125,878 122,206
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS'EQUITY $1,325,093 $1,319,321
======= =======
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
(unaudited)
<CAPTION>
Three Months Ended
March 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
INTEREST INCOME
Loans, including fees $14,913 $13,811
Securities:
Taxable 5,937 6,449
Exempt from federal income taxes 2,196 1,768
Federal funds sold and interest-bearing
deposits 303 13
-------- --------
TOTAL INTEREST INCOME 23,349 22,041
-------- --------
INTEREST EXPENSE
Deposits 10,454 9,480
Short-term borrowings 478 496
Notes payable - 81
-------- --------
TOTAL INTEREST EXPENSE 10,932 10,057
-------- --------
NET INTEREST INCOME 12,417 11,984
Provision for loan losses 150 150
-------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 12,267 11,834
-------- --------
OTHER INCOME
Service charges on deposit accounts 1,282 1,197
Income for trust services 211 193
Investment product fees 280 363
Other operating income 495 430
Securities gains 353 118
-------- --------
TOTAL OTHER INCOME 2,621 2,301
-------- --------
OTHER EXPENSE
Salaries and employee benefits 4,437 4,288
Net occupancy expense 752 855
Equipment expense 418 410
Data processing expense 499 296
Amortization of intangible assets 422 495
Other operating expenses 1,488 1,430
-------- --------
TOTAL OTHER EXPENSE 8,016 7,774
-------- --------
INCOME BEFORE INCOME TAXES 6,872 6,361
Income tax expense 2,127 2,030
-------- --------
NET INCOME $4,745 $4,331
======== ========
NET INCOME PER COMMON SHARE
Basic $0.39 $0.36
Diluted $0.38 $0.35
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING:
Basic 12,126,604 12,088,132
Diluted 12,521,716 12,480,237
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<CAPTION>
Three Months Ended
March 31,
------------------
1998 1997
OPERATING ACTIVITIES ----- -----
<S> <C> <C>
Net income $4,745 $4,331
Adjustments to reconcile net income to net cash
provided by operating activities:
Discount accretion on securities (558) (438)
Deferred loan fee accretion (170) (101)
Provision for loan losses 150 150
Securities gains (353) (118)
Depreciation and amortization 472 457
Deferred income taxes (96) (136)
Net amortization of purchase accounting
adjustments 513 665
Increase in accrued interest income (490) (971)
Increase (decrease) in accrued interest expense (102) 159
Other, net 206 652
------ ------
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,317 4,650
------ ------
INVESTING ACTIVITIES
Securities held-to-maturity:
Proceeds from maturities, repayments and calls 1,885 2,377
Securities available-for-sale:
Proceeds from maturities, repayments and calls 24,500 17,566
Proceeds from sales 11,304 22,635
Purchases (8,176) (38,797)
Net increase in loans (6,868) (16,786)
Purchases of premises and equipment (263) (816)
Proceeds from sales of other real estate owned 184 572
------ ------
NET CASH USED IN INVESTING ACTIVITIES 22,566 (13,249)
------ ------
FINANCING ACTIVITIES
Net increase (decrease) in deposits (5,206) 17,860
Net decrease in federal funds purchased - (13,000)
Net increase in securities sold
under agreeements to repurchase 6,873 2,344
Principal payments on notes payable - (2,000)
Proceeds from stock option exercises 50 818
Dividends paid (1,335) (1,212)
------ ------
NET CASH PROVIDED FROM FINANCING ACTIVITIES 382 4,810
------ ------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 27,265 (3,789)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 51,078 43,830
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $78,343 $40,041
====== ======
SUPPLEMENTAL DISCLOSURES:
Interest paid $11,050 $9,877
Income taxes paid 365 175
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Purchases of common shares $218 $1,223
<FN>
See accompanying notes to consolidated financial statements.
</TABLE>
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1-PROPOSED MERGER
On January 14, 1998, the Company, First Midwest Bancorp, Inc. ("First
Midwest") and First Midwest Acquisition Corporation, a wholly owned subsidiary
of First Midwest ("Acquisition Corporation"), entered into an Agreement and
Plan of Merger ("Merger Agreement") whereby the Company will be merged with and
into Acquisition Corporation (the "Merger"). Pursuant to the Merger
Agreement, the transaction will be structured as a tax-free exchange and
accounted for as a pooling-of-interests. Each of the Company's outstanding
common shares will be converted into 0.7695 shares of First Midwest common
stock. The Merger Agreement has been approved by the boards of directors of
both companies.
