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FORM 10-KSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
ANNUAL REPORT UNDER SECTION 13 or 15(d) of the
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 1996
HERITAGE FINANCIAL SERVICES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Tennessee 62-1484807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Jefferson Street, Clarksville, Tennessee 37040
(Address of Principal Executive Office) (Zip Code)
(615) 553-0500
(Issuer's telephone number including area code)
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $2.00 par value per share
Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X NO
----- -----
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB X
-----
State issuer's revenues for its most recent fiscal year:
$14,291,862
As of December 31, 1996, 551,367 shares of the registrant's Common Stock
were outstanding with an aggregate market value of $17,346,006, using the
average sale price over the last 60 days.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Heritage Financial Services, Inc. (the "Company" or "HFSI") is a registered bank
holding company which was incorporated under Tennessee law in 1992. The
Company's activities are primarily conducted through its wholly-owned
subsidiary, Heritage Bank (the "Bank") which began business in 1989 and was
acquired by the Company in 1992. The Bank is a Tennessee state bank, which was
organized in 1989 after three locally-owned banks headquartered in Montgomery
County were acquired. From the time of its opening in June 1989, until December
31, 1996, the Bank has grown to total assets exceeding $132 million.
The Bank's primary trade area is comprised of Montgomery County, Tennessee, and
the surrounding counties in Tennessee and Kentucky. The Bank provides a wide
range of competitive retail and commercial banking services. Deposit services
offered include various personal and business checking accounts, savings
accounts, money market investment accounts, certificates of deposit, automated
teller machines networking into national teller systems, and retirement
accounts. Lending services include consumer loans, commercial real estate loans,
personal lines of credit, home equity loans, credit cards, real estate
construction loans, commercial loans to small and medium size businesses and
professionals, and letters of credit. Accounts receivable billing services are
also provided. Drive through and night depository facilities are provided, as
well as five automated teller machines. Safe deposit facilities, cashier's
checks, money orders, travelers checks, U.S. savings bonds, bank-by-mail and
wire transfer services are also offered. Additionally, the Bank originates,
services and markets residential mortgage loans through its mortgage banking
operation. Heritage Bank also has three non-bank affiliates which provide
services incidental to the Bank's operations, including brokerage services,
property ownership, and reinsurance of credit life, accidental and health
insurance. The Bank does not provide trust services.
The Bank conducts its banking business in Clarksville, Tennessee at its five
branch locations of 25 Jefferson Street, 1805 Madison Street, 111 Cunningham
Lane, 2786 Wilma Rudolph Boulevard and 400 Highway 49 (Hilltop Super Market). A
mortgage origination office is located at 529 North Second Street. The Bank's
wholly-owned subsidiary, Heritage Investment Center, Inc., is engaged in earning
fees from investment brokerage services through Robert Thomas Securities, Inc.
The Bank has another wholly-owned subsidiary, Heritage Investment Corporation, a
limited partner in a partnership, engaged in the development and sale of a
speculative industrial building located in the Clarksville/Montgomery County
Industrial Park. Also, in December 1996, Central Life Insurance Company
(Central) was incorporated as a wholly-owned subsidiary of the Bank. Central has
entered into a reinsurance arrangement and receives underwriting profits by
providing life and disability insurance to borrowers of the Bank.
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The Bank considers its primary market for loans and deposits to be individuals,
small-to-medium size businesses, and professionals within the Bank's primary
trade area. The Bank is actively soliciting business in this target market and
considers the potential growth opportunities to be favorable. No material
portion of the Bank's deposits has been obtained from any single person or group
of persons.
The Bank is subject to the regulatory authority of the Department of Financial
Institutions of the State of Tennessee and the Federal Deposit Insurance
Corporation (FDIC).
COMPETITION
Commercial banking in the market area serviced by the Bank is highly
competitive. The Bank faces substantial competition from other commercial banks,
savings banks, credit unions, brokerage firms, mortgage companies and other
non-traditional financial entities. In marketing its services, the Bank
emphasizes that it is a "locally owned bank" which offers personal service,
flexibility and responsiveness to the needs of the Clarksville\Montgomery County
community.
The Bank competes in the Montgomery County market with other banks and financial
institutions, many of which have greater financial resources than the Bank. At
December 31, 1996, the Bank competed with approximately twenty-five (25)
commercial bank branches, six (6) savings and loan branches, and four (4) credit
union branches within Montgomery County. Additionally, four (4) separate
brokerage offices operate in Montgomery County.
LOANS
Various types of secured and unsecured commercial, consumer and real estate
loans are offered by the Bank. The Bank's current policy is to make loans to
borrowers who maintain depository relationships with the Bank or reside or work
in the Bank's market area. Generally, real estate loans are secured by real
property located in the Bank's market area.
The Bank provides each lending officer with written loan guidelines. Lending
authority is delegated by the Board of Directors to loan officers, each of whom
has limited authority to extend secured and unsecured credit. Any credit in
excess of $250,000 must have the approval of the executive committee of the
board of directors, which consists of both management and non-management
directors of the Bank. Any loan in excess of 15% of regulatory capital must be
approved by the full board of directors.
MONETARY POLICIES
The operating results of the Bank and the Company are affected by credit
policies of monetary authorities, particularly the Federal Reserve Board. The
instruments of monetary policy employed by the Federal Reserve Board include
open market operations in U.S. government securities, changes in the discount
rate on bank borrowings, and changes in reserve requirements against bank
deposits.
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PERSONNEL
At December 31, 1996, the Company had 86 full-time equivalent employees of which
25 are Bank officers. Although the Bank has only been in existence since 1989,
the Bank believes its staff possesses a high degree of experience and expertise.
Coming primarily from other Clarksville banking institutions, staff members have
banking experience ranging from one to thirty-one years. The Company is not a
party to any collective bargaining agreement and believes its employee relations
generally are good.
Employee benefit programs include group life, disability, dental and health
insurance, a 401(k) pension plan, an employee stock ownership plan (ESOP),
discretionary incentive bonuses, a stock option plan, training programs and paid
vacations.
SUPERVISION AND REGULATION
GENERAL. The Company and the Bank are subject to extensive regulation under
state and federal statutes and regulations. The discussion in this section,
which briefly summarizes certain of such statutes, does not purport to be
complete, and is qualified in its entirety by reference to such statutes. Other
state and federal legislation and regulations directly and indirectly affecting
banks and other financial institutions likely are to be enacted or implemented
in the future; however, such legislation and regulations and their effect on the
business of the Company and the Bank cannot be predicted.
HERITAGE FINANCIAL SERVICES, INC.. The Company is a bank holding company subject
to the supervision of the Board of Governors of the Federal Reserve System (the
"Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended.
As a bank holding company, the Company is required to file annual reports with,
and is subject to examination by, the Federal Reserve Board.
HERITAGE BANK. The Bank is incorporated under the banking laws of the State of
Tennessee, and as such, is subject to provisions of the Tennessee Banking Act
and the supervision of and regular examination by the Tennessee Department of
Financial Institutions (the "Department"). The Bank is a member of the FDIC and,
therefore, also is subject to the provisions of the Federal Deposit Insurance
Act and to supervision and examination by the FDIC.
CAPITAL. The Federal Reserve Board and the FDIC have adopted final risk-based
capital guidelines for bank holding companies. The minimum guidelines for the
ratio of total capital ("Total Capital") to risk weighted assets (including
certain off balance sheet activities, such as standby letters of credit) is
8.00%. At least half of the Total Capital must be composed of "Tier 1 or core
capital," which consists of common stockholders' equity, minority interests in
the equity accounts of consolidated subsidiaries non-cumulative perpetual
preferred stock and a limited amount of cumulative perpetual preferred stock,
less goodwill ("Tier 1 Capital"). The remainder, Tier 2 Capital, may consist of
subordinated debt, other preferred stock and a limited amount of loan loss
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reserves. At December 31, 1996, the Company's risk-based Tier 1 Capital and
risk-based Total Capital ratios were 9.96% and 11.21%, respectively.
In addition, the Federal Reserve Board has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio (Tier 1 Capital to total assets, less goodwill) of 4% to 5% for
most bank holding companies. The Company's leverage ratio at December 31, 1996
was 7.88%.
Failure to meet FDIC capital requirements can subject an FDIC-insured state bank
to a variety of enforcement remedies, including issuance of a capital directive,
termination of deposit insurance and a prohibition on the taking of brokered
deposits. Substantial additional restrictions can be imposed under the "prompt
corrective action" regulations, as described below.
PAYMENT OF DIVIDENDS. The Company is a legal entity separate and distinct from
the Bank. The principal source of the Company's revenues, however, is from
dividends declared by the Bank. Under Tennessee law, the Bank can only pay
dividends out of its undivided profits, which at December 31, 1996 were
approximately $5,461,000. This amount will be increased by the Bank's net
earnings and decreased by any losses. Any transfer from the Bank's surplus
account to undivided profits requires the prior approval of the Commissioner of
the Department. The Bank's ability to pay dividends also may depend on its
ability to meet minimum capital levels established from time to time by FDIC.
Under such regulations, FDIC-insured state banks are prohibited from paying
dividends, making other distributions or paying any management fee to a parent
if, after such payment, the Bank would fail to have a risk-based Tier 1 Capital
ratio of 4%, a risk-based Total Capital ratio of 8% and a Tier 1 leverage
capital ratio of 4%.
Under Tennessee law, the Company may pay common stock dividends if, after giving
effect to the dividends, the Company can pay its debts as they become due in the
ordinary course of business and the Company's total assets exceed its total
liabilities. The payment of dividends by the Company also may be affected or
limited by certain factors, such as the requirements to maintain adequate
capital above regulatory guidelines. In addition, if, in the opinion of the
applicable regulatory authority, a bank holding company or a bank under its
jurisdiction is engaged in or is about to engage in an unsafe or unsound
practice (which, depending on the financial condition of the bank, could include
the payment of dividends), such authority may take various supervisory actions
to prevent such action, including a cease and desist order prohibiting such
practice. Given the above restrictions, at December 31, 1996, the Company would
have approximately $5,359,000 available for payment of dividends. In 1996, the
Company raised its annual dividend 33% to $1.00 per share from the 1995 level of
$.75 per share.
THE COMPANY'S SUPPORT OF THE BANK. Under Federal Reserve Board policy, the
Company is expected to act as a source of financial strength and to commit
resources to the Bank. Such support may be required at times when, absent such
Federal Reserve Board policy, the Company may not be inclined to provide it.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA"), a depository institution insured by the FDIC can be held liable for
any loss incurred by, or reasonably
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expected to be incurred by, the FDIC in connection with (i) the default of a
commonly controlled FDIC-insured depository institution or (ii) any assistance
provided by the FDIC to any commonly controlled FDIC-insured depository
institution "in danger of default." "Default" is defined generally as the
appointment of a conservator or receiver and "in danger of default" is defined
generally as the existence of certain conditions indicating that a default is
likely to occur in the absence of regulatory assistance.
Any capital loans by a bank holding company to any of its subsidiary banks are
subordinate in right of payment to deposits and to certain other indebtedness of
such subsidiary banks. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank must be assumed by the bankruptcy
trustee and entitled to a priority of payment over certain other creditors.
PROMPT CORRECTIVE ACTION
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires the Federal banking regulators to assign to each insured institution
one of five capital categories ("well capitalized", "adequately capitalized" or
one of three under-capitalized categories) and to take progressively more
restrictive regulatory actions depending upon the assigned category. Under the
"prompt corrective action" regulations adopted pursuant to FDICIA, in order to
be considered "adequately capitalized", national banks must have a risk-based
Tier 1 Capital ratio of at least 4%, a risk-based Total Capital ratio of 8% and
a Tier 1 leveraged capital ratio of at least 4%. Well-capitalized institutions
are those which have a risk-based Tier 1 Capital ratio above 6%, a risk-based
Total Capital ratio above 10% and a Tier 1 leveraged capital ratio above 5%, and
which are not subject to a written agreement, order or capital directive to
maintain capital at a specific level. The Bank is considered a "well
capitalized" institution under these definitions.
All institutions, regardless of their capital levels, are restricted from making
any capital distribution or paying any management fees that would cause the
institution to fail to satisfy the minimum levels to be considered adequately
capitalized. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") is: (i) subject to
increased monitoring by the appropriate federal banking regulator, (ii) required
to submit an acceptable capital restoration plan within 45 days; (iii) subject
to asset growth limits; and (iv) required to obtain prior regulatory approval
for acquisitions, branching and new lines of business. The capital restoration
plan must include a guarantee by the institution's holding company that the
institution will comply with the plan until it has been adequately capitalized
on average for four consecutive quarters. Pursuant to the guarantee, the
institution's holding company would be liable up to the lesser of 5% of the
institution's total assets or the amount necessary to bring the institution into
capital compliance as of the date it failed to comply with its capital
restoration plan. If the controlling bank holding company fails to fulfill its
obligations under the guarantee and files (or has filed against it) a petition
under the Federal Bankruptcy Code, the appropriate federal banking regulator
could have a claim as a general creditor of the bank holding company, and, if
the guarantee were deemed to be a commitment to maintain capital under the
Federal Bankruptcy Code, the claim would be entitled to priority in such
bankruptcy proceeding over third-party creditors and shareholders of the bank
holding company.
