UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                   FORM 10-KSB


  X   ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
      ACT OF 1934


                  FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2002

                                       OR

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

                         Commission File No.: 000-49637

                            HERITAGE BANCSHARES, INC.
--------------------------------------------------------------------------------
                 (Name of Small Business Issuer in its charter)


           Delaware                                     75-2963969
------------------------------------       -------------------------------------
     State or other jurisdiction                      (I.R.S. Employer
  of incorporation or organization)                Identification Number)

      102 West High Street
        Terrell, Texas                                    75160
------------------------------------       -------------------------------------
     (Address of Principal                              (Zip Code)
       Executive Offices)

        Issuer's telephone number, including area code: (972) 563 - 2657

         Securities registered under Section 12(b) of the Exchange Act:
                                 NOT APPLICABLE

         Securities registered under Section 12(g) of the Exchange Act:

                    COMMON STOCK (PAR VALUE $0.01 PER SHARE)
--------------------------------------------------------------------------------
                                (Title of Class)

Check  whether  the issuer (1) has filed all reports  required  to be filed by
Section 13 or 15(d) of the  Exchange Act during the past 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
     ____     ____

Check if  disclosure  of delinquent filers in response to Item 405 of Regulation
S-B is not  contained  in this form,  and no  disclosure  will be  contained,
to the  best of  Registrant's  knowledge,  in  definitive  proxy or information
statements  incorporated  by reference  in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.    X
                                ____

Issuer's revenues for its most recent fiscal year:  $3.3 million

As of March 18, 2003, the aggregate  value of the 371,243 shares of Common Stock
of the Registrant  issued and outstanding on such date,  which excludes  102,005
shares held by all  directors  and  executive  officers of the  Registrant  as a
group, was  approximately  $5.3 million.  This figure is based on the last known
trade price  of$14.25  per share of the  Registrant's  Common Stock on March 18,
2003.

Number of shares of Common Stock outstanding as of March 18, 2003: 473,248

Transitional Small Business Disclosure Format:  Yes         No  X
                                                    _____      _____

                       DOCUMENTS INCORPORATED BY REFERENCE

         List  hereunder the  following  documents  incorporated  by reference
and the Part of the Form 10-KSB into which the document is incorporated:

(1)      Portions  of the  Annual  Report  to  Stockholders  for the  fiscal
year  ended  December  31,  2002  are incorporated into Parts II and III.
(2)      Portions of the definitive proxy statement for the Annual Meeting of
Stockholders  are  incorporated  into Part III.


<PAGE>




PART I.

ITEM 1.   DESCRIPTION OF BUSINESS

GENERAL

     Heritage Bancshares, Inc. (the "Company") is a Delaware corporation and the
sole stockholder of Heritage Bank, SSB ("Heritage Bank" or the "Bank"). Heritage
Savings Bank, SSB converted to the stock form of organization in February 2002
and changed its name to Heritage Bank, SSB effective May 17, 2002. The business
of the Company consists primarily of the business of the Bank. At December 31,
2002, the Company had total consolidated assets of $47.6 million, total
consolidated deposits of $34.1 million, and total consolidated stockholders'
equity of $7.9 million.

     Founded in 1922 as Terrell Building and Loan and subsequently Terrell
Federal Savings and Loan Association, Heritage Bank is a community and customer
oriented stock savings bank organized under the laws of the State of Texas.
Heritage Bank conducts business out of its main office in Terrell, Texas. The
Bank's deposits are insured by the Savings Association Insurance Fund ("SAIF")
of the Federal Deposit Insurance Corporation ("FDIC") to the maximum extent
permitted by law. References herein to the Company refer to the consolidated
operations of the Company and the Bank unless otherwise noted.

     Heritage Bank's business consists  principally of attracting  deposits from
the general  public and using those funds to originate  loans secured by one- to
four-family residential properties.  Heritage Bank also originates a significant
volume of  construction  and commercial  real estate loans.  One- to four-family
residential  loans amounted to $11.9 million at December 31, 2002,  representing
31.1% of the total  gross loan  portfolio.  Construction  loans at the same date
amounted to $17.1  million,  or 44.4% of the total gross loan  portfolio,  while
commercial real estate loans amounted to $5.2 million or 13.6% of the total loan
portfolio.  Heritage Bank's profitability  depends primarily on its net interest
income,  which is the  difference  between the income the Bank receives on loans
and other assets and the cost of funds,  which  consists of the interest paid on
deposits and borrowings.

     The Bank  currently  exceeds  all  applicable  minimum  regulatory  capital
requirements.  At December 31, 2002,  the Bank had Tier 1, total  risk-based and
leverage capital ratios of 15.8%, 16.8% and 13.5%, respectively,  as compared to
the minimum requirements of 4.0%, 8.0%, and 4.0%, respectively.

     The Company, as a registered savings and loan holding company, is subject
to examination and regulation by the Office of Thrift Supervision ("OTS") and
the Texas Savings and Loan Department (the "Department"), and is subject to
various reporting and other requirements of the Securities and Exchange
Commission ("Commission"). The Bank is also subject to examination and
comprehensive regulation by the Department, which is the Bank's chartering
authority, and by the FDIC, as the administrator of the SAIF. The Bank is
subject to certain reserve requirements established by the Federal Reserve Board
and is a member of the

                                       1

<PAGE>


Federal Home Loan Bank ("FHLB") of Dallas, which is one of the 12 regional banks
comprising the FHLB System.

LENDING ACTIVITIES

     GENERAL.  At December 31,  2002,  the net loan  portfolio of Heritage  Bank
totaled $38.0 million,  representing approximately 79.8% of total assets at that
date. The principal  lending  activities of Heritage Bank are the origination of
one- to four-family  (which are also known as  single-family)  residential loans
and construction loans (primarily related to non-speculative,  pre-sold,  one-to
four-family  residences).  At December 31, 2002,  single-family  residential and
construction  loans  amounted to $29.0  million or 75.5% of the total gross loan
portfolio  (including unfunded amounts).  In addition,  Heritage Bank originates
commercial real estate, consumer and multi-family loans. On an increasing basis,
Heritage Bank offers commercial business loans.

     The types of loans that  Heritage Bank may originate are subject to federal
and state laws and  regulations.  Interest  rates  charged on loans are affected
principally  by the demand for such loans and the supply of money  available for
lending purposes and the rates offered by its competitors. These factors are, in
turn,  affected by general and economic  conditions,  the monetary policy of the
federal  government,  including the Federal  Reserve Board,  legislative and tax
policies, and governmental budgetary matters.

     Under  Texas  law,  a  savings  bank  is   generally   required  to  follow
requirements on lending limits applicable to Federal savings banks.  Under these
rules,  an institution  generally may not make loans to one borrower and related
entities in an amount which exceeds 15% of its  unimpaired  capital and surplus,
although loans in an amount equal to an additional 10% of unimpaired capital and
surplus  may be made to a  borrower  if the loans are fully  secured  by readily
marketable  securities.  In certain cases an  institution  may make loans to one
borrower in an amount not to exceed the lesser of 30% of unimpaired  capital and
surplus or $30,000,000, provided these loans are to develop domestic residential
housing units that meet specific criteria. At December 31, 2002, Heritage Bank's
regulatory limit on loans-to-one  borrower was $944,000.  Its five largest loans
or groups of loans-to-one borrower, including related entities, were:

        o  $993,399 to a restaurateur  consisting of two SBA  guaranteed  loans
           and one auto loan. The SBA guaranteed portion of these loans were
           $733,218, resulting in an exposure to the Bank of $260,181.
        o  $854,200 consisting of four interim construction loans on townhouse
           units to a homebuilder.
        o  $787,335:  one loan to a small business secured by real estate with
           an 80%  loan-to-value  ratio and a 75% SBA guarantee in the amount of
          $590,501, resulting in an exposure to the Bank of $196,834.
        o  $756,716  consisting  of two loans to a developer of lots for
           single-family  homes secured by real estate with a 65% loan-to-value
           ratio.


                                       2
<PAGE>

        o  $751,000  consisting  of three  loans to a  homebuilder  secured by
           single-family  homes with 80% or less loan-to-value ratios and
           residential lots with 65% or less loan-to-value ratios.

         All of these loans or groups of loans were  performing  in  accordance
with their  terms at December  31, 2002.

         LOAN PORTFOLIO COMPOSITION.  The following table sets forth the
composition of Heritage Bank's loan portfolio by type of loan at the dates
indicated.

<TABLE>
<CAPTION>

                                                                         December 31,
                                            --------------------------------------------------------------------

                                                           2002                                2001
                                            --------------------------------------------------------------------
                                                 Amount            Percent            Amount          Percent
                                            ----------------   --------------      -------------    ------------
                                                                        (In Thousands)
Real estate loans:
<S>                                             <C>                 <C>                <C>             <C>
  One-to four-family................            $11,947             31.1%              $13,076         35.3%
  Multi-family......................                152              0.4                   455          1.2
  Commercial........................              5,210             13.5                 5,449         14.7
  Construction......................             17,089             44.4                16,200         43.7
Commercial Business.................              1,690              4.4                   702          1.9
Consumer loans:
  Loans secured by deposits.........                465              1.3                   282           .7
  Other.............................              1,902              4.9                   924          2.5
                                                 ------          --------               ------        ------
    Total loans receivable (1)......             38,455            100.0%               37,088        100.0%
                                                                   ======                             ======


Less:

Allowance for loan losses..........                (416)                                  (320)
Deferred fees.......................                (49)                                   (62)
Loans in process....................                  --                                (5,037)
                                                 -------                               -------
  Loans receivable, net.............             $37,990                               $31,669
                                                ========                               =======
---------------
(1)  Substantially all of Heritage Bank's loans are collateralized with real
     estate, automobiles, deposits or other assets.
</TABLE>



     ORIGINATION OF LOANS.  The lending  activities of Heritage Bank are subject
to  the  written   underwriting   standards  and  loan  origination   procedures
established  by the Board of Directors and  management.  Loan  originations  are
obtained  through a variety of  sources,  including  referrals  from real estate
brokers, builders and existing customers. Written loan applications are taken by
loan  officers.  The loan officers  also  supervise  the  procurement  of credit
reports,  appraisals  and other  documentation  involved  with a loan.  Property
valuations are performed by independent outside appraisers approved by the Board
of Directors of Heritage Bank.

     Under the real estate lending policy of Heritage Bank, a title certificate
signed by an approved attorney licensed by the State of Texas or a title policy
issued by a reputable title insurance company that satisfies secondary market
requirements is received prior to closing. Heritage Bank also requires hazard
insurance and flood insurance where the security property is located in a flood
hazard area as designated by the Department of Housing and Urban Development.
Heritage Bank does not require borrowers to advance funds to an escrow account
for the payment of real estate taxes or hazard insurance premiums.


                                       3
<PAGE>



     Heritage Bank's loan approval  process is intended to assess the borrower's
ability to repay the loan,  the  viability  of the loan and the  adequacy of the
value of the  property  that will secure the loan.  Heritage  Bank's loan policy
assigns separate and cumulative unsecured and secured lending limits to officers
of Heritage Bank. Under the policy,  an individual  officer may approve loans up
to his/her  lending limit with a second  signature from another,  higher ranking
lending officer. The highest amount of loan authority held by any one officer is
$100,000 held by the  President.  Aggregate  credits over $100,000 and less than
$250,000  may be approved by an  Officer's  Loan  Committee,  consisting  of the
President,  the Chief Lending  Officer,  the Credit Officer,  and one other Bank
Officer. The affirmative vote of both the President and Chief Lending Officer is
required for approval in the  Officer's  Loan  Committee.  Aggregate  credits of
$250,000  to $700,000  require  approval  from the  Director's  Loan  Committee,
consisting  of three  outside  Directors  of the  Bank  and the Bank  President.
Aggregate credits of $700,000 up to the  institution's  legal lending limit must
be approved by a majority vote of the Bank's Board of Directors. If a loan has a
binding forward commitment from a secondary market buyer, the President or Chief
Loan Officer may approve a loan of any amount up to the Bank's lending limit.

     Heritage Bank also purchases participations in single-family and commercial
real estate loans, subject to the same underwriting  standards that govern loans
generated by Heritage Bank. By engaging in loan participations, Heritage Bank is
able to take lending  opportunities that otherwise would not be available to it,
because of its size.  Heritage Bank enters into agreements with the institutions
that originate these purchased loans generally on a non-recourse basis, that is,
Heritage Bank will bear the risk of default  pro-rata with other lenders holding
participations in the loan, including the originating  institution.  At December
31, 2002, there were no loan participations which were classified credits.

                                       4

<PAGE>

<TABLE>
<CAPTION>

         The following table shows total loans originated, sold and repaid during the periods indicated.

                                                                     Year Ended December 31,
                                                            -----------------------------------------
                                                                  2002                   2001
                                                            -------------------    ------------------
<S>                                                               <C>                    <C>

                                                                         (In Thousands)
     LOAN ORIGINATIONS:
       Real estate loans:
         One- to four-family..............................     $  3,742                $  2,583
         Multi-family.....................................          313                      --
         Commercial.......................................        2,492                     450
         Construction.....................................       27,178                  12,674
       Commercial business................................        1,136                      79
       Consumer loans:
         Loans secured by deposits........................          256                     121
         Other...........................................         1,969                     642
                                                               --------                --------
         Total loans originated...........................       37,086                  16,549
                                                                -------                --------
     LOAN PARTICIPATIONS PURCHASED:
       One- to four-family................................          936                     853
       Commercial loans, real estate secured..............        1,110                   3,382
     SALES AND LOAN PRINCIPAL REDUCTIONS:
       Loans sold(1)......................................           --                      --
       Loan participations sold..........................           591                     111
       Loan principal reductions..........................       32,128                  14,113
                                                                 ------                  ------
         Total loans sold and principal reductions........       32,719                  14,224
                                                                 ------                  ------
     Increase (decrease) due to other items, net(2).......           (9)                      4
                                                             ----------              ----------
     Net increase in loan portfolio.......................     $  6,404                 $ 6,564
                                                                =======                  ======
     ---------------------------
(1)     Loans sold consist of one- to four-family real estate.
(2)     Other items consist of loans in process, deferred fee, unearned
        interest,  charge-offs, and allowance for loan losses.
</TABLE>

     Although  federal  laws and  regulations  permit  savings  institutions  to
originate  and purchase  loans  secured by real estate  located  throughout  the
United States,  Heritage Bank  concentrates  its lending activity to its primary
market  area  of  Kaufman   County.   Heritage  Bank  will  also  consider  loan
applications  from the  adjacent  counties of Dallas,  Ellis,  Henderson,  Hunt,
Rockwall and Van Zandt.

