Heritage Bankshares 10Q 2009 Q3 Quarterly report

Heritage Bankshares (HBKS) Inactive 10-Q2009 Q3 Quarterly report

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U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

x	Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2009

¨	Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period ended

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)

(IRS Employer

Identification Number)

150 Granby Street, Suite 150, Norfolk, Virginia 23510

(Address of principal executive office)

(757) 648-1700

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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):

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

A total of 2,291,352 shares of the registrant’s common stock were outstanding as of October 31, 2009.

TABLE OF CONTENTS


		Page No.
Part I. FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

Consolidated Balance Sheets September 30, 2009 and December 31, 2008		3

Consolidated Statements of Income Three and Nine Months Ended September 30, 2009 and 2008		4

Consolidated Statements of Cash Flows Nine Months Ended September 30, 2009 and 2008		5

Notes to Consolidated Financial Statements		6

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operation	14

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	22

Item 4T -	Controls and Procedures	22

Part II. OTHER INFORMATION

Item 1 -	Legal Proceedings	22

Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds	22

Item 3 -	Defaults Upon Senior Securities	23

Item 4 -	Submission of Matters to a Vote of Security Holders	23

Item 5 -	Other Information	23

Item 6 -	Exhibits	23

Signatures		24

Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS


	At September 30, 2009 (Unaudited)			December 31, 2008 (Audited)
	(in thousands, except per share data)
ASSETS
Cash and due from banks	$	4,636		$	5,304
Interest-bearing deposits in other banks		15,088			—
Federal funds sold		8,820			8,114

Total cash and cash equivalents		28,544			13,418
Securities available for sale, at fair value (adjusted cost of $48,081 and $59,722, respectively)		49,776			60,742
Loans, net
Held for investment, net of allowance for loan losses of $1,771 and $1,652, respectively		176,927			176,562
Held for sale		—			—
Accrued interest receivable		641			735
Stock in Federal Reserve Bank, at cost		324			323
Stock in Federal Home Loan Bank of Atlanta, at cost		1,476			622
Premises and equipment, net		12,015			11,908
Other real estate owned		153			178
Other assets		880			972

Total assets	$	270,736		$	265,460


LIABILITIES AND STOCKHOLDERS’ EQUITY

Liabilities
Deposits
Noninterest-bearing	$	72,602		$	53,988
Interest-bearing		153,471			161,794

Total deposits		226,073			215,782

Federal Home Loan Bank advances		5,000			5,000
Securities sold under agreements to repurchase		1,241			1,247
Other borrowings		—			1
Accrued interest payable		168			236
Pending settlement, securities available for sale		—			15,846
Other liabilities		1,525			1,509

Total liabilities		234,007			239,621


Stockholders’ equity
Preferred stock, no par value – 1,000,000 shares authorized:
Series A, 10,103 and 0 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively		10,103			—
Series B, 303 and 0 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively		303			—
Common stock, $5 par value – 6,000,000 shares authorized; 2,291,352 and 2,279,252 shares issued and outstanding at September 30, 2009, and December 31, 2008, respectively		11,457			11,396
Additional paid-in capital		6,435			6,330
Retained earnings		7,615			7,439
Discount on preferred stock		(302	)		—
Accumulated other comprehensive income, net		1,118			674

Total stockholders’ equity		36,729			25,839

Total liabilities and stockholders’ equity	$	270,736		$	265,460

See notes to financial statements.

HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)


	Three Months Ended September 30					Nine Months Ended September 30
	2009			2008		2009			2008
	(in thousands, except share and per share data)
Interest income
Loans and fees on loans	$	2,266		$	2,454	$	6,735		$	7,398
Taxable investment securities		491			308		1,666			1,212
Nontaxable investment securities		—			7		—			33
Dividends on FRB and FHLB stock		10			10		20			42
Interest on federal funds sold		1			53		2			135
Other interest income		24			1		49			433

Total interest income		2,792			2,833		8,472			8,824

Interest expense
Deposits		496			816		1,664			2,748
Borrowings		33			53		107			199

Total interest expense		529			869		1,771			2,947
Net interest income		2,263			1,964		6,701			5,877
Provision for loan losses		65			68		141			68


Net interest income after provision for loan losses		2,198			1,896		6,560			5,809


Noninterest income
Service charges on deposit accounts		99			111		286			316
Late charges and other fees on loans		12			10		36			43
Gains on sale of loans held for sale, net		—			24		3			92
Gain on sale of investment securities		—			513		—			518
Gain on bank-owned life insurance		—			—		35			—
Other		100			80		206			233

Total noninterest income		211			738		566			1,202

Noninterest expense
Compensation		1,080			1,007		3,134			3,090
Data processing		123			132		381			409
Occupancy		191			193		613			599
Furniture and equipment		149			131		476			419
Taxes and licenses		68			72		204			204
Professional fees		145			71		359			231
FDIC insurance		86			34		374			99
Marketing		20			32		75			109
Telephone		24			25		79			75
Loss on disposal or impairment of fixed assets		—			68		4			68
Other		186			269		543			769

Total noninterest expense		2,072			2,034		6,242			6,072

Income before provision for income taxes		337			600		884			939
Provision for income taxes		131			215		296			344


Net income		206			385		588			595

Preferred stock dividend and accretion of discount		(10	)		—		(10	)		—


Net income available to common stockholders	$	196		$	385	$	578		$	595

Earnings per common share
Basic	$	0.09		$	0.17	$	0.25		$	0.26

Diluted	$	0.09		$	0.17	$	0.25		$	0.26

Dividends per share	$	0.06		$	0.06	$	0.18		$	0.18


Weighted average shares outstanding - basic		2,286,579			2,278,840		2,282,982			2,278,715
Effect of dilutive stock options		10,579			18,223		11,407			16,151

Weighted average shares outstanding - diluted		2,297,158			2,297,063		2,294,389			2,294,866

See notes to financial statements.

HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


	Nine Months Ended September 30,
	2009			2008
	(in thousands)
Cash flows from operating activities:
Net income	$	588		$	595
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss		141			68
Amortization of loan yield adjustments, net		298			314
Depreciation, amortization and accretion, net		686			238
Stock-based compensation		179			123
Deferred compensation		133			29
Exercise of stock options tax benefit		14			1
Net (gains) losses on sale of:
Sale of securities		—			(518	)
Sale, disposal, or impairment of property, plant and equipment		4			67
Impairment of real estate owned		25			—
Net gain on bank owned life insurance		(35	)		—
Changes in assets/liabilities net
Decrease (increase) in interest receivable and other assets		(143	)		404
Decrease in interest payable and other liabilities		(194	)		(159	)
Decrease in loans held for sale		—			878

Net cash provided by operating activities		1,696			2,040

Cash flows from investing activities:
Proceeds from maturities and principal repayments of securities available for sale		16,651			12,706
Proceeds from maturities, calls and principal repayments of securities held to maturity		—			106
Purchases of securities available for sale		(21,064	)		(40,748	)
Proceeds from sales of securities available for sale		—			29,228
Proceeds from sales of securities held to maturity		—			569
Net increase in loans held for investment		(804	)		(17,349	)
Purchases of Federal Home Loan Bank stock and Federal Reserve Bank stock		(1,738	)		(2,078	)
Redemption of Federal Home Loan Bank stock and Federal Reserve Bank stock		883			2,163
Purchases of premises and equipment		(596	)		(2,049	)
Proceeds from sales of premises and equipment		15			7
Proceeds from bank owned life insurance		135			—

Net cash used for investing activities		(6,518	)		(17,445	)

Cash flows from financing activities:
Proceeds from exercise of stock options		83			4
Net increase in deposits		10,291			26,622
Proceeds from Federal Home Loan Bank advances		148,100			49,000
Repayments of Federal Home Loan Bank advances		(148,100	)		(51,000	)
Net increase (decrease) in securities sold under agreements to repurchase		(6	)		367
Proceeds from federal funds purchased		43,736			—
Repayment of federal funds purchased		(43,737	)		—
Repayments of other borrowings		—			(50	)
Net proceeds from issuance of preferred stock		9,992			—
Cash dividends paid		(411	)		(410	)

Net cash provided by financing activities		19,948			24,533

Increase in cash and cash equivalents		15,126			9,128

Cash and cash equivalents, beginning of period		13,418			14,420

Cash and cash equivalents, end of period	$	28,544		$	23,548

Supplemental disclosure:
Interest paid	$	1,839		$	2,991
Income taxes paid	$	315		$	405

See notes to financial statements.

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements

Note 1 – Principles of Consolidation and Basis of Presentation

The accompanying unaudited 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.

Heritage Bankshares, Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia in 1983, and serves as the holding company for its wholly-owned subsidiaries. The Company’s only subsidiary, Heritage Bank (the “Bank”), 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 accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For additional financial information regarding the Company, please refer to the audited consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008.

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

The Company believes its critical accounting policies are those that are particularly sensitive in terms of judgments and the extent to which estimates are used, and such policies include (a) the valuation of the allowance for loan losses and the impairment of loans, (b) the impairment of financial investments and other accounts, (c) the deferral of loan fees and direct loan origination costs, and (d) accounting for income taxes.

The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”). In June 2009, the FASB issued an accounting standard which established the Codification to become the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities, with the exception of guidance issued by the U.S. Securities and Exchange Commission (the “SEC”) and its staff. All guidance contained in the Codification carries an equal level of authority. The Codification is not intended to change GAAP, but rather is expected to simplify accounting research by reorganizing current GAAP into approximately 90 accounting topics. The Company adopted this accounting standard in preparing its consolidated financial statements for the period ended September 30, 2009. The adoption of this accounting standard, which was subsequently codified into ASC Topic 105, “Generally Accepted Accounting Principles,” had no impact on retained earnings and will have no impact on the Company’s statements of income and condition.

Allowance for Loan Losses; Impairment of Loans.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.

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

The Bank evaluates various loans individually for impairment as required by ASC Topic 310 “Receivables”. 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 ASC Topic 450 “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 ASC Topic 310; (3) Loan Segments – an amount to adjust the historical allocation for the four loan segments based on environmental factors under ASC Topic 450; and (4) Unallocated – an amount to reflect the imprecision inherent in these calculations.

Impairment of Financial Investments and Other Accounts. Impairment of investment securities, other equity investments and other asset accounts results in a write-down that must be included in net income when the fair value of the asset declines below cost and is other-than-temporary. The fair values of these investments and other assets are subject to change, as they are influenced by market conditions and management decisions.

Deferral of Loan Fees and Direct Loan Origination Costs. ASC Topic 310 generally requires that loan fees and direct loan origination costs be deferred and recognized as an adjustment to the loan’s yield. While the amount of fees to be deferred is generally apparent in the origination of a loan, the Company utilizes estimates to determine the amount of deferred direct origination costs, especially payroll costs, that are attributable to the loan origination process. Management’s estimates of the amount of costs associated with successful loan origination activities are reviewed and updated annually.

Accounting for Income Taxes. The determination of the Company’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Company’s tax returns are subject to audit by various tax authorities. Although we believe that our estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

Subsequent Events. In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through November 5, 2009, the date the financial statements were issued.

Note 2 – Share-Based Compensation

Under the Heritage 2006 Equity Incentive Plan, as amended and restated effective January 28, 2009 (“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 under the 2006 Incentive Plan 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” 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.

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

The following table presents a summary of stock option activity to date during 2009:


	Shares		Weighted Average Exercise Price		Weighted Average Remaining Term (Years)	Aggregate Intrinsic Value
						(in thousands)
Outstanding at January 1, 2009	295,000		$	14.10	—		—
Granted	8,000			8.25	—		—
Exercised	(12,100	)		6.89	—		—
Forfeited/expired	(23,900	)		7.25	—		—

Outstanding at September 30, 2009	267,000		$	12.02	6.4	$	137

Exercisable at September 30, 2009	160,200		$	11.64	5.7	$	121

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 quarter 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 September 30, 2009. 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.

