<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 June 30, 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 - 583,440
shares as of July 31, 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 14
SIGNATURES 15
</TABLE>
2
<PAGE> 3
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1999 1998 1998
------------ ------------ ------------
(Unaudited) (Unaudited) (Note)
<S> <C> <C> <C>
ASSETS:
Cash and due from banks $ 6,987 $ 4,803 $ 7,611
Federal funds sold 6,735 -- --
Securities available-for-sale, at fair value 22,278 21,165 21,865
Mortgage loans held for sale 1,802 2,486 3,222
Loans 172,387 150,983 164,296
Allowance for loan losses (2,547) (2,220) (2,702)
------------ ------------ ------------
Net loans 169,840 148,763 161,594
Premises and equipment 11,252 7,551 10,355
Accrued interest receivable 1,585 1,605 1,889
Deferred income taxes 785 571 576
Foreclosed and repossessed assets 662 186 297
Other assets 828 634 802
------------ ------------ ------------
TOTAL ASSETS $ 222,754 $ 187,764 $ 208,211
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits:
Noninterest-bearing $ 25,036 $ 18,499 $ 24,163
Interest-bearing 167,543 134,680 152,455
------------ ------------ ------------
Total deposits 192,579 153,179 176,618
Federal funds purchased and other short-term borrowings -- 7,035 3,675
Long-term borrowings 10,708 10,756 9,732
Accrued interest payable 776 687 742
Other liabilities 1,589 1,296 1,649
------------ ------------ ------------
TOTAL LIABILITIES 205,652 172,953 192,416
STOCKHOLDERS' EQUITY:
Preferred stock, 1,000,000 shares authorized,
no shares issued or outstanding -- -- --
Common stock, 3,000,000 shares authorized 1,166 1,139 1,159
Additional paid-in capital 5,607 5,151 5,464
Retained earnings 10,510 8,444 9,055
Accumulated other comprehensive income, net (181) 77 117
------------ ------------ ------------
TOTAL STOCKHOLDERS' EQUITY 17,102 14,811 15,795
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 222,754 $ 187,764 $ 208,211
============ ============ ============
Common shares issued and outstanding 583,040 569,926 579,645
</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 JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees $ 4,292 $ 3,802 $ 8,408 $ 7,340
Investment securities:
Taxable 233 230 467 456
Tax-exempt 72 53 143 107
Federal funds sold 27 -- 32 --
---------- ---------- ---------- ----------
TOTAL INTEREST INCOME 4,624 4,085 9,050 7,903
---------- ---------- ---------- ----------
INTEREST EXPENSE:
Deposits 1,790 1,602 3,530 3,058
Other 132 189 279 428
---------- ---------- ---------- ----------
TOTAL INTEREST EXPENSE 1,922 1,791 3,809 3,486
---------- ---------- ---------- ----------
NET INTEREST INCOME 2,702 2,294 5,241 4,417
Provision for loan losses 441 240 700 441
---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,261 2,054 4,541 3,976
---------- ---------- ---------- ----------
NONINTEREST INCOME:
Service charges on deposit accounts 349 370 689 700
Service charges on ATM transactions 91 76 166 137
Mortgage banking activities 220 212 382 434
Accounts receivable financing 70 58 148 135
Net securities gains (losses) (2) 1 31 3
Brokerage fees 74 117 160 205
Premiums from life and disability insurance 60 79 111 125
Gain on sale of industrial building -- 148 -- 148
Other 158 136 275 238
---------- ---------- ---------- ----------
TOTAL NONINTEREST INCOME 1,020 1,197 1,962 2,125
---------- ---------- ---------- ----------
NONINTEREST EXPENSES:
Salaries and employee benefits 1,143 1,093 2,257 2,113
Occupancy 210 151 405 295
Furniture and equipment 262 201 511 386
Data processing 103 117 194 223
Advertising and public relations 64 56 145 126
Communications 82 77 162 135
Supplies 85 71 159 126
Life and disability insurance benefits and expenses 39 45 50 62
Other 152 187 351 336
---------- ---------- ---------- ----------
TOTAL NONINTEREST EXPENSES 2,140 1,998 4,234 3,802
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES 1,141 1,253 2,269 2,299
Income taxes 411 458 778 836
---------- ---------- ---------- ----------
NET INCOME $ 730 $ 795 $ 1,491 $ 1,463
========== ========== ========== ==========
Net income per share $ 1.26 $ 1.39 $ 2.57 $ 2.57
========== ========== ========== ==========
Net income per share - assuming dilution $ 1.25 $ 1.38 $ 2.56 $ 2.54
========== ========== ========== ==========
Average number of common shares 580,982 569,926 580,579 569,778
Average number of common shares - assuming dilution 582,641 577,080 582,222 576,903
</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>
SIX MONTHS ENDED JUNE 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,652 $ 977
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available-for-sale 1,153 84
Maturities and redemptions of securities available-for-sale 3,445 1,503
Purchase of securities available-for-sale (5,391) (3,492)
Net increase in loans (8,946) (16,262)
