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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 COMMISSION FILE NO. 000-31825
HERITAGE FINANCIAL
HOLDING CORPORATION
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 63-1259533
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(State of Incorporation) (I.R.S. Employer Identification Number)
211 LEE STREET, N.E.
DECATUR, ALABAMA 35601
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(256) 355-9500
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(REGISTRANT'S TELEPHONE NUMBER)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
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(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 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 [ ]
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]
AS OF APRIL 10, 2002 THE AGGREGATE MARKET VALUE OF VOTING STOCK HELD BY
NON-AFFILIATES OF THE REGISTRANT WAS $59,955,912.
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S CLASSES OF
COMMON STOCK AS OF THE LATEST PRACTICABLE DATE; THE NUMBER OF SHARES OUTSTANDING
AS OF APRIL 10, 2002, OF THE REGISTRANT'S ONLY ISSUED AND OUTSTANDING CLASS OF
COMMON STOCK, ITS $.01 PER SHARE PAR VALUE COMMON STOCK WAS 8,521,147.
DOCUMENTS INCORPORATED BY REFERENCE
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THE INFORMATION SET FORTH UNDER ITEMS 10, 11, 12 AND 13 OF PART III OF THIS
REPORT IS INCORPORATED BY REFERENCE FROM THE REGISTRANT'S DEFINITIVE PROXY
STATEMENT FOR ITS 2002 ANNUAL MEETING OF STOCKHOLDERS THAT WILL BE FILED NO
LATER THAN APRIL 30, 2002.
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HERITAGE FINANCIAL HOLDING CORPORATION
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
ITEM NUMBER
IN FORM 10-K DESCRIPTION PAGE
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PART I
Item 1. Business................................................................... 3
Item 2. Properties................................................................. 12
Item 3. Legal Proceedings.......................................................... 12
Item 4 Submission of Matters to a Vote of Security Holders........................ 12
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters..................................................... 12
Item 6. Selected Financial Data.................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................... 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................. 40
Item 8. Financial Statements and Supplementary Data................................ 41
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure................................................ 78
PART III
Item 10. Directors and Executive Officers of the Registrant......................... 78
Item 11. Executive Compensation..................................................... 78
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.............................. 78
Item 13. Certain Relationships and Related Transactions............................. 78
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............ 79
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PART I
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report and documents incorporated by reference herein, may
contain certain statements relating to our future results based on information
currently available. The presentations, and certain of the other disclosures in
this Annual Report, including any statements preceded by, followed by or which
include the words, "may," "could," "should," "will," "would," "believe,"
"expect," "anticipate," "estimate," "intend," "plan," "assume," or similar
expressions, constitute forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. These forward looking
statements, implicitly and explicitly, include the assumptions underlying the
statements and other information with respect to our beliefs, plans, objectives,
goals, expectations, anticipations, estimates, intentions, financial condition,
results of operations, future performance and business, including our
expectations and estimates with respect to our revenues, expenses, return on
equity, return on assets, efficiency ratio, asset quality and other financial
data and capital and performance ratios.
Although we believe that the expectations reflected in our
forward-looking statements are reasonable, these statements involve risks and
uncertainties, which are subject to change based on various important factors
(some of which are beyond our control). The following factors, among others,
could cause our financial performance to differ materially from our goals, plan,
objectives, intentions, expectations, and other forward-looking statements: (1)
the strength of the United States economy in general and the strength of the
regional and local economics in which we conduct operations; (2) the effects of,
and changes in, trade, monetary and fiscal policies and laws, including interest
rate policies of the Board of Governors of the Federal Reserve System; (3)
inflation, interest rate, market and monetary fluctuations; (4) our timely
development of new products and services to a changing environment, including
the features, pricing and quality compared to the products and services of our
competitors; (5) the willingness of users to substitute competitors' products
and services for our products and services; (6) the impact of changes in
financial services policies, laws and regulations, including laws, regulations
and policies concerning taxes, banking securities and insurance, and the
application thereof by regulatory bodies; (7) technological changes; (8) changes
in consumer spending and savings habits; and (9) regulatory or judicial
proceedings.
If one or more of the factors affecting our forward-looking information
and statements proves incorrect, then our actual results, performance or
achievements could differ materially from those expressed in, or implied by
forward-looking information and statements contained in this Annual Report. We
do not intend to update or revise our forward-looking information and
statements, whether written or oral, to reflect any changes. All forward-looking
statements attributable to us are expressly qualified by these cautionary
statements.
ITEM 1. BUSINESS
GENERAL
We are a Delaware-chartered bank holding company headquartered in
Decatur, Alabama. We offer a broad range of banking and related products and
services in eight locations in Northern Alabama through Heritage Bank, an
Alabama banking corporation and our principal subsidiary. We had assets of
approximately $568 million, loans of approximately $505 million, deposits of
approximately $504 million and stockholders' equity of approximately $36 million
at December 31, 2001. Our principal executive offices are located at 211 Lee
Street, N.E., Decatur, Alabama 35601, and the telephone number is (256)
355-9500.
RECENT DEVELOPMENTS
In January 2002, Heritage Bank opened a new office in Trussville,
Alabama, a rapidly growing suburb of metropolitan Birmingham. The Bank is
leasing approximately 4,000 square feet of space in a new 10,000 square foot
building located in a highly traversed area of Trussville. The Company and the
Bank believe this location will be a great success this year and over time.
On March 12, 2002, Reginald D. Gilbert, President, Chief Executive
Officer and Director of the Company and the Bank, elected to voluntarily retire
as an employee and sever his relationship with the Company and the
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Bank. In conjunction with his retirement and severance, the Company and Reginald
D. Gilbert ("Gilbert") entered into a "Retirement, Release and Settlement
Agreement" (the "Agreement"), providing for severance pay and certain other
nonqualified retirement benefits in consideration of his retirement, his years
of service and certain non-competition and other agreements and covenants. Our
independent accountants have notified us that current accounting regulations
require that substantially all of the benefits to be received by Gilbert from
the Company, as provided for in the Agreement must be reflected as compensation
cost in our 2002 consolidated financial statements. The aggregate amount of
compensation cost, net of tax benefit, to be recognized by us as a charge
against 2002 earnings, due solely to the provisions of the Agreement, is
estimated to be approximately $3.7 million or $0.43 per common share. Although
our earnings will be adversely affected, the nature of Gilbert's benefits
allows for an offsetting increase in stockholders' equity of approximately $4.3
million, thereby increasing stockholders' equity by approximately $600,000
more than the charge against earnings. Net book value per share would therefore
increase by approximately $0.07 per common share due solely to the provisions of
the Agreement. The Board of Directors has begun a formal search process for a
new President and Chief Executive Officer of the companies. In the meantime, the
Board of Directors has elected Harold B. Jeffreys, a Director, as Interim
President and Chief Executive Officer.
On April 9, 2002, the Board of Directors voted to disengage with its
current investment banking firm and cease any further negotiations with other
banks or bank holding companies regarding a possible merger. The Board has
decided to focus on selecting a new President and Chief Executive Officer and
other senior management officers of the Company including a Chief Financial
Officer, and take steps to generate growth for the Company along all lines of
business.
At the same meeting on April 9, 2002, the Board elected Timothy A.
Smalley, Chairman of the Board and Director, as interim Chief Financial Officer.
Mr. Smalley is a certified public accountant and has provided certain accounting
services to the Company over the past several years. The Board has full
confidence in Mr. Smalley and believes that he will provide the Company with
efficient and effective service in this capacity until such time as the Board
selects a permanent Chief Financial Officer.
Finally, on April 9, 2002, the Board of Directors also accepted the
resignations of all the current inside directors from the Board, including: John
W. Whitley, President, Heritage Bank Decatur, Vernon C. Bice, President,
Heritage Bank Huntsville, and Michael R. Washburn, President, Heritage Bank
Birmingham. These individuals believed it would benefit the Company on many
levels if they would remove themselves from the direct oversight responsibility
of the Board of Directors. The city presidents plan to focus going forward on
growing the Company and the Bank at the operations level and provide support and
information to the Board of Directors in order to increase overall stockholder
value.
SERVICES
We focus on commercial, consumer, residential mortgage and real estate
construction lending to customers in our local markets. Our retail loan products
include mortgage banking services, home equity lines of credit, consumer loans,
including automobile loans, and loans secured by certificates of deposit and
savings accounts. Our commercial loan products include working capital lines of
credit, term loans for both real estate and equipment, letters of credit and
Small Business Administration loans. We also offer a variety of deposit programs
to individuals and businesses and other organizations, including a variety of
personal checking, savings, money market and NOW accounts, as well as business
checking and saving accounts. In addition, we offer individual retirement
accounts, safe deposit and night depository facilities and additional services
such as internet banking and the sale of traveler's checks, money orders and
cashier's checks.
MARKET AREAS
The Company conducts its banking activities in Morgan, Madison and
Jefferson counties in Alabama and in the surrounding vicinities. Within those
areas, the Company has banking offices located in the cities of Decatur,
Huntsville, Madison, Birmingham and Trussville, Alabama.
LENDING ACTIVITIES
General. We offer a range of lending services, including real estate,
consumer and commercial loans, primarily to individuals and businesses and other
organizations that are located in or conduct a substantial portion of their
business in our market areas. Our total loans at December 31, 2001 were $505.4
million, or 91.7% of total earning assets. The interest rates we charge on loans
vary with the risk, maturity and amount of the loan and are subject to
competitive pressures, money market rates, availability of funds and government
regulations. We do not have any foreign loans or loans for highly leveraged
transactions.
LOAN PORTFOLIO
Real Estate Loans - Loans secured by real estate are a significant
component of our loan portfolio, constituting $344.7 million, or 68.2% of total
loans at December 31, 2001. Our primary type of real estate loan is
single-family first mortgage loans, typically structured with fixed or
adjustable interest rates, based on market conditions. Fixed rate loans usually
have terms of five years or less, with payments through the date of maturity
generally based on a 15 to 30 year amortization schedule. Adjustable rate loans
generally have a term of 5 to 30 years. We charge an origination fee on these
mortgage loans.
Our nonresidential mortgage loans include commercial, industrial and
land loans. The commercial real estate loans are typically used to provide
financing for retail establishments, offices and manufacturing facilities. We
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generally require nonresidential mortgage loans to have an 80% loan-to-value
ratio and usually underwrite commercial loans on the basis of the borrower's
cash flow and ability to service the debt from earnings, more than on the basis
of the value of the collateral. Terms are typically five years and may have
payments through the date of maturity based on a 15 to 30 year amortization
schedule. Construction loans usually have a term of twelve months and generally
require personal guarantees.
Commercial, Financial and Agricultural Loans - At December 31, 2001, we
had general commercial, financial and agricultural loans of $138.3 million,
comprising 27.4% of the total loan portfolio. Commercial loans consist primarily
of operating loans made to manufacturers, wholesalers and retailers of goods,
service companies and other industries. We concentrate on making loans to small
to medium size companies. The primary repayment risk for commercial loans is the
failure of the borrower due to economic or financial factors. Although we
typically look to a commercial borrower's cash flow as the principal source of
repayment, many commercial loans are secured by inventory, equipment, accounts
receivable and other assets. These loans are typically made on terms up to five
years at fixed or variable rates and are secured by accounts receivable,
inventory or, in the case of equipment loans, the financed equipment. We attempt
to reduce our credit risk on commercial loans by limiting the loan to value
ratio to 65% on loans secured by accounts receivable or inventory and 75% on
equipment loans. Agricultural loans are comprised of loans to finance
agricultural production, loans to farmers and loans secured by farmland. We are
able to manage the risks inherent in these types of loans due to our small
number of agricultural loans.
Consumer Loans - At December 31, 2001, loans to individuals for
personal expenditures totaled $22.3 million, comprising some 4.4% of our loan
portfolio. These consumer loans include credit card loans and other revolving
plans, as well as other consumer loans to purchase automobiles, recreational
vehicles, mobile homes, appliances and boats. Consumer loans are underwritten
based on the borrower's income, current debt, credit history and collateral.
Terms generally range from four to five years on automobile loans and one to
three years on other consumer loans.
CREDIT PROCEDURES AND REVIEW
Loan Approval - We attempt to minimize loan losses through various
means and uses generally recognized underwriting criteria. In particular, on
larger credits, we generally rely on the cash flow of a debtor as the source of
repayment and secondarily on the value of the underlying collateral. In
addition, we attempt to utilize shorter loan terms in order to reduce the risk
of a decline in the value of such collateral.
We address repayment risks by adhering to internal credit policies and
procedures that include officer and customer lending limits, a multi-layered
loan approval process for larger loans, periodic documentation examination and
follow-up procedures for any exceptions to credit policies. The point in our
loan approval process at which a loan is approved depends on the size of the
borrower's credit relationship with the Bank.
Loan Review - The Bank has a loan review process designed to promote
early identification of credit quality problems. All lending officers are
charged with the responsibility of reviewing all past due loans in their
respective portfolios. Lending officers establish a watch list of loans to be
reviewed by management and the Board of Directors. Lending officers also conduct
a regular centralized internal review which tests compliance with loan policy
and documentation for all loans over $250,000 and a sampling of smaller loans.
The entire loan portfolio undergoes close scrutiny to maintain its
quality and diversity and to assure proper documentation. This policy also
requires that each loan have an agreed upon repayment schedule and gives
individual lending officers the responsibility of obtaining, and analyzing
current credit information. Maximum loan to value ratios and terms are
established in the policy for the various types of loans. The criteria outlined
in the Bank's loan policy follows guidelines provided by banking regulators in
terms of loan to value ratios, etc. Through the Bank's credit policy and credit
review procedures, management believes that it is able to identify areas of
concern in the loan portfolio and to take corrective action when necessary.
DEPOSITS
Core deposits are our principal source of funds, constituting
approximately 72.0% of our total deposits as of December 31, 2001. Core deposits
consist of demand deposits, interest-bearing transaction accounts, savings
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deposits and certificates of deposit (excluding certificates of deposits and
other time deposits over $100,000). Transaction accounts include checking, money
market and NOW accounts that provide the Bank with a source of fee income and
cross-marketing opportunities, as well as a low-cost source of funds. Time and
savings accounts also provide a relatively stable and low-cost source of
funding. The largest source of funds for the Bank is certificates of deposit.
Certificates of deposit in excess of $100,000 are held primarily by customers in
our market areas.
Deposit rates are reviewed weekly by senior management. We believe our
rates are competitive with those offered by competing institutions in our market
areas; however, we focus on customer service, not high rates, to attract and
retain deposits.
COMPETITION
The banking industry is highly competitive, and our profitability
depends principally on our ability to compete in our market areas. In our market
areas, we face competition from both regional banks and smaller community banks.
We encounter strong competition both in making loans and attracting deposits.
Competition among financial institutions is based upon interest rates offered on
deposit accounts, interest rates charged on loans and other credit and service
charges. Customers also consider the quality and scope of the services rendered,
the convenience of banking facilities and, in the case of loans to commercial
borrowers, relative lending limits, and may also consider the fact that other
banks offer different services. Many of the large regional banks against which
we compete have significantly greater lending limits and may offer additional
products; however, we believe we have been able to compete effectively with
other financial institutions, regardless of their size, by emphasizing customer
service and by providing a wide array of services. In addition, most of our
non-bank competitors are not subject to the same extensive federal regulations
that govern bank holding companies and federally insured banks. See "Supervision
and Regulation." Competition may further intensify if additional financial
services companies enter markets in which we conduct business.
EMPLOYEES
As of December 31, 2001, the Company employed approximately 105
individuals of which approximately 93 were full-time employees. We believe that
our employee relations have been good and continue to be good.
SUPERVISION AND REGULATION
We are a bank holding company under the Bank Holding Company Act
("BHCA"). We are subject to the supervision, examination and reporting
requirement of the Federal Reserve Board and the BHCA. The BHCA and other
federal laws subject bank holding companies to particular restrictions on the
types of activities in which they may engage and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
The supervision and regulation of bank holding companies and their
subsidiaries are intended primarily for the protection of depositors, the
deposit insurance funds of the Federal Deposit Insurance Corporation (the
"FDIC") and the banking system as a whole, not for the protection of bank
holding company stockholders or creditors. The banking agencies have broad
enforcement power over bank holding companies and banks, including the power to
impose substantial fines and other penalties for violation of laws and
regulations. The following description summarizes some of the laws to which we
are subject. References herein to applicable statutes and regulations are brief
summaries thereof, do not purport to be complete and are qualified in their
entirety by reference to such statutes and regulations.
Heritage Bank, an Alabama state chartered bank, is subject to the
regulation, supervision and examination by the Federal Deposit Insurance
Corporation and the Alabama Banking Department.
Regulatory Restrictions on Dividends - The payment of dividends to the
Company by the Bank is subject to certain restrictions imposed by state and
federal banking laws, regulations and authorities. The Federal Reserve Board
requires that bank holding companies should pay cash dividends on common stock
only out of income
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available over the past year and only if prospective earnings retention is
consistent with the bank holding company's expected future needs and financial
condition. This policy provides that bank holding companies should not maintain
a level of cash dividends that undermines the bank holding company's ability to
serve as a source of strength for its banking subsidiaries.
Under Alabama law, a bank may not pay a dividend in excess of 90% of
its net earnings until the bank's surplus is equal to at least 20% of its
capital. The Bank is also required by Alabama law to obtain the prior approval
of the Superintendent of the State Banking Department of Alabama for its payment
of dividends if the total of all dividends declared by the Bank in any calendar
year will exceed the total of (1) the Bank's net earnings (as defined by
statute) for that year, plus (2) its retained net earnings for the preceding two
years, less any required transfers to surplus. In addition, no dividends may be
paid from the Bank's surplus without the prior written approval of the
Superintendent.
In addition, federal bank regulatory authorities have authority to
prohibit the payment of dividends by bank holding companies if their actions
constitute unsafe or unsound practices. The Federal Reserve Board has issued a
policy statement on the payment of cash dividends by bank holding companies,
which expresses the Federal Reserve Board's view that a bank holding company
experiencing earnings weaknesses should not pay cash dividends that exceed its
net income or that could only be funded in ways that weaken the bank holding
company's financial health, such as by borrowing. Our ability and the Bank's
ability to pay dividends in the future is currently, and could be further,
influenced by bank regulatory policies and capital guidelines.
At December 31, 2001, an aggregate of approximately $3.4 million was
available for payment of dividends by the Bank to the Company under applicable
restrictions, without obtaining regulatory approval.
Source of Strength - Under Federal Reserve Board policy, a bank holding
company is expected to act as a source of financial strength for its bank
subsidiary and commit resources to its support. This support may be required by
the Federal Reserve Board at times when, absent this policy, a bank holding
company may not be inclined. A bank holding company, in certain circumstances,
could be required to guarantee the capital plan of an undercapitalized banking
subsidiary. In addition, any capital loans by a bank holding company to any of
its depository institution subsidiaries are subordinate in right of payment to
deposits and to certain other indebtedness of the banks.
Under the Federal Deposit Insurance Act ("FDIA"), an FDIC-insured
depository institution can be held liable for any loss incurred by, or
reasonably expected to be incurred by, the FDIC in connection with (1) the
default of a common controlled FDIC-insured depository institution or (2) any
assistance provided by the FDIC to any commonly controlled FDIC-insured
depository institution "in danger of default." "Default" is defined generally as
the appointment of a conservator or receiver, and "in danger of default" is
defined generally as the existence of certain conditions indicating that a
default is likely to occur in the absence of regulatory assistance. The FDIC's
claim for damages is superior to claims of stockholders of the insured
depository institution or its holding company but is subordinate to claims of
depositors, secured creditors and holders of subordinated debt (other than
affiliates) of the commonly controlled FDIC-insured depository institution.
Common controlled FDIC-insured depository institutions are liable to the FDIC
for any losses incurred in connection with the failure of a commonly controlled
institution.
Safe and Sound Banking Practices - Bank holding companies are not
permitted to engage in unsafe or unsound banking practices. The Federal Reserve
Board has broad authority to prohibit activities of bank holding companies and
their non-banking subsidiaries which represent unsafe or unsound banking
practices or which constitute violations of laws or regulations, and can assess
civil money penalties for certain activities conducted on a knowing or reckless
basis, if those activities caused a substantial loss to a depository
institution. The penalties can be as high as $1,000,000 for each day the
activity continues.
Capital Adequacy Requirements - We are required to comply with the
capital adequacy standards established by the Federal Reserve Board, and the
Bank is subject to additional requirements of the FDIC and the Alabama Banking
Department. The Federal Reserve Board has adopted two basic measures of capital
adequacy for bank holding companies: a risk-based measure and leverage measure.
All applicable capital standards must be satisfied for a bank holding company to
be in compliance.
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The risk-based capital standards are designed to make regulatory
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance-sheet exposure, and to minimize
disincentives for holding liquid capital assets. Assets and off-balance-sheet
items are assigned to broad risk categories, each with appropriate weights. The
resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance-sheet items.
The minimum guidelines for the ratio ("Total Risk-Based Capital Ratio")
of total capital ("Total Capital") to risked-weighted assets (including certain
off-balance sheet items, such as standby letters of credit) is 8%. At least half
of Total Capital must be comprised of common stock, minority interests in the
equity accounts of consolidated subsidiaries, noncumulative perpetual preferred
stock, and a limited amount of cumulative perpetual preferred stock, less
goodwill and other intangible assets ("Tier 1 Capital"). The remainder may
consist of subordinated debt, other preferred stock, and a limited amount of
loan loss reserves ("Tier 2 Capital").
In addition, the Federal Reserve Board has established minimum leverage
ratio guidelines for bank holding companies. These guidelines provide for a
minimum ratio (the "Leverage Ratio") of Tier 1 Capital to average assets, less
goodwill and certain other intangible assets, of 3% for bank holding companies
that meet certain specified criteria, including having the highest regulatory
rating. All other bank holding companies generally are required to maintain a
Leverage Ratio of at least 3%, plus an additional cushion of 100 to 200 basis
points. The Company's Leverage Ratio at December 31, 2001, was 7.86%. The
guidelines also provide that bank holding companies experiencing internal growth
or making acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels without significant reliance
on intangible assets. Furthermore, the Federal Reserve Board has indicated that
it will consider a tangible Tier 1 Capital Leverage Ratio (deducting all
intangibles) and other indicia of capital strength in evaluating proposals for
expansion or new activities.
