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HBKS > SEC Filings for HBKS > Form 10-Q on 10-Nov-2011All Recent SEC Filings

Show all filings for HERITAGE BANKSHARES INC /VA | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for HERITAGE BANKSHARES INC /VA


10-Nov-2011

Quarterly Report


Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations

As used in this Quarterly Report on Form 10-Q, the "Company," "we," "our" and "us" refer to Heritage Bankshares, Inc. and its subsidiaries, unless the context requires otherwise.

Forward-Looking Statements

Statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of such words as "may," "will," "believe," "expect," "anticipate," "should," "planned," "estimated" and "potential", among others, though these words are not the exclusive means of identifying such forward-looking statements. These forward-looking statements relate to, among other things, expectations regarding the business environment in which we operate, projections of future performance and perceived opportunities in the market, and they are based on management's current beliefs, assumptions and expectations. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. For a detailed discussion of the factors that might cause such a difference, see Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission on March 28, 2011.

Factors that might affect forward-looking statements include, among other things:

the demand for our products and services;

actions taken by our competitors;

changes in prevailing interest rates;

changes in delinquencies and defaults by our borrowers;

changes in loan quality and performance;

changes in FDIC insurance assessments;

legislative or regulatory changes or actions that affect our business, including new regulations imposed by the Dodd-Frank Act;

our ability to achieve financial goals and strategic plans;

our participation in the Small Business Lending Fund Program;

litigation; and

credit and other risks of lending activities.

As a result, we cannot assure you that our future results of operations, financial condition or other matters will be consistent with those expressed or implied in any forward-looking statements. You should not place undue reliance on these forward-looking statements, as they all are based only on information available at this time, and we assume no obligation to update any of these statements.

Financial Condition of the Company at September 30, 2011

Total Assets. The Company's total assets increased by $16.4 million, or 5.8%, from $281.4 million at September 30, 2010 to $297.8 million at September 30, 2011. The increase in assets resulted primarily from a $10.4 million, or 18.3%, increase in our aggregate cash, securities available for sale, interest-bearing deposits in other banks and federal funds sold and a $6.7 million, or 3.2%, increase in the balance of our loan portfolio. As compared to December 31, 2010, total assets increased by $30.7 million, or 11.5% at September 30, 2011, driven primarily by increases in cash and cash equivalents and investment securities available for sale.


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Investments. Investments in certain securities available for sale late in the third quarter increased our portfolio by $17.9 million, or 75.0%, to $41.8 million at September 30, 2011 compared to $23.9 million at September 30, 2010. Certificates of deposit, interest-bearing deposits in other banks, and federal funds sold decreased by a total of $9.2 million from $29.1 million at September 30, 2010 to $19.9 million at September 30, 2011. Compared to December 31, 2010 securities available for sale and other interest-earning assets (excluding loans) increased by $28.2 million from $35.3 million to $63.5 million at September 30, 2011 primarily as a result of a $33.5 million increase in deposit balances.

Loans. Loans held for investment, net, were $214.3 million at September 30, 2011, an increase of $6.7 million, or 3.2%, from the loan balance of $207.6 million at September 30, 2010. Loans held for investment were unchanged at September 30, 2011 compared to December 31, 2010.

Asset Quality. Nonperforming assets were $1,753,000, or 0.59% of assets, at September 30, 2011, compared to $60,000 of nonperforming assets at September 30, 2010. In addition to a bank branch site that we no longer plan to utilize, we obtained an additional property during the third quarter through foreclosure proceedings against one borrower. A total of $1.5 million in loans to one borrower were placed in nonaccrual status during the second quarter. These nonaccrual loans are secured by a multi-purpose, owner-occupied office building located in Hampton Roads, and the Bank has obtained an appraisal of the building that reflects current market conditions to assist the Bank in its determination of the appropriate carrying value for the loans. At December 31, 2010, nonperforming assets contained only a bank branch site that will not be utilized.

