Heritage Bankshares (HBKS) 10-K/A 2008 FY Annual report (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

Amendment No. 1

x ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 0-11255

HERITAGE BANKSHARES, INC.

(Exact Name of Registrant as Specified in its Charter)

Virginia	54-1234322
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
150 Granby Street Norfolk, Virginia	23510
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number (757) 648-1700

Securities registered pursuant to Section 12(b) of the Exchange Act: None

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $5.00 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Section 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of the registrant’s stock held by non-affiliates of the registrant as of June 30, 2008 was approximately $24,435,000, computed by reference to the sales price of the Common Stock of the Company on June 30, 2008 of $13.50 per share, and 1,810,000 shares of voting stock held by non-affiliates of the Company on June 30, 2008.

As of February 27, 2009, 2,279,252 shares of Common Stock of the Company, par value $5.00 per share, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None.

EXPLANATORY NOTE

Pursuant to Rule 12b-15 of the Securities Exchange Act of 1934, this Amendment No. 1 on Form 10-K/A (this “Amendment”) to the Annual Report on Form 10-K of Heritage Bankshares, Inc. (the “Company”) for the year ended December 31, 2008 (the “Form 10-K”) is being filed to revise the Company’s Consolidated Statement of Cash Flows for the year ended December 31, 2008 (the “Cash Flow Statement”), and Note 5 to the Company’s Consolidated Financial Statements — Loans (“Note 5”) as explained below.

During the preparation of the Cash Flow Statement, purchases of securities were reflected as cash flows used by investing activities, including those that were pending settlement for which no cash had been expended. The offsetting liability affected cash flows from operating activities as an increase in other liabilities. Current thinking, however, is that, because the pending settlement does not represent a true cash item, its effect should be reversed from operating activities as well as from purchases of securities. The Cash Flow Statement has been revised accordingly.

In Note 5, the Company has revised its calculation for the “Average investment in impaired loans (while impaired)” for 2008 to present the “Daily average investment in impaired loans during the period” instead. The Company believes impaired loan exposure calculated on an average daily basis better presents the average recorded investment in its impaired loans during 2008.

Such revisions have no impact on the Report of Independent Registered Public Accounting Firm included in the Company’s Form 10-K.

This Amendment continues to speak as of the date of the Form 10-K and no attempt has been made to modify or update disclosures in the Form 10-K, except as noted above. This Amendment does not reflect events occurring after the filing of the Form 10-K or modify or update any related disclosures and information not affected by the Amendment is unchanged and reflects the disclosure made at the time of the filing of the Form 10-K with the Securities and Exchange Commission on March 26, 2009.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

The Stockholders and Board of Directors

Heritage Bankshares, Inc.

Norfolk, Virginia

We have audited the consolidated balance sheets of Heritage Bankshares, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 Bankshares, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

/s/ Elliott Davis LLC

Galax, Virginia

May 14, 2009

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HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

At December 31, 2008 and 2007

	2008		2007
ASSETS
Cash and due from banks	$	5,304,046	$	5,463,202
Federal funds sold		8,113,693		8,956,822
Cash and cash equivalents		13,417,739		14,420,024
Securities available for sale, at fair value		60,742,946		38,114,589
Securities held to maturity, at cost		—		676,261
Loans, net
Held for investment, net of allowance for loan losses of $1,652,174 and $1,399,875, respectively		176,561,604		153,850,151
Held for sale		—		878,200
Accrued interest receivable		734,821		811,644
Stock in Federal Reserve Bank, at cost		322,800		312,900
Stock in Federal Home Loan Bank of Atlanta, at cost		622,700		716,000
Premises and equipment, net		11,908,044		9,962,768
Other real estate owned		177,500		—
Other assets		1,006,242		1,503,077
Total assets	$	265,494,396	$	221,245,614
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Noninterest-bearing	$	53,988,420	$	48,390,271
Interest-bearing		161,793,271		137,624,213
Total deposits		215,781,691		186,014,484
Federal Home Loan Bank Advance		5,000,000		7,000,000
Securities sold under agreements to repurchase		1,246,536		1,130,780
Other borrowings		1,000		50,000
Accrued interest payable		236,636		320,957
Pending settlement, securities available for sale		15,846,233		—
Other liabilities		1,496,350		1,604,789
Total liabilities		239,608,446		196,121,010
Commitments and contingent liabilities
Stockholders’ equity
Common stock, $5 par value – authorized 3,000,000 shares; issued and outstanding: 2,279,252 shares at December 31, 2008; 2,278,652 shares at December 31, 2007		11,396,260		11,393,260
Additional paid-in capital		6,329,854		6,172,256
Retained earnings		7,486,301		7,345,024
Accumulated other comprehensive income, net		673,535		214,064
Total stockholders’ equity		25,885,950		25,124,604
Total liabilities and stockholders’ equity	$	265,494,396	$	221,245,614

The notes to consolidated financial statements are an integral part of these statements.

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2008 and 2007

	2008		2007
Interest income
Loans and fees on loans	$	9,847,868	$	9,963,316
Taxable investment securities		1,662,764		1,887,600
Nontaxable investment securities		32,726		50,153
Dividends on FRB and FHLB stock		47,224		43,832
Interest on federal funds sold		142,944		816,758
Other interest income		7,228		11,917
Total interest income		11,740,754		12,773,576
Interest expense
Deposits		3,476,331		5,198,529
Borrowings		235,615		81,160
Total interest expense		3,711,946		5,279,689
Net interest income		8,028,808		7,493,887
Provision for loan losses		452,770		104,644
Net interest income after provision for loan losses		7,576,038		7,389,243
Noninterest income
Service charges on deposit accounts		415,093		505,615
Late charges and other fees on loans		51,732		66,030
Gains on sale of loans held for sale, net		91,533		120,215
Net gains on sale of investment securities		518,148		1,170
Gain on sale of fixed assets		6,030		529,530
Gain on sale of other real estate owned		36,702		—
Settlement with a former professional services provider		—		345,000
Other		328,613		410,784
Total noninterest income		1,447,851		1,978,344
Noninterest expense
Compensation		4,088,588		4,179,058
Occupancy		798,033		780,143
Furniture and equipment		554,504		531,452
Data processing		527,317		519,427
Professional fees		346,701		438,592
Taxes and licenses		269,586		217,300
Marketing		118,758		138,239
Telephone		101,363		119,439
Stationery and supplies		78,954		130,417
FDIC insurance		96,277		64,508
Loss on disposal or impairment of fixed assets		69,778		66,351
Other		895,176		783,303
Total noninterest expense		7,945,035		7,968,229
Income before provision for income taxes		1,078,854		1,399,358
Provision for income taxes		390,665		479,314
Net income	$	688,189	$	920,044
Earnings per common share
Basic	$	0.30	$	0.40
Diluted	$	0.30	$	0.40
Dividends per share	$	0.24	$	0.24
Weighted average shares outstanding – basic		2,278,849		2,278,579
Effect of dilutive stock options		15,471		15,965
Weighted average shares outstanding – assuming dilution		2,294,320		2,294,544

The notes to consolidated financial statements are an integral part of these statements

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years Ended December 31, 2008 and 2007