The federal banking regulatory agencies' ratios are minimum supervisory
ratios generally applicable to banking organizations that meet certain specified
criteria, assuming that they have the highest regulatory rating. Bank holding
companies not meeting these criteria are expected to operate with capital
positions well above the minimum ratios. The Federal Reserve Board may set
capital requirements for a particular bank holding company that are higher than
the minimum ratios when certain circumstances warrant.
The Bank was in compliance with the applicable minimum capital
requirements at December 31, 2001. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Failure to meet capital
guidelines could subject the Bank to a variety of enforcement measures and
remedies by federal bank regulatory agencies, including termination of deposit
insurance and other restrictions on business.
As of December 31, 2001, both the Company and the Bank were "well
capitalized."
Acquisitions by Bank Holding Companies - The BHCA requires every bank
holding company to obtain prior approval of the Federal Reserve Board before it
(1) may acquire all or substantially all of the assets of any bank; (2) may
acquire direct or indirect ownership or control of any voting shares of any
bank, if after such acquisition it would own or control, directly or indirectly,
more than 5% of the voting shares of such bank; or (3) may merger or consolidate
with any other bank holding company. In approving bank acquisitions by bank
holding companies, the Federal Reserve Board is required to consider the
financial and managerial resources and future prospects of the bank holding
company and the banks concerned, the convenience and needs of the communities to
be served and various other factors.
The BHCA further provides that the Federal Reserve Board may not
approve any transaction that would result in a monopoly or would be in
furtherance of any combination or conspiracy to monopolize or attempt to
monopolize the business of banking in any section of the United States, or the
effect of which may be substantially to lessen competition or to tend to create
a monopoly in any section of the country, or than in any other manner would be
in restraint of trade, unless the anti-competitive effects of the proposed
transaction are clearly outweighed by the public interest in meeting the
convenience and needs of the communities to be served. The Federal Reserve Board
is required to consider the financial and managerial resources and future
prospects of the bank holding companies and banks concerned, including capital
adequacy, and the convenience of the community to be served including the
parties' performance under the Community Reinvestment Act of 1977 ("CRA").
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Control Acquisitions - The Change in Bank Control Act prohibits a
person or group of persons from acquiring "control" of a bank holding company
unless the Federal Reserve Board has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the Federal Reserve
Board, the acquisition of 10% or more of a class of voting stock of a bank
holding company with a class of securities registered under Section 12 of the
Exchange Act, would, under the circumstances set forth in the presumption,
constitute acquisition of control of that bank holding company.
In addition, under the BHCA, any company is required to obtain the
prior approval of the Federal Reserve Board before acquiring 25% (and bank
holding companies are required to obtain prior approval from the Federal Reserve
Board before acquiring 5%) or more of the outstanding common stock of a bank
holding company, or otherwise obtain control or a "controlling influence" over
the bank holding company.
Branching - The BHCA, as amended by the interstate banking provisions
of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") repealed prior statutory restrictions on interstate
banking, such that a bank holding company may acquire a bank located in any
other state, and any bank holding company located outside Alabama may lawfully
acquire any Alabama-based bank regardless of state law to the contrary, in
either case subject to certain deposit-percentage, aging requirements and other
restrictions. In addition, the Interstate Banking Act generally provided that
after June 1, 1997, national state-chartered banks may branch interstate through
acquisition of banks in other states. The State of Alabama has laws relating
specifically to acquisition of banks, bank holding companies and other types of
financial institutions in each state, by financial institutions that are based
in, and not based in those states. Alabama law has set five years as the minimum
age of banks which may be acquired.
Restrictions on Transactions With Affiliates and Insiders -
Transactions between the Bank and its affiliates, including the Company, are
subject to Sections 23A and 23B of the Federal Reserve Act. In general, Section
23A imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or any of its subsidiaries. Section 23B of the
Federal Reserve Act generally requires that certain transactions between a bank
and its respective affiliates be on terms substantially the same, or at least as
favorable to such bank, as those prevailing at the time for comparable
transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors executive officers, principal
stockholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and bank holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions. State
banking laws also have similar provisions.
FDIC Insurance Assessments - Pursuant to FDIA, the FDIC adopted a
risk-based assessment system for insured depository institutions that takes into
account the risks attributable to different categories and concentrations of
assets and liabilities. The system assigns an institution to one of three
capital categories: (1) well capitalized; (2) adequately capitalized; and (3)
undercapitalized. These three categories are substantially similar to the prompt
corrective action categories described above, with the "undercapitalized"
category including institutions that are undercapitalized, significantly
undercapitalized, and critically undercapitalized for prompt corrective action
purposes. An institution is also assigned by the FDIC to one of three
supervisory subgroups within each capital group. The supervisory subgroup to
which an institution is assigned is based on a supervisory evaluation provided
to the FDIC by the institution's primary federal regulator and information which
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance funds (which may include, if applicable,
information provided by the institution's state supervisor). An institution's
insurance assessment rate is then determined based on the capital category and
supervisory category to which it is assigned. Under the risk-based assessment
system, there are nine assessment risk classifications (i.e., combinations of
capital groups and supervisory subgroups) to which different assessment rates
are applied.
Under the FDIA, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe and unsound practices,
is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order, or condition imposed by the FDIC.
9
Community Reinvestment Act - The Bank is subject to the CRA. The
CRA and the regulations issued thereunder are intended to encourage banks to
help meet the credit needs of their service area, including low and moderate
income neighborhoods, consistent with the safe and sound operations of the
banks. These regulations also provide for regulatory assessment of a bank's
record in meeting the needs of its service area when considering applications to
establish branches, merger applications and applications to acquire the assets
and assume the liabilities of another bank. The Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") requires federal banking
agencies to make public a rating of a bank's performance under the CRA. In the
case of a bank holding company, the CRA performance record of the banks involved
in the transaction are reviewed by federal banking agencies in connection with
the filing of an application to acquire ownership or control of shares or assets
of a bank or thrift or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction. The Bank
has received a satisfactory CRA rating from federal banking agencies.
Consumer Laws and Regulations - In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits, making loans to or
engaging in other types of transactions with such customers.
INSTABILITY OF REGULATORY STRUCTURE
Various bills are routinely introduced in the United States Congress
and the Alabama legislature with respect to the regulation of financial
institutions. Certain of these proposals, if adopted, could significantly change
the regulations of banks and the financial services industry. We cannot predict
whether any of these proposals will be adopted or, if adopted, how these
proposals would affect us.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, especially the monetary policy
of the Federal Reserve Board, have a significant effect on the operating results
of bank holding companies and their subsidiaries. Among the means available to
the Federal Reserve Board to affect the money supply are open market operations
in U.S. Government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on our business and earnings cannot be predicted.
[The remainder of this page intentionally left blank]
10
ITEM 1 - STATISTICAL DISCLOSURE
Page(s)
Loan Portfolio............................................................................................ 17
Selected Loan Maturity and Interest Rate Sensitivity...................................................... 17
Securities Portfolio...................................................................................... 18
Securities Portfolio Maturity Schedule.................................................................... 19
Maturities of Large Time Deposits......................................................................... 20
Maturities of Long-Term Debt.............................................................................. 21
Return on Equity and Assets............................................................................... 22
Capital Adequacy Ratios................................................................................... 22
Interest Rate Sensitivity Analysis........................................................................ 24
Average Balances, Interest Income/Expense and Yields/Rates................................................ 26
Rate/Volume Variance Analysis............................................................................. 27
Summary of Loan Loss Experience........................................................................... 29
Allocation of Loan Loss Reserve........................................................................... 30
Nonperforming Assets...................................................................................... 31
Noninterest Income........................................................................................ 31
Noninterest Expenses...................................................................................... 32
Interest Rate Risk........................................................................................ 34
11
ITEM 2. PROPERTIES
Our headquarters are located at 211 Lee Street, N.E., Decatur, Morgan
County, Alabama. We operate eight banking offices throughout Northern Alabama.
We own two and lease six of these offices. Rental expense on the leased
properties totaled approximately $428,000 in 2001.
ITEM 3. LEGAL PROCEEDINGS
While we may from time-to-time be a party to various legal proceedings
arising from the ordinary course of business, we believe that there are
currently no proceedings threatened or pending against us at this time that
will, individually or in the aggregate, materially or adversely affect our
business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders of the Company
during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company is not listed on any exchange and there is no organized
trading market for the shares of its common stock. When shares are traded, they
are traded in privately negotiated transactions.
The following table sets forth, on a per share basis for the periods
indicated, the high and low sale prices of the Company's common stock.
High Low
--------- ---------
2001 First Quarter...................... $ 13.00 $ 12.50
Second Quarter..................... 13.00 12.00
Third Quarter...................... 13.00 12.00
Fourth Quarter..................... 12.50 8.00
2000 First Quarter...................... $ 10.00 $ 10.00
Second Quarter..................... 11.00 11.00
Third Quarter...................... 11.50 11.00
Fourth Quarter..................... 11.50 11.50
As of December 31, 2001, the Company had approximately 1,037
stockholders of record.
Holders of our common stock are entitled to receive dividends when, as
and if declared by our board of directors. We have never paid dividends on our
common stock. We conduct our principal business through our subsidiaries,
primarily the Bank. We derive cash available to pay dividends primarily, if not
entirely, from dividends paid by our subsidiaries. There are certain
restrictions that limit the Bank's ability to pay dividends to us and on our
ability to pay dividends. Our ability to pay dividends to our stockholders will
depend on our earnings and financial condition, liquidity and capital
requirements, the general economic and regulatory climate, our ability to
service any equity or debt obligations senior to our common stock and other
factors deemed relevant by our board of directors. We currently intend to retain
any future earnings to fund the development and growth of our business.
Therefore, we do not at the present time anticipate paying any cash dividends on
our common stock in the foreseeable future.
12
MANAGEMENT'S STATEMENT ON
RESPONSIBILITY FOR FINANCIAL REPORTING
HERITAGE FINANCIAL HOLDING CORPORATION
The management of Heritage Financial Holding Corporation is responsible
for the content and integrity of the consolidated financial statements and all
other financial information included in this annual report. Management believes
that the financial statements have been prepared in conformity with generally
accepted accounting principles applied on a consistent basis to reflect, in all
material respects, the substance of events and transactions that should be
included, and that the other financial information in the annual report is
consistent with those financial statements. The financial statements necessarily
include amounts that are based on management's best estimates and judgements.
Management maintains and depends upon Heritage Financial Holding
Corporation's accounting systems and related systems of internal controls. The
internal control systems are designed to ensure that transactions are properly
authorized and recorded in the Company's financial record and to safeguard the
Company's assets from material loss or misuse. The Company maintains an internal
audit staff which monitors compliance with the Company's systems of internal
controls and reports to management and to the audit committee of the board of
directors.
The audit committee of the board of directors, composed solely of
outside directors, has responsibility for recommending to the board of directors
the appointment of the independent auditors for Heritage Financial Holding
Corporation. The committee meets periodically with the internal auditors and the
independent auditors to review the scope and findings of their respective
audits. The internal auditors, independent auditors and management each have
full and free access to meet privately as well as together with the committee to
discuss internal controls, accounting, auditing, or other financial reporting
matters.
The consolidated financial statements of Heritage Financial Holding
Corporation have been audited by Schauer, Taylor, Cox, Vise & Morgan, P.C.,
independent auditors, who were engaged to express an opinion as to the fairness
of presentation of such financial statements.
/s/ Timothy A. Smalley /s/ Harold B. Jeffreys
Timothy A. Smalley Harold B. Jeffreys
Chairman of the Board Interim President and
and Interim Chief Chief Executive Officer
Financial Officer
13
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data and ratios for the
Company and should be read in conjunction with our consolidated financial
statements including the related notes and "Management's Discussion and Analysis
of Financial Condition and Results of Operations." See "Item 8. Heritage
Financial Holding Corporation and Subsidiaries Financial Statements."
Years ended December 31,
---------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- -------
(Dollars in thousands except per share data)
EARNINGS SUMMARY:
Interest income ......................................... $ 44,253 $ 35,660 $ 17,248 $ 9,383 $ 4,924
Less interest expense ................................... 28,594 22,018 9,874 5,399 2,863
Net interest income ..................................... 15,659 13,642 7,374 3,984 2,061
Provision for loan losses ............................... 3,602 3,389 1,808 828 336
Net interest income after provision for
loan losses ........................................... 12,057 10,253 5,566 3,156 1,725
Noninterest income ...................................... 1,556 1,039 642 397 174
Noninterest expense ..................................... 10,023 8,113 4,952 2,937 1,443
Income before income taxes .............................. 3,590 3,179 1,256 616 456
Applicable income taxes ................................. 1,224 991 395 197 163
Net income .............................................. 2,366 2,188 861 419 293
PER COMMON SHARE DATA:
(Retroactively adjusted for effects of stock splits)
Net income - basic ...................................... $ 0.28 $ 0.26 $ 0.12 $ 0.07 $ 0.07
Net income - diluted .................................... 0.23 0.22 0.11 0.07 0.07
Cash dividends declared per common share ................ 0.00 0.00 0.00 0.00 0.00
SELECTED AVERAGE BALANCES:
Total assets ............................................ $559,921 $401,615 $213,101 $114,834 $62,371
Total loans ............................................. 489,897 333,340 172,418 83,217 42,989
Securities .............................................. 26,662 23,183 19,405 15,786 14,121
Earning assets .......................................... 546,517 389,795 204,643 109,675 58,846
Deposits ................................................ 496,283 348,819 180,072 94,796 53,928
Stockholders' equity .................................... 34,178 29,910 19,062 11,606 7,692
Shares outstanding (thousands) (split adjusted) ......... 8,485 8,317 7,226 5,616 4,336
SELECTED PERIOD-END BALANCES:
Total assets ............................................ $568,291 $471,458 $297,952 $167,378 $88,615
Total loans ............................................. 505,381 422,135 244,620 116,723 58,360
Securities .............................................. 25,894 26,846 19,969 21,723 15,340
Earning assets .......................................... 550,865 458,478 287,307 155,068 84,012
Deposits ................................................ 504,310 421,244 249,032 137,001 72,596
Stockholders' equity .................................... 36,124 33,499 21,920 19,009 10,478
Shares outstanding (thousands) (split adjusted) ......... 8,515 8,476 7,581 7,192 5,342
SELECTED RATIOS:
Return on average equity ................................ 6.92% 7.32% 4.52% 3.61% 3.81%
Return on average assets ................................ 0.42 0.54 0.40 0.36 0.47
Net interest margin (taxable equivalent) ................ 2.88 3.52 3.63 3.65 3.52
Allowance for loan losses to loans ...................... 1.20 1.20 1.24 1.20 1.20
Net charge-offs to average loans ........................ 0.53 0.41 0.10 0.15 0.01
Average equity to average assets ........................ 6.10 7.45 8.95 10.11 12.33
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following is a narrative discussion and analysis of significant
changes in our results of operations and financial condition. This discussion
should be read in conjunction with the consolidated financial statements and
selected financial data included elsewhere in this Annual Report.
Our principal subsidiary is Heritage Bank, a financial institution
organized and existing under the laws of Alabama and headquartered in Decatur,
Alabama. The Bank operates eight offices throughout Northern Alabama. The
Company also has another wholly-owned subsidiary, Heritage Financial Statutory
Trust I ("Heritage Trust"), a Connecticut statutory trust. Heritage Trust is a
consolidated special purpose entity formed solely to issue cumulative trust
preferred securities.
The Company was established in the year 2000 in order to facilitate a
reorganization and merger of the Company and the Bank into a bank holding
company structure. The reorganization was effective on August 31, 2000.
RECENT DEVELOPMENTS
In January 2002, Heritage Bank opened a new office in Trussville,
Alabama, a rapidly growing suburb of metropolitan Birmingham. The Bank is
leasing approximately 4,000 square feet of space in a new 10,000 square foot
building located in a highly traversed area of Trussville. The Company and the
Bank believe this location will be a great success this year and over time.
On March 12, 2002, Reginald D. Gilbert, President, Chief Executive
Officer and Director of the Company and the Bank, elected to voluntarily retire
as an employee and sever his relationship with the Company and the Bank. In
conjunction with his retirement and severance, the Company and Reginald D.
Gilbert ("Gilbert") entered into a "Retirement, Release and Settlement
Agreement" (the "Agreement"), providing for severance pay and certain other
nonqualified retirement benefits in consideration of his retirement, his years
of service and certain non-competition and other agreements and covenants. Our
independent accountants have notified us that current accounting regulations
require that substantially all of the benefits to be received by Gilbert from
the Company, as provided for in the Agreement must be reflected as compensation
cost in our 2002 consolidated financial statements. The aggregate amount of
compensation cost, net of tax benefit, to be recognized by us as a charge
against 2002 earnings, due solely to the provisions of the Agreement, is
estimated to be approximately $3.7 million or $0.43 per common share. Although
our earnings will be adversely affected, the nature of Gilbert's benefits allows
for an offsetting increase in stockholders' equity of approximately $4.3
million, thereby increasing stockholders' equity by approximately $600,000 more
than the charge against earnings. Net book value per share would therefore
increase by approximately $0.07 per common share due solely to the provisions of
the Agreement. The Board of Directors has begun a formal search process for a
new President and Chief Executive Officer of the companies. In the meantime, the
Board of Directors has elected Harold B. Jeffreys, a Director, as Interim
President and Chief Executive Officer.
On April 9, 2002, the Board of Directors voted to disengage with its
current investment banking firm and cease any further negotiations with other
banks or bank holding companies regarding a possible merger. The Board has
decided to focus on selecting a new President and Chief Executive Officer and
other senior management officers of the Company including a Chief Financial
Officer, and take steps to generate growth for the Company along all lines of
business.
At the same meeting on April 9, 2002, the Board elected Timothy A.
Smalley, Chairman of the Board and Director, as interim Chief Financial Officer.
Mr. Smalley is a certified public accountant and has provided certain accounting
services to the Company over the past several years. The Board has full
confidence in Mr. Smalley and believes that he will provide the Company with
efficient and effective service in this capacity until such time as the Board
selects a permanent Chief Financial Officer.
Finally, on April 9, 2002, the Board of Directors also accepted the
resignations of all the current inside directors from the Board, including:
John W. Whitley, President, Heritage Bank Decatur, Vernon C. Bice, President,
Heritage Bank Huntsville, and Michael R. Washburn, President, Heritage Bank
Birmingham. These individuals believed it would benefit the Company on many
levels if they would remove themselves from the direct oversight responsibility
of the Board of Directors. The city presidents plan to focus going forward
on growing the Company and the Bank at the operations level and provide support
and information to the Board of Directors in order to increase overall
stockholder value.
SUMMARY
Our net income for 2001 was $2,366,000, an 8.2% increase from 2000
which was $2,188,000. Net income for the year 2000 represented a 154.1% increase
from 1999 net income of $861,000. Our basic earnings per common share for 2001,
2000 and 1999 were $0.28, $0.26 and $0.12, respectively. Pretax income for 2001
increased $411,000 or 12.9% from 2000 and pretax income for 2000 increased
$1,923,000 or 153.1% from 1999.
The increase in net income each year is primarily attributable to
increased net interest income, while the Company's provision for loan losses and
noninterest expenses increased by lesser amounts.
15
EARNING ASSETS
Our total assets were $568,291,000 at December 31, 2001, an increase of
$96,833,000, or 20.5% from $471,458,000 as of December 31, 2000. The increase in
total assets primarily related to an increase in loans, net of unearned income,
of $83,246,000 and mortgage loans held-for-sale of $12,548,000. The increase in
total assets was funded primarily by an increase in deposits and our issuance of
subordinated debentures.
Our average earning assets were approximately $546,517,000 in 2001,
representing an increase of $156,722,000 or 40.21% over 2000. Average earning
assets in the year 2000 were approximately $389,795,000, representing an
increase of $185,152,000 or 90.48% over the 1999 amount of $204,643,000.
Management considers many criteria in managing assets, including
creditworthiness, diversification and structural characteristics, maturity and
interest rate sensitivity. The following table sets forth the Bank's
interest-earning assets by category at December 31, in each of the last three
years.
Years Ended December 31,
----------------------------------
2001 2000 1999
---------- --------- ---------
(In thousands)
Interest-bearing deposits with banks.......... $ 326 $ 817 $ 9,533
Securities.................................... 25,894 26,846 19,969
Federal funds sold............................ 6,716 8,680 13,185
Mortgage loans held-for-sale.................. 12,548 -- --
Loans:
Real estate................................ 344,749 296,025 162,075
Commercial and other....................... 160,632 126,110 82,545
---------- --------- ---------
Total loans.............................. 505,381 422,135 244,620
---------- --------- ---------
Interest-earning assets ...................... $ 550,865 $ 458,478 $ 287,307
========== ========= =========
LOAN PORTFOLIO
Loans are the largest category of interest-earning assets and typically
provide higher yields than other types of interest-earning assets. Loans involve
inherent risk and liquidity risks which management attempts to control and
mitigate. Our average loans increased $156,557,000 or 46.97% from year-end 2000
to 2001. The increase in loans was a result of strong loan demand. Loan growth
for 2001 was funded primarily through customer deposits. The most significant
loan increase came from commercial, financial and agricultural loans which
increased approximately $32,951,000 or 31.26% over the 2000 year end amount.
Our average loans increased $160,922,000 or 93.33% from year-end 1999
to 2000. The increase in loans was a result of continued loan demand. Loan
growth for the year 2000 was funded primarily through customer deposits. The
most significant loan increase came from real estate loans which increased by
$133,950,000 or 82.6% over 1999.
16
The Loan Portfolio table presents the classifications of loans by major
category at December 31, 2001, and for each of the preceding four years.
LOAN PORTFOLIO
December 31,
---------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------- ------------------- ------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
of of of of of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
Commercial,
financial and
agricultural .... $138,344 26.71% $105,393 24.97% $ 66,144 27.04% $ 45,105 38.64% $ 25,069 42.95%
Real estate -
construction .... 70,073 13.53 90,603 21.46 49,432 20.21 12,583 10.78 1,833 3.14
Real estate -
mortgage ........ 274,676 55.46 205,422 48.66 112,643 46.05 45,320 38.83 24,094 41.29
Consumer .......... 22,288 4.30 20,717 4.91 16,410 6.70 13,658 11.70 6,995 11.99
Other ............. -- 0.00 -- 0.00 -- 0.00 57 0.05 369 0.63
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
505,381 100.00% 422,135 100.00% 244,629 100.00% 116,723 100.00% 58,360 100.00%
====== ======
Allowance for
loan losses ..... (6,074) (5,065) (3,036) (1,402) (700)
Unearned income ... -- -- (9) -- --
-------- -------- -------- -------- --------
Net loans ......... $499,307 $417,070 $241,584 $115,321 $57,660
======== ======== ======== ======== =======
The following table sets forth maturities of selected categories of the
loan portfolio and the related sensitivity to interest rate changes.
SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY
Rate Structure for Loans
Maturity Maturing Over One Year
------------------------------------------------ ------------------------------
Over One
One Year Over Predetermined Floating or
Year or Through Five Interest Adjustable
Less Five Years Years Total Rate Rate
-------- ---------- ------- -------- ------------- -----------
(Amounts in thousands)
Commercial, financial
and agricultural ............. $ 68,524 $59,358 $10,462 $138,344 $47,483 $22,337
Real estate - construction ..... 54,972 13,915 1,186 70,073 9,138 5,963
-------- ------- ------- -------- ------- -------
Total ...................... $123,496 $73,273 $11,648 $208,417 $56,621 $28,300
======== ======= ======= ======== ======= =======
SECURITIES PORTFOLIO
Our securities portfolio decreased by $952,000 or 3.55% from the year
2000 to 2001. The balance in the securities portfolio decreased as a result of
strong loan demand in 2001. Our securities portfolio increased by $6,877,000 or
34.44% from 1999 to 2000. The balance in the securities portfolio increased as
funds became available throughout the year 2000.
We maintain an investment strategy of seeking portfolio yields within
acceptable risk levels, as well as providing liquidity. The Bank maintains one
classification of securities: "Available-for-Sale." The classification of
securities as Available-for-Sale is consistent with our investment philosophy of
maintaining flexibility to manage the portfolio. The Available-for-Sale
securities are carried at fair market value and represent all of our securities
at year-end 2001 and 2000. At year-ends 2001 and 2000, unrealized gains (losses)
in the Available-for-Sale portfolio amounted to ($94,581) and ($264,845),
respectively.
17
At year-ends 2001 and 2000, obligations of the United States Government
or its agencies and obligations of states and political subdivisions represented
approximately 73.0% and 81.1%, respectively, of our securities portfolio.
The following table presents the carrying amounts of our securities
portfolio at December 31, in each of the last three years.
SECURITIES PORTFOLIO
December 31,
-------------------------------
2001 2000 1999
--------- -------- --------
(In thousands)
AVAILABLE-FOR-SALE
U.S. government and agencies................................. $ 15,697 $ 18,450 $ 14,168
Mortgage-backed securities................................... 617 1,020 1,367
Asset-backed securities...................................... 4,474 1,986 --
State and municipal.......................................... 2,590 2,300 2,085
Corporate debt securities.................................... 1,190 1,244 1,099
Equity securities............................................ 1,326 1,846 1,250
--------- -------- --------
Total...................................................... $ 25,894 $ 26,846 $ 19,969
========= ======== ========
18
The maturities and weighted average yields of the investments in the
2001 portfolio of securities are presented below.
SECURITY PORTFOLIO MATURITY SCHEDULE
Maturing
---------------------------------------------------------------------------------
Within After One But After Five But After
One Year Within Five Years Within Ten Years Ten Years
---------------- ----------------- ------------------ ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Amounts in thousands)
SECURITIES AVAILABLE-FOR-SALE
(amortized cost)
U.S. Government and agencies.. $ -- 0.00% $ 5,791 5.49% $ 5,896 5.17% $ 3,995 6.14%
Mortgage-backed securities.... -- 0.00 -- 0.00 -- 0.00 613 5.62
Asset-backed securities....... -- 0.00 -- 0.00 1,984 2.59 2,467 2.56
State and municipal (1)....... -- 0.00 -- 0.00 -- 0.00 2,666 5.23
Corporate debt securities..... -- 0.00 -- 0.00 -- 0.00 1,250 7.00
Equity securities............. -- 0.00 -- 0.00 -- 0.00 1,326 7.74
------ ------- ------- -------
$ -- 0.00 $ 5,791 5.49 $ 7,880 4.52 $12,317 5.46
====== ======= ======= =======
- -----------------
(1) The weighted average yields are calculated on the basis of the cost and
effective yield weighted for the scheduled maturity of each security. The
weighted average yields on tax-exempt obligations have been computed on a
fully taxable equivalent basis using a tax rate of 34%. The taxable
equivalent adjustment represents the annual amounts of income from
tax-exempt obligations multiplied by 152%.
We did not hold any securities of which the aggregate value on December
31, 2001, 2000 and 1999 exceeded ten percent of stockholders' equity at that
date. (Securities which are payable from and secured by the same source of
revenue or taxing authority are considered to be securities of a single issuer.
Securities of the U.S. Government and U.S. Government agencies and corporations
are not included.)
DEPOSITS AND BORROWED FUNDS
Our average deposits rose $147,464,000 or 42.28% from the year 2000 to
2001. Total deposits increased $83,066,000 or 19.72% from 2000 to 2001. The
largest area of growth in 2001 was in other time deposits of less than $100,000,
which increased $33,227,000 or 16.08%. From 2000 to 2001, other time deposits of
more than $100,000 increased $7,126,000 or 5.31%. Savings deposits increased
$13,501,000 or 38.92%, and interest-bearing demand accounts increased
$19,570,000 or 57.21%. From year-end 2000 to year-end 2001, total non-interest
bearing deposits increased $9,642,000 or 82.74%. Deposit growth has been
generated primarily in our local markets.
Our average deposits rose $168,747,000 or 93.71% from 1999 to 2000.
Total deposits increased $172,212,000 or 69.15% from 1999 to 2000. The largest
area of growth in 2000 was in other time deposits of less than $100,000, which
increased $96,022,000 or 86.83%. From 1999 to 2000, other time deposits of more
than $100,000 increased $61,975,000 or 85.93%, savings deposits increased
$10,415,000 or 42.91%, and interest-bearing demand accounts increased $5,836,000
or 20.57%. From year-end 1999 to year-end 2000, total non-interest bearing
deposits decreased $2,036,000 or (14.87%).
19
The following table sets forth our deposit structure at December 31, of
each of the last three years.
December 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(In thousands)
Noninterest-bearing deposits:
Individuals, partnerships and corporations.................... $ 21,296 $ 11,374 $ 13,416
U.S. Government and states and political subdivisions......... -- -- --
Certified and official checks................................. -- 280 274
--------- --------- ---------
Total noninterest-bearing deposits.......................... 21,296 11,654 13,690
--------- --------- ---------
Interest-bearing deposits:
Interest-bearing demand accounts.............................. 53,776 34,206 28,370
Savings accounts.............................................. 48,187 34,686 24,271
Certificates of deposit, less than $100,000................... 239,831 206,604 110,582
Certificates of deposit, more than $100,000................... 141,220 134,094 72,119
--------- --------- ---------
Total interest-bearing deposits............................. 483,014 409,590 235,342
--------- --------- ---------
Total deposits.............................................. $ 504,310 $ 421,244 $ 249,032
========= ========= =========
The following table presents a breakdown by category of the average
amount of deposits and the average rate paid on deposits for the periods
indicated:
Years Ended December 31,
---------------------------------------------------------------------
2001 2000 1999
------------------ ------------------ -------------------
Amount Rate Amount Rate Amount Rate
-------- ---- -------- ---- -------- ----
(Dollars in thousands)
Noninterest-bearing deposits ......... $ 16,975 0.00% $ 13,116 0.00% $ 9,499 0.00%
Interest-bearing demand deposits ..... 39,299 3.10 28,895 3.74 23,328 3.93
Savings deposits ..................... 43,079 3.17 28,664 5.16 16,096 4.73
Time deposits ........................ 396,930 6.09 278,144 6.58 131,149 5.73
-------- ---- -------- ---- -------- ----
Total deposits .................... $496,283 5.39% $348,819 5.98% $180,072 5.11%
======== ======== ========
At December 31, 2001, time deposits greater than $100,000 aggregated
approximately $141,220,000. The following table indicates, as of December 31,
2001, the dollar amount of $100,000 or more by the time remaining until maturity
(in thousands):
MATURITIES OF LARGE TIME DEPOSITS
(In thousands)
Three months or less........................................................... $ 36,597
Over three through six months.................................................. 34,341
Over six through twelve months................................................. 30,886
Over twelve months............................................................. 39,396
--------
Total........................................................................ $141,220
========
Borrowed funds of $23,000,000 as of December 31, 2001, consist of
long-term Federal Home Loan Bank advances and an advance from a pooled trust
preferred private placement for subordinated debentures. We had $13,500,000 in
available lines to purchase Federal Funds, on an unsecured basis, from
commercial banks. At December 31, 2001, 2000 and 1999, we had no funds advanced
against these lines. We are also approved to borrow up to $59,000,000 under
various short-term and long-term programs offered by the Federal Home Loan Bank
of Atlanta. These borrowings are secured under a blanket lien agreement on
certain qualifying mortgage instruments in loan and security portfolios. The
unused portion of these available funds amounted to $46,000,000 at year-end
2001, $35,000,000 at year-end 2000 and $7,700,000 at year-end 1999.
20
The following table sets forth the expected debt service for the next
five years based on interest rates and repayment provisions as of December 31,
2001.
MATURITIES OF LONG-TERM DEBT
(In thousands)
2002 2003 2004 2005 2006
------ ------ ------ ------ ------
Interest on indebtedness ..... $1,609 $1,609 $1,609 $1,609 $1,609
Repayment of principal ....... -- -- -- -- --
------ ------ ------ ------ ------
$1,609 $1,609 $1,609 $1,609 $1,609
====== ====== ====== ====== ======
CAPITAL RESOURCES
Stockholders' equity increased $2,624,578 or 7.83% to $36,123,880 as of
December 31, 2001. The increase in stockholders' equity was primarily
attributable to net income. Stockholders' equity increased $11,579,252 or 52.82%
to $33,499,302 as of December 31, 2000. Stockholders' equity increased
$2,911,113 or 15.31% to $21,920,050 as of December 31, 1999. The increases in
stockholders' equity in 2000 and 1999 were attributable to net income and the
issuance of stock through exempt offerings, employee stock purchase plan
purchases and the exercise of stock options.
On February 22, 2001, Heritage Financial Statutory Trust I ("Heritage
Trust"), a Connecticut statutory trust established by the Company, received
$10,000,000 in proceeds in exchange for $10,000,000 principal amount of Heritage
Trust's 10.20% cumulative trust preferred securities (the "preferred
securities") in a pooled trust preferred private placement. The proceeds of that
transaction were then used by Heritage Trust to purchase an equal amount of our
10.20% subordinated debentures (the "subordinated debentures"). We have fully
and unconditionally guaranteed all obligations of Heritage Trust on a
subordinated basis with respect to the preferred securities. We
account for the Heritage Trust preferred securities as a minority interest.
Subject to certain limitations, the preferred securities qualify as Tier 1
capital and are presented in the Consolidated Statements of Financial Condition
as "Guaranteed preferred beneficial interests in the Company's subordinated
debentures." The sole asset of Heritage Trust is the subordinated debentures
issued by us. Both the preferred securities of Heritage Trust and our
subordinated debentures each have 30-year lives. However, both the Company and
Heritage Trust have a call option of ten years, subject to regulatory approval,
or earlier, depending upon certain changes in tax or investment company laws, or
regulatory capital requirements.
A strong capital position, which is vital to our continued
profitability, also promotes depositor and investor confidence and provides a
solid foundation for the future growth of the organization. The objective of
management is to maintain a level of capitalization that is sufficient to take
advantage of profitable growth opportunities while meeting regulatory
requirements. This is achieved by improving profitability through effectively
allocating resources to more profitable businesses, improving asset quality,
strengthening service quality, and streamlining costs. The primary measures used
by management to monitor the results of these efforts are the ratios of return
on average assets, return on average common equity and average equity to average
assets.
21
The table below summarizes these and other key ratios for us for each
of the last three years.
RETURN ON EQUITY AND ASSETS
2001 2000 1999
---- ---- ----
Return on average assets........................................... 0.42% 0.54% 0.40%
Return on average common equity.................................... 6.92 7.32 4.52
Dividend payout ratio.............................................. 0.00 0.00 0.00
Average common stockholders' equity to average
assets ratio.................................................... 6.10 7.45 8.95
In addition, banks and bank holding companies are required to maintain
capital to support, on a risk-adjusted basis, certain off-balance sheet
activities such as loan commitments. The Federal Reserve Board has adopted
capital guidelines governing the activities of bank holding companies. These
guidelines require the maintenance of an amount of capital based on
risk-adjusted assets so that categories of assets with potentially higher credit
risk will require more capital than assets with lower risk.
The capital guidelines classify capital into two tiers, referred to as
Tier I and Tier II. Under risk-based capital requirements, Total Capital
consists of Tier I capital which is generally common stockholders' equity less
goodwill and Tier II capital which is primarily a portion of the allowance for
loan losses and certain qualifying debt instruments. In determining risk-based
capital requirements, assets are assigned risk-weights of 0% to 100%, depending
primarily on the regulatory assigned levels of credit risk associated with such
assets. Off-balance sheet items are considered in the calculation of
risk-adjusted assets through conversion factors established by the regulators.
The framework for calculating risk-based capital requires banks and bank holding
companies to meet the regulatory minimums of 4% Tier I and 8% total risk-based
capital. In 1990 regulators added a leverage computation to the capital
requirements, comparing Tier I capital to total average assets less goodwill.
The table below illustrates our regulatory capital ratios under federal
guidelines at December 31, 2001, 2000 and 1999:
CAPITAL ADEQUACY RATIOS
Years ended December 31,
Statutory ----------------------------------------
Minimum 2001 2000 1999
--------- ----------- ----------- -----------
(Amounts in thousands)
Tier I Capital $ 46,180 $ 33,658 $ 22,812
Tier II Capital 6,074 5,065 3,034
----------- ----------- -----------
Total Qualifying Capital $ 52,254 $ 38,723 $ 25,846
=========== =========== ===========
Risk Adjusted Total Assets (including
off-balance-sheet exposures) $ 488,824 $ 413,536 $ 242,718
=========== =========== ===========
Adjusted quarterly average assets $ 587,901 $ 463,464 $ 267,110
=========== =========== ===========
Tier I Capital Ratio 4.00% 9.45% 8.14% 9.40%
Total Capital Ratio 8.00 10.69 9.36 10.65
Leverage Ratio 4.00 7.86 7.26 8.54
On December 31, 2001, 2000 and 1999, the Company and the Bank each
exceeded the regulatory minimums and together qualified as a well capitalized
institution under the regulations.
22
LIQUIDITY MANAGEMENT
The goal of liquidity management is to provide adequate funds to meet
changes in loan demand or any potential unexpected deposit withdrawals.
Additionally, management strives to maximize our earnings by investing our
excess funds in securities.
Historically, we have maintained a high loan-to-deposit ratio. To meet
our short-term liquidity needs, we maintain core deposits and have borrowing
capacity through the FHLB and federal funds lines. Long-term liquidity needs are
met primarily through these sources, time deposits, the repayment of loans,
sales of loans and the maturity or sale of investment securities, including
short-term investments. We have entered into certain contractual obligations and
commercial commitments that arise in the normal course of business and involve
elements of credit risk, interest rate risk and liquidity risk.
The liability portion of the balance sheet provides liquidity through
various interest-bearing and noninterest-bearing deposit accounts. At December
31, 2001, we had $13,500,000 of federal funds available and a line of credit of
approximately $59,000,000 from The Federal Home Loan Bank of which approximately
$46,000,000 was available and unused. At December 31, 2000, we had $10,000,000
of federal funds available and a line of credit of approximately $47,000,000
from The Federal Home Loan Bank of which approximately $35,000,000 was available
and unused. At December 31, 1999, we had $11,500,000 of federal funds available
and a line-of-credit of approximately $33,000,000 from the Federal Home Loan
Bank of which approximately $8,000,000 was available and unused.
INTEREST RATE SENSITIVITY MANAGEMENT
Interest rate sensitivity is a function of the repricing
characteristics of our portfolio of assets and liabilities. These repricing
characteristics are the time frames within which the interest-bearing assets and
liabilities are subject to change in interest rates either at replacement or
maturity during the life of the instruments. Sensitivity is measured as the
difference between the volume of assets and liabilities in our current portfolio
that are subject to repricing in future time periods. The differences are known
as interest sensitivity gaps and are usually calculated separately for segments
of time ranging from zero to thirty days, thirty-one to ninety days, ninety-one
days to one year, one to five years, over five years and on a cumulative basis.
23
The following table shows interest sensitivity gaps for different
intervals as of December 31, 2001.
INTEREST RATE SENSITIVITY ANALYSIS
(Amounts in thousands)
0-30 31-90 91-365 1-5 Over 5
Days Days Days Years Years Total
-------- --------- --------- -------- --------- --------
Interest-earning assets (1)
Loans .................................. $166,115 $ 16,000 $ 46,767 $ 266,259 $ 6,178 $501,319
Mortgage loans held-for-sale ........... 12,548 -- -- -- -- 12,548
Securities available-for-sale .......... 4,474 -- 208 6,295 14,917 25,894
Time deposits in other banks ........... 326 -- -- -- -- 326
Federal funds sold ..................... 6,716 -- -- -- -- 6,716
-------- --------- --------- -------- --------- --------
190,179 16,000 46,975 272,554 21,095 546,803
-------- --------- --------- -------- --------- --------
Interest-bearing liabilities (2)
Demand deposits (3) .................... 17,925 17,925 17,926 -- -- 53,776
Savings deposits (3) ................... 16,062 16,062 16,063 -- -- 48,187
Time deposits .......................... 33,559 55,621 199,166 92,705 -- 381,051
Long-term debt ......................... -- -- -- -- 23,000 23,000
-------- --------- --------- -------- --------- --------
67,546 89,608 233,155 92,705 23,000 506,014
-------- --------- --------- -------- --------- --------
Interest sensitivity gap ................. $122,633 $ (73,608) $(186,180) $179,849 $ (1,905) $ 40,789
======== ========= ========= ======== ========= ========
Cumulative interest sensitivity gap ...... $122,633 $ 49,025 $(137,155) $ 42,694 $ 40,789
======== ========= ========= ========= =========
Ratio of interest-earning assets to
interest-bearing liabilities ........... 2.82 0.18 0.20 2.94 0.92
Cumulative ratio ............................ 2.82 1.31 0.65 1.09 1.08
Ratio of cumulative gap to total
interest-earning assets ................ 0.22 0.09 (0.25) 0.08 0.07
- --------------------------
(1) Excludes nonaccrual loans and securities
(2) Excludes matured certificates which have not been redeemed by the
customer and on which no interest is accruing.
(3) Demand and savings deposits are assumed to be subject to movement into
other deposit instruments in equal amounts during the 0-30 day period,
the 31-90 day period, and the 91-365 day period.
The above table indicates that in a rising interest rate environment
our earnings may be positively affected in the short-term because 37.7% of
earning assets reprice within 90 days and only 31.1% of interest-bearing
liabilities reprice during the same period. As seen in the preceding table, for
the first 30 days of repricing opportunity there is an excess of earning assets
over interest-bearing liabilities of approximately $122.6 million. For the first
365 days, interest-bearing liabilities exceed earning assets by $137.2 million.
During this one-year time frame, 77.1% of all interest-bearing liabilities will
reprice compared to 46.3% of all interest-earning assets. Changes in the mix of
earning assets or supporting liabilities can either increase or decrease the net
interest margin without affecting interest rate sensitivity. Due to management's
continued emphasis on profitability, many of the higher-yielding assets
presented in the table above have call or prepayment features, which may result
in such assets having a shorter effective life. This in turn may reduce the
interest rate sensitivity gap presented above. It should be noted, therefore,
that a matched interest-sensitive position by itself would not ensure maximum
net interest income.
Management continually evaluates the condition of the economy, the
pattern of market interest rates, and other economic data to determine the types
of investments that should be made and at what maturities. Using this analysis,
management from time to time assumes calculated interest sensitivity gap
positions to maximize net interest income based upon anticipated movements in
the general level of interest rates.
24
RESULTS OF OPERATIONS
NET INTEREST INCOME
The largest component of our net income is net interest income, which
is the difference between the income earned on interest-earning assets and
interest paid on deposits and borrowings. Net interest income is determined by
the rates earned on our interest-earning assets, rates paid on our
interest-bearing liabilities, the relative amounts of interest-earning assets
and interest-bearing liabilities, the degree of mismatch, and the maturity and
repricing characteristics of our interest-earning assets and interest-bearing
liabilities. Net interest income divided by average interest-earning assets
represents our net interest margin. The following discussion is on a taxable
equivalent basis.
Our net interest income increased $2,019,000 or 14.71% to $15,747,000
from 2000 to 2001. Net interest income increased $6,292,000 or 84.62% from 1999
to 2000. The increase in the net interest income from all periods is primarily
due to a consistent and significant increase in total loans. Interest income was
$44,340,000 in 2001, which represented an increase of $8,594,000 or 24.04% over
2000. Interest income was $35,746,000 in 2000, which represented an increase of
$18,436,000 or 106.50% over 1999. Interest and fee income produced by the loan
portfolio increased $9,800,000 or 30.81% in 2001 from 2000. Interest and fee
income produced by the loan portfolio increased $16,521,000 or 108.06% in 2000
from 1999. Interest income on securities decreased $81,000 or 4.68% from 2000 to
2001. The decrease in interest income on securities from 2000 to 2001 was
primarily the result of the significant decrease in bond yields during the year
2001. Interest income on securities increased $404,000 or 30.47% from 1999 to
2000. The increase in securities income from 1999 to 2000 was due to an increase
in average taxable securities. Interest income other than loans and securities
decreased $1,125,000 or 51.00% from 2000 to 2001 and increased by $1,511,000 or
217.41% in 2000 from 1999.
Total interest expense increased by $6,577,000 or 29.87% in 2001 from
2000. The interest expense increase from 2000 to 2001 is primarily due to the
increase in interest-bearing deposit accounts. Interest expense on deposit
accounts increased $5,886,000 or 28.21% from 2000 to 2001. Total interest
expense increased by $12,144,000 or 122.99% in 2000 from 1999. The interest
expense increase from 1999 to 2000 is primarily due to the increase in
interest-bearing deposit accounts. Interest expense on deposit accounts
increased $11,672,000 or 126.95% from 1999 to 2000.