Deposits. Total deposits at September 30, 2011 were $257.6 million compared to $233.6 million at September 30, 2010, an increase of $24.0 million, or 10.3%. Core deposits, which are comprised of noninterest-bearing, money market, NOW and savings deposits, increased by $24.0 million, or 13.0%, from $184.2 million at September 30, 2010 to $208.2 million at September 30, 2011. Total deposits increased by $33.5 million, or 14.9%, compared to $224.1 million at December 31, 2010, attributable almost entirely to core deposits.

Average total deposits increased by $9.2 million, or 4.0%, from $228.2 million for the nine month period ended September 30, 2010 to $237.4 million for the nine month period ended September 30, 2011. Average core deposits increased by $9.3 million over the comparable nine-month periods. In addition, the mix of average noninterest-bearing deposits to average total deposits increased from 33.9% in the first nine months of 2010 to 36.3% in the first nine months of 2011, a factor that contributes to the improvement in our net interest margin.

Borrowed Funds. Borrowed funds decreased by $6.2 million, from $8.6 million at September 30, 2010 to $2.4 million at September 30, 2011. During the third quarter of 2010, the company repaid a $10.0 million, 2.40% fixed rate, medium term advance from the Atlanta Federal Home Loan Bank, incurring a $49,000 loss on extinguishment of debt. Compared to $3.5 million at December 31, 2010, borrowed funds decreased by $1.1 million at September 30, 2011.

Capital. Stockholders' equity decreased by $1.5 million, or 4.2%, from $37.4 million at September 30, 2010 to $35.9 million at September 30, 2011. In March 2011, consistent with our strategic plan and with the approval of the U.S. Treasury, the Company redeemed 2,606 shares of Series A Preferred Stock, resulting in a decrease of $2.6 million in the outstanding balance of our TARP preferred stock. During the third quarter of 2011, the Company sold to the U. S. Treasury $7.8 million of non-cumulative preferred stock in connection with our participation in the SBLF program. The Company used the proceeds from this transaction to redeem the balance of our outstanding TARP preferred stock of $7.8 million. The resulting $2.4 million reduction in stockholders' equity from the decrease in the balance of preferred stock was partially offset by an increase in retained earnings of $1.0 million between September 30, 2010 and September 30, 2011. Stockholders' equity decreased by $1.7 million, from $37.6 million at December 31, 2010 attributable to the same variables as described above.

Comparison of Operating Results for the Three Months Ended September 30, 2011 and 2010

Overview. The Company's pretax income was $847,000 for the third quarter of 2011, compared to pretax income of $994,000 for the third quarter of 2010, a decrease of $147,000. This decrease resulted primarily from $278,000 in gains on sales of securities occurring in the third quarter of 2010 that did not recur in the third quarter of 2011, partially offset by a $145,000 decrease in provision for loan losses.

Net Interest Income. The Company's net interest income before provision for loan losses remained virtually unchanged comparing the third quarters of 2011 and 2010. Our average loan portfolio increased by $13.8 million from $200.5 million in the third quarter of 2010 to $214.3 million in the third quarter of 2011, while our average investment in securities available for sale and other interest-earning assets (excluding loans) decreased by $27.6 million for a net reduction in interest-earning assets of $13.8 million. Average interest-bearing liabilities


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decreased by $22.5 million from the third quarter of 2010 to $160.6 million in the third quarter of 2011, resulting primarily from reductions in average interest bearing deposits of $5.6 million and borrowings of $16.9 million. Our interest rate spread increased 21 basis points from 3.52% in the third quarter of 2010 to 3.73% in the third quarter of 2011. Our net interest margin increased 21 basis points from 3.84% in the third quarter of 2010 to 4.05% in the third quarter of 2011, due to the increase in interest rate spread as well as an increase of $10.4 million in average noninterest-bearing deposits.

Provision for Loan Losses. A provision for loan losses of $33,000 was recorded for the third quarter of 2011, compared to a provision of $178,000 for the third quarter 2010, a decrease of $145,000. The provision for loan losses in the third quarter at 2010 related primarily to increases in loans outstanding.

