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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, 1997 Commission File Number 0-15059
HERITAGE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Illinois 36-3139645
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
17500 South Oak Park Avenue
Tinley Park, Illinois 60477
(Address of principal executive offices) (Zip code)
(708) 532-8000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, no 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 the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate 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 18, 1998, 12,140,528 common shares, no 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 18, 1998) held by non-
affiliates was approximately $273,400,000. See "Item 5. Market for Registrant's
Common Shares and Related Shareholder Matters".
DOCUMENTS INCORPORATED BY REFERENCE
None
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HERITAGE FINANCIAL SERVICES, INC.
FORM 10-K TABLE OF CONTENTS
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Part I
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Item 1 Business 3
Item 2 Properties 10
Item 3 Legal Proceedings 10
Item 4 Submission of Matters to a Vote of Security Holders 10
Part II
Item 5 Market for Registrant's Common Shares and Related Shareholder Matters 11
Item 6 Selected Financial Data 12
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 8 Financial Statements and Supplementary Data 30
Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 53
Part III
Item 10 Directors and Executive Officers of the Registrant 54
Item 11 Executive Compensation 56
Item 12 Security Ownership of Certain Beneficial Owners and Management 60
Item 13 Certain Relationships and Related Transactions 63
Part IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 63
Signatures 64
Exhibit Index 65
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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 seventeen 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
15 - Condensed Financial Statements - Parent Company" of the Notes to
Consolidated Financial Statements included under Item 8 of this document.
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 is
conditioned upon, among other things, approval by the shareholders of both the
Company and First Midwest and receipt of customary regulatory approvals. The
Merger Agreement has been approved by the boards of directors of both companies.
It is anticipated that the acquisition will be consummated late in the second
quarter of 1998. 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. Copies of the Merger Agreement and
Option Agreement have been filed as exhibits to the Company's Current Report on
Form 8-K filed January 27, 1998.
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.
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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 Lockport had
total assets of $104 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 limited to trust and insurance agency operations.
In 1996 Lockport was authorized by bank and insurance regulators to act as an
insurance agent or broker. In 1997 Lockport, now headquartered in Monee,
Illinois, began to offer insurance products through its Heritage Insurance
Services division.
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 and has an automated
loan application feature 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 loans, 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, 1997, approximately 47% 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 and mid-
sized 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.
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In recent years the Bank has expanded its marketing and origination
activities for retail 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, 1997, residential real estate loans and home
equity loans comprised 52% 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 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 and DuPage County. For many years there has
been significant economic and population growth in the outlying areas of
southwest Cook County and DuPage County and in many 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 provides 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.
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 the 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 Bank opened a branch office in Joliet, located in Will
County, and a branch office in Darien, located in southeast DuPage County. The
Company plans to open at least one branch office in Will County in 1998.
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.
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Competition
The Company encounters significant competition in all of its activities. It
competes for commercial and individual deposits, loans, trust business and other
financial services with local and regional banks, thrifts, mortgage banking
companies, finance companies, credit unions and a number of large national
companies including manufacturers, insurance companies and brokerage firms. The
Company faces additional competition in attracting deposits from money market
funds, mutual funds and other investment funds. Many of the Company's
competitors are generally much larger and have greater access to capital and
other resources. Some of the financial institutions and financial services
companies with which the Company competes are not subject to the same degree of
regulation as that imposed on bank holding companies, and federally insured,
state-chartered banks and national banks. As a result, such nonbank competitors
have advantages over the Company in providing certain services.
The banking industry is undergoing rapid technological changes with
frequent introductions of new technology-driven products and services. In
addition to better serving customers, the effective use of technology increases
efficiency and enables financial institutions to reduce their costs. The Company
is committed to addressing the needs of its customers by implementing technology
that is cost-effective in delivering its products and services. However, many of
the Company's competitors have substantial resources to invest in technological
improvements, and therefore, may have an advantage in offering and marketing
such products and services.
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. The system of
supervision and regulation applicable to the Company and its subsidiaries is
intended to protect the deposit insurance system, 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.
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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.
Deposit Insurance
As an FDIC insured institution, the Bank is required to pay deposit
insurance premiums based on the risk it poses to the insurance fund. The FDIC
has adopted a risk-based insurance premium system under which 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 by the FDIC)
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.
In 1996 and 1997, the Bank's assessment rate for each semi-annual period
was zero. As of December 31, 1997, 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, 1998. There are no assurances, however, that
future assessment rates will remain at that level. See "Supervision and
Regulation - Capital Adequacy" below.
Under federal law, FDIC insured institutions are 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. Until
January 1, 2000, FICO assessments made against members of the FDIC's Bank
Insurance Fund ("BIF") may not exceed 20% of the amount of FICO assessments
against members of the FDIC's Savings Association Insurance Fund ("SAIF"). In
1997, the Company began paying FICO assessments at the rate of .013% of BIF
deposits. For the semi-annual period ending June 30, 1998, the Bank's FICO
assessment rate remained the same.
Capital Adequacy
The Federal Reserve and the FDIC have adopted risk-based capital guidelines
and ratio requirements for bank holding companies and state-chartered nonmember
banks, respectively. 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 discretionary actions by regulators that may
have a direct material effect on a bank's financial statements.
At December 31, 1997, 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 16 - Regulatory Restrictions and Capital
Adequacy" of the Notes to Consolidated Financial Statements included under Item
8 of this document.
The quantitative capital measures established by the FDIC and the Federal
Reserve Board are minimum requirements and higher capital levels may be required
if warranted by the particular circumstances or risk profiles of particular
organizations. For example, the regulations of the FDIC and the Federal Reserve
provide that additional capital may be required to take adequate account of,
among other things, interest rate risk, or risks posed by concentrations of
credit, nontraditional activities or securities trading activities.
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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, 1997, 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 16 -
Regulatory Restrictions and Capital Adequacy" of the Notes to Consolidated
Financial Statements included under Item 8 of this document.
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 (unless
the Company already owns a majority of the voting shares of such 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 non-
banking activities currently permitted for bank holding companies include, among
other things, mortgage, consumer and commercial finance activities, equipment
leasing and the operation of a thrift. The Bank Holding Company Act, as
implemented by Federal Reserve Board regulations, generally does not place
territorial restrictions on the domestic activities of non-bank subsidiaries of
bank holding companies.
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. Effective June 1, 1997 the State
of Illinois enacted legislation permitting interstate mergers subject to certain
conditions, including a prohibition against such mergers if the Illinois bank
involved has not been in existence and operation for at least five years.
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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, 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. In 1997 the FDIC performed
a CRA examination of the Bank and rated it "satisfactory".
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, 1997, the Company had approximately 441 full-time
equivalent employees. The Company provides 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".
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ITEM 2. PROPERTIES
At December 31, 1997, the Company had 17 banking locations, of which 13
were owned and four 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, five are located in adjacent Will County and one
is located in southeast DuPage 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 all 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.
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 or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
10
<PAGE>
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 included in the shares held by affiliates 712,818
shares (as of December 31, 1997) which may be voted by certain officers of the
Company as trustees of a profit sharing trust for the Company and subsidiaries.
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, 1997, there were approximately 785 holders of record of the Company's
shares.
The following table sets forth the dividends paid, common share prices and
number of shares traded during each quarter of 1997 and 1996, as reported by
Nasdaq. The information has been adjusted to reflect the Company's three-for-two
stock split paid in June, 1997:
<TABLE>
<CAPTION>
Market Price Range Number
Dividends -------------------------------------- of Shares
Paid High Low Close Traded
--------- ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
1997
4th Quarter $ .10 $29.00 $19.75 $29.00 987,173
3rd Quarter .10 21.25 19.13 20.13 627,655
2nd Quarter .10 20.75 16.50 20.63 749,447
1st Quarter .10 17.00 14.33 16.50 578,763
1996
4th Quarter $.087 $14.67 $13.83 $14.17 403,059
3rd Quarter .087 14.50 13.83 14.00 442,827
2nd Quarter .087 14.50 12.33 14.50 417,480
1st Quarter .087 12.83 12.17 12.17 246,494
</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. Regulatory authorities
limit the amount of dividends which can be paid by the Bank without prior
approval from such authorities. At December 31, 1997, 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 16 - Regulatory Restrictions and Capital
Adequacy" of the Notes to Consolidated Financial Statements included under Item
8 of this document.
On January 13, 1998, the Company's board of directors increased the
quarterly cash dividend to 11 cents per share payable February 10, 1998 to
shareholders of record on January 26, 1998. While the Company anticipates paying
quarterly dividends 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.
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
Company is prohibited from paying quarterly dividends in excess of 11 cents per
share.
11
<PAGE>
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. Per share data has been adjusted to reflect a
three-for-two stock split paid in June 1997. Earnings per share data has been
restated to reflect the adoption of SFAS 128.
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
Summary of Operations (in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest income $91,156 $83,824 $73,860 $60,158 $55,259
Interest expense 42,736 38,606 33,364 22,116 21,122
------- ------- ------- ------- -------
Net interest income 48,420 45,218 40,496 38,042 34,137
Provision for loan losses 600 400 200 90 500
Other income 9,607 7,724 6,971 6,487 6,101
Other expense 31,765 30,801 27,670 26,218 24,220
------- ------- ------- ------- -------
Income before income taxes 25,662 21,741 19,597 18,221 15,518
Income tax expense 7,869 6,903 6,303 5,804 4,493
------- ------- ------- ------- -------
Net income $17,793 $14,838 $13,294 $12,417 $11,025
======= ======= ======= ======= =======
Per Common Share Data
Diluted earnings per share $ 1.43 $ 1.19 $ 1.07 $ 1.00 $ .89
Cash dividends .40 .35 .29 .24 .21
Book value at year end 10.11 8.94 8.13 7.00 6.38
Market price at year end 29.00 14.17 12.83 11.00 10.67
Financial Ratios
Net interest margin (TE) 4.45% 4.43% 4.58% 4.90% 4.82%
Return on average assets 1.40% 1.25% 1.31% 1.39% 1.33%
Return on average shareholders' equity 16.12% 15.00% 15.10% 15.81% 15.77%
Dividend payout ratio 27.15% 27.80% 26.27% 22.93% 22.73%
Average equity to average assets 8.71% 8.34% 8.65% 8.78% 8.45%
Tier 1 capital to total assets 7.81% 7.19% 7.75% 7.41% 7.87%
Total capital to risk-adjusted assets 15.17% 14.00% 14.66% 13.73% 14.45%
Loan Quality
Net charge-offs (recoveries) to average
loans .06% .11% .08% (.03)% .13%
Allowance for loan losses to loans 1.35% 1.47% 1.49% 1.66% 1.68%
Nonperforming loans to loans .16% .66% .85% 1.04% 1.03%
Nonperforming assets to loans plus OREO .26% .75% .98% 1.15% 1.15%
Year End Balances (in millions)
Total assets $ 1,319 $ 1,229 $ 1,066 $ 953 $ 834
Net loans 702 630 561 516 448
Total deposits 1,140 1,053 915 824 727
Total shareholders' equity 122 106 97 83 75
Average Balances (in millions)
Total assets $ 1,267 $ 1,187 $ 1,018 $ 895 $ 827
Total loans 676 616 545 489 454
Total deposits 1,092 1,021 877 776 724
Total shareholders' equity 110 99 88 79 70
</TABLE>
12
<PAGE>
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, 1997, 1996 and 1995. 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 statements of income from the
date of acquisition.
Overview
In 1997 the Company achieved record net income and earnings per share. For
the year, net income was $17.8 million, up 20% from $14.8 million in 1996. In
1996 net income increased 12% from $13.3 million in 1995. Diluted earnings per
share were $1.43 compared with $1.19 in 1996 and $1.07 in 1995. The Company's
return on average assets in 1997 was 1.40%, compared to 1.25% in 1996 and 1.31%
in 1995. The return on average equity was 16.12% in 1997 compared to 15.00% in
1996 and 15.10% in 1995.
The growth in earnings in 1997 was principally due to increases in net
interest income and other income. The improvement in net interest income was
primarily attributable to the growth in the volume of earning assets and
interest-bearing liabilities, reflecting strong internal growth during the year.
The growth in other income primarily reflected increases in deposit service
charges and other operating income. Earnings in 1997 were also positively
affected by the following after-tax items: a recovery of $96,000 of interest
income on a nonaccrual loan, the reimbursement of $90,000 of legal costs related
to litigation settled in 1996, and the receipt of a state income tax refund
which totaled $379,000.
In 1996 the increases in net interest income and other income were the
major factors contributing to the increase in net income. The improvement in net
interest income was attributable to the growth in the volume of earning assets
and interest-bearing liabilities, primarily reflecting the acquisition of
Lockport during the year. In 1996 a decline in the net interest spread partially
offset the positive impact of volume growth. The growth in other income
primarily reflected increases in deposit service charges and investment product
fee income. A decrease in Federal Deposit Insurance Corporation ("FDIC") deposit
insurance premiums also contributed to the increase in net income for the year.
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.
13
<PAGE>
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>
<CAPTION>
Table 1 Distribution of Assets, Liabilities and Shareholders' Equity
Interest, Rates and Net Yields
1997 1996
----------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Average Average
ASSETS Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- --------
Federal Funds sold and
interest-bearing deposits $7,855 $424 5.40% $13,254 $694 5.24%
Taxable securities 358,372 25,088 7.00 360,553 24,001 6.66
Non-taxable securities(1) 147,547 12,112 8.21 113,935 9,572 8.40
-------------- ------------- ------------- -------------
Total securities 505,919 37,200 7.35 474,488 33,573 7.08
Loans (2):
Commercial and industrial(1) 173,326 15,469 8.92 151,658 13,783 9.09
Real estate(1) 402,769 33,731 8.37 371,717 31,180 8.39
Consumer 99,873 8,897 8.91 92,399 8,289 8.97
-------------- ------------- ------------- -------------
Total loans 675,968 58,097 8.59 615,774 53,252 8.65
-------------- ------------- ------------- -------------
Total earning assets 1,189,742 95,721 8.05 1,103,516 87,519 7.93
------------- -------------
Cash and due from banks 36,305 41,728
Other assets(3) 40,828 41,258
-------------- -------------
Total assets $1,266,875 $1,186,502
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW and money market accounts $226,640 $7,912 3.49% $191,447 $6,115 3.19%
Savings deposits 196,765 5,407 2.75 212,312 5,908 2.78
Time deposits 494,451 27,373 5.54 445,055 24,304 5.46
-------------- ------------- ------------- -------------
Total interest-bearing deposits 917,856 40,692 4.43 848,814 36,327 4.28
Short-term borrowings 52,127 1,904 3.65 47,489 1,675 3.53
Notes payable 2,145 141 6.57 9,315 604 6.48
-------------- ------------- ------------- -------------
Total interest-bearing liabilities 972,128 42,737 4.40 905,618 38,606 4.26
------------- -------------
Demand deposits 173,862 172,447
Other liabilities 10,519 9,497
Shareholders' equity 110,366 98,940
-------------- -------------
Total liabilities and
shareholders' equity $1,266,875 $1,186,502
============== =============
Net interest income $52,984 $48,913
============= =============
Net interest spread 3.65% 3.67%
Impact of non-interest bearing funds .80% .76%
----- -----
Net yield on interest earning assets 4.45% 4.43%
===== =====
1995
----------------------------------------
<S> <C> <C> <C>
Average
ASSETS Balance Interest Rate
------- -------- ----
Federal Funds sold and
interest-bearing deposits $40,761 $2,378 5.83%
Taxable securities 287,951 18,881 6.56
Non-taxable securities(1) 72,482 6,838 9.43
--------------- -----------
Total securities 360,433 25,719 7.14
Loans(2):
Commercial and industrial(1) 136,339 13,057 9.58
Real estate(1) 318,413 27,380 8.60
Consumer 89,986 8,122 9.03
--------------- -----------
Total loans 544,738 48,559 8.91
--------------- -----------
Total earnings assets 945,932 76,656 8.10
-----------
Cash and due from banks 37,149
Other assets(3) 34,990
---------------
Total assets $1,018,071
===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
NOW and money market accounts $161,341 $5,052 3.13%
Savings deposits 209,799 6,256 2.98
Time deposits 361,911 20,208 5.58
--------------- -----------
Total interest-bearing deposits 733,051 31,516 4.30
Short-term borrowings 41,749 1,661 3.98
Notes payable 2,689 187 6.95
--------------- -----------
Total interest-bearing liabilities 777,489 33,364 4.29
-----------
Demand deposits 144,388
Other liabilities 8,175
Shareholders' equity 88,019
---------------
Total liabilities and
shareholders' equity $1,018,071
===============
Net interest income $43,292
============
Net interest spread 3.81%
Impact of non-interest bearing funds .77%
-----
Net yield on interest earning assets 4.58%
=====
</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 $1,181 in 1997, $1,305 in 1996 and $1,187 in
1995.
(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.
14
<PAGE>
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>
1997 Compared to 1996 1996 Compared to 1995
-------------------------------------- -----------------------------------------
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 $ (291) $ 21 $ (270) $ (1,462) $ (222) $ (1,684)
Taxable securities (146) 1,233 1,087 4,829 292 5,121
Non-taxable securities (2) 2,764 (224) 2,540 3,552 (819) 2,733
--------- --------- --------- ----------- -------- ---------
Total securities 2,618 1,009 3,627 8,381 (527) 7,854
--------- --------- --------- ----------- -------- ---------
Loans:
Commercial and industrial (2) 1,938 (252) 1,686 1,416 (690) 726
Real estate (2) 2,601 (50) 2,551 4,486 (686) 3,800
Consumer 666 (58) 608 217 (50) 167
--------- --------- --------- ----------- --------- ---------
Total loans 5,205 (360) 4,845 6,119 (1,426) 4,693
--------- --------- --------- ----------- --------- ---------
Total interest income 7,532 670 8,202 13,038 (2,175) 10,863
--------- --------- --------- ----------- --------- ---------
Interest-Bearing Liabilities:
Interest-bearing deposits:
NOW and money market accounts 1,193 604 1,797 960 103 1,063
Savings deposits (428) (73) (501) 74 (422) (348)
Time deposits 2,730 339 3,069 4,549 (453) 4,096
--------- --------- --------- ----------- --------- ---------
Total interest-bearing deposits 3,495 870 4,365 5,583 (772) 4,811
Short-term borrowings 168 61 229 214 (200) 14
Notes payable (468) 4 (464) 430 (13) 417
--------- --------- --------- ----------- --------- ---------
Total interest expense 3,195 935 4,130 6,227 (985) 5,242
--------- --------- --------- ----------- --------- ---------
Net interest income $ 4,337 $ (265) $ 4,072 $ 6,811 $ (1,190) $ 5,621
========= ========= ========= =========== ========= =========
</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 $4.1 million, or
8% in 1997, compared to an increase of $5.6 million, or 13% in 1996. 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 1997 average earning assets increased by $86 million, or 8%, and average
interest-bearing liabilities increased $67 million, or 11%, compared with 1996
(Table 1). The higher volume of earning assets and interest-bearing liabilities
in 1997 reflected strong internal deposit growth during the year. In 1996
average earning assets increased by $158 million, or 17%, and average interest-
bearing liabilities increased $128 million, or 16%, compared with 1995. Growth
in the volume of earning assets and interest-bearing liabilities in 1996
resulted from the acquisition of Lockport coupled with internal deposit growth
during the year. As a percentage of average earning assets, the level of average
interest-bearing liabilities was 81.7% in 1997 compared to 82.1% in 1996 and
82.2% in 1995.