Purchases of premises and equipment (1,179) (2,265)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (10,918) (20,432)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 15,961 18,798
Decrease in federal funds purchased
and other short-term borrowings (3,675) (1,115)
Repayment of long-term borrowings (24) (1,030)
Proceeds from long-term borrowings 1,000 3,000
Proceeds from issuance of common stock 115 74
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 13,377 19,727
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 6,111 272
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 7,611 4,531
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,722 $ 4,803
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 3,785 $ 3,355
Cash paid during period for income taxes 798 779
Noncash investing activity: capitalized interest 10 117
stock dividends 31 30
</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
and six month periods ended June 30, 1999 are not necessarily indicative of the
results that may be expected for the entire year.
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. 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.
6
<PAGE> 7
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 June 30, 1999 and 1998 amounted to
($345,000) and $3,000, respectively. Comprehensive income included in equity for
the six months ended June 30, 1999 and 1998 totaled ($400,000) and $21,000,
respectively.
3. INVESTMENT SECURITIES
The following table reflects the amortized cost and fair values of investment
securities held at June 30, 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 $ 4,693 $ 1 $ (87) $ 4,607
Mortgage-backed:
U.S. agencies 10,397 15 (164) 10,248
Tax-exempt securities 6,542 49 (97) 6,494
Equity securities 929 -- -- 929
---------- ---------- ---------- ----------
$ 22,561 $ 65 $ (348) $ 22,278
========== ========== ========== ==========
</TABLE>
4. LOANS
A summary of loans outstanding by category follows:
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
--------- --------- ------------
Real Estate: (in thousands)
<S> <C> <C> <C>
1 to 4 family residential properties $ 48,377 $ 43,334 $ 44,743
Construction 8,952 14,071 12,442
Commercial 64,886 49,998 60,072
Commercial, financial and agricultural 30,416 27,077 27,004
Consumer 21,971 17,376 22,043
--------- --------- ------------
174,602 151,856 166,304
Less unearned interest (2,215) (873) (2,007)
--------- --------- ------------
Total loans $ 172,387 $ 150,983 $ 164,296
========= ========= ============
</TABLE>
5. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
(in thousands) 1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 2,707 $ 2,058 $ 2,702 $ 1,908
Provision charged to operations 441 240 700 441
Loan losses:
Loans charged off (633) (80) (984) (141)
Recoveries on loans previously charged off 32 2 129 12
---------- ---------- ---------- -----------
Balance at end of period $ 2,547 $ 2,220 $ 2,547 $ 2,220
========== ========-= ========== ===========
</TABLE>
7
<PAGE> 8
6. DEPOSITS
A summary of deposits follows:
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
Noninterest-bearing demand $ 25,036 $ 18,499 $ 24,163
Interest checking 11,115 10,639 11,934
Money market accounts 41,486 24,436 30,816
Savings 5,679 5,268 5,768
Retirement accounts 3,302 3,681 3,495
Certificates of deposit of $100,000 or more 16,197 15,007 14,174
Other time deposits 89,764 75,649 86,268
------------ ------------ ------------
$ 192,579 $ 153,179 $ 176,618
============ ============ ============
</TABLE>
7. STOCKHOLDERS' EQUITY
The Company's capital amounts and ratios were as follows:
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
Amount:
Tier 1 leverage $ 17,222 $ 14,457 $ 15,623
Tier 1 risk-based 17,222 14,457 15,623
Total risk-based 19,362 16,367 17,606
Ratio:
Tier 1 leverage 8.16% 7.70% 7.68%
Tier 1 risk-based 10.18% 9.48% 9.97%
Total risk-based 11.45% 10.73% 11.24%
</TABLE>
8. STOCK COMPENSATION PLANS
Following is a summary of activity in the Company's stock option plans:
<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 -- 2,000 38.25
Options granted 5,000 -- 82.00
Options forfeited (400) -- 55.00
Options exercised (2,450) (2,450) 15.10
------------ ------------ ------------
Options outstanding at June 30, 1999 88,369 2,400 $ 48.79
============ ============ ============
</TABLE>
8
<PAGE> 9
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 has tested each system's ability to properly
perform and corrective measures have been implemented. A business resumption
plan has been formulated in the event that systems are unable to operate. The
Company has also made arrangements for additional liquidity in the event that
customers choose to withdraw extra funds. At this point, the Company anticipates
no difficulty in achieving full year 2000 capability or meeting customer demands
and does not expect the related costs to be material.