	Common Stock			Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income		Total
	Shares	Amount
Balance, December 31, 2006	2,277,652	$	11,388,260	$	6,031,549	$	6,971,856		$	12,513	$	24,404,178
Comprehensive income:
Net income for 2007	—		—		—		920,044			—		920,044
Change in unrealized gain on securities available-for-sale, net of tax of $103,831	—		—		—		—			201,551		201,551
Total comprehensive income												1,121,595
Exercise of stock options and related tax benefits	1,000		5,000		5,281		—			—		10,281
Equity-based compensation expense	—		—		135,426		—			—		135,426
Cash dividends ($0.24 per share)	—		—		—		(546,876	)		—		(546,876	)
Balance, December 31, 2007	2,278,652	$	11,393,260	$	6,172,256	$	7,345,024		$	214,064	$	25,124,604
Comprehensive income:
Net income for 2008	—		—		—		688,189			—		688,189
Change in unrealized gain on securities available-for-sale, net of reclassification adjustment and tax of $236,697	—		—		—		—			459,471		459,471
Total comprehensive income	—		—		—		—			—		1,147,660
Exercise of stock options and related tax benefits	600		3,000		2,319		—			—		5,319
Equity-based compensation expense	—		—		155,279		—			—		155,279
Cash dividends ($0.24 per share)							(546,912	)				(546,912	)
Balance, December 31, 2008	2,279,252	$	11,396,260	$	6,329,854	$	7,486,301		$	673,535	$	25,885,950

The notes to consolidated financial statements are an integral part of these statements.

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

Years Ended December 31, 2008 and 2007

	2008			2007
Cash flows from operating activities:
Net Income	$	688,189		$	920,044
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss		452,770			104,644
Amortization of loan yield adjustments, net		414,086			475,091
Depreciation, amortization and accretion, net		371,426			(21,512	)
Stock based compensation		155,279			135,426
Exercise of stock options tax benefit		969			3,461
Lease incentive		—			242,840
Net (gains) losses on sale of:
Securities		(518,147	)		(1,170	)
Property, plant, and equipment		69,778			(529,530	)
Other assets		—			(20,480	)
Other real estate owned		(36,702	)		—
Loss on sale, disposal or impairment of long-lived assets		—			66,351
Changes in assets/liabilities, net
Decrease(Increase) in interest receivable and other assets		336,961			(479,027	)
Increase(Decrease) in interest payable and other liabilities		(184,525	)		358,168
Decrease(Increase) in loans held for sale		878,200			(358,200	)
Net cash provided by operating activities		2,628,284			896,106
Cash flows from investing activities:
Proceeds from maturities and principal repayments of securities available for sale		18,202,267			33,611,191
Proceeds from maturities and principal repayments of securities held to maturity		105,941			2,737
Purchases of securities available for sale		(52,824,185	)		(40,822,941	)
Proceeds from sales of securities available for sale		29,228,364			14,815,500
Proceeds from sales of securities held to maturity		568,771			—
Proceeds from sale of other assets		—			73,431
Proceeds from sale of other real estate owned		552,202			—
Net increase in loans held for investment		(24,271,310	)		(14,311,377	)
Purchases of Federal Home Loan Bank stock and Federal Reserve Bank stock		(2,417,400	)		(1,125,000	)
Redemption of Federal Home Loan Bank stock		2,500,800			818,300
Purchases of premises and equipment		(2,573,450	)		(3,955,848	)
Proceeds from sales of premises and equipment		6,030			736,769
Net cash used for investing activities		(30,921,970	)		(10,157,238	)
Cash flows from financing activities:
Proceeds from exercise of stock options		4,350			6,820
Net increase (decrease) in deposits		29,767,207			(2,382,801	)
Proceeds from Federal Home Loan Bank advances		56,500,000			25,000,000
Repayments of Federal Home Loan Bank advances		(58,500,000	)		(18,000,000	)
Net increase (decrease) in securities sold under agreements to repurchase		115,756			(2,585,212	)
Proceeds from federal funds purchased		48,002,000			—
Repayment of federal funds purchased		(48,001,000	)		—
Repayments of other borrowings		(50,000	)		(5,000,000	)
Cash dividends paid		(546,912	)		(546,876	)
Net cash provided by (used for) financing activities		27,291,401			(3,508,069	)
Decrease in cash and cash equivalents		(1,002,285	)		(12,769,201	)
Cash and cash equivalents, beginning of period		14,420,024			27,189,225
Cash and cash equivalents, end of period	$	13,417,739		$	14,420,024
Supplemental disclosure:
Interest paid	$	3,796,267		$	5,335,212
Income Taxes paid	$	465,000		$	345,000
Noncash financing activities:
Transfer of loans to other real estate owned	$	1,078,000		$	—
Transfer of other real estate owned to loans	$	385,000		$	—
Pending settlement of securities available for sale	$	15,846,233		$	—

The notes to consolidated financial statements are an integral part of these statements.

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HERITAGE BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2008 AND 2007

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Heritage Bankshares, Inc. and its wholly-owned subsidiary, Heritage Bank. All significant intercompany balances and transactions have been eliminated in consolidation.

Nature of Operations

Heritage Bankshares, Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia in 1983, and at December 31, 2008, serves as the holding company for its wholly-owned subsidiary, Heritage Bank.

Heritage Bank (the “Bank”) is a wholly-owned subsidiary of the Company and is a state banking corporation engaged in the general commercial and retail banking business. The Bank is a full-service bank conducting a general commercial and consumer banking business with its customers located throughout the Hampton Roads area of Virginia. The Bank has one wholly-owned subsidiary, Sentinel Financial Group, Inc. (“Sentinel Financial”). At December 31, 2008, Sentinel Financial owned an interest in each of Infinex Investments, Inc. (formerly Bankers Investment Group, LLC), and Bankers Insurance, LLC, providers of various insurance and investment products. The financial activities pertaining to these interests are recorded on the cost method of accounting for investments. In addition, at December 31, 2008, Sentinel Financial owned other real estate owned. This real estate is recorded at fair value.

IBV Real Estate Holdings, Inc. (“IBV”), formerly a wholly-owned subsidiary of the Company formed for the sole purpose of owning additional real estate assets acquired by the Company or the Bank, was voluntarily dissolved and terminated by the Company. The accompanying consolidated financial statements of the Company include, where applicable, the results of operations and accounts of IBV prior to its dissolution and termination in 2008.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 periods presented. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of deferred tax assets.

Significant Group Concentrations of Credit Risk

Substantially all of the Company’s lending activities are with customers located in southeastern Virginia. Note 5 presents the Company’s lending activities. The Company invests in a variety of securities, principally obligations of the U.S., U.S. government sponsored enterprises, mortgage-backed securities and obligations of states and political subdivisions. Note 4 presents the Company’s investment activities. The Company does not have any significant concentrations of loans in any one industry or customer.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and overnight investments with Federal Home Loan Bank.

Investment Securities

Investment securities are classified in three categories and accounted for as follows:

• Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost.

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• Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings.

• Debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, a separate component of stockholders’ equity.

Gains and losses on sales of securities are computed based on specific identification of the adjusted cost of each security and included in other income. Amortization of premiums and accretion of discounts are computed by the effective yield method and recognized in interest income.

Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to fair value. These write-downs would be included in earnings as realized losses.

