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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
COMMISSION FILE NUMBER 000-31825
HERITAGE FINANCIAL HOLDING CORPORATION
(Exact name of registrant specified in its charter)
Delaware 63-1259533
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1323 Stratford Road 35601
Decatur, Alabama (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (256) 355-9500
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock -- Par Value $0.01 Per Share
(Title of Class)
Indicate by a check mark whether 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, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by a 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 the 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.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price of such common equity,
as of the last business day of the registrant's most recently completed second
fiscal quarter. Common Stock, par value $0.01 per share -- $42,141,554.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of March 24, 2003. Common Stock, par value $0.01 per
share -- 9,113,122 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual proxy statement for the annual meeting of
stockholders on May 20, 2003 incorporated by reference into Part III.
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HERITAGE FINANCIAL HOLDING CORPORATION
2002 FORM 10-K ANNUAL REPORT
Table of Contents
PART I............................................................................................................1
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS.........................................................1
RISK FACTORS...................................................................................................2
ITEM 1. BUSINESS........................................................................................3
ITEM 2. PROPERTIES.....................................................................................14
ITEM 3. LEGAL PROCEEDINGS..............................................................................14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................14
PART II..........................................................................................................14
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......................14
ITEM 6. SELECTED FINANCIAL DATA........................................................................17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........18
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................40
ITEM 8. FINANCIAL STATEMENTS...........................................................................40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........83
PART III.........................................................................................................83
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........................................................................83
ITEM 14. CONTROLS AND PROCEDURES........................................................................84
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...............................85
EXHIBIT 11 - STATEMENTS RE: COMPUTATION OF PER SHARE EARNINGS..........................................102
EXHIBIT 12 - STATEMENTS RE: COMPUTATION OF RATIOS......................................................103
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT............................................................104
EXHIBIT 24 - POWER OF ATTORNEY.........................................................................105
EXHIBIT 99.1 - CERTIFICATION OF PRESIDENT AND CEO......................................................107
EXHIBIT 99.2- CERTIFICATION OF CHIEF FINANCIAL OFFICER.................................................108
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, plans, objectives,
intentions, expectations, and other forward-looking statements: (1) the extent
to which we are able to achieve and maintain certain capital ratios at the
Company and the Bank, as well as the effects of the inability or failure to
achieve such ratios; (2) the effects of certain operating restrictions on the
Company and the Bank, including, without limitation, the ability to declare or
pay dividends without prior regulatory approval; (3) the strength of the United
States economy in general and the strength of the regional and local economics
in which we conduct operations; (4) 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; (5) inflation, interest rate,
market and monetary fluctuations; (6) 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; (7) the willingness of
users to substitute competitors' products and services for our products and
services; (8) 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; (9)
technological changes; (10) changes in consumer spending and savings habits;
(11) regulatory or judicial proceedings; and (12) the declaration of war and the
commencement of hostilities in Iraq and elsewhere. We also direct your attention
to the Risk Factors discussed immediately following this section under the
heading "Risk Factors."
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.
1
RISK FACTORS
The Company and the Bank are Restricted from Certain Activities Including
Payment of Dividends to Stockholders.
During 2002, management of the Company identified significant operational
and asset quality deficiencies at the Bank. These deficiencies resulted in
material increases to the Bank's loan loss reserves, resulting in material
reductions in the capital levels of the Company and the Bank. As a result, the
Board of Directors and management of the Company and the Bank have identified
specific corrective steps and actions to address capital deficiencies, improve
asset quality, and enhance operational controls and procedures. The Bank,
without the prior written approval of its regulators, may not declare or pay any
cash dividends. In addition, the Bank has determined to hire and retain certain
personnel who have been given specific written authority by the Board of
Directors to implement sound lending, recordkeeping and accounting practices.
The Bank also has taken steps to develop an educational program for board
members and to create a written review of the Bank's staffing requirements. The
Board of Directors of the Company intends to cause management of the Company and
the Bank to take steps to attain and maintain a Tier 1 leverage ratio of 8
percent and to be "well-capitalized" as defined by the FDIC by March 31, 2003.
Should the Tier 1 leverage ratio fail to meet the specified Tier 1 leverage
ration of 8 percent or subsequently fall below such level, the Bank must notify
the regulatory authorities and take steps to increase capital sufficient to meet
the required ratios within 30 days.
If the quality of the Company's assets does not improve, or if there is
further deterioration in the Bank's loan portfolio, the Company and the Bank may
be required to take additional remedial action that may further restrict the
Company's and the Bank's operations in future periods.
The Company and the Bank Have Made Significant Changes to the Bank's Loan Loss
Reserves as a Result of Reviews of the Bank's Loan Portfolio, and The Bank May
Be Required to Further Increase the Allowance for Loan and Lease Losses.
During the course of a targeted, limited scope review of the loan portfolio
of the Company's wholly-owned subsidiary Heritage Bank, an Alabama state banking
corporation (the "Bank"), and a concurrent safety and soundness audit and
information systems examination conducted by regulatory authorities, management
identified certain assets in the Bank's loan portfolio that management believed
should be classified. Due to the erosion in asset quality identified by the
review, the Company increased its allowance for loan losses by $2,000,000 during
the quarterly period ended June 30, 2002. Additional review of the Bank's loan
portfolio subsequently identified additional asset quality problems, which
resulted in the Company increasing the allowance for loan losses net of charge
offs and recoveries by a total of $20,916,364 for the year ending December 31,
2002. As of December 31, 2002, the allowance for loan losses on the Company's
consolidated balance sheet totaled $26,990,594, compared to $6,074,230 at
December 31, 2001.
The fourth quarter provision for loan losses in the amount of $16,393,000
contributed to a quarterly loss of $9,829,000, and a loss for the year of
$14,413,000. The Board of Directors and management of the Company and of the
Bank engaged in discussions regarding the Bank's Tier 1 capital that ultimately
led to the Company entering into a Loan Agreement with First Tennessee Bank
National Association dated October 30, 2002, pursuant to which the Company was
able to borrow up to $7.5 million (the "First Tennessee Loan"). Immediately
following the execution of the Loan Agreement, the Company drew down $5 million
of the First Tennessee Loan and contributed said loan proceeds to the capital of
the Bank. Subsequently, on December 27, 2002, the Company drew down an
additional $1.5 million of the First Tennessee Loan and contributed said loan
proceeds to the capital of the Bank. Following the $5 million and $1.5 million
contributions, the Bank's Tier 1 leverage ratio increased to approximately 5.99
percent as of the year ending December 31, 2002.
Management has continued the credit review process, and this has resulted
in additional classification of assets following September 30, 2002. Additional
classification of assets may result in an additional increase in the Bank's
allowance for loan losses, and such increases could have a material adverse
effect on the Company's and the Bank's financial condition and results of
operations.
The Board of Directors of the Company intends to cause management of the
Company and the Bank to take steps to attain and maintain a Tier 1 leverage
ratio at the Bank of 8 percent by March 31, 2003. The Bank did not
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achieve a Tier 1 leverage ratio of 7.5 percent as of December 31, 2002, and
management believes the Bank may not achieve a Tier 1 leverage ratio of 8
percent if the Bank is unable to acquire additional capital. Failure to achieve
these capital ratios could subject the Bank and the Company to regulatory
enforcement actions or proceedings.
The Company Has Had a Significant Change in Operating Strategy and Management
Since March 12, 2002 and There Can Be No Assurance that the New Strategy or
Management Will Result in Improved Financial Condition or Net Income.
On March 12, 2002, Reginald D. Gilbert, President, Chief Executive Officer
and Director of the Company and the Bank, ended his relationship with the
Company and the Bank. Harold B. Jeffreys, a Director, has been serving as
Interim President and Chief Executive Officer of the Company until such time as
the Company hires a new President and Chief Executive Officer. In addition, on
April 9, 2002, the Board of Directors accepted the resignations from the Board
of Directors of three officers of the Bank who had been serving on the Board.
Effective July 11, 2002, the Board of Directors hired Thomas E. Hemmings as
Chief Financial Officer of the Company. Mr. Hemmings has been charged with
taking steps to improve profitability for the Company and, more recently,
helping the Company to address its internal controls and procedures.
On October 23, 2002, the Board of Directors engaged Larry R. Mathews as
President and Chief Executive Officer of the Bank. The decision to retain Mr.
Mathews, given his experience in the areas of management, credit quality and
internal controls and procedures, is part of the Company's renewed focus on the
loan portfolio of the Bank and the overall credit quality of the Bank, as well
as the operating controls and procedures of the Bank. The Board of Directors
intends for Mr. Mathews to focus his initial efforts on improving asset quality
and loan administration, continuing the review and implementation of internal
controls and procedures and improving the Company's overall performance.
On October 25, 2002, the Board of Directors engaged Don Pruett as Executive
Vice President and Chief Lending Officer for the Bank. The Board of Directors
has given Mr. Pruett the authority and responsibility to implement sound lending
practices, credit underwriting standards, loan documentation and administration
practices. Mr. Pruett also has been given the overall responsibility for
improving the quality of the Bank's loan portfolio and maintaining the Bank's
asset quality in a manner that fully meets safe and sound banking practices
requirements and is in compliance with applicable laws and regulations.
On January 8, 2003, Heritage Bank employed Robert F. Harwell, Jr. and
Michael Hockman as President and Senior Lender, respectively, of the North
Alabama region. Mr. Harwell will have responsibility for both the Huntsville and
Decatur markets. Since 1996, he has been employed with a regional bank holding
company in Huntsville including the last eighteen months as President of their
North Alabama Division. Mr. Hockman served with the same regional bank holding
company prior to accepting his position with the Bank.
The Company and the Bank have continued to add experienced personnel to
assist in the review and oversight of important areas such as credit quality and
loan review. Despite these changes in management and the Board of Directors'
mandate to management to address the Bank's asset quality and lending
procedures, and to improve the Company's financial results, there can be no
assurance that the new management will be successful in improving the financial
condition or increasing the net income of the Company.
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
ten locations in Northern Alabama through Heritage Bank, an Alabama banking
corporation and our principal subsidiary. We had assets of approximately $593
million, loans of approximately $524 million, deposits of approximately $526
million and stockholders' equity of approximately $24 million at December 31,
2002. Our principal executive offices are located at 1323 Stratford Road,
Decatur, Alabama 35601, and the telephone number is (256) 355-9500.
3
The Company's business is conducted primarily through the Bank. Although we
have no immediate plans to conduct any other business, the Company may engage
directly or indirectly in a number of activities which the Federal Reserve has
determined to be so closely related to banking or managing or controlling banks
as to be a proper incident thereto.
SUBSIDIARY BANK
At December 31, 2002, the Bank conducted business through 10 locations in
Morgan, Madison, Marshall and Jefferson counties, Alabama. We offer a wide range
of commercial and retail banking services, including savings and time deposit
accounts, personal and commercial loans and personal and commercial checking
accounts. We seek to provide superior service to our customers and to become a
vital component of each of the communities which we serve.
RECENT DEVELOPMENTS
As previously reported in the Form 10-Q filings of the Company for the
quarterly periods ended June 30, 2002 and September 30, 2002, a targeted,
limited scope review of the loan portfolio of the Bank by regulatory authorities
identified certain assets of the Bank that the regulatory authorities believed
should be classified. In connection with such review, the Company and the Bank
took steps to charge off or establish additional loan loss reserves for
specified assets and to adjust the Bank's levels of loan loss provisions.
The Board of Directors of the Company and the Bank have imposed certain
restriction on the operations of the Company and the Bank in order to address
asset quality concerns, operational controls and procedures, and capital
deficiencies. The Bank, without the prior written approval of its regulatory
authorities, may not declare or pay any cash dividends. In addition, the Bank
has undertaken to hire and retain qualified lending and operational personnel
with the specific written authority by the Board of Directors to implement sound
lending, recordkeeping and accounting practices. The Bank also has undertaken to
develop an educational program for board members and to create a written review
of the Bank's staffing requirements. Our management and staff are working toward
meeting all of these requirements and implementing policies which will make the
Company and the Bank stronger and more efficient.
The Board of Directors of the Bank has determined to improve and increase
the capital ratios of the Bank, which have declined as a result of the increase
in the Bank's loan loss reserves. The Board of Directors of the Company intends
to cause management of the Company and the Bank to take steps to attain and
maintain a Tier 1 leverage ratio of 8 percent and to be "well-capitalized" as
defined by the FDIC by March 31, 2003. Should the Tier 1 leverage ratio fail to
meet or exceed the specified ratio of 8 percent or subsequently fall below such
level, the Bank must notify the regulatory authorities and take steps to
increase capital sufficient to meet the required ratios within 30 days.
Management believes the Bank may fail to achieve a Tier 1 leverage ratio of 8
percent if the Bank is unable to acquire additional capital.
The management of the Company and the Bank has aggressively addressed asset
quality, loan and audit issues. The Bank has charged off the balance of any
assets classified Loss and one-half of those assets classified Doubtful in any
official report of examination by any of the regulatory authorities, and has
gone further by conducting additional reviews of the Bank's loan portfolio to
insure full knowledge of the Bank's asset quality issues. The Bank must reduce
the balance of assets classified Substandard or Doubtful in accordance with a
specific timetable, and may not extend additional credit to any borrower
obligated to the Bank on any extension of credit that has been charged off by
the Bank or classified Loss or Doubtful as long as such credit remains
uncollected. In addition, the Bank is obligated to review its existing written
loan policies and to adopt new internal loan review systems to address problems
with the Bank's loan portfolio.
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
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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, Marshall
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
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, 2002 were $523.9
million, or 89.1% 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.
LOAN PORTFOLIO
Real Estate Loans - Loans secured by real estate are a significant
component of our loan portfolio, constituting $371.7 million, or 71.0% of total
loans at December 31, 2002. Our primary type of real estate loan is
single-family first mortgage loans, construction loans and acquisition and
development 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 typically 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 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, 2002, we had
general commercial, financial and agricultural loans of $132.2 million,
comprising 25.2% 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
and 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, 2002, loans to individuals for personal
expenditures totaled $19.9 million, comprising some 3.8% of our loan portfolio.
These consumer loans include loans to purchase automobiles, recreational
vehicles, mobile homes, appliances and boats, and the Bank continues to hold a
small amount of credit card loans. 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.
5
CREDIT PROCEDURES AND REVIEW
The regulatory authorities found significant weaknesses with our loan
policy, including our loan approval process, credit analysis, loan review and
other key lending support functions. As part of our response to these issues, we
have revised the Bank's loan policy to address areas the regulatory authorities
found to be inadequate, and have hired additional personnel to upgrade our
compliance in these areas.
Loan Approval - We attempt to minimize loan losses through various means
and use 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 have reduced the unsecured
lending authority of our officers and have reduced the overdraft authority of
our officers in order to address certain loan portfolio issues.
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. We require approval by the Board
of Directors of the Bank for new advances of credit to any borrowers with loans
classified Substandard and prohibit the advance of additional credit to any
borrower with loans classified Doubtful or Loss.
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. 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
71.4% of our total deposits as of December 31, 2002. Core deposits consist of
demand deposits, interest-bearing transaction accounts, savings 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
outside of 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 in Alabama is highly competitive, and our
profitability depends principally on our ability to compete in our market areas.
The area is dominated by a number of major banks and bank holding companies
which have substantially greater resources, and numerous offices and affiliates
operating over wide geographic areas. 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
6
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, 2002, the Company employed approximately 133 individuals
of which approximately 124 were full-time employees.
SUPERVISION AND REGULATION
The Company, as a bank holding company under the Bank Holding Company Act
of 1956, as amended ("BHCA"), is subject to the supervision, examination and
reporting requirements 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 Company is required to file with the
Federal Reserve periodic reports and such other information as the Federal
Reserve may request. The Federal Reserve conducts examinations of the Company,
and also may examine its subsidiaries. The State of Alabama does not regulate
bank holding companies.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act ("GLBA"),
which made substantial revisions to the statutory restrictions separating
banking activities from certain other financial activities. Under the GLBA, bank
holding companies that are "well-capitalized" and "well-managed" and whose
subsidiary banks have satisfactory or better ratings under the Community
Reinvestment Act of 1977, as amended (the "CRA"), and meet certain other
conditions can elect to become "financial holding companies." Financial holding
companies and their subsidiaries are permitted to acquire or engage in
previously impermissible activities, such as insurance underwriting, travel
agency activities, broad insurance agency activities, merchant banking, and
other activities that the Federal Reserve determines to be financial in nature
or complimentary to financial activities. In addition, under the merchant
banking authority added by the GLBA and Federal Reserve regulations, financial
holding companies are authorized to invest in companies that engage in
activities that are not financial in nature, as long as the financial holding
company makes its investment with the intention of limiting the terms of its
investment, does not manage the company on a day-to-day basis, and the investee
company does not cross-market with any of the financial holding company's
controlled depository institutions. Financial holding companies continue to be
subject to the overall oversight and supervision of the Federal Reserve. While
the Company has not elected to become a financial holding company, and may not
do so at the present time, it may elect to do so in the future.
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.
The Bank is subject to regulation, supervision and examination by the
Federal Reserve, the Federal Deposit Insurance Corporation ("FDIC") and the
Alabama Banking Department. As a member of the FDIC, the Bank's deposits are
insured to the maximum extent provided by law.
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
7
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. The prior approval
of the Federal Reserve is required if the total of all dividends declared by the
state member bank in any calendar year will exceed the sum of such bank's net
profits for the year and its retained net profits for the preceding two calendar
years, less any required transfers to surplus. Federal law also prohibits any
state member bank from paying dividends that would be greater than such bank's
undivided profits after deducting statutory bad debt reserves in excess of such
bank's allowance for loan losses. The Bank is currently prohibited from paying a
cash dividend to the Company without seeking prior written approval from federal
banking authorities.
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. No dividends may be paid from the
Bank's surplus without the prior written approval of the Superintendent. The
Bank is currently prohibited from paying dividends to the Company without the
prior approval of the Superintendent of the State Banking Department.
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.
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, additional
investments in a troubled bank may not otherwise be warranted. 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
likely will be unsecured and 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.
The Federal Reserve adopted the Federal Financial Institutions Examination
Council's ("FFIEC") updated rating system which assigns each financial
institution a confidential composite "CAMELS" rating based on an
8
evaluation and rating of six essential components of an institution's financial
condition and operations including capital adequacy, asset quality, management,
earnings, liquidity and sensitivity to market risk. For most institutions, the
FEIEC has indicated that market risk is rated based upon, but not limited to, an
assessment of the sensitivity of the financial institution's earnings or the
economic value of its capital to adverse changes in interest rates, foreign
exchange rates, commodity prices, or equity prices; management's ability to
identify, measure, monitor and control exposure to market risk; and the nature
and complexity of interest rate risk exposure arising from nontrading positions.
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.
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 and state member banks. 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 1% - 2%, if the institution has less than the highest regulatory rating. 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 Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), among other things, requires the federal banking agencies to take
"prompt corrective action" regarding depository institutions that do not meet
minimum capital requirements. FDICIA establishes five capital tiers: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." A bank's capital tier will
depend upon how its capital levels compare to various relevant capital measures
and certain other factors, as established by regulations.
All of the federal banking agencies have adopted regulations establishing
relevant capital measures and relevant capital levels. The relevant capital
measures are the Total Capital ratio, Tier 1 capital ratio, and the leverage
ratio. Under the regulations, a state member bank will be (i) well capitalized
if it has a Total Capital ratio of 10% or greater, a Tier 1 capital ratio of 6%
or greater, a Tier 1 leverage ratio of 5% or greater and is not subject to any
written agreement, order, capital directive or prompt corrective action
directive by a federal bank regulatory agency to meet and maintain a specific
capital level for any capital measure, (ii) adequately capitalized if it has a
Total Capital ratio of 8% or greater, a Tier 1 capital ratio of 4% or greater,
and a leverage ratio of 4% or greater (3% in certain circumstances), (iii)
undercapitalized if it has a Total Capital ratio of less than 8%, a Tier 1
capital ratio of less than 4% (3% in certain circumstances), and a leverage
ratio of less than 4%, (iv) significantly undercapitalized if it has a Total
Capital ratio of less than 6%, a Tier 1 capital ratio of less than 3% and a
leverage ratio of less than 3% or (v) critically undercapitalized if its
tangible equity is equal to or less than 2% of average quarterly tangible
assets.