The aggregate intrinsic value of options exercised during the nine months ended September 30, 2009 and September 30, 2008 were $42,635 and $2,850, respectively. Cash received from exercises of options during the first nine months of 2009 and 2008 was $83,325 and $4,350, respectively.

The amount charged against income, before income tax benefit of $57,816, in relation to the stock-based payment arrangement was $178,634 for the nine months ended September 30, 2009. The amount charged against income, before income tax benefit of $11,395, in relation to the stock-based payment arrangement, was $122,854 for the nine months ended September 30, 2008. At September 30, 2009, unrecognized compensation expense, net of estimated forfeitures, related to unvested stock option grants was $268,421 and is currently expected to be recognized over a weighted average period of 1.1 years as follows:


At September 30, 2009:	Stock-Based Compensation Expense
	(in thousands)
2009	$	38
2010		145
2011		70
2012		11
2013		4

Total	$	268

Note 3 – Other Comprehensive Income

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


	Three Months Ended						Nine Months Ended
	September 30, 2009			September 30, 2008			September 30, 2009			September 30, 2008
	(in thousands)
Unrealized holding gains (losses) on available-for-sale securities	$	556		$	(702	)	$	674		$	(477	)
Tax effect		(189	)		239			(229	)		162

Net of tax amount	$	367		$	(463	)	$	445		$	(315	)

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

Note 4 – Earnings Per Share Reconciliation

The basic and diluted earnings per share calculations are presented in the following table:


	Three Months Ended					Nine Months Ended
	September 30, 2009			September 30, 2008		September 30, 2009			September 30, 2008
	(in thousands, except share and per share data)
Net income (numerator, basic and diluted)	$	206		$	385	$	588		$	595
Less: Accumulated dividends on Series A and Series B Preferred Stock		(9	)		—		(9	)		—
Accretion of net discount on Series A and Series B Preferred Stock		(1	)		—		(1	)		—

Net income available to common stockholders	$	196		$	385	$	578		$	595

Weighted average shares outstanding (denominator)		2,286,579			2,278,840		2,282,982			2,278,715
Earnings per common share - basic	$	0.09		$	0.17	$	0.25		$	0.26

Effect of dilutive securities

Weighted average shares outstanding during the period		2,286,579			2,278,840		2,282,982			2,278,715

Effect of dilutive stock options		10,579			18,223		11,407			16,151

Weighted diluted average shares outstanding (denominator) during the period		2,297,158			2,297,063		2,294,389			2,294,866

Earnings per common share – diluted	$	0.09		$	0.17	$	0.25		$	0.26

Note 5 – Disclosure About Fair Value of Financial Instruments

The following summary presents an estimate of the fair value of the Company’s financial instruments. 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 that will actually be realized or paid upon settlement or maturity of the various instruments could be significantly different.

The following table presents the carrying amounts and fair value of the Company’s financial instruments at September 30, 2009:


	At September 30, 2009
	Carrying Amount		Fair Value
	(Dollars in Thousands)
Financial assets:
Cash and due from banks	$	19,724	$	19,724
Federal funds sold		8,820		8,820
Securities available for sale		49,776		49,776
Loans held for investment, net		176,927		177,309
Accrued interest receivable		641		641
Stock in FRB and FHLB		1,800		1,800
Bank-owned life insurance		535		535

Financial liabilities:
Deposits		226,073		226,316
Federal Home Loan Bank advance		5,000		5,093
Other borrowing and securities sold under agreements to repurchase		1,241		1,241
Accrued interest payable		168		168

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other 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 ASC Topic 310, “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.

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.

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.

Assets Recorded at Fair Value on a Recurring Basis


September 30, 2009 in thousands	Total		Level 1		Level 2		Level 3
Investment in securities available for sale	$	49,776	$	—	$	49,776	$	—

Total Assets at Fair Value	$	49,776	$	—	$	49,776	$	—


Assets Recorded at Fair Value on a Non-Recurring Basis

September 30, 2009 in thousands	Total		Level 1		Level 2		Level 3
Loans	$	2	$	—	$	2	$	—
Other real estate owned	$	153		—	$	153		—

Total Assets at Fair Value	$	155	$	—	$	155	$	—

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

Note 6 – Securities


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(in thousands)
At September 30, 2009

Securities available for sale

U.S. Treasury Securities	$	—	$	—	$	—	$	—
Mortgage-backed securities		48,081		1,695		—		49,776

Total securities available for sale	$	48,081	$	1,695	$	—	$	49,776

Total securities(1)	$	48,081	$	1,695	$	—	$	49,776


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(in thousands)
At December 31, 2008

Securities available for sale

U.S. Treasury Securities	$	1,761	$	12	$	—	$	1,773
Mortgage-backed securities		57,961		1,012		4		58,969

Total securities available for sale	$	59,722	$	1,024	$	4	$	60,742

Total securities(1)	$	59,722	$	1,024	$	4	$	60,742

(1)	At September 30, 2009 and at December 31, 2008, the Company held no securities classified as held to maturity.

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 September 30, 2009 and at December 31, 2008. 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 September 30, 2009

Less Than 12 Months

12 Months or More

Total

(in thousands)

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

U.S. Treasury Securities

—

Mortgage-backed securities

—

Total temporarily impaired securities

—

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)


	At December 31, 2008
	Less Than 12 Months				12 Months or More				Total
	(in thousands)
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

U.S. Treasury Securities	$	150	$	—	$	—	$	—	$	150	$	—
Mortgage-backed securities		3,377		4		—		—		3,377		4

Total temporarily impaired securities	$	3,527	$	4	$	—	$	—	$	3,527	$	4

The amortized cost and fair value of investment securities at September 30, 2009, 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)
	(in thousands)
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	—	$	—	$	—	$	—

Due after one year through five years		20,910		21,336		—		—

Due after five years through ten years		21,494		22,570		—		—

Due after ten years		5,677		5,870		—		—


Total	$	48,081	$	49,776	$	—	$	—

(1)	At September 30, 2009, the Company held no securities classified as held to maturity.

