Heritage Bankshares (HBKS) 10-Q 2012 Q1 Quarterly report

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

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

For the transition period from              to             

Commission File Number 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  x    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 2,305,965 shares of the registrant’s common stock were outstanding as of April 30, 2012.

TABLE OF CONTENTS

	Page No.
Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets March 31, 2012 and December 31, 2011		3
Consolidated Statements of Income Three Months Ended March 31, 2012 and 2011		4
Consolidated Statements of Cash Flows Three Months Ended March 31, 2012 and 2011		5
Consolidated Statements of Comprehensive Income Three Months Ended March 31, 2012 and 2011		6
Notes to Consolidated Financial Statements		7
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operation		21
Item 3 - Quantitative and Qualitative Disclosures About Market Risk		25
Item 4 - Controls and Procedures		25
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 - Mine Safety Disclosures		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, 2012		At December 31, 2011
	(unaudited)		(audited)
	(in thousands)
ASSETS
Cash and due from banks	$	5,989	$	5,335
Interest-bearing deposits in other banks		9,988		8,646
Federal funds sold		16		33
Total cash and cash equivalents		15,993		14,014
Securities available for sale, at fair value		52,549		45,310
Loans, net
Held for investment, net of allowance for loan losses		215,346		213,183
Accrued interest receivable		754		694
Stock in Federal Reserve Bank, at cost		594		591
Stock in Federal Home Loan Bank of Atlanta, at cost		891		834
Premises and equipment, net		10,994		11,029
Other real estate owned		1,682		1,719
Bank-owned life insurance		5,559		5,616
Other assets		1,887		1,594
Total assets	$	306,249	$	294,584
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Noninterest-bearing	$	94,927	$	92,839
Interest-bearing		162,049		157,139
Total deposits		256,976		249,978
Federal Home Loan Bank Advances		7,300		4,000
Securities sold under agreements to repurchase		2,414		1,502
Other borrowings		703		782
Accrued interest payable		54		83
Other liabilities		2,044		1,802
Total liabilities		269,491		258,147
Commitments and contingencies		—		—
Stockholders’ equity
Preferred stock, no par value - 1,000,000 shares authorized: Senior non-cumulative perpetual preferred stock, Series C, 7,800 shares issued and outstanding at both March 31, 2012 and December 31, 2011		7,800		7,800
Common stock, $5 par value - 6,000,000 shares authorized; 2,305,965 shares and 2,304,965 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively		11,530		11,525
Additional paid-in capital		6,729		6,704
Retained earnings		10,411		9,967
Accumulated other comprehensive income, net		288		441
Total stockholders’ equity		36,758		36,437
Total liabilities and stockholders’ equity	$	306,249	$	294,584

See accompanying notes to consolidated financial statements.

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME(Unaudited)

	Three Months Ended March 31,
	2012			2011
	(in thousands except per share data)
Interest income
Interest income and fees on loans	$	2,668		$	2,855
Interest on taxable investment securities		276			148
Dividends on FRB and FHLB stock		12			12
Interest on federal funds sold		—			—
Other interest income		6			27
Total interest income		2,962			3,042
Interest expense
Deposits		251			305
Borrowings		9			16
Total interest expense		260			321
Net interest income		2,702			2,721
Provision for loan losses		—			—
Net interest income after provision for loan losses		2,702			2,721
Noninterest income
Service charges on deposit accounts		68			92
Late charges and other fees on loans		47			16
Income from bank-owned life insurance		66			—
Other		80			76
Total noninterest income		261			184
Noninterest expense
Compensation		1,099			1,083
Data processing		155			144
Occupancy		223			191
Furniture and equipment		138			146
Taxes and licenses		79			85
Professional fees		107			119
FDIC assessment		40			79
Marketing		26			39
Telephone		32			32
Loss on sale or impairment of other real estate owned		37			—
Other		145			154
Total noninterest expense		2,081			2,072
Income before provision for income taxes		882			833
Provision for income taxes		252			273
Net income	$	630		$	560
Preferred stock dividend and accretion of discount		(47	)		(199	)
Net income available to common stockholders	$	583		$	361
Earnings per common share
Basic	$	0.25		$	0.16
Diluted	$	0.25		$	0.16
Dividends per share	$	0.06		$	0.06
Weighted average shares outstanding - basic		2,305,820			2,307,502
Effect of dilutive stock options		39,239			10,589
Weighted average shares outstanding - diluted		2,345,059			2,318,091

See accompanying notes to consolidated financial statements.