9
As of December 31, 2002, the consolidated capital ratios of the Company and
the Bank were as follows:
Regulatory
Minimum Company Bank
Tier 1 leverage ratio 3.0-5.0% 4.94% 5.99%
Tier 1 Risk-based capital ratio 4% 6.09% 7.68%
Total Risk-based capital ratio 8% 7.81% 8.98%
As of December 31, 2002, both the Company and the Bank were "adequately
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 merge 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 that 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.
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 - The Company is
a legal entity separate and distinct from the Bank. Transactions between the
Bank and its affiliates, including the Company, are subject to Sections
10
23A and 23B of the Federal Reserve Act. Section 23A defines "covered
transactions," which include extensions of credit, and limits a bank's covered
transactions with any affiliate to 10% of such bank's capital and surplus. All
covered and exempt transactions between a bank and its affiliates must be on
terms and conditions consistent with safe and sound banking practices, and banks
and their subsidiaries are prohibited from purchasing low-quality assets from
the bank's affiliates. Finally, Section 23A requires that all of a bank's
extensions of credit to an affiliate be appropriately secured by acceptable
collateral, generally United States government or agency securities. 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 - Each financial institution is assigned to one
of three capital groups - well capitalized, adequately capitalized or
undercapitalized - and further assigned to one of three subgroups within a
capital group, on the basis of supervisory evaluations by the institution's
primary federal and, if applicable, state regulators and other information
relevant to the institution's financial condition and the risk posed to the
applicable insurance fund. The actual assessment rate applicable to a particular
bank will, therefore, depend in part upon the risk assessment classification so
assigned to the bank by the FDIC.
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.
Community Reinvestment Act - The Company and the Bank are subject to the
Community Reinvestment Act ("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. The CRA does not establish
specific lending requirements or programs for financial institutions, nor does
it limit an institution's discretion to develop the types of products and
services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires a bank's primary federal regulator, in
connection with its examination of the institution, to assess the institution's
record of assessing and meeting the credit needs of the community served by that
institution, including low- and moderate-income neighborhoods. These regulatory
assessments are utilized by the Federal Reserve 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.
Current CRA Regulations rate banks based on their actual performance in
meeting community credit needs. CRA performance is evaluated by the Federal
Reserve, the Bank's primary federal regulator, using a lending test, or
investment test, and a service test. The Federal Reserve also will consider: (i)
demographic data about the community; (ii) the bank's capacity and constraints;
(iii) the bank's product offerings and business strategy; and (iv) data on the
prior performance of the bank and similarly-situated lenders. As a result of the
GLBA, CRA agreements with private parties must be disclosed and annual CRA
reports must be made to a bank's primary federal regulator. A bank holding
company will not be permitted to become a financial holding company and no new
activities authorized under GLBA may be commenced by a holding company or by a
bank financial subsidiary if any of its bank subsidiaries received less than a
"satisfactory" CRA rating in its latest CRA examination.
11
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.
LEGISLATIVE AND REGULATORY CHANGES
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 regulation 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.
12
STATISTICAL DISCLOSURE
Statistical and other information regarding the following items are set forth in
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" in the pages indicated below. Page(s)
Loan Portfolio...............................................................................................20
Selected Loan Maturity and Interest Rate Sensitivity.........................................................21
Securities Portfolio.........................................................................................21
Securities Portfolio Maturity Schedule.......................................................................22
Maturities of Large Time Deposits............................................................................23
Maturities of Long-Term Debt.................................................................................24
Return on Equity and Assets..................................................................................25
Capital Adequacy Ratios......................................................................................25
Interest Rate Sensitivity Analysis...........................................................................27
Average Balances, Interest Income/Expense and Yields/Rates...................................................29
Rate/Volume Variance Analysis................................................................................30
Summary of Loan Loss Experience..............................................................................32
Allocation of Loan Loss Reserve..............................................................................33
Nonperforming Assets.........................................................................................34
Noninterest Income...........................................................................................34
Noninterest Expenses.........................................................................................35
Interest Rate Risk...........................................................................................36
13
ITEM 2. PROPERTIES
Our headquarters are located at 1323 Stratford Road, 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 $635,667 in 2002.
ITEM 3. LEGAL PROCEEDINGS
The Bank has received demand letters from two former directors, officers
and employees of the Bank. The Bank terminated such officers in November 2002
for cause, as such term is defined by their respective employment contracts. One
officer has claimed monetary compensation, stock options and attorneys' fees,
while the second officer has claimed monetary compensation, as well as stock
options and payment of country club dues for two years following the date of his
termination. The Bank maintains that it terminated each of these officers for
"cause" and that it is under no obligation to pay them any additional
compensation. On March 14, 2003, one of these officers filed a lawsuit against
the Bank in the Circuit Court for Morgan County, Alabama, alleging breach of
contract and demanding certain payments and benefits allegedly due under his
employment agreement. The Bank intends to vigorously defend this and any other
action brought against the Bank by either of the officers, and does not believe
that the final outcome will have a material impact on the Bank or the Company.
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 other 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. Therefore, no reliable information
is available as to trades of the Company's common stock, or as to the prices at
which such common stock has traded.
Management has reviewed the limited information available to the Company as
to the ranges at which shares of the Company's common stock has been sold. 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.
Fiscal 2002 Fiscal 2001
----------------------- -----------------------
High Low High Low
--------- --------- ---------- ---------
First Quarter $ 12.50 $ 8.00 $ 13.00 $ 12.50
Second Quarter $ 12.00 $ 10.00 $ 13.00 $ 12.00
Third Quarter $ 10.50 $ 9.50 $ 13.00 $ 12.00
Fourth Quarter $ 9.50 $ 9.50 $ 12.50 $ 8.00
As of December 31, 2002, the Company had approximately 1,116 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
14
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.
In addition, the Bank is currently prohibited from paying dividends to the
Company without the prior approval of the Superintendent of the State Banking
Department. 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.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2002 regarding
compensation plans (including individual compensation arrangements) under which
common stock of the Company is authorized for issuance.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities
remaining available for
Number of Securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
warrants and rights rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity Compensation
Plans Approved by
Security Holders 3,239,016 3.75 --
Equity Compensation
Plans not Approved by
Security Holders -- -- --
Total 3,239,016 3.75
See Note 13 to the Consolidated Financial Statements for information regarding
the material features of the above plans. Each of the above plans provides that
the number of shares with respect to which options may be granted, and the
number of shares of Company Common Stock subject to an outstanding option, shall
be proportionately adjusted in the event of a subdivision or consolidation of
shares or the payment of a stock dividend on Company Common Stock, and the
purchase price per share of outstanding options shall be proportionately
revised.
15
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 judgments.
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, and Fowler,
P.C., independent auditors, who were engaged to express an opinion as to the
fairness of presentation of such financial statements.
/s/ Thomas E. Hemmings /s/ Harold B. Jeffreys
- --------------------------- ---------------------------
Thomas E. Hemmings Harold B. Jeffreys
Chief Financial Officer Interim President and
Chief Executive Officer
16
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,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ---------- ----------- ----------
(Dollars in thousands except per share data)
Earnings Summary:
Interest income..................................$ 41,939 $ 44,253 $ 35,660 $ 17,248 $ 9,383
Interest expense................................. 21,742 28,594 22,018 9,874 5,399
Net interest income.............................. 20,197 15,659 13,642 7,374 3,984
Provision for loan losses........................ 29,469 3,602 3,389 1,808 828
Net interest income (loss) after
provision for loan losses...................... (9,272) 12,057 10,253 5,566 3,156
Noninterest income............................... 2,275 1,556 1,039 642 397
Noninterest expense.............................. 15,303 10,023 8,113 4,952 2,937
Income (loss) before income taxes................ (22,300) 3,590 3,179 1,256 616
Income taxes..................................... (7,887) 1,224 991 395 197
Net income (loss)................................ (14,413) 2,366 2,188 861 419
Per Common Share Data:
(Retroactively adjusted for effects of stock splits)
Net income (loss) - basic........................$ (1.65) $ 0.28 $ 0.26 $ 0.12 $ 0.07
Net income (loss) - diluted...................... (1.40) 0.23 0.22 0.11 0.07
Cash dividends declared per common share......... 0.00 0.00 0.00 0.00 0.00
Selected Average Balances:
Total assets.....................................$ 617,255 $ 559,921 $ 401,615 $ 213,101 $ 114,834
Total loans...................................... 544,079 489,897 333,340 172,418 83,217
Securities....................................... 39,961 26,662 23,183 19,405 15,786
Earning assets................................... 605,723 546,517 389,795 204,643 109,675
Deposits......................................... 544,598 496,283 348,819 180,072 94,796
Stockholders' equity............................. 35,296 34,178 29,910 19,062 11,606
Shares outstanding (thousands) (split adjusted).. 8,717 8,485 8,317 7,226 5,616
Selected Period-End Balances:
Total assets.....................................$ 592,942 $ 568,291 $ 471,458 $ 297,952 $ 167,378
Total loans...................................... 523,850 505,381 422,135 244,620 116,723
Securities....................................... 36,762 25,894 26,846 19,969 21,723
Earnings assets.................................. 587,734 550,865 458,478 287,307 155,068
Deposits......................................... 525,631 504,310 421,244 249,032 137,001
Stockholders' equity............................. 23,703 36,124 33,499 21,920 19,009
Shares outstanding (thousands) (split adjusted).. 8,821 8,515 8,476 7,581 7,192
Selected Ratios:
Return on average equity......................... (4.08)% 6.92% 7.32% 4.52% 3.61%
Return on average assets......................... (2.34) 0.42 0.54 0.40 0.36
Net interest margin (taxable equivalent)......... 3.35 2.88 3.52 3.63 3.65
Allowance for loan losses to loans............... 5.15 1.20 1.20 1.24 1.20
Net charge-offs to average loans................. 1.57 0.53 0.41 0.10 0.15
Average equity to average assets................. 5.72 6.10 7.45 8.95 10.11
17
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 ten 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
As previously reported in the Form 10-Q filings of the Company for the
quarterly periods ended June 30, 2002 and September 30, 2002, a targeted,
limited scope review of the loan portfolio of the Bank by regulatory authorities
identified certain assets of the Bank that the regulatory authorities believed
should be classified. In connection with such review, the Company and the Bank
took steps to charge off or establish additional loan loss reserves for
specified assets and to adjust the Bank's levels of loan loss provisions.
The regulatory authorities charged with overseeing the Bank's operations
have outlined certain corrective actions to be taken by the Bank to address
concerns identified by the regulatory authorities. The Bank has agreed that it
will not declare or pay any cash dividends without seeking the prior approval of
the regulatory authorities. In addition, the Bank agreed to hire and retain
certain personnel who would be given specific written authority by the Board of
Directors to implement sound lending, recordkeeping and accounting practices.
The Bank is developing an educational program for board members and has created
a written review of the Bank's staffing requirements. Both the Board education
program and the written review of staffing requirements are required to be
submitted to the regulatory authorities for their review and comment.
The Bank also agreed to meet certain capital ratios. By December 31, 2002,
management of the Company and the Bank agreed to take steps to increase the
Bank's Tier 1 leverage ratio to 7.5 percent and to be "well-capitalized" as
defined by the FDIC. The Bank's Tier 1 leverage ratio must be no less than 8
percent by March 31, 2003, and the Bank must maintain a ratio of at least 8
percent until a reduction is approved by the regulatory authorities. The Bank
did not achieve a Tier 1 leverage ratio of 7.5 percent as of December 31, 2002,
and we believe the Bank may not achieve a Tier 1 leverage ratio of 8 percent if
the Bank is unable to acquire additional capital. Should the Tier 1 leverage
ratio fall below the minimum specified levels, the Bank must notify the
regulatory authorities and take steps to increase capital sufficient to meet the
required ratios within 30 days.
Management of the Company and the Bank are focused on addressing asset
quality, loan and audit issues. The Bank has charged off the balance of any
assets classified Loss and one-half of those assets classified Doubtful in any
official report of examination by any of the regulatory authorities. The Bank
has also reduced the balance of assets classified Substandard or Doubtful, and
has refused to extend additional credit to any borrower obligated to the Bank on
any extension of credit that has been charged off by the Bank or classified Loss
or Doubtful as long as such credit remains uncollected. In addition, the Bank
has commenced a review of its existing written loan policies and has adopted new
internal loan review systems to address problems with the Bank's loan portfolio.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
general practices within the banking industry. Following is a
18
description of the accounting policies applied by the Company which are deemed
"critical." In determining which accounting policies are "critical" in nature,
the Company has identified the policies that require significant judgment or
involve complex estimates. The application of these policies has a significant
impact on the Company's financial statements. Financial results could differ
significantly if different judgments or estimates are applied.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan losses
charged to operations. Loans are charged against the allowance for loan losses
when management believes that the collection of principal is unlikely.
Subsequent recoveries are added to the allowance. Management's evaluation of the
adequacy of the allowance for loan losses is based on a formal analysis which
assesses the risk within the loan portfolio. This analysis includes
consideration of historical performance, current economic conditions, level of
nonperforming loans, loan concentrations, and review of certain individual
loans. Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions to the allowance for loan losses may be necessary based on changes in
economic conditions and the results of management's ongoing review of the loan
portfolio. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the bank's allowances for loan
losses. Such agencies may require the bank to recognize additions to the
allowance for loan losses based on their judgments.
SUMMARY
Our net loss for 2002 was ($14,413,000), a 709.2% decrease from 2001 which
was $2,366,000. Net income for the year 2001 represented a 8.2% increase from
2000 net income of $2,188,000. Our basic earnings (loss) per common share for
2002, 2001 and 2000 were $(1.65), $0.28 and $0.26, respectively. Pretax loss for
2002 decreased $25,890,000 or 721.2% from 2001 and pretax income for 2001
increased $411,000 or 12.9% from 2000.
The decrease in net income for 2002 is primarily attributable to an
increase in provision for loan losses, and retirement costs associated with the
retirement of the Company's former CEO.
EARNING ASSETS
Our total assets were $592,942,000 at December 31, 2002, an increase of
$24,651,000, or 4.3% from $568,291,000 as of December 31, 2001. The increase in
total assets primarily related to an increase in securities available for sale
of $10,868,000 and other assets, primarily deferred tax assets, of $9,169,000.
The increase in total assets was funded primarily by an increase in deposits.
Our average earning assets were approximately $605,723,000 in 2002,
representing an increase of $59,206,000 or 10.8% over 2001 Average earning
assets in the year 2001 were approximately $546,517,000, representing an
increase of $156,722,000 or 40.2% over the 2000 amount of $389,795,000.
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,
----------------------------------------------
2002 2001 2000
------------- ------------- --------------
(In thousands)
Interest-bearing deposits with banks............................. $ 98 $ 326 $ 817
Securities....................................................... 36,762 25,894 26,846
Federal funds sold............................................... 14,681 6,716 8,680
Mortgage loans held-for-sale..................................... 12,343 12,548 --
Loans:
Real estate................................................... 371,714 344,749 296,025
Commercial and other.......................................... 152,136 160,632 126,110
------------- ------------- --------------
Total loans................................................. 523,850 505,381 422,135
------------- ------------- --------------
Interest-earning assets ......................................... $ 587,734 $ 550,865 $ 458,478
============= ============= ==============
19
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 $54,182,000 or 11.1% from year-end 2002 to
2001. The increase in loans was a result of strong loan demand. Loan growth for
2002 was funded primarily through deposits. The most significant loan increase
came from real estate mortgage loans which increased approximately $36,832,000
or 13.4% over the 2001 year-end amount.
Our average loans increased $156,557,000 or 47.0% from year-end 2000 to
2001. The increase in loans was a result of continued loan demand. Loan growth
for the year 2001 was funded primarily through deposits. The most significant
loan increase came from commercial, financial and agricultural loans which
increased by $32,951,000 or 31.3% over 2000.
The Loan Portfolio table presents the classifications of loans by major
category at December 31, 2002, and for each of the preceding four years.
Loan Portfolio
December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------ ------------------ ------------------ ------------------ -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Commercial,
financial and
agricultural............... $132,237 25.24% $138,344 26.71% $105,393 24.97% $66,144 27.04% $45,105 38.64%
Real estate - construction.. 60,206 11.49 70,073 13.53 90,603 21.46 49,432 20.21 12,583 10.78
Real estate - mortgage....... 311,508 59.47 274,676 55.46 205,422 48.66 112,643 46.05 45,320 38.83
Consumer..................... 19,899 3.80 22,288 4.30 20,717 4.91 16,410 6.70 13,658 11.70
Other........................ -- 0.00 -- 0.00 -- 0.00 -- 0.00 57 0.05
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
.............................. 523,850 100.00% 505,381 100.00% 422,135 100.00% 244,629 100.00% 116,723 100.00%
======== ======== ======== ======== ========
Allowance for loan losses.... (26,991) (6,074) (5,065) (3,036) (1,402)
Unearned income.............. -- -- -- (9) --
-------- -------- -------- -------- --------
Net loans.................... $496,859 $499,307 $417,070 $241,584 $115,321
======== ======== ======== ======== ========
20
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........ $ 71,571 $ 51,850 $ 8,816 $ 132,237 $ 45,839 $ 14,827
Real estate - construction. 45,032 12,735 2,439 60,206 6,009 9,165
----------- ----------- ----------- ----------- ------------- ------------
Total................. $ 116,603 $ 64,585 $ 11,255 $ 192,443 $ 51,848 $ 23,992
=========== =========== =========== =========== ============= ============
SECURITIES PORTFOLIO
Our securities portfolio increased by $10,868,000 or 42.0% from the year
2001 to 2002. The balance in the securities portfolio increased as a result of
deposit growth in 2002. Our securities portfolio decreased by $952,000 or 3.6%
from 2000 to 2001 as a result of strong loan demand in 2001.
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 2002 and 2001. At year-ends 2002 and 2001, unrealized losses in the
Available-for-Sale portfolio amounted to $94,509 and $94,581, respectively.
At year-ends 2002 and 2001, obligations of the United States Government or
its agencies and obligations of states and political subdivisions represented
approximately 63.1% and 73.0%, 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,
----------------------------------------------
2002 2001 2000
------------- ------------- --------------
(In thousands)
Available-for-Sale
U.S. government and agencies................................. $ -- $ 15,697 $ 18,450
Mortgage-backed securities................................... 23,208 617 1,020
Asset-backed securities...................................... -- 4,474 1,986
State and municipal.......................................... 1,330 2,590 2,300
Corporate debt securities.................................... 10,588 1,190 1,244
Equity securities............................................ 1,636 1,326 1,846
------------- ------------- --------------
Total...................................................... $ 36,762 $ 25,894 $ 26,846
============= ============= ==============
21
The maturities and weighted average yields of the investments in the 2002
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)
Mortgage-backed securities.... $ 32 -- $ 2,517 3.63% $ 9,371 4.35% 10,912 4.38%
State and municipal (1)....... -- -- -- -- -- -- 1,294 5.27
Corporate debt securities..... -- -- 2,433 3.99 -- -- 8,472 6.86
Equity securities............. -- -- -- -- -- -- 1,636 7.74
-------- -------- -------- ---------
$ 32 -- $ 4,950 3.81 $ 9,371 4.35 $ 22,314 5.62
======== ======== ======== =========
(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,
2002, 2001 and 2000 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 $48,315,000 or 9.7% from the year 2001 to 2002.