Note 7 – Prior Period Adjustments to FDIC Insurance Expense

The unaudited financial statements and accompanying information contained in this Form 10-Q reflect the impact of corrections to FDIC insurance expense related to certain prior periods. Specifically, as a result of such corrections, retained earnings at December 31, 2008 decreased by $47,000 compared to the originally-reported amount. Further, net income for the three months ended September 30, 2008 decreased by $1,000, from $386,000, as originally reported, to $385,000 (earnings were $0.17 per diluted share both before and after the correction). Net income for the nine months ended September 30, 2008 decreased by $22,000, from $617,000, or $0.27 per diluted share as originally reported, to $595,000, or $0.26 per diluted share. Corrections were made in accordance with the guidance in SEC Staff Accounting Bulletin No. 108.

Note 8 – TARP Capital Purchase Program

On September 25, 2009, as part of the Capital Purchase Program (the “Program”) established under the Troubled Asset Relief Program, the Company and the U.S. Department of the Treasury (“Treasury”) entered into a Letter Agreement and a Securities Purchase Agreement – Standard Terms attached thereto, (collectively, the “Securities Purchase Agreement”), as amended by a side letter agreement, pursuant to which the Company issued and sold, and the Treasury purchased, (i) 10,103 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (“Series A Preferred Shares”), and (ii) a warrant (the “Warrant”) to purchase up to 303.00303 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (“Series B Preferred Shares”), at an exercise price of $0.01 per share, for an aggregate purchase price of $10,103,000 in cash. The Warrant was exercised by the Treasury immediately following the closing of the transaction on a cashless basis, resulting in the issuance to the Treasury of 303 Series B Preferred Shares.

HERITAGE BANKSHARES, INC.

Notes to Consolidated Financial Statements—(Continued)

dividends at a rate of 9% per annum. Dividends are payable on both the Series A Preferred Shares and the Series B Preferred Shares (collectively, the “Preferred Shares”) quarterly and are payable on February 15, May 15, August 15 and November 15 of each year.

The Preferred Shares are not convertible into any other securities and generally are non-voting. The Preferred Shares have no maturity date and rank senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. In addition, the Securities Purchase Agreement provides for certain restrictions on dividend payments and stock repurchases by the Company. The Treasury may unilaterally amend the Securities Purchase Agreement and all related documents to the extent required to comply with any changes in applicable federal statutes after the execution thereof.

Please see our Current Report on Form 8-K filed September 25, 2009 for additional details regarding the Company’s participation in the Program.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Forward-Looking Statements

Statements contained in this quarterly report on Form 10-Q which are not historical facts are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of such words as “may,” “will,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” These forward-looking statements relate to, among other things, expectations regarding the business environment in which we operate, projections of future performance and perceived opportunities in the market, and they are based on management’s current beliefs, assumptions and expectations. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. For a detailed discussion of the factors that might cause such a difference, see Item 1A, “Risk Factors,” in our 2008 annual report on Form 10-K, filed March 26, 2009.

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

•

the demand for our products and services;

•

actions taken by our competitors;

•

changes in the prevailing interest rates;

•

changes in delinquencies and defaults by our borrowers;

•

changes in loan quality and performance;

•

changes in FDIC insurance premiums;

•

legislative or regulatory changes or actions that affect our business;

•

our ability to achieve financial goals and strategic plans;

•

litigation; and

•

credit and other risks of lending activities.

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

Financial Condition of the Company at September 30, 2009

Total Assets. The Company’s total assets increased by $24.6 million, or 10.0%, from $246.1 million at September 30, 2008 to $270.7 million at September 30, 2009. The increase in assets resulted primarily from increases of $12.6 million, $6.1 million and $5.0 million in the ending balances of securities available for sale, loans held for investment and cash and cash equivalents, respectively. Total assets increased by $5.2 million, or 2.0%, from $265.5 million at December 31, 2008.

Total Cash and Cash Equivalents and Investment Securities. Total cash and cash equivalents and investment securities available for sale were $78.3 million at September 30, 2009, compared to a combined balance of $60.7 million at September 30, 2008, reflecting an increase in the combined balance of $17.6 million that largely relates to an increase in interest-bearing deposits in other banks. Total cash and cash equivalents increased by $15.1 million, from $13.4 million at December 31, 2008 to $28.5 million at September 30, 2009, due primarily to a $15.1

million increase in interest-bearing deposits in other banks. Securities available for sale decreased by $10.9 million, from $60.7 million at December 31, 2008, to $49.8 million at September 30, 2009, primarily related to amortization and prepayments of mortgage-backed securities balances.

Loans. Loans held for investment, net of the allowance for loan losses, at September 30, 2009, were $176.9 million, which represents an increase of $6.1 million, or 3.6%, from the September 30, 2008, loan balance of $170.8 million. Net loan balances were essentially unchanged from our net loan balance of $176.6 million at December 31, 2008.

Asset Quality. The Company’s total nonperforming assets increased to $553,000, or 0.20% of assets, at September 30, 2009, compared to $52,000, or 0.02% of assets, at September 30, 2008, attributable to an increase in the balance of other real estate owned as well as increases in nonaccrual and restructured loans. Nonperforming assets at December 31, 2008 were $218,000, or 0.08% of assets.

Deposits. Driven by continued growth in core deposits, total deposits increased by $13.5 million, or 6.3%, from $212.6 million at September 30, 2008, to $226.1 million at September 30, 2009. Core deposits, which are comprised of checking, savings and money market accounts, increased by $13.7 million, or 8.6%, from $160.8 million at September 30, 2008, to $174.5 million at September 30, 2009. Total deposits at September 30, 2009 increased by $10.3 million, or 4.8%, from $215.8 million in total deposits at December 31, 2008.

Average total deposits increased by $30.6 million, or 16.0%, from $191.1 million for the nine months ended September 30, 2008, to $221.7 million for the nine months ended September 30, 2009. Average core deposits increased by $29.5 million and average certificate of deposit balances increased by $1.1 million between the comparable nine month periods.