The trend in net interest income is commonly evaluated in terms of
average rates using the net interest margin and the interest rate spread. The
net interest margin or the net yield on earning assets is computed by dividing
fully taxable equivalent net interest income by average earning assets. This
ratio represents the difference between the average yield on average earning
assets and the average rate paid for all funds used to support those earning
assets. Our net interest margin decreased 64 basis points in 2001 from 3.52% at
year-end 2000 to 2.88% at year-end 2001. The net interest margin decreased 11
basis points in 2000 from 3.63% at year-end 1999 to 3.52% at year-end 2000. The
yield on earning assets decreased 106 basis points to 8.11% in 2001 from 9.17%
in 2000 and increased 71 basis points to 9.17% in 2000 from 8.46% in 1999. The
net cost of funds, defined as interest expense divided by average earning
assets, decreased 42 basis points to 5.23% at year-end 2001 from 5.65% at
year-end 2000 and increased 82 basis points to 5.65% at year-end 2000 from 4.83%
in 1999.
The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest bearing sources of
funds. The interest rate spread eliminates the impact of noninterest bearing
funds and gives a direct perspective on the effect of market interest rate
movements. During recent years, the net interest margins and interests rate
spreads have been under intense pressure to maintain historical levels, due in
part to tax laws that discouraged investment in tax-exempt securities and
intense competition for funds with non-bank institutions. Our interest rate
spread decreased 55 basis points to 2.43% from 2000 to 2001 and 10 basis points
to 2.98% from 1999 to 2000, due to effects of the overall economic environment
and unprecedented interest rate moves by the Federal Reserve primarily in 2001.
25
The tables that follow show, for the periods indicated, the daily
average balances outstanding for the major categories of interest-bearing assets
and interest-bearing liabilities, and the average interest rate earned or paid
by us thereon. Such yields are calculated by dividing income or expense by the
average balance of the corresponding assets or liabilities. Also shown are the
changes in income attributable to changes in volume and changes in rate.
AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES
Taxable Equivalent Basis
Years Ended December 31,
------------------------------------------------------------------------------
2001 2000
----------------------------------- -------------------------------------
Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
-------- --------- ------- --------- -------- -------
(Dollars in thousands)
ASSETS
Earning assets:
Loans, net of
unearned income (1) .............. $489,897 $41,610 8.49% $333,340 $31,810 9.54%
Securities:
Taxable ........................... 24,308 1,460 6.01 20,852 1,542 7.39
Tax exempt ........................ 2,354 189 8.03 2,331 188 8.07
-------- -------- --------- --------
Total securities ................ 26,662 1,649 6.18 23,183 1,730 7.46
Time deposits in other banks ...... 446 25 5.61 5,920 365 6.17
Federal funds sold ................ 29,512 1,056 3.58 27,352 1,841 6.73
-------- -------- --------- --------
Total interest-
earning assets (2) ............. 546,517 44,340 8.11 389,795 35,746 9.17
Noninterest-earning assets:
Cash and due from banks ........... 5,410 6,744
Premises and equipment ............ 6,220 4,536
Accrued interest
and other assets ................ 7,541 4,582
Allowance for loan losses ......... (5,767) (4,042)
-------- ---------
Total assets .................... $559,921 $401,615
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand deposits ................... $ 39,299 $ 1,219 3.10% $ 28,895 $ 1,080 3.74%
Savings deposits .................. 43,079 1,367 3.17 28,664 1,478 5.16
Time deposits ..................... 396,930 24,166 6.09 278,144 18,308 6.58
-------- -------- --------- --------
Total deposits .................. 479,308 26,752 5.58 335,703 20,866 6.22
Other short-term borrowings .......... 53 2 3.77 27 1 3.70
Long-term debt ....................... 24,271 1,841 7.59 19,910 1,151 5.78
-------- -------- --------- --------
Total interest-
bearing liabilities ............ 503,632 28,595 5.68 355,640 22,018 6.19
-------- -------- --------- --------
Noninterest-bearing liabilities:
Demand deposits ................... 16,975 13,116
Accrued interest and
other liabilities ............... 5,136 2,949
Stockholders' equity .............. 34,178 29,910
-------- ---------
Total liabilities and
stockholders' equity ........... $559,921 $401,615
-------- ---------
Net interest income/net
interest spread ................... 15,747 2.43% 13,728 2.98%
======= ======
Net yield on earning assets .......... 2.88% 3.52%
======= ======
Taxable equivalent adjustment:
Loans ............................. 23 22
Investment securities ............. 65 64
-------- --------
Total taxable equivalent
adjustment ..................... 88 86
-------- --------
Net interest income .................. $15,659 $13,642
======== ========
Years Ended December 31,
------------------------------------
1999
------------------------------------
Interest Average
Average Income/ Yields/
Balance Expense Rates
-------- -------- -------
ASSETS
Earning assets:
Loans, net of
unearned income (1) .............. $172,418 $15,289 8.87%
Securities:
Taxable ........................... 17,674 1,191 6.74
Tax exempt ........................ 1,731 135 7.80
-------- -------
Total securities ................ 19,405 1,326 6.83
Time deposits in other banks ...... 2,526 150 5.94
Federal funds sold ................ 10,294 545 5.29
-------- -------
Total interest-
earning assets (2) ............. 204,643 17,310 8.46
Noninterest-earning assets:
Cash and due from banks ........... 5,029
Premises and equipment ............ 3,444
Accrued interest
and other assets ................ 1,989
Allowance for loan losses ......... (2,004)
--------
Total assets .................... $213,101
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand deposits ................... $ 23,328 $ 917 3.93%
Savings deposits .................. 16,096 762 4.73
Time deposits ..................... 131,149 7,515 5.73
-------- -------
Total deposits .................. 170,573 9,194 5.39
Other short-term borrowings .......... 41 2 4.88
Long-term debt ....................... 12,767 678 5.31
-------- -------
Total interest-
bearing liabilities ............ 183,381 9,874 5.38
-------- -------
Noninterest-bearing liabilities:
Demand deposits ................... 9,499
Accrued interest and
other liabilities ............... 1,159
Stockholders' equity .............. 19,062
--------
Total liabilities and
stockholders' equity ........... $213,101
========
Net interest income/net
interest spread ................... 7,436 3.08%
=======
Net yield on earning assets .......... 3.63%
=======
Taxable equivalent adjustment:
Loans ............................. 16
Investment securities ............. 46
-------
Total taxable equivalent
adjustment ..................... 62
-------
Net interest income .................. $ 7,374
- ---------------------------
(1) Average loans include nonaccrual loans. All loans and deposits are domestic.
(2) Tax equivalent adjustments have been based on an assumed tax rate of 34
percent, and do not give effect to the disallowance for federal income
tax purpose of interest expense related to certain tax-exempt earning
assets.
26
RATE/VOLUME VARIANCE ANALYSIS
Taxable Equivalent Basis
Average Volume Change in Volume Average Rate
-------------------------------- ---------------------- ----------------------
2001 2000 1999 2001-2000 2000-1999 2001 2000 1999
-------- -------- -------- --------- --------- ---- ---- ----
(Dollars in thousands)
EARNING ASSETS:
Loans, net of unearned income ....... $489,897 $333,340 $172,418 $156,557 $160,922 8.49% 9.54% 8.87%
Securities:
Taxable ............................. 24,308 20,852 17,674 3,456 3,178 6.01 7.39 6.74
Tax exempt .......................... 2,354 2,331 1,731 23 600 8.03 8.07 7.80
-------- -------- -------- -------- --------
Total securities .................. 26,662 23,183 19,405 3,479 3,778 6.18 7.46 6.83
-------- -------- -------- -------- --------
Interest-bearing deposits with other
banks .................................. 446 5,920 2,526 (5,474) 3,394 5.61 6.17 5.94
Federal funds sold ..................... 29,512 27,352 10,294 2,160 17,058 3.58 6.73 5.29
-------- -------- -------- -------- --------
Total earning assets .............. $546,517 $389,795 $204,643 $156,722 $185,152 8.11 9.17 8.46
-------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES:
Deposits:
Demand .............................. $ 39,299 $ 28,895 $ 23,328 $ 10,404 $ 5,567 3.10 3.74 3.93
Savings ............................. 43,079 28,664 16,096 14,415 12,568 3.17 5.16 4.73
Time ................................ 396,930 278,144 131,149 118,786 146,995 6.09 6.58 5.73
-------- -------- -------- -------- --------
Total deposits .................... 479,308 335,703 170,573 143,605 165,130 5.58 6.22 5.39
-------- -------- -------- -------- --------
Other short-term borrowings ............ 53 27 41 26 (14) 3.77 3.70 4.88
Long-term borrowings ................... 24,271 19,910 12,767 4,361 7,143 7.59 5.78 5.31
-------- -------- -------- -------- --------
Total interest-bearing
liabilities ............................ $503,632 $355,640 $183,381 $147,992 $172,259 5.68 6.19 5.38
-------- -------- -------- -------- --------
Net interest income/net interest spread 2.43 2.98 3.08
Net yield on earning assets ............ 2.88 3.52 3.63
Net cost of funds ...................... 5.23 5.65 4.83
Variance Attributed to (1)
Interest ---------------------------------------
Income/Expense Variance 2001 2000
--------------------------- -------------------- ------------------ -----------------
2001 2000 1999 2001-2000 2000-1999 Volume Rate Volume Rate
------- ------- ------- --------- --------- ------- ------- ------- ------
(Dollars in thousands)
EARNING ASSETS:
Loans, net of
unearned income .............. $41,610 $31,810 $15,289 $9,800 $16,521 $13,611 $(3,811) $15,284 $1,237
Securities:
Taxable ........................ 1,460 1,542 1,191 (82) 351 232 (314) 228 123
Tax exempt ..................... 189 188 135 1 53 2 (1) 48 5
------- ------- ------- ------ ------- ------- ------- ------- ------
Total securities ............. 1,649 1,730 1,326 (81) 404 234 (315) 276 128
------- ------- ------- ------ ------- ------- ------- ------- ------
Interest-bearing deposits
with other banks ............... 25 365 150 (340) 215 (336) (4) 204 11
Federal funds sold ................ 1,056 1,841 545 (785) 1,296 135 (920) 1,113 183
------- ------- ------- ------ ------- ------- ------- ------- ------
Total earning assets ......... 44,340 35,746 17,310 8,594 18,436 13,644 (5,050) 16,877 1,559
Interest-bearing liabilities:
Deposits:
Demand ......................... 1,219 1,080 917 139 163 345 (206) 209 (46)
Savings ........................ 1,367 1,478 762 (111) 716 583 (694) 641 75
Time certificates .............. 24,166 18,308 7,515 5,858 10,793 7,309 (1,451) 9,531 1,262
------- ------- ------- ------ ------- ------- ------- ------- ------
Total deposits ............... 26,752 20,866 9,194 5,886 11,672 8,237 (2,351) 10,381 1,291
Other short-term borrowings ....... 2 1 2 1 (1) 1 -- (1) --
Long-term borrowings .............. 1,841 1,151 678 690 473 284 406 408 65
------- ------- ------- ------ ------- ------- ------- ------- ------
Total interest-bearing
liabilities .................. 28,595 22,018 9,874 6,577 12,144 8,522 (1,945) 10,788 1,356
------- ------- ------- ------ ------- ------- ------- ------- ------
Net interest income/net
interest spread ................ $15,745 $13,728 $ 7,436 $2,017 $ 6,292 $ 5,122 $(3,105) $ 6,089 $ 203
======= ======= ======= ====== ======= ======= ======= ======= ======
- ------------------------------------------
(1) The change in interest due to both rate and volume has been allocated
to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each.
27
ALLOWANCE FOR LOAN LOSSES
The Bank's lending officers are responsible for the ongoing review and
administration of each loan. They make the initial identification of loans which
present some difficulty in collection or where there is an indication that the
probability of loss exists. Lending officers are responsible for the collection
effort on a delinquent loan. Senior management is informed of the status of
delinquent and problem loans on a monthly basis.
Management makes recommendations monthly to the Board of Directors as
to-charge-offs. Management reviews the allowance for loan losses on a monthly
basis. Our policy is to discontinue interest accrual when payment of principal
and interest is 90 days or more in arrears.
The allowance for loan losses represents management's assessment of the
risks associated with extending credit and its evaluation of the quality of the
loan portfolio. Management analyzes the loan portfolio to determine the adequacy
of the allowance for loan losses and the appropriate provisions required to
maintain a level considered adequate to absorb anticipated loan losses. In
assessing the adequacy of the allowance, management reviews the size, quality
and risk of loans in the portfolio. Management also considers such factors as
loan loss experience, the amount of past due and nonperforming loans, specific
known risks, the status and amount of nonperforming assets, underlying
collateral values securing loans, current and anticipated economic conditions
and other factors which affect the allowance for loan losses.
While it is our policy to charge off in the current period the loans in
which a loss is considered probable, there are additional risks of future losses
which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.
Management believes that the $6,074,000 for December 31, 2001, and the
$5,065,000 for December 31, 2000, in the allowance for loan losses were adequate
to absorb known risks in the portfolio. No assurance can be given, however, that
adverse economic circumstances will not result in increased losses in the loan
portfolio, and require greater provisions for possible loan losses in the
future.
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28
The following table sets forth certain information with respect to our
loans, net of unearned income, and the allowance for loan losses for the five
years ended December 31, 2001.
SUMMARY OF LOAN LOSS EXPERIENCE
2001 2000 1999 1998 1997
--------- --------- --------- --------- --------
(Dollars in thousands)
Allowance for loan losses at beginning of year ........ $ 5,065 $ 3,036 $ 1,402 $ 700 $ 369
Loans charged off:
Commercial, financial and agricultural .............. 1,262 1,039 -- 15 --
Real Estate - mortgage .............................. 1,046 -- -- -- --
Consumer ............................................ 387 416 195 136 5
--------- --------- --------- --------- --------
Total loans charged off ........................... 2,695 1,455 195 151 5
--------- --------- --------- --------- --------
Recoveries on loans previously charged off:
Commercial, financial and agricultural .............. 33 66 -- -- --
Real Estate - mortgage .............................. 28 -- -- -- --
Consumer ............................................ 41 29 21 25 --
--------- --------- --------- --------- --------
Total recoveries .................................. 102 95 21 25 --
--------- --------- --------- --------- --------
Net loans charged off ................................. 2,593 1,360 174 126 5
Provision for loan losses ............................. 3,602 3,389 1,808 828 336
--------- --------- --------- --------- --------
Allowance for loan losses at end of period ............ $ 6,074 $ 5,065 $ 3,036 $ 1,402 $ 700
========= ========= ========= ========= ========
Loans, net of unearned income, at end of period ....... $ 505,381 $ 422,135 $ 244,620 $ 116,723 $ 58,360
Average loans, net of unearned income,
outstanding for the period .......................... 489,897 333,340 172,418 83,217 42,989
Ratio of net charge-offs to net average loans ......... 0.53% 0.41% 0.10% 0.15% 0.01%
In evaluating the allowance, management also considers our historical
loan loss experience, the amount of past due and nonperforming loans, current
and anticipated economic conditions, lender requirements and other appropriate
information. We allocate the allowance for loan losses to specific loan
categories based on an average of the previous two years net losses for each
loan type and management's judgement as to potential losses and significant
areas of risk in the portfolio.
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29
Management allocated the allowance for loan losses to specific loan
classes as follows:
ALLOCATION OF LOAN LOSS RESERVE
December 31,
------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------------- ----------------- ----------------- ------------------ ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
(Dollars in Thousands)
DOMESTIC LOANS
Commercial, financial
and agricultural ..... $1,622 26.71% $1,265 24.97% $ 821 27.04% $ 542 38.64% $175 42.95%
Real estate - mortgage . 4,191 68.99 3,552 70.13 2,012 66.26 696 49.61 175
44.43
Consumer ............... 261 4.30 248 4.90 203 6.70 164 11.75 350 12.62
------ ------ ------ ------ ------ ------ ------ ------ ---- ------
$6,074 100.00% $5,065 100.00% $3,036 100.00% $1,402 100.00% $700 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ==== ======
NONPERFORMING ASSETS
Nonperforming assets include nonperforming loans and foreclosed real
estate held for sale. Nonperforming loans include loans classified as nonaccrual
or renegotiated. A delinquent loan is placed on nonaccrual status when it
becomes 90 days or more past due and management believes, after considering
economic and business conditions and collection efforts, that the borrower's
financial condition is such that the collection of interest is doubtful. When a
loan is placed on nonaccrual status, all interest which has been accrued on the
loan but remains unpaid is reversed and deducted from earnings as a reduction of
reported interest income. No additional interest income is accrued on the loan
balance until the collection of both principal and interest becomes reasonably
certain. When a problem loan is finally resolved, there may ultimately be an
actual write-down or charge-off of the principal balance of the loan to the
allowance for loan losses. The accrual of interest on loans is discontinued at
the time the loan is 90 days delinquent unless the loan is well collateralized
and in process of collection. Recognition of any interest after a loan has been
placed on nonaccrual is accounted for on a cash basis.
We had nonperforming assets at December 31, 2001, of approximately
$12,415,000, $6,188,000 as of 2000, $1,170,000 as of 1999, $34,000 as of
December 31, 1998, and $50,000 as of December 31, 1997.
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30
The following table presents information concerning outstanding
balances of nonperforming assets at December 31, 2001, 2000, 1999, 1998 and
1997.
NONPERFORMING ASSETS
December 31,
--------------------------------------------------------------
2001 2000 1999 1998 1997
-------- ------- ------- -------- --------
(Dollars in thousands)
Nonaccruing loans ..................................... $ 4,062 $ 617 $ 43 $ 11 $ 28
Loans past due 90 days or more ........................ 4,125 5,358 914 23 22
Restructured loans .................................... -- -- -- -- --
-------- ------- ------- -------- --------
Total nonperforming loans ......................... 8,187 5,975 957 34 50
Nonaccruing securities ................................ -- -- -- -- --
Other real estate ..................................... 4,228 213 213 -- --
-------- ------- ------- -------- --------
Total ............................................. $ 12,415 $ 6,188 $ 1,170 $ 34 $ 50
======== ======= ======= ======== ========
Percentages:
Loan loss allowance to total nonperforming assets ... 48.92% 81.85% 259.49% 4,123.53% 1,400.00%
Total nonperforming loans to total loans
(net of unearned interest) ........................ 1.62 1.42 0.39 0.03 0.09
Total nonperforming assets to total assets .......... 2.18 1.31 0.39 0.02 0.06
There has been no significant impact on our financial statements as a
result of the provisions of Statement of Financial Accounting Standards No. 114,
Accounting by Creditors for Impairment of a Loan, or Statement of Financial
Accounting Standards No. 118, Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosures.
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities including fee-based services and profits and
commissions earned through credit life insurance sales and other activities. In
addition, gains or losses realized from the sale of investment portfolio
securities are included in noninterest income. Total noninterest income
increased by $517,000 or 49.76% for the year ended December 31, 2001, as
compared to the year 2000. Total noninterest income increased by $397,000 or
61.84% for the year ended December 31, 2000, as compared to 1999.
The table below sets forth the components of our noninterest income for
the periods indicated.
NONINTEREST INCOME
Years Ended December 31, Percent Change
------------------------------ -------------------------
2001 2000 1999 2001/2000 2000/1999
-------- ------- ----- --------- ---------
(Dollars in thousands)
Service charges on deposits ........................... $ 867 $ 745 $ 503 16.38% 48.11%
Mortgage origination fees and
service release premiums ........................... 544 224 97 142.86 130.93
Document prep fees .................................... 86 40 18 115.00 122.22
Securities gains ...................................... 24 -- 1 -- --
Safe deposit box rentals .............................. 28 22 17 27.27 29.41
Other ................................................. 7 8 6 (12.50) 33.33
-------- ------- -----
Total .............................................. $ 1,556 $ 1,039 $ 642 49.76% 61.84%
======== ======= =====
31
NONINTEREST EXPENSES
Noninterest expense increased $1,910,000 or 23.54% from the year 2000
to 2001. Salaries and employee benefits increased $847,000 or 18.36%.
Noninterest expense increased $3,161,000 or 63.83% from 1999 to 2000. Salaries
and employee benefits increased $1,817,000 or 64.99%. These increases are
attributed to the overall growth and expansion of the Company.
Occupancy and equipment expense increased $353,000 or 40.11% from the
year 2000 to 2001 and increased $305,000 or 53.04% from 1999 to 2000.
The table below sets forth our noninterest expenses for the periods
indicated.
NONINTEREST EXPENSES
Years Ended December 31, 2001/2000 2000/1999
-------------------------------- Percent Percent
2001 2000 1999 Change Change
-------- ------- ------- --------- ---------
(Dollars in thousands)
Salaries and employee benefits ........................ $ 5,460 $ 4,613 $ 2,796 18.36% 64.99%
Occupancy and equipment expense ....................... 1,233 880 575 40.11 53.04
Professional fees ..................................... 583 471 256 23.78 83.98
Advertising ........................................... 336 291 180 15.46 61.67
Supplies .............................................. 262 294 184 (10.88) 59.78
Data processing ....................................... 190 136 86 39.71 58.14
Bank charges and
collection expense ................................. 180 24 8 650.00 200.00
Telephone ............................................. 171 158 88 8.23 79.55
Regulatory charges .................................... 168 23 31 630.43 (25.81)
Director and committee fees ........................... 153 151 118 1.32 27.97
Postage ............................................... 125 90 60 38.89 50.00
Other ................................................. 1,162 982 570 18.33 72.28
-------- ------- -------
Total .............................................. $ 10,023 $ 8,113 $ 4,952 23.54 63.83%
======== ======= =======
INCOME TAXES
Income tax expense increased $233,000 or 23.49% to $1,224,000 for the
year-end December 31, 2001 and increased $596,000 or 151.1% to $991,000 for the
year-end December 31, 2000. The increases were the result of the applicable
increases in pre-tax income in each year. The effective tax rate as a percentage
of pretax income was 34.09% in 2001, 31.2% in 2000 and 31.4% in 1999. There is
no current or pending tax legislation of which management is aware that if
passed would have any material effect on the consolidated financial statements.
For further information concerning the provision for income taxes, refer to Note
15, Income Taxes, of the "Notes to Financial Statements."
