SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996 Commission File No. 0-11255
Heritage Bankshares, Inc.
Virginia 54-1234322
(State or other jurisdiction of (IRS Employer incorporation
incorporation or organization) identification number)
200 East Plume Street
Norfolk, Virginia 23514
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (804) 523-2600
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $5 par Value Securities not registered on a stock exchange
Title of Each Class
Indicate by a 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, 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 SB 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 the Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the registrant as of March 21, 1997:
$7,630,870*
Indicate the number of shares outstanding of each of the registrant's classes
of common stock as of March 21,1997:
Common Stock, $5 Par Value - 786,450
- ----------------------------------------------
In calculating the aggregate market value, we have used the most recent sales
price of Common Stock known to the Company, which is $11.38 per share and
voting stock held by non-affiliates of the registrant at March 21, 1997 of
670,551 shares.
Part I
Item 1. BUSINESS
GENERAL
Heritage Bankshares, Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia in 1983. In August of 1992, two wholly-owned
subsidiaries, Princess Anne Bank and The Heritage Bank-McLean, were spun
off, and the Company has operated as a one bank holding company since that time.
The principal executive office of the Company is located at 200 East Plume
Street, Norfolk, Virginia. The Company has three wholly-owned subsidiaries
including one bank: Heritage Bank & Trust (the "Bank") with offices in
Norfolk and Chesapeake, Virginia. IBV Real Estate Holdings, Inc., a Virginia
corporation is the other subsidiary.
The total consolidated assets of the Company on December 31, 1996 were
$76,846,000.
THE BANK
Heritage Bank & Trust is engaged in the general commercial and retail banking
business. The cities of Norfolk and Chesapeake, Virginia, constitute the
primary service area of the Bank and to a lesser extent the Bank includes the
remaining areas of Hampton Roads in its market area.
Heritage Bank & Trust is a state banking corporation. The Bank was
incorporated as a Virginia corporation on September 19, 1975, and commenced
business at its main office at 841 North Military Highway in Norfolk,
Virginia on February 7, 1977. On December 31, 1996, the Bank had assets of
$76,795,000, with loans of $45,259,000 and deposits of $68,427,000.
IBV REAL ESTATE HOLDINGS, INC.
IBV Real Estate Holdings, Inc., is a corporation formed for the sole purpose
of owning additional real estate assets acquired by the Company or the Bank.
Currently, IBV Real Estate Holdings, Inc. owns a 1% interest in IBV Partners,
LP, a Virginia limited partnership formed in December 1986. IBV Real Estate
Holdings, Inc.,serves as the sole general partner of the partnership. The
partnership's sole asset is a 17,200 square-foot office building located at
1450 South Military Highway, Chesapeake, Virginia. Heritage Bank & Trust is
a major tenant in the property.
COMPETITION
The banking business in the cities of Norfolk and Chesapeake, as well as all
of the Hampton Roads area is highly competitive. All of the major commercial
banking institutions based in Virginia conduct business in the area. The
Bank also encounters competition from local banks, savings and loan
associations, money market and mutual funds, small loan companies, credit unions
, brokerage firms and other financial institutions.
EMPLOYEES
The Company and the Bank have 33 employees. Of this total, 27 are full-time
and 6 are part-time. Management considers its employee relations to be
excellent.
REGULATION AND SUPERVISION
THE BANK
Regulatory Matters
The Bank is subject to state and federal banking laws and regulations which
impose specific requirements or restrictions, and provide for general
regulatory oversight with respect to virtually all aspects of operations,
including, but not limited to, maintenance of cash reserves, loans,
mortgages, maintenance of minimum capital, payment of dividends, and
establishment of branch offices. As a state-chartered bank and a member of
the Federal Reserve System, the Bank is supervised and regularly examined by
representatives of the Board of Governors of the Federal Resreve System
("The Federal Reserve") and the Bureau of Financial Institutions of the
Commonwealth of Virginia.
The Bank is a member of the Federal Reserve and Virginia Bureau of
Financial Institutions . In addition to being affected by general economic
conditions, earnings of the Bank may be affected by the fiscal and monetary
policies of the Federal Reserve . The techniques used by the Federal
Reserve include setting the reserve requirements of member banks and
establishing the discount rate on member banks's borrowing. The impact of the
policies of the Federal Reserve, and other regulatory authorities
cannot be accurately predicted.
These policies can, however, materially affect the revenues and net income of
commercial banks because they have a direct effect on the amount of bank
loans and deposits and the interest rates charged and paid thereon.
The Bank is also subject to restrictions under Section 23A of the Federal
Reserve Act ("The Act"). These restrictions limit the transfer of funds to
the Company and certain other affiliates, as defined in the Act, in the form
of loans, extensions of credit, investments or purchase of assets. Such
transfers by the Bank to the company are limited in amount to 10% of the
Bank's capital. Furthermore, such loans and extensions of credit are also
subject to various collateral requirements. See note 3 of the Consolidated
Financial Statemetns, which are incorporated herein by reference under Item
7-"Financial Statements".
The Bank is also subject to restrictions on the payment of dividends under
Section 33 of the Federal Reserve Act. Under this section, the approval of
the applicable Federal Reserve Bank is required if the total
of all dividends declared by the Bank during any calendar year exceeds the total
of its net profits (as defined by the Act) of that year combined with its net
profits of the preceding two years.
The Federal Reserve Bank and the Bureau of Financial Institutions of Virginia
requires the Bank to maintain certain minimum capital ratios. The Bank and
the Company are required to maintain minimum risk-based capital to asset ratios,
as defined by the regulators, of 4.00% for the Tier 1 capital ratio and 8.00%
for the Tier 2 capital ratio. Additionally, a leverage capital ratio, defined
as Tier 1 capital divided by average assets, must also be maintained by
financial institutions. For financial institutions with the best regulatory
rating, a minimum leverage ratio of 5.00% must be maintained. The Bank and
the Company met the minimum risk-based capital requirements at December 31,
1996.
Mergers and Acquisitions
The Bank Holding Company Act formerly prohibited the Federal Reserve from
approving an application from a bank holding company to acquire shares of a
bank located outside the state in which the operations of the holding
company's banking subsidiaries were principally conducted, unless such an
acquisition was specifically authorized by statute of the state in which the
bank whose shares were to be acquired was located. However, under recently
enacted federal legislation, the restriction on interstate acquisitions was
abolished effective September 29, 1995, and bank holding companies from any
state may now acquire banks and bank holding companies located in any other
state. Banks also will be able to branch across state lines effective June
1, 1997, provided certain conditions are met, including that applicable
state law must expressly permit such interstate branching. Under Virginia
law, effective July 1, 1995, Virginia banks can branch across state lines in
those states with which Virginia has reciprocal agreements. Although this
will have a significant impact on the banking industry, it is not possible
to determine, with any degree of certainty, its impact on individual
institutions.
Deposit Insurance
Section 38 of the Federal Deposit Insurance Act, as amended by the Federal
Deposit Insurance Corporation Improvement Act (FDICIA), requires that the
federal banking agencies establish five capital levels for insured depository
institutions - "well capitalized", "adequately capitalized",
"undercapitalized", significantly "undercapitalized" and, "critically
undercapitalized" and requires or permits such agencies to take certain
supervisory actions as an insured institution's capital level falls. The
Bank has been notified by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") that it is classified as a "well
capitalized" institution for this purpose. An "adequately capitalized"
institution is restricted from accepting brokered deposits. A "significantly
undercapitalized" institution must develop a capital restoration plan and is
subject to a number of mandatory and discretionary supervisory actions.
These powers and authorities are in addition to the traditional powers of
the federal banking agencies to deal with undercapitalized institutions. As
more fully disclosed in the following paragraph the FDIC deposit insurance
premiums required to be paid by institutions depend, in part, on their
capital levels, and "undercapitalized" institutions will be required to pay
significantly greater premiums than more highly capitalized institutions.
The FDIC has implemented a risk-based deposit insurance assessment system under
which the assessment rate for an insured institution may vary according to
regulatory capital levels of the institution and other factors (including
supervisory evaluations). Effective January 1, 1996, depository institutions
insured by the Bank Insurance Fund ("BIF"), ranked in the top risk
classification category of well capitalized, are required to pay only the
statutory minimum assessment of $2,000 annually for deposit insurance, while
all other banks are required to pay premiums ranging from .03% to .30% of
domestic deposits. These rate schedules are subject to future adjustments by
the FDIC. In addition, as more fully disclosed in the following paragraph,
the FDIC has authority to impose special assessments from time to time.
The Deposit Insurance Funds Act of 1996 ( the "Funds Act") was enacted on
September 30, 1996. Among other provisions, the Funds Act: (1) requires that
certain depository institutions pay a one-time special assessment (65.7 cents
per $100 of SAIF-assessable deposits) to the FDIC to capitalize the Savings
Association Insurance Fund ("SAIF") at its statutorily required reserve
ratio of 1.25% of insurable deposits; (2) exempts certain depository
institutions with SAIF assessable deposits that meet any of several specified
criteria from paying the special assessment, (3)authorizes the Financing
Corporation ("FICO") to impose periodic assessments on depository
institutions that are members of BIF, in addition to institutions that are
members of the SAIF, in order to spread the cost of the interest payments on
the outstanding FICO bonds over a larger number of institutions. Until this
change in the law, only SAIF-member institutions bore the cost of funding
these interest payments. FICO assessment rates for the first semiannual
period of 1997 were set at 1.30% annually for BIF-assessable deposits and at
6.48% annually for SAIF-assessable deposits. These rates may be adjusted
quarterly to reflect changes in assessment bases for the BIF and the SAIF.
By law, the FICO rate on BIF-assessable deposits must be one-fifth the rate
on SAIF assessable deposits until the insurance fiends are merged or until
January 1, 2000, whichever occurs first.
Regulations
On December 15, 1994, the Federal Reserve Board, the Office of Thrift
Supervision, the Office of the Controller of the Currency ("OCC"), and the
FDIC (collectively the "agencies") issued a final rule entitled, Risk-
Based Capital Standards: Concentration of Credit Risk and Risks of
Nontraditional Activities. The final rule amends the risk-based capital
standards by explicitly identifying concentrations of credit risk and certain
risks arising from nontraditional activities, as well as an institution's
ability to manage these risks, as important factors in assessing an
institution's overall capital adequacy. While no quantitative measure of
such risk is included in the final rule, to the extent appropriate, the
agencies will issue examination guidelines on new developments in
nontraditional activities or concentrations of credit to ensure that adequate
account is taken of the risks of these activities. Moreover, the agencies
also believe that institutions identified though the examination process as
having significant exposure to concentration of credit risk, or as not
adequately managing concentration risks, should hold capital in excess of the
regulatory minimums. Therefore, due to the subjective nature of this final
rule, the Bank is unable to determine what effect, if any, this rule may have
on regulatory capital requirements.
On August 2, 1995, the OCC, the Federal Reserve Board, and the FDIC
(collectively the "banking agencies") issued a final rule entitled, Risk-
Based Capital Standards: Interest Rate Risk. The final rule implements
minimum capital standards for interest rate risk exposures in a two-step
process. The final rule implements the first step of that process by
revising the capital standards of the banking agencies to explicitly
include a bank's exposure to declines in the economic value of its capital
due to changes in interest rates as a factor that the banking agencies will
consider in evaluating a bank's capital adequacy. It is important to note
that the banking agencies intend to implement this rule on a case-by-case
basis during the examination process. The second step of the banking
agencies' process will be to issue a proposed rule that would establish
an explicit minimum capital charge for interest rate risk, based on the level
of the bank's measured interest rate risk exposure.
Due to the subjective nature of the first phase of this final rule, the Bank is
unable to determine what effect, if any, this rule may have on its regulatory
capital requirements On November 16, 1995, the Federal Reserve Board issued
guidelines entitled, Federal Reserve Guidelines for Rating Risk Management
at State Member Banks and Bank Holding Companies (the "Guidelines"). The
Guidelines specify that principles of sound management should apply to the
entire spectrum of risks facing a banking institution including, but not
limited to, credit, market, liquidity, operational, legal, and reputational
risk and that, for state member banks, a single numerical rating for risk
management should be provided as part of the examination process. The
Guidelines also specify that examination reports should make reference to the
types and nature of corrective actions that need to be taken by institutions
to address noted risk management and internal control deficiencies. Where
appropriate, institutions should also be advised that the Federal Reserve
Board will initiate supervisory actions if the failure to separate critical
operational duties creates the potential for serious losses or if material
deficiencies or situations that threaten the safe and sound conduct of their
activities are not adequately addressed in a timely manner. Due to the
subjective nature of the risk-management evaluation, the Bank is not able to
determine what effect, if any, this rule may have on the operation of the Bank.