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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended March 31,
	2012			2011
	(in thousands)
Cash flows from operating activities:
Net income	$	630		$	560
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of loan yield adjustments, net		75			94
Depreciation, amortization and accretion, net		154			157
Stock based compensation		22			16
Deferred compensation		15			66
Exercise of stock options tax benefit		1			—
Net loss on:
Sale or impairment of other real estate owned		37			—
Net gain on bank owned life insurance		(66	)		—
Changes in assets/liabilities, net
Increase in interest receivable and other assets		(273	)		(40	)
Increase in interest payable and other liabilities		203			14
Net cash provided by operating activities		798			867
Cash flows from investing activities:
Proceeds from maturities and principal repayments of securities available for sale		11,513			2,362
Purchases of securities available for sale		(18,996	)		(3,007	)
Net decrease in certificates of deposit		—			734
Net increase in loans held for investment		(2,238	)		(259	)
Purchases of Federal Home Loan Bank stock and Federal Reserve Bank stock		(60	)		(5	)
Purchases of premises and equipment		(114	)		(8	)
Purchases of and premiums paid for bank-owned life insurance		(12	)		(13	)
Proceeds from bank owned life insurance		135			—
Net cash used for investing activities		(9,772	)		(196	)
Cash flows from financing activities:
Proceeds from exercise of stock options		8			—
Net increase in deposits		6,998			2,265
Net increase in Federal Home Loan Bank advances		3,300			6,000
Net increase/(decrease) in securities sold under agreements to repurchase		912			(1,358	)
Repayments of other borrowings		(79	)		(77	)
Repurchase of preferred stock		—			(2,606	)
Cash dividends paid		(186	)		(283	)
Net cash provided by financing activities		10,953			3,941
Increase in cash and cash equivalents		1,979			4,612
Cash and cash equivalents, beginning of period		14,014			16,380
Cash and cash equivalents, end of period	$	15,993		$	20,992
Supplemental disclosure:
Interest paid	$	290		$	323
Income taxes paid	$	213		$	479

See accompanying notes to consolidated financial statements.

5

HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended March 31,
	2012			2011
	(in thousands)
Net income for three months ended March 31	$	630		$	560
Unrealized holding losses on securities available for sale		(233	)		(115	)
Tax effect on unrealized losses		80			39
Total comprehensive income	$	477		$	484

See accompanying notes to consolidated financial statements.

6

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, 2011. 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 based on guidance for 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 provided by guidance for contingencies. As part of the loan loss reserve methodology, loans are placed into one of four major categories or segments of loans: (1) commercial and industrial loans, (2) consumer loans, (3) 1-4 family residential loans (including home equity loans and lines), and (4) multi-family and other commercial real estate loans.

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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 guidance for 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 has 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 April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments were effective for the Company on January 1, 2012 and had no effect on the financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning January 1, 2012 and had no effect on the financial statements.

The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Company on January 1, 2012 and have been applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.

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.

8

Note 2 – Share-Based Compensation

The following table presents a summary of stock option activity for the period of January 1, 2012 through March 31, 2012.

	Shares			Weighted Average Exercise Price			Weighted Average Remaining Term(years)		Aggregate Intrinsic Value
									(in thousands)
Outstanding at January 1, 2012		235,800		$	12.65
Granted		—			—
Exercised		(1,000	)		(7.50	)
Forfeited/expired		—			—
Outstanding at March 31, 2012		234,800		$	12.67			4.5	$	324
Exercisable at March 31, 2012		226,400		$	12.75			4.4	$	305

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, 2012. 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. The aggregate intrinsic value of options exercised during the three months ended March 31, 2012 was $3,700. Cash received from exercises of options during the first three months of 2012 was $7,500. There were no options exercised during the three months ended March 31, 2011.