15
<PAGE>
On a tax equivalent basis, the net interest spread decreased slightly to
3.65% in 1997 compared to 3.67% in 1996. The change in the net interest spread
reflected an increase of .12% in the yield on average earning assets while the
rate paid on interest-bearing liabilities increased .14%. The increase in the
yield on earning assets was primarily due to a .27% increase in the yield on
securities, reflecting higher rates earned on new purchases and the sale and
reinvestment of lower-yielding securities. The increase in the rate paid on
interest-bearing liabilities was primarily due to higher rates paid on money
market deposit accounts and time deposits, reflecting higher rates paid on new
account promotions during the year.
In 1996 the tax equivalent net interest spread decreased to 3.67% 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 volume 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.
A factor also contributing to lower net interest spreads in 1997 and 1996
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 1996 and 1997, the
yield curve generally flattened as the spreads between long-term and short-term
market interest rates compressed. The Company cannot predict whether the 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.
For additional information on the Company's interest rate risk and
management practices, see the "Asset/Liability Management and Interest Rate
Risk" section below.
Provision for Loan Losses
The provision for loan losses in 1997 was $600,000 compared to $400,000 in
1996 and $200,000 in 1995. The increase in provisions in 1997 and 1996 primarily
resulted from increased loan growth and, in 1996, higher net charge-offs. 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 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>
<CAPTION>
TABLE 3 Other Income
$ Change
From Prior Year
---------------------------
1997 1996 1995 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Service charges on deposits $5,210 $4,477 $4,097 $ 733 $ 380
Income for trust services 874 784 737 90 47
Investment product fees 1,257 1,134 909 123 225
Other operating income 1,975 1,209 1,005 766 204
Securities gains 291 120 223 171 (103)
-------- ------- ------- -------- --------
Total other income $9,607 $7,724 $6,971 $ 1,883 $ 753
======== ======= ======= ======== ========
</TABLE>
Service charges on deposits, the largest component of other income,
increased 16% in 1997 and 9% in 1996. The increase in service charge income in
1997 was principally due to changes in overdraft service charge methods. In 1996
the increase in income was due in part to the additional fee income of Lockport
and the changes in overdraft service charge methods. While the Company has
historically experienced increases in deposit service charges, the growth has
been tempered by the introduction of
16
<PAGE>
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 of service charge revenue.
Income from trust services increased 11% in 1997 and 6% in 1996. In 1997 the
increase reflected continued growth of employee benefit plans and other asset
management accounts serviced by Heritage Trust Company, a wholly owned
subsidiary of the Company. The growth in trust revenue in 1996 was primarily
attributable to the trust accounts acquired from Lockport. At December 31, 1997,
total customer trust assets were approximately $227 million, up $44 million from
year-end 1996.
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 which
it offers. The growth in investment product income in 1997 and 1996 was in part
due to the increased product offerings combined with greater customer demand.
Other operating income increased 63% in 1997, primarily due to ATM surcharge
fees which were established in December, 1996. The increase also reflected
$231,000 of interest on a state income tax refund received in the fourth quarter
of 1997. In 1996 other operating income increased 20%, reflecting the additional
other operating income of Lockport.
Net securities gains in 1997 were $291,000 compared to net gains of $120,000
in 1996 and $223,000 in 1995. In 1997 the Company recognized net gains of
$101,000 from the sale of $58 million of fixed-rate and adjustable-rate
securities. The balance of net securities gains recognized in 1997 reflected a
market value adjustment of an investment security classified as trading. In 1996
the Company recognized a net loss of $58,000 from the sale of $38 million of
fixed-rate and adjustable-rate securities. In 1996 the Company also recognized a
gain of $135,000 on the payoff of a nonaccrual tax-exempt obligation and 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.
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. Over the past two years the overall
growth of operating expenses has been contained due to the realization of
certain economies of scale from the Lockport acquisition, efficient staffing and
management's ongoing efforts to reduce costs through investments in technology
and competitive bidding. In 1996 the increase in most expense categories was
attributable to the Lockport acquisition.
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 51.0% in 1997 compared to 54.5%
in 1996 and 55.3% in 1995. The improvement in the efficiency ratio in 1997 and
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
-----------------
1997 1996 1995 1997 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Salaries and employee benefits $17,307 $16,645 $15,146 $ 662 $1,499
Net occupancy expense 3,190 3,107 2,618 83 489
Equipment expense 1,731 1,697 1,569 34 128
Data processing expense 1,247 1,105 817 142 288
Federal deposit insurance premiums 123 53 958 70 (905)
Amortization of intangible assets 2,006 2,251 1,613 (245) 638
Stationery and supplies 742 766 700 (24) 66
Professional fees 959 633 681 326 (48)
Marketing and promotion 774 679 528 95 151
Other operating expenses 3,686 3,865 3,040 (179) 825
------- ------- ------- ----- ------
Total other expense $31,765 $30,801 $27,670 $ 964 $3,131
======= ======= ======= ===== ======
</TABLE>
17
<PAGE>
Salaries and employee benefits, the largest component of other expense,
increased 4% in 1997 compared to 10% in 1996. The increases in both years were
primarily attributable to annual merit increases paid to employees and incentive
compensation. In 1996 higher expenses were also due to the additional salary
expense from Lockport and an increase in profit sharing expense. At December 31,
1997, the number of full-time equivalent ("FTE") employees totaled 441 compared
to 446 and 434 at December 31, 1996 and 1995, respectively. The increase in the
number of FTE employees in 1996 was primarily due to the additional employees of
Lockport.
Occupancy expense increased 3% in 1997 and 19% in 1996. The significant
increase in 1996 expense was primarily due to higher real estate taxes,
reflecting increases in property valuations which were reassessed in 1996. A
majority of Heritage Bank's real estate properties are reassessed by taxing
authorities every three years. The growth in occupancy expense in 1997 and 1996
also reflects the additional costs of branch expansion. In June 1997 the Company
moved into a permanent branch facility in Monee, Illinois. Prior to that, the
Company had been leasing a temporary facility. In April 1997 the Company opened
a branch office in Joliet, Illinois and in September 1997 opened a branch in
Darien, Illinois. The Company currently plans to open one additional branch
facility in 1998.
For several 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. As a result, data
processing and equipment expenses have increased each year. In 1997 data
processing expense increased 13% compared to an increase of 35% in 1996.
Equipment expense increased 2% in 1997 compared to an increase of 8% in 1996.
The increase in data processing expense in 1997 was primarily due to general
price increases in third-party data processing services. Higher data processing
and equipment expenses in 1996 were primarily due 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 1996 also reflected the additional costs to process the
activity of Lockport.
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 a 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 indicate that their hardware or
software is or will be Year 2000 compliant by the end of 1998. In 1997 the
Company's third-party data processing vendor indicated that the Company would
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 of 1998 and will result
in the Company incurring one-time conversion costs of approximately $250,000. As
part of the data processing conversion, the Company will also install a new
retail banking platform which will result in additional one-time costs of
approximately $400,000.
The significant decline in deposit insurance expense in 1996 was due to a
reduction in the Bank Insurance Fund ("BIF") assessment rates. Effective June 1,
1995, the FDIC reduced Heritage Bank's assessment rate from .23% of deposits to
.04% of deposits. In 1996 and 1997 the Bank's assessment rate for each semi-
annual period was zero. In December, 1997, the FDIC set the Company's BIF
assessment rate for the semi-annual assessment period ending June 30, 1998, at
zero. There are no assurances, however, that future assessment rates will remain
at that level. In 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. In 1997 the Company paid FICO assessments at the rate of
.013% of BIF deposits.
The increase in the amortization of intangible assets in 1996 resulted from
the acquisition of Lockport. The increase in professional fees in 1997 was
primarily due to certain consulting fees incurred in connection with special
projects during the year. Higher marketing and promotion expenses in 1997 and
1996 were primarily attributable to increased advertising and direct mail costs
associated with loan and deposit promotions. The increase in other operating
expenses in 1996 reflected a charge of approximately $300,000 to settle a
lawsuit filed by Federal Insurance Company in May, 1995. In the first quarter of
1997, the Company received $150,000 from its insurance carrier as a
reimbursement of legal costs related to this litigation.
18
<PAGE>
Income Taxes
In the 1997 fourth quarter, the Company received a refund of state income
taxes as a result of an amendment to a prior year income tax return. As a result
of the refund, the Company amended other state income tax returns and paid taxes
due with such returns. On a net basis, the Company recognized $148,000 of income
tax benefits as a result of the tax refund and interest earned thereon.
Excluding the benefits of the state income tax refund described above, income
tax expense increased $1,114,000 in 1997 and $600,000 in 1996. Higher income tax
expense in both years was principally due to the increases in pre-tax earnings.
The Company's effective tax rate was 31.2% in 1997 (excluding the net state
income tax refund), 31.7% in 1996 and 32.2% in 1995. The decrease in the
effective tax rate in 1997 and 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
-------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------- -------------- -------------- -------------- --------------
% 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 $163,967 23% $143,811 23% $130,508 23% $124,351 24% $127,499 28%
Commercial real estate 157,809 22% 148,798 23% 145,080 25% 142,833 27% 138,471 30%
Construction 12,188 2% 13,515 2% 8,645 2% 6,096 1% 5,055 1%
Residential real estate 275,482 39% 239,380 37% 200,323 35% 162,246 31% 133,178 29%
Home equity 95,924 13% 85,113 13% 73,525 13% 72,394 13% 33,132 7%
Other consumer 7,406 1% 10,192 2% 13,782 2% 20,078 4% 19,824 5%
-------------- -------------- -------------- -------------- --------------
Total $712,776 100% $640,809 100% $571,863 100% $527,998 100% $457,159 100%
============== ============== ============== ============== ==============
</TABLE>
The Company's primary organizational emphasis is commercial lending. A
majority of the commercial loan portfolio represents loans to small and mid-
sized 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 $28 million or 9% in 1997 compared to an increase of $22 million
or 8% in 1996. 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.
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 1997 this portfolio increased $36 million or
15% compared to $39 million or 19% in 1996. 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 1997 and
1996 were 15-year 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, 1997, approximately $37 million, or 39%, of home
equity loans were floating rate advances under equity lines of credit. The
remaining balance of the portfolio consisted of fixed-rate installment loans
with terms of five to 15 years.
19
<PAGE>
The maturity distribution and interest rate sensitivity of commercial and
industrial, commercial real estate and construction loans at December 31, 1997
are set forth below (in thousands):
<TABLE>
<CAPTION>
TABLE 6 Loan Maturity Distribution and Interest Rate Sensitivity
Maturity (1)
-------------------------------------------------
Within After
1 Year (2) 1-5 Years 5 Years Total
---------- --------- ------- -----
<S> <C> <C> <C> <C>
Commercial and industrial $ 97,547 $ 57,557 $ 8,863 $163,967
Commercial real estate 27,076 93,087 37,646 157,809
Construction 12,188 - - 12,188
-------- -------- ------- --------
Total $136,811 $150,644 $46,509 $333,964
======== ======== ======= ========
Fixed rate loans $ 47,462 $125,812 $42,807 $216,081
Variable rate loans 89,349 24,832 3,702 117,883
-------- -------- ------- --------
Total $136,811 $150,644 $46,509 $333,964
======== ======== ======= ========
</TABLE>
- -----------------
(1) Based on scheduled principal repayments.
(2) Includes demand loans, past due loans and overdrafts.
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.
The following table sets forth the aggregate amount of the Company's
nonperforming assets for the last five years (in thousands):
<TABLE>
<CAPTION>
TABLE 7 Nonperforming Assets
December 31
-------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $903 $3,421 $3,919 $4,272 $4,299
Loans past due 90 days or more 216 783 938 1,201 409
------ ------ ------ ------ ------
Total nonperforming loans 1,119 4,204 4,857 5,473 4,708
Other real estate owned 722 618 760 563 524
------ ------ ------ ------ ------
Total nonperforming assets $1,841 $4,822 $5,617 $6,036 $5,232
====== ====== ====== ====== ======
Restructured loans $139 - - $582 -
====== ====== ====== ====== ======
Nonperforming loans to loans .16% .66% .85% 1.04% 1.03%
Nonperforming assets to loans plus OREO .26% .75% .98% 1.15% 1.15%
</TABLE>
At December 31, 1997, the composition of nonperforming loans primarily
consisted of loans secured by local commercial real estate or residential real
estate of which no single loan exceeded $125,000. Other real estate owned
primarily consisted of residential real estate. At December 31, 1997, the
largest OREO property was a residential property with a carrying value of
$280,000.
In addition to the loans classified as nonperforming at December 31, 1997,
other loans with a total principal balance of approximately $2.3 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.
20
<PAGE>
Impaired Loans
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.
The following table sets forth the recorded investment in impaired loans
and the related valuation allowance for each loan category as of December 31,
1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
TABLE 8 Impaired Loans
Amount of Impaired Loans
----------------------------------
No Valuation Valuation Amount of
Allowance Allowance Valuation
Required Required Total Allowance
-------- -------- ----- ---------
<S> <C> <C> <C> <C>
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
====== ====== ====== ====
December 31, 1996
Commercial and industrial $137 $646 $783 $275
Commercial real estate 816 955 1,771 200
Residential real estate 812 240 1,052 66
------ ------ ------ ----
Total impaired loans $1,765 $1,841 $3,606 $541
====== ====== ====== ====
</TABLE>
Of the total amount of impaired loans at December 31, 1997, $717,000 were
measured using the present value of expected future cash flows and $2,052,000
were measured based on the fair value of collateral. The average recorded
investment in impaired loans for the years ended December 31, 1997 and 1996,
were $2,942,000 and $5,855,000, respectively. Interest income recognized on
impaired loans totaled $144,000 in 1997 and $236,000 in 1996.
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, 1997 were nonaccrual loans of $742,000
and loans 90 days or more past due of $79,000. At December 31, 1996, the balance
of impaired loans included nonaccrual loans of $2,951,000.
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.
21
<PAGE>
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>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $9,407 $8,477 $8,720 $7,655 $7,755
Allowance of acquired banks - 1,179 - 850 -
-------- -------- -------- -------- --------
Provision for loan losses 600 400 200 90 500
-------- -------- -------- -------- --------
Loans charged off:
Commercial and industrial 213 112 348 100 571
Commercial real estate 298 565 351 182 310
Construction - - - - -
Residential real estate 47 164 61 127 96
Home equity 116 37 52 23 18
Other consumer 32 47 53 108 112
-------- -------- -------- -------- --------
Total charge-offs 706 925 865 540 1,107
-------- -------- -------- -------- --------
Recoveries on loans previously charged off:
Commercial and industrial 40 96 234 97 379
Commercial real estate 220 121 36 477 35
Construction - - - - -
Residential real estate 28 27 111 43 32
Home equity 1 - - - -
Other consumer 31 32 41 48 61
-------- -------- -------- -------- --------
Total recoveries 320 276 422 665 507
-------- -------- -------- -------- --------
Net charge-offs (recoveries) 386 649 443 (125) 600
-------- -------- -------- -------- --------
Balance at end of period $9,621 $9,407 $8,477 $8,720 $7,655
======== ======== ======== ======== ========
Specific valuation reserves for impaired loans $210 $541 $822
======== ======== ========
Average loans $675,968 $615,774 $544,738 $489,298 $453,673
======== ======== ======== ======== ========
Net charge-offs (recoveries) to average loans .06% .11% .08% (.03)% .13%
Allowance for loan losses to loans 1.35% 1.47% 1.49% 1.66% 1.68%
Allowance for loan losses to nonperforming loans 860% 224% 175% 159% 163%
</TABLE>
The Company minimizes credit risk by adhering to sound underwriting and credit
review policies. These policies are reviewed at least annually, and changes are
approved by Bank's 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 Bank's board of directors also reviews the status of delinquent
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 higher loan loss provisions in 1997 and 1996 primarily
due to increased loan growth and, in 1996, to higher net charge-offs. The
provisions in both years were also influenced by the improvement in asset
quality and reductions in potential risks associated with impaired loans. The
loan loss provision in 1994 was influenced by a large recovery of a previously
charged-off commercial real estate loan. Excluding the large recovery, the
Company's net charge-off ratio for 1994 would have been .06%.
22
<PAGE>
At December 31, 1997, the allowance for loan losses as a percentage of
loans was 1.35% compared to 1.47% at year-end 1996. The decrease in the level of
the allowance was primarily due to the growth in the loan portfolio. As a
percentage of nonperforming loans, the allowance increased to 860% at December
31, 1997 compared to 224% at December 31, 1996. The increase in the allowance
coverage of nonperforming loans was primarily attributable to the reduction in
nonperforming loans in 1997.
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
--------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial and industrial $2,121 $2,157 $2,077 $2,570 $2,905
Commercial real estate 4,050 4,200 4,100 4,500 3,300
Construction - - - - -
Residential real estate 2,600 2,250 1,550 1,100 1,100
Home equity and other consumer 850 800 750 550 350
------ ------ ------ ------ ------
Total $9,621 $9,407 $8,477 $8,720 $7,655
====== ====== ====== ====== ======
</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, 1997 and 1996 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.
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.
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
------------------------------------------------------
1997 1996 1995
---------------- --------------- ---------------
% of % of % of
By Type: Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
REMICs and CMOs $153,006 29% $166,709 33% $121,695 29%
Pass-through obligations and pools 130,330 25 92,353 18 61,359 15
Adjustable-rate mortgage pools 28,750 6 68,065 13 93,198 22
State and municipal securities 167,229 32 128,367 25 97,807 24
Asset-backed securities 29,810 6 33,533 7 34,511 8
Other securities 11,513 2 19,902 4 7,045 2
--------------- ---------------- ----------------
Total $520,638 100% $508,929 100% $415,615 100%
=============== ================ ================
By Classification:
Available-for-sale $407,087 78% $392,754 77% $318,159 77%
Held-to-maturity 113,101 22 115,913 23 97,456 23
Trading 450 - 262 - - -
--------------- ---------------- ----------------
Total $520,638 100% $508,929 100% $415,615 100%
=============== ================ ================
</TABLE>
23
<PAGE>
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. Approximately one-half of the mortgage-backed
portfolio represents investments in fixed-rate 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 1997 and 1996 the Company increased its investments in fixed-rate,
intermediate- and long-term mortgage-backed securities having average lives
ranging from three to ten years. Fixed-rate mortgage-backed securities
comprised 54% of total securities at December 31, 1997, compared to 51% in 1996
and 44% in 1995. 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.