Loans

Loans are reported at their principal outstanding balance net of charge-offs, deferred loan fees and costs on originated loans, unearned income, and unamortized premiums or discounts, if any, on purchased loans. Interest income is generally recognized when income is earned using the interest method. Loan origination fees and certain direct loan origination costs are deferred and the net amounts are amortized as an adjustment to yield on the respective loans.

Loans Held For Sale

Mortgage loans originated and intended for sale in the secondary market are carried at cost. Loans held for sale are pre-committed to secondary market investors and, subsequent to being closed, are held for short holding periods pending receipt of loan documents.

Allowance For Loan Losses

The Bank maintains an allowance for loan losses at a level which, in management’s judgment, is adequate to absorb estimated credit losses on existing loans. The amount of the allowance is affected by: (1) loan charge-offs, which decrease the allowance, (2) recoveries on loans previously charged-off, which increase the allowance, and (3) the provision for loan losses charged to income, which increases the allowance.

The Bank analyzes its loan portfolio through ongoing credit review processes and constructs a comprehensive allowance analysis for its loan portfolio at least quarterly. This analysis includes two basic elements: (1) specific allowances for individual loans, and (2) general allowances for loan portfolio segments, which factor in historical loan loss experience and delinquency rates for the Bank and the banking industry and numerous other environmental factors.

The Bank evaluates various loans individually for impairment as required by Statement of Financial Accounting Standard (“SFAS”) No. 114,“Accounting by Creditors for Impairment of a Loan.” An evaluation is based upon either discounted cash flows or collateral evaluations. If the evaluation shows that a particular loan is impaired, then a specific reserve is established, or a charge-off is made, for the amount of any impairment.

For loans without an individual measure of impairment, the Bank makes estimates of losses for groups of loans as required by SFAS No. 5,“Accounting for Contingencies.” As part of the loan loss reserve methodology, loans are placed into one of four major categories or segments of loans: (1) commercial and industrial loans, (2) consumer loans, (3) 1-4 family residential loans (including home equity loans and lines), and (4) multi-family and other commercial real estate loans.

The Bank then considers the impact of various bank, industry, economic and other environmental factors and documents which factors are used in the analysis.

The Bank’s allowance for loan losses is divided into four distinct portions: (1) Historical – an amount based on the Bank’s actual net charge-offs; (2) Impaired Loans – an amount for specific allocations on significant individual credits under SFAS 114; (3) Loan Segments – an amount to adjust the historical allocation for the four loan segments based on environmental factors under SFAS 5; and (4) Unallocated – an amount to reflect the imprecision inherent in these calculations.

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Income Recognition on Nonaccrual Loans

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-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful, or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual, if repayment in full of principal and/or interest is in doubt.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower.

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. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis.

Other Real Estate Owned

Other real estate owned is comprised of real estate acquired through foreclosure, acceptance of a deed in lieu of foreclosure, or loans in which the Company receives physical possession of the debtor’s real estate. Other real estate owned is carried at the lower of the recorded investment in the loan or the fair value of the real estate less estimated costs to sell. Net operating income of such properties, exclusive of depreciation, is included in other income and related depreciation expense is included in other expense.

Restructured Loans

Loans are considered troubled debt restructurings if, for economic or legal reasons, a concession has been granted to the borrower related to the borrower’s financial difficulties that the Company would not have otherwise considered. The Company restructures certain loans in instances where a determination is made that greater economic value will be realized under new terms than through foreclosure, liquidation, or other disposition. The terms of the renegotiation generally involve some or all of the following characteristics: a reduction in the interest pay rate to reflect actual operating income, an extension of the loan maturity date to allow time for stabilization of operating income, and partial forgiveness of principal and interest.

The carrying value of a restructured loan is reduced by the fair value of assets or equity interest received from the borrower, if any. Prior to demonstrating performance, the Company generally classifies restructured loans as nonaccrual. The accrual of interest resumes when such loans can demonstrate performance, generally evidenced by six months of pre- or post-restructuring payment performance in accordance with the restructured terms, or by the presence of other significant factors. In addition, at the time of restructuring, loans are generally classified as impaired. A restructured loan that is not impaired, based on the restructured terms, and has a stated interest rate greater than or equal to a market interest rate at the date of the restructuring, is reclassified as unimpaired in the year immediately following the year it was disclosed as restructured.

Off Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit and issue standby letters of credit. Such financial instruments are recorded when they are funded.

Rate Lock Commitments

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e., rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 90 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. In such instances, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss is recognized on the rate lock commitments.

Sale of Loans

Transfers of loans are accounted for as sales when control over the loans has been surrendered. Control over transferred loans is deemed to be surrendered when (1) the loans have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred loans, and (3) the Company does not maintain effective control over the transferred loans through an agreement to repurchase them before their maturity.

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Premises and Equipment

Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets, ranging from 2 years to 40 years.

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

As a member of the Federal Reserve Bank (“FRB”), the Company is required to hold shares of FRB capital stock, $100 par value, in an amount equal to 6% of the Bank’s total common stock and capital surplus.

As a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, the Company is required to hold shares of capital stock in the FHLB in an amount equal to 0.18% of total assets plus 4.50% of borrowings from the FHLB.

FRB stock and FHLB stock are carried at cost.

Income Taxes

The Company files a consolidated tax return. Provisions for income taxes reflect tax expense incurred as a consolidated group. Tax expense is allocated among the members of the consolidated group in accordance with an intercompany agreement for tax expense. 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 investment securities, deferred loan fees, allowance for loan losses, allowance for losses on foreclosed real estate, premises and equipment and deferred compensation 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. An allowance is provided if it is more likely than not that the Company will not realize the benefits of a deferred tax asset. Through December 31, 2008, no valuation allowance has been provided against the Company’s deferred tax asset.

The Company analyzes tax positions taken or expected to be taken on its tax returns to determine if it has any liability related to uncertain tax positions in accordance with FIN 48. Liabilities, if any, resulting from this evaluation are recorded in the current period.

Deferred Compensation Plans

The Company maintains deferred compensation agreements with certain current and former directors and the beneficiary of its former chief executive officer. The Company’s policy is to accrue the present value of estimated amounts to be paid under the contracts over the required service period to the date the participant is fully eligible to receive the benefits. At December 31, 2008, the discount rate the Company utilized to determine the deferred compensation liability was determined by computing the average of the last three year-end periods’ AA corporate bond yield, whose approximate maturity corresponded to the approximate time remaining to pay out the expected benefits for each participant.

Bank-Owned Life Insurance

The Company has purchased life insurance policies on certain current and former directors. Company-owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

Stock Compensation Plans

At December 31, 2008, the Company has one stock-based compensation plan, the Heritage 2006 Equity Incentive Plan (the “2006 Incentive Plan”). Prior to January 1, 2006, the Company had elected to account for stock options pursuant to APB No. 25,Accounting for Stock Issued to Employees.Effective January 1, 2006, the Company adopted SFAS No. 123(R),Accounting for Stock-Based Compensation (“SFAS 123(R)”). SFAS 123(R) requires that the fair value of equity instruments, such as stock options, be recognized as an expense in the financial statements as services are performed. The Company elected to follow the modified prospective transition method, under which compensation expense is recognized prospectively for all unvested options outstanding at January 1, 2006 and for all awards modified or granted after that date. The Company had no existing stock options that remained unvested as of January 1, 2006. A description of the 2006 Incentive Plan and additional disclosures required by SFAS No. 123(R) are included in Note 10.