On January 25, 2012, the Company’s Board of Directors granted, effective February 1, 2012, 43,600 shares of restricted stock to certain executives under the Heritage 2006 Equity Incentive Plan, as amended (“2006 Incentive Plan”). The shares vest at a rate of 20% over a five year period beginning on February 1, 2013 and on each February 1 thereafter. Upon the death or permanent disability of the executive or a change of control of the Company, any remaining unvested shares will vest immediately.

As defined in the 2006 Incentive Plan, fair value of the shares was measured by 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 or, if the Company’s shares were not traded on the grant-date, 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. In addition, because the share-recipients are not entitled to dividends until the shares vest, the grant date fair value of the award was reduced by the present value of the dividends expected to be paid on the underlying shares during the service period, discounted at the appropriate risk-free interest rate.

The following table presents a summary of restricted stock award activity for the period of January 1, 2012 to March 31, 2012.

	Shares		Fair Value at Grant Date
Outstanding at January 1, 2012		—		—
Granted		43,600	$	11.28
Vested		—		—
Forfeited/expired		—		—
Outstanding at March 31, 2012		43,600	$	11.28

9

The amount charged against income, before income tax benefit of $5,574, in relation to stock-based payment arrangements was $21,651 for the three months ended March 31, 2012. The amount charged against income, before income tax benefit of $620, in relation to stock-based payment arrangements was $16,173 for the three months ended March 31, 2011. At March 31, 2012, unrecognized compensation expense, net of estimated forfeitures, related to unvested stock option and restricted stock grants was $492,578 and is currently expected to be recognized over a weighted average period of 2.4 years as follows:

At March 31, 2012:	Stock-Based Compensation Expense
	(in thousands)
2012	$	87
2013		102
2014		98
2015		99
2016		99
2017		8
Total	$	493

Note 3 – 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,
	2012		2011
	(in thousands, except share) and per share data)
Net income available to common stockholders (numerator, basic and diluted)	$	583	$	361
Weighted average common shares outstanding (denominator)		2,305,820		2,307,502
Earnings per common share - basic	$	0.25	$	0.16
Effect of dilutive securities
Weighted average common shares outstanding during the period		2,305,820		2,307,502
Effect of dilutive stock options		39,239		10,589
Weighted diluted average common shares outstanding during the period (denominator) during the period		2,345,059		2,318,091
Earnings per common share - assuming dilution	$	0.25	$	0.16

Note 4 – 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.

10

The following table presents the carrying amounts, fair value and level of input of those financial instruments whose fair value differs from carrying amount at March 31, 2012 and December 31, 2011.

	At March 31, 2012
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
	(in thousands)
Financial Assets:
Loans held for investment	$	215,346	$	220,724	$	—	$	1,683	$	219,041
Financial liabilities:
Deposits	$	256,976	$	257,116	$	—	$	257,116	$	—
Other borrowings		703		739		—		—		739
	At December 31, 2011
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
	(in thousands)
Financial Assets:
Loans held for investment	$	213,183	$	219,056	$	—	$	—	$	219,056
Financial liabilities:
Deposits	$	249,978	$	250,167	$	—	$	250,167	$	—
Other borrowings		782		823		—		—		823

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 by 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. Fair value is measured using modeling software that incorporates various assumptions based on observable market data such as interest rate fluctuations and cash flow data. 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.

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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.

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. The Company may, from time to time, revise its evaluation of the fair value of a property and provide an allowance based on subjective criteria such as declines in assessed value, which the Company considers to be Level 3 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 recurring or nonrecurring basis.