As a financial institution, the Company is also exposed to potential risks 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 first two quarters
of 1999 increased 16.6%, or $27.0 million, to $189.7 million from $162.7 million
for the first six months of 1998. This compares to average earning asset growth
of 24.7% for the six months ended June 30, 1998 over the same 1997 period. The
Company's ratio of average earning assets to average total assets for the first
six months of 1999 declined to 91.4%, compared to 93.1% and 94.3% for the same
period in 1998 and 1997, respectively. The decline is the result of a $5.6
million increase in average nonearning assets, primarily attributable to
construction of a new main office building which was completed during the second
quarter of 1999.
Economic investments and expansions in the local market place have enabled the
Bank to continue to grow its loan portfolio (the primary earning asset). Average
loans for the first six months of 1999 increased 16.0%, or $23.0 million to
$166.4 million from $143.4 million in 1998. This compares to average loan growth
of 29.0% for the first six months of 1998 over the same 1997 period. The mix of
earning assets remained favorable during the first half of 1999 with average
loans at 87.8% of total average earning assets compared to 88.2% during the same
1998 period.
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 varies as portions of the proceeds from the sale, call
and maturity of securities and the principal collected on mortgage-backed
securities are periodically used to fund loan growth. The average balance of
securities (including federal funds sold) increased $4.0 million during the
first six months of 1999 over the same period in 1998 and 1997. Average
securities for the first two quarters of 1999 were 12.2% of total average
earning assets, compared to 11.8% during the same period of 1998.
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 six months of
1999 increased 16.8%, or $23.1 million, to $160.5 million from $137.4 million
for the same period of 1998. This compares to 14.1%, or $17.0 million, growth
for the first half of 1998 over the same period in 1997. Local deposits
accounted for 83.4% and 84.8% of average interest-bearing liabilities for the
first six 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 through a national network. The
average balance of these alternative funding sources for the first two quarters
of 1999 increased 29.0%, or $6.2 million, to $27.7 million from $21.5 million
during the same period of 1998. Alternative funding sources totaled 16.6% of
average interest-bearing liabilities for the first half of 1999 and 15.2% for
the same period in 1998.
Management believes the use of alternative funding sources is a cost effective
means of supplementing local area deposits to fund loan growth. 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>
June 30, June 30, December 31,
1999 1998 1998
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
Nonperforming assets:
Nonaccrual loans $ 668 $ 485 $ 803
Restructured loans 106 105 99
Accruing loans that are contractually
past due 90 days or more 1,251 1,105 1,941
Foreclosed and repossessed assets 662 186 297
------------ ------------ ------------
Total nonperforming assets $ 2,687 $ 1,881 $ 3,140
============ ============ ============
Potential problem assets not included
in nonperforming assets $ 3,726 $ 2,308 $ 3,368
============ ============ ============
Nonperforming assets to portfolio loans and
foreclosed and repossessed assets 1.55% 1.24% 1.91%
Allowance for loan losses to portfolio loans 1.48% 1.47% 1.64%
Allowance for loan losses to nonperforming assets 95% 118% 86%
Allowance for loan losses to nonperforming
assets and potential problem loans 40% 53% 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 $17.1 million or 7.68% of total assets at June 30, 1999
compared to $14.8 million or 7.89% at June 30, 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 $114,000 and $74,000 of capital during the first two quarters 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. Rising interest rates
caused the fair value of securities held for sale to decline during the first
six months of 1999, resulting in a decrease in stockholders' equity of $298,000,
compared to an increase of $21,000 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 earnings 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 statements. 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 in accordance with regulatory accounting practices.