On October 1, 1996, the banking agencies issued new guidelines amending the
Interagency Guidelines Establishing Standards for Safety and Soundness
(the "Guidelines") to include asset quality and earnings standards. The
Guidelines were adopted pursuant to the requirements of Section 39 of the
Federal Deposit Insurance Act. The Guidelines require financial
institutions to identify problem assets and estimate inherent losses. In
order to comply with these Guidelines a financial institution shall: (1)
consider the size and potential risks of material concentrations of credit
risk; (2) compare the level of problem assets to the level of capital and
establish reserves sufficient to absorb anticipated losses on those and
other assets, (3) take appropriate corrective action to resolve problem
assets, as appropriate; and (4) provide periodic asset quality reports
to the board of directors to assess the level of asset risk. The earnings
standards specified by the Guidelines require an institution to compare its
earnings trends ( relative to equity, assets, and other common benchmarks)
with its historical experience and with the earnings trends of its peers.
The Guidelines, relative to the earnings standards, require the institution
to: (1) evaluate the adequacy of earnings with regard to the institution's
relative size and complexity, and the risk profile of the institution's
assets and operations; (2) assess the source, volatility, and sustainability
of earnings, (3) evaluate the effect of nonrecurring or extraordinary income
or expense; (4) take steps to ensure that earnings are sufficient to maintain
adequate capital and reserves after considering asset quality and the
institution's rate of growth; and (5) provide periodic reports with adequate
information for management and the board of directors to assess earnings
performance. The Guidelines note that the complexity and sophistication of an
institution's monitoring, reporting systems, and corrective actions should be
commensurate with the size, nature and scope of the institution's operations.
The Bank does not believe that these Guidelines will materially effect its
operations or financial condition.
The Federal Financial Institutions Examination Council ("FFIEC") has approved
revisions to the reporting requirements for the Reports of Condition and Income
(Call Report) that will take effect as of March 31, 1997. The revisions
that are expected to have the greatest impact on most financial institutions
will be the adoption of generally accepted accounting principles ("GAAP") as
the reporting basis for the balance sheet, income statement and related Call
Report schedules. This will involve the revision of Call Report instructions
that currently depart from GAAP, the addition of a small number of new items
to meet supervisory data needs resulting from the adoption of GAAP, and the
modification of other existing Call Report items or instructions. In the
March 31, 1997 Call Report, financial institutions are required to adopt the
provisions of Financial Accounting Standards Board ("FASB") Statement No. 125,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, for transfers and servicing of assets occuring after December 31
1996. As FASB 125 provides standards for distinguishing the transfer of
financial assets from secured borrowings and, therefore, the recognition and
derecognition of financial assets, regulatory capital calculations could be
significantly impacted. The Bank is currently considering the relevant
provisions of FASB 125, and assessing the accounting treatment and legal
ramifications of modifying participation agreements. Additional information
with respect to this pronouncement is included in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" under Recent
Accounting Pronouncements and is incorporated herein by reference thereto.
On December 20, 1996 the FDIC Board of Directors adopted the FFIEC's updated
statement of policy entitled Uniform Financial Institutions Rating System
("UFIRS"). The updated UFIRS replaces the previous rating system established
in the 1979 statement of policy, and is effective January 1, 1997. Under the
existing UFIRS, each financial institution is assigned a composite rating
based on an evaluation and rating of five essential components of an
institution's financial condition and operations. The five component areas
are Capital adequacy, Asset quality, Management, Earnings and Liquidity
("CAMEL"). The updated UFIRS includes the addition of a sixth component for
Sensitivity to market risk ("CAMELS"). The new sixth component addresses the
degree to which changes in interest rates, foreign exchange rates, commodity
prices or equity prices can adversely affect a financial institution's
earnings or capital. The new component focuses on an institution's ability
to monitor and manage its market risk, and will provide an institution's
management with a clearer and more focused indication of supervisory concerns
in this area. The Bank does not believe that this statement of policy will
materially effect its operations.
THE COMPANY
As a bank holding company, the Company is subject to regulation by the Federal
Reserve System in accordance with the provisions of the Bank Holding Company
Act of 1956, as amended, and the rules and regulations promulgated thereunder.
A bank holding company is required to file with the Federal Reserve Board
annual reports and those of its subsidiaries. It is also subject to
examination by the Federal Reserve Board and is required to obtain Federal
Reserve Board approval prior to acquiring, directly or indirectly, ownership
or control of any voting shares of any bank if, after such acquisition, it
would own or control, directly or indirectly, more than 5.00% of the voting
stock of such bank. Furthermore, a bank holding company is, with limited
exceptions, prohibited from acquiring direct or indirect ownership or
control of more than 5.00% of any company which is not a bank or bank holding
company, and must engage only in the business of banking or managing or
controlling banks or furnishing services to or performing services for its
subsidiary banks. One of the exceptions to this prohibition is the ownership
of shares of a company, the activities of which the Federal Reserve Board
has determined to be so closely related to banking or managing or controlling
banks as to be a proper incident thereto.
The Federal Reserve Board has determined that numerous activities are closely
related to banking, and thus bank holding companies may apply to the Federal
Reserve Board for permission to retain or acquire an interest in a company
engaging in or proposing to engage in these activities. The permitted
non-banking activities include making loans that would be made by mortgage,
finance, credit card or factoring companies; operating as an industrial bank;
servicing loans; performing the functions of a trust company; leasing
personal property; making investments to promote community welfare; providing
bookkeeping or data processing services; acting as insurance agent or broker
with respect to insurance that is directly related to the extension of credit
or other financial services and acting as an underwriter for credit life
insurance and credit health and accident insurance directly related to
extensions of credit by the appraisal activities. Also, an application may
be filed as to other activities, but the Federal Reserve Board will publish a
notice of opportunity for hearing only if it believes there is a reasonable
basis for concurring in the holding company's opinion that the activity
applied for is closely related to banking.
A bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with the extension of credit or
provision of any property or service. Thus, an affiliate of a bank holding
company may not extend credit, lease, sell property or furnish any services
or fix or vary the consideration for these services on the condition that (a)
the customer must obtain or provide some additional credit, property, or
services from or to its bank holding company or subsidiaries thereof, or (b)
the customer may not obtain or provide some additional credit, property, or
services from a competitor, except to the extent reasonable conditions are
imposed to assure soundness of credit extended.
Item 2. PROPERTIES
The bank owns two of its banking locations, 841 North Military Highway and
200 East Plume Street, in Norfolk, Virginia. Management believes these
locations are in excellent condition. A third banking location and
the bank's operations center are located at 1450 South Military Highway in
Chesapeake, Virginia. See "IBV Real Estate Holdings, Inc." under Item 1 and
"Certain Relationships and Related Transactions" under Item 2. The
Bank has purchased a parcel of land at 4807 Colley Avenue in Norfolk,
Virginia to construct a branch office that is tentatively scheduled to open
on December 1, 1997.
Item 3. LEGAL PROCEEDINGS
The Company is subject to claims and lawsuits which arise primarily in the
ordinary course of business. Based on information presently available to
management and advice received from legal counsel, there are no
meritorious claims involving the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of securities holders during the fourth
quarter of 1996.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
There is a limited public market for the Company's common stock. It is not
listed for trading on a registered exchange. There are no "market makers"
for the stock. Trades in the common stock occur on a local basis. Scott &
Stringfellow Inc., a Virginia brokerage firm, attempts to match orders to buy
and sell the common stock. Accordingly, there is no established public
trading market for shares of common stock, and quotations do not necessarily
reflect the price that would be paid in an active, liquid market. There can
be no assurance an active trading market will develop in the future. The
following table sets forth the closing high and low sales price for
the common stock by calendar quarters for the past two years as reported to
the Company by Scott & Stringfellow
Inc.
Calendar Quarter
1996
HIGH LOW
Fourth Quarter $9.75 $ 9.25
Third Quarter 9.00 8.50
Second Quarter 8.63 8.50
First Quarter 7.75 7.00
1995
Fourth Quarter $ 6.38 $ 5.88
Third Quarter 6.75 5.50
Second Quarter 5.00 4.50
First Quarter 6.00 5.87
At March 21, 1997, there are 1,377 record holders of the 786,450 outstanding
shares of common stock.
As of March 21, 1997, the most recent sales price of common stock known to the
Company was $11.38 per share.
The Company's Board of Directors determines whether to declare dividends and
the amount of such dividends. Determinations by the Board take into account
the Company's financial condition, results of operations, capital
requirements, general business conditions and other relevant factors. The
Company's principal source of funds for cash dividends is the dividends paid
to the Company by the Bank. The Company declared and paid dividends of $.12
and $.08 per share in 1996 and 1995, respectively.
Item 6. SELECTED FINANCIAL DATA AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following sets forth certain selected financial data with respect to the
Company. The data presented below for the years ended December 31, 1996 and
1995, respectively, should be read in conjunction with the Consolidated
Financial Statements and notes thereto, which have been audited by Goodman &
Company, L.L.P. independent accountants. (The Consolidated Financial
Statements and notes thereto for the years ended December 31, 1996 and 1995
are filed herewith). This data should also be read in conjunction with the
discussion and analysis that follows.
Summary of Consolidated Financial Data
(Dollars in thousands, except per share data)
1996 1995
FOR THE YEAR
Interest income $ 5,380 $ 4,919
Interest expense 2,495 2,179
Net interest income 2,885 2,740
Provision for loan losses 93 193
Noninterest income 246 234
Noninterest expense 1,950 1,941
Income taxes 21 95
Net income 870 745
AT YEAR END
Assets $ 76,846 $ 67,285
Loans, net 45,259 43,783
Federal funds sold 5,92 5,720
Securities 20,197 13,003
Deposits 68,427 61,053
Stockholders' equity 6,112 5,338
AVERAGE BALANCES
Assets $ 70,968 $ 62,807
Loans, net 42,970 40,025
Federal funds sold 8,605 6,925
Securities 14,509 11,939
Deposits 64,519 57,058
Stockholders' equity 5,686 4,935
PER SHARE DATA
Earnings per common and
common equivalent share $ 1.09 $ 0.94
Cash dividends declared 0.12 0.08
Book value at year end 7.79 6.80
Shares outstanding at
year end 784,150 784,150
Weighted average shares
includes common stock
equivalents) 799,944 788,974
RATIOS
Return on average assets 1.23% 1.19%
Return on average equity 15.30% 15.10%
Average equity to average
assets 8.01% 7.86%
Allowance to year end loans 1.83% 1.74%
Net loans charged-off
to average loans 0.03% .17%
PERFORMANCE SUMMARY:
In 1996, net income for Heritage Bankshares, Inc. totaled $870,000 compared to
$745,000 earned in 1995. Heritage Bank & Trust's net income was $878,000 and
net holding company expenses were $8,000. In 1995, Heritage Bank & Trust's
net income was $749,000 and net holding company expenses were $4,000.00.
Earnings per common and common equivalent share in 1996 was $1.09 compared
to $.94 in 1995.
The 1996 provision for loan losses was $93,000 compared to the 1995 provision
of
$193,000. Net interest income increased $146,000 in 1996 to $2,886,000, from
2,740,000 in 1995.
Total assets increased at the end of 1996 to $76,846,000. Total assets at the
end of 1995 were $67,285,000. Gross loans increased $2,319,000 from
43,783,000 at the end of 1995 to $46,102,000 at the end of 1996. Deposits
increased from $61,053,000 at December 31, 1995 to $68,427,000 at December
31, 1996.
LIQUIDITY:
Liquidity is the ability of the Company to efficiently fund depositors'
withdrawals and extensions of credit to borrowers. The Company and Heritage
Bank & Trust must consider both immediate liquidity needs, as well as
the long-term matching of maturing loans and investments with obligations to
depositors.
The Company's Consolidated Statement of Cash Flows, found in the Consolidated
Financial Statements, provides information as to cash provided and used from
operating, investing and financing activities. At December 31, 1996, cash
and cash equivalents available to meet immediate liquidity needs and reserve
requirements were $8,994,000. The bank also has borrowing capacity of $5.9
million, as a member of the Federal Home Loan Bank System.
