Heritage Bankshares (HBKS) 10-Q 2011 Q1 Quarterly report

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 March 31, 2011

¨ 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):

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

A total of 2,307,502 shares of the registrant’s common stock were outstanding as of April 30, 2011.

TABLE OF CONTENTS

		Page No.
Part I.	FINANCIAL INFORMATION
Item 1 -	Financial Statements (Unaudited)
Consolidated Balance Sheets March 31, 2011 and December 31, 2010			3
Consolidated Statements of Income Three Months Ended March 31, 2011 and 2010			4
Consolidated Statements of Cash Flows Three Months Ended March 31, 2011 and 2010			5
Notes to Consolidated Financial Statements			6
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operation		21
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk		24
Item 4 -	Controls and Procedures		24
Part II.	OTHER INFORMATION
Item 1 -	Legal Proceedings		25
Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds		25
Item 3 -	Defaults Upon Senior Securities		25
Item 4 -	(Removed and Reserved)		25
Item 5 -	Other Information		25
Item 6 -	Exhibits		25
Signatures			26

2

Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

	At March 31, 2011 (Unaudited)			December 31, 2010 (Audited)
	(in thousands, except per share data)
ASSETS
Cash and due from banks	$	4,133		$	3,056
Interest-bearing deposits in other banks		16,460			12,923
Federal funds sold		399			401
Total cash and cash equivalents		20,992			16,380
Certificates of deposit in other banks		1,526			2,260
Securities available-for-sale, at fair value		17,878			17,368
Loans, net
Held for investment, net of allowance for loan losses of $2,093 and $2,090, respectively		214,507			214,342
Accrued interest receivable		663			668
Stock in Federal Reserve Bank (“FRB”), at cost		592			587
Stock in Federal Home Loan Bank of Atlanta (“FHLB”), at cost		1,773			1,773
Premises and equipment, net		11,032			11,165
Other real estate owned		263			263
Other assets		2,379			2,282
Total assets	$	271,605		$	267,088
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Noninterest-bearing	$	80,558		$	85,308
Interest-bearing		145,809			138,794
Total deposits		226,367			224,102
Federal Home Loan Bank Advances		6,000			—
Other borrowings		1,010			1,087
Securities sold under agreements to repurchase		1,020			2,378
Accrued interest payable		98			100
Other liabilities		1,919			1,841
Total liabilities		236,414			229,508
Commitments and contingencies		—			—
Stockholders’ equity
Preferred stock, no par value - 1,000,000 shares authorized:
Fixed rate cumulative perpetual preferred stock, Series A, 7,497 shares and 10,103 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively		7,497			10,103
Fixed rate cumulative perpetual preferred stock, Series B, 303 shares issued and outstanding at both March 31, 2011 and December 31, 2010		303			303
Common stock, $5 par value - 6,000,000 shares authorized; 2,307,502 shares issued and outstanding at both March 31, 2011 and December 31, 2010, respectively		11,538			11,538
Additional paid-in capital		6,674			6,658
Retained earnings		9,007			8,801
Discount on preferred stock		(164	)		(235	)
Accumulated other comprehensive income, net		336			412
Total stockholders’ equity		35,191			37,580
Total liabilities and stockholders’ equity	$	271,605		$	267,088

See accompanying notes to financial statements.

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

	Three Months Ended March 31
	2011				2010
	(in thousands, except per share data)
Interest and dividend income
Loans and fees on loans	$	2,855			$	2,299
Taxable investment securities		148				400
Dividends on FRB and FHLB stock		12				9
Interest on federal funds sold		—				—
Other interest income		27				36
Total interest income		3,042				2,744
Interest expense
Deposits		305				355
Borrowings		16				34
Total interest expense		321				389
Net interest income		2,721				2,355
Provision for loan losses		—				—
Net interest income after provision for loan losses		2,721				2,355
Noninterest income
Service charges on deposit accounts		92				117
Gain on sale of investment securities		—				254
Late charges and other fees on loans		16				15
Other		76				68
Total noninterest income		184				454
Noninterest expense
Compensation		1,083				1,228
Data processing		144				137
Occupancy		191				194
Furniture and equipment		146				150
Taxes and licenses		85				86
Professional fees		119				106
FDIC assessment		79				78
Marketing		39				31
Telephone		32				23
Loss on sale or impairment of fixed assets		—				33
Other		154				180
Total noninterest expense		2,072				2,246
Income before provision for income taxes		833				563
Provision for income taxes		273				202
Net income	$	560			$	361
Preferred stock dividends and accretion of discount		(199	)			(146	)
Net income available to common stockholders	$	361			$	215
Earnings per common share
Basic	$	0.16			$	0.09
Diluted	$	0.16			$	0.09
				��
Dividends per common share	$	0.06			$	0.06
Weighted average common shares outstanding - basic		2,307,502				2,291,800
Effect of dilutive stock options		10,589				7,187
Weighted average common shares outstanding - assuming dilution		2,318,091				2,298,987

See accompanying notes to financial statements.