Borrowed Funds. Borrowed funds decreased by $257,000, from $6.5 million at September 30, 2008, to $6.2 million at September 30, 2009. Borrowed funds were unchanged from our $6.2 million balance at December 31, 2008.

Capital. Stockholders’ equity increased by $11.6 million, or 46.3%, from $25.1 million at September 30, 2008, to $36.7 million at September 30, 2009. Stockholders’ equity increased primarily as a result of the $10.1 million of preferred stock issued by the Company on September 25, 2009, to the U.S. Treasury under its Capital Purchase Program. Stockholders’ equity also increased due to a $1.2 million increase in accumulated after-tax comprehensive income attributable to an increase in the market value of the Company’s available for sale investment securities portfolio. Stockholders’ equity at September 30, 2009, increased by $10.9 million, from $25.8 million at December 31, 2008, primarily as a result of the preferred stock issuance under the Capital Purchase Program.

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

The tables below set forth, for the periods indicated, information with respect to the Company’s nonperforming assets and allowance for loan losses.

Nonperforming assets were:


	At September 30,
	2009		2008
	(in thousands)
Nonaccrual loans	$	189	$	44
Accruing loans past due 90 days or more		6		8


Total nonperforming loans		195		52

Restructured loans		205		—
Other real estate owned, net		153		—


Total nonperforming assets	$	553	$	52

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


	Three Months Ended						Nine Months Ended
	September 30, 2009			September 30, 2008			September 30, 2009			September 30, 2008
	(in thousands)
Balance, beginning of period	$	1,728		$	1,592		$	1,652		$	1,400
Provision for loan losses		65			68			141			68
Loans charged-off		(39	)		(57	)		(69	)		(58	)
Recoveries		17			(7	)		47			186

Balance, end of period	$	1,771		$	1,596		$	1,771		$	1,596

Comparison of Operating Results for the Three Months Ended September 30, 2009 and 2008

Overview. The Company’s pretax income was $337,000 for the third quarter of 2009, compared to pretax income of $600,000 for the third quarter of 2008. Compared to the third quarter of 2008, net interest income increased by $299,000, provision for loan losses decreased by $3,000, noninterest income decreased by $527,000 and noninterest expense increased by $38,000.

Net Interest Income. The Company’s net interest income before provision for loan losses increased by $299,000 in the third quarter of 2009, compared to the third quarter of 2008. This increase was primarily attributable to an increase of $37.2 million in the average balance of interest-earning assets, which more than offset an increase of $17.6 million in average interest-bearing liabilities, and to an increase in net interest spread from 3.06% to 3.25%. Net interest margin decreased by 8 basis points, from 3.72% in the third quarter of 2008 to 3.64% in the third quarter of 2009.

Provision for Loan Losses. Provision for loan losses for the three months ended September 30, 2009, was $65,000 compared to a $68,000 loan loss provision for the three months ended September 30, 2008.

Noninterest Income. Total noninterest income decreased by $527,000, from $738,000 in the third quarter of 2008 to $211,000 in the third quarter of 2009. This decrease was primarily attributable to nonrecurring net gains of $513,000 in the third quarter of 2008 related to sales of investment securities.

Noninterest Expense. Total noninterest expense increased by $38,000, from $2.03 million in the third quarter of 2008, to $2.07 million in the third quarter of 2009. This increase in noninterest expense was driven primarily by a $74,000 increase in professional fees attributable to several legal projects unrelated to asset quality issues; a $73,000 increase in compensation expense largely related to a $105,000 one-time charge for the immediate vesting of benefits under a supplemental executive retirement plan; and a $52,000 increase in FDIC insurance expense impacted by an increase in FDIC assessment rates and growth in deposit balances. These increases were partially offset by a $96,000 decrease in courier expense and a $68,000 decrease in loss on disposal or impairment of fixed assets, as well as decreases in a variety of miscellaneous expenses.

Income Taxes. The Company’s income tax expense for the quarter ended September 30, 2009, was $131,000, which represented an effective tax rate of 39.0%, compared to income tax expense of $215,000 for the quarter ended September 30, 2008, which represented an effective tax rate of 35.9%. The higher effective tax rate was primarily attributable to a higher percentage of net non-deductible items relative to pre-tax income in the third quarter of 2009.

Comparison of Operating Results for the Nine Months Ended September 30, 2009 and 2008

Overview. The Company’s pretax income was $884,000 for the first nine months of 2009, compared to pretax income of $939,000 for the first nine months of 2008, a decrease of $55,000. Compared to the first nine months of 2008, net interest income increased by $824,000, provision for loan losses increased by $73,000, noninterest income decreased by $636,000 and noninterest expense increased by $170,000.

Net Interest Income. The Company’s net interest income before provision for loan losses increased by $824,000 for the first nine months of 2009, compared to the first nine months of 2008. This increase was primarily attributable to an increase of $34.6 million in the average balance of interest-earning assets, which more than offset an increase of $21.1 million in average interest-bearing liabilities, and to an increase in net interest spread from 2.97% to 3.25%. Net interest margin decreased by 7 basis points, from 3.74% for the first nine months of 2008, to 3.67% for the first nine months of 2009.

Provision for Loan Losses. Provision for loan losses for the nine months ended September 30, 2009, was $141,000 compared to a $68,000 provision for the nine months ended September 30, 2008. Net charge-offs in the nine months ended September 30, 2009, were $22,000 compared to $128,000 in net recoveries for the nine months ended September 30, 2008.

Noninterest Income. Total noninterest income decreased by $636,000, from $1.2 million in the first nine months of 2008, to $566,000 in the first nine months of 2009. This decrease was primarily due to a $518,000 decrease in net gains on the sale of investment securities, a $89,000 decrease in gains on sales of mortgage loans held for sale and a $30,000 decrease in the service charges on deposit accounts.

Noninterest Expense. Total noninterest expense increased by $170,000, from $6.1 million in the first nine months of 2008, to $6.3 million in the first nine months of 2009. Increases of $275,000 and $128,000 in FDIC insurance expense and professional fees, respectively, were partially offset by a $230,000 decrease in courier expense.