The Company's cash and cash equivalents increased by $50,000 in 1996. Net cash
provided by financing activities was $8,692,000. This was primarily due to
growth in both time and demand deposits, which increased $8,723,000 by year-
end 1996. This increase is largely due to the expansion of current customer
relationships. This was offset by net cash used by investing activities of
$9,555,000, which is largely due to the $7,194,000 increase in investment
securities and a $2,319,000 increase in gross loans.
Table 2: Selected Liquidity Statistics
For the Year Ended December 31,
1996 1995
(Dollars in thousands)
Available short-term assets (1) 8,262 $ 9,458
Certificates of deposit $100,000
and over 6,728 7,750
Net available short-term assets 1,534 1,708
Ratio of available short-term assets to
certificates $100,000 and over 123% 122%
Ratio of loans to deposits 66% 72%
Ratio of certificates $100,000 and
over to total assets 9% 12%
(1)As of December 31, 1996 available short-term assets include federal funds
sold of $5,925,000 and held-to-maturity and available-for-sale securities
maturing within one year of $547,000 and $1,790,000, respectively.
At December 31, 1995, available short-term assets included federal funds
sold of $5,720,00 and held-to- maturity- and available-for-sale securities
maturing within one year of $743,000 and $2,995,000 respectively.
PARENT COMPANY LIQUIDITY:
The parent company incurred expenses for stockholder-related activities, stock
transfer and other functions necessary for the administration of the Company.
See Note 3 of the Consolidated Financial Statements for the parent company's
Cash Flow Statement for further information on cash provided or used by the
parent for operating and investing activities.
CAPITAL:
Stockholders' equity at December 31, 1996 was $6,112,000 compared to $5,338,000
at the end of the prior year. Book value per share increased from $6.80 at
December 31, 1995 to $7.79 at December 31, 1996.
the Year ended December 31,
1996 1995
(Dollars in thousands)
Risk-based capital:
Tier I Capital
Stockholders' equity
$ 6,081 $5,304
Tier II Capital
Allowance for loan losses (limited) 569 534
Total $ 6,681 $ 5,838
Risk adjusted assets $ 45,230 $ 42,717
Risk-based capital ratios:
Tier I 13.44% 12.42%
Total 14.70% 13.67%
Leverage ratio 8.57% 8.44%
Primary capital ratio 8.91% 8.92%
RATE SENSITIVITY:
At December 31, 1996 the Company had, on a cumulative basis, $8,139,000 more in
liabilities subject to repricing within one year than assets. It is
management's view that the Company is an asset-sensitive company.
This view is based on the fact that historically the Company's earnings have
been more favorable during periods of increasing interest rates.
Table 4 provides an interest sensitivity analysis as of December 31, 1996.
Heritage Bankshares, Inc
Interest Sensitivity Analysis
December 31, 1996
Within Over3 Over Over Over
1 month thru 1 Yr 3 yr 5 thru Total
thru 3 12 thru thru 10 thru Over
months months 3 5 yrs 10 yrs 10yrs Total
Earning assets:
Federal funds $5,925 $- $- $- $- $5,92 $- $5,925
Investment
securities(2 500 1,837 11,395 4,702 676 19,110 1,041 20,151
Loans 21,695 2,458 6,214 5,542 2,239 38,148 8,011 46,159
Total Earning
Assets $28,120 $4,295 $17,609 $10,244 $2,915 $63,183 $9,052 $72,235
Interest and non-interest bearing liabilities:
Commercial DDA(3)$5,311 $- $3,187 $2,124 $- $10,622 $- $10,622
Personal DDA(3) - - 1,126 375 375 1,877 - 1,877
TT&L Note 131 - - - - 131 - 131
Savings(3) - - 2,806 935 935 4,676 - 4,676
Money Market(3) - 2,455 2,455 - - 4,910 - 4,910
NOW(3) - - 4,421 1,474 1,474 7,368 - 7,368
Certificates 7,253 24,055 6,206 1,460 - 38,974 - 38,974
Securities sold
Under agreements to
repurchase 1,349 - - - - 1,349 - 1,349
Total Interest and non interest
bearing liabilities $14,044 $26,510 $20,200 $6,369 $2,784 $69,907 $- $69,907
Interest
sensitivity gap $14,076 $(22,215)$(2,591)$3,875 $131 $(6,724)$9,052 $2,328
Cumulative gap $14,076 $(8,139)$(10,730)$(6,855)$(6,724)
Ratio interest sensitive assets
to interest-sensitive
liabilities 2.00 0.16 0.87 1.61 1.05 0.90
Ratio of cumulative gap to
total earning assets 19.49%-11.27%-14.85%-9.49%-9.31%
(1)Assets and liabilities are presented in the period they mature or reprice,
whichever is earlier
(2)Presented on an amortized cost basis.
(3)Based on the proposed range of maturities for non-maturity deposits issued
by the banking agencies.
NET INTEREST INCOME:
Net interest income is the difference between interest earned on loans,
investment securities and short-term investments and interest paid on
deposits, securities sold under agreements to repurchase and other short-term
borrowing. Material factors affecting net interest income included interest
rates earned on loans and investments and those paid on deposits, the mix
and volume of earning assets and interest-bearing liabilities,and the level
of noninterest-bearing liabilities.
Net interest income increased from $2,740,000 in 1995 to $2,886,000 in 1996, a
$146,000 increase. The increase is primarily attributable to the 55% increase
in investment securities and to a lesser extent the 5% increase in gross loans.
Table 5 presents the components of net interest income. Table 6 allocates
changes in volume and rate on net interest earnings.
Table 5: Components of Net Interest Income
For the years ended December 31,
1995 1996
Interest earning assets: (taxable equivalent basis (1))
Loans(net)(2)) $ 43,781 $ 4,146 9.47% $ 40,025 $3,939 9.84%
Investment
securities
taxable(4) 14,360 853 5.94% 11,939 653 5.47%
Investment
securities
non-taxable(1)4) 149 10 6.71% - - -
Federal Funds 8,605 456 5.30% 6,925 407 5.88%
Total Interest
earning assets 66,895 5,465 8.17% 58,889 4,999 8.49%
Noninterest earning assets:
Cash and due
from banks 2,525 2,389
Allowance for
loan losses (811) (733)
Other real
estate owned 503 540
Premises and
equipment 603 648
Other assets 1,253 1,074
4,073 3,918
Total Assets 70,968 62,807
Liabilities and stockholders' equity
Interest bearing liabilities:
Money Market and
NOW accounts $ 14,235 $ 407 2.86% $ 12,981 $382 2.94%
Savings Deposits 4,718 158 3.35% 4,826 175 3.63%
Savings Certificates 28,065 1,599 5.70% 22,128 1,215 5.49%
Large denomination
certificates 6,449 328 5.09% 6,626 404 6.10%
Securities sold under
agreements to
repurchase 14 1 4.36% - - -
Short-term borrowings 96 3 3.13% 99 3 3.03%
Total interest bearing
liabilities 53,577 2,495 4.66% 46,660 2,179 4.67%
Noninterest bearing liabilities:
Demand deposits 11,051 10,497
Other 654 715
Total Liabilities 65,282 57,872
Stockholders' equity 5,686 4,935
Total liabilities and stockholders'
equity $ 70,968 $ 62,807
Net interest earnings $ 2,970 $ 2,820
Net interest yield margin on average interest earning
assets taxable equivalent basis
4.44% 4.79%
Less tax equivalent adjustment $ (85) $ (80)
Net interest income $ 2,885 $ 2,740
Net interest spread (taxable
equivalent basis)
3.51% 3.82%
(1) Tax equivalent adjustments (using 34% federal income tax rates) have been
made in calculating the yields on tax-free loans and investments Virginia
banks are exempt from state income tax.
(2) For the purposes of these computations, nonaccruing loans are included in
the daily average loan amounts outstanding.
(3) Daily average balances are calculated using the aggregate daily average
balances on a monthly basis.
(4)The yield/rate of the investment securities is computed using the amortized
cost basis.
Table 6: Effect of Changes in Volume and Rate on Net Interest Earnings
For the years ended December 31, (1)
1996 / 1995 1995 / 1994
(Dollars in thousands)
Increase (Decrease) Increase (Decrease)
Due to Change In: Due to Change In:
Volume Rate Total Volume Rate Total
Interest income (2):
Loans $ 346 $(139) $ 207 $ 146 $ 330 $476
Taxable securities 140 60 200 (24) 81 57
Non-taxable securities 10 - 10 - - -
Federal funds sold 82 (33) 49 115 95 210
Total interest income 578 (112) 466 237 506 743
Interest expense:
Money Market and NOW
accounts 35 (10) 25 (13) 26 13
Savings (4) (13) (17) (149) 30 (119)
Certificates 336 47 383 302 182 484
Certificates of
$100,000 or more (11) (65) (76) 37 119 156
Securities sold under
agreements to
repurchase 1 - 1 - - -
Short-term borrowings - - - - 1 1
Total interest
expense 357 (41) 316 177 358 535
Net change in interest
earnings $ 221 $(71) $ 150 $ 60 $ 148 $ 208
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar of the changes in each.
(2)Interest income includes taxable equivalent adjustments of $85,000 in 1996
and $80,000 in 1995 used to adjust interest on tax exempt assets to a fully
taxable basis.
ASSET QUALITY
PROVISION AND ALLOWANCE FOR LOAN LOSSES:
The provision for loan losses is charged to operations in an amount sufficient
to maintain the allowance for loan losses at a level management considers
adequate to provide for future loan losses inherent in the loan portfolio.
Loans are charged against this allowance when management perceives the
collection of the loan is unlikely. The level of the allowance is based
upon management's ongoing review of the loan portfolio and includes the
present and prospective financial condition of borrowers, consideration of
actual loan loss experience and projected economic conditions in general and
for the Bank's service area.
In 1996, the provision for loan losses was $93,000, a 52% decrease compared to
the $193,000 provision for loan losses in 1995. Net loans charged-off in 1996
were $14,000 compared to $68,000 in 1995.
Table 7 summarizes activity in the Allowance for Loan Losses and provides
statistics on nonperforming
assets and past due loans. There were no restructured loans, as defined by
applicable securities rules and regulations.
Table 7: Summary of the Allowance For Loan Losses
Nonperforming Assets and Past Due Loans
and Selected Loan Loss Statistics
For The Years Ended
December 31,
1996 1995
(Dollars in Thousands)
Allowance for Loan Losses:
Balance, December 31 $763 $ 639
Charge-offs:
Commercial 36 110
Real estate 0 8
Consumer 48 23
Total loans charged-off 84 141
Recoveries:
Commercial 42 9
Real estate 18 61
Consumer 11 2
Total recoveries 71 72
Net charge-offs 13 69
Provision for loan losses 93 193
Balance, December 31, 1996 $ 843 $ 763
Ratio of net charge-offs to
average loans outstanding 0.03% 0.17%
Ratio of allowance for loan
losses to loans at period-end 1.83% 1.74%
Nonperforming Assets and Loans Past Due 90 Days
Nonaccrual loans $ 13 $ 18
Other real estate owned 444 514
Total nonperforming assets $457 $ 532
Ratio of nonperforming
assets to total assets 0.59% 0.79%
Nonaccrual loans:
Interest income that
would have been recorded
under original terms $ 2 $ 2
Interest income recorded
during the period $ - $ -
Loans 90 days past due
and still accruing $ 15 $ 3
A breakdown of the allowance is provided in Table 8; however, such a breakdown
has not historically been maintained by the Company and management does not
believe the allowance can be fragmented by category with any precision that
would be useful to investors. The entire amount of the allowance is
available to absorb losses occurring in any category. The allowance is
allocated below based on the relative percent of loans in each category to
total loans.
Table 8: Allocation of the Allowance for Loan Losses
December 31,
1996 1995
Balance at End of Period Applicable to:
Percent Percent
of of
Amount Total Amount Total
Commercial $ 171 20% $ 148 19%
Real estate - mortgage 577 68% 515 68%
Real estate - construction 38 5% 45 6%
Consumer 7 7% 55 7%
Total
$ 843 100% $ 763 100%
POTENTIAL PROBLEM LOANS:
At December 31, 1996 and December 31, 1995, loans on either nonaccrual status
or loans past due 90 days or more and still accruing amounted to $28,000 and
$21,000, respectively. At December 31, 1996, the Company had approximately
$668,000 of loans that have been internally classified, and $699,000 which
require more than normal attention and are potential problem loans. The
Company has considered these loans in establishing the level of the allowance
for loan losses. At December 31, 1995, loans that had been internally
classified or which required more than normal attention and were potential
problem loans were $240,000 and $1,849,000, respectively.