At December 31, 1997, 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 $14,106,000
and $14,691,000, respectively. In addition to securities, the Company has
granted tax-exempt loans to the Village of Alsip which totaled $4,462,000 at
December 31, 1997. All securities and loans are secured by the general taxing
authority of the Village of Alsip except for $257,000 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,
1997, 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 $11,342 8.94% $ 42,463 8.20% $55,559 8.00% $ 3,737 10.30% $113,101
=============== ================ =============== =============== ========
Available-for-Sale
Mortgage-backed securities:
REMICs and CMOs $24,110 7.37% $ 97,906 6.87% $13,343 6.90% $17,647 6.90% $153,006
Pass-through obligations and pools 16,055 7.02% 84,847 7.38% 11,713 7.33% 17,715 7.31% 130,330
Adjustable-rate mortgage pools 28,750 7.05% - - - - - - 28,750
Asset-backed securities 9,643 6.77% 19,406 6.88% 761 6.84% - - 29,810
State and municipal securities - - 5,969 8.11% 28,713 8.19% 19,446 8.38% 54,128
Other securities 10,255 6.30% 808 6.19% - - - - 11,063
------- -------- ------- ------- --------
Total $88,813 7.02% $208,936 7.11% $54,530 7.67% $54,808 7.56% $407,087
=============== ================ =============== =============== ========
</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 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.
24
<PAGE>
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
------------------------------------------------------------
1997 1996 1995
---------------- ---------------- --------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Demand deposits $ 186,358 16% $ 185,705 18% $161,400 18%
NOW and money market accounts 262,679 23 190,955 18 175,407 19
Savings deposits 189,128 17 203,483 19 201,542 22
Time deposits 501,466 44 473,160 45 376,943 41
---------------- ---------------- --------------
Total deposits $1,139,631 100% $1,053,303 100% $915,292 100%
================ ================ ==============
</TABLE>
At December 31, 1997, total deposits increased $86 million or 8% compared to
year-end 1996. The increase resulted from strong internal deposit growth in
1997. In 1996 total deposits increased $138 million or 15%, reflecting the
acquisition of Lockport and strong deposit growth during the year.
Over the past two years the composition of deposits continued to reflect a
shift to higher interest-bearing deposits such as money market accounts and time
deposits. In 1997 and 1996 the growth in these accounts was primarily due to
premium-rate account promotions. The growth also reflected the shift of funds
from savings deposits as a result of the widening of the interest rate
differential between savings deposits and money market 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
----------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
3 months or less $ 57,309 $ 45,330 $35,001
Over 3 months but within 6 months 28,042 22,190 19,967
Over 6 months but within 12 months 15,353 23,873 14,663
Over 12 months 18,225 15,980 12,687
-------- -------- -------
Total $118,929 $107,373 $82,318
======== ======== =======
</TABLE>
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>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
At December 31:
Securities sold under agreements to repurchase $45,569 $40,706 $47,002
Federal funds purchased - 13,000 -
Notes payable - 7,000 -
------- ------- -------
Total $45,569 $60,706 $47,002
======= ======= =======
Average interest rate 3.69% 3.24% 3.88%
==== ==== ====
</TABLE>
25
<PAGE>
TABLE 15 Short-term Borrowings (continued)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ---
<S> <C> <C> <C>
Maximum Outstanding at Any Month-end During the Year:
Securities sold under agreements to repurchase $53,717 $50,790 $51,553
Federal funds purchased 19,000 16,500 -
Notes payable 5,000 14,000 5,000
--------- --------- ---------
Total $77,717 $81,290 $56,553
========= ========= =========
Averages for the Year:
Securities sold under agreements to repurchase $48,858 $45,846 $41,749
Federal funds purchased 3,269 1,643 -
Notes payable 2,145 9,315 2,689
--------- --------- ---------
Total $54,272 $56,804 $44,438
========= ========= =========
Average interest rate 4.13% 4.01% 4.16%
===== ===== =====
</TABLE>
Securities sold under agreements to repurchase primarily represent borrowings
originated as part of cash management services offered to corporate customers.
Substantially all of the borrowings mature in one business day. Federal funds
purchased represent temporary overnight borrowings from correspondent banks.
Notes payable represented borrowings by the Company to partially fund bank
acquisitions. For more information on acquisitions and borrowings, see "Note 2-
Acquisition" and "Note 7 - Notes Payable" of the Notes to Consolidated Financial
Statements included under Item 8 of this document.
Asset/Liability Management and Interest Rate Risk
The composition of the Company's balance sheet consists of investments in
earning assets (primarily loans and securities) which are primarily funded by
interest-bearing liabilities (deposits and short-term borrowings). All of the
Company's financial instruments are non-trading assets or liabilities, except
for certain securities classified as trading. Such financial instruments have
varying levels of sensitivity to changes in general market interest rates. The
Company's net interest income is dependent, among other things, on the amounts
and yields of its earning assets as compared to the amounts of and rates on its
interest-bearing liabilities. Net interest income is therefore sensitive to
changes in market interest rates or 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
earning assets differ significantly from the maturity or repricing
characteristics of interest-bearing liabilities.
The primary goals of asset/liability management are to maximize net interest
income within the interest rate risk limits approved by the Company's board of
directors. 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. The Company's exposure to interest rate risk is managed
primarily by selecting the types and terms of interest-sensitive assets and
interest-bearing liabilities which generate favorable earnings, while limiting
the potential negative effects of changes in market interest rates. Since the
primary funding sources are interest-bearing customer deposits, the Company's
ability to manage the types and terms of such deposits is limited due to
customer investment and maturity preferences. In addition, the Company's ability
to manage interest-bearing deposits is further limited by competing deposit and
investment products offered by other financial institutions and non-banking
companies. The terms and interest rates charged or earned on loans made and
securities purchased by the Company permit it to achieve a positive
interest rate spread while at the same time limiting its exposure to interest
rate risk.
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 twelve and twenty-four months. Incorporated into the
forecasts are changes in the absolute level of interest rates, changes in the
shape of the yield curve and changes in interest rate relationships. The model
also includes assumptions about how the balance sheet is likely to evolve under
different interest rate scenarios. Such assumptions include, but are not limited
to, the following: (i) loan and deposit growth and run-off assumptions are made
based on historical trends, the
26
<PAGE>
absolute level of interest rates and management's growth expectations and
outlook; (ii) changes in cash flows due to prepayments on mortgage-backed
securities and real estate loans are based on each interest rate scenario;
(iii) prepayments on mortgage-backed securities are projected based on
consensus prepayment estimates of securities brokers; (iv) prepayments on real
estate loans are estimated based on management's interest rate stratification of
loans and assumptions of prepayment expectations; (v) the maturity of most time
deposits are assumed to renew within the same maturity category; and (vi) a
portion of savings deposits are assumed to run-off or shift into certain time
deposit categories.
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 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 risk over a twelve month period.
Net interest income is measured assuming a 200 basis point increase or decrease
in market interest rates during the twelve month period, occurring in 50 basis
point quarterly increments. The results of these scenarios are compared to a
base "stable rate" scenario under which market interest rates remain at current
levels for the twelve month period. If the projected change in net interest
income in the rising or falling interest rate scenario is more than 5% of stable
rate net interest income, management is required to develop strategies to manage
or reduce this risk.
Set forth in the following table is the Company's forecasted percentage change
in interest income or expense in a rising or falling rate scenario as computed
in accordance with policy guidelines as of December 31, 1997:
Table 16 Sensitivity Analysis Table
<TABLE>
<CAPTION>
Percentage Change in
Interest for Each Category
Due to Change in Interest Rate
--------------------------------
-2.00% +2.00%
-------------- ---------------
<S> <C> <C>
Earning assets (TE):
Loans:
Fixed-rate (7.2)% 3.2%
Variable-rate (14.4)% 14.4%
Securities and short-term investments:
Fixed-rate 3.6% 0.2%
Variable-rate (10.6)% 1.7%
Total earning assets (4.7)% 3.9%
Interest-bearing liabilities:
Deposits:
Fixed-rate(1) (1.4)% 1.4%
Variable-rate(2) (16.3)% 15.5%
Short-term borrowings (36.3)% 43.5%
Total interest-bearing liabilities (15.0)% 14.6%
Net interest income (TE) 3.6% (4.8)%
</TABLE>
- --------------------
(1) Includes NOW and savings deposits
(2) Includes money market accounts and time deposits.
As indicated in Table 16, the results of simulation modeling as of December
31, 1997 project net interest income would decrease by approximately 4.8% of
stable rate net interest income if market interest rates gradually increased two
percentage points over the next year. The model projects that net interest
income would increase by approximately 3.6% of stable rate net interest income
if market interest rates gradually decreased by two percentage points over the
next year. In either case, the Company's estimated change in net interest income
fall within the 5% policy guidelines. Management believes that its interest rate
sensitivity position is appropriate given the current economic and interest rate
environment.
27
<PAGE>
The computation of forecasted effects of hypothetical market interest rate
changes is based upon numerous assumptions, including the slope of the yield
curve, relative levels of market interest rates, prepayments of loans and
securities and deposit decay, and should not be relied upon as indicative of
actual future results. Further, the forecasted effects do not take into
consideration any actions that management may take in response to changes in
market conditions, inflation expectations or interest rates.
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. Heritage 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, Heritage Bank may purchase up to $55 million under informal
federal funds lines with correspondent banks. In 1997 Heritage Bank's average
amount of federal funds sold was approximately $8 million. For the three and
twelve months ended December 31, 1997, the aggregate principal payments received
on mortgage-backed and asset-backed securities totaled approximately $14 million
and $55 million, respectively. At December 31, 1997, Heritage Bank had $19
million of securities having contractual maturities of one year or less and
expects to receive approximately $58 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
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, 1997, the amount of undistributed earnings of Heritage Bank available for
payment of dividends within such limitations was sufficient to fund the
anticipated cash requirements of HFS. For a further discussion of Heritage
Bank's capital requirements and dividend restrictions, see "Note 16 - Regulatory
Restrictions and Capital Adequacy" of the Notes to Consolidated Financial
Statements included under Item 8 of this document.
Capital
At December 31, 1997 total shareholders' equity increased to $122.2 million,
up $16.5 million or 16% from December 31, 1996. In 1996 shareholders' equity
increased $8.9 million or 9% compared with year-end 1995. The growth in equity
primarily reflected the retention of current year earnings, less dividends paid,
cost of treasury stock purchased and reissued, and changes in the composition
and market values of securities available-for-sale.
In 1997 the Company paid dividends of 40 cents per share, an increase of 14%
over the 1996 annual dividend rate. On January 13, 1998, the board of directors
increased the annual dividend rate 10% to 44 cents per share, payable quarterly
at the rate of 11 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 16 - 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. 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 1997, on a split adjusted basis, the Company
repurchased 205,001 common shares at a cost of $3,446,000 and reissued 296,128
treasury shares upon the exercise of stock options. In 1996, on a split adjusted
basis, the Company repurchased 130,950 common shares at a cost of $1,852,000 and
reissued 1,912 treasury shares upon the exercise of stock options. At December
31, 1997, the Company had 129,049 common shares remaining to be repurchased
under the stock repurchase program. Effective January 14, 1998, the Company
rescinded the balance of its stock repurchase program in connection with the
proposed merger discussed below.
28
<PAGE>
On May 14, 1997, the board of directors of Heritage Financial Services, Inc.
declared a three-for-two stock split, payable June 13, 1997, to shareholders of
record at the close of business on May 27, 1997. The board of directors also
voted to eliminate the par value of common shares. As a result of the stock
split, shareholders of record as of May 27, 1997 received one additional common
share for every two shares owned. Shareholders entitled to fractional shares
received cash in lieu of fractional shares. Per share information included in
the consolidated financial statements has been adjusted to reflect the split.
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 is
conditioned upon, among other things, approval by the shareholders of both the
Company and First Midwest and receipt of customary regulatory approvals. The
Merger Agreement has been approved by the boards of directors of both companies.
It is anticipated that the acquisition will be consummated late in the second
quarter of 1998.
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.
New Accounting Pronouncements Not Yet Effective
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No ("SFAS") 130, "Reporting
Comprehensive Income", which establishes standards for reporting and display of
comprehensive income and its components in a full set of financial statements.
Comprehensive income is the total of reported net income and all other revenues,
expenses, gains and losses that under generally accepted accounting principles
bypass reported net income. SFAS 130 requires that comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements and requires an entity to (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and surplus in the equity section of the balance sheet. SFAS 130 is
effective for fiscal years beginning after December 15, 1997. Companies are also
required to report comparative totals for comprehensive income in interim
reports. Management is currently considering the impact of SFAS 130, but does
not believe it will have a material effect on the Company's consolidated
financial statements.
In June 1997, FASB issued 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.
29
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
December 31 ,
--------------------------
1997 1996
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks $ 48,214 $ 43,830
Federal funds sold and interest-bearing deposits 2,864 -
---------- ----------
Total cash and cash equivalents 51,078 43,830
Securities:
Held-to-maturity (market value: $116,544 in 1997 and $117,046 in 1996) 113,101 115,913
Available-for-sale, at market 407,087 392,754
Trading, at market 450 262
---------- ----------
Total securities 520,638 508,929
Loans, net of unearned income 711,541 639,004
Less: allowance for loan losses (9,621) (9,407)
---------- ----------
Net loans 701,920 629,597
Premises and equipment 19,585 18,786
Goodwill and core deposit intangibles 16,190 18,196
Other assets 9,910 9,682
---------- ----------
Total assets $1,319,321 $1,229,020
========== ==========
LIABILITIES
Demand deposits $ 186,358 $ 185,705
NOW and money market accounts 262,679 190,955
Savings deposits 189,128 203,483
Time deposits 501,466 473,160
---------- ----------
Total deposits 1,139,631 1,053,303
Federal funds purchased - 13,000
Securities sold under agreements to repurchase 45,569 40,706
Notes payable - 7,000
Other liabilities 11,915 9,324
---------- ----------
Total liabilities 1,197,115 1,123,333
---------- ----------
SHAREHOLDERS' EQUITY
Preferred shares - no par value; shares authorized: 12,000,000;
shares issued: none - -
Common shares - no par value in 1997, $.625 par value in 1996;
shares authorized: 16,000,000; shares issued: 12,128,313 in 1997
and 11,950,548 in 1996 - 4,979
Surplus 24,181 17,634
Retained earnings 93,346 83,374
Net unrealized gains on securities, net of tax 5,367 1,525
Treasury stock, at cost (37,911 shares in 1997 and 129,038 shares in 1996) (688) (1,825)
---------- ----------
Total shareholders' equity 122,206 105,687
---------- ----------
Total liabilities and shareholders' equity $1,319,321 $1,229,020
========== ==========
See accompanying notes to consolidated financial statements.
</TABLE>
30
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Interest Income
Loans, including fees $57,772 $52,907 $48,156
Securities:
Taxable 25,088 24,001 18,881
Exempt from federal income taxes 7,872 6,222 4,445
Federal funds sold and interest-bearing deposits 424 694 2,378
------- ------- -------
Total interest income 91,156 83,824 73,860
------- ------- -------
Interest Expense
Deposits 40,692 36,327 31,516
Short-term borrowings 1,904 1,675 1,661
Notes payable 140 604 187
------- ------- -------
Total interest expense 42,736 38,606 33,364
------- ------- -------
Net interest income 48,420 45,218 40,496
Provision for loan losses 600 400 200
------- ------- -------
Net interest income after provision for loan losses 47,820 44,818 40,296
------- ------- -------
Other Income
Service charges on deposit accounts 5,210 4,477 4,097
Income for trust services 874 784 737
Investment product fees 1,257 1,134 909
Other operating income 1,975 1,209 1,005
Securities gains 291 120 223
------- ------- -------
Total other income 9,607 7,724 6,971
------- ------- -------
Other Expense
Salaries and employee benefits 17,307 16,645 15,146
Net occupancy expense 3,190 3,107 2,618
Equipment expense 1,731 1,697 1,569
Federal deposit insurance premiums 123 53 958
Data processing expense 1,247 1,105 817
Amortization of intangible assets 2,006 2,251 1,613
Other operating expenses 6,161 5,943 4,949
------- ------- -------
Total other expense 31,765 30,801 27,670
------- ------- -------
Income before income taxes 25,662 21,741 19,597
Income tax expense 7,869 6,903 6,303
------- ------- -------
Net income $17,793 $14,838 $13,294
======= ======= =======
Net income per common share:
Basic $1.48 $1.25 $1.12
Diluted $1.43 $1.19 $1.07
Weighted average common and common equivalent
shares outstanding:
Basic 12,052,443 11,898,714 11,905,635
Diluted 12,463,805 12,486,834 12,463,506
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands except per share data)
<TABLE>
<CAPTION>
Net
Unrealized
Preferred Common Retained Gains (Losses) Treasury
Shares Shares Surplus Earnings on Securities Stock Total
------ ------ ------- -------- ------------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 - $ 4,947 $ 17,385 $ 62,879 $ (2,100) $ 83,111
Net income - - - 13,294 - 13,294
Cash dividends ($.29 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 $2,468 - - - - 3,741 3,741
--------- ------- -------- -------- --------- ------- --------
Balance, December 31, 1995 - 4,962 17,499 72,681 1,641 96,783
Net income - - - 14,838 - 14,838
Cash dividends ($.35 per share) - - - (4,125) - (4,125)
Common shares issued upon
exercise of stock options - 17 135 - - 152
Purchases of common shares - - - - - (1,852) (1,852)
Treasury stock reissued upon
exercise of stock options - - - (20) - 27 7
Change in net unrealized gains
(losses) on securities, net of
related taxes of $(76) - - - - (116) - (116)
--------- ------- -------- -------- --------- ------- --------
Balance, December 31, 1996 - 4,979 17,634 83,374 1,525 (1,825) 105,687
Net income - - - 17,793 - - 17,793
Cash dividends ($.40 per share) - - - (4,831) - - (4,831)
Change in common share par value - (5,053) 5,053 - - - -
Common shares issued upon
exercise of stock options - 74 877 - - - 951
Purchases of common shares - - - - - (3,446) (3,446)
Treasury stock reissued upon
exercise of stock options - - 617 (2,990) - 4,583 2,210
Change in net unrealized gains
(losses) on securities, net of
related taxes of $2,536 - - - - 3,842 - 3,842
--------- ------- -------- -------- --------- ------- --------
Balance, December 31, 1997 - $ - $ 24,181 $ 93,346 $ 5,367 $ (688) $122,206
========= ======= ======== ======== ========= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Operating Activities
Net income $17,793 $14,838 $13,294
Adjustments to reconcile net income to net cash
provided by operating activities:
Discount accretion on securities (1,925) (1,473) (978)
Deferred loan fee accretion (394) (452) (311)
Provision for loan losses 600 400 200
Securities gains (291) (120) (223)
Depreciation and amortization 1,877 1,740 1,690
Deferred income taxes (450) (346) (464)
Net amortization of purchase accounting adjustments 2,442 2,818 2,085
Increase in accrued interest income (503) (270) (1,249)
Increase in accrued interest expense 78 115 703
Other, net 1,576 869 (430)
--------- --------- ---------
Net cash provided by operating activities 20,803 18,119 14,317
--------- --------- ---------
Investing Activities
Securities held-to-maturity:
Proceeds from maturities, repayments and calls 12,045 9,894 51,333
Purchases (8,472) (25,635) (114,787)
Securities available-for-sale:
Proceeds from maturities, repayments and calls 66,168 88,142 14,391
Proceeds from sales 57,490 38,093 7,962
Purchases (130,397) (150,994) (58,834)
Purchase of trading security - (250) -
Net increase in loans (73,651) (35,308) (45,985)
Purchases of premises and equipment (2,780) (2,180) (1,288)
Proceeds from sales of other real estate owned 695 945 645
Purchase price of acquired bank net of cash and cash equivalents - (7,798) -
--------- --------- ---------
Net cash used in investing activities (78,902) (85,091) (146,563)
--------- --------- ---------
Financing Activities
Net increase in deposits 86,404 56,946 91,848
Net increase (decrease) in federal funds purchased (13,000) 13,000 -
Net increase (decrease) in securities sold under agreements to repurchase 4,863 (10,205) 13,984
Proceeds from notes payable - 14,000 -
Principal payments on notes payable (7,000) (7,000) (6,500)
Proceeds from stock option exercises 1,134 159 129
Dividends paid (4,831) (4,125) (3,492)
Purchases of common shares (2,223) (1,852) -
--------- --------- ---------
Net cash provided from financing activities 65,347 60,923 95,969
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 7,248 (6,049) (36,277)
Cash and cash equivalents at beginning of year 43,830 49,879 86,156
--------- --------- ---------
Cash and cash equivalents at end of year $51,078 $43,830 $49,879
========= ========= =========
Supplemental disclosures:
Interest paid $42,734 $38,595 $32,807
Income taxes paid 8,400 6,825 7,005
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 767 901 735
Loans made in connection with the disposition of other real estate owned - 370 -
Supplemental schedule of non-cash financing activities:
Purchases of common shares $ 1,223 $ - $ -
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE>
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 (a national banking association limited to trust and
insurance agency operations) and Heritage Trust Company (collectively, the
"Company"). Significant intercompany accounts and transactions are eliminated
in consolidation. Certain amounts in the 1996 and 1995 consolidated financial
statements have been reclassified to conform to the 1997 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 significantly from those estimates. Estimates that
are particularly susceptible to significant changes relate to the determination
of the allowance for loan losses.