Assets Recorded at Fair Value on a Recurring Basis

	At March 31, 2012
	Total		Level 1		Level 2		Level 3
	(in thousands)
Investment in securities available for sale:
U.S. Treasury notes	$	2,036	$	—	$	2,036	$	—
U.S. government sponsored enterprises		43,016		—		43,016		—
Mortgage-backed securities		7,497		—		7,497		—
Other financial assets		276		—		276		—
Total assets at fair value	$	52,825	$	—	$	52,825	$	—
	At December 31, 2011
	Total		Level 1		Level 2		Level 3
	(in thousands)
Investment in securities available for sale:
U.S. Treasury notes	$	2,043	$	—	$	2,043	$	—
U.S. government sponsored enterprises		34,188		—		34,188		—
Mortgage-backed securities		9,079		—		9,079		—
Other financial assets		245		—		245		—
Total assets at fair value	$	45,555	$	—	$	45,555	$	—

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Assets Recorded at Fair Value on a Non-Recurring Basis

	At March 31, 2012
	Total		Level 1		Level 2		Level 3
	(in thousands)
Impaired loans
Real estate-commercial	$	804	$	—	$	804	$	—
Real estate-construction		879		—		879		—
Other real estate owned		1,682		—		1,456		226
Total assets at fair value	$	3,365	$	—	$	3,139	$	226
	At December 31, 2011
	Total		Level 1		Level 2		Level 3
	(in thousands)
Other real estate owned	$	1,719	$	—	$	1,719	$	—
Total assets at fair value	$	1,719	$	—	$	1,719	$	—

Note 5 – Securities

	At March 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
Securities Available for Sale
U.S Treasury notes	$	2,004	$	32	$	—		$	2,036
U.S. government sponsored enterprises		42,995		96		(75	)		43,016
Mortgage-backed securities		7,114		383		—			7,497
Total securities available for sale	$	52,113	$	511	$	(75	)	$	52,549
Total securities (1)	$	52,113	$	511	$	(75	)	$	52,549
	At December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
Securities Available for Sale
U.S Treasury Notes	$	2,004	$	39	$	—		$	2,043
U.S. government sponsored enterprises		34,000		188		—			34,188
Mortgage-backed securities		8,637		442		—			9,079
Total securities available for sale	$	44,641	$	669	$	—		$	45,310
Total securities (1)	$	44,641	$	669	$	—		$	45,310

(1) At March 31, 2012 and December 31, 2011, the Company held no securities classified as held to maturity.

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The following table shows fair value and gross unrealized losses 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, 2012. Current year unrealized losses on investment securities, if any, are a result of changes in interest rates during the periods. 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, 2012
	Less Than 12 Months					12 Months or More				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(in thousands)
U.S. government sponsored enterprises	$	9,925	$	(75	)	$	—	$	—	$	9,925	$	(75	)
Total temporarily impaired securities	$	9,925	$	(75	)	$	—	$	—	$	9,925	$	(75	)

There were no investment securities with unrealized losses at December 31, 2011.

The amortized cost and fair value of investment securities at March 31, 2012, by contractual maturity, are reflected 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
	Amortized Cost		Fair Value
	(in thousands)
Due in one year or less	$	—	$	—
Due after one year through five years		6,301		6,525
Due after five years through ten years		45,812		46,024
Due after ten years		—		—
Total	$	52,113	$	52,549

There were no sales of securities available for sale in the first quarters of either 2012 or 2011.

Note 6 – Loans held for investment, net

Loans at the dates indicated consisted of the following:

	At March 31, 2012			At December 31, 2011
	(in thousands)
Commercial	$	37,262		$	39,212
Real estate-commercial		120,422			110,350
Real estate-construction and land		10,043			14,075
Real estate-residential 1-4		47,650			49,894
Consumer		2,079			1,743
Total loans		217,456			215,274
Allowance for loan losses		(2,110	)		(2,091	)
Loans, net	$	215,346		$	213,183

All loan amounts are presented net of unearned fees and costs for March 31, 2012 and December 31, 2011.