CREDIT RISK AND REGULATORY MATTERS:
Credit risk, the risk of loss from default, is inherent in lending. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions. Management and the boards of directors of the Company believe
the allowance is a reasonable estimate of potential loss exposure in the loan
portfolio at year end, however, many factors affecting the ability of borrowers
to repay their loans, including economic factors beyond the control of the
Company or the borrowers, will impact this estimate on an ongoing basis.
Reports of examinations furnished by state and federal banking authorities are
also considered by management. Regulatory agencies periodically review the
allowance for loan losses as part of their examination process and may
require the Bank to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
During 1996 and 1995, regulators completed regular examinations of the
Company and the Bank. A federal examination was conducted in the fourth
quarter of 1996 for the balance sheet dated September 30, 1996. In the fourth
quarter of 1995 a state examination was conducted for the balance sheet dated
September 30, 1995. No additions to the allowance for loan losses were
recommended as a result of these examinations.
NONPERFORMING ASSETS:
Nonperforming assets consist of loans on nonaccrual status and other real
estate owned. Loans are placed on nonaccrual status when they become over
90 days past due unless such loans are fully collateralized and,
in management's judgment, are collectible. Other real estate owned consists
of real estate acquired in settlement of loans. These properties are carried
at the lower of cost or estimated fair value. Losses from the acquisition of
other real estate owned in full or partial satisfaction of a loan are charged
to the allowance for loan losses. Subsequent declines in value or losses upon
disposition are charged to noninterest expense.
Table 9 provides an analysis of the size, number and collateral composition of
nonperforming assets at December 31, 1996.
Table 9: Nonperforming Assets
December 31, 1996
(Dollars in thousands)
Nonperforming assets by dollar amount:
Percent
Number of
of items Balances Total Dollars
$400,000 and over - - 0%
$300,000 - $400,000 - - 0%
$200,000 - $300,000
$100,000 - $200,000 4 444 97%
$50,000 - $100,000
$50,000 and under 14 13 3%
18 $ 457 100%
Nonperforming assets by collateral composition:
Percent
Number Of
of Items Balance Total Dollars
1-4 Family residential 1 $131 29%
Automobile, equipment and other 0 0 0%
Commercial property 0 0 0%
Land 0 0 0%
Multi-family residential 3 313 68%
Uncollateralized 14 13 3%
18 $457 100%
LOAN PORTFOLIO:
The loan portfolio is the largest category of the Company's earning assets.
Table 10 shows the type and maturity of loans outstanding as of December 31,
1996. Also provided are the amounts due after one year classified according
to sensitivity to changes in interest rates.
Table 10: Loan Maturities
(Dollars in thousands)
After 1
eal estate - mortgage 6,214 13,543 11,536
Real estate - construction 2,112 37 222
Consumer 1,442 1,780 36
$ 14,354 $18,973 $12,775
Loans maturing
after 1 year with:
Fixed interest rates $ 11,111 $ 10,176
Variable interest rates 7,862 2,599
$ 18,973 $ 12,775
Table 11 includes loans collateralized by real estate at December 31, 1996.
Some of these loans are included in commercial loans for purposes of Table 10.
Table 11: Loans Collateralized By Real Estate
Percentage
of total
Amount loan portfolio
(Dollars in thousands)
Construction and land development $ 2,371 7%
Collateralized by 1 - 4 family
residential properties 16,439 49%
Collateralized by multi-family
residential properties 794 2%
Collateralized by non-farm
non-residential properties 14,060 42%
$ 33,664 100%
INVESTMENT PORTFOLIO:
The company's investment portfolio is a source of liquidity and is the second
largest category of earning assets. The investment portfolio is used to
provide liquidity in the event of the withdrawal of large deposits or to
satisfy unusual loan demands, and consists primarily of U.S. Treasury and
government agency securities.
Table 12 shows the maturities of investment securities at December 31, 1996,
and the weighted average yields to maturity of such securities:
Table 12: Investment Securities (1)
December 31, 1996
(Dollars in thousands)
1 Year 2-4 4-5 (2) Over 5(3)
or less years years years
Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury,
government agencies
state and political
subdivisions $ 2,337 5.88% $ 13,793 6.09% $ 2,248 6.36% $1,516 5.98%
Other - - 65 6.00% - - 202 7.25%
Total $ 2,337 5.88% $13,858 6.05% $ 2,248 6.36% $1,718 6.62%
1) Presented on an amortized cost basis
(2) Includes $233,000 in tax free securities with a weighted average yield of
4.30%
(3) Includes $258,000 in tax exempt securities with a weighted average yield of
4.50%.
DEPOSITS:
The Company's deposit base includes large denomination certificates of deposit
of $100,000 or more which represent approximately 10% of total deposits at
December 31, 1996. The Bank pays market rates for these funds. Management
of the Bank attempts to match large denomination certificates of deposit with
rate-sensitive assets. At December 31, 1996, available short-term assets
totaled $8,262,000.
Table 13 presents remaining maturities of large denomination certificates
($100,000 or more) at December 31, 1996.
Table 13: Remaining Maturities of Large Denomination Certificates
December 31, 1996
(Dollars in thousands)
Amount
Three Months or less $ 2,680
Over three through six months 2,982
Over six through twelve months 225
Over twelve months 841
$ 6,728
NONINTEREST INCOME:
Noninterest income increased $12,000 or 5% from 1995 to 1996 primarily due to
an increase in charges on deposit accounts. This reflects increased activity
related to the bank's merchant credit card program. Income from the discount
rate on merchant credit card transactions increased by $11,000 in 1996
compared to 1995.
A comparison of noninterest income may be found in Table 14.
Table 14: Noninterest Income
(Dollars in thousands)
For the Years Ended December 31,
1996 1995 1996 over 1995
Service Charges $ 172 $ 169 $ 3
Other Income 74 65 9
$ 246 $ 234 $ 12
NONINTEREST EXPENSE:
Noninterest expense increased $9,000 or .46% from 1995 to 1996. This slight
increase reflects management's continued success in controlling overhead and
other non-interest related expenses.
A comparison of noninterest expense may be found in Table 15.
Table 15: Noninterest Expense
(Dollars in thousands)
For the Years Ended December 31,
1996 1995 1996 over 1995
Salaries and employee benefits $ 1,046 $991 $ 55
Occupancy expenses 174 169 5
FDIC Insurance 2 60 (58)
Furniture and equipment expense 96 125 (29)
Automated services 103 91 12
Accounting and audit 40 40 -
Stationery and supplies 47 43 4
Director fees 39 33 6
Taxes & Licenses 63 56 7
Insurance expense 37 31 6
Marketing expense 22 19 3
Other 281 283 (2)
$ 1,950 1,941 $ 9
INCOME TAXES:
For the year ended December 31, 1996, the Company recognized an expense of
$218,000. This represents a $123,000 increase from the $95,000 expense for
1995. The increase primarily reflects the utilization of net operating
losses for tax return purposes in 1995.
RECENT ACCOUNTING PRONOUNCEMENTS:
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement No. 125, Accounting for Transfers and Servicing of Financial
Assets and of Liabilities. This Statement provides accounting and reporting
standards for servicing of financial assets and extinguishments of liabilities,
and provides s for distinguishing transfers of financial assets that are sales
from transfers that secure borrowings.
Except for certain provisions affecting repurchase agreements and other similar
transactions, this Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December
31, 1996, and is applied prospectively. Earlier or retroactive application
is not permitted. The effective date of the provisions affecting repurchase
agreements and similar transactions, including related transfers of collateral,
is delayed for one year, to allow more time for accounting systems to be put
in place to properly reflect the requirements and guidance of this Statement.
This Statement also provides implementation guidance for assessing isolation of
transferred assets (one of the requirements for recognizing transfers), and for
accounting for transfers of partial interests, servicing of financial assets,
securitizations, transfers of sales-type and direct financing lease
receivables, securities lending transactions, repurchase agreements including
"dollar rolls","wash sales", loan syndications and participations, risk
participations in banker's acceptances, factoring arrangements, transfers of
receivables with recourse, and extinguishments of liabilities. Except for the
provisions affecting loan participations, the Statement is not expected
to materially affect financial condition or results of operations. However,
pursuant to the Statement's provisions, if a loan participation agreement
constrains the transferees (participating bank) from pledging or exchanging
their participations, the transferor (originating bank) has not relinquished
control over the loan and shall account for the transfer as a secured
borrowing. The Statement also provides that a transferor's right of first
refusal on a bona fide offer from a third party, a requirement to obtain the
transferor's permission that shall not be unreasonably withheld, or a
prohibition on sale to the transferor's competitor is a limitation on the
transferee's rights but presumptively does not constrain a transferee from
exercising its right to pledge or exchange.
The Company is currently considering these provisions, and assessing the
accounting treatment and legal ramifications of modifying participation
agreements.
On November 14, 1996, the Emerging Issues Task Force (EITF) of the FASB reached
consensus on Issue No. 96-12 ( the Issue),Recognition of Interest Income and
Balance Sheet Classification of Structured Notes. Structured notes are debt
instruments whose cash flows are linked to the movement in one or more indexes,
interest rates, foreign exchange rates, commodities prices, prepayment rates, or
similar variables. They are issued by U.S. government-sponsored enterprises,
multilateral development banks, municipalities, and private corporations.
The Issue addresses the accounting for certain structured notes that are in
the form of debt securities. The EITF reached a consensus that investors
should use the retrospective interest method for recognizing income on
structured note securities that are classified as available-for-sale and held-
to-maturity debt securities under FASB Statement No. 115, Accounting for
Certain Investments in Debt and Equity Securities, and that meet certain
conditions. Under the retrospective interest approach, income on the
structured notes for the current period is measured based on changes in
estimates of future cash flows between periods, and cash receipts of interest
income in the current period and, therefore, is different from recognizing
income on the interest method of accounting for securities. The EITF
observed that changes in accounting for this Issue should be applied to all
structured notes within the scope of this Issue either currently as a change in
accounting principle, or prospectively to new securities acquired after November
14, 1996. Management believes the Bank does not hold securities within the
scope of the Issue, and does not plan to investment in such securities in the
foreseeable future. Therefore, this EITF Issue is not expected to materially
affect financial condition or results of operation in the foreseeable future.
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants has issued Statement of Position (SOP) 96-1,
Environmental Remediation Liabilities. SOP 96-1 provides guidance on
accounting for environmental remediation liabilities within the framework
established by FASB Statement No. 5, Accounting for Contingencies.
It includes benchmarks to aid in the determination of when environmental
remediation liabilities should be recognized in accordance with FASB No. 5,
and guidance on measurement, display, and disclosure of such liabilities.
The SOP is effective for fiscal years beginning after December 15, 1996, with
earlier application encouraged. Management does not believe this SOP will
materially affect financial condition or results of operation of the Company
in the foreseeable future.
Item 7: FINANCIAL STATEMENTS
The report of independent accountants and the Company's consolidated financial
statements and footnotes for the years ended December 31, 1996 and 1995 are
incorporated herein by reference. The Annual Report on Form 10-KSB should
be read in conjunction with the Company's consolidated financial statements
and footnotes.
Item 8: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
On January 5, 1990, the Board of Directors voted to amend the by-laws to
increase the size of the Board of Directors from 12 to 14 members. As of
December 31, 1996, there were 9 directors.
The following schedule sets forth certain information concerning the directors
and executive officers of the Company.
Director's Term to Positions With
Name Age Expire The Company
James A. Cummings 54 1998 Director
F. Dudley Fulton 48 1999 Director
Henry U. Harris, III 45 1997 Director and
Vice-Chairman of the Board
Stephen A. Johnsen 51 1997 Director and
Secretary of the Board
Robert J. Keogh 48 1998 President;
Director and
President-Heritage
Bank & Trust
Peter M. Meredith, Jr. 45 1998 Director and
Chairman of the Board
Gerald L .Parks 63 1999 Director
Ross C. Reeves 48 1999 Director
Harvey W. Roberts, III 52 1998 Director
James A. Cummings was appointed director of the Company effective November
1992, and has served as a director of Heritage Bank & Trust since April 1992.
He currently serves as Vice President of Southern Atlantic Label Company.