4

HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(in thousands)
Cash flows from operating activities:
Net income	$	560		$	361
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss		—			—
Amortization of loan yield adjustments, net		94			82
Depreciation, amortization and accretion, net		157			199
Stock based compensation		16			36
Deferred compensation		66			10
Exercise of stock options tax benefit		—			13
Net (gains) losses on:
Sale of securities		—			(254	)
Sale or impairment of real estate owned		—			33
Net gain on bank owned life insurance		(13	)		(13	)
Changes in assets/liabilities, net:
Decrease(increase) in interest receivable and other assets		(40	)		143
Increase in interest payable and other liabilities		14			224
Net cash provided by operating activities		854			834
Cash flows from investing activities:
Proceeds from maturities and principal repayments of securities available for sale		2,362			9,362
Purchases of securities available for sale		(3,007	)		—
Proceeds from sales of securities available for sale		—			6,837
Net decrease in certificates of deposit at other banks		734			728
Proceeds from sale of other real estate owned		—			120
Net (increase)decrease in loans held for investment		(259	)		3,007
Purchases of FHLB stock and FRB stock		(5	)		(1	)
Purchases of premises and equipment		(8	)		(37	)
Net cash provided by (used for) investing activities		(183	)		20,016
Cash flows from financing activities:
Proceeds from exercise of stock options		—			42
Net increase(decrease) in deposits		2,265			(10,080	)
Proceeds from FHLB advances		26,650			34,050
Repayments of FHLB advances		(20,650	)		(34,050	)
Net increase(decrease) in securities sold under agreements to repurchase		(1,358	)		3,373
Repayments of other borrowings		(77	)		—
Repurchase of preferred stock		(2,606	)		—
Cash dividends paid		(283	)		(271	)
Net cash provided by(used for) financing activities		3,941			(6,936	)
Increase in cash and cash equivalents		4,612			13,914
Cash and cash equivalents, beginning of period		16,380			22,004
Cash and cash equivalents, end of period	$	20,992		$	35,918
Supplemental disclosure:
Interest paid	$	323		$	372
Income taxes paid	$	479		$	233

See accompanying notes to financial statements.

5

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 the Company 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 for 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. These unaudited consolidated financial statements should be read in conjunction with and with reference to the audited consolidated financial statements and accompanying footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2010. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

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.

Allowance for Loan Losses; Impairment of Loans.The Bank maintains an allowance for loan losses at a level that, 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 generally accepted accounting principles related to receivables. The 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 generally accepted accounting principles related to 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.

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The Bank then considers the impact of various bank, industry, economic and other environmental factors and documents, which are further 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 as prescribed by generally accepted accounting principles related to receivables; (3) Loan Segments – an amount to adjust the historical allocation for the four loan segments based on environmental factors as provided by guidance for contingencies; 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 the decline 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. Generally accepted accounting principles relating to accounts receivable require 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, there can be no assurance 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 accordance with accounting guidance, the Company evaluated events and transactions for potential recognition or disclosure in these financial statements through the date the financial statements were issued.

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in their interim and annual financial statements. See Note 7 to our (Unaudited) Financial Statements below.

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.

Disclosures related to TDRs under ASU 2010-20 will be effective for reporting periods beginning after June 15, 2011.

Also in December 2010, the Business Combinations topic of the ASC was amended to specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendment also requires that the supplemental pro forma disclosures include a description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This amendment is effective for the Company for business combinations for which the acquisition date is on or after January 1, 2011, although early adoption is permitted. The Company does not expect the amendment to have any impact on its financial statements.

7

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.

Note 2 – Share-Based Compensation

The following table presents a summary of stock option activity for the period of January 1, 2011 to March 31, 2011:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Term (Years)		Aggregate Intrinsic Value
							(in thousands)
Outstanding at January 1, 2011		241,400	$	12.62
Granted		—		—
Exercised		—		—
Forfeited/expired		2,000		14.84
Outstanding at March 31, 2011		239,400	$	12.60		5.4	$	143
Exercisable at March 31, 2011		208,200	$	12.59		5.3	$	107

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 March 31, 2011. The amount changes based on the fair market value of the Company’s common stock, as reflected by stock market prices. The Company’s current policy is to issue new shares of common stock to satisfy option exercises.

