<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999 Commission file number 33-45240
HERITAGE FINANCIAL SERVICES, INC.
---------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER 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 Offices)
Issuer's telephone number, including area code: (931) 553-0500
Check whether the issuer: (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act 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
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: Common Stock - 580,591
shares as of April 30, 1999.
Traditional small business disclosure format (check one):
Yes No X
--- ---
<PAGE> 2
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION 13
SIGNATURES 14
</TABLE>
2
<PAGE> 3
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, DECEMBER 31,
1999 1998 1998
--------- --------- ------------
(Unaudited) (Unaudited) (Note)
<S> <C> <C> <C>
ASSETS:
Cash and due from banks $ 6,055 $ 4,538 $ 7,611
Federal funds sold 1,642 -- --
Securities available-for-sale, at fair value 21,531 18,869 21,865
Mortgage loans held for sale 1,378 1,491 3,222
Loans 164,535 142,124 164,296
Allowance for loan losses (2,707) (2,058) (2,702)
--------- --------- ---------
Net loans 161,828 140,066 161,594
Premises and equipment 10,908 6,602 10,355
Accrued interest receivable 1,737 1,481 1,889
Deferred income taxes 648 572 576
Foreclosed and repossessed assets 259 243 297
Other assets 802 1,077 802
--------- --------- ---------
TOTAL ASSETS $ 206,788 $ 174,939 $ 208,211
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits:
Noninterest-bearing $ 22,803 $ 18,007 $ 24,163
Interest-bearing 154,172 124,378 152,455
--------- --------- ---------
Total deposits 176,975 142,385 176,618
Federal funds purchased and other short-term borrowings -- 6,110 3,675
Long-term borrowings 10,711 10,775 9,732
Accrued interest payable 694 566 742
Other liabilities 1,830 1,091 1,649
--------- --------- ---------
TOTAL LIABILITIES 190,210 160,927 192,416
STOCKHOLDERS' EQUITY:
Preferred stock, 1,000,000 shares authorized,
no shares issued or outstanding -- -- --
Common stock, 3,000,000 shares authorized 1,161 1,139 1,159
Additional paid-in capital 5,575 5,151 5,464
Retained earnings 9,780 7,648 9,055
Accumulated other comprehensive income, net 62 74 117
--------- --------- ---------
TOTAL STOCKHOLDERS' EQUITY 16,578 14,012 15,795
--------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 206,788 $ 174,939 $ 208,211
========= ========= =========
Common shares issued and outstanding 580,592 569,926 579,645
</TABLE>
(Note) The consolidated balance sheet at December 31, 1998 has been derived from
the audited financial statements at that date.
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
-------- --------
<S> <C> <C>
INTEREST INCOME:
Loans, including fees $ 4,096 $ 3,538
Investment securities:
Taxable 233 226
Tax-exempt 71 54
Federal funds sold 5 --
-------- --------
TOTAL INTEREST INCOME 4,405 3,818
-------- --------
INTEREST EXPENSE:
Deposits 1,740 1,456
Other 148 239
-------- --------
TOTAL INTEREST EXPENSE 1,888 1,695
-------- --------
NET INTEREST INCOME 2,517 2,123
Provision for loan losses 259 201
-------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,258 1,922
-------- --------
NONINTEREST INCOME:
Service charges on deposit accounts 339 330
Service charges on ATM transactions 75 62
Mortgage banking activities 184 222
Accounts receivable financing 78 77
Net securities gains (losses) 33 2
Brokerage fees 87 88
Premiums from life and disability insurance 51 46
Other 117 101
-------- --------
TOTAL NONINTEREST INCOME 964 928
-------- --------
NONINTEREST EXPENSES:
Salaries and employee benefits 1,113 1,020
Occupancy 195 144
Furniture and equipment 249 185
Data processing 91 106
Advertising and public relations 82 70
Communications 79 58
Supplies 74 56
Life and disability insurance benefits and expenses 11 17
Other 199 148
-------- --------
TOTAL NONINTEREST EXPENSES 2,094 1,804
-------- --------
INCOME BEFORE INCOME TAXES 1,128 1,046
Income taxes 367 378
-------- --------
NET INCOME $ 761 $ 668
======== ========
Net income per share $ 1.31 $ 1.17
======== ========
Net income per share - assuming dilution
$ 1.30 $ 1.16
======== ========
Average number of common shares 580,171 569,628
Average number of common shares - assuming dilution 583,442 576,621
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
------- -------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,224 $ 182
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available-for-sale 594 --
Maturities and redemptions of securities available-for-sale 1,570 807
Purchase of securities available-for-sale (1,855) (457)
Net increase in loans (493) (7,326)