At June 30, 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 second quarter of 1999, the Company reported net income of $730,000
compared to $795,000 in 1998. Second quarter basic net income per share for 1999
decreased 9.35% to $1.26 from $1.39 in 1998. Diluted net income per share
decreased 10.07% to $1.25 from $1.38 in the second quarter of 1998. Annualized
return on average stockholders' equity (ROE) for the second quarter of 1999 was
17.26% compared to 21.90% in 1998. Second quarter 1999 annualized return on
average assets (ROA) was 1.38% compared to 1.77% in 1998.
Net income through June 30, 1999 was $1,491,000 compared to $1,463,000 in 1998,
an increase of 1.91%. Basic net income per share for the first six months of
1999 was $2.57 and diluted net income per share was $2.56, compared to $2.57 and
$2.54, respectively, for the first half of 1998. Annualized return on average
stockholders' equity for the first two quarters of 1999 was 18.03% and
annualized return on average assets was 1.44%, compared with 20.75% and 1.67%,
respectively, for the same period in 1998.
The Company's 1998 net income included a gain of $148,000 ($95,000 after-tax)
from the sale of an industrial building by the Bank's subsidiary, Heritage
Investment Corporation. The gain increased basic net income per share by $.16
and diluted net income per share by $.17 during the second quarter and first
half of 1998, respectively.
NET INTEREST INCOME (TAXABLE EQUIVALENT BASIS). Second quarter net interest
income grew $419,000, an 18.10% increase over 1998. The yield on average earning
assets decreased 19 basis points to 9.67% while the cost of interest-bearing
liabilities decreased 40 basis points to 4.56%. The decreased yield in average
earning assets was primarily due to competition and lower market interest rates,
while the decreased cost of interest-bearing liabilities was attributable to
lower market interest rates. The net interest spread was 5.11% and the net
interest margin was 5.68% in the second quarter, compared to 4.92% and 5.58%,
respectively, for the same period in 1998.
Capitalized interest costs associated with the construction of the new main
office building reduced the cost of interest-bearing liabilities by $6,000 and
$65,000 during the quarter ended June 30, 1999 and 1998, respectively. Had
capitalized interest been included in interest expense, the cost of
interest-bearing liabilities for the second quarter of 1999 would have been
4.58% and the net interest margin 5.67%, compared with 5.15% and 5.42%,
respectively, for the same period in 1998.
During the first half of 1999, net interest income increased $842,000, or
18.89%, over the same period in 1998. The yield on average earning assets
decreased 17 basis points to 9.69% while the cost of interest-bearing
liabilities decreased 37 basis points to 4.61%. The decreased yield in average
earning assets was primarily due to competition and lower market interest rates,
while the decreased cost of interest-bearing liabilities was attributable to
lower market interest rates. The net interest spread was 5.08% and the net
interest margin was 5.64% for the first two quarters, compared to 4.88% and
5.53%, respectively, during 1998.
Capitalized interest costs reduced the cost of interest-bearing liabilities by
$10,000 and $117,000 during the first half of 1999 and 1998, respectively. Had
capitalized interest been included in interest expense, the cost of
interest-bearing liabilities for the first six months of 1999 would have been
4.62% and the net interest margin 5.62%, compared with 5.15% and 5.39%,
respectively, during the same 1998 period.
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 84% from $240,000 for the second quarter of 1998 to
$441,000 for the same period in 1999. Year-to-date, the provision increased
$259,000, or 59%, over the same period last year.
The increase was required to cover the growth of the loan portfolio and
increases in net chargeoffs, nonperforming assets, and potential problem assets.
Losses during 1999 have primarily been in non-real estate consumer and
commercial loans. It is management's policy 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.
12
<PAGE> 13
Annualized net chargeoffs to average portfolio loans outstanding (excludes
mortgage loans held for sale) was 1.44% for the second quarter of 1999 compared
to 0.21% for 1998. The coverage ratio of net income plus provision for loan
losses to net chargeoffs was 1.95 and 13.27 for the second quarter of 1999 and
1998, respectively. The allowance for loan losses divided by annualized second
quarter net chargeoffs yielded a coverage ratio of 1.06 and 7.12 as of June 30,
1999 and 1998, respectively.