There were no options exercised during the three months ended March 31, 2011. The aggregate intrinsic value of options exercised during the three months ended March 31, 2010 was $39,121, and cash received from exercises of options during the first three months of 2010 was $41,529.

The amount charged against income, before income tax benefit of $620, in relation to the stock-based payment arrangements was $16,173 for the three months ended March 31, 2011. The amount charged against income, before income tax benefit of $3,000, in relation to the stock-based payment arrangements was $35,894 for the three months ended March 31, 2010. At March 31, 2011, unrecognized compensation expense, net of estimated forfeitures, related to unvested stock option grants was $60,622 and is currently expected to be recognized over a weighted average period of 0.7 years as follows:

	Stock-Based Compensation Expense
	(in thousands)
At March 31, 2011:
2011	$	47
2012		10
2013		4
Total	$	61

8

Note 3 – Other Comprehensive Income

The components of the Company’s other comprehensive income and related tax effects are as follows:

	Three Months Ended March 31,
	2011			2010
	(in thousands)
Unrealized holding gains/(losses) on available-for-sale securities	$	(115	)	$	20
Realized gains on sales of available-for-sale securities		—			(254	)
Tax effect on realized gains		—			86
Tax effect on unrealized gains/(losses)		39			(6	)
Other comprehensive income, net of tax	$	(76	)	$	(154	)

Note 4 – Earnings Per Common Share Reconciliation

The Company’s basic and diluted earnings per common share calculations are presented in the following table:

	Three Months Ended March 31,
	2011		2010
	(in thousands, except share and per share data)
Net income available to common stockholders (numerator, basic and diluted)	$	361	$	215
Weighted average common shares outstanding (denominator)		2,307,502		2,291,800
Earnings per common share – basic	$	0.16	$	0.09
Effect of dilutive securities
Weighted average common shares outstanding during the period		2,307,502		2,291,800
Effect of dilutive stock options		10,589		7,187
Weighted diluted average common shares outstanding (denominator) during the period		2,318,091		2,298,987
Earnings per common share – assuming dilution	$	0.16	$	0.09

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.

9

The following table presents the carrying amounts and fair value of the Company’s financial instruments at March 31, 2011 and December 31, 2010:

	At March 31, 2011					At December 31, 2010
	Carrying Amount			Fair Value		Carrying Amount		Fair Value
	(Dollars in Thousands)
Financial assets:
Cash, due from banks, and interest-bearing deposits at other banks	$	20,593	��	$	20,593	$	15,979	$	15,979
Federal funds sold		399			399		401		401
Certificates of deposit in other banks		1,526			1,526		2,260		2,260
Securities available for sale		17,878			17,878		17,368		17,368
Loans held for investment		214,507			217,504		214,342		217,450
Accrued interest receivable		663			663		668		668
Stock in FRB and FHLB		2,365			2,365		2,360		2,360
Bank-owned life insurance		597			597		584		584
Other financial assets		182			182		148		148
Financial liabilities:
Deposits		226,367			226,539		224,102		224,337
FHLB advance		6,000			6,000		—		—
Securities sold under agreements to repurchase		1,020			1,020		2,378		2,378
Other borrowings		1,010			1,026		1,087		1,104
Accrued interest payable		98			98		100		100

Fair Value Hierarchy

“Fair Value Measurements and Disclosures” 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 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 that are deemed to be impaired are valued in accordance with guidance related to receivables. 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.

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Other Real Estate Owned

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. Once management’s intentions change regarding the utilization of its own property, that property is transferred to other real estate owned at 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.

Other Financial Assets

Other financial assets are recorded at fair value on a recurring basis. Fair value is based on quoted market prices which are considered 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
March 31, 2011
in thousands	Total		Level 1		Level 2		Level 3
Investment in securities available for sale
U.S. Treasury notes	$	2,993		—	$	2,993		—
Mortgage-backed securities		14,885		—		14,885		—
Other financial assets		182		—		182		—
Total Assets at Fair Value	$	18,060	$	—	$	18,060	$	—
December 31, 2010
in thousands	Total		Level 1		Level 2		Level 3
Investment in securities available for sale
Mortgage-backed securities	$	17,368	$	—	$	17,368	$	—
Other financial assets		148		—		148		—
Total Assets at Fair Value	$	17,516	$	—	$	17,516	$	—
Assets Recorded at Fair Value on a Non-Recurring Basis
March 31, 2011
in thousands	Total		Level 1		Level 2		Level 3
Other real estate owned	$	263		—	$	263		—
Total Assets at Fair Value	$	263	$	—	$	263	$	—
December 31, 2010
in thousands	Total		Level 1		Level 2		Level 3
Other real estate owned	$	263	$	—	$	263	$	—
Total Assets at Fair Value	$	263	$	—	$	263	$	—