F. Dudley Fulton was appointed director of the Company effective December 31,
1991, and has served as a director of Heritage Bank & Trust since 1988. He
currently serves as President and Chief Executive Officer of Henderson and
Phillips, Inc.
Henry U. Harris, III has been a director of the Company since November 1992 and
has served as Vice-Chairman since January 1995. He has been a director of
Heritage Bank & Trust since September 1990. He has served as Vice President
of Virginia Investment Counselors for ten years.
Stephen A. Johnsen has been a director of the Company since 1988 and has served
as Secretary since January 1995. He has served as a director of Heritage Bank
& Trust since 1984. Mr. Johnsen has been the President of The Flagship Group
since 1984.
Robert J. Keogh has been a director since 1989. He has served as President and
as a director of Heritage Bank & Trust since August 1988. He previously was a
Senior Vice President of First American Bank of Virginia from December 1983 to
August 1988.
Peter M. Meredith, Jr. was elected as a director of the Company in November
1992 and has served as Chairman since January 1995. He has served as a
director of Heritage Bank & Trust since September 1991. He had been the
President of Meredith Construction Company for several years and currently
serves as Chairman and Chief Executive Officer.
Gerald L. Parks has been a director of the Company since 1987 and has served as
a director of Heritage Bank & Trust since its inception. He had been President
of Capes Shipping Agencies, Inc. for several years, and is now serving as
Chairman and Chief Executive Officer.
Ross C. Reeves was elected as a director of the Company in February 1995. He
has been a member of the law firm of Willcox & Savage, P.C. since 1982.
Harvey W. Roberts, III was elected as a director of the Company in January
1993. Mr. Roberts is a senior partner in the accounting firm of Roberts &
Speece, CPA, P.L.C.
Item 10. EXECUTIVE COMPENSATION
1. CASH COMPENSATION:
Set forth below is information concerning the compensation paid to the
Company's executive officer.
Summary Compensation Table
Annual Compensation (1)
Director's
Name and Principal Position Year Salary Bonus Fees Options(2)
Robert J. Keogh 1996 $ 93,450 $23,700 $ 4,800 -
President & Chief
Executive Officer 1995 $ 93,000 $14,000 $ 3,125 36,000
1994 $ 89,000 $13,000 $ 2,400 -
(1) No compensation earned in either year was deferred.
(2) During 1995 options were granted to purchase common stock of the Company at
the option price ranging from $6.50 per share to $9.50 per share. See
"Compensation Pursuant to Plans". No stock options or stock appreciation
rights were exercised by Mr. Keogh in either year represented above.
2. COMPENSATION PURSUANT TO PLANS:
EMPLOYEE STOCK OPTION PLAN
As of December 31, 1996, stock options for 110,750 shares are outstanding and,
of these shares, 61,875 are exercisable. Options are granted and are
exercisable at option prices ranging from $4.60 to $9.50 per share.
DEFERRED COMPENSATION AND RETIREMENT ARRANGEMENTS
In 1985, Heritage Bank & Trust entered into deferred compensation and
retirement arrangements with seven directors and one officer. Each
participant is fully vested. The Company's policy is to accrue the estimated
amounts to be paid under the contracts over the expected period of active
service or employment.
Upon reaching age 70, each participant will receive a retirement benefit
ranging from $391 to $3,355 per month for each of the next 120 months. If
the participant dies prior to reaching age 70, his beneficiary will begin
receiving the monthly retirement benefits. The bank has purchased life
insurance contracts in order to fund the expected liabilities under the
deferred compensation arrangements. As of December 31, 1996, Heritage Bank &
Trust had accrued $227,860 to reflect the anticipated liability.
In 1990, Robert J. Keogh, President of Heritage Bank & Trust, became a
participant in the Heritage Bank & Trust Executive Security Plan. In the
event Mr. Keogh dies prior to age 65, his beneficiary will receive monthly
payments of $4,167 for each of the next 180 months. Upon his retirement at
age 65, Mr. Keogh will receive $4,167 per month for each of the next 180
months or until his death, and thereafter other beneficiaries will receive
such retirement benefits. Heritage Bank & Trust funds this obligation
through a life insurance contract. Heritage Bank & Trust had accrued $51,428
as of December 31, 1996 to reflect the anticipated liability.
Effective January 1, 1984, the Board of Directors adopted an Employee's
Stock Bonus Plan and Trust (the "ESOP"). The ESOP covered substantially all
employees, whereby funds contributed were used to purchase outstanding
common stock of the Company. Contributions were allocated to the participants
based on the employee/participant's annual compensation. Employee
participants in the ESOP included all employees who have reached the age of
21 and have completed one year of service (1,000 hours), beginning with the
effective date of the ESOP. Benefits were be payable upon separation from
service or upon retirement, disability or death. Employees are 30% vested
with respect to the benefits under the ESOP in three years and the vested
percentage was increased annually, reaching 100% after seven years.
Participants were automatically 100% vested in the ESOP upon reaching age 65,
death or disability. Participants vote all shares allocated to their
respective accounts and the trustees of the ESOP vote any unallocated shares.
The Board of Directors of the Company has the right to amend or terminate the
ESOP and trust at any time. The Company made no contribution to the plan for
years ending December 31, 1996 and 1995. In October of 1995, the trustees of
the ESOP voted to terminate the plan and the participants in the plan were
notified of their options concerning distribution of their shares in the
plan in accordance with the terms of the ESOP and applicable law. At
December 31, 1996, 25,490 of the 25,934 shares in the plan had been
distributed.
Effective January 1, 1993, the Board of Directors adopted a Retirement Program
(the "401K"). The Company may contribute cash to the 401K annually, as
determined each year by the Board of Directors. Contributions to the 401K
are allocated to its participants based on the employee/participant's
contributions to the plan. Eligible participants in the 401K include all
employees who have completed six months of service (500 hours) beginning
with the effective date of the 401K. Benefits will be payable upon
separation from service or upon retirement, disability or death. Employees
are 20% vested with respect to the benefits under the 401K in two years and
the vested percentage is increased annually, reaching 100% after six years.
Participants are automatically 100% vested in the 401K upon reaching age 65,
death or disability. The Company has the right to amend or terminate the
401K. The Company accrued $28,000 and $25,000 for a contribution to the
plan as of December 31, 1996 and 1995, respectively.
COMPENSATION OF DIRECTORS:
Directors of the Company and Directors of Heritage Bank & Trust receive $400
for each Board of Directors' meeting attended and $100 for each committee
meeting attended
ITEM 11: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following schedule sets forth information regarding the beneficial
ownership of the Company's common stock as of March 10, 1997, of (i) each of
the Company's directors; (ii) each person known by the Company to be the
holder of 5% or more of the Company's outstanding common stock; and (iii)
all of the Company's directors and executive officers as a group.
OWNERSHIP OF COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS
NAME OF INDIVIDUAL PERCENT OF
SHARES CLASS
James A.Cummings
2073 Thomas Bishop Lane
Virginia Beach, VA 23454 USA 5,138 0.65%
F. Dudley Fulton
5306 Lakeside Avenue
Virginia Beach, VA 23451 USA 2,100 0.27%
Henry U. Harris, III
1503 North Shore Road
Norfolk, VA 23505 USA 25,705 (1) 3.27%
Stephen A. Johnsen
401 College Place
Norfolk, VA 23510 USA 1,968 0.25%
Robert J. Keogh
6146 Sylvan Street
Norfolk, VA 23508 USA 7,495(2) 0.95%
Peter M. Meredith, Jr.
5320 Edgewater Drive
Norfolk, VA 23508 USA 36,950(3) 4.70%
Gerald L. Parks
27307 Evergreen Lane
Harborton, VA 23389 USA 5,147 (4) 0.65%
Ross C. Reeves
1068 Algonquin Road
Norfolk, VA 23505 USA 4,142(5) 0.53%
Harvey W. Roberts, III
7612 North Shore Road
Norfolk, VA 23505 USA 27,254(6) 3.47%
Directors and Executive Officers as
a group (9 persons) 115,899 14.74%
(1) Includes 3,555 shares owned by his wife. Also includes 4,249 shares
held as custodian for others.
(2) Includes 1,335 shares owned jointly with his wife. Also includes 1,998
shares owned by Scott & Stringfellow as an IRA for Mr. Keogh. Does not
include 43,700 shares that may be acquired by Mr. Keogh pursuant to the
Stock Option Plan for key employees of the Company. See "Compensation
Pursuant to Plans". If such shares were included, Mr. Keogh would own
6.80% of the outstanding shares.
(3) Includes 10,960 shares held as Meredith Realty Company, L.L.C., 9,455
shares held as Pomar Holding, L.L.C. and 3,000 shares held as Meredith Realty
Associates. Also includes 8,203 shares owned by Davenport & Company for
Mr. Meredith.
(4) Includes 4,556 shares owned jointly with his wife.
(5) Includes 3,142 shares held as custodian for others.
(6) Includes 15,455 shares owned by his wife and 3,000 shares owned jointly
with his wife. Also includes 287 shares owned by Scott & Stringfellow as an
IRA for Roberts & Speece, CPA, P.L.C.
OWNERSHIP OF COMMON STOCK BY CERTAIN HOLDERS
NAME OF INDIVIDUAL
PERCENT OF
SHARES CLASS
L. Steven Gossett 48,313 (1) 6.14%
5225 Riverwood Road
Norfolk, VA 23502 USA
(1) Mr. Gossett reports that he shares voting and dispositive power over
31,094 shares of the Company's Common Stock with his wife Diane M. Gossett
and his daughters Stephanie D. Gossett and Nancy Gossett Hance.
ITEM 12: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
Many directors of the Company and Heritage Bank & Trust and their associates,
including firms and corporations of which they are officers or directors or
in which they and their immediate families have a substantial interest, are
customers of Heritage Bank & Trust. As such, they have had transactions
with the bank, including loans made in the ordinary course of business on
substantially the same terms, including interest rates, collateral
and repayment terms, as those prevailing at the time for comparable loans to
other parties. Such loans have not involved more than the normal risk of
collectibility or other unfavorable features. At December 31, 1996, the
total loans outstanding to officers and directors of the Company and
Heritage Bank & Trust were $3,407,000. Related party deposits amounted to
approximately $5,500,000 and $5,300,000 at December 31, 1996 and 1995,
respectively.
Heritage Bank & Trust occupies 7,581 square feet of space in a building
located at 1450 South Military Highway in Chesapeake, Virginia. The building
is owned by IBV Partners, L.P., a Virginia limited partnership which has as its
sole general partner IBV Real Estate Holdings, Inc., a wholly-owned
subsidiary of the Company. Former and current directors of Heritage Bank &
Trust own an aggregate of approximately 34% of the partnership
interests. IBV Partners, L.P. and Heritage Bank & Trust entered into a lease
in December 1986 which was modified in December 1996. Future minimum lease
payments of $64,439 are required under the long-term non-cancellable lease
agreement as of December 31, 1996, which expires in December 2,001. Total
lease expense was $75,810 for each of the years 1996 and 1995. See Notes 12
& 13 of the Notes to Consolidated Financial Statements.
The Company and Heritage Bank & Trust purchase various types of business
insurance through the Flagship Group, of which Stephen A. Johnsen is
President. Mr. Johnsen is a director and Secretary of the Company.
Insurance premiums paid to the Flagship Group as agent for commercial
insurance providers was $31,325 during 1996. The Bank has also sold securities
to the Flagship Group under agreements to repurchase. See Note 9 of the
Consolidated Financial Statements for additional information.
PART IV
Item 13: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
10-KSB
(A) (1) The following consolidated financial statements of Heritage Bankshares,
Inc. and its subsidiaries are incorporated herein by reference in Item 8:
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Income - Years ended December 31, 1996 and 1995
Consolidated Statements of Changes in Stockholders' Equity - Years ended
December 31, 1996 and 1995
Consolidated Statements of Cash Flows - Years ended December 31, 1996 and 1995
Notes to Consolidated Financial Statements
Reports of independent accountants
(A) (2) Financial Statement Schedules:
All other schedules provided for in the applicable regulation of the
Securities and Exchange Commission pertain to items which do not appear in
the financial statements, to items which are insignificant, or to items as
to which the required disclosures have been made elsewhere in the financial
statements and notes thereto. These schedules have therefore been omitted.
(A) (3) Exhibits:
3.1 Articles of Incorporation. (Incorporated herein by reference to the
Corporation's Form 10-K for 1983 filed March 29, 1984.)