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 1996 Statement of Cash Flows is the purchase
price of an acquisition, 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.
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". 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.
34
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
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.
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, 1997 and 1996, 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.
35
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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-line 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.
Stock Options
The Company accounts for employee stock option plans under APB Opinion 25 and
related Interpretations. Accordingly, no compensation expense is recognized for
grants of stock options.
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.
Earnings Per Share
Effective December 15, 1997, the Company adopted SFAS 128, "Earnings Per
Share". SFAS 128 establishes standards for computing and presenting earnings per
share ("EPS") and applies to entities with publicly held common stock or
potential common stock. SFAS 128 replaces the presentation of primary EPS with
earnings per common share ("basic EPS"). Basic EPS is computed by dividing net
income by the weighted average number of common shares outstanding for the
period. SFAS 128 also requires presentation of EPS assuming dilution ("diluted
EPS"). Diluted EPS 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. The dilutive effect of stock
options is computed using the treasury stock method. In accordance with SFAS
128, the Company has restated all prior period earnings per share data. Weighted
average common shares have also been adjusted to reflect the Company's 1997
three-for-two stock split. The computation of basic and diluted EPS is set forth
in Note 12 .
Capital Structure
Effective December 15, 1997, the Company adopted SFAS 129, "Disclosure of
Information About Capital Structure". SFAS 129 essentially consolidates
disclosure requirements found in other previously existing literature regarding
capital structure. Since SFAS 129 contains no changes in disclosure
requirements, the adoption of this standard had no effect on the Company's
capital structure disclosures.
Transfers of Financial Assets, Servicing Rights and Extinguishment of
Liabilities
As of January 1, 1997, the Company adopted the provisions of 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. The adoption of SFAS 125 did not
have a material effect on the Company's consolidated financial condition or
results of operations.
36
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
New Accounting Pronouncements Not Yet Effective
In June 1997, FASB issued SFAS 130, "Reporting Comprehensive Income", which
establishes standards for reporting and display of comprehensive income and its
components in a full set of financial statements. Comprehensive income is the
total of reported net income and all other revenues, expenses, gains and losses
that under generally accepted accounting principles bypass reported net income.
SFAS 130 requires that comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements and
requires an entity to (a) classify items of other comprehensive income by their
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and surplus in the equity
section of the balance sheet. SFAS 130 is effective for fiscal years beginning
after December 15, 1997. Companies are also required to report comparative
totals for comprehensive income in interim reports. Management is currently
considering the impact of SFAS 130, but does not believe it will have a material
effect on the Company's consolidated financial statements.
In June 1997, FASB issued 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 2 - ACQUISITION
On February 2, 1996, the Company acquired all of the common stock 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.
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, 1997
State and municipal obligations $113,101 $ 3,514 $ (71) $116,544
======== ======== ======== ========
December 31, 1996
State and municipal obligations $115,913 $ 1,986 $ (853) $117,046
======== ======== ======== ========
</TABLE>
37
<PAGE>
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, 1997
Mortgage-backed securities:
REMICs and CMOs $150,471 $ 2,582 $ (47) $153,006
Adjustable rate mortgage pools 27,752 998 - 28,750
Pass-through obligations and pools 127,084 3,300 (54) 130,330
Asset-backed securities 29,434 395 (19) 29,810
U.S. Treasury and governmental agencies 6,007 6 (7) 6,006
State and municipal obligations 52,378 1,758 (8) 54,128
Other securities 5,057 - - 5,057
-------- ------- -------- --------
Total $398,183 $ 9,039 $ (135) $407,087
======== ======= ======== ========
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
======== ======= ======== ========
</TABLE>
Securities with carrying values of $155,514,000 and $162,920,000 at December
31, 1997 and 1996, 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 $57,740,000 in 1997,
$38,093,000 in 1996 and $7,962,000 in 1995. In 1997 gross gains from sales were
$482,000 and gross losses were $381,000. In 1997 calls of securities resulted in
gross gains of $1,000. The balance of securities gains recognized in 1997
reflected a market value adjustment of an investment security classified as
trading. In 1996 gross gains from sales were $63,000 and gross losses were
$121,000. 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 gross gains from
sales were $177,000. In 1995 calls of securities resulted in gross gains of
$47,000 and gross losses of $1,000. Income tax expense recognized on net
securities gains was $116,000 in 1997, $43,000 in 1996 and $93,000 in 1995.
38
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes the contractual maturities of securities held-
to-maturity and available-for-sale at December 31, 1997. 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 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 $ 11,150 $ 11,282
Due after one year through five years 31,569 32,200
Due after five years through ten years 59,922 61,957
Due after ten years 10,460 11,105
--------- ---------
Total held-to-maturity $ 113,101 $ 116,544
========= =========
Available-for-Sale:
Due in one year or less $ 10,276 $ 10,275
Due after one year through five years 1,577 1,602
Due after five years through ten years 10,313 10,458
Due after ten years 41,276 42,856
--------- ---------
Subtotal 63,442 65,191
Mortgage-backed securities 305,307 312,086
Asset-backed securities 29,434 29,810
--------- ---------
Total available-for-sale $ 398,183 $ 407,087
========= =========
</TABLE>
NOTE 4 - LOANS
The following table summarizes loan balances by category as of December 31,
1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Commercial and industrial $ 163,967 $ 143,811
Commercial real estate 157,809 148,798
Construction 12,188 13,515
Residential real estate 275,482 239,380
Home equity 95,924 85,113
Other consumer 7,406 10,192
--------- ---------
Gross loans 712,776 640,809
less: unearned income (1,235) (1,805)
--------- ---------
Loans, net of unearned income $ 711,541 $ 639,004
========= =========
</TABLE>
Loans on which the accrual of interest has been discontinued amounted to
$903,000 and $3,421,000 at December 31, 1997 and 1996, respectively. If interest
on those loans had been accrued at their original terms, such income would
approximate $58,000 in 1997 and $170,000 in 1996. The amount of interest accrued
on these loans and included in interest income was $18,000 in 1997 and $76,000
in 1996. At December 31, 1997, restructured loans totaled $139,000. There were
no restructured loans at December 31, 1996.
Real estate loans with carrying values of $10,843,000 and $10,686,000 at
December 31, 1997 and 1996, respectively, were pledged to secure public fund
deposits.
39
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 those prevailing at the time for comparable transactions with
unrelated persons. The aggregate balance of these loans was $8,670,000 at
December 31, 1997 and $9,056,000 at December 31, 1996. During 1997 $5,802,000 of
new loans were made and repayments were $6,188,000.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The changes in the allowance for loan losses for the years ended December 31,
1997, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year $9,407 $8,477 $8,720
Allowance of acquired bank - 1,179 -
Provision for loan losses 600 400 200
Loan charge-offs (706) (925) (865)
Loan recoveries 320 276 422
------ ------ ------
Balance, end of year $9,621 $9,407 $8,477
====== ====== ======
</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, 1997
and 1996 (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, 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
====== ====== ====== ====
December 31, 1996
Commercial and industrial $137 $646 $783 $275
Commercial real estate 816 955 1,771 200
Residential real estate 812 240 1,052 66
------ ------ ------ ----
Total impaired loans $1,765 $1,841 $3,606 $541
====== ====== ====== ====
</TABLE>
The average recorded investment in impaired loans for the years ended December
31, 1997 and 1996, were $2,942,000 and $5,855,000, respectively. Interest
income recognized on impaired loans totaled $144,000 in 1997 and $236,000 in
1996. Included in the total balance of impaired loans at December 31, 1997 and
1996, were nonaccrual loans of $742,000 and $2,951,000, respectively. Of the
total amount of impaired loans at December 31, 1997, $717,000 were measured
using the present value of expected future cash flows and $2,052,000 were
measured based on the fair value of collateral.
40
<PAGE>
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, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Land $ 5,333 $ 5,245
Buildings and improvements 19,559 18,324
Furniture and equipment 16,474 15,583
------- -------
Total cost 41,366 39,152
Less: accumulated depreciation and amortization (21,781) (20,366)
-------- -------
Premises and equipment, net $19,585 $18,786
======== =======
</TABLE>
The Company leases certain banking facilities under noncancelable operating
leases which expire on various dates from 1998 through 2017. 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
$268,000 in 1997, $270,000 in 1996 and $234,000 in 1995. Aggregate amounts of
minimum rental commitments under noncancelable operating leases are $2,957,000
and for each of the years subsequent to December 31, 1997, are $246,000 (1998),
$253,000 (1999), $211,000 (2000), $172,000 (2001) and $117,000 (2002).
NOTE 7 - NOTES PAYABLE
Notes payable, which were repaid in 1997, represented borrowings under a $20
million unsecured revolving line of credit. At December 31, 1996, the weighted
average interest rate of notes payable 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, 1997 and 1996 there were no preferred shares
issued.
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. Common shares issued pursuant to the exercise of stock options totaled
177,808 in 1997, 41,510 in 1996 and 35,081 in 1995.
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 plans. 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 1997, on a split adjusted basis, the Company
repurchased 205,001 common shares at a cost of $3,446,000 and reissued 296,128
treasury shares upon the exercise of stock options. In 1996, on a split adjusted
basis, the Company repurchased 130,950 common shares at a cost of $1,852,000 and
reissued 1,912 treasury shares upon the exercise of stock options. At December
31, 1997, the Company had 129,049 common shares remaining to be repurchased
under the stock repurchase program.
On May 14, 1997, the Company's board of directors declared a three-for-two
stock split, payable June 13, 1997, to shareholders of record at the close of
business on May 27, 1997. The board of directors also voted to eliminate the par
value of common shares. As a result of the stock split, shareholders of record
as of May 27, 1997 received one additional common share for every two shares
owned. Shareholders entitled to fractional shares received cash in lieu of
fractional shares. Per share information included in the consolidated financial
statements has been adjusted to reflect the split.
41
<PAGE>
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 675,000 common shares
(split adjusted). The Plan replaced the 1987 Stock Option Plan (the "Prior
Plan") for grants of stock options after September, 1990. The Prior Plan
provided for options of up to 1,125,000 common shares (split adjusted). 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 (the "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,
1997 and 1996 is presented below (shares in thousands):
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------- -----------------
Weighted Weighted
Option Average Option Average
Shares Price Shares Price
------ ----- ------ -----
<S> <C> <C> <C> <C>
Balance, beginning of period 1,022 $5.82 1,065 $5.73
Granted - - - -
Exercised (474) $4.98 (43) $3.70
Forfeited - - - -
----- -----
Balance, end of period 548 $6.55 1,022 $5.82
===== =====
</TABLE>
A summary of the Company's outstanding and exercisable options at December
31, 1997 is presented below (shares in thousands):
<TABLE>
<CAPTION>
Outstanding Options Exercisable Options
--------------------------- -------------------
Weighted Average Weighted
Option Average Remaining Option Average
Exercise Price Ranges: Shares Price Life Shares Price
------ ----- ---- ------ -----
<S> <C> <C> <C> <C> <C>
$4.73 - $7.08 418 $5.60 2.6 yrs 418 $5.60
$9.00 - $11.00 130 $9.60 5.5 yrs 100 $9.20
--- ---
Total 548 518
=== ===
</TABLE>
NOTE 10 - PROFIT SHARING PLAN
The Company has a noncontributory profit sharing plan which covers
substantially all employees who meet certain age and employment requirements.
The contribution to the plan each year 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, 1997, 1996 and 1995 amounted to $1,120,000,
$1,184,000 and $940,000, respectively.
42
<PAGE>
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, 1997, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $6,816 $5,644 $5,370
State 1,504 1,605 1,397
------ ------ ------
Total current 8,320 7,249 6,767
------ ------ ------
Deferred:
Federal (682) (338) (439)
State 231 (8) (25)
------ ------ ------
Total deferred (451) (346) (464)
------ ------ ------
Total income tax expense $7,869 $6,903 $6,303
====== ====== ======
</TABLE>
A reconciliation of the federal statutory tax rate to the Company's effective
tax rate for the years ended December 31, 1997, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<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 4.4 4.7 4.6
Amortization of goodwill 1.5 1.8 1.5
Tax-exempt interest income, less disallowed interest
expense (10.1) (9.7) (8.3)
Other, net (.1) (.1) (.6)
----- ---- ----
Actual effective income tax rate 30.7% 31.7% 32.2%
===== ==== ====
</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, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 3,824 $ 3,690
Loan fees 229 288
State net operating loss carryforward - 232
Compensation expense 746 594
Other 131 123
------- -------
4,930 4,927
------- -------
Deferred tax liabilities:
Purchase accounting adjustments (3,086) (3,607)
Net unrealized gains on securities (3,544) (1,008)
Depreciation (84) (85)
Other (80) (6)
------- -------
(6,794) (4,706)
------- -------
Net deferred tax asset (liability) $(1,864) $ 221
======= =======
</TABLE>
Management believes that it is more likely than not that deferred tax assets
will be fully realized. As a result, no valuation allowances were recorded at
December 31, 1997 and 1996.
43
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share for the years ended December 31, 1997, 1996 and 1995 (in thousands,
except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income available to common shareholders $17,793 $14,838 $13,294
======= ======= =======
Weighted average common shares outstanding use
in basic earnings per share calculation 12,053 11,899 11,906
Dilutive effect of employee stock options after
application of the treasury stock method 411 588 558
------- ------- -------
Weighted average number of shares outstanding adjusted
for the effect of dilutive securities 12,464 12,487 12,464
======= ======= =======
Basic earnings per share $1.48 $1.25 $1.12
===== ===== =====
Diluted earnings per share $1.43 $1.19 $1.07
===== ===== =====
</TABLE>
NOTE 13 - 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, 1997 and 1996 are as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Commitments to extend credit:
Unused lines of credit: $ 65,564 $ 66,994
Commercial and other 32,293 19,808
Home equity 27,768 29,019
Commitments to originate credit -------- --------
Total $125,625 $115,821
======== ========
Letters of credit $11,361 $9,199
======== ========
</TABLE>
44
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
At December 31, 1997, approximately 60% of the securities portfolio was
comprised of mortgage-backed securities which consisted 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, 1997, the amortized cost and market value of Village of
Alsip securities were $14,106,000 and $14,691,000, respectively. In addition to
securities, the Company has granted tax-exempt loans to the Village of Alsip
which totaled $4,462,000 at December 31, 1997. All securities and loans are
secured by the general taxing authority of the respective issuer except for
$257,000 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 limit
the risk from 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 or
results of operations of the Company.
NOTE 14 - 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.
45
<PAGE>
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, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------------- -------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 51,078 $ 51,078 $ 43,830 $ 43,830
Securities:
Held-to-maturity 113,101 116,544 115,913 117,046
Available-for-sale 407,087 407,087 392,754 392,754
Trading 450 450 262 262
Loans, net 701,920 717,239 629,597 636,671
Interest receivable 7,922 7,922 7,419 7,419
Financial Liabilities:
Demand deposits 186,358 186,358 185,705 185,705
NOW, money market and savings deposits 451,807 451,807 394,438 394,438
Time deposits 501,466 500,678 473,160 473,184
Federal funds purchased - - 13,000 13,000
Securities sold under agreements to
repurchase 45,569 45,569 40,706 40,706
Notes payable - - 7,000 7,000
Interest payable 3,488 3,488 3,410 3,410
</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 U.S.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.