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Note 6 – Securities

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
At March 31, 2011
Securities available for sale
U.S. Treasury notes	$	3,006	$	—	$	(13	)	$	2,993
Mortgage-backed securities		14,363		522		—			14,885
Total securities available for sale	$	17,369	$	522	$	(13	)	$	17,878
Total securities (1)	$	17,369	$	522	$	(13	)	$	17,878
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
At December 31, 2010
Securities available for sale
Mortgage-backed securities	$	16,744	$	624	$	—		$	17,368
Total securities available for sale	$	16,744	$	624	$	—		$	17,368
Total securities (1)	$	16,744	$	624	$	—		$	17,368

(1) At March 31, 2011 and at December 31, 2010, 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 March 31, 2011 and at December 31, 2010. Any current year unrealized losses on investment securities, if any, are a result of changes in interest rates during the period. Unrealized losses on investment securities, if any, are considered by management to be temporary given the credit ratings on these investment securities and the short duration of any unrealized loss due to credit quality.

	At March 31, 2011
	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 notes	$	1,994	$	(13	)	$	—	$	—	$	1,994	$	(13	)
Mortgage-backed securities		—		—			—		—		—		—
Total temporarily impaired securities	$	1,994	$	(13	)	$	—	$	—	$	1,994	$	(13	)
	At December 31, 2010
	Less Than 12 Months					12 Months or More				Total
	(in thousands)
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities		—		—			—		—		—		—
Total temporarily impaired securities	$	—	$	—		$	—	$	—	$	—	$	—

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The amortized cost and fair value of investment securities at March 31, 2011, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because some securities may be called or prepaid prior to their contractual maturity:

	Securities Available for Sale (in thousands)
	Amortized Cost		Fair Value
Due in one year or less	$	408	$	416
Due after one year through five years		12,345		12,624
Due after five years through ten years		4,616		4,838
Due after ten years		—		—
Total	$	17,369	$	17,878

Note 7 – Loans held for investment, net

Loans at the dates indicated consisted of the following:

	March 31, 2011			December 31, 2010
	(in thousands)
Commercial	$	35,885		$	37,354
Real estate – commercial		102,222			101,080
Real estate – consumer		56,325			55,694
Real estate – construction		18,156			18,389
Consumer		4,012			3,915
Total loans		216,600			216,432
Allowance for loan losses		(2,093	)		(2,090	)
Loans, net(1)	$	214,507		$	214,342

⁽¹⁾ Loans amounts are presented net of unearned fees and costs for March 31, 2011 and December 31, 2010.

Nonperforming assets at the dates indicated were:

	March 31, 2011		December 31, 2010
	(in thousands)
Nonaccrual loans	$	—	$	—
Accruing loans past due 90 days or more		—		—
Total nonperforming loans		—		—
Real estate owned, net		263		263
Total nonperforming assets	$	263	$	263

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

	At March 31,
	2011			2010
	(in thousands)
Balance, beginning of year	$	2,090		$	1,773
Provision for loan losses		—			—
Loans charged-off
Commercial		(1	)		(13	)
Real estate – commercial		—			—
Real estate – consumer		—			—
Real estate – construction		—			—
Consumer		—			(11	)
Total loans charged-off		(1	)		(24	)
Recoveries
Commercial		2			1
Real estate – commercial		—			—
Real estate – consumer		2			—
Real estate – construction		—			—
Consumer		—			—
Total loans recovered		4			1
Net recoveries		3			(23	)
Balance, end of period	$	2,093		$	1,750

The following table presents the aging analysis of the Company’s loan portfolio at March 31, 2011:

	30-59 Days Past Due		60-89 Days Past Due		90 days or more Past Due		Total Past Due		Current		Total Loans Outstanding		Loans 90 days past due and accruing
	(in thousands)
Commercial	$	—	$	—	$	—	$	—	$	35,885	$	35,885	$	—
Real estate – commercial		—		—		—		—		102,222		102,222		—
Real estate – consumer		—		—		—		—		56,325		56,325		—
Real estate – construction		—		—		—		—		18,156		18,156		—
Consumer		—		—		—		—		4,012		4,012		—
Total	$	—	$	—	$	—	$	—	$	216,600	$	216,600	$	—

The following table presents the aging analysis of the Company’s loan portfolio at December 31, 2010:

	30-59 Days Past Due		60-89 Days Past Due		90 days or more Past Due		Total Past Due		Current		Total Loans Outstanding		Loans 90 days past due and accruing
	(in thousands)
Commercial	$	—	$	—	$	—	$	—	$	37,354	$	37,354	$	—
Real estate – commercial		—		—		—		—		101,080		101,080		—
Real estate – consumer		131		—		—		131		55,563		55,694		—
Real estate – construction		—		—		—		—		18,389		18,389		—
Consumer		—		—		—		—		3,915		3,915		—
Total	$	131	$	—	$	—	$	131	$	216,301	$	216,432	$	—

The Bank utilizes an internal system based on payment history as its primary credit indicator on its commercial and commercial real estate loan portfolios. Loans that consistently meet an established historical payment schedule are not given further scrutiny other than that given in the ordinary course of business. Any loan

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that misses its normal payment date falls into a category of heightened scrutiny to determine whether a potential weakness exists. Based upon the collection and analysis of certain data, if there is a determination that no weakness exists, the loan will be given no further heightened scrutiny. If, however, current financial information indicates a potential weakness, aggressive investigation will begin into collateral values and borrower ability to pay to determine loss potential to the Bank. If loss potential is small, the loan is placed into a category of continued monitoring. If loss potential is high, the process of collateral realization may begin.

The following table is a summary of credit quality indicators related to the Bank’s commercial and real estate loans at March 31, 2011:

	Commercial		Real Estate Commercial		Real Estate Construction		Total
	(in thousands)
Category:
Normal review	$	35,885	$	100,753	$	18,156	$	154,794
Closely monitored		—		1,469		—		1,469
In collection		—		—		—		—
Total	$	35,885	$	102,222	$	18,156	$	156,263

The following table is a summary of credit quality indicators related to the Bank’s commercial and real estate loans at December 31, 2010:

	Commercial		Real Estate Commercial		Real Estate Construction		Total
	(in thousands)
Category:
Normal review	$	37,354	$	99,602	$	18,389	$	155,345
Closely monitored		—		1,478		—		1,478
In collection		—		—		—		—
Total	$	37,354	$	101,080	$	18,389	$	156,823

For regulatory purposes, the Bank utilizes an internal credit classification system to manage the credit quality of its commercial and real estate loan portfolios. Loans classified as “substandard” have well-defined weaknesses and typically have experienced a degradation in either the current value of the pledged collateral or of the paying capacity of the borrower; these loans carry a distinct possibility that the Bank could sustain some loss unless the weakness is corrected. Loans classified as “doubtful” have uncorrected weaknesses that have a high possibility of loss; a loan may reside in this classification temporarily until a currently unquantifiable expected loss can be determined with a greater degree of accuracy. Any loan classified in the “loss” risk class is considered uncollectible and is to be charged-off within 30 days or less.

The following table presents a summary of commercial and real estate loans classified by this internal credit classification at March 31, 2011:

	Commercial		Real Estate Commercial		Real Estate Construction		Total
	(in thousands)
Grade:
Pass	$	35,884	$	100,141	$	16,584	$	152,609
Substandard		1		2,081		1,572		3,654
Doubtful		—		—		—		—
Loss		—		—		—		—
Total	$	35,885	$	102,222	$	18,156	$	156,263

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The following table presents a summary of commercial and real estate loans classified by this internal credit classification at December 31, 2010:

	Commercial		Real Estate Commercial		Real Estate Construction		Total
	(in thousands)
Grade:
Pass	$	37,346	$	98,715	$	16,789	$	152,850
Substandard		8		2,365		1,600		3,973
Doubtful		—		—		—		—
Loss		—		—		—		—
Total	$	37,354	$	101,080	$	18,389	$	156,823

The Bank utilizes delinquency status in its evaluation of credit exposure for consumer loans, which include both revolving and closed-end mortgages as well as installment and personal loans. Consumer loans are considered to be nonperforming when severely delinquent, defined as 90 days or more past due.

The following table represents the credit risk profile for the consumer portfolio at March 31, 2011:

	Consumer Mortgages		Installment and Other Consumer		Total
	(in thousands)
Performing	$	56,325	$	4,012	$	60,337
Nonperforming		—		—		—
Total	$	56,325	$	4,012	$	60,337

The following table represents the credit risk profile for the consumer portfolio at December 31, 2010:

	Consumer Mortgages		Installment and Other Consumer		Total
	(in thousands)
Performing	$	55,694	$	3,915	$	59,609
Nonperforming		—		—		—
Total	$	55,694	$	3,915	$	59,609

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The following tables present an allocation of the Company’s allowance for loan losses and the respective loans evaluated based on its allowance methodology at March 31, 2011:

	Commercial		Real Estate Commercial		Real Estate Consumer		Real Estate Construction		Consumer		Unallocated		Total
	(in thousands)
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	13	$	—	$	—	$	—	$	—	$	13
Ending balance:
Collectively evaluated for impairment		314		882		514		159		35		176		2,080
Ending balance:
Loans acquired with deteriorated credit		—		—		—		—		—		—		—
Total Ending Balance	$	314	$	895	$	514	$	159	$	35	$	176	$	2,093
	Commercial		Real Estate Commercial		Real Estate Consumer		Real Estate Construction		Consumer		Unallocated		Total
	(in thousands)
Total loans:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	1,469	$	—	$	—	$	—	$	—	$	1,469
Ending balance:
Collectively evaluated for impairment		35,885		100,753		56,325		18,156		4,012		—		215,131
Ending balance:
Loans acquired with deteriorated credit		—		—		—		—		—		—		—
Total Ending Balance	$	35,885	$	102,222	$	56,325	$	18,156	$	4,012	$	—	$	216,600

(1) Certain loans were evaluated for impairment at March 31, 2011. Based on this evaluation process, it was determined that no impairment was required.

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The following tables present an allocation of the Company’s allowance for loan losses and the respective loans evaluated based on its allowance methodology at December 31, 2010:

	Commercial		Real Estate Commercial		Real Estate Consumer		Real Estate Construction		Consumer		Unallocated		Total
	(in thousands)
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	13	$	—	$	—	$	—	$	—	$	13
Ending balance:
Collectively evaluated for impairment		327		872		508		162		34		174		2,077
Ending balance:
Loans acquired with deteriorated credit		—		—		—		—		—		—		—
Total Ending Balance	$	327	$	885	$	508	$	162	$	34	$	174	$	2,090
	Commercial		Real Estate Commercial		Real Estate Consumer		Real Estate Construction		Consumer		Unallocated		Total
	(in thousands)
Total loans:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	1,478	$	—	$	—	$	—	$	—	$	1,478
Ending balance:
Collectively evaluated for impairment		37,354		99,602		55,694		18,389		3,915		—		214,954
Ending balance:
Loans acquired with deteriorated credit		—		—		—		—		—		—		—
Total Ending Balance	$	37,354	$	101,080	$	55,694	$	18,389	$	3,915	$	—	$	216,432

(1) Certain loans were evaluated for impairment at December 31, 2010. Based on this evaluation process, it was determined that no impairment was required.

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The Company had no impaired loans at March 31, 2011. The following table reflects the average daily recorded investment in impaired loans during the quarter then-ended and interest income recognized on those loans:

	Recorded Investment		Unpaid Balance		Related Allowance		Average Daily Recorded Investment		Interest Income Recognized
	(in thousands)
With no allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—
With an allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—
Total
Commercial	$	—	$	—	$	—	$	—	$	—
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—

The following is a summary of information pertaining to impaired loans at December 31, 2010:

	Recorded Investment		Unpaid Balance		Related Allowance		Average Daily Recorded Investment		Interest Income Recognized
	(in thousands)
With no allowance recorded:
Commercial	$	—	$	—	$	—	$	44	$	2
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		9		1
Total	$	—	$	—	$	—	$	53	$	3
With an allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—
Total
Commercial	$	—	$	—	$	—	$	44	$	2
Real Estate – Commercial		—		—		—		—		—
Real Estate – Consumer		—		—		—		—		—
Real Estate – Construction		—		—		—		—		—
Consumer		—		—		—		9		1
Total	$	—	$	—	$	—	$	53	$	3

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Note 8 – Partial TARP Repayment

In March 2011, consistent with its strategic plan and with the approval of the U.S. Treasury, the Company repaid $2.6 million, or 25%, of its outstanding TARP preferred stock, with a resulting decrease in net income available to common shareholders of $57,000 from the accelerated accretion of a portion of the discount on its outstanding TARP preferred stock.

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Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Forward-Looking Statements

Statements contained in this quarterly report on Form 10-Q that are not historical facts are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of such words as “may,” “will,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential”, among others, though these words are not the exclusive means of identifying such forward-looking statements. These forward-looking statements relate to, among other things, expectations regarding the business environment in which we operate, projections of future performance and perceived opportunities in the market, and they are based on management’s current beliefs, assumptions and expectations. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. For a detailed discussion of the factors that might cause such a difference, see Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2010, filed March 28, 2011.

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

• the demand for our products and services;

• actions taken by our competitors;

• changes in prevailing interest rates;

• changes in delinquencies and defaults by our borrowers;

• changes in loan quality and performance;

• changes in FDIC insurance assessments;

• legislative or regulatory changes or actions that affect our business, including new regulations imposed by the Dodd-Frank Act;

• our ability to achieve financial goals and strategic plans;

• our participation in the TARP Capital Purchase Program;

• litigation; and

• credit and other risks of lending activities.