Incident to the entry into the Merger Agreement, the Company and First
Midwest executed a Stock Option Agreement (the "Option Agreement") pursuant to
which the Company granted First Midwest an option to acquire up to 2,400,000
common shares (representing 19.9% of the Company's then outstanding common
shares) at a price of $21.25 per share, subject to certain terms and conditions
set forth in the Option Agreement.
The Merger is conditioned upon, among other things, approval by the
shareholders of both the Company (as to the Merger) and First Midwest (as to
authorization of necessary shares) and receipt of customary regulatory
approvals. First Midwest has received approvals from the appropriate banking
agencies. Shareholder meetings for both Heritage and First Midwest have been
scheduled for June 17, 1998. It is anticipated that the acquisition will be
completed in early July, 1998.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements include the accounts of
Heritage Financial Services, Inc. and its subsidiaries (the "Company"). In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the financial position,
results of operations and cash flows for the interim periods have been made.
Certain amounts reported in prior periods have been reclassified for
presentation or comparative purposes. The results of operations for the three
months ended March 31, 1998 are not necessarily indicative of the results to
be expected for the entire fiscal year.
The unaudited interim financial statements have been prepared in conformity
with generally accepted accounting principles and reporting practices. Certain
information in footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles and
industry reporting practices has been condensed or omitted pursuant to rules
and regulations of the Securities and Exchange Commission, although the Company
believes the disclosures are adequate to make the information not misleading.
These financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's 1997 Form 10-K.
Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding for the period. Diluted earnings
per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock. The Company's potential dilutive instruments represent common shares
issuable under its stock option plans. Such common stock equivalents are
computed using the treasury stock method. Weighted average common shares have
been adjusted to reflect the Company's 1997 three-for-two stock split. The
computation of basic and diluted earnings per share is set forth in Exhibit 11
of this document.
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. ("SFAS") 131, "Disclosures
About Segments of an Enterprise and Related Information", which establishes
standards for public companies to report certain financial information about
operating segments in interim and annual financial statements. Operating
segments are components of a business about which separate financial
information is available and that are evaluated regularly by the chief
operating decision maker in assessing performance and deciding how to allocate
resources. The statement also requires public companies to report certain
information about their products and services and the geographic areas in which
they operate. SFAS 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The statement does not need to be applied
to interim financial statements in the initial year of its application, but
such comparative information will be required in interim statements in the
second year. At this time, management is assessing this statement and has not
determined whether the new reporting provisions will require supplemental
disclosures by the Company.
NOTE 3-COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS 130, "Reporting
Comprehensive Income", which establishes standards for reporting and display
of comprehensive income and its components. SFAS 130 requires that the
Company's unrealized gains or losses (net of related taxes) on securities
available-for-sale be included in other comprehensive income. Prior to adoption
of SFAS 130 unrealized gains or losses were reported separately in
shareholders' equity. The adoption of SFAS 130 had no impact on the Company's
net income or shareholders' equity. Prior year financial statements have been
reclassified to conform to the reporting requirements of SFAS 130.
<TABLE>
The components of comprehensive income, net of related taxes, for the three
months ended March 31, 1998 and 1997 are as follows (in thousands):
<CAPTION>
Three Months Ended
March 31,
------------------
1998 1997
----- -----
<S> <C> <C>
Net Income $4,745 $4,331
Unrealized gains (losses) on securities,
net of reclassification adjustment 212 (2,410)
----- -----
Comprehensive Income $4,957 $1,921
===== =====
Disclosure of Reclassification Amount:
Unrealized holding gains arising during the period $ 483 $(2,383)
Less: Reclassification adjustment for gains
included in net income (271) (27)
----- ------
Net unrealized gains (losses) on securities $ 212 $(2,410)
===== =======
</TABLE>
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
<TABLE>
NOTE 4-LOANS
The following table summarizes loan balances by category (in thousands):
<CAPTION>
March 31, December 31
1998 1997
---------- ----------
<S> <C> <C>
Commercial and industrial $158,042 $163,967
Commercial real estate 158,499 157,809
Construction 10,701 12,188
Residential real estate 291,001 275,482
Home equity 94,625 95,924
Other consumer 6,786 7,406
--------- ---------
Gross loans 719,654 712,776
Less: unearned income (1,121) (1,235)
--------- ---------
Total $718,533 $711,541
========= =========
</TABLE>
NOTE 5-COMMON SHARES
Pursuant to a Registration Statement on Form S-8 filed in March, 1993, as
amended by a Post-Effective Amendment filed in May, 1997, the Company registered
1,241,700 common shares for issuance pursuant to the Company's stock option
plans. During the three month period ended March 31, 1998, common shares
issued pursuant to the exercise of stock options totaled 17,215. Subsequent
to March 31, 1998, an additional 400,396 common shares were issued pursuant to
the exercise of stock options.