Noninterest Income. Total noninterest income decreased by $317,000, from $514,000 in the third quarter of 2010 to $197,000 in the third quarter of 2011, with this reduction primarily attributable to $278,000 in gains on sale of investment securities in the third quarter of 2010 that did not recur in the third quarter of 2011.

Noninterest Expense. Total noninterest expense remained stable, reflecting a small decrease of $36,000 from $2.097 million for the third quarter of 2010 to $2.061 million for the third quarter of 2011. During the third quarter of 2011, additional expenses for rent, supplies, and other expenses of $38,000 were incurred to open the new Greenbrier branch and compensation expense included a $21,000 cumulative adjustment for prior periods for stock option forfeiture estimates. These increases were more than offset by decreases in the FDIC assessment and professional fees of $62,000 and $22,000, respectively. In addition, there was a loss of $49,000 on the early extinguishment of debt in the third quarter of 2010 that did not recur in 2011.

Income Taxes. The Company's income tax expense for the third quarter of 2011 was $299,000, reflecting an effective tax rate of 35.3%, compared to income tax expense of $346,000 for the third quarter of 2010, reflecting an effective tax rate of 34.9%. This increase in effective tax rate is primarily attributable to the impact on tax from the nondeductible cumulative adjustment for stock option forfeitures and to adjustments to tax estimated expense from prior periods based on actual taxes paid.

Net Income Available to Common Stockholders. Because of the refinancing of our outstanding TARP preferred stock with SBLF preferred stock, the remaining unaccreted discount associated with the TARP preferred stock was expensed during the third quarter of 2011, reducing net income available to shareholders by $153,000. After the impact of this accelerated accretion of the discount on our preferred stock and our preferred stock dividends, net income available to common stockholders was $296,000 for the third quarter of 2011, compared to $501,000 for the third quarter of 2010, a decrease of $205,000.

Comparison of Operating Results for the Nine Months Ended September 30, 2011 and 2010

Overview. The Company's pretax income was $2.56 million for the first nine months of 2011, compared to pretax income of $2.26 million for the first nine months of 2010, an increase of $301,000. This increase resulted from a $718,000 increase in net interest income, a $293,000 decrease in provision for loan losses, and a decrease in noninterest expense of $67,000, the total of which was partially offset by a $677,000 decrease in gains on sales of securities from $764,000 in 2010 to $87,000 in 2011.

Net Interest Income. The Company's net interest income before provision for loan losses increased by $718,000 to $8.2 million in the first nine months of 2011, compared to $7.5 million in the first nine months of 2010. Interest income in the first nine months of 2011 grew significantly, primarily due to a change in the mix in our average interest-earning assets from securities into loans. We reduced the average balance of securities available for sale and other interest-earning assets (excluding loans) from $74.9 million in the first nine months of 2010 to $47.1 million in the first nine months of 2011. At the same time we increased our average loan portfolio by $28.5 million compared to the first nine months of 2010. Our interest rate spread increased 42 basis points from 3.46% in the first nine months of 2010 to 3.88% in the first nine months of 2011, and our net interest margin increased 39 basis points from 3.83% in the first nine months of 2010 to 4.22% in the first nine months of 2011.

Provision for Loan Losses. A provision for loan losses of $44,000 was recorded for the first nine months of 2011, compared to a provision of $337,000 for the first nine months 2010, which related primarily to the substantial increase in the outstanding balance of our loan portfolio during 2010.

Noninterest Income. Total noninterest income decreased by $777,000, from $1.4 million in the first nine months of 2010 to $627,000 in the first nine months of 2011. The primary factor in this decrease was $764,000 of gains on the sales of investment securities in the first nine months of 2010, compared to a gain of only $87,000 in the first nine months of 2011.


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Noninterest Expense. Total noninterest expense decreased by $67,000 from $6.30 million in the first nine months of 2010 to $6.23 million in the first nine months of 2011. Decreases in compensation expense, FDIC assessment, and loss on early extinguishment of debt of $75,000, $109,000, and $49,000, respectively, were partially offset by increases in occupancy and other expenses of $51,000 and $78,000, respectively.