Purchases of premises and equipment (693) (1,227)
------- -------
NET CASH USED IN INVESTING ACTIVITIES (877) (8,203)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 357 8,004
Decrease in federal funds purchased
and other short-term borrowings (3,675) (2,040)
Repayment of long-term borrowings (21) (1,010)
Proceeds from long-term borrowings 1,000 3,000
Proceeds from issuance of common stock 78 74
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (2,261) 8,028
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS 86 7
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 7,611 4,531
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,697 $ 4,538
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION: $ 1,940 $ 1,685
Cash paid during period for interest
Cash paid during period for income taxes -- 81
Noncash investing activity: capitalized interest 4 52
stock dividends 15 15
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. 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 (Bank).
Accordingly, the discussion that follows relates primarily to the financial
condition and results of operation of the Bank and its subsidiaries.
BASIS OF PRESENTATION. The consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
consolidated financial statements. The accompanying consolidated financial
statements should be read in conjunction with the notes to the consolidated
financial statements contained in the 1998 annual report on Form 10-KSB.
PROSPECTIVE INFORMATION. Certain of the information included in this discussion
and analysis includes forward-looking statements. Many factors affect the
Company's financial position and profitability, including fluctuations in local,
national and global economies (e.g., inflation or deflation, employment levels,
availability of resources, production and sales levels, foreign competition,
etc.), the volatility of interest rates, political events, regulatory actions,
changes in technology, competition from other providers of financial services,
and the continued growth of the market in which the Company operates. Because
these factors are unpredictable and beyond the Company's control, actual results
may vary materially from those anticipated.
NATURE OF BUSINESS. 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 general commercial banking services
(including mortgage banking, accounts receivable financing and commercial
leasing) through five banking offices. The Bank also has four non-bank
affiliates which provide financial services incidental to the Bank's operations,
including brokerage services, property ownership, consumer finance loan
origination, and reinsurance of credit life, accident and health insurance
contracts.
RESULTS OF OPERATIONS. The Company's consolidated results of operations are
dependent primarily on net interest income, which is the difference between the
interest income earned on interest-earning assets, such as loans and securities,
and the interest expense incurred on interest-bearing liabilities, such as
deposits and other borrowings. The Company also generates noninterest income,
including service charges on deposit accounts and fees from mortgage banking
activities, insurance sales and brokerage services. The Company's noninterest
expenses consist primarily of employee compensation and benefits and other
general and administrative expenses.
ESTIMATES. In preparing financial statements, management is required to make
assumptions and estimates which affect the Company's reported amounts of assets,
liabilities and results of operations. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. The results of operations for the three
month period ended March 31, 1999 are not necessarily indicative of the results
that may be expected for the entire year.
6
<PAGE> 7
SIGNIFICANT EVENT. On January 22, 1999, the city of Clarksville, Tennessee
sustained substantial property damage as the result of a tornado which left much
of the historic central business district in ruins. A preliminary estimate by
local authorities placed the damage to real and personal property at $72.65
million, excluding the cost of business interruption, public/private cost of
debris removal from right of ways, and the value of vehicles and trees lost or
damaged during the storm. A total of 515 properties were damaged including 320
dwellings, 150 commercial/industrial facilities and 45 government-owned
buildings. Of those properties, 306 received minor damage, 82 moderate damage,
22 major damage and 105 were completely destroyed. While management cannot
predict the impact of the tornado on the community as a whole, it does not
appear that any of the Bank's customers sustained material uninsured property
losses.