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The bank regulatory agencies have discretionary authority to reclassify
well-capitalized institutions as adequately capitalized or to impose on
adequately capitalized institutions requirements or actions specified for
undercapitalized institutions if the agency determines after notice and an
opportunity for hearing that the institution is in an unsafe or unsound
condition or is engaging in an unsafe or unsound practice, which can consist of
the receipt of an unsatisfactory examination rating if the deficiencies cited
are not corrected. A significantly undercapitalized institution, as well as any
undercapitalized institution that did not submit an acceptable capital
restoration plan, may be subject to regulatory demands for recapitalization,
broader applications of restrictions on transactions with affiliates,
limitations on interest rates paid on deposits, asset growth and other
activities, possible placement of directors and officers, and restrictions on
capital distributions by any bank holding company controlling the institution.
Any company controlling the institution could also be required to divest the
institution or the institution could be required to divest subsidiaries. The
senior executive officers of a significantly undercapitalized institution may
not receive bonuses or increases in compensation without prior approval and the
institution is prohibited from making payments of principal or interest on its
subordinated debt. If an institution's ratio of tangible capital to total assets
falls below a level established by the appropriate federal banking regulator
(the "Critical capital level"), which may not be less than 2% nor more than 65%
of the minimum tangible capital level otherwise required, the institution will
be subject to conservatorship or receivership within 90 days unless periodic
determinations are made that forbearance from such action would better protect
the deposit insurance fund. Unless appropriate findings and certifications are
made by the appropriate federal bank regulatory agencies, a critically
undercapitalized institution must be placed in receivership if it remains
critically undercapitalized on average during the calendar quarter beginning 270
days after the date it became critically undercapitalized.
ACQUISITION AND EXPANSION. The Bank Holding Company Act requires any bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire substantially all the assets of any bank, or ownership or control
of any voting shares of any bank, if, after acquiring such shares, it would own
or control directly or indirectly, more than 5% of the voting shares of such
bank. Effective September 29, 1995, the Tennessee Bank Structure Act of 1974 was
amended to, among other things, prohibit (subject to certain exceptions) a bank
holding company from acquiring a bank for which the home state is Tennessee if,
upon consummation, the company would directly or indirectly control 30% or more
of the total deposits in insured depository institutions in Tennessee. As of
December 31, 1996, the Company estimates it held less than 1% of such deposits.
Subject to certain exceptions, the Tennessee Bank Structure Act prohibits a bank
holding company from acquiring a bank in Tennessee which has been in operation
for less than five years. Tennessee banks may open additional branches in any
county in the state.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"IBBEA") authorizes interstate acquisitions of banks and bank holding companies
without geographic limitation beginning one year after enactment. In addition,
beginning June 1, 1997, a bank may merge with a bank in another state as long as
neither of the states has opted out of interstate branching between the date of
enactment of the IBBEA and May 31, 1997. The IBBEA further provides that states
may enact laws permitting interstate merger transactions prior to June 1, 1997.
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A bank may establish and operate a de novo branch in a state in which the bank
does not maintain a branch if that state expressly permits de novo branching.
Once a bank has established branches in a state through an interstate merger
transaction, the bank may establish and acquire additional branches at any
location in the state where any bank involved in the interstate merger
transaction could have established or acquired branches under applicable federal
or state law. A bank that has established a branch in a state through de novo
branching may establish and acquire additional branches in such state in the
same manner and to the same extent as a bank having a branch in such state as a
result of an interstate merger. If a state opts out of interstate branching
within the specified time period, no bank in any other state may establish a
branch in the opting out of state, whether through an acquisition or de novo.
Tennessee law allows banks and bank holding companies in any state to acquire
banks and bank holding companies in Tennessee provided that the state in which
such acquirer is headquartered also permits Tennessee banks and bank holding
companies to acquire banks and bank holding companies in that state.
Acquisitions of banks or bank holding companies in Tennessee require the
approval of the Commissioner of Financial Institutions.
The Bank Holding Company Act also prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company that
is not a bank and from engaging in any business other than banking or managing
or controlling banks. The Federal Reserve Board is authorized to approve
ownership of shares by a bank holding company in any company, the activities of
which the Federal Reserve Board has determined to be so closely related to
banking or to managing or controlling banks as to be a proper incident thereto.
Certain activities have been found to be closely related to banking by Federal
Reserve Board regulations, including operating a trust company, mortgage
company, finance company or factoring company; performing data processing
operations; providing investment advice; and engaging in certain kinds of
credit-related insurance activities.
FDIC INSURANCE ASSESSMENTS; DIFA. The FDIC reduced the insurance premiums it
charges on bank deposits insured by the Bank Insurance Fund ("BIF") to the
statutory minimum of $2,000.00 for "well capitalized" banks, effective January
1, 1996. Premiums related to deposits assessed by the Savings Association
Insurance Fund ("SAIF"), including savings association deposits acquired by
banks, continued to be assessed at a rate of between 23 cents and 31 cents per
$100.00 of deposits. On September 30, 1996, the Deposit Insurance Funds Act of
1996 ("DIFA") was enacted and signed into law. DIFA provided for a special
assessment to recapitalize the SAIF to bring the SAIF up to statutory required
levels. The assessment imposed a one-time fee to banks that own previously
acquired thrift deposits of $.526 per $100 of thrift deposits they held at March
31, 1995. This assessment did not apply to the Company. DIFA further provides
for assessments to be imposed on insured depository institutions with respect to
deposits insured by the BIF (in addition to assessments currently imposed on
depository institutions with respect to SAIF-insured deposits) to pay for the
cost of Financing Corporation ("FICO") bonds. All banks will be assessed to pay
the interest due on FICO bonds starting on January 1, 1997. The Company expects
the cost to the Company to be immaterial.
Under the FDICIA, insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe and unsound practices, is in
an unsafe or unsound condition to
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continue operations or has violated any applicable law, regulation, rule, order
or condition imposed by a federal bank regulatory agency.
CERTAIN TRANSACTIONS BY THE COMPANY WITH ITS AFFILIATES. There also are various
legal restrictions on the extent to which the Company and any nonbank subsidiary
can borrow or otherwise obtain credit from its bank subsidiaries. An insured
bank and its subsidiaries are limited in engaging in "covered transactions" with
its nonbank or nonsavings bank affiliates to the following amounts: (i) in the
case of any such affiliate, the aggregate amount of covered transactions of the
insured bank and its subsidiaries will not exceed 10% of the capital stock and
surplus of the insured bank; and (ii) in the case of all affiliates, the
aggregate amount of covered transactions of the insured bank and its
subsidiaries will not exceed 20% of the capital stock and surplus of the Bank.
"Covered transactions" are defined by statute to include a loan or extension of
credit, as well as purchase of securities issued by an affiliate, a purchase of
assets (unless otherwise exempted by the Federal Reserve Board), the acceptance
of securities issued by the affiliate as a collateral for a loan and the
issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate. Further, a bank holding company and its subsidiaries are prohibited
from engaging in certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services.
RECENT BANKING LEGISLATION. In addition to the matters discussed above, FDICIA
made other extensive changes to the federal banking laws.
STANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal bank regulatory
agencies to prescribe, by regulation, standards for all insured depository
institutions and depository institution holding companies relating to: (i)
internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v)
asset growth; and (vi) compensation, fees and benefits. The compensation
standards must prohibit employment contracts, compensation or benefit
arrangements, stock option plans, fee arrangements or other compensatory
arrangements that would provide excessive compensation, fees or benefits or
could lead to material financial loss, but (subject to certain exceptions) may
not prescribe specific compensation levels or ranges for directors, officers or
employees. In addition, the federal banking regulatory agencies would be
required to prescribe by regulation standards specifying: (i) maximum classified
assets to capital ratios; (ii) minimum earnings sufficient to absorb losses
without impairing capital; and (iii) to the extent feasible, a minimum ratio of
market value to book value for publicly-traded shares of depository institutions
and depository institution holding companies.
BROKERED DEPOSITS. FDICIA amends the Federal Deposit Insurance Act to prohibit
insured depository institutions that are not well-capitalized from accepting
brokered deposits unless a waiver has been obtained from the FDIC. Deposit
brokers will be required to register with FDIC.
CONSUMER PROTECTION PROVISIONS. FDICIA seeks to encourage enforcement of
existing consumer protection laws and enacts new consumer-oriented provisions
including a requirement of notice to regulators and customers for any proposed
branch closing and provisions intended to encourage the offering of "lifeline"
banking accounts and lending in distressed communities. FDICIA also
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requires depository institutions to make additional disclosures to depositors
with respect to the rate of interest and the terms of their deposit accounts.
MISCELLANEOUS. FDICIA extends the deadline for the mandatory use of
state-certified and state-licensed appraisers and authorizes acquisitions of
banks by savings associations on the same terms as savings associations may be
acquired by banks. With certain exceptions, state-chartered banks are limited to
the activities of national banks. Within nine months of the date of enactment of
FDICIA, the federal bank regulatory agencies are required to adopt uniform
regulations for real estate mortgage and construction loans. The federal bank
regulatory agencies are required to biannually review risk-based capital
standards to ensure that they adequately address interest rate risk,
concentration of credit risk and risks from non-traditional activities.
FDICIA also made extensive changes in the applicable rules regarding audit,
examinations and accounting. FDICIA generally requires annual on-site full-scope
examinations by each bank's primary federal regulator. FDICIA also imposes new
responsibilities on management, the independent audit committee and outside
accountants to develop, approve or attest to reports regarding the effectiveness
of internal controls, legal compliance and off-balance-sheet liabilities and
assets.
INTEREST RATE LIMITATIONS. The maximum permissible rates of interest on most
commercial and consumer loans made by the Bank are governed by Tennessee's
general usury. Certain other usury laws affect limited classes of loans, but the
laws referenced above are by far the most significant. Tennessee's general usury
law authorizes a floating rate of 4% per annum and also allows certain loan
charges, generally on a more liberal basis than does the general usury law.
EFFECT OF GOVERNMENT POLICIES. The earnings and business of the Company are and
will be affected by the policies of various regulatory authorities of the United
States, especially by the Federal Reserve Board. The Federal Reserve Board,
among other functions, regulates the supply of credit and deals with general
economic conditions within the United States. The instruments of monetary policy
employed by the Federal Reserve Board for these purposes influence in various
ways the overall level of investments, loans, other extensions of credit and
deposits, and the interest rates paid on liabilities and received on assets.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank's main office is located at 25 Jefferson Street in the central business
district of the city. The Bank purchased approximately three acres of land and
constructed a 4,000 square foot temporary facility, which began operations in
1989. An additional 3,950 square feet of temporary space was later constructed
to provide for additional growth bringing the total facility to 7,950 square
feet. An automated teller machine was also added. As further discussed below,
the Bank's permanent main office is currently under construction and the
temporary facility currently utilized will be moved or raized.
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A branch is located at 1805 Madison Street in the Hilldale area of Clarksville.
The facility is leased and contains approximately 2,000 square feet of space.
This location opened February 19, 1991, and is a full service branch with drive
through lanes. An ATM is in operation at this location.
The mortgage origination office is located at 529 North Second Street near the
main business district of Clarksville. This facility is leased and contains
approximately 2,900 square feet. The mortgage origination office is not a full
service location.
An additional branch is located at 111 Cunningham Lane in the north Clarksville
area. A .74 acre lot was purchased and a 2,600 square foot facility was
constructed. The facility opened on January 19, 1993, and is a full service
branch including drive through lanes. An ATM is in operation at this location.
A third branch is located on 2786 Wilma Rudolph Boulevard in the northeast (St.
Bethlehem) area of Clarksville. A two acre lot was purchased and a 3,500 square
foot facility was constructed. The facility opened on May 9, 1994, and is a full
service branch including drive through lanes. An ATM is in operation at this
location.
A fourth full service branch was opened in November, 1995. This location is
leased space inside Hilltop Market on Highway 149. The 400 square foot facility
is a full service branch, but does not provide drive through facilities. An ATM
is in operation at this facility.
Heritage Investment Center, Inc. (the brokerage service) is located at 720
Memorial Drive in the Hilldale area of Clarksville. The facility is leased and
contains approximately 1,000 square feet of space. The full service brokerage
began operations in July 1995, under a broker/dealer relationship with Robert
Thomas Securities.
In July 1996, the Bank leased a 2,500 square foot commercial building at 319
Riverside Drive, which neighbors the main office building. The Bank's accounting
and marketing personnel will occupy the facility until the new main office
building is completed.
In 1993, the Bank acquired a 2.1 acre lot and building adjacent to the main
office location. This facility is currently used for storage and meeting
functions. This property and the temporary main office property discussed above
are the site for the Bank's permanent main office building which began
construction during 1996. The new 40,000 square foot facility is scheduled for
completion in early 1998, and the mortgage origination, accounting and marketing
personnel will relocate to this facility. Construction cost of the permanent
main office is estimated at $4 million.
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ITEM 3. LEGAL PROCEEDINGS
The Bank is not aware of any material pending legal proceedings, other than
ordinary routine litigation incidental to the business, to which the Bank is a
party or of which any of their properties are the subject.