10

Earnings Per Common Share

Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. Earnings per share calculations are presented in Note 9.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, and realized gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Components of other comprehensive income are presented in Note 2.

Business Segments

The Company currently reports its activities as a single business segment. In determining appropriate segment definition and reporting, the Company considers components of the business about which financial information relating to performance and resource allocation is available and regularly evaluated by management. Management determines components for which it will implement performance and resource measurement procedures based upon criteria of relative importance and materiality to the organization.

Reclassifications

Certain reclassifications have been made to prior year financial statements to conform them to the current year presentation.

NOTE 2 – OTHER COMPREHENSIVE INCOME

The components of other comprehensive income and related tax effects are as follows:

	Years Ended December 31,
	2008			2007
Unrealized holding gains on available-for-sale securities	$	696,168		$	305,382
Tax Effect		(236,697	)		(103,831	)
Net of tax amount	$	459,471		$	201,551

NOTE 3 – RESTRICTIONS ON CASH AND DUE FROM BANKS

The Bank is required to maintain average balances on hand or with the Federal Reserve Board. At December 31, 2008 and 2007, these reserve balances amounted to $0 and $412,000, respectively.

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NOTE 4 – SECURITIES

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
At December 31, 2008
Securities available for sale
U.S. Treasury Securities	$	1,761,259	$	12,493	$	3	$	1,773,749
Mortgage-backed securities		57,961,180		1,011,768		3,751		58,969,197
Total securities available for sale	$	59,722,439	$	1,024,261	$	3,754	$	60,742,946
Total securities(1)	$	59,722,439	$	1,024,261	$	3,754	$	60,742,946
(1)    At December 31, 2008, the Company held no securities classified as held to maturity.
At December 31, 2007
Securities available for sale
U.S. Treasury securities	$	999,226	$	5,614	$	—	$	1,004,840
U.S. government sponsored enterprises		5,002,563		27,137		—		5,029,700
Mortgage-backed securities		31,098,629		264,500		—		31,363,129
Obligations of states and political subdivisions		689,831		27,089		—		716,920
Total securities available for sale		37,790,249		324,340		—		38,114,589
Securities held to maturity
Mortgage-backed securities		6,512		91		—		6,603
Obligations of states and political subdivisions		469,749		10,286		—		480,035
Preferred trust securities		200,000		9,200		—		209,200
Total securities held to maturity		676,261		19,577		—		695,838
Total securities	$	38,466,510	$	343,917	$	—	$	38,810,427

Investment securities having carrying value of $150,001 and $1,483,201 at December 31, 2008 and 2007, respectively, were made available to secure deposits of the U.S. government and the Commonwealth of Virginia. The fair values of these securities were $149,998 and $1,499,266 at December 31, 2008 and 2007, respectively.

Investment securities having carrying values of $6,079,726 and $5,002,563 at December 31, 2008 and 2007, respectively, are made available for retail repurchase agreements. The estimated fair values of these securities were $6,300,249 and $5,029,700 at December 31, 2008 and 2007, respectively.

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The following tables show gross unrealized losses and fair value on investment securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008 and 2007. The current year unrealized losses on investment securities, if any, are a result of changes in interest rates during the periods. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities and the short duration of the unrealized loss.

	At December 31, 2008
	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasury Securities	$	149,998	$	3	$	—	$	—	$	149,998	$	3
Mortgage-backed securities		3,376,929		3,751		—		—		3,376,929		3,751
Total temporarily impaired securities	$	3,526,927	$	3,754	$	—	$	—	$	3,526,927	$	3,754
	At December 31, 2007
	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasury Securities	$	—		—	$	—	$	—	$	—	$	—
Mortgage-backed Securities		—		—		—		—		—		—
Total temporarily impaired securities	$	—	$	—	$	—	$	—	$	—	$	—

The amortized cost and fair value of investment securities at December 31, 2008, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities since some securities may be called or prepaid prior to their contractual maturity:

	Securities Available for Sale				Securities Held to Maturity (1)
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	1,761,258	$	1,773,749	$	—	$	—
Due after one year through five years		19,138,285		19,415,522		—		—
Due after five years through ten years		20,963,426		21,490,459		—		—
Due after ten years		17,859,470		18,063,216		—		—
Total	$	59,722,439	$	60,742,946	$	—	$	—

(1) At December 31, 2008, the Company held no securities classified as held to maturity.

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NOTE 5 – LOANS

Loans consist of the following:

	At December 31,
	2008			2007
Commercial	$	32,847,457		$	26,108,173
Real estate - mortgage		112,371,561			101,095,900
Real estate - construction		27,883,927			23,104,633
Installment and consumer		4,385,595			4,149,881
Total loans:		177,488,540			154,458,587
Allowance for loan losses		(1,652,174	)		(1,399,875	)
Unearned loan fees/costs		725,238			791,439
Loans net	$	176,561,604		$	153,850,151

Nonperforming assets were:

	At December 31,
	2008		2007
Nonaccrual loans (1)	$	30,754	$	136,650
Accruing loans past due 90 days or more		9,937		26,709
Total nonperforming loans		40,691		163,359
Real estate owned, net		177,500		—
Total nonperforming assets	$	218,191	$	163,359

(1) At December 31, 2008 and 2007, includes restructured loans of $0 and $136,650, respectively.

If interest on nonaccrual loans had been accrued, such income would have approximated $21,502 and $35,216 in 2008 and 2007, respectively, none of which was recognized in income.

A summary of the activity in the allowance for loan losses account is as follows:

	At December 31,
	2008			2007
Balance, beginning of year	$	1,399,875		$	1,373,000
Provision for loan losses		452,770			104,644
Loans charged-off		(397,818	)		(196,941	)
Recoveries		197,347			119,172
Balance, end of year	$	1,652,174		$	1,399,875

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The following is a summary of information pertaining to impaired loans:

	At December 31,
	2008		2007
Impaired loans without a valuation allowance	$	30,754	$	—
Impaired loans with a valuation allowance		—		136,650
Total impaired loans:	$	30,754	$	136,650
Valuation allowance related to impaired loans	$	—	$	20,497
	Years Ended December 31,
	2008		2007
Daily average investment in impaired loans during the period	$	195,786	$	175,499
Interest income recognized on impaired loans	$	—	$	—

NOTE 6 – PREMISES AND EQUIPMENT

Premises and equipment consist of the following:

	At December 31,
	2008			2007
Land and improvements	$	3,915,500		$	3,915,500
Buildings and improvements		2,941,100			1,414,381
Leasehold improvements		1,710,267			1,875,159
Equipment, furniture and fixtures		3,137,027			3,131,775
Fixed assets not in service		2,462,485			1,713,278
		14,166,379			12,050,093
Less – accumulated depreciation		(2,258,335	)		(2,087,325	)
	$	11,908,044		$	9,962,768

Depreciation expense for the years ended December 31, 2008 and 2007 was $552,366 and $497,866, respectively.

In 2008 and 2007, the Company incurred losses on disposal and impairment charges related to equipment of $69,778 and $66,351, respectively.

Total rent expense for the years ended December 31, 2008 and 2007 amounted to $353,379 and $333,781, respectively.