2. COMPREHENSIVE INCOME
Comprehensive income includes net income and other comprehensive income which is
defined as non-owner related transactions in equity. Comprehensive income
included in equity for the three months ended March 31, 1999 and 1998 amounted
to ($55,000) and $17,000, respectively.
3. INVESTMENT SECURITIES
The following table reflects the amortized cost and fair values of investment
securities held at March 31, 1999, all of which are classified as
available-for-sale:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. agencies $ 5,193 $ 17 $ (20) $ 5,190
Mortgage-backed:
U.S. agencies 9,252 41 (32) 9,261
Tax-exempt securities 6,077 117 (28) 6,166
Equity securities 914 -- -- 914
-------- -------- -------- --------
$ 21,436 $ 175 $ (80) $ 21,531
======== ======== ======== ========
</TABLE>
4. LOANS
A summary of loans outstanding by category follows:
<TABLE>
<CAPTION>
March 31, March 31, December 31,
1999 1998 1998
--------- --------- ------------
(in thousands)
<S> <C> <C> <C>
Real Estate:
1 to 4 family residential properties $ 44,703 $ 41,463 $ 44,743
Construction 10,537 15,232 12,442
Commercial 61,129 46,038 60,072
Commercial, financial and agricultural 29,268 24,063 27,004
Consumer 21,130 15,752 22,043
--------- --------- ---------
166,768 142,548 166,304
Less unearned interest (2,234) (425) (2,007)
--------- --------- ---------
Total loans $ 164,534 $ 142,123 $ 164,296
========= ========= =========
</TABLE>
7
<PAGE> 8
5. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
(in thousands) 1999 1998
------- -------
<S> <C> <C>
Balance at beginning of period $ 2,702 $ 1,908
Provision charged to operations 259 201
Loan losses:
Loans charged off (351) (61)
Recoveries on loans previously charged off 97 10
------- -------
Balance at end of period $ 2,707 $ 2,058
======= =======
</TABLE>
6. DEPOSITS
A summary of deposits follows:
<TABLE>
<CAPTION>
March 31, March 31, December 31,
1999 1998 1998
--------- --------- ------------
(in thousands)
<S> <C> <C> <C>
Noninterest-bearing demand $ 22,803 $ 18,007 $ 24,163
Interest checking 12,000 11,037 11,935
Money market accounts 32,616 22,640 30,816
Savings 6,083 5,381 5,768
Retirement accounts 3,446 3,654 3,495
Certificates of deposit of $100,000 or more 15,952 12,450 14,174
Other time deposits 84,075 69,216 86,268
-------- -------- --------
$176,975 $142,384 $176,618
======== ======== ========
</TABLE>
7. STOCKHOLDERS' EQUITY
The Company's capital amounts and ratios were as follows:
<TABLE>
<CAPTION>
March 31, March 31, December 31,
1999 1998 1998
--------- --------- ------------
(in thousands)
<S> <C> <C> <C>
Amount:
Tier 1 leverage $16,462 $12,877 $15,623
Tier 1 risk-based 16,462 12,877 15,623
Total risk-based 18,482 14,662 17,606
Ratio:
Tier 1 leverage 8.09% 7.39% 7.68%
Tier 1 risk-based 10.31% 9.03% 9.97%
Total risk-based 11.58% 10.28% 11.24%
</TABLE>
8
<PAGE> 9
8. STOCK COMPENSATION PLANS
Following is a summary of the Company's stock option plans as of and for the
three months ended March 31, 1999:
<TABLE>
<CAPTION>
Weighted-
Total Average
Option Exercisable Exercise
Shares Shares Price
------- ----------- ---------
<S> <C> <C> <C>
Options outstanding at December 31, 1998 86,219 2,850 $ 45.93
Options which became exercisable -- 1,000 21.50
Options granted -- -- --
Options forfeited (400) -- 55.00
Options exercised -- -- --
------- ------- -------
Options outstanding at March 31, 1999 85,819 3,850 $ 45.89
======= ======= =======
</TABLE>
9. YEAR 2000 ISSUES
The approach of the year 2000 presents potential problems to computer users such
as the Company. Many computer systems in use today, particularly older computers
and computer programs, may not be able to properly interpret dates after
December 31, 1999 because they use only two digits to indicate the year in a
date. For example, the year 2000 could be interpreted as the year 1900 by such
systems. As a result, the systems could produce inaccurate data, or not function
at all.