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

Financial Condition of the Company at March 31, 2011

Total Assets. The Company’s total assets increased by $3.5 million, or 1.3%, from $268.1 million at March 31, 2010 to $271.6 million at March 31, 2011. The increase in assets resulted primarily from a $36.1 million, or 20.2%, increase in loans held for investment, net, offset by $32.6 million, or 44.7%, decrease in securities and cash held at other banks. An increase in total assets of $4.5 million, or 1.7%, from $267.1 million at December 31, 2010 is mainly attributable to an increase in cash and cash equivalents and certificates of deposit held at other banks of $3.9 million.

21

Investments.Investment securities available for sale were $17.9 million at March 31, 2011 compared to $33.9 million at March 31, 2010, a decrease of $16.0 million, or 47.2%. Certificates of deposit and interest-bearing deposits in other banks and federal funds sold decreased by a total of $16.6 million, or 47.4%, from $35.0 million at March 31, 2010 to $18.4 million at March 31, 2011. The proceeds from these decreases in investment securities, bank deposits, and federal funds sold were primarily used to fund new loans. Investments increased by $3.3 million from $33.0 million at December 31, 2010 to $36.3 million at March 31, 2011, primarily due to an increase in interest-bearing deposits held at other banks.

Loans. Loans held for investment, net, were $214.5 million at March 31, 2011, an increase of $36.1 million, or 20.2%, from the loan balance of $178.5 million at March 31, 2010. As compared to $214.3 million at December 31, 2010, loans held for investment, net, remained steady.

Asset Quality. Nonperforming assets were $263,000, or 0.10% of assets, at March 31, 2011 and December 31, 2010, compared to $310,000, or 0.12% of assets, at March 31, 2010. The Company’s sole nonperforming asset as of March 31, 2011 consisted of a bank branch site that we no longer plan to utilize.

Deposits. The Company achieved a net increase in total deposits of $7.3 million, or 3.3%, from $219.1 million at March 31, 2010 to $226.4 million at March 31, 2011. Core deposits, which are comprised of noninterest-bearing, money market, NOW and savings deposits, increased by $10.5 million, or 6.2%, from $167.7 million at March 31, 2010 to $178.2 million at March 31, 2011. An increase of $2.3 million in total deposits from $224.1 million at December 31, 2010 is the result of increases in core deposits.

Average total deposits increased by $10.5 million, or 4.8%, from $217.3 million during the three months ended March 31, 2010 compared to $227.8 million during the three months ended March 31, 2011. Average core deposits increased by $9.6 million over the comparable three-month periods. In addition, the mix of average noninterest-bearing deposits to average total deposits increased from 32.7% in the first three months of 2010 to 36.5% in the first three months of 2011, further contributing to the improvement in our net interest margin.

Borrowed Funds. Borrowed funds decreased by $2.4 million, from $10.4 million at March 31, 2010 to $8.0 million at March 31, 2011. This reduction related to a decrease of $4.4 million in securities sold under agreements to repurchase partially offset by a $2.0 million increase in Federal Home Loan Bank advances and other borrowings. Borrowings increased by $4.5 million to $8.0 million at March 31, 2011 from $3.5 million at December 31, 2010 and were used primarily to fund interest-bearing deposits in other banks.

Capital. Stockholders’ equity decreased by $1.6 million, or 4.4%, from $36.8 million at March 31, 2010 to $35.2 million at March 31, 2011. In March 2011, consistent with our strategic plan and with the approval of the U.S. Treasury, the Company redeemed 2,606 shares of Series A Preferred Stock, resulting in a decrease of $2.6 million in the outstanding balance of our TARP preferred stock. This decrease in stockholders’ equity was partially offset by an increase in retained earnings of $1.1 million between March 31, 2010 and March 31, 2011. At December 31, 2010 stockholders’ equity was $37.6 million.

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

Comparison of Operating Results for the Three Months Ended March 31, 2011 and 2010

Overview. The Company’s pretax income was $833,000 for the first quarter of 2011, compared to pretax income of $563,000 for the first quarter of 2010, an increase of $270,000. This increase resulted from a $366,000 increase in net interest income combined with a $174,000 decrease in noninterest expense, partially offset by a decrease in noninterest income of $270,000.