There are no material legal proceedings to which any director, any nominee for
election as a director, principal officer of the Bank or Company or any
associate of the foregoing or any owner of record or beneficial owner of more
than 5% of any class of voting securities of the Company is a party adverse to
the Company, or the Bank, or has a material adverse impact to the Company or the
Bank
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
No matter was submitted during the fourth quarter of the year ended December 31,
1996, to a vote of security holders, through the solicitation of proxies or
otherwise.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of Heritage Financial Services, Inc. is not traded through an
organized exchange nor is there a known active trading market. The following
table indicates the quarterly range of high and low sale prices for the stock
during the years of 1996 and 1995. The sales prices represent known transactions
and may not necessarily represent all trading transactions for the periods.
<TABLE>
<CAPTION>
Year Ended December 31, 1996 Year Ended December 31, 1995
---------------------------------------- ---------------------------------------------
Dividend Dividend
High Low Declared High Low Declared
----------- ----------- -------------- ---------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter 25.20 25.00 - 24.00 24.00 -
Second Quarter 30.00 30.00 - 25.00 25.00 -
Third Quarter 32.00 30.00 - 25.00 25.00 -
Fourth Quarter 32.00 25.00 1.00 25.00 25.00 0.75
</TABLE>
As of December 31, 1996, there were 916 shareholders of record of Heritage
Financial Services, Inc.
<PAGE> 13
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
The purpose of this discussion and analysis is to provide readers with
information relevant to understanding and assessing the financial condition and
results of operations of Heritage Financial Services, Inc. (Heritage Financial
or Company). Heritage Financial's business activity is currently limited to
holding the stock of its wholly-owned subsidiary, Heritage Bank (the Bank).
Accordingly, the discussion that follows relates primarily to the financial
condition and results of operation of Heritage Bank and its subsidiaries. This
discussion should be read in conjunction with the consolidated financial
statements and accompanying notes.
Heritage Bank is a locally owned independent bank with its primary market in
Montgomery County, Tennessee and the surrounding counties of Tennessee and
Kentucky. The Bank provides a wide range of financial services, such as making
commercial and consumer loans; originating, marketing and servicing mortgage
loans; issuing and servicing credit cards; offering a wide range of deposit
products; issuing letters of credit and providing safe deposit facilities.
Heritage Bank also has three non-bank affiliates which provide services
incidental to the Bank's operations, including brokerage services, property
ownership, and reinsurance of credit life, accident and health insurance.
FINANCIAL CONDITION
OVERVIEW. At December 31, 1996, the Company reported total assets of $132.8
million compared with $112 million at the end of 1995. Average assets were
$119.4 million in 1996 compared with $101.7 million in 1995.
EARNING ASSETS. Average earning assets of the Company for 1996, increased 18%,
or $17.4 million to $112.6 million from $95.2 million for 1995. This compares to
growth of average earning assets of 17% and 20% for 1995 and 1994, respectively.
Loan growth during 1996 was partially funded by a reduction in securities, the
other significant earning asset category. The Company's average earning assets
to average assets ratio was 94.3% for 1996, compared to 93.7% and 93.4% for 1995
and 1994, respectively.
Economic growth in the local market has enabled the Bank to achieve continued
loan growth (the primary earning asset). Average loans for 1996 increased 29%,
or $21 million, to $93.6 million. Average loan growth for 1995 and 1994 was 24%
and 19%, respectively. The changing mix of earning assets was favorable during
the last two years. Average loans for 1996 were 83% of total average earning
assets, compared to 76% and 72% during 1995 and 1994, respectively. Strong loan
demand and a slowed growth of deposits used for investment in securities has led
to the improved earning asset composition.
<PAGE> 14
Commercial loans (real estate and other) continued as the single largest loan
category, representing 45% of total loans at both December 31, 1996 and 1995.
Commercial loans grew $9.8 million (27%) in 1996 and $11.1 million (44%) in
1995. Real estate construction loans amounted to 16% and 11% of total loans at
December 31, 1996 and 1995, respectively. Real estate construction loans
increased $7.6 million (83%) in 1996 and $2.7 million (41%) in 1995. These
increases in commercial and construction loans reflect the economic growth and
vigorous housing market in the Bank's lending area.
The consumer loan portfolio consists of real estate, auto, and other consumer
installment loans that require periodic payments of principal and interest.
Consumer loans represented 18% of total loans at both December 31, 1996 and
1995. Consumer loans increased $3.8 million (26%) in 1996 and $1.3 million (10%)
in 1995. Portfolio residential (1-4 family, excluding mortgage loans held for
sale) loans amounted to 22% and 25% of total loans at December 31, 1996 and
1995, respectively. Portfolio residential loans increased 10% in 1996 and 12% in
1995.
The Bank maintains a securities portfolio of principally debt securities held
for sale as a source of income and liquidity, to balance interest rate risk with
other categories of the balance sheet, and to supply securities to pledge as
required collateral for certain deposits. During 1996, a portion of the proceeds
from the sale and maturity of securities and the principal collected on
mortgage-backed securities was used to fund loan growth. Average securities
decreased $3.4 million in 1996 after increasing $.9 million in 1995. Average
securities for 1996 were 17% of total earning assets, as compared to 24% and 27%
during 1995 and 1994, respectively.
At December 31, 1996, the securities portfolio consisted of: U.S. agency
obligations - 59%, mortgage-backed securities - 22%, tax-exempt securities - 17%
and equity securities - 2%. U.S. agency obligations include $2.3 million of
structured notes (as currently defined by regulatory agencies). Mortgage-backed
securities consist of Real Estate Mortgage Investment Conduit (REMIC) and
collateralize mortgage obligation (CMO) instruments. The REMIC issues are 100%
U.S. agency issues and the CMO issues are marketable, collateralized mortgage
obligations backed by agency-pooled collateral. All tax-exempt securities are
rated investment grade by Moody's or Standard & Poor's.
In November 1995, the Bank reclassified the remaining held-to-maturity
securities as available-for-sale as permitted by the Financial Accounting
Standards Board's guide to implementation of SFAS No. 115. The reclassification
had no impact on the Bank's earnings, but permitted maximum flexibility in
adapting to interest rate changes, managing liquidity and changing the Bank's
earning asset mix.
FUNDING SOURCES. Management relies upon local area deposits as a stable source
of funding. The Bank had total deposits of $115.3 million as of December 31,
1996, compared to $100.1 million as of December 31, 1995. Average 1996 deposits
increased 16%, or $14.3 million to $105.8 million from $91.5 million in 1995.
Average deposit growth for 1995 and 1994 was $12.5 million (16%) and $13.8
million (21%), respectively. Certificates of deposit (generally the Bank's
highest rate paying deposit) accounted for most of the deposit growth in 1996
and 1995.
<PAGE> 15
During 1996 and 1995, to fund loan growth, management increased marketing
efforts and offered attractive rates for certificates of deposit. Average 1996
certificates of deposit increased 25%, or $10.6 million to $53.6 million from
$43 million in 1995. Average certificate of deposit growth for 1995 and 1994 was
$9.3 million (27%) and $3.5 million (11%), respectively. The Bank has no
brokered deposits.
During periods of low deposit growth, the deposit base is supplemented with
alternative funding sources, Federal funds purchased and Federal Home Loan Bank
(FHLB) advances, to fund loan growth. The average balances of Federal funds
purchased and FHLB advances amounted to $2.4 million, $1.2 million and $.4
million for the years ended December 31, 1996, 1995 and 1994, respectively. Due
to the highly competitive local market for deposits, management anticipates the
continued use of alternative funding sources to partially fund loan growth.
NONPERFORMING ASSETS, PAST DUE LOANS, POTENTIAL PROBLEM ASSETS, AND THE
ALLOWANCE FOR LOAN LOSSES. Nonperforming assets consist of (1) nonaccrual loans
where the recognition of interest income was discontinued, (2) loans which have
been restructured to provide for a reduction or deferral of interest or
principal because the borrower's financial condition deteriorated, and (3)
foreclosed and repossessed assets. Nonperforming assets at December 31, 1996
were .31% ($333,000) of total loans and foreclosed and repossessed assets, down
from .56% ($460,000) at December 31, 1995.
Past due loans are loans contractually past due 90 days or more as to interest
or principal payments, but have not yet been placed on nonaccrual status. Past
due loans were $935,000 or .88% of total loans at December 31, 1996, as compared
to $16,000 or .02% of total loans at December 31, 1995. The increase reflects
the overall trend in loan delinquencies and the return to more historical past
due levels.
Potential problem assets, which are not included in nonperforming assets, were
.72% ($766,000) of total loans at December 31, 1996, as compared to .61%
($498,000) of total loans at December 31, 1995. Potential problem assets
represent those assets where information about possible credit problems of
borrowers has caused management to have serious doubts about the borrower's
ability to comply with present repayment terms. This definition is believed to
be substantially consistent with the standards established by banking regulatory
agencies for loans classified substandard and doubtful.
Management's policy is to maintain the allowance for loan losses at a level
sufficient to absorb all estimated losses inherent in the loan portfolio. The
allowance for loan losses was 1.49% of outstanding portfolio loans (excludes
mortgage loans held for sale) at December 31, 1996, as compared to 1.57% at
December 31, 1995. The allowance is 464% compared to 276% of nonperforming
assets, and 140% compared to 132% of potential problem assets and nonperforming
assets, as of December 31, 1996 and 1995, respectively.
<PAGE> 16
CAPITAL. Management believes that a strong capital position is vital to
continued profitability and to promote depositor and investor confidence.
Stockholders' equity was $11.3 million or 8.48% of total assets at December 31,
1996, and $9.3 million or 8.35% of total assets at December 31, 1995. Net income
is the primary source of new capital for the Company. In addition, proceeds from
the sale of common stock through director and employee plans contributed
$432,000 and $154,000 of capital in 1996 and 1995, respectively. Unrealized gain
or loss on securities held for sale, net of applicable income taxes, are
recorded directly to stockholders' equity. To record the fair value of
securities held for sale, stockholders' equity was reduced by $41,000 and $8,000
at December 31, 1996 and 1995, respectively.
Heritage Financial's continuing record of strong earnings performance allowed
the board of directors to raise the annual dividend 33% to $1.00 per share in
1996 from the 1995 level of $.75 per share. Additionally, the board of directors
develops and reviews the capital goals of Heritage Financial Services, Inc. and
the Bank. The Company's dividend policy is designed to retain sufficient amounts
for healthy financial ratios, considering future planned asset growth and other
prudent financial management principles. Due to the Company's earnings
performance and capital strength, the dividend reinvestment plan was suspended
during 1995.
Capital adequacy in the banking industry is evaluated primarily by the use of
ratios which measure capital against assets that are weighted based on risk
characteristics. These "risk-based" capital ratios are presented in Note 15 to
the consolidated financial statements. Heritage Bank's capital ratios
substantially exceed regulatory minimums and compare favorably to industry
averages.
LIQUIDITY AND INTEREST RATE RISK
Liquidity management involves planning to meet depositors' and borrowers' cash
flow requirements at a reasonable cost, as well as developing contingency plans
to meet unanticipated funding needs or a loss of funding sources. The Bank's
consumer deposits provide stability with respect to liquidity. In addition,
membership in the Federal Home Loan Bank and Federal funds purchased lines of
credit provide cost-effective alternate sources of funding.
Interest rate risk is the risk that future changes in interest rates will reduce
the Bank's net interest income and the market value of its portfolio equity. A
movement in interest rates and the corresponding effect on net interest income
may significantly affect profitability. The degree of any potential consequences
of such interest rate changes can be mitigated by maintaining a balance between
interest rate sensitive assets and liabilities within given time frames.
Management endeavors to maintain consistently strong earnings with minimal
interest rate risk by closely monitoring the sensitivity and repricing of assets
and liabilities to interest rate fluctuations.
One means of evaluating the sensitivity of an institution's net interest income
to changes in interest rates is to examine the extent to which its assets and
liabilities are "interest rate sensitive" and by monitoring an institution's
interest rate sensitivity "gap". An asset or liability is said to
<PAGE> 17
be interest rate sensitive within a specific time period if it will mature or
reprice within that time period. The interest rate sensitivity gap is defined as
the difference between the amount of interest-earning assets maturing or
repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. The following table
reflects the Bank's interest rate sensitivity position both individually and
within specified time periods and cumulatively, over various time horizons. In
the table, assets and liabilities are placed in categories based on their actual
or estimated repricing date. As indicated, at December 31, 1996, the ratio of
rate-sensitive assets to rate-sensitive liabilities maturing or repricing within
one year or less is 108% (a positive one-year gap position). In a period of
generally falling interest rates, this gap position will normally result in a
decrease in net interest income. Whereas, in a period of generally rising
interest rates, this gap position will normally result in an increase in net
interest income.
INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
(dollars in thousands) TIME TO REPRICING OR MATURITY FROM DECEMBER 31, 1996
4 MONTHS OVER 1
3 MONTHS THROUGH THROUGH OVER 3
OR LESS 1 YEAR 3 YEARS YEARS TOTAL
--------------- --------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $50,288 $27,662 $22,628 $ 3,199 $103,777
Mortgage loans held for sale 2,333 - - - $ 2,333
Securities 4,784 2,782 7,373 4,206 $ 19,145
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $57,406 $30,443 $30,001 $ 7,406 $125,256
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Transaction and savings $28,571 $ 860 $6,424 $ 3,137 $ 38,993
Certificates of deposit 11,032 36,138 11,188 776 $ 59,134
Borrowed funds 4,859 30 63 81 $ 5,033
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $44,462 $37,029 $17,675 $ 3,994 $103,160
- ------------------------------------------------------------------------------------------------------------------------------------
Interest sensitivity gap $12,943 $(6,585) $12,326 $ 3,411 $ 22,096
Cumulative interest sensitivity gap $12,943 $ 6,358 $18,684 $22,096
Cumulative net interest-earning
assets as a percentage of
interest-bearing liabilities 129% 108% 119% 121%
</TABLE>
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994. Heritage Financial
recorded record earnings in 1996 with net income of $2,105,000, an increase of
25% over 1995 earnings of $1,687,000. Net income for 1995 increase 41% from the
$1,201,000 earned in 1994 while 1994 net income increased 18% . Net income per
share was $3.84 in 1996, up 23% over the $3.12 earned in 1995. In 1995, net
income per share rose 32% from $2.37 earned in 1994. Return on average equity
rose to 20.27% in 1996 from 19.79% in 1995 and 17.38% in 1994.
<PAGE> 18
Return on average assets improved for the year ended December 31, 1996, to 1.76%
from 1.66% in 1995 and 1.39% in 1994.
NET INTEREST INCOME. The Bank's largest single source of earnings results from
net interest income, the difference between interest (including fees) earned on
loans, securities and other earning assets and the interest paid on deposits and
other borrowings obtained to fund them. The net interest margin is net interest
income, on a taxable equivalent (TE) basis, expressed as a percentage of average
earning assets. This permits comparability by incorporating the tax savings of
certain assets. The margin is influenced by a number of factors, such as the
volume and mix of earning assets and funding sources, the interest rate
environment and income tax rates. The level of earning assets funded by interest
free funding sources (primarily noninterest-bearing demand deposits and equity
capital) also impacts net interest margin.
Measured on a fully taxable equivalent (TE) basis, net interest income for 1996
increased $1,124,000 or 22% over the prior year. Average earning assets
increased 18% or $17.4 million between years while the net interest margin
increased slightly from 5.43% to 5.59%. During 1996, the yield on average
earning assets increased 34 basis points due to: (1) loan yields rising from
10.32% to 10.41% and (2) the significant change in the mix of earning assets as
the average balances of higher yielding loans rose $21 million (29%) while
securities decreased $3.4 million (15%). Average interest-bearing liabilities
grew $13.3 million or 17%. The Bank experienced slight growth in savings and
daily interest checking, up 3%, while higher paying money market accounts and
certificates of deposit grew 7% and 25%, respectively. The growth in higher
paying deposit accounts, combined with interest rate pressures in 1996, caused
the cost of interest-bearing liabilities to rise to 5.01%, a 28 basis point
increase.
In 1995, net interest income (TE) increased $1,024,000 or 25%, compared to an
increase of $747,000 or 22% in the prior year. Average earning assets rose 17%
or $14.1 million while the net interest margin increased from 5.11% to 5.43%.
During 1995, the yield on average earning assets increased 112 basis points due
to: (1) loan yields increasing 114 basis points from 9.18% to 10.32%, and (2)
the shift in the mix of earning assets towards the higher yielding loan
portfolio as the average balances of loans rose $14 million (24%) while
investment securities rose only $.9 million (4%). Average interest-bearing
liabilities increased $10.3 million (15%). This increase was primarily due to
the increase in higher paying certificates of deposit, up $9.3 million (27%), as
all other deposit accounts grew only 1%. The change in the mix towards higher
paying certificates of deposit combined with increased market interest rates and
competitive pressures in 1995, caused the cost of interest bearing liabilities
to rise to 4.73%, a 104 basis point increase.
PROVISION FOR LOAN LOSSES. The provision for loan losses is the charge to
operating earnings that management determines to be necessary to maintain the
allowance for loan losses at an adequate level, and reflects management's
estimate of the risk of loss inherent in the loan portfolio. The provision for
loan losses was $485,000, $374,000 and $307,000 in 1996, 1995 and 1994,
respectively. The provision has increased to cover the growth in the loan
portfolio and the increase in net chargeoffs. Net chargeoffs to average loans
outstanding was .22% ($208,000), .18% ($129,000) and .13% ($79,000) for 1996,
1995 and 1994, respectively.
<PAGE> 19
NONINTEREST INCOME. Noninterest income, also called fee income, is a significant
source of the Bank's revenue. Excluding securities gains, noninterest income
contributed 35%, 33% and 35% in 1996, 1995 and 1994, respectively, of tax
equivalent revenues. Total noninterest income (excluding securities gains in all
periods) increased 33%, 14% and 28% in 1996, 1995 and 1994, respectively.
Noninterest income (excluding securities gains) as a percentage of average
assets was 2.82%, 2.48% and 2.56% for 1996, 1995 and 1994, respectively.
The mortgage banking operation increased its market share during 1996, as
mortgage banking income increased $362,000 (74%) following declines in 1995 of
$98,000 (17%) and 1994 of $131,000 (18%). The brokerage subsidiary's first full
year of operations under the broker/dealer relationship Robert Thomas Securities
resulted in increased brokerage fees of $191,000 (332%) in 1996, following an
increase of $9,000 (13%) in 1995 and a decline of $50,000 (41%) in 1994. Service
charges on deposit accounts increased $60,000 (5%) in 1996, $186,000 (16%) in
1995 and $478,000 (72%) in 1994.
NONINTEREST EXPENSES. Noninterest expense, also called operating expense,
increased $1,255,000 (27%), $466,000 (11%) and $1,063,000 (35%) in 1996, 1995
and 1994, respectively. The increases in noninterest expense are primarily due
to the Bank's rapid growth. The ratio of noninterest expense as a percentage of
average assets was 4.90%, 4.52% and 4.76% for 1996, 1995 and 1994, respectively.
Salaries and employee benefits, the largest component of noninterest expense,
increased 37% in 1996 compared to 10% and 32% in 1995 and 1994, respectively.
The ratio of personnel expense as a percentage of average assets was 2.62% in
1996, compared to 2.24% and 2.40%, respectively for 1995 and 1994. Salaries and
employee benefits include commissions paid in the brokerage service and mortgage
banking operation. As the revenues increase or decrease in these business lines,
the commissions change accordingly. Also, contributions to the employee
incentive bonus and ESOP pension plans are contingent upon the Company attaining
certain asset growth and/or net income goals which are predetermined annually.
The contributions to these plans increase or decrease in relationship to the
level of asset growth and/or net income achieved. Management plans to leverage
personnel costs through continued investments in advanced technology equipment.
All of the noninterest expense categories increased in 1996, 1995 and 1994.
These increases are the result of the Bank's rapid growth, investment in
branches and technology, and costs related to generating noninterest income.
However, these increases were partially offset by lower deposit assessment rates
as the recapitalization of the FDIC Bank Insurance Fund (BIF) was completed in
1995. The regulatory risk classification of "well capitalized" entitles the Bank
to receive the lowest deposit assessment rate from the FDIC. Assessments for
FDIC deposit insurance were $2,000, $99,000, and $167,000 for 1996, 1995, and
1994, respectively. The Bank's occupancy expense is anticipated to increase
following the construction of a new main office building with a scheduled
completion date in early 1998, and an estimated construction cost of $4 million.
Also, increased furniture and equipment expense is anticipated in 1997 and 1998
due to additional
<PAGE> 20
leases for automated teller machines, advanced technological equipment and
furnishings for the new main office building.
PROVISION FOR INCOME TAXES. The Company records a provision for income taxes
currently payable and for taxes payable in the future because of differences in
the timing of recognition of certain items for financial statement and income
tax purposes. The major differences between the effective tax rate applied to
the Company's financial statement income and the federal statutory rate is
caused by state income taxes, net of federal tax benefit, and interest on
tax-exempt securities and loans. The Company's effective tax rate was 37%, 36%
and 35% in 1996, 1995 and 1994, respectively. See Note 9 to the consolidated
financial statements for additional details of the Company's income tax
provision.
<PAGE> 21
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND
INTEREST DIFFERENTIAL. The following table sets forth certain information
relating to the Company's average consolidated balance sheets and consolidated
statements of income for the years ended December 31, 1996 and 1995.
AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
(Dollars in Thousands) 1996 1995
----------------------------------- --------------------------------
AVERAGE Average
AVERAGE YIELD/ Average Yield/
ASSETS BALANCE INTEREST COST Balance Interest Cost
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Earning Assets
Net loans (1) $ 93,599 $ 9,746 10.41% $ 72,635 $7,497 10.32%
Taxable securities 15,524 930 5.99% 18,568 1,130 6.08%
Tax-exempt securities 3,478 246 7.07% 3,870 277 7.16%
Federal funds sold 51 3 4.98% 150 8 5.64%
- ---------------------------------------------------------------------------------------------------------------------
Total earning assets 112,651 10,925 9.70% 95,222 8,912 9.36%
Nonearning assets 6,787 6,460
- ---------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $119,438 $101,682
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing Liabilities
Interest checking $ 8,523 $ 178 2.09% $ 8,450 $ 188 2.22%
Money market accounts 19,656 848 4.31% 18,386 763 4.15%
Savings deposits 4,976 122 2.46% 4,714 116 2.45%
Retirement accounts 3,227 178 5.51% 3,292 194 5.88%
Certificate of deposits 53,626 3,175 5.92% 43,008 2,410 5.60%
Other borrowings 2,359 129 5.45% 1,216 71 5.86%
- ---------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 92,367 4,629 5.01% 79,066 3,741 4.73%
Noninterest-bearing liabilities 16,684 14,173
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities 109,052 93,239
Stockholders' equity 10,386 8,443
- ---------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $119,438 $101,682
Net interest income/net interest spread $ 6,295 4.69% $5,171 4.63%
Net earning assets/net interest margin (2) $ 20,284 5.59% $ 16,156 5.43%
</TABLE>
(1) Net loans include mortgage loans held for sale, and principal balances on
non accrual loans. Interest income relating to nonaccrual loans is not
included.
(2) Net interest margin represents net interest income divided by average
earning assets.
(3) Tax-exempt loans and securities are presented on a taxable equivalent basis.
<PAGE> 22
RATE/VOLUME ANALYSIS. The following table presents for the years ended December
31, 1996 and 1995, the extent to which changes in interest rates and changes in
the volume of earning assets and interest-bearing liabilities have affected the
Company's interest income and expense during the years indicated.
RATE / VOLUME ANALYSIS
(dollars in thousands)
<TABLE>
<CAPTION>
1996 VS. 1995 1995 VS. 1994
ASSETS INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
----------------------------- -----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans $2,164 $ 85 $2,249 $1,287 $828 $2,115
Taxable securities (185) (14) (199) 47 95 142
Tax exempt securities (28) (3) (31) 5 1 6
Federal funds sold (6) (1) (7) (35) 2 (33)
- -------------------------------------------------------------------------------------------------
Total interest income 1,945 67 2,012 1,304 926 2,230
- -------------------------------------------------------------------------------------------------
Interest expense on:
Interest checking 2 (12) (10) 11 1 12
Money market accounts 53 32 85 (43) 218 175
Savings deposits 6 1 7 14 (1) 13
Retirement accounts (4) (12) (16) 30 31 61
Certificates of deposit 595 170 765 417 473 890
Other borrowings 67 (10) 57 35 20 55
- -------------------------------------------------------------------------------------------------
Total interest expense 719 169 888 464 742 1,206
- -------------------------------------------------------------------------------------------------
NET INTEREST INCOME $1,226 $(102) $1,124 $ 840 $184 $1,024
</TABLE>
Changes attributable to changes in both rate and volume have been allocated to
rate.
<PAGE> 23
INVESTMENT PORTFOLIO. All of the Bank's investment securities are classified as
available-for-sale. The carrying value of investment securities is summarized as
follows:
(dollars in thousands)
<TABLE>
<CAPTION>
December 31
Investment Category 1996 1995
------------------- ------- --------
<S> <C> <C>
U.S. Agencies $11,341 $10,866
Mortgage-backed securities 4,204 6,770
Tax-exempt securities 3,202 3,846
Equity securities 398 300
------- --------
Total $19,145 $21,782
======= ========
</TABLE>
The following table presents the carrying value by maturity distribution of the
investment portfolio along with weighted average yields thereon as of December
31, 1996.
(dollars in thousands)
<TABLE>
<CAPTION>
Within 1-5 Beyond 5
Investment Category 1 Year Years Years Total
------------------- ------ ----- -------- -----
<S> <C> <C> <C> <C>
U.S. agencies $ 348 $ 8,003 $2,990 $11,341
Tax-exempt securities 312 1,876 1,014 3,202
----- ------- ------ -------
Total $ 660 $ 9,879 $4,004 $14,543
===== ======= ====== =======
Weighted average yield (tax
equivalent basis) 5.60% 5.81% 7.32% 6.22%
===== ======= ====== =======
Mortgage-backed and equity securities $ 4,602
=======
Weighted average yield of mortgage-backed and equity securities 6.49%
=======
</TABLE>
<PAGE> 24
LOAN PORTFOLIO. The following table presents as of December 31, 1996 and 1995, a
summary of loans outstanding by category.