Future minimum lease payments, by year and in the aggregate, under noncancelable leases with remaining terms of one year or more at December 31, 2008 were as follows:

2009	$	229,998
2010		234,598
2011		239,290
2012		244,076
2013- 2017		1,137,000
	$	2,084,962

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NOTE 7 – DEPOSITS

Interest-bearing deposits consist of the following:

	December 31,
	2008		2007
Money Market and NOWs	$	106,386,474	$	83,858,366
Savings		2,753,441		2,139,648
Certificates of deposit $100,000 and over		4,704,899		7,281,976
Other time deposits		47,948,457		44,344,223
	$	161,793,271	$	137,624,213

At December 31, 2008 the scheduled maturities of time deposits are as follows:

2009	$	47,322,405
2010		3,180,015
2011		1,631,536
2012		263,205
2013 and thereafter		256,195
	$	52,653,356

NOTE 8 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS

Investment securities having carrying values of $6,079,726 and $5,002,563 and fair values of $6,300,248 and $5,029,700 were made available to secure deposits of the U.S. Government, the Commonwealth of Virginia and retail repurchase agreements at December 31, 2008 and December 31, 2007, respectively. Information concerning securities sold under agreements to repurchase is summarized as follows:

	December 31,
	2008			2007
Balance at end of year	$	1,246,536		$	1,130,780
Average balance during the year	$	1,662,391		$	1,461,922
Weighted average interest rate during the year		1.48	%		3.80	%
Interest expense during the year	$	24,667		$	55,592
Maximum month-end balance during the year	$	2,324,857		$	2,109,625

The Bank is a member of the FHLB of Atlanta, which had established, at December 31, 2008, a credit availability for the Bank in an amount equal to 20% of total assets. At December 31, 2008, the Bank had a $5.0 million outstanding medium term advance which will mature on March 4, 2013. At December 31, 2008, other short-term borrowings consisted of $1,000 of Federal Funds purchased from correspondent banks.

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NOTE 9 – EARNINGS PER SHARE RECONCILIATION

The Company calculates its basic and diluted earnings per share (“EPS”) in accordance with SFAS No. 128 –Earnings Per Share. The components of the Company’s EPS calculations are as follows:

	Years Ended December 31,
	2008		2007
Net income (numerator, basic and diluted)	$	688,189	$	920,044
Weighted average shares outstanding (denominator)		2,278,849		2,278,579
Earnings per common share – basic	$	0.30	$	0.40
Effect of dilutive securities
Weighted average shares outstanding		2,278,849		2,278,579
Effect of stock options		15,471		15,965
Diluted average shares outstanding (denominator)		2,294,320		2,294,544
Earnings per common share – assuming dilution	$	0.30	$	0.40

Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is calculated by applying the treasury stock method. Under the treasury stock method, the exercise of dilutive stock options is assumed. The sum of the assumed proceeds of (a) the stock option exercises, (b) the amount of any tax benefits that would be credited to additional paid-in capital assuming exercise of the options, and (c) the unamortized compensation expense on in-the-money options not yet recognized pursuant to FAS 123(R) (see Note 10 – Employee and Director Benefit Plans – Stock Compensation Plans) are assumed to be used to purchase common stock at the average market price during the period. The incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased), if any, are included in the denominator of the diluted earnings per share calculation.

Any difference in the number of shares used for basic earnings per share and diluted earnings per share for each of the two years results solely from the dilutive effect of stock options. Options on an average of 222,500 shares and 157,000 shares were not included in computing diluted earnings per share for the years ended December 31, 2008 and December 31, 2007, respectively, because the effects of the options were antidilutive.

NOTE 10 – EMPLOYEE AND DIRECTOR BENEFIT PLANS

Stock Compensation Plans

Effective January 1, 2006, the Company adopted SFAS No. 123(R),Accounting for Stock-Based Compensation (“SFAS 123(R)”). SFAS 123(R) requires that the fair value of equity instruments, such as stock options, be recognized as an expense in the financial statements as services are performed. The Company elected to follow the modified prospective transition method, under which compensation expense is recognized prospectively for all unvested options outstanding at January 1, 2006 and for all awards modified or granted after that date. The Company had no existing stock options that remained unvested as of January 1, 2006.

Under the Heritage 2006 Equity Incentive Plan (“2006 Incentive Plan”), the Board of Directors may grant up to 250,000 stock options, stock appreciation rights, restricted stock and certain other equity awards, in the aggregate, to officers and nonemployee directors of the Company and the Bank. The Board of Directors may approve the grant of nonstatutory stock options and options qualifying as incentive stock options, and the option price of both a nonstatutory stock option and an incentive stock option will be the fair market value of the Company’s common stock on the date of grant. Prior to January 28, 2009, “Fair Market Value” was defined generally as the weighted average (based on daily trading volume) during the thirty (30) day period next preceding the date of grant of the “last sale” prices of a share of the Company’s common stock on the five (5) days nearest preceding the date of grant on which at least 300 shares were traded. On January 28, 2009, the Board amended the definition of “Fair Market Value” under the 2006 Incentive Plan to consist of the following: (i) the closing price of a share of the Company’s common stock on the OTC Bulletin Board on the grant date of the applicable award, if the grant date is a trading day; or (ii) if shares of the Company’s common stock are not traded on the grant date of the applicable award, then the closing price of a share of common stock on the OTC Bulletin Board on the next preceding date on which a trade occurred; or (iii) if (i) and (ii) are inapplicable, the fair market value as determined in good faith by the Board.

A total of 200,000 options were outstanding at December 31, 2008 under the 2006 Incentive Plan. For purposes of determining the “fair value” under SFAS 123(R) of options granted under the 2006 Incentive Plan, the measurement date will be the

17

date of grant. The fair value of each stock option award is estimated on the measurement date using a Black-Scholes valuation model that uses assumptions described below. Expected volatility is based on the historical volatility of the Company’s stock, using weekly price observations over the expected term of the stock options. The expected term represents the period of time that stock options granted are expected to be outstanding and is estimated based on management’s business plan and provisions of the grant including the contractual term and vesting schedule. The expected dividend yield is based on recent dividend history. The risk-free interest rate is the U.S. Treasury zero coupon yield curve in effect at the measurement date for the period corresponding to the expected life of the option.

All options granted will become exercisable earlier upon a change in control (as defined in the 2006 Incentive Plan) of the Company. The options may also become exercisable earlier upon the optionee’s retirement, disability or death, and in the case of an optionee who is an employee, the optionee’s termination without cause or resignation for good reason. No option may be exercised after ten (10) years from the date of grant.