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Nonperforming assets at the dates indicated were:

	At March 31, 2012		At December 31, 2011
	(in thousands)
Nonperforming loans	$	—	$	—
Real estate owned		1,682		1,719
Loans, net	$	1,682	$	1,719

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

	At March 31,
	2012			2011
	(in thousands)
Balance, beginning of year	$	2,091		$	2,090
Provision for loan losses		—			—
Loans charged-off
Commercial		—			(1	)
Real estate-commercial		—			—
Real estate-construction and land		—			—
Real estate-residential 1-4		—			—
Consumer		(1	)		—
Total loans charged-off		(1	)		(1	)
Loans recovered
Commercial		—			2
Real estate-commercial		—			—
Real estate-construction and land		20			—
Real estate-residential 1-4		—			2
Consumer		—			—
Total loans recovered		20			4
Net recoveries		19			3
Balance, end of period	$	2,110		$	2,093

The following table presents the aging analysis of the Company’s loan portfolio at March 31, 2012:

	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	$	—	$	—	$	—	$	—	$	37,262	$	37,262	$	—
Real estate-commercial		433		—		—		433		119,989		120,422		—
Real estate-construction and land		—		—		—		—		10,043		10,043		—
Real estate-residential 1-4		64		200		—		264		47,386		47,650		—
Consumer		—		—		—		—		2,079		2,079		—
Total Loans	$	497	$	200	$	—	$	697	$	216,759	$	217,456	$	—

All of the past due loans reflected in the above table were brought current as of April 30, 2012.

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The following table presents the aging analysis of the Company’s loan portfolio at December 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	$	—	$	—	$	—	$	—	$	39,212	$	39,212	$	—
Real estate-commercial		—		—		—		—		110,350		110,350		—
Real estate-construction and land		—		—		—		—		14,075		14,075		—
Real estate-residential 1-4		33		—		—		33		49,861		49,894		—
Consumer		—		—		—		—		1,743		1,743		—
Total Loans	$	33	$	—	$	—	$	33	$	215,241	$	215,274	$	—

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 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, commercial real estate and construction real estate loans at March 31, 2012:

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Total
	(in thousands)
Category:
Normal review	$	37,262	$	119,185	$	9,164	$	165,611
Closely monitored		—		1,237		879		2,116
In collection		—		—		—		—
Total	$	37,262	$	120,422	$	10,043	$	167,727

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

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Total
	(in thousands)
Category:
Normal review	$	39,212	$	109,788	$	12,948	$	161,948
Closely monitored		—		562		1,127		1,689
In collection		—		—		—		—
Total	$	39,212	$	110,350	$	14,075	$	163,637

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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, commercial real estate, and construction real estate loans classified by this internal credit classification at March 31, 2012:

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Total
	(in thousands)
Category:
Pass	$	37,252	$	119,057	$	8,996	$	165,305
Substandard		10		1,365		1,047		2,422
Doubtful		—		—		—		—
Total	$	37,262	$	120,422	$	10,043	$	167,727

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

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Total
	(in thousands)
Category:
Pass	$	39,200	$	109,219	$	12,778	$	161,197
Substandard		12		1,131		1,297		2,440
Doubtful		—		—		—		—
Total	$	39,212	$	110,350	$	14,075	$	163,637

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, 2012:

	Real Estate Residential 1-4		Consumer		Total
	(in thousands)
Category:
Performing	$	47,650	$	2,079	$	49,729
Nonperforming		—		—		—
Total	$	47,650	$	2,079	$	49,729

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

	Real Estate Residential 1-4		Consumer		Total
	(in thousands)
Category:
Performing	$	49,894	$	1,743	$	51,637
Nonperforming		—		—		—
Total	$	49,894	$	1,743	$	51,637

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, 2012:

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Real Estate Residential 1-4		Consumer		Unallocated		Total
	(in thousands)
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment (1)	$	—	$	11	$	8	$	—	$	—	$	—	$	19
Ending balance:
Collectively evaluated for impairment		326		1,044		80		433		18		190		2,091
Total Ending Balance	$	326	$	1,055	$	88	$	433	$	18	$	190	$	2,110
	Commercial		Real Estate Commercial		Real Estate Construction and Land		Real Estate Residential 1-4		Consumer				Total
	(in thousands)
Total loans:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	1,236	$	879	$	—	$	—			$	2,115
Ending balance:
Collectively evaluated for impairment		37,262		119,186		9,164		47,650		2,079				215,341
Total Ending Balance	$	37,262	$	120,422	$	10,043	$	47,650	$	2,079			$	217,456