Net Interest Income. The Company’s net interest income before provision for loan losses increased by $366,000 to $2.72 million in the first quarter of 2011, compared to $2.36 million in the first quarter of 2010. Interest income in the first quarter of 2011 grew significantly, primarily due to a $36.2 million increase in our average loan portfolio compared to the first quarter of 2010. Our interest rate spread increased 50 basis points from 3.47% in the first quarter of 2010 to 3.97% in the first quarter of 2011, and our net interest margin increased 48 basis points from 3.85% in the first quarter of 2010 to 4.33% in the first quarter of 2011.

22

Provision for Loan Losses. No provision for loan losses was recorded for the first quarter of either 2011 or 2010.

Noninterest Income. Total noninterest income decreased by $270,000, from $454,000 in the first quarter of 2010 to $184,000 in the first quarter of 2011. The Company recognized a $254,000 gain on the sale of investment securities in the first quarter of 2010, but did not sell any securities in the first quarter of 2011, largely accounting for the decrease.

Noninterest Expense. Total noninterest expense decreased by $174,000 from $2.25 million in the first quarter of 2010 to $2.07 million in the first quarter of 2011. Compensation expense decreased by $145,000, from $1.23 million in the first quarter of 2010 to $1.08 million in the first quarter of 2011, primarily attributable to various compensation accruals in 2010 that did not recur in 2011.

Income Taxes. The Company’s income tax expense for the first quarter of 2011 was $273,000, reflecting an effective tax rate of 32.8%, compared to income tax expense of $202,000 for the first quarter of 2010, reflecting an effective tax rate of 35.9%. This reduction is primarily attributable to an increase in tax-exempt interest income from certain loans.

Net Income Available to Common Stockholders. After the impact of dividends and accelerated accretion of the discount on our outstanding TARP preferred stock, net income available to common stockholders was $361,000 for the first quarter of 2011, compared to $215,000 for the first quarter of 2010. The Company repaid $2.6 million, or 25%, of its outstanding TARP preferred stock in March 2011, with a resulting decrease in net income available to common shareholders of $57,000 from the accelerated accretion of a portion of the discount on our outstanding TARP preferred stock.

Commitments

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

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

We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments. Unless otherwise noted, we require collateral or other security to support financial instruments with credit risk.

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

	At March  31, 2011		At March 31, 2010
	(in thousands)
Commitments to extend credit	$	37,821	$	37,335
Standby letters of credit		166		1,495
	$	37,987	$	38,830

Liquidity

Liquidity refers to the availability of sufficient funds to meet the needs of depositors, borrowers, creditors and investors and to fund operations. Our primary sources of funds are customer deposits, cash and cash equivalents, certificates of deposit in other banks, nonpledged 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 March 31, 2011, cash and cash equivalents and certificates of deposit at other banks were $22.5 million, an increase of $3.9 million, from $18.6 million at December 31, 2010.

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In addition, we maintain a liquid available-for-sale investment securities portfolio. At March 31, 2011, the balance of our nonpledged available-for-sale investment portfolio was $16.9 million, compared to a $15.0 million balance at December 31, 2010. We also are able to obtain funds through approved borrowing lines with the Federal Home Loan Bank of Atlanta and another financial institution. Management believes our existing liquidity sources are sufficient to satisfy the Company’s operational requirements and obligations. We maintain a high level of liquidity due to a concentration in some customer deposits, which can fluctuate significantly as depositor needs change.

Capital Resources

The Company’s capital is reflected in its stockholders’ equity, which was $35.2 million at March 31, 2011, compared to $37.6 million at December 31, 2010, a decrease of $2.4 million. This decrease in capital is primarily attributable to the $2.6 million partial redemption of our outstanding Series A Preferred Stock, described above, partially offset by retained earnings. At March 31, 2011, the Company and the Bank were considered “well-capitalized” as defined by the Federal Reserve Bank. We monitor the current and projected capital levels of the Bank and the Company and will consider additional sources of capital, through the issuance of stock, debt or otherwise, as needs arise.

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 4 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 March 31, 2011. 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 March 31, 2011 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 March 31, 2011 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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

None

Item 3 Defaults Upon Senior Securities

None

Item 4 (Removed and Reserved)

Item 5 Other Information

None

Item 6 Exhibits

See Index to Exhibits

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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)
May 11, 2011	/s/ Michael S. Ives
	Michael S. Ives,
	President & Chief Executive Officer
	(Principal Executive Officer)
May 11, 2011	/s/ John O. Guthrie
	John O. Guthrie,
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

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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 September 25, 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 September 25, 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.)
*10.29	Elective Deferred Compensation Agreement with Michael S. Ives. (Incorporated herein by reference to the Company’s Form 8-K filed on February 2, 2010.)

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*10.30	Deferred Compensation Plan Trust. (Incorporated herein by reference to the Company’s Form 8-K filed on February 2, 2010.)
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.

** Filed herewith.

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