Total deposits increased $21,321,000 or 4.2% from 2001 to 2002. The largest area
of growth in 2002 was in interest bearing demand accounts, which increased
$7,417,000 or 13.8%. From 2001 to 2002, other time deposits of more than
$100,000 increased $4,990,000 or 3.5%. Savings deposits increased $3,582,000 or
7.4%, and time deposits of less than $100,000 increased $4,616,000 or 1.9%. From
year-end 2001 to year-end 2002, total non-interest bearing deposits increased
$716,000 or 3.4%. Deposit growth has been generated primarily outside of our
local markets.
Our average deposits rose $147,464,000 or 42.3% from 2000 to 2001. Total
deposits increased $83,066,000 or 19.7% 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 16.1%. From 2000 to 2001, other time deposits of more than
$100,000 increased $7,126,000 or 5.3%, savings deposits increased $13,501,000 or
38.9%, and interest bearing demand accounts increased $19,570,000 or 57.2%. From
year-end 2000 to year-end 2001, total non-interest bearing deposits increased
$9,642,000 or 82.7%. Deposit growth has been generated primarily in our local
markets.
22
The following table sets forth our deposit structure at December 31, of
each of the last three years.
December 31,
----------------------------------------------
2002 2001 2000
------------- ------------- --------------
(In thousands)
Noninterest-bearing deposits:
Individuals, partnerships and corporations.................... $ 22,012 $ 21,296 $ 11,374
U.S. Government and states and political subdivisions......... -- -- --
Certified and official checks................................. -- -- 280
------------- ------------- --------------
Total noninterest-bearing deposits.......................... 22,012 21,296 11,654
------------- ------------- --------------
Interest-bearing deposits:
Interest-bearing demand accounts.............................. 61,193 53,776 34,206
Saving accounts............................................... 51,769 48,187 34,686
Certificates of deposit, less than $100,000................... 244,447 239,831 206,604
Certificates of deposit, more than $100,000................... 146,210 141,220 134,094
------------- ------------- --------------
Total interest-bearing deposits............................. 503,619 483,014 409,590
------------- ------------- --------------
Total deposits.............................................. $ 525,631 504,310 $ 421,244
============= ============= ==============
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,
------------------------------------------------------------------------
2002 2001 2000
--------------------- ---------------------- -----------------------
Amount Rate Amount Rate Amount Rate
---------- --------- ---------- --------- ----------- ---------
(Dollars in thousands)
Noninterest-bearing deposits............. $ 21,832 .00% $ 16,975 0.00% $ 13,116 0.00%
Interest-bearing demand deposits......... 50,622 1.61 39,299 3.10 28,895 3.74
Savings deposits......................... 64,773 1.92 43,079 3.17 28,664 5.16
Time deposits............................ 407,370 4.33 396,930 6.09 278,144 6.58
---------- --------- ---------- --------- ------------ ---------
Total deposits........................ $ 544,597 3.62% $ 496,283 5.39% $ 348,819 5.98%
========== ========== ============
At December 31, 2002, time deposits greater than $100,000 aggregated
approximately $146,209,000. The following table indicates, as of December 31,
2002, 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........................................................... $ 19,951
Over three through six months.................................................. 35,112
Over six through twelve months................................................. 45,821
Over twelve months............................................................. 45,325
-------------
Total........................................................................ $ 146,209
=============
Borrowed funds of $39,650,000 as of December 31, 2002, consist of long-term
Federal Home Loan Bank advances, an advance from a pooled trust preferred
private placement for subordinated debentures and a short-term borrowing from a
commercial bank. We had $13,500,000 in available lines to purchase Federal
Funds, on an unsecured basis, from commercial banks. At December 31, 2002, 2001
and 2000, we had no funds advanced against these lines. We are also approved to
borrow up to $65,223,000 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
investment security portfolios. The unused portion of these available funds
amounted to $42,223,000 at year-end 2002 and $46,000,000 at year-end 2001.
23
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, 2002.
MATURITIES OF LONG-TERM DEBT
(In thousands)
2003 2004 2005 2006 2007
--------- --------- --------- --------- ---------
Interest on indebtedness......................... $ 1,986 $ 1,986 $ 1,986 $ 1,986 $ 1,986
Repayment of principal........................... -- -- -- -- --
--------- --------- --------- --------- ---------
$ 1,986 $ 1,986 $ 1,986 $ 1,986 $ 1,986
========= ========= ========= ========= =========
CAPITAL RESOURCES
Stockholders' equity decreased $12,421,000 or 34.4% to $23,703,000 as of
December 31, 2002. The decrease in stockholders' equity was primarily
attributable to the net loss for the year. Stockholders' equity increased
$2,625,000 or 7.8% to $36,124,000 as of December 31, 2001. Stockholders' equity
increased $11,579,000 or 52.8% to $33,499,000 as of December 31, 2000. The
increases in stockholders' equity in 2001 and 2000 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").
Under the terms of the indenture, we may elect to defer payments of
interest for up to ten semiannual payment periods. For the duration of such
deferral period, we are restricted from paying dividends to shareholders or
paying debt that is junior to the 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.
24
The table below summarizes these and other key ratios for us for each of
the last three years.
RETURN ON EQUITY AND ASSETS
2002 2001 2000
----------- ----------- -----------
Return on average assets........................................... (2.34)% 0.42% 0.54%
Return on average common equity.................................... (4.08) 6.92 7.32
Dividend payout ratio.............................................. 0.00 0.00 0.00
Average common shareholders' equity to average
assets ratio.................................................... 5.72 6.10 7.45
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
1 and Tier 2. Under risk-based capital requirements, Total Capital consists of
Tier 1 capital which is generally common stockholders' equity less goodwill and
Tier 2 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 1 and 8% total risk-based
capital. In 1990 regulators added a leverage computation to the capital
requirements, comparing Tier 1 capital to total average assets less goodwill.
The table below illustrates our regulatory capital ratios under federal
guidelines at December 31, 2002, 2001 and 2000:
CAPITAL ADEQUACY RATIOS
Statutory Years ended December 31,
----------------------------------------
Minimum 2002 2001 2000
------------ ----------- ----------- -----------
(Amounts in thousands)
Tier 1 Capital $ 30,749 $ 46,180 $ 33,658
Tier 2 Capital 8,687 6,074 5,065
----------- ----------- -----------
Total Qualifying Capital $ 39,436 $ 52,254 $ 38,723
=========== =========== ===========
Risk Adjusted Total Assets (including
off-balance-sheet exposures) $ 505,129 $ 488,824 $ 413,536
=========== =========== ===========
Adjusted quarterly average assets $ 650,604 $ 587,901 $ 463,464
=========== =========== ===========
Tier 1 Capital Ratio 4.00% 6.09% 9.45% 8.14%
Total Capital Ratio 8.00 7.81 10.69 9.36
Leverage Ratio 4.00 4.94 7.86 7.26
On December 31, 2001 and 2000, the Company and the Bank each exceeded the
regulatory minimums and together qualified as a well capitalized institution
under the regulations. On December 31, 2002, the Bank qualified as an adequately
capitalized institution under the regulations.
25
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, 2002, we had $13,500,000 of federal funds available, $850,000 available
under the short-term borrowing and a line of credit of approximately $65,223,000
from The Federal Home Loan Bank of which approximately $42,223,000 was available
and unused. 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.
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 is 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.
26
The following table shows interest sensitivity gaps for different intervals
as of December 31, 2002.
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............................ $ 53,911 $ 39,059 $ 88,489 $ 256,350 $ 70,247 $ 508,056
Mortgage loans held-for-sale..... 12,343 -- -- -- -- 12,343
Securities available-for-sale.... 32 -- -- 4,516 32,214 36,762
Time deposits in other banks..... 98 -- -- -- -- 98
Federal funds sold............... 14,681 -- -- -- -- 14,681
----------- ----------- ----------- ----------- ----------- -----------
81,065 39,059 88,489 260,866 102,461 571,940
Interest-bearing liabilities (2)
Demand deposits (3).............. 20,398 20,398 20,397 -- -- 61,193
Savings deposits (3)............. 17,256 17,256 17,257 -- -- 51,769
Time deposits.................... 16,417 34,183 217,137 122,920 -- 390,657
Other debt....................... -- -- 6,650 -- 33,000 39,650
----------- ----------- ----------- ----------- ----------- -----------
54,071 71,837 261,441 122,920 33,000 543,269
----------- ----------- ----------- ----------- ----------- -----------
Interest sensitivity gap......... $ 26,994 $ (32,778) $ (172,952) $ 137,946 $ 69,461 $ 28,671
=========== ============ ============ =========== =========== ===========
Cumulative interest
sensitivity gap.................. $ 26,994 $ (5,784) $ (178,736) $ (40,790) $ 28,671
=========== ============ ============ =========== ==========
Ratio of interest-earning assets to
interest-bearing liabilities..... 1.50 .55 .34 2.13 3.11
Cumulative ratio................... 1.50 .96 .54 .92 1.06
Ratio of cumulative gap to total
interest-earning assets.......... .05 (.01) (.30) (.07) .05
(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 negatively affected in the short-term because 21.0% of earning
assets reprice within 90 days and only 23.2% of interest-bearing liabilities
reprice during the same period. As seen in the preceding table, for the first 90
days of repricing opportunity there is an excess of interest-bearing liabilities
over earning assets of approximately $5.8 million. For the first 365 days,
interest-bearing liabilities exceed earning assets by $178.7 million. During
this one-year time frame, 71.3% of all interest-bearing liabilities will reprice
compared to 36.5% 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.
27
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 $4,538,000 or 29.0% to $20,197,000 from
2001 to 2002. This increase in net interest income is due primarily to a
decrease in interest paid on deposits. Our net interest income increased
$2,017,000 or 14.8% to $15,659,000 from 2000 to 2001. The increase in the net
interest income for this period is primarily due to a consistent and significant
increase in total loans. Interest income was $41,939,000 in 2002, which
represented a decrease of $2,314,000 or 5.2% over 2001. Interest income was
$44,253,000 in 2001, which represented an increase of $8,593,000 or 24.1% over
2000. Interest and fee income produced by the loan portfolio increased
$9,800,000 or 30.8% in 2001 from 2000. Interest and fee income produced by the
loan portfolio decreased $1,712,000 or 4.1% in 2002 from 2001. Interest income
on securities increased $151,000 or 9.6% in 2002 from 2001. This change is
primarily due to an increase in the size of the investment portfolio. Interest
income on securities decreased $81,000 or 4.7% 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
other than loans and securities decreased $754,000 or 69.8% from 2001 to 2002
and decreased by $1,125,000 or 51.0% in 2000 from 2001.
Total interest expense decreased by $6,853,000 or 24.0% in 2002 from 2001.
This reduction is primarily due to a decline in the rates paid on deposits.
Interest expense on deposits decreased $7,035,000 or 26.3% in 2002 from 2001.
Total interest expense increased by $6,576,000 or 29.9% 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 28.2% from 2000 to 2001.
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 increased 47 basis points in 2002 from 2.88% at year-end
2001 to 3.35% at year-end 2002. The net interest margin decreased 64 basis
points in 2001 from 3.52% at year-end 2000 to 2.88% at year-end 2001. The yield
on earning assets decreased 117 basis points to 6.94% in 2002 from 8.11% in 2001
and decreased 106 basis points to 8.11% in 2001 from 9.17% in 2000. The net cost
of funds, defined as interest expense divided by average earning assets,
decreased 164 basis points to 3.59% at year-end 2002 from 5.23% at year-end 2001
and decreased 42 basis points to 5.23% at year-end 2001 from 5.65% in 2000.
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 increased 60 basis points to 3.03% from 2001 to 2002 and decreased 55
basis points to 2.43% from 2000 to 2001, due to effects of the overall economic
environment and unprecedented interest rate moves by the Federal Reserve
primarily in 2001.
28
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,
2002 2001 2000
------------------------------- ------------------------------- -------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates Balance Expense Rates
--------- --------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Assets
Earning assets:
Loans, net of
unearned income (1). $ 544,079 $ 39,897 7.33% $ 489,897 $ 41,610 8.49% $ 333,340 $ 31,810 9.54%
Securities:
Taxable.............. 37,513 1,603 4.27 24,308 1,460 6.01 20,852 1,542 7.39
Tax exempt........... 2,448 202 8.25 2,354 189 8.03 2,331 188 8.07
--------- --------- --------- --------- --------- ---------
Total securities... 39,961 1,805 4.52 26,662 1,649 6.18 23,183 1,730 7.46
Time deposits in
other banks......... 161 6 3.73 446 25 5.61 5,920 365 6.17
Federal funds sold... 21,522 320 1.49 29,512 1,056 3.58 27,352 1,841 6.73
--------- --------- --------- --------- --------- ---------
Total interest-
earning assets (2) 605,723 42,028 6.94 546,517 44,340 8.11 389,795 35,746 9.17
Noninterest-earning assets:
Cash and due from banks 4,452 5,410 6,744
Premises and equipment 6,753 6,220 4,536
Accrued interest
and other assets... 8,915 7,541 4,582
Allowance for loan losses (8,588) (5,767) (4,042)
--------- --------- ---------
Total assets....... $ 617,255 $ 559,921 $ 401,615
========= ========= =========
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Demand deposits...... $ 50,622 $ 854 1.69% $ 39,299 $ 1,219 3.10% $ 28,895 $ 1,080 3.74%
Savings deposits..... 64,773 1,245 1.92 43,079 1,367 3.17 28,664 1,478 5.16
Time deposits........ 407,371 17,618 4.32 396,930 24,166 6.09 278,144 18,308 6.58
--------- --------- --------- --------- --------- ---------
Total deposits..... 522,766 19,717 3.77 479,308 26,752 5.58 335,703 20,866 6.22
Other short-term
borrowings........... 928 36 3.88 53 2 3.77 27 1 3.70
Long-term debt.......... 32,520 1,988 6.11 24,271 1,841 7.59 19,910 1,151 5.78
--------- --------- --------- --------- --------- ---------
Total interest-
bearing liabilities 556,214 21,741 3.91 503,632 28,595 5.68 355,640 22,018 6.19
--------- --------- ---------
Noninterest-bearing liabilities:
Demand deposits...... 21,832 16,975 13,116
Accrued interest and
other liabilities.. 3,913 5,136 2,949
Stockholders' equity. 35,296 34,178 29,910
--------- --------- ---------
Total liabilities
and stockholders'
equity........... $ 617,255 $ 559,921 $ 401,615
========= ========= =========
Net interest income/net
interest spread...... 20,287 3.03% 15,745 2.43% 13,728 2.98%
========= ========= =========
Net yield on earning assets 3.35 2.88% 3.52%
Taxable equivalent adjustment:
Loans................ 21 22 22
Investment securities 69 64 64
--------- --------- ---------
Total taxable equivalent
adjustment........ 90 86 86
--------- --------- ---------
Net interest income..... $ 20,197 $ 15,659 $ 13,642
========= ========= =========
(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.
29
RATE/VOLUME VARIANCE ANALYSIS
Taxable Equivalent Basis
Average Volume Change in Volume Average Rate
------------------------------- ------------------------- ------------------------------
2002 2001 2000 2002-2001 2001-2000 2002 2001 2000
--------- --------- --------- ----------- ----------- -------- -------- --------
(Dollars in thousands)
Earning assets:
Loans, net of
unearned income......... $ 544,079 $ 489,897 $ 333,340 $ 54,182 $ 156,557 7.33% 8.49% 9.54%
Securities:
Taxable................. 37,513 24,308 20,852 13,205 3,456 4.27 6.01 7.39
Tax exempt.............. 2,448 2,354 2,331 94 23 8.25 8.03 8.07
--------- --------- --------- ----------- -----------
Total securities...... 39,961 26,662 23,183 13,299 3,479 4.52 6.18 7.46
--------- --------- --------- ----------- -----------
Interest-bearing deposits
with other banks........ 161 446 5,920 (285) (5,474) 3.73 5.61 6.17
Federal funds sold......... 21,522 29,512 27,352 (7,990) 2,160 1.49 3.58 6.73
--------- --------- --------- ----------- -----------
Total earning assets.. $ 605,723 $ 546,517 $ 389,795 $ 59,206 $ 156,722 6.94 8.11 9.17
========= ========= ========= =========== ===========
Interest-bearing liabilities:
Deposits:
Demand ................. $ 50,622 $ 39,299 $ 28,895 $ 11,323 $ 10,404 1.69 3.10 3.74
Savings................. 64,773 43,079 28,664 21,694 14,415 1.92 3.17 5.16
Time.................... 407,371 396,930 278,144 10,441 118,786 4.32 6.09 6.58
--------- --------- --------- ----------- -----------
Total deposits........ 522,766 479,308 335,703 43,458 143,605 3.77 5.58 6.22
--------- --------- --------- ----------- -----------
Other short-term borrowings 928 53 27 875 26 3.88 3.77 3.70
Long-term borrowings....... 32,520 24,271 19,910 8,249 4,361 6.11 7.59 5.78
--------- --------- --------- ----------- -----------
Total interest-bearing
liabilities......... $ 556,214 $ 503,632 $ 355,640 $ 52,582 $ 147,992 3.91 5.68 6.19
========= ========= ========= =========== ===========
Net interest income/net interest spread 3.03 2.43 2.98
Net yield on earning assets 3.35 2.88 3.52
Net cost of funds.......... 3.59 5.23 5.65
Variance Attributed to (1)
Interest ---------------------------------------
Income/Expense Variance 2002 2001
---------------------------- ------------------------ ------------------ ------------------
2002 2001 2000 2002-2001 2001-2000 Volume Rate Volume Rate
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
(Dollars in thousands)
Earning assets:
Loans, net of
unearned income.... $ 39,897 $ 41,610 $ 31,810 $ (1,713) $ 9,800 $ 4,318 $ (6,031) $ 13,611 $ (3,811)
Securities:
Taxable.............. 1,603 1,460 1,542 143 (82) 645 (502) 232 (314)
Tax exempt........... 202 189 188 13 1 8 5 2 (1)
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Total securities... 1,805 1,649 1,730 156 (81) 653 (497) 234 (315)
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Interest-bearing deposits
with other banks..... 6 25 365 (19) (340) (14) (5) (336) (4)
Federal funds sold...... 320 1,056 1,841 (736) (785) (233) (503) 135 (920)
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Total earning assets 42,028 44,340 35,746 (2,312) 8,594 4,724 (7,036) 13,644 (5,050)
Interest-bearing liabilities:
Deposits:
Demand............... 854 1,219 1,080 (365) 139 288 (653) 345 (206)
Savings.............. 1,245 1,367 1,478 (122) (111) 536 (658) 583 (694)
Time certificates.... 17,618 24,166 18,308 (6,548) 5,858 623 (7,171) 7,309 (1,451)
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Total deposits..... 19,717 26,752 20,866 (7,035) 5,886 1,447 (8,482) 8,237 (2,351)
Other short-term borrowings 36 2 1 34 1 34 0 1 --
Long-term borrowings.... 1,988 1,841 1,151 147 690 550 (403) 284 406
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Total interest-bearing
liabilities........ 21,741 28,595 22,018 (6,854) 6,577 2,031 (8,885) 8,522 (1,945)
-------- -------- -------- ----------- ----------- -------- -------- -------- --------
Net interest income/net
interest spread...... $ 20,287 $ 15,745 $ 13,728 $ 4,542 $ 2,017 $ 2,693 $ 1,849 $ 5,122 $ (3,105)
======== ======== ======== =========== =========== ======== ======== ======== ========
(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.
30
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.
The allowance for loan losses for December 31, 2001 was $6,074,000. As a
result of events described in the "Recent Developments" section of this Form
10-K, this allowance for loan losses was increased by $2,000,000 during the
second quarter of 2002, and by $20,916,000, net of charge offs, for the year
ending December 31, 2002. As of December 31, 2002, the allowance for loan losses
on the Company's consolidated balance sheet totaled $26,990,594, which
Management believes is 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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31
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, 2002.