Income Taxes. The Company's income tax expense for the first nine months of 2011 was $861,000, reflecting an effective tax rate of 33.6%, compared to income tax expense of $799,000 for the first nine months of 2010, reflecting an effective tax rate of 35.4%. This reduction in effective tax rate was primarily attributable to an increase in tax-exempt interest income from certain loans.

Net Income Available to Common Stockholders. The Company repaid $2.6 million, or 25%, of its outstanding TARP preferred stock in March 2011, with a resulting decrease in net income available to common shareholders of $57,000 from the accelerated accretion of the corresponding discount on our outstanding TARP preferred stock. During the third quarter of 2011, we redeemed our remaining TARP preferred stock with the proceeds of $7.8 million of non-cumulative preferred stock issued in connection with our participation in the SBLF program, expensing the remaining net discount, and reducing income available to common shareholders by a total of $153,000 in the third quarter of 2011. Even after the impact of preferred stock dividends and accelerated accretion of the entire discount on our TARP preferred stock, net income available to common stockholders was $1.137 million for the first nine months of 2011, compared to $1.021 million for the first nine months of 2010, an increase of $116,000.

Commitments

We are a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or loans approved but not yet funded, standby letters of credit, and commitments to sell loans. These instruments involve, to varying degrees, elements of risk which have not been recognized in our consolidated balance sheets.

Loan commitments are agreements to extend credit to a customer so long as there are no violations of the applicable contract terms prior to the funding. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Because certain of the commitments are expected to be withdrawn or expire unused, the total commitment amount does not necessarily represent future cash requirements. Standby letters of credit are written unconditional commitments to guarantee the performance of a Bank customer to a third party.

We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments. Unless otherwise noted, we require collateral or other security to support financial instruments with credit risk.

The following table reflects our other loan commitments outstanding at the dates indicated:

                                      At September  30,       At September  30,
                                            2011                    2010
                                                   (in thousands)
      Commitments to extend credit   $            31,524     $            35,713
      Standby letters of credit                       76                     221

                                     $            31,600     $            35,934

Liquidity

Liquidity refers to the availability of sufficient funds to meet the needs of depositors, borrowers, creditors and investors and to fund operations. Our primary sources of funds are customer deposits, cash and cash equivalents, certificates of deposit in other banks, unpledged investment securities available for sale, loan repayments and borrowings. These funds are used to make loans, purchase investment securities, meet depositor withdrawals and fund operations. At September 30, 2011, cash and cash equivalents and certificates of deposit in other banks were $25.7 million, an increase of $7.0 million from $18.7 million at December 31, 2010.

In addition, we maintain a liquid available-for-sale investment securities portfolio. At September 30, 2011, the balance of our unpledged available-for-sale investment portfolio was $40.3 million, compared to a $15.0 million balance at December 31, 2010. We also are able to obtain funds through approved borrowing lines with the Federal


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Home Loan Bank of Atlanta and other financial institutions. Management believes our existing liquidity sources are sufficient to satisfy the Company's operational requirements and obligations. We maintain a high level of liquidity due to a concentration in some customer deposits, which can fluctuate significantly as depositor needs change.

Capital Resources

The Company's capital is reflected in its stockholders' equity, which was $35.9 million at September 30, 2011, compared to $37.6 million at December 31, 2010, a decrease of $1.7 million. This decrease is primarily attributable to the $2.6 million partial redemption of our outstanding TARP Series A Preferred Stock in March of this year, followed by participation in the SBLF program which was consummated in August of this year, the proceeds from which were used to redeem the entire remaining balance of our TARP Series A and Series B Preferred Stock, as described above, partially offset by an increase in retained earnings. At September 30, 2011, the Company and the Bank were considered "well-capitalized" as defined by the Federal Reserve Bank. We monitor the current and projected capital levels of the Bank and the Company and will consider additional sources of capital, through the issuance of stock, debt, or otherwise, as needs arise.

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