     Subject to its loans-to-one borrower limitation, Heritage Bank is permitted
to invest without limitation in residential mortgage loans and up to 400% of its
capital in loans secured by non-residential or commercial real estate.  Heritage
Bank may invest up to 40% of its assets in non-real  estate  secured  commercial
loans.  Heritage Bank may also invest in secured and unsecured consumer loans in
an amount not exceeding 35% of total assets. This 35% limitation may be exceeded
for  certain  types of  consumer  loans,  including  home  equity  and  property
improvement  loans secured by residential real property.  In addition,  Heritage
Bank may invest up to 10% of its total assets in secured and unsecured loans for
commercial, corporate, business or agricultural purposes.

     MATURITY  OF  LOAN  PORTFOLIO.   The  following   table  presents   certain
information at December 31, 2002,  regarding the dollar amount of loans maturing
in Heritage  Bank's  portfolio based on their  contractual  terms to maturity or
scheduled  amortization,  but does not  include  potential  prepayments.  Demand
loans,  loans having no stated schedule of repayments and stated  maturity,  and
overdrafts  are reported as becoming due within one year.  Loan  balances do not

                                       5

<PAGE>


include  undisbursed  loan  proceeds,  net deferred loan  origination  costs and
allowance for loan losses.


<TABLE>
<CAPTION>

                                                           Commercial                      Total
                                          Real Estate       Business       Consumer        Loans
                                          ------------    ------------    ----------    ---------
<S>                                          <C>              <C>             <C>           <C>
                                                                 (In Thousands)

AMOUNTS DUE IN:
  One year or less......................   $ 18,811          $   700       $  327         $19,838
  More than one year to five years......      6,001              685        1,768           8,454
  More than five years..................      9,586              305          272          10,163
                                              -----              ---          ---         -------
    Total amount due....................     34,398          $ 1,690       $2,367         $38,455
                                            =======          =======       ======         =======

</TABLE>


        The following table sets forth the dollar amount of all loans, before
net items, due after December 31,2003,  which have fixed interest rates or which
have floating or adjustable interest rates.

<TABLE>
<CAPTION>

                                           Fixed-Rate     Floating or Adjustable-Rates       Total
                                           -----------    ----------------------------      -------
<S>                                           <C>                    <C>                      <C>
                                                                 (In Thousands)
Real estate loans:
  One- to four-family...................... $11,901                $   45                 $ 11,946
  Multi-family.............................      --                    --                       --
  Commercial...............................   2,520                   109                    2,629
  Construction.............................   1,012                    --                    1,012
Commercial business.......................      990                    --                      990
Consumer loans:
  Loans secured by deposits................     301                    --                      301
  Other....................................   1,739                    --                    1,739
                                              -----                ---------                ------
     Total loans..........................  $18,463                $  154                 $ 18,617
                                            =======                =========              ========
</TABLE>


     Scheduled  contractual  maturities of loans do not necessarily  reflect the
actual expected term of the loan  portfolio.  The average life of mortgage loans
is  substantially   less  than  their  average   contractual  terms  because  of
prepayments.  The average life of mortgage  loans tends to increase when current
mortgage  loan  rates are  higher  than rates on  existing  mortgage  loans and,
conversely,  decrease  when  rates on  current  mortgage  loans are  lower  than
existing  mortgage  loan  rates  (due  to  refinancing  of  adjustable-rate  and
fixed-rate loans at lower rates).  Under the latter  circumstance,  the weighted
average  yield on loans  decreases  as  higher  yielding  loans  are  repaid  or
refinanced at lower rates.

     ONE- TO  FOUR-FAMILY  RESIDENTIAL  REAL  ESTATE  LOANS.  One of the primary
lending  activities  of Heritage  Bank is the  origination  of loans  secured by
single-family  residences.  At December 31, 2002,  $11.9 million or 31.1% of the
total gross loan portfolio,  before net items,  consisted of one- to four-family
residential loans.

     The loan-to-value ratio, maturity and other provisions of the loans made by
Heritage  Bank  generally  have  reflected  the  policy of making  less than the
maximum loan permissible under applicable regulations,  in accordance with sound
lending practices,  market conditions and underwriting  standards established by
Heritage Bank.  Heritage Bank's present lending  policies

                                       6

<PAGE>

on one- to  four-family residential  mortgage loans  generally limit the maximum
loan-to-value  ratio to 80% of the  lesser of the  appraised  value or  purchase
price of the property up to $500,000.  If Heritage Bank originates a residential
mortgage  loan  with  a loan-to-value ratio  in  excess  of 80%,  Heritage  Bank
typically   requires  the  borrower  to  obtain  private   mortgage   insurance.
Residential  mortgage  loans are amortized on a monthly basis with principal and
interest due each month. The loans do include "due-on-sale" clauses.

     Heritage  Bank's  residential  mortgage  loans have  either  fixed rates of
interest or  interest  rates which  adjust  periodically  during the term of the
loan. The maximum  maturity for  residential  mortgage loans is 30 years.  These
loans are fully  amortizing  with monthly loan payments  sufficient to repay the
total  amount of the loan with  interest  by the end of the loan term.  Heritage
Bank's  residential   mortgage  loans  generally  are  originated  under  terms,
conditions   and   documentation   which   permit   them  to  be  sold  to  U.S.
Government-sponsored   agencies,   such  as  the  Federal  Home  Loan   Mortgage
Corporation,  and other investors in the secondary  market for mortgages.  It is
Heritage  Bank's current policy to sell or broker into the secondary  market all
newly  originated  fixed rate mortgage loans with  maturities  greater than five
years. At December 31, 2002, Heritage Bank did not have any loans held for sale.
Additionally,  at December  31, 2002,  the  majority of Heritage  Bank's one- to
four-family residential mortgage loans were seasoned fixed-rate loans.

     The  adjustable-rate  single-family  residential  mortgage loans  currently
offered  by  Heritage  Bank  have  interest  rates  which  adjust  each  year in
accordance with a designated  index, plus a stipulated  margin.  Heritage Bank's
adjustable-rate single-family residential real estate loans generally have a cap
of 2% on any increase or decrease in the interest rate at any  adjustment  date,
and include a specified  cap on the maximum  interest  rate over the life of the
loan, which cap generally is 6% above the initial rate. There also is a floor of
2% below the initial rate. These loans generally are  underwritten  based on the
initial rate.  Heritage  Bank's  adjustable-rate  loans require that any payment
adjustment  resulting  from a change in the interest rate of an  adjustable-rate
loan be sufficient to result in full  amortization of the loan by the end of the
loan term and,  thus, do not permit any of the increased  payment to be added to
the  principal  amount of the  loan,  or  so-called  negative  amortization.  At
December 31, 2002,  $45,000 of Heritage  Bank's one- to four-family  residential
mortgage loans were adjustable-rate loans.

     Adjustable-rate  loans  decrease  the  risks  associated  with  changes  in
interest  rates but involve  other risks,  primarily  because as interest  rates
increase,  the loan payment by the borrower increases to the extent permitted by
the terms of the loan, thereby  increasing the potential for default.  Moreover,
as with fixed-rate  loans, as interest rates increase,  the marketability of the
underlying  collateral  property  may be adversely  affected by higher  interest
rates.  Heritage Bank  believes that these risks,  which have not had a material
adverse  effect  on  Heritage  Bank to date,  generally  are less than the risks
associated  with  holding  fixed-rate  loans  in  an  increasing  interest  rate
environment.

     COMMERCIAL REAL ESTATE LOANS. Heritage Bank's commercial real estate loan
portfolio primarily consists of loans secured by owner occupied small business,

                                       7
<PAGE>

office buildings, small warehouses, production facilities, retail stores and
restaurants located within Heritage Bank's market area. Commercial real estate
loans amounted to $5.2 million or 13.5% of the total loan portfolio at December
31, 2002, of which $4.9 million or 94.6% were fixed-rate loans and $278,000 or
5.4% were adjustable-rate loans. Heritage Bank's commercial real estate loans
typically have a loan-to-value ratio of 80% or less and generally have higher
interest rates than single-family residential mortgage loans. Heritage Bank's
commercial real estate loan policy provides for loans with fixed rates to
contain maturities of five years or less, with payments calculated on a maximum
amortization of twenty years. The Bank's policy provides for variable rate
commercial real estate loans with maturities of up to twenty years, and a rate
adjustment period of no longer than one year, and preferably monthly or daily.

     Commercial real estate lending is generally  considered to involve a higher
degree  of risk than  one- to  four-family  residential  lending.  Such  lending
typically  involves  large loan balances  concentrated  in a single  borrower or
groups of related borrowers for rental or business properties.  In addition, the
payment experience on loans secured by income-producing  properties is typically
dependent  on the success of the  operation  of the related  project and thus is
typically  affected by adverse  conditions  in the real estate market and in the
economy.  Heritage Bank generally attempts to mitigate the risks associated with
its commercial real estate lending by, among other things,  lending primarily in
its market area and using low loan-to-value ratios in the underwriting process.

     CONSTRUCTION  LOANS. At December 31, 2002,  Heritage Bank had approximately
$17.1 million,  or 44.4% of the total loan portfolio,  in construction loans, of
which  $758,000 or 4.7% were  fixed-rate  loans and $16.3  million or 95.3% were
adjustable-rate loans. In comparison,  at December 31, 2001, approximately $16.2
million,  or 43.7% of the total loan portfolio were  construction  loans.  These
increases  reflect the shift in  Heritage  Bank's  lending  focus from that of a
traditional  thrift lender to that of a commercial bank, with a greater emphasis
on construction  lending.  The construction loans of Heritage Bank are comprised
largely of loans made to builders to construct  individual  pre-sold homes based
upon the commitment for a third party to do the permanent loan. The maximum loan
to value ratio is 80% of the real estate as it will be improved for  speculative
homes, and 85% of the as-improved value for pre-sold and/or  individually  owned
homes with take-out  commitments from permanent lenders.  Heritage Bank requires
copies of the underwriting  documents for the permanent loan prior to committing
the interim  financing  for any loan closed under this 85%  loan-to-value  rule.
Interest-only  payments are required during the  construction  period,  which is
typically nine to 12 months.

      Construction lending is generally considered to involve a higher degree of
risk of loss than long-term  financing on improved,  owner-occupied  real estate
because of the uncertainties of construction, including the possibility of costs
exceeding the initial  estimates and the need to obtain a tenant or purchaser if
the property will not be  owner-occupied.  Heritage Bank  generally  attempts to
mitigate the risks associated with construction  lending by, among other things,
lending in its market area,  using  conservative  underwriting  guidelines,  and
monitoring  the  construction  process.  Heritage Bank also  generally  requires
personal guarantees of builders and buyers of homes.

                                       8
<PAGE>


     MULTI-FAMILY  RESIDENTIAL LOANS. At December 31, 2002, $152,000, or 0.4% of
total loans receivable were multi-family  (over four units)  residential  loans.
The  multi-family  residential  mortgage loans are underwritten on substantially
the  same  basis  as  its  commercial  real  estate  loans.   Loans  secured  by
multi-family  real  estate  are  underwritten  based  on  the  income  producing
potential of the property and the financial  strength of the  borrower.  The net
operating income, which is the income derived from the operation of the property
less all operating expenses, must be sufficient to cover the payments related to
the outstanding debt.  Heritage Bank generally requires personal guarantees from
borrowers in addition to the  security  property as  collateral  for such loans.
Heritage Bank generally requires an assignment of rents or leases in order to be
assured  that the cash  flow  from the  project  will be used to repay the debt.
Appraisals on properties securing  multi-family and commercial real estate loans
are performed by independent state licensed fee appraisers approved by the board
of directors.

     Heritage Bank  generally  maintains a tax and insurance  escrow account for
loans secured by multi-family  real estate.  In order to monitor the adequacy of
cash flows on income-producing properties, the borrower is requested or required
to provide periodic  financial  information.  Loans secured by multi-family real
estate  properties  are generally  larger and involve a greater degree of credit
risk than one- to four-family  residential  mortgage loans. Such loans typically
involve large balances to single borrowers or groups of related borrowers.

     Because  payments on loans secured by multi-family  real estate  properties
are often dependent on the successful operation or management of the properties,
repayment of such loans may be subject to adverse  conditions in the real estate
market or the  economy.  If the cash flow from the  project  is  reduced,  or if
leases are not obtained or renewed, the borrower's ability to repay the loan may
be impaired.

     OTHER  LENDING.  Heritage Bank also has a relatively  small but  increasing
amount of consumer and commercial  business loans.  At December 31, 2002,  these
loans amounted to $2.4 million and $1.7 million,  respectively, or 6.2% and 4.4%
of the total loan portfolio.

     Consumer loans generally involve greater risk than do residential  mortgage
loans, particularly in the case of consumer loans that are unsecured or that are
secured by rapidly depreciable assets, such as automobiles.  In these cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the  outstanding  loan balance as a result of the greater
likelihood  of  damage,  loss  or  depreciation.   In  addition,  consumer  loan
collections are dependent on the borrower's continuing financial stability,  and
therefore  are more  likely to be affected  by adverse  personal  circumstances.
Furthermore,  the  application  of various  federal  and state  laws,  including
bankruptcy and  insolvency  laws, may limit the amount which can be recovered on
such loan.  Twenty  percent of the Bank's  consumer  loans are fully  secured by
deposits in the Bank, primarily in the form of Certificates of Deposit.

     LOAN  ORIGINATION  AND OTHER FEES. In addition to interest earned on loans,
Heritage Bank receives loan origination fees or "points" for originating  loans.
Loan points are a

                                       9
<PAGE>



percentage of the principal  amount of the mortgage loan and are charged to the
borrower in connection with the origination of the loan.

ASSET QUALITY

     GENERAL.  Heritage  Bank  mails  delinquent  notices  to  borrowers  when a
borrower  fails to make a  required  payment  within  16 days of the  date  due.
Telephone  calls commence when an account  becomes 16 days past due.  Collection
letters  are sent when the  account  is more  than 30 days  past  due.  If these
efforts fail to result in the loan being reinstated, Heritage Bank will initiate
the necessary  legal actions.  This may include  recommendations  for extension,
repossession,  or the  initiation  of other  legal  proceedings.  In most cases,
deficiencies are cured promptly.  While Heritage Bank generally  prefers to work
with  borrowers  to  resolve  these  problems,   Heritage  Bank  will  institute
foreclosure  or other  collection  proceedings  when  necessary  to minimize any
potential loss.

