SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                     10-KSB
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
                   OF THE SECURITIES EXCHANGE ACT OF 1934 For
       the fiscal year ended December 31, 1997 Commission File No. 0-11255


                            Heritage Bankshares, Inc.



             Virginia                                        54-1234322
(State or other jurisdiction of                     (IRS Employer incorporation
 incorporation or organization)                     identification number)


       200 East Plume Street
         Norfolk, Virginia                                        23514
(Address of principal executive offices)                        (Zip Code)


Registrant's telephone number, including area code:           (804) 523-2600



Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $5 par Value         Securities not registered on a stock exchange
   Title of Each Class

Indicate  by a check  mark  whether  the  registrant  (1) has filed all  reports
required to be filed by Section 13 or 15 (d) of the  Securities  Exchange Act of
1934 during the  preceding  12 months,  and (2) has been  subject to such filing
requirements for the past 90 days.

                  Yes   X                            No

Indicate by check mark if disclosure of delinquent  filers  pursuant to item 405
of Regulation SB is not contained herein, and will not be contained, to the best
of  registrant's  knowledge,  in  definitive  proxy  or  information  statements
incorporated  by  reference  in Part III of the Form 10-KSB or any  amendment to
this Form 10-KSB. [X]

State the aggregate market value of the voting stock held by  non-affiliates  of
the registrant as of March 24, 1998: $12,857,775*

Indicate the number of shares outstanding of each of the registrant's classes of
common stock as of March 24, 1998:
                  Common Stock,     $5 Par Value - 797,250




----------------------------------------------
 *   In calculating  the aggregate  market value,  we have used the most recent
     sales price of Common Stock known to the Company, which is $19.00 per share
     and voting stock held by non-affiliates of the registrant at March 24, 1998
     of 676,725 shares.

<PAGE>



Part I

         This Form 10-KSB contains certain forward-looking  statements. For this
purpose any statements  contained in this Form 10-KSB that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, words such as "may", "will", "expect",  "believe",  "anticipate",
"estimate"  or "continue"  or  comparable  terminology  are intended to identify
forward looking-statements. These statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially depending on a
variety of factors.

Item 1.  BUSINESS

GENERAL

         Heritage  Bankshares,  Inc. (the "Company") was incorporated  under the
laws  of  the  Commonwealth  of  Virginia  in  1983.  In  August  of  1992,  two
wholly-owned subsidiaries, Princess Anne Bank and The Heritage Bank-McLean, were
spun off, and the Company has operated as a one bank holding  company since that
time. The principal executive office of the Company is located at 200 East Plume
Street, Norfolk, Virginia. Currently, the Company does not transact any material
business  other than  through its  wholly-owned  banking  subsidiary.  The total
consolidated assets of the Company on December 31, 1997 were $83,002,000

THE BANK

         Heritage Bank & Trust is engaged in the general  commercial  and retail
banking business. The cities of Norfolk and Chesapeake, Virginia, constitute the
primary  service area of the Bank and to a lesser  extent the Bank  includes the
remaining areas of Hampton Roads in its market area.

         Heritage  Bank & Trust  is a state  banking  corporation.  The Bank was
incorporated  as a Virginia  corporation  on September  19, 1975,  and commenced
business at its main office at 841 North Military  Highway in Norfolk,  Virginia
on February 7, 1977. On December 31, 1997,  the Bank had assets of  $82,875,000,
with loans of $52,130,000 and deposits of $72,837,000.

IBV REAL ESTATE HOLDINGS, INC.

         IBV Real Estate  Holdings,  Inc., is a corporation  formed for the sole
purpose of owning  additional  real estate assets acquired by the Company or the
Bank.  Currently,  IBV Real  Estate  Holdings,  Inc.  owns a 1%  interest in IBV
Partners,  LP, a Virginia limited  partnership formed in December 1986. IBV Real
Estate  Holdings,  Inc.,  serves as the sole general partner of the partnership.
The partnership's  sole asset is a 17,200 square-foot office building located at
1450 South Military Highway,  Chesapeake,  Virginia.  Heritage Bank & Trust is a
major tenant in the property.

SENTINEL TITLE SERVICES, INC. AND SENTINEL TRUST SERVICES, L.L.C.

         Sentinel Title Services,  Inc. and Sentinel Trust Services,  L.L.C. are
wholly-owned  subsidiaries which own an interest in providers of title and trust
services. The financial activities pertaining to these interests are recorded on
the  cost  method  of  accounting  for  investments.   The  Company's  strategic
relationship  with these entities  provides the Bank with the ability to provide
title and trust services to its customers.

COMPETITION

         The banking  business in the cities of Norfolk and Chesapeake,  as well
as all of the  Hampton  Roads  area  is  highly  competitive.  All of the  major
commercial banking  institutions based in Virginia conduct business in the area.
The  Bank  also  encounters  competition  from  local  banks,  savings  and loan
associations,  money  market and mutual  funds,  small  loan  companies,  credit
unions, brokerage firms and other financial institutions.

EMPLOYEES

         The  Company  and the Bank have 39  employees.  Of this  total,  32 are
full-time and 7 are part-time. Management considers its employee relations to be
excellent.

REGULATION AND SUPERVISION

THE BANK

Regulatory Matters

         The Bank is subject to state and federal  banking laws and  regulations
which impose  specific  requirements  or  restrictions,  and provide for general
regulatory  oversight  with  respect to  virtually  all  aspects of  operations,
including,  but not limited to, maintenance of cash reserves,  loans, mortgages,
maintenance  of minimum  capital,  payment of dividends,  and  establishment  of
branch offices.  As a  state-chartered  bank and a member of the Federal Reserve
System,  the Bank is supervised and regularly examined by representatives of the
Board of Governors of the Federal Reserve System (the "Federal Reserve") and the
Bureau of Financial  Institutions of the Commonwealth of Virginia (the "Virginia
Bureau of Financial Institutions").

         In addition to being affected by general economic conditions,  earnings
of the Bank may be affected by the fiscal and  monetary  policies of the Federal
Reserve.  The techniques used by the Federal Reserve include setting the reserve
requirements of member banks and establishing the discount rate on member banks'
borrowing.  The  impact  of  the  policies  of the  Federal  Reserve  and  other
regulatory  authorities,  cannot be accurately  predicted.  These  policies can,
however,  materially  affect the  revenues  and net income of  commercial  banks
because  they have a direct  effect on the amount of bank loans and deposits and
the interest rates charged and paid thereon.

         The Bank is also  subject  to  restrictions  under  Section  23A of the
Federal Reserve Act ("The Act").  These restrictions limit the transfer of funds
to the Company and certain other affiliates,  as defined in the Act, in the form
of loans,  extensions  of  credit,  investments  or  purchase  of  assets.  Such
transfers  by the Bank to the company are limited in amount to 10% of the Bank's
capital.  Furthermore,  such loans and  extensions of credit are also subject to
various  collateral  requirements.  See  Note  3 of the  Consolidated  Financial
Statements for additional information on restrictions.

         The Bank is also  subject to  restrictions  on the payment of dividends
under Section 33 of the Federal Reserve Act. Under this section, approval of the
applicable  Federal  Reserve  Bank is  required  if the  total of all  dividends
declared  by the Bank  during any  calendar  year  exceeds  the total of its net
profits  (as defined by the Act) of that year  combined  with its net profits of
the preceding two years. See Note 3 of the Consolidated Financial Statements for
additional information on restrictions.

         The  Federal  Reserve  and the  Bureau  of  Financial  Institutions  of
Virginia requires the Bank to maintain certain minimum capital ratios.  The Bank
and the Company are  required to maintain  minimum  risk-based  capital to asset
ratios, as defined by the regulations, of 4.00% for the Tier 1 capital ratio and
8.00% for the Total (Tier 1 plus Tier 2) capital ratio. Additionally, a leverage
capital ratio, defined as Tier 1 capital divided by average assets, must also be
maintained by financial  institutions.  For financial institutions with the best
regulatory  rating,  generally,  a  minimum  leverage  ratio  of  5.00%  must be
maintained.  The  Bank  and the  Company  met  the  minimum  risk-based  capital
requirements  at December 31, 1997.  See Note 15 of the  Consolidated  Financial
Statements for additional information on regulatory capital matters.

Mergers and Acquisitions

         The Bank Holding  Company Act formerly  prohibited the Federal  Reserve
from approving an application from a bank holding company to acquire shares of a
bank located outside the state in which the operations of the holding  company's
banking subsidiaries were principally conducted,  unless such an acquisition was
specifically  authorized  by statute of the state in which the bank whose shares
were to be acquired was located. The restriction on interstate  acquisitions was
abolished  effective  September 29, 1996,  and bank holding  companies  from any
state may now  acquire  banks and bank  holding  companies  located in any other
state.  Banks may branch  across state lines  effective  June 1, 1997,  provided
certain  conditions are met,  including that applicable state law must expressly
permit such interstate  branching.  Under Virginia law,  effective July 1, 1995,
Virginia banks can branch across state lines in those states with which Virginia
has reciprocal  agreements.  Although this will have a significant impact on the
banking industry, it is not possible to determine, with any degree of certainty,
its impact on individual institutions.

Deposit Insurance

         Section 38 of the  Federal  Deposit  Insurance  Act,  as amended by the
Federal  Deposit  Insurance  Corporation  ("FDIC")  Improvement  Act ("FDICIA"),
requires that the federal  banking  agencies  establish  five capital levels for
insured depository institutions - "well capitalized",  "adequately capitalized,"
"undercapitalized,"    "significantly    "undercapitalized"   and,   "critically
undercapitalized",  and  requires  or  permits  such  agencies  to take  certain
supervisory  actions as an insured  institution's  capital level falls. The Bank
has been  notified  by the  Federal  Reserve  that it is  classified  as a "well
capitalized"   institution  for  this  purpose.   An  "adequately   capitalized"
institution is restricted from accepting  brokered  deposits.  A  "significantly
undercapitalized"  institution  must develop a capital  restoration  plan and is
subject to a number of mandatory and discretionary  supervisory  actions.  These
powers and authorities are in addition to the traditional  powers of the federal
banking  agencies  to deal with  undercapitalized  institutions.  As more  fully
disclosed  in the  following  paragraph,  the FDIC  deposit  insurance  premiums
required to be paid by  institutions  depend,  in part, on their capital levels,
and  "undercapitalized"  institutions  will  be  required  to pay  significantly
greater premiums than more highly capitalized institutions.

         The FDIC has  implemented  a risk-based  deposit  insurance  assessment
system  under  which the  assessment  rate for an insured  institution  may vary
according to  regulatory  capital  levels of the  institution  and other factors
(including  supervisory  evaluations).  Effective  January 1,  1996,  depository
institutions insured by the Bank Insurance Fund ("BIF"),  ranked in the top risk
classification  category  of well  capitalized,  are  required  to pay  only the
statutory minimum assessment of $2,000 annually for deposit insurance, while all
other banks are required to pay premiums  ranging from .03% to .30% annually per
$100  of  domestic  deposits.   These  rate  schedules  are  subject  to  future
adjustments by the FDIC. In addition,  as more fully  disclosed in the following
paragraph,  the FDIC has authority to impose  special  assessments  from time to
time. The Bank is currently  assessed the statutory minimum assessment of $2,000
annually.

         The Deposit  Insurance Funds Act of 1996 ( the "Funds Act") was enacted
on September 30, 1996. Among other provisions,  the Funds Act: (1) requires that
certain  depository  institutions pay a one-time special  assessment (65.7 cents
per $100 of  SAIF-assessable  deposits)  to the FDIC to  capitalize  the Savings
Association Insurance Fund ("SAIF") at its statutorily required reserve ratio of
1.25% of insurable  deposits;  (2) exempts certain depository  institutions with
SAIF assessable deposits that meet any of several specified criteria from paying
the special  assessment,  (3)authorizes  the Financing  Corporation  ("FICO") to
impose periodic assessments on depository  institutions that are members of BIF,
in addition to institutions that are members of the SAIF, in order to spread the
cost of the interest payments on the outstanding FICO bonds over a larger number
of  institutions.  Until this change in the law, only  SAIF-member  institutions
bore the cost of funding these interest payments.  FICO assessment rates for the
first  semiannual  period  of 1997 were set at 1.30%  (per  $100)  annually  for
BIF-assessable  deposits  and 6.48%  (per  $100)  annually  for  SAIF-assessable
deposits. These rates may be adjusted quarterly to reflect changes in assessment
bases for the BIF and the SAIF. By law, the FICO rate on BIF-assessable deposits
must be  one-fifth  the rate on SAIF  assessable  deposits  until the  insurance
fiends  are  merged or until  January 1, 2000,  whichever  occurs  first.  These
changes in FDIC  insurance  are not  expected  to have a material  effect on the
Bank's financial  condition and results of operation for the foreseeable future.
The Bank is currently  assessed at a rate of 1.3%  annually  (per $100) for FICO
purposes.

Regulations

         On  December  15,  1994,  the  Federal  Reserve,  the  Office of Thrift
Supervision,  the Office of the Controller of the Currency ("OCC"), and the FDIC
(collectively the "agencies")  issued a final rule entitled,  Risk-Based Capital
Standards:  Concentration of Credit Risk and Risks of Nontraditional Activities.
The final rule amends the risk-based capital standards by explicitly identifying
concentrations  of credit risk and certain  risks  arising  from  nontraditional
activities,  as well as an  institution's  ability  to manage  these  risks,  as
important factors in assessing an institution's overall capital adequacy.  While
no  quantitative  measure of such risk is  included  in the final  rule,  to the
extent  appropriate,  the  agencies  will issue  examination  guidelines  on new
developments in nontraditional  activities or concentrations of credit to ensure
that adequate account is taken of the risks of these activities.  Moreover,  the
agencies  also  believe  that  institutions  identified  though the  examination
process as having  significant  exposure to  concentration of credit risk, or as
not adequately  managing  concentration  risks, should hold capital in excess of
the regulatory minimums.  Therefore,  due to the subjective nature of this final
rule, the Bank is unable to determine what effect, if any, this rule may have on
regulatory capital requirements.

         On  August  2,  1995,  the  OCC,  the  Federal  Reserve,  and the  FDIC
(collectively the "banking  agencies") issued a final rule entitled,  Risk-Based
Capital Standards: Interest Rate Risk. The final rule implements minimum capital
standards for interest rate risk exposures in a two-step process. The final rule
implements  the first step of that process by revising the capital  standards of
the banking agencies to explicitly  include a bank's exposure to declines in the
economic  value of its capital due to changes in interest rates as a factor that
the banking agencies will consider in evaluating a bank's capital  adequacy.  It
is important to note that the banking  agencies intend to implement this rule on
a  case-by-case  basis during the  examination  process.  The second step of the
banking  agencies' process will be to issue a proposed rule that would establish
an explicit minimum capital charge for interest rate risk, based on the level of
the bank's measured interest rate risk exposure. Due to the subjective nature of
the first phase of this final rule, the Bank is unable to determine what effect,
if any, this rule may have on its regulatory capital requirements

         On October 1, 1996, the banking agencies issued new guidelines amending
the Interagency Guidelines  Establishing Standards for Safety and Soundness (the
"Safety  and  Soundness  Guidelines")  to include  asset  quality  and  earnings
standards.  The Safety and  Soundness  Guidelines  were adopted  pursuant to the
requirements of Section 39 of the Federal Deposit  Insurance Act. The Safety and
Soundness  Guidelines require financial  institutions to identify problem assets
and estimate inherent losses. In order to comply with these Safety and Soundness
Guidelines a financial  institution  shall:  (1) consider the size and potential
risks of  material  concentrations  of credit  risk;  (2)  compare  the level of
problem  assets to the level of capital and  establish  reserves  sufficient  to
absorb  anticipated  losses  on those  and other  assets,  (3) take  appropriate
corrective  action to resolve  problem assets,  as appropriate;  and (4) provide
periodic asset quality  reports to the of directors to assess the level of asset
risk. The earnings  standards  specified by the Safety and Soundness  Guidelines
require an  institution  to compare  its  earnings  trends ( relative to equity,
assets, and other common benchmarks) with its historical experience and with the
earnings trends of its peers. The Safety and Soundness  Guidelines,  relative to
the earnings standards, require the institution to: (1) evaluate the adequacy of
earnings with regard to the institution's relative size and complexity,  and the
risk profile of the institution's assets and operations;  (2) assess the source,
volatility,   and  sustainability  of  earnings,  (3)  evaluate  the  effect  of
nonrecurring or extraordinary  income or expense;  (4) take steps to ensure that
earnings  are  sufficient  to  maintain  adequate  capital  and  reserves  after
considering asset quality and the institution's  rate of growth; and (5) provide
periodic  reports with  adequate  information  for  management  and the board of
directors to assess earnings  performance.  The Safety and Soundness  Guidelines
note that the  complexity and  sophistication  of an  institution's  monitoring,
reporting systems,  and corrective actions should be commensurate with the size,
nature and scope of the institution's operations. The Bank does not believe that
these Safety and Soundness  Guidelines will materially  effect its operations or
financial condition in the foreseeable future.