The estimates of fair value derived from the Black-Scholes option pricing model are theoretical values for stock options, and changes in assumptions used in the model could result in materially different fair value estimates. The actual value of the stock options will depend on the market value of the Company’s common stock when the options are exercised. There were no options granted in 2008. The fair value of options granted during 2007 were estimated with the following assumptions:

	Year Ended December 31 2007
Expected dividend yield	1.6%
Expected stock price volatility	21.2%
Risk-free interest rate	3.76%
Expected life of options	6.5 years
Weighted average fair value of options granted during the period	$ 3.54

The following table presents a summary of stock option activity during 2008 and 2007:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Term (Years)	Aggregate Intrinsic Value
						(in thousands)
Outstanding at January 1, 2008	297,600		$	14.08	—		—
Granted	—			—	—		—
Exercised	(600	)		7.25	—		—
Forfeited/expired	(2,000	)		12.12	—		—
Outstanding at December 31, 2008	295,000		$	14.10	6.3	$	92
Exercisable at December 31, 2008	184,600		$	13.25	5.2	$	92
Outstanding at January 1, 2007	258,600		$	14.35	—		—
Granted	40,000			12.12	—		—
Exercised	(1,000	)		6.82	—		—
Forfeited/expired	—			—	—		—
Outstanding at December 31, 2007	297,600		$	14.08	6.6	$	292
Exercisable at December 31, 2007	142,000		$	12.58	5.4	$	292

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the applicable year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2008 and December 31, 2007, respectively. The amount changes based on the fair market value of the Company’s stock. The Company’s current policy is to issue new shares to satisfy share option exercises.

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The aggregate intrinsic value of options exercised for the twelve months ended December 31, 2008 and December 31, 2007 was $2,850 and $10,180, respectively. Cash received from option exercises during 2008 and 2007 was $4,350 and $6,820, respectively. The total fair value of shares vested for the same periods was $162,056 and $125,224, respectively.

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The amount charged against income, before income tax benefit of $14,475, in relation to the stock-based payment arrangement was $155,279 for the year ended December 31, 2008. The amount charged against income, before income tax benefit of $16,785, in relation to the stock-based payment arrangement, was $135,426 for the year ended December 31, 2007. At December 31, 2008, unrecognized compensation expense, net of estimated forfeitures, related to unvested stock option grants was $354,395 and is currently expected to be recognized over a weighted average period of 1.4 years as follows:

	Stock-Based Compensation Expense
	(in thousands)
For the year ended December 31:
2009	$	141
2010		136
2011		68
2012		9
Total	$	354

Stock option awards granted in 2008 and 2007 under the 2006 Incentive Plan provide for accelerated vesting under certain circumstances as defined in the Plan, such as a change of control with respect to the Company, the optionee’s retirement, death, permanent disability and, if the optionee is an employee of the Company, resignation for good reason or termination without cause. Occurrence of these events may cause the requisite service period to be less than reflected in the schedule above, and unamortized stock-based compensation expense recognized at that time.

Deferred Compensation Plan

In 1985, the Company entered into a deferred compensation and retirement arrangement with certain directors and subsequently with one officer. The Company’s policy is to accrue the present value of estimated amounts to be paid under the contracts over the required service period to the date the participant is fully eligible to receive the benefit. At December 31, 2008 and 2007, other liabilities included $669,222 and $707,059, respectively, related to the deferred compensation plans. Compensation expense related to this plan was $29,692 and $36,919, for the years ended December 31, 2008 and 2007, respectively.

Employee Stock Ownership Plan

The Board of Directors adopted an Employees’ Stock Ownership Plan (the “ESOP”) effective January 1, 1998. The ESOP covers substantially all employees after they have met eligibility requirements, and funds contributed to the plan are used to purchase outstanding common stock of the Company.

The Company recognized no compensation expense related to the ESOP for the years ended December 31, 2008 and 2007, respectively. Dividends received by the ESOP are used for administrative expenses of the plan. At both December 31, 2008 and 2007, the ESOP owned 10,271 shares of common stock of the Company. There were no stock purchases for the year ended December 31, 2008 and 786 shares purchased for the year ended December 31, 2007. No shares were distributed to terminated employees during either year. At December 31, 2008 and 2007, the fair market value of the total shares held by the ESOP totaled $82,168 and $114,522, respectively.

401(k) Retirement Program

Effective January 1, 1993, the Board of Directors adopted a Retirement Program (the “401(k)”). Eligible employees who have completed the required months of service are eligible to participate and make contributions. The Company makes employer matching contributions. The Company expensed $95,657 and $134,673 for the years ended December 31, 2008 and December 31, 2007, respectively.

NOTE 11 – OTHER REAL ESTATE OWNED

In December 2008, the Company foreclosed on three properties, two of which were sold during that month. At December 31, 2008, the Company had other real estate owned in the amount of $177,500. The Company had no other real estate owned at December 31, 2007.

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NOTE 12 – OTHER NONINTEREST INCOME AND EXPENSE

The components of other noninterest income are as follows:

	Years Ended December 31,
	2008		2007
Credit card interchange fees	$	37,312	$	35,707
ATM fees		123,584		129,989
Merchant discount fees		50,268		46,445
Income from bank-owned life insurance, net		20,270		21,008
Other		97,179		177,635
Total other noninterest income	$	328,613	$	410,784

The components of other noninterest expense are as follows:

	Years Ended December 31,
	2008		2007
ATM transaction	$	108,444	$	122,343
Credit card		3,780		(59	)
Postage		74,678		70,563
Courier		262,802		121,331
Service bureau expense		93,934		66,775
Insurance expense		46,717		46,287
Travel		28,157		24,261
Shareholder		38,765		43,513
Training		15,960		17,816
Loan servicing		20,779		36,357
Other miscellaneous		201,160		234,116
Total other noninterest expense	$	895,176	$	783,303

NOTE 13 – INCOME TAXES

The principal components of income tax expense are as follows:

	Years Ended December 31,
	2008			2007
Federal income tax expense/(benefit)-current	$	402,070		$	446,839
Deferred Federal income tax expense/(benefit)		(11,405	)		32,475
Income tax expense	$	390,665		$	479,314

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A reconciliation of income tax expense calculated at the federal statutory rate and that shown in the statements of income is summarized as follows:

	Years Ended December 31,
	2008			2007
Federal income tax expense – at 34% statutory rate	$	366,810		$	475,782
Effect of tax-exempt interest		(19,689	)		(28,780	)
Effect of Life insurance proceeds, premiums, and increases in value, net		(4,458	)		(4,708	)
Effect of FAS 123(R) – incentive stock options		37,805			29,259
Other		10,197			7,761
	$	390,665		$	479,314

A cumulative net deferred tax asset is included in other assets at December 31, 2008 and 2007. The components of the asset are as follows:

	At December 31,
	2008		2007
Deferred Tax Assets
Deferred compensation	$	227,536	$	240,400
Allowance for loan losses		490,994		405,213
FAS 123(R) – non-qualifying options		46,363		31,887
Investment in partnerships		12,530		12,228
Other		7,182		57,999
Total Deferred Tax Assets		784,605		747,727
Deferred Tax Liabilities
Deferred loan costs, net		246,581		269,089
Net appreciation on available-for-sale securities		330,610		110,275
Premises and equipment		133,689		83,435
Other		646		646
Total Deferred Tax Liabilities		711,526		463,445
Net Deferred Tax Assets	$	73,079	$	284,282

NOTE 14 – COMMITMENTS AND CONTINGENCIES—RELATED PARTY

During 2007 and prior years, the Company was a party to a lease with a related party to provide space for the Bank’s operations center. This lease was classified as an operating lease for financial reporting purposes. The facility that housed the operations center was sold in August 2007 to an unrelated party, and the Company leased the facility from the unrelated party from August 2007 until the lease was terminated in December 2008. Total rent expense paid by the Bank in 2007 in respect of the related party lease was $72,996 (the Company did not have any such related party lease expense in 2008).