3.2 Bylaws, as amended.
10.1 Stock Option Plan for Employees (Incorporated herein by reference to the
Corporation's Form 10-K for 1987 filed March 25, 1988.)
10.2 Employees Stock Option Plan. (Incorporated herein by reference to the
Corporation's Form 10-K for 1987 filed March 25, 1988.)
10.3 Employee Stock Ownership Plan (Incorporated herein by reference to the
Corporation's Form 10-K for 1984 filed April 12, 1985.)
10.4 Lease dated December 29, 1986, between IBV Partners, L.P. as landlord, and
Heritage Bank & Trust, as Tenant, for the lease of 7,581 square feet of
space in a building located at 1450 South Military Highway, Chesapeake,
Virginia. (Incorporated herein by reference to the Corporation's Form 10-K
for 1986 filed March 1987.)
10.5 Amended and restated January 1, 1989, Stock Ownership Plan, which provided
for certain changes required by IRS regulations including changes in
participant vesting schedules. (Incorporated herein by reference to the
Corporation's Form 10-K for 1990 filed March 30, 1991.)
POWER OF ATTORNEY
Each person whose signature appears below under "SIGNATURES" hereby authorizes
Robert J. Keogh and Peter M. Meredith, Jr. or either of them, to execute in
the name of each such person, and to file any amendment to this report, and
hereby appoints Robert J. Keogh and Peter M. Meredith, Jr. or either of them,
as attorneys-in-fact to sign on his behalf, individually and in each capacity
stated below, and to file any and all amendments to this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Heritage Bankshares, Inc.
(Registrant)
Date: March 26,1997 by__________________________________
Robert J. Keogh, President and Chief
Executive Officer
by__________________________________
Peter M. Meredith, Jr., Chairman of the
Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by
the following persons on behalf of the Registrant and in the capacities
indicated on March 27, 1996.
SIGNATURES
_____________________________________
Peter M. Meredith, Jr.
Chairman of the Board of Directors
_____________________________________
Robert J. Keogh
President and Chief Executive Officer & Director
_____________________________________
Henry U. Harris, III
Vice-Chairman of the Board of Directors
_____________________________________
Stephen A. Johnsen
Secretary of the Board of Directors
_____________________________________
James A. Cummings
Director
_____________________________________
F. Dudley Fulton
Director
_____________________________________
Gerald L. Parks
Director
_____________________________________
Ross C. Reeves
Director
_____________________________________
Harvey W. Roberts, III
Director
19
Consolidated
Financial Statements
Years Ended December 31,
1996 and 1995
HERITAGE BANKSHARES, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
The Stockholders and Board of Directors
Heritage Bankshares, Inc
Norfolk, Virginia
We have audited the accompanying consolidated balance sheets of Heritage
Bankshares, Inc. and its subsidiaries at December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
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 consolidated financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management,
as well as evaluating the overall consolidated 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 consolidated financial position of
Heritage Bankshares, Inc. and its subsidiaries as of December 31, 1996 and
1995, and the consolidated results of their operations and their cash flows
for the years then ended in conformity with generally accepted accounting
principles.
Goodman & Company
One Commercial Place
Norfolk, Virginia
28-Jan-97
Consolidated Balance Sheets
Heritage Bankshares, Inc.
December 31, 1996 and 1995
1996 1995
Assets
Cash and due from banks $3,068,651 $3,223,837
Federal funds sold 5,925,000 5,720,000
Securities available for sale 14,367,341 5,701,087
Securities held to maturity 5,829,535 7,302,230
Loans, net 45,259,390 43,019,213
Accrued interest receivable 828,551 740,829
Other real estate owned 443,731 514,375
Premises and equipment 588,434 635,687
Other Assets 535,172 427,657
$76,845,806 $67,284,915
Liabilities and Stockholders' Equity
Deposits:
Noninterest bearing deposits $12,498,845 $12,663,061
Interest-bearing deposits 55,927,746 48,390,405
68,426,591 61,053,466
Securities sold under agreements
to repurchase 1,349,091 -
Short term borrowings 130,552 66,427
Accrued interest payable 290,583 255,604
Other liabilities 537,214 571,341
$70,734,031 61,946,838
Stockholders' equity:
Common stock, $5 par value - authorized
3,000,000 shares; issued and
outstanding 784,150 shares 3,920,750 3,920,750
Additional paid-in capital (380,330) (380,330)
Retained earnings 2,539,941 1,763,581
Unrealized appreciation (depreciation)
on securities available for sale
31,414 34,076
6,111,775 5,338,077
$76,845,806 $67,284,915
The notes to consolidated financial statements
are an integral part of this statement.
-2-
HERITAGE BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF INCOME
Heritage Bankshares, Inc. - Years Ended December 31, 1996 and 1995
1996 1995
Interest income:
Interest and fees on loans $4,064,107 $3,859,138
Interest on investment securities:
Available-for-sale 507,245 268,119
Held-to-maturity 352,626 385,033
859,871 653,152
Interest on federal funds sold 456,299 406,642
Total interest income 5,380,277 4,918,932
Interest expense:
Interest on deposits 2,491,616 2,175,706
Interest on short-term borrowings 3,104 3,333
Total interest expense 2,494,720 2,179,039
Net interest income 2,885,557 2,739,893
Provision for loan losses 92,935 193,000
Net interest income after
provision for loan losses 2,792,622 2,546,893
Noninterest income:
Services charges 171,921 168,685
Other 73,642 65,131
245,563 233,816
Noninterest expense:
Other 465,024 430,353
Salaries and employee benefits 1,045,502 991,232
Occupancy expenses 174,276 169,443
Automated services 103,265 91,400
Furniture and equipment expense 95,997 124,506
Taxes & licenses 63,642 56,322
FDIC insurance 2,000 60,416
1,949,706 1,923,672
Income before income taxes 1,088,479 857,037
Income tax (expense) (218,021) (95,089)
Net income $870,458 $761,948
Net income per common and common
equivalent share $1.09 $0.94
The notes to consolidated financial statements are an integral part of this
statement
Consolidated Statements of Stockholders' Equity
Heritage Bankshares, Inc.
December 31, 1996 Net
and 1995 Additional unrealized
Common stock paid-in Retained Appr.
Shares Amount Capital Earnings(Depr)
On Sec. Total
Bal, Dec. 31,
1994 769,630 $3,848,150 $(374,667) $1,081,524 $(92,379) $4,462,628
Stock options
exercised
in 1995(14,520
sahres at $4.61
per share) 14,520 72,600 (5,663) 66,937
Net changes in unrealized depreciation
on securities available-for-sale
net of applicable income taxes of $31,614 126,455 126,45
Net income 1995 744,789 744,78
Less dividends paid in 1995 (62,732) (62,732)
Bal.Dec. 31,
1995 784,150 3,920,750 (380,330)1,763,581 34,076 5,338,077
Net changes in unrealized depeciation on
securities available-for-sale,net of
applicable income taxes of $1,371 (2,622)
Net income 1996 870,458 870,458
Less dividends paid 1996 (94,098)
Balance
Dec 31,1996 784,150 $3,920,750 $(380,330) $2,539,941 $31,414 $6,111,775
HERITAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,1996 AND 1995
NOTE I - ORGANIZATION AND BUSINESS
Heritage Bankshares, lnc- (the "Company") was organized under the laws of
the Commonwealth of Virginia in 1983. The Company has two wholly-owned
subsidiaries, including one bank: Heritage Bank & Trust (the "Bank") with
offices in Norfolk and Chesapeake, Virginia. The
Company's other subsidiary is IBV Real Estate Holdings, Inc., a Virginia
corporation. The Bank is a state-chartered bank and a member of the Federal
Reserve System. The deposits of the Bank are insured by the Federal Deposit
Insurance Corporation (the "FDIC") to the extent and subject to the
limitations set forth in the Federal Deposit Insurance Act, as amended.
The Bank is a full-service bank conducting a general commercial and consumer
banking business with its customers located throughout the Hampton Roads
area of Virginia. Its principal banking activities include
receiving demand,
savings and time deposits for personal and commercial
accounts; making commercial, real estate and consumer loans; acting as a
United States tax
depository facility; providing money transfer and cash management services;
selling travelers checks,
bank money orders; issuing letters of credit, and investing in U.S. Treasury
securities and securities
of other U.S. government agencies and corporations, and mortgage-backed and
state and municipal
securities.
IBV Real Estate Holdings, Inc. was formed in December, 1986. Presently, its
only business is owning a 1% general partnership interest in IBV Partners,
L.P., the lessor of office space to Heritage Bank and Trust in Chesapeake,
Virginia.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Statement Presentation and Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Heritage Bankshares, Inc- and its wholly-owned subsidiaries, Heritage Bank
and Trust and IBV Real Estate Holdings, Inc. All significant intercompany
balances and transactions have been eliminated in consolidation.
Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, interest bearing deposits with banks and federal
funds sold. Generally, federal funds are sold for one-day periods.
(Notes continued on next page)
7 -
The notes to consolidated financial statements
are an integral part of this statement.
6
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities
Investments in debt securities that management has the positive intent and
ability to hold to maturity are classified as "held to maturity" and
reflected at amortized cost. Investments that are purchased and held
principally for the purpose of selling them in the near term, if any, are
classified as "trading securities" and reflected at fair value, with
unrealized gains and losses included in earnings. Investments not classified
as either of the above are classified as "available for sale" and reflected
at fair value, with unrealized gains and losses excluded from operations and
reported as a separate component of stockholders' equity.
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity on held to-maturity and available-for
- -sale securities. Other-than-temporary declines in the fair value of
individual held-to-matudty and available-for-sale securities, if any, result
in write-downs of the individual securities to fair value. Gains and losses
are determined using the specific-identification method.
Loans
Loans are reported at their principal outstanding balance net of charge-offs,
deferred loan fees and costs on originated loans, unearned income, and
unamortized premiums or discounts, if any, on purchased loans. Interest
income is generally recognized when income is earned using the interest
method. Loan origination fees and certain direct loan origination costs are
deferred and the net amounts are amortized as adjustments to the loans'
yields.
Allowance for Loan Losses
The Bank adopted FASB Statement No. II 4, Accounting by Creditors for
Impairment of a Loan, on January 1, 1995. Under the standard, a loan is
considered impaired, based on current information and events, if ft is probable
that the Bank will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the historical effective interest
rate, except that all collateral-dependent loans are measured for impairment
based on the fair value of the collateral. The adoption of FASB Statement
No. 1 14 did not result in an additional provision for loan losses.
The adequacy of the allowance for loan losses is periodically evaluated by the
Bank, in order to maintain the allowance at a level that is sufficient to
absorb probable credit losses. Management's evaluation of the adequacy of
the allowance is based on a review of the Bank's historical loss experience,
known and inherent risks in the loan portfolio, including adverse
circumstances that may affect the ability of the borrower to repay interest
and/or principal, the estimated value of collateral,and an analysis of the
levels and trends of delinquencies, charge-offs, and the risk ratings of
the various loan categories. Such factors as the level and trend of
interest rates and the condition of the national and local economies are
also considered. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Bank's allowance
for losses on loans- Such agencies may require the Bank to recognize
additions to the allowance based on their judgements of information
available to them at the time of their examination.
(Notes continued on next page)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses (continued)
The allowance for loan losses is established through charges to earnings in the
form of a provision for loan losses. Increases and decreases in the allowance
due to changes in the measurement of impaired loans, if applicable, are
included in the provision for loan losses. Loans continue to be classified
as impaired unless they are brought fully current and the collection of
scheduled interest and principal is considered probable.
When a loan or portion of a loan is determined to be uncollectible, the portion
deemed uncollectible is charged against the allowance and subsequent
recoveries, if any, are credited to theallowance.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well-secured and in the process of
collection. If a loan or a portion of a loan is classified as doubtful, or
is partially charged off, the loan is generally classified as nonaccrual.
Loans that are on a current payment status or past due less than 90 days may
also be classified as nonaccrual, if repayment in full of principal and/or
interest is in doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment
within an acceptable period of time,and there is a sustained period of
repayment performance (generally a minimum of six months) by the borrower,
in accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding. When the future
collectibility of the recorded loan balance is expected, interest income may
be recognized on a cash basis. In the case where a nonaccrual loan had been
partially charged off, recognition of interest on a cash basis is limited to
that which would have been recognized on the recorded loan balance at the
contractual interest rate. Cash interest receipts in excess of that amount
are recorded as recoveries to the allowance for loan losses until prior
charge- offs have been fully recovered.