     Loans  are  placed on  non-accrual  status  when  management  believes  the
probability  of  collection  of  interest  is  insufficient  to warrant  further
accrual, based upon significant  deterioration in the financial condition of the
borrower,  where repayment in full of interest and principal is not expected, or
where the loan is 90 days past due,  unless  well  secured and in the process of
collection.  When a loan is placed on non-accrual status, previously accrued but
unpaid interest is deducted from interest  income.  Loans  previously  placed on
non-accrual  status due to  delinquent  payments  are not placed back on accrual
status  until six  consecutive  months have passed  where the loan has been paid
without being thirty days or more past due.

     Real  estate and other  assets  acquired  by  Heritage  Bank as a result of
foreclosure  or by  deed-in-lieu  of  foreclosure  are classified as real estate
owned until sold.  Heritage  Bank had  $602,000 or 1.3% of total  assets in real
estate owned at December 31, 2002.  At December 31, 2002 other real estate owned
consisted of four residential  properties.  The Company has valued properties at
the lower of their cost of  acquisition  or fair value less  estimated  costs to
sell.

     DELINQUENT  LOANS.  The following table sets forth  information  concerning
delinquent  loans at December 31, 2002, in dollar amounts and as a percentage of
Heritage Bank's total gross loan portfolio.  The amounts presented represent the
total  outstanding  principal  balances  of the related  loans,  rather than the
actual payment amounts which are past due.

                                       10

<PAGE>


<TABLE>
<CAPTION>


                                                                   December 31, 2002

                                               30-59               60-89 Days Overdue          90 or More Days
                                           Days Overdue                                            Overdue
                                     -------------------------  -------------------------  ------------------------
                                                     Percent                   Percent                   Percent
                                                    of Total                  of Total                  of Total
                                                      Gross                     Gross                     Gross
                                        Amount        Loans       Amount        Loans       Amount        Loans
                                    ------------  ------------  ----------   ----------   ----------   ------------
<S>                                       <C>           <C>        <C>          <C>          <C>           <C>

                                                                (Dollars in Thousands)
Real estate loans:
  One- to four-family..............  $   792          2.1%         $279            .7%        $161          .4%
  Construction.....................      288           .7           541           1.4           --          --
  Loans secured by deposits........       --           --            --            --           --          --
  Other............................       34           .1             1            --           --          --
                                     -------         ------       -----          ------      ------        -------
  Total loans......................  $ 1,114          2.9%         $821           2.1%        $161          .4%
                                      =====         ======        =====          =====       ======        ======


-------------------------------------------------------------------------------------------------------------------
</TABLE>

     NONPERFORMING ASSETS. The following table presents information with respect
to Heritage Bank's nonperforming assets at the dates indicated.

                                                    At December 31,
                                              -------------------------
                                               2002               2001
                                              -------           -------
                                                (Dollars in Thousands)

NONACCRUING LOANS:
Real estate loans:
    One- to four-family....................   $301                 $560
    Construction...........................     --                   --
  Consumer loans:
    Loans secured by deposits..............     --                   --
    Other..................................     --                   18
                                               ---                  ---
      Total nonaccruing loans..............    301                  578
                                               ---                  ---
Real estate owned..........................    602                   --
                                               ---                  ---
      Total nonperforming assets(1).........   903                  578
Troubled debt restructurings................    --                   --
                                               ---                  ---
Troubled debt restructurings and total
 nonperforming assets.......................  $903                 $578
                                               ===                  ===
Total nonperforming loans and troubled debt
  restructurings as a percentage of total
  gross loans...............................    2.4%                1.6%
Total nonperforming assets and
  troubled debt restructurings as a
  percentage of total assets...............     1.9%                1.5%

-------------------------

(1)     Nonperforming  assets consist of nonperforming  loans,  impaired loans,
        other repossessed assets and other real estate.

     The net increase in troubled debt  restructurings and nonperforming  assets
of $325,000 was  primarily due to the addition of other real estate owned in the
amount of $602,000  partially offset by a $259,000  decrease in nonaccruing one-
to four-family loans.

     If the $301,000 of  nonaccruing  loans of Heritage Bank had been current in
accordance  with their terms during the year ended  December 31, 2002, the gross
income on such  loans  would have been  approximately  $26,000.  No  significant
interest  income was actually  collected  by Heritage  Bank on such loans in the
year ended December 31, 2002.

                                       11
<PAGE>


     CLASSIFIED ASSETS.  Federal  regulations  require that each insured savings
institution  classify its assets on a regular basis. In addition,  in connection
with examinations of insured  institutions,  federal examiners have authority to
identify  problem assets and, if  appropriate,  classify  them.  There are three
classifications  for  problem  assets:  "substandard,"  "doubtful"  and  "loss."
Substandard  assets have one or more defined weaknesses and are characterized by
the distinct  possibility that the insured institution will sustain some loss if
the  deficiencies  are not  corrected.  Doubtful  assets have the  weaknesses of
substandard assets with the additional  characteristic  that the weaknesses make
collection  or  liquidation  in full on the basis of currently  existing  facts,
conditions and values  questionable,  and there is a higher possibility of loss.
An asset  classified loss is considered  uncollectible  and of such little value
that  continuance  as an  asset of the  institution  is not  warranted.  Another
category  designated  "special  mention" also must be established and maintained
for assets which do not currently expose an insured  institution to a sufficient
degree of risk to  warrant  classification  as  substandard,  doubtful  or loss.
Assets  classified  as  substandard  or  doubtful  require  the  institution  to
establish general  allowances for loan losses. If an asset or portion thereof is
classified  loss,  the  insured   institution  must  either  establish  specific
allowances  for loan  losses in the  amount of 100% of the  portion of the asset
classified loss, or charge-off such amount.  General loss allowances established
to cover possible  losses related to assets  classified  substandard or doubtful
may be  included in  determining  an  institution's  regulatory  capital,  while
specific  valuation  allowances  for loan  losses do not  qualify as  regulatory
capital.   Federal   examiners  may  disagree  with  an  insured   institution's
classifications and amounts reserved.

     Heritage  Bank's total  classified  assets at December 31, 2002  (excluding
loss assets specifically reserved for) amounted to $2,064,565. Classified assets
include classified loans of $1,462,736 (of which $1,122 was classified  doubtful
and  $1,461,614  was  classified  substandard)  and Other Real  Estate  Owned of
$601,830.   Non-performing  loans  accounted  for  $301,000  of  the  amount  of
classified  loans. The remaining $1.2 million relate to potential  problem loans
due to various conditions affecting the loan.

         The five largest classified assets at December 31, 2002 consisted of:

        o $356,815: two performing loans to a homebuilder consisting of one lot
          loan for $52,113 and one pre-sold home for $304.702.  The builder's
          financial  statements indicate losses in the last four quarters, but
          the loan's interest payments were current per the original note. The
          loan is secured with a single family dwelling at a loan to value ratio
          of 80% based on the appraised value.

        o $327,282: two performing  loans  consisting of two speculative  single
          family homes in the amounts of $327,282  and  $282,677  (100% of the
          balance of this second loan has been sold to a  participant bank as a
          pro-rata  participation)  to a general  partnership,  the managing
          partner of which is the homebuilder and borrower for the previous and
          largest  classified  asset above. This credit facility is secured by
          real estate  appraised at

                                       12
<PAGE>




          $740,000 (loan to value ratio of 82%) and is further  secured by the
          guarantees of two partner  individuals  with substantial net worth and
          liquid assets exceeding $4,000,000.

        o $241,387:  a single family home, Other Real Estate Owned, with an
          appraised value of $289,000.

        o $231,213:  a single family home  classified as  substandard  occupied
          by a borrower that has sought protection under Chapter 13 of the
          Bankruptcy code and is making payments under his temporary plan.

        o $188,450:  a  single  family  home,  Other  Real  Estate  Owned,
          incomplete  construction  with an appraised value of $245,000.

     RESERVE  POLICY AND  METHODOLOGY.  Heritage Bank maintains an allowance for
credit losses to absorb losses inherent in the loan portfolio.  The allowance is
based on ongoing,  monthly assessments of the probable estimated losses inherent
in the loan portfolio.

     Heritage  Bank's  methodology  for  assessing  the  appropriateness  of the
allowance  consists of several key elements,  which include a general  allowance
and specific allowances for identified problem loans. In addition, the allowance
incorporates  the results of  measuring  impaired  loans as provided in SFAS No.
114,  "Accounting  by  Creditors  for  Impairment  of a Loan" and SFAS No.  118,
"Accounting  by  Creditors  for  Impairment  of a  Loan-Income  Recognition  and
Disclosures."  These  accounting  standards  prescribe the measurement  methods,
income recognition and disclosures related to impaired loans.

     The general allowance is calculated by applying loss factors to outstanding
loans based on the internal risk  evaluation of the loan  portfolio.  Changes in
risk evaluations of both performing and nonperforming loans affect the amount of
the  general  allowance.  Loss  factors  are based both on the  historical  loss
experience as well as on significant  factors that include portfolio mix, trends
in loans  past  due,  trends  in loan  losses,  economic  conditions,  portfolio
management and expected growth. These factors, in management's judgment,  affect
the collectibility of the loan portfolio as of each evaluation date.

     The  appropriateness  of the  allowance  is  reviewed  and  established  by
management  based upon its  evaluation  of  then-existing  economic and business
conditions affecting Heritage Bank's key lending areas. To the extent that these
conditions  are  evidenced by a  specifically  identifiable  credit or portfolio
segment as of an evaluation  date,  management's  estimate of the effect of such
condition may be reflected as a specific  allowance  applicable to the credit or
portfolio segment.  Individual loans that are impaired,  have specified inherent
weaknesses,  or have special characteristics or trends that warrant management's
attention are specifically evaluated. Construction loans and one- to four-family
mortgage loans are evaluated as separate portfolio segments.  Where any of these
conditions is not evidenced by a specifically  identifiable  credit or portfolio
segment as of the evaluation date,  management's  evaluation of the loss related
to this condition is reflected in the unallocated  allowance.  The evaluation of
the inherent loss with

                                       13

<PAGE>




respect to these conditions is subject to a higher degree of uncertainty because
they are not identified with specific problem credits or portfolio segments.

     Management  also  evaluates  the adequacy of the  allowance for loan losses
based on a review of individual  loans,  historical  loan loss  experience,  the
value and adequacy of  collateral,  and economic  conditions in Heritage  Bank's
market area.  This evaluation is inherently  subjective as it requires  material
estimates,  including the amounts and timing of future cash flows expected to be
received on impaired loans that may be susceptible  to significant  change.  For
all specifically reviewed loans for which it is probable that Heritage Bank will
be  unable  to  collect  all  amounts  due  according  to the  terms of the loan
agreement,  Heritage Bank determines impairment by computing a fair value either
based on  discounted  cash flows using the loan's  initial  interest rate or the
fair value of the collateral if the loan is collateral dependent.

     Because  the  allowance  for loan  losses is based on  estimates  of losses
inherent in the loan portfolio,  actual losses can vary  significantly  from the
estimated amounts.  Heritage Bank's methodology as described permits adjustments
to any loss factor used in the computation of the general allowance in the event
that,  in   management's   judgment,   significant   factors  which  affect  the
collectibility  of the portfolio as of the evaluation  date are not reflected in
the loss  factors.  By  assessing  the  estimated  losses  inherent  in the loan
portfolio  on a monthly  basis,  Heritage  Bank is able to adjust  specific  and
inherent loss estimates based upon any more recent  information  that has become
available.  In  addition,  management's  determination  as to the  amount of the
allowance  for loan  losses is subject to review by the Texas  Savings  and Loan
Department and the Federal Deposit Insurance Corporation,  which may require the
establishment  of  additional  general or specific  allowances  based upon their
judgment of the information  available to them at the time of their  examination
of Heritage Bank.

     Heritage  Bank may also  use  ratio  analysis  as a  supplemental  tool for
evaluating the  reasonableness  of the loan loss reserves.  This analysis may be
used to identify  divergent trends (compared to the institution's peer group and
its own historical practices) in such things as the relationship of the reserves
to classified and  non-classified  loans, to past due and non-accrual  loans, to
total  loans and to  historical  gross and net  charge-offs.  Ratio  analysis is
regarded as a supplemental  checking system and is not used by itself as a basis
for determining the adequacy of loss reserves.

     As a  further  cross-check  on the  adequacy  of the  loan  loss  reserves,
Heritage Bank will compare its reserves against the following guidelines:

        o    50 percent of the portfolio that is classified doubtful.

        o    15 percent of the portfolio that is classified substandard.

        o    10 percent of the portfolio  that is classified  watch.  (Watch
             loans are loans that do not have specified inherent  weaknesses,
             but rather  special  characteristics  or trends that warrant
             management's attention.)

                                       14

<PAGE>


        o    For the  portions  of the  portfolio  that have not been
             classified  (including  those  loans  designated special  mention),
             estimated  credit  losses over the  upcoming  twelve  months  given
             facts and circumstances as of the evaluation date,  based on the
             institution's  average annual rate of net charge-offs  experienced
             over the  previous  two or three years on similar  loans,  adjusted
             for current conditions and trends.

Heritage   Bank  uses  the  amount   derived  from  these   calculations   as  a
cross-reference, but not as a basis for the setting of the reserves.

     The following table sets forth information concerning the allocation of
Heritage Bank's allowance for loan losses by loan categories at the dates
indicated.

                                              December 31,
                                 -----------------------------------------------
                                      2002                      2001
                                 ---------------------    ----------------------
                                             Percent of               Percent of
                                              Loans in                 Loans in
                                                Each                     Each
                                            Category to              Category to
                                            Total Gross              Total Gross
                                 Amount        Loans       Amount       Loans
                                 ------       --------    --------   ----------
                                             (Dollars in Thousands)

Real estate loans:
  One- to four-family.......       $117        31.1%        $114        35.3%
  Multi-family.............          --         0.4            4         1.2
  Commercial................         39        13.5           47        14.7
  Construction..............        216        44.4          141        43.7
Commercial business.........         22         4.4            6         1.9
Consumer loans:
  Loans secured by deposits.         --         1.2           --          .7
  Other.....................         22         5.0            8         2.5
                                  ------      -------       ------      ------
    Total...................       $416       100.0%        $320        100.0%
                                    ===       =====          ===        =====


     Consumer loans involve more risk than mortgage loans because consumer loans
are often  either  unsecured  or secured  by assets  that  depreciate  in value.
Heritage  Bank's  consumer  loans  totaled  $2.4 million and equaled 6.2% of the
total gross loan  portfolio at December  31, 2002,  compared to 3.2% at December
31, 2001.  Heritage Bank had $2.4 million of consumer loans at December 31, 2002
of which $465,000 were secured by deposits.