(1) Certain loans were evaluated for impairment at March 31, 2012. Based on this evaluation process, it was determined that no specific allowance 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, 2011:

	Commercial		Real Estate Commercial		Real Estate Construction and Land		Real Estate Residential 1-4		Consumer		Unallocated		Total
	(in thousands)
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment (1)	$	—	$	5	$	10	$	—	$	—	$	—	$	15
Ending balance:
Collectively evaluated for impairment		343		961		113		455		15		189		2,076
Total Ending Balance	$	343	$	966	$	123	$	455	$	15	$	189	$	2,091
	Commercial		Real Estate Commercial		Real Estate Construction and Land		Real Estate Residential 1-4		Consumer				Total
	(in thousands)
Total loans:
Ending balance:
Individually evaluated for impairment(1)	$	—	$	562	$	1,127	$	—	$	—			$	1,689
Ending balance:
Collectively evaluated for impairment		39,212		109,788		12,948		49,894		1,743				213,585
Total Ending Balance	$	39,212	$	110,350	$	14,075	$	49,894	$	1,743			$	215,274

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

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The following table reflects the average daily recorded investment in impaired loans as of March 31, 2012 and interest income recognized on those loans for the three month period ending March 31, 2012:

	Recorded Investment		Unpaid Principal Balance		Specific Related Allowance		Average Daily Recorded Investment		Interest Income Recognized
	(in thousands)
With no allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		804		801		—		679		7
Real estate - construction and land		879		877		—		1,005		8
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	1,683	$	1,678	$	—	$	1,684	$	15
With an allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		—		—		—		—		—
Real estate - construction and land		—		—		—		—		—
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—
Total
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		804		801		—		679		7
Real estate - construction and land		879		879		—		1,005		8
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	1,683	$	1,678	$	—	$	1,684	$	15

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The following table is a summary of information pertaining to impaired loans at December 31, 2011:

	Recorded Investment		Unpaid Principal Balance		Specific Related Allowance		Average Daily Recorded Investment		Interest Income Recognized
	(in thousands)
With no allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		562		559		—		488		—
Real estate - construction and land		1,127		1,124		—		17		—
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	1,689	$	1,683	$	—	$	505	$	—
With an allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		—		—		—		—		—
Real estate - construction and land		—		—		—		—		—
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—
Total
Commercial	$	—	$	—	$	—	$	—	$	—
Real estate - commercial		562		559		—		488		—
Real estate - construction and land		1,127		1,124		—		17		—
Real estate - residential 1-4		—		—		—		—		—
Consumer		—		—		—		—		—
Total	$	1,689	$	1,683	$	—	$	505	$	—

During the three month period ending March 31, 2012, two loans to one borrower were restructured in which both concessions on interest rate and extensions of payment terms were granted. The pre-modification recorded investment was $1,118,000 for the real estate construction loan and $560,000 for the commercial real estate loan. Post-modification recorded investments in these two loans were $879,000 for the real estate construction loan and $805,000 for the commercial real estate loan.

During the three month period ended March 31, 2012, no loans that had been restructured during the prior twelve months went into default.

At the time of restructuring, loans that are considered troubled are evaluated for impairment allowances based on collateral value, expected cash flows and/or financial strength of the borrower. Any such loan deemed impaired may be assigned a specific allowance in the calculation of allowance for loan losses. If there are subsequent payment defaults on troubled debt restructured loans, additional evaluations are conducted to determine impairment levels. No impairment allowance was deemed necessary at March 31, 2012.

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

21

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, 2011, filed with the Securities and Exchange Commission on March 29, 2012.

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 Small Business Lending Fund 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, 2012

Total Assets. The Company’s total assets increased by $34.6 million, or 12.8%, from $271.6 million at March 31, 2011 to $306.2 million at March 31, 2012. The increase in assets resulted primarily from a $28.1 million increase in our aggregate cash, securities available for sale, interest-bearing deposits in other banks and federal funds sold, together with a $5.0 million increase in bank-owned life insurance. Compared to December 31, 2011, total assets increased by $11.6 million, or 4.0% from $294.6 million, primarily from increases in interest-bearing deposits in other banks, securities available for sale, and loans.