IMPACT OF INFLATION AND CHANGING PRICES
A bank's asset and liability structure is substantially different from
that of an industrial company in that virtually all assets and liabilities of a
bank are monetary in nature. Management believes the impact of inflation on
financial results depends upon our ability to react to changes in interest rates
and by such reaction to reduce the inflationary impact on performance. Interest
rates do not necessarily move in the same direction, or at the same magnitude,
as the prices of other goods and services. As discussed previously, management
seeks to manage the relationship between interest-sensitive assets and
liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
32
MARKET RISK
Market risk is the risk arising from adverse changes in the fair value
of financial instruments due to a change in interest rates, exchange rates and
equity prices. The Company's primary market risk is interest rate variations in
the short-term time horizons also known as interest rate risk.
The primary objective of our Asset/Liability Management is to manage
interest rate risk and achieve reasonable stability in net interest income
throughout interest rate cycles. This is achieved by maintaining the proper
balance of rate sensitive earning assets and rate sensitive liabilities. The
relationship of rate sensitive earning assets to rate sensitive liabilities is
the principal factor in projecting the effect that fluctuating interest rates
will have on future net interest income. Rate sensitive earning assets and
interest-bearing liabilities are those that can be repriced to current market
rates within a relatively short time period. Management monitors the rate
sensitivity of interest-earning assets and interest-bearing liabilities over the
entire life of the instruments, but places particular emphasis on the first
year. An Asset/Liability Management policy requires risk assessment relative to
interest pricing and related terms.
We use additional tools to monitor and manage interest rate
sensitivity. One of the primary tools is simulation analysis. Simulation
analysis is the primary method of estimating earnings at risk and capital at
risk under varying interest rate conditions. Simulation analysis is used to test
the sensitivity of our net interest income and stockholders' equity to both the
level of interest rates and the slope of the yield curve. Simulation analysis
accounts for the expected timing and magnitude of assets and liability cash
flows, as well as the expected timing and magnitude of deposits that do not
reprice on a contractual basis. In addition, simulation analysis includes
adjustments for the lag between movements in market interest rates on loans and
interest-bearing deposits. These adjustments are made to reflect more accurately
possible future cash flows, repricing behavior and ultimately net interest
income.
As of December 31, 2001, our simulation analysis reflected that our
earnings are at greatest risk in a decreasing interest rate environment.
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33
The following table below depicts the results of the simulation
assuming one and two percent decreases and increases in the prime interest rates
in a one-year time horizon.
INTEREST RATE RISK
(Amounts in thousands)
One Year Time Horizon
Estimated Repricing Amounts
----------------------------------------------------------------
Down Up Down Up
1 Percent 1 Percent 2 Percent 2 Percent
------------ ------------- ------------- --------------
RATE SENSITIVE ASSETS:
Loans......................................... $ 271,988 $ 255,113 $ 283,239 $ 249,488
Deposits in banks............................. 310 310 310 310
Federal funds sold............................ 6,716 6,716 6,716 6,716
Securities.................................... 15,701 5,458 15,745 4,429
------------ ------------- ------------- --------------
TOTAL RATE SENSITIVE ASSETS................. 294,715 267,597 306,010 260,943
------------ ------------- ------------- --------------
RATE SENSITIVE LIABILITIES
Deposits - Demand............................. 20,696 28,888 20,695 28,888
Deposits - Time............................... 255,277 255,277 255,277 255,277
------------ ------------- ------------- --------------
TOTAL RATE SENSITIVE LIABILITIES............ 275,973 284,165 275,972 284,165
------------ ------------- ------------- --------------
RATE SENSITIVITY GAP............................. $ 18,742 $ (16,568) $ 30,038 $ (23,222)
============ ============= ============= ==============
Change in Amount of Net Interest Margin.......... $ (187) $ (166) $ (601) $ (464)
============ ============= ============= ==============
Change in Percent of Net Interest Margin......... (0.03)% (0.03)% (0.11)% (0.08)%
============ ============== ============= ==============
OTHER ACCOUNTING ISSUES
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities. This statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial condition and measure those
instruments at fair value. The accounting for changes in the fair value of a
derivative is to be determined based upon the intended use of the derivative.
For certain hedge designations (cash flow and foreign currency exposure) the
derivative's gain or loss is reported as a component of other comprehensive
income. Other designations require the gain or loss to be recognized in earnings
in the period of change. This statement, amended as to effective date by SFAS
No. 137, is effective for financial statements for periods beginning after June
15, 2000. In June 2000, the Financial Accounting Standards Board also issued
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of SFAS No. 133. The adoption of SFAS No. 133, as
amended by SFAS No. 138 did not have a material impact on our consolidated
financial statements.
In September 2000, the FASB issued SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -
a replacement of FASB Statement No. 125. While SFAS No. 140 carries over most of
the provisions of SFAS No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, it provides new standards
for reporting financial assets transferred as collateral and new standards for
the derecognition of financial assets, in particular transactions involving the
use of special purpose entities. SFAS No. 140 also prescribes additional
disclosures for collateral transactions and for securitization transactions
accounted for as sales. The new collateral standards and disclosure requirements
are effective for fiscal years ending after December 15, 2000, while the new
standards for the derecognition of financial assets are effective
34
for transfers made after March 31, 2001. The adoption of this statement did not
have a material effect on our consolidated financial statements.
In May 2001, the Auditing Standards Board issued Statement on Auditing
Standards ("SAS") No. 94, The Effect of Information Technology on the Auditor's
Consideration of Internal Control in a Financial Statement Audit. This statement
amends SAS No. 55, Consideration of Internal Control in a Financial Statement
Audit, by providing additional guidance related to the understanding by the
auditor of an entity's use of information technology relevant to the audit. This
auditing standard is effective for audits of financial statements for periods
beginning on or after June 1, 2001. The impact on the audit of our consolidated
financial statements resulting from the issuance of this auditing standard is
not expected to be material.
In June 2001, the FASB issued SFAS No. 141, Business Combinations. This
statement address financial accounting and reporting for business combinations
and supersedes ABP Opinion No. 16, Business Combinations, and SFAS No. 38,
Accounting for Preacquisition Contingencies of Purchased Enterprises. All
business combinations in the scope of SFAS No. 141 are to be accounted for using
one method, the purchase method. Prior to the issuance of this statement,
subject to certain criteria, business combinations were accounted for using one
of two methods, the pooling-of-interests method or the purchase method. The two
methods produce different financial statement results. The single-method
approach used in SFAS No. 141 reflects the conclusion that virtually all
business combinations are acquisitions and therefore should be accounted for in
the same manner as other asset acquisitions based on the values exchanged. This
statement provides expanded and revised guidance related to the allocation of
the purchase price to goodwill and other intangibles arising from the business
combination. The provisions of SFAS No. 141 apply to all business combinations
initiated after June 30, 2001.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets, which addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. SFAS No. 142 provides new standards for accounting relating
to intangible assets after initial recognition in the financial statements. This
statement proscribes the accounting practice of amortizing or expensing
intangibles ratably over a prescribed period of time and imposes new guidance
requiring that goodwill and certain other intangibles be tested for impairment
at least annually by comparing fair values of those assets with their recorded
amounts. Additional disclosure requirements also are provided. The provisions of
SFAS No. 142 are required to be applied in fiscal years beginning after December
15, 2001.
The adoption of SFAS No. 141 and SFAS No. 142 are not expected to have
a material effect on our consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This statement is effective for financial statements
issued for fiscal years beginning after June 15, 2002. The adoption of this
statement is not expected to have a material effect on our consolidated
financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets. This statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supersedes FASB Statement No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the Results
of Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of a business (as previously defined in that opinion).
This statement also amends Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. The major changes
resulting from this statement relate to the establishment of a single method for
the recognition of impairment losses on long-lived assets to be held and used
whether from discontinuance of a business segment or otherwise. This statement
is effective for financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of this statement is not expected to have a
material effect on our consolidated financial statements.
35
In December 2001, the Accounting Standards Executive Committee issued
Statement of Position ("SOP") 01-6, Accounting by Certain Entities (Including
Entities With Trade Receivables) That Lend to or Finance the Activities of
Others. This statement reconciles and conforms the accounting and financial
reporting provisions for similar transactions as applied to different entities
within the financial services industry. It eliminates differences in disclosure
practices where not warranted and should provide greater consistency in
reporting by entities in the financial services industry. This statement is
effective for annual and interim financial statements issued for fiscal years
beginning after December 15, 2001. The adoption of SOP 01-6 is not expected to
have a material effect on our consolidated financial statements.
In December 2001, the Auditing Standards Board issued SAS No. 95,
Generally Accepted Auditing Standards. This statement supersedes Generally
Accepted Auditing Standards of SAS No. 1 and generally provides additional
guidance to the independent auditor in the conduct of an audit engagement,
primarily by addressing authoritative and nonauthoritative publications for
audit consideration and guidance. This SAS is effective for audits of financial
statements for periods beginning on or after December 15, 2001.
In January 2002, the Auditing Standards Board issued SAS No. 96, Audit
Documentation. This statement supersedes SAS No. 41, Working Papers and amends
SAS No. 47, Audit Risk and Materiality in Conducting an Audit, SAS No. 56,
Analytical Procedures and SAS No. 59, The Auditor's Consideration of an Entity's
Ability to Continue as a Going Concern. This statement provides revised guidance
to the independent auditor as to the type, purpose and requirements of audit
documentation. This SAS is effective for audits of financial statements for
periods beginning on or after May 15, 2002.
The impact of SAS No. 95 and SAS No. 96 on the audit of our
consolidated financial statements resulting from the issuance of these auditing
standards is not expected to be material.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Market Risk," which is
incorporated herein by reference.
36
ITEM 8. FINANCIAL STATEMENTS
The financial statements and supplemental data required by Regulation
S-X and by Item 302 of Regulation S-K are set forth in the pages listed below.
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
FINANCIAL STATEMENTS
Page(s)
-------
Independent Auditors' Report............................................................................... 42
Consolidated Statements of Financial Condition
as of December 31, 2001 and 2000....................................................................... 43
Consolidated Statements of Income
for the Years Ended December 31, 2001, 2000 and 1999................................................... 44
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999................................................... 45
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2001, 2000 and 1999................................................... 46
Notes to Consolidated Financial Statements................................................................. 47
Quarterly Results (Unaudited).............................................................................. 76
37
SCHAUER, TAYLOR, COX, VISE & MORGAN, P.C.
CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS
150 OLDE TOWNE ROAD
BIRMINGHAM, ALABAMA 35216
DOUGLAS B. SCHAUER, CPA TELEPHONE - 205.822.3488 C. DAVID BROOKS, CPA
EDWARD R. TAYLOR, CPA WATS - 800.466.3488 M. BRYANT KING, CPA
W. ERNEST COX, CPA FAX - 205.822.3541 OR 205.822.0645 STEVEN D. MILLER, CPA
DONALD G. VISE, CPA EMAIL - FIRM@SCHAUERTAYLOR.COM RAYMOND A. PATTON, CPA
PHILLIP D. MORGAN, CPA RUSSELL D. PAYNE, CPA
DAVID A. BOWERS, CPA STEWART T. WILSON, CPA
BENJAMIN N. VANCE, CPA
STEVEN W. BROWN, CPA
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Heritage Financial Holding Corporation
Decatur, Alabama
We have audited the accompanying consolidated statements of financial condition
of Heritage Financial Holding Corporation (a Delaware corporation) and
subsidiaries as of December 31, 2001 and 2000, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Heritage Financial
Holding Corporation and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
Birmingham, Alabama /s/ Schauer, Taylor, Cox, Vise & Morgan, P.C.
January 18, 2002, except for
Note 26, as to which the date
is April 2, 2002
SCHAUER, TAYLOR, COX, VISE & MORGAN, P.C.
MEMBER OF AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, SEC PRACTICE
SECTION AND ALABAMA SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS
38
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2001 AND 2000
2001 2000
--------------- ---------------
ASSETS
Cash and due from banks ................................................ $ 6,660,032 $ 6,143,475
Interest-bearing deposits with other banks ............................. 325,736 816,541
Federal funds sold ..................................................... 6,716,000 8,680,000
--------------- ---------------
CASH AND CASH EQUIVALENTS .......................................... 13,701,768 15,640,016
Securities available-for-sale .......................................... 25,893,863 26,846,421
Mortgage loans held-for-sale ........................................... 12,548,322 --
Loans .................................................................. 505,380,611 422,135,461
Allowance for loan losses .............................................. (6,074,230) (5,064,889)
--------------- ---------------
NET LOANS .......................................................... 499,306,381 417,070,572
Premises and equipment, net ............................................ 6,407,022 5,566,060
Accrued interest ....................................................... 3,873,413 4,396,467
Foreclosed real estate ................................................. 4,227,926 212,875
Other assets ........................................................... 2,332,392 1,725,114
--------------- ---------------
TOTAL ASSETS ....................................................... $ 568,291,087 $ 471,457,525
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing .................................................. $ 21,295,986 $ 11,653,705
Interest-bearing ..................................................... 483,013,752 409,590,533
--------------- ---------------
TOTAL DEPOSITS ..................................................... 504,309,738 421,244,238
Accrued interest ....................................................... 4,204,515 4,152,248
FHLB advances .......................................................... 13,000,000 12,000,000
Guaranteed preferred beneficial interest in the Company's
subordinated debentures .............................................. 10,000,000 --
Other liabilities ...................................................... 652,954 561,737
--------------- ---------------
TOTAL LIABILITIES .................................................. 532,167,207 437,958,223
STOCKHOLDERS' EQUITY
Preferred stock - par value $0.01 per share; 10,000,000
authorized, none issued .............................................. -- --
Common stock - par value $.01 per share, 40,000,000 shares
authorized, 8,515,147 shares issued and outstanding at
December 31, 2001 and 8,475,822 shares issued and
outstanding at December 31, 2000 ..................................... 85,151 84,758
Paid-in capital ........................................................ 30,359,218 30,203,113
Retained earnings ...................................................... 5,736,259 3,370,338
Accumulated other comprehensive income: net unrealized losses
on securities available-for-sale, net of deferred income tax ......... (56,748) (158,907)
--------------- ---------------
TOTAL STOCKHOLDERS' EQUITY ......................................... 36,123,880 33,499,302
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ......................... $ 568,291,087 $ 471,457,525
=============== ===============
See notes to consolidated financial statements
39
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ------------ ------------
INTEREST INCOME
Interest and fees on loans ................................... $ 41,587,737 $ 31,788,388 $ 15,274,336
Interest and dividends on securities:
Taxable securities ......................................... 1,460,386 1,542,276 1,190,610
Nontaxable securities ...................................... 124,585 123,619 88,554
Interest on deposits with other banks ........................ 24,905 365,000 150,062
Interest on federal funds sold and securities
purchased under agreements to resale ....................... 1,055,690 1,840,891 544,756
------------ ------------ ------------
TOTAL INTEREST INCOME .................................... 44,253,303 35,660,174 17,248,318
INTEREST EXPENSE
Interest on deposits ......................................... 26,751,607 20,867,463 9,194,229
Interest on FHLB borrowings .................................. 962,690 1,150,833 678,000
Interest on short-term borrowings ............................ 1,888 229 2,023
Interest on guaranteed preferred beneficial interest in
the Company's subordinated debentures ...................... 878,334 -- --
------------ ------------ ------------
TOTAL INTEREST EXPENSE ................................... 28,594,519 22,018,525 9,874,252
------------ ------------ ------------
Net interest income ............................................. 15,658,784 13,641,649 7,374,066
Provision for loan losses ....................................... 3,602,047 3,388,973 1,807,765
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES .............................................. 12,056,737 10,252,676 5,566,301
NONINTEREST INCOME
Customer service fees ........................................ 867,323 745,377 503,337
Investment security gains .................................... 23,926 -- 1,110
Other operating income ....................................... 665,197 293,666 137,377
------------ ------------ ------------
TOTAL NONINTEREST INCOME ................................. 1,556,446 1,039,043 641,824
------------ ------------ ------------
NONINTEREST EXPENSES
Salaries and employee benefits ............................... 5,460,426 4,612,785 2,795,569
Occupancy and equipment expense .............................. 1,232,525 879,910 574,713
Other operating expenses ..................................... 3,330,345 2,620,324 1,582,182
------------ ------------ ------------
TOTAL NONINTEREST EXPENSES ............................... 10,023,296 8,113,019 4,952,464
------------ ------------ ------------
Income before income taxes ...................................... 3,589,887 3,178,700 1,255,661
Provision for income taxes ...................................... 1,223,966 991,169 394,800
------------ ------------ ------------
NET INCOME ...................................................... $ 2,365,921 $ 2,187,531 $ 860,861
============ ============ ============
EARNINGS PER COMMON SHARE
Basic ........................................................ $ 0.28 $ 0.26 $ 0.12
Diluted ...................................................... 0.23 0.22 0.11
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ........................................................ 8,484,624 8,316,756 7,226,044
Diluted ...................................................... 10,486,966 10,133,865 7,860,469
See notes to consolidated financial statements
40
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Accumulated
Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income Total
------- ----------- ---------- ------------- -----------
Balance at December 31, 1998 ................ $71,928 $18,608,626 $ 321,946 $ 6,437 $19,008,937
Net income - 1999 ........................... -- -- 860,861 -- 860,861
Unrealized losses on available-for-
sale securities, net of
reclassification adjustment, net
of tax of $599,503 ....................... -- -- -- (899,254) (899,254)
-----------
Comprehensive loss .......................... -- -- -- -- (38,393)
-----------
Issuance of shares from
stock offerings .......................... 2,530 2,166,970 -- -- 2,169,500
Issuance of shares under
employee stock purchase plan ............. 87 28,618 -- -- 28,705
Stock option exercise ....................... 1,265 264,510 -- -- 265,775
Compensatory options ........................ -- 106,015 -- -- 106,015
Tax benefit of exercised options ............ -- 379,511 -- -- 379,511
------- ----------- ---------- -------- -----------
Balance at December 31, 1999 ................ 75,810 21,554,250 1,182,807 (892,817) 21,920,050
Net income - 2000 ........................... -- -- 2,187,531 -- 2,187,531
Unrealized gains on available-for-
sale securities, net of
reclassification adjustment, net
of tax of $(489,273) ..................... -- -- -- 733,910 733,910
-----------
Comprehensive income ........................ -- -- -- -- 2,921,441
-----------
Issuance of shares from
stock offerings .......................... 8,500 8,491,500 -- -- 8,500,000
Issuance of shares under stock
option plan .............................. 400 66,347 -- -- 66,747
Issuance of shares under
employee stock purchase plan ............. 48 29,630 -- -- 29,678
Compensatory options ........................ -- 61,386 -- -- 61,386
------- ----------- ---------- -------- -----------
BALANCE AT
DECEMBER 31, 2000 ........................ 84,758 30,203,113 3,370,338 (158,907) 33,499,302
NET INCOME - 2001 ........................... -- -- 2,365,921 -- 2,365,921
UNREALIZED GAINS ON AVAILABLE-FOR-
SALE SECURITIES, NET OF
RECLASSIFICATION ADJUSTMENT, NET
OF TAX OF $(68,104) ...................... -- -- -- 102,159 102,159
-----------
COMPREHENSIVE INCOME ........................ -- -- -- -- 2,468,080
-----------
STOCK OPTION EXERCISE ....................... 360 86,850 -- -- 87,210
ISSUANCE OF SHARES UNDER
EMPLOYEE STOCK PURCHASE PLAN ............. 33 31,412 -- -- 31,445
COMPENSATORY OPTIONS ........................ -- 37,843 -- -- 37,843
------- ----------- ---------- -------- -----------
BALANCE AT
DECEMBER 31, 2001 ........................ $85,151 $30,359,218 $5,736,259 $(56,748) $36,123,880
======= =========== ========== ======== ===========
See notes to consolidated financial statements
41
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------- -------------- --------------
OPERATING ACTIVITIES
Net income ................................................... $ 2,365,921 $ 2,187,531 $ 860,861
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses .................................. 3,602,047 3,388,973 1,807,765
Depreciation, amortization and accretion, net .............. 437,999 321,341 276,817
Deferred tax benefit ....................................... (264,948) (746,779) (367,000)
Decrease (increase) in accrued interest receivable ......... 523,054 (2,314,056) (846,549)
Increase in accrued interest payable ....................... 52,267 2,679,350 572,010
Security gains ............................................. (23,926) -- (1,110)
Net increase in mortgage loans held for sale ............... (12,548,322) -- --
Loss on disposition of fixed assets ........................ 1,786 -- 10,446
Other, net ................................................. (319,217) (47,723) 352,040
------------- -------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES .................. (6,173,339) 5,468,637 2,665,280
------------- -------------- --------------
INVESTING ACTIVITIES
Purchases of securities available-for-sale ................... (18,774,196) (7,008,487) (7,122,398)
Proceeds from sales of securities available-for-sale ......... 520,493 -- 51,100
Proceeds from calls, paydowns and maturities of
securities available-for-sale .............................. 19,399,714 1,358,567 7,296,448
Net increase in loans to customers ........................... (89,959,157) (178,875,187) (128,284,131)
Purchase of premises and equipment ........................... (1,287,676) (2,224,003) (876,900)
Proceeds from disposition of fixed assets .................... 7,665 -- 11,631
Proceeds from disposition of foreclosed real estate .......... 106,250 -- --
------------- -------------- --------------
NET CASH USED IN INVESTING ACTIVITIES ...................... (89,986,907) (186,749,110) (128,924,250)
------------- -------------- --------------
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts,
and savings accounts ....................................... 38,279,518 20,653,089 26,958,411
Net increase in certificates of deposit ...................... 44,785,982 151,558,986 85,072,692
Net decrease in short-term borrowings ........................ -- (24,719) (12,798)
Net proceeds from (payments to) FHLB advances ................ 1,000,000 (13,000,000) 15,000,000
Stock subscriptions receivable ............................... -- -- 948,968
Net proceeds from issuance of stock .......................... 118,655 8,596,425 2,463,980
Compensatory options ......................................... 37,843 61,386 106,015
Issuance of guaranteed preferred beneficial interest
in the Company's subordinated debentures ................... 10,000,000 -- --
------------- -------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES .................. 94,221,998 167,845,167 130,537,268
------------- -------------- --------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS ............................................. (1,938,248) (13,435,306) 4,278,298
Cash and Cash Equivalents at Beginning of Year .................. 15,640,016 29,075,322 24,797,024
------------- -------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR ........................ $ 13,701,768 $ 15,640,016 $ 29,075,322
============= ============== ==============
See notes to consolidated financial statements
42
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Heritage Financial Holding Corporation (a Delaware corporation) and its
wholly-owned subsidiaries, Heritage Bank (the "Bank")(an Alabama corporation)
and Heritage Financial Statutory Trust I ("Heritage Trust")(a Connecticut
Statutory Trust)(referred to herein collectively as the "Company") operate
predominantly in the domestic commercial banking industry. The Company's main
office is in Decatur, Alabama with additional Bank branch locations in Morgan,
Madison and Jefferson counties of North and Central Alabama.