In December 2006, the Bank contracted with Meredith Construction Company, Inc. (“Meredith Construction”) as general contractor to build, for a maximum price of $1.4 million (which includes approximately a $127,000 fee to Meredith Construction), the Bank’s new retail banking office at its Lynnhaven Parkway site in Virginia Beach. Peter M. Meredith, Jr. is Chairman and CEO of Meredith Construction, and Mr. Meredith also is Chairman of the Board of the Company. Meredith Construction is utilizing ColonialWebb Contractors Co. (“ColonialWebb”) as the heating and air conditioning subcontractor related to construction of the Lynnhaven office for a price of $82,454. Howard W. Webb is a director of ColonialWebb, and Mr. Webb also was a director of the Company, having retired at the end of January 2009.

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In December 2007, the Board approved signage for the Bank’s Lynnhaven office with Southern Atlantic Screenprint & Sign Company (“Southern”) for less than $1,000, and similarly in December of 2008 the Board approved signage to be provided by Southern for the Bank’s Laskin Road office for less than $1,000. James A. Cummings is a director of Southern, and Mr. Cummings also is a director of the Company.

In May 2007, the Bank again contracted with Meredith Construction as general contractor to build, for a maximum price of $2.3 million (which includes approximately a $208,000 fee to Meredith Construction), the Bank’s new retail banking office at its Laskin Road site in Virginia Beach. Meredith Construction again has utilized ColonialWebb as the heating and air conditioning subcontractor related to construction of the Laskin office for a price of $195,659.

The Bank also contracted in December 2008 with Meredith Construction as general contractor to renovate, for a maximum price of $111,076 (which includes approximately a $14,488 fee to Meredith Construction), the Bank’s retail banking office at its North Military Highway site in Norfolk.

NOTE 15 – OTHER RELATED PARTY TRANSACTIONS

The Bank has loan and deposit transactions with certain of its executive officers and directors, and with companies in which the officers and directors have a financial interest.

A summary of related party loan activity for the Bank is as follows:

	2008		2007
Balance, December 31	$	12,788,685	$	11,557,471
Originations		7,617,776		1,349,286
Repayments		3,570,789		3,718,072
Other*		—		3,600,000
Balance, December 31	$	16,835,672	$	12,788,685
*       The “Other” balance above includes loans for which related parties are partial guarantors.

In the opinion of management, such related party loans are made in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the same time for comparable loans to unrelated persons and did not involve more than the normal risk of collectibility or present other unfavorable features.

Commitments to extend credit and letters of credit to related parties amounted to $4,319,009 and $4,287,678 at December 31, 2008 and 2007, respectively. (See Note 14 for additional commitments to related parties.)

NOTE 16 – COMMITMENTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET CREDIT RISK

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

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

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The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Unless otherwise noted, the Company requires collateral or other security to support financial instruments with credit risk. Contractual amounts for financial instruments whose contract amounts represent credit risk at December 31, 2008 and December 31, 2007 were as follows:

	2008		2007
Commitments to extend credit	$	42,365,456	$	48,572,911
Standby letters of credit		2,155,080		2,061,113
Commitments to sell loans		—		417,000
	$	44,520,536	$	51,051,024

As of December 31, 2008, the Company had $7.6 million in deposits in financial institutions in excess of amounts insured by the FDIC, the majority of which was on deposit at the Federal Home Loan Bank of Atlanta.

NOTE 17 – REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements may result in certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital) to average assets (as defined). Management believes that, as of December 31, 2008, the Bank meets all capital adequacy requirements to which it is subject.

The Bank is “well capitalized” under the applicable regulatory framework. To be categorized as well capitalized, the Bank must maintain the minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios set forth in the table below. There are no conditions or events that management believes have changed the Bank’s categorization. Additionally, management believes that, as of December 31, 2008, the Company meets all capital adequacy requirements to which it is subject. At December 31, 2008, the Company’s total risk-based capital, Tier 1 risk-based capital, and Tier 1 capital (leverage) ratios were 13.43%, 12.61% and 10.13%, respectively.

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The capital amounts and ratios for the Company (consolidated) and the Bank as of December 31, 2008 and 2007 are presented in the following table:

	Actual				For Capital Adequacy Purposes				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
At December 31, 2008
Total Capital (to Risk-Weighted Assets)
Consolidated Company	$	26,865	13.43	%	$	16,000	8.0	%	$	N/A	N/A
Bank	$	26,393	13.20	%	$	15,997	8.0	%	$	19,997	10.0	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated Company	$	25,212	12.61	%	$	8,000	4.0	%	$	N/A	N/A
Bank	$	24,741	12.37	%	$	7,999	4.0	%	$	11,998	6.0	%
Tier 1 Capital (to Average Assets)
Consolidated Company	$	25,212	10.13	%	$	9,957	4.0	%	$	N/A	N/A
Bank	$	24,741	9.94	%	$	9,956	4.0	%	$	12,445	5.0	%
At December 31, 2007
Total Capital (to Risk-Weighted Assets)
Consolidated Company	$	26,310	14.99	%	$	14,043	8.0	%	$	N/A	N/A
Bank	$	25,591	14.61	%	$	14,015	8.0	%	$	17,519	10.0	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated Company	$	24,911	14.19	%	$	7,022	4.0	%	$	N/A	N/A
Bank	$	24,191	13.81	%	$	7,007	4.0	%	$	10,511	6.0	%
Tier 1 Capital (to Average Assets)
Consolidated Company	$	24,911	11.13	%	$	8,956	4.0	%	$	N/A	N/A
Bank	$	24,191	10.81	%	$	8,954	4.0	%	$	11,193	5.0	%

Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. Loans or advances are limited to 10.0% of the Bank’s stockholders’ equity.

NOTE 18 – DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following summary presents the methodologies and assumptions used to estimate the fair value of the Company’s financial instruments presented below. Because no active market readily exists for a portion of the Company’s financial instruments, fair values of some financial instruments are based on estimates using present value and other valuation techniques. Much of the information used to determine fair value is highly subjective in nature and therefore the results may not be precise. The subjective factors include, among other things, estimates of cash flows, risk characteristics, credit quality, and interest rates, all of which are subject to change. Accordingly, the amounts which will actually be realized or paid upon settlement or maturity of the various instruments could be significantly different.

Cash, Due From Banks and Federal Funds Sold

For cash due from banks and federal funds sold, the carrying amount is a reasonable estimate of fair value.

Investment Securities

Fair values are based on quoted market prices. For unquoted securities, the fair value is estimated by the Company on the basis of financial and other information. Securities available for sale are recorded at fair value.

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Loans

The fair value of loans is estimated by discounting the future estimated scheduled cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.

The fair value of loans does not include the value of the customer relationship or the right to fees generated by the account.

Accrued Interest Receivable

The carrying amount of accrued interest approximates fair value.

Stock in Federal Reserve Bank and Federal Home Loan Bank

The carrying value for FRB and FHLB stock approximates fair value.

Bank-Owned Life Insurance

The carrying value of life insurance approximates fair value, as this investment is carried at cash surrender value.

Deposit Liabilities

The fair value of deposits with no stated maturities (which includes demand deposits, savings accounts, and money market deposits) is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit was estimated using a discounted cash flow model based on the rates offered for deposits of similar remaining maturities. Weighted average rates paid and posted rates were used for December 2008 and 2007.