SUMMARY OF LOAN LOSS EXPERIENCE
2002 2001 2000 1999 1998
--------- ---------- -------- -------- ----------
(Dollars in thousands)
Allowance for loan losses at beginning of year....... $ 6,074 $ 5,065 $ 3,036 $ 1,402 $ 700
Loans charged off:
Commercial, financial and agricultural.......... 4,274 1,262 1,039 -- 15
Real Estate - mortgage.......................... 3,847 1,046 -- -- --
Consumer........................................ 704 387 416 195 136
--------- ---------- -------- -------- ----------
Total loans charged off...................... 8,825 2,695 1,455 195 151
--------- ---------- -------- -------- ----------
Recoveries on loans previously charged off:
Commercial, financial and agricultural.......... 201 33 66 -- --
Real Estate - mortgage.......................... 3 28 -- -- --
Consumer........................................ 69 41 29 21 25
--------- ---------- -------- -------- ----------
Total recoveries............................. 273 102 95 21 25
--------- ---------- -------- -------- ----------
Net loans charged off................................ 8,552 2,593 1,360 174 126
Provision for loan losses............................ 29,469 3,602 3,389 1,808 828
--------- ---------- -------- -------- ----------
Allowance for loan losses at end of period........... $ 26,991 $ 6,074 $ 5,065 $ 3,036 $ 1,402
========= ========== ======== ======== ==========
Loans, net of unearned income, at end of period...... $ 523,850 $ 505,381 $422,135 $244,620 $ 116,723
Average loans, net of unearned income,
outstanding for the period...................... 544,079 489,897 333,340 172,418 83,217
Ratio of net charge-offs to net average loans........ 1.57% 0.53% 0.41% 0.10% 0.15%
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 judgment as to potential losses and significant areas
of risk in the portfolio.
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32
Management allocated the allowance for loan losses to specific loan classes
as follows:
ALLOCATION OF LOAN LOSS RESERVE
December 31,
-----------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ----------------- ----------------- ----------------- -----------------
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..... $ 9,593 24.55%$ 1,622 26.71%$ 1,265 24.97%$ 821 27.04%$ 542 38.64%
Real estate ............ 16,881 71.78 4,191 68.99 3,552 70.13 2,012 66.26 696 49.61
Consumer................ 517 3.67 261 4.30 248 4.90 203 6.70 164 11.75
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
$ 26,991 100.00%$ 6,074 100.00%$ 5,065 100.00%$ 3,036 100.00%$ 1,402 100.00%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
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, 2002, of approximately
$29,782,000, $12,415,000 as of 2001, $6,188,000 as of 2000, $1,170,000 as of
1999 and $34,000 as of December 31, 1998.
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33
The following table presents information concerning outstanding balances of
nonperforming assets at December 31, 2002, 2001, 2000, 1999 and 1998.
NONPERFORMING ASSETS
December 31,
----------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- -------- -------- ---------
(Dollars in thousands)
Nonaccruing loans.................................... $ 15,794 $ 4,062 $ 617 $ 43 $ 11
Loans past due 90 days or more....................... 8,560 4,125 5,358 914 23
Restructured loans................................... -- -- -- -- --
--------- --------- -------- -------- --------
Total nonperforming loans....................... 24,354 8,187 5,975 957 34
Nonaccruing securities............................... -- -- -- -- --
Other real estate.................................... 5,428 4,228 213 213 --
--------- --------- -------- -------- --------
Total........................................... $ 29,782 $ 12,415 $ 6,188 $ 1,170 $ 34
========= ========= ======== ======== ========
Percentages:
Loans loss allowance to total
nonperforming assets........................ 90.63% 48.92% 81.85% 259.49% 4,123.53%
Total nonperforming loans to total loans
(net of unearned interest)...................... 4.65 1.62 1.42 0.39 0.03
Total nonperforming assets to total assets........... 5.02 2.18 1.31 0.39 0.02
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 $719,000 or 46.2% for the year ended December 31, 2002, as compared
to the year 2001. Total noninterest income increased by $517,000 or 49.8% for
the year ended December 31, 2001, as compared to 2000.
The table below sets forth the components of our noninterest income for the
periods indicated.
NONINTEREST INCOME
Years Ended December 31, Percent Change
------------------------------- --------------------------
2002 2001 2000 2002/2001 2001/2000
--------- -------- -------- --------------------------
(Dollars in thousands)
Service charges on deposits.......................... $ 1,018 $ 867 $ 745 17.42% 16.38%
Mortgage origination fees and
service release premiums........................ 831 544 224 52.76 142.86
Document prep fees................................... 149 86 40 73.26 115.00
Securities gains..................................... 262 24 -- 991.67 --
Other................................................ 15 35 30 (57.14) 16.67
--------- -------- --------
Total........................................... $ 2,275 $ 1,556 $ 1,039 46.21% 49.76%
========= ======== ========
34
NONINTEREST EXPENSES
Noninterest expense increased $5,281,000 or 52.7% from the year 2001 to
2002. Salaries and employee benefits increased $2,928,000 or 53.6%. Noninterest
expense increased $1,910,000 or 23.5% from 2000 to 2001. Salaries and employee
benefits increased $847,000 or 18.4% from 2000 to 2001. These increases are
attributed to the overall growth and expansion of the Company.
Occupancy and equipment expense increased $392,000 or 31.8% from the year
2001 to 2002 and increased $353,000 or 40.1% from 2000 to 2001.
The table below sets forth our noninterest expenses for the periods
indicated.
NONINTEREST EXPENSES
Years Ended December 31, 2002/2001 2001/2000
---------------------------------
Percent Percent
2002 2001 2000 Change Change
--------- --------- -------- --------- ---------
(Dollars in thousands)
Salaries and employee benefits....................... $ 8,388 $ 5,460 $ 4,613 53.63% 18.36%
Occupancy and equipment expense...................... 1,625 1,233 880 31.79 40.11
Professional fees.................................... 1,275 583 471 118.70 23.78
Charge off and collection expense.................... 533 139 24 283.45 479.17
Loan fees and services............................... 453 303 200 49.51 51.50
Data processing...................................... 421 190 136 121.58 39.71
Advertising.......................................... 401 336 291 19.35 15.46
Supplies............................................. 399 262 294 52.29 (10.88 )
Telephone............................................ 241 171 158 40.94 8.23
Postage.............................................. 142 125 90 13.60 38.89
Exam and assessment.................................. 138 122 72 13.11 69.44
Other................................................ 1,288 1,099 884 17.20 24.32
--------- --------- --------
Total........................................... $ 15,304 $ 10,023 $ 8,113 52.69% 23.54%
========= ========= ========
INCOME TAXES
Income tax expense decreased $9,111,000 or 644.4% to ($7,887,000) for the
year-end December 31, 2002 and increased $233,000 or 23.5% to $1,224,000 for the
year-end December 31, 2001. The decrease is the result of the net loss from
operations. The effective tax rate as a percentage of pretax income was 35.4% in
2002, 34.1% in 2001 and 31.2% in 2000. 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.
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.
35
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, 2002, our simulation analysis reflected that our
earnings are at greatest risk in a declining interest rate environment.
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
One Year Time Horizon
Estimated Repricing Amounts
Down Up Down Up
1 Percent 1 percent 2 Percent 2 Percent
----------- ----------- ----------- -----------
RATE SENSITIVE ASSETS:
Loans............................................. $ 322,314 $ 308,279 $ 331,671 $ 303,601
Deposits in banks................................. 93 93 93 93
Federal funds sold................................ 14,681 14,681 14,681 14,681
Securities........................................ 19,376 15,098 20,542 14,476
----------- ----------- ----------- -----------
TOTAL RATE SENSITIVE ASSETS.................... 356,464 338,151 366,987 332,851
----------- ----------- ----------- -----------
RATE SENSITIVE LIABILITIES
Deposits - Demand................................. 23,397 32,207 23,397 32,207
Deposits - Time................................... 236,503 236,503 236,503 236,503
Other Borrowed Money.............................. -- -- -- 8,000
----------- ----------- ----------- -----------
TOTAL RATE SENSITIVE LIABILITIES............... 259,900 268,710 259,900 276,710
----------- ----------- ----------- -----------
RATE SENSITIVITY GAP................................... $ 96,564 $ 69,441 $ 107,087 $ 56,141
=========== =========== =========== ===========
Change in Amount of Net Interest Margin................ $ (966) $ 694 $ (2,142) $ 1,123
=========== =========== =========== ===========
Change in Percent of Net Interest Margin............... (0.16)% 0.12% (0.36)% 0.19%
=========== =========== =========== ===========
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
36
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 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
37
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.
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.
In April 2002, the Financial Accounting Standards Board issued SFAS No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. SFAS No. 145 addresses accounting
and financial reporting for extinguishments of debt, intangible assets of motor
carriers and leases. SFAS No. 145 is effective for fiscal years beginning after
and transactions occurring after May 15, 2002. The adoption of this statement is
not expected to have a material effect on the Company's consolidated financial
statements.
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities. The statement
addresses financial reporting and accounting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). The
primary difference between SFAS No. 146 and Issue 94-3 relates to the
requirement for recognition of a liability related to the cost of an exit or
disposal activity when the liability is incurred. Under 94-3, such liability
would be recognized at the date of an entity's commitment to an exit plan. SFAS
No. 146 is effective for exit or disposal activities initiated after December
31, 2002, with early application encouraged. The adoption of this statement is
not expected to have a material impact on the Company's consolidated financial
statements.
In June 2002, the Auditing Standards Board issued SAS No. 97, Amendment to
Statement on Auditing Standards No. 50, Reports on the Application of Accounting
Principles. This statement prohibits an accountant from providing a written
report on the application of accounting principles not involving facts and
circumstances of a specific entity. This SAS is effective for written reports
issued or oral advice provided on or after June 30, 2002. The
38
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 September 2002, the Auditing Standards Board issued SAS No. 98, Omnibus
Statement on Auditing Standards - 2002. This statement revises and amends
several previously issued Statements on Auditing Standards. The changes required
impose enhanced quality controls and audit considerations on a firm of
independent auditors in the conduct of their audit of a company's financial
statements. The additional requirements primarily relate to more descriptive
guidance on the application of auditing procedures, the auditors report and
related disclosures and supplementary information. This SAS No. 98 was effective
upon issuance except for the amendment to SAS No. 70, which is effective for
reports issued on or after January 1, 2003. The impact on the audit of the
Company's consolidated financial statements resulting from the issuance of this
auditing standard was not material.
In October 2002, the Financial Accounting Standards Board issued SFAS No.
147, Acquisitions of Certain Financial Institutions, an amendment of SFAS No. 72
and 144 and FASB Interpretation No. 9. Except for transactions between two or
more mutual enterprises, SFAS No. 147 removes acquisitions of financial
institutions from the scope of SFAS No. 72 and Interpretation 9 and requires
those transactions be accounted for in accordance with SFAS No. 141 and 142.
SFAS No. 147 also amends SFAS No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor and borrower relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the same
undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that SFAS No. 144 requires for other long-lived assets
that are held and used. SFAS No. 147 is essentially effective as of October 1,
2002. As a result, the Company adopted SFAS No. 147 on October 1, 2002, with no
material impact on the Company's consolidated financial statements.
In October 2002, the Auditing Standards Board issued SAS No. 99,
Consideration of Fraud in a Financial Statement Audit. This statement supersedes
SAS No. 82 and amends SAS No. 1 and SAS No. 85. SAS No. 99 describes fraud and
its characteristics; discusses the need for auditors to exercise professional
skepticism; requires (as part of planning the audit) that there be a discussion
among the audit team members regarding the risks of material misstatement due to
fraud; and requires auditors to gather information necessary to identify risks
of material misstatement due to fraud. This SAS is effective for audits of
financial statements for periods beginning on or after December 15, 2002. 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 November 2002, the auditing Standards Board issued SAS No. 100, Interim
financial Information. This statement supersedes SAS No. 71 and establishes
standards on the nature, timing and extent of the procedures to be performed by
an independent accountant when conducting a review of interim financial
information. This SAS is effective for interim periods within fiscal years
beginning after December 15. 2002. 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 November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation changes the current
practice of accounting for, and the disclosures related to guarantees.
Interpretation No. 45 requires certain guarantees to be recorded at fair value,
which is a change from the current practice of generally only recording a
liability when a loss is probable and reasonably estimable. The interpretation
also requires a guarantor to make new disclosures, even when the likelihood of
making any payments under the guarantee is remote, which is another change from
current practice. The disclosure requirements of this interpretation are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The interpretation's initial recognition and initial
measurement provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002. The guarantor's previous accounting
for guarantees issued prior to the date of Interpretation No. 45 are not to be
revised or restated to reflect the interpretation's provisions. The adoption of
the disclosure requirements of Interpretation No. 45 did not have a material
impact on the Company's consolidated financial statements. The adoption of the
initial recognition and initial measurement provisions of Interpretation No. 45
is not expected to have a material impact on the Company's consolidated
financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This statement amends SFAS No. 123 to
provide alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation. It also amends the disclosure provisions of that Statement to
require prominent disclosure about the effects on reported net
39
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. This Statement also amends APB Opinion No. 28 to require
disclosure about those effects in interim financial information. This Statement
is effective for financial statements for fiscal years ending after December 15,
2002 and for financial reports containing condensed financial statements for
interim periods beginning after December 15, 2002. The adoption of SFAS No. 148
did not have a material impact on the Company's consolidated financial
statements.
In January 2003, the auditing Standards Board Issued SAS No. 101, Auditing
Fair Value Measurements and Disclosures. This statement establishes standards on
auditing the measurement and disclosure of assets, liabilities, and specific
components of equity presented or disclosed at fair value in financial
statements. This SAS is effective for audit of financial statements for periods
beginning on or after June 15, 2003. 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.
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.
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.
[The remainder of this page intentionally left blank]
40
HERITAGE FINANCIAL HOLDING CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENTS
Page(s)
Independent Auditors' Report..................................................................................42
Consolidated Statements of Financial Condition
as of December 31, 2002 and 2001..........................................................................43
Consolidated Statements of Income
for the Years Ended December 31, 2002, 2001 and 2000......................................................44
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 2002, 2001 and 2000......................................................45
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002, 2001 and 2000......................................................46
Notes to Consolidated Financial Statements....................................................................47
Quarterly Results (Unaudited).................................................................................81
41
Schauer Taylor Cox Vise Morgan & Fowler, P.C.
Certified Public Accountants and Consultants
150 Olde Towne Road
Birmingham, Alabama 35216
Douglas B. Schauer, CPA Donald G. Vise, CPA David A. Bowers, CPA
Edward R. Taylor, CPA Phillip D. Morgan, CPA Benjamin N. Vance, CPA
W. Ernest Cox, CPA Dale E. Fowler, CPA Steven W. Brown, CPA
________________ * * * ________________
C. David Brooks, CPA Telephone - 205.822.3488 Russell D. Payne, CPA
M. Bryant King, CPA Wats - 800.466.3488 Raymond A. Patton, CPA
Steven D. Miller, CPA Fax - 205.822.3541 or 205.822.0645 Stewart T. Wilson, CPA
Email - Firm@schauertaylor.com
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, 2002 and 2001, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2002. 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, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
Birmingham, Alabama
February 25, 2003
/s/ Schauer Taylor Cox Vise Morgan & Fowler, P.C.
Member of American Institute of Certified Public Accountants,
SEC Practice Section and Alabama Society of Certified Public Accountants
42
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2002 and 2001
2002 2001
--------------- ---------------
Assets
Cash and due from banks................................................. $ 4,759,310 $ 6,660,032
Interest-bearing deposits with other banks.............................. 97,707 325,736
Federal funds sold...................................................... 14,681,498 6,716,000
--------------- ----------------
Cash and Cash Equivalents........................................... 19,538,515 13,701,768
Securities available-for-sale........................................... 36,761,802 25,893,863
Mortgage loans held-for-sale............................................ 12,343,440 12,548,322
Loans................................................................... 523,849,502 505,380,611
Allowance for loan losses............................................... (26,990,594) (6,074,230)
--------------- ----------------
Net Loans........................................................... 496,858,908 499,306,381
Premises and equipment, net............................................. 7,105,706 6,407,022
Accrued interest........................................................ 3,404,344 3,873,413
Foreclosed real estate.................................................. 5,428,047 4,227,926
Other assets............................................................ 11,501,035 2,332,392
--------------- ----------------
Total Assets........................................................ $ 592,941,797 $ 568,291,087
=============== ================
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Noninterest-bearing................................................... $ 21,961,197 $ 21,295,986
Interest-bearing...................................................... 503,669,662 483,013,752
--------------- ----------------
Total Deposits...................................................... 525,630,859 504,309,738
Short-term borrowings................................................... 6,650,000 --
Accrued interest........................................................ 3,288,749 4,204,515
FHLB advances........................................................... 23,000,000 13,000,000
Guaranteed preferred beneficial interest in the Company's
subordinated debentures............................................... 10,000,000 10,000,000
Other liabilities....................................................... 669,143 652,954
--------------- ----------------
Total Liabilities................................................... 569,238,751 532,167,207
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, 8,821,144 shares issued and outstanding at
December 31, 2002 and 8,515,147 shares issued and
outstanding at December 31, 2001...................................... 88,211 85,151
Paid-in capital......................................................... 32,234,654 30,359,218
Retained earnings....................................................... (8,676,524) 5,736,259
Accumulated other comprehensive income (loss): net unrealized (gains)
losses on securities available-for-sale, net of deferred income tax... 56,705 (56,748)
--------------- ----------------
Total Stockholders' Equity.......................................... 23,703,046 36,123,880
--------------- ----------------
Total Liabilities and Stockholders' Equity.......................... $ 592,941,797 $ 568,291,087
=============== ================
See notes to consoildated financial statements
43
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
--------------- --------------- ----------------
Interest Income
Interest and fees on loans........................... $ 39,876,186 $ 41,587,737 $ 31,788,388
Interest and dividends on securities:
Taxable securities................................. 1,603,251 1,460,386 1,542,276
Nontaxable securities.............................. 133,119 124,585 123,619
Interest on deposits with other banks................ 6,264 24,905 365,000
Interest on federal funds sold and securities
purchased under agreements to resale............... 320,016 1,055,690 1,840,891
--------------- --------------- ----------------
Total Interest Income............................ 41,938,836 44,253,303 35,660,174
Interest Expense
Interest on deposits................................. 19,716,658 26,751,607 20,867,463
Interest on FHLB borrowings.......................... 977,348 962,690 1,150,833
Interest on short-term borrowings.................... 35,700 1,888 229
Interest on guaranteed preferred beneficial interest
in the Company's subordinated debentures........... 1,012,029 878,334 --
--------------- --------------- ----------------
Total Interest Expense........................... 21,741,735 28,594,519 22,018,525
--------------- --------------- ----------------
Net interest income..................................... 20,197,101 15,658,784 13,641,649
Provision for loan losses............................... 29,468,734 3,602,047 3,388,973
--------------- --------------- ----------------
Net Interest Income (Loss) After Provision
For Loan Losses...................................... (9,271,633) 12,056,737 10,252,676
Noninterest Income
Customer service fees................................ 1,018,421 867,323 745,377
Investment security gains............................ 233,372 23,926 --
Other operating income............................... 1,023,487 665,197 293,666
--------------- --------------- ----------------
Total Noninterest Income......................... 2,275,280 1,556,446 1,039,043
--------------- --------------- ----------------
Noninterest Expenses
Salaries and employee benefits....................... 8,388,132 5,460,426 4,612,785
Occupancy and equipment expense...................... 1,625,162 1,232,525 879,910
Other operating expenses............................. 5,290,357 3,330,345 2,620,324
--------------- --------------- ----------------
Total Noninterest Expenses....................... 15,303,651 10,023,296 8,113,019
--------------- --------------- ----------------
Income (loss) before income taxes....................... (22,300,004) 3,589,887 3,178,700
Provision for income tax expense (benefit).............. (7,887,221) 1,223,966 991,169
--------------- --------------- ----------------
Net Income (Loss)....................................... $ (14,412,783) $ 2,365,921 $ 2,187,531
=============== =============== ================
Earnings (Loss) Per Common Share
Basic................................................ $ (1.65) $ 0.28 $ 0.26
Diluted.............................................. (1.40) 0.23 0.22
Weighted Average Shares Outstanding
Basic................................................ 8,717,303 8,484,624 8,316,756
Diluted.............................................. 10,262,070 10,486,966 10,133,865
See notes to consoildated financial statements
44
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2002, 2001 and 2000
Accumulated
Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income Total
----------- -------------- --------------- --------------- --------------
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
Net loss - 2002...................... -- -- (14,412,783) -- (14,412,783)
Unrealized gains on available-for-
sale securities, net of
reclassification adjustment, net
of tax of $(75,636)............... -- -- -- 113,453 113,453
--------------
Comprehensive loss................... -- -- -- -- (14,299,330)
--------------
Compensatory options................. -- 1,126,914 -- -- 1,126,914
Tax benefit on stock options......... -- 702,817 -- -- 702,817
Stock option exercise................ 3,037 20,534 -- -- 23,571
Issuance of shares under
employee stock purchase plan...... 23 25,171 -- -- 25,194
----------- -------------- --------------- ---------------- --------------
Balance at
December 31, 2002................. $ 88,211 $ 32,234,654 $ (8,676,524) $ 56,705 $ 23,703,046
=========== ============== =============== ================ ==============
See notes to consoildated financial statements
45
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
--------------- --------------- ----------------
Operating Activities
Net income (loss).................................... $ (14,412,783) $ 2,365,921 $ 2,187,531
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses.......................... 29,468,734 3,602,047 3,388,973
Depreciation, amortization and accretion, net...... 790,839 437,999 321,341
Deferred tax benefit............................... (6,700,257) (264,948) (746,779)
Security gains..................................... (261,671) 23,926 --
Loss on disposition of fixed assets................ 2,250 1,786 --
Losses on other real estate........................ 249,491 23,926 --
Decrease (increase) in accrued interest receivable. 469,069 523,054 (2,314,056)
Increase (decrease) in accrued interest payable.... (915,766) 52,267 2,679,350
Net decrease (increase) in mortgage
loans held for sale.............................. 204,882 (12,548,322) --
Increase in income tax receivable.................. (1,832,399) (188,178) --
Other, net......................................... 7,381 531,321 (47,723)
--------------- --------------- ----------------
Net Cash Provided By (Used In)
Operating Activities........................... 7,069,770 (6,173,339) 5,468,637
--------------- --------------- ----------------
Investing Activities
Purchases of securities available-for-sale........... (101,267,892) (18,774,196) (7,008,487)
Proceeds from sales of securities available-for-sale. 35,340,361 520,493 --
Proceeds from calls, paydowns and maturities of
securities available-for-sale...................... 55,317,503 19,399,714 1,358,567
Net increase in loans to customers................... (31,020,203) (89,959,157) (178,875,187)
Purchase of premises and equipment................... (1,343,238) (1,287,676) (2,224,003)
Proceeds from disposition of fixed assets............ 44,315 7,665 --
Proceeds from disposition of foreclosed real estate.. 2,549,330 106,250 --
--------------- --------------- ----------------
Net Cash Used In Investing Activities............ (40,379,824) (89,986,907) (186,749,110)
--------------- --------------- ----------------
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts............................... 34,867,423 38,279,518 20,653,089
Net increase (decrease) in certificates of deposit... (13,546,302) 44,785,982 151,558,986
Net increase (decrease) in short-term borrowings..... 6,650,000 -- (24,719)
Net proceeds from (payments to) FHLB advances........ 10,000,000 1,000,000 (13,000,000)
Net proceeds from issuance of stock.................. 48,766 118,655 8,596,425
Compensatory options................................. 1,126,914 37,843 61,386
Issuance of guaranteed preferred beneficial interest
in the Company's subordinated debentures........... -- 10,000,000 --
--------------- --------------- ----------------
Net Cash Provided By Financing Activities........ 39,146,801 94,221,998 167,845,167
--------------- --------------- ----------------
Increase (Decrease) in Cash and
Cash Equivalents..................................... 5,836,747 (1,938,248) (13,435,306)
Cash and Cash Equivalents at Beginning of Year.......... 13,701,768 15,640,016 29,075,322
--------------- --------------- ----------------
Cash and Cash Equivalents at End of Year................ $ 19,538,515 $ 13,701,768 $ 15,640,016
=============== =============== ================
See notes to consoildated financial statements
46
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
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.