                                       15
<PAGE>


     The following table sets forth an analysis of Heritage Bank's allowance for
loan losses during the periods indicated. Year Ended December 31, 2002 2001
<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                                 -------------------------------------------------
                                                          2002                       2001
                                                 ---------------------     -----------------------
<S>                                                       <C>                        <C>
                                                              (Dollars in Thousands)

       Total loans outstanding..............            $38,455                     $37,088
       Average loans outstanding, gross.....             36,104                      28,989
       Balance at beginning of period.......                320                         310
       CHARGE-OFFS:
       Real estate loans:
            Construction and development....                (54)                         --
            Residential 1-4 family..........                 (6)                         --
                                                        --------                   ---------

                                                            (60)                         --
       Consumer Loans:
         Other..............................                 (4)                         (5)
                                                        --------                   ---------
             Total charge-offs..............                (64)                         (5)
       RECOVERIES:                                      --------                    --------
       Consumer loans:
         Loans secured by deposits..........                 --                          --
         Other..............................                 --                          --
                                                       ---------                   ---------
             Total recoveries...............                 --                          --
                                                       ---------                   ---------
       Net charge-offs......................                (64)                         (5)
                                                       ---------                   ---------
       Provision for loan losses............                160                          15
                                                       ---------                   ---------
       Balance at end of period.............          $     416                   $     320
                                                        ========                    ========
       Allowance for loan losses as a
         percent of total gross loans
         outstanding........................               1.1%                         1.0%
                                                        ========                    ========
       Allowance for loan losses as a
         percent of total non-performing
         loans                                            138.2%                       55.4%
                                                        ========                    ========
       Ratio of net charge-offs to
         average loans outstanding.........                  .2%                         --%
                                                        ========                    ========

</TABLE>

INVESTMENT SECURITIES

     Heritage  Bank has  authority  to invest in  various  types of  securities,
including  mortgage-backed  securities,   United  States  Treasury  obligations,
securities of various federal  agencies and of state and municipal  governments,
certificates  of deposit at  federally-insured  banks and savings  institutions,
certain  bankers'  acceptances  and federal funds.  Heritage  Bank's  investment
strategy  is  established  by  the  Asset/Liability  Committee  which  presently
consists of the entire Board of Directors.  The Asset/Liability  Committee meets
on  a  quarterly  basis  and  the  strategy  established  by  the  committee  is
implemented by Heritage Bank's  President and its Chief Financial  Officer.  Any
material  deviations  from the  investment  strategy  requires  approval  by the
Asset/Liability Committee.

                                       16

<PAGE>





     The following table sets forth information  relating to the amortized costs
and fair  value of  Heritage  Bank's  investment  securities  (all of which were
classified as available for sale) at the dates indicated.

                                                December 31,

                            ------------------------  ------------------------
                                       2002                       2001

                            -----------  ----------  ------------  -----------
                            Amortized                 Amortized
                             Cost        Fair Value      Cost       Fair Value
                            -----------  ----------  ------------  -----------
                                              (In Thousands)

AVAILABLE FOR SALE:
  U.S. Government
    Agency obligations...     $1,100          $1,100     $ 500         $ 519
  Mortgage-backed
    Securities...........        803             821     1,369         1,404
                              ------         -------    ------        ------
    Total available for
    sale................      $1,903          $1,921    $1,869        $1,923
                              ======         =======    ======        =======



     The  following  table sets forth the amount of Heritage  Bank's  securities
which  mature  during each of the periods  indicated  and the  weighted  average
yields for each range of  maturities at December 31, 2002.  The amounts  reflect
fair value of Heritage Bank's securities at December 31, 2002.

<TABLE>
<CAPTION>
                                                               Contractually Maturing

                             ---------  -----------  ----------  ---------  ----------  ---------  ---------  ---------  ---------
                                         Weighted                Weighted               Weighted              Weighted
                             1 Year       Average                 Average                Average    Over 10    Average
                              or Less      Yield     1-5 Years     Yield    5-10 Years    Yield      Years      Yield     Total
                             --------    ----------  ----------  ---------  ----------  ---------  ---------  ---------  ---------
<S>                             <C>         <C>         <C>         <C>         <C>        <C>        <C>        <C>        <C>

                                                                   (In Thousands)

U.S. Government Agency
  obligations..............    $1,100      4.1%        $ --         --%         $ --       --%       $ --        --%      $1,100
  Mortgage-backed securities       15      5.7           28        8.0             1     13.2          777       4.9         821
                               -------                  ---                      ---                   ---                  ----
   Total securities available
    for sale................   $1,115                   $28                    $  1                   $777                $1,921
                                =====                   ===                     ===                   ====                 =====

</TABLE>


     Mortgage-backed  securities represent a participation interest in a pool of
one- to four-family or  multi-family  mortgages.  The mortgage  originators  use
intermediaries  (generally  U.S.  Government  agencies and  government-sponsored
enterprises)  to pool and repackage the  participation  interests in the form of
securities,  with investors receiving the principal and interest payments on the
mortgages.  Such U.S. Government agencies and  government-sponsored  enterprises
guarantee the payment of principal and interest to investors.

     Mortgage-backed  securities  are  typically  issued with  stated  principal
amounts,  and the  securities  are backed by pools of mortgages  that have loans
with  interest  rates that are within a range and have varying  maturities.  The
underlying pool of mortgages,  i.e.,  fixed-rate or adjustable-rate,  as well as
prepayment  risk,  are  passed  on to the  certificate  holder.  The  life  of a
mortgage-backed  pass-through  security  approximates the life of the underlying
mortgages.

                                       17

<PAGE>


     The  mortgage-backed  securities  of Heritage  Bank  consist of  Government
National Mortgage Association securities, Federal Home Loan Mortgage Corporation
securities and Federal National Mortgage Association securities.  The Government
National  Mortgage  Association is a government  agency within the Department of
Housing   and   Urban   Development   which   is   intended   to  help   finance
government-assisted  housing programs.  Government National Mortgage Association
securities are backed by loans insured by the Federal Housing Administration, or
guaranteed by the Veterans  Administration,  and the timely payment of principal
and  interest  on  Government  National  Mortgage  Association   securities  are
guaranteed by the Government  National  Mortgage  Association  and backed by the
full faith and credit of the U.S.  Government.  The Federal  Home Loan  Mortgage
Corporation  is a private  corporation  chartered  by the U.S.  Government.  The
Federal Home Loan Mortgage Corporation issues participation  certificates backed
principally  by  conventional  mortgage  loans.  The Federal Home Loan  Mortgage
Corporation guarantees the timely payment of interest and the ultimate return of
principal  on  participation   certificates.   The  Federal  National   Mortgage
Association  is a private  corporation  chartered  by the U.S.  Congress  with a
mandate to establish a secondary market for mortgage loans. The Federal National
Mortgage Association  guarantees the timely payment of principal and interest on
Federal National  Mortgage  Association  securities.  Federal Home Loan Mortgage
Corporation and Federal National Mortgage Association  securities are not backed
by the full faith and credit of the United States,  but because the Federal Home
Loan Mortgage Corporation and the Federal National Mortgage Association are U.S.
Government-sponsored  enterprises,  these  securities are considered to be among
the highest quality investments with minimal credit risks.

     Mortgage-backed  securities  generally  yield  less  than the  loans  which
underlie  such  securities   because  of  their  payment  guarantees  or  credit
enhancements  which offer  nominal  credit risk.  In  addition,  mortgage-backed
securities  are more liquid than  individual  mortgage  loans and may be used to
collateralize borrowings or other obligations of Heritage Bank.

SOURCES OF FUNDS

     GENERAL.  Deposits  are the  primary  source of Heritage  Bank's  funds for
lending and other investment  purposes.  In addition to deposits,  principal and
interest payments on loans and mortgage-backed securities are a source of funds.
Loan repayments are a relatively  stable source of funds,  while deposit inflows
and outflows are  significantly  influenced by general  interest rates and money
market  conditions.  Borrowings  may  also  be  used on a  short-term  basis  to
compensate for reductions in the availability of funds from other sources and on
a longer-term basis for general business purposes.

     DEPOSITS.  Deposits are attracted by Heritage Bank  principally from within
its  primary  market  area.  Deposit  account  terms  vary,  with the  principal
differences being the minimum balance required,  the time periods the funds must
remain on deposit and the interest rate.

     Heritage Bank obtains deposits primarily from residents of Texas.  Heritage
Bank  currently  does not solicit  deposits  from  outside  Texas or pay fees to
brokers to solicit funds for deposit. At December 31, 2002, Heritage Bank had no
brokered deposits.

                                       18

<PAGE>


     Interest rates paid, maturity terms,  service fees and withdrawal penalties
are established on a periodic basis.  Management  determines the rates and terms
based on rates  paid by  competitors,  the need for funds or  liquidity,  growth
goals and federal and state  regulations.  Heritage Bank attempts to control the
flow of deposits by pricing its accounts to remain  generally  competitive  with
other financial institutions in its market area.

     Heritage Bank is currently  focused on serving its depositor base with more
bank-like products  including checking accounts,  negotiable order of withdrawal
accounts,  debit  cards,  credit  cards,  ATM  services  and  cashier's  checks.
Management is  particularly  focusing its attention on increasing  the number of
demand deposit accounts.

     The following table shows the distribution of and certain other information
relating to Heritage Bank's deposits by type as of the dates indicated.

                                                    December 31,
                                  ----------------------------------------------
                                          2002                    2001

                                  -------------------      ---------------------
                                              Percent                Percent
                                                of                     of
                                   Amount     Deposits    Amount     Deposits
                                  -------    ---------   -------    ----------
                                            (Dollars in Thousands)
Transaction accounts:
  Demand deposits..............   $ 3,381       9.9%      $ 1,931       5.9%
 Money market..................     2,518       7.4         2,553       7.8
  Savings deposits..............    1,589       4.7         1,837       5.6
                                  -------     -------     -------    ------
    Total short term accounts..     7,488      22.0         6,321      19.3
                                  -------     -------     -------    ------
Certificate accounts:
  1.0% - 1.99%................      5,122      15.0         1,211       3.7
  2.0% - 2.99%................     10,775      31.6         3,504      10.7
  3.0% - 3.99%................      2,884       8.4         5,139      15.7
  4.0% - 4.99%................      2,350       6.9         3,784      11.6
  5.0% - 5.99%................      2,447       7.1         7,500      23.0
  6.0% - 6.99%................      3,068       9.0         5,223      16.0
                                  -------    ------       -------    ------
    Total certificate accounts.    26,646      78.0        26,361      80.7
                                  -------    ------        ------    ------
      Total deposits...........   $34,134     100.0%      $32,682     100.0%
                                  =======    ======       =======    ======


     The following table sets forth the savings activities of Heritage Bank
during the periods indicated.


                                                Year Ended December 31,
                                         ---------------------------------------
                                              2002                  2001
                                         -----------------   ------------------
                                                    (In Thousands)

Total deposits at beginning of period..     $1,837                $2,116
   Net (withdrawals)...................       (264)                 (303)
Interest credited......................         16                    24
                                             ------                -------
  Total deposits at end of period......     $1,589                $1,837
                                            =======               =======

     The following  table shows the interest rate and maturity  information  for
Heritage Bank's certificates of deposit at December 31, 2002.

                                       19

<PAGE>

<TABLE>
<CAPTION>


                                                            Maturity Date
                      ----------------------------------------------------------------------------------------------

   Interest Rate        One Year or Less     Over 1-2 Years     Over 2-3 Years      Over 3 Years         Total
-----------------     -------------------    ---------------   ----------------    --------------     --------------
<S>                            <C>                <C>                <C>                  <C>              <C>
                                                           (In Thousands)
1.0% - 1.99%             $  5,108              $    14           $     --            $      --          $  5,122
2.0% - 2.99%                8,604                1,743                428                   --             10,775
3.0% - 3.99%                  693                  859                733                  599             2,884
4.0% - 4.99%                  467                  704                134                1,045             2,350
5.0% - 5.99%                1,795                  566                 31                   55             2,447
6.0% - 6.99%                2,363                  705                 --                   --             3,068
                           -------               ------             ------               ------          -------
    Total                 $19,030               $4,591             $1,326               $1,699           $26,646
                          ========              ======             ======               ======           =======


</TABLE>


     As  of  December  31,  2002,  the  aggregate  amount  of  outstanding  time
certificates  of deposit at Heritage  Bank in amounts  greater  than or equal to
$100,000,  was  approximately  $4.4 million.  The following  table  presents the
maturity of these time certificates of deposit at such dates.

                                                   December 31, 2002
                                          ---------------------------------
                                                     (In Thousands)


3 months or less.................                      $1,451
Over 3 months through 6 months...                         412
Over 6 months through 12 months..                       1,629
Over 12 months...................                         921
                                                       ------
                                                       $4,413
                                                       ======





     BORROWINGS.  Heritage  Bank may obtain  advances from the Federal Home Loan
Bank of Dallas upon the  security  of the common  stock it owns in that bank and
certain  of  its  residential  mortgage  loans  and  mortgage-backed  and  other
investment  securities,  provided certain standards related to  creditworthiness
have been met. These advances are made pursuant to several credit programs, each
of which has its own interest  rate and range of  maturities.  Federal Home Loan
Bank advances are generally  available to meet seasonal and other withdrawals of
deposit accounts and to permit increased lending.