Investments.Securities available for sale increased by $34.7 million to $52.6 million at March 31, 2012 compared to $17.9 million at March 31, 2011. Certificates of deposit, interest-bearing deposits in other banks, and federal funds sold decreased by a total of $8.4 million, from $18.4 million at March 31, 2011 to $10.0 million at March 31, 2012. Compared to December 31, 2011, interest-bearing deposits at other banks, federal funds sold, and securities available for sale have increased by $8.6 million from $54.0 million to $62.6 million at March 31, 2012.

Loans. Loans held for investment, net, were $215.3 million at March 31, 2012, an increase of $800,000, or 0.4%, from the loan balance of $214.5 million at March 31, 2011. At December 31, 2011, loans held for investment were $213.2 million.

Asset Quality. Nonperforming assets were $1,682,000, or 0.55% of assets, at March 31, 2012, compared to $263,000, or 0.10% of assets, in nonperforming assets at March 31, 2011, and $1,719,000, or 0.58% of assets, at December 31, 2011. Other real estate owned consisted of a bank branch site that we no longer plan to utilize and an additional property obtained through foreclosure proceedings against one borrower.

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Deposits. Total deposits at March 31, 2012 were $257.0 million compared to $226.4 million at March 31, 2011, an increase of $30.6 million, or 13.5%. Core deposits, which are comprised of noninterest-bearing, money market, NOW and savings deposits, increased by $43.8 million, or 24.6%, from $178.2 million at March 31, 2011 to $222.0 million at March 31, 2012. Noninterest-bearing deposits increased by $14.4 million to $94.9 million at March 31, 2012 and, as a percentage of total deposits, increased from 35.6% at March 31, 2011 to 36.9% at March 31, 2012. At March 31, 2012, total deposits have increased $7.0 million, from $250.0 million at December 31, 2011, as a result of a $16.4 million increase in core deposits, offset by a $9.4 million decrease in certificates of deposit.

Average total deposits increased by $25.6 million, or 11.2%, from $227.8 million for the three-month period ended March 31, 2011 to $253.4 million for the three-month period ended March 31, 2012. Average core deposits increased by $34.9, or 19.4%, million over the comparable three-month periods. Average noninterest-bearing deposits have increased by $8.8 million from $83.1 million in the three-month period ending March 31, 2011 to $91.9 million in the comparable period ending March 31, 2012. As a percentage of total average deposits, average noninterest-bearing deposits decreased slightly from 36.5% at March 31, 2011 to 36.3% at March 31, 2012.

Borrowed Funds. Borrowed funds increased by $2.4 million, from $8.0 million at March 31, 2011 to $10.4 million at March 31, 2012. Compared to December 31, 2011, borrowed funds increased by $4.1 million from $6.3 million.

Capital. Stockholders’ equity increased by $1.6 million, or 4.5%, from $35.2 million at March 31, 2011 to $36.8 million at March 31, 2012, primarily from an increase in earnings. Stockholders’ equity was $36.4 million at December 31, 2011.

Comparison of Operating Results for the Three Months Ended March 31, 2012 and 2011

Overview. The Company’s pretax income was $882,000 for the first quarter of 2012, compared to pretax income of $833,000 for the first quarter of 2011, an increase of $49,000.

Net Interest Income. The Company’s net interest income before provision for loan losses remained unchanged, comparing the first quarters of 2012 and 2011. Our average loan portfolio decreased by $1.0 million from $217.9 million in the first quarter of 2011 to $216.9 million in the first quarter of 2012, while our average investment in securities available for sale and other interest-earning assets (excluding loans) increased by $16.9 million, for a net increase in interest-earning assets of $15.9 million comparing the two quarters. Average interest-bearing liabilities increased by $14.7 million from the first quarter of 2011 to $167.3 million in the first quarter of 2012, resulting primarily from increases in average interest-bearing deposits of $16.8 million, partially offset by a $2.1 million reduction in borrowings. The average yield on our interest-earning assets was adversely impacted by lower yields on loans and an increase in the average balance of investment securities and other interest-earning assets, which was only partially offset by a decrease in the average cost of interest-bearing liabilities. As a result, our interest rate spread decreased 17 basis points from 3.97% in the first quarter of 2011 to 3.80% in the first quarter of 2012, and our net interest margin decreased 29 basis points from 4.33% in the first quarter of 2011 to 4.04% in the first quarter of 2012.