46
<PAGE>
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 15 - CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY
The following presents the condensed Balance Sheets as of December 31, 1997
and 1996, and Statements of Income and Statements of Cash Flows for each of the
three years ended December 31, 1997, for Heritage Financial Services, Inc. (in
thousands):
<TABLE>
<CAPTION>
Balance Sheets
1997 1996
---- ----
<S> <C> <C>
Cash $ 3,889 $ 2,678
Trading securities 450 262
Investment in bank subsidiaries 115,804 108,629
Investment in non-bank subsidiary 1,927 1,761
Other assets 911 153
-------- --------
Total assets $122,981 $113,483
======== ========
Notes payable $ - $ 7,000
Other liabilities 775 796
Shareholders' equity 122,206 105,687
-------- --------
Total liabilities and shareholders' equity $122,981 $113,483
======== ========
</TABLE>
<TABLE>
<CAPTION>
Statements of Income
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Income:
Dividends from bank subsidiary $15,000 $18,500 $10,500
Other income 291 71 40
------- ------- -------
Total income 15,291 18,571 10,540
------- ------- -------
Expenses:
Interest on notes payable 141 604 187
Salaries and employee benefits 793 564 559
Other expenses 499 429 320
------- ------- -------
Total expenses 1,433 1,597 1,066
------- ------- -------
Income before income taxes and equity in
undistributed earnings of subsidiaries 13,858 16,974 9,474
Income tax benefit (436) (634) (460)
Equity in undistributed earnings of subsidiaries 3,499 (2,770) 3,360
------- ------- -------
Net income $17,793 $14,838 $13,294
======= ======= =======
</TABLE>
47
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
<TABLE>
<CAPTION>
Statements of Cash Flows
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Operating Activities:
Net income $ 17,793 $ 14,838 $ 13,294
Adjustments to reconcile net income to cash
provided by operating activities:
Equity in undistributed earnings of subsidiaries (3,499) 2,770 (3,360)
Securities gains (188) (12) -
Increase (decrease) in accrued expenses (21) 316 (48)
Other, net 56 18 (94)
--------- ---------- ---------
Net cash provided by operating activities 14,141 17,930 9,792
--------- ---------- ---------
Investing Activities:
Acquisition of bank subsidiary - (16,820) -
Purchase of trading security - (250) -
--------- ---------- ---------
Net cash used in investing activities - (17,070) -
--------- ---------- ---------
Financing Activities:
Proceeds from notes payable - 14,000 -
Principal payments on notes payable (7,000) (7,000) (6,500)
Proceeds from stock option exercises 1,134 159 129
Dividends paid (4,831) (4,125) (3,492)
Purchases of common stock (2,223) (1,852) -
--------- ---------- ---------
Net cash provided by (used in) financing activities (12,920) 1,182 (9,863)
--------- ---------- ---------
Net increase (decrease) in cash 1,221 2,042 (71)
Cash at beginning of year 2,678 636 707
--------- ---------- ---------
Cash at end of year $ 3,899 $ 2,678 $ 636
========= ========== ==========
Supplemental disclosures:
Interest paid $162 $582 $284
Income tax benefit received 436 634 460
</TABLE>
NOTE 16 - 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, 1997 and 1996 were $12,382,000 and $15,126,000, 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.
48
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 table sets forth the actual and required regulatory capital amounts
and ratios of the Company and Bank as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
To Be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ------------------ -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997
Tier I Capital to Average Assets
Consolidated $100,651 7.81% greater than $51,572 4.00%
Bank $ 93,042 7.26% greater than $51,256 4.00% greater than $64,070 5.00%
Tier I Capital to Risk Weighted Assets
Consolidated $100,651 13.91% greater than $28,933 4.00%
Bank $ 93,042 12.86% greater than $28,951 4.00% greater than $43,426 6.00%
Total Capital to Risk Weighted Assets
Consolidated $109,700 15.17% greater than $57,866 8.00%
Bank $102,096 14.11% greater than $57,901 8.00% greater than $72,376 10.00%
December 31, 1996
Tier I Capital to Average Assets
Consolidated $ 85,757 7.19% greater than $47,723 4.00%
Bank $ 87,537 7.36% greater than $47,558 4.00% greater than $59,448 5.00%
Tier I Capital to Risk Weighted Assets
Consolidated $ 85,757 12.74% greater than $26,915 4.00%
Bank $ 87,537 13.03% greater than $26,874 4.00% greater than $40,311 6.00%
Total Capital to Risk Weighted Assets
Consolidated $ 94,183 14.00% greater than $53,830 8.00%
Bank $ 95,948 14.28% greater than $53,748 8.00% greater than $67,185 10.00%
</TABLE>
Management believes that the Company and the Bank meet all capital adequacy
requirements as of December 31, 1997. The most recent notification from the
Federal Deposit Insurance Corporation, dated December 31, 1997, 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, 1997, 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
the Bank to Heritage Financial Services, Inc. without prior approval from such
authorities. At December 31, 1997, $31,222,000 of undistributed earnings of the
Bank were available for payment of dividends to Heritage Financial Services,
Inc. without prior regulatory approval.
NOTE 17 - SUBSEQUENT EVENTS
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. In conjunction with
the approval of the Merger Agreement, the Company rescinded the balance of its
stock repurchase program authorized in June 1996.
49
<PAGE>
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Merger is conditioned upon, among other things, approval by the
shareholders of both the Company and First Midwest and receipt of customary
regulatory approvals. The Merger Agreement has been approved by the boards of
directors of both companies. It is anticipated that the acquisition will be
consummated late in the second quarter of 1998.
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.
NOTE 18 - QUARTERLY FINANCIAL DATA (unaudited)
The following sets forth condensed quarterly results of operations for 1997
and 1996 (in thousands, except per share data):
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
1997
Interest income $22,041 $22,575 $23,076 $23,464
Interest expense 10,057 10,519 10,917 11,243
------- ------- ------- -------
Net interest income 11,984 12,056 12,159 12,221
Provision for loan losses 150 150 150 150
Other income 2,301 2,234 2,342 2,730
Other expense 7,774 7,931 7,799 8,261
Income tax expense 2,030 1,957 2,054 1,828
------- ------- ------- -------
Net income $ 4,331 $ 4,252 $ 4,498 $ 4,712
======= ======= ======= =======
Net income per common share:
Basic $.36 $.35 $.37 $.39
Diluted $.35 $.34 $.36 $.38
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:
Basic $.29 $.32 $.32 $.32
Diluted $.28 $.30 $.31 $.30
</TABLE>
50
<PAGE>
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
51
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
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, 1997 and 1996 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, 1997 and 1996, 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 19, 1998
52
<PAGE>
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Certain matters discussed in this Annual Report on Form 10-K 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 harbors 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 affect 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;
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
Annual Report on Form 10-K and the Company undertakes no obligation to publicly
update such forward-looking statements to reflect subsequent events or
circumstances.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
53
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors of the Company are divided into three classes having
staggered terms of three years. Class I consists of Messrs. Groebe, Sterling and
Stranczek, whose terms expire in the year 2000. Class II consists of Messrs.
Sampias, Gallagher, Mathis and Sieloff, whose terms expire in the year 1998.
Class III consists of Messrs. Wojcik, Payan, Tichenor and Velo, whose terms
expire in the year 1999. Each of the directors has served as a director of the
Company, including its predecessor by merger, since 1981, except Mr. Stranczek,
who became a director in 1983, Mr. Groebe, who became a director in 1984, and
Messrs. Payan and Sieloff, who became directors in 1995. Messrs. Wojcik, Sampias
and Groebe are also directors of the First National Bank of Lockport and
Heritage Trust Company. None of the Company's directors or executive officers is
related by blood, marriage or adoption.
The following table sets forth certain information about each of the
Company's directors and executive officers:
<TABLE>
<CAPTION>
Name Age Positions with the Company and Subsidiaries
- ---- --- -------------------------------------------
<S> <C> <C>
Directors
- ---------
Richard T. Wojcik 59 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 50 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 58 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
John J. Gallagher 71 Director of the Company and Heritage Bank
Lael W. Mathis 63 Director of the Company and Heritage Bank
Jack Payan 67 Director of the Company and Heritage Bank
Arthur E. Sieloff 75 Director of the Company and Heritage Bank
John L. Sterling 54 Director of the Company and Heritage Bank
Chester Stranczek 68 Director of the Company and Heritage Bank
Arthur G. Tichenor 84 Director of the Company and Heritage Bank
Dominick J. Velo 80 Director of the Company and Heritage Bank
Executive Officers
- ------------------
Ramesh L. Ajwani 51 Executive Vice President of Heritage Bank
John E. Barry 53 Executive Vice President of Heritage Bank and a Director of Heritage Trust Company
Paul A. Eckroth 40 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 48 Executive Vice President of Heritage Bank and a Director of Heritage Trust Company
Albert A. Stroka 55 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. He 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 Alsip from December 1992 until that
bank's merger into Heritage Bank in April 1993 and for 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. He currently serves as President and a Director of the
First National Bank of Lockport and served in such positions for Heritage Bank
Alsip from December 1992 until that bank's merger into Heritage Bank in April
1993 and for Heritage Bank Midlothian from July 1994 until that bank's merger
into Heritage Bank in October 1994.
54
<PAGE>
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 since April, 1993 and
prior to that was the Executive Vice President of the Company and the Bank for
more than the past five years. Mr. Groebe served as Executive Vice President,
Secretary and a Director of 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. Gallagher has been Chairman or President of Gallagher Asphalt
Corporation, asphalt paving contractors, for more than the past five years.
Mr. Mathis has been President of G. E. Mathis Company, a steel fabricator,
for more than the past five years.
Mr. Payan has been a Senior Executive of Payan, Alberts & Thompson, Ltd.,
an independent insurance agency, for more than the past five years.
Mr. Sieloff has been Senior Vice President and Partner or Vice President of
Wm. C. Groebe & Co., a real estate company, for more than the past five years.
Mr. Sterling has been President of and has owned and operated Sterling
Lumber Company for more than the past five years. He served as a Director of
Heritage Bank Alsip from December 1992 until that bank's merger into Heritage
Bank in April 1993 and of Heritage Bank Midlothian from July 1994 until that
bank's merger into Heritage Bank in October 1994.
Mr. Stranczek has been Chairman or President of Cresco Lines, Inc., a
trucking company, for more than the past five years.
Mr. Tichenor has been Chairman of the Board of California Amforge
Corporation, a manufacturer of forgings, for more than the past five years.
Mr. Velo has been Chairman of D.J. Velo & Company, a general contractor,
for more than the past five years. He served as a Director of Heritage Bank
Alsip from December 1992 until that bank's merger into Heritage Bank in April
1993 and of 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.
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 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. 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.
55
<PAGE>
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 and regulations
thereunder require directors and certain officers of the Company and persons who
beneficially own more than 10% of the Company's stock to file initial reports of
ownership and reports of changes in ownership of the Company's stock with the
Securities and Exchange Commission and to furnish the Company with copies of
such reports. Based solely upon a review of copies of such reports furnished to
the Company and representations of reporting persons, all such persons filed on
a timely basis reports required by Section 16(a) during the most recent fiscal
year.
ITEM 11. EXECUTIVE COMPENSATION
Director Compensation
Currently, each Director of the Company receives an annual fee of $8,000
for these services. Each is also a Director of Heritage Bank and receives an
annual fee of $8,000 for these services, which is paid by Heritage Bank. In
addition, Directors receive a $1,000 or $500 fee for attendance at certain
meetings of committees of the boards of the Company and Heritage Bank and
received a $500 fee for attendance at a special meeting of the board of the
Company in 1997.
Executive Officer Compensation
Summary Compensation Table
The following table sets forth the indicated compensation with respect to
each of the last three fiscal years for the Company's Chief Executive Officer
and its four other most highly compensated executive officers:
<TABLE>
<CAPTION>
Long Term
Compensation
--------------------
Awards Payouts
Annual Compensation ------ -------
-------------------------------------- Securities All Other
Incentive Underlying Compensa-
Name and Principal Position Year Salary Compensation Other (1) Options LTIP tion (2)
- --------------------------- ---- -------- ------------ --------- ------- ---- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Richard T. Wojcik 1997 $256,000 $140,000 $154,878 - - $21,601
Chairman and Chief Executive 1996 246,000 125,000 64,629 - - 17,994
Officer 1995 240,000 120,000 72,682 - - 19,560
Frederick J. Sampias 1997 213,200 117,000 84,919 - - 21,601
President 1996 205,000 100,000 11,620 - - 17,994
1995 200,000 94,000 13,609 - - 19,560
Ronald P. Groebe 1997 153,500 77,000 68,258 - - 21,601
Senior Executive Vice President 1996 149,000 58,000 11,641 - - 17,994
and Secretary 1995 145,000 55,000 13,438 - - 19,560
John E. Barry 1997 144,600 72,000 - - - 21,601
Executive Vice President 1996 139,000 55,000 - - - 17,994
1995 135,000 52,000 - - - 19,560
Paul A. Eckroth 1997 118,800 60,000 - - - 21,601
Executive Vice President 1996 111,000 50,000 - - - 17,994
and Treasurer 1995 105,000 40,000 - - - 19,931
</TABLE>
- -----------
(1) Amounts shown for certain officers include that portion of income earned on
deferred compensation accounts above 120% of the applicable federal long-
term rate.
(2) Amounts shown in this column represent contributions allocated to each
officer under the Company's profit sharing plan.
56
<PAGE>
Option Exercises and Year-End Value Table
For each of the executive officers named in the Summary Compensation Table
above, the following table sets forth the number of shares acquired and value
realized on exercise of stock options and the indicated year-end 1997 value and
number of unexercised options.
<TABLE>
<CAPTION>
Exercise of Options # of Securities Value of Unexercised
in 1997 (1) Underlying Unexercised In-the-Money
---------------------- Options at Options at
# of December 31, 1997 (1) December 31, 1997 (2)
Shares Value ---------------------------- ----------------------------
Name Acquired Realized Exercisable Unexercisable Exercisable Unexercisable
---- -------- ---------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Richard T. Wojcik 134,819 $1,758,049 119,731 4,875 $2,721,176 $88,564
Frederick J. Sampias 122,157 1,508,419 105,919 4,125 2,413,026 74,939
Ronald P. Groebe 75,924 878,007 84,750 2,962 1,934,312 53,820
John E. Barry 51,338 620,972 72,150 2,737 1,642,110 49,723
Paul A. Eckroth 48,788 565,550 58,800 2,025 1,347,884 36,788
</TABLE>
- -----------
(1) Common shares and options have been adjusted to reflect the Company's 1997
three-for-two stock split.
(2) Based on the common share closing price of $29.00 at December 31, 1997.
Employment and Termination Benefits Agreements
The Company has an Employment Agreement with each of Messrs. Wojcik,
Sampias, Groebe and Eckroth. The Agreements provide for salaries and other
compensation as may be authorized by the board of directors, subject to
specified salary minimums. The current term under the Agreements expires
December 31, 2000. The Agreements may be terminated by the Company with or
without cause or upon the disability of the employee. Upon termination without
cause (including, generally, within two to three years after a change in control
of the Company), the Company is obligated to pay the employee his base
compensation for a three year period beginning on the date of termination. Base
compensation generally represents the average of the last five years'
compensation. In the event of termination upon disability, the Company is
obligated to pay the employee, at an annual rate equal to one and one-half times
his base compensation, less Company-provided disability insurance benefits, for
the lesser of two years or the remainder of the term. The Company has an
Employment Termination Benefits Agreement with Mr. Barry which provides that,
upon his termination (other than for cause, disability or death) generally
within two years after a change in control of the Company, the Company is
obligated to pay his base compensation for a two year period beginning on the
date of termination.
Compensation Committee Interlocks and Insider Participation
Messrs. Mathis, Sieloff, Sterling and Velo, who are members of the
Compensation Committee, and their associates and families, were indebted to
Heritage Bank during 1997. All such outstanding loans, commitments to make
loans, transactions in repurchase agreements and certificates of deposit and
depository relationships, in the opinion of management, were made in the
ordinary course of business, on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features.
57
<PAGE>
Company Stock Price Performance
The graph below compares the cumulative total shareholder return on the
Company's common shares ("Company Index") for the last five years with the
cumulative total returns for the CRSP NASDAQ Stock Market (U.S. Companies) index
("Market Index") and the CRSP NASDAQ Holding Offices index (1) ("Peer Index")
over the same period. The stock price performance shown on the graph is not
necessarily indicative of future price performance.
[GRAPH APPEARS HERE]
Comparison of Five-Year Cumulative Total Returns (2)
<TABLE>
<CAPTION>
Company Index Market Index Peer Index
------------- ------------ ----------
<S> <C> <C> <C>
12/31/92 $100 $100 $100
12/31/93 123 115 112
12/30/94 130 112 112
12/29/95 155 159 166
12/31/96 176 195 220
12/31/97 368 240 371
</TABLE>
- -----------
(1) The Holding Offices peer index represents NASDAQ U.S. companies which are
primarily engaged in holding or owning the securities of banks or other
financial companies.
(2) The indices, as well as the graph data, were prepared by the Center for
Research in Security Prices ("CRSP") of the University of Chicago Graduate
School of Business. The graph amounts represent year-end index levels derived
from compounded daily returns that include all dividends. The graph assumes that
the value of the investment in the Company's common shares (and in each of the
other indices) was $100 on December 31, 1992.
Report of Compensation Committee
The Compensation Committee (the "Committee") is comprised of Messrs.
Mathis, Sieloff, Sterling and Velo, all of whom are Directors of the Company and
its principal subsidiary, Heritage Bank (the "Bank"), and none of whom is a
former or current officer or employee of the Company or any of its subsidiaries.
The Committee is responsible for administering, setting and approving annual
compensation and incentive awards affecting the Company's executive officers (as
disclosed in the Summary Compensation Table above) as well as other elected
officers of the Bank. It does not itself determine awards under the Company's
1990 Executive Equity Incentive Plan ("Stock Incentive Plan"), which are made by
the stock option committee described below.
In general the Company's compensation programs, which affect executive
officers and other elected officers, are balanced to provide competitive
salaries combined with incentive compensation which is substantially contingent
upon the annual earnings and growth performance of the Company. To promote long
term performance, awards of stock options have been made to certain employees
under the Stock Incentive Plan and its predecessor stock option plan. The
Company's board of directors believes that stock options align the interests of
shareholders and employees through the appreciation in the value of the
Company's common shares.
58
<PAGE>
The Committee reviewed and set 1997 salaries for Messrs. Wojcik, Sampias,
Groebe, Barry and Eckroth and reviewed and approved 1997 salary recommendations
made by management regarding the other elected officers of the Bank. The 1997
base salaries of executive officers, including Mr. Wojcik, Chairman and CEO, and
the salaries of the other elected officers of the Bank have been established
primarily based on surveys of competitive salaries being paid to officers with
similar responsibilities in peer group banks. To a lesser extent, increases in
base salaries of executive officers and other elected officers have also been
adjusted to recognize the Company's growth and corresponding increase in
officers' responsibilities.
The Committee also approved the incentive compensation paid to executive
officers and other elected officers based upon the achievement of annual Company
net income and growth goals and accomplishment of individual management
objectives established at the beginning of the year. The amount of incentive
compensation is based upon an officer's level of responsibility and contribution
to the Company's achievement of its financial performance goals. For executive
officers, incentive compensation, as a percentage of base salary, can range from
0% to a maximum of approximately 55%. The incentive compensation paid to Mr.
Wojcik for 1997 was based solely upon the financial performance of the Company
and represented approximately 55% of his base salary.
All Directors of the Company, except those who are officers/employees,
serve as a stock option committee which administers and approves awards under
the Stock Incentive Plan. On an annual basis the stock option committee
determines which employees receive grants of stock options and accompanying
limited stock appreciation rights ("LSARs") under the Stock Incentive Plan and
the number of shares subject to each award. In 1997 the committee made no stock
option or LSAR awards.