     The following  table shows  certain  information  regarding the  short-term
borrowings of Heritage Bank at or for the dates indicated:

                                                     At or for the Year Ended
                                                           December 31,
                                                      2002             2001

                                                  ------------------------------
                                                      (Dollars In Thousands)
FHLB open line of credit:
  Average balance outstanding.................       $3,513           $1,688
  Maximum amount outstanding at any
    month-end during the period................       5,400
  Balance outstanding at end of period.........      $5,400           $1,940
  Average interest rate during the period......         4.0%             7.0%
  Weighted average interest rate at end of
    period.....................................         4.7%             7.0%

     At December 31, 2002,  Heritage Bank had $599,000 of Federal Home Loan Bank
advances secured by investment securities  aggregating $599,000. The residual of
the borrowings

                                       20
<PAGE>






were secured by certain real estate and small business loans in conjunction with
a blanket loan  security  agreement  between  Heritage Bank and the Federal Home
Loan Bank. Of total  Federal Home Loan Bank  borrowings at December 31, 2002, $1
million  contractually mature in 2003, $3.7 million contractually mature in 2004
and  $650,000  contractually  mature in 2005.  If these  advances  mature or are
called in a rising interest rate  environment,  Heritage Bank may be required to
replace these advances with higher rate advances.

SUBSIDIARIES

     At December 31, 2002, the Company's wholly-owned subsidiary,  Heritage Bank
had one subsidiary,  TFS Investment Corporation.  TFS Investment Corporation was
established in 1995 for the purpose of constructing single-family residences for
resale. At December 31, 2002, TFS Investment  Corporation had 97 lots for resale
with a cost basis of $234,000.

TOTAL EMPLOYEES

     Heritage  Bank had 24 full-time  employees  and one  part-time  employee at
December 31,  2002.  None of these  employees  are  represented  by a collective
bargaining  agent, and Heritage Bank believes that it enjoys good relations with
its personnel.

COMPETITION

     Heritage Bank faces significant competition both in attracting deposits and
in making loans.  Heritage  Bank's  profitability  and any expansion  into other
markets depends upon Heritage Bank's continued ability to compete  successfully.
Its most direct  competition for deposits has come  historically from commercial
banks,  credit  unions and other  savings  institutions  located in its  primary
market area,  including  many large  financial  institutions  which have greater
financial and marketing resources available to them. In addition,  Heritage Bank
faces significant  competition for investors' funds from short-term money market
securities, mutual funds and other corporate and government securities. Heritage
Bank does not rely upon any individual group or entity for a material portion of
its  deposits.  The  ability of  Heritage  Bank to attract  and retain  deposits
depends on its ability to generally provide a rate of return, liquidity and risk
comparable to that offered by competing investment opportunities.

     Heritage Bank's  competition for real estate loans comes  principally  from
mortgage banking  companies,  commercial banks,  other savings  institutions and
credit unions.  Heritage Bank competes for loan  originations  primarily through
the interest  rates and loan fees it charges,  and the efficiency and quality of
services it provides borrowers. Factors which affect competition include general
and local economic  conditions,  current  interest rate levels and volatility in
the mortgage  markets.  Competition  may increase as a result of the  continuing
reduction of restrictions on the interstate operations of financial institutions
and the anticipated slowing of refinancing activity.

                                       21
<PAGE>


REGULATION

     The  following  discussion  of  certain  laws  and  regulations  which  are
applicable  to  Heritage  Bancshares,  Inc.,  and  Heritage  Bank,  as  well  as
descriptions of laws and regulations contained elsewhere herein,  summarizes the
aspects of such laws and regulations which are deemed to be material to Heritage
Bancshares, Inc., and Heritage Bank. However, the summary does not purport to be
complete and is qualified  in its entirety by reference to  applicable  laws and
regulations.

     RECENT LEGISLATION.  On July 30, 2002, President George W. Bush signed into
law the Sarbanes-Oxley Act of 2002, which generally  establishes a comprehensive
framework to modernize  and reform the  oversight  of public  company  auditing,
improve the quality and  transparency of financial  reporting by those companies
and strengthen the  independence of auditors.  Certain of the new  legislation's
more significant reforms are noted below.

o    The new  legislation  creates a public company  accounting  oversight board
     which is empowered to set auditing,  quality control and ethics  standards,
     to inspect  registered public  accounting firms, to conduct  investigations
     and to take disciplinary actions,  subject to SEC oversight and review. The
     new board will be funded by  mandatory  fees paid by all public  companies.
     The new legislation also improves the Financial Accounting Standards Board,
     giving it full financial independence from the accounting industry.

o    The  new  legislation   strengthens  auditor  independence  from  corporate
     management  by,  among  other  things,  limiting  the  scope of  consulting
     services that auditors can offer their public company audit clients.

o    The  new  legislation   heightens  the  responsibility  of  public  company
     directors and senior  managers for the quality of the  financial  reporting
     and  disclosure  made by  their  companies.  Among  other  things,  the new
     legislation  provides for a strong public company audit committee that will
     be directly responsible for the appointment,  compensation and oversight of
     the work of the public company auditors.

o    The  new   legislation   imposes  a  range  of  new  corporate   disclosure
     requirements.  Among other  things,  the new  legislation  requires  public
     companies to report all  off-balance-sheet  transactions and conflicts,  as
     well  as to  present  any  pro  forma  disclosures  in a way  that  is  not
     misleading  and in accordance  with  requirements  to be established by the
     SEC. The new legislation also accelerated the required reporting of insider
     transactions, which now generally must be reported by the end of the second
     business day following a covered transaction;  requires that annual reports
     filed with the SEC include a statement by management  asserting  that it is
     responsible for creating and  maintaining  adequate  internal  controls and
     assessing the  effectiveness of those controls;  and requires  companies to
     disclose  whether  or not they  have  adopted  an  ethics  code for  senior
     financial  officers,  and, if not, why not, and whether the audit committee
     includes at least one "financial  expert," a term which is to be defined by
     the SEC in accordance with specified

                                       22

<PAGE>


     requirements.  The new  legislation  also  requires  the SEC,  based on
     certain enumerated  factors,  to  regularly  and  systematically  review
     corporate filings.

o    The new  legislation  contains a number of provisions to deter  wrongdoing.
     CEOs and CFOs will have to certify that company financial statements fairly
     present  the  company's  financial  condition.  If a  misleading  financial
     statement later resulted in a restatement, the CEO and CFO must forfeit and
     return  to the  company  any  bonus,  stock  or stock  option  compensation
     received in the twelve months  following the misleading  financial  report.
     The new  legislation  also  prohibits any company  officer or director from
     attempting to mislead or coerce an auditor.  Among other  reforms,  the new
     legislation  empowers  the  SEC to bar  certain  persons  from  serving  as
     officers or directors of a public company;  prohibits insider trades during
     pension fund "blackout  periods;"  directs the SEC to adopt rules requiring
     attorneys to report  securities  law  violations;  and requires  that civil
     penalties  imposed by the SEC go into a disgorgement fund to benefit harmed
     investors.

o    The new legislation  contains  provisions which generally seek to limit and
     expose to public view possible conflicts of interest  affecting  securities
     analysts.

o    Finally,  the new legislation imposes a range of new criminal penalties for
     fraud and other  wrongful  acts, as well as extends the period during which
     certain types of lawsuits can be brought against a company or its insiders.

HERITAGE BANCSHARES, INC.

     HOLDING COMPANY ACQUISITIONS.  Heritage Bancshares,  Inc., is a savings and
loan holding company within the meaning of the Home Owners' Loan Act, as amended
(the "HOLA") and has registered with the Office of Thrift  Supervision.  Federal
law generally  prohibits a company,  without prior Office of Thrift  Supervision
approval,  from  acquiring the ownership or control of any savings bank electing
to be subject to its provisions.  Under the HOLA, Heritage Bancshares,  Inc., is
subject  to  periodic  examination  by the Office of Thrift  Supervision  and is
required  to  file  periodic  reports  of its  operations  and  such  additional
information as the Office of Thrift  Supervision may require.  Because  Heritage
Bank is chartered under Texas law, Heritage Bancshares, Inc., is also subject to
registration  with, and regulation by, the Commissioner  under the Texas Savings
Bank Act.

     ACTIVITIES AND OTHER  LIMITATIONS.  A savings and loan holding company is a
legal entity separate and distinct from its subsidiary bank. Normally, the major
source of a holding  company's  revenue is dividends a holding company  receives
from its  subsidiary  bank.  The right of a savings and loan holding  company to
participate  as a stockholder  in any  distribution  of assets of its subsidiary
bank upon its liquidation or reorganization or otherwise is subject to the prior
claims of creditors of such  subsidiary  bank. The subsidiary bank is subject to
claims by creditors for long-term and  short-term  debt  obligations,  including
deposit liabilities.

     The HOLA also  prohibits a savings and loan holding  company,  with certain
exceptions, from acquiring more than 5% of the voting shares of any company that
is not a savings  association and from engaging in any business other than those
permissible  for a financial

                                       23
<PAGE>







holding  company  under the Bank  Holding  Company Act of 1956,  as amended (the
"BHCA").  Financial holding companies may engage in a broad range of financially
related  activities,   including  insurance  and  securities   activities,   and
activities  that  are  financial  in  nature  or  incidental  to such  financial
activities.  The BHCA lists certain activities that are considered  financial in
nature and  permits  the  Federal  Reserve  Board to expand that list to include
other  activities  that are  complementary  to the activities on the preapproved
list. The preapproved  activities include (1) securities  underwriting,  dealing
and market making,  (2) insurance  underwriting,  (3) merchant banking,  and (4)
insurance company portfolio investments.

     In  addition to  activities  permitted  for  financial  holding  companies,
Heritage  Bancshares,  Inc.,  as a savings  and loan  holding  company,  is also
permitted to (1) furnish or perform  management  services for Heritage Bank, (2)
conduct an insurance agency and escrow business,  (3) hold,  manage or liquidate
assets owned or acquired from Heritage Bank, (4) hold or manage  properties used
or occupied by Heritage Bank, (5) act as a trustee under a deed of trust and (6)
engage in any  activity  permissible  for a multiple  savings  and loan  holding
company  as of March 5, 1987  (including  various  real  estate  management  and
development  activities).  In addition,  a savings and loan holding  company may
engage in  activities  that the Federal  Reserve  Board permits for bank holding
companies.  These  activities  include  operating  a mortgage  company,  finance
company,  credit  card  company,  factoring  company,  trust  company or savings
association;  performing certain data processing  operations;  providing limited
securities  brokerage  services;  acting as an investment or financial  advisor;
acting as an  insurance  agent for certain  types of  credit-related  insurance;
leasing personal property on a full-payout,  non-operating basis;  providing tax
planning and preparation services;  operating a collection agency; and providing
certain courier services.

     RESTRICTIONS  ON  TRANSACTIONS  WITH  AFFILIATES.  Transactions  between  a
savings bank and its  "affiliates"  are subject to quantitative  and qualitative
restrictions  under  Sections  23A and 23B of the  Federal  Reserve Act and FDIC
regulations.  Affiliates of a savings bank include,  among other  entities,  the
savings  bank's  holding  company and companies  that are controlled by or under
common control with the savings bank.

     Section 23A applies to certain "covered  transactions" between an affiliate
and a savings  bank.  In  general,  the  extent  to which a savings  bank or its
subsidiaries  may  engage in such  "covered  transactions"  with  affiliates  is
limited to an amount equal to 10% of the institution's  capital and surplus,  in
the case of covered transactions with any one affiliate,  and to an amount equal
to 20% of such capital and surplus, in the case of covered transactions with all
affiliates. A "covered transaction" is defined to include a loan or extension of
credit  to an  affiliate;  a  purchase  of  investment  securities  issued by an
affiliate; a purchase of assets from an affiliate, with certain exceptions;  the
acceptance  of  securities  issued by an affiliate as  collateral  for a loan or
extension of credit to any party; or the issuance of a guarantee,  acceptance or
letter of credit on behalf of an  affiliate.  Section  23B  applies to  "covered
transactions"  as well as to the sale of  securities  or assets to an affiliate,
the  payment  of  money  or the  furnishing  of  services  to an  affiliate  and
transactions  in which an affiliate acts as an agent or broker or receives a fee
for its services to the savings  association.  These transactions may be engaged
in only on terms and under  circumstances that are substantially the same, or at
least as favorable to the savings bank or its

                                       24

<PAGE>

subsidiary,  as those  prevailing at the time for comparable  transactions  with
nonaffiliated companies.

     In  addition,  Sections  22(h)  and (g) of the  Federal  Reserve  Act place
restrictions   on  loans  to  executive   officers,   directors   and  principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a bank, and certain affiliated interests of
either, may not exceed, together with all other outstanding loans to such person
and  affiliated  interests,  the bank's loans to one borrower  limit  (generally
equal to 15% of the institution's unimpaired capital and surplus). Section 22(h)
also  requires  that  loans  to  directors,  executive  officers  and  principal
stockholders  be made on terms  substantially  the same as offered in comparable
transactions to other persons and also requires prior board approval for certain
loans.  In addition,  the aggregate  amount of extensions of credit by a bank to
all insiders  cannot exceed the  institution's  unimpaired  capital and surplus.
Furthermore,  Section 22(g) places additional restrictions on loans to executive
officers.

     FEDERAL SECURITIES LAWS.  Heritage  Bancshares,  Inc., filed with the SEC a
registration  statement under the Securities Act of 1933 for the registration of
the common stock issued pursuant to the Conversion.  Heritage Bancshares,  Inc.,
has  registered  its  common  stock  with  the SEC  under  Section  12(g) of the
Securities  Exchange Act of 1934. Heritage  Bancshares,  Inc., is subject to the
proxy and  tender  offer  rules,  insider  trading  reporting  requirements  and
restrictions, and certain other requirements under the Exchange Act. Pursuant to
FDIC  regulations  and the Plan of Conversion,  Heritage  Bancshares,  Inc., has
agreed to maintain such  registration for a minimum of three years following the
Conversion.

     The  registration  under the  Securities  Act of the shares of common stock
issued in the  Conversion  does not cover the resale of such  shares.  Shares of
common stock purchased by persons who are not affiliates of Heritage Bancshares,
Inc.,  may be sold  without  registration.  Shares  purchased by an affiliate of
Heritage  Bancshares,  Inc., will be subject to the resale  restrictions of Rule
144 under the Securities Act. If Heritage  Bancshares,  Inc.,  meets the current
public  information  requirements  of Rule 144 under the  Securities  Act,  each
affiliate of Heritage  Bancshares,  Inc., who complies with the other conditions
of Rule 144 would be able to sell in the public market, without registration,  a
number of shares not to exceed, in any three-month period, the greater of (a) 1%
of the  outstanding  shares of  Heritage  Bancshares,  Inc.,  or (b) the average
weekly  volume of trading in such  shares  during the  preceding  four  calendar
weeks.