         On December  20, 1996 the FDIC Board of  Directors  adopted the FFIEC's
updated  statement of policy  entitled  Uniform  Financial  Institutions  Rating
System  ("UFIRS").  The  updated  UFIRS  replaces  the  previous  rating  system
established in the 1979 statement of policy,  and is effective  January 1, 1997.
Under the existing  UFIRS,  each  financial  institution is assigned a composite
rating based on an  evaluation  and rating of five  essential  components  of an
institution's  financial condition and operations.  The five component areas are
Capital adequacy, Asset quality,  Management,  Earnings and Liquidity ("CAMEL").
The updated UFIRS includes the addition of a sixth  component for Sensitivity to
market risk  ("CAMELS").  The new sixth component  addresses the degree to which
changes in interest rates,  foreign  exchange rates,  commodity prices or equity
prices can adversely affect a financial  institution's  earnings or capital. The
new  component  focuses on an  institution's  ability to monitor  and manage its
market risk,  and will provide an  institution's  management  with a clearer and
more focused indication of supervisory  concerns in this area. The Bank does not
believe that this statement of policy will  materially  effect its operations in
the foreseeable future.


THE COMPANY

         As a bank holding company,  the Company is subject to regulation by the
Federal  Reserve in accordance  with the provisions of the Bank Holding  Company
Act of 1956, as amended, and the rules and regulations  promulgated  thereunder.
The Federal  Reserve may require a bank holding  company to serve as a source of
financial  strength  to its  subsidiary  depository  institution  and to  commit
resources to support such institutions in circumstances where it might not do so
absent such policy. In addition, the "cross-guarantee" provisions of the federal
law require insured  depository  institutions  under common control to reimburse
the Federal  Deposit  Insurance  Corporation for any loss suffered or reasonably
anticipated  by either the Savings  Association  Insurance  Fund ("SAIF") or the
Bank Insurance Fund ("BIF") as a result of the default of a commonly  controlled
insured  depository  institution  in  danger of  default.  The  Federal  Deposit
Insurance  Corporation's claim for damages is superior to claims of shareholders
of the insured  depository  institution or it holding company but is subordinate
to claims of  depositors,  secured  creditors and holders of  subordinated  debt
(other  than  affiliates)  of  the  commonly   controlled   insured   depository
institutions.

         A bank  holding  company is required  to file with the Federal  Reserve
annual  reports  along with  those of its  subsidiaries.  It is also  subject to
examination  by the Federal  Reserve and is required to obtain  Federal  Reserve
approval prior to acquiring, directly or indirectly, ownership or control of any
voting shares of any bank if, after such  acquisition,  it would own or control,
directly  or  indirectly,  more than  5.00% of the  voting  stock of such  bank.
Furthermore, a bank holding company is, with limited exceptions, prohibited from
acquiring  direct or  indirect  ownership  or  control of more than 5.00% of any
company which is not a bank or bank holding company, and must engage only in the
business of banking or managing or controlling  banks or furnishing  services to
or performing  services for its subsidiary  banks. One of the exceptions to this
prohibition is the ownership of shares of a company, the activities of which the
Federal  Reserve has determined to be so closely  related to banking or managing
or controlling banks as to be a proper incident thereto.

         The Federal Reserve has determined that numerous activities are closely
related to banking,  and thus bank  holding  companies  may apply to the Federal
Reserve for permission to retain or acquire an interest in a company engaging in
or proposing to engage in these activities. The permitted non-banking activities
include  making  loans that would be made by mortgage,  finance,  credit card or
factoring   companies;   operating  as  an  industrial  bank;  servicing  loans;
performing the functions of a trust company;  leasing personal property;  making
investments  to  promote  community  welfare;   providing  bookkeeping  or  data
processing  services;  acting as  insurance  agent or  broker  with  respect  to
insurance that is directly related to the extension of credit or other financial
services  and acting as an  underwriter  for credit  life  insurance  and credit
health and accident  insurance  directly  related to extensions of credit by the
appraisal activities.  Also, an application may be filed as to other activities,
but the Federal Reserve will publish a notice of opportunity for hearing only if
it believes there is a reasonable basis for concurring in the holding  company's
opinion that the activity applied for is closely related to banking.

         A bank  holding  company  and  its  subsidiaries  are  prohibited  from
engaging in certain  tie-in  arrangements  in  connection  with the extension of
credit or  provision of any  property or service.  Thus,  an affiliate of a bank
holding  company  may not extend  credit,  lease,  sell  property or furnish any
services or fix or vary the  consideration  for these  services on the condition
that (a) the customer must obtain or provide some additional  credit,  property,
or services from or to its bank holding company or subsidiaries  thereof, or (b)
the customer  may not obtain or provide some  additional  credit,  property,  or
services  from a  competitor,  except to the extent  reasonable  conditions  are
imposed to assure soundness of credit extended.

         The Company is also  registered  under the bank holding company laws of
Virginia.  Accordingly,  the Company and its  subsidiaries  are also  subject to
regulation and supervision by the Virginia Bureau of Financial Institutions.

Federal Securities Laws

         The  Company's  Common  Stock  is  registered  with the SEC  under  the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is
subject to the information, proxy solicitation,  insider trading restriction and
other  requirements  of the SEC under the  Exchange  Act.  Under the  Securities
Enforcement  and Penny  Stock  Reform Act of 1990,  the  Company may be subject,
among other  things,  to civil money  penalties  for  violations  of the federal
securities laws.

FEDERAL AND STATE TAXATION

General

         The Company and the Bank are subject to the  applicable  corporate  tax
provisions of the Internal  Revenue Code of 1986,  as amended (the  "Code"),  as
well as certain additional  provisions of the Code that apply to banks and other
types of financial  institutions.  The  following  discussion  of tax matters is
intended  only  as a  summary  and  does  not  purport  to  be  a  comprehensive
description of the tax rules applicable to the Company and the Bank.

         Under the  applicable  statutes of  limitation,  the Company's  federal
income tax returns for 1994 through 1997 are open to examination by the Internal
Revenue Service (the "Service"). The Company is unaware, however, of any current
or pending Service  examinations of the Company's  returns for any of those open
years.

         Historically,  the Company has  reported its income and expenses on the
accrual  method of  accounting  and filed its  consolidated  federal  income tax
returns on a December 31, fiscal year basis.  Consolidated  tax returns have the
effect of eliminating intercompany distributions,  including dividends, from the
computation  of  consolidated  taxable  income for the taxable year in which the
distributions occur.

Corporate Minimum Tax

         The Company  and its  subsidiaries  could be subject to an  alternative
minimum  tax  ("AMT")  which  is  imposed  to the  extent  that it  exceeds  the
consolidated  group's regular tax liability for a year. The alternative  minimum
tax generally  will apply at a rate of 20% to a base of regular  taxable  income
plus certain tax  preferences  and  adjustments  ("alternative  minimum  taxable
income" or "AMTI"), less an exemption amount.  Currently no more than 90% of the
AMTI may be offset by net operating  losses (as determined  for AMTI  purposes).
Payment of the AMT may be used as a credit  against a portion of the regular tax
liabilities in future years.  The Code provisions  relating to the AMT also: (i)
treat as a preference item interest on certain tax exempt private activity bonds
issued on or after August 8, 1986; (ii) include in AMTI (for tax years beginning
after  1989) an  amount  equal  to 75% of the  amount  by which a  corporation's
adjusted  current  earnings exceed its AMTI  (determined  without regard to this
preference and before  reduction for the alternative tax net operating  losses.)
In addition,  an environmental tax of 0.12% of the excess, if any, of AMTI (with
certain  modifications)  over $2 million is imposed on corporations,  whether or
not an AMTis paid. The consolidated group was not subject to the AMT in 1997.

Corporate Dividends Received Deduction

         The Company is permitted to exclude from its taxable income 100% of any
dividends  received  from the Bank and may  exclude  from its  income  dividends
received  from  its  subsidiaries  pursuant  to  the  regulation  applicable  to
consolidated income tax returns.  The Company and the Bank may deduct from their
income 80% of any dividends  received from an  unaffiliated  corporation if they
own at least 20% of the stock of the  corporation.  If they own less than 20% of
the stock of a corporation paying a dividend,  70% of any dividends received may
be excluded from income.

State and Local Taxation

         The  Company's  subsidiaries  (other  than the  Bank)  are  subject  to
Virginia corporate income taxes. The Virginia corporate income tax is imposed at
a rate of 6% on the  combined net income of the  Company,  and its  subsidiaries
(other than the Bank) as reported for federal  income tax purposes  with certain
modifications.

         The Bank is chartered under the laws of Virginia and,  accordingly,  is
not subject to the  Virginia  corporate  income  tax.  It is instead  subject to
Virginia's  Bank  Franchise  Tax.  Under this system,  the Bank's net capital is
subject to tax at a rate of one  percent.  Net capital is composed  generally of
the equity accounts  (common stock,  additional  paid-in  capital,  and retained
earnings)  adjusted  for  investments  in real and  personal  property,  certain
reserves and certain securities exempt from state taxation.



Item 2. PROPERTIES

         The Bank  owns  three of its  banking  locations,  841  North  Military
Highway,  200 East Plume  Street and 4815 Colley  Avenue in  Norfolk,  Virginia.
Management believes these locations are in excellent condition.  A third banking
location  and the bank's  operations  center are located at 1450 South  Military
Highway in Chesapeake, Virginia. See "IBV Real Estate Holdings, Inc." under Item
1 and "Certain Relationships and Related Transactions" under Item 12.

Item 3. LEGAL PROCEEDINGS

         The Company is subject to claims and lawsuits which arise  primarily in
the ordinary  course of business.  Based on information  presently  available to
management  and advice  received from legal  counsel,  there are no  meritorious
claims involving the Company.

Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

         No matters were  submitted to a vote of securities  holders  during the
fourth quarter of 1997.


<PAGE>


PART II

Item 5.  MARKET FOR  THE REGISTRANT'S COMMON STOCK AND RELATED
         STOCKHOLDER MATTERS


         There is a limited public market for the Company's  common stock. It is
not listed for trading on a registered  exchange.  There are no "market  makers"
for the  stock.  Trades in the  common  stock  occur on a local  basis.  Scott &
Stringfellow  Inc., a Virginia  brokerage firm,  attempts to match orders to buy
and sell the common stock.  Accordingly,  there is no established public trading
market for shares of common stock, and quotations do not necessarily reflect the
price that would be paid in an active,  liquid market. There can be no assurance
an active  trading market will develop in the future.  The following  table sets
forth the  closing  high and low sales  price for the common  stock by  calendar
quarters  for  the  past  two  years  as  reported  to the  Company  by  Scott &
Stringfellow Inc.

Calendar Quarter

                         HIGH             LOW
        1997
Fourth Quarter         $    18.00      $    17.13

Third Quarter               13.75           13.75

Second Quarter              13.25           13.25

First Quarter               11.63           11.25


        1996
Fourth Quarter         $     9.75      $     9.25

Third Quarter                9.00            8.50

Second Quarter               8.63            8.50

First Quarter                7.75            7.00


         At March 24,  1998,  there  are 1,345  record  holders  of the  797,250
outstanding shares of common stock.

         As of March 24,  1998 , the most  recent  sales  price of common  stock
known to the Company was $19.00 per share.

         The  Company's  Board  of  Directors   determines  whether  to  declare
dividends  and the amount of such  dividends.  Determinations  by the Board take
into account the Company's financial condition,  results of operations,  capital
requirements,  general  business  conditions  and other  relevant  factors.  The
Company's  principal source of funds for cash dividends is the dividends paid to
the Company by the Bank. The Company  declared and paid annual dividends of $.14
and $.12 per share in 1997 and 1996,  respectively.  Regulatory  restrictions on
the payment of dividends  by the Bank to the Company are  disclosed in Note 3 to
the   Consolidated   Financial   Statements   for   additional   information  on
restrictions.


<PAGE>


Item 6.  SELECTED FINANCIAL DATA AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS

         The following sets forth certain  selected  financial data with respect
to the Company.  The data presented  below for the years ended December 31, 1997
and 1996,  respectively,  should be read in  conjunction  with the  Consolidated
Financial  Statements  and notes  thereto,  which have been audited by Goodman &
Company, L.L.P. independent accountants.  (The Consolidated Financial Statements
and notes  thereto  for the years  ended  December  31,  1997 and 1996 are filed
herewith).  This data should also be read in conjunction with the discussion and
analysis that follows.

Summary of Consolidated Financial Data
(Dollars in thousands, except per share data)

                                                         1997             1996

FOR THE YEAR
Interest income                                         $6,185           $5,380
Interest expense                                         2,909            2,495
Net interest income                                      3,277            2,885
Provision for loan losses                                   88               93
Noninterest income                                         288              246
Noninterest expense                                      2,056            1,950
Income taxes                                               440              218
Net income                                                 980              870

AT YEAR END
Assets                                                 $83,002          $76,846
Loans, net                                              51,242           45,259
Federal funds sold                                       1,697            5,925
Securities                                              22,595           20,197
Deposits                                                72,797           68,427
Stockholders' equity                                     7,081            6,112

AVERAGE BALANCES
Assets                                                 $81,376          $70,968
Loans, net                                              47,322           42,970
Federal funds sold                                       6,122            8,605
Securities                                              22,490           14,509
Deposits                                                71,322           64,519
Stockholders' equity                                     6,607            5,686


PER SHARE DATA
Basic earnings per common share                          $1.24            $1.11
Diluted earnings per common share                        $1.17            $1.09
Cash dividends declared                                   0.14             0.12
Book value at year end                                    8.91             7.79
Shares outstanding at year end                         795,050          784,150
Weighted average shares                                790,450          784,150
Diluted average common shares outstanding              836,920          800,399

RATIOS
Return on average assets                                 1.20%            1.23%
Return on average equity                                14.83%           15.30%
Average equity to average assets                         8.12%            8.01%
Allowance to year end loans                              1.71%            1.83%
Net loans charged-off to average loans                   0.09%            0.03%





PERFORMANCE SUMMARY:

         In 1997,  net income for  Heritage  Bankshares,  Inc.  (the  "Company")
totaled  $980,000  compared to $870,000 earned in 1996.  Heritage Bank & Trust's
(the "Bank") net income was $972,000 and net holding  company income was $8,000.
In 1996, Heritage Bank & Trust's net income was $878,000 and net holding company
expenses were $8,000.
Basic earnings per common share in 1997 was $1.24 compared to $1.11 in 1996.
Diluted  earnings  per common  share was $1.17 and 1.09 at December 31, 1997 and
1996, respectively.

               The 1997  provision  for loan losses was $88,000  compared to the
1996 provision of $93,000.  Net interest  income  increased  $391,000 in 1997 to
$3,277,000, from $2,886,000 in 1996.

               Total assets  increased at the end of 1997 to $83,002,000.  Total
assets at the end of 1996 were $76,846,000.  Net loans increased $5,982,000 from
$45,259,000  at the end of  1996 to  $51,242,000  at the end of  1996.  Deposits
increased  from  $68,427,000 at December 31, 1996 to $72,797,000 at December 31,
1997.

LIQUIDITY:

               Liquidity  is the  ability  of the  Company to  efficiently  fund
depositors'  withdrawals and extensions of credit to borrowers.  The Company and
Heritage Bank & Trust must consider both immediate  liquidity  needs, as well as
the long-term  matching of maturing loans and  investments  with  obligations to
depositors.

               The Company's  Consolidated Statement of Cash Flows, found in the
Consolidated Financial Statements,  provides information as to cash provided and
used from operating,  investing and financing activities.  At December 31, 1997,
cash and cash  equivalents  available  to meet  immediate  liquidity  needs  and
reserve  requirements were $5,716,000.  The Bank also has borrowing  capacity of
$5.9 million,  as a member of the Federal Home Loan Bank System.  As of December
31, 1997, no amounts have been drawn on this line of credit.

               The Company's cash and cash  equivalents  decreased by $3,277,000
in 1997  compared  to a $50,000  increase  in 1996.  Net cash used by  investing
activities was  $9,278,000 in 1997 and  $9,555,000 in 1996. In both years,  this
was primarily due to growth in both the loan and investment portfolios. In 1997,
gross  loans  increased   $6,029,000  and  the  investment   portfolio  grew  by
$2,399,000.  In 1996, gross loans increased $2,320,000 and investment securities
increased $7,194,000.  The increase in loans in both years is largely due to the
expansion of current customer  relationships.  In 1997, the net cash provided by
financing activities of $4,852,000, is largely due to the $4,370,000 increase in
deposits.  In 1996, net cash provided by financing  activities of $8,692,000 was
primarily  due to the  increase in  deposits of  $7,374,000.  The  expansion  of
current   customer   relationships   and  the  bank's  continued  sales  efforts
contributed to these increases.

PARENT HOLDING COMPANY LIQUIDITY:

              The    parent    holding    company    incurred    expenses    for
stockholder-related activities, stock transfer and other functions necessary for
the administration of the Company.