In June, 1996, the Company's board of directors approved a stock repurchase
program which authorized the repurchase of up to 325,000 common shares to be
used for the issuance of shares under the Company's stock option plan. In May,
1997, the board of directors authorized the repurchase of an additional 68,850
shares as a result of the Company's 1997 three-for-two stock split. The shares
were authorized to be repurchased from time to time in the open market or in
private transactions.
In conjunction with the approval of the Merger Agreement with First Midwest,
the Company rescinded the balance of its stock repurchase program. During the
three month period ended March 31, 1998, 7,605 treasury shares were acquired
through an exchange of common shares in exercises of stock options. During the
same period, 40,516 treasury shares were reissued upon the exercise of stock
options. Subsequent to March 31, 1998, an additional 74,260 treasury shares
were acquired through an exchange of common shares in exercises of stock
options, and 79,260 treasury shares were reissued upon the exercise of stock
options.
HERITAGE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
<TABLE>
NOTE 6-STOCK OPTIONS
A summary of stock option activity for the three months ended March 31,
1998 is presented below (shares in thousands):
<CAPTION>
Weighted
Option Average
Shares Price
------ ------
<S> <C> <C>
Balance, December 31, 1997 548 $6.55
Granted - -
Exercised (57) $4.69
Forfeited - -
------ ------
Balance, March 31, 1998 491 $6.77
====== ======
</TABLE>
<TABLE>
A summary of outstanding and exercisable stock options at March 31, 1998
is presented below (shares in thousands):
<CAPTION>
Outstanding Options Exercisable Options
-------------------- -------------------
Weighted Average Weighted
Option Average Remaining Option Average
Shares Price Life Shares Price
<S> <C> <C> <C> <C> <C>
Exercise Price Ranges ----- ----- ----- ----- -----
$4.73 - $7.08 361 $5.75 2.6 yrs 361 $5.75
$9.00 - $11.00 130 $9.60 5.2 yrs 126 $9.55
----- -----
Total 491 487
===== =====
</TABLE>
Subsequent to March 31, 1998, an additional 479,656 options were exercised
at a weighted average price of $6.67.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
The following represents management's analysis of the Company's results of
operations for the three months ended March 31, 1998 and 1997 and its
consolidated financial condition at March 31, 1998 as compared to December 31,
1997. This discussion should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere in this Form 10-Q.
PROPOSED MERGER
On January 14, 1998, the Company, First Midwest Bancorp, Inc. ("First
Midwest") and First Midwest Acquisition Corporation, a wholly owned subsidiary
of First Midwest ("Acquisition Corporation"), entered into an Agreement and
Plan of Merger ("Merger Agreement") whereby the Company will be merged with and
into Acquisition Corporation ("the Merger"). Pursuant to the Merger
Agreement, the transaction will be structured as a tax-free exchange and
accounted for as a pooling-of-interests. Each of the Company's outstanding
common shares will be converted into 0.7695 shares of First Midwest common
stock. The Merger Agreement has been approved by the boards of directors of
both companies.
Incident to the entry into the Merger Agreement, the Company and First
Midwest executed a Stock Option Agreement (the "Option Agreement") pursuant to
which the Company granted First Midwest an option to acquire up to 2,400,000
common shares (representing 19.9% of the Company's then outstanding common
shares) at a price of $21.25 per share, subject to certain terms and conditions
set forth in the Option Agreement.
The Merger is conditioned upon, among other things, approval by the
shareholders of both the Company (as to the Merger) and First Midwest (as to
authorization of necessary shares) and receipt of customary regulatory
approvals. First Midwest has received approvals from the appropriate banking
agencies. Shareholder meetings for both Heritage and First Midwest have been
scheduled for June 17, 1998. It is anticipated that the acquisition will be
completed in early July, 1998.