For the first half of 1999, annualized net chargeoffs to average portfolio loans
outstanding was 1.04% compared to 0.18% during 1998. The coverage ratio of net
income plus provision for loan losses to net chargeoffs was 2.56 and 14.76 for
the first six months of 1999 and 1998, respectively. The allowance for loan
losses divided by annualized first half chargeoffs yielded a coverage ratio of
1.49 and 8.60 as of June 30, 1999 and 1998, respectively.
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 and the nonrecurring gain on the sale of the industrial
building, second quarter 1999 noninterest income decreased 2.48% or $26,000 from
1998.
Noninterest income, excluding securities gains or losses and the nonrecurring
gain on the sale of the industrial building, contributed 27.21% of tax
equivalent income (net interest income plus noninterest income) in the second
quarter of 1999 as compared to 31.16% for the same period in 1998. Annualized
noninterest income, excluding securities gains and losses and the nonrecurring
gain on the sale of the industrial building, as a percentage of average total
assets was 1.94% and 2.34% for the three months ended June 30, 1999 and 1998,
respectively.
Year-to-date noninterest income, excluding the same items as above, decreased
2.18% or $43,000 from the amount earned in 1998. Noninterest income contributed
26.70% and 30.69% of tax equivalent income (net interest income plus noninterest
income) during the first two quarters of 1999 and 1998, respectively. Annualized
noninterest income totaled 1.86% and 2.26% of average total assets during the
first half 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 simultaneously providing new or enhanced
products and higher levels of customer service.
For the second quarter of 1999, noninterest expense increased 7.11% or $142,000
as compared to 1998. The ratio of annualized noninterest expense to average
total assets was 4.05% and 4.46% for the three months ended June 30, 1999 and
1998, respectively.
During the first six months of 1999, noninterest expense increased $ 432,000 or
11.36% over the same 1998 period. These increases were primarily attributable to
increased salaries and employee benefits and additional occupancy and furniture
and equipment expenses related to the new main office building. The ratio of
annualized noninterest expense to average total assets was 4.08% for the first
half of 1999 as compared to 4.35% 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 (annualized noninterest expense minus noninterest income,
excluding securities gains and losses and the nonrecurring gain from the sale of
the industrial building, divided by average assets) was 2.12% and 2.13% for the
second 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 56.98%
and 59.34% for the second quarter of 1999 and 1998, respectively.
The expense ratio was 2.22% for the first two quarters of 1999 as compared to
2.11% for the same period in 1998. The efficiency ratio was 58.55% and 59.03%
for the first half of 1999 and 1998, respectively.
13
<PAGE> 14
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
36.02% and 36.55% for the second quarter of 1999 and 1998, respectively. For the
first six months of 1999, the effective income tax rate was 34.29% compared to
36.36% for the same 1998 period.
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) 27 Financial Data Schedule (for SEC use only)
(b) There have been no reports filed on form 8-K during the
quarterly period ended June 30, 1999.
14
<PAGE> 15
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 August 13, 1999 By EARL O. BRADLEY, III
------------------------ ---------------------------------
Earl O. Bradley, III
President and Chief
Executive Officer
Date August 13, 1999 By JACK L. GRAHAM
------------------------ ---------------------------------
Jack L. Graham
Senior Vice President and
Chief Financial Officer
15
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 6,987
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 6,735
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 22,278
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<LOANS> 174,189
<ALLOWANCE> 2,547
<TOTAL-ASSETS> 222,754
<DEPOSITS> 192,579
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<LIABILITIES-OTHER> 2,365
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0
0
<COMMON> 1,166
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<TOTAL-LIABILITIES-AND-EQUITY> 222,754
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<INTEREST-INCOME-NET> 5,241
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<EXPENSE-OTHER> 4,234
<INCOME-PRETAX> 2,269
<INCOME-PRE-EXTRAORDINARY> 2,269
<EXTRAORDINARY> 0
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<NET-INCOME> 1,491
<EPS-BASIC> 2.57
<EPS-DILUTED> 2.56
<YIELD-ACTUAL> 5.64
<LOANS-NON> 668
<LOANS-PAST> 1,251
<LOANS-TROUBLED> 106
<LOANS-PROBLEM> 3,726
<ALLOWANCE-OPEN> 2,707
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