(dollars in thousands)
<TABLE>
<CAPTION>
As of December 31,
---------------------
Type of Loan 1996 1995
------------ -------- -------
<S> <C> <C>
Domestic:
Real estate:
1-4 family residential properties $ 22,336 $20,288
Construction 16,729 9,164
Commercial 26,077 20,663
Commercial, financial and
agricultural 20,291 15,926
Consumer 18,379 14,573
-------- -------
103,812 80,614
Less: unearned interest (35) (44)
-------- -------
Total loans $103,777 $80,570
======== =======
</TABLE>
The following is a presentation of real estate-commercial, real
estate-construction, and commercial, financial and agricultural loans by
contractual maturity as of December 31, 1996.
<TABLE>
<CAPTION>
(dollars in thousands) Over 1
1 year through Over 5
Type of Loan or less 5 years years Total
- ------------ ------- ------- ------ --------
<S> <C> <C> <C> <C>
Domestic:
Real estate - commercial $ 3,932 4,176 17,969 $26,077
Real estate - construction $16,492 22 215 $16,729
Commercial, financial and
agricultural $13,533 4,987 1,771 $20,291
</TABLE>
At December 31, 1996, loans due after one year with predetermined interest rates
totaled $14,424,000, and loans due after one year with floating or adjustable
interest rates totaled $45,918,000.
The following table presents information regarding nonperforming assets and
accruing loans which are contractually past due 90 days or more as to principal
or interest payments. Nonperforming assets consist of (a) nonaccrual loans, (b)
restructured loans, and (c) foreclosed and repossessed assets.
<PAGE> 25
(dollars in thousands)
<TABLE>
<CAPTION>
Nonperforming Assets: December 31, 1996 December 31, 1995
- --------------------- ------------------ -----------------
<S> <C> <C>
Nonaccrual loans $ 173 $ 120
Restructured loans 86 93
Foreclosed and repossessed assets 74 247
----- -----
Total nonperforming assets $ 333 $ 460
===== =====
Accruing loans (including consumer
loans) which are contractually past
due 90 days or more as to principal
and interest payments $ 935 $ 16
===== =====
</TABLE>
A loan is considered impaired when it is probable that the Company will be
unable to collect the scheduled payments of principal and interest due under the
contractual terms of the loan agreement. Impaired loans are measured at the
present value of expected cash flows discounted at the loan's effective interest
rate, at the loan's observable market price, or at the fair value of the
collateral if the loan is collateral dependent.
The Company considers all loans on nonaccrual to be impaired. Interest accruals
on loans are discontinued when, in the opinion of management, it is not
reasonable to expect that such interest will be collected, or generally, when
collection of principal or interest becomes 90 days or more past due. Management
may make exceptions to this policy when the estimated net realizable value of
the collateral is sufficient to recover the principal and interest balance. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
During 1996, interest income that would have been earned on nonaccrual loans if
the loans had been current in accordance with their original terms and had been
outstanding throughout the period amounted to $13,000. Interest income
recognized on nonaccrual loans amounted to $5,000 in 1996.
Potential problem loans, which are not included in nonperforming assets, were
$766,000 of total loans at December 31, 1996, as compared to $498,000 of total
loans at December 31, 1995. Potential problem assets represent those assets
where information about possible credit problems of borrowers has caused
management to have serious doubts about the borrower's ability to comply with
present repayment terms. This definition is believed to be substantially
consistent with the standards established by banking regulatory agencies for
loans classified substandard and doubtful.
There are no other loans which are not disclosed above, but where known
information about possible credit problems of borrowers causes management to
have serious doubts as to the ability of such borrowers to comply with the
present loan repayment terms.
<PAGE> 26
As of December 31, 1996, the Bank had no concentrations of ten percent or more
of total loans in any single industry nor any geographical area outside the
immediate market area of the Bank.
Although the Company's loan portfolio is concentrated in Montgomery County,
Tennessee and the surrounding counties in Tennessee and Kentucky, management
does not believe this geographic concentration presents an abnormally high risk.
SUMMARY OF LOAN LOSS EXPERIENCE. The activity in the Bank's allowance for loan
losses is presented in the following table for the years ended December 31, 1996
and 1995.
(dollars in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------
1996 1995
------ -------
<S> <C> <C>
Balance at beginning of period $1,267 $1,023
------ ------
Charge-offs:
Real estate:
1-4 family residential properties - -
Construction - -
Commercial - -
Commercial, financial and agricultural 93 19
Consumer 151 131
------- ------
244 150
------- ------
Recoveries:
Real estate:
1-4 family residential properties - -
Construction - -
Commercial - -
Commercial, financial and agricultural 29 1
Consumer 7 19
------- ------
36 20
------- ------
Net charge-offs 208 130
------- ------
Additions charged to operations 485 374
------- ------
Balance at end of period $ 1,544 $1,267
======= ======
Ratio of net charge-offs to average loans
outstanding during the periods 0.22% 0.18%
------- ------
</TABLE>
<PAGE> 27
At December 31, 1996 and 1995, the allowance for loan losses was allocated as
follows:
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------------- ---------------------------
% of loans % of loans
in each category in each category
Amount to toal loans Amount to toal loans
------ ------------- ------ -------------
<S> <C> <C> <C> <C>
Real estate:
1-4 family residential properties $ 129 21.5% $ 72 25.2%
Construction 125 16.1% 70 11.4%
Commercial 160 25.1% 170 25.6%
Commercial, financial & agricultural 265 19.6% 158 19.8%
Consumer 231 17.7% 186 18.0%
Unallocated 634 N/A 611 N/A
Total $1,544 100% $1,267 100%
====== === ====== ===
</TABLE>
DEPOSITS. The following tables present, for the periods indicated, the average
amount of and average rate paid on each of the following deposit categories:
(dollars in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31,1996 December 31,1995
------------------ -------------------
Average Average Average Average
Deposit Category Amount Rate Paid Amount Rate Paid
---------------- -------- --------- -------- ---------
<S> <C> <C> <C> <C>
Non interest-bearing demand $ 15,747 - $13,648 -
Interest checking 8,523 2.09% 8,450 2.22%
Money market accounts 19,656 4.31% 18,386 4.15%
Savings deposits 4,976 2.46% 4,714 2.45%
Retirement accounts 3,227 5.51% 3,292 5.88%
Certificates of deposit 53,626 5.92% 43,008 5.60%
-------- -------
Total $105,755 $91,498
======== =======
</TABLE>
<PAGE> 28
The following table presents the amount outstanding of time certificates of
deposit of $100,000 or more and respective maturities for the year ended
December 31, 1996.
(dollars in thousands)
<TABLE>
<CAPTION>
Time Certificate
of Deposits
----------------
<S> <C>
3 months or less $1,984
3 to 6 months 629
6 to 12 months 2,854
over 12 months 743
-------
Total $6,210
=======
</TABLE>
RETURN ON EQUITY AND ASSETS. Return on average assets (ROA), return on average
stockholders' equity (ROE), average equity to average assets ratio, and dividend
payout ratio for the periods indicated are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------
1996 1995
------ ------
<S> <C> <C>
Return on average assets 1.76% 1.66%
Return on average equity 20.27% 19.79%
Average equity to average assets ratio 8.69% 8.28%
Dividend payout ratio 26.04% 23.54%
</TABLE>
SHORT-TERM BORROWINGS. The Company did not have any category of short-term
borrowings for which the average balance outstanding during the reported periods
was 30 percent or more of stockholders' equity at the end of the reported
periods.
<PAGE> 29
ITEM 7. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heritage Financial Services, Inc.
We have audited the consolidated balance sheets of Heritage Financial Services,
Inc. and Subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our 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 financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Heritage Financial
Services, Inc. and Subsidiary as of December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for mortgage servicing rights in 1996.
/s/ Heathcott & Mullaly P.C.
January 10, 1997
<PAGE> 30
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $ 3,598,438 4,512,673
Securities, available-for-sale, at fair value 19,144,724 21,781,294
Mortgage loans held for sale 2,333,480 1,696,280
Loans 103,777,428 80,569,610
Allowance for loan losses (1,544,123) (1,267,252)
- -----------------------------------------------------------------------------------------------------
NET LOANS 102,233,305 79,302,358
- -----------------------------------------------------------------------------------------------------
Premises and equipment 2,490,820 2,363,142
Accrued interest receivable 1,293,007 942,626
Deferred income taxes 571,797 436,211
Foreclosed and repossessed assets 73,450 246,982
Other assets 1,044,426 679,796
- -----------------------------------------------------------------------------------------------------
TOTAL ASSETS $132,783,447 111,961,362
=====================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------
DEPOSITS:
Noninterest-bearing $ 17,184,748 16,998,699
Interest-bearing 98,126,860 83,059,479
- -----------------------------------------------------------------------------------------------------
TOTAL DEPOSITS 115,311,608 100,058,178
- -----------------------------------------------------------------------------------------------------
Federal funds purchased 4,850,000 1,400,000
Advances from Federal Home Loan Bank 183,159 220,792
Accrued interest payable 442,872 418,670
Other liabilities 732,606 516,735
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 121,520,245 102,614,375
- -----------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Common stock, $2.00 par value. Authorized
1,000,000 shares; issued 552,862 shares
in 1996 and 529,622 shares in 1995 1,105,724 1,059,244
Additional paid-in capital 4,880,475 4,494,993
Retained earnings 5,358,522 3,800,907
Unrealized losses on securities
available-for-sale, net (40,536) (8,157)
Less 1,495 treasury shares at cost (40,983) -
- -----------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 11,263,202 9,346,987
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $132,783,447 111,961,362
=====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 31
- ------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Loans, including fees $ 9,741,973 7,479,626 5,375,594
Investment securities:
Taxable 930,172 1,129,585 987,135
Tax-exempt 171,462 192,492 190,975
Federal funds sold 2,534 8,452 41,639
- ---------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 10,846,141 8,810,155 6,595,343
- ---------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits 4,500,893 3,669,951 2,518,709
Other 128,590 71,267 16,917
- ---------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 4,629,483 3,741,218 2,535,626
- ---------------------------------------------------------------------------------------------
NET INTEREST INCOME 6,216,658 5,068,937 4,059,717
PROVISION FOR LOAN LOSSES 485,000 374,000 307,000
- ---------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 5,731,658 4,694,937 3,752,717
- ---------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Service charges on deposit accounts 1,383,177 1,323,463 1,137,835
Mortgage banking activities 852,127 490,156 588,146
Net securities gains 83,126 1,986 3,142
Brokerage fees 273,029 82,180 72,959
Other 854,262 632,636 423,896
- ---------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME 3,445,721 2,530,421 2,225,978
- ---------------------------------------------------------------------------------------------
NONINTEREST EXPENSES:
Salaries and employee benefits 3,129,271 2,280,444 2,080,744
Occupancy 487,888 407,443 317,010
Furniture and equipment 417,587 372,519 336,561
Data processing 412,363 365,478 283,380
Advertising and public relations 280,536 262,834 218,565
Other 1,126,049 909,915 896,439
- ---------------------------------------------------------------------------------------------
TOTAL NONINTEREST EXPENSES 5,853,694 4,598,633 4,132,699
- ---------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 3,323,685 2,626,725 1,845,996
INCOME TAXES 1,218,685 939,816 645,427
- ---------------------------------------------------------------------------------------------
NET INCOME $ 2,105,000 1,686,909 1,200,569
=============================================================================================
NET INCOME PER SHARE $ 3.84 3.12 2.37
=============================================================================================
AVERAGE NUMBER OF COMMON AND
COMMON EQUIVALENT SHARES 547,900 540,001 506,497
=============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 32
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
UNREALIZED
ADDITIONAL GAINS
COMMON PAID-IN RETAINED (LOSSES) ON TREASURY
STOCK CAPITAL EARNINGS SECURITIES STOCK
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993 939,112 3,833,423 1,611,066 131,929 -
Dividends declared, $0.60 per share - - (300,509) - -
Exercise of stock options 55,220 220,880 - - -
Shares issued under employee benefit
plan and dividend reinvestment plan 34,072 316,782 - - -
Purchase of treasury shares - - - - (1,327)
Change in unrealized gain (loss) on
securities available-for-sale - - - (584,951) -
Net income - - 1,200,569 - -
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 1,028,404 4,371,085 2,511,126 (453,022) (1,327)
Dividends declared, $0.75 per share - - (397,128) - -
Exercise of stock options 30,840 123,360 - - -
Purchase of treasury shares - - - - (1,000)
Sale of treasury shares - 548 - - 2,327
Change in unrealized loss on
securities available-for-sale - - - 444,865 -
Net income - - 1,686,909 - -
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 1,059,244 4,494,993 3,800,907 (8,157) -
Dividends declared, $1.00 per share - - (547,385) - -
Issuance of common stock 3,584 50,176 - - -
Exercise of stock options 25,694 108,776 - - -
Purchase of treasury shares - - - - (40,983)
Shares issued under employee
benefit plan 17,202 226,530 - -
Change in unrealized loss on
securities available-for-sale - - - (32,379) -
Net income - - 2,105,000 - -
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 $1,105,724 4,880,475 5,358,522 (40,536) (40,983)
=================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 33
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
NET INCOME $ 2,105,000 1,686,909 1,200,569
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred income tax benefit (117,000) (117,000) (110,000)
Depreciation and amortization 356,122 366,113 328,151
Net securities gains (83,126) (1,986) (3,142)
Provision for loan losses 485,000 374,000 307,000
Net accretion of securities (106,613) (77,646) (111,904)
Mortgage loans originated for sale (40,324,099) (25,763,263) (29,881,718)
Proceeds from sale of mortgage loans 39,686,899 25,405,147 30,796,160
Increase in accrued interest receivable (350,381) (178,026) (238,875)
Increase in accrued interest payable 24,202 126,991 117,798
Increase in other liabilities 215,871 55,779 244,708
Other, net (227,479) (104,349) 85,730
- --------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,664,396 1,772,669 2,734,477
- --------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in federal funds sold -- -- 300,000
Proceeds from sales of securities available-for-sale 3,428,727 1,417,813 660,662
Maturities and redemptions of securities
available-for-sale 2,128,530 1,660,240 1,437,418
Maturities and redemptions of securities
held-to-maturity -- 745,743 762,891
Purchases of securities available-for-sale (2,762,675) (1,478,906) (1,374,352)
Purchases of securities held-to-maturity -- (617,177) (5,232,114)
Advances to limited liability company (2,662) (485,157) --
Net increase in other loans (23,415,947) (17,571,893) (11,057,119)
Purchases of premises and equipment, net (463,995) (210,282) (663,098)
- --------------------------------------------------------------------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (21,088,022) (16,539,619) (15,165,712)
- --------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 15,253,430 14,972,753 12,064,429
Increase in federal funds purchased 3,450,000 280,000 1,120,000
Increase (decrease) in advances
from Federal Home Loan Bank (37,633) (38,784) 259,576
Proceeds from issuance of common stock 431,962 154,200 626,954
Purchase of treasury shares (40,983) (1,000) (1,327)
Proceeds from sale of treasury shares -- 2,875 --
Cash dividends paid (547,385) (397,128) (300,509)
- --------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 18,509,391 14,972,916 13,769,123
- --------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND
DUE FROM BANKS (914,235) 205,966 1,337,888
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 4,512,673 4,306,707 2,968,819
- --------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF YEAR $ 3,598,438 4,512,673 4,306,707
- --------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during year for interest $ 4,605,281 3,614,227 2,255,029
Cash paid during year for income taxes $ 1,416,594 1,059,102 810,207
- --------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 34
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Heritage Financial Services, Inc., through its subsidiary, Heritage
Bank, provides a variety of banking and investment services to
individuals and businesses from its seven locations in Clarksville and
Montgomery County, Tennessee. Its primary deposit products are demand
and savings deposits and certificates of deposit, and its primary
lending products are commercial, real estate mortgage and installment
loans. The Bank provides investment services through Heritage
Investment Center, Inc. and insurance services through Central Life
Insurance Company, both wholly-owned subsidiaries of the Bank (see Note
16). The accounting principles followed and the methods of applying
those principles conform with generally accepted accounting principles
and to general practices in the banking industry. The significant
policies are summarized as follows:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the
accounts of Heritage Financial Services, Inc. (the Company), a
one-bank holding company formed April 15, 1992, and its wholly-owned
subsidiary, Heritage Bank (the Bank). Material intercompany accounts
and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting periods. Actual results could differ
from those estimates.