During the course of a targeted, limited scope review of the loan portfolio of
the Company's wholly-owned subsidiary Heritage Bank, an Alabama state banking
corporation (the "Bank"), and a concurrent safety and soundness examination
conducted by regulatory authorities, management identified certain assets in the
Bank's loan portfolio that management believed should be classified. Additional
review of the Bank's loan portfolio subsequently identified additional asset
quality problems, which resulted in the Company increasing the allowance for
loan losses net of charge offs and recoveries by a total of $20,916,364 for the
year ending December 31, 2002. Management believes that the allowance for loan
losses is adequate to absorb known risks in the loan portfolio.
The Bank has engaged a new President/Chief Executive Officer, Chief Financial
Officer and Chief Lending Officer. These individuals have been given the
authority and responsibility to strengthen internal controls, improve asset
quality and improve bank profitability. The Company and the Bank have continued
to add experienced personnel to assist in the review and oversight of important
areas such as credit quality and loan review.
The Board of Directors and senior management have developed a new capital plan.
This plan addresses the current capital deficiencies, and outlines a return to
capital adequacy.
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.
47
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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.
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,
2002, approximates their aggregate net realizable value. Gains or losses on the
sale of mortgage loans held for sale are included in other income.
48
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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 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.
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.
49
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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, 2002, 2001 and 2000.
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.
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 or within 90 days thereafter, 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.
50
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
Advertising Costs
The Company's policy is to expense advertising costs as incurred. Advertising
expense for the years ended December 31, 2002, 2001 and 2000 amounted to
approximately $401,000, $336,000 and $291,000, 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.
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
hasassumed, 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.
51
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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
$65,223,000 with the Federal Home Loan Bank of Atlanta ("FHLB") of which
$42,223,000 was available and unused at December 31, 2002, subject to proper
collateralization.
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 2001 and 2000 have been reclassified to conform with the 2002
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 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 FASB 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.
52
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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 was not material.
In June 2001, the FASB issued SFAS No. 141, Business Combinations. This
statement addresses financial accounting and reporting for business combinations
and supersedes Accounting Principles Board ("APB") 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
53
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
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 did not 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 did not 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 did not have a material effect on
the Company's consolidated financial statements.
54
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
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. The impact on
the audit of the Company's consolidated financial statements resulting from the
issuance of this auditing standard was not material.
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 on the audit of the
Company's consolidated financial statements resulting from the issuance of this
auditing standard was not material.
In April 2002, the Financial Accounting Standards Board issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections. SFAS No. 145 addresses accounting and financial
reporting for extinguishments of debt, intangible assets of motor carriers and
leases. SFAS No. 145 is effective for fiscal years beginning after and
transactions occurring after May 15, 2002. The adoption of this statement is not
expected to have a material effect on the Company's consolidated financial
statements.
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities. The statement
addresses financial reporting and accounting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). The
primary difference between SFAS No. 146 and Issue 94-3 relates to the
requirement for recognition of a liability related to the cost of an exit or
disposal activity when the liability is incurred. Under 94-3, such liability
would be recognized at the date of an entity's commitment to an exit plan. SFAS
No. 146 is effective for exit or disposal activities initiated after December
31, 2002, with early application encouraged. The adoption of this statement is
not expected to have a material impact on the Company's consolidated financial
statements.
In June 2002, the Auditing Standards Board issued SAS No. 97, Amendment to
Statement on Auditing Standards No. 50, Reports on the Application of Accounting
Principles. This statement prohibits an accountant from providing a written
report on the application of accounting principles not involving facts and
circumstances of a specific entity. This SAS is effective for written reports
issued or oral advice provided on or after June 30, 2002. 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.
55
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
In September 2002, the Auditing Standards Board issued SAS No. 98, Omnibus
Statement on Auditing Standards - 2002. This statement revises and amends
several previously issued Statements on Auditing Standards. The changes required
impose enhanced quality controls and audit considerations on a firm of
independent auditors in the conduct of their audit of a company's financial
statements. The additional requirements primarily relate to more descriptive
guidance on the application of auditing procedures, the auditors report and
related disclosures and supplementary information. This SAS No. 98 was effective
upon issuance except for the amendment to SAS No. 70, which is effective for
reports issued on or after January 1, 2003. The impact on the audit of the
Company's consolidated financial statements resulting from the issuance of this
auditing standard was not material.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions, an amendment of SFAS No. 72 and 144 and FASB Interpretation No. 9.
Except for transactions between two or more mutual enterprises, SFAS No. 147
removes acquisitions of financial institutions from the scope of SFAS No. 72 and
Interpretation 9 and requires those transactions be accounted for in accordance
with SFAS No. 141 and 142. SFAS No. 147 also amends SFAS No. 144 to include in
its scope long-term customer-relationship intangible assets of financial
institutions such as depositor and borrower relationship intangible assets and
credit cardholder intangible assets. Consequently, those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS No. 144 requires for other
long-lived assets that are held and used. The provisions of SFAS No. 72
requiring the intangible recognition and subsequent amortization of any excess
fair value of net liabilities assumed in an acquisition will no longer apply.
SFAS No. 147 is essentially effective as of October 1, 2002. As a result, the
Company adopted SFAS No. 147 on October 1, 2002, with no material impact on the
Company's consolidated financial statements.
In October 2002, the Auditing Standards Board issued SAS No. 99, Consideration
of Fraud in a Financial Statement Audit. This statement supersedes SAS No. 82
and amends SAS No. 1 and SAS No. 85. SAS No. 99 describes fraud and its
characteristics; discusses the need for auditors to exercise professional
skepticism; requires (as part of planning the audit) that there be a discussion
among the audit team members regarding the risks of material misstatement due to
fraud; and requires auditors to gather information necessary to identify risks
of material misstatement due to fraud. This SAS is effective for audits of
financial statements for periods beginning on or after December 15, 2002. 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 November 2002, the Auditing Standards Board issued SAS No. 100, Interim
Financial Information. This statement supersedes SAS No. 71 and establishes
standards on the nature, timing and extent of the procedures to be performed by
an independent accountant when conducting a review of interim financial
information. This SAS is effective for interim periods within fiscal years
beginning after December 15. 2002. 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.
56
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This interpretation changes the current practice of
accounting for, and the disclosures related to guarantees. Interpretation No. 45
requires certain guarantees to be recorded at fair value, which is a change from
the current practice of generally only recording a liability when a loss is
probable and reasonably estimable. The interpretation also requires a guarantor
to make new disclosures, even when the likelihood of making any payments under
the guarantee is remote, which is another change from current practice. The
disclosure requirements of this interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
interpretation's initial recognition and initial measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The guarantor's previous accounting for guarantees issued
prior to the date of Interpretation No. 45 are not to be revised or restated to
reflect the interpretation's provisions. The adoption of the disclosure
requirements of Interpretation No. 45 did not have a material impact on the
Company's consolidated financial statements. The adoption of the initial
recognition and initial measurement provisions of Interpretation No. 45 is not
expected to have a material impact on the Company's consolidated financial
statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This statement amends SFAS No. 123 to
provide alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation. It amends the disclosure provisions of that Statement to require
prominent disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation.
This Statement also amends APB Opinion No. 28 to require disclosure about those
effects in interim financial information. This Statement is effective for
financial statements for fiscal years ending after December 15, 2002 and for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a
material impact on the Company's consolidated financial statements.
In January 2003, the Auditing Standards Board Issued SAS No. 101, Auditing Fair
Value Measurements and Disclosures. This statement establishes standards on
auditing the measurement and disclosure of assets, liabilities, and specific
components of equity presented or disclosed at fair value in financial
statements. This SAS is effective for audits of financial statements for periods
beginning on or after June 15, 2003. 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 January 2003, the FASB issued FIN 46, which clarifies the application of
Accounting Research Bulletin ("ARB") 51, Consolidated Financial Statements, to
certain entities (called variable interest entities) in which equity investors
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The disclosure
requirements of this Interpretation are effective for all financial statements
issued after January 31, 2003. The consolidation requirements apply to all
variable interest entities created after January 31, 2003. In addition, public
57
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - Continued
companies must apply the consolidation requirements to variable interest
entities that existed prior to February 1, 2003 and remain in existence as of
the beginning of annual or interim periods beginning after June 15, 2003.
Management is currently assessing the impact of FIN 46, and does not expect this
Interpretation to have a material impact to the Consolidated Financial
Statements.
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. The following reconciles the
weighted average number of shares outstanding:
2002 2001 2000
--------------- --------------- ----------------
Weighted average of common shares outstanding........... 8,717,303 8,484,624 8,316,756
Effect of dilutive options.............................. 1,544,767 2,002,342 1,817,109
--------------- --------------- ----------------
Weighted average of common shares
outstanding effected for dilution.................... 10,262,070 10,486,966 10,133,865
=============== =============== ================
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
Reporting Comprehensive Income, on December 31, 1998. This statement establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. The statement
requires that an enterprise classify items of other comprehensive income by
their nature in the financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and additional paid
in capital in the equity section of a statement of financial condition.
Comprehensive income is generally defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.
58
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 1 - Summary of Significant Accounting Policies - 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,
--------------------------------------------------------------
2002 2001 2000
------------------ ------------------ ------------------
Unrealized gains (losses) on securities
Unrealized holding gains arising
during period................................ $ 422,461 $ 194,189 $ 1,223,183
Less reclassification adjustments for
gains included in net income................. (233,372) (23,926) --
------------------ ------------------ ------------------
Net unrealized gains........................... 189,089 170,263 1,223,183
Income tax related to items of other
comprehensive loss........................... (75,636) (68,104) (489,273)
------------------ ------------------ ------------------
Other comprehensive income........................ $ 113,453 $ 102,159 $ 733,910
================== ================== ==================
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, 2002.
Years Ended December 31,
--------------------------------------------------------------
2002 2001 2000
------------------ ------------------ ------------------
Cash paid during the year for interest............ $ 22,657,501 $ 28,542,252 $ 19,339,175
Cash paid during the year for
income taxes, net.............................. 645,436 1,670,781 1,767,689
Non-cash Disclosures:
- --------------------
Net increase in unrealized gains/
losses on securities available-for-sale........ 189,089 170,263 1,223,183
Tax benefit of non-qualified options exercised.... 702,817 -- --
Loans transferred to foreclosed real estate
during the year................................ 5,029,426 4,920,288 --
59
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
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,
other cash items, or on deposit with the Federal Reserve. The average amount of
those reserves required at December 31, 2002 and 2001 was approximately
$3,467,000 and $3,530,000, 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, 2002 and
2001 were as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- -------------- ------------- --------------
Securities Available-for-Sale
December 31, 2002:
Mortgage-backed securities............... $ 22,832,366 $ 375,515 $ -- $ 23,207,881
State and municipal securities........... 1,294,471 39,543 4,433 1,329,581
Corporate debt securities................ 10,904,495 -- 316,116 10,588,379
Equity securities........................ 1,635,961 -- -- 1,635,961
-------------- --------------- -------------- ---------------
$ 36,667,293 $ 415,058 $ 320,549 $ 36,761,802
============== =============== ============== ===============
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
============== =============== ============== ===============
60
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 4 - Securities - Continued
The contractual maturities of securities available-for-sale at December 31,
2002, 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...................................................... $ 32,132 $ 32,132
Due after one year through five years........................................ 4,950,484 4,992,639
Due after five years through ten years....................................... 9,371,082 9,500,313
Due after ten years.......................................................... 20,677,634 20,600,757
Equity securities............................................................ 1,635,961 1,635,961
--------------- ----------------
$ 36,667,293 $ 36,761,802
=============== ================
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, 2002, 2001 and 2000 were as follows:
2002 2001 2000
--------------- --------------- ----------------
Realized gains....................................... $ 350,233 $ 23,926 $ --
Realized losses...................................... 116,861 -- --
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 $1,560,100 and $1,250,000 at December
31, 2002 and 2001.
Securities pledged to secure public funds on deposit and for other purposes as
required by law amounted to approximately $20,873,000 and $23,702,000 at
December 31, 2002 and 2001, respectively.
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61
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
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, 2002 and 2001 are as
follows:
2002 2001
--------------- ---------------
Commercial, financial and agricultural....................................... $ 132,236,338 $ 138,344,502
Real estate - construction................................................... 60,205,855 70,073,145
Real estate - mortgage....................................................... 311,508,055 274,675,368
Consumer..................................................................... 19,899,254 22,287,596
--------------- ----------------
523,849,502 505,380,611
Allowance for loan losses.................................................... 26,990,594 6,074,230
--------------- ----------------
Net loans.................................................................... $ 496,858,908 $ 499,306,381
=============== ================
Total loans, which the Bank considered to be impaired at December 31, 2002 and
2001, were $15,794,000 and $4,062,000, respectively. All of these loans were on
nonaccrual status and had related allowances of $2,991,000 and $897,000,
respectively. Collateral dependent loans, which were measured at the fair value
of the collateral, constituted the majority of impaired loans at December 31,
2002 and 2001. The average recorded investment in impaired loans for the years
ended December 31, 2002 and 2001 was approximately $10,324,000 and $5,275,000,
respectively. No material amount of interest income was recognized on impaired
loans for the years ended December 31, 2002 and 2001. For the years ended
December 31, 2002 and 2001, 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 $561,000 for 2002 and $519,000 for 2001.
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 $86,353,000 and $87,089,000 at December
31, 2002 and 2001, respectively (see Note 9).
[The remainder of this page intentionally left blank]
62
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 6 - Allowance for Loan Losses
Changes in the allowance for loan losses for the years ended December 31, 2002,
2001 and 2000 were as follows:
2002 2001 2000
--------------- --------------- ----------------
Balance at beginning of year............................ $ 6,074,230 $ 5,064,889 $ 3,035,549
Charge-offs............................................. (8,825,046) (2,695,237) (1,454,447)
Recoveries.............................................. 272,676 102,531 94,814
--------------- --------------- ----------------
Net charge-offs...................................... (8,552,370) (2,592,706) (1,359,633)
Provision for loan losses............................... 29,468,734 3,602,047 3,388,973
--------------- --------------- ----------------
Balance at end of year.................................. $ 26,990,594 $ 6,074,230 $ 5,064,889
=============== =============== ================
Note 7 - Premises and Equipment
Premises and equipment as of December 31, 2002 and 2001 is as follows:
2002 2001
--------------- ---------------
Land ...................................................................... $ 1,152,443 $ 930,595
Buildings................................................................... 1,879,962 1,565,225
Land and leasehold improvements............................................. 1,761,777 1,675,856
Furniture and equipment..................................................... 3,927,885 3,179,740
Automobiles................................................................. 188,220 135,364
Construction in progress.................................................... -- 183,559
--------------- ----------------
8,910,287 7,670,339
Accumulated depreciation.................................................... 1,804,581 1,263,317
--------------- ----------------
Premises and equipment, net................................................. $ 7,105,706 $ 6,407,022
=============== ================
The provision for depreciation charged to occupancy and equipment expense for
the years ended December 31, 2002, 2001 and 2000 was $597,989, $437,263 and
$324,834, respectively.
63
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
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, 2002 and 2001 were
$146,208,880 and $141,220,175, respectively. Time deposits of less than $100,000
totaled $244,446,429 and $239,830,989 at December 31, 2002 and 2001,
respectively. Demand deposits reclassified as loan balances as of December 31,
2002 and 2001 amounted to $134,739 and $271,982, respectively.