In anticipation of this potential problem, the Company has developed a
comprehensive plan to ensure that all of its systems are able to properly deal
with the year 2000. The Company is nearing completion of tests of each system's
ability to properly perform, and is implementing corrective measures when
deficiencies are found. At this point, the Company anticipates no difficulty in
achieving full year 2000 capability and does not expect the costs of achieving
full capability to be material.
As a financial institution, the Company is also exposed to potential risk if
borrowers and depositors suffer year 2000-related difficulties and are unable to
repay their loans or maintain their deposit balances. The Company has provided
general information to customers regarding year 2000 risks and has performed an
assessment of the year 2000 readiness of significant borrowers and depositors.
At this time, the Company is unable to determine what impact, if any, the year
2000 will have on either the loan payment performance of borrowers or the
balances of key depositors. Thus far, however, none of the Company's borrowers
or depositors have reported the expectation of material adverse impacts as a
result of the year 2000.
10. RECLASSIFICATIONS
Certain amounts have been reclassified in the previous year's financial
statements to conform with the current year's classifications.
9
<PAGE> 10
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
EARNING ASSETS. Average earning assets of the Company for the three months ended
March 31, 1999 increased 17.3%, or $27.4 million to $185.9 million from $158.5
million for the three months ended March 31, 1998. This compares to average
earning asset growth of 26.3% for the first three months of 1998 over the same
1997 period. The Company's ratio of average earning assets to average total
assets for the first three months of 1999 declined to 91.5%, compared to 93.1%
and 94.2% for the first three months of 1998 and 1997, respectively. The 1999
decline is the result of a $5.6 million increase in average nonearning assets,
primarily attributable to construction costs for the main office building.
Approximately $1.0 million in construction costs will be required during 1999.
Economic growth in the local economy has enabled the Bank to achieve continued
loan growth (the primary earning asset). Average loans for the first three
months of 1999 increased 17.7%, or $24.7 million to $164.1 million from $139.4
million for the first three months of 1998. This compares to average loan growth
of 31.2% for the first three months of 1998 over the same 1997 period. The
changing mix of earning assets was favorable during the first three months of
1999. Average loans for the first three months of 1999 were 88.3% of total
average earning assets, compared to 88.0% during the same 1998 period. Strong
loan demand has led to the improved earning asset composition.
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. The level of average securities to
average earnings assets declined during 1999 and 1998 as a portion of the
proceeds from the sale, call and maturity of securities and the principal
collected on mortgage-backed securities was used to fund loan growth. The
average balance of securities (including federal funds sold) increased $2.7
million for the three months of 1999 compared to a $0.2 million decrease for the
same period in 1998. Average securities for the first three months of 1999 were
11.7% of total average earning assets, compared to 12.0% during the same 1998
period.
FUNDING SOURCES. The Bank's primary funding source is its base of local area
deposits which consists of noninterest-bearing demand, interest checking,
savings, money market and retirement accounts, and certificates of deposit. The
average balance of the Bank's local deposit base for the first three months of
1999 increased 15.8%, or $21.6 million to $158.3 from $136.7 million for the
first three months of 1998. This compares to 15.6%, or $18.4 million, growth for
the first three months of 1998 over the same period in 1997. Local deposits
accounted for 84.8% and 87.3% of average interest-bearing liabilities for the
first three months of 1999 and 1998, respectively.