Income Taxes.The Company’s income tax expense for the nine months ended September 30, 2009, was $296,000, which represented an effective tax rate of 33.4%, compared to income tax expense for the nine months ended September 30, 2008 of $344,000, which represented an effective tax rate of 36.7%. The lower effective tax rate for the first nine months of 2009, was primarily attributable to a $48,000 tax benefit resulting from an increase in nonqualified stock options related to certain of the stock options that were repriced in the first quarter of 2009 and to nontaxable life insurance income recorded in the second quarter of 2009.

Commitments

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 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 agreements 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.

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.

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


	At September 30, 2009		At September 30, 2008
	*(in thousands)*
Commitments to extend credit	$	35,943	$	45,449
Standby letters of credit		1,012		2,167
Commitments to sell loans		—		—

	$	36,955	$	47,616

Liquidity

Liquidity refers to the availability of sufficient funds to meet the needs of depositors, borrowers, creditors and investors and to fund operations. The Company’s primary sources of funds are customer deposits, cash and cash

equivalents, investment securities available for sale, loan repayments and borrowings. These funds are used to make loans, purchase investment securities, meet depositor withdrawals and fund operations. At September 30, 2009, cash and cash equivalents were $28.5 million, an increase of $15.1 million from $13.4 million at December 31, 2008, largely due to $10.1 million in proceeds from preferred stock issued on September 25, 2009, to the U.S. Department of the Treasury under the Capital Purchase Program.

In addition, the Company maintains a liquid available for sale investment securities portfolio. At September 30, 2009, the balance of the available for sale investment portfolio was $49.8 million, compared to a $60.7 million balance at December 31, 2008. The Company also is able to obtain funds through approved borrowing lines with the Federal Home Loan Bank of Atlanta and another financial institution. Management believes the Company’s liquidity sources are sufficient to satisfy the Company’s operational requirements and obligations. The Company maintains a high level of liquidity due to a concentration in some customer deposits, which can fluctuate significantly as depositor needs change.

Capital Resources

The Company’s capital is reflected in its stockholders equity, which was $36.7 million at September 30, 2009, compared to $25.8 million at December 31, 2008. This increase in stockholders equity of $10.9 million was primarily attributable to $10.1 million in proceeds from preferred stock issued on September 25, 2009, to the U.S. Department of the Treasury under the Capital Purchase Program. At September 30, 2009, the Company and the Bank were considered “well-capitalized” as defined by the Federal Reserve Bank. The Company monitors the current and projected capital levels of the Bank and the Company and will consider additional sources of capital, through the issuance of stock, debt, or otherwise, as needs arise.

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In December 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) Statement of Financial Accounting Standards (“SFAS”) 132(R)-1 (FASB ASC 715-20-65), “Employers’ Disclosures about Postretirement Benefit Plan Assets,” (“FSP SFAS 132(R)-1”). This FSP provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The objective of the FSP is to provide the users of financial statements with an understanding of: (a) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (b) the major categories of plan assets; (c) the inputs and valuation techniques used to measure the fair value of plan assets; (d) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and (e) significant concentrations of risk within plan assets. The FSP also requires a nonpublic entity, as defined in SFAS 132, to disclose net periodic benefit cost for each period for which a statement of income is presented. FSP SFAS 132(R)-1 is effective for fiscal years ending after December 15, 2009. The Staff Position is not expected to require the Company to provide additional disclosures related to its benefit plans.

FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20” (FASB ASC 325-40-65) (“FSP EITF 99-20-1”), was issued in January 2009. Prior to the FSP, other-than-temporary impairment was determined by using either Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets,” (“EITF 99-20”) or SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), depending on the type of security. EITF 99-20 required the use of market participant assumptions regarding future cash flows regarding the probability of collecting all cash flows previously projected. SFAS 115 determined impairment to be other than temporary if it was probable that the holder would be unable to collect all amounts due according to the contractual terms. To achieve a more consistent determination of other-than-temporary impairment, the FSP amends EITF 99-20 to determine any other-than-temporary impairment based on the guidance in SFAS 115, allowing management to use more judgment in determining any other-than-temporary impairment. The FSP was effective for reporting periods ending after December 15, 2008. Management has reviewed the Company’s security portfolio and evaluated the portfolio for any other-than-temporary impairments.

On April 9, 2009, the FASB issued three staff positions related to fair value which are discussed below.

FSP SFAS 115-2 and SFAS 124-2 (FASB ASC 320-10-65), “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP SFAS 115-2 and SFAS 124-2”), categorizes losses on debt securities

available-for-sale or held-to-maturity determined by management to be other-than-temporarily impaired into losses due to credit issues and losses related to all other factors. Other-than-temporary impairment (OTTI) exists when it is more likely than not that the security will mature or be sold before its amortized cost basis can be recovered. An OTTI related to credit losses should be recognized through earnings. An OTTI related to other factors should be recognized in other comprehensive income. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. Annual disclosures required in SFAS 115 and FSP SFAS 115-1 and SFAS 124-1 are also required for interim periods (including the aging of securities with unrealized losses).

FSP SFAS 157-4 (FASB ASC 820-10-65), “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not Orderly”, recognizes that quoted prices may not be determinative of fair value when the volume and level of trading activity has significantly decreased. The evaluation of certain factors may necessitate that fair value be determined using a different valuation technique. Fair value should be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction, not a forced liquidation or distressed sale. If a transaction is considered to not be orderly, little, if any, weight should be placed on the transaction price. If there is not sufficient information to conclude as to whether or not the transaction is orderly, the transaction price should be considered when estimating fair value. An entity’s intention to hold an asset or liability is not relevant in determining fair value. Quoted prices provided by pricing services may still be used when estimating fair value in accordance with SFAS 157; however, the entity should evaluate whether the quoted prices are based on current information and orderly transactions. Inputs and valuation techniques are required to be disclosed in addition to any changes in valuation techniques.