Deposit liabilities with no stated maturity are reported at the amount payable on demand without regard for the inherent funding value of these instruments. The Company believes that significant value exists in this funding source. The fair value of deposits does not include the value of the customer relationship or the rights to fees generated by the account.

Federal Home Loan Bank Advances

The fair value of FHLB advances is estimated using discounted cash flow analysis based on rates offered at the reporting date for borrowings of similar remaining maturities.

Other Borrowings and Securities Sold Under Agreements to Repurchase

The carrying amount for other borrowings and securities sold under agreements to repurchase is a reasonable estimate of fair value.

Accrued Interest Payable

The carrying value of accrued interest payable is a reasonable estimate of fair value.

Loan Commitments and Standby Letters of Credit

The carrying value of notional principal amounts of loan commitments and standby letters of credit are reasonable estimates of fair value.

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The following table presents the carrying amounts and fair value of the Company’s financial instruments at December 31, 2008 and December 31, 2007.

	2008				2007
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in Thousands)
Financial assets:
Cash and due from banks	$	5,304	$	5,304	$	5,463	$	5,463
Federal funds sold		8,114		8,114		8,957		8,957
Securities available for sale		60,743		60,743		38,115		38,115
Securities held to maturity		—		—		676		696
Loans held for investment		176,562		178,458		153,850		155,544
Loans held for sale		—		—		878		878
Accrued interest receivable		735		735		812		812
Stock in FRB and FHLB		946		946		1,029		1,029
Bank-owned life insurance		619		619		584		584
Financial Liabilities:
Deposits		215,782		216,150		186,014		186,004
Federal Home Loan Bank Advance		5,000		5,140		7,000		7,000
Other borrowing and securities sold under agreements to repurchase		1,248		1,248		1,131		1,131
Accrued interest payable		237		237		321		321

During 2008, the Bank converted to a model that calculates the fair value of loans and deposits in greater detail. Utilizing that model, the fair value of loans and deposits at December 31, 2007 was $155,544 and $186,004, respectively, rather than $157,044 and $185,949, respectively, as previously reported.

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements”, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Fair Value Hierarchy

SFAS 157 establishes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is based on quoted prices in active markets for identical assets or liabilities.

Level 2: Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3: Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value is measured based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other

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model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 2 securities include Treasury notes and bills, mortgage-backed securities issued by government sponsored entities, municipal bonds and other securities issued by government sponsored agencies.

Loans

The Company does not record loans at fair value on a recurring basis. From time to time, a loan is considered impaired. Loans which are deemed to be impaired are valued according to SFAS 114, “Accounting by Creditors for Impairment of a Loan”. The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value, and discounted cash flows. When the fair value of collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as Level 2. If the fair value of the loan is based on criteria other than observable market prices or current appraised value, the loan is recorded as Level 3. The Company had three impaired loans at December 31, 2008.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Foreclosed assets are carried at the lower of the carrying value or fair value. Fair value is based upon independent observable market prices or appraised values of the collateral, which the Company considers to be Level 2 inputs. The Company had foreclosed assets at December 31, 2008 with a fair value of $177,500.

General

The Company has no liabilities carried at fair value or measured at fair value on a nonrecurring basis.

The Company has no assets or liabilities whose fair values are measured using Level 3 inputs.

FASB Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the first quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis.

Assets Recorded at Fair Value on a Recurring Basis

December 31, 2008
in thousands	Total		Level 1		Level 2		Level 3
Investment in securities available for sale	$	60,743	$	—	$	60,743	$	—
Total Assets at Fair Value	$	60,743	$	—	$	60,743	$	—

Assets Recorded at Fair Value on a Non-Recurring Basis

December 31, 2008
in thousands	Total		Level 1		Level 2		Level 3
Impaired loans	$	31	$	—	$	31	$	—
Other real estate owned		178		—		178		—
Total Assets at Fair Value	$	209	$	—	$	209	$	—

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NOTE 19 – CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.

(Parent Company Only)

The following condensed financial statements of Heritage Bankshares, Inc. are presented below on a parent company only basis for the years indicated.

	At December 31,
	2008			2007
Condensed Balance Sheets
Assets
Cash	$	44,715		$	127,863
Investment in Heritage Bank		25,414,562			24,404,878
Other assets		478,699			660,336
Total Assets	$	25,937,976		$	25,193,077
Liabilities and Stockholders’ Equity
Other liabilities	$	52,026		$	68,473
Total Liabilities	$	52,026		$	68,473
Common stock		11,396,260			11,393,260
Additional paid-in capital		6,329,854			6,172,256
Retained earnings		7,486,301			7,345,024
Accumulated other comprehensive income		673,535			214,064
Stockholders’ equity	$	25,885,950		$	25,124,604
Total Liabilities and Stockholders’ Equity	$	25,937,976		$	25,193,077
	Years Ended December 31,
	2008			2007
Condensed Statements of Income
Dividends from subsidiary bank	$	410,193		$	—
Equity in undistributed net income of subsidiaries		394,933			816,523
Other income		—			39,716
Settlement with a former professional services provider		—			345,000
Interest and dividend income		—			256
Interest expense		—			(3,229	)
Other expenses		(177,178	)		(224,985	)
Income before income taxes		627,948			973,281
Income tax expense (benefit)		(60,241	)		53,237
Net Income	$	688,189		$	920,044

Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. Pursuant to federal regulations, dividends are generally restricted to net profits, as defined, for the current year, plus retained net profits for the previous two years. The maximum amount available for transfer from the Bank to the Company in the form of loans and advances is 10.0% of the Bank’s stockholders’ equity.

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Heritage Bankshares, Inc.

Statements of Cash Flows

	Years Ended December 31,
	2008			2007
Cash flows from operating activities
Net income	$	688,189		$	920,044
Add (deduct) items not affecting cash during the year
Stock-based compensation		155,279			135,426
Undistributed net income of subsidiaries		(394,933	)		(816,523	)
Exercise of stock options tax benefit		969			3,461
Net gain on sale of other investments		—			(22,361	)
Changes in assets/liabilities, net
(Increase) decrease in other assets		26,357			(293,384	)
Increase (decrease) in other liabilities		(16,447	)		26,368
Net cash (used for) operating activities		459,414			(46,969	)
Cash flows from investing activities
Proceeds from sale of other investments		—			73,431
Net cash provided by investing activities		—			73,431
Cash flows from financing activities
Proceeds from exercise of stock options		4,350			6,820
Repayment of other borrowings		—			(5,000,000	)
Cash dividends paid		(546,912	)		(546,876	)
Net cash provided by (used for) financing activities		(542,562	)		(5,540,056	)
Increase (decrease) in cash and cash equivalents		(83,148	)		(5,513,594	)
Cash and cash equivalents at beginning of year		127,863			5,641,457
Cash and cash equivalents at end of year	$	44,715		$	127,863

* * * * *

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

The following exhibits are filed herewith as part of this amendment to Annual Report on Form 10-K/A (Amendment No. 1).

23.2	Consent of Elliott Davis LLC.
31.1	Certification of Principal Executive Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Principal Financial Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Principal Executive Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Principal Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HERITAGE BANKSHARES, INC.
	(Registrant)
Date: May 14, 2009	/s/ Michael S. Ives
	Michael S. Ives,
	President and Chief Executive Officer

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