ANALYSIS OF INCOME STATEMENTS
SUMMARY OF OPERATIONS
Net income in the first quarter of 1998 increased to $4,745,000, up 10% from
$4,331,000 earned in the same quarter of 1997. On a diluted basis, earnings
per share for the quarterly period increased to 38 cents per share, up 9%
compared to 35 cents per share earned in the first quarter of 1997. The
Company's annualized return on average assets in the first quarter of 1998 was
1.46% compared to 1.43% in the year ago quarter. The annualized return on
average equity for the three month period was 15.69% in 1998 compared to 16.48%
in 1997.
Higher earnings in 1998 were principally due to an increase in net interest
income. In the first quarter of 1998, earnings were also affected by pre-tax
securities gains of $353,000 and $225,000 of data processing conversion
expenses. In the first quarter of 1997, earnings were positively affected by
a pre-tax recovery of $160,000 of interest income on a nonaccrual loan, the
reimbursement of $150,000 of legal costs related to litigation settled in 1996
and securities gains of $118,000.
NET INTEREST INCOME
<TABLE>
The following table sets forth the average balances, tax equivalent yields
and effective rates for the major categories of earning asset and
interestbearing liabilities for the three months ended March 31, 1998 and 1997
(in thousands):
<CAPTION>
Three Months Ended March 31,
-----------------------------
1998 1997
-------- --------
Average Average
Balance Rate Balance Rate
------- ----- --------- ----
<S> <C> <C> <C> <C>
Loans $711,950 8.54% $647,042 8.71%
Securities 500,760 7.54 505,359 7.36
Short-term investments 22,812 5.39 972 5.42
--------- ---- --------- ----
Total earning assets $1,235,522 8.08% $1,153,373 8.11%
========= ---- ========= ----
Time deposits $501,615 5.57% $482,366 5.46%
NOW and money market accounts 262,323 3.66 198,353 3.29
Savings deposits 189,079 2.56 202,652 2.75
Short-term borrowings 53,474 3.63 53,731 3.74
Notes payable - - 5,311 6.19
---------- ---- ------- ----
Total interest-bearing
liabilities $1,006,491 4.41% $942,413 4.33%
========== ----- ======== -----
Net interest spread 3.67% 3.78%
Impact of non-interest bearing funds 0.82% 0.80%
---- -----
Net yield on interest earning assets 4.49% 4.58%
==== ====
</TABLE>
On a tax equivalent basis, net interest income for the first quarter of 1998
was $13,682,000, an increase of $666,000 or 5% compared with the 1997 first
quarter. The growth in net interest income for the three month period was due
to increases in the volume of earning assets and interest-bearing liabilities,
partially offset by the effect of changes in interest rates. The higher volume
of earning assets and interest-bearing liabilities in 1998 reflected strong
internal deposit growth over the past twelve months. As a percentage of
average earning assets, the level of average interest-bearing liabilities was
81.5% in 1998 compared to 81.7% in 1997.
Average loans for the first three months of 1998 were $712 million, an
increase of $65 million or 10% compared to the same period in 1997. The
increase was primarily in residential real estate loans which increased $37
million. Average short-term investments increased $22 million compared to the
1997 three month period as the Company increased its level of federal funds
sold in 1998. The Company continues to purchase fixed-rate, longer-term
bank-qualified tax-exempt securities while the balance of taxable securities has
decreased.
The increase in average earning assets was primarily funded by growth in
average money market accounts and time deposits, which increased $59 million
and $19 million, respectively, year-over-year. The growth in money market
accounts was primarily due to the promotion of the Company's Premier Money
Market Account in the fourth quarter of 1997. The growth in time deposits
primarily resulted from a combination of time deposit promotions and generally
higher interest rates offered on time deposits compared to other
interest-bearing deposit products.
On a tax equivalent basis, the annualized net interest spread in the 1998
first quarter decreased .11% compared to the same period in 1997. The change
in the net interest spread reflected a decrease of .03% in the yield on average
earning assets while the rate paid on interest-bearing liabilities increased
.08%. The decrease in the yield on earning assets was due to a decrease in the
yield on loans, primarily reflecting lower rates earned on new volumes of
commercial and industrial loans and commercial real estate loans. The increase
in the rate paid on interest-bearing liabilities was primarily due to higher
rates paid on money market deposit accounts and time deposits, reflecting
higher rates paid on new account promotions.