FSP SFAS 107-1 and APB 28-1 (FASB ASC 825-10-65), “Interim Disclosures about Fair Value of Financial Instruments”, requires disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements and also requires those disclosures in summarized financial information at interim reporting periods A publicly traded company includes any company whose securities trade in a public market on either a stock exchange or in the over-the-counter market, or any company that is a conduit bond obligor. Additionally, when a company makes a filing with a regulatory agency in preparation for sale of its securities in a public market it is considered a publicly traded company for this purpose.

The three staff positions are effective for periods ending after June 15, 2009, with early adoption of all three permitted for periods ending after March 15, 2009. The Company adopted the staff positions for its second quarter Form 10-Q. The staff positions had no material impact on the financial statements. Additional disclosures have been provided where applicable.

Also on April 1, 2009, the FASB issued FSP SFAS 141(R)-1 (FASB ASC 805-20-25, 30, 35, 50), “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” The FSP requires that assets acquired and liabilities assumed in a business combination that arise from a contingency be recognized at fair value. If fair value cannot be determined during the measurement period as determined in SFAS 141 (R), the asset or liability can still be recognized if it can be determined that it is probable that the asset existed or the liability had been incurred as of the measurement date and if the amount of the asset or liability can be reasonably estimated. If it is not determined to be probable that the asset/liability existed/was incurred or no reasonable amount can be determined, no asset or liability is recognized. The entity should determine a rational basis for subsequently measuring the acquired assets and assumed liabilities. Contingent consideration agreements should be recognized initially at fair value and subsequently reevaluated in accordance with guidance found in paragraph 65 of SFAS 141 (R). The FSP is effective for business combinations with an acquisition date on or after the beginning of the Company’s first annual reporting period beginning on or after December 15, 2008. The Company will assess the impact of the FSP if and when a future acquisition occurs.

The Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 111 (FASB ASC 320-10-S99-1) on April 9, 2009 to amend Topic 5.M., “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities”, and to supplement FSP SFAS 115-2 and SFAS 124-2. SAB 111 maintains the staff’s previous views related to equity securities; however debt securities are excluded from its scope. The SAB provides that “other-than-temporary” impairment is not necessarily the same as “permanent” impairment and unless evidence exists to support a value equal to or greater than the carrying value of the equity security investment, a write-down to fair value should be recorded and accounted for as a realized loss. The SAB was effective upon issuance and had no impact on the Company’s financial position.

SFAS 165 (FASB ASC 855-10-05, 15, 25, 45, 50, 55), “Subsequent Events” (“SFAS 165”), was issued in May 2009 and provides guidance on when a subsequent event should be recognized in the financial statements.

Subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet should be recognized at the balance sheet date. Subsequent events that provide evidence about conditions that arose after the balance sheet date but before financial statements are issued, or are available to be issued, are not required to be recognized. The date through which subsequent events have been evaluated must be disclosed as well as whether it is the date the financial statements were issued or the date the financial statements were available to be issued. For nonrecognized subsequent events which should be disclosed to keep the financial statements from being misleading, the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made, should be disclosed. The standard is effective for interim or annual periods ending after June 15, 2009. Management has completed its review and all proper disclosures have been made in accordance with SFAS 165.

The FASB issued SFAS 166 (not yet reflected in FASB ASC), “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140,” (“SFAS 166”) in June 2009. SFAS 166 limits the circumstances in which a financial asset should be derecognized when the transferor has not transferred the entire financial asset by taking into consideration the transferor’s continuing involvement. The standard requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. The concept of a qualifying special-purpose entity is removed from SFAS 140 along with the exception from applying FIN 46(R). The standard is effective for the first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company does not expect the standard to have any impact on the Company’s financial statements.

SFAS 167 (not yet reflected in FASB ASC), “Amendments to FASB Interpretation No. 46(R),” (“SFAS 167”) was also issued in June 2009. The standard amends FIN 46(R) to require a company to analyze whether its interest in a variable interest entity (“VIE”) gives it a controlling financial interest. A company must assess whether it has an implicit financial responsibility to ensure that the VIE operates as designed when determining whether it has the power to direct the activities of the VIE that significantly impact its economic performance. Ongoing reassessments of whether a company is the primary beneficiary is also required by the standard. SFAS 167 amends the criteria to qualify as a primary beneficiary as well as how to determine the existence of a VIE. The standard also eliminates certain exceptions that were available under FIN 46(R). SFAS 167 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. Comparative disclosures will be required for periods after the effective date. The Company does not expect the standard to have any impact on the Company’s financial position.

The FASB issued ASU 2009–05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value,” in August 2009 to provide guidance when estimating the fair value of a liability. When a quoted price in an active market for the identical liability is not available, fair value should be measured using (a) the quoted price of an identical liability when traded as an asset; (b) quoted prices for similar liabilities or similar liabilities when traded as assets; or (c) another valuation technique consistent with the principles of Topic 820, such as an income approach or a market approach. If a restriction exists that prevents the transfer of the liability, a separate adjustment related to the restriction is not required when estimating fair value. The ASU was effective October 1, 2009 for the Company and should have no impact on financial position or operations.

ASU 2009-12, “Fair Value Measurements and Disclosures (Topic 820)—Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent),” issued in September 2009, allows a company to measure the fair value of an investment that has no readily determinable fair market value on the basis of the investee’s net asset value per share, as provided by the investee. This allowance assumes that the investee has calculated net asset value in accordance with the GAAP measurement principles of Topic 946 as of the reporting entity’s measurement date. Examples of such investments include investments in hedge funds, private equity funds, real estate funds and venture capital funds. The update also provides guidance on how the investment should be classified within the fair value hierarchy based on the value for which the investment can be redeemed. The amendment is effective for interim and annual periods ending after December 15, 2009 with early adoption permitted. The Company does not currently have investments in such entities and, therefore, there will be no impact to our current financial statements.

ASU 2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force,” was issued in October 2009 and provides guidance on accounting for products or services (deliverables) separately rather than as a combined unit utilizing a selling price hierarchy to determine the selling price of a deliverable. The selling price is based on vendor-specific evidence, third-party evidence or estimated selling price. The amendments in the update are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with early adoption permitted. The Company does not expect the update to have an impact on its financial statements.

