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HBKS > SEC Filings for HBKS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for HERITAGE BANKSHARES INC /VA

Form 10-Q for HERITAGE BANKSHARES INC /VA


9-Nov-2012

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, 2011, filed with the Securities and Exchange Commission on March 29, 2012.

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

Total Assets. The Company's total assets increased by $14.9 million, or 5.0%, from $297.8 million at September 30, 2011 to $312.7 million at September 30, 2012. The increase in assets resulted primarily from an $11.6 million increase in our aggregate cash, securities available for sale, interest-bearing deposits in other banks and federal funds sold, together with a $5.0 million increase in bank-owned life insurance. Compared to December 31, 2011 total assets increased $18.1 million, primarily from a $38.5 million increase in our interest-bearing deposits in other banks, federal funds sold and certificates of deposits in other banks, offset by a $19.1 million decrease in securities available for sale.

Investments. Securities available for sale decreased by $15.6 million, from $41.8 million at September 30, 2011 to $26.2 million at September 30, 2012. Overnight funds increased by $20.4 million and certificates of


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deposit, interest-bearing deposits in other banks (excluding overnight funds), and federal funds sold increased by a total of $6.9 million, with a resulting aggregate increase in such investment balances from $19.9 million at September 30, 2011 to $47.2 million at September 30, 2012. Compared to December 31, 2011 securities available for sale decreased by $19.1 million from $45.3 million. Other interest-earning assets (excluding loans) increased $38.5 million from $8.7 million at December 31, 2011. Overnight funds contributed $25.2 million to this overall increase in other interest-bearing assets.

Loans. Loans held for investment, net, were $213.1 million at September 30, 2012, a decrease of $1.2 million from our loan balance of $214.3 million at September 30, 2011. At December 31, 2011, loans held for investment were $213.2 million.

Asset Quality. Nonperforming assets were $591,000, or 0.19% of total assets, at September 30, 2012, compared to $1,753,000 in nonperforming assets, or 0.59% of total assets, at September 30, 2011 and $1,719,000, or 0.58% of total assets, at December 31, 2011. Other real estate owned consisted of a bank branch site that we no longer plan to utilize and one additional single family home obtained through foreclosure proceedings against one borrower during the third quarter of 2012.

Deposits. Total deposits at September 30, 2012 were $272.6 million compared to $257.6 million at September 30, 2011, an increase of $15.0 million, or 5.8%. Core deposits, which are comprised of noninterest-bearing, money market, NOW and savings deposits, increased by $39.4 million, or 18.9%, from $208.2 million at September 30, 2011 to $247.6 million at September 30, 2012. Noninterest-bearing deposits increased by $8.6 million to $101.0 million at September 30, 2012 and, as a percentage of total deposits, increased from 35.8% at September 30, 2011 to 37.0% at September 30, 2012. Total deposits increased by $22.6 million, or 9.1%, compared to $250.0 million at December 31, 2011, attributable to a $41.9 million increase in core deposits offset by a $19.3 million decrease in certificates of deposit.

Average total deposits increased by $27.9 million, or 11.8%, from $237.4 million for the nine-month period ended September 30, 2011 to $265.4 million for the nine-month period ended September 30, 2012. Average core deposits increased by $44.3 million, or 23.5%, over the comparable nine-month periods. Average noninterest-bearing deposits increased by $11.4 million, from $86.3 million in the nine-month period ending September 30, 2011 to $97.7 million in the comparable period ending September 30, 2012. As a percentage of total average deposits, average noninterest-bearing deposits increased slightly from 36.3% at September 30, 2011 to 36.8% at September 30, 2012.

Borrowed Funds. Borrowed funds decreased by $1,647,000, from $2,404,000 at September 30, 2011 to $757,000 at September 30, 2012. Compared to $5.9 million at December 31, 2011, borrowed funds decreased $5.5 million at September 30, 2012, primarily due to a $4.0 million decrease in FHLB advances.