Due to the competitive local market for deposits, the Bank supplements its local
deposit base with alternative funding sources including Federal funds purchased,
borrowings from the Federal Home Loan Bank (FHLB), brokered certificates of
deposit, and certificates of deposit obtained via a national network. The
average balance of these alternative funding sources for the first three months
of 1999 increased 43.6%, or $8.7 million, to $28.5 million from $19.8 million
for the first three months of 1998. Alternative funding sources totaled 15.2% of
average interest-bearing liabilities for the first three months of 1999 and
12.7% for the same period in 1998.
Management expects an increasing need to rely on alternative funding sources to
fund future loan growth. Additional use of FHLB borrowing and Federal funds
purchased, as well as brokered and nonlocal certificates of deposit may be
necessary to meet the challenge of obtaining acceptable funding sources without
incurring an undesirable amount of interest rate risk.
10
<PAGE> 11
NONPERFORMING ASSETS, PAST DUE LOANS, POTENTIAL PROBLEM ASSETS AND THE ALLOWANCE
FOR LOAN LOSSES. The following table sets forth information regarding the
Company's nonperforming assets, past due loans, potential problem assets and the
allowance for loan losses:
<TABLE>
<CAPTION>
March 31, March 31, December 31,
1999 1998 1998
--------- --------- ------------
(in thousands)
<S> <C> <C> <C>
Nonperforming assets:
Nonaccrual loans $ 803 $ 434 $ 803
Restructured loans 90 103 99
Accruing loans that are contractually
past due 90 days or more 1,683 996 1,941
Foreclosed and repossessed assets 259 243 297
------ ------ ------
Total nonperforming assets $2,835 $1,776 $3,140
====== ====== ======
Potential problem assets not included $5,411 $2,820 $3,368
in nonperforming assets ====== ====== ======
Nonperforming assets to portfolio loans and
foreclosed and repossessed assets 1.72% 1.25% 1.91%
Allowance for loan losses to portfolio loans 1.65% 1.45% 1.64%
Allowance for loan losses to nonperforming assets 95% 116% 86%
Allowance for loan losses to nonperforming
assets and potential problem loans 33% 45% 42%
</TABLE>
CAPITAL. Management believes that a strong capital position is vital to
continued profitability and to promote depositor and investor confidence.
Stockholders' equity was $16.6 million or 8.02% of total assets at March 31,
1999 compared to $14.0 million or 8.01% at March 31, 1998. Net income is the
primary source of new capital for the Company. In addition, net proceeds from
stock transactions, including shares issued through director and employee plans,
contributed $78,000 and $74,000 of capital during the first three months of 1999
and 1998, 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
decreased by $55,000 during the first three months of 1999, compared to an
increase of $17,000 during the same period in 1998.
The board of directors develops and reviews the capital goals of Heritage
Financial 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.
The Company and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statement. Capital adequacy in the banking industry is
evaluated primarily by the use of ratios which measure capital against assets
and certain off-balance-sheet items. Certain ratios weight these assets based on
risk characteristics according to regulatory accounting practices.
At March 31, 1999, the Company's capital exceeded the regulatory minimums and
met the regulatory definition of "well-capitalized". The Company's capital
ratios are presented in Note 7 to the consolidated financial statements.
11
<PAGE> 12
RESULTS OF OPERATIONS
For the first three months of 1999, the Company reported net income of $761,000
compared to $668,000 in 1998. First quarter basic net income per share for 1999
increased 12.0% to $1.31 from $1.17 in 1998. Diluted net income per share
increased 12.1% to $1.30 from $1.16 in the first quarter of 1998. Annualized
return on average stockholders' equity (ROE) for the first three months of 1999
was 19.12% compared to 19.82% in 1998. First quarter 1999 annualized return on
average assets (ROA) was 1.52% compared to 1.59% in 1998.