Lael W. Mathis Arthur E. Sieloff John L. Sterling Dominick J. Velo
59
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tabulation shows, as of February 10, 1998 unless otherwise
indicated, the name, address and common share ownership for certain shareholders
of the Company including each person known by the Company to be the beneficial
owner of more than five percent of the Company's outstanding common shares (the
only class of voting securities outstanding). Information with respect to
beneficial ownership is based on information furnished to the Company by such
shareholders or contained in the records of the Company.
Carl C. Greer has sole voting power over all of the 757,620 shares referred
to below under his heading, 390,315 as sole beneficial owner and 367,305 as
President of Martin Marketing Corporation ("Martin Marketing"), the sole general
partner of Martin Oil Marketing, Ltd. ("Martin Oil Marketing"), which holds such
shares. Mr. Greer has sole dispositive power over all his own shares and
dispositive power (which may be shared with certain Martin Marketing officers)
over the Martin Oil Marketing shares.
Joyce M. Brown, Eloise W. Martin and Melinda M. Sullivan, as the three
trustees of each of five testamentary trusts under the Will of Harold T. Martin,
deceased, share voting and dispositive power over 725,730 shares held by the
trusts. In addition, Ms. Sullivan herself owns 13,256 shares, as to which she
has sole voting and dispositive power.
<TABLE>
<CAPTION>
Number of
Common Percent of
Shares Common
Beneficially Shares
Name and Addresses of Beneficial Owners Owned Outstanding
- --------------------------------------- ------------ -----------
<S> <C> <C>
Shares as to which Carl C. Greer has sole voting power(1):
Carl C. Greer 390,315 3.2%
Martin Marketing Corporation 367,305 (2) 3.0%
-------
Total 757,620 (3) 6.2% (3)
======= ===
Shares as to which the Trustees of the Harold T. Martin Trusts/Trust Funds
have sole or shared voting power(4):
Melinda M. Sullivan 13,256 *
Trusts/Trust Funds under the Will of Harold T. Martin, deceased 725,730 6.0%
-------
Total 738,986 6.1%
======= ===
Heritage Financial Services Profit Sharing Trust(5) 712,818 5.9%
First Midwest Bancorp, Inc.(6):
As beneficial owner 45,300 *
Pursuant to option(6) 2,400,000 16.5%
---------
Total 2,445,300 16.8%
========= ====
</TABLE>
_____
* Not greater than 1%
(1) The address for the persons listed under the Greer heading in the table
is P.O. Box 298, Blue Island, Illinois 60406. The nature of their beneficial
ownership is sole voting and investment power, except as described above and set
forth in the footnotes below.
(2) All such shares are held by Martin Oil Marketing.
(3) Mr. Greer has sole voting power over such 757,620 shares, 390,315 as
beneficial owner and 367,305 as President of Martin Marketing.
(4) The address for the three trustees of the testamentary trusts created
under the Will of Harold T. Martin, deceased, is 4501 W. 127th Street, Alsip,
Illinois 60803.
(5) As of December 31, 1997. The address for the Trust is 17500 S. Oak Park
Avenue, Tinley Park, Illinois 60477. The nature of beneficial ownership is sole
voting power, with no investment power. The shares are voted by Messrs. Wojcik,
Sampias, Groebe, Barry and another bank officer as trustees.
(6) First Midwest Bancorp, Inc., which has entered into an Agreement and Plan
of Merger, dated January 14, 1998, to acquire the Company, has an option to
purchase up to 2,400,000 of the Company's common shares (up to 19.9% of the then
outstanding shares).
60
<PAGE>
Security Ownership of Management
The following tabulation shows the common share ownership (including
exercisable options) for each Director, each of the executive officers named in
the Summary Compensation Table and all Directors and executive officers as a
group.
Percent of
Outstanding
Number of Common
Common Shares Owned
Shares (Including
Beneficially Exercisable
Name of Beneficial Owners Owned (1) Options)
- ------------------------- ------------ ------------
Richard T. Wojcik 500,019 (2) 4.1%
Frederick J. Sampias 320,355 (3) 2.6%
Ronald P. Groebe 232,764 (4) 1.9%
John J. Gallagher 82,017 *
Lael W. Mathis 131,475 (5) 1.1%
Jack Payan 14,355 (6) *
Arthur E. Sieloff 16,125 (7) *
John L. Sterling 146,706 (8) 1.2%
Chester Stranczek 495,900 (9) 4.1%
Arthur G. Tichenor 557,344 4.6%
Dominick J. Velo 11,372 (10) *
John E. Barry 140,147 (11) 1.2%
Paul A. Eckroth 121,650 (12) 1.0%
All directors and executive officers
as a group (16 persons) 2,970,726 (13) 24.4%
______
* Not greater than 1%
(1) As of February 10, 1998, except as otherwise indicated. The nature of
beneficial ownership is sole voting and investment power, except as set forth in
the footnotes below. Information with respect to beneficial ownership is based
on information furnished to the Company by the shareholders or contained in the
records of the Company. Fractional shares subject to options are not reflected.
All of the Directors and executive officers have entered into an Affiliate's
Letter and Agreement of Affiliates which indicate that they will vote their
shares in favor of the acquisition by First Midwest Bancorp, Inc. and which
specify restrictions on disposition of their shares.
(2) Includes 28,712 shares held in a self-directed IRA trust and Keogh trust
for the benefit of Mr. Wojcik, 314,584 shares held in trust by Mr. Wojcik and
96,800 shares which may be acquired upon the exercise of stock options.
Includes 59,922 shares held for the benefit of Mr. Wojcik in the Company's
Profit Sharing Trust as of December 31, 1997 but excludes the other shares
referred to in footnote 13 below.
(3) Includes 135,179 shares held in trust by Mr. Sampias, 8,364 shares held in
custody for the benefit of Mr. Sampias, 3,972 shares held in trust for the
benefit of Mr. Sampias, 110,044 shares which may be acquired upon the exercise
of stock options, 12,375 shares held in trust by his wife, 3,981 shares held in
trust for the benefit of his wife, 2,250 shares held by his wife as custodian
for their son and 450 shares held by their son. Includes 43,739 shares held for
the benefit of Mr. Sampias in the Company's Profit Sharing Trust as of December
31, 1997 but excludes the other shares referred to in footnote 13 below.
(4) Includes 20,194 shares held in a self-directed IRA trust and Keogh Plan
for the benefit of Mr. Groebe, 2,046 shares held in trust for the benefit of his
wife and 68,962 shares which may be acquired upon the exercise of stock options.
Includes 41,563 shares held for the benefit of Mr. Groebe in the Company's
Profit Sharing Trust as of December 31, 1997 but excludes the other shares
referred to in footnote 13 below.
61
<PAGE>
(5) Includes 63,900 shares held in trust by Mr. Mathis and 67,575 shares held in
trust by his wife.
(6) Includes 4,230 shares held in trust by Mr. Payan, 8,625 shares held in trust
by his wife and 1,500 shares held by a corporation owned by Mr. Payan and his
wife.
(7) Includes 15,000 shares held in joint tenancy with Mr. Sieloff's wife.
(8) Includes 12,000 shares held in joint tenancy with his wife, 122,763 shares
held in trust for the benefit of Mr. Sterling and his wife and 11,643
shares held by Mr. Sterling's son.
(9) Includes 379,500 shares held in trust by Mr. Stranczek, 108,150 shares
held in trust for the benefit of Mr. Stranczek and 7,500 shares held by
Mr. Stranczek's wife as trustee for a relative.
(10) Includes 1,372 shares held for the benefit of Mr. Velo by the D.J. Velo &
Company Profit Sharing Trust as of October 31, 1997, for which Mr. Velo is the
Trustee. Excludes the remaining 51,609 shares in such Trust voted by Mr. Velo
but held for the benefit of others. Includes 10,000 shares held in joint
tenancy with Mr. Velo's wife.
(11) Includes 74,887 shares which may be acquired upon the exercise of stock
options and 13,142 shares held for the benefit of Mr. Barry in the Company's
Profit Sharing Trust as of December 31, 1997 but excludes the other shares
referred to in footnote 13 below.
(12) Includes 72,000 shares held by Mr. Eckroth in joint tenancy with his
wife and 49,650 shares which may be acquired upon the exercise of stock options.
(13) Excludes 712,818 shares as of December 31, 1997 voted by Messrs. Wojcik,
Sampias, Groebe, Barry and another bank officer as the trustees of the Heritage
Financial Services Profit Sharing Trust, except to the extent held for such
named officers' individual benefit and hence included as indicated in the
foregoing footnotes. Includes 86,400 shares which may be acquired upon the
exercise of stock options by, and 49,952 shares held as of December 31, 1997 in
the Company's Profit Sharing Trust for the benefit of, three executive officers
not named above.
62
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Directors and executive officers of the Company and their associates and
families were customers of, and had transactions with, Heritage Bank during
1997, and, at December 31, 1997, were indebted to Heritage Bank in the aggregate
amount of $8,670,000. All such outstanding loans, commitments to make loans,
transactions in repurchase agreements and certificates of deposit and depository
relationships, in the opinion of management, were made in the ordinary course of
business, on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons and did not involve more than the normal risk of collectibility or
present other unfavorable features. Additional transactions may be expected to
take place in the future.
Mr. Payan is employed by Payan, Alberts & Thompson, Ltd. ("P,A&T"), which
is owned in part by three of his sons and which provides services as insurance
agent to the Company. In 1997 the Company paid P,A&T approximately $428,000,
including premiums, for business insurance coverage. In addition, P,A&T served
as agent with respect to the Company's employee group insurance coverage, for
which approximately $883,000 was paid directly to the insurers in 1997. As
agent, P,A&T solicits competitive bids for all of the Company's business and
employee group insurance coverage.
The Company has an indemnification agreement with each Director of the
Company which provides that the Company shall indemnify the Director against
certain claims which may be asserted against the Director by reason of serving
on the board.
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, 1997 and 1996
Consolidated Statements of Income - For the Years Ended December 31, 1997,
1996 and 1995
Consolidated Statements of Changes in Shareholders' Equity - For the Years
Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows - For the Years Ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements - For the Years Ended December
31, 1997, 1996 and 1995
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(j) 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, 1997. 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.
63
<PAGE>
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 2nd day of March, 1998.
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 2nd day of March, 1998 by the following
persons on behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE AND TITLE SIGNATURE AND TITLE
------------------- -------------------
<S> <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/ Jack Payan *
by /s/ Frederick J. Sampias ---------------------------------------------
--------------------------------------------- Jack Payan, Director
Frederick J. Sampias, President and Director
by /s/ Arthur E. Sieloff *
by /s/ Paul A. Eckroth ---------------------------------------------
--------------------------------------------- Arthur E. Sieloff, Director
Paul A. Eckroth, Executive Vice President and
Treasurer
(Principal Financial and Accounting Officer) by /s/ John L. Sterling *
---------------------------------------------
John L. Sterling, Director
by /s/ John J. Gallagher *
---------------------------------------------
John J. Gallagher, Director by
---------------------------------------------
Chester Stranczek, Director
by /s/ Ronald P. Groebe
---------------------------------------------
Ronald P. Groebe, 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>
64
<PAGE>
HERITAGE FINANCIAL SERVICES, INC.
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
<TABLE>
<CAPTION>
Exhibit
Number Description and Page or Incorporation Reference
- ------- -----------------------------------------------
<S> <C>
2(a) 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).
2(b) Agreement and Plan of Merger, dated January 14, 1998, by and
among First Midwest Bancorp, Inc., First Midwest Acquisition
Corporation and Heritage Financial Services, Inc. (incorporated
by reference to the Registrant's Current Report on Form 8-K
filed January 27, 1998) and a list briefly identifying the
contents of omitted schedules, together with agreement to
furnish supplementally a copy of any omitted schedule to the
Commission upon request (filed herewith).
2(c) Stock Option Agreement, dated January 14, 1998, between Heritage
Financial Services, Inc. (as Issuer) and First Midwest Bancorp,
Inc. (as Grantee) (incorporated by reference to the Registrant's
Current Report on Form 8-K filed January 27, 1998).
3(a) Articles of Incorporation of the Registrant including May 1997
amendment (filed herewith).
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 Quarterly Report on Form 10-Q for the period
ended June 30, 1997).
4(c) By-laws (See Exhibit 3(b) above).
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) Amendments to 1990 Executive Equity Incentive Plan dated March
1996 and October 1997 (filed herewith).
10(d) 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).
</TABLE>
65
<PAGE>
HERITAGE FINANCIAL SERVICES, INC.
EXHIBIT INDEX (continued)
(Pursuant to Item 601 of Regulation S-K)
<TABLE>
<C> <S>
Exhibit
Number Description and Page or Incorporation Reference
- -------- ---------------------------------------------------------------------------------------------------
10(e) 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).
10(f) (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(g) Amendment #1 to 1995 Deferred Compensation Trust, dated as of November 19, 1996, 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, 1996).
10(h) 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(i) 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(j) 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 (incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year ended December 31, 1996).
11 Statement Re Computation of Per Share Earnings (filed herewith).
21 Subsidiaries of Registrant (filed herewith).
23 Consent of Arthur Andersen 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.
66
<PAGE>
EXHIBIT 2(b)
Exhibits to Agreement and Plan of Merger dated January 14, 1998 among First
Midwest Bancorp, Inc., Heritage Financial Services, Inc. and First Midwest
Acquisition Corporation*
Exhibit Description Section
- ------- ----------- -------
Exhibit A - Legal Opinion of First Midwest's Counsel 2.7(j)
Exhibit B - Legal Opinion of Heritage's Counsel 2.8(p)
Exhibit C - Exchange Agent Agreement 3.4(a)
Exhibit D - Affiliate's Representation Letter 6.11
Exhibit E - Stock Option Agreement 6.14
Exhibit F - List of Directors to be Appointed 7.11
________
*Pursuant to Regulation S-K Item 601(b)(2), the exhibits listed on this page
(other than Exhibit E which is filed as a separate exhibit) have been omitted
from the filing of the Agreement and Plan of Merger with the Securities and
Exchange Commission ("Commission"). The Registrant agrees to furnish
supplementally a copy of any omitted exhibit to the Commission on request.
<PAGE>
EXHIBIT 3(a)
Articles of Incorporation of Heritage Financial Services, Inc.
Form BCA-10.30 Articles of Amendment
1. CORPORATE NAME: Heritage Financial Services, Inc.
2. MANNER OF ADOPTION OF AMENDMENT:
The following amendment of the Articles of Incorporation was adopted on May
13, 1997 in the manner indicated below.
By a majority of the board of directors, in accordance with Section 10.15,
shares having been issued but shareholder action not being required for the
adoption of this amendment.
3. TEXT OF AMENDMENT:
RESOLVED, that the Articles of Incorporation of the corporation be and
they hereby are amended to eliminate the par value of the currently
authorized Common Shares of the corporation without any change in the paid-
in capital of the corporation.
RESOLVED FURTHER, that Article Four, Paragraph 1 of the Articles of
Incorporation of the corporation be and it hereby is amended to read in its
entirety as follows:
Paragraph 1: The authorized shares shall be:
Par Value Number of Shares
Class Per Share Authorized
----- --------- ----------------
Common.................... n/a 16,000,000
Preferred................. n/a 12,000,000
RESOLVED FURTHER, that upon the effectiveness of this Amendment, each
of the Common Shares, par value $.625 per share, of the corporation which
is issued immediately prior to such effectiveness, shall ipso facto,
automatically and without any action on the part of the holder thereof,
become and be automatically converted into one (1) issued Common Share,
without par value, of the corporation, and each such share which has been
converted from a share which was issued and outstanding prior to such
effectiveness, shall, upon effectiveness, be issued and outstanding, fully
paid and non-assessable.
<PAGE>
RESOLVED FURTHER, that the number of shares of the corporation issued
immediately prior to the effectiveness of this Amendment and so converted
shall be reported by the corporation on Form BCA-14.30 in accordance with
law.
Dated May 13, 1997 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-2-
<PAGE>
Form BCA-10.30 Articles of Amendment
1. CORPORATE NAME: Heritage Financial Services, Inc.
2. MANNER OF ADOPTION OF AMENDMENT:
The following amendment of the Articles of Incorporation was adopted on
April 26, 1994 in the manner indicated below.
By the shareholders, in accordance with Section 10.20, a resolution of the
board of directors having been duly adopted and submitted to the
shareholders. At a meeting of shareholders, not less than the minimum
number of votes required by statute and by the articles of incorporation
were voted in favor of the amendment.
3. TEXT OF AMENDMENT:
RESOLVED, that Article Eight of the Articles of Incorporation of the
corporation be and it hereby is amended by adding paragraph seven, which
shall read as follows:
Paragraph 7: A Director of the corporation shall not be personally
liable to the corporation or its shareholders for monetary damages for
breach of fiduciary duty as a Director, provided that this provision does
not eliminate or limit the liability of a Director (i) for any breach of
the Director's duty of loyalty to the corporation or its shareholders, (ii)
for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law, (iii) under Section 8.65 of the
Illinois Business Corporation Act of 1983 (the "Act"), or (iv) for any
transaction from which the Director derived an improper personal benefit.
If the Act is amended to permit, or Illinois law at any time otherwise
permits, further elimination or limitation of the personal liability of a
director, then the liability of a Director of the corporation shall be
eliminated or limited to the full extent permitted by the Act as so amended
or otherwise as permitted by Illinois law. Neither the amendment nor
repeal of this Paragraph 7, nor the adoption or amendment of any other
provision of the Articles of Incorporation or By-Laws of the corporation,
shall adversely affect any right or protection of a Director of the
corporation with respect to any act or failure to act which occurred prior
to such amendment, repeal or adoption.
Dated April 26, 1994 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-3-
<PAGE>
Form BCA-10.30 Articles of Amendment
1. CORPORATE NAME: Heritage Financial Services, Inc.
2. MANNER OF ADOPTION OF AMENDMENT:
The following amendment of the Articles of Incorporation was adopted on
April 14, 1992, in the manner indicated below.
By a majority of the board of directors, in accordance with Section 10.15,
shares having been issued but shareholder action not being required for the
adoption of the amendment.
(INSERT AMENDMENT)
RESOLVED, That the Articles of Incorporation of the corporation be and
they hereby are amended to split the issued whole Common Shares and
unissued authorized Common Shares and Preferred Shares by multiplying them
by the number two (2).
RESOLVED FURTHER, That, upon the effectiveness of this Amendment, the
number of authorized Common Shares of the corporation shall become and be
16,000,000 Common Shares, par value $.625 per share, and the number of
authorized Preferred Shares of the corporation shall become and be
12,000,000 Preferred Shares, without par value, so that Article Four,
Paragraph 1 of the Articles of Incorporation of the corporation shall be
and it hereby is amended to read in its entirety as follows:
Paragraph 1: The authorized shares shall be:
Par Value Number of Shares
Class Per Share Authorized
- ----- --------- ----------------
Common................ $.625 16,000,000
Preferred............. n/a 12,000,000
RESOLVED FURTHER, That, upon the effectiveness of this Amendment, each
Common Share, par value $1.25 per share, of the corporation which is issued and
outstanding immediately prior to such effectiveness, shall ipso facto,
automatically and without any action on the part of the holder thereof, become
and be converted into two (2) issued and outstanding Common Shares, par value
$.625 per share, of the corporation, each of which Common Shares, par value
$.625 per share, shall be fully paid and non-assessable.