The accounting and reporting policies of the Company conform to generally
accepted accounting principles in the United States of America and to general
practice within the banking industry. The following summarizes the most
significant of these policies.
Basis of Consolidation
The consolidated financial statements include the accounts of Heritage Financial
Holding Corporation, the Bank and Heritage Trust. All significant intercompany
balances and transactions have been eliminated. Investments in subsidiaries are
carried at the parent company's equity in the underlying net assets.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Securities Purchased Under Agreements to Resell
Securities purchased under agreements to resell are generally treated as
collateralized financing transactions and are recorded at the amount at which
the securities were acquired. The market value of the collateral is monitored
and additional collateral obtained when deemed appropriate.
Securities
Securities are classified as either held-to-maturity, available-for-sale, or
trading.
Securities held-to-maturity are those securities for which management has the
ability and intent to hold until maturity. These securities are carried at
amortized cost, adjusted for amortization of premiums and accretion of discount
to the earlier of the maturity or call date.
Securities available-for-sale represent those securities intended to be held for
an indefinite period of time, including securities that management intends to
use as part of its asset/liability strategy, or that may be sold in response to
changes in interest rates, changes in prepayment risk, the need to increase
regulatory capital, or other similar factors. Securities available-for-sale are
recorded at market value with unrealized gains and losses net of any tax effect,
added or deducted directly from stockholders' equity.
43
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Securities carried in trading accounts are carried at market value with
unrealized gains and losses reflected in income.
Realized and unrealized gains and losses are based on the specific
identification method.
Declines in the fair value of individual held-to-maturity and available-for-sale
securities below their cost that are other than temporary result in write-downs
of the individual securities to their fair value. The related write-downs are
included in earnings as realized losses.
The Company has no held-to-maturity or trading securities.
Mortgage Loans Held For Sale
Mortgage loans held for sale are carried at the lower of aggregate cost or
market. The cost of mortgage loans held for sale is the mortgage note amount
plus certain net origination costs less discounts collected. Gains and losses
resulting from changes in the market value of the inventory are netted. Any net
gain that results is deferred; any net loss that results is recognized when
incurred. The aggregate cost of mortgage loans held for sale at December 31,
2001, approximates their aggregate net realizable value. Gains or losses on the
sale of mortgage loans held for sale are included in other income.
Loans
Loans are stated at unpaid principal balances, less the allowance for loan
losses and net deferred loan fees.
Loan origination and commitment fees, as well as certain direct origination
costs, when material, are deferred and amortized as a yield adjustment over the
lives of the related loans using the interest method.
Allowance For Possible Loan Losses
A loan is considered impaired, based on current information and events, if it is
probable that the Bank will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate, while all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. Smaller balance
homogeneous loans which consist of residential mortgages and consumer loans are
evaluated collectively and reserves are established based on historical loss
experience.
The allowance for loan losses is established through charges to earnings in the
form of a provision for loan losses. Increases and decreases in the allowance
due to changes in the measurement of the impaired loans are included in the
provision for loan losses. Loans continue to be classified as impaired unless
they are brought fully current and the collection of scheduled interest and
principal is considered probable. When a loan or portion of a loan is determined
to be uncollectable, the portion deemed uncollectable is charged against the
allowance and subsequent recoveries, if any, are credited to the allowance.
44
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Management's periodic evaluation of the adequacy of the allowance is based on
the Bank's past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrowers' ability to repay, estimated
value of any underlying collateral and an analysis of current economic
conditions. While management believes that it has established the allowance in
accordance with generally accepted accounting principles and has taken into
account the views of its regulators and the current economic environment, there
can be no assurance that in the future the Bank's regulators or its economic
environment will not require further increases in the allowance.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well collateralized and in the process
of collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due are reasonably assured of repayment within an acceptable
period of time, and there is a sustained period of repayment performance by the
borrower, in accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding, except in the case of
loans with scheduled amortizations where the payment is generally applied to the
oldest payment due. When the future collectibility of the recorded loan balance
is expected, interest income may be recognized on a cash basis. In the case
where a nonaccrual loan has been partially charged off, recognition of interest
on a cash basis is limited to that which would have been recognized on the
recorded loan balance at the contractual interest rate. Receipts in excess of
that amount are recorded as recoveries to the allowance for loan losses until
prior charge offs have been fully recovered. Interest income recognized on a
cash basis was immaterial for the years ended December 31, 2001, 2000 and 1999.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Expenditures for additions and major improvements that significantly extend the
useful lives of the assets are capitalized. Expenditures for repairs and
maintenance are charged to expense as incurred. The carrying values of assets
traded in are used to adjust the carrying values of the new assets acquired by
trade. Assets which are disposed of are removed from the accounts and the
resulting gains or losses are recorded in operations.
Depreciation is provided generally by accelerated and straight-line methods
based on the estimated useful lives of the respective assets.
45
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Foreclosed Real Estate
Foreclosed real estate includes both formally foreclosed property and
in-substance foreclosed property. In-substance foreclosed properties are those
properties for which the institution has taken physical possession, regardless
of whether formal foreclosure proceedings have taken place.
At the time of foreclosure, foreclosed real estate is recorded at the lower of
the carrying amount or fair value less cost to sell, which becomes the
property's new basis. Any write-downs based on the asset's fair value at date of
acquisition are charged to the allowance for loan losses. After foreclosure,
these assets are carried at the lower of their new cost basis or fair value less
cost to sell.
Costs incurred in maintaining foreclosed real estate and subsequent adjustments
to the carrying amount of the property are included in income (loss) on
foreclosed real estate.
Advertising Costs
The Company's policy is to expense advertising costs as incurred. Advertising
expense for the years ended December 31, 2001, 2000 and 1999 amounted to
approximately $336,000, $291,000 and $180,000, respectively.
Income Taxes
Income taxes are provided for the tax effects of the transactions reported in
the financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the basis of available-for-sale
securities, allowance for loan losses, estimated losses on foreclosed real
estate, accumulated depreciation and accrued employee benefits for financial and
income tax reporting. The deferred tax assets and liabilities represent the
future tax return consequences of those differences, which will either be
taxable or deductible when the assets and liabilities are recovered or settled.
Deferred tax assets and liabilities are reflected at income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
The Company and its subsidiary bank file a consolidated federal and state income
tax return. The subsidiary bank provides for income taxes on a separate return
basis and remits to the Company amounts determined to be currently payable.
Stock-Based Compensation
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation, which defines a fair value based method of accounting for an
employee stock option plan. This statement establishes financial accounting and
reporting standards for stock-based employee compensation plans and stock-based
non-employee compensation. Under the fair value based method, compensation is
measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. However, SFAS No.
123 allows an entity to continue to measure compensation costs for those plans
using the intrinsic value based method of accounting prescribed by APB Opinion
No, 25, Accounting for Stock Issued to Employees. The Company has elected to
follow APB No. 25 in accounting for its stock option plans.
46
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Benefit Plans
The Bank has adopted a 401(k) Plan which covers substantially all of its
employees. Contributions to the plan are determined by the board of directors
and are included in salaries and employee benefits expense.
The Bank has also adopted an Employee Stock Purchase Plan, which the Company has
assumed, covering substantially all employees which allows employees the
opportunity to acquire shares of common stock of the Company through payroll
deduction. The Board approved and ratified modification of the Employee Stock
Purchase Plan on May 8, 2001.
Off-Balance Sheet Financial Instruments
In the ordinary course of business the Bank has entered into off-balance sheet
financial instruments consisting of commitments to extend credit, commitments
under credit card arrangements, commercial letters of credit and standby letters
of credit. Such financial instruments are recorded in the financial statements
when they become payable.
The Bank has available as a source of short-term financing the purchase of
federal funds from other commercial banks from available lines totaling
$13,500,000.
The Bank also has available as a source of financing a line of credit of
$59,563,000 with the Federal Home Loan Bank of Atlanta ("FHLB") of which
$46,563,000 was available and unused at December 31, 2001.
Segment Information
All of the Company's offices offer similar products and services, are located in
the same geographic region and serve the same customer segments of the market.
As a result, management considers all units as one operating segment and
therefore feels that the basic consolidated financial statements and related
footnotes provide details related to segment reporting.
Reclassifications
Certain amounts in 2000 and 1999 have been reclassified to conform with the 2001
presentation.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. The accounting for changes in the fair value of a
derivative is to be determined based upon the intended use of the derivative.
For certain hedge designations (cash flow and foreign currency exposure) the
derivative's gain or loss is reported as a component of other comprehensive
income. Other designations require the gain or loss to be recognized in
47
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
earnings in the period of change. This statement, amended as to effective date
by SFAS No. 137, is effective for financial statements for periods beginning
after June 15, 2000. In June 2000, the Financial Accounting Standards Board also
issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of SFAS No. 133. The adoption of SFAS No. 133,
as amended by SFAS No. 138 did not have a material impact on the Company's
consolidated financial statements.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities - a replacement
of FASB Statement No. 125. While SFAS No. 140 carries over most of the
provisions of SFAS No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, it provides new standards for
reporting financial assets transferred as collateral and new standards for the
derecognition of financial assets, in particular transactions involving the use
of special purpose entities. SFAS No. 140 also prescribes additional disclosures
for collateral transactions and for securitization transactions accounted for as
sales. The new collateral standards and disclosure requirements are effective
for fiscal years ending after December 15, 2000, while the new standards for the
derecognition of financial assets are effective for transfers made after March
31, 2001. The adoption of this statement did not have a material effect on the
Company's consolidated financial statements.
In May 2001, the Auditing Standards Board issued Statement on Auditing Standards
("SAS") No. 94, The Effect of Information Technology on the Auditor's
Consideration of Internal Control in a Financial Statement Audit. This statement
amends SAS No. 55, Consideration of Internal Control in a Financial Statement
Audit, by providing additional guidance related to the understanding by the
auditor of an entity's use of information technology relevant to the audit. This
auditing standard is effective for audits of financial statements for periods
beginning on or after June 1, 2001. The impact on the audit of the Company's
consolidated financial statements resulting from the issuance of this auditing
standard is not expected to be material.
In June 2001, the FASB issued SFAS No. 141, Business Combinations. This
statement addresses financial accounting and reporting for business combinations
and supersedes ABP Opinion No. 16, Business Combinations, and SFAS No. 38,
Accounting for Preacquisition Contingencies of Purchased Enterprises. All
business combinations in the scope of SFAS No. 141 are to be accounted for using
one method, the purchase method. Prior to the issuance of this statement,
subject to certain criteria, business combinations were accounted for using one
of two methods, the pooling-of-interests method or the purchase method. The two
methods produce different financial statement results. The single-method
approach used in SFAS No. 141 reflects the conclusion that virtually all
business combinations are acquisitions and therefore should be accounted for in
the same manner as other asset acquisitions based on the values exchanged. This
statement provides expanded and revised guidance related to the allocation of
the purchase price to goodwill and other intangibles arising from the business
combination. The provisions of SFAS No. 141 apply to all business combinations
initiated after June 30, 2001.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which addresses financial accounting and reporting for acquired goodwill
and other intangible assets and supersedes APB Opinion No. 17, Intangible
Assets. SFAS No. 142 provides new standards for accounting relating to
48
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
intangible assets after initial recognition in the financial statements. This
statement proscribes the accounting practice of amortizing or expensing
intangibles ratably over a prescribed period of time and imposes new guidance
requiring that goodwill and certain other intangibles be tested for impairment
at least annually by comparing fair values of those assets with their recorded
amounts. Additional disclosure requirements also are provided. The provisions of
SFAS No. 142 are required to be applied in fiscal years beginning after December
15, 2001.
The adoption of SFAS No. 141 and SFAS No. 142 are not expected to have a
material effect on the Company's consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. This statement requires that the fair value of a liability for an
asset retirement obligation be recognized in the period in which it is incurred
if a reasonable estimate of fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset. This statement is effective for financial statements issued
for fiscal years beginning after June 15, 2002. The adoption of this statement
is not expected to have a material effect on the Company's consolidated
financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-lived Assets. This statement addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This statement
supersedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of a business (as previously defined in that opinion).
This statement also amends Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. The major changes
resulting from this statement relate to the establishment of a single method for
the recognition of impairment losses on long-lived assets to be held and used
whether from discontinuance of a business segment or otherwise. This statement
is effective for financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of this statement is not expected to have a
material effect on the Company's consolidated financial statements.
In December 2001, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 01-6, Accounting by Certain Entities (Including Entities
With Trade Receivables) That Lend to or Finance the Activities of Others. This
statement reconciles and conforms the accounting and financial reporting
provisions for similar transactions as applied to different entities within the
financial services industry. It eliminates differences in disclosure practices
where not warranted and should provide greater consistency in reporting by
entities in the financial services industry. This statement is effective for
annual and interim financial statements issued for fiscal years beginning after
December 15, 2001. The adoption of SOP 01-6 is not expected to have a material
effect on the Company's consolidated financial statements.
49
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
In December 2001, the Auditing Standards Board issued SAS No. 95, Generally
Accepted Auditing Standards. This statement supersedes Generally Accepted
Auditing Standards of SAS No. 1 and generally provides additional guidance to
the independent auditor in the conduct of an audit engagement, primarily by
addressing authoritative and nonauthoritative publications for audit
consideration and guidance. This SAS is effective for audits of financial
statements for periods beginning on or after December 15, 2001.
In January 2002, the Auditing Standards Board issued SAS No. 96, Audit
Documentation. This statement supersedes SAS No. 41, Working Papers and amends
SAS No. 47, Audit Risk and Materiality in Conducting an Audit, SAS No. 56,
Analytical Procedures and SAS No. 59, The Auditor's Consideration of an Entity's
Ability to Continue as a Going Concern. This statement provides revised guidance
to the independent auditor as to the type, purpose and requirements of audit
documentation. This SAS is effective for audits of financial statements for
periods beginning on or after May 15, 2002.
The impact of SAS No. 95 and SAS No. 96 on the audit of the Company's
consolidated financial statements resulting from the issuance of these auditing
standards is not expected to be material.
Earnings Per Common Share
Basic earnings per common share are computed by dividing earnings available to
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflect per share amounts that would have
resulted if dilutive potential common stock had been converted to common stock,
as prescribed by SFAS No. 128, Earnings per Share. All per share amounts
included in these financial statements have been retroactively adjusted to
reflect the effects of the 2-for-1 stock split which occurred during 1999. The
following reconciles the weighted average number of shares outstanding:
2001 2000 1999
----------- ----------- -----------
Weighted average of common shares outstanding ................... 8,484,624 8,316,756 7,226,044
Effect of dilutive options ...................................... 2,002,342 1,817,109 634,425
----------- ----------- -----------
Weighted average of common shares
outstanding effected for dilution ............................ 10,486,966 10,133,865 7,860,469
=========== =========== ===========
Comprehensive Income
Comprehensive income is the total of net income and all other non-owner changes
in equity. Items that are to be recognized under accounting standards as
components of comprehensive income are displayed in statements of stockholders'
equity.
50
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Comprehensive Income - Continued
In the calculation of comprehensive income, certain reclassification adjustments
are made to avoid double counting items that are displayed as part of net income
for a period that also had been displayed as part of other comprehensive income
in that period or earlier periods. The disclosure of the reclassification
amounts and other details of other comprehensive income are as follows:
Years Ended December 31,
-------------------------------------------------
2001 2000 1999
----------- ----------- -----------
Unrealized gains (losses) on securities
Unrealized holding gains (losses)
arising during period ....................... $ 194,189 $ 1,223,183 $(1,497,647)
Less reclassification adjustments for
gains included in net income ................ (23,926) -- (1,110)
----------- ----------- -----------
Net unrealized gains (losses) ................. 170,263 1,223,183 (1,498,757)
Income tax related to items of other
comprehensive income (loss) ................. (68,104) (489,273) 599,503
----------- ----------- -----------
Other comprehensive income (loss) ................ $ 102,159 $ 733,910 $ (899,254)
=========== =========== ===========
Statements of Cash Flows
The Company considers cash, due from banks and short-term investments as cash
equivalents in preparing the consolidated statements of cash flows. The
following is supplemental disclosure to the statements of cash flows for the
three years ended December 31, 2001.
Years Ended December 31,
-------------------------------------------------
2001 2000 1999
----------- ----------- -----------
Cash paid during the year for interest ........... $28,542,252 $19,339,175 $ 9,302,242
Cash paid during the year for
income taxes, net ............................. 1,670,781 1,767,689 452,550
Non-cash Disclosures:
Net increase (decrease) in unrealized gains/
losses on securities available-for-sale ....... 170,263 1,223,183 (1,498,757)
Tax benefit of non-qualified options exercised ... -- -- 379,511
Loans transferred to foreclosed real estate
during the year ............................... 4,920,288 -- 212,875
51
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 2 - BUSINESS COMBINATIONS
In August 2000, the Company effected a business combination with Heritage Bank
by exchanging 8,475,822 shares of its common stock for all the outstanding
common stock of Heritage Bank. The combination has been accounted for as a
pooling of interests and, accordingly, all periods presented reflect the Company
and Heritage Bank on a combined basis. Prior to the effective date of the
merger, the Company had no operations.
NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The Bank is required to maintain average reserve balances either in vault cash
or on deposit with the Federal Reserve. The average amount of those reserves
required at December 31, 2001 and 2000 was approximately $3,530,000 and
$1,009,000, respectively.
NOTE 4 - SECURITIES
The carrying amounts of securities as shown in the consolidated statements of
financial condition and their approximate fair values at December 31, 2001 and
2000 were as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------ ------------ -------------
SECURITIES AVAILABLE-FOR-SALE
DECEMBER 31, 2001:
U. S. GOVERNMENT AND
AGENCY SECURITIES...................... $ 15,682,142 $ 177,499 $ 162,720 $ 15,696,921
MORTGAGE-BACKED SECURITIES............... 612,916 3,944 -- 616,860
ASSET-BACKED SECURITIES.................. 4,451,625 22,280 -- 4,473,905
STATE AND MUNICIPAL SECURITIES........... 2,665,900 14,694 89,978 2,590,616
CORPORATE DEBT SECURITIES................ 1,250,000 -- 60,300 1,189,700
EQUITY SECURITIES........................ 1,325,861 -- -- 1,325,861
------------- ------------ ------------ -------------
$ 25,988,444 $ 218,417 $ 312,998 $ 25,893,863
============= ============ ============ =============
December 31, 2000:
U. S. Government and
agency securities...................... $ 18,661,134 $ 837,374 $ 1,048,398 $ 18,450,110
Mortgage-backed securities............... 1,042,199 20,417 42,470 1,020,146
Asset-backed securities.................. 1,982,222 3,218 -- 1,985,440
State and municipal securities........... 2,329,357 217,324 246,690 2,299,991
Corporate debt securities................ 1,250,000 144,848 150,468 1,244,380
Equity securities........................ 1,846,354 -- -- 1,846,354
------------- ------------ ------------ -------------
$ 27,111,266 $ 1,223,181 $ 1,488,026 $ 26,846,421
============= ============ ============ =============
52
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 4 - SECURITIES - CONTINUED
The contractual maturities of securities available-for-sale at December 31,
2001, are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Amortized Fair
SECURITIES AVAILABLE-FOR-SALE Cost Value
- ----------------------------- ------------- -------------
Due in one year or less...................................................... $ -- $ --
Due after one year through five years........................................ 5,791,281 5,886,100
Due after five years through ten years....................................... 7,880,536 7,948,482
Due after ten years.......................................................... 10,990,726 10,733,420
Equity securities............................................................ 1,325,861 1,325,861
------------- -------------
$ 25,988,404 $ 25,893,863
============= =============
Mortgage-backed securities have been included in the maturity tables based upon
the guaranteed payoff date of each security.
Gross realized gains and losses on dispositions of securities available-for-sale
for the years ended December 31, 2001, 2000 and 1999 were as follows:
2001 2000 1999
--------- ----- --------
Realized gains....................................... $ 23,926 $ -- $ 1,110
Realized losses...................................... -- -- --
Equity securities include a restricted investment in Federal Home Loan Bank
stock which must be maintained to secure available lines of credit. The amount
of investment in this stock amounted to $1,250,000 at December 31, 2001 and
2000.
Securities pledged to secure public funds on deposit and for other purposes as
required by law amounted to approximately $23,702,000 and $22,621,000 at
December 31, 2001 and 2000, respectively.
53
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 5 - LOANS
The Company grants loans to customers primarily in Morgan, Madison and Jefferson
counties of North and Central Alabama.
The major classifications of loans as of December 31, 2001 and 2000 are as
follows:
2001 2000
------------- --------------
Commercial, financial and agricultural....................................... $ 138,344,502 $ 105,392,849
Real estate - construction................................................... 70,073,145 90,603,025
Real estate - mortgage....................................................... 274,675,368 205,421,797
Consumer..................................................................... 22,287,596 20,717,790
------------- --------------
505,380,611 422,135,461
Allowance for loan losses.................................................... 6,074,230 5,064,889
------------- --------------
Net loans.................................................................... $ 499,306,381 $ 417,070,572
============= ==============
Total loans, which the Bank considered to be impaired at December 31, 2001 and
2000, were $4,062,000 and $617,000, respectively. All of these loans were on
nonaccrual status and had related allowances of $897,000 and $93,000,
respectively. Collateral dependent loans, which were measured at the fair value
of the collateral, constituted the majority of impaired loans at December 31,
2001 and 2000. The average recorded investment in impaired loans for the years
ended December 31, 2001 and 2000 was approximately $5,275,000 and $538,000,
respectively. No material amount of interest income was recognized on impaired
loans for the years ended December 31, 2001 and 2000. For the years ended
December 31, 2001 and 2000, the difference between gross interest income that
would have been recorded in such period if the nonaccruing loans had been
current in accordance with their original terms and the amount of interest
income on those loans that was included in such period's net income was
approximately $519,000 for 2001 and an immaterial amount for 2000.