Other Real Estate Owned
Other real estate owned is comprised of real estate and other assets acquired
through foreclosure, acceptance of a deed in lieu of foreclosure, or loans in
which the Bank receives physical possession of the debtor's assets. Other
real estate owned is carried at the lower of the recorded investment in the
loan or the fair value less estimated costs to sell. Upon transfer of a loan
to foreclosed status, an appraisal is obtained and any excess of the loan
balance over the fair value less estimated costs to sell is charged against
the provision for credit losses. Revenues and expenses,and subsequent
adjustments to fair value less estimated costs to sell are classified as an
expense for other real estate owned.
(Notes continued on next page)
9 -
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Restructured Loans
Loans are considered troubled debt restructurings under FASB Statement No. 15,
Accounting by Debtors and Creditors for Troubled Debt Restructurings, if for
economic or legal reasons, a concession has been granted to the borrower
related to the borrower's financial difficulties that the Bank would not have
otherwise considered. The Bank has restructured certain loans in instances
where a determination was made that greater economic value will be realized
under new terms than through foreclosure, liquidation, or other disposition.
The terms of the renegotiation generally involve some or all of the following
characteristics: a reduction in the interest pay rate to reflect actual
operating income, an extension of the loan matudty date to allow time for
stabilization of operating income, and partial forgiveness of principal and
interest.
The carrying value of a restructured loan is reduced by the fair value of any
assets or equity interest received, if any. Prior to demonstrating
performance, the Bank generally classifies impaired restructured loans, if
any, as nonaccrual. The accrual of interest resumes when such loans can
demonstrate performance, generally evidenced by six months of pre- or
post-restructuring payment performance in accordance with the restructured
terms, or by the presence of other significant factors. In addition, at the
time of restructuring, loans are generally classified as impaired. A
restructured loan that is not impaired, based on the restructured terms and
that has a stated interest rate greater than or equal to a market interest
rate at the date of the restructuring, is reclassified as unimpaired in the
year immediately following the year it was disclosed as restructured.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. For
financial reporting purposes, assets are depreciated over their estimated
useful lives using the straight-line method. For income tax purposes, the
accelerated cost recovery system and the modified accelerated cost recovery
system are used.
Income Taxes
The Company files a consolidated tax return. Provisions for income taxes
reflect tax expense incurred as a consolidated group. Tax expense is
allocated among the members of the consolidated group in accordance with an
intercompany agreement for tax expense. Income taxes are provided
for the tax effects of the transactions reported in the financial statements
and consist of taxes currently due plus deferred taxes related primarily to
differences between the basis of available-for sale securities, deferred
loan fees, allowance for loan losses, allowance for losses on foreclosed
real estate, accumulated depreciation and deferred compensation for financial
and income tax reporting. The deferred tax assets and liabilities represent
the future tax return consequences of those differences, which will either
be taxable or deductible when the assets and liabilities are recovered
or settled. Deferred taxes are also recognized for alternative minimum tax
credit carryforwards that are available to offset future federal income
taxes.
(Notes continued on next page)
1 0 -
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Deferred Compensation Plans
The Bank maintains deferred compensation and retirement arrangements with
certain directors and officers. The Company's policy is to accrue the
estimated amounts to be paid under the contracts over the expected period of
active employment. The Bank purchased life insurance contracts to fund the
expected liabilities under the contracts.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance-sheet
financial instruments consisting of commitments to extend credit, commitments
under credit card arrangements, commercial letters of credit, standby letters
of credit and financial guarantees written. Such financial instruments are
recorded in the financial statements when they become payable.
Use of Estimates
The preparation of financial statements requires Management to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the
allowances for losses on loans and foreclosed real estate, management obtains
independent appraisals for significant properties. While management uses
available information to recognize losses on loans and foreclosed real
estate, future additions to the allowances may be necessary
based on changes in local economic conditions and other factors.
Earnings per Share
Earnings per common and common equivalent share is obtained by dividing net
income by the weighted average number of common shares outstanding, which
includes, where applicable, the dilutive effect of stock options computed
using the treasury stock method. The weighted average number of shares used
in the computation of earnings per share was 799,944 and 788,974 for 1996
and 1995, respectively. Primary and fully diluted earnings per share do not
materially differ.
Reclassifications
Certain reclassifications have been made to prior year financial statements to
conform them to the current years presentation.
(Notes continued on next page)
NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
(PARENT COMPANY ONLY)
The financial position, results of operations and cash flows of Heritage
Bankshares, Inc. are presented below on a parent company only basis for the
years indicated
Condensed Balance Sheets December 31,
Assets 1996 1995
Cash on deposit with Heritage Bank and Trust $8,615 67,340
Investment in Heritage Bank and Trust 5,918,242 5,151,529
Investment in non-banking subsidiaries 132,649 117,549
Premises and equipment 19,951 28,147
Other assets 245,034 207,742
6,324,391 5,572,307
Total assets
December 31,
Liabilities and Stockholders' Equity 1996 1995
Due to IBV Real Estate Holdings 110,000 110,000
Other liabilities 102,616 124,230
Common stock 3,920,750 3,920,750
Additional paid-in capital 380,330 380,330
Retained earnings 2,539,941 1,763,581
Unrealized appreciation
(depreciation) on securities available fo
sale 31,414 34,076
$ 6,324,391 $ 5,572,307
Income:
Dividends from subsidiary bank $ 109,098 $ 62,732
Other 12,000 12,292
121,098 75,024
Expenses:
Other 24,991 27,966
Income before income taxes and equity in undistributed net income of
Heritage Bank and Trust 96,107 47,058
Applicable income tax benefit 4,976 11,711
Income before equity in undistributed net income of Heritage Bank
and Trust 101,083 58,769
Equity in undistributed net inc 769,375 686,020
Bank & Trust
$ 870,458$ 744,789
(Notes continued on next page)
-12-
NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
(PARENT COMPANY ONLY) (Continued)
Years Ended December 31,
Condensed Statements of Cash Flows 1996 1995
Operating activities:
Net income $ 870,458$ 744,789
Adjustments to reconcile to net cash provided by operating activities:
Depreciation 8,196 8,196
Undistributed net income of Heritage Bank 769,375 686,020
Changes in:
Other assets 37,292 65,761
Other liabilities 21,614 7,013
Net cash provided by operating activities 50,373 8,217
Investing activities:
Investment in non-banking subsidiaries 15,000 -
Financing activities:
Net proceeds from exercise of stock optio - 66,937
Cash dividends paid (94,098) (62,732)
Net cash provided by financing activities 94,098 4,205
Not increase (decrease) in cash and cash 58,726 12,422
Cash and cash equivalents at beginning of 67,340 54,918
Cash and cash equivalents at end of year $ 8,615$ 67,340.00
Certain restrictions exist regarding the ability of Heritage Bank and Trust to
transfer funds to Heritage Bankshares, Inc. in the form of cash dividends,
loans or advances. Pursuant to Federal Regulations, dividends are generally
restricted to net profits, as defined, for the current year, plus retained
net profits for the previous two years. At December 31, 1996, dividends
from the Bank to the Company are limited to approximately $1,985,000 under
these regulations. The maximum amount available for transfer from Heritage
Bank and Trust to the Company in the form of loans and advances is 10% of
Heritage Bank and Trust's stockholders equity. At December 31, 1996, such
maximum amount available is approximately $592,000.
(Notes continued on next page)
- 13 -
NOTE 4 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The Bank is required by the Federal Reserve Bank to maintain average reserve
balances. The average amount of maintained reserve balances for the year
ended December 31, 1996 was approximately $661,000, with the average reserve
requirement for the same period being approximately $382,000. On December
31, 1996, the reserve balance was approximately $768,000.
NOTE 5 - SECURITIES
Securities at December 31, 1996 and 1995 are as follows:
Gross Gross
AmortizedUnrealized UnrealiEstimated
Cost Gains Losses Fair Value
December 31, 1996:
Securities available for sale:
U.S. Treasury $10,495,374$ 29,182$ 7,148 $10,517,408
U.S. government agencies 3,025,362 26,295 7,341 3,044,316
Mortgage-backed securities 800,091 6,965 1,756 805,300
$14,320,827 62,442 16,245 14,367,024
Securities held to maturity:
U.S. Treasury $1,732,665 $ 3,039 $ 2,134 $ 1,733,570
U.S. government agencies 1,999,226 $ 5,362$ 723$ 2,003,866
Mortgage-backed securitie 1,340,585 $ 9,651$ 1,330,934
States and political
subdivisions $ 490,359$ 197 $ 490,556
Other $ 266,700 - $ 266,700
$5,829,535 $ 8,598 $12,508$ 5,825,625
December 31, 1995:
Securities available for sale
U.S. Treasury 3,741,725 $ 43,164$ 564$ 3,784,325
U.S. government agencies 1,300,000 1,110 3,720 1,297,390
Mortgage-backed secuhties 616,768 6,180 3,576 619,372
$5,658,493 $ 50,454 7,860 5,701,087
Securities held to maturity:
U.S. Treasury $3,981,998 $ 12,278 $10,285 $ 3,983,991
U.S. government agencies 1,500,000 7,810 25,781 1,482,029
Mortgage-backed securities 544,597 - 7,559 537,038
Other 1,275,635 15,913 1,259,722
$7,320,230 $ 20,088 59,538 7,262,780
(Notes continued on next page)
- 14 -
NOTE 5 - SECURITIES (Continued)
Investment securities having carrying values of $3,902,828 and $4,839,926 at
December 31,1996 and 1995, respectively, are pledged to secure deposits of
the U.S. Government and the Commonwealth of Virginia. The estimated fair
values of these securities were $3,904,806 and $4,809,355 at December 31,
1996 and 1995, respectively.
The amoritized cost and fair value of securities by maturity date, including
the contractual maturities of mortgage-backed securities, at December 31,
1996 are as follows:
Securities Held to Maturity Securities Available for Sale
AmortizedEstimated AmortizEstimated
Cost Fair Value Cost Fair Value
Due in one year
or less $ 547,245$ 545,156 1,789,677 $1,793,403
Due from one year
to five years 4,255,883 4,257,467 11,776,217 11,813,663
Due from five
years to ten years 322,712 322,804 418,252 423,889
Due after ten years 703,695 700,198 336,681 336,069
$5,829,53$ $5,825,625 $14,320,827 $ 14,367,024
NOTE6-LOANS
Loans consist of the following:
December 31,
1996 1995
Gross loans-
Commercial $9,334,87$ 8,510,867
Real estate - mortgage 31,551,38 29,559,276
Real estate - construction 2,083,717 2,580,988
Installment and consumer loans 3,132,132 3,131,400
Total gross loans 46,102,10 43,782,531
Less - allowance for loan losses -842,715 -763,318
Loans,net 45,259,39 43,019,213
A summary of the activity in the allowance for loan losses account is as
follows:
Years Ended December 31,
1996 1995
Balance, beginning of year $ 763,318$ 638,675
Provision charged to operations 92,935 193,000
Loans charged-off (84,239) (140,810)
Recoveries 70,702 72,453
Balance, end of year $ 842,715 $ 763,318
(Notes continued on next page)
- 15 -
NOTE 6 - LOANS (Continued)
Loans on which the accrual of interest has been discontinued amount to $12,550
and $18,26 at December 31, 1996 and 1995, respectively. If interest on these
loans had been accrued, such income would have approximated $2,000 and $1,720
for 1996 and 1995, respectively. No interest income was recognized or
received on these loans in 1996 and 1995.
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
December
1996 1995
Land and improvements $ 161,168 $ 161,168
Buildings 673,631 649,626
Leasehold improvements 7,951 7,951
Equipment, furniture and fixtures 1,018,562 1,011,476
Less - accumulated depreciation (1,272,878)(1,194,534)
$ 588,434 635,687
Depreciation charged to operating expense for the years ended December 31,
1996 and 1995 was $78,344 and $100,413, respectively.