NET INTEREST INCOME (TAXABLE EQUIVALENT BASIS). First quarter net interest
income grew $407,000, a 19.0% increase over 1998. The yield on average earning
assets decreased 14 basis points to 9.69% while the cost of interest-bearing
liabilities decreased 33 basis points to 4.67%. The decreased yield in average
earning assets was primarily due to competitive pressures and lower market
interest rates, while the decreased cost of interest-bearing liabilities was
attributable to lower market interest rates and capitalized interest on the new
main office building. The net interest spread was 5.02% compared to 4.83% in the
first quarter of 1998, and the net interest margin was 5.57% compared to 5.49%
in 1998.
Capitalized interest costs associated with the construction of the new main
office building reduced the cost of interest-bearing liabilities for 1999 and
1998. Had capitalized interest been included in interest expense, the cost of
interest-bearing liabilities for the first quarter of 1999 would have been 4.68%
and the net interest margin 5.56%, compared with 5.16% and 5.36%, respectively,
for the same period in 1998.
PROVISION FOR LOAN LOSSES. The provision for loan losses is the charge to
operating income 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 increased 28.9% from $201,000 for the first quarter of 1998 to
$259,000 for the same period in 1999. The increases were required to cover the
growth of the loan portfolio and increases in net chargeoffs, nonperforming
assets, and potential problem assets.
Annualized net chargeoffs to average portfolio loans outstanding (excludes
mortgage loans held for sale) was 0.64% for the first quarter of 1999 compared
to 0.15% for the first quarter of 1998. The coverage ratio of net income plus
provision for loan losses to net chargeoffs was 4.00 in 1999 and 17.04 in 1998.
The allowance for loan losses divided by net chargeoffs yielded a coverage ratio
of 10.62 and 40.35 as of March 31, 1999 and 1998, respectively. During 1999,
management plans to adequately provide for both net chargeoffs and for
identifiable future losses associated with planned increases in the Bank's
commercial, mortgage and consumer portfolios.
NONINTEREST INCOME. Besides the attention to net income, the Company focuses on
its ability to generate additional noninterest income from both core business
and newer initiatives, such as brokerage and insurance. Excluding securities
gains or losses, first quarter 1999 noninterest income increased 0.5% or $5,000
over the 1998 amount. Noninterest income, excluding securities gains or losses,
contributed 26.7% of tax equivalent income (net interest income plus noninterest
income) in the first quarter of 1999 as compared to 30.1% for the same period in
1998. Annualized noninterest income, excluding securities gains and losses, as a
percentage of average total assets was 1.86% and 2.21% for the first three
months of 1999 and 1998, respectively.
NONINTEREST EXPENSE. Noninterest expense is significant to the Company's
financial performance. Management is continually challenged to control operating
costs and improve efficiencies while still providing higher levels of customer
service. For the first quarter of 1999, noninterest expense increased 16.1% or
$290,000 as compared to 1998. The ratio of annualized noninterest expense to
average total assets was 4.18% in 1999 and 4.30% in 1998.
The Company monitors its expense ratio and utilizes the efficiency ratio as a
measure of its success in increasing revenues, while controlling costs. The
expense ratio (noninterest expense minus noninterest income, excluding
securities gains and losses, divided by average assets) was 2.32% and 2.09% for
the first quarter of 1999 and 1998, respectively. The efficiency ratio, which is
calculated excluding the same items, divides noninterest expense by net interest
income (tax equivalent) plus noninterest income. The efficiency ratio was 60.10%
and 58.72% for the first quarter of 1999 and 1998, respectively.
12
<PAGE> 13
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 income tax rate was
32.5% and 36.1% for the first quarter of 1999 and 1998, respectively.
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Ex-27 Financial Data Schedule (for SEC Use Only)
(b) There have been no reports filed on form 8-K during the
quarterly period ended March 31, 1999.
13
<PAGE> 14
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
In accordance with the requirements of the Exchange act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HERITAGE FINANCIAL SERVICES, INC.
(Registrant)
Date May 14, 1999 By EARL O. BRADLEY, III
------------------------------- -----------------------------------
Earl O. Bradley, III
President and Chief
Executive Officer
Date May 14, 1999 By JACK L. GRAHAM
------------------------------- -----------------------------------
Jack L. Graham
Senior Vice President and
Chief Financial Officer
14
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