Capital. Stockholders' equity increased by $1.3 million, or 3.8%, from $35.9 million at September 30, 2011 to $37.2 million at September 30, 2012, primarily due to an increase in earnings. Stockholders' equity was $36.4 million at December 31, 2011.

Comparison of Operating Results for the Three Months Ended September 30, 2012 and 2011

Overview. The Company's pretax income was $981,000 for the third quarter of 2012, compared to pretax income of $847,000 for the third quarter of 2011, an increase of $134,000. A $284,000 gain on the sale of investment securities more than offset a decrease of $258,000 in net interest income. Our effective tax rate decreased from 35.3% in the third quarter of 2011 to 29.4% in the third quarter of 2012.

Net Interest Income. The Company's net interest income before provision for loan losses decreased by $258,000, comparing the third quarters of 2012 and 2011. Our average loan portfolio decreased by $2.3 million from $214.3 million in the third quarter of 2011 to $212.0 million in the third quarter of 2012, while our average overnight funds increased by $18.1 million and our average investment in securities available for sale and other interest-earning assets (excluding loans and overnight funds) increased by $6.5 million, for a net increase in interest-earning assets of $22.3 million comparing the two quarters. Average interest-bearing liabilities increased by $15.9 million from the third quarter of 2011 to $176.5 million in the third quarter of 2012, resulting primarily from a $16.9 million increase in average interest-bearing deposits. The average yield on our interest-earning assets was adversely impacted by lower yields on loans and an increase in the average balance of investment securities and other interest-earning assets, which was only partially offset by a decrease in the average cost of interest-bearing liabilities. As a result, our interest rate spread decreased 52 basis points from 3.74% in the third quarter of 2011 to 3.22% in the third quarter of 2012, and our net interest margin decreased 63 basis points from 4.06% in the third quarter of 2011 to 3.43% in the third quarter of 2012.


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Provision for Loan Losses. There was no provision for loan losses in the quarter ending September 30, 2012 compared to a provision for loan losses of $33,000 in the quarter ending September 30, 2011.

Noninterest Income. Total noninterest income increased by $295,000, from $197,000 in the third quarter of 2011 to $492,000 in the third quarter of 2012. This increase is primarily attributable to a $284,000 gain on sale of investment securities and $43,000 in income from bank-owned life insurance in the third quarter of 2012 that did not occur in the third quarter of 2011.

Noninterest Expense. Total noninterest expense was $1.997 million for the third quarter of 2012, a $64,000 decrease from the third quarter of 2011, primarily due to an $82,000 decrease in compensation expense in the third quarter of 2012.

Income Taxes. The Company's income tax expense for the third quarter of 2012 was $288,000, reflecting an effective tax rate of 29.4%, compared to income tax expense of $299,000 for the third quarter of 2011, reflecting an effective tax rate of 35.3%. This reduction in effective tax rate was attributable to increases in tax-exempt interest income and other non-taxable income.

Net Income Available to Common Stockholders. Because of qualified loan growth, the dividend rate on our SBLF program preferred stock was 1.00% for the third quarter of 2012, resulting in dividends on preferred stock of $20,000, a savings of $232,000 compared to $252,000 of TARP preferred stock dividends and dividend accretion for the third quarter of 2011. Net income available to common stockholders was $673,000 for the third quarter of 2012, compared to $296,000 for the third quarter of 2011, an increase of $377,000, or $0.16 per weighted average diluted common share.

Comparison of Operating Results for the Nine Months Ended September 30, 2012 and 2011

Overview. The Company's pretax income was $2,614,000 for the first nine months of 2012, compared to pretax income of $2,560,000 for the first nine months of 2011, an increase of $54,000. This increase resulted primarily from a $331,000 increase in noninterest income and an $87,000 decrease in noninterest expense, partially offset by a $373,000 decrease in net interest income between the two nine-month periods. The Company's effective tax rate for the first nine months of 2012 was 28.6% compared to an effective tax rate of 33.6% for the first nine months of 2011.