The maturities of time certificates of deposit and other time deposits issued by
the Bank at December 31, 2002, are as follows:
Years Ending December 31,
2003............................................................................. $ 267,737,736
2004............................................................................. 73,918,671
2005............................................................................. 36,398,208
2006............................................................................. 7,415,927
2007............................................................................. 5,184,767
----------------
Total.......................................................................... $ 390,655,309
================
Note 9 - Short-term Borrowings
On October 30, 2002, the Company entered into a short-term loan agreement with a
commercial bank, whereby the Company can borrow up to $7,500,000 bearing
interest at LIBOR plus 2.5%. The note matures September 30, 2003 and is secured
by the stock of the bank and guaranteed by the Board of Directors of the
Company. It is the intention of management to seek renewal of this loan. The
loan agreement contains certain restrictive covenants that the Company is either
in compliance with or has requested and received waivers for until March 31,
2003. At December 31, 2002 the balance was $6,650,000 whereas at December 31,
2001 there were no borrowings.
[The remainder of this page intentionally left blank]
64
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 10 - Long-term Debt
At December 31, 2002 and 2001, the Bank had long-term debt totaling $33,000,000
and $23,000,000, respectively.
Long-term debt consists of the following at December 31, 2002 and 2001:
2002 2001
--------------- ---------------
Long-term Federal Home Loan Bank advances; at December 31, 2002 -
maturity dates of February 2011 through February 2012, fixed
interest rates ranging from 3.85% to 4.97%; at December 31, 2001 -
maturity dates in February 2011, fixed interest rates ranging from
4.16% to 4.97; all of the debt at December 31, 2002 and 2001 is
subject to early termination options y the Bank and conversion
by the issuer into a three month LIBOR-based floating rate
advance; secured by real estate mortgage loans............................... $ 23,000,000 $ 13,000,000
Long-term Heritage Financial Statutory Trust advance from a pooled
trust preferred private placement for subordinated debentures;
dated February 22, 2001, 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 10,000,000
--------------- ---------------
$ 33,000,000 $ 23,000,000
=============== ===============
Maturities of long-term debt following December 31, 2002, are as follows:
Years Ending December 31,
2003............................................................................. $ --
2004............................................................................. --
2005............................................................................. --
2006............................................................................. --
2007............................................................................. --
Thereafter....................................................................... 33,000,000
----------------
Total.......................................................................... $ 33,000,000
================
Note 11 - 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.
65
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 11 - Stockholders' Equity - Continued
At December 31, 2002 and 2001, 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,
8,821,144 shares and 8,515,147 shares issued and outstanding as of December 31,
2002 and 2001, 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.
On March 26, 2003, the Company commenced a private placement of up to 1,000,000
shares of common stock to raise up to $3,340,000 in equity capital. The private
placement is being conducted in order to augment the capital levels of the
Company and the Bank. The Company intends to use the net proceeds of the
offering to make a capital contribution to the Bank. The offering is being made
only to a limited number of investors, including the directors and officers of
the Company and the Bank and certain other accredited investors.
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 12 - 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.
66
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 12 - Reorganization - Continued
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 13 - 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, 2002, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2002, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as adequately capitalized under the
regulatory framework for prompt corrective action. To be 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 Bank and Company have agreed to meet certain capital ratios. As of December
31, 2002, management of the Company and the Bank have taken steps to increase
the Bank's Tier I leverage ratio to 7.5% and to be "well-capitalized" as defined
by the FDIC. The Bank's Tier I leverage ratio should be no less than 8 % by
March 31, 2003, and the Bank should maintain a ratio of at least 8%. The Bank
did not achieve a Tier I leverage ratio of 7.5% as of December 31, 2002 and the
Bank may fail to achieve a Tier I leverage ratio of 8% if the Bank is unable to
acquire additional capital. Should the Tier I leverage ratio fall below the
minimum desired levels, the Bank will take steps to increase capital sufficient
to meet desired ratios within 30 days.
67
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 13 - Regulatory Capital Matters - Continued
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, 2002:
Total Capital
Consolidated............... $ 39,436 7.81% $ 40,410 8.00% $ 50,513 10.00%
Heritage Bank.............. 45,182 8.98 40,233 8.00 50,292 10.00
Tier I Capital
Consolidated............... 30,749 6.09 20,205 4.00 30,308 6.00
Heritage Bank.............. 38,640 7.68 20,117 4.00 30,175 6.00
Tier I Leverage
Consolidated............... 30,749 4.94 24,923 4.00 31,154 5.00
Heritage Bank.............. 38,640 5.99 25,794 4.00 32,243 5.00
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
Note 14 - 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, 2002, 2001 and 2000:
68
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 14 - Incentive Stock Compensation Plan - Continued
Fixed Options
2002 2001 2000
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
----------- ----------- ----------- ----------- ----------- ----------
Outstanding, beginning of the year.. 3,957,032 $ 3.77 3,970,032 $ 3.72 4,008,000 $ 3.70
Granted.......................... 120,000 3.34 23,000 11.50 2,000 10.00
Exercised........................ (451,016) 3.89 (36,000) 2.42 (39,968) 1.67
Forfeited........................ (387,000) 3.70 -- 0.00 -- 0.00
----------- ----------- -----------
Outstanding, end of the year........ 3,239,016 3.75 3,957,032 3.77 3,970,032 3.72
=========== =========== ===========
Exercisable, end of the year........ 1,559,816 3.92 1,630,232 4.03 1,227,632 4.05
Weighted average fair value of options
granted during the year.......... $ 1.52 $ 3.43 $ 3.38
Information pertaining to options outstanding at December 31, 2002, is as
follows:
Outstanding Expiration Options
Number Date Exercisable
---------------- -------------- --------------
Options with an exercise price of $2.84....................... 64,478 04/17/03 64,478
Options with an exercise price of $3.34....................... 300,000 07/14/03 300,000
Options with an exercise price of $3.34....................... 72,000 07/08/09 24,000
Options with an exercise price of $3.34....................... 2,448,000 08/24/08 972,000
Options with an exercise price of $3.34....................... 60,000 03/25/03 --
Options with an exercise price of $5.50....................... 60,000 07/01/04 60,000
Options with an exercise price of $6.50....................... 6,000 07/01/04 6,000
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 1,200
Options with an exercise price of $7.50....................... 120,000 11/07/09 36,000
Options with an exercise price of $10.00...................... 86,538 12/28/04 86,538
Options with an exercise price of $10.00...................... 2,000 01/28/05 1,200
Options with an exercise price of $11.50...................... 16,000 03/02/06 6,400
Of the 3,239,016 outstanding options at December 31, 2002, 1,559,816 were
exercisable with the remaining 1,679,200 having remaining vesting periods of up
to approximately 7 years. The weighted average exercise price of the exercisable
options at December 31, 2002, was $3.92. Exercise prices for options outstanding
as of December 31, 2002, ranged from $2.84 to $11.50. Total unexercised options
of 3,239,016 have a weighted average contractual life of 4.83 years and a
weighted average exercise price of $3.75.
At December 31, 2002, the shares under option include nonqualified options of
2,682,000 issued primarily to Company directors and incentive stock options of
557,016 issued to certain key employees of the Company.
69
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 14 - Incentive Stock Compensation Plan - Continued
If the Company had elected to recognize compensation cost for options granted in
2002, 2001 and 2000, 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,
-------------------------------------------------
2002 2001 2000
---------------- ------------- --------------
Net income (loss):
As reported.................................................. $ (14,412,783) $ 2,365,921 $ 2,187,531
Pro forma.................................................... (14,529,404) 1,801,959 1,453,844
Basic earnings (loss) per share:
As reported.................................................. $ (1.65) $ 0.28 $ 0.26
Pro forma.................................................... (1.67) 0.21 0.17
Diluted earnings (loss) per share:
As reported.................................................. $ (1.40) $ 0.23 $ 0.22
Pro forma.................................................... (1.42) 0.17 0.14
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 1,544,767, 2,002,342 and 1,817,109 for 2002, 2001 and 2000,
respectively.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model for 2002, 2001 and 2000 grants:
2002 2001 2000
------------- ------------- --------------
Expected dividend yield....................................... 0.00% 0.00% 0.00%
Expected stock price volatility............................... 26.00 21.70 24.20
Risk-free interest rate....................................... 4.00 4.95 6.00
Expected life of options...................................... 1 year 5 years 5 years
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.
70
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 15 - Other Operating Expenses
The major components of other operating expenses included in noninterest
expenses at December 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000
--------------- --------------- ----------------
Professional fees....................................... $ 1,275,308 $ 582,783 $ 471,283
Charge off and collection expense....................... 532,782 139,469 12,642
Loan fees and services.................................. 453,301 302,525 199,763
Data processing......................................... 420,998 190,300 136,168
Advertising............................................. 401,505 336,017 290,941
Supplies................................................ 398,449 262,024 294,201
Telephone............................................... 240,428 170,874 157,816
Postage................................................. 141,624 125,546 90,207
Exam and assessment..................................... 138,000 122,056 72,408
Other................................................... 1,287,962 1,098,751 894,895
--------------- --------------- ----------------
$ 5,290,357 $ 3,330,345 $ 2,620,324
=============== =============== ================
Note 16 - Income Taxes
Federal and state income taxes receivable (payable) as of December 31, 2002 and
2001 included in other assets (other liabilities), were as follows:
2002 2001
--------------- ---------------
Current
Federal.................................................................... $ 2,041,058 $ 166,712
State...................................................................... 54,843 (127,352)
The components of the net deferred income tax asset included in other assets as
of December 31, 2002 and 2001 are as follows:
2002 2001
--------------- ---------------
Deferred tax asset:
Federal.................................................................... $ 8,283,071 $ 1,671,166
State...................................................................... 1,292,401 294,723
--------------- ----------------
Deferred income tax asset................................................ 9,575,472 1,965,889
Valuation allowance for tax law provision.................................. (319,472) --
--------------- ----------------
Total deferred income tax asset.......................................... 9,256,000 1,965,889
Deferred tax liability:
Federal.................................................................... (465,818) (288,808)
State...................................................................... (60,771) (50,966)
--------------- ----------------
Total deferred income tax liability...................................... (526,589) (339,774)
--------------- ----------------
Net deferred tax asset................................................... $ 8,729,411 $ 1,626,115
=============== ================
71
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 16 - Income Taxes - Continued
The tax effects of each type of income and expense item that gave rise to
deferred taxes are:
2002 2001
--------------- ---------------
Depreciation............................................................... $ (474,204) $ (339,774)
Allowance for loan losses.................................................. 8,437,534 1,810,821
Net operating loss carryforward............................................ 458,642 --
Unamortized expenses....................................................... 27,466 34,068
Net unrealized losses (gains) on securities available-for-sale............. (37,803) 37,833
Deferred compensation on stock options..................................... 297,373 82,098
Other...................................................................... 20,403 1,069
--------------- ----------------
Net deferred tax asset..................................................... $ 8,729,411 $ 1,626,115
=============== ================
The components of income tax expense (benefit) for the years ended December 31,
2002, 2001 and 2000 were as follows:
2002 2001 2000
---------------- --------------- ----------------
Current
Federal.................................................. $ (1,132,120) $ 1,361,567 $ 1,641,466
State.................................................... (54,844) 127,347 121,036
Deferred
Federal.................................................. (6,022,845) (224,469) (655,483)
State.................................................... (677,412) (40,479) (115,850)
---------------- --------------- ----------------
$ (7,887,221) $ 1,223,966 $ 991,169
================ =============== ================
Tax effect of securities transactions for the years ended December 31, 2002,
2001 and 2000 were approximately $104,668, $9,570 and $-0-, 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, 2002,
2001 and 2000:
2002 2001 2000
--------------- --------------- ----------------
Statutory federal income tax rate....................... (34.0)% 34.0% 34.0%
Effect on rate of:
Tax exempt security income........................... (0.2) (1.2) (1.3)
Tax exempt loan income............................... (0.1) (0.4) (0.5)
State income tax, net of federal tax................. (3.2) 1.2 (1.1)
Devaluation of tax carryover benefits................ 1.4 0.0 0.0
Other ............................................... 0.7 0.5 0.1
--------------- --------------- ----------------
Effective income tax rate............................... (35.4)% 34.1% 31.2%
=============== =============== ================
72
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 17 - 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, 2002, 2001 and 2000 was $91,859, $65,604 and $50,032, 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, 2002
and 2001 was $9.50 and $12.50 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 18 - 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.
Loan commitments are made to accommodate the financial needs of the Company's
customers. Standby letters of credit commit the Company to make payments on
behalf of customers when certain specified future events occur. Historically,
most loan commitments and standby letters of credit expire unused. The Company's
exposure to credit loss in the event of nonperformance by the counter-party to
the financial instrument for loan commitments and standby letters of credit is
represented by the contractual amount of those instruments. The Company uses the
same underwriting standards in making commitments and conditional obligations as
it does for on-balance sheet instruments. The amount of collateral obtained is
based on management's credit evaluation of the customer. Collateral held varies,
but may include accounts receivable, inventory, property, plant, and equipment,
and income-producing commercial properties.
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73
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 18 - Commitments and Contingencies - Continued
A summary of the Bank's commitments and contingent liabilities at December 31,
2002 and 2001, is as follows:
Contract or
Notional Amount
--------------------------------
2002 2001
--------------- ---------------
Commitments to extend credit................................................. $ 75,574,000 $ 68,927,000
Credit card arrangements..................................................... -- 3,047,000
Standby letters of credit.................................................... 3,259,000 3,174,000
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 19 - 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, 2002 and 2001 amounted to $-0- and $128,412, respectively.
Note 20 - 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, 2003, the Bank cannot declare dividends,
without prior regulatory approval.
74
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 21 - 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,
2002, 2001 and 2000, rental expense for such lease agreements was $635,667,
$457,615 and $358,938, respectively.
Future minimum lease payments under these operating lease agreements at December
31, 2002, are as follows:
Years Ending December 31,
2003............................................................................. $ 473,147
2004............................................................................. 478,313
2005............................................................................. 465,894
2006............................................................................. 468,897
2007............................................................................. 421,293
Thereafter....................................................................... 1,264,845
----------------
Total minimum lease payments................................................... $ 3,572,389
================
Note 22 - Related Party Transactions
Loans: Certain directors, executive officers and principal stockholders
including their immediate families and associates were loan customers of the
Bank during 2002 and 2001. 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, 2002 and 2001, amounted to $14,895,966 and $15,067,983,
respectively. Activity during 2002 and 2001 in loans to related parties is as
follows:
2002 2001
--------------- ---------------
Balance at beginning of year................................................. $ 15,067,983 $ 13,767,900
New loans.................................................................. 5,227,395 6,746,436
Repayments................................................................. (5,248,925) (5,446,353)
Change in composition...................................................... (150,487) --
--------------- ----------------
Balance at end of year....................................................... $ 14,895,966 $ 15,067,983
=============== ================
Deposits: Deposits held from related parties were $3,511,847 and $4,358,804 at
December 31, 2002 and 2001, respectively.
75
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 23 - Litigation
The Bank has received demand letters from two former directors, officers and
employees of the Bank. The Bank terminated such officers in November 2002 for
cause, as such term is defined by their respective employment contracts. One
officer has claimed monetary compensation, stock options and attorneys' fees,
while the second officer has claimed monetary compensation, as well as stock
options and payment of country club dues for two years following the date of his
termination. The Bank maintains that it terminated each of these officers for
"cause" and that it is under no obligation to pay them any additional
compensation. On March 14, 2003, one of these officers filed a lawsuit against
the Bank in the Circuit Court for Morgan County, Alabama, alleging breach of
contract and demanding the benefits due under his employment agreement. The Bank
intends to vigorously defend this and any other action brought against the Bank
by either of the officers, and does not believe that the final outcome will have
a material impact on the Bank or the Company.
Note 24 - 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.
76
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 24 - Fair Value of Financial Instruments - Continued
Short-Term Borrowings: The carrying amounts of short-term borrowings approximate
their fair values.
Long-term Debt: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate fair value of existing debt.
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, 2002 and 2001 are as follows:
2002 2001
-------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------- --------------- --------------- ---------------
(in thousands) (in thousands)
Financial Assets
Cash and short-term investments.......... $ 13,539 $ 13,539 $ 13,702 $ 13,702
Securities............................... 36,810 36,810 25,894 25,894
Mortgage loans held-for-sale............. 12,343 12,343 12,548 12,548
Loans.................................... 523,850 554,047 505,381 529,578
Accrued interest receivable.............. 3,404 3,404 3,873 3,873
--------------- ---------------- --------------- ----------------
Total Financial Assets................. $ 589,946 $ 620,143 $ 561,398 $ 585,595
=============== ================ =============== ================
Financial Liabilities
Deposits................................. $ 525,631 $ 527,869 $ 504,310 $ 513,757
Short-term borrowings.................... 6,650 6,650 -- --
Subordinated debentures.................. 10,000 10,000 10,000 10,308
FHLB Advances............................ 23,000 30,829 13,000 13,778
Accrued interest payable................. 3,289 3,289 4,205 4,205
--------------- ---------------- --------------- ----------------
Total Financial Liabilities............ $ 568,570 $ 578,637 $ 531,515 $ 542,048
=============== ================ =============== ================
Unrecognized Financial Instruments
Commitments to extend credit............. $ 75,574 $ 75,574 $ 71,974 $ 71,974
Standby letters of credit................ 3,259 3,259 3,174 3,174
--------------- ---------------- --------------- ----------------
Total Unrecognized Financial
Instruments.......................... $ 78,833 $ 78,833 $ 75,148 $ 75,148
=============== ================ =============== ================
77
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 25 - Condensed Parent Company Information
Statements of Financial Condition
December 31,
---------------------------------
2002 2001
--------------- ---------------
Assets
Cash and due from banks...................................................... $ 15,853 $ 529,538
Investment in and amounts due from subsidiaries (equity
method) -eliminated upon consolidation..................................... 39,017,232 45,469,845
Other assets................................................................. 2,530,043 961,623
--------------- ----------------
Total Assets............................................................. $ 41,563,128 $ 46,961,006
=============== ================
Liabilities and Stockholders' Equity
Liabilities
Guaranteed preferred beneficial interest in the Company's
subordinated debentures.................................................... $ 10,310,000 $ 10,310,000
Note payable - commercial bank............................................... 6,650,000 --
Other liabilities............................................................ 900,082 527,126
--------------- ----------------
Total Liabilities........................................................ 17,860,082 10,837,126
Stockholders' Equity............................................................ 23,703,046 36,123,880
--------------- ----------------
Total Liabilities and Stockholders' Equity............................... $ 41,563,128 $ 46,961,006
=============== ================
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78
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 25 - Condensed Parent Company Information - Continued
Statements of Income
Years Ended December 31,
---------------------------------
2002 2001
--------------- ---------------
Income
From subsidiaries - eliminated upon consolidation:
Dividends.................................................................. $ 720,000 $ 2,115,710
Management fees............................................................ -- 218,000
Interest income............................................................ 31,357 27,228
--------------- ----------------
Total Income............................................................. 751,357 2,360,938
--------------- ----------------
Expenses
Interest expense............................................................. 1,099,886 905,562
Salaries and benefits........................................................ 2,119,946 394,734
Other expenses............................................................... 538,525 471,462
--------------- ----------------
Total Expenses........................................................... 3,758,357 1,771,758
--------------- ----------------
Income (loss) before income taxes and equity
in undistributed earnings of subsidiary...................................... (3,007,000) 589,180
Income tax benefit.............................................................. 1,279,879 583,857
--------------- ----------------
Income (loss) before equity in undistributed earnings of subsidiary............. (1,727,121) 1,173,037
Equity (deficit) in undistributed earnings of subsidiary........................ (12,685,662) 1,192,884
--------------- ----------------
Net Income (Loss)............................................................... $ (14,412,783) $ 2,365,921
=============== ================
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79
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 25 - Condensed Parent Company Information - Continued
Statements of Cash Flows
Years Ended December 31,
---------------------------------
2002 2001
--------------- ---------------
Operating Activities
Net income (loss)............................................................ $ (14,412,783) $ 2,365,921
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income of subsidiary............................... 12,685,662 (1,192,884)
Deferred tax benefit....................................................... (212,257) (14,548)
Other, net................................................................. 100,013 (778,339)
--------------- ----------------
Net Cash Provided By (Used In) Operating Activities...................... (1,839,365) 380,150
--------------- ----------------
Investing Activities
Capital injection in subsidiaries............................................ (6,500,000) (10,320,200)
--------------- ----------------
Net Cash Used In Investing Activities.................................... (6,500,000) (10,320,200)
--------------- ----------------
Financing Activities
Net proceeds from issuance of stock.......................................... 48,766 118,656
Compensatory options recognition............................................. 1,126,914 37,843
Issuance of guaranteed preferred beneficial interest in the
Company's subordinated debentures.......................................... -- 10,310,000
Loan proceeds - short-term borrowing......................................... 6,650,000 --
--------------- ----------------
Net Cash Provided By Financing Activities................................ 7,825,680 10,466,499
--------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents............................ (513,685) 526,449
Cash and Cash Equivalents at Beginning of Year.................................. 529,538 3,089
--------------- ----------------
Cash and Cash Equivalents at End of Year........................................ $ 15,853 $ 529,538
=============== ================
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80
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 26 - 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)
2002:
Total interest income........... $ 10,496 $ 10,592 $ 10,555 $ 10,296 $ 41,939
Total interest expense.......... 5,492 5,238 5,404 5,608 21,742
Provision for loan losses....... 609 3,087 9,380 16,393 29,469
Net interest income (loss)
after provision for
loan losses.................. 4,395 2,267 (4,229) (11,705) (9,272)
Other noninterest income........ 543 458 573 701 2,275
Other noninterest expense....... 4,885 3,016 3,392 4,010 15,303
Income tax benefit.............. 18 59 2,626 5,184 7,887
Net Income (Loss)............... 71 (232) (4,422) (9,830) (14,413)
Per Common Share:
Basic earnings (loss)........ 0.01 (0.03) (0.50) (1.13) (1.65)
Diluted earnings (loss)...... 0.01 (0.02) (0.44) (0.95) (1.40)
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
81
HERITAGE FINANCIAL HOLDING CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
Note 26 - 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)
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
82
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 15, 2003, in connection with the
Company's 2003 Annual Meeting of Stockholders is incorporated herein by
reference.