Issued October 2009, ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing,” amends ASC Topic 470 and provides guidance for accounting and reporting for own-share lending arrangements issued in contemplation of a convertible debt issuance. At the date of issuance, a share-lending arrangement entered into in respect of an entity’s own shares should be measured at fair value in accordance with Topic 820 and recognized as an issuance cost, with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs. The amendments also require several disclosures, including a description and the terms of the arrangement and the reason for entering into the arrangement. The effective dates of the amendments depend upon the date the share-lending arrangement is entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009. The Company has no current plans to issue convertible debt and, therefore, does not expect the update to have an impact on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

TARP Capital Purchase Program

The Series A Preferred Shares will qualify as Tier 1 capital and pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. The Series B Preferred Shares will pay cumulative dividends at a rate of 9% per annum. Dividends are payable on both the Series A Preferred Shares and the Series B Preferred Shares (collectively, the “Preferred Shares”) quarterly and are payable on February 15, May 15, August 15 and November 15 of each year.

The Series A Preferred Shares, the Warrant and the Series B Preferred Shares were issued in a private placement transaction exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The Company has agreed to register for resale the Series A Preferred Shares and the Series B Preferred Shares upon the request of the Treasury. The Securities Purchase Agreement provides that the Preferred Shares will not be subject to any contractual restrictions on transfer, except that the Treasury and its transferees may not effect any transfer of the Preferred Shares that would cause the Company to otherwise become subject to the periodic reporting requirements of the Securities Exchange Act of 1934.

The Articles of Amendment to the Company’s Articles of Incorporation filed in advance of the closing under the Program provide that the Company may not redeem the Preferred Shares for three years except with the proceeds from a “Qualified Equity Offering” (as defined in the Articles of Amendment). However, under the American Recovery and Reinvestment Act of 2009 (the “ARRA”), which amended the Emergency Economic Stabilization Act of 2008, and pursuant to an agreement with the Treasury pertaining to the ARRA, the Company may, subject to consultation with the Federal Reserve Bank of Richmond, redeem all or certain portions of the Preferred Shares at any time for the aggregate liquidation preference amount plus any accrued and unpaid dividends without first raising additional capital in an equity offering.

Please see our Current Report on Form 8-K filed September 25, 2009 for additional details regarding the Company’s participation in the Program.

Item 3

Quantitative and Qualitative Disclosures About Market Risk

The Company is a smaller reporting company and thus is not required to provide the information required by this Item 3.

Item 4T

Controls and Procedures

The Company is required to maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to Company management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, the Company recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2009. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have determined that our disclosure controls and procedures with respect to financial reporting were effective as of September 30, 2009 to ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported as and when required.

Changes in Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. This system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

There were no changes in the Company’s internal control over financial reporting in the quarter ended September 30, 2009 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1

Legal Proceedings

The Company is a party to routine litigation incidental to our business, none of which is considered likely to have a material effect on the Company.

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

Information regarding unregistered sales of equity securities of the Company sold by the Company during the period covered by this quarterly report on Form 10-Q previously was included in our Current Report on Form 8-K filed on September 25, 2009.

Item 3

Defaults Upon Senior Securities

None

Item 4

Submission of Matters to a Vote of Security Holders

None

Item 5

Other Information

None

Item 6

Exhibits

See Index to Exhibits

SIGNATURES

Pursuant to the requirements 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 BANKSHARES, INC.
		(Registrant)

November 5, 2009		/S/ MICHAEL S. IVES
		Michael S. Ives,
		President and Chief Executive Officer

November 5, 2009		/S/ JOHN O. GUTHRIE
		John O. Guthrie,
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

Index to Exhibits



3.1		Amended and Restated Articles of Incorporation of Heritage Bankshares, Inc. (Incorporated herein by reference to the Company’s Form 10-Q filed on August 11, 2009.)

3.2		Articles of Amendment to the Articles of Incorporation of Heritage Bankshares, Inc. Establishing the Terms of the Preferred Shares. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

3.3		Amendment to Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

4.1		Form of Certificate for the Series A Preferred Stock. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

4.2		Form of Certificate for the Series B Preferred Stock. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

4.3		Warrant to Purchase up to 303.00303 shares of Series B Preferred Stock, dated September 25, 2009. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

10.8		Amended and Restated Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Company’s Form 8-K filed on May 3, 2005.)

10.11		Amendment to Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Company’s Form 8-K filed on August 1, 2006.)

*10.16		Heritage 2006 Equity Incentive Plan (As Amended and Restated Effective January 28, 2009). (Incorporated herein by reference to the Company’s Form S-8 filed on July 27, 2009.)

10.22		Letter Agreement, dated September 25, 2009, including Securities Purchase Agreement – Standard Terms, incorporated by reference therein, between Heritage Bankshares, Inc. and the United States Department of the Treasury. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

10.23		Side Letter, dated September 25, 2009, between Heritage Bankshares, Inc. and the United States Department of the Treasury. (Incorporated herein by reference to the Company’s Form 8-K filed on March 5, 2009.)

10.24		ARRA Agreement, dated September 25, 2009, between Heritage Bankshares, Inc. and the United States Department of the Treasury. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

*10.25		Form of Waiver. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

*10.26		Form of Amendment to Employment Agreement. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

*10.27		Amendment to Employment Agreement of Michael S. Ives dated September 23, 2009. (Incorporated herein by reference to the Company’s Form 8-K filed on March 5, 2009.)

*10.28		Supplemental Executive Retirement Plan between the Company and Michael S. Ives dated September 23, 2009. (Incorporated herein by reference to the Company’s Form 8-K filed on September 25, 2009.)

31.1		Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



31.2		Certification of principal financial officer 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.

*	Indicates management contract or compensatory plan or arrangement.

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. freshman Avg

Large accelerated filer

Accelerated filer

Non-accelerated filer

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Smaller reporting company