                See  Note 3 of the  Consolidated  Financial  Statements  for the
parent company's Cash Flow Statement for further information on cash provided or
used by the  parent  for  operating,  financing  and  investing  activities.  In
addition, certain restrictions on cash dividends, loans and advances are imposed
by regulation of the Bank, which are also disclosed in Note 3.
<TABLE>
Table 2: Selected Liquidity Statistics
For the year ended December 31,
<CAPTION>
                                                       1997                     1996
                                                          (Dollars in thousands)
<S> <C>
Available short-term assets (1)                       $7,272                   $8,262
Certificates of deposit $100,000 and over              8,128                    6,728
                                                       -----                    -----
Net available short-term assets                        ($856)                  $1,534

Ratio of available short-term assets to
certificates $100,000 and over                            89%                     123%

Ratio of loans to deposits                                72%                      66%

Ratio of certificates $100,000 and over to
   total assets                                           10%                       9%
</TABLE>

(1)As of December 31, 1997,  available  short-term  assets include federal funds
   sold of $1,697,000 and held-to-  maturity and  available-for-sale  securities
   maturing  within one year of  $1,019,000  and  $4,556,000,  respectively.  At
   December 31, 1996, available short-term assets included federal funds sold of
   $5,925,000 and held-to- maturity and  available-for-sale  securities maturing
   within one year of $547,000 and $1,790,000 respectively.

CAPITAL:

               Stockholders' equity at December 31, 1997 was $7,081,000 compared
to $6,112,000 at the end of the prior year.  Book value per share increased from
$7.79 at December 31, 1996 to $8.91 at December 31, 1997.

               Table  3  provides  information  on  the  Company's   risk-based,
leverage  and  capital  ratios at  December  31,  1997 and 1996.  The Company is
considered  well-capitalized  and in  compliance  with all  relevant  regulatory
capital requirements.  See Note 15 of the Consolidated  Financial Statements for
additional  information  with  respect to  compliance  with  regulatory  capital
requirements.

Table 3: Capital Ratios
For the year ended December 31,

                                               1997                     1996
                                                  (Dollars in thousands)

Risk-based capital:
Tier I Capital
   Stockholders' equity                       $7,024                   $6,081
Tier II Capital
    Allowance for loan losses                    639                      569
                                              ------                   ------
(limited)
Total                                         $7,663                   $6,650

Risk adjusted assets                         $50,848                  $45,230

Risk-based capital ratios:
   Tier I                                      13.81%                   13.44%
   Total                                       15.07%                   14.70%

Leverage ratio                                  8.63%                    8.57%

Primary capital ratio                           9.50%                    8.91%


RATE SENSITIVITY:

               At December  31, 1997,  the Company  had, on a cumulative  basis,
$12,508,000  more in  liabilities  subject  to  repricing  within  one year than
assets. It is management's view that the Company is an asset-sensitive  company.
This view is based on the fact that  historically  the  Company's  earnings have
been more favorable during periods of increasing interest rates.

               Table 4 provides an interest  sensitivity analysis as of December
31, 1997.

Table 4:  Interest Sensitivity Analysis
 December 31, 1997
<TABLE>
<CAPTION>
<S> <C>
                                      Within      Over 3     Over 1 Yr  Over 3 Yr  Over 5 Yr   Total
                                   1 through 3    through     through    through    through   through    Over
                                      months     12 months     3 yrs      5 yrs     10 yrs    10 yrs   10 yrs(4)     Total
                                   -----------------------------------------------------------------------------------------
Earning assets: (1)
  Federal funds                         $1,697      $    -    $     -    $     -     $    -     $1,697   $     -     $1,697
  Investment securities (2)              3,644       4,797     10,446      2,848        193     21,928       581     22,509
  Loans                                 21,555       2,005      8,084      7,368      2,988     42,000    10,131     52,131
                                   -----------------------------------------------------------------------------------------
Total Earning Assets                   $26,896      $6,802    $18,530    $10,216     $3,181    $65,625   $10,712    $76,337
                                   -----------------------------------------------------------------------------------------

Interest and non-interest bearing
liabilities: (1)
  Commercial DDA (3)                    $4,701           -     $2,820     $1,880                $9,401         -     $9,401
  Personal DDA (3)                           -           -      2,101        700        700      3,501         -      3,501
  TT&L Note                                 52                                 -          -         52         -         52
  Savings(3)                                             -      2,757        919        919      4,595         -      4,595
  Money Market(3)                                    2,309      2,309          -          -      4,618         -      4,618
  NOW(3)                                                 -      4,378      1,460      1,460      7,298         -      7,298
  Certificates                           9,345      27,854      4,966      1,275          -     43,440         -     43,440
  Repurchase Agreements                  1,945           -          -          -          -      1,945         -      1,945
                                   -----------------------------------------------------------------------------------------
Total Interest and non interest
  bearing liabilities                  $16,043     $30,163    $19,331     $6,234     $3,079    $74,850   $     -    $74,850
                                   -----------------------------------------------------------------------------------------


Interest sensitivity gap                10,853     (23,361)      (801)     3,982        102     (9,225)   10,712      1,487


Cumulative gap                          10,853     (12,508)   (13,309)    (9,327)    (9,225)

Ratio interest sensitive assets
to interest-sensitive liabilities         1.68        0.23       0.96       1.64       1.03       0.88

Ratio of cumulative gap to
 total earning assets                    14.22%     -16.38%    -17.43%    -12.22%    -12.08%
</TABLE>

(1)Assets and  liabilities  are  presented in the period they mature or reprice,
   whichever is earlier.
(2)Presented on an amortized cost basis.
(3)Based  on the  proposed  range of  permissible  maturities  for  non-maturity
   deposits issued by the banking agencies in the Joint Policy Statement (August
   2, 1995): Supervisory Policy Statement Concerning a Supervisory Framework for
   Measuring and Assessing Banks' Interest Rate Risk Exposure)
(4)Includes non-interest bearing liabilities.

NET INTEREST INCOME:

               Net interest income is the difference  between interest earned on
loans,  investment  securities and short-term  investments  and interest paid on
deposits,  securities sold under  agreements to repurchase and other  short-term
borrowing.  Material  factors  affecting net interest income  included  interest
rates earned on loans and  investments  and those paid on deposits,  the mix and
volume of earning  assets  and  interest-bearing  liabilities,  and the level of
noninterest-bearing liabilities.

               Net  interest  income   increased  from  $2,886,000  in  1996  to
$3,277,000 in 1997, a $391,000 increase.  The increase is primarily attributable
to the 13% increase in gross loans.  The growth in loans is an indication of the
Bank's growing sales effectiveness.

            Table 5 presents  the  components  of net interest  income.  Table 6
allocates changes in volume and rate on net interest earnings.
<TABLE>
<S> <C>
Table 5:  Components of Net Interest Income
For the years ended December 31,                                      1997                                 1996
 (Dollars in thousands)
                                                          Average               Average       Average              Average
                                                        Balance(1) Interest    yield/rate    Balance(1) Interest  yield/rate
Interest earning assets: (taxable equivalent basis(2))
Loans (net of unearned discount (3))                      $ 48,166  $ 4,531       9.41%     $   43,781  $  4,146   9.47%
Investment securities-taxable (4)                           21,818    1,330       6.10%         14,360       853   5.94%
Investment securities- non-taxable (1) (4)                     672       31       4.61%            149        10   6.71%
Federal Funds                                                6,122      334       5.46%          8,605       456   5.30%
                                                          --------  -------       ----      ----------  --------   ----
Total Interest earning assets                             $ 76,778  $ 6,226       8.11%     $   66,895  $  5,465   8.17%
                                                          ========  =======       ====      ==========  ========   ====


Noninterest earning assets:
Cash and due from banks                                      2,644                               2,525
Allowance for loan losses
                                                             (843)                               (811)
Other real estate owned                                        442                                 503
Premises and equipment                                         831                                 603
Other assets                                                 1,524                               1,253
                                                          --------                          ----------
Total Assets                                              $ 81,376                          $   70,968
                                                          ========                          ==========

Liabilities and stockholders' equity
Interest bearing liabilities:
Money Market and NOW accounts                              $12,849  $   341       2.65%     $   14,235  $    407   2.86%
Savings Deposits                                             5,050      176       3.49%          4,718       158   3.35%
Savings Certificates                                        34,599    1,937       5.60%         28,065     1,599   5.70%
Large denomination certificates                              6,482      379       5.85%          6,449       328   5.09%
Securities sold under agreements to repurchase               1,810       73       4.03%             14         1   7.14%
Short-term borrowings                                           75        3       4.00%             96         3   3.13%
                                                          --------  -------       ----      ----------  --------   ----
Total interest bearing liabilities                         $60,865  $ 2,909       4.78%     $   53,577  $  2,495   4.66%
                                                          ========  =======       ====      ==========  ========   ====
Noninterest bearing liabilities:
Demand deposits                                             12,341                              11,051
Other                                                        1,563                                 654
                                                          --------                          ----------
 Total Liabilities                                          74,769                              65,282
Stockholders' equity                                         6,607                               5,686
                                                             -----                               -----

  Total liabilities and stockholders'
      equity                                              $ 81,376                          $   70,968
                                                          ========                          ==========

Net interest earnings                                               $3,317                              $ 2,970
                                                                    ======                              =======

Net interest yield  margin on average interest earning
 assets (taxable equivalent basis)                                                   4.32%                            4.44%
                                                                                     =====                            =====

Less tax equivalent adjustment                                      $  (41)                             $   (85)
                                                                    ------                              -------
Net interest income                                                 $3,276                              $ 2,885
                                                                    ======                              =======

 Net interest spread (taxable
    equivalent basis)                                                                3.33%                            3.51%
                                                                                     =====                            =====
</TABLE>

(1) Daily average  balances are  calculated  using the  aggregate  daily average
balances on a monthly basis.
(2) Tax  equivalent  adjustments  (using 34% federal income tax rates) have been
made in calculating the yields on tax-free loans and investments. Virginia banks
are exempt from state income tax.
(3) For the purposes of these  computations,  nonaccruing  loans are included in
the daily average loan amounts outstanding.
(4)The  yield/rate of the investment  securities is computed using the amortized
cost basis.

Table 6:  Effect of Changes in Volume and Rate on Net Interest Earnings
For the years ended December 31, (1)
<TABLE>
<CAPTION>
                                           1997 / 1996                                       1996 / 1995
                                                               (Dollars in thousands)
                                       Increase (Decrease)                               Increase (Decrease)
                                       Due to Change In (1):                              Due to Change In (1):

                                  Volume        Rate         Total                     Volume     Rate         Total
<S> <C>
Interest income (2):
  Loans                               $412         ($26)        $386                    $346        ($139)        $207
  Taxable securities                   454           23          477                     140           60         $200
  Non-taxable
securities                              23           (2)          21                      10            -          $10
  Federal funds sold                  (136)          14         (122)                     82          (33)        $ 49
                                     -----         ----        -----                   -----        -----         ----
    Total interest income             $753           $9         $762                    $578        ($112)        $466
                                   =======       ======      =======                  ======      =======      =======


Interest expense:
  Money Market and NOW
    accounts                           (38)         (28)         (66)                     35          (10)         25
  Savings                               11            7           18                      (4)         (13)        (17)
  Certificates                         365          (27)         338                     336           47         383
  Certificates of $100,000
    or more                              2           49           51                     (11)         (65)        (76)
  Securities sold under                                                                                             -
   agreements to repurchase             72            -           72                       1            -           1
  Short-term borrowings                  -            -            -                       -            -           -
                                     -----         ----        -----                   -----        -----         ----
    Total interest expense             412            1          413                     357          (41)        316
                                   =======       ======      =======                  ======      =======      =======

Net change in
interest
  earnings                         $   341       $    8      $   349                  $  221      $   (71)     $   150
                                   =======       ======      =======                  ======      =======      =======
</TABLE>

(1)The change in  interest  due to both rate and volume  has been  allocated  to
   volume and rate changes in  proportion  to the  relationship  of the absolute
   dollar of the changes in each.

(2)Interest income includes  taxable  equivalent  adjustments of $41,000 in 1997
   and $85,000 in 1996,  which are used to adjust  interest on tax exempt assets
   to a fully taxable basis.


ASSET QUALITY

PROVISION AND ALLOWANCE FOR LOAN LOSSES:

               The  provision  for loan  losses is charged to  operations  in an
amount  sufficient  to  maintain  the  allowance  for  loan  losses  at a  level
management  considers adequate to provide for future loan losses inherent in the
loan  portfolio.  Loans are  charged  against  this  allowance  when  management
perceives the collection of the loan is unlikely.  The level of the allowance is
based upon  management's  ongoing  review of the loan portfolio and includes the
present and  prospective  financial  condition of  borrowers,  consideration  of
actual loan loss experience and projected economic conditions in general and for
the Bank's service area.

               In 1997, the provision for loan losses was $88,000, a 5% decrease
compared to the $93,000 provision for loan losses in 1996. Net loans charged-off
in 1997 were $42,000 compared to $13,000 in 1996.

               Table 7 summarizes  activity in the Allowance for Loan Losses and
provides  statistics on nonperforming  assets and past due loans.  There were no
restructured loans, as defined by applicable securities rules and regulations.
<TABLE>

Table 7:  Summary of the Allowance For Loan Losses
                Nonperforming Assets and Past Due Loans
                and Selected Loan Loss Statistics
<CAPTION>
<S> <C>
For The Years Ended
December 31,                                                  1997          1996
(Dollars in Thousands)

Allowance for Loan Losses:
Balance, December 31
                                                            $    843      $    763
                                                            --------      --------
Charge-offs:
   Commercial                                                      0      $     36
   Real estate                                                     2             0
   Consumer                                                       47            48
                                                            --------      --------
      Total loans charged-off                                     49            84
Recoveries:
   Commercial                                                      0            42
   Real estate                                                     5            18
   Consumer                                                        2            11
                                                            --------      --------
      Total recoveries                                             7            71
Net charge-offs                                                   42            13
                                                            ========      ========
Provision for loan losses                                         88            93
                                                            --------      --------
Balance, December 31, 1997                                      $889          $843
                                                            --------      --------

Ratio of net charge-offs to average loans outstanding           0.09%         0.03%
                                                            --------      --------

Ratio of allowance for loan losses to loans at period-end       1.71%         1.83%
                                                            --------      --------


Nonperforming Assets and Loans Past Due 90 Days
   Nonaccrual loans
                                                            $     27      $     13

   Other real estate owned
                                                                 429           444
                                                            --------      --------

      Total nonperforming assets
                                                            $   456       $    457
                                                            =======       =========

   Ratio of nonperforming assets to total assets               0.55%          0.59%

   Nonaccrual loans:
      Interest income that would have been recorded
      under original terms                                  $     4       $       2
                                                            =======       =========

      Interest income recorded during the period            $     0       $       0
                                                            =======       =========

   Loans 90 days past due and still accruing                $    15       $      15
                                                            =======       =========
</TABLE>

         A breakdown of the  allowance is provided in Table 8;  however,  such a
breakdown has not  historically  been maintained by the Company,  and management
does not believe the  allowance can be fragmented by category with any precision
that  would be useful to  investors.  The  entire  amount  of the  allowance  is
available to absorb losses occurring in any category. The allowance is allocated
below based on the relative percent of loans in each category to total loans.

Table 8:  Allocation of the Allowance for Loan Losses

December 31,
<TABLE>
<CAPTION>

                                             1997                                 1996
Balance at End of Period Applicable to:
                                                        Percent                              Percent
                                            Amount      of Total                 Amount     of Total
                                         --------------------------            ------------------------
<S> <C>
Commercial                                 $ 160               18%              $     171          20%
Real estate - mortgage                       640               72%                    577          68%
Real estate - construction                    27                3%                     38           5%
Consumer                                      62                7%                     57           7%
                                         ---------------        --             --------------       --
                                          $  889              100%              $     843         100%
                                         ============         ====             ===========        ====
</TABLE>

          At December 31, 1997 and December 31, 1996, loans on either nonaccrual
status or loans past due 90 days or more and still accruing  amounted to $42,000
and $28,000,  respectively.  At December 31, 1997, the Company had approximately
$828,000  of loans that have been  internally  classified,  and  $823,000  which
require more than normal attention and are potential  problem loans. The Company
has considered  these loans in establishing  the level of the allowance for loan
losses. At December 31, 1996, loans that had been internally classified or which
required  more than  normal  attention  and were  potential  problem  loans were
$668,000 and $699,000, respectively.

CREDIT RISK AND REGULATORY MATTERS:

               Credit  risk,  the risk of loss  from  default,  is  inherent  in
lending.  While  management  uses available  information to recognize  losses on
loans,  future  additions to the allowance may be necessary  based on changes in
economic conditions. Management and the board of director of the Company believe
the  allowance is a reasonable  estimate of potential  loss exposure in the loan
portfolio at year end, however,  many factors affecting the ability of borrowers
to repay  their  loans,  including  economic  factors  beyond the control of the
Company or the borrowers, will impact this estimate on an ongoing basis.

               Reports of  examinations  furnished by state and federal  banking
authorities are also considered by management.  Regulatory agencies periodically
review the  allowance for loan losses as part of their  examination  process and
may require the Bank to  recognize  additions  to the  allowance  based on their
judgment  of  information  available  to them at the time of their  examination.
During 1997,  regulators did not perform a regular examination of the Company or
the Bank. A federal  examination was conducted in the fourth quarter of 1996 for
the balance  sheet dated  September  30, 1996. No additions to the allowance for
loan losses were recommended as a result of the examination.