83
ITEM 14. CONTROLS AND PROCEDURES.
(a) Within the 90 days prior to the date of filing this Annual Report on Form
10-K, the Company carried out an evaluation, under the supervision and
participation of its management, including the Chief Executive Officer and
the Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rules 13a-14(c) and 15d-14(c). Based on that evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including
its consolidated subsidiaries) required to be included in the Company's
periodic SEC filings. However, the Company recently has experienced several
changes in top management, and the effectiveness of such disclosure
controls and procedures is dependent on the Company's personnel to report
any issues or matters required to be disclosed in the Company's SEC filings
to the appropriate management personnel on a timely basis.
(b) As previously reported, banking regulatory authorities recently performed
both a targeted, limited scope review of the Bank's loan portfolio and a
safety and soundness examination of the Bank. In conjunction with these
reviews, management commenced a comprehensive review of the Company's
internal control structures. Management's review of the internal control
structures of the Company and the Bank indicated significant weaknesses in
the Company's and the Bank's internal controls and procedures, particularly
with respect to the Bank's lending functions, including credit underwriting
and loan review. As a result of the information gathered in the course of
these reviews, management of both the Company and the Bank have taken steps
to modify and supplement internal controls and procedures in order to
augment the Company's reporting and to ensure timely evaluation of
reporting regarding the operations of the Bank, particularly with respect
to the credit and asset quality of the Bank. Furthermore, in the course of
these reviews, the Company and the Bank determined that certain internal
controls relating to loan policies and procedures have not been followed by
Bank personnel, and have taken steps to correct these matters, including
the dismissal of certain employees of the Bank. The Bank has retained a new
President and Chief Executive Officer, and, additionally, the Company has
changed outside legal counsel. Management has disclosed the control
weaknesses discovered in the course of its review to its Audit Committee
and to the outside auditors of the Company, and is continuing to seek their
advice and support in revising and supplementing the internal controls and
procedures of the Company and the Bank.
The management of the Company and the Bank, including the Chief Executive
Officer and Chief Financial Officer of the Company, does not expect that
either the disclosure controls or the internal controls of the Company and
the Bank will prevent all error and all fraud. A control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Control issues
can present particular difficulties for entities such as the Company and
the Bank, which have experienced recent lapses in their control systems and
are endeavoring to update their controls and procedures in a manner
designed to prevent future lapses. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within
the Company or the Bank have been detected. These inherent limitations
include the realities that judgment in decision-making can be faulty, and
that breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals in all
potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the
policies or procedures may deteriorate. Because of the inherent limitations
in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.
84
ITEM 15. 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
(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.
(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)-1Heritage 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)-2Heritage 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.
85
(10)-3Employment 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.
(10)-4Employment Agreement dated as of July 11, 2002, by and among Heritage
Financial Holding Corporation, Heritage Bank and Thomas E. Hemmings,
filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for
the period ended September 2002.
(10)-5Employment Agreement dated as of January 23, 2003, effective as of October
23, 2002, by and between Heritage Bank and Larry R. Mathews.
(10)-6Loan Agreement dated as of October 30, 2002, by and between Heritage
Financial Holding Corporation and First Tennessee Bank National
Association, filed as Exhibit 99.2 to the Company's Current Report on Form
8-K on November 5, 2002.
11 Statement re: computation of per share earnings
12 Statement re: computation of ratios
21 Subsidiaries of the Registrant
24 Powers of Attorney. See the signature page to this Annual Report on Form
10-K
(99)-1 Chief Executive Officer - Certification pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(99)-2 Chief Financial Officer - Certification pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
During the Quarter ended December 31, 2002, the Company filed the following
Current Reports on Form 8-K:
Form 8-K filed November 5, 2002 to disclose under Item 5 certain other events
related to a review of the Bank by regulatory authorities.
(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 III, Item
15(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 III, Item
15(a) (2) of this Annual Report on Form 10-K, and are incorporated herein by
reference.
86
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: March 28, 2003 By: /s/ Harold B. Jeffreys
----------------------- -------------------------------
Harold B. Jeffreys
Interim Chief Executive Officer
Date: March 28, 2003 By: /s/ Thomas E. Hemmings
----------------------- -------------------------------
Thomas E. Hemmings
Chief Financial Officer
87
CERTIFICATIONS
I, Harold B. Jeffreys, certify that:
1. I have reviewed this annual report on Form 10-K of Heritage Financial
Holding Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14, for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions);
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 28, 2003
-------------------------
/s/ Harold B. Jeffreys
-------------------------
Harold B. Jeffreys
Interim President and Chief Executive Officer
88
CERTIFICATIONS
I, Thomas E. Hemmings, certify that:
1. I have reviewed this annual report on Form 10-K of Heritage Financial
Holding Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14, for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions);
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 28, 2003
-------------------------
/s/ Thomas E. Hemmings
-------------------------
Thomas E. Hemmings
Chief Financial Officer
89
EXHIBIT (10)-5
EMPLOYMENT AGREEMENT
THIS AGREEMENT (this "Agreement"), is made and entered into this 23rd day
of January, 2003, but effective as of October 23, 2002, by and among Heritage
Financial Holding Corporation, a Delaware corporation (hereinafter referred to
as the "Company"), Heritage Bank, an Alabama state banking corporation (the
"Bank"), and Larry R. Mathews (the "Executive").
W I T N E S S E T H:
- - - - - - - - - - -
WHEREAS, the Company and the Bank desire to employ the Executive as
President and Chief Executive Officer of the Bank on the terms and conditions
hereinafter provided, and the Executive desires to accept such employment on the
terms and conditions hereinafter set forth;
NOW, THEREFORE, in consideration of the mutual promises, covenants and
agreements set forth in this Agreement, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto, intending to be legally bound, do
hereby agree as follows:
SECTION 1: EMPLOYMENT OF EXECUTIVE; DUTIES AND RESPONSIBILITIES
1.1 Employment of Executive. The Company and the Bank shall employ the
Executive, and the Executive shall provide services to the Company and the
Bank, as President and Chief Executive Officer of the Bank, upon and
subject to the terms and conditions of this Agreement.
1.2 Term of Employment of Executive. Subject to the provisions of Section 3
hereof, the employment of the Executive by the Company and the Bank
pursuant to this Agreement shall be for an initial term of three (3) years
commencing on October 23, 2002, and ending on October 22, 2005; provided
that such term may be renewed annually by mutual agreement of the Board of
Directors of the Bank, the Board of Directors of the Company and the
Executive for one additional year on each anniversary of the effective date
of this Agreement such that, if such renewal election is made by the Bank
and the Company, on each of such anniversary dates the remaining term
hereunder will be three years. The period of the Executive's employment
hereunder is referred to herein as the "Employment Period."
1.3 Offices and Positions of Executive. Except as otherwise mutually agreed by
the Company, the Bank and the Executive and subject to Section hereof, the
Executive shall serve as President and Chief Executive Officer of the Bank
and any other position agreed upon by the parties.
90
1.4 Duties and Responsibilities. During the Employment Period, the Executive
shall report directly to the Board of Directors of the Bank and the Board
of Directors of the Company and shall perform such duties and
responsibilities as the Board of Directors of the Bank and/or the Board of
Directors of the Company shall reasonably assign to the Executive from time
to time and as are commensurate with his position and which may be set
forth in the Bank's bylaws. During the Employment Period, Executive shall
devote his full business time, attention, skill and efforts to the
performance of his duties hereunder, except during periods of illness or
periods of vacation and leaves of absence consistent with the Company and
Bank policies. The Executive may devote reasonable periods of time to serve
as a director or advisor to other organizations, to charitable and
community activities and to managing his personal investments, provided
that such activities do not materially interfere with the performance of
his duties to the Company or the Bank and are not in conflict or
competitive with, or adverse to, the interests of the Company or the Bank.
The Executive's office shall be located in the City of Decatur, Alabama,
but the Executive understands and agrees that performance of his duties
hereunder may involve extensive travel.
1.5 Board of Directors Position. The Bank and the Company shall each use its
best efforts to cause the Executive to be elected to fill a vacant seat on
the Board of Directors of the Bank. If so elected, the Executive agrees to
serve as a member of the Board of Directors of the Bank, and the Bank
agrees that the Executive shall be entitled to indemnification as provided
by the terms of the Articles of Incorporation of the Bank, as amended from
time to time, and the bylaws of the Bank, as amended from time to time, and
that the Bank shall take any necessary steps to provide that the Bank's
directors and officers insurance coverage shall extend to Executive.
SECTION 2: COMPENSATION; REIMBURSEMENT; AND BENEFITS
2.1 Base Salary and Bonus. During the Employment Period, the Company and/or the
Bank shall pay to the Executive the annual base salary (the "Base Salary")
at the rate of $185,000 per year (provided that nothing herein requires or
shall be construed to require duplicate salary payments by each of the Bank
and the Company), beginning October 23, 2002 and continuing at such rate
until December 31, 2003. Beginning with calendar year 2004, the Base Salary
shall be reviewed no less frequently than annually by the compensation
committee of the Board of Directors of the Bank for the year 2004 and for
each subsequent calendar year; if the Board of Directors in its discretion
should modify the Base Salary upon any such review then, for purposes of
this Agreement, the term Base Salary shall thereafter mean such modified
amount, provided that the Base Salary may not be decreased without the
consent of Executive.
In addition to the Base Salary, the Company and/or the Bank may pay the
Executive such bonus or bonuses, if any, as the Board of Directors of the
Company and/or the Bank may from time to time determine. The Executive
shall be eligible to be considered for bonuses under the Executive
Management Bonus Program of the Company and/or the
91
Bank, and specific criteria will be developed for the position of President
and Chief Executive Officer of the Bank under the terms of such Executive
Management Bonus Program.
2.2 Payment of Base Salary and Bonus. The Company and/or the Bank shall pay the
Base Salary and bonuses, if any, due the Executive in accordance with the
policy or policies of the Company and/or the Bank as in effect from time to
time for the payment of salary and bonuses to senior executive personnel.
2.3 Incentive Stock Option. Within one hundred eighty (180) days of the
effective date of this Agreement, the Company shall grant to Executive
stock options (the "Option") to acquire one hundred twenty thousand
(120,000) shares of the common stock of the Company, par value $0.01 per
share, pursuant to and in accordance with the terms and conditions of the
Heritage Financial Holding Corporation Incentive Stock Compensation Plan
(the "Plan"), and the Option shall be an Incentive Stock Option (as defined
in the Plan) as to the greatest number of shares permitted pursuant to the
Plan and shall be a Supplemental Stock Option (as defined in the Plan) with
respect to the remaining shares. The per share exercise price of the Option
shall be not less than the fair market value of a share of common stock of
the Company as of the date of the grant, as required under the terms of the
Plan. The Option shall vest according to the following schedule: (i) 20,000
shares shall vest immediately upon the date of the grant; (ii) 20,000 shall
vest on the first anniversary of the date of the grant; (iii) 20,000 shall
vest on the second anniversary of the date of the grant; (iv) 20,000 shall
vest on the third anniversary of the date of the grant; and (v) 20,000
shall vest on the fourth anniversary of the date of the grant; and (vi)
20,000 shares shall vest on the fifth anniversary of the date of the grant.
Notwithstanding the foregoing, in the event of a Change of Control (as
defined in Section 3.1(d) of this Agreement), the Option shall become fully
vested immediately upon the effective time of such Change of Control, as
provided by the terms of the Plan.
2.4 Insurance. The Executive shall participate in any long term defined benefit
plan of the Company and/or the Bank with respect to Bank Owned Life
Insurance, if and when any such plan is implemented by the Company and/or
the Bank. The Company and/or the Bank shall purchase, and shall be the
owner of, a term life insurance policy in the face amount of $1,000,000 for
Executive, the beneficiary of which shall be a trust or such other
beneficiary as may be designated by the Executive; provided that upon the
termination of Executive's employment hereunder for any reason other than
death, the Executive may purchase such policy from the Company and/or the
Bank on such terms as may be agreed upon by the parties at such time or
else the Company and/or the Bank may terminate such policy or otherwise
permit it to lapse; and provided further, that upon agreement of the
Company and/or the Bank and the Executive, the Company and/or the Bank's
obligation pursuant to this sentence may be satisfied by the assumption of
a certain term life insurance policy in the face amount of $1,000,000 for
Executive which Executive currently owns. The Company and/or the Bank shall
purchase disability insurance for the benefit of the Executive with a
benefit per month that is at least equal to one-twelfth of the Base Salary
hereunder, assuming that Executive qualifies for such an amount of
disability insurance under the benefit programs or plans of the Company
and/or the Bank.
92
2.5 Other Benefits. The Executive shall be entitled to participate on the same
basis as other similarly situated employees of the Company and the Bank in
all incentive and benefit programs or arrangements made available by the
Company and the Bank to such employees.
2.6 Automobile; Cellular Telephone. During the Employment Period, the Company
and/or the Bank will furnish the Executive with the use of an automobile in
accordance with the Bank's Executive Automobile Program dated as of May 28,
2002, subject to the policies and procedures of the Company and the Bank
with respect to the personal use of such automobile. During the Employment
Period, the Company or the Bank will furnish the Executive with the use of
a cellular telephone subject to the policies and procedures of the Company
or the Bank, as applicable, with respect to the personal use of such
telephone.
2.7 Business Expenses. The Company and/or the Bank shall reimburse the
Executive for all reasonable expenses incurred by him in accordance with
the standard policies and procedures of the Company and/or the Bank in the
course of rendering his services pursuant to this Agreement; provided,
however, that the Executive shall promptly submit such reasonable
documentation as may be requested by the Company and/or the Bank to verify
such expenditures.
2.8 Country Club and Civic Club Dues. The Company and/or the Bank shall
reimburse the Executive's reasonable expenses for initiation fees, dues and
capital assessments for membership in the Decatur Country Club and for
other civic club memberships, as authorized by the compensation committee,
entered by the Executive during the Employment Period; provided that if the
Executive during the Employment Period ceases his membership in any such
clubs and any bonds or other capital payments made by the Company and/or
the Bank are repaid to the Executive, the Executive shall pay over such
payments to the Company and/or the Bank; and provided further, that upon
the termination of the Executive's employment hereunder, Executive shall
either terminate such memberships and return to the Company and/or the Bank
any bonds or other capital payments made by the Company and/or the Bank
that are repaid to the Executive or purchase such memberships from the
Company and/or the Bank and reimburse the Company and/or the Bank for any
and all initiation fees and bonds or other capital payments made by the
Company and/or the Bank with respect to such memberships.
2.9 Vacation. The Executive shall be entitled to three (3) weeks of paid
vacation per year. The vacation to which the Executive is entitled pursuant
to this Section 2.9 shall be available under the same terms and conditions
as are applicable to similarly situated executive personnel of the Company
and the Bank. The Executive shall take into consideration the needs of the
Company and the Bank in setting his vacation schedule.
2.10 Relocation Expenses. The Company and/or the Bank shall pay, or reimburse
the Executive for, reasonable moving expenses of Executive, as approved in
advance by the compensation committee of the Company's
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and/or the Bank's Board of Directors, in connection with the relocation by
Executive of his primary residence to Decatur, Alabama. Executive shall
promptly submit such reasonable documentation as may be requested by the
Company and/or the Bank to verify such moving expenses.
2.11 Indemnification. The Executive shall be entitled to indemnification (and to
reimbursement of expenses incurred in connection with such indemnified
claims, etc.) as an officer and director of the Bank to the full extent
provided for in the Articles of Incorporation and Bylaws of the Bank, as
the same may be amended from time to time, and subject to applicable law.
The Bank shall also use its best efforts to obtain coverage for the
Executive under any insurance policy now in force or hereinafter obtained
during the term of this Agreement covering the other officers and directors
of the Bank against lawsuits.
SECTION 3 TERMINATION OF EMPLOYMENT
3.1 Termination of Employment Period. The Employment Period may be terminated
in the following manner:
(a) Termination on Death or Disability. The Employment Period shall
automatically terminate upon the death or Disability of the Executive.
The term "Disability" shall mean the Executive's physical or mental
incapacity that renders him incapable of performing the essential
functions of the duties required of him by this Agreement for one
hundred eighty (180) or more consecutive days, even with reasonable
accommodation. In the case of termination upon the Disability of the
Executive, there shall be a determination by the Board of Directors of
the Company and/or the Bank that such grounds for termination exist.
(b) Termination upon Notice. The Employment Period may be terminated by
the Executive at any time, upon thirty (30) days' written notice to
the Company and/or the Bank. The Employment Period may be terminated
by the Company and/or the Bank, by resolution of its Board of
Directors, for any other reason other than for "Cause" (as defined in
Section 3.1(c) of this Agreement), upon thirty (30) days written
notice to the Executive.
(c) Termination for Cause. The Employment Period may be terminated by the
Company and/or the Bank, by resolution of its Board of Directors, for
"Cause" at any time during the Employment Period immediately upon
written notice to the Executive, which notice shall state the facts
constituting such "Cause." For the purpose of this Section , the term
"Cause" shall mean (i) intentional misconduct or gross malfeasance, or
an act or acts of gross negligence in the course of employment or any
material breach of Executive's obligations contained herein,
including, without limitation, acts competitive with or deliberately
harmful to the business of the Company or the Bank; (ii) any
intentional misstatement or omission to the directors or executive
officers of the Company or the Bank with respect to any matter; (iii)
the intentional failure of the Executive to follow the reasonable
instructions and policies of the Company or the Bank; (iv) the
Executive's conviction, admission or confession of any felony or an
94
unlawful act involving active and willful fraud or moral turpitude; or
(v) the violation by the Executive of applicable state and federal
regulations, rules, or statutes. The Company and/or the Bank shall
have the power to temporarily suspend Executive (with such pay, if
any, as the Company and/or the Bank may determine) from duty if there
is substantial evidence of probable Cause until Cause is either proved
or disproved; if disproved, full reinstatement with pay will
immediately be effected.