Provision for Loan Losses. There was no provision for loan losses recorded for the quarters ending March 31, 2012 and March 31, 2011.

Noninterest Income. Total noninterest income increased by $77,000, from $184,000 in the first quarter of 2011 to $261,000 in the first quarter of 2012. This increase is primarily attributable to $66,000 in income from bank-owned life insurance in the first quarter of 2012 that did not occur in the first quarter of 2011.

Noninterest Expense. Total noninterest expense was $2.1 million for the first quarter of 2012, unchanged from the first quarter of 2011. Increases in a valuation allowance for other real estate owned and occupancy expenses of $37,000 and $32,000, respectively, were mostly offset by decreases in the FDIC assessment, marketing expenses, and professional fees of $39,000, $13,000 and $12,000, respectively.

Income Taxes.The Company’s income tax expense for the first quarter of 2012 was $252,000, reflecting an effective tax rate of 28.5%, compared to income tax expense of $273,000 for the first quarter of 2011, reflecting an effective tax rate of 32.8%. This reduction in rate was attributable to increases in tax-exempt interest income and other non-taxable income.

Net Income Available to Common Stockholders. Because of qualified loan growth, the dividend rate on our SBLF program preferred stock was 2.44% for the first quarter 2012, compared to a composite 5.25% rate on our TARP preferred stock for the first quarter of 2011, resulting in a decrease in dividends on preferred stock of $80,000

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in the first quarter of 2012 compared to the first quarter of 2011. Net income available to common stockholders was $583,000 for the first quarter of 2012, compared to $361,000 for the first quarter of 2011, an increase of $222,000, or $0.09 per diluted share.

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,
	2012		2011
	(in thousands)
Commitments to extend credit	$	35,288	$	37,821
Standby letters of credit		189		166
Total Commitments	$	35,477	$	37,987

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, unpledged 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, 2012, liquid assets, which include cash and due from banks, interest-bearing deposits in other banks, federal funds sold and nonpledged securities available for sale, were $66.1 million, an increase of $8.3 million from $57.8 million at December 31, 2011.

We also are able to obtain funds through approved borrowing lines with the Federal Home Loan Bank of Atlanta and other financial institutions. At March 31, 2012 there was an outstanding balance of $7.3 million with FHLB.

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 $36.8 million at March 31, 2012, up from $36.4 million at December 31, 2011, primarily attributable to an increase in retained earnings. At March 31, 2012, 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.

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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, 2012. 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, 2012 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, 2012 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

None

Item 3 Defaults Upon Senior Securities

None

Item 4 Mine Safety Disclosures

Not Applicable

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 10, 2012	/s/ Michael S. Ives
	Michael S. Ives,
	President & Chief Executive Officer (Principal Executive Officer)
May 10, 2012	/s/ John O. Guthrie
	John O. Guthrie,
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

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Index to Exhibits

Exhibit No.	Description
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 SBLF Preferred Shares. (Incorporated herein by reference to the Company’s Form 8-K filed on August 11, 2011.)
3.3	Amendment to Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Company’s Form 8-K filed on April 2, 2012.)
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.)
*10.17	2012 Amendments to Heritage 2006 Equity Incentive Plan (As Amended and Restated Effective January 28, 2009). (Incorporated herein by reference to the Company’s Form 10-K filed on March 29, 2012.)
10.22	SBLF Securities Purchase Agreement, dated August 11, 2011, between Heritage Bankshares, Inc. and the Secretary of the Treasury. (Incorporated herein by reference to the Company’s Form 8-K filed on August 11, 2011.)
10.23	TARP Repurchase Document, dated August 11, 2011, 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 August 11, 2011.)
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.**
101	Interactive Data File#

* Indicates management contract or compensatory plan or arrangement.

** Indicates filed herewith.

# Indicates furnished herewith. In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

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