The Bank has no commitments to loan additional funds to the borrowers of
non-accrual loans.
Commercial and residential real estate loans pledged to secure Federal Home Loan
Bank advances amounted to approximately $87,089,000 and $70,700,000 at December
31, 2001 and 2000, respectively (see Note 9).
[The remainder of this page intentionally left blank]
54
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31, 2001,
2000 and 1999 were as follows:
2001 2000 1999
------------- ------------- ------------
Balance at beginning of year............................ $ 5,064,889 $ 3,035,549 $ 1,401,979
Charge-offs............................................. (2,695,237) (1,454,447) (195,378)
Recoveries.............................................. 102,531 94,814 21,183
------------- ------------- ------------
Net charge-offs...................................... (2,592,706) (1,359,633) (174,195)
Provision for loan losses............................... 3,602,047 3,388,973 1,807,765
------------- ------------- ------------
Balance at end of year.................................. $ 6,074,230 $ 5,064,889 $ 3,035,549
============= ============= ============
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment as of December 31, 2001 and 2000 is as follows:
2001 2000
------------ ------------
Land ...................................................................... $ 930,595 $ 320,279
Buildings................................................................... 1,565,225 1,550,599
Land and leasehold improvements............................................. 1,675,856 331,346
Furniture and equipment..................................................... 3,179,740 2,733,105
Automobiles................................................................. 135,364 133,797
Construction in progress.................................................... 183,559 1,354,557
------------ ------------
7,670,339 6,423,683
Accumulated depreciation.................................................... 1,263,317 857,623
------------ ------------
Premises and equipment, net.................................................. $ 6,407,022 $ 5,566,060
============ ============
The provision for depreciation charged to occupancy and equipment expense for
the years ended December 31, 2001, 2000 and 1999 was $437,263, $324,834 and
$245,248, respectively.
55
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 8 - DEPOSITS
The aggregate amounts of time deposits of $100,000 or more, including
certificates of deposit of $100,000 or more at December 31, 2001 and 2000 were
$141,220,175 and $134,094,483, respectively. Time deposits of less than $100,000
totaled $239,830,989 and $206,603,766 at December 31, 2001 and 2000,
respectively. Demand deposits reclassified as loan balances as of December 31,
2001 and 2000 amounted to $271,982 and $687,221, respectively.
The maturities of time certificates of deposit and other time deposits issued by
the Bank at December 31, 2001 are as follows:
Years Ending December 31,
-------------------------
2002............................................................................. $ 288,345,800
2003............................................................................. 51,961,883
2004............................................................................. 8,787,962
2005............................................................................. 25,912,618
2006............................................................................. 6,042,901
--------------
Total.......................................................................... $ 381,051,164
==============
NOTE 9 - LONG-TERM DEBT
At December 31, 2001 and 2000, the Bank had long-term debt totaling $23,000,000
and $12,000,000, respectively.
Long-term debt consists of the following at December 31, 2001 and 2000:
2001 2000
------------- -------------
Long-term Federal Home Loan Bank advances; at December 31, 2001 - maturity dates
in February 2011, fixed interest rates ranging from 4.16% to 4.97%; at December
31, 2000 - maturity dates of September 2002 through April 2004, variable and
fixed interest rates ranging from 5.01% to 6.82%; all of the debt at December
31, 2001 is subject to early termination options by the Bank and conversion by
the issuer into a three month LIBOR-based floating rate advance; secured by real
estate mortgage loans. All of the outstanding advances at December 31, 2000 were
paid off during 2001 .............................................................. $ 13,000,000 $ 12,000,000
Long-term Heritage Financial Statutory Trust advance from a pooled trust
preferred private placement for subordinated debentures; interest rate fixed at
10.20%, the subordinated debenture has a 30-year life with a call option of 10
years, subject to regulatory approval, or earlier, dependent upon certain
changes in tax or investment company laws, or regulatory capital requirements...... 10,000,000 --
------------- -------------
$ 23,000,000 $ 12,000,000
============= =============
56
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 9 - LONG-TERM DEBT - CONTINUED
Maturities of long-term debt following December 31, 2001, are as follows:
Years Ending December 31,
-------------------------
2002............................................................................. $ --
2003............................................................................. --
2004............................................................................. --
2005............................................................................. --
2006............................................................................. --
Thereafter....................................................................... 23,000,000
-------------
Total.......................................................................... $ 23,000,000
=============
NOTE 10 - STOCKHOLDERS' EQUITY
As discussed in Notes 2 and 11, the Company was formed in year 2000 and through
a 1-for-1 exchange of stock acquired Heritage Bank employing
pooling-of-interests accounting treatment. As a result, all information
contained in these financials, including share information, is represented as if
the Company and the Bank had been combined for all periods presented.
At December 31, 2001 and 2000, stockholders' equity of the Company consisted of
the following:
Preferred Stock: 10,000,000 shares authorized, with a par value of $0.01 per
share, none issued.
Common Stock: 40,000,000 shares authorized, with a par value of $0.01 per share,
8,515,147 shares and 8,475,822 shares issued and outstanding as of December 31,
2001 and 2000, respectively. Voting rights equal to one vote per share.
Paid-in Capital: Represents the funds received in excess of par value upon the
issuance of stock, net of issuance costs and the related effect of stock
dividends and stock splits.
Retained Earnings: Represents the accumulated net earnings of the Company.
Accumulated Other Comprehensive Income: Represents the change in equity during
each period from the effects of unrealized holding gains and losses on
securities available for sale, net of tax.
Stock Splits: In November 1999, the Bank issued a 2-for-1 stock split. All per
share amounts included in these financial statements have been adjusted to give
retroactive effect to each split.
During September 1999, the Bank offered for sale up to 115,385 shares (230,770
Split adjusted) shares of its common stock at an offering price of $13.00 per
share ($6.50 Split adjusted). This sale was closed during 1999, raising a total
of $669,500 in additional capital.
57
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 10 - STOCKHOLDERS' EQUITY - CONTINUED
On February 29, 2000, the Bank completed an oversubscribed exempt offering of
1,000,000 shares of its common stock, $0.01 par value per share, at $10.00 per
share. The offering to new stockholders in the Birmingham, Decatur and
Huntsville, Alabama markets commenced on December 1, 1999, and culminated in
raising approximately $10,000,000 in new capital, before expenses associated
with the offering. The proceeds from the offering were used for the
establishment of Heritage Bank's Birmingham location, working capital and other
various uses.
NOTE 11 - REORGANIZATION
On March 14, 2000, the board of directors of the Bank approved a Plan of
Reorganization and Agreement of Merger to form a bank holding company and
through the exchange of stock become a wholly-owned subsidiary. The Bank filed
documents with the Federal Reserve, FDIC and the Alabama State Banking
Department to effectuate this reorganization and merger. Stockholders of the
Bank voted approval upon this matter at the 2000 Annual Meeting of Stockholders.
On July 17, 2000, the Federal Deposit Insurance Corporation issued a combined
Order and Basis for Corporation Approval approving the Interagency Bank Merger
Application submitted on behalf of the Bank for consent to merge with Heritage
Interim Corporation under the charter and title of the Bank. On July 20, 2000,
the Board of Governors of the Federal Reserve System approved the application by
the Company to become a bank holding company by acquiring the Bank pursuant to
the Bank Holding Company Act. The Bank and the Company consummated the
reorganization and merger in August 2000.
NOTE 12 - REGULATORY CAPITAL MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the state and federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
regulatory capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and its subsidiary bank must meet specific
capital guidelines involving quantitative measures of the Company and its
subsidiary bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts and
classification under the prompt corrective guidelines are also subject to
qualitative judgements by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of Total
Capital and Tier I Capital to risk-weighted assets (as defined in the
regulations), and Tier I Capital (Leverage) to adjusted total assets (as
defined). Management believes, as of December 31, 2001, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
58
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 12 - REGULATORY CAPITAL MATTERS - CONTINUED
As of December 31, 2001, the most recent notification from the Federal Deposit
Insurance Corporation catagorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To remain categorized as well
capitalized, the Bank will have to maintain minimum Total Capital, Tier I
Capital and Tier I Leverage ratios as disclosed in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
The Company's and Bank's actual capital amounts and ratios are also presented in
the table.
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
-------------------- -------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------ --------- ----- --------- ------
(In thousands)
AS OF DECEMBER 31, 2001:
TOTAL CAPITAL
CONSOLIDATED............... $ 52,254 10.69% $ 39,106 8.00% $ 48,882 10.00%
HERITAGE BANK.............. 50,899 10.42 39,080 8.00 48,850 10.00
TIER I CAPITAL
CONSOLIDATED............... 46,180 9.45 19,553 4.00 29,329 6.00
HERITAGE BANK.............. 44,825 9.18 19,540 4.00 29,310 6.00
TIER I LEVERAGE
CONSOLIDATED............... 46,180 7.86 23,516 4.00 29,395 5.00
HERITAGE BANK.............. 44,825 7.63 23,500 4.00 29,376 5.00
As of December 31, 2000:
Total Capital
Consolidated............... $ 38,723 9.36% $ 33,083 8.00% $ 41,354 10.00%
Heritage Bank.............. 38,687 9.35 33,104 8.00 41,380 10.00
Tier I Capital
Consolidated............... 33,658 8.14 16,541 4.00 24,812 6.00
Heritage Bank.............. 33,622 8.13 16,552 4.00 24,828 6.00
Tier I Leverage
Consolidated............... 33,658 7.26 18,539 4.00 23,173 5.00
Heritage Bank.............. 33,622 7.25 18,539 4.00 23,173 5.00
59
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 13 - INCENTIVE STOCK COMPENSATION PLAN
The Company entered into an Incentive Stock Compensation Plan (the "Compensation
Plan") with the Company's directors and certain key officers and employees.
Under the Compensation Plan, the Company has entered into Incentive Stock Option
Agreements and Nonqualified Option Agreements (together the "Agreements") which
provide for these directors and key employees to purchase shares of the
Company's $0.01 par value common stock at the fair market value at the dates of
grant. The options granted under the Agreements may be exercised within 5 years
and 10 years from the dates of grant. The following summary sets forth activity
under the Agreements for the years ended December 31, 2001, 2000 and 1999:
Fixed Options
2001 2000 1999
------------------------ ------------------------- -------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
OPTIONS PRICE Options Price Options Price
----------- -------- ----------- -------- ----------- --------
Outstanding, beginning of the year.. 3,970,032 $ 3.72 4,008,000 $ 3.70 3,720,000 $ 3.25
Granted.......................... 23,000 11.50 2,000 10.00 420,554 7.20
Exercised........................ (36,000) 2.42 (39,968) 1.67 (126,554) 2.10
Forfeited........................ -- 0.00 -- 0.00 (6,000) 6.50
----------- ----------- -----------
Outstanding, end of the year........ 3,957,032 3.77 3,970,032 3.72 4,008,000 3.70
=========== =========== ===========
Exercisable, end of the year........ 1,630,232 1,227,632 992,280
Weighted average fair value of options
granted during the year.......... $ 3.43 $ 3.38 $ 3.51
Information pertaining to options outstanding at December 31, 2001, is as
follows:
Outstanding Expiration Options
Number Date Exercisable
----------- ---------- -----------
Options with an exercise price of $2.84....................... 139,478 04/17/03 139,478
Options with an exercise price of $3.34....................... 330,000 07/14/03 330,000
Options with an exercise price of $3.34....................... 72,000 07/08/09 16,000
Options with an exercise price of $3.34....................... 3,048,000 08/24/08 906,000
Options with an exercise price of $5.50....................... 60,000 07/01/04 60,000
Options with an exercise price of $6.50....................... 12,000 07/01/04 12,000
Options with an exercise price of $6.50....................... 2,000 07/08/04 2,000
Options with an exercise price of $6.50....................... 2,000 09/16/04 800
Options with an exercise price of $7.50....................... 20,000 11/07/04 8,000
Options with an exercise price of $7.50....................... 120,000 11/07/09 24,000
Options with an exercise price of $10.00...................... 126,554 12/28/04 126,554
Options with an exercise price of $10.00...................... 2,000 01/28/05 800
Options with an exercise price of $11.50...................... 23,000 03/02/06 4,600
The number of shares and weighted average exercise prices have been restated to
give effect for the 2-for-1 stock split effective November 8, 1999.
60
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 13 - INCENTIVE STOCK COMPENSATION PLAN - CONTINUED
Of the 3,957,032 outstanding options at December 31, 2001, 1,630,232 were
exercisable with the remaining 2,326,800 having remaining vesting periods of up
to 7 years. The weighted average exercise price of the exercisable options at
December 31, 2001, was $4.03. Exercise prices for options outstanding as of
December 31, 2001, ranged from $2.84 to $11.50. Total unexercised options of
3,957,032 have a weighted average contractual life of 5.82 years and a weighted
average exercise price of $3.77.
At December 31, 2001, the shares under option include nonqualified options of
2,622,000 issued primarily to Company directors and incentive stock options of
1,335,032 issued to certain key employees of the Company.
If the Company had elected to recognize compensation cost for options granted in
2001, 2000 and 1999, based on the fair value of the options as permitted by SFAS
No. 123, net income and earnings per share would have been reduced to the pro
forma amounts indicated below:
Years Ended December 31,
---------------------------------------------------
2001 2000 1999
------------ ------------ -----------
NET INCOME:
As reported.................................................. $ 2,365,921 $ 2,187,531 $ 860,861
Pro forma.................................................... 1,801,959 1,453,844 (611,645)
BASIC EARNINGS PER SHARE:
As reported.................................................. $ 0.28 $ 0.26 $ 0.12
Pro forma.................................................... 0.21 0.17 (0.08)
DILUTED EARNINGS PER SHARE:
As reported.................................................. $ 0.23 $ 0.22 $ 0.11
Pro forma.................................................... 0.17 0.14 (0.08)
All options are assumed to be exercised in the calculations of diluted average
common shares outstanding, causing the equivalent number of shares outstanding
on a diluted basis to be greater than that used to calculate basic earnings per
share by 2,002,342, 1,817,109 and 634,425 for 2001, 2000 and 1999, respectively.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model for 2001, 2000 and 1999 grants:
2001 2000 1999
------- ------- ----------
Expected dividend yield....................................... 0.00% 0.00% 0.00%
Expected stock price volatility............................... 21.70 24.20 24.20
Risk-free interest rate....................................... 4.95 6.00 6.00
Expected life of options...................................... 5 YEARS 5 years 5-8.5 years
61
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 13 - INCENTIVE STOCK COMPENSATION PLAN - CONTINUED
The effects of applying FAS 123 for providing pro forma disclosures are not
likely to be representative of the effects on reported earnings for future
years, nor are the dividend estimates representative of commitments on the part
of the Bank's Board.
NOTE 14 - OTHER OPERATING EXPENSES
The major components of other operating expenses included in noninterest
expenses at December 31, 2001, 2000 and 1999 are as follows:
2001 2000 1999
------------ ------------ ------------
Professional fees....................................... $ 582,783 $ 471,283 $ 255,723
Advertising............................................. 336,017 290,941 180,170
Supplies ............................................... 262,024 294,201 184,389
Data processing......................................... 190,300 136,168 89,900
Telephone............................................... 170,874 157,816 87,787
Director committee fees................................. 152,746 151,233 118,200
Postage................................................. 125,546 90,207 59,966
Franchise taxes......................................... 121,808 57,779 3,262
Equity line expenses.................................... 103,691 78,697 39,821
Other ............................................... 1,284,556 891,999 562,964
------------ ------------ ------------
$ 3,330,345 $ 2,620,324 $ 1,582,182
============ ============ ============
NOTE 15 - INCOME TAXES
Federal and state income taxes receivable (payable) as of December 31, 2001 and
2000 included in other assets (other liabilities), were as follows:
2001 2000
----------- -----------
Current
Federal.................................................................... $ 166,712 $ (21,466)
State...................................................................... (127,352) (121,036)
62
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 15 - INCOME TAXES - CONTINUED
The components of the net deferred income tax asset included in other assets as
of December 31, 2001 and 2000 are as follows:
2001 2000
------------ ------------
Deferred tax asset:
Federal.................................................................... $ 1,671,166 $ 1,450,843
State...................................................................... 294,723 255,974
------------ ------------
Total deferred income tax asset.......................................... 1,965,889 1,706,817
Deferred tax liability:
Federal.................................................................... (288,808) (235,913)
State...................................................................... (50,966) (41,632)
------------ ------------
Total deferred income tax liability...................................... (339,774) (277,545)
------------ ------------
Net deferred tax asset................................................... $ 1,626,115 $ 1,429,272
============ ============
The tax effects of each type of income and expense item that gave rise to
deferred taxes are:
2001 2000
--------------- ---------------
Depreciation............................................................... $ (339,774) $ (277,545)
Allowance for loan losses.................................................. 1,810,821 1,497,731
Unamortized expenses....................................................... 34,068 35,857
Net unrealized losses on securities available-for-sale..................... 37,833 105,938
Deferred compensation on stock options..................................... 82,098 66,960
Other...................................................................... 1,069 331
--------------- ----------------
Net deferred tax asset..................................................... $ 1,626,115 $ 1,429,272
=============== ================
The components of income tax expense (benefit) for the years ended December 31,
2001, 2000 and 1999 were as follows:
2001 2000 1999
------------ ------------ -----------
Current
Federal.................................................. $ 1,361,567 $ 1,641,466 $ 701,814
State.................................................... 127,347 121,036 59,986
Deferred
Federal.................................................. (224,469) (655,483) (312,000)
State.................................................... (40,479) (115,850) (55,000)
------------ ------------ -----------
$ 1,223,966 $ 991,169 $ 394,800
============ ============ ===========
63
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 15 - INCOME TAXES - CONTINUED
Tax effect of securities transactions for the years ended December 31, 2001,
2000 and 1999 were approximately $9,570, $-0- and $444, respectively.
The principal reasons for the difference in the effective tax rate and the
federal statutory rate are as follows for the years ended December 31, 2001,
2000 and 1999:
2001 2000 1999
----- ----- -----
Statutory federal income tax rate....................... 34.0% 34.0% 34.0%
Effect on rate of:
Tax exempt security income........................... (1.2) (1.3) (2.4)
Tax exempt loan income............................... (0.4) (0.5) (0.8)
State income tax, net of federal tax................. 1.2 (1.1) (1.2)
Other ............................................... 0.5 0.1 1.8
----- ----- -----
Effective income tax rate............................... 34.1% 31.2% 31.4%
===== ===== =====
NOTE 16 - RETIREMENT PLAN
The Bank adopted a 401(k) Plan ("the Plan") on August 1, 1995. The Plan covers
substantially all employees, subject to eligibility requirements. Employees may
defer up to fifteen percent of their compensation, not to exceed $11,000, with a
fifty percent matching employer contribution of up to six percent of
compensation. Total expense included in salary and benefits for years ended
December 31, 2001, 2000 and 1999 was $65,604, $50,032 and $35,395, respectively.
The Bank also adopted an Employee Stock Purchase Plan (the "Stock Plan") on June
20, 1995. The Company assumed the Stock Plan in its holding company
reorganization that was finalized in August 2000. The Stock Plan covers
substantially all employees, subject to eligibility requirements. Under the
Stock Plan, employees are given the opportunity to subscribe to purchase shares
of the Company's common stock at a purchase price equivalent to 85% of the
stated fair value of the common stock, as determined by the board of directors
of the Company. The stated fair value of the common stock at December 31, 2001
and 2000 was $12.50 and $11.50 per share, respectively. Employee contributions
to the Stock Plan are made through payroll deduction. The maximum number of
shares available-for-sale under the Stock Plan is 100,000. The Board approved
and ratified modification of the Employee Stock Purchase Plan on May 8, 2001.
NOTE 17 - COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Bank offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements.
64
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 17 - COMMITMENTS AND CONTINGENCIES - CONTINUED
A summary of the Bank's commitments and contingent liabilities at December 31,
2001 and 2000, is as follows:
Contract or
Notional Amount
-------------------------------
2001 2000
------------- -------------
Commitments to extend credit................................................. $ 68,927,000 $ 68,295,000
Credit card arrangements..................................................... 3,047,000 2,575,000
Standby letters of credit.................................................... 3,174,000 5,141,000
Commitments to extend credit, credit card arrangements, commercial letters of
credit and standby letters of credit all include exposure to some credit loss in
the event of nonperformance of the customer. The Bank's credit policies and
procedures for credit commitments and financial guarantees are the same as those
for extension of credit that are recorded on the statements of financial
condition. Because these instruments have fixed maturity dates, and because many
of them expire without being drawn upon, they do not generally present any
significant liquidity risk to the Bank.
Management conducts regular reviews of these instruments on an individual
customer basis, and the results are considered in assessing the adequacy of the
Bank's allowance for loan losses. Management does not anticipate any material
losses as a result of these commitments.
NOTE 18 - CONCENTRATIONS OF CREDIT
All of the Bank's loans, commitments and commercial and standby letters of
credit have been granted to customers in the Bank's market area. The
concentrations of credit by type of loan are set forth in Note 5.
The Bank maintains its cash accounts at various commercial banks in Alabama,
Georgia and Tennessee. The total cash balances in commercial banks are insured
by the FDIC up to $100,000. Total uninsured balances held at commercial banks at
December 31, 2001 and 2000 amounted to $128,412 and $128,118, respectively.
NOTE 19 - RESTRICTIONS ON DIVIDENDS
The Bank is subject to the dividend restrictions set forth by the State Banking
Department. Under such restrictions, the Bank may not, without the prior
approval of the State Banking Department, declare dividends in excess of the sum
of the current year's earnings plus the retained earnings from the prior two
years. For the year ending December 31, 2002, the Bank can declare dividends,
without prior regulatory approval, of approximately $3,405,543 plus an
additional amount equal to its net profits for 2002.
65
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 20 - LEASES
The Bank has various operating lease agreements involving land, buildings and
equipment. These leases are noncancellable and expire on various dates. The
leases provide for renewal options and generally require the Bank to pay
maintenance, insurance and property taxes. For the years ended December 31,
2001, 2000 and 1999, rental expense for such lease agreements was $457,615,
$358,938 and $229,115, respectively.