Net Interest Income. The Company's net interest income before provision for loan losses decreased by $373,000, comparing the first-nine month periods of 2012 and 2011. Our average loan portfolio decreased by $900,000 from $215.9 million in the first nine months of 2011 to $215.0 million in the first nine months of 2012, while our average investment in overnight funds increased by $9.7 million and our average investment in securities available for sale and other interest-earning assets (excluding loans and overnight funds) increased by $12.5 million, for a net increase in interest-earning assets of $21.3 million comparing the two nine-month periods. Average interest-bearing liabilities increased by $15.7 million from the first nine months of 2011 to $171.6 million in the first nine months of 2012, resulting primarily from a $16.6 million increase in average interest-bearing deposits. The average yield on our interest-earning assets was adversely impacted by lower yields on loans and an increase in the average balance of investment securities and other interest-earning assets, which was only partially offset by a decrease in the average cost of interest-bearing liabilities. As a result, our interest rate spread decreased 36 basis points from 3.88% in the first nine months of 2011 to 3.52% in the first nine months of 2012, and our net interest margin decreased 47 basis points from 4.22% in the first nine months of 2011 to 3.75% in the first nine months of 2012.

Provision for Loan Losses. Provision for loan losses was $35,000 and $44,000 for the nine months ending September 30, 2012 and 2011, respectively.

Noninterest Income. Total noninterest income increased by $331,000, from $627,000 in the first nine months of 2011 to $958,000 in the first nine months of 2012. The primary factors in this increase were a $197,000 increase in gains on sale of investment securities and a $161,000 increase in income from bank-owned life insurance in the first nine months of 2012.

Noninterest Expense. Total noninterest expense decreased by $87,000, from $6.233 million in the first nine months of 2011 to $6.146 million in the first nine months of 2012, primarily attributable to decreased compensation expense of $104,000.


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Income Taxes. The Company's income tax expense for the first nine months of 2012 was $749,000, reflecting an effective tax rate of 28.6%, compared to income tax expense of $861,000 for the first nine months of 2011, reflecting an effective tax rate of 33.6%. This reduction in effective tax rate was primarily attributable to an increase in tax-exempt interest income and other non-taxable income.

Net Income Available to Common Stockholders. After the impact of dividends on our preferred stock, net income available to common shareholders was $1.779 million for the first nine months of 2012, or earnings per diluted common share of $0.76, compared to net income available to common stockholders of $1.137 million for the first nine months of 2011, or earnings per diluted common share of $0.49, an increase of $642,000, or $0.27 per diluted common share. This increase in earnings available to common stockholders is primarily attributable to qualified loan growth which resulted in a 1.47% dividend rate on our SBLF program preferred stock in the first nine months of 2012, compared to accelerated accretion of the discount on outstanding TARP preferred stock and the associated dividend rate of 8.96% in the first nine months of 2011.

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,
                                                  2012         2011
                                                   (in thousands)

                 Commitments to extend credit   $ 35,453     $ 31,524
                 Standby letters of credit           189           76

                 Total Commitments              $ 35,642     $ 31,600

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, 2012, liquid assets, which include cash and due from banks, interest-bearing deposits in other banks, federal funds sold, certificates of deposit in other banks and nonpledged securities available for sale, were $78.9 million, an increase of $21.1 million from $57.8 million at December 31, 2011.

We also are able to obtain funds through approved borrowing lines with the Federal Home Loan Bank of Atlanta and other financial institutions. At September 30, 2012, there were no outstanding balances with these 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.


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Capital Resources

The Company's capital is reflected in its stockholders' equity, which was $37.2 million at September 30, 2012, up from $36.4 million at December 31, 2011, primarily attributable to an increase in retained earnings. At September 30, 2012, 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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