CASH AND CASH EQUIVALENTS
For the purpose of presentation in the statements of cash flows, cash
and cash equivalents are defined as those amounts included in the
balance sheet caption "cash and due from banks".
INVESTMENT SECURITIES
Securities are classified into three categories: held-to-maturity
(HTM), available-for-sale (AFS), and trading. Securities classified as
held-to-maturity, which are those the Company has the positive intent
and ability to hold to maturity, are reported at amortized cost.
Securities classified as available-for-sale may be sold in response to
changes in interest rates, liquidity needs, and for other purposes.
These securities are reported at fair value and include securities not
classified as held-to-maturity or trading. Trading securities are those
held principally for the purpose of selling in the near future and are
carried at fair value. Unrealized holding gains and losses for
available-for-sale securities are excluded from earnings and reported,
net of any income tax effect, as a separate component of stockholders'
equity. Realized gains and losses are reported in earnings based on
the adjusted cost of the specific security sold. The Company currently
has no held-to-maturity or trading securities.
LOANS
Loans which management has the intent and ability to hold for the
foreseeable future are reported at their outstanding principal
balance. Interest on commercial and real estate loans is computed
daily based on the principal amount outstanding. Interest on
installment loans is recognized using both the interest method and a
method which approximates the interest method. Loan origination fees
in excess of related direct costs are deferred and recognized as an
adjustment of yield using the interest method.
<PAGE> 35
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
LOANS, CONTINUED
A loan is considered impaired when it is probable that the Company
will be unable to collect the scheduled payments of principal and
interest due under the contractual terms of the loan agreement.
Impaired loans are measured at the present value of expected future
cash flows discounted at the loan's effective interest rate, at the
loan's observable market price, or at the fair value of the collateral
if the loan is collateral dependent. If the measure of the impaired
loan is less than the recorded investment in the loan, a creditor
shall recognize an impairment by creating or adjusting a valuation
allowance with a corresponding charge or credit to the provision for
loan losses.
The Company considers all loans on non-accrual status to be impaired.
Interest accruals on loans are discontinued when, in the opinion of
management, it is not reasonable to expect that such interest will be
collected, or generally, when collection of principal or interest
becomes 90 days or more past due. Management may make exceptions to
this policy when the estimated net realizable value of the collateral
is sufficient to recover the principal and interest balance. When
interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the
extent cash payments are received.
MORTGAGE LOANS HELD FOR SALE
Certain mortgage loans held for sale to permanent investors are stated
at lower of cost or market in the aggregate with respect to the entire
portfolio. At December 31, 1996, cost approximates the market value of
such loans.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established by charges to operations
based on management's evaluation of the assets, economic conditions
and other factors considered necessary to maintain the allowance at an
adequate level. In evaluating the adequacy of the allowance, management
makes certain estimates and assumptions which are susceptible to
change in the near term. While management uses available information
to recognize losses on loans, future additions to the allowance may be
necessary based on changes in economic conditions. Uncollectible loans
are charged to the allowance account in the period such determination
is made. Recoveries on loans previously charged off are credited to
the allowance account in the period received. Allowances for impaired
loans are generally determined based on collateral values or the
present value of estimated cash flows.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. The provision for depreciation is
computed principally on the straight-line method over the estimated
useful lives of the assets.
FORECLOSED AND REPOSSESSED ASSETS
Real estate acquired through foreclosure is recorded at the lower of
the outstanding loan amount or fair value, determined by appraisal,
less estimated costs to sell, at the date of foreclosure. Other
repossessed assets are recorded at the lower of the loan amount or fair
value, determined by recognized industry standards at the date the
properties are repossessed. Further declines in value, as well as
losses resulting from disposition are charged to operations.
<PAGE> 36
PER SHARE AMOUNTS
Earnings per share is calculated based on the weighted average number
of shares outstanding and common stock equivalents arising from the
assumed exercise of outstanding stock options.
MORTGAGE SERVICING RIGHTS
Effective January 1, 1996, the Company adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights". SFAS No. 122, among other
provisions, requires the recognition of originated mortgage servicing
rights (OMSRs) as assets by allocating the total cost incurred between
the loan and the servicing right based on their fair value. To
determine the fair value of the servicing rights created, the Company
uses market prices under comparable servicing sale contracts. The
OMSRs are being amortized as noninterest expense over the period of
estimated net servicing revenues. The Company has no purchased
mortgage servicing rights.
STOCK-BASED COMPENSATION
In October, 1995, the Financial Accounting Standards Board issued SFAS
No. 123, "Accounting for Stock-Based Compensation", which is effective
for awards granted in fiscal years beginning after December 31, 1995.
The standard defines a fair value-based method of measuring employee
stock options or similar equity instruments. Under this method,
compensation cost is measured at the option grant date based on the
value of the award and is recognized over the service period, which is
usually the vesting period. In lieu of recording the value of such
options, the Company has elected to continue to measure compensation
cost using APB Opinion 25 and to provide pro forma disclosures
quantifying the difference between compensation cost included in
reported net income and the related cost measured by such fair
value-based method.
INCOME TAXES
The Company files a consolidated tax return with its subsidiary.
Income taxes are allocated to members of the consolidated group on a
separate return basis. Income taxes have been provided using the
liability method as prescribed by Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes".
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that value. These fair values are provided for
disclosure purposes only and do not impact carrying values of financial
statement amounts.
Cash and Cash Equivalents - The carrying amounts reported in the
balance sheet for cash and cash equivalents approximate those assets'
fair values.
Securities (including mortgage-backed securities) - Fair values for
securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
Loans Receivable - For variable-rate loans that reprice frequently and
have no significant change in credit risk, fair values are based on
carrying values. The fair values for other loans are estimated using
discounted cash flow analyses, using interest rates currently offered
for loans with similar terms to borrowers of similar credit quality.
Deposit Liabilities - The fair values disclosed for demand deposits
are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). The carrying amounts
for variable-rate, fixed-term money market accounts and certificates of
deposits approximate their fair values at the reporting date. Fair
values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently
offered on certificates to a schedule of expected monthly maturities on
time deposits.
<PAGE> 37
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED Short-Term Borrowings -
The carrying amounts of federal funds purchased approximate their fair
values.
Long-Term Borrowings - The fair values of advances from the Federal
Home Loan Bank are estimated using discounted cash flow analyses,
based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
Accrued Interest - The carrying amounts of accrued interest
approximate their fair values.
Off-Balance Sheet Instruments - Fair values for off-balance sheet
lending commitments are based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standings.
(2) RESTRICTED CASH BALANCES
The Company's subsidiary bank is required to maintain reserves, in the
form of cash and due from banks against its deposit liabilities.
Aggregate reserves of $764,000 were required to be maintained to
satisfy federal regulatory requirements at December 31, 1996.
(3) INVESTMENT SECURITIES
The following table reflects the amortized cost and fair values of
investment securities held at December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996
----------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agencies $11,446,346 26,608 132,153 11,340,801
Mortgage-backed:
U.S. agencies 4,230,377 52,500 78,686 4,204,191
Tax-exempt securities 3,133,226 72,552 4,146 3,201,632
Equity securities 398,100 -- -- 398,100
----------------------------------------------------------------------------------
$19,208,049 151,660 214,985 19,144,724
----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
1995
----------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agencies $11,010,278 35,448 179,837 10,865,889
Mortgage-backed:
U.S. agencies 6,702,589 132,916 65,982 6,769,523
Tax-exempt securities 3,780,702 107,409 42,229 3,845,882
Equity securities 300,000 -- -- 300,000
----------------------------------------------------------------------------------
$21,793,569 275,773 288,048 21,781,294
----------------------------------------------------------------------------------
</TABLE>
<PAGE> 38
(3) INVESTMENT SECURITIES, CONTINUED
The amortized cost and fair value of debt securities at December 31,
1996 by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the
right to call or prepay obligations.
<TABLE>
<CAPTION>
AMORTIZED FAIR
Available-for-Sale: COST VALUE
-------------------------
<S> <C> <C>
Due in one year or less $ 660,066 659,493
Due after one through five years 9,955,294 9,879,277
Due after five through ten years 3,844,212 3,879,693
Due after ten years 120,000 123,970
Mortgage-backed securities 4,230,377 4,204,191
------------------------
$18,809,949 18,746,624
========================
</TABLE>
Securities carried at $1,777,000 and $5,983,000 at December 31, 1996
and 1995, respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.
Included in securities at December 31, 1996, are $2,031,606 in
obligations of political subdivisions located within the state of
Tennessee. Otherwise, the Company did not hold the securities of any
single issuer, other than obligations of U.S. Government agencies,
whose aggregate book value exceeded ten percent of stockholders'
equity.
For the years ended December 31, 1996, 1995 and 1994, the Company had
gross realized gains from sales of securities available-for-sale of
$85,988, $3,142 and $18,658 respectively, and gross realized losses of
$2,862, $827, and $0, respectively.
As a result of a Special Report issued in November, 1995 by the FASB,
the Company reassessed its classification of investment securities and
transferred, at fair value, securities with an amortized cost of
$10,721,000 from held-to-maturity to available-for-sale in December,
1995. The unrealized gain on these securities at the date of transfer
was approximately $40,000.