NONPERFORMING ASSETS:

               Nonperforming  assets  consist of loans on nonaccrual  status and
other real estate owned.  Loans are placed on nonaccrual status when they become
over 90 days  past due  unless  such  loans  are fully  collateralized  and,  in
management's judgment, are collectible. Other real estate owned consists of real
estate  acquired in settlement  of loans.  These  properties  are carried at the
lower of cost or estimated fair value. Losses from the acquisition of other real
estate  owned  in full or  partial  satisfaction  of a loan are  charged  to the
allowance  for  loan  losses.  Subsequent  declines  in  value  or  losses  upon
disposition are charged to noninterest expense.

               Table 9 provides an analysis of the size,  number and  collateral
composition of nonperforming assets at December 31, 1997.

<TABLE>

Table 9:  Nonperforming Assets
              December 31, 1997
              (Dollars in thousands)
<CAPTION>
<S> <C>
Nonperforming assets by dollar amount:                                                   Percent
                                       Number                                               Of
                                      of Items               Balance                   Total Dollars
                                      --------             -----------                 -------------
$400,000 and over                            -             $         -                       -
$300,000 - $400,000                          -                       -                       -
$200,000 - $300,000                          -                       -                       -
$100,000 - $200,000                          4                     429                      94%
$50,000 - $100,000                           -                       -                       -
$50,000 and under                           14                      27                       6%
                                      --------             -----------                 -------------
                                            18                    $456                     100%
                                      --------             -----------                 -------------


Nonperforming assets by collateral composition:
<CAPTION>
                                                                                   Percent
                                     Number                                           Of
                                     of Items                 Balance           Total Dollars
                                     --------               ----------          -------------
1-4 Family residential                    1                 $     127                  28%
Automobile, equipment and other           -                         -                   -
Commercial property                       -                         -                   -
Land                                      -                         -                   -
Multi-family residential                  3                       302                  66%
Uncollateralized                         14                        27                   6%
                                     --------               ----------          -------------
                                         18                      $456                 100%
                                     --------               ----------          -------------
</TABLE>
LOAN PORTFOLIO:

                    The loan portfolio is the largest  category of the Company's
earning assets.  Table 10 shows the type and maturity of loans outstanding as of
December 31, 1997.
<TABLE>
Table 10:  Loan Maturities
 (Dollars in
thousands)
<CAPTION>
<S> <C>
                                                          After 1
                                          Within         but within          After
                                          1 year          5 years           5 years
                                          ------          -------           -------
Commercial                                $5,757           $2,967              $635
Real estate-mortgage                       7,570           15,875            14,331
Real estate-construction                   1,627                0                 0
Consumer                                     200            2,942               227
                                          ------          -------           -------
                                         $15,154          $21,784           $15,193


Loans maturing after 1 year with:
Fixed  interest rates                                     $14,784           $13,119
Variable interest rates                                     7,000             2,074
                                                          -------           -------
                                                          $21,784           $15,193
</TABLE>

Table 11 includes loans collateralized by real estate at December 31, 1997. Some
of these loans are included in commercial loans for purposes of Table 10.





Table 11:  Loans Collateralized By Real Estate
<TABLE>
<CAPTION>
<S> <C>

                                                                                  Percentage
                                                                                   of total
                                                              Amount            loan portfolio
                                                                 (Dollars in thousands)
                                                          -------------------------------------
Construction and land development                            $ 1,661                  3%
Collateralized by 1 - 4 family residential properties         18,282                 35%
Collateralized by multi-family residential properties            674                  1%
Collateralized by non-farm non-residential properties         16,122                 31%
                                                              ------
                                                             $36,739                 70%
</TABLE>

INVESTMENT PORTFOLIO:

               The company's  investment  portfolio is a source of liquidity and
is the second largest  category of earning assets.  The investment  portfolio is
used to provide liquidity in the event of the withdrawal of large deposits or to
satisfy  unusual  loan  demands,  and consists  primarily  of U.S.  Treasury and
government agency securities.

               Table  12  shows  the  maturities  of  investment  securities  at
December  31,1997,   and  the  weighted  average  yields  to  maturity  of  such
securities:


Table 12:  Investment Securities (1)
      December 31, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
<S> <C>
                                 1 Year or less          2 - 4 Years          4 - 5 Years (2)       Over 5 Years (3)
                                Amount     Yield      Amount     Yield       Amount     Yield       Amount     Yield
                              ---------------------  ---------------------  ---------------------  --------------------
U.S. treasury, government
 agencies, state and political
 subdivisions                  $   5,575     5.89%    $ 13,961      6.17%    $  1,300      6.44%    $  1,028     5.84%

Other                                  -        -           65      6.00%           -         -          581     7.25%
                               ---------     ----     --------      ----     --------      ----     --------     ----
                               $   5,575     5.89%    $ 14,026      6.09%    $  1,300      6.44%    $  1,609     6.55%
                               =========     ====     ========      ====     ========      ====     ========     ====
</TABLE>

(1)Presented on an amortized cost basis
(2)Includes  $484,296 in tax exempt  securities with a weighted average yield of
   4.40%
(3)Includes  $343,286 in tax exempt  securities with a weighted average yield of
   5.05%

DEPOSITS:

               The   Company's   deposit  base   includes   large   denomination
certificates of deposit of $100,000 or more which represent approximately 11% of
total deposits at December 31, 1997. The Bank pays market rates for these funds.
Management  of the Bank  attempts to match large  denomination  certificates  of
deposit with rate-sensitive  assets. At December 31, 1997,  available short-term
assets totaled $7,272,000.

               Table 13  presents  remaining  maturities  of large  denomination
certificates ($100,000 or more) at December 31, 1997.

Table 13:  Remaining Maturities of Large Denomination Certificates
 December 31, 1997
(Dollars in thousands)

                                                       Amount
                                                       ------
Three months or less                                   $2,510
Over three through six months                           5,518
Over six through twelve months                              -
Over twelve months                                        100
                                                       ------
    Total                                              $8,128
                                                       ======

NONINTEREST  INCOME:

              Noninterest  income  increased  $42,000  or 17% from  1997 to 1996
primarily due to an increase in charges on deposit accounts. A reimbursement for
site  improvements on City property due to the construction of the Bank's Colley
Avenue  office in Norfolk of $13,000  attributed  to the 25%  increase  in other
income.

              A comparison of noninterest income may be found in Table 14.

Table 14:  Non-interest Income
(Dollars in thousands)
For the years ended December 31,

                               1997             1996           1997over1996
                          --------------------------------------------------
Service charges                 $ 195,865       $  171,921       $ 23,944
Other income                       91,874           73,642         18,232
                                ---------       ----------       --------
                                $ 287,739       $  245,563       $ 42,176

NONINTEREST EXPENSE:

              Noninterest  expense  increased  $106,000 or 5% from 1996 to 1997.
The increase  relates to additional  salary  expenses due to the addition of the
Bank's Colley Avenue location.  Also,  employee benefit costs increased 18% from
$165,000 in 1996 to $195,000 at December 31, 1997.  Increased  costs  related to
health benefits and the addition of an Employee's  Stock Ownership Plan were the
chief components of the increase at $7,000 and $12,000, respectively.
             A comparison of noninterest expense may be found in Table 15.

Table 15:  Non-interest Expense
(Dollars in thousands)
For the years ended December 31,
<TABLE>
<CAPTION>
<S> <C>
                                       1997        1996           1997 over/ (under) 1996
                                    --------------------------------------------------------
Salaries and employee benefits       $    1,169  $    1,046            $    123
Other                                       235         283                 (48)
Occupancy                                   165         174                  (9)
Automated services                          112         103                   9
Furniture and equipment                      95          96                  (1)
Taxes & licenses                             76          63                  13
Stationery and supplies                      56          47                   9
Director's fees                              47          39                   8
Insurance                                    35          37                  (2)
Accounting and audit                         38          40                  (2)
Marketing                                    28          22                   6
                                     ----------  ----------            --------
                                     $    2,056  $    1,950            $    106
                                     ==========  ==========            ========
</TABLE>

INCOME TAXES:

                For the year ended December 31, 1997, the Company  recognized an
expense of  $440,000.  This  represents  a $222,000  increase  from the $218,000
expense  for 1996.  See Note 11 of the  Consolidated  Financial  Statements  for
additional information with respect to income taxes.

YEAR 2000 PROJECT:

         Heritage  Bankshares,  Inc.  has  undertaken  a variety of  measures to
ensure that the  Company's  hardware and  software  systems will be century date
compliant.  The Company has  established  a project  team and plan,  completed a
hardware and software  inventory,  developed an impact assessment rating and has
assigned a rating to the areas  identified.  The company has initiated  contacts
with  vendors for specific  product  compliance  confirmation.  Testing of these
systems is expected to be  completed  by  year-end  1998 and is not  expected to
result in material  additional costs. The Bank has compiled a list of commercial
customers who will be contacted  regarding  their Year 2000 readiness  plans. In
1997, the Company's progress in addressing the Year 2000 issues were reviewed by
the Federal  Reserve Bank.  Based upon the results of the impact  assessment and
information  provided  by  vendors,   management  believes  that  its  plan  for
determining  century date  compliance  is adequate and that the Company will not
incur significant incremental costs to achieve compliance.

RECENT ACCOUNTING PRONOUNCEMENTS:

         The Financial  Accounting Standards Board ("FASB") issued Statement No.
130, Reporting  Comprehensive  Income. This Statement  establishes standards for
reporting  and display of  comprehensive  income and its  components  (revenues,
expenses,  gains,  or  losses)  in  a  full  set  of  general-purpose  financial
statements, and is effective for fiscal years beginning after December 15, 1997.
This Statement  requires that all items that are required to be recognized under
accounting  standards as  components  of  comprehensive  income be reported in a
financial  statement  that is  displayed  with  the  same  prominence  as  other
financial statements. This Statement does not require a specific format for that
financial   statement  but  requires  that  an  enterprise   display  an  amount
representing  total  comprehensive  income  for the  period  in  that  financial
statement. This Statement also requires that an enterprise (a) classify items of
other  comprehensive  income by their  nature in a financial  statement  and (b)
display the accumulated  balance of other  comprehensive  income separately from
retained  earnings and  additional  paid-in  capital in the equity  section of a
statement of financial  position.  The Company is currently assessing the impact
of this statement on its future financial statement  presentation.  However, the
only known item of other comprehensive income to which this standard would apply
is unrealized gains and losses on available-for-sale securities.

         FASB  Statement No. 131,  Disclosures  about Segments of an Enterprise,
establishes  standards  for the way  that  public  business  enterprises  report
information about operating  segments in annual financial  statements,  requires
that those enterprises  report selected  information about operating segments in
interim  financial reports issued to shareholders and is effective for financial
statements for periods  beginning  after December 15, 1997. It also  establishes
standards for related  disclosures  about  products and  services,  geographical
areas  and major  customers.  This  Statement  requires  that a public  business
enterprise  report  financial and descriptive  information  about its reportable
operating  segments.  Operating  segments are components of an enterprise  about
which separate financial information is available that is evaluated regularly by
the chief operating  decision maker in deciding how to allocate resources and in
assessing  performance.  Generally,  financial  information  is  required  to be
reported  on the  basis  that  it is  used  internally  for  evaluating  segment
performance and deciding how to allocate resources to segments.

         This Statement also requires that a public business enterprise report a
measure of segment profit or loss,  certain  specific revenue and expense items,
and segment assets. It requires reconciliations of total segment revenues, total
segment profit or loss,  total segment assets,  and other amounts  disclosed for
segments to corresponding amounts in the enterprises's general-purpose financial
statements.  It requires that all public business enterprises report information
about the  revenues  derived  from the  enterprises's  products or services  (or
groups of similar  products  and  services),  about the  countries  in which the
enterprise earns revenues and holds assets, and about major customers regardless
of whether that information is used in making operating decisions. However, this
Statement  does not  require an  enterprise  to report  information  that is not
prepared for internal use if reporting it would be impracticable.  Management is
currently  assessing  the  impact  of this  statement  on its  future  financial
statement disclosures.

         FASB Statement No. 132, Employers'  Disclosures about Pension and Other
Post Retirement Benefits,  revises disclosures  regarding pension and other post
retirement benefits and standardizes certain disclosure  requirements  regarding
these  items.  This  Statement is effective  for fiscal  years  beginning  after
December 15, 1997.  Management will assess the impact, if any, of this Statement
on the Company's future disclosures.


Item 7:  FINANCIAL STATEMENTS

         The  financial  statements  of the Company are included  (with an index
listing of all such  statements) in a separate  financial  section at the end of
this Annual Report on Form 10-KSB.

Item 8:  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
         FINANCIAL DISCLOSURES:

                None.


<PAGE>


PART III

Item 9.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         On January 5, 1990,  the Board of Directors  voted to amend the by-laws
to increase  the size of the Board of  Directors  from 12 to 14  members.  As of
December 31, 1997, there were 10 directors.


         The following  schedule sets forth certain  information  concerning the
directors and executive officers of the Company.
<TABLE>
<CAPTION>
Director's                                        Term to   Position(s) With
Name                                   Age         Expire   The Company
-------------------------------------------------------------------------------------------------------------
<S> <C>
James A. Cummings                     55           1998     Director

Lisa F. Chandler                      43           2000     Director

F. Dudley Fulton                      49           1999     Director

Henry U. Harris, III                  46           2000     Director and Vice-Chairman of the Board

Stephen A. Johnsen                    52           2000     Director and Secretary of the Board

Robert J. Keogh                       49           1998     President; Director and President-Heritage
                                                            Bank & Trust

Peter M. Meredith, Jr.                46           1998     Director and Chairman of the Board

Gerald L .Parks                       64           1999     Director

Ross C. Reeves                        49           1999     Director

Harvey W. Roberts, III                53           1998     Director
</TABLE>
         James A.  Cummings  was  appointed  director of the  Company  effective
November 1992, and has served as a director of Heritage Bank & Trust since April
1992. He has served as Vice President of Southern  Atlantic Label Company,  Inc.
since 1972.

         Lisa F. Chandler was appointed director of the Company effective August
1997. She has served as Executive  Vice President of Nancy Chandler  Associates,
Inc. since 1992.

         F.  Dudley  Fulton was  appointed  director  of the  Company  effective
December 31, 1991, and has served as a director of Heritage Bank and Trust since
1988.  He has served as President and Chief  Executive  Officer of Henderson and
Phillips, Inc. since 1986.

         Henry U. Harris,  III has been a director of the Company since November
1992 and has served as Vice-Chairman  since January 1995. He has been a director
of Heritage Bank & Trust since  September  1990. He is the President of Virginia
Investment Counselors, Inc. for ten years.

         Stephen A.  Johnsen has been a director  of the Company  since 1988 and
has served as  Secretary  since  January  1995.  He has served as a director  of
Heritage Bank & Trust since 1984. Mr. Johnsen has been the President of Flagship
Group, LTD since 1984.

         Robert  J.  Keogh is  President  and  Chief  Executive  Officer  of the
Company.  He has served as  President  and a director of  Heritage  Bank & Trust
since August 1988. He previously  was a Senior Vice  President of First American
Bank of Virginia from December 1983 to August 1988.

         Peter M.  Meredith,  Jr. was  elected as a director  of the  Company in
November 1992 and has served as Chairman  since January 1995. He has served as a
director  of  Heritage  Bank & Trust  since  September  1991.  He had  been  the
President of Meredith Construction Company, Inc. for several years and currently
serves as Chairman and Chief Executive Officer.

         Gerald L. Parks has been a director of the  Company  since 1987 and has
served as a director of Heritage Bank & Trust since its  inception.  He had been
President of Capes Shipping Agencies, Inc. for several years, and is now serving
as Chairman of the Board of Directors.

         Ross C.  Reeves was  elected as a director  of the  Company in February
1994. He has been a member of the law firm of Willcox & Savage, P.C. since 1982.

         Harvey W.  Roberts,  III was  elected as a director  of the  Company in
January 1993. Mr.  Roberts has been a senior  partner in the accounting  firm of
Roberts and Speece, P.L.C Certified Public Accountants for over twenty years.

Item 10.  EXECUTIVE COMPENSATION

1.  CASH COMPENSATION:

         Set forth below is information  concerning the compensation paid to the
Company's executive officer.

Summary Compensation table
Annual Compensation (1)
<TABLE>
<CAPTION>
<S> <C>
                                                                                    Director's
Name and Principal Position                 Year         Salary         Bonus          Fees       Options (2)
---------------------------------------------------------------------------------------------------------------
Robert J. Keogh
 President & Chief Executive Officer        1997       $ 94,725       $ 34,800   $ 4,800
                                            1996       $ 93,450       $ 23,700   $ 4,800
                                            1995       $ 93,000       $ 14,000   $ 2,400             36,000
</TABLE>

(1)No compensation earnined in either year was deferred.
(2)During 1995 options  were granted to purchase  common stock of the Company at
   the  option  price  ranging  from  $6.50 per share to $9.50  per  share.  See
   "Compensation Pursuant to Plans". 5,600 shares were exercised by Mr. Keogh in
   1997.