Future minimum lease payments under these operating lease agreements at December
31, 2001, are as follows:
Years Ending December 31,
-------------------------
2002............................................................................. $ 350,445
2003............................................................................. 386,287
2004............................................................................. 401,813
2005............................................................................. 389,394
2006............................................................................. 392,397
Thereafter....................................................................... 1,609,637
------------
Total minimum lease payments................................................... $ 3,529,973
================
NOTE 21 - RELATED PARTY TRANSACTIONS
Loans: Certain directors, executive officers and principal stockholders
including their immediate families and associates were loan customers of the
Bank during 2001 and 2000. Such loans are made in the ordinary course of
business at normal credit terms, including interest rates and collateral and do
not represent more than a normal risk of collection. Total loans to these
persons at December 31, 2001 and 2000, amounted to $15,067,983 and $13,767,900,
respectively. Activity during 2001 and 2000 in loans to related parties is as
follows:
2001 2000
------------- -------------
Balance at beginning of year................................................. $ 13,767,900 $ 13,437,981
New loans.................................................................. 6,746,436 6,934,060
Repayments................................................................. (5,446,353) (6,604,141)
------------- -------------
Balance at end of year....................................................... $ 15,067,983 $ 13,767,900
============= =============
Deposits: Deposits held from related parties were $4,358,804 and $5,079,275 at
December 31, 2001 and 2000, respectively.
66
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 22 - LITIGATION
While the Company and its subsidiary are party to various legal proceedings
arising from the ordinary course of business, management believes after
consultation with legal counsel that there are no proceedings threatened or
pending against the Company that will, individually or in the aggregate, have a
material adverse effect on the business or financial condition of the Company.
NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Short-Term Investments: For those short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Securities: For securities available-for-sale and securities held-to-maturity,
fair values are based on quoted market prices or dealer quotes. For other
securities, fair value equals quoted market price, if available. If a quoted
market price is not available, fair value is estimated using quoted market
prices for similar securities.
Mortgage Loans Held For Sale: For these short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Loans: For certain homogeneous categories of loans, such as some residential
mortgage, credit card receivables and other consumer loans, fair value is
estimated using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The fair value of other types
of loans is estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
Accrued Interest Receivable: The carrying amount of accrued interest receivable
approximates its fair value.
Deposits: The fair value of demand deposits, savings accounts and certain money
market deposits in the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposit of similar remaining maturities.
Accrued Interest Payable: The carrying amount of accrued interest payable
approximates its fair value.
Short-Term Borrowings: The carrying amounts of short-term borrowings approximate
their fair values.
Long-term Debt: Rates currently available to the Bank for debt with similar
terms and remaining maturities are used to estimate fair value of existing debt.
67
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED
Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees
Written: The fair value of commitments, letters of credit and financial
guarantees is estimated to be approximately the same as the notional amount of
the related commitment.
The estimated fair values of the Company's financial instruments as of December
31, 2001 and 2000 are as follows:
2001 2000
-------------------------- ----------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
---------- ---------- ---------- ----------
(IN THOUSANDS) (in thousands)
FINANCIAL ASSETS
Cash and short-term investments.......... $ 13,702 $ 13,702 $ 15,640 $ 15,640
Securities............................... 25,894 25,894 26,846 26,846
Mortgage loans held-for-sale............. 12,548 12,548 -- --
Loans.................................... 505,381 529,578 422,135 420,526
Accrued interest receivable.............. 3,873 3,873 4,396 4,396
---------- ---------- ---------- ----------
TOTAL FINANCIAL ASSETS................. $ 561,398 $ 585,595 $ 469,017 $ 467,408
========== ========== ========== ==========
FINANCIAL LIABILITIES
Deposits................................. $ 504,310 $ 513,757 $ 421,244 $ 424,173
Subordinated debentures.................. 10,000 10,308 -- --
FHLB Advances............................ 13,000 13,778 12,000 11,600
Accrued interest payable................. 4,205 4,205 4,152 4,152
---------- ---------- ---------- ----------
TOTAL FINANCIAL LIABILITIES............ $ 531,515 $ 542,048 $ 437,396 $ 439,925
========== ========== ========== ==========
UNRECOGNIZED FINANCIAL INSTRUMENTS
Commitments to extend credit............. $ 71,974 $ 71,974 $ 70,870 $ 70,870
Standby letters of credit................ 3,174 3,174 5,141 5,141
---------- ---------- ---------- ----------
TOTAL UNRECOGNIZED FINANCIAL
INSTRUMENTS.......................... $ 75,148 $ 75,148 $ 76,011 $ 76,011
========== ========== ========== ==========
68
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 24 - CONDENSED PARENT COMPANY INFORMATION
STATEMENTS OF FINANCIAL CONDITION
December 31,
------------- -------------
2001 2000
------------- -------------
ASSETS
Cash and due from banks...................................................... $ 529,538 $ 3,089
Investment in and amounts due from subsidiaries (equity
method) -eliminated upon consolidation..................................... 45,469,845 33,463,043
Other assets................................................................. 961,623 33,170
------------- -------------
TOTAL ASSETS............................................................. $ 46,961,006 $ 33,499,302
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Guaranteed preferred beneficial interest in the Company's
subordinated debentures.................................................... $ 10,310,000 $ --
Other liabilities............................................................ 527,126 --
------------- -------------
TOTAL LIABILITIES........................................................ 10,837,126 --
STOCKHOLDERS' EQUITY............................................................ 36,123,880 33,499,302
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................... $ 46,961,006 $ 33,499,302
============= =============
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69
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 24 - CONDENSED PARENT COMPANY INFORMATION - CONTINUED
STATEMENTS OF INCOME
Years Ended December 31,
----------------------------------
2001 2000
------------ ------------
INCOME
From subsidiaries - eliminated upon consolidation:
Dividends.................................................................. $ 2,115,710 $ 25,000
Management fees............................................................ 218,000 --
Interest income............................................................ 27,228 --
------------ ------------
TOTAL INCOME............................................................. 2,360,938 25,000
------------ ------------
EXPENSES
Interest expense............................................................. 905,562 --
Salaries and benefits........................................................ 394,734 61,386
Other expenses............................................................... 471,462 21,911
------------ ------------
TOTAL EXPENSES........................................................... 1,771,758 83,297
------------ ------------
Income (loss) before income taxes and equity
in undistributed earnings of subsidiary...................................... 589,180 (58,297)
Income tax benefit.............................................................. 583,857 33,170
------------ ------------
Income (loss) before equity in undistributed earnings of subsidiary............. 1,173,037 (25,127)
Equity in undistributed earnings of subsidiary.................................. 1,192,884 2,212,658
------------ ------------
NET INCOME...................................................................... $ 2,365,921 $ 2,187,531
============ ============
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70
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 24 - CONDENSED PARENT COMPANY INFORMATION - CONTINUED
STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------
2001 2000
-------------- -------------
OPERATING ACTIVITIES
Net income................................................................... $ 2,365,921 $ 2,187,531
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income of subsidiary............................... (1,192,884) (2,212,658)
Deferred tax benefit....................................................... (14,548) (32,334)
Other, net................................................................. (778,339) (836)
-------------- -------------
NET CASH USED IN OPERATING ACTIVITIES.................................... 380,150 (58,297)
-------------- -------------
INVESTING ACTIVITIES
Capital injection in subsidiaries............................................ (10,320,200) --
-------------- -------------
(10,320,200) --
-------------- -------------
FINANCING ACTIVITIES
Net proceeds from issuance of stock.......................................... 118,656 --
Compensatory options recognition............................................. 37,843 61,386
Issuance of guaranteed preferred beneficial interest in the
Company's subordinated debentures.......................................... 10,310,000 --
-------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES................................ 10,466,499 61,386
-------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS....................................... 526,449 3,089
Cash and Cash Equivalents at Beginning of Year.................................. 3,089 --
-------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR........................................ $ 529,538 $ 3,089
============== =============
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71
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 25 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Selected quarterly results of operations for the four quarters ended December 31
are as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
--------- --------- --------- --------- ---------
(In Thousands)
2001:
TOTAL INTEREST INCOME........... $ 10,953 $ 11,058 $ 11,348 $ 10,894 $ 44,253
TOTAL INTEREST EXPENSE.......... 7,084 7,369 7,479 6,662 28,594
PROVISION FOR LOAN LOSSES....... 1,046 981 850 725 3,602
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES.... 2,823 2,708 3,019 3,507 12,057
OTHER NONINTEREST INCOME........ 337 370 410 439 1,556
OTHER NONINTEREST EXPENSE....... 2,469 2,460 2,606 2,488 10,023
INCOME TAX EXPENSE.............. 273 188 323 440 1,224
NET INCOME...................... 418 430 500 1,018 2,366
PER COMMON SHARE:
BASIC EARNINGS............... 0.05 0.05 0.06 0.12 0.28
DILUTED EARNINGS............. 0.04 0.04 0.05 0.10 0.23
2000:
Total interest income........... $ 6,778 $ 8,431 $ 9,881 $ 10,570 $ 35,660
Total interest expense.......... 3,848 5,065 6,351 6,754 22,018
Provision for loan losses....... 670 966 763 990 3,389
Net interest income after
provision for loan losses.... 2,260 2,400 2,767 2,826 10,253
Other noninterest income........ 211 274 262 292 1,039
Other noninterest expense....... 1,789 1,964 2,078 2,282 8,113
Income tax expense.............. 259 275 379 78 991
Net Income...................... 423 435 572 758 2,188
Per Common Share:
Basic earnings............... 0.05 0.05 0.07 0.09 0.26
Diluted earnings............. 0.04 0.04 0.06 0.08 0.22
72
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 25 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) - CONTINUED
Selected quarterly results of operations for the quarters ended December 31 are
as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- ---------
(In Thousands)
1999:
Total interest income........... $ 3,310 $ 3,841 $ 4,514 $ 5,583 $ 17,248
Total interest expense.......... 1,891 2,201 2,583 3,199 9,874
Provision for loan losses....... 289 308 458 753 1,808
Net interest income after
provision for loan losses.... 1,130 1,332 1,473 1,631 5,566
Other noninterest income........ 152 133 177 180 642
Other noninterest expense....... 940 1,053 1,382 1,577 4,952
Income tax expense
(benefit).................... 137 170 123 (35) 395
Net Income...................... 205 242 145 269 861
Per Common Share:
Basic earnings............... 0.03 0.03 0.02 0.04 0.12
Diluted earnings............. 0.03 0.03 0.02 0.03 0.11
NOTE 26 - SUBSEQUENT EVENTS
On March 25, 2002, Reginald D. Gilbert, President, Chief Executive Officer and
Director of the Company and the Bank, elected to voluntarily retire as an
employee and sever his relationship with the Company and the Bank. In
conjunction with his retirement and severance, the Company and Reginald D.
Gilbert ("Gilbert") entered into a "Retirement, Release and Settlement
Agreement" (the "Agreement"), providing for severance pay and certain other
nonqualified retirement benefits in consideration of his retirement, his years
of service and certain non-competition and other agreements and covenants.
Current accounting regulations require that substantially all of the benefits to
be received by Gilbert from the Company, as provided for by the Agreement
between the Company and Gilbert, be reflected as compensation cost in the
Company's year 2002 consolidated financial statements. The aggregate amount of
compensation cost, net of tax benefit, to be recognized by the Company as a
charge against its' year 2002 earnings, due solely to the provisions of the
Agreement, is estimated to be approximately $3.7 million or $0.43 per common
share. Although earnings of the Company will be adversely affected, the nature
of the benefits allows for an offsetting increase in stockholders' equity of
approximately $4.3 million, thereby increasing stockholders' equity by
approximately $600,000 more than the charge against earnings. Net book value per
share would therefore increase by approximately $0.07 per common share due
solely to the provisions of the Agreement.
73
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;
EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS; AND CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the captions "Directors and Executive
Officers," "Executive Compensation," "Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters," and "Certain
Relationships and Related Transactions" included in the Company's definitive
proxy statement to be filed no later than April 30, 2002, in connection with the
Company's 2002 Annual Meeting of Stockholders is incorporated herein by
reference.
[The remainder of this page intentionally left blank]
74
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements, Financial Schedules and Exhibits.
(1) The consolidated financial statements of Heritage
Financial Holding Corporation and its subsidiaries
filed as a part of this Annual Report on Form 10-K
are listed in Item 8 of this Annual Report on Form
10-K, which is hereby incorporated by reference
herein.
(2) All schedules to the consolidated financial
statements of Heritage Financial Holding Corporation
and its subsidiaries have been omitted because they
are not required under the related instructions or
are inapplicable, or because the required information
has been provided in the consolidated financial
statements or the notes thereto.
(3) The exhibits required by Regulation S-K are set forth
in the following list and are filed either by
incorporation by reference from previous filings with
the Securities and Exchange Commission or by
attachment to this Annual Report on Form 10-K as
indicated below.
EXHIBIT
NO. EXHIBIT PAGE
- ------- ------- ----
(2)-1 Plan of Reorganization and Agreement of Merger, dated as of March 14,
2000, by and among Heritage Financial Holding Corporation, Heritage
Interim Corporation and Heritage Bank, filed as Exhibit 2 to the
Company's current report on Form 8-K on November 9, 2000, is hereby
incorporated herein by reference.
(3)-1 Certificate of Incorporation of Heritage Financial Holding Corporation,
filed as Exhibit 1 to the Company's Registration Statement on Form 8-A,
is hereby incorporated herein by reference.
(3)-2 Bylaws of Heritage Financial Holding Corporation, filed as Exhibit 2 to
the Company's Registration Statement on Form 8-A, is hereby
incorporated herein by reference.
(4)-1 Indenture, dated as of February 22, 2001, between Heritage Financial
Holding Corporation and State Street Bank and Trust Company, filed as
Exhibit 4-1 to the Company's annual report on Form 10-KSB filed March
31, 2001, is hereby incorporated by reference.
(4)-2 Guarantee Agreement, dated as of February 22, 2001, between Heritage
Financial Holding Corporation and State Street Bank and Trust Company,
filed as Exhibit 4-2 to the Company's annual report on Form 10-KSB
filed March 31, 2001, is hereby incorporated by reference.
75
EXHIBIT
NO. EXHIBIT PAGE
- ------- ------- ----
(4)-3 Placement Agreement, dated as of February 9, 2001, by and among First
Tennessee Capital Markets, Keefe, Bruyette & Woods, Inc., Heritage
Financial Holding Corporation and Heritage Financial Statutory Trust I,
filed as Exhibit 4-3 to the Company's annual report on Form 10-KSB
filed March 31, 2001, is hereby incorporated by reference.
(10)-1 Heritage Financial Holding Corporation Employee Stock Purchase Plan,
filed as Exhibit (4)-2 to the Company's Registration Statement on Form
S-8 (Registration No. 333-55942), is hereby incorporated herein by
reference.
(10)-2 Heritage Financial Holding Corporation Incentive Stock Compensation
Plan, filed as Exhibit (4)-3 to the Company's Registration Statement on
Form S-8 (Registration No. 333-55942), is hereby incorporated herein by
reference.
(10)-3 Employment Agreement dated as of May 13, 1999, by and between Heritage
Bank and John E. Whitley, filed as Exhibit (10)-4 to the Company's
annual report on Form 10-KSB filed March 31, 2001, is hereby
incorporated by reference.
(10)-4 Employment Agreement dated as of May 13, 1999, by and between Heritage
Bank and Vernon C. Bice, filed as Exhibit (10)-5 to the Company's
annual report on Form 10-KSB filed March 31, 2001, is hereby
incorporated by reference.
(10)-5 Employment Agreement dated as of May 31, 1999, by and between Heritage
Bank and Michael R. Washburn, filed as Exhibit (10)-6 to the Company's
annual report on Form 10-KSB filed March 31, 2001, is hereby
incorporated by reference.
11 Statement re: computation of per share earnings......................................... 77
12 Statement re: computation of ratios..................................................... 78
21 Subsidiaries of the Registrant ........................................................ 78
24 Powers of Attorney. See the signature page to this Annual Report on Form 10-K.......... 79
(b) Reports on Form 8-K
The Company filed a Form 8-K, disclosing information on Item 9,
Regulation FD Disclosure, on November 9, 2001. No financial statements
were filed therewith.
(c) Exhibits
The exhibits required to be filed with this Annual Report on Form 10-K
pursuant to Item 601 of Regulation S-K are listed under "Exhibits" in
Part IV, Item 14(a) (3) of this Annual Report on Form 10-K, and are
incorporated herein by reference.
(d) Financial Statement Schedules.
The Financial Statement Schedules required to be filed with this Annual
Report on Form 10-K are listed under "Financial Statement Schedules" in
Part IV, Item 14(a) (2) of this Annual Report on Form 10-K, and are
incorporated herein by reference.
76
EXHIBIT 11 - STATEMENTS RE: COMPUTATION OF PER SHARE EARNINGS
HERITAGE FINANCIAL HOLDING CORPORATION
Computation of Net Income Per Common Share
The following tabulation presents the calculation of basic and diluted earnings
per common share for the years ended December 31, 2001, 2000 and 1999.
2001 2000 1999
------------- ------------- ------------
BASIC EARNINGS PER SHARE:
Net income................................................. $ 2,365,921 $ 2,187,531 $ 860,861
============= ============= ============
Earnings on common shares.................................. $ 0.28 $ 0.26 $ 0.12
============ ============= ============
Weighted average common shares outstanding - basic......... 8,484,624 8,316,756 7,226,044
============= ============= ============
Basic earnings per common share............................ $ 0.28 $ 0.26 $ 0.12
============ ============= ============
DILUTED EARNINGS PER SHARE:
Net income................................................. $ 2,365,921 $ 2,187,531 $ 860,861
============= ============= ============
Weighted average common shares
outstanding.............................................. 8,484,624 8,316,756 7,226,044
Net effect of the assumed exercise of stock
options - based on the treasury stock method
using average market price for the year.................. 2,002,342 1,817,109 634,425
------------- ------------- ------------
Weighted average common shares outstanding -
diluted.................................................. 10,486,966 10,133,865 7,860,469
============= ============= ============
Diluted earnings per common share.......................... $ 0.23 $ 0.22 $ 0.11
============ ============= ============
76
EXHIBIT 12 - STATEMENTS RE: COMPUTATION OF RATIOS
HERITAGE FINANCIAL HOLDING CORPORATION
Computation of Ratio of Earnings to Fixed Charges
Year Ended December 31,
-----------------------------------------------
2001 2000 1999
--------- --------- ---------
(Dollars in thousands)
Pretax income................................................. $ 3,590 $ 3,179 $ 1,256
Add fixed charges:
Interest on deposits....................................... 26,752 20,867 9,194
Interest on borrowings..................................... 1,843 1,152 680
Portion of rental expense representing interest expense.... 151 118 76
--------- --------- ---------
Total fixed charges...................................... 28,746 22,137 9,950
--------- --------- ---------
Income before fixed charges................................... $ 32,336 $ 25,316 $ 11,206
========= ========= =========
Pretax income................................................. $ 3,590 $ 3,179 $ 1,256
Add fixed charges (excluding interest on deposits):
Interest on borrowings..................................... 1,843 1,152 680
Portion of rental expense representing interest expense.... 151 118 76
--------- --------- ---------
Total fixed charges...................................... 1,994 1,270 756
--------- --------- ---------
Income before fixed charges (excluding interest on
deposits).................................................. $ 5,584 $ 4,449 $ 2,012
========= ========= =========
RATIO OF EARNINGS TO FIXED CHARGES
Including interest on deposits............................. 1.12 1.14 1.13
Excluding interest on deposits............................. 2.80 3.50 2.66
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
Subsidiaries - Direct/Wholly-owned State of Incorporation
- ---------------------------------- ----------------------
Heritage Bank Alabama
Heritage Financial Statutory Trust I Connecticut
77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HERITAGE FINANCIAL HOLDING
CORPORATION
Date: April 15, 2002 By /s/ Harold B. Jeffreys
-----------------------------------
Harold B. Jeffreys
Interim Chief Executive Officer
78
EXHIBIT 24 - POWER OF ATTORNEY
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Harold B. Jeffreys and Timothy A.
Smalley, and each of them, the true and lawful agents and his attorneys-in-fact
with full power and authority in each said agents and attorneys-in-fact, acting
singly, to sign for the undersigned as Director or an officer of the Company, or
as both, the Company's 2001 Annual Report on Form 10-K to be filed with the
Securities Exchange Commission, Washington, D.C. under the Securities Exchange
Act of 1934, and to sign any amendment or amendments to such Annual Report,
including an Annual Report pursuant to 11-K to be filed as an amendment to the
Form 10-K; hereby ratifying and confirming all acts taken by such agents and
attorneys-in-fact as herein authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
Signature Title Date
- -------------------------------------- ------------------------------------------ ---------------------------
/s/ Harold B. Jeffreys Interim President, Chief Executive Officer April 15 , 2002
- -------------------------------------- and Director
Harold B. Jeffreys
(Principal Executive Officer)
/s/ Timothy A. Smalley Chairman of the Board, Interim April 15, 2002
- -------------------------------------- Chief Financial Officer and Director
Timothy A. Smalley
(Principal Accounting Officer)
/s/ Marc A. Eason Director April 15, 2002
- -------------------------------------- Marc A. Eason
/s/ Bingham D. Edwards Director April 15, 2002
- -------------------------------------- Bingham D. Edwards
/s/ Lenny L. Hayes Director April 15, 2002
- -------------------------------------- Lenny L. Hayes
/s/ Neal A. Holland, Jr. Director April 15, 2002
- -------------------------------------- Neal A. Holland, Jr.
/s/ Larry Landman Director April 15, 2002
- -------------------------------------- Larry Landman
/s/ Vernon A. Lane Director April 15, 2002
- -------------------------------------- Vernon A. Lane
/s/ John T. Moss Director April 15, 2002
- -------------------------------------- John T. Moss
79
Signature Title Date
- -------------------------------------- ------------------------------------------ ---------------------------
/s/ T. Gerald New, M.D. Director April 15, 2002
- -------------------------------------- T. Gerald New, M.D.
/s/ Gregory Parker Director April 15, 2002
- -------------------------------------- Gregory Parker
/s/ Betty B. Sims Director April 15, 2002
- -------------------------------------- Betty B. Sims
/s/ Jeron Witt Director April 15, 2002
- -------------------------------------- Jeron Witt
80