NOTE 8 - DEPOSITS
Interest bearing deposits consist of the following:
December 31,
1996 1995
Money Market and NOW account deposits$ 12,278,300 11,997,470
Savings deposits 4,675,568 4,957,616
Certificates of deposit $100,00 6,727,894 7,749,841
Other time deposits 32,246,984 23,685,478
$55,927,746 48,390,405
At December 31, 1996 and 1995, the scheduled maturities of time deposits are
as follows:
1996 1995
Maturing in less than one year $ 31,506,878 24,015,319
Maturing in more than a year,
but less than five years 7,467,000 7,420,000
Maturing in more than five years - -
38,973,878 31,435,319
(Notes continued on next page)
- 16 -
NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND SHORT-TERM
BORROWINGS
Securities sold under agreements to repurchase generally mature within one to
four days from the transaction date. Information concerning securities sold
under agreements to repurchase is summarized as follows:
December 31,
1996 1995
Average balance during the year $14,308.0-
Average interest rate during the year 4.36%-
Maximum month end balance during the year 1,349,0-
Short-term borrowings consist of U.S. Treasury tax and loan deposit notes,
which are payable on demand and fully collateralized by investment
securities.
During 1994, the Bank became a member of the Federal Home Loan Bank of
Atlanta. One of the benefits of membership is a borrowing capacity of
$5-9 million secured by a blanket floating lien on the unpaid principal
balance of the Bank's one-to-four unit residential, real estate loans.
As of December 31, 1996, the Bank had not drawn any amounts on this line of
credit.
NOTE 10 - STOCK COMPENSATION PLANS
At December 31, 1996, the Bank has fixed stock compensation plans for its
officers- The Bank applies Accounting Principles Board Opinion No. 25
(APB 25), Accounting for Stock Issued to Employees, and related
interpretations in accounting for its plans. Accordingly, no compensation
cost has been recognized for these plans against earnings. For those companies
applying APB 25, FASB Statement No. 123, Accounting for Stock-Based Compensation
, requires certain pro-forma disclosures of net income and earnings per share.
Net income and earnings per share computed under FASB Statement No. 123 do not
materially differ from the amounts reported.
All options have ten year terms, vest and become fully exercisable in three
years. The option exercise price equals or exceeds the market price of the
stock as of the date the option was granted. The following is a summary of
the banks stock option activity, and related information for the years ended
December 31,: 1996 1995
Weighted- Weighted-
Average Average
Exercise Exercise
Options Price Options Price
Outstanding
Beginning of year 110,750 $7.39 57,520$ $5.64
Granted - 67,750 8.27
Exercised (14,520) 4.61
Forfeited
Outstanding -
End of year 110,750 7.39 110,750 7.39
Exercisable
End of year 61,875 6.47 49,938 6.16
1
(Notes continued on next page)
- 17 -
NOTE 11 - INCOME TAXES
The principal components of income tax expense are as follows:
Years Ended December 31,
1996 1995
Federal income tax expense - current 222,599 (184,300)
Deferred federal income tax benefit (expense) related to
temporary differences in reporting:
Bad debt deduction (28,177) (50,217)
Premium amortization and discount accreti (2,867) 8,776
Depreciation 16,163 (4,021)
Deferred compensation (14,633) (6,162)
Deferred loan fees 11,076 10,169
Employee benefits (641) (1,882)
Other 4,326 8,495
Utilization of minimum tax credit carryforward 10,175 115,147
Utilization of contribution carryover - 8,906
(4,578) 89,211
Income tax expense 218,021 (95,089)
Differences between income tax expense calculated at the statutory rate and
that shown in the statements of income are summarized as follows:
1996 1995
Federal income tax expense - at (370,083)(285,559)
Tax effect of-.
Tax exempt interest 49,475 48,021
Change in valuation allowance 97,475 151,168
Other 5,112 (8,719)
(218,021) (95,089)
(Notes continued on next page)
1 8 -
NOTE 11 - INCOME TAXES (Continued)
The Company has the following deferred tax assets and liabilities at December
31, 1996 and 1995
1996 1995
Deferred tax assets:
Deferred compensation 94,958 80,325
Bad debts 195,588 167,411
Minimum tax credit carryforward 12,997 120,647
Other 9,222 12,907
312,765 381,290
Less - valuation allowance (97,475)
Total deferred tax asset 312,765 283,815
Deferred tax liabilities:
Deferred loan fees (14,383) (3,307)
Discount accretion on securitie (11,723) (14,590)
Net unrealized appreciation on available-for-
sale securities (14,783) (8,519)
Fixed assets (20,454) (4,291)
61,343 (30,707)
Net deferred tax asset 251,422 253,108
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Company has entered into a long-term lease with a related party to provide
space for one branch and the Bank's operations center. This lease has been
classified as an operating lease for financial reporting purposes. Future
minimum lease payments of $64,439 are required each year for five years under
the long-term non-cancellable lease agreement as of December 31, 1996, which
expires in December, 2001. Total lease expense was $75,810 for each of the
years 1996 and 1995.
NOTE 13 - RELATED PARTY TRANSACTIONS
The Bank has loan and deposit transactions with its officers and directors, and
with companies in which the officers and directors have a financial interest.
Related party deposits amounted to approximately $5,500,000 and $5,300,000 at
December 31, 1996 and 1995, respectively. All securities sold under
agreements to repurchase were transacted with a related party. A summary
of related party loan activity for Heritage Bank and Trust is as follows during
1996:
Balance, December 31, 1995 $ 3,217,295
Originations - 1996 1,845,805
Repayments - 1996 (1,655,754)
Balance, December 31, 1996 3,407,346
(Notes continued on next page)
- 19 -
NOTE 13 - RELATED PARTY TRANSACTIONS (Continued)
In the opinion of Management, such loans are made in the ordinary course of
business at normal credit terms, including interest rate and collateral
requirements and do not represent more than normal credit risk.
In the ordinary course of business, the Company has engaged in transactions
with certain of its directors' companies for legal services and insurance.
Additionally, lease expense under related party leases was $75,810 for each
of the years 1996 and 1995.
Commitments to extend credit and letters of credit to related parties amounted
to $1,166,800 and $858,950 at December 31, 1996 and 1995, respectively.
NOTE 14 - CREDIT COMMITMENTS AND CONCENTRATIONS OF CREDIT RISK
The Bank has outstanding at any time a significant dollar amount of commitments
to extend credit. To accommodate major customers, the Bank also provides
standby letters of credit and guarantees to third parties. Those
arrangements are subject to strict credit control assessments.
Guarantees and standby letters of credit specify limits to the Bank's
obligations. The amounts of loan commitments, guarantees and standby
letters of credit are set out in the following table as of
December 31, 1996 and 1995. Because many commitments and almost all standby
letters of credit and guarantees expire without being funded in whole or in
part, the contract amounts are not estimates of future cash flows. The
majority of commitments to extend credit have terms up to one
year. Interest rates on fixed-rate commitments range from 14% to 18%.
1996 1995
Variable Rate FixedVariable Rate Fixed Rate
Commitments CommitmCommitments Commitments
Loan Commitments $ 10,456,377$648,085 $ 8,807,606 702,075
Standby letters of credit and
guarantees written 124,133 24,240 378,297 5,000
All of the guarantees outstanding at December 31, 1996 expire during 1997.
(Notes continued on next page)
- 20 -
NOTE 14 - CREDIT COMMITMENTS AND CONCENTRATIONS OF CREDIT RISK (Continued)
Loan commitments, standby letters of credit and guarantees written have off-
balance-sheet credit risk because only origination fees and accruals for
probable losses, if any, are recognized in the statement of financial
position, until the commitments are fulfilled or the standby letters of
credit or guarantees expire. Credit risk represents the accounting loss
that would be recognized at the reporting date if counterparties failed
completely to perform as contracted. The credit risk amounts are equal to
the contractual amounts, assuming that the amounts are fully advanced and
that, in accordance with the requirements of FASB Statement No. 105,
Disclosure of Information about Financial Instruments with Off-Balance-Sheet
Risk and Financial Instruments with Concentrations of Credit Risk, collateral
or other security is of no value. The Bank's policy is to require customers
to provide collateral prior to the disbursement of approved loans. For
retail loans, the Bank usually retains a security interest in the property
or products financed, which provides repossession rights in the event of
default by the customer. For business loans and financial guarantees,
collateral is usually in the form of inventory or marketable securities
(held in trust) or property (notations on title).
Concentrations of credit risk (whether on or off balance sheet) arising from
financial instruments exist in relation to certain groups of customers. A
group concentration arises when a number of counterparties have similar
economic characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic or other
conditions. The Bank does not have significant exposure to any individual
customer or counterparty. The major concentrations of credit risk for the
Bank adse by customer loan type in relation to loans and credit commitments,
as shown in the following table. A geographic concentration arises because
the Bank operates primarily in southeastern Virginia.
Installment
ResidentiCommercial Small and
Property Property Busines-Consumer Total
Loans and
receivables $19,711,926 14,060,583 $9,177,408 $3,152,188 $ 46,102,105
Credit
commitment 2,918,911 424,489 4,831,137 3,077,897 11,3252,434
22,630,837 14,485,072 14,005,545 6,230,085 57,354,539
The credit risk amounts represent the maximum accounting loss that would be
recognized at the reporting date if counterparties failed completely to
perform as contracted and any collateral orsecurity proved to be of no value.
The Bank has experienced little difficulty in accessing collateral when
required. The amounts of credit risk shown, therefore, greatly exceed
expected losses, which are included in the allowance for loan losses.
(Notes continued on next page)
- 21 -
NOTE 15 - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. 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 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 the regulators
about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1996,
the Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 1996, the most recent notification from the Federal Reserve
Bank of Richmond 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 total risk based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table. There are
no conditions or events since that notification that management believes have
changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the table.
To Be Well
Capitalized under
For Capital Prompt Corrective
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1996:
Total Capital
(to Risk Weighted Assets) $ 6,650 14.70% $3,618 8.00% $4,523 10.00%
Tier 1 Capital
to Risk Weighted Assets) $ 6,081 13.44% $1,809 4.00% $2,714 6.00%
Tier 1 Capital
to Average Assets) $ 6,081 8.57% $2,839 4.00% $3,548 5.00%
There is no significant difference between the Banks actual ratios disclosed
above, and the related actual ratios of the Company.
(Notes continued on next page)
- 22 -
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair value of the Bank's
financial instruments at December 31, 1996 and 1995. FASB Statement No. 107,
Disclosures about Fair Value of Financial Instruments, defines the fair value
of a financial instruments as the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. The carrying amounts in the table are
included in the balance sheet under the indicated captions.
1996 1995
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial Assets
Cash and cash equivalents 8,994 8,994 8,944 8,944
Loans (net) 45,259 45,719 43,014 42,906
Investment securities 20,196 20,193 13,003 12,964
Accrued interst receivable 535 535 428 428
Financial Liabilities:
Deposit liabilities 68,427 68,427 61,160 61,160
Accrued interest payable 291 291 254 254
Short-term borrowings 131 131 66 66
Securities sold under
agreements to repurchase 1,349 1,349
Estimation of Fair Values
The following notes summarize the major methods and assumptions used in
estimating the fair value of financial instruments:
Short-term financial instruments are valued at their carrying amounts
included in the Bank's balance sheet, which are reasonable estimates of
fair value due to the relatively short period to maturity of the instruments.
This approach applies to cash and cash equivalents, short-term borrowings,
and securities sold under agreements to repurchase.
Loans are valued on the basis of estimated future receipts of principal and
interest, discounted at various rates. Loan prepayments are assumed to
occur at the same rate as in previous periods when interest rates were at
levels similar to current levels. Future cash flows for homogeneous
categories of consumer loans, such as motor vehicle loans, are estimated on
a portfolio basis and discounted at current rates offered for similar loan
terms to new borrowers with similar credit profiles. The fair value of
nonaccrual loans also is estimated on a present value basis, using higher
discount rates appropriate to the higher risk involved.
Investment securities are valued at quoted market prices if available. For
unquoted securities, the fair value is estimated by the Bank on the basis of
financial and other information.
(Notes continued on next page)
- 23 -
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Estimation of Fair Values (continued)
The fair value of demand deposits and deposits with no defined maturity is
taken to be the amount payable on demand at the reporting date. The fair
value of fixed - maturity deposits is estimated using rates currently offered
for deposits of similar remaining maturities. The intangible value of long-
term relationships with depositors is not taken into account in estimating
the fair values disclosed.
The carrying amounts of accrued interest approximate fair value.
It is not practicable to separately estimate the fair values for off-balance-
sheet credit commitments, including standby letters of credit and guarantees
wdften, due to the lack of cost effective reliable measurement methods for
these instruments.
24 -
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