2.  COMPENSATION PURSUANT TO PLANS:

EMPLOYEE STOCK OPTION PLAN

         As  of  December  31,  1997,   stock  options  for  99,850  shares  are
outstanding and, of these shares,  67,913 are  exercisable.  Options are granted
and are exercisable at option prices ranging from $4.60 to $9.50 per share.  See
disclosures  regarding  stock  option  plans  in  Note  10 to  the  Consolidated
Financial Statements.

DEFERRED COMPENSATION AND RETIREMENT ARRANGEMENTS

         In 1985,  Heritage Bank & Trust entered into deferred  compensation and
retirement  arrangements with seven directors and one officer.  Each participant
is fully vested.  The Company's policy is to accrue the estimated  amounts to be
paid  under  the  contracts  over the  expected  period  of  active  service  or
employment.

         Upon  reaching  age 70,  each  participant  will  receive a  retirement
benefit  ranging  from $391 to $3,355 per month for each of the next 120 months.
If the  participant  dies prior to reaching age 70, his  beneficiary  will begin
receiving the monthly retirement benefits. The bank has purchased life insurance
contracts  in  order  to  fund  the  expected  liabilities  under  the  deferred
compensation  arrangements.  As of December 31, 1997,  Heritage Bank & Trust had
accrued $208,239 to reflect the anticipated liability.

         In 1990, Robert J. Keogh,  President of Heritage Bank & Trust, became a
participant in the Heritage Bank & Trust  Executive  Security Plan. In the event
Mr. Keogh dies prior to age 65, his beneficiary will receive monthly payments of
$4,167 for each of the next 180 months. Upon his retirement at age 65, Mr. Keogh
will  receive  $4,167  per  month  for each of the next 180  months or until his
death, and thereafter other beneficiaries will receive such retirement benefits.
Heritage Bank & Trust funds this obligation  through a life insurance  contract.
Heritage Bank & Trust had accrued $61,756 as of December 31, 1997 to reflect the
anticipated liability.

         Effective January 1, 1984, the Board of Directors adopted an Employee's
Stock Bonus Plan and Trust (the  "ESOP").  The ESOP  covered  substantially  all
employees,  whereby funds contributed were used to purchase  outstanding  common
stock of the Company.  Contributions were allocated to the participants based on
the  employee/participant's  annual compensation.  Employee  participants in the
ESOP included all  employees  who have reached the age of 21 and have  completed
one year of service  (1,000  hours),  beginning  with the effective  date of the
ESOP.  Benefits were payable upon  separation  from service or upon  retirement,
disability or death. Employees are 30% vested with respect to the benefits under
the ESOP in three  years  and the  vested  percentage  was  increased  annually,
reaching 100% after seven years.  Participants were automatically 100% vested in
the ESOP upon reaching age 65, death or disability. Participants vote all shares
allocated  to their  respective  accounts  and the trustees of the ESOP vote any
unallocated shares. The Board of Directors of the Company has the right to amend
or terminate the ESOP and trust at any time. The Company made no contribution to
the plan for years ending  December 31, 1997 and 1996.  In October of 1995,  the
trustees of the ESOP voted to  terminate  the plan and the  participants  in the
plan were notified of their options  concerning  distribution of their shares in
the plan in  accordance  with the  terms of the  ESOP  and  applicable  law.  At
December 31, 1997, 25,761 of the 25,934 shares in the plan had been distributed.

         Effective  January 1, 1993, the Board of Directors adopted a Retirement
Program (the "401K").  The Company may contribute cash to the 401K annually,  as
determined  each year by the Board of Directors.  Contributions  to the 401K are
allocated to its participants based on the employee/participant's  contributions
to the plan.  Eligible  participants  in the 401K include all employees who have
completed six months of service (500 hours) beginning with the effective date of
the  401K.  Benefits  will be  payable  upon  separation  from  service  or upon
retirement,  disability  or death.  Employees are 20% vested with respect to the
benefits  under the 401K in two years and the  vested  percentage  is  increased
annually,  reaching 100% after six years.  Participants are  automatically  100%
vested in the 401K upon  reaching age 65, death or  disability.  The Company has
the right to amend or  terminate  the 401K.  The  Company  expensed  $36,000 and
$28,000 for plan  contributions  for the years ended December 31, 1997 and 1996,
respectively.

         Effective January 1, 1997, the Board of Directors adopted an Employee's
Stock Ownership Plan (the "ESOP").  The ESOP covers substantially all employees,
whereby funds contributed are used to purchase  outstanding  common stock of the
Company.   Contributions  are  allocated  to  the  participants   based  on  the
employee/participant's  annual compensation.  Employee  participants in the ESOP
includes all employees who have  completed six months of service  beginning with
the  effective  date of the ESOP.  Benefits  are payable  upon  separation  from
service or upon retirement,  disability or death.  Employees are 20% vested with
respect to the benefits under the ESOP in three years and the vested  percentage
increases   annually,   reaching  100%  after  seven  years.   Participants  are
automatically 100% vested in the ESOP upon reaching age 65, death or disability.
Participants  vote all shares  allocated  to their  respective  accounts and the
trustees of the ESOP vote any unallocated  shares. The Board of Directors of the
Company has the right to amend or  terminate  the ESOP at any time.  The Company
expensed $12,000 for plan contributions for the year ended December 31, 1997.

COMPENSATION OF DIRECTORS:

         Directors of the Company and Directors of Heritage Bank & Trust receive
$400 for each Board of Directors'  meeting  attended and $100 for each committee
meeting attended.




ITEM 11:  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following schedule sets forth information  regarding the beneficial
ownership of the Company's common stock as of March 10, 1997, of (i) each of the
Company's  directors;  (ii) each person known by the Company to be the holder of
5% or more of the  Company's  outstanding  common  stock;  and  (iii) all of the
Company's directors and executive officers as a group.

OWNERSHIP OF COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS
                                                                     PERCENT OF
NAME OF INDIVIDUAL                           SHARES                    CLASS


James A.Cummings                           5,138 (1)                    0.64%
2073 Thomas Bishop Lane
Virginia Beach, VA  23454 USA

Lisa F. Chandler                             200 (2)                    0.03%
6127 Studeley Avenue
Norfolk, VA  USA  23508

F. Dudley Fulton                           2,700                        0.34%
5306 Lakeside Avenue
Virginia Beach, VA  23451 USA

Henry U. Harris, III                      26,405  (3)                   3.31%
1503 North Shore Road
Norfolk, VA  23505 USA

Stephen A. Johnsen                         1,968                        0.25%
401 College Place
Norfolk, VA  23510 USA

Robert J. Keogh                            8,748 (4)                    1.10%
6146 Sylvan Street
Norfolk, VA  23508 USA

Peter M. Meredith, Jr.                    36,950 (5)                    4.64%
5320 Edgewater Drive
Norfolk, VA  23508 USA

Gerald L. Parks                            5,195 (6)                    0.65%
27307 Evergreen Lane
Harborton, VA  23389  USA

Ross C. Reeves                             4,142 (7)                    0.52%
1068 Algonquin Road
Norfolk, VA  23505 USA

Harvey W. Roberts, III                    29,079 (8)                    3.65%
7612 North Shore Road
Norfolk, VA  23505 USA

Directors and Executive Officers as a
     group (10 persons)                  120,525                       15.12%

(1) Includes  1,500 shares  owned  jointly with his wife.  Also  includes  1,766
    shares owned by Scott & Stringfellow for Mr. Cummings.
(2) Shares owned jointly with her husband.
(3) Includes 3,555 shares owned by his wife.  Also includes 4,249 shares held as
    custodian for others and 3,700 shares held in trust.
(4) Includes  1,335 shares  owned  jointly with his wife.  Also  includes  2,051
    shares  owned  by Scott &  Stringfellow  as an IRA for Mr.  Keogh.  Does not
    include  38,100  shares that may be acquired  by Mr.  Keogh  pursuant to the
    Stock  Option  Plan for key  employees  of the  Company.  See  "Compensation
    Pursuant to Plans." If such shares were included,  Mr. Keogh would own 5.89%
    of the outstanding shares.
(5) Includes 10,960 shares held as Meredith Realty Company, L.L.C., 9,455 shares
    held as Pomar  Holding,  L.L.C.  and 3,000  shares held as  Meredith  Realty
    Associates.  Also includes 8,203 shares owned by Davenport & Company for Mr.
    Meredith.
(6) Includes 4,614 shares owned jointly with his wife.
(7) Includes 3,142 shares held as custodian for others.
(8) Includes 15,455 shares owned by his wife and 3,000 shares owned jointly with
    his  wife.  Also  includes  2,112  shares  owned  by  Scott  &  Stringfellow
    consisting  of 257 shares as an IRA for Roberts & Speece,  CPA,  P.L.C.  and
    1,825 owned for Mr. Roberts.



ITEM 12:  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:

         Many  directors  of the  Company  and  Heritage  Bank & Trust and their
associates,  including  firms and  corporations  of which they are  officers  or
directors;  or in which they and their  immediate  families  have a  substantial
interest,  are  customers  of  Heritage  Bank & Trust.  As such,  they  have had
transactions  with the bank,  including  loans  made in the  ordinary  course of
business on substantially the same terms,  including interest rates,  collateral
and repayment  terms,  as those  prevailing at the time for comparable  loans to
other  parties.  Such  loans  have not  involved  more than the  normal  risk of
collectibility or other unfavorable features. See related party loan and deposit
disclosures in Note 13 of the Consolidated Financial Statements.

         Heritage Bank & Trust occupies 7,581 square feet of space in a building
located at 1450 South Military Highway in Chesapeake,  Virginia. The building is
owned by IBV Partners,  L.P., a Virginia limited  partnership,  which has as its
sole general partner IBV Real Estate Holdings,  Inc., a wholly-owned  subsidiary
of the Company.  Former and current  directors  of Heritage  Bank & Trust own an
aggregate of approximately 34% of the partnership interests.  IBV Partners, L.P.
and  Heritage  Bank & Trust  entered  into a lease in  December  1986  which was
modified in December 1996.  See  disclosures  regarding the lease  commitment in
Note 12 of the Consolidated Financial Statements.

         The  Company  and  Heritage  Bank & Trust  purchase  various  types  of
business  insurance  through the Flagship Group LTD, of which Stephen A. Johnsen
is President. Mr. Johnsen is a director and Secretary of the Company.  Insurance
premiums  paid to the  Flagship  Group  LTD as agent  for  commercial  insurance
providers  was $21,661  during 1997.  The Bank has also sold  securities  to the
Flagship   Group  LTD  under   agreements  to   repurchase,   which   constitute
approximately  91% of the  securities  sold under  agreements  to  repurchase at
December 31,  1997.  See Note 9 of the  Consolidated  Financial  Statements  for
additional information.

         Heritage  Bank & Trust has  retained  the law firm of Willcox & Savage,
P.C. in connection with certain legal representations and expects to continue to
do so in the future. Ross c. Reeves, a director of the Company is an attorney in
the law firm.  Fees paid to Willcox & Savage,  P.C. by Heritage Bank & Trust was
$2,118 in 1997.


<PAGE>


PART IV

Item 13:  EXHIBITS AND REPORTS ON FORM 8-K

(A) (3) Exhibits:

              3.1    Articles   of   Incorporation.   (Incorporated   herein  by
                     reference  to the  Corporation's  Form 10-K for 1983  filed
                     March 29, 1984.)

              3.2    Bylaws, as amended.

             10.1    Stock  Option Plan for  Employees  (Incorporated  herein by
                     reference  to the  Corporation's  Form 10-K for 1987  filed
                     March 25, 1988.)

             10.2    Employees  Stock  Option  Plan.   (Incorporated  herein  by
                     reference  to the  Corporation's  Form 10-K for 1987  filed
                     March 25, 1988.)

             10.3    Employee  Stock  Ownership  Plan  (Incorporated  herein  by
                     reference  to the  Corporation's  Form 10-K for 1984  filed
                     April 12, 1985.)

             10.4    Lease dated December 29, 1986,  between IBV Partners,  L.P.
                     as landlord,  and Heritage Bank & Trust, as Tenant, for the
                     lease of 7,581  square feet of space in a building  located
                     at  1450  South  Military  Highway,  Chesapeake,  Virginia.
                     (Incorporated herein by reference to the Corporation's Form
                     10-K for 1986 filed March 1987.)

             10.5    Amended and restated January 1, 1989, Stock Ownership Plan,
                     which  provided  for  certain   changes   required  by  IRS
                     regulations   including  changes  in  participant   vesting
                     schedules.   (Incorporated   herein  by  reference  to  the
                     Corporation's Form 10-K for 1990 filed March 30, 1991.)

            10.6     Employee's Stock Ownership Plan (filed herewith).

(B)   Reports on Form 8-K

No reports were filed on Form 8-K during the year ended December 31, 1997.



<PAGE>


                                POWER OF ATTORNEY


         Each person whose  signature  appears below under  "SIGNATURES"  hereby
authorizes  Robert J.  Keogh and Peter M.  Meredith,  Jr. or either of them,  to
execute  in the name of each  such  person,  and to file any  amendment  to this
report, and hereby appoints Robert J. Keogh and Peter M. Meredith, Jr. or either
of them, as  attorneys-in-fact  to sign on his behalf,  individually and in each
capacity stated below, and to file any and all amendments to this report.

                                   SIGNATURES

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

                                  Heritage Bankshares, Inc.
                                    (Registrant)

Date:  March 25,1998                  by /s/ Robert J. Keogh
                                        ----------------------------------------
                                        Robert J. Keogh, President and Chief
                                        Executive Officer

                                      by /s/ Peter M. Meredith, Jr.
                                        ----------------------------------------
                                        Peter M. Meredith, Jr., Chairman of the
                                        Board of Directors


<PAGE>


         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities indicated on March 25, 1998.

SIGNATURES

/s/ Peter M. Meredith, Jr.
-------------------------------------
Peter M. Meredith, Jr.
Chairman of the Board of Directors

/s/ Robert J. Keogh
-------------------------------------
Robert J. Keogh
President and Chief Executive Officer & Director

/s/ Henry U. Harris, III
-------------------------------------
Henry U. Harris, III
Vice-Chairman of the Board of Directors

/s/ Stephen A. Johnsen
-------------------------------------
Stephen A. Johnsen
Secretary of the Board of Directors

/s/ Lisa F. Chandler
--------------------------------------
Lisa F. Chandler
Director

/s/ James A. Cummings
-------------------------------------
James A. Cummings
Director

/s/ F. Dudley Fulton
-------------------------------------
F. Dudley Fulton
Director

/s/ Gerald L. Parks
-------------------------------------
Gerald L. Parks
Director

/s/ Ross C. Reeves
-------------------------------------
Ross C. Reeves
Director

/s/ Harvey W. Roberts, III
-------------------------------------
Harvey W. Roberts, III
Director


<PAGE>


                                             HERITAGE BANKSHARES, INC.
                                    INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                        Page

Report of Independent Accountants                                         1


Financial Statements:

     Consolidated Balance Sheets                                          2

     Consolidated Statements of  Income                                   3

     Consolidated Statements of Stockholders' Equity                      4

     Consolidated Statements of Cash Flows                                5

     Notes to Consolidated Financial Statements                           6
<PAGE>
                                                     Consolidated
                                                     Financial Statements
                                                     Years Ended December 31,
                                                     1997 and 1996












                            HERITAGE BANKSHARES, INC.


<PAGE>



                        REPORT OF INDEPENDENT ACCOUNTANTS


The Stockholders and Board of Directors
Heritage Bankshares, Inc.
Norfolk, Virginia


           We have  audited  the  accompanying  consolidated  balance  sheets of
Heritage  Bankshares,  Inc. and its  subsidiaries at December 31, 1997 and 1996,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These consolidated  financial statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

           We  conducted  our  audits  in  accordance  with  generally  accepted
auditing standards.  Those standards require that we plan and perform the audits
to  obtain  reasonable  assurance  about  whether  the  consolidated   financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and  significant  estimates made by  management,  as well as evaluating the
overall  consolidated  financial  statement  presentation.  We believe  that our
audits provide a reasonable basis for our opinion.

           In our opinion,  the consolidated  financial  statements  referred to
above present  fairly,  in all material  respects,  the  consolidated  financial
position of Heritage  Bankshares,  Inc. and its  subsidiaries as of December 31,
1997 and 1996, and the  consolidated  results of their operations and their cash
flows for the years then ended in conformity with generally accepted  accounting
principles.


/s/ Goodman & Company, L.L.P.