(4) LOANS
A summary of loans outstanding by category follows:
<TABLE>
<CAPTION>
1996 1995
----------------------------------------------------------------------
<S> <C> <C>
Real estate:
1 to 4 family residential properties $ 22,336,000 20,288,000
construction 16,729,000 9,164,000
commercial 26,077,000 20,663,000
Commercial, financial and agricultural 15,926,000
Consumer 14,572,610
-----------------------------------------------------------------------
103,812,428 180,613,610
Less unearned interest (35,000) (44,000)
-----------------------------------------------------------------------
Total loans $103,777,428 180,569,610
=======================================================================
</TABLE>
At December 31, 1996 and 1995, the Bank had loans amounting to
$173,065 and $120,469, respectively that were specifically classified
as impaired. The allowance for loan losses related to impaired loans
amounted to approximately $26,000 and $18,000 at December 31, 1996 and
1995, respectively. The average balance of these loans amounted to
approximately $107,000, $41,000 and $202,000 for the years ended
December 31, 1996, 1995 and 1994, respectively. The amount of interest
income recognized on these loans was not material to the Bank's
results of operations.
<PAGE> 39
(4) LOANS, CONTINUED
Certain parties (principally directors and officers of the Bank,
including their affiliates, families, and companies in which they hold
ten percent or more ownership) were customers of, and had loans and
other transactions with the Bank in the ordinary course of business.
The outstanding balances of such loans totaled $1,975,200 and
$1,625,700 as of December 31, 1996 and 1995, respectively. During
1996, $2,436,200 of new loans were made and repayments amounted to
$2,086,700. These loan transactions were made on substantially the
same terms as those prevailing at the time for comparable loans to
other persons. They did not involve more than the normal risk of
collectibility or present other unfavorable features.
(5) COMMITMENTS AND CONTINGENT LIABILITIES
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to
extend credit, standby letters of credit and mortgage loans sold with
recourse. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the balance sheet.
The contract or notional amounts of those instruments reflect the
extent of involvement the Bank has in those particular financial
instruments.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend
credit, standby letters of credit, and mortgage loans sold with
recourse is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance
sheet instruments.
<TABLE>
<CAPTION>
CONTRACT OR
NOTIONAL
AMOUNT
-----------
<S> <C>
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $18,611,000
Standby letters of credit 740,000
</TABLE>
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained if deemed
necessary by the Bank upon extension of credit is based on management's
credit evaluation. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing, and
similar transactions. All letters of credit are due within one year or
less of the original commitment date. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers.
In connection with its mortgage banking activities, the Bank may be
required to repurchase certain loans sold if they become delinquent
within a specified period, generally no longer than 120 days. The
number of loans the Bank has been required to repurchase since
inception of the mortgage banking department has not been material.
<PAGE> 40
(5) COMMITMENTS AND CONTINGENT LIABILITIES, CONTINUED
The Bank primarily serves customers located in Montgomery County,
Tennessee and surrounding areas. As such, the Bank's loans,
commitments, and stand-by letters of credit have been granted to
customers in that area. The area's largest employer is the United
States Army base at Fort Campbell which employs approximately 23,000
military personnel and 5,000 civilians. Concentrationof credit by type
of loan is presented in Note 4.
In the normal course of business, the Bank is involved in various
legal proceedings. Management has concluded, based upon advice of
counsel, that the result of these proceedings will not have a material
effect on the Bank's financial condition or results of operations.
(6) ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCE AT BEGINNING OF YEAR $ 1,267,252 1,022,732 794,663
Provision charged to operating expenses 485,000 374,000 307,000
Loan losses:
Loans charged off (244,581) (149,605) (95,881)
Recoveries on loans previously charged off 36,452 20,125 16,950
-------------------------------------------------------------------------------------------------
BALANCE AT END OF YEAR $ 1,544,123 1,267,252 1,022,732
-------------------------------------------------------------------------------------------------
</TABLE>
(7) PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
Annual provisions for depreciation and amortization totaled $336,317,
$353,381, and $321,162 for 1996, 1995 and 1994, respectively. The
following is a summary of bank premises and equipment as of December
31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
-----------------------------------------------------
<S> <C> <C>
Land $ 934,809 934,809
Buildings 884,868 882,159
Furniture and equipment 1,531,771 1,381,860
Leasehold improvements 348,010 338,691
Construction in progress 293,299 --
-----------------------------------------------------
3,992,757 3,537,519
Less allowance for
depreciation and amortization 1,501,937 1,174,377
-----------------------------------------------------
$2,490,820 2,363,142
=====================================================
</TABLE>
During 1996, construction was begun on a new main office building.
Total expenditures for the building are expected to be approximately
$4,000,000 with completion scheduled for early 1998.
Rent expense for 1996, 1995 and 1994 was $246,994, $148,372, and
$124,083, respectively. Future minimum rental payments required under
operating leases that have initial or remaining non-cancelable lease
terms in excess of one year as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
------------ -------
<S> <C>
1997 $378,337
1998 372,779
1999 286,885
2000 171,912
2001 102,417
</TABLE>
<PAGE> 41
(8) DEPOSITS
A summary of deposits at December 31, 1996 and 1995 follows:
<TABLE>
<CAPTION>
1996 1995
-------------------------------------------------------------------------
<S> <C> <C>
Noninterest-bearing demand $17,184,748 16,998,699
Interest checking 9,467,575 9,612,776
Money market accounts 20,755,654 18,439,472
Savings 5,471,362 4,805,588
Retirement accounts 3,298,158 3,240,291
Certificates of deposit of $100,000 or more 6,210,047 5,525,227
Other time 52,924,064 41,436,125
-------------------------------------------------------------------------
$115,311,608 100,058,178
==========================================================================
</TABLE>
Interest expense on deposits of $100,000 or more amounted to $382,048,
$263,370 and $174,431 in 1996, 1995 and 1994, respectively.
(9) INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT: Federal $ 1,118,052 877,376 624,101
State 217,633 179,440 131,326
--------------------------------------------------------------------------------------
Total current 1,335,685 1,056,816 755,427
--------------------------------------------------------------------------------------
DEFERRED: Federal (98,500) (98,500) (91,000)
State (18,500) (18,500) (19,000)
--------------------------------------------------------------------------------------
Total deferred (117,000) (117,000) (110,000)
--------------------------------------------------------------------------------------
Total provision for income taxes $ 1,218,685 939,816 645,427
======================================================================================
</TABLE>
The sources of deferred income taxes (benefits) and the tax effect of
each follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision for loan losses $ (98,500) (84,000) (98,000)
Depreciation (24,500) (40,000) (25,160)
Organization costs -- -- 8,400
Other, net 6,000 7,000 4,760
-------------------------------------------------------------------------------------
$ (117,000) (117,000) (110,000)
=====================================================================================
</TABLE>
The tax effects of each type of temporary difference that gives rise
to net deferred tax assets are as follows:
<TABLE>
<CAPTION>
1996 1995
-------------------------------------------------------------------
<S> <C> <C>
Allowance for loan losses $ 505,260 406,760
Property and equipment 61,500 37,000
Other, net (17,760) (11,760)
Unrealized losses on securities 22,797 4,211
-------------------------------------------------------------------
$ 571,797 436,211
===================================================================
</TABLE>
<PAGE> 42
(9) INCOME TAXES, CONTINUED
A reconciliation of the provision for income taxes with the amount of
income taxes computed at the federal statutory rate (34%) follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax expense at statutory rate $ 1,130,053 893,087 627,639
Increase (decrease) in taxes resulting from:
Tax exempt interest (60,983) (78,598) (68,245)
Disallowed interest expense 8,895 11,768 8,500
State income taxes, net of federal tax benefit 131,428 106,220 72,650
Other, net 9,292 7,339 4,883
---------------------------------------------------------------------------------------------
Total provision for income taxes $ 1,218,685 939,816 645,427
---------------------------------------------------------------------------------------------
</TABLE>
(10) ADVANCES FROM FEDERAL HOME LOAN BANK
The Bank participates in a program with the Federal Home Loan Bank
(FHLB) of Cincinnati to provide funds to the public for affordable
housing. The FHLB advances funds to the bank with the requirement that
the advances be secured by qualifying loans, essentially one to four
family residential mortgages. To participate in this program, the
banks are required to be members of and own stock in the FHLB. The
Bank owns $398,100 of such stock at December 31, 1996 to satisfy this
requirement.
At December 31, 1996, advances from the FHLB totaled $183,159. The
interest rate on these advances ranged from 4.90% to 6.35%. Qualifying
loans totaling $275,000 were pledged as security under a blanket
pledge agreement with the FHLB at December 31, 1996.
Maturities of the FHLB advances are as follows:
<TABLE>
<S> <C>
1997 $ 38,808
1998 41,967
1999 21,469
2000 14,850
2001 25,680
Later years 40,385
--------
$183,159
========
</TABLE>
(11) MORTGAGE SERVICING RIGHTS
The outstanding balance of loans serviced for others was $3,054,000
and $681,000 at December 31, 1996 and 1995, respectively. Mortgage
servicing rights of $33,100 were capitalized in 1996, and amortization
of those rights amounted to approximately $1,000. The Company had no
capitalized servicing rights prior to 1996.
<PAGE> 43
(12) STOCK COMPENSATION PLANS
The Company has two stock option plans, an Employee Stock Option Plan
and an Incorporator Stock Option Plan, which are described below. As
discussed in Note 1, The Company will continue to apply APB Opinion 25
and related Interpretations in accounting for its plans. Accordingly,
no compensation cost has been recognized for either plan. Had
compensation cost for the Company's plans been determined based on the
fair value at the grant date for awards under those plans consistent
with the method of FASB Statement No. 123, the Company's net income
and earnings per share for 1996 would have been reduced to the pro
forma amounts indicated below:
<TABLE>
<S> <C>
Net Income:
As reported $2,105,000
Pro forma 2,091,000
Earnings per Share:
As reported $ 3.84
Pro forma 3.83
</TABLE>
In calculating the pro forma disclosures, the fair value of the
options granted is estimated as of the date granted using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants: dividend yield of 3.0 percent, expected
volatility of 19 percent, risk free interest rate of 7.0 percent; and
expected lives of 4.5 years. No options were granted in 1995. Pro
forma disclosure is not required for 1994.
Employee Stock Option Plan - Adopted in 1989, this plan provides for
the granting of options to purchase up to 150,000 shares. The
per-share exercise price of the options may not be less than the fair
value of a share of common stock on the date the option is granted.
Options become exercisable over a period not to exceed ten years and
generally expire three months after employment is terminated.
Incorporator Stock Option Plan - Adopted in 1989, this plan provides
for the granting of options to purchase up to 35,000 shares for $10
per share (the fair value of the stock at the grant date). As of
December 31, 1996, 35,000 shares have been granted, 33,197 have been
exercised, and 1,803 shares are currently exercisable.
A summary of the status of the Company's stock option plans for the
three years ended December 31, 1996 and changes during those years is
presented below.
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
TOTAL OPTION EXERCISABLE EXERCISE
SHARES SHARES PRICE
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Options outstanding at December 31, 1993 78,880 71,880 10.25
Granted 5,000 - 18.00
Options which became exercisable - 1,000 12.00
Exercised (27,610) (27,610) 10.00
--------------------------------------------------------------------------------------------
Options outstanding at December 31, 1994 56,270 45,270 11.07
Options which became exercisable - 1,500 14.00
Exercised (15,420) (15,420) 10.00
--------------------------------------------------------------------------------------------
Options outstanding at December 31, 1995 40,850 31,350 11.47
Options which became exercisable - 1.500 14.00
Granted 10,050 - 25.00
Exercised (12,847) (12,847) 10.47
--------------------------------------------------------------------------------------------
Options outstanding at December 31, 1996 38,053 20,003 15.38
============================================================================================
</TABLE>
<PAGE> 44
(12) STOCK COMPENSATION PLANS, CONTINUED
The weighted-average fair value of options, calculated using the
Black-Scholes option pricing model, granted during 1996 is $9.42.
The following table summarizes information about the stock options
outstanding under the Company's plans at December 31, 1996:
<TABLE>
<CAPTION>
AVERAGE
EXERCISE NUMBER REMAING NUMBER
PRICE OUTSTANDING LIFE EXERCISABLE
----------------- ----------- ---------- -----------
<S> <C> <C> <C>
10 16,003 2.5 years 16,003
12 7,000 3.5 years 3,000
18 5,000 7.3 years 1,000
25 10,050 6.6 years -
</TABLE>
The effect of these options after applying the "treasury stock" method
was to increase average common shares outstanding by 12,493 in 1996, 17,
414 in 1995, and 24,329 in 1994.
(13) OTHER NONINTEREST INCOME AND EXPENSES
Included in other noninterest income are fees for account receivable
processing of $371,239 in 1996, $264,875 in 1995, and $151,709 in 1994.
A summary of other noninterest expenses is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Communications $ 206,564 157,882 160,908
Supplies 235,702 157,844 158,796
FDIC and general insurance 38,646 131,361 196,386
Other 645,137 462,828 380,349
----------------------------------------------------------------------------------------
$ 1,126,049 909,915 896,439
========================================================================================
</TABLE>
(14) EMPLOYEE BENEFITS
During 1992 the Company established a noncontributory Employee Stock
Ownership Plan ("ESOP"), which covers substantially all employees.