HERITAGE BANK

     GENERAL.  Heritage  Bank is a  Texas-chartered  savings  bank,  the deposit
accounts of which are insured by the Savings  Association  Insurance Fund of the
FDIC. As a Savings Association Insurance Fund insured,  Texas-chartered  savings
bank, the Savings Bank is subject to the examination, supervision, reporting and
enforcement  requirements  of the  Texas  Savings  and Loan  Department,  as the
chartering  authority for Texas savings banks, and the FDIC, as administrator of
the Savings  Association  Insurance  Fund,  and to the statutes and  regulations
administered  by the Texas Savings and Loan  Department  and the FDIC  governing
such matters as capital  standards,  mergers,  establishment  of branch offices,
subsidiary investments and activities and general investment authority. Heritage
Bank is required to file reports with the

                                       25

<PAGE>

Texas Savings and Loan  Department  and the FDIC  concerning  its activities and
financial condition and will be required to obtain regulatory approvals prior to
entering into certain transactions,  including mergers with, or acquisitions of,
other financial institutions.

     The  Texas  Savings  and  Loan  Department  and  the  FDIC  have  extensive
enforcement authority over Texas-chartered savings banks, such as Heritage Bank.
This enforcement  authority  includes,  among other things, the ability to issue
cease-and-desist  or removal  orders,  to assess  civil money  penalties  and to
initiate  injunctive  actions.  In  general,  these  enforcement  actions may be
initiated  for  violations  of laws  and  regulations  and  unsafe  and  unsound
practices.

     The Texas Savings and Loan  Department  has  established a schedule for the
assessment  of  "supervisory  fees"  upon all  Texas  savings  banks to fund the
operations of the Texas Savings and Loan Department.  These supervisory fees are
computed  on  the  basis  of  each  savings   bank's  total  assets   (including
consolidated  subsidiaries) and are payable at the end of each calendar quarter.
A schedule of fees has also been  established  for certain filings made by Texas
savings banks with the Texas Savings and Loan Department.  The Texas Savings and
Loan  Department  also  assesses  fees for  examinations  conducted by the Texas
Savings and Loan Department's staff, based upon the number of hours spent by the
staff  performing  the  examination.  During the year ended  December  31, 2002,
Heritage Bank paid approximately $13,000 in supervisory fees and expenses.

     SUPERVISORY  ORDER.  In May of 2000,  in  response to  regulatory  findings
regarding  losses  on  securities   activities,   deficient  internal  controls,
accounting  errors and  recordkeeping,  the lack of an internal audit,  Heritage
Bank entered into a supervisory order placing it under the voluntary supervisory
control of the  Commissioner  of the Texas Savings and Loan  Department  and was
subject to a formal order of  investigation  by the FDIC.  John H.  Mackey,  the
current   President  of  Heritage  Bank,   was  selected  as  the   Department's
representative under the terms of an "Agreed Upon Order Placing Heritage Savings
Bank, ssb. Under Voluntary  Supervisory Control." The Order required a number of
things,  among them:  during the period of  supervision  pursuant to this order,
Heritage Bank and its directors,  officers and employees were required to act in
accordance with the  instructions and directions given by the Commissioner or by
Mr. Mackey as supervisory  representative of the Commissioner;  as a supervisor,
Mr. Mackey would manage the affairs of Heritage Bank and its subsidiary and take
charge of books, records,  property,  assets,  liabilities,  and business of the
bank;  meetings of the Board of Directors were not permitted without the written
approval of the supervisor; no action of the Board of Directors was deemed valid
without written  approval of the supervisor or the  Commissioner;  each Director
agreed to resign his or her position upon the request of the  Commissioner;  and
the Order was not to be lifted until,  in the opinion of the  Commissioner,  the
bank had acceptable  management,  established  acceptable  internal controls and
segregation of duties,  investment policies and practices,  operational policies
and had achieved profitability in operations.

     In February of 2001, citing the considerable  progress the bank had made in
correcting operational deficiencies, the supervisory order was terminated by the
Commissioner of the Texas Savings and Loan Department.  Termination of the Order
was subject to adoption by the Board of Directors  of a  resolution  agreeing to
maintain acceptable management,  a Tier 1 leverage capital ratio of at least 7%,
at least 8 directors  as required  by the bylaws of  Heritage  Bank,  with


                                       26

<PAGE>

these  directors  to include  members  having a cross  section  of  banking  and
business experience,  supervision of lending and investment policies, accounting
procedures and internal control adequate to safeguard the interests of the bank,
sufficient  oversight of management to ensure  compliance  with board  policies,
statutes and regulations,  and quarterly reporting to the Texas Savings and Loan
Department  and the FDIC  regarding  the  status  of the  bank's  financial  and
operating  condition.  Management  of Heritage Bank believes it is in compliance
with these conditions, with the exception of the requirement for 8 directors. In
May of 2001, the Commissioner removed the quarterly reporting requirement.

     INSURANCE  OF ACCOUNTS.  The  deposits of Heritage  Bank are insured to the
maximum extent  permitted by the Savings  Association  Insurance Fund,  which is
administered  by the  FDIC.  As  insurer,  the  FDIC is  authorized  to  conduct
examinations of, and to require reporting by, FDIC-insured institutions. It also
may prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious threat to the FDIC. The FDIC
also has the authority to initiate  enforcement  actions  against  savings banks
such as Heritage Bank.

     Savings Association Insurance Fund insured institutions are assigned to one
of three capital groups which are based solely on the level of an  institution's
capital--"well  capitalized,"  "adequately capitalized," and "undercapitalized."
These  capital  levels  are  defined  in the same  manner  as under  the  prompt
corrective  action system discussed  below.  These three groups are then divided
into three subgroups which reflect varying levels of supervisory  concern,  from
those banks which are  considered to be healthy to those which are considered to
be of substantial  supervisory  concern.  The matrix so created  results in nine
assessment  risk  classifications,   with  rates  ranging  from  zero  for  well
capitalized, healthy institutions to .27% for undercapitalized institutions with
substantial  supervisory concerns.  The insurance premiums for Heritage Bank for
2002 were  .0002%  (per  annum) of insured  deposits.  The  Savings  Association
Insurance  Fund is  required  by law to  maintain  a  reserve  ratio of 1.25% of
insured deposits.

     The FDIC may  terminate  the deposit  insurance  of any insured  depository
institution,  including Heritage Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices,  is in an
unsafe  or  unsound  condition  to  continue  operations,  or has  violated  any
applicable law, regulation,  order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance  temporarily  during the hearing
process for the permanent  termination of insurance,  if the  institution has no
tangible  capital.  If insurance of accounts is terminated,  the accounts at the
institution at the time of the termination,  less subsequent withdrawals,  shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of Heritage Bank's deposit insurance.

     CAPITAL  REQUIREMENTS.  The FDIC has promulgated  regulations and adopted a
statement of policy  regarding  the capital  adequacy of  state-chartered  banks
which,  like Heritage Bank, are not members of the Federal Reserve  System.  The
FDIC's  capital  regulations  establish a minimum  3.0% Tier I leverage  capital
requirement for the most highly-rated state-chartered, non-member banks, with an
additional  cushion  of  at  least  100  to  200  basis  points  for  all  other
state-chartered,  non-member banks,  which effectively will increase the minimum
Tier I leverage

                                       27

<PAGE>

ratio for such other banks to 4.0% to 5.0% or more. Under the FDIC's regulation,
highest-rated  banks are those that the FDIC determines are not  anticipating or
experiencing  significant  growth and have well diversified  risk,  including no
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and, in general,  which are considered a strong  banking  organization,
rated  composite  1 under the  Uniform  Financial  Institutions  Rating  System.
Leverage or core  capital is defined as the sum of common  stockholders'  equity
(including  retained  earnings),  noncumulative  perpetual  preferred  stock and
related surplus, and minority interests in consolidated subsidiaries,  minus all
intangible  assets  other than  certain  qualifying  supervisory  goodwill,  and
certain   purchased   mortgage   servicing   rights  and  purchased  credit  and
relationships.

     The FDIC  also  requires  that  savings  banks  meet a  risk-based  capital
standard.  The  risk-based  capital  standard  for savings  banks  requires  the
maintenance   of  total   capital  which  is  defined  as  Tier  I  capital  and
supplementary (Tier 2 capital) to risk weighted assets of 8%. In determining the
amount of  risk-weighted  assets,  all assets,  plus  certain off balance  sheet
assets,  are multiplied by a risk-weight  of 0% to 100%,  based on the risks the
FDIC believes are inherent in the type of asset or item.

     The  components of Tier I capital are equivalent to those  discussed  above
under the 3% leverage standard. The components of supplementary (Tier 2) capital
include  certain  perpetual  preferred  stock,  certain  mandatory   convertible
securities,  certain  subordinated  debt and  intermediate  preferred  stock and
general  allowances  for loan and  lease  losses.  Allowance  for loan and lease
losses  includable in supplementary  capital is limited to a maximum of 1.25% of
risk-weighted   assets.   Overall,   the  amount  of  capital   counted   toward
supplementary  capital cannot exceed 100% of core capital. At December 31, 2002,
Heritage Bank met each of its capital requirements.

     A bank which has less than the minimum leverage capital  requirement  must,
within 60 days of the date as of which it fails to comply with such requirement,
submit to its FDIC regional  director for review and approval a reasonable  plan
describing  the means and  timing by which  the bank will  achieve  its  minimum
leverage capital requirement. A bank which fails to file such plan with the FDIC
is deemed to be operating in an unsafe and unsound  manner and could subject the
bank to a  cease-and-desist  order from the FDIC.  The FDIC's  regulations  also
provide that any insured  depository  institution with a ratio of Tier I capital
to total assets that is less than 2.0% is deemed to be operating in an unsafe or
unsound condition  pursuant to Section 8(a) of the Federal Deposit Insurance Act
and is subject to potential  termination of deposit insurance.  However, such an
institution will not be subject to an enforcement  proceeding  thereunder solely
on account of its  capital  ratios if it has entered  into and is in  compliance
with a written  agreement with the FDIC to increase its Tier I leverage  capital
ratio to such level as the FDIC deems  appropriate and to take such other action
as may be  necessary  for the  institution  to be  operated  in a safe and sound
manner. The FDIC capital  regulation also provides,  among other things, for the
issuance by the FDIC or its designee(s) of a capital directive, which is a final
order  issued to a bank that fails to  maintain  minimum  capital to restore its
capital to the minimum  leverage  capital  requirement  within a specified  time
period.   Such   directive  is  enforceable  in  the  same  manner  as  a  final
cease-and-desist order.


                                       28
<PAGE>


     At December 31, 2002,  Heritage Bank exceeded all of its regulatory capital
requirements,  with Tier 1, total  risk-based  and  leverage  capital  ratios of
15.8%,  16.8% and 13.5%,  respectively.  The following table sets forth Heritage
Bank's compliance with the above-described  capital  requirements as of December
31, 2002.

<TABLE>
<CAPTION>
                                                                                   Total
                                                                Tier 1          Risk-Based             Leverage
                                                              Capital(1)          Capital              Capital

                                                            ----------------------------------------------------------
                                                                             (Dollars in Thousands)
<S>                                                              <C>                  <C>                 <C>


Capital under generally accepted accounting principles:         $ 6,310                 $ 6,310           $6,310
                                                                 ======                  ======            =====
Regulatory capital                                                6,298                   6,714            6,298
Minimum required regulatory capital(2)                            1,596                   3,193            1,863
                                                                 ------                  ------            -----
Excess regulatory capital                                         4,702                   3,521            4,435
                                                                 ======                  ======            =====

Regulatory capital as a percentage                                 15.8%                   16.8%            13.5%
Minimum capital required as a
   percentage(2)                                                    4.0%                    8.0%             4.0%
Regulatory capital as a percentage
 in excess of requirements                                          11.8%                   8.8%             9.5%
</TABLE>



----------------

(1)  Does not reflect the 4.0% requirement to be met in order for an institution
     to be "adequately capitalized." See "- Prompt Corrective Action."

(2)  Tier 1 capital and total risk-based capital are computed as a percentage of
     "Risk-weighted"  assets as computed  for  purposes of this  requirement  of
     $39.9  million.  Leverage  capital is computed as a  percentage  of average
     total assets of $46.7 million.

     Any savings bank that fails any of the capital  requirements  is subject to
possible  enforcement  actions by the FDIC. Such actions could include a capital
directive, a cease and desist order, civil money penalties, the establishment of
restrictions  on the  institution's  operations,  termination of Federal deposit
insurance and the appointment of a conservator or receiver.

     Under the Texas  Savings Bank Act, a savings bank,  such as Heritage  Bank,
must maintain minimum capital as prescribed by the Commissioner in an amount not
less than the regulatory  capital  required for national  banks. A national bank
must  maintain  Tier 1 capital in an amount  equal to at least 3.0% of  adjusted
total  assets,  and at least 8.0% of risk-based  capital.  The Texas Savings and
Loan  Department  may  establish  higher  minimums  based upon a savings  bank's
history, management or earnings prospects.

     LIQUIDITY.  A Texas savings bank must maintain investments in liquid assets
equal  to at least  10% of its  average  daily  deposits  for the most  recently
completed  calendar  quarter.  Liquid  assets for these  purposes  include cash,
balances  in a Federal  Reserve  Bank or  Federal  Home Loan Bank,  and  readily
marketable  investments,  including  unencumbered  Federal government  sponsored
enterprises securities.


                                       29
<PAGE>


     DIVIDENDS. Under the Texas Savings Bank Act, dividends may be declared when
out of current and retained income.

     PROMPT CORRECTIVE  ACTION.  Under the "Prompt Corrective Action" provisions
of the Federal Deposit Insurance Act ("FDIA"), the federal banking agencies have
established   five   capital   categories   ("well   capitalized,"   "adequately
capitalized,"    "undercapitalized,"    "significantly   undercapitalized"   and
"critically undercapitalized"). The prompt corrective action provisions of FDIA,
and the regulations  promulgated  thereunder,  require certain mandatory actions
and authorize other discretionary actions to be taken by the appropriate federal
banking  agency  with  respect  to  institutions  in the three  undercapitalized
categories, with the nature and extent of such action dependent primarily on the
category in which the institution is placed.