-4-
<PAGE>
RESOLVED FURTHER, That said Amendment shall be effective at the close
of business on April 30, 1992.
3. As a result of this amendment, each of the issued and outstanding 3,917,136
Common Shares, $1.25 par value, automatically becomes two (2) Common
Shares, $.625 par value, for a total of 7,834,272 issued and outstanding
Common Shares, $.625 par value.
Dated April 17, 1992 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-5-
<PAGE>
BCA-14.25 REPORT OF REDUCTION OF PAID-IN CAPITAL, CANCELLATION OF SHARES OR
REPORT FOLLOWING MERGER, CONSOLIDATION OR EXCHANGE
1. The name of the corporation is Heritage Financial Services, Inc.
2. The State or Country of incorporation is Illinois.
3. The aggregate number of shares which are issued and outstanding, as last
reported to the Secretary of State on any document other than an annual report
form are:
4,012,192.50 Common Shares, par value $1.25 per share.
4. The amount of paid-in capital, as last reported to the Secretary of State
on any document other than an annual report form, is:
$23,039,461.
5. The number of shares listed in 3 above resulted from a 5-for-4 stock split
on July 14, 1989. On the same date, the fractional shares, aggregating 46.5
shares, were cashed out for the aggregate sum of $814.
6. Giving effect to the changes herein reported, the aggregate number of
shares which are issued and outstanding are:
4,012,146 Common Shares, par value $1.25 per share.
7. Giving effect to the changes herein reported, the amount of its paid-in
capital is:
$23,038,647.
Dated July 14, 1989 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-6-
<PAGE>
BCA-14.20 REPORT OF ISSUANCE OF SHARES AND INCREASES IN PAID-IN CAPITAL
1. The name of the corporation is Heritage Financial Services, Inc.
2. The State or Country of incorporation is Illinois.
3. The aggregate number of shares it is authorized to issue is:
8,000,000 Common Shares, par value $1.25 per share
6,000,000 Preferred Shares, without par value
4. The aggregate number of shares which are issued and outstanding, as last
reported to the Secretary of State on any document other than an annual report
form are:
3,209,754 Common Shares, par value $1.25 per share.
5. The amount of paid-in capital, as last reported to the Secretary of State
on any document other than an annual report form, is:
$23,039,461.
6. (a) List all issuances of shares not previously reported to the Secretary
of State and give the value of the entire consideration received therefor or the
amounts added or transferred to paid-in capital for or on account of such
shares.
802,438.50 Common Shares, par value $1.25 per share, issued 7-14-89 without
consideration.
(b) The shares were issued pursuant to a 5-for-4 stock split which became
effective July 14, 1989. As a result, the number of issued shares increased
by 25% (1/4 X 3,209,754 = 802,438.50).
7. N/A
8. Giving effect to the changes herein reported, the aggregate number of
shares which are issued and outstanding are:
4,012,192.50 Common Shares, par value $1.25 per share.
-7-
<PAGE>
9. Giving effect to the changes herein reported, the amount of paid-in capital
is:
$23,039,461.
Dated July 14, 1989 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-8-
<PAGE>
Form BCA-10.30 Articles of Amendment
ARTICLE ONE The name of the corporation is Heritage Financial Services, Inc.
ARTICLE TWO The following amendment of the Articles of Incorporation was
adopted on June 23, 1987 in the manner indicated below.
By the shareholders, in accordance with Section 10.20, a
resolution of the board of directors having been duly adopted and
submitted to the shareholders. At a meeting of shareholders, not
less than the minimum number of votes required by statute and by
the articles of incorporation were voted in favor of the
amendment.
(INSERT AMENDMENT)
RESOLVED, that Articles Four and Six of the Articles of Incorporation of
the corporation be and they hereby are amended to read in their entirety as
follows:
ARTICLE FOUR
Paragraph 1: The authorized shares shall be:
<TABLE>
<CAPTION>
Par Value Number of Shares
Class Per Share Authorized
- ----- --------- ----------------
<S> <C> <C>
Common $1.25 8,000,000
Preferred n/a 6,000,000
</TABLE>
Paragraph 2: The preferences, qualifications, limitations, restrictions
and the special or relative rights in respect of the shares of each class are:
(A) PREFERRED SHARES. The Preferred Shares may be issued from time to time
by the Board of Directors as shares of one or more series. Subject to the
provisions hereof and the limitations prescribed by law, the Board of Directors
is expressly authorized, prior to issuance (by adopting resolutions providing
for the issuance of, or providing for a change in the number of, shares of any
particular series and, by doing and performing all other acts and deeds required
by law, including, if and to the extent from time to time required by law, by
filing a statement pursuant to the Illinois Business Corporation Act of 1983, as
amended), to establish or change the number of shares to be included in each
such series and to fix the designation and relative powers, preferences and
rights and the qualifications and limitations or restrictions thereof relating
to the shares of each such series. The authority of the Board of Directors with
respect to each series shall include, but not be limited to, determination of
the following:
(i) the distinctive serial designation of such series and the number
of shares constituting such series, provided that the aggregate number
of shares
-9-
<PAGE>
constituting all series of Preferred Shares shall not exceed the
number authorized in Paragraph 1 of this Article Four;
(ii) the dividend rate on shares of such series, whether dividends
shall be cumulative and, if so, from which date or dates;
(iii) whether the shares of such series shall be redeemable and, if
so, the price, terms and conditions of such redemption, including the
date or dates upon and after which such shares shall be redeemable,
and the amount per share payable in case of redemption, which amount
may vary under different conditions and at different redemption dates;
(iv) the amount(s) payable upon and the rights of the shares of such
series in the event of the (a) voluntary or (b) involuntary,
liquidation, dissolution or winding-up of the corporation;
(v) the obligation, if any, of the corporation to retire shares of
such series pursuant to a sinking fund;
(vi) whether shares of such series shall be convertible into, or
exchangeable for, shares of any other class or classes (or series of
any class) and, if so, the terms and conditions of such conversion or
exchange, including the price or prices or the rate or rates of
conversion or exchange and the terms of adjustment, if any;
(vii) whether the shares of such series shall have voting rights, in
addition to the voting rights required by law, and, if so, the terms
of such voting rights including any limitations thereon or any special
rights thereto, including, without limitation, the right, if any, of
the holders of the shares of any such class or series to elect a
specified number or percentage of directors; and
(viii) any other relative rights, powers, preferences, qualifications,
limitations or restrictions thereof relating to such series.
Each of the Preferred Shares within any one series shall be identical with one
another in all respects except as to the dates from and after which dividends
thereon shall cumulate, if cumulative.
(B) COMMON SHARES. Subject to all of the rights of the Preferred Shares,
and except as may be expressly provided with respect to the Preferred Shares
herein, by law or by the Board of Directors pursuant to this Article Four:
(i) dividends may be declared and paid or set apart for payment upon
the Common Shares out of any assets or funds of the corporation
legally available for the payment of dividends;
-10-
<PAGE>
(ii) the holders of Common Shares shall have the right to vote for
the election of directors and on all other matters requiring
shareholder action, with each share being entitled to one vote on each
matter, and with no share being entitled to cumulative voting rights
in any circumstance; and
(iii) upon the voluntary or involuntary liquidation, dissolution or
winding-up of the corporation, the net assets of the corporation shall
be distributed pro rata to the holders of the Common Shares in
accordance with their respective rights and interests.
ARTICLE SIX
Paragraph 1: The number of Directors to constitute the Board of Directors
shall be not less than nine (9) nor more than fourteen (14), and such number
shall be fixed by, or in the manner provided in, the By-Laws of the corporation.
The Directors shall be divided into three classes: Class I, Class II and Class
III; and the number of Directors in such classes shall be as nearly equal as
possible. The term of office of the initial Class I Directors shall expire at
the annual meeting of shareholders of the corporation in 1988; the term of
office of the initial Class II Directors shall expire at the annual meeting of
shareholders of the corporation in 1989; and the term of office of the initial
Class III Directors shall expire at the annual meeting of shareholders of the
corporation in 1990; and in each case until their respective successors are duly
elected and qualified. At each annual election held after 1987 the Directors
chosen to succeed those whose terms then expire shall be identified as being of
the same class as the Directors they succeed and shall be elected for a term of
three (3) years expiring at the third succeeding annual meeting or thereafter
until their respective successors are duly elected and qualified. If the number
of Directors is changed, any increase or decrease in the number of Directors
shall be apportioned among the classes so as to maintain the number of Directors
in each class as nearly equal as possible. Any Director elected to fill a
vacancy in any class (whether such vacancy is caused by death, resignation or
removal, or by an increase in the number of Directors in such class) in
accordance with the By-Laws of the corporation, shall hold office for a term
which shall expire with the term of the Directors in such class.
Paragraph 2: Subject to the rights of the holders of any Preferred Shares
or series of Preferred Shares then outstanding, newly created directorships
resulting from any increase in the authorized number of Directors or any
vacancies in the Board of Directors resulting from death, resignation,
retirement, removal from office or other cause shall be filled by a majority
vote of the Directors then in office. Directors so chosen shall hold office for
a term expiring at the annual meeting of shareholders at which the term of the
class to which they have been elected expires. No decrease in the number of
Directors constituting the Board of Directors shall shorten the term of any
incumbent Director.
Paragraph 3: Anything contained in these Articles of Incorporation to the
contrary notwithstanding and subject to the rights of the holders of any
Preferred Shares or series of Preferred Shares then outstanding, any Director
may be removed from office, but only for cause
-11-
<PAGE>
and only by the affirmative votes of the holders of at least 80% of the voting
power of all the shares of the corporation entitled to vote for the election of
Directors.
Paragraph 4: Subject to the rights of the holders of any Preferred Shares
or series of Preferred Shares then outstanding, nominations for the election of
Directors may be made by the Board of Directors or a committee appointed by the
Board of Directors or by any shareholder entitled to vote in the election of
Directors generally. However, any shareholder entitled to vote in the election
of Directors generally may nominate one or more persons for election as
Directors at a meeting only if written notice of such shareholder's intent to
make such nomination or nominations has been given, either by personal delivery
or by United States first class mail, postage prepaid, to the Secretary of the
corporation not later than (i) with respect to an election to be held at an
annual meeting of shareholders, ninety (90) days prior to the anniversary date
of the immediately preceding annual meeting, and (ii) with respect to an
election to be held at a special meeting of shareholders for the election of
Directors, the close of business on the seventh (7th) day following the date on
which notice of such meeting is first given to shareholders. Each such notice
shall set forth: (a) the name and address of (i) the shareholder who intends to
make the nomination and (ii) the person or persons to be nominated; (b) the
representation that the shareholder is a record owner of shares of the
corporation entitled to vote at such meeting and intends to appear in person or
by proxy at the meeting to nominate the person or persons specified in the
notice; (c) a description of all arrangements or understandings between the
shareholder and each nominee and any other person or persons (naming such person
or persons) pursuant to which the nomination or nominations are to be made by
the shareholder; (d) such other information regarding each nominee proposed by
such shareholder as would be required to be included in a proxy statement and
filed pursuant to the proxy rules of the United States Securities and Exchange
Commission; and (e) the executed consent of each such nominee to serve as a
Director of the corporation if so elected. The presiding officer of the meeting
may refuse to acknowledge the nomination of any person not made in compliance
with the foregoing procedure, or applicable law.
ARTICLE EIGHT
RESOLVED, that Article Eight of the Articles of Incorporation of the
corporation be and it hereby is amended by adding paragraphs three through six,
which shall read as follows:
Paragraph 3: Any action required or permitted to be taken by the
shareholders of the corporation must be taken at a duly called annual or special
meeting of shareholders of the corporation and may not be taken by consent in
writing by such shareholders.
Paragraph 4: It is hereby declared to be a proper corporate purpose,
reasonably calculated to benefit shareholders, for the Board of Directors to
base the response of the corporation to any "Acquisition Proposal" on the Board
of Directors' evaluation of what is in the best interest of the corporation and
for the Board of Directors, in evaluating what is in the best interests of the
corporation, to consider:
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<PAGE>
(i) the best interests of the shareholders; for this purpose the
Board shall consider, among other factors, not only the consideration
being offered in the Acquisition Proposal, in relation to the then
current market price of the corporation's shares, but also in relation
to the then current value of the corporation in a freely negotiated
transaction and in relation to the Board of Directors' then estimate
of the future value of the corporation as an independent entity; and
(ii) such other factors as the Board of Directors determines to be
relevant, including, among other factors, the effects, including,
without limitation, the social, legal and economic effects, of any
action upon employees, suppliers, customers and business of the
corporation, communities in which offices or other establishments of
the corporation are located and all other pertinent factors.
"Acquisition Proposal" means any proposal of any person (a) for a tender
offer or exchange offer for any equity security of the corporation, (b) to merge
or consolidate the corporation with or into another corporation or (c) to
purchase or otherwise acquire all or substantially all of the properties and
assets of the corporation.
Paragraph 5: None of Article XII nor Section 5 of Article II nor Sections
2, 3 and 10 of Article III of the By-Laws of the corporation shall be altered,
amended or repealed and no provision inconsistent therewith shall be adopted
without the affirmative vote of (a) at least a majority of the Board of
Directors or (b) the holders of at least eighty percent (80%) of all shares of
stock of the corporation then entitled to vote in the election of Directors,
considered for this purpose as one class.
Paragraph 6: Notwithstanding Paragraph 1 of this Article Eight, the
affirmative vote of the holders of eighty percent (80%) of all shares of stock
of the corporation then entitled to vote in the election of Directors,
considered for this purpose as one class, shall be required for any of the
following actions:
(i) for the adoption of any amendment, alteration, change or repeal
of any provision of these Articles of Incorporation;
(ii) for the adoption of any agreement for the merger or
consolidation of the corporation with or into any other corporation;
(iii) to authorize any sale, lease, exchange or other disposition of
all or substantially all of the assets of the corporation;
(iv) to authorize any share exchange in which the acquiring entity
is not the corporation or any of its subsidiaries; or
(v) to authorize the dissolution of the corporation.
-13-
<PAGE>
The voting requirements set forth in this Paragraph 6 of Article Eight shall be
not applicable to any one of the foregoing actions and any such actions shall
only require the affirmative vote of the holders of not less than a majority of
the outstanding shares entitled to vote in the election of Directors, considered
for this purpose as one class, if the action shall have been approved by not
less than sixty six and two-thirds percent (66-2/3%) of all Directors.
Dated June 23, 1987 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-14-
<PAGE>
Form BCA-10.30 Articles of Amendment
ARTICLE ONE The name of the corporation is Heritage Financial Services, Inc.
ARTICLE TWO The following amendment of the Articles of Incorporation was
adopted on July 15, 1986 in the manner indicated below.
By a majority of the board of directors, in accordance with
Section 10.15, shares having been issued but shareholder action
not being required for the adoption of the amendment.
(INSERT AMENDMENT)
RESOLVED, That the Articles of Incorporation of the corporation be and
they hereby are amended to split the issued whole shares and unissued
authorized shares by multiplying them by the number four (4).
RESOLVED FURTHER, That, upon the effectiveness of this Amendment, the
number of authorized shares of the corporation shall become and be
4,000,000 Common Shares, par value $1.25 per share.
RESOLVED FURTHER, That, upon the effectiveness of this Amendment, each
Common Share, par value $5.00 per share, of the corporation which is issued
and outstanding immediately prior to such effectiveness, shall ipso facto,
automatically and without any action on the part of the holder thereof,
become and be converted into four (4) issued and outstanding Common Shares,
par value $1.25 per share, of the corporation, each of which Common Shares,
par value $1.25 per share, shall be fully paid and non-assessable.
RESOLVED FURTHER, That each holder of Common Shares, par value $5.00
per share, of the corporation ("$5.00 Shares") which shall have been so
converted into Common Shares, par value $1.25 per share, of the corporation
("$1.25 Shares"), upon surrender of certificates for $5.00 Shares, in
proper form to the corporation for cancellation, shall be entitled to
receive, as evidence of the $1.25 Shares into which the $5.00 Shares shall
have been so converted, stock certificates bearing the name of the
corporation as issuer, for the number of shares of the corporation
theretofore represented by the certificates surrendered, multiplied by the
whole number four (4). Until so surrendered, the outstanding certificates
which had represented $5.00 Shares shall be deemed and treated for all
corporate purposes to represent the ownership of $1.25 Shares into which
the $5.00 Shares shall have been converted as though said surrender and
exchange had taken place.
ARTICLE THREE As a result of this amendment, each of the issued and outstanding
539,666 Common Shares, $5.00 par value, automatically becomes
-15-
<PAGE>
four (4) Common Shares, $1.25 par value, for a total of 2,158,664
issued and outstanding Common Shares, $1.25 par value.
Dated July 18, 1986 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Frederick J. Sampias
Secretary President
-16-
<PAGE>
BCA-14.25 REPORT OF REDUCTION OF PAID-IN CAPITAL, CANCELLATION OF SHARES OR
REPORT FOLLOWING MEGER, CONSOLIDATION OR EXCHANGE
1. The name of the corporation is Heritage Financial Services, Inc.
2. The State or Country of incorporation is Illinois.
3. The aggregate number of shares which are issued and outstanding, as last
reported to the Secretary of State on any document other than an annual report
form are:
200 Common Shares, par value $5.00 per share.
4. The amount of paid-in capital, as last reported to the Secretary of State on
any document other than an annual report form, is:
$1,000.
5. The nature of the change effected was the Merger with County Bankshares,
Inc. on July 2, 1984.
6. Giving effect to the changes herein reported, the aggregate number of shares
which are issued and outstanding are:
539,666 Common Shares, par value $5.00 per share.
7. Giving effect to the changes herein reported, the amount of its paid-in
capital is:
$8,741,358.
8. The corporation elects to pay franchise taxes on its entire paid-in capital.
Dated July 9, 1984 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Richard T. Wojcik
Secretary President
-17-
<PAGE>
BCA-11.25 ARTICLES OF MERGER, CONSOLIDATION, EXCHANGE
Pursuant to the provisions of "The Business Corporation Act of 1983", the
undersigned corporations hereby adopt the following Articles of Merger.
1. The names of the corporations proposing to merge, and the State or Country
of their incorporation, are:
Heritage Financial Services, Inc. Illinois
County Bankshares, Inc. Delaware
2. The laws of the State or Country under which each corporation is
incorporated permit such merger, consolidation or exchange.
3. The name of the surviving corporation is Heritage Financial Services, Inc.
and it shall be governed by the laws of Illinois.
4. The plan of merger is as follows:
PLAN OF MERGER
OF
COUNTY BANKSHARES, INC.
(a Delaware corporation)
INTO
HERITAGE FINANCIAL SERVICES, INC.