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The allowance for loan losses is an amount which is available to absorb
potential credit losses. The allowance is comprised of both specific and
general valuation allowances and is maintained at a level management believes
to be adequate to provide for known and potential risks inherent in the
Company's loan portfolio. Management assesses the adequacy of the allowance
for loan losses on a quarterly basis. Management's evaluation of the adequacy
of the allowance considers such factors as prior loss experience, loan
portfolio growth, loan delinquency levels and trends, and reviews of impaired
loans and the value of underlying collateral securing these loans. A provision
for loan losses is charged to income to increase the allowance to a level
deemed to be adequate, but not excessive, based on management's evaluation.
When a loan or a part thereof is considered by management to be uncollectible,
a charge is made against the allowance. Recoveries of loans previously charged
off are credited back to the allowance.
<TABLE>
The changes in the allowance for loan losses for the three months ended
March 31, 1998 and 1997 were as follows (in thousands):
<CAPTION>
Three Months Ended
March 31,
-------------------
1998 1997
------ ------
<S> <C> <C>
Balance at beginning of period $9,621 $9,407
Provision for loan losses 150 150
Loan charge-offs (77) (197)
Loan recoveries 107 46
----- ------
Balance at end of period $9,801 $9,406
===== ======
Net charge-offs (recoveries)
to average loans (.02)% .09%
Allowance for loan losses to loans 1.36% 1.43%
Allowance for loan losses to
nonperforming loans 587% 324%
</TABLE>
The provision for loan losses for the first three months of 1998 remained
unchanged from the year-ago quarter. The 1998 provision was primarily
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 and impaired loans, see the "Asset Quality" section below.
<TABLE>
The following table sets forth an allocation of the allowance for loan
losses and the percent of loans in each category to total loans outstanding for
the periods and categories shown (in thousands):
<CAPTION>
March 31, 1998 December 31, 1997
-------------- -----------------
Amount % Amount %
------- --- ------- ---
<S> <C> <C> <C> <C>
Commercial and industrial $2,101 22 $2,121 23
Commercial real estate 4,050 23 4,050 22
Construction - 1 - 2
Residential real estate 2,750 40 2,600 39
Home equity and other consumer 900 14 850 14
-------- --- ------- ---
Total $9,801 100 $9,621 100
======== === ======= ===
</TABLE>
Changes in the allocation of the allowance to individual loan categories
since December 31, 1997 were primarily the result of loan portfolio growth and
changes in management's risk assessment and assignment of unallocated reserves.
ASSET QUALITY
Nonperforming Assets
<TABLE>
The following table sets forth the Company's nonperforming assets and asset
quality ratios (in thousands):
<CAPTION>
March 31, December 31,
1998 1997
-------- -----------
<S> <C> <C>
Nonaccrual loans $1,495 $903
Loans past due 90 days or more 174 216
-------- --------
Total nonperforming loans 1,669 1,119
Other real estate owned 544 722
-------- --------
Total nonperforming assets $2,213 $1,841
======== ========
Restructured loans - $139
======== ========
Nonperforming loans to loans 0.23% 0.16%
Nonperforming assets to loans plus
OREO 0.31% 0.26%
</TABLE>
Impaired Loans
<TABLE>
The following table sets forth the recorded investment in impaired loans and
the related valuation allowance for each loan category (in thousands):
<CAPTION>
Amount of Impaired Loans
------------------------
No Valuation Valuation Amount of
Allowance Allowance Valuation
Required Required Total Allowance
-------- -------- ------ ------
<S> <C> <C> <C> <C>
March 31, 1998
Commercial and industrial $368 $396 $764 $76
Commercial real estate 1,013 414 1,427 55
Residential real estate 223 1,101 1,324 147
------- ------- ------ ------
Total impaired loans $1,604 $1,911 $3,515 $278
======= ======= ====== ======
December 31, 1997
Commercial and industrial $94 $171 $265 $4
Commercial real estate 951 518 1,469 76
Residential real estate 385 650 1,035 130
------- ------- ------ ------
Total impaired loans $1,430 $1,339 $2,769 $210
======= ======= ====== ======
</TABLE>
The average recorded investment in impaired loans for the three months ended
March 31, 1998 was approximately $3,142,000. Interest income recognized on
impaired loans for the first three months of 1998 totaled $41,000 compared to
$21,000 in the same period a year ago. Included in the balance of impaired
loans at March 31, 1998, were $145,000 of loans 90 days or more past due and
$1,324,000 of nonaccrual loans.