     The severity of the actions  authorized or required to be taken by the FDIC
increases as an institution's  capital position  deteriorates.  Under the prompt
corrective  action  provisions,  the FDIC is required to monitor  closely and to
restrict asset growth,  acquisitions,  branching and new lines of business of an
undercapitalized  bank.  The FDIA also  prohibits  dividends  and other  capital
distributions if, following such distribution,  a bank would be undercapitalized
and  requires  an  undercapitalized  bank  to  submit  to  the  FDIC  a  capital
restoration plan.

     At  December  31,  2002,  Heritage  Bank  was  deemed  a  well  capitalized
institution for purposes of the above  regulations and as such is not subject to
the above mentioned restrictions.

     SAFETY AND SOUNDNESS  GUIDELINES.  The FDIC and the other  Federal  banking
agencies  have  established  guidelines  for  safety and  soundness,  addressing
operational  and  managerial  standards,  as well as  compensation  matters  for
insured financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate Federal regulators. The
FDIC and the other agencies have also  established  guidelines  regarding  asset
quality and earnings standards for insured institutions.  Heritage Bank believes
that it is in compliance with these guidelines and standards.

     COMMUNITY  REINVESTMENT ACT AND THE FAIR LENDING LAWS.  Savings banks, such
as Heritage Bank, have a responsibility under the Community  Reinvestment Act of
1977 and related  regulations of the FDIC to help meet the credit needs of their
communities,  including low- and moderate-income neighborhoods. In addition, the
Equal  Credit  Opportunity  Act and the Fair  Housing Act  (together,  the "Fair
Lending Laws") prohibit lenders from  discriminating  in their lending practices
on the basis of  characteristics  specified in those statutes.  An institution's
failure to comply with the provisions of the Community  Reinvestment  Act could,
at a minimum,  result in regulatory  restrictions on its activities.  Failure to
comply with the Fair  Lending Laws could  result in  enforcement  actions by the
FDIC, as well as the Department of Justice.

     QUALIFIED THRIFT LENDER TEST. As a Texas-chartered  savings bank,  Heritage
Bank is  currently  required,  and  after the  conversion  will  continue  to be
required,  to comply with the  qualified  thrift  lender or QTL test pursuant to
Section 92.204 of the Texas Finance Code. Additionally,  for us to register as a
savings and loan holding company, Heritage Bank is required to meet the QTL test
under Office of Thrift  Supervision  regulations.  Heritage Bank can comply with
the QTL test either by qualifying as a domestic building and loan association as
defined in


                                       30
<PAGE>




the  Internal  Revenue  Code or by meeting the second  prong of the QTL test set
forth in the HOLA, as described below.

     Under the "domestic building and loan" test a savings association must meet
a supervisory  test, a business  operations test, and an asset  composition test
which  requires  that 60% of total  assets must consist of cash,  United  States
obligations, share loans, and loans secured by residential real estate. Heritage
Bank meets the definition of a "domestic  building and loan  association"  under
this test.

     Currently,  the  prong of the QTL test  that is not  based on the  Internal
Revenue  Code  requires  that 65% of an  institution's  "portfolio  assets"  (as
defined)  consist of certain  housing and  consumer-related  assets on a monthly
average basis in nine out of every 12 months.  Assets that qualify without limit
for inclusion as part of the 65% requirement include:

o    loans made to purchase,  refinance,  construct,  improve or repair domestic
     residential housing;

o    home equity loans;

o    most mortgage-backed securities;

o    stock issued by the Federal Home Loan Bank of Dallas; and

o    direct or indirect obligations of the FDIC.

     In addition, the following assets, among others, may be included in meeting
the  test  subject  to an  overall  limit  of 20% of the  savings  institution's
portfolio assets:  50% of residential  mortgage loans originated and sold within
90  days of  origination;  100%  of  consumer  loans  (limited  to 10% of  total
portfolio assets);  and stock issued by the FHLMC or the FNMA.  Portfolio assets
consist  of total  assets  minus the sum of (1)  goodwill  and other  intangible
assets,  (2) property used by the savings  institution  to conduct its business,
and (3) liquid assets up to 20% of the  institution's  total assets. At December
31, 2002, the qualified thrift  investments of Heritage Bank were  approximately
78% of its portfolio assets.

     FEDERAL  HOME LOAN BANK  SYSTEM.  Heritage  Bank is a member of the Federal
Home Loan Bank of Dallas,  which is one of 12 regional  Federal  Home Loan Banks
that  administers the home financing  credit  function of savings  institutions.
Each  Federal Home Loan Bank serves as a reserve or central bank for its members
within its assigned  region.  It is funded  primarily from proceeds derived from
the sale of  consolidated  obligations of the Federal Home Loan Bank System.  It
makes  loans to  members  (i.e.,  advances)  in  accordance  with  policies  and
procedures  established by the Board of Directors of the Federal Home Loan Bank.
At December 31, 2002,  Heritage  Bank had $5.4 million of Federal Home Loan Bank
advances. See Note 10 to Consolidated Financial Statements.

     As a member,  Heritage  Bank is required to purchase and maintain  stock in
the  Federal  Home Loan Bank of Dallas in an amount  equal to at least 1% of its
aggregate  unpaid  residential


                                       31
<PAGE>




mortgage loans or similar obligations at the beginning of each year. At December
31, 2002,  Heritage Bank had $483,000 in Federal Home Loan Bank stock,  of which
$270,100 was the minimum required for compliance with this requirement.

     The  Federal  Home  Loan  Banks  are  required  to  provide  funds  for the
resolution  of troubled  savings  institutions  and to  contribute to affordable
housing programs through direct loans or interest subsidies on advances targeted
for community  investment and low- and moderate-income  housing projects.  These
contributions  have  adversely  affected  the  level of  Federal  Home Loan Bank
dividends  paid in the past and could do so in the future.  These  contributions
also could have an adverse  effect on the value of Federal  Home Loan Bank stock
in the future.  The  dividend  yield on Heritage  Bank's  Federal Home Loan Bank
stock was 2.7% in 2002 and 4.1% in 2001.

     FEDERAL RESERVE  SYSTEM.  The Federal Reserve Board requires all depository
institutions to maintain reserves against their transaction  accounts (primarily
NOW and Super NOW checking accounts) and non-personal time deposits. No reserves
are required to be maintained on the first $5.5 million of transaction accounts,
reserves of 3% were required to be maintained for amounts up to$42.8  million of
net  transaction  accounts,  and a reserve of $1.3  million plus 10% against net
transaction accounts above this amount. The above dollar amounts and percentages
are  subject to  periodic  adjustment  by the  Federal  Reserve  Board.  Because
required   reserves  must  be  maintained  in  the  form  of  vault  cash  or  a
noninterest-bearing  account  at a  Federal  Reserve  Bank,  the  effect of this
reserve  requirement is to reduce an institution's  earning assets and constrain
its ability to lend.


                                    TAXATION

FEDERAL TAXATION

     GENERAL.  Heritage  Bancshares,  Inc., and Heritage Bank are subject to the
corporate  tax  provisions of the Internal  Revenue  Code,  and Heritage Bank is
subject to certain additional  provisions which apply to thrifts and other types
of financial  institutions.  The  following  discussion  of Federal  taxation is
intended only to summarize certain pertinent Federal income tax matters relevant
to the taxation of Heritage  Bancshares,  Inc.,  and Heritage  Bank and is not a
comprehensive  discussion of the tax rules  applicable  to Heritage  Bancshares,
Inc., and Heritage Bank.

     FISCAL YEAR.  For Federal  income tax  purposes,  Heritage  Bank  currently
reports its income and expenses on the accrual  method of accounting  and uses a
tax year ending December 31 for filing its Federal income tax returns.

     BAD DEBT RESERVES. Savings institutions such as Heritage Bank are permitted
to  establish  a  reserve  for bad  debts and to make  annual  additions  to the
reserve. As an institution with less than $500 million in assets,  Heritage Bank
has elected to use the experience method for computing additions to its bad debt
reserve.


                                       32

<PAGE>


     Under the experience  method,  the deductible  annual  addition to Heritage
Bank's bad debt reserves is the amount  necessary to increase the balance of the
reserve at the close of the taxable  year to the greater of (a) the amount which
bears the same ratio to loans  outstanding  at the close of the taxable  year as
the total net bad debts sustained during the current and five preceding  taxable
years bear to the sum of the loans  outstanding  at the close of those six years
or (b) the lower of (i) the balance in the  reserve  account at the close of the
last taxable  year prior to the most recent  adoption of the  experience  method
(the "base year"),  except that for taxable years beginning after 1987, the base
year is the last taxable year  beginning  before 1988,  or (ii) if the amount of
loans  outstanding  at the close of the taxable  year is less than the amount of
loans outstanding at the close of the base year, the amount which bears the same
ratio to loans  outstanding  at the close of the taxable  year as the balance of
the  reserve  at the  close  of the  base  year  bears  to the  amount  of loans
outstanding at the close of the base year.

     Legislation  adopted in August 1996 (i) repealed the  provision of the Code
which  authorized  the  use  of the  percentage  of  taxable  income  method  by
qualifying savings institutions to determine deductions for bad debts, effective
for  taxable  years  beginning  after  1995,  and (ii)  requires  that a savings
institution  recapture for tax purposes (i.e.  take into income) over a six-year
period its applicable excess reserves,  which for a savings  institution such as
Heritage Bank which is a "small bank," as defined in the Code,  generally is the
excess  of the  balance  of its bad debt  reserves  as of the  close of its last
taxable year beginning  before January 1, 1996 over the balance of such reserves
as of the close of its last taxable year beginning before January 1, 1988, which
recapture  would be suspended  for any tax year that begins  after  December 31,
1995 and before January 1, 1998 (thus a maximum of two years) in which a savings
institution originates an amount of residential loans which is not less than the
average of the  principal  amount of such  loans  made by a savings  institution
during its six most  recent  taxable  years  beginning  before  January 1, 1996.
Heritage  Bank does not  believe  that  these  provisions  will have a  material
adverse effect on Heritage Bank's financial condition or operations.

     The  above-referenced  legislation also repealed certain  provisions of the
Code that only apply to thrift  institutions  to which Section 593 applies:  (i)
the denial of a portion of certain tax credits to a thrift institution; (ii) the
special rules with respect to the  foreclosure  of property  securing loans of a
thrift institution; (iii) the reduction in the dividends received deduction of a
thrift  institution;  and (iv) the ability of a thrift  institution to use a net
operating  loss to offset its income  from a residual  interest in a real estate
mortgage  investment  conduit.  It is not  anticipated  that the repeal of these
provisions  will have a material  adverse  effect on Heritage  Bank's  financial
condition or operations.

     At December 31, 2002, Heritage Bank had no Federal income tax reserves
for which Federal income tax had not been provided. Any Federal income tax
reserves and liquidation account to be established for the benefit of certain
depositors of Heritage Bank in connection with the conversion would cause the
retained earnings of Heritage Bank to be substantially restricted.

     DISTRIBUTIONS.  If  Heritage  Bank  distributes  cash  or  property  to its
stockholders,  and the  distribution  is treated  as being from its  accumulated
pre-1988 tax bad debt  reserves,  the  distribution  will cause Heritage Bank to
have additional taxable income. A distribution to

                                       33
<PAGE>




stockholders  is deemed to have been made from  accumulated bad debt reserves to
the  extent  that (a) the  reserves  exceed  the  amount  that  would  have been
accumulated on the basis of actual loss experience,  and (b) the distribution is
a  "non-dividend  distribution."  A  distribution  in  respect  of  stock  is  a
non-dividend  distribution  to the extent that, for Federal income tax purposes,
(i) it is in redemption of shares,  (ii) it is pursuant to a liquidation  of the
institution,  or (iii) in the case of a current distribution,  together with all
other such  distributions  during the taxable year, it exceeds  Heritage  Bank's
current and post-1951 accumulated earnings and profits. The amount of additional
taxable  income created by a  non-dividend  distribution  is an amount that when
reduced  by  the  tax  attributable  to  it  is  equal  to  the  amount  of  the
distribution.

     NET OPERATING LOSS CARRYOVERS.  A financial  institution may carry back net
operating  losses  to the  preceding  three  taxable  years and  forward  to the
succeeding 15 taxable years.  Effective for net operating  losses arising in tax
years  beginning  after October 1, 1997,  the  carryback  period is reduced from
three years to two years and the  carryforward  period is extended from 15 years
to 20 years.  At December 31, 2002,  Heritage  Bank had $8,000 in net  operating
loss carryforwards for Federal income tax purposes that will expire in 2019.

     CORPORATE  DIVIDENDS-RECEIVED  DEDUCTION. The corporate  dividends-received
deduction is 80% in the case of dividends  received from corporations with which
a corporate  recipient does not file a consolidated tax return, and corporations
which own less than 20% of the stock of a  corporation  distributing  a dividend
may deduct only 70% of dividends received or accrued on their behalf. However, a
corporation  may deduct 100% of dividends  from a member of the same  affiliated
group of corporations.

STATE AND LOCAL TAXATION

     STATE OF TEXAS.  Effective August 12, 1991, the Texas  legislature  enacted
the 1991 Texas Revenue Bill which,  among other things,  imposes a franchise tax
on Heritage Bancshares,  Inc. Under the law, we will pay an annual franchise tax
equal to the  greater  of $2.50 per  $1,000 of taxable  capital  apportioned  to
Texas,   or  $4.50  per  $100  of  net  taxable   earned  surplus  with  certain
modifications.

     DELAWARE  TAXATION.  As a Delaware  holding  company not earning  income in
Delaware, Heritage Bancshares, Inc. is exempt from Delaware corporate income tax
but is required to file an annual report with and pay an annual franchise tax to
the State of Delaware.

     OTHER MATTERS.  Federal  legislation  is introduced  from time to time that
would  limit the  ability of  individuals  to deduct  interest  paid on mortgage
loans.  Individuals  are currently not permitted to deduct  interest on consumer
loans.  Significant  increases  in tax  rates  or  further  restrictions  on the
deductibility of mortgage interest could adversely affect Heritage Bank.

     Heritage  Bank's  Federal  income tax returns for the tax years ended 2001,
2000 and 1999 are open  under the  statute  of  limitations  and are  subject to
review by the IRS. Heritage Bank has not been audited by the IRS during the last
five years.


                                       34
<PAGE>




ITEM 2.   DESCRIPTION OF PROPERTY.