Employer contributions to the ESOP are determined annually by the
board of directors and amounted to $131,250 in 1996, $110,000 in 1995
and $80,000 in 1994.
The Company does not provide postretirement or postemployment benefits
other than those mentioned above.
(15) STOCKHOLDERS' EQUITY
During 1993, the Company adopted a Dividend Reinvestment Plan whereby
stockholders who own at least 100 shares of Company stock are allowed
to reinvest cash dividends in common stock. Shares issued under this
plan amounted to 9,286 in 1994. The Plan was suspended in 1995.
<PAGE> 45
(15) STOCKHOLDERS' EQUITY, CONTINUED
Funds for cash distributions to shareholders and normal operating
expenses of the Company are derived primarily from dividends from the
subsidiary bank. The subsidiary is subject to federal and state
statutes and regulations that impose restrictions on the amount of
dividends that can be declared without prior regulatory approval. At
December 31, 1996, approximately $5,600,000 of retained earnings was
available for dividend declaration without prior regulatory approval.
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company's subsidiary bank is required to
meet specific capital adequacy guidelines that involve quantitative
measures of a bank's assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. Failure to
meet minimum capital requirements can initiate certain mandatory and
possible additional discretionary actions by regulators that, if
undertaken, could have a material effect on the Company's financial
condition. The bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. The risk-based guidelines are
based on the assignment of risk weights to assets and off-balance
sheet items depending on the level of credit risk associated with
them.
In addition to minimum capital requirements, under the regulatory
framework for prompt corrective action, regulatory agencies have
specified certain ratios an institution must maintain to be considered
"undercapitalized", "adequately capitalized", and "well capitalized".
As of December 31, 1996 the most recent notification from the bank's
regulatory authority categorized the bank as "well capitalized". There
are no conditions or events since that notification that management
believes have changed the bank's category.
The bank's capital amounts and ratios at December 31, 1996 were as
follows:
<TABLE>
<CAPTION>
REQUIRED
TO BE REQUIRED
ADEQUATELY TO BE WELL BANK'S
CAPITALIZED CAPITALIZED ACTUAL
-----------------------------------------------------------------------------------
Amount
<S> <C> <C> <C>
Tier I leverage 5,238,000 6,604,000 10,403,000
Tier I risk-based 4,177,000 6,266,000 10,403,000
Total risk-based 8,354,000 10,442,800 11,711,000
Ratio
Tier I leverage 4.00% 5.00% 7.88%
Tier I risk-based 4.00% 6.00% 9.96%
Total risk-based 8.00% 10.00% 11.21%
</TABLE>
(16) BANK SUBSIDIARIES
Heritage Investment Corporation (the Corporation) was incorporated
March 1, 1995, as a wholly-owned subsidiary of Heritage Bank. The only
asset of the Corporation is 40.5 percent of Bi-Banc Industrial
Development, L.L.C. (the LLC). The purpose of the LLC is to build for
speculative sale an industrial building in Clarksville, Tennessee. The
Bank had advanced approximately $485,000 to the LLC as its share of
construction costs at December 31, 1996. That amount is carried in the
balance sheet in other assets. The building was complete and available
for sale or lease at December 31, 1996.
<PAGE> 46
(16) BANK SUBSIDIARIES, CONTINUED
Heritage Investment Center (the Center) was incorporated June 28,
1995, as a wholly-owned subsidiary of Heritage Bank. On July 24, 1995,
the Center purchased the assets of an investment brokerage business.
Goodwill in the amount of $78,735 related to the purchase is being
amortized over five years. The Center is engaged in investment
brokerage activities under the broker/dealer relationship of Robert
Thomas Securities.
Central Life Insurance Company (Central) was incorporated December,
1996 as a wholly-owned subsidiary of Heritage Bank. Central has
entered into a reinsurance arrangement and receives underwriting
profits by providing life and disability insurance to borrowers of
Heritage Bank. Management services are provided to Central through a
third party.
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
----------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 3,598,438 3,598,438 4,512,673 4,512,673
Securities 19,144,724 19,144,724 21,781,294 21,781,294
Loans receivable 103,777,428 104,730,000 80,569,610 80,700,000
Financial liabilities:
Deposits $ 115,311,608 115,546,000 100,058,178 100,110,000
Federal funds purchased 4,850,000 4,850,000 1,400,000 1,400,000
FHLB advances 183,159 180,000 220,792 217,000
Off-balance sheet instruments:
<CAPTION>
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loan commitments $ 18,611,000 - 11,593,000 -
Letters of credit 740,000 - 992,000 -
</TABLE>
<PAGE> 47
(18) PARENT COMPANY FINANCIAL INFORMATION
Following are condensed balance sheets of Heritage Financial Services,
Inc. (parent company only) as of December 31, 1996 and 1995, and the
related condensed statements of operations and cash flows for the
three years ended December 31, 1996.
<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
DECEMBER 31, 1996 1995
--------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash $ 345,159 55,160
Investment in subsidiary bank, at equity 10,909,369 9,241,167
Other assets 9,674 50,760
-------------------------------------------------------------------------------------------
TOTAL ASSETS $11,264,202 9,347,087
===========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Other liabilities $ 1,000 100
Stockholders' equity:
Common stock, $2.00 par value 1,105,724 1,059,244
Additional paid-in capital 4,880,475 4,494,993
Retained earnings 5,358,522 3,800,907
Unrealized losses on AFS securities, net (40,536) (8,157)
Less treasury stock at cost (40,983) -
-------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 11,263,202 9,346,987
-------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $11,264,202 9,347,087
===========================================================================================
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 1995 1994
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME:
Dividends from subsidiary $ 400,000 400,000 300,000
Other income 12,381 12,505 -
------------------------------------------------------------------------------------------------------
TOTAL INCOME 412,381 412,505 300,000
------------------------------------------------------------------------------------------------------
EXPENSES:
Other expenses 3,962 9,253 17,711
------------------------------------------------------------------------------------------------------
NET INCOME BEFORE INCOME TAXES AND EQUITY
IN UNDISTRIBUTED INCOME OF SUBSIDIARY 408,419 403,252 282,289
INCOME TAX EXPENSE (BENEFIT) 4,000 656 (6,000)
------------------------------------------------------------------------------------------------------
NET INCOME BEFORE EQUITY IN
UNDISTRIBUTED EARNINGS OF SUBSIDIARY 404,419 402,596 288,289
EQUITY IN UNDISTRIBUTED EARNINGS
OF SUBSIDIARY 1,700,581 1,284,313 912,280
------------------------------------------------------------------------------------------------------
NET INCOME $2,105,000 1,686,909 1,200,569
======================================================================================================
</TABLE>
<PAGE> 48
18) PARENT COMPANY FINANCIAL INFORMATION, CONTINUED
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 1995 1994
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,105,000 1,686,909 1,200,569
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed earnings
of subsidiary (1,700,581) (1,284,313) (912,280)
Other, net 41,986 8,884 (31,865)
- ---------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 446,405 411,480 256,424
- ---------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 431,962 154,200 626,954
Purchase of treasury stock (40,983) (1,000) (1,327)
Proceeds from sale of treasury stock -- 2,875 --
Capital contributed to subsidiary -- (150,000) (567,000)
Cash dividends paid (547,385) (397,128) (300,509)
- ---------------------------------------------------------------------------------------------------------------
NET CASH USED BY FINANCING ACTIVITIES (156,406) (391,053) (241,882)
- ---------------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH 289,999 20,427 14,542
CASH AT BEGINNING OF YEAR 55,160 34,733 20,191
- ---------------------------------------------------------------------------------------------------------------
CASH AT END OF YEAR $ 345,159 55,160 34,733
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> 49
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements with the Company's independent auditors on any
matters of accounting principles or practices or financial statement disclosure.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
Information with respect to the directors and executive officers is incorporated
herein by reference to the proxy statement relating to the annual meeting of
shareholders to be held April 15, 1997.
Biographies of Executive Officers
Earl O. Bradley, III (age 41) has served as President, Chief Executive Officer
and Director of the Bank since its formation in 1989. Mr. Bradley graduated form
Austin Peay State University in 1977 with a B.S. degree in accounting. He is a
licensed Certified Public Accountant and is a graduate of the University of
Wisconsin School for Bank Administration and Tennessee Commercial Lending School
held at Vanderbilt University.
John T. Halliburton (age 49) has served as Executive Vice President and
Secretary of the Board since its formation in 1989. Mr. Halliburton graduated
from Austin Peay State University in 1969 with a B.S. degree in business
administration. He is a graduate of Tennessee Commercial Lending School held at
Vanderbilt University.
Frank G. Wallace (age 46) has served as Vice President and Cashier of the Bank
since 1989. In charge of operations, Mr. Wallace previously served as Vice
President of Dominion Bank of Middle Tennessee. Mr. Wallace is a graduate of the
School for Bank Administration at the University of Wisconsin and the Vanderbilt
School of Banking.
J. Randal Clouser (age 43) has served as Vice President\Commercial Lending since
1990. A banker of 14 years, Mr. Clouser previously served as a commercial loan
officer with Dominion Bank of Middle Tennessee. Mr. Clouser is a 1978 graduate
of Austin Peay State University.
Paul E. Schaaf (age 56) has served as Vice President\Commercial Lending since
1991. A veteran banker of 31 years, Mr. Schaaf previously served as Senior Vice
President of Dominion Bank of Middle Tennessee. Mr. Schaaf is a graduate of the
School for Bank Administration at the Banking School of the South at Louisiana
State University.
<PAGE> 50
David L. Watson (age 54) has served as Vice President\Marketing since joining
the Bank in 1994. Mr. Watson previously served as Vice President of Nationsbank
of Tennessee, and is a graduate of Austin Peay State University. Mr. Watson has
17 years of banking experience with specific emphasis in marketing, employee
training and consumer loan management.
Jack L. Graham (age 46) joined the Bank as Chief Financial Officer in 1995. Mr.
Graham previously served as President, Chief Executive Officer and Director of
Guaranty Federal Savings Bank in Clarksville, Tennessee. Mr. Graham is a
licensed Certified Public Accountant and is a graduate of Western Kentucky
University with bachelors' degrees in accounting and economics.
ITEM 10. EXECUTIVE COMPENSATION.
Information with respect to executive compensation is incorporated herein by
reference to the proxy statement relating to the annual meeting of shareholders
to be held April 15, 1997.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information with respect to the security ownership of certain beneficial owners
and management is incorporated herein by reference to the proxy statement
relating to the annual meeting of shareholders to be held April 15, 1997.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information with respect to certain relationships and related transactions is
incorporated herein by reference to the proxy statement relating to the annual
meeting of shareholders to be held April 15, 1997.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
(1) Articles of Incorporation and Bylaws*
(2) Annual Report to Shareholders
(3) Financial Data Schedule (SEC Use only)
* Incorporated herein by reference to the Preeffective Amendment No. 2
to the Form S-4 Registration Statement on Heritage Financial Service,
Inc. filed with the Securities and Exchange Commission on January 23,
1992.
(b) No Reports on Form 8-K were filed during the 1996 calendar year.
<PAGE> 51
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Heritage Financial Services, Inc.
- ---------------------------------
(Registrant)
By Earl O. Bradley, III
--------------------
Earl O. Bradley, III
President and Chief Executive Officer
Date March 13, 1997
--------------
By Jack L. Graham
-----------------------
Jack L. Graham
Chief Financial Officer
Date March 13, 1997
-----------------------
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By John T. Halliburton By Jeffrey V. Bibb
------------------- ---------------------
Date March 13, 1997 Date March 13, 1997
------------------- ---------------------
By David R. Farris By James W. Russell, Sr.
------------------- ---------------------
Date March 13, 1997 Date March 13, 1997
------------------- ---------------------
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1,000
<CASH> 3,598
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 19,145
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 106,111
<ALLOWANCE> 1,544
<TOTAL-ASSETS> 132,783
<DEPOSITS> 115,312
<SHORT-TERM> 4,850
<LIABILITIES-OTHER> 1,175
<LONG-TERM> 183
0
0
<COMMON> 5,986
<OTHER-SE> 5,277
<TOTAL-LIABILITIES-AND-EQUITY> 132,783
<INTEREST-LOAN> 9,742
<INTEREST-INVEST> 1,102
<INTEREST-OTHER> 2
<INTEREST-TOTAL> 10,846
<INTEREST-DEPOSIT> 4,501
<INTEREST-EXPENSE> 4,629
<INTEREST-INCOME-NET> 6,217
<LOAN-LOSSES> 485
<SECURITIES-GAINS> 83
<EXPENSE-OTHER> 5,854
<INCOME-PRETAX> 3,324
<INCOME-PRE-EXTRAORDINARY> 2,105
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,105
<EPS-PRIMARY> 3.84
<EPS-DILUTED> 3.84
<YIELD-ACTUAL> 4.69
<LOANS-NON> 173
<LOANS-PAST> 935
<LOANS-TROUBLED> 86
<LOANS-PROBLEM> 766
<ALLOWANCE-OPEN> 1,267
<CHARGE-OFFS> 244
<RECOVERIES> 36
<ALLOWANCE-CLOSE> 1,544
<ALLOWANCE-DOMESTIC> 910
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 634
</TABLE>