One Commercial Place
Norfolk, Virginia
January 30, 1998









                                       F-1


<PAGE>
<TABLE>
HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS


<CAPTION>

December 31,                                                                    1997                  1996
--------------------------------------------------------------------------------------------------------------------
<S> <C>
                                ASSETS

Cash and due from banks                                                  $         4,019,169    $         3,068,651
Federal funds sold                                                                 1,697,207              5,925,000
Securities available for sale                                                     15,729,585             14,367,024
Securities held to maturity                                                        6,865,595              5,829,535
Loans, net                                                                        51,241,833             45,259,390
Accrued interest receivable                                                          692,488                535,172
Other real estate owned                                                              428,500                443,731
Premises and equipment, net                                                        1,328,297                582,971
Other assets                                                                         998,846                834,332
                                                                        --------------------------------------------

                                                                         $        83,001,520    $        76,845,806
                                                                        ============================================


                 LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits:
     Noninterest bearing deposits                                        $        12,902,336    $        12,498,845
     Interest-bearing deposits                                                    59,894,701             55,927,746
                                                                        --------------------------------------------
                                                                                  72,797,037             68,426,591
Securities sold under agreements to repurchase                                     1,945,212              1,349,091
Short-term borrowings                                                                 52,248                130,552
Accrued interest payable                                                             342,306                290,583
Other liabilities                                                                    783,971                537,214
                                                                        --------------------------------------------
                                                                                  75,920,774             70,734,031
                                                                        --------------------------------------------

Stockholders' equity:
     Common stock, $5 par value - authorized
              3,000,000 shares; issued and outstanding:
                   1997 - 795,050 shares; 1996 - 784,150 shares                    3,975,250              3,920,750
     Additional paid-in capital                                                     (360,790)              (380,330)
     Retained earnings                                                             3,409,668              2,539,941
     Unrealized appreciation on securities
         available for sale                                                           56,618                 31,414
                                                                        --------------------------------------------
                                                                                   7,080,746              6,111,775
                                                                        --------------------------------------------

                                                                         $        83,001,520    $        76,845,806
                                                                        ============================================



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

                                                                                                               F- 2

<PAGE>
HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME


<CAPTION>

Years Ended December 31,                                                              1997                1996
-----------------------------------------------------------------------------------------------------------------------

Interest income:
     Interest and fees on loans                                                 $       4,490,735    $       4,064,107
                                                                               ----------------------------------------
     Interest on investment securities:
         Available for sale                                                               912,280              507,245
         Held to maturity                                                                 448,749              352,626
                                                                               ----------------------------------------
                                                                                        1,361,029              859,871
                                                                               ----------------------------------------

     Interest on federal funds sold                                                       333,650              456,299
                                                                               ----------------------------------------
             Total interest income                                                      6,185,414            5,380,277
                                                                               ----------------------------------------

Interest expense:
     Interest on deposits                                                               2,832,417            2,491,616
     Interest on short-term borrowings                                                     76,247                3,104
                                                                               ----------------------------------------
            Total interest expense                                                      2,908,664            2,494,720
                                                                               ----------------------------------------

               Net interest income                                                      3,276,750            2,885,557

Provision for loan losses                                                                  88,333               92,935
                                                                               ----------------------------------------

            Net interest income after provision for loan losses                         3,188,417            2,792,622
                                                                               ----------------------------------------

Noninterest income:
     Services charges                                                                     195,865              171,921
     Other                                                                                 91,874               73,642
                                                                               ----------------------------------------
                                                                                          287,739              245,563
                                                                               ----------------------------------------

Noninterest expense:
     Salaries and employee benefits                                                     1,169,148            1,045,502
     Other                                                                                439,739              467,024
     Occupancy expenses                                                                   164,786              174,276
     Automated services                                                                   112,003              103,265
     Furniture and equipment expense                                                       94,746               95,997
     Taxes & licenses                                                                      76,018               63,642
                                                                               ----------------------------------------
                                                                                        2,056,440            1,949,706
                                                                               ----------------------------------------

Income before income taxes                                                              1,419,716            1,088,479

Income tax expense                                                                        439,746              218,021
                                                                               ----------------------------------------

Net income                                                                      $         979,970    $         870,458
                                                                               ========================================

Earnings per common share - basic                                               $            1.24    $            1.11
                                                                               ========================================

Earnings per common share - assuming dilution                                   $            1.17    $            1.09
                                                                               ========================================



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

                                                                                                                  F- 3

<PAGE>
HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<CAPTION>


Years Ended December 31, 1997 and 1996
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Net Unrealized
                                                                                                       Appreciation
                                                                        Additional                    (Depreciation)
                                                    Common Stock         Paid-in        Retained      on Securities
                                           -------------------------
                                             Shares       Amount         Capital        Earnings    Available-for-Sale  Total
                                           ----------  -------------  -------------  --------------  ------------  ---------------

Balance, December 31, 1995                   784,150    $ 3,920,750    $  (380,330)   $  1,763,581    $   34,076    $   5,338,077

Net changes in unrealized depreciation
     on securities available-for-sale,
     net of applicable income taxes
             of $1,371                             0              0              0               0        (2,662)          (2,662)

Net income for 1996                                0              0              0         870,458             0          870,458

Less: Dividends paid in 1996                       0              0              0         (94,098)            0          (94,098)
                                           ---------------------------------------------------------------------------------------

Balance, December 31, 1996                   784,150      3,920,750       (380,330)      2,539,941        31,414        6,111,775


Stock options exercised in 1997               10,900         54,500         19,540               0             0           74,040

Net changes in unrealized appreciation
     (depreciation) on securities
     available-for-sale, net of applicable
     income taxes of $14,384                       0              0              0               0        25,204           25,204

Net income for 1997                                0              0              0         979,970             0          979,970

Less:  Dividends paid in 1997                      0              0              0        (110,243)            0         (110,243)
                                           ---------------------------------------------------------------------------------------

Balance, December 31, 1997                   795,050    $ 3,975,250    $  (360,790)   $  3,409,668    $   56,618    $   7,080,746
                                           =======================================================================================



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

                                                                                                                             F- 4

<PAGE>
HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>


Years Ended December 31,                                                                           1997                1996
-----------------------------------------------------------------------------------------------------------------------------------

Operating activities:
     Net income                                                                              $        979,970     $        870,458
     Adjustments to reconcile to net cash
         provided by operating activities:
         Provision for loan losses                                                                     88,333               92,937
         Provision for losses on real estate owned                                                     15,231               70,644
         Provision for depreciation and amortization                                                   71,226               78,344
         Amortization of investment security premiums,
            net of discounts                                                                            8,065                 (270)
         Deferred loan origination fees, net of costs                                                 (15,604)              (2,479)
         Changes in:
            Interest receivable                                                                      (157,316)            (107,515)
            Interest payable                                                                           51,723               34,979
            Other assets                                                                             (178,898)             (90,385)
            Other liabilities                                                                         246,757              (34,127)
                                                                                           ----------------------------------------
                Net cash provided by operating activities                                           1,109,487              912,586
                                                                                           ----------------------------------------

Investing activities:
     Proceeds from maturities of available-for-sale securities                                      2,669,820            1,599,270
     Proceeds from maturities of held-to-maturity securities                                        2,625,314            3,970,805
     Purchases of available-for-sale securities                                                    (3,993,939)         (10,263,221)
     Purchases of held-to-maturity securities                                                      (3,668,293)          (2,500,143)
     Loan originations, net of principal repayments                                                (6,055,172)          (2,330,635)
     Proceeds from condemnation of land                                                                 9,503                    0
     Purchases of premises and equipment                                                             (826,055)             (31,091)
                                                                                           ----------------------------------------
                Net cash used by investing activities                                              (9,238,822)          (9,555,015)
                                                                                           ----------------------------------------

Financing activities:
     Net decrease in demand deposits,
         NOW accounts and savings accounts                                                            (92,597)            (165,433)
     Net increase in certificates of deposit                                                        4,463,043            7,538,558
     Net increase in securities sold under agreements to repurchase                                   596,121            1,349,091
     Net increase (decrease) in short-term borrowings                                                 (78,304)              64,125
     Net proceeds from exercise of stock options                                                       74,040                    0
     Cash dividends paid                                                                             (110,243)             (94,098)
                                                                                           ----------------------------------------
                Net cash provided by financing activities                                           4,852,060            8,692,243
                                                                                           ----------------------------------------

Increase (decrease) in cash and cash equivalents                                                   (3,277,275)              49,814

Cash and cash equivalents at beginning of year                                                      8,993,651            8,943,837
                                                                                           ----------------------------------------

Cash and cash equivalents at end of year                                                     $      5,716,376     $      8,993,651
                                                                                           ========================================

Supplemental schedules and cash flow information:

     Cash paid for:
         Interest on deposits and other borrowings                                         $        2,856,941   $        2,459,741
                                                                                           ========================================

         Income taxes                                                                      $          279,922   $          244,583
                                                                                           ========================================




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

                                                                                                                              F- 5
</TABLE>

<PAGE>

HERITAGE BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1997 AND 1996
--------------------------------------------------------------------------------


NOTE 1 - ORGANIZATION AND BUSINESS

           Heritage  Bankshares,  Inc. (the  "Company") was organized  under the
laws of the Commonwealth of Virginia in 1983. The Company has four  wholly-owned
subsidiaries,  including one bank:  Heritage Bank & Trust (the "Bank") with four
full service branches in Norfolk and Chesapeake,  Virginia.  The Company's other
subsidiaries  are IBV  Real  Estate  Holdings,  Inc.,  a  Virginia  corporation,
Sentinel  Title  Services,  Inc., a Virginia  corporation,  and  Sentinel  Trust
Services,   L.L.C.,  a  Virginia  limited  liability  company.  The  Bank  is  a
state-chartered bank and a member of the Federal Reserve System. The deposits of
the Bank are insured by the Federal Deposit  Insurance  Corporation (the "FDIC")
to the extent and subject to the  limitations  set forth in the Federal  Deposit
Insurance Act, as amended.

           The Bank is a full-service  bank conducting a general  commercial and
consumer  banking  business with its customers  located  throughout  the Hampton
Roads area of Virginia.  Its  principal  banking  activities  include  receiving
demand,  savings and time deposits for personal and commercial accounts;  making
commercial,  real  estate  and  consumer  loans;  acting as a United  States tax
depository  facility;  providing  money transfer and cash  management  services;
selling  traveler's  checks,  bank money orders;  issuing letters of credit; and
investing in U.S.  Treasury  securities and securities of other U.S.  government
agencies  and  corporations,   and   mortgage-backed  and  state  and  municipal
securities.

           IBV  Real  Estate  Holdings,  Inc.  was  formed  in  December,  1986.
Presently,  its only business is owning a 1% general partnership interest in IBV
Partners,  L.P.,  the  lessor  of  office  space to  Heritage  Bank and Trust in
Chesapeake, Virginia.

           Sentinel Title Services, Inc. and Sentinel Trust Services, L.L.C. are
wholly-owned subsidiaries, which own an interest in providers of title and trust
services. The financial activities pertaining to these interests are recorded on
the  cost  method  of  accounting  for  investments.   The  Company's  strategic
relationship  with these entities  provides the Bank with the ability to provide
title and trust services to its customers.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        Basis of Statement Presentation and Principles of Consolidation

        The accompanying  consolidated financial statements include the accounts
of Heritage Bankshares,  Inc. and its wholly-owned  subsidiaries,  Heritage Bank
and Trust and IBV Real Estate Holdings,  Inc., Sentinel Title Services, Inc. and
Sentinel  Trust  Services,  L.L.C.  All  significant  intercompany  balances and
transactions have been eliminated in consolidation.



                         (Notes continued on next page)

                                      F- 6


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Cash Equivalents

        For purposes of reporting cash flows, cash and cash equivalents  include
cash on hand,  amounts due from banks,  interest bearing deposits with banks and
federal funds sold. Generally, federal funds are sold for one-day periods.

        Securities

        Investments in debt  securities  that management has the positive intent
and  ability  to hold to  maturity  are  classified  as "held to  maturity"  and
reflected at amortized cost. Investments that are purchased and held principally
for the purpose of selling  them in the near term,  if any,  are  classified  as
"trading  securities"  and reflected at fair value,  with  unrealized  gains and
losses  included in earnings.  Investments not classified as either of the above
are  classified  as  "available  for sale" and  reflected  at fair  value,  with
unrealized  gains and losses excluded from operations and reported as a separate
component of stockholders' equity.

        Premiums  and  discounts  are  recognized  in interest  income using the
interest   method  over  the  period  to  maturity   on   held-to-maturity   and
available-for-sale  securities.  Other-than-temporary declines in the fair value
of individual held-to-maturity and available-for-sale securities, if any, result
in write-downs of the individual  securities to fair value. Gains and losses are
determined using the specific-identification method.

        Loans

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

        Allowance for Loan Losses

        The Bank accounts for loan losses in accordance  with FASB Statement No.
114,  Accounting by Creditors for  Impairment of a Loan.  Under the standard,  a
loan is considered  impaired,  based on current information and events, if it is
probable  that the Bank will be unable to  collect  the  scheduled  payments  of
principal or interest  when due according to the  contractual  terms of the loan
agreement.  The  measurement of impaired loans is generally based on the present
value of  expected  future cash flows  discounted  at the  historical  effective
interest  rate,  except that all  collateral-dependent  loans are  measured  for
impairment based on the fair value of the collateral.



                         (Notes continued on next page)

                                      F- 7


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Allowance for Loan Losses (continued)

        The adequacy of the allowance for loan losses is periodically  evaluated
by the Bank, in order to maintain the allowance at a level that is sufficient to
absorb  probable credit losses.  Management's  evaluation of the adequacy of the
allowance is based on a review of the Bank's  historical loss experience,  known
and inherent risks in the loan portfolio,  including adverse  circumstances that
may affect the ability of the borrower to repay interest and/or  principal,  the
estimated  value of  collateral,  and an  analysis  of the  levels and trends of
delinquencies, charge-offs, and the risk ratings of the various loan categories.
Such factors as the level and trend of interest  rates and the  condition of the
national  and  local  economies  are  also  considered.  In  addition,   various
regulatory  agencies,   as  an  integral  part  of  their  examination  process,
periodically  review the Bank's allowance for losses on loans. Such agencies may
require  the  Bank to  recognize  additions  to the  allowance  based  on  their
judgements of information available to them at the time of their examination.

        The allowance for loan losses is established through charges to earnings
in the form of a provision  for loan  losses.  Increases  and  decreases  in the
allowance due to changes in the  measurement of impaired  loans,  if applicable,
are included in the provision for loan losses.  Loans  continue to be classified
as  impaired  unless  they are  brought  fully  current  and the  collection  of
scheduled interest and principal is considered probable.

        When a loan or portion of a loan is determined to be uncollectible,  the
portion  deemed  uncollectible  is charged  against the allowance and subsequent
recoveries, if any, are credited to the allowance.

        Income Recognition on Impaired and Nonaccrual Loans

        Loans,  including impaired loans, are generally classified as nonaccrual
if they are past due as to maturity or payment of  principal  or interest  for a
period of more than 90 days,  unless  such  loans  are  well-secured  and in the
process  of  collection.  If a loan  or a  portion  of a loan is  classified  as
doubtful,  or is partially  charged off,  the loan is  generally  classified  as
nonaccrual.  Loans that are on a current payment status or past due less than 90
days may also be  classified  as  nonaccrual,  if repayment in full of principal
and/or interest is in doubt.

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

        While a loan is classified as nonaccrual  and the future  collectibility
of the recorded loan balance is doubtful,  collections of interest and principal
are generally applied as a reduction to principal  outstanding.  When the future
collectibility of the recorded loan balance is expected,  interest income may be
recognized  on a cash  basis.  In the  case  where a  nonaccrual  loan  had been
partially  charged  off,  recognition  of interest on a cash basis is limited to
that which  would  have been  recognized  on the  recorded  loan  balance at the
contractual  interest rate. Cash interest  receipts in excess of that amount are
recorded as recoveries to the allowance for loan losses until prior  charge-offs
have been fully recovered.




                         (Notes continued on next page)

                                      F- 8


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Other Real Estate Owned

        Other real estate  owned is  comprised  of real estate and other  assets
acquired through  foreclosure,  acceptance of a deed in lieu of foreclosure,  or
loans in which the Bank receives  physical  possession  of the debtor's  assets.
Other real estate  owned is carried at the lower of the recorded  investment  in
the loan or the fair value less estimated costs to sell. Upon transfer of a loan
to  foreclosed  status,  an  appraisal  is  obtained  and any excess of the loan
balance over the fair value less estimated  costs to sell is charged against the
provision for credit losses.  Revenues and expenses,  and subsequent adjustments
to fair value less  estimated  costs to sell are  classified  as an expense  for
other real estate owned.

        Restructured Loans

        Loans are considered troubled debt  restructurings  under FASB Statement
No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, if
for economic or legal  reasons,  a  concession  has been granted to the borrower
related to the borrower's  financial  difficulties  that the Bank would not have
otherwise considered. The Bank has restructured certain loans in instances where
a determination  was made that greater economic value will be realized under new
terms than through foreclosure,  liquidation, or other disposition. The terms of
the   renegotiation   generally   involve   some   or  all   of  the   following
characteristics:  a  reduction  in the  interest  pay  rate  to  reflect  actual
operating  income,  an  extension  of the loan  maturity  date to allow time for
stabilization  of operating  income,  and partial  forgiveness  of principal and
interest.

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

        Premises and Equipment

        Premises and equipment are stated at cost less accumulated depreciation.
For financial  reporting  purposes,  assets are depreciated over their estimated
useful  lives  using the  straight-line  method.  For income tax  purposes,  the
accelerated  cost  recovery  system and the modified  accelerated  cost recovery
system are used.