(an Illinois corporation)
PLAN OF MERGER of COUNTY BANKSHARES, INC., a Delaware corporation
(hereinafter sometimes referred to as "COUNTY" or the "Merged Corporation"),
into HERITAGE FINANCIAL SERVICES, INC., an Illinois corporation (hereinafter
sometimes referred to as "HERITAGE" or the "Surviving Corporation"), both such
corporations hereinafter sometimes referred to jointly as the "Constituent
Corporations".
ARTICLE I
---------
1.1 HERITAGE is a corporation duly organized and existing under the
laws of the State of Illinois, having its principal office in the State of
Illinois at 12015 South Western Avenue, Blue Island, Illinois 60406. The
authorized capital of HERITAGE consists of 1,000,000 Common Shares, par value
$5.00 per share, of which 200 shares are issued and outstanding and owned by
COUNTY.
1.2 COUNTY is a corporation duly organized and existing under the laws
of the State of Delaware, having its principal office in the State of Illinois
at 12015 South Western Avenue, Blue Island, Illinois 60406. The authorized
capital of COUNTY consists of 1,000,000 shares of Common Stock, par value $5.00
per share, of which 539,666 shares are issued and outstanding.
1.3 The registered office of COUNTY in the State of Delaware is
located at number 100 West Tenth Street in the City of Wilmington, County of New
Castle, and the name of the registered agent of COUNTY at said address is The
Corporation Trust Company. COUNTY is qualified to transact business as a foreign
corporation in the State of Illinois. The registered office of both COUNTY and
HERITAGE in the State of Illinois is located at 12015 South Western Avenue, in
the City of Blue Island, County of Cook, and the name of registered agent of
both corporations at said address is Richard T. Wojcik.
ARTICLE II
----------
At the Effective Time of the Merger (as hereinafter defined in Article
VII):
2.1 In accordance with the applicable provisions of the laws of the
State of Illinois and the State of Delaware, COUNTY shall be merged with and
into HERITAGE, which shall be the surviving corporation (such merger being
hereinafter sometimes called the "Merger"), and as the Surviving Corporation it
shall continue to be governed by the laws of the State of Illinois;
-18-
<PAGE>
2.2 The separate existence of the Merged Corporation shall cease, and
the Surviving Corporation shall have all the rights, privileges, immunities and
powers and be subject to all the duties and liabilities of a corporation
organized under the Illinois Business Corporation Act of 1983;
2.3 The Surviving Corporation shall thereupon and thereafter possess
all the rights, privileges, immunities, powers and franchises as well of a
public as of a private nature, of each of the Constituent Corporations; and all
property, real, personal, and mixed, and all debts due on whatever account,
including subscriptions to shares, and all other choses in action, and all and
every other interest, of or belonging to or due to each of the Constituent
Corporations, shall be taken and deemed to be transferred to and vested in or
shall continue to be vested in the Surviving Corporation without further act or
deed; and the title to all real estate, or any interest therein, vested in
either of the Constituent Corporations shall not revert or be in any way
impaired by reason of the Merger; and
2.4 The Surviving Corporation shall thenceforth be responsible and
liable for all the liabilities and obligations of each of the Constituent
Corporations; and any claim existing or action or proceeding pending by or
against either of the Constituent Corporations may be prosecuted to judgment as
if the Merger had not taken place, or the Surviving Corporation may be
substituted in its place, and neither the rights of creditors nor any liens upon
the property of either of the Constituent Corporations shall be impaired by the
Merger.
ARTICLE III
-----------
3.1 The Articles of Incorporation of the Surviving Corporation as
existing and constituted immediately prior to the Effective Time of the Merger
shall continue to be and constitute the Articles of Incorporation of the
Surviving Corporation. The Articles of Incorporation, among other things: (i)
deny cumulative voting rights and (ii) specify a requirement of a majority vote
of outstanding shares for mergers, amendments to the Articles, dissolution, sale
of all or substantially all assets not in the ordinary course of business and
any other actions which might otherwise require a two-thirds vote under the
Illinois Business Corporation Act of 1983.
3.2 The by-laws of the Surviving Corporation as existing and
constituted immediately prior to the Effective Time of the Merger shall continue
to be and constitute the by-laws of the Surviving Corporation.
3.3 The board of directors, and the members thereof, of the Surviving
Corporation immediately prior to the Effective Time of the Merger shall continue
to be and constitute the board of directors, and the members thereof, of the
Surviving Corporation.
3.4 The officers of the Surviving Corporation immediately prior to
the Effective Time of the Merger shall continue to be and constitute the
officers of the Surviving Corporation.
ARTICLE IV
----------
The mode of carrying into effect the Merger provided for in this Plan and
the manner and basis of converting shares of the Constituent Corporations are as
follows:
19
<PAGE>
4.1 At the Effective Time of the Merger each Common Share, par value
$5.00 per share, of HERITAGE theretofore issued and outstanding shall be retired
and cancelled, and no shares of stock or other securities or property shall be
issued in respect thereto.
4.2 At the Effective Time of the Merger:
(a) each share of Common Stock, par value $5.00 per share, of the
Merged Corporation which is issued and outstanding immediately prior to the
Effective Time of the Merger, shall ipso facto, automatically and without any
action on the part of the holder thereof, become and be converted into one (1)
issued and outstanding Common Share, par value $5.00 per share, of the Surviving
Corporation, each of which Common Shares shall be fully paid and nonassessable;
and
(b) each holder of shares of Common Stock of the Merged Corporation
which shall have been so converted into Common Shares of the Surviving
Corporation, upon surrender of certificates for shares of Common Stock of the
Merged Corporation in proper form to the Surviving Corporation for cancellation,
shall be entitled to receive, as evidence of the Common Shares of the Surviving
Corporation into which the shares of Common Stock of the Merged Corporation
shall have been so converted, stock certificates bearing the name of the
Surviving Corporation as issuer, for the number of shares of the Surviving
Corporation represented by the certificates surrendered. Until so surrendered,
the outstanding certificates which had represented shares of Common Stock of the
Merged Corporation shall be deemed and treated for all corporate purposes to
represent the ownership of Common Shares of the Surviving Corporation into which
the shares of Common Stock of the Merged Corporation shall have been converted
as though said surrender and exchange had taken place.
4.3 At the Effective Time of the Merger, the paid-in capital of the
Surviving Corporation shall be equal to the sum of the paid-in capital of
HERITAGE and the stated capital and paid-in surplus of the Merged Corporation
prior thereto.
ARTICLE V
---------
The Surviving Corporation, as the surviving corporation, shall pay all
expenses of carrying this Plan into effect and accomplishing the Merger herein
provided for.
ARTICLE VI
----------
If at any time the Surviving Corporation shall consider or be advised that
any further assignment or assurance in law is necessary or desirable to vest in
the Surviving Corporation the title to any property or rights of the Merged
Corporation, the proper officers and directors of the Merged Corporation shall,
and will execute and make all such proper assignments and assurances in law and
do all things necessary or proper to thus vest such property or rights in the
Surviving Corporation, and otherwise to carry out the purposes of this Plan.
ARTICLE VII
-----------
7.1 Consummation of the Merger shall be effected by (i) the filing of
a Certificate of Ownership and Merger with the Secretary of State
20
<PAGE>
of the State of Delaware pursuant to Section 253 of Title 8 of the Delaware Code
of 1953 and (ii) the filing of Articles of Merger in the State of Illinois and
the issuance by the Secretary of State of the State of Illinois of a Certificate
of Merger, all after satisfaction of the respective requirements of the
applicable laws of Delaware and Illinois prerequisite to such filings. The
Effective Time of the Merger shall be when a Certificate of Merger shall be
issued by the Secretary of State of the State of Illinois.
7.2 The Constituent Corporations, by authorization of their Boards of
Directors, may, by mutual agreement between them, amend this Plan at any time
prior to the filings referred to in 7.1 above; provided that an amendment made
subsequent to the adoption of this Plan by the stockholders of either
constituent corporation shall not (i) alter or change the amount or kind of
shares, securities, cash, property and/or rights to be received in exchange for
or on conversion of all or any of the shares of any class or series thereof of
such constituent corporation, (ii) alter or change any term of the articles of
incorporation of the surviving corporation to be effected by the Merger, or
(iii) alter or change any of the terms and conditions of this Plan if such
alteration or change would adversely affect the holders of any class or series
thereof of such constituent corporation.
7.3 Anything herein or elsewhere to the contrary notwithstanding,
this Plan may be terminated by either of the Constituent Corporations by
appropriate resolutions of its Board of Directors at any time prior to the
filing referred to in 7.1 above, notwithstanding approval of this Plan by the
stockholders of either or both of the Constituent Corporations.
ARTICLE VIII
------------
The Surviving Corporation may be served with process in the State of
Delaware in any proceeding for enforcement of any obligation of COUNTY as well
as for enforcement of any obligation of the Surviving Corporation arising from
the merger; and the Surviving Corporation does hereby irrevocably appoint the
Secretary of State of Delaware as its agent to accept service of process in any
such suit or other proceedings. The address to which a copy of such process
shall be mailed by the Secretary of State of Delaware is
Heritage Financial Services, Inc.
12015 South Western Avenue
Blue Island, Illinois 60406
Attention: President
until the Surviving Corporation shall have hereafter designated in writing to
the said Secretary of State a different address for such purpose. In the event
of such service upon the Secretary of State in accordance with Subsection (d) of
Section 252 of Title 8 of the Delaware Code of 1953, the Secretary of State
shall forthwith notify the Surviving Corporation by letter, certified mail,
return receipt requested, directed to the Surviving Corporation at the above
address, unless the Surviving Corporation shall have designated in writing to
the Secretary of State a different address for such purpose, in which case it
shall be mailed to the last address so designated. Such letter shall enclose a
copy of the process and any other papers served on the Secretary of State
pursuant to the foregoing Subsection (d).
21
<PAGE>
5. The plan of merger was approved, (a) as to each corporation not organized in
Illinois, in compliance with the laws of the state under which it is organized,
and (b) as to each Illinois corporation, as follows:
Heritage Financial Services, Inc. By written consent of ALL the shareholders
entitled to vote on the action, in
accordance with section 7.10 and
section 11.20.
The undersigned corporations have caused these articles to be signed by
their duly authorized officers, each of whom affirm, under penalties of perjury,
that the facts stated herein are true.
Dated July 2, 1984 COUNTY BANKSHARES, INC.
attested by /s/ Ronald P. Groebe by /s/ Richard T. Wojcik
Secretary President
Dated July 2, 1984 HERITAGE FINANCIAL SERVICES, INC.
attested by /s/ Ronald P. Groebe by /s/ Richard T. Wojcik
Secretary President
-22-
<PAGE>
BCA-2.10 ARTICLES OF INCORPORATION
ARTICLE ONE The name of the corporation is Heritage Financial Services, Inc.
ARTICLE TWO The name and address of the initial registered agent and its
registered office are Richard T. Wojcik, 12015 South Western
Avenue, Blue Island, Illinois 60406, Cook County.
ARTICLE THREE The purpose or purposes for which the corporation is organized
are:
The transaction of any or all lawful businesses for which
corporations may be incorporated under the Illinois Business
Corporation Act of 1983.
ARTICLE FOUR Paragraph 1: The authorized shares shall be:
Class Par Value per share Number of shares authorized
----- ------------------- ---------------------------
Common $5.00 1,000,000
Paragraph 2: The preferences, qualifications, limitations,
restrictions and the special or relative rights in respect of the
shares of each class are: N/A
ARTICLE FIVE The number of shares to be issued initially, and the
consideration to be received by the corporation therefor, are:
Par Value Number of shares Consideration to
Class per share proposed to be issued be received therefor
----- --------- --------------------- --------------------
Common $5.00 200 $1,000
TOTAL $1,000
ARTICLE SIX N/A
ARTICLE SEVEN N/A
-23-
<PAGE>
ARTICLE EIGHT OTHER PROVISIONS
Paragraph 1:
(a) This Paragraph 1 of Article Eight hereby supersedes the requirement of
the affirmative vote of the holders of not less than two-thirds (2/3) of the
outstanding shares entitled to vote, and in the event any class is entitled to
vote as a class, of the holders of not less than two-thirds (2/3) of the
outstanding shares of each class of shares so entitled to vote as a class, for:
(i) an amendment by the shareholders to the Articles of Incorporation; (ii) a
plan of merger, consolidation or exchange of shares; (iii) dissolution by vote
of shareholders; and (iv) sale, lease, exchange or other disposition of all or
substantially all the property and assets other than in the usual and regular
course of business (each of items (i) through (iv) inclusive hereinafter a
"Proposal"); and
(b) A Proposal shall be approved upon receiving the affirmative vote of
the holders of not less than a majority of the outstanding shares entitled to
vote on the Proposal, and in the event any class is entitled to vote as a class
on the Proposal, upon receiving, in addition, the affirmative vote of the
holders of not less than a majority of the outstanding shares entitled to vote
on the Proposal of each class of shares so entitled to vote as a class.
Paragraph 2: No shareholder shall have cumulative voting rights.
NAMES AND ADDRESSES OF INCORPORATORS
The undersigned incorporator hereby declares, under penalties of perjury,
that the statements made in the foregoing Articles of Incorporation are true.
Dated July 2, 1984
/s/ Joel S. Corwin 208 S. LaSalle Street, Suite 550
Chicago, Illinois 60604
-24-
<PAGE>
EXHIBIT 10(c)
March 1996 Amendment to 1990 Executive Equity Incentive Plan
The first sentence of Article 3 was amended to read as follows:
3. Administration. The Plan shall be administered by a committee, to
be known as the Stock Option Committee (the "Committee"), which shall
include not less than three persons who are directors of the Company and
not employees of the Company or any of its subsidiaries, and each of whom
shall qualify as a "disinterested person" as the term is defined by Rule
16b-3 under the 1934 Act (as defined in Article 9(a)) and, effective
immediately following the 1996 Annual Meeting of Shareholders of the
Company, as an "outside director" within the meaning of Internal Revenue
Code Section 162(m) and regulations thereunder.
In addition, the following sentence was added at the end of Article 9(c):
Notwithstanding the foregoing provisions of this Article 9(c) or the
provisions of any option agreement to the contrary, the benefit upon the
exercise of a limited stock appreciation right shall not be paid in cash
if, in the opinion of the Committee, with respect to any particular
exercise, it would be in the best interests of the Company that such
benefit be paid in Stock, in which case such benefit shall be paid in Stock
as the Committee shall determine.
October 1997 Amendment to 1990 Executive Equity Incentive Plan
The first sentence of Article 3 was amended to read as follows:
3. Administration. The Plan shall be administered by a committee, to
be known as the Stock Option Committee (the "Committee"), which shall
include not less than three persons who are directors of the Company and
not employees of the Company or any of its subsidiaries, and each of whom
shall qualify as a "Non-Employee Director" as the term is defined by Rule
16b-3 under the 1934 Act (as defined in Article 9(a)) and, effective
immediately following the 1996 Annual Meeting of Shareholders of the
Company, as an "outside director" within the meaning of Internal Revenue
Code Section 162(m) and regulations thereunder.
<PAGE>
EXHIBIT 11
Statement Re: Computation of Per Share Earnings
Effective December 15, 1997, the Company adopted SFAS 128, "Earnings Per
Share. SFAS 128 replaces the presentation of primary EPS with earnings per
common share ("basic EPS"). Basic EPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. SFAS 128
also requires presentation of EPS assuming dilution ("diluted EPS"). Diluted EPS
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. The dilutive effect of stock options is computed
using the treasury stock method. In accordance with SFAS 128, the Company has
restated all prior period earnings per share data. Weighted average common
shares have also been adjusted to reflect the Company's 1997 three-for-two stock
split.
The calculation of the Registrant's basic and diluted earnings EPS required
by Item 601(b)(11) of Regulation S-K is presented below (dollars in thousands,
except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S><C> <C> <C> <C>
Net income available to common shareholders $17,793 $14,838 $13,294
======== ======== ========
Weighted average common shares outstanding used
in basic earnings per share calculation 12,053 11,899 11,906
Dilutive effect of employee stock options after
application of the treasury stock method 411 588 558
-------- -------- --------
Weighted average number of shares outstanding adjusted
for the effect of dilutive securities 12,464 12,487 12,464
======== ======== ========
Basic earnings per share $1.48 $1.25 $1.12
===== ===== =====
Diluted earnings per share $1.43 $1.19 $1.07
===== ===== =====
</TABLE>
<PAGE>
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
<PAGE>
EXHIBIT 23
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 19, 1998, appearing in this Annual Report on Form 10-K of Heritage
Financial Services, Inc. for the year ended December 31, 1997.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 2, 1998
<PAGE>
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, 1997 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 17, 1998
by /s/ John J. Gallagher by /s/ Lael W. Mathis
------------------------------ ----------------------------
John J. Gallagher Lael W. Mathis
by /s/ Jack Payan by /s/ Arthur E. Sieloff
------------------------------ ----------------------------
Jack Payan Arthur E. Sieloff
by /s/ John L. Sterling by
------------------------------ ----------------------------
John L. Sterling Chester Stranczek, Director
by /s/ Arthur G. Tichenor by /s/ Dominick J. Velo
------------------------------ ----------------------------
Arthur G. Tichenor Dominick J. Velo
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<CIK> 0000355946
<NAME> HERITAGE FINANCIAL SERVICES, INC.
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 48214
<INT-BEARING-DEPOSITS> 464
<FED-FUNDS-SOLD> 2400
<TRADING-ASSETS> 450
<INVESTMENTS-HELD-FOR-SALE> 407087
<INVESTMENTS-CARRYING> 113101
<INVESTMENTS-MARKET> 116544
<LOANS> 711541
<ALLOWANCE> 9621
<TOTAL-ASSETS> 1319321
<DEPOSITS> 1139631
<SHORT-TERM> 45569
<LIABILITIES-OTHER> 11915
<LONG-TERM> 0
<COMMON> 0
0
0
<OTHER-SE> 122206
<TOTAL-LIABILITIES-AND-EQUITY> 1319321
<INTEREST-LOAN> 57772
<INTEREST-INVEST> 32960
<INTEREST-OTHER> 424
<INTEREST-TOTAL> 91156
<INTEREST-DEPOSIT> 40692
<INTEREST-EXPENSE> 42736
<INTEREST-INCOME-NET> 48420
<LOAN-LOSSES> 600
<SECURITIES-GAINS> 291
<EXPENSE-OTHER> 31765
<INCOME-PRETAX> 25662
<INCOME-PRE-EXTRAORDINARY> 25662
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17793
<EPS-PRIMARY> 1.48
<EPS-DILUTED> 1.43
<YIELD-ACTUAL> 4.45
<LOANS-NON> 903
<LOANS-PAST> 216
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 9407
<CHARGE-OFFS> 706
<RECOVERIES> 320
<ALLOWANCE-CLOSE> 9621
<ALLOWANCE-DOMESTIC> 9621
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