(d) Termination for Good Reason. The Employment Period may be terminated
by the Executive for "Good Reason," as hereinafter defined, at any
time during the Employment Period upon thirty (30) days' written
notice to the Company and/or the Bank, which notice shall state the
facts constituting such "Good Reason." For the purpose of this Section
3.1(d), the term "Good Reason" shall mean (i) a significant change,
without the consent of the Executive, in the nature or scope of the
Executive's authorities or duties from those described in Sections 1.3
and 1.4 or those generally commensurate with the position of President
and Chief Executive Officer of the Bank; (ii) the occurrence of a
Change in Control (as hereinafter defined), (iii) a reduction in the
Executive's base salary without his consent, or (iv) following a
Change in Control, a reduction in the Executive's base salary or any
failure to pay the Executive any compensation or benefits to which he
is entitled within five days of the date due, or the failure by the
Company and the Bank to (A) continue in effect (without reduction in
benefit level and/or reward opportunities) any material compensation
or employee benefit plan in which the Executive was participating at
any time within ninety days preceding the date of a Change in Control
or at any time thereafter, unless such plan is replaced with a plan
that provides substantially equivalent compensation or benefits to the
Executive or (B) provide the Executive with compensation and benefits,
in the aggregate, at least equal (in terms of benefit levels and/or
reward opportunities) to those provided for under each other employee
benefit plan, program and practice in which the Executive was
participating at any time within ninety days preceding the date of a
Change in Control or at any time thereafter. For the purpose of this
Section 3.1(d), the term "Change in Control" means (A) the acquisition
at any time by a "person" or "group" (as such terms are used in
Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934
(the "Exchange Act")) who or which are the beneficial owners (as
defined in Rule 13(d)-3 under the Exchange Act), directly or
indirectly, of securities representing more than 35% of the combined
voting power in the election of directors of the then outstanding
securities of the Company or any successor of the Company; (B) if
during any period (an "Applicable Period") of two (2) years or less,
with the first day (the "Start Date") for any such Applicable Period
to be no earlier than the effective date of this Agreement, there
shall occur the termination (except by reason of death, disability,
voluntary resignation or retirement) of the service of the Required
Number of the persons serving as of the Start Date as directors of the
Board of Directors of the Company (as used herein, the "Required
Number" of directors shall be that number which, as of the Start Date,
constituted a majority of the Board of Directors of the Company); (C)
the sale or disposition (which shall not include a pledge by the
Company of the capital stock of the Bank as security for obligations
of the Company unless and until the pledgee thereof exercises remedies
against said stock to effect a sale or disposition) by the Company of
any of the capital stock of the Bank or approval by the shareholders
of the Company of any sale or disposition of substantially all of the
assets or earning power of the Company; (D) approval by the
shareholders of the Company of any merger, consolidation, or statutory
95
share exchange to which the Company is a party as a result of which
the persons who were shareholders immediately prior to the effective
date of the merger, consolidation or share exchange shall have
beneficial ownership of less than 35 % of the combined voting power in
the election of directors of the surviving corporation; or (E) the
appointment of an individual as chief executive officer of the Company
if such individual is not the Executive, a member of the Board of
Directors of the Company as of the date hereof, or an individual
mutually agreed upon by the Executive and the Company.
3.2 Consequences of Termination.
(a) By the Company and/or the Bank for Cause or By Executive other than
for Good Reason. In the event Executive's employment is terminated (i)
by the Company and/or the Bank for Cause under Section 3.1(c) hereof,
(ii) by the Executive other than for Good Reason under Section 3.1(d)
hereof, or (iii) as a result of the Executive's death or Disability
under Section hereof, neither the Company or the Bank shall be under
any further obligation to make any payments or provide any benefits to
the Executive, except for Base Salary earned but unpaid at the time of
such termination, expenses otherwise reimbursable herein incurred by,
but not yet reimbursed to, the Executive at the time of such
termination, any earned but unpaid incentive awards due to the
Executive, and group health coverage that is required to be continued
by applicable law.
(b) By the Company and/or the Bank other than for Cause or By Executive
for Good Reason. In the event the Employment Period is terminated by
the Executive for Good Reason under Section 3.1(d) hereof or by the
Company and/or the Bank for a reason other than Cause pursuant to
Section 3.1(b) hereof, the Company and/or the Bank shall pay to the
Executive (i) an aggregate amount equal to two (2) times the Base
Salary, payable in monthly installments each equal to one-twelfth of
the Base Salary, for the twenty-four months following such
termination, and (ii) Base Salary earned but unpaid at the time of
such termination, expenses otherwise reimbursable herein incurred by,
but not yet reimbursed to, the Executive at the time of such
termination, any earned but unpaid incentive awards due to the
Executive, and group health coverage that is required to be continued
by applicable law; provided, however, that, at the election of the
Company and/or the Bank by decision of its Board of Directors, the
Company and/or the Bank may pay to the Executive, in lieu of the
payment provided for by (i) above, an aggregate amount equal to one
(1) times the Base Salary, payable in monthly installments each equal
to one-twelfth of the Base Salary, for the twelve months following
such termination and, if the Company and/or the Bank makes such
election, the non-competition period under Section 4.3(a) shall be
reduced to a period of one (1) year following such termination;
provided further, however, that neither the Company or the Bank shall
have the right to make any such election in anticipation of or
following a Change in Control. In addition, in the event the
Employment Period is terminated by the Executive for Good Reason under
Section 3.1(d) hereof or by the Company and/or the Bank for a reason
other than Cause pursuant to Section 3.1(b) hereof, the Option granted
pursuant to Section 2.3 hereof shall become fully vested immediately
upon the effective time of such termination.
96
(c) Obligation of the Company and/or the Bank to make the payments under
Section 3.2(b) of this Agreement. Compliance by the Executive with
Section 4 of this Agreement is a condition precedent to the Company's
and/or the Bank's obligation to make, or to continue to make, the
payments referred to in Section 3.2(b) of this Agreement.
(d) Payments made to the Executive net of Taxes. All payments made by the
Company or the Bank to the Executive pursuant to this Agreement shall
be received by the Executive net of all applicable withholding and
payroll taxes.
(e) Resignation from Board of Directors. Executive agrees to tender his
resignation as a director of the Bank, if he is then serving in such
capacity, immediately upon the termination of his employment hereunder
for any reason.
(f) Certain Litigation Expenses. If litigation after a Change in Control
should be brought to enforce or interpret any provision contained in
this Agreement and the Executive shall prevail in such litigation, the
Company and the Bank shall, to the full extent permitted by applicable
law, indemnify Executive for Executive's reasonable attorneys' fees
and disbursements incurred in such litigation to the extent the
Executive has prevailed therein.
(g) Employment by Company and Bank. In the event that the Employment
Period is terminated by any of the Company or the Bank or the
Executive pursuant to this Section 3, then the Executive's employment
by both the Company and the Bank shall be terminated.
SECTION 4: CONFIDENTIALITY PROVISIONS; PROHIBITION OF INSIDER TRADING AND
TIPPING; NON-COMPETITION
4.1 Confidentiality. (a) The Executive hereby acknowledges that during the
Employment Period he will have contacts with and develop and service the
customers of the Company, the Bank and their affiliates and that in all of
his activities, and through the nature of complying with his obligations
pursuant to this Agreement, he will have access to and will acquire
confidential and proprietary information, including, but not limited to,
information relating to the business, assets, operations, customers,
suppliers, contractual parties and other persons with whom the Company, the
Bank and their affiliates do business. The Executive hereby acknowledges
and confirms that such information constitutes the exclusive and unique
property of the Company, the Bank or their affiliates, as the case may be,
and that such information is proprietary and confidential in nature.
(b) The Executive agrees that he shall not at any time during the term of
Employment or thereafter disclose to other persons or entities (except
as permitted in writing and as directed by the Board of Directors of
the Company or the Board of Directors of
97
the Bank or only as to the extent required pursuant to a subpoena or
order of a court of competent jurisdiction) any such information
referred to in Section 4.1(a) of this Agreement.
4.2 Prohibition of Insider Trading and Tipping. The Executive acknowledges that
during the Employment Period he may become aware of or be provided with
material non-public information concerning the Company. The Executive
acknowledges and agrees that the trading in, purchase or sale of any
security of the Company while in possession of any material non-public
information concerning the Company is prohibited as is the unauthorized
communication of any such information to any person or entity. The
Executive agrees to abide by these prohibitions and shall use all
reasonable efforts to cause his affiliates to abide by these prohibitions.
4.3 Non-Competition.
(a) In the event the Executive's employment under this Agreement shall be
terminated during the Employment Period by the Executive for Good
Reason under Section 3.1(d) hereof or by the Company or the Bank for a
reason other than Cause pursuant to Section 3.1(b) hereof, then for
two (2) years following such termination (subject to the proviso
contained in Section 3.2(b) hereof), and in the event the Executive's
employment under this Agreement shall terminate for any other reason
pursuant to Section 3.1 of this Agreement during the Employment Period
then for one (1) year following such termination, the Executive shall
not, in any county where the Company, the Bank or any of their
majority-owned subsidiaries has a bank branch that accepts deposits
that are insured by the Federal Deposit Insurance Corporation ("FDIC")
at the time of such termination (each a "Branch County"), or in Shelby
County, Alabama (which is contiguous to a Branch County), physically
work or perform services as a consultant to, or serve as a member of
management or as an employee of, a financial institution whose
deposits are insured by the FDIC. Bank branches of successors and
assigns of the Company or the Bank shall not be considered in
determining the prohibited geographical area. Notwithstanding the
foregoing, this Section 4.3 shall not apply at any time after a Change
in Control shall have occurred. In the event that the Company and/or
the Bank is obligated to pay to the Executive the payments provided
for in Section 3.2(b) of this Agreement and the Company and/or the
Bank fails to make, or fails to continue to make, the payments
referred to in Section 3.2(b) within ten (10) days of such payments or
portions thereof becoming due under Section 3.2(b), then the Executive
shall thereafter cease to be subject to the provisions of this Section
4.3, provided that nothing in this sentence shall be construed to
release the Executive from the obligations set forth in this Section
4.3 in the event that Executive's employment is terminated in a manner
which does not give rise to the payment obligations under Section
3.2(b) (including, without limitation, termination by the Company for
Cause under Section 3.1(c) hereof or by the Executive other than for
Good Reason under Section 3.1(d) hereof).
(b) The parties have entered into this Section 4.3 in good faith and for
the reasons set forth in the recitals hereto and assume that this
Agreement is legally binding. If, for any reason, this Agreement is
not binding because of its geographical scope or because of its term,
then the parties agree that this Agreement shall be
98
deemed effective to the widest geographical area and/or the longest
period of time (but not in excess of two years) as may be legally
enforceable.
4.4 Specific Performance. The Executive agrees that in the event of a breach or
threatened breach of Section 4.1, 4.2 or 4.3 of this Agreement, that the
Company and the Bank are likely to suffer, and will suffer, immediate and
irreparable injury for which there is no adequate remedy at law. Therefore,
in addition to any other rights or remedies which the Company and the Bank
may have under this Agreement, the Company and the Bank will be entitled to
enforce the specific performance of this Agreement by the Executive and to
obtain a preliminary injunction, without the requirement of posting a bond,
enjoining the Executive from engaging in any activity in violation thereof.
SECTION 5: ADDITIONAL CONDITIONS
5.1 Condition to Executive's Employment. The initial employment of Executive
under this Agreement is subject to the Company's and/or the Bank's receipt
and review of Executive's credit history and personal financial statements
and subject to the information contained therein being satisfactory to the
Company in its sole discretion.
SECTION 6: GENERAL PROVISIONS
6.1 Non-assignability. Neither this Agreement nor any of the rights,
obligations or interest arising hereunder may be assigned by the Executive
without the prior written consent of the Company and the Bank; provided,
however, that nothing in this Section 6.1 shall preclude the Executive from
designating, in writing, a beneficiary to receive any compensation payable
to him or any other benefit receivable by him under this Agreement upon the
death or incapacity of the Executive, nor shall it preclude the executors,
administrators or any other legal representatives of the Executive or his
estate from assigning any rights hereunder to the person or persons
entitled thereto. Neither this Agreement nor any of the rights, obligations
or interest arising hereunder may be assigned by the Company and the Bank
without the prior written consent of the Executive to a person other than
(1) an affiliate of the Company, or (2) any party with which the Company
merges or consolidates, or to whomever the Company may sell all or
substantially all of its assets; provided, however, that any such affiliate
or successor shall expressly assume all of the Company's and the Bank's
obligations and liabilities to the Executive under this Agreement.
6.2 Severability. This Agreement shall be deemed severable and any part hereof
which may be held invalid by a court or other entity of competent
jurisdiction shall be deemed automatically excluded from this Agreement and
the remaining parts shall remain in full force and effect.
99
6.3 Merger. This Agreement contains the entire understanding of the parties
hereto and constitutes the only agreement between the Company, the Bank and
the Executive regarding the employment of the Executive by the Company and
the Bank. This Agreement supersedes all prior agreements, either express or
implied, between the parties hereto regarding the employment of the
Executive by the Company and/or the Bank.
6.4 Amendment. None of the terms and conditions of this Agreement shall be
amended or modified unless expressly consented to in writing and signed by
each of the parties hereto.
6.5 Governing Law. This Agreement shall be governed by and construed under the
laws of the State of Alabama without regard to provisions thereof governing
conflicts of law.
6.6 Notices. All notices or other communications to be given by the parties
among themselves pursuant to this Agreement shall be in writing, and all
payments to be made hereunder shall be deemed to have been duly made if
mailed by certified mail or hand delivered to either of the parties at
their respective addresses as they appear on the records of the Company.
Any of the parties hereto may change their respective addresses upon
written notice to the other given in the manner provided in this Section.
6.7 Waiver. No waiver by any of the parties to this Agreement of any condition,
term or provision of this Agreement shall be deemed to be a waiver of any
preceding or subsequent breach of the same or any other condition, term or
provision hereof.
6.8 Survival. Notwithstanding anything in this Agreement to the contrary, and
notwithstanding any termination of the Employment Period, the provisions of
this Agreement intended to govern the obligations of the parties hereto
upon the termination of the Executive's employment hereunder for any
reason, including, but not limited to Section 3 (inclusive of each of the
subsections thereof) and Section 4, shall continue in full force and
effect.
100
IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
at the date and year first above written.
HERITAGE FINANCIAL HOLDING
CORPORATION
/s/ Timothy A. Smalley
----------------------------------
Timothy A. Smalley
Chairman of the Board of Directors
HERITAGE BANK
/s/ Timothy A. Smalley
----------------------------------
Timothy A. Smalley
Chairman of the Board of Directors
/s/ Larry R. Mathews
----------------------------------
Larry R. Mathews
101
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, 2002, 2001 and 2000.
2002 2001 2000
------------- ------------- -------------
Basic Earnings (Loss) Per Share:
Net income (loss)............................................$(14,412,783) $ 2,365,921 $ 2,187,531
============= ============= =============
Earnings (loss) on common shares............................. (1.65) 0.28 0.26
============= ============= =============
Weighted average common shares outstanding - basic........... 8,717,303 8,484,624 8,316,756
============= ============= =============
Basic earnings (loss) per common share....................... (1.65) 0.28 0.26
============= ============= =============
Diluted Earnings (Loss) Per Share:
Net income (loss)............................................$(14,412,783) $ 2,365,921 $ 2,187,531
============= ============= =============
Weighted average common shares outstanding................... 8,717,303 8,484,624 8,316,756
Net effect of the assumed exercise of stock
options - based on the treasury stock method
using average market price for the year.................... 1,544,767 2,002,342 1,817,109
------------- ------------- -------------
Weighted average common shares outstanding - diluted............ 10,262,070 10,486,966 10,133,865
============= ============= =============
Diluted earnings (loss) per common share........................$ (1.40) $ 0.23 $ 0.22
============= ============= =============
102
EXHIBIT 12 - STATEMENTS RE: COMPUTATION OF RATIOS
HERITAGE FINANCIAL HOLDING CORPORATION
Computation of Ratio of Earnings to Fixed Charges
Year Ended December 31,
-------------------------------------------
2002 2001 2000
------------- ------------ -------------
(Dollars in thousands)
Pretax income (loss)............................................ $ (22,300) $ 3,590 $ 3,179
Add fixed charges:
Interest on deposits......................................... 19,717 26,752 20,867
Interest on borrowings....................................... 2,025 1,843 1,152
Portion of rental expense representing interest expense...... 209 151 118
------------- ------------ -------------
Total fixed charges....................................... 21,951 28,746 22,137
------------- ------------ -------------
Income (loss) before fixed charges.............................. $ (349) $ 32,336 $ 25,316
============= ============ =============
Pretax income (loss)............................................ $ (22,300) $ 3,590 $ 3,179
Add fixed charges (excluding interest on deposits):
Interest on borrowings....................................... 2,025 1,843 1,152
Portion of rental expense representing interest deposits..... 209 151 118
------------- ------------ -------------
Total fixed charges....................................... 2,234 1,994 1,270
------------- ------------ -------------
Income (loss) before fixed charges
(excluding interest on deposits)............................. $ (20,066) $ 5,584 $ 4,449
============= ============ =============
Ratio of Earnings (Loss) to Fixed Charges
Including interest on deposits............................... (0.02) 1.12 1.14
Excluding interest on deposits............................... (8.98) 2.80 3.50
103
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
Subsidiaries - Direct/Wholly-owned State of Incorporation
Heritage Bank Alabama
Heritage Financial Statutory Trust I Connecticut
104
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 2002 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
Interim President, Chief Executive Officer and
/s/ Harold B. Jeffreys Director
_________________________ Harold B. Jeffreys March 28, 2003
(Principal Executive Officer)
/s/ Thomas E. Hemmings Chief Financial Officer
_________________________ Thomas E. Hemmings March 28, 2003
(Principal Accounting Officer)
/s/ Timothy A. Smalley Chairman of the Board and Director March 28, 2003
_________________________ Timothy A. Smalley
/s/ Bingham D. Edwards Director March 28, 2003
_________________________ Bingham D. Edwards
/s/ Lenny L. Hayes Director March 28, 2003
_________________________ Lenny L. Hayes
/s/ Neal A. Holland, Jr. Director March 28, 2003
_________________________ Neal A. Holland, Jr.
/s/ Larry Landman Director March 28, 2003
_________________________ Larry Landman
/s/ Vernon A. Lane Director March 28, 2003
_________________________ Vernon A. Lane
/s/ John T. Moss Director March 28, 2003
_________________________ John T. Moss
/s/ T. Gerald New, M.D. Director March 28, 2003
_________________________ T. Gerald New, M.D.
105
/s/ Gregory Parker Director March 28, 2003
_________________________ Gregory Parker
/s/ Betty B. Sims Director March 28, 2003
_________________________ Betty B. Sims
/s/ Jeron Witt Director March 28, 2003
_________________________ Jeron Witt
106
EXHIBIT 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
In connection with Heritage Financial Holding Corporation's ("Company") Annual
Report on Form 10-K for the period ended December 31, 2002 ("Report"), the
undersigned certifies that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: March 28, 2003 By: /s/ Harold B. Jeffreys
------------------- ---------------------------------------------
Harold B. Jeffreys
Interim President and Chief Executive Officer
107
EXHIBIT 99.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
In connection with Heritage Financial Holding Corporation's ("Company") Annual
Report on Form 10-K for the period ended December 31, 2002 ("Report"), the
undersigned certifies that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: March 27, 2003 By: /s/ Thomas E. Hemmings
------------------- ---------------------------------------------
Thomas E. Hemmings
Chief Financial Officer
108