                         (Notes continued on next page)

                                      F- 9


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Income Taxes

        The Company files a consolidated tax return. Provisions for income taxes
reflect tax expense  incurred as a consolidated  group. Tax expense is allocated
among the members of the  consolidated  group in accordance with an intercompany
agreement for tax expense.  Income taxes are provided for the tax effects of the
transactions reported in the financial statements and consist of taxes currently
due plus deferred taxes related  primarily to  differences  between the basis of
investment securities,  deferred loan fees, allowance for loan losses, allowance
for losses on  foreclosed  real estate,  accumulated  depreciation  and deferred
compensation for financial and income tax reporting. The deferred tax assets and
liabilities  represent the future tax return  consequences of those differences,
which will either be taxable or deductible  when the assets and  liabilities are
recovered or settled,  and the  deferred  tax asset or liability  created by the
difference in fair value and amortized cost of available-for-sale securities.

        Deferred Compensation Plans

        The Bank maintains  deferred  compensation  and retirement  arrangements
with certain  directors  and  officers.  The  Company's  policy is to accrue the
estimated  amounts to be paid under the  contracts  over the expected  period of
active  employment.  The Bank  purchased  life  insurance  contracts to fund the
expected liabilities under the contracts.

        Off-Balance-Sheet Financial Instruments

        In  the  ordinary  course  of  business,   the  Bank  has  entered  into
off-balance-sheet  financial  instruments  consisting of  commitments  to extend
credit,  commitments  under  credit  card  arrangements,  commercial  letters of
credit,  standby  letters  of credit  and  financial  guarantees  written.  Such
financial  instruments are recorded in the financial statements when they become
payable.

        Use of Estimates

        The  preparation  of financial  statements  requires  Management to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting period. Actual results could differ from those estimates.

        Material  estimates  that are  particularly  susceptible  to significant
change relate to the  determination of the allowance for losses on loans and the
valuation  of  real  estate  acquired  in  connection  with  foreclosures  or in
satisfaction of loans. In connection  with the  determination  of the allowances
for losses on loans and foreclosed real estate,  management obtains  independent
appraisals  for  significant   properties.   While   management  uses  available
information  to recognize  losses on loans and  foreclosed  real estate,  future
additions to the allowances may be necessary  based on changes in local economic
conditions and other factors.


                         (Notes continued on next page)

                                      F-10


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Earnings per Share

        The Company  adopted FASB  Statement  No. 128,  Earnings  Per Share,  on
December 31, 1997.  This  Statement  establishes  standards  for  computing  and
presenting  earnings  per  share  (EPS).  This  Statement  supersedes  standards
previously set in APB Opinion No. 15, Earnings Per Share. FASB 128 requires dual
presentation of basic and diluted EPS on the face of the income  statement,  and
requires a  reconciliation  of the  numerator and  denominator  of the basic EPS
computation  with the numerator and denominator of the diluted EPS  computation.
This Statement is effective for financial  statements  issued for periods ending
after December 15, 1997. In accordance with the  requirements of this Statement,
all prior period EPS data have been  restated to reflect the change in reporting
requirements.

        Basic EPS excludes dilution and is computed by dividing income available
to common shareholders by the weighted-average  number of shares outstanding for
the period.  Diluted EPS reflects  the  potential  dilution  that could occur if
securities or other  contracts to issue common stock were  exercised,  converted
into common  stock or resulted in the  issuance of common stock that then shared
in the earnings of the entity.

        Reclassifications

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


NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
           (PARENT COMPANY ONLY)

        The financial position, results of operations and cash flows of Heritage
Bankshares,  Inc.  are  presented  below on a parent  company only basis for the
years indicated.
<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                ------------------------------------
Condensed Balance Sheets
Assets                                                                               1997                    1996
                                                                               ------------------------------------
<S> <C>
Cash on deposit with Heritage Bank and Trust                                   $     39,$20            $      8,615
Investment in Heritage Bank and Trust                                             6,720,165               5,918,242
Investment in non-bank subsidiaries                                                 217,549                 132,549
Premises and equipment                                                               11,755                  19,951
Other assets                                                                        509,498                 245,034
                                                                               ------------------------------------

        Total assets                                                           $  7,498,887            $  6,324,391
                                                                               ====================================


Liabilities and Stockholders' Equity

Other liabilities                                                              $    418,140            $    212,616
Common stock                                                                      3,975,250               3,920,750
Additional paid-in capital                                                         (360,790)               (380,330)
Retained earnings                                                                 3,409,669               2,539,941
Unrealized appreciation on securities available for sale                             56,618                  31,414
                                                                               ------------------------------------

        Total liabilities and stockholders' equity                             $  7,498,887            $  6,324,391
                                                                               ====================================
</TABLE>

                                          (Notes continued on next page)

                                      F-11


<PAGE>



NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
           (PARENT COMPANY ONLY) (Continued)
<TABLE>
<CAPTION>


                                                                                     Years Ended December 31,
                                                                                ------------------------------------
Condensed Statements of Income                                                       1997                   1996
                                                                                ------------------------------------
<S> <C>
Income:
   Dividends from subsidiary bank                                              $    195,243            $    109,098
   Other                                                                             12,759                  12,000
                                                                                -----------------------------------
                                                                                    208,002                 121,098
Expenses:
   Other                                                                             27,443                  24,991
                                                                                -----------------------------------

Income before income taxes and equity in undistributed net income of
     subsidiaries                                                                   180,559                  96,107
Applicable income tax benefit                                                        22,693                   4,976
                                                                                -----------------------------------

Income before equity in undistributed net income of subsidiaries                    203,252                 101,083

Equity in undistributed net income of subsidiaries                                  776,718                 769,375
                                                                                -----------------------------------

        Net income                                                             $    979,970            $    870,458
                                                                               ====================================


                                                                                     Years Ended December 31,
                                                                                -----------------------------------
Condensed Statements of Cash Flows                                                  1997                   1996
                                                                                -----------------------------------

Operating activities:
Net income                                                                     $    979,970            $    870,458
Adjustments to reconcile to net cash provided by operating activities:
   Depreciation                                                                       8,196                   8,196
   Undistributed net income of subsidiaries                                        (776,718)               (769,375)
   Changes in:
      Other assets                                                                 (264,464)                (37,292)
      Other liabilities                                                             205,524                 (21,614)
                                                                                -----------------------------------
Net cash provided by operating activities                                           152,508                  50,373
                                                                                -----------------------------------

</TABLE>


                         (Notes continued on next page)

                                      F-12


<PAGE>



NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
        (PARENT COMPANY ONLY) (Continued)
<TABLE>
<CAPTION>


Investing activities:
   Investment in Sentinel Trust Services, L.L.C.                                    (85,000)                 15,000
                                                                                -----------------------------------
<S> <C>
Financing activities:
Net proceeds from exercise of stock options                                          74,040                    -
Cash dividends paid                                                                (110,243)                (94,098)
                                                                                -----------------------------------

Net cash used by financing activities                                               (36,203)                (94,098)
                                                                                -----------------------------------


Net increase (decrease) in cash and cash equivalents                                 31,305                 (58,725)

Cash and cash equivalents at beginning of year                                        8,615                  67,340
                                                                                -----------------------------------

Cash and cash equivalents at end of year                                       $     39,920            $      8,615
                                                                                -----------------------------------
</TABLE>

        Certain  restrictions  exist  regarding the ability of Heritage Bank and
Trust  to  transfer  funds  to  Heritage  Bankshares,  Inc.  in the form of cash
dividends,  loans or advances.  Pursuant to Federal  Regulations,  dividends are
generally  restricted to net profits,  as defined,  for the current  year,  plus
retained net profits for the previous two years. At December 31, 1997, dividends
from the Bank to the Company are limited to approximately $2,232,000 under these
regulations.  The maximum  amount  available for transfer from Heritage Bank and
Trust to the Company in the form of loans and  advances is 10% of Heritage  Bank
and Trust's  stockholder's  equity.  At December 31, 1997,  such maximum  amount
available is approximately $672,000.


NOTE 4 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS

        The Bank is  required by the Federal  Reserve  Bank to maintain  average
reserve  balances.  The  average  amount  of  maintained  reserve  balances  was
approximately  $710,000 for the year ended  December 31, 1997,  with the average
reserve  requirement  for the  same  period  being  approximately  $432,000.  On
December 31, 1997, the reserve balance was approximately $707,000.







                         (Notes continued on next page)

                                      F-13


<PAGE>



NOTE 5 - SECURITIES

        Securities at December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
                                                                    Gross         Gross
                                                    Amortized     Unrealized    Unrealized    Estimated
                                                      Cost          Gains         Losses      Fair Value
                                                   -----------   -----------   -----------   -----------
<S> <C>
December 31, 1997:
   Securities available for sale:
     U.S. Treasury                                 $ 9,997,043   $    50,198   $       121   $10,047,120
     U.S. government agencies                        4,817,324        25,776         2,359     4,840,741
     Mortgage-backed securities                        829,433        13,082           791       841,724
                                                   -----------   -----------   -----------   -----------

                                                   $15,643,800   $    89,056   $     3,271   $15,729,585
                                                   ===========   ===========   ===========   ===========


   Securities held to maturity:
     U.S. Treasury                                 $ 2,233,944   $    17,934   $      --     $ 2,251,878
     U.S. government agencies                        2,702,120        14,178           554     2,715,744
     Mortgage-backed securities                        455,649          --           1,327       454,322
     States and political
        subdivisions                                   827,582        15,457          --         843,039
     Other                                             646,300          --            --         646,300
                                                   -----------   -----------   -----------   -----------

                                                   $ 6,865,595   $    47,569   $     1,881   $ 6,911,283
                                                   ===========   ===========   ===========   ===========

December 31, 1996:
   Securities available for sale
     U.S. Treasury                                 $10,495,374   $    29,182   $     7,148   $10,517,408
     U.S. government agencies                        3,025,362        26,295         7,341     3,044,316
     Mortgage-backed securities                        800,091         6,965         1,756       805,300
                                                   -----------   -----------   -----------   -----------

                                                   $14,320,827   $    62,442   $    16,245   $14,367,024
                                                   ===========   ===========   ===========   ===========

   Securities held to maturity:
     U.S. Treasury                                 $ 1,732,665   $     3,039   $     2,134   $ 1,733,570
     U.S. government agencies                        1,999,226         5,362           723     2,003,865
     Mortgage-backed securities                      1,340,585          --           9,651     1,330,934
     States and political
        subdivisions                                   490,359           197          --         490,556
     Other                                             266,700          --            --         266,700
                                                   -----------   -----------   -----------   -----------

                                                   $ 5,829,535   $     8,598   $    12,508   $ 5,825,625
                                                   ===========   ===========   ===========   ===========
</TABLE>



                         (Notes continued on next page)

                                      F-14


<PAGE>



NOTE 5 - SECURITIES (Continued)

          Investment   securities  having  carrying  values  of  $4,363,566  and
$3,902,828  at December 31, 1997 and 1996,  respectively,  are pledged to secure
deposits of the U.S. Government and the Commonwealth of Virginia.  The estimated
fair values of these  securities  were $4,395,129 and $3,904,806 at December 31,
1997 and 1996, respectively.

          The  amoritized  cost and fair value of securities  by maturity  date,
including the contractual maturities of mortgage-backed  securities, at December
31, 1997 are as follows:
<TABLE>
<CAPTION>

                                              Securities Held to Maturity        Securities Available for Sale
                                              ---------------------------        -----------------------------
                                               Amortized         Estimated        Amortized           Estimated
                                                  Cost           Fair Value          Cost             Fair Value
                                               ---------         ---------        ---------           ---------
<S> <C>
     Due in one year or less                 $ 1,018,998         $1,018,938       $4,556,046          $4,559,909
     Due from one year to five years           4,766,880          4,803,656       10,558,544          10,633,990
     Due from five years to ten years                -                -               92,435              94,556
     Due after ten years                       1,079,717          1,088,689          436,775             441,130
                                             -----------         ----------       ----------          ----------
                                             $ 6,865,595         $6,911,283       $15,643,800         $15,729,585
                                             ===========         ==========       ===========         ===========
</TABLE>


NOTE 6 - LOANS

     Loans consist of the following:
<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                -----------------------------------
                                                                                    1997                      1996
                                                                               ------------            ------------
<S> <C>
        Gross loans:
           Commercial                                                          $  9,359,223            $  9,334,870
           Real estate - mortgage                                                37,775,710              31,551,386
           Real estate - construction                                             1,626,634               2,083,717
           Installment and consumer loans                                         3,369,650               3,132,132
                                                                               ------------            ------------
              Total gross loans                                                  52,131,217              46,102,105

           Less - allowance for loan losses                                        (889,384)               (842,715)
                                                                               ------------            ------------

              Loans, net                                                       $ 51,241,833            $ 45,259,390
                                                                               ============            ============

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

                                                                                      Years Ended December 31,
                                                                                -----------------------------------
                                                                                   1997                    1996
                                                                               ------------            ------------
           Balance, beginning of year                                          $    842,715            $    763,318
           Provision charged to operations                                           88,333                  92,935
           Loans charged-off                                                        (48,690)                (84,239)
           Recoveries                                                                 7,026                  70,702
                                                                               ------------            ------------

              Balance, end of year                                             $    889,384            $    842,715
                                                                               ============            ============

                         (Notes continued on next page)

                                      F-15
</TABLE>


<PAGE>



NOTE 6 - LOANS (Continued)

         Loans on which the accrual of interest has been discontinued  amount to
$26,866 and $12,550 at December 31, 1997 and 1996, respectively.  If interest on
these loans had been  accrued,  such income would have  approximated  $3,545 and
$2,000 for 1997 and 1996,  respectively.  No interest  income was  recognized or
received on these loans in 1997 and 1996.


NOTE 7 - PREMISES AND EQUIPMENT

         Premises and equipment consist of the following:
<TABLE>
<CAPTION>
<S> <C>
                                                                                           December 31,
                                                                                -----------------------------------
                                                                                    1997                   1996
                                                                               ------------            ------------
               Land and improvements                                           $    252,829            $    161,168
               Buildings                                                          1,166,522                 673,631
               Leasehold improvements                                                 7,951                   7,951
               Equipment, furniture and fixtures                                  1,182,723                 994,434
                                                                               ------------            ------------
                                                                                  2,610,025               1,837,184
               Less - accumulated depreciation                                   (1,281,728)             (1,254,213)
                                                                               ------------            ------------

                                                                               $  1,328,297            $    582,971
                                                                               ============            ============

         Depreciation  charged to operating expense for the years ended December
31, 1997 and 1996 was $71,226 and $78,344, respectively.


NOTE 8 - DEPOSITS

         Interest bearing deposits consist of the following:

<CAPTION>
                                                                                             December 31,
                                                                                -----------------------------------
                                                                                   1997                     1996
                                                                               ------------            ------------
           Money Market and NOW account deposits                               $ 11,870,772            $ 12,278,300
           Savings deposits                                                       4,587,008               4,675,568
           Certificates of deposit $100,000 and over                              8,128,297               6,727,894
           Other time deposits                                                   35,308,624              32,245,984
                                                                               ------------            ------------

                                                                               $  59,894,701           $ 55,927,746
                                                                               =============           ============

         At  December  31,  1997 and  1996,  the  scheduled  maturities  of time
deposits are as follows:
<CAPTION>
                                                                                    1997                   1996
                                                                               ------------            ------------
           Maturing in less than one year                                      $ 37,195,696            $ 31,506,878
           Maturing in more than a year, but less than five years                 6,241,225               7,467,000
                                                                               ------------            ------------

                                                                               $ 43,436,921            $ 38,973,878
                                                                              =====================================
</TABLE>


                         (Notes continued on next page)

                                      F-16


<PAGE>



NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND SHORT-TERM
BORROWINGS

        Securities sold under  agreements to repurchase  generally mature within
one to four days from the transaction date.  Information  concerning  securities
sold under agreements to repurchase is summarized as follows:
<TABLE>
<CAPTION>
<S> <C>
                                                                                            December 31,
                                                                                -----------------------------------
                                                                                   1997                   1996
                                                                               ------------            ------------
           Average balance during the year                                     $  1,809,640            $     14,308
                                                                                ============           ============
           Average interest rate during the year                                       4.05%                   4.36%
                                                                                ===========            ============
           Maximum month end balance during the year                           $  2,555,645            $  1,349,091
                                                                                ===========            ============
</TABLE>
        Short-term  borrowings  consist of U.S.  Treasury  tax and loan  deposit
notes,  which are  payable  on demand  and fully  collateralized  by  investment
securities.

        The Bank is a member of the Federal  Home Loan Bank of  Atlanta.  One of
the benefits of membership is a borrowing  capacity of $5.9 million secured by a
blanket floating lien on the unpaid principal balance of the Bank's  one-to-four
unit  residential,  real estate loans. As of December 31, 1997, the Bank had not
borrowed any amounts on this line of credit.