OTHER INCOME
Other income, excluding securities transactions, for the three months ended
March 31, 1998 increased $85,000 or 4% compared to the same period in 1997.
The increase was principally due to an increase in deposit service charges.
In the 1998 first quarter, the Company recognized net securities gains of
$353,000 compared to gains of $118,000 in the first quarter in 1997. In 1998,
securities gains of $329,000 were recognized on the sale of $11 million of
adjustable-rate securities. The balance of securities gains recognized in 1998
reflected a market value adjustment of an investment security classified as
trading.
OTHER EXPENSE
Other expense in the 1998 first quarter increased $242,000 or 3% compared
to the same period in 1997. The growth in expenses was primarily attributable
to increases in salaries and benefits and data processing expense.
Salaries and employee benefits, the largest component of other expense,
increased $149,000 or 3% for the first three months of 1998 compared to the
same period a year ago. The increase primarily reflected normal salary
increases and higher incentive compensation expense. A reduction in staffing
levels from the year ago period partially limited the growth in salaries and
employee benefits. At March 31, 1998, the number of full-time equivalent
employees totaled 419 compared to 447 at March 31, 1997.
Data processing expense increased $203,000 or 69% in 1998 compared with the
1997 three month period. The increase primarily resulted from costs associated
with the Company's planned conversion of its data processing systems to a new
third-party data processor. The Company expects to incur additional conversion
costs through the end of the 1998 third quarter. For further information, see
the "Year 2000 Compliance section" below.
YEAR 2000 COMPLIANCE
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The data processing systems and software
include those developed and maintained by the Company's third-party data
processing vendor and purchased software which is run on in-house computer
networks. In 1997, the Company initiated a review and assessment of all
hardware and software to confirm that it will function properly in the year
2000. To date, those vendors which have been contacted and have responded
indicated that their hardware or software is or will be Year 2000 compliant by
the end of 1998. The Company's third-party data processor, however, indicated
that the Company will have to convert to new software applications in 1998 to
be Year 2000 compliant. In light of this, the Company reviewed other
third-party data processing application systems and products and, in January,
1998, elected to convert its data processing systems to a new third-party
vendor. The data processing conversion is anticipated to occur in the fourth
quarter.
In connection with the proposed Merger with First Midwest, the Company and
First Midwest have initiated a review of all data processing applications,
including those used to process transactions and information for loan, deposit
and trust customers. First Midwest currently purchases the services for these
systems from three nationally recognized data processing vendors. Following
the consummation of the Merger, First Midwest plans to convert the Company's
loan, deposit and trust systems to its vendors during 1998 in conjunction with
integration of the Company into First Midwest. The Company and First Midwest
also have other in-house applications, interface equipment and interfaces that
will be reviewed and may require modification. First Midwest has developed a
Year 2000 plan and has identified internal resources to address the Year 2000
issues. First Midwest's goals are to be fully compliant by November 1998 and
to conduct testing of all programs/applications during the period January
through June 1999.
INCOME TAXES
Income tax expense for the three months ended March 31, 1998 increased
$97,000 compared to the same period in 1997. The increase in income tax
expense in 1998 was primarily due to an increase in pre-tax earnings. The
Company's effective tax rate (income tax expense divided by net income before
taxes) decreased to 31.0% in 1998 compared to 31.9% in the same period a year
ago. The lower effective tax rate is attributable to a relatively higher level
of tax-exempt interest income in 1998.
ANALYSIS OF BALANCE SHEETS
ASSETS
Total assets at March 31, 1998 were $1.325 billion, an increase of $6
million compared to December 31, 1997. Changes in total assets since December
31, 1997 primarily reflected increases of $27 million in cash and cash
equivalents and $7 million in net loans. Combined, the balance of the
Company's securities portfolio decreased $28 million.
LIABILITIES
The Company's funding sources, consisting of deposits and short-term
borrowings, increased $2 million since December 31, 1997. Changes in funding
sources since year-end primarily reflected increases of $7 million in securities
sold under agreements to repurchase and $3 million in time deposits. Partially
offsetting the growth in those categories was a decrease of $8 million in
demand deposits.
CAPITAL
At March 31, 1998, total shareholders' equity increased to $126 million, up
$4 million from December 31, 1997. The growth in equity reflected the
retention of current year earnings, less dividends paid and the cost of
treasury stock purchased, plus the proceeds from the exercise of stock options.
The change in equity also reflected a $212,000 increase in the market value of
securities available-for-sale.
The capital ratios of the Company and Heritage Bank (the "Bank") are
presently in excess of the requirements necessary to meet the "well
capitalized" capital category established by banking regulators. The capital
ratios of the Company and the Bank at March 31, 1998 and the minimum capital
ratios for "well capitalized" financial institutions are as follows:
<TABLE>
<CAPTION>
Minimum
Well
Capitalized Company Heritage
Ratio Consolidated Bank
----------- ------------ --------
<S> <C> <C> <C>
Tier I capital to average assets > 5.00% 8.03% 7.63%
-
Tier I capital to risk weighted assets > 6.00% 14.41% 13.56%
-
Total capital to risk weighted assets > 10.00% 15.66% 14.81%
-
</TABLE>
Pursuant to a Registration Statement on Form S-8 filed in March, 1993, as
amended by a Post-Effective Amendment filed in May, 1997, the Company registered
1,241,700 common shares for issuance pursuant to the Company's stock option
plans. During the three month period ended March 31, 1998, common shares
issued pursuant to the exercise of stock options totaled 17,215. Subsequent
to March 31, 1998, an additional 400,396 common shares were issued pursuant to
the exercise of stock options. For further information on the Company's stock
options, see "Note-6-Stock Options" of the Notes to Consolidated Financial
Statements included under Item 1 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. In May,
1997, the board of directors authorized the repurchase of an additional 68,850
shares as a result of the Company's 1997 three-for-two stock split. The shares
were authorized to be repurchased from time to time in the open market or in
private transactions.
In conjunction with the approval of the Merger Agreement with First Midwest,
the Company rescinded the balance of its stock repurchase program. During the
three month period ended March 31, 1998, 7,605 treasury shares were acquired
through an exchange of common shares in exercises of stock options. During the
same period, 40,516 treasury shares were reissued upon the exercise of stock
options. Subsequent to March 31, 1998, an additional 74,260 treasury shares
were acquired through an exchange of common shares in exercises of stock
options, and 79,260 treasury shares were reissued 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.
LIQUIDITY
Liquidity management in banking involves the ability to generate funds to
support asset growth and meet cash flow requirements of customers and other
obligations. The Bank's immediate liquidity needs have historically been met
by daily investments in federal funds sold, monthly cash flows from
mortgage-backed and asset-backed securities and maturities of other securities.
When necessary, the Bank may purchase up to $55 million under informal federal
funds lines with correspondent banks. For the first three months of 1998, the
Bank's average amount of federal funds sold was $22 million. For the three and
twelve months ended March 31, 1998, the aggregate principal payments received
on mortgage-backed and asset-backed securities totaled approximately $16
million and $56 million, respectively. At March 31, 1998, the Bank had $11
million of securities having contractual maturities of one year or less and
expects to receive approximately $63 million of payments on mortgage-backed and
asset-backed securities over the next twelve months. The cash flow
projections for mortgage-backed and asset-backed securities are based on
consensus prepayment estimates of securities brokers. Other sources of
potential liquidity include the sale of securities classified as available-
for-sale and advances under a $143 million credit facility with the Federal Home
Loan Bank.
For the parent company, Heritage Financial Services, Inc.("HFS"), liquidity
means having cash available to pay shareholder dividends, to service debt and
to fund operating expenses. The ability of HFS to pay dividends, as well as
fund its operations and service debt, is dependent upon receipt of dividends
from the Bank. Regulatory authorities limit the amount of dividends which can
be paid by the Bank without prior approval from such authorities. At March 31,
1998, the amount of undistributed earnings of the Bank available for the
payment of dividends within such limitations is sufficient to fund the
anticipated cash requirements of HFS.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995
Certain matters discussed in this Quarterly Report on Form 10-Q are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. The Company intends such forward-looking statements to be
covered by the safe harbor provisions for forward-looking statements contained
in the Private Securities Litigation Reform Act of 1995, and is including this
statement for purposes of these safe harbor provisions. Forward-looking
statements, which are based on certain assumptions and describe future plans,
goals, objectives, strategies and expectations of the Company, are generally
identifiable by use of the words "believe," "expect," "intend," "anticipate,"
" estimate," "project," or other similar words or expressions. The Company's
ability to predict results or the actual effect of future plans or strategies
is inherently uncertain. Factors which could have a material adverse effect
on the operations and future prospects of the Company and its subsidiaries
include, but are not limited to: significant fluctuations in market interest
rates; changes in general economic conditions and inflation; changes in the
competitive environment that can affect the Company's funding and asset
generation capabilities; changes in management's assessment of the adequacy of
the allowance for loan losses based upon changes in the composition of the loan
portfolio, loan delinquency rates, the level of loan losses, and business and
market conditions that affect the value of collateral securing loans;
legislative or regulatory changes which adversely affect the business of the
Company or its subsidiaries, including federal deposit insurance premiums; and
changes in accounting principles, policies and guidelines. These risks and
uncertainties should be considered in evaluating the forward-looking statements,
and undue reliance should not be placed on such forward-looking statements. The
forward-looking statements included herein are only made as of the date of this
Quarterly Report on Form 10-Q, and the Company undertakes no obligation to
publicly update such forward-looking statements to reflect subsequent events or
circumstances.
PART II-OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 11 - Statement Re Computation of Per Share Earnings (included at
page 17).
(b) Exhibit 27 - Financial Data Schedule.
(c) On January 27, 1998, the Company filed a Current Report on Form 8-K
disclosing under Item 5 of Form 8-K the granting of a stock option to and
proposed merger with, First Midwest Bancorp, Inc. and including copies of
the Option Agreement and the Merger Agreement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HERITAGE FINANCIAL SERVICES, INC.
(Registrant)
Date: May 11, 1998 by /s/ Frederick J. Sampias
Frederick J. Sampias
President
(Duly Authorized Officer)
Date: May 11, 1998 by /s/ Paul A. Eckroth
Paul A. Eckroth
Executive Vice President and Treasurer
(Principal Financial and Chief Accounting
Officer)
Exhibit 11 - Statement Re: Computation of Per Share Earnings
The calculation of the Registrant's basic and diluted earnings per share
required by Item 601(b)(11) of Regulation S-K is presented below (dollars in
thousands, except per share data):
Three Months Ended
March 31,
-------------------
1998 1997
------- -------
Net income available to common shareholders $4,745 $4,331
====== ======
Weighted average common shares outstanding 12,127 12,088
used in basic earnings per share calculation
Dilutive effect of employee stock options after
application of the treasury stock method 395 392
Weighted average number of shares outstanding ------- -------
adjusted for the effect of dilutive securities 12,522 12,480
====== ======
Basic earnings per share $0.39 $0.36
====== ======
Diluted earnings per share $0.38 $0.35
====== ======
Share data has been adjusted for a three-for-two stock split paid in
June, 1997.
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000355946
<NAME> HERITAGE FINANCIAL SERVICES, INC.
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 35088
<INT-BEARING-DEPOSITS> 455
<FED-FUNDS-SOLD> 42800
<TRADING-ASSETS> 471
<INVESTMENTS-HELD-FOR-SALE> 380516
<INVESTMENTS-CARRYING> 111393
<INVESTMENTS-MARKET> 114923
<LOANS> 718533
<ALLOWANCE> 9801
<TOTAL-ASSETS> 1325093
<DEPOSITS> 1134409
<SHORT-TERM> 52442
<LIABILITIES-OTHER> 12364
<LONG-TERM> 0
0
0
<COMMON> 0
<OTHER-SE> 125878
<TOTAL-LIABILITIES-AND-EQUITY> 1325093
<INTEREST-LOAN> 14913
<INTEREST-INVEST> 8133
<INTEREST-OTHER> 303
<INTEREST-TOTAL> 23349
<INTEREST-DEPOSIT> 10454
<INTEREST-EXPENSE> 478
<INTEREST-INCOME-NET> 10932
<LOAN-LOSSES> 150
<SECURITIES-GAINS> 353
<EXPENSE-OTHER> 8016
<INCOME-PRETAX> 6872
<INCOME-PRE-EXTRAORDINARY> 6872
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4745
<EPS-PRIMARY> .39
<EPS-DILUTED> .38
<YIELD-ACTUAL> 4.49
<LOANS-NON> 1495
<LOANS-PAST> 174
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 9621
<CHARGE-OFFS> 77
<RECOVERIES> 107
<ALLOWANCE-CLOSE> 9801
<ALLOWANCE-DOMESTIC> 9801
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