     The  following  table sets forth  certain  information  with respect to the
Bank's offices at December 31, 2002.
                                              Net Book              Amount of
                                              Value of             Deposits at
Description/Address           Leased/Owned    Property        December 31, 2002
-------------------           -------------  -----------      ------------------
                                                     (In Thousands)


102 West High Street            Owned           $247                  $34,134
Terrell, Texas  75160

ITEM 3. LEGAL PROCEEDINGS.
------  ------------------

     Heritage Bank, the Company's principal subsidiary, is a defendant in a
proceeding brought by Linda Kay Gober, a former employee of Heritage Bank that
commenced on January 27, 2003, in the United Stated District Court for the
Northern District of Texas, Dallas, Division. The plaintiff alleges that during
the course of her employment and/or as a result of her separation from
employment, she was subjected to illegal age discrimination pursuant to the Age
Discrimination in Employment Act, 29 U. S. C. ss. 621, et seq., sexual
harassment and retaliation for complaining about sexual harassment, pursuant to
Title VII of the Civil Rights Act of 1964, 42 U. S. C. ss. 2000e, et seq. The
plaintiff seeks lost wages and benefits, emotional distress damages, punitive
damages, liquidated damages (pursuant to the Age Discrimination in Employment
Act), and other compensatory damages, as well as equitable relief, including
reinstatement and an injunction against future age discrimination, sexual
harassment and retaliation, pre- and post-judgment interest and attorneys' fees.
No sum of damages has yet been specified. Heritage Bank is also a defendant in a
proceeding brought by Vicki Renee Sereseroz, a former employee of Heritage Bank,
commenced on February 10, 2003 in the same court, alleging similar facts,
asserting the same claims, and seeking the same relief. The Company intends to
vigorously oppose both these actions and believes them to be without merit.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
------  ----------------------------------------------------

         Not applicable.


PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
------  ---------------------------------------------------------

     The  information  required by Item 201 of Regulation S-B is incorporated by
reference from the information contained in the sections captioned  "Stockholder
Information" and "Stock  Information" in the Registrant's  2002 Annual Report to
Stockholders.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
------  ----------------------------------------------------------

     The  information  required by Item 303 of Regulation S-B is incorporated by
reference from the information contained in the section captioned  "Management's
Discussion and Analysis" in the Registrant's 2002 Annual Report to Stockholders.

ITEM 7. FINANCIAL STATEMENTS.
------  --------------------

     The  information  required by Item 310(a) of Regulation S-B is incorporated
by reference from the Consolidated  Financial Statements of Heritage Bancshares,
Inc. and  Subsidiary as of December 31, 2002 and 2001,  together with the report
of Payne Falkner Smith & Jones,  P.C., in the Registrant's 2002 Annual Report to
Stockholders.


                                       35
<PAGE>


ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.
------- ---------------------------------------------------------------

        Not applicable.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
------  ------------------------------------------------------------------------
        WITH  SECTION   16(A)  OF   THE  EXCHANGE ACT.
        ---------------------------------------------

     The  information  required  by  Items  401  and  405 of  Regulation  S-B is
incorporated  by  reference  from  the  information  contained  in  the  section
captioned  "Election of Directors" and  "Executive  Compensation - Section 16(a)
Beneficial Ownership Reporting  Compliance,"  respectively,  in the Registrant's
Proxy Statement for the 2003 Annual Meeting of Stockholders ("Proxy Statement").

ITEM 10.       EXECUTIVE COMPENSATION.
--------       ----------------------

     The  information  required by Item 402 of Regulation S-B is incorporated by
reference from the  information  contained in the section  captioned  "Executive
Compensation" in the Registrant's Proxy Statement.

ITEM 11.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
               AND RELATED STOCKHOLDER MATTERS.
-------        -----------------------------------------------------------------

     The  information  required  by Items  201(d) and 403 of  Regulation  S-B is
incorporated  by  reference  from  the  information  contained  in  the  section
captioned  "Executive  Compensation-Equity  Compensation  Plan  Information" and
"Beneficial Ownership," respectively, in the Registrant's Proxy Statement.

ITEM 12.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
-------        -----------------------------------------------

     The  information  required by Item 404 of Regulation S-B is incorporated by
reference from the  information  contained in the section  captioned  "Executive
Compensation - Indebtedness of Management" in the Registrant's Proxy Statement.

ITEM 13.       EXHIBITS, LIST AND REPORTS ON FORM 8-K.
--------       ---------------------------------------

        (a)    Documents filed as part of this Report.

                (1)  The  following  documents  are  filed  as  part  of  this
report and  are incorporated herein by reference to Item 7 of this Annual Report
on Form 10-KSB:


                                       36
<PAGE>




        Independent Auditors' Report.

        Consolidated Balance Sheet as of December 31, 2002 and 2001.

        Consolidated Statements of Income for the Years Ended December 31, 2002
        and 2001.

        Consolidated Statement of Changes in Stockholders' Equity for the Years
        Ended December 31, 2002 and 2001.

        Consolidated Statement of Cash Flows for the Years Ended December 31,
        2002 and 2001.

        Notes to Consolidated Financial Statements.

                 (2) All schedules for which provision is made in the applicable
accounting regulation of the Commission are omitted  because they are not
applicable or the required information is included in the Consolidated Financial
Statements or notes thereto.

                (3)(a) The  following  exhibits  are filed as part of this Form
10-KSB,  and this list  includes the Exhibit Index.

No.                              Description
---          -------------------------------------------------------------------

3.1          Certificate of Incorporation of Heritage Bancshares, Inc.1/
3.2          Amended and Restated Bylaws of Heritage Bancshares, Inc.
4.1          Form of Stock Certificate of Heritage Bancshares, Inc.1/
13           2002 Annual Report to Stockholders
21           Subsidiaries of the Registrant
99.1         Certification  of Chief Executive  Officer  Pursuant to Section 906
             of the  Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
99.2         Certification  of Chief Financial  Officer  Pursuant to Section 906
             of the  Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)


____________________________

1/      Incorporated by reference from the Registration  Statement on Form SB-2
        (Registration No. 333-70782) filed by the issuer with the Commission on
        October 2, 2001, as amended.

        (3)(b)  Reports filed on Form 8-K.

     On November 27, 2002, Heritage Bancshares, Inc. filed a Form 8-K under Item
5 announcing  the hiring of an Executive  Vice  President  and Chief  Financial
Officer on November 20, 2002.


                                       37
<PAGE>


ITEM 14.  CONTROLS AND PROCEDURES.
--------  ------------------------

     Within 90 days prior to the date of this annual report, the Company carried
out an  evaluation,  under the  supervision  and with the  participation  of the
Company's management,  including the Company's Chief Executive Officer and Chief
Financial  Officer,  of the  effectiveness  of the design and  operation  of the
Company's  disclosure controls and procedures.  Based upon that evaluation,  the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure  controls and  procedures  are  effective.  There were no significant
changes  in the  Company's  internal  controls  or in other  factors  that could
significantly affect these controls subsequent to the date of their evaluation.

     Disclosure controls and procedures are the controls and other procedures of
the Company  that are  designed to ensure  that the  information  required to be
disclosed by the Company in its reports filed or submitted  under the Securities
Exchange  Act of 1934,  as  amended  ("Exchange  Act") is  recorded,  processed,
summarized and reported, within the time periods specified in the Securities and
Exchange  Commission's  rules and  forms.  Disclosure  controls  and  procedures
include,  without  limitation,  controls and procedures  designed to ensure that
information  required to be disclosed by the Company in its reports  filed under
the Exchange Act is accumulated and  communicated  to the Company's  management,
including the principal  executive officer and principal  financial officer,  as
appropriate to allow timely decisions regarding required disclosure.

                                       38

<PAGE>



                                   SIGNATURES

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



                           HERITAGE BANCSHARES, INC.


Date: March 27, 2003           By:/s/ JOHN H. MACKEY
                                  ----------------------------------------------
                                  John H. Mackey
                                  President and Chief Executive Officer
                                  (Duly Authorized Representative)

     In  accordance  with the Exchange Act, this report has been signed below by
the following  persons on behalf of the  Registrant and in the capacities and on
the dates indicated.


/s/ J. PAT BAKER                                                  March 27, 2003
--------------------------------------------------
J. Pat Baker
Chairman of the Board



/s/ JOHN H. MACKEY                                                March 27, 2003
--------------------------------------------------
John H. Mackey
Director, President and Chief Executive
  Officer (Principal Executive Officer)


/s/ JON D. PATTERSON                                              March 27, 2003
--------------------------------------------------
Jon D. Patterson
Executive Vice President and Chief Financial
  Officer (Principal Financial and Accounting
  Officer)


/s/ JOY MILTON CATLIN
--------------------------------------------------
Joy Milton Catlin                                                 March 27, 2003
Director


                                       39

<PAGE>


/s/ SWITZER L. DEASON                                             March 27, 2003
---------------------------------------------------
Switzer L. Deason
Director


/s/ MARY CAYLE RAMSEY                                             March 27, 2003
--------------------------------------------------
Mary Gayle Ramsey
Director


/s/ MILTON LEE RISINGER                                           March 27, 2003
--------------------------------------------------
Milton Lee Risinger
Director


/s/ THOMAS J. WAGEMAN                                             March 27, 2003
--------------------------------------------------
Thomas J. Wageman
Director

                                       40



<PAGE>



                                 CERTIFICATIONS


I, John H. Mackey, certify that:

1.   I have reviewed  this annual report on Form 10-KSB of Heritage  Bancshares,
     Inc. (the "Registrant");

2.   Based on my  knowledge,  this  annual  report  does not  contain any untrue
     statement of a material fact or omit to state a material fact  necessary to
     make the statements  made, in light of the  circumstances  under which such
     statements  were made, not misleading with respect to the period covered by
     this annual report;

3.   Based on my  knowledge,  the  financial  statements,  and  other  financial
     information included in this annual report,  fairly present in all material
     respects the financial  condition,  results of operations and cash flows of
     the Registrant as of, and for, the periods presented in this annual report;

4.   The  Registrant's  other  certifying  officers  and I are  responsible  for
     establishing and maintaining disclosure controls and procedures (as defined
     in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

         a)   designed such  disclosure  controls and  procedures to ensure that
              material  information  relating to the  Registrant,  including its
              consolidated  subsidiaries,  is made known to us by others  within
              those  entities,  particularly  during  the  period in which  this
              annual report is being prepared;

         b)   evaluated  the   effectiveness  of  the  Registrant's   disclosure
              controls and  procedures  as of a date within 90 days prior to the
              filing date of this annual report (the "Evaluation Date"); and

         c)   presented  in  this  annual  report  our  conclusions   about  the
              effectiveness  of the disclosure  controls and procedures based on
              our evaluation as of the Evaluation Date;

 5.       The Registrant's other certifying officers and I have disclosed, based
          on our most recent  evaluation,  to the Registrant's  auditors and the
          audit  committee  of  Registrant's  board  of  directors  (or  persons
          performing the equivalent functions):

         a)   all  significant  deficiencies  in  the  design  or  operation  of
              internal  controls which could adversely  affect the  Registrant's
              ability to record,  process,  summarize and report  financial data
              and have  identified  for the  Registrant's  auditors any material
              weaknesses in internal controls; and


<PAGE>


         b)   any fraud,  whether or not material,  that involves  management or
              other  employees who have a significant  role in the  Registrant's
              internal controls; and

 6.       The  Registrant's  other  certifying  officers and I have indicated in
          this annual report  whether or not there were  significant  changes in
          internal controls or in other factors that could significantly  affect
          internal   controls   subsequent  to  the  date  of  our  most  recent
          evaluation,   including   any   corrective   actions  with  regard  to
          significant deficiencies and material weaknesses.


Date:  March 27, 2003                      /s/ JOHN H. MACKEY
                                           -------------------------------------
                                           John H. Mackey
                                           President and Chief Executive Officer


<PAGE>


I, Jon D. Patterson, certify that:

 1.       I have  reviewed  this  annual  report  on  Form  10-KSB  of  Heritage
          Bancshares, Inc. (the "Registrant");

 2.       Based on my knowledge,  this annual report does not contain any untrue
          statement  of a  material  fact  or  omit to  state  a  material  fact
          necessary to make the statements  made, in light of the  circumstances
          under which such  statements were made, not misleading with respect to
          the period covered by this annual report;

 3.       Based on my knowledge,  the financial statements,  and other financial
          information  included in this  annual  report,  fairly  present in all
          material respects the financial  condition,  results of operations and
          cash flows of the Registrant as of, and for, the periods  presented in
          this annual report;

 4.       The Registrant's  other certifying  officers and I are responsible for
          establishing  and maintaining  disclosure  controls and procedures (as
          defined in Exchange  Act Rules  13a-14 and 15d-14) for the  Registrant
          and we have:

          a)   designed such  disclosure  controls and procedures to ensure that
               material  information  relating to the Registrant,  including its
               consolidated  subsidiaries,  is made known to us by others within
               those  entities,  particularly  during  the  period in which this
               annual report is being prepared;

          b)   evaluated  the  effectiveness  of  the  Registrant's   disclosure
               controls and  procedures as of a date within 90 days prior to the
               filing date of this annual report (the "Evaluation Date"); and

          c)   presented  in  this  annual  report  our  conclusions  about  the
               effectiveness of the disclosure  controls and procedures based on
               our evaluation as of the Evaluation Date;

 5.       The Registrant's other certifying officers and I have disclosed, based
          on our most recent  evaluation,  to the Registrant's  auditors and the
          audit  committee  of  Registrant's  board  of  directors  (or  persons
          performing the equivalent functions):

          a)   all  significant  deficiencies  in the  design  or  operation  of
               internal  controls which could adversely  affect the Registrant's
               ability to record,  process,  summarize and report financial data
               and have  identified for the  Registrant's  auditors any material
               weaknesses in internal controls; and

          b)   any fraud,  whether or not material,  that involves management or
               other employees who have a significant  role in the  Registrant's
               internal controls; and

<PAGE>

 6.       The  Registrant's  other  certifying  officers and I have indicated in
          this annual report  whether or not there were  significant  changes in
          internal controls or in other factors that could significantly  affect
          internal   controls   subsequent  to  the  date  of  our  most  recent
          evaluation,   including   any   corrective   actions  with  regard  to
          significant deficiencies and material weaknesses.



Date:  March 27, 2003                       /s/ JON D. PATTERSON
                                            ------------------------------------
                                            Jon D. Patterson
                                            Executive Vice President and Chief
                                             Financial Officer