NOTE 10 - STOCK COMPENSATION PLANS

        At December 31, 1997,  the Bank has fixed stock  compensation  plans for
its officers.  The Bank applies Accounting  Principles Board Opinion No. 25 (APB
25),  Accounting for Stock Issued to Employees,  and related  interpretations in
accounting for its plans. Accordingly,  no compensation cost has been recognized
for these plans  against  earnings.  For those  companies  applying APB 25, FASB
Statement No. 123,  Accounting for Stock-Based  Compensation,  requires  certain
pro-forma  disclosures  of net income  and  earnings  per share.  Net income and
earnings  per share  computed  under FASB  Statement  No. 123 do not  materially
differ from the amounts reported.

        All options have ten year terms,  vest and become fully  exercisable  in
three years. The option exercise price equals or exceeds the market price of the
stock as of the date the option was granted.  The  following is a summary of the
Bank's  stock  option  activity,  and  related  information  for the years ended
December 31,:
<TABLE>
<CAPTION>
<S> <C>
                                                           1997                                 1996
                                               ---------------------------            -------------------------
                                                                 Weighted-                            Weighted-
                                                                  Average                              Average
                                                                 Exercise                              Exercise
                                                  Options          Price               Options           Price
                                                  -------          -----               -------           -----
Outstanding - Beginning of year                   110,750          $7.39               110,750           $7.39
Granted                                                 -                -                   -               -
Exercised                                         (10,900)         6.79                      -               -
Forfeited                                               -                -                 -                 -
                                                  -------          -----               -------           -----
Outstanding - End of year                          99,850         $7.45                110,750           $7.39
                                                  =======         =====                =======           =====
Exercisable - End of year                          67,913           $6.87              61,875            $6.47
                                                  =======         =====                =======           =====
</TABLE>

                         (Notes continued on next page)

                                      F-17


<PAGE>



NOTE 11 - INCOME TAXES

        The principal components of income tax expense are as follows:
<TABLE>
<CAPTION>
<S> <C>

                                                                                       Years Ended December 31,
                                                                                -----------------------------------
                                                                                    1997                   1996
                                                                               ------------            ------------
        Federal income tax expense - current                                   $    479,492            $    222,599

        Deferred federal income tax expense (benefit)                               (39,758)                  4,578
                                                                               ------------            ------------

        Income tax expense                                                     $    439,746            $    218,021
                                                                               ============            ============

        Differences  between income tax expense calculated at the statutory rate
and that shown in the statements of income are summarized as follows:
<CAPTION>


                                                                                       Years Ended December 31,
                                                                                -----------------------------------
                                                                                    1997                   1996
                                                                               ------------            ------------
        Federal income tax expense - at statutory rate                         $    459,276            $    370,083
        Tax effect of:
           Tax exempt interest                                                      (21,003)                (49,475)
           Exercised stock options                                                   20,228                       -
           Other                                                                    (18,755)                 (5,112)
           Change in valuation allowance                                                  -                 (97,475)
                                                                               ------------            ------------

        Income tax expense                                                     $    439,746            $    218,021
                                                                               ============            ============


</TABLE>


                         (Notes continued on next page)

                                      F-18


<PAGE>



NOTE 11 - INCOME TAXES (Continued)

        The Company has the following deferred tax assets and liabilities at
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
<S> <C>
                                                                                    1997                   1996
                                                                               ------------            ------------
            Deferred tax assets:
               Deferred compensation                                           $     94,028            $     94,958
               Bad debts and other provisions                                       276,116                 195,588
               Other                                                                 15,886                   9,222
               Minimum tax credit carryforward                                         --                    12,997
                                                                               ------------            ------------

               Total deferred tax asset                                             386,030                 312,765
                                                                               ------------            ------------

            Deferred tax liabilities:
               Deferred loan fees                                                   (41,666)                (14,383)
               Discount accretion on securities                                     (17,300)                (11,723)
               Net unrealized appreciation on available-for-
                  sale securities                                                   (29,167)                (14,783)
               Fixed assets                                                         (21,101)                (20,454)
                                                                               ------------            ------------
                                                                                   (109,234)                (61,343)
                                                                               ------------            ------------

               Net deferred tax asset                                          $    276,796            $    251,422
                                                                               ============            ============
</TABLE>


NOTE 12 - COMMITMENTS AND CONTINGENCIES- RELATED PARTY

        The Company has entered into a long-term  lease with a related  party to
provide space for one branch and the Bank's  operations  center.  This lease has
been classified as an operating lease for financial reporting  purposes.  Future
minimum  lease  payments of $64,439 are required  each year for five years under
the long-term  non-cancellable  lease  agreement as of December 31, 1996,  which
expires in December,  2001.  Total lease expense was $64,440 and $75,810 for the
years 1997 and 1996, respectively.


NOTE 13 - OTHER RELATED PARTY TRANSACTIONS

        The Bank  has  loan and  deposit  transactions  with  its  officers  and
directors,  and with  companies  in which  the  officers  and  directors  have a
financial interest.  Related party deposits amounted to approximately $7,270,000
and $5,500,000 at December 31, 1997 and 1996, respectively.  All securities sold
under agreements to repurchase were transacted with related  parties.  A summary
of related party loan activity for Heritage Bank and Trust is as follows  during
1997:


Balance, December 31, 1996                      $  3,407,346
Originations - 1997                                1,767,508
Repayments - 1997                                 (1,067,609)
                                                ------------

Balance, December 31, 1997                      $  4,107,245
                                                ============


                         (Notes continued on next page)

                                      F-19


<PAGE>



NOTE 13 - OTHER RELATED PARTY TRANSACTIONS (Continued)

        In the opinion of Management, such loans are made in the ordinary course
of business at normal  credit  terms,  including  interest  rate and  collateral
requirements and do not represent more than normal credit risk.

        In  the  ordinary  course  of  business,  the  Company  has  engaged  in
transactions  with certain of its  directors'  companies for legal  services and
insurance.

        Commitments  to extend  credit and letters of credit to related  parties
amounted  to  $1,181,800   and   $1,166,800  at  December  31,  1997  and  1996,
respectively.


NOTE 14 - CREDIT COMMITMENTS AND CONCENTRATIONS OF CREDIT RISK

        The Bank has  outstanding  at any time a  significant  dollar  amount of
commitments to extend  credit.  To accommodate  major  customers,  the Bank also
provides  standby  letters  of credit and  guarantees  to third  parties.  Those
arrangements  are subject to strict credit control  assessments.  Guarantees and
standby letters of credit specify limits to the Bank's obligations.  The amounts
of loan commitments, guarantees and standby letters of credit are set out in the
following table as of December 31, 1997 and 1996.  Because many  commitments and
almost all standby letters of credit and guarantees  expire without being funded
in whole or in part,  the  contract  amounts  are not  estimates  of future cash
flows.  The majority of  commitments to extend credit have terms up to one year.
Interest rates on fixed-rate commitments range from 14% to 18%.
<TABLE>
<CAPTION>
<S> <C>

                                                             1997                              1996
                                             --------------------------------------------------------------------
                                               Variable Rate       Fixed Rate      Variable Rate     Fixed Rate
                                                Commitments       Commitments       Commitments      Commitments
                                                -----------       -----------       -----------      -----------

     Loan Commitments                          $  8,651,143      $  904,068        $  10,456,377    $  648,085

     Standby letters of credit and
        guarantees written                     $    100,000      $  223,166        $     124,133    $   24,240

     All of the guarantees outstanding at December 31, 1997 expire during 1998.
</TABLE>



                         (Notes continued on next page)

                                      F-20


<PAGE>



NOTE 14 - CREDIT COMMITMENTS AND CONCENTRATIONS OF CREDIT RISK (Continued)

        Loan commitments,  standby letters of credit and guarantees written have
off-balance-sheet  credit risk  because only  origination  fees and accruals for
probable losses, if any, are recognized in the statement of financial  position,
until  the  commitments  are  fulfilled  or the  standby  letters  of  credit or
guarantees  expire.  Credit risk  represents the  accounting  loss that would be
recognized at the reporting date if counterparties  failed completely to perform
as  contracted.  The credit risk amounts are equal to the  contractual  amounts,
assuming that the amounts are fully  advanced and that,  in accordance  with the
requirements  of  FASB  Statement  No.  105,  Disclosure  of  Information  about
Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with
Concentrations of Credit Risk,  collateral or other security is of no value. The
Bank's  policy  is to  require  customers  to  provide  collateral  prior to the
disbursement  of approved  loans.  For retail loans,  the Bank usually retains a
security  interest  in  the  property  or  products  financed,   which  provides
repossession rights in the event of default by the customer.  For business loans
and  financial  guarantees,  collateral  is usually in the form of  inventory or
marketable securities (held in trust) or property (notations on title).

        Concentrations  of credit risk (whether on or off balance sheet) arising
from financial  instruments exist in relation to certain groups of customers.  A
group concentration arises when a number of counterparties have similar economic
characteristics  that would cause their ability to meet contractual  obligations
to be similarly  affected by changes in economic or other  conditions.  The Bank
does not have significant  exposure to any individual  customer or counterparty.
The major concentrations of credit risk for the Bank arise by customer loan type
in relation to loans and credit commitments,  as shown in the following table. A
geographic   concentration   arises  because  the  Bank  operates  primarily  in
southeastern Virginia.
<TABLE>
<CAPTION>
<S> <C>

                                                                                  Installment
                          Residential       Commercial            Small               and
                           Property          Property            Business           Consumer             Total
                           --------          --------            --------           --------             -----
Loans and
receivables             $   19,389,572    $   16,293,967      $   9,595,316      $   6,852,$62       $  52,131,217
Credit
commitments                 2,707,313            296,471          4,002,079          2,872,514           9,878,377
                        --------------    --------------      -------------      -------------       -------------

                        $   22,096,885    $   16,590,438      $   13,597,395     $   9,724,$76       $  62,009,594
                        ==============    ==============      ==============     =============       =============
</TABLE>
        The credit risk amounts represent the maximum accounting loss that would
be recognized  at the  reporting  date if  counterparties  failed  completely to
perform as contracted and any  collateral or security  proved to be of no value.
The  Bank  has  experienced  little  difficulty  in  accessing  collateral  when
required. The amounts of credit risk shown,  therefore,  greatly exceed expected
losses, which are included in the allowance for loan losses.








                         (Notes continued on next page)

                                      F-21


<PAGE>



NOTE 15 - REGULATORY MATTERS

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

         Quantitative  measures  established  by  regulation  to ensure  capital
adequacy  require the Bank to maintain  minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the  regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as  defined).  Management  believes,  as of December 31, 1997,  the Bank
meets all capital adequacy requirements to which it is subject.

         As of September 30, 1996, the most recent notification from the Federal
Reserve  Bank of Richmond  categorized  the Bank as well  capitalized  under the
regulatory  framework for prompt  corrective  action.  To be categorized as well
capitalized,   the  Bank  must  maintain  minimum  total  risk-  based,  Tier  I
risk-based,  and Tier I leverage ratios as set forth in the table.  There are no
conditions  or events since that  notification  that  management  believes  have
changed the institution's category.

         The Bank's actual capital  amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
                                                                                                To Be Well
                                                                                             Capitalized Under
                                                                      For Capital            Prompt Corrective
                                               Actual               Adequacy Purposes         Action Provisions
                                        -------------------         -----------------         -----------------
                                        Amount        Ratio         Amount     Ratio         Amount      Ratio
                                        ------        -----         ------     -----         ------      -----
<S> <C>
As of December 31, 1997:
   Total Capital
   (to Risk-Weighted Assets)          $ 7,663,000     15.07%     $ 4,068,000   8.00%      $ 5,085,000    10.00%
   Tier I Capital
   (to Risk-Weighted Assets)          $ 7,024,000     13.81%     $ 2,034,000   4.00%      $ 3,051,000     6.00%
   Tier I Capital
   (to Average Assets)                $ 7,024,000      8.63%     $ 3,255,000   4.00%      $ 4,069,000     5.00%

</TABLE>





                         (Notes continued on next page)

                                      F-22


<PAGE>



NOTE 15 - REGULATORY MATTERS (Continued)
<TABLE>
<CAPTION>


                                                                                                To Be Well
                                                                                             Capitalized Under
                                                                      For Capital            Prompt Corrective
                                               Actual               Adequacy Purposes         Action Provisions
                                        -------------------         -----------------         -----------------
                                        Amount        Ratio         Amount     Ratio         Amount      Ratio
                                        ------        -----         ------     -----         ------      -----
<S> <C>
As of December 31, 1996:
   Total Capital
   (to Risk-Weighted Assets)          $ 6,650,000    14.70%      $ 3,618,000    8.00%      $ 4,523,000  10.00%
   Tier I Capital
   (to Risk-Weighted Assets)          $ 6,081,000    13.44%      $ 1,809,000    4.00%      $ 2,714,000   6.00%
   Tier I Capital
   (to Average Assets)                $ 6,081,000     8.57%      $ 2,839,000    4.00%      $ 3,548,000   5.00%
</TABLE>

        There is no  significant  difference  between the Bank's  actual  ratios
disclosed above, and the related actual ratios of the Company.


NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS

        The following table presents the carrying  amounts and fair value of the
Bank's  financial  instruments at December 31, 1997 and 1996. FASB Statement No.
107,  Disclosures  about Fair Value of Financial  Instruments,  defines the fair
value of a financial  instruments as the amount at which the instrument could be
exchanged in a current  transaction  between  willing  parties,  other than in a
forced or liquidation  sale.  The carrying  amounts in the table are included in
the balance sheet under the indicated captions.
<TABLE>
<CAPTION>
<S> <C>
                                                        1997                               1996
                                                ----------------------             ----------------------
                                                Carrying       Fair                Carrying       Fair
                                                 Amount        Value                Amount        Value
                                                ---------     --------             ---------    ---------
                                                (Dollars in thousands)             (Dollars in thousands)
Financial Assets:
        Cash and cash equivalents               $   5,716     $  5,716             $   8,994    $   8,994
        Loans (net)                                51,242       52,688                45,259       45,719
        Investment securities                      22,595       22,641                20,196       20,193
        Accrued interest receivable                   692          692                   535          535

Financial Liabilities:
        Deposit liabilities                        72,797       73,049                68,427       68,678
        Accrued interest payable                      342          342                   291          291
        Short-term borrowings                          52           52                   131          131
        Securities sold under
          agreements to repurchase                  1,945        1,945                 1,349        1,349

</TABLE>




                         (Notes continued on next page)

                                      F-23


<PAGE>



NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

        Estimation of Fair Values

        The following notes summarize the major methods and assumptions  used in
estimating the fair value of financial instruments:

        Short-term  financial  instruments are valued at their carrying  amounts
included in the Bank's  balance sheet,  which are  reasonable  estimates of fair
value due to the relatively  short period to maturity of the  instruments.  This
approach  applies  to cash  and cash  equivalents,  short-term  borrowings,  and
securities sold under agreements to repurchase.

        Loans are valued on the basis of estimated  future receipts of principal
and  interest,  which are  discounted at various  rates.  Loan  prepayments  are
assumed to occur at the same rate as in previous  periods  when  interest  rates
were at levels  similar to current  levels.  Future  cash flows for  homogeneous
categories of consumer  loans,  such as motor vehicle loans,  are estimated on a
portfolio  basis and  discounted at current rates offered for similar loan terms
to new  borrowers  with similar  credit  profiles.  The fair value of nonaccrual
loans also is estimated on a present value basis,  using higher  discount  rates
appropriate to the higher risk involved.

        Investment  securities  are valued at quoted market prices if available.
For unquoted securities, the fair value is estimated by the Bank on the basis of
financial and other information.

        The fair value of demand deposits and deposits with no defined  maturity
is taken to be the amount  payable  on demand at the  reporting  date.  The fair
value of fixed - maturity  deposits is estimated using rates  currently  offered
for deposits of similar remaining maturities.  The intangible value of long-term
relationships  with  depositors is not taken into account in estimating the fair
values disclosed.

        The carrying amounts of accrued interest approximate fair value.

        It is not  practicable  to  separately  estimate  the  fair  values  for
off-balance-sheet  credit  commitments,  including standby letters of credit and
guarantees  written,  due to the  lack of cost  effective  reliable  measurement
methods for these instruments.






                         (Notes continued on next page)

                                      F-24


<PAGE>


NOTE 17 - EARNINGS PER SHARE RECONCILIATION

        The following is a reconciliation  of the numerators and denominators of
the basic and diluted earnings per share computations.
<TABLE>
<CAPTION>

                                                                                    1997                   1996
                                                                               ------------            ------------
<S> <C>
Net income (numerator, basic and diluted)                                      $    979,970            $    870,458

Weighted average shares outstanding (denominator)                                   790,450                 784,150
                                                                               ------------            ------------

        Earnings per common share-basic                                        $       1.24            $       1.11
                                                                               ============            ============

Effect of dilutive securities:

Weighted average shares outstanding                                            $    790,450            $    784,150
Effect of stock options                                                              46,470                  16,249
                                                                               ------------            ------------
Diluted average shares outstanding (denominator)                                    836,920                 800,399
                                                                               ------------            ------------

        Earnings per comon share-assuming dilution                             $       1.17            $       1.09
                                                                               ============            ============
</